I definitely think you’ve got the right idea suggesting that the increased demand could be a sign that bets are going bad. And when the other players in the market start getting wind of someone else’s unusually voracious hunger for cash, it could be that those other banks are reluctant to lend for fear they won’t get paid back. Of course, the Fed is always available if nobody wants to lend — and the banks are very aware of this.
The repo market’s routine transactions are built upon a stable relationship of trust and normally, the market is pretty tame as a result. It’s when institutions start side-eying each other that things get ugly. If lenders start to fear what is on the borrower’s balance sheet, that’s when liquidity starts evaporating.
Interestingly, when Bear Stearns fell, it was the repo market that initially spelled their demise. They were very prominent players in it . Some of the risky securities on their books started to sour and suddenly, the overnight funding started to dry up. No one wanted to lend because the counterparty risk was deemed too high. They really struggled to pull together repo funding just to get through the next day.
The repo market, I think, is kind-of overlooked as a source of economic unravelling. But the reality is, if banks can’t get their essential funding through the repo market, it starts to show, then public trust erodes, and things start to crumble from there. 2008 was evidence that conditions could start unraveling in the deceptively calm repo markets, which is why I think they’re worth keeping an eye on now!
Thanks for commenting :)