How JP Morgan broke the repo market

17 December 2019/127 Comments
By Nick Dunbar

The Fed relied on JP Morgan to lend out cash into the repo market. But that was before the too-big-to-fail giant made a pivot out of cash into securities.

There has been a lot written about September’s turmoil in the dollar repo market. And I mean a lot. On 17 September, the secured overnight financing rate (SOFR), which had hitherto closely tracked the Federal Funds rate, suddenly rocketed up to 10%. For a brief moment, US dollar repo enjoyed the same overnight funding cost as Brazil.

At this moment, banks were not doing their customary job of lending out the cash that the Federal Reserve had provided (via reserve balances). They had stopped purchasing treasury bonds and other securities from counterparties, which they would resell a short time later at a slightly lower price. The Fed had to step in and start lending instead, providing up to $75 billion each day.

The pivot to securities

Only a couple of weeks after that, JP Morgan was in the frame. Analysts had noted a big decline in the bank’s cash and reserve balance at the end of 2018, and Risky Finance data confirms this. Between June 2018 and June 2019, JP Morgan’s cash and reserve balance fell by $138 billion, a decline of more than a third. By contrast, cash and reserve balances for the other five largest US banks barely fell at all during this period, as the Risky Finance banking tool shows.

Screenshot of interactive chart tool available to subscribers

JP Morgan’s pivot was described in February by the bank’s then-CFO as a “yield-enhancing opportunity to redeploy cash” on the grounds that money market rates were higher than the interest rate on excess reserves (IOER) paid on balances at the Fed. The bank used some of the cash to buy securities, adding $50 billion of treasury bonds and $30 billion of agency mortgage-backed securities in the 12 months up to June. With bond yields falling during this period, it was a good move from a shareholder perspective to make the switch, and helped boost the bank’s interest income.

A lender of last resort

As the Bank for International Settlements noted in its December 2019 quarterly report, the reduction in cash by “top four banks” (read JP Morgan) coincided with a structural change in the repo market – instead of using repo as a funding source as they had done in the past, the largest US banksJP Morgan instead became a net provider of funding. We see this in the chart of net repo assets versus liabilities of the banks over time.

While the BIS took care to anonymise the names of the largest banks in its study, we can be less circumspect. According to Risky Finance data, JP Morgan accounted for 41% of all repo lending by the six biggest US banks at the end of 2016. By June 2019, this had increased to 46%, or $465 billion of repo loans. In effect, JP Morgan was the lender-of-last-resort to the repo market.

Related Articles