People are worried about investment banker liquidity 

This was told to me by an investment banker I met a few days back, who obviously doesn’t want to be named. But like Matt Levine writes about people being worried about bond market liquidity, there is also a similar worry about the liquidity of the market for investment bankers as well. 

And once again it has to do with regulations introduced in the aftermath of the 2008 global financial crisis. It has to do with the European requirement that bankers’ bonuses are not all paid immediately, and that they be deferred and amortised over a few years. 

While good in spirit what the regulation has led to is that bankers don’t look to move banks any more. This is because each successful (and thus well paid) banker has a stock of deferred compensation that will be lost in case of a job change. 

This means that any bank looking to hire one such banker will have to compensate for all the deferred compensation in terms of a really fat joining bonus. And banks are seldom willing to pay such a high price. 

And so the rather vibrant and liquid market for investment bankers in Europe has suddenly gone quiet. Interbank moves are few and far in between – with the deferred compensation meaning that banks look to hire internally instead. 

And lesser bankers moving out has had an effect on the number of openings for banker jobs. Which has led to even fewer bankers looking to move. Basically it’s a vicious cycle of falling liquidity! 

Which is not good news for someone like me who’s just moved into London and looking for a banking job!

PS: speaking of liquidity I have a book on market design and liquidity coming out next month or next next month. It’s in the publication process right now. More on that soon! 

Dealing with loss of cash

Ever since Rs. 500 and Rs. 1000 notes ceased to be legal tender on Tuesday night, the internet has been full of “human stories” of people for whom tragedy has struck because they are not able to transact.

This is a valid concern – for there is a significant portion of the population without access to banking (numbers in a Mint piece I’ve sent but they’re yet to publish), and access to banking is necessary to do any transaction of reasonable size (there’s only so much you can pay with 100 buck notes).

One fallacy, though, is that people in rural areas, where access to banks and ATMs is lower compared to urban areas, are going to have it harder till the cash gets adequately replaced. While these places may be out of the way, what will help them tide it over is that everyone pretty much knows everyone else.

In Money: The Unauthorised Biography, Felix Martin argues that money is neither a store of value nor a medium of exchange. Instead, it is simply a method to keep track of debts, with the elegance being offered by the fact that money is “negotiable”. If I have a 100 rupee note, all it says is I’m owed 100 rupees. Who owes me those 100 rupees doesn’t matter. “I promise to pay the bearer the sum of one hundred rupees”, the front of the note declares. It just doesn’t matter who the “I” in question is.

In order to illustrate his theory of money, Martin gives the example of Ireland around 1970, when a six-month banking strike left the country’s financial system in tatters. Life didn’t come to a standstill, though, as people figured out ways of maintaining their credits and transferring them.

Initially, people wrote each other cheques. Despite the inherent credit risk, and the fact that they couldn’t be encashed in near future, people accepted them from people they knew. Then the cheques became negotiable, after “reputed community people” such as barmen started vouching for people’s creditworthiness. And so the economy moved along.

Debts were finally settled many months later when the banking system reopened, and people could cash in the cheques they held. A similar story played out in Argentina in the early 2000s when rampant inflation had rendered the currency useless – cities managed to invent their own currencies and life went on.

In a similar fashion, in small towns, and other communities where most people tend to know one another, people are unlikely to face that much trouble because of the cash crunch. Credit is already fairly common in such places, except that it will have to be extended for a longer period of time until the cash supply returns. It is similar in other remote unbanked areas, and perhaps even among tightly-knit communities of businessmen. Systems will spontaneously come up to extend and exchange credit, and life will go on.

The concern, however, is for the urban poor, since they tend to do a large number of transactions with people they don’t know well. In such situations, extension of credit is impossible, and people might find it hard.

Help me name my book!

The more perceptive of you here would’ve known by now that I’ve finished the manuscript of a book on Liquidity. Having finished the draft, and one basic round of editing, I’m now sending it around to publishers, hoping to strike a deal.

