Repo Madness

All our times have come
Here but now they're gone
--Blue Oyster Cult

As we've noted, the Fed has embarked on another monetization program. A primary focus of this intervention is the repo market, where short term financing rates have skyrocketed over the past few weeks, surpassing highs during last decade's credit market freeze.

We've written about repos before, and speculated that they could potentially lie at the epicenter of the next financial system meltdown (here, here, here).

The question, however, is why now? What is causing the repo market to crack at this moment?

The regulatory backdrop has been ripe for some time. Post-crises revisions to banking regulations have forced banks to set aside more than $1 trillion in reserves. Repo rates are rising in part not because of a scarcity of cash in the banking system, but because that cash cannot be used to fund repo loans. Regulations are also constraining the return creditors can realize on large lending positions in short term money markets.

The Fed's sell down of QE program assets has exacerbated the stress. Until the Fed (predictably) suspended its QE unwind a couple months back, it was draining tens of billion$ monthly from the system as it sold back the bonds that it had previously purchased during QE (with money created out of thin air, of course). Those sell backs took cash off the repo market, perhaps to a tipping point. Now, the Fed's recent monetization program is once again sending cash (created out of thin air) in exchange for bonds (as shown above).

Peter Schiff adds that ever more federal debt coupled with shorter maturities on that debt means that record levels of debt need to be financed daily. Banks have dutifully bought those bonds--as they in part are required to do by recapitalization laws put in place since 2008. Once again, this leaves less cash available to fund repos.

Perhaps it has just been the confluence of these factors that have cracked the repo market, although I can't help but think that something more acute is pushing this situation overboard. We'll likely know soon enough.

Also not hard to think back to the early days of the credit collapse. Early tremors (e.g., New Century Financial) before the dominos starting hitting each other in the mortgage markets. Is the repo market an early tremor this time around?