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. 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. 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. December 13, 2019. The third was the huge tax cuts of 2017, much of which was spent on buybacks. But US Treasuries are not risk-free. Party B borrows it, showing a liability of $100 ($100 of securities sold, not yet purchased). They recognize that what appears to be an 8% risk-free arbitrage is anything but risk-free. © 2021 Forbes Media LLC. The repo rate rose just 0.08 percentage points above recent levels, suggesting that the Fed’s efforts to make the market more resilient had succeeded. All Rights Reserved, This is a BETA experience. An anti-fragile system is one that becomes stronger and more resilient as a result of shocks, not weaker. 66 No. Overall this is all part of the market shifting through time to a new set of realities.” ( Adds Wednesday’s repo rate quote in third paragraph. 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. One of the secondary effects of repo market volatility is the impact it could have on banks’ adoption of the secured overnight financing rate, or SOFR, as an alternative interest rate benchmark to the London interbank offered rate, or Libor. Many analysts do too. And no one really knows how much double-, triple-, quadruple-, etc. 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 does this mean for markets in the short-term? Party A owns a particular US Treasury Bond, showing an asset of $100. It has no lender of last resort because it doesn’t need one. I saw inaccuracies in Wall Street’s. But repo rates spiked way above unsecured lending rates last week, even for “risk-free” collateral such as US Treasuries. Opinions expressed by Forbes Contributors are their own. The repo blow-up of 2019 set markets on edge and prompted the Fed to pump billions of dollars of emergency funding into the financial system. It’s called “rehypothecation.”). 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 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. Bilateral repo transactions can either allow for general collateral or ... SIFMA 2019 US Repo Market Fact Sheet SIFMA Research Banks are supposedly healthy and flush with cash, right? 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. 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. This is the real reason why the repo market periodically seizes up. h�b```f``2�l@��9 9Ls/5j3)�=8 m�������| �!��Ƃ�!ڥrwuyu�� @Ō*Oӻ�����T�VqG�5���@��O���*0Ht40dtt0�Ftt40 Here I distinguish between price volatility and systemic volatility. 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. Oct. 30, 2019, 08:21 AM ... "Banks have little reason to use this cash to take a potential risk of default in the repo market when they are getting such a sweet deal from the Fed," he said. For every US Treasury security outstanding, roughly three parties believe they own it. 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). Borrowers in the market for repurchase, or repo, agreements briefly had to pay an annual rate of more than 4 percent, after weeks of paying … these hqla municipal obligations represent the collateral for the repo’s and are the same as cash for lcr stress/testing. At the same time, the next largest 25 banks reduced their demand for repo funding, turning the net repo position of the banking sector positive (centre panel, dashed line). Everyone knows someone will eventually lose. h�T�Mo�0��� Oct. 24, 2019 9:30 am. 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. The balance sheets balance because Party B records a liability, so auditors don’t catch the problem. Last week the financial system ran out of cash. Multiple parties report that they own the very same asset, when only one of them truly does. 0 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. It always has been. The repo market shook the financial world in September when an unexpected rate spike choked short-term lending, spurring the Federal Reserve to intervene. 96 0 obj <>/Filter/FlateDecode/ID[<75BBE75DDF940D664DA42F4064FE2148><010798172367E348B0C8A73984EB871B>]/Index[84 22]/Info 83 0 R/Length 77/Prev 172015/Root 85 0 R/Size 106/Type/XRef/W[1 3 1]>>stream 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. What’s Wrong With the Repo Market? In this regard, Bitcoin is an insurance policy against financial market instability. counting of US Treasuries takes place. 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. Essentially, repurchase agreements — or repos — are how banks borrow cash from money market funds, often overnight. The Repo-Crisis of September 2019 O n Tuesday, September 17th. %%EOF Following the 2008 financial crisis, investors focused on a particular type of repo known as repo 105. That’s the layman’s explanation of what’s happening. We advocate for effective and resilient capital markets. Bitcoin is no one’s IOU. This is why the FT’s interview with Williams was so extraordinary. ICMA, January 2020 The European repo market at 2019 year-end 7 | P a g e Periphery repo Periphery GC rates tend to cheapen over year-end, in particular Italy, and 2019 was no exception although the moves were relatively range bound. 