Episode 314 - Professor Valentin Haddad: How Competitive is the Stock Market?

24:03If I'm completely uninformed, I see the price drop, I don't know if it's because there was bad news about the stock or because it's a good deal. So we tend to not react very much. So that creates this connection, this very natural connection between elasticity and information. That's why we think that informed investors are more active. They get signal, they trade based on their signal. When they see the price move for a wrong reason, they come in aggressively. But it doesn't have to be. I can just be aggressive because maybe I don't know much. I know I'm just aggressive. I'm an aggressive investor.

24:33I'm not very afraid of risk. This distinction makes that it's not so easy to know. Now, the other thing you ask in a way is well, could the consequence beyond price informativeness matter? I think the answer is yes. I think it kind of depends even what we mean by price informativeness. So there's two parts in a way, again, is that one part is, is the information into prices? And the other part is, is only the information into prices? Is there noise as well? The price moves one to one when we have good news, bad news, like these markets are really smart. There's a ton of noise around this. People make mistakes.

25:08And it might be that the information is still there, but that we have more noise. And the noise is bad, of course, because the noise is really risk for investors that come in and out of the market and so on. Those two aspects might be somewhat independent. You explained that well. Connected the docs for me. This is a really interesting conversation. Do your findings support the concept of a bubble in large stocks due to flows into index funds? So there's been a lot of discussion of that. I have mixed feelings towards this. I'm going to give you the researcher answer that is we don't really know, which is not very satisfying as an answer.

25:41No. So let me try to say more, maybe it's a little bit more satisfying. What our findings say, they say two things. Large stock is not that elastic and even less so than it used to be. That's telling us there's a potential irrational flows into large stock to have a big price impact. That's true. I think another piece of the puzzle that suggests this could happen is that, as we said, passive investors are tilted towards large stock, so they will tend to come in more into large stock. That's not about LST, that's just to tell you about dollars coming into those stocks. There's more investors coming into large stocks that's been shipped away from smaller stocks.

26:20If you put those two together, it starts to say, well, that's going to push the price of those large stocks up, potentially too much. The reason I'm a little bit unsure is we don't know if that's the case. We don't know if the prices were right before. We don't have a good sense of the magnitude of those flows. There's a bunch of ingredients that tell you it's possible. And I think a few years ago, people would have dismissed these kind of stories. And I think by now, we have a grasp that this is possible. But have we seen clear evidence of that? It's difficult to tell. If we think about the large stocks these days, it's plausible that there's a bubble, I think.

26:55These are very, very highly valued. And there are companies that are very highly valued relative to their output right now. Their profits today. Is it a bubble quality? I guess it's too early for me to call it, I think. So I will not go there. There are some ingredients that say this could be possible. I've tried a little bit to think through this algebra, how many more dollars are coming if I multiply the LCT, but it's not completely clear to me that it's a very large number. Does this start to tie into your other research on bubbles and innovation, do you think? A little bit, yeah. In that other research, in a way, we're more thinking about what starts the bubble, in a way.

27:32In that other work, we're thinking more about people speculating, people have different views on stocks. The story today for why passive investing creates a bubble on large stocks is more where flows of money into large stocks just because passive investing invests more into large stocks. I was thinking about alternative explanations for the valuations of those large stocks being so high right now. Could be index funds, but it could be innovation. It's a little bit of a developed sword, I think, for stock prices. It does two things that go in the same direction, but with different long-term consequences.

28:07And that was the theme of this other paper we have on bubbles and value of innovation. The starting point always is that innovation is good, it's valuable. And so when we have lots of innovation, we see these firms getting very highly valued. And in recent years, we've seen baseline electric cars. These days, I guess we talk a lot about NVIDIA and GPU for AI. The other side of innovation, and that's what got us thinking in that other paper, was speculation often comes with innovation. That is, we want to know who is the winner. It's like every day we see articles about is OpenAI going to be the thing we all use or is it going to be the Google solution, the Lama from Facebook.

