from Birch Gold Group:
In 2008, the “freezing of the repo markets was one of the most damaging aspects” of the financial crisis, according to a report by the Bank of International Settlements (BIS).
This detail sets the stage for an eerie revelation contained in the same report: that four major banks sit at the root of the recent repo crisis that started back in September.
First, a quick refresh on what “repo transactions” are, directly from the BIS report itself:
A repo transaction is a short-term (usually overnight) collateralized loan, in which the borrower (of cash) sells a security (typically government bonds as collateral) to the lender, with a commitment to buy it back later at the same price plus interest. […] Repo markets redistribute liquidity between financial institutions […] they help other financial markets to function smoothly.
Until now, the Fed “line” has been that the repo crisis started because of “corporations draining liquidity from the system to pay their quarterly tax payments alongside a large auction of U.S. Treasury securities settling and adding to the cash drain.”
Of course, we already know that the Fed has flooded the repo market with hundreds of billions of dollars since September, and plans to keep doing so into 2020. So blaming the situation on “corporations paying their quarterly taxes” doesn’t seem to add up.
The BIS report completely exposes the fallacy of this “line”, essentially squashing any of the Fed’s credibility on the topic, saying, “US repo markets currently rely heavily on four banks as marginal lenders.”
As seen below, the four banks (Citigroup, JPMorgan Chase, Bank of America, and Wells Fargo) have taken on critical roles in the lending market – perhaps too much so.
So if these big banks are key lenders, and the repo markets rely heavily on them, those banks sure look like they are at the center of all this. But it gets worse…
Underlying Problems with Fed “QE” Are Escalating
Normally, repo markets operate without intervention by the Fed. They hum along day after day, lending money, and things are usually okay.
At the start of this repo crisis, the Fed was handling the sudden increase in repo lending rates. It was an emergency situation. If the problem stopped there, no harm, no foul.
But the problem didn’t stop there, and therein lies the much bigger problem…
The Fed continued to flood the repo markets with cash in October to keep them liquid. The banks’ need for more and more cash is a big deal all by itself, but it brought another problem to light. The banks need more cash than the Fed can offer.
This is called being “oversubscribed.” Dave Kranzler described the escalation of the situation like this (emphasis ours):
The 28-day repo QE for $25 billion that was added to the program Nov 14th was nearly 2x oversubscribed this morning, which means the original $25 billion deemed adequate 3 weeks ago was not nearly enough – a clear indicator the problems in the banking system are escalating at a rate faster than the Fed’s money printing operation.
So it appears the bank’s liquidity issues may exceed the Fed’s ability to provide liquidity, and that isn’t good.
Kranzler added his dire outlook: “I am convinced that the ‘repo’ money is needed to help banks shore up their liquidity as loans and other assets begin to melt-down. This is quite similar to 2008.”
The last thing the U.S. economy needs is a repeat of what happened over a decade ago.
It Only Gets More Uncertain From Here
This critical lending cog in the repo markets is a bit rusty. The Fed keeps trying to grease it, with the four big banks at the center of it all. But their efforts may come up short.
If these lending markets “freeze” like they did in 2008, it could create a retirement nightmare for anyone who isn’t prepared for the bumpy ride.