JEFF SNIDER: My name is Jeff Snider.
I work for Alhambra Investments.
I'm the head of global research there.
It's a registered investment advisor based out of Florida.
What I do is, as the head of global research, is I focus in on the monetary mechanics, the
plumbing, so to speak, behind what actually goes on in the world.
I take a particular focus on something I call the Eurodollar system because as a global
currency, it really is the global reserve currency.
Because it's a global reserve currency, what that does is that touches pretty much every
part of the global economy in almost every part of the global markets.
The way in which that happens is it's a lot of times very complex.
A lot of times, it's hard to decipher, but what you should know is that the Eurodollar
system is everywhere.
It's out there, it's happening, it goes on, and very few people pay attention to it, and
a few still understand what really means and what it really does.
It was way back in early part of my career, I started looking at bank balance sheets,
for example, as an equity analyst, as a return a portfolio management firm.
You take a look at banks, and what you found out was that the way the banks operate and
the way that individual banks balance sheets were put together was not what you were taught
in school.
There was all the things going on, on these balance sheets and in this monetary system
that was very different from what everybody was saying, what everybody believed in and
so I started investigating that.
What really drove me to look at it was the fact that nobody had any answers for these
things.
These things would happen, you could see them on balance sheets, and you could see that
there was more behind them but when you stop to talk to people who were supposedly in the
know, people were supposed to know these things.
You listen to central bankers and economists, for example, it was very clear they didn't
have a very good understanding.
For me, it just drove me further and further that hey, maybe someday this will be important.
Of course, first you had the dot-com bust and then of course, what happened in 2008.
You started really to think, okay, there's something really going on here that's worth
investigating and worth understanding in a particular level, because there's a lot that's
attached to it.
Well, what literally happened last week was the repo rate shot up.
Because it shot up, there's various linkages between the repo market and the Federal Funds
market.
Monetary policy at the Federal Reserve operates on Federal Funds so as Federal Funds rose
in the range, and then actually broke out of the target policy range, that caught the
Fed's attention.
They can't any longer ignore something going on the repo market that's spilling over into
Federal Funds.
That's literally what happened, was that these report rates skyrocketed because of a lack
of liquidity, which forced the Fed to respond, which they did with these overnight repo operations
that have become daily, which are now sprinkled in with term repo operations simply because
there's a lack of liquidity in the system.
We're not really sure why.
The Fed doesn't know, most people in the mainstream don't know, there's really not a whole lot
of answers about what's really going on there.
There's certainly been a lot of theories, but there hasn't been a lot of answers.
For what I said, what I've been saying for a long time is that this didn't just happen
out of the blue.
We've been talking about Fed funds repo, for in this particular case, for over a year and
a half.
In fact, the Federal Reserve knew something was going on because they have been altering
their mechanics, just a little slightly here along the way.
Going back to June of last year, for example, June of 2018, they changed IOER for the first
time.
They dropped it five basis points below where it was.
The idea was that that would help liquidity in the marketplace, that would get banks to
lend some of their free reserves into essentially repo and then have that trickle down into
Federal Funds.
That never happened.
They kept on adjusting IOER expecting that this little nothing of a problem would just
go away.
They kept finding out that, hey, there's something going on here.
There's something else going on here.
Really, that's the big message behind all of this.
When you stop and look at what's going on in the repo market, Federal Funds and some
of the wider issues with the fixed income marketplace as a whole, what you keep coming
back to is there's something going on here.
First, you say there's something missing.
Obviously, there's something missing.
We saw that last week.
There's a big piece of liquidity missing, but there's something else going on here because
this keeps building and building, and what happened last week was it finally broke out
into the open so that everybody started paying attention to what was essentially something
that had been happening for quite some time beforehand.
IOER is the rate the Fed pays on excess reserves.
Going back to 2008, the Fed has created excess bank reserves and it pays a specific rate
on those reserves to the banking system.
The idea is that helps the Fed control money market rates like the Federal Funds rate.
The reason it is because where they place IOER in the range of their policy range or
in the range of actual transactions gives banks alternatives of where they can put free
cash or free funds, however you want to call bank reserves.
