Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Tracy Allaway and I'm Joe. Wisn'tal so, Joe? I
Speaker 1: was in New York with you in early September, wasn't I?
Speaker 1: We did the Odd Thoughts Live show. That was early September. Yes,
Speaker 1: I think it was. That already seems like a really
Speaker 1: long time ago to me, but yeah, that was really
Speaker 1: fun and we had a great, a great lineup of
Speaker 1: guests and it was it was just it was absolutely perfect.
Speaker 1: I wouldn't have changed one thing about the lineup of
Speaker 1: guests that we had. Then. Uh, there was one thing
Speaker 1: that I would have changed, which is that we were
Speaker 1: due to have Sultan Posar on one of the panels
Speaker 1: and unfortunately get to drop out a couple of days
Speaker 1: before for a sort of last minute commitment. But the
Speaker 1: reason it would have been great to have him there
Speaker 1: was because something big happened in the market that same week, right,
Speaker 1: So I was just trolling a little bit. I agree
Speaker 1: with you. That would have been the one change that
Speaker 1: would have been the one thing that would have made
Speaker 1: it absolutely perfect. And of course what you're referring to
Speaker 1: was the tantrum or I'm not sure what we were,
Speaker 1: what word we're using to describe it, but the sort
Speaker 1: of craziness, the rebo madness of early September was right
Speaker 1: around that time, and of course Sulton is by many
Speaker 1: people considered to be the pre eminent expert on in
Speaker 1: this area. Right also a former Odd Thoughts guest, and
Speaker 1: I should just back into this a little bit. So
Speaker 1: Zoltan pos Our, former advisor to the U. S. Treasury Department,
Speaker 1: now a strategist at Credit Swiss, and he's been writing
Speaker 1: a lot about the repo market. In fact, you know,
Speaker 1: just four or so weeks before we had that rebo
Speaker 1: madness incident, and this was where short term borrowing rates
Speaker 1: in the money market suddenly surge. Four weeks before that
Speaker 1: actually happened, Zulton had been writing again some eerily prophetic things,
Speaker 1: like he actually wrote in a piece of August research
Speaker 1: that the funding pressures that Credit Swiss is forecasting include
Speaker 1: overnight general collateral repo rates drifting outside the FEDS target band.
Speaker 1: And that is exactly what happened. I remember, and I'm
Speaker 1: not just saying this because he's here in studio and
Speaker 1: we're about to talk to him, but I remember even
Speaker 1: before I noticed. I remember the day that the rates
Speaker 1: shot up. I didn't even notice it until some trader
Speaker 1: at a bank I beat me on my Bloomberg and said,
Speaker 1: are you watching what's going on in the repo market.
Speaker 1: It's exactly what Alton predicted. And that was the first
Speaker 1: Then I went and looked. That was my first, uh,
Speaker 1: my first indication that something was amiss. Someone alerting me
Speaker 1: in that way. That's how that's how closely his research
Speaker 1: is tied to we've seen in people's minds in the market. Yeah,
Speaker 1: Sultan is at one with the repo market and uh,
Speaker 1: money market crunches. Again, just to provide a bit of background,
Speaker 1: So what we actually saw on that day was rebo rates, uh,
Speaker 1: the cost basically of making secured overnight collateralized loans. Those
Speaker 1: repo rates jumped from I think it was about two
Speaker 1: percent to something like ten and lots of people had
Speaker 1: talked about the possibility of a funding squeeze, especially around
Speaker 1: quarter ends, which is where we get these sort of
Speaker 1: traditional crunch points in the financial systems because big banks
Speaker 1: have to pull back on their rebo financing ahead of
Speaker 1: quarterly liquidity requirements and other regulations. But far far fewer
Speaker 1: people had expected it to happen at this sort of
Speaker 1: random juncture in time, this slightly random week in September,
Speaker 1: so again it was really unusual. It spooked quite a
Speaker 1: few people and everyone immediately he said, we must speak.
Speaker 1: Resulting coodes are absolutely and it's important to remember too
Speaker 1: that when people see this stuff, everyone has sort of
Speaker 1: still after all these years post crisis PTSD, and you
Speaker 1: look at bank overnight funding costs and they're soaring from
Speaker 1: two to ten percent in a day, And of course
Speaker 1: a big debate immediately broke out. Is this something strictly
Speaker 1: about financial market plumbing or is there something deeper and
Speaker 1: more systemic at play that sort of speaks to some
Speaker 1: inherent frailty of the financial system. And obviously things have
Speaker 1: quieted down quite a bit since then, but nonetheless I
Speaker 1: think you know, they're still people are still unsettled, and
Speaker 1: no one really knows what the ultimate fix is going
Speaker 1: to be. The Fed is applied temporary fixes, greater expanding
Speaker 1: its a supply of reserves uh or overnight operations to
Speaker 1: satisfy the bank demand for this short term liquidity, but
Speaker 1: no one really knows where this is ultimately headed. It
Speaker 1: seems right, So I'd say it's actually debatable whether or
Speaker 1: not things have calmed down in the repo market. But
Speaker 1: why don't we just jump straight into the discussion with
Speaker 1: Zoltan and we'll be able to get into all of
Speaker 1: these really really interesting and fascinating questions. So, Sultan Postar,
Speaker 1: thank you so much for coming on yet again. Very
Speaker 1: nice to be here. So let's start off with that
Speaker 1: week in September. Presumably you're sat in Credit Swiss, maybe
Speaker 1: watching overnight market rates as you do. What are you
Speaker 1: thinking when you start to see the repo rate jump
Speaker 1: like it did. Well, Actually, I wasn't in Credit Swiss
Speaker 1: the day of this happening. I was actually traveling down
Speaker 1: to the See to see some clients with one of
Speaker 1: our sales guys. And you know, we saw the markets
Speaker 1: open up and you're chatting in the cafe cars and okay,
Speaker 1: well Monday wasn't good. Tuesday's shaping up to be worse.
Speaker 1: And I'm not kidding. Five minutes into that train ride,
Speaker 1: the train broke down and we were basically told to
Speaker 1: have to get off the train and there's going to
Speaker 1: be another train coming. You have to call the client.
Speaker 1: That's sort of but the train is running late. And
Speaker 1: then the FEDER announced the REPO operations. But then the
Speaker 1: FED was late with the first operation due to technical glitches.
Speaker 1: And I looked at Phil, the sales guy, and I
Speaker 1: told him, look, I'm in the country. Is funding itself
Speaker 1: overnight in the repo market the trains don't run and
Speaker 1: the fense do an operation on times it has to
Speaker 1: be has to be a joke or about some sorts.
Speaker 1: But the September blowout was, you know, it took many
Speaker 1: people by surprise. UM. I think a lot of people
Speaker 1: focus on what happened and they kind of look for
Speaker 1: the trigger that triggered it on that day, and I
Speaker 1: think that's actually the wrong question, on the wrong thing
Speaker 1: to focus on. The September blowout in the report market
Speaker 1: was a long time in the making. What it had
Speaker 1: to do with is basically taper, and taper was just
Speaker 1: very slow burning process where you know, the fat took
Speaker 1: more and more reserves out of the system, and when
Speaker 1: when the system ran out of liquidity, which in this
Speaker 1: specific case means you know, reserves that the system can
Speaker 1: settle with. You know, the moment you ran out of
Speaker 1: ran out of those reserves, the repal market seized up.
