Matt Levine's explanation of what happened is considerably less sensationalized. Take a look at the second item of his column today [0]. It's too long to quote and doesn't lend itself to an easy excerpt, but here are the facts that he quotes, from Bloomberg [1]:
> A sudden surge in the overnight rate on Treasury repurchase agreements that began on Monday continued Tuesday -- with the rate opening at 7%, according to ICAP. …
> What happened was an unfortunate coincidence -- just as companies were withdrawing cash from money markets to pay corporate tax, a glut of new bonds appeared on the market as the U.S. government sold some $78 billion of 10- and 30-year debt last week.
> With just $24 billion of bonds maturing in the period, this became one of three occasions this year when the imbalance between debt redemption and cash needed to buy new Treasuries exceeded $50 billion.
Again, if those paragraphs don't obviously relate to the overnight lending market, read his column for context.
>a glut of new bonds appeared on the market as the U.S. government sold some $78 billion of 10- and 30-year debt last week.
But this isn't slowing down any time soon, so the problem will keep recurring. Deficit's are rising, and foreign purchases of treasury debt has plateaued the past few years.
This, some say, is the real problem: banks are forced to purchase this debt and so the funding needs of the US government are crowding out domestic banking sector. If continues, this means the Fed will effectively be monetizing US deficits.
Luke Gromen has covered this in various podcast interviews[0] and on twitter: @LukeGromen.
That the US deficit is not going to be paid for by selling debt to people around the world, it is going to be paid for by the federal reserve creating money and giving it to the treasury.
The problem with this type of inflation is that it's lopsided. Assets inflate -- equities and real estate. That's great for asset owners. But wages haven't really increased, because most workers don't "need" to own equities, and most Americans already own a house, so they aren't affected by rising rents and home prices.
This is why rent can raise 10% in one year -- the largest expense for nearly everyone -- and you can have 1% inflation. Most people aren't renters. So they aren't paying more for their rent. In fact, when bond prices go down (from this manipulation), mortgages get cheaper, so most people are paying LESS for the same house / mortgage.
Equities go through the roof.
If you're a laborer / renter, this is like a double gut punch. If you're a capitalist aristocrat, it's like a double gift horse.
And, as far as inflation goes, at least the way the Fed measures it -- it doesn't have a huge effect.
Commodities are so globalized now, and the US isn't 50% of the global economy anymore -- more like 20%. So strong upward pressure on commodities here, doesn't have a huge impact on commodities prices.
Yeah effectively it's rich people deciding that enormous sums of money should be invented out of nowhere and given to rich people. And somehow everyone is ok with that
Actually I read that in period of high inflation, the factory workers tend to do OK. They are often unionised, have leverage by doing strikes, they typically manage to keep their wages in check with inflation. It is office workers that are going to be the most impacted.
Though that was from experience from times where there wasn’t this imbalance between supply and demand between blue collar (excess) and white collar (shortage).
Your comment has contradictions. For example, if "most Americans already owns a house", how are they at the same not affected by home prices increasing?
Like a lot of financial analysis I read, you seem to look at only one side of the transaction. For every renter, there's a rentee. For every buyer, a seller. For every borrower, a lender. Those people are abundant as well, and the exact opposite comment could be written about them.
Source? Most of my friends (outside of the tech echo chambers) are worried they'll never become buyers because of student loans, decades of wage stagnation, skyrocketing rent, real estate, college tuition, etc..
Aug 12, 2019: "U.S. consumer inflation outlook declined as Fed weighed rate cuts .... The Fed’s preferred inflation gauge, known as the core personal consumption expenditures price index, gained at an annualized 1.6% pace in June."
You don't "own" your own debt. The bank / other entity you are indebted to "owns" the debt, hence why they can sell it to a debt collector for pennies on the dollar. Instead of owning your debt, you are liable (or there's a better word than "liable") for your debt. Basically, you already "sold" your debt when you first became indebted.
It's not really a dumb question. I get why people might look at their debt as something they own, given the debt itself is tied to their identity and credit score until paid off.
It's important to note that the amount of money you accept for that paper need not be what's written on it. I.e., you could sell a bond saying you'll pay back $1000 + interest and get only $981 for it, say, or maybe $1017 dollars for it, or any other number.
If the bond sells for more than its nominal value, then the effective interest rate you pay to borrow will be lower than the nominal interest rate, and if the bond sells for less, then your effective interest rate will be higher than the nominal interest rate.
The face value of the bond is what you will receive at maturity. When the bond trades in the intermediate term, its price is determined by prevailing and expected interest rates.
What you do is invent the phrase “as good as gold”. Then you convince the world that your paper is more valuable than theirs, and they store it in their vaults instead of gold. That’s how you export inflation and sell your debt to suckers.
All money in modern economies is based on this kind of debt. Central banking is... confusing.
The immediate effect of the fed doing that isn't catastrophic, it's just devaluing the US Dollar, or put in another way, inflation.
Inflation at a certain level is thought of as a good thing, the fed and economists have inflation targets where they don't want it to be too high or too low. One of the thing that moderates inflation is how the fed creates money and lends it out.
The recipe for WWIII is runaway inflation where in order to keep things together, a central bank issues money at an exponentially increasing rate with a very small doubling period and the currency becomes worthless in trade with other currencies and to purchase goods.
