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2020-01-15 07:00 by Karl Denninger
in Federal Reserve , 475 references Ignore this thread
What The HELL Is Going On?
[Comments enabled]

The market is flat-out ignoring what are clearly emergency measures being taken by The Fed.

There's only one thing worse than an emergency, and that's an emergency that people are actively trying to hide.

What am I referring to?  That The Federal Reserve has been frantically adding reserves to the financial system in an amount that is utterly stunning, running well north of $400 billion over the last four months.

A quick primer is in order here.  "Repo" transactions are undertaken all the time in the financial system.  The purpose of them is to balance reserves between banks.  Let's say you buy a $250,000 house.  On the day you close $250,000 leaves one financial institution (your lender or, if it's a cash deal, your bank) and is wired to the seller (through the title company, which deducts the various fees and such that are due.)  That's a large hunk of cash that leaves one place and goes another.

Now on-balance banks tend to be on the "selling" and "buying" side about equally.  That is, you're not the only one buying or selling something among their customers and affiliates; lots of people are.  Therefore most of the time the net change between these banks is small or non-existent.  But not always -- there are, for example, certain dates where very large movements tend to take place, such as tax deposit due dates for estimated taxes, dates for corporate and personal income taxes, and the end of the year when people tend to do an outsized amount of moving things around for tax purposes (either to take advantage of a lower rate on this year's taxes than the anticipated rate next year, or to crystallize a loss, etc.)

If a bank finds itself out of balance with where it wants to be (or worse, where it has to be for regulatory purposes) in terms of reserves it uses a repo operation.  Tri-party repos, the most-common, are held ("secured") by the NY Fed which is the custodian and executed between the parties.  So if Bank #1 is "heavy" $500 million in cash and Bank #2 is "light" $500 million in cash Bank #2 can post up some sort of collateral, usually Treasury bonds or Mortgages (frequently in securitized form) that it holds with The Fed as collateral and borrows that money from Bank #1.  For this Bank #2 pays a fee, typically right about the Fed Funds (overnight) rate, which is of course 1/365th of it assuming that loan matures the next day.  When the loan matures the transaction is reversed; the cash is repaid and the securities returned.

The important thing to remember is that this goes on every day and is completely normal.  But, there are two facts that together make no sense.

First, there is supposedly $1.3 trillion, more or less, in excess reserves on deposit with The Fed.  That's an aggregate amount but it's utterly staggering.  This, if it's really there, is free cash that the banks have that they're "storing" with The Fed but do not have to keep on hand, thus the name "excess" reserves.  This is distinct from required reserves which the bank may not dip into.

Note that since these are excess reserves and the belong to the bank in question there is no fee involved in grabbing and using them on a temporary basis to balance one's books.  It costs nothing to do that, where to go into the Repo Market to obtain those funds costs money.  The IOER rate is currently 1.55% where the Fed Funds rate is 1.5 - 1.75%.  A Repo transaction typically costs slightly more than the IOER rate.

But, and this is important, unless something severe is wrong it will never be other than slightly different.  Why? Well, why would you pay (for example) 5% for an overnight Repo when your opportunity cost on an IOER pull-back is 1.55%?

Put another way how many people do you know who intentionally hold a bonfire out in their back yard and burn $100 bills?

That's what I thought.

Second, repo loans are secured with Treasuries or other very solid collateral.  The key point is that the value of that collateral should not change at all during the time of the Repo.  If it does one side or the other has an incentive to default on purpose because they can stick the other side with the asset that has moved the wrong way against them.  There is no premium built into these transactions to compensate for that and worse, it results in the screwed party winding up with more of what they don't want and less of what they do.

So in September suddenly there was a dislocation in this market that came without warning.  The rate for these overnight loans went from around 2% to roughly four times that amount.  This is what caused The Fed to start offering Repos on their own, rather than allowing the market to do it as it usually does.

