(pleasant mallet percussion music)
- [Narrator] Take a look at this chart.
It tracks how much banks and others pay for overnight loans
using something called repurchase agreements.
This is also known as the repo rate.
These bumps right here on September 16th and 17th
have caused a really big stir in the financial world.
That's because the repo market is a critical part
of the financial system.
It provides a lot of the grease
that keeps the wheels spinning,
meaning it provides the cash that financial firms need
to run their daily operations.
When the repo market chokes and cash stops flowing,
trouble can reverberate through the economy.
That's what happened in September,
and in response, the Federal Reserve had to step in to help,
providing tens of billions of dollars to borrowers
to keep the system cranking.
In the weeks since this happened,
experts have called the incident a technical malfunction,
and banks, for their part,
have said it could have been prevented.
They're blaming the rules that were put in place
after the financial crisis,
rules intended to keep the banking system
from falling apart.
(dramatic mallet percussion music)
(pleasant mallet percussion music)
Imagine two people, Karen and Mark.
Karen has $1000 and she'd like
to earn some fast interest on her money.
Mark has a stack of treasury notes but no cash,
so he strikes a deal with Karen.
One note for $100, but there's a catch.
Mark has to agree to buy that note back tomorrow for $101.
The difference between the price of the note
on day one and day two, that's the repo rate.
If everything works properly,
Mark gets the cash he needs right when he needs it
and Karen makes some fast money.
The repo market functions in the same way.
You just have to replace the Karens with money market funds
and other asset managers who are looking
to make a little money without a lot of risk
and replace the Marks with hedge funds,
Wall Street traders, and banks who have a lot of assets
but need cash on hand to fund their day-to-day trading.
In the repo market, Karens and Marks
all over the financial system lend back and forth
for short periods, often overnight,
and they do this at an enormous scale.
Usually, more than $1 trillion runs through it every day.
On September 16th and 17th when the rate spiked,
the Karens were not willing to trade cash for securities
at the usual rate, so the Marks who needed cash
kept offering more and more and more
until the Fed arrived with help.
(pleasant mallet percussion music)
When the Fed announced its surprise repo operations,
people wanted to know,
why did the Karens suddenly stop lending?
Experts point to two financial deadlines
that sapped cash out of the system on the same night,
causing a crunch. (gears snapping)
September 16th was the cut-off for banks
to submit their quarterly tax payments,
so a lot of money that they might usually lend
in the repo market was being sucked out of their accounts
and deposited into the Treasury.
September 16th was also the day
that $78 billion of Treasury debt was scheduled to settle,
which just means that another chunk of cash
was being turned into securities on that day, too.
Now, some banks said the crunch was compounded
by another factor, a rule put in place
after the financial crisis to keep banks solvent.
The rule, which is called Liquidity Coverage Ratio, or LCR,
requires banks to keep a certain amount of reserves
or cash on hold at the Fed at all times, among other things.
The idea was to improve the banking sector's ability
to absorb shocks arising from financial and economic stress.
You can see it on this chart.
Since the crisis,
banks have stockpiled cash in their reserve accounts.
There argument is that keeping these funds on hold
makes it harder for them to lend out cash on a dime
when money gets tight.
Now, for the Fed's part, Chairman Jerome Powell
dismissed the possibility of revisiting those rules.
- If we concluded that we needed to raise the level
of required reserves for banks to meet the LCR,
we'd probably raise the level of reserves
rather than lower the LCR.
- [Narrator] What he's saying is that the Fed
would rather provide the extra funds itself
than lower those liquidity requirements for banks,
and since that press conference,
the Fed's done just that.
In October, it announced it would start buying
short-term treasury debt at $60 billion a month
and continue through at least June of 2020,
which means there's gonna be money to borrow
even if the Karens stop lending again.
Its aim is to boost reserves,
allowing banks to stay liquid without violating the rule,
and in doing so, to keep the wheels
of the financial system spinning.