INSIDE ECONOMICS

Mark Zandi:                       Welcome to Inside Economics. I'm Mark Zandi, the Chief Economist of Moody's Analytics, and I'm joined by my two trusted cohosts, Cris deRitis and Marisa DiNatale. Hi guys.

Cris deRitis:                        Hey, Mark.

Marisa DiNatale:              Hey, Mark.

Mark Zandi:                       How was the week?

Cris deRitis:                        Busy. Busy.

Mark Zandi:                       Busy?

Marisa DiNatale:              Yeah. Very busy.

Mark Zandi:                       Busier than normal or just busy busy?

Cris deRitis:                        Usual busy.

Mark Zandi:                       Usual busy. You too, Marisa?

Marisa DiNatale:              Yeah. January's tough. There's a lot to do in January, so...

Mark Zandi:                       Yeah, I've been traveling. I've been in South Florida. I had a board meeting and then I had presented to the International Council of Shopping centers and a couple other stops along the way. One thing, I've never been, believe it or not, in all my years I've never been on Brickell Avenue in Miami. You guys ever been in Brickell Avenue in Miami?

Cris deRitis:                        Nope.

Mark Zandi:                       It's a happening-

Marisa DiNatale:              No [inaudible 00:01:04]-

Mark Zandi:                       ... place, man. It's a happening place. There's towers going up everywhere. It's just amazing. It's just an amazing place.

Cris deRitis:                        Is that the Wall Street of Miami? Is that [inaudible 00:01:16]-

Mark Zandi:                       I guess so. It's kind of near the central business district and just a lot of activity. It's really interesting to see, but we've got an action-packed podcast. We've got Samim Ghamami. He's a SEC, Securities and Exchange Commission, official, and we're going to talk about... This is a tough topic, but a really important one, liquidity in the Treasury security market. We've been talking about all of the things that could do us in. The economy's performing well. What could go wrong? We talk about stress in the financial system, particularly in the non-bank part of the system, and the Treasury market's kind of at the top of the list of concerns because there's issues. Believe it or not, it's a huge market, but there's issues around liquidity that's gotten on everybody's radar screen.

                                                Samim is kind of leading the way in terms of reforms there, so we're going to talk to him about that, but before we do, we've got a lot of economic data this past week. The headline was GDP, but a bunch of other stuff, and I'll have to say, and I'm kind of leading the conversation, it was unbelievably good economic news, I mean, on every level. You got to really stretch, and I know Cris will stretch to find something that wasn't good, but right? Am I wrong? Marisa, what do you think? It was a pretty amazing week of data.

Marisa DiNatale:              Yeah, we got GDP, we got personal income, we've got housing data that looked good, almost universally good. Yeah, I agree, and I also agree that Cris will find the one thing that wasn't good.

Mark Zandi:                       Cris-

Cris deRitis:                        That's my job.

Mark Zandi:                       ... top level-

Cris deRitis:                        That's my contribution.

Mark Zandi:                       ... 30,000 foot, anything at all that doesn't suggest the economy's soft landing and performing well and going to perform well going forward? Anything at all?

Cris deRitis:                        Not at the moment, no.

Mark Zandi:                       No?

Cris deRitis:                        Right.

Mark Zandi:                       Yeah.

Cris deRitis:                        GDP, PCE, everything is-

Mark Zandi:                       Personal consumption-

Cris deRitis:                        ... kind of coming into alignment.

Mark Zandi:                       ... expenditures. Yeah.

Cris deRitis:                        Yeah, yeah, the [inaudible 00:03:18]-

Marisa DiNatale:              Jobless claims rose, but they're still extremely low.

Cris deRitis:                        Yeah.

Mark Zandi:                       The interesting thing, the Bureau of Economic Analysis, they're the folks that put the GDP numbers together, they put on their website these tables, and first thing I do is I got to look at the table number one, I guess. It shows growth rates for different components of GDP. Not all the gory detail, kind of the top-line consumption, durable service, investment, equipment structures, information, intellectual property, that kind of level. When you look, every time you look down that column, you see pluses and minuses, growth and adding to growth or subtracting from growth. The one thing that struck me about this report, I looked down the column, I didn't see a single negative, nothing.

Cris deRitis:                        Yeah.

Mark Zandi:                       It was all positive, right?

Cris deRitis:                        Yeah.

Mark Zandi:                       Marisa, did you see the same thing?

Marisa DiNatale:              Motor vehicle production, I think, was-

Mark Zandi:                       That's one-

Marisa DiNatale:              ... [inaudible 00:04:14]-

Mark Zandi:                       ... level down, I think [inaudible 00:04:15]-

Marisa DiNatale:              ... subtraction from growth.

Mark Zandi:                       ... I mean, it's a big economy. There's going to be something that's-

Marisa DiNatale:              Of course-

Mark Zandi:                       ... negative

Marisa DiNatale:              ... yeah.

Mark Zandi:                       ... but kind at the higher level of detail, durable goods spending, consumer spending, which is where motor vehicles are, I think it was a small positive, but it was positive. Nothing, government spending, trade, inventories, business fixed investment, everything, everything was-

Marisa DiNatale:              Even residential fixed investment for the second-

Mark Zandi:                       ... housing. Yeah.

Marisa DiNatale:              Yeah.

Cris deRitis:                        Yeah.

Mark Zandi:                       Right, right.

Cris deRitis:                        Small, but yeah. Small positive, but positive.

Mark Zandi:                       Well, of all the number this past week, Marisa, which would would you call out as being most representative of the reality of what's going on in the economy? Would it be GDP or would it be something else?

Marisa DiNatale:              It would be GDP and other things in that report like the personal consumption expenditures index. That's another big thing, so we have GDP growth in the fourth quarter at 3.3%, and core PCE at 2%, right? So-

Mark Zandi:                       Core-

Marisa DiNatale:              ... [inaudible 00:05:12]-

Mark Zandi:                       ... PCE being-

Marisa DiNatale:              ... yeah, the personal consumptions expenditure, which is the Fed's preferred measure of inflation, stripping out energy and food prices.

Mark Zandi:                       Right.

Marisa DiNatale:              This is the overall deflator 1.7% in the fourth quarter. We got monthly numbers I think this morning

Mark Zandi:                       Mm-hmm.

Marisa DiNatale:              ... that I didn't look at, but we're right at the Fed's target on PCE for the fourth quarter with-

Mark Zandi:                       [inaudible 00:05:41].

Marisa DiNatale:              ... above potential growth.

Mark Zandi:                       Right. I think, and I looked at the monthly data that came out today, in the last six months of 2023, so if I look at the second half of the year, June to December, and annualized the increase in core consumer expenditure, deflator inflation, it was 1.8. I'm going to go to the second significant digit, 1.86% annualized.

Cris deRitis:                        That's-

Mark Zandi:                       [inaudible 00:06:11]-

Cris deRitis:                        ... 1.9 [inaudible 00:06:12].

Mark Zandi:                       ... okay, 1.9. That's below 2.

Marisa DiNatale:              It's still... yeah.

Mark Zandi:                       You look at that and you go, "Whoa, could it be possible that we're already back to the Fed's target? Is that possible?" It feels like it. Cris?

Cris deRitis:                        It certainly is moving in that direction, right?

Mark Zandi:                       Yeah.

Cris deRitis:                        Even the year-over-year core PCE has a two-handle, as my Wall Street friends like to say, 2.9%, so-

Mark Zandi:                       That's year over year, right?

Cris deRitis:                        Yeah-

Mark Zandi:                       Yeah over year.

Cris deRitis:                        ... year over year, so it's-

Mark Zandi:                       Yeah. We were just [inaudible 00:06:45]-

Cris deRitis:                        ... spitting distance. Spitting distance, that's my phrase, spitting distance of the target.

Mark Zandi:                       Now, CPI, consumer price inflation, is a little bit higher. It is higher, but that's only by construction. The CPI puts a higher weight on the cost of housing services than the PCE deflator that the FEd's focused on. That remains elevated, but that also is coming in pretty quickly-

Marisa DiNatale:              Mm-hmm.

Mark Zandi:                       ... here. Based on the consumer expenditure deflator, it feels like we're already back to the Fed's target based on the CPI. We're not quite there, but as you say, spitting distance.

Cris deRitis:                        Yeah, back to the target. Okay.

Mark Zandi:                       Okay. Anything else? You mentioned UI, unemployment insurance claims.

Marisa DiNatale:              Yeah.

Mark Zandi:                       They remain, right?

