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Treasury Collateral Shortage Soars: 2 Year Trades -2.8% In Repo
While stocks continue to surge to recorder higs on ever lower volume, as algos ignite each-other's momentum, interpreting the Yellen speech in whatever way will lead to the S&P hitting Goldman's 2016 year end target of 2200 by the end of the quarter, other asset markets continue to trade in a bizarre and outright deformed manner. Case in point, the Treasury curve, where according to the latest repo data from Stone McCarthy, there is now a historic shortage of collateral in the short end of the curve.
To wit: the 5-year note is at -174 basis points this morning, the tightest it has been since September. The 2-year note, at -279 basis points, is the tightest since at least 2009. Both the 2-year and 5-year notes have traded very tightly in the past, though today's values are extremely tight for both. It is worth mentioning that it is rare for both to trade so tight so close together.
There is hope that the negative repo rate in the 2 Year will moderate following today's 2 Year auction, however, that does not explain why both the 5 Year and now, the 10 Year are all special as well.
And since by now it is mostly central banks intervening in the bond market, it has become meaningless to attempt to infer what is causing this epic shortage of underlying paper (which is the only conclusion one can derive) and instead the only option is to sit back and watch and see how this all plays out.
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This is not the kind of money that you can run out of. So if there is a shortage, the Fed will step in and provide it.
Its called the lead up to hyperinflation.
Can you explain please?
The fact that there is more demand than supply shows there is something broken in the matrix. Treasuries are the lead mechanism of money creation. The way the matrix works suggests that there should be an exponential increase in the supply
Need more deficits.
Bing-fucking-O dude.
But increasing the US budget deficit ain't gonna happen when it looks like tax revenues are about to implode due to a weakening economy.
That's why Obongoid wants to tax corporate foreign cash holdings now among other measures
That's where the fun starts.......
The Fed can't sell any Treasuries it has monetized because then the US government would have to pay interest on them for real to another holder. The Fed pays the Treasury back all the interest it collects on these bonds bills and notes right now. The Fed has to keep holding until there is some kind of Federal revenue recovery. They also have to keep monetizing to make sure no unpayable interest gets paid out. The Treasury actually has to fork over less money over time this way because they really pay no interest.
There is no Treasury market. It is just a big money pipeline from the Fed to the Treasury, with a lot of historical appendages that have not evolved off of it yet. Most of the money the Treasury spends these days is purely printed via this dog and pony show. The rates can go anywhere because the Fed buys everything. But they will stay super low to dissuade anyone real from ever buying any and collecting interest. People trading Treasury debt here are basicly the dumbest of the dumb, unless they know where the fed is going to stick prices. You have to be in the club.
thank god there ain't no collusion going on...
True, but trading the volatility in zeroes and futures can be very profitable.
But at -2.8% in repo, you know that Moe...er, Mr. Yellen, is going to say we have to raise rates (and thus all the banksters get paid on their shorts). It is a headfake before the hyperinflation to make the sheeple lose their last few pennies, but it will work.
Indeed. Plenty moar paper can be printed. When you run out of trees, there is a lot of free hard drive space for the 1's and 0's.
Are you suggesting that all these paper claims are going to somehow start seeking out real goods and services soon? LOL!!! Oh do tell, don't tease us like that Spitzer, do tell...
What exactly is a collateral shortage? Who is short and how? Have parties reversed collateral that don't have and now can't get it to deliver? Thanks in advance.
Yes, especially since in the current "mark to model (i.e. mark to fantasy)" world collateral can be pretty much whatever the fuck they want it to be.
coulld some clarify please, thanks.
I googled this article. I still don't understand what "collateral shortage" means. Further clarification would be appreciated. Thank you
economics.mit.edu/files/4854/
Look up "Naked" or "Exposed". Every financial vehicle has some sort of collateral to validate it's worth. STocks are collateralized with ownership of the company. Unless you're a current listed stock whose market cap to volume exceeds the expectation of reality thanks to algo "volume" in the market and you become like Enron with dodgy accounting that causes the company to run out when they can't pay their shareholders.
