This is great news. RepoWatch is stoked.
Suddenly, it seems that everyone in the financial markets is worried about the repurchase market, because of the debt-ceiling stand-off in Washington, and the press is faithfully reporting the concern. Obviously, the crisis is not good news, but the reporting is.
But there’s one problem. The stories are by and large not making the connection between the 2008 financial crisis and the current one.
One Wall Street Journal story even went out of its way to say the two situations are very different. Egad. In RepoWatch’s view, they are the same: The quality of the repo collateral is in doubt.
To repeat a point RepoWatch has made often since the financial crisis in 2008: Fixing mortgages won’t stop the next run on repo if lenders panic over a different kind of collateral or hear a false rumor and panic for no reason at all.
Still, many of this week’s stories are insightful. Here are some of the best, worth reading from beginning to end:
From As U.S. Debt Impasse Continues, Risks Loom in Repo Market, a July 26 Dow Jones Newswires story, by Min Zeng:
The key concern is that Treasury bonds might no longer be considered top-quality collateral in repurchase agreement markets—better known as repo— thereby choking a primary channel of short-term funding for banks. That in turn could push investors such as U.S. money funds to cut lending to banks, stifling liquidity and pushing up the cost of funding.
Repo, which grew to become the so-called shadow banking system, is often regarded as the oil that lubricates the economy. Higher borrowing costs would have a broad impact, hurting everything from consumer borrowing to corporate finances.
Look, Dow Jones put the r-word in the headline.
From Heading for a “Haircut,” a July 28 Wall Street Journal story by reporters Matt Phillips, Ben Levisohn and Serena Ng:
The debt stalemate in Washington is creating stress in a little-known but vital corner of the bond market, increasing the risk that banks, hedge funds and other investors will have to pay billions of dollars in additional costs if the U.S. defaults or is downgraded.
Rates are rising for repurchase agreements, or repos—a roughly $4 trillion market that greases the wheels of the U.S. financial system—as officials in Washington feud over how to bring down the nation’s debt.
Unfortunately, this is the story that thinks 2011 is very different than 2008.
The jitters in the repo market this time are very different from the strains the market saw in 2008, when lenders backed away from providing overnight cash to Bear Stearns Cos. shortly before its collapse, and other Wall Street dealers. The lenders were worried that troubled financial institutions that pledged shaky mortgage securities as collateral for loans wouldn’t be able to return the cash, leaving lenders with assets whose values were suspect.
This time the stress focuses on how the market might react to a downgrade.
And this is different how?
From Banks Find Few Signs of Default Distress in Repo, Credit Markets, a July 28 Bloomberg story by Dakin Campbell and Michael J. Moore:
Pacific Investment Management Co. Chief Executive Officer Mohamed A. El-Erian said the most critical indicators of distress will come from the markets.
“That’s the very first thing I do now is I go over to our money market desk and ask them, ‘What you are seeing today? How’s the repo market operating?’” El-Erian said in a radio interview on “Bloomberg Surveillance” with Tom Keene. “Because that is what can really trip an economy. So far it’s functioning OK, but we’re seeing some pressure.”
From Debt Ceiling Impasse Rattles Short-Term Credit Markets, a July 28 New York Times story by Nelson D. Schwartz and Azam Ahmed:
The overnight repo rate, which started the week at about three basis points, was about 17 basis points Thursday evening, according to Credit Suisse. That means that to finance $100 million overnight in the repo market it would now cost about $472 per day, up from about $83 on Monday.
“It’s a bigger deal than a lot of people recognize,” said Howard Simons, a strategist at Bianco Research, a bond market specialist. “If you downgrade the securities you have to put more up for collateral and that affects pretty much everybody out there who has held these in reserve. I don’t care if you’re a bank, insurance company, exchange or clearinghouse.”
The bad news about this New York Times story is that it put the repo discussion at the end. The good news is that it did mention 2008.
To be sure, most observers say the ripples in the repo market will not be anything like those felt in the fall of 2008, when creditors lost faith in the ability of banks to pay back their short-term loans. That caused a problem for companies like General Electric, which struggled to finance its daily operations as a result. Back then, the sharp drop-off in repo lending helped bring the financial system to its knees.
Readers will notice that these stories use a variety of dueling numbers to indicate the size of the repurchase market. The bottom line is that we do not have the repo data we need in order to analyze the market with precision. Three years after the financial crisis, this is a scandal.
While RepoWatch is applauding the U.S. business press, it’s only fair to remind readers that the UK’s Financial Times writes about the repurchase market all the time. Here are some examples:
From Bank chiefs send US debt default warning, a July 28 story by Tom Braithwaite, Michael Mackenzie and Robin Harding:
Banks are concerned about a wide range of operational issues as well as the broader question of how the Fed would support the financial system if there were disruption caused by a failure to raise the debt ceiling.
For example, they would like to know whether the Fed would be willing to lend against Treasuries with a defaulted interest payment, which would support the repo market. At a broader level, they would like to know whether the Fed will support the refinancing of Treasury securities by stepping in and buying any unsold stock at auctions.
From Banks stock up on cash amid US rating fear, a July 27 story by Justin Baer, Tom Braithwaite and Michael Mackenzie:
Bankers are particularly concerned the impact a possible downgrade would have on the $3,000bn repurchase, or “repo”, market, on which large institutions rely for short-term funding.
From US money market funds build liquidity, a July 27 story by Dan McCrum:
Money market funds, which hold $338bn of US government debt, according to Citigroup, are also reducing the amount of time they are willing to lend. This could raise funding concerns for banks, as they are reliant on short-term borrowing in the repurchase or repo market.
Finally, from US default would spell turmoil for the repo market, an informative July 28 Q & A about repos by economists Darrell Duffie and Anil K Kashyap:
Concerns are mounting that the US could default on its debt obligations if no agreement is reached on the country’s debt ceiling. But what exactly would be the consequences? The repo market would take a big hit for a start.