Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Tracy Alla White and I'm Joe Wisntal So Joe, uh.
Speaker 1: I know there's a lot to talk about when it
Speaker 1: comes to the recent market turmoil, but I have to
Speaker 1: say there is one thing that stands out to me,
Speaker 1: and that is what we've seen in the U. S. Treasury.
Speaker 1: Can I just can I just back up for once.
Speaker 1: I got I just got a thought, you know, it
Speaker 1: would be funny when well, I don't. I don't know
Speaker 1: funny it's exactly the right word here. But it would
Speaker 1: be very interesting to compile a complete compendium of all
Speaker 1: of our podcast intros over the last couple of months
Speaker 1: and through this as things get crazier and crazier, because
Speaker 1: I feel like in the beginning it was like, well,
Speaker 1: let's talk a little bit about disruptions to a Chinese
Speaker 1: supply chain, and then we're at the point of let's
Speaker 1: talk about how suddenly the safest asset in the world
Speaker 1: is a trading like how it's supposed to be. And
Speaker 1: I feel like we could track the course of the
Speaker 1: entire crisis just by comparing our little intros here day
Speaker 1: after day. So maybe that's a project will do one day. Yeah,
Speaker 1: definitely not funny, but probably noteworthy, that's for sure. That's funny,
Speaker 1: but sarkly funny. Maybe. Yeah, I don't know why I'm laughing. Actually,
Speaker 1: um okay, But you're exactly right, because the crazy thing
Speaker 1: about the big sell off in the treasury market, people
Speaker 1: complaining about lack of liquidity in the treasury market, is
Speaker 1: that it is supposed to be the most liquid market
Speaker 1: in the world and um a safe asset in times
Speaker 1: of turmoil. It's supposed to be cash like, and we
Speaker 1: haven't necessarily seen that over the past few weeks. Right, exactly.
Speaker 1: This is a very key and important thing to understand,
Speaker 1: which is that US treasuries, they have the full faith
Speaker 1: and credit of the United States in a normal stressful scenario,
Speaker 1: in a normal period where people are worried about the
Speaker 1: economy or worried about you know whatever, worried about the
Speaker 1: financial system. Because they are almost they're essentially money, money
Speaker 1: that pays an interest rate. People tend to buy them,
Speaker 1: and people tend to hoard them during dark times. But
Speaker 1: what we've seen in recent weeks is such an extreme
Speaker 1: dislocation and such extreme anxiety that even an asset that's
Speaker 1: arguably the safest asset in the world. US treasuries has
Speaker 1: at times being been gotten sold even at times it's
Speaker 1: perceived as not being safe enough, and understanding why that
Speaker 1: is the mechanics of our financial markets, or understanding why
Speaker 1: there have been periods of stress where they've gotten sold,
Speaker 1: can really tell us a lot about the plumbing of
Speaker 1: the US financial system. Well, I think the issue is
Speaker 1: not only have U S treasuries sold off, but the
Speaker 1: actual selling process wasn't as smooth as many people might
Speaker 1: have expected. So for instance, we saw bid ask spreads
Speaker 1: in off the run treasuries much much higher than they
Speaker 1: would normally be, but even on the run securities were
Speaker 1: higher as well, and market depth basically across the treasury
Speaker 1: curve really plunged all the way back I think to
Speaker 1: the two thou crisis slows, And as we've discussed on
Speaker 1: previous episodes, the thing about US treasuries is they're basically
Speaker 1: the funding market for everything in the global financial system.
Speaker 1: So if you have trouble in treasuries, if you have
Speaker 1: a liquidity, and if you have a sell off, then
Speaker 1: it can feed into all sorts of things, including financial
Speaker 1: conditions and that's probably the way that it starts to
Speaker 1: affect the real economy as well. So we're gonna be
Speaker 1: talking about the U S. Treasury market, We're gonna be
Speaker 1: talking about plumbing issues. Uh. But the thing to keep
Speaker 1: in mind is that all of this really im hacks
Speaker 1: the pain now being felt across and I just want
Speaker 1: to as we have to do these days. We didn't
Speaker 1: have used to have to do it so much. But
Speaker 1: you know, we always have to have this caveat in
Speaker 1: the beginning of every episode where we point out the
Speaker 1: exact date that we're recording this, because again, things can
Speaker 1: change so much by the time recording has happened, so
Speaker 1: the time people listen to it, we were recording this
Speaker 1: on Tuesday, March. And I also want to just point
Speaker 1: out the FED has already done a number of things
Speaker 1: to ease some of this tension a little bit. So
Speaker 1: we'll talk a little bit more about what the breakdown was,
Speaker 1: what the FED has already done to relieve some of
Speaker 1: these tensions we're seeing in the treasury market, in the
Speaker 1: funding market, and of course whether it's enough and what
Speaker 1: that tells us about how the system works. But just again,
Speaker 1: whenever you're listening to this. Tuesday, March nine am Eastern
Speaker 1: time is when we're recording this. It's kind of worrying
Speaker 1: that we have to provide the hour nowadays as well. Yeah,
Speaker 1: exactly right, Okay, Well, without further ado, we're going to
Speaker 1: talk to someone who has been on top of a
Speaker 1: lot of the troubles in the treasury market for some time.
Speaker 1: He's someone who's research I've been following closely for years now,
Speaker 1: and I have to say he's really come out on
Speaker 1: top in the recent volatility. His stuff has been excellent
Speaker 1: and lots of people are reading it. Josh Younger is
Speaker 1: a strategist over at JP Morgan. Thanks so much for
Speaker 1: coming on, Josh. Thanks for having me, Josh. I just
Speaker 1: wanted to uh, I just for listeners before we get started.
Speaker 1: Want to point out several people have suggested in the
Speaker 1: past um that we should have you on, so I'm
Speaker 1: really excited about this. And of course your name came
Speaker 1: up in one of our best episodes that we did
Speaker 1: with Brad Setser where we talked about the Taiwanese life
Speaker 1: insurers and how they were hedging their currency risk. He
Speaker 1: mentioned that you were one of the best on this,
Speaker 1: so you are definitely a sort of a long time
Speaker 1: high wishless guest for for us a lot of our listeners.
Speaker 1: So I really appreciate. I'm excited to be I'm a
Speaker 1: fan of the show, so it's always it's always great
Speaker 1: to participate. Alright, awesome, So, Josh, just to begin with,
Speaker 1: I want to start out with the troubles that we've
Speaker 1: seen in the treasury market. So I spoke a little
Speaker 1: bit about the liquidity issues, but I wondered if we
Speaker 1: could maybe zoom in on one thing in particular, which
Speaker 1: was this notion of levered US treasury trade. So one
Speaker 1: thing that happened recently in the market sell off was
Speaker 1: that we suddenly got a big difference between futures contracts
Speaker 1: for US treasuries and the cash U S treasuries. Can
Speaker 1: you explain exactly why that happened? Yeah? Sure. So withoud
Speaker 1: anything like this, a crisis of this magnitude, it always
Speaker 1: starts in a place you really recognize immediately, and then
Speaker 1: it accelerates in the place you didn't really expect. And
Speaker 1: so back in two thousand eight, that was the subprime
Speaker 1: mortgage market was the accelerant, and in this case the
Speaker 1: acceller it turned out to be uh, not a not
Speaker 1: a risky st not credit markets, but but like like
Speaker 1: you mentioned earlier, you know, risk free assets, things with
Speaker 1: no credit risk, treasury bonds. And so the question is
Speaker 1: sort of why was this divergence that you mentioned really important?