Bonds have collateral too. (corporates? In the case of the US Treasury, the "collateral" is the full faith and obligation of the taxpayers to pay. Which isn't because we didn't agree to this.
in my understanding, it's always about "High Quality Collateral Shortage", see ZH: http://www.zerohedge.com/news/2013-05-01/desperately-seeking-112-trillio...
"Over a year ago, we first explained what one of the key terminal problems affecting the modern financial system is: namely the increasing scarcity and disappearance of money-good assets ("safe" or otherwise) which due to the way "modern" finance is structured, where a set universe of assets forms what is known as "high-quality collateral" backstopping trillions of rehypothecated shadow liabilities all of which have negligible margin requirements (and thus provide virtually unlimited leverage) until times turn rough and there is a scramble for collateral, has become perhaps the most critical, and missing, lynchpin of financial stability. "
again, in my understanding, if you had a rehypothecation chain that is suddently unsound, you need a replacement for the underpinning collateral which is used for virtually unlimited leverage
of course I would wish to know how many times the same rehypothecation asset is really used again and again for moar leverage, but hey, there is a reason why it's called shadow banking
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this article is the best ZH primer I know of for this theme: http://www.zerohedge.com/news/why-uk-trail-mf-global-collapse-may-have-a...
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Under the U.S. Federal Reserve Board's Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140% of the client's liability to the prime broker. For example, assume a customer has deposited $500 in securities and has a debt deficit of $200, resulting in net equity of $300. The broker-dealer can re-hypothecate up to $280 (140 per cent. x $200) of these assets.
But in the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated. In fact, brokers are free to re-hypothecate all and even more than the assets deposited by clients. Instead it is up to clients to negotiate a limit or prohibition on re-hypothecation. On the above example a UK broker could, and frequently would, re-hypothecate 100% of the pledged securities ($500).
This asymmetry of rules makes exploiting the more lax UK regime incredibly attractive to international brokerage firms such as MF Global or Lehman Brothers which can use European subsidiaries to create pools of funding for their U.S. operations, without the bother of complying with U.S. restrictions.
In fact, by 2007, re-hypothecation had grown so large that it accounted for half of the activity of the shadow banking system. Prior to Lehman Brothers collapse, the International Monetary Fund (IMF) calculated that U.S. banks were receiving $4 trillion worth of funding by re-hypothecation, much of which was sourced from the UK. With assets being re-hypothecated many times over (known as “churn”), the original collateral being used may have been as little as $1 trillion – a quarter of the financial footprint created through re-hypothecation.
Keen to get in on the action, U.S. prime brokers have been making judicious use of European subsidiaries. Because re-hypothecation is so profitable for prime brokers, many prime brokerage agreements provide for a U.S. client’s assets to be transferred to the prime broker’s UK subsidiary to circumvent U.S. rehypothecation rules.
Under subtle brokerage contractual provisions, U.S. investors can find that their assets vanish from the U.S. and appear instead in the UK, despite contact with an ostensibly American organisation.
Potentially as simple as having MF Global UK Limited, an English subsidiary, enter into a prime brokerage agreement with a customer, a U.S. based prime broker can immediately take advantage of the UK’s unrestricted re-hypothecation rules.
This is exactly what Lehman Brothers did through Lehman Brothers International (Europe) (LBIE), an English subsidiary to which most U.S. hedge fund assets were transferred. Once transferred to the UK based company, assets were re-hypothecated many times over, meaning that when the debt carousel stopped, and Lehman Brothers collapsed, many U.S. funds found that their assets had simply vanished.
A prime broker need not even require that an investor (eg hedge fund) sign all agreements with a European subsidiary to take advantage of the loophole. In fact, in Lehman’s case many funds signed a prime brokerage agreement with Lehman Brothers Inc (a U.S. company) but margin-lending agreements and securities-lending agreements with LBIE in the UK (normally conducted under a Global Master Securities Lending Agreement).
