I saw inaccuracies in Wall Street’s ledger systems while running Morgan Stanley’s pension solutions business (2007-2016), holding senior roles at Credit Suisse (1997-2007) and starting my career at Salomon Brothers (1994-1997). A crucial but little-known market that ordinarily hums steadily along, this week we saw a shortage of cash cause a massive spike in repo rates. It ramped up the operations on March 9, offering $175 billion in overnight and $45 billion in two-week repo. That’s nonsense. They noted that firms not subject to bank regulations, such as money market funds, government-sponsored enterprises, and pension funds, also seemed reluctant to step in when repo rates rose sharply in mid-September, suggesting that factors other than bank regulations may be important. Banks also say that government supervisors sometimes express a preference that banks hold reserves instead of Treasuries by questioning assumptions bank make when they say they could quickly sell Treasuries without a large discount at a moment of stress. Then, on March 12, the Fed announced a huge expansion. hosted by the Hutchins Center on Fiscal & Monetary Policy on December 5, 2019. At a systemic level, the traditional financial system is as fragile as Bitcoin is anti-fragile. A reverse repurchase agreement (reverse repo) is the mirror of a repo transaction. It’s as close as a regulator will come to admitting the reality that the system doesn’t work the way most of us think it does and that the Fed may not even understand critical things about it. This is the real reason why the repo market periodically seizes up. I saw inaccuracies in Wall Street’s. Every player knows there aren’t enough chairs. But repo rates spiked way above unsecured lending rates last week, even for “risk-free” collateral such as US Treasuries. But these two anticipated developments don’t fully explain the volatility in the repo market. Between 2008 and 2014, the Fed engaged in Quantitative Easing (QE) to stimulate the economy. But the Fed has signaled that it wants to wind down the intervention: Federal Reserve Vice Chair Richard Clarida said, “It may be appropriate to gradually transition away from active repo operations this year,” as the Fed increases the amount of money in the system via purchases of Treasury bills. It’s akin to musical chairs—no one knows how many players will be without a chair until the music stops. The TGA has become more volatile since 2015, reflecting a decision by the Treasury to keep only enough cash to cover one week of outflows. Post was not sent - check your email addresses! That’s the fairy tale to keep everyone calm while the central banks scramble to figure out what happened. This is why US Treasuries aren’t risk-free—they’re the most rehypothecated asset in financial markets, and the big banks know this. It always has been. Probably the most glaring omission that needed to be addressed was that lack of visibility, and here we are in 2016 and we still don’t have it.”. First of all, what is the Repo Market? That’s right. The repo market channels more than $1 trillion in funds through Wall Street every day, usually without fanfare. Bitcoin Value Tops Half A Trillion Dollars—Is The Bitcoin Price About To Smash $30,000? The repo rate spiked in mid-September 2019, rising to as high as 10 percent intra-day and, … I’m a 22-year Wall Street veteran who has been active in bitcoin since 2012, and whose passion is a fair and stable financial system. The secure overnight funding rate (SOFR) more than doubled in the intraday range jumped about 700 basis points (repo rates typically fluctuate in an intraday range of 10 to 20 basis points). I can sum up why this happened in two words: central banks. The Fed targeted the interest rate in this market and added or drained reserves when it wanted to move the fed funds interest rates. The repurchase agreement, or “repo,” market is an obscure but important part of the financial system that has drawn increasing attention lately. As former Fed governor Daniel Tarullo put it at the Hutchins Center event: “With the budget deficit having increased by about 50 percent in the last two years, the supply of new Treasuries that need to be absorbed by debt markets has grown enormously. The repo market has nothing to do with cars or other purchases getting repossessed, but it is a crucial part of the financial system. And therefore, we could not redeploy it into repo market, which we would’ve been happy to do. The secure overnight funding rate (SOFR) more than doubled in the intraday range jumped about 700 basis points (repo rates typically fluctuate in an intraday range of 10 to 20 basis points). Bitcoin is no one’s IOU. Some in financial markets are skeptical, however, because QE eased monetary policy by expanding the balance sheet, and the new purchases have the same effect. What happened? But then they reversed course, cut rates three times, and also re … Both Party A and Party C report that they own the same asset (!) The additional debt leaves primary dealers—Wall Street middlemen who buy the securities from the government and sell them to investors—with increasing amounts of collateral to use in the repo market. The repo market is where dealers in low-risk liquid assets are able to obtain short-term cash through selling their securities to counterparty buyers through a repurchasing agreement before being required to purchase the securities back at a pre-agreed point in time. The core function of the repo market is exchanging Treasury securities — in other words, government debt — for cash. In the case of a repo, a dealer sells government securities to … As risk premiums go, 8% is shockingly high—for a supposedly risk-free asset! The balance sheets balance because Party B records a liability, so auditors don’t catch the problem. QE was designed, in part, to reduce long-term interest rates in order to encourage borrowing and economic growth and to spur more risk-taking, by driving investors into stocks and private bonds. Specifically, the Fed’s focus on the fed funds market is misplaced because the real action is in the much bigger, much more global repo market; the Fed shouldn’t have allowed America’s big banks to pay dividends or buy back stock when they’re so capital-constrained that they can’t even pick up an 8% “risk-free” arbitrage; the Fed’s proclamation that “the financial system remains resilient,” when it released the results of the most recent bank stress tests in June 2019, strains credulity; a staggering amount of US dollar liabilities have been issued offshore in recent decades and the Fed not only doesn’t control them but can’t measure them with any degree of accuracy; and banks’ financial statements don’t accurately reflect