And finally, the amount of liquidity that The Fed has injected in these operations is several multiples of the maximum amount they ever took during the financial panic in 2008 and 2009!  In fact the maximum is on the order of four times the maximum ever taken down during the 2008-09 time frame.

The problem is that The Fed has refused to explain why that was necessary and why it still is even today -- that is, who (or more-likely, what set of "whos") was refusing to transact without charging an utterly ridiculous penalty rate and why.

Worse is that The Fed has continued to add to the outstanding repo amounts and now has over $400 billion outstanding.

This last week a small "take back" occurred in that some of the original issues from September forward matured -- but that's the first "take back" that has happened since this "problem" showed up.  Up until that point this was a one-way train.

The stock market is ignoring this set of facts, going bat**** crazy to the upside with all this extra "liquidity" in the market which it assumes is a "gift" and so is the bond market.  They damn well should not; both parts of said market should demand answers to the following questions and so should you.

1. The Fed claimed this was a short term problem of a couple of days and tried to blame it on tax remittances at the end of September.  It is true that corporate tax remittances do come due at that time.  However, if it was a couple of day problem for that reason they would have taken it all back in the ensuing weeks and they did not; they instead increased it.

2. The Fed then claimed that a similar event might happen over the end of the year.  That's plausible; there is a large funding demand right at the end of the year, as I've pointed out.  However, they didn't remove the excess funds in the three month intervening period!

3. There is allegedly $1.3 trillion, or three times plus a bit, the $400 billion The Fed printed out of thin air, on deposit with The Fed in the form of excess reserves.  To use a Fed Repo facility you must pay interest.  To use your excess reserves it costs nothing other than foregone interest.  Why haven't traders, banks, politicians and you demanded that The Fed explain, in detail, why banks would choose to hold a bonfire in the street with $100 bills in the form of interest charges that are higher than the IOER instead of using the excess reserves they already had to meet daily liquidity needs.  Is the truth that the $1.3 trillion is a fiction and doesn't actually exist?

4. Who had the problem originally, what was it, and why wasn't the $1.3 trillion in alleged excess reserves sufficient to cover it given that it was cheaper, by a LOT in September, and remains cheaper (by a bit) today to do so?  It makes zero sense that this program was "necessary" given the above facts.

SOMEONE IS LYING AND BY DOING SO THEY HAVE ESSENTIALLY CAUSED THE FED TO ACT IN A FORM THAT IS ECONOMICALLY INDISTINGUISHABLE FROM "QE."

If that entity is a financial institution or group of them and they had the money then they have engaged in extortion (a serious federal offense), bank fraud (by claiming to not have reserves when they do; any falsification of a bank's economic condition is a serious felony) and conspiracy to defraud the United States as well everyone in it by forcing The Fed to devalue the currency.  Further, if The Fed knew about it originally or learned about it and has not turned over same to the FBI and Congress then the entire FOMC is criminally complicit and must be indicted and imprisoned NOW.

If the entity is a financial institution or group of them and the excess reserves claimed do not exist then (1) The Federal Reserve itself has engaged in massive fraud along with (2) all the entities who claimed to have said excess reserves but do not.  In this case exactly how it is that The Fed is claiming these reserves exist when they don't, and the banks claim they exist but they don't, must be explained and everyone involved arrested with the institutions involved seized as they are factually insolvent.  In this case everyone involved must be indicted and imprisoned now.

If there was no problem at all and The Fed and the banks conspired together to cause "QE" to be undertaken under false pretense (e.g. to goose the stock market) then everyone involved with either actual or constructive knowledge of same who has said nothing have also committed fraud and, in the case of anyone who has made any official statement on same (e.g. an earnings report, testimony before Congress, etc) they have committed perjury, which is also a felony.  In that case imprisonment is far too kind; we're now in flat-out putsch-by-deception territory among a handful of very wealthy banksters and an arm of the government in the form of The Fed and we ought to be talking about 1776.

If there's an alternative explanation I'm all ears -- let's have it.