These agreements permitted Lehman to transfer client assets between various affiliates without the fund’s express consent, despite the fact that the main agreement had been under U.S. law. As a result of these peripheral agreements, all or most of its clients’ assets found their way down to LBIE.
----
With weak collateral rules and a level of leverage that would make Archimedes tremble, firms have been piling into re-hypothecation activity with startling abandon. A review of filings reveals a staggering level of activity in what may be the world’s largest ever credit bubble.
Engaging in hyper-hypothecation have been Goldman Sachs ($28.17 billion re-hypothecated in 2011), Canadian Imperial Bank of Commerce (re-pledged $72 billion in client assets), Royal Bank of Canada (re-pledged $53.8 billion of $126.7 billion available for re-pledging), Oppenheimer Holdings ($15.3 million), Credit Suisse (CHF 332 billion), Knight Capital Group ($1.17 billion),Interactive Brokers ($14.5 billion), Wells Fargo ($19.6 billion), JP Morgan($546.2 billion) and Morgan Stanley ($410 billion).
"
It's what you are suppose to post against the 100x derivative position you have insured.....boom
There is a whiff of panic in tne air.
Thanks, Ghordius. That's what i suspected. The problem isn't a shortage of collateral but muliple re-hypothecation. I truly detest the buzz-word, jargon loaded obscuration, bullshit and deception around these imprudent, reckless industry-wide practices.
Thanks to others who took the time. I'll read through the responses as I have time.
Ask knucks some time. He does this, I don't. It's basicly a short term collateral thang for bond trades. Only certain types of instruments are qualified. There are big penalties for noncompliance, unless you are one of the TBTJ.
Thanks, Kaiser. I hope Knucks shows up and comments.
But we can always redefine High Quality Collateral, right?
Thank you, Ghordius.
Shadow system cannot create reserves.
They lend existing reserves in exchange for collateral, like times of old with gold.
So, if IBM needs urgent cash to pay salaries, they swap let's say $10 million of Treasuries they have at let's say 0.2% for 1 week.
A pension fund will lend them $10 million cash expecting to be paid in 1 week or 3 days or 1 day and so on. Think of USTs as if it were gold.
Most of such swaps are between 1 and 3 days.
Now, assume the pension fund is in need of Treasuries because another party is calling its Treasuries back.
So, it would be the pension fund now begging IBM and paying them for their Treasuries.
Those treasuries could go up to 4 hands one after another, it is called REHYPOTHETICATION.
When one party calls for its treasuries, then the chain to call it back starts from hand to hand.
it is like a margin call, but in this case it is a collateral call.
If you can't get hold of it, then you default
Babylonians used to do that with Gold and Grains/cattle, collateral lending only.
In Canada rehypothetication is forbidden
In USA is allowed up to 140%
In UK is legally INFINITE, but it usually occurs up to 400%, 4 hands
Collapse always occurs in the City of London where bear stearns, lehamn, AIG and MF Global gambled and collapsed, not in USA
OK, I get it, but isn't the problem here not the shortage of collateral, but rather the pension fund's inability to reserve for collateral that they knew might become due?
Colateral is rehypotheticated, which means it has been lent out again.
So, you transfer your gold to me in exchange for money.
I transfer it to John, John transfers your gold to Jack.
Your gold (or UST) is held by Jack and you have no interaction with Jack, you have to wait until John takes it back from jack, I take it back from john and I give it to you, assuming any of us is solvent.
"So, if IBM needs urgent cash to pay salaries, they swap let's say $10 million of Treasuries they have"
A "Reverse Repo" right?
But how can someone "call back" their Tresuries before the term is up on the reverse repo? And where is the big surprise to the lender (pensions fund in your example) if he took the Treasuries in as collateral for a week, he redelivers them (the borrower repurchases them) at the end of the term. All good. How is this a surprise toe the pension fund? How does he come up short unless loans that collateral out and can't get it back -- ie. his counterparty fails (defaults)?
