Perry Mehrling Explains Why "The Money View" Is Key To Understanding Financial Markets

I would say it's one of our favorite topics. Yeah, and we also like to talk about the repo market. And one other thing we like to talk about is the inadequacies of traditional economic models. So what if we were going to talk about all three of those in one big episode? Oh? I like that, like a true trifecta. Like we had a recent episode on the repo market

with the Alton posts Are that was great. We had UH We talked to Lord Skidelski recently on the failure of traditional UH in traditional economists to understand money, and as you mentioned, we talked about money all the time. So I agree that if we could sort of combine all of these themes economist failures, money, repo, all these things,

that would be a very satisfying discussion. All right, well, I have a feeling you're in for a satisfying discussion because our guest today is funny that you should mention Sultan Posar, but it's someone who has worked with Sultan in the past, someone who result In actually quoted when he did that episode of All Bots back in November, and someone who Sulton says, has informed his thinking on the repo market and the reason we're sort of focused

on the repo market particularly. But and it's going to become clear as we embark on this conversation, but there was this moment during the big rebo madness in September where even though we had repo rates shoot up to ten cent, we didn't see market participants come in and actually take advantage of that rate and actually arbitrage it out. And this was one of the big questions of that event, like why didn't JP Morgan come in and earn ten

percent overnight in September in the repo market? Right that whole incident. So we got through the year without another major hiccup. Obviously, the FED sort of realized that things were problematic, that there was a shortage of liquidity and so on. And so they took a number of steps basically in the final quarter of to prevent another blow

up like we saw an early September. But that doesn't take away from the fact that that incident in early September, when REPO rates sword, raised a whole host of new questions about the current structure of this sort of bank liquidity system and whether it's adequate and whether people really understand it well. So even in the absence of another blow up, there's still just tons of discussion about what really needs to be done to um to address flaws

in the plumbing of the system. That's exactly right, and we're going to be looking at that particular REPO example through the prism of money and also an economic model that takes into account a sort of new definition of money. So, without further ado, why don't I bring on our guests. I'm very excited. It's Perry Maryland, the professor of International Political Economy at the Party School of Global Studies at

Boston University. Perry, thanks for coming on. Nice to be here. So, uh, you can tell Joe and I are both excited to talk with you, and we have a lot to get through. But maybe just to begin with you walk us through your definition of what money actually is and how your you call it the money view. How does that differ from a traditional economic model? UM, Well, the money view U is an approach to thinking about UM economic interactions that emphasizes when you when you say it's a different

view of money, it treats money. The essential quality of money is that it's a means of settlement. It means a payment of settling bills. UM that most of the economy is organized as an interlocking UH set of balance sheets promises to pay, and what you're promising to pay is money. So the settlement constraint is the essential constraint on the economy as a whole that keeps it sort of coherent that people are focusing their minds on I'm not going to actually satisfy that promise that I've made,

and so clearing and settlement becomes very central. Now you you mentioned in the intro that that's something that he's not really central in standard economics. UM. Standard economics is thinking about intertemporal budget constraints and and essentially a wealth constraint that that if you have wealth, then you can convert that wealth into consumption or investment or whatever, and it it pretty much assumes an economy of infinite liquidity that you can convert from one form of wealth to

another form of wealth with no problem at all. Okay, now that's a useful abstraction for some purposes. Um. But if what you're interested in is money, Uh, it's not a useful thing. It's abstracting for money essentially, and looking behind the veil of money. The money view says, let's look at the veil of money. The veil of money is the essence of what's happening in the economy, not

something that's obscuring what's happening at some deeper level. Um. So we look at the plumbing as a very serious piece of instrumentation for a market economy, and that settlement constraint is is the first key thing that we focus on. So we were talking recently with the economist Robert Skidelski, and there's this recurring theme that mainstream economists, still more or less in their head, think of the economy as

a barter system. You have a couple of bananas, I have some apples, and uh, money solves for the dual coincidences of wants in case there's some sort of you know, time lag issue. Maybe I don't want bananas, so we find someone with pairs and so on, and money solves. In the mainstream view of economics more or less, money just sort of lubricates barter. And he sort of explained

