From the editor:
To those of you who read the latest from the New York Fed’s Liberty Street economists, Stabilizing the Tri-Party Repo Market by Eliminating the ‘Unwind,’ I hope you read to the end of the piece.
At issue is whether a task force of bankers and regulators is making progress in reforming the $1.7 trillion tri-party repo market, especially in eliminating the intraday credit that JP Morgan Chase and Bank of New York Mellon extend to tri-party repo borrowers during the day.
In 2008 that extension of intraday credit exposed JP Morgan and Bank of New York to potentially huge losses, when tri-party borrowers like Bear Stearns and Lehman Brothers spiraled toward insolvency. Among regulators’ greatest fears was that the tri-party repo market, which is thought to handle about one-fourth of U.S. repo transactions, would freeze, and bank giants JP Morgan and Bank of New York would fail.
Tri-party supplies much of the credit that large financial institutions use to operate, and it is where the Fed conducts monetary policy. A frozen tri-party market was unthinkable.
In 2009, the New York Fed formed a task force of the large bank companies, mortgage giant Fannie Mae and the New York Fed to study ways to reduce the potential for systemic risk in tri-party repo. In May 2010 the task force issued 16 recommendations. The most important, they said, was to get rid of the intraday credit by October 2011. Their plan was to eliminate the “unwind.” Here’s what that means:
In the tri-party market, repo borrowers and lenders make their deals in the afternoon and undo them, or unwind them, the next morning. Even if the loan is for more than a day, it’s still unwound each morning and renewed each afternoon. JP Morgan and Bank of New York become the borrower’s interim repo lenders during the day. That’s where the intraday risk resides.
On July 6 the task force released a progress report.
How are they doing in getting rid of the intraday credit, and the unwind?
RepoWatch found little to cheer. From a July 15 RepoWatch story:
Three years after the financial crisis, Wall Street banks still have not fixed one of the most dangerous flaws in the markets, and they said July 6 they will not be able to meet an October 2011 deadline for reform because they haven’t figured out what to do.
Liberty Street economist Antoine Martin, on the other hand, applauded the task force’s work and spent his entire July 20 paper explaining the value of eliminating the unwind.
The good news is that the proposed reforms, once implemented, will contribute to the stability of the tri-party repo market. Important prerequisites for achieving these reforms will be implemented this year …
Not until the last two sentences do we get the following:
The bad news is that the reform task force acknowledged unspecified delays in eliminating the unwind. As a result, the goal of linking the settlement of maturing repos to new repos and greatly reducing the need for credit provided by the clearing banks will not be realized as early as expected. Until that key step is taken, the market will be more fragile than necessary.