Gallery

Obama plan barely mentions repos

Obama

Obama

The Obama Administration barely mentions repurchase agreements in its long-awaited plan to reform financial regulation issued June 17.

Repos finally make an appearance on page 51, and they’re not heard from again in the 88-page report, even though the report admits that the systemic risk feared by regulators in 2007 and 2008 was repos and credit default swaps.

When major financial institutions came under significant financial stress during 2008, policymakers were extremely concerned that weaknesses in settlement arrangements for certain financial transactions, notably tri-party repurchase agreements and OTC derivatives, would be a source of contagion.

Instead, “A New Foundation, Financial Regulatory Reform, Rebuilding Financial Supervision and Regulation” makes recommendations on mortgages, derivatives, futures, securitization, insurance companies, capital and liquidity requirements, big banks, accountants, affiliates, thrifts, interstate branching, bank holding companies, industrial loan companies, hedge funds, private equity funds, venture capital funds, money market funds, Fannie Mae and Freddie Mac, credit rating agencies, payment systems, consumer protection, arbitration clauses, Federal Trade Commission, investment advisors, prospectuses, whistleblowers, executive compensation, automatic IRAs, retirement, and international regulatory standards.

Everything on anyone’s wish list is there.

No wonder Americans aren’t clear on what happened in 2007 and 2008. 

Here’s the main thing that happened to force the taxpayer bailout:  Repo lenders stopped lending because they were concerned about the quality of their collateral, a large chunk of which was mortgage-backed securities. Bankers couldn’t get repo loans. The value of the securities fell. People who used credit default swaps to bet on the securities won or lost their bet. Credit froze.

The Obama plan says it’s terribly hard to reform the repurchase market. Its proposed solution: Put the Fed in charge.

From the Obama report:

D. Strengthen Oversight and Functioning of Systemically Important Payment, Clearing, and Settlement Systems and Related Activities

We propose that the Federal Reserve have the responsibility and authority to conduct oversight of systemically important payment, clearing and settlement systems, and activities of financial firms.

A key determinant of the risk posed by the  interconnectedness of financial institutions is the strength or weakness of arrangements for settling payment obligations and financial transactions between banks and other financial institutions. Where such arrangements are strong they can help guard against instability in times of crisis. Where they are weak they can be a major source of financial contagion, transmitting a financial shock from one firm or market to many other firms and markets.

When major financial institutions came under significant financial stress during 2008, policymakers were extremely concerned that weaknesses in settlement arrangements for certain financial transactions, notably tri-party repurchase agreements and OTC derivatives, would be a source of contagion.

For several years prior to 2008, the Federal Reserve had worked with other regulators and market participants to strengthen those arrangements. In the case of CDS and other OTC derivatives, significant progress was achieved, notably the cessation of unauthorized assignments of trades, reductions of backlogs of unconfirmed trades, and efforts to compress portfolios of outstanding trades. Still, progress was slow and insufficient.

Progress in strengthening payment and settlement arrangements is inherently difficult because improvements in such arrangements require collective action by market participants. Existing federal authority over such arrangements is incomplete and fragmented. In such circumstances, the Federal Reserve and other regulators have been forced to rely heavily on moral suasion to encourage market participants to take such collective actions.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s