Counter DD: NY Fed $400 bln reverse repos is not tied to margin calls. It’s worse.

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Changed May 16th: Please see Update at bottom of post.

Today there is hype about an Italian financial news site reporting that the New York Fed has lent 400 billion USD to 39 financial institutes over the past two days. It concludes that big Wall Street parties have been margin called and are panic borrowing from the Fed to make margin. Link: https://www.money.it/Fed-repo-miliardi-Wall-Street

Google translated screenshot of the news article

None of it is correct.

TL;DR

• The numbers are about reverse repos, which mean that the Fed is the one borrowing cash and providing US Treasury bonds as collateral.
• The numbers are about overnight reverse repos (ON RRP) which have same day settlement. The cash makes a roundtrip in the same day so cannot be added together: there will be significant overlap between the numbers of subsequent days.
• ON RPP rate is currently 0%, which means the Fed borrows cash at 0% interest and provides US Treasury bonds as collateral. The incentive why someone would lend to the Fed at 0% interest rate is to hold the bond, perhaps for short term shorting.
• The Fed has on March 16 increased the maximum amount of cash they will borrow daily from a counterparty from 30 billion to 80 billion per counterparty. Reverse repo transactions have increased daily since.
• It’s not financial institutes borrowing cash because they got margin called. It’s the contrary: it’s them depositing cash to profit from babysitting holding US Treasury bonds.
  • which they perhaps use for nefarious purposes ^{this is an understatement}
  • Please see Update.

Good day apes! This is my first attempt at a DD if you can call it that. I’m actually just formulating an in-depth reply to other daily trending posts:

• 20k upvotes: https://www.reddit.com/r/Superstonk/comments/nb9pon/european_financial_news_is_reporting_major_margin/
• 11k upvotes: https://www.reddit.com/r/Superstonk/comments/nbg01m/regarding_recent_rumors_about_fed_bailing_out_hfs/
• 8.3k upvotes: https://www.reddit.com/r/Superstonk/comments/nbbrg6/margin_called_front_page_moneyit/
• 5.3k upvotes: https://www.reddit.com/r/Superstonk/comments/nbbg13/reverse_repo_loan_amounts_by_day_since_january/

If I’m wrong then shame be on me and I will delete this post or leave it up for posterity, whatever the people deem best. If I’m right, a lot of people are getting excited about some news site that is wrongly interpreting what it means when the Fed conducts reverse repo operations: it’s the opposite. So here goes.

WHERE ARE THE NUMBERS FROM?

So first off, what is this $400 billion figure coming from? Again look at the shared news article: https://www.money.it/Fed-repo-miliardi-Wall-Street

400 billion is the lazy sum of 209 billion and 181 billion (context: Italians call a billion a milliardi). Those numbers can be found on the NY Fed site here: https://apps.newyorkfed.org/markets/autorates/tomo-results-display?SHOWMORE=TRUE&startDate=01/01/2000&enddate=01/01/2000

The numbers are from reverse repos

Take note that the page contains daily summaries of repos and reverse repos. Nothing is happening in terms of repos (.000 abound), the numbers are about reverse repos.

WHAT ARE REVERSE REPOS?

I’ve only learned today what a repo or reverse repo is, but it’s enough to conclude that the news site has it wrong. There seems to be some confusion today because of one definition on Investopedia, and another definition on the Fed site. But we are talking about numbers posted on the Fed site, so lets look at their FAQ.

Here is what the NY Fed’s FAQ says:

“A reverse repurchase agreement conducted by the Desk, also called a “reverse repo” or “RRP,” is a transaction in which the Desk sells a security to an eligible counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future.”

Source: https://www.newyorkfed.org/markets/rrp_faq.html

“The Desk” refers to the Open Market Trading Desk which represents the Fed. So in a reverse repo (RRP) the Fed sells a security to gain cash, but has an agreement to buy the security back. That’s where we can already conclude the 400 billion is not being lent to Wall Street at all, it’s being borrowed from Wall Street. It has nothing to do with margin calls.

If I’m wrong, correct me please, but here is a few more sources to back up this interpretation.

