FT: Fed plans revamp of tri-party repo

The Federal Reserve Bank of New York has recently created a task force to try to build a better plumbing system for the financial markets, the Financial Times reported October 23.

The focus of the task force’s work will be the tri-party repurchase market.

Progress in reforming the repo market will “say a lot about how serious the Fed and dealers are about reform,” writes reporter Michael Mackenzie.

 From the story:

At the heart of the global markets’ financial plumbing lies the repurchase or “repo” market. While it is an arcane topic, the repo market is similar to a person borrowing cash against the value of their home.

Beyond the current debate over bonus payments, restricting pay for bankers and regulating derivatives trading, reforming the repo market is where the rubber meets the road for regulators. …

Banks and investors use repo to borrow against a range of assets they hold and this type of funding was, and remains, a crucial source of liquidity and leverage underpinning financial markets. Such borrowing played a pivotal role in fomenting the financial crisis.

When risk-taking was ascendent investors accepted all types of collateral in return for lending money to banks. But, when the music stopped, investors only wanted Treasuries and nothing to do with riskier assets held by banks.

This was the moment the modern financial system collided with an iceberg as investors frantically pulled their money out of Bear Stearns. Several months later, this “run on the bank” via repo, engulfed Lehman and threatened other banks, given their strong dependence on funding their balance sheets via the repo market.

This, in turn, potentially threatened the two repo clearing banks, JPMorgan and Bank of New York Mellon, which act as custodians between investors and dealers in what is called tri-party repo.

What shocked the Fed at the time was the realisation that a cardiac arrest for a dealer could potentially spark the collapse of one of the two clearing banks and wreak havoc.