Speaker 1: Of where did it come from? So the initial phase
Speaker 1: of this was really a shift and fundamental So any
Speaker 1: economists will tell you that long term interest rates should
Speaker 1: have a lot to do with long term potential growth
Speaker 1: and to some extent of flight to quality. And as
Speaker 1: the as the COVID nineteen outbreak accelerated, there was a
Speaker 1: real shift in expectations. This is real fundamentals here. You know,
Speaker 1: growth expectations come down, Uh, the set of risks around
Speaker 1: those growth expectations increased, and so there was a natural
Speaker 1: flight quality and interest rates naturally go lower, especially if
Speaker 1: the Fed starts to cut rates. So the question is,
Speaker 1: you know, how can you access the market, like how
Speaker 1: effectively can you access the market. And treasuries have usually
Speaker 1: been this highly liquid, you know, cash like asset that
Speaker 1: trades very tight, it ask very low transaction costs. The
Speaker 1: issue arose really from the initially the velocity of this move,
Speaker 1: because expectations are changing so rapidly that you had two
Speaker 1: things happened. The first is it's just very hard to
Speaker 1: be the buyer to the sellers and the seller to
Speaker 1: the buyers. If prices are moving around all over the
Speaker 1: place every day, it's just a very difficult exercise. And
Speaker 1: so that means your willingness to participate in those transactions
Speaker 1: is a little less. That's particularly true of high frequency
Speaker 1: traders who are really trying to monetize the very small
Speaker 1: difference between the bid and the ask price. And when
Speaker 1: things are highly volatile, there's this risk that a bunch
Speaker 1: of orders you had outstanding that you thought weren't necessarily
Speaker 1: going to get hit end up getting hit because the
Speaker 1: prices moves rapidly and so high fre concentrators or something
Speaker 1: like eight percent of liquid in the treasury market, and
Speaker 1: that dropped to at times when when prices are moving
Speaker 1: around that violently. In that kind of environment, really the
Speaker 1: the flight to liquidity among products. So we we think
Speaker 1: of this as liquidity tearing. And if I need quick
Speaker 1: access at low transaction cost, futures are the best outlet
Speaker 1: for that, just go to the exchange. Treasury futures are
Speaker 1: going to be the tightest fit ask the lowest transaction costs,
Speaker 1: the largest size, the biggest group of participants most because
Speaker 1: they don't require balance sheet and they're they're traded on
Speaker 1: an exchange, so they're they're pretty transparent in their pricing.
Speaker 1: And so because rates removing lower you know, lower yields
Speaker 1: higher prices, the future has lad that move and they
Speaker 1: started to diverge a bit from the bonds into which
Speaker 1: you can deliver. The futures contracts. You think of a
Speaker 1: treasury futures contract, it's just like an oil contract. Do
Speaker 1: you have an agreement to sell at some future date
Speaker 1: which gives you economic exposure to the price of that thing.
Speaker 1: And in the case of treasuries, you have a bond
Speaker 1: that's part of a deliverable basket. And at the expert
Speaker 1: the future, I give the bond to whoever bought to
Speaker 1: whoever I sold the future too. So in principle those
Speaker 1: things should be really tightly correlated. Uh, just simply because
Speaker 1: I could hold the futures contract to expiry and deliver
Speaker 1: the bond, so I have could guarantee fire from my
Speaker 1: bond um. But over the course of that period before expiry,
Speaker 1: you can get these sharp discrepancies, and in this case,
Speaker 1: because of the liquidity value of that futures contract, they
Speaker 1: started to rich and relative to the cash bonds that
Speaker 1: could have been contained. That's happened in the past. That's
Speaker 1: pretty common. Actually, there's sort of an old adage and
Speaker 1: in treasury trading that if you don't know why prices
Speaker 1: are moving, you just say it's futures lead because that's
Speaker 1: the through most of pay part of the market. Uh So,
Speaker 1: when prices are going down, futures prices tend to go
Speaker 1: down more. And when future when prices are going up,
Speaker 1: futures prices tend to go up more. Um In this case,
Speaker 1: uh it was a little more severe than than was typical,
Speaker 1: but it wasn't completely outside the range of possibility. But
Speaker 1: it did put a lot of pressure on two groups
Speaker 1: which are key to this whole thing. The first is
Speaker 1: the relative value active man manager community, who really are
Speaker 1: holding a lot of positions where they're long the bonds
Speaker 1: and short the futures contract. And the second is the
Speaker 1: dealers themselves, because when they are asked to bid on
Speaker 1: af the round treasuries, it's it's hard to find the
Speaker 1: buyer for that bond immediately and so the tendency is
Speaker 1: to sell a futures contract to reduce your exposure as
Speaker 1: quickly as possible. And so both hedge funds and dealers
Speaker 1: were in this very large futures basis position, by which
Speaker 1: we mean they own the bonds generally in a levered basis,
Speaker 1: and they're short the futures contracts. So when the futures
Speaker 1: contract rich and relative to bonds, they face losses. There's
Speaker 1: a lot of I want to break down here, but
Speaker 1: talk to us about the significance of the discrepancy that
Speaker 1: always exists basically in any market between an on the
Speaker 1: run treasury and an off the run treasury. So I
Speaker 1: take that of freshly the treasury issues an auction and
Speaker 1: a fresh auction of tenure treasuries those are on the run,
Speaker 1: but a previous thirty year auction that was done twenty
Speaker 1: years ago, it's the same length that's technically should trade
Speaker 1: around the same price as a ten year auction today
Speaker 1: would be less liquid. And their entities that take advantage
Speaker 1: of these discrepancies. Talk to us a little bit about
Speaker 1: the mechanics of why that phenomenon exists, and then why
Speaker 1: that continue, why that sort of the stress that we've
Speaker 1: seen of late this dash for liquidity exacerbated them. Yeah,
Speaker 1: so generally speaking, those discrepancies are pretty small. They arise
Speaker 1: from a bunch of different things. But in the case
Speaker 1: that you're talking about, if you had an old thirty
Speaker 1: year originally thirty year bond, it's rolled down to ten years,
Speaker 1: it probably had a much higher coupon back in the day,
Speaker 1: and so rates are lower another than they were ten
Speaker 1: years ago. Uh, and that means that that bond is
Speaker 1: trading at a high premium. Right, So when rates go
Speaker 1: down and the coupon stays the same, there's a lot
Speaker 1: of value in that safe four percent coupon. If today's
Speaker 1: coupon would be two or one percent, or even today
Speaker 1: even low potentially, so it's gonna not gonna be a
Speaker 1: hundred dollars for for the bond is gonna be more.