Marisa DiNatale:              We have solid GDP growth, inflation that's closing in on the Fed's target, and we have a job market that is slowly gracefully with no sign of increased layoffs. It's like everything you want, right?

Mark Zandi:                       Right, and of course, one of the more interesting thing, or there's so many interesting things, but one of the particularly interesting things is economy is growing so strongly based on GDP, I think fourth quarter of last year compared to fourth quarter this year, the growth rate was 3.1%. That's real GDP growth over the year, and in that period, unemployment actually increased a little bit, so that went from... I'm splitting hairs here, but it went from, I don't know, 3.3, 3.4 to 3.6, 3.7, something like that. Very, very low, but it moved higher, which would suggest that the economy's potential rate of growth is actually north of 3.

                                                Now, there are a lot of measurement things going on here, and I'm sure that probably overstates the case and we get some revisions to the data, downward revisions, but nonetheless, that suggests that the supply side of the economy is rip-roaring here, right? Can you interpret it any other way, Cris?

Cris deRitis:                        No, no, no.

Mark Zandi:                       No.

Cris deRitis:                        Certainly not. There was no recession in 2023. We can [inaudible 00:09:03]-

Mark Zandi:                       Not only-

Cris deRitis:                        ... [inaudible 00:09:03]-

Mark Zandi:                       ... was there no recession in '23, it was a fabulous year.

Cris deRitis:                        Yes.

Mark Zandi:                       It was like a really, really good year. No recession, but a really good year. It's just amazing. It's just [inaudible 00:09:16]-

Cris deRitis:                        Yeah, consumers-

Mark Zandi:                       ... and you kind of look [inaudible 00:09:18]-

Cris deRitis:                        ... outdid themselves.

Mark Zandi:                       ... yeah, and you kind of look forward and you're going, "Okay, forecast is, say, 2% for 2024, but it feels like if we're going to be wrong, it's going to be stronger than that, not lower and less than that." No? It feels like that. I know we're at a point where we've changed the forecast, but I don't know.

Cris deRitis:                        Yeah.

Marisa DiNatale:              There's a lot of risk out there.

Cris deRitis:                        Yeah, it's-

Mark Zandi:                       On the downside? Or you're saying-

Marisa DiNatale:              Yeah.

Mark Zandi:                       ... on the downside?

Marisa DiNatale:              Yeah-

Mark Zandi:                       Okay.

Marisa DiNatale:              ... and there is more upside risk to talk about, too, but there is a lot of downside risk out there.

Mark Zandi:                       Okay, we're going to keep this short because we want to get to Samim and talk about the Treasury market, but okay, give me your number one worry. What's your number one worry Marisa? Say we are forecasting GDP growth calendar year 2024 of 2%. You're saying the risk is that it'll be less than that. Why? What's the threat?

Marisa DiNatale:              I'm increasingly concerned about geopolitical risk.

Mark Zandi:                       Hmm.

Marisa DiNatale:              It seems to be widening in the Middle East, so this could end up being a bigger supply chain disruption or increase in oil prices or something like that. That's my main worry right now.

Mark Zandi:                       Of all geopolitical risk, you put the turmoil in the Middle East, Israel, Hamas, what the Houthis are doing, the [inaudible 00:10:43]-

Marisa DiNatale:              The Houthis, yeah, that seems-

Mark Zandi:                       ... [inaudible 00:10:44] so on.

Marisa DiNatale:              ... to be escalating, right, so-

Cris deRitis:                        [inaudible 00:10:46] and the link back to us is through oil prices.

Marisa DiNatale:              Yeah.

Mark Zandi:                       Okay, through trade. Cris?

Cris deRitis:                        Yeah, I guess along those lines I see the most immediate threat some reacceleration of inflation, whether it's through an oil shock, supply chains, I think that's the crux of it. That's what would cause the Fed perhaps to pivot-

Mark Zandi:                       Mm-hmm.

Cris deRitis:                        ... or cuts or certainly keeping rates higher for more, I'm sorry, more rate increases or certainly keeping rates higher for an extended period of time, but that would certainly slow things down here. Geopolitical-

Mark Zandi:                       Yeah [inaudible 00:11:22]-

Cris deRitis:                        ... risk, that seems like the most obvious channel for that rate acceleration of inflation, certainly Middle East, but I'd keep an eye on Russia-Ukraine as well. That's certainly lots of tensions in Europe, lots of fears and concern, anxiety there as well.

Mark Zandi:                       Yeah, but what you're saying is there's got to be some kind of what I call an exogenous event, something that... I mean, that you can't really predict. Yeah, maybe in their scenarios and their darker scenarios, but it's not something that feels endogenous to the economy, something that's going to be internally generated. It's something's got to happen out there in the external world to create a problem and even those feel less, I have to say, there's always geopolitical risk. You didn't mention the presidential election year in the U.S. in [inaudible 00:12:18]-

Marisa DiNatale:              Yeah, that was-

Mark Zandi:                       ... [inaudible 00:12:18]-

Marisa DiNatale:              ... my-

Mark Zandi:                       ... that-

Marisa DiNatale:              ... my hesitation-

Mark Zandi:                       ... [inaudible 00:12:21].

Marisa DiNatale:              ... was, am I more worried about that or am I more worried about external forces?

Mark Zandi:                       But-

Marisa DiNatale:              That also would be an exogenous-

Mark Zandi:                       ... yeah, just feels-

Marisa DiNatale:              ... event.

Mark Zandi:                       ... yeah, it feels less... The endogenous positive surprise is we get more growth on the supply side of the economy, more labor force, more productivity growth, and-

Marisa DiNatale:              Yeah.

Mark Zandi:                       ... we're able to grow more without generating inflation. That's kind of an endogenous positive risk of the forecast. To get to a downside scenario, you've got to come up with it feels like an exogenous risk. It doesn't feel like something within the economy that's going to do us in, but-

Marisa DiNatale:              Unless there's something in the financial system, which you are very much worried about, right?

Mark Zandi:                       Good point. Good point.

Marisa DiNatale:              We'll lead into our next guest, just-

Mark Zandi:                       Yep.

Marisa DiNatale:              ... there's a lot of opacity in certain parts of the financial system that have tripped us up before where no one saw something coming. If there's something in there that's exacerbated by a higher interest rate environment, for example, that could also be another thing that-

Mark Zandi:                       Great point-

Marisa DiNatale:              ... breaks us down.

Mark Zandi:                       ... great point, and thus the guest, and we'll get to him in one second. One last thing I'm going to do with you guys because we haven't done this in a while, probability of a recession starting at sometime in calendar year 2024. Marisa, tell me what you are today and where you were the last time we did this.

Marisa DiNatale:              I think I'm still at 20%, maybe moving maybe the softer side of 20%, but that's I think where I was the last time we did this.

Mark Zandi:                       The unconditional probability of recession would be about 15-

Marisa DiNatale:              Mm-hmm.

Mark Zandi:                       ... simply defined, so you're-

Marisa DiNatale:              Yeah.

Mark Zandi:                       ... almost back to this. Is it going to be-

Marisa DiNatale:              Yeah, slightly elevated.

Mark Zandi:                       ... slightly elevated. Cris?

Cris deRitis:                        I think it was at 35, and I would knock it down to 30-

Mark Zandi:                       30.

Cris deRitis:                        ... so still higher. I think that the downside risks outweigh the upside risks here.

Mark Zandi:                       I was at 25, I'm going to 15.

Marisa DiNatale:              Wow.

Mark Zandi:                       I'm there. I think-

Marisa DiNatale:              It's back to normal.

Mark Zandi:                       ... I think the risks are perfectly symmetric now, both on the upside and the downside. I don't think the downside risks are predominant at this point, and I'm very close to declaring victory, soft landing. Not quite there yet, but...

Marisa DiNatale:              Yeah, when can we stop talking about this?

Mark Zandi:                       ... yeah, I think-

Marisa DiNatale:              Is it... I think it's mostly inflation-based. Once the Fed is in a interest rate normalization period and once we can confidently say that inflation is back at the Fed's target and it's staying there, I guess is when we stop talking about the risk of recession and-

Mark Zandi:                       I think when they cut the first rate cut, boom-

Marisa DiNatale:              Uh-huh.

Mark Zandi:                       ... that's it. Mm-hmm. That's when that's when I would declare victory I think to be [inaudible 00:15:06]-

Cris deRitis:                        Unless it's a rate cut because of recession.

