What is repo and why should we care?

The FED is having liquidity problems. If people stop using repo because the interest rates don't make it profitable, they stop buying t bills to use in repo. stop buying T bills, and the fed has to buy their own T bills, Quantitative Easing . So they just try to get a step ahead and pay down the interest rate with repo/tomo injections to the "free" money flows and the systems "operates" as "normal". which of course is anything but normal. The FED has created a system of free money, to fix prior financial crisis, but which became normal operating procedure, and now it is finally locking up. The only question is will the whole sham come crashing down, or will they paper over this crisis with a few trillion paper squares and keep it shambling along for another 5 or 10 years. It's so funny, after all these REPOs, the 30 year yield is STILL dropping like a stone. QE4 is just around the corner. This is a sovereign, either Saudi or China, or some other entity making a run on the US banking system. This is a deliberate systematic draw down. Bank Runs are what they are afraid of as DeutschBank is broke. so what is a Repo anyway : A repurchase agreement in short : repo , is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day. A repurchase agreement is the sale of a security combined with an agreement to repurchase the same security at a higher price at a future date. It is also referred to as a "repo." For the party selling the security and agreeing to repurchase it in the future, it is a repo; for the party on the other end of the transaction, buying the security and agreeing to sell in the future, it is a reverse repurchase agreement. Repos are typically used to raise short-term capital. This is How it works. Example of a repo: For example, trader A may sell a specific security to trader B for a set price and agree to buy back the security for a specified amount at a later date. In actuality, however, the sale is not a real sale, but rather a loan, secured by the security. As with collateralized loans, the security being used as collateral is "held" by trader B (in case trader A defaults and does not repayment the amount to trader A.) The incremental amount to be repaid by trader A to repurchase the security is the amount of "interest" earned on the loan by trader B. Repos are usually very short term transactions, mostly with overnight terms although some extend for a period of years. For short term repos, the risks are very low. For longer long repos, with the possibility of fluctuations in the market, collateral risk is much higher. Repurchase agreements are generally considered safe investments because the security in question functions as collateral, which is why most agreements involve U.S. Treasury bonds. Classified as a money-market instrument, a repurchase agreement functions in effect as a short-term, collateral-backed, interest-bearing loan. The buyer acts as a short-term lender, while the seller acts as a short-term borrower. The securities being sold are the collateral. Thus the goals of both parties, secured funding and liquidity, are met. Repurchase agreements can take place between a variety of parties. The Federal Reserve enters into repurchase agreements to regulate the money supply and bank reserves. Individuals normally use these agreements to finance the purchase of debt securities or other investments. Repurchase agreements are strictly short-term investments, and their maturity period is called the "rate," the "term" or the "tenor." Despite the similarities to collateralized loans, repos are actual purchases. However, since the buyer only has temporary ownership of the security, these agreements are often treated as loans for tax and accounting purposes. In the case of bankruptcy, in most cases repo investors can sell their collateral. This is another distinction between repo and collateralized loans; in the case of most collateralized loans, bankrupt investors would be subject to an automatic stay. Why it matters: Repurchase agreements have grown into a very large portion of the money markets, fueling the growth of short-term markets for mutual funds in trading government-backed securities, such as T-bills. Indeed, the Treasury, through its Federal Reserve bank banking system, is a large purchaser of repos, providing important liquidity for short-term market traders. Term vs. Open Repurchase Agreements . The major difference between a term and an open repo lies in the amount of time between the sale and the repurchase of the securities. Repos that have a specified maturity date (usually the following day or week) are term repurchase agreements. A dealer sells securities to a counterparty with the agreement that he will buy them back at a higher price on a specific date. In this agreement, the counterparty gets the use of the securities for the term of the transaction, and will earn interest stated as the difference between the initial sale price and the buyback price. The interest rate is fixed, and interest will be paid at maturity by the dealer. A term repo is used to invest cash or finance assets when the parties know how long they will need to do so. An open repurchase agreement (also known as on-demand repo) works the same way as a term repo except that the dealer and the counterparty agree to the transaction without setting the maturity date. Rather, the trade can be terminated by either party by giving notice to the other party prior to an agreed-upon daily deadline. If an open repo is not terminated, it automatically rolls over each day. Interest is paid monthly, and the interest rate is periodically repriced by mutual agreement. The interest rate on an open repo is generally close to the federal funds rate. An open repo is used to invest cash or finance assets when the parties do not know how long they will need to do so. But nearly all open agreements conclude within one or two years. Repos with longer tenors are usually considered higher risk. During a longer tenor, more factors can affect repurchaser creditworthiness, and interest rate fluctuations are more likely to have an impact on the value of the repurchased asset. It's similar to the factors that affect bond interest rates. In normal credit market conditions, a longer-duration bond yields higher interest. Long-term bond purchases are bets that interest rates will not rise substantially during the life of the bond. Over a longer duration, it is more likely that a tail event will occur, driving interest rates above forecasted ranges. If there is a period of high inflation, the interest paid on bonds preceding that period will be worth less in real terms. This same principle applies to repos. The longer the term of the repo, the