One of these publishers wrote to me saying that while she loves the chapters I’ve sent her (a small sample), she doesn’t like the name of the book. “Liquidity”, she says, is too bland and doesn’t reflect the contents of the book, and has asked me to come up with a better name.

And I’m at a loss, in terms of coming up with a name. I don’t even know what kind of name I should pick for the book. So I need you to help out!

The book is about liquidity, in the context of different markets. Apart from the handful of obligatory chapters (my chapters are mostly tiny, and there are 21 of them) on financial markets, I have stories on markets in taxis, dating, footballers, real estate, agriculture, job hunting, food, etc.

Here is part of an introduction to the book I’ve written, which might help you help me!

Why do people with specialised skills find it hard to switch jobs? Why do transfer fees for footballers always seem either too high or too low? Why are real estate brokers still in business despite the large number of online portals that have sought to replace them?

 

[….]

… we analyse why the market for romantic relationships, both matrimonial and dating, is mostly broken, and none of the new platforms are doing anything to fix it. We take a look at how taxi regulation is inherently inefficient thanks to liquidity issues, and how Uber’s much- maligned surge pricing algorithm helps create liquidity by means of superior information exchange. We will also see how liquidity helped build up the credit derivatives market, and then ultimately led to the global financial crisis.

So if you have any cool ideas on what to name the book, or at least a framework I need to follow to name it, please do let me know in the comments here! It might help you to know that the “acknowledgements” part of the book hasn’t been written yet!

Liquidity and the Trump Trade

The United States Treasury department has floated a new idea to improve liquidity in the market for treasury bonds, which has been a concern ever since the Volcker Rule came into place.

The basic problem with liquidity in the bond market is that there are a large number of similar instruments trading, which leads to a fragmented market. This is a consequence of the issuer (the US Treasury in this case) issuing a new bond every time they wish to borrow more money, and with durations being long, many bonds are in the market at the same time.

The proposed solution, which commentators have dubbed the “Trump Trade” (thanks to the Republican Presidential candidate’s penchant for restructuring debt of his companies), involves the treasury buying back bonds before they have run their full course. These bonds bought back will be paid for by newly issued 10-year bonds.

The idea here is that periodic retirement of old illiquid bonds and their replacement by a new “consolidated” bond can help aggregate the market and boost liquidity. This is not all. As the FT ($) reports,

The US Treasury would then buy older, less liquid and therefore cheaper debt across the market, which could in theory then be reissued at a lower yield. In recent months, yields on older issues have risen more than those for recently sold debt, suggesting a deterioration in liquidity.

This implies that because these “off the run” treasuries are less liquid, they are necessarily cheaper, and this “Trump Trade” is thus a win. This, however, is not necessarily the case. Illiquidity need not always imply lower price – it is more likely that it leads to wider spreads.

Trading an illiquid instrument implies that you need to pay a higher transaction cost. The “illiquidity discount” that many bonds see is because people are loathe to holding them (given the transaction cost), and thus less people are willing to buy them.

When the treasury wants to buy back such instruments, however, it is suddenly a seller’s market – since a large number of bonds need to be bought back to take it off the market, sellers can command a higher spread over the “mid price”.

Matt Levine of Bloomberg View has a nice take on the “IPO pop” which I’ve written about on this blog several times (here, here, here and here). He sees it as the “market impact cost” of trying to sell a large number of securities on the market at a particular instant.

Instead the typical trade of selling, say, $1 million of a bond with $1 billion outstanding, and paying around 0.3 percent ($3,000) for liquidity, you want to sell, say, $1 billion worth of a bond with zero bonds outstanding. That is: You want to issue a brand-new bond, and sell all of it in one day. What sort of bid-ask spread should you pay? First principles would tell you that if selling a few bonds from a large bond issue costs 0.3 percent, then selling 100 or 1,000 times as many bonds — especially brand-new bonds — should cost … I mean, not 100 or maybe even 10 times as much, but more, anyway. No?

