Thursday, March 12, 2020

From pandemic to financial crisis?

Yes, the stock market is jumping around, but Treasury markets are also going a bit nuts. And the NY Fed is pulling out the Bazookas:
Today, March 12, 2020, the Desk will offer $500 billion in a three-month repo operation at 1:30 pm ET that will settle on March 13, 2020.  Tomorrow, the Desk will further offer $500 billion in a three-month repo operation and $500 billion in a one-month repo operation for same day settlement.  Three-month and one-month repo operations for $500 billion will be offered on a weekly basis for the remainder of the monthly schedule.  The Desk will continue to offer at least $175 billion in daily overnight repo operations and at least $45 billion in two-week term repo operations twice per week over this period.
In English, you can get cash quick by parking  your treasury securities to the Fed. And the Fed is getting ready for huge amounts.
These changes are being made to address highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak. 
If I read this right, we're looking at a cut to 0.25% very soon.

A pandemic should be one grand stay-cation. (Writing here about  the economy, and those of us who do not get sick. It is of course combined with a health care disaster, which I don't write about for the simple reason that I'm not a pandemic health policy expert.) The economy shuts down as it seems to do over Christmas - New Years, or Europe in August, and then starts right back up again. Except people and businesses make sure they have cash to pay bills over the vacation. If the US follows Italy to a national shutdown, businesses start to fail, banks get in trouble, here we go. I think these are signs of a flight to cash starting up.

As far as I know the "stress tests" never asked "what are you going to do in a pandemic."

Informed commentary from market participants is especially welcome. Thanks to correspondents for both of these links, which I do not regularly follow.


  1. I have no desire for more cash. We already had one foot on the path of the Triffin Dilemma before this virus hit. Other countries were working on workaroundsfor SWIFT and petrodollars long before this virus hit.I have no faith in the future value of pieces of paper and/or bits stored in a computer now that we're at QE 5.

    Not sure why gold is down so much so fast. The common explanation seems to be liquidation due to margin calls but I've seen no data to confirm this. Did I miss the CNN poll?

    As people lose faith in IOUs, commodities (i.e., real stuff) will be where the money goes. A bushel of corn, a bar of gold, a bottle of scotch, an ingot of steel, maybe a case of 000 buckshot. The game of Monopoly will revert to its original form: instead of losing money by owning all the railroads you'll make money as in the original game. I think I'll still pass on Boardwalk and Park Place though. Talk to people who escaped eastern Europe after WW2. They traded diamonds for a box of cereal. L

    Boeing is the poster child for financial engineering. Share buybacks at all time highs? No rational business owner does that, but greedy executives with stock options or bonuses for hitting price targets do. And now they've shot their wad borrowing for the (now devalued) buybacks and have trouble borrowing while trying to make payments on existing debt. What chafes my rash is that these executive scumbags are going to walk off with their loot, leaving the employees and local economy holding the empty bag.

    One can only hope that this will kill off self-serving financial engineering and stop the exportation of pollution and human rights violations in exchange for lower prices. I'm not holding my breath.

    As far as the pandemic is concerned I'm still wary of the data. There have been plenty of flu seasons where hospitals were on "drive by" (i.e., telling EMTs "don't bring patients here, there's no room at the inn") but they haven't shut down the NBA. Flu season is still with us, with 29 million cases and 16,000 deaths but that didn't put Italy on staycation.

    At best, social distancing helps prevent the drive-by problem. The virus will still spread but instead of a huge overwheming bolus of cases into the health care system, it will prolong the pandemic but at lower levels of demand, avoiding (hopefully) overwhelming the health care system.

    Right now there's more heat than light but I'm still leaning toward gold short term and in the long term base metals. I'm also tempted to invest in torches and pitchforks.

    BTW if you're worried about running out of toilet paper just go buy a couple of small dogs.

    /rant off

  2. Query. If the Fed is infusing cash into the Repo market so as to avoid December 2019 rates of about 8%, do I infer short term debt is a problem to the extent there is a run on deposits?

  3. Egads.

    John Cochrane has written several times about the inherent fragility of the US commercial banking system. I wish someone had listened.

    So now John Cochrane (who is not a fear-monger) is discussing the live possibility of a financial collapse.

    The US commercial banking system has largely been rebuilt nearly to original specs, and is inherently fragile. Summing up, banks borrow short to lend long on illiquid assets, and lend 700% of what they borrowed (through the endogenous creation of money.)

    So, summing up:

    1. Children are largely immune to coronavirus

    2. Non-elderly middling healthy adults in general are not at risk from the coronavirus.

    3. The elderly, who are largely not in the labor force, can be at risk from the coronavirus, although fatality rates are rather low.


    Collapse the economy and financial system to fight the coronavirus!

    1. @Michael Gorback - excellent rant, but the last sentence is odd: "BTW if you're worried about running out of toilet paper just go buy a couple of small dogs." - what? I don't want to know. I have numerous dogs and understand at times they are practice copraphilia ...

