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. ... on Wednesday, July 31, 2019. In this regard, Bitcoin is an insurance policy against financial market instability. This is why the FT’s interview with Williams was so extraordinary. 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. endstream endobj startxref That’s right. 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. 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. 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. The September 16 Repo Market Fiasco. Bitcoin’s price is highly volatile, but as a system it is more stable. The repo market blew out in mid-September. 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. the financial system is. It’s akin to musical chairs—no one knows how many players will be without a chair until the music stops. 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 is why US Treasuries aren’t risk-free—they’re the most rehypothecated asset in financial markets, and the big banks know this. 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. Banks are supposedly healthy and flush with cash, right? However, it provides a “teachable moment” regarding systemic fragility and anti-fragility. 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 $100. Kai Ryssdal and Maria Hollenhorst Oct 9, 2019. ET Specifically, the Fed’s focus on the fed funds market is misplaced because the real action is in the much bigger, much more global repo market; the Fed shouldn’t have allowed America’s big banks to pay dividends or buy back stock when they’re so capital-constrained that they can’t even pick up an 8% “risk-free” arbitrage; the Fed’s proclamation that “the financial system remains resilient,” when it released the results of the most recent bank stress tests in June 2019, strains credulity; a staggering amount of US dollar liabilities have been issued offshore in recent decades and the Fed not only doesn’t control them but can’t measure them with any degree of accuracy; and banks’ financial statements don’t accurately reflect their financial health. No one knows, but I doubt this is “the big one.” Sure, the repo market is flashing red sirens. fO�9 r�Xe�dL�$�{��4�1X���(�?c�O� �� 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 … 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. 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. The Repo-Crisis of September 2019 O n Tuesday, September 17th. The four largest US banks specifically turned into key players: their net lending position (reverse repo assets minus repo liabilities) increased quickly, reaching about $300 billion at end-June 2019 (Graph A.1, centre panel, red bars). Italy GC averaged -0.30, around 17bp cheaper than Every player knows there aren’t enough chairs. 84 0 obj <> endobj Both Party A and Party C report that they own the same asset (!) ;���$�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��. It had already briefly blown out at the end of 2018, then settled back down. It has no lender of last resort because it doesn’t need one. For every US Treasury security outstanding, roughly three parties believe they own it. I hold degrees from Harvard Law School (JD, 1994), the Kennedy School of Government (MPP, 1994) and the University of Wyoming (BA, 1990). But repo rates spiked way above unsecured lending rates last week, even for “risk-free” collateral such as US Treasuries. The Fed has a theory about why. The third was the huge tax cuts of 2017, much of which was spent on buybacks. Last week the financial system ran out of cash. This is the real reason why the repo market periodically seizes up. In stark contrast to the traditional financial system, Bitcoin is not a debt-based system that periodically experiences bank run-like instability. 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 The Financial Crisis and the Repo Market . The repo market shook the financial world in September when an unexpected rate spike choked short-term lending, spurring the Federal Reserve to intervene. 34 U.S. Department of Agriculture Agricultural Marketing ServiceLivestock, Poultry & Grain Market News USDA AMS Livestock, Poultry & Grain Market News 1 Published on September 17, 2019, 7:40 PM EDT It was a modern version of a bank run, and it’s not over yet. Rather, I’m referring to the practice in the repo market that allows more people to believe they own US Treasuries than actually do. At a systemic level, the traditional financial system is as fragile as Bitcoin is anti-fragile. Everyone knows someone will eventually lose. 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). %%EOF Somebody—probably a big bank—needs cash so badly that it has been willing to pay a shockingly high cost to obtain it. 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. 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). You may opt-out by. Here I distinguish between price volatility and systemic volatility. December 13, 2019. But US Treasuries are not risk-free. Following the 2008 financial crisis, investors focused on a particular type of repo known as repo 105. h�b```f``2�l@��9 9Ls/5j3)�=8 m�������| �!��Ƃ�!ڥrwuyu�� @Ō*Oӻ�����T�VqG�5���@��O���*0Ht40dtt0�Ftt40 h�T�Mo�0��� 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. And no one really knows how much double-, triple-, quadruple-, etc. 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. 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. these hqla municipal obligations represent the collateral for the repo’s and are the same as cash for lcr stress/testing. 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.”. Multiple parties report that they own the very same asset, when only one of them truly does. I saw inaccuracies in Wall Street’s. 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. Party A owns a particular US Treasury Bond, showing an asset of $100. Here, we … We advocate for effective and resilient capital markets. The repo market is huge. Oct. 24, 2019 9:30 am. ICMA, January 2020 The European repo market at 2019 year-end 7 | P a g e Periphery repo Periphery GC rates tend to cheapen over year-end, in particular Italy, and 2019 was no exception although the moves were relatively range bound. On the flip side, the better question is why banks weren’t willing to lend against “risk-free” collateral for an 8% “risk-free” gain? It’s called “rehypothecation.”). Singh has been recommending for years that regulators’ financial stability assessments of big banks be adjusted to back out “pledged collateral, or the associated reuse of such assets.” Financial regulators should have followed his advice years ago! The repo market is an essential part of the financial system and any issues with it will have big knock-on effects. 