"The "smart money" is now exploiting a new regulatory loophole in the options market to make a quick (lucrative) buck. They are selling large amounts of deep out-of-the-money 0DTE options, without having to post margin to clearinghouses, who don't count intraday expiries.." My question: if margins aren't needed to be posted, doesn't this allow extra 'money' (liquidity) to flow into the system, just like derivatives increased money supply in the economy in the Great Financial Crisis?
"For starters, the Fed can provide financial behemoths with billions, if not trillions, of liquidity via its securities lending program, regardless of changes in its balance sheet’s size. Banks can borrow the Fed’s assets to fuel more credit creation, hence more “liquidity”."
Isn't this liquidity draining? The non-banking sector gives the banks cash in exchange for Treasury or whatever they pledge as collateral.
The collateral borrowed nets the banks a cash profit on a spread since they are also usually funding a leveraged position of a hedge fund. So overall it’s boosting animal spirits.
The collateralized REPO loans that the banks make to nonbanks (like HFs) are overall LARGER in $ (because of leverage, rehypothecation...) than the cash that the banks give out in exchange for Fed's assets. So, even though the Fed's balance sheet' size doesn't change, the banks' balance sheets get bigger. As a result, it is a net increase of liquidity provided to the nonbank players in the markets. Can it be understood in this way?
So basically, you're saying the Fed provides the collateral for the bank to make a loan (realistically, REPO - which is just a collateralized loan). Liquidity is nebulous. In my models, I tend to ignore most "broader" liquidity except for deposits...since, you know...you actually need those to purchase assets or goods/services.
It is Important to recognize constraints in monetary policy due to the unprecedented size of public/federal debt- - over 30 trillion today in an economy with roughly 23trillion GDP. In 1981, the ratio of federal debt/GDP was 32% when Reagan/Volcker broke the back of inflation with a fed funds rate that approached 20%. . Today, a fed funds rate of only 10% would create interest costs of roughly 3 trillion in a federal government whose total revenue collection from all sources is less than FIVE trillion dollars for ALL federal operations.
The level of US federal debt places the US with the likes of Lebanon, Greece, and Italy (from a fiscal/debt standpoint). While the Fed can create a deep recession/depression (which it is in the process of doing through persistent rate hikes in the context recurrent public policy blunders)- the enormous size of the public debt precludes a successful Volcker like battle against inflation. In a word, inflation will ultimately win this battle - and the only course left will result in stagflation and debasement of the currency.
The idea that unlimited liquidity can be injected into this system has a consequence and a name- project Zimbabwe.
Agreed. That said, the federal interest as percent of GDP today is similar to that in 1981 (about 2%). Not to say the Fed has done such a good job, but to point out the other side of the coin...
"The "smart money" is now exploiting a new regulatory loophole in the options market to make a quick (lucrative) buck. They are selling large amounts of deep out-of-the-money 0DTE options, without having to post margin to clearinghouses, who don't count intraday expiries.." My question: if margins aren't needed to be posted, doesn't this allow extra 'money' (liquidity) to flow into the system, just like derivatives increased money supply in the economy in the Great Financial Crisis?
Yes because you can bypass regulatory limits by hedging jntraday. You don’t have to report your positions to clearinghouses.
"For starters, the Fed can provide financial behemoths with billions, if not trillions, of liquidity via its securities lending program, regardless of changes in its balance sheet’s size. Banks can borrow the Fed’s assets to fuel more credit creation, hence more “liquidity”."
Isn't this liquidity draining? The non-banking sector gives the banks cash in exchange for Treasury or whatever they pledge as collateral.
The collateral borrowed nets the banks a cash profit on a spread since they are also usually funding a leveraged position of a hedge fund. So overall it’s boosting animal spirits.
The collateralized REPO loans that the banks make to nonbanks (like HFs) are overall LARGER in $ (because of leverage, rehypothecation...) than the cash that the banks give out in exchange for Fed's assets. So, even though the Fed's balance sheet' size doesn't change, the banks' balance sheets get bigger. As a result, it is a net increase of liquidity provided to the nonbank players in the markets. Can it be understood in this way?
“Liquidity” in brackets points to the complexity of what is “liquidity”. There are so many definitions. 😂
So basically, you're saying the Fed provides the collateral for the bank to make a loan (realistically, REPO - which is just a collateralized loan). Liquidity is nebulous. In my models, I tend to ignore most "broader" liquidity except for deposits...since, you know...you actually need those to purchase assets or goods/services.
It is Important to recognize constraints in monetary policy due to the unprecedented size of public/federal debt- - over 30 trillion today in an economy with roughly 23trillion GDP. In 1981, the ratio of federal debt/GDP was 32% when Reagan/Volcker broke the back of inflation with a fed funds rate that approached 20%. . Today, a fed funds rate of only 10% would create interest costs of roughly 3 trillion in a federal government whose total revenue collection from all sources is less than FIVE trillion dollars for ALL federal operations.
The level of US federal debt places the US with the likes of Lebanon, Greece, and Italy (from a fiscal/debt standpoint). While the Fed can create a deep recession/depression (which it is in the process of doing through persistent rate hikes in the context recurrent public policy blunders)- the enormous size of the public debt precludes a successful Volcker like battle against inflation. In a word, inflation will ultimately win this battle - and the only course left will result in stagflation and debasement of the currency.
The idea that unlimited liquidity can be injected into this system has a consequence and a name- project Zimbabwe.
Agreed. That said, the federal interest as percent of GDP today is similar to that in 1981 (about 2%). Not to say the Fed has done such a good job, but to point out the other side of the coin...
https://fredblog.stlouisfed.org/2021/11/higher-public-debt-but-a-lower-cost-to-service-it/?utm_source=series_page&utm_medium=related_content&utm_term=related_resources&utm_campaign=fredblog