Explained: Counterparty Risk And How It Impacts Markets

Описание: On today’s show, Preston interviews USC finance professor and the author of Layered Money, Nik Bhatia. Nik provides his thoughts on counterparty risk and how it impacts markets.


Preston Pysh
One of the ideas that you talk about right after this idea is counterparty risk. Instead of talking about counterparty risk in the historical sense, I’d be more curious to hear some of your thoughts on what we saw back in March, April timeframe of 2020, just call it nine to 10 months ago and how counterparty risk played such an enormous part in that liquidity squeeze that we saw get into all the nuances of this for people.

Nik Bhatia
The problem with our current financial system is the interbank counterparty risk, where banks don’t trust each other when things get tough, because they all are expecting the Fed and the central banks to come in and save the situation. So when things get difficult, they all pull back from each other. And that is actually now the natural state of our financial system. And I do believe that that’s due to this moral hazard that the Fed has created by responding to every situation with unlimited bailouts. And it’s not to fault them explicitly because they have no other choice, the system is broken and the banks don’t trust each other. And that is the core problem with the financial system. And so when things got crazy in March, April of last year, when the pandemic started, the banks, what they do is that they don’t lend to each other in the wholesale money market anymore.

Nik Bhatia
They don’t engage in repo’s lending to each other, meaning that even US treasury collateral doesn’t warrant a loan from your banking neighbor. And that is a problem. That’s why the Fed had to step in and basically create a repo facility in which they basically said all treasury collateral across the world included foreign institutions later in this. Everybody with a treasury can get cash from us if you need it. I mean, that’s a bandaid on the system that you can never rip off. That is why I refer to the Fed as the lender of only resort. They’re the only game in town because there is no liquidity otherwise.

Preston Pysh
So as you were describing that, I flipped to page 72 in your book. And something that I love that you did here is you showed the layers of money throughout time and how they’ve evolved and how they’ve changed and how they’re being used today. So when you were talking about the treasury repo, I’m looking at this chart on page 72, where you’re talking about the US dollar system today and I can see right where that fits into the layer of “currency” or money that we’re using. So when we look at this counterparty risk and we look at what it played out back 10 months ago, you saw gold and I should probably say paper gold, sell off not dramatically, but it’s sold off just like everything else sold off. But I think what everyone’s not seeing is they’re not seeing the dollar and every other Fiat currency get bid relative to everything else that got sold off. No one talks about that, but that’s effectively what’s playing out because of all this counterpart. Everything is a counterparty risk to these monetary baseline Fiat units that we’re talking about, correct?


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