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So: global warming is the ultimate problem of oil companies because oil causes it, and it's the ultimate problem for government haters because without government intervention, you can't solve it. Those twin existential threats, to cash and to worldview, meant that there was never any shortage of resources for the task of denying climate change.
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Bill McKibben (Falter: Has the Human Game Begun to Play Itself Out?)
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Repo is a true market. Repo rates are determined by the interaction of supply and demand. Supply is the number of securities outstanding and the amount of those securities available in the marketplace. Demand is the amount of cash in the market. It’s also the number of shorts in the market – the traders who have sold Treasury securities short and must borrow them. Repo stands for “Repurchase Agreement,” which means that if I loan a security to you, you agree to give it back. The opposite of that is officially called a Reverse-Repurchase agreement. It’s the opposite of a Repo. If I borrow a security from you, I agree to return it back to you. In basic terms, Repo is a collateralized loan. One party borrows cash and holds a security as collateral.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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Repo is the oil that lubricates the engine of the financial markets. It keeps it running smoothly; it’s the plumbing of the financial system. You might even say it’s the oil that lubricates the engine of the entire economy. Here are some important characteristics of the Repo market: In one respect, Repo is a popular instrument for short-term cash investments for institutional investors, with “short-term” meaning from overnight through one year. It’s an ultra-safe investment. It’s an investment collateralized with a Treasury security at a competitive market rate of interest. In another respect, Repo is a mechanism for market participants to cover short sales of U.S. Treasurys. This is a big part of the Repo market and arguably the most interesting part. In another respect, it provides collateralized funding for large leveraged investors. OK, let’s just get this said up front. Yes, the Repo market is the way hedge funds can highly leverage their trading positions. More on this later.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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As interest rates began to rise in the post-war period, leaving your cash at a bank that paid near zero percent interest was not such a good investment. Corporations and municipalities had millions of dollars to invest, but could not get a decent return on the short-term cash. They wanted a rate, because any rate was better than nothing. At the same time, securities dealers on Wall Street began holding trading positions. Previously the role of the broker-dealer was as a pure middleman. That’s the broker part of broker-dealer. When a client wanted to sell a bond, the firm’s salesmen scoured the market to find a buyer. If they could find a buyer, the trade was done: end-user seller to end-user buyer, and the Wall Street firm just stood in the middle. That changed in the 1950s. Some broker-dealers, like Bear Stearns and Salomon Brothers, realized they could make money buying bonds for their own trading account. And, they could even make money betting on the direction of interest rates.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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Overall, it was a pretty good trading strategy. He made money in two out of three possible scenarios. If bond prices went down, he made a lot of money. If the market stayed the same, he earned free interest on the cash. If the Treasury market rallied, he risked a pretty big loss. And guess what? Between February 1982 and May 1982, the Treasury market reversed its decline and started to rally. This was the one chance in three that he wasn’t hoping for. When the May 15, 1982, coupon interest payments were due on a Monday, Drysdale was wiped out and didn’t have enough money to make the payments. That Sunday evening, Heuwetter called Drysdale's clearing bank, Chase Manhattan, and informed them that "we may have a problem" meeting the $160 million interest payment due the next day. Could Chase possibly lend Drysdale $200 million to tide them over? What he didn’t tell them was that, yes, the market rally had wiped them out, but the problem was even worse than that. Drysdale had conducted its Repo trading mostly through Chase's Securities Lending Department.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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The modern use of Repo financing, though not yet called a Repo, began shortly after the U.S. entered World War I in 1917. Part of the Fed’s official mandate was to "provide an elastic currency," which, as we know, includes providing liquidity to the banking system. During its first few years, injecting cash into the financial system exclusively involved the rediscounting of commercial paper. The Fed loaned money to banks and received commercial paper as collateral. Then, with the growing issuance of Liberty Bonds by the U.S. government, banks began presenting these new government securities to the Fed for rediscounting. When the Fed rediscounted the first Liberty Bond, the Repo market was born.