Mark Zandi:                       ... yeah, okay. Fair enough, fair enough. Yeah, fair enough, fair enough. Okay. Well, we've got a lot to discuss with regard to the risks to the financial system, and we're going to focus on the Treasury market. With that, let's bring in our guest, Samim Ghamami. Hi, Samim.

Samim Ghamami:            Hi, Mark. Good to see you.

Mark Zandi:                       Good. I hope I'm not being too forward, but are you Egyptian? What kind of name is Ghamami? I'm just really curious?

Samim Ghamami:            Sure. I'm originally from Iran.

Mark Zandi:                       Oh, geez.

Marisa DiNatale:              Mark.

Cris deRitis:                        Mark.

Mark Zandi:                       Gosh.

Cris deRitis:                        Ooh.

Mark Zandi:                       I should know that. Zandi is, of course, Iranian. You know that. You know that.

Samim Ghamami:            Yeah.

Mark Zandi:                       I did not know that.

Samim Ghamami:            Yeah.

Mark Zandi:                       Oh.

Samim Ghamami:            Yeah.

Mark Zandi:                       Ghamami is-

Samim Ghamami:            Yeah. I was born in Iran, Tehran.

Mark Zandi:                       In Tehran. Oh, when did you come to this country?

Samim Ghamami:            Almost 20 years ago.

Mark Zandi:                       Oh, very good.

Samim Ghamami:            Yeah.

Mark Zandi:                       It's good to have you. Well, maybe it's a good place for you just to give us a sense of you. Maybe you can give us a little bit of your background. You're at the SEC now, but how'd you get there?

Samim Ghamami:            Sure, so my background is a mix of working academia, private sector, and official sector. I've been affiliated with UC Berkeley and NYU on the official sector side. Prior to joining the SEC, I worked for the Federal Reserve Board as an economist, and then at the U.S. Treasury as a senior economist and Associate Director of Research at the Office of Financial Research that I'm sure you know about.

                                                On the private sector side, I've worked for Goldman Sachs as an economist. I've also worked for a buy-side firm. I joined the SEC last year, and I'm working on some of the commission's initiatives and proposals on different parts of the financial market. I will just need to mention the usual disclaimer that my views obviously are my personal views and not reflected by the commission commissioners, the SEC Chair, and my colleagues at the SEC.

Mark Zandi:                       Got it. It seems like you've done an awful lot in 20 years. I couldn't keep up. That's a lot in 20 years. Yeah. That's-

Samim Ghamami:            It has been intense.

Mark Zandi:                       ... yeah. Very cool, and the OFR, Office of Financial Research, that was the group that was set up. I guess it's part of Treasury. Is it part of Treasury? I'm not sure.

Samim Ghamami:            Part of Treasury after the Dodd-Frank Act and officially supporting the mandate of FSOC.

Mark Zandi:                       Yeah, and so OFR kind of scans the financial landscape to try to identify potential threats and risks. The idea being we all got surprised-

Samim Ghamami:            To financial stability, yeah [inaudible 00:18:08]-

Mark Zandi:                       ... yeah financial stability. We all got surprised by the financial crisis. Where did that come from? The intent here is to be prepared or more prepared for the possibility that something could go wrong in the system.

Samim Ghamami:            Exactly, exactly.

Mark Zandi:                       Yeah, and your work at SEC, so maybe where are you kind of the hierarchy there? Where are you there?

Samim Ghamami:            I'm an economist working at a division called DERA, Division of Economic and Risk Analysis.

Mark Zandi:                       Hmm. Oh, okay. Very interesting, and you've been there for a year.

Samim Ghamami:            Yeah.

Mark Zandi:                       I thought it'd be really good to have a conversation because you are focused on one potential problem or threat in the financial system, and that's the way I frame it, and I'll just riff for a minute and then turn it back to you and see if you frame it in a different way, is liquidity in the Treasury market. The Treasury-

Samim Ghamami:            Yes.

Mark Zandi:                       ... market, the Treasury securities market is a massive market, the largest in the world. Based on that, you would think this market has to be really deep and well-functioning. There's very little chance that you'd have any trouble with the trading in this market, but we have had trouble points in time, and we should talk about those points in time, pandemic and the teeth of the pandemic is one of the most recent good examples.

                                                Liquidity seemingly breaks down or it becomes disconnected and the market isn't functioning well, and that's a problem, a potential problem because the Treasury market is so critical to the wealth functioning of the global financial system. It's the benchmark. The 10-year Treasury yield is kind of a benchmark interest rate for all other financial securities. Everything gets priced off of that, and if you don't have liquidity in this market and you can't get reasonable pricing, the whole financial system feels like it could be at risk of not functioning properly or well. Do I have that roughly right?

Samim Ghamami:            Exactly, exactly, Mark. Yes, exactly as you pointed out, it's the most important financial market in the world, and for different reasons, the Fed's monetary policy gets through Treasury markets. Essentially that's the Treasury securities or benchmark securities for pricing almost all assets in the financial markets and, of course, the Treasury essentially finances activities of the U.S government through debt issuance. Most of the debt issuance is based on marketable securities. The size of treasury market is massive, as you know. Marketable securities by the end of 2023 last year were more than $25 trillion.

Cris deRitis:                        Yeah, almost a hundred percent of GDP, right? So-

Samim Ghamami:            Exactly.

Cris deRitis:                        ... yeah.

Samim Ghamami:            Exactly.

Mark Zandi:                       It's grown very rapidly. If you go back before the financial crisis, and I'm speaking from memory so I may not have this exactly right, but the publicly traded Treasury debt to GDP-

Samim Ghamami:            They're both.

Mark Zandi:                       ... yeah, it was less than 50%. I think it was closer to 40%, something like that.

Samim Ghamami:            Yeah.

Mark Zandi:                       It had been quite stable for many decades after World War II, and it went up and it went down depending on conditions, but generally kind of 40, 50% of GDP. Then, since the financial crisis, it's ballooned to-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... a hundred percent of GDP. All the trend lines don't order well here in the sense that we're going to see significant increases in debt going forward unless we change policy dramatically, which doesn't feel like fiscal policy, doesn't feel like that's happening anytime soon. This market is big, it's gotten bigger over time, and it feels like it's going to get really big going forward.

Samim Ghamami:            Exactly. Exactly.

Mark Zandi:                       Yeah.

Samim Ghamami:            Exactly.

Mark Zandi:                       I mentioned that we've had these periods of what I'll call illiquidity where-

Samim Ghamami:            Yeah.

Mark Zandi:                       ... trading between buyers and sellers kind of have broken down, bid-ask spreads have kind of gapped out, widened, and it's been difficult to trade. The one that comes to mind is when the pandemic first hit, it felt like we had a bit of a bout of illiquidity. Is that the most recent example of illiquidity or a good example-

Samim Ghamami:            Yes-

Mark Zandi:                       ... of illiquidity?

Samim Ghamami:            ... exactly, so that's the most recent one and roughly the most intense one in terms of volatility in Treasury securities, and like you mentioned, different measures of illiquidity. The most basic one, the ones that you just mentioned, bid-ask spreads. Before that, I'm sure you know about there was the repo market disruption in September 2019. Before that, it was the flash crash in October 2014, but those two market disruptions were not comparable to what we witnessed in March and April of 2020.

Mark Zandi:                       Yeah, and can you just describe the symptoms of that illiquidity? What happened exactly?

Samim Ghamami:            [inaudible 00:23:50] sure, so we can think of illiquidity, I mean, one measure of that we just discussed, bid-ask spread, as a function of market volatility in normal times. The COVID shock hit the economy and Treasury securities became more volatile. That explains parts of the market illiquidity that we observed in March 2020, but it turned out that the illiquidity was much more intense than could be explained by just market volatility. That was essentially due to the constraints on the balance sheet and market=making capacity of large broker-dealers that are mostly subsidiaries of large banks. One may ask, what caused the balance sheet constraints and constraints on market-

Mark Zandi:                       Can I stop you before we move forward?

Samim Ghamami:            Sure, yeah.

Mark Zandi:                       I want to get to that in just a few minutes. I just want to flesh this out a little bit. If I go back to that event in the early part of the pandemic, what we saw was the illiquidity manifested in, as you say, extraordinary volatility in interest rates, yields were going all over the place.

Samim Ghamami:            Yep.

Mark Zandi:                       This is just in my mind's eye, and I haven't investigated, but I'm curious if you observed that the market, the bond market, the Treasury market, it feels more volatile than in times past. When I say that, in a given day, it feels like the yield on the 10-year Treasury bond can move five, 10, even 15 basis points, which if I go back 10 years ago, 15 years ago, it felt like it would move a basis point or two, and that was a big deal. Now, it can move so fast so quickly. Is that something else? Or is that a part of the liquidity-

Samim Ghamami:            Well, so-

Mark Zandi:                       ... issue?