7�(P�Bںz؇�vwHL�4B��~��Z� ��'�m�v�����Ïz�3t�5���5B���B���z^��zh�P��L3;ۍ��$�3$��_��pH�=�wo����\���? The closest I’ve heard a financial regulator speak publicly of this is former CFTC Chairman Chris Giancarlo, to his credit, when he answered a question after a 2016 speech: “At the heart of the financial crisis, perhaps the most critical element was the lack of visibility into the counterparty credit exposure of one major financial institution to another. The problem arises when you aggregate the three US GAAP financial statements. The financial system is fragile. Overall this is all part of the market shifting through time to a new set of realities.” ( Adds Wednesday’s repo rate quote in third paragraph. Why was someone willing to borrow cash at a 10% interest rate last Tuesday, in exchange for pledging US Treasury collateral that yields only 2% or less? One of the secondary effects of repo market volatility is the impact it could have on banks’ adoption of the secured overnight financing rate, or SOFR, as an alternative interest rate benchmark to the London interbank offered rate, or Libor. If this topic makes you uncomfortable, it should. @����[�K�B����N��g�O��>�|�~���/�3�Y�@�] Most financial regulators baffle us with jargon when they discuss this issue, making it barely intelligible to regular folks (cloaking it in such terms as “clogged transmission mechanisms,” “length of collateral chains”). SIFMA is the voice of the U.S. securities industry. Final rule effective July 5, 2019). h޼TmO"1�+���p}��v�Q.��;M�~X��^�,�D��ʹ��Q���t��[g�Պ0�s�9'Z�8጑�K�`J3�~�������RhrtDO�i�K�@?-8�b�ۥ�f��6�� �����m3-�7�r0����hQ�ݱ�7���G�(�C���KrW�kʘpZ��Ř��L��f�k��*���zꖞh&��h ���u��3W��=����E`GpN�u9_�4���7��e�t!� 0��l������ڪ����� Z�$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�_� 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. endstream endobj 85 0 obj <> endobj 86 0 obj <> endobj 87 0 obj <>stream An anti-fragile system is one that becomes stronger and more resilient as a result of shocks, not weaker. Bilateral repo transactions can either allow for general collateral or ... SIFMA 2019 US Repo Market Fact Sheet SIFMA Research 0 endstream endobj 88 0 obj <>stream 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. 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. On Monday, September 16, 2019, a similar situation occurred in the overnight repurchase agreement (repo) funding market. Bitcoin is no one’s IOU. Kevin Drum Political Blogger Bio ... the Fed has continued injecting cash into the repo market … For me, Bitcoin is empowering because it provides a choice to opt out of the traditional financial system. What started in the repo market last week isn’t new—it’s actually the fourth such episode since 2008. A Followup. This describes Bitcoin, whose network security grows as the system’s processing power grows. 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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. In light of the traditional financial system’s instability, despite all of Bitcoin’s drawbacks, I find that a powerful concept. EGG MARKET NEWS REPORT ISSN 1520-6122 Monday, August 26, 2019 Vol. It’s unstable. The moment all three developments were spent, around the fall … 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. © 2021 Forbes Media LLC. No one really knows how solvent (insolvent?) Party B borrows it, showing a liability of $100 ($100 of securities sold, not yet purchased). 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. But the issues started bubbling up again. counting of US Treasuries takes place. 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. Many analysts do too. J�H?�5+����r��-��`�=���wX�ŀxܕX �H!4�*�'r���"}.�'׻��_�����^s"� ��� The article by Kevin George finishes with a piece of advice, to read beyond the headlines: It always has been. 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 … 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. 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. Auditors can’t help here, and the accounting profession bears some of the blame for this problem. 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. In June 2014, FASB updated the US GAAP accounting rules for repos. 66 No. You can see how much liquidity that the Fed has injected in the repo markets in the official balance sheet. 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 … 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. But almost no one is talking about the elephant in the room. What’s Wrong With the Repo Market? That’s the layman’s explanation of what’s happening. But at … 105 0 obj <>stream All Rights Reserved, This is a BETA experience. Far from it. The balance sheets balance because Party B records a liability, so auditors don’t catch the problem. v � !�� R0���(T� V�dr1Х�̕F@�����c`�af�f�gt`�v��'�����#�i�>`8�U10_� �)w�)���Q � T�W� They recognize that what appears to be an 8% risk-free arbitrage is anything but risk-free. 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 started in the repo market last week isn’t new—it’s actually the fourth such episode since 2008. If you want to understand the repo market, think about renting shoes at a bowling alley. … The repo market shook the financial world in September when an unexpected rate spike choked short-term lending, spurring the Federal Reserve to intervene. What does this mean for markets in the short-term? 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). Essentially, repurchase agreements — or repos — are how banks borrow cash from money market funds, often overnight. Last week the financial system ran out of cash. %PDF-1.6 %���� (By this, I’m not referring to the US potentially defaulting on its debt obligations. Auditors can’t catch this because GAAP accounting standards obfuscate it, as I’ll explain later. That trade lost someone a whopping 8% (annualized) overnight, but presumably the trade allowed the bank to stay in business for another day. 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. (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. For years, IMF economist Dr. Manmohan Singh has done terrific work estimating it (see examples here, here, here, here, here, here and here). 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. 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 … the Repo Market in the US deteriorated in a dramatic surge of demand for liquidity in … As risk premiums go, 8% is shockingly high—for a supposedly risk-free asset! So why aren’t banks falling over themselves to rake in such easy, “risk-free” profits? 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