The US is very far away from that. The increase in the deficit and debt is problematic and significant, but not anywhere near catastrophic.
Interestingly, deflation can also cause wars and lead to an economic downward spiral where everyone is worse off. Retaining the Gold Standard was a major contributor to both WW1 and the Great Depression. Japan’s deflation lost it a decade of economic growth more recently.
Incrementalism. As long as the U.S. does it on a relatively small scale (emphasis on relatively), no one will want to pay the costs involved in fighting against it, even if over longer periods of time it adds up.
To a large degree, they aren't accepting it. This is why around 2014 treasury holdings by rest of world stopped growing on net.
Many governments/central banks are trying to exit the $ and UST's and are buying gold instead of treasuries.
Ultimately, the US has quite a large amount of liabilities, and entitlement spending on retiring boomers coming due in the next few years. Currently, at the peak of the economic cycle, we are running $trillion deficits.
Imagine what happens if there is a recession? Even if there isn't, these fiscal deficits, along with our large trade deficit mean:
The rest of the world gives us real goods, we give them paper IOU's. The debt is not shrinking but is growing, and faster.
So, they are not tolerating it. Problem is, in the petrodollar system, the reason this whole ponzi could occur is dollars were needed to buy oil. Post-71 Nixon shock, the $ was as good as oil. Saudi and others only sold oil for dollars putting a floor on the value of dollar and incentivizing both oil exporters and rest of world to want to hold dollars, thus recycling their surpluses into treasury debt to both fund their export economies and fund our consumption.
This CANNOT continue because by definition it means rest of world works and produces for never ending, and ever growing, US consumption. Holding dollars, amidst a growing realization the Fed would have to monetize this debt and government would never pay it back in "real terms" has led many oil exporters to try to sell oil in other currencies, and countries generally to try to exit the dollar for trade.
Iraq[0], Libya, Iran, Russia, and Venezuela[1]. Do we see a pattern of what happens to nations that try to do this?
They either get regime-changed or become enemy number one for US government. Do you think it is a coincidence that Venezuela has the largest oil reserves in the world and just happens to be the next country US is involved in pushing regime change (them or Iran)?
To read about this system of petrodollar recycling, and how/when it was created in the early 70's because of collapse of Bretton Woods, check out an this excerpt[3] from excellent book "The Global Minotaur: America, Europe and the Future of the Global Economy" by Yanis Varoufakas former Greek minister of finance.
Good thread [3] covering a broad summary of trade, the dollar, and petrodollar warfare [4]
> entitlement spending on retiring boomers coming due in the next few years
This is a frequently overblown fact. 12.4% of the population was >65 in 2000, increasing to 15.2% in 2006. So this huge incremental wave of retiring boomers is... 3% of the population.
> The rest of the world gives us real goods, we give them paper IOU's.
This is fun to say but try paying for goods with a paper IOU. Chances are the store will prefer dollars, even though they're technically the same concept.
> Problem is, in the petrodollar system, the reason this whole ponzi could occur is dollars were needed to buy oil. Post-71 Nixon shock, the $ was as good as oil. Saudi and others only sold oil for dollars putting a floor on the value of dollar and incentivizing both oil exporters and rest of world to want to hold dollars, thus recycling their surpluses into treasury debt to both fund their export economies and fund our consumption.
People want dollars for various reasons. The dollar is stable relative to other currencies. They're harder for authoritarian governments to seize. There's inertia (It's already the reserve currency and working fine, so why change?). It's extremely liquid. All more valid reasons than this random oil conspiracy theory.
> This CANNOT continue because by definition it means rest of world works and produces for never ending, and ever growing, US consumption.
Not sure how this follows, at all.
> Holding dollars, amidst a growing realization the Fed would have to monetize this debt and government would never pay it back in "real terms" has led many oil exporters to try to sell oil in other currencies, and countries generally to try to exit the dollar for trade.
Nobody is exiting the dollar for trade. What're you gonna do, switch to euros? yuan?
HN and wacky economic conspiracy theories, name a more iconic duo.
You’ve been able to trade petroyuan in Shanghai since early 2018. The volume there is made up almost exactly with what a less conspiracy based hypothesis would expect: domestic Chinese firms, Russians avoiding sanctions & arbitraging actors.
There has not been a mass exodus to the yuan, quite the opposite China has been manipulating it up through that entire time.
Euro denominated oil is likely to come online in the next year or 2. The E.U. started a benchmark program this summer. Roseneft (a big Russian producer) switched to Euros a couple of weeks ago.
That doesn't seem like a convincing argument against the whole petrodollar "conspiracy". It seems like there is no assurance that trading in these alternative currencies can't increase dramatically among other countries.
I think the conspiracy theory is backwards. We didn’t use hegemony to make people us petrodollars. They used petrodollars because it made the most sense. By dramatically increasing our use of sanctions we’ve turned that on its head. And we are going to see petrodollars become less important.
We aren’t going to go to war with China, Russia or the Euro zone for switching off petrodollars. The opposite conclusion is ludicrous.
This is along the lines of how I was interpreting things. Its really scary. I would be happy to hear a convincing argument against this version of reality if such a thing is possible and if anyone is able to make one.
