Comment by tripletao | Hacker News Reader

Comment by tripletao | Hacker News Reader

Parent Full thread

This article is incredibly misleading. The Fed is buying ETFs instead of constituent bonds because the ETFs are a more liquid and convenient way to buy the constituent bonds. The net effect is roughly the same as if they bought all the bonds individually, just with less effort and lower transaction costs. (People seem to find it weird that a basket of securities could be more liquid than the securities themselves, and I agree that it's weird; but it seems to be true, and failing to understand that leads to grossly wrong conclusions like those of this article. Matt Levine has many excellent discussions of this effect.)

BlackRock is just the administrator, and derives no benefit beyond their management fees. The direct benefit is to the sellers of the constituent bonds (whether individually or as part of the ETF), who get a higher price. There's also indirect benefit to the non-selling owners of the bonds, since that stops the price from dropping to the point they'd get a margin call and be forced to sell. That indirect benefit is the primary goal of this program, to avoid forced, cascading, 2008-style deleveraging. The Fed isn't trying to directly support the issuers (though the issuers do benefit from functioning capital markets, if they do choose to raise more money at this time).

The $75B allocated for losses is just an accounting placeholder; they don't know what the losses or gains will be. Historically these kinds of programs have often ended up net profitable, though that's not that point.

This is also a misleading comment. The main purpose of the Secondary Market Corporate Credit Facility is to purchase secondary market bonds and this is stated in the IMA and term sheet. The only reason why they're buying ETFs right now is because it's easier operationally and the issuer registration process for primary and secondary bond purchases has been difficult so far. They are not buying ETFs because they are "more liquid and convenient" vs underlying.

The Fed also is absolutely trying to directly support issuers through these facilities and ETF purchases are an important part of this. Primary issuance is dictated by where secondary markets are trading and if some of the most liquid corp instruments (ETFs) are trading extremely wide or at a huge discount to NAV (like they were before these facilities were announced) then primary issuance will either be much more expensive or completely closed.

I'm not sure where we disagree? What's the difference between your "easier operationally" and my "more liquid and convenient"? You agree in your other comment that the ETFs were more liquid than the underlying. And I agree and noted previously that issuers benefit from working (secondary) capital markets.

Your post says that they’re not buying bonds because ETFs are a better option. That’s exactly true and ETF purchases are not the main goal of the facility. There is way more capital allocated towards primary and secondary bond purchases than there is for ETFs and they’ve stated that ETFs are last in their purchase waterfall.

Operationally, it’s much more difficult to get the bond purchases rolling because they have to get individual issuer certifications before making any purchases. This is a restriction created by Congress and had it not been in place, they would be buying bonds right now. They are likely going to make some modifications to the facility in order to streamline this process because it’s preventing them from achieving the main goal of it: buying bonds.

First, I think you're missing a "not" in your second sentence?

The certifications are an interesting additional detail that I wasn't aware of. So if I understand correctly, the program wrote one set of rules for purchases of individual bonds, and then a different set of rules for purchases of ETFs. It allocated more money for individual bonds, but the Fed discovered that those rules meant that no issuers wanted to participate. So the Fed instead purchased ETFs.

I think I'd still say that makes the ETFs more convenient? Certainly that's true under those rules; and to the extent those different rules exist for good reason (e.g., because with a diversified and liquid index, it's easier to avoid both the appearance of political favor and the actual thing), that seems fundamentally true too. So I don't see what that changes in my initial statement, though it's interesting that it happened "by accident" instead of by design.

> First, I think you're missing a "not" in your second sentence?

Yes, thank you for pointing out.

> The certifications are an interesting additional detail that I wasn't aware of. So if I understand correctly, the program wrote one set of rules for purchases of individual bonds, and then a different set of rules for purchases of ETFs. It allocated more money for individual bonds, but the Fed discovered that those rules meant that no issuers wanted to participate. So the Fed instead purchased ETFs.

The rules were not spelled out at the time of the announcement; including the part on personal certification by the issuer. If you look to the ECB corporate program for example, they do not require issuer certification and that was seen as a model for the operations of this.

Without getting too deep into things, Congress wanted to make sure that US companies benefited from this and that's part of the certification process. Additionally, certification requires attesting that the issuer has not received money under the CARES act and while it's not been publicly stated, it's suspected that's one of the reasons why personal issuer certification is required.

While all of this was evolving, PPP launched and there was a lot of backlash on large corporations receiving money. Between the logistics of having individual issuers certify and issuers being reluctant to certify, the bond purchase portion of the program has been stalled.

So yes, the Fed made its first corporate facility purchases through ETFs as a result of all of this but also took two months to do so. If the main goal of the facility was to buy ETFs and they really wanted to get it done, they could get that up and running within a week max if not sooner.

> I think I'd still say that makes the ETFs more convenient? Certainly that's true under those rules; and to the extent those different rules exist for good reason (e.g., because with a diversified and liquid index, it's easier to avoid both the appearance of political favor and the actual thing), that seems fundamentally true too. So I don't see what that changes in my initial statement, though it's interesting that it happened "by accident" instead of by design.

