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I know this might not be a very quantitative question, but I figure this is the most relevant place to ask this.

Over that last few days, there has been a lot of news from the repo market, for example, https://www.bloomberg.com/news/articles/2019-09-17/with-repo-market-still-on-edge-fed-preps-second-blast-of-cash

Approximately half of the repo market is attributed to overnight repurchase agreements. What is the point of entering a repo agreement for such a short term? I have been able to find a lot of material with examples of two parties entering the agreement and explanations of how they work, but what is the motivation?

If I put up 100 million worth of treasury bills and in return, get cash and enter an agreement that I have to repurchase those bills the next day, what is the point of that cash? What can I do with that money in such a short time? Is it simply for some regulatory/filing purposes to show that you have cash on hand?

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  • $\begingroup$ This link maybe help you understand what's going on a bit more business.financialpost.com/pmn/business-pmn/… $\endgroup$ – amdopt Sep 18 '19 at 17:54
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    $\begingroup$ It is not just "for regulatory purposes". It is real cash that can be used to pay bills that are coming due today, and that you must absolutely pay if you are a financial institution. $\endgroup$ – Alex C Sep 18 '19 at 18:24
  • $\begingroup$ but in a repurchase agreement, you need to have the cash back the next day to repurchase the T bills (or whatever collateral). So if you use that cash to pay the bills, what cash do you use to do the repurchase? $\endgroup$ – Mustard Tiger Sep 18 '19 at 19:18
  • $\begingroup$ @MustardTiger You can rollover the debt with another repo: pay the existing, get a new one $\endgroup$ – alexbougias Sep 18 '19 at 19:22
  • $\begingroup$ But then why are most of them so short term? the borrower should have an idea of what duration he needs to pay back the cash, why are they not set based on that? $\endgroup$ – Mustard Tiger Sep 18 '19 at 19:24
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The reason that repos are often overnight is because it corresponds with the settlement and funding processes, and people want maximum flexibility. Note further that most overnight RPs are rolled over (renewed) each day with the amounts potentially changing.

To use your example: I buy 100M of 2 year notes and need to fund it. Great. That works. Why not fund for 2 years? Because I'm not going to hold it that long and, tbh, I don't know how long I'm going to hold it. But I do know that normal settlement occurs next day in USTs. So if I sell $100M (or $50M) of my position today, I can unwind my financing tomorrow.

Why don't I fund it for 2 yrs? Because I want flexibility and there is often carry involved. Usually the overnight rate is less than the 2 year rate. Generally that is what leveraged money is after: I buy a 2 year note at 2% and fund it overnight at 1.55%. Unsurprisingly, the 2 year RP rate will probably closely match the 2 yr note yield (this would not generally be true for assets farther out the risk spectrum).

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One important reason why repos are often short term is that the banks obtain the other side of the market from money market funds. These investors want to make a cash deposit secured by high quality collateral (i.e. a reverse repo). However it must be short term because they are offering daily liquidity to their investors at a price equal to par. If they were to invest in (say) 6month repo, they would be stuck if a lot of folks withdrew their money from the fund.

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You have positions that you need to finance via overnight repo. You secure financing by simultaneously entering into repo transaction with a bank to secure the cash to purchase the Treasury security, then providing this security to the bank as collateral.

in other words, this is a form of collateral lending similar to getting a mortgage on a house. You don't have millions of dollars sitting around so you obtain a loan to buy the property. If you fail to make repayment on your loan, the bank seizes your house.

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Ok, think about it this way... every time any bank's customer enters any transaction with someone else, who is the customer of a different bank, there is an inter-bank transfer.

Each bank's balance at the central bank at the close of business will be different. But the aggregate will be no different; just the composition/mix. Cash can move around within the system; but can't (or struggles to) ever enter or exit the system. You buy gold; your cash just goes to the seller's account...

This variability in the flow of transactions doesn't change the cash circulating in the system; but it does alter its distribution, who ends up with the surpluses and who the deficits on any day to the next. Repos simply allow banks to net these off in a manner free from credit risk (given the colllateral). One bank will have excess cash, and not so keen earning below-repo with excess reserves. Another will have the opposite, and not so keen covering this direct with the CB. Repos just net off these floating fluctuation, without credit risk.

As such, they're far from elegant; just less inelegant than the alternatives.

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