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The repo market has been stressed recently and the Fed has had to step in and inject a lot of capital to help alleviate the problem. But they don’t know what’s causing the problem or how much money it will take to fix it.

In this Dark Corners, we will explore the repo market in more detail. But first, what is a repo? “Repo” is short for repurchase agreement. A repurchase agreement is essentially a short-term loan, usually between banks. Imagine you are a bank and you have clients who need to make payroll, but you don’t have enough cash on hand to cover the withdrawal. So you pledge a portion of your holdings (typically government securities) via a repurchase agreement with another bank. Bank B loans you the cash, you pledge your collateral, and you pay Bank B back tomorrow with interest. Bank B makes a little more money on the loan, picking up the yield on the government security and the interest you paid them.

CMG wrote a great post several weeks about their perspective. A full link to their post is below. Bloomberg also highlighted this recently as well. But here’s the high level:

  • The Fed has provided ~$500 billion in liquidity support to the repo market since the crisis first spiked in September.
  • The amount is likely to continue growing as they don’t know why the problem exists.
  • Not only did the spike in the repo rate come as a surprise to the New York Fed, but they also haven’t been able to normalize it as quickly as they thought they could.
  • Some analysts have also pointed to a new corner of the market, which has seen immense growth: sponsored repo. This allows banks to transact with counterparties like money-market funds without impacting their balance sheet constraints. The downside is that it’s only available on an overnight basis, and as a result has further concentrated funding risk.
  • The Fed may have to start buying long term Treasury bonds which would amount to another round of QE.

https://www.bloomberg.com/news/articles/2019-12-20/repo-oracle-zoltan-pozsar-expects-even-more-turmoil

I hope you enjoyed the first installment of Dark Corners.

Best Regards,

Jared Toren
CEO & Founder

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Author: Jared Toren

Jared Toren is CEO and Founder at Proper Wealth Management. Proper was born out of frustration with the inherent conflicts of interest at big brokerage firms influencing advisors to sell products that were not suitable for clients but profitable to the firm along with a consistently mixed message of who’s interest was supposed to be put first; the clients’, the firms’, shareholders or advisors. At Proper, our clients interests come first. We are compensated the same regardless of which investments we utilize so there’s no incentive for us to sell high commission products. Since we focus on a small number of clients, we are able to truly tailor our advice to each person’s unique circumstances.
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