TFTC: A Bitcoin Podcast - Tales from the Crypt #122: Parker Lewis

Episode Date: December 15, 2019

Join Marty as he sits down with Parker Lewis to discuss: - What is QE? - The Fed's balance sheet over the last decade - Unwinding the balance sheet - Repo market madness - Source of the repo liquidity crunch - Moving forward - much more Follow Parker on Twitter: https://twitter.com/parkeralewis Shoutout to this week's sponsors. Cash App. Head over to the App Store or Google Play Store, download cash.app and start #stackingsats today. Use the promo code: "stackingsats" to receive $10 and contribute $10 to OWLS Lacrosse you download the app. Subscribe to our YouTube channel: tftc.tv Contribute to the show: https://tftc.io/contribute/

What is up, freaks? Welcome back to Tales from the Crypt. It's your boy, Marty. Been here on a cold Sunday morning, very cold Sunday morning, waiting for my coffee to heat up. Have not had that dose of caffeine. You freaks are going to be happy to know I've been buying my coffee and making it at home more recently. It's been about three months now. It's been good. I haven't bought coffee in quite a while. Yeah, we got a great conversation with Parker Lewis here. today quick 45 minute rip uh really wanted to talk to parker about what's going on in the repo markets in particular he's not an expert per se he'll tell you this in the conversation that we

have but parker has been a fed uh watcher in a past life and has a lot of intimate knowledge about fed policy uh in the post 2008 world that we find ourselves in and uh this conversation was extremely illuminating, particularly because it starkly highlights the fact that the Fed had no idea that the unwinding of its balance sheet was going to cause this liquidity crunch in the repo markets. I'm not going to rehash what we talked about. You guys are about to listen to the good stuff. So this episode of Tales from the Crypt is brought to you by the Cash App. If you already know all about them, the Cash App is helping us stack sats, It's helping us sell sats, not that we recommend doing that.

You can send sats from the app to a personal wallet and from the personal wallet to the app. On top of that, have you freaks heard about Cash App investing? They're letting you stack slivers of stocks now. Cash App is now letting you buy stocks, not only buy stocks, buy partial stocks, parts of a stock, a sliver of a share, if you will. All right, so when your favorite company's stock is a little bit out of your price range, you can buy as little as one dollar you can buy as little as one dollar their stock if

something like apple's trading above a thousand dollars i don't even know where it is right now you just get a little little piece of that all right so introducing cash app investing and the good thing about this you don't have to wait for the money to hit four or five days for the money to hit your account since cash app is connected to your bank account uh there's no waiting for four to five days it gets directly there um and then on top of this they have their incredible boost program too all right when you go to your booster changing they've been changing a lot recently i've used the mta boost to save a dollar on a subway card a couple days ago um i saw they had door dash now too and a couple others taco bill still in there um but yeah use the boost

you can stack sats you can uh stack slivers of shares as well and you should know that brokerage services are provided by cash app investing a subsidiary of square and member sipc and as always when you sign up use the code stacking sats that's one word you're going to get ten dollars and cash app is going to send ten dollars to our very good friends at owls lacrosse owls lacrosse not that creeper al al is a very very wayward very wayward man stay away from him if you ever see him in public definitely do not accept any candy from him use the code stacking sacks download the cash app today from the app store or the google play store all right i hope you guys enjoyed this episode of parker parker is somebody who i get a lot of pleasure that sounded

weird i uh i i have a i'm always very intellectually stimulated when engaging in conversations with parker particularly around the fed this was all fed speak we barely talk about bitcoin or what unchained is working on in this this was pure fed talk so for you fed nerds out there enjoy what is up freaks welcome back to tales from the crypt it's your boy marty bent here on a thursday thursday it's not thursday it's saturday here on a saturday afternoon for a very special edition of Tales from the Crypt. I'm sitting down with a former guest, a very good friend of the show, Parker Lewis.

Parker, welcome back. Marty, it's good to be on. Given everything that's going on with the Fed, it is the holidays, but it's good to come back on and yak about the Fed. And I imagine we'll talk a little bit about Bitcoin, but a lot has gone on in the last three months in the world of the Fed and the repo market.

