Of course, that in itself wouldn’t be enough to cause a scarcity of cash in the banking system since firms in aggregate still have over a trillion dollars in reserves. And no one really knows how much double-, triple-, quadruple-, etc. the financial system is. For me, Bitcoin is empowering because it provides a choice to opt out of the traditional financial system. In the repo market, there were more Treasury securities to be financed in the market that day with relatively less cash. Since January 2018 I've volunteered in my native state of Wyoming to enact a series of enabling blockchain laws, and am a gubernatorial appointee to the Wyoming Blockchain Task Force. © 2020 Forbes Media LLC. And when you squeeze funding markets, you are usually squeezing hedge funds and other investors that may have to cut positions which can spark broader volatility.”, JPMorgan CEO Jamie Dimon summed up the conundrum last week, saying that “banks have a tremendous amount of liquidity, but also have a tremendous amount of restraints on how they use that liquidity.”. QUESTION: Marty; The goldbugs are back and claiming the Repo Crisis is MMT and this is again just printing money endlessly to cover up a major banking crisis in the USA so buy gold of course. You said at the WEC cocktail party this would happen because these people never understand the world economy. During the week of September 16th the repo market… 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. This is why the FT’s interview with Williams was so extraordinary. It’s unstable. Pumping cheap cash into the financial system has historically come with the risk of spurring too much inflationary pressure, but after a decade of ultra-low inflation, that isn’t much of a concern today. “The machine of liquidity management is just not oiled anymore,” said GLMX Chief Executive Officer Glenn Havlicek, who runs a trading platform for repo securities and has four decades of experience in funding markets. Why was this necessary? 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? The closest I’ve heard a financial regulator speak publicly of this is former CFTC Chairman Chris Giancarlo, to his credit, when he answered a question after a 2016 speech: “At the heart of the financial crisis, perhaps the most critical element was the lack of visibility into the counterparty credit exposure of one major financial institution to another. As risk premiums go, 8% is shockingly high—for a supposedly risk-free asset! Yes, it’s true that a run in the repo market is serious, since the big banks are still overly reliant on it and one dropped ball by the Fed could quickly turn the brush fire into an inferno. In 2017, it was less than half that. The overnight lending rate quickly shot up to 10% and the Fed temporarily lost control of its benchmark rate. Recent stories on regulatory rollback so far, here and here. The $1 trillion "repo market" allows banks and other financial institutions to borrow and lend from one another, usually overnight. If this topic makes you uncomfortable, it should. The Repo Market’s a Mess. They contend that those two forces, rather than a mere confluence of technical factors, are what’s really behind this past week’s disruptions. Growing the balance sheet might also be the easier one, some strategists say. Every player knows there aren’t enough chairs. On Friday, the New York Fed announced a series of overnight and term operations over the next three weeks to boost short-term liquidity. It sounds crazy: even National Public Radio is talking about repo rates. For one, the money that investors and dealers lend to the government in the form of bond purchases takes money out of the banking system. 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. What started in the repo market last week isn’t new—it’s actually the fourth such episode since 2008. … In fact, the Fed has already been creating uncertainty in the markets since last September. I hold degrees from Harvard Law School (JD, 1994), the Kennedy School of Government (MPP, 1994) and the University of Wyoming (BA, 1990). In normal times, not even Wall Street thinks too much about the arcana of short-term money markets. “The repo market isn’t used to being prime time,” in terms of liquidity management, he said. Most financial regulators baffle us with jargon when they discuss this issue, making it barely intelligible to regular folks (cloaking it in such terms as “clogged transmission mechanisms,” “length of collateral chains”). 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. 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. For every US Treasury security outstanding, roughly three parties believe they own it. 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The event doesn’t mean another financial meltdown is necessarily imminent—just that the risk of one is heightened—since the brush fire can be doused either by the Fed, or by the banks raising more equity capital. So why aren’t banks falling over themselves to rake in such easy, “risk-free” profits? counting of US Treasuries takes place. No one knows, but I doubt this is “the big one.” Sure, the repo market is flashing red sirens. And the fact the New York Fed stumbled out of the gate as it tried to come to the rescue on Tuesday shows just how out of practice the institution is when it comes to those types of ad-hoc operations, according to GLMX’s Havlicek. The "repo" crisis that the Federal Reserve has been dealing with since early September 2019 appears to be backing off and hopefully the Fed will have time for other issues. When that same bond is reused again and again and again in similar transactions, the magnitude of double counting within the financial system builds in a manner that no one can accurately measure. Despite assurances by the Fed and others to the contrary, the stress in the market for repurchase agreements, or repos, has exposed some fundamental weaknesses in the nation’s financial system which have been a decade in the making. (2015) analyze how euro area repo market activity responded to financial stress from 2006 to 2013 using a data set on GC repo transactions from the Eurex Repo platform. “The Fed wanted the market to restructure to a new equilibrium and institutions to figure out how to fund themselves,” said Julia Coronado, president of Macropolicy Perspectives. But US Treasuries are not risk-free. Many analysts do too. For years, IMF economist Dr. Manmohan Singh has done terrific work estimating it (see examples here, here, here, here, here, here and here). ): QuickTake. (Xinhua/Wang Ying via Getty Images) Xinhua News Agency. The plan includes providing an additional $425 billion in short-term funding to banks in dire need of cash. In its first overnight repo market operation since the financial crisis, the New York Fed injected $53 billion worth of cash in exchange for short-term Treasury bills. Fed ‘Manipulation’ Crushes Can’t-Miss Trade in U.S. An anti-fragile system is one that becomes stronger and more resilient as a result of shocks, not weaker. The New York Fed announced Thursday it’s planning to inject almost half a trillion dollars into the overnight repo market through the new year, significantly increasing intervention to ensure short-term interest rates are kept in check. That trade lost someone a whopping 8% (annualized) overnight, but presumably the trade allowed the bank to stay in business for another day. Again, the capacity for banks to intermediate and the cost of balance sheet have played out, and can be seen in the In addition, the New York Fed provided $56.40 billion in an overnight repo loan. 