The Reverse Repo

The crisis is over, say the feds. Now, they can begin turning off the taps.

“Fed takes first step in exit strategy,” is the headline in The Financial Times. A more accurate headline would have been…

“Fed dodges and weaves…fakes exit.”

The only way to exit is by the door the Fed came in. It barged into the market buying up toxic assets and Treasury notes and bonds. In order to get back out the door, it has to get rid of all the debt it gobbled up. How? It has to sell them back to the people it bought them from – or to someone else.

Instead, the Fed has come up with a subterfuge: the reverse repo.

“In a reverse repo,” The Financial Times explains, “the Fed sells assets, such as Treasury securities, to dealers for cash, with an agreement to buy them back later at a slightly higher price…”

No kidding. That’s what it says. Now, let us put the question to you, dear reader. Having thus reverse repo-ed a boatload of debt, has the Fed:

a) unloaded its unwanted debt and drained liquidity from the system,
b) not unloaded any debt at all…but merely lent out the credits at negative interest rates
c) postponed the problem until later?

If you answered “all of the above” you are not paying attention to the choices we’ve given you. It’s not on the list. Still, it’s probably the right answer…

The Fed says it’s going to try out this reverse repo trick and see how it works. We can tell them now. Save them some trouble. Either the Fed is the bagman of bad US debt, or it is not. It is either in or out. Long or short. Either Fannie Mae, AIG, GM are backed by the government or they’re not. If they’re not, the market will sort them out in its own good time. If they are the bagmen…well, then, the feds will squirm and dissemble…get themselves in deeper and deeper…until, finally, the bags drag them beneath the surface.

This reverse repo is just a scam to disguise the situation…so the Fed can pretend to exit without actually going out the door.

The Daily Reckoning