The repurchase market was the lifeblood of investment banks in the run-up to the financial crisis of 2007 and 2008, and it was the loss of this funding that brought Bear Stearns to its knees in March of 2008, according to a new report from the International Monetary Fund.
Senior economist Ashok Vir Shatia writes:
“Bear Stearns provided the first warning that investment banking groups fully compliant with capital and liquidity regulations could nonetheless abruptly lose access to the short-term “repo” funding that was their lifeblood. Repo is a form of financing in which securities are sold for cash, often at a discount known as a ‘haircut,’ under agreements to repurchase at a price differential amounting to interest, often the next day. On Thursday, March 13, 2008, haircuts charged to Bear Stearns on its repo borrowing jumped sharply, effectively rendering the group illiquid.
“Until then, the secured nature of repo transactions had been thought to make such funding stable and reliable. With the benefit of hindsight, however, it became clear that even the repo market is vulnerable to sudden losses of confidence.”