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Repo Meltdown Shows Budget Deficit Has Limits

(Bloomberg Opinion) -- The repo market madness lives on for a ninth day.

The Federal Reserve Bank of New York announced Wednesday that it would increase the size of its next overnight system repurchase agreement operation to a $100 billion maximum, from $75 billion previously, and also raise the limit on its 14-day term repo operation to $60 billion from $30 billion. Simply put, the bank wants to flood the funding market with enough cash to soak up all the securities that dealers submit(1)and leave no doubt that the critical financial-system plumbing is in fine working order ahead of the end of the quarter.

By now, just about everyone has heard the explanations for this persistent liquidity squeeze, which has lasted long enough to refute the earlier notion that it was merely a one-day confluence of unfortunate events. To some, the main structural issue is that banking regulations are disrupting the financial system’s inner workings. Others say the Fed has simply found the lower bound for reserves necessary to control short-term rates and can move forward accordingly.

In addition to those two assessments, I’d offer another angle that’s largely flown under the radar: The chaos in repo markets was a long time coming given the widening U.S. budget deficits and the lenders that are financing that shortfall.

Deficits, while nothing new, add up over time. And while they declined each year from 2011 through 2015, both overall and as a percentage of gross domestic product, the gap has widened again under President Donald Trump. Put it all together, and the amount of U.S. Treasury securities outstanding has roughly tripled since the financial crisis:

This growth was mostly under control in the years after the financial crisis because the Fed had been buying up large chunks of the Treasury market through its quantitative easing...

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