Why Jamie Dimon’s Repo Gripe Stirs Sympathy, Skepticism

(Bloomberg) -- When the markets that keep funds flowing throughout the financial system suffered a seizure in September, the Federal Reserve was forced to step in with emergency support for the first time since the 2008 crisis. That calmed the markets but ignited debates over why it happened -- in particular, why big banks seemingly flush with cash didn’t tap their reserves to help out, since they could have made a pretty penny in the process. Jamie Dimon, the head of the biggest U.S. bank, JPMorgan Chase & Co., later pointed to post-crisis rules that he said have tied his hands. Treasury Secretary Steven Mnuchin responded with sympathy, saying he was open to revising those regulations -- even after Senator Elizabeth Warren, a front-runner to challenge Mnuchin’s boss in the 2020 presidential election, warned him not to.

1. What was the market turmoil about?

The trouble happened in the repo market, an obscure but crucial part of the financial plumbing where high quality securities are swapped daily for trillions of dollars of cash, making a wide range of transactions easier. Repo made headlines in mid-September when the amount of cash available dropped just as the demand to borrow it jumped, driving interest rates sharply higher.

2. What did big banks do?

Nothing much. Typically, such crunches present an opportunity for banks with funds to spare to lend some out, reaping a profit from the higher rates. JPMorgan certainly liked that trade last December, when a rate spike presented what then-CFO Marianne Lake called a “market opportunity.” But the bank stayed with its peers on the sidelines of September’s turmoil. Federal Reserve Chairman Jerome Powell in his October press conference expressed surprise that banks didn’t do more.

3. What does Dimon say happened?

He says that rules adopted since the financial crisis stake too many claims on bank reserves -- their spare cash -- making it hard to put them to more-profitable use. In an October earnings call, Dimon said he believed that the cash the bank had at the central bank was earmarked for “resolution and recovery, and liquidity stress testing.” As a result, it couldn’t be plowed into the repo market, though “we’d have been happy to do it,” he said, adding that he believed a lot of his peers were in a similar position.

4. What’s he talking about?

Since the crisis, new rules have curbed banks’ riskiest behaviors on a range of fronts. But the measures that have drawn the most attention in this repo episode are those meant to stop banks from running out of funds if a market shock makes them less willing, or able, to lend to each another. What’s known as a liquidity coverage ratio requires large or globally interconnected banks to hold enough cash or cash-like assets to tide them over for 30 days. In other words, an amount roughly equivalent to the cash outflows they’d expect over that time. Those deemed global systemically important banks, of which JPMorgan is the largest, must also hold an extra chunk of capital as a buffer.

5. Is that the only liquidity issue?

No. In fact, Mnuchin and Powell have focused on a related issue, something called intraday liquidity. Before the crisis, banks were allowed (under some conditions) to run “daylight overdrafts” in their accounts with the central bank within the course of the day, to cover any gaps between big payments and settlements as they came along. Banks would then net out anything owed around the close of business. Over the last decade, the Fed has nudged banks toward settling those transactions as they arise instead of waiting till the end of the day.

6. How could that have caused the problem?

That intraday settlement, some banks argue, means sharper swings in their reserves during the day, which makes it hard for them to commit cash elsewhere. A more flexible stance from the Fed on overdrafts might help at the margins, but it may not satisfy banks angling for regulators to lower their reserve requirements. Goldman Sachs Group Inc. strategists are among those who see pressures building from “bottlenecks” in the flow of funds through the financial system, temporary shortages that can get worse when banks hoard cash to prepare for regulatory reviews, most notably around year-end.

7. Do others agree?

The answers from outside the banking community range from possibly to absolutely not. Critics say banks are using the repo turmoil to lobby for the rollback of regulations they’ve never liked at a time when Mnuchin and President Donald Trump have focused on loosening the reins on U.S. industry. That’s what Warren, the Massachusetts senator who’s angling to be the Democratic nominee to run against Trump, contended in a recent letter to Mnuchin.

8. What does the Fed think?

One reason Powell expressed surprise is that the Fed’s recent survey of the big banks on their “discomfort level” -- how low their reserves could drop before they became worried about liquidity -- suggested they had more room to maneuver. While only the overall numbers are publicly released, the Fed can see individual submissions, and these from August suggested some of the biggest banks’ reserves weren’t close to strained. Powell declared Oct. 30 that liquidity in the system is “ample” and a further rewrite of capital or liquidity requirements was unlikely, but that the Fed’s stance on daylight overdrafts might be worth revisiting.

9. Who gets to decide this?

While Mnuchin chairs the interagency Financial Stability Oversight Council, Powell arguably has the most on the line here. He’s the head of the institution that’s now single-handedly propping up a market at the heart of the U.S. financial system, injecting hundreds of billions of dollars of temporary liquidity and buying $60 billion of Treasury bills a month to restock reserves.

The Reference Shelf

• The repo market’s liquidity crisis has been a decade in the making.
• Ex-prop traders who won big on repo are ready for the next big spike.
• A research paper on post-crisis bank regulations and liquidity.
• Fed Vice Chair Randal Quarles on the evolution of macroprudential regulation.
• Former Fed Vice Chairman Stanley Fischer on the resolution framework for banks.
• The Fed explains bank living wills.

To contact the reporters on this story: Emily Barrett in New York at ebarrett25@bloomberg.net;Jesse Hamilton in Washington at jhamilton33@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, ;Jesse Westbrook at jwestbrook1@bloomberg.net, John O'Neil, Nick Baker

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