So it'll be helpful to take a break from Bitcoin and just get to the brass tacks. yeah well even while you're sitting here talking about the fed you're not getting a break from bitcoin there is a taproot uh workshop going on in the background behind you you are in a conference room just putting in work as a taproot uh workshop goes on behind you yeah i'm just here to chaperone to make sure sure that they don't go too nuts but uh yeah it's a it's a beautiful day here in Austin, Texas, not just because it's 75 degrees and sunny, but Justin is rallying the troops to work through a taproot workshop

that OPTEC has put together. So if there's any noise in the background, apologies in advance. Justin can sometimes get a little animated and loud, but we'll do the best we can. And if I become distracted, it's because he's causing too much commotion in the background. As Justin tends to do. shout out to Justin for leading the Taproot workshop. We need more. We need more people

learning how to develop on Bitcoin. Yes, but the subject matter of today is the Fed, the repo operations. We've been talking about this subject a lot in the bent and on this podcast for the last few weeks, last few months. It's always a big topic. I feel like the issue is sort of pressing at the moment and we need to dive in and get some clarity on what's going on. So let's start in res media a bit here, a little movie term there, or literature term, excuse me. September, we had the repo spasm in the middle of the month. It became obvious that there was some liquidity crunch going on. People were wondering what it was. In early November, Xero had dropped a piece surmising that it may have been JP Morgan as they were rotating out

of cash and into longer term bonds. And then last week, the Bank of International Settlements came out and basically pointed at the demand for liquidity and said that it was hedge funds that are levered up and needed funding for their leveraged positions. But we want to go back to the beginning, get to the basics. We'll get back to what's happened in the last three months. But first, we want to understand what QE is and what the hell, why these operations are needed at the moment so i'll let you take it from here parker you know i'll i'll try not to after every sentence say and this is why bitcoin exists but um i think it's safe to assume that with a lot of this discussion as it relates to qe and as it relates to what's going on presently with within the repo

markets as well as that's response to it that you can just well assume that you know if i'm not saying it or you're not saying it you were both thinking about it so yeah i thought it would be useful to do a little rewind and bring us back not only to the present future but but to the future that you know in terms of what happened in september but to set a baseline on really what what qe is because i think it is the backdrop not just to how we've gotten here but to where we go from here um you know recognizing that you know at the end of the day what qe is is the fed swapping a financial asset to provide more dollars to the system and you know essentially the fed you know back in 2008 when things started to get a little bit dicey in the economy kind of early

2008 leading up to september had cut short-term interest rates to zero and then and then there was a liquidity crisis and then the fed began to put in significantly more reserves and ultimately more liquidity into the system to stop the financial or to quell what was the financial system collapsing and you know one of the things that I think is often missed and will come into this discussion is that I believe it was December of 2015 so essentially just giving a timeline Lehman Brothers 2008 you know essentially beginning of QE1 in you know the time frame of the fall of of 2008, early 2009, then QE2 around, you know, 2010, 2011, and then QE3, which is often referred to as QE2 infinity or QE infinity from, you know, I believe it was 2013 or 2012 to 2014.

Then toward the end of 2015 or through the back half of 2014 into 2015, the Fed tapered the rate of their asset purchases. And then in December of 2015, they actually started raising short-term interest rates. And one important thing to note is, and I think, and there may be some debate on this, but for the framing for this discussion, And the way that I think about it is that at least from the supply side, there is nothing that changes interest rates other than increasing or decreasing the supply of dollars. And QE was essentially increasing supply of dollars. When the Fed began raising short-term interest rates in December of 2015, nothing was changing in terms of the number of dollars that were actually in the system.

So if you went and looked at the fact of supplying reserves by the Fed, essentially from December 15 to October of 17, the reserves in the system were flat. So the Fed was essentially maintaining the size of its balance sheet. Then in October 2017, in the months preceding that, the Fed signaled that they were going to begin to unwind QE1, QE2, QE3. I think anyone that was intimately familiar, and even maybe them themselves, would admit that knowing at that time that they would never be able to actually fully unwind, and we'll talk about some of the reasons why. But what then began happening in October of 2017 was the Fed, I don't want to say slowly ramped up, but ramped up ultimately to a rate of withdrawing $50 billion a month from the system. And that's one thing that I think can sometimes be missed on people that when, you know, and again, I'll caveat into Bitcoin for a second just to draw the comparison, but where we think about a fixed money supply, it's not just to cure a problem that exists with inflating the money supply, that there are actually systemic issues that occur both by increasing the money supply and then decreasing the money supply. And so what the Fed began doing in October of 2017 was draining a massive amount of liquidity out of the system. And something that is often missed is when they add money into the system, when they increase the size of their balance sheet by approximately $4 trillion,

