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Think of the repo market as an accumulator. It stores or pumps money into the system as demand changes. In fact, the Fed does that in many different ways. Here’s a quick rundown on how the Fed and banks use the repo market to manage money.
Repurchase agreements (“repos”) work like this: one entity sells a security to a second entity with the agreement to buy it back from them at a higher price. Yes, at a higher price. Why would someone do that? Well, think of it like a brief loan. You get money and pay back more than you borrowed. In this way repos are like collateralized loans. But the borrow and payback periods are usually really short. Typically, the money is just borrowed overnight. Think of the extra that the borrower buys back the securities for as the interest rate.
When a massive bank operates it has periods of time when it needs more cash. Let’s say it has to pay taxes, or a loan it took comes due. Perhaps there is a unique buying opportunity and the bank won’t have enough funds until tomorrow, but the chance to buy is tonight. There are many reasons why a bank needs money overnight – it is a very normal practice for banks to borrow overnight. Repos are just one way banks meet overnight needs.
In the Fall of 2019 though the system had a problem. Treasuries were made available, which banks wanted, but many of them had just paid their tax bills so they were short on cash. This meant that demand for money far exceeded supply of money. Supply and demand dictated that the “repo rate” surged to nearly 10%. Nearly a trillion dollars had been pulled out of the system when the Fed offered the Securities (the Fed gets paid for their securities, then “sits” on that money; it is not part of the money supply). So you can see how the Fed, through things like repos, acts like an accumulator. The accumulator in this case pulls money out of the system when there is too much and pushes money into the system when there is too little.
But the Fed isn’t quite a mechanical accumulator that can perfectly respond to pressure/supply-and-demand changes in the system. Instead, it is a collection of economists analyzing quantitative and qualitative data. So they can improperly respond. Because of that, they have a tendency to err on the side of caution.
That’s your quick rundown of repos!
Questions, comments, concerns?
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