• https://www.federalreserve.gov/monetarypolicy/overnight-reverse-repurchase-agreements.htm“When the Federal Reserve conducts an overnight RRP, it sells a security to an eligible counterparty and simultaneously agrees to buy the security back the next day.”
• https://www.learningmarkets.com/the-federal-reserves-open-market-operations/“When the Fed wants to extract money from the system, it sells Treasury securities to its primary dealers in a reverse repo.”

Moreover, the reverse repos involving the reported numbers are overnight reverse repos, meaning the transaction is inverted the next day. Therefore it’s also incorrect to just sum up the numbers: the 209 billion of one day and the 181 billion of the day before probably have a lot of overlap. So scrap that 400 billion number altogether.

Numbers are from same-day settlement reverse repos, i.e. ‘overnight’

Until this part is just setting the record straight. I do have an alternative theory to propose.Reminder: My personal stance has changed, feel free to entertain the theory but please make sure to also read the update at the end of the post and the referenced counter perspectives.

Remainder of the post is the original theory.

SO WHAT IS ACTUALLY GOING ON WITH THESE INCREASING NUMBERS?

If you look at the data again on the NY Fed site, numbers have been increasing steadily every week day: 154, 161, 175, 181, 209 billion. That can be seen in this graph, which was made by u/xpurplexamyx today:

All credit to u/xpurplexamyx and her post at https://www.reddit.com/r/Superstonk/comments/nbbg13/reverse_repo_loan_amounts_by_day_since_january/

If you look at the graph, you can see the numbers start increasing rapidly after March 17. Well something very relevant happened on that day. Before March 17, any reverse repo (RRP) counter party could deposit up to 30 billion per day at the Fed. On March 17, this changed to 80 billion.

Source: https://www.newyorkfed.org/markets/opolicy/operating_policy_210317 and https://www.federalreserve.gov/newsevents/pressreleases/monetary20210428a1.htm

Now assuming there is incentive for counterparties (that would be banks) to participate in the Fed’s RRP program, it is to be expected that numbers would rise from that point on. Why did it increase gradually instead of immediately from March 17 onward? What is that spike on March 31? I don’t know, hope someone can fill us in. Why did the Fed decide to raise the limit to 80 billion? I don’t know either but it has something to do with that bRRR-man. I hope someone with knowledge of monetary policy can jump in here.

Lets talk about incentives. Normally the incentive for counterparties to take part in the reverse repo program, i.e. deposit cash at the Fed is because they make interest on that deposit. Otherwise, why wouldn’t they rather use that money to make money? So normally, the Fed offers some interest, but not more than other banks. The interest rate for reverse repos is tweaked by the Fed to act as a lower limit to what interest banks charge each other, the latter is called the federal funds rate.

My crude attempt at summarizing this: the interest rate that the Fed pays in reverse repos can be decreased by the Fed to incentivize banks to borrow from each other, and increased to incentivize borrowing from the Fed. People that actually know economics can come shit over me now.

What is interesting to me and a bit surprising is that the current interest rate for overnight reverse repos, the ON RRP rate, is currently 0.00%. Source: https://www.federalreserve.gov/newsevents/pressreleases/monetary20210428a1.htm.

Again, the interest rate that one would get for using the Fed as a daycare for their cash, is currently 0.00%. Yet participation in the ON RRP program is increasing daily, both in terms of money exchanged and number of counterparties participating as evidenced by those 181 billion, 209 billion and today 235 billion. The 400 billion number from the Italian site was summed up where summing isn’t valid, but at this rate we will reach it soon on a single day!

What’s the incentive? Well perhaps you want the collateral that the Fed offers, which in the case of the reverse repos we are looking at are exclusively Treasury Bonds. The Fed gets to babysit your cash, you get to babysit some US treasury bonds.

The incentive may be that when you park your cash at the Fed and get to hold on to US Treasury bonds, you can do stuff with those bonds for a day since you do own them until the Fed purchases them back the next day. Here are some things I can think of to do with these freely borrowed bonds:

• Lend them to short sellers for a borrow fee
• Use them yourself to short
• If anyone can come up with other reasons to deposit funds somewhere for 0% interest, receiving treasury bonds as collateral, please fill me in. I would like to know the least nefarious reason for someone to make use of this reverse repo program.

