Re: Economic Crash of 2020: The Fuckening
Posted: Thu Mar 26, 2020 10:26 pm
Larry Fink, Master of the Universe, once again. Gillian Tett's latest:
And from the Alphaville end of the pool:
This month, Wall Street watchers might feel as if they are living in Groundhog Day. Now, as in 2008, markets are melting down. Once again, the US Federal Reserve is frantically innovating to stop a financial freeze. And, as these wild policy experiments unfold, a familiar figure is also back in the frame: Larry Fink, chief executive of BlackRock, the $7tn asset management behemoth.
Twelve not-so-long years ago, the Fed turned to BlackRock to manage the three Maiden Lane vehicles that it created to hold assets from the defunct insurer AIG and also Bear Stearns. On Tuesday, it again tapped BlackRock’s Financial Markets Advisory, its consultancy arm, again to run three vehicles the Fed will create to buy corporate debt from the primary and secondary markets, and also commercial mortgage-backed securities.
Is this replay a smart move by the Fed? The answer depends on if you have a wartime or peacetime perspective. In calm market times, as existed a month ago (remember that?), Tuesday’s announcement would look very odd.
Never mind that the Fed has used BlackRock before, or that Mr Fink is fabulously well-connected. What is more notable is that BlackRock received this mandate without a contest. Moreover, his asset management firm has such a humungous footprint that it will inevitably collide with those Fed vehicles.
Take the $140bn world of investment grade US corporate bond exchange traded funds. On Monday the Fed pledged to invest in some ETFs to support corporate funding flows. However, as it happens a BlackRock-run ETF, called LQD, is the biggest of this type. The price of LQD, like other ETFs, has already rallied since the announcement. If the Fed does a broad ETF programme, LQD will probably be part of that mix.
This leaves some BlackRock rivals muttering about conflicts of interest — and non-American regulators caustically pointing out that since 2008 Mr Fink has been adept in persuading US regulators to refrain from sweeping regulatory reforms on asset managers, such as his.
Fair enough. But the problem the Fed faces is that it does not have the luxury of operating in peacetime; it is fighting a war to stop a financial freeze. Thankfully, the White House is letting Fed officials experiment as flexibly as they did in 2008, contrary to earlier fears among policy veterans such as Hank Paulson, the former US Treasury secretary, that the Fed’s hands would be tied.
However, even with this freedom, Fed officials face a practical problem: they do not have all the resources they need in terms of manpower and skills.
Consider, again, corporate debt. The Fed says it will only buy investment grade credit, to limit possible losses. But, as Scott Minerd of Guggenheim points out, “There are approximately $1tn worth of investment-grade corporate bonds that are in danger of being downgraded”. Indeed, $36bn of Ford debt has already become junk.
Fed officials hope they can offset these risks by using a $30bn Treasury fund to absorb future losses. But it is also imperative to have external managers, given that the Fed has never exposed itself to such credit risk. And while numerous financial groups have asset management or consultancy skills, none has the combination on BlackRock’s scale.
For the key thing to understand about the canny Mr Fink is that he has not only spent the past decade building a highly visible asset management company, he has also quietly used the Maiden Lane experience to make FMA dominant in its consultancy space. It has 280 staff, and has quietly worked for numerous public institutions, including the UK Treasury and European Central Bank.
As a result BlackRock has extensive “expertise with purchasing large amounts of all relevant types of corporate debt issuance and corporate bonds in the secondary market”, as the New York Fed notes. In plain English, BlackRock’s experience and data base make it a natural Fed partner — if it can manage those potential conflicts of interest.
Can it? Both sides insist so. BlackRock officials stress that its asset manager and consultancy units are separated by strict Chinese walls. Fed officials point out that BlackRock’s mandate is only a short-term contract, and thus will be reviewed soon. Most important, the $2tn stimulus bill in Congress stipulates that details of Fed’s actions must be published after a seven-day lag.
If honoured, this should provide transparency about trades and BlackRock’s fees, in a welcome contrast to what happened in 2008. “We’ve learnt from the past,” insists one Fed official. “We won’t repeat the mistakes.”
Maybe so. But 2008 also shows that decisions that seem sensible in the heat of war can spark furious political backlash later. If Fed officials, and Mr Fink, want to minimise these risks, it will be crucial to maintain transparency and conduct proper beauty parades when normality returns. If, or when, we return to that point, US regulators will then need to ask another question: why did they let the asset management world become so concentrated that the ever-present Mr Fink reigns supreme?
And from the Alphaville end of the pool:
There are only a handful of global experts on how eurodollar markets, dollar swaps, shadow banks and money market funds interact with central banks. International monetary and economic expert Robert McCauley, a senior research associate at the Global History of Capitalism project, is one of them. He’s sent us a useful account of the extraordinary moves central banks like the Federal Reserve are now taking to stabilise securities markets and how exceptional they are in relation to recent precedents.
A key observation is that while the Fed hasn’t yet exhausted its options in this arena, some of the moves it is now experimenting with are on the verge of opening a new chapter in central bank support for securities markets.
McCauley cautions, however, that the objective shouldn’t just be security price support. This especially applies to the corporate bond market, where a sudden dearth of dedicated market makers for bond ETFs (known as authorised participants) is creating an urgent need for the central bank to step in as authorised participant of last resort in a bid to maintain market liquidity.
McCauley’s notes follow below.
How can a central bank stabilise security markets?
Central banks’ motivation to intervene in security markets is clear: in the face of runs on securities markets, the real economy faces threats of disruption of credit flows, unnecessary defaults and fire sales.
