A Primary Dealer Cash Shortage?

Tyler Durden's picture

When one thinks of the US banking system, the one thing few consider these days is the threat of a liquidity shortage. After all how can banks have any liquidity strain at a time when the Fed has dumped some $1.7 trillion in excess reserves into the banking system? Well, on one hand as we have shown previously, the bulk of the excess reserve cash is now solidly in the hands of foreign banks who have US-based operations. On the other, it is also safe to assume that with the biggest banks now nothing more than glorified hedge funds (courtesy of ZIRP crushing Net Interest Margin and thus the traditional bank carry trade), and with hedge funds now more net long, and thus levered, than ever according to at least one Goldman metric, banks have to match said levered bullishness to stay competitive with the hedge fund industry. Which is why the news that at noon the Fed reported that Primary Dealer borrowings from its SOMA portfolio, which amounted to $22.3 billion, just happened to be the highest such amount since 2011, may be taken by some as an indicator that suddenly the 21 Primary Dealers that face the Fed for the bulk of their liquidity needs are facing an all too real cash shortage.

For those who are unfamiliar the SOMA Securities Lending Program (described in detail here) is just another shadow conduit allowing Primary Dealers to obtain Fed funds at a tiny cost, in this case paying a fee rate that dealers paid in order to borrow the specified issues. These borrowed issues are subsequently used as downstream collateral to obtain liquidity in the shadow interbank market, or to demonstrate sufficiency of eligible quality collateral for regular way margined/levered transaction. With the average weighted rate on today's lending operation a meager 0.05% it is clear that the opportunity cost to obtain quality collateral is negligible.

Why wouldn't Primary Dealer fund all their liquidity needs using SOMA loans then? Well, for one, the Fed's SOMA portfolio was never supposed to be the gargantuan monstrosity it is now, and historically until the failure of Lehman, the primary liquidity conduit was the Fed's Discount Window (since slammed shut due to the glut in excess reserves and fear of Discount Window stigma which many say is what gave Lehman away as having acute liquidity needs in the days before its filing). On the other hand, there is a $5 billion aggregate limit per dealer, which means that loans from the Fed's SOMA while not nearly sufficient to provide wholesale funding to run a bank, are usually a last ditch liquidity conduit, which indeed has been mostly used during quarter end window dressing to make bank books appear in better shape than they usually are.

But perhaps the best definition of the Fed's securities lending operation comes once again from SourceWatch which defines it as follows:

The Federal Reserve expanded the SOMA securities lending by $36 billion (an increase of $2 billion per primary dealer, of which there were 18 as of July 27, 2009). The program provides liquidity for the dealers in the event of an emergency. It allows the borrowers to avoid reserve requirements by allowing them to post Treasury securities rather than cash as collateral for loans.

In brief: Treasurys for cash with the Fed's blessing. Got it.

Those who are curious about the actual dynamics behind the SOMA loans need to be familiar with a rather shadow-banking specific concept known as "borrow-versus-pledge" which underlies every security-for-security repo transaction. To wit, from the Fed:

Dealers that have elected to participate in the program may submit bids via their Fedline terminals. The bid rate represents the lending fee rate that a participant is willing to pay in order to borrow the security. It is not a repo rate. Because the program operates on a borrow-versus-pledge basis, the bid rate may be considered equivalent to the spread between the general collateral rate and the specials rate for the borrowed security

To understand what this means in further detail we go all the way back to 2008 and Matt King's seminal work "Are the Brokers Broken?" who explains the literal magic of how thus deemed borrowings end up completely disappearing from the dealers books:


The explanation lies in the magic of the intricacies of repo accounting, and in the way that hedge funds run their books [ZH: in this case Primary Dealer banks]. Figures 6 and 7 contrast a normal repo transaction (“borrowed versus cash”), in which cash is lent against the reverse repoing in of collateral, with a “borrowed/loaned versus pledged” transaction. The latter works in exactly the same way, except that instead of cash being lent, securities are. Another way of thinking of it is as though a counterparty had collapsed together a simultaneous repo and reverse repo transaction into a single trade. One of the counterparties is said to have “loaned versus pledged”. The other is said to have “borrowed versus pledged”. The distinction between the two is supposed to be made on the basis of who is ‘driving’ the transaction, but is best described as confusing. The magic occurs in that under FASB, borrowed versus pledged transactions do not feature on balance sheet; under IFRS, neither borrowed versus pledged nor loaned versus pledged transactions are consolidated.

In other words, a Fed loan that does not appear on the Dealers' books? The plot thickens.

But leaving all the accounting technicalities to the side, what all of the above can be summarized as is that in period of marginal liquidity squeezes, the SOMA Securities Lending Program is where Dealers go to obtain stealth funding which, for one reason or another, they desperately need.

