Repo Chains and Financial Instability
There are three issues with Repos.
- Repo chains as source of instability
- Impact of Repo on Money Supply
- Re-hypothecation: Reuse of Repo and Leverage
From Collateral Shortages and Intermediation Networks
In the pre-crisis period, financial markets witnessed a growing reliance on short-term funds raised in wholesale markets. In particular, there was a dramatic rise in the use of sales and repurchase (repo) agreements to fund longer-term investment opportunities or to finance inventories of securities held for market-making purposes. Given that such funding opportunities were secured by collateral, they were mostly considered to be safe. Since the crisis of 2007–8, however, the repo and the asset-backed commercial paper (ABCP) markets have been viewed as one of the potential sources of fragility in the financial system, with conventional wisdom (partially) attributing the collapse of Bear Stearns, Lehman Brothers, and Northern Rock to their reliance on wholesale funding.
From The Economics of Collateral Chains
The ‘supply’ of pledged collateral is typically received by the central collateral desk of banks that re-use the collateral to meet the ‘demand’ from the financial system. The key providers of primary (or source) collateral to the ‘street’ (or large banks) are: hedge funds; securities lending (via custodians) on behalf of pension funds, insurers, official sector accounts, etc. and commercial banks that liaise with large banks. The securities they hold are continuously re-invested to maximize returns over their maturity tenor. Source collateral is collateral that can be re-pledged, creating dynamic collateral chains. The term re-pledged is a legal term and means that the dealer receiving the collateral has the right to reuse in its own name. Since a single piece of source collateral can be re-used several times by several different intermediaries, the aggregate volume of repledged collateral reflects both the availability of collateral (that is collateral from the source) as well as the velocity (or reuse rate) of source collateral.
From The Economics of Collateral Chains
The ratio of the total collateral received by the large banks divided by the ‘source’ collateral is the velo- city of collateral due to the intermediation by the street. For end-2007, the numerator of $10 trillion is what the large banks received in pledged collateral. We then compare it to the denominator or the primary sources of collateral via the hedge funds and security lenders acting on behalf of pension, insurers, official accounts, etc. − this was about $3.4 trillion. Empirical evidence suggests that the chains were longer pre-Lehman and around 3 as of end-2007; they have decreased to about 2.4 as of end-2010. Intuitively, this means that collateral from a primary source now takes ‘fewer steps’ to reach the ultimate client. This is due to the concern of source collateral providers about counterparty risk of the large banks, and also from the demand for higher quality collateral by the ultimate clients. Lower quality collateral is difficult to move in the present time.
From The Economics of Collateral Chains
This decline in the re-use of collateral may be viewed positively from a financial stability perspective. However, from a monetary policy perspective, the lubrication in the global financial markets is now lower as the velocity of money type instruments has declined. The shorter “chains” − from constraining the collateral moves lowers global financial lubrication will increase overall cost of capital to the real economy.
Overall, global liquidity remains below pre-Lehman levels. When we consider collateral use/re-use in addition to M2 or the monetary base in U.S., U.K. and Eurozone, financial lubrication was over $30 trillion before Lehman (and one-third came via pledged collateral); now it is lower by about $4-5 trillion. Since cross-border funding is important for large banks, allowing for the efficient arbitrage of their funding operations, (e.g., consider the recent surge in the demand for U.S. dollar funding by European banks), the state of the pledged collateral market needs to be considered when setting monetary policy.
Key Sources of Research:
Velocity of Pledged Collateral: Analysis and Implications
Manmohan Singh
November 2011
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1961904
Sizing Up Repo
Arvind Krishnamurthy Stefan Nagel
Dmitry Orlov
June 2011
Click to access Sizing-up-repo_June29.pdf
RESALEABLE DEBT AND SYSTEMIC RISK
Jason Roderick Donaldson Eva Micheler
January 2, 2016
Infante, S. (2015).
Liquidity windfalls: The consequences of repo rehypothecation.
Technical report, Federal Reserve Board of Governors Finance and Economics Dis- cussion Series 2015-22.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2460979
Kahn, C. M. and H. J. Park
(2015).
Collateral, rehypothecation, and efficiency.
