The Second Repo Crisis Just Days Away – And This Time It Will Be Worse

September 16th marked the beginning of the recent repo crisis. If you are unfamiliar with the repo market, I highly suggest

before you read this post. Since then, the Fed has been in emergency mode, effectively “bailing out” the overnight cash repo markets continuously.

These efforts were supposed to allow banks some breathing room to build up their cash reserves and resume overnight lending as normal once again. According to new research on the topic, this has not happened. Zoltan Poszar (who helped design the repo system) explains in his recent Global Money Notes #26 the likely cash crunch we face coming into the end of the year, what the Fed will have to do in response, and what the likely outcomes will be.

In this post, I will break down his technical report into common language. Full disclosure: anytime you are distilling complex topics, there will be details that are skipped or misrepresented. The purpose of this is to provide a broad overview of the problems in a way most people can digest, while maintaining the accuracy and integrity of the whole as much as possible.

Let’s dive in.

Nothing Has Changed Since September

The Fed has intervened almost every night in the repo market since the rates first spiked out of control on September 16th. The interventions and cash injections have usually been to the tune of about $75 billion. Despite all the liquidity the Fed has been providing, it has only served as a bandaid. The problem which caused the spike in the first place has not been resolved. If the Fed were to withdraw the overnight injections, the rates would spike immediately.

There are a few underlying issues causing the liquidity crunch. The main is a lack of cash reserves at banks. The major players who usually provide the overnight lending do not have the cash to lend. And the ones that do have the cash to lend are not lending it. Instead of cash to lend, banks’ balance sheets are filled with collateral – mostly treasuries.

Despite the Fed increasing its own balance sheet, essentially performing Quantitative Easing (QE), the banks have not been able to turn their excess treasuries into usable cash. This is because the Fed is only buying TBills in an attempt to avoid admitting they are doing QE. They are not buying treasuries. This has put the biggest banks in a bind because these big banks are required to buy treasuries at auction, and now they have no one to sell them to.

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Disclosure: I am currently short the S&P500 through the use of put options. This is not investment advice.

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Gary Anderson 6 months ago Contributor's comment

Very worthwhile.