and maybe off on rounding by a couple hundred billion, but maybe it was $3.6 trillion. And when they did that, there's a lot of confusion as to, well, why didn't inflation just appear immediately? And the reason being that the effects of that are generally felt through the credit system over time because the credit system is so much larger than the actual base money supply. When the Fed is doing any QE operations or not QE as they're referring to it today, it's actually increasing the base money supply. and that base money supply is then used to support liabilities that exist in the system and so if we go just back from october of 17 when when the fed started to unwind the balance sheet um to september 2017 when the repo market broke now having the context that that this the and think Think about this as if there was a chart with an X and Y axis, debt in the US system-wide

has increased from approximately $68 trillion around October of 2017 to $74.5 trillion to September of this year. So essentially, thinking about that debt as going up, at least in terms of change in debt, going up and to the right, above the Y axis. But then what was happening on the other side in terms of the actual liquidity in the system, it was going down and to the right as a function of the Fed draining liquidity and actually affecting a reverse QE operation. And so, you know, kind of thinking about where we were then just two years ago to where we

are today, liabilities and debt are higher by approximately six and a half trillion. But the Fed had actually reduced liquidity in the system by $700 billion. So they had shrunken their balance sheet from $4.5 trillion to $3.8 trillion, which is approximately reducing 15% of Fed reserves. But the problem becomes worse because not all of those dollars exist within the banking system. And the way that the banking system works today, the dollars within the banking system can service the liabilities that exist within the banking system. And so when you – but then when you actually look at the cash on the bank's balance sheets, in October of 2017, it was approximately in aggregate $2.4 trillion. And in September of 2019, it was $1.6 trillion. So essentially, every dollar that the Fed reduces in its reverse QE or was reducing in its reverse QE came out dollar for dollar from the cash that the banks had.

But then if you go one level lower and you look at excess reserves, the excess reserves in October of 2017 were $2.2 trillion, and the excess reserves in September were only $900 billion. So when you kind of put that into context, the Fed's reducing their balance sheet by $700 billion, which is 15.5%. But the actual cash from the banks is actually down 34%, and the actual excess reserves are down 40%. And so all of these liabilities are piling up in the banking system. The banking system and the amount of debt has grown by $6.4 trillion. but the liquidity has been absolutely crushed in the system ultimately it's very predictable what would happen there was already too much debt and too few dollars in the system and then again it was difficult to predict the timeline of what when the repo market would break or whether the

repo market would break but the easy thing to predict was that some market would break you can't keep stacking on more and more liabilities all while you're taking $50 billion a month out of the economy. And so I did want us to kind of set that backdrop. I know that was a little bit of a long-winded intro to set this discussion up, but it's important to have that context as people think about what happened in September and then I think what will happen from here. yeah no and i'll give you some time to breathe and um it's it's it's incredible how succinct you you explain everything though i was you freaked couldn't see it but i'm sitting here uh doe-eyed like drilled in on this

explanation because it's so clear so basically what we're witnessing is uh the way i like to think about this stuff is all about flows like i literally like to think about it like a tide and water and water flowing through a system um and so what we're what you just described is what we're witnessing is the tide going out and the the repo spasm that we saw in september was the fish uh sort of flailing on the the sand that that does not have water over it anymore we're seeing who is over levered and who who is not collateralized properly in the system and i think what you're trying to get at is it may not be possible to be properly collateralized in the system without debt increasing into the future. So I think diving into more specifics

is something you mentioned, talking about the excess reserves. And that's really something that I think we should hone in on, right? Because that's what the federal funds rate revolves around, right? Is those excess reserves. That's the rate on what they are trading at. So let's try to understand what the repo market is let's focus in on the repo market and how this excess excess reserve rate sort of dictates everything yeah and and you know one it's it's very difficult just by the construct to know exactly but to to at least highlight you know essentially some background and you know there are others that that are you know certainly more of experts as it relates to the inner workings of the repo market but understanding