28:45There's this kind of like messiness of innovation that naturally creates speculation. It's like, well, we're all trying to guess to be informed about who's going to win and we found views on this. We don't know too much about two years ago none of us knew anything about AI pretty much. So today I bet we all have opinions about which company is going to be the leader in AI. and so on. Out of these disagreements, there's speculation and bubbles can come out of this phenomenon as well. That would be the other side of innovation. We're partly high stock prices because of speculation and partly high stock prices just because the innovation is good.

29:18We're going to come back to that in a sec. Your research on that is super, super interesting. We're going to dig into it more. But before we go there, what regulatory interventions do you think, if any, do you think makes sense to address what's going on with index funds? The first thing I'll say is there's one dimension we haven't talked at all about, and maybe it's my fault. The first-order fact about index funds is we had a bunch of people investing in random stocks. And forget about how the market works. They're just for their own personal consequences, taking a lot of risks. And they're not doing that.

29:47I'm a finance professor. Like what every finance professor has thought for the past 50 years, maybe, is we should all invest in index funds. So at first order, this is a massive gain of welfare, a massive positive of passive funds. Even if my research points that there can be other consequences and some of those consequences might be negative, I think we should not forget the elephant in the room. That is, for many individuals' lives, this has been progress. My sense is, it's a question of regulations and so on. They're not quite yet for today. They are on the horizon. It's like if passive funds become more like 5-10 % to 40%, if we go to 60%, 70%, 80%, this might become a problem.

30:25We might see bigger spikes in volatility. we had GameStop a few years ago in the past month as well. Those things might multiply, might happen more frequently and might become a concern. I've been thinking about doing research on this to try to know when it's going to become too much. But I think it's hard to forget the part of the trade-off that is just a vast amount of people are just much better off out of more passive investing. And the market might be a little bit different and we should pay attention to that, but that's not necessarily the dominant effect. This example of maybe a bubble on large stocks, Of course, if it had a massive crash, it would have big consequences.

31:00If we had a stock market crash, we could really pin on passive phone. Maybe, but I think it's way too early to think. I mean, this is not impossible, but it's not very, very possible at this stage in my mind. And I hope I've not been wrong too fast. You mentioned that we hadn't talked about the benefits of index funds yet. I would say that's a key message of our last. This is episode 314 of our podcast. I think the reason we didn't ask about that specifically is because we've talked about it so much already. We definitely agree with that message. That doesn't mean we shouldn't worry about it. Market crashes that are not always too rational are a big problem.

31:36Even homes and bus, mispricing, all these things are big consequences. They can make firms invest in wrong directions. I think these concerns with passive investing are meaningful. I don't think it's quite yet the time for a very strong regulatory call base. Regulators should keep track of this evolution. I think a few years ago, there was a proposal to get rid of 13 net filings or the publication of 13 net filings. We can't tell anymore what large investors are doing or what most investors are doing. I think this type of information is important and it's quite relevant to keep track of. But in terms of co-active action or preventing people from investing passively, I don't think that time has come yet.

32:14So just to finish up on this section, what do you think individual investors should do with this information? Depends on. Inform the thing there, I would say. Yeah, that's such a good answer. That comes back to this kind of like two-sided aspect. First, you can become passive. If anything, that's telling you, because markets have become more fragile, if you don't know too much, you should become more passive. The more other people are passive, the more markets are messy and hard to understand, the more as somebody who's not informed, you should go and be passive. And not informed doesn't mean that you know nothing.

32:47That sounds like diminutive. the people who are very informed markets are extremely sophisticated. So it's more relatively uninformed. The flip side, again, is there are more opportunities. They might be hard to find, but there are more opportunities. And actually, for a long time, we think trading in geos stocks is not a great idea. The more I look at this research, the more I think, well, maybe it's not that bad an idea that you focus on something, you try to learn about a stock. Of course, it's not an idea for everybody and you need to have a way to get information and so on. I don't mean to say, you know, we should live in a world where everybody's trying to pick stocks, but there's something to this to try to identify situations that large groups have investors that miss.

