The Man With No Name?
Our unprecedented in depth coverage of the repo ruckus finishes, following up on Part 12: The Sad Hill Trio Ride Again?
Re: above quoted and limiting ourself to three not so trivial items. 1. Price discovery for cost of loan funds. Lets replace rigged LIBOR (eurodollar) with an index of the cost of securities lending in a "wholesale funding" market where: regulatory disintermediation, convexity, collateral and maturity transformation, synthetic arbitrage, negative carry and yields all exist... the new SOFR "tool" will effect monetary policy via the price of loan funds for commercial and consumer markets. Hello? Anybody home? THINK McFly? NEXT!
3. When #2 above occurs at the pawn shop hidden in the corner of repo, the FHLB, MMF's and banks all profit. However, the MMF investors and banks are laying all the risk off on the public (FHLB) for what should be a much larger premium. Putting away the soapbox. Moving West and speaking of largess...
2019 YTD FHLB Issuance: Discount Notes (o/n to 12 month) 5.1; at the peak of the GFC in 2008 10.9, as in TRILLION. Now you know why the FHLB is considered the "beating heart of the funding network that underpins the U.S. financial system." - Louie Woodall. As of September 30, 2019: Outstanding FHLB debt $1 trln; 70% of advances and 80% of all FHLB debt matures in under one year. Advances totaled $658.8 bln, a decrease of 10% in short-term advances, principally those made to large members. FHLB YOY: Net interest income Q3 -19% YTD -12%; Net income Q3 -17% YTD -27%.
Take away: When the Fed was raising rates, short yields rose (variable and rollover costs increased) while long yields succumbed to convexity hedged carry arbs, squeezing margin and inverting the UST yield curve viz decrease in higher yield long assets and average balance of bank advances; increase in average balance of lower yielding "liquid" UST's (oh the irony). The FHLB investment portfolio and interest income took a hit, resulting in a -27% income decline. Bonus? Decreased market liquidity as the FHLB borrowed from MMF's and lent to banks -$500 bln less. Silver lining? All the above without rising default rates or executives committing fraud.
Tuco chiming in: Sarcasm you say? Aside from Slim's family, his GSE pawn shop (FHLB) is a very large source of funding through advances to banks, non banks and non depository lending institutions who provide mortgages and MBS. Speaking of which...
With consideration for operational changes due to disintermediation, both rate (cost of loan funds) and regulatory induced, less actors, different actors filling gaps, less liquidity, fewer and narrower exits in the "new paradigm", a quick review: August 7th: Keep calm and carry on... the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.
Three short days later... August 10th: The Federal Reserve is providing liquidity to facilitate the orderly functioning of financial markets. In current circumstances depository institutions may experience unusual funding needs because of dislocations in money and credit markets. To wit, lubricant = money or collateral for intraday debits and credits viz clearing.
A week later, the FOMC cut the discount rate (the interest rate charged on discount window loans) by 50 bps and extended the available term for these loans from overnight to 30 days. August 17th: To promote the restoration of orderly conditions in financial markets... to provide depositories with greater assurance about the cost and availability of funding... The Fed will continue to accept a broad range of collateral... including home mortgages and related assets.
Speaking of which... our Nattering about cost of loan funds, dwindling MBS repo volume share, and the effects would not be complete without the following. The main risk with MBS is the timing of prepayments. When refi CPR (Conditional Prepayment Rate) is low due to rising rates, duration extends viz negative convexity. When CPR is high, duration gets shorter exactly when investors want longer duration to take advantage of lower rates. A higher CPR means the value of MSR (mortgage servicing rights, an asset) decreases, and investors are less comfortable paying a premium for new or existing MBS coupons. Fast buck Freddie and just gittin by Ginnie's higher CPR, means higher risk and less liquidity than Fannie's chit.
