Reverse Repo Trend and FRED “Scheduled Maintenance” On Monday- Is Something Up?

For those of you who like spending your time on such things, there’s a very interesting chart published by the Saint Louis Federal Reserve Bank – often referred to as FRED for short – that shows how much cash the Federal Reserve is pumping out into the reverse reposession (reverse repo, or even rrepo, for short) market. In a very simplified nutshell, reverse repossession is a process by which one investor, or financial entity such as a bank or money market fund, makes an agreement with another investor or financial entity, to exchange some sort of collateral for a short-term cash loan. When the term of the loan is up, their agreement specifies that the entity offering the collateral will repurchase it from the counterparty for the full value of the loan plus a little interest. It is the repurchase agreement portion of the transaction that gives rise to the term “repossession” in its name. Reverse repo can also be called a collateralized loan because it requires that the party receiving the cash must offer collateral, usually a U.S. Treasury or mortgage backed security, equal to the value of the loan being received. If the entity receiving the loan defaults, the lending party simply keeps the collateral and gets to use it or sell it or dispose of it as they please because they now own it.

Reverse repo loans are not restricted to commercial banks, private businesses and small financial entities. Indeed, one of the biggest and, to date, most profoundly important, players in the reverse repo market is our own central bank – the Federal Reserve. And exactly how much reverse repo has the Fed engaged in for the past several decades? The Reverse Repo chart on the FRED web site shows how many billions, or even trillions, of dollars’ worth of U.S. Treasuries it’s pledged in the past, and is currently pledging daily, as collateral to America’s commercial banks in exchange for cash directly from their reserve accounts. Now, it’s important to note that the cash that the Fed is taking from the banks in exchange for its Treasury securities via reverse repo loans isn’t really the bank’s money, It’s OUR COLLECTIVE SAVINGS held in “excess reserves” accounts at the Fed itself. In other words, it’s OUR COLLEVTIVE SAVINGS that the banks are handing to the Fed during every reverse repo operation. Now, if the Fed doesn’t return the cash it borrows from the banks’ reserves because, say, it’s handing them to the Treasury to be used by our government to pay its bills, the banks lose that reserve cash (OUR SAVINGS) but get to keep the Treasuries, to hold as interest bearing assets or sell to the highest bidder. This is an important concept to keep in mind for later in this article.

This Sounds Like A Shell Game. What’s the Purpose?

Why do reverse repos occur? Because somebody’s short on cash and can’t balance their books. They need a loan. Rrepo loans are usually just overnight affairs, giving the borrowers the money they need until they can straighten out their books the next day. But why on earth would anybody make a loan to a business or financial institution that can’t balance it’s books? Well, first, because being temporarily unable to balance their books is a normal daily state of affairs for most businesses. Money goes in and out unevenly and rarely does the exact same amount come in as goes out on any given day. So being flush or short is a perfectly normal daily occurrence for any bank or business. The attractive aspect of collateralized loans is that the borrower agrees to pay back the loan with a little interest to get their asset back. For the lender, it’s an easy way to put their excess cash to work. Otherwise, it would be just sitting around gathering dust or earning less than it could bring in in interest if it were being used to make more lucrative types of loans such as home mortgages, business start-ups, personal loans and so on. Engaging in reverse repo/collateralized loans puts idle money sitting in a potential lender’s account to work making a quick profit with no risk to the lender. (In the case of reverse repo between the banks and the Fed, the banks are lending money to the Fed in exchange for boring but risk-free Treasuries as collateral.) If they don’t get their excess cash back plus interest the next day (or on a specified date perhaps a week or two in the future), or they get to keep the collateral and sell it for whatever profit they can get for it. And the entity receiving the loan gets to live for another day.

