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Monday's Reverse Repo Test A Disaster?

Tyler Durden's picture


On Monday the Federal Reserve held a major reverse repo test, as was announced by the NY Fed and by Zero Hedge. We have subsequently received several unconfirmed reports that the conducted test has been a disaster (we have calls into the Federal Reserve to confirm or deny this, we are eagerly awaiting their reply). Presumably, after conducting various repos last year, a typical transaction would be in the $1 to $5 billion range. At around the time the financial system was being pulled apart, were two separate $50 billion repo transactions on September 18, 2008, a day when as Paul Kanjorski had highlighted earlier in the year the money market system nearly collapsed as a result of Lehman and AIG's failure, and the Reserve Fund breaking the buck. Notable about Monday's reverse repo "test" was that it was quite sizable: in the $100 billion ballpark, on parallel with the biggest liquidity extraction from 2008. The outcome was the discovery that the dealer community does not have the capacity to do reverse transactions of this magnitude. As a result the Fed was forced to go directly to the money market industry, which has been speculated as a key source of excess liquidity withdrawals, another topic we discussed previously.

This sets a dangerous precedent on two levels. First, if the dealer community, recently expanded to consist of such middle-market banks as Jefferies which allegedly has over $20 billion on its balance sheet compliments of various Fed repo actions, is unable to satisfy reverse repos of this size, a big question mark appears as to what is the illiquid collateral backing the Dealer community, if it is unable to comply with a $100 billion liquidity withdrawal. Second, it indicates that reverse repos as a source of liquidity extraction by the Fed will be contained to the very precarious money market industry. All that is needed, in today's hair-trigger mindset on liquidity, is for another systemic glitch to be made apparent to all market participants, before yet another run on money markets occurs. As readers will recall, money markets were recently stripped of their implicit Federal guarantees: as such, this is the biggest potential threat to a nascent "recovery."

We will follow this topic closely, as the rumor now is that the Fed will no longer attempt dealer-based reverse repos after Monday's failure, but confine them exclusively to money markets. Whether or not the Fed is correct in gambling with the $3 trillion+ money market industry when it should be doing all it can to extract liquidity out of the very same dealer community it has so generously been rewarding for over 7 months, is very much open to debate.


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Wed, 10/21/2009 - 09:58 | Link to Comment Paul S.
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"The outcome was the discovery that the dealer community does not have the capacity to do reverse transactions of this magnitude."

Doesn't have the capacity or doesn't want to?

Wed, 10/21/2009 - 10:19 | Link to Comment Cognitive Dissonance
Cognitive Dissonance's picture

I think everyone understands at this point that any significant removal of liquidity from the "dealer Community" will be the straw that breaks the camels back. This is just confirmation of that understanding.

I agree with your view. I think "they" don't want to even entertain the idea of removal at this point. Everyone is wound so tight no one wants to be the first one to begin the process of removing the punch bowl.

There is no capability for a rest or to refresh. It's either continue the express elevator to God knows what point or it's a plunge to the bottom with all the stops removed.

Wed, 10/21/2009 - 10:44 | Link to Comment deadhead
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Wed, 10/21/2009 - 10:54 | Link to Comment Steak
Steak's picture

And I would very much like to be corrected if wrong, but they are also very much against bringing what was put up as collateral back on their balance sheets, correct?  So also presumably the MM funds are now getting stuffed with BB collateral that has a AAA stamp? 

All that seems self evident from ZH's post, but I'm just making sure I'm not missing a step here.

Wed, 10/21/2009 - 10:54 | Link to Comment Miles Kendig
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And my favorites, the securitized unrealized comps from premium credit cards and sub-prime Winnebago sales.

Wed, 10/21/2009 - 13:49 | Link to Comment Gordon_Gekko
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I think most likely the "dealer community" along with the benevolent Fed wants the MMF's to be the bag-holders for the toxic shit the Fed has to offer for these repos. No wonder they don't have the "capacity for transactions of this magnitude". Sure.

Wed, 10/21/2009 - 11:10 | Link to Comment Assetman
Assetman's picture


Very good observations, CD.