To be clear, a GC repo at 7% to 9% is outrageously high. Lack of short term financing can have severe repercussions that ripple throughout the financial system.
Well, I guess it would be high on a typical loan. On an overnight loan, the difference between 9% APR and 1% APR is the difference between paying 0.0236% in interest for the loan and paying and 0.00273% [1].
Why do banks need special assistance in that situation? If you depend on your input prices not going up by that much for a short period, you're hosed anyway...
> Well, I guess it would be high on a typical loan. On an overnight loan, the difference between 9% APR and 1% APR is the difference between paying 0.0236% in interest for the loan and paying and 0.00273%
As a rates trader, your positions are denominated in the millions of dollars. Some back of the envelope math:
1mm of 10y treasuries (repo'd at EOD) is roughly $1k of risk (dv01 -- if rates move by 1bp, your pnl fluctuates by $1k). To finance that position, you're paying $236 at 9% vs $27 at 1%.
Now say you've got 1mm of 2y treasuries. That's roughly $0.2k dv01. Unless 2y rates move 1.25bp overnight, you're losing money just financing the position.
In short, there's a massive difference between paying 2.3bps and paying 0.27bps.
> So your business collapses when you have to temporarily pay $236 for something that normally costs $27?
No, think of it as paying $236,000 for something that normally costs $27,000.
You can think of this business as providing banking services to large corporations, who aren't able to simply put money in a savings account at their local credit union.
It's doesn't collapse in the short run, but it can harm the ability of these corporations to access their funds. Short term financing disruptions can have major impacts across all markets.
Show me a business where a sudden 10x increase in costs isn't painful...
Yes, those costs were computed on a book long 1 billion dollars of notional. There's a difference between notional and risk though. 1 billion dollars of 10y treasuries will be ~1mm dv01. Both matter.
> lending out at higher interest all the time
This isn't how rates trading works. Entering positions costs money. You're not making loans. If you hold treasuries, you're earning the coupon on them for the period that you own them. It gets more complicated when you factor in repo, but typically you pay GC repo when you're long.
This article is about repurchase agreements (repos). They are a form of collateralized loan used in rates trading. If you need to borrow money for a short period, you can do so in the repo market. You sell treasuries to a counterparty, agreeing to buy them back at a later date. You agree to pay an interest rate called a repo rate for this transaction. This is the rate the article is discussing.
Someone borrowing through the repo market is doing it to satisfy liquidity needs. They need the liquidity for some ongoing concern or investment or trade, or something (I don't know the details or relevant term, but it doesn't matter for the point).
That venture has some ROI. The temporarily higher repo rates have to be compared to that. That venture's costs are temporarily going from .002 percent to .02 percent of capital invested. Either way, a small portion. I don't see the emergency beyond "I wish this made the higher profit I am accustomed to".
> That venture has some ROI. The temporarily higher repo rates have to be compared to that. That venture's costs are temporarily going from .002 percent to .02 percent of capital invested. Either way, a small portion. I don't see the emergency beyond "I wish this made the higher profit I am accustomed to".
The difference between rates markets and, say, equities markets is that you think of your risk in basis points and not percentage points. A 10bp change in equities prices on a $1 billion book will cause $1mm change in pnl. However the $1mm dv01 treasury book (with notional $1 billion) will make or lose $10mm with a 10bp change in interest rates. You can see why basis point moves can be much more meaningful in the rates space.
Let's consider market makers now. They are mandated to make money by provisioning liquidity, not by taking views. This means that their return is supposed to come from earning spread and not from being positioned the right way on market moves. This often requires holding and financing hedged positions overnight. If your financing costs are >2bp, there's a pretty solid chance you're going to lose money on the positions you're holding, considering that you hedged them specifically to try to minimize fluctuations. It's not just a matter of making less profit as much as it is one of losing money entirely. Were such increases in financing costs to become prolonged or more frequent, there would be a deleterious effect on rates markets in general.
No one is saying that paying more for a short period of time is going to destroy the financial system. However, if this does continue for a longer period of time, many cannot afford to finance at these rates and it also shows that the Fed has lost control of things.
I just think it's funny that rich people can get billions of dollars to stay solvent in a sudden crisis, and I can't get a dime when I can't pay for lunch.
Am I reading this wrong? Is this a bad analogy? Is it not exemplary of how creditworthiness seems to rise at a higher rate than the means used to justify that creditworthiness? I'm a layman, but I'd like to know more.
If you are rolling short term debt and only have long term assets you can't sell, you are taking a liquidity risk. You may be perfectly solvent (have more assets than liabilities) but if you cannot refinance the debt one day, you will go bust.
The Federal reserve is not in the business of injecting capital into insolvent banks (which is why TARP in 2008 was a very unusual and controversial measure), it is in the business of providing a backstop of liquidity to banks that are solvent (this is enforced through capital requirement) but may require liquidity on a short term basis.
Is there a reason why I can't, say, sell equity in my car to cover the shortfall? I have a vehicle worth $nK at purchase, so I'm also solvent, just with a liquidity problem.
It just seems like real cash and assets are valued less than financial instruments? Because they're More Future Money That We Expect To Exist compared to Less Now Money Which Actually Exists? I guess that makes sense but is also absolutely insane?
