What is happening at the Repo market?
Rehypothecation - The process by which someone pledges an asset for a loan but it has already been pledge for another prior loan. Strange but it seems that this practice is allowed and common among hedge funds, banks and financial institutions. It is also possibly the source of the problem manifesting in the Repo market.
The Repo Market - There are 3 players in the Repo market. The main banks, qualified financial institutions and the Federal Reserve. Banks and financial institutions have to maintain a minimum deposit held at the reserve bank in proportion to their loan portfolio. At the end of the day banks and financial institution lend to each other to keep the system in balance. This system works well and has been working perfectly without the participation of the Federal Reserve since the financial crisis of 2008, that is until September 16 this year, when the Repo rate hit 10%. The Reserve Bank stepped in to provide liquidity and calmed the markets. Since then they have provided 300 billion in short term liquidity.
What happened on 16 September 2019?
Even though some banks had ample reserve deposited at the Reserve Bank, they were unwilling to lend to other institutions as per usual, because they did not trust the "existence" of the assets (treasury bills) that were offered as collateral. They suspected that something was not right.
In overnight lending at the Repo market, the securities are only promised and not actually transferred. So in theory the banks trusted one another to deliver if needed. This trust evaporated on September 16, and borrowers had to offer ever higher interest rates or better securities. Borrowers had to have this money or they will be in breached of their lending ratio. ( Similar to exceeding your bank overdraft limit and the bank request that you deposit money to bring the overdraft under the limit immediately. You have to comply at whatever the cost or your cheques will bounce and your facility terminated. )
The banks knew something and they were unwilling to lend to one or some institutions at the standard Repo rate or perhaps at any interest rate! The only option left for those institutions is the Federal Reserve. Attempts were made to discover the identity of the institutions concerned but the Federal Reserve have block these requests. It seems that they do not have to disclose this information for 2 years.
So now, only the Federal Reserve is able and willing to lend on the promissory notes of the financial institutions affected and to this effect they have printed and loaned out 300 billion on a "temporary short term" basis. This problem is only growing is not going away anytime soon. The Federal Reserve will have to stop pretending that this is short term and actually "bring" those assets into their balance sheet permanently. But there is a problem. These assets don't exist and they do not know how large the problem is. It is at least 300 billion and growing.
In 2008 under QE1 they actually bought the toxic mortgages (Mortgage Back Securities) from the banks and financial institutions giving them fresh liquidity. ( This is similar to a company in trouble transferring or selling the bad debts or dead inventory in their books to another party. ) They actually cannot do the same with treasury bills this time, because the treasury bills don't exist! The banking system has no way of tracking how many institutions have claims to the same securities. Speculations are abound that it is as high as 3 dollars promised for every dollar of treasuries issued! Surely not! But the fact remains that there are no assets for the Federal Reserve to buy. The only option is permanent Repo market operations until they figure this out how large this problem is.
When the tide goes out we will know who is swimming naked.
Under normal circumstances, if a bank borrows on the Repo market from another bank, it will repay the other party with excess money from it's daily operations such as interest received, loan maturities and daily deposits, and take back their promissory note.
However if other banks sense that a particular institution is in trouble then they would require a higher interest, better securities or just refuse to lend. That institution will then have to go to the Federal Reserve window for funding and everyone will then know that, that institution is in trouble and no other banks will be willing to lend on their promise to pay, backed only by securities of doubtful value, as in the case of Lehman Brothers in September 2008.
If circumstances were normal then the failure of a single institution will be just that. However circumstances are not normal. The problem has only grown larger. The Federal Reserve have expanded overnight lending and also refuse to name the institutions involved. The likely scenario is that it is a systemic problem. All the banks and financial institutions are involved no one knows the extent of the rehypothecation. It is at least a 300 billion problem and growing!
How does this end ?
The Reserve Bank cannot keep renewing and extending the lending in the Repo market. This situation must be made permanent sometime and soon. If the treasuries are non existent, then the problem is even worse than 2008. The Federal Reserve can't even pretend to hold these assets in heir balance sheet as they do not exist. It has to be written off. The financial institutions involve declared insolvent and made bankrupt.
But alas the problem is again too big and involve institutions too big to fail. WE HAVE A HUGE PROBLEM. The solution will affect the value of the US dollar and by implication the world economy as the US dollar is the world's reserve currency.
How do we protect ourselves ?
The only way is to hold on to cash, precious metals, collectibles, blue chip companies and perhaps even cryptos. Any asset that does not carry a counter-party risk. Blockchain is a very young industry and we do not even know which crypto will ultimately prevail. My bet is on Bitcoin SV but that is only a personal opinion. Good Luck. Hold on to your seats there is turbulence ahead!
------------------------------
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References
https://www.forbes.com/sites/caitlinlong/2019/09/25/the-real-story-of-the-repo-market-meltdown-and-what-it-means-for-bitcoin/#46e927207caa
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1961904
https://www.thebalance.com/stock-market-crash-of-2008-3305535#:~:targetText=The%20stock%20market%20crash%20of,rejected%20the%20bank%20bailout%20bill.
https://wallstreetonparade.com/2019/11/the-fed-has-created-the-big-lie-for-congress-on-its-repo-loans-while-the-new-york-fed-blocks-freedom-of-information-requests/
Rehypothecation - The process by which someone pledges an asset for a loan but it has already been pledge for another prior loan. Strange but it seems that this practice is allowed and common among hedge funds, banks and financial institutions. It is also possibly the source of the problem manifesting in the Repo market.
