WSJ on repo: the news is still depressing

The WSJ is having a field day reporting on repo. Two related back-to-back articles, “Banks Retreat From Market That Keeps Cash Flowing” (August 12th and updated on the 13th) and “Fed Officials Suggest Limiting Banks’ Repo Exposure” (August 13th). Both are by Ryan Tracy. Little of the news is good.

The first article noted the pullback in the balance sheet dedicated to repo

“…Goldman Sachs Group Inc. reduced its repo activity by about $42 billion in the first six months of this year, citing capital requirements. Barclays PLC cut back lending through repos and similar agreements by roughly $25 billion, to $289 billion in the first half of the year….Bank of America Corp and Citigroup Inc. made first-half reductions in repo lending of about $11.4 billion and about $8 billion, respectively. J.P. Morgan Chase & Co.’s repo lending stayed roughly flat…”

Tracy said that thinner repo markets could add to volatility. He quoted Barclays’ Joseph Abate:

“…The diminishing role of banks in repos “could exacerbate swings in markets when interest rates rise” or other financial turbulence emerges, said Barclays analyst Joseph Abate…”

But not all the news was (that) bad:

“…New rules are “a constraint, but one that facilitates financial stability in the long run,” said Federal Deposit Insurance Corp. Vice Chairman Thomas Hoenig…”

Tracy went on to write about repo fails. We think he made a good point about dealers dedicating fewer resources to repo hence there is less depth to the market. So when an issue gets tight, there are fewer players to lean against the market, making it potentially more volatile. Referencing a meeting held by the Treasury,

“…At the meeting inside the Hay Adams Hotel near the White House, one private-sector adviser told Treasury officials that market middlemen “have declined in number and capacity, making the system less able to deal with unexpected volatility,” according to meeting minutes…”

Then the article lost some of its focus as it veered off on the Fed’s RRP program and quoted a money manager about collateral shortages. Demand for specials (used for short covering) is a different dynamic than the General Collateral (GC) market. Saying there are some specials that are very tight isn’t necessarily indicative of what is happening to supply and demand in the inter-dealer GC market and even less relevant to RRP. Sure, they are all repo and impacted by dealers cutting back on repo balance sheet, but we wish journalists would do a better job of distinguishing between the underlying dynamics.

The second article  was about an August 13th Fed conference on wholesale funding. Tracy set the tone by quoting Fed Governors Rosengren and Dudley:

“…Federal Reserve Bank of Boston President Eric Rosengren and New York Fed President William Dudley said large and opaque markets for repurchase agreements—widely used short-term loans that seized up during the 2008 crisis—could cause instability again absent changes…”

“…Mr. Rosengren said the vulnerability posed by short-term funding like repos is one of the “financial stability issues that still really scares me.” Large broker-dealers, some of which are owned by big banks, still rely heavily on potentially volatile short-term funding like repos to finance activities on behalf of themselves and their clients—and that funding may not be available in a crisis, he said…”

“…Regulators should consider forcing broker-dealers to bolster their capital levels if they rely too heavily on short-term financing or take other actions, such as limiting the extent to which brokers can use short-term repos “to finance long-term assets or high-credit-risk assets,” Mr. Rosengren said…”

This is the same rhetoric heard around the debate on fire sales. While fire sales are a legitimate concern for less liquid assets, the vast majority of the repo markets are HQLA and we wonder if this isn’t just a bit overblown. The Fed has noted that funding of less liquid assets have lengthened in maturity, likely in response to LCR rules. But it doesn’t seem to be enough. One of these days, the Fed might make some concrete proposals on how they wish to address the maturity transformation and credit transformation issues at the heart of their concerns.

We look forward to taking a closer look at the speeches in the conference to see if there are some solid clues to what comes next.

We apologize if the links to the WSJ articles aren’t working. They are behind the paywall.

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