Federal Reserve’s Repo Market Fix Is No Fix at All
The central bank has become the lender of first resort when it should be the lender of last resort and offer funds at a penalty rate.
The Federal Reserve has pumped billions of dollars into a key part of the financial markets.
Photograph: Bloomberg
With their best intentions in mind, central banks and governments have instituted rules to ensure that financial institutions have enough liquidity to withstand another crisis. But liquidity coverage ratios, high quality liquid assets rules, Basel 3 compliance, global systemically important bank charges, and the soon-to-be-implemented net stable funding ratios have made supplying the all-important repo market’s needs so byzantine that no one really knows what exactly is required, least of all the Federal Reserve.
The Fed understood these new rules posed an uncertainty risk, which is why they regularly surveyed and consulted primary dealers for feedback. And yet, with no real experience with these new rules, everyone was essentially guessing. Add massive issuance of U.S. Treasury securities to meet trillion-dollar budget deficits and by mid-September the all-important repo market broke, unable to handle ever-increasing demand.