Speaker 1: And so there are some participants that don't like to
Speaker 1: buy premium bonds because it doesn't have as friendly accounting treatment,
Speaker 1: or they don't want to put up that much cash
Speaker 1: for the same income. Right, the yield is the same,
Speaker 1: the dollar prices different. So uh, there there are other there,
Speaker 1: there are different incentives that people face both economically and
Speaker 1: accounting and otherwise, and so there might be less demand
Speaker 1: for that bond than the on the run treasury the
Speaker 1: on the run tenure, even though the maturities are the same,
Speaker 1: the issue is the same, etcetera. So those little features matter, um,
Speaker 1: and the liquidity in the on the run tends to
Speaker 1: be better. Just because we we had an auction, we
Speaker 1: know we're a priced and there's a lot of it outstanding. Um.
Speaker 1: One of one of the issues you run into with
Speaker 1: off the runs is the FED is maybe bought up
Speaker 1: a bunch of this bond too, so you don't really
Speaker 1: have a ton of pricing transparency. So all these little
Speaker 1: things matter. Under normal circumstances. It's worth a couple hundreds
Speaker 1: of a percentage point, which for some people in the
Speaker 1: market is a lot, But in general it's really a
Speaker 1: very small pricing difference. And and and that reflects the
Speaker 1: fact that at the end of the day, these are
Speaker 1: really the same instrument fundamentally, it's just these small differences
Speaker 1: change the price. What we've seen recently is much larger
Speaker 1: discrepancies in the pricing and especially volatility in those discrepancies.
Speaker 1: So the issue for a dealer is less whether or
Speaker 1: not this bond is trading at a lower price than
Speaker 1: you would expect given the yield on some more recent
Speaker 1: liquid issue. It's the fact that if those prices are
Speaker 1: moving relative to each other rapidly, it's very hard to
Speaker 1: manage the volatility and there in their book, because generally speaking,
Speaker 1: a dealer is going to be long owning a bunch
Speaker 1: of these author own issues, and they're going to try
Speaker 1: to hedge their first order risk, which is just the
Speaker 1: level of rates with something much more liquid. So, just
Speaker 1: going back to the levered US treasury trade that we
Speaker 1: were discussing, I mean, you mentioned that a lot of
Speaker 1: these relative value players were obviously borrowing money, they were
Speaker 1: levered in that position. I guess the clue is in
Speaker 1: the name of the trade, levered US Treasury trading um.
Speaker 1: And you also mentioned the dealers being less able to
Speaker 1: intermediate some of those trades. Can you talk about the
Speaker 1: relationship between hedge funds and dealers and where the report
Speaker 1: market actually comes into this, Yeah, tell me so. Well,
Speaker 1: the report market comes in simply because these price discrepancies
Speaker 1: are very small. So if you want to make a
Speaker 1: certain amount of money, you have to take out loans,
Speaker 1: you need to lever it up, and so that was
Speaker 1: generally case. That's been the case for a very long time.
Speaker 1: There's a couple of big differences now, and it rises
Speaker 1: from the interaction of markets and regulatory changes and the
Speaker 1: way that banks have been incentivized to manage their own
Speaker 1: balance sheets. So one of the big lessons of the
Speaker 1: crisis in two thousand eight it was clearly too big
Speaker 1: to fail as a problem, and so the regulatory suite
Speaker 1: that was introduced was partly meant to address this too
Speaker 1: big to fail issue. And in doing so, we need
Speaker 1: to define bigness, because that's not an obvious thing to define.
Speaker 1: The easiest way to think about it is simply size,
Speaker 1: and it doesn't really matter what you own. You can
Speaker 1: own just treasuries and that's a low risk asset. But
Speaker 1: we don't want to risk weight assets anymore if we're
Speaker 1: trying to control bigness in general. So we want to
Speaker 1: think about it holistically, so that we put put a
Speaker 1: limit on leverage in general at banks. And the implication
Speaker 1: of that is that the balance, the space on your
Speaker 1: balanty taken up by anything has value because you're using
Speaker 1: it instead of doing something else, And in particular for
Speaker 1: a bank, it means you have to think about your
Speaker 1: balanty ahead of time. You need to plan ahead, increasing
Speaker 1: your leverage as a dealer to take on more treasury
Speaker 1: bonds in your inventory. That didn't necessarily add to your
Speaker 1: cost of apple. But in the case of a bank,
Speaker 1: now we have to allocate balance sheet because it's a
Speaker 1: scarce commodity, and so we need to think ahead. That
Speaker 1: means you have to plan ahead, which means you have
Speaker 1: to make allocations in advance. So generally speaking, the strategy
Speaker 1: has been to look at a list of clients, think
Speaker 1: about how much they've utilized balance sheet in the past,
Speaker 1: how they utilized balance sheet, and repo is definitely the
Speaker 1: most significant source of that usage. And so you say, look,
Speaker 1: you use the billion dollars last year, we'll give you
Speaker 1: a billion dollars this year. You use two billion dollars
Speaker 1: last year, we'll give you twoillion dollars this year. And
Speaker 1: if you don't use it, well, you might not get
Speaker 1: as much next year, which is a very reasonable way
Speaker 1: to think about it. Use it or lose it. I
Speaker 1: just think it was a budgeting exercise, so that created
Speaker 1: a different set of incentives that were less economic. If
Speaker 1: I'm a relative value trader. I've got two things that
Speaker 1: I need to think about. One is what is the
Speaker 1: set of actual opportunities, the economic incentives, which are trading
Speaker 1: a price that's too low versus other bonds? And what
Speaker 1: bonds of trading a prices too high relative to the
Speaker 1: are bonds? How am I going to make money? Uh?
Speaker 1: The second thing is how do I maintain access to
Speaker 1: the leverage I need to make those trades interesting in
Speaker 1: the first place. So if the opportunity set is not
Speaker 1: particularly appealing right now, how do I make sure that
Speaker 1: I'm using my balance sheet, my balanciet allocation simply to
Speaker 1: have access to it when something more interesting comes up
Speaker 1: in the future. And so one way to do that
Speaker 1: is to find a trade that has limited downside. It's
Speaker 1: almost an arbitrage if not a zero limited downside position.
Speaker 1: It uses a lot of balance sheet uh. And it's
Speaker 1: something I'm familiar with in general. And so that's where
Speaker 1: this this future's basis position comes in because it is
Speaker 1: balance sheet intensive. So I'm gonna buy a bond, I'm
Speaker 1: gonna lever it with repo, and then I'm going to
Speaker 1: sell the future against it. And the way I think
Speaker 1: about it worst case scenario, I'll just give the bond
Speaker 1: to whoever bought the future for me at xpery. So
Speaker 1: I have limited downside and I've taken up that an allocation.
Speaker 1: So before we uh get to how everything started breaking
Speaker 1: down a little bit more, I want to go back
Speaker 1: to one quick thing you said, which is, you know,
Speaker 1: part of the post crisis shift in the sort of
Speaker 1: regulatory regime was to try to avoid too big to fail,
Speaker 1: move risk away from the banking sector. So now we
Speaker 1: have all of these uh, non bank entities engaging in
Speaker 1: all these trades, and you know, so far, there's a claim,
Speaker 1: and we talked about this before, there's a claim that
Speaker 1: maybe if you look at what's going on in the market,
Speaker 1: there's some vindication of the post crisis regulations because although
Speaker 1: there's a lot of fragility and the financial markets so far,
Speaker 1: there is not particularly much concern about the banks themselves.
