The Financial Markets and COVID-19

the bond market under circumstances of global pandemic. To help make sense of the somewhat bizarre and anomalous behaviors of the markets right now, I'm joined by an expert on those things. He's Boas Weinstein, the founder of Saba Capital, a hedge fund in Manhattan. Boas has been deep in the markets for almost twenty years now, and he has a repute as among the most intellectually brilliant students of the subject. We spoke on Monday. Wells, thank you very

much for joining me. I want to start with something that maybe probably is incredibly obvious to people in your line of work, but the rest of us are a little bit puzzled by, and that is the economy is in a shambles. Companies are shutting down, thirty million people are just about are going to be unemployed, and yet the stock market, after an initial marked decline, has been climbing mostly back up. At the most basic level, why is this happening? So I myself, I'm scratching my head

wondering how can that be? And so you know, there are a number of explanations, but let's just talk about the best one, the easiest to understand. And so, you know, I think nobody would disagree that the economic picture looks terrible. It's worse in the quarter that we're now in than in the first quarter was pretty terrible. But stocks represent the future cash blows of a company for all of time.

So a dollar earned in twenty twenty two may be less certain and less valuable than a dollar in today, But since the interest rates are hovering near zero, the difference between those two dollars, one earned today and one earned a year or two from now, is not that significant in a financial model, and so that's what's meant

by the time value of money. So even if you write off this year as a year where corporate profits in the aggregate are going to be quite weak, if you believe that the economy is headed for a V shaped recovery, you can justify stock prices where they are today. And of course there's this question, is a V shaped recovery the best guess of what the future holds? So

V shape recovery we can all picture it. We shot down on one egg of the V, and then we're going to shoot back up on the other leg of the V. There are other options, though, and they all have little letters attached to them. So what are some of the other options, and maybe help us while you're describing the different options, help us think about whether one

is more credible to believe in than the other. Right, So the cousin of the of the V is the U. In fact, they're right next to each other in the alphabet, which you didn't need me to come on and talk about. And so in that telling, it's unclear where we are in the U. Did we hit the bottom and we're about to start curving upward or things going to get worse?

But we know they're going to get better. And so I think people can also not fret about stock prices if they think we're in a U. And I should also say part of why we even think we might be here. Has a ton to do with what the Federal Reserve and the government has been doing, which we'll get to, i'm sure in just a minute. But aside from V and you you know, there's then all of a sudden, you start getting too much scarier letters. The

L is dreaded, the L is really bad. But I think the W is really where my head is at, that we're going to be in a world where we just don't know, and the emotional side of investing, you know, is the Fed's interventions going to be enough, Is the economy can recovery? Is there going to be a vaccine soon enough? You know, we're going to get these fits and arts and rallies and der markets are very very typical,

so that in a sense that's not unusual. And so for me, the W best reflects the seesaw that we're going to be in. So let's talk about the W, because in the W, we first come down like the beginning of the V, and then we start to come back up again, and we're probably in that second bit of the W where we're coming back up, and then it's going to go back down again before it comes

up and in that theory. Presumably one of the reasons that we're coming back up is the government's intervention, the Federal reserves intervention of essentially pouring cash into the economy and giving it to investors at incredibly low, unimaginably previously low interest rates, just draining cheap cash. How is that

affecting the market. I mean, I've heard people say, and this seems intuitively plausible, that because there's just so much money coming in that reassures investors to keep the values of stocks high. But I've heard other people saying, well, it's not even that sophisticated. There's no reassurance. It's just free money. And what are you gonna do with the

free money. You're gonna have to put it into the markets because you've got to put it somewhere, right, Well, you know there's that you have to put it somewhere. Wall Street's really built on alphabet, soup, and acronyms, and that is best encapsulated with two, which is fear of missing out. So fomo if you don't put it somewhere, and then things do go up. The emotional side of did you miss it? You know, why were you not following the herd. And then of course, Tina, there is

