Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Allawatt and I'm Joe. Wi isn't thal Joe?
Speaker 1: Do you ever think about US treasuries? Yeah? Every day,
Speaker 1: that's like on ironically, first thing get up in the morning,
Speaker 1: think about treasuries. Absolutely. Yeah, I mean treasuries are sort
Speaker 1: of the thing that the entire market is revolving around
Speaker 1: at the moment, Like, there's so many things that are
Speaker 1: correlated with yields. But I guess let me frame that
Speaker 1: question a bit differently. Do you ever think about what
Speaker 1: a treasury actually is? Yeah? I mean I don't have
Speaker 1: a strong like intuitions about it, but I kind of
Speaker 1: feel that, Yeah I do, But you know, I'm always
Speaker 1: up for learning more. Yeah. Um, well, that's what we're
Speaker 1: going to be doing in this episode. And I think
Speaker 1: it's an important topic. I mean, it's obviously an important topic.
Speaker 1: But one of the reasons it's worth looking into is
Speaker 1: because I think most people tend to think of a
Speaker 1: U S treasury as you know, it's a bond issued
Speaker 1: by the US government, it's unlikely to default, it acts
Speaker 1: as a sort of safe asset in the financial system.
Speaker 1: There's one other aspect of US treasuries that doesn't get
Speaker 1: as much attention. And that's the fact that it's supposed
Speaker 1: to be this huge and liquid market that's really easy
Speaker 1: to trade. Yeah, I mean, so you ask, like, what
Speaker 1: what is a treasure? And how I think about it?
Speaker 1: And at some level I really do think it's almost
Speaker 1: like it's like the fundamental building block of the entire
Speaker 1: global financial system is the deepest market. It is the
Speaker 1: most liquid market. It has no credit risk, um, you
Speaker 1: know for the most part, and so the price there's
Speaker 1: like a purity to the price. But as as liquid
Speaker 1: as it is, everyone's in a law all and despite
Speaker 1: the fact that it should be like the simplest thing
Speaker 1: to trade, every once in a while it kind of
Speaker 1: breaks in this weird way and nothing of her good
Speaker 1: happened if the treasury market is breaking. Yeah, that's right.
Speaker 1: So we've had these big moments of disruption in the
Speaker 1: treasury market. Recently, we had, um, well, the big one
Speaker 1: was the March mayhem in the market when a bunch
Speaker 1: of lever trades blew up. But most recently we had
Speaker 1: the yield spike in February, and you know, way before that,
Speaker 1: we had the repo madness in September I think it
Speaker 1: was twenty nineteen, and then we had the the flash
Speaker 1: crash in US treasuries back in although maybe something around
Speaker 1: there I should say up crash because yields went down. Yeah, okay,
Speaker 1: But the point is that these sort of disruptions keep happening,
Speaker 1: and they're happening in a really important market, as you said,
Speaker 1: and in a market that's supposed us to be liquid
Speaker 1: and easy to trade, and yet it seems to be
Speaker 1: seizing up every once in a while. So that's what
Speaker 1: we're going to talk about today. Great, I can't wait. No,
Speaker 1: it's a it's a fascinating question because why the safest
Speaker 1: most liquid asset in the world, which in theory the
Speaker 1: Federal Reserve, could you know, stands ready to buy you know,
Speaker 1: in theory at any moment, why it should ever sees
Speaker 1: up is sort of this like mystery to me, like
Speaker 1: I don't quite get why it should ever happen, but
Speaker 1: it clearly happens enough that something's going on. A twenty
Speaker 1: one trillion dollar mystery. Yes, all right, well we have
Speaker 1: the that's the size of the U. S Treasury market.
Speaker 1: By the way, we have the perfect person to discuss
Speaker 1: all of this. Our guest for this episode is Yeesha
Speaker 1: yead If. She's a professor of law over at Vanderbilt
Speaker 1: Law School, and she's done a ton of research on
Speaker 1: exactly this topic. So Yesha, welcome to the show. Tracy
Speaker 1: and Joe, thank you so very much for having me
Speaker 1: such a pleasure to be here, UM, and particularly to
Speaker 1: get to talk to you about US Asian markets. What
Speaker 1: can be more exciting than that? Nothing? I agree, alright,
Speaker 1: So maybe just to begin with, I mean, I just
Speaker 1: listed some recent um, let's say, conniptions in the U. S.
Speaker 1: Treasury market. It feels to me like these are happening
Speaker 1: more often. But you know, I haven't gone back and
Speaker 1: looked throughout all of the market's history, Is that right? Like,
Speaker 1: do you think this sort of random bouts of volatility
Speaker 1: is happening more often? It certainly feels that way, Tracy,
Speaker 1: it really does. UM. I think one of the things
Speaker 1: that has been happening in the U. S. Treasury market, UM,
Speaker 1: is that this market structure has changed really profoundly over
Speaker 1: the last decade or so. UM. So this used to
Speaker 1: be known. I think UM across the market is being
Speaker 1: a really super boring space. This was really the market
Speaker 1: in which UM the trading would happen over the counter
Speaker 1: by telephone, using screens, requests for quotes and so on
Speaker 1: and so forth. It was slow UM. It was just
Speaker 1: very steady market where nothing would be seem like it
Speaker 1: could go wrong. And it was essentially dominated by the
Speaker 1: primary dealers UM that were the keen to mejories in
Speaker 1: the space, both in the primary as well as in
Speaker 1: the secondary market. UM. And what we've seen over the
Speaker 1: last decade or so, and you and your colleagues at
Speaker 1: Bloomberg have reported extensively on this UM, it's really this
Speaker 1: change in market structure that has affected how this market
Speaker 1: is working UM, that has affected UM, the risks that
Speaker 1: are impacting this market, as well as also the quality
Speaker 1: of the liquidity provision that is coming into this market
Speaker 1: and how resilient this liquidity provision is UM. And that
Speaker 1: change really has been UM. This emergence as it has
Speaker 1: been across the entire UH marketplace pretty much the emergence
Speaker 1: of high frequency trading in the inter dealer space in
Speaker 1: the secondary market, which has really become the dominant form
Speaker 1: of liquidity vision UM. And what has happened here obviously
Speaker 1: means that primary dealers in hf T traders now are
Speaker 1: competing a lot more fiercely. There's a great deal more
Speaker 1: technology that is coming to bear in the U S
Speaker 1: treasury market is no longer the sleepy space full of telephones.