Distinction: Note the temporal proximity, in June 2019, despite major differences in liquidity and CPR, the UMBS initiative unified FNMA and FHLMC debt into a single comingled security. In October, UMBS 30-year pass throughs delivered to settle in TBA (To Be Announced) trades exhibited 1 month CPR of 40, 40 and 57.5 for the 3.5%, 4% and 4.5% coupons. Back in January they were 4, 7 and 10, respectively.
Take away: Double whammy. Rates rise and 25% refi cash outs hit, then synthetic arb UST curve inversion, lowers long rates and 40% refi volumes hit, rising CPR's hit Agency MBS MSR asset prices, monthly payment income, and investor returns. FHLMC and FNMA stock tanked (-41%), related MReit's, and ultimately UMBS, GNMA, FHLMC and FNMA bond prices plunged. Below FNMA 3.0 coupon price going off a cliff -172 bps from September 4 - 13. Coincidence with the repo ruckus? We think not.
Dollar rolls can be extended (rolled, hence the name), and many MBS players who went outside of repo to extend their borrowing terms and bought fixed rate swaps that receive floating LIBOR, (since Dec 25: -92bps; since June 1: -60bps) got their heads handed to them, in what turned out to be a bloody pig-sty. Pun intended.
Oh munificent one, what does this have to do with repo? Patience impairment breath. The collateralized market for mortgages has heavy reliance upon repo viz loans funded with deposits? In what world? Get real. All the players have something in common. Hint: like pig slop there's plenty O in the trough, and many are wallowing in the mire.
Commercial banks are the largest FHLB borrowers at $433 bln or 63.1%. Excluding deposits, the FHLB provides 25% of all long term funding for the largest commercial banks. Commercial banks are the largest holders of Agency MBS with 2.1 trln. As of October 2019, 1.5 trln held by the top 25 domestic banks, with an additional $520 bln held by small domestic banks.
MMF's as of September 30, 2019 net assets blns US Agency 1820 (69%); Government and Treasury MMF US holdings: 2500; Repo (38%) 1016 ; Agency (26%) 683 of which FHLB (73%) 500 or (20%) of total. MMF assets held by the banks in repo; 33% = $885 bln; 27% US; 73% foreign. Foreign investors hold 16% of all agency MBS = $1 trln.
2019 MBS issuance: est. 2 trln x 50% = 1 trln through REPO warehouse lines. Between May 9th and Aug 9th in blns GCF: term -175; o/n +175. 2019 1H avg monthly issuance 140; surging 50% Aug - Oct 215; daily trading volume MBS 250 ; UST 600. Agency market share in REPO: primary dealer RRP 15% ; RP 25%; Tri party 38%; GCF 75%; overall 30%.
Take away: May - Aug saw a shift from term to o/n, then the flood of refis hit in August. Banks (domestic - foreign), MMF's and repo hold large volumes of MBS (50% non bank originated) which are non trivial. The majority Agency and FHLB collateral or CLO derivative of "transmogrified" bank whole loans.
Many have offered "repo ruckus" explanations, all speculative, some partial, some good, most superficial parroting of the narrative, but nothing concrete. Reconsider the process, plumbing and distinctions through out this in depth series, then the confluence of repo "vaso-constrictive" events leading up to the ruckus. What's left? A temporally proximate, highly symptomatic giant elephant sitting in the middle of the room, being ignored.
CB's targeting low and negative cost of loan funds, utilization of IOER (credit cloaking device) and synthetic arbritage (alchemy). Those unnatural things inverted the short end of the retail and wholesale funding yield curve (inside, outside and swap rates). The reversal of maturity and credit transformation caused an upheaval, a side effect of which adversely impacted amongst other things, MBS valuation.
Fed, FNMA and FHLMC reduced their balance sheets, Fed MBS purchases went to zero, float deterioration was 25-50 bln month. Feddie along with Fannie lent less in GCF repo, who along with Freddie and Slim (FHLB) borrowed less from MMF's, while Slim lent less to the banks viz. overall vascular contraction (less liquidity), hypertension (rising repo) and atrophy (fewer actors), and the stage was set.
