Cryptocurrency for Beginners: with Crypto Casey

Can Fed Prevent Crypto Collapse? (Bullish Again?)

August 02, 2021 Crypto Casey Season 2021 Episode 31
Cryptocurrency for Beginners: with Crypto Casey
Can Fed Prevent Crypto Collapse? (Bullish Again?)
Show Notes Transcript Chapter Markers

In this video we discuss breaking news this week about the expansion of repo operations that may give the FED the ability to prevent a cryptocurrency market crash. The question is can they do and will they do it if the need arises?

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Has the Fed come to the rescue? Have they implemented something that could prevent a crypto collapse from happening?

Hello, I’m Crypto Casey and in this video we are going to discuss something that transpired just this week that has me pivoting from my short term bearish outlook to a more bullish one.

If you haven’t checked out my three-part video series explaining why I’ve had a bearish outlook on crypto in the short term, click on the link to watch video one where I break down the current structure of the financial system, and more specifically the reverse repo market.

Awesome. So let’s discuss how the Fed may have done something that could ease a crypto crash or prevent one from happening all together.

Let’s hit it.

Okay, let me go ahead and preface this video with the fact that I could be completely wrong in my interpretation of the events we will discuss.

However, it could be plausible and makes sense especially considering the timing of it all.

This past Wednesday on July 28th, the Federal Reserve released a statement regarding reverse repurchase agreement arrangements.

Let’s do a quick recap together on what reverse repurchase agreements are and current activity in the reverse repo market.

Basically, there is a massive excess of cash in the financial ecosystem and not enough pristine collateral like US treasury bonds.

Without enough collateral in the financial ecosystem, big banks are choosing to park large amounts of cash overnight with the Federal Reserve in exchange for US treasury bonds.

Why would banks rather park excess cash with the Federal Reserve than lend it out at far  more favorable rates? Well, because there is too much risk in the markets right now, as most entities that need loans: do not have sufficient collateral to secure the loan, are on the brink of insolvency, 

or the US treasury bonds they do have are rehypothecated, meaning no one knows who actually owns a particular US treasury because financial institutions are allowed to list a one single US treasury bond on multiple balance sheets simultaneously. 

And before we get into the Fed’s announcement, it’s important to understand that there only a select few banks deemed eligible counterparties to engage in reverse repo agreements *directly with the Federal Reserve. 

Outside of parking cash directly with the Fed, other financial entities can choose to park cash directly with major central bank facilities. 

And there is so much demand in the reverse repo market that, just this week: 1 - a Cash Flood Drives Use of Fed Reserve Repo to Record $1 Trillion Dollars

2 - An overabundance of cash in U.S. interest-rate markets has for the first time ever pushed the amount that investors are parking at a major central bank facility to more than $1 trillion.

Eighty-six participants on Friday placed an unprecedented total of $1.04 trillion at the Federal Reserve’s overnight reverse repurchase facility, in which counterparties like money-market funds can place cash with the central bank. That surpassed the previous all-time high volume of $991.939 billion from June 30, New York Fed data show.

So as systemic risks to the entire financial system at large continue to mount with lack of sufficient collateral, mass rehypothecation of US treasury bonds, 

inflation of prices of goods and services, formation of asset bubbles, artificially propped up valuations in the stock market, impending real estate foreclosures, the metastasized cancer within the cryptocurrency market also known as Tether, just a ton of crazy things in flux - 

It’s no surprise that in response, the Fed made a move.

3 - The Federal Open Market Committee on Wednesday announced the establishment of two standing repurchase agreement (repo) facilities—a domestic standing repo facility (SRF) and a repo facility for foreign and international monetary authorities (FIMA repo facility). 

These facilities will serve as backstops in money markets to support the effective implementation of monetary policy and smooth market functioning.

So basically, the Fed is setting up two permanent repo facilities, a domestic one for the United States market and one for international markets.

