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Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.

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Speaker 1: I'm Tracy Alla White and I'm Joe Wisntal So Joe, uh.

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Speaker 1: I know there's a lot to talk about when it

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Speaker 1: comes to the recent market turmoil, but I have to

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Speaker 1: say there is one thing that stands out to me,

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Speaker 1: and that is what we've seen in the U. S. Treasury.

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Speaker 1: Can I just can I just back up for once.

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Speaker 1: I got I just got a thought, you know, it

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Speaker 1: would be funny when well, I don't. I don't know

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Speaker 1: funny it's exactly the right word here. But it would

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Speaker 1: be very interesting to compile a complete compendium of all

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Speaker 1: of our podcast intros over the last couple of months

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Speaker 1: and through this as things get crazier and crazier, because

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Speaker 1: I feel like in the beginning it was like, well,

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Speaker 1: let's talk a little bit about disruptions to a Chinese

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Speaker 1: supply chain, and then we're at the point of let's

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Speaker 1: talk about how suddenly the safest asset in the world

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Speaker 1: is a trading like how it's supposed to be. And

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Speaker 1: I feel like we could track the course of the

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Speaker 1: entire crisis just by comparing our little intros here day

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Speaker 1: after day. So maybe that's a project will do one day. Yeah,

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Speaker 1: definitely not funny, but probably noteworthy, that's for sure. That's funny,

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Speaker 1: but sarkly funny. Maybe. Yeah, I don't know why I'm laughing. Actually,

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Speaker 1: um okay, But you're exactly right, because the crazy thing

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Speaker 1: about the big sell off in the treasury market, people

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Speaker 1: complaining about lack of liquidity in the treasury market, is

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Speaker 1: that it is supposed to be the most liquid market

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Speaker 1: in the world and um a safe asset in times

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Speaker 1: of turmoil. It's supposed to be cash like, and we

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Speaker 1: haven't necessarily seen that over the past few weeks. Right, exactly.

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Speaker 1: This is a very key and important thing to understand,

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Speaker 1: which is that US treasuries, they have the full faith

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Speaker 1: and credit of the United States in a normal stressful scenario,

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Speaker 1: in a normal period where people are worried about the

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Speaker 1: economy or worried about you know whatever, worried about the

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Speaker 1: financial system. Because they are almost they're essentially money, money

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Speaker 1: that pays an interest rate. People tend to buy them,

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Speaker 1: and people tend to hoard them during dark times. But

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Speaker 1: what we've seen in recent weeks is such an extreme

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Speaker 1: dislocation and such extreme anxiety that even an asset that's

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Speaker 1: arguably the safest asset in the world. US treasuries has

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Speaker 1: at times being been gotten sold even at times it's

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Speaker 1: perceived as not being safe enough, and understanding why that

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Speaker 1: is the mechanics of our financial markets, or understanding why

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Speaker 1: there have been periods of stress where they've gotten sold,

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Speaker 1: can really tell us a lot about the plumbing of

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Speaker 1: the US financial system. Well, I think the issue is

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Speaker 1: not only have U S treasuries sold off, but the

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Speaker 1: actual selling process wasn't as smooth as many people might

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Speaker 1: have expected. So for instance, we saw bid ask spreads

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Speaker 1: in off the run treasuries much much higher than they

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Speaker 1: would normally be, but even on the run securities were

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Speaker 1: higher as well, and market depth basically across the treasury

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Speaker 1: curve really plunged all the way back I think to

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Speaker 1: the two thou crisis slows, And as we've discussed on

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Speaker 1: previous episodes, the thing about US treasuries is they're basically

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Speaker 1: the funding market for everything in the global financial system.

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Speaker 1: So if you have trouble in treasuries, if you have

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Speaker 1: a liquidity, and if you have a sell off, then

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Speaker 1: it can feed into all sorts of things, including financial

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Speaker 1: conditions and that's probably the way that it starts to

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Speaker 1: affect the real economy as well. So we're gonna be

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Speaker 1: talking about the U S. Treasury market, We're gonna be

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Speaker 1: talking about plumbing issues. Uh. But the thing to keep

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Speaker 1: in mind is that all of this really im hacks

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Speaker 1: the pain now being felt across and I just want

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Speaker 1: to as we have to do these days. We didn't

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Speaker 1: have used to have to do it so much. But

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Speaker 1: you know, we always have to have this caveat in

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Speaker 1: the beginning of every episode where we point out the

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Speaker 1: exact date that we're recording this, because again, things can

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Speaker 1: change so much by the time recording has happened, so

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Speaker 1: the time people listen to it, we were recording this

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Speaker 1: on Tuesday, March. And I also want to just point

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Speaker 1: out the FED has already done a number of things

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Speaker 1: to ease some of this tension a little bit. So

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Speaker 1: we'll talk a little bit more about what the breakdown was,

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Speaker 1: what the FED has already done to relieve some of

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Speaker 1: these tensions we're seeing in the treasury market, in the

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Speaker 1: funding market, and of course whether it's enough and what

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Speaker 1: that tells us about how the system works. But just again,

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Speaker 1: whenever you're listening to this. Tuesday, March nine am Eastern

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Speaker 1: time is when we're recording this. It's kind of worrying

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Speaker 1: that we have to provide the hour nowadays as well. Yeah,

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Speaker 1: exactly right, Okay, Well, without further ado, we're going to

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Speaker 1: talk to someone who has been on top of a

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Speaker 1: lot of the troubles in the treasury market for some time.

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Speaker 1: He's someone who's research I've been following closely for years now,

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Speaker 1: and I have to say he's really come out on

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Speaker 1: top in the recent volatility. His stuff has been excellent

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Speaker 1: and lots of people are reading it. Josh Younger is

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Speaker 1: a strategist over at JP Morgan. Thanks so much for

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Speaker 1: coming on, Josh. Thanks for having me, Josh. I just

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Speaker 1: wanted to uh, I just for listeners before we get started.

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Speaker 1: Want to point out several people have suggested in the

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Speaker 1: past um that we should have you on, so I'm

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Speaker 1: really excited about this. And of course your name came

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Speaker 1: up in one of our best episodes that we did

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Speaker 1: with Brad Setser where we talked about the Taiwanese life

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Speaker 1: insurers and how they were hedging their currency risk. He

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Speaker 1: mentioned that you were one of the best on this,

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Speaker 1: so you are definitely a sort of a long time

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Speaker 1: high wishless guest for for us a lot of our listeners.

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Speaker 1: So I really appreciate. I'm excited to be I'm a

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Speaker 1: fan of the show, so it's always it's always great

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Speaker 1: to participate. Alright, awesome, So, Josh, just to begin with,

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Speaker 1: I want to start out with the troubles that we've

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Speaker 1: seen in the treasury market. So I spoke a little

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Speaker 1: bit about the liquidity issues, but I wondered if we

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Speaker 1: could maybe zoom in on one thing in particular, which

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Speaker 1: was this notion of levered US treasury trade. So one

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Speaker 1: thing that happened recently in the market sell off was

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Speaker 1: that we suddenly got a big difference between futures contracts

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Speaker 1: for US treasuries and the cash U S treasuries. Can

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Speaker 1: you explain exactly why that happened? Yeah? Sure. So withoud

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Speaker 1: anything like this, a crisis of this magnitude, it always

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Speaker 1: starts in a place you really recognize immediately, and then

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Speaker 1: it accelerates in the place you didn't really expect. And

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Speaker 1: so back in two thousand eight, that was the subprime

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Speaker 1: mortgage market was the accelerant, and in this case the

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Speaker 1: acceller it turned out to be uh, not a not

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Speaker 1: a risky st not credit markets, but but like like

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Speaker 1: you mentioned earlier, you know, risk free assets, things with

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Speaker 1: no credit risk, treasury bonds. And so the question is

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Speaker 1: sort of why was this divergence that you mentioned really important?

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Speaker 1: Of where did it come from? So the initial phase

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Speaker 1: of this was really a shift and fundamental So any

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Speaker 1: economists will tell you that long term interest rates should

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Speaker 1: have a lot to do with long term potential growth

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Speaker 1: and to some extent of flight to quality. And as

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Speaker 1: the as the COVID nineteen outbreak accelerated, there was a

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Speaker 1: real shift in expectations. This is real fundamentals here. You know,

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Speaker 1: growth expectations come down, Uh, the set of risks around

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Speaker 1: those growth expectations increased, and so there was a natural

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Speaker 1: flight quality and interest rates naturally go lower, especially if

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Speaker 1: the Fed starts to cut rates. So the question is,

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Speaker 1: you know, how can you access the market, like how

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Speaker 1: effectively can you access the market. And treasuries have usually

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Speaker 1: been this highly liquid, you know, cash like asset that

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Speaker 1: trades very tight, it ask very low transaction costs. The

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Speaker 1: issue arose really from the initially the velocity of this move,

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Speaker 1: because expectations are changing so rapidly that you had two

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Speaker 1: things happened. The first is it's just very hard to

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Speaker 1: be the buyer to the sellers and the seller to

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Speaker 1: the buyers. If prices are moving around all over the

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Speaker 1: place every day, it's just a very difficult exercise. And

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Speaker 1: so that means your willingness to participate in those transactions

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Speaker 1: is a little less. That's particularly true of high frequency

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Speaker 1: traders who are really trying to monetize the very small

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Speaker 1: difference between the bid and the ask price. And when

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Speaker 1: things are highly volatile, there's this risk that a bunch

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Speaker 1: of orders you had outstanding that you thought weren't necessarily

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Speaker 1: going to get hit end up getting hit because the

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Speaker 1: prices moves rapidly and so high fre concentrators or something

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Speaker 1: like eight percent of liquid in the treasury market, and

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Speaker 1: that dropped to at times when when prices are moving

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Speaker 1: around that violently. In that kind of environment, really the

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Speaker 1: the flight to liquidity among products. So we we think

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Speaker 1: of this as liquidity tearing. And if I need quick

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Speaker 1: access at low transaction cost, futures are the best outlet

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Speaker 1: for that, just go to the exchange. Treasury futures are

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Speaker 1: going to be the tightest fit ask the lowest transaction costs,

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Speaker 1: the largest size, the biggest group of participants most because

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Speaker 1: they don't require balance sheet and they're they're traded on

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Speaker 1: an exchange, so they're they're pretty transparent in their pricing.

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Speaker 1: And so because rates removing lower you know, lower yields

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Speaker 1: higher prices, the future has lad that move and they

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Speaker 1: started to diverge a bit from the bonds into which

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Speaker 1: you can deliver. The futures contracts. You think of a

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Speaker 1: treasury futures contract, it's just like an oil contract. Do

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Speaker 1: you have an agreement to sell at some future date

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Speaker 1: which gives you economic exposure to the price of that thing.