Speaker 1: So this was basically a six billion dollar process, which
Speaker 1: is how much the fat tapered. The one thing that
Speaker 1: was very important to watch is basically look at who
Speaker 1: are the most reserves rich banks, how much reserves they
Speaker 1: have lost as the FED was tapering the balance sheet
Speaker 1: and what is the body language of banks CEOs and
Speaker 1: banks CFOs and when you listen to them during earning
Speaker 1: scolls as to what is the minimum number of reserves
Speaker 1: that they need to hold from a business perspective, you know,
Speaker 1: the largest bank that held them most amount of reserves,
Speaker 1: JP Morgan during the stapor process has gone from having
Speaker 1: three dollars of reserves at the FED two hundred and
Speaker 1: spenty billion as of the end of the second quarter
Speaker 1: of this year. And so when you saw that number,
Speaker 1: you knew that the bank that was always the lender
Speaker 1: of next less resorts in the repo market basically ran
Speaker 1: out of money. So let's back up, just for people
Speaker 1: that maybe aren't as familiar with some of the terminology
Speaker 1: or even the structure of the banking system and the
Speaker 1: hopes that they can understand this topic. When you or
Speaker 1: I have our money held at a bank, we have
Speaker 1: a deposit. The reserves are essentially where banks deposit their
Speaker 1: money at the FED and the there's a fixed amount
Speaker 1: of reserves available, and that greatly expanded during the financial
Speaker 1: crisis thanks to quantitative easing. Essentially the FED going out
Speaker 1: and buying safe assets like treasuries or mortgage backed securities
Speaker 1: with reserves, and then it's starting to shrink them as
Speaker 1: part of the taper process. And essentially what happened or
Speaker 1: what's going on is the shrinking of the balance sheet
Speaker 1: collided with regulatory requirements on banks to hold a certain
Speaker 1: yes amount of reserves at the FED. To explain this
Speaker 1: sort of collision of arguably different arms of the government
Speaker 1: make imposing different demands on the Okay, so let's let's
Speaker 1: start with um two observations. Number one. You know, the
Speaker 1: payment system used to be used to be no longer
Speaker 1: is used to be a credit system, which basically means
Speaker 1: that pre crisis, you know, when banks make payments between
Speaker 1: each other and they transfer money from one bank's reserve
Speaker 1: account to another bank's reserve account, you know, it used
Speaker 1: to be the case that banks would go into a
Speaker 1: negative balance in their reserve accounts at the FED. So
Speaker 1: that's the whole intraday credit provision that the FED used
Speaker 1: to provide to the system, which basically ensured that payments
Speaker 1: between banks never bounce. Okay, if there's not enough money
Speaker 1: in your reserve account, the FED is going to put
Speaker 1: in the right amount of money so that payments can settle,
Speaker 1: and then that intraday credit provision by the FED gets
Speaker 1: pushed into the overnight markets used to be the overnight
Speaker 1: FED funds market, and that's the way the banks settled
Speaker 1: UH those claims at night. Post crisis and post Basil three,
Speaker 1: there is no bank that is ever going to use
Speaker 1: intraday credit from the FED, because if you were to
Speaker 1: use intraday credit, it means that you are in severe
Speaker 1: breach of your liquidity coverage ratio or your introdict liquidity
Speaker 1: requirements and all that stuff. So, quite literally, post Basil three,
Speaker 1: the system settles with the amount of reserves that are
Speaker 1: in the system, so there's nobody who's taking cash from
Speaker 1: the FED on the margin. Then you look at the
Speaker 1: amount of reserves that are in the system. The distribution
Speaker 1: of those reserves UH is not equal. Some banks hold more,
Speaker 1: some banks hold less, But basically the banks that have
Speaker 1: the abundance of reserves, the reserves rich banks, they are
Speaker 1: the ones that are lending into the system's settlement process
Speaker 1: on the margin. So in English, you bent from the
Speaker 1: Fed adding liquidity into the system on the margin so
Speaker 1: that payments can settle. Two and this is no secret
Speaker 1: um writing about this all the time, to JP Morgan
Speaker 1: basically using its hbo A portfolio to take their excess liquidity,
Speaker 1: high quality, high quality liquid assets. Again, most of US
Speaker 1: two years ago was reserves, taking that money and lending
Speaker 1: it into the report market or whichever corner of the
Speaker 1: funding markets such that payments can happen. Okay, So basically
Speaker 1: you went from the FED providing introduting liquidity in the
Speaker 1: system to JP Morgan and other reserved RISH banks. But
Speaker 1: again JP Morgan is the largest example providing introduce credit
Speaker 1: UH in the system on the margin. What has happened
Speaker 1: is that as you taper the balance sheet, you basically
Speaker 1: took reserves away from the system. Quite literally, you basically
Speaker 1: forced UH these large reserves rich banks to trade out
Speaker 1: of reserves, and there's collateral coming in cash being taken out.
Speaker 1: On top of it, the FED is basically cutting the
Speaker 1: interest on reserves rate trying to encourage all these reserves
Speaker 1: rich banks to let go of their reserves and reverse
Speaker 1: in more collateral by treasuries, and by by that process
Speaker 1: they are forcing a redistribution of reserves across the system.
Speaker 1: But as they were forcing that change, they basically uh
Speaker 1: flattened the distribution of reserves. They basically um forced the
Speaker 1: large bank to spend their reserves such that repo trades
Speaker 1: normal on any given day. But then basically the flip
Speaker 1: side of that was that they exposed the system two
Speaker 1: very bad days in the report market, on tough days
Speaker 1: when a lot of money has to move. We'll come
Speaker 1: back to that in a second, and quarter ends and
Speaker 1: on your ends. So a lot of people just on
Speaker 1: the reserve point. Then it's at a lot of people
Speaker 1: have been debating the language around this. Is it a
Speaker 1: scarcity of bank reserves or a shortage? And why does
Speaker 1: the difference between the two actually matter. I don't think
Speaker 1: there's a difference. I mean it's a shortage. Basically, what
Speaker 1: I'm saying is that the system ran out of tokens
Speaker 1: to settle this right, because again back to the earlier point,
Speaker 1: the FED was always ready in the past to add
Speaker 1: reserves into the system on the margin intraday as needed. Okay,
Speaker 1: So it was never possible to run out of reserves.
Speaker 1: But in this regime where the FED had x amount
Speaker 1: of reserves in the system and nobody is going to
Speaker 1: take credit from the FED, you literally the system literally
Speaker 1: settles with the amount of reserves that are in the system.
