Market Maelstrom: An Introduction to the Repo Market
The Repo Market, while many are unaware of this term, has spiked to become a trending Google search following the commotion that occurred on Thursday September 19th. In the United States, it is one of the most vital parts of its financial infrastructure, but one that remains a mystery for most. Bloomberg compares the Repo Market to the plumbing of a house- you only notice it when it springs a leak.
What is the Repo Market?
The Repo Market is defined as the place where cash and securities come together in the form of repurchase agreements. A repurchase agreement, or repo for short, refers to a financial contract where a security vendor will agree to repurchase securities from a buyer at an agreed upon price. In particular, the securities dealt with are usually government securities, and repurchasing can be seen as forms of “short-term” borrowing for such vendors. A dealer will sell the government securities it has to interested investors and typically buy them back from them within a day. Repos are used to earn short-term capital.
Who is involved in the process?
The parties that are usually involved in the Repo market are typically those in the finance industry, with a particular emphasis on broker-dealers, corporate entities, insurance companies, money market funds, bond market speculators, and most importantly, banks. The central bank and the local banks tend to be the largest participants in this market as central banks typically use repo as the method for providing accommodations to local banks. Banks have many reasons to engage in the Repo market, however the biggest selling point would be the fact that it is one of the easiest methods to acquire funding, as well as it being a convenient manner of satisfying wholesale clients.
The Federal American government is also greatly involved in this process. It is no news that repo has been used for decades globally, typically to extend credit when the market is tight, and to stabilize operating and financing costs as well as interest rates. Following the Great Recession in 2008, the American Repo Market came to a slow trickle adding to the financial struggle for banks. Learning from this instance, the Federal government has made it a point to establish new rules and regulations to prevent any repetitions of that year.
Last Week in the Repo Market- September 19th
Last week, an issue was identified in the flow of the repo pipes: there was not enough cash for the parties who relied on the Repo market to supply their needs. The reason being was a surplus of cashing had been flowing out at the same time that a surplus of securities were flowing inside. From the week before, the repo rate managed to fall from a 2% to a drastic 10% on Tuesday September 17th.
The Federal government was looking to decrease its target range for its effective federal funds to 2%, but the maelstrom in the Repo market caused it to increase to 2.30%. This was a cause for concern in the Federal government as this number surpassed their upper limit in said range which had been 2.25%.
Rising Concerns
Many believe that it was a combination of events that had acted as catalysts for the problem last week, but it can be pinpointed to an underlying issue: there simply was not enough liquidity in the repo system to sustain and satisfy the demand. At the end of the day, it is a job for the central bank to mend, but this problem has required a little extra help from the Federal government to make a few patches.
The Federal government made its first and only contribution to the banking sector of the country since the Great Recession. In the form of temporary cash, the government injected $200 billion over the following days in order to lower the effective federal fund rates. While it managed to pacify the issue at the time, it has been a rising concern for both economists and strategists alike.
For many Americans, this poses as a much more long-term threat to the American economy, as the new rules and regulations created to make the market “safer” have negatively influenced dealers, causing a decline in Repo market involvement. For others, this is a matter of the American economy lacking reserves in the banking system to provide the banking sector with the buffers and aid they may need in times of crisis. Representatives of the banking sector worry that this aid will be just enough- but for how long?
Written by Naoshin Fariha, Writer for the Junior Economist
Originally published on Wednesday September 25th, 2019
