Liquidity Crisis: Wells Fargo & Repo Markets Sound Alarms

[...] Just like we saw QE 1 fatally morph from QE2-4 into “Unlimited QE,” we shall soon see fiscal policy 1 morph into unlimited “fiscal policy” at a nation-state near you; beginning, of course, with Biden et al.

But as we’ve said many times elsewhere, addiction—be it to monetary stimulus or fiscal stimulus—always ends the same way: One either quits or dies.

Again, even the bankers and a small handful of brain-celled politicos know this, which is why we are starting to see signs of a genuine hangover (i.e., liquidity crisis) in our artificial yet liquidity-addicted financial system.

As for these flashing warning signs, let’s just consider two recent tremors percolating below our feet: 1) Wells Fargo and 2) the reverse repo market.

1. Wells Fargo Welches in Panic

We’ve given many prior warnings regarding the objective evidence of banking risk in the global financial system, and despite Basel III’s virtue signaling, we also warned that those risks were anything but “transitory.”

In fact, even the big boys in the big banks are getting nervous—as well as ahead of—the financial crisis they see coming after years of benefiting almost exclusively from a credit binge which they themselves engineered.

In short, the liquidity they once relied upon is drying up.

Thinking always of themselves first and clients second, Wells Fargo just announced that they are permanently suspending/closing all personal lines of credit (from $3k to $300K) in the coming weeks.

Yes. That’s kind of a big deal…

Wells Fargo is effectively confessing that they are worried (seriously worried) about inevitable credit/loan defaults on their consumer credit lines for which they charge interest at anywhere from 9% to 21% (and who thought usury was dead?).

Why the sudden change of heart at that oh-so generous bank?

Because Wells Fargo is worried about a crisis ahead—namely a liquidity crisis.

Nor is Wells Fargo alone. Many insider businesses (i.e., publicly-traded fat cats) who benefit from the best loan terms and unfair capital access are taking on less debt.

Why?

Because their massive debt exposures have just gotten too big to ignore, and they have no choice but to borrow less rather than more.

Of course, less borrowing means less lending, and less lending means tightened credit, and tightened credit means a credit crunch (i.e., liquidity crisis), and a credit crunch in a world/market addicted to credit (i.e., debt) means ”uh-oh” for risk assets like stocks, bonds and real estate.

Meanwhile, as Wells Fargo hunkers down for the pain ahead, JP Morgan, one of the smartest insiders in the entire (rigged) banking system, is beginning to carefully hoard and stockpile cash ($500B) and moving more to the safety of short-term bonds.

Why?

Well, they’d like to have some dry-powder when risk assets tank and rates rise, for the best time to buy is when there’s blood in the streets; and the best time to lend is when inflation and rates are rising, not falling.

But more to the point, JP Morgan (like Wells Fargo) sees a liquidity crisis on the horizon…

But what suddenly tipped them off?

Let’s talk about the Reverse Repo market…

2. The Reverse Repo Market—Banks Losing Trust in Each Other

Signals from that esoteric (and hence media-misunderstood) corner of the banking system known as the repo market have been making neon-flashing warning signs.

Traditionally, the reverse repo market is where banks went to borrow from banks, typically offering collateral (US Treasuries) for some short-term liquidity—i.e., money at low rates.

But in September of 2019, those rates spiked dramatically for the simple reason that banks began distrusting each other’s credit risk and collateral. That’s a bad sign.

What is happening now is that the Fed, rather than the commercial banks, are taking a much greater role in back-stopping this increasingly fractured intra-bank repo (credit) market.

And unlike retail clients paying double-digit rates for credit lines, the Fed has lifted the interest (IER) they pay to banks (no shocker there) as banks are parking more money at the Fed where they are exchanging cash for Treasuries in a now unignorable flight to safety.

As a result, the repo market has skyrocketed as banks are parking nearly $1T per day at the Fed, which is 3X the normal operational amount.

This is a screaming sign of counter-party risk among the banks themselves, whose last hope is the Fed, not each other.

And why are the too-big-to-fail banks looking for low-rate handouts and T-bills from these grotesquely bloated (and Fed-supported) repo markets?

Because they see a crash coming and are bracing for the transition from credit addiction to financial crisis—i.e., less “liquidity” to grease the broken wheels of an overheated credit system.

Risk Assets Facing Real Risk

What does this mean for the great inflation-deflation debate?

Well, a liquidity crisis is never good for risk assets like stocks, which will see a price decline and hence “deflation;” but don’t confuse that with the real-world notion of inflation—namely rising prices for the things most mortals need to live.

As more banks are swapping T-bills as collateral from the Fed rather than each other for cash, this means massive amounts of money (“liquidity”) is coming out of the system.

The money markets are moving alarming amounts of dollars to the Fed, which means bank reserve accounts are moving from the banks to the Fed itself; this, in turn, means less bank reserves and hence less bank lending—i.e., a credit tightening rather than credit binging.

Such reduced “liquidity,” as mentioned above, is a very bad omen for risk asset markets. (read more)