Repo Overhaul May Include Federal Clearing Bank

A plan said to be in the works at the Federal Reserve to bring sweeping changes to the broad repurchase markets may involve the formation of a federal clearing bank to take the place of banks like Bank of New York Mellon (BK) and JPMorgan Chase (JPM). Repurchase markets — or repo markets — involve a borrower putting up collateral in return for short-term loans from large investment managers. The transactions literally occur overnight, meaning the lender repurchases the funds the next morning. Problems arose, however, as borrowers put up increasing amounts of asset- and mortgage-backed securities as collateral. When the underlying value of the assets decline, valuating the security as collateral becomes something of a gamble. As a result, many depository clearing banks tend to withdraw from the repo market and the risk involved. A Fed clearing bank, on the other hand, would act as a facilitator between borrowers and lenders in these overnight loan transactions. It would also put taxpayer funds on the line instead of the traditional shareholder interest risked by banks. Federal Reserve officials are slated to discus reforms to the system with its players next month with the goal of establishing a new repo system by October, unnamed sources told the Financial Times. One of HousingWire‘s sources inside a major investment management firm says some voluntary overhaul efforts are already in the primary stages due to all the asset-backed securities offered as collateral. “The government is planning a revamp just because it has ended up with so much ABS paper as collateral,” says the source. “It is probably surprised and a little overwhelmed by how much ABS its finally ended up saddled with, triple-A or not.” Any efforts to overhaul the system on a federal level, despite individual efforts to counter the buildup of ABS collateral, would signal a deeper reach of the administration into the financial sector. The Fed’s efforts to facilitate balance within assets and liabilities in the system would come as the administration’s latest attempt in a series of steps to increase its presence in the US banking and financial system. Write to Diana Golobay. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.