The bad thing that happened, of course, was the Covid-19 pandemic. To combat the economic carnage that came along with it, the Fed and U.S. government both pursued stimulus policies in order to safeguard the economy. For the central bank, that meant buying up Treasury and mortgage-backed securities from banks in exchange for reserves. The Treasury, meanwhile, issued a slew of bills to ensure it had enough cash on hand to cover stimulus programs that passed Congress. While the proceeds of the bill auctions were waiting to be spent, the amount of cash held in the Treasury’s account at the Fed soared to a record $1.83 trillion.
The Treasury’s cash pile has since shrunk to about $260 billion. But as that buffer receded, the money made its way into the financial system via bank balance sheets. Now, banks and money-market funds are sitting on a mountain of cash with very few places to put it. And because investors are all competing for the same assets, that has pushed yields on short-term paper — anything maturing in less than one year — close to zero or below. That makes the Fed’s reverse repo facility a more compelling investment for those who have access — even though it only pays 0.05%.
While Reddit’s fascination with reverse repo began in earnest in May, the facility was started in 2013 in an effort to prevent short-term U.S. interest rates from going below 0%, making it an essential part of the financial system’s plumbing. In anticipation of greater demand for the facility, the Fed boosted the size of the counterparty limit in March of this year — followed by a doubling of the cap in September — and made changes to counterparty eligibility criteria to make it more accessible.
The posters on Superstonk have followed along all the way, even though prophecies of financial doom have so far gone unfilled. “Well, we somehow got through October without the big market crash,” user “bahits” wrote on Oct. 29. “The longer they wait and kick the can, the bigger the splash.... or splat.''
How Does Overnight Reverse Repo Work?
The repurchase agreements drawing all of the social-media attention are basically secured loans, in which one party sells securities to another and agrees to buy them back in the future. When it comes to the Fed’s overnight reverse repo, eligible counterparties, such as money-market mutual funds and government-sponsored enterprises like Fannie Mae and Freddie Mac, purchase securities from the central bank and agree to sell them back the next day.
Here’s how it works. Every weekday between 12:45 p.m. and 1:15 p.m. New York time, eligible participants in the program submit propositions electronically to what’s known as the FedTrade system. They detail the amount -- in increments of $1 million and not exceeding $160 billion — that they want to invest in RRP along with a desired interest rate that doesn't exceed the specified offering rate, currently 0.05%.
Meme from Reddit
Then the total amounts are posted on the New York Fed’s website… and Reddit does its thing.
Such internal workings of the financial system like this are rarely discussed among stock-market investors. And because it’s a lubricant for the world’s financial system, people outside of this corner of the market only seem to pay attention when something breaks, like in September 2019, when a confluence of events pushed the rate for these overnight loans as high as 10%, forcing the U.S. central bank to intervene.
Yet as usage of the program began rising consistently, the Reddit user “pctracer” began posting the results each day, starting on May 26. To this observer, the swelling sums are “more an indicator of what’s going on and what we are going to expect. Numbers here are out of control, a very BIG crash is incoming.” The Reddit user said they began tracking the facility at the beginning of May when the National Securities Clearing Corp. proposed changing the frequency at which it may collect supplemental liquidity deposits in order to respond to liquidity shortfalls. It was around May 12 that pctracer noticed that a lot of stocks became correlated somehow, “and the RRP started being abused,” they wrote in a message. Pctracer, who declined to give his or her real name, added that they believe GameStop is a once-in-a-lifetime opportunity and "maybe even one in a millennium opportunity."
From there, the lore of the RRP took on a life of its own as usage of the facility continued to snowball, surpassing $1 trillion for the first time since its inception. For Reddit users trying to create some semblance of order in a universe that’s plagued by rising threats of inflation, supply chain disruptions and economic chaos, the reverse repo facility has become a blank screen for people to project their own ideas as to what the mammoth demand for the facility is signaling.