The Fed’s Big, Red Flag

I knew this repo crisis would require more injections, but it wasn’t easy to get clear data on just how many it would take. I was trying to identify how much money has gone into propping up the repo or overnight bank lending market since its sudden spike in rates to 10% signaled a crisis in liquidity.

It’s like no one on Wall Street wants to talk about this… Hmmm….

Rodney Johnson finally found a credible article. Remember that $60 billion initial injection in mid-September that came to calm that spike in rates? Well, it mushroomed to $380B (billion) as of mid-December. No wonder Wall Street is not talking about this… It’s obviously not a small, temporary crisis! This is a big, red flag. At the peak of quantitative easing, $60B a month was being injected into the financial markets. This is the equivalent of $190B a month!

In mid-September, the large banks suddenly decided that they would rather keep their reserves with the Fed at 1.55% than lend at slightly higher rates to smaller banks, and leveraged investors that have to borrow overnight to cover their shortfalls.

There are two reasons for this, from what I can see. First, the Fed finally tapered a bit and sold of some of their bond stash which took reserves and liquidity out of the system, so less excess to lend. Second, these larger banks are starting to smell more risk in this normally risk-free overnight market. Some of these loans are to gunslinging, leveraged hedge funds.

Here’s the chart that tells the real story.

(Click on image to enlarge)

The largest chunk of the $380B through mid-December is the Fed purchasing repo agreements directly or lending against them to bail-out the lenders and borrowers overnight. That’s $237B. The other $144B is the Fed buying T-bills. They are doing that to make it look like something other than QE, which tends to buy longer-term bonds to push down longer-term rates that they can’t control as easily as they do by simply setting short-term rates through the Fed funds rate. They buy bonds artificially with funny money and push rates down.

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