33:25Again, there are just less investors around trying to identify these situations than before. So there's going to be some spots in the market that are profitable. I'm not going to tell you how to find them. I don't know how to find them, but maybe somebody can know how to find them. Somebody's going to find them. Maybe. Maybe not the active funds. Maybe if index funds are growing, active funds are becoming less active, maybe there are more opportunities for informed individual investors. It's too big of a kind of worms to go in there. But like, if you think about what happened with GameStop, to me, it's a long use that there was a bubble on GameStop and so on.

33:59But it's like the short squeeze that happened, this idea that like, wow, a bunch of investors can go and target this short and break this short. You could imagine a few years ago, a couple of active investors do it. And this was something that was led by individual investors. And we can have debates on whether short switch should happen, whether they should be forbidden. This is not my point. My point is, this was possible that this happened. I think if you had asked most people before it happened, whether this is possible, I think we said no way. For two reasons, we would have said first, individual investors cannot matter for anything.

34:32But we also have said, if there's a good deal to be made there, active investors would take advantage of it. All right, I want to move on to that bubbles and innovation research. I love this topic. And this paper is very cool. How do you define bubbles in your research? Indirectly. We don't try to be the true sayer to say we know it's going to be a bubble in advance. We use a method that some other researchers actually came up with and say, well, if it looks like a bubble, if it sounds like a bubble, if it smells like a bubble, then there's a good chance it's a bubble. Of course, we try to be not forward-looking.

35:03So it's all based on backward-looking measures that we don't cheat in a way and just define a bubble by the fact that it has crash exposed. We look at EPISA's industries, where there's been a big, big price ramp up over the past few years. And at the same time, there's been big increase in trading volume altogether. So what other people have shown is that this is not a perfect way to detect a bubble. There will be lots of false positive. But on average, this is much more likely to be a bubble than a typical EPISA, these kind of periods. It's a way to say, well, EPISA where all of us would look at markets and say it's a bubble, or it's likely to be a bubble.

35:39that's what we call bubbles in the data. In our theory, for us, a bubble is an episode where people speculate, disagree, make prices being too high. You're taking industry portfolios and then defining a bubble as an industry that's had a big price run-up and a big increase in trading volume? I should have looked at the bubble and the money's had recently, but I think in the past two years. Both a big run-up, I think it needs to be both a big run-up for the industry and relative to the index. So it cannot be just that the whole index is climbing up. How do you measure the value of an innovation?

36:12We leverage some research that a lot of people have done, but that's kind of a cool idea. So first, we should think it's hard to measure the value of an innovation. Something like ChatGPT comes out. We all have a sense that it's extremely valuable, but how valuable is it? One simple way to define that is to think, well, what are the consequences of this innovation? So, you know, you're going to see, keep track of all the profits that OpenAI is going to make. That's the, well, you could call the private value of innovation. and to the innovator, their social value also, that other people will make more profits.

36:39So you can think about this in your head. Measuring the profits of OpenAI is okay. The other people's profits from this innovation already gets tricky. But you can start thinking through that. The idea that we're leveraging up, and that is something that we're going to criticize, is to say, well, you can try to use the stock market. So you could say, well, take the day where OpenAI released ChatGPT. So formally, what we do is take the day where the USPTO approves a patent by a firm, and looks at how much the subprice of that term goes up when this patent is approved. The total market capitalization is telling us how much value was created by this patent being approved and released.

37:16And there's also evidence that people will pay a lot of attention to those releases. That's the way to measure the value of the innovation. That's the market value of innovation. That's what we call it. So in the paper, we try to separate those two values. In the ideal world, those two numbers are the same in a way. The actual realized value, or not necessarily realized, but expected realized value, and the market value. We try to measure the two together to see, well, do they always line up? Starting point was this concern and we'd say, well, but when there's lots of innovation, so that's when we really need those measures, there's also lots of speculation and we start to worry that market prices might be off.