As ironic as it sounds, the same prime dealer community has the ability to handle trillions worth of liquidity injections.  Start taking the punchbowl away, and it's a totally different issue.

One good thing about this is that the Fed actually tested the waters on the reverse repo front well ahead of time.  It's not surprising that they didn't get the result they were hoping for... and news TD brings up here is potentially very significant.

The real danger here is that the Fed cannot respond to inflationary pressures by taking out liquidity at the pace they put it in... in fact, I would argue they will need to take out the liquidity much FASTER.  They cannot do that through conventional means, so they will do reverse repos through the money markets.  You better hope your MMMF isn't the "greater fool"-- or if they do these agreements-- they get "full faith and credit" protection in a big hurry.

One gets the sense that the Fed is really going to test the outer limits of its authority when it comes time to pull liquidity back in.  Again, this is clearly NOT a problem now... but it could be a BIG problem at the drop of a hat.

Wed, 10/21/2009 - 13:14 | Link to Comment Gordon_Gekko
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I think we can all agree that anyone keeping any money in a MMF at this point is an idiot.

Wed, 10/21/2009 - 21:15 | Link to Comment Anonymous
Wed, 10/21/2009 - 10:08 | Link to Comment bonddude
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Wed, 10/21/2009 - 10:27 | Link to Comment Anonymous
Wed, 10/21/2009 - 11:49 | Link to Comment bonddude
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Hello Father...

Wed, 10/21/2009 - 10:10 | Link to Comment Oso
Oso's picture

Any thoughts on whether them attempting to unwind this retardation is what is cratering the dollar today??

Wed, 10/21/2009 - 10:11 | Link to Comment EB
EB's picture

Indeed.  If there are truly $692 billion in bank non-borrowed excess reserves (which would be held mainly by primary dealers and are the result of QE OMOs), what is the problem?  Given the correlation between bank NBER and the stock market rally, one wonders if these "excess" reserves are otherwised encumbered or tied up in leveraged loans to momo hedge funds.


Wed, 10/21/2009 - 10:27 | Link to Comment Cognitive Dissonance
Cognitive Dissonance's picture

Everyone remember the 1989 Loma Prieta earthquake that hit San Francisco? I still remember those pictures from the Marina district of buildings tilted at crazy angles and 2 x 4's jamed against the sides of the buildings to keep them from collapsing in the aftershocks.

I think the "$692 billion in bank non-borrowed excess reserves" are the proverbial 2 x 4's holding up this economy and no one is even considering removing one stick of supporting wood from this mess. 

Wed, 10/21/2009 - 10:57 | Link to Comment Miles Kendig
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The duct tape & 2X4 economy in one picture.

Wed, 10/21/2009 - 11:04 | Link to Comment drbill
drbill's picture

Come on! Everyone knows that duct tape holds the world together. ;-)

Wed, 10/21/2009 - 12:03 | Link to Comment just.a.guy
just.a.guy's picture

if it moves and it shouldn't -- duct tape

if it doesn't move and it should -- WD-40


and right now the world is AWASH in WD-40.

Wed, 10/21/2009 - 11:54 | Link to Comment bonddude
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And that funny little guy loading grocery bags of cash out of the falling house in the Marina was...the Yankee Clipper. Yup, he didn't trust banks either. I wish he told what he knew back then.

Wed, 10/21/2009 - 10:11 | Link to Comment Bearish Spirits
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The PDs don't have billions for a reverse repo, but they can continue to drive the market up every day.

Wed, 10/21/2009 - 13:34 | Link to Comment Anonymous
Wed, 10/21/2009 - 10:14 | Link to Comment IE
IE's picture

"... a big question mark appears as to what is the illiquid collateral backing the Dealer community"...  Really?  A big question mark?

Wed, 10/21/2009 - 13:35 | Link to Comment Anonymous
Wed, 10/21/2009 - 10:29 | Link to Comment Printfaster
Printfaster's picture

The problem is that the price was not right for the PDs.  The fed needed to find a greater fool.  It seems to have found them in MMs.