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. 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? If this topic makes you uncomfortable, it should. I hold degrees from Harvard Law School (JD, 1994), the Kennedy School of Government (MPP, 1994) and the University of Wyoming (BA, 1990). That trade lost someone a whopping 8% (annualized) overnight, but presumably the trade allowed the bank to stay in business for another day. The moment all three developments were spent, around the fall … By the end of July, the repo problems made their way into the Fed’s meeting, as we learned when the minutes of that meeting were released in August. This is why US Treasuries aren’t risk-free—they’re the most rehypothecated asset in financial markets, and the big banks know this. v � !�� R0���(T� V�dr1Х�̕F@�����c`�af�f�gt`�v��'�����#�i�>`8�U10_� �)w�)���Q � T�W� Rather, I’m referring to the practice in the repo market that allows more people to believe they own US Treasuries than actually do. 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.”. Singh has been recommending for years that regulators’ financial stability assessments of big banks be adjusted to back out “pledged collateral, or the associated reuse of such assets.” Financial regulators should have followed his advice years ago! The New York Fed has been working with tri-party repo market participants to make changes to improve the resiliency of the market to financial stress. The repo rate spiked in mid-September 2019, rising to as high as 10 percent intra-day and, even then, financial institutions with excess cash refused to … 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. It was a modern version of a bank run, and it’s not over yet. At a systemic level, the traditional financial system is as fragile as Bitcoin is anti-fragile. The repo market seized up last week, with median repurchase rates skyrocketing from their usual band of 2.00-2.25% to 2.46% on Monday, and 5.25% on … On Monday, September 16, 2019, a similar situation occurred in the overnight repurchase agreement (repo) funding market. SIFMA is the voice of the U.S. securities industry. 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. ;���$�5��}m�[3 *����CP��r�hpr�F���FJ��1�E h��|RqU����'����#e Ѫd�Lk�UGTn�JI�¹�%zdj�@J�S�r��rs��mE#%!��'�Z��J6�*�(堞HT�G�!_�Y�Xq��. This describes Bitcoin, whose network security grows as the system’s processing power grows. No one knows, but I doubt this is “the big one.” Sure, the repo market is flashing red sirens. In June 2014, FASB updated the US GAAP accounting rules for repos. endstream endobj 85 0 obj <> endobj 86 0 obj <> endobj 87 0 obj <>stream The Fed Repo-market turmoil raises almost existential question about post-crisis Wall Street rules, former Fed official says Published: Dec. 6, 2019 at 8:09 a.m. You can see how much liquidity that the Fed has injected in the repo markets in the official balance sheet. the financial system is. The repo market is an essential part of the financial system and any issues with it will have big knock-on effects. 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. For me, Bitcoin is empowering because it provides a choice to opt out of the traditional financial system. Last week the financial system ran out of cash. EGG MARKET NEWS REPORT ISSN 1520-6122 Monday, August 26, 2019 Vol. Both Party A and Party C report that they own the same asset (!) But at … The article by Kevin George finishes with a piece of advice, to read beyond the headlines: In stark contrast to the traditional financial system, Bitcoin is not a debt-based system that periodically experiences bank run-like instability. For years, IMF economist Dr. Manmohan Singh has done terrific work estimating it (see examples here, here, here, here, here, here and here). A Followup. As risk premiums go, 8% is shockingly high—for a supposedly risk-free asset! 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 blew out in mid-September. 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. (By this, I’m not referring to the US potentially defaulting on its debt obligations. In light of the traditional financial system’s instability, despite all of Bitcoin’s drawbacks, I find that a powerful concept. … The Fed has a theory about why. endstream endobj 88 0 obj <>stream The repo market is huge. %PDF-1.6 %���� If you want to understand the repo market, think about renting shoes at a bowling alley. The four largest US banks specifically turned into key players: their net lending position (reverse repo assets minus repo liabilities) increased quickly, reaching about $300 billion at end-June 2019 (Graph A.1, centre panel, red bars). (Reuters) - The $2.2 trillion repurchase agreement market - part of the inner workings of the U.S. financial system - is facing what could be another strain as the year comes to a close. ET the Repo Market in the US deteriorated in a dramatic surge of demand for liquidity in … That’s right. Far from it. 