      As for guns and ammo, I'm posting from the very self-sufficient Greek countryside now, where we're 100% fine and grow everything but electricity (though we have both solar and diesel generators). Sad however I can't visit my girl in Manila due to travel restrictions placed yesterday by the Trump-aping PH president R. Duterte.

    2. The small dog comment is based on an old joke where a bear and a rabbit are taking a dump in the woods. The bear asks the rabbit if feces stick to its fur. The rabbit says yes so the bear picks up the rabbit and wipes himself with it.

      Not sure this will pass the filters.

      Too bad we can't post pictures because there's a great one of a guy with his pants down backed up to an open fire hydrant.

      Lots of interesting comments on the web about how toilet paper hoarding has become a symptom of panic buying.

      I'm tempted to head out to my hunting cabin for a while. We have gas, propane and solar electric power but limited water. There's a stream nearby so I guess we'll need some bleach. No shortage of game meat and I'd suggest if you go this route learn about Kratky hydroponic gardening. Very simple and easy to do.

  4. "A pandemic should be one grand stay-cation." I think you're really missing how deadly and virulent this is. Merkel is saying two-thirds of Germans could get it, each infection infects more people than the flu. I've heard estimates for the United States of 75 million to 150 million and a 1% mortality rate vs 0.1% for the flu. That's a million Americans dead. This is not some grand stay-cation, that's extremely flippant. Of course, we have to make sure that the response is not a draconian one that does more harm that good, but the right response right now is a bias to action by voluntarily staying at home despite a desire to go elsewhere (the exact opposite of a true stay-cation).

    Implicit in your comment that "Except people and businesses make sure they have cash to pay bills over the vacation" is the notion that it would be rational for lots of small business owners to have large rainy day funds. Even absent the moral hazard of government subsidized loans through the Small Business Administration though, I don't know how true that actually is. Lot's of small businesses struggle and fail anyways without a black swan event. Razor thin profit margins in say the restaurant industry don't exactly lead to large surpluses of cash for new restaurants. In a competitive market businesses regularly fail. And in a recession with a black swan event a lot will understandably struggle. Even large corporations do not necessarily keep as much cash on hand (as a share of operating costs) as certain small businesses will need to weather the storm that's going to hit some restaurants.

  5. An interesting but essentially short-term fix. Suppose I were to park $100 million face value Treasury bills with the NY FED, and the bank were to credit my account with, say, $100 million, and I spend it (payroll,taxes, supplier credit paid down,etc). Tomorrow, when the overnight loan expires, I would be required to deposit $100 million in cash with the NY FED and repossess the $100 million in T-bills. Suppose that I can only come up with $64 million (because business conditions have deteriorated). The NY FED is fully covered by the collateral provided. The process is repeated until either I run out of T-bills or the economy stabilizes and turns around. How does this help? It doesn't address the underlying problem.

  6. If the implied rates of bonds are declining, their market prices are increasing. Prices go up when demand exceeds supply. I think that problem should be addressed by Treasury, not the Fed.

    Treasury to create and sell more bonds. Lots of them. This is one place where the solution to one problem is helpful in dealing with another problem.

    The other problem is that the Federal deficit is now running at a Trillion Dollars a year. If it continues to grow, debt service will grow and assume larger and larger portions of the annual budget.

    With rates now at historic lows, Treasury should print and sell long term bonds -- Trillions of Dollars of them. By doing that, interest payments will be locked at low rates for what could be a very long time.

    Bonds with maturities of 20 or 30 years are very cheap, 0.94% and 1.56% on Friday March 13, respectively. Issuing them now could lock in low rates right through the predictable social security crisis of 2035, when the OASDI trust fund is exhausted and benefits will have to be cut by ~25%. An event which will unleash a major political upheval.

    Not only that, but every bond issued is a tax increase enacted. Either luckless pedestrians will pay their FICA and Income Taxes and the bond holders will be paid off, or the bond will be defaulted thus imposing a 100% wealth tax on bondholders.

    Locking in low rates is therefore like a tax cut. And, if the COVID-19 coronavirus panic is driving the economy into recession, the taxcut of locked in low rates will be a stimulus and a tonic for the economy.

    The conclusion is easy. Treasury should endeavor to sell as many 10 and 30 year bonds as they can as quickly as they can.

  7. Boeing is a good illustration of buyback extreme. The company now has negative equity of -$8.3 billion after buying back stock, much at higher prices. Once a Aa3 company, the bonds are starting to trade at below investment grade levels. Will banks have buyback remorse? Will the next CCAR put the brakes on buybacks? Has the cycle been broken? Buying back equity when capital is easy and raising capital when it is dear? For the top ten banks, almost 9% of common shares were scheduled for repurchase from July 1 , 2019 thru June 30, 2020. With prices lower, will buybacks continue? Buy high and sell low?

  8. Thanks Prof, Cash is king. atb

  9. German policy is now to lend directly to businesses. I lost the link and can't provide more details at the moment.

    This could be like Bagehot bypassing the middlemen, the banks. Sounds like Cochrane on steroids! :-)

  10. Found it!

    There is no upper limit to the loans. Yeah, discount freely!

  11. Yeah! For financial crisis, its just that we have a savings and loans that helped us.


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