About the Fed supporting the repurchase market (the repo market)

I am not a financial person, and I don’t understand specialty markets like the overnight repurchase market. The Fed has been intervening in this market a lot lately to prop it up. There is a lot of speculation as to why they have to do this, but I have a more basic question.

When the Fed injects, say $75 billion, into the market day after day, does the money accumulate? That is, say the Fed injects $75B/day for five days, next week has the Fed added $375B into the financial system? Or since the repo market is for overnight loans, is it in effect the same $75B injected 5 times?

Second question, the Fed is requiring banks to fully collateralize these loans. Does that mean this isn’t the Fed creating money, just forcing banks to buy $75B/day of Gov’t bonds? I don’t really get this, since the money is fully collateralized, is the Fed process creating money or just moving existing money from one place (bank reserves) to another place (overnight bank loans)? Or do the banks get to double-count? Perhaps the same bonds count as part of the bank reserves and as collateral for the overnight loan money. I don’t know.


I was hoping an expert would show up, because I have questions of my own. But I’ll take a stab at answering OP’s questions

The ‘repo market’ involves very short-term no-risk loans. As such, one would expect the interest rate to track the Fed’s target for overnight zero-risk loans. Instead the rate soared above 9% recently, so the Fed intervened. (9% may not be quite as high as it seems: 9% of a million is $90,000 but that’s per annum. Lend out the million just for one day and even at 9% the interest is just $250.)

I think the $75 billion loaned daily for five days should count as just $75 billion — don’t multiply by 5. However, the Fed also provided $30 billion for 14-day repos, and one news report suggests the total funding may rise futher. Not to worry. (!) This is just a minor intervention painting over some peculiarity. The Fed has tried to unwind its QE2; perhaps this latest liquidity problem suggests the Fed should/will start buying notes again.

The Fed lending will increase M1 money IIUC, but so would the same activity by a commercial bank. I think these money measures often tend to be irrelevant.

My own questions:
(1) When a business borrows in the repo market putting up Treasury notes as collateral, isn’t that conceptually similar to simply selling the notes (and then buying them back a day or a week or two later)? I suppose there’s a difference in which party assumes the risk of a change in the price of that note, but (ignoring paid interest) any price change should be small.
(2) If the businesses did simply sell their notes instead of borrowing via repo, would that have avoided this liquidity problem?
(3) Federally chartered banks have excess reserves on deposit at the Fed exceeding $1 trillion. Why didn’t the banks just use some of this money to service the needs of their repo customers?
(4) A partial answer to (3) is that banks were getting 1.55% interest on those excess reserves, so have little incentive to look for other “risk-free” investments. Cynics would call this interest a gift of $20 billion annually to the banks. Even a non-cynic like myself has trouble understanding what public purpose the interest serves.

TL;DR: The liquidity crisis in the repo market seems to be a minor technical glitch rather than any real problem. Nevertheless, I think it calls into question the meme that the U.S. banking system is a well-oiled machine.

I hope to get more explanations from others, it is a somewhat obscure topic.

As to your questions, I think of the 1.55% as a kind of rebate to the banks who have to pay to be part of the Fed. Why the rebate? Don’t know. It isn’t like they have a choice about joining. Are there still solely state chartered banks in the US?

The Indicator from NPR did a short story on this topic.

Not my area of expertise either, but I am pretty sure this money is not accumulating. These are short term (overnight or maybe a few days) injections of cash into the financial system to prevent spikes interest rates. $75 billion a day would quickly amount to an enormous injection of cash.

As always in things financial, it isn’t the actual money or transactions that are the issue, it is people’s reactions to them. These cash injections into the repo (repa :slight_smile: )
market are something that was inevitable due to the increased debt of the federal government arriving at a particularly bad time when cash is needed in a big way. The only interesting part of this is how people react to this event. So far it seems people are reacting relatively calmly and with curiosity, not panic or loss of faith. So the beat goes on. The economy works because people want it to work and are willing to take pieces of paper, or numbers in a computer, as a store of value. If that ever stops, times will become known as bad…