37:50How does the market value of innovation change during bubble periods? It goes up. We all know during bubbles, the market values go up, but that's not what we measure. So we measure how much the price change after the release of innovation, but it turns out those are bigger as well. In a way, the market does price everything bigger. And so we see these big reactions to innovation. Part of it should not be unexpected in that when we have big waves of innovation, the innovations are better. So we should see the markets value those innovations better. What we've kind of found out, both through kind of theory and trying to look at different measures, is that it looks like it's too much.

38:26So it looks like these price increases are larger than what's justified by the subsequent performance of those innovations. That is super interesting. The market tends to respond positively to patents, but during bubbles, the response is more extreme. Yeah. If you look at, for example, how do the profits of a firm respond to a patent, it also responds positively subsequently, but not more so after or during. So we see this disconnect. The markets have to value things a lot, even though they don't have better consequences. What effect does innovation have on real outcomes? What we find is that in a way, the market overvalues innovation relative to the gain they provide, international real outcomes, profits, sales.

39:13They produce good real outcomes, but when you look back, the stock prices react more positively than they should have? Yes, exactly. How are competitors of the innovative firm affected by the innovation? That to us was the flair that really made us think that it has to be a bubble. When I do an innovation and you're my competitors, this is kind of bad news for you typically. You could say, well, you can build on my innovation, but at first order, I step ahead of you. And so competitors tend to suffer. If you look outside of bubble, you see these phenomena. You see the stock price of competitors drop when an innovation pattern is approved.

39:49And you also see subsequently the sales of those competitors, the profits of those competitors go down. If you look during bubbles, in the real outcomes, you see that the sales will suffer, you see that those outcomes will suffer. But now you don't see a stock price reaction. The market is giving too much credit to the firm that innovated, but it's not punishing the firms that are suffering, that are the kind of losers of this innovation process. Wow. That's because they're in the same bubble industry? The way we sort of is actually by trying to dissect a little bit, what does it mean to be in a bubble?

40:24How do bubble pricing work? So it might be a little bit strange, but like bubbles are not just a big mess where people overvalue everything. The overvaluation is an outcome, but we thought maybe there's a method to this madness a little bit of the bubble. The kind of mechanism we had in mind was something based on disagreement, that different investors have different views on who are going to be the winners. If we go back, we're talking a little bit about AI. I might believe that open AI is the other ones. They are going to be the big successful innovators. You might believe that Meta is going to get all the profits.

40:57What this does is that, well, I'm going to be the investor in OpenAI, naturally, and Cameron is going to invest in Meta. We start to get this specialization of investors, and it's kind of like fan clubs for value stocks. And of course, the fan clubs of each stock is investing in that stock. So now if you start thinking what happens when you get a good news about OpenAI, the people who are valuing it are people like me who love OpenAI. So then the surprise of OpenAI is going to climb up like crazy. I already knew OpenAI was amazing. I get these good news. It's so amazing. You're the one that matters for Meta.

41:27You hear about OpenAI, but you're like, well, OpenAI sucks. Who cares? I know Meta is going to be the best, so they can innovate. It doesn't matter to me. Why would I worry? It's a little bit like we're going to run a race, and we think we're the best in the race in a way. If Cameron thinks he's going to win and I break my leg, he still thinks he's going to win. If I get better shoes and I run faster, he still thinks he's going to win. That's how you get that the competitors don't respond in a way, is that everybody has strong belief into their own firm and competitors don't worry and the firm that innovates gets all the gains.

41:58That's really interesting. It's like the cult of Tesla concept. Yeah, exactly. Yes. You see both the cult of Tesla and the competitors don't suffer that much. So the cult of Tesla tells you why Tesla is going up so much. It's not like we show for Tesla specifically, but if you apply this, the cult of Tesla is so good, but people like Ford so much. People who invest in Ford like Ford so much, they think electric cars don't matter. So Ford doesn't suffer too much. So what are the implications of this research for innovation policy? It depends how much innovation you think we should have. Maybe the most common view is innovation is always good in the end.