The Financial World Runs on Repo Operations

In normal times, trillions of dollars of reverse repo and repo operations – repo just being the name for the lending side of the same collateralized loan transactions – take place every night across America and the world with absolutely no problems at all. Millions of businesses, investors and financial institutions settle up their cash imbalances amongst themselves through the process of debtors entering the open market to find lenders freely willing to make them a loan in exchange for collateral and repayment with interest. The whole process occurs with no fuss at all while most of us are asleep. Repo and reverse repo operations – the global, institutionalized version of private individuals finding payday loan outlets willing to grant them some quick cash in exchange for their car titles – are a completely normal part of the business and investing world. Indeed, they’re absolutely critical to the functioning of the global financial system. Stop them for even one night, and the global economy would come to a screeching halt the next day. Businesses and institutions would be unable to balance their books, they would be unable to pay some or all of their bills due that day, and everybody would suddenly start distrusting everybody else. Who is going to lend out their precious cash which they, themselves, may need that night to balance their own books, when they can’t trust that the entities coming to them for loans were really credit worthy? And who is going to be able to ask for a loan, if they have no collateral that anybody with spare cash would consider worth taking if there’s a good chance they won’t get their money (plus the promised interest), back?

Enter the Federal Reserve

The historically most popular form of collateral for offering in the process of reverse repo has been U.S. Treasury bills, bonds and notes. Because the U.S. dollar is the world’s reserve currency, Treasury securities are considered the most safe, easily sold or traded, and liquid assets in the world. And they’re backed by the most rock-solid guarantee in the world: “the full faith and credit of the U.S. government”! As I explained in an earlier paper, this is simply a euphemism for the power to tax the American public by whatever amount necessary to pay back any debt incurred by our government. Such a deal!

While Treasury securities are, of course created and offered for sale by the Treasury department, the ones purchased by a group of authorized banks may be re-sold to the Fed for a small profit. After purchasing, the Fed may do any of several things with its Treasurys, including offering them as collateral back to banks (including but not limited to the banks they purchased them from) in exchange for cash from the banks. Normally, the Fed will return the banks’ cash to them the next morning, with a little bit of interest. The banks are happy because they’ve made a bit of safe, easy profit, and the government is happy because it’s acquired the cash necessary to pay its daily bills. (If you’re wondering where the government is getting the cash necessary to replenish the money they used overnight to pay its bills, well, the truth is, it’s not. Uncle Sam is just filling the financial hole with IOU’s that they hope to pay back later by raising taxes. The government will simply use the extra tax money harvested tomorrow to replace the money it took to pay its bills today, and give you back dollars that each have less purchasing power than they did when Uncle stole them. To date, over 15 % of our collective savings in the nation’s banks has been spent via reverse repo operations, replaced by IOU’s that the Treasury will either never be able to replace (because the economy would have to run a huge surplus in order to honestly create that much extra money), or will replace by raising your future taxes to get the money from you directly so it can quietly re-liquefy your bank reserves from which it was secretly stolen. It wouldn’t be unreasonable to suppose that if the majority of the public knew what was going on, we’d quickly have the mother of all bank runs on our hands. That’s why dear old Uncle hopes you never find out about where he’s getting the funding to cover his little spending problem from.

Reverse Repo Suddenly Has an Obesity Problem.