Wed, 10/21/2009 - 10:40 | Link to Comment bkrolik
bkrolik's picture

Most likely, for now all talks about liquidity removal are nonsense; liquidity will be added and dollar will be on the course of devaluation. I do not see any substantial group among decision makers, that would be interested in the opposite. The big question, though, what would be a catalyst to break this trend. Noticeable change in current account deficite might be it...

Wed, 10/21/2009 - 13:00 | Link to Comment ElvisDog
ElvisDog's picture

I completely agree. Any talk from the Fed about being responsible and removing liquidity is just so much B.S. The game plan from late last year has been "keep the game going and hope it gets better on its own or at the very least get one more round of bonuses". If they remove liquidity the game is over, so therefore they won't remove liquidity.

Wed, 10/21/2009 - 10:48 | Link to Comment Unscarred
Unscarred's picture

"Whether or not the Fed is correct in gambling with the $3 trillion+ money market industry when it should be doing all it can to extract liquidity out of the very same dealer community it has so generously been rewarding for over 7 months, is very much open to debate."

It is a bit hypocritical, but how many other viable options would they actually have?

I do, however, find it a pleasant surprise that the Fed is actually trying to get out in front of the curve, for once.

Wed, 10/21/2009 - 11:02 | Link to Comment Miles Kendig
Miles Kendig's picture

I cannot but help to believe that the fed is not out front, but placating the vigilantes and the Chinese.  As alluded to earlier, isn't there some 700bn  in non borrowed reserves?   All show and no go.

Wed, 10/21/2009 - 11:09 | Link to Comment EB
EB's picture

This does smell of a dog and pony show.  The Fed was clearly testing its own highwater estimate, almost looking for failure at a known breaking point, that it had previously disclosed to the FT:

"The obvious counterparties for reverse repo deals are the Wall Street primary dealers. However, the Fed thinks they would only have balance sheet capacity to refinance about $100bn of assets. By contrast, the money-market funds have $2,500bn in assets, which means they could plausibly refinance as much as $500bn in Fed assets. Officials think there would be appetite on the part of the funds, which are under pressure from regulators and investors to stick to low-risk liquid investments."

Wed, 10/21/2009 - 12:03 | Link to Comment Anonymous
Wed, 10/21/2009 - 10:55 | Link to Comment Anonymous
Wed, 10/21/2009 - 11:02 | Link to Comment Anonymous
Wed, 10/21/2009 - 11:09 | Link to Comment Printfaster
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The fed is in no win.  If they pull money out of the MMs, then the MMs will not invest in commercial paper or other forms of industrial paper or private credit.

Either way, the fed disintermediates and kills expansion.  It looks like they press forward to kill the dollar until someone rescues it from the tracks.  I guess this is a game of chicken with the other CBs.  At the end of the day international finance is dead.

Wed, 10/21/2009 - 11:16 | Link to Comment Steak
Steak's picture

I'm fascinated by the angle you mentioned...less MM funds for CP, higher short term rates, right?  So that would be a nail in the coffin for the steepener trade as well.

Wed, 10/21/2009 - 11:27 | Link to Comment Printfaster
Printfaster's picture

Worse, the fed may be holding disappearing paper by selling their short paper and holding long.  This is a massive attempt to keep the yield curve from steeping.  It may even invert if they try to push this short term paper.

Add to that

An interesting issue has come up with regard to MBS.  The Dayton Daily News reports that bank foreclosures have stopped.  No, there are more and more homes in default, the banks have just stopped processing foreclosures.

What has happened?  The banks sold all the paper to the greater fool a long time ago.  Do the banks even have any interest in processing foreclosures since the paper is now owned by the government?

Will it be politically possible for the fed to foreclose on Fannie, Freddie, Ginnie, FHA debt?  I see all the paper that the fed holds as garbage.  Or the fed has to inflate the crap out of the currency?


Wed, 10/21/2009 - 11:45 | Link to Comment Assetman
Assetman's picture

Yep.  The Fed may have no other choice than to market short term paper-- and what complicates that is the US Treasuries own need for future issuance.  Besides ongoing deficit financing, there's a lot of short dated Treasuries that will mature over the next year or two.