Speaker 1: Why does it make sense, just just for this, just
Speaker 1: for my own edification, why does it make sense to
Speaker 1: count risk free assets treasuries against any entity balance you
Speaker 1: when when evaluating side does that make sense? Yeah? So
Speaker 1: just being bigger makes you more complicated if if you've
Speaker 1: got big issues So in the case of Lehman, a
Speaker 1: lot of the disruptions that were caused by the bankruptcy
Speaker 1: were not necessarily just their credit portfolio. It was unwinding
Speaker 1: the whole institution. So they had a very large swap
Speaker 1: book that was mostly collateralized with stuff like treasuries and cash,
Speaker 1: and that was such a large position to move to
Speaker 1: somebody else, I mean, you have to you have to
Speaker 1: find someone else to take the other side of those trades. Um,
Speaker 1: that's a very complicated exercise. Is why when you look
Speaker 1: at things like Global Systemically Important Banking Scores, which are
Speaker 1: used to evaluate capital search charges and other things, basically
Speaker 1: an assessment of cost to being big to society. It's
Speaker 1: not just size, it's also complexity. So if i'm if,
Speaker 1: I'm relatively small but highly complex, and that's Lehman was
Speaker 1: another great example of that. It was not the big
Speaker 1: bank and the by any measure, but it was highly complex.
Speaker 1: That creates issues as well for markets in the event
Speaker 1: of a really online So it's both size and complexity. Yeah,
Speaker 1: it's all these different components of bigness, which is why
Speaker 1: I'm sort of not calling it size and calling it
Speaker 1: bigness because Bigness takes on many forms, and one of
Speaker 1: them is simply the size of the institution. The other
Speaker 1: is the risk they take, just like back in the day.
Speaker 1: Um and and there's other things like my reliance and
Speaker 1: short term wholesale funding, my complexity, that the level of
Speaker 1: exposure to things like exotic derivatives, things like that which
Speaker 1: can be which can be very disruptive if if things
Speaker 1: go bad. Okay, so we've sort of touched on the
Speaker 1: lever US treasury trade, uh and what was happening there,
Speaker 1: but described for us just how badly things actually went
Speaker 1: in the U S. Treasury market over the past few weeks. Yeah. So,
Speaker 1: so over time this position got quite large simply because
Speaker 1: people wanted to or balance sheets. So the situation describing
Speaker 1: before where I'm doing treasury basis trading simply to park
Speaker 1: balance sheet and maintain my my access to it. That
Speaker 1: grew to a very large position. So at most it
Speaker 1: was probably it was as much as two six billion dollars.
Speaker 1: We think it's not necessarily that large, and that's just
Speaker 1: from public data. But even if it was half of that,
Speaker 1: that's a three billion dollar lever position that is non
Speaker 1: economic and under normal circumstances. That would be fine. It
Speaker 1: would actually reduce the risk of that kind of levered position.
Speaker 1: But two things started going wrong. The first was this
Speaker 1: liquidity tiering led to mark to market losses on the
Speaker 1: future's basis position because futures were outpacing treasuries as rates declined.
Speaker 1: And that was again mostly about fundamentals. It was mostly
Speaker 1: about a shift in the economic outlook and a very
Speaker 1: rapid shift in how people price interest rate risk and
Speaker 1: things like that. So that was I wouldn't say expected,
Speaker 1: but understandable and expected under these circumstances, and there was.
Speaker 1: It was at least a sense that at worst, like
Speaker 1: like we talked about before, I could just deliver the
Speaker 1: bond at the expertly the futures contract. My downside was limited.
Speaker 1: I'm not going to actually realize these marked market losses.
Speaker 1: It's just a passing thing and I just have to
Speaker 1: be a little patient and and weather it for a
Speaker 1: few weeks. The problem became as more of these banks
Speaker 1: started to do work from home arrangements. Operational risk started
Speaker 1: to be an important consideration, which is to say, these
Speaker 1: level positions are very operationally intensive simply because you have
Speaker 1: to source funding there's a lot of underlying transactions to
Speaker 1: getting that much repo leverage in the system. When everyone's
Speaker 1: at their desk, that's not a problem at all. It
Speaker 1: might be a little bit of an operational cost, but
Speaker 1: it's something that can happen quite easily. But as everyone's
Speaker 1: starting to migrate to work from home, there was a
Speaker 1: concern that those mark to market losses, which in theory
Speaker 1: are passing, might end up being realized simply because the
Speaker 1: operational shoes forced me out of a position at a
Speaker 1: bad level, and that became risk to manage, not because
Speaker 1: it was necessarily happening, because hey, if I think it
Speaker 1: might happen, I might want to reduce my exposure, especially
Speaker 1: if it's not an economically driven position in the first place,
Speaker 1: UM and B, and this is a financial markets thing
Speaker 1: that happens a lot. I might be worried that the
Speaker 1: next guy thinks it might happen, so I want to
Speaker 1: be so the the perception, so the perception that operational
Speaker 1: risk was important to me potentially to others, caused a
Speaker 1: little bit of an acceleration in that process at precisely
Speaker 1: the wrong time, because that was when dealers were already
Speaker 1: using most of their balance sheets for the activity that
Speaker 1: already occurred, and all of a sudden you'd have an
Speaker 1: influx of selling from these highly levered positions. The important
Speaker 1: thing here is if you take even small losses on
Speaker 1: a future basis position, most of them are levered, so
Speaker 1: you could end up eating through capital pretty quickly. And
Speaker 1: so there was an added incentive to reduce exposure to
Speaker 1: that that involves the sale of bonds two dealers who
Speaker 1: are now taking even more balance sheet and that created
Speaker 1: a bit of a vicious cycle that infected other areas
Speaker 1: of the treasury market and caused market depth deployment even
Speaker 1: more so. Just to press on on this idea of
Speaker 1: operational risk, because clearly it was on a lot of
Speaker 1: people's minds, and I actually wrote a little bit about
Speaker 1: this at the time based on your research, and one
Speaker 1: of the pushbacks I got from some readers was that
Speaker 1: operational risk wasn't really a thing in the financial system
Speaker 1: because banks all did, you know, exercises and stress tests,
Speaker 1: and they were all supposed to be able to work
Speaker 1: remotely from home, and it just wasn't as big an
Speaker 1: issue as some people were making it out to be.
Speaker 1: What would you say in response to that criticism, so
Speaker 1: it may not be. It may not end up being
Speaker 1: a significant risk. It's more about the perception of those
Speaker 1: risks and the willingness of particularly a leveled position. It's
Speaker 1: already taken losses to rely on those operational issues, So
Speaker 1: I guess the way I would think about it is
Speaker 1: if the perception is that this might be a problem,
Speaker 1: and I totally agree that stress testing is an important
Speaker 1: part of this, that planning for these types of scenarios
Speaker 1: is a big part of it. Banks are much better
Speaker 1: capitalized than they used to be. They have many more
Speaker 1: people in the operational positions, they're much more efficient in
Speaker 1: doing so, and in principle they had plans for work
Speaker 1: from home. But if if it all goes according to plan,
Speaker 1: then it's no problem and business as usual. If or
Speaker 1: close to it, if it goes wrong, I have a
Speaker 1: much bigger problem, especially because at best I'm not even
Speaker 1: looking to make money on these trains, so I'm trying
Speaker 1: to maintain access to balance it. I'm not necessarily trying
Speaker 1: to put on a large directional positions, so the upside
Speaker 1: is limited or zero, and the downside becomes very large.
