WEBVTT - Fabio Natalucci on How to Think About Financial Risk Right Now 0:00:10.680 --> 0:00:14.319 Hello, and welcome to a special episode of the Odd 0:00:14.360 --> 0:00:18.560 Thoughts podcast. I'm Tracy Alloway, I'm Joe Wisenthal. So this 0:00:18.640 --> 0:00:20.919 is a live recording that we are doing at the 0:00:20.960 --> 0:00:24.279 Credit Market Structure Alliance Conference. We are going to be 0:00:24.320 --> 0:00:28.760 talking about one of the thorniest, most controversial topics in 0:00:29.040 --> 0:00:34.159 financial markets. And it's not compensation, it's liquidity, right, and 0:00:34.280 --> 0:00:36.960 so obviously, you know, it's kind of a wild year 0:00:37.120 --> 0:00:41.199 for markets overall. In two I guess markets have been 0:00:41.240 --> 0:00:44.640 a little bit more constructive calm so far to start, 0:00:46.040 --> 0:00:48.479 but like I mean, I think it's still pretty clear 0:00:48.520 --> 0:00:50.879 that people are like anxious about like what are what 0:00:50.960 --> 0:00:53.920 are the various risks lurking out there, particularly like coming 0:00:53.920 --> 0:00:57.240 off such a big pricing of interest rates and such 0:00:57.240 --> 0:01:00.760 an uncertain macro environment, That's exactly. And we have had 0:01:00.880 --> 0:01:05.240 instances where liquidity risk has reared its head recently, notably 0:01:05.600 --> 0:01:08.240 with some real estate funds based in the UK that 0:01:08.319 --> 0:01:12.440 had to suspend redemptions that prompted a well known question 0:01:12.480 --> 0:01:14.720 of whether or not we should actually have these liquid 0:01:14.760 --> 0:01:17.200 assets in a liquid wrapper. So we are going to 0:01:17.280 --> 0:01:20.680 be delving into all of that with really the perfect guest. 0:01:20.880 --> 0:01:23.240 We are going to be speaking with Fabio natal Lucci. 0:01:23.400 --> 0:01:26.360 He is the Deputy Director of the Monetary and Capital 0:01:26.400 --> 0:01:30.640 Markets Department at the International Monetary Fund. He's responsible for 0:01:30.680 --> 0:01:33.440 the Global Financial Stability Report that the i m F 0:01:33.520 --> 0:01:36.959 puts out every year. Previously at the Fed and the Treasury. 0:01:37.040 --> 0:01:39.479 So really the perfect guest, Fabio, Thank you so much 0:01:39.480 --> 0:01:44.240 for coming on. Thanks. Um. So, maybe a very simple question. 0:01:44.440 --> 0:01:46.880 It seems like a simple question just to begin with, 0:01:47.360 --> 0:01:52.360 but it never is. What is liquidity? So liquidity and 0:01:52.520 --> 0:01:54.960 I think we're talking about market liquid here, not liquidly 0:01:55.000 --> 0:01:58.400 on the balancial banks, but essentially is the ability to 0:01:58.920 --> 0:02:03.080 uh liquid by in a position at market prices they know, 0:02:03.280 --> 0:02:07.520 at a price that doesn't move or dual ow prices significantly, 0:02:07.560 --> 0:02:09.919 so you can do it quickly, you can do without 0:02:10.000 --> 0:02:13.200 much market impact, so you can essentially refi a position 0:02:13.240 --> 0:02:16.200 without having a major impact on the overall market. So 0:02:16.919 --> 0:02:20.160 you know, I mentioned that in the interio was kind 0:02:20.160 --> 0:02:23.880 of a wild year for multiple asset classes, etcetera. Why 0:02:23.919 --> 0:02:27.760 and large though not too much broke, right, I mean 0:02:27.800 --> 0:02:30.320 I think like so you have the looking back, it 0:02:30.360 --> 0:02:32.400 feels like it could have been worse. So this is 0:02:32.440 --> 0:02:34.480 the big question, right, So if you work in financials 0:02:34.560 --> 0:02:36.960 a bility now and you say, okay, if someone told 0:02:36.960 --> 0:02:39.200 you a year ago that the Federals are would raise 0:02:39.360 --> 0:02:44.080 interest rate four under fifty business points under business points, Uh, 0:02:44.440 --> 0:02:46.320 do you think he would have worked smoothly or what 0:02:46.400 --> 0:02:49.040 would have broke? And I think the answer you would 0:02:49.080 --> 0:02:52.720 be looking for praising things that they were something didn't 0:02:52.760 --> 0:02:56.640 work right now. There were some instances, I think so 0:02:56.760 --> 0:03:00.360 the pension l D. I think in the okay, it 0:03:00.400 --> 0:03:06.960 was a good example of liquidity problem interacting with leverage problem. Right, 0:03:07.000 --> 0:03:10.240 so that's a combinational to vulnerabilities that amplify each other. 