all the reasons why this is a flawed view. And I guess what you're saying is the money view, which is the framework that you put in really makes the money the central part. That our lives are not about exchanging bananas for pairs or oranges or apples or whatever,

but about meeting a series of financial obligations. Yes, that's right, um, And I would what Satowski is referring to there is that in standard economics, money is treated as a medium of exchange, okay, And that's what you're saying between the bananas and apples on so forth, Um, that it's just greasing the wheels, um, not means of payment. So that's that's the contrast that I'm trying to make and the media. This this money view, I should mention, is by no

means an invention of my own. There's there's it's a long tradition in in economics of people thinking in this way. Um, and I've learned a great deal from them, but it's always been a kind of minority position. There seems to be something attractive about looking through the veil of money to see something deeper. Um and Uh, but that does prevent you from seeing what's right in your face, and

sometimes it's very much in your face. Um. As this repo business that you were mentioning, Um, suddenly the only thing that's important is means of payment? Is means of payment? Can you just clarify something you said, what is the difference between money as a means of payment versus money as a settlement mechanism? You sort of drew a distinction. I'm not sure if I totally the same thing I'm meaning.

I'm meaning that to be settling a debt is paying the debt saying yeah, So I'm just using different words that might appeal to different people or different intuition. So

I definitely want to dig into the repo market. But before we do, UM, I wondered if you could talk a little bit more about how the money view informs your understanding of capital markets, Because if we think that money is sort of a promise to pay, and that every day those promises need to be settled, which means every day, you know, ideally you have a balance between the promises or the io use that were made and the actual cash inflows that are coming into the system.

But I think on most days you wouldn't have that. You would always have some sort of borrower in the financial system that doesn't have enough cash on hand to satisfy it's promised to pay or it's iou. And that's kind of where the capital market comes in. Well that's where so so let me make a distinction here between the capital market and the money market. Um. If you are on on on in today, um that your cash

inflows are uh not sufficient to meet your cash commitments. UM, then you are a deficit agent at the settlement and you have to find a way to meet that deficit, and that might be borrowing overnight okay in the money market, um, in order to in order to meet that. So you're just pushing off that day of settlement by one day. The overnight rate of interest is essentially the cost of delaying settlement by one day in the money view. That's

how you think of it. Now, the capital markets come in because there are longer term assets there are bonds, for example, um which are not promises to pay tomorrow right, their promises to pay in ten years or various coupons over the next ten years. But they have a certain market value today. So their value today is as collateral okay, that you can use that that their form of wealth that you can use as collateral for borrowing overnight to

make your settlement. So there's this connection between money markets and capital markets that that the capital values are collateral for borrowing overnight in the money markets, and that's basically what a repo is. So repo is side going back to just this key question of this of the money view as you put it, you're not really the first originator of this view, but that it's kind of been

my minority view all along. How would you describe, uh, the negative consequences to economics and to the understanding of our system from uh the veil perspective, from the traditional perspective on economics and banking which sort of abstracts away money. What are the what are the downfalls of that system of that approach? Well, to follow up just from where we were talking about the capital markets, there's one in particular, which is that you wind up having an an adequate

theory of where asset prices come from. That asset prices, the price of these capital assets is formed in dealer markets UM by dealers who are quoting buy and sell prices. UM and are and and and so that the economics of the dealer function is key for understanding the market value of of of of these capital assets and hence the collateral that can be used in burrowing overnight UM. This is another thing UM that the standard economics view

abstracts from. There are no dealers right in standard economics. It's supply and demand. There are the people who want the assets and the people who want to sell the assets. There's no one in between them that's making markets. So this market making function of dealers is a second key piece of the money view. They're really that those are the two key pieces. One is the settlement constraint and

the second is the dealer function. UM. Bringing those up to the center of attention things that have been abstracted away in in standard economics. You said the economics of the dealer function are are crucial to understanding what's happening here.

