The real story of the turmoil in the repo market, why do bitcoin have better anti-vulnerability?

Foreword: An anti-fragile system is a system that becomes stronger and more resistant with impact, rather than becoming weaker. This describes bitcoin, and its network security grows as the system's processing power grows.

Note: The original author, Caitlin Long, was a Credit Suisse executive from 1997-2007. She was responsible for Morgan Stanley's pension business in 2007-2016, and since 2012, Caitlin Long has been exposed to Bitcoin, and in 2016- She served as chairman and president of the blockchain company Symbiont during 2018 and is currently appointed as the head of the Wyoming blockchain task force.

Btc (Image courtesy of

The following is a translation:

Last week, the entire financial system had a problem of insufficient cash. This is a modern version of the bank run, and it is not over yet. Taking a step back, it reveals two major problems in the financial market: First, US Treasury bonds are not truly “risk-free” assets as most people think, and second, large banks are seriously undercapitalized. This incident does not mean that another financial crisis is coming (just increase the risk), because the Federal Reserve (Fed) or banks can fight the crisis by raising more equity capital. However, it provides an “educational moment” about system vulnerability and anti-vulnerability.

what happened? Please use "personal words"

Someone (probably a big bank) needs cash so much that it is willing to pay a surprisingly high price to get cash, which is a layman's explanation. To put it another way, interest rates are contrary to common sense (the interest rate in the repo market should be lower than the interest rate in the unsecured market), because the repurchase is guaranteed by assets, so it is considered to be less risky. But last week, even with "risk-free" collateral like US Treasury bonds, repo rates soared, causing it to be significantly higher than the unsecured lending rate.

But in fact, US Treasury bonds are not without risks, far from it. (On this point, I am not referring to the possibility of US default debts, but to the practice of repurchasing the market, that is, allowing more people to believe that they own US Treasury bonds. Instead of actually owning the national debt. This practice is called “re-mortgage”)

Last Tuesday, why would anyone be willing to borrow cash at a 10% interest rate in exchange for US Treasury mortgages (yield of only 2% or less)? The deal caused someone to lose up to 8% (annualized) profits overnight, but it is speculated that the deal allowed the bank to continue to operate . As the risk premium rises, 8% is staggeringly high for an asset that should be risk free!

On the other hand, the better question is why banks are reluctant to use “no risk” mortgages to get 8% “risk free” benefits ? Banks should be healthy, cash should be abundant, right? So why don't banks make such easy “risk-free” profits?

What is shocking is that the Federal Reserve has admitted that it has raised the same issue, as disclosed in a special interview with Financial Times' John Pauls, the chairman of the New York Fed, on Friday. The Fed provides an explanation theory, as many analysts say, but almost no one is talking about "the elephant in the room."

"The elephant in the room"

For every outstanding US Treasury bond, about three parties will believe that they own it. Yes, when only one party actually owns the same asset, multiple parties report that they own the same asset. According to estimates by the International Monetary Fund, the same collateral was reused 2.2 times in 2018, which means that the original owner plus 2.2 follow-up people believe that they have the same collateral (usually US Treasury bonds) .

That's why US Treasury bonds are risky. They are the most re-collateralized assets in the financial markets, and big banks know this. The auditor could not understand this because the GAAP accounting standards confuse this (I will explain later). All of this means that although the financial statements of each bank show that the bank is solvent, the entire financial system has no solvency. No one really knows how many times the calculation of US Treasury bonds has occurred (three times, four times, etc.). US Treasury bonds are the core assets that every financial institution uses to meet its capital and liquidity requirements, which means that no one really knows how big the loophole is at the system-wide level .

This is the real reason for the cyclical failure of the repo market. This is like grabbing a seat game. No one knows how many people will not be able to grab a seat before the music stops. Every participant knows that a chair is not enough, and everyone knows that someone will eventually lose .

Financial regulators can't publicly admit it, but big banks know it's true, which is why when they feel that their "relatives" are in trouble, they choose to back down (and stop lending). They recognize that the seemingly 8% risk-free arbitrage is not risk-free at all .

