Why Didn’t Dimon Step In on Repo? Just Ask the Fed

(Bloomberg Opinion) -- If JPMorgan Chase & Co. Chief Executive Jamie Dimon had had his way, he would have happily lent money in the repo market last month to help offset a spike in short-term interest rates.

If it weren’t for those meddling regulators, that is.

When the head of the biggest U.S. bank was asked about the recent chaos in the short-term funding markets during a third-quarter earnings call, he wasted no time citing a range of limitations on how JPMorgan deploys its cash at the Fed:

“We have a checking account at the Fed with a certain amount of cash in it. Last year, we had more cash than we needed for regulatory requirements, so repo rates went up, we went from the checking account, which was paying IOER, into repo. Obviously makes sense, you make more money.

Now, the cash in the account, which is still huge, it’s $120 billion in the morning, that cash we believe is required under resolution and recovery and liquidity stress testing. And therefore, we could not redeploy it into the repo market, which we would have been happy to do. It’s up to regulators to decide if they want to recalibrate the kind of liquidity they expect us to keep in that account.  I think a lot of banks were in the same position, by the way.

...

We believe the requirement under CLAR and resolution and recovery is that we need enough in that account so that if there’s extreme stress during the course of the day it doesn’t go below zero. To go back to before the crisis, you go below zero all the time during the day. So the question is, how hard is that of a red line...? That will be up to regulators to decide, but right now we have to meet those rules and we don’t want to violate what we told them we are going to do.”

Dimon ticking off a number of Federal Reserve regulations in just a few breaths is a sign of just how top-of-mind these constraints are to him. He also twice concludes that it’s “up to regulators to decide” if these rules are good for the plumbing of the financial system, making it easy to read between the lines about his views.

By now, analysts have cited any number of reasons for the unexpected spike in rates in the more than $2 trillion repo market in mid-September, when they hit a record 10%. The Fed, which initially appeared to be asleep at the wheel, has since stepped into short-term funding markets in a big way, first with persistent repo operations and more recently with the announcement that it would buy $60 billion of Treasury bills a month at least into the second quarter.

One such theory for the repo madness centered specifically on JPMorgan. An Oct. 1 article from Reuters pointed at changes to the bank’s $2.7 trillion balance sheet as a key factor in last month’s dislocation:

Publicly-filed data shows JPMorgan reduced the cash it has on deposit at the Federal Reserve, from which it might have lent, by $158 billion in the year through June, a 57% decline.

Although JPMorgan’s moves appear to have been logical responses to interest rate trends and post-crisis banking regulations, which have limited it more than other banks, the data shows its switch accounted for about a third of the drop in all banking reserves at the Fed during the period.

“It was a very big move,” said one person who watches bank positions at the Fed but did not want to be named. An executive at a competing bank called the shift “massive.”

Other banks brought down their cash, too, but by only half the percentage, on average.

In a blunt statement, a person familiar with repo trading told Reuters that without the constraints on JPMorgan, the rate would have never reached 10%. That kind of assessment, combined with Dimon’s musings on Tuesday, are a clear shot across the bow at bank regulators. The message is straightforward: This is what happens under your rules when markets are good. Are you willing to see what happens if markets turn bad?

Once the initial scare had passed, guess who began offering more money in the repo market? JPMorgan, according to executives in the market who spoke to Bloomberg News. As Dimon said, it did the same thing during last year’s fourth quarter, after repo rates exceeded what the Fed offers banks on reserves, known as the interest rate on excess reserves, or IOER.

There’s no indication that the Fed will consider loosening its requirements on banks to shore up the repo market. Instead, the central bank appears to prefer to do everything itself, abruptly reversing course on the size of its balance sheet and increasing the amount of reserves. St. Louis Fed President James Bullard said on Tuesday that a standing repo facility would be a sensible “endgame” to prevent more bouts of extreme volatility in funding markets.

If the Fed wants big banks like JPMorgan to lend a hand, though, it’s not ingratiating itself with Dimon with current regulations. For now, that’s a trade-off policy makers seem willing to make.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

©2019 Bloomberg L.P.