Samim Ghamami:            ... so that's a very good point, Mark. Because of the change in market structure for Treasury securities in the past 10, 15, 20 years, so prior to that period of time, most of the inter-dealer market used to be intermediated by large broker-dealers that I just mentioned were subsidiaries of large banks. In the past several years, most of the transactions in the inter-dealer market are being intermediated by [inaudible 00:26:53] so-called "principal trading firms." Most of the principal trading firms are high-frequency trading firms. That has essentially increased the speed of trading even in the inter-dealer part of the Treasury market.

                                                The second segment of the Treasury market is the dealer-to-client part. The dealer-to-client part can be viewed as essentially the traditional bilateral over-the-counter or OTC market. Most of the trading activity is being done in the inter-dealer market. Now, principal trading firms, high-frequency trading firms, as I just mentioned, play a very important role, and this combination and the presence of ETFs have essentially to some extent increased the normal volatility that we observe in the Treasury market.

Mark Zandi:                       Okay, so to restate that, if you go back 10, 15, 20 years ago, the trading was done by these large broker-dealers that are still around and they still are a key part of the market, but they were the market back 15, 20 years ago. These are parts of large banks like a JPMorgan Chase or a Bank-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... of America, that kind of thing-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... but increasingly over tie, the broker-dealers, their share of this trading has declined. In the wake of that, we've seen an increase in the trading done by, as you call them, principal trading firms-

Samim Ghamami:            Right.

Mark Zandi:                       ... which tell me if I'm wrong, but I call them hedge funds. I mean...

Samim Ghamami:            Not-

Mark Zandi:                       ... not exactly?

Samim Ghamami:            ... not necessarily, so one example is Citadel Securities, right?

Mark Zandi:                       Citadel-

Samim Ghamami:            Citadel-

Cris deRitis:                        Right.

Samim Ghamami:            ... Securities.

Cris deRitis:                        Yeah.

Samim Ghamami:            Citadel Securities is a broker-dealer, is a market-making financial firm, but Citadel itself is a hedge fund-

Mark Zandi:                       Mm-hmm.

Samim Ghamami:            ... so sometimes, I mean, the distinction can get blurry, but there are examples like Citadel where Citadel Securities is a broker-dealer market maker, not a hedge fund.

Mark Zandi:                       Okay, okay, so Citadel plays both roles. It plays kind of a traditional broker-deal intermediation, but it also has an arm that it's buying and selling to make-

Samim Ghamami:            Two separate-

Mark Zandi:                       ... two separate things, two separate things.

Samim Ghamami:            ... two separate entities, two separate financial firms, Citadel Securities and Citadel LLC, yeah.

Mark Zandi:                       Yeah. Okay, but the increase in volatility that I'm feeling and that I'm observing is real volatility that in any given day or hour, I'm seeing bigger swings in the interest rate on Treasury securities. That is happening and that's partly or more significantly due to this kind of change in the market structure away from broker-dealers kind of managing the trading intermediation to-

Samim Ghamami:            Yes.

Mark Zandi:                       ... these principal trading firms.

Samim Ghamami:            Right, and not fully away from traditional broker-dealers. Roughly half of the share in the inter-dealer market is being done by PTFs, principal trading firms, and the other half is still by bank-affiliated broker-dealers, but mostly in electronic trading platforms and mostly in the format of high-frequency trading.

Mark Zandi:                       Okay. Okay, very good, and would another reason for the increase in volatility be just who the buyers are? In going back to that pandemic event in the early part of the pandemic, the way we got out of that, the way market functioning was restored was the Fed stepped in, stepped in in a big way and bought-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... Treasuries. Okay.

Samim Ghamami:            Exactly-

Mark Zandi:                       Okay.

Samim Ghamami:            ... so in the first quarter of 2020, the Fed purchased more than $1 trillion of Treasury securities, mostly because of what is called Market Function Purchase Program essentially to calm down the Treasury market. Part of that was because of QE following the COVID shock, but Fed intervened aggressively and massively. Yeah.

Mark Zandi:                       Okay, so the QE, the quantitative easing, that was the Fed coming in and buying securities in an effort to get long-term interest rates down, and in so doing, they helped to restore market functioning in this period when there was this illiquidity in the market.

Samim Ghamami:            That's right. That's right-

Mark Zandi:                       Got it.

Samim Ghamami:            ... but there is research showing how we can essentially distinguish the QE part of Fed intervention from their Market Function Purchase Program.

Mark Zandi:                       Oh, interesting.

Samim Ghamami:            At least for the first quarter of 2020, most of that was purchases of Treasury securities and, as I just mentioned, roughly around or more than $1 trillion. Yeah.

Mark Zandi:                       Got it. Got it, and of course, one thing that's now happening is the Fed is no longer QEing. It's QTing, it's letting the Treasury securities on its own back. It bought all these Treasury securities when it was QEing to keep rates down. Now, it's QTing. It's allowing those securities to mature, and if they're mortgage securities potentially prepay, although I don't think there's much prepayment. It's in kind of a very different place with regard to the Treasury market. Instead of providing liquidity and support to the market, it's now pulling away from the market. I don't know what the right way to say it is. It's not adding to the illiquidity, but it's certainly not helping in terms of liquidity. Would that be fair to say?

Samim Ghamami:            Yes, that's fair to say, but at the same time, I guess, I think it's one important point is there is a tension. There could be a tension between, like you mentioned, monetary policy and central bank Market Function Purchase Program when the central bank, the Fed wants to tighten monetary policy exactly because of what you pointed out. The two could be aligned during the time of quantitative easing, and we can discuss this further if you're interested, but that in part motivates this discussion on whether it's better to do emergency central bank asset purchase programs with good design or think about fiscal buyback programs through which the Treasury would purchase securities during market stress.

Mark Zandi:                       Oh, interesting. Has that ever happened? Has the Treasury ever done that?

Samim Ghamami:            Yes-

Mark Zandi:                       Oh.

Samim Ghamami:            ... in the '90s, but at that time U.S. was running budget surplus, not budget deficit.

Mark Zandi:                       Yeah, right.

Samim Ghamami:            That time was different, but actually this year, the Treasury is designing a buyback program. It hasn't been finalized yet as far as I know, but that won't be an emergency buyback program. That is what is often referred to as a regular and predictable buyback program.

Mark Zandi:                       Got it. Got it. Before we move on to the things we can do to help improve the liquidity of the market, and I know you've done a lot of work here and want to go through that, and before that we're going to play the game, but I want to continue to explore potentially other reasons why the market feels less liquid and why there's more volatility. One of the other potential explanations, it was something I alluded to earlier, that hedge funds, while the Federal Reserve has been kind of moving away from the market through QT, hedge funds have been coming into the market. They're playing their big role, increasingly their role in the market, and there's a trade called a basis trade where they're kind of playing the futures market off the cash market. If there's a little bit of a spread there and they can make money and they can make a ton of money if they're using a lot of leverage to do so. Did I describe that right? How how big a deal is that? Is that something we should be worried about?

Samim Ghamami:            That was something that was of concern in the first quarter of 2020, so exactly, Mark, like you mentioned. That's essentially the basis trade has become a popular long and short investment strategy among hedge funds that essentially is purchasing or going long Treasury securities and selling or going short Treasury futures because at least around that time that we have been discussing Treasury securities were cheaper compared to Treasury futures in the derivatives markets. It is well-known that when everything is predictable, when markets don't face shock and extreme volatility, these type of long-short strategies would converge. Hedge funds use a lot of leverage so they can profit from the small spread associated with this long and shorter basis trade, but when the COVID shock hit the financial system, markets became more volatile and hedge funds had to unwind these positions massively.

                                                That also contributed to a so-called "negative demand shock" in the Treasury market, essentially saving pressure by hedge funds as well. That's something that I think the financial sector is closely monitoring, meaning like you mentioned, hedge funds, principal trading firms are essentially now liquidity providers in the Treasury market. Naturally, they will take leverage so that they can generate profit for the investors, and sometimes when leverage hedge funds deleverage suddenly, and we know that from the global financial crisis, that could destabilize the financial system.

