1988 - 2nd Quarter (4)
1988 - 2nd Quarter (4)
"Were we a money market fund?"
"No, we played the role of investors who steadily entrusted money to a fund."
"?"
In the distant future, repo-style CMAs and money market funds (MMFs) are clearly distinguished, but this is an era where things haven't been subdivided to that degree yet.
Both ultimately operate on repos anyway.
"Right now, we have ten million dollars from the partial liquidation of our U.S. Treasuries, correct?"
"Yes."
"You've heard that interest accrues on that, right?"
"I know that. About $1,700 a day, isn't it?"
"Right. How can interest be generated when it's not at a commercial bank?"
"......Huh?"
If it were a regular deposit, it could earn interest.
But an investment bank cannot accept deposits.
The concept of entrusted funds may exist, but the concept of savings deposits does not.
Naturally, the money in the account cannot be moved by the bank, and since the bank cannot use that money, interest cannot be generated.
Yet, we are receiving interest.
"It's because that money is placed in an MMF operated by the bank."
From an individual's perspective, you could think of it as a repo for a CMA.
"MMF......"
"When you have cash on hand immediately, but its use isn't clearly decided yet, or you have to wait until a large sum accumulates, what should you do? If you're an individual, you'd put it in a savings account, but if you're an institution?"
"Hmm. A sort of institutional savings account?"
"If that's easier to understand, you can think of it that way."
The purpose itself isn't that different, so it probably doesn't matter.
If this were an era where HTS was common, it would be easier to explain it as an on-demand repo.
"In such cases, you put it in a money market fund."
"Then do they pay interest there?"
"To be precise, they give bonds."
"Huh?"
"When they receive money from us, the fund uses that money to buy ultra-short-term bonds. The interest from those is paid to us. Of course, they take a small fee."
Fundamentally, it's not much different from a commercial bank paying interest to customers.
It's just legally classified as funds different from deposits.
"I see."
"Now, the reason this topic came up while discussing repos is, do you think institutions with idle funds like us are just one or two?"
"......No."
It's a given.
A normal investor should always hold some cash on hand.
Who would dump all their assets not knowing when something might happen?
"But then, Master, you haven't created idle funds until now."
"......I'm an exception."
I'm an abnormal investor.
A Regressionist can get away with that.
"Anyway, you need to keep that reserve money, but it's a waste to not put it to work, so you put it in an MMF. To at least earn some minimal interest."
Moreover, if it were a small amount, it would be peanuts, but institutions are large by nature.
For a small fry fund like ours, we only put in about ten million dollars, so we only get $1,700 a day.
But what if it's tens of millions, hundreds of millions of dollars?
The interest from the MMF alone would be enough to pay employee salaries and then some.
"Plus, that's daily interest; if you leave it for about a month, it's over fifty thousand dollars."
"Isn't the interest rate alone lower than a bank deposit?"
"It's similar or a bit lower."
"I see."
Unless you handle large sums, it's the same operation an individual could do.
"The difference is that, unlike deposits, interest is paid daily and immediately."
"That's good."
"Ahem. So, do you understand how an MMF works?"
"Yes. The fund takes money, buys short-term bonds with it, and pays out the interest, right?"
"What have we been talking about so far?"
"Repo......Ah!"
When a bank does a re-repo, it gets money from the interbank market.
So why do interbank participants lend money to the bank?
That's the answer.
"Ultimately, the IB takes money from institutions like us and passes it on to other institutions. Of course, that includes pension funds and commercial banks."
"So the money we put in the MMF is being used by other hedge funds or traders?"
I nodded.
Money in the financial system circulates like that 24/7.
"If you understand that far, you're almost there."
"It's not the end?"
"There's a bit left. This time, let's change our perspective again."
"Perspective?"
"We looked at repos from the perspective of institutions and banks. This time, from the perspective of a nation."
Repos operate using bonds.
So why does the Treasury endlessly churn out daily, monthly short-term bonds?
If they simply need financing, they could just issue more annual bonds.
"The nation?"
