The repo market has been grabbing the headlines lately. That’s because this little-known but vital aspect of the U.S. financial system is under duress. The situation has forced the U.S. Federal Reserve to step in for the first time since the global financial crisis of 2008.
Many had hoped that the intervention of the Fed would stop the bleeding. However, it appears that the situation keeps getting worse and there’s no end in sight.
According to Anthony Pompliano, the Fed would throw another $75 billion into the repo market today, bringing the size of the weeklong operation to over $275 billion. In less than a week, the Fed injected 34.4% of the $800 billion that it printed during the 2008 bailout. This is why you should start paying attention to the repo market.
What Is the Repo Market?
The repo market – short for repurchase agreement – is a $2.2 trillion marketplace. Many retail investors are not aware that such a bourse exists. However, it is an essential component of the U.S. financial system.
In the repo market, financial institutions such as hedge funds and investment banks borrow cheap money from large investors such as mutual banks to fund their operations. The borrower (hedge fund) or the dealer sells securities such as the U.S. Treasury bills as a form of collateral for the short-term loan. The counterparty or the buyer (mutual banks) takes the collateral and earns a small interest once the borrower repurchases the security.
In short, the repo market is the biggest pawnshop in the world.
For example, hedge funds may borrow money from mutual banks to finance leveraged investments. When trading in leverage, every point that moves in your favor counts. Thus if you can borrow cheap money with an interest rate of less than 2% and you gain more than 3% on your leveraged trade, you earn profits plus the capacity to…