Global wholesale money markets trade upwards of $4 trillion per day across the tri-party (cleared) setment of the repo market and the bilateral OTC (non-cleared) segment of repo. Often described as the “plumbing” of the financial system, money markets provide short-term lending to banks and nonbank financial institutions. Originally designed for lending amoung commerial banks, repo has broadly expanded to include “shadow banks” of the financial system–the unregulated hedge funds, private equity and debt funds.

When money markets experience distress, that distress reverberates throughout the entire financial system, creating large losses in equity and debt markets. To minimize the risk of large losses related to money markets, a tremendously important factor is is whether unregulated money market lenders retain faith, or are losing faith, in prevailing hedge fund or private equity  (shadow bank) strategies.

Hedge funds and private equity/debt funds are the largest consumers of money market funds. Therefore, leveraged hedge fund strategies have an enormous impact on market liquidity and stability. Virtually every hedge fund uses money markets (nowadays, the repo markets) to borrow short and invest long. If hedge funds and private equity/debt funds are unable to access the money markets, longer term investments that depend on money markets for initial financing and roll-over refinancing can evaporate, causing significant market distress. Large losses in correlated investments naturally follow.

Even though repo lender sentiment can change rapidly, there are always warning signs. In Sept. 2019, the warning signs were CRE turmoil brought on by insolvency of WeWork. In 2007, the warning signs were massive mortgage defaults after unaffordable interest rates reset on variable-rate loans. There are always warning signs for those who look carefully.