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Strategies & Market Trends : The coming US dollar crisis -- Ignore unavailable to you. Want to Upgrade?

To: Real Man who wrote (55762)	7/14/2014 12:04:34 PM
From: the navigator	Read Replies (1) \| Respond to of 71484

Not sure how the Fed can do anything with reverse repo i won't pretend that i understood the article, because it is way over my head. it was the comments that brought some small bit of clarity to what they were trying to convey...in particular...this person's comment laid it out in terms i could sort of grasp... gmak... Market players are leveraging by borrowing T-bills and T-notes from the FED and providing them as collateral against loans from other lenders. The cash is being thrown into margin accounts and leveraged again in buying financial assets. This is leverage on leverage and ALWAYS ends badly when the growth rate of the assets falls below the implicit interest rate and growth of the leverage. Re-hypothecation is the leverage on the leverage on the leverage. Financial assets need increasing amounts of leverage against them to grow at the same rate percentage-wise. The lack of collateral out there means the FED has to provide more. BUT the mechanism used limits the ability to re-hypothecate (or so they are saying, I believe). Long story short: leverage on leverage on leverage is becoming leverage on leverage. If it falls to just leverage, then the asset liquidation is underway. ie asset prices will fall leading to margin calls leading to de-leveraging - and the rehypothecation means that someone will not have a chair to sit in when they need their collateral back. Background: If I'm a financial entity and I borrow from another (say a hedge fund using a highly leveraged margin account, or one F.E. doing a swap [derivatives] with another], a risk is created. The lender has to have capital allocated to that risk and this starts to strain the balance sheet (leverage) over time. To mitigate this risk, the lender asks for collateral, usually in the form of liquid t-notes and t-bills. The FED has been buying up T-notes and T-bills in QE. So there aren't as many out there in private hands as there used to be. For leveraged asset "investors", getting their hands on these to use as collateral is critical. They borrow them from the FED (called a reverse repo) to give as collateral to their lenders (this is a tri-party reverse repo because the borrower of the notes and bills from the FED is not keeping them, but passing them on). Here's the rub. The dance of increasing leverage to buy equities and other assets has been kept going by the re-hypothecation of collateral. Apparently, a tri-party arrangement limits the amount of re-hypothecation which limits leverage. If leverage grows less than the growth rate of assets + the implied interest charges then it starts to unwind. As asset prices fall or stop growing, there are margin calls. assets are liquidated but at some point there are no more assets and still margin to cover. The collateral is 'seized'. The FED now wants its T-bills and T-notes back for some reason and the borrower of these has lost them as collateral. They have to buy the instruments from somewhere and no one wants to (or can) sell. Price goes up.