Reverse Repos Go Parabolic: ‘Liquidity Shock’ Derivatives Me

Reverse Repos Go Parabolic: ‘Liquidity Shock’ Derivatives Melt-Down Has Begun!
Posted on April 17, 2015 by The Doc
11 Comments 18,258 views

The strange volatility we’ve been experiencing in the markets is occurring because there’s is a massive derivatives melt-down going on behind the scenes.
The Fed is engaging in an enormous reverse repo operation in order to prevent the global financial system from collapsing.
The ONLY REASON the Fed would need to inject massive amounts of Treasuries into the global banking system is because there’s an extreme shortage.
A massive derivatives accident requiring MASSIVE amounts of collateral to be posted has developed:
Submitted by PM Fund Manager Dave Kranzler, Investment Research Dynamics:
A reverse repurchase agreement, also called a “reverse repo” or “RRP,” is an open market operation in which the Desk sells a security to an eligible RRP counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future.  LINK…IMF tells regulators to brace for global ‘liquidity shock’ -LINK.
The financial news spin-doctors are attributing today’s abrupt sell-off to a report of a Bloomberg terminal outage and to a report that China has expanded its list of stocks available for shorting.   This explanation for the plunge in stocks globally is so absurd it almost leaves me speechless.
I have been postulating since mid-December that the strange volatility we’ve been experiencing in the markets – combined with the most intensive effort I’ve ever seen by the Plunge Protection Team (the Fed + the Treasury’s Working Group on Financial Markets) to prop up the stock market and keep a manipulative cap on gold – is occurring because there’s is a massive derivatives melt-down going on behind the scenes.  The volatility reflects the turmoil and the market intervention in stocks and precious metals reflects the effort to keep the problem covered up.
But a good friend and colleague showed me graph this morning that shows my thinking about a derivatives collapse may be correct – click to enlarge:

That graph shows the Fed’s Reverse Repurchase Agreement operations with foreign Central Banks and big foreign banks.   A reverse repo is an operation which generally is thought of as being used as a tool to remove short term liquidity from the banking system.  However, as you can see from the timing of the first massive spike up, which occurred in early September 2008, it is an absurd notion to think the Fed would have removed liquidity from the system. (Note:  the second spike up in 2011 coincided with the Fed’s “Operation Twist” which was essentially a huge QE extension disguised with a “twist” – but nonetheless was done to keep the system from collapsing).
No, instead the massive operation was conducted to INJECT Treasury collateral into the global banking system.Treasuries are used as collateral against derivatives positions.  It’s in a sense margin collateral for the big boys.   When an entity (typically a bank or hedge fund) takes on a derivatives bet, it needs to post collateral to protect the counterparty from a decline in the value of the bet.  Treasuries are the de rigeur collateral, although the ECB now allows everything for collateral except loans to lemonade stands.
When the value of the derivatives bet declines because the value of the underlying asset declines (think:  Greek debt, oil debt), more collateral has to posted.  Eventually, the market runs out of collateral and there’s a collateral short squeeze.  The use of hypothecation exacerbates the situation by several multiples.  Please note that Zerohedge intermittently reports big spikes up in Treasury settlement fails.  This reflects the extreme shortage of collateral.  When collateral has been posted but not hypothecated, it can be called and used for settlement.  When that Treasury has been hypothecated by the custodian of the collateral, it becomes harder to call, especially when it’s been hypothecated several times.  Big spikes up in settlement fails occur.
Circling back to my postulation that a massive, ongoing derivatives melt-down has started, as the derivatives lose value, more Treasury collateral has to be posted.  When the situation becomes extreme, collateral isn’t posted and counterparties begin to fail, especially if the counterparty can’t come up with the cash needed to remedy a derivatives bet gone bad.   My bet is that the Greece situation ignited the problem and the collapse in the price of oil threw millions of gallons of napalm on the situation.
The reason I believe this explanation is correct, is from the graph above.   We know that in 2008 we were told that a big derivatives accident started in Europe and spread to the U.S.  Lehman filed for Chap 11 on Sept 11, 2008.    We also know that AIG and Goldman experienced a massive counterparty default collapse in September 2008 that was remedied thanks to rather explicit lies circulated by Ben Bernanke and Henry Paulson about systemic collapse if TARP wasn’t approved.
A reverse repo can be looked at as tool to remove liquidity from the system OR as a tool to inject Treasury collateral into the system.  We know the Fed has been “testing” a new Reverse Repo system since mid-2013 that take Treasuries from its “SOMA” holdings (SOMA = the Treasuries the Fed purchased with QE) and use them for reverse repos, including reverse repos with MONEY MARKET FUNDS and foreign central banks/ Too Big To Fail banks.  Nothing happens by accident and that spike above shows us why the Fed was “testing” a new reverse repo system.
The only reason the Fed would need to inject massive amounts of Treasuries into the global banking system is because there’s an extreme shortage.  A massive derivatives accident requiring massive amounts of collateral to be posted has developed.  If Treasuries are not available to post as collateral, while at the same time a massive amount of hypothecated (Treasuries out on loan, several times over) collateral fails are occurring, it will cause the banking system to seize up.  The giant spike up shown in the graph above is occurring because the Fed is engaging in an enormous reverse repo operation in order to prevent the global financial system from collapsing.
Remember I suggested some time ago that the elitists like give us a warning before something bad is about to happen.   As my colleague John Titus states:  “the true elite aristocracy are polite criminals – they consider it gauche to flush the toilet while we’re in the shower without giving us a heads up.”
This is why the IMF issued this warning yesterday for the financial media to publish:
The so-called ‘flash crash’ on US bond markets last October and the collapse of the Swiss currency floor in January showed how quickly liquidity can vanish, acting as “a powerful amplifier of financial stability risks.”  LINK:   IMF tells regulators to brace for global ‘liquidity shock’
THIS is why stock markets globally are selling off hard today.   The S&P 500 is now down over 1%.  Typically the Plunge Protection Team has been able to prop it up by noon EST when it falls at the open.  So far today the sell-off has accelerated.
I guarantee that the reason for this  is unequivocally NOT because the Chinese Government is letting the public short a few more stock issues OR because Bloomberg experienced a widespread terminal outage.   But it does go a long way to explaining THIS: LINK
http://www.silverdoctors.com/reverse-repos-go-parabolic-liquidity-shock-derivatives-melt-down-has-begun/#more-52629