Banks not processing forclosures on government owned paper is the pentultimate "screw you".  One could surmise that the FHA becomes a much bigger entity and "services" what foreclosures it can-- even for Fannie, Freddie & Ginnie.  But yeah, MBS is only worth as much as the mortgages from which its derived.

Wed, 10/21/2009 - 11:46 | Link to Comment Anonymous
Wed, 10/21/2009 - 13:39 | Link to Comment Anonymous
Wed, 10/21/2009 - 11:48 | Link to Comment Nick Utah
Nick Utah's picture

I understand a normal repo agreement: Fed takes an asset in return for posting reserves with an agreement that at a future date the asset will be returned and the reserves are given back to the FED with interest.

In the reverse repo agreement: Fed give a fully owned asset in return for cash with an agreement to take back the asset at a future date and return the cash with interest.

The problem we have is the FED now full owns assets with little known value? If the original funding to the banks was done under a true repo agreement, it would have been clear that the reserves come back from the bank they were give to. The banks want no part of taking the crap back. The FED is stuck.

I trust the MM are smart enough to know that these assets are not worth par what the FED paid for them. Maybe 10 cents on the dollar???? Who really knows. Most assets are probably worthless or even liabilities.

The FED really has now way out of this mess except to deal with the MM and hit the tax payer for the difference.

It sucks to be a tax payer.. Go Turbo Tim...

Wed, 10/21/2009 - 12:15 | Link to Comment Assetman
Assetman's picture

That's right... and the real issue is which "asset" the Fed will market in the reverse repo.

Hey, if it's a Treasury note backing the agreement, I'm in.  Anyone know how much in Treasuries is on the B/S currently?  Don't let it go unnoticed, though, that the Fed is exchanging T-Notes for Agency debt and banks are hoarding it in reserves.

If its toxic MBS and agency debt... I demand explicit (not implicit) guarantees on both principal AND interest at PAR VALUE.  Otherwise, I'm getting out the 10-foot pole if I'm a MM fund.  I'm sure that the Fed has some sort of magical "swap agreement" conjured up so that they are actually issuing different tranches of FR Notes to the public while quietly allowing the Treasury to absorb the losses on the really toxic assets.

That's about the only way the Fed will able able to pull this off.

Wed, 10/21/2009 - 11:56 | Link to Comment Anonymous
Wed, 10/21/2009 - 12:16 | Link to Comment Printfaster
Printfaster's picture

Given yields that are in double digit basis points, gold is now the money market instrument.  Either way , you get no interest.


Wed, 10/21/2009 - 13:42 | Link to Comment Gordon_Gekko
Gordon_Gekko's picture

Yes, and that "something else" is physical Gold. If you just pull cash out of your MMF, that's just half of it (albeit a very important half). The other important thing you need to do is protect against currency devaluation (as is happening RIGHT NOW) and buy PHYSICAL Gold with it, preferably in your personal possession. 

Wed, 10/21/2009 - 22:39 | Link to Comment Anonymous
Wed, 10/21/2009 - 12:49 | Link to Comment Anonymous
Wed, 10/21/2009 - 13:20 | Link to Comment Anonymous
Wed, 10/21/2009 - 14:11 | Link to Comment Anonymous
Wed, 10/21/2009 - 14:11 | Link to Comment Anonymous
Wed, 10/21/2009 - 14:13 | Link to Comment Anonymous
Wed, 10/21/2009 - 14:15 | Link to Comment Unscarred
Unscarred's picture

Any word if this what caused the bump in short-term Euro commercial paper yesterday?

Wed, 10/21/2009 - 14:49 | Link to Comment B9K9
B9K9's picture

Talk about boiling frogs. After 6 mos of being exposed to rampant illegal activity, we have come to accept previously unheard of levels of corruption, fraud and collusion on the part of the Fed, Treasury and PDs.

That these arrangements now constitute a new baseline standard of how business is conducted in the US says a a lot about something that would have been vehemently denied as being even remotely possible just a short time ago.