Let’s break down what this means, or at least the way I interpret it. Any financial entity that needs cash, that currently isn’t able to secure a loan from banks for aforementioned reasons, if they set up an account with the Fed, the Fed will take whatever collateral they have, and provide them with the cash they need.

Check it out: 4 - Under the SRF, the Federal Reserve will conduct daily overnight repo operations against Treasury securities, agency debt securities, and agency mortgage-backed securities, with a maximum operation size of $500 billion. 

Counterparties for this facility will include primary dealers and will be expanded over time to include additional depository institutions.

So, thinking back to my video explaining the structure of the current financial system, we all know that in general, most US treasury securities in this realm among these entities are rehypothecated, 

agency debt securities which are less salient types of collateral than even rehypothecated treasuries, and mortgage-backed securities… in the midst of the longest running rent/mortgage/eviction moratoria ever? 

Yeah, basically the Fed is willing to accept trash collateral that banks aren’t touching to provide cash to a larger amount of entities in the greater financial system, obviously to lessen the severity of a systemic collapse or avoid a potential collapse altogether by facilitating a slow bleed out situation.

So just to be clear, this would be an extension of the repurchase agreement market. Not reverse repo. Because again, if we remember from my previous video, a reverse repo is just the other side of a repo.

So instead of a reverse repo situation that would be these entities parking money with the Fed, they are able to engage in regular repo activity, where they park collateral with the Fed in exchange for cash, borrowing cash. 

Whoever is taking cash, it’s a repo for them because they are promising to repurchase collateral at a later date plus interest. Whoever is taking the collateral, it’s a reverse repo for them.

This is where it gets strange. Because, if we think about the crazy demand for reverse repo agreements, it suggests there is way too much cash and liquidity in the markets. Banks would rather have collateral than hold all this excess cash.

So why would the Fed create permanent domestic and international repo operations? Well, as we pointed out earlier, there is too much counterparty risk for major central banks to lend cash to entities that make up the greater financial system.

So basically, big banks have too much cash, while all other entities are cash-starved and need liquidity. Instead of going through banks unwilling to lend, they will be able to get cash directly from the Fed.

An example to further illustrate the perspective of big banks with excess cash, imagine you personally have a $100 million dollars cash lying around, and some random person that you know for a fact will not be able to pay you back, asks to borrow $10,000.

Even though you have the money, you’re probably not going to do it, unless you’re just giving it away as charity because the risk is too high.

So why would they set this up Wednesday, July 28th of all days? Strange, but could it have something to do with what happened July 27th, the day before?

5 - Tether and Facebook Coin Spur Worry at Yellen’s Closed-Door Meeting

6 - Tether and the Facebook Inc.-backed Diem token were a main focus of a recent meeting U.S. regulators held on the financial risks posed by stablecoins, a fast-growing corner of the cryptocurrency industry, said people familiar with the matter.

The President’s Working Group on Financial Markets, a team of watchdogs led by Treasury Secretary Janet Yellen, was particularly concerned about Tether’s claims that it holds massive amounts of commercial paper -- debt that companies issue to meet their short-term funding needs, the people said. 

Participants likened the situation to an unregulated money-market mutual fund that could be susceptible to a chaotic investor exodus, said the people who asked not to be named because the meeting was private.

The past month or so, stablecoins have been in the spotlight and for a good reason. If you haven’t yet, check out video two of the three part series where I breakdown the current structure of the cryptocurrency markets.

I agree with what Eric Rosengren, president of the Federal Reserve Bank of Boston voiced a month ago, identifying Tether and other stable-value tokens as a risk to the financial system.

7 - The systemic role stablecoins play in crypto trading and lending has caused some investors to worry about worst-case scenarios, such as what could happen should stablecoins issuers face massive redemption requests. 

The risk could also spill over to the traditional markets. The credit ratings firm Fitch said in a report earlier this month that risks facing stablecoins are potentially “contagious.” 

So since Tether’s first audit, released this past March of 2020, stablecoins have been the talk of the town and for a good reason.