no alternative. Tina's really really special in this market. And so to your question, you know, it's not just low interest rates. We've been in a low interest rate world forever, well at least for many years, even if it's lower now. But it's also the enormous amount of purchasing of US traguries mortgage backed securities, which I think people have to understand, take them out of the hands of investors, and then

they have cash. They sold them because they got, you know, an amazing price, and now the question is where do they put it? And they could leave it in cash, but the theory, of course is that many of those investors will put it somewhere else. But the fed's backing of the market has extended to the commercial paper funding facility, the primary dealer credit facility, the money market mutual fund liquidity facility, and I could name ten more if you only let me. And so they've really gone whole hog

and are not done yet. And so if you just look in the aggregate of what the stimulus has been from the three bills thus far, I find this quite shocking. The stimulus in the aggregate is greater than the stimulus that happened over a four year period after the Great Depression. So we've already just in a few short months, spent a bigger percentage of our GDP than was spent to stimulate the economy back in nineteen twenty nine. And of

course back then it didn't quite work right. It wasn't really until I know, there's a big debate about this, but it really wasn't until a World War two that we got the kind of rise in production that helped get the economy out of the doldrums. Sure, so that could be the reason why they have to go bigger

this time. So the question is was it just a question of size, or can the government, in the face of a credibly steep correction, recession, maybe even depression, can they actually stop up all of that supply of people who want to exit risk and restore the markets. And I think that question is going to go and fits

and starts, which is where the w comes in. Even where we are with respect to the economy turning back on Visa VI, the pandemic ebbing, and you know, all these things are open questions, and so I think one interesting kind of meta question about The original topic here is why do investors have such confidence? You know, we're supposed to have confidence in markets that look like markets

we've been in. The people you know that have been trained in finance, whether it's at Wharton or Harvard or anywhere else, or you know, from the mean streets of Wall Street have used models and heuristics that apply to a certain range of examples. And are we not now in uncharted territory for anyone who was, you know, barely alive even during the Great Depression? How can you have confidence that the market ought to be higher than it

was a year ago? And that's I think where, you know, I start to feel like this has a lot more to do with temporary factors in psychology. And I see examples from a different market than the stock market, from the credit market, which is the aggregate bigger than the stock markets, that's the bond market, the loan market, and I see signs that are much more worrying than the confidence inspired by the recent rallying stocks. Let's turn to

that other market. So until now, we've been mostly talking about the stock market, which is equity, which means that what's being traded our shares, which means you still have an ownership stake in that company going forward, and even if the company were to fail, if you hold shares in it, you still have a claim on the assets of the company, and if it reorganizes itself, you still

hold onto your shares. Bond markets are different. There, we're trading the money that the companies owe, the cash that they owe. Tell us what are the bad signs, the ominous signs that you're seeing there, because my impression is that the bond markets do not share the apparent enthusiasm of the stock market. Well, so, firstly, there are arguments that they ought to share in it because if you look at what the FED has done, some of it

is to in fact restore confidence in that market. The FED hasn't resorted to buying stocks yet, but they have agreed to buy basically pools of risky credit, not low risk mortgage backed securities or US treasuries, but high risk in fact, things that are called junk. The FED has gone to buying junk through exchange traded funds and also lending to companies that used to be investment grade and

are now raded junk. And that occurred late in March because of COVID, and so we saw it most notably happened to Ford and to Macy's and to energy companies like Occidental Petroleum. And so the things that are most worrying to me in the bond market that you don't see in the stock market is that despite that action, despite the FED being there to lend, we see a lot of hiled companies that were already a pretty risky spot. So, you know, recently J. C. Penny has announced that it's

skipping its interest payments. It's days away from actually filing for bankruptcy. Jay Crewe has filed for bankruptcy. Neiman Marcus filed for bankruacy. So some of those, one might say, well, they were already teetering for a while, so you know, how unusual is that. On the other hand, we've seen companies that were trading very well before COVID that have been dramatically affected, notably Hurts, which was a company whose bonds were trading at one hundred at the full claim.

