Can You Ever Actually De-Risk The Banking System?

Joe Weisenthal (0:02)

Bloomberg Audio Studios.

Tracy Alloway (0:04)

Podcasts, radio, news.

Joe Weisenthal (0:19)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

Tracy Alloway (0:23)

And I'm Tracy Alloway.

Joe Weisenthal (0:25)

Tracy, you know we do all these episodes about private credit and obviously hedge funds, multi-strategy hedge funds in particular lately. And of course, it all sort of seems to be part of a bigger story of a bunch of things that used to happen inside banks, no longer happening inside banks.

Tracy Alloway (0:40)

Right, and this has been like a continual process ever since like the 2008 financial crisis. But even before that, we had like big periods of bank disintermediation, which we talked about recently on that episode with Hugh Van Steenis.

Joe Weisenthal (0:55)

Totally, there's a lot going on and not all of these trends date back to the financial crisis. But you know, this was obviously kind of an express goal, I think, of the Dodd-Frank regulations. And just from my seat sitting here, like, yeah, it seems pretty good, bunch of risky stuff, like multi-strategy hedge funds, et cetera, seems kind of risky. You can lose a lot of money in theory. Lending to random middle market companies seems like you could lose a lot of money. It's like, yeah, it seems pretty good that it's not happening inside the banks. And maybe that's good that it's not connected directly to deposit-taking institutions.

Tracy Alloway (1:28)

Yeah, and I think given the increases we've seen in rates over the past couple of years, the fact that like nothing really broke or exploded in the private credit market seems like a good sign. But again, it's still relatively small and it is growing very rapidly. So I think there are more questions to be asking about this particular space.

Joe Weisenthal (1:49)

Well, you brought up something recently on an episode of Synthetic Risk Transfers, where banks sort of offload some of their credit risk onto third-party entities. And that's been really stuck in my head, which is, you know, okay, so these third-party entities take the risk of the assets from the banks. But then that's an asset that can be levered up. And where do you get leverage? Presumably, from a bank. And so I have this sort of...

Tracy Alloway (2:13)

It's very circular, isn't it?

Joe Weisenthal (2:15)

Yeah, and I just have this nagging thing in my head somewhere. It's like, okay, yeah, great, we moved it all off the banks. There's, okay, we're not going to have another 2008 But what if in some way it still goes back to the banks? And the risk still is there, and it just sort of takes the loop out and then comes back in.

Tracy Alloway (2:32)

It goes into prime brokerage instead of the balance sheet.

Joe Weisenthal (2:35)

That's a good way to put it. And so I'm still like, I'm like, yeah, things are pretty good, but maybe there are still some reasons to be concerned. Like, can you ever, I guess maybe we could title this episode, like, can you ever really de-risk the banking system?

Tracy Alloway (2:48)

Oh, that's a good one. Let's use that.

Joe Weisenthal (2:50)

Okay, well, I am really excited. We have the perfect guest on today's show, someone we've had on the podcast before and someone we've known and talked to for a long time. We are gonna be speaking with Steven Kelly, Associate Director of Research at the Yale Program on Financial Stability. So Steven, thank you so much for coming back on Odd Lots.

Steven Kelly (3:08)

Great to be back. You know, sometimes you guys say literally the perfect guest, and so I'm all for two on that. I've only gotten perfect guest, but I'll be coming back.

Tracy Alloway (3:15)

We have people who complain about when we forget to say the perfect guest, but you've kicked it up to another level and are complaining about not saying literally the perfect guest. This is a new era.

Joe Weisenthal (3:26)

For what it's worth, I do not think that the word perfect does not actually need any adjectives, because either it's perfect or it's not. It's like the word when people call something very unique. It's like either it's unique, one of a kind, or it's not. So I wouldn't take that to...

Steven Kelly (3:41)

I would agree with you.

Joe Weisenthal (3:42)

I wouldn't take that to literally.

Steven Kelly (3:43)

I would agree with you if you followed your own advice.

Joe Weisenthal (3:46)

Okay. That's fair enough. Steven Kelly, literally the perfect guest who made that correction. I just, should I be, like I said, oh, everything seems fine, but are there reasons to think, and we're gonna get into specific, so this is an incredibly broad question, but just conceptually, are there reasons to think about how these risks that migrate off of bank balance sheets find a way to migrate back onto them?