Fed takes away the punchbowl. Corona..not so much Graham: Okay, so what's happening right now is a market situation. Coronavirus has very little to do with this. And there's a lot of people out there saying Coronavirus is this global pandemic, it's going to be like the Spanish flu. My answer to that is the Coronavirus first showed up in China back in the fall, around I think September, and at first started getting really nasty in December. China has 80 airplanes flying between the US and China every day, commercial airlines, 80 planes every day.
Graham: So this thing came to the US months and months and months ago, probably many people already had it and thought it was the flu or just a cold. 80% of people who get it, there's no need for medical care and it tends to be very dangerous for the elderly, but specifically the elderly who have preexisting medical conditions. So if this was going to be this global pandemic, just wiped us off the face of the earth, that process would already be over. We'd already be seeing millions of people dying so that that myth needs to be put to rest.
Graham: So what's actually happening? What's happening is if you wind back the clock to 2018, at the end of that year, we had a really, really nasty market sell off. The market just went absolutely straight down and lost about 20% over the course of six weeks. That situation was caused by the Federal Reserve draining too much liquidity from the system. So it really freaked the frat out. The Fed out, I should say. So you fast forward to 2019, and we're starting to approach the end of the year, and the fed is terrified that they could cause another one of these situations like they had the year before. And so they started launching all these different programs to provide liquidity to the financial system. We had three interest rate cuts. We had a 60 billion per month quantitative easing program, and then we had these repo programs. And it's the repo programs we need to focus on.
Graham: If you're a hedge fund or a financial firm or a bank, by law, you're required to keep a certain amount of your assets in cash or cash-like equivalence. So that means either you own actual cash or you own things like short term treasuries that you can just dump and immediately convert to cash. The problem is a lot of hedge funds and a lot of financial firms have used tremendous leverage, so they borrowed a lot of money, and then they've invested that money in assets, whether it's stocks or real estate or what have you. But because they've done that, they're falling below their cash requirements. So what they do is they go to the fed and they say, "Hey, if I give you some of these assets of mine overnight, or for a week, say, will you give me cash in exchange for them so that I maintain my cash requirements without actually having to hit the sell button and dump these things I own?"
Graham: The Fed said, "Sure, we'll do that. We don't want another crisis." But the problem with this was it sent a message to everybody that the Fed was willing to basically allow leverage to get even crazier. Because if you know you can go to the Fed, and you know you can exchange assets for cash anytime you like, you're going to start buying and buying and buying. This is why, starting in the last little three or four months of 2019, the market just went up and up and up and up and just wouldn't even have a 1% correction. So you fast forward and the Fed starts to realize that it's made a mistake. It's basically inducing a kind of mini bubble in stocks. So around December, January the Fed starts saying, "Okay, we're going to start pulling back on the repos. We're going to stop providing all this free cash to these hedge funds and these guys."
Graham: That was what got us into this situation where you had ... Basically think of it this way, three to four months of froth building up in the markets, and then the Fed suddenly said, "We're going to start taking away the punchbowl." That's why you're seeing the markets go straight down. Coronavirus happened to be the kind of the excuse or the narrative the media is coming up with. And for sure there are stocks that are impacted by that. For instance, airlines, hospitality, cruise lines, those are things that are getting hit by Coronavirus because no one wants to be on them anymore. But in terms of the broader market, we started to get this really nasty meltdown because the Fed started taking away the punchbowl and a lot of these big institutions had to sell. You don't get market sell off like this from guys like you or me going to our brokerage account and hitting sell. You get it when someone really big who manages billions is having to sell everything because they're having to meet their cash requirements and the Fed's not giving them free money anymore. So that's-
Doug: In 2008, that was the [crosstalk 00:08:52] crisis in 2008, correct? That's what they [crosstalk 00:08:51]?
Graham: That was on a much larger scale because at that point it was trillions and trillions of dollars of derivatives which were bought using leverage. And those derivatives, the reason you could get so much leverage was it was based on real estate. Everybody viewed real estate could never collapse. And so because of that, people were allowed to take their leverage to levels you couldn't imagine. Like Lehmann Brothers had their leverage close to 26, I think it was 30 to 1. With leverage of 30 to 1, if the asset you owns falls, even something like 10%, you've pretty much wiped out your entire market cap.
Graham: So that's why that happened. We're nowhere near ... I mean that could happen again this go round, but we're way too early for that to be starting. And the reason I say that is because yes, the leverage levels are higher, and yes there is a danger of a credit event, but we're still early in the game that it's not a good idea to just panic and sell everything. This is like the kind of Bear Stearns moment, for lack of a better word. This isn't Lehmann Brothers necessarily. And we need to sort of step back and look at this and try to figure out what's going on.