Monday, January 20, 2020

What Is Repo?

This evening, a friend, via email, asked me to clarify a few points/terms made in my "Bonus Quote of the Day" post from this morning. I'm thinking many of our readers would appreciate some clarity as well.

The question was, what is "repo liquidity play" and what does "facilities" refer to?

Here was my response:

Repo is short for "repurchase agreement". And here it refers to the "market" (repo market) where financial institutions help each other meet their day to day liquidity needs.

With regard to banks specifically: Every night banks have to meet their minimum reserve requirements. If during the day a bank experiences withdrawals of cash (let's say Amazon pays its quarterly tax bill out of its Citibank account) that takes it below its minimum required cash reserves, it'll borrow from another bank that has more than it needs. When it borrows in this overnight (repo) market, it offers up collateral (say, a T-Bill) -- actually, in my example, Citi sells a T-Bill to, say, JP Morgan and agrees to buy it back ("repurchase" it) the next day for a little more than it sold it for; the 'little more' amounts to the interest rate.

The "repo liquidity play" referenced in the quote was how Brigden describes the phenomenon that's been going on since September 16th of last year. That night, for a variety of reasons, there was insufficient liquidity (at any reasonable interest rate) in the repo market to handle the needs of the institutions that fell short. It was a crazy night! At one point the repo rate (the interest rate on the loans) jumped to 10% (it usually runs right near the Fed funds rate, which is 1.5% to 1.75%) to attract cash from wherever it could legally show up from. The New York Fed had to come to the rescue with $75 billion that night to calm things down!

In the immediate aftermath, the Fed said that it was all just a technical glitch and that by the end of September things would be back to normal. Well, they clearly didn't understand their own problem. Believe it or not, they've had to inject cash every night since; in December the Fed printed half a trillion dollars (yep!) to keep the repo market flowing. They're now formally committed to printing $60 billion a month for this purpose alone through June, but they're having to step in consistently with more than that.

The stock market has clearly interpreted this as any other liquidity injection that is typically good for a strong rally. Problem is, that wasn't the Fed's intent; which of course creates a potential problem for the market (and the Fed) when it's really time to -- i.e., when they figure out how to -- back off from all of this money printing; which they'll have to at some point relatively soon...

The term "facilities" in this context is used to describe any coordinated scheme or effort (facility) to get cash into the system. In 1999, a facility was turned on to inject cash into the system just in case the Y2K scare (computers freezing up because of the last two zeroes in the year 2000) turned out to be real. The "Quantitative Easing" programs instituted during and after the 2008 meltdown were themselves "facilities."

The facility of the moment refers to the Fed's nightly liquidity injections into the repo market...

Yes, this is something we're paying close attention to!

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