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.”. The repo market is important because it serves as the grease that keeps the global capital markets spinning. The repo-market as a harbinger. (The other two being continued ad-hoc interventions or a so-called standing repo facility, which would make cash loans available on a daily basis.). Banks are supposedly healthy and flush with cash, right? It’s called “rehypothecation.”). The Fed has a theory about why. The increase in the repo rates on September 16 seemed to stem from a demand-supply mismatch in the market. What does this mean for markets in the short-term? The Great Debate of 2021: What to Do With All That Cash? When the Repo Crisis erupted, the Fed could no longer entertain lowering interest rates when the free market was raising them. But almost no one is talking about the elephant in the room. The trillions in quiet cash and securities that are transferred back and forth between banks each day and night, comprise the repo market which is short for re-purchase agreement. Somebody—probably a big bank—needs cash so badly that it has been willing to pay a shockingly high cost to obtain it. That follows four straight days of repo transactions, something it hasn’t done in a decade. In the past, the Fed has disputed the idea that its balance-sheet unwind left bank reserves in short supply. This is why US Treasuries aren’t risk-free—they’re the most rehypothecated asset in financial markets, and the big banks know this. The answer is sobering. You may opt-out by. Suddenly, everyone is asking the same question: What does it mean? I'm speaking of the ongoing crisis in the repo markets. Last week the financial system ran out of cash. Repo-markets ‘blew-up’ because of the massive leverage built into the financial system through constant central bank support which made them unstable . Another sinister situation has continued to unfold behind the scenes, taking a backseat to the immediate threat at our doorstep. 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 repo market, which powers trillions in overnight borrowing by the world’s biggest banks and financial institutions, came within a hair of full-blown meltdown in September. And at his post-policy news conference on Sept. 18, Fed Chairman Jerome Powell sidestepped questions about whether he felt bank regulations were a catalyst for the market turmoil. It always has been. The balance sheets balance because Party B records a liability, so auditors don’t catch the problem. The problem arises when you aggregate the three US GAAP financial statements. 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). The repo market is where the big boys come to play. The Financial Crisis and the Repo Market Following the 2008 financial crisis, investors focused on a particular type of repo known as repo 105. All Rights Reserved, This is a BETA experience. This crisis has precipitated an intervention by the Federal Reserve, providing $500 Billion in funding between now and the end of January 2020. It was a modern version of a bank run, and it’s not over yet. Wall Street On Parade believes that the repo crisis on Wall Street may, at least in part, relate to big Wall Street banks backing away from lending to Deutsche Bank. Rather, I’m referring to the practice in the repo market that allows more people to believe they own US Treasuries than actually do. But repo rates spiked way above unsecured lending rates last week, even for “risk-free” collateral such as US Treasuries. Recent studies on the European repo market have also focused on the tensions occurring during the great financial crisis and the euro area sovereign debt crisis. The repo market’s liquidity crisis has been a decade in the making. It has no lender of last resort because it doesn’t need one. They recognize that what appears to be an 8% risk-free arbitrage is anything but risk-free. Those liquidity constraints came into full view over the past few days when corporate tax payments, big Treasury auctions and maneuvers by financial firms to manage their capital requirements prior to quarter-end drained cash available for repo transactions. “The longer the Fed goes without making changes, the more often you might have these type of incidences.”. In this regard, Bitcoin is an insurance policy against financial market instability. Financial regulators can’t publicly admit to this, but big banks know it’s true—and that’s why they hunker down (and stop lending) when they sense one of their kin is in trouble. A research paper on post-crisis … Congress Stalemate on Covid Liability Adds to Doubts on Reli... Loonie Corporate Bond Sales Break Record as CFOs Stockpile C... Gold Gains With Stimulus Impasse Spooking Equity Investors. Last week the financial system ran out of cash. US Treasuries are the core asset used by every financial institution to satisfy its capital and liquidity requirements—which means that no one really knows how big the hole is at a system-wide level. With Monday’s 1000 point stock market plunge the internet has been set ablaze with a discussion of a new crash looming on the horizon. But over the past week, the Federal Reserve has had to work unusually hard to rein in a key policy rate after overnight repo lending dried up. But the run on repo can be stalled in one of two ways: (1) banks raise new equity capital, or (2) the Fed injects more dollars into the system. F OR ANYONE who lived through the global financial crisis, trouble in the market for repurchase agreements, or repos, induces a cold sweat. and what exactly is going on in the financial markets? 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