Panic meeting at Federal Reserve: short-term money market problems

On Wednesday, a secret meeting took place between the New York Federal Reserve and Wall Street banks. Reason: alarming signals in the market for short-term loans, also known as the repo system. Why did this meeting have to take place so quickly?

Worrying signals regarding short loans

John Williams, chairman of the New York Federal Reserve, urgently summoned major banks and financial institutions. The reason: disturbing signals from the central bank’s repo system – a mechanism that should normally bring calm to the market.

Through this system, banks can quickly obtain liquidity by taking out short-term loans against strong collateral, such as government bonds. The idea is simple: borrow today, pay back tomorrow. But something goes wrong. Instead of stability, signals of stress are now emerging within the system.

Repo rates skyrocket

Banks pay interest on these loans. This is usually lower than the interest rates that the central bank targets for regular loans. However, in recent times, the repo rate has exceeded the target rate several times. A clear signal of tightness in the liquidity of the repo system.

These types of signals were also previously seen in 2018 and 2019, when there was also a clear liquidity crunch in the market.

The cause lies in the years of policy of the central bank itself. By winding down their balance sheet and reducing reserves, there is simply less money available for lending. That drives up interest rates, causing banks to avoid the system.

Fear of reputational damage

In addition, banks are reluctant because participation in the system can be seen as a weakness. No one wants customers to suspect that their bank is in financial trouble. Although the names of users are only made public after two years, the reputational damage is a real risk.

Yet the central bank wants institutions to continue using the system. Only in this way can interest rates stabilize and the system can continue to do its work. According to Williams, the system is working as intended, but needs to be used more actively to remain effective.