Are repo market regulations really behind the money market’s problems? That’s what bankers and their hired mouthpieces are saying.
So I need to get a few things off my chest about this notion that post financial crash Dodd-Frank bank regulations are the cause of the current repo market problems.
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It’s total bullshit. The bankers and their superleveraged hedge fund friends, with Jamie “Teflon Don” Dimon leading the way, are all bleating like stuck pigs that, “Oh, if it weren’t for that evil witch Liz Warren, and her capital and cash coverage ratio rules, we’d have no problems in the repo market.”
What a bunch of crap. These fat pigs are so leveraged that they can’t meet margin calls if their bond portfolio values so much has downtick by a percent or two. And they’re arguing that they need even MORE LEVERAGE? WTF is wrong with these greedy bastards?
Oh, right, that’s what’s wrong. Because as we all know deep down, greed isn’t really good. Sure maybe a little bit drives innovation, but exponentially growing greed manifested in the financial markets inevitably leads to really horrific outcomes.
Take a drive through Appalchia, or the former industrial heartland towns, or our inner cities sometimes, if you want to see the physical manifestations shutting people out of participating in the economy. While Manhattan and Greenwich, the Hamptons, Silicon Valley, LA and DC are doing just great, vast swaths of the US have been devastated. The rich are getting richer and what was the great middle class is shrinking and getting poorer.
Bank Leverage Regulation Isn’t The Problem
No, repo market bank regulation isn’t the problem. Bank leverage rules are not the problem. Too much leverage is the problem! They say that they need more. And paid Wall Street talking heads and analysts pick up the cudgel and agree with them? Deflecting attention away from the real issue, and blaming Liz Warren?
I mean, get real!
They complain also that loan growth is curtailed by these “overly restrictive” capital and cash coverage ratios? Restricted, my ass. That’s a bunch of crap.
Look at this chart, Wall Street arseholes.
The Complaint that Loan Growth Has Been Restricted is Bullcrap
That’s too slow loan growth? Wow. Bank repo outstanding zoomed from a 0 growth rate to 63% in July. Then it backed off to 54% in mid September when a limit was finally reached, whatever that limit was. Banks pulled the plug, and the system froze.
54% growth wasn’t enough? And it’s still at an annual growth rate of 47%, even with the pullback.
That’s not enough lending? There’s not enough leverage?
What is wrong with these people? They are gaslighting us, plain and simple.
So Much Leverage, Any Decline in Collateral Value Can Not Be Tolerated
We have a system that is so leveraged now that these turds can’t even tolerate a 1% drop in the value of their fixed income portfolios. They get margin calls that they can’t meet because their collateral doesn’t cover the loan.
And Wall Street’s solution is even MOAR LEVERAGE!
Look at this. Every dollar of new Treasury inventory that the banks have piled into their portfolios over the past couple of years they have financed with repo. The banking system owns virtually nothing outright. Zilch! dealers and banks have repoed themselves into a corner.
Look at that chart. From June 24, 2017 until September 4, 2019, 12 days before the repo market froze up, bank holdings of US Treasury paper rose by $503 billion. At the same time their repo loans outstanding rose by $453 billion.
In other words, they had added $503 billion in Treasuries to their books while lending out 90% of that. That’s 90% leverage, plain and simple. They are taking on the new Treasury issuance month after month, but they can only do it with repo money. With hundreds of billions in new issuance, quarter after quarter after quarter, the US Treasury has sucked up every cent of cash available for investment.
And now there is NO WAY OUT! The Fed must buy this stuff from now till Kingdom Come. Because the US Treasury will continue to need to raise money in the markets by selling more and more debt until tax and spending policy changes. Which means forever.
With 90% leverage, any decline in bond prices whatsoever simply cannot be tolerated. It will bring the system down. Over. Kaput. Fini!