The idea is if I lower IOER, that means I'm going to pay banks-- as the Fed, I'm going
to pay the banks a little bit less to give them a little bit more incentive to go into
repo or Federal Funds that will bring those rates down and add a little bit more liquidity
to the system where it's supposedly needed.
That didn't happen.
Every time they reduced IOER, you didn't see much of a response in either repo or Federal
Funds.
Federal funds kept rising inside the range.
In fact, earlier March of this year, Federal Funds broke above IOER for the first time
and they responded by just lowering IOER again expecting, again, the idea that will pay banks
a little bit less on their reserves so that they'll chase a higher return which was by
then a much higher return in Federal Funds and repo.
Again, we come back to that same question, why didn't the banks do that?
Where were they?
What are we missing here?
Thanks for not taking that advantage of what should have been of much higher incentives
to add liquidity into repo and Federal Funds and these other places.
They weren't doing it.
What we're really talking about here is banks being constrained.
The reason they're not going into these marketplaces is because they don't want to there.
There's something else going on in the system.
I think it goes back to last year.
If you look at May 29th , 2018 for example, what happened on May 29th , 2018 was nothing
more than interest rates tumbling.
They fell sharply.
What that said was that the market was concerned about something.
Something happened on May 29th . We may not know exactly what it is, but because it wasn't
just US Treasury yields, you had German bond yields and other yields of sovereign bond
yields around the world tumbling on May 29th, what it did was it announced that something
had just happened in the global system.
Again, we're talking about a global reserve currency, therefore a global monetary system.
Something happened on May 29th that wasn't good that forced mostly banks in the system
to buy and value Treasury bonds, German bonds, those types of instruments.
What happened after that point is, and you see this in all of the charts, all the charts
that matter anyway, May 29th turned out to be an inflection point.
Everything changed after.
Inflation expectations for example, before May 29th, it was going along the way-- the
TIPS market was going along the way that Jay Powell said it was.
The economy was booming, everything was great, we're going to have an inflationary breakout,
inflation expectations in the TIPS market were rising.
May 29th happens, that's no longer the case.
Inflation expectations plateaued and then they have been falling ever since.
Something changed on May 29th, and because it was US Treasury bonds, because it was German
bonds, what that suggests is that there was a problem in collateral, which is the other
side of the repo market.
The repo market has a cash side and also has a collateral side.
You can't go in the repo market and fund whatever you're trying to do if you don't have the
acceptable collateral that the repo market's looking for.
What we know from May 29th is something happened, and likely happened in the collateral system,
that ever since that point, ever since May 29th of last year, these banks, this global
banking system, this global monetary system has been increasingly reluctant to respond
whenever you see these other opportunities, let's call them, to offer liquidity to offer
to funds.
They don't want to do it, they're staying out of it.
Again, something's missing, something is absent.
I think a lot of it has to do with the collateral side in the repo market.
The collateral side is not an easy thing to explain because it's one of those things,
it's part of the global framework of modern money.
It's just, again, the stuff that you were never taught in school how it actually works.
It's a very complicated, almost bizarre, weird place.
A lot of different things happen on the collateral side.
It's something called securities lending, but even the idea of lending securities is
probably foreign to most people because it sounds fantastic.
Why would you be lending securities?
Oh, by the way, we're not just lending securities, we're also transforming securities.
We have collateral lending, we have rehypothecation, we have collateral transformation, we have
all these weird things going on, that these dealer banks know is going on.
Not only do they know what's going on, they probably have a decent idea of who it's going
on with and they also have an idea of how much this is taking place.
If there's an issue in the collateral system, we can suspect, again, we don't have any direct
evidence for these things because it's hidden in these offshore spaces of this global marketplace.
We can begin to suspect by what we see in market prices and dealer bank behavior that
there's some concern about all of the things that were going on the collateral side of
the repo market, may be in danger of creating bigger problems.
That might answer, in my view, probably does answer at least a good part of why dealers
are reluctant to step in when they should be stepping in, when they should be taking,
hey, I got lower IOER, why am I not taking advantage of the spread to repo or Federal
Funds?
Well, if I'm worried about all these other things, I'm probably going to be shy about
everything.
In many ways, we've never recovered from 2008.