. . . and thanks for your comments, ekm.
Everybody is gambling.
50% of stock trading is done by brokers who go to shadow banking to obtain money by using treasuries of customers
And no, if you gave your UST to john and john gave it jack and jack gave to Maria, if any of them goes bankrupt, you are screwed.
Shadow banking is hoping the Fed will back them up. The Fed did so with reverse repos. It is not a bailout, it is just a lifeline to live another day
In the 80s I negotiated structured finance private placement -- basically term repos. Our niche was that under our deal, the lender (investor) could get a perfected security interest in the borrowers collateral which was held by the third party Trustee at all times and marked to market daily. In case of default on the part of the borrower, the collateral could be liquidated as it was already the property of the lender but subject to the terms of the contract--held by the Trustee until maturity (returned to the borrower) or default (liquidated to the benefit of the lender). Back then the boilerplate for the "street repo" was about 45 pages (mostly bullshit) which essentially sent the collateral into the fog. So yes, I understand what happens to collateral -- under standard street practice it has about the same reliability as SLV silver or GLD gold.
So the shortage of collateral is a situation that arises from the intentially vague and non-binding provisions for collateral custody which results in a chain of re-hypothecation. Then, at some link in the re-hypo chain theres is an FTD and then counterparties scramble so as not fail to deliver themselves. FTD, which sounds like a technical issue is, in substance, usually a default, like a naked short that can't cover.
The Fed bought too much of the toilet paper the Treasury issued, now there's not enough to go around.
Collateral is bonds made available by the FED for the treasury to buy back. (Repo) normally. BUT, the banks have all the bonds, so there are not nearly enough available for Jack to buy back. (Shortage of bonds for repo)
The banks are never ever ever ever ever ever going to sell those bonds...
Short and long refers to the dated treasuries 1's 2's 5's are the short dated securities (short end) 10's 20's 30's are naturally the long dated securities or the (long end) of the curve. Prices move inverse of yeild so a bear curve means a higher bond price and vice versa.
Hope that helps.
The nested do-loop of paper collateral continues....
FORTRAN FOREVER!
And on punch cards!
Can someone explain please?
The Feral Reserve and other Central Banks have gobbled up almost all Treasury bonds to fund QE
So there's a severe shortage of "high quality collateral" as the basis for printing moar Feral Reserve notes be they paper or digital.
And there ain't gonna be enough Treasury bonds cause the Gubmint knows tax revenues are gonna drop like a rock now.
So drink up while you can!
Meh..30 yr still lookin good. :)
"the only option is to sit back and watch and see how this all plays out."
Pull up a deck chair and listen to the lovely music while we watch.
So I supposed the fed would use a repo 105 to make the Treasuries look good on the books? Japan will buy anything.
Reverse Repo's? http://www.newyorkfed.org/markets/omo/dmm/temp.cfm?SHOWMORE=TRUE
We are talking about $50 to $150 Billion of Reverse Repos every day.
Fed officials may raise $300 billion cap on reverse-repo exit tool: minutes
18 February 2015, by Michael S. Derby - New York (MarketWatch)
http://www.marketwatch.com/story/fed-officials-may-raise-300-billion-cap-on-reverse-repo-exit-tool-minutes-2015-02-18
http://scottskyrm.com/2013/03/april-collateral-shortage-preview/
Every year, well almost every year, Repo rates decline from the middle of April to around the middle of May. This has come to be known as the “April Collateral Shortage” or “Seasonal April Collateral Shortage” or something like that. The collateral shortage is best described as a relative decline in Repo rates since it’s literally a shortage in overnight general collateral and not in a decline in all short-term rates. It occurs when a large amount of Treasury bills mature right after the April 15 tax date, that loss of short-term bills creates a shortage of collateral in the Repo market. Not only are there fewer Treasury securities, but much of the money that was invested in those bills is freed up and moves into the Repo market. This is the main cause of the seasonal collateral shortage and it’s directly related to “tax season” each year.
