Why The Repo Markets Went Crazy, And Why December Could Be Even Worse

Tracy Alloway (0:12)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:17)

And I'm Joe Weisenthal.

Tracy Alloway (0:19)

So Joe, I was in New York with you in early September, wasn't I? We did the Odd Lots live show. That was early September.

Joe Weisenthal (0:27)

Yes, I think it was. That already seems like a really long time ago to me, but yeah, that was really fun.

And we had a great lineup of guests, and it was absolutely perfect. I wouldn't have changed one thing about the lineup of guests that we had then.

Tracy Alloway (0:44)

There was one thing that I would have changed, which is that we were due to have Zoltan Pozsar on one of the panels. And unfortunately, he had to drop out a couple of days before for a sort of last minute commitment. But the reason it would have been great to have him there was because something big happened in the markets that same week.

Joe Weisenthal (1:06)

Right, so I was just trolling a little bit. I agree with you, that would have been the one change, that would have been the one thing that would have made it absolutely perfect. And of course, what you're referring to was the tantrum, or I'm not sure what word we're using to describe it, but the sort of craziness.

The repo madness of early September was right around that time. And of course, Zoltan is by many people considered to be the preeminent expert in this area.

Tracy Alloway (1:34)

Right, also a former Odd Lots guest. And I should just back into this a little bit. So Zoltan Pozsar, a former advisor to the US Treasury Department, now a strategist at Credit Suisse.

And he's been writing a lot about the repo market. In fact, just four or so weeks before we had that repo madness incident, and this was where short-term borrowing rates in the money market suddenly surged.

Four weeks before that actually happened, Zoltan had been writing, again, some eerily prophetic things. He actually wrote in a piece of August research that the funding pressures that Credit Suisse is forecasting include overnight general collateral repo rates drifting outside the Fed's target band. And that is exactly what happened in September.

Joe Weisenthal (2:24)

I'm not just saying this because he's here in studio and we're about to talk to him, but I remember even before I noticed, I remember the day that the rates shot up, I didn't even notice it until a trader at a bank I.B.ed me on my Bloomberg and said, are you watching what's going on in the repo market? It's exactly what Zoltan predicted. And that was the first, then I went and looked. That was my first indication that something was amiss, someone alerting me in that way. That's how closely his research is tied to what we've seen in people's minds in the market.

Tracy Alloway (3:02)

Yeah, Zoltan is at one with the repo market and money market crunches.

Again, just to provide a bit of background. So what we actually saw on that day was repo rates, the cost basically of making secured overnight collateralized loans, those repo rates jumped from, I think it was about 2% to something like 10%. And lots of people had talked about the possibility of a funding squeeze, especially around quarter ends, which is where we get these sort of traditional crunch points in the financial systems, because big banks have to pull back on their repo financing ahead of quarterly liquidity requirements and other regulations. But far, far fewer people had expected it to happen at this sort of random juncture in time, this slightly random week in September. So again, it was really unusual. It spooked quite a few people and everyone immediately said, we must speak to Zoltan Pozsar.

Joe Weisenthal (4:03)

Absolutely, and it's important to remember too, that when people see this stuff, everyone has sort of still, after all these years post-crisis PTSD, and you look at bank overnight funding costs, and they're soaring from 2% to 10% in a day. And of course, a big debate immediately broke out. Is this something strictly about financial market plumbing, or is there something deeper and more systemic at play that sort of speaks to some inherent frailty of the financial system?

And obviously things have quieted down quite a bit since then, but nonetheless, I think people are still unsettled and no one really knows what the ultimate fix is going to be. The Fed has applied temporary fixes, greater expanding its supply of reserves or overnight operations to satisfy the bank demand for this short-term liquidity, but no one really knows where this is ultimately headed, it seems.