WEBVTT - Why Treasury Market Spasms That Shouldn't Happen Keep Happening 0:00:10.840 --> 0:00:14.440 Hello, and welcome to another episode of the All Thoughts Podcast. 0:00:14.560 --> 0:00:18.439 I'm Tracy Allawatt and I'm Joe. Wi isn't thal Joe? 0:00:18.520 --> 0:00:22.320 Do you ever think about US treasuries? Yeah? Every day, 0:00:22.400 --> 0:00:26.280 that's like on ironically, first thing get up in the morning, 0:00:26.440 --> 0:00:31.120 think about treasuries. Absolutely. Yeah, I mean treasuries are sort 0:00:31.120 --> 0:00:34.839 of the thing that the entire market is revolving around 0:00:34.880 --> 0:00:36.760 at the moment, Like, there's so many things that are 0:00:36.800 --> 0:00:40.280 correlated with yields. But I guess let me frame that 0:00:40.400 --> 0:00:42.239 question a bit differently. Do you ever think about what 0:00:42.240 --> 0:00:46.479 a treasury actually is? Yeah? I mean I don't have 0:00:46.640 --> 0:00:50.080 a strong like intuitions about it, but I kind of 0:00:50.120 --> 0:00:53.840 feel that, Yeah I do, But you know, I'm always 0:00:53.920 --> 0:00:57.319 up for learning more. Yeah. Um, well, that's what we're 0:00:57.320 --> 0:01:00.120 going to be doing in this episode. And I think 0:01:00.160 --> 0:01:04.000 it's an important topic. I mean, it's obviously an important topic. 0:01:04.080 --> 0:01:07.240 But one of the reasons it's worth looking into is 0:01:07.319 --> 0:01:10.399 because I think most people tend to think of a 0:01:10.520 --> 0:01:12.759 U S treasury as you know, it's a bond issued 0:01:12.760 --> 0:01:17.000 by the US government, it's unlikely to default, it acts 0:01:17.040 --> 0:01:20.800 as a sort of safe asset in the financial system. 0:01:20.840 --> 0:01:23.720 There's one other aspect of US treasuries that doesn't get 0:01:23.760 --> 0:01:27.800 as much attention. And that's the fact that it's supposed 0:01:27.800 --> 0:01:32.119 to be this huge and liquid market that's really easy 0:01:32.200 --> 0:01:36.240 to trade. Yeah, I mean, so you ask, like, what 0:01:36.240 --> 0:01:37.960 what is a treasure? And how I think about it? 0:01:38.000 --> 0:01:40.319 And at some level I really do think it's almost 0:01:40.400 --> 0:01:43.280 like it's like the fundamental building block of the entire 0:01:43.319 --> 0:01:47.720 global financial system is the deepest market. It is the 0:01:47.760 --> 0:01:51.880 most liquid market. It has no credit risk, um, you 0:01:51.880 --> 0:01:54.200 know for the most part, and so the price there's 0:01:54.240 --> 0:01:58.160 like a purity to the price. But as as liquid 0:01:58.160 --> 0:02:01.080 as it is, everyone's in a law all and despite 0:02:01.080 --> 0:02:03.000 the fact that it should be like the simplest thing 0:02:03.080 --> 0:02:06.000 to trade, every once in a while it kind of 0:02:06.040 --> 0:02:08.200 breaks in this weird way and nothing of her good 0:02:08.240 --> 0:02:12.880 happened if the treasury market is breaking. Yeah, that's right. 0:02:12.960 --> 0:02:17.000 So we've had these big moments of disruption in the 0:02:17.040 --> 0:02:20.480 treasury market. Recently, we had, um, well, the big one 0:02:20.800 --> 0:02:24.480 was the March mayhem in the market when a bunch 0:02:24.480 --> 0:02:27.919 of lever trades blew up. But most recently we had 0:02:27.960 --> 0:02:32.000 the yield spike in February, and you know, way before that, 0:02:32.040 --> 0:02:35.360 we had the repo madness in September I think it 0:02:35.440 --> 0:02:38.840 was twenty nineteen, and then we had the the flash 0:02:38.880 --> 0:02:47.360 crash in US treasuries back in although maybe something around 0:02:47.360 --> 0:02:50.560 there I should say up crash because yields went down. Yeah, okay, 0:02:50.639 --> 0:02:55.520 But the point is that these sort of disruptions keep happening, 0:02:55.639 --> 0:02:58.520 and they're happening in a really important market, as you said, 0:02:58.600 --> 0:03:00.800 and in a market that's supposed us to be liquid 0:03:00.880 --> 0:03:03.000 and easy to trade, and yet it seems to be 0:03:03.040 --> 0:03:05.640 seizing up every once in a while. So that's what 0:03:05.680 --> 0:03:07.880 we're going to talk about today. Great, I