That being said, why would anyone here expect that the primary players would now alter their behavior? What possible motivation would lead them to deviate from pursuing any course of action that stretches (actually, grossly exceeds) the limits of illegality in the pursuit of profits?

How many times are we going to be shocked? Look, the whole game is a stable crash. The PTB are going to do anything/everything they want to achieve their goals. If there's one thing we've learned, it's that there are simply no laws nor enforcement mechanisms that could possibly deter them.

So what's next on the agenda? To get wages to rise in order to offset the commodity price increases and bring existing mortgage obligations in line with traditional LTV ratios. How do you raise wages with 25% (U6) unemployment? How has anything been achieved to date?

Don't be surprised if we get wage/price controls. Nixon did it back in 1971, when the US was orders of magnitude more committed to separation of gov't and private enterprise. This is were health care and cap & trade come in; more gov't control via fiat means they can simply decree what people are to be paid.

If the Chinese and other CBs don't like, tough titty. Think about what Bernanke & Summers have written/said about the $USD - it's just green pieces of paper. It means whatever they say it means.

Wed, 10/21/2009 - 14:56 | Link to Comment EQ
EQ's picture

The Fed isn't going to be doing any reverse repos.  Most likely ever. 

Wed, 10/21/2009 - 15:09 | Link to Comment i.knoknot
i.knoknot's picture

lots of shorthand jargon on Money Markets today. If I have it right, the MMs that are really being spoken about here are "Money Market Mutual Funds" (MMF/MMMF), vs the "Money Market CDs" (MM) that local banks created in response to the invention of MMMFs, correct?

That said, I understand that the local bank MM CDs have always been a cruddy investment, albeit more available/convenient.

So, I'm hearing in the article/comments that indicate the next bubble to deflate is the MMMFs (kinda like last Sept 18)?

And while nobody here dispenses financial advice (...), within the broader market, where would you folks migrate assets if they are stuck in an IRA/401k? (can't buy physical without going to a specialty PM IRA mechanism...)

  • dollars: dropping like a rock (maybe not to going be the flight to safety in the coming equity crash, this time)
  • treasuries: dropping until the coming equity panic
  • equities: ...
  • PM ETFs: probably better than many alternatives available to IRA/401x holders
  • FOREX ETFs: so long as we don't go latvia/romania currencies...
  • commodities: if you follow Schiff, yes, if you like Mish, then no :^) (?)
  • oil: (special case commodity...) usually safe bet that it'll be going up over time...
  • bonds: depends on how likely the borrower is to be around tomorrow to pay you back, or that the gubbmint will intervene to help cut your hair (see chrysler bondholders...). Not too promising.
  • stuff: liquidate it all and buy food, guns, whiskey, women, etc. :^)

yes/no/maybe? I (mostly?) don't know what I'm talking about, so all comments welcomed, I don't think I'm the only neophyte with an interest in this right now...


Wed, 10/21/2009 - 18:08 | Link to Comment Rollerball
Rollerball's picture

Shorting the dollar is shortly to become a crowded trade.  An safety "event" (Iran, etc.) will bounce the dollar (short term).  If I've learned anything lately, it's be long or don't play.  Shorts get squeezed.  Long physical gold/silver/euros/oil/interest rates is probably a better play. 

Wed, 10/21/2009 - 20:31 | Link to Comment Gordon_Gekko
Gordon_Gekko's picture

Yes we are referring to the Money market mutual funds. You should be completely in monetary metals at this point as they will outperform all other commodities during this phase of the commodity bull (including oil). If I were you, I'd do anything to get a majority of my money into physical Gold/some Silver ASAP in my personal posession. If for some reason you can't do that, then you can buy individual gold stocks (of course after doing due diligence as to the prospect of a company - I would avoid those with a hedge book ala Barrick like the plague) or the GDX ETF. I'd still avoid the GLD ETF, but maybe go with CEF? (I have no position in either). I'd avoid the forex ETF's too as you don't know which corrupt government these days will go insane doing competitive devaluation. 

