The transcript from this week’s MiB: PIMCO’s Jerome Schneider is below.
You can stream/download the full conversation, including the podcast extras on Bloomberg, iTunes, Overcast, and Soundcloud. Our earlier podcasts can all be found on iTunes, Soundcloud, Overcast and Bloomberg.
ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST: This weekend on the podcast, I have an extra special guest. His name is Jerome Schneider. He is the head of had a short-term portfolio management of PIMCO. If you are remotely interested in fixed income bonds, trading, the plumbing of how finance works, this is a master class and tremendous details of how the fixed income market works. It is absolutely fascinating.
If you are remotely considering any sort of fixed income investing, working on a bond desk, being a portfolio manager of any sort, then this is a conversation you have to listen to. It’s absolutely fascinating.
With no further ado, my conversation with PIMCO’s Jerome Schneider.
My special guest today is Jerome Schneider. He is the head of short-term portfolio management and funding at PIMCO which manages about $1.75 trillion as of the end of 2017.
Prior to joining PIMCO in 2008, he was a senior managing director at Bear Stearns specializing in credit and mortgage related funding transactions. He held a number of various positions on the municipal and fixed-income trading desks at Bear. Morning Star named him the Fixed Income Fund Manager of the Year for 2015. He manages three separate funds, one over $14 billion dollars, the other, over $8 billion, the smallest, a mere $2.2 billion. Jerome Schneider, welcome to Bloomberg.
JEROME SCHNEIDER, HEAD OF SHORT-TERM PORTFOLIO MANAGEMENT AND FUNDING, PIMCO: Thanks very much, Barry. It’s great to be here.
RITHOLTZ: This is the perfect time to be speaking with you given everything that’s going on in — with the Fed, with rising rates, with yield curve, but let me start with a little bit of background. How did you first get interested in finance?
SCHNEIDER: Pretty easily on, I had a great uncle who was always sort of fascinated with the stock market at that point in time and had bought me a handful of shares, you know, like everybody does and from that fascination, you quickly realize that the power of capital and I think at the age of 11, I had asked my dad, you know this stock market thing is pretty interesting.
Let’s read about it. Let’s read about it on the Wall Street Journal, and for my 12th birthday, he actually took me to the Stock Exchange on the floor and for young chap from Oklahoma, Oklahoma City that is — that’s a pretty, pretty empowering thing to see your dream location come true.
So, for me it was a trip to the Stock Exchange and to see the Yankees who I loved at that point in time and really, put together in your mind how you actually get to that point from being 12 to being a young professional and the steps it takes, so that was a magical moment in my formative years.
RITHOLTZ: And that was back in the day when you could both A, get on the floor of the Stock Exchange, you can’t do that really today and B, it’s not just the front (ph) for a television studio, that was where stocks were actually traded back then.
SCHNEIDER: Yes, and amazing and thinking about it, you know, I was probably hardly five-feet tall at that point in time. You know, it was a scrum and this was in the mid-early 80s and I looked back at the photos we took and the funniest thing, obviously is the people and how they are dressed and second of all, it was a functioning entity in a physical sense, not just a literal sense and a spiritual sense as it is now, along with computers, but it’s a physical breathing entity.
And then today, obviously, it’s changed and the NYSE is — and all the stock exchanges have their functioning perspective to code up to technology, but I think more importantly, and this is the thing that I would say is that, as a young person having the ability to have that experience and learning from people what it took — it takes to get there and then putting those steppingstones in place, seeing the right people, understanding what they took to get there even though they might be 10, 20, 30, 40 years your senior — that’s a very powerful thing.
And I think, one of the key things for people whether they are interested in finance or otherwise is to find people that will serve as mentors, rabbis — whatever it is to help empower them to achieve their goals in that kind of way and I was just fortunate to have a ton of people around me.
RITHOLTZ: It sounds like that was a formative experience for you.
SCHNEIDER: Yes, it was. It was great and I think, you know, people recognized that at that point in time, as odd as it might be from young kid in Oklahoma City, it might have been one of those things that it was a way out, so to speak, and so for me Oklahoma is a great place to be from and is a great place to be going back to with family, but at the same time, I haven’t lived there since high school.
RITHOLTZ: No interest in being a roughneck and working in the oil fields or any of that?
SCHNEIDER: Not as —
RITHOLTZ: Physical labor?
SCHNEIDER: Not at this point. Well, I mean, that was the other formative expense in my life actually being exposed to the roughnecks and when you grow up in Oklahoma and Texas and your whole family is exposed to the oil industry, in the late 70s and early 80s —
RITHOLTZ: During the oil crash? Yes, sure.
SCHNEIDER: The oil bust basically was an eye-opening experience and then frankly, that was one of the things that led me to want to understand capital markets because, you know when you’re in the oil business, you’re putting together a ton of capital, a lot of it is not your money and so your incentives are very different.
And at the same time, when you think about the ramifications of a re-pricing event, in that case, it’s oil and everybody — I mean, they’re in there sitting on the oil patch and things, oil prices only go, up but as a young kid, you see everybody going from having literally Learjets and third and fourth lake homes and multiple cars to nothing overnight and you look around, and you know, we had a very modest upbringing.
I would say that, you know, in retrospect, it was – the (ph) down side is fairly limited compared to some people —
RITHOLTZ: Not a lot of leverage —
SCHNEIDER: Well, not a lot of leverage, so to speak, but at the same time, not a lot of the different up side, but I learned at that point in time, the strength of leverage and the danger of leverage, which oddly, as my professional career evolved in the fixed income — that obviously became a keystone to that.
RITHOLTZ: So, you go to University of Pennsylvania and then you get your MBA at NYU Stern?
SCHNEIDER: Correct.
RITHOLTZ: And what was your first job right out of the school?
SCHNEIDER: So, when I graduated Penn, I wanted sort of a degree that was related to finance, but really more economics related and so I had a more customized degree in international finance economics and international relations and so, Penn was a perfect place to do that.
Unfortunately, when I was graduating and started with an interview in 1994, my background was a series of internships for a small — from a small shop in Oklahoma City called Stifel Nicolaus —
RITHOLTZ: Oh sure.
SCHNEIDER: And then —
RITHOLTZ: Which is now not such a small shop.
SCHNEIDER: Not such a small shop, but they were really focused on muni bonds back then, which is a good and bad thing and the other one was running a guy’s campaign for state treasurer of Oklahoma, which was successful, but that was both — it took me back to Oklahoma and so, as a result, at Penn, you’re looking out for internships and most of the kids in the East Coast had connections to New York and Wall Street and things like that and I didn’t have any of those connections, so to speak.
So, I was really trying to find my way to get to Wall Street at that point in time and it took a little bit more effort. That combined with the fact that when I was graduating in 1994, it wasn’t the best job market in the in the world and when you think about it, you had to get in on any floor whatsoever. So, I interviewed. I interviewed with people who were trying to sell limited partnerships, limited — people who were trying to trade stocks and be in the operations group, and oddly, coincidentally, the job I took was with Bear Stearns and I joined their operations training program at that that tender young age for a very small salary, but a great opportunity to learn.
RITHOLTZ: Let’s talk a little bit about the Federal Reserve today and the impact they have on the fixed income market. First off, what do you think about today’s Federal Reserve?
SCHNEIDER: Yes, I think today’s Federal Reserve is — one thing it’s very different than it was before. You know, they try to be as transparent as possible.
RITHOLTZ: Is that a good or a bad thing?