A friend and colleague of mine was chatting with a business acquaintance last week.  The acquaintance had been stopped at a train crossing.  What he described was a bit of shock: the train itself was at least a mile long;  every train car was loaded with military police equipment, including dozens of tanks and vehicles – all kinds of artillery;  based on the markings on the equipment, it appeared as if the equipment belonged to the Dept of Homeland Security;  the train was headed north.
Why would a train loaded with military equipment be headed north out of the Denver area?  It clearly was not being moved to a port for shipment overseas.  This was equipment destined for domestic use.
When I mentioned this to my colleague Rory Hall (The Daily Coin), he told me that Dave Hodges (The Common Sense Show –  we’re hosting Hodges on our next Shadow of Truth podcast, which should be posted Sunday or Monday.   ) was fielding similar reports from his blog audience from all over the country.   Hodges has been collecting videos taken of these trains.   Apparently there’s a massive amount of military equipment being moved all around the country.
The question is, what is the purpose of this large scale deployment of domestic-use military equipment?  Perhaps Michael Snyder of End of the American Dream blog is on to something:
What in the world are the elite up to? In recent days, we have learned that the New York Fed is moving a lot of operations to Chicago because of concerns about what a “natural disaster” could do, the federal government is buying 62 million rounds of ammunition commonly used in AR-15 semi-automatic rifles for “training” purposes, and NORAD is moving back into Cheyenne Mountain because it is “EMP-hardened”. In addition, government authorities have scheduled a whole host of unusual “training exercises” all over the nation. So are the elite doing all of this in order to prepare for something really BIG, or should we just chalk up all of this strange activity to rampant government paranoia?
You can read his entire post on this subject here:  Signs That The Elite Are Feverishly Preparing For Something Big.
There’s definitely something extremely unusual going on behind the scenes, out of sight, and unreported by any mainstream media and most alternative media.
I believe that something is collapsing behind the veil of the rising stock market.  The effort to keep a lid on the price of gold has never been this intense or blatant in the 14 years that I’ve been involved in the precious metals sector.  The intra-day volatility of the S&P 500 has been incredible.  Nearly every morning the S&P 500 starts to drop quickly and within a couple hours, miraculously, it’s pushing positive territory.
In sharing these observations with Bill “Midas” Murphy last week, he said that he had just got off the phone with John Embry and Embry has said the same thing I had written to Bill. We both think that something has collapsed or is collapsing – likely a massive derivatives melt-down – and the Plunge Protection Team is working overtime to prevent this fact from being reflected by the stock market and gold.
Perhaps the military preparations are in anticipation of the time when the elitists can no longer keep the markets from reflecting the truth and the public decides it’s time to take back their country…
http://investmentresearchdynamics.com/is-government-preparing-for-martial-law/

FAQs: Overnight Reverse Repurchase Agreement Operational Exercise
Effective January 14, 2015
What are the overnight reverse repurchase agreements (ON RRPs) conducted by the Desk?
The Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York (New York Fed) is responsible for conducting open market operations under the authorization and direction of the Federal Open Market Committee (FOMC).  A reverse repurchase agreement, also called a “reverse repo” or “RRP,” is an open market operation in which the Desk sells a security to an eligible RRP counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future. The difference between the sale price and the repurchase price, together with the length of time between the sale and purchase, implies a rate of interest paid by the Federal Reserve on the cash invested by the RRP counterparty.

When the Desk conducts an overnight RRP, as in the current ON RRP exercise, it is selling an asset held in the System Open Market Account (SOMA) with an agreement to buy it back on the next business day.  This leaves the SOMA portfolio the same size, as securities sold temporarily under repurchase agreements continue to be shown as assets held by the SOMA in accordance with generally accepted accounting principles, but the transaction changes some of the liabilities on the Federal Reserve’s balance sheet from deposits to reverse repos while the trade is outstanding.

Why is the Fed testing ON RRPs?
The Desk has been testing ON RRPs since September 2013, and the Committee has indicated in the normalization principles released in September 2014 that it intends to use an ON RRP facility as a tool in the normalization of policy as needed.  In that regard, it has directed the Desk to continue testing to further examine how the ON RRP facility might be best structured to help control the federal funds rate while also limiting the potential for unintended effects in financial markets.

Does this operational exercise represent a change in the stance of monetary policy?
Like earlier operational readiness exercises, these operations are a matter of prudent advance planning by the Federal Reserve.  They do not represent a change in the stance of monetary policy, and no inference should be drawn about the timing of any future change in the stance of monetary policy.  Additionally, the operations are technical exercises that are not intended to have a material impact on short-term interest rates.

How long will this operational exercise last?
The FOMC has authorized the Desk to conduct these operations through January 29, 2016.

What collateral will be used for these operations?
The RRPs during this operational exercise are expected to be collateralized by Treasury securities.  SOMA’s holdings of agency debentures and agency mortgage-backed securities are also available, but will not be used in this exercise.

At what time of day will operations be conducted?
ON RRP operations will generally be conducted from 12:45 p.m. to 1:15 p.m. (Eastern Time).

How will the operations be conducted?
The operations will be conducted using the Desk’s FedTrade system.

