What the F*&$@ is a repo? Eli5 inside

robert2032

New member
Okay, it's become apparent that the vast majority of you don't know what a repo is. That's fine, you can largely live your life and invest successfully without this knowledge. But it is the topic du jour so let's see if I can't offer the most simplistic of explanations here to help provide some context of today's events.

Lets say you have 10 brothers and sisters. You're all young adults and have been quite successful in life. Your father is pretty conservative and asks that you keep your savings primarily in treasuries so you do.

Right now you have 1MM in 10yr treasuries saved up but you don't have a lot of cash on hand. The cable bill is due today and you get paid tomorrow. Wat do? You can of course liquidate some of your million worth of bonds but that's silly right? Your brother has 500k of cash sitting in his weed box. So you waltz over to his room and ask for $100 to cover the cable and promise to pay him back tomorrow. He thinks you're a bit of an asshole so he says no because he doesn't trust you. So you offer him this: you sell him $100 worth of your treasury bonds and he tells you he'll sell it back to you tomorrow for $100.01. Congrats you've funded your need for cash today while preserving your balance sheet. That's a repurchase agreement or repo.

So now you and your siblings have a thriving market of trading these overnight promises back and forth all while your dad is slowly selling more bonds to you and taking your cash. Eventually you run in to a problem where there just ain't enough cash right? Your brother the dick decides to still offer the same agreement but tomorrow instead of you buying your $100 worth of bonds for $100.01 he tells you he needs $105. That's a huge difference but given how little cash everyone has you might need to pay it. Enter your mom, she keeps the family in order but doesn't normally like to step in to the finances. She tells you she'll start buying your bonds and selling them back tomorrow at the aforementioned $100.01. That's what the Fed has been doing lately.

Takeaway: nobody here is bankrupt or insolvent. You've all got millions of dollars worth of bonds but you need cash to fund short term obligations and there just isn't much going around.

Obviously the real world is significantly more complex but this should serve as a very basic framework of understanding for what repos are and what some of the news you've been reading means.

E: I want to be clear: this is nothing short of the most dumbed down explanation possible. If you're looking to further explore this topic it's best to abandon the analogies and dive right in. I generally don't love analogies in thus world because at some point someone's trying to argue if the FDIC is your uncle roofus who vouches for you or your dads side chick that slips you money to not fuck up. That doesn't help anyone. So once you get a grasp on the basic framework you should either decide if that's good enough for you or expect a much steeper learning curve from there.
 
@moemoes Various places, corporate tax quarterlies were due, the Fed has been reducing it's balance sheet which adds treasuries to the market being purchased for cash, the treasury is increasing deficits which again is a trade of cash for treasuries. Rate disparities making overseas carry trades pull more cash from the domestic market. Basically a lot of concurrent factors.

Also a little birdie told me there might could have been an out of country bank that might could have asked for a large amount of cash unexpectedly. That bank might could have been German. But that's just a rumor and definitely not corroborated or anything.
 
@robert2032 This is the part that I don't really understand. I get that the Fed is reducing its balance sheet. However, wasn't that balance sheet expanded as part of QE and what's happening now is just unwinding that (supposedly) temporary operation to a more natural state. Is the underlying financial system not recovered enough that the Fed can restore its balance sheet to a more "traditional" equilibrium?
 
@cazazby210 For the Fed, it's actually pretty simple: when they sell a bond, their balance sheet literally shrinks. They don't record dollars on their balance sheet, those dollars are just "gone". So if they had $1T in bonds yesterday on the balance sheet, and sold $100B of bonds today, the total of their balance sheet just dropped to $900B.

When they buy a bond, their balance sheet does the opposite: they create cash that's never existed before (back in the day they would literally print it, now it shows up on some bank's electronic account) and give it to someone. If they Fed takes its $900B in treasuries and goes out and buys $100B more, their balance sheet grows.
 
@eseven
when they sell a bond, their balance sheet literally shrinks. They don't record dollars on their balance sheet, those dollars are just "gone".

Not sure I follow. Either they are getting $ in return for the bond or they are not selling the bond.

So if they issue bonds, they are not issuing debt?

So if they had $1T in bonds yesterday on the balance sheet, and sold $100B of bonds today, the total of their balance sheet just dropped to $900B

If they had $1000 bonds outstanding and issued $100 more, wouldnt they have $1100 debt?
 
@cazazby210 The Federal Reserve does not issue bonds. The US Treasury does.

The Federal Reserve buys/sells bonds, that at one point were issued by the Treasury, from private entities (in practice: big banks).
 
@eseven Sorry, I knew that. Sometimes its all the same. Red m&m, blue m&m....

So basically buy buying & selling bonds, they are directly affecting the money supply, with expansionary or contractionary monetary policy?
 

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