Aware, but don’t fully understand. Doing something, though only just to make it look like something is being done. Never truly radical enough because what’s radical is the absolute need to basically rewrite a half century.
Before there was March 2020, there had been May 29, 2018; the two connected by an unusually unvaried line running through the Treasury market. That line was detoured slightly by the events of September 2019, and how those led the Fed to make everything worse.
Ostensibly, everything in all three dates and months related to repo and its complicated, misunderstood marketplace. Money is very easy, they all say, central bankers most of all. Just create some digital bank reserves out of thin air, stand back and watch the inflationary magic set off an accelerating recovery of sustained, badly-needed economic growth.
Except, no inflation. No magic.
In September 2019, the puzzled illusionists did what they also do. A sizable repo market breakdown – though only a dress rehearsal – pushed disinclined policymakers back into the QE business where they didn’t (yet) want to be. Reflecting this reluctance, officials were specific that this particular bout of Treasury market buying, in order to create those bank reserves, wouldn’t amount to QE.
This not-QE was further distinguished by its exclusive target – bills only. No notes. No bonds. Those others, according to the Fed, would have led the public to think about it as if it was QE. Bills alone, on the other hand, not-QE.
While the targeting and labeling was really nothing more than arbitrary hocus pocus, the effect on the repo market was anything but. The media dutifully quieted down any more uncomfortable questions about real repo authorities couldn’t answer and went back to sleep under the pleasing skies of more, more, more bank reserves.
Fewer, fewer, fewer Treasury bills, on the other hand, became available for market use in the real repo market. Come March, those would have been handy. The most prominent feature of those global liquidations was watching the scramble for T-bills early on key mornings, especially during Asian trading hours, witnessing bill yields drop to sometimes -20 bps or lower as the funding desperation climaxed, this collateral shortage then echoed repeatedly in the stock market on what would be some of its worst single days on record.
It was a possibility that began on May 29, 2018. Not began, really, but transformed from uncertain fears to more tangible probability in terms of what would become March’s collateral bottleneck. A slow-burn buying panic in the best quality collateral, German bunds and US Treasuries in particular. Stunned “experts” couldn’t make much of it, blaming the May 2018 peculiarities related to Italian finance ministers or some such.
Meanwhile, the market was growing anxious about what the growing global dollar shortage might do to the collateral side of the repo system, fears that would only get worse during 2019 (thus, September), leaving the entire system exposed after the dangerous, ridiculously unhelpful not-QE program.
These experts should not have been so far in the dark, the technical side of repo never should have been left so deep within these unnecessarily long monetary shadows. That central bankers and monetary authorities don’t know much about what’s in them is no excuse for everyone else.
What law says we are bound to only these corrupt and ineffective institutions for knowledge and understanding on these grave matters?
In Europe, believe it or not, there actually is a law and one that isn’t waiting around for the ECB to get its act together.
Before that, though, on October 14, 2014, the Financial Stability Board (FSB), a quasi-supranational think tank made up of former supervisors and regulators, had issued guidelines for various national regulators to begin thinking about maybe someday advising standardized haircuts for non-centrally cleared securities financing transactions (SFT).
Haircuts and SFT’s? Repo. Repo collateral and most important of all, the securities lending businesses which support – or take support from – this central global funding mechanism. Authorities had belatedly learned that not everything is as it seems in all their textbooks, particularly when it came to the repo market, collateral-side. A key feature of the first global financial crisis (GFC1), as well as the second outbreak in 2011, was that repo collateral is a very tricky thing, to put it mildly.
Thus, when adopting REGULATION (EU) 2015/2365 of November 25, 2015, the European “Parliament” began by noting:
“The global financial crisis that emerged in 2007-2008 has revealed excessive speculative activities, important regulatory gaps, ineffective supervision, opaque markets and overly complex products in the financial system…SFTs allow the build-up of leverage, pro-cyclicality and interconnectedness in the financial markets. In particular, a lack of transparency in the use of SFTs has prevented regulators and supervisors as well as investors from correctly assessing and monitoring the respective bank-like risks and level of interconnectedness in the financial system in the period preceding and during the financial crisis.” [emphasis added]
The period preceding and during the financial crisis, OK, but what about after it?
