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Repo: How Roughly $1 Trillion Moves Overnight | WSJ - YouTube
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(pleasant mallet percussion music)
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- [Narrator] Take a look at this chart.
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It tracks how much banks and
others pay for overnight loans
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using something called
repurchase agreements.
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This is also known as the repo rate.
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These bumps right here on
September 16th and 17th
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have caused a really big
stir in the financial world.
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That's because the repo
market is a critical part
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of the financial system.
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It provides a lot of the grease
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that keeps the wheels spinning,
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meaning it provides the cash
that financial firms need
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to run their daily operations.
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When the repo market chokes
and cash stops flowing,
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trouble can reverberate
through the economy.
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That's what happened in September,
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and in response, the Federal
Reserve had to step in to help,
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providing tens of billions
of dollars to borrowers
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to keep the system cranking.
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In the weeks since this happened,
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experts have called the incident
a technical malfunction,
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and banks, for their part,
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have said it could have been prevented.
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They're blaming the rules
that were put in place
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after the financial crisis,
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rules intended to keep the banking system
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from falling apart.
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(dramatic mallet percussion music)
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(pleasant mallet percussion music)
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Imagine two people, Karen and Mark.
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Karen has $1000 and she'd like
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to earn some fast interest on her money.
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Mark has a stack of
treasury notes but no cash,
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so he strikes a deal with Karen.
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One note for $100, but there's a catch.
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Mark has to agree to buy that
note back tomorrow for $101.
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The difference between
the price of the note
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on day one and day two,
that's the repo rate.
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If everything works properly,
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Mark gets the cash he needs
right when he needs it
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and Karen makes some fast money.
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The repo market functions in the same way.
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You just have to replace the
Karens with money market funds
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and other asset managers who are looking
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to make a little money
without a lot of risk
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and replace the Marks with hedge funds,
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Wall Street traders, and
banks who have a lot of assets
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but need cash on hand to fund
their day-to-day trading.
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In the repo market, Karens and Marks
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all over the financial
system lend back and forth
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for short periods, often overnight,
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and they do this at an enormous scale.
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Usually, more than $1 trillion
runs through it every day.
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On September 16th and
17th when the rate spiked,
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the Karens were not willing
to trade cash for securities
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at the usual rate, so
the Marks who needed cash
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kept offering more and more and more
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until the Fed arrived with help.
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(pleasant mallet percussion music)
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When the Fed announced its
surprise repo operations,
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people wanted to know,
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why did the Karens suddenly stop lending?
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Experts point to two financial deadlines
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that sapped cash out of the
system on the same night,
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causing a crunch.
(gears snapping)
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September 16th was the cut-off for banks
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to submit their quarterly tax payments,
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so a lot of money that
they might usually lend
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in the repo market was being
sucked out of their accounts
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and deposited into the Treasury.
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September 16th was also the day
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that $78 billion of Treasury
debt was scheduled to settle,
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which just means that
another chunk of cash
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was being turned into
securities on that day, too.
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Now, some banks said the
crunch was compounded
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by another factor, a rule put in place
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after the financial crisis
to keep banks solvent.
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The rule, which is called
Liquidity Coverage Ratio, or LCR,
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requires banks to keep a
certain amount of reserves
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or cash on hold at the Fed at
all times, among other things.
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The idea was to improve the
banking sector's ability
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to absorb shocks arising from
financial and economic stress.
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You can see it on this chart.
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Since the crisis,
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banks have stockpiled cash
in their reserve accounts.
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There argument is that
keeping these funds on hold
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makes it harder for them
to lend out cash on a dime
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when money gets tight.
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Now, for the Fed's part,
Chairman Jerome Powell
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dismissed the possibility
of revisiting those rules.
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- If we concluded that we
needed to raise the level
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of required reserves for
banks to meet the LCR,
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we'd probably raise the level of reserves
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rather than lower the LCR.
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- [Narrator] What he's
saying is that the Fed
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would rather provide
the extra funds itself
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than lower those liquidity
requirements for banks,
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and since that press conference,
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the Fed's done just that.
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In October, it announced
it would start buying
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short-term treasury debt
at $60 billion a month
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and continue through
at least June of 2020,
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which means there's
gonna be money to borrow
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even if the Karens stop lending again.
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Its aim is to boost reserves,
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allowing banks to stay liquid
without violating the rule,
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and in doing so, to keep the wheels
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of the financial system spinning.
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