Speaker 1: This is a marketplace that is in motion all the time.
Speaker 1: And as a result of that, we have new risks,
Speaker 1: we have a new dynamics that are impacting the space.
Speaker 1: But the essential point here is that none of this
Speaker 1: is really that new, because it's been happening in the
Speaker 1: equities and gervities markets for a whole hell of a
Speaker 1: long time, similar um disappearances of liquidity, flash crashes, many
Speaker 1: flash crashes, and so on and so forth. But now
Speaker 1: these are happening in the US treasury markets exactly as
Speaker 1: we would expect because we've seen it in equity in gervitives,
Speaker 1: but unfortunately in the US treasuries we just haven't been
Speaker 1: focusing on it, and so it's really taken us by surprise.
Speaker 1: And so really it feels like this is happening more often.
Speaker 1: So I want to get in, you know, we want
Speaker 1: to get into obviously, like what this new structure looks
Speaker 1: like and why it's not as a resilient or robust
Speaker 1: as the old sleepier structure. But before we do that,
Speaker 1: what do we just zoom out for a second, and
Speaker 1: what don't you tell us about your work and the
Speaker 1: sort of you know, trade to mention you're at the
Speaker 1: law school. What is the lens with which you come
Speaker 1: to this problem from? And uh seek to sort of
Speaker 1: understand problems and solutions. You know, thanks to that question, Joe,
Speaker 1: because you know I wonder that myself sometimes, because you
Speaker 1: know this is this is I'm a law professor. I remember,
Speaker 1: really boring law professor A strudy market structure and the
Speaker 1: regulation of market structure. And for the longest time folks
Speaker 1: have been very pollyanish about us treasure market structure, in
Speaker 1: other words, that it will always work. M This will
Speaker 1: be the most resilient, most robust market structure anywhere in
Speaker 1: the world. As you said, Tracy, that and Joe that
Speaker 1: this is the deepest most quid market in the world.
Speaker 1: That is a standard spiel that we see every single
Speaker 1: time we have a report from the regulators. This is
Speaker 1: the deepest, most liquid market in the world. And so
Speaker 1: you might wonder why it is A law professor really
Speaker 1: would want to look at this because what we do
Speaker 1: is look for problems, right, That's our job. The U
Speaker 1: S Truasure market structure. When I started studying it, you know,
Speaker 1: I was bowled over. Um. I was coming at it
Speaker 1: from the regulatory stide. I wanted to understand how this
Speaker 1: market is regulated. I wanted to see if that regulation
Speaker 1: is fit for the job that is doing today, which
Speaker 1: is regulating this extremely important as well as technologically advancing market.
Speaker 1: And what I discovered there was a complete shock. The
Speaker 1: paradigm by which this market is regulated is like none other,
Speaker 1: UM in our space. The regulatory structure I think deserves
Speaker 1: a conversation because it is really feels like it does
Speaker 1: not work. Um, it is just not set to work.
Speaker 1: This regulatory structure, the public structure as well as the
Speaker 1: private structure, in some sense just leaves in nor miss gaps.
Speaker 1: And the reason for those gaps possibly stems from the
Speaker 1: belief that this market will be perfect and will always
Speaker 1: perform and it's completely risk free. And so regulators, I feel,
Speaker 1: have really taken their eye off the ball, and that
Speaker 1: structure that we have in place today really just does
Speaker 1: not exist to function to regulate a marketplace and to
Speaker 1: match the marketplace that we have today, um, and so
Speaker 1: it should not be surprising that we're seeing some of
Speaker 1: these connections, Stracy said, happening with ever greater regularity because
Speaker 1: some of the guard rails that have been put in
Speaker 1: place in other markets just don't exist in treasuries, right,
Speaker 1: and so it should not be surprising to us that
Speaker 1: this is happening. You know. One of the things that
Speaker 1: that you guys mentioned was in relation to the flash
Speaker 1: crash and the flash rally in two thousand and fourteen,
Speaker 1: and that's really set off this kind of regulatory circumspection, UM,
Speaker 1: this reflection on US treasury markets. And I think that's
Speaker 1: when regulators discovered that this market actually has a whole
Speaker 1: bunch of risks that they never knew exist that and
Speaker 1: that they had to come to this space with a
Speaker 1: greater degree of deliberation and intention that they have done historically.
Speaker 1: But it also showed that the regulatory structure that we
Speaker 1: have today is really not set to do the job
Speaker 1: that we expected to. And the reason for that is
Speaker 1: that this market structure for regulating the public structure for
Speaker 1: regulating US treasury markets is extremely fragmented, Unlike every other market,
Speaker 1: like equities, observatives. This market does not have a lead regulator.
Speaker 1: There is no one person that is policing this market.
Speaker 1: We have a fragmented, loose association of four or five
Speaker 1: superstar regulators, the big top regulators for the marketplace, but
Speaker 1: none of them has elite status. Right So the US,
Speaker 1: the US Treasury, Um, the New York FED, they are
Speaker 1: responsible in the auction space. We have the sec UM
Speaker 1: and FINRA that are taking care of the securities market
Speaker 1: firms that trade in this space. We have the FED
Speaker 1: to reserve the fat in the o c C that
Speaker 1: look after the bands that are the main dealers in
Speaker 1: this space. And so everyone is sharing a little bit
Speaker 1: of the authority. And that can be great because they
Speaker 1: bring their expertise and their insights into the space. But
Speaker 1: equally it means that no one person always has incentive
Speaker 1: to come forward and take a lead and set an
Speaker 1: agenda and coordinate information costs. You have to share information,
Speaker 1: you have to develop a plan for enforcement and reform.
Speaker 1: And so we should not be surprised that rulemaking that
Speaker 1: is taken for granted in other markets just does not
Speaker 1: happen in US treasuries. It just hasn't happened in US treasuries,
Speaker 1: And perhaps the starkest example of that is the lack
Speaker 1: of information in this market. Right. So up until two
Speaker 1: thousand and seventeen, and you guys are you know you
Speaker 1: report on markets? You know this stuff? You are you
Speaker 1: know you are steeped in this stuff. It's shocking, I
Speaker 1: think for all of us to do this. It discovered it.