Speaker 1: So if the bank that has the access and is
Speaker 1: lending into into the system and the margin runs out
Speaker 1: of that money runs out of reserves, the system literally
Speaker 1: seizes up because you run out of tokens. What was
Speaker 1: the regulatory logic, as you mentioned the Botel three requirements,
Speaker 1: what is the regulatory logic of no longer wanting the
Speaker 1: banks to be able to essentially have overdraft capabilities or
Speaker 1: use overdraft capabilities at the FED. I don't think that
Speaker 1: there is a piece of regulation that says, you know,
Speaker 1: don't take it, or the FED never said that I
Speaker 1: will never give it. I think it's just, you know,
Speaker 1: if if every bank has to like the LCR for example,
Speaker 1: licuity coverage ratio tells that every bank has to pre
Speaker 1: fund thirty days worth of outflows, Okay, so every bank
Speaker 1: is going to be thirty days pre funded. Okay, So
Speaker 1: no one is going to be in the funding markets
Speaker 1: to kind of get the liquority to be able to settle, okay,
Speaker 1: And this is actually a very important question you're asking, right,
Speaker 1: So the banks don't have a liquality problem here, right,
Speaker 1: All that has happened is that, you know, the banks
Speaker 1: have been the marginal lenders into the report market. So
Speaker 1: the entities that ended up with a liquidity problem or
Speaker 1: the dealers, but basically for the past year it were
Speaker 1: the banks that were the marginal lenders in the report market.
Speaker 1: But the banks are only going to lend into the
Speaker 1: report market on the margin until they reach a limit
Speaker 1: in terms of how much reserves they have to hold
Speaker 1: at the FED and below which they are unwilling to
Speaker 1: go okay. So this was basically a liquidity problem for
Speaker 1: the dealer community. And the problem at a higher level
Speaker 1: was that the banks, despite having the liquidity, were unable
Speaker 1: to lend more into the report market because if they
Speaker 1: were to be lending more, they would breach their intra
Speaker 1: day liquidity requirements. It's just it's just one of those
Speaker 1: unintended consequences where it's just one of the unintended consequences
Speaker 1: of the rules where where everybody basically wants to show,
Speaker 1: you know, how much liquidity they have to the Fed,
Speaker 1: and they are unwilling to go below that because then
Speaker 1: there is regulatory scrutiny to pay. So just just up
Speaker 1: back for a second, because this question comes up quite
Speaker 1: a lot. But if you're not in the money markets,
Speaker 1: sort of in the weeds of a lot of this,
Speaker 1: why should you care about what happened to the repo
Speaker 1: market in September? And I mentioned, you know, for instance,
Speaker 1: the effective federal funds rate getting pulled up along with
Speaker 1: repo rates. Is that the big sort of takeaway from
Speaker 1: this that the Fed sort of briefly lost control of
Speaker 1: money market rates or monetary policy, or however you want
Speaker 1: to put it. I don't know. I think it's I
Speaker 1: think it's something far bigger. So why does this matter?
Speaker 1: You know, it's an overnight rate? I tweeted, By the way,
Speaker 1: I said, what should we ask? Assulton? That that was
Speaker 1: this was by far the most common question. It's like,
Speaker 1: it's interesting, but why should we care? So? Repo is
Speaker 1: how you get to live to fight another day. Okay,
Speaker 1: so that's not my meme, that's, you know, coming from
Speaker 1: Perry Merlin. Yeah, but again. Repo is how you get
Speaker 1: to live to fight another day. It's very What that
Speaker 1: means is you go to the overnight rebol market because
Speaker 1: you run out of money. You can't make payments today,
Speaker 1: payments that are due today. So on the margin, you
Speaker 1: go and try to get some money so that you
Speaker 1: can make a payment today and you pay that money
Speaker 1: back tomorrow to someone. If you can't borrow in the
Speaker 1: repo markets and you can't get the cash to make
Speaker 1: your payments today, you're not going to open up tomorrow, okay.
Speaker 1: So if you are an RV fund that needs to
Speaker 1: roll funding on its position, if you are a primary
Speaker 1: dealer and you can't fund to roll your positions and
Speaker 1: top up your clearing account that at your clearing bank.
Speaker 1: If you're a small dealer that can't fund, you're right
Speaker 1: of business tomorrow. So that is why you basically care
Speaker 1: about this stuff. You know, It's like when you look
Speaker 1: at on electric cardiogram and the heart ticks. You know,
Speaker 1: it takes ticks ticks, and it doesn't take and it
Speaker 1: starts to beep. So it's something like that either ticks
Speaker 1: or it doesn't tick. So it's existential. You know, when
Speaker 1: you see these rates at ten percent, it means that
Speaker 1: people are having a hard time getting the money to
Speaker 1: make payments. U S Treasury is having a hard time
Speaker 1: pumping treasuries into the system on settlement days, you know,
Speaker 1: the money is not moving to the Treasury general account
Speaker 1: because people are not bidding to part with their money.
Speaker 1: In this case, the large banks run out of reserves,
Speaker 1: so the money ain't going to the US Treasury. So
Speaker 1: quite frankly, you know, if you need to pay unemployment
Speaker 1: insurance benefits and food stems and all that stuff, the
Speaker 1: funding of that stuff process gets comed up. So this
Speaker 1: is this is this is serious stuff. And you know
Speaker 1: the reason why the FED response to these things quickly.
Speaker 1: I mean, they could have responded quicker, but the reason
Speaker 1: why they respond to it quickly is because, you know,
Speaker 1: they just recognize the nature of these overnight markets where
Speaker 1: the money doesn't flow, people can't pay, people can't pay,
Speaker 1: they go out of business. Headlines can happen, right, you know.
Speaker 1: The the good thing was that, you know, this dislocation
Speaker 1: didn't last for more than a day. If these these
Speaker 1: locations go on for two days, three days a week,
Speaker 1: it can turn into an existential problem for a lot
Speaker 1: of people. So another thing that I've been wondering just
Speaker 1: on the idea of the FED having to come in
Speaker 1: and sort of swoop in and fix this problem as
Speaker 1: soon as possible, although as you point out, it could
Speaker 1: have been faster and they did have technical difficulties when
Speaker 1: they first tried to do it. How much of the
Speaker 1: confusion or the fact that reboat rates actually got to
Speaker 1: ten percent, how much of that do you think had
Speaker 1: to do with Simon Potter having recently left the New
Speaker 1: York Fed? And also, actually I've always wondered this, but
Speaker 1: do you ever talked to the FED about these issues?
Speaker 1: Do do they, you know, talk to you about your
Speaker 1: thoughts on this? But for the record, in five years,
Speaker 1: I've seen them once two years ago it was any
Speaker 1: other question. I don't think so, I think. I think
Speaker 1: again it's you know, I guess the the the message
Speaker 1: would be that, you know, Taper, I guess was a mistake.
Speaker 1: So the difference between the report market printing normally like
Speaker 1: it has been for the past five years versus the
Speaker 1: report market falling apart on December thirty one of last
Speaker 1: year early September this year, it's basically those six billion
Speaker 1: dollars of reserves that were taken out of the system
Speaker 1: by Taper. So if you look at the usage of
Speaker 1: the reverse report facility the other report facility, right, you know,
Speaker 1: that's the facility where money go os when that money
Speaker 1: is not needed because there is not enough collateral. People
Speaker 1: don't have the balance sheet, there's not eno farbitrash opportunities,
Speaker 1: so nobody takes the money from the money funds and
Speaker 1: on the money funds put it at the FED, and
Speaker 1: then money goes there to die. It's very important to
Speaker 1: to kind of realize that Taper started when the usage
Speaker 1: of that facility was zero. That means that you know,
Speaker 1: lazy cash in the system was already gone when Taper started.
