Collateral wasn't enough

Every day, dealers and other firms borrow over a trillion dollars overnight against Treasury securities in the repo market, mostly from money-market funds and banks. SOFR, the Secured Overnight Financing Rate, measures what those collateralized loans cost. The federal funds rate measures a different market with different participants: unsecured overnight loans, mostly from Federal Home Loan Banks to commercial banks. Normally the two rates sit close together.

On Monday, September 16, 2019, two things drained cash at once. Quarterly corporate tax payments were due, and $54 billion of newly issued Treasury debt settled, which dealers then had to finance in the repo market. Together they pulled about $120 billion of reserves out of the banking system over two business days, when reserves were already near their lowest level since 2012.

SOFR rose to 2.43% that day. On Tuesday it hit 5.25%, more than double the effective fed funds rate of 2.30%, which was itself above the top of the Fed's 2.00–2.25% target range. Lenders with cash were slow to move it into repo, held back by uncertainty about their own cash needs and by regulatory constraints.

The New York Fed stepped in that morning with its first overnight repo operation in a decade, offering $75 billion. Rates came down almost immediately. The FOMC cut its target range the next day, which is the step down in the green ceiling line, and in October began buying Treasury bills to rebuild reserves.

The central problem was access to cash, not the quality of Treasury collateral. The episode showed that money-market plumbing can seize up on its own, and it shaped the Fed's decision to keep more reserves in the system afterward.