Speaker 1: So I'm totally fascinating by this. So obviously from a
Speaker 1: just sort of pure and strect markets perspective, what we
Speaker 1: know that over the last several weeks has been this
Speaker 1: historic attempt to grab cash or grab liquidity in any scenario.
Speaker 1: And we see this from individuals, we see this from companies,
Speaker 1: We see it from companies drawing down revolving credit lines.
Speaker 1: We know it exists. It's and everyone people we've talked
Speaker 1: to say they've never really seen anything like this. So
Speaker 1: that that accelerates selling, that blows out some of these
Speaker 1: trades because okay, you know it is not time to
Speaker 1: do we need to sell treasures, we need to get
Speaker 1: liquid assets. Talk to us a little bit more about
Speaker 1: the specific operational concerns, because I don't think many people
Speaker 1: understand this at all. And I know, Tracy, just to
Speaker 1: ask you about this, and you mentioned it. But when
Speaker 1: you say that just from an operational standpoint, executing these trades,
Speaker 1: obtaining the liquidity you need to hold onto the trade
Speaker 1: until they become profitable, is necessary, just talk to what
Speaker 1: is that involved? What's it like? What what? What? What
Speaker 1: makes it uh operationally intensive to hold on to the trade.
Speaker 1: So really it's because a lot of this funding tends
Speaker 1: to be overnight. So repo markets are very strongly skewed
Speaker 1: towards overnight funding. Part of that is because it's easier
Speaker 1: for banks to do overnight funding. It's it's harder to
Speaker 1: have funding that's locked over statement dates and things like
Speaker 1: that when when all of these regulatory charges are assessed.
Speaker 1: And so if you keep your the funding you offer
Speaker 1: as as a lender overnight, you have a lot more
Speaker 1: flexibility going forward, and that means that the client side
Speaker 1: is going to be pushed in the same direction that
Speaker 1: that's the accommodation that's made the problem is to to
Speaker 1: roll your trades overnight, you have to do no trade
Speaker 1: every day, and there's a risk that there's no one
Speaker 1: on the other side of the phone. And we saw
Speaker 1: this most acutely in two thousand one. Excuse me just
Speaker 1: just to go back you mean phone literally right? Literally? Yeah? Um,
Speaker 1: and maybe calugh carding doesn't work right of people who
Speaker 1: have this view that like all markets are just done
Speaker 1: over the computer. You entering some keys and you make
Speaker 1: a trade. This is key part of the financial plumbing
Speaker 1: over the phone. Yeah, a lot of this, A lot
Speaker 1: of stuff still happens over the phone or ornamentium over
Speaker 1: chat or things like that, and there's confirmed confirms that
Speaker 1: go back and forth. Banking is still a very or
Speaker 1: dealing is still a very paperwright intensive business. Even if
Speaker 1: that paper is is digital, it goes back and forth
Speaker 1: a lot, and so it's a to have someone on
Speaker 1: the other side of the phone and be to make
Speaker 1: sure there's someone to put a price on it. No.
Speaker 1: I only asked that because again, I do think a
Speaker 1: lot of people have this imagine imagination that it's all
Speaker 1: l goes and keystrokes and logging into an account, and uh,
Speaker 1: I think an important bascet to drive home totally. And
Speaker 1: there are parts of the market that are very electronic,
Speaker 1: but these things are plumbing oriented, tend tend not today,
Speaker 1: got it? Okay? So just to sum up, we had
Speaker 1: this lever treasury position or basically a basis trade between
Speaker 1: the futures and the cash contracts that got strained in
Speaker 1: the recent route, partly because dealers weren't able to come
Speaker 1: in and intermediate through the repo market. And at the
Speaker 1: same time we had all these liquidity strains like huge
Speaker 1: bit ask spreads and things like that emerging in what
Speaker 1: again was supposed to be the most liquid market in
Speaker 1: the world. Up. Fast forward a little bit, and we
Speaker 1: have seen this issue pop up with the Federal Reserve,
Speaker 1: and in fact, Jerome Powell was talking about what had
Speaker 1: happened in the treasury market in one of his emergency
Speaker 1: Sunday announcements. What do you think about the feds moves
Speaker 1: so far? How much of this is on their radar?
Speaker 1: Are they understanding the concerns correctly? And are they doing
Speaker 1: the right things to fix it? Yeah, so they're definitely
Speaker 1: aware of it. They're definitely responding with the kind of
Speaker 1: magnitude they need to. And it's it's interesting to think
Speaker 1: about these asset purchases is that they've announced Initially it
Speaker 1: was five of treasury purchases and and unspecified pace, and
Speaker 1: now it's essentially unlimited. The reason why they're responding like
Speaker 1: that is not because it's QUI in the usual sense.
Speaker 1: I think. I always asked if this is QUEI, and
Speaker 1: he basically said, call it whatever you want. QUI is
Speaker 1: Quantitative easing is UH is really a monetary policy tool
Speaker 1: to take term premium out of rates and incentivize people
Speaker 1: to take credit risk. So when you when you think
Speaker 1: about investing in fixed income products. I can take term risk,
Speaker 1: I can lock my money up for longer. I should
Speaker 1: receive some sort of premium for that. Or I can
Speaker 1: take credit risk in the sense that I might not
Speaker 1: get my money back. And so if you reduce the
Speaker 1: returns I get simply by locking up my money for longer,
Speaker 1: well maybe I want to. I might want to do
Speaker 1: take more credit risk, and that was the original intent
Speaker 1: of quantitative easing. This is not about that at all.
