Followup On Repo…


by Karl Denninger, Market Ticker:

In follow-up to my previous post on the Repo mess, here’s another thing to consider: Negative rate bonds.

Remember that these are guaranteed loss-making instruments if held to maturity.  That is, you give a government $100,000, they give you back $99,000 (as an example) one year later.  And so on.

The only way to make money on them is for rates to go more negative by enough that you can sell them for more than you paid because the new bond is even worse.

Now economists thought these could never be sold to anyone, anywhere, for that reason.  They are a literal intentional cash bonfire with the only possible redemption being the continued stupidity of the issuer and people’s willingness to buy them.  Note that in the US at least “Primary Dealers” in exchange for being the sole source of non-direct purchases are obligated to buy at the auctions.

So what happens if you, as one of these banks, are stuffed full of this garbage?  Somehow you have to make that capital back.  One way to do it is for The Fed to have alleged “Excess Reserves” which they pay for 1.5% interest on.  Heh, now we could have a -1% bond, 1.5% IOER, and, well, that nets to 0.5%, right?  Sort of.  Except that the two things are disjoint; excess reserves come from deposits of cash or sales of securities (you have to have the cash first) while negative bonds are purchased.

Hmmm… not so linked, are they?

But the ECB and others arm-twisted and indeed these bonds got sold, and bought.  Then the ECB monetized a bunch of them and issued Euros.  Heh wait — that’s a flat-out intentional currency devaluation, isn’t it?  Uh huh.

So now all this trash is laying around, and suddenly there’s a problem — rumblings on the horizon about the ECB and Euro zone generally may be basically forced to exit negative rates.

Well what if they do?  What happens to the value of all the ones currently out there?  They get bushwhacked!

What if that happens while you have these allegedly-safe “bonds” in a Repo transaction somewhere?  Oh, that would be bad.

Who’s got a crap-ton of this stuff?  Good question — but there’s about $13 trillion, by the last guess I saw, of this garbage out there, and I think it’s fair to bet that the ordinary retail dude or the holder of a bond fund wouldn’t be buying them on purpose.  So does he have them?  Probably not.

Oh, and one final question: Is the Fed’s more-or-less, it appears, “permanent” Repo attempting to act as a sink for these, and if so, under exactly what authority did The Fed act (and why does Congress and the American public permit) to transfer the negative yield implication — that is, the capital loss on a foreign government bond to the US Taxpayer?

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