                                                That is something that is closely being monitored. One cause of the disruption in the Treasury market in March 2020, and the other one, and I think the main one is that like we discussed at the beginning, Treasury securities, the amount of Treasury securities outstanding is going up because of the fiscal deficit. At the same time, because of some bank capital and regulatory regulation that has made them safer, but it has essentially reduced the market-making capacity of large banks. That was another main cause of the problem.

Mark Zandi:                       Got it, got it, so just to reiterate, what's happening is the large broker-dealers that were key, that are still key, but were more instrumental in managing the market and providing liquidity and intermediating between buyers and sellers, they're not keeping up with the growth in the-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... size of the Treasury market.

Samim Ghamami:            Exactly.

Mark Zandi:                       The reason for that, or one of the reasons or maybe multiple, is capital. The capital rules are making it more difficult from an economic perspective for the big banks to grow the size of the broker-dealers to keep up with the rapid growth of the size of the Treasury market. Is that fair?

Samim Ghamami:            Exactly. Yeah-

Mark Zandi:                       Yeah.

Samim Ghamami:            ... so capital regulation has the banking sector obviously safe after the global financial crisis, but some of the capital rules we can discuss if you're interested essentially have adversely affected the market-making capacity of bank-affiliated broker-dealers, essentially extremely active in Treasury markets.

Mark Zandi:                       Got it. Got it. There's one other thing I wanted to bring up. Shoot, I can't quite remember. It'll come back to me, but maybe at this point before we move on, I want to play the game next and then come back to reforms and changes. I'll turn the conversation back to Cris and Marisa. This is hard to digest. This conversation is we're now deep into the plumbing, which by the way, I think it's critical because it's the stuff that's deep in the plumbing that does you in. The stuff that's so obvious, that's not the thing that's going to be the problem. The financial system isn't going to seize up on that, and we're not going to a crisis based on that. It's the stuff that is hard to understand. It's not completely transparent, a little bit more opaque, a little bit more difficult to get your mind around it will do you in.

                                                This is very important that we take this dive into the plumbing, but nonetheless, it's in the plumbing and it's very complicated. Cris, based on the conversation so far, any questions or comments or other questions you'd like to post to Samim?

Cris deRitis:                        Sure, I'll perhaps ask a naïve maybe terribly basic question just to-

Mark Zandi:                       Fire away, those are good.

Cris deRitis:                        ... so what about... Just thinking about Treasury markets in general, there's been a lot of chatter about foreign investors and foreign central banks pulling back not only for financial reasons, but exposure to the dollar is a concern. You have some countries, a China, Russia certainly concerned about dollar exposure. Other countries maybe as well fearing. Do you see that for an investment to playing any role in the Treasury liquidity story?

Samim Ghamami:            I don't think so in the sense that compared to the market disruption that we observed in March 2020. I don't think that would be a concern, that exposure to dollar, but that said, let's compare the global financial crisis to the 2020 COVID crisis. In 2008, around September 2008, foreigners, both the foreign official sector and foreign investors had purchased massively Treasury securities, particularly at the longer maturity part of the yield curve. In contrast to that, in 2020, foreigners, both the official sector and foreign investors, massively sold Treasury securities, again, the long maturity ones. That wasn't because of currency dominance or currency issues, it was because of the massive holding of Treasury securities by the official sector of foreign countries and the investors. One could ask what changed the trend when we compared to 2008 and 2020, the COVID crisis, but that's a different issue.

Mark Zandi:                       Okay [inaudible 00:44:11]. Marisa, anything you want to pose? Again, this is a complicated topic, so no naïve questions. There are no naïve questions.

Marisa DiNatale:              Okay, good, because-

Mark Zandi:                       Yeah, yeah.

Samim Ghamami:            [inaudible 00:44:24].

Marisa DiNatale:              There's been a lot of volatility in interest rates recently. We've seen the 10-year go up, down, all over the place. Is any of... Certainly we know that some of that is just based on movements, typical economic news, what the Fed does and says, but it's been very volatile lately. Is any of this related, do you think, to any of this high-frequency trading that hedge funds are doing or any of the liquidity issues in the Treasury market? Can you always tell what is driving that volatility?

Samim Ghamami:            That's a very good point and question, so I think maybe it's helpful to think of, like we discussed before, market, I mean, illiquidity being a function of market volatility and other factors like the market-making capacity of large banks. Another factor, like you mentioned, is the presence of principal trading firms, but you mentioned at the beginning more recently there are other events. For example, we know that volatility in the Treasury market increased also around the default of the SVB Bank in March 2023. At that time, a combination of market events, Federal Reserve fine-tuning monetary policy to mitigate inflation.

                                                There are many factors in play, yeah, but I would also just mention that since 2020, particularly last year in 2023, the level of market volatility that we observed in the Treasury market is comparable to the level that we observed in the first quarter of 2020. Last year, there wasn't any meaningful disruption in the Treasury market, so-

Mark Zandi:                       How interesting.

Samim Ghamami:            ... because of that, it's important essentially to increase, diversify, and stabilize the market-making capacity overall in the Treasury markets.

Mark Zandi:                       Yeah, so what you're saying is the volatility that we're observing may have nothing to do with any kind of illiquidity in the market, it's just the conditions that are buffeting the market, everything that's-

Samim Ghamami:            That's right.

Mark Zandi:                       ... going on.

Samim Ghamami:            So the-

Mark Zandi:                       Yeah.

Samim Ghamami:            ... yep.

Mark Zandi:                       Yeah, exactly. One other quick... I'll throw it out as another potential factor. Maybe investors are kind of sort of thinking about credit risk for the first time ever. Debt limit debacle, rating agencies downgrading, could that potentially also be... It's certainly part of the volatility and maybe also a concern in the context of liquidity in the market, or am I stretching?

Samim Ghamami:            To be honest with you, I don't know about investors' concern about default risk. That might be hard to judge or analyze at this stage, but another way to look at it, like we discussed before, is because of the massive budget deficit at any Treasury auction, for example, that happened last November, one could think that, "Okay, Treasury prices went down, yields went up. That was because of investors concerned that they may not want to or may not be absorbed the Treasury securities in the secondary part of the Treasury market." I'm not sure if we can tie it directly to the default risk, but that's, let's say, due to the debt-to-GDP ratio going up.

Mark Zandi:                       Got it. Okay. All right. We're going to come back to what should be done about all this, and there's a lot of good ideas, and I know you've been working on that and we'll come back to it, but before that, let's play the game, the stats game. We each put forward a statistic. The rest of the group tries to figure that out through questions, deductive reasoning clues. The best stat is one that's not so easy we get it all immediately. Not one that's not so hard we never get it, and if it's apropos to the topic at hand, fantastic. We'll let Marisa go first. That's tradition, and Samim, you'll see how this is done, so Marisa, you're up.

Marisa DiNatale:              Okay. My statistic is 1.1 percentage points.

Mark Zandi:                       1.1 percentage points. Inflation related?

Marisa DiNatale:              No.

Mark Zandi:                       Is it related to this topic at hand?

Marisa DiNatale:              No.

Mark Zandi:                       Treasury? Oh, so it's an economic-

Samim Ghamami:            No?

Mark Zandi:                       ... So it's an economic statistic?

Marisa DiNatale:              It's an economic statistic.

Mark Zandi:                       Okay.

Cris deRitis:                        GDP-related?

Marisa DiNatale:              It is GDP-related.

Cris deRitis:                        Okay.

Mark Zandi:                       Some component of GDP that grew 1.1%?

Marisa DiNatale:              No, let me give you a hint.

Mark Zandi:                       Okay.

Marisa DiNatale:              It's the difference between two numbers.

Mark Zandi:                       [inaudible 00:49:58]. I think it's the difference between the core consumer expenditure for later and the CPI. I think that is 1.1%, but I thought that was-

Marisa DiNatale:              It might be.

Mark Zandi:                       ... that was a 10

Cris deRitis:                        [inaudible 00:50:10].

Mark Zandi:                       ... exactly. Oh is it 1? Is it 1%-

Cris deRitis:                        I don't know.

Mark Zandi:                       ... on the nose? Okay. It's the difference-

Cris deRitis:                        [inaudible 00:50:15].

Mark Zandi:                       ... between two things in the GDP report.

Cris deRitis:                        Not GDP and GDI?

Marisa DiNatale:              No.

Cris deRitis:                        No.

Mark Zandi:                       No.

Cris deRitis:                        [inaudible 00:50:23]-

Mark Zandi:                       That didn't come out right.

Samim Ghamami:            That's a difficult one.

Mark Zandi:                       That's a difficult one. Yeah. Can you give us any other hints without giving it away?