Speaker 1: So all these you know, Taper and increase in treasuries,
Speaker 1: cash penancies, the increase in the foreign report pool was
Speaker 1: basically taking money out of bank hql A portfolios is
Speaker 1: your liquidity portfolios of the banks, and it was taking
Speaker 1: reserves out of the portfolios of JPMorgan and all the
Speaker 1: other large American banks. So basically, you know in English,
Speaker 1: that means that Taper was taking the liquidity buffer away
Speaker 1: from the system. That basically ensured that these large banks
Speaker 1: have the extra cash to lend in to periodic these
Speaker 1: locations in the report market and in the FX market
Speaker 1: and all all sorts of other markets. So the fact
Speaker 1: that we engineered taper and we tapered as much as
Speaker 1: fast as we did without the safety valve built into
Speaker 1: the process where if God forbid to we take out
Speaker 1: too much reserves, we should have a facility to kind
Speaker 1: of put as much liqurity back into the system as
Speaker 1: as as needed, right and let that the usage of
Speaker 1: that facility speak loud that taper should stop. We didn't
Speaker 1: do that. So back to your other question, I think
Speaker 1: the problem is that we tapered this much, this fast,
Speaker 1: So it was kind of a architectural mistake. So personnel changes,
Speaker 1: I would say, have nothing to do with, you know,
Speaker 1: the blowout and the response to that blowout the day
Speaker 1: of I think it has to do more with why
Speaker 1: did we end up in this position in the first place.
Speaker 1: And by the way, when you when you listen to
Speaker 1: you to the FED throughout the whole taper episode, you know,
Speaker 1: when you read those speeches, the indicators that the FED
Speaker 1: was looking at to see if things are getting tight
Speaker 1: or if you should stop taper, we're the wrong things
Speaker 1: to look at the feed was looking for banks use
Speaker 1: of introday credit force for signs of stress to show up.
Speaker 1: You know, earlier in the conversation we said that there's
Speaker 1: no bank that is ever going to use introduce credit
Speaker 1: from the FED post Bossal tree because it's not worth
Speaker 1: the reputational risk. Nobody wants to be the first one
Speaker 1: to use it. Nobody wants to be the person to
Speaker 1: max out the the lines. And if people were to
Speaker 1: use it, you know, no one's going to be willing
Speaker 1: to kind of let those things faster and be rolled
Speaker 1: into the UH the risk can been though, So basically
Speaker 1: I think I think you had the wrong things they
Speaker 1: were looking at, and and they they tapered way too much,
Speaker 1: pay too fast, and they put the system into a
Speaker 1: precarious position. And again the conditions for what happened in
Speaker 1: the ripple market in September. We're building over time as
Speaker 1: they were shrinking the balance sheet. It's almost like a
Speaker 1: wildfire where you have all these dry leaves accumulate and
Speaker 1: then something that happens, and then a wildfire gets really
Speaker 1: bad because because the dry leaves accumulated over over the time.
Speaker 1: You mentioned something there that speaks to the last time
Speaker 1: you appeared on our show, and that relates to the
Speaker 1: role of a foreign participants in the market. We just
Speaker 1: did an episode actually with Brad Setser and which we
Speaker 1: talked about Taiwanese life insurers and their thirst for dollar
Speaker 1: denominated assets. I think it was what we talked about.
Speaker 1: I think it was back in April or May, was
Speaker 1: the last time we talked to you, and it was
Speaker 1: kind of about this topic and that as rates on
Speaker 1: dollar denominated assets, particularly treasuries, were coming down, there was
Speaker 1: less appeal to hold US government debt and that it
Speaker 1: made more sense for foreign buyers to essentially just have
Speaker 1: money at the federal reserve, leaving all these treasuries on
Speaker 1: the dealer balance sheets. Talk to us about this aspect
Speaker 1: of the repo crunch. How much of it is essentially
Speaker 1: a result of what you were talking about when we
Speaker 1: talked to you in the spring, about the fact that
Speaker 1: normally these foreign buyers would be in the government bond market,
Speaker 1: but when raids got too low, it just didn't make
Speaker 1: any sense. So on I just hold the money right
Speaker 1: at the Fed, exacerbating the reserve shortage. Yeah, so you know,
Speaker 1: rave gets too low, and the other important thing is
Speaker 1: that the curve inverted. Right, So that's what we talked
Speaker 1: about last time. It has a lot to do with it,
Speaker 1: right because if you think about what the world used
Speaker 1: to look like too three years ago, when Japan and
Speaker 1: Taiwan and all those Asian accounts are buying more, I
Speaker 1: mean they're still buying, but not as much and definitely
Speaker 1: not enough preductive to supply. The theme in the money
Speaker 1: markets back then was that, you know, Asia, Asia is buying,
Speaker 1: they have to hedge it back to yen, you know,
Speaker 1: to euros and other currencies, and they typically do the
Speaker 1: three month points. So you buy, attend your treasury, you
Speaker 1: hedge it back and roll those hedges every three months.
Speaker 1: So that's a pressure on three month funding costs. Now,
Speaker 1: libor widened sixty basis points around money funder form, which
Speaker 1: also coincided with that with the time in markets, cross
Speaker 1: currency bases between yen and dollars widened as much as
Speaker 1: a hundred basis points. Very interestingly, the Fed didn't care
Speaker 1: one bit about the so called oys oys basis blowing
Speaker 1: out to a hundred basis points between yen and dollars
Speaker 1: I mean English, but that means basically that parity between
Speaker 1: term funding on shore and term dollar funding in Tokyo
Speaker 1: completely broke down, you know. So people in Tokyo were
Speaker 1: paying a hundred basis points over for dollars at the
Speaker 1: three month point, then people on shore here in New York.
Speaker 1: That was kind of a big deal, but you had
Speaker 1: no speeches about it, no blogs, no papers, no nothing.
Speaker 1: You know, when three month funding costers are stressed in
Speaker 1: the fex S pop market, right as a dealer, you
Speaker 1: can lend into that demand by borrowing in UH at
Speaker 1: the three month point. Also in the fex S pop
Speaker 1: market in its unsecured markets, secured markets, or you can
Speaker 1: borrow not at the three month point, but at the
Speaker 1: one month point, the one week point, the overnight point.
Speaker 1: So the point here is that you know, the dominant
Speaker 1: bid for funding is at the three month point. The
Speaker 1: funding of that of that borrowing need can be distributed
Speaker 1: along a three month stretch in money markets going from
Speaker 1: overnight to three months. So overnight markets are going to
Speaker 1: kind of feel this stuff, but only a part of it,
Speaker 1: a little part of it. When a curve gets inverted, okay,
Speaker 1: And as we discussed last time, all the carry traders
Speaker 1: get knocked away on the margin. So the foreign hedge
Speaker 1: buyer is not buying as much as the foreign banks
Speaker 1: are not buying as much. The r V hedge funds
Speaker 1: can buy as there's one group of entities that has
Speaker 1: to buy by law. Those are the primary dealers. So
Speaker 1: the dealers started to back up with inventory. But the
Speaker 1: dealers are in the moving business, they are not in
Speaker 1: the carey business. So dealer is never going to term
Speaker 1: fund its inventory. Uh, they tend to fund it overnight
Speaker 1: and roll it overnight. And here's the important point. When
Speaker 1: the dealer is the marginal buyer of treasuries and they
Speaker 1: fund things overnight, the only way you can fund it
Speaker 1: overnight funding demand is overnight. You can't you can't go anywhere.