it at a high level you know not only in terms of what happened in September but also just just in terms of how a repo transaction works to at least lay that that baseline for people so in September the overnight repo rate was around three percent and then overnight it increased to or spiked over 10 percent so the the rate at which those that were borrowing in that market you know more than tripled overnight and in the repo market i don't know precisely how large it is but it's a massive it's a massive funding market and essentially what happens in the repo market is that an asset whether it be you know thinking about it as a treasury a treasury is essentially sold and in cash is is is on the other side of that transaction so some one party sells a sells a treasury the

other party receives the cash but there's a repurchase obligation and if that repurchase obligation you know if the cash is not repaid for the treasury then the um that the individual that owns or the counterpart that owns the treasury can go in the market to sell them to get the reserves and one of the theories as to what what happened that caused this spike in the repo market which which, again, you know, it's relevant, but it will ultimately get to why, you know, the who and why are less relevant. The most relevant piece is that the market broke and that the Fed didn't know it was going to break. But, you know, essentially what appears to have happened was that a party that was a large funder on the supply side to that market left the market or left, you know, and not necessarily over, you know, overnight, but left over time. And then when

there wasn't liquidity to satisfy the demand, everyone figured it out all at once. And I think that is something too, just to highlight, which is that when we talk about, and not to say that the Fed necessarily thinks about it this way, but oftentimes when it's summarized, and even when I I just summarized it before, and I talk about how the excess reserves were decreased from $2.2 trillion in October 2017 to $900 billion in September of 2019. I have to go back and check. It may be a decrease of $900 billion, so it may be $1.3 trillion, but the point being that um that markets are ultimately fragmented um and especially you know thinking about you know

the inner workings and the plumbing of the system um just because there are 900 billion or maybe it's 1.3 trillion of of excess reserves that those those excess reserves are not you know in the counterparties that lend in the repo markets you know that everyone's not lending to every different market. And so, you know, what seems to have happened is that the large counterparties that were, you know, there are still a massive amount of excess reserves for the counterparties that were providing that supply to those markets left, and they can't easily be replaced by someone else that's traditionally lending or a bank that's lending in another market. And that, you know, what essentially happened from there after the Fed, or sorry,

after the repo market in my terms broke which which i believe it did um you know i think that a number of people are paying attention to it it's a little bit confounding that that more people aren't and that you know there's this on either side there's this view that the fed is in control um but if the fed understood that this was happening why would they have been draining liquidity you know why would they have been draining liquidity 50 billion a month think about how much money 700 billion is so they had they had already they had already stopped um draining money at this point when it broke and they had already signaled that they were planning to do something but they also had no idea that you know i don't know if the date was september

15th or september 16th was going to happen but you know when it did then the fed had to immediately i think they did it within 24 hours they came back in by providing it did it over the weekend right i don't know if it was over the weekend i think it happened like a friday night or something like that i remember correctly i can't we'd have to check the dates it was either you know it happened on thursday night or it was sunday it was sunday into monday it was sunday into monday that's what it was yeah um but but just thinking about how phenomenal that fact is and i don't remember the initial amount but we can talk a little bit about the consequence All right. And in case you freaks missed it, the fact is that the Fed is an institution which we think has, or we don't think that, a lot of people think has control over the system.

And they were trying to unwind QE. And while doing that, they did not realize that that would dry up liquidity in these repo markets and cause a crunch where they would have to step in again as lenders of last resort. And this is actually something I'm very curious to get your thoughts on. So what is the Fed's original mandate? It is to step in and be the lender of last resort. And I always thought the lender of last resort to banks specifically. I didn't know they could be the lender of last resorts to hedge funds looking to margin trade. When did these hedge funds start getting access to this Fed window? well and you know honestly i think that it would be very interesting to to see you know if the fed

would just publish for every uh repo auction that they do just you know we don't need to audit the fed just just tell us you know who are the counterparties on the other side um because that would that would provide a lot of insight and you know to tell you the truth i'm not um 100% certain whether certain hedge funds have direct access or whether there are players in that market that act as intermediary, such that whether a bank is participating in the repo and then lending those monies on to hedge funds. Because what could be the case is, and this is the idea that if you owe the bank $100, it's your problem. But if you owe the bank hundred million dollars it's the bank's problem where the banks are ultimately counterparties

