Still Broken Five Years Later

Weekend Edition February 21-23, 2014

NY Fed's Dudley Warns that "Firesales" Could Trigger Another Financial Crisis

by MIKE WHITNEY

“The repo market wasn’t just a part of the meltdown. It was the meltdown.”

– David Weidner, Wall Street Journal, May 29, 2013.

Ask your average guy-on-the-street ‘what caused the financial crisis’, and you’ll either get a blank stare followed by a shrug of the shoulders or a brusque, three-word answer: “The housing bubble”. Even people who follow the news closely are usually sketchy on the details. They might add something about subprime mortgages or Lehman Brothers, but not much more than that. Very few people seem to know that the crisis began in a shadowy part of the financial system called repo, which is short for repurchase agreement. In 2008, repo was ground zero, the epicenter of the meltdown. That’s where the bank run took place that froze the credit markets and sent the financial system into freefall. Unfortunately, nothing has been done to fix the problems in repo, which means that we’re just as vulnerable today as we were five years ago when Lehman imploded and all hell broke loose.

Repo is a critical part of today’s financial architecture. It allows the banks to fund their long-term securities cheaply while giving lenders, like money markets, a place where they can park their money overnight and get a small return. The entire repo market is roughly $4.5 trillion, although the more volatile tri-party repo market is around $1.6 trillion. (Note: That’s $1.6 trillion that’s rolled over every day.)

Repo works a lot like a pawn shop. You bring your rusty bike and your imitation Van Gogh “Starry Night” to Rosie’s E-Z-Pawn, and the guy with the gold earring behind the counter gives you 15 bucks in return. That’s how repo works too, the only difference is that repo is a loan. The banks post collateral –mostly pools of mortgages (MBS) or US Treasuries– and get overnight loans from a cash-heavy lenders, like money markets, insurance companies or pension funds. Borrowers repay the loan with interest added to the original sum.

http://www.counterpunch.org/2014/02/21/still-broken-five-years-later/