Before 2008, as people know, from the term subprime mortgages, mortgage bonds were a
very big part of the collateral chain, they were a big part of the collateral system in
the repo markets.
Once the financial crisis became severe enough, those mortgage bonds were no longer really
acceptable in repo.
What we were left with is pristine collateral, which is the top layer of collateral out there,
it was nothing more than US Treasuries and for a while, it was all the European sovereigns
until 2011 when those Portuguese, Italian and Greek bonds suddenly, they were no longer
acceptable either.
What we're really talking about here is, the availability or supply of collateral in the
system has been impaired and has been cut back since 2008.
Nothing has ever been done about that, at least not an official level.
Now, the banking system has tried at various points along the way to deal with what is
essentially a systemic or chronic shortage of collateral, which is what we're really
talking about here with Treasuries and German bonds.
The way that they've done that is by various points along the way, they've transformed
other forms of collateral, lesser forms of collateral, using the limited availability
of the top tier stuff, the pristine collateral, and attempting to essentially get around what
is this chronic shortage.
When you do that, you're adding elements of risk to the system and the way collateral
trades and the way the collateral is redistributed is almost like-- it's almost currency like
in its own behavior.
There are times when dealer banks are more than happy to do all these lending and transformations
and all that stuff.
There's also times when they're shy about it.
It's almost like there's a collateral multiplier.
I know that's weird to say and that's weird to contemplate, but that's really the truth
here.
When the collateral multiplier is big, or pot big, largely positive, the repo market's
fine.
There's plenty of collateral, I don't want to say plenty, but there's collateral out
there in the system, it's distributed, it flows where it needs to go or where it largely
needs to go.
On the opposite times when banks are a little bit less sure of things, more aware of the
risks involved, that collateral multiplier tends to collapse a little bit and that causes
problems because what do you do in that case?
Where do you go to if you don't have good collateral?
Well, the one thing you do is you buy the top tiers.
You buy US Treasuries.
You buy German bonds.
The insiders in the system, because again, we have very little-- we can't really see
what's going on in this offshore system because a lot of it takes place outside of the purview
of anybody.
There's not any statistics.
Basically, the only people who know what's going on are the people involved in it, the
big banks and the banks who deal with the big banks in this global dollar redistribution
scheme.
If they're looking at what's going on out there, we don't really have a direct way of
observing what's going on out there.
If they're acting quite shy about what they perceive is going on, or what they know is
going on, that's a pretty clear signal that something must be going on and something is
making them reluctant to take advantage of what should be an easy arbitrage in Federal
Funds or IOER, therefore we should take from that the idea that, hey, something's going
on out there that they probably see that they're reacting negatively to that it's got to be
a substantial thing.
Oh, by the way, it's preventing them from reacting in a way that would allow for this
normal functioning in these other markets that people are paying attention to in the
places that we can see.
Regulations definitely have played a role here.
They played a procyclical role, which is obviously the opposite of the intent.
The regulations, when you're talking about basal three, the liquidity coverage ratio,
HQLA, all that good stuff, it codified what banks were doing anyway, which was they were
holding more of a pristine collateral inventory on their own anyway but yes, the regulations
did play a role in making banks hold even more.
There's already an existing liquidity margin that has built into whether it's perception
or regulation, that's already built into the system in the post-crisis era.
You also have to factor in quantitative easing, too, which was the Fed essentially were raising
some of that collateral by buying it up and storing it into its summer portfolio.
It's a multi-dimensional problem that is a chronic problem, a systemic problem but it's
not a straight line problem.
It shows up in these different, in these discrete periods along the way, but regulations definitely
did play a role.
They have made banks hold probably more collateral than they might have otherwise.
No, it's definitely hand-waving.
The reason is, look, the Fed did overnight repo operations daily.
They have been since last week, and it hasn't had much of an effect.
The repo rate isn't as elevated as it was in the middle of last week, but that was just
because that was a seasonal low point on the calendar.
All that happened that brought the report back down where it was before was that the
seasonal bottleneck had passed.
Before the bottleneck, you had the repo rates and the Federal Funds rate elevated suggesting
lack of liquidity.