Can you walk us through exactly how you incorporate those into your model, and the thing I'm trying to get it, or the thing that I'm curious about, is whether or not you're sort of looking at the dealers from a behavioral perspective in the sense that they might all react in a not necessarily logical or rational way because of some behavioral pattern um that they've experienced before, or are you incorporating them from a sort of purely economic technical standpoint,

how are you actually doing that? Well, so you bring up the topic of behavioral economics. The the money view is is not a an argument that people are irrational or something like that. What the money view emphasizes is that a lot of the behavior of people is what we would call in mathematics a corner solution. That you're forced to do something. You know, that's what the settlement constraint does. Right, you have to pay, and you promised to pay, and now you have to pay, and if

you don't pay, you are out of the game. Liquidity kills you quick. And so that means that in order to meet that settlement, you might have to pay ten percent overnight. That the it's not a it's not a choice, right, it's a it's a corner solution in order to keep in the keeping the game. Now, why is it a corner solution. Okay, it's because the economy as it actually exists in reality is not an intertemporal general equilibrium. It

is period by period, day by day settlement by settlement. Um. If people behaved in the actual world the way they behave in economic models, they would be out of the game very soon. So it's irrational to be a rational actor in the real world. In the real world, the settlement constraint actually exists. You can abstract away from it in an economic model, but not in the real world. In the real world, prices are formed by in dealer markets.

You can abstract from dealers in the in the in the abstract economic model, you cannot abstract from from dealer from the dealer function in actual in actual performance and dealing in the real world. So this is what people get people. This is what attracts people to the money view, that it's very much more rooted in the reality of market practice. And that's why the money view, as I say,

is not an invention by me um. It's a natural point of view of people who live in the world where you're facing these settlement constraints where you are you are a dealer, you're you're you're carrying on a dealer function or or something like that. You are a central banker. Um, this is the natural point of view for somebody who lives in that part of the system. They can't abstract

away from these things because that's their business. I remember when we did our interview with Sulton, he talked about repo being I think he described it how you live to see another day. And of course that's very similar to what you're saying. Go talk talk to us a little bit about the financial crisis, because something you hear from a lot of people is that mainstream economist, traditional economics was ill equipped to see the financial crisis coming

to explain it. It didn't fit into their sort of general equilibrium models and so forth. Connect the dots for us between the sort of corner solutions that absolute requirements of the dealers to do whatever they had to do to survive another day, and the money viewers perspective on how the financial crisis came about. Um. Well, I've written a book about the financial crisis, The New Lombard Street. Um. The short answer is that to understand you're talking about

the two thousand nine. Yeah. Yeah. So the way that I would understand this is that this was a test of this emerging market based credit system UM, sometimes called shadow banking UM. And the the the notion of shadow banking that I would urge UM on your listeners is to understand shadow banking as money market funding of capital market lending. It's the form of banking that's sort of

natural for a modern globalized, financialized economy. UM. Where you're talking about the money market funding UM is wholesale funding in money markets UM, not deposits right as in banks. UM. And the capital market lending is is capital markets you know. This is again wholesale pricing in dealer markets UM, not bank loans you know that are that are specific to

the relationship between a bank and and the borrower. UM. This is the modern form of of banking that evolved as we were globalizing, UM the market system, but we hadn't yet developed the systems for backstopping it and supporting it, and so we had a little crisis there where when you're doing shadow banking money market funding a capital market lending, that means that periodically you have to roll your funding.

And if you can't roll your funding. You have to sell your asset um and that's a fire sale, and that's the liquidity aspect of it. The central banks put a floor on this crisis basically by taking the shadow banking system onto their own balance sheet, doing shadow banking on the balance sheet of the central bank, and that put a floor on it. But it took a while to to sort all this out, and meanwhile there is a bit of a crisis. So what are the implications

for financial stability now? Based on your definition of shadow banking, so money market funding of capital market lending, when when most regulators talk about shadow banking, they usually use a definition that's something like financial intermediation by non bank entities, which basically sounds like it's a bunch of unregulated activity that it's probably nefarious in some way. But your definition seems much more neutral. You're basically talking about extending credit

just through a slightly different channel. So how shall we

be thinking of that in terms of financial stability. Well, that my definition is meant to um include that form of lending if it's even if it's on a bank balance sheet, which in most cases in two thousand seven it was on bank balance sheet in Europe, okay, but it was not on the bank balance sheet of the United States, and that had to do with regulation, okay, Um, But the economics of it was very similar whether it's on a bank balance sheet or on some other bank

