Heisenberg Report

Jamie Dimon Could Have Stopped The Repo Squeeze. Here’s Why He Didn’t…

Jamie Dimon knows whose fault it is that he couldn’t step in to prevent (or otherwise ameliorate) the acute funding squeeze that rippled across money markets in the 48 hours ahead of the September Fed meeting.

Spoiler alert: Blame regulations.

“Curious your take on everything that went on in the repo markets during the quarter, and I would love it if you could put it in the context of maybe the fourth quarter of last year”, Evercore’s Glenn Schorr implored, on JPMorgan’s Q3 call Tuesday. 

“If I remember correctly, you stepped in, in the fourth quarter. So higher rates, threw money at it, made some more money, and it calmed the markets down”, Schorr continued. “I’m curious what’s different this quarter that that did not happen”.

Jamie was glad Schorr asked. Here’s his response (from a transcript of the call):

So if I remember correctly, you got to look at the concept of — we have a checking account at the Fed with a certain amount of cash in it. Last year, we had more cash than we needed for regulatory requirements. So repo rates went up, we went with the checking account which paid IOER into repo. Obviously makes sense, you make more money. But now the cash in the account, which is still huge. It’s $120 billion in the morning, and it goes down to $60 billion during the course of the day and back to $120 billion at the end of the day. That cash, we believe, is required under resolution and recovery and liquidity stress testing. And therefore, we could not redeploy it into repo market, which we would’ve been happy to do. And I think it’s up to the regulators to decide they want to recalibrate the kind of liquidity they expect us to keep in that account.

And again, I look at this as technical. A lot of reasons why those balances dropped to where they were. I think a lot of banks are in the same position, by the way. But I think the real issue when you think about it, is does that mean that we have bad markets because that’s kind of hitting a red line in that checking account. You’re also going to hit a red line in LCR, like HQLA, which cannot be redeployed either. So to me, that will be the issue when the time comes.

And it’s not about JPMorgan. JPMorgan declined — in any event, it’s about how the regulators want to manage the system and who they want to intermediate when the time comes.

And that wasn’t all he said on the subject.

The next question on the repo chaos came from BofA’s Erika Najarian.

“As you think about the cross current of resolution planning, LCR, and liquidity stress testing, could you help us — what is the level of excess deployable cash at JPMorgan?”, Najarian wondered.

Again, Dimon was quick to suggest that his hands are effectively tied by regulations. Implicit in his remarks was the notion that perhaps – just perhaps – some of those regulations are either too onerous, ill-conceived or a little bit of both. Here’s Dimon:

I said we have $120 billion in our checking accounts with the Fed, and it goes down to $60 billion and then back to $120 during the average day. But we believe the requirement under CLAR and resolution recovery is that when we’d opened that account such that if there’s extreme stress, during the course of day, it doesn’t go below 0. You go back to before the crisis you go below 0 all the time during the day. So the question is, how hard is that as a red line  – was the intent to regulate to a CLAR resolution to lock up that much of reserves in account of Fed. And that will be up to regulators to decide. But right now, we have to meet those rules. And we don’t want to violate anything we told them we’re going to do.

Bloomberg’s Brian Chappatta (who penned a good little piece on Dimon’s remarks on Tuesday) reminds you that Reuters placed some of the blame for the funding squeeze at JPMorgan’s feet – if only because Dimon’s house has simply become too large.

“Analysts and bank rivals said big changes JPMorgan made in its balance sheet played a role in the spike in the repo market”, Reuters said on October 1, adding that “JPMorgan reduced the cash it has on deposit at the Fed… by $158 billion in the year through June, a 57% decline”.

The article acknowledges that the bank’s moves “appear to have been logical responses to interest rate trends and post-crisis banking regulations, which have limited it more than other banks”.

And indeed, that’s kind of the point.

As Reuters goes on to say, JPMorgan “was limited in how much of its remaining cash it could provide because of regulatory and other constraints” during the week of September 16, when things went awry. Had those constraints not tied Dimon’s hands, one source who spoke to Reuters suggested the turmoil would have been considerably less acute.

In his postmortem of the funding squeeze, BofA’s Mark Cabana wrote that the Fed wouldn’t likely consider easing regulations to address the problem. To wit:

Potential solutions: To combat the issue of reserve scarcity the Fed needs to shift from temporary open market operations to permanent open market operations or ease liquidity regulations. We are less optimistic on regulatory relief since Chair Powell’s comments at the September FOMC meeting stated that “we’d probably raise the level of reserves rather than lower the LCR.” 

The Fed did, of course, choose to expand the balance sheet and will begin purchasing $60 billion in T-Bills/month starting this week.

As Bloomberg’s Chappatta writes, “the message [from Dimon] is straightforward: This is what happens under your rules when markets are good. Are you willing to see what happens if markets turn bad?”

Late last month, former Minneapolis Fed chief Narayana Kocherlakota penned a Bloomberg Op-Ed that essentially blamed the post-crisis regulatory regime which he fretted “has disrupted some of the system’s most basic functions”.

Although Kocherlakota said he isn’t particularly concerned about the Fed achieving its goals and didn’t seem to think money market chaos imperils the central bank’s ability to conduct monetary policy, he did say he believes that “something’s very wrong with the financial system”.

“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 warned.