How The Fed Turned A Flood Of Treasury Debt Into A Scarcity Of Repo Collateral

by David Stockman
 
Here’s a shocking tidbit. The Fed’s financial repression policies have so contorted the government bond market that repo on 5-year treasuries has recently been trading at a negative 25 basis points. That’s right. The hunger for good collateral is so great on Wall Street that some players are willing to lend short-term cash at a negative rate in order to get their hands on Uncle Sam’s debt paper.
Now that’s some kind of financial deformation. For the past 14 years, in fact, Washington has been spewing red ink at unprecedented rates. Since the year 2000, publicly held treasury debt has soared from $3.5 trillion to about $12.6 trillion at present. And its first cousin—–defacto government debt issued by GSE’s such as Fannie and Freddie—-has exploded from $2 trillion to more than $6 trillion. So in theory, the markets should be floating on a sea of “good” collateral.






But that’s where this century’s massive outbreak of central bank money printing comes in. In their lunatic quest to stimulate jobs and growth through ultra-low interest rates, the central banks have absorbed massive amounts on government debt through their QE operations. The US central bank alone has expanded its balance sheet from $500 billion to nearly $4.5 trillion since the time of the dotcom bust in 2000. That means that enormous amounts of otherwise available collateral has been stuffed in the vaults of the state’s monetary central planning agency.
During the final phase of QE, in fact, the Fed has focused its purchases on the so-called “belly” of the curve, scarfing up huge amounts of treasury paper in the 3-7 year maturity range. Accordingly, it has created an enormous and insensible scarcity which, in turn, has driven the yield on the 5-year treasury note to the absurd level of 1.6%.
Now the fact of the matter is that US treasuries are taxable; the current CPI rate is running at 2%; and it has averaged 2.4% over the last decade and one-half. So the real after-tax return on the 5-year note is deeply negative. Needless to say, nothing like that could happen in an honest free market for debt that was not pegged and administered by the Fed.
Moreover, the Fed has had a lot of central bank help in creating this destructive artificial scarcity in the government debt market. Altogether, the central banks of the world and their sovereign investment fund affiliates own about $6 trillion or nearly half of the publicly held US treasury debt. It has simply been stuffed in the central bank vaults which function as a convoy of monetary roach motels: The bonds go in, but they never come out!
And the resulting financial distortions are legion. Most corporate bonds, mortgage loans and other long-term fixed income securities are priced at a spread over treasuries, and are accordingly vastly mis-priced. Likewise, the politicians in Washington sit on their hands while the national debt soars and the structural deficit is left unattended because the “carry cost” of Uncle Sam’s debt is dirt cheap.
And now comes the greatest absurdity of all, as described by the Wall Street Journal article below. Having wrecked the treasury market proper, the Fed is now flummoxed by the growing distress in the repo market—-a place where it has managed to turn a tsunami of government debt into a severe shortage of good collateral.