Neil, I just discovered your page here, I'm having a blast going through all your previous posts. Right, so I started to read your paper with Mehrling and Grad (The evolution of last-resort...), but I got stuck in figure 1 there. (USD overnight rate spreads x fed funds): How come the treasury repo rate spiked below the fed funds? Can you expand a little bit on that? Thanks
That particular spike was a very important moment in the crisis. Repo rates spiked down because there was a sudden demand for high-quality collateral. Normally the substitution between collateral and money is very smooth, and the price of repo tracks the price of other short-term funding. But at that moment, early in the crisis, short-term funding was becoming illiquid. Dealers needed to borrow in the repo markets, which they had been doing against MBS collateral, but suddenly no one would accept it. There was a scramble for Treasury collateral, and if you had cash you could get Treasuries in the repo market. That is a reversal of the usual hierarchical structure, in which money is better than Treasuries: what it demonstrated was how important repo had become as part of the rise of market-based finance.
Neil, I just discovered your page here, I'm having a blast going through all your previous posts. Right, so I started to read your paper with Mehrling and Grad (The evolution of last-resort...), but I got stuck in figure 1 there. (USD overnight rate spreads x fed funds): How come the treasury repo rate spiked below the fed funds? Can you expand a little bit on that? Thanks
Hi Marcus, and thanks for reading!
That particular spike was a very important moment in the crisis. Repo rates spiked down because there was a sudden demand for high-quality collateral. Normally the substitution between collateral and money is very smooth, and the price of repo tracks the price of other short-term funding. But at that moment, early in the crisis, short-term funding was becoming illiquid. Dealers needed to borrow in the repo markets, which they had been doing against MBS collateral, but suddenly no one would accept it. There was a scramble for Treasury collateral, and if you had cash you could get Treasuries in the repo market. That is a reversal of the usual hierarchical structure, in which money is better than Treasuries: what it demonstrated was how important repo had become as part of the rise of market-based finance.
Hope this helps.
It's cristal clear now. I'll catch up with the rest of your readings here, thanks for doing this.