Fear the Repo, Man
Effective July 29, 2021, the Federal Reserve directed the New York Federal Reserve’s Trading Desk (the Desk), to:
Conduct overnight repurchase agreement operations with a minimum bid rate of 0.25 percent and with an aggregate operation limit of $500 billion; the aggregate operation limit can be temporarily increased at the discretion of the Chair.
What does this mean?
Per the Desk:
In a repo transaction, the Desk purchases securities from a counterparty subject to an agreement to resell the securities at a later date.
As the Fed announced, through the domestic Standing Repo Facility (SRF), they are willing to create up to $500 billion in order to buy securities such as US Treasurys or mortgage-backed securities (MBS) from primary dealers like JP Morgan Securities. The following day, the primary dealers will buy the security back, but at a higher price, which equates to an interest rate of 0.25 percent.
Whether it's for emergency purposes or so the institution can think of a creative way to use the loan has yet to be seen. “Over time,” the facility is expected to be available to depository institutions.
It doesn’t end there! A second facility was announced under similar terms, but offered to “Foreign and International Monetary Authorities” (FIMA), which encompasses “foreign central bank and international accounts maintained at a Federal Reserve Bank.” The limit for each counterparty who takes the Fed’s offer is $60 billion, whereas no cap per counterparty was specified for the SRF.
The newly announced SRF and FIMA repo facilities are not to be confused with reverse repos, which are similar but follow the opposite arrangement, as the Desk explains:
the Desk sells securities to a counterparty subject to an agreement to repurchase the securities at a later date.
In a reverse repo (RRP), firms are in effect lending money to the Fed and currently making 0.05 percent for their service. The volume of RRPs that primary dealers are currently utilizing has now surpassed $1 trillion.
There are various explanations for why the Fed might want to engage in repo transactions, but the explanation offered in the press release was:
These facilities will serve as backstops in money markets to support the effective implementation of monetary policy and smooth market functioning.
Chair Jerome Powell echoed the statement when asked about the new facilities in his latest address:
So it really is a backstop … it's there to help address pressures in money markets—money markets that could impede the effective implementation of monetary policy. So, really, it's to support the function of—functioning of monetary policy and its effectiveness.
The repetitive nature of Powell’s speech as he echoed the press release doesn’t offer much comfort. Given the recession has long passed, and anything cataclysmic like a bank failure doesn’t seem to be on the Fed’s radar, it’s unfortunate they’ve given the public little more than the “smooth market function” rationale. Hollow phrases have the ability to permit every action by the Fed, but in no way do they constitute an explanation based on economic theory.
As for the reverse repo facilities of $1 trillion a day, these overnight, nearly risk-free and lucrative trades deserve some reflection. But can anyone blame an institution for making what practically amounts to “free money” by lending to the Fed? Of course, they’ll never explain it as such. Rather, Powell says:
[S]o we think it's doing what it's supposed to do, what we expect of it to do, which is to help provide a floor for money market rates and help ensure that the federal funds rate stays within the target range.
Therefore, it’s important the wealthiest institutions in the world lend $1 trillion to the central bank for overnight lending, quite possibly with money they created out of thin air itself, in order to keep rates in the appropriate range, says the Fed.
Domestic repos, international repos, and reverse repos; once the financial schemes are invented, they have a habit of never going away. On top of that, they continually reinvent themselves in new and interesting ways, while the dollar amounts continue to increase ever so steadily … As of this writing, no plan of winding down these facilities has been noted.