11/15/18 30 year mortgage at 4.94%, eleven months later 09/05/19 -145bps at 3.49%, while convexity trades drove down dollar swap rates. MBS repo volume shares were declining due to lower issuance, said decline in cost of loan funds spurred higher refi (CPR) volumes. In early September with all the above factors at a crescendo, and $175 bln MBS shifted from term to o/n GCF, a 50% surge (reflated to GFC levels) in the MBS pipeline which began in August hit. This would have been like a hypertensive mainlining epinephrine.
Agency MBS coupon prices went into a vertical tailspin exactly when a confluence of seasonal flows, regulatory disintermediation, dealer (Jamie Gang) withdrawal and massive UST issuance, constricted the repo arterial system even further. The resulting "rate volatility" impairment affected the many holding or hedging and funding MBS in repo, the GSE's, FHLB, MMF's, banks and by proxy anyone involved in repo.
Guilt by association befell Slim's (FHLB) magical chit due to it's well known blanket pledged assets. Systemic heart palpitations caused Slim (FHLB) to divert away from larger clients (synth repo and alt arb reindeer games) to support smaller customers viz the rest of the US banking system which became effected. As o/n and term trades, synthetic or collateral "afflicted" gone South caused margin calls, more risk, higher rate for funding as short term roll over became the order du jour.
As the MBS affliction went viral, everyone holding it felt the effect. With a minimum of 30-38% by volume of repo collateral suddenly requiring additional premium, GCF (blind) at 74% agency froze out of literally blind fear viz. A-fib. In tri-party imagine, if MBS was offered the cash counterpart either made the premium prohibitive, or flat out refused the trade viz. infarction. For which the Fed sheriff's showed with a crash cart, defib and clean up crew.
This Fed (who helped cause the event in the first place) bailout is of epic proportion heretofore unseen, and had they not, the cascade into equities, bonds and RE would have dwarfed Lehman Bear. Hence the nothing's wrong here, look over there narrative, with escalating triage and artificial stimulation. Patient history, symptoms, EKG's (graphs), circumstance and temporal proximity confirm the diagnosis.
When markets get over saturated with chit of all kinds, and repo gets inundated with "preferred" negative carry balance sheet instrument UST's, HQLA portfolios and arbitrage flows cannot absorb additional excess collateral. Perhaps especially what would be normally accepted substitutes of a known "lesser" quality? Varied narratives, not enough UST? Collateral? Cash? or Participants? All contributory, as something was rotten in Denmark, and CON-fidence was lost while fear took over.
Unfortunately, despite IOER being lower the Fed is right back where it was before. With 75bps in cuts, the Fed continues to buy short duration notes to steepen the curve, and indeed it has, for the moment, yet long and short rates descend further. Over-subscription to the bail out, wonder why actors are treating MBS and UST like hot potatoes? There's too much chit floating already, and what's coming? Lots more UST, lots more MBS, more refi's and convexity arbs, rinse and repeat. A preview of things to come? Much like the FHLB -27% income, US Banking industry Q3 2019 YOY net income -7.3% and QOQ -8.3% (see FDIC Pg 16 and Union Bank Pg 20 for clues). TBD.
While the electorate, politicians, government and Federales might be clueless, those wily bankers are anything but. Despite knowing about all the shenanigans, as long as they can make a buck, those repo disco dancers will all be packin and passin the same faux chit. What happens when your hand suddenly don't look so good, and your bluff gets called? A sudden lack of CON-fidence in your game? What happens if any of the market actors, including the foreigners, back away? Those funding inversions, forced another Fed Daddy cut rate, repo viagra bail out, and stuck the sheriff in the disco permanent like a bouncer. Otherwise Slim's operation and the whole banking system would have gone the way of the economy. Just like the politicos and journalistas said, turned the corner alright... then flipped over three times, struck a tree and burst into flames. Do you feel lucky? Well do ya? Listen fellas, the copious chatter about Slim has been downright nostalgic, but I'm sick and tired of this here ruckus. Just tryin to make an honest livin, we got a long haul tomorrow for next to nuthin, so let's get some shuteye. Slowly tipping his fedora brim back down: night boy's but first some apropos music... you dig. Fade to black.