Traders first started noticing the collateral shortage after April 1997, that was the first year the U.S. government ran a budget surplus and tax receipts were abnormally high that April. For the last two weeks of April 1997, general collateral (GC) averaged 12.8 basis points below fed funds. Before that, the most significant April collateral shortage occurred in 1990, when a massive (!) $26.9 billion bills matured mid-month. Obviously things have changed a lot since then, swings of $26.9 billion in Treasury issuance and maturities happen quite frequently now.
There isn’t a collateral shortage every April, but it’s still is a fairly regular occurrence. The most severe shortages pushed GC to average 21.3 basis points* below funds in 2000, 20.3 basis points below funds in 2008, and 18 basis points below funds in 2001. In general, the collateral shortage can be expect to begin on April 15, or when the first Cash Management Bills (CMBs) mature, and last until the middle of May, usually May 15. However, some years the shortage ended as soon as April 29 (2005), as late as June 1 (2006), and once it even stretched as far as July 17 in 2000.
These days it takes much larger numbers to move overnight rates. A change of $26.9 billion today is only worth one or two days of a fed funds pressure or soft funding. In 2007, the amount of bill collateral maturing was $89.8 billion and it created a premium for Treasury GC of 13.3 basis points below fed funds. In 2004, the maturing amount was $69 billion and that only moved GC to 7 basis points below fed funds. Large bill maturities don’t necessarily translate into guaranteed shortages. Whereas back in 1999 there was $101 billion in regular bills and CMBs maturing, it resulted in virtually no collateral shortage, GC averaged only 3.3 basis points below funds that season. Obviously, there are other factors at work.
The Reasons Why – The Technicals
Just like in many markets, the collateral shortage is a function of supply and demand. There are two factors that naturally compete in the Repo market, the supply and demand for collateral, and the supply and demand for cash. For the April collateral shortage, it’s effectively a double whammy – there’s a decrease in the supply of collateral (fewer Treasury bills) and there’s also more cash at the Treasury.
In anticipation of the tax revenue arriving on April 15, the Treasury begins to increase the size of its Treasury bill auctions, both CMBs and regular bills, beginning in February. They need to borrow additional funds to make it through the April 15 tax date, but once the tax receipts start coming in, the Treasury no longer needs to borrow as much, at least for a while. The CM bills generally mature a few days after April 15 and, as those bills mature, more and more cash goes into the Repo market. This is what creates the shortage on the collateral side – a large amount of short-term bills mature over short period of time.
On the cash side of the equation, as the Treasury collects tax revenue it goes into the Treasury Tax and Loan accounts (TT&L) accounts. That rising Treasury cash balances create more cash in the system looking for short-term investments, which again, pushes more cash into the Repo market.
Factors That Increase The Shortage
The size and depth of the collateral shortage would be easy to predict if the size of the bill maturities were the only factor. Given the Repo market is so large, with many moving parts, there are several other factors which play a role in the size and depth of the shortage.
Factors That Decrease The Shortage
Recently
The effects of the collateral shortage have not been severe in recent years. In 2009, 2010, and 2012 there were no significant collateral shortages. During these years, April 2011 was the only year that had a high premium for Treasury securities during the collateral shortage season. Why? Simple. QE2 was already taking about $100 billion in Treasurys out of the market each month, the additional bills maturating in April pushed GC rates even lower.
This is a good description of supply and demand in the Treasury market but does not address the concept of "collateral shortage." What are the mechanics of the collateral shortage? Who doesn't have enough collateral? Lenders? Because they re-hypothecated it and are unable to return it to borrowers?
This will mean big trouble if there is a sizable margin or collateral call.
If stops are taken out, on the low side, this could be ugly and suppress commodity (pm) prices.
It might create good opportunities.