balance or some other balance sheet. That's why I want to use that definition, so that we're not reaffying sort of regulatory categories, but thinking about economic categories. So in in in today's world, the important place where you see money market funding of capital market lending is in fact in the emerging market. UM. As you, as I'm sure your listeners know, the the major amount of credit growth since the financial crisis has re we've been in the

periphery in the emerging markets. These are these are dollar borrowers, UM, long term dollar borrowers. But the actual funding of that has been happening in the global money market dollar money market system, sometimes using for exchange swaps in order to in order to move it into domestic domestic funding in other currencies. UM. This is the system that's been building

up since the since the financial crisis of two thousand seven. UM. And this is a system that it seems to me is most likely to be tested in in the next uh critical moments of the of the system, and hopefully we'll get through that and we'll find out where it breaks and we'll fix that. So that's the place that I'm watching. So let's just to spell it out for the listeners. We're talking about. Okay, money market funding of

capital markets activities. You're seeing it growing in emerging markets globally, so essentially people borrowing short term overnight in dollars then using that funding for longer term projects. Talk to us about uh, you know, you're saying, this is what you're watching. What are the stresses that you're looking for, and what you know from a financial stability perspective, what kind of red flags or yellow yellow light should people be on

alert for. Well, what I watch is this sort of circular loop where just imagine the following that you have a let us say a Brazilian national champion firm that is borrowing five year bond dollar bond okay um, and they're using those funds for whatever their businesses. Okay, that that bond, where does the money come from? Okay, that bond is bought let's say by some uh Asian bank that is then going to fund that in three months

dollar money markets. It's borrowing from some French bank that's issuing that's buying that three month paper, which is funding in overnight repo in in in global money markets, which or maybe in the eurodollar market. And then the Central Bank of Brazil is acquiring dollar balances as its reserves.

So that's you see how that's a round trip. Okay, So Brazil as a country is borrowing five year in dollars, that's its on the non financial corporate um and lending um in the in the global dollar money markets as the central bank reserves. So all of that loop work okay,

until it doesn't. Their number of links right that we're looking at, and any one of those lengths that if it were to fail, would cause a would cause problems in the system as a whole that that loop has to close in order for in order for the system to be maintained. One place that loop might not close is that Brazil is is borrowing long and lending shorts, okay, and the rest of the world is is lending long

and borrowing short. Thing, So the rest of the world is acting like a bank for Brazil, right, and and Brazil's source of liquidity is its deposits in that rest of the World Bank, which is which is not in the United States at all. By the way, you noticed that I haven't mentioned the United States. Okay, it's all in dollars, but it's not in the United States. So there's another little link. What is the link between the lender of last resort, the actual source of dollars, the FED, okay,

and this global dollar system that is offshore. So all of these links are, they exist, there are lengths um and they will be tested. That's what financial crisis are for at some high level, to to to see if you have the proper links and to and to improve them. That we learn in each crisis where exactly is the weak link, and then we fix that link and we go on and then we find out where the next week oft link is. And this is how the system works.

I've forgot to mention at the beginning. There's actually a fourth major odd thoughts topic that your research also touches on, and that is the dominance of the US dollar in the global financial system. Of course, and we've spoken to people like Hun Song Shin from the Bank for International Settlements about this centrality of the dollar in global markets. Mostly via funding markets and capital markets. As you point out, UM,

I do want to talk about the repo market. But before we do, and since we're on the topic of emerging markets, what is the money view actually say about China? About China? I guess one of the things that I've said about China is that the notion that the R and B is going to be the global currency is not any time soon. UM. I think that's now the usual point of view. But when I was writing about this or five years ago, UM, maybe you remember, there

was some excitement about R and B replacing the dollar. UM. But I think that's because people saw that China was a large country and they were not understanding what what what what does it mean to be a global reserve currency that all of the plumbing, all of the apparatus. Are you really prepared to do all of that stuff? Um? And the answers basically no. So the the the the the world system is still global dollar system. UM. And

I I'm glad you mentioned hun Shin. UM. I learned very much from the reports of the b I S and from and from hun Shin and his whole group, so they are I view them as fellow travelers in the money view. Um, we're on the same point of view. And as I said, that's because it's a natural point of view for people who are in central banks. And what's more central banking than the b I s, it's the it's the place where the central banks I'll talk

to each other. Well, so you gave that example of the Brazilian company going out and borrowing for five years maybe from an Asian bank, which then gets its funding from a French bank and so on, and as you pointed out, you could have this entire dollar system without it actually without any involvement of a US financial entity.