The Repo Market - There are 3 players in the Repo market. The main banks, qualified financial institutions and the Federal Reserve. Banks and financial institutions have to maintain a minimum deposit held at the reserve bank in proportion to their loan portfolio. At the end of the day banks and financial institution lend to each other to keep the system in balance. This system works well and has been working perfectly without the participation of the Federal Reserve since the financial crisis of 2008, that is until September 16 this year, when the Repo rate hit 10%. The Reserve Bank stepped in to provide liquidity and calmed the markets. Since then they have provided 300 billion in short term liquidity.
What happened on 16 September 2019?
Even though some banks had ample reserve deposited at the Reserve Bank, they were unwilling to lend to other institutions as per usual, because they did not trust the "existence" of the assets (treasury bills) that were offered as collateral. They suspected that something was not right.
In overnight lending at the Repo market, the securities are only promised and not actually transferred. So in theory the banks trusted one another to deliver if needed. This trust evaporated on September 16, and borrowers had to offer ever higher interest rates or better securities. Borrowers had to have this money or they will be in breached of their lending ratio. ( Similar to exceeding your bank overdraft limit and the bank request that you deposit money to bring the overdraft under the limit immediately. You have to comply at whatever the cost or your cheques will bounce and your facility terminated. )
The banks knew something and they were unwilling to lend to one or some institutions at the standard Repo rate or perhaps at any interest rate! The only option left for those institutions is the Federal Reserve. Attempts were made to discover the identity of the institutions concerned but the Federal Reserve have block these requests. It seems that they do not have to disclose this information for 2 years.
So now, only the Federal Reserve is able and willing to lend on the promissory notes of the financial institutions affected and to this effect they have printed and loaned out 300 billion on a "temporary short term" basis. This problem is only growing is not going away anytime soon. The Federal Reserve will have to stop pretending that this is short term and actually "bring" those assets into their balance sheet permanently. But there is a problem. These assets don't exist and they do not know how large the problem is. It is at least 300 billion and growing.
In 2008 under QE1 they actually bought the toxic mortgages (Mortgage Back Securities) from the banks and financial institutions giving them fresh liquidity. ( This is similar to a company in trouble transferring or selling the bad debts or dead inventory in their books to another party. ) They actually cannot do the same with treasury bills this time, because the treasury bills don't exist! The banking system has no way of tracking how many institutions have claims to the same securities. Speculations are abound that it is as high as 3 dollars promised for every dollar of treasuries issued! Surely not! But the fact remains that there are no assets for the Federal Reserve to buy. The only option is permanent Repo market operations until they figure this out how large this problem is.
When the tide goes out we will know who is swimming naked.
Under normal circumstances, if a bank borrows on the Repo market from another bank, it will repay the other party with excess money from it's daily operations such as interest received, loan maturities and daily deposits, and take back their promissory note.
However if other banks sense that a particular institution is in trouble then they would require a higher interest, better securities or just refuse to lend. That institution will then have to go to the Federal Reserve window for funding and everyone will then know that, that institution is in trouble and no other banks will be willing to lend on their promise to pay, backed only by securities of doubtful value, as in the case of Lehman Brothers in September 2008.
If circumstances were normal then the failure of a single institution will be just that. However circumstances are not normal. The problem has only grown larger. The Federal Reserve have expanded overnight lending and also refuse to name the institutions involved. The likely scenario is that it is a systemic problem. All the banks and financial institutions are involved no one knows the extent of the rehypothecation. It is at least a 300 billion problem and growing!
How does this end ?
The Reserve Bank cannot keep renewing and extending the lending in the Repo market. This situation must be made permanent sometime and soon. If the treasuries are non existent, then the problem is even worse than 2008. The Federal Reserve can't even pretend to hold these assets in heir balance sheet as they do not exist. It has to be written off. The financial institutions involve declared insolvent and made bankrupt.
But alas the problem is again too big and involve institutions too big to fail. WE HAVE A HUGE PROBLEM. The solution will affect the value of the US dollar and by implication the world economy as the US dollar is the world's reserve currency.
How do we protect ourselves ?
The only way is to hold on to cash, precious metals, collectibles, blue chip companies and perhaps even cryptos. Any asset that does not carry a counter-party risk. Blockchain is a very young industry and we do not even know which crypto will ultimately prevail. My bet is on Bitcoin SV but that is only a personal opinion. Good Luck. Hold on to your seats there is turbulence ahead!
------------------------------
This money button tip slider will only work if you are registered at www.moneybutton.com
References
https://www.forbes.com/sites/caitlinlong/2019/09/25/the-real-story-of-the-repo-market-meltdown-and-what-it-means-for-bitcoin/#46e927207caa
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1961904
https://www.thebalance.com/stock-market-crash-of-2008-3305535#:~:targetText=The%20stock%20market%20crash%20of,rejected%20the%20bank%20bailout%20bill.
https://wallstreetonparade.com/2019/11/the-fed-has-created-the-big-lie-for-congress-on-its-repo-loans-while-the-new-york-fed-blocks-freedom-of-information-requests/
nice info
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