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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The 1970s was a decade marked by runaway inflation and the Fed’s attempt to control that inflation. Early in the decade, short-term interest rates spiked in 1973-1974, reaching a high of 14% as the U.S. went off the gold standard and was hit with an oil embargo. Where banks were now allowed to pay 3.00% interest on savings accounts, overnight Repo rates were trading between 10% and 20%. Institutional investors were obviously attracted to the high rates in the Repo market and flocked to get in. Many more large corporations amended their investment rules to allow them to invest in Repo, bringing even more cash investors into the market.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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As its name suggests, Tri-Party Repo is an agreement between three parties. There’s the seller of the securities (the securities dealer), the buyer of the securities (cash investor), and the clearing bank (the bank that holds both the securities and the cash). The cash investor liked the transaction because they have better security. They knew the securities were priced and margined correctly by the clearing bank. For the securities dealer, Tri-Party minimized settlements and ticket processing. It gave them more time to allocate collateral throughout the day, and it made it easier to finance smaller pieces. The clearing bank did most of the work. They handled the risk management, pricing the collateral, and accommodated collateral substitutions. They managed the settlement risk, cleared the trades, provided valuation, and the position reporting. And, on top of that, they get paid a fee. Sounds like everyone wins! When there was a problem with HIC Repo, the market figured out a way to reduce investor risk. It brought cash investors back to the Repo market.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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Now, picture a bank that’s financing CDOs for a hedge fund through Repo transactions. Suppose the floor dropped-out from under the CDO market, like it did in 2007, and the bank issued a margin call to the hedge fund. Suppose the hedge fund told the bank, “We will give you your cash as soon as we sell some CDOs. Maybe next week.” That doesn’t work. But the Repo counterparty has an out. No need to wait. Once there is technically a default or bankruptcy, the bank can take over the hedge fund’s positions and liquidate them. Then they cross their fingers that they had taken enough margin to cover the losses on the forced sale! That brings up a good question. Why are there runs on banks and shadow banks? The question is easily answered when you look at what banks and shadow banks have in common. They lend long and borrow short. It’s the age-old business model flaw of the banking system. They are lending money long-term and borrowing money short-term. A bank writes a 30-year mortgage loan to a homeowner and borrows money from their depositors to cover the loan. Remember, the depositors can show up any day and withdraw their money. Unfortunately, this same bank business model flaw extends to the shadow banks. They also lend long and borrow short. Just like a bank, a REIT’s MBS portfolio might have an average weighted maturity of, say, seven years.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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Let’s say there was a slight shortage of liquidity (cash) in the system and the fed funds rate was trading a little high at 5.3125% (5 5/16%), instead of the target rate of 5.25%. The Fed would enter the market, announce an operation, and borrow securities from the market. By taking securities out of the market, it put cash into the market. Securities come out and cash goes in. Now, let’s say the fed funds rate was trading at 5.1875% (5 3/16%) with the same target rate of 5.25%. The Fed would execute the opposite transaction. Because there was a little excess liquidity in the system, they would loan securities into the market, taking cash out. These Open Market Operations are more fine-tuning of overnight rates, but there were plenty of times when the actual fed funds rate deviated from the target rate by much more than a sixteenth.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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The Government Securities Act (GSA) of 1986 was passed and signed by President Reagan, which required government securities dealers to register with the SEC or be regulated as subsidiaries of banks. The Secretary of the Treasury had the authority to make rules for custody, the proper use of customer securities, net capital ratios, and the allowable leverage for Repo transactions. Not surprising, customers were still unwilling to invest their cash in hold-in-custody Repo after 1984.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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There is a subtle and distinct difference between Matched Sales and a Reverse-Repo transaction. Matched Sales are an outright sale of securities with an outright purchase booked at a future date. Under a Reverse-Repo with the Fed, the Fed loans securities to Primary Dealers for a day or more. The end result is the same: The Fed is draining liquidity by putting securities into the market. Why Matched Sales instead of Reverse-Repo? At the time, Fed lawyers believed there were potential legal problems with the Fed borrowing cash from securities dealers. But selling them securities and buying back those securities in the future was legally OK.