Why the 2019 Repo Shock Happened and Whether It Could Happen Again

The repo market is the financial system’s plumbing, a multi-trillion-dollar market where banks, hedge funds, and dealers lend cash in exchange for collateral. In September 2019, this plumbing suddenly clogged, sending short-term borrowing rates spiking from 2% to 10% in a matter of hours. Take a look at the Secured Overnight Financing Rate (SOFR) for the month of September 2019:

Today, many of the underlying structural pressures that led to the 2019 crisis have returned, but with one critical new safety valve installed by the Federal Reserve.

What Really Happened in September 2019?

The 2019 spike was not caused by wild panic or an economic recession; it was caused by rational, regulation-driven behavioral gridlock:

A Perfect Storm Drained Cash: A major corporate tax deadline and a surge in U.S. Treasury debt auctions pulled over $150 billion in cash out of the banking system in just a few days, right as the Fed was winding down its bond holdings (Quantitative Tightening, or QT).

Dealers Needed Cash: Wall Street primary dealers were flooded with new Treasury bonds and urgently needed overnight cash to finance them.

The “Hoarding” Paradox: The four largest U.S. banks held plenty of cash, approximately $1 trillion at the Federal Reserve. Normally, banks would eagerly lend that cash into the repo market to earn high interest. However, they refused to lend even at 10% return.

Why Banks Held Back: Internal risk rules and post-2008 banking regulations (such as resolution liquidity rules and strict leverage limits) required bank treasurers to keep a hard minimum cash buffer directly at the Fed. Crossing below that limit would trigger regulatory alarms.

The combination of all these factors led to what is called a “fallacy of composition”. In other words, each bank acted rationally by protecting its own cash cushion, but their collective refusal to lend caused the entire overnight lending market to freeze until the Fed stepped in to provide cash directly.

Are We At Risk Today?

Today’s financial plumbing exhibits several unmistakable similarities, along with a few vulnerabilities:

Vulnerability Driver	What Happened in 2019	What is Happening Today
Fed Balance Sheet Run-Off (QT)	QT had been draining excess cash down to a critical tipping point.	QT and massive U.S. Treasury debt issuance have drained the Fed’s cash buffer (Overnight Reverse Repo Facility) from $2.5 trillion to near zero. Questions remain, however, whether reserve levels have fallen enough to approach banks’ minimum comfort level.
Record Supply of Treasury Bonds	Heavy Treasury issuance clogged dealer balance sheets.	Multi-trillion-dollar federal deficits are forcing dealers to warehouse even larger volumes of government debt.
Hedge Fund Leverage (The Basis Trade)	Present at moderate levels	An estimated $1.2 trillion Treasury cash-futures “basis trade” relies on overnight repo borrowing, creating a massive daily demand for cash. And in a period of constrained balance sheets and insufficient cash supply, we’ll likely see a severe funding crisis.
Bank Caution on Cash	Banks guarded cash due to regulatory requirements.	Following the 2023 regional banking turmoil (e.g., Silicon Valley Bank) bank treasurers may be more cautious about maintaining ample liquidity buffers.

While the pressures on overnight cash are just as high today as in 2019, the Federal Reserve introduced a safety valve in 2021 by what is called a Standing Repo Facility (SRF), which allows primary dealers and banks to exchange Treasuries for cash directly from the Fed at a pre-set maximum rate.

Conclusion

The transition toward tighter reserves, combined with massive government bond supply and leveraged hedge fund demand, increases the likelihood of generating periodic volatility and upward pressure on short-term rates. As 2019 demonstrated, having hundreds of billions in cash across the banking system does not guarantee that cash will flow where it is needed, especially when regulations penalize banks for deploying it.

While the Fed’s SRF should mitigate extreme spikes (like the 10% clip we saw in 2019), non-bank financial players (like hedge funds) cannot access the facility directly. I suspect pressure will eventually mount to broaden liquidity access beyond traditional banking institutions. If such support ultimately requires a significantly larger Federal Reserve balance sheet, concerns about long-term dollar purchasing power could become increasingly relevant.