You know, you make a loan and you're owed back one hundred percent. The bonds of Hurts or the gaming reservation Mohegan's Son were even above par and now they're down into the teens or twenties cents in the dollar in the case of Hurts and Mohican Son has fallen in half. And so there are a number of companies despite all of this, that are defaulting, that will default. Expectations for a default rate is extremely high in credit

and also for small businesses. And so despite all of this money being offered to airlines to cruise lines, I see continued fear in the credit market, as evidenced by the price of the bonds, and also a market called

the credit rative market. And I see banks that are using this derivatives market to hedge themselves to American Airlines, United Airlines, Royal Caribbean forward hedging in a way that to me, the prices suggest these companies have a real chance of defaulting, even though that is inconsistent with the idea that the government is going to save those companies. So from an intuitive perspective of all that makes sense. Right. So, I mean, to the ordinary civilian you think of Hurts,

They're doing just fine. They're a well run company. Lots of people are renting cars, fewer people maybe owned cars. So then in the long run you expect a lot of people to rent cars. You expect Hurts to be able to pay back its debts, then suddenly no one's going anywhere, and you expect it to be a lot more likely the Hurts won't be able to pay off

its debts. So that sort of makes common sense. And then the thing that you would imagine would not make it go down would just be that the government was going to effectively bail out Hurts, right, that the government was going to buy their debt or make of they're debt in some way. And if people think maybe the government won't do that for Hurts, then what you're describing

makes a lot of sense. And it seems as though the credit markets are behaving closer to what an outsider to the financial markets would expect, and that it's the stock market that's the surprising bit. Am I getting that right? Yeah, it would be incongruous to have a default rate which is in the double digits, which is what's really being expected now. So it's not that i'mbarished and mine is in the double digits, but others are in the single digits.

We're expecting a default rate equal or greater to what happened in two thousand and eight when we had Lehman Brothers default in all of the General Motors and Chrysler and everything that came after it. We're expecting actually a higher default rate and for a much longer period of time. And the third part, which is pernicious is that the recoveries what the bond holders are getting back for suffering

these defaults, are very very low. There was just last week a auction of recently defaulted bonds for a company called Whiting Petroleum, and those bonds only fetched seven cents in the dollar. So normally, as a bond holder, since you have a claim on the assets of the company, you might expect a recovery more like thirty cents forty cents, even if you didn't have a security, you know, like

in a mortgage. But recoveries have been very low, defaults have been high, and so it's really historically inconsistent to have a world where the default rate is high, companies are defaulting, and the stock market is high at the same time. Of course, it didn't have to be this way. Companies could have been less levered, which would have given

them more liquidity, more time to weather the storm. But you know, there are a lot of signs pre COVID that leverage was running extremely high at the corporate level and the default rate was even picking up. Despite the bull market we were in, there were wearying signs from the credit market, which is what I followed day in and day out, which was already giving you pause. And here we are, the defaults are not just coming through.

I would say the stigma of defaulting has changed, because now it's not well, we mismanaged the business or a Y and z, it's blame it on COVID, which is not necessarily unfair. But the stigma of missing a bond payment feels, you know, and I can't exactly say why, feel like in the marketplace defaulting is becoming more tolerable

and it's it's contagious. Well, I mean you sort of have said why, right, I mean, here you have companies that are already highly levered, meeting they already owe as much money as they could conceivably owe, and maybe more than they should, and so they were a little teetery. And then as you say, you know, this is human nature,

there's an excuse to do it. You say, well, you know it's true that they were contributing factors, but really, we would have gotten through this were it not for this unforeseeable event, And it just seems like that's the way excuse has hurt done all the time. You know, it's a sort of dog gate my homework way of thinking about it, But there's some truth to it if the dog really ate your homework, or at least you

know it slobbered all over it. So I think you've given a sufficient psychological account of why not only would companies say this, but other people would be prepared to listen to it. And the contagion point also makes sense. If lots of companies are doing it, there's just a limit to how much stigma you can attach to each company that does it, and so pretty soon there's not that much stigma. So that part, I think you've already

