Triparty Repo Market is Failing

While I've been resting, I am doing some research on our financial system, and how MF Global failed. So I thought I’d put together a post about that for your perusal, as we see what the market brings us today.

MF Global’s failure is basically due to risk-taking by lenders (typically banks) on the permitted re-lending of borrowed assets. And the market in which this is done is failing, according to the Fed. In a lead article by Michael S Derby, Dow Jones Newswires, you will find some of the quoted excerpts below. Some are my thoughts.

First, read an eye-opening article about the Repo construct.

http://soberlook.com/2012/02/increase-in-triparty-repo-usage-and.html

Now we understand why the FED buys RMBS's. A bank-owned RMBS can be relent to other banks (less the prescribed haircut) and therefore it's worth becomes greater, due to the relending leverage. If the mortgage backing the RMBS fails, this leverage comes crashing down.

Remember, the Fed has bought RMBSs and will hold them to maturity (or until the troubled asset packed into the security is repurchased by leveraged buyout (Private Equity) or by foreclosure). If the income from the security is not adequate to pay the interest, the Fed can simply issue liquidity (print money) to pay the interest, keeping the system afloat.

In the long run, the Fed can be the winner, because the RMBS will mature, all the properties under the RMBS will mature, the interest will be paid. And there’s the reason for inflation, it’s hoped that with enough inflation, (2% minimum per year) there will be enough appreciation so the RMBS is not retired at 0 worth, but at full value worth. (That's (simply) why Bernank said deflation is our greatest enemy.

If you’ve got deep enough pockets, and a long enough time, and the ability to create inflation, you will be the winner. The Fed has all these. Albeit some trouble on inflation….

Today, the NY Fed said the triparty repo market is failing.

Because fixing RMBSs doesn’t fix the problem. The problem is that originally, only Treasuries were “Repo-able”. But that didn’t fit bank’s requirements for profits, so regulators (not the law) changed the rules so that basically any AAA rated security (or other not so high rated securities) can be repo-ed. As long as you can find a buyer, you can repo it. A repo is simply a financial product created to make money. In other words, it makes money out of money. It does not create wealth, it creates liquidity. Liquidity (like debt) can create the appearance of wealth. But true wealth only comes from productivity funded by capital. There’s no productivity in a repo.

So here’s the problem: the Banksters have created liquidity, funded by the 0% interest rate they can get from the Fed, and profits of money which they dole out as bonuses to their salesmen selling these created repos on their trading desks. These Wall Street guys are simply used car salesmen, with an Earl Scheib repainted rustbucket they put lipstick on and sell.

Today, Mr. Derby’s article said that “At issue is the state of the triparty repo market….And because the market is dominated by short-term activity, a loss of confidence in a particular firm can kill its access to credit and potentially kill the institution, which can, in turn, create problems for the broader functioning of financial markets…...The effort to repair the market came to a head Wednesday with the release of a report by the Tri-Party Repo Infrastructure Reform Task Force, a private industry group operating with the support of the New York Fed. The report was to offer the group's final recommendations,” but the NY Fed said “ … the amount of intraday credit provided by clearing banks has not yet been meaningfully reduced, and therefore, the systemic risk associated with this market remains unchanged,"

Simply put, there are too many Earl Scheib rustbuckets, too few Used car salesmen, and even fewer tire-kickers.

Mr. Derby continues “As a result, the bank (The NY Fed) said it "will intensify its direct oversight" of the triparty repo market.”.

Are you frightened? You oughta be. Because direct oversight will not eliminate rustbuckets, hire qualified salesmen, and drum up customers, It will only get in the way, and make things worse.

The systemic risk with this market remains unchanged. What is the market? Sovereign debt. Treasuries. Bonds. Corporate stocks. Anything the worthless rating agencies rate AAA. The liquidity of the system depends on this market, and it can be brought down by any participant. That’s exactly what happened to MFGlobal.

If somebody looks cross-eyed at the wrong CEO, the system is toast. We’re toast. We will take the haircuts as the banks fail, as did the customers of MFGlobal.

Somebody didn’t like Corzine. That’s the cause of the MFGlobal failure. That’s the cause of the investors losing their retirements.

The other thing that can bring down the system, as I explained about the RMBS above, is the reduced value of any of the repo'ed securities. Like sovereign debt. I mean, that could never lose value, right?

You oughta be scared.