And speaking of the centrality of the dollar, that was actually Mark Carney's speech at Jackson Hole about how this is becoming a problem so speak, because the US is becoming a smaller and smaller share of GDP around the globe, and yet the dollar and therefore the influence of the

FED is taking this outside role. Does that concern you, I mean, do you share that view that ultimately there's an instability there and that the longer it goes on without some sort of next thing or post dollar multi currency world, that that creates a problem or is that more or less sustainable. I think it can work. I

think it is. It is potentially sustain annable. UM. I would I would point you to a key piece of this UM at the moment are the liquidity swaps between the major central banks UM which connect the dollar with all the other currencies UM as as a backstop for this global dollar system. The fact that the United States is it is a shrinking fraction of a larger global economy, okay, does not seem to me necessarily to say that therefore we need a multi currency system or that we can't

have a global dollar system. It's just that what's happening is the internationalization of the dollar, okay. UM that the dollar is not just the United States problem. It's everyone's problem. It's everyone's currency, and so it's a political challenge, I think more than an economic challenge. Like that, the management of the global dollar system is not just the Fed's problem. It's the it's the problem of all the central banks and the committee, if you will, of central banks working

together to to manage the global dollar system. Them It's not just the USS dollar anymore, it's everyone's dollar. You mentioned the coordinating role of the global central banks and at Columbia. The professor Adam Two's wrote this wrote this book crashed, and it really talked a lot about the various UHC swap lines that the FED set up with other central banks to ameliorate the dollar shortage UH during the crisis. Do you worry about the politics of that? So,

let's say that needed to be fleshed out. I mean, I'm trying to imagine in today's world, there's so much uh, you know, and antipathy towards globalization. UH, this twitter world we live in, whether politics could get in the way of essentially creating the plumbing fixes that would need to maintain the dollar standard on a global basis. Yes, making his work politically is I think the biggest challenge. As

I said, The economics I think is pretty clear. Um, once you get out of standard economics, as I say, and you start to see this through the money view, you understand you understand what this is about. UM. You mentioned Adam too. He was my colleague when I was at Colombia, and we talked a lot about these matters. We we ran a project at the c GT together, UM and he he this foreign exchange swap. He cites

my little article on foreign exchange swaps. So this is this is another fellow traveler in the money view, I would say, so this is very much compatible with UH. And he is as a historian thinking about the politics of this, Um, how is this going to be? What is this? This is a challenge. This was a global crisis, right. This was not just a domestic in the US crisis in in the subprime mortgage market. It was global money markets,

global dollar money markets that froze up. That's why it was a global crisis, and it took form in different countries around the world, depending in a different form um, depending on where and how they kind of tacked to this global dollar system. That's the great thing about his book is to really make clear um the global character of this thing um and that it was global because the dollar system is global, that this crisis was a

crisis of the dollar system. Well, let's talk about the repo market blow up in September, because that was another crisis in dollar funding markets that could conceivably have gone global if the Federal Reserve hadn't acted UH relatively quickly. What's your understanding of what happened in the repo market and the conditions through the money view prism that led up to it. Well, I guess I do think that

zoltan Posts analysis of this is basically right. Um I would he's down in the weeds, you know, because he's dealing directly with people who are trading in this market. Let me just pull back to the feet view a little bit, thinking about what the response of regular or authorities was to the financial crisis, And to a large extent, the response has been imagining that what we really need to do is get more capital in this system. We need, we need to We're thinking about this as a solvency problem,

not a liquidity problem, okay. And the way they they therefore, the regulatory apparatus UH with Dodd Frank and others responded was to try to kill unsecured money market credit and to and to emphasize secured money market credit, which is to say, to kill the Fed funds market, to kill the your a dollar market, and to focus on the repo market as a money market because repo is secured