Speaker 1: I mean, you're not gonna, you know, fund an overnight
Speaker 1: funding demand with like the three month point because you know,
Speaker 1: if the fat cuts and you're in a bad position.
Speaker 1: So everything over the past year in fixed income markets,
Speaker 1: in money markets was funded at the overnight point. And
Speaker 1: that's a dangerous situation because if the money doesn't come in,
Speaker 1: but it goes out maybe because there's a large settlement day,
Speaker 1: maybe because there's a tax payment day. Now, once the
Speaker 1: money goes away, you literally hit an air pocket, okay,
Speaker 1: and if there's no want to lend into that air pocket,
Speaker 1: you have a problem. And the Fed cares deeply about
Speaker 1: our overnight rate sprint. So the overnight rates breaking down
Speaker 1: and those spreads widening out massively is a far bigger
Speaker 1: deal than three months cross currentcy basis blowing out to
Speaker 1: a hundred basis points. You know, the inversion dealers becoming
Speaker 1: the last bid for treasuries. Everything happening overnight, which is
Speaker 1: the FEDS sensitive points UM has a lot to do
Speaker 1: with with everything that happened. There's quite a lot of
Speaker 1: irony in this when you think about a lot of
Speaker 1: those UM post crisis liquidity rules were basically aimed at
Speaker 1: taking at improving fragilities in the repo market, right and
Speaker 1: like strengthening the overnight plunding market, and instead you seem
Speaker 1: to have ended up with a slightly opposite situation. Well
Speaker 1: you you know, you ended up in a slightly opposite
Speaker 1: situation because I think the other the other important thing
Speaker 1: that people tend to overlook is that the report market
Speaker 1: has grown tremendously this year. Is that because of treasury
Speaker 1: issuance or something else. Well, partly treasury issuance, but also
Speaker 1: the growth of sponsored dripo. Sponsored dripo for those who
Speaker 1: don't live in the front end, is basically a new
Speaker 1: I don't know, okay, so let's educate Joe a little
Speaker 1: bit here. So sponsored dripo is is a new way
Speaker 1: of of doing ripo in net Okay. So there's basically
Speaker 1: three banks for now UH that have the ability to
Speaker 1: do sponsored dripo. These are State Street, Bony and JP
Speaker 1: Morgan sponsored dripo. The the idea is basically to let
Speaker 1: well capitalized member banks there's not dealers from now banks
Speaker 1: of f I c C to sponsor in money funds
Speaker 1: and sponsoring hetge funds into the repo markets such that
Speaker 1: when you sponsor these entities in and you let them
Speaker 1: face off against each other through a matched book that
Speaker 1: you provide UM, you can net these positions so they
Speaker 1: don't use balance sheet okay. So this is basically a
Speaker 1: way for UH, for the system to provide more balance
Speaker 1: sheet and more liquid it into the report market that
Speaker 1: are using balance because balance sheet constraints is one of
Speaker 1: those things that that basil trees is constraining. So all
Speaker 1: these treasury collateral coming into the system um has for
Speaker 1: the most part being funded in the sponsored repo market.
Speaker 1: Sponsored reaper at the moment is only available on an
Speaker 1: overnight basis. So if you were an RV fund or
Speaker 1: if you were whoever and you needed balance sheet in
Speaker 1: the report market, it's a relative value fund right well,
Speaker 1: and if you needed balance sheet in the report market,
Speaker 1: it was only available to you overnight because term term
Speaker 1: trades are not available, not available in the sponsored report
Speaker 1: space just yet. You know, in addition to the things
Speaker 1: we discussed before that dealers got backed up with the paper,
Speaker 1: they had to fund it overnight. It was also the
Speaker 1: case that the ReLit, the value hedge funds and whoever
Speaker 1: you know, uses report to fund treasuries could only do
Speaker 1: that overnight. So this this kind of new new piece
Speaker 1: of the market sponsored report, which has grown to something
Speaker 1: like three billion dollars in size, also was a part
Speaker 1: of priming the system for a accident, because again, if
Speaker 1: the money doesn't come in because it has to go
Speaker 1: someplace sells, then basically a lot of long positions that
Speaker 1: are funded overnight I can't get rolled. And that's precisely
Speaker 1: how you can end up with report. It's going from
Speaker 1: normal to ten percent the next day. But I want
Speaker 1: to get soon to the sort of how ultimately the
Speaker 1: FED fixes this structural plumbing. What have you issued? But
Speaker 1: before we do, I just want to go back to
Speaker 1: one key question that I recalled coming up in the
Speaker 1: immediate wake of the repub madness. The bank, the big
Speaker 1: banks like JP Morgan, did they still have tech quicly speaking,
Speaker 1: excess reserves beyond their liquidity requirements? The banks had reserves,
Speaker 1: but those reserves were by no means excess. And this
Speaker 1: is and this is what people tend to get lost on. Right,
Speaker 1: So it is perfectly possible for the largest US banks
Speaker 1: to sit on a hundred plus billion dollars of reserves
Speaker 1: in their reserve accounts. And it's perfectly understandable why they
Speaker 1: don't lend those reserves, right because they need those reserves
Speaker 1: to satisfy their intra day aliquidity requirements. They need those
Speaker 1: reserves to be able to pass their resolution stress tests
Speaker 1: things like that. Okay, so again, when you when you
Speaker 1: go to a bank that had three hundred billion two
Speaker 1: years ago down to a hundred and it wouldn't lend
Speaker 1: more in the report market. The two hundred billion was
Speaker 1: the access and all of that was spent and whatever
Speaker 1: is left is not there to be played with. You know,
Speaker 1: if you think about these reserves as high powered money,
Speaker 1: that hundred billion that's there, that ain't high powered money.
Speaker 1: That's dry powder that has to sit there and you
Speaker 1: can't use it. You know. The two weeks before the
Speaker 1: REPO blowout, I've seen um they are all clients of
Speaker 1: credits with the bank portfolios. I've seen four of the
Speaker 1: largest bank portfolios. And you talk to the c i
Speaker 1: os that run these portfolios, they will tell you that
Speaker 1: I would like to earn more with my cash. I
Speaker 1: would like to harvest yields in treasury markets. I would
Speaker 1: like to harvest you know, yields in the g C market,
Speaker 1: but I can't. And currently I'm making uneconomic decisions with
Speaker 1: my reserves because I need to hold those for regulatory purposes.
