An unaddressed cause of the 2008 financial crisis was banks’ reliance on elaborate schemes called repurchase agreements, or “repos,” to fund their operations. Four years later, usual suspects like Goldman Sachs, JPMorgan Chase and Bank of America remain heavily dependent on them, endangering the financial system, as shown in a new Public Citizen report, “The Repo Ruse.”
Flickr by Truthout.org
Repos, often associated with the largely unregulated “shadow banking” system, are loans dressed up to look like sales. In a repo agreement, the borrower, for example Goldman Sachs, “sells” an asset (such as a bond) to another party, for example a money market mutual fund. The borrower also agrees to buy back the asset, often the next day, paying a little bit more as “interest.” These sales and buybacks continue on and on until one party decides to end the agreement.
So why do the parties choose to engage in such contractual gymnastics instead of just agreeing to a conventional loan? There are two big reasons, both of which create excessive risk.
First, Congress has carved out a special exemption for repo transactions from the usual requirements of federal bankruptcy law. Traditionally, if a borrower goes bankrupt, the lender has to compete with other creditors in the bankruptcy process to recoup its investment. Not so with repo agreements. Congress has accepted the buy-and-sell charade of repos and affirmed that repo lenders can sell collateral immediately if repo borrowers go bankrupt. This permission makes repo lenders more willing than normal creditors to engage in sloppy lending practices, and more likely to dash for the exits at the first sign that their borrowers are in trouble–imperiling individual institutions and potentially triggering market panics.
Second, the fiction that repo borrowers “sell” the assets that serve as collateral permits them to cover up problems on their balance sheets.
