E Unstable Repos And The London Connection

I ran across a great article by Jeffrey P. Snider written in May 2016. He has many astute articles regarding Fed behavior posted here at Talkmarkets and people should read them anytime they have the opportunity to do so. But this article posted elsewhere was certainly an eye opener to me. It has to do with a subject he often covers, repo fails. 

I want to first mention that at the end of this article we can see what this disturbing wholesale financial market is doing to the world economy, and we can see that most of this trading is done in the Square Mile, as London is the seat of world finance.* 

Repo fails result from counterparties failing to deliver US treasury bonds for a deal. Often, the counterparties see treasury bonds of various maturities being more valuable than the cash they would get in the loan they request. When the bonds are special, they are in massive demand. They are hoarded. When the repo failures reached a peak, in the liquidation of the economy in 2008, Mr. Snider stated this concerning that time period:

Obviously that means in these times that, at the margins, collateral is more “valuable” than cash. Where that imbalance is greatest you find a rush or surge in “fails”, meaning a great number of counterparties decide they will at the end of the repo just keep the security rather than take back the cash that was lent.The worst of those was in early October 2008 and the repo stats from that time are unbelievable. The New York Fed estimates that in the last week of September 2008 total fails among primary dealer inventories were $3.5 trillion (combining both “to receive” and “to deliver”), up from $577 billion the week before when Lehman first failed. By the week of October 15, total fails hit $5.3 trillion and stayed at that level again the following week. The S&P 500 lost 32% during these weeks where repo fails surged. 

 What then happened, as he goes on to say, is that a 3% fail penalty was placed upon those who failed to deliver the collateral. That calmed things down. However, in 2016 fails ballooned again. Mr. Snider says: 

For the week of March 9, 2016, the New York Fed reports dealer fails of $889 billion, by far the highest since 2008 and greater than at any point during the 2011 crisis. This was not a surprise, however, as repo specials proliferated throughout several maturities with trading close to and even slightly below the calculated fails penalty (it’s not a strictly 3% rate, it is a calculation related to federal funds). The following week, the actual week of the government funding auction, fails held high again at $873 billion. The middle of March is a seasonally strong part of the auction calendar, so clearly OTR to OFR was in that dreaded “dead spot” of transition but this was way, way out of those proportions.