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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The firm collapsed on August 17, 1982, when it came to light that they had under-collateralized many of their safekeeping Repo transactions. After the bankruptcy was announced, Lombard-Wall filed a stay provision in bankruptcy court, which was a temporary restraining order so that Repo counterparties could not sell their collateral without court approval. One month later, the court ruled that Repo was not a collateralized loan and the Repo counterparties had the right to liquidate their trades. This was good news for the Street – the dealer community – but customers who had left both their securities and their cash at Lombard-Wall had no ability to liquidate their trades and get their cash back.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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Corporations pay taxes quarterly on March 15, June 15, September 15, and December 15. The market calls them “corporate tax dates.” On the days when corporations send tax payments to the Treasury, there’s a little less cash in the market. The Repo Market Panic of September 2019 was initially blamed on the September 15 tax date, but after further review, it was clear the tax date played only a minor role, if any.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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The securities lending business boils down to one concept: exchanging a security that someone needs for a different security or cash. The business is driven by the need of the dealer community to cover short positions, be it in stocks, Treasurys, agencies, corporate bonds, ADRs, or even ETFs. When a dealer is looking to cover a short position, they first check what are colloquially known as the “sec lenders.” The securities lending group will pull the security out of the end-user portfolio and lend it into the Repo market. When a securities lending group loans a security, they either receive cash or bonds in return. If they receive cash, they reinvest the cash. If they receive a bond, they earn a fee on the spread between where they loan the bond and borrow the other. In the case of cash, they need to invest it. They need an investment that generates a sufficient return to make the business viable, yet, at the same time, without taking too much risk. The safest and easiest way to invest is in overnight Treasury repo. The problem is that there’s very little profit lending a Treasury and reinvesting in a Treasury. In order to enhance returns, the securities lending groups take some risk. It’s not necessarily a lot of risk, but increasing returns involves increasing risk. It can be either interest rate risk, credit risk, or liquidity risk. Technically a combination of all three is possible, too, but that’s pretty dangerous. The yield curve is upward sloping most of the time, so investing for a longer period of time generally generates a higher yield. Let’s say the overnight rate is 2.00%, the one-month rate is 2.05%, and the three-month rate is at 2.15%. Instead of reinvesting cash overnight, there’s an extra 15 basis points for investing for three months. Since the end-investor clients usually hold their bonds to maturity, there’s only a small chance they will sell a bond during that three-month period. On top of that, the securities lending groups run multi-billion dollar portfolios, so they can ladder their investments.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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PRIME Prime is an ever-changing condition, a segment of a journey, not a haven at the end of the road. Companies in Prime are recognizable: All aspects work well together, all operations thrive, and all members of the organization know where it is going and how to stay on track. Prime is a state of balance: Flexibility and control, function and form, imagining and producing, innovation and administration. But companies in that exultant equilibrium — so hard to achieve, so easy to lose — continually risk sliding back to childish habits or stumbling into the rigidity of old age. An organization is no less vulnerable in Prime than it is at any other stage of its lifecycle. The cash shortage of Infancy, the founder’s heavy hand in Go-Go, the infighting of Adolescence — those are challenges it has overcome. Now the complacency that comes with a surfeit of success looms as a potential and significant threat. I have a rule of thumb by which I judge an adult company: If it does not produce significant new products or spin off promising start-ups within any three-year period, it is either decaying or on the brink of decline. Ask yourself what percentage of your revenues come from products you were not selling three years ago? Be honest. There are enhancements, changes that are cosmetic in nature that make old products look new. Pharmaceutical manufacturers are well known for
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lchak Adizes (The Pursuit of Prime: Maximize your Companys Success with the Adizes Program)
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The UN’s World Food Programme (WFP), which compared ‘food versus cash’ in four countries, found that in three of the four – Ecuador, Uganda and Yemen (before the civil war) – cash transfers led to better nutrition at lower cost, meaning many more people could be helped for the same outlay. (In the fourth, Niger, severe seasonal food shortages meant that in-kind deliveries improved dietary diversity more than cash.)54 This has led the WFP to put more emphasis on cash transfers; today, just over a quarter of WFP’s aid globally is cash-based.