0:03:11.360 --> 0:03:13.880 Of course, the trigger of the shock was very unique. 0:03:13.919 --> 0:03:17.519 It was a physical policy shock that it's kind of 0:03:17.680 --> 0:03:20.200 US incretic if you want. There was some other example 0:03:20.280 --> 0:03:24.320 like a Korean as ber securities market, but generally speaking, 0:03:24.360 --> 0:03:26.480 particularly focus in the US, I think things have gone 0:03:27.200 --> 0:03:29.600 pretty smoothly, which if you work on the other side 0:03:29.639 --> 0:03:31.560 you need to worry about risk. Then the question is 0:03:31.600 --> 0:03:36.240 like did I miss something? All the system is really 0:03:36.240 --> 0:03:39.920 more resilient, and I should feel comfortable, and it's always uncomfortable. 0:03:40.040 --> 0:03:43.480 Feel comfortable. So well, this is something that I always 0:03:43.480 --> 0:03:46.640 like to ask regulators, which is so much of so 0:03:46.720 --> 0:03:48.920 much of the financial stability risk seems to be in 0:03:48.960 --> 0:03:51.920 things that we don't see coming. So given that we've 0:03:51.920 --> 0:03:54.920 been talking about liquidity risk for you know, probably eight 0:03:55.000 --> 0:03:57.360 or ten years at this point, like should we be 0:03:57.480 --> 0:04:00.240 looking at something else or do you think the problem 0:04:00.320 --> 0:04:02.720 has largely been solved? So the way if I'm at 0:04:02.760 --> 0:04:04.880 for a second thing, how we think about financial stability 0:04:04.880 --> 0:04:07.200 of the fund right, so we don't try to forecast 0:04:07.280 --> 0:04:09.000 what the next shock could be. So I think I 0:04:09.000 --> 0:04:11.720 would admiss all of them. Right if you think about Cowvid, 0:04:11.880 --> 0:04:14.360 that's not what probably wasn't my top lists the war, 0:04:14.880 --> 0:04:16.359 So I don't want to be in that business. I 0:04:16.360 --> 0:04:18.480 think what we can do and we try to do, 0:04:18.960 --> 0:04:21.120 is to figure out what are the vulnerabilities. I think 0:04:21.160 --> 0:04:23.680 of vulnerability is an amplifier that there's any shock that 0:04:23.800 --> 0:04:26.040 hit whatever that is, and then there are fragilities in 0:04:26.080 --> 0:04:28.560 the financial system and make the shock bigger. And so 0:04:28.680 --> 0:04:30.760 we have some sort of like metrics where we look 0:04:30.760 --> 0:04:36.120 at different sectors, so the sovereign debt for example, household corporations, banks, 0:04:36.160 --> 0:04:38.839 and then when we call non bank financial institutions, and 0:04:38.839 --> 0:04:41.960 then we look at different vulnerabilities. So liquidly it's one 0:04:42.000 --> 0:04:45.160 of them, or lack of liquidity leverage. Financial leverage is 0:04:45.200 --> 0:04:49.360 another one. Effects exposure or interconnections between the system and 0:04:49.360 --> 0:04:52.480 then we try to fill the metrics based on the 0:04:52.560 --> 0:04:55.039 data we have and we do this for the twenty 0:04:55.160 --> 0:04:58.040 nine time important countries and we track them over time. 0:04:58.640 --> 0:05:01.520 So liquidit it's one of them. Again, there were example 0:05:01.640 --> 0:05:04.160 like the Dash for cash in was a good example 0:05:04.200 --> 0:05:07.080 and involved the specific entity in the non bank financial 0:05:07.080 --> 0:05:10.120 intermediation sector. There was the l d I in the UK. 0:05:10.240 --> 0:05:13.440 It's a combination of liquidity and leverage. There was Archegos 0:05:13.560 --> 0:05:17.400 is another example. I think more of financial leverage perhaps interconnectness. 0:05:17.440 --> 0:05:20.599 So those are the things we're looking at. But again, um, 0:05:20.839 --> 0:05:23.359 the thing to me the biggest puzzle now is financial leverage. 