Then after there were the bottleneck, you had elevated repo rates and Federal Funds
rate.
Not as elevated as middle of last week, but still elevated this week.
Oh, by the way, there are now standing repo facility, but there are now overnight repo
operations, and these term repos along with it.
They accomplish much, because the repo market Federal Funds is in the same shape as it was
before the bottleneck.
That hasn't really done much in the answer.
The reason is because the Federal Reserve is looking at this from the perspective of
only bank reserves.
They're all in the large part doing it because they're only looking at it from the perspective
of Federal Funds.
Monetary policy is only concerned about whether or not the Federal Funds rate, the effective
rate stays within their range.
The only reason we got overnight repo operations was because it broke out of that range.
They're looking at it from the perspective, a narrow perspective of just Federal Funds,
just bank reserves, and therefore, the idea is maybe we need to keep Federal Funds in
this range and the way we do that is through a standing repo facility, which is only bank
reserve.
Has nothing to do with collateral, has nothing to do with why dealers are sitting on their
hands when they should be acting in the marketplace.
It's only allowing some variation in the level of bank reserves.
What I tell people is well, if we go back to the pre-crisis era, there were no bank
reserves.
There was maybe 10 billion in the system.
For a multi-trillion dollar system, there were no bank reserves in the system before
2008.
Yet the repo market functioned fine.
What was the repo market using to settle this liquidity when there were no bank reserves,
or was using other forms of liquidity, other forms of bank driven liquidity?
The answer in the repo market today can't just be bank reserves, because the repo market
encompasses so much more than just what the Fed is offering.
The Fed is offering a small slice of what might help the repo market.
We've already seen that the problem is much bigger.
Again, going back to May 29th, why are dealers refusing to act in these places?
That's the real question, has nothing to do with a standing repo facility, nothing to
do with overnight repo operations.
It's why are dealers not being involved when they should be?
Everything, everything in the marketplace says these guys should be acting.
You see the repo rate skyrocket to 10%, why are you sticking at 2.1 in IOER?
You should be in the repo market.
There's tons of opportunity there.
That's the real issue here.
It's not the level of bank reserves.
It's not standing repo facilities.
It's why are banks refusing to get involved here?
Well, I think people are focused rightly because nobody knows, nobody really understands the
system as it actually works.
That includes policymakers, by the way, sadly.
The fact is that monetary policy is not a money policy.
It's not about understand liquidity and understanding this global system.
Monetary policy is only about managing people's expectations.
That's what the Fed's doing.
What happened last week was the Fed found out it's hard to manage people's expectations
when you have an obvious problem in a way that everybody's talking about it.
If you have a situation where the Federal Funds Rate breaks out of its range, it's hard
to manage people's expectations positively.
In fact, the economy in a positive way is policymakers expect if you have this problem
in repo.
In fact, everybody keeps talking about this problem repo because it raises uncomfortable
questions, and you don't have the answers to why, what is going on in repo?
Why is it still going on in repo?
If you don't know, it makes it much more difficult.
The idea here is that the level of monetary expertise, the level of expertise about the
monetary system as it actually functions is very low.
It's even lower in the general public because for a very long time, nobody paid attention
to these things.
Everybody just thought, well, Alan Greenspan's got it covered.
Ben Bernanke's got it covered.
We don't need to understand repo because somebody out there does.
Therefore, nobody's ever asked any real questions about the monetary plumbing of the system.
That includes policymakers who thought we'll just do some QEs or something.
Whether it works or not, as long as people think it works, then good enough for us.
Overall, it's a lack of understanding about how things actually work.
That's not a small thing because again, as I touched on in the beginning, this is a global
monetary system that affects every part of the global economy and a lot of global markets.
I think it's also important to point out that this is not the first time we've seen this
tightening.
This is actually the fourth time this has happened since 2008.
The first one, obviously, everybody knew about.
That was the Global Financial Crisis in 2008.
Everybody focused in on subprime mortgages, but that was only maybe the catalyst which
kicked things off.
We know from things like the dollar swaps that the Federal Reserve did with the foreign
central banks.
What really happened in 2008 was a global dollar shortage, same kind of dollar shortage
we're talking about today.
