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 repo market has nothing to do with cars or other purchases getting repossessed, but it is a crucial part of the financial system. Before coronavirus turmoil hit the market, the Fed was offering $100 billion in overnight repo and $20 billion in two-week repo. A significant amount of cash (supply) flowed out of the repo market just as more securities (demand) were flowing in. It made me uncomfortable when I first realized all of this, which for me happened during the financial crisis while I was working on Wall Street and took a deep dive into why the crisis was happening. To wit, the IMF has estimated that the same collateral was reused 2.2 times in 2018, which means both the original owner plus 2.2 subsequent re-users believe they own the same collateral (often a US Treasury security). The repo market is an important component of short-term funding markets and the source of financing for dealers’ holdings of Treasury bonds. When the Fed injects cash into the repo market, they are buying government debt, and it remains to be seen whether the Fed can or should become the buyer of last resort for government debt. 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. Overnight lending rates topped at an annualized rate of 10% last week, four times higher than the prior week. This shift means that those purchases will likely need to be financed, at least until end investors acquire the Treasuries, and perhaps longer. Heading toward the end of the year, the demand for cash by these financial institutions increases, primarily to balance their books in order to comply with federal regulations. The repo market is an important component of short-term funding markets and the source of financing for dealers’ holdings of Treasury bonds. Banks and their lobbyists tend to say the regulations were a bigger cause of the problems than do the policymakers who put the new rules into effect after the global financial crisis of 2007-9. 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. Yet few observers expect the Fed to start up such a facility soon. Jamie Dimon, chairman and chief executive of J.P. Morgan Chase, points to these restrictions as an issue. Most repos are overnight, though they can be longer. What Happened Last Week in Repo? counting of US Treasuries takes place. Since these increased deficits are not the result of countercyclical policies, one can anticipate continued high supply of Treasuries, absent a significant shift in fiscal policy. These rules may have led banks to hold on to reserves instead of lending them in the repo market in exchange for Treasury securities. In an October 2019 call with analysts, he said, “[C]ash, we believe, is required under resolution and recovery and liquidity stress testing. Stepping back, it reveals two big things about financial markets: first, US Treasuries are not truly “risk-free” assets, as most consider them to be, and second, big banks are significantly undercapitalized. This brings us to the market on September 16, 2019. The repo market channels more than $1 trillion in funds through Wall Street every day, usually without fanfare. The Fed created reserves to buy securities, dramatically expanding its balance sheet and the supply of reserves in the banking system. If this topic makes you uncomfortable, it should. Post-crisis rules require that banks prepare recovery and resolution plans, or living wills, to describe the institutions’ strategy for an orderly resolution if they fail. Strains in the repo market that emerged on the morning of September 16 quickly spilled over to the fed funds market later that day. 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 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. 1. All Rights Reserved, This is a BETA experience. hosted by the Hutchins Center on Fiscal & Monetary Policy on December 5, 2019. 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. A repurchase agreement (repo) is a short-term secured loan: one party sells securities to another and agrees to repurchase those securities later at a higher price. 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. 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. The regulatory authority responsible for the markets, the Federal Reserve of New York (FRoNY), had to stage a … Between 2008 and 2014, the Fed engaged in Quantitative Easing (QE) to stimulate the economy. 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. That’s the fairy tale to keep everyone calm while the central banks scramble to figure out what happened. Guidance for the Brookings community and the public on our response to the coronavirus (COVID-19) », Learn more from Brookings scholars about the global response to coronavirus (COVID-19) ». 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. 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