The FSB’s haircut recommendations were published on October 14, 2014, meaning the very next day following their release was October 15. As luck (of the unfortunate kind) would have it, the Treasury market (and Germany’s) would experience a day that had many of the same characteristics as May 29, 2018, too many shared with one like September 15, 2008. Despite the FSB drawing attention, everyone else was talking about electronic trading in Treasuries, especially the “experts”, when the real problem might’ve (should’ve) been more widely appreciated.
SFT’s, in other words. I wrote in November 2014:
“It may sound strange, but a ‘buying panic’ in US treasury bonds is a form of illiquidity. The modern shadow system has in many ways inverted or at least distorted what could fairly be called ‘currency’ or a ‘dollar.’ As I have said on many occasions, repo collateral is in many ways ‘moneylike’ in its behavior and properties. At times, collateral becomes far dearer than actual currency, or even ledger balances of currency, and thus behaves more ‘moneylike.’ Such derivative function makes straightforward analysis extremely difficult, especially to the outside.”
Instead, despite talk and papers and the occasional statement, even law, the conventional narrative on money therefore economy has left “straightforward analysis extremely difficult” to conduct anyway. No kidding, right?
Think long and hard about this the next time you hear about any central bank’s inflationary policies, in the context of thinking about why none of their past policies had ever been.
That’s the thing though; the first global financial crisis which had revealed the huge fracture potential in repo due to collateral and securities financing (including repledging, transformation, and, yes, rehypothecation) as well as non-uniform, dynamic haircut assessments, all those things happened, you’ll remember, in 2008.
The FSB wrote up some stuff in August 2013, five years later, which the G20 endorsed the following month. Issued a statement. Europe’s presumed legislative body formally took up the matter in November 2015 and, authorizing the European securities business regulator (formed in 2010) to get to work, which it finally got around to the data collection experimentation phase…earlier this year.
At this rate, regulators - but just those in Europe - might figure out something worthwhile around the turn of the next decade. They do seem to be taking their time.
But at least the Europeans are trying. Where’s the Fed? Nowhere. Not-QE’s and bank reserves. Congress? Please. OCC? FDIC? There's enough regulatory agencies, not a single monetary authority nor central bank among them (Fed included).
The G20 endorsed nothing more than a statement which, reading between the lines, said only that the financial world is much more complicated than anyone ever told the public (or politicians). The layperson figured that much out around October 2008; what took the “experts” so long?
And while Europe is doing something, that something is pathetically limited and small. Their assigned regulator, the European Securities and Markets Authority (ESMA) signed up four – only four – “TR’s” who would begin reporting SFT data in real-time. A “TR” is a trade repository or third-party custodian which arranges, settles, and mediates these kinds of SFT’s. Some of them.
Those four are: DTCC Derivatives Repository Plc (DDRL), Krajowy Depozyt Papierów Wartosciowych S.A. (KDPW), Regis-TR S.A. and UnaVista TRADEcho B.V.
There’s a few missing from the list. Not only that, most of the securities lending business is conducted bilaterally (or trilaterally in some complicated cases). In other words, there’s not going to be data either way because it’s not going on any central exchange. That’s another thing authorities have been “working on” for more than a decade – talking about creating transparency by moving shadow business onto clearinghouses.
But, like the Fed’s conspicuous absence, the banking system resists. Why? Opacity in SFT benefits them the most; the shadows are one of the few remaining business opportunities left for global money dealers. They’re biggest mistake, in recent years, was in believing Ben Bernanke about 2014 – thus, October 15 – before then believing more in Janet Yellen about 2017 – thus, May 29, 2018 – both times leading to deflationary messes collateral-first.
Over in Europe, that last outbreak had delivered the European economy to the doorstep of recession, if not already within one during the final few quarters of 2019 (long before COVID). The excruciatingly slow grind of SFT material makes even less sense given already two prior recessions, big ones, linked to it.
And ESMA isn’t even close to producing usable data, either. When the four TR’s were signed up in April, it was for something like a pilot program. After publishing formal regulatory rules in July and then taking two more months to solicit feedback and conduct consultations, a final report won’t be issued until around the first quarter of 2021.
Maybe authorities could be forgiven their snail’s pace since they seem to be creating this idea they were unprepared because this proliferation of financial products (to use a specific term) was sprung on them last minute. As if banks came up with all this stuff in, what, September 2008?