Wed, 10/21/2009 - 22:48 | Link to Comment Anonymous
Wed, 10/21/2009 - 15:28 | Link to Comment Cursive
Cursive's picture

Delicious.  The only thing better would be jail time / executions for these treasonous bastards.

Wed, 10/21/2009 - 16:10 | Link to Comment Cursive
Cursive's picture

About 5 minutes after I posted this, the market fell off the cliff.  Even more delicious.  May all of these banksters be ruined.

Wed, 10/21/2009 - 18:45 | Link to Comment johngaltfla
johngaltfla's picture

Pathetic but not unexpected. The PD's are only there because they have to be. They have been gettting the promise of 100% Mafia protection from the Treasury and Fed so they can continue their Caribbean Laundry operation for Treasury paper. With the Fed ceasing the monetization merry-go-round and soon the MBS buyback program the choices facing the Fed are between "oh crap" and "oh hell" because IF they stop the monetization process or easy money this economy screeches to a halt. Despite their best efforts starts and permits are trending downwards and we have yet to recover to levels above the Kennedy Era; that's JFK for you young ones. Thus watch out for a major nightmare about to impact in Q4 09 and Q1 10 as the banksters have to finally recognize to some degree the actual valuations of all this crap on their books.

That's when life will get interesting and the triple short ETFs will get shut down.

Wed, 10/21/2009 - 21:09 | Link to Comment Anonymous
Thu, 10/22/2009 - 02:29 | Link to Comment Assetman
Assetman's picture

In normal times, the FOMC provides open market operations in which they buy and sell Treasuries for the purpose of "fine tuning" interest rates.  So you're on the right track there.

But there are not in normal times.  From about March 2009 forward the Fed has embarked on a massive buying spree-- adding assets to the books with credit created out of thin air.  This process is what the Fed refers to as "credit easing" or the rest of us as "quantitative easing".  We went this far because open market operations have driven the short end close to 0% and even more liquidity was needed.

At some point, the Fed would like to reduce their expanded balance sheet.  They bought $300bln of Treasuries they could sell.  They're marketable, liquid, and assumed to be relatively safe.  So the Fed will go though Primary Dealers who serve as "middlemen" where the buyer may be banks, PIMCO, etc.  Treasuries are an "easy sell" and would take some liquidity out of the system.

The Fed, however, been buying much more in the way of Agency debt and agency MBS-- and their still buying it and adding to its balance sheet.  Since much of the mortgage market isn't marking to market and the Fed has been buying based on fantasy values, it's highly likely the Fed has been grossly overpaying for these assets.  Banks, foreign central banks, and asset firms like PIMPCO have been more than happy to exchange Agency-related crap for Treasuries and/or cold hard cash.

If inflation rears its ugly head, the Fed needs an exit stategy to unwind QE 1.0.  That means reducing the assets on its bloated balance sheet-- of which most is dubious MBS that no recent seller (banks) want back. 

So the Fed is experimenting by going into reverse repo agreements with expanding the number of "middlemen" and hope there will be interested buyers.  The reverse repos would unload the toxic assets at the buyer with a promise to buy them back at a later date.

So far, so bad.  If it were you, would you buy a toxic asset that had an undetermined value, with the promise from an entity that has been accountable to no one... pay you back in full at a later date.  I don't trust my own bank... and my bank won't do the repo... so why would I trust the Fed if they sold it to my MMMF?  That's the problem the Fed faces in taking liquidity out of the system.


Wed, 10/21/2009 - 21:13 | Link to Comment Anonymous
Wed, 10/21/2009 - 21:33 | Link to Comment Chignos
Chignos's picture

Please take the time to write/email the following to your Senators: Senator xyz: "Why? Please answer just this simple question: Why should the American taxpayer, at the behest of Senators like you, bail out those Wall Street bankers who have levered themselves beyond comprehension through complex financial instruments like naked CDOs, MBS, and credit default swaps, i.e., derivatives? Why?"

Wed, 10/21/2009 - 22:52 | Link to Comment Anonymous
Thu, 10/22/2009 - 06:32 | Link to Comment Anonymous
Thu, 12/03/2009 - 21:40 | Link to Comment Anonymous
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