I take issue with saying that they're making ETF purchases because they're more liquid and convenient for a few reasons. One of the main reasons is that only reason why they're buying them right now is because it's the only thing they're actually able to buy. Liquidity and convenience really mean nothing when you only have a single option.

As far as avoiding anything with politics, there was no consideration given for that when the facilities were announced and I doubt there is any now. They changed purchase eligibility retroactively to include fallen angels and the cutoff date magically included Ford while excluded several sizable issuers by a day or two. It's also very tough to hand out favors through bond purchases in a way that would materially affect funding costs for a specific issuer AND have it slip under the radar. While that doesn't escape the appearance of political favors, I would argue that by selecting Blackrock as the investment manager they really don't care about the appearance of politics. In fact, by selecting Blackrock, it shows that their primary goal was bonds rather than ETFs as you can easily find an investment manager to manage a few billion in ETFs; it's much harder to find one that can manage few hundred billion in bonds.

Appreciate the deeper context from a practitioner, and no question that they intended to buy individual bonds--as you note, this could have been a much simpler program if they intended only/primarily to buy ETFs. I think the question is whether to consider their failure to buy individual bonds as an ordinary bureaucratic delay, or as the emergent but "correct" result?

For example, is it just an inconsistency that issuers need to attest that they didn't receive money under the CARES act if their bonds are purchased directly, but not if they're purchased as part of an ETF? Or does that make sense, since it's politically acceptable to support a diversified index, but not to support a specific company that already received other government help? I like the latter choice because it's satisfying and logical, though I understand that the reality is hazier.

I truly believe that it emerged as a bureaucratic screw-up and can see how it evolved to its current state. I think it makes sense that they have a certification process for primary issuance and given CARES act strings attached, I can see how that also got attached to the secondary facility. Requiring issuer certification for secondary purchases was a complete surprise to everyone and the base assumption was that they were going to just follow some sort of index approach. Mentioned before but the ECB does not have any sort of certification process for their corporate program but that corporate program was also not launched at the same time as a huge fiscal program, so politics.

I do agree that buying ETFs is "cleaner" for all sorts of reasons. The certification process for bonds vs ETFs is slightly inconsistent but given that they're not going to participate in the create/redeem process, I don't have too much an issue with it. If they were buying ETFs, redeeming them, and then actively managing the bonds from there, then it would be a little more murky. Besides the fallen angel ETFs, none of the ETFs they've bought so far (and everything that qualifies as well) does not have any real issuer concentration that you could argue tremendously favors any particular issuer beyond reflecting the actual bond market.

To further expand on the overall topic, if all the Fed did was buy ETFs, there's a real risk that would not be enough. During any crisis, in order to be effective, central banks need to make big moves. To use a crude metaphor, individual bullets fired separately don't have nearly as much impact as a single bazooka round and sometimes you only have a chance for one shot. Bond markets aren't as efficient as equities and without secondary purchases, there could have been a real chance that you had ETFs more or less stabilized but several underlying issuer/sectors/whatever aggregate group continue to be dislocated. For another crude metaphor, sometimes the tail (ETFs) wags the dog on this stuff and vice versa. In order to have functioning markets, you need complete control over the entire animal which would be primary issuance, secondary bonds, and one of the more liquid proxies.

Very interesting, thanks. But if the Fed buys broad ETFs to support the overall index but isolated issuer/sector/whatever prices still fall sharply, is that good or bad? Like cruise ship bonds really should be falling more than tech bonds, and if the Fed pushes up prices of a broad ETF then the market can still decide that on its own (as long as all the changes over the entire index average out to whatever the Fed is targeting).

If the Fed buys individual bonds, then they have to decide the relative amounts that they're going to support each subgroup, which seems a lot more politically fraught to me. I understand the idea that if the Fed sees what they perceive as panic selling in a particular sector then they can intervene just there and get more effect per dollar spent, but that judgment seems a lot more controversial the narrower the group benefiting gets.

They're buying shares of ETFs because it's easier operationally but not because its more liquid and convenient? Those seem pretty close to synonymous to me.

They’re quite different for the purposes of this facility and really trading in general. As I mentioned a few times here, the Fed is requiring individual issuer certification for bond purchases. They have not had any issuers certify yet so they have not made any bond purchases.

Liquidity and convenience in the markets means I can trade in size with tight bid/ask and possibly don’t need to deal with a scumbag dealer on the phone/chat. Operationally to me means there is something that prevents me from trading at all.

OK. Issuers need a certification to sell to the Fed. My understanding is that no one wants to sell to the Fed because the first person that does will be seen as having a weak financial position. This was the reasoning for TARP - the Feds made every bank take money, even if they didn't need it.

If no one wants to sell to the Fed, why do they need a certification? Also they're buying ETFs of bonds, are you saying this is materially different than buying the actual bonds?

