What The HELL Is Going On?


by Karl Denninger, Market Ticker:

The market is flat-out ignoring what are clearly emergency measures being taken by The Fed.

There’s only one thing worse than an emergency, and that’s an emergency that people are actively trying to hide.

What am I referring to?  That The Federal Reserve has been frantically adding reserves to the financial system in an amount that is utterly stunning, running well north of $400 billion over the last four months.

A quick primer is in order here.  “Repo” transactions are undertaken all the time in the financial system.  The purpose of them is to balance reserves between banks.  Let’s say you buy a $250,000 house.  On the day you close $250,000 leaves one financial institution (your lender or, if it’s a cash deal, your bank) and is wired to the seller (through the title company, which deducts the various fees and such that are due.)  That’s a large hunk of cash that leaves one place and goes another.

Now on-balance banks tend to be on the “selling” and “buying” side about equally.  That is, you’re not the only one buying or selling something among their customers and affiliates; lots of people are.  Therefore most of the time the net change between these banks is small or non-existent.  But not always — there are, for example, certain dates where very large movements tend to take place, such as tax deposit due dates for estimated taxes, dates for corporate and personal income taxes, and the end of the year when people tend to do an outsized amount of moving things around for tax purposes (either to take advantage of a lower rate on this year’s taxes than the anticipated rate next year, or to crystallize a loss, etc.)

If a bank finds itself out of balance with where it wants to be (or worse, where it has to be for regulatory purposes) in terms of reserves it uses a repo operation.  Tri-party repos, the most-common, are held (“secured”) by the NY Fed which is the custodian and executed between the parties.  So if Bank #1 is “heavy” $500 million in cash and Bank #2 is “light” $500 million in cash Bank #2 can post up some sort of collateral, usually Treasury bonds or Mortgages (frequently in securitized form) that it holds with The Fed as collateral and borrows that money from Bank #1.  For this Bank #2 pays a fee, typically right about the Fed Funds (overnight) rate, which is of course 1/365th of it assuming that loan matures the next day.  When the loan matures the transaction is reversed; the cash is repaid and the securities returned.

The important thing to remember is that this goes on every day and is completely normal.  But, there are two facts that together make no sense.

First, there is supposedly $1.3 trillion, more or less, in excess reserves on deposit with The Fed.  That’s an aggregate amount but it’s utterly staggering.  This, if it’s really there, is free cash that the banks have that they’re “storing” with The Fed but do not have to keep on hand, thus the name “excess” reserves.  This is distinct from required reserves which the bank may not dip into.

Note that since these are excess reserves and the belong to the bank in question there is no fee involved in grabbing and using them on a temporary basis to balance one’s books.  It costs nothing to do that, where to go into the Repo Market to obtain those funds costs money.  The IOER rate is currently 1.55% where the Fed Funds rate is 1.5 – 1.75%.  A Repo transaction typically costs slightly more than the IOER rate.

But, and this is important, unless something severe is wrong it will never be other than slightly different.  Why? Well, why would you pay (for example) 5% for an overnight Repo when your opportunity cost on an IOER pull-back is 1.55%?

Put another way how many people do you know who intentionally hold a bonfire out in their back yard and burn $100 bills?

That’s what I thought.

Second, repo loans are secured with Treasuries or other very solid collateral.  The key point is that the value of that collateral should not change at all during the time of the Repo.  If it does one side or the other has an incentive to default on purpose because they can stick the other side with the asset that has moved the wrong way against them.  There is no premium built into these transactions to compensate for that and worse, it results in the screwed party winding up with more of what they don’t want and less of what they do.

So in September suddenly there was a dislocation in this market that came without warning.  The rate for these overnight loans went from around 2% to roughly four times that amount.  This is what caused The Fed to start offering Repos on their own, rather than allowing the market to do it as it usually does.

And finally, the amount of liquidity that The Fed has injected in these operations is several multiples of the maximum amount they ever took during the financial panic in 2008 and 2009!  In fact the maximum is on the order of four times the maximum ever taken down during the 2008-09 time frame.

The problem is that The Fed has refused to explain why that was necessary and why it still is even today — that is, who (or more-likely, what set of “whos”) was refusing to transact without charging an utterly ridiculous penalty rate and why.

Worse is that The Fed has continued to add to the outstanding repo amounts and now has over $400 billion outstanding.

This last week a small “take back” occurred in that some of the original issues from September forward matured — but that’s the first “take back” that has happened since this “problem” showed up.  Up until that point this was a one-way train.

The stock market is ignoring this set of facts, going bat**** crazy to the upside with all this extra “liquidity” in the market which it assumes is a “gift” and so is the bond market.  They damn well should not; both parts of said market should demand answers to the following questions and so should you.

1. The Fed claimed this was a short term problem of a couple of days and tried to blame it on tax remittances at the end of September.  It is true that corporate tax remittances do come due at that time.  However, if it was a couple of day problem for that reason they would have taken it all back in the ensuing weeks and they did not; they instead increased it.

2. The Fed then claimed that a similar event might happen over the end of the year.  That’s plausible; there is a large funding demand right at the end of the year, as I’ve pointed out.  However, they didn’t remove the excess funds in the three month intervening period!

3. There is allegedly $1.3 trillion, or three times plus a bit, the $400 billion The Fed printed out of thin air, on deposit with The Fed in the form of excess reserves.  To use a Fed Repo facility you must pay interest.  To use your excess reserves it costs nothing other than foregone interest.  Why haven’t traders, banks, politicians and you demanded that The Fed explain, in detail, why banks would choose to hold a bonfire in the street with $100 bills in the form of interest charges that are higher than the IOER instead of using the excess reserves they already had to meet daily liquidity needs.  Is the truth that the $1.3 trillion is a fiction and doesn’t actually exist?

4. Who had the problem originally, what was it, and why wasn’t the $1.3 trillion in alleged excess reserves sufficient to cover it given that it was cheaper, by a LOT in September, and remains cheaper (by a bit) today to do so?  It makes zero sense that this program was “necessary” given the above facts.


If that entity is a financial institution or group of them and they had the money then they have engaged in extortion (a serious federal offense), bank fraud (by claiming to not have reserves when they do; any falsification of a bank’s economic condition is a serious felony) and conspiracy to defraud the United States as well everyone in it by forcing The Fed to devalue the currency.  Further, if The Fed knew about it originally or learned about it and has not turned over same to the FBI and Congress then the entire FOMC is criminally complicit and must be indicted and imprisoned NOW.

If the entity is a financial institution or group of them and the excess reserves claimed do not exist then (1) The Federal Reserve itself has engaged in massive fraud along with (2) all the entities who claimed to have said excess reserves but do not.  In this case exactly how it is that The Fed is claiming these reserves exist when they don’t, and the banks claim they exist but they don’t, must be explained and everyone involved arrested with the institutions involved seized as they are factually insolvent.  In this case everyone involved must be indicted and imprisoned now.

If there was no problem at all and The Fed and the banks conspired together to cause “QE” to be undertaken under false pretense (e.g. to goose the stock market) then everyone involved with either actual or constructive knowledge of same who has said nothing have also committed fraud and, in the case of anyone who has made any official statement on same (e.g. an earnings report, testimony before Congress, etc) they have committed perjury, which is also a felony.  In that case imprisonment is far too kind; we’re now in flat-out putsch-by-deception territory among a handful of very wealthy banksters and an arm of the government in the form of The Fed and we ought to be talking about 1776.

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