The challenge with real assets is they are hard to value, and hard to sell quickly. Therefore the interest and fees charged are higher (also people prone to need short term loans using their car as collateral are also very prone to not pay these loans back).
These financial assets can be calculated, sold, more purchased, etc. in known quantities very close to instantly. Standardized financial assets are very easy to move or use in large quantities for these reasons. A 5 yr US Gov't bond is a known quantity.
Which, arguably, should be a thing, so long as it's elevated in priority to the level of a debt to the IRS (i.e. can put liens on anything you own and garnish wages).
Similarly, if the Fed loans to these banks at a penalty rate -- presumably much more that regular risk-free loans like in e.g. securities a money market fund -- I wish the Fed would let people sign up for these programs so our idle cash could get lent out at that rate.
You car is not a very good asset from the bank point of view, so it's not going to be cheap. But the typical example is to draw on your mortgage, (equity release, i.e. reborrow a little more against your home). That's pretty much as cheaply as a consumer can get liquidity against an illiquid asset (home).
And that's pretty much what banks do with the Fed. They have assets that they get funding for from the Fed with a short term repo transaction. In theory the Fed takes very little risk on the transaction.
You can in fact take out loans against your ownership of a vehicle, assuming you own it free and clear.
For assets whose ownership is more nebulous than an automobile you typically have to temporarily relinquish ownership of it to use it to secure a temporary loan, ie, pawn it.
> Is there a reason why I can't, say, sell equity in my car to cover the shortfall?
This is what a loan is. Look at the assets and revenue someone has and give them money if you think they can pay it back. You could reconstitute that situation as thinking of it as selling the equity in your assets and future profits and then buying it back in installments.
Companies try as hard as they can to minimize the amount of money just sitting around and not doing anything. They accomplish this with frequent short term loans that smooth out the noise in their cashflow.
You can sell equity on your home with Point (https://point.com/) but I'm not aware of the same thing existing for cars, probably because it's a comparatively small chunk of change, and cars just depreciate in value, whereas homes are supposed to appreciate. Instead you could use your car as collateral for a loan, assuming you owned it.
_Land_ appreciates. "Real property". Many homes are built on land, and either come with the land itself as a package deal (almost all standalone residential property is like this, in the UK it would be "Freehold") or is offered as a long lease with an inherent interest in the land (more common where multiple homes share footprint, in the UK "Leasehold" or the more modern "Commonhold").
The building doesn't appreciate, if you spend $5000 on home improvements or repairs almost invariably an honest agent will tell you the value of the building was only marginally increased by doing this, because it was never the building value that mattered.
Where people just own the building and NOT the land, "mobile homes" or "manufactured homes" depreciation destroys the value of the home relatively quickly, within a lifetime usually.
Primary reason is that property has a stable value as you said.
There is also another reason. In most jurisdictions a mortgage is a super senior claim. It is senior even to the taxman, which is very rarely the case for private debt.
1) Imagine you own 10 houses outright. Congratulations, you're worth $5 million dollars! You want to spend some of that on a boat, but it's not liquid fungible money, so you can't, not without some intermediary steps that inject liquidity into your situation. You're basically solvent, no bank owns a claim on you.
2) Now, imagine you "own" 10 houses, only they each have a $500,000 mortgage. You are worth negative $5 million. But it's okay! You rent them out, and generate enough revenue to pay the mortgages. Again, you're solvent.
3) Repeat #2, only without the rent revenue. You're insolvent.
This doesn't mean insolvency & illiquidity can't coexist, but one is not an extreme form, nor does it necessitate, the other. You can be insolvent but very liquid. You can be illiquid but solvent. You can be insolvent and illiquid (which is basically #3 above)
Yes, I understand that it's possible to be illiquid but solvent. I understand the concept of not being able to buy things with the house directly so you have to get a loan. I understand that those terms have different definitions.
My point was that, when the illiquidity is sufficiently advanced -- when you the actual ability to sell is far enough into the future, and the possibility of making a sale is increasingly dubious -- then those judgments of how much it's "worth" become likewise dubious, and the venture is more reasonably characterized as insolvent, because the unwillingness of others to buy means the property doesn't have a value that supports its status as sufficient collateral.
Also, in your example, assuming (which was the thing I was conditionally disputing) that the real estate really is worth the $5 million, you'd be worth $0, not negative $5 million.
You're right, I'm wrong, it's a debt that counts against you, but also an asset that counts for you, cancelling each other out (assuming market value of the home == mortgage amount)
Aside from the fact that you can easily borrow money for lunch in a variety of ways, the main difference is that banks almost never default, compared to individuals.
Only one bank has failed in the US in the last two years.
This feels like a circular argument: Banks get bailed out, because banks always repay their loans, because banks can’t go broke, because banks get bailed out.
Not really. It's more like, when a bank fails, there's a system in place to ensure a quick, transparent sale of assets to another financially sound institution.
This is true- but for perspective in 2010 around 100 U.S. banks went under (actually seized, closed, and merged out by the FDIC).
But yes, it’s far easier to get funded as a bank than an individual, mostly because there are laws, institutions, and processes to try and remedy problem banks if trouble happens and individuals are really on their own to find advice and resources.
EDIT: I was wrong, according to FDIC it was 157[0].