If there is something preventing you from making trades it means you have lower liquidity.

> If no one wants to sell to the Fed, why do they need a certification?

I don't understand your first question. The certification process covers both primary and secondary purchases. The Fed's terms for primary purchases are pretty punitive and most issuers that qualify for it would easily be able to raise in syndicated markets. Markets are open right now so this does not present an issue.

The problem is the Fed is also unable to make secondary purchases unless issuers go through the certification process. The main purpose of the SMCCF is to buy secondary corporate bonds and they're unable to move on that because of the certification process.

Issuers would love to sell to the Fed but your understanding is only a small reason why none have certified yet. A lot has changed since these facilities were announced and there was extreme backlash against larger corporations taking advantage of PPP. There's a similar fear attached to this.

> Also they're buying ETFs of bonds, are you saying this is materially different than buying the actual bonds?

Yes, there absolutely is a material difference for the purposes of this facility and in actual trading. For the purposes of this facility, there are still many sectors/subsectors trading pretty wide to pre-covid levels. If you believe that these bond purchases facilitate the Fed's mandate of maximum employment, then targeting specific sectors that are having funding pressures would be one of accomplishing that.

> If there is something preventing you from making trades it means you have lower liquidity.

That's a really bizarre definition of liquidity for the context of this; especially when you're talking about the Fed. The discussion was on ETFs being more liquid than the underlying bonds. Something preventing me from trading does not mean that the thing being traded is illiquid. For example, there are many securities that require an ISDA to trade and offer way more liquidity than other similar options.

The Fed does not want to do credit analysis. They do not want to be the primary purchasers of debt. As a lender of last resort, they want to buy debt from primary purchasers in the hope that they valued the debt correctly.

Of course... Everyone with poor debt quality would LOVE to sell to the Fed...

One of the big lessons of ETFs the past year has been whether the underlying "fake" liquidity of ETFs would cause problems for the underlying real poor liquidity of bonds. The Fed is buying ETFs because the price of the ETF goes into the underlying bonds. The Fed is buying bonds. They think it's close enough to buying the bonds.

It's really bizarre to me that you think a poor definition of liquidity is that you personally cannot sell bonds. I don't care if the market is bad or your phone is too broken to make your sell order. Complain to your boss that the market was fine but you couldn't make the trade. See what they say. You cannot trade. Your liquidity is bad.

I think I understand whatok's distinction, and I think it's significant. They're saying the Fed is buying ETFs instead of individual bonds not because they prefer to buy ETFs, but because the certification rules forbid them from buying bonds. That's a consequence of those rules, and not of the market for the individual bonds, except to the extent the different characteristics of the individual bonds vs. ETFs caused those different rules to be written in the first place (which I do believe is the case, per my other comment).

I believe my original comment more or less correctly describes the operation of the program, and the reason for that operation. That operation wasn't actually the intent of the program, though, just the consequence of rules that didn't work like the drafters expected.

Be precise.

It seems like you think the Fed's failure is that they don't buy individual bonds. Why would the Fed prefer to buy individual bonds? The Fed buys individual bonds. It buys government debt and people hate them for it.

I'm not sure what you mean? I think the Fed buying ETFs is fine, and that the Fed buying individual corporate bonds on the secondary market would be fine too but more complicated to administer without the appearance of political favoritism.

So it makes sense to me that they're buying ETFs. whatok pointed out that the Fed didn't originally set out to buy mostly (or exclusively) ETFs, but rather to buy mostly individual bonds--it's just that the individual-bonds program turned out to be too complicated to actually use, so they ended up buying all ETFs. I thought that was a good clarification, and an interesting lesson on the complexity of modern finance (that even the creators of the program failed to predict how it would actually work).

I'm not sure what to say to someone who hates the Fed for buying government debt, beyond that they've grossly misunderstood how a central bank works. I'd guess they also hate both the individual corporate bonds and the ETFs, so I'm not sure what your point is there?

>People seem to find it weird that a basket of securities could be more liquid than the securities themselves

Why would this be weird? A basket of securities is more diverse which spreads out your risk. Therefore, it makes sense that, in general, it would be more liquid.

Lower / more diversified risk doesn't necessarily mean more liquid. For every big liquid ETF, there's many smaller ETFs with similar holdings and thus similar diversification and risk, but much lower volume, wider spreads, shallower order books, etc.

Though I agree that long-term, smart investors will prefer to own a diversified product because of that lower risk. So it does make sense that whatever diversified product they choose becomes more liquid than its constituents, just for the small number of winners they coordinate on (thanks to better marketing, lower fees, better deals with market makers, etc.) and not all ETFs with comparable risk profile.

There's an additional liquidity transformation with the fact that a majority of trading in the underlying happens over the phone/chat. Lack of liquidity in the underlying is why all of these ETFs were trading at 5%+ discounts to NAV while something like SPY was much more well-behaved back in March.

Reply on news.ycombinator.com