Taking an off-the-run bond off the market is reverse of this trade – instead of selling, you are buying a large number of bonds at the same time. And that results in a market impact cost, and you need to pay a significant bid-ask spread. So rather than buying the illiquid bond for cheap, the US Treasury will actually have to pay a premium to retire such bonds.

In other words, the Trump Trade is unlikely to really work out too well – the transaction costs of the scheme are going to defeat it. Instead, I second John Cochrane’s idea of issuing perpetual bonds and then buying them back periodically.

These securities pay $1 coupon forever. Buy these back, not on a regular schedule, but when (!) the day of surpluses comes that the government wants to pay down the debt. Then there is one issue, with market depth in the trillions, and the whole on the run vs. off the run phenomenon disappears.

People don’t worry enough about liquidity when they are trying to solve other liquidity worries, it seems!

 

I completed the manuscript of my book

I had set myself an April 15 deadline to finish the first draft of my book, and I’m happy to let you know that I’ve achieved it. This draft weighs in at around 75,000 words, which is probably longer than I’d expected.

Now the hard part begins – of finding publishers, editing, promotions and all that jazz. I don’t even know where to start and which publishers to approach. This is a popular economics book where I use the concept of market liquidity (from finance) to explain why certain markets are structured the way they are, and how markets can be made more efficient.

Here is a brief introduction of the book that I’ve written. I’m yet to give it a name, but the subtitle is “How financial markets explain life”:

Why do people with specialised skills find it hard to switch jobs? Why do transfer fees for footballers always seem either too high or too low? Why are real estate brokers still in business despite the large number of online portals that have sought to replace them?

The answer to all this lies in liquidity. Broadly speaking, market liquidity refers to the ease with which a product or service can be bought or sold in a particular market. With its origins in financial markets, the concept has far-reaching implications in a large number of markets.

In this book, Karthik Shashidhar, a management consultant and public policy researcher, explores a large number of markets, financial and otherwise, and explains why they are structured the way they are. From relationships to property rights, from big macs to public transport, a large number of markets are dissected to show why liquidity remains a useful concept well beyond financial markets where it originated.

Now, while many of the examples are from India, I’ve written this book with a global audience in mind. Hopefully I should be able to publish and sell this book internationally.

There is a full chapter on the economics of Uber, and how surge pricing is critical to creating liquidity in the rides marketplace. There are also chapters on matchmaking, obsolete technologies, agricultural markets and why most Indians cook at home.

I haven’t really seen any other popular economics books from India, so don’t know where to start my publisher hunt. Any leads will be welcome. I’m currently in Barcelona, but will be returning to Bangalore in mid-May.

Oh, and there is very little intersection with this blog, or anything I’ve published so far. One chapter intersects one blogpost here, and another draws from a Mint piece I’ve written, but the rest is all fresh material. So, you people have no excuse but to buy the book when it does come out!

Wish me luck!

Barriers to entry in cab aggregation

The news that Reliance might be getting into the cab aggregation game got me thinking about the barriers to entry in this business. Considering that it is fundamentally an unregulated industry, or rather an industry where players actively flout regulations, the regulatory barrier is not there.

Consequently, anyone who is able and willing to make the investment and set up the infrastructure will be able to enter the industry. The more important barrier to entry, however, is scale.

Recently I was talking to an Uber driver who had recently switched from TaxiForSure. The latter, he said had lost “liquidity” over the last couple of months (after the Ola takeover), with customers and drivers deserting the service successively in a vicious cycle. Given that cab aggregation is a two-sided market, with prominent cross-sided network effects (number of customers depends on number of cabs and vice versa), it is not possible to do business if you are small, and it takes scale.

For this reason, for a new player to enter the cab aggregation business, it takes significant investments. The cost of acquisition for drivers and passengers is still quite high, and this has to be borne by the new player. Given that a significant number of drivers have to be initially attracted, it takes deep pockets to be able to come in.

Industry players were probably banking on the fact that with the industry already seeing consolidation (when Ola bought TaxiForSure), Venture Capitalists might stop funding newer businesses in this segment, and for that reason Uber and Ola might have a free rein. Ola had even stopped subsidising passengers in the meantime, reasoning (correctly for the time) that with their only competition being Uber they might charge market rates.