SCHNEIDER: It’s a good thing because the purpose of the Federal Reserve is to communicate effective monetary policy and unlike Federal Reserves of two decades, three decades ago who used to do things in the silence of the night or affect open money market operations and you simply saw all the cash mover in or out a specific time during the day because they were adjusting the excess reserves in the repo markets.
Now, it actually is quite effective because what they hope to do is manage expectations over the medium-term; one, in terms of — clearly, in terms of growth of the economy and also unemployment clearly, but also, in terms of inflation and that second metric is what is incredibly important to the communication effort.
And so, being communicative, it obviously comes with its criticism, because of this criticism, because people want when they — people communicate want them to be succinct and clear and precise and if you don’t have those three things, which aren’t necessarily the same, people start to offer their own criticism.
RITHOLTZ: Let’s go over that. Succinct, clear and precise. Meaning you want short and sweet? You want it accurate although there is a difference between precision and —
(CROSSTALK)
SCHNEIDER: And precision is the accountability. The best thing about the Fed though and people fail to realize is that the Fed wants to maintain its optionality and that’s what it has continued to do, not only during this hiking cycle, but the really since the financial crisis and in doing so, they want to find themselves to basically point a direction but they want to alter the course and speed of that direction over a period of time.
And I think one of the failures of the market quite honestly, is understanding and comprehending that reconciliation process. Frankly because much of the market can’t imagine themselves as being that central banker in that seat, but if you were, you know, like any good parent, you wouldn’t necessarily want to be painted in the corner by your kid. When the kids come home and says, “Mom, dad I want to eat junk food for the next year.” They are going to say, “Well, let’s try to have a balance of it. Let’s figure out — we’ll have some days that are healthy, some days that you can go and eat potato chips all day.”
In this situation, the Fed wants to simply be as clear as they possibly can at that point in time without being fully committed to an ingredient mix, which they can’t fully bake a masterpiece in the future and that’s ultimately what they want to do is try to be as clear as they can at this point in time and balance it to manage the expectations of the marketplace without upsetting them, and that’s what people have called the put of you know —
RITHOLTZ: Bernanke, Greenspan —
SCHNEIDER: Right, whatever they’ll input and I think that there is a — there is a trade-off in that and that is the insurance policy or the cost, if you will, of the policy measure, trying to be as open open-minded and communicative as they have been.
RITHOLTZ: Some people have said that the transparency of the Fed in this constant communication has made the job of the balance (ph) manager easier and others have said, “No, they say one thing and it turns out not to be true and they do another,” and it has made it more challenging. Where do you fall on that continuum?
SCHNEIDER: I honestly think that the marketplace has evolved in such a way that you are not simply looking at a single variable at this point in time, meaning the Fed.
In fact, there’s other influences you have to look at, which is obviously the global influence. We can see that you know, just because you have a view on U.S. interest rates or U.S. monetary policy doesn’t mean that it’s not influenced by other policies around the world.
We saw that basically two years ago at the end of 2015, when the global financial conditions worsened. It obviously effectuated the Fed policy. So, as a trader, as a portfolio manager, as a manager of capital for our clients, the thing we want to be most mindful of is these inputs, these variables and mitigating these risks in a way that produces positive risk-adjusted returns.
The bottom line is that there is just as much forecasting that we are going to do and think about at PIMCO looking at the macroeconomics, which has clearly been the baseline of our forecasting for 40 years plus at our firm, but you also have to incorporate the evolving market dynamics and most importantly, the market perception of the market pricing.
Meaning, sometimes understanding where the market is whether it’s overpriced, mispriced, whatnot is actually just as important to your portfolio positioning as anything else in the policy measures that you might observe from the Fed or the data that comes every week or whatnot.
RITHOLTZ: So, let’s stay with the Fed because you’re really the right person to ask this question. The work you did in the back office in the early parts of your career, doing the settlements and DTC and all that other stuff, explain what the Fed is actually doing mechanically when they raise or lower rates? I don’t think the average person understands what this process is like.
SCHNEIDER: Yes, it actually, you know, it actually isn’t as complicated now as it probably once was simply because the magic of computers and electronic money so to speak, but effectively what you’re doing is effectuating monetary reserves, excess reserves in multiple ways.
The first one basically being that you know, as we have seen over the past two years, even with the emergency monetary stimulus that they’re able to grow their balance sheet, which creates excess reserves into the system and in a variety ways and that means, they are purchasing bonds, purchasing mortgages, purchasing treasuries, which increases the amount of monetary supply — the money available to help all set the conditions that they are trying to counterbalance.
RITHOLTZ: Meaning, they take these paper assets and bring them onto their balance sheet in exchange for actual dollars.
SCHNEIDER: Correct, and I think this is important because that’s a semi-permanent way of establishing reserves whereas what they used to do is — what they referred to as open market operations, which possibly you are returning more to the colloquial that open market operations for decades was simply the Fed coming in and purchasing bonds on short short-term operations, repo operations to buy bonds effectively versus lending out cash to the marketplace.
And by doing that, they would make small incremental adjustments to the effective Fed funds rate or the Fed funds target rate at that point in time and actually, because it wasn’t posted on Bloomberg or wasn’t said at that point in time, in the late 70s, early 80s you wouldn’t actually know that the Fed was actually targeting or adjusting interest rates until you actually saw those processes or felt them in the marketplace occurring in the short-term markets.
RITHOLTZ: So, you said semi-permanent earlier when discussing what we can, I guess called quantitative easing. Why semi-permanent? Because some of these asset classes have a maturity date and eventually run off? Or they could always decide to unwind at a later date? What makes it permanent versus semi-permanent?
SCHNEIDER: Well, we’ve evolved now over the past two years into an acceptance and actually implementation of a normalization process of our monetary policy. We are moving from emergency measures to one that’s more normalized and going — trying to go back to where we were to pre-crisis mode. So, what does that mean?
We have to take our balance sheet from what it was and it has now grown to $4.2 trillion in size and gently decrease it over time through basically letting it amortize down. Mortgages that the Fed owns will pay down. Treasuries will eventually go off the balance sheet and in doing so, that’s going to gradually tighten monetary conditions as those excess reserves — as those excess monies get removed from the marketplace and the repurchases — and the Fed doesn’t repurchase as much of the securities as they are maturing in their portfolio.
So, it’s a passive reduction in that process and it’s very important because for the marketplace, because it is a mile marker effectively that we are heading toward not just higher rates, but a normalization process, which is going to gently move real rates higher over a period of time. It’s not far —
RITHOLTZ: Gently, I hear you say.
SCHNEIDER: Generally because —
RITHOLTZ: Because it’s just such a gradual flow process —
SCHNEIDER: It’s a gradual thing and as Janet Yellen likes to say, “Hey, it’s in the background. Nothing to see here, just move on.” And in an ideal world, that’s what’s going to happen and I actually think it will work out that way.
People at the beginning were very concerned that the Fed was going to come in and sell all of their asset and do it overnight, but what we’ve learned from the Fed and this is what I think is — you know, getting back to my point about the market reacting and the market’s perception that would be foolhardy because the mark — because the Fed wants to always maintain their optionality.
And so, the reality is that the Fed wants to keep those asses on its balance sheet, not only to nod up at the market, but also to maintain optionality for the future. As it is right now, they’ve been pretty clear about the prescription of how much they’re going to increase that reduction, I guess, that’s an oxymoron, but increase that reduction of their balance sheet over the next few quarters by a prescribed amount and that has been forecasted and digested by the market. It is not that upsetting at all to the marketplace as we have seen over the past few years —
RITHOLTZ: I was always stunned at the claims in the beginning of QE, “Hey, you know, they are going to have to unwind this and it’s going to be so disruptive,” and it just didn’t make any sense. All this paper has a maturity date. You could just — and they are not all the same date. There is a curve — that duration curve, you could just let that one off naturally. Why was there such fear that, you know, “When the Fed unwinds, it is going to be really problematic.”