Fifty years ago, the Fed could respond to the default of a large issuer of commercial paper (CP) by opening the discount window to banks. Easy access to Fed credit allowed banks to fund industrial firms that were unable to roll over maturing CP. Today we see firms drawing down on the system of formal credit lines that was introduced as a backstop for the CP market following the Penn Central railroad crisis of 1970. Last week the Fed opened the discount window as wide as possible, just as it did back then.
At the time of the Penn Central crisis, however, it was possible for the big weekly reporting banks to expand their corporate loans by 3 per cent in order to offset a 10 per cent decline in nonbank CP. A bank lender of last resort could in practice therefore backstop a substantial securities market in one move.
Today, the US corporate bond market — much of it rated just a notch higher than junk — amounts to $7tn, according to the Bloomberg Barclays US corporate bond index. Its sheer size means last-resort lending to banks is likely to struggle to stop runs on security markets.
Going beyond the banking system with its last resort credit is therefore essential for central banks like the Fed.
But what options do central banks really have when it comes to stabilising securities markets?
In reality, there are only five: 1) Acting as a lender of last resort to securities firms, 2) acting as a lender of last resort to investment funds, 3) acting as a securities dealer of last resort, 4) acting as a securities underwriter of last resort and finally 5) acting as a securities buyer of last resort.
By Monday 23 March, the Fed had put in place programmes under three of those five options. It has been backing into another and it is not hard to imagine it will soon experiment with the last one.
Acting as a “lender of last resort to securities firms”
The Fed returned to its 2008 playbook last week by reprising its role as last resort lender to securities firms. The Primary Dealer Credit Facility funnels collateralised Fed credit for up to 90 days to its designated primary dealers. Collateral can include equities, which is otherwise a no-go for the bank discount window.
Acting as a “lender of last resort to investment funds”
While the holding companies of Bank of New York and Goldman Sachs recently came to the rescue of their money market funds, the Fed has not yet lent to investment funds. In the US, central bank action of this sort would require the use of emergency Section 13.3 powers with Treasury approval.
Nonetheless a recent precedent for official support of investment funds is the Treasury’s Exchange Stabilisation Fund (ESF) guarantee of the par value of money market fund liabilities after the Lehman default in September 2008.
This, in combination with the Fed’s, in effect, purchasing and underwriting of CP, successfully stopped the run on money market funds. The only other precedent was the Bank of Japan’s funding of investment trusts in the mid-1960s during the Yamaichi crisis.
Acting as a “securities dealer of last resort”
Whatever its intentions, at its March 18 balance sheet snapshot, the Fed looked very much like a securities dealer of last resort. The central bank has stepped in to intermediate on both sides of the repo market to the extent of $234bn — this is known in the industry as running a matched book. On one side are foreign central banks and money market funds as cash lenders; on the other are securities dealers as cash borrowers. It’s important to stress this balance arose as the Fed lent cash to stop market forces from lifting short-term rates rather than from an intention to keep the repo market going per se.
The Systemic Risk Council, an advisory body made up of former government officials and financial experts, is now urging central banks to take on this role more broadly.
Acting as a “securities underwriter of last resort”
The Federal Reserve reprised the role it played as underwriter of last resort for CP back in 2008-09 with its offer last week to buy CP directly from firms. For a small underwriting fee of 10 basis points, the Fed will now buy CP if the prime issuer cannot sell it in the market at less than 2 per cent over overnight rates. This time the Exchange Stabilization Fund (ESF) is providing a layer of Treasury equity to shield the Fed from losses. The last time the Fed made this offer it walked away with a profit.
On March 23, the Fed extended its role as underwriter of last resort further out the yield curve when it moved to support the issuance of investment grade corporate bonds or loans of up to four year’s maturity. Again, the ESF takes equity risk. But this intervention in the primary corporate bond market, along with the secondary market operation below, opens a new chapter in central bank support for securities markets.
Acting as a “securities buyer of last resort”
The precedent for acting as a securities buyer of last resort occurred in 2008-09 when the Federal Reserve Bank of Boston made non-recourse loans to custodians to finance the purchase of asset-backed CP from mutual funds.
On March 18, the Fed announced a similar but broader programme under which the Boston Fed would make non-recourse loans to any bank secured by CP bought from money market mutual funds.
On March 20, the Fed added municipal paper to the programme.
On March 23, the Fed announced that it would buy US investment grade corporate bonds or exchange traded funds in the secondary market. Again, the ESF would be providing a slice of equity risk.
All these actions in security markets are significant.
But it’s important to stress that the hundreds of billions of dollars of programmes announced so far may not be enough to backstop the dollar-denominated corporate bond market outright. Not only are there $7 trillion in US corporate bonds, the Bank for International Settlements (BIS) counts dollar bonds outstanding of non-US residents other than banks as having grown from $2.5 trillion at end-2008 to $6.2 trillion in September 2019. Beyond US Treasuries and agencies, the global dollar bond market amounts to tens of trillions of dollars.
And while Fed purchases of corporate bonds can prevent market seizures in the short-term by providing a bid for bonds in the face of mutual fund redemptions, over time they do little to add liquidity to the market overall. Corporate bonds purchased in the secondary market, in essence, end up parked in a Fed special purpose vehicle.
To revive liquidity the Fed could eventually repurpose the programme into a secondary market liquidity scheme. One option, in this regard, is for the Fed to buy and sell corporate bonds in the secondary market in order to narrow spreads and to encourage more private market-making. The Fed could even use such buying and selling to arbitrage the prices of highly traded exchange traded funds and the prices of the poorly traded underlying bonds, where wide gaps have apparently opened. This would see the Fed become the ETF market’s authorised participant of last resort, in so doing backstopping the liquidity of securities, not just their price.
Whether the Fed moves in that direction, of course, remains to be seen. What we can be sure of is that more measures to stabilise securities markets are coming.