Speaker 1: One because the treasure care is already quite flat, there's
Speaker 1: very little term premium. In fact, by many measures, it's negative,
Speaker 1: so we certainly don't need to take and bringing out
Speaker 1: of the curve. It's much more about operational and market
Speaker 1: structure issues, and they were quite clear on that. So
Speaker 1: the question comes up, why respond with this kind of
Speaker 1: size to something that really what we've been talking about
Speaker 1: is a group of relative value hedge funds, the market
Speaker 1: making and treasuries specifically, and all pretty arcane topics. I mean,
Speaker 1: this has been a pretty technical conversation. So why is
Speaker 1: the FED doing unlimited QWI to address this rather technical
Speaker 1: issue which is important to a lot of people, but
Speaker 1: not necessarily to most participants in financial markets. So of
Speaker 1: course there have been several different FED operations that we've
Speaker 1: seen just over the last week. So again, today's March yesterday,
Speaker 1: March twenty three was when we saw the the announcement
Speaker 1: of all kinds of new lending operations plus the alphabet
Speaker 1: soup of the programs and the unlimited QUI. The Sunday
Speaker 1: before that was when Paul made the surprise as announcement
Speaker 1: to cut rates to basically zero and the seven billion
Speaker 1: dollars and asset purchases who almost didn't do anything for
Speaker 1: risk assets. And the week before that we saw a
Speaker 1: technical announcement out of the New York FED talking about
Speaker 1: how they are massively expanding the reball operations. And that
Speaker 1: New York Fed announcement came out, They're like, Okay, I
Speaker 1: don't know, this is QUEI. This is a major boom
Speaker 1: for these relative value funds that we've been talking about,
Speaker 1: the ones that arbitrage the difference in pricing between futures
Speaker 1: and treasuries, and this sort of saved them to some
Speaker 1: extent or really protected them. And what I'm wondering is
Speaker 1: do we need them? Like? Are they are? They? Are
Speaker 1: they essential to the way the financial system works that
Speaker 1: we need entities out there levering themselves fifty two one
Speaker 1: to take advantage of minor price discrepancies between all the
Speaker 1: run treasuries and futures. Or is this just, uh, could
Speaker 1: we live without these entities performing dysfunction? We certainly need
Speaker 1: somebody to police these relationships, but the moment is less
Speaker 1: about what we need in the financial system and more
Speaker 1: about what we don't need, which is a disorderly and
Speaker 1: rapid unwide of these positions. So what the FETE is
Speaker 1: doing is they're putting up fire brakes and they're saying,
Speaker 1: I want to isolate this issue to a certain segment
Speaker 1: of the market, and I really want to prevent delevering
Speaker 1: in one sector from turning into delevering, and other sectors
Speaker 1: in particular delivering the banking system more broadly. So, the
Speaker 1: risk was that the pace and ferocity of this online
Speaker 1: took up so much dealer balance sheet that they were
Speaker 1: unable to intermediate other markets as well, and so you
Speaker 1: started seeing issues in credit markets, particularly in short term
Speaker 1: credit markets. You also saw this dislocation becoming so acute
Speaker 1: that you could do riskless both credit risk free and
Speaker 1: interest rate risk free unlevered trades and make more doing that.
Speaker 1: Buying the bond levered selling the futures, you can make
Speaker 1: more money doing that than buying bank seeping. So you
Speaker 1: had two risks. One was severe intermediation frictions and other markets,
Speaker 1: and the other being a demand shock to the credit market,
Speaker 1: particularly the short term credit market, which is really the
Speaker 1: lifeblood of a lot of institutions. And if you follow
Speaker 1: that chain, there's a scenario that starts to become not
Speaker 1: necessarily based case, but certainly more likely, where corporations lose
Speaker 1: access to capital markets because of these market structure issues
Speaker 1: and they're forced to draw in their bank revolvers, and
Speaker 1: that becomes an incentive for banks to start selling assets
Speaker 1: to fund those draws. And we've actually seen over a
Speaker 1: hundred and three billion of those draws already based on
Speaker 1: public information. So that's when you encircle the banking system,
Speaker 1: when you force corporations who need liquidity for real economy
Speaker 1: reasons to tap their banking lines rather than capital markets.
Speaker 1: And now banks have to sell assets. So now I
Speaker 1: have heade funds selling assets, credit funds selling assets, banks
Speaker 1: selling assets. And there's a risk that's materialized in part
Speaker 1: where you start seeing the redemption of money market shares.
Speaker 1: So prime money market funds, particularly those owned by institutions,
Speaker 1: have lost more than assets in a week. And that's
Speaker 1: the kind of scenario where you start to see echoes
Speaker 1: of the two eight crisis. We're not there yet, but
Speaker 1: that that was the epicenter of two thousand eight, was
Speaker 1: this run on the prime funds, and you're starting to
Speaker 1: see some contagion from again a relatively arcane world, through
Speaker 1: the accelerant of the dealer complex and the constraints that
Speaker 1: they have, and into the credit markets, right, and a
Speaker 1: lot of the programs that the FED has announced so
Speaker 1: far are I don't want to say rip offs, but
Speaker 1: replicants of some of the stuff that we saw in
Speaker 1: two thousand eight. So they have announced a plan to
Speaker 1: support money market funds, and they've also announced another iteration
Speaker 1: of the Asset Purchased Program TAK, which I'm sure anyone
Speaker 1: who is around in two thousand nine will remember that
Speaker 1: one um one thing they haven't done, and maybe this
Speaker 1: is important since we're talking so much about the balance
Speaker 1: sheet constraints for dealer banks, But one thing they haven't
Speaker 1: done is loosen regulatory constraints on banks. And I just
Speaker 1: wonder if that's something that you would ever expect to happen.
Speaker 1: Here in Hong Kong, we have seen some of this.
Speaker 1: The financial regulator here actually lowered some capital buffer requirements
Speaker 1: for banks to help them get through this and help
Speaker 1: them keep lending to the economy. So is that something
Speaker 1: that we could see in the US. It's possible they've
Speaker 1: taken too or they floated two approaches to this is
Speaker 1: kind of the supervisory angle. When we think about FED intervention.
Speaker 1: There's direct intervention markets through open market operations. That's the
Speaker 1: purchase program that you're describing, also offering repout a blow
Speaker 1: market price. Uh. There's facilities that are temporary emergency facilities
Speaker 1: like the commercial paper funding facility and the various other
Speaker 1: acronyms that that won't do a launcher list of that
Speaker 1: right now, but lots of two thousand eight vintage type
Speaker 1: stuff which are really about providing a buyer blast resort
Speaker 1: for various assets, at least on a temporary basis. And
Speaker 1: then you also have these supervisory solutions which are to
Speaker 1: say the we need to change the incentives and the
Speaker 1: costs that we assess banks to enable them to perform
Speaker 1: their function more efficiently. Particularly under these circumstances. So in
Speaker 1: that statement, uh, I don't even remember what it was
Speaker 1: at this point, but there was floated the idea that
Speaker 1: we need to reassess capital and thequidity requirements, and they
Speaker 1: dropped required reserves to zero and things like that. So
Speaker 1: it's certainly under consideration. It's a lot easier to intervene
Speaker 1: in markets than it is to change bank regulations, simply
Speaker 1: because regulations create all kinds of different incentives, and in
Speaker 1: principle you could you could pretty rapidly change that incentive structure,
Speaker 1: but you want to be careful about it in a
Speaker 1: couple of ways. The first is one of the things
Speaker 1: I mentioned was reducing liquidity requirements. So banks, as a
Speaker 1: consequence of this liquidity coverage ratio rule, are required to
Speaker 1: hold high, high quality liquid assets in a certain amount
Speaker 1: to cover potential outflows. So what the what the regulars do?
Speaker 1: As they say, this kind of liability has this kind
Speaker 1: of run risk, and this kind of liability has this
Speaker 1: kind of run risk, and we go through the bank
Speaker 1: balance sheet on the liability side, and we say, you
Speaker 1: need to be able to cover your thirty days stressed
Speaker 1: outflows with what we deem to be high quality liquid assets,
Speaker 1: which are functionally just treasuries in cash for the most
Speaker 1: part um. So in principle, what they could say is, too, banks,
Speaker 1: you can just hold less of those liquid assets. We
Speaker 1: kind of told you to hold liquidity for precisely this situation. Right,
Speaker 1: You're you're facing a demand for cash. You have high
Speaker 1: quality liquid assets that you're supposed to be able to
Speaker 1: monetize at a reasonable cost, and so why don't you
Speaker 1: just sell those assets and fund whatever draws on your
Speaker 1: cash you need? That That was the point of this
Speaker 1: thing in the first place. The issue is this particular
Speaker 1: crisis is localized to the high quality liquid asset market,
Speaker 1: so large scale sales of high quality liquid assets, particularly treasuries,
Speaker 1: to fund draws and credit facilities, are just gonna make
Speaker 1: the problem worse. So that's not necessarily the right supervisory solution.