> Only one bank has failed in the US in the last two years.
That's not really that comforting, especially when there were 8 failures in 2017. 2018 was the first time since 2006 that there wasn't a bank failure and multiple bank failures. 2006 was also the last time we had consecutive years without a bank failure.
I wonder: as a percentage of the total number of banks, how does this compare to individual bankruptcies as a percentage of the total population?
From a quick search: apparently in 2017, there were 767,721 non-business bankruptcies in the US. That's about 0.236% of the population.
And that year, there were 4,909 banks. 8 failures would represent 0.163% of them.
So it looks like individuals were a bit more likely to go bust than banks in 2017, but those figures aren't really all that different.
(I haven't checked exactly what these figures mean, or how authoritative they are. Just wanted a ballpark idea...)
OK, we probably should exclude children from the calculation of the individual bankruptcy rate, which would make it look rather worse. Still, the difference between individuals and banks isn't as dramatic as I'd have expected.
You can borrow money interest free for 4-7 weeks for lunch by using a credit card. These banks are borrowing money with interest for one day (overnight) to keep solvency and liquidity.
This isn't a bailout. The Fed is there for this specific reason, to ensure the market functions smoothly. The money injected into the repo market ensured that things ran smoothly. I would think they would simply unwind the repo positions as normal when the forcing factors on the market resolve... With no money lost or won...
Think of it as lubrication for a system that is a bit squeaky in some places.
The Federal Reserve implements its mandate to control interest rates and inflation by managing the money supply. Specifically, they do that by creating and destroying money by buying and selling government bonds on the market, until the price of those bonds is such that the interest from holding them falls within the target interest rate range.
When certain interest rates were, for a moment, excessively high, they took a modestly extraordinary step to intervene. That's all.
Bank bailouts were a bad idea that increased moral hazard and left the economy more at risk than it was before, but this isn't a bailout, and the commentary is about as topical here as a generic Microsoft rant on a random HN article about compilers.
And you get good credit by proving to banks that you won't run off with their money. In fact, they will loan you $1000s each month at 0% interest if you pay it back the next.
HN comments tend to have more charity than other places online – it's unlikely I "proved his point" by answering his query regarding if it's a bad analogy :)
Its not that "no one cares" about "a little guy", it's that even though I didn't eat lunch today, my colleagues did. If me skipping lunch meant my colleagues didn't have any food, someone would step in to avoid my colleagues dying
Presumably it's because if a bank goes under, the economy can quickly nosedive (see 2008). If you can't get lunch, you're hungry for a couple of hours, but the world pretty much goes on unscathed.
It's hard to make analogies between household finance and corporate/national finance. Modern finance is a huge and complex topic. If you haven't and are interested, start with some basic economics, then move on to more focused topics.
There's a middle ground between making it impossible for certain private companies to fail (basically turning those industries into a permanent oligarchy) and saying "fuck it, let it burn".
As the income and wealth disparity, between people and between generation, the number of people thinking "let it burn" increases. A lot.
This is then multiplied when those people are those who actually do the work. Rich people in retirement homes can't get their stocks and 401ks or whatever to wipe their asses.
also a layman, but i think a lot of people feel the same way, and it’s (as far as i can see) one of the motivations for a lot of the political change going on in the u.s
one other thing though, that i think about a lot is:
why do we even have a system that needs so many bailouts and adjustments and hacks to keep it going... seems like our “economic os” is lacking “memory protection”...
Basically, the Fed issued a bunch of promises of positive growth in order to get businesses or people with money (cash) to dump that money into the banks to increase liquidity if I'm understanding this right.
The financial market actually only gets into trouble when money (capital reserves) get low in comparison to balances/liabilities. "Money now" being in the right places is more important in keeping things going smoothly than "Money Later" being dumped into the market.
"Money Now" shortages cause bank runs. "Money Later" (Treasury Bonds) excesses tend to attract "Money Now" when people want somewhere safe to plop "Money Now" to get back "Money Later". The extra "Money Now" allows interest rates on lending to drop.
As I understand it, low "Money Now" supplies are responded to by lending at increased rates, because the bank in question can't just issue loans without the capital to service them.
Or something like that.
Shit, I don't even know if I managed to help. I just spent a week pouring over economics stuff to try to make sense of it all, and I'm still not sure I'm grokking it.
It would help if much of the financial industry didn't purposely obfuscate the meanings, uses, and ramifications of use of their tools. There seems to be a lot of euphemistic jargon in use, for example.
try holding the world economy hostage with a massive amount of capital you've accrued through a combination of violence and abuse of capitalism's boom-bust nature for decades. then if you miss your lunch you can probably get someone to cover it : )
> I just think it's funny that rich people can get billions of dollars to stay solvent in a sudden crisis, and I can't get a dime when I can't pay for lunch.
i think that says more about your relationship with your friends than it does the banking system.
Given that these sorts of things can shock the economy, we usually have significant more wiggle room at all times to deal with coincidences like this. The fact that we're running out of wiggle room is the sensational problem. It's not like these coincidences haven't been happening since 2008..
Seems like a pretty bad idea in an ostensibly good economy. QE was considered dangerous and hypothetical until 10 years ago and that was an actual crisis. Do you see some danger in normalizing QE (even in more niche markets like overnight)?