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User Info What The HELL Is Going On? in forum [Market-Ticker]
Mtdm
Posts: 725
Incept: 2009-07-23

NH
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So, Im assuming that the entity/entities at the repo window are not the same ones as have the excess reserves.

Not saying that it doesnt stink, but not necessarily for that particular reason ... am I missing something?
Tickerguy
Posts: 161139
Incept: 2007-06-26
A True American Patriot!
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@Mtdm - That's highly unlikely, at least in terms of size. Is there the odd firm that doesn't overlap? Sure. But in the main do they overlap? I'm willing to bet that correlation is extremely high.

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Winding it down.
Beeninacave2long
Posts: 4
Incept: 2009-03-15

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Contrary to the mainstream explanation for the repo market situation, Jeff Snider explains this is not a liquidity issue. This is a collateral issue. Collateral has become shady/toxic. The FED is essentially swapping junk bonds/credit for treasury credits and replacing that toxic sludge in the repo market with treasuries to keep the Repo market working.

I'm curious what the forum thinks of this explanation.

See Jeff Snider's explanation in this youtube video: https://www.youtube.com/watch?v=w5AR-KBV....
Tickerguy
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@Beeninacave2long - That's basically what I was pointing out, in that (1) this issue has ALWAYS existed but (2) when rates are extremely low, as they are now, the risk goes up.

What is the value delta in underlying collateral over the Repo period that is necessary to make it worth it to stick the other party with it?

The premise of a Repo is that the collateral will NOT change in value. If it does, because the daily interest charge is so small, it is DEFINITELY worth it for one of the parties to default on purpose (strategically) and stick the other with the collateral. This ****s one of the parties and GREATLY enriches the other.

But more to the point, if that happens it destroys the mechanism because the entire premise of a Repo is that this WON'T happen. Well, ok, but what prevents it from happening other than convention? STABILITY OF THE COLLATERAL OVER THE TERM.

If that stability is threatened......

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Winding it down.
Aztrader
Posts: 8493
Incept: 2007-09-10

Scottsdale, AZ
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Saw this on ZH yesterday. Isn't this completely illegal?

https://www.zerohedge.com/markets/fed-co....
Asimov
Posts: 113028
Incept: 2007-08-26

East Tennessee
Online
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If this is a bank or a group of banks, SOMEBODY knows who it is. Just like they knew the last time.

Look for unusual options activity? One that has offered competitive rates before but isn't anymore?

Not sure if there's any way to narrow it down, but I am sure of one thing - somebody's going to make multiple fortunes off of it, just like they did last time.

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It's justifiably immoral to deal morally with an immoral entity.

Festina lente.
Truthseeker
Posts: 9020
Incept: 2007-10-07
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Southern Oregon
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Are we seeing the reemergence of the toxic paper buried in 2008-2009?

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"...But people better realize that the worst-case scenario could actually happen.9/11 happened. This can happen. An economic 9/11, the likes of which we've never seen." Gerald Celente
Tickerguy
Posts: 161139
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@Aztrader - Not technically. Under The Fed's charter they could actually lend you money directly to buy a car, house, etc.

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Winding it down.
Mtdm
Posts: 725
Incept: 2009-07-23

NH
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Ok, fine, I take your point. Now, the question in my mind is whether this is a case of (i) one big institution in September was close to failing and the Fed said we all accept your crappy box of chocolates in the repo market to save you ... followed, since then, by other entities going to the Fed and blackmailing then with - well, you took crap collateral from those guys so take ours too or well (insert threats here) ... or of ... (ii) lots of institutions are close to failing and they all need this accommodation in order to avoid doing so.

I mean, at some level once its a crash it all comes down so maybe theres not much of a distinction to make between the two scenarios... but my cynical gut suggests it is more a case of (i) than (ii).
Tickerguy
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Someone's passing off dog**** as chocolate

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Winding it down.
Aztrader
Posts: 8493
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Scottsdale, AZ
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Just saw this article pop up. This guy nailed the list of fraud:

https://www.zerohedge.com/markets/32-mis....
Quik49
Posts: 6468
Incept: 2007-12-11

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Thanks for this KD, was trying to wrap my brain around it...this definitely helped.