Normally, as I said above, the process of obtaining trillions of dollars’ worth of overnight or short-term cash through the offering of collateral (the making of collateralized loans, or reverse repo), carries on without a hitch among millions of businesses and institutions every single night. Almost never has the Fed need to step in and offer Treasury securities itself (i.e., engage in reverse repo) to keep the process flowing. since it started the process of monetary easing (QE). But twice, first between starting August 2013 ending January, 2019, and again starting the very end of February, 2021 and continuing today, something went wrong. But twice, first between starting August 2013 ending January, 2019, and again starting the very end of February, 2021 and continuing today, something went wrong. The reverse repo spike that started in 2013 happened because the Fed, like most other central banks, embarked on a possibly mistaken errand to re-stimulate he economy by lowering interest rates to nearly zero. A the same time, they purchased huge and growing numbers of Treasury bond assets from the banks and credited the banks the equivalent amount of cash in their reserve accounts in exchange. (This is the process commonly referred to as “quantitative easing”.) The Fed effectively bloated the banks’ reserve accounts with excess cash¹ in hopes that the banks would find customers eager to borrow at low rates and spend, spend, spend to haul the economy back onto its feet. The banks, in turn, did loan, pretty much to anybody who had a pulse, increasing their exposure to risky customers. They also bought more risky securities, like junk stocks, in order to have something that earned them more income than the lousy near-zero interest rates offered by Treasuries. In essence, the Fed’s persistent and relentless buying of Treasury and mortgage-backed securities from the banks and replacing of those securities with cash in the banks’ reserve accounts, essentially forced the banks into a bidding war to get any type of securities that paid more than Treasury paper did. That was fantastic for propping up the stock market! As the market exploded, those holding stocks felt more wealthy, and more confident about spending, Yay! The Fed’s plan was working! Except that it really wasn’t. All it was doing was preventing fundamentally unsound and insolvent banks and businesses from going under and being replaced by more sound institutions, and thus generating more instability and uncertainty in the global banking system. When the Fed saw that the banks were unable (or, in some cases, unwilling) to use the Fed-created excess reserves to make good loans that would, in theory, get the economy going again, and saw that the cash being credited to the banks’ reserve accounts was being used instead to blow massive stock, commercial bond and housing bubbles, the Fed tried to abruptly reverse course, Between August and November, 2018, the Fed suddenly became a persistent seller of Treasury and mortgage backed securities from the banks. They tried to drain the banks of the excess cash they had put in there in the first place, to control the market bubbles forming. But the banks would have none of it! Suddenly, investing in only the most secure of all types of investments – namely, Treasury securities – would do! After the EZ money from the Fed stopped rolling in, the banks no longer felt safe entrusting “their” reserves and the income stream based upon them, to just any old business or fund that might or might not be financially sound. A flight to quality investments began. The stock market, being full of overpriced and shaky stocks, began to tank. This was both an economically and politically untenable situation, so the Fed once again began buying as many Treasury securities from the banks as the banks would sell them, providing a safer source of revenue, and pumping cash back into the banks’ (only slightly) depleted reserves in a move that Fed Chair Powell called “Not QE” (ibid.).

But the Trap Had Already Sprung

Unfortunately, because of the fundamental structural flaws that the original QE had already created in the domestic and global financial systems, coupled with the Federal government’s relentlessly increasing need for cash, the stage was set for a disaster that we’re still dealing with. On the night of September 16, 2019, so much cash had been pulled out of the banking system between the Fed needing to pay its daily bills and businesses needing to pay their quarterly taxes, that the banks collectively ran low on reserves. multiple banks needed lots and lots of cash immediately, or they would be unable to open for business the next day. Hedge funds, ordinary businesses and large investors of course also needed their overnight loans, as well. The needs of the borrowers suddenly outstripped the capacity of the lenders so badly that some borrowers were willing to pay literally anything to get their hands on enough cash to survive another day. The free market mechanics of supply and demand briefly overpowered the Fed’s efforts to manage the markets and loan rates briefly spiked as high as almost 10%. Lenders didn’t trust borrowers. Who knew if the collateral being offered worth the risk of giving my money to somebody who was in imminent danger of economic failure? Lenders with cash wanted either only the most trusted collateral, or questionable collateral in greater amounts than usual. Fear had pervaded the system. A global credit freeze within hours looked imminent. That night, in a stunning reversal of policy, the Fed once again saved the global economy by abruptly pumping massive quantities of cash into the banks’ reserve accounts and taking Treasury securities back out of the market (ibid.) In doing this, the Fed saved the day, but also set the stage for the disaster that we’re currently dealing with, namely, the reverse repo crisis.

What Happens When You Exit the Frying Pan?

The whole process of the Fed offering Treasury securities in exchange for bank cash reserves when needed has become an acute (a condition which should happen almost never in a properly functioning free market within a healthy economy). Of course, reverse repo began in relatively tiny amounts. However, as with most things pertaining to banking and government, it grew. Between 2013 and 2019, the Fed engaged in reverse repo in amounts that bounced quite unevenly between $5 and $475 billion. (Adjusted for inflation, that would have been between $5.69B and $540B in today’s dollars). Such borrowing seemed outrageous and quite dangerous and out of control at the time. But fast forward to the night of Thursday, Feb. 25, 2021, when the amount of Treasury repo suddenly spiked to over $11 billion. (That would be equal to about $9.67 billion in inflation-adjusted dollars averaged between 2013 and 2019.) After calming right back down, it suddenly spiked again to just over $11 billion on the night of Thursday, March 11. It calmed again briefly before the next sudden spike to almost $27 billion on Thursday, March 18. The next spike hit $134 billion on the night of Wednesday, March 31, and never went back down to $0. Since then, in a rather steep and relentless march upwards, repo has reached a peak value (so far) of $1,087,342 on the night of Thursday, August 12, 2021.