I mean, look at what’s been trending downwards:

Price of treasury bonds has been trending down

For more juicy cooking recipes with treasury bonds, please refer to the Everything Short by u/atobitt. I’m not saying the Everything Short and this here are the same argument, actually I need to reread it knowing everything I learned today. What I am saying is that treasury bonds are shiny.

And I don’t even know what they look like!

Since the value of treasury bonds is trending downward and these financial institutes can borrow treasury bonds from the Fed free of charge via reverse repos, that might explain why so many parties are participating in this reverse repo program and why daily cash deposited at the Fed is ever increasing. Although this mechanism was made by the Fed as a way to withhold money from the market, in effect they are lending out treasury bonds for free.

They have quite the conundrum: the ON RPP rate is zero, which should be no incentive for banks to deposit cash at the Fed daily, yet they do. That means that babysitting treasury bonds is profitable and the ON RPP rate should be negative, which means institutes pays the Fed a fee to borrow those treasury bonds. But the ON RPP rate is also meant to be a lower limit for federal funds rate, which they don’t want going negative.

If I understand all of this correctly, the ability to short treasury bonds is like an exploit that makes the reverse repo program ripe for exploitation. Financial institutes can borrow treasury bonds for free, which can be turned into profit with a little creativity, and the Fed can’t charge for it because that could unintentionally cause negative interest rates across the economy.

Please let me know your thoughts. I do not have much confidence in this theory, but it’s the only one I could come up with to explain things that otherwise don’t make sense to me.

Why did the Fed increase the daily limit for any RRP counterparty from 30 billion to 80 billion?

Can the reverse repo program be used as an exploit to borrow treasury bonds for free and then short the bonds using them? If not, why are banks participating in the reverse repo program at 0.00% interest?

Why is the ON RPP rate 0.00%, what’s the objective? Does it make sense for the Fed to set it at 0.00% as opposed to negative?Update: Mostly harmless

I asked for opposing perspectives to my tinfoil hat theory and received several. Please see u/usefully_useless‘s reply for a counter perspective that this is just the money market working as intended. The fact that we’re seeing record numbers in reverse repos day by day can be explained by record numbers of excess cash. Incentive to store at the cash at the Fed at 0% is due to the obligation of money market funds to lend (forbidden to hoard). Lending to other financial institutions is currently not as competitive as usual (overnight interest only 0.01% on average), so there are clear reasons to park excess cash at the Fed (low overhead, zero insolvency risk).

On the other side of the equation, u/jsmar18 stressed the role of the Fed in their reply and I would like to highlight that although I posed the question ‘why would the Fed do x’, I meant it as a general inquiry and not an accusation of suspicion. However read his summary of RRP history and Fed goals. Fed actions sus? No, in line with their monetary policy and their hyperfocus on controlling inflation.

u/HotBoyFF also remarked with his experience that it’s likely not daily short selling, but it could be that the financial institutions desperately need treasury securities for something other, such as reporting reasons. u/jsmar18 in their reply also linked some good information on that. Treasuries are certainly used for ‘window-dressing’ (cooking books legally). I found this study on that subject if anyone is interested: https://www.aeaweb.org/conference/2018/preliminary/paper/KdB9i9QE

A popular question was: does this align with u/atobitt‘s Everything Short? Now that I believe that it’s mostly money market funds using the reverse repo program, who cannot directly in a legal way tunnel assets to hedge funds, I think it is more likely that hedge funds would just naked short over exploiting the reverse repo program. The original theory aligned with Everything Short, my updated stance just says: The NY Fed’s reverse repo program is probably not an efficient way for hedgies to implement the Everything Short. Here is a little snack that does support the Everything Short, which is JPow’s Q&A from April 27-28 time 47:00. “As you know at the beginning of this recent crisis, there was such a demand for selling treasuries, including by foreign central banks, that really the dealers could not handle the volume.” Insane demand so the dealers couldn’t handle it, could that have included naked short selling? Likely.

But while we should keep an eye on Citadel and any parties trying to short attack the US treasuries, I don’t believe Citadel is overleveraged in naked shorting US treasuries because retail and whales catching a falling GME was the big surprise to them. In US treasuries, the 52wk high-low (for example TLT: 177 – 136) is much tighter than GME (483 – 3.77) and the market for treasuries is much more resilient. So US treasuries no squeeze potential in case you were considering it (and I know some of you apes did). The ball is still GME.