Speaker 1: Up until two thousand and seventeen, there was no mandatory
Speaker 1: secondary reporting regime portrayed in US treasuries, right, And that
Speaker 1: is kind of shocking. And what that means is that
Speaker 1: regulators have not had information to figure out what exactly
Speaker 1: is happening in secondary market activity on a granular basis.
Speaker 1: And it's you know, comes as no surprise that it
Speaker 1: took a year to figure out what the flash rally
Speaker 1: was about, and even then into the two thousand and
Speaker 1: fourteen flash rally, and even then they did not have
Speaker 1: a conclusion. We still don't fully know what caused marsh twenty,
Speaker 1: the blowout that you were mentioning, the march madness, Tracy Um.
Speaker 1: And the reason for so much of that is that
Speaker 1: this market does not have comprehensive data, It does not
Speaker 1: have granular reporting even today, Um sorry, can I jump
Speaker 1: in there, because this is something I wanted to ask you. So,
Speaker 1: given the lack of transparency in the US treasury market,
Speaker 1: you know, even though it's the sort of bedrock of
Speaker 1: the financial system, we don't quite know what's going on
Speaker 1: with it at all times, how do we actually measure
Speaker 1: treasury market liquidity? Like, what do you look at in
Speaker 1: your research? I'm curious because everyone has different definitions of
Speaker 1: ease of trading? So what are you watching and how
Speaker 1: has it sort of evolved over time? Yeah, I mean
Speaker 1: that's a that's a terrific question. It's a twenty one
Speaker 1: trillion dollar question. In fact, it's a six billion dollar
Speaker 1: question a daily basis, because that's that's the liquidity that
Speaker 1: is coursing through the treasury secondary market in a daily basis,
Speaker 1: compared to around five hundred billion in the equity space. Right,
Speaker 1: So this is supposedly a market in which we have
Speaker 1: six hundred billion odd I think that was March one. Rather,
Speaker 1: you know, we have twenty six hundred billion dollars worth
Speaker 1: of liquidity. Course in this market every day liquidity is
Speaker 1: hard to measure. But the idea here is that you
Speaker 1: should be able to trade without causing price impacts. Right,
Speaker 1: particularly in this market, you should be able to make
Speaker 1: large trades without there are being a price impact in
Speaker 1: the market structure. That is exactly what we're not seeing.
Speaker 1: So in the context of the blowout in February, for example,
Speaker 1: we saw that the five year and the seven year
Speaker 1: UH tenor just incredible amounts of movement in the spreads
Speaker 1: in just a very short period of time, and that
Speaker 1: was due to liquidity concerns. In the case of March,
Speaker 1: we saw enormous prices locations that were happening because liquidity
Speaker 1: in this market disappeared. And what that means is that
Speaker 1: that the price changes are not happening because of fundamental
Speaker 1: informational changes. Right. So of course we expect volatility takes
Speaker 1: that's in the marketplace because information will affect how price
Speaker 1: changes happen. But in the treasury market, we should not
Speaker 1: expect these price changes to happen because the market is
Speaker 1: becoming a liquid because dealers are not there to supply
Speaker 1: trading opportunities constantly throughout the trading day. Liquidity in this
Speaker 1: market should be taken for granted, so that the price
Speaker 1: changes that are happening are big. Is even informational and
Speaker 1: fundamental issues rather than because of liquidity issues, because they're
Speaker 1: not enough trading opportunities for buyers to have sellers and
Speaker 1: sellers to have buyers. So really, that's how I understand
Speaker 1: it that we are that we are relying on a
Speaker 1: marketplace that is supposed to be responding to information, not
Speaker 1: a marketplace that should be responding to disappearances of trading opportunity.
Speaker 1: So talk us through because in theory, you know, you
Speaker 1: describe the old sleepy treasury market of the dealer community
Speaker 1: and a lot of it being done by phone, and
Speaker 1: now we have this sort of like I guess richer
Speaker 1: treasury ecosystem and shifts and hedge funds and inter dealer
Speaker 1: trading and all that stuff in theory and think, okay,
Speaker 1: more participants, different preferences that would make it more liquid.
Speaker 1: So what is the failure between theory and practice such
Speaker 1: that even though there is this sort of you know,
Speaker 1: a whole like flora and fauna of treasury participants, it
Speaker 1: doesn't translate automatically to uh, greater liquidity. And we do
Speaker 1: seem to see this rise of dislocations, like what are
Speaker 1: the leading theories for why? Basically, yeah, that's an awesome question, Joe,
Speaker 1: and you know, I think it's one that perplexes regulators
Speaker 1: and perplexes market participants because exactly as you said, you
Speaker 1: look at the market and you know there are there's
Speaker 1: three hundred billion dollars worth of daily trading in the
Speaker 1: inter dealer space, which is the super liquid space with
Speaker 1: dealers are trading with each other, and on a normal day,
Speaker 1: that liquidity seems so incredible, it seems so lush and
Speaker 1: robust because we do have the primary dealers ELM, we
Speaker 1: do have these brand new high frequency traders that are
Speaker 1: expansively providing liquidity throughout the trading day. Now, the HFT
Speaker 1: participation in the US inter dealer spaces around is around
Speaker 1: sort of sixty five, And of course what that means
Speaker 1: is that we expect them to be available and they
Speaker 1: are generally to be providing liquidity robustly throughout the trading day.
Speaker 1: But what we have is a problem that liquidity can
Speaker 1: disappear just when we need it the most. In other words,
Speaker 1: that the market participants here, the automated trader and HFT
Speaker 1: traders as well as the primary dealers, have no incentive
Speaker 1: to remain on the market when conditions get stressed. Rather,
Speaker 1: these folks now are competing with one another. Right. Whereas
Speaker 1: primary dealers dominated for much of the treasury market history,
Speaker 1: right recent history. Now the competition with primary dealers in
Speaker 1: the inter dealer space means that they've been pushed out.
Speaker 1: Their margins are smaller, they're no longer the biggest players,
Speaker 1: who don't have as much skin in the game in
Speaker 1: this marketplace that they traditionally have done. And HFC experts, uh,
Speaker 1: you know, these traders tend to operate which much leaner operations.