overnight money. Right, there's some some some capital asset that is collateral for this borrowing, whereas Fed funds and your a dollar are not secured. These are these are just interbank borrowing. So by shifting the emphasis in what is the instrument that you're using as a death sit agent to satis to live to fight another day, your seeing repo. There's much much more emphasis on that kind of credit now than there was ten years ago, and so the

shortage of collateral can cause problems. We this is now the marginal source of overnight credit globally, so it's much more important market than than it was formally and and so all that's where the stresses are going to show up. And that's what you saw in September, that that's where the stresses showed up. It wouldn't have been so um ten ten years ago because there would have been alternative places where if you needed to borrow overnight you could

And that's less so. And some of that's because of regulatory constraints. Some of that's misguided. They're not understanding that there's a liquidity dimension to this thing that you need to be you need to be paying attention to, and that just making it safe, that is to say, secure credit is safer than unsecured credit. UM, maybe making it more fragile. Explain that further, because I don't think that's

an intuitive concept to people generally. But this idea, and you know, for those who haven't listened to the past, the repo market, you have to post collateral and then you get liquidity, and in theory that's safer. But what you're saying, and again this goes back to your original point that it's not about wealth constraints or budget constraints, it's about liquidity constraints or that's where the weakness in

the system is. Explain how uh sort of regulators may have taken the wrong lesson from the crisis by misunderstanding the money view, and how we still have things defects. Well, some of this is about the politics of regulation, right. The the what was pushing the regulatory reform was the concern that the taxpayer not beyond the hook. Okay, And

so this is about solvency. We want to make we want to make sure that the taxpayer is not is not bailing out bankers, is not we're not taking wealth from households like me, okay and giving it to large banks that have made ridiculous ridiculous best. Okay. That's the politics, right, That is about redistribution from the taxpayer to to some financiers. Who have made bad bets, and so that's why the focus was on getting more capital in the system as a buffer that you can run through that you won't

have to rely on the taxpayer. That was the politics of it. Okay. However, a great deal of this crisis was not at all about UM losses. Like that. You know that there that there were capital market assets that that had a value of zero UM, and so therefore there were losses to be absorbed. These were liquidity problems. Liquidity problems which meant putting off the promise to pay until tomorrow until you can pay it so ultimately it can be paid, just not today. Okay, that's a liquidity problem.

A liquidity problem is when you can't make a payment today, but you will be able to make attainment tomorrow or in a week or in three months, and you need money to bide you over UM. But that is not money that's coming from the taxpayer, because it's repaid. It's not a wealth transfer, right, it's just And so this is this is the alchemy of banking that we use.

You expand balance sheets UM in order and by providing extra means of payment today which you can then pull back UM later on when when this when you get a better alignment between the pattern of cash promises and the cat pattern of actual cash flow. That's what a

liquidity That's what liquidity is about. Is about maintaining that balance between the pattern across the economy as a whole, across the world as a whole of of promises to pay and the pattern across the economy as a whole across the world of whole as a whole of actual capacity to make those payments. Um and misalignment of that,

that's when you have a financial crisis. Right. So, post crisis, regulators sort of focused on solvency, encouraging banks to hold all this additional capital, and maybe arguably didn't focus enough on liquidity and liquidity risks. Uh So, now we have the Federal Reserve that is injecting billions of dollars worth of liquidity into the repo market. There's some talk also about creating a standing repo facility. This is something that I think it was Bill Dudley mentioned recently, what's your

preferred solution to repo market vulnerability at the moment. So again, thirty thousand feet, let's back up. We've been shifting from a bank lending credit system to a market based credit system. These proposals that you're talking about are an attempt to adapt the modern operations central banking to this new market based credit system by operating in the instruments that the

market based credit system is using. So those two examples you gave um that the FED can inject new liquid more liquidity um, which it has done by by engaging with dealers um. Or it could create a repo facility. This is what we call in the economics of the dealer function, the difference between the inside spread and the outside spread. The the repo the repo facility that you're

talking about is an outside spread. It's saying if you if there's a problem in the repo market, the FED will do repo with you, but at an unfavorable price. You know, it will go either way, it will. It's a it's a like a by cell spread that the FED is offering away from the market price. So normally it's like the discount rate for for the bank lending system.