QE is a pretty sneak way to keep a stagnated economy going. And, lets be clear, the stagnation is happening because trillions of dollars are hoarded in financial schemes whose only goal is to produce interest, not on producing anything. The biggest example we have is the way big corporations are furiously repurchasing their own stock. This is a huge fortune spent every few days for no productive reason, with the only goal of making big company returns to look more attractive than they are. All the money pumped in this economy is going for share repurchasing programs, stock market investments made by funds in these same companies, real state speculation, and a small portion into venture capital for companies that for their own nature have uncertain returns.
>The biggest example we have is the way big corporations are furiously repurchasing their own stock. This is a huge fortune spent every few days for no productive reason, with the only goal of making big company returns to look more attractive than they are.
Stock buybacks are the same thing financially as a corporation issuing dividends except that with a buyback, the holder isn't forced to take a taxable event. It's almost always better for the owners to receive buybacks rather than dividends, especially if the owners pay income taxes.
They're not the same thing financially: with dividends, it is much easier for shareholders to invest the money in some other company that is better managed. Stock buybacks give the illusion of profit growth, when in fact the profits per share are engineered by company executives. The biggest winners in this arrangement are without question the executives, who practically guarantee share growth and, therefore, large bonuses.
It is not an illusion. Companies state the buyback amounts and outstanding shares. The market for the most part is quite savvy and knows how to price in these mechanical changes. Nobody is being fooled at scale.
Oh brother. There's no illusion. I guess the average guy off the street doesn't get it, but no one in the finance world is fooled into believing a share buyback increased profit. Not a single one. It decreases share count in exchange for cash. Pure balance sheet transaction.
Stock purchases are no different than dividends, which have been around forever. The only difference is being forced to realize tax gains (on the shareholders’ parts).
Returning money to shareholders is much better than pissing it away on whimsical experiments because the market is a better investor than some exec board at a company sitting on cash.
People are not having many children. This has a long term effect, which will last decades. QE will become more and more necessary, as the decades go by, if birth rates remain low. Of course, we could, instead, have the government build things. I live in NYC, I would like to see the government build a new subway system. I'd like to see a system of walkways above the streets, where people can ride their scooters without having to worry about automobiles. I'd like to see the government buy up more land and convert it to parks. We need a vast system of dykes, to keep the coasts safe, in a century when the oceans will be rising. For the New Jersey, New York and Connecticut tri-state area, I can think of $1 trillion in improvements I'd like to see. Other parts of the country also need improvements. Let's say $10 trillion over all. Over 20 years, that's an extra $500 billion of spending a year. If we had that kind of stimulus, we would not need QE.
But birth rates are low, so demand is going to be depressed for many decades to come. So we will need something, either fiscal stimulus or QE.
By the way, when I say birth rates are low, I'm very much including China. The one child policy has global effects. World wide interest rates would be wildly higher if Chinese families had continued to have 4 to 5 children, which is that they were having right before the imposition of the one child policy. It's because China has so few children that they have so much savings, leading to the global savings glut that has given us interest rates near 0%.
I don't know if its a good idea to continue either, but Japan has been actively doing something similar for a while now. It hasn't caused catastrophe, but it hasn't pulled them into high growth either - but it could be argued that there are other factors affecting the overall economy there (the graying and shrinking of their population for one).
They don't have the worlds reserve currency nor run twin deficits, fiscal and trade. Their defense is largely supplied by the US also.
So much different outcome for US with large trade deficit and ever growing fiscal deficits. Some argue if we did go the route of Fed monetizing (which almost certainly has to happen) the $ will be value much lower than it is today. This would help to close the trade deficit though, and repatriate some lost industrial capacity, boosting exports.
This is a pretty technical subject with a lot of moving parts so it's hard to really have a full understanding of things. This is not a one-off event and can easily happen in the future under similar or different circumstances unless the Fed makes some changes (that they've been seen behind the curve on). This is easily dismissed right now but this happened under relatively calm market conditions. When stuff like this happens under more volatile markets stuff breaks really quickly.
The Fed is not behind the curve. The Fed's role is to keep the inflation at target rates. Not finance structural budgetary deficits through quantitative easing.
Isn't this working as intended? Where else does the FED actually "enforce" its short term fed funds rate? I mean how else the current 2.00-2.25% rate is forced onto the financial system? Why else would anyone even care about what the FED funds rate is?
In my home country the central bank rate is enforced by providing central bank deposits and central bank loans, available in unlimited quantity for commercial banks. When the market gets cash congested (like here) banks just start tapping the infinite central bank credit line, at central bank rate. Similarly if the market gets flush with cash banks just deposit it at the central bank. Ergo the market interbank lending rate is always between the central bank deposit and credit rates.
The fact that it doesn't normally happen is like when most purchased options are not exercised but sold back. Yeah, sure, but if there was no possibility of exercising them then options would have no value. So it has to be there, then we can safely almost never use it.
> I mean how else the current 2.00-2.25% rate is forced onto the financial system?
Traditionally, Fed used open market operations to target the fed funds rate. This entailed either buying/selling treasuries or conducting repo operations (as was done here). This was a corridor system, as banks could earn no less than 0% interest keeping reserves on the Fed's balance sheet (no negative interest) and could finance at a cost no higher than the discount rate in which banks borrowed directly from the Fed's discount window (this, however, sent a very negative signal to the market).
