Reuters reports U.S. banks have agreed in recent weeks to make billions of dollars of repurchase loans to European banks, contrary to the official word from U.S. regulators that American banks have reduced their exposure to European banks to a minimum since the onset of the Greek debt crisis.
Citing bankers directly involved in the transactions, reporter Gareth Gore says U.S. bankers told him they are attracted to the deals because European banks agree to pay generous interest rates and to post collateral worth considerably more than the amount of the repo loan.
Collateral includes corporate loans and mortgage portfolios, Gore reports. He does not name the U.S. banks involved.
From the September 16 article in Reuters’ International Financing Review:
Agreements worth tens of billions of dollars have been signed in the past month alone, according to bankers directly involved, who added that senior management of firms on both sides of the transactions had been closely involved in hammering out deals.
In his article, Gore writes one of RepoWatch’s all-time favorite descriptions of repo, and he gives a striking illustration of why bankers like to borrow money on the repurchase market:
Repo facilities are the financial market equivalent of pawnshops. They are appealing because they mean that banks can generate cash from assets sitting on their balance sheets without having to sell them.
“Doing repo means you don’t have to sell and don’t have to take the loss on many of these assets upfront,” said another banker at a US bank, who has signed off on such deals in recent weeks. “You can do it privately, so nobody needs to know, and spread losses over the lifetime of the assets.”
The repo loans from U.S. banks replace – and are probably helping to repay – repo loans that money market funds are withdrawing as the Greek debt crisis worsens. The scene seems reminiscent of 2007 when U.S. money market funds and other repo lenders began to withdraw from mortgage lenders, in a trend that escalated into a full-blown credit panic in 2008.
Gore’s article, though an important news scoop, fails to explain how the repo lending adds to the fragility of financial markets and economies trying to navigate the schoals of the European debt crisis. The article needs a couple of paragraphs something like the following, in RepoWatch’s view:
The repo loans pile more debt, with onerous terms, on European banks already having financial problems, and they increase the interconnectedness that proved so devastating in the financial crisis of 2007-2008, when many repo lenders withdrew their loans from U.S. investment banks and caused a death spiral in the credit markets that was halted only by massive Federal Reserve intervention.
In essence, the repo loans represent a doubling down by both borrowers and lenders, who are betting that European and U.S. governments and central banks will bail them out if Greece defaults and European banks have to write down their Greek holdings. Looked at another way, the repo loans are an example of the moral hazard created by the Fed’s intervention in 2008.
Gore says as much, albeit obliquely, while explaining that U.S. banks need to find a profitable way to use the flood of cash they’re receiving from depositors spooked by the uncertain world financial markets:
Repo lending is seen as a sensible – and profitable – way to use that cash, with one banker saying that bosses had increased available funds for repo lending in recent weeks. Because the loans are backed by collateral, US banks are seen as well protected.
“US banks are not sure about what is going to happen, so they want to have liquid assets,” added the second US banker.
Many of the securities are also eligible for the Fed’s discount window operations, meaning that US banks can quickly turn them into cash in an emergency situation.