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The Modern CFO podcast is designed to illuminate the hard work that is behind the scenes in financing next-generation ideas and technologies, as well as acknowledging the developing role of senior financial professionals, and the tools they rely upon.
[00:00:00] Andrew Seski: Hello and welcome back to The Modern CFO podcast, as always, I'm your host, Andrew Seski. Today I'm thrilled to be joined with a special guest: Steven Kelly, Associate Director at the Yale School of Management, who studies financial stability. Steven, thank you so much for being here.
[00:00:24] Steven Kelly: Great to be here, Andrew.
[00:00:25] Andrew Seski: So I wanted to kick today's episode off by kind of explaining a slight reformatting and why I think today's conversation is really important, along with a bunch of thank yous to both Steven for his time and the rest of the audience for being so engaging. So about five years ago, I joined Nth Round. Chris and Graham McConnell took me on as one of the very first hires. And we were looking to try to solve some of the most complex pieces of the private market infrastructure, including liquidity. That is something that I'm sure people know by now, just in knowing me and the company, but wanted to say thank you to Chris and Graham.
[00:00:58] Andrew Seski: Also, what people may not know is that I have been studying liquidity provisions for quite some time with one of my best friends, Beauchamp Zirnkilton, an undergrad. And this is kind of where this conversation all started. I reached out to the Yale school for the first time, maybe close to eight years ago. So I just wanted to say thank you to all those involved. And thank you for Steven for what I'm sure is going to be an incredible conversation relevant to CFOs who are trying to better understand risk, how to mitigate it, and maybe some kind of aspects of how to manage risk in a more international environment in today's kind of unprecedented times.
[00:01:32] Andrew Seski: So, Steven, I want to kick it off to you and would love for you to introduce yourself and explain kind of how you got situated at Yale and some of your focuses.
[00:01:42] Steven Kelly: Yeah, so I'm at the Yale program on financial stability. We're sort of like a quasi-think tank inside the Yale School of Management. We're very much a finance program. We're not economists, we're not lawyers. We're really, sort of mechanics almost - real market realists thinking about particularly how to fight financial crises as they occur. Sort of the break the glass playbook. Our chair is Tim Geithner. He's a former Treasury secretary.
[00:02:11] Steven Kelly: He was at the New York Fed when the 2008 crisis really started and then became Treasury secretary. And he kind of saw really firsthand the costs of, even a day, an hour of not knowing what to do as a crisis fighter. And there's a huge apparatus out in the world and academia in international institutions to think about prevention, think about crisis prevention.
[00:02:36] Steven Kelly: But the thing is, if you're at something like the IMF, the World Bank, the Bank for International Settlements, you kind of have to say, “Okay, here's our prevention framework, and it's going to work.” And you start asking questions of, like, “Okay, what happens when it fails and there's a crisis anyways?” And you get shut down - nobody wants to talk about a crisis for fear of causing one, right? I mean, as a policymaker, you can't go out and say, “Here's all the things we're thinking about for when there's a financial crisis.” But we know we have them. There's basically always one going on somewhere in the world, at least one.
[00:03:09] Steven Kelly: I mean, this is sort of the IMF's job. So anyways, we're really focused. We sort of pick up the baton there. We have a lot of political insulation here and because the things that are done in a crisis are really unpopular, I mean, the things that work - again, it goes back to the sort of market mechanics, the things that make banks function and make the system really get back to standing on its feet - are really unpopular. It's things like rescuing banks and keeping executives who made mistakes in their jobs because they know where the bodies are buried and they know how to get us out of this, and spending money at the government level, like bigger deficits, things like that - just a lot of policies that are really unpopular. So it helps to have sort of political insulation to just say, “Okay, here's what works - do with it what you will.” So really, I came into this space to work on 2008 and that quickly got sidetracked by 2020. I mean, COVID was not a financial crisis in sort of the classic sense, but we use a lot of the same tools.
[00:04:10] Steven Kelly: Obviously, it was sort of an all-of government approach. So you have you had the financial crisis tools being pulled off the shelf. But you also had every other - the Department of Education doing stuff and the FDA and whoever - everybody was working on that. And so that was sort of a crisis avoided. And then now, COVID is like my historical example, and I'm teaching 2023 and talking about 2023 as really a more traditional banking crisis. And so, we're obviously working on 2023 and sort of improving the crisis fighting apparatus, which really got sort of hamstrung post-2008. Because like I said, this stuff is really unpopular.
[00:04:50] Andrew Seski: Can you break down some of the tools and levers that are actually being pulled during crises, what those conversations actually entail? I think it might be relevant and maybe timely as CFOs think about communicating risk to investors, to the board, and maybe they can learn something about how you communicate internally.
[00:05:09] Steven Kelly: Yeah. I mean, the biggest thing - and it's almost a meme at this point - is the Fed and the money printer as being sort of the first crisis response. So, obviously, you can talk about cutting interest rates. It's not always fit for purpose. I mean, this sort of goes back to the difference between a recession, sort of a garden variety recession, and a financial crisis. If you take the standard recession response and you superimpose it over March 2023 - or 2008. For sure, 2008 - you repeat the Great Depression. It just wouldn't have worked. So, the Fed's got all these other tools they can use to sort of provide liquidity to the financial system more broadly. Talking about being hamstrung, they can't really do the rescues that they used to. We talk about the “Fed put”, like the Fed is always gonna be there to rescue the market, and that's sort of a misconception. It's sort of a misread of the Fed's job, to be a put on the economy basically.