For the past decade, the Fed has relied on interest on excess reserves (IOER) to target the fed funds rate, a policy known as a floor system. Here, banks earn a given interest rate on reserves kept on the fed's balance sheet. The floor system theoretically ensures short term rates do not drop below the IOER rate (although it is not always the case). This does not entail engaging in open market operations.
> Why else would anyone even care about what the FED rate is?
All dollar interest rates are impacted in one way or another by the fed funds rate. The strength of the dollar is also impacted by the fed funds rate, as it may become more or less attractive to keep balances in the US. The floor system currently employed makes it less attractive for banks to use excess reserves to make loans, as the risk free rate (on the fed balance sheet) is greater. This diminishes the money multiplier effect that banks have.
Additionally, some foreign institutions are able to keep money on the fed's balance sheet, helping them avoid negative interest rates. Again, this disincentivizes them from making loans and also undermines monetary policy implemented by their local central banks. Finally, some currencies have a USD peg (e.g. HKD). These pegs effectively import Federal Reserve monetary policy (to help mitigate the risk of currency crises) which affects the local economies.
It sounds like you agree that this is the mechanism of choice used to push down overnight interbank interest rates to keep them in line with the federal funds rate. IOER, by design, provides just a floor. Discount rate is, by design, quite a bit higher than the fed funds rate, and is only tapped for credit in emergencies.
Also this is what Wikipedia says on the topic:
> The (effective) federal funds rate is achieved through open market operations at the Domestic Trading Desk at the Federal Reserve Bank of New York which deals primarily in domestic securities (U.S. Treasury and federal agencies' securities).
> Discount rate is, by design, quite a bit higher than the fed funds rate, and is only tapped for credit in emergencies.
That's right. Open market operations were traditionally used to target the fed funds rate. The discount window does serve as the upper bound though in extreme cases. Typically, reserves would be loaned overnight between banks on the fed funds market. This market has been decimated by the floor system.
> IOER, by design, provides just a floor.
In theory, yes. It has also acted as a ceiling. Not all institutions with access to Fed's balance sheet are able to receive IOER (e.g. GSE's). These entities loan the money to banks overnight at a rate below IOER. The banks then earn IOER on that money. This arbitrage can lead to an effective fed funds rate below IOER.
> This market has been decimated by the floor system.
You mean there has been so much cash around that nobody really needed to get cash via the fed funds market, for quite a while? It does seem like the spread between fed funds and IOER is generally just a few bp, maybe even 1bp sometimes, which I guess is where the "ceiling" you were talking about comes from:
> You mean there has been so much cash around that nobody really needed to get cash via the fed funds market, for quite a while?
Prior to IOER, banks needed to lend money on the fed funds market to earn interest on any excess reserves. Doing so exposed them to the credit risk of their counterparty. Once it became possible to earn IOER risk free, banks had no incentive to expose themselves to the credit risk. Since banks (of all sizes) could not then rely on being able to access the fed funds market for liquidity, it became necessary for them to keep more reserves at the Fed. Perversely, as the quantity of reserves held at the Fed increased, interbank lending decreased (for more detail, see [0] pages 33-39).
> It does seem like the spread between fed funds and IOER is generally just a few bp
Until recently, it looks like the spread has been roughly 5-17bps [1]. For a floor system, it seems rather odd that this would exist at all, especially for a period of a decade (see [0] pages 18-19).
This is all true. But it is worth noting that the Fed has increasingly tried to apply untraditional monetary policies. For instance with operation twist, the Fed was trying to control long term rate with bond buying. Also I believe they also keep an eye on repos, not the least because it will be the basis for SOFR, the replacement of LIBOR.
If you look at the trading desk logs, most recent operations have been reverse repos rather than repo operations. In other words, this week the Fed lent cash & borrowed treasuries to inject cash into the market, while in the recent past it's mostly borrowed cash & lent treasuries to remove cash from the market.
That's consistent with the recent shift from a tightening (rising rates) environment to a softening environment. I agree it's not particularly newsworthy.
> "The Fed won't admit this," Cabana said, "but it looks and smells an awful lot like the monetary authority is financing the fiscal authority."
Frightening... if true. I hope Matt Levine's explanation (cited by mrosett) is the correct one.
But also, if short-term rates are spiking (even if it's a rather different type of shrt-term rate), does that mean that the Fed was incorrect to drop the rate at its last meeting?
This has almost always been the case. The government is a huge part of the economy and risk-free debt is a huge part of liquidity. It is boring but stuff like the timing of payments matters. Paying taxes is a big, lumpy issue...and the reason the Fed came into existence was because of big, lump payments relating to the crop cycle (i.e. money becoming tight every year as banks lent to farmers...iirc). And before the 1980s (maybe the 70s), liquidity was the primary concern of policy-makers (you can go through FED minutes in the 1960s from ALFRED, the main policy tool was free funds).
What happened is nothing to do with the level of rates. It is to do with the volume (and often the location) of liquidity (location because tax payments just go on deposit somewhere else, but it still causes a dislocation).