0:05:23.360 --> 0:05:26.159 There's a lot of talks of leverage position being unwound 0:05:26.200 --> 0:05:30.400 and resolates more higher volatilitarizes, but you don't really see 0:05:30.440 --> 0:05:33.000 the system breaking. So again it's see that because it's 0:05:33.040 --> 0:05:35.600 been the financial egolators have done a great job for 0:05:35.839 --> 0:05:39.800 financial crisis, or maybe we're missing something they're like, think 0:05:39.839 --> 0:05:41.680 of the l d I in the UK. Maybe this 0:05:41.800 --> 0:05:44.160 is like a tramore that it's under the surface and 0:05:44.640 --> 0:05:46.760 we don't see it, but something else may break. That's 0:05:46.760 --> 0:05:49.119 the biggest concern at this point, that we're missing something 0:05:49.120 --> 0:05:51.240 and we're not looking the right place. So I do 0:05:51.320 --> 0:05:53.919 think that, like at the start of two, if you 0:05:53.960 --> 0:05:55.480 had sent to someone, Okay, the FED is going to 0:05:55.600 --> 0:05:59.159 hike for your fifty basis points, and by and large 0:05:59.320 --> 0:06:01.000 things would be would like I think that would be 0:06:01.000 --> 0:06:04.040 surprising for a number of reasons. Everyone had become used 0:06:04.080 --> 0:06:09.160 to zero de facto zero interest rate. It was dramatic 0:06:09.240 --> 0:06:13.800 hiking by any standards. Let's start like, how would you 0:06:13.960 --> 0:06:18.599 like to what degree would you say that the smoothness 0:06:18.640 --> 0:06:21.880 of markets last year can be attributed to post grade 0:06:21.920 --> 0:06:26.240 financial crisis reforms? So I think that's certainly an aspect 0:06:26.240 --> 0:06:29.600 of that. Right, So the financial post financial crisis regulation, 0:06:30.320 --> 0:06:33.160 in my view, most certainly made the system the core 0:06:33.200 --> 0:06:35.760 of the systems. So the banking sector more rezilient, right, 0:06:35.839 --> 0:06:39.080 the more liquidity, the more capital, the resolution plans a 0:06:39.120 --> 0:06:42.039 bunch of feature that made like, if you want the 0:06:42.040 --> 0:06:45.160 fortress of the financial system safer, there is can move 0:06:45.240 --> 0:06:47.359 away from there. And they moved towards we called the 0:06:47.440 --> 0:06:49.680 nba FI or non bank Financial Institution. I think of 0:06:49.720 --> 0:06:53.640 that as hedge funds, investment funds, solving wealth fund, pension 0:06:53.640 --> 0:06:57.119 insurance um and part of it, I think it's okay 0:06:57.160 --> 0:07:00.960 because they have different risk profile, the different investment aizing, 0:07:01.080 --> 0:07:04.880 different investment funding structure, and so part of it is fine. 0:07:04.920 --> 0:07:08.599 The question is one whether we have visibility into this 0:07:08.680 --> 0:07:11.040 corner of the financial system, right, So do I can 0:07:11.080 --> 0:07:13.280 I actually assess the same way I would assess a bank, 0:07:13.320 --> 0:07:15.800 And I think the answer is no, because there is 0:07:15.840 --> 0:07:17.840 a number of data gaps that have to do with 0:07:18.120 --> 0:07:21.840 this institution. Whether this has to do with leverage for example, 0:07:21.880 --> 0:07:23.840 perhaps that's the most difficult one, or even liquid it. 0:07:24.440 --> 0:07:28.320 The other question is are they systemic enough? So suppose 0:07:28.360 --> 0:07:31.000 something goes wrong and the shock gets absorbed by that 0:07:31.200 --> 0:07:34.559 entity in the non bank financial sector, maybe it's okay 0:07:34.600 --> 0:07:37.200 because it's not systemic. You can absorb it doesn't create 0:07:37.200 --> 0:07:42.440 a financial stability even f X, Yeah, in some sense. 0:07:42.760 --> 0:07:44.840 And then the other part is like, is there a 0:07:44.920 --> 0:07:47.320 feedback though into the banking sector right that we have 0:07:47.360 --> 0:07:50.000 no considered right? So Archegos. I think the example there 0:07:50.160 --> 0:07:53.600 was yes that the entity per se perhaps was not systemic, 0:07:53.680 --> 0:07:55.560 but there was so much feedback into the back door 0:07:55.600 --> 0:07:58.440 of the banking sector to prom brokerage for example. Right, 0:07:58.520 --> 0:08:01.480 so that that's kind of with think about it, um, 0:08:01.600 --> 0:08:05.640 I think the reform there are some unfinished business in 0:08:05.680 --> 0:08:10.000 the nonbank financial intermediation performed agenda. Some of it it's 