A period such as... now.

The chart below shows the total usage of the SOMA loan portfolio.

One thing that is obvious in the chart above, and as highlighted in yellow, is the frequent, periodic quarter-end spike in lending, which, as explained above, makes sense: these are the times when Dealers, who have to open their books to their accountants for the quarter end unofficial review, do everything in their power to demonstrate a pristine balance sheet.

So what happens when one normalizes for the window dressing by assuming an average balance of the days immediately before and after? This:

The chart above allows us to appreciate a more disturbing development: the surge of PD borrowings under this program at a pace that has been unseen since the summer of 2011, when the stock market plunged by some 20% following the debt ceiling fiasco and the US downgrade, and is now as high as it was when the summer of 2011 rumblings began, and is also as high as it was during the last market swoon in March of 2012 when everyone thought Europe was fixed, when in reality it was all just the ECB's €1 trillion LTRO effect, which fizzled in March leading to yet another market correction.

So, one wonders, is the recent surge in daily SOMA lending facility usage, which was at just $5 billion on January 18, and has since spiked to $22.3 billion, more indicative of the market correction we may be entering following yesterday and today's sell off, or of more systemic liquidity problems at the Primary Dealers who, just as they always do when they run out of liquidity, go to the Fed for extra cash?

We will find out in the days to come: luckily the Fed updates the daily usage of its SOMA Lending Facility daily at this page.

We urge readers to keep a close eye on it because this time, unlike the last, there is at least a way to know in advance if the financial system is once again starting to freeze up.

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Say What Again's picture

Let me tell you how I know that we've reached a top in the market.  When I opened the ZH page in previous weeks, I was always presented with advertisements for girls from asia, russia, or brazil.  Now I'm getting ads from T-Row & Price, Schwab, etc. telling me that they have some great investment opportunities.

MFLTucson's picture

And which girls did you like best?

Dear Infinity's picture

How many retail day traders are left? Clearly not enough for those monkeys to earn their keep. I had a WellsTrade account with 100 free trades and when I actually used it to trade as such, they immediately placed sanctions on my account so I have to CALL them every time I want to place an order. Of course when I place an order over the phone with them, I don't get to use my free trade! What a joke! Thanks FINRA et al for continously screwing the little guy.

Just trying to dump my SLV shares for some physical, according to www.comparesilverprices.com it seems like the premiums have settled from yesterday's surge, if only I could actually trade my account at will.

Lesson learned, never ever use WellsTrade.

Kitler's picture

$50 bucks says Tyler Durden just made Obama's Kill List.

Good work Ty... now 'eyes up' and keep an ear out for buzzing sounds.

Say What Again's picture

News Flash --- CNBC says to BUY THE DIP

I love this shit!!!

Poetic injustice's picture

It's always a good time to buy a dip! Realtors and brokers know what they are talking about, they got good looking printed out diplomas on their walls!

Mudduckk's picture

SOMA Hematoma Carcinoma. Just saying.


Bicycle Repairman's picture

Soma, poma.  You're on to them.  So what? Investigative journalism is so 1970s.  Look at the murderous stuff they are doing right in everybody's face.  And you've exposed yet another financial scam that J6P can never understand.  Wowie Zowie!!!!!

Sunshine used to be the best antiseptic.  Now it's just sunshine.  Thanks for the effort, but it doesn't matter.

And as long as $ can be crammed into suitcases and you are required to pay your taxes with $$, the show goes on.  Let me know when the empire cannot "create a new reality" on command, then the tide has turned.  Until then they are firmly in control.  Of everything now, unlike in 2008.

Panafrican Funktron Robot's picture

As an fyi, an average day for SOMA operations is $8 billion.  The average so far in February is $18 billion.  

Panafrican Funktron Robot's picture

It's also worth noting that the last big borrowing binge was back in June of 2011.  What a fucking surprise.  

Cheduba's picture

I just tuned into CNBC because it has been about year since I watched it and I was treated to a gem.  Some housing "expert" - House prices to surge 7-10% this year!  Buy a vacation home!  Why would anyone not want to buy a home with money so cheap?  Buy a house before it's too late!

TheGardener's picture

Nobody gets killed, idiot. Mixed race pussies on the run,
maybe. Don`t get scared, unless you happen to own a mirrow.

hswalj's picture

Play that funky music white boy!

BandGap's picture

I actually started dating one of the Snorg Tees girls

JenkinsLane's picture

I'm holding out for the Papua New Guinea girls.

nope-1004's picture

Which one?  Don't leave me hangin man......


waterwitch's picture

Maybe those girls are now working for T-Row etc? /s

CheapBastard's picture


You've got to be nimble these days...roll with the punches and smile at those ads...

