Danger of a ‘Repo Implosion’ Grows for Wall Street

Danger of a ‘Repo Implosion’ Grows for Wall Street

October 15, 2013 • 4:20PM

Warnings of chaos on the derivatives markets and serious dangers to big banks are now being made to Congress and the public, and the actual threat is starting to appear on the bond markets for U.S. Treasuries. As we reported earlier, on the potential crash implications for the largest banks, of a freezing up of so-called repurchase agreements (repos) by which these banks leveraged themselves up prior to their 2008 blowout and have done so again in 2011-13. They dramatically increased their derivatives exposures at the same time. This leverage depends to a very significant extent on short-term U.S. Treasury bills, whose buoyant prices have been guaranteed by Federal Reserve actions for five years.

Securities Industries and Financial Markets Association (SIFMA) head Kenneth Bentsen complained at length to the Senate Banking Committee Oct. 10 of the great importance of the now-endangered “repo” markets to Wall Street. At the annual conference of the big banks’ global lobby, the International Institute of Finance (IIF), which accompanied the IMF meetings, the mood was described as “bankster panic” by the Daily Beast. PIMCO’s Mohammed El-Arian is quoted as warning, “It’ll freeze the system” if short-term Treasury markets seize up.

On Tuesday the crumbling of these markets accelerated. The Wall Street Journal reported that banks (Citibank and State Street bank are named; JPMorgan Chase was added in Reuters coverage) are trying to protect themselves by preemptively freezing their repurchase agreement operations for Treasury bills below 3 months’ maturity; but this in turn is causing their counterparties, such as PIMCO, Fidelity Investments, and the like to try to sell and exit these markets, and increases the danger.

The yields for these Treasuries had completely inverted in the past week as a result, with the 1-month interest rate reaching four times the 3-month interest rate. One-month bills are effectively becoming radioactive.

But on Tuesday, the interest rate on 3-month bills suddenly doubled, making clear that this freeze-up process will not end with a “deal” which extends the debt ceiling and budget resolution for three months. Instead, that would merely extend the “radioactivity” to 3-month bills, and this is already being foreshadowed.

Forecasts are now appearing of increased hyperinflationary “QE” from central banks, as in the Houston Chronicle Oct. 15 (reporting bankers’ notices and statements), “We May Get a New Wave of Global Central Bank Easing in the Coming Weeks.”

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