Like I always say, income inequality is bad enough, but information inequality is what's really eating away at this country.
For instance, a very small group of big bank CEOs, central bank policymakers, and a few other assorted D.C. and Wall Street apparatchiks have information that our economy - and, by extension, our society - may be just days away from seizing up like an engine with all the oil bled out.
You aren't hearing that vital liquidity and credit - the lifeblood and oxygen that make the United States, well, go - are simply... going away. Out with the tide.
The past three days - or to be precise, three nights - have seen some extraordinarily troubling activity in the "gray" but critically important "repo" markets.[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]
I'm simplifying here, but this is how the repurchase ("repo") market works: Repo trades are the repurchasing of bonds by Wall Street companies and banks that have used these securities as collateral to raise cash for lending activities from the central bank. These borrowers then buy back the bonds the next day at a nominal interest rate near that "benchmark rate" you always hear about at the Fed.
You don't hear much about repo markets, but this happens every day, and it's critical. The repo markets are where banks go to raise badly needed cash for their lending operations.
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The fact that we're seeing banks experiencing a cash crunch is alarming. However, I've warned before about liquidity problems in both Germany and Italy in recent months.
And I've been told by professors... economists... central bankers... those big bank CEOs... private equity managers... and others... the same thing, time and time again.
Just like you've been told that we learned from the Great Recession... after learning from the Great Depression... that bank and lending liquidity will be fine so much as we keep our faith in the system and trust those central bankers.
They might tell us to blame the fact that companies withdrew money to pay quarterly taxes. And we can say that last week's nearly $80 billion bond sale by the United States required a lot of institutions to settle their tabs.
But ultimately the fact is that the repo market is flashing a big red sign about banking reserves.
On Monday night, there wasn't enough cash to go around. The recent ~2.15% repo rate went parabolic, topping 5.2%. Tuesday night was even worse - more than 8%, up into the double digits in some cases.
The Fed tried to keep a lid on things; it injected some $205 billion into the markets in three waves of repo operations. It failed. Wednesday morning, that critical lending rate actually traded above the Fed's target rate of 2% to 2.25%.
Fear - the ultimate driver of market behavior - can fuel spikes in those repo rates if people are afraid of lending.
And when that happens, it sends a shockwave up the credit cycle of the U.S. economy and can paralyze money flows; think of how your drive might feel if you were doing 65 on the highway and your engine violently disintegrated.
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For all the talk about stress tests and liquid reserves, we know that banking reserves aren't truly reserves at all. They were simply a function of massive quantitative easing created by the central bank after the crisis. When the Fed buys bonds from primary dealers, it creates their accounts at the Federal Reserve Bank of New York (FRBNY) with numbers on a screen (excess reserves).
That bank is critical.
Think of your checking account at your local bank - and all the other accounts in that local bank.
The FRBNY is the bank for commercial lenders that offered electronic credits for all those QE bonds. The Fed wasn't printing money. It was just giving out electronic credits.
Back when the Fed started raising interest rates in 2015, the amount of bank reserves sat at about $2.8 trillion. It wanted to stimulate lending as much as possible. And it pumped a lot of credits into that system.
When the Fed started "normalizing," - cutting down on its balance sheet and raising rates - excess bank reserves started falling.
They're about half of where they were back in 2015.
So, what happened? First, those excess reserves ended up leading to higher asset prices. This year, the market rally has relied more on price/earnings expansion than fundamentals.
Second, the Fed started holding bonds on its balance sheet and cutting rates. (We can debate the role of the excess reserve interest rate and the convergence with the Fed funds rate at a different time.)
The problem, it appears, is that it wound down excess reserves too quickly - or the Fed does not know how much in excess reserves is required for banks to function normally.
So, it was interesting when the Fed concluded that it was adjusting the benchmark range to "foster trading in the federal funds market at rates well within the FOMC's target range."
It's not so much about giving the economy a boost with a rate cut - like the administration seems to imply.
It's about providing enough accommodation to ensure that reserves remain healthy and that the benchmark rate remains in the target range. Those reserves are the primary source of funding the repo markets and key credit operations.
If the Fed is unable to control this situation, then we have a serious problem on our hands.
That's the easiest way that I can describe the events of the last three days - and why the somber reaction to yesterday's 25-basis-point cut is so ominous.
The fact that we're injecting $205 billion into these markets requires a significant amount of reanalysis by virtually everyone on Wall Street all the way down to the junior teller at the local bank.
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