How are bids submitted in each ON RRP operation?
Each counterparty is permitted to submit one bid of up to $30 billion in each operation and each bid must also specify a rate of interest.  The rate submitted must be at or below the specified offering rate and must be submitted in percent form in increments of one basis point.  The minimum bid size is $1 million, with a minimum increment of $1 million.

Can negative rates be submitted?
Yes, the rate submitted as part of each bid is subject to a maximum, referred to as the “offering rate,” but rates below this level, including negative rates, are permitted.

Is there a maximum size for each operation?
Yes, the total amount awarded in any operation is subject to an overall size limit, which is currently $300 billion.

What rate of interest is paid on ON RRP operations?
If the total amount of bids received is less than or equal to the overall size limit, awards will be made at the offering rate (discussed above) to all counterparties that submit bids.  If the sum of all bids received exceeds the overall size limit, awards will be made at the rate at which the overall size limit was achieved (the “stopout rate”), with all bids below this rate awarded in full and all bids at this rate awarded on a pro rata basis.  The stopout rate will be determined by evaluating all bids in ascending order by submitted rate up to the point at which the total quantity of offers equals the overall size limit.

Example 1:  5 bids are submitted, each for $5 billion, at rates of 1, 2, 3, 4, and 5 basis points.  Since the total amount of bids submitted ($25 billion) is less than $300 billion, each bid is awarded at 5 basis points.

Example 2: 20 bids are submitted, each for $20 billion, with 4 bids submitted at each of 1, 2, 3, 4, and 5 basis points.  Since the total amount of bids submitted ($400 billion) exceeds $300 billion, each bid submitted at 1, 2, and 3 basis points is awarded in full, each bid submitted at 4 basis points is awarded 75% of the amount bid (i.e. $15 billion), and each bid submitted at 5 basis points is not awarded, for a total award amount of $300 billion.

Can an ON RRP operation have a negative stopout rate?
Yes.  If the overall size limit is less than or equal to the amount of bids that are submitted at negative rates, the outcome determined by the award process specified above would result in a negative stopout rate.

What is the difference between the offering rate, the bid rates submitted by counterparties, and the stopout rate?
The offering rate is the rate at which all awards will be made if the total amount of bids received is less than or equal to the overall size limit.  This rate, which is authorized to vary between zero and five basis points, is currently set at five basis points.

The bid rate is the rate submitted by counterparties that must be at or below that auction’s offering rate.

The stopout rate is the rate determined by evaluating all bids in ascending order by bid rate up to the point at which the total quantity of offers equals the overall size limit.

How will the offering rate, per-counterparty bid limit, and overall size limit change for the operations?
Any changes to these parameters must be approved by the Chair, and will be subject to the limits specified by the Committee in its latest authorization to the Desk.

How will changes to the ON RRP operations be communicated?
Any future changes to the ON RRP operations will be announced on the New York Fed’s website with prior notice of at least one business day, so that all parameters are known to all market participants before each day’s trading session.

Who is eligible to participate in the operations?
Participation in the operations is open to the Federal Reserve’s primary dealers as well as its expanded RRP counterparties, which covers a wide range of entities including 2a-7 money market funds, banks, and government-sponsored enterprises (Fannie Mae, Freddie Mac, and Federal Home Loan Banks).  Additional details on the RRP counterparties are available on the New York Fed’s website.
FAQ: September 19, 2014 »
http://www.newyorkfed.org/markets/rrp_faq.html

IMF tells regulators to brace for global 'liquidity shock'
Financial engineering that preceded the last two financial crises is back, International Monetary Fund warns

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The so-called 'flash crash' on US bond markets last October and the collapse of the Swiss currency floor in January showed how quickly liquidity can vanish, acting as "a powerful amplifier of financial stability risks."