What has happened over the last dozen years or so, is we've had these intermittent dollar
shortages show up.
Last year and a half is just the fourth in a series of them.
There was a second one in 2011-2012.
There was another one in 2014-2015, lessens in early part of 2016.
Then this one showed up early on in 2018.
Well, everybody's been talking about trade wars.
Before anybody paid attention to repo, everybody was experts in tariffs in Chinese goods.
No, this stuff is just repeating.
We see that consistently across these markets, the same market signals that we have today
telling us that there's a dollar shortage going on now that's leading up to repo and
collateral, all this other stuff we talking about.
We saw the same market behaviors three times before now.
It's important to understand that this isn't the first time that's happened.
The reason we want to understand that is because we want to understand what the real problem
is.
It's a systemic issue.
Collateral is only part of the story.
Again, it's a systemic thing, where it's causing a negative effect again across the entire
global economy.
It's leading to uncertainty in a lot of marketplaces.
It's leading on to just generalized uncertainty in whether you're talking about politics and
social factors.
What I'm saying is that what people have focused in on trade wars and trade wars are not helpful.
That's a negative.
That's definitely a negative pressure in the real economy.
What's happened in the global economy overall is more about a dollar shortage, a repeated
dollar shortage and is about trade wars.
The reason people are focused on trade wars is because there's a lack of any alternative
explanation.
What else could it be?
Nobody else has any real answers.
Again, like the repo thing, what else could it be?
Nobody has any answers.
Because nobody really pays attention to these things.
Even after 2008, there's been a lack of curiosity about the global monetary system, which is
to me is strange, but it makes sense because most people just want to believe that Ben
Bernanke, Janet Yellen, Jay Powell, they all have it covered.
We don't know how they haven't covered, but we want to believe that they do.
Therefore, they say everything is fine, it must be trade wars, because we don't have
an alternative explanation but in truth, the dollar problem showed up before the trade
wars did.
Not only that, this is just the fourth iteration of the same event.
People are attributing the effects of this dollar shortage to trade wars because they
don't have any other explanation.
Well, it's a systemic issue, because we go back to the pre-crisis era, banks would just
expand and part of that expansion was liquidity, money.
Well, it's difficult if not impossible to define money and liquidity but we know that
was there, because everything was going gangbusters in the pre-crisis era.
Subprime mortgages were a symptom of that expansion.
It was a monetary expansion.
It was a global monetary expansion.
Even the authorities knew what was going on.
They just misunderstood.
Ben Bernanke in 2005 called it a global savings block.
It wasn't a global savings block, it was a global monetary block.
They just happened to take place offshore outside the US jurisdictions.
Then this just crisis happens.
Starting in August of 2007, the banking system began to doubt itself.
Why wouldn't it?
Because a lot of what was going on was going on based on myths and short hands and perceptions
about things that weren't real.
As the banking system began to ask real questions about the stability of everything, bank behavior
changed, especially once Bear Stearns failed, or nearly failed, was turned into a "merger".
What happened with Bear Stearns was it reminded everybody that there was suddenly a very real
downside to doing all of these things that they used to do exponentially.
The downside was, hey, you really can go out of business here.
They could take the entire bank with it.
Then, of course, that message was reinforced later in 2008 with Lehman Brothers, AIG and
all the rest.
The system began to doubt all the things that it used to do before the crisis, all these
liquidity things, securities transformation, repo markets, commercial paper.
All those things that happened before the crisis era, banks began to attach real risk
to them, and then they didn't really want to do them anymore.
Then the problem was that the global system-- because remember, this is a globalizing economic
system up until 2008, it required those things to be done, it needed the monetary and financial
resources in order for the economy to move.
If the banking system says I don't want to do those things anymore, all of the sudden,
it's hard to do all the things that would in economic terms as well as market terms,
that happened before the crisis era.
If the bank don't want to create the liquidity, you're going to have a constant liquidity
problem.
In an overview sense, what it is, is the system was unstable to begin with.
It operated for a very long time, because everybody assumed it was stable.
They also assumed that the Federal Reserve was behind it, which turned out to not be
true, too.