can't wait. No, 0:03:07.960 --> 0:03:11.760 it's a it's a fascinating question because why the safest 0:03:11.840 --> 0:03:15.040 most liquid asset in the world, which in theory the 0:03:15.080 --> 0:03:19.040 Federal Reserve, could you know, stands ready to buy you know, 0:03:19.080 --> 0:03:21.480 in theory at any moment, why it should ever sees 0:03:21.600 --> 0:03:23.800 up is sort of this like mystery to me, like 0:03:23.800 --> 0:03:25.880 I don't quite get why it should ever happen, but 0:03:25.919 --> 0:03:29.760 it clearly happens enough that something's going on. A twenty 0:03:29.760 --> 0:03:33.560 one trillion dollar mystery. Yes, all right, well we have 0:03:33.680 --> 0:03:36.200 the that's the size of the U. S Treasury market. 0:03:36.240 --> 0:03:39.560 By the way, we have the perfect person to discuss 0:03:39.600 --> 0:03:42.960 all of this. Our guest for this episode is Yeesha 0:03:43.080 --> 0:03:46.400 yead If. She's a professor of law over at Vanderbilt 0:03:46.560 --> 0:03:49.440 Law School, and she's done a ton of research on 0:03:49.680 --> 0:03:54.160 exactly this topic. So Yesha, welcome to the show. Tracy 0:03:54.200 --> 0:03:55.760 and Joe, thank you so very much for having me 0:03:55.840 --> 0:03:58.200 such a pleasure to be here, UM, and particularly to 0:03:58.240 --> 0:04:00.800 get to talk to you about US Asian markets. What 0:04:00.840 --> 0:04:07.720 can be more exciting than that? Nothing? I agree, alright, 0:04:07.760 --> 0:04:10.360 So maybe just to begin with, I mean, I just 0:04:10.480 --> 0:04:14.080 listed some recent um, let's say, conniptions in the U. S. 0:04:14.120 --> 0:04:17.880 Treasury market. It feels to me like these are happening 0:04:18.240 --> 0:04:21.480 more often. But you know, I haven't gone back and 0:04:21.640 --> 0:04:26.280 looked throughout all of the market's history, Is that right? Like, 0:04:26.440 --> 0:04:30.760 do you think this sort of random bouts of volatility 0:04:30.839 --> 0:04:34.799 is happening more often? It certainly feels that way, Tracy, 0:04:34.839 --> 0:04:36.760 it really does. UM. I think one of the things 0:04:36.839 --> 0:04:39.520 that has been happening in the U. S. Treasury market, UM, 0:04:39.600 --> 0:04:43.880 is that this market structure has changed really profoundly over 0:04:43.920 --> 0:04:46.520 the last decade or so. UM. So this used to 0:04:46.560 --> 0:04:50.039 be known. I think UM across the market is being 0:04:50.160 --> 0:04:54.200 a really super boring space. This was really the market 0:04:54.320 --> 0:04:58.480 in which UM the trading would happen over the counter 0:04:58.720 --> 0:05:02.919 by telephone, using screens, requests for quotes and so on 0:05:02.960 --> 0:05:05.960 and so forth. It was slow UM. It was just 0:05:06.080 --> 0:05:09.320 very steady market where nothing would be seem like it 0:05:09.360 --> 0:05:12.479 could go wrong. And it was essentially dominated by the 0:05:12.520 --> 0:05:15.680 primary dealers UM that were the keen to mejories in 0:05:15.720 --> 0:05:17.640 the space, both in the primary as well as in 0:05:17.640 --> 0:05:20.520 the secondary market. UM. And what we've seen over the 0:05:20.600 --> 0:05:23.279 last decade or so, and you and your colleagues at 0:05:23.279 --> 0:05:27.480 Bloomberg have reported extensively on this UM, it's really this 0:05:27.600 --> 0:05:30.320 change in market structure that has affected how this market 0:05:30.400 --> 0:05:33.880 is working UM, that has affected UM, the risks that 0:05:33.920 --> 0:05:38.320 are impacting this market, as well as also the quality 0:05:38.360 --> 0:05:40.880 of the liquidity provision that is coming into this market 0:05:40.880 --> 0:05:44.320 and how resilient this liquidity provision is UM. And that 0:05:44.480 --> 0:05:48.360 change really has been UM. This emergence as it has 0:05:48.360 --> 0:05:52.440 been across the entire UH marketplace pretty much the emergence 0:05:52.560 --> 0:05:55.760 of high frequency trading in the inter dealer space in 0:05:55.800 --> 0:05:59.080 the secondary market, which has really become the dominant form 0:05:59.200 --> 0:06:02.800 of liquidity vision UM. And what has happened here obviously 0:06:03.240 --> 0:06:06.320 means that primary dealers in hf T traders now are 0:06:06.360 --> 0:06:10.080 competing a lot more fiercely. There's a great deal more 0:06:10.080 --> 0:06:13.240 technology that is coming to bear in the U S 0:06:13.279 --> 0:06:16.440 treasury market is no longer the sleepy space full of telephones. 