0:08:10.080 --> 0:08:12.640 holds and not being called by their form agenda somewhere 0:08:12.640 --> 0:08:16.480 that to implementation. UM I don't want to just say 0:08:16.520 --> 0:08:18.800 that it's all bad though, and their advantaging positive of 0:08:18.920 --> 0:08:21.560 activity and risk moving to the non bank financial intermediation 0:08:21.640 --> 0:08:26.000 right there again different risk profile, different lendings UH, funding structure, 0:08:26.040 --> 0:08:29.520 different investment horizon UH. And they provide to growth to 0:08:29.680 --> 0:08:33.240 the financial system, provide lending, provide financial services, so that 0:08:33.360 --> 0:08:36.720 part is good. Other reason, and it's not just financial regulation. 0:08:36.920 --> 0:08:39.720 Activities move away from the banks to the non bank 0:08:39.720 --> 0:08:43.600 financial intermediation sector also because of technology, so some changing 0:08:43.640 --> 0:08:46.280 market structure are conducive to being done outside of the 0:08:46.280 --> 0:08:49.720 bank's balance is there too structure they're non nimble enough. 0:08:50.200 --> 0:08:52.959 There are also conjunctual aspect right. So for example, when 0:08:53.000 --> 0:08:56.400 you are at zero interest rate for all ten plus years, 0:08:56.720 --> 0:08:58.840 it's normal and some of the risk cree shuffles around 0:08:58.880 --> 0:09:01.319 their way from the banking sector and then the last one, 0:09:01.360 --> 0:09:05.240 perhaps especially in advance a Gono, the center banks that 0:09:05.320 --> 0:09:09.080 played an important role, people may say too large a 0:09:09.200 --> 0:09:11.400 role in a number of markets, and so that's an 0:09:11.440 --> 0:09:14.120 impact on pricing itself. So there's a number of factor 0:09:14.200 --> 0:09:17.040 I think that contributed to this. Some are positive, some 0:09:17.120 --> 0:09:20.880 are still I think open for assessment. You know, you 0:09:20.920 --> 0:09:24.680 mentioned Archagos, and one thing I often wonder is in 0:09:24.760 --> 0:09:29.360 the market, we talk a lot about excesses and stretched valuations, 0:09:29.440 --> 0:09:32.520 and those seem like bad things, but they don't always 0:09:32.640 --> 0:09:36.480 manifest in terms of financial stability risk except Archaicos was 0:09:36.520 --> 0:09:38.840 actually a really good example of that. So could you 0:09:38.880 --> 0:09:41.560 maybe talk a little bit about how you see, you know, 0:09:41.600 --> 0:09:44.640 on a day when we're talking about financial conditions basically 0:09:44.640 --> 0:09:47.440 going back to where they were before the FED started hiking, 0:09:47.760 --> 0:09:50.560 talk to us about what excess in the market means 0:09:50.640 --> 0:09:53.640 for financial stability. So there's two aspects of this, right, 0:09:53.679 --> 0:09:55.120 So I want us to do that if you want 0:09:55.120 --> 0:09:57.719 to call it like price misalignment or financial conditions are 0:09:57.760 --> 0:10:01.120 too easy compared to the fundamental values. However you measure 0:10:01.120 --> 0:10:05.280 fundamental values, that's one piece. I think that if there 0:10:05.320 --> 0:10:07.880 are is no leverage employed, if there is no major 0:10:08.000 --> 0:10:11.640 liquidly mismatch. No, it's not necessary systemic per set. Someone 0:10:11.679 --> 0:10:13.640 will lose money, someone will make money, but let's not 0:10:13.679 --> 0:10:17.280 part of my job. The concern is when that unwinding 0:10:17.440 --> 0:10:22.120 of financial condition interact with vulnerabilities liquidity or in case 0:10:22.160 --> 0:10:25.520 of our chegos, is financial leverage, right, because then that 0:10:25.600 --> 0:10:28.400 vulnerability becomes a major amplifier. So it's not just that 0:10:28.600 --> 0:10:32.240 risk as surprise risk risk as a reprise is that 0:10:32.240 --> 0:10:35.080 the de leveraging in the case become an amplifier of 0:10:35.080 --> 0:10:37.160 the reprise and I fire yourself. And all the de 0:10:37.240 --> 0:10:40.120 leveraging that we saw during the financial crisis, there was 0:10:40.240 --> 0:10:43.000 that component there. I think there was financial level employed 0:10:43.040 --> 0:10:46.480 through the realtives, through prime brokerage, and the other weak 0:10:46.559 --> 0:10:49.280 link there was that that was provided by banks, right, 0:10:49.320 --> 0:10:51.560 and so there was an entry point into the banking sector. 