Samim Ghamami on How to Reform the Treasury Market

Samim Ghamami is an economist at the Securities and Exchange Commission (SEC), where he has been working on reforming the US Treasury market, and he joins David on Macro Musings to talk about these efforts. Samim and David also discuss the long run path of interest rates, the basics of the Treasury market, Samim’s outlook for Treasury market reform, and much more.

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Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

DISCLAIMER: Samim’s views are his own and do not represent those of his SEC colleagues, the commissioners, or the Chair.

David Beckworth: Samim, welcome to the program.

Samim Ghamami: Thank you very much, David. It's really good to be here.

David: It's great to have you on. We always like to talk about the Treasury market, the most important financial asset market in the world. It's the benchmark for many other markets. And there's been some challenges in this market, and you're working on that at the SEC. Now, you have an interesting history as to how you got to the SEC. So, walk us through your journey there.

Samim’s Journey to the SEC

Samim: Sure. I mean, my background is a mix of work in the official sector and private sector. On the official sector side, I started out working as an economist at the Federal Reserve Board several years ago. Then, I joined the US Treasury Office of Financial Research. I worked there, first as a senior economist, and then [as] Associate Director of Research. More recently, since late 2022, I've been with the SEC, and have had the opportunity to work with the senior management and the SEC chair on the different aspects of the reform of the Treasury market. On the private sector side, I've worked at different firms. For example, I've worked at Goldman Sachs on the sell side. I've also worked at Millennium Management more recently before joining the SEC on the buy side.

David: Okay. Now, something that's interesting about the Treasury market, and maybe because it is so important, is that it has many regulators, and SEC is one of them, but just a quick rundown. Treasury writes the rules. The Federal Reserve Bank of New York facilitates debt auctions of Treasuries. The SEC and FINRA supervise firms that trade Treasuries. CFTC oversees derivatives tied to Treasuries. And the Fed, the OCC, [and] FDIC oversee primary dealers. So, you come in at the SEC. What do you do at the SEC with the Treasury market?

Samim: From the SEC side, my work has been focused on— probably, you're familiar with the broader central clearing mandate, a rule that was finalized last December by the SEC. That has been one aspect of my work at the SEC, and other rulemakings as well that would overlap with the reform of the Treasury market. So, for example, a mandate for firms that are essentially doing market-making in Treasury markets, to register with the SEC as broker-dealers, the so-called broker-dealer rule. At the SEC, I'm at a division called DERA, the Division of Economic and Risk Analysis. So, my work is partly policy-oriented, and it's partly research-oriented. At the research front, I work on different topics, [such as] the interplay between macroeconomics and finance, and that has been, essentially, one of the reasons behind my interest in working on Treasury market reforms in the past several years.

David: So, you helped finish up the work on the new central clearing rule at the SEC, and some other topics. What is the timing of that rule? When does it kick into play? When will participants in the market have to follow it?

Samim: So, in roughly two years from now, hopefully, the rule would be completely implemented, successfully. It's a phased-in process. We can get into details if you are interested. For example, by roughly next year, this time, or 10 months from now, the only central counterparty that is essentially in charge of the clearing of the whole— almost whole— secondary part of the Treasury market would need to finalize its implementation of different types of client clearing models. We can get into that. But then, there would be, after that, a clearing for the cash part of the Treasury market, and then, finally, the repo part of the Treasury market. So, roughly two years from now, we would have the full implementation. That's the plan.

David: So, it will be a very different Treasury market in two years. So, we'll see what happens as we get closer to that. Well, let's step back a bit and just take a broad view of the Treasury market, its size, its features. We'll get into the structure, and then, ultimately, to some of the challenges and the reforms, including central clearing, that we want to talk about with you. So, if you listen to politicians, it's an election season. Some of them like to throw out the number, "Oh, the Treasury market, we owe $34 trillion in debt." 

David: Now, that's the par value, and it's also including that intergovernmental debt. So, it always bothers me when they throw that number out, because it's a little misleading. It's still huge. There's still $26.9 trillion in marketable debt at par value, so it's sizable. That's $7 trillion there, or so, of intergovernmental debt. As someone outside the Treasury world— if they're not like you, they don't have their daily engagement with it— which number really matters, in your view? The total amount, the $34-35 trillion, or the $26 trillion? What should we care about as, say, US citizens?