Speaker 1: So that is basically the environment in which we are
Speaker 1: getting closer to this, to this REPO blow out. A
Speaker 1: lot of people, you know, point their fingers at the
Speaker 1: bank saying, you know, they were the ones who caused it,
Speaker 1: because they have so much at the FED, why didn't
Speaker 1: they land more. There's nothing that a bank would like
Speaker 1: to do more than to earn a ten percent yield
Speaker 1: by moving all their cash into an overnight market and
Speaker 1: get that money back tomorrow and make ten percent. So
Speaker 1: the fact that you have these yields has to do
Speaker 1: with just banks inability to land, not their building investiment. Right.
Speaker 1: So this is sort of what I was getting at
Speaker 1: with these scarcity versus shortage of reserves earlier. There's this
Speaker 1: big arbitrage available in the market, free money basically, but
Speaker 1: the banks can't come in and do it. So just
Speaker 1: getting to solutions to this problem. We've seen the Fed
Speaker 1: uh increased overnight liquidity operations and also announced that um
Speaker 1: I think it's going to buy up to six was
Speaker 1: it sixty billion of TEA bills or did they increase
Speaker 1: it recently? Sixty billion a month? Sixty billion a month
Speaker 1: of te bills? And yet there have been a couple
Speaker 1: of times this month where we have seen repo rates
Speaker 1: start to creep up again, and we've seen some analysts
Speaker 1: at the cell side, JP Morgan, Goldman, SAX and Bank
Speaker 1: of America Mary Lynch also saying that they think the
Speaker 1: FED hasn't done enough to solve the market problem. So
Speaker 1: what exactly is it that the FED needs to do
Speaker 1: and how big of a sort of problem in the
Speaker 1: repo market remains. So I agree with the strategists at
Speaker 1: JP Morgan and Bank of America. I I think as
Speaker 1: well that the FED has not done enough. What we
Speaker 1: have is good for now, but it's not a structural fix.
Speaker 1: You know, there's a big difference between you know, a
Speaker 1: liquidity problem and a liquidity problem and a balance sheet problem. Okay,
Speaker 1: So you know, in September we had a liquidity problem
Speaker 1: because the system ran out of reserves, you know, the
Speaker 1: tokens you settled it. So the only thing the FED
Speaker 1: had to do is just pump in reserves on a margin.
Speaker 1: You know. The big event that's coming up is the
Speaker 1: year end turn and during year and no one is
Speaker 1: going to have the balance sheet two move money around.
Speaker 1: So you know what what I'm trying to say with
Speaker 1: that is, you know, it's okay that the FED has
Speaker 1: a report facility. Uh And for as long as there
Speaker 1: are primary dealers that are willing to take liquidity from
Speaker 1: that facility and broadcast that liquidity to the rest of
Speaker 1: the system, to the hedge funds and little dealers and
Speaker 1: and whoever needs that money, the facility works. But once
Speaker 1: the primary dealers have a balance sheet constraints, and they
Speaker 1: won't be the intermediary between the FED and the rest
Speaker 1: of the system. It doesn't matter how much the FED
Speaker 1: wants to put liquidity into the system with that report facility,
Speaker 1: there's not going to be a mechanism through which they
Speaker 1: can inject that that liquidity into the system. So like
Speaker 1: a very weird analogy here would be that, you know,
Speaker 1: if I'd like to play tennis, but I don't have
Speaker 1: membership at the country club. You do, Joe, Um, you know,
Speaker 1: I can go in with you. It would be the
Speaker 1: exact opposite in real life. But well, right, but if
Speaker 1: you're out taking a hike, there's no tenants for me
Speaker 1: because my friend who's got membership to the country club,
Speaker 1: you know, cannot get me in. So you basically need
Speaker 1: someone to hold your hand to get that liquidity. And
Speaker 1: during year end, no one has the balance sheet and
Speaker 1: no one has the ability to be, you know, to
Speaker 1: be the good Samaritan is going to take to the
Speaker 1: compurity from the FED and give it to you. So again,
Speaker 1: and we we've hit on this, but just to make
Speaker 1: it clear, you know, quarter end r end are important
Speaker 1: because regulator there's a snapshot taken of the bank's financials,
Speaker 1: and it's literally on that day that the regulators take
Speaker 1: a look at the books and everyone. It's like kind
Speaker 1: of cleaning your room before your parents get home and
Speaker 1: something like something like that. So what is the solution then,
Speaker 1: such that we can avoid having these problems pop up
Speaker 1: every time that the parents come home to check out
Speaker 1: the check out whether the room is cleaned. And do
Speaker 1: you expect that in the absence of something new, we
Speaker 1: are going to see something dramatic again reappear on the
Speaker 1: market over the next you know, as we get close
Speaker 1: to your end. Yeah, so there's there's a couple of things.
Speaker 1: Let's talk about reple first, and I'm make to the
Speaker 1: bill purchases. You know, fundamentally, the issue is that the
Speaker 1: repo operations that the FED is doing, in technical lingo,
Speaker 1: it's done on a tri party basis, so it cannot
Speaker 1: be netted. So that's how you get to the sort
Speaker 1: of balance problems. People say that the fetch to turn
Speaker 1: this threeple facility into a I mean, it's a standing
Speaker 1: reple facility effectively anyway, But I think what they really
Speaker 1: mean is that they need to make the FED needs
Speaker 1: to make this reple facility nettable. I think that that
Speaker 1: will never happen. It will never happen because the FED,
Speaker 1: just by its d n A, they like, they like
Speaker 1: to be super senior in their dealings. And there is
Speaker 1: no way that the FED is ever going to lend
Speaker 1: into f I c C, the Fix Them Clearing Corporation,
Speaker 1: you know, A. They are not going to lend into
Speaker 1: the clearing corporate, into the clearinghouse and be a peri
Speaker 1: passu lender alongside everyone else. It's just not the way
Speaker 1: they do things. Two, if they were to do things,
Speaker 1: uh in a super senior way, they would basically upset
Speaker 1: everyone in the clearing house because everybody just got subordinated
Speaker 1: to the largest lander in in the clearing house. So
Speaker 1: I think it's either the FET who's not going to
Speaker 1: do it because they're not comfortable with it, or they
Speaker 1: will do it in a way which is just going
Speaker 1: to set the stage for them for a massive coordination
Speaker 1: problem and you know, just upsetting the governance of the
Speaker 1: Fixing Com Clearing Corporation, which again is the is the
Speaker 1: central clearing house for for report transactions, uh, not to
Speaker 1: mention other things like you know, with the With this
Speaker 1: growth of sponsored repot, there is now as we speak
Speaker 1: about hedge funds that now have access to f I
Speaker 1: c C. So are we really going to go into
Speaker 1: a regime where hedge funds can put collateral into the
Speaker 1: clearing house and and and the FETE effectively on the
Speaker 1: margin is going to fundle That's probably not. I don't
Speaker 1: think that we should go down that path. So that's
Speaker 1: the thing that one thing they do, but they will
Speaker 1: never do really. Um. The second thing they could do
Speaker 1: is to open up this facility for banks as well
Speaker 1: as dealers. So this is a very important distinction at
Speaker 1: the moment non primary dealers. Well no, so at the moment,
Speaker 1: it's the primary dealers that have access to this facility,
