This week from Monday, Sept. 16 to Wednesday the 18th the banking system had a bank and bond market “repurchase” (repo) market crisis. The repurchase market (repo) is where a bond dealer buys a Treasury bond and then finances the purchase by selling it and agreeing to immediately repurchase it (allowing the dealer to get cash), somewhat like a loan. Normally the interest rate for these is about the same as the Fed funds rate, about 2%, but on Monday it spiked to 9.5%.
The problem was caused by unwisely written overly strict rules such as the Liquidity Coverage Ratio which is a stress test based on extreme hypothetical conditions like the crash of 2008. Even though there has been a huge amount of excess reserves in the banking system since the 2008 crash, the new rules caused an artificial shortage of funds.
The Federal Reserve has stepped in this week and lent additional funds to dealers who were in need of funds and thus it should become a non-issue.
Basically the modern system of central banking has tremendous abilities to fix an intangible type of financial problem such as an alleged bank failure by simply printing up money and lending it to a failing or allegedly failing institution. The key is that since it is hard to measure whether or not an asset is fairly valued then the Fed can simply allege that an asset isn’t impaired and can lend against it and create a fantasy that no need exists for a crash, a bank run, or for an asset to be labeled an impaired asset, etc.
I suspect the catalyst for Monday’s bank dealer flash crash was that bankers working at the giant big six banks that have 90% of the banking industry assets became overconfident (because they became spoiled by their oligopolistic power) and didn’t adequately plan ahead for the possibility that all the banks with surplus funds available to lend were already committed and thus, in fact, for that particular night there was an inadequate amount of lenders ready and able to lend.
It is inevitable that a recession will eventually occur, since it has been 10 years since the last one. However, when it comes, I expect the central banks to “solve” problems of an intangible, financial nature by simply printing and lending to banks so as to prop up the banking system and create the appearance that all is well. The thing central banks can’t do is they can’t fix problems of a tangible nature such as lack of demand for goods available for sale. Central banks are not going to buy up unwanted goods, etc. to create jobs. Thus the coming recession will be full of stories about a loss of manufacturing jobs, excess inventory that no one is buying, etc. But the recession won’t have many big stories about failed banks or insurance companies because the regulatory system learned a huge, dramatic lesson in the 2008 crash: don’t ever allow a systemic failure of financial companies, etc., instead prop them up with loans from the Fed of newly printed money.
In this week’s mini-crisis no one was claiming the banks and brokers have any financial distress; instead it as an artificially induced panic.
People interested in following up on bearish scenarios should not waste time looking for “clues” about a systemic crash associated with a highly intangible phenomenon like the bank dealer repurchase (repo) market, but should instead look at more tangible topics such as unemployment, trade barriers, the ISM index, manufacturing, GDP, etc.
Investors need independent financial advice about the risks of misunderstanding banking crashes.