Breaking Down the Size and Composition of the Treasury Market

Samim: For US citizens, the total amount matters, obviously. From the perspective of Treasury market resilience, and the liquidity, or potential illiquidity disruptions in the Treasury market, the marketable public debt matters more, which is the number estimate that you just mentioned, roughly $27 trillion, across bills, notes, bonds, TIPS, [and] FRNs in 2024.

David: So, why should a US citizen care about the intergovernmental portion of that? That's just debt that the government owes to itself, right? I understand the marketable part. That's like real resources that taxpayers have to give up to bondholders. But why should we care about the intergovernmental portion of that total $34 trillion number?

Samim: One aspect of that, I think, is the whole budget process. So, I think, if citizens are worried about the accumulation of public debt and deficits, they need to be worried about the overall debt in general, not just the marketable public debt. I think that's the essence of it.

David: Okay. One other question, just on the size of the Treasury market. So, TIPS are Treasury Inflation Protected Securities. So, they're real securities, but they aren't as big as nominal, or regular Treasuries. Why do you think that's been? Why haven't we seen more interest in TIPS?

Samim: It’s in part because of the demand by investors, households, and in part because of the policies and strategies of the Office of Debt Management. So, as you know better than me, from a purely academic perspective, the optimal maturity structure of the debt would need to spread across different maturities, across different products. So, that's one aspect of it. So, essentially, it's supply-demand, and policies and strategies of the Office of Debt Management. Another aspect of it— we can get into this in more detail— but since the COVID shock in March 2020, as you may know, there has been more issuance of bills. So, these are, essentially, shock absorbers in the market, and we know that, in terms of the total issuance of bills since Q1 of 2020, that has been a bit above the advice of TBAC. So, in short, it depends on ODM’s policies and strategies, and it depends on whether we have a shock to the economic system, or financial system.

David: So, some of this is simply the Treasury responding to the demand. So, the public, the market, wants nominal priced Treasury securities, whether bonds, notes, or bills, and less TIPS, apparently. So, I guess, then, the question is, why does the public not want more TIPS? One theory I have, I'll throw it out there, and you can evaluate it for me, is that we suffer from money illusion. We like fixed nominal priced securities. There’s something about it, like this is a $1,000-security, as opposed to a security that changes value based on the CPI, and it’s just less clear. What do you think? Is that a potential reason why we prefer—?

Samim: I agree with you. Money illusion could be a potential reason. The other reason is [that] before the COVID shock, as you know, we have been through an extremely deflationary environment for more than 30 years, around 40 years. So, that could be another reason for that. But if you ask me, what is the reason behind not seeing the rise of TIPS after the COVID shock compared to, for example, bills, part of that could be exactly like you said, money illusion. The other part of that is that bills are essentially shock absorbers. They are cash-like assets.

David: Because you could imagine a world where everything is perfectly indexed, like a world where inflation should have no problem, no effect, no cause, but we don't see that. Okay, let's move on, then, and talk about some other facts about the market. So, we already mentioned its size. I checked this morning, 10-year Treasury yields are at 4.2%, so it's come down some. It was quite a bit higher. Where do you see interest rates going over the long run? So, there's this discussion about R-star, the equilibrium rate. Where do you think we're going, and what would be the potential stories behind that?

Explaining the Long Run Path of Interest Rates

Samim: We are all familiar with inflation being a monetary phenomenon. If we think about the path of R-star, the so-called neutral real interest rate, in the long run, there might be some structural forces in the background as well— for example, demography [and] globalization. So, I'm in the camp that, I think— and I explain why— that let's say that from now until 10, 15 years from now, we will be in an environment where R-star, or the neutral rate, would be around 2%, and inflation would be between 2% [and] 3%. I'm in this camp.