[00:06:12] Steven Kelly: They don't really care about the market except for the extent to which it represents something going on in the economy. And we've sort of gotten, we've sort of seen that borne out in the last couple of years, like serious bear events, and the Fed has said, “We're going to keep hiking”. So the Fed can do stuff on the margin. It's job gets complicated, one by being hamstrung by post crisis regulation, which says: you can't rescue one firm at a time anymore. Illegal. So what you did for Bear Sterns, what you did for AIG, yes - you saved the world, but we're Congress and we don't like it. There's sort of a famous instance where the Fed dispensed $85 billion to AIG overnight. And that was a whole story in itself. AIG had like shopping carts of literal collateral. They were like running down the street, like to the Fed. I mean, it was [a] crazy situation. And Ben Bernanke, who was chair of the Fed is talking to, to some leaders of Congress at the time. Barney Frank goes, “Where did you get $85 billion?”
[00:07:04] Steven Kelly: And Ben Bernanke goes, “I have $800 billion”, because the money printer really is powerful. So you can see how Congress wouldn't like something like that. And they said, “All right, you can do market stuff, but you can't rescue a firm anymore.” Okay. So that makes life harder. What we saw in 2023 was the FDIC guaranteeing deposits, uninsured deposits. And the difference there between that and the past, again, this is post-GFC stuff, post global financial crisis stuff is, the FDIC can't help an open bank anymore. So the Congress said, “Hey, if you're a bank, you have to fail before the FDIC is going to help you.” So again, it's just making life harder. It's making things more stressful. And the Treasury again is pretty limited. They have some discretionary funds, but not many. And so these are kind of the tools at our disposal, but they're weaker than they used to be when we really get into crisis trouble. And the other thing is, I mean, [in an] ideal world, banks play a sort of insular role to the economy. Like when you're in trouble, you should be able to go to your banker. And when the economy's in trouble, it should be able to go to its banks and the banks sort of underwrite the economy. And even that is a little squishier than it used to be because banks have to hold so much more capital now and their risk-taking is so much more controlled, and that's why you see these sort of like weird market blowups that CFOs have had to deal with.
[00:08:24] Steven Kelly: And you're like, what's going on in the Treasury market all of a sudden? Or like, what's going on with commodities all of a sudden? Why are these weird things breaking? And it's because we used to just let banks like underwrite that and banks just could just blow up their bit, like just increase their balance sheets and we trusted them. And that's good? I mean, the flip side is like, the short version of 2007-2008 is like, okay; 2007 housing gets soft and all these little things start breaking, that banks are sort of supporting and they say, “All right, put it on our balance sheet. We'll take it. It's fine.” Like, this is we'll buy the dip basically.
[00:08:59] Steven Kelly: But it wasn't the dip, like the real dip was coming and then the banks blow up because they had taken all this risk. So you can see, like, that was sort of the trade-off that policymakers made. But where we're at and where that leaves us is: banks themselves are much less willing to intervene. So that's why we're in, like, we're in a strong economy. We have high interest rates and central banks are still - it's still every day you see a headline, “Is the Fed going to rescue this market? Is the ECB going to rescue that market?” Why is this happening when the economy is so strong? And that's why; balance sheets in the private sector are just stickier.
[00:09:33] Andrew Seski: Right. I'm curious if you think that there's going to be [an] interesting intersection of new technologies playing a role in maybe some of the more predictive elements of making these decisions. I'm also curious as to if you think that there's a chance for technology to better predict and suggest what should be generally accepted collateral. So we're going to talk about the health of a bank balance sheet, or even a company balance sheet. It's what's considered - actually generally accepted - collateral. I think student loans are considered generally accepted collateral. So then the bigger question is: how often is that being rehypothecated? Where is it being stored in banks around the world? And are there things that aren't even being tracked that are incredibly toxic? There have been suggestions I was researching. It's interesting to see some blockchain applications coming to life about tracking debt in a more transparent way. That's somewhat interesting, but likely pretty inefficient and difficult to do as well. But I'm curious as to where you view that intersection of all of these new AI tools, and maybe some CFOs can glean some insights from how you're observing it from the academic level.
[00:10:42] Steven Kelly: Yeah, it's sort of a double-edged sword. I guess it's my natural inclination to say, “Okay, what's going to happen in peacetime, and what's going to happen in crisis time?” And at peacetime, this seems great. Like, you get huge efficiencies from staffing, perspective, to the extent that AI blockchain, these things can make payments faster. You catch more float, you lose less float to stuff like that. But when it comes to crisis, it's sort of a double-edged sword because one thing that's nice is, sort of - in a crisis, people get nervous and people look where they can for cash. One thing they do is they just go to their counterparties and they go, “I think you owe us a little more collateral. All of a sudden, I don't like this mark”. And so to the extent you can have AI or smart contract that's sort of [a] blockchain-based smart contract that's governing the valuations. If you're that counterparty, you can say, no, no, no. It says what it says: I don't owe you anything.