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Speaker 1: And in the case of treasuries, you have a bond

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Speaker 1: that's part of a deliverable basket. And at the expert

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Speaker 1: the future, I give the bond to whoever bought to

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Speaker 1: whoever I sold the future too. So in principle those

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Speaker 1: things should be really tightly correlated. Uh, just simply because

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Speaker 1: I could hold the futures contract to expiry and deliver

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Speaker 1: the bond, so I have could guarantee fire from my

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Speaker 1: bond um. But over the course of that period before expiry,

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Speaker 1: you can get these sharp discrepancies, and in this case,

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Speaker 1: because of the liquidity value of that futures contract, they

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Speaker 1: started to rich and relative to the cash bonds that

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Speaker 1: could have been contained. That's happened in the past. That's

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Speaker 1: pretty common. Actually, there's sort of an old adage and

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Speaker 1: in treasury trading that if you don't know why prices

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Speaker 1: are moving, you just say it's futures lead because that's

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Speaker 1: the through most of pay part of the market. Uh So,

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Speaker 1: when prices are going down, futures prices tend to go

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Speaker 1: down more. And when future when prices are going up,

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Speaker 1: futures prices tend to go up more. Um In this case,

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Speaker 1: uh it was a little more severe than than was typical,

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Speaker 1: but it wasn't completely outside the range of possibility. But

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Speaker 1: it did put a lot of pressure on two groups

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Speaker 1: which are key to this whole thing. The first is

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Speaker 1: the relative value active man manager community, who really are

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Speaker 1: holding a lot of positions where they're long the bonds

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Speaker 1: and short the futures contract. And the second is the

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Speaker 1: dealers themselves, because when they are asked to bid on

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Speaker 1: af the round treasuries, it's it's hard to find the

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Speaker 1: buyer for that bond immediately and so the tendency is

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Speaker 1: to sell a futures contract to reduce your exposure as

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Speaker 1: quickly as possible. And so both hedge funds and dealers

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Speaker 1: were in this very large futures basis position, by which

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Speaker 1: we mean they own the bonds generally in a levered basis,

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Speaker 1: and they're short the futures contracts. So when the futures

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Speaker 1: contract rich and relative to bonds, they face losses. There's

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Speaker 1: a lot of I want to break down here, but

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Speaker 1: talk to us about the significance of the discrepancy that

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Speaker 1: always exists basically in any market between an on the

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Speaker 1: run treasury and an off the run treasury. So I

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Speaker 1: take that of freshly the treasury issues an auction and

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Speaker 1: a fresh auction of tenure treasuries those are on the run,

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Speaker 1: but a previous thirty year auction that was done twenty

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Speaker 1: years ago, it's the same length that's technically should trade

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Speaker 1: around the same price as a ten year auction today

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Speaker 1: would be less liquid. And their entities that take advantage

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Speaker 1: of these discrepancies. Talk to us a little bit about

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Speaker 1: the mechanics of why that phenomenon exists, and then why

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Speaker 1: that continue, why that sort of the stress that we've

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Speaker 1: seen of late this dash for liquidity exacerbated them. Yeah,

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Speaker 1: so generally speaking, those discrepancies are pretty small. They arise

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Speaker 1: from a bunch of different things. But in the case

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Speaker 1: that you're talking about, if you had an old thirty

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Speaker 1: year originally thirty year bond, it's rolled down to ten years,

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Speaker 1: it probably had a much higher coupon back in the day,

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Speaker 1: and so rates are lower another than they were ten

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Speaker 1: years ago. Uh, and that means that that bond is

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Speaker 1: trading at a high premium. Right, So when rates go

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Speaker 1: down and the coupon stays the same, there's a lot

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Speaker 1: of value in that safe four percent coupon. If today's

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Speaker 1: coupon would be two or one percent, or even today

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Speaker 1: even low potentially, so it's gonna not gonna be a

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Speaker 1: hundred dollars for for the bond is gonna be more.

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Speaker 1: And so there are some participants that don't like to

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Speaker 1: buy premium bonds because it doesn't have as friendly accounting treatment,

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Speaker 1: or they don't want to put up that much cash

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Speaker 1: for the same income. Right, the yield is the same,

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Speaker 1: the dollar prices different. So uh, there there are other there,

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Speaker 1: there are different incentives that people face both economically and

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Speaker 1: accounting and otherwise, and so there might be less demand

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Speaker 1: for that bond than the on the run treasury the

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Speaker 1: on the run tenure, even though the maturities are the same,

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Speaker 1: the issue is the same, etcetera. So those little features matter, um,

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Speaker 1: and the liquidity in the on the run tends to

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Speaker 1: be better. Just because we we had an auction, we

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Speaker 1: know we're a priced and there's a lot of it outstanding. Um.

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Speaker 1: One of one of the issues you run into with

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Speaker 1: off the runs is the FED is maybe bought up

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Speaker 1: a bunch of this bond too, so you don't really

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Speaker 1: have a ton of pricing transparency. So all these little

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Speaker 1: things matter. Under normal circumstances. It's worth a couple hundreds

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Speaker 1: of a percentage point, which for some people in the

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Speaker 1: market is a lot, But in general it's really a

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Speaker 1: very small pricing difference. And and and that reflects the

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Speaker 1: fact that at the end of the day, these are

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Speaker 1: really the same instrument fundamentally, it's just these small differences

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Speaker 1: change the price. What we've seen recently is much larger

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Speaker 1: discrepancies in the pricing and especially volatility in those discrepancies.

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Speaker 1: So the issue for a dealer is less whether or

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Speaker 1: not this bond is trading at a lower price than

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Speaker 1: you would expect given the yield on some more recent

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Speaker 1: liquid issue. It's the fact that if those prices are

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Speaker 1: moving relative to each other rapidly, it's very hard to

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Speaker 1: manage the volatility and there in their book, because generally speaking,

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Speaker 1: a dealer is going to be long owning a bunch

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Speaker 1: of these author own issues, and they're going to try

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Speaker 1: to hedge their first order risk, which is just the

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Speaker 1: level of rates with something much more liquid. So, just

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Speaker 1: going back to the levered US treasury trade that we

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Speaker 1: were discussing, I mean, you mentioned that a lot of

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Speaker 1: these relative value players were obviously borrowing money, they were

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Speaker 1: levered in that position. I guess the clue is in

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Speaker 1: the name of the trade, levered US Treasury trading um.

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Speaker 1: And you also mentioned the dealers being less able to

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Speaker 1: intermediate some of those trades. Can you talk about the

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Speaker 1: relationship between hedge funds and dealers and where the report

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Speaker 1: market actually comes into this, Yeah, tell me so. Well,

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Speaker 1: the report market comes in simply because these price discrepancies

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Speaker 1: are very small. So if you want to make a

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Speaker 1: certain amount of money, you have to take out loans,

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Speaker 1: you need to lever it up, and so that was

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Speaker 1: generally case. That's been the case for a very long time.

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Speaker 1: There's a couple of big differences now, and it rises

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Speaker 1: from the interaction of markets and regulatory changes and the

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Speaker 1: way that banks have been incentivized to manage their own

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Speaker 1: balance sheets. So one of the big lessons of the

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Speaker 1: crisis in two thousand eight it was clearly too big

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Speaker 1: to fail as a problem, and so the regulatory suite

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Speaker 1: that was introduced was partly meant to address this too

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Speaker 1: big to fail issue. And in doing so, we need

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Speaker 1: to define bigness, because that's not an obvious thing to define.

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Speaker 1: The easiest way to think about it is simply size,

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Speaker 1: and it doesn't really matter what you own. You can

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Speaker 1: own just treasuries and that's a low risk asset. But

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Speaker 1: we don't want to risk weight assets anymore if we're

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Speaker 1: trying to control bigness in general. So we want to

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Speaker 1: think about it holistically, so that we put put a

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Speaker 1: limit on leverage in general at banks. And the implication

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Speaker 1: of that is that the balance, the space on your

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Speaker 1: balanty taken up by anything has value because you're using

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Speaker 1: it instead of doing something else, And in particular for

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Speaker 1: a bank, it means you have to think about your

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Speaker 1: balanty ahead of time. You need to plan ahead, increasing

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00:16:51,120 --> 00:16:54,920
Speaker 1: your leverage as a dealer to take on more treasury

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Speaker 1: bonds in your inventory. That didn't necessarily add to your

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Speaker 1: cost of apple. But in the case of a bank,

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Speaker 1: now we have to allocate balance sheet because it's a

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Speaker 1: scarce commodity, and so we need to think ahead. That

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Speaker 1: means you have to plan ahead, which means you have

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Speaker 1: to make allocations in advance. So generally speaking, the strategy

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Speaker 1: has been to look at a list of clients, think

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Speaker 1: about how much they've utilized balance sheet in the past,

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Speaker 1: how they utilized balance sheet, and repo is definitely the

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Speaker 1: most significant source of that usage. And so you say, look,

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Speaker 1: you use the billion dollars last year, we'll give you

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Speaker 1: a billion dollars this year. You use two billion dollars

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Speaker 1: last year, we'll give you twoillion dollars this year. And

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Speaker 1: if you don't use it, well, you might not get

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Speaker 1: as much next year, which is a very reasonable way

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Speaker 1: to think about it. Use it or lose it. I

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Speaker 1: just think it was a budgeting exercise, so that created

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Speaker 1: a different set of incentives that were less economic. If

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Speaker 1: I'm a relative value trader. I've got two things that

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Speaker 1: I need to think about. One is what is the

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Speaker 1: set of actual opportunities, the economic incentives, which are trading

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Speaker 1: a price that's too low versus other bonds? And what

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Speaker 1: bonds of trading a prices too high relative to the

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Speaker 1: are bonds? How am I going to make money? Uh?

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Speaker 1: The second thing is how do I maintain access to

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Speaker 1: the leverage I need to make those trades interesting in

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Speaker 1: the first place. So if the opportunity set is not

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Speaker 1: particularly appealing right now, how do I make sure that

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Speaker 1: I'm using my balance sheet, my balanciet allocation simply to

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Speaker 1: have access to it when something more interesting comes up

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Speaker 1: in the future. And so one way to do that

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Speaker 1: is to find a trade that has limited downside. It's

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Speaker 1: almost an arbitrage if not a zero limited downside position.

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Speaker 1: It uses a lot of balance sheet uh. And it's

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Speaker 1: something I'm familiar with in general. And so that's where

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Speaker 1: this this future's basis position comes in because it is

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Speaker 1: balance sheet intensive. So I'm gonna buy a bond, I'm

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Speaker 1: gonna lever it with repo, and then I'm going to

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Speaker 1: sell the future against it. And the way I think

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Speaker 1: about it worst case scenario, I'll just give the bond

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Speaker 1: to whoever bought the future for me at xpery. So

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Speaker 1: I have limited downside and I've taken up that an allocation.

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Speaker 1: So before we uh get to how everything started breaking

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Speaker 1: down a little bit more, I want to go back

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Speaker 1: to one quick thing you said, which is, you know,

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Speaker 1: part of the post crisis shift in the sort of

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Speaker 1: regulatory regime was to try to avoid too big to fail,

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Speaker 1: move risk away from the banking sector. So now we

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00:19:24,200 --> 00:19:29,399
Speaker 1: have all of these uh, non bank entities engaging in

355
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Speaker 1: all these trades, and you know, so far, there's a claim,

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Speaker 1: and we talked about this before, there's a claim that

357
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Speaker 1: maybe if you look at what's going on in the market,

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Speaker 1: there's some vindication of the post crisis regulations because although

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00:19:42,760 --> 00:19:45,920
Speaker 1: there's a lot of fragility and the financial markets so far,

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Speaker 1: there is not particularly much concern about the banks themselves.