0:10:51.960 --> 0:10:53.920 That's where I think you need to be super careful 0:10:53.960 --> 0:10:57.720 because for a lot of this financing structure or liquidity provision, 0:10:58.120 --> 0:11:01.200 somehow it touches a balance of back in some formal 0:11:01.320 --> 0:11:04.280 shape somewhere along the chain hits the Boden set of 0:11:04.320 --> 0:11:06.960 the bank. So part of it it's a risk, but 0:11:07.000 --> 0:11:09.480 it's it's an opportunity for the regulativity should be able 0:11:09.520 --> 0:11:21.760 to see it once it touched the bond shield bank. 0:11:25.720 --> 0:11:27.760 You know another thing that I think when I think 0:11:27.760 --> 0:11:30.520 about the last year, maybe the last two years, is 0:11:31.400 --> 0:11:33.920 uh sitting aside the market volatility. There was a lot 0:11:33.960 --> 0:11:36.400 of growth, I mean, and maybe it's just nominal growth. 0:11:36.440 --> 0:11:38.079 But of course with if you have a debt, like 0:11:38.120 --> 0:11:40.880 the most important thing is you get it paid. How 0:11:40.960 --> 0:11:45.000 much does just that maintaining a growing economy, unlike say 0:11:45.120 --> 0:11:47.680 what we saw in the second half of two thou eight, 0:11:48.040 --> 0:11:51.080 how important does that in terms of butchersing financial stability 0:11:51.080 --> 0:11:54.400 is just they're not a lot of people defaulting because 0:11:54.600 --> 0:11:58.199 people have good incomes, whether it's households, low unemployment rates 0:11:58.280 --> 0:12:02.080 or low default rates for corporation. So usually um, the 0:12:02.160 --> 0:12:04.720 one this is how we used to look at the FED. Growth. 0:12:04.720 --> 0:12:07.280 To me, it's a precondition for financials to build it. Right. 0:12:07.320 --> 0:12:10.400 You cannot have franchis debate without you need growth. So 0:12:10.440 --> 0:12:13.120 growth it's really important. And so that growth that came 0:12:13.240 --> 0:12:16.280 off the if you want the procession if you want 0:12:16.280 --> 0:12:18.200 to called the way of the COVID was in part 0:12:18.240 --> 0:12:22.160 because Center Bank stepped in majority. Right, So the FED 0:12:22.240 --> 0:12:24.400 here at a major central bank and ended up back 0:12:24.440 --> 0:12:27.600 stopping the full financial system. If you compare that with 0:12:27.720 --> 0:12:31.359 two thousand and eight, back stopping was faster, more aggressive, 0:12:31.400 --> 0:12:34.840 and wider. U. The other difference with two thousand and 0:12:34.840 --> 0:12:37.080 seven two dosan A was fiscal policy. Right. So if 0:12:37.120 --> 0:12:39.720 you remember the size of the ABAN administration physical plan 0:12:40.000 --> 0:12:42.520 and think about the number of physical measures they've been 0:12:42.559 --> 0:12:45.880 taking the US during COVID and the size of those, right, 0:12:46.400 --> 0:12:49.760 the combination the two easy financial condition plus physical policy 0:12:49.800 --> 0:12:53.560 as turbosh are essentially the economy now. Downside of that 0:12:53.720 --> 0:12:57.199 is I think perhaps we as a community in general, policymaker, 0:12:57.280 --> 0:13:00.120 maybe market so we have been slow to recognize is 0:13:00.160 --> 0:13:04.280 the inflation problem? Right, So because growth was going fast 0:13:04.360 --> 0:13:07.720 and because physical policy and be using that size for 0:13:07.760 --> 0:13:11.600 a while, Um, that's where I think the concern is now, 0:13:11.679 --> 0:13:13.440 and this is why we went into the Tilaning Morning, 0:13:13.480 --> 0:13:15.560 Repolis and so on. So the flip side of that 0:13:15.600 --> 0:13:18.880 fast growth has been inflation at levels that we haven't 0:13:18.880 --> 0:13:22.520 seen since the plate seventy early eighties. Is inflation? How 0:13:22.559 --> 0:13:26.440 does inflation manifest itself in financial stability risks? Yeah, So 0:13:26.520 --> 0:13:28.920 that's that's the risk here, And I think That's why 0:13:29.040 --> 0:13:31.600 priced ability is so important. Is that if you don't 0:13:31.640 --> 0:13:35.240 tackle inflation now, So if you don't let prevent inflationary 0:13:35.280 --> 0:13:38.319 pressure from becoming entrenched into the infression dynamics, so core 0:13:38.360 --> 0:13:43.000 inflation wages and you'll let inflation expectation and more from 0:13:43.040 --> 0:13:45.280 the target is going to be way more expensive to 0:13:45.280 --> 0:13:48.439 bring inflation down. So in sometimes the personally I don't think. 