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Guy Standing (Basic Income: And How We Can Make It Happen)
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There’s a subtle difference between an overnight Repo investment and an overnight fed funds investment. Repo General Collateral is collateralized with securities, whereas fed funds are uncollateralized. A fed funds cash investor doesn’t hold any collateral; they rely on the credit of their counterparty – another bank. Now, given the collateralization of Repo transactions, you would assume that Repo rates will always trade below fed funds. Sometimes, but not always. Over the years, Repo GC[15] has traded anywhere from 25 basis points above fed funds to 500 basis points below. That’s a huge range and just partly driven by the collateralization.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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An important event occurred at that time. The Fed began paying interest to banks on their required reserves. All of the cash that banks were required to leave at the Fed could earn interest. The new rate was called Interest On Reserves (IOR) and the change made a lot of sense. Had it ended there, this would be a much different chapter. However, the Fed went one step further and offered to pay interest on any excess reserves that banks deposited at the Fed. That became known as the Interest On Excess Reserves (IOER) and it was effectively the final nail in the coffin of the fed funds market. For banks with excess cash, depositing at the Fed was a no-brainer. Why give your cash to another bank when you can give it to the risk-free Federal Reserve? And, on top of that, the Fed paid higher than market rates. A layup. So, it’s no surprise that cash began to move out of the fed funds market. Pre-Financial Crisis, in 2007, the size of the funds market was around $200 billion, and it peaked at $400 billion in 2009 during the crisis. Since then, it’s declined just about every year since.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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The fed funds market is not dead, however, mainly because all of its market participants don’t have access to the IOER. Due to the legal structure of the Federal Home Loan Banks (FHLBs), they can’t loan cash to the Fed. That makes them the largest lender of fed funds out there, supplying about 75% of the cash in the market each day. To add insult to injury, foreign banks are often the cash borrowers, relending the funds back to the Fed and taking advantage of the spread between fed funds and IOER. Yes, effectively arbitraging the U.S. government.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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Beginning in 2001, there was another shift in the Repo market. The CFTC changed their margin investment rules, allowing for FCMs (Futures Commission Merchants) to invest their cash in federal agencies, municipal bonds, and corporate bonds, instead of just Treasurys. The premium that U.S. Treasury collateral enjoyed narrowed. Before the rule change in 2000, GC was averaging around 7 basis points below fed funds. Beginning in 2001, GC was averaging almost flat to fed funds. When there’s less demand for Treasurys, there’s a smaller premium.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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Initially, the CD futures contract was the most popular. In fact, for the first four years, it had twice the open interest and trading volume as the Eurodollar futures contract. However, something happened that would change short-term interest rate futures forever. Continental Illinois National Bank, the seventh largest bank in the U.S., began suffering from liquidity problems. In the futures market, anyone receiving a delivery on the CD futures contract always received a Continental Illinois National Bank CD. When Continental Illinois collapsed in 1984, the CD futures contract was all but dead, lasting only two more years until 1986. What was bad news for the CD futures contract was good news for its sister contract, Eurodollar futures. The Eurodollar contract proved to be resilient during that banking crisis. Banks could still estimate their borrowing costs, and the survey method allowed banks to patch the holes in their yield curve when there was no actual CD issuance. The Eurodollar futures contract went on to become one of most successful futures contracts ever. The first cracks in LIBOR appeared during the Liquidity Crisis of August 2007. At the time, cash investors were unsure which banks were holding subprime debt and CDOs linked to subprime, so they stopped buying bank CDs altogether. Between August and September 2007, no bank could issue CDs with a maturity greater than one month. So, what do you do as a LIBOR submitter when you’re called at 11:00 AM and asked where you are issuing CDs? Ironically, banks did what they were supposed to do: they estimated. Of course, those estimates ended up being extremely low. The Liquidity Crisis of 2007 showed that the LIBOR survey method could break down during a major crisis.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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When cash moves in and out of money market funds (MMF), it affects Repo rates. Yes, these funds invest a majority of their funds in bank CDs, commercial paper, U.S. Treasurys, corporate bonds, and discount notes, but their uninvested cash goes directly into the Repo market. Large funds like Fidelity, Vanguard, Federated, PIMCO, and Blackrock invest hundreds of billions of dollars in the Repo market each day. When individual inventors put money in these funds, a percentage of that cash filters into the Repo market.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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When interest rates decline, local governments will often refinance their debt, just as an individual might refinance their home mortgage. The municipality will issue new municipal bonds at lower interest rates. At the same time, they buy Treasurys and place them in a trust to pay the outstanding bond issue. The municipality matches the cash flows of the outstanding municipal bond issue with cash flows of the Treasurys.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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At the beginning of every month, homeowners send mortgage payments to their bank or mortgage servicing agent. Many of these mortgage payments are either securitized or guaranteed by Fannie Mae, Ginnie Mae, or Freddie Mac – the GSEs, or Government Sponsored Enterprises. That means billions of dollars of mortgage principal and interest payments are being collected by the GSEs at the beginning of the month and paid to bondholders later in the month. During the period of the time between payments, the GSEs invest a substantial amount of cash straight into the Repo market.