more likely that the value of the collateral securities will fluctuate prior to the repurchase, and business activities will affect the repurchaser's ability to fulfill the contract. In fact, counterparty credit risk is the primary risk involved in repos. As with any loan, the creditor bears the risk that the debtor will be unable to repay the principal. Repos function as collateralized debt, which reduces the total risk. And because the repo price exceeds the value of collateral, these agreements remain mutually beneficial to buyers and sellers. There are three types of repurchase agreements. The most common type is a third-party repo (also known as a tri-party repo). In this arrangement, a clearing agent or bank conducts the transactions between the buyer and seller and protects the interests of each. It holds the securities and ensures that the seller receives cash at the onset of the agreement and that the buyer transfers funds for the benefit of the seller and delivers the securities at maturation. The primary clearing banks for tri-party repo in the United States are JPMorgan Chase and Bank of New York Mellon. In addition to taking custody of the securities involved in the transaction, these clearing agents also value the securities and ensure that a specified margin is applied. They settle the transaction on their books and assist dealers in optimizing collateral. What clearing banks do not do, however, is act as matchmakers; these agents do not find dealers for cash investors or vice versa, and they do not act as a broker. Typically, clearing banks settle repos early in the day, although a delay in settlement usually means that billions of dollars of intraday credit are extended to dealers each day. These agreements constitute more than 90% of the repurchase agreement market, which held approximately $1.8 trillion as of 2016. In a specialized delivery repo, the transaction requires a bond guarantee at the beginning of the agreement and upon maturity. This type of agreement is not very common. In a held-in-custody repo, the seller receives cash for the sale of the security, but holds it in a custodial account for the buyer. This type of agreement is even less common because there is a risk the seller may become insolvent and the borrower may not have access to the collateral. When government central banks repurchase securities from private banks, they do so at a discounted rate, known as the repo rate. Like prime rates, repo rates are set by central banks. The repo rate system allows governments to control the money supply within economies by increasing or decreasing available funds. A decrease in repo rates encourages banks to sell securities back to the government in return for cash. This increases the money supply available to the general economy. Conversely, by increasing repo rates, central banks can effectively decrease the money supply by discouraging banks from reselling these securities. In order to determine the true costs and benefits of a repurchase agreement, a buyer or seller interested in participating in the transaction must consider three different calculations: #1) Cash paid in the initial security sale #2) Cash to be paid in the repurchase of the security #3) Implied interest rate The cash paid in the initial security sale and the cash paid in the repurchase will be dependent upon the value and type of security involved in the repo. In the case of a bond, for instance, both of these values will need to take into consideration the clean price and the value of the accrued interest for the bond. A crucial calculation in any repo agreement is the implied rate of interest. If the interest rate is not favorable, a repo agreement may not be the most efficient way of gaining access to short-term cash. A formula which can be used to calculate the real rate of interest is below: Interest rate = [(future value/present value) – 1] multiplied by year/number of days between consecutive legs Once the real interest rate has been calculated, a comparison of the rate against those pertaining to other types of funding will reveal whether or not the repurchase agreement is a good deal. Generally, as a secured form of lending, repurchase agreements offer better terms than money market cash lending agreements. From the perspective of a reverse repo participant, the agreement can generate extra income on excess cash reserves as well. Following the 2008 financial crisis, investors focused on a particular type of repo known as repo 105. There was speculation that these repos had played a part in Lehman Brothers’ attempts at hiding its declining financial health leading up to the crisis. In the years immediately following the crisis, the repo market in the U.S. and abroad contracted significantly. However, in more recent years it has recovered and continued to grow. The crisis revealed problems with the repo market in general. Since that time, the Fed has stepped in to analyze and mitigate systemic risk. The Fed identified at least three areas of concern: 1) The tri-party repo market’s reliance on the intraday credit which the clearing banks provide 2) A lack of effective plans to help liquidate the collateral when a dealer defaults 3) A shortage of viable risk management practices Starting in late 2008, the Fed and other regulators established new rules to address these and other concerns. Among the effects of these regulations was an increased pressure on banks to maintain their safest assets, such as Treasuries. They are incentivized to not lend them out through repo agreements. Per Bloomberg, the impact of the regulations has been significant: up through late 2008, the estimated value of global securities loaned in this fashion stood close to $4 trillion. Since that time, though, the figure has hovered closer to $2 trillion. Further, the Fed has increasingly entered into repurchase (or reverse repurchase) agreements as a means of offsetting temporary swings in bank reserves. Nonetheless, in spite of regulatory changes over the last decade, there remain systemic risks to the repo space. The Fed continues to worry about a default by a major repo dealer that might inspire a fire sale among money funds which could then negatively impact the broader market. The future of the repo space may involve continued regulations to limit the actions of these transactors, or it may even eventually involve a shift toward a central clearinghouse system. For the time being, though, repurchase agreements remain an important means of facilitating short-term borrowing.




The Financial Armageddon Economic Collapse Blog tracks trends and forecasts , futurists , visionaries , free investigative journalists , researchers , Whistelblowers , truthers and many more