Marisa DiNatale:              You might not like the statistic.

Mark Zandi:                       Oh.

Cris deRitis:                        Oh.

Mark Zandi:                       Doesn't fit-

Cris deRitis:                        [inaudible 00:50:36]-

Mark Zandi:                       ... the narrative.

Cris deRitis:                        ... oh, I know what it is. I do know what it is. It's the error in process.

Marisa DiNatale:              Yes, yes.

Samim Ghamami:            I see.

Mark Zandi:                       That was a good hint, by the way.

Samim Ghamami:            That was a good hit. Exactly.

Mark Zandi:                       Yeah, yeah, yeah, yeah. You want to explain?

Marisa DiNatale:              Yes, it is the forecast miss, so it's the difference between actual reported fourth quarter GDP growth, which was 3.3%, and what our forecast was for GDP growth, which was 1.1 percentage points lower than that. We're not alone in this. We were actually closer to the GDP number than consensus was, so-

Mark Zandi:                       By a lot, I thought. The consensus was-

Marisa DiNatale:              ... because-

Mark Zandi:                       ... 1.5, we were-

Marisa DiNatale:              ... yeah, yeah-

Mark Zandi:                       ... 22-

Marisa DiNatale:              ... so, I mean-

Mark Zandi:                       ... and the reality was-

Marisa DiNatale:              ... there was-

Mark Zandi:                       ... 3.3. Yeah.

Marisa DiNatale:              ... a universally large miss on the GDP number that came out the other day.

Mark Zandi:                       Yeah, because I pay really close attention to those numbers. We missed on trade and inventory-

Marisa DiNatale:              Yeah.

Mark Zandi:                       ... which are particularly hard to forecast-

Marisa DiNatale:              Yes.

Mark Zandi:                       ... because they're lagged. They're very lagged in terms of the monthly data that we have. I suspect there might be some revision here once we get more data.

Marisa DiNatale:              I knew you were going to say that. Yeah.

Mark Zandi:                       You did? Okay.

Marisa DiNatale:              This is the first estimate, so we'll get two more revisions in the subsequent months and, yeah, we may see a downgrade.

Mark Zandi:                       Yeah.

Marisa DiNatale:              Inventories had contributed a lot to GDP in the third quarter, so we were expecting the change in inventories to be much less and detract from GDP growth. It was actually a slight positive gain again for the second quarter in a row, so that was-

Mark Zandi:                       That was a good-

Marisa DiNatale:              ... that was a big miss.

Mark Zandi:                       ... that was a good one. That was really good. Okay, Samim, you're up. You said-

Samim Ghamami:            Okay.

Mark Zandi:                       ... you were going to play. I don't think I've ever gotten a government official to play the stats game, so congratulations. Yeah.

Samim Ghamami:            Thank you, Mark. I mentioned two, I mean, these are not accurate stats, but average numbers-

Mark Zandi:                       Well, hold it, hold it, hold it.

Samim Ghamami:            ... so-

Mark Zandi:                       That's not really fair, Samim, if they're not accurate statistics.

Samim Ghamami:            Well, I mean, I'll tell you-

Mark Zandi:                       Go ahead, I'm just joking.

Samim Ghamami:            ... these are why not accurate, so one is... I mean, one hint is they both go back to statistics related to Q3 and Q4 of last year.

Mark Zandi:                       Okay.

Samim Ghamami:            One is roughly 5% or 6.2%, and the other one is roughly 5%.

Mark Zandi:                       Well, 5% was [inaudible 00:53:05]-

Samim Ghamami:            Related to our discussion and other hints.

Mark Zandi:                       ... well, the 5%, could that be the 10-year Treasury yield? The peak in the 10-year Treasury yield?

Samim Ghamami:            That's right, Mark, but that's actually the average of one-year yield on bills-

Mark Zandi:                       Oh, oh.

Samim Ghamami:            ... two-year notes and 10-year.

Mark Zandi:                       Oh no, that's interesting. Oh, okay, so you took the average of the yield on the one-year, the...

Samim Ghamami:            On the two-year note and-

Mark Zandi:                       ... two-year-

Samim Ghamami:            ... and the 10-year.

Mark Zandi:                       ... and the 10-year-

Samim Ghamami:            Yep.

Mark Zandi:                       ... and it was 5%.

Samim Ghamami:            Yep.

Cris deRitis:                        Partial credit-

Mark Zandi:                       Interesting.

Cris deRitis:                        ... Mark. Partial credit.

Mark Zandi:                       Oh yeah. Well, now why would you do that? Just because that's kind of-

Samim Ghamami:            So-

Mark Zandi:                       ... the blended cost of [inaudible 00:53:46]-

Samim Ghamami:            ... I'll tell you after you [inaudible 00:53:48].

Mark Zandi:                       ... okay, okay, okay, okay.

Cris deRitis:                        The other one is the key.

Samim Ghamami:            Yeah, what is [inaudible 00:53:51]-

Cris deRitis:                        6.2%.

Mark Zandi:                       Is that the off-the-run yield on Treasuries? I mean, one's-

Samim Ghamami:            [inaudible 00:54:02].

Mark Zandi:                       ... the-

Cris deRitis:                        No.

Mark Zandi:                       ... oh, okay. On-the-run one... Okay, we don't even have to go down that path because that would be a big spread. That would be way too big a spread.

Samim Ghamami:            Yeah.

Mark Zandi:                       Yeah. It's related to the liquidity of the Treasury market?

Samim Ghamami:            No.

Mark Zandi:                       Oh, okay, okay. I'm glad I asked.

Samim Ghamami:            Related to GDP.

Mark Zandi:                       Oh, related-

Cris deRitis:                        Oh.

Mark Zandi:                       ... to GDP. Oh, interesting. Is that nominal GDP growth?

Cris deRitis:                        Exactly.

Mark Zandi:                       Oh, okay, okay. Got it. Okay, that's interesting.

Samim Ghamami:            Yeah, yeah, yeah.

Mark Zandi:                       Okay, so explain, Samim. Why did you pick those numbers?

Samim Ghamami:            The reason is I'm sure you know this debate and discussion about RNG, the nominal growth rate in GDP and its importance in comparison with the average interest rate. That's essentially the gauge based on which we can see whether the government can roll over its debt. When R is below G, that's doable. When R gets close to G or exceeds GD, the fiscal deficit may not be sustainable-

Mark Zandi:                       Yeah, that makes sense.

Samim Ghamami:            ... and 5 and 6 were quite close, so that's a warning sign.

Mark Zandi:                       Yeah, so if you do kind of the math around the debt, if your nominal growth rate is higher than your cost of borrowing, it gives you a lot of latitude. The debt-to-GDP won't balloon out, but if-

Samim Ghamami:            Yep.

Mark Zandi:                       ... if your nominal growth rate is less than or close to your what you're borrowing at, you got a problem. Then it can-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... become unsustainable very quickly. Got it.

Samim Ghamami:            Exactly.

Mark Zandi:                       That's very good. That was good. That was a really good one.

Samim Ghamami:            Yeah.

Mark Zandi:                       Cris, you're up.

Cris deRitis:                        Okay. My numbers are not Treasury market-related. Economic data that came out this week. My hint is a lot of positive numbers that came out this week, Mark. I'm sure-

Mark Zandi:                       Oh.

Cris deRitis:                        ... you're going to highlight them, so I had to look for something. I have to get back

Mark Zandi:                       [inaudible 00:56:23] so good.

Cris deRitis:                        ... down. 19% and 53.2%.

Mark Zandi:                       It's in the economic data that came out this week?

Cris deRitis:                        Correct.

Mark Zandi:                       Government-related statistic?

Cris deRitis:                        Yes, it's a government statistic.

Marisa DiNatale:              19% and 52%?

Cris deRitis:                        53.2%.

Mark Zandi:                       In the GDP numbers?

Cris deRitis:                        No.

Mark Zandi:                       Okay.

Marisa DiNatale:              Oh, is it bankruptcies?

Cris deRitis:                        Oh, bingo.

Mark Zandi:                       Aah.

Cris deRitis:                        Marisa on fire. That's a-

Marisa DiNatale:              So-

Cris deRitis:                        ... yeah.

                                                ... personal bankruptcy filings?

                                                Yep, that's the year-over-year increase in-

Marisa DiNatale:              Okay.

Cris deRitis:                        ... personal bankruptcies, so that was 19%, 53% increase, 53.2% increase in business bankruptcies. All right, so those are big numbers.