Reverse Repo- Canary In an Economic Coal Mine?

In a matter of just under six months, if one counts the first little spike to about $11 billion on the night of Feb. 26 as the beginning of the current reverse repo trend (that’s what I choose to do since $11 billion happened quickly after a baseline of zero or almost zero since mid-June of 2020), the amount of reverse repo pumped out by the Fed and taken by investors and institutions has increased from quite literally zip to over a trillion dollars per night. What that means is that businesses, investors and financial institutions are giving the Fed up to, or even more than, one trillion dollars of cash nightly in return for that dollar amount worth of treasury securities.

Why? And, what does that mean?

It seems that the reasons for this sudden change are known mostly to a few people at the Fed itself, and some higher-level global banks. For the rest of us, guesses must be hazarded and assumptions pieced together from the indirect evidence available.

There are quite a few differing opinions on what’s driving the surge in reverse repo. They range from the Fed hauling out incredible sums to feed cash to the Treasury to cover payments on our exploding debt, to banks parking as much cash as possible with the Fed to earn the .05% risk-free return the Fed is offering on their excess reserves. (Taking a paltry .05% interest isn’t great, but in a deteriorating economic environment, it can still provide a decent return when applied to huge sums while offering greater convenience and safety than trying to lend it out when borrowers are fewer and less credit worthy.) Some economists also think that banks and other institutions might be re-selling (or hypothecating) the Treasury securities to highly leveraged hedge funds, corporations and speculators who desperately need high quality collateral to maintain their liquidity in an increasingly volatile economic environment. When push comes to shove, entities that badly need high-quality collateral will pay just about anything to get it. One could argue that banks would be foolish to pass up such an excellent source of risk-free easy money.

There are several things that we CAN know for sure, however, about the current reverse repo explosion. One is that there is a strong market, or desire, for what is considered the safest form of collateral for collateralized loans. Indeed, the most preferred form of treasury securities lately is short term Treasuries (1-3 month duration). Why short-term Treasuries, instead of higher paying, longer dated Treasuries, of say 10 or 30 years? Again, those who know don’t seem to be saying, but there are two reasonable potential interpretations. One is that entities with money to lend see steep inflation ahead, making the very low real returns on longer dated Treasuries deeply negative. There would be nothing advantageous about holding onto a long-dated Treasury that’s losing significant sums of money every year. And with interest rates already so low, there’s almost no room for the Fed to cut them further and make bonds attractive as a potential sale later on. Although the mathematically astute know that there is money to be made if bonds bought at a positive rate of return are sold after rates turn negative, it’s become clear that the Fed is highly unlikely to follow Europe and Japan in pushing Treasury rates negative because doing so would create a crisis and collapse in the massive money market funds which are a backbone of the American economy.

Taken together, they paint a troubling picture. One of the easiest and most outstanding things one can verify is that, at least currently, the trend for this burst of reverse repo is not only steeply positive, but (so far) is accelerating. Rrepo hit its first, and very brief, peak of just over $134 billion on Wednesday, March 31. It very quickly dropped back down to $3.45 million the next business night, after which it began its rapid and so far unabated climb to its current level. Along the way, it hit a peak of almost $992 billion on June 30, after which it quickly pulled back to $731 billion before slowly climbing back to reach a new peak of $1.039 trillion on July 30. From the first, brief, and now almost comically small peak on March 31, it took 91 days for the reverse repo market to reach its second peak on June 30. It then took 30 days (from June 30 to July 30) for the total sum of reverse repo to reach its new, greater, second high. Although this second peak, like the others, was followed immediately by a brief but significant decline (it dropped to $909 billion), it also, like the others, began clawing back to yet another peak at $1.051 trillion on Friday, August 13. The number of days required to reach the third peak from the second peak was only 14.

Could A Couple Of Bad Hedge Funds Be The Main Reason?