explained it. Well, it's probably fun to note that there is one person that took bankruptcy to a new level and it didn't stop him from making the most out of it, and that's that's our president, whose company suffered bankruptcy dozens of times. So anyhow, I don't know if that really has a role, but you know, that's actually fundamentally what's happening that companies are defaulting. We'll be back in just a moment. Let's turn Baus to what's going to happen next? You say the bond markets are a

little bit are more than a little bit nervous. They're concerned, and if you're right, you're also suggesting the possibility that the stock market itself could go down. What's going to happen? You know, how prepared is the government for another crisis? You know, for the third leg in the w where having boosted us all up, we go back down again. What will that day look like? Well, so now you're asking me to opine about this murkiness that I said

was highly uncertain and hard to predict. We'll give us a range of options. How about that? In my telling of it, having seen what happened, where at the first sign of trouble the government stepped in and arranged a marriage in two thousand and eight between JP Morgan and bear Stearns. Bear Sterns needed a rescue and so they were saved and the default didn't occur. But then with Lehman Brothers the default did occur, And with General Motors

and Christ's Third the default did occur. And so there is this question of if we really do have finite money, if there is something to be believed in what Mitch McConnell said, you know, worrying about the total level of debt and said quite instantly early things about perhaps municipalities need to default. So if the D word is going to you know, be present and causing pain for investors, I think rationing the stimulus to where it's most needed

is maybe how things are going to evolve. And so maybe the answer isn't to save every company that's going to get hurt because of the COVID crisis, but instead protect the jobs of those companies without necessarily protecting the bond holders. And so that's one way it could evolve. And in that way, asset prices can go down, bond prices certainly can go down, and even stock prices should go down. And in that world, you know, perhaps the

dollars are better spent on the individual investor. And it really raises I think something that's going on right now, we can see it. We don't have to wait for the future. This is something I listened with interest to a week ago said by Larry Summers on Bloomberg TV, which is if you look at how companies are scrambling right now to raise money. Almost all of that money is being raised in the debt market. So just ten days ago Boeing raised twenty five billion dollars through more debt.

Forward raised seven billion GM four billion. Retailers like Polls or Gap Stores came into the debt market to bar own more money. But Summers raised the question of is that actually the best thing for the company when it comes to solvency. Ought they not raise equity at the same time, or aught they not raise significant amounts of equity instead of debt as a way to bolster their balancie. It is a way for them to have cash without

having the obligation to pay it back. And so in the way that I think a lot of Americans are upset when they see companies take money and go buy back shares. In a sense, this is like the inverse of it. Well, now they're in trouble, why don't they issue shares? Why don't they raise money? The way I saw over my career companies do in times of fear, like in two thousand and two when we had and Ron default in worldcome a lot of companies at that

point in time chose to raise equity. And so while it is happening today, the International steel company Mittal raised some equity, United did Carnival did. I think the best answer of why it's not happening is that the management is too afraid to dilute their shareholders, and so the amounts of money they would need to raise to deal with the COVID crisis is so great that they would really be hurting their stock price, but they would be shoring up their liquidity and their solvency, and so that's

to me. The next phase is that whether the government's loans come with equity stakes, which basically creates that situation where they are diluted, or companies do it themselves where they access the markets, whether they're forced to or want to through equity, which would be a much in my view, much better outcome for all of Americans. And when you say that the corporate management doesn't want to dilute their shareholders, do you mean that they're basically just worried that then

the shareholders will vote them out. Well, part of it is maybe just the amount of money they need to raise is so great that they just couldn't get there purely with equity, but we're seeing a lot of the capital raising done purely on the debt side, So it doesn't answer why are they not doing both or why are they not doing heavy amounts of equity. And I think some of it comes back to the greed of

not wanting their share price to go down. But by taking out more debt, you're creating a more levered situation, a company that is more exposed to a prolonged downturn leading to default. And so it might be in the shareholder's interest, and I think the FED in somebody's has encouraged it by saying they're going to backstop lending to fallen angels and they're going to buy high oldtfs, when

really there should be a lot more equity raised. When the government signals that it's willing to basically ensure companies, why shouldn't they go borrow that money in cash. They're gambling that someone's going to back them up if they fail.

