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This article is incredibly misleading. The Fed is buying ETFs instead of constituent bonds because the ETFs are a more liquid and convenient way to buy the cons

This article is incredibly misleading. The Fed is buying ETFs instead of constituent bonds because the ETFs are a more liquid and convenient way to buy the constituent bonds. The net effect is roughly the same as if they bought all the bonds individually, just with less effort and lower transaction costs. (People seem to find it weird that a basket of securities could be more liquid than the securities themselves, and I agree that it's weird; but it seems to be true, and failing to understand that leads to grossly wrong conclusions like those of this article. Matt Levine has many excellent discussions of this effect.) BlackRock is just the administrator, and derives no benefit beyond their management fees. The direct benefit is to the sellers of the constituent bonds (whether individually or as part of the ETF), who get a higher price. There's also indirect benefit to the non-selling owners of the bonds, since that stops the price from dropping to the point they'd get a margin call and be forced to sell. That indirect benefit is the primary goal of this program, to avoid forced, cascading, 2008-style deleveraging. The Fed isn't trying to directly support the issuers (though the issuers do benefit from functioning capital markets, if they do choose to raise more money at this time). The $75B allocated for losses is just an accounting placeholder; they don't know what the losses or gains will be. Historically these kinds of programs have often ended up net profitable, though that's not that point.

whatok 6y ago
This is also a misleading comment. The main purpose of the Secondary Market Corporate Credit Facility is to purchase secondary market bonds and this is stated in the IMA and term sheet. The only reason why they're buying ETFs right now is because it's easier operationally and the issuer registration process for primary and secondary bond purchases has been difficult so far. They are not buying ETFs because they are "more liquid and convenient" vs underlying. The Fed also is absolutely trying to directly support issuers through these facilities and ETF purchases are an important part of this. Primary issuance is dictated by where secondary markets are trading and if some of the most liquid corp instruments (ETFs) are trading extremely wide or at a huge discount to NAV (like they were before these facilities were announced) then primary issuance will either be much more expensive or completely closed.
- tripletao 6y ago
  I'm not sure where we disagree? What's the difference between your "easier operationally" and my "more liquid and convenient"? You agree in your other comment that the ETFs were more liquid than the underlying. And I agree and noted previously that issuers benefit from working (secondary) capital markets.
  - whatok 6y ago
    Your post says that they’re not buying bonds because ETFs are a better option. That’s exactly true and ETF purchases are not the main goal of the facility. There is way more capital allocated towards primary and secondary bond purchases than there is for ETFs and they’ve stated that ETFs are last in their purchase waterfall. Operationally, it’s much more difficult to get the bond purchases rolling because they have to get individual issuer certifications before making any purchases. This is a restriction created by Congress and had it not been in place, they would be buying bonds right now. They are likely going to make some modifications to the facility in order to streamline this process because it’s preventing them from achieving the main goal of it: buying bonds.
    - tripletao 6y ago
      First, I think you're missing a "not" in your second sentence? The certifications are an interesting additional detail that I wasn't aware of. So if I understand correctly, the program wrote one set of rules for purchases of individual bonds, and then a different set of rules for purchases of ETFs. It allocated more money for individual bonds, but the Fed discovered that those rules meant that no issuers wanted to participate. So the Fed instead purchased ETFs. I think I'd still say that makes the ETFs more convenient? Certainly that's true under those rules; and to the extent those different rules exist for good reason (e.g., because with a diversified and liquid index, it's easier to avoid both the appearance of political favor and the actual thing), that seems fundamentally true too. So I don't see what that changes in my initial statement, though it's interesting that it happened "by accident" instead of by design.
      - 6y ago
phone8675309 6y ago
>People seem to find it weird that a basket of securities could be more liquid than the securities themselves Why would this be weird? A basket of securities is more diverse which spreads out your risk. Therefore, it makes sense that, in general, it would be more liquid.
- whatok 6y ago
  There's an additional liquidity transformation with the fact that a majority of trading in the underlying happens over the phone/chat. Lack of liquidity in the underlying is why all of these ETFs were trading at 5%+ discounts to NAV while something like SPY was much more well-behaved back in March.
- tripletao 6y ago
  Lower / more diversified risk doesn't necessarily mean more liquid. For every big liquid ETF, there's many smaller ETFs with similar holdings and thus similar diversification and risk, but much lower volume, wider spreads, shallower order books, etc. Though I agree that long-term, smart investors will prefer to own a diversified product because of that lower risk. So it does make sense that whatever diversified product they choose becomes more liquid than its constituents, just for the small number of winners they coordinate on (thanks to better marketing, lower fees, better deals with market makers, etc.) and not all ETFs with comparable risk profile.

