Still Broken Five Years Later

[unhappycamper]

http://smirkingchimp.com/thread/mike-whitney/54377/still-broken-five-years-later

“The repo market wasn’t just a part of the meltdown. It was the meltdown.”
– David Weidner, Wall Street Journal, May 29, 2013.

Still Broken Five Years Later
Economic Policy
by Mike Whitney | February 22, 2014 - 10:26am

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.

The problem that arose in 2008, and that will likely crop up in the future, was that the value of the underlying collateral (subprime MBS) was steadily downgraded forcing the banks to take steep haircuts. (which means they couldn’t borrow as much on their collateral) The bigger the haircuts, the less money the banks had to fund their securities which forced them to sell assets to make up the difference. When banks and other financial institutions deleverage quickly, asset prices plunge and capital is wiped out forcing the Fed to step in and backstop the system to prevent a full-blown meltdown. And that’s exactly what the Fed did in 2008. It slashed rates to zero, set up myriad lending facilities and provided unlimited backing for both regulated and unregulated financial institutions. It was the biggest financial rescue operation of all time and it cost somewhere in the neighborhood of 12 to 13 trillion dollars in loans and other guarantees. Under the provisions of the Dodd Frank financial reforms, the Fed is forbidden from carrying out a similar bailout in the future, although you can bet-your-bippy that Yellen and Co. will bend the rules if there’s another catastrophe.

[TygrBright]

1. There's actually an easy fix for this.

But NO will to implement it:

Turn mortgage and property securities into non-negotiable instruments.

That is, once a mortgage or security agreement has been completed, both parties are obligated to renegotiate it only with each other. It may not be sold, bartered, re-mortgaged, re-secured, etc.

Of course, Wall Street would collapse, so this will never happen.

wistfully,
Bright