UIUC Working paper.
Lee, J. (2015).
Collateral circulation and repo spreads.
Technical report
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2548209
Singh, M. (2010).
The velocity of pledged collateral.
Technical report, IMF.
Singh, M. and J. Aitken (2010).
The (sizable) role of rehypothecation in the shadow banking system.
Technical report, IMF.
Gorton, G. and A. Metrick (2010).
Haircuts.
Review (Nov), 507–520.
Gorton, G. and A. Metrick (2012).
Securitized banking and the run on repo.
Journal of Financial Economics 104(3), 425–451.
Copeland, A., A. Martin, and M. Walker (2014).
Repo runs: Evidence from the tri- party repo market.
The Journal of Finance 69(6), 2343–2380.
Antinolfi, G., F. Carapella, C. Kahn, A. Martin, D. Mills, and E. Nosal (2014).
Repos, Fire Sales, and Bankruptcy Policy.
Review of Economic Dynamics, (forthcoming).
Financial Intermediation Networks
Marco Di Maggio† Alireza Tahbaz-Salehi
March 2015
Click to access Intermeidation-March2015.pdf
Collateral Shortages and Intermediation Networks
Marco Di Maggio Alireza Tahbaz-Salehi
October 1, 2015
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2492007
The political economy of repo markets
Daniela Gabor
Click to access gabor_political_economy_of_repo_markets.pdf
Collateral Risk, Repo Rollover and Shadow Banking
Shengxing Zhangú
August 28, 2014
Click to access Zhang%20paper.pdf
Shadow Interconnectedness: The Political Economy of (European) Shadow Banking
Daniela Gabor
September 16, 2013
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2326645
Systemic Risk, Contagion, and Financial Networks: A Survey
Matteo Chinazzi Giorgio Fagiolo
June 3, 2015
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2243504
A Map of Collateral Uses and Flows
Andrea Aguiar Richard Bookstaber Dror Y. Kenett Thomas Wipf
Click to access OFRwp-2016-06_Map-of-Collateral-Uses.pdf
Aguiar, A., R. Bookstaber, and T. Wipf.
“A Map of Funding Durability and Risk.”
Office of Financial Research Working Paper no. 14-03, 2014.
Baklanova, V.,
“Repo and Securities Lending: Improving Transparency with Better Data.”
Office of Financial Research Brief no. 15-03, 2015.
Baklanova, V., A. Copeland, and R. McCaughrin.
“Reference Guide to U.S. Repo and Securities Lending Markets.”
Office of Financial Research Working Paper no. 15-17, 2015.
Shadow Banks and Systemic Risks
Rui Gong Frank H. Page Jr.
July 23, 2015
Financial Contagion with Collateralized Transactions: A Multiplex Network Approach
Gustavo Peralta Ricardo Crisóstomo
July 2016
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2717411
Non-bank financial institutions: Assessment of their impact
on the stability of the financial system
Taxonomy of Studies on Interconnectedness
Gazi Kara Mary H. Tian Margaret Yellen
December 15, 2015
Financial Plumbing and Monetary Policy
Manmohan Singh
June 2014
Haircuts and Repo Chains
Tri Vi Dang
Gary Gorton
Bengt Holmström
Click to access Paper_Repo.pdf
Nonbank Financial Intermediation, Financial Stability, and the Road Forward
Stanley Fischer
Click to access fischer20150330a.pdf
Financial Intermediation Chains in an OTC Market
Ji Shen Bin Wei Hongjun Yan
December 15, 2015
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2577497
Dealer Networks
Dan Li Norman Schürhoff
October 22, 2014
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2023201
Systemic Risks in Repo Markets
Somnath Chatterjee
8, November 2013
Click to access 2013-operacionalizacion-estabilidad-financiera-t-07.pdf
Systemic risk in the repo market.
Alexander Shkolnik
Click to access fmws1_12590.pdf
The Economics of Collateral-Chains
Manmohan Singh
2012
Collateral Reuse as a Direct Funding Mechanism in Repo Markets
George Issa Elvis Jarnecic
Click to access EFMA2016_0566_fullpaper.pdf
Repo Runs
Antoine Martin David Skeie Ernst-Ludwig von Thadden
Securitized Banking and the Run on Repo
Gary Gorton
Andrew Metrick
First version: January 22, 2009 This version: November 13, 2009
Click to access gorton_run_on_repo_nov.pdf
Who Ran on Repo?
