““The collapse of Lehman was not an isolated failure of a single broker-dealer, but rather one of a string of crises for multiple broker-dealers,” Mr. Rosengren (Boston Fed President) said in his speech. While repo borrowing has fallen from its peak before the financial crisis, it is still by far the largest source of borrowing for broker-dealers…
…In 2013, repos and similar types of borrowings accounted for 52 percent of broker-dealer obligations, according to figures in a chart that Mr. Rosengren cited in his speech, down from 59 percent in 2007.“The funding model, the core of the problem, hasn’t changed at all,” Mr. Rosengren said in an interview. “It is a model that is designed for government intervention.””, Peter Eavis, New York Times
“During the 1998 global liquidity crisis, IndyMac was a publicly-traded mortgage reit that was primarily funded by repo borrowings from Wall Street. We learned a tough lesson about the volatility and lack of reliability of capital markets funding (repo and commercial paper) and prudently sought shareholder approval to de-reit and become a thrift in mid-2000; so that we would have access to federally insured deposits, FHLB advances, and FRB funding. As a result, when the repo and commercial paper markets collapsed in 2007/2008, IndyMac had no repo or commercial paper outstanding and several billion in operating liquidity. Our bank run wasn’t caused by an imprudent funding model (as it was with broker-dealers and many others), it was caused by a United States Senator who in June 2008, inexplicably and inappropriately publicly released letters he had sent the banking regulators, expressing concerns about our financial health. At that time, if he or anyone of his stature had done the same to almost any other major financial institution in America, I doubt they would have survived either.”, Mike Perry, former Chairman and CEO, IndyMac Bank
Boston Fed Chief Warns of Dangers to Repo Market
By PETER EAVIS
Wall Street banks continue to rely for billions of dollars in borrowing on a market that dried up suddenly in 2008, sending shock waves through the financial system and the wider economy.
Since the crisis, some steps have been taken to shore up the potentially unstable debt market, known as the repo market. But on Wednesday, Eric S. Rosengren, president of the Federal Reserve Bank of Boston, became the latest prominent regulator to call for a more ambitious overhaul of the repo market. In particular, he suggested that financial institutions making large use of repo borrowing should maintain higher levels of capital.
“Broker-dealers can experience significant funding problems during times of financial stress,” he said on Wednesday in remarks for a conference at the Federal Reserve Bank of New York. “Unfortunately that potential for problems has not been fully addressed.”
The Dodd-Frank Act of 2010 and international regulatory agreements have introduced many new rules since the crisis that are aimed at making the financial system stronger. Still, some regulators, including Janet L. Yellen, the Fed chairwoman, and Daniel K. Tarullo, the Fed governor who oversees regulation, are still concerned about Wall Street’s heavy use of short-term debt markets to finance their operations.
Most of the concern centers on repurchase agreements, known in the banking world as repos. These allow broker-dealers to borrow at low rates for short periods against collateral, usually bonds. The market turned treacherous in 2008 as broker-dealers like Lehman Brothers encountered severe financial trouble, causing the repo market to seize and prompting the Fed to make billions of dollars of emergency loans across Wall Street to keep the market functioning and prevent a failure of the system.
“The collapse of Lehman was not an isolated failure of a single broker-dealer, but rather one of a string of crises for multiple broker-dealers,” Mr. Rosengren said in his speech.
While repo borrowing has fallen from its peak before the financial crisis, it is still by far the largest source of borrowing for broker-dealers. In 2013, repos and similar types of borrowings accounted for 52 percent of broker-dealer obligations, according to figures in a chart that Mr. Rosengren cited in his speech, down from 59 percent in 2007.
“The funding model, the core of the problem, hasn’t changed at all,” Mr. Rosengren said in an interview. “It is a model that is designed for government intervention.”
The authorities’ focus on the repo market comes at a time when Wall Street banks are holding smaller inventories of bonds on their balance sheets. The banks use repos to finance these stockpiles. But recent regulations, particularly a capital rule known as the leverage ratio, are making it less economical for banks to use repos for this purpose.
Some analysts are now concerned that as banks’ bond inventories decline in size, bond prices could fall more sharply during periods of heavy selling. When bond prices fell steeply last year, for instance, Wall Street firms were also reducing their holdings of bonds.
But a study last year by the New York Fed determined that the broker-dealers most likely cut back during the sell-off because they were reassessing risks in the market, not because of regulations.
Even so, the new rules are prompting broker-dealers to make significant changes to their trading operations, debt market experts say.
“It’s not creating particular strain or stress right now, but there are a lot of uncertainties about how the structure of the markets will evolve,” said Lou Crandall, chief economist at Wrightson ICAP.
Changes since the crisis have made the repo market less of a threat. Assets that back repo loans are, for instance, less risky than before the crisis. And banks also have bigger sources of cash on hand, for times when the repo market dries up.
Still, apparent weaknesses continue to exist, according to regulators. The repo market is potentially vulnerable, Mr. Rosengren asserted, because money market funds are one of the main lenders in the market. Investors typically see these funds as having very low risk. As a result, when investors thought they might suffer losses on money market funds in 2008, they withdrew their money in droves. In turn, this reduced the amount of money that the funds could lend to banks through repos, depriving the banks of their financial lifeblood.
The Securities and Exchange Commission last month approved new rules aimed at preventing runs on money market funds.
In his speech, Mr. Rosengren gave the overhaul two cheers. “While I would have preferred even more protection against financial runs on money market mutual funds, this element of the recent rule-making does represent a meaningful improvement,” he said.
The commission is the primary regulator of banks’ broker-dealer subsidiaries, where much repo borrowing takes place. Mr. Rosengren noted that the S.E.C. had not significantly changed capital and other regulations for broker-dealers since the crisis.
The Fed, however, may decide in the coming months to forge ahead with its own measures to address banks’ short-term borrowing. Mr. Rosengren, for instance, suggested that banks that make heavy use of short-term borrowings should be required to maintain higher levels of capital.
At Wall Street banks, capital amounts to a small fraction of their repo borrowings, so a slight increase in capital might not have much of an effect. But Mr. Rosengren responded that any rise would make capital “less tiny than it is.”