whatok 6y ago

This is also a misleading comment. The main purpose of the Secondary Market Corporate Credit Facility is to purchase secondary market bonds and this is stated in the IMA and term sheet. The only reason why they're buying ETFs right now is because it's easier operationally and the issuer registration process for primary and secondary bond purchases has been difficult so far. They are not buying ETFs because they are "more liquid and convenient" vs underlying. The Fed also is absolutely trying to directly support issuers through these facilities and ETF purchases are an important part of this. Primary issuance is dictated by where secondary markets are trading and if some of the most liquid corp instruments (ETFs) are trading extremely wide or at a huge discount to NAV (like they were before these facilities were announced) then primary issuance will either be much more expensive or completely closed.

tripletao 6y ago
I'm not sure where we disagree? What's the difference between your "easier operationally" and my "more liquid and convenient"? You agree in your other comment that the ETFs were more liquid than the underlying. And I agree and noted previously that issuers benefit from working (secondary) capital markets.
- whatok 6y ago
  Your post says that they’re not buying bonds because ETFs are a better option. That’s exactly true and ETF purchases are not the main goal of the facility. There is way more capital allocated towards primary and secondary bond purchases than there is for ETFs and they’ve stated that ETFs are last in their purchase waterfall. Operationally, it’s much more difficult to get the bond purchases rolling because they have to get individual issuer certifications before making any purchases. This is a restriction created by Congress and had it not been in place, they would be buying bonds right now. They are likely going to make some modifications to the facility in order to streamline this process because it’s preventing them from achieving the main goal of it: buying bonds.
  - tripletao 6y ago
    First, I think you're missing a "not" in your second sentence? The certifications are an interesting additional detail that I wasn't aware of. So if I understand correctly, the program wrote one set of rules for purchases of individual bonds, and then a different set of rules for purchases of ETFs. It allocated more money for individual bonds, but the Fed discovered that those rules meant that no issuers wanted to participate. So the Fed instead purchased ETFs. I think I'd still say that makes the ETFs more convenient? Certainly that's true under those rules; and to the extent those different rules exist for good reason (e.g., because with a diversified and liquid index, it's easier to avoid both the appearance of political favor and the actual thing), that seems fundamentally true too. So I don't see what that changes in my initial statement, though it's interesting that it happened "by accident" instead of by design.
    - 6y ago

phone8675309 6y ago

>People seem to find it weird that a basket of securities could be more liquid than the securities themselves Why would this be weird? A basket of securities is more diverse which spreads out your risk. Therefore, it makes sense that, in general, it would be more liquid.

whatok 6y ago
There's an additional liquidity transformation with the fact that a majority of trading in the underlying happens over the phone/chat. Lack of liquidity in the underlying is why all of these ETFs were trading at 5%+ discounts to NAV while something like SPY was much more well-behaved back in March.
tripletao 6y ago
Lower / more diversified risk doesn't necessarily mean more liquid. For every big liquid ETF, there's many smaller ETFs with similar holdings and thus similar diversification and risk, but much lower volume, wider spreads, shallower order books, etc. Though I agree that long-term, smart investors will prefer to own a diversified product because of that lower risk. So it does make sense that whatever diversified product they choose becomes more liquid than its constituents, just for the small number of winners they coordinate on (thanks to better marketing, lower fees, better deals with market makers, etc.) and not all ETFs with comparable risk profile.