This series is dedicated to those challenged by macro, the dismal science, the banking system, repo, STIR and negative yields. This author would be remiss not to mention one of my mentors S. Trutta, without whose tutelage this labor of love would not have been possible.
In regards to the repo ruckus, many have commented as to cause. Of note from Yves Smith, Scott Skyrm, Jeffrey P. Snider, and Nathan Tankus (here too). For perspective, read them all.
This piece from FT utilizes some nice graphics as one scrolls down through the timeline of events. While scrolling, bear in mind the concomitant dollar swap - interest rate collapses, multiple cost of funds curve inversions and MBS pipeline volume shares, all Nattered about previously in this series. Again, for perspective read them all.
Recommended Reading:
A Fistful Of Dollars?
For A Few Dollars More?
The Good, The Bad And The Ugly?
A Coffin Full Of Dollars?
A Dollar To Die For?
The Devil's Dollar Sign?
The Million Dollar Bloodhunt?
Blood For a Dirty Dollar?
High Plains Drifter?
Pale Rider?
Sad Hill Unearthed?
The Sad Hill Trio Ride Again?
A Negative Disposition?
A Wayward Italian in Kansas?
First Rule Of Bond Market: You Do Not Talk About Keynes?
At a later date, more to come in our epilogue, as we take a look at items discovered along the way to a grave at Sad Hill marked "UNKNOWN", but not to be ignored in Part 14: Arch Stanton's Grave? Stay tuned, no flippin.
Business sure is booming, or is somebody attempting to fill a void of late? As in repo substituting for other functions that it really shouldn't? - Sad Hill Unearthed?With Tuco and Angel Eye's help, the Man With No Name finally pins down the infamous Slim in the apropos named epic Part 13 finale: The Man With No Name? Nattering about dollar rolls, debt volumes, collapsing and inverted rate structures, margin squeezes, the MBS and repo plumbing, and what happened at the heart of the system.
(Poster Art courtesy of Cyberjazz @ PlexCollectionPosters)
Re: above quoted and limiting ourself to three not so trivial items. 1. Price discovery for cost of loan funds. Lets replace rigged LIBOR (eurodollar) with an index of the cost of securities lending in a "wholesale funding" market where: regulatory disintermediation, convexity, collateral and maturity transformation, synthetic arbitrage, negative carry and yields all exist... the new SOFR "tool" will effect monetary policy via the price of loan funds for commercial and consumer markets. Hello? Anybody home? THINK McFly? NEXT!
One can only hope this "ruck" has nothing to do with LCR upgrades? AKA CB's park mortgage loans at FHLBs as collateral against advances, use proceeds from CLO to buy HQLA. - Ruck This? - 09/18/192. LCR liquidity and transmogrification shenanigans. Transformation of junk collateral through FHLB agency notes, bonds, and sponsored FICC GCF repo netting. Much like a sell transaction or dollar roll (more later), the latter allows "window dressing" where the parent offloads crap collateral in repo "sale" to a holding company "SIV". Repo 105 ala Lehman comes to mind. NEXT!
3. When #2 above occurs at the pawn shop hidden in the corner of repo, the FHLB, MMF's and banks all profit. However, the MMF investors and banks are laying all the risk off on the public (FHLB) for what should be a much larger premium. Putting away the soapbox. Moving West and speaking of largess...
2019 YTD FHLB Issuance: Discount Notes (o/n to 12 month) 5.1; at the peak of the GFC in 2008 10.9, as in TRILLION. Now you know why the FHLB is considered the "beating heart of the funding network that underpins the U.S. financial system." - Louie Woodall. As of September 30, 2019: Outstanding FHLB debt $1 trln; 70% of advances and 80% of all FHLB debt matures in under one year. Advances totaled $658.8 bln, a decrease of 10% in short-term advances, principally those made to large members. FHLB YOY: Net interest income Q3 -19% YTD -12%; Net income Q3 -17% YTD -27%.
