Reforming Repo Rules

This October, the derivatives firm MF Global filed for bankruptcy after losing more than $1 billion of its customer's funds in a number of complex "repos," or repurchase agreements. Until repos are reformed, the stability of the global financial system will remain at risk.

CAMBRIDGE – Sometimes, we just don’t learn.

After the financial crisis, the United States enacted the Dodd-Frank Act to overhaul American financial regulation, with the aim of reducing the risk of another financial meltdown. But it did nothing to reform “repo” lending – arguably the weakest link in the financial chain. And we have just seen another major financial firm collapse as a result.

A repo, or repurchase agreement, is a sale of a security (often a US Treasury obligation) that the seller promises to buy back later – often the day following the original sale – at a slightly higher price. The repo buyer thus lends to the seller, with the difference between the immediate “spot” price of the obligation and the “forward” repurchase price representing the interest on the loan. These repo loans give firms – typically financial firms – access to vast pools of cheap financing (often emanating from US money-market funds). It is a market measured in the trillions of dollars.

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