Fed opens its doors wider to repo trading

The Federal Reserve has assumed a much bigger role in a key funding market that has long been a prime component of the unregulated shadow banking system, reflecting central bank concerns that it poses a systemic risk.

The growing presence of the Fed, at the expense of established “dealer-banks”, is a stark shift for the repo market, where banks have historically pawned out their assets to lenders including money market funds, insurers and mutual funds, in exchange for short-term financing.

The loans help lubricate the wider financial markets, but a pullback in repo financing intensified the financial crisis of 2008. Now with the central bank taking a more central role in this crucial funding market, the shadow banking system stands to have greater official support during the next financial crisis.

A wave of financial rules and a new “reverse repo” facility provided by the Fed have combined to move repo transactions away from the biggest banks. The Fed began testing its reverse repo facility last September with investors and has subsequently increased its use.

The central bank’s reverse repo facility is designed to give the Fed greater control over short-term interest rates by lending out assets from its vast portfolio of securities to banks as well as non-banks such as money market funds.

While the Fed has 22 established primary dealers, the reverse repo facility has been extended to include 90 money market funds, a bulwark of the shadow banking system.

“The shadow banking system is such a large part of the market but the Fed’s not really designed for that,” says Scott Skyrm, a former repo broker who estimates that the Fed now makes up about 17 per cent of the $1.6tn tri-party market. “The Fed is opening its door a little crack just to let some of the shadow banking system in.”

Why Russia backs the gold standard?

Arkady Dvorkevich, the Kremlin’s chief economic adviser, said Russia would favour the inclusion of gold bullion in the basket-weighting of a new world currency based on Special Drawing Rights issued by the International
Monetary Fund.

Mr Dvorkevich said it was “logical” that the new currency should include the rouble and the yuan, adding that “we could also think about more effective use of gold in this system”.

The Gold Standard was the anchor of world finance in the 19th Century but began breaking down during the First World War as governments engaged in unprecedented spending. It collapsed in the 1930s when the British Empire,
the US, and France all abandoned their parities.

It was revived as part of fixed dollar system until US inflation caused by the Vietnam War and “Great Society” social spending forced President Richard Nixon to close the gold window in 1971.

The world’s fiat paper currencies have lacked any external anchor ever since. It is widely argued that the financial excesses and extreme debt leverage of the last quarter century would have been impossible – or less
likely – under the discipline of gold.

Russia is a major gold producer with large untapped reserves of ore so it has a clear interest in promoting the idea. The Kremlin has already instructed the central bank of gradually raise the gold share of foreign reserves to 10pc.

China’s government has floated a variant of this idea, suggesting a currency based on 30 commodities along the lines of the “Bancor” proposed by John Maynard Keynes in 1944.