There is something about repo which repels mainstream curiosity. It’s more than weird, how throughout their long history repurchase agreements have gone so studiously overlooked. It has to be intentional. The real irony is that the Federal Reserve itself essentially introduced these things into American monetary practice.
Having examined just two weeks ago what 1982’s Drysdale Affair could have meant had the hapless bureaucrats at the Federal Reserve actually paid some interest in doing their job, where might we be today? To have understood, decades before 2007, that repo and collateral had become the central focus.
This likely accounts for the self-enforced blindness; central bankers can’t admit competition. Certainly not in their post-Volcker incarnation whereby they pretend to be the supreme monetary agency somewhat recognizable to the model imagined by the public; the same created by Walter Bagehot.
Believe it or not, repo has been over a century in operation, yet little has been uncovered, even less made known about how it gets practiced (or how much). Repeated opportunity has been passed up in favor of, always, bank reserves, then interest rate targets barely hoping to achieve correlation with certain economic aggregates.
If Paul Volcker’s people targeted a certain range for fed funds, what would that have accomplished? They didn’t know, but 1983’s robust recovery just so happened to have broken out at the same time, therefore while no one can possibly explain how a range of fed funds might ever account for it, they all just blindly accept there must be some causal relationship somewhere.
Such mysticism, while it can’t explain what really happens, it also prevents other avenues of inquiry from filling in these huge blanks. Don’t Fight The Fed has come to be accepted as self-imposed obliviousness.
And, again, it is deeply embedded in academic history. Consider the following written by Edward Simmons in 1954 for The Journal of Finance (Vol. 9, No. 1) when referring to the early days of repo closing in on four decades old by that time:
“Although not a negligible fraction of Federal Reserve credit, government securities acquired under repurchase agreement attracted little attention in discussions of central bank policy.”
A timeless, damning statement if ever there was one.
“Not a negligible fraction” because beginning in 1916 the Fed thought it in the nation’s patriotic best interest to bend the rules (surprising, isn’t it?) Prohibited from funding the activities of securities dealers and non-member banks (which were a large fraction of the overall banking industry at the time) through the usual means, rediscounting and whatnot, policymakers under political pressure to help get Liberty Bonds sold figured out an easy bypass.
They wouldn’t finance the sale of Liberty Bonds, not directly, but they would buy them from securities dealers and non-member banks under agreement to resell them at a later date (from the perspective of the securities dealer or bank, it was an agreement to repurchase, thus repo). Not truly a purchase, this was instead a collateralized loan as it was always intended to be.
The charade of buying and selling was only necessary to provide the legal deniability.
FRBNY’s Fourth Annual Report covering the year 1918 enthusiastically endorsed the cheating:
“While the Federal Reserve Bank [FRBNY] could not discount directly for nonmember banks, it has freely purchased from them whenever necessary, at the same rate at which it was discounting for its member banks, certificates of indebtedness with an agreement on their part to repurchase within 15 days, and under authority of the Federal Reserve Board has offered to rediscount their paper when secured by Government obligations, with the indorsement of a member bank.”
There immediately had been born repo dealers, these member banks who as members could arrange – for a fee - steady finance for practically anyone who wanted to pocket leveraged spreads on safe, liquid instruments.
And what were these certificates of indebtedness? Short-term government issued instruments, like T-bills only paying a coupon instead of being issued at a discount. From its very inception, repo participants have absolutely favored short-term safe, liquid government debt instruments.
As plainly stated in its Fourth Annual Report, requests to banks by the Treasury Department “for assistance in selling and financing Liberty loans has been almost without exception of the most generous and enthusiastic nature.” Left unsaid is how enthusiasm linked directly to repo funding.
Throughout the Roaring Twenties, Fed-linked repo was “not a negligible fraction” of the central bank’s activities. While the Great Collapse scrambled the program entirely for a couple decades, the practice found a rebirth in the early fifties with the Federal Reserve yet again heavily involved, this time over the “conflict” in Korea and another round of debt issuance to finance it.
Simmons observed in ’54, “At times the amount of government securities held under repurchase agreement [on the Fed’s balance sheet] has approached the volume of paper rediscounted for member banks.” This often had meant, “Weekly changes in securities held under repurchase agreement have sometimes been as large as changes in government securities bought outright.”
Between that time and 1982’s Drysdale Affair, however, “something” changed whereby repo went rogue, so to speak, previously well-established with and for the Federal Reserve’s political interests but then going on only ever from the outside. They never had much interest in diving deep in the money marketplace when it was conducted right out from their own back door, even less when focus first shifted to private practice more exclusively before then moving offshore.