SCHNEIDER: Well, the question is who is incremental buyer? And that’s actually a real question to posit today, but in a different size and a different scale. There’s one thing that if you are going to let you know, an entire $4 trillion worth of assets run off the balance sheet of excess reserves very quickly and it is another thing just to have incremental supply coming in to the market.
One is a $500 billion plus question and the other is a $4 trillion question, but the question in both of them is who is the incremental buyer of treasuries? Is it foreign central banks? Is it a retail investor? Are there corporate cash investors who need to buy this? Are there banks who need to buy it for regulatory purposes, not so much anymore —
RITHOLTZ: But what about just the maturity issue? If, hey, I am holding 2020 paper, one 2020 rolls around. All right, the paper matures. It goes away. I get cash. Nothing actually hits the market unless they decide to reinvest that.
SCHNEIDER: Right. That is correct, so what hits the market, they have to reinvest. They are reinvesting a certain amount, but not all of their maturities and so, they’re doing it in a pro rata portion across the curve and so, they are trying not to disrupt that allocation of what is already coming to market.
And that was the key, it’s — they’re not trying to shape — this is not an operation twist. So, they are not trying to reshape the yield curve here. What they are simply try to do is reduce their overall footprint to the treasury market over time in a methodical manner.
RITHOLTZ: We are deep in the weeds. This is pure fixed income wonkery and there is an audience that will really appreciate that.
SCHNEIDER: It is wonkery, but it’s important. They one take away for your listeners is that the wonkery is the is the magic of how people are going to think about adapting to higher rates going forward and that is the facet which is mostly misunderstood when we get to these periods of monetary policy.
Monetary policy is fascinating, but if you don’t understand what’s going on, it can be pretty dangerous.
RITHOLTZ: How many times over the past 10 years have we heard. “Oh, the bull market in bonds is over.” Is this multi-decade bond bull market finally over?
SCHNEIDER: Well, I think it’s too early to say for us. So, there’s so many factors in the bond market that led to the bull conditions as we knew it for many years. The dollar — the view of the dollar of the United States, the reemergence of other factors on the on the global forces and I think that when we think about this, it’s not a pivot point that you can simply say, “This is the exact pivot that we are moving back the other way.”
In fact, I think there are more factors today that come into that condition that need to be brought into —
RITHOLTZ: Such as?
SCHNEIDER: Obviously, treasury supply. We are dealing with larger physical stimulus at this point in time. Tax cuts and things like that that are going to impact the fiscal side of the equation and the need to borrow more money in the United States —
RITHOLTZ: Two things that is a recipe for higher rates or just all of that supply hitting the market —
(CROSSTALK)
SCHNEIDER: It’s one factor in this. The other factor is the demand-side, and I think that that is the other factor as we mentioned previously whether it comes from foreign central banks or foreign investors or even U.S. investors. You know, that is an important factor and condition and more specifically, the demographics which people and we at PIMCO has spent a lot of time thinking about the demographic factor is actually one that is in favor of bonds over the next few years as people look to de-risk and move into higher-yielding asset classes.
You know, the higher rates right now are something to incentivize people to finally reallocate potentially out of higher risk out allocations and moving to the safety of bonds for that current income and current yield that they offer.
And so, there is a variety of factors on the pro and con side, but to simply declare this as the as the pivot point of the end of the bull market, it is too early to determine and more importantly, there is a growing awareness in the global economy, the improving factors globally that are going to the data, not just in the United States, the Euro zone, even Japan is starting to see that.
So, as we have evolved over the past 30 years from the bull market into the bull market, it’s a global force and so that will ultimately decide whether this was the end of the bull market or not.
RITHOLTZ: So, you referenced supply. Let’s go back to that a second. It seems like there has been, I don’t know if the word shortage is the right word, but when you look at high-quality, sovereign fixed-income products, it doesn’t seem like there’s been an overwhelming supply of that?
SCHNEIDER: Right, so the key to this is the plumbing. When people think about where have bonds gone? Where has safety gone? It’s all in the plumbing. The repo markets have basically been detrimentally affected by regulation globally that it constrains on bank balance sheets to which basically function as the grease for treasury markets and high-quality bond markets around the world.
So, if you put a constraint on the amount of grease in the system, the repo markets — that affects liquidity and that affects pricing and otherwise. So, that’s one element. Ultimately, when you also think about it, on the supply side is also the demand-side and the demand over the past five, six, seven years as we’ve gone into emergency stimulus mode globally has been the central banks, buying the safe assets.
And so, they have been buying bonds to help produce this warm blanket around risk assets globally for the past five to 10 years and as a result there is a dearth of high quality safe assets that people have been searching for, so they have been the number one buyer, being the central banks, of these assets over a period of time.
And as they reduce that footprint, people who have actually needed to buy these safe assets will actually emerge as a marginal buyer over the next few years. So, it could be a nice hand off if things go according to plan, although nothing ever goes smoothly, as you know Barry.
So, we have to be prepared for those repricing and that’s — but as active managers at PIMCO, that’s what we are poised to take advantage of.
RITHOLTZ: So, you mentioned that we haven’t been running giant deficits — immediately after the financial crisis, there was a huge set of deficits, but that seemed to work its way down pretty quickly over seven years or so, the new tax bill is at least $1.5 trillion. They’re talking about a big infrastructure spend, all of which raises the question, should there be a reissuance of much longer-term bonds, be it treasuries at 30 years, 50 years — some people have talked about hundred-year bonds. Should we do that and what are the odds of that actually happening?
SCHNEIDER: Yes, I mean, optically people would say take it into lower rates and issue a lot and turn out the debt and there’s obviously been —
RITHOLTZ: Do some 50 years —
SCHNEIDER: A lot of countries who have done that — Mexico issued 100-year bond. You know, there is a good variety of precedent for this, but ultimately you go where the demand is and when you look at the committees — the treasury borrowing committee, the TBAC, they’ve actually assessed this and while it was floated in the very beginning by the Treasury Secretary Mnuchin, the reality is that there wasn’t a good demand assessment concluded at that point in time and so, you don’t issue into a void. No issuer whether corporate or sovereign wants to issue into a void where there is not enough demand.
Because that means your execution is not going to be good and more importantly, the secondary liquidity will be marginalized and so, what they are going to do is simply add on to existing maturities and work precisely — and this is what is important for investors at this point in time, is increase allocations to the front end of the yield curve, specifically in the T-bill space and I think what’s noteworthy about it —
RITHOLTZ: That happens to be your playground.
SCHNEIDER: Which happens to be my playground and I always love more people in my playground but they are going to add $500 billion worth of supply over the course of the next year, probably backloaded to the second half of this year to that playground and so what does that mean? Well, it is great for those investors looking for safety, looking for you marginal increase in yields as that new supply hits, but it doesn’t do a lot to the asset liability.
The caution or the urge of people wanting to term out the liability structure in the US, although what is noteworthy is the fact that when you look at the overall construct, the average life of the U.S. debt is actually not that much different than what was previously prescribed, so you know, they have done a pretty good job about managing that asset liability mismatch.
