So, what exactly is a repo? – No, I’m not talking about a car repo; I mean a repo with the Federal Reserve Bank of New York. What is it? That’s the subject that’s had my curious ears to the ground.
Since mid‐August 2019, the Federal Reserve Bank (FRB) has opened a window called the repurchase market (repo for short). In the simplest terms, it’s an emergency ATM for banks and other financial institutions that need short‐term cash.
Sounds nice, right? That’s because it is!
Here is a light hearted scenario of how it works.
Imagine you own an investment bank – we’ll call it Lehman Brothers – and your neighbor owns Bear Sterns.
Your neighbor calls and says, “Hey, Neighbor, I need a billion for a loan I’m trying to underwrite; I’m a bit short on cash.” You reply, “Fine, here you go. I want it back in 30 days.”
Bear Stearns charges you a small interest rate and, hey presto, you get a billion. It’s always good to have friends – wink, wink! This is called interbank lending and it’s a very normal, healthy part of our financial system.
However, there is another place to go for money. Let’s go back to the scenario.
So, this time you (Lehman) call your neighbor (Bear Sterns) and you ask for a billion from him. Seems simple, only now your neighbor is having issues and doesn’t want to play.
Undeterred, you call all your other friends – Merrill Lynch, JP Morgan, UBS, Wells Fargo – but it’s the same story all over town: “Sorry, Lehman, no cash.” In a panic, you call the lender of last resort.
Enter the FRB. They will make your short‐term cash needs go away and, what’s more, the FRB won’t disclose who asked for the money.
Quick history interlude. Post 2008, the FRB has become very sensitive and aware of stress in the financial markets; it certainly doesn’t want a repeat of 2008. That said, the repo market has been accessed lots of times since then – too many to mention. All you really need to remember is QE1, QE2, QE3. Quantitative easing (QE) was essentially designed to help alleviate the broad financial stress that was implemented by the mechanics of the repo market.
Back to the scenario…
You own Lehman and you need a billion dollars now, not next week! The FRB opens the repo market and lends you a billion at the rate of 1.55% for 14 days (repo rates as of 11/20/19 www.newyorkfed.org/markets/rrp_counterparties). You give the FRB collateral that isn’t performing or that’s of no immediate use, and the FRB gives you lovely, crisp, free cash for you to loan out to your customers. Pretty sweet!
In the last 3 months alone, the FRB has lent out $400 billion to unnamed financial intuitions to help maintain normal lending conditions in and outside the United States.
It’s hard to quantify the results of the repo market’s operations at the moment, since it will keep going through to year end, according to Jay Powell. It does serve a useful function for our economy: No one wants credit stress in banks to spread and no bank CEO wants to go without their bonus.
It also raises a bigger question: Have we fixed the pre‐2008 problems, or did we just slap a Band‐Aid on and are hoping it won’t come unstuck? That has me on the fence.
To some degree, yes, mortgage bonds are significantly more secure, and have stricter underwriting standards. But corporate America and our natural tendency toward prosperity and hubris will always manifest a problem.
For now, it is worth watching and commenting. The sheer dollar size is noteworthy and my experience with former credit problems has my Spidey‐sense tingling. But sarcasm has my tongue. I mean, who cares about $400 billion when you’re $23 trillion in debt.
If this manifests into something larger, I’ll be in touch. Till then, Happy Thanksgiving.
Cheers
Christopher R. Lakian