That's that's essentially what this is is an analog to the discount window, but for the market based credit system, that's what that's what this report facility is intended to be exactly how to run that so that it doesn't cause moral hazard problems. You know, we have a hundred years of experience running a discount window in order to make that work. We're just making it up right now for the market based credit system. So it we can

learn things from the past. But but we need to be a little humble and appreciate that we're inventing some new thing for this new globalized market based credit system. That's the context of these of these proposals. UM. The right thing from my point of view, for the most important thing for a central bank to be focusing on is the dealer of last resort function. That it that it is a backstop to prevent financial crises. That and so that's why this repo facility to me, is the

more important thing. UM. When the when the set is trading with the market, um injecting and and and pulling out. It's operating at the insides, but it's operating at the market price, but the outside spread, which is its promise. It's it's facility that usually in normal times doesn't get used at all. It's just standing there and dealers know it's there, and so they know that if there's a problem, um, that's the price that they're going to have to pay

to get liquidity, and it's not a nice price. So they try to organize their books and their business so they don't have to go there. But if they have to go there, they can go there. I want to just step back for a second to something you said, because I have a feeling there's a lot of people

who disagree, and I'm curious how you addressed it. When you're talking about the crisis, You're like, Okay, regulators really put a high emphasis on capital requirements and making sure that banks are solvent, and that really they sort of neglected the role of illiquidity in the crisis, And I think in the popular conception, everyone would be like, look, I saw that movie where they made really stupid loans two people in Florida, and the loans were bad, and

obviously bankers were doing all these uh ninja loans and sub prime borrowers, and obviously in the popular concept, it's not about liquidity but just about bad underwriting and greed and all that. How do you if someone were to say that to you, how do you make the case that, yes, that may all have existed, but still it really was in large part a liquidity problem as opposed to a capital shortfall problem problem. Well, I would say that person, it's I've seen those movies too, Okay, And all of

that is true. All of that happened, and in exuberant periods, crazy things happen, um, and an illegal things happen, um, And you need to clean that up. Okay, But that doesn't necessarily lead to a global financial crisis. Okay. That happened to be the trigger, okay, but it actually was not the substance of the of the global financial crisis. If all it had been was just a subprime mortgage crisis, there wouldn't have been a global financial crisis, um. And

we would have been able to clean that up. And in cleaning that up, you do need to fix underwrite, you do need to to to change some of that regulation. All of that was a reasonable reaction to a subprime evolution that got out of hand and ninja loans and all of that. Um. So I agree with all of that that that it wasn't that that that cleaning that up was was useless. It's just that cleaning that up

was not all you needed to do. And it's and cleaning it up is not going to prevent another global financial crisis because what actually caused the global financial crisis was the freeze up in global funding markets, and that

was a liquidity crisis largely. It was caused, I mean, if you want to get down into weaves about this, by the fact that a lot of these securitized mortgages were funded overnight, you know, on the balance sheet of of Deutsche Bank and UBS in Europe, okay, and they then couldn't roll their funding, and they couldn't roll the funding for that, They couldn't roll the funding for anything. Global money markets froze up, and so there was contagion

across the whole world. That's what you need to need to make sure it doesn't happen that if you have a problem in some little area like subprime mortgages, it doesn't lead to a global financial crisis. You just deal with that little area and meanwhile put a floor under the under the system as a whole so that it doesn't proliferate. Um. It did deliferate, right, that's what we saw.

The politics of it meant that you could, um, you could focus on the subprime cleaning that up, and we did, and that's what And putting more more capital in banks allows them to take losses if they make back bad loans. That's all fine, okay, But but by itself, that's not what caused what what led to the to the global financial crisis. You may you may even remember at the I mean I remember I was around when it was happening.

There were many economists who who shall me remain unnamed, who who said when the when the subprime market was melted down, don't worry about this. This is small money compared to the size of the mortgage market as a whole. It's small money compared to the size of capital markets as a whole. It will it's just pennies on the dollar.