42:35What underlies that view is this idea that there's always going to be good speedovers to innovation. We get better computers. That's going to be good not only for whoever came up with a better computer, but like over time, all of us will get more computing power, everything will get better. And of course, but if you're the person creating the computer, you don't get gains from those spillovers. There's a common view that there's just not enough innovation. And so then in that view, bubbles are kind of good news because they amplify the incentives for innovation. They create more incentives for innovation.

43:05You can ride the bubble and get extra gain in terms of market capitalization. That's the positive view. So to say, well, as innovation policy, you should be aware there's a bubble. So you shouldn't overestimate how much innovation is going on. But at the same time, it's good news that innovation is stimulated. The flip side is that the bubble can create overinvestment. If you're not necessarily so convinced that we always need more innovation, we always need more investment. If we go back to Tesla, for example, it's like, well, it's great. This huge Tesla bubble completely accelerated the development of electric car.

43:36The issue, though, is there's a bubble. So people will lose their job. Tesla will suffer subsequently compared to the peak. We see sales go down. We see jobs being lost, and these are real consequences that are some fragility, and we should also be concerned. The first alarm message for policymakers was more watch out, in a way. You can gain from bubbles, but at the end, the end of the bubble comes. The long-term gains from the innovation are still there, but many people who partake in the bubble are going to suffer a lot. So you would have to balance those aspects. What are the implications for investors hoping to earn high returns by investing in innovative firms?

44:14Be careful. This is an extremely common pattern. We went back to a lot of history, actually. We tried to read a lot about this. When we talk about bubbles, the historical example, people talk about the tulip bubbles, things that are like bubbles on boots that don't matter, like gold bubbles. But it turns out a lot of bubbles look more like bubbles. There's something new and exciting. It's clearly good. It's clearly valuable. And people rush to try to develop the technology. Sometimes you win because the technology comes to pressure. but often there's overvaluation along the way prices drop subsequently the other thing to me that's important to realize is it's really difficult to pick winners as ai has been developing that's something that keeps coming to my mind is open ai showed up nice a huge firm and i have nothing negative to say about them i don't know that much to be honest if i see one in four years is open ai going to be the leader of ai who knows i was thinking like go back to the beginning of online commerce.

45:10We thought eBay was going to be the big online commerce. eBay was the clear leader. One thing that is, Amazon won. Even if you're betting on the right technology, I think we have a bias of thinking we can identify who's going to win, and that's something to avoid. I would say if you want to bet on AI today, that is risky because they're likely above all, I would say. But also, don't try to be a winner. You will have lots of failures along the way. There tends to be crazy skewness in technology bubbles. It's like what you said. If you're right about the industry, it's going to be one firm that drives most of the value creation and you can't know which one it's going to be.

45:48People have different biases or different priors in how they value it. I think many people would say OpenAI is the first one, so they're going to be ahead of everybody else. I think historically there's no evidence that this is true, but many people think like that, I would say. Many other people would think, well, for example, Meta or Google, they have a long track record of success in technology, so they will be able to take them over. That's also plausible, but again, not clear that that happens. Often we see new firms come out. That part, I think, is the part that amplifies the bubble in a way and is quite dangerous for investors.

46:17I think that investors often don't realize. All right. I want to move on to one more paper of yours that's in the Review of Financial Studies on Fixed Income During COVID-19. Another just fascinating paper. Can you talk about what happened in the US investment-grade corporate bond market in March of 2020? It blew up. COVID was a table pile for humanity, I think. Something that happened is that starting in late February, March 2020, as the pandemic was expanding, markets started to crash. This is a really unprecedented crash due to its speed. The one I think many people paid attention to at that time, just because we're used to follow the stock market, was the stock market.

46:53So the stock market drops a little bit more than 30%, and maybe even quite a bit more than 30 % over a few weeks. If you go back to 2008, for example, it was a massive stock market drawdown, but it took six months, nine months. The bottom of the market was in March 2009, six months later. This was just over a few weeks. So that's already a pretty strong event. But what we found out is that if you look at corporate bonds, and so in particular, we looked at investment-grade corporate bonds, so the safest of corporate bonds, their price dropped nearly 20%. And that's unprecedented because stock prices are extremely volatile, but bonds, we expect them to be safe and safe bonds to be safe.