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Speaker 1: Why does it make sense, just just for this, just

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Speaker 1: for my own edification, why does it make sense to

363
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Speaker 1: count risk free assets treasuries against any entity balance you

364
00:20:00,840 --> 00:20:06,360
Speaker 1: when when evaluating side does that make sense? Yeah? So

365
00:20:07,320 --> 00:20:10,560
Speaker 1: just being bigger makes you more complicated if if you've

366
00:20:10,600 --> 00:20:13,800
Speaker 1: got big issues So in the case of Lehman, a

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Speaker 1: lot of the disruptions that were caused by the bankruptcy

368
00:20:16,680 --> 00:20:19,680
Speaker 1: were not necessarily just their credit portfolio. It was unwinding

369
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Speaker 1: the whole institution. So they had a very large swap

370
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Speaker 1: book that was mostly collateralized with stuff like treasuries and cash,

371
00:20:27,520 --> 00:20:30,159
Speaker 1: and that was such a large position to move to

372
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Speaker 1: somebody else, I mean, you have to you have to

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Speaker 1: find someone else to take the other side of those trades. Um,

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Speaker 1: that's a very complicated exercise. Is why when you look

375
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Speaker 1: at things like Global Systemically Important Banking Scores, which are

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00:20:43,000 --> 00:20:46,080
Speaker 1: used to evaluate capital search charges and other things, basically

377
00:20:46,800 --> 00:20:51,320
Speaker 1: an assessment of cost to being big to society. It's

378
00:20:51,359 --> 00:20:54,399
Speaker 1: not just size, it's also complexity. So if i'm if,

379
00:20:54,440 --> 00:20:57,439
Speaker 1: I'm relatively small but highly complex, and that's Lehman was

380
00:20:57,440 --> 00:20:59,320
Speaker 1: another great example of that. It was not the big

381
00:20:59,359 --> 00:21:02,639
Speaker 1: bank and the by any measure, but it was highly complex.

382
00:21:03,320 --> 00:21:06,160
Speaker 1: That creates issues as well for markets in the event

383
00:21:06,200 --> 00:21:11,040
Speaker 1: of a really online So it's both size and complexity. Yeah,

384
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Speaker 1: it's all these different components of bigness, which is why

385
00:21:13,840 --> 00:21:15,840
Speaker 1: I'm sort of not calling it size and calling it

386
00:21:15,880 --> 00:21:18,320
Speaker 1: bigness because Bigness takes on many forms, and one of

387
00:21:18,359 --> 00:21:20,719
Speaker 1: them is simply the size of the institution. The other

388
00:21:20,800 --> 00:21:22,960
Speaker 1: is the risk they take, just like back in the day.

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Speaker 1: Um and and there's other things like my reliance and

390
00:21:25,400 --> 00:21:30,919
Speaker 1: short term wholesale funding, my complexity, that the level of

391
00:21:31,000 --> 00:21:33,680
Speaker 1: exposure to things like exotic derivatives, things like that which

392
00:21:33,720 --> 00:21:37,320
Speaker 1: can be which can be very disruptive if if things

393
00:21:37,320 --> 00:21:41,800
Speaker 1: go bad. Okay, so we've sort of touched on the

394
00:21:41,880 --> 00:21:45,200
Speaker 1: lever US treasury trade, uh and what was happening there,

395
00:21:45,280 --> 00:21:49,800
Speaker 1: but described for us just how badly things actually went

396
00:21:50,080 --> 00:21:54,680
Speaker 1: in the U S. Treasury market over the past few weeks. Yeah. So,

397
00:21:54,680 --> 00:21:59,000
Speaker 1: so over time this position got quite large simply because

398
00:21:59,000 --> 00:22:02,959
Speaker 1: people wanted to or balance sheets. So the situation describing

399
00:22:03,040 --> 00:22:08,520
Speaker 1: before where I'm doing treasury basis trading simply to park

400
00:22:08,760 --> 00:22:11,560
Speaker 1: balance sheet and maintain my my access to it. That

401
00:22:11,640 --> 00:22:14,760
Speaker 1: grew to a very large position. So at most it

402
00:22:14,800 --> 00:22:18,199
Speaker 1: was probably it was as much as two six billion dollars.

403
00:22:18,240 --> 00:22:20,480
Speaker 1: We think it's not necessarily that large, and that's just

404
00:22:20,520 --> 00:22:23,280
Speaker 1: from public data. But even if it was half of that,

405
00:22:23,280 --> 00:22:27,080
Speaker 1: that's a three billion dollar lever position that is non

406
00:22:27,119 --> 00:22:31,359
Speaker 1: economic and under normal circumstances. That would be fine. It

407
00:22:31,400 --> 00:22:34,160
Speaker 1: would actually reduce the risk of that kind of levered position.

408
00:22:34,200 --> 00:22:37,320
Speaker 1: But two things started going wrong. The first was this

409
00:22:37,440 --> 00:22:40,800
Speaker 1: liquidity tiering led to mark to market losses on the

410
00:22:40,840 --> 00:22:45,399
Speaker 1: future's basis position because futures were outpacing treasuries as rates declined.

411
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Speaker 1: And that was again mostly about fundamentals. It was mostly

412
00:22:47,760 --> 00:22:50,520
Speaker 1: about a shift in the economic outlook and a very

413
00:22:50,640 --> 00:22:53,960
Speaker 1: rapid shift in how people price interest rate risk and

414
00:22:54,000 --> 00:22:56,840
Speaker 1: things like that. So that was I wouldn't say expected,

415
00:22:56,840 --> 00:23:01,879
Speaker 1: but understandable and expected under these circumstances, and there was.

416
00:23:02,640 --> 00:23:05,439
Speaker 1: It was at least a sense that at worst, like

417
00:23:05,680 --> 00:23:07,720
Speaker 1: like we talked about before, I could just deliver the

418
00:23:07,760 --> 00:23:10,640
Speaker 1: bond at the expertly the futures contract. My downside was limited.

419
00:23:10,920 --> 00:23:14,000
Speaker 1: I'm not going to actually realize these marked market losses.

420
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Speaker 1: It's just a passing thing and I just have to

421
00:23:16,160 --> 00:23:18,879
Speaker 1: be a little patient and and weather it for a

422
00:23:18,880 --> 00:23:22,639
Speaker 1: few weeks. The problem became as more of these banks

423
00:23:22,640 --> 00:23:26,959
Speaker 1: started to do work from home arrangements. Operational risk started

424
00:23:27,000 --> 00:23:30,720
Speaker 1: to be an important consideration, which is to say, these

425
00:23:30,800 --> 00:23:33,560
Speaker 1: level positions are very operationally intensive simply because you have

426
00:23:33,600 --> 00:23:37,280
Speaker 1: to source funding there's a lot of underlying transactions to

427
00:23:37,480 --> 00:23:41,679
Speaker 1: getting that much repo leverage in the system. When everyone's

428
00:23:41,720 --> 00:23:43,680
Speaker 1: at their desk, that's not a problem at all. It

429
00:23:43,760 --> 00:23:45,560
Speaker 1: might be a little bit of an operational cost, but

430
00:23:45,960 --> 00:23:48,880
Speaker 1: it's something that can happen quite easily. But as everyone's

431
00:23:48,880 --> 00:23:51,480
Speaker 1: starting to migrate to work from home, there was a

432
00:23:51,520 --> 00:23:55,119
Speaker 1: concern that those mark to market losses, which in theory

433
00:23:55,160 --> 00:23:58,359
Speaker 1: are passing, might end up being realized simply because the

434
00:23:59,080 --> 00:24:02,240
Speaker 1: operational shoes forced me out of a position at a

435
00:24:02,240 --> 00:24:06,040
Speaker 1: bad level, and that became risk to manage, not because

436
00:24:06,040 --> 00:24:09,320
Speaker 1: it was necessarily happening, because hey, if I think it

437
00:24:09,400 --> 00:24:11,919
Speaker 1: might happen, I might want to reduce my exposure, especially

438
00:24:11,960 --> 00:24:14,840
Speaker 1: if it's not an economically driven position in the first place,

439
00:24:15,240 --> 00:24:17,680
Speaker 1: UM and B, and this is a financial markets thing

440
00:24:17,720 --> 00:24:19,800
Speaker 1: that happens a lot. I might be worried that the

441
00:24:19,800 --> 00:24:22,560
Speaker 1: next guy thinks it might happen, so I want to

442
00:24:22,560 --> 00:24:26,240
Speaker 1: be so the the perception, so the perception that operational

443
00:24:26,320 --> 00:24:31,480
Speaker 1: risk was important to me potentially to others, caused a

444
00:24:31,480 --> 00:24:35,080
Speaker 1: little bit of an acceleration in that process at precisely

445
00:24:35,520 --> 00:24:38,080
Speaker 1: the wrong time, because that was when dealers were already

446
00:24:38,520 --> 00:24:41,600
Speaker 1: using most of their balance sheets for the activity that

447
00:24:41,680 --> 00:24:43,840
Speaker 1: already occurred, and all of a sudden you'd have an

448
00:24:43,840 --> 00:24:49,000
Speaker 1: influx of selling from these highly levered positions. The important

449
00:24:49,000 --> 00:24:52,000
Speaker 1: thing here is if you take even small losses on

450
00:24:52,000 --> 00:24:56,199
Speaker 1: a future basis position, most of them are levered, so

451
00:24:57,359 --> 00:24:59,879
Speaker 1: you could end up eating through capital pretty quickly. And

452
00:25:00,040 --> 00:25:02,720
Speaker 1: so there was an added incentive to reduce exposure to

453
00:25:02,800 --> 00:25:06,640
Speaker 1: that that involves the sale of bonds two dealers who

454
00:25:06,640 --> 00:25:09,600
Speaker 1: are now taking even more balance sheet and that created

455
00:25:09,640 --> 00:25:12,520
Speaker 1: a bit of a vicious cycle that infected other areas

456
00:25:12,520 --> 00:25:15,160
Speaker 1: of the treasury market and caused market depth deployment even

457
00:25:15,160 --> 00:25:19,119
Speaker 1: more so. Just to press on on this idea of

458
00:25:19,280 --> 00:25:23,080
Speaker 1: operational risk, because clearly it was on a lot of

459
00:25:23,080 --> 00:25:25,760
Speaker 1: people's minds, and I actually wrote a little bit about

460
00:25:25,760 --> 00:25:28,640
Speaker 1: this at the time based on your research, and one

461
00:25:28,680 --> 00:25:32,840
Speaker 1: of the pushbacks I got from some readers was that

462
00:25:33,440 --> 00:25:36,959
Speaker 1: operational risk wasn't really a thing in the financial system

463
00:25:37,080 --> 00:25:41,840
Speaker 1: because banks all did, you know, exercises and stress tests,

464
00:25:41,880 --> 00:25:44,280
Speaker 1: and they were all supposed to be able to work

465
00:25:44,359 --> 00:25:47,000
Speaker 1: remotely from home, and it just wasn't as big an

466
00:25:47,000 --> 00:25:50,200
Speaker 1: issue as some people were making it out to be.