Samim: So, what are the reasons behind that, and behind my thinking? So, we know that, before the COVID shock, we were in an environment of excess desired saving over investment, from the household sector to the non-financial corporate sector. If we ask ourselves, what is the reason behind that dynamic? There could be several reasons, but one could be, as I mentioned a few seconds ago, demography, [and] one could be globalization. Advanced economies, essentially, were swimming in cheap labor, before the COVID shock, for 20 to 30 years during the era of the rise of China, and that's essentially what we call globalization; minimum barriers for international trade, and relatively free flows of capital. So, that can be viewed as a massive positive shock to the labor supply in the advanced economies.

Samim: So, that would lower the bargaining power of the labor force. That would lead to potentially lower U-star, the natural rate of unemployment. At the same time, we were in a period of decline in dependency ratios, meaning, more workers compared to the young or the old. So, that whole thing is quite deflationary, because when you have more workers, [then] they would produce more than they consume, but when you have, compared to a scenario where the dependency ratio would rise— this is happening right now in the advanced economies— then you have more consumers compared to producers. So, when you have more consumers, all else being equal, that's more inflationary. So, I just discussed demography very quickly, globalization. So, that would essentially lead to, perhaps, less saving in the household sector, [and], perhaps, less saving in the non-financial corporate sector.

Samim: But on the investment side, particularly in the US, it's extremely tricky, because we know that corporate profits have been rising. At the same time, the desire for investment in the corporate sector has been declining in the past 30 years. So, if that changes, for some reason, [and] if we would have more private investment, [then] I would be more confident about R-star staying above 2%, and inflation remaining between 2% to 3%. As you may know, there could be several reasons behind that, [like] the lack of private investment, particularly in the US. Some have argued that it could be because of market concentration, monopoly. So, it's difficult to decisively say it is because of monopoly and concentration. But there are some estimates— for example, researchers have shown that when concentration is not positively correlated with productivity growth, then this is bad concentration.

Samim: And we know that, in the past 20 years or so, concentration in the non-financial corporate sector has not been positively correlated with productivity growth. So, I would just call this bad concentration. There could be other reasons, but I think that, in my personal view, the bottom line is that savings would be reduced on the household sector side and maybe in the corporate sector. As I just said a few seconds ago, the investment part is tricky. Some would argue that, because of the fight against global warming, the corporate sector may be inclined to invest more, but that is the tricky part.

David: So, you're saying that, on the corporate side, there may be a productivity boom. Real returns to capital [are] going up due to investment in green technology, maybe AI.

Samim: AI, exactly. 

David: Maybe even the pandemic shock shook things up and made us more efficient, better labor matching, all of those things. And so, we have a higher equilibrium rate, and you said even potentially above 2%, I thought I heard you say, which would really add another 2% inflation, [and] you'd be above 5%, [or] getting close to 5%.

Samim: Yes, so, I think that if we have more private sector investment, assuming that the saving would decrease, then I think that R-star would be [somewhere] around 2%, and inflation would be [somewhere] a bit more than 2%.

David: Now, on the demographic side, the story that you told is a little different than the one was told, say, before the pandemic. Before the pandemic, [it was] the aging planet, saving more, more risk averse, we're going to hold more safe assets. But you're saying that we're coming to a place where that story is going to be flipped, or different. People are going to be saving less, and therefore, we'll have a higher R-star.

Samim: In part, I think, because of the rise in dependency ratios in advanced economies. So, let's say, even if policymakers manage to increase the retirement age in advanced economies from, let's say, 65 to 70, but if the life expectancy has been 82, or would become 80, then, naturally, when you have this rise in the dependency ratio, heavily weighted through having older people in societies, then, naturally, it means less saving.

David: Okay. Alright, so, going forward— not just short term, but you're saying that in the medium to long run, we could see a higher R-star, and therefore, higher rates more generally. So, someone who's waiting for their mortgage rate to go down, they may not get that. They may not get what they had pre-2020.

Samim: Right, and two other important aspects of it that I forgot to mention— I would quickly mention that, as you know, the dynamics of R-star, at least in advanced economies, is a global phenomenon. We are talking about advanced economies. The other thing is— We briefly discussed the accumulation of public debt and deficits at the very beginning, and we know that if the debt-to-GDP ratio continues to rise, [and] if the deficit-to-GDP ratio continues to rise, [then] that would be a push for having a higher interest rate. So, that's another major factor.

