Guest Post by The Zman
There used to be a time when the mass media covered the Federal Reserve as if it was Hollywood or a professional sports league. Whenever the Fed acted or the Fed chairman made a statement, it was big news. That has not been the case for a long time, mostly due to the mortgage meltdown. Worshiping the money men was no longer good copy after they came close to blowing up the world. Halfway through the Trump tenure, the media barely mentions the Fed or Fed policy.
Still, the central banks remain the most important government institutions on earth and this is particularly true of the Federal Reserve. They control the global economy, because they control the supply of money and credit. This is why the massive intervention into the credit markets by the Federal Reserve recently should be front page news. Something very big is happening and no one seems to know why, but the Fed is responding to it with $500 billion in new money.
Now, they are not just printing up cash and throwing it out the window. Instead, they are intervening in the repo market to head-off a market crash. For those who don’t know, the repo market is not where repossessed items are sold. The word “repo” is slang for repurchase agreement¹. A repurchase agreement is a short-term funding mechanism where one party needing cash, sells an asset to a party for cash, with an agreement to repurchase the asset at an agreed upon price.
A repurchase agreement functions in effect as a short-term, collateral-backed, interest-bearing loan. Much of what happens in the world of investment banks is reliant on the repo market. In order for these entitles to function, there has to be enough cash available in the system for these transactions to occur. Otherwise, borrowing rates go up, which means the cost of doing business goes up. Taken to the extreme, no cash available means the credit markets lock up.
Since the financial system is like a watch with gears interlocking with gears, one gear seizing up has the potential to seize up all the other gears. A frozen repo market could result in a cash crunch for banks, which locks up business and retail lending. That locks up the Main Street economy and we’re looking at bread lines. The economy, as we understand it, relies on a steady supply of money and credit freely flowing through the system according to the rules established by central banks.
As an aside, if the repo market probably sounds a lot like a pawnshop to you. A pawn shop offers short-term, collateral based loans. You take the family silver into the pawnshop and they give you cash. You agree to come back with the cash, plus interest, to get the family silver out of hock. If you blow the cash on a sure thing and are unable to pay the pawnshop, they take ownership of your item and sell it for cash. So yes, the financial system is built on the logic of the pawnshop.
Now, this move by the Fed is very curious. Clearly, something has caused this problem in the repo market, but no one seems to know the cause. It’s serious enough that the Fed’s balance sheet, currently at $4.1 trillion, will surpass its all-time high of $4.5 trillion. For several years now the Fed has made clear its intent to shrink its balance sheet. Therefore, this problem is serious enough to cause the Federal Reserve to change course and blow up its balance sheet.
The question is, what’s going on?
One possible answer is bad rule making over the last decade that has rewarded banks for hoarding cash. Instead of lending to one another, they are sitting on cash reserves. The risk-reward is better than short term lending. This could be due to a combination of market factors created by Fed policy and regulations on banks regarding their cash reserves. In other words, the government has created a distorted short-term lending market, through regulation and Fed policy that discourages short-term lending.
Another, more worrisome cause is that central banks have built a low-interest rate trap for themselves that they cannot escape. In lowering rates and intervening so aggressively in the market to stave off collapse a decade ago, they have created a system that cannot exist without low rates and aggressive intervention. Efforts to restore rates to historic norms or attempts to shrink the balance sheets of central banks threatens the very existence of the global financial system.
In such a scenario, the system controlled by the central banks becomes increasing complex with every intervention. Currently, the Fed does not know why the repo market is broken. They are simply reacting to the short-term effects. Their actions, however, will be part of the problem to be solved, a problem they don’t fully grasp. By the time they do understand the issue, they may have been forced to make additional interventions that further change the complexity of the problem.
Of course, a world of permanently low interest rates and unlimited intervention by the central bank is not a world controlled by the central bank. Rather, the central bank is now controlled by the system it created. The main weapons the central bank has used in the past to address systemic failure are no longer available. Taken to its logical conclusion, the financial system is a run-a-way train. The Feds do what they can to keep it on the tracks, but eventually, the inevitable happens.
In the long run, the story of credit money may be that it is simply a complex way to pull forward the benefits of economic activity, for the benefit of a few. Eventually, all of the pain avoidance with low interest rates and central bank intervention consume all of the economy to pull forward. Those accrued costs are reversed out all at once and system collapse in the result. The resulting political fallout then topples over the liberal democratic order and we enter an entirely new age.