[00:11:41] Steven Kelly: I mean, this was a big thing. Again, in 2008, people just wouldn't answer phones. I mean, and that's sort of good. Like if AIG had been governed by smart contracts and AI valuations, they would have gone bankrupt before the Fed could rescue them. Like the biggest thing they did was just say, “I don't agree with your marks. I'm not sending you money, Goldman Sachs”. And then Goldman Sachs would go to the Fed and say, “Come on!” And so that like by time, it's actually really important. And really what we see across crises is that contracts are sort of loosely enforced or not enforced that like laws are straight up broken. And the penalty is often either not guilty or guilty and the damages are $1. So to the extent you start moving money from you have AI governing that, you sort of lose that human discretion to basically break the law or break a contract, which actually has systemic benefits.
[00:12:39] Andrew Seski: We don't have the contagion effects all of the time for every counterparty. So, like a classic run on a bank, right? If everyone is sprinting at the same time, or it's governed by something that's automatic, it could have the potential to have catastrophic events.
[00:12:55] Steven Kelly: And the other thing is thinking about accounting standards. When an asset goes illiquid, like the accounting for it changes. I mean, you're allowed to make certain exceptions for, “Okay, I no longer think I'm supposed to, this is a level 1 price anymore”. I think there's some sort of better model valuation, whatever - you marked a model instead of marking the market. And okay, that's sort of like, okay, you're dodging your marks on the one side. And on the other side, you're like, well, maybe the marks really are bad and you're not going to sell. So again, it goes back and forth, and we see like the SEC and others deal with this in a crisis. Like sometimes they'll get calls to ban short selling or change the accounting. And sometimes they come out and say, look, anything that's illiquid? Stick with your old marks, like whatever. And other times they don't. So it's a hard thing to write into code, basically.
[00:13:45] Andrew Seski: Right, interesting. What are some of the non-obvious reactions that also caused more harm that, at an individual or a business level, just don't serve the purpose of stability? Are there kind of gut reactions that you've seen a lot of financial folks make that in kind of wartime have caused more harm than good?
[00:14:07] Steven Kelly: It's tough to say because usually what's happening in a financial crisis is everybody's acting rationally, and collectively it doesn't make sense. Collectively, it's horrible - but you can't blame any of the individuals for running on the bank or whatever else. I mean, when you have a deposit or something that you're expecting to pay out at par, you really have no incentive to worry about that. It's just you're there or you're not there - because you've done no valuation. Right? I mean, so to the extent you think things are safe. I'm working this field and I don't - I haven't analyzed my own bank's balance sheet, like to the extent of knowing whether it's credit [is] good - but I don't have to think about it.
[00:14:48] Steven Kelly: Like I have a bank that's safe and I've got deposit insurance and all that, but to the extent I all of a sudden have to think about it, I'll take my money out and figure it out later. So it's tough to say because it's totally rational to just hear a rumor and move your money. I mean, it's really that simple. You see your banker at the bar and you go, “You know what? No, forget about it.” And the flip side too is like institutional money can often get a lot of yield by helping the financial sector take risk. So if you're sitting on a big pile of cash on your balance sheet as a CFO, as a treasurer, you've got way more than deposit insurance is going to do you any good for it. Right? So you're invested in money market funds, you're invested in other things. And maybe there's not that many Treasury bills out in the world, or maybe they're yielding zero. And you go, all right, I'll take an extra 50 bips to buy some commercial paper, to buy some repos, because it rolls every night.
[00:15:46] Steven Kelly: And so as soon as I get nervous, I'm gone. And I've made an extra 50 bips on my billion-dollar cash pool in the meantime. And so that works perfectly from that CFO's perspective and from that business's perspective. They just harvested 50 basis points buying like short term private paper. And they got out as soon as things got remotely nervous. But what they did was finance, really maturity transformation, short-term funding into some long-term thing. And then they ran on it. So again, it makes sense from a private perspective and it's sort of not managed well systemically.
[00:16:18] Andrew Seski: Well, I know you've just spent the last six months basically analyzing Silicon Valley Bank and likely Credit Suisse and a lot of pretty eventful transactions and failure events this year. So I'm really interested in hearing - maybe at just a high level - what you've been focused on. Any learnings that have arisen maybe towards the end of your research? And if there are insights that we can learn, that just we haven't, normal folks like me haven't had the time to sit around and study as closely as I'm sure you have.
[00:16:52] Steven Kelly: Yeah, I mean, as far as like broad lessons, especially considering your CFO audience, I would say a few things. One is: there's always a price for sort of turnkey niche service. So, the advantages that SVB had were, they're like, okay, we're tech. We're going to help tech. We understand tech companies in a way that JP Morgan and Bank of America don't. We can help you. We can get you access to these fun events and whatever else. And that's fine. And that's good. I mean, there's nothing wrong with a business model that says we're going to help an industry that we think is underserved. But when it comes to finance, you really don't want like niche-ness, you don't want something that's innovative necessarily, when it comes to like the base of your pyramid of finance, like your deposits and your payroll, and so that's the business that's going to fail. And that's a business model that makes a ton of sense if it's got a huge balance sheet behind it, like it works great. JP Morgan bought First Republic, and they're going to make a ton of money. And the First Citizens bankers are going to HSBC and they're going to MUFJ.