"Let's revisit the earlier example. We bought U.S. Treasuries and sold them to the IB as repo collateral, right?"
"Yes."
"The IB re-repoed that collateral to the interbank market."
"I understood that far too. Ultimately, the MMF gives money to the IB and holds that bond as collateral, right?"
"Then how much money is released into the market?"
"???"
Ara tilted her head, then spoke as if it were too obvious.
"Ten million dollars. They borrowed ten million dollars with a ten million dollar bond."
"Right?"
On the surface, that seems correct.
"The answer is twenty million dollars."
"......Huh? Why?"
With one long-term bond worth ten million dollars, the amount released into the market is at least double.
And that's a reduced version; if the re-repo goes through multiple rounds or is split into smaller repos, it increases much more.
"It's a concept called the money multiplier, but I'll explain that later if we need to discuss commercial banks or macroeconomics. First, the ten million dollars we provided as collateral. That's obvious, right?"
"Yes."
"And what happens when the IB re-repos it?"
"Isn't it just intermediation?"
"If you only look at the flow of funds and bonds, yes, but on the balance sheet, a loan receivable of ten million dollars and a liability of ten million dollars are both recorded."
That's natural.
While the U.S. Treasury bond itself isn't recorded as an asset, the money to be received from us and the money to be paid to the MMF remain on the balance sheet.
"Does that cause a problem?"
"While net assets remain the same, the company's assets and scale have increased by that much."
In IBs, which have various regulations, the type and use of assets are clearly regulated.
If a bank lacks money or safe assets, it simply cannot make investments.
That's why balance sheet management is extremely important.
And for inflating that balance sheet, nothing beats repos.
"So, the bank can attract money proportional to its increased scale. Even through credit loans."
"Hmm-."
"Next, the MMF. They paid ten million dollars and bought bonds of the same amount, so total assets remain the same. Skipping the difficult parts and just looking at the balance sheets, our and the IB's assets doubled, while the MMF's remained the same."
"What about liabilities?"
"Adding those gives you net assets, but banks usually hide their net assets."
"Why?"
"Because business goes better when you look bigger."
Well, that's true even if you're not a bank.
Isn't debt considered a capability too?
"This is a very simplistic example; in reality, a single bond gets circulated, split, and circulated again, inflated dozens of times over."
"From a nation's perspective, doesn't that make management harder?"
"Management is harder, but they can reduce the issuance volume of bonds."
"Ah!"
And re-repos aren't infinitely possible either.
The Treasury and brokers track bonds and constantly monitor whether they are being used as re-collateral.
Of course, monitoring doesn't mean they grasp everything.
"Ultimately, for the U.S. national system to be maintained, they have no choice but to use repos."
Otherwise, the bond issuance volume itself would have to be inflated dozens of times over.
If repos aren't used, there are only two answers.
Either revert the money supply size to past levels, like during World War II.
Or shrink the economic scale itself to that period.
"......Honestly, I don't understand all of it. It's too difficult."
"Well, that can't be helped."
"I'm sorry. I'll keep studying."
"Don't worry. Even if not now, you'll naturally come to understand later."
I said while patting Ara's head.
The Bond Massacre of '94, the Asian Currency Crisis of '97, the LTCM bankruptcy of '98, and the Great Recession of 2008.
Experiencing those one by one, you'll physically feel how that system operates.
"Maybe not all, but most crises severe enough to shake the U.S. nation happen because of repos. If it's really hard to understand, you can think of repos as the word 'liquidity'."
"......I'll keep studying."
Liquidity is everything in the modern economy.
If you don't understand that, you can't understand why governments, despite hating them so much, still try to save banks.
Does it make sense that the world economy would shake if a few large investment banks went bankrupt?
Yet, they have no choice but to pour tax money to save them.
Because the world economy really does shake.
All because of just a few banks.
"The reason I'm explaining this so complicatedly now is because economic crises are precisely our opportunity to step up."
"Economic crises?"
"Yes. Opportunities."
The name of my family office is BE Company.
BE.
Bubble Eater.
All those crises created by endless liquidity will become my prey.