RITHOLTZ: Let’s talk a little bit about what’s going on in the modern markets and in particular on the equity side. We’ve seen a fairly substantial shift away from active management towards passive management. And yet, the data shows on the bond side, active management actually adds alpha. Why — or the bond equivalent of alpha, but is there a different name for that or do we just call that alpha?
SCHNEIDER: We call it alpha.
RITHOLTZ: You call it alpha. Why does active management generate alpha on the bond side?
SCHNEIDER: Well, it’s not magic and it takes a lot of work to have that and the data does quite clearly point to the fact in fixed income, all active management does clearly add benefits to client’s portfolios and some of it comes from offensive, meaning learning how to create better risk-adjusted portfolios, i.e. there’s income that you can have in your portfolio and some capital appreciation when times are good by picking the right sectors and creating a diversified portfolio.
But, Barry, this is the more important thing, as we go pivot into this time of the cycle when we don’t have quantitative easing in the warm blanket of monetary policies globally really supporting all asset valuations, the ability to differentiate risk asset classes is incredibly powerful and in fixed income, we need to be thinking about the ways to create that diversification and steering clear of those pitfalls that might be in portfolio construction.
We saw that clearly in 2005, 2006 and 2007 when you had the illusion of structured products, the evolution of abundant leverage in the marketplace, even in my own lovely repo markets. You had mispriced bonds and structured products that simply weren’t sound to the AAA moniker that many rating agencies gave them, but if you have the ability to discern, re-underwrite and distinguish between these different credit risks, whether it is corporate credit risk or structured credit risks and then understand how they interplay with each other, you can actually steer clear of a lot of dangers and pitfalls that passive management would steer right into.
And the case in point at 0.2 is even in my own domain, the short-term universe and I call it short-term zero to five years, we manage on our team $200 plus billion in that sector right now. The vote of confidence that we have is that we have steered clear of a lot of credits that were mispriced in 2005, 2006 and 2007. We had steered clear of asset-backed commercial paper that many folks were just simply buying, an additional bait because it was an additional one basis point, one, on hundredth of a percent additional.
RITHOLTZ: Come on, really? All that risk for a bip. That’s crazy.
SCHNEIDER: But that’s the way the market was functioning in the cash equivalent space and when you’ve gone through the crisis, people were basically underwriting liquidity risk from marginal income. They didn’t understand the downside risk they have and to this day, I hear still people when I go over into retail branches, which I do quite honestly because I want to hear about people’s experience with managing their cash, when I hear about that, they will say, “You know what, I still have these auction rate securities in my portfolio because they are still frozen,” or this, that and the other —
RITHOLTZ: Still frozen a decade later —
SCHNEIDER: Some are, but once a year, somebody will come up to me with a story and the thing about it is in order to understand the value and the perception of where the marketplace is going, you have to take a setback and understand what the influences are and more importantly, have the resources to discern and understand that.
And so my background, while being formerly in operations in the repo desk, in the derivative desk at Bear Stearns and understanding structured products because we ran at that point in time, a funding vehicle related to structured investment vehicles —
RITHOLTZ: One or two, sure —
SCHNEIDER: — vehicles, that was a magical time because it allowed me to understand and have a good array of knowledge, and build that array and arsenal of knowledge that when I came to PIMCO as a portfolio manager, I understood all of these different markets and underplayed them and more importantly, as we think about our team construction, the portfolio management team around me, we have people who are specialized in corporate bonds and understanding non-dollar events. We have a person who is focused solely on funding and the beauty of this and you mentioned this in my title, I am the head of our short-term portfolio management and funding. The key element to understanding liquidity management is funding.
The key element to understanding short-term markets which is interest rates is funding and liquidity. They are all the same and if you are an interest rate — if you are an interest-rate practitioner, if you’re a saver, if you are thinking about ways to manage your capital for capital preservation plus an income and you don’t have an insight to where funding markets are trading, meaning the cost of capital — that is like baking a cake without any flour.
So, it might look good, but it doesn’t taste very good, and it might fall on you.
RITHOLTZ: So, let’s talk a little bit about the mechanics of some these processes specifically at Bear Stearns — was it at Bear Stearns, you worked on repo conduit financing companies.
SCHNEIDER: Correct.
RITHOLTZ: That sounds and we are going to go a little bit into the weeds here, but that sounds like that is really the specific plumbing of how dollars find their way to specific assets. Describe a little bit exactly what that is?
SCHNEIDER: So, the premise of what we’re trying to do was you have to have a fundamental belief and understand what a repo agreement is. A repurchase agreement and all a repurchase agreement is, is a borrowing of — you are basically borrowing dollars or borrowing funds in exchange for collateral and that collateral is usually bonds, but the beauty of a repo agreement is that it’s over collateralized.
So, you might be posting $100.00 with bonds, but only get $0.70 worth of cash away —
RITHOLTZ: Sounds safe.
SCHNEIDER: So, the beauty of a repo and I still believe this to this day and I think it’s one of the most underappreciated assets in the entire world is that repos, in general, are market to market daily, so your risk is limited and the fact is you can calibrate them, it haircuts the excess margin to what you think the risk is and so, if you’re a good practitioner, your understanding of the market place is simply what is the value of the car (ph) you hold on any given point in time and have enough excess margin.
The idea here is that with any experience and understanding, you can actually back into what you think is a superb asset even better than a treasury because you have the over collateralization, so what we were doing in that marketplace is looking and lending through what we called liquid funding, which is a structured investment vehicle at that point in time to borrow money in the funds market and lend it to a variety of clients and do it over a collateralized basis and it worked very well — very terrific until about 2007 and at a point in time, the funding markets, not the asset markets, but the funding markets deteriorated at a point that the optics and frankly, the economics didn’t work out and so, we closed that business you now, and all of our equity holders got their capital back.
RITHOLTZ: When did Bear close that business?
SCHNEIDER: So, we closed it in early 2007.
RITHOLTZ: Really, and you are at Bear — you went through the entire crisis. When did you leave Bear?
SCHNEIDER: I was actually there. I was there until the very end and actually worked one day at J.P. Morgan and retired from J.P. Morgan and then went out to California after two things — one, my wife wanted me to move out there for our family, but a gentleman by the name of Paul McCulley called me up on the phone —
RITHOLTZ: Previous guest on the show, sure —
SCHNEIDER: And Paul is a great friend of mine and an avid fisherman and a great economist who obviously, you know coined the term Minsky moment and everything else, but to have them sitting there you as my partner sitting on the desk and welcoming was an opportunity that I simply couldn’t pass up.
RITHOLTZ: Could not say no and he is now at Cornell, I think in the fall teaching and then back in New Port Beach —
SCHNEIDER: That is correct. He is teaching — he is a great teacher and more importantly, he is a great communicator and he was a great, great mentor and sponsored me at PIMPCO, you know, at the very early years because I walked in from one storm into — and obviously, at PIMCO, you’re on the defense at that point in time.
RITHOLTZ: So, before we leave Bear, I have to ask, what was it like at Bear Stearns in that sort of storm? That has to be just a wild experience?
SCHNEIDER: So, I think what you — and when you think about Bear, Bear was a meritocracy, PIMCO is a meritocracy in way. You work hard, you try to strive, you try to put all the pieces together and I think people at that point time were focused on the markets and the market perception and I am not here to rehash history per se, but I think it’s important that there is a tremendous amount of lessons to be learned from what whole experience and fortunately for me and actually a lot of other ex-Bear brethren, you can look around the street now —
RITHOLTZ: They’re everywhere.
