Sometimes the mouth goes faster than the brain.
I chat with Lindsay Williams on his Strictly Business Podcast, once every couple of months. When I spoke with him on Thanksgiving Day I said something that I immediately realized was wrong. I said that there’s no way to know how leveraged the Primary Dealers are in their bond portfolios.
Of course, that’s wrong. The New York Fed publishes enough data every week for us to figure it out. So I set to figuring.
The question is how to put that data together in a meaningful way. There’s a lot of it, and a lot of figuring, rumination, trial, and error to be done. This is just the first installment.
What I can show so far is not earth shaking. We already knew intuitively that the dealers are leveraged to the hilt, and therefore in grave danger if bond prices fall below a certain level. We don’t know exactly what that level is, but at some point, soon I think, they’re going to face calls from their unindicted co-conspirators for more collateral.
It’s 2 PM. Do you know where your margin man is? You know. The guy with the tire iron.
So below is the first chart that I painted with the data. It shows the level of dealer net Treasury repo borrowings versus their total Treasury holdings. Surprise, surprise! They correlate!
I’ve been reporting to you their total repo borrowings before this. Those totals have been in the $1.75 trillion range, which is about 8 times their total Treasury holdings. That would be like you having a $3 million mortgage on your $400,000 home. OK. It doesn’t work.
They’re not just borrowing to support their Treasury inventories. They’re also banks. They lend. Most of that borrowing is to finance their lending activities. So I ran their reverse repo operations, where they take in securities as collateral for lending cash to degenerate gamblers like me and you, but mostly the big hedge fund wiseguys in Greenwich, Palm Beach, and the Upper East Side.
Netting that lending activity out leaves us with their net cash borrowings, which should in theory bear some relationship to their Treasury holdings.
Not that their loan sharking activities are without risk. But this is the big boy, in my opinion—the net leverage on their Treasury collateral. It’s like your margin account, except it’s not 50% margin. It’s more like 75% to 200%.
Since the Fed took over the bond market in September 2019, buying approximately 85% of all new Treasury issuance, on average, the ratio of dealer net borrowings to their Treasury holdings has stayed pretty close to 100%.
Why isn’t that a problem? Because, Praise the Load, Jaysus of the Church of the Fed is backstopping them. But despite the fact that He has been relieving them of some of that inventory since May, the dealers keep increasing their leverage.
This report includes that chart, along with what it tells us about present conditions, what to expect in the near future, and what we should do about that.
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