One might be tempted to think that the closely timed and massively spectacular failures of Archegos hedge fund and Greesill Capital in England might be behind the sudden demand for high security loan collateral. The demise of Archegos meant billions in losses for other massive institutions such as Credit Suisse ($5.5 billion) and Nomura ($2.9 billion). (Morgan Stanley and UBS also lost out, though at a relatively paltry $911 and $861 million, respectively.)² An important aspect of the Archegos failure, for our purposes, is the fact that when its brokerage account fell below the acceptable level, it was required to fund the difference between what was in the account and what was required by adding cash or collateral. Archegos had the requisite amount of neither. Public acknowledgement of Archegos’ failure was first acknowledged on Monday, March 29, although Goldman Sachs and Morgan Stanley each reportedly dumped billions’ worth of Archegos shares, ($10 B and $8B, respectively), on March 26, suggesting that insiders knew of a problem before the story broke widely on the 29th³. Interstingly, although the first significant increase in reverse repo in several years occurred on the night of Thursday, March 18, when it jumped to $26.6B from $0 on March 17, the size of the jump from March 26 ($11.45B) to March 29 (the next business night, at $40.35B), and then on to a peak of $134B on Wednesday, March 31, suggests that the massive Archegos debacle could plausibly have sparked a fear based demand for unquestionable collateral while multiple institutions tried to figure out whether, and by how much, they were exposed to losses from Archegos’ demise.

There are likely to be two primary effects of Archegos’ collapse. First, margin requirements are likely to be tightened and the way margin requirements are calculated is likely to be changed. Second, and more important for this investigation, is that the ways that risk levels of equity assets used to determine margin requirements are determined, are likely to be revised, In other words, there will likely be a reconsideration of how regulators and institutional risk management officers judge the fitness of various types of securities for use as loan collateral⁴. (https://opengamma.com/insights/failure-of-archegos-margin-requirements/ May 13, 2021) Regulatory change is likely to take time to implement, but there’s no reason why bans could not or should not more rapidly implement their own upgraded risk standards to avoid getting caught exposed to another Archegos (ibid). Considering that the global derivatives market is estimated to be in the quadrillions of dollars, extremely opaque and deeply intertwined among tens of thousands of institutions, and given the emergence of unique new sources of market volatility such as Wall Street Bets, there is little reason to believe that there are not quite a few Archegos-type time bombs ticking within the global economy. Banks, businesses, hedge funds and other institutions would do well to insist that any collateral they receive for taking the risk of loaning money into a deeply dangerous market, should be only top of the line.

Interestingly, Greensill failed on approximately April 8, 2021. That was actually the day it was put into Administration – the British process of filing for insolvency. Overnight reverse repo actually went from $35B on April 7 down to about $28B the night of April 8, but then up to about $31B the following night and pretty much straight up in a relatively unbroken climb from there on out. While correlation is certainly not proof of causation, the timing IS very interesting. There could be a reasonable case made that the two closely timed failures of Archegos and then Greensill could, together, have prompted institutions around the globe to reconsider what they believe to be safe collateral for taking the risk of lending out their money.

Could Archegos and Greensil Have Been the Skunks in the Global Economic Woodpile?

Although the known economic fallout from the fall of Archegos Capital seems to have stabilized by the end of March near a total of $10B, there’s no way for outsiders to the financial system to truly know whether there is anything else still brewing out of sight. One major victim, global banker Credit Suisse, was also one hit hard by the Greensill collapse. As a global banking ‘node’, what happens if Credit Suisse suddenly becomes too battered to meet its credit obligations? Although the other major Greensill victims, such as British rent-to-own housing retailer BrightHouse and Singaporean commodities trader AgriTrade ⁵, probably aren’t directly connected to Credit Suisse or any of the other institutions that lost substantial sums of money from Archegos, who knows in what ways they may be indirectly entangled through multiple daisy chains of secondary and tertiary derivatives made with intermediary entities?

Anyway, it’s certainly interesting that the amount of reverse repo required by the markets increased quickly, dramatically and probably irreversibly very quickly after the Archegos and Greensill shocks to the global economy. At the very least, it’s worth contemplating whether the sudden collapse of two massive financial businesses (one a hedge fund and the other a massive invoice finance company) could have given other institutions pause to consider the risks involved in lending to even apparently large and well-funded entities and the quality of the collateral required in return.