David: Yes. So, I'm definitely concerned about that as well, that it doesn't seem like there's any practical way to rein in debt-to-GDP going forward. We see primary deficits as far as the eye can see going forward, which would raise interest rates. Okay, so, again, I have friends who ask, "David, when can we refinance?" I tell them, "Well, maybe never. Just accept that rates will be higher," so, for those who did not finance their homes in 2021, or the decade prior. Alright, let's talk about the structure of the Treasury market, because this is where we get into the issues and the need for reform. So, let's walk through some of the key components. Tell us, how do you think of the Treasury market? What are its key segments?

The Key Segments of the Treasury Market

Samim: Treasury markets— We can think of two main segments of the market, the so-called inter-dealer market, and the dealer-to-client market. So, that's one aspect of it. The other aspect of it is— as we maybe briefly discussed earlier— the secondary part of the Treasury market can be divided into the so-called cash Treasuries, the repo, and the reverse repo market. 

David: Okay, so, what markets have been the most consequential? When we think of, for example, March 2020, you hear a lot about the cash-futures basis trade market. Was that an important part of the story? Is that where we should be looking, if we're thinking about the Treasury market, or should we still be concerned about the inter-dealer market as well, and the other ones?

Samim: There are several reasons behind the disruption in the US Treasury market due to the COVID shock between March and April of 2020. One is that— we will discuss it briefly— principal trading firms becoming more active players in the inter-dealer market. So, the inter-dealer market used to be dominated by primary dealers; essentially, broker-dealers, dealers that are affiliated with large banks. These are the main trading counterparties of the Federal Reserve Bank of New York.

Samim: But in the past several years, principal trading firms— these are firms that would put on high-frequency trading strategies in the US Treasury market, and other parts of the financial markets— These have become active players in the inter-dealer market, and in the context of the so-called cash-futures basis trade, we can discuss their role in [those] type of trading strategies, and the contribution of that type of trading strategy in the disruption, in the liquidity of the US Treasury market after the COVID shock. Another main factor has been a reduction in the market-making capacity of the old-school broker-dealers that are bank-affiliated; Goldman Sachs, J.P. Morgan, Morgan Stanley, Citi, Wells Fargo. So, the reduction in the market-making capacity of these G-SIBs, Global Systemically Important Banks, have been mostly because of the post-Global Financial Crisis capital and liquidity regulation.

Samim: That capital and liquidity regulation has been very good, in the sense that it stabilized the financial system after the GFC, but a natural consequence of that was that large banks, G-SIBs, essentially reduced the size of their balance sheet. At the same time, that coincided with the accumulation of public debt and deficits that we just discussed. So, Treasury [is] issuing more marketable debt, [and] at the same time, [there is] some reduction, significant reduction in the size of the balance sheet of G-SIBs. So, that essentially means a reduction in market-making capacity.

David: Okay, so, you shared several, sounds like, important developments. One is these principal trading firms, high-frequency traders. Now, they are— In a sense, they've become the market makers, right? They're the ones that really matter to make sure transactions happen.

Samim: In the inter-dealer market, currently, their share of trading is between 50% to 60%. The rest of that is still with bank-affiliated broker-dealers.

David: The traditional approach.

Samim: Yes.

David: But they're very important. Now, they were a part of the cash-futures basis trade, is that right?

Samim: That's right.

David: So then, they tie into the March 2020 story, when everything came apart, and the dash for cash took place. So, you have that important development, high-frequency trading, and they're trying to make a little bit of arbitrage, or a spread. Then, when the chaos hits, they flee. So, they're an important part of the market, and when they get out, that really undermines the rest of the Treasury market. Now, the other thing that you mentioned— well, two other things you mentioned, so, I guess, three big developments. The other two would be the huge accumulation of debt and the ongoing expected accumulation of debt. We've touched on that, the primary deficits going forward. Then, the other one is the fact that the primary dealers' bank balance sheet capacity has shrunk. They simply can't intermediate all of this debt. So, from both sides, we're seeing more debt, and we're seeing less ability to intermediate that debt, post-financial crisis.

Samim: Exactly.

