Glenn Beck alluded several times to the games being played by the Fed and the US Treasury, and he had a guest on who explained it away as “Oh, that’s a repo agreement – those are done all the time”.
I’ve heard of Repos before, but not really understood them. A Repo agreement is a two step transaction – the seller owns a bond (or other financial instrument) and agrees to sell the bond to a buyer, but with an additional requirement that the seller will buy back the bond at a future time at a fixed price. The only credit risk is if the seller is unable to buy back the bond in the future and the value of the bond has dropped, then the buyer has to resell the bond and eats any loss.
So how does this work in practice? Let’s say you’re a primary dealer for the New York Federal Reserve Bank (a securities firm that trades in US Treasuries and has a special relationship with the Fed).
Here is a scenario – the primary dealer currently has $1 billion in cash on account at the Federal Reserve.
The US Treasury holds an auction and sells $1 billion in Treasury bonds to our Security Dealer (let’s say it is Goldman Sachs, for example). GS transfers $1 billion to the US Treasury and gets $1 Billion in bonds. The US Treasury now has $1 billion more on account with the Fed (until they spend it).
GS now takes the $1 billion in bonds and enters into a Repo agreement with the NY Fed. It agrees to sell the $1 billion in bonds to the NY Fed, and agrees to buy them back at a later date. The NY Fed now adds $1 billion in bonds to its stockpile of Repo agreements, and puts the $1 billion back into GS’s Federal Reserve account. There is of course interest being paid and collected, and that’s accounted for in the pricing of the Repo agreeement.
So at the end of the transaction, the US Treasury has an extra Billion in debt and cash to spend, the Federal Reserve has temporary ownership of $1 billion in US Treasury debt, and GS is back pretty much to where they started, other than they probably make a nice profit on the deal – but the Fed didn’t actually buy any securities directly from the US Treasury.
It’s magic!
Here is the Fed’s explanation of Open Market Operations and how they use Repos and Reverse Repos to control the money supply. The writeup mentions that Repos are usually done for only a day at a time. How much money and debt is sloshing back and forth each night between the Fed and the Primary Dealers?
The Fed puts that information online weekly:
http://www.newyorkfed.org/markets/soma/sysopen_accholdings.html
about $1.6 trillion dollars….