to these hedge funds that are that are massively levered so i don't know enough to to say finitely whether you know hedge funds are participating directly in these repo auctions but you know it does make sense when you understand the leverage profile a lot of the these large relative value hedge funds that they are you know part of the the large demand that could have caused such a dramatic rise in repo rates overnight all right so let's let's dive into that topic leverage how does how does leverage play into all this and how does it affect everything well so you know when you when you think about the context of the and there's many ways to think about leverage but when we're thinking about you know financial liabilities and the the dollars that can pay

for those financial liabilities if if there's today if 75 trillion just just bringing it back up you know not necessarily to the actual repo operations and the leverage profile potentially the counterparties that are causing the spikes in repo but um talking to a system-wide perspective there's approximately 75 trillion of debt in the system and the banks at least as of September 2019, which has changed, which we'll talk about, was only $1.6 trillion. And so in that context, when you think about it at the highest level and take a step back and just look at the field through those lens, that's for every dollar that actually exists on the left side of the bank's balance sheets today, there were $47 worth of debt. And then another way to think about

that is for every dollar that exists it's been lent out 47 times and that in that construct and if i have this visualization of the of the u.s financial system and especially the overnight markets where essentially every dollar that can be lent out is wrung out you know like a wet rag trying to find every dollar that can potentially go to satisfy the demand on on a short-term basis that um thinking about the imbalance from that construct it's less relevant as to um you know who or what but you know recognizing that a liquidity crisis and somebody that you know whether it's in the overnight markets or in the 30-day markets or in the 60-day markets anyone that's massively levered in funding their operations on a on a short-term basis

their problem can't be solved by a 15-day repo facility. And I think the ultimate consequence of that is that essentially we will see, likely very soon, Operation Twist 2.0. And so even if today the Fed is maintaining that this is not QE because we're not buying duration, they are increasing the size of their balance sheet they're increasing liquidity in the system and it will come they will in order to to solve you know on a temporary basis these acute needs they will have to transition the the duration profile of what they're doing through these 15 day and 30 day repo or even overnight repo auctions and additional liquidity they're providing to the system to actually make sure that the market knows that those reserves will

be there not just one day or 15 days or 30 days but for two years three years 30 years um so i think what we'll see from here is that solving that immediate liquidity crisis and the fact that the system is massively too levered by ultimately providing more duration in terms of liquidity that they're providing so a lot of the same back to back to qe it seems and so let's like so it seems like the fed doesn't know what it was doing like you've been saying they walked into a buzzsaw they created like is there any fixing this going forward so let's talk about the fact that the fed didn't see this coming and i know we don't want to talk about specific players but i think just for the fact that this come for the uh benefit of this conversation let's talk

about jp morgan's balance sheet uh restructuring did they see something coming and try to get out the way first do you think yeah and i think so to provide the background on that this is something you know i haven't been uh been able to be as quite as much of a as a fed whisperer and tracking the fed as i as i was you know a few years ago but in terms of some of the reports that i read that that do seem to to make sense is that you know over the course of 2000 maybe late 2018 but But certainly in 2019, that JP Morgan, and correct me if I'm wrong on the numbers, they moved, say, 400 billion of what were formerly reserves into longer term treasuries. Not necessarily, you know, saying 30 year treasuries, but they essentially moved those reserves from being cash in their balance sheet into treasury coupon bonds. And, you know, kind of recognizing that JP Morgan, I believe it's the largest bank in the United States, was a large funding mechanism to those repo markets that, you know, as they are essentially selling reserves for coupon bonds, those reserves are going to other, you know, essentially, not necessarily directly to other banks in the system.

