Something Blew Up Again In The Financial System

Investment Research Dynamics

Something occurred in the banking system in September that required a massive reverse repo operation in order to force the largest ever Treasury collateral injection into the repo market.   Ordinarily the Fed might engage in routine reverse repos as a means of managing the Fed funds rate.   However, as you can see from the graph below, there have been sudden spikes up in the amount of reverse repos that tend to correspond the some kind of crisis – the obvious one being the de facto collapse of the financial system in 2008:

You can also see from this graph that the size of the “spike” occurrences in reverse repo operations has significantly increased since 2014 relative to the spike up in 2008. In fact, the latest two-week spike is by far the largest reverse repo operation on record.

Besides using repos to manage term banking reserves in order to target the Fed funds rate, reverse repos put Treasury collateral on to bank balance sheets.  We know that in 2008 there was a derivatives counter-party default melt-down.  This required the Fed to “inject” Treasury collateral into the banking system which could be used as margin collateral by banks or hedge funds/financial firms holding losing derivatives positions OR to “patch up” counter-party defaults (see AIG/Goldman).

What’s eerie about the pattern in the graph above is that since 2014, the “spike” occurrences have occurred more frequently and are much larger in size than the one in 2008.   This would suggest that whatever is imploding behind the scenes is far worse than what occurred in 2008.

What’s even more interesting is that the spike-up in reverse repos occurred at the same time – September 16 – that the stock market embarked on an 8-day cliff dive, with the S&P 500 falling 6% in that time period.  You’ll note that this is around the same time that a crash in Glencore stock and bonds began.   It has been suggested by analysts that a default on Glencore credit derivatives either by Glencore or by financial entities using derivatives to bet against that event would be analogous to the “Lehman moment” that triggered the 2008 collapse.

The blame on the general stock market plunge was cast on the Fed’s inability to raise interest rates.  However that seems to be nothing more than a clever cover story for something much more catastrophic which began to develop out sight in the general liquidity functions of the global banking system.

Without a doubt, the graphs above are telling us that something “broke” in the banking system which necessitated the biggest injection of Treasury collateral in history into the global banking system by the Fed.