[00:18:10] Steven Kelly: Like big banks want this service and they have the stability of the big balance sheet behind it. But when you go niche, customers of SVB and these related banks got a lot of particular services in the meantime, but the cost was they had a bank that can go - like JP Morgan is not a bank that will disappear and really risk its depositors and people using its services. So that's sort of the price that's hard to see, I think, in finance is there's a huge cost to using someone who's not diversified and really has a specialization. The other big takeaway, I think, is really to stay engaged with your equity investors, especially in finance, but really across the board - that junior layer of funding. When that disappears, the rest of the capital structure collapses because you have, debt holders all of a sudden become equity holders in the case of banks. If you're a deposit holder, you're gone, right? If you're a short-term debt holder, you're gone. When SVB announces on March 9th, and they said, look, we tried to do this equity raise for $2.25 billion. We did not get the funds. We got half a billion and we're going to try to raise the rest.
[00:19:26] Steven Kelly: The run was on. So you really always want to have contingent capital that can come in and you can sort of say, as soon as you need the capital, you can say we have it. You don't want to be in a situation where you're like, “Okay, we need equity”. It's different if you need to raise debt, you need to raise whatever. If you lose that junior layer, everybody else is going to feel like they're there now the junior layer - it just waterfalls down the capital structure. So really the biggest thing is stay in touch with that junior layer of funding and have a contingent junior layer. And same with Credit Suisse - Credit Suisse basically failed sideways for, you can go back as far as you want. Years, certainly months. They had all this time in the world, yeah, they're trading at $4 a share, but they're sort of muddling along. And then their biggest shareholder goes on the news and Bloomberg News says, would you put more money in? And he says, absolutely not. Poor choice of words, but that was it. I mean, the Swiss national bank will tell you [themselves].
[00:20:24] Steven Kelly: They said that was the moment that this thing unraveled. So really, it's being in close communication with your equity investors, and having contingent equity ready to go basically as ready to go as you can. You don't have to say, “Hey, we need equity. We're going to go try to get it”. You can say “We needed equity, and we got it”.
[00:20:43] Andrew Seski: You mentioned a few times at the beginning that you feel like we have a really strong economy, and I'm curious as to how you think about stacking up different levels of maybe market risk at the moment. And then I'm very curious as to the ongoing debate. I'm not sure if you listened to the All-In podcast - everyone on that show constantly debates whether or not it's even important as the U.S., as we're kind of a global reserve currency still, and is there a country that's better off than us? And does that even matter? So curious as to how you're thinking about consumer debt being at an all-time high, 13-year low of home purchases in the U.S.? I think a lot of the institutional dollars are buying now even single family homes.
[00:21:24] Andrew Seski: And did the collapse of SVB collapse other regional banks, and do those regional banks actually add a layer of diversification, or are they too small of a pool to really matter? So, I know that's a lot of different pieces kind of stacked together, but it's just how I'm thinking about some of the kind of post-recession realities that we're living in right now. And how that how do you measure that? Because again, you mentioned that you feel we have still very strong economy.
[00:21:53] Steven Kelly: Yeah, so I guess I could say a few things trying to go in reverse order. The regional bank question is very much an open one as far as: do we need these banks? What role do they play in the economy? Does it make sense for them to merge and get bigger? Does it make sense for them to downsize and specialize more? I mean, certainly what we saw from 2023 is the barbell of the financial system has held up okay. The big banks did fine - community banks, they're like super so niche. I mean, obviously they're dependent on a local economy then, which is risky, and they fail more frequently than big banks. But they weren't necessarily vulnerable to the kind of runs that took down three regional banks. So that's very much an open question. And policymakers are sort of wrestling with that, “Do we want this sort of barbell financial system?”
[00:22:43] Steven Kelly: Generally they say no, but it's hard to be a regional bank that's not quite at scale and be stable in all environments, especially if you want to be niche. If you want to be niche, you really want to be small. And if you want to be stable, you want to be big. There's kind of natural gravitational pulls each way. As far as like the economic effect that we've seen, there's been some ongoing tightening and lending. We obviously didn't have a financial crisis. Part of that was the nature of the run. Like I said, it was on these more specialized banks. There was never really that feeling of like, “Oh my God, this is going to go to Goldman Sachs, and this is going to take down Morgan Stanley”. We just never had that, which is good.
[00:23:23] Steven Kelly: If you can keep the core of the system intact, you're in a good spot. But certainly at the margin, it contributes to a tightening of credit. But that's also kind of what the Fed wants. They don't like when banks fail, but at the same time, it did some of their rate tightening for them. The question of reserve currency, yeah - this is sort of an evergreen debate and it sort of changes its form. I mean, the most recent iteration is like - well, I guess it's two things. The most recent iteration is the Fed or the US government, like it's going to shut down, or it's going to hit the debt ceiling and default, and that's bad for treasuries.