SCHNEIDER: They are everywhere and there was —
RITHOLTZ: Sure, that’s a lot of quality people.
SCHNEIDER: There was a tremendous amount of quality people and more importantly, we all learned from each other and we learned from the experience and we were able to grow out of it and whether it was market forces or internal issues or whatnot, I think there’s a lot of experience and a lot of history that we can go back and read from and glean information from and actually, I am fortunate and I — Bear was a great sponsor of my upbringing, allowed me to grow and every time I got — I needed some more challenge, they gave me an incremental bit of line to go and run with.
And PIMCO is the same way. We try to groom young people to do the same and that I think is a very strong parallel to the success we have.
RITHOLTZ: It looks like that the Bear Stearns acquisition by Jamie Dimon at J.P. Morgan turned out to be a really good fit. Is that your perspective from the outside? Because I haven’t heard any stories of — usually there is a takeover. There’s all sorts of tumult and turmoil and you hear — I haven’t really heard a lot of that sort of chatter.
SCHNEIDER: Being the fact that I worked there for all of one day, I don’t have that much insight to that, but I would say that, you know, for most people, you know, 10 years on almost now, I think it’s one of things that people take it as a learning lesson and the market as a whole clearly has.
RITHOLTZ: So, we’ve heard the expression over the years, the bond market is supposed to be the smart money. What is your take on that?
SCHNEIDER: I would hope so. I’m not saying it it’s no pat on the back to myself, but I think that when you look at how capital markets function, we try to be more proactive than most in terms of allocating capital on the active management side than most and I think that’s a pretty powerful thing when you think about the smart money aspect.
And a lot of smart money is because smart money or not central banks and some of them are very, very smart and very sophisticated are in that realm as well and so, they’re not necessarily, you know with the exception of one or two central banks in the equity realm yet, but —
RITHOLTZ: Japan — other than Japan, who else is in —
SCHNEIDER: Sweden sounds good. I am sorry, Switzerland, I would say, those two are primarily, you know the ETFs in Japan are clearly the big ones, but the smart money despite a lot more smart people in that fixed income market. Now, what it means though is that, that’s institutional side. As a retail investor, you can’t be complacent about how you are thinking about your fixed-income allocation, especially amongst rising rates and so the challenge for the retail investor now is to challenge their financial advisors, kick the tires, understand how their portfolios perform in upward rate environments, albeit slowly and more importantly, where on the interest rate curve they are destined.
Then, the second element to (inaudible) is just because you’ve earned a very handsome coupon, a very handsome income over the past three, four or five years in your portfolios because you reached out the curve in terms of risk, maybe you are invested in a high-yield fund, something like that, take that into consideration now and take that into consideration how you derive that income. What kind of risk are you taking? And do some homework and maybe it’s time to de-risk a little and look in the yield curve, shorter end, the short-term side and take advantage of mutual funds or ETFs out there that might my offer better risk-adjusted returns.
RITHOLTZ: We haven’t talked much about inflation, obviously a key factor for the Fed and for the bond market. What are your thoughts on TIPS? Treasury and inflation protected securities?
SCHNEIDER: Yes, they have moved up quite a bit over the breakeven, so that is the inflation expectation. It had moved up quite a bit over the past few weeks and they’re probably fair in value at this point in time.
The key factor here is that what does that mean to the Fed itself? And to the Fed itself, it is actually probably a positive sign that the market is repricing in a forward expectation of inflation, similar to their own views moving forward, meaning the low periods of inflation were transitory. Now, the market is sort of agreeing with that and that’s a positive thing for the Fed to basically accept the fact that we are probably going to have higher rates to come because if the market can accept higher inflation then that basically says the market is also accepting the notion that we are going to get higher rates to come.
But the key here is not just higher real rates, meaning risk-adjusted rates, but it is higher nominal rates and for a fixed income investor, when they hear about higher rates, they tend to get scared, but this isn’t the time to get scared because of high rates. It is actually a time to embrace those high rates going forward.
RITHOLTZ: We have been speaking with Jerome Schneider, head of short-term portfolio management and funding. If you enjoy this conversation, be sure and check out our Podcast Extras where we keep the tape rolling and continue discussing all things bond related. You can find out wherever finer podcasts are sold — iTunes, Overcast, Sound Cloud, Bloomberg.com.
We love your comments, feedback and suggestions. Write to us at MIBpodcast@Bloomberg.net. Check out my daily column on Bloombergview.com. Follow me on Twitter @ritholtz. I am Barry Ritholtz. You are listening to Masters in Business on Bloomberg Radio.
Welcome to the podcast. Jerome. Thank you so much for doing this. This is really fascinating stuff and I love going deep into the weeds on some of these issues.
I had no idea he knew Paul McCulley, you know I know Paul pretty well, right.
SCHNEIDER: Yes, absolutely.
RITHOLTZ: We fish in Maine every year, although, lately he’s been sort of all around the world and I don’t think he’s been doing all that much fishing. I remember when he went from clean-cut PIMCO to the Jesus version of Paul McCulley with hair past the shoulders and long beard and then kind of came back to the clean-cut version, it was kind of an interesting transition.
SCHNEIDER: Well, you know, I think he was trying to scare the fish out of the water at that point in time.
RITHOLTZ: I think he scared everybody else. You know, a few questions I didn’t get to — we touched upon Bear Stearns. I was really fortunate that I got a little lucky and I was pretty much out of equities and heavily into bonds and shorts, so the financial crisis wasn’t emotionally painful. However, I had friends that were getting fired everywhere. I used to send out an e-mail list of about 2,000 people and it astonishing starting in the late -I am going to say late ’07, early ’08. I could track the economy based on the amount of bad e-mail bounces that out of this list of 2,000, by the time the crisis was done, it was down to like 900 — that many people had either switched jobs or lost their jobs.
You were right in the eye of the hurricane. What was that like?
SCHNEIDER: You know, I remember — obviously, I remember like it was yesterday, but I think the important factor that we all think about is that the market — we were in unprecedented times and the playbook, so to speak was — it was one that had to be consistently evolving and you know, history will try to reconstruct all the minutia that happened during the financial crisis starting with the funds that basically were gated at parabola in 2007 and obviously, the Bear Stearns, Bear Stearns Asset Management Funds and things like that, but I think what we recognize is the fact that there was a structural breakage and that structural breakage was number one, investors failed to understand risk and that was institutional and retail investors.
And number two, the central bankers themselves weren’t doing anything to provide guardrails sufficient enough to offset the leverage points that they saw in the marketplace on a real-time basis. They were aware of them, but at the same time, so it was our job —
RITHOLTZ: Let me interrupt you right there because, I hear from the same people depending on what is going on in the market, the Fed — you know, this isn’t a free market anymore. There is too much intervention. The Fed should just let the market do its thing and stop distorting it, but a few years earlier, it’s like when is the Fed going to step in and fix this? It is a disaster. It seems they want it both ways. Am I overstating that or —
SCHNEIDER: I think that and this goes on sort of tugging both sides of the coin here. From PIMCO’s perspective, they were clearly early to the game. We were starting to see signs of the housing market in 2005 and 2006 when we sort of pulled in our reins with regard to that and that risk.
Actually, at Bear at that same point in time, we — you know, from our perspective in many of the businesses we ran, we actually were — we resisted doing transactions that we saw doing down in the marketplace because we thought they are over-levered and simply did not make sense.
The irony of the whole thing, even though we were prudent in many regards, we were obviously the first ones to take it —
RITHOLTZ: Huge exposure, the more —
(CROSSTALK)
SCHNEIDER: Right.