0:13:48.440 --> 0:13:50.200 I think there is in a symmetryn cost here, right, 0:13:50.240 --> 0:13:52.760 So if you say, okay, what's the cost sire? If 0:13:52.800 --> 0:13:56.080 I am tithening not enough for if tithing I'm not 0:13:56.120 --> 0:13:58.480 tithening too much, that's when I think the cost society 0:13:58.480 --> 0:14:00.680 if you're not aggressively approached this. Do you think of 0:14:00.760 --> 0:14:03.400 the late sevent y earlieries in the US, It took 0:14:03.440 --> 0:14:06.800 a lot of high any more other policy bring in 0:14:06.800 --> 0:14:10.360 freshtion down, right, So being proactive and preventing the entrenchment 0:14:10.440 --> 0:14:14.640 and increasing frention in pressing expectation, I think it's crucial 0:14:14.679 --> 0:14:17.080 because you can control it, then you can bring invent 0:14:17.120 --> 0:14:20.760 eventually you can bring race down to a rather I'm 0:14:20.760 --> 0:14:23.160 supposed to go now. Of course, if you do this 0:14:23.280 --> 0:14:27.160 space on which this is done, financial condition tied. If anything. Now, 0:14:27.240 --> 0:14:31.040 the puzzle is why they haven't tied more than otherwise. Right, 0:14:31.640 --> 0:14:33.640 any model that we you run, if you say, okay 0:14:33.680 --> 0:14:36.480 that the frisk free rate moves by four and fifty 0:14:36.480 --> 0:14:40.040 basis point, I think example, at least based on historical relationship, 0:14:40.040 --> 0:14:42.160 will tell you the financial condition should be way tighter. 0:14:42.960 --> 0:14:47.680 I mean, we had merged. It was just the FED, 0:14:48.040 --> 0:14:50.640 you know, in addition to the massive stimulus and or 0:14:50.640 --> 0:14:53.480 a couple other rounds of stimulus afterwards, and then the 0:14:53.520 --> 0:14:56.720 Fed just you know, opening up one acronym after another 0:14:56.920 --> 0:15:00.600 trying to backstop the market. And maybe you know, retrospect 0:15:00.600 --> 0:15:03.520 that contributed to inflation. But was that a sort of 0:15:03.560 --> 0:15:06.880 like you know, from your perspective, it is like this 0:15:06.960 --> 0:15:09.280 is an example of we saw what happened in two 0:15:09.280 --> 0:15:11.120 thousand and eight, two thousand nine when we go slow 0:15:11.160 --> 0:15:14.440 and we let growth collapse, when we've let nominal income collapsed, 0:15:14.640 --> 0:15:18.360 and sort of a successful lesson learned. I have no 0:15:18.440 --> 0:15:20.760 doubt that was successful. I mean the alternative would have 0:15:20.760 --> 0:15:22.640 been like fall into a creator of growth right in 0:15:22.720 --> 0:15:27.280 the Great Procession story. Um. The issue is that that 0:15:27.400 --> 0:15:30.560 response and the easing of financial condition and the build 0:15:30.640 --> 0:15:33.320 up of some of the vulnerability highlighted. Some of the 0:15:33.360 --> 0:15:37.560 reform agenda that you mentioned before has now been addressed. Right. 0:15:37.600 --> 0:15:40.160 So the chapter that we pulled out in last October, 0:15:40.160 --> 0:15:42.440 it was about open end investment fund and that's an example. 0:15:42.600 --> 0:15:45.880 I think a sector where there are liquid in mismatch, right, 0:15:45.920 --> 0:15:50.560 particularly those open and investment fund to have daily redemption 0:15:51.080 --> 0:15:54.120 for a liquidous right think about high you know, corporate 0:15:54.160 --> 0:15:56.960 bond for example, That's where I think there is case 0:15:57.000 --> 0:15:59.760 and that's what we have seen. In March twenty the 0:16:00.000 --> 0:16:04.560 outflows from those open ended funds was about five percent 0:16:04.640 --> 0:16:07.600 of assets. That was larger than during the financial crisis. 