0:06:17.040 --> 0:06:20.200 This is a marketplace that is in motion all the time. 0:06:20.520 --> 0:06:23.560 And as a result of that, we have new risks, 0:06:24.120 --> 0:06:28.160 we have a new dynamics that are impacting the space. 0:06:28.760 --> 0:06:32.039 But the essential point here is that none of this 0:06:32.279 --> 0:06:35.120 is really that new, because it's been happening in the 0:06:35.120 --> 0:06:37.359 equities and gervities markets for a whole hell of a 0:06:37.400 --> 0:06:41.680 long time, similar um disappearances of liquidity, flash crashes, many 0:06:41.720 --> 0:06:44.200 flash crashes, and so on and so forth. But now 0:06:44.279 --> 0:06:47.440 these are happening in the US treasury markets exactly as 0:06:47.440 --> 0:06:50.200 we would expect because we've seen it in equity in gervitives, 0:06:50.240 --> 0:06:53.640 but unfortunately in the US treasuries we just haven't been 0:06:53.680 --> 0:06:56.680 focusing on it, and so it's really taken us by surprise. 0:06:57.240 --> 0:06:59.640 And so really it feels like this is happening more often. 0:07:00.040 --> 0:07:01.400 So I want to get in, you know, we want 0:07:01.400 --> 0:07:04.080 to get into obviously, like what this new structure looks 0:07:04.120 --> 0:07:07.240 like and why it's not as a resilient or robust 0:07:07.320 --> 0:07:10.480 as the old sleepier structure. But before we do that, 0:07:10.560 --> 0:07:12.880 what do we just zoom out for a second, and 0:07:12.920 --> 0:07:15.520 what don't you tell us about your work and the 0:07:15.640 --> 0:07:18.320 sort of you know, trade to mention you're at the 0:07:18.400 --> 0:07:21.880 law school. What is the lens with which you come 0:07:21.920 --> 0:07:25.640 to this problem from? And uh seek to sort of 0:07:25.760 --> 0:07:29.880 understand problems and solutions. You know, thanks to that question, Joe, 0:07:29.920 --> 0:07:32.040 because you know I wonder that myself sometimes, because you 0:07:32.080 --> 0:07:35.600 know this is this is I'm a law professor. I remember, 0:07:35.600 --> 0:07:38.520 really boring law professor A strudy market structure and the 0:07:38.520 --> 0:07:43.000 regulation of market structure. And for the longest time folks 0:07:43.320 --> 0:07:47.040 have been very pollyanish about us treasure market structure, in 0:07:47.080 --> 0:07:49.920 other words, that it will always work. M This will 0:07:49.920 --> 0:07:54.720 be the most resilient, most robust market structure anywhere in 0:07:54.800 --> 0:07:58.320 the world. As you said, Tracy, that and Joe that 0:07:58.400 --> 0:08:01.200 this is the deepest most quid market in the world. 0:08:01.200 --> 0:08:04.320 That is a standard spiel that we see every single 0:08:04.360 --> 0:08:07.520 time we have a report from the regulators. This is 0:08:07.560 --> 0:08:10.160 the deepest, most liquid market in the world. And so 0:08:10.200 --> 0:08:12.760 you might wonder why it is A law professor really 0:08:12.880 --> 0:08:15.120 would want to look at this because what we do 0:08:15.200 --> 0:08:18.640 is look for problems, right, That's our job. The U 0:08:18.720 --> 0:08:21.240 S Truasure market structure. When I started studying it, you know, 0:08:21.280 --> 0:08:23.840 I was bowled over. Um. I was coming at it 0:08:23.840 --> 0:08:26.200 from the regulatory stide. I wanted to understand how this 0:08:26.240 --> 0:08:28.600 market is regulated. I wanted to see if that regulation 0:08:29.160 --> 0:08:31.000 is fit for the job that is doing today, which 0:08:31.040 --> 0:08:35.760 is regulating this extremely important as well as technologically advancing market. 