RITHOLTZ: — housing, that was their specialty.
SCHNEIDER: But at the same time, it wasn’t just mortgages and housing. It was equities, it was correlation trades and things like that that basically brought the entire market to where we became and so the market to market issues just generally speaking, was one because of incremental leverage requires whenever there is a market to market that you have to point additional capital —
RITHOLTZ: Or sell assets.
SCHNEIDER: Or sell assets and that’s the digital spin, and so it wasn’t necessarily one asset class. It wasn’t just mortgages. It was everything and so, that’s the correlation you have to understand when you get into these situations that is pretty — you know, it is pretty damaging to a portfolio.
So, leverage works great, assuming that you understand the cost of that leverage and you can play defense against it, which is why us understanding that cost of that capital and funding cost most importantly is incredibly important to understanding why a fixed income is valued the way it is today.
RITHOLTZ: So, that’s been the criticism of Ace Greenberg. It’s not the paperclips which are the insignificant rounding error, it’s the focus on the minutia and at the same time ignoring the giant exposure, although really to be fair to him, by the time ’05, ’06 came around, he was Chairman Emeritus. He wasn’t really running things day to day, was he?
SCHNEIDER: I mean, that’s a great case and point. I’m not here to point fingers. but I do think that number one, there is a fantastic book that he wrote, which is called, “Memos from the Chairman,” and in it, he has —
RITHOLTZ: “Memos from the Chairman.”
SCHNEIDER: Yes, and you should pick up a copy. It’s a quick read, but there is a fictional character which he calls Haimchinkel and Haimchinkel was the guy who came around and said you know, “Why does anybody need things tomorrow? Meaning, why do you FedEx? When I walked into Bear Stearns in 1995, they handed me two things, I think a fire warden hat and a direction where to get — how to get out of the building and a paper bag that was probably 3 inches x 2 inches that had a box of paperclips, 10 rubber bands and some tape. And they said, “This is all you’ll need in your entire career.” And literally, I think I still didn’t even get through the paperclips.
But the idea behind it was is you know, saving the money goes into the partner’s pockets, so that is clearly — and at that point in time, Bear was a public company, but as the mentality that you are an owner, you want to protect capital, you want to protect your capital and in doing so, you want to make sure that your business is profit-motivated to generate the highest returns and best risk-adjusted returns.
And that creates adverse situations as well because you are going to try to shoot the moon at various points in time and that’s just not a bear thing, its Wall Street at that point in time.
So, I think that was one moment, but it also takes macro management and risk — we had actually very strong risk management at Bear around the horn, but when you put it all together in terms of thinking about how it was related to the board room et cetera, there is now much more rigid input from a risk management group in every bank, in every portfolio management, in every buy side shop today that it probably ever has been and that simply increased the stake and makes sure that capital was allocated by — and more importantly criticized those allocations by independent parties.
So, risk management became something that was from the back office or maybe not appreciated to actually pretty glamorous and in the spotlight over the past 10 years.
RITHOLTZ: I don’t know if glamorous is the right word, but certainly, it’s a focus that every bank now — compliance and risk management are the two fastest-growing departments to say the least.
SCHNEIDER: But I’ll tell you this, even at PIMCO, you know, when we come in and have due diligences, we have entire sectors — segments, ours plus with other risk management them that is global. They are robust and they are — they are sophisticated and they need to understand and do stress testing for portfolios and they want — they are going to offer their objective to you in terms of how your port is positioned, what idiosyncratic events you can be defensively or offensively positioned for and it is a critical element to our tour teams and PIMCO’s success to protect capital of our clients.
RITHOLTZ: So, let me shift gears a little bit on you. We talked about the Fed earlier, some people — well, let me start with his question, some people have said, the Fed is distorting the bond market. Doesn’t the Fed always distort the bond market? Isn’t that what raising and lowering rates does?
SCHNEIDER: No, it’s more — it’s not that the Fed is distorting the bond market. It’s that they’re trying to adjust the market’s perceptions of the fair pricing of the bond market and the case —
RITHOLTZ: That’s nuance, but it seems to make sense.
SCHNEIDER: Well, I mean, it depends if you think that the tail is wagging the dog or the other way around, you know. The reality is when you look at how the bond market functions, irrational things happen all the time, in almost any market. As an example, two examples, one being, the pricing of dollar funding over yearend, there are certain constraints that forbid banks from lending dollars over a year, and as a result, if you had excess dollars, it is a great time because you’re able to earn a huge excess premium to lend those dollars to foreign investors who need to borrow those dollars every yearend.
The same thing goes on with regard to treasuries and fixed-income securities. There is a premium assigned to fixed-income securities as a safe haven asset and it used to be that treasuries were the golden child of safe haven asset and they still are to some extent, but when you got to a zero balance in terms of yield, when you had the 10-year at sub 2 percent, when you had the two-year note at sub 1 percent, those weren’t really attractive safe haven assets because you couldn’t necessarily squeeze any more juice out of those.
And the reality is, it’s hard to make you know, during times of stress, it’s hard to make lemonade out of those lemons because you have already squeezed all the juice out. We call that basically the term premium these days. And when you think about it, the marketplace right now still has an excess amount of term premium assigned to owning a treasury, meaning they’re willing to pay up, earn less yield by owning a treasury than they typically would otherwise. That’s the key metric and what the Fed is trying to do is influence what they view to be that term premium to be over time.
RITHOLTZ: Do they want to reduce that term premium? Is that the expectation?
SCHNEIDER: Well, they want to reduce it because they ultimately think that inflation is going higher over a period of time and shape the yield curve accordingly to those inflation expectations, so that’s one element.
The other element —
RITHOLTZ: Well, before we move let’s talk about inflation because we really didn’t get to that as much as I wanted. It seems to be that there’s not a lot of inflation and inflation has been preternaturally low for Lord knows how long, are we going to see an uptick in inflation? That the best description I’ve heard and I — this may have started yet another thing that started with McCulley, was we have inflation of things we need and deflation in the things we want and if it’s not Paul, it certainly sounds like him.
So, where are we in the process of inflation, disinflation, deflation or all of the above number?
SCHNEIDER: The number one metric and this gets back into my comments about optionality for the Fed, but the number one metric that the Fed is going to be focused on is the tightness of the job market and wage pressures on the go-forward basis, so sure inflation — headline inflation has perked up a little bit. A lot of that has to do with energy pricing over the past few months and when you approach $65.00 to $70.00 a barrel of oil, there’s going to be some headline pressure, so to speak.
But what they really want to see is increase in wage pressures and increase in growth and we started to see that, some of it is in relation to the job or to the tax reform. You were saying just immediately come through in terms of bonus payments and some increase in wages, but they want to see on a sustained basis and so, getting some of those wage indicators, average hourly earnings, things like that on an upward trajectory, not as flat, but upward trajectory over the next quarter or two, will actually give some sustenance to the Fed to actually continue to move forward, which they likely will, but I am saying that’s really what they are focused on in terms of that wage — in terms of that inflation metric.
RITHOLTZ: In 2018, we’ve seen 18 states and I believe it’s 22 or 23 municipalities raise their minimum wage. What does that do to “wage pressure” how it trickles up the pay scale and how does the Fed perceive that sort of legislative attempt to drive wages higher?
SCHNEIDER: That’s one-side of it. You know, they clearly want — that’s clearly one mandated wage pressure so to speak, so that’s going to play into that, but they actually want to see other things go into it. They are going to see obviously, unemployment go clearly below 4 percent probably this year —
RITHOLTZ: Really?
