NY Fed Blog on Repo Fire Sales
The Federal Reserve Bank of New York's "Liberty Street Economics" blog writes "Crisis Chronicles: The Commercial Credit Crisis of 1763 and Today's Tri-Party Repo Market." It says in a section entitled, "Distressed Fire Sales and the Tri-Party Repo Market," "As we saw during the recent financial crisis, the tri-party repo market was overly reliant on massive extensions of intraday credit, driven by the timing between the daily unwind and renewal of repo transactions. Estimates suggest that by 2007, the repo market had grown to $10 trillion -- the same order of magnitude as the total assets in the U.S. commercial banking sector -- and intraday credit to any particular broker/dealer might approach $100 billion. And as in the commercial crisis of 1763, risk was underpriced with low repo "haircuts" -- a haircut being a demand by a depositor for collateral valued higher than the value of the deposit. Much of the work to address intraday credit risk in the repo market will be complete by year-end 2014, when intraday credit will have been reduced from 100 percent to about 10 percent. But as New York Fed President William C. Dudley noted in his recent introductory remarks at the conference "Fire Sales" as a Driver of Systemic Risk, "current reforms do not address the risk that a dealer's loss of access to tri-party repo funding could precipitate destabilizing asset fire sales." For example, in a time of market stress, when margin calls and mark-to-market losses constrain liquidity, firms are forced to deleverage. As recently pointed out by our New York Fed colleagues, deleveraging could impact other market participants and market sectors in current times, just as it did in 1763.... As we look toward a tri-party repo market structure that is more resilient to "destabilizing asset fire sales" and that prices risk more accurately, we ask, can industry provide the leadership needed to ensure that credit crises don't persist? Or will regulators need to step in and play a firmer role to discipline dealers that borrow short-term from money market fund lenders and draw on the intraday credit provided by clearing banks? Tell us what you think."