Take away: When the Fed was raising rates, short yields rose (variable and rollover costs increased) while long yields succumbed to convexity hedged carry arbs, squeezing margin and inverting the UST yield curve viz decrease in higher yield long assets and average balance of bank advances; increase in average balance of lower yielding "liquid" UST's (oh the irony). The FHLB investment portfolio and interest income took a hit, resulting in a -27% income decline. Bonus? Decreased market liquidity as the FHLB borrowed from MMF's and lent to banks -$500 bln less. Silver lining? All the above without rising default rates or executives committing fraud.
Tuco chiming in: Sarcasm you say? Aside from Slim's family, his GSE pawn shop (FHLB) is a very large source of funding through advances to banks, non banks and non depository lending institutions who provide mortgages and MBS. Speaking of which...
With consideration for operational changes due to disintermediation, both rate (cost of loan funds) and regulatory induced, less actors, different actors filling gaps, less liquidity, fewer and narrower exits in the "new paradigm", a quick review: August 7th: Keep calm and carry on... the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.
Three short days later... August 10th: The Federal Reserve is providing liquidity to facilitate the orderly functioning of financial markets. In current circumstances depository institutions may experience unusual funding needs because of dislocations in money and credit markets. To wit, lubricant = money or collateral for intraday debits and credits viz clearing.
A week later, the FOMC cut the discount rate (the interest rate charged on discount window loans) by 50 bps and extended the available term for these loans from overnight to 30 days. August 17th: To promote the restoration of orderly conditions in financial markets... to provide depositories with greater assurance about the cost and availability of funding... The Fed will continue to accept a broad range of collateral... including home mortgages and related assets.
Speaking of which... our Nattering about cost of loan funds, dwindling MBS repo volume share, and the effects would not be complete without the following. The main risk with MBS is the timing of prepayments. When refi CPR (Conditional Prepayment Rate) is low due to rising rates, duration extends viz negative convexity. When CPR is high, duration gets shorter exactly when investors want longer duration to take advantage of lower rates. A higher CPR means the value of MSR (mortgage servicing rights, an asset) decreases, and investors are less comfortable paying a premium for new or existing MBS coupons. Fast buck Freddie and just gittin by Ginnie's higher CPR, means higher risk and less liquidity than Fannie's chit.
Distinction: Note the temporal proximity, in June 2019, despite major differences in liquidity and CPR, the UMBS initiative unified FNMA and FHLMC debt into a single comingled security. In October, UMBS 30-year pass throughs delivered to settle in TBA (To Be Announced) trades exhibited 1 month CPR of 40, 40 and 57.5 for the 3.5%, 4% and 4.5% coupons. Back in January they were 4, 7 and 10, respectively.
Take away: Double whammy. Rates rise and 25% refi cash outs hit, then synthetic arb UST curve inversion, lowers long rates and 40% refi volumes hit, rising CPR's hit Agency MBS MSR asset prices, monthly payment income, and investor returns. FHLMC and FNMA stock tanked (-41%), related MReit's, and ultimately UMBS, GNMA, FHLMC and FNMA bond prices plunged. Below FNMA 3.0 coupon price going off a cliff -172 bps from September 4 - 13. Coincidence with the repo ruckus? We think not.
Independent mortgage banks (IMB's) are non depository institutions reliant upon cash, unencumbered assets, short term financing such as bank provided "warehouse lines secured by collateral" (which is a form of repo), and the issuance of long term debt. - Sad Hill Unearthed?Dollar rolls are the primary channel for pass through Agency MBS borrowing and lending in the TBA (in return not same, but identical of lesser value) market. Sell side broker dealers normally pay a "drop" fee to rehypothecate the pig's in a blanket. Distinction: Just prior to and since the repo ruckus, rapid or high CPR caused dollar roll rates in MBS repo to trade negative. Negative drop translated: rather than pay to rent Porky, the swine hoteliers were instead charging ransom to hold the pig in the poke.