467
00:25:50,600 --> 00:25:53,840
Speaker 1: What would you say in response to that criticism, so

468
00:25:53,920 --> 00:25:55,560
Speaker 1: it may not be. It may not end up being

469
00:25:55,920 --> 00:25:58,400
Speaker 1: a significant risk. It's more about the perception of those

470
00:25:58,520 --> 00:26:02,080
Speaker 1: risks and the willingness of particularly a leveled position. It's

471
00:26:02,080 --> 00:26:06,120
Speaker 1: already taken losses to rely on those operational issues, So

472
00:26:07,240 --> 00:26:08,959
Speaker 1: I guess the way I would think about it is

473
00:26:09,640 --> 00:26:12,240
Speaker 1: if the perception is that this might be a problem,

474
00:26:12,280 --> 00:26:15,040
Speaker 1: and I totally agree that stress testing is an important

475
00:26:15,040 --> 00:26:17,720
Speaker 1: part of this, that planning for these types of scenarios

476
00:26:17,800 --> 00:26:19,320
Speaker 1: is a big part of it. Banks are much better

477
00:26:19,359 --> 00:26:21,240
Speaker 1: capitalized than they used to be. They have many more

478
00:26:21,280 --> 00:26:24,560
Speaker 1: people in the operational positions, they're much more efficient in

479
00:26:24,680 --> 00:26:27,720
Speaker 1: doing so, and in principle they had plans for work

480
00:26:27,760 --> 00:26:30,160
Speaker 1: from home. But if if it all goes according to plan,

481
00:26:30,240 --> 00:26:34,000
Speaker 1: then it's no problem and business as usual. If or

482
00:26:34,080 --> 00:26:36,520
Speaker 1: close to it, if it goes wrong, I have a

483
00:26:36,600 --> 00:26:40,240
Speaker 1: much bigger problem, especially because at best I'm not even

484
00:26:40,280 --> 00:26:42,280
Speaker 1: looking to make money on these trains, so I'm trying

485
00:26:42,280 --> 00:26:44,720
Speaker 1: to maintain access to balance it. I'm not necessarily trying

486
00:26:44,760 --> 00:26:49,280
Speaker 1: to put on a large directional positions, so the upside

487
00:26:49,359 --> 00:26:54,240
Speaker 1: is limited or zero, and the downside becomes very large.

488
00:26:54,920 --> 00:26:58,600
Speaker 1: So I'm totally fascinating by this. So obviously from a

489
00:26:58,720 --> 00:27:03,439
Speaker 1: just sort of pure and strect markets perspective, what we

490
00:27:03,560 --> 00:27:07,200
Speaker 1: know that over the last several weeks has been this

491
00:27:07,400 --> 00:27:12,680
Speaker 1: historic attempt to grab cash or grab liquidity in any scenario.

492
00:27:12,720 --> 00:27:16,200
Speaker 1: And we see this from individuals, we see this from companies,

493
00:27:16,600 --> 00:27:19,359
Speaker 1: We see it from companies drawing down revolving credit lines.

494
00:27:20,000 --> 00:27:24,000
Speaker 1: We know it exists. It's and everyone people we've talked

495
00:27:24,040 --> 00:27:27,040
Speaker 1: to say they've never really seen anything like this. So

496
00:27:27,119 --> 00:27:30,040
Speaker 1: that that accelerates selling, that blows out some of these

497
00:27:30,080 --> 00:27:32,119
Speaker 1: trades because okay, you know it is not time to

498
00:27:32,119 --> 00:27:34,120
Speaker 1: do we need to sell treasures, we need to get

499
00:27:34,320 --> 00:27:38,200
Speaker 1: liquid assets. Talk to us a little bit more about

500
00:27:38,240 --> 00:27:41,960
Speaker 1: the specific operational concerns, because I don't think many people

501
00:27:42,080 --> 00:27:44,280
Speaker 1: understand this at all. And I know, Tracy, just to

502
00:27:44,280 --> 00:27:46,400
Speaker 1: ask you about this, and you mentioned it. But when

503
00:27:46,440 --> 00:27:51,200
Speaker 1: you say that just from an operational standpoint, executing these trades,

504
00:27:51,320 --> 00:27:54,840
Speaker 1: obtaining the liquidity you need to hold onto the trade

505
00:27:54,920 --> 00:27:59,080
Speaker 1: until they become profitable, is necessary, just talk to what

506
00:27:59,160 --> 00:28:01,680
Speaker 1: is that involved? What's it like? What what? What? What

507
00:28:01,760 --> 00:28:08,840
Speaker 1: makes it uh operationally intensive to hold on to the trade.

508
00:28:09,000 --> 00:28:11,480
Speaker 1: So really it's because a lot of this funding tends

509
00:28:11,520 --> 00:28:15,600
Speaker 1: to be overnight. So repo markets are very strongly skewed

510
00:28:15,640 --> 00:28:18,240
Speaker 1: towards overnight funding. Part of that is because it's easier

511
00:28:18,800 --> 00:28:21,879
Speaker 1: for banks to do overnight funding. It's it's harder to

512
00:28:22,000 --> 00:28:24,639
Speaker 1: have funding that's locked over statement dates and things like

513
00:28:24,680 --> 00:28:27,639
Speaker 1: that when when all of these regulatory charges are assessed.

514
00:28:28,280 --> 00:28:30,200
Speaker 1: And so if you keep your the funding you offer

515
00:28:30,520 --> 00:28:33,159
Speaker 1: as as a lender overnight, you have a lot more

516
00:28:33,160 --> 00:28:37,040
Speaker 1: flexibility going forward, and that means that the client side

517
00:28:37,119 --> 00:28:39,400
Speaker 1: is going to be pushed in the same direction that

518
00:28:39,560 --> 00:28:42,320
Speaker 1: that's the accommodation that's made the problem is to to

519
00:28:42,400 --> 00:28:44,200
Speaker 1: roll your trades overnight, you have to do no trade

520
00:28:44,200 --> 00:28:47,959
Speaker 1: every day, and there's a risk that there's no one

521
00:28:48,000 --> 00:28:50,040
Speaker 1: on the other side of the phone. And we saw

522
00:28:50,120 --> 00:28:53,760
Speaker 1: this most acutely in two thousand one. Excuse me just

523
00:28:53,760 --> 00:28:57,560
Speaker 1: just to go back you mean phone literally right? Literally? Yeah? Um,

524
00:28:57,640 --> 00:29:00,560
Speaker 1: and maybe calugh carding doesn't work right of people who

525
00:29:00,600 --> 00:29:03,320
Speaker 1: have this view that like all markets are just done

526
00:29:03,400 --> 00:29:06,480
Speaker 1: over the computer. You entering some keys and you make

527
00:29:06,520 --> 00:29:10,000
Speaker 1: a trade. This is key part of the financial plumbing

528
00:29:10,720 --> 00:29:12,840
Speaker 1: over the phone. Yeah, a lot of this, A lot

529
00:29:12,840 --> 00:29:15,560
Speaker 1: of stuff still happens over the phone or ornamentium over

530
00:29:16,320 --> 00:29:19,880
Speaker 1: chat or things like that, and there's confirmed confirms that

531
00:29:19,920 --> 00:29:22,960
Speaker 1: go back and forth. Banking is still a very or

532
00:29:23,080 --> 00:29:26,080
Speaker 1: dealing is still a very paperwright intensive business. Even if

533
00:29:26,080 --> 00:29:28,640
Speaker 1: that paper is is digital, it goes back and forth

534
00:29:28,680 --> 00:29:30,960
Speaker 1: a lot, and so it's a to have someone on

535
00:29:31,000 --> 00:29:32,480
Speaker 1: the other side of the phone and be to make

536
00:29:32,520 --> 00:29:33,840
Speaker 1: sure there's someone to put a price on it. No.

537
00:29:33,960 --> 00:29:35,960
Speaker 1: I only asked that because again, I do think a

538
00:29:36,000 --> 00:29:38,920
Speaker 1: lot of people have this imagine imagination that it's all

539
00:29:39,480 --> 00:29:43,560
Speaker 1: l goes and keystrokes and logging into an account, and uh,

540
00:29:43,600 --> 00:29:48,960
Speaker 1: I think an important bascet to drive home totally. And

541
00:29:49,000 --> 00:29:50,840
Speaker 1: there are parts of the market that are very electronic,

542
00:29:50,880 --> 00:29:54,240
Speaker 1: but these things are plumbing oriented, tend tend not today,

543
00:29:54,640 --> 00:29:58,200
Speaker 1: got it? Okay? So just to sum up, we had

544
00:29:58,200 --> 00:30:03,320
Speaker 1: this lever treasury position or basically a basis trade between

545
00:30:03,320 --> 00:30:07,120
Speaker 1: the futures and the cash contracts that got strained in

546
00:30:07,200 --> 00:30:10,840
Speaker 1: the recent route, partly because dealers weren't able to come

547
00:30:10,880 --> 00:30:14,880
Speaker 1: in and intermediate through the repo market. And at the

548
00:30:14,920 --> 00:30:18,680
Speaker 1: same time we had all these liquidity strains like huge

549
00:30:18,760 --> 00:30:22,160
Speaker 1: bit ask spreads and things like that emerging in what

550
00:30:22,480 --> 00:30:25,240
Speaker 1: again was supposed to be the most liquid market in

551
00:30:25,280 --> 00:30:27,560
Speaker 1: the world. Up. Fast forward a little bit, and we

552
00:30:27,600 --> 00:30:31,080
Speaker 1: have seen this issue pop up with the Federal Reserve,

553
00:30:31,160 --> 00:30:34,640
Speaker 1: and in fact, Jerome Powell was talking about what had

554
00:30:34,680 --> 00:30:37,160
Speaker 1: happened in the treasury market in one of his emergency

555
00:30:37,680 --> 00:30:42,600
Speaker 1: Sunday announcements. What do you think about the feds moves

556
00:30:42,720 --> 00:30:45,240
Speaker 1: so far? How much of this is on their radar?

557
00:30:45,680 --> 00:30:50,000
Speaker 1: Are they understanding the concerns correctly? And are they doing

558
00:30:50,000 --> 00:30:53,320
Speaker 1: the right things to fix it? Yeah, so they're definitely

559
00:30:53,320 --> 00:30:55,800
Speaker 1: aware of it. They're definitely responding with the kind of

560
00:30:55,840 --> 00:30:58,800
Speaker 1: magnitude they need to. And it's it's interesting to think

561
00:30:58,800 --> 00:31:01,840
Speaker 1: about these asset purchases is that they've announced Initially it

562
00:31:01,880 --> 00:31:06,720
Speaker 1: was five of treasury purchases and and unspecified pace, and

563
00:31:06,760 --> 00:31:11,240
Speaker 1: now it's essentially unlimited. The reason why they're responding like

564
00:31:11,320 --> 00:31:13,440
Speaker 1: that is not because it's QUI in the usual sense.