David: So, you have primary dealers, the bank-affiliated part of the Treasury market— It's shrinking in its role, but we are seeing a growth in the principal trading firms. So, they're picking up the slack. Is that a fair assessment? Are they doing what the primary dealers aren't doing as much, or is it different?

Samim: To some extent only, because if they had picked up the slack fully without unwinding the cash-futures basis trade, then we wouldn't have seen the disruption after the COVID shock. But I think the main issue has been them unwinding these relative value trades between cheaper cash Treasuries, more expensive Treasury futures, by essentially having sometimes extremely high leverage, and at the same time, shrinking the market-making capacity of bank-affiliated broker-dealers. That led to the disruption in the Treasury market after the COVID shock.

David: Okay, so they have stepped in, they just are not stepping in enough. They can't do enough, and they're not reliable. They run when there's stress in the market.

Samim: That's right.

David: Okay, but to be clear, high-frequency trading, principal trading firms, they were a development, a phenomenon, before the Great Financial Crisis. They just stepped up their role when there was this void created by the new regulations that dialed back the big banks.

Samim: That's right. In my personal view, that was a natural transformation of the Treasury market after the Global Financial Crisis from the perspective of the players in the private sector. So, for example, consider a scenario where mutual funds want to buy Treasury futures for hedging purposes, for example, or to take views on the movements in the yield curve. Now, take the perspective of principal trading firms, large hedge funds, for example, Citadel or Millennium, where they devise a relative value trading strategy, where they find it profitable to use leverage to sell these Treasury futures to mutual funds, and buy Treasury securities, and finance it through the repo market, and [they are] doing it on a very large scale. So, they essentially become a liquidity provider, because they buy Treasury securities, but the problem is that, during market distress, if the spread associated with this trading strategy goes in the wrong direction, [then] they need to unwind their positions. They also need to sell the Treasury securities. So, we could see times--

David: It makes it worse.

Samim: Exactly. So, we could see times that— PTFs that could be liquidity providers, in normal times, would need to sell Treasury securities. At that time, mutual funds would need to sell Treasury securities, a dash for cash. That's what we observed in March of 2020. And at the same time, G-SIBs wouldn't have enough balance sheet space to buy these Treasury securities, and that's when the Federal Reserve intervened and it purchased, essentially, roughly, more than $1 trillion of Treasury securities and mortgage-backed securities in just roughly one month from March to April of 2020, to calm down the market.

David:  So, I have heard cynical takes on this development that, with the Great Financial Crisis, all of these regulations that stepped in that have shrunk the balance sheets of banks and primary dealers, and the growth of high-frequency trading— that it forces the hand of the Fed. The Fed has to step in more regularly now, because you don't have a committed buyer in the Treasury market, as you just described. These high-frequency traders have to sell their securities. It creates a fire sale, and there's chaos in the market. So, the cynical take is that these regulations are making the Fed kind of like the liquidity provider of last resort on a more regular basis, and they have to step in. 

David: So, the endgame is the Fed here. They have to be more engaged, but I'm guessing that the reforms that have been suggested are a way to maybe take the pressure off the Fed. So, why don't we go and talk about some of these reforms now? We've touched on one that you have been very heavily involved in, and that's central clearing. So, why would central clearing make a big difference, both, say, in normal times, but also in stressful times, say, like March 2020?

Central Clearing as a Treasury Market Reform

Samim: Sure. So, if [it’s] okay, let me just briefly mention different elements associated with the reform program.

David: Sure.

Samim: Then, I will jump into central clearing, broader central clearing. So, as you essentially mentioned, the main objective of the reform program has been, essentially, increasing, diversifying, and stabilizing the market-making capacity in the US Treasury market. How can that objective be achieved? Two different elements. So, one is, for example, realigning the risk-sensitive and risk-insensitive capital regulation of large banks. I'm sure that you know about the leverage ratio in comparison with risk-weighted assets of large banks. So, that's one element. Another element is the standing repo facility that was set up a few years ago by the Fed, [which] was originally supposed to be open to more than just the trading counterparties of the New York Fed, according to the recommendation of the G30, to essentially increase the market-making capacity. But currently, it's open to only the trading counterparties of the New York Fed. So, that was one element of the program that could increase and diversify the market-making capacity in the US Treasury market.