[00:24:00] Steven Kelly: And the other thing is like, okay, the US has started using sanctions more as a weapon. So do other countries really want to still hold dollars and really stash their money in a way that can be sanctioned so easily? And I would say we're a long way from this. This sounds almost scary to say, but the US’s best export, one of its best exports is its financial system - is debt. We have the legal structure. We have the right institutions in place to basically produce a ton of Treasury debt that the world needs. We have a strong economy. We have an advanced economy where we're sort of, we have liquid capital markets. We have [a] strong legal structure.
[00:24:41] Steven Kelly: And those things really drive invoicing and dollars globally, and holding reserve assets and dollars globally, and that's a hard thing to replicate and replace. It wasn't too long ago: we were talking about breaking up the Eurozone, China obviously doesn't have free movement of capital and is highly political, so it's hard to see a rival really replace the dollar, particularly in the short to medium term. That's kind of my response there.
[00:25:15] Andrew Seski: Thinking about the role of institutional trust in a system like ours, and perhaps some of the degradation from the public and institutional trust when it comes to maybe COVID responses, maybe government and governing in general - and then, in an even more complex system, like the Fed and responses to crises, and communicating those responses and then going into government and having politicians maybe do not the best job in explaining the details as to some of the decisions. There were positive externalities from the global financial crisis that are hard to discuss because it was a huge, life-altering moment for most Americans.
[00:26:00] Andrew Seski: So kind of curious as to how you think of your role and helping to reestablish some of that institutional trust in the financial system - how do you see that changing, in forms of when you communicate either to like we are now, or just even internally with your team?
[00:26:20] Steven Kelly: Yeah, I think certainly - obviously we're focused on crisis response and this sort of relates to your question about the dollars, the US role globally, is the extent to which the US can credibly underwrite the global system and communicate that to the world of like, “Okay, we are here.” That does wonders for us. I mean, a big thing the Fed does and the US government does, and this really goes under the radar, like even Congress doesn't pay attention to this, and one of the biggest things the Fed does is: it sends a bunch of dollars overseas in a crisis. So during COVID, during the GFC, like trillions.
[00:27:03] Steven Kelly: Hundreds of billions rolled over to foreign central banks, and the foreign central banks send the money out into their economies because people need dollars. And there's a demand for dollars. And that is hugely supportive of a dollar system globally. And that communicates a real credibility of the U.S. globally to say, like, we are not going to let this thing burn. We are not going to let politics interfere with our role and with underwriting this system that serves the globe. And so I do think those communications, and more importantly, the following through, and again, it goes back to institutional credibility. They can point to their authority and say, “Look, we can do this. We will do it as necessary’. And as you know, that often does the work for them. It's just saying “We're here, we'll do it if we need to”. And the market takes a lot of comfort in that.
[00:27:58] Andrew Seski: Yeah, that's really, really great. Boy, I'm glad you brought that up. I do think there are a lot of aspects of the work that goes into these crisis responses that are not well discussed or publicized. So I'm glad we have an opportunity to do that. I'm curious as to what brought you to your focuses in general. I remember, like I mentioned earlier, just having a buddy who is really, really interested in perceived versus realized liquidity in ETFs and ETNs, some of the most liquid instruments on the planet when those flash crashes occur where actual capital is moving in and out of individual stocks. And that was my foray. I was hooked immediately on liquidity and now in private markets as well. But curious as to some of those early interests that led you into your role now?
[00:28:42] Steven Kelly: Yeah, like I kind of alluded to, it was really [the] global financial crisis and sort of exactly that phenomenon I explained earlier with Ben Bernanke and Barney Frank of like, “Oh, I have $800 billion.” Like that dynamic, there's all these authorities, and all this crazy firefighting that can be done, or should be done, or we don't know what should be done. That really is the difference between a recession and a depression. And I was like, okay, this is a big issue. This is really financial, but it's also policy, and something that can draw a line under a recession and prevent it from becoming a depression. That was just really interesting to me.
[00:29:20] Steven Kelly: My undergrad was in finance and political science. Obviously great professors, political economy professors, and then did more work in capital management, which was kind of in this sphere, and a masters in systemic risk. And so it all sort of kind of came together as, all right, let's think about the next crisis that's going to happen in 70 years. And then COVID happened, and then 2023 happened. And us financial crisis people are few and we're supposed to be like cicadas: we're supposed to just sort of disappear and come back very rarely, instead of every couple of years. It's proved more immediately useful - I was expecting to write a dusty book and put it on the shelf and have someone dust it off and hopefully use it in some future crisis. And instead, we've been on the phone, like you said, for the last 6 months.
[00:30:12] Andrew Seski: So what might be interesting? Well, I'm interested personally, but whether it's podcasts or books that you're reading, when you're going to seek out information, maybe you have an incredibly curated Twitter/X, or LinkedIn or something - but when you're going to seek out information, what are some of the resources that you use? Obviously, you've got Yale - all the resources of the university - but are there other places that maybe I've never heard of? Or maybe see if those [I] can go to as well, outside of the too frequent WSJ notifications on our iPhone.