Dollar rolls can be extended (rolled, hence the name), and many MBS players who went outside of repo to extend their borrowing terms and bought fixed rate swaps that receive floating LIBOR, (since Dec 25: -92bps; since June 1: -60bps) got their heads handed to them, in what turned out to be a bloody pig-sty. Pun intended.
Oh munificent one, what does this have to do with repo? Patience impairment breath. The collateralized market for mortgages has heavy reliance upon repo viz loans funded with deposits? In what world? Get real. All the players have something in common. Hint: like pig slop there's plenty O in the trough, and many are wallowing in the mire.
Commercial banks are the largest FHLB borrowers at $433 bln or 63.1%. Excluding deposits, the FHLB provides 25% of all long term funding for the largest commercial banks. Commercial banks are the largest holders of Agency MBS with 2.1 trln. As of October 2019, 1.5 trln held by the top 25 domestic banks, with an additional $520 bln held by small domestic banks.
MMF's as of September 30, 2019 net assets blns US Agency 1820 (69%); Government and Treasury MMF US holdings: 2500; Repo (38%) 1016 ; Agency (26%) 683 of which FHLB (73%) 500 or (20%) of total. MMF assets held by the banks in repo; 33% = $885 bln; 27% US; 73% foreign. Foreign investors hold 16% of all agency MBS = $1 trln.
2019 MBS issuance: est. 2 trln x 50% = 1 trln through REPO warehouse lines. Between May 9th and Aug 9th in blns GCF: term -175; o/n +175. 2019 1H avg monthly issuance 140; surging 50% Aug - Oct 215; daily trading volume MBS 250 ; UST 600. Agency market share in REPO: primary dealer RRP 15% ; RP 25%; Tri party 38%; GCF 75%; overall 30%.
Take away: May - Aug saw a shift from term to o/n, then the flood of refis hit in August. Banks (domestic - foreign), MMF's and repo hold large volumes of MBS (50% non bank originated) which are non trivial. The majority Agency and FHLB collateral or CLO derivative of "transmogrified" bank whole loans.
Engines do not seize for "mysterious" reasons, components fail due to heat stress, usually created by inefficiencies and/or a lack of lubricant, and somebody holding out For A Few Dollars More?Angel Eye's: Try running one of them new fangled motors with 30% less pig grease, much less runnin your horse flat out on 75% less water and feed, see what happens. Seize right up on ya, right quick. Tuco: Hell knows I've been shot before, but if I lost 20% of my blood, it would be impossible for my heart to pump a sufficient amount of blood to my body, and organ failure would ensue.
Many have offered "repo ruckus" explanations, all speculative, some partial, some good, most superficial parroting of the narrative, but nothing concrete. Reconsider the process, plumbing and distinctions through out this in depth series, then the confluence of repo "vaso-constrictive" events leading up to the ruckus. What's left? A temporally proximate, highly symptomatic giant elephant sitting in the middle of the room, being ignored.
CB's targeting low and negative cost of loan funds, utilization of IOER (credit cloaking device) and synthetic arbritage (alchemy). Those unnatural things inverted the short end of the retail and wholesale funding yield curve (inside, outside and swap rates). The reversal of maturity and credit transformation caused an upheaval, a side effect of which adversely impacted amongst other things, MBS valuation.
Fed, FNMA and FHLMC reduced their balance sheets, Fed MBS purchases went to zero, float deterioration was 25-50 bln month. Feddie along with Fannie lent less in GCF repo, who along with Freddie and Slim (FHLB) borrowed less from MMF's, while Slim lent less to the banks viz. overall vascular contraction (less liquidity), hypertension (rising repo) and atrophy (fewer actors), and the stage was set.