Samim: Another element is a broader central clearing mandate. On that, I would just mention that— let's say, assuming successful implementation of the SEC rule, we will have more transparency on their centrally-cleared US Treasury market; again, both the cash side and the repo side. Another impact would be a potential increase in the market-making capacity of bank-affiliated broker-dealers. So, that's a bit tricky. I'm not sure whether that would materialize. Another aspect of central clearing is, again, if implemented successfully, it could make the US Treasury market more stable. So, let me go back to why we care about transparency, because we know that more than 70% of both the cash part of the Treasury market and the repo part was traded on a bilateral basis, let's say, between a broker-dealer and a customer, [and] could be a hedge fund.

Samim: Over the OTC trading, bilateral trading, is, by definition, opaque. So, under broader central clearing mandates, regulators, policymakers— from their perspective, the Treasury market would become a bit more visible, so that's good. Transparency is good. On the financial stability side, we briefly discussed the cash futures trade. I mentioned that that trading strategy became profitable for large hedge funds, because they were able to use a lot of leverage.

Samim: So, we know that, under central clearing, we have the mandate of margin requirements. If under margin requirements, again, implemented successfully, independent broker-dealers, or hedge funds, can't take that much of leverage. So, that could increase financial stability in the US Treasury market. And on the impact of central clearing on the dealer balance sheet side, I mentioned that that's a bit tricky, because it highly depends on whether netting efficiencies, achieved through central clearing, would dominate and outperform netting efficiencies that currently exist in the non-centrally cleared part of the Treasury market. If that materializes, then we would see more capacity for market-making from the perspective of bank-affiliated broker-dealers.

David: So, we would see more balance sheet capacity, as you just mentioned, more market-making, so something like this may--

Samim: That's tricky, though.

David: It's tricky, but it's possible. So, something like this, had it been in place prior to March 2020, would it have made a potentially different outcome than the dash for cash?

Samim: Yes. If in a scenario where, under central clearing, multilateral netting dominates bilateral netting, [then] we would have more market-making capacity by G-SIBs. Going back to the COVID shock period, then, probably, bank-affiliated broker-dealers would buy more Treasury securities from the buy side [and] from, also, for example, foreign investors as well, both on the private side and in the official foreign sector.

David: You mentioned a number of other reforms as well. I'm going to list them again, and you tell me, how would you rank them in terms of importance? Again, I know central clearing is like your baby, your thing, so, you have a lot of heart and effort invested in it. But if you had to rank [them], which ones would you do, and [which would] have the most impact? So, you mentioned central clearing. There's also talk of all-to-all trading, which would also, I think, complement central clearing. Post-trade transaction reporting, the supplemental leverage ratio tweak— which Chair Powell, recently, in a hearing, said they're working on— that could happen again, which they did during the pandemic.

David: Darrell Duffie suggested automated market functioning purchase programs, so, doing large-scale asset purchases just on a regular basis when the market's under stress, but not doing QE long-term. Then, [there is] broadened access to the standing repo facility. So, make it easier, maybe change collateral requirements, so anyone could tap in, and turn the repos into Treasuries, or vice versa. If you had to rank them or pick the ones that you think would make the most difference, the most bang for your buck, where would you start?

Picking the Most Effective Treasury Market Reform

Samim: So, I would say broader access to the standing repo facility—

David: Really?

Samim: --To diversify the market-making capacity. Again, it wasn't opened up to more than trading counterparties of the New York Fed because of the right concern that it could incentivize more leverage by buy side firms in the Treasury market. But imagine a market configuration where almost all repo and reverse repo trades, most of the Treasury, the cash part of the market, would be cleared to, hopefully, more than one CCP, more than one central counterparty, and a good margin requirement would also be in place. In that scenario, the Federal Reserve, the New York Fed, would face the CCP, and would not face, for example, Citadel directly. 

David: Interesting.

Samim: And in the presence of margin requirements, Citadel cannot take that much of leverage, because margin would lower leverage, and, potentially, the standing repo facility could be opened up to more than just 23 trading counterparties of the New York Fed. So, that's my personal view. Then, we have, I think, broader central clearing.