565
00:31:13,640 --> 00:31:15,560
Speaker 1: I think. I always asked if this is QUEI, and

566
00:31:15,560 --> 00:31:18,880
Speaker 1: he basically said, call it whatever you want. QUI is

567
00:31:19,160 --> 00:31:23,560
Speaker 1: Quantitative easing is UH is really a monetary policy tool

568
00:31:24,040 --> 00:31:27,520
Speaker 1: to take term premium out of rates and incentivize people

569
00:31:27,520 --> 00:31:29,440
Speaker 1: to take credit risk. So when you when you think

570
00:31:29,440 --> 00:31:32,600
Speaker 1: about investing in fixed income products. I can take term risk,

571
00:31:32,640 --> 00:31:34,440
Speaker 1: I can lock my money up for longer. I should

572
00:31:34,440 --> 00:31:36,560
Speaker 1: receive some sort of premium for that. Or I can

573
00:31:36,560 --> 00:31:39,120
Speaker 1: take credit risk in the sense that I might not

574
00:31:39,280 --> 00:31:42,920
Speaker 1: get my money back. And so if you reduce the

575
00:31:42,920 --> 00:31:45,360
Speaker 1: returns I get simply by locking up my money for longer,

576
00:31:45,440 --> 00:31:47,080
Speaker 1: well maybe I want to. I might want to do

577
00:31:47,320 --> 00:31:49,360
Speaker 1: take more credit risk, and that was the original intent

578
00:31:49,800 --> 00:31:52,280
Speaker 1: of quantitative easing. This is not about that at all.

579
00:31:52,680 --> 00:31:55,320
Speaker 1: One because the treasure care is already quite flat, there's

580
00:31:55,360 --> 00:31:58,360
Speaker 1: very little term premium. In fact, by many measures, it's negative,

581
00:31:58,440 --> 00:32:00,640
Speaker 1: so we certainly don't need to take and bringing out

582
00:32:00,640 --> 00:32:04,080
Speaker 1: of the curve. It's much more about operational and market

583
00:32:04,120 --> 00:32:06,520
Speaker 1: structure issues, and they were quite clear on that. So

584
00:32:07,240 --> 00:32:10,120
Speaker 1: the question comes up, why respond with this kind of

585
00:32:10,160 --> 00:32:12,760
Speaker 1: size to something that really what we've been talking about

586
00:32:12,880 --> 00:32:17,000
Speaker 1: is a group of relative value hedge funds, the market

587
00:32:17,040 --> 00:32:22,800
Speaker 1: making and treasuries specifically, and all pretty arcane topics. I mean,

588
00:32:23,160 --> 00:32:25,480
Speaker 1: this has been a pretty technical conversation. So why is

589
00:32:25,520 --> 00:32:28,560
Speaker 1: the FED doing unlimited QWI to address this rather technical

590
00:32:28,600 --> 00:32:30,600
Speaker 1: issue which is important to a lot of people, but

591
00:32:30,680 --> 00:32:35,600
Speaker 1: not necessarily to most participants in financial markets. So of

592
00:32:35,640 --> 00:32:39,720
Speaker 1: course there have been several different FED operations that we've

593
00:32:39,760 --> 00:32:44,240
Speaker 1: seen just over the last week. So again, today's March yesterday,

594
00:32:44,320 --> 00:32:49,920
Speaker 1: March twenty three was when we saw the the announcement

595
00:32:50,000 --> 00:32:53,520
Speaker 1: of all kinds of new lending operations plus the alphabet

596
00:32:53,560 --> 00:32:56,840
Speaker 1: soup of the programs and the unlimited QUI. The Sunday

597
00:32:56,880 --> 00:33:00,760
Speaker 1: before that was when Paul made the surprise as announcement

598
00:33:00,840 --> 00:33:03,680
Speaker 1: to cut rates to basically zero and the seven billion

599
00:33:03,720 --> 00:33:06,880
Speaker 1: dollars and asset purchases who almost didn't do anything for

600
00:33:07,040 --> 00:33:10,680
Speaker 1: risk assets. And the week before that we saw a

601
00:33:10,840 --> 00:33:14,160
Speaker 1: technical announcement out of the New York FED talking about

602
00:33:14,200 --> 00:33:18,920
Speaker 1: how they are massively expanding the reball operations. And that

603
00:33:19,000 --> 00:33:21,560
Speaker 1: New York Fed announcement came out, They're like, Okay, I

604
00:33:21,600 --> 00:33:25,080
Speaker 1: don't know, this is QUEI. This is a major boom

605
00:33:25,320 --> 00:33:29,080
Speaker 1: for these relative value funds that we've been talking about,

606
00:33:29,440 --> 00:33:33,240
Speaker 1: the ones that arbitrage the difference in pricing between futures

607
00:33:33,280 --> 00:33:36,040
Speaker 1: and treasuries, and this sort of saved them to some

608
00:33:36,160 --> 00:33:39,200
Speaker 1: extent or really protected them. And what I'm wondering is

609
00:33:40,080 --> 00:33:42,600
Speaker 1: do we need them? Like? Are they are? They? Are

610
00:33:42,680 --> 00:33:46,160
Speaker 1: they essential to the way the financial system works that

611
00:33:46,320 --> 00:33:49,840
Speaker 1: we need entities out there levering themselves fifty two one

612
00:33:49,960 --> 00:33:54,520
Speaker 1: to take advantage of minor price discrepancies between all the

613
00:33:54,680 --> 00:33:59,640
Speaker 1: run treasuries and futures. Or is this just, uh, could

614
00:33:59,680 --> 00:34:04,640
Speaker 1: we live without these entities performing dysfunction? We certainly need

615
00:34:04,720 --> 00:34:07,920
Speaker 1: somebody to police these relationships, but the moment is less

616
00:34:07,920 --> 00:34:09,960
Speaker 1: about what we need in the financial system and more

617
00:34:10,000 --> 00:34:12,680
Speaker 1: about what we don't need, which is a disorderly and

618
00:34:12,880 --> 00:34:15,160
Speaker 1: rapid unwide of these positions. So what the FETE is

619
00:34:15,200 --> 00:34:17,320
Speaker 1: doing is they're putting up fire brakes and they're saying,

620
00:34:17,800 --> 00:34:21,560
Speaker 1: I want to isolate this issue to a certain segment

621
00:34:21,600 --> 00:34:24,200
Speaker 1: of the market, and I really want to prevent delevering

622
00:34:24,239 --> 00:34:26,920
Speaker 1: in one sector from turning into delevering, and other sectors

623
00:34:27,000 --> 00:34:31,160
Speaker 1: in particular delivering the banking system more broadly. So, the

624
00:34:31,360 --> 00:34:34,960
Speaker 1: risk was that the pace and ferocity of this online

625
00:34:35,440 --> 00:34:38,120
Speaker 1: took up so much dealer balance sheet that they were

626
00:34:38,560 --> 00:34:41,759
Speaker 1: unable to intermediate other markets as well, and so you

627
00:34:41,840 --> 00:34:45,520
Speaker 1: started seeing issues in credit markets, particularly in short term

628
00:34:45,560 --> 00:34:51,120
Speaker 1: credit markets. You also saw this dislocation becoming so acute

629
00:34:51,280 --> 00:34:54,800
Speaker 1: that you could do riskless both credit risk free and

630
00:34:55,000 --> 00:34:58,640
Speaker 1: interest rate risk free unlevered trades and make more doing that.

631
00:34:59,120 --> 00:35:01,799
Speaker 1: Buying the bond levered selling the futures, you can make

632
00:35:01,840 --> 00:35:04,400
Speaker 1: more money doing that than buying bank seeping. So you

633
00:35:04,520 --> 00:35:09,440
Speaker 1: had two risks. One was severe intermediation frictions and other markets,

634
00:35:09,480 --> 00:35:12,640
Speaker 1: and the other being a demand shock to the credit market,

635
00:35:12,719 --> 00:35:15,440
Speaker 1: particularly the short term credit market, which is really the

636
00:35:15,560 --> 00:35:18,320
Speaker 1: lifeblood of a lot of institutions. And if you follow

637
00:35:18,480 --> 00:35:22,440
Speaker 1: that chain, there's a scenario that starts to become not

638
00:35:22,640 --> 00:35:26,959
Speaker 1: necessarily based case, but certainly more likely, where corporations lose

639
00:35:27,040 --> 00:35:30,600
Speaker 1: access to capital markets because of these market structure issues

640
00:35:30,920 --> 00:35:33,520
Speaker 1: and they're forced to draw in their bank revolvers, and

641
00:35:33,840 --> 00:35:37,080
Speaker 1: that becomes an incentive for banks to start selling assets

642
00:35:37,520 --> 00:35:40,480
Speaker 1: to fund those draws. And we've actually seen over a

643
00:35:40,560 --> 00:35:43,400
Speaker 1: hundred and three billion of those draws already based on

644
00:35:43,480 --> 00:35:46,560
Speaker 1: public information. So that's when you encircle the banking system,

645
00:35:46,600 --> 00:35:51,120
Speaker 1: when you force corporations who need liquidity for real economy

646
00:35:51,200 --> 00:35:55,800
Speaker 1: reasons to tap their banking lines rather than capital markets.

647
00:35:55,840 --> 00:35:57,800
Speaker 1: And now banks have to sell assets. So now I

648
00:35:57,880 --> 00:36:02,000
Speaker 1: have heade funds selling assets, credit funds selling assets, banks

649
00:36:02,040 --> 00:36:05,560
Speaker 1: selling assets. And there's a risk that's materialized in part

650
00:36:05,640 --> 00:36:09,240
Speaker 1: where you start seeing the redemption of money market shares.