By Ambrose Evans-Pritchard, in Washington
2:28PM BST 15 Apr 2015
 120 Comments
An illusion of liquidity has beguiled financial markets across the world and spawned some of the worst excesses seen on Wall Street in modern times, the International Monetary Fund has warned.
Investors are borrowing money to buy shares on the US stockmarket at a torrid pace and are resorting to the same sorts of financial engineering that preceded the last two financial crises.
"Margin debt as a percentage of market capitalisation remains higher than it was during the late-1990s stock market bubble. The increasing use of margin debt is occurring in an environment of declining liquidity," said the IMF in its Global Financial Stability Report.
"Lower market liquidity and higher market leverage in the US system increase the risk of minor shocks being propagated and amplified into sharp price corrections," it said.
The report said there are clear signs that underwriting standards are deteriorating in a pervasive search for yield. So-called "covenant-light loans" with poor protection for creditors now make up two-thirds of all new leveraged loans in the US.

The ratio of non-financial corporate debt to underlying assets has reached 27pc, even higher than it was just before the Lehman crash in 2008. Issuance of "second lien" loans that face a likely wipe-out in cases of default are running near record levels once again.
This is becoming hazardous as the US Federal Reserve prepares to raise rates, a move that risks a spike in global borrowing costs and may cause liquidity to dry up almost overnight. "A sudden shift in market views that unwinds compressed premiums and sends yields higher could trigger a market liquidity shock," said the report.
The so-called 'flash crash' on US bond markets last October and the collapse of the Swiss currency floor in January showed how quickly liquidity can vanish, acting as "a powerful amplifier of financial stability risks."

The risk of seizure has been made worse by new regulations that effectively force market makers and dealers to hold much lower inventories, or to drop out of the business altogether. The IMF said that large inflows of money into mutual funds have "provided an illusion of liquidity in credit markets" but this will be no protection in a major shock.
The report warned that distress in the global oil industry could be the trigger for the next storm. Lending to the oil and gas industry reached $450bn last year, double the pre-Lehman peak. New bond issuance graded at `junk' level have almost tripled to 45pc. The total debt outstanding is now $3 trillion.
Defaults in the energy sector tend to lag oil price crashes by around twelve months since drillers typically hedge their output on the futures markets for a while. "Aftershocks for the corporate sector may not yet have fully filtered through," said the IMF.
The slump in oil prices is a powerful shot in the arm for world economy. It rotates vast sums of surplus capital from the oil-states into consumption, countering the chronic lack of demand that has held back global growth since 2008.

Yet there is a dark side for investors. The IMF said the oil states have accumulated $1.1 trillion over the last five years in foreign reserves alone, "an important source of funding for the global banking sector and capital markets."
These states hold $2 trillion in US assets, with $1.3 trillion concentrated in equities and $580bn in US Treasuries, and $230bn in credit. They are already having to draw down on this wealth to plug holes in their budgets at home, extracting a net $88bn last year. This could have "market repercussions" if it accelerates, said the report.
The IMF itself is in a delicate position. It is has been a cheer-leader for ultra-loose monetary policy to stave off global deflation and prevent debt-dynamics spinning out of control in Europe, Japan, and the US. Yet many of the risks now emerging are a direct result of quantitative easing and zero-rates.

A third of all sovereign bonds in the eurozone now carry negative yields. This is causing havoc for money markets and for the life insurance industry, which has locked into commitments stretching out for thirty years that are becoming untenable.
"A prolonged low interest rate environment will pose severe challenges for a number of financial institutions. Weak European midsized life insurers face a high and rising risk of distress. The failure of one or more midsize insurers could trigger an industry-wide loss of confidence," it said.
"The industry has a portfolio of €4.4 trillion in assets in the EU, with high and rising interconnectedness with the wider financial system. A large mark-to-market shock could force life insurers into asset reallocations and sales that could engulf the financial system," it said.
The IMF does love to keep us awake at night
http://www.telegraph.co.uk/finance/economics/11538509/IMF-tells-regulators-to-brace-for-global-liquidity-shock.html