Samim Ghamami:            Yep.

Cris deRitis:                        Yeah, certainly raises some eyebrows. I saw a number of financial analysts on TV talking about them, that there's real concern about the rise in bankruptcies, and certainly there is, however, a little context needed. We're still well below what we-

Mark Zandi:                       Yeah.

Cris deRitis:                        ... the level of bankruptcy that we had in 2019. Personal bankruptcies are about 35, close to 40% below 2019 levels, so-

Mark Zandi:                       Yeah.

Cris deRitis:                        ... a little context there, and business bankruptcies as well are still below that 2019 level. At this point, seems more like normalization than a real concern, but something to certainly keep an eye on.

Mark Zandi:                       I guess I'd also point out business formations have been extraordinary.

Cris deRitis:                        They have.

Samim Ghamami:            Right.

Mark Zandi:                       If you have formations, you're going to have failure almost by definition, right?

Cris deRitis:                        Yeah.

Mark Zandi:                       Yeah, yeah. That doesn't-

Cris deRitis:                        That's not enough.

Marisa DiNatale:              Doesn't [inaudible 00:58:09]-

Mark Zandi:                       ... that's not [inaudible 00:58:09]-

Cris deRitis:                        Not enough to bring it back down.

Mark Zandi:                       ... it's not, nah, nah, but anyway. Okay, here's mine. Three numbers, all related to the topic at hand. 98%, 115%, and 181%.

Cris deRitis:                        That's a GDP-

Marisa DiNatale:              That's a GDP ratio-

Samim Ghamami:            But yeah-

Marisa DiNatale:              ... over time.

Mark Zandi:                       Very good. Oh, that was... Boy, you guys are good.

Samim Ghamami:            Yeah, exactly.

Mark Zandi:                       Okay, you got to give me-

Marisa DiNatale:              The years.

Mark Zandi:                       ... you got to give me the-

Samim Ghamami:            10 years from now, the 115%, 10 years-

Mark Zandi:                       Very good.

Samim Ghamami:            ... from now-

Mark Zandi:                       Yeah.

Samim Ghamami:            ... and the last one, 181, I think 30 years from now.

Mark Zandi:                       Oh my gosh. You guys are-

Marisa DiNatale:              Wow.

Mark Zandi:                       ... fantastic. Yeah, that's cool. Samim, you could play this game anytime, but yeah, the actual publicly traded debt-to-GDP as of 2023. I think it's fiscal year... This is data from the Congressional Budget Office was 98%, We talked a little bit about that earlier.

Samim Ghamami:            Yep, yep.

Mark Zandi:                       No policy changes. Assuming no chance in policy, 10 years from now is going to be 115%, in 30 years from now in 2053, 191%. I think that's when the CBO ends its forecast, but I think you could do your own forecast after that. At some point, R is going to be above G in that kind of scenario and that's just not sustainable, but that brings it back to the conversation at hand. Yeah, I suspect we will see some policy changes here on the other side of the election that might change that trajectory a little bit, but it's going to be hard to change it a whole lot. The size of the Treasury market's going to continue to grow, and because of the constraints on the broker-dealer market that we discussed, kind of the capital rules, I don't think the regulator is going to change those.

                                                That leaves us with the Treasury market is vulnerable to illiquidity now. It's going to be even more vulnerable going forward unless we make some reforms. Samim, let me turn it back to you. I know there's been a lot of work here. You're kind of been doing a lot of work here, and I should say the good news here is that this concern about the Treasury market is not something that others aren't thinking about. At Jackson Hole, for example, that's-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... the confab that the Fed holds every year, they had Darrell Duffie. By the way, Darrell Duffie, he used to be on the Board of Directors of Moody's. He was a Stanford-

Samim Ghamami:            Yes.

Mark Zandi:                       ... professor. He gave a speech-

Samim Ghamami:            Yes, yes.

Mark Zandi:                       ... on this issue and put forth some proposals so this is not news. We know this is an issue, but let me turn it back to you, Samim. Like at the-

Samim Ghamami:            Sure.

Mark Zandi:                       ... top of the list of things that we could do, what would you do to address this problem?

Samim Ghamami:            Sure, so I would mention, Mark, some of the well-known proposed reforms, some of them put forward by Darrell Duffie and the Group of Thirty, so one is going back to the beginning of our discussion. One is improving bank capital and liquidity regulation. A quick example is, as you know, before the global financial crisis, bank capital was almost always risk-based, meaning if I have a risky loan on the asset side of my balance sheet, I would need to hold more equity capital against that as a buffer. If I have a U.S. Treasury security on the asset side of my balance sheet, I can be penalized less and hold less equity capital. One of the major part of bank capital regulation reform after the GFC was having a backstop to these risk-based capital rules, which are size-based rules. As you know, these are called leverage requirements.

                                                In my example, if the leverage requirement binds for a large bank, then the Treasury security on the balance sheet would be penalized in a similar way as in the case of a risky law. One proposed reform has been improving and realigning risk-based capital requirements and leverage ratio requirements. For example, one idea is to exempt Treasury securities from the leverage ratio requirement. In fact, the Fed asset purchase program went through really successfully by the end of the first quarter of 2020 when the Federal Reserve essentially when Treasury securities became exempted from the so-called "supplementary leverage ratio." That's one category of reforms, I mean realigning, as you said.

Mark Zandi:                       That seems like a pretty straightforward slam dunk kind of thing to do. Why wouldn't we do that? Is there any good reason why? What's the downside to-

Samim Ghamami:            So-

Mark Zandi:                       ... exempting Treasuries from the liquidity requirement?

Samim Ghamami:            ... so I think-

Mark Zandi:                       The leverage requirement?

Samim Ghamami:            ... at this, sure, so I think at this stage, based on what we have observed since the global financial crisis, there is no good reason, but proponents of the leverage ratio requirement would always point to the fact that right before the global financial crisis, risk-based capital, I mean, ratios at large banks were all good. That didn't signal any stress in the financial system. Another argument is risk-based capital requirements are very, very complex. They can be gained, but setting that aside, I think the experience of the COVID crisis showed that it makes sense to think about some type of exemption, permanent or temporary, for reserves and Treasuries from the leverage ratio requirement.

Mark Zandi:                       Yeah, it makes sense to have a leverage. I think it makes sense to have a leverage ratio requirement. You have to be careful-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... how you set it relative to your risk-based capital standards, but yeah-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... but-

Samim Ghamami:            It's about the calibration of leverage.

Mark Zandi:                       ... yeah, but not to... It seems like you should exempt Treasury securities. If we're going exempt Treasury securities from that leverage, that seems like a pretty straightforward thing to do.

Samim Ghamami:            That's right.

Mark Zandi:                       Yeah, okay. Fine.

Samim Ghamami:            That's right.

Mark Zandi:                       Okay, that sounds good. Okay, second on your list.

Samim Ghamami:            The second one is broader central clearing for Treasury securities. If you remember when we discussed the market structure for Treasuries, I mentioned, for example, the client-to-dealer segment of the Treasury securities market is essentially an OTC market being done mostly bilaterally. Even in the inter-dealer market between bank-affiliated broker dealers and principal trading firms, it's only around 20% of trades being clear through central counterparties-

Mark Zandi:                       Mm-hmm.

Samim Ghamami:            ... or CCPs. The benefits of central clearing are well-known. The obvious one is it would bring more transparency to the financial system. It could make the financial system less interconnected. The less obvious one probably is it could under some conditions mitigate counterparty credit risk, so the second category of reform, the main proposed reform has been, as I said, a broader central clearing mandate in the Treasury market. Actually, the SEC adopted its final rule last December, and it will hopefully get implemented fully by mid-2026.

Mark Zandi:                       Got it. Got it. We've got in the current system is these broker-dealers and others are kind of making the market and there's a lot of bespoke trading and bilateral trading. Let's just put it all in a central platform clearinghouse to-

Samim Ghamami:            That's right.

Mark Zandi:                       ... make the trades. Okay, so that seems also like a slam dunk thing to do. Why haven't we done that? Who's against that idea? Maybe-

Samim Ghamami:            [inaudible 01:07:35]-

Mark Zandi:                       ... the broker-dealers themselves don't want that to happen. Why wouldn't we do that?

Samim Ghamami:            Cost and benefit analysis for this particular proposal, broader central clearing hasn't been easy. One reason is in the bilateral part of the Treasury market that we just discussed, essentially most of the time there is no margin requirement. If you and I trade a Treasury security or get into a repo transaction, we are not required to post exchange margin or collateral. In the CCP world, in the world of central counterparties, having solid collateral requirement is necessary because essentially at the end of the day, the CCP would pool and concentrate almost all the counterparty credit risk in the financial system.