Speaker 1: Their balance sheets are smaller. Um they are there. They
Speaker 1: are they are more nimble, they are securities forms. They
Speaker 1: don't tend to be the banks, right, and so there
Speaker 1: is no incentive for folks to remain because age super
Speaker 1: costly to be there. They're competing with each other, and
Speaker 1: when conditions get stressed, the algorithms may not perform as
Speaker 1: perfectly as they normally should, and so in those situations
Speaker 1: it makes more sense to exit or reduce your participation,
Speaker 1: or to reduce the market depth that which you participate,
Speaker 1: or to reposition yourself um to the back of the
Speaker 1: queue rather than necessarily be there to forth rightly provide liquidity.
Speaker 1: And that's what we've seen time and time again in
Speaker 1: these episodes. In March, for example, we saw we saw
Speaker 1: HFT traders rather pull back quite drastically, very sharply in
Speaker 1: the context of that that March episode. In this most
Speaker 1: recent episode in February, it was just a general pullback. Right.
Speaker 1: In this case, the primary dealers to the auction went horribly.
Speaker 1: As you know, one of your colleagues, List McCormick has
Speaker 1: written about so wonderfully recently, right that the auction went
Speaker 1: horribly and there was just a general pullback and liquidity
Speaker 1: at that at that at that moment. And so the
Speaker 1: liquidity looks great on its surface on a normal day,
Speaker 1: it looks beautiful and wonderful. But when it's time for
Speaker 1: the rubbert to hit the road and when it's time
Speaker 1: for stress, I think that's when we have the greatest
Speaker 1: fear that it might disappear, causing these liquidity bouts to
Speaker 1: happen and causing for prices to dislocate. And I think
Speaker 1: what's really, really, really kind of horrifying for me as
Speaker 1: a as a as a as a person that studies
Speaker 1: this market, and for all of us really that need
Speaker 1: this market is that the treasury market is supposed to
Speaker 1: perform exactly during periods of stress, right, it says the
Speaker 1: market that's a little bit countercyclical. In other words, that
Speaker 1: when everything is going cluster is in the normal market.
Speaker 1: This is the market that's supposed to stand up and
Speaker 1: to be there and to be resilient and to provide
Speaker 1: liquidity so that when we all rush in there in
Speaker 1: our flight to safety, we're going to have the trading
Speaker 1: opportunities we need either to buy or sell. Mhm. So,
Speaker 1: just on that note, can you talk a little bit
Speaker 1: more about the role of the primary dealers here, because
Speaker 1: in theory, they're supposed to be, you know, the big
Speaker 1: market maker um in the treasury market, and there's a
Speaker 1: suggestion that because of various post crisis rules and trends,
Speaker 1: they've sort of retreated from the market. And then, I
Speaker 1: guess my second question is based on what you just
Speaker 1: said about h f T s retreating from the market
Speaker 1: at precisely the moment where you would want to have
Speaker 1: them there to provide liquidity. Is the answer that you
Speaker 1: somehow force primary dealers and other market makers to intermediate,
Speaker 1: and how would you actually go about doing that? Yeah,
Speaker 1: I'm so glad you asked that, Tracy, I mean on
Speaker 1: on the on the first part, the role of the
Speaker 1: primary dealers here is super interesting because as you said,
Speaker 1: they've been involved throughout these folks have been they have
Speaker 1: relied upon in the auction space, as we know, they
Speaker 1: have traditionally been relied on in the secondary market, and
Speaker 1: they do dominate in the dealers to decline space. So
Speaker 1: there is one space, which is where the clients interact
Speaker 1: with the treasury market when we are able to go,
Speaker 1: when we have the big institutions and they're able to
Speaker 1: go and buy and sell treasuries, the mutual funds, the
Speaker 1: hedge funds, the foreign governments and others that are able
Speaker 1: to obtain treasuries through the dealer to client market, and
Speaker 1: that is still dominated by the primary dealers. And again
Speaker 1: that's the market with around three hundred billion dollars worth
Speaker 1: of daily turnovers. So it is a it is a
Speaker 1: solid component that we rely on for primary dealers to
Speaker 1: take care of, which is this dealers decline space, which
Speaker 1: is still very much in ot see space and bilateral
Speaker 1: space in which primary dealers are the key players. Now
Speaker 1: their retreat as it were, competitively is really happened in
Speaker 1: the intero dealers space, and so you know, one question
Speaker 1: to ask is what's their skin in the game in
Speaker 1: the market at present, And it's an interesting question because
Speaker 1: they are facing balance sheet pressures. You guys had a
Speaker 1: triffic podcast a couple of weeks ago with Saltan pots
Speaker 1: Are on the SLR issue and other issues um that
Speaker 1: discuss the balance sheet pressures on primary dealers in the
Speaker 1: treasury market. And certainly there has been a lot of
Speaker 1: commentary here that the post crisis reforms following Dodd Frank
Speaker 1: have put pressure on primary dealer balance sheets. And the
Speaker 1: other thing to appreciate here is that primate dealers are
Speaker 1: also extremely active in the repo market right and they're
Speaker 1: extremely active in the much larger repo market where US
Speaker 1: treasuries are now post crisis, the preferred form of collateral.
Speaker 1: So these folks, you're facing tremendous pressures on a daily
Speaker 1: basis to maintain the function of the treasury market where
Speaker 1: trillions of dollars of treasuries the essentially locked up as collateral,
Speaker 1: as well as to have treasuries and cash available to
Speaker 1: intermediate in the dealer's decline, as well as in the
Speaker 1: inter dealer space as well as obviously in the auction
Speaker 1: space to the extent they need cash to purchase on
Speaker 1: a regular basis, So there are tremendous balance sheet pressures there.
Speaker 1: And as you discussed in the episode a couple of
Speaker 1: weeks ago, you do have the SLR issue that is
Speaker 1: now we have an answer to that, but you also
Speaker 1: have other regulations like that gesup charge. That means that
Speaker 1: there is a constant balancing that is happening here, which
Speaker 1: can be a little scary sometimes during crisis periods because
Speaker 1: you don't know if primary dealers have the balance sheet
Speaker 1: space to come in there and provide liquidity, to come
Speaker 1: in there and provide cash if they need to. And
Speaker 1: that is something that we need to worry about when
Speaker 1: it comes to understanding the liquidity of this market under stress.