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J�H?�5+����r��-��`�=���wX�ŀxܕX �H!4�*�'r���"}.�'׻��_�����^s"� ��� As you can see, a total of about $500 billion has been injected since September 2019, which is when the Fed started the new "repo machine" back up. It had already briefly blown out at the end of 2018, then settled back down. Final rule effective July 5, 2019). The feared chaos in the repo market over the year-end period didn't materialize as the Fed had flooded the market with cash via repo operations and purchases of T-bills. Auditors can’t help here, and the accounting profession bears some of the blame for this problem. In mid-September 2019, overnight money market rates spiked and exhibited significant volatility, amid a large drop in reserves due to the corporate tax date and increases in … What started in the repo market last week isn’t new—it’s actually the fourth such episode since 2008. The Federal Reserve is closing out 2019 seemingly in control, at least for the moment, of a problem that only a few months ago threatened to spiral into a crisis. Why was someone willing to borrow cash at a 10% interest rate last Tuesday, in exchange for pledging US Treasury collateral that yields only 2% or less? h�bbd```b``��`� D�d�H�F�� Kai Ryssdal and Maria Hollenhorst Oct 9, 2019. 7�(P�Bںz؇�vwHL�4B��~��Z� ��'�m�v�����Ïz�3t�5���5B���B���z^��zh�P��L3;ۍ��$�3$��_��pH�=�wo����\���? Published on September 17, 2019, 7:40 PM EDT No one really knows how solvent (insolvent?) The Financial Crisis and the Repo Market . 105 0 obj <>stream Italy GC averaged -0.30, around 17bp cheaper than Bitcoin’s price is highly volatile, but as a system it is more stable. So why aren’t banks falling over themselves to rake in such easy, “risk-free” profits? endstream endobj startxref The repo market shook the financial world in September when an unexpected rate spike choked short-term lending, spurring the Federal Reserve to intervene. It’s akin to musical chairs—no one knows how many players will be without a chair until the music stops. Every player knows there aren’t enough chairs. 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. 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. 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”). The September 16 Repo Market Fiasco. The financial system is fragile. 84 0 obj <> endobj You may opt-out by. But the issues started bubbling up again. It’s unstable. US Repo Market Fact Sheet, 2019 US Repo Market Fact Sheet, 2018 US Repo Market Fact Sheet, 2017 US Repo Market Fact Sheet, 2016 US Repo Market Fact Sheet, 2015 About SIFMA. ... on Wednesday, July 31, 2019. But the interest rates … Auditors can’t catch this because GAAP accounting standards obfuscate it, as I’ll explain later. However, it provides a “teachable moment” regarding systemic fragility and anti-fragility. But almost no one is talking about the elephant in the room. The problem arises when you aggregate the three US GAAP financial statements. What started in the repo market last week isn’t new—it’s actually the fourth such episode since 2008. 34 U.S. Department of Agriculture Agricultural Marketing ServiceLivestock, Poultry & Grain Market News USDA AMS Livestock, Poultry & Grain Market News 1 fO�9 r�Xe�dL�$�{��4�1X���(�?c�O� �� Here, we … Interest rates have betrayed common sense—interest rates in the repo market should be lower than rates in unsecured markets, for example, because repos are secured by assets and thus supposedly lower-risk. Kevin Drum Political Blogger Bio ... the Fed has continued injecting cash into the repo market … h޼TmO"1�+���p}��v�Q.��;M�~X��^�,�D��ʹ��Q���t��[g�Պ0�s�9'Z�8጑�K�`J3�~�������RhrtDO�i�K�@?-8�b�ۥ�f��6�� �����m3-�7�r0����hQ�ݱ�7���G�(�C���KrW�kʘpZ��Ř��L��f�k��*���zꖞh&��h ���u��3W��=����E`GpN�u9_�4���7��e�t!� 0��l������ڪ����� Z�$h8/r���$��:?���M�(�`���P�ȗu5�-�#��-~��m��oZz��G�_�b���l�j��k�]ۙk���`4��+�9�Wn^�}͚[wH���U��2#L���`\��։���,7���{�hpE 6 �۠�&1B�V)3�P�,S��$�{��yJ ��9z�[����LX�I�'C�DD am@��d^�!���H�v��2y��dnt�ڌal�NW�Fº��l�T2�Y)"�D��������F �]E'��㭖Fd�*�L�锊�\`&k�]�����n��05KO��f��4����(qz�N�_� Bank run-like instability makes you uncomfortable, it should, as I ’ ll explain later EGG NEWS. And the accounting profession bears some of the financial system because it doesn t!, August 26, 2019 the room, this is the real why! Oct 9, 2019 repo market last week isn ’ t banks falling themselves... Chairs—No one knows how solvent ( insolvent? such episode since 2008 auditors can ’ t need.! 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