                                                Counterparty credit risk, in our case, Treasury securities would mostly materialize in the form of settlement failures. There is a cost factor, and if you put yourself in the position of buy-side or sell-side firms, in the current regime, they are trading relatively in an opaque way, relatively with minimum margin. In an alternative market configuration where most of the trades will be cleared through CCPs, margin requirements, collateral requirements would most likely be in place, so that would increase the cost. Yeah.

Mark Zandi:                       It seems like, to me, that feels like we should be doing that, and I can understand why the current players might have some, "I like the way this works now because it's opaque," and so forth and so on, but from a regulatory perspective, from a financial system stability perspective, it feels like a central clearing mechanism makes a whole lot of sense.

Samim Ghamami:            Exactly.

Mark Zandi:                       Okay.

Samim Ghamami:            Exactly.

Mark Zandi:                       All right. Fair enough.

Samim Ghamami:            Yeah.

Mark Zandi:                       Hopefully that makes some of the-

Samim Ghamami:            We need to make sure that CCPs are risk-managed well as well. Yeah.

Mark Zandi:                       They're-

Samim Ghamami:            [inaudible 01:09:55].

Mark Zandi:                       ... going to be SIFI. Wouldn't they be systemically important, too? Wouldn't they be-

Samim Ghamami:            They are.

Mark Zandi:                       ... probably?

Cris deRitis:                        So-

Mark Zandi:                       They'd-

Samim Ghamami:            ... yeah.

Mark Zandi:                       ... they'd be-

Samim Ghamami:            They are.

Mark Zandi:                       ... in their part higher regulatory scrutiny, maybe some-

Samim Ghamami:            Exactly.

Mark Zandi:                       ... additional capital or... yeah. Okay. Go ahead, Cris. Sorry.

Cris deRitis:                        I was just going to say I think some of the criticism, what I've heard or read, is just some debate about the timing of the transition, how this is a pretty large market, right? How quickly do you transition it-

Mark Zandi:                       I see.

Cris deRitis:                        ... for time? If you try to compress it, that could be highly disruptive, so...

Samim Ghamami:            Yeah, exactly. Exactly, and I think because of that, the final SEC rule has designed a careful-staged transition, so almost two and a half years from now till the implementation of the broader central clearing mandate would go through, so there is time.

Mark Zandi:                       Okay, so adjust the leverage ratio requirement, exclude Treasuries, establish a central clearing platform mechanism for trading. What's third on the list?

Samim Ghamami:            Actually, this should have been the first on the list-

Mark Zandi:                       Oh, first on the list.

Samim Ghamami:            ... which is-

Mark Zandi:                       Okay, okay.

Samim Ghamami:            ... this should have been the first on the list.

Mark Zandi:                       Yeah.

Samim Ghamami:            A Standing Repo Facility-

Mark Zandi:                       Yeah, okay.

Samim Ghamami:            ... would be very broad access to not just the few primary dealers that are trading counterparties of the Federal Reserve Bank of New York, but also it would be opened up to other market participants, for example, large asset management firms as well. That was the first recommendation of the Group of Thirty, and as you know, the Federal Reserve developed a Standing Repo Facility in 2021, but it is essentially open to only primary dealers which are trading 22 or 21, and these are, as I just, the trading counterparts of the New York Fed. The concern rightly has been that if we open up this facility to hedge funds, large asset management firms, and et cetera, that could create moral hazard because the Standing Repo Facility is there.

                                                That could incentivize the buildup of more leverage in the financial system, but for example, under a broader central clearing mandate, and because of the margin requirements that we just discussed, well-designed margin requirements could somehow in a way to some extent control the build up of the leverage in the financial system. For example, if the Federal Reserve becomes a counterparty to the CCP, that will clear the Treasury securities market. Then, buy-side and sell-side firms would face the CCP and not directly the Fed, and everything would happen in the presence of margin requirements that could control to some extent-

Mark Zandi:                       Oh.

Samim Ghamami:            ... the leverage and mitigate the subsequent moral hazard problem.

Mark Zandi:                       Got it.

Samim Ghamami:            [inaudible 01:13:24]-

Mark Zandi:                       Guys, if you run the-

Samim Ghamami:            ... [inaudible 01:13:25].

Mark Zandi:                       ... if you run the access to this Repo Facility through the CCP, the central clearing platform, that would help to mitigate this concern about moral hazard that might be created by giving access to this Repo Facility.

Samim Ghamami:            Exactly. If the CCP and its structure, its collateral requirements are very, very well-designed, that-

Mark Zandi:                       Yep.

Samim Ghamami:            ... that could happen.

Mark Zandi:                       Yep. Okay. Okay. Anything... We're getting a little long in the tooth here and I don't want to keep you too much longer. I know you've got a job to do. You've got to go save-

Samim Ghamami:            Sure.

Mark Zandi:                       ... the Treasury market. It was funny, I was traveling yesterday in a car a little bit. I was listening to NPR and they had this guy on talking about all the trash around the Earth because we've sent up all these satellites and rockets and there's a lot of debris up there, and his main concern and worry is that some of that debris hits a critical satellite and knocks out communication for the Northeast Corridor or something like that. That's his concern.

Samim Ghamami:            [inaudible 01:14:36].

Mark Zandi:                       You feel like that kind of guy to me for the Treasury market. It's like you know there's all these problems out there, and so the interviewer in NPR asked the guy, "How worried are you? Do you stay up at night thinking that the satellite is going to get knocked out?" The guy goes, "I am really very nervous that this is going to happen." My question to you, how nervous are you that the Treasury market's going to... before we make these changes that we just discussed, that we're going to have an event? Or maybe it's we have to have the event to generate the will to actually make these changes. I don't know, so how worried should we be about this, Samim? Is it a big deal or a small deal or what's the deal?

Samim Ghamami:            I think, Mark, I think it's a big deal because of the fiscal outlook-

Mark Zandi:                       Yep.

Samim Ghamami:            ... mostly because of the fiscal outlook, but I think the recommendations and proposed reforms that we just discussed, they could be in place in two years. On top of that, we know that the federal Reserve may start cutting rates this year, next year, and in 2026. That would essentially make Federal Reserve also a buyer of Treasury securities, narrowly viewing when the Treasury would issue more debt, whether there are entities that can absorb that, so-

Mark Zandi:                       Okay.

Samim Ghamami:            ... yeah, I think it's a big deal. It's a main concern, but hopefully in the next two, three years, we are not going to see events similar to what we observe in 2020.

Mark Zandi:                       Got it. You're saying we got all this debris flying around. If we don't do something, something's going to happen, but we've got a little bit of a window here next couple, three years because the interest rates are coming in, market conditions are going to ease, therefore it's less likely a debris is going to hit a satellite, but nonetheless, if we don't make these reforms at some point down the road, we're going to take out a satellite.

Samim Ghamami:            That's right. Mostly because of the fiscal outlook.

Mark Zandi:                       Yeah, the fiscal outlook. Got it. Okay. Very good. Well, I want to thank you for walking us through this because this is a very, again, difficult topic, but you did a great job. I really appreciate it and-

Samim Ghamami:            Thank you, Mark.

Mark Zandi:                       ... I-

Samim Ghamami:            Thank you for inviting me.

Mark Zandi:                       ... I know you're really worried, but I feel less worried because you're really worried. I know that sounds weird, but the fact that you're really worried, I'm less worried, so keep at it.

Samim Ghamami:            Thanks, Mark.

Mark Zandi:                       Yeah, keep at it. Thanks so much.

Samim Ghamami:            Yeah.

Mark Zandi:                       Cris-

Samim Ghamami:            Thanks for inviting me. Yep.

Mark Zandi:                       ... anything else?

Cris deRitis:                        Just thank you.

Samim Ghamami:            [inaudible 01:17:30].

Cris deRitis:                        That was really-

Marisa DiNatale:              Yeah.

Cris deRitis:                        ... enlightening. Yeah.

Marisa DiNatale:              Thank you.

Cris deRitis:                        Very enlightening.

Samim Ghamami:            Thank you, Cris, Marisa. Nice speaking-

Mark Zandi:                       Well, thank you-

Samim Ghamami:            ... with you.

Mark Zandi:                       ... thank you, Samim, and thank you, dear listener. Appreciate your listening in and we'll talk to you next week. Take care now.