0:16:08.120 --> 0:16:11.080 Um and the camera faction of the FED not stepping 0:16:11.080 --> 0:16:13.960 in very quickly and starting to backstop not just quei 0:16:14.320 --> 0:16:17.400 or supporters by back stopping current market would have been 0:16:17.440 --> 0:16:20.120 a much larger decline. A surprises, right. So what we 0:16:20.200 --> 0:16:23.920 show in that chapter, it's one that there is a 0:16:24.000 --> 0:16:27.800 link between the liquidity of the funds and what they hold, right. 0:16:27.840 --> 0:16:30.200 So assets that are held by liquid funds tend to 0:16:30.280 --> 0:16:32.800 drop in prices much more and that there are much 0:16:32.800 --> 0:16:35.960 more volatility in return. So for example, once and the 0:16:36.000 --> 0:16:38.280 deviation shock in the liquidity or some sort of what 0:16:38.360 --> 0:16:42.520 you saw in March twenty increase volatility of return by 0:16:42.880 --> 0:16:45.600 which is a large, significantly large number. And that's where 0:16:45.640 --> 0:16:47.800 I think you need to think about doing what what 0:16:47.840 --> 0:16:50.400 do we need to fit fit in terms of policy agenda, 0:16:50.720 --> 0:16:52.680 is there a whole we need to think about the 0:16:52.800 --> 0:16:57.000 regulatory emiter, what tools do we need? So, just on 0:16:57.080 --> 0:17:00.920 the snow, there is that inherent tension between you know, 0:17:01.000 --> 0:17:04.160 offering someone liquid assets and putting them in some sort 0:17:04.160 --> 0:17:06.359 of liquid wrapper that allows them to go in and 0:17:06.400 --> 0:17:10.640 out on a daily basis. What is the fund's view 0:17:10.800 --> 0:17:12.919 on the best way to deal with that risk? And 0:17:13.000 --> 0:17:16.520 also given what we saw in when the FED effectively 0:17:16.600 --> 0:17:19.880 came in and back stopped not just credit markets but 0:17:20.400 --> 0:17:23.159 the treasury market as well, which is supposed to be 0:17:23.200 --> 0:17:26.160 the most liquid market in the world, Like, does that 0:17:26.240 --> 0:17:30.040 mean was that the endgame problem solved? Central banks back 0:17:30.080 --> 0:17:32.960 stop this and liquidity risk is no longer an issue? No, 0:17:33.200 --> 0:17:35.840 So my personal view is that if you want to 0:17:35.840 --> 0:17:38.080 live in a world where every X number of years 0:17:38.119 --> 0:17:40.200 the center banks needs to step in and back stop 0:17:40.280 --> 0:17:43.680 the financial system and every time push the line one more, 0:17:43.960 --> 0:17:46.359 I think you need to rethink the regulatory perimier. Then, right, 0:17:46.359 --> 0:17:48.720 if you want to be on the perceiving end of 0:17:48.760 --> 0:17:51.399 the financial sector back stop, then the perimer need to 0:17:51.400 --> 0:17:53.439 be different, right, So you need to be within the periment. 0:17:53.480 --> 0:17:56.600 They're not outside the perimid obviously, but there's a different 0:17:56.600 --> 0:17:59.760 way of thinking about financial stabilities because systemic risk at 0:17:59.760 --> 0:18:02.480 that point it right. So the issue here is that 0:18:02.560 --> 0:18:06.680 you're providing dare liquidly when there is underlying a liquid US. Now, 0:18:06.760 --> 0:18:08.919 of course they all liquidly buffer and so on, so 0:18:08.960 --> 0:18:12.520 that's a threshold for period of non stress. Perhaps the 0:18:12.600 --> 0:18:15.439 system is fine, people can have different views. The problem 0:18:15.480 --> 0:18:18.600 is during stress if you eat through the liquidly buffer. Therefore, 0:18:18.680 --> 0:18:21.280 to sell us right, you face redemption. You sell, you 0:18:21.359 --> 0:18:24.840 generally fire yourself. And because of the structure, there is 0:18:24.880 --> 0:18:27.280 an incentive to run first because you're not bearing the 0:18:27.320 --> 0:18:30.640 transaction cost when you get out the way this is designed, 0:18:30.920 --> 0:18:32.720 and so I want to get out the first before 0:18:33.080 --> 0:18:35.639 the market's price are going down essentially the enemy, so 0:18:35.720 --> 0:18:40.560 that generate the run dynamics. That has important systemic implication 0:18:40.600 --> 0:18:43.679 because you go into fire sale and that social cost 0:18:43.800 --> 0:18:46.920 