The short-term funding market has still not recovered from its seizure at the start of the week–at least not enough to be taken off central bank life support.
The Federal Reserve Bank of New York announced Thursday afternoon that it would once again intervene in the repo market on Friday morning, its fourth consecutive day of supplying tens of billions of dollars to hold down interest rates in the short term funding market.
The NY Fed said it would purchase up to $75 billion of debt between 8:15 a.m. and 8:30 a.m. Securities eligible to be sold to the Fed include Treasuries, government-sponsored agency mortgage-backed securities, and debt issued by Fannie Mae and Freddie Mac.
The Fed has been intervening in the repo market, which provides short-term funding vital to the largest Wall Street banks, ever since interest rates spiked on Monday. The cause of the interest rate spike remains a matter of speculation. The most popular theory on Wall Street is that the Fed’s earlier balance sheet reduction has left the market with too few dollars relative to Treasuries held by financial institutions.
The repo market is at the center of the U.S. financial system but it is little understood even by most people working in finance.
The word repo is short for repurchase. In a repo, one party sells another a security while promising to buy it back at a later date, often the very next day. The repurchase price is a bit higher than the initial sale, creating a positive return for the cash provider. Although technically structured as sales and repurchases, essentially what’s going on here is the creation of short-term loans collateralized with Treasuries, mortgage-backed securities, and agency debt. The higher repurchase price is equivalent to earning interest on the loan.
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