Speaker 1: but the banks do not. Okay, So just to just
Speaker 1: to give you a concrete example, let's say JP Morgan
Speaker 1: Securities as a primary dealer has access to the report
Speaker 1: facility JP Morgan Chase Bank and A the depository does not. So,
Speaker 1: if you go back to the earlier conversation, we had
Speaker 1: dealers got backed up with treasuries they needed to get
Speaker 1: that funding in the report market, and the banks, the
Speaker 1: bank portfolios were the marginal landers in the report market. Okay. So,
Speaker 1: and the reason why the money dried up in the
Speaker 1: report market on the margin is because the banks hit
Speaker 1: their logos level of reserves and need ald so they
Speaker 1: stopped landing. Despite the fact that they have all those reserves,
Speaker 1: just can't go below it because you would be reaching
Speaker 1: your regulations. So what you could do is you could
Speaker 1: open up this facility for banks and uh, the chief
Speaker 1: regulator who's random quarrels in the FED would have to
Speaker 1: give a speech saying, we are fine with large banks
Speaker 1: to have all bonds h A portfolios. This you know,
Speaker 1: hundred odd billion dollars that is sitting at each of
Speaker 1: the large banks hl A portfolio can be spent to
Speaker 1: the last penny. It's okay for these largest banks to
Speaker 1: have bonds only in their h A portfolio because the
Speaker 1: FED stands ready with a report facility to turn those
Speaker 1: bonds into cash when introdated liquidity needs a rise. And
Speaker 1: if there is a resolution scenario where the bank has
Speaker 1: to be one down and um, you know, we will
Speaker 1: take those treasuries, give money in turn and let that
Speaker 1: money pay out its creditors and wind down in an
Speaker 1: orderly fashion. If that speech were to happen. And if
Speaker 1: that change to the philosophy with which the regulator would
Speaker 1: like to see the banks run their liquidity portfolio happens,
Speaker 1: and the banks get access to the report facility, then
Speaker 1: you basically free up easily five to six billion dollars
Speaker 1: of reserves. And that's five to six billion dollars of
Speaker 1: extra money that can go into the treasury market, and
Speaker 1: it can go into the report market. Is that going
Speaker 1: to happen? Probably not, because you are not going to
Speaker 1: change the philosophy with which you run these security portfolio
Speaker 1: is just to get through this year end turn that's
Speaker 1: coming up. A third thing you could do is you
Speaker 1: can put a footnote on the on the Repo facility
Speaker 1: page of the New York Fed's website saying here and
Speaker 1: is shaping up to be a very bad event. Let's
Speaker 1: just be clear that whatever money you will take from
Speaker 1: this facility going into that turn is going to be nettable.
Speaker 1: So from a regulatory perspective, you're just not going to
Speaker 1: have to count that in your leverage ratio and all
Speaker 1: these things. So you know, if I'm a dealer and
Speaker 1: I go to this facility, I take fifty billion and
Speaker 1: I pass it on. I mean, the FED knows exactly
Speaker 1: how much I took, and it knows exactly how much
Speaker 1: balance sheet to ignore from my calculation. Is that going
Speaker 1: to happen? I don't know. I mean, a couple of
Speaker 1: the dealers that are primary dealers run their report books
Speaker 1: out of branches. Those branches roll up to the holding
Speaker 1: company in their respective countries for reporting purposes. So can
Speaker 1: the FED guarantee that the French regulator and the Japanese
Speaker 1: regulator is going to have the same view on what's
Speaker 1: notable and what's notable? I don't know, So I think
Speaker 1: it's kind of a coordination problem. So I don't think
Speaker 1: that any of those things will happen. And if none
Speaker 1: of these things happen, you basically set the stage for
Speaker 1: something quite ugly happening around the year and turn. Because
Speaker 1: it's not going to be just a liquity problem, right.
Speaker 1: The people are not going to have the balance sheet
Speaker 1: to take the liquility that the FED is trying to
Speaker 1: put into the system, and the market can really get
Speaker 1: seized up. So if you thought September was bad, December
Speaker 1: can get universe. But then again, you know, you see
Speaker 1: headlines Treasury secretaries looking into ways of dealings, you know,
Speaker 1: with some of the REGs and maybe some changes coming
Speaker 1: from the regulatory side, you just don't know, you know.
Speaker 1: So if something big is going to come then here
Speaker 1: and there's less of an issue. If if none of
Speaker 1: those things will come here and is an issue. Right,
Speaker 1: so you can imagine that any tweaking of the existing regulation,
Speaker 1: like there's an optics problem there, which is like a
Speaker 1: bunch of people will say that you're basically rolling back
Speaker 1: bank regulation. Um. And in fact, we've seen, you know,
Speaker 1: people like Elizabeth Woren actually start talking about repo markets
Speaker 1: and what Jamie Diamond over at JP Morgan was saying,
Speaker 1: I have one more question, and you sort of alluded
Speaker 1: to it just then. But um, we've been talking about
Speaker 1: the repo market sort of in isolation, although as you say,
Speaker 1: it is a very very big deal for markets overall.
Speaker 1: But is there a specific scenario in which a coming
Speaker 1: up in repo another bout of repo madness, maybe one
Speaker 1: that's worse at the year end. Is there a scenario
Speaker 1: in which that impacts risk asset exposure at the primary
Speaker 1: dealers or the banks or big market participants as well. Oh, definitely, definitely,
Speaker 1: In fact, in fact, you've seen a micro tremor and
Speaker 1: in September. You know, it's hard to see it, but
Speaker 1: you know, if you if you talk to h to
Speaker 1: the equity desk at a dealer, they will tell you
Speaker 1: that this happened. So what happened in um in September
Speaker 1: and REPO blew out the equities that the street was
Speaker 1: the most long in sold off and the equities that
Speaker 1: the street was most short in rallied. So what that
Speaker 1: tells you is that the balance sheet that the equity
Speaker 1: derivatives desks and you know cash equity desks are providing
Speaker 1: to the streets, the lungs were trimmed because there was
Speaker 1: no balance sheet for them, and the shorts were trimmed
Speaker 1: and because there was no balance sheet for them, right,
Speaker 1: So that's what caused those moves. And what happened was that,
Speaker 1: you know, it's some dealers and it's not all dealers
Speaker 1: worked like this, but there are some dealers where equity
Speaker 1: derivatives and FFEX forwards and REPO basically rolls up to
Speaker 1: a single person. So you shift equity across these businesses
Speaker 1: based on where the spreads are the richest. So in September,
Speaker 1: when ripo blew out. There were some dealers that to
Speaker 1: balance it away from equity derivatives and the flex desk
Speaker 1: and moved it to the repo desk because you wanted
Speaker 1: to harvest those widespreads to the extent possible. And as
Speaker 1: you move that equity, as you moved to equity and
Speaker 1: you took balance sheet from equities away, there was an
Speaker 1: impact on equity market. The reason why this didn't get
Speaker 1: out of hand and it didn't start to impact more
Speaker 1: names and didn't last for longer is because the fat
Speaker 1: step then started to and in the report market, and
Speaker 1: the report market calm down, So whatever equity you shifted
Speaker 1: there went back to to the equity desk. So again,
