What is the repo market?

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.