47:31So that almost never happened before such extreme, extreme movements. That kind of got us puzzled. Like you have to imagine, you know, this is the beginning of the lockdown. I'm with my co-host, we're locked down at home and we look at the news every day, the financial news every day, and we see this happening. And we have done a lot of work before. Our financial institutions can create crises. We have done a lot of work around the 2000 crisis and so on. But it looked like nothing was seen before. So we wanted to dig into this some more. And how did the response in the bond market differ from the credit default swap market?

48:02A simple way to think about bond prices, corporate bond prices, is that while the price is going to be down, the company is likely to default. That would be the natural explanation, at least at first glance for this period. So while we're going to have a big recession due to COVID, many firms are going to go bankrupt, so that's why we see the price go down. But there's another place where you can get that information, that's the credit default swap market. So there are contracts where investors buy and sell insurance against default. Insurance is expensive. That means that the company is likely to be.

48:30We didn't see the price of those insurance go up during that pay for the sale. It went up a little bit. I shouldn't say we didn't see it go up by a small amount. To give you a concrete example and that's kind of my favorite example of this part is to look at Google. Google is an extremely safe company. Before even I tell you any price number, there was no reason to believe COVID-19 was going to do harm to Google. If anything, this was a We all spend more time on computers. This was good news for Google. And if you look at the CDS, or the credit default swap for Google, the price didn't move. So I think it costs a few basis points to ensure, again, the default of Google, something like 50 basis points.

49:03It went up a little bit, but if I show you the plot, it looks pretty flat. The price of a five-year Google bond went down to pretty much 80 cents on the dollars. That looks like it's pricing a massive risk of default for Google. Once you look at everything else, you don't see this risk of default. So we like credit default swap because it's also a price. It's also in the market. and you didn't see this price move. You just see the price of the bond itself go down. That's something that told us that something wrong was going on in markets more so than with the way markets worked, more so than with Google itself.

49:34Man, that's interesting. You see the bond prices tank. You think the price of risk is increasing, but then you look at another place where you can see the price of risk and it hasn't actually changed that much. What was causing the crash in bonds then? A natural guess, people don't want to buy bonds. More presented, people want to sell bonds, but it's not because the bonds themselves are risky in a way. It's because people want to offer positions. That's why you would call a massive higher sale going on in this market. So then we try to ask ourselves, well, where are the investors selling and how come this has such a big effect?

50:05There's a few dimensions you can point to. The biggest one, and even after our paper, people have done more studies and I think that's the one that's the most important, is that bond mutual funds sold a lot of positions. So a lot of bond mutual funds experience very large outflows. And what a lot of them did, not even funds specialize in more safe bonds, but a lot of mutual funds would sell their safer bonds first. So you have to imagine even if you have a mix of investment-grade high-yield bond, you get a bigger flow. It turns out the funds chose to sell the more liquid bonds first, the usually more liquid bonds first.

50:39All those funds went to the simple rule of thumb, that is, by the way, a good rule of thumb 99 % of the time, That is, if you have to liquidate, sell liquid assets. But it is so much so that then the liquidity deteriorated a ton in those markets. That's one big aspect. That's unprecedented because until 2008, we didn't have very big bond mutual funds in the US. There are some big ones that we know. FIMCO was actually in bond mutual funds, all this stuff. Most bonds were held through insurance companies, through much more stable institutions. After 2008, we saw this big growth of bond mutual funds.

51:15And that is completely kicked back the economy because with the outflows that there was just massive sales. So why weren't market participants stepping in to buy the bonds as these prices fell? So you have to ask yourself, well, who can step in? One category that historically plays a role when are those acute episodes are dealers, the bond dealers. So you think about like large investment banks. So historically, they intermediate a lot of the trading in this market. And so they would say, oh, we have an acute crisis. We're going to buy those bonds, keep them on our balance sheet for a few days.

