Repo Madness

I’ve been furiously reading about the economic meltdown. There are so many factors and so many people involved. The system is so complex. For those of us who never studied economics, this has been an eye-opening experience. I foolishly thought that huge Wall Street firms had some amount of cash on hand. This cash would then be used to fund the trades of that firm and its clients. Well, this just proves that I’m old and misinformed. That is not how it’s done.

The repo market, repurchase transaction, grew up in the late 80s and early 90s. These amount to short-term loans which these large financial institutions like Goldman Sachs, Lehman Brothers and Citibank depend on on a day-to-day basis. As I understand it, in order to operate, these financial giants and large banks will raise billions of dollars on a day-to-day basis in order to fund their operations. These loans are backed with the securities that are held by these financial institutions. The loans can be as short as 24 hours and as long as a week to 10 days.

It is unclear how large the repo market really is. According to one professor, the repo market is $12 trillion (that is trillion with a T.)

So, one source of the major collapse of Bear Stearns and Lehman Brothers was the repo market. If your stock is getting hammered, for whatever reason, and people are worried about your financial health, it is understandable that these short-term loans would become problematic. Those institutions lending money weakened asked for more and more collateral. Therefore, as in the case of Bear Stearns, some institutions asked for more collateral every single day for the same loan. Finally, as the rumors continued to mount, those institutions simply stopped lending money. This is money that you use every day to operate. Without the money, you’re stuck in the water without paddles.

This repo market was one of the reasons that these extremely large institutions collapsed so quickly. Now, I have not read every single word of the Wall Street Financial Reform Act. I don’t think they addressed the repo market at all. This seems to be a huge problem in our financial system. Maybe it’s more politically correct to state that it is a “huge challenge.” It seems to be nothing but craziness to me.

What are your thoughts on the repo market?