[00:30:43] Steven Kelly: Yeah. Well, it's funny to say that I do have what I think is a highly curated X feed. And I think I'm going to be the last person to leave because I don't remember how to go type in like wallstreetjournal.com and just like scroll. But I always tell people to find reporters that they like and trust and try to follow their work. So that really can make your life easier and help you narrow those notifications that you get. As far as podcasts, I think broadly: I gotta shout out Bloomberg Odd Lots. I know that's a pretty popular one, but still, it doesn't have perfect penetration obviously. Bloomberg Odd Lots, they really sort of - it's sort of the, what's hot in the economy, but also they really do a deep dive and get detailed, so that's a fun one. There's a couple of weeks and they'll do everything from like, “What's going on in the lumber trading market?” to, “What's going on in the macroeconomy?”. So you can sort of skip around as you please. But yeah, I also have the luxury that practitioners don't, which is my job: to read and write.
[00:31:49] Steven Kelly: So I'm always reading Bloomberg and the WSJ and the Financial Times - shout out to the FT Alphaville. If you don't follow them, you don't even need a Financial Times subscription. They do great work. It's a collection of journalists that cover market research. They cover stuff going on and they do it in a really thinly edited way. So it's honestly just like free sell-side research. So yeah, FT Alphaville, got to give a shout out to them too.
[00:32:16] Andrew Seski: That's awesome. I appreciate that. I'm thinking more in terms of the next 12 months, what you're most focused on. I know you've kind of had your eyes pinned on the rear-view mirror in all the events that have taken place, but what should CFOs be on the lookout for that maybe are there leading or lagging indicators that are just not obvious, that people can be drilled into in case they can notice something that seems irregular for them?
[00:32:43] Steven Kelly: Yeah. I would say my eyes are very much still on the banking situation. Even after all this time, I was very much pushing the narrative in May-ish, in April/May, that what we saw in March was confined to those banks. And it really wasn't, like I said before, we never had that feeling of like, this is going to go viral. This is going to go to Morgan Stanley. This is going to go to JP Morgan. And that's because it was sort of misdiagnosed at the time. It was like, “Oh, this is a run on the banking system”. And it really wasn't. It was a run on tech, crypto’y banks, which tech and crypto themselves were kind of in recession. So it makes sense that their banks – when the economy goes into recession, banks go into recession. So when the tech economy goes into recession, the tech banks are going to go into recession.
[00:33:35] Andrew Seski: Is that clear from the beginning or no?
[00:33:37] Steven Kelly: It wasn't the narrative. I would say it wasn't clear that very weekend, but it was - again, I was pushing it pretty quickly because we haven't gotten any new banks that we're worried about since then. Like that March week, we got like, 10 banks in particular that we were worried about and they've all sort of been figured out. Like, three of them failed and two of them raised capital and the other one merged and the rest did fine or whatever, like we sort of figured that situation out. That being said, the narrative was this is a run on the banking system because rates are so high and uninsured deposits are so many.
[00:34:13] Steven Kelly: But why that makes me more nervous than the narrative now is that run is still out there. Like there is still a possibility if rates move higher, a run on unrealized losses, a run on uninsured deposits. So I'm still thinking about that and watching that because the narrative is very much, “Oh, we saw that run and it got quashed”, but really we didn't. We saw a run on tech and crypto, which makes a little more sense. So that's kind of still what my eyes are on, and I'm thinking about the banking system. That being said, it's not my base case. And again, it goes back to: are your relationships inevitable? Banking with SVB, that's not inevitable. Banking with JPMorgan, like not to pick, not to tell you who to bank with, but again - there's an unseen price to going for specialty service and going for nicheness, which is you lose that benefit of diversification that a behemoth has and the government relations and all that stuff.
[00:35:10] Andrew Seski: I think as a CFO, when I see multiple headlines, it's very difficult to go from an SVB collapse to Credit Suisse collapse to interest rates rising without stringing those together and planning as if they were all linked. I'm curious how you communicate separating those events as isolated and not trends, and what does link them to becoming trends so that you can start to piece together the health – and the stability - of the economy.
[00:35:41] Steven Kelly: Yeah. I do think the U. S. bank failures that we saw were related to each other, but not necessarily. They didn't necessarily foreshadow more, and Credit Suisse was a separate thing, but the timing obviously is not a coincidence. The one thing I would say as far as pattern identification here is: this is what happens in a world of much higher interest rates and as things start to break. And so thinking about what your vulnerabilities are in that world - just a lot of capital structures that made sense when the borrowing was good just don't make sense when the yield curve inverts or when the short term rate sort of matches what you're getting on long term or surpasses it. And so you start to see stuff that breaks. So again, it's about stress testing your counterparty relationships. Imagine you're going to lose a significant counterparty, whether it's your bank in the case of SVB or it's some other financial supplier in particular. Long before we saw banks fail, we saw like auto-lending firms start to wobble.