That’s far from the case, however. Financial innovation, blending and blurring the lines between money and credit, is something that has been going gangbusters for more than half a century. In February 1981 – 1981! - Günter Dufey of the University of Michigan along with Ian H Giddy of Columbia wrote a paper for the Journal of International Business Studies documenting many of the ways, means, and transactions the international (read: offshore) marketplace had experimented with during the sixties and seventies.
Those decades had been a boon for amazing changes in the way banks operated – and the way the monetary system behaved as well as how it behaved. There are simply too many to list here (you can and should read the paper, not the least for which how it gives you the sense researchers and economists in 1981 were in so much better of a position to understand 2020), but the combination of all of them might be best summed up in this one quote:
“The remarkable feature of this use of forward contracts in the Eurocurrency market, for example, is that it enables banks to offer deposits or loans in any currency for which there is a forward exchange market, even if no external money market exists in that currency. The result is that the Eurodollar is the only full-fledged external money in existence; other Eurocurrencies are often simply Eurodollars linked to forward exchange contracts.” [emphasis added]
Understand that these innovations were not strictly limited to deposit accounts of any variety, nor the swap instruments which removed constraints on how depository institutions could work through them. An external monetary system like this had represented a true sea change. How might this ability to transcend boundaries and limits work in, say, securities financing transactions?
This is a question that, in October 2020, we shouldn’t still be waiting for an official response. Not with everything that wrecked QE’s and economy over the last thirteen years. The lack of urgency is damning.
It was, after all, Alan Greenspan who in June 2000 paraded the “proliferation of products” around the FOMC’s boardroom – if only to argue why the Fed’s monetary policies didn’t, and couldn’t, contain any money in them. They didn’t even know where to begin, a fact of monetary policy life that had come about not in June 2000 nor in the decade of the nineties. It had been, as Gufey and Giddy had carefully recorded, the sixties and seventies.
But like all the rest of his counterparts across the world, Greenspan felt in 2000 that it wouldn’t matter. He might have been occasionally uneasy about this inability to stay on top of the financial system as it expanded even more vigorously in qualitative ways beyond the strictly quantitative bubbly-ness, the official position worldwide was that monetary details were best left to be worked out by the banks themselves. Details, schmetails.
Well, 2007 and 2008 proved them wrong; only, it took authorities several more years (like it always does) to realize this (subprime mortgages!) Again, let’s go back one more time to the November 2015 EU regulatory statement:
“In particular, a lack of transparency in the use of SFTs has prevented regulators and supervisors as well as investors from correctly assessing and monitoring the respective bank-like risks and level of interconnectedness in the financial system…”
This isn’t about preventing another Lehman Brothers.
Reconcile that statement with Gufey and Giddy’s 1981 paper (which wasn’t some obscure academic dithering) and then how it has taken more than thirteen years since August 2007 to finally attempt a small data collection effort into just European SFT practices. The FSB’s recommendation on October 14, 2014, useless in the face of what followed it the very next day – endorsements that still haven’t been lived up to now six years later despite October 15 being repeated, and global recovery yet again thwarted, on May 29.
March 2020 was downright unnecessary. Not just in the Federal Reserve’s absolutely disastrous decision to swap bank reserves for badly needed T-bills (I mean, if they were trying to crash the system like so many wrongly claim, what would they have done differently?), but for all these times when collateral (SFT, more broadly) showed up and warned the world to pay strict attention.
What you’re left with is the distinct impression this isn’t a serious effort. Real determination like there should have been from October 2008 onward wouldn’t have needed the additional hundred and forty-four months since to come up with little greater than nothing on SFT (never mind all the rest of the eurodollar’s “full-fledged external money” which doesn’t even come up). Had this been serious, SFT’s would’ve become common knowledge before ZIRP was ever tried along with QE in December 2008.
But these are not serious people. These are not serious efforts. They are moved forward, grudgingly, only by continued failure and only enough to keep the metaphorical torches and pitchforks from coming for central bankers and bank regulatory officials. Doing just enough to sound like they’re doing something.
The real something, like SFT practices, that had been done more than a half century ago. It’s late 2020 heading toward 2021, and central banks like regulatory authorities still haven’t caught up to the last half of the 20th century. But inflation therefore real economic recovery is just over the horizon because this time, unlike all those other times, they figured out the right QE?
Some jokes just aren’t funny.
