Tags: Morgenson | repo | market | banks

NYT: Repo Market Might Cause Another Financial Crisis

By    |   Tuesday, 17 September 2013 08:18 AM

The repo market.

That's the crucial vulnerability in our financial system that could cause another financial crisis, some experts worry.

In fact, former FDIC chief Sheila Blair, New York Fed Chief William Dudley and Fed Chairman Ben Bernanke have all expressed concerns about the repo market.

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"Now $4.6 trillion in size, it is where almost every financial crisis since the 1980s has begun. Little has been done, however, to reduce its risks," writes New York Times columnist Gretchen Morgenson.

The repo market, also called the repurchase obligation or wholesale funding market, is the "plumbing" of our financial system, she notes Banks can finance their securities holdings cheaply, and money market funds can to put their cash to work by lending to banks and other financial players.

Banks and other financial institutions can sell their securities into the repo market with the promise they can be repurchased the next day. In practice, both sides constantly agree to roll over the deals rather than unwinding them the next day. If one party decides not to renew the transaction, there could be trouble. That's what happened to Bear Stearns and Lehman Brothers.

The problem is that the repo market is based on trust — which can disappear instantly in a panic.

Plus, just two banks, Bank of New York Mellon and JPMorgan Chase, now dominate the business, standing in the middle of repo deals as clearinghouses, Morgenson argues.

Some experts recommend creating a central clearing platform where all participants could trade directly, similar to platforms the Dodd-Frank Act mandated for derivatives, according to the Morgenson.

"While such an entity would be a 'too big to fail' institution, so are the two banks now serving as intermediaries," she explains. "And a central clearing platform could be set up as a utility, with officials monitoring transactions and requiring margin payments to finance bailouts in the event of a participant's default."

New regulations in the works would require banks to hold capital against assets they finance in the repo market. That could prompt them to shrink their repo operations, which could reduce liquidity of the Treasury debt.

Regulations have shrunk the repo market from $7.02 trillion in the first quarter of 2008 to $4.6 trillion daily outstanding, Bloomberg reports.

That declining liquidity could lead to higher borrowing costs, experts warn.

"Recent regulatory changes will cause dealers to reduce risk and to make markets less aggressively," Bruce Tuckman, a senior fellow at the Center for Financial Stability, tells Bloomberg.

"End users will lose some liquidity as dealers adjust to higher risk capital mandates, lower leverage limits, and increased margin requirements."

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The repo market. That's the crucial vulnerability in our financial system that could cause another financial crisis, some experts worry.
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2013-18-17
Tuesday, 17 September 2013 08:18 AM
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