By the time the Great Inflation raged, hardly anyone seemed so perturbed by how much of real money was being run in and by private-only repo. One of the few to raise the issue, in 1981, had been the flustered President of the Fed’s Boston branch, Mr. Frank Morris.
“MR. MORRIS. We have overnight RPs, for example, that are used by a good many corporations as transactions balances, and RPs are not in M-1B at all. I really don't think we will ever, from now on, be able to have a concept of a transactions balance in which we can have the same confidence we used to have in the old M1. At least we knew then that M1 was the store of money that people had available to them to make payments.”
The banking system – becoming predominantly skewed by the activities of global securities dealers rather than depositories – would no longer rely on the Fed funding their activities in repo, from the fifties (eurodollar emergence) having worked into its own ecosystem that, unlike the Fed’s bank reserves, actually provided useful money for real economy participants like the corporations Frank Morris had cited much later on.
Even at the height of the Great Inflation, the very result of “missing money” evolution, repo barely elicited more than the occasional half-hearted complaint, merely lumped together with all the rest of incapacitating monetary mystification. Not even Drysdale elicited the tiniest bit of inquisitiveness.
On some level, authorities believed (more like hoped) that repo and other wholesale formats would simply tie back to traditional money. In the same way they employed the mysticism of correlations between fed funds and the real economy, officials put blind faith that some causal link might happen for reasons well beyond their limited grasp between a fed funds target and repo.
This was always a ridiculous premise because repo is money but in two parts; almost a binary that places emphasis as much on the one side as the other. You know what I mean: the collateral side.
From the rebirth of repo in the fifties under the Fed’s auspices to the total outgrowth by the seventies, then into the nineties we had Solly and the widespread cheating (outright fraud) across government and GSE securities essentially highlighting the supremacy of collateral in repo and the supremacy of repo for global effective money supply.
What I wrote more than seven years ago about that key 1991 signpost for repo dominance stands as another reminder:
“There is great significance of government and agency debt at auction and issuance, as it is on-the-run securities that control the repo environment. A bond, note or bill just auctioned is the most liquid because it contains the most direct and quantifiable characteristics…”
That was the thing, on-the-run, to the point they were all willing to risk total shutdown in its pursuit. And I do mean everyone; the government’s report on Solomon Brothers was expanded to include all government auction practices, one conducted by the usual alphabet soup of federal agencies. In it, they exposed ninety-eight dealers (nearly all investigated) flagrantly flaunting several basic rules of corporate governance and honesty (including keeping different sets of books!) in order to get to that on-the-run collateral.
Even after their lengthy investigation, the whole thing remained, including dealers’ ultimate aim, unclear to the official book. How was it that everyone outside of government and the Fed knew this, but no one in government or at the Fed could figure it out?
Once more, Mr. Simmons: “…government securities acquired under repurchase agreement attracted little attention in discussions of central bank policy.”
After this week’s 75-bps rate hike, the current FOMC put their own reverse repo rate (RRP rate) – which is not repo – at 2.30%. And yet, yesterday the first day of trading with it, 4-week T-bills – the absolute best of on-the-run - were auctioned by Treasury to a high yield of 2.14%. At the same time, 8-week instruments fetched a high yield of 2.21%.
Low yields at 1.99% and 2.00%, respectively.
Massive liquidity premiums being paid across a wide swath of the actual center of the monetary universe.
Consider how the US economy just suffered a “technical recession”, the BEA’s data this week confirming at the very least real GDP declined across the entire first half of this year – just as previous markets from last year had been expecting even if hardly anyone else outside of them had. A far cry from the red-hot economy foretold as recently as January and February, whether or not these results meet any definition of recession is beside the point.
Bond markets and curves right now are positioned for worse still to come, more than a contraction already having achieved the same downside GDP proportions as 2001’s dot-com recession. Forward-looking markets are looking forward as if “it” still hasn’t hit yet, while the media and politicians like Mr. Powell try to litigate various interpretations of the just-concluded past.
Throughout the “technical recession” curves have only gotten worse, more distorted, deeper inversion, meaning it wasn’t Q1 and Q2 weighing on them. It’s what’s still ahead that must be. How does anyone explain this?
Government securities acquired under repurchase agreement have attracted immense attention by action of everything central banks don’t follow.
Add a huge collateral shortage to the existing high levels of recession probabilities a “technical recession” – whether it counts as one doesn’t matter – introduces from the very start, and, yes, you rather easily appreciate the serious and increasingly dangerous implications of clueless central bankers rate-hiking for inflation conditions that don’t exist while money and economy directly disappear right from under their noses.
While the media are coerced into arguing about the very recent past, they’d find far more relevant and useful answers honestly looking into how after more than a hundred years, and almost half of them done right from its own doorstep, our “central bank” cares so little about any of it.