0:08:36.200 --> 0:08:39.360 And what I discovered there was a complete shock. The 0:08:39.400 --> 0:08:43.280 paradigm by which this market is regulated is like none other, 0:08:43.600 --> 0:08:47.439 UM in our space. The regulatory structure I think deserves 0:08:47.440 --> 0:08:51.720 a conversation because it is really feels like it does 0:08:51.760 --> 0:08:54.520 not work. Um, it is just not set to work. 0:08:54.760 --> 0:08:57.240 This regulatory structure, the public structure as well as the 0:08:57.240 --> 0:09:00.840 private structure, in some sense just leaves in nor miss gaps. 0:09:00.880 --> 0:09:04.600 And the reason for those gaps possibly stems from the 0:09:04.640 --> 0:09:07.400 belief that this market will be perfect and will always 0:09:07.440 --> 0:09:11.160 perform and it's completely risk free. And so regulators, I feel, 0:09:11.559 --> 0:09:14.200 have really taken their eye off the ball, and that 0:09:14.320 --> 0:09:17.760 structure that we have in place today really just does 0:09:17.800 --> 0:09:21.440 not exist to function to regulate a marketplace and to 0:09:21.480 --> 0:09:24.160 match the marketplace that we have today, um, and so 0:09:24.200 --> 0:09:26.880 it should not be surprising that we're seeing some of 0:09:26.920 --> 0:09:32.080 these connections, Stracy said, happening with ever greater regularity because 0:09:32.160 --> 0:09:33.840 some of the guard rails that have been put in 0:09:33.880 --> 0:09:36.600 place in other markets just don't exist in treasuries, right, 0:09:36.920 --> 0:09:38.719 and so it should not be surprising to us that 0:09:38.800 --> 0:09:41.360 this is happening. You know. One of the things that 0:09:41.360 --> 0:09:44.680 that you guys mentioned was in relation to the flash 0:09:44.720 --> 0:09:46.920 crash and the flash rally in two thousand and fourteen, 0:09:47.440 --> 0:09:52.160 and that's really set off this kind of regulatory circumspection, UM, 0:09:52.200 --> 0:09:55.679 this reflection on US treasury markets. And I think that's 0:09:55.679 --> 0:09:58.400 when regulators discovered that this market actually has a whole 0:09:58.440 --> 0:10:00.800 bunch of risks that they never knew exist that and 0:10:00.840 --> 0:10:02.360 that they had to come to this space with a 0:10:02.400 --> 0:10:06.079 greater degree of deliberation and intention that they have done historically. 0:10:06.440 --> 0:10:09.040 But it also showed that the regulatory structure that we 0:10:09.120 --> 0:10:11.880 have today is really not set to do the job 0:10:11.960 --> 0:10:14.560 that we expected to. And the reason for that is 0:10:14.600 --> 0:10:19.120 that this market structure for regulating the public structure for 0:10:19.160 --> 0:10:23.880 regulating US treasury markets is extremely fragmented, Unlike every other market, 0:10:24.040 --> 0:10:27.840 like equities, observatives. This market does not have a lead regulator. 0:10:28.040 --> 0:10:30.880 There is no one person that is policing this market. 0:10:30.960 --> 0:10:35.320 We have a fragmented, loose association of four or five 0:10:35.760 --> 0:10:40.240 superstar regulators, the big top regulators for the marketplace, but 0:10:40.360 --> 0:10:43.920 none of them has elite status. Right So the US, 0:10:44.400 --> 0:10:47.600 the US Treasury, Um, the New York FED, they are 0:10:47.640 --> 0:10:51.280 responsible in the auction space. We have the sec UM 0:10:51.280 --> 0:10:54.400 and FINRA that are taking care of the securities market 0:10:54.440 --> 0:10:57.079 firms that trade in this space. We have the FED 0:10:57.160 --> 0:10:59.160 to reserve the fat in the o c C that 0:10:59.200 --> 0:11:01.679 look after the bands that are the main dealers in 0:11:01.679 --> 0:11:04.760 this space. And so everyone is sharing a little bit 0:11:04.760 --> 0:11:07.000 of the authority. And that can be great because they 0:11:07.000 --> 0:11:10.720 bring their expertise and their insights into the space. But 0:11:10.800 --> 0:11:14.640 equally it means that no one person always has incentive 0:11:14.679 --> 0:11:16.680 to come forward and take a lead and set an 0:11:16.720 --> 0:11:20.800 agenda and coordinate information costs. You have to share information, 0:11:20.880 --> 0:11:24.360 you have to develop a plan for enforcement and reform. 