Friday, July 26, 2013

"Everything is either a repo or an ETF"

In addition to the professional writing and the podcasts, FT Alphaville's Izabella Kaminska has a personal blog that reminds me of a television quote*:
Sheldon: I've been thinking about Dr.Green's efforts to make science palatable for the masses.
Leonard: Yeah? What about it?
Sheldon: That's all. I've just been thinking about it. Now I'm thinking about fractal equations. Now I'm thinking about the origin of the phrase "train of thought." Now I'm thinking about trains....
That is, her blog is a lot more stream-of-consciousness than her Alphaville posts are and sometimes, when the neurons really get firing, the result can be scary-smart.

From Dizzynomics:

ETFs are like central banks
The following is a truncated version of an email I sent someone, trying to explain why ETFs are like central banks, and vice versa. It’s a bit of a ramble as it wasn’t structured as a post.
Everything is either a repo or an ETF.

A central bank, for example, is really a giant ETF. And ETFs are like central banks which promise to provide the market with permanent QE style asset purchases/sales to ensure their units are never over or under supplied relative to their target index.

A central bank is like Blackrock. It issues units which are ultimately backed by its balance sheet. In some cases the units are directly backed by collateral. In some cases, the units are just backed by the implied strength of the balance sheet. If you take the consolidated book of Blackrock, it will have a certain amount of collateral on its book for every single ETF unit it has issued. The ETF units really are like Blackrock-issued central bank money.

Of course, when faith in the Blackrock balance sheet is good, Blackrock can issue uncollateralised units as well.

In that case on an aggregated basis it has a mix of collateralised units and non-collateralised units, just like a central bank.

When it issues uncollateralised units it is effectively absorbing someone else’s unit (in this case central bank $$) in exchange for its own units. The cash it accumulates is a bit like the FX reserves a central bank accumulates in the course of doing operations. When an ETF aborbs cash on an uncollateralised basis it is basically accumulating reserves in the same way. Reserves which are subject to redemption request only if the actual institution collapses, or the ETF cannot meet the FX demands related to the valuation promise it made. (So a bit like when China promises that the yuan units it issues will always track the dollar, but then it turns out that when everybody tries to redeem yuan for dollar, there aren’t enough dollars in the system to have allowed China to make that valuation promise).

Of course, a central bank can also issue completely uncollateralised units into circulation by pure money printing: in exchange for no collateral at all. This is indeed inflationary and represents a dilution of the amount of claims circulating in the system versus the underlying collateral....MORE
* The Big Bang Theory: Season 4, Episode 20
   The Herb Garden Germination
   Original airdate 7 Apr. 2011