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Long Vaseline....

Ktrosper
Posts: 3579
Incept: 2010-04-06

ft collins co
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KD wrote..
Someone's passing off dog**** as chocolate

Shadow-inventories (mortgages that are not being paid on that never officially get put through the foreclosure process) finally coming home to roost?

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The unexamined life is not worth living.-Socrates
The only stable state is the one in which all men are equal before the law.-Aristotle
Liberty exists now in the spaces government has not yet chosen to occupy.-Doc Zero
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Jal
Posts: 826
Incept: 2009-03-25

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Thanks. You made it a little bit clearer.
Larry K. is the perfect example of the lies.( As I write he is on fox pushing his "game")

The elite enablers all went to the same school and are all playing the same game.

Thanks.
Flyanddive
Posts: 4297
Incept: 2008-10-10

Detroit
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We all know what's going on, the collateral is hot garbage. Nothing has been fixed from the early 2000's, the market is narrative driven these days.

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"I've seen people go into real poverty trying to pretend to be rich."
Mooreupp
Posts: 538
Incept: 2007-10-31

Ohio
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Explained whole process great. Thank you.

I am constantly amazed how they can keep things from blowing up fully this long (not that we aren't feeling huge effects still). I wish I was amazed the big economic news sites weren't covering this really.

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The Constitution is the law. It is not, and was never meant to be a "living document."
Attilahooper
Posts: 3239
Incept: 2007-08-28

New York, by way of Montreal Canada.
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Wolf has some good articles on this, I'm still trying to wrap my head around it. Banks are trading in their dog**** until maturity, at which point they purchase it back.

https://wolfstreet.com/2020/01/10/the-wa....


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Changing it up, skate or Die!
https://www.youtube.com/watch?v=-03q9VE0....
Hot-dog-guy
Posts: 225
Incept: 2019-04-03

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"was trying to wrap my brain around it...this definitely helped."

Nope. Not here. I read something about the fed directly liquefying hedge funds and a fuse blew.

I just keep flashing back to the high school cafeteria. Here's the poor kids getting their subsidized lunches. Here's the blue collar kids with brown bags stuffed full of momma's good cookin. The rich kids all piled into their BMWs and they are going to the club and they are trailing cash all the way.

Surely this is the hand of fate. None of us had a hand in creating our situations. We can struggle vainly against our lot in life or stoically accept it. I for one have resolved to carry extra small bills in my pocket so I can sneak up on men in expensive suits and cram more cash in their pockets. Stuff bills through the windows of Lambos and Lincoln town cars. No I insist, take it, take it all! Hold a sign that says DADDY NEEDS A NEW SUMMER COTTAGE IN THE HAMPTONS.

I know, I know, the Hamptons are over-rated. Martha's Vineyard is where it's at.
Little_eddie
Posts: 1367
Incept: 2009-04-30

Delaware
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I still think the trend has changed and rates are increasing and most every one is so far in debt that they can't let it happen.

I think the banks & others can't make the payments out of cash flow anymore and have to close the doors OR go deeper into debt and hope for the best.

I think the fed is praying alot.

This won't end well

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Think of how stupid the average person is, and realize half of them are stupider than that. - George Carlin

From BP's 2019 Statistical Review, page 13: "In 2018, 81% of the global population lived in countries where average energy demand per capita was less than 100 GJ/head, " (The US uses 294 GJ/head for comparis
Drifter
Posts: 439
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Pacific Northwest
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The lessons learned from 2008 is that you can financially******the country and not be burned at the stake.

