In mid-September repo trading froze up and rates soared. Though the rates were brought back in-line, the Federal Reserve has intervened ever since as a repo provider and as liquidity pump via Treasury purchases from a number of the Wall Street firms heavily involved. This has swelled the fed’s balance sheet by almost $300 billion in 12 weeks: a pace not seen since the fed’s biggest round of treasury purchases under QE ended in 2012. Concern seems to have rather swiftly abated, but without any consensus of what drove the dislocation nor why that driver is no longer a cause for concern.
I recently attended an investment forum in Los Angeles. When I asked the panel what their diagnosis of the repo turmoil was, one of them assured that it was due a senior member of repo operations retiring in the week of dislocation without anyone readied to step-in and take his place. On Wednesday, Fed’s Vice Chair Randal Quarles testified for the House Financial Services Committee. When asked why the fed’s intervention was necessary, Quarles said in an officious but seemingly-dissembling manner that banks’ liquidity had suddenly tightened due to requirements under the 2010 Dodd-Frank Act. My own question to the panel had been whether what we saw was emblematic of banks becoming wary of lending to one another. The panel’s response was a categorical no.
I cannot and do not know what the source of the trouble has been, but I am not comforted by these sorts of attributions for it. I have read that the problem has not passed, and that European banks may be prevented from participating in repo as the year ends. At year-end, banks typically retract their repo participation to reduce their balance sheets for December 31 regulatory calculations. Let’s see what happens then. The Bear and Lehman crises started in repo; something that was not open-knowledge until after the fact. By then, banks had been selling their holdings of toxic mortgage backed securities in a carefully ‘discrete’ manner that kept the perception of their quality up among buyers long enough to reap full value from the sales. When something weakens the support of the banking system, the bankers historically do not let-on. Noone wants to precipitate a panic.