That may sound overly apocalyptic, but consider how political institutions must weather a crisis. The people must not only want to preserve those institutions, they must trust the people running them. A great systemic collapse of the economic order would need a lot of trust in the political order to avoid revolts. At no time in the West has the current political order be less trusted. It needs the good economy to survive. That sound a lot like a house of cards waiting for the wrong decision.
¹Short primer on repurchase agreements.
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You sound like the lickspittle MSM explaining Impeachment to Useful Idiots. The Federal Reserve is a crooked bank that prints and loans money to its’ Elite syndicate members so they can buy, control and enslave America. They know what they are doing: they create the crisis and they let no crisis go to waste. Repo is chump change to Bankster buddies holding some crap gone to shit they were told to buy, compared to trillions the Oligarchs spend and loan to members to pump Wall Street and buy businesses and farms; to throttle Precious Metals and retail competitors; to control the MSM and Hollywood to pump out their Big Lie propaganda; to control Politicians, Think Tanks, NGOs, Bureaucrats, Clergy, and the MIC; to enjoy hookers, drugs, vacation retreats, DUMBs and pay the security and hit men. PS: Trump isn’t a saint but be doesn’t want average Americans Chipped and treated like cattle, so The Deep State has their Orders; it ain’t gonna happen.
“Still, the central banks remain the most important government institutions”
All the historic information I ever ran across clearly states that central banks are NOT a government institution.
The principle of banks lending money to government was first invented by the Fuggers and Medici in Europe in the middle ages. The principle was picked up again by Amshel Rothschild in Frankfurt, Germany a couple hundred years later. Rothschild like Fugger understood that lending money to governments is a sure thing, because governments (or kings back then) have the best collateral, which are taxes they can raise at will. But once the government was indebted to the bank, the power transferred, too. As it is written “The borrower is slave to the lender” Proverbs 22:7, so Rothschild understood “Give me control of the money supply of a nation and I do not care who makes its laws.” And thus Rothschild established central banks in all European nations, and his descendants did so in the US.
Valid point, using the strict sense of the word “private.”
However, I’m willing to cut Zman a little slack, inasmuch as the Fed chairman is appointed by the President, and the various Fed Governors and regional presidents are given personal security and other government benefits in accordance with federal legislation.
Also, as you say, via government indebtedness, power was transferred to the central bankers. Having been subordinated, governments were tasked with waging wars and collecting taxes on their behalf, and we the tax-paying serfs essentially function as debt-slaves. In this tragic sense, the banking cartel is an overlord entity.
Unsaid in the video at the end that attempts to explain things (yes, it is a pawnshop, of sorts) is how things used to work before-say in the Volker/Greenspan era. In those days, overnight interbank lending was facilitated by what is still called the fed funds rate, which is nothing more than a variable rate of interest agreed upon by the lending and the borrowing banks and dependent on variables common to many types of loans. That type of lending used to be for the sole purpose of meeting reserve requirements-one bank is a little short of what the Fed requires them to have on the overnight and another is a little long; the funds movement from one to the other solves the regulatory requirement mandated by the Fed. Rinse and repeat the next night.
IMHO the main culprit these days and is leverage, which-in a seat of the pants definition-is nothing more than a way to enjoy higher returns through the use of OPM/other people’s money. When things go awry the leverage one joyfully embraced can quickly become lethal, just like it did for Lehman and Bear Stearns (again, as mentioned in the video), as well as for a lot of other leveraged borrowers of different stripes.
Also unsaid is-again back in “the good old days” when things worked much better-a more common method of short term borrowing for periods usually longer than overnight, and especially in the corporate world, was through the issuance of commercial paper. CP historically was a noncollateralized loan where the borrower had a high credit rating, say like a General Electric used to have. In general, leveraged financing has done away with a lot of the noncollateralized lending. Therefore a reliance on different types of lending vehicles. The repo market is not new, but the increasing use of it is. I would bet that both the number of borrowers qualified to write CP and the gross amount written are substantially less than even 25 years ago.
A key point the video makes is that back in the run-up to the ’08 crunch the “collateral” being offered and accepted for repo financing was inferior and, as learned later on, became in cases worthless once things went from bad to worse.
The video makes the distinction between commercial banks and investment banks, with the later being the ones that caused much of the damage in ’08. The guy in the video makes a reasonable guess that the investment banks may well have something going on now that is driving the sudden need for short term borrowing that the banking industry cannot support, therefore the lender of last resort-the Fed-is stepping in.
Apparently the lessons from ’08 have been forgotten by some of the big players, so here we are again with more deja vu quickly approaching, likely thanks to some of the too-big-to-fail guys and an asleep-at-the-wheel Fed.