I read Hussman alot- he claims this isn't QE. Whether QE or no, we are getting ****ed, some way, some how. Anyway, he says:

"...it should be clear why the Federal Reserves recent repo facilities do not, in fact, represent a fresh round of QE. The difference is that the repo facilities replace interest-bearing Treasury bills with bank reserves that are eligible for the same rate of interest. This swap does nothing to promote yield-seeking speculation. Now, the psychology around these repos has certainly been good for a burst of investor enthusiasm and a nice little can-kick. But that enthusiasm isnt driven by actual yield differentials as QE was it rests wholly on the misconception that these repos themselves represent fresh QE."

QE or not QE: I think about the dog that didn't bark in the nighttime-- something is happening and few are noticing the obvious.
Gauntlet33
Posts: 183
Incept: 2009-03-30

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I would advise people, if possible, to have $10k in a safe place outside of the banks' hands...
Click
Posts: 769
Incept: 2017-06-26

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What the hell, indeed. And isn't fractional reserve banking fun?

Firstly, the Federal Reserve has a target where THEY want interest rates to be. They want to be the decider. Like a Borg Banking Collective they want central control of the prime rate. Period. Losing control of the overnight rate would be very bad for the Borg Central Bank, because it naturally pushes up all short-term rates. And if interest rates rise too high too fast, it's game over for the entire centrally controlled system. Right now the Borg Fed wants interest rates kept low... and the liquidity to flow, flow and flow...

On the other hand, Mr. Market wants interest rates to match up with the real risk of lending and/or the supply of money available to make loans. Under normal conditions the rule of thumb is the more risk, the higher the interest rate.

The reason why overnight rates went up is because somehwere in the financial system risk went up. Something happened that caused big banks to not want to make overnight loans and other very short-term loans.

Each and every day big banks transfer a stunning amount of capital in behalf of clients, to FOREIGN BANKS, to each other, to counterparties in behalf of super-wealthy clients, hedge funds and so on and so forth. At the end of the day a bank either has enough "money" on hand or it has excess money or not enough to meet Federal law. Those banks with not enough normally borrow from those with more than enough.

So what happened? Why the spike in overnight rates? Why does Bank A no longer wants to loan to bank B?

The reason why is traced all the way back to "foreign banks" and "clients" and "hedgefunds" and FOREIGN CENTRAL BANKS who have ****ing 16 trillion of negative-interest-rate-toxic-mother-****ing-radio-active bonds and other debt obligations on their BOOKS.... The Euro is going to its intrinsic value (all the smart guys know it) and Bank A simply doesn't trust Bank B's books anymore - especially if the book is packed with negative interest rate ****. So, this situation is something like in 2008 when Bank A didn't trust Bank B. Only this time it's much bigger, because Euroland Central banks have doomed their entire banking system (and currency) with negative interest rates...

And that's all I'm going to say on that subject. Take it for what you think it's worth. When the truth finally comes out, if it ever does, it will be clear that the source of the contagion was Marxist EU and Jap negative interest rates and all of the associated leverage, carry trade and derivative instruments including the massive amount of forwards, futures, options, swaps and all the rest of that financial bull**** stacked on negative interest quicksand...

Pssst. Don't trust any bank, hedgefund or anyone who is exposed to negative interest...







Supernumb
Posts: 29
Incept: 2017-10-30

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@Click nailed it. I was skimming to that point to see if anybody else got it before posting same myself.

It's $18T of EU neg rate bonds that banks will not give face value to as collateral, because face is gone the moment the thing is bought! So either the value is severely discounted (duh) or the rate charged spikes.

Martin Armstrong warned last summer BEFORE September happened. Fed can't hold short end back much longer, major CBs in meetings next week, MA suggests to negotiate backing away from NIRP. If that can happen in a controlled manner and what ripple effect there is on markets, well that's the big question isn't it?
Thomasblair
Posts: 128
Incept: 2009-04-03

NC
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Trying to understand this. So for example on a 100 million dollar tri-party repo the overnight interest would be about 425,000?

1/365th of 1.55% x $100,000,000
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