11/15/18 30 year mortgage at 4.94%, eleven months later 09/05/19 -145bps at 3.49%, while convexity trades drove down dollar swap rates. MBS repo volume shares were declining due to lower issuance, said decline in cost of loan funds spurred higher refi (CPR) volumes. In early September with all the above factors at a crescendo, and $175 bln MBS shifted from term to o/n GCF, a 50% surge (reflated to GFC levels) in the MBS pipeline which began in August hit. This would have been like a hypertensive mainlining epinephrine.
Agency MBS coupon prices went into a vertical tailspin exactly when a confluence of seasonal flows, regulatory disintermediation, dealer (Jamie Gang) withdrawal and massive UST issuance, constricted the repo arterial system even further. The resulting "rate volatility" impairment affected the many holding or hedging and funding MBS in repo, the GSE's, FHLB, MMF's, banks and by proxy anyone involved in repo.
Guilt by association befell Slim's (FHLB) magical chit due to it's well known blanket pledged assets. Systemic heart palpitations caused Slim (FHLB) to divert away from larger clients (synth repo and alt arb reindeer games) to support smaller customers viz the rest of the US banking system which became effected. As o/n and term trades, synthetic or collateral "afflicted" gone South caused margin calls, more risk, higher rate for funding as short term roll over became the order du jour.
As the MBS affliction went viral, everyone holding it felt the effect. With a minimum of 30-38% by volume of repo collateral suddenly requiring additional premium, GCF (blind) at 74% agency froze out of literally blind fear viz. A-fib. In tri-party imagine, if MBS was offered the cash counterpart either made the premium prohibitive, or flat out refused the trade viz. infarction. For which the Fed sheriff's showed with a crash cart, defib and clean up crew.
This Fed (who helped cause the event in the first place) bailout is of epic proportion heretofore unseen, and had they not, the cascade into equities, bonds and RE would have dwarfed Lehman Bear. Hence the nothing's wrong here, look over there narrative, with escalating triage and artificial stimulation. Patient history, symptoms, EKG's (graphs), circumstance and temporal proximity confirm the diagnosis.
When markets get over saturated with chit of all kinds, and repo gets inundated with "preferred" negative carry balance sheet instrument UST's, HQLA portfolios and arbitrage flows cannot absorb additional excess collateral. Perhaps especially what would be normally accepted substitutes of a known "lesser" quality? Varied narratives, not enough UST? Collateral? Cash? or Participants? All contributory, as something was rotten in Denmark, and CON-fidence was lost while fear took over.
Risk free collateral is sometimes viewed as a complete substitute for counterparty credit risk, and collateral may generate unexpected losses. - Pale Rider?Angel Eye's: Not all chit is created the same, and there are subtle differences even with close tradin substitutes. Federale's UST chit has the full faith and credit of the U.S. government. Even though it is implied, Slim's (GSE) homesteadin chit does not. Unlike UST, MBS contains underlyin credit and duration risk, as those notes are callable.
Unfortunately, despite IOER being lower the Fed is right back where it was before. With 75bps in cuts, the Fed continues to buy short duration notes to steepen the curve, and indeed it has, for the moment, yet long and short rates descend further. Over-subscription to the bail out, wonder why actors are treating MBS and UST like hot potatoes? There's too much chit floating already, and what's coming? Lots more UST, lots more MBS, more refi's and convexity arbs, rinse and repeat. A preview of things to come? Much like the FHLB -27% income, US Banking industry Q3 2019 YOY net income -7.3% and QOQ -8.3% (see FDIC Pg 16 and Union Bank Pg 20 for clues). TBD.