0:11:24.480 --> 0:11:27.600 And so we should not be surprised that rulemaking that 0:11:27.720 --> 0:11:30.360 is taken for granted in other markets just does not 0:11:30.520 --> 0:11:34.079 happen in US treasuries. It just hasn't happened in US treasuries, 0:11:34.600 --> 0:11:38.240 And perhaps the starkest example of that is the lack 0:11:38.280 --> 0:11:42.440 of information in this market. Right. So up until two 0:11:42.440 --> 0:11:45.160 thousand and seventeen, and you guys are you know you 0:11:45.240 --> 0:11:47.679 report on markets? You know this stuff? You are you 0:11:47.720 --> 0:11:51.200 know you are steeped in this stuff. It's shocking, I 0:11:51.240 --> 0:11:53.439 think for all of us to do this. It discovered it. 0:11:53.520 --> 0:11:56.960 Up until two thousand and seventeen, there was no mandatory 0:11:57.040 --> 0:12:01.080 secondary reporting regime portrayed in US treasuries, right, And that 0:12:01.320 --> 0:12:05.200 is kind of shocking. And what that means is that 0:12:05.320 --> 0:12:10.160 regulators have not had information to figure out what exactly 0:12:10.240 --> 0:12:14.040 is happening in secondary market activity on a granular basis. 0:12:15.040 --> 0:12:18.240 And it's you know, comes as no surprise that it 0:12:18.280 --> 0:12:20.880 took a year to figure out what the flash rally 0:12:20.920 --> 0:12:22.959 was about, and even then into the two thousand and 0:12:23.000 --> 0:12:25.480 fourteen flash rally, and even then they did not have 0:12:25.559 --> 0:12:30.400 a conclusion. We still don't fully know what caused marsh twenty, 0:12:30.920 --> 0:12:35.000 the blowout that you were mentioning, the march madness, Tracy Um. 0:12:35.040 --> 0:12:38.160 And the reason for so much of that is that 0:12:38.200 --> 0:12:42.600 this market does not have comprehensive data, It does not 0:12:42.840 --> 0:12:48.000 have granular reporting even today, Um sorry, can I jump 0:12:48.000 --> 0:12:50.400 in there, because this is something I wanted to ask you. So, 0:12:50.679 --> 0:12:54.360 given the lack of transparency in the US treasury market, 0:12:54.400 --> 0:12:56.360 you know, even though it's the sort of bedrock of 0:12:56.400 --> 0:12:59.000 the financial system, we don't quite know what's going on 0:12:59.080 --> 0:13:02.679 with it at all times, how do we actually measure 0:13:03.200 --> 0:13:06.800 treasury market liquidity? Like, what do you look at in 0:13:06.880 --> 0:13:10.960 your research? I'm curious because everyone has different definitions of 0:13:11.200 --> 0:13:14.600 ease of trading? So what are you watching and how 0:13:14.640 --> 0:13:17.600 has it sort of evolved over time? Yeah, I mean 0:13:17.600 --> 0:13:19.600 that's a that's a terrific question. It's a twenty one 0:13:19.640 --> 0:13:22.040 trillion dollar question. In fact, it's a six billion dollar 0:13:22.120 --> 0:13:25.080 question a daily basis, because that's that's the liquidity that 0:13:25.160 --> 0:13:28.200 is coursing through the treasury secondary market in a daily basis, 0:13:28.240 --> 0:13:31.240 compared to around five hundred billion in the equity space. Right, 0:13:31.320 --> 0:13:34.480 So this is supposedly a market in which we have 0:13:34.640 --> 0:13:39.400 six hundred billion odd I think that was March one. Rather, 0:13:39.760 --> 0:13:42.040 you know, we have twenty six hundred billion dollars worth 0:13:42.040 --> 0:13:44.800 of liquidity. Course in this market every day liquidity is 0:13:44.840 --> 0:13:47.760 hard to measure. But the idea here is that you 0:13:47.800 --> 0:13:51.520 should be able to trade without causing price impacts. Right, 0:13:51.640 --> 0:13:53.920 particularly in this market, you should be able to make 0:13:54.160 --> 0:13:58.880 large trades without there are being a price impact in 0:13:58.920 --> 0:14:01.600 the market structure. That is exactly what we're not seeing. 