Speaker 1: And so one thing you asked the second part of
Speaker 1: your question, Tracy, which I think is a really brilliant
Speaker 1: question on that policy side, which is what do we
Speaker 1: do do we have what are afformative market making obligations
Speaker 1: attaching to both HF the key h F T players
Speaker 1: as well as the primary dealers, And I think that's
Speaker 1: a that should be an idea on the table. In
Speaker 1: other words, do we go back to the idea that
Speaker 1: was prevalent in the equity market, for example, UM in
Speaker 1: the eighties and nineties, that you have these afformative market
Speaker 1: makers that always provide liquidity, that trade against the wind
Speaker 1: if they have to, UM, that promised to stay on
Speaker 1: the market, to trade even during times of stress. Do
Speaker 1: we do that today in the treasury market because it's
Speaker 1: more important and I think it's a good idea to
Speaker 1: have on the table. The interesting question here is how
Speaker 1: it links back to your first question, which is this
Speaker 1: balance sheet space for primary dealers UM as well as
Speaker 1: HFT folks who are who do have these thinner, smaller
Speaker 1: balance sheets. In general, do these institutions today have the
Speaker 1: elasticity in their balance sheets to be able to perform
Speaker 1: in the event of a crisis and the event that
Speaker 1: they are subject to informative market making because that is
Speaker 1: expensive us as you can imagine. Let me let me
Speaker 1: jump in there, because this brings to mind a question
Speaker 1: I've been thinking about. So you've talked about the sort
Speaker 1: of the fragmentation of regulation in this space. There isn't
Speaker 1: a single clear regulator, but something I've been thinking about
Speaker 1: and the sort of the tensions that led up to
Speaker 1: the SLR decision. It was sort of around this is
Speaker 1: this sort of like intersection between post GFC regulatory decisions
Speaker 1: versus macro policy. So you have these determinations, it's like, Okay,
Speaker 1: banks have to hold a certain amount of liquid assets
Speaker 1: and have a certain amount of capital and so forth.
Speaker 1: On the other hand, you have the FED making um
Speaker 1: non regulatory macro decisions that even time about the size
Speaker 1: of its balance sheet asset purchases, UH for you know,
Speaker 1: for broader hitting its dual policy goals. How much is
Speaker 1: the tension uh emerged from the fact that these regulatory
Speaker 1: decisions that were made about bank balance sheets didn't necessarily
Speaker 1: anticipate a decade of very expanded FED balance sheet, multiple
Speaker 1: rounds of asset purchases, very heavy treasury issuance on a
Speaker 1: historical scale. And it's sort of essentially this sort of
Speaker 1: like collision course between two different priorities. It's a great question,
Speaker 1: and unfortunately I'm gonna you know, I'm gonna do it
Speaker 1: my law sheets do which is take a pass on
Speaker 1: this one, because you know it's not you know, it's
Speaker 1: it's it's such a tough one because I think you
Speaker 1: know what I what I think has been happening here
Speaker 1: and which your question really speaks to, is that we
Speaker 1: don't have the regulatory picture as fully as we do
Speaker 1: want it to be there, right, so we're making decisions
Speaker 1: without necessarily seeing the full parts of the elephant. And
Speaker 1: so obviously we come in after the two thou and
Speaker 1: ten crisis clearly wanting to make bank balance sheets as
Speaker 1: robust as possible. Right, of course we want to do that.
Speaker 1: Of course we need to do that. And then of
Speaker 1: course we also want to make sure the repo market
Speaker 1: is as secure as possible. So we you know, so
Speaker 1: we we try and make this market is dependent on
Speaker 1: treasuries as possible with respect of the collateralization of this market.
Speaker 1: And guess what, that's exactly what's happened, right, So sixty
Speaker 1: seven percent or sixty eight percent of the market in
Speaker 1: the Bilagal report market is now collateralized by treasurey. It's
Speaker 1: even higher in the reverse report market around So of course,
Speaker 1: you know, we've done a good job there to make
Speaker 1: these markets SA. On the other hand, we still require
Speaker 1: on the we still require the nuts and boats of
Speaker 1: intermediation to be provided, and so we need the primary
Speaker 1: dealers to have the elasticity in their balance sheets to
Speaker 1: be able to do that. And then on the other side,
Speaker 1: we have this incredibly dynamic macro picture in which, as
Speaker 1: you said, QUEI FED purchases. Um, we just have this
Speaker 1: really interesting global picture also emerging with respect to the
Speaker 1: role of the US and the role of Treasury and
Speaker 1: the role of the dollar that is happening. We have
Speaker 1: so many factors to consider here, but what is missing
Speaker 1: is a regulatory structure that can do that job. The FED,
Speaker 1: the Treasury, the CFTC and others are all fragmented. In
Speaker 1: the treasury space, The f STOCK, the Financial Stability Oversight
Speaker 1: Council created in the wake of Dot Frank that could
Speaker 1: coordinate doesn't coordinate in this space. So we're not having
Speaker 1: the conversation that you want us to have, Joe, which
Speaker 1: is being able to try and put these pictures together. Um.
Speaker 1: And so you know, for that reason, I feel like
Speaker 1: I have to take a past because there is no
Speaker 1: real coherence to the approach that we have such that
Speaker 1: trying to find a trying to find a a narrative
Speaker 1: that can explain the interactions is really difficult. You mentioned
Speaker 1: the REPO market there, And um, I wanted to get
Speaker 1: your thoughts on repo market reform because it feels like
Speaker 1: this was on the radar immediately after the financial crisis
Speaker 1: because so much of you know, the two thousand eight
Speaker 1: housing bubble sort of emanated from trouble in the repo market.
