From the editor:
The main reason world finance officials want to prevent Greece from defaulting on its debt is the same reason U.S. officials bailed out the investment banks in 2008: To prevent a credit crisis on the repurchase market.*
Here’s the issue in Europe: Many European banks hold Greek debt, and the European Central Bank (ECB) is the main lender still willing to accept Greek debt as collateral for repo loans. But the European Central Bank has said it will stop accepting the Greek debt if Greece defaults.
This would slash credit to European banks, it could cause the Greek banking industry to fail, and it could trigger a worldwide credit panic like the one U.S. officials struggled to overcome in 2008.
You wouldn’t know this by reading The New York Times, the Wall Street Journal or Bloomberg News, who go out of their way to avoid mentioning the r-word (repos). Fortunately, the UK’s Financial Times does write about the important repurchase market, which it described January 10 as:
… the flow of money that is the lifeblood of the financial system.
That story even put the r-word in the headline:
Reliance on ECB fuels repo debt worries
The U.S. press’s omission matters, because an informed public needs to understand that at the root of the 2011 Greece crisis and the 2008 U.S. crisis is a fundamental flaw in the structure of world finance: The $7 trillion U.S. and European repurchase markets, which financial institutions use to create credit and central banks use to execute monetary policy, are vulnerable to runs and so interconnected that they’re the epicenter of systemic risk worldwide.
Of course, in today’s interconnected world there are other markets and structures vulnerable to systemic risk, such as derivatives including credit default swaps, unsecured and asset-backed commercial paper, securities lending, money market funds, off-the-books securitization trusts, insurers. and the stock and bond markets.
But repos play the most important role in world finance, and they can be the drivers of a dangerous contagion. For example, in the 2008 U.S. crisis, spooked repo lenders began rejecting many kinds of collateral, not just subprime mortgage securities. Today one fear is that repo lenders will begin rejecting the sovereign debt of other countries, not just Greece. As we learned in 2008, this kind of run on the repo market can become a crippling credit crisis within hours.
I’m proud of the work we business journalists do, covering complex topics in a world where people don’t have to tell us a darned thing, unlike political reporters who have Freedom of Information laws to help them. But our blind spot for repos is preventing Americans from having a clear picture of the dangers in the financial markets.
That said, I realize I don’t see every story. If you see a repo story by mainstream business journalists, I hope you will let RepoWatch readers know.
Following are some examples of ways press coverage of the Greek crisis has shortchanged readers:
In writing about the Greek crisis, The New York Times trained its big guns on credit default swaps, not repos. Here’s the lead on a June 22 story:
It’s the $616 billion question: Does the euro crisis have a hidden A.I.G.?
That’s an important question, but it’s an odd one to ask without first dissecting the risk on the repurchase market. RepoWatch asked the New York Times reporter and her editor in a June 28 e-mail to do a story about the repurchase market, but the journalists did not reply.
According to the article, the struggle to find a way to avoid a Greek default is driven by derivative fears:
The pervasiveness of these opaque contracts has complicated negotiations for European officials, and it underscores calls for more transparency in the derivatives market.
The uncertainty, financial analysts say, has led European officials to push for a “voluntary” Greek bond financing solution that may sidestep a default …
A week later the New York Times looked at money market funds, asking whether U.S. investors in money market funds that lend to European banks could get hurt by the Greek crisis.
That, too, is an important question, but the June 28 story does not explain that a key reason European banks might not be able to repay money market funds is if they can’t get the money they need from the European Central Bank.
Instead, the reporter writes:
… the fear of a default could potentially set off turmoil across the world’s financial markets.
If that happens, analysts say, Greek bond yields would jump. The euro and stock markets would fall. The cost of lending between European banks might potentially spike as banks doubt one another’s creditworthiness.
Check out how the New York Times buries repos in its July 4 story, “Europe faces tough road on effort to ease Greek debt.” In paragraph 5, the writer describes the dangers of default:
European leaders are trapped between domestic political demands for banks to share the cost of a Greek bailout, and the dire consequences of a default. These would include the collapse of Greek banks, probably followed by the collapse of the Greek economy and Greece’s exit from the euro zone.
A crisis in Greece could quickly spread to European banks, particularly in France and Germany, which own government bonds or have lent money to Greek individuals and businesses. Ratings of French banks have already suffered because of their vulnerability to the Greek economy. And once the precedent of a euro zone default had been set, investors would likely abandon the debts of other struggling members, including Portugal and Spain. More worryingly, a tower of credit default swaps — a form of debt insurance typically sold by investment banks — has been built on the debts of those countries, and the cost of paying up in a default would be huge.