651
00:36:09,480 --> 00:36:12,480
Speaker 1: So prime money market funds, particularly those owned by institutions,

652
00:36:12,920 --> 00:36:16,200
Speaker 1: have lost more than assets in a week. And that's

653
00:36:16,200 --> 00:36:18,960
Speaker 1: the kind of scenario where you start to see echoes

654
00:36:19,000 --> 00:36:22,080
Speaker 1: of the two eight crisis. We're not there yet, but

655
00:36:22,239 --> 00:36:24,360
Speaker 1: that that was the epicenter of two thousand eight, was

656
00:36:24,480 --> 00:36:27,640
Speaker 1: this run on the prime funds, and you're starting to

657
00:36:27,760 --> 00:36:33,319
Speaker 1: see some contagion from again a relatively arcane world, through

658
00:36:34,200 --> 00:36:37,840
Speaker 1: the accelerant of the dealer complex and the constraints that

659
00:36:37,880 --> 00:36:42,080
Speaker 1: they have, and into the credit markets, right, and a

660
00:36:42,160 --> 00:36:44,239
Speaker 1: lot of the programs that the FED has announced so

661
00:36:44,400 --> 00:36:47,400
Speaker 1: far are I don't want to say rip offs, but

662
00:36:47,840 --> 00:36:50,160
Speaker 1: replicants of some of the stuff that we saw in

663
00:36:50,239 --> 00:36:52,840
Speaker 1: two thousand eight. So they have announced a plan to

664
00:36:52,920 --> 00:36:56,520
Speaker 1: support money market funds, and they've also announced another iteration

665
00:36:56,840 --> 00:37:01,360
Speaker 1: of the Asset Purchased Program TAK, which I'm sure anyone

666
00:37:01,400 --> 00:37:03,600
Speaker 1: who is around in two thousand nine will remember that

667
00:37:03,719 --> 00:37:07,840
Speaker 1: one um one thing they haven't done, and maybe this

668
00:37:08,000 --> 00:37:10,720
Speaker 1: is important since we're talking so much about the balance

669
00:37:10,800 --> 00:37:13,400
Speaker 1: sheet constraints for dealer banks, But one thing they haven't

670
00:37:13,440 --> 00:37:18,640
Speaker 1: done is loosen regulatory constraints on banks. And I just

671
00:37:18,719 --> 00:37:21,640
Speaker 1: wonder if that's something that you would ever expect to happen.

672
00:37:22,320 --> 00:37:25,160
Speaker 1: Here in Hong Kong, we have seen some of this.

673
00:37:25,320 --> 00:37:29,080
Speaker 1: The financial regulator here actually lowered some capital buffer requirements

674
00:37:29,120 --> 00:37:32,080
Speaker 1: for banks to help them get through this and help

675
00:37:32,160 --> 00:37:35,160
Speaker 1: them keep lending to the economy. So is that something

676
00:37:35,200 --> 00:37:38,760
Speaker 1: that we could see in the US. It's possible they've

677
00:37:38,800 --> 00:37:41,360
Speaker 1: taken too or they floated two approaches to this is

678
00:37:41,440 --> 00:37:44,719
Speaker 1: kind of the supervisory angle. When we think about FED intervention.

679
00:37:45,200 --> 00:37:49,160
Speaker 1: There's direct intervention markets through open market operations. That's the

680
00:37:49,440 --> 00:37:52,759
Speaker 1: purchase program that you're describing, also offering repout a blow

681
00:37:52,800 --> 00:37:57,360
Speaker 1: market price. Uh. There's facilities that are temporary emergency facilities

682
00:37:57,440 --> 00:38:00,560
Speaker 1: like the commercial paper funding facility and the various other

683
00:38:00,760 --> 00:38:03,400
Speaker 1: acronyms that that won't do a launcher list of that

684
00:38:03,560 --> 00:38:06,120
Speaker 1: right now, but lots of two thousand eight vintage type

685
00:38:06,160 --> 00:38:10,040
Speaker 1: stuff which are really about providing a buyer blast resort

686
00:38:10,120 --> 00:38:13,040
Speaker 1: for various assets, at least on a temporary basis. And

687
00:38:13,120 --> 00:38:16,279
Speaker 1: then you also have these supervisory solutions which are to

688
00:38:16,320 --> 00:38:19,040
Speaker 1: say the we need to change the incentives and the

689
00:38:19,160 --> 00:38:22,840
Speaker 1: costs that we assess banks to enable them to perform

690
00:38:22,920 --> 00:38:26,600
Speaker 1: their function more efficiently. Particularly under these circumstances. So in

691
00:38:26,760 --> 00:38:30,160
Speaker 1: that statement, uh, I don't even remember what it was

692
00:38:30,200 --> 00:38:32,600
Speaker 1: at this point, but there was floated the idea that

693
00:38:32,680 --> 00:38:36,239
Speaker 1: we need to reassess capital and thequidity requirements, and they

694
00:38:36,320 --> 00:38:40,560
Speaker 1: dropped required reserves to zero and things like that. So

695
00:38:40,880 --> 00:38:45,240
Speaker 1: it's certainly under consideration. It's a lot easier to intervene

696
00:38:45,280 --> 00:38:47,960
Speaker 1: in markets than it is to change bank regulations, simply

697
00:38:48,000 --> 00:38:52,400
Speaker 1: because regulations create all kinds of different incentives, and in

698
00:38:52,520 --> 00:38:56,400
Speaker 1: principle you could you could pretty rapidly change that incentive structure,

699
00:38:56,920 --> 00:38:58,560
Speaker 1: but you want to be careful about it in a

700
00:38:58,640 --> 00:39:01,279
Speaker 1: couple of ways. The first is one of the things

701
00:39:01,320 --> 00:39:05,920
Speaker 1: I mentioned was reducing liquidity requirements. So banks, as a

702
00:39:05,960 --> 00:39:09,600
Speaker 1: consequence of this liquidity coverage ratio rule, are required to

703
00:39:09,760 --> 00:39:13,720
Speaker 1: hold high, high quality liquid assets in a certain amount

704
00:39:13,800 --> 00:39:16,960
Speaker 1: to cover potential outflows. So what the what the regulars do?

705
00:39:17,040 --> 00:39:21,239
Speaker 1: As they say, this kind of liability has this kind

706
00:39:21,280 --> 00:39:23,560
Speaker 1: of run risk, and this kind of liability has this

707
00:39:23,640 --> 00:39:25,160
Speaker 1: kind of run risk, and we go through the bank

708
00:39:25,239 --> 00:39:27,120
Speaker 1: balance sheet on the liability side, and we say, you

709
00:39:27,200 --> 00:39:30,800
Speaker 1: need to be able to cover your thirty days stressed

710
00:39:30,840 --> 00:39:34,160
Speaker 1: outflows with what we deem to be high quality liquid assets,

711
00:39:34,200 --> 00:39:37,080
Speaker 1: which are functionally just treasuries in cash for the most

712
00:39:37,160 --> 00:39:41,200
Speaker 1: part um. So in principle, what they could say is, too, banks,

713
00:39:41,360 --> 00:39:43,320
Speaker 1: you can just hold less of those liquid assets. We

714
00:39:43,440 --> 00:39:46,960
Speaker 1: kind of told you to hold liquidity for precisely this situation. Right,

715
00:39:47,000 --> 00:39:50,000
Speaker 1: You're you're facing a demand for cash. You have high

716
00:39:50,080 --> 00:39:52,000
Speaker 1: quality liquid assets that you're supposed to be able to

717
00:39:52,040 --> 00:39:55,120
Speaker 1: monetize at a reasonable cost, and so why don't you

718
00:39:55,160 --> 00:39:59,279
Speaker 1: just sell those assets and fund whatever draws on your

719
00:39:59,320 --> 00:40:01,200
Speaker 1: cash you need? That That was the point of this

720
00:40:01,280 --> 00:40:04,200
Speaker 1: thing in the first place. The issue is this particular

721
00:40:05,239 --> 00:40:08,720
Speaker 1: crisis is localized to the high quality liquid asset market,

722
00:40:09,280 --> 00:40:13,400
Speaker 1: so large scale sales of high quality liquid assets, particularly treasuries,

723
00:40:13,880 --> 00:40:16,239
Speaker 1: to fund draws and credit facilities, are just gonna make

724
00:40:16,280 --> 00:40:21,080
Speaker 1: the problem worse. So that's not necessarily the right supervisory solution.

725
00:40:21,440 --> 00:40:23,560
Speaker 1: The other thing you could do is you could say, well,

726
00:40:23,600 --> 00:40:27,080
Speaker 1: remember when we said all assets count towards your leverage, Well,

727
00:40:27,160 --> 00:40:30,640
Speaker 1: now cash and treasuries don't, so so those are no

728
00:40:30,800 --> 00:40:34,399
Speaker 1: longer contributors to your leverage because they are risk free,

729
00:40:34,760 --> 00:40:37,160
Speaker 1: and therefore you can intermediate as much as you want

730
00:40:37,200 --> 00:40:40,879
Speaker 1: and you won't incur balancing cost um. That's a big

731
00:40:41,040 --> 00:40:44,120
Speaker 1: change to how banks do business. And you know, it's

732
00:40:44,160 --> 00:40:46,400
Speaker 1: it's something people have talked about. We don't have a

733
00:40:46,440 --> 00:40:49,040
Speaker 1: sense of whether or not that's likely, but that's that's

734
00:40:49,080 --> 00:40:51,799
Speaker 1: one thing under consideration, and I guess the last way

735
00:40:51,840 --> 00:40:54,319
Speaker 1: to think about it is with these facilities, they can

736
00:40:54,400 --> 00:40:57,840
Speaker 1: get special treatment under regulations. So the money market liquidity

737
00:40:57,880 --> 00:41:02,120
Speaker 1: funding facility that you mentioned earlier, that's to provide secondary

738
00:41:02,160 --> 00:41:05,000
Speaker 1: market support for sales or short term credit instruments. So

739
00:41:05,120 --> 00:41:07,960
Speaker 1: if a prime fund is facing redemptions, they need to

740
00:41:08,040 --> 00:41:10,640
Speaker 1: sell commercial paper to fund them or to maintain their

741
00:41:10,719 --> 00:41:15,319
Speaker 1: liquidity requirements. Dealers need to be able to both purchase those,

742
00:41:15,360 --> 00:41:17,880
Speaker 1: hold them on their balance sheet and finance them. And

743
00:41:18,000 --> 00:41:20,040
Speaker 1: what the FETE has done is they provided this facility

744
00:41:20,719 --> 00:41:25,040
Speaker 1: to offer funding. So they take as collateral assets sold

745
00:41:25,080 --> 00:41:28,760
Speaker 1: by prime money market funds preferentially and they offer cash

746
00:41:29,200 --> 00:41:32,160
Speaker 1: for that, and they carve that out of existing regulations,

747
00:41:32,200 --> 00:41:34,279
Speaker 1: so they said, this doesn't count towards your levels, this

748
00:41:34,320 --> 00:41:37,480
Speaker 1: doesn't count towards your risk space capital. So through these

749
00:41:37,480 --> 00:41:41,239
Speaker 1: emergency facilities you can you can offer preferential treatment that

750
00:41:41,360 --> 00:41:44,800
Speaker 1: lets the fire brakes work more effectively. Without changing the

751
00:41:44,840 --> 00:41:49,000
Speaker 1: whole incentive structure of bank regulations. How much have what

752
00:41:49,200 --> 00:41:52,879
Speaker 1: we are have, what we've seen so far in terms

753
00:41:52,960 --> 00:41:56,560
Speaker 1: of the response to the crisis, as well as the

754
00:41:56,680 --> 00:42:00,880
Speaker 1: fact that the crisis has not effect in affected the

755
00:42:01,080 --> 00:42:05,560
Speaker 1: core banks particularly much a sort of vindication in your

756
00:42:05,680 --> 00:42:09,200
Speaker 1: view of the system the regulations that were passed by

757
00:42:09,239 --> 00:42:12,120
Speaker 1: Congress and the wick of the Great Financial Crisis, and

758
00:42:12,200 --> 00:42:15,239
Speaker 1: the facilities that Ben Bernake and others built at the

759
00:42:15,320 --> 00:42:18,560
Speaker 1: FED during it. So the way I think about it is,

760
00:42:18,680 --> 00:42:21,560
Speaker 1: what we're facing here is a cash shortage in the

761
00:42:21,600 --> 00:42:25,080
Speaker 1: real economy. So if you're if you don't have enough cash,

762
00:42:25,840 --> 00:42:29,000
Speaker 1: and the sole producer of cash, namely the FED, can

763
00:42:29,080 --> 00:42:32,840
Speaker 1: simply produce more cash, like that should really solve the problem.