Speaker 1: A lot of trades were collateralized with you know, sub
Speaker 1: prime structured finance A B S and stuff like that,
Speaker 1: and then it all went awry. But it also feels
Speaker 1: like the repo market hasn't changed all that much, like
Speaker 1: the the nature of the collateral has changed, but the
Speaker 1: actual functioning, if anything, seems to have become more concentrated
Speaker 1: on one or two key players. Um, what are your
Speaker 1: thoughts there and how does the report market fit into
Speaker 1: your overall research on treasuries? Great, So, the report market
Speaker 1: is mammoth. It's extremely important, and it's a market in
Speaker 1: which the daily consumption of treasuries in cash changes incredibly
Speaker 1: differently on a on on a daily basis, Right, So
Speaker 1: the needs of this market on a daily basis diverge
Speaker 1: sharply from one week to the next, as we saw
Speaker 1: in the case of the September as An incident September
Speaker 1: two incident. The report market is liable still to sudden
Speaker 1: disappearances in its liquidity and its functioning. UM. I have
Speaker 1: a trific colleague at Vanderbout Morgan Rix who has written
Speaker 1: about a report market reform from the structural perspective to
Speaker 1: try and shore up some of the cash like aspects
Speaker 1: of this market. But as you said, right, the attention
Speaker 1: on the report market and on report market reform has
Speaker 1: really has really disappeared, right. UM, we have not been
Speaker 1: focusing on what we should do to make this market
Speaker 1: secure to deal with the fact that it's still fragile.
Speaker 1: Um that it does change in a week by week
Speaker 1: basis that the consumption of treasuries in cash does change.
Speaker 1: One of the proposals that's been on the table for
Speaker 1: both the secondary market as well as for the report
Speaker 1: market is in relation to central clearing, right, which is
Speaker 1: trying to bring in a greater degree of clearing into
Speaker 1: the space. We do have some we have the tri
Speaker 1: party report market that does have some clearing arrangements, and
Speaker 1: whether or not we should think about making clearing more
Speaker 1: systematically a part of this as well as the secondary
Speaker 1: market in treasury. So that is one idea that has
Speaker 1: been on the table. But again, as you say, you know,
Speaker 1: the question is this market has become enormous. It is
Speaker 1: a market in which we are intermediating around six trillion
Speaker 1: dollars worth every single day to meet the daily financial
Speaker 1: needs or financial farms across the system. So trying to
Speaker 1: get this into a clearinghouse even is something that does
Speaker 1: feel slightly intimidating and haunting and scary um and possibly
Speaker 1: something that we could talk about in this conversation. But
Speaker 1: it does feel like it's become a problem from the
Speaker 1: structural standpoint that maybe has become a little too big
Speaker 1: to address at this point. So it feels like we're
Speaker 1: going on like we've done before and really using the
Speaker 1: fact of treasuries as being the performed form of collateral
Speaker 1: to provide the safety that we need in this market.
Speaker 1: In otherwise, in other words, we're looking to collateralization as
Speaker 1: the means of securing this market rather than structural reform
Speaker 1: as my colleagues have talked about, or you know, moving
Speaker 1: into central clearing as a way to try and protect
Speaker 1: this market against us. Can you just you mentioned that
Speaker 1: central clearing and can you sort of just spell out
Speaker 1: the basic idea of what that would theoretically look like
Speaker 1: in the treasury market and what the I don't know,
Speaker 1: drawbacks of that would be. Yeah, I'm so glad you
Speaker 1: asked that, Joe, because you know, clearing, clearing is clearing
Speaker 1: is this amazing thing that we have in our securities markets, right,
Speaker 1: clearing houses are as I'm sure I thought of your
Speaker 1: listeners know, this is the fundamental structure in our market
Speaker 1: that protects all of us and that we hardly ever
Speaker 1: get to see. And that's a good thing. So essentially,
Speaker 1: you know, central clearing houses, they are the guardians of
Speaker 1: the market. They protect us against counterparty risk failure that
Speaker 1: the counterparty trading what will not provide the securities of
Speaker 1: the cash that you need. And in return, what clearing
Speaker 1: houses do is that they have a whole bunch of
Speaker 1: things that they put in place to keep the keep
Speaker 1: themselves and the market safe. In other words, they make
Speaker 1: sure that the folks participating in the market provide collateral margin,
Speaker 1: that they have procedures in place to share losses between
Speaker 1: their members. Um, but the clearing house is well resourced
Speaker 1: in case even their their members don't have the resources
Speaker 1: that they need. So this is the structures that's design
Speaker 1: that's designed to absorb and buffer risk, and for the
Speaker 1: most part it works really well. But as you might expect,
Speaker 1: this is a structure that's also just incredibly too big
Speaker 1: to fail, and it's one that has grown in its
Speaker 1: footprint following Dot Frank as we rely on clearing houses
Speaker 1: much more systematically to protect the gervatives and swaps market.
Speaker 1: So the idea here has been and Darryl Daffie and
Speaker 1: others have have have thought about to try and bring
Speaker 1: central clearing into the U S. Treasuries market, and I
Speaker 1: think it's a it's a terrific idea, but I think
Speaker 1: if we take a step back, it's worth while noting
Speaker 1: that clearing does actually exist in the U S. Treasury markets. Unfortunately,
Speaker 1: the clearing in this market, as it does exist, is
Speaker 1: a hot mess. So we do have central clearing in
Speaker 1: a in the U S. Treasury market, but it's a
Speaker 1: completely hodge podge and confusing system. Central clearing does exist
Speaker 1: when you have say two dealers to primary dealers for example,
Speaker 1: that trade with one another, but it does not exist
Speaker 1: or you will not get central clearing when you have
Speaker 1: saying eight two hift s trading with one another. So
Speaker 1: this is a patchwork of clearing that exists in the U. S.
Speaker 1: Treasury market, and unfortunately that's a disaster Joe. That is
Speaker 1: like the worst off the two worlds that we could
Speaker 1: possibly imagine. In other words, we have a clearinghouse that
Speaker 1: exists that partially clears US treasuries. I think there was
Speaker 1: a terrific treasure market Treasury Practice Markets Group report UM
Speaker 1: in two thousand and eighteen, I think that dealt with
Speaker 1: clearing in the U. S. Treasury markets, and what it
Speaker 1: described was that approximately seventy five of the thing the
Speaker 1: inter dealer market is not essentially cleared, but t is.
Speaker 1: And so you can imagine the risks of that that
Speaker 1: the clearing house does not have a full picture of
Speaker 1: what the risks in this market are. That market participants
Speaker 1: who are members of the clearinghouse don't have a full
Speaker 1: picture of what is happening in this market will kind
Speaker 1: of risk the clearinghouse faces and you don't get the
Speaker 1: benefits of central clearing for the market as a whole um.