A lot of these assumptions have been challenged and proven false and then it's led to this
situation where we have this constant malfunctioning system that requires banks to expand when
they're no longer willing to do that.
This fourth eruption, what we've seen over the last year and a half, and what we saw
last week in repo is just an extension of that problem.
When there's an opportunity for banks to extend and create liquidity, they're saying we don't
want to do it.
Yeah.
It's two different things, or two things that are related to each other.
Number one, 2008 was not a one-off event.
Everybody assumes it happened, it's over with, we're onto something else.
No, it was an inflection point.
The system that existed before 2008 no longer exists today.
It's still in place, but it doesn't work.
It doesn't work for the people inside it, it doesn't work for the people outside it.
Because very few people are aware that it's there, very few people are aware of what it
does, it hasn't received the recognition that requires and it deserves.
The other thing is that what was going on in the system that existed before 2008, as
I said before, was unstable.
It was a ridiculous system because it rewarded all the worst behaviors.
In some ways, it was like a spinning top.
A spinning top that spins fast seems stable but as soon as it starts to slow down, it
wobbles and falls down.
The banks that operate this-- because what we're really talking about here is a credit
based global monetary system, and credit based means something.
It means that it requires bank balance sheet capacities for this thing to operate in at
least the appearance of stability.
If the banks aren't willing to put in the resources, to put in liquidity, to put in
the balance sheet expansion for that system to operate, it is inherently-- the inherent
instability in it shows up and it shows up in these discrete periods that we've talked
about, these four different dollar shortages that have erupted along the way.
2008 was a monetary break, was a systemic break and collateral is just one part of that
systemic break.
A lot of it has to do-- we all come back to, again, we're asking the question, where are
the banks?
Why are they sitting on their hands?
That's the reason.
If you're looking at it from an overview perspective, going back to 2008, the system was never ever
fixed.
That's the real point here is that there's really survivability at stake here, because
that's what we saw.
Bear Stearns went out of business.
Yes, Bear Stearns was merged and as far as the Fed was concerned, that was a successful
rescue.
If you're a manager at Bear Stearns, you're a shareholder at Bear Stearns, that's not
how you view it.
You lost everything.
The partners of Bear Stearns and shareholder of Bear Stearns, they saw what the downside
of this is.
That message was transmitted to all the rest of the banks.
They understand post-crisis, there's no Fed behind everything, liquidity is shaky, you
know what, we don't really want to do this anymore.
Even when the repo rate is 10%, that's not really enough, because we're aware of the
potential downside and the potential risks that could be out there.
Oh, by the way the Fed isn't.
The main takeaway is simply that something's going on.
Even if you don't know exactly what it is, you got to say, hey, something's going on
here and it doesn't seem like our policymakers, the authorities have a whole lot of answers.
That's important too because you have to realize that what's going on in the system, what may
be going on in the system, if there's nothing behind it, if there's no backstop behind it,
which everybody's thought from day one-- the Fed is the lender of last resort.
What if there is no lender of last resort?
That's a very different risk spectrum.
Then if you thought, well, Jay Powell will just do a standing repo facility and we'll
forget about this stuff.
In other words, there's something going on here, it's a substantial thing.
It entails risks, not just to the repo market, not just to Treasury markets, which would
be a positive thing for Treasury markets because people would go into those markets, interest
rates would fall further.
We've already seen the effects in the global economy.
Think about what happened in 2018, or what was supposed to happen for 2018 to 2019, authorities
were saying the economy's booming, inflation is going to break out, we're going to do more
rate hikes in 2019.
What happened in 2019?
The opposite.
We've got questions about a global recession, and some economies that look like they're
already in recessions, important ones like Germany, that already looked like they're
in recession.
There's no inflation, inflation expectations have fallen, as I said before, since May 29th
. Oh, by the way, now, the Fed's cutting rates and they're not the only ones.
It's global, central banks around the world are all cutting rates.
We've already seen the effects of the global monetary tightening.
What we're really talking about here is a global monetary tightening in the system that
very few people understand.
It's already had serious effects in the entire global economy.
What does repo rumble or whatever it was last week, it just emphasizes this fact that there
are negative monetary risks that have very real implications for pretty much anywhere
around the world.