Overnight repos—shorthand for bond-repurchase agreements between banks and other financial institutions—have become a vital source of life support for the broader economy. Or at the least, as the Federal Reserve admits, these agreements play a “pivotal role in the normal functioning of the US financial system”—the dominant realm of capital today. Since its inception in 1913, the Fed has acted to mitigate capitalist crises, almost always favoring capital over labor. These days, repo markets are central to this work, a fact that highlights the vast scale of the financialization of the economy and the potential threat this poses to the capitalist system.
A repurchase agreement occurs when a commercial bank, such as Bank of America, sells some of its government bonds to a money-market fund like BlackRock to promptly secure liquid cash, with the agreement that the bank will later repurchase those bonds at a slightly higher price (a 1 percent repo interest rate on a $1 billion loan from BlackRock, for example, would require Bank of America to pay back $1.01 billion).
This is essentially a system of cash lending, mediated by the trading of bonds as collateral. Mess with the repo rate, and you are messing with what the Financial Times and Bloomberg call the “plumbing” of the economy.
That is exactly what the Fed has been doing in its aggressive effort to tamp down inflation. Practically all other interest rates follow downstream from overnight lending rates, as it has become central policy for the Fed to alter system-wide rates by way of overnight repos. Since March 2022, for instance, overnight lending rates have shot up to 5.25 percent, up from 0.5 percent, causing home-mortgage rates to jump nearly 140 percent and 100 percent for 15- and 30-year fixed-rate mortgages, respectively.
As a precarious academic, I couldn’t afford to buy a home even before this. But the same rate hikes are imposing other forms of pain on me and others in my class position. For instance, my credit-card company now charges me a 27.24 percent rate of interest on purchases, compared to 15.99 percent before April 2022. The new rate is so high and out of my control that, really, all I can do is laugh.
When the Fed moves to change interest rates, it is usually a little more complicated than just changing a percentage point in a computer system. Rather, the Fed likes to manipulate existing rates through what it calls “open-market operations,” which really just means it inserts itself into the “free” market by purchasing or selling bonds like any other participating financial institution. The Fed enters the overnight repo market when seeking to immediately change interest rates, and focuses on maturity bonds when seeking to influence them long-term.
Repos have the effect of quickly pumping cash in or out of financial circulation, where supply-demand logics then work to alter the interest rates, likewise in rapid fashion. As the Federal Reserve of St. Louis reports, the Fed enters the overnight repo market as a buyer or seller of bonds in order to “temporarily add or drain [cash] reserves available to the banking system and influence day-to-day trading.”
The Fed purchasing bonds to push money into the economy has the effect of lowering interest rates, whereas selling bonds to take money out of the economy tends to raise them. Since 2019, repos have been the Fed’s preferred tool to control circulation and steer the rate to its desired range (currently, 5 percent to 5.25 percent).
So why has the repo market come to play such an important role in the economy? It is the result of the growing disconnect between the real economy and the financial economy.
Marxist and heterodox economists have argued that the reliance on repos follows from capitalism’s gradual and inevitable degeneration: Unable to rely on extracting profit from the exploitation of labor in commodity production, the system must turn ever more frequently to the creation of fictitious capital through speculation, convoluted money-market activity, and credit-debt regimes. Overnight repo transactions are the oil that keep this speculative machine running, not to mention the whole economic system that now follows its lead.
Through this interbank lending process, somewhere between $4 and $5 trillion is moved every day, according to the Department of Treasury’s new Office of Financial Research. Prior to 2018, daily volume had never reached $1 trillion. In just five years, the role of interbank lending has ballooned significantly, as financial institutions facing systemically low liquid reserves have come to view repos as the quickest and safest way to get the cash they need for running regular client services. But dramatic shifts in the interest rates since early 2022 have caused financial institutions to run into funding troubles, calling into question the system’s long-term sustainability.
As the story commonly goes, after the 2008-09 financial crisis, the Fed set historically low interest rates, buying up long-term bonds and increasing its balance sheet, so that banks could take on short-term credit at incredibly cheap, near-zero cost.
Such “quantitative easing,” proponents argue, incentivizes investment into productive industry, spurring economic activity and thus increasing prosperity and opportunity for the general public. But in an era of slowing rates of industrial profit, the return on investment in commodity production tends to pale in comparison to what Big Finance can get from simply investing back into debt securities (such as government and corporate bonds) or the public stock market.
The trickle-down line of argument from system loyalists hardly matters right now, though, as the Fed began shifting policy in 2018. Even before the more dramatic change of course in March 2022, it was already turning to quantitative tightening and interest-rate hikes. True, when Covid lockdowns happened, the Fed had to inject money into both the financial system and real economy to save both from collapse. This momentarily kept the system afloat, but the quantitative easing on steroids quickly led interest rates back to near-zero.
The same kind of cheap-credit problems popped up, prompting the Fed to return again to tightening. Now, in July 2023, we are at a point where rates are the highest they have been since just before the 2008 financial crisis.
Continuing to raise rates could send a shock to repo markets, with trickle effects throughout the financial system, like what we witnessed with the Silicon Valley Bank collapse on a larger scale. As the Marxist academic Fabio Vighi notes, “SVB collapsed because it held a high volume of traditionally safe long-term Treasuries (US government bonds) that suddenly lost their value. As interest rates went up, the price of these bonds fell, making the bank’s debt exposure untenable and causing the bank runs.”
At the same time, transitioning to lower interest rates would go against the Fed’s purported objective to curb inflation and excess liquidity. Either way, we are left with 12 unelected “experts” on the Federal Open Market Committee to decide our fate.
Again, at the root of this dilemma is the increasing reliance on fictitious capital. It puts a huge amount of pressure on debt and speculative finance to be the new base for the system, allowing wealth to grow at the financial top without requiring the same for the economy, production, and meaningful jobs, leading to greater inequality and social and political crisis, not least the rise of populism on the right and the left.
The gap between real and fictitious capital that was already apparent before the Fed’s 2018 monetary-policy shift is best captured by the fact that the global derivatives market topped $1 quadrillion in 2017, compared to $75 trillion in “gross world product or the total value of goods and services produced worldwide,” according to sociologist William I. Robinson.
At a time when prominent corporations across a range of industries are reporting record profits, this may seem surprising. It isn’t much of a surprise to the Federal Reserve, though, which warned in September 2022 of the “coming long-run slowdown in corporate profit growth.” (Morgan Stanley likewise predicts a 16 percent earnings drop for S&P 500 companies, which have already seen declines for three straight quarters.)
This isn’t to suggest that we need to relitigate long-running Marxist debates about the tendency for the rate of profit to fall under capitalism. More important is the question of which mechanisms the state and capitalist class adopt—or what structural reconfigurations they pull off—to regenerate steady profits and conserve the capitalist ecosystem. Meanwhile, capitalism’s internal contradictions are only accelerating.