[00:36:47] Steven Kelly: We saw non-bank mortgage lenders start to wobble. We saw crypto explode, obviously. So all these things, firms can just start to not make sense as the capital structure gets tightened. And so. any good CEO knows that risk management isn't just risk mitigation. It's also thinking about risk tolerance and what risks are you willing to take? And I would suggest think about the next step of, okay, you've accepted some amount of risk. Let's say that risk is realized. What's your plan in place then? How are that's sort of that's sort of crisis management step of “Okay, let's assume we've got that loss that we said we would tolerate.”
[00:37:27] Steven Kelly: “And how do we come back from that? And how do we make sure we're not swept up in their contagion?” That's really the big step because stuff is fragile in a way it hasn't been in a long time. The economy stable, it's strong. And that sort of helps underwrite some of the red flags you raised earlier: student debt and government debt and all these things. I mean, we live in a nominal world, so you can have big nominal numbers of these debts, but if people's wages are going up, if jobs are going up, that's an offset. So if we do end up in a recession, again: things will start to break and be a little more fragile. And so it's really about stress-testing your balance sheet and those relationships and starting from a point of, “Okay, let's say I failed. What happened?” And sort of that reverse stress test of, “Okay, my balance sheet unwound”, that it's inconceivable to think of that my balance sheet would fail, but let's just start from that supposition and work backwards. What would have happened?
[00:38:24] Andrew Seski: I mean, I think that's a great piece for all CFOs to start thinking about more thoroughly, especially in today's M&A market, which is becoming more ripe, I think you made a great point. The banks are an interesting example where JP Morgan has the stability to be able to acquire other types of assets like that. I think that's a great, I say microcosm, but an interesting example, more so for CFOs to think through, not just mitigation, but planning for future acquisitions. One thing I really want to talk about. I really love the history of exchanges. We're in Philadelphia, not far from the first Philadelphia stock exchange, preceded by something about a buttonwood tree in New York and all the way back to Amsterdam. And now we're actually near Vanguard here in Philadelphia where Bogle helped really spread the ETF kind of craze.
[00:39:16] Andrew Seski: And I'm curious about some of the innovations that are taking place that are blending public and private markets, that are facilitating more liquidity in both, and maybe if there's something that you're really excited about that's going to take place in the next 3 to 5 years from your perspective, or maybe something like the convergence of public and private markets and what that may look like. But just because I know you've studied the history. I know you're deep in the trenches. I would love to know what you're thinking 3 to 5 years from now, what the world may look like.
[00:39:46] Steven Kelly: Yeah, what I see is really sort of a big matzo ball out there for innovation. And this is maybe going to sound surprising given what's going on at the Southern district of New York court this week. It is really some of this blockchain stuff. And I know the CFO audience is probably so sick of hearing blockchain this and AI that, but the crypto stuff is obviously like a joke. I mean, all the coins and all that stuff. I mean, it's effectively useless. The underlying blockchain, there's a couple of things that the biggest one, and you'll see big companies doing this already is supply chain.
[00:40:25] Steven Kelly: And so what you can do on a blockchain one is: you can transfer ownership. So all the paperwork of a supply chain can go away. All the tracking can go away and be done via blockchain. But the other big piece is that you can put physical goods and money on the same rails. So right now, you think I deliver you a physical thing and we sign some paper and it transfers over and then you, I write you a check or whatever, And that whole exchange can be condensed down to one interaction of: okay, once the goods are transferred, the money, the money zips the other direction. And that's really going to innovate supply chains in particular, it's going to innovate finance to the extent. Again, you're familiar with this thinking about exchanges and thinking about ETFs - security settlement is such a nightmare and the risk of failed trades, or failed to deliver. I mean, that can all go away if you can get money and securities on the same rails - oh I send money via the bank, and that sends it via the Fed wire and I send the securities on this exchange and then it settles and you're blah, blah, blah.
[00:41:31] Steven Kelly: If you can condense that down into one transaction - 3 to 5 years, I'm not necessarily seeing that - but certain innovations are already happening in that space. Lots of banks are doing this. I mean, when they have big enough balance sheets, they can let their clients pay each other on their own blockchain. You can get paid on a Sunday, like things like that. So really that's sort of the slow moving, innovative piece to come out of some of the hype of the last few years. Obviously AI, but I don't need to talk about that, everyone sort of - that's a big question mark for everybody.
[00:42:02] Andrew Seski: Yeah, one of the things that was upsetting for me to realize in the deep dive of blockchain and different rails, aligning is - it doesn't change the counterparty risk. To put to disintermediate collateral chains is one thing. But the strength of the counterparty is still the strength of the counterparty. So, the efficiency is great. Nobody wants T+14 or something. And so closer to instantaneous settlement, I think that is strong. But one thing I was excited about initially when I was first learning about all this was: could you disintermediate all these collateral chains? And again, it just doesn't impact the quality of the counterparty risk at the end of the day. And at the end of the change isn't holding up, then you're really not adding a layer of stability.
[00:42:52] Steven Kelly: Right. And if the money moves faster, you may risk a blow up if everything's moving instantaneously-
[00:42:58] Andrew Seski: A little less fun part of immutability.
[00:43:01] Steven Kelly: Yeah, exactly. Exactly.