Speaker 1: if this thing persists, and you know this is just
Speaker 1: a spill over into risk assets. But if this thing persists,
Speaker 1: remember that repo is how you get to live to
Speaker 1: fight another day. If you have to fund at ten
Speaker 1: percent for a day, another day, and a third day,
Speaker 1: it can become existential to the point where you end
Speaker 1: up with headlines and newspapers front page, you know, so
Speaker 1: that can also spill over into risk assets. So I
Speaker 1: think I think there is a very real chance uh
Speaker 1: that if we don't have a better set of pipes
Speaker 1: from the FED and a more aggressive QUEI um than
Speaker 1: you have a very very problematic here. In turn, you
Speaker 1: just opened up the if we we don't have time
Speaker 1: to go there because you just opened up the most
Speaker 1: controversial Pandora's box of whether they should even count is
Speaker 1: whether this is QUEI or not. And I feel like
Speaker 1: we could do a whole separate discussion on that. Unfortunately,
Speaker 1: I don't think we have the time. But I think
Speaker 1: that was a great leaving us with that potentially gloomy
Speaker 1: note of maybe a bigger repo madness coming in December,
Speaker 1: and one that potentially spills over into a risk assets
Speaker 1: something to uh, I wouldn't exactly say look forward to,
Speaker 1: but something for everyone to pay attention. And I think
Speaker 1: after this discussion, hopefully people have a much deeper understanding
Speaker 1: of what's really going on. So Sulton is so great
Speaker 1: to talk to you. Thanks for coming out, Thank you
Speaker 1: very mu sure, thanks Alton, that's so good, Joe. You
Speaker 1: know what I love about that conversation is that Bolton
Speaker 1: sort of brings these big picture theoretical approaches to everything
Speaker 1: that we've just seen in the repo market. But he
Speaker 1: also gives you the sort of technical, behind the scenes
Speaker 1: look with what is actually happening at some of these
Speaker 1: desks and the primary dealers. So I really like that. No,
Speaker 1: I think this is incredibly important and it's kind of
Speaker 1: touched on what we talked about last time, but in
Speaker 1: a more specific way that it's easy to say, look
Speaker 1: at some charts and say, oh, this bank should have
Speaker 1: access reserves and this is just a plumbing issue and
Speaker 1: so forth. But then you get into these very specific
Speaker 1: scenarios in which people who are running portfolios or people
Speaker 1: who have to figure out how they're going to provision
Speaker 1: their own liquidity, may move money or may decide to
Speaker 1: move money from one activity to another, and it's, uh,
Speaker 1: it's very real world. It's not just a series of
Speaker 1: cells on a spreadsheet that should, uh should behave in
Speaker 1: some predictable pattern. Right. Well, I also think you know
Speaker 1: people here money markets and rebot badness, and they think
Speaker 1: this was a really technical issue in the plumbing of
Speaker 1: the financial system, as people always put it, but actually
Speaker 1: a lot of it is behavioral, sort of on both sides.
Speaker 1: So you have people who, for instance, don't want to
Speaker 1: access the discount window because it seemed to be a
Speaker 1: bad thing post crisis. And then on the regulatory and
Speaker 1: political side, you have people who probably are unwilling to
Speaker 1: really tackle this issue because of the optics involved. Right,
Speaker 1: you don't want to be seen to be bailing out
Speaker 1: banks or rolling back financial regulation, even though you know
Speaker 1: logically there seems to be something slightly off with the system,
Speaker 1: or even as he described the fed's own posture of
Speaker 1: not wanting to be subordinate, or other entities that want
Speaker 1: to lend into this market not wanting to compete with
Speaker 1: the Federal Reserve. All kinds of questions that again on
Speaker 1: paper or on Twitter, someone might be able to The
Speaker 1: FED just needs to do X, set up a standing
Speaker 1: repo facility. Why haven't they done that already? I thought.
Speaker 1: I learned a lot from that conversation about why it's
Speaker 1: not not quite so simple as just setting up a
Speaker 1: new death square. Anyone can swap treasuries for reserves and
Speaker 1: have the liquidity they need for regulators, Yes, indeed, and
Speaker 1: now of course, uh, we'll all be watching out for
Speaker 1: what happens at the year end if we weren't doing
Speaker 1: so already, So we'll have to have a sultan back
Speaker 1: on in the new year to Yeah, I actually thought
Speaker 1: that wasn't I thought. I was like, Okay, they're never
Speaker 1: gonna let this happen again, because we saw this, and
Speaker 1: we know that the urine is already stressful. So I'm
Speaker 1: I'm a little disconcerted about how concerned a sultan is
Speaker 1: for the year. And one other point that I really liked,
Speaker 1: and I think it's to get the language of a
Speaker 1: cross here and this idea, and he used the term
Speaker 1: several times tokens to describe reserves, and it's a good
Speaker 1: reminder that money, while they may you know, there are
Speaker 1: many different forms of the dollar, and they basically trade
Speaker 1: it one to one all the time, they're not completely fungible.
Speaker 1: And so you think about a casino, uh, and you
Speaker 1: have a dollar, and you have a one dollar token
Speaker 1: or token worth one dollar, and in theory you know
Speaker 1: that they're pegged perfectly and they always trade. But it
Speaker 1: doesn't mean you can't have an issue, or that the
Speaker 1: poker players who want to leave wouldn't be really upset
Speaker 1: if there was some issue with just the mechanics of
Speaker 1: the conversion. Even if say the casino owner had plenty
Speaker 1: of money and they could make good for everyone, you
Speaker 1: could get these sort of very technical, angry situations, stressful
Speaker 1: moments if they were a token shortage or something else.
Speaker 1: And that really sort of speaks to the issue that
Speaker 1: there are all these different forms of the dollar, but
Speaker 1: if there's a shortage of one, you could still have
Speaker 1: or if there's a temporary shortage in the provision of one,
Speaker 1: you could still have these issues. So I think the
Speaker 1: language he used there is extremely helpful in that understanding. Yeah,
Speaker 1: it's sort of like, um, I guess liquidity, liquidity everywhere,
Speaker 1: but not a drop to drink kind of thing, right,
Speaker 1: the systems awashing liquidity, But that doesn't necessarily mean that
Speaker 1: you can move it from one end to the other.
Speaker 1: So if you have if your regulator wants you to
Speaker 1: have one, very specific types of type of liquidity, because again,
Speaker 1: treasury bills three months are among the most liquid, safest,
Speaker 1: most valuable assets in the world, and if even they're
Speaker 1: not good enough under certain sort of regulatory demands, you
Speaker 1: get these bizarre situations in which highly liquid, well capitalized
Speaker 1: banks could still find themselves uh with some sort of shortfall. Yes, indeed,
Speaker 1: all right, again, something for us to watch out for
Speaker 1: going into the year end. This has been another episode
Speaker 1: of the All Thoughts podcast. I'm Tracy Alloway. You can
Speaker 1: follow me on Twitter at Tracy Alloway and I'm Joe
Speaker 1: wi Isn't Though. You can follow me on Twitter at
Speaker 1: the Stalwart and be sure to follow our producer on
Speaker 1: Twitter at Laura M. Carlson. And all the Bloomberg podcast
Speaker 1: check them out at the handle at podcasts. Thanks for
Speaker 1: listening one