From this perspective it is significant that the new player who is entering is an industrial powerhouse with both deep pockets and with a reputation of getting their way around in terms of regulation. The first ensures that they can make the requisite investment (without resorting to VC money) and the second gives the hope that the industry might get around the regulatory troubles it’s been facing so far.

I once again go back to this excellent blog post by Deepak Shenoy on the cab aggregation industry. He had mentioned that what Uber and Ola are doing is to lay down the groundwork for a new sector and more efficient urban transport services. That they may not survive but the ecosystem they create will continue to thrive and add value to urban transport. Reliance’s entry into this sector is a step in making this sector more sustainable.

Will I switch once they launch? Depends upon the quality of service. Currently I’m loyal to Uber primarily because of that factor, but if their service drops and Reliance can offer better service I will have no hesitation in switching.

The ET article linked above talks about drivers cribbing about falling incentives by Uber and Ola. It will be interesting to see how the market plays out once the market stabilises and incentives hit long-run market rates (at which aggregators need to make a profit). A number of drivers have invested in cabs now looking at the short-term profits at hand, but these will surely drop with incentives as the industry stabilises.

Reliance’s entry into cab aggregation is also ominous to other “new” sectors that have shown a semblance of settling down after exuberant VC activity – in the hope that VCs will stop funding that sector and hence competition won’t grow. After the entry into cab aggregation, I won’t be surprised if Reliance Retail were to move into online retail and do a good job of it. The likes of Flipkart beware.

Arranged Scissors 16: Liquidity

Ok so the last time I wrote about Arranged Scissors was more than five and a half years back, when the person who is now my wife had just about started on her journey towards ending up as my wife. And today she made a very interesting observation on arranged marriage markets, which made me revisit the concept. She tweeted:

It is a rather profound concept, well summarised into one tweet. Yet, it doesn’t tell the full picture because of which I’m writing this blog (more permanence than tweet, can explain better and all that).

Reading the above tweet by the wife makes you believe that the arranged marriage market is becoming less liquid, because of which people are experiencing more trouble in finding a potential partner on that market. And there is a positive feedback loop in play here – the more illiquid the arranged marriage market becomes, the more the likelihood for people to exit the market, which results in making the market even more illiquid!

But this makes you believe that there was a time when the arranged marriage market was rather liquid, when people were happy finding spice there, and then it all went downhill from there. The fact, however, is that there are two countervailing forces that have been acting on the liquidity of the arranged marriage market.

On the one hand, more people are nowadays marrying “for love”, and are hence removing themselves from the arranged marriage market. This is an increasing trend and has resulted in the vicious circle I pointed to two paragraphs earlier. Countervailing this, however, is globalisation, and the fact that the world is becoming a more connected place, which is actually increasing the liquidity of the market.

Consider the situation a century back, when most marriages in India were “arranged”, and when it was the norm to pick a spouse through this market. While that in theory should have made the market liquid, the fact remained that people’s networks back in those days was extremely limited, and more importantly, local. Which meant that if you lived in a village, you could get married to someone from a village in a small radius, for example. Your search space was perhaps larger in a city, but even then, networks were hardly as dense as they are today. And so there was a limited pool you could pick from, which meant it was rather illiquid.

And over time, the market has actually become more liquid, with the world becoming a more connected place. Even a generation ago, for example, it was quite possible (and not uncommon) to get “arranged married” to someone living in a far-off city (as long as caste and other such factors matched). In that sense, the market actually got better for a while.

But it coincided with the time when social norms started getting liberalised, and more and more people found it okay to actually exit the arranged marriage market. And that was when the illiquidity-vicious-circle effect started coming into play.

In recent times, connectedness has hit a peak (though it can be argued that online social networking has helped extend people’s connections further), and the vicious circle continues unabated, and this is the reason that we are observing that the arranged marriage market is becoming less liquid.

Oh, and if you’re in the market, do get in touch with the wife. She might be able to help you!