David: Yes.

Samim: So, that's necessary, because if you want to contain and reduce the overall leverage in the financial system, then we would have the realignment of risk-sensitive and risk-insensitive capital requirement at banks, in parallel to making sure that the capital and liquidity regulation of independent broker-dealers— meaning, broker-dealers that are not affiliated with banks would also be sound and robust, and that's very important. And I think that the SEC’s broker-dealer rule has done a very good job on that, because broker-dealers who now can be viewed one way or the other as liquidity providers in the US Treasury market would need to register with the SEC, and they automatically become subject to, for example, the SEC's net capital rule. So, that could also, potentially, under successful implementation, limit the amount of leverage that they can take.

David: Okay. Well, that was an interesting list that you provided. So, you're close to this market. You're close to all of the policy developments. I'm sure that you follow closely people like Chair Powell, who recently said— at least he hinted at that the supplemental leverage ratio might be tweaked or changed. So, it looks to me like central clearing— we're going to get that. [We’re] likely going to get some change to the supplemental leverage ratio. What is your outlook for these other hopes and aspirations for fixing the Treasury market?

Samim: You mean for SLR?

David: Yes.

Samim’s Future Outlook for Other Treasury Market Reforms

Samim: So, to be honest with you, I never understood the logic behind not exempting reserves permanently from the SLR. So, we, a few minutes ago, discussed the more than $1 trillion intervention of the Fed between March and April of 2020 to calm the US Treasury market. In the absence of temporary exemption for reserves at the SLR, that intervention wouldn't have been true, successfully. So, again, I don't see any case for not exempting reserves from the SLR. For Treasuries, I think that there is a strong case to make them exempt from the SLR, because you can have more risk weights added to them in the risk-weighted-based bank capital regulation, or in the risk-sensitive bank capital regulation. So, in short, I think that the Treasuries and reserves can be exempted from the SLR, but risk-weighted assets can be increased a little bit, and that's what we have seen under the so-called Basel III Endgame.

David: So, you are hopeful that this will actually happen with the SLR?

Samim: Yes.

David: Okay, so two things down. We got central clearing, [and] SLR, it looks like, will be changed. What about changes to the standing repo facility? What about all-to-all trading? Are there other things that you foresee happening in this space going forward?

Samim: Sure. For all-to-all trading, I think that that's also extremely tricky. The reason is, I mentioned client clearing at the beginning of our conversation, and CCP's central counterparties may come up with client clearing models that could incentivize all-to-all trading, but they may increase risks to financial stability. So, let me quickly, maybe, explain this with an example. Consider a scenario [where] a CCP is in charge of a broader central clearing mandate for the US Treasury market— FICC, Fixed Income Clearing Corporation— and let's say that Goldman Sachs is a direct member of FICC. And let's say that Goldman Sachs would clear a trade between two hedge funds— let's say Millennium and Citadel— and would send it to FICC for central clearing.

Samim: The essence of central clearing is novation, meaning that FICC would become the buyer-to-seller, ultimately, and the seller-to-buyer, and would have legal responsibility for the performance of the trade to both counterparties of the trade. So, in my example, if under a client clearing model, the CCP would not have any right or obligation for the performance of the trade to Goldman Sachs, [and] if one of the two hedge funds become under distress, I wouldn't call that central clearing. But that would incentivize the all-to-all trade market configuration. So, the point here is that there might be a tradeoff between incentivizing all-to-all trade, and making sure that the CCP would, really, centrally clear these two trades. That's the caveat. But other than that, yes, under successful implementation, under sound and robust risk management practices at CCPs, central clearing may incentivize all-to-all trading.

David: And maybe we should be very clear about what all-to-all is. So, you gave the example of two hedge funds, but could it also be two retail individuals doing--?

Samim: Yes.

David: So, you and I could be on opposite sides.

Samim: Exactly, yes.

David: So, I have a Treasury that I want to buy, and you have one that you want to sell. It would, in theory, go through the CCP and, boom, it's done.