When discussing this issue, most financial regulators will use jargon to confuse us, making it almost impossible for ordinary people to understand (such as "transmission mechanism blockage", "collateral chain length" and other terms to cover up). The conversation I recently heard about financial regulators talking about the matter publicly came from former CFTC chairman Chris Giancarlo. It is commendable that he answered a question after a speech in 2016:

“The core of the financial crisis, perhaps the most critical factor is the lack of visibility of one major financial institution’s credit exposure to another. The most obvious omission that may need to be addressed is the lack of visibility, which is now 2016, but We still lack visibility."

That's why the Financial Times' interview with Williams is so unusual. That is, regulators are increasingly acknowledging that this system does not work as most of us think, and the Fed may not even understand the key issues of its existence. Specifically, the Fed’s focus on its fund market is wrong because the real action is in a larger, more global repo market. The Fed should not allow big US banks to pay dividends or buy back equity if they are under tight capital (even if 8% of “no risk” arbitrage is dare to try). When the Fed announced the results of the bank stress test in June 2019, it announced that “the financial system is still resistant”, which is hard to believe. In recent decades, the Fed has issued an alarming amount of US dollar debt overseas. They are not only unable to control these debts, but they cannot be measured with any degree of accuracy. The bank's financial statements also do not accurately reflect its financial status. No one really knows how much the solvency of the financial system is.

Auditors can't do anything about it, and the accounting profession has to take some responsibility for this issue. In June 2014, the US Financial Accounting Standards Board (FASB) updated the US Repurchase Accounting Standards (GAAP). The following is the case when the transferee (Party A) sells the collateral collateral to a third party (Party C):

  1. Party A owns US Treasury bonds, showing assets of $100;
  2. Party B borrowed the national debt and showed that the liability was $100 (a collateral worth $100 was sold but not yet purchased);
  3. Party C shows assets of $100.

If you add up the positions of the parties, there is no economic problem, because the net value of the two long positions and a short position is $100. But when you add up to three US-recognized financial statements, the problem arises. Both Party A and Party C report that they own the same asset (!). This balance sheet is because Party B recorded a liability, so the auditor will not find the problem. When the same bond is reused again and again in similar transactions, the degree of double counting in the financial system will be established in a way that no one can accurately measure.

Over the years, IMF economist Dr. Manmohan Singh has conducted an excellent assessment (examples are ( 1 ), ( 2 ), etc.).

Singh has been advising regulators over the years to adjust the financial stability assessment of big banks, and financial regulators should follow his advice many years ago!

What does this mean for the market in the short term? No one knows, but I suspect it will have a big impact (the repo market is flashing a red alert). Of course, the reversal of the repurchase can be mitigated in one of two ways: (1) the bank raises new equity capital, or (2) the Fed injects more dollars into the system. Yes, the runback in the repo market is really serious, because big banks are still over-reliant on buybacks, and a big mistake by the Fed may soon turn this trouble into hell. However, as always, the Fed will almost certainly adopt the measures it has consistently taken: injecting cash into the financial system in various ways, thereby causing losses to all dollar holders.

Bitcoin has better anti-fragility

If this topic makes you feel uncomfortable, this is normal. When I first realized this, I felt very uncomfortable. It was during the financial crisis, when I was working on Wall Street, then I thought Explore the causes of the crisis. The financial system is fragile, it is unstable, and it has always been the case. The situation in the repo market last week is not new. In fact, this is the fourth time since 2008.

At the system level, the traditional financial system is as fragile as Bitcoin.

And an anti-fragile system is a system that becomes stronger and more resistant with impact, rather than becoming weaker. This describes bitcoin, and its network security grows as the system's processing power grows.

Here I distinguish between price fluctuations and system fluctuations. Bitcoin price fluctuations are large, but as a system, it is more stable. In stark contrast to the traditional financial system, Bitcoin is not a debt-based system.

In this regard, Bitcoin is an insurance policy that prevents financial market instability. Bitcoin is not the lender of anyone (IOU), it has no final lender because it does not.

For me, Bitcoin represents autonomy, just as it provides an option that allows you to exit the traditional financial system. In view of the instability of the traditional financial system, despite the various disadvantages of Bitcoin, I found that it is still a strong concept.