their financial health. The Fed has gone out of its way to say that this is not another round of quantitative easing (QE). Banks are supposedly healthy and flush with cash, right? Shockingly, the Fed admitted to asking itself this same question, as revealed in an extraordinary interview on Friday with New York Fed President John Williams in the\Financial Times. The repo market can be split into two main segments: Bilateral Repo – The bilateral repo market has investors and collateral providers directly exchange money and securities, absent a clearing bank. But former and current regulators point out that the LCR probably didn’t contribute to the repo market volatility because Treasury securities and reserves are treated identically for the definition of high-quality liquid assets in the regulation. The financial panic of 2007-8 stemmed from a run on the repurchase or "repo" market -- the primary source of funds for the securitized banking system -- rather than a run on monetary deposits as in earlier banking panics, according to a recent study by Gary Gorton and Andrew Metrick. So why aren’t banks falling over themselves to rake in such easy, “risk-free” profits? Why was someone willing to borrow cash at a 10% interest rate last Tuesday, in exchange for pledging US Treasury collateral that yields only 2% or less? Repo is a vital cog in how Wall Street works and a major way that investors big and small—including anyone who owns a money-market savings account—could earn interest. Somebody—probably a big bank—needs cash so badly that it has been willing to pay a shockingly high cost to obtain it. Many analysts do too. The good news is that while what happened in the repo market may sound alarming, there’s no need to worry. It’s unstable. The repo market is important because it serves as the grease that keeps the global capital markets spinning. Amazon and Walmart have raked in billions in additional profits during the pandemic, and shared almost none of it with their workers, How misinformation is distorting COVID policies and behaviors. The repo market has nothing to do with cars or other purchases getting repossessed, but it is a crucial part of the financial system. The repo market allows financial institutions that own lots of securities (e.g. This explainer draws, in part, from a public event, The repo market disruption: What happened, why, and should something be done about it? What started in the repo market last week isn’t new—it’s actually the fourth such episode since 2008. Here’s what the books of three parties show when a transferee (Party A) sells pledged collateral to a third party (Party C): If you add up the positions of all parties, economically there’s no problem because the net of the two longs and one short position add up to $100. They recognize that what appears to be an 8% risk-free arbitrage is anything but risk-free. On the flip side, the better question is why banks weren’t willing to lend against “risk-free” collateral for an 8% “risk-free” gain? The good news is that while what happened in the repo market may sound alarming, there’s no need to worry. Starting on September 16 interest rates rose sharply in the market for repurchase agreements, or repo. This resulted in a large transfer of reserves from the financial market to the government, which created a mismatch in the demand and supply for reserves. When interest rates in the overnight lending market (known as the repo market) spiked in September, there was a real fear that it was a sign of something far worse. But US Treasuries are not risk-free. The Repo Market provides wholesale short term funding for a period of 1 to 30 days. In addition, the marginal purchaser of the increased supply of Treasuries has changed. The repo market is an important component of short-term funding markets and the source of financing for dealers’ holdings of Treasury bonds. I bring you bitcoin/blockchain thru a 22-year Wall St. veteran's lens, EY & Citi On The Importance Of Resilience And Innovation, Impact 50: Investors Seeking Profit — And Pushing For Change, Michigan Economic Development Corporation With Forbes Insights. And I think it’s up to the regulators to decide they want to recalibrate the kind of liquidity they expect us to keep in that account.”. I jumped to blockchain to try to fix these problems, and from 2016-2018 I was chairman and president of Symbiont, an enterprise blockchain company, where I jointly spearheaded blockchain delivery of index data to Vanguard. However, it provides a “teachable moment” regarding systemic fragility and anti-fragility. What happened? All Rights Reserved, This is a BETA experience. What it all means is that, while each bank’s financial statements show the bank is solvent, the financial system as a whole isn’t. When the government runs a budget deficit, it borrows by issuing Treasury securities. In this regard, Bitcoin is an insurance policy against financial market instability. It was a modern version of a bank run, and it’s not over yet. The $1 trillion "repo market" allows banks and other financial institutions to borrow and lend from one another, usually overnight. But, as usual, the Fed will almost certainly do what it always does—stem the run by injecting cash into the system in various ways, thereby socializing losses among all US dollar holders. And no one really knows how much double-, triple-, quadruple-, etc. Join the conversation on Twitter using #RepoMarket In September, a disruption in the market in which banks and others lend and borrow for very short periods of time, the repo market… (By this, I’m not referring to the US potentially defaulting on its debt obligations. This brings us to the market on September 16, 2019. The repo market is a critical resource for large businesses to get the overnight financing they need to pay taxes, make payroll, fund operations, etc. The Fed’s involvement in the repo market can be traced back to Sept. 16, when a traffic jam occurred at the intersection of cash and securities. Fed officials concluded that the dysfunction in very-short-term lending markets may have resulted from allowing its balance sheet to shrink too much and responded by announcing plans to buy about $60 billion in short-term Treasury securities per month for at least six months, essentially increasing the supply of reserves in the system. In an October 2019 call with analysts, he said, “[C]ash, we believe, is required under resolution and recovery and liquidity stress testing. But almost no one is talking about the elephant in the room. Banks have some preference for reserves to Treasuries because reserves can meet significant intra-day liabilities that Treasuries cannot. 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