0:14:02.120 --> 0:14:05.560 So in the context of the blowout in February, for example, 0:14:06.120 --> 0:14:09.560 we saw that the five year and the seven year 0:14:10.160 --> 0:14:14.160 UH tenor just incredible amounts of movement in the spreads 0:14:14.240 --> 0:14:16.080 in just a very short period of time, and that 0:14:16.160 --> 0:14:19.800 was due to liquidity concerns. In the case of March, 0:14:20.400 --> 0:14:24.800 we saw enormous prices locations that were happening because liquidity 0:14:24.840 --> 0:14:28.360 in this market disappeared. And what that means is that 0:14:28.360 --> 0:14:32.160 that the price changes are not happening because of fundamental 0:14:32.240 --> 0:14:36.160 informational changes. Right. So of course we expect volatility takes 0:14:36.240 --> 0:14:40.720 that's in the marketplace because information will affect how price 0:14:40.840 --> 0:14:45.240 changes happen. But in the treasury market, we should not 0:14:45.360 --> 0:14:48.840 expect these price changes to happen because the market is 0:14:48.920 --> 0:14:51.600 becoming a liquid because dealers are not there to supply 0:14:51.760 --> 0:14:55.800 trading opportunities constantly throughout the trading day. Liquidity in this 0:14:55.920 --> 0:14:58.280 market should be taken for granted, so that the price 0:14:58.360 --> 0:15:01.600 changes that are happening are big. Is even informational and 0:15:01.680 --> 0:15:06.480 fundamental issues rather than because of liquidity issues, because they're 0:15:06.520 --> 0:15:10.040 not enough trading opportunities for buyers to have sellers and 0:15:10.200 --> 0:15:13.560 sellers to have buyers. So really, that's how I understand 0:15:13.600 --> 0:15:17.080 it that we are that we are relying on a 0:15:17.200 --> 0:15:21.840 marketplace that is supposed to be responding to information, not 0:15:21.960 --> 0:15:41.600 a marketplace that should be responding to disappearances of trading opportunity. 0:15:43.760 --> 0:15:47.120 So talk us through because in theory, you know, you 0:15:47.240 --> 0:15:51.960 describe the old sleepy treasury market of the dealer community 0:15:52.160 --> 0:15:54.640 and a lot of it being done by phone, and 0:15:54.680 --> 0:15:58.040 now we have this sort of like I guess richer 0:15:58.240 --> 0:16:03.200 treasury ecosystem and shifts and hedge funds and inter dealer 0:16:03.280 --> 0:16:06.400 trading and all that stuff in theory and think, okay, 0:16:06.400 --> 0:16:10.120 more participants, different preferences that would make it more liquid. 0:16:10.400 --> 0:16:13.760 So what is the failure between theory and practice such 0:16:13.880 --> 0:16:16.240 that even though there is this sort of you know, 0:16:16.280 --> 0:16:20.200 a whole like flora and fauna of treasury participants, it 0:16:20.280 --> 0:16:24.640 doesn't translate automatically to uh, greater liquidity. And we do 0:16:24.680 --> 0:16:26.920 seem to see this rise of dislocations, like what are 0:16:26.920 --> 0:16:31.240 the leading theories for why? Basically, yeah, that's an awesome question, Joe, 0:16:31.400 --> 0:16:34.280 and you know, I think it's one that perplexes regulators 0:16:34.440 --> 0:16:38.560 and perplexes market participants because exactly as you said, you 0:16:38.640 --> 0:16:41.360 look at the market and you know there are there's 0:16:41.440 --> 0:16:44.960 three hundred billion dollars worth of daily trading in the 0:16:44.960 --> 0:16:47.440 inter dealer space, which is the super liquid space with 0:16:47.520 --> 0:16:51.000 dealers are trading with each other, and on a normal day, 0:16:51.040 --> 0:16:56.040 that liquidity seems so incredible, it seems so lush and 0:16:56.160 --> 0:17:00.360 robust because we do have the primary dealers ELM, we 0:17:00.440 --> 0:17:03.720 do have these brand new high frequency traders that are 0:17:04.119 --> 0:17:08.720 expansively providing liquidity throughout the trading day. Now, the HFT 0:17:08.880 --> 0:17:12.320 participation in the US inter dealer spaces around is around 0:17:12.400 --> 0:17:16.879 sort of sixty five, And of course what that means 0:17:17.040 --> 0:17:20.520 is that we expect them to be available and they 0:17:20.560 --> 0:17:25.200 are generally to be providing liquidity robustly throughout the trading day. 0:17:25.240 --> 0:17:29.880 But what we have is a problem that liquidity can 0:17:29.920 --> 0:17:33.000 disappear just when we need it the most. In other words, 0:17:33.320 --> 0:17:37.679 that the market participants here, the automated trader and HFT 0:17:37.800 --> 0:17:40.360 traders as well as the primary dealers, have no incentive 0:17:40.760 --> 0:17:44.760 to remain on the market when conditions