That's fairer baus. Let me just close by asking you what should I be asking you about what's going to happen or what is happening that I haven't I mean, there's obviously a huge amount of complexity here, and you've gone very far towards clarifying and simplifying it for the listeners and for me, which I'm really grateful for. But what am I not asking you that I should be

asking you? So the thing that I most want to get off my chest is that I see a market that normal, non professional investors believe is driven by fundamental forces, and I see it more than ever driven by technical forces. And define that what are technical forces? So instead of what's the intrinsic value of a company worth using a financial model, it's who's doing what to whom and in what quantity? How many sellers are there compared to buyers?

What's the relationship between related instruments such as the debt of a company and the equity of a company, And I see large divergences. As an investor, I've always been much more focused on relative value on looking at a company. Let's take United Airlines, which is having tremendous issues. They had to shelve a debt deal. They were bringing debt, They did bring a little bit of equity beforehand, and

they had to shelve it over lack of demand. And I look at the difference in price between the debt of the US airlines and the equity which still has considerable value, and I see a dislocation there compared to history. I see that the debt is actually giving a much more negative picture. And so when I look at the market today versus five years ago and even much further back, I see a market really driven by technical forces, and so the things that are of interest to my relative

value strategies are off the charts. Interesting right now, there's a type of trade that we've been doing for about a dozen companies that in my twenty two years of doing this type of trade has never been this good, and normally you don't expect that to be, you know, in a market where we're only ten fifteen percent off of the high. My takeaway from that is is that markets are highly unstable because relationships that tend to correlate are right now breaking down. There's a lot of havoc.

There's a lot of market segmentation where some investors are only doing one kind of thing and other investors are doing another, and it's led to an opportunity set which is really quite exceptional for my kind of strategy. But it also even though I don't have any more crystal ball than anyone else. It does give me great caution

when it comes to the direction of markets. I'm quite worried that the markets are going to be headed lower and that the if the V comes, you know, the V was already mostly priced in, and the risk of it not being a V is far greater based on current levels. Well, it's not a cheerful moment on which to end, but it is definitely honest and I really appreciate it. Boaz, thank you so much for your time.

Thank you, Noah. Boaz's account gives us substantial food for thought when we think about the behavior of the financial markets right now. He's validating our general concern that there's something strange about the way that the stock market the equity markets continue to be behaving as though a V shape recovery were to be soon expected. Going forward, the deep question is whether the different signals being sent by bond markets and the stock market will eventually come into coordination.

Logically speaking, if they do, there's only two ways that can happen. Either things can get better in the bond markets than they are now, or it seems much more likely things in the stock market can get a lot worse. Above all, I'm really struck that just as we're highly dependent upon scientists in a moment of pandemic to try to explain in ordinary language what's going on, we're also dependent on financial market experts to try to explain to the rest of us what they see happening in their

own very distinctive and very consequential world. Until the next time I speak to you, be careful, be safe, and be well. Deep background is brought to you by Pushkin Industries. Our producer is Lydia Jane Cott, with research help from Zooie Wynn and mastering by Jason Gambrel and Martin Gonzalez. Our showrunner is Sophie mckibbon. Our theme music is composed by Luis gera special thanks to the Pushkin Brass, Malcolm Gladwell,

Jacob Weisberg, and Mia Loebell. I'm Noah Feldman. I also write a regular column for Bloomberg Opinion, which you can find at Bloomberg dot com slash Feldman. To discover Bloomberg's original slate of podcasts, go to Bloomberg dot com slash podcasts. And one last thing. I just wrote a book called The Arab Winter a trag. I would be delighted if you checked it out. You can always let me know what you think on Twitter about this episode, or the book,

or anything else. My handle is Noah R. Feldman. This is deep background