Gary Gorton, Andrew Metrick
October 4, 2012
Click to access whorancompleteoctober4.pdf
Repo Runs: Evidence from the Tri-Party Repo Market
Adam Copeland Antoine Martin Michael Walker
Matching Collateral Supply and Financing Demands in Dealer Banks
Adam Kirk, James McAndrews, Parinitha Sastry, and Phillip Weed
DECEMBER 2014
Collateral Reuse in Shadow Banking and Monetary Policy
Ameya Muley∗
7th January 2016
http://economics.mit.edu/files/10999
Money for Nothing: The Consequences of Repo Rehypothecation
Sebastian Infante
Federal Reserve Board September 19th, 2014 Abstract
Intermediary Funding Liquidity and Rehypothecation as Determinants of Repo Haircuts and Interest Rates
Egemen Eren
Stanford University July 23, 2014
Re-use of collateral in the repo market
Lucas Marc Fuhrer, Basil Guggenheim and Silvio Schumacher
2015
Click to access working_paper_2015_02.n.pdf
Collateral Reuse as a Direct Funding Mechanism in Repo Markets
George Issa Elvis Jarnecic
Click to access EFMA2016_0566_fullpaper.pdf
Rehypothecation and Liquidity
David Andolfatto Fernando M. Martin Shengxing Zhang
2015-02-02
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2646142
Matching Prime Brokers and Hedge Funds∗
Egemen Eren†
JOB MARKET PAPER
December 23, 2015
Collateral, Rehypothecation, and Efficiency
Charles M. Kahn† Hye Jin Park‡
Last updated: April 15, 2015
Click to access Collateral_Rehypothecation_and_Efficiency.pdf
The market for Collateral: the Potential impact of Financial Regulation
Jorge Cruz Lopez, Royce Mendes and Harri Vikstedt
Click to access fsr-0613-lopez.pdf
Rehypothecation
David Andolfatto Fernando Martin Shengxing Zhang
February 26, 2014
Click to access andolfatto_spring2014.pdf
Collateralized Security Markets
John Geanakoplos William R. Zame
Click to access refs4661465000000000040.pdf
Rehypothecation
CRL MONNeT
Click to access brq411_Rehypothecation.pdf
Collateral and Monetary Policy
Manmohan Singh
2013
Financial Plumbing and Monetary Policy
Prepared by Manmohan Singh
June 2014
Understanding the role of collateral in financial markets
M Singh
Click to access 20150223-singh-slides.pdf
Systemic Risk and Stability in Financial Networks
Daron Acemoglu Asuman Ozdaglar Alireza Tahbaz-Salehi
This version: January 15, 2013
http://dspace.mit.edu/bitstream/handle/1721.1/77606/Acemoglu13-03.pdf?sequence=1
Systemic Risk in Endogenous Financial Networks
Daron Acemoglu Asuman E. Ozdaglar Alireza Tahbaz-Salehi
January 22, 2015
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2553900
Towards a theory of shadow money
Daniela Gabor and Jakob Vestergaard
Do Shadow Banks Create Money?
Jo Michell
How Does Monetary Policy Affect Shadow Bank Money Creation?
Kairong Xiao†
June 17, 2016
The Economic Consequences of ‘Market-Based’ Lending
Carolyn Sissoko
May 24, 2016
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2766693
Key Mechanics of the U.S. Tri-Party Repo Market
Adam Copeland, Darrell Duffie, Antoine Martin, and Susan McLaughlin
2012
The Failure Mechanics of Dealer Banks
Darrell Duffie
2010
Click to access DuffieFailureMechanicsDealerBanks2010.pdf
The Euro Interbank Repo Market
Loriano Mancini Angelo Ranaldo Jan Wrampelmeyer
March 26, 2014
Click to access angeloranaldopaper_4.pdf
Viewpoints which Matter 