In paragraph 11, the writer continues to fret over credit default swaps:
Europe is seeking to avoid a default at all cost because it could also initiate payment of credit-default swaps, with unpredictable results. There is little public information on which financial institutions have sold credit-default swaps and might have to absorb losses if Greece defaulted, but it is likely that American banks and insurance companies have taken on the largest share.
The shock to the global economy might compare to the collapse of Lehman Brothers in 2008, the European Central Bank has warned. …
The writer finally gets to the repurchase market – without using the r-word, of course – down in paragraph 19:
A serious problem is how to prevent a collapse of Greek banks if the country is declared to be in default.
Greek banks, cut off from international money markets, use their holdings of domestic government debt as collateral for cheap loans from the European Central Bank. If Greece defaulted, the European Central Bank could probably no longer accept the debt as collateral.
The Wall Street Journal and Bloomberg News also rarely use the r-word, which means their readers do not see how the 2011 Greek crisis and the 2008 U.S. crisis are similar.
From the July 2 Wall Street Journal:
ECB officials have warned that Greek debt will be rejected as backing for the ECB loans that are crucial to that country’s banks.
ECB officials have left little if any room for compromise on Greece, saying their rules forbid them from accepting Greek government bonds as collateral under a default, an action that would throw the Greek economy into turmoil and threaten the rest of Europe.
From the July 5 Wall Street Journal:
…some European officials have admitted privately that they have been discussing ways of handling the impact of a default declaration. Chief of their concerns is the reaction of the European Central Bank. ECB officials have repeatedly warned they won’t accept Greek government bonds as collateral for loans under a default or selective default, a scenario that could lead to a collapse of the Greek banking system.
From a July 4 Bloomberg News story:
Standard & Poor’s said today a rollover plan serving as the basis for talks between investors and governments would qualify as a distressed exchange and prompt a “selective default” grade. That may leave the bondholders unwilling to complete the transaction and the European Central Bank unable to accept Greek government debt as collateral, impairing the lifeline it has provided the country’s banks.
The Greek trauma has exposed another shortcoming in press coverage of the financial markets: The role of money market funds in the U.S. crisis of 2008 and the Greek crisis of 2011.
The New York Times’ June 28 story about money market funds was one of several by the business press about the risk the Greece situation may pose to people who keep money in money market funds. The stories usually cited a June 21 Fitch Ratings report.
But RepoWatch saw only two items about another problem, also mentioned in the Fitch Ratings report: The flow of credit throughout Europe would be reduced if money market funds stop making repo and other loans to European banks.
In the financial crisis of 2007-2008, money market funds played two roles. First, they stopped making repo loans to banks and they stopped buying asset-backed commercial paper (ABCPaper), thus helping to trigger the two runs on securitized banking that caused the credit panic. The mainstream press has rarely covered this role.
Second, after money market funds stopped making repo loans to Lehman Brothers and helped cause the company’s collapse, their frightened depositors fled in mass from money market funds that might have held Lehman debt. The press has widely covered this role.
Federal officials stepped in to stop all three runs, on repo, ABCPaper and money market funds.
Here are the two reporters who mentioned the important role of money market funds as lenders to banks:
Wall Street Journal reporter David Reilly warned June 22 about the danger that money market funds might stop lending to Greek banks:
When Lehman Brothers collapsed, a run ensued in an unforeseen place—U.S. money-market funds. In light of that, investors and regulators are rightly worried about how these funds will fare in the face of further euro-zone trouble.
But the real risk may not be that the funds suffer runs. Rather, it’s that they themselves run from European markets, contributing to another credit crunch.
Simon Boughey also wrote about the problem, in a July 4 column in the Financial News, a UK sister publication to the Wall Street Journal:
There is accumulating evidence that money market funds are reluctant to extend transatlantic credit. This, of course, recalls the dark days of late 2008 and early 2009 when banks stopped lending to each other. European banks couldn’t get their hands on dollars for love or money, and short-term borrowing rates went through the roof.
From the Fitch Ratings report:
The other dimension of the relationship between banks and money market funds is money market funds as a source of short-term bank funding. … While the overall funding reliance on money market funds might not appear significant, the potential withdrawal of money market fund funding could create negative perceptions about an institution’s financial condition.
In the Fitch study, loans from money market funds to European banks include making deposits and buying banks’ certificates of deposit, commercial paper, asset-backed commercial paper, repurchase agreements, and other short-term notes.
* Other crises that saw federal officials take extraordinary steps to protect the repurchase market include the 9/11 terrorist attacks in 2001 and the near collapse of Long Term Capital Management hedge fund in 1998.