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Sunday, June 24, 2018

What Is The "Repo Market" & Why Did The Fed Bail It Out In September 2019?

This post is about the September 2019 bank bailout related to the repo market. It will provide answers to the following questions:

1) what is a repo? 
2) how are banks being bailed out?
3) why is the bailout happening?
4) what does it mean for the great value migration?
5) what can you do?

First, let's understand why the bailout is so important.

Why is the September 2019 bailout so important?

The September 2019 bailout is important because the Federal Reserve is pumping money into OUR economy, non-stop ($260 billion in assets to the Fed’s balance sheet since mid-September). Yet, we have heard little about this. When the Fed bailed out banks in 2008, it was alarming. Everyone knew about it, today, only the business community is covering it.

Why is this bailout happening?

A large bank probably went bust in September. We'll never know which one because it was "bailed out".

How are banks being bailed out?

The Federal Reserve is pumping large amounts of money into the economy every night through an overnight lending program they have set up for banks. For a small fee, banks can make sure they have enough cash to stay open tomorrow. If there's a large demand for overnight funds, the fee goes up. In September, the fee went up so much due to the demand for overnight funds, the Fed had to step in to assist. In other words, the Federal Reserve had to step in to guarantee funding for any bank that needed it.

What is a repo?

A repo is short for repurchase agreement. This is the name of the banking product used to make overnight loans. In the same way that a mortgage is the name of the banking product used to make loans for houses, a repo is the name of the banking product that is used to make overnight loans.

So, when people talk about the Fed bailing out the repo market, they are referring to another massive bailout for the loan market, except this time it's the overnight lending market (repos) not mortgages (mortgaged backed securities).

What is the size of the repo market?

The repo market is huge. According to the Securities Industry and Financial Markets Association, the average daily repo volume in 2018 totaled nearly $2.2 trillion. So the repo market – with about $2.2 trillion outstanding – blew up in mid-September and repo rates spiked to 10%. Then, the Fed stepped in with a bailout.

Why is the Fed allowed to do this?

In 2008, it was decided that certain banks were deemed "too big to fail". As a result, the Fed has the precedent authority to bailout any large bank. So, we'll never know what large bank was bailed out this time (perhaps JP Morgan), but we do know that it took a massive amount of cash to do so. We also know that the Fed is playing this by ear. In fact, they have no idea what's happening. The new Federal Reserve Chair has openly stated his ignorance regarding next steps. This is even more evident in the announcements made by the Fed's trading desk. Brad Huston on Twitter provides a good overview of the Fed's announcements through Twitter below.

High Level Overview

We got in the weeds there so let's pan out for a moment. 

What are the main takeaways from this?

1)  The Fed just bailed out another massive bank (at least one). And, it will continue to do so until the U.S. dollar collapses.

2) The Federal Reserve will do everything it can to prevent a recession. This is a new development in economic theory. It used to be that recessions were an inevitable part of a market economy. Now, they aren't allowed.

What does this mean from an investment perspective?

Ultimately, it means that if you're just listening to MSM, you could be on the wrong side of many trades. It's time to take all the cash you can afford to lose and invest it in the stock market. The Federal Reserve, through its repo program (lender of last resort) and quantitative easing program (buyer of last resort), will continue to support or bailout any issue related to the stock market. The Fed knows the stock market is the primary indicator of economic health for most folks, so it will continue to prop it up by buying assets. This is why the Fed and central banks across the world are pushing rates lower (see article on negative rates below). All that cash has to go somewhere, and it's going into the market. The best thing you can do for your portfolio is buy on dips. 

How does this relate to the Great Value Migration from the dollar to bitcoin?

While it's time to invest your "extra" cash in the stock market (especially the ones that make up the major averages (DJIA, S&P, NASDAQ)), it's also time to start putting the cash that you can't afford to lose in safer places. This means assets that aren't associated or "backed" by a certain institution or counterparty, i.e, real estate, bitcoin, precious metals, artwork, jewelry. That way, if the market fails, it won't impact the intrinsic value of the asset you hold.

What is Counterparty Risk & Why You Don't Want It?

In the financial world, "backing" is referred to as a "counterparty". A counterparty can be a bank, the Federal Reserve or any institution that's willing to "back" an asset. So the risk associated with buying assets that are backed by a certain institution is referred to as counterparty risk. Almost all assets in the market, except for the ones listed above, gain value from the counterparty backing. The dollar is backed by the Federal Reserve. Stocks are backed by the company. Mortgaged backed securities are backed by the people paying the mortgages. Repos are backed by the lender. Bitcoin is backed by the people that use it (no counterparty). Gold is backed by its own intrinsic properties (no counterparty).

The great value migration refers to the migration from currency "backed" by central bankers to currency with no counterparty risk, like bitcoin and gold.

Get ready. We're crossing the Rubicon. 

If you're hungry for more on this subject I recommend:

Max Keiser's video, click here.

To read more about how central banks are becoming insolvent read my article on SeekingAlpha.

To read more about negative rates and what Greenspan, Warren and Cramer think, read my article on negative rates by clicking here.

To read more about the impact of the great migration on the dollar, read my article on the ban of bitcoin and its implication for America.

To read more about the current market phenomena of debt deflation and its impact on the global economy, click here.

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