Now For A Prediction…

In light of the above facts and the order in which I’ve chosen to view them to create a possible story, I’d like to make a prediction based upon them. My prediction is set within the following context:

1. The U.S. national debt has grown beyond mathematical possibility of repayment, and even the interest on the debt has become difficult to service with the help of rock-bottom interest rates
2. The Fed can neither lower interest rates to make interest on the debt cheaper, nor raise them to combat inflation. Indeed, the government both wants and needs as much inflation as it can possibly inflict upon the people in order to keep the debt manageable for a little while longer through inflating its value away. Therefore, there is no realistic possibility that the economy will go into prolonged deflation, although a sudden, but brief, asset deflation crash is likely before permanent price inflation papers over the loss of real asset value.
3. Even by the Fed’s own grossly massaged standards, inflation is rising in size and speed faster than government policy wonks predicted. Pandemic lockdowns, climate change and lucrative unemployment are conspiring to create price inflation pressure above and beyond the price inflation pressure being created by the distribution of trillions of dollars in “free” money to businesses and individuals under the guise of COVID relief. The U.S. is in intractable financial trouble and has just about run out of tools with which to stave off the inevitable.
4. The IMF recently announced that they have scheduled the largest ever distribution of their global currency – Special Drawing Rights – for August 23. Since SDR’s are “a versatile asset that can be used to bolster a country’s (currency) reserves” and can be used by countries to pay for imports or used in trade if each country simply agrees to exchange them for their underlying currencies^.7 SDR’s are being brought in under the cover of pandemic relief to begin slowly but surely replacing the US dollar as the world’s reserve currency.
5. Deliberate manipulation of the precious metals markets has been increasingly aggressive recently, and the drop in prices for gold and silver over he past couple of weeks, in the face of extreme demand from private investors, suggests that bullion banks are attempting to exit their massive short positions in both metals as cheaply and expeditiously as possible.
6. Sunday is the fiftieth anniversary of the closing of the gold window by Richard Nixon
7. The average lifespan of paper currencies, globally and throughout history, is about fifty years
8. The Federal Reserve of St. Louis web site (FRED for short) – the web site where data on repo and reverse repo are reported – is displaying a notice that it will be “down for scheduled maintenance” on Monday.

My conclusion? There’s a reasonable argument to be made that, possibly, our government is planning for a deliberate “economic event” to occur, or begin occurring, on Monday, August 16. Am I likely to be right? Given that I’m not a trained economist, I won’t make that assumption. I’ll admit that the possibility seems almost like conspiracy theory and too grandiose to appear real. Even the government probably realizes that doing something on the weekend of the 50th anniversary of the Nixon shock or on the first business day afterwards, is a bit obvious and heavy-handed. I have no doubt that there are much more compelling and informed arguments than mine to explain what’s going on. And as I mentioned earlier, correlation does not prove causation. However, my intent is not to advise anyone of what to do or think, but to reason out loud about things I observe. If any readers have comments or alternative perspectives on the data I’ve presented, I’d be pleased if you would share them. If nothing else, Monday will likely be a interesting day, if for no other reason than there are a lot of us out there all watching and preparing for something that most of us hope won’t happen.

References

1. Malinen, Tuomas https://gnseconomics.com/2019/12/14/repo-market-turmoil-staring-into-the-financial-abyss/ 12/14/2019)

2. Makertoff, Kaylena “Bank Losses Linked to Archegos Top $10bn After Latest Results”, April 27, 2021, http://www.TheGuardian.com

3. (McDowell, Hayley “The Collapse of Archegos Capital Management”, TheTradeNews.com, July 16, 2021)

4. https://opengamma.com/insights/failure-of-archegos-margin-requirements/ May 13, 2021

5. Bickers, Michael https://bcrpub.com/news/greensill-fallout-%E2%80%93-what-can-be-expected 3/10/21

6. (Araoye, Omataro https://www.arise.tv/imf-approves-650bn-sdrs-to-member-countries-effective-august-23/, August 3, 2021