51:45things will cool down and we'll put it back. In this case, there were two concerns, I think, that prevented this from happening. One is the reality that dealers cannot intermediate as much as they used to. We just have much more regulation in the market preventing that. The other one is that this crisis and the pandemic, it did last quite a long time. So there was a sense that even though it's very acute, it can be a long-lasting problem. What we would need is investors that can wait it out. That kind of kicked out the dealers. The dealers, even when they had bigger balances, didn't want to take on assets for a long time.

52:16So there was a lack of this long-term absorption capacity. Now you could look for other investors. You could say, well, maybe insurance companies could step in. Insurance companies, a lot of them didn't step in. So de facto, they didn't want to step in too much. They tend to be much more stable in terms of their inflows and outflows than bond funds. But they start to worry because as the price of the bonds drop, if it drops too much, the company will go bankrupt. And so it seemed like they were worried and not that willing to participate. Some did participate. I think I might be quoting the wrong one, but I believe MetLife, for example, did come into this market a bit during that period.

52:50But just not nearly enough to stabilize the market. There was not enough capacity to come in. So what was needed at this point was to come in on short notice and to be able to say, I'm going to come in, I'm going to hold that throughout the pandemic. It seemed like not many investors were willing to do it. something interesting we even talked to pension funds large pension funds i guess i cannot tell you which one a large pension fund and they asked us to come talk about this research and what was interesting is that the people managing the phone were telling us we knew this we knew there were good deals we could see those good deals but it's just our management was like you know it's the crisis we're not going to suddenly start to switch our policy so there's also just a bunch of friction in a way that make that a lot of investors cannot move into a market that fast wow yeah Yeah, that's super interesting.

53:36Sounds like a job for the Fed. What effect did the Fed's intervention have? The Fed did step in. They might step in, I should say to be precise. What happened is the Fed did something they never did before. They stepped into the corporate bond market. In 2008, the Fed did QE. So that was one of the first times they would say, well, we buy long-term treasuries, we buy mortgage-backed securities. But even after that, I think most people thought this was very limited to treasuries or treasury-like securities. I think there was always this idea that you shouldn't participate in the stock market, You shouldn't participate in corporate bonds.

54:05You shouldn't start to decide which firms are doing better. But in a pretty unexpected way, they just stepped in and they said, we're going to create those institutions. So it was the primary market credit facility, secondary market credit facility. We're going to absorb some of those bonds. They said at first they could buy up to$300 billion of investment-grade corporate bonds. Later, it got expanded in different dimensions, but up to$800 billion. So that's a big step in. And the day they announced that, the market recovers. I think about a third of the crash recovers just that morning. Is that good for markets?

54:42I'll tell you briefly about some other paper we've done. And that's not going to answer whether it's good or bad, but it's going to amplify the debate, I think. They said, we can step in up to$300 billion. And later, we can step in up to$800 billion. The market did recover. And it turned out the Fed never really stepped in. The Fed only bought something like$14 billion of assets. by the fall 2020, the Fed is not owning any corporate bond anymore. What we think is that, well, there was a possibility that the fire cell could get even worse. And what the Fed did really was say, well, I'm willing to do whatever it takes to fix it.

55:15It turns out the pandemic was not as bad as people thought it could get. It was extremely bad, just to be completely clear. But it was not as bad as we thought it could get. And so really, most of the Fed intervention did not happen. It could have happened, but it did not happen. Why does that make things kind of worse or more stressful is that the positive side is, well, that's great. They can stabilize market and the exports didn't do much. So then there's not much cost. The worrisome part is, well, they might be willing to step in again. And now they kind of like open the box and create this commitment.

55:47Now, that's another form of Fed puts that it will always step in when things are risky. We try to look a little bit in that subsequent research. Do we see traces on that? And we see some traces that suggest a little bit of this. So if you look since 2020, after the pandemic cooled down, the price of investment-grade carbon bond, if anything, seems too high. It's hard to tell. But if you talk casually to a lot of investment-grade bond traders, I don't know today, but I haven't talked to them recently, but even a year or two ago, the Fed is in this market somehow. Even though they're not intervening, there's a view that the possibility that the Fed steps in is just popping up the market.