SCHNEIDER: Yes, and —
RITHOLTZ: And what does that do to —
SCHNEIDER: And they are going to also look at the broader employment measures, you know, which are hovering just north of 8 percent looking — see those dip, but again, it’s simply — is there a hidden capacity in terms of jobs and the economy?
Maybe some, but we are getting to a diminished size right now. In fact, there are articles about employment, employers looking for employees who they probably who they probably would have never talked to over the past few years —
RITHOLTZ: People with prison records.
SCHNEIDER: Right.
RITHOLTZ: I read that same thing.
SCHNEIDER: Exactly, and so I mean that sort of gets you scratching your head like you know, actually maybe my kid this summer can actually get a job because he is not competing with someone who is forced to early retirement, you know, over the summer but you know, I think that that is — that is what we are ultimately looking at.
So, yes, you can legislate minimum wage, but they are also looking at the growth segment across the breadth and the breadth of the employment sector is really what they are going to be focused on. So, they are pretty sophisticated in this regard.
RITHOLTZ: So, here’s the push back to that. It is, well we have created all these jobs, but a lot of them are in low-paying sectors without benefits or very modest benefits like hospitality and the lower end of healthcare in and the lower end of retail, has the quality of the U.S. labor market affected how the Fed perceives wages and inflation?
SCHNEIDER: Perhaps. But let me offer something else to that. It’s that, if there is a demand to employ people and people can’t and those employers can’t find people to employ, what is going to happen? It gets back to my whole supply and demand —
RITHOLTZ: You bring some people in who’ve left the labor force and theoretically HB-1 visas and other qualified immigrants, but eventually you start running out of bodies.
SCHNEIDER: Right and that’s the point is that eventually when you start running out of that supply, you are going to have to facilitate it by getting people to move back to your arena and the way you do that is you increase your wages and so that’s the key of what they want to do.
And this is weird, one thing that hasn’t even entered our discussion here today, Barry is productivity and I think that is something that we have to focus on.
RITHOLTZ: Okay, so let’s talk that because that’s one of my favorite questions. I have long been — so some of this is the do with my particular lens in the world of finance. I see just a huge uptick in productivity in the benefits of software and automation and technology in my job, which you don’t necessarily see in the data. So, I’m forced to either say, “Hey, am I just in a field that happens to be unusually productive, so my view is skewed?” Or is there something wrong with the measurements where we are missing a ton of these productivity gains in broader society?
SCHNEIDER: Maybe you’re just productive, way more productive as you thought —
RITHOLTZ: Yes, but it’s not just me. I keep coming back to it. It’s not just me — is there — it could be both, is there a productivity softness or is there a measurement issue?
SCHNEIDER: There’s both. I mean, let’s be fair. I mean, this is just like any politics. You would get evangelists on both sides of the aisle, but like, you know, I think at this point, we have to be rational.
As we get older —
RITHOLTZ: Why start now?
SCHNEIDER: Well, that’s a whole different discussion. And perhaps a separate podcast, but the reality is that, you have to — as you get older, you are going to adapt to things that make you more productive. That’s clearly one-side of the equation and it is very important.
So, the willingness to adapt to things that will make you more productive is actually something that we, as human beings are going to have to be open-minded to over the over the next few decades and I think that that’s one regard. But the measurement side, the measurement side is a key element and that is very difficult to handicap.
You know, personally I think when you look at things that are misguided in terms of productivity and technology and things like that, we are going to look back in 20 or 30 years just as we did. I remember — just as we did 10 or 20 years ago about the impact of the internet, impact of robotics, impact of simply you know, even in portfolio management for goodness’ sake.
You know, we are doing more stuff that’s not —
RITHOLTZ: With less bodies and —
SCHNEIDER: With less bodies and not as many fingers in the air, you can pull a lot of charts and then do a lot of analysis or need a lot of reams of paper, but there’s some pretty interesting things we are doing your computer power and some really smart analytics that we weren’t doing three, four, or five years ago and that makes us all that more productive —
RITHOLTZ: But that doesn’t necessarily show up in the actual management —
SCHNEIDER: Bingo, bingo. And I think that we have to — like any piece of data is open to interpretation, then you have to be rational and unless you are willing to do that, then you’re simply driving down the road at 55 miles an hour no matter the traffic conditions and you know what, that’s a terrifying place to be.
RITHOLTZ: There are two questions — I want to get to my favorite questions, but there are two things I didn’t come back to I have to ask about, one is the liquidity issue with trading, the number of training bond desks on Wall Street and trading firms on Wall Street has declined dramatically. What does this mean for liquidity in the bond market or is everybody just forced to trade with Blackrock’s bond desk and they have replaced Wall Street?
SCHNEIDER: Or PIMCO?
RITHOLTZ: Yes, you too. You guys are coming up on $2 trillion and so that’s fixed income —
SCHNEIDER: So, I would say this, it’s that it’s a great thing for our clients and the reason is that we are able to understand and assess good opportunities and entry points into bond markets and opportunities and most importantly, earn liquidity premiums for our clients. What I mean by that is, in the old days, everything used to be sort of lot market’s, liquidity. You know, liquidity was very open, you know, everybody had a bond desk and things like that.
We may get back there, but not to that point.
RITHOLTZ: I don’t think — I don’t see that move going back in that direction, do you?
SCHNEIDER: But you have to admit that the regulatory winds have changed over the past six months and so you don’t have to get all the way back there, but the point I would make is that, when you have inefficiencies in markets, it is an ideal time for fixed-income asset managers or asset managers who can influence and most importantly, understand and participate in those inefficiencies and so for clients of PIMCO, that is a great asset in and of itself. Because as a portfolio manager, sure I’m telling people how to position themselves, but Barry, I am spending 60 percent of day trading.
I get in the office at 3:30 in the morning and I’m looking at markets in London and I stay until six, or seven o’clock at night looking at how Asia opens. Those are great opportunities for global investors to really take advantage of.
So, for our clients over the past five to 10 years as market conditions have evolved or devolved however you want to look at it, that’s been really powerful.
RITHOLTZ: What is the most important thing people don’t know about your background?
SCHNEIDER: That they don’t know about my background. They clearly know I’m from Oklahoma and so I view that as being a — I view that as being a huge attribute. I would say, being self, you know, being a self-starter and understanding sort of how things are put together in a very simplistic term, not to say I am simpleminded, but that upbringing was very powerful.
I think, the transition really and I guess being a minority in Oklahoma — one of the few Jews in Oklahoma, I think that actually was an open-minding experience in a lot of ways and I had friends from all different religions, sort of coming forth and it wasn’t until I moved for the East Coast that I actually had an ability to reconcile my heritage effectively with that. And so I would say that for me, you know, just sort of being that minority for many years was a positive and negative influence and experience, but it also is very, very formative that way.
RITHOLTZ: That’s quite interesting. Tell us about some of your mentors, some of your early mentors. We know who your latter mentor was.
SCHNEIDER: Yes, so there’s a couple that come to mind here. Of course, you have my speech and debate teacher who pulls you out of the — who says you have the good gift for gab or at least extemporaneous speaking, so that’s one. Glenda Ferguson was her name and she sort of molded, helped to mold me at least to say something coherent in probably ninth grade, but you also have other people, and then there was a gentleman.