Speaker 1: You don't have set off a netting across all these
Speaker 1: secondary market treasury transactions that could reduce the risk of
Speaker 1: the clearing house and individual members space. So this is
Speaker 1: a really confusing and just an unacceptable picture for central
Speaker 1: clearing in US treasuries in the secondary market space at present.
Speaker 1: So you know, the question is whether or not we
Speaker 1: bring central clearing in here, and I think it's a
Speaker 1: solution that needs to be on the table because obviously
Speaker 1: it's one that has worked in other markets. But to
Speaker 1: do this, we need to be extremely careful because we
Speaker 1: are going to be setting up the clearing houses to
Speaker 1: end all clearing houses right for US treasury market function.
Speaker 1: And again, given the counter cyclical aspect of treasury markets,
Speaker 1: that is that they have to work when every other
Speaker 1: market is collapsing, that we really need to make sure
Speaker 1: that this clearing house, over and above every single other
Speaker 1: financial institution in the whole wide galaxy world whatever, is
Speaker 1: the one that is safe enough to protect us. So
Speaker 1: I get the sense from this discussion that a lot
Speaker 1: of the problems that are happening in the treasury market
Speaker 1: um and the weaknesses that you described, like a lot
Speaker 1: of those are the results of similar forces to what
Speaker 1: we've seen in other asset classes. So stocks has gone through,
Speaker 1: you know, its own a bout of electronification. People have
Speaker 1: had the same discussions about whether or not high frequency
Speaker 1: traders actually provide liquidity in stocks and moments of stress.
Speaker 1: But and and to some extent, you know, corporate bonds
Speaker 1: are sort of going through this as well. But I
Speaker 1: guess my question is, like, is the problem that the
Speaker 1: treasury market is encountering these issues that aren't necessarily specific
Speaker 1: to treasures? But the difficulty is that regulatory fragmentation that
Speaker 1: you describe before. Is that a fair way of thinking
Speaker 1: about it, Like, this is not necessarily a treasury market
Speaker 1: specific problem, but the thing that makes it bad is
Speaker 1: the fact that no one's responsible for it, and no
Speaker 1: one's looking at it in a holistic way. Exactly. I
Speaker 1: feel like you just wrote a law of your article, Tracy.
Speaker 1: I think that was that was that was the perfect
Speaker 1: that was the perfect summary there. That's exactly what you know.
Speaker 1: That at least to me, that seems to be the
Speaker 1: problem that we have exactly as you said, seeing these
Speaker 1: phenomena before in other markets. Post two thousand and ten
Speaker 1: with the flash crash, regulators went through an incredible degree
Speaker 1: of investigation and research, and the SEC and the CFTC
Speaker 1: did such a great job in collating a whole amount
Speaker 1: of research and doing the analysis, doing a bunch of rulemaking,
Speaker 1: so we saw systems compliance and integrity, for example, the
Speaker 1: SEC rule, direct market access. All of these different rules
Speaker 1: come into place did trying to shore up the resiliency
Speaker 1: of a highly automated, super fast market structure. And for
Speaker 1: the most part, these reforms have done a great job
Speaker 1: in making this market more resilient, more robust. I think,
Speaker 1: you know, we've gone through periods of volatility, We've gone
Speaker 1: through periods of extreme stress, and that market structure has
Speaker 1: held up. Unfortunately, US Treasury market, even these very very
Speaker 1: basic reforms just to safeguard the resiliency of the trading
Speaker 1: infrastructure just haven't happened, right, They just haven't taken place.
Speaker 1: And the X factor that I that I that I
Speaker 1: put some of this blame at is this super fragmented
Speaker 1: regulator model that we have in the U S Treasury market.
Speaker 1: It's unsurprising that regulatory updating in this market is so
Speaker 1: thin because we have to get a lot of regulators,
Speaker 1: big busy regulators in the same room to talk about
Speaker 1: these issues, to share information, to come up with the
Speaker 1: plan to coordinate. There are a whole bunch of costs
Speaker 1: that just don't exist for the regulators that are primary
Speaker 1: regulators and other markets. They can act essentially with enormous
Speaker 1: amounts of power, control and deference given to their actions
Speaker 1: in the equity space with the SEC, or in the
Speaker 1: gersy space with the CFTC in the treasury markets. However,
Speaker 1: they have to come together to coordinate, and there are
Speaker 1: barriers here to their coordination. So, for example, there have
Speaker 1: been difficulties between regulators and sharing information. There are institutional
Speaker 1: constraints that they have in providing fulsom information to each other.
Speaker 1: In addition, we're dealing with regulators that have very different
Speaker 1: approaches at times. Right, So the FAT in the New
Speaker 1: York FED and the o c C. These are prudential regulators.
Speaker 1: They are designed to safeguard the safety and soundness of
Speaker 1: the financial system in general. That doesn't mean that that
Speaker 1: that means that they don't love the idea of a
Speaker 1: whole bunch of disclosure in the market to tell everyone
Speaker 1: what the skeletons in this market might be, as it
Speaker 1: might create some conditions for a systemic run for a
Speaker 1: problem to happen in that market space. On the other hand,
Speaker 1: we have the cft you see in Finnver that are
Speaker 1: that are the securities markets. Regulators, they are much more
Speaker 1: into creating these super liquid markets just disclosure and transparency
Speaker 1: in these other factors. So we have differences in approach,
Speaker 1: we have differences in agency mandates. We have the need
Speaker 1: for all of these institutions to come together to develop
Speaker 1: a plan. And it should not be any surprise whatsoever
Speaker 1: that we just haven't seen the kind of rulemaking that
Speaker 1: we have in other markets. So I'm not saying that
Speaker 1: we have, you know, a huge amount of regulation here
Speaker 1: that that's not That's not what I'm saying. What I'm
Speaker 1: saying is that we at least need to have a
Speaker 1: regulatory structure in place that is geared towards providing even
Speaker 1: the most basic reforms that how are tried and tested
Speaker 1: in other markets, that work in other markets, but that
Speaker 1: are sadly missing in US treasuries, and that leave this
Speaker 1: market therefore very vulnerable the systematic fragility. Yes, thank you
Speaker 1: so much for coming on. That was Thank you guys
Speaker 1: so much for having me. I just completely I wish
Speaker 1: you could have seen me in my little room. My
Speaker 1: arms are boiling everywhere. I was going crazy. You know,
Speaker 1: you have such great questions, and you know I could
Speaker 1: talk to you guys for like another hour like this
Speaker 1: is you know, this is so cool. We'll definitely have
Speaker 1: to do it again. Yeah, I would love it. And
Speaker 1: thank you guys so much. I mean, it was so cool.