Let’s talk about how the Fed’s setting up permanent repo operations to serve both domestic and international markets could potentially be an attempt to prevent a collapse in the stock market, credit markets, housing markets, and, our pride and joy, the cryptocurrency market.

On one hand, the Fed could be taking a wild, random guess at what would help the current market stay afloat, and when you look at increased demand for reverse repo operations, why not set up a wider, more inclusive repo operation.

Let’s read further through the Fed’s statement about providing repo services to international markets: 8 - Under the FIMA repo facility, the Federal Reserve will enter into overnight repurchase agreements as needed 

with foreign official institutions against their holdings of Treasury securities maintained in custody at the Federal Reserve Bank of New York.  

By creating a temporary source of dollar liquidity for FIMA account holders, the facility can help address pressures in global dollar funding markets that could otherwise affect financial market conditions in the United States.

Interesting how they’re setting up a *permanent repo operation that would create *temporary sources of liquidity. Like they do now with not even bothering to move the US treasury bonds from their balance sheets to other entities’, it will likely just roll over indefinitely in most situations in this crazy global economy.

Also, note they say an international repo facility can help address pressures in global dollar funding markets that could otherwise affect market conditions in the US.

Who could be short on dollars overseas that could affect the US markets? Cough cough. Binance. Cough Bitfinex. Cough Tether?

So the Fed set this up so they could provide liquidity to otherwise uncreditworthy entities that need cash. This could be a wide range of businesses and entities, even outside of the financial system, like companies that produce real goods in the economy.

Did they set this up because of the terrifying situation with Tether being so massive and pervasive in the crypto markets? Or did they do it because a lot of things in the global financial system could go bust?

At the end of the day, the Fed set this up for one obvious reason: to keep any entities on the brink of insolvency from going bust.

Let’s think about it. If there was a run on exchanges, could the Coinbases, Binances, Bitfinex’s, and even Tether Limited’s of the world use these new repo operations to prevent massive liquidity issues and ultimately a severe crash? The way I read it and interpret it, theoretically, yes.

Does this solve the problem? Absolutely not. But it would be doing what the Fed is actually a bit competent at: kicking the can down the road.

Best case scenario, an all out crash is completely evaded, worst case scenario: it doesn’t. Next best scenario is that it allows for a slow, careful extraction of the Tether’s of crypto and a seamless replacement of more trustworthy, transparent ones.

However, this could unfortunately allow centralized fed tokens to take over, which would negate the whole point of decentralized blockchain technology and cryptocurrency as far as creating a new, fair global financial system.

Again, I could be completely misinterpreting the institution of permanent global repo operations, but time will tell. And if it would serve to provide liquidity to crypto markets in the event of a run on exchanges or if tether goes bust, 

then I’m inclined to feel more bullish about the short term price movements than I have been feeling the past few months. 

As usual, I will continue to monitor the situation and keep you guys updated as more information comes to light. 

In the meantime, YouTube is cracking down extremely hard on crypto content channels, so be sure to use the links in the description area below to follow my other accounts and subscribe to my email newsletter to keep in touch in case this channel becomes a target.

Awesome. Well, I hope you found the content interesting and feel a bit more at ease after this video than my recent series.

If you enjoyed the content, please make sure to like this video and subscribe to my channel for more crypto content. 

So what do you think the Fed is hoping to achieve with these new repo operations?

Do you think they had the Tether situation in mind?

Or do you think they would let the crypto market go bust if things went awry?

Let me know in the comments below.

Be safe out there.

I Could Be Wrong...
Federal Reserve Announcement
Reverse Repo Market
Reverse Repo Activity Over $1 Trillion
Federal Reserve Made a Move
What Expansion of Reverse Repo Operations COULD Mean
Repo Versus Reverse Repo Agreements
Why is the Fed Doing This?
What Happened the Day Before?
Can the FED Prevent a Global Market Crash?
Which International Entities Could Affect US Markets?
Could this Prevent a Crypto Collapse?
Potential Scenarios