Short-term borrowing on Wall Street has always been pervasive, and reform legislation has done little to stop it. That’s why regulators remain concerned about a money market they still consider volatile, says The New York Times’ DealBook.
As the NYT explains, repos, or repurchase agreements, enable broker-dealers to “borrow at low rates for short periods against collateral, usually bonds.” Although repos are no longer as rampant as they were prior to the recession, they are “still by far the largest source of borrowing for broker-dealers,” says the NYT. They constituted 52% of broker-dealer commitments in 2013, down just 7 percentage points from 2007.
The repo market is problematic because when the financial crisis hit, it came under extreme stress. “Many [of the broker-dealers'] creditors did not want to take possession of the collateral backing the repurchase agreements in the event of a default by a broker-dealer,” Rosengren said. “As a result, there were widespread runs on broker-dealers, particularly those experiencing acute financial problems.”
There are grumblings from other major financial regulators, not just Rosengren. Federal Reserve Chair Janet Yellen, for instance, has expressed deep concern about Wall Street using short-term debt markets to fund their operations.
Another reason the repo market is still vulnerable to financial stress is because money-market funds, seen by investors as low-risk, are one of the market’s main lenders. During the economic crisis, investors, thinking they would suffer considerable losses, withdraw their money from these funds. The withdrawals “reduced the amount of money that the funds could lend to banks through repos, depriving the banks of their financial lifeblood,” according to the NYT.
(Last month, the U.S. Securities and Exchange Commission passed new regulation that would prevent runs on money market funds. Rosengren acknowledged this reform but said would have “preferred even more protection” against runs.)
Regulators are considering reforming the repo market by having banks “with big repo borrowings … obtain proportionately more of their financing from much more stable sources like retaining their own profits and issuing stock,” says the NYT. Yet banks might not support this effort to increase capital because it could lower the value of their existing shares.