We can absorb this. They were right about that, but that didn't mean that it didn't cause a global financial crisis because of the interactions between that little crisis and and and everything else, which they did not realize. They were not right about that that this was not a wealth problem. If it was a wealth problem, it would

have been easily solved because it wasn't very big. You know, there were there was a lot of skullduggery, but it wasn't very big compared to the size of the global market, and so it seems like we should be able to absorb this if it's just a wealth crisis. But it wasn't. It was a liquidity crisis, and it was a global aquidity crisis. That's that's the piece of it that you

couldn't see looking at it from standard economics. But if you knew how these things were being funded in the shadow banking system, money market funding of capital market lending, then you knew there was going to be a lot more to this. It wasn't just about a wealth transfer from people making god loans, um. You were going to have a problem with rolling this funding. And it was, and that's exactly what happened. It got a lot worse. That's why economists didn't see it right because they weren't

paying attention to the plumbing. They were thinking of this as as as a wealth problem, not as a liquidity problem. And it was a wealth problem in part, okay, but that's not what caused the crisis. It was a liquidity problem that caused the crisis. Professor Perry Merling, thank you

so much for being on odds. I just gotta say, uh, you know when I whenever I put out something on Twitter saying who should we have on odd lots, your name for like the last several months as all or last year maybe is always one of the most frequent responses. So I'm really glad we finally made it. Well. Um, probably that's because, as you know, I have this online

course on course Era. So there's now half a million people who have gone through that class and they so they think about the world in this money view way, um, but they don't see it in the media very much, and so it's there. That's what they're pushing for. They're pushing to see uh, that language moving into more more more common usage. I'm gonna go ahead and take the course, Sarah course, and I'm glad that it's free. Joe, It's free. I know I'm gonna do it, I promised. Thank you.

That was great, Well, thank you for having me. Well, Joe, I really enjoyed that conversation. As I said in the intro, it's sort of brought together a lot of major macro themes that we've seen on all thoughts recently. Uh, and I named a few, but we even got a bonus fourth one, which was the premisee of the dollar in the global financial system. Yeah, no, I totally agree. I feel like that was no It's like, no wonder so many people have we've told us that we needed to

have Perry on because it really does. His work touches on basically all of our big topics here. But I really like that because obviously we recently, uh you know, we talked to Skidelski recently about the failure of economists to understand money, and I feel like, uh, Perry was really able to drill down on this idea and put some sort of meat on the bone about how important it is to understand to place money at the center

of our understanding. So certainly if you follow finance, or if you're involved in finance, and if you were in any way following it back in two thousand eight, when we have the financial crisis, this money view understanding of everything just feels kind of intuitive. And I actually like disagree with your last point about how lots of people are going to think this is about insolvency and the subprime crisis and greedy banks. It's definitely part of it.

But people who were following the issue very very closely will know that it was actually caused by a massive crunch in the shadow banking system and in the repo market. And I don't know if you remember, but a previous All Boughts guest, Matt King from City Group actually wrote that amazing note in early September two tho, all about repo market funding and how it was going to end

in tears for the broker dealers. Yeah. No, I mean, certainly people who who were in the weeds on this stuff or reported obviously understood the or many of them I don't know actually if it's obvious, but many of them did understand the centrality of the money market and in short term funding to the crisis. But I still think in the popular conception, and you know, as Perry pointed out, and I think it's really important, um in all these fixes or you can't ignore the politics of this.

And because in the popular conception, the crisis was about greedy bankers making bad loans to people in Florida with no jobs or no income, that did have a very big impact on what the post regulation landscape looked like, perhaps to our detriment, and perhaps the reason why we still see these fragilities in the system. Yeah, for sure. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe wi isn't thought you could

follow me on Twitter at the Stalwart. And you should follow Perry Maryland on Twitter. His handle is at p Maryland and check out his Coursera course. I'm going to do so because it's free, and be sure to follow our producer on Twitter, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head Of podcast on Twitter, Francesca Leavy, She's at Francesca Today, and check out all of the Bloomberg podcasts under the handle at podcasts. Thanks for listening, O