History of Repo markets in US..

I wrote a piece in BQ looking at evolution of Repo markets in India.

John Mullin writes on repo markets in US.

What led to rise of Repo market? In 1970s as inflation rose deposit rates could not rise due to regulatory caps. This is much like India where interbank repo markets developed as call rates were capped.

At a very basic level, a repurchase agreement is a loan secured by collateral. Collateralized loans are nothing new, of course. They go back at least as far as ancient Greece and take a variety of different forms — two everyday examples include real estate loans secured by property and loans on cars subject to repossession. The contractual conventions and market structures associated with collateralized loans vary depending on the type of collateral, and they evolve over time in response to changing market conditions. This is particularly true for the repo market — where today’s market arrangements are different in many important respects from those that existed in the immediate aftermath of World War II.

The U.S. repo market greatly increased in size and importance as inflation accelerated in the late 1970s and early 1980s. This rapid growth was spurred by a process that is referred to by economists as “disintermediation.” As short-term interest rates increased during the period in response to increased inflation, banks could not respond by increasing the deposit rates they offered to their customers because checking deposit rates were capped by the Fed’s longstanding Regulation Q. A growing disconnect between capped bank rates and increasing market rates created an incentive for institutions and individuals to bypass banks. Through this process of disintermediation, many institutions began to channel money directly to the repo market, while other institutions and individuals invested in money market mutual funds, which in turn channeled money to the repo market.

The rise in repo led to legal issues:

As the repo market grew in the early 1980s, a series of bankruptcies highlighted a number of legal and structural problems that needed to be sorted out. Prior to this period, there had been a great deal of ambiguity about the legal status of repo transactions. Most notably, there was a widespread presumption that repos were unlike other collateralized loans in one crucial respect: They were thought by many to be exempt from the bankruptcy code’s automatic stay provision. This was a technical assumption that made a big difference because an exemption from the automatic stay provision would imply that repo collateral would not become tied up in bankruptcy proceedings of indeterminate length and that repo lenders would be able to sell the collateral immediately in the event of a default.

Yet prior to the 1980s, this assumption had never been put to a definitive test. It took a default episode and an act of Congress to resolve the ambiguity. When a small broker-dealer named Lombard-Wall filed for bankruptcy in August 1982, the court overseeing the case declared that the firm’s repo liabilities would be treated as collateralized loans and therefore would not be exempt from automatic stay provisions. The court issued a temporary restraining order prohibiting the firm’s repo creditors from selling the collateral backing the firm’s repos. This caused a great deal of anxiety among private market participants and regulators alike, who were concerned that the court’s rulings might discourage repo lending and substantially damage the availability of credit on the repo market, particularly during periods of heightened financial market uncertainty. In 1984, following a vigorous lobbying campaign by Wall Street firms that was joined by Fed Chair Paul Volcker, Congress enacted legislation that exempted repos on Treasuries (and other select securities) from the automatic stay provision of the bankruptcy code.

Wow. This weakness led to Triparty repo market:

A further series of defaults in the 1980s encouraged another major structural change in repo markets — the ascendance of the tri-party repo market. It turned out that, for repo lenders, it was one thing to have the legal right to sell collateral in the event of a default, but it was quite another to have access to the collateral in order to be able to sell it. For example, after Lion Capital Group filed for bankruptcy in 1984, repo creditors ended up recovering only about three-quarters of the value of their loans because the collateral available to back the loans ultimately proved to be insufficient. What was needed was a mechanism to ensure that the collateral backing repo loans would be fully available to creditors in the event of default.

The tri-party repo market — which had been pioneered by Salomon Brothers in the late 1970s — provided just such a mechanism. In the tri-party market, repo collateral is earmarked and held in custody by an agent bank. Repo lenders are protected because they can access and sell collateral in the event of a borrower’s default; repo borrowers are protected because they can secure access to the collateral that they have pledged once they repay their loan. The tri-party repo market grew rapidly from the 1980s onward and ultimately accounted for the majority of repo market activity for large government securities dealers.

He traces the journey to 2008 crisis where repo funding played a large role and the sudden spike in repo rate in Sep-2019..

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