[00:43:02] Andrew Seski: Yeah. All right, cool. Well, one of my favorite questions on the podcast doesn't have to be related to finance, to technology, or even stability. One thing that you think is just genuinely underestimated in the world today: what would that be?
[00:43:15] Steven Kelly: Well, I guess I would keep it kind of related. I'm going to say the general desire to get things right among federal public servants, I think, is high. I'm not talking about Congress necessarily, but there is just so much conspiracy out there with the Federal Reserve and with the Treasury Department and all these departments. I can say, at least in the case of the financial departments, it's really unwarranted. And I say that as someone who criticizes the Fed, criticizes policy, says, “Hey, you got this wrong”, or “You didn't disclose this, you should be doing this better”. There's really, really a lack of that, “We are the puppet masters and we're just going to tell people what we tell people and do the real thing behind the curtain”.
[00:44:10] Steven Kelly: There's just a lot of cynicism, particularly on Wall Street and finance, it's about the Fed and if you're thinking that the Fed is playing 4D chess, you're thinking two degrees too much. And a lot of financial analysts do this and it's often a more straightforward story of public service trying to get it right. And so I think the burden of proof is on the cynical version, and that's really not where it's typically cast, and it should be. So anyways, that's kind of what I'd say, is broadly in finance: that the cynical assumption really is unjustified.
[00:44:45] Andrew Seski: Interesting. And you said you feel that it's coming from Wall Street, that that's where the-
[00:44:48] Steven Kelly: Especially. I mean, yeah, turn on Bloomberg News. It's “The Fed is manipulating the economy” or “They're hiding this or that”, or “They just want to get reappointed”. And we should be watching for those things, 100%. It's just not borne out. It's just really not.
[00:45:05] Andrew Seski: Interesting. Well, I think being public and having more conversations like this should help that. and it's interesting. I think sometimes when you need somebody else to blame, the Fed is right there to be that for some folks. And it's complicated - as you mentioned, some of our tools are less effective than they have been. It's going to be interesting to see how some of our responses are modernized, how we think about the tech stack of the Fed, and some of the future. We should know absolutely where we can find your writings. Do you have a popular platform that you use to just share your thoughts or you just publish?
[00:45:49] Steven Kelly: I'm most active, I mean, on Twitter: @StevenKelly49 or X. I have a website where I'll put out occasional free research notes, sort of about market happenings. That's withoutwarningresearch.com. So yeah, it's financial stability stuff, Fed stuff. And there's maybe one or two a month. Part of the reason for withoutwarning is I don't really have a plan for when I put stuff out. And then, obviously publishing stuff through Yale, but that's maybe, more for an academic crowd. But yeah, it's, it's sort of a market, more sell-sidey feel to the stuff I put out on my website.
[00:46:26] Andrew Seski: All right, cool. And for folks interested in maybe executive education or continuous education, where should people learn maybe more about the financial stability department at Yale School of Management? Are there resources out there for CFOs to consider? Maybe doing something in the evenings or continuous programs?
[00:46:46] Steven Kelly: Yeah, yeah. I mean, we're always excited to talk to people and think about how they're managing financial stability. So I would encourage anyone to reach out. we have a master's program that's really for people with a financial stability mandate. So this would be people who are working in banks, doing capital management or thinking about other financial stability aspects, treasury, things like that, and also public officials globally. Obviously we have executive education MBAs, and all that stuff too. But yeah, poke around our website, we have interviews with ex-crisis fighters that are just insightful, management interviews, honestly, like crazy stuff.
[00:47:25] Steven Kelly: We have some interviews with some X New York Fed people from the 2008 crisis. One guy didn't leave the building for 42 days. And he's interesting because he was Tim Geithner's sort of second-in-command. And we always try here, when we talk about crisis policy, sometimes we'll say like, oh, this is a wartime policy or peacetime and we say like, okay, we shouldn't really use war analogies to describe like finance stuff. And this guy had spent time in Iraq, and he was like, “Yeah, the financial crisis was more unsettling to me than being in Iraq”. So we're like, gosh. Just when we're, you know. There's cool interviews like that that are useful, I think, across management and crisis management and thinking about how to run an organization in sort of crazy times. I'd advise checking those out too.
[00:48:13] Andrew Seski: Yeah, I'll try to make sure that we link those in the show notes. I know I'm definitely going to go watch them. I mean, we all think we have a perfect recollection of those days. But hearing firsthand those interviews, I'm sure it would be really, really entertaining and insightful. I'll definitely make sure that we can share those as well. I also just wanted to say thank you one more time for all of your generosity and sharing all of your insights today. I know this is a slight departure from interviewing CFOs and I'm just happy that we have the opportunity still to have the flexibility to have these kinds of conversations that I hope have evergreen value for folks. So just want to say thanks again for joining the show.
[00:48:49] Steven Kelly: Yeah. It's great to be here, Andrew. Thanks.
[00:48:51] Andrew Seski: It's been another episode of The Modern CFO podcast. As always, please take a moment to Like, Subscribe and continue to Follow on for more conversations with either great folks like Steven or for more CFO interviews.