But when they're transferring out of that market, they're leaving a void, and the counterparties that they're transacting with may not be participating in the same market, and that that likely – or at least it's an explanation that makes sense as to what created this massive imbalance. And so whether – and there's also theories that they understood what would happen and that they were moving into treasury coupons as essentially a front-running of Fed's future QE4 or the formal QE4 such that if they were reducing the amount of reserves that they held and ultimately the excess reserves, And it was going to, whether they were intending to do it or not, I don't think that anyone has suggested that necessarily, that they weren't intending to cause something to happen like what happened in September. but that the ultimate consequence of draining liquidity out of that market would be that there would be a spike in those uh overnight repo markets and then eventually or you know whether it was as soon as the fed had to come in or whether it was in 2020 that the fed would ultimately come in and have to start rebuying treasuries and do a formal qe process and when they were doing that they would essentially be buying jp morgan's treasury notes back

at a higher price i mean it makes a lot of sense and it wouldn't surprise me at all jamie diamond has proven to be a very uh very cold capitalist and and if you i mean many people have been saying the writing isn't on the wall is on the wall the fed's backed in the corner they're going to have to revert to qe one day and it would make sense if jamie diamond cares about his long-term business prospects that he would try to move first and that's it seems to me just observationally that it seems like a get-out-first type move and sort of a front-run, like you described. And it's pretty crazy.

It's happening on the scale that it is. So where do we go from here? How long does this go on? Are we just going to have to print money forever? Is modern monetary theory going to win out? Is that the future? Modern monetary theory, I think we talked about this last time,

And we'll always get some pushback, but it's not a theory, right? Like it's some bastardization of two bastardized theories that people have kind of combined into one in the last six to 12 months or maybe two years to explain away why the federal government can run $1.2 trillion deficits into perpetuity, which I think anybody that has any sense or reason understands that that game can't go on forever. But, you know, I do think, and again, it's helpful to look at history and just to put the context as to, because we've talked a lot about what happened in September, and we talked about the fact that how phenomenal it was that the Fed came in so quickly. Can you hear me? Yeah, you just cut out there for a second, but you're good.

Okay. But when you think about, you know, so one of the things that Chairman Powell has received a lot of criticism for is that he said this is not QE, this is nothing like QE. And that when you look at what's happened from September when the repo market broke to today, in terms of the overall size of the Fed's balance sheet or the amount of reserves that the Fed is supplying, just looking today or last week as of September, the balance sheet is larger by $320 billion. And it grew at its fastest pace in the last 10 years too, correct? Yeah, so the rate of growth was faster than at any point throughout QE, I believe. Except for, well, technically, that may be true. But if you go back to the actual Lehman and in the aftermath of the Lehman crisis, so if we look at least, so there have been three months since the repo market broke in September.

and the feds increased the size of his balance sheet by 320 billion in the three months after Lehman the the fed increased its balance sheet by 1.3 trillion so we we weren't necessarily at at Lehman levels but that also may not have yet formally been QE1 that that was stealth QE1 that that happened in the background but then QE2 for the first three months of QE2 the fed increased the size of its balance sheet by 170 billion and the first three months of qe3 they increased the size of the balance sheet by 145 billion so what they've done you know and seemingly you know you know or not seemingly but as a matter of fact they've called it not qe they've increased the size of their balance sheet by you know far more than they did you know in the

subsequent months after the beginning of QE2 and QE3. So I think that, you know, if it looks and quacks like, you know, looks, quacks, walks like a duck, it is a duck. And, you know, regardless of definitions, what will happen from here is that this amount of liquidity will grow. The Fed's already signaled that to solve for what many have projected to be a coming liquidity crisis that will happen around year end. So I don't know in terms of the net amount, but I believe it's an incremental $350 billion that they're planning to make available between now and the end of the year on top of what they've already increased in terms of the size of their balance sheet and in terms of liquidity that they've added to the system um and then ultimately what happens from there is that

that is turned into a formal qe4 and that the assets that have short duration today that they're buying are transitioned into longer duration and so um you know not only can can this not go on forever um but it's also important to recognize that because of the dynamics in the credit system and because you know in terms of those metrics that i've mentioned both last time we spoke but then also earlier today about just that thinking 75 trillion of debt you know as of three months ago one approximately 1.6 trillion of cash on the bank's balance sheets today it's just under you know just right around 2 trillion that because of that dynamic it is a moral certainty that more liquidity has to be added to the system um you know how much you know is

anybody's guess um and and how quickly it really depends on the market but but i think the things that that can't be questioned are these ideas there's two sides of the equation one is and you know the market has seemingly been lulled to sleep by the fed and its operations but it's that idea that if the Fed knew that this was going to happen, they never would have decreased the size of their balance sheet and drain liquidity as fast as they did. And I think that makes sense to a common person when they just take a step back and recognize how much money $50 billion a month is and how much money $700 billion is in aggregate. And if each one of those dollars is levered you know going into the you know into the unwind that ratio is 30 to 1 in terms of debt to

