Money, Money, Money
Unintended consequences
The trades threatening the Treasury market
The spread between the fixed rate in an interest rate swap and the comparable yield on a Treasury bond has traded below zero because of differences in capital treatment. Swaps are cleared; bonds are held on balance sheet. Banks find it more capital intensive to hold bonds because of financial regulation.
Hedge funds and other speculated that the spread would collapse once regulations made it easier for banks to hold bonds. They borrowed money to put on the trade expressing this view.
The problem with speculating with borrowed money is you have to be able to survive the volatility. When things get choppier, the lenders make it more difficult for you to keep the trade on; they require more collateral.
Deregulation isn’t happening quickly enough, swap spread edition.
‘In February, Barclays estimated that the scrapping of the “supplementary leverage ratio” alone could create about $6tn of “leverage exposure capacity”, which would in particular help Treasuries. As a result, hedge funds earlier this year went long Treasuries and short swaps in the expectation that the spread would flip from being deeply negative to closer to zero.
‘However the convergence trade only works with lots of leverage (you might have detected a theme here). And the recent volatility has ratcheted up margin requirements across the board, unravelling many of these trades.
‘That has in turn made the swap spread even more negative, and led to new round of margin calls, even more negative swap spreads, and so on.’
Congress Can Help End Debanking
Vague regulatory language risks abuse.
‘In March, Sen. Tim Scott (R., S.C.) led the way by introducing the Financial Integrity and Regulation Management, or FIRM, Act. It would eliminate the vague term “reputational risk” as an element by which regulators might prevent banks from offering accounts to disfavored, though legal, businesses or people. Congressional action is needed because debanking has been resistant to reform. The Justice Department’s Operation Choke Point, initiated in 2013, aimed to investigate risky practices by financial institutions—and ended up debanking people and entities the Obama administration didn’t like. Last month, President Trump condemned the practice as “lawless” and “a disgrace.”’
Markets should be wary of an SEC exodus
Some people joined the government to regulate.
‘Just days after Donald Trump’s return to the White House in January, a seasoned enforcement attorney at the Securities and Exchange Commission picked up the phone. “I’m ready to leave,” she told me, her voice edged with frustration.
‘For years, she had taken pride in holding Wall Street accountable. But now she felt like a lifeguard at a pool with no swimmers. Cases had slowed to a trickle. Deregulation, a hallmark of the administration’s agenda, eroded the sense of purpose that had anchored her career. Political pressure further complicated decision-making and investigations stalled. She wasn’t alone in feeling idle. “I didn’t sign up to sit on the sidelines,” one former senior member of staff confided in me.
‘Across the SEC, legal and compliance professionals are quietly making their exit. Beyond voluntary departures, internal restructuring is also pushing professionals out. The so-called Department of Government Efficiency (Doge) has incentivised resignations, is seeking to eliminate regional office leases, and cut senior positions.