US Fed prepared for inflation-fighting pain; China's economy struggles; inflation bites Russia and Turkey hard; UST 10yr 2.94%; gold down and oil up; NZ$1 = 62.6 USc; TWI-5 = 70.3

I also appreciate Audaxes posts, even if sometimes I am unconvinced by Snider.

The liquidity crunch he talking about is one that he has discussed for years; his frustration with the Fed comes from their refusal to acknowledge the eurodollar market and manage the impact of it when in fact I think there is no chance the Fed could manage it.  What the Fed could do would be to understand how the euro-dollar liquidity shortages will affect treasury bonds and how this removes liquidity from the US thereby nullifying the Fed's strategies for US market support.

The existence of the euro-dollar market, the largest reserves market on the planet, is due to the $ being the reserve currency of the planet and therefore the underlying currency of all global trade.  This has little to do with the US and is a natural construction of the financial industry.  It is unmanageable by design, this feature allows the price discovery of liquidity to be guaranteed and not politicised overtly.  To the betterment of global trade.

Fitz, I think you have done a great job simplifying and explaining Audaxes post, thank you. 

Think of T bills as being the "best" type of cash. Snider is saying that the demand for this best, safest, type of cash is enormous.  Snider is talking about a liquidity crunch.

by Audaxes | 2nd Apr 22, 3:46pm

Banks are more interested in the return of their money than the return on it. Furthermore:

Nobody buys securities; they borrow and claim to “own.”- Repo. The hedge fund (client) says it wants to own XYZ US Treasury issue, puts up a minimal upfront investment, enough to cover some overcollateralization requirement, and borrows for the rest of the purchase price. In many instances, the broker is the lender as well as custodian.

To make this securities funding transaction as cheap as possible, the client will agree to allow the dealer to re-pledge or rehypothecate (for our purposes here, the language is interchangeable though in a legal and regulatory sense these terms can have different meanings) the very security the client is claiming to own.

What that means is the dealer acts as an intermediary rather than lending its own cash for the purposes of the client owning this particular security. Instead, the dealer will repledge that security in the repo market or to other dealers in order to borrow the cash ultimately used to “purchase” and then fund the transaction (rolling over) to its ultimate end. Not just a securities financing transaction, a whole series of them.

And this series becomes horizontal as well vertical; the already re-pledged security posted by the client’s dealer to the next dealer in line can be re-pledged again depending upon the conditions set forth between the client’s dealer and what is now the client’s dealer’s dealer. As you may already guess, the client’s dealer’s dealer may also be able to re-pledge – the same security – to its dealer; specifically, the client’s dealer’s dealer’s dealer.

In many if not most cases, there needn’t be the original client need for this chain of re-pledging, either. What I mean is, the first link in that chain doesn’t have to originate out of the client’s need to borrow directly; if permissible, the client’s dealer may re-pledge the client’s security(ies) for its own purposes, with the client being sufficiently incentivized.

Thus, a dealer who does this kind of business with many financial clients can build up a stash of usable collateral that it doesn’t exactly own; these securities belong to other firms and vehicles, but are more than useful for the dealer to fund and carry out its dealer activities as a whole because of these peculiar usage rights.

The permissibility of these kinds of doings is, and remains, much higher in the offshore domain (the non-harmonized part of these rehypothecation regimes). The more a dealer could do re-pledging for themselves, the better terms it would offer its customers; giving Lehman Brothers International Europe a serious leg up on Lehman Brothers Inc.

Net result, Lehman Brothers as a global firm had acquired a significant pool of collateral owned by its customers and custodied at Lehman Brothers International Europe which underlay a whole range of dealer activities carried out by Lehman Brothers Inc., including securities financing transactions in its own proprietary book as well as a creating a margin collateral cushion for a whole host of derivative transactions and potential counterclaims.

So, what happens when customers start to feel a little uncertain about these arrangements? Quite naturally, they may begin to wonder about what their exposure might be given how their securities are in London. In fact, this, not subprime mortgages, is what led to Lehman’s end.

Hedge funds and dealers as Lehman clients scrambled to change these prime brokerage agreements limiting Lehman Brothers Inc. from being able to transfer assets into Lehman Brothers International Europe, or demanding they be transferred back, having the effect of stripping Lehman of a huge chunk of what had been available collateral by which to supply its global operations.

The rest was typical, traditional bank run stuff; rumors of Lehman being shaky led to the initial customer collateral “run” which then made Lehman shakier leading to more customers running in and changing their brokerage language. Soon enough, bye bye Lehman.

It was a run, but it wasn’t like one Walter Bagehot or Benjamin Strong would’ve recognized. It sure hadn’t been something Ben Bernanke or any of his kind considered too important, either. The latter group, contemporary central bankers, focused instead on the level of bank reserves, even as the federal funds effective rate had plummeted and been undershooting for a year by then.

Better than cash.