dollars that when they're reducing you know 70 700 billion of of liquidity that's impacting 30 to 1 in terms of how tight credit becomes and this just happened in terms of the repo market to be the the market that broke first but it likely won't be the last yeah so a little decrease in the balance sheet has uh undue effects on on the rest of the market yes um and and then on the other side of the equation it is the the market saying oh well you know kind of ignoring the fact that the fed walked into a buzzsaw and didn't understand it and then saying oh well hey don't don't worry, guys, you know, show's not over. Let's keep buying equities because the Fed is in control.

And, you know, I don't know if I would equate Chairman Powell's comment about how this is not QE, but I would just, you know, bring back up the Jock Clon-Yunker's statement about when it gets serious, you have to lie. It is what I think that they're doing now. yeah well that's what was crazy about this week is that i was astonished that the bis came out and tried to identify somebody i think and they even acknowledged a problem um

like and again like and what i'm trying to hone in so like going back to you mentioned it there's a lot to worry about the end of year fund like a lot of people think these next couple weeks are very crucial um for the next for the next for going forward with how policy will be established like why is this end of the year um these next few weeks so important in particular with the funding and stuff like that why are people freaking out about uh the end of the year funding switch yeah and and you know full disclosure in terms of the mechanics of this This is an aspect that I'm less well-read on. You should probably get someone like our friend Brooks Dudley on.

He can probably dive in, or Nick Batia. I'm trying to. Brooks, get the corporate shackles off your hands. Come on the pod. Yeah, work this through compliance, Brooks. Come on. We need it. But what seemingly happens at the end of each quarter and then in a more material way at the end of the year

is that there are certain tests that are, whether it's the Fed, that look at the capital ratios of the banks and assess the leverage and then, you know, require certain remedial actions to be taken. And, you know, without being an expert in, you know, kind of regulatory calcs and how the window dressing actually impacts the banks on a go forward basis, I do think that kind of at a high level, a way to think about it is that rules were put in place to and whether they should be or shouldn't you know in a world where you don't have bailouts it would just be hey let certain banks you know be more reckless other banks you know be more conservative and the banks that that are more reckless would just fail in the

market would would solve the problem but in our current construct there are there are rules in plays to measure leverage and to address leverage in an attempt to prevent excess leverage being taken from banks. And so what essentially happens at the end of quarters and at the end of years is that banks perform some window addressing to reduce their leverage ratios. How do they do that? They borrow reserves on an overnight basis or on a short-term basis to make their balance sheets you know look healthier or less levered and and it's pretty remarkable to think about that in the context of what the fed is now doing they're essentially saying okay these rules are in place to to prevent excessive leverage but we know that the banks all do it and at the end of

the quarter when it comes to their reporting and their testing they just borrow some dollars on repo, move other assets off their books, get their leverage stats good, and then unwind that at the end of the year. That's a problem because it creates a massive amount of demand for dollars to do that window addressing towards the end of quarters and the end of years. And so we're going to create these rules to have certain things in place. And then we're going to provide this massive repo facility to the banks to actually facilitate the window addressing. So we're going to set the rules and then we're going to provide the liquidity to allow this circumvention of the rules it's pure insanity man and we actually had the one of the architects of the repo market

um come out this week and he's predicting a crash within the next few days um what the hell is his name pozar zoltan zoltan pozar one of the architects of the repo it's unclear whether or not uh the fed red dab report and then you know again within 24 hours signaled to the market that they were providing you know hundreds of billions of additional liquidity to the repo markets um whether they were planning to do that all along or whether you know they were doing their own analysis and looking at this problem and saying okay we need to to front run a uh you know significant liquidity problem you know on top of what's already happened in the repo markets to prevent you know another because i think it happened just last year where the equity

market started to crash uh towards year end because you know again you know what starts in the repo markets and especially if it is in fact you know being caused by over levered hedge funds could very easily um in really a knock-on effect bleed into other markets as well so seems like the feds attempting to to front run those risks that um that that former fed analyst was was raising you know last week or the week before in this research yeah it's almost like uh how do i want to phrase this it's almost like the fed is taking the the n64 cartridges out blowing on it when it when it freezes and putting it back in like is this like how many times can and they blow on it, put it back in, turn it on