Samim: Exactly. Essentially, two firms would be able to trade cash Treasuries or repos directly without the intervention of bank-affiliated broker-dealers, or an independent broker-dealer, and the trade could be submitted to the CCP to be centrally cleared. That's a nice market configuration, and all I'm saying is that we need to make sure that that market configuration would go through when legal rights and obligations would be written down extremely carefully. So, if one of the two firms would default, [then] other players would know who is responsible to guarantee the performance of the trade until maturity. In the absence of that, all-to-all trade could essentially increase risks to financial stability.

David: Okay, but the benefit of all-to-all trade is that it would facilitate more trade [and] lower the cost of trading.

Samim: Exactly.

David: Okay, so, maybe expand the market, have--

Samim: The benefits of that would be huge.

David: Right, and we wouldn't depend on high-frequency traders to carry the load, or other important players. Alright, so, you touched on the potential risk there. One other risk that often comes up in this conversation is that, well, if we go to central clearing, [then] all of these transactions are in one node in the financial system, and if that node breaks down, we have a systemic crisis. How do you respond to concerns about placing all of this risk in one place?

Addressing Risk Concentration Concerns

Samim: That’s a very good concern to have. One mitigating factor could be that most of large CCPs are essentially systemically important financial institutions. These are SIFIs. And one would think that, under the SIFI assignment, they will be subject to more supervision, closer regulation, and better regulation. So, that's one aspect of that. But setting that aside, I completely agree that, in an ideal market configuration, there will be, hopefully, more than one CCP responsible for the central clearing of most of the second part of the Treasury market, the cash side and the repo side. That would be ideal.

David: Okay. Then, going back to the standing repo facility, my understanding is that it hasn't really been used a lot, not a lot of pickup in its use. Do you foresee changes in that? Do you see any interest or discussion about making the standing repo facility different?

Samim: I don't think that, in normal times, that the standing repo facility would be used a lot. History has shown that for different types of facilities that the Fed has set up since the Global Financial Crisis. But again, if it would be opened up to more than just the current trading counterparties of the New York Fed, its potential use in stress times can be really beneficial, in my view, to the financial system. That's one thing. Another thing is the market function purchase programs. If they would also be more formally incorporated--

David: Like Darrell Duffie's suggestion?

Samim: Exactly, Darrell's suggestion, incorporated in the rule book of the Fed, [then] I think that that would be beneficial. One caveat there is whether it's better to have the Fed carrying out the market-function purchase program, or whether it would be better for the Treasury to have an emergency-type buyback program. There are pros and cons, for example, we know that, roughly two years ago, while the Bank of England was raising rates to fight inflation, there was a disruption in the market, and at the same time, they had to purchase gilts.

Samim: So, depending on the business cycle we are at, there could be a misalignment between a central bank market purchase program and its monetary policy stance. So, even during QE, quantitative easing, market participants may not be able to clearly differentiate whether it is a market-function purchase program, or whether it is QE. This would become very blurry, whether it is monetary policy implementation or a market-function purchase program implementation. It might be better for the Treasury to have an emergency-type buyback program. I would emphasize the emergency-type buyback program, because, as you know, in the past one year or so, Treasury has had this regular and predictable buyback program back, essentially, to make sure that we have good liquidity in the US Treasury market.

David: I was going to ask you about that, and maybe we can end on that note. So, the Treasury introduced this buyback program, and it was very clear that this is just for normal operating procedures, just to take off-the-run Treasuries out of circulation and on-the-run, more liquid Treasuries, but it could easily be built into something more, or have a version of it for emergency crises, and that might be a better way, with what you're saying, to avoid the confusion that— here's the Fed, once again, is it doing QE? Is it doing market function?

Samim: Yes, exactly.

David: And so, stick to Treasury having an emergency facility, and I think that's a great idea, because it also addresses some of the fiscal side of what the Fed does. [If] the Fed does enough intervention, it becomes more of a fiscal tool, and this way, we're trying, at least a little bit, to delineate fiscal policy better from monetary policy.

Samim: That's right.

David: Okay, with that, our time is up. Our guest today has been Samim Ghamami. Samim, thank you so much for coming on the program.

Samim: Thank you very much, David, for having me. I enjoyed it.