Paid episode

The full episode is only available to paid subscribers of Capital Flows and Asset Markets


LCH has already had problems, but this time the Federal Reserve will struggle to bail them out

Most investors now understand how the LME bailed out its member caught short nickel. And hopefully investors can now understand how placing clearinghouses at the centre of financial systems actually reduces transparency. With that understanding, I am going to revisit the Repo market blow up, and explain how this was caused by LCH. This blow up required the Federal Reserve to bail out a number of hedge funds caught on the wrong side of the trade by intervening in the repo market. My best guess is that the hedge funds that got bailed out have doubled down on this trade, and without the Federal Reserve restarting QE soon, should lead to chaos in the repo markets and the LCH. I have talked about the repo market before, but as a brief cap, the middle chart below is form BIS shows how repo markets have become bifurcated, with banks on one side and hedge fund on the other.

In my view, and strongly corroborated by the joint press release issued by JP Morgan, Goldman Sachs and other members of LCH, was that hedge funds had become extremely leverage on spread trades in the treasury market, and the repo market disfunction in 2019 was driven by these fund being on the cusp of blowing up. The Federal Reserve stepping into do USD60bn of repo a day, essentially bailed out these funds.

This leaves three questions in my mind. How did the hedge funds get enough leverage to make the treasury market dysfunctional? Who are the hedge funds involved? And finally are they still doing it?

Watch with a 7-day free trial

Subscribe to Capital Flows and Asset Markets to watch this video and get 7 days of free access to the full post archives.

Issues with clearinghouses
Russell Clark