There’s two people that — I always had jobs in my entire life and I had owned a lawn mowing business, but the summer before my senior of high school, I had two people influence me. The first one was a gentleman by the name of Leroy Gilmer and Leroy was not anybody who was significant in a noteworthy way, but he was significant in my life because she was a hard worker. He worked three jobs and we worked at basically a sports bar is what we worked at and he hired me on a whim because he thought I was probably from the right side of the tracks, but hard enough working that I would work any hours I wanted to.
So, my hours were 5 p.m. to 2:30 in the morning and what he taught me was the ability to prioritize an industrial kitchen and what to do when you get slammed. So, there’s nothing like a sporting event where you have 50 tickets of food sitting in front you and you have to prioritize all those hungry possibly drunk patrons at a very quick point in time. And for me, Leroy was the epitome of hard work and diligence and the understanding how to logically put sequencing together during times of stress.
What happened during that…
RITHOLTZ: Sounds like it’s applicable to future events.
SCHNEIDER: So, one of the first things that I ask people is what is your first job? When I interview them, probably learned to (inaudible) that, and they said, internship at XYZ investment bank is my first job. It’s a very short interview because the reality is, is that want people to have real experiences, who can understand how to adapt and that’s an important thing.
And so, I’m more real-world than probably the most of brethren at PIMCO in terms of the types of questions they ask because they all want — just try to stump people with some intellectual like quantitative thing. That’s one element, but the other person who molded my life was a gentleman by the name of Tom Love.
RITHOLTZ: Tom Love —
SCHNEIDER: Tom Love, and so you probably know Tom, but Tom’s worth several billion dollars and what is interesting about Tom Love and you get into the gas industry, I had two people who are very close to me in that, but Tom Love had a series of truck stops called “Loves Country Stores” and you might see him on the interstates and there’s now tons of them, but back in the early 90s, there was a good few, but it was more of a regional type of situation.
Anyway, I had worked at — he had very few bad investments in his life, I think, but he had one investment which is in a carwash and the car wash is a very tough business, but I worked my daytime shifts at the car wash and I was a salesman and I did some cleaning of the cars of course and things like that, but he lost money on it and he was so perturbed by that, he actually showed up every day in his Oldsmobile truck, I remember at that point in time and here I was — he was very frustrated by the fact that this was a money-losing operation at that point in time. He had invested in a million dollars in this property and another million in the plant and never came to fruition.
And he kept every day coming in to see what was going on and talking to the employees at the ground level and I made a couple of suggestions to him. He was open-minded with my suggestions and number two, no matter how big his business became, he was actually very hands-on in terms of understanding how to learn from this failure.
And so, I learned two things from him. It is important to be not an absentee owner, number one and number two, learn from your failures and Tom to this day is obviously quite successful.
RITHOLTZ: Let’s talk about books. This is everybody’s favorite question. Tell us some books that you think you’ve read recently or you think are important?
SCHNEIDER: Yes, there is a couple here but you know, obviously, it’s funny to this day ask people interviewing, have you read, “Liar’s Poker” and clearly that was sort of formative in the beginning of the year, or there’s one called, “The Bombardiers” by Po Bronson and those are just sort of industry books —
RITHOLTZ: But Po Bronson was a big Silicon Valley —
(CROSSTALK)
SCHNEIDER: Yes, exactly. But it’s amazing to me that people who are just coming in this industry have no understanding of that history and I literally will buy it for them just to give them that sense of history, not that it was right or the wrong, it’s just the sense of history.
Philosophically, you have to think about places like Ayn Rand and the “Fountainhead” and places like that, not necessarily that you covet it, but I think it was sort of an eye-opening experience for me to read it as a young adult. But I actually go back to my upbringing in the oil bust and there was a book by a gentleman with the name Mark Singer called “Funny Money” and it was the beginning of the end of the savings and loan crisis.
And what you don’t realize actually is that the savings and loan crisis that everybody thinks that the Continental of Illinois being the pinnacle of it, but it started from literally a bank branch in the middle of a parking lot called Penn Square in Oklahoma City. Penn Square Bank did so many bad oil deals that it was out of — a branch of this probably no bigger than an average house, you know, a couple thousand square feet, but yet that was ground zero for the savings and loan crisis.
And it is often misunderstood about how things grow and become disproportioned and misaligned in terms of risk and as I mentioned before, it was the upbringing I had was how to react to ultimately the oil bust and that was very formative, but that book really gets in to the detail of how euphoria cultivates the self and more importantly, personalities captivate people. And that’s an important factor.
RITHOLTZ: Tell us what you do outside of the office to either relax or stay fit or mentally unwind?
SCHNEIDER: I love to spend time with my family and my wife. That’s a good balance. I try to work out. I have been doing CrossFit for 10 years and so that’s a —
RITHOLTZ: How are your knees?
SCHNEIDER: They’re great. I know that I had a handful of surgeries, but not because of that, but I do it as a stress relief. There is admittedly some movements I will clearly steer away from, but the people that you deal — that you train with and you work out are not in your everyday life and it’s fascinating to hear their stories. And you know my goals is not to back squat 500 pounds, but it’s to stay fit and more importantly, you know, sweat a little and have a good time and that’s what I find.
RITHOLTZ: So, if a millennial or someone just graduating college comes up to you and says they are interested in a career in fixed income, what sort of advice would you give them?
SCHNEIDER: Two pieces of advice. Be patient. I just had this conversation with a colleague not so long ago. The expectation is that somebody is making more money around you and you should make as much money around it. Where they can have more priority.
The reality is that careers take a long time to build and your firm is likely investing in your career in a variety of ways, shapes or form, they will be rewarded over time and so patience is essential. Believe me, people told me that along the way.
I had an old boss, his name was Lenny Fetter who basically helped me to get me enter my way and you know, took me places from London to Dublin, Ireland where I lived for a couple years, back to New York. The reality is that patience is an incredibly a powerful thing in a career and I think that’s number one.
Number two, if you really want to be in finance these days, no offense to New York because I love New York and spent many years here, finance is a global industry and if somebody is going to hand you an opportunity and that could be in London or Munich or Singapore or Tokyo or Sydney or Newport Beach, run with it. And you’ve got to be open-minded enough for you and your significant other to take those opportunities when they come because opportunities don’t fall in your lap very often, and the most successful people are the ones who can capitalize on that and then grow beyond that.
RITHOLTZ: And our final question, what is it that you know about the fixed income market today that you wish you knew 20 years ago when you were getting started?
SCHNEIDER: Well, one of the things that Ace Greenberg was very mad at me about was the fact that I was actually in the fixed-income market. He wanted me to be in the equity market because he was not a bond guy —
RITHOLTZ: Oh really?
SCHNEIDER: And so, one of the things — and I got — to be honest with you, my — being in the fixed-income market was a little bit by chance, but it’s something that I became fascinated with.
I think one of the things that would’ve been really useful in understanding it is how leverage really plays itself in the system and more importantly, have a better mapping tool to understand how leverage proliferate throughout the entire global system at this point in time. It’s something that you think you know. But it is very difficult to map out in any articulate way and no matter what people think, that is something that’s more of an educated guess as opposed to precise measurement factor.
RITHOLTZ: We have been speaking with Jerome Schneider. He is the head of short-term portfolio management and funding at PIMCO. If you enjoyed this conversation, be sure to look up an inch or down an inch at any of the other hundred and gee, 80 or so such conversations.
We love your comments, feedback and suggestions. Write to us at MIBpodcast — that’s M-I-Bpodcast@Bloomberg.net. I would be remiss if I did not thank my crack team who helps put together these weekly conversations. Taylor Riggs is our booker. Mike Batnick is our head of research. Medina Parwana is our audio engineer/producer. I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
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