764
00:42:32,960 --> 00:42:35,440
Speaker 1: So you're gonna see a lot of volatility in the

765
00:42:35,480 --> 00:42:38,520
Speaker 1: meantime because the demand fair cash and the creation of

766
00:42:38,600 --> 00:42:42,080
Speaker 1: cash will be offset in timing. Like you sometimes the

767
00:42:42,200 --> 00:42:44,840
Speaker 1: FED will offer a certain amount of cash and the

768
00:42:44,920 --> 00:42:47,280
Speaker 1: market actually needs more than that, so you'll see more stress.

769
00:42:47,360 --> 00:42:50,319
Speaker 1: But over time, if you average that over the next

770
00:42:50,360 --> 00:42:52,919
Speaker 1: few months, this is a problem the FED can solve.

771
00:42:53,680 --> 00:43:00,560
Speaker 1: So it's less about the the existence of credit products

772
00:43:00,640 --> 00:43:02,840
Speaker 1: that were much riskier than they were thought to be.

773
00:43:03,000 --> 00:43:04,879
Speaker 1: That was the issue two thousand eight. Right now, it's

774
00:43:04,880 --> 00:43:06,960
Speaker 1: just a demand for cash that can't be met by

775
00:43:07,000 --> 00:43:10,520
Speaker 1: the markets themselves for a variety of reasons. But the

776
00:43:10,640 --> 00:43:13,440
Speaker 1: FED can solve that. So I think it's a vindication

777
00:43:14,200 --> 00:43:17,000
Speaker 1: of a bunch of things, one but the most important

778
00:43:17,080 --> 00:43:19,840
Speaker 1: being the willingness of the FED to provide liquidity in

779
00:43:19,920 --> 00:43:24,200
Speaker 1: these kinds of episodes, to avoid the fire sale of

780
00:43:24,760 --> 00:43:27,319
Speaker 1: money good assets like things like treasuries. You're gonna get

781
00:43:27,360 --> 00:43:29,680
Speaker 1: your principal back. It's but it's simply a matter of

782
00:43:30,040 --> 00:43:33,480
Speaker 1: piping it through the right plumbing and and the FED

783
00:43:33,560 --> 00:43:36,359
Speaker 1: can help alleviate those stressors, and in doing so they

784
00:43:36,400 --> 00:43:40,879
Speaker 1: can avoid bigger liquidity issues turning into credit events. Because

785
00:43:40,960 --> 00:43:43,840
Speaker 1: the issue is, we don't have a credit problem necessarily

786
00:43:44,040 --> 00:43:46,480
Speaker 1: right now, at least at the scale of the economy.

787
00:43:46,560 --> 00:43:49,160
Speaker 1: But if capital markets are shut and there's no access

788
00:43:49,280 --> 00:43:51,120
Speaker 1: to cash and there's still a need for it, especially

789
00:43:51,160 --> 00:43:52,759
Speaker 1: we're going to shut down the economy for a couple

790
00:43:52,800 --> 00:43:55,239
Speaker 1: of months and the FED is not providing that cash,

791
00:43:55,400 --> 00:43:58,879
Speaker 1: then then it can turn into something much more through

792
00:43:59,040 --> 00:44:03,160
Speaker 1: deep in the financial system. M hmm. I guess the

793
00:44:03,239 --> 00:44:06,680
Speaker 1: trade off of constraining bank balance sheets so that they

794
00:44:06,719 --> 00:44:09,359
Speaker 1: can withstand this kind of thing. Is that it means

795
00:44:09,400 --> 00:44:11,960
Speaker 1: that you have to rely on the FED a little

796
00:44:12,000 --> 00:44:15,040
Speaker 1: bit more to provide that sort of UM last stop

797
00:44:15,280 --> 00:44:20,719
Speaker 1: liquidity UM. Just on that note, Josh, you've been writing

798
00:44:20,760 --> 00:44:22,960
Speaker 1: about this for a long time. In fact, I think

799
00:44:23,080 --> 00:44:26,080
Speaker 1: this week you published like a five part series on

800
00:44:27,040 --> 00:44:30,520
Speaker 1: the FEDS emergency measures and how those are playing out

801
00:44:30,520 --> 00:44:32,719
Speaker 1: in the U. S. Treasury market. Just to sum it

802
00:44:32,760 --> 00:44:36,920
Speaker 1: all up, how long do you expect these stresses to continue?

803
00:44:38,280 --> 00:44:40,560
Speaker 1: It's really hard to say. I wouldn't be surprised if

804
00:44:40,600 --> 00:44:44,160
Speaker 1: it's a few weeks, simply because the size of the

805
00:44:44,239 --> 00:44:46,919
Speaker 1: position that ultimately might be on wound is quite large,

806
00:44:46,960 --> 00:44:49,840
Speaker 1: and it has to go through a relatively narrow pipe.

807
00:44:49,880 --> 00:44:52,840
Speaker 1: And that's if we keep it isolated to that futures

808
00:44:52,880 --> 00:44:56,480
Speaker 1: basis trade and it's obviously gone into other areas as

809
00:44:56,520 --> 00:44:59,840
Speaker 1: well at this point, But over a few weeks to

810
00:45:00,000 --> 00:45:02,080
Speaker 1: a couple of months, like the FED should be able

811
00:45:02,160 --> 00:45:05,080
Speaker 1: to manage this process. I think the thing to keep

812
00:45:05,080 --> 00:45:07,480
Speaker 1: in mind is that, at least from my perspective, FED

813
00:45:07,520 --> 00:45:11,200
Speaker 1: intervention is not about making things normally. It's about avoiding

814
00:45:11,680 --> 00:45:15,040
Speaker 1: the more catastrophic outcomes. So the FED is not supposed

815
00:45:15,040 --> 00:45:16,960
Speaker 1: to intervene and make everything look like it did six

816
00:45:17,040 --> 00:45:21,400
Speaker 1: months ago, when liquidity was bountiful and markets were trading

817
00:45:21,840 --> 00:45:24,560
Speaker 1: very liquidly with zero transaction costs in some cases, and

818
00:45:24,760 --> 00:45:26,400
Speaker 1: like very large size, and it was easy to do

819
00:45:26,480 --> 00:45:29,000
Speaker 1: anything and so forth. Like. That's not the fed's mandate.

820
00:45:29,000 --> 00:45:32,000
Speaker 1: They're they're supposed to be an emergency a crisis manager,

821
00:45:32,440 --> 00:45:35,480
Speaker 1: and in that sense, I think they'll get control of

822
00:45:35,520 --> 00:45:38,240
Speaker 1: the situation reasonably quickly. They already have to some extent,

823
00:45:38,280 --> 00:45:41,719
Speaker 1: at least in the futures market, where things have really

824
00:45:41,800 --> 00:45:47,040
Speaker 1: been been most acute. There are some incremental issues there.

825
00:45:47,440 --> 00:45:49,799
Speaker 1: Marginal requirements going up in futures is one of them,

826
00:45:49,880 --> 00:45:54,440
Speaker 1: which exacerbates the problem. But fundamentally that situation I think

827
00:45:54,719 --> 00:45:56,800
Speaker 1: is mostly at least under control in the sense that

828
00:45:56,880 --> 00:46:01,879
Speaker 1: it's unlikely to accelerate in a bad a. I mean,

829
00:46:02,320 --> 00:46:05,560
Speaker 1: if the real economy side of the situation continues to

830
00:46:05,760 --> 00:46:09,720
Speaker 1: deteriorate at the speed that we've seen, then the number

831
00:46:09,840 --> 00:46:15,000
Speaker 1: of any sort of credit needing institutions, including companies that

832
00:46:15,600 --> 00:46:18,480
Speaker 1: right now today might be considered high grade and high

833
00:46:18,560 --> 00:46:23,080
Speaker 1: quality or investment grade, could in theory continue to deteriorate,

834
00:46:23,239 --> 00:46:25,520
Speaker 1: and so a company who Okay, we can issue them

835
00:46:25,600 --> 00:46:27,560
Speaker 1: commercial paper because it's high quality, we don't have to

836
00:46:27,560 --> 00:46:32,359
Speaker 1: worry about their credit worthiness. Eventually the economic degradation could

837
00:46:32,480 --> 00:46:36,000
Speaker 1: limit anyone from really being able to make cash flows

838
00:46:36,080 --> 00:46:39,800
Speaker 1: if other things don't stabilize. Does that eventually become a

839
00:46:39,960 --> 00:46:43,560
Speaker 1: problem that essentially the FED can't get under control if

840
00:46:43,640 --> 00:46:47,960
Speaker 1: they start to whether it's municipal markets, companies, etcetera, where

841
00:46:48,040 --> 00:46:50,120
Speaker 1: we start to see a real problem where we doubt

842
00:46:50,160 --> 00:46:55,000
Speaker 1: anyone's ability to make their payments totally. If if things

843
00:46:55,120 --> 00:46:57,560
Speaker 1: keep going at the pace they've been going, we're going

844
00:46:57,600 --> 00:47:01,000
Speaker 1: to have big credit problems. But they something fundamentally different

845
00:47:01,040 --> 00:47:05,920
Speaker 1: about this recession then prior recessions and especially two. And

846
00:47:06,160 --> 00:47:09,319
Speaker 1: the key here is that the it's a totally exogenous event.

847
00:47:09,760 --> 00:47:13,720
Speaker 1: So this is not about companies that appear to be viable,

848
00:47:13,800 --> 00:47:17,960
Speaker 1: enterprises that were actually inviable and we just didn't realize

849
00:47:18,000 --> 00:47:20,320
Speaker 1: it and it's not actually a reasonable business model and

850
00:47:20,360 --> 00:47:22,960
Speaker 1: those companies have to go. It's creative destruction. It's just

851
00:47:23,040 --> 00:47:25,640
Speaker 1: happening too quickly. This is not that this is a

852
00:47:25,920 --> 00:47:29,279
Speaker 1: pure stoppage and it's liquidity issue. So if you have

853
00:47:29,440 --> 00:47:35,000
Speaker 1: a company that would otherwise be going concern under normal circumstances,

854
00:47:35,040 --> 00:47:37,920
Speaker 1: and you just stop the economy for three months, the

855
00:47:38,040 --> 00:47:41,000
Speaker 1: FED can bridge that gap, and the government can bridge

856
00:47:41,040 --> 00:47:44,920
Speaker 1: that gap under the assumption that when everybody leaves their houses,

857
00:47:45,280 --> 00:47:47,919
Speaker 1: the world is not as it was, but at least

858
00:47:48,640 --> 00:47:53,359
Speaker 1: it's it's reasonably similar. Yeah, and so if that's the case,

859
00:47:53,440 --> 00:47:58,279
Speaker 1: it's really literally a liquidity issue. And that's precisely the

860
00:47:58,360 --> 00:48:01,799
Speaker 1: kind of thing the FED can solve. If the interventions

861
00:48:02,040 --> 00:48:05,680
Speaker 1: are structured in a way that doesn't necessarily solve the

862
00:48:05,760 --> 00:48:09,640
Speaker 1: core problem, or are otherwise too small or delayed, you

863
00:48:09,680 --> 00:48:12,800
Speaker 1: could end up with real credit problems as liquidity becomes

864
00:48:12,880 --> 00:48:17,319
Speaker 1: credit stress. The FED is clearly shown a couple of things.

