Thread by @interfluidity

Listening to the conversation between @csissoko and @DavidBeckworth on the evolution of banking and money markets, which is of course amazing. podcasts.apple.com/us/podcast/mac…

Some highlights for me: 1/

@csissoko points out the obvious-once-you-think-about-it fact that in a world where institutional money is collateralized, borrowed liquidity (i.e. repo), a change in interest rates amounts to a sharp change in the quantitative money supply… 2/

and immediate in that it does not depend on a reequilibration of investment decisions, which would unfold over time, that is implicit in imagined "hurdle rate" channels. (Interest rate rises, equivalently bond price drops, mechanically destroy collateral value.) 3/

@cssisoko emphasizes that lots of money in a macroeconomic sense is almost entirely submerged, invisible, unmeasurable, bc it takes the form of *off-balance-sheet* contingent liabilities, like committed lines of bank credit that don't show up on most stmts until they r tapped. 4/

@csissoko & @DavidBeckworth go thru an account whereby a regulatory tweak at the Fed (charging for intraday credit) nudges instit'ns into using repo as money, + an incrementally increasing role by JP Morgan in triparty repo, plus TBTF, turns JPM into a "de facto central bank". 5/

@csissoko, i think it's fair to say, sees the way our money markets have evolved, placing leveraged collateral at the center of "money" made of margined loans and contingent liabilities ("derivatives") as unfortunate… 6/

a deviation from a prior system where trust, mutual surveillance, and internalized responsibility for outcomes vouchsafed security and stability rather than mechanical and deceptively "objective" collateral values. 7/

She traces the evolution of this not-so-great system to three developments:

i) adoption of TBTF in the early 1970s US, even for a fraudulent bank; 8/

ii) a financial-deregulatory arms race between the US and Britain (forcing an end to the joint-and-severally-liable partnership model for US investment banks); and 9/

iii) legal innovations privileging and expediting recovery of collateral on margined loans and derivatives, including firm normalization of derivatives with this privileged recovery, where previously derivative counterparties faced legal uncertainties under antigambling laws. 10/

@DavidBeckworth asks whether, given the sensitivity of institutional money to collateral prices, wouldn't it be better for the US Treasury to issue predominantly short, to avoid instability due to the sensitivity of the effective money supply to interest rates? 11/

Thank goodness (my editorializing), @csissoko pushes back against that. Issuance of long-term debt is an important tool for preserving sovereign power against the vicissitudes of financiers. 12/

Instead, @csissoko suggests regulatory changes that would strongly favor short-term debt as repo collateral over longer-term, more volatile securities. 13/

(I wonder of the effect of this wouldn't be just to make long-term debt very expensive to issue, as collateral demand dries up, pushing the Treasury back to issuing mostly short as @DavidBeckworth suggested and @csissoko resisted.) 14/

The podcast ends with first an acknowledgment that the current system is very unstable and, for now, the current system relies almost entirely on the US Federal Reserve to stabilize it, and then a discussion of reforms that might make it more inherently stable. 15/

"Stability" in this conversation (not surprisingly on @DavidBeckworth's Macro Musings) is very macro- focused, how can we avoid disruptive crises and shocks? 16/

From other contexts, I know that @csissoko has useful critiques that more micro- focused, on qualitative repercussions of our evolution to this brave new collateral-centric financial system. 17/

Both @csissoko and @DavidBeckworth are great. If you are interested in this stuff at all, give it a listen. /fin