People just don't like how resources are appropriated as they are subject to a different work mechanism in exchange for resources and not everyone else is. These headlines are mainly to trigger that sentiment.
I dunno, a lot of the mechanisms mentioned in thread sound pretty socialistic, and at any rate dispenses with advocacy for free markets fairly completely.
Maybe it's time for the system to admit this, it can't be worse than universal health care.
> "There is not enough cash in the banking system for the banks to meet all of their liquidity and regulatory needs. I'm not that worried, because the Fed will fix it."
I for one am deeply worried, because this pretty much looks and quacks like a liquidity crisis, so it might as well be a liquidity crisis, I've last had this feeling in October 2008. At least that's what "not enough cash" means to a layperson like myself.
No, it means that the federal funds rate has begun to stop responding to changes in the Federal Reserve's overnight rate based on supply and demand. The Federal Reserve will be required to use other policy tools, such as QE, if it wants to exert greater influence on interest rates.
I was wonder the impression that banks could always borrow reserves from the Fed at e.g. 100 bps above the Fed funds rate target. Guess I was mistaken?
I believe the idea is that not all entities and institutions are eligible to borrow via the FED discount window, e.g. there is the primary credit system (primarily banks), and the second credit system (for some other low risk entities). Thus the repo market serves this segment of the market for liquidity.
>the whole reason they exist is to manage the money supply.
That's a lot like saying the whole reason google exists is to help people find information. There are greedier reasons for these organizations to exist.
> That's a lot like saying the whole reason google exists is to help people find information.
No it's not.
> There are greedier reasons for these organizations to exist.
Any “greedier reason” for the Fed is a particular application of managing the money supply; it to exists to manage the money supply, independently of whether it exists to do that for the public interest or “greedier reasons”.
Something I've always wondered about overnight lending. All the money is basically repayable at one point in time, the start of business in the morning. What happens if theres a problem? What happens if a banks systems crash and that money can't be repaid, presumably having knock on impacts on the next days overnight lending.
I'm not suggesting it would be an end of days scenario, just curious.
Failing a rescue from a central bank, you could have a bank run.
I still don’t know why the ordinary payments system has to be coupled with hedge funds and derivatives and whatnot. It should be completely separate. It’s like having your car explode because a cup holder got a crack.
The system is coupled with hedge funds and etc. because the money they use come from banks. Goldman Sachs and others don't have the money to maintain all their obligations, it all comes from other banks that loan the required funds. When there are problems in money part of the banking system, everything goes down.
But that's what central banks are there for, to provide emergency liquidity to regulated banks in order to support the stability of the financial system.
Also do consider that most contracts include grace periods for technical glitches.
But the first line of defense is the enormous amount of cash and liquid assets banks are required to hold to ensure they remain liquid.
So it could be as bad as that? It's kind of why I asked the question, but I thought there would be a rule or process or something. It's 'nice' how occasionally you get a glimpse at the gaffer tape and baling twine holding the world together.
One of the problems is intraday liquidity. Long story short, financial regulations and Treasury supply have forced banks into holding securities that are unable to provide intraday liquidity. It's very hard to have a repo spike like this when excess reserves are actually plentiful.
> On Tuesday morning, the NY Fed launched what's called an "overnight repo operation," during which the central bank attempts to ease pressure in markets by purchasing Treasuries and other securities.
It was my (perhaps mistaken?) understanding that the Fed operates an overnight repo facility regularly - like, every night. It reads like CNN is reporting this like an exceptional emergency maneuver. Is the newsworthiness in fact just the size of the liquidity injection, and CNN is a little confused about what the ON repo does? Or am I mistaken about the Fed making overnight repo agreements regularly?
It's an overnight transaction, it should go away very quickly.
The Fed has been surprisingly consistent in its reduction of QE [1]. There is no way QE will be drained by the next recession but what is interesting is that they keep draining even though they are considering lowering rates. I am surprised it doesn't have a bigger impact on the market given how large of an impact QE had on the way up.
I suppose it's not something that the Fed would want trumpeted in every paper, but thanks for informing me that they were reversing QE. I agree, you would think that the effects of selling off a half trillion in assets per year since the beginning of last year would be much more substantial. Didn't they buy up a whole bunch of mortgages?
Originally read this headline as "NYFD rescues overnight lending market with $53B" and momentarily thought the calendar photoshoots were more than just a joke.
This is the best technical write-up. Most mainstream financial reporting will focus on explaining repo so hard to get into the details, and the truth is that 95%+ of those who work in financial services have no idea what the repo market is.
> A sudden surge in the overnight rate on Treasury repurchase agreements that began on Monday continued Tuesday -- with the rate opening at 7%, according to ICAP. …
> What happened was an unfortunate coincidence -- just as companies were withdrawing cash from money markets to pay corporate tax, a glut of new bonds appeared on the market as the U.S. government sold some $78 billion of 10- and 30-year debt last week.
> With just $24 billion of bonds maturing in the period, this became one of three occasions this year when the imbalance between debt redemption and cash needed to buy new Treasuries exceeded $50 billion.
Again, if those paragraphs don't obviously relate to the overnight lending market, read his column for context.
[0]: https://www.bloomberg.com/opinion/articles/2019-09-17/wework...
[1]: https://www.bloomberg.com/news/articles/2019-09-17/it-starts...