get stressed. Rather, 0:17:45.400 --> 0:17:48.280 these folks now are competing with one another. Right. Whereas 0:17:48.280 --> 0:17:52.240 primary dealers dominated for much of the treasury market history, 0:17:52.400 --> 0:17:56.000 right recent history. Now the competition with primary dealers in 0:17:56.000 --> 0:17:58.400 the inter dealer space means that they've been pushed out. 0:17:58.800 --> 0:18:01.399 Their margins are smaller, they're no longer the biggest players, 0:18:01.400 --> 0:18:03.720 who don't have as much skin in the game in 0:18:03.760 --> 0:18:08.439 this marketplace that they traditionally have done. And HFC experts, uh, 0:18:08.520 --> 0:18:12.920 you know, these traders tend to operate which much leaner operations. 0:18:12.960 --> 0:18:15.840 Their balance sheets are smaller. Um they are there. They 0:18:15.840 --> 0:18:18.919 are they are more nimble, they are securities forms. They 0:18:18.960 --> 0:18:22.000 don't tend to be the banks, right, and so there 0:18:22.080 --> 0:18:25.800 is no incentive for folks to remain because age super 0:18:25.880 --> 0:18:29.399 costly to be there. They're competing with each other, and 0:18:29.400 --> 0:18:34.560 when conditions get stressed, the algorithms may not perform as 0:18:35.000 --> 0:18:38.880 perfectly as they normally should, and so in those situations 0:18:38.920 --> 0:18:43.200 it makes more sense to exit or reduce your participation, 0:18:43.400 --> 0:18:45.680 or to reduce the market depth that which you participate, 0:18:45.760 --> 0:18:48.199 or to reposition yourself um to the back of the 0:18:48.280 --> 0:18:52.080 queue rather than necessarily be there to forth rightly provide liquidity. 0:18:52.080 --> 0:18:54.679 And that's what we've seen time and time again in 0:18:54.720 --> 0:18:59.440 these episodes. In March, for example, we saw we saw 0:19:00.080 --> 0:19:03.719 HFT traders rather pull back quite drastically, very sharply in 0:19:03.760 --> 0:19:07.160 the context of that that March episode. In this most 0:19:07.200 --> 0:19:10.480 recent episode in February, it was just a general pullback. Right. 0:19:10.520 --> 0:19:13.360 In this case, the primary dealers to the auction went horribly. 0:19:13.800 --> 0:19:16.040 As you know, one of your colleagues, List McCormick has 0:19:16.040 --> 0:19:19.040 written about so wonderfully recently, right that the auction went 0:19:19.080 --> 0:19:21.960 horribly and there was just a general pullback and liquidity 0:19:22.000 --> 0:19:24.960 at that at that at that moment. And so the 0:19:25.040 --> 0:19:27.959 liquidity looks great on its surface on a normal day, 0:19:27.960 --> 0:19:31.240 it looks beautiful and wonderful. But when it's time for 0:19:31.320 --> 0:19:33.280 the rubbert to hit the road and when it's time 0:19:33.280 --> 0:19:36.200 for stress, I think that's when we have the greatest 0:19:36.359 --> 0:19:40.760 fear that it might disappear, causing these liquidity bouts to 0:19:40.800 --> 0:19:44.560 happen and causing for prices to dislocate. And I think 0:19:44.640 --> 0:19:47.719 what's really, really, really kind of horrifying for me as 0:19:47.800 --> 0:19:50.280 a as a as a as a person that studies 0:19:50.280 --> 0:19:52.240 this market, and for all of us really that need 0:19:52.320 --> 0:19:55.520 this market is that the treasury market is supposed to 0:19:55.640 --> 0:20:00.399 perform exactly during periods of stress, right, it says the 0:20:00.440 --> 0:20:03.919 market that's a little bit countercyclical. In other words, that 0:20:03.960 --> 0:20:08.520 when everything is going cluster is in the normal market. 