Speaker 1: The other thing you could do is you could say, well,
Speaker 1: remember when we said all assets count towards your leverage, Well,
Speaker 1: now cash and treasuries don't, so so those are no
Speaker 1: longer contributors to your leverage because they are risk free,
Speaker 1: and therefore you can intermediate as much as you want
Speaker 1: and you won't incur balancing cost um. That's a big
Speaker 1: change to how banks do business. And you know, it's
Speaker 1: it's something people have talked about. We don't have a
Speaker 1: sense of whether or not that's likely, but that's that's
Speaker 1: one thing under consideration, and I guess the last way
Speaker 1: to think about it is with these facilities, they can
Speaker 1: get special treatment under regulations. So the money market liquidity
Speaker 1: funding facility that you mentioned earlier, that's to provide secondary
Speaker 1: market support for sales or short term credit instruments. So
Speaker 1: if a prime fund is facing redemptions, they need to
Speaker 1: sell commercial paper to fund them or to maintain their
Speaker 1: liquidity requirements. Dealers need to be able to both purchase those,
Speaker 1: hold them on their balance sheet and finance them. And
Speaker 1: what the FETE has done is they provided this facility
Speaker 1: to offer funding. So they take as collateral assets sold
Speaker 1: by prime money market funds preferentially and they offer cash
Speaker 1: for that, and they carve that out of existing regulations,
Speaker 1: so they said, this doesn't count towards your levels, this
Speaker 1: doesn't count towards your risk space capital. So through these
Speaker 1: emergency facilities you can you can offer preferential treatment that
Speaker 1: lets the fire brakes work more effectively. Without changing the
Speaker 1: whole incentive structure of bank regulations. How much have what
Speaker 1: we are have, what we've seen so far in terms
Speaker 1: of the response to the crisis, as well as the
Speaker 1: fact that the crisis has not effect in affected the
Speaker 1: core banks particularly much a sort of vindication in your
Speaker 1: view of the system the regulations that were passed by
Speaker 1: Congress and the wick of the Great Financial Crisis, and
Speaker 1: the facilities that Ben Bernake and others built at the
Speaker 1: FED during it. So the way I think about it is,
Speaker 1: what we're facing here is a cash shortage in the
Speaker 1: real economy. So if you're if you don't have enough cash,
Speaker 1: and the sole producer of cash, namely the FED, can
Speaker 1: simply produce more cash, like that should really solve the problem.
Speaker 1: So you're gonna see a lot of volatility in the
Speaker 1: meantime because the demand fair cash and the creation of
Speaker 1: cash will be offset in timing. Like you sometimes the
Speaker 1: FED will offer a certain amount of cash and the
Speaker 1: market actually needs more than that, so you'll see more stress.
Speaker 1: But over time, if you average that over the next
Speaker 1: few months, this is a problem the FED can solve.
Speaker 1: So it's less about the the existence of credit products
Speaker 1: that were much riskier than they were thought to be.
Speaker 1: That was the issue two thousand eight. Right now, it's
Speaker 1: just a demand for cash that can't be met by
Speaker 1: the markets themselves for a variety of reasons. But the
Speaker 1: FED can solve that. So I think it's a vindication
Speaker 1: of a bunch of things, one but the most important
Speaker 1: being the willingness of the FED to provide liquidity in
Speaker 1: these kinds of episodes, to avoid the fire sale of
Speaker 1: money good assets like things like treasuries. You're gonna get
Speaker 1: your principal back. It's but it's simply a matter of
Speaker 1: piping it through the right plumbing and and the FED
Speaker 1: can help alleviate those stressors, and in doing so they
Speaker 1: can avoid bigger liquidity issues turning into credit events. Because
Speaker 1: the issue is, we don't have a credit problem necessarily
Speaker 1: right now, at least at the scale of the economy.
Speaker 1: But if capital markets are shut and there's no access
Speaker 1: to cash and there's still a need for it, especially
Speaker 1: we're going to shut down the economy for a couple
Speaker 1: of months and the FED is not providing that cash,
Speaker 1: then then it can turn into something much more through
Speaker 1: deep in the financial system. M hmm. I guess the
Speaker 1: trade off of constraining bank balance sheets so that they
Speaker 1: can withstand this kind of thing. Is that it means
Speaker 1: that you have to rely on the FED a little
Speaker 1: bit more to provide that sort of UM last stop
Speaker 1: liquidity UM. Just on that note, Josh, you've been writing
Speaker 1: about this for a long time. In fact, I think
Speaker 1: this week you published like a five part series on
Speaker 1: the FEDS emergency measures and how those are playing out
Speaker 1: in the U. S. Treasury market. Just to sum it
Speaker 1: all up, how long do you expect these stresses to continue?
Speaker 1: It's really hard to say. I wouldn't be surprised if
Speaker 1: it's a few weeks, simply because the size of the
Speaker 1: position that ultimately might be on wound is quite large,
Speaker 1: and it has to go through a relatively narrow pipe.
Speaker 1: And that's if we keep it isolated to that futures
Speaker 1: basis trade and it's obviously gone into other areas as
Speaker 1: well at this point, But over a few weeks to
Speaker 1: a couple of months, like the FED should be able
Speaker 1: to manage this process. I think the thing to keep
Speaker 1: in mind is that, at least from my perspective, FED
Speaker 1: intervention is not about making things normally. It's about avoiding
Speaker 1: the more catastrophic outcomes. So the FED is not supposed
Speaker 1: to intervene and make everything look like it did six
Speaker 1: months ago, when liquidity was bountiful and markets were trading
Speaker 1: very liquidly with zero transaction costs in some cases, and
Speaker 1: like very large size, and it was easy to do
Speaker 1: anything and so forth. Like. That's not the fed's mandate.
Speaker 1: They're they're supposed to be an emergency a crisis manager,
Speaker 1: and in that sense, I think they'll get control of
Speaker 1: the situation reasonably quickly. They already have to some extent,
Speaker 1: at least in the futures market, where things have really
Speaker 1: been been most acute. There are some incremental issues there.
Speaker 1: Marginal requirements going up in futures is one of them,
Speaker 1: which exacerbates the problem. But fundamentally that situation I think
Speaker 1: is mostly at least under control in the sense that
Speaker 1: it's unlikely to accelerate in a bad a. I mean,
Speaker 1: if the real economy side of the situation continues to
Speaker 1: deteriorate at the speed that we've seen, then the number
Speaker 1: of any sort of credit needing institutions, including companies that
Speaker 1: right now today might be considered high grade and high
Speaker 1: quality or investment grade, could in theory continue to deteriorate,
Speaker 1: and so a company who Okay, we can issue them
Speaker 1: commercial paper because it's high quality, we don't have to
Speaker 1: worry about their credit worthiness. Eventually the economic degradation could
Speaker 1: limit anyone from really being able to make cash flows
Speaker 1: if other things don't stabilize. Does that eventually become a
Speaker 1: problem that essentially the FED can't get under control if
Speaker 1: they start to whether it's municipal markets, companies, etcetera, where
Speaker 1: we start to see a real problem where we doubt
Speaker 1: anyone's ability to make their payments totally. If if things
Speaker 1: keep going at the pace they've been going, we're going
Speaker 1: to have big credit problems. But they something fundamentally different
Speaker 1: about this recession then prior recessions and especially two. And
Speaker 1: the key here is that the it's a totally exogenous event.
