Repo-bits: Quick peeks at repo’s role in the crisis

The repo market lies hidden under so much of what happened in the financial crisis in 2007 and 2008. Only now and then does the public get a glimpse of repo’s role.

Consider these isolated repo-bits:

(1) “(John) Merriwether, who joined Salomon on the financing desk, known as the Repo Department, got there just as the bond world was turning topsy-turvy.”
–“When Genius Failed,” by Roger Lowenstein, 2000, page 8.

(2) “Ralph Cioffi spent several years creating CDOs for Bear Stearns and a couple of more years on the repurchase or “repo” desk, which was responsible for borrowing money every night to finance Bear Stearns’s broader securities portfolio.”
–The Financial Crisis Inquiry Report, 2011, page 8.

(3) “Virtually all trading today is financed in the market, through the repo or secured loan markets, so prop trading is hard to identify simply as being financed by a firm’s own money.”
–Roy C. Smith, professor of international business at New York University’s Stern School of Business, writing in Financial News March 7, 2011.

In other words: Two giants in the world of failed hedge funds got their training on the repo desks at leading investment banks. And why does that matter? Because almost all trading today is financed on the repo market.

In the very public discussions about the Volcker rule and whether banks should have to stop proprietary trading, do you remember anyone saying that the repo market was a big reason proprietary trading was so dangerous during the crisis?

Who are Merriwether and Cioffi?

–Merriweather founded Long-Term Capital Management, whose failure in 1998 nearly brought the world’s financial markets to their knees. What caused Long-Term Capital Management to fail? A key reason was a run on LTCM by its repo lenders, who stopped financing the hedge fund in the turmoil that followed Russia’s devaluation of the ruble and declaration of a debt moratorium on August 17, 1998.

— Cioffi founded the two Bear Stearns hedge funds that collapsed June 20, 2007, in one of the early signs of subprime panic. The two funds had borrowed money in the repo market and collateralized the repo loans with CDOs. They collapsed when their repo lenders stopped financing them.


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