865
00:48:17,360 --> 00:48:19,440
Speaker 1: When is they're willing to act in size at a minimum,

866
00:48:19,719 --> 00:48:23,359
Speaker 1: when you when you have open ended purchase operations, they're

867
00:48:23,360 --> 00:48:25,040
Speaker 1: gonna buy more than six hundred billion dollars. But the

868
00:48:25,080 --> 00:48:29,480
Speaker 1: Treasury this week, So this is a massive pace of intervention.

869
00:48:29,520 --> 00:48:33,280
Speaker 1: There's five trillion of liquidity through repo operations. They're talking

870
00:48:33,320 --> 00:48:36,480
Speaker 1: about a small business lending facility that could reach for

871
00:48:36,680 --> 00:48:39,560
Speaker 1: trillion dollars like they're they're talking about really big numbers,

872
00:48:39,600 --> 00:48:42,680
Speaker 1: So I don't think size is an issue here. Uh.

873
00:48:42,880 --> 00:48:46,719
Speaker 1: The the structuring of these programs is something they've been

874
00:48:46,760 --> 00:48:50,120
Speaker 1: quite dynamic about. So the Commercial Paper Funding Facility announced

875
00:48:50,200 --> 00:48:53,080
Speaker 1: last week prices too high. They brought it down this week.

876
00:48:53,320 --> 00:48:56,160
Speaker 1: They went from two over o I s rates or

877
00:48:56,200 --> 00:49:00,560
Speaker 1: two d over fed funds to ten over. So they're

878
00:49:00,600 --> 00:49:03,840
Speaker 1: they're willing to adjust the scope and and the pricing

879
00:49:03,880 --> 00:49:06,600
Speaker 1: of these programs to make sure they're effective, and they're

880
00:49:06,600 --> 00:49:08,439
Speaker 1: willing to roll out new things. And this money market

881
00:49:08,520 --> 00:49:12,320
Speaker 1: Liquidity funding facility was was was the new thing, so

882
00:49:13,280 --> 00:49:15,759
Speaker 1: it resembled something else, but it still was a new thing.

883
00:49:15,920 --> 00:49:20,359
Speaker 1: So as long as they are being creative and being

884
00:49:21,000 --> 00:49:24,799
Speaker 1: big and being timely, it should be something that can

885
00:49:24,800 --> 00:49:27,719
Speaker 1: be kept under control. The risk is always that the

886
00:49:28,280 --> 00:49:31,560
Speaker 1: longer term economic consequences of an event it magnets to

887
00:49:31,600 --> 00:49:33,840
Speaker 1: it are very hard to have a sense that. We

888
00:49:33,880 --> 00:49:38,439
Speaker 1: don't have a lot of examples of that. No, Josh,

889
00:49:38,520 --> 00:49:43,719
Speaker 1: that was an absolutely fascinating conversation. We really appreciate both

890
00:49:43,760 --> 00:49:47,560
Speaker 1: your research and you coming on to have this conversation. Finally,

891
00:49:47,800 --> 00:49:49,719
Speaker 1: Um you were able to have you so, thank you

892
00:49:49,840 --> 00:49:53,160
Speaker 1: so much. Yeah, now it's been it's been fun. There's

893
00:49:53,239 --> 00:50:08,000
Speaker 1: Jeff so Joe. You can probably tell I really enjoyed

894
00:50:08,080 --> 00:50:12,800
Speaker 1: that conversation. I love digging into this, you know, treasury

895
00:50:12,880 --> 00:50:15,440
Speaker 1: basis trade because it's one of those things that not

896
00:50:15,600 --> 00:50:20,320
Speaker 1: many people were looking at or writing about, except and

897
00:50:20,440 --> 00:50:23,480
Speaker 1: please allow me this one small victory lap. I love

898
00:50:23,560 --> 00:50:28,719
Speaker 1: that something that had the potential to blow up is

899
00:50:28,800 --> 00:50:32,680
Speaker 1: kind of doing so in an expected way. But you know, again,

900
00:50:32,800 --> 00:50:34,640
Speaker 1: the big deal when it comes to the U. S.

901
00:50:34,680 --> 00:50:37,759
Speaker 1: Treasury market is that it's not supposed to be a

902
00:50:37,880 --> 00:50:41,080
Speaker 1: risky market. You're not supposed to get these big sell

903
00:50:41,160 --> 00:50:44,319
Speaker 1: off events and this type of volatility, and yet that's

904
00:50:44,360 --> 00:50:46,880
Speaker 1: what we've just seen. One day we'll do an episode

905
00:50:46,960 --> 00:50:48,920
Speaker 1: where with something I was writing about a few years

906
00:50:48,960 --> 00:50:50,920
Speaker 1: ago and it all happens. But I don't know what

907
00:50:51,000 --> 00:50:55,560
Speaker 1: that's going to be. I thought he was great because yeah,

908
00:50:55,640 --> 00:50:58,000
Speaker 1: something like that. Maybe when the coin finally gets minted,

909
00:50:58,360 --> 00:51:01,000
Speaker 1: we'll do an episode on that. Two things. One his

910
00:51:01,200 --> 00:51:05,120
Speaker 1: his explanation and like what these uh futures choiceories basis

911
00:51:05,160 --> 00:51:08,239
Speaker 1: trades are incredibly clear and simple, and I appreciate that,

912
00:51:09,080 --> 00:51:11,919
Speaker 1: Like I have to say, I just sort of appreciated

913
00:51:12,360 --> 00:51:15,719
Speaker 1: his calum demeanor at this time, because you know, this

914
00:51:15,920 --> 00:51:20,040
Speaker 1: is a crazy time. He was probably the most chill, relaxed,

915
00:51:20,239 --> 00:51:23,359
Speaker 1: clear person I've talked to in a while, So I really, uh,

916
00:51:23,760 --> 00:51:27,879
Speaker 1: I really appreciated that as well. Yeah, and his point

917
00:51:27,920 --> 00:51:32,080
Speaker 1: about the perception of operational risk, I think is another

918
00:51:32,160 --> 00:51:35,640
Speaker 1: one of those things that doesn't necessarily make it into

919
00:51:36,000 --> 00:51:40,399
Speaker 1: models of how the financial system works. Like people think

920
00:51:40,760 --> 00:51:44,400
Speaker 1: that banks are always going to be there to sponsor

921
00:51:44,480 --> 00:51:49,080
Speaker 1: repo trades and intermediate the financial system, but as we've

922
00:51:49,120 --> 00:51:51,560
Speaker 1: seen time and time again in a big crisis, there

923
00:51:51,640 --> 00:51:54,520
Speaker 1: are times when you know, like in two thousand eight,

924
00:51:54,719 --> 00:51:57,520
Speaker 1: people just didn't pick up the phone because they were

925
00:51:57,560 --> 00:51:59,839
Speaker 1: scared and they didn't know what to do. And now

926
00:52:00,120 --> 00:52:03,480
Speaker 1: in two thousand twenty, people possibly aren't picking up up

927
00:52:03,520 --> 00:52:06,200
Speaker 1: the phone because they're all working from home and I

928
00:52:06,280 --> 00:52:08,279
Speaker 1: don't know, their phones run out of batteries or they

929
00:52:08,320 --> 00:52:11,399
Speaker 1: don't hear it or whatever. And that type of real

930
00:52:11,560 --> 00:52:16,600
Speaker 1: world quirk I think is really important to consider totally.

931
00:52:16,640 --> 00:52:19,120
Speaker 1: And I think it's something that you know, I've learned

932
00:52:19,120 --> 00:52:22,520
Speaker 1: a lot about from some of our episodes with Chris

933
00:52:22,640 --> 00:52:25,960
Speaker 1: White talking about how the bond market works, and I

934
00:52:26,200 --> 00:52:30,080
Speaker 1: sort of I'm always interested in this topic that so

935
00:52:30,360 --> 00:52:33,560
Speaker 1: much of our financial markets operates this way, whether it's

936
00:52:33,560 --> 00:52:37,960
Speaker 1: through a chat room hopefully they're using Bloomberg ib plugging that,

937
00:52:38,719 --> 00:52:42,000
Speaker 1: or a picking up the phone that you know, people

938
00:52:42,080 --> 00:52:44,640
Speaker 1: have this idea that the all of our financial markets,

939
00:52:44,680 --> 00:52:47,080
Speaker 1: it's just robots and algorithms out there and everyone can

940
00:52:47,160 --> 00:52:50,680
Speaker 1: just go home and actually for the most important things,

941
00:52:50,760 --> 00:52:55,320
Speaker 1: including like finding liquidity to buy the most safe asset

942
00:52:55,440 --> 00:52:59,000
Speaker 1: in the world, that's still done by phone. Is a

943
00:52:59,160 --> 00:53:02,600
Speaker 1: really strike in fact, and it helped me understand some

944
00:53:02,800 --> 00:53:07,600
Speaker 1: of the dislocations and breakdowns and correlations that we've seen

945
00:53:07,719 --> 00:53:11,640
Speaker 1: over the last couple of weeks. Yes, indeed, so this

946
00:53:11,840 --> 00:53:15,040
Speaker 1: has been another episode of the All Thoughts podcast. I'm

947
00:53:15,080 --> 00:53:18,200
Speaker 1: Tracy Alloway. You can follow me on Twitter at Tracy Alloway,

948
00:53:18,719 --> 00:53:21,680
Speaker 1: and I'm Joe Wisenthal. You can follow me on Twitter

949
00:53:21,880 --> 00:53:25,400
Speaker 1: at the Stalwart, and you should follow our producer on Twitter,

950
00:53:25,520 --> 00:53:29,800
Speaker 1: Laura Carlson. She's at Laura and Carlson. Follow the Bloomberg

951
00:53:29,840 --> 00:53:33,600
Speaker 1: Head of Podcasts on Twitter, Francesca Leady at Francesca Today,

952
00:53:34,160 --> 00:53:37,440
Speaker 1: and check out all of the Bloomberg podcasts under the

953
00:53:37,520 --> 00:54:01,640
Speaker 1: handle at podcast. Thanks for listening. O