0:20:09.040 --> 0:20:12.119 This is the market that's supposed to stand up and 0:20:12.200 --> 0:20:14.920 to be there and to be resilient and to provide 0:20:14.920 --> 0:20:16.800 liquidity so that when we all rush in there in 0:20:16.800 --> 0:20:19.119 our flight to safety, we're going to have the trading 0:20:19.160 --> 0:20:24.000 opportunities we need either to buy or sell. Mhm. So, 0:20:24.800 --> 0:20:26.680 just on that note, can you talk a little bit 0:20:26.680 --> 0:20:30.399 more about the role of the primary dealers here, because 0:20:30.440 --> 0:20:33.840 in theory, they're supposed to be, you know, the big 0:20:33.880 --> 0:20:38.359 market maker um in the treasury market, and there's a 0:20:38.400 --> 0:20:42.760 suggestion that because of various post crisis rules and trends, 0:20:42.800 --> 0:20:45.119 they've sort of retreated from the market. And then, I 0:20:45.119 --> 0:20:47.399 guess my second question is based on what you just 0:20:47.440 --> 0:20:51.439 said about h f T s retreating from the market 0:20:51.560 --> 0:20:54.359 at precisely the moment where you would want to have 0:20:54.480 --> 0:20:57.720 them there to provide liquidity. Is the answer that you 0:20:58.400 --> 0:21:03.679 somehow force primary dealers and other market makers to intermediate, 0:21:03.840 --> 0:21:08.320 and how would you actually go about doing that? Yeah, 0:21:08.359 --> 0:21:10.520 I'm so glad you asked that, Tracy, I mean on 0:21:10.640 --> 0:21:13.000 on the on the first part, the role of the 0:21:13.000 --> 0:21:16.399 primary dealers here is super interesting because as you said, 0:21:16.480 --> 0:21:20.119 they've been involved throughout these folks have been they have 0:21:20.200 --> 0:21:22.840 relied upon in the auction space, as we know, they 0:21:23.359 --> 0:21:26.040 have traditionally been relied on in the secondary market, and 0:21:26.040 --> 0:21:28.800 they do dominate in the dealers to decline space. So 0:21:28.840 --> 0:21:31.800 there is one space, which is where the clients interact 0:21:31.880 --> 0:21:33.840 with the treasury market when we are able to go, 0:21:33.920 --> 0:21:35.800 when we have the big institutions and they're able to 0:21:35.840 --> 0:21:37.760 go and buy and sell treasuries, the mutual funds, the 0:21:37.760 --> 0:21:40.600 hedge funds, the foreign governments and others that are able 0:21:40.600 --> 0:21:43.600 to obtain treasuries through the dealer to client market, and 0:21:43.640 --> 0:21:46.520 that is still dominated by the primary dealers. And again 0:21:46.560 --> 0:21:49.160 that's the market with around three hundred billion dollars worth 0:21:49.160 --> 0:21:52.439 of daily turnovers. So it is a it is a 0:21:52.520 --> 0:21:56.159 solid component that we rely on for primary dealers to 0:21:56.240 --> 0:21:58.960 take care of, which is this dealers decline space, which 0:21:59.000 --> 0:22:01.280 is still very much in ot see space and bilateral 0:22:01.520 --> 0:22:04.760 space in which primary dealers are the key players. Now 0:22:04.760 --> 0:22:07.960 their retreat as it were, competitively is really happened in 0:22:08.000 --> 0:22:10.679 the intero dealers space, and so you know, one question 0:22:10.720 --> 0:22:12.919 to ask is what's their skin in the game in 0:22:12.960 --> 0:22:16.240 the market at present, And it's an interesting question because 0:22:16.720 --> 0:22:20.040 they are facing balance sheet pressures. You guys had a 0:22:20.080 --> 0:22:22.800 triffic podcast a couple of weeks ago with Saltan pots 0:22:22.800 --> 0:22:25.920 Are on the SLR issue and other issues um that 0:22:26.040 --> 0:22:30.119 discuss the balance sheet pressures on primary dealers in the 0:22:30.160 --> 0:22:32.919 treasury market. And certainly there has been a lot of 0:22:33.000 --> 0:22:37.760 commentary here that the post crisis reforms following Dodd Frank 0:22:38.560 --> 0:22:42.520 have put pressure on primary dealer balance sheets. And the 0:22:42.560 --> 0:22:46.359 other thing to appreciate here is that primate dealers are 0:22:46.400 --> 0:22:50.120 also extremely active in the repo market right and they're 0:22:50.160 --> 0:22:54.119 extremely active in the much larger repo market where US 0:22:54.160 --> 0:22:58.800 treasuries are now post crisis, the preferred form of collateral. 0:22:59.280 --> 0:23:03.040 So these folks, you're facing tremendous pressures on a daily 0:23:03.080 --> 0:23:07.440 basis to maintain the function of the treasury market where 0:23:07.440 --> 0:23:10.720 trillions of dollars of treasuries the essentially locked up as collateral, 0:23:11.200 --> 0:23:14.439 as well as to have treasuries and cash available to 0:23:14.480 --> 0:23:16.919 intermediate in the dealer's decline, as well as in the 0:23:17.119 --> 0:23:19.080