"Meet the Perfect Christian Single" on the right sided advert (chosen by God for you, of course)... or hook up with that Hot Asian number on the left side of the page.


Don't waste your time with those mutual funds. They will not bring you the same Happy Ending the girls will bring.

resurger's picture


I thought i got a worm in my fucking browser or something of that sort regarding those websites.

ParkAveFlasher's picture

I got a worm in my pants, and it does a great impression of a meerkat looking for trouble when it sees the ad for ColumbianCupids.com. 

Buck Johnson's picture

You hit it right on the head.

MFLTucson's picture

And where may I ask is the Fed getting money?  Of course, we all know the answer, the printing press.  So this is otherwise refered to as a circle jerk!

Xibalba's picture

nothing to see here.  move along .... or else!

fuu's picture

Is this "Cash for Clunkers 2.0"?

ekm's picture

What have I been saying, it's been 6 months?


At least one primary dealers is going shit and I think this time will be a non US based one.

My speculation is on Deutsche Securities.

ekm's picture

The financial system was NEVER unfrozen, never since 2008.


The Fed was simply providing cash to primary dealers so they pay their swap losses.

However, it looks like the order must have come from the dear leader to stop doing that.

The reason: CRUDE OIL

Mine Is Bigger's picture

So, it's not a paypack for Germany asking gold back?

Winston Churchill's picture

Not so sure about Deutsche.

BofA is actually looking good to shit the bed.

A twofer with them owning Merrill Lynch.

ekm's picture

We've had 3 US based primary dealers die:

Bear stearns




Time for european one to go, you know, shared pain.

seek's picture

BofA is the other bank in addition to DB that's on my super-short list of known problem children in the banking world. They've been a mess for a while, but they've also got TBTF helping them out. I think it's far more likely it's a non-US dealer that is imploding.

I agree with you, though, when a US dealer(s) go, BofA will be first in line.

fonzannoon's picture

You think Deutsche Bank? They are a whale. That would be something.

They would get bailed out.

ekm's picture

Somebody here told me few months ago that deutsche sec bought a shitload of spanish bonds.

It reminded me of MFG buying italian bonds.


re: Seth Klarman

I'm trying to say that his philosophical conclusion is carved in stone. I never said he is infallible, as far as his AIG investment.

fonzannoon's picture

Fair enough about Klarman.

Why wouldn't said PD just pick the the red phone and call the bernank and have some benny bucks deposited behind the scenes? Why would they have to go flopping on  the deck of the boat like a dying fish in the market? An incident like that could drag the S&P down 5 or 6 points....

ekm's picture

One answer:



Only the dear leader and the republican softie (Boehner) have the legal power to TEMPORARILY pause QEs. We know boehner has no balls, so it's up to Obama.

His hand will be forced by crude oil price.

fonzannoon's picture

It's an interesting theory but it seems like our dear leader is knockong down crude right now easily enough, no?

ekm's picture


As I said, little drops here and there, don't matter.

I'm waiting for $10-20 crude oil drop in one day.

ekm's picture

We are far beyond the point of 5 or 10 S&P point drops.

I'm waiting for 50 or 100 S&P collapse in one day, after the dear leader signs the order.

seek's picture

I think that's a good call. I can't get into details but I have had a business relationship with them, and they're clearly shutting down a lot of IB/wealth management activities.

Not positive it'll be them, but I have a lot of signs that several firms are in a pretty bad place. The post yesterday about bank profits after taxpayer support is subtracted says volumes about how things really are.

ekm's picture

Thx a lot for sharing that information.

fonzannoon's picture

I am just playing devils advocate here a bit ekm, not in any way trying to be a dick. But regardingthe comment about DB shutting operations etc...what bank isn't?

Also, you start taking the S&P down 87 style and you have undone all the good work the bernak has done with his wealth effect. Why wreck that?

ekm's picture

Answer: CRUDE OIL.


Shortage of crude oil = starvation.

ekm's picture

Somebody has to carry the bag.

Same as for MFG, they'll load the shit into DB and shut it down.

Same for Lehman or Bear stearns.

fonzannoon's picture

we should be shorting high end steakhouses.

FoeHammer's picture

I say it's high time to get real local!

seek's picture

There's a difference from a gradual wind-down and a panic shutdown, and I'm seeing a panic shutdown of the group I worked with.

As far as S&P, da Bernank is playing a world's largest game of whack-a-mole. Priorities of what gets whacked (manipulated) have been changed, and that's being reflected in the markets the past week.

I would read into the priority change that something more urgent, and thus scarier -- than the current economy has come up, so wealth got put on back burner. My guess is it relates to the "shadow" crash many of us saw happening in last 2012 starting to surface in bank balance sheets, and the economic headwinds are so strong that need to shift strategies.