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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once the issue settled, Tiger and Quantum agreed to have Salomon manage their positions. Salomon had complete control of the entire 2 Year Note. By the middle of May, it was clear there was something wrong. The 2 Year Note’s price was completely distorted; it was trading extremely rich and the yield was extremely low. There was no squeeze in the Repo market, however, because Salomon loaned the securities into the market each day. This created one of the strangest squeezes ever. There was no shortage in the Repo market, but there was a huge premium in the cash market. As the squeeze in the April 2 Year Note continued, Salomon submitted large bids again for the next 2 Year Note settling at the end of May. They were able to accumulate an abnormally large position once again. Prices across the entire 2 year sector were now distorted. Prices were abnormally high and yields were abnormally low. Everyone knew that Salomon had the issue and Salomon was not selling. At this point, all of the trading in the market was from one short seller to another. There were no real owners selling. All of the buyers were existing short-sellers who had ridden their losses as far as they could go and got stopped out. All of the sellers were new short-sellers willing to take short positions and higher and higher prices. There was no way for the squeeze to end without Salomon selling. What was Salomon’s goal? They had already achieved a very successful squeeze. Prices moved in their favor and they had a huge win under their belt. The biggest short-squeeze of all time! However, in July things started to unravel. Market participants started complaining to the Fed. Everyone knew that Salomon owned the entire issue. The Fed passed the information to the Treasury Department. Treasury then passed it to the SEC, who immediately launched an investigation. By the end of July, it was all over.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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The Velocity of Collateral is like the economics term the Velocity of Money.[33] In economics circles, the Velocity of Money is how much, on average, a single dollar is re-used over a period of time. It’s how fast a currency passes from one holder to another. Think of the same principle, except in the Repo market. The VofC is how much, on average, a security turns over before it gets from end-seller to end-buyer. The Repo market has a high velocity because there are many players making markets, speculating on interest rates, and borrowing and lending securities. In the diagram below, $100 million of securities is loaned from a leveraged portfolio to Bank A, then to Bank B, then to Bank C before it reaches its final destination, the cash provider. Every time the security is re-used (rehypothecated), assets and liabilities are created by the velocity of the collateral.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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The real significant shortages were caused by one of the following: 1. Cheapest-To-Deliver (CTD) – A specific security must be delivered to the exchange (CME) to fulfill a futures delivery requirement. If the correct security is not delivered, it’s a very expensive fine. This is a can’t-fail scenario. 2. Gone From The Market – This was the case with the 3.625% 5/15/2013. There was no supply available and deep shorts. 3. Settlement Distortion – During the September 11, 2001, period, the entire settlement system broke down. BONY couldn’t clear securities for days. 4. Flight-To-Quality – End-investors buy-up all of the Treasurys, pack them away in their portfolios, and don’t loan them into the Repo market. These are solid reasons for securities shortages. However, when you take these out, the rest can generally be attributed to the Repo market, assisted by the Repo market, or helped along by the Repo market. A “Repo market squeeze” is a short squeeze that’s orchestrated by someone in the Repo market. The squeezer could be a Primary Dealer, a bank, a broker-dealer, or even a West Coast money manager. The concept is simple: Buy or borrow as much of a Treasury issue as possible and hold that supply out of the market. Don’t loan it to anyone. Then see how low Repo rates go. When the security begins to trade rich in the cash market or term Repo rates decline, sell the position. Or sell as much as possible.
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Scott E.D. Skyrm (The Repo Market, Shorts, Shortages, and Squeezes)
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In the 140 years we’ve been a state we’ve had good years and we’ve had lean years. (The leanest of all being from 1861 to 1869.) We’ve had good and bad; however, we’ve always had a shortage of two items: cash and honest politicians.
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P.D. East (The Magnolia Jungle: The Life, Times, and Education of a Southern Editor)
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For the Germanic peoples, unity or disunity was the crucial variable in military strength; while for the Romans, as we have seen, it was the abundance or shortage of cash.
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Bryan Ward-Perkins (The Fall of Rome: And the End of Civilization)
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People and businesses were starting to shun cash because it’s ‘dirty’ and might have covid-19 on it when this first started. Now I regularly see signs that they don’t take cash anymore. Throw in a coin shortage and heck, might as well just give up on cash!! We are being both pulled and shoved into 1984!!
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J. Micha-el Thomas Hays (Book Series Update and Urgent Status Report: Vol. 3 (Rise of the New World Order Status Report))
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King Salman was more decisive. The overwhelming majority of the 100 billion dollars in assets obtained from the Ritz Carton detainees was not in cash or equities, but in raw land. Well over 50 percent of the undeveloped urban real estate in Riyadh and Jeddah was returned to government ownership. Along with a new mortgage law that finally found a way to deal with sharia opposition to foreclosures, this new stock of available building sites has begun to resolve the Saudi housing shortage.
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David Rundell (Vision or Mirage: Saudi Arabia at the Crossroads)
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So: global warming is the ultimate problem for oil companies because oil causes it, and it’s the ultimate problem for government haters because without government intervention, you can’t solve it. Those twin existential threats, to cash and to worldview, meant that there was never any shortage of resources for the task of denying climate change.
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Bill McKibben (Falter: Has the Human Game Begun to Play Itself Out?)
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