Who Ran Out of Cash?

Who’s insolvent? One or more big financial companies have run out of cash to pay bills they owe.

A key interest rate (over night repo) spiked up this week, into the 5-10% range. Historically, this signals a panic in the money market. Some players were willing to pay up to get cash they needed right away.

The FED was forced into lending $75 billion (on collateral) in order to prevent a panic. It is still lending this amount over night for the 4th straight day. The FED says that it will continue doing this until Oct. 10 and after.

The FED is bailing out some players who have played it so close in chasing higher interest income that some loans have gone bad or payments have been delayed, and now they’re scrambling to get the cash to pay their own obligations.

One or more financial institutions ran out of cash! They could have been ordinary banks, primary dealers or investment banks. Someone didn’t receive the cash they counted on. The FED has moved into the breach.

Banks as a group are sitting on immense amounts of reserves. Reserves are cash. There are particular institutions, however, that need the cash at a particular time; and no one was ready and waiting to lend them that cash in the overnight market at a low rate like 2%. So rates spiked up.

Sooner or later, we’ll find out which institutions were troubled (insolvent). Blaming “technical” factors is not good enough, because the big guys know all the rules of this market. The fact is that some players drained their reservoirs of cash and ran out of money.

FED and government oversight has again failed to detect these insolvent players beforehand and stop them from running out of cash. The same thing happened in 2008. The system encourages players to borrow short and lend long and thereby raise their risks of insolvency. They know that the FED is their backstop in a pinch.

In the old days, cash mismanagement of this sort led to sharp interest rate spikes and liquidation of the weaker players.

This event tells us that the long expansion has reached a point where at least some players have fragile balance sheets. If they fail, it will weaken the balance sheets of stronger institutions. But even this event alone without any failures and with the FED’s emergency loans will cause greater caution among financial institutions.


2:40 pm on September 20, 2019