Speaker 1: Your questions were just brilliant. You're writing. Some of the
Speaker 1: reporting that you guys do has been so important to
Speaker 1: the writing I've done. I could not have got the
Speaker 1: information and insights I did without that. Um and honestly,
Speaker 1: I just have so much fun. I just thank you
Speaker 1: so much. That's great. Thank you so Joe. I thought
Speaker 1: that was really fascinating conversation and such an important one because,
Speaker 1: as you laid out at the very beginning, this is
Speaker 1: an ultra significant market for well, for the entire market,
Speaker 1: and it's sort of the thing on which everything else rests.
Speaker 1: It's the you know, the benchmark risk free rate, and
Speaker 1: and there is this assumption, I mean you should touched
Speaker 1: on it. There is an assumption that in times of trouble,
Speaker 1: you should be able to liquidate a risk position and
Speaker 1: trade it for something considered safe, which you know would
Speaker 1: usually be a U. S. Treasury bond. And if the
Speaker 1: market can't serve that function, it seems like that's a
Speaker 1: bit of a problem. Yeah. Absolutely, Like this idea that's like, okay,
Speaker 1: like in times, you know, normal times, treasury trading is fine,
Speaker 1: and higher volatility times actually you know, victorizes treasury trading
Speaker 1: is still probably fine. But then this idea that's like
Speaker 1: you hit some new threshold with the volatility in last
Speaker 1: March was the clear example, get so high that this
Speaker 1: sort of like safety veilve market that exists out there,
Speaker 1: even it starts to break, then it becomes a real
Speaker 1: problem and can't sort of perform the I guess countercyclical
Speaker 1: function the hope it would. Of course we had to.
Speaker 1: We saw the FED step in last year. It definitely
Speaker 1: seems like if they're that level, whenever it is, we
Speaker 1: don't hit it that often, but we seem to hit
Speaker 1: it enough that it's, uh, you know that it's an
Speaker 1: issue that needs addressing. Yeah. Absolutely, And it is kind
Speaker 1: of frightening that, as we discussed, we still don't know
Speaker 1: exactly why these volatility issues keep propping up or you know,
Speaker 1: why we are getting these moments of drama in the market,
Speaker 1: and that's kind of I mean, that's a little bit
Speaker 1: frightening because it is this twenty one trillion dollar market
Speaker 1: um that kind of touches on everything else. It seems
Speaker 1: weird that people aren't um more dedicated to tracking it
Speaker 1: and sort of figuring out what's going on. But I
Speaker 1: guess that speaks to the regulatory fragmentation that Yesha was describing.
Speaker 1: It still seems like they're is more that, like, I
Speaker 1: don't know, maybe the FED could do to treat treasuries
Speaker 1: as a true risk free asset. And I know we
Speaker 1: talked about this a little bit in our discussion with
Speaker 1: Josh Younger, but obviously reserves are sort of like the
Speaker 1: ultimate ultimate risk free asset because they're all fungible, they're
Speaker 1: all identical, and treasuries are close. But because they have
Speaker 1: different liquidity h questions and different maturities and stuff, they're
Speaker 1: not quite the same. But it still feels like perhaps
Speaker 1: there could be more done, such that like a standing
Speaker 1: reverse repo facility something such that at any time someone
Speaker 1: can be guaranteed by the government to get a liquid
Speaker 1: cash for their treasuries. It seems like that could be
Speaker 1: part of the answer. But that's just that's just my
Speaker 1: that's just to take no, no, no. I think you're right,
Speaker 1: and I think it does feel like the FED is
Speaker 1: taking more of an interest or UM I guess, a
Speaker 1: more proactive approach to the treasury market overall. Like it.
Speaker 1: So I've said before that like I think the treasury
Speaker 1: like smooth functioning of the treasury market is now a
Speaker 1: sort of unspoken UM priority, if not target for the
Speaker 1: FED UM And I think that's right, and I think
Speaker 1: they're going to be looking at it more and more
Speaker 1: as these issues crop up. Yeah, no, and it should be.
Speaker 1: I mean, look at you know, the the the entire
Speaker 1: Yode curve as I see it, should be understood as
Speaker 1: a policy instrument, and you have like the shortest lowest
Speaker 1: duration assets are reserves and the longest duration like way
Speaker 1: out on the curve. But it always an expression of policy.
Speaker 1: And I think this gets to the question that I
Speaker 1: asked about, like this sort of intersection between macro policy
Speaker 1: and regulatory policy, because you know, it's all right, we're
Speaker 1: running large deficits, because we're running countercyclical fiscal policy right now,
Speaker 1: we're running a large balance sheet policy on the part
Speaker 1: of the FED. So at some level, the regulative the
Speaker 1: regulatory regime has to acknowledge that the fiscal and monetary
Speaker 1: regime needs to use these tools from time to time
Speaker 1: and sort of recognize that. But again, I guess that
Speaker 1: guests to the answer of like, well, who is the
Speaker 1: individual regulator that's going to make that call? And we
Speaker 1: still don't have that? Yeah, all right, Um, shall we
Speaker 1: leave it there? Yeah? Leave it there? Alright. This has
Speaker 1: been another episode of the All Thoughts Podcast. I'm Tracy Halloway.
Speaker 1: You can follow me on Twitter at Tracy Halloway and
Speaker 1: I'm Joe Wisn't though. You can follow me on Twitter
Speaker 1: at the Stalwart. Follow our producer Laura Carlson. She's at
Speaker 1: Laura M. Carlson. Followed the Bloomberg head of podcast francesco
Speaker 1: Lead at Francesca Today, and check out all of our
Speaker 1: podcasts at Bloomberg under the handle A Podcast. Thanks for
Speaker 1: listening to A