before it just never turns on again? You're talking about the repo market's breaking. Will they ever break beyond repair? I mean, if the Fed... That's a really obviously difficult question to answer. I think that from a practical perspective, the Fed can put liquidity into the system. they can't make it go where it needs to be on a sustained basis um and if you and whoever the

problem children may be in terms of the most over levered and the most likely insolvent um you know the only way to solve their problems are two ways one allow pain to be felt and restructure, you know, whether it's the composition of a portfolio and taking down, you know, gross exposure or whether, you know, whether it be a mortgage REIT that's financing their carry trade on a 30-day or 60-day term. The only way to solve those problems are twofold. One, allowing, you know, restructuring, or two, providing more liquidity. But still, even then, regardless of how much liquidity the Fed puts in the system, they can't directly provide that term financing to these most over-levered counterparties. And so that's where, you know,

if you're thinking about the, you know, whether it's the excess reserves or the cash in the bank's balance sheets on an aggregate basis, the plumbing is so jammed up that no one, you know, No one wants to be the counterparty directly to those most troubled players. And this is, you know, there's something that at least I've been trying to formulate around this idea of, OK, if we have a financial system that is massively levered and that the only way to solve the short term problem is to provide additional liquidity in the system. And I'm not saying that because I don't think it's a solution, but it is a way to kick the can down the road, at least for the Fed, that you can't solve a debt problem by inducing more debt. And that's all really QE can possibly do. And that when we recognize that the Fed has a price stability mandate and a full employment

mandate because the credit system is so large and because there are so few dollars in the system relative to that, that the credit system is the marginal price setter. in such that if that system was ever allowed to start to unwind, it would unwind in a very dislocated way, and it would essentially collapse on itself. And so the Fed is stuck in this catch 22, where the only way that they can kick the can down the road is providing more liquidity. But ultimately, at the end of the day, their solution to the problem is, I've got a debt problem and i you know the the patient is dying um let me give it more debt and and the way that that happens is essentially they provide liquidity into the system in terms of base money and then

eventually they stabilize asset prices they allow those asset prices to sustain otherwise unsustainable amounts of debt and then eventually the the banks begin to lend again and allow the credit system to expand and the system you know continues to par long slowly you know one day that all comes crashing down when i don't you know i try not to lose sleep about it or think about it too much because it's impossible to predict and it's you know at least in terms of i think how both of us are trying to to to be very very very small parts of that solution is doing work in and around bitcoin because i you know do you think that that's ultimately the solution i do as well Well, I do as well. That is why I work on Bitcoin. That is why I left the financial world. Are we

still in the financial world? Maybe I left the traditional financial world for Bitcoin. Things are hairy out there, freaks. And luckily, we have people like Parker out there doing the hard homework to sort of understand what's going on and explain this to us. Parker, I want to thank you for taking 45 minutes out of your Saturday, out of that Taproot workshop to help explain all this to us? Yeah, well, while these guys back here are doing the real work, the real grunt work to build this rocket ship for us, we can at least come in here and yak about how clownish the Fed is and the Fed looks and help educate people as to, I think, ultimately, you know, where we go. And, you know, it's my expectation that increasingly people will, that QE will become

a trigger term to explain to people or to allow people to understand why Bitcoin works and why it will increasingly become intuitive to people. Yes. Are there any final thoughts on the subject that you want to get off your chest before we wrap up here? No, I think we should just sit and wait, enjoy the ride. And then, you know, it would be funny if it wasn't so serious because I think anybody should be concerned when something happens in September and then, you know, three months later, $320 billion are just created out of thin air. You know, I would really like to one day see what a cash flow statement of the Federal Reserve looks like.

Not necessarily one of those people that cameras for auditing the Fed, but maybe we should do a quarterly check in to see, you know, what, you know, we've talked about what's happened in the last three months, but I expect a lot more of this in the next three months. So maybe we can sit down in March and talk about how much the Fed has bungled the situation from here to there. yes i would like to see some of those cash flow statements too and i believe 2020 will be having a lot of check-ins with you parker absolutely thank you for this in particular check-in that's all we got this week freaks peace and love