The problem, again, with how MBS was used in the same way a decade ago was uncertainty about pricing – the thing that kills collateral potential in repo and repo transformation. Neither the repo market nor [any] Bank has any interest in being a part of using an increasingly risky and therefore potentially illiquid asset in the chain. Risky... bond products, suspect repo collateral chains, global downturn, and the growing prospects for illiquid pricing. A bad combination. - Jeffrey P. SniderSpeaking of a decade ago and bad combinations... all the FOMC quotes herein are from 2007. History repeats, and in the case of this repo ruckus, it's not sub prime, it's 30% of what's in every repo counterparty wallet, and for some 70% of their holdings. And there will be blood... wait till the curve flattens and inverts again, or better yet, when defaults begin to mount... for banks, when net interest margins decline viz. funding costs rise faster than asset yields... when commercial banks, MMF's or other fin institutions reevaluate the risk involved, and perhaps lose their taste for extending cheap credit. Oh wait, isn't that what just happened?
In a deposit run, when the quality of a bank’s assets is brought into question, depositors immediately withdraw their funds from the bank. In the case of the repo market, lenders raised the haircuts required for the repo loans or refused to roll over the repo loans collateralized by [subprime - redacted] mortgage assets. This is equivalent to a partial or a complete withdrawal of funds from the market by the lenders. - Joseph Tracy EVP FRBNYAt the end of the day, there is something in this more than natural, something is rotten in Denmark, and now you know The Good, The Bad And The Ugly of it, as least as we see it, and that's the end of this here long yarn. Stealth in the corner, poncho adorned, head slumped over, feet propped upon table next to an extinguished cigarillo and empty bottle of bourbon, the Man With No Name suddenly tipped his eye shading leather fedora upwards and scratchily uttered...
While the electorate, politicians, government and Federales might be clueless, those wily bankers are anything but. Despite knowing about all the shenanigans, as long as they can make a buck, those repo disco dancers will all be packin and passin the same faux chit. What happens when your hand suddenly don't look so good, and your bluff gets called? A sudden lack of CON-fidence in your game? What happens if any of the market actors, including the foreigners, back away? Those funding inversions, forced another Fed Daddy cut rate, repo viagra bail out, and stuck the sheriff in the disco permanent like a bouncer. Otherwise Slim's operation and the whole banking system would have gone the way of the economy. Just like the politicos and journalistas said, turned the corner alright... then flipped over three times, struck a tree and burst into flames. Do you feel lucky? Well do ya? Listen fellas, the copious chatter about Slim has been downright nostalgic, but I'm sick and tired of this here ruckus. Just tryin to make an honest livin, we got a long haul tomorrow for next to nuthin, so let's get some shuteye. Slowly tipping his fedora brim back down: night boy's but first some apropos music... you dig. Fade to black.
This series is dedicated to those challenged by macro, the dismal science, the banking system, repo, STIR and negative yields. This author would be remiss not to mention one of my mentors S. Trutta, without whose tutelage this labor of love would not have been possible.
In regards to the repo ruckus, many have commented as to cause. Of note from Yves Smith, Scott Skyrm, Jeffrey P. Snider, and Nathan Tankus (here too). For perspective, read them all.
This piece from FT utilizes some nice graphics as one scrolls down through the timeline of events. While scrolling, bear in mind the concomitant dollar swap - interest rate collapses, multiple cost of funds curve inversions and MBS pipeline volume shares, all Nattered about previously in this series. Again, for perspective read them all.
Recommended Reading:
A Fistful Of Dollars?
For A Few Dollars More?
The Good, The Bad And The Ugly?
A Coffin Full Of Dollars?
A Dollar To Die For?
The Devil's Dollar Sign?
The Million Dollar Bloodhunt?
Blood For a Dirty Dollar?
High Plains Drifter?
Pale Rider?
Sad Hill Unearthed?
The Sad Hill Trio Ride Again?
A Negative Disposition?
A Wayward Italian in Kansas?
First Rule Of Bond Market: You Do Not Talk About Keynes?
At a later date, more to come in our epilogue, as we take a look at items discovered along the way to a grave at Sad Hill marked "UNKNOWN", but not to be ignored in Part 14: Arch Stanton's Grave? Stay tuned, no flippin.
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