The Fed Has Taken the Dealers and Banks Off the Hook for Now
The Fed has taken the Primary Dealers and banks off hook for now, lending to the dealers via TOMO (Temporary Open Market Operations), and promising to buy most new issuance from them outright via POMO (Permanent Open Market Operations).
As of Tuesday, October 22, the Fed has $193 billion in Fed repos outstanding via TOMO since the crisis erupted into full view on September 17. It has also bought $44.3 billion of Treasuries outright, and climbing, since then.
This will go on and on.
But This Time, QE New Isn’t Working
But note that after the Fed had added a couple hundred billion in QE to the markets in March and April of 2009 stock and bond prices responded instantly by zooming higher. The first $240 billion of QE 1 saw the S&P 500 gain 9% after it had already gained 19% in a couple of weeks anticipating the money. The market response continued as the money gushed.
This time, there was no anticipation because the money market woes took the Fed by surprise. As usual, the Fed was asleep at the switch. The Fed looked beneath the hood and panicked. It started QE New with no advance notice.
The initial $240 billion injection has seen the 10 year Treasury yield decline by all of 5 basis points since the new TOMO began. But since October 8, that yield has risen by 25 basis points. It is going the wrong way. That’s a very bad sign.
Meanwhile, the S&P 500 has risen all of … oh, wait… It hasn’t risen at all since QE New began. As of Tuesday’s close, the SPX was down 8 points since September 17.
QE New Isn’t Working Because Markets Are More Leveraged Today
QE New isn’t working because the markets are actually in far worse shape now than they were in March 2009. They are bloated, overleveraged, POS’s.
Bank repo market regulations aren’t too tight! They haven’t worked. Bankers who never were forced to face the music are behaving badly yet again. Whoda thunk?
In contrast, by March of 2009, the excesses of the prior episode of the credit bubble had been largely written down. Leverage was reduced, and some cash had built up in the system as selling intensified. The system was already on its way to recovery.
Perhaps more importantly, Primary Dealers were virtually flat in their bond positions in early 2009. They were not stuffed to the gills with long Treasury inventory.
Sure, QE may have given the market a nudge in 2009, but it was ready. The crash had already laid groundworkfor recovery. The haircuts had been taken. The stock market had already begun to rally, just on the thought that QE was coming. That could only happen if there was cash available in the system.
This time, the Primary Dealers that run this mess are so leveraged that they are unwilling and unable to take any haircut at all. They know that this disaster waiting to happen is a much bigger one than the one that had already been written down in 2009. The individual billions of ill gotten gains that they have accumulated from the trillions of Fed QE that enabled massive gaming of the system are now at extreme risk. They are unwilling to see one penny of it taken away.
The Fed Attempts To Ride To the Rescue
So their wholly owned subsidiary, the Fed, has sprung into action to see that they need not face those losses.
Meanwhile, the banker/dealer Dons and Wall Street godfathers want the post Financial Crisis repo market bank regulations and leverage rules relaxed so that they can pile even more leverage on this bloated pig. But that would only work for so long. Sooner rather than later, repo lenders would reach the new limit, and the top heavy system would come toppling down.
We’ve reached a point where the central banks must now buy virtually everything in sight. They must do so to keep prices inflated so that the dealers, bankers, and hedgefund boyz need never take those haircuts.
The BoJ has already been doing it for years. It has kept their markets inflated but Japan’s economy is a basket case. Their demographics are a disaster. Their population is aging. There’s no growth, and the future looks so bleak, no one wants to have kids.
The US is headed toward the same unhappy future. Ultimately we don’t know what the final outcome will look like, but it will almost certainly require a massive reset. The Fed is trying to prevent that.
The question to us as investors is how do we protect our own capital in an environment fraught with such dangers. To answer that, I analyze the macro liquidity, show you the forces that dictate the trends, and provide common sense recommendations on how to manage your money accordingly at Liquidity Trader.
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Meanwhile, you can follow the entire sordid money printing, attempted asset inflation saga at Federal Reserve QE New. Bookmark it for future reference.