Former Fed Official Worries Recent Repo Turmoil Signals ‘Something’s Very Wrong With The Financial System’

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Written by Dana Sanchez
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Former Fed chief Narayana Kocherlakota wrote a Bloomberg column about the repo market. He thinks “something’s very wrong with the financial system”. Photo by Pepi Stojanovski on Unsplash

The $2.2 trillion repurchase agreement or repo market turned chaotic last week when cash available to banks for their short-term funding needs almost dried up.

Interest rates in U.S. money markets went up more than four times the Fed’s rate to as much as 10 percent for some overnight loans, Reuters reported.

The New York Fed announced that it has increased the size of both its term and overnight repos scheduled for Sept. 26. The 14-day term operation will now have an aggregate limit of $60 billion compared to $30 billion, while the overnight operation will be for up to $100 billion as opposed to $75 billion previously, according to the Heisenberg Report.

Repo market signals something’s wrong

Former Minneapolis Fed chief Narayana Kocherlakota wrote a Bloomberg opinion piece on Wednesday and sounded worried.

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Kocherlakota said he thinks “something’s very wrong with the financial system” and he blames the post-crisis regulatory regime which he said “has disrupted some of the system’s most basic functions”.

“Since the 2008 crisis, regulatory reforms have constrained the ability of flush banks to lend, and of tight banks to borrow (and) such constraints interact in complicated ways with financial market conditions”, Kocherlakota wrote. He added that “reserves are siloed in the flush banks, so the financial system is acting more like it has $1.3 billion in excess reserves than the actual $1.3 trillion”.

While the central bank can temporarily inject cash into the markets to control short-term rates, Kocherlakota said it’s hard to understand how funding markets will respond to future shocks.

Last week, interest rates in U.S. money markets went up more than four times the Fed’s rate to as much as 10 percent for some overnight loans, Reuters reported.

Though overnight rates have since gone down from record levels, general collateral repo has climbed back above 2 percent and was trading around 2.09 percent on Wednesday, ICAP data showed according to Bondbuyer.