of the first mover is not addressed by the way 0:18:47.119 --> 0:18:50.240 the design of this of these fissures are now so 0:18:51.400 --> 0:18:52.800 what we look at. We look at a bunch of 0:18:52.800 --> 0:18:57.400 possible solution there measure and we did some work across countries. Usually, 0:18:57.400 --> 0:19:00.360 what the most common tools in terms of liquidly risk 0:19:00.400 --> 0:19:04.600 management tools are either suspension obviously or redemption gates or 0:19:04.600 --> 0:19:08.680 redemption fast. Those are pretty much widespread. What is much 0:19:08.800 --> 0:19:12.240 less common is either what because swing prices so essentially 0:19:12.240 --> 0:19:14.800 the ability to incorporates in the price you pay to 0:19:14.880 --> 0:19:18.240 exit of the externality or if you want the transaction 0:19:18.280 --> 0:19:20.800 cause the impose of those sustained the fund. Those are 0:19:20.840 --> 0:19:23.800 not common or not the in in DUS for sure, and 0:19:23.840 --> 0:19:26.760 even in Europe or in some sense they're voluntary. And 0:19:26.800 --> 0:19:28.639 then this open debate of what do you do with 0:19:28.680 --> 0:19:30.680 the liquid buffer? Do they work or not? So what 0:19:30.760 --> 0:19:34.119 we find there is that the liquidity buffer that seems 0:19:34.119 --> 0:19:36.800 to be some relationship between the liquid of the underlying 0:19:36.840 --> 0:19:40.320 and liquid buffer. That is, if you hold more liquid usset, 0:19:40.440 --> 0:19:43.760 you generally on average, tend to have higher liquid buffer. 0:19:44.720 --> 0:19:47.639 The results that's more interesting though, is that one there 0:19:47.720 --> 0:19:50.920 is very widespread use of this liquid buffers. Some when 0:19:50.920 --> 0:19:53.119 you talk to people to in market, some tend to 0:19:53.160 --> 0:19:56.120 actually use them actively. So I'm gonna sell the most 0:19:56.160 --> 0:19:58.600 liquid stuff, use my ready lines and hope for the 0:19:58.640 --> 0:20:01.439 best if you want. Others don't want to touch it 0:20:01.760 --> 0:20:03.520 because they don't know what's coming nest and so they 0:20:03.520 --> 0:20:06.280 start selling less liquid stuff. So there's a very different 0:20:06.600 --> 0:20:09.360 use of this liquidity buffer. But on average at least, 0:20:09.400 --> 0:20:12.960 what we find is that during stress, the average fund 0:20:12.960 --> 0:20:14.800 if you want, tend to grow the relear butter. They 0:20:14.800 --> 0:20:16.040 just don't want to use it. They don't know what 0:20:16.080 --> 0:20:18.919 it's coming. So if that's the case, that is not 0:20:19.040 --> 0:20:22.720 helpful for the example incentive to run right, it doesn't 0:20:22.720 --> 0:20:27.200 prevent that. Swing prices are mostly used in Europe. Again, 0:20:27.240 --> 0:20:29.800 swing prices the ability a century to correct the price 0:20:29.880 --> 0:20:32.480 which you take money out based on this transaction costs 0:20:32.480 --> 0:20:36.040 they impost on others. The problem is in principle they 0:20:36.080 --> 0:20:38.960 are effective to reduce volatility. The problem is that the 0:20:39.000 --> 0:20:41.200 buffer of the swing factor, if you want, how much 0:20:41.240 --> 0:20:43.240 of this is used, is too small compared to what 0:20:43.359 --> 0:20:47.199 would be used, and either because of competitive reason or 0:20:47.280 --> 0:20:50.320 because of stigma, whatever the reason is, they're not calibrated 0:20:50.400 --> 0:20:53.240 to the way that they should be calibrated during stress time. 0:20:53.359 --> 0:20:57.760 At least, another option, which is more extreme if you 0:20:57.800 --> 0:21:01.199 want is to more formally link your ability to exit 0:21:01.280 --> 0:21:04.640 these vehicles from to the liquid of the underlying right. 0:21:04.680 --> 0:21:07.800 So you mentioned the real estate one, they're the liquid. 0:21:07.840 --> 0:21:09.960 It is not daily, right, you only a specific period 0:21:09.960 --> 0:21:13.920 where you can withdraw. Um. If you go into landmark 0:21:14.000 --> 0:21:16.280 in duance and you go back decades, there was no 0:21:16.359 --> 0:21:18.719 daily liquidity. They used to be if I remember correctly, 0:21:18.760 --> 0:21:21.640