56:22And that can be worrisome. That creates more al-azard. That creates issues of the Fed stepping in too much. At the same time, markets are not perfect. The crash to start with is not an efficient market phenomenon that we want to let happen. It makes sense that we want to fix this. The reason they step in so fast is they didn't want 2008 to happen. They didn't want this to spill over somewhere else. To me, I view it more as like there's a cost-benefit trade-off. At least in my mind, we are past the world to say the Fed should never intervene in markets. We should always respect markets. When I look at this episode, everything screams that something wrong is going on in the organization of markets, that there are frictions and it makes sense for a policymaker to interview.

57:01The problem is that once you come in once, you build commitments to come in again and those commitments might be costly. And that we, you know, only time wins. It's a great answer to the question, but it highlights how messy this system is. Extremely messy, yes. Crazy. What do you think the implications of this research are for the safety of bonds in a crisis? What we learned, I think, from this episode is the corporate bond market is much less stable maybe than it used to and that we thought it was and there's been a big debate actually before even that crisis even before that crisis there was a big debate that is if you look at everything about the corporate market it looked much better than before actually it looked much more liquid bid as far as small and it's because bond mutual funds etfs also like that you know that we have big growth of bond etfs so everybody's trading bonds the market looks like it's better but what we learned is that this liquidity is very fragile in a way.

57:56That is, you can have these big outflows, they can destroy everything on their way. So that's one lesson. The lesson in terms of how to fix it, to us, we keep going back to this thing that what we need is not just better intermediation. So a lot of the lessons from 2008 was intermediation is really important. We need to have a good trading system. We need to be able to move those bonds around fast. In that case, it was not a question of moving the bonds around. It was that we needed to hold those bonds. People often use this analogy of like the pipes of finance matter a lot. In my mind, that's not the problem.

58:28The problem was not the pipes was that we needed like water tank. We need a whole tank to all the assets for a long time. Now we're like three years out. We've made big progress in having those. So I would still be quite concerned for the stability of those markets where we to have another big negative shock. The shock was not starting in corporate bond. It was just a broader economic negative shock. And it just propagated in this market. What do you think is a safe asset in a crisis? So far, treasuries have done okay. Even treasuries, there was some notion that there was a safety premium on treasuries, typically that this premium was getting even negative, that people just needed cash.

59:07COVID was special in some sense. This episode really highlighted some prejudice in the corporate world market. It's not clear that many crisis would look like COVID. Crisis of cash, really. There was a sense, particularly at that point in time, that a big consequence was that business were going to be closed for a while. This is a world where you have to shut down for a while and open later so that you need cash. That's the only thing you need. You need to survive for a few months. The only safe asset was cash. At least from the point of view of investors. This will happen much faster than the horizon at which you need the cash, but that's what I think everybody was looking for.

59:40We shouldn't say that it would never happen again, but this is very specific to this type of crisis. Many other recessions, even large recessions, large crises, don't look like that. And so I think safer assets can hold their safety in those places. Final question for you, Valentin. How do you define success in your life? I think I don't think about success that much. I think about happiness. Am I happy right now? Am I setting myself up to be happy? I don't really have a very final goal. I feel like when you talk about success, it's like a final goal. I'm trying to enjoy the journeys. A lot of this happiness is at home.

1:00:14I have a wife that I love and a daughter that I love. And we spend a lot of time experiencing together. in my work, it's kind of the same. It's, I enjoy the journey a lot. These are very important questions. I hope I can contribute to the world and to the conversation, but I also enjoy the process of working through those questions. That's my two cents philosophy. It's a great answer. Great answer for sure. Great to have you, Valentin. This has been an incredible conversation. Thanks for your knowledge. No, thank you for having me. This was really fun. Awesome. Thanks, Valentin.

1:00:48Thank you.