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Moody’s optimistic about tri-party repo reform

Moody’s analysts believe reform of the U.S. tri-party repurchase market now underway should substantially reduce a repeat of the bank runs that triggered the financial crisis of 2007 and 2008, according to a Financial Times report on a Feb. 22 teleconference by credit rating agency Moody’s Investors Service.

RepoWatch is trying to obtain a copy of the study presented by Moody’s analysts during the teleconference. Meanwhile, check out the story by The Financial Times, which obtained an advance copy.

In tri-party repo, J.P. Morgan Chase and Bank of New York Mellon act as clearing banks for repo transactions, providing such services as settling the transaction and valuing and managing collateral. In that role, they were Ground Zero for systemic risk in 2007 and 2008, in part because the mechanics of the transactions required them to extend trillions of dollars in credit daily to the repo borrowers.

Much of the government bailout in 2008 was a frantic effort by regulators to save the two mega-banks and the tri-party market from collapse.

In 2009, the New York Fed formed a task force to study ways to improve tri-party repo, which RepoWatch estimates represents about 25 percent of the U.S. repo market including all Federal Reserve transactions and many of the repos done by money market funds.

The task force, in its report issued May 17, 2010, recommended eliminating the intraday credit by October 2011. According to the Financial Times, the tri-party market now hopes 20 to 30 percent of the intraday credit will be gone by June, rising to 50 per cent soon after and approaching 90 per cent by August.

Moody’s said 19 percent of tri-party collateral, or $320 billion, is less liquid and more risky than conventional collateral like government bonds, according to the Financial Times. This is down from 30 per cent at the market’s peak in 2008. The risky and illiquid nature of so much collateral was the key reason for the credit panic and bank runs in 2008, regulators have said.

The task force issued 16 recommendations in its May report, but none will prevent the next run, and may even make it worse, the task force reported.  Its members said they tried to agree on a solution for panics, but they could not.

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