The repo market: a faultline waiting for a crisis?

A source of vast leveraging.

In 1987, having been swept from the Oxford University metallurgy department to Wall Street, I was given a grim warning at a meeting. “We have exacting standards. Only the very best will succeed on our graduate training program. For those of you who do not make it, your fate lies here…” at which our eyes were directed towards a row of desk-bound troglodytes feasting upon pizza at seven in the morning. It was the Repo desk.

If capitalism really is doomed to go through periodic crises then you are well advised to look for the next problem in the place where you previously thought inconsequential. In the 1990’s a curiosity evolved that allowed investors to insure against a company going bust these days known as credit default swaps.  Eighteen years later, after the hilarity had died down and we’d all wiped a collective tear from our eye, credit default swaps brought down AIG, caused the biggest bankruptcy in corporate history and contributed to the near-vaporization of the global financial system.

The same can be said of the repo market – on the face of it, it looks like nothing but has an underlying menace we should take notice of.  Repo stands for repurchase and it works the same way as pawnbroking. You take a watch to a pawnbroker and borrow money against it. A week later you have to pay back the money plus interest to get the watch back, or repurchase it. The repo market merely uses financial securities, such as government bonds, for collateral, instead of watches. It sounds like a simple and safe thing to do but in the wrong hands it can be deadly.

The danger comes from the fact that it allows people with no money to access vast amounts of securities. A hedge fund or bank can buy securities THEN go looking for the money to pay for them through the repo market. All is well as long as you are earning more on the securities than you are paying in interest for the repo market loan that pays for them. But if the market value of the securities begins to fall you are in real trouble.

Nobody knows how large the repo market actually is. Estimates range between ten to fifteen trillion dollars or bigger than the annual income of the entire United States. But what we do know is that the process of quantitative easing has pumped the system up with lots of cheap money. At the same time our central banks have given those who use the repo market the confidence that their securities (bonds and equities) won’t fall in value. It’s a poisonous combination: a rise in borrowing costs combined with a decline in the value of securities would lead to a stampede for the door and someone will get trampled on. Federal Reserve chairman Ben Bernanke in a recent, seemingly innocuous, speech let the cat out of the bag when he said that “More work is needed to better prepare investors and other market participants to deal with the potential consequences of a default by a large participant in the repo market.” In other words, it’s coming. Low interest rates and stable securities values won’t last forever. Someone is going out of business.

Psychologists put our periodic crises down to people’s inability to self-limit. Anthropologists put it down to western culture’s inability to join up the various silos in society to reveal the whole, faulted, picture. In reality, to spot the next crisis all you have to do is follow the money: it’s with the troglodytes on the Repo desk.

Head of Fixed Income and Macro, Old Mutual Global Investors

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How Theresa May laid a trap for herself on the immigration target

When Home Secretary, she insisted on keeping foreign students in the figures – causing a headache for herself today.

When Home Secretary, Theresa May insisted that foreign students should continue to be counted in the overall immigration figures. Some cabinet colleagues, including then Business Secretary Vince Cable and Chancellor George Osborne wanted to reverse this. It was economically illiterate. Current ministers, like the Foreign Secretary Boris Johnson, Chancellor Philip Hammond and Home Secretary Amber Rudd, also want foreign students exempted from the total.

David Cameron’s government aimed to cut immigration figures – including overseas students in that aim meant trying to limit one of the UK’s crucial financial resources. They are worth £25bn to the UK economy, and their fees make up 14 per cent of total university income. And the impact is not just financial – welcoming foreign students is diplomatically and culturally key to Britain’s reputation and its relationship with the rest of the world too. Even more important now Brexit is on its way.

But they stayed in the figures – a situation that, along with counterproductive visa restrictions also introduced by May’s old department, put a lot of foreign students off studying here. For example, there has been a 44 per cent decrease in the number of Indian students coming to Britain to study in the last five years.

Now May’s stubbornness on the migration figures appears to have caught up with her. The Times has revealed that the Prime Minister is ready to “soften her longstanding opposition to taking foreign students out of immigration totals”. It reports that she will offer to change the way the numbers are calculated.

Why the u-turn? No 10 says the concession is to ensure the Higher and Research Bill, key university legislation, can pass due to a Lords amendment urging the government not to count students as “long-term migrants” for “public policy purposes”.

But it will also be a factor in May’s manifesto pledge (and continuation of Cameron’s promise) to cut immigration to the “tens of thousands”. Until today, ministers had been unclear about whether this would be in the manifesto.

Now her u-turn on student figures is being seized upon by opposition parties as “massaging” the migration figures to meet her target. An accusation for which May only has herself, and her steadfast politicising of immigration, to blame.

Anoosh Chakelian is senior writer at the New Statesman.

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