Markets are untrustworthy
The big lesson of this week: Don't trust the markets.
What's happening: U.S. money markets fell into chaos this week as risk-free overnight interest rates spiked to almost 10%. But, while market information is a very important signal, it should never be taken as being definitive.
- In the stock market, public order books on "lit" markets — where all the buy and sell orders for any given stock are theoretically visible to all traders — have been functionally useless for years. High-frequency traders place and withdraw millions of orders every second, and there's a mini "flash crash" in some stock or other every day, with the price plunging and then recovering within the blink of an eye.
- In precious metals futures, criminal racketeering and market manipulation went on for some 8 years, according to a complaint this week against JPMorgan traders, including the former head of the bank's precious metals desk.
- In fixed-income markets, banks have been fined billions of dollars — and 5 bankers have gone to jail — for manipulating the key Libor interest rate.
Where it stands: This week's chaos was largely due to a series of technical factors, including the fact that the Treasury issued some $54 billion of new bonds at exactly the same time that companies started withdrawing cash in order to make their Sept. 15 quarterly tax payments.
- That created a liquidity crunch, forcing the Fed to step in with $203 billion of short-term cash.
Context: Until the financial crisis in 2008, the Fed conducted open market operations every day to keep interest rates at their target level. Those operations ended when quantitative easing massively expanded the central bank's balance sheet.
- Now that its balance sheet is shrinking and banks need abundant reserves for regulatory reasons, the Fed is going to have to step in more frequently to ensure that rates are where they should be.
My thought bubble: The Fed's traders could probably have told Treasury's liability-management team that the timing of their bond issues would be problematic for the money markets.
- But we no longer live in a world where Tim Geithner could move effortlessly from Treasury to the New York Fed and back again. President Trump is waging war against the Fed, which makes things very awkward at Treasury.
What they're saying: "There are some advantages to just asking banks to make up the interest rate," writes the indispensable Bloomberg columnist Matt Levine. "To the extent that reality is messy and idiosyncratic there is something nice about abstracting away from it."
The bottom line: Multitrillion-dollar financial markets often look reasonably stable from afar. But they're always slapdash and human, and prone to deliberate or accidental breakage.
- When that happens, governments and technocrats need to be able to step in to fix what's broken. Governments aren't perfect, but taking them out of the system entirely, as some Bitcoin true believers would like to do, seems like a terrible idea.