The Fed got the message – the Jaws jokes worked – “we’re gonna need a bigger boat”.
The New York Fed on Wednesday announced it has increased the size of both its term and overnight repos scheduled for September 26. The 14-day term operation will now have an aggregate limit of $60 billion compared to $30 billion, while the O/N operation will be for up to $100 billion, versus $75 billion previously.
The announcement follows a string of oversubscriptions, including Wednesday’s O/N operation, which saw dealers submit almost $92 billion in securities for the $75 billion agreement. On Tuesday, the first of three 14-day term repos was two times oversubscribed.
Read more: ‘We’re Gonna Need A Bigger Repo’
Former Minneapolis Fed chief Narayana Kocherlakota penned a Bloomberg Op-Ed on Wednesday that struck a decidedly worried tone.
Although he isn’t particularly concerned about the Fed achieving its goals and doesn’t seem to think last week’s money market chaos imperils the central bank’s ability to conduct monetary policy, Kocherlakota does think “something’s very wrong with the financial system”.
Essentially, he blames the post-crisis regulatory regime which he frets “has disrupted some of the system’s most basic functions”.
“Since the 2008 crisis, regulatory reforms have constrained the ability of flush banks to lend, and of tight banks to borrow [and] such constraints interact in complicated ways with financial market conditions”, Kocherlakota writes, adding that “reserves are siloed in the flush banks, so the financial system is acting more like it has $1.3 billion in excess reserves than the actual $1.3 trillion”.
Meanwhile, on the heels of Wednesday’s news of the upsized repos, Bloomberg flagged renewed interest in the SOFR-FF trade which has attracted attention amid recent dislocations.
“Spikes in the overnight SOFR-FF spread occur more frequently and are larger, particularly at month- and quarter-ends when dealers (and sponsored repo providers) temporarily step away from the market”, Barclays wrote Wednesday, weighing in.
(Barclays)
“We think the old adage that every stove looks hot to a once-burned cat also applies in the repo market”, the bank went on to muse. “After last week, term and overnight SOFR ‘look hot’ — spreads should widen to fed funds to reflect what we consider to be a permanent random shock risk”.
Updated schedule from the New York Fed
It’s time to look under the hood and see what’s going on with tri-party relationships. This is still about hoarding and banks not wanting to play with the Dodd Frank ball.
No time today, but from BOA SEC filing, which has tons of related stuff. Still think this is hoarding and manipulation …
The Dodd-Frank Act imposes new restrictions on transactions between affiliates by amending these two sections of the Federal Reserve Act. Under the Dodd-Frank Act, restrictions on transactions with affiliates are enhanced by (i) including among “covered transactions” transactions between bank and affiliate-advised investment funds; (ii) including among “covered transactions” transactions between a bank and an affiliate with respect to securities repurchase agreements and derivatives transactions; (iii) adopting stricter collateral rules; and (iv) imposing tighter restrictions on transactions between banks and their financial subsidiaries
Appreciate H, V and others staying on this issue. I personally struggle to understand the intricacies, and maybe my theories about what is going wrong are, well, wrong, but I do definitely feel that something isn’t “smelling right”.
Interesting old Powell stuff on repo world. This is just some background history, but brings up the question as to why the Fed seemed so unaware of what was going on a week ago, or did they know exactly what they were doing??
November 17, 2015
Central Clearing in an Interdependent World
Governor Jerome H. Powell
Barring an operational event, CCPs (central counterparty) only face credit or liquidity risk when one of their members fails to make a payment when due. Thus, one effective way to make a CCP safer is to make its members safer. In that sense, the post-crisis reforms that have greatly strengthened our largest and most systemically important banking institutions have directly benefitted CCPs and other FMIs ( financial market infrastructures).
The higher cost of funding for large financial institutions has made these liquidity arrangements substantially more expensive and more difficult to obtain. Given the balance sheet costs involved, financial institutions may also be less willing to hold cash deposits on behalf of their CCP clients.
One area where market participants are actively searching for new business models is the repo market, where there are currently several private initiatives for greater central clearing. Expanded repo clearing could potentially bring a range of benefits, including greater opportunities for netting and related reductions in balance sheet costs for dealers affiliated with a bank holding company. The evolution of repo markets and central clearing can serve to illustrate both the potential benefits and the complexities that arise as the market seeks new infrastructure models.
The tri-party repo market (segments 4 and 5) is used to finance general collateral pools rather than specific securities, and trades in this portion of the market are settled on the books of the two clearing banks, Bank of New York Mellon and JP Morgan Chase. 6 Money market mutual funds and securities lenders are among the most prominent cash providers in segment 4, while securities dealers are the primary borrowers of cash. Dealers may use this cash to fund their own portfolios; they may also lend it to other dealers in the general collateral finance (GCF) repo market (segment 5). This segment is cleared through the Fixed Income Clearing Corporation, and is currently the only segment of the market that is centrally cleared.
Another key question is how great the opportunities for netting actually are, in light of the dominance of “one-way flows” in U.S. repo markets. Netting for balance sheet purposes is only permitted for offsetting trades with the same maturity and counterparty.11
The many repo market participants who act as either lenders or borrowers–but not both–have little opportunity for netting. Netting opportunities are therefore more likely to occur in the interdealer market, so it is not surprising that the current repo CCP operates in this segment of the market.12
Further gains in netting could arise if clearing expanded to the bilateral market or if some of the larger end users in the tri-party market, for example money market mutual funds or hedge funds, were able to gain access to the CCP. This could pose its own complications, however, as some of these institutions may be unwilling or legally unable to engage in the risk mutualization that exists in most clearing models.
In my view, clearing should be limited to those assets that are highly liquid and expected to remain so even in severely stressed market conditions. While any model for expanded repo clearing will have to satisfy stringent regulatory requirements, regulators should be open to emerging clearing solutions where they provide substantial benefits and can meet these standards. This may be particularly true for repo trading in government and agency securities, since new regulations require financial institutions to hold such high-quality collateral under the assumption that it can be quickly converted to cash.
https://www.federalreserve.gov/newsevents/speech/powell20151117a.htm