Speaker 1: So this is not about companies that appear to be viable,
Speaker 1: enterprises that were actually inviable and we just didn't realize
Speaker 1: it and it's not actually a reasonable business model and
Speaker 1: those companies have to go. It's creative destruction. It's just
Speaker 1: happening too quickly. This is not that this is a
Speaker 1: pure stoppage and it's liquidity issue. So if you have
Speaker 1: a company that would otherwise be going concern under normal circumstances,
Speaker 1: and you just stop the economy for three months, the
Speaker 1: FED can bridge that gap, and the government can bridge
Speaker 1: that gap under the assumption that when everybody leaves their houses,
Speaker 1: the world is not as it was, but at least
Speaker 1: it's it's reasonably similar. Yeah, and so if that's the case,
Speaker 1: it's really literally a liquidity issue. And that's precisely the
Speaker 1: kind of thing the FED can solve. If the interventions
Speaker 1: are structured in a way that doesn't necessarily solve the
Speaker 1: core problem, or are otherwise too small or delayed, you
Speaker 1: could end up with real credit problems as liquidity becomes
Speaker 1: credit stress. The FED is clearly shown a couple of things.
Speaker 1: When is they're willing to act in size at a minimum,
Speaker 1: when you when you have open ended purchase operations, they're
Speaker 1: gonna buy more than six hundred billion dollars. But the
Speaker 1: Treasury this week, So this is a massive pace of intervention.
Speaker 1: There's five trillion of liquidity through repo operations. They're talking
Speaker 1: about a small business lending facility that could reach for
Speaker 1: trillion dollars like they're they're talking about really big numbers,
Speaker 1: So I don't think size is an issue here. Uh.
Speaker 1: The the structuring of these programs is something they've been
Speaker 1: quite dynamic about. So the Commercial Paper Funding Facility announced
Speaker 1: last week prices too high. They brought it down this week.
Speaker 1: They went from two over o I s rates or
Speaker 1: two d over fed funds to ten over. So they're
Speaker 1: they're willing to adjust the scope and and the pricing
Speaker 1: of these programs to make sure they're effective, and they're
Speaker 1: willing to roll out new things. And this money market
Speaker 1: Liquidity funding facility was was was the new thing, so
Speaker 1: it resembled something else, but it still was a new thing.
Speaker 1: So as long as they are being creative and being
Speaker 1: big and being timely, it should be something that can
Speaker 1: be kept under control. The risk is always that the
Speaker 1: longer term economic consequences of an event it magnets to
Speaker 1: it are very hard to have a sense that. We
Speaker 1: don't have a lot of examples of that. No, Josh,
Speaker 1: that was an absolutely fascinating conversation. We really appreciate both
Speaker 1: your research and you coming on to have this conversation. Finally,
Speaker 1: Um you were able to have you so, thank you
Speaker 1: so much. Yeah, now it's been it's been fun. There's
Speaker 1: Jeff so Joe. You can probably tell I really enjoyed
Speaker 1: that conversation. I love digging into this, you know, treasury
Speaker 1: basis trade because it's one of those things that not
Speaker 1: many people were looking at or writing about, except and
Speaker 1: please allow me this one small victory lap. I love
Speaker 1: that something that had the potential to blow up is
Speaker 1: kind of doing so in an expected way. But you know, again,
Speaker 1: the big deal when it comes to the U. S.
Speaker 1: Treasury market is that it's not supposed to be a
Speaker 1: risky market. You're not supposed to get these big sell
Speaker 1: off events and this type of volatility, and yet that's
Speaker 1: what we've just seen. One day we'll do an episode
Speaker 1: where with something I was writing about a few years
Speaker 1: ago and it all happens. But I don't know what
Speaker 1: that's going to be. I thought he was great because yeah,
Speaker 1: something like that. Maybe when the coin finally gets minted,
Speaker 1: we'll do an episode on that. Two things. One his
Speaker 1: his explanation and like what these uh futures choiceories basis
Speaker 1: trades are incredibly clear and simple, and I appreciate that,
Speaker 1: Like I have to say, I just sort of appreciated
Speaker 1: his calum demeanor at this time, because you know, this
Speaker 1: is a crazy time. He was probably the most chill, relaxed,
Speaker 1: clear person I've talked to in a while, So I really, uh,
Speaker 1: I really appreciated that as well. Yeah, and his point
Speaker 1: about the perception of operational risk, I think is another
Speaker 1: one of those things that doesn't necessarily make it into
Speaker 1: models of how the financial system works. Like people think
Speaker 1: that banks are always going to be there to sponsor
Speaker 1: repo trades and intermediate the financial system, but as we've
Speaker 1: seen time and time again in a big crisis, there
Speaker 1: are times when you know, like in two thousand eight,
Speaker 1: people just didn't pick up the phone because they were
Speaker 1: scared and they didn't know what to do. And now
Speaker 1: in two thousand twenty, people possibly aren't picking up up
Speaker 1: the phone because they're all working from home and I
Speaker 1: don't know, their phones run out of batteries or they
Speaker 1: don't hear it or whatever. And that type of real
Speaker 1: world quirk I think is really important to consider totally.
Speaker 1: And I think it's something that you know, I've learned
Speaker 1: a lot about from some of our episodes with Chris
Speaker 1: White talking about how the bond market works, and I
Speaker 1: sort of I'm always interested in this topic that so
Speaker 1: much of our financial markets operates this way, whether it's
Speaker 1: through a chat room hopefully they're using Bloomberg ib plugging that,
Speaker 1: or a picking up the phone that you know, people
Speaker 1: have this idea that the all of our financial markets,
Speaker 1: it's just robots and algorithms out there and everyone can
Speaker 1: just go home and actually for the most important things,
Speaker 1: including like finding liquidity to buy the most safe asset
Speaker 1: in the world, that's still done by phone. Is a
Speaker 1: really strike in fact, and it helped me understand some
Speaker 1: of the dislocations and breakdowns and correlations that we've seen
Speaker 1: over the last couple of weeks. Yes, indeed, so this
Speaker 1: has been another episode of the All Thoughts podcast. I'm
Speaker 1: Tracy Alloway. You can follow me on Twitter at Tracy Alloway,
Speaker 1: and I'm Joe Wisenthal. You can follow me on Twitter
Speaker 1: at the Stalwart, and you should follow our producer on Twitter,
Speaker 1: Laura Carlson. She's at Laura and Carlson. Follow the Bloomberg
Speaker 1: Head of Podcasts on Twitter, Francesca Leady at Francesca Today,
Speaker 1: and check out all of the Bloomberg podcasts under the
Speaker 1: handle at podcast. Thanks for listening. O