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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The NS leader: Cold Britannia

Twenty years after the election of New Labour, for the left, it seems, things can only get worse. 

Twenty years after the election of New Labour, for the left, it seems, things can only get worse. The polls suggest a series of grim election defeats across Britain: Labour is 10 points behind the Conservatives even in Wales, putting Theresa May’s party on course to win a majority of seats there for the first time in a century. Meanwhile, in Scotland, the psephologist John Curtice expects the resurgent Tories, under the “centrist” leadership of Ruth Davidson, to gain seats while Labour struggles to cling on to its single MP.

Where did it all go wrong? In this week’s cover essay, beginning on page 26, John Harris traces the roots of Labour’s present troubles back to the scene of one of its greatest triumphs, on 1 May 1997, when it returned 418 MPs to the Commons and ended 18 years of Conservative rule. “Most pop-culture waves turn out to have been the advance party for a new mutation of capitalism, and so it proved with this one,” Mr Harris, one of the contributors to our New Times series, writes. “If Cool Britannia boiled down to anything, it was the birth of a London that by the early Noughties was becoming stupidly expensive and far too full of itself.”

Jump forward two decades and London is indeed now far too dominant in the British economy, sucking in a disproportionate number of graduates and immigrants and then expecting them to pay £4 for a milky coffee and £636,777 for an average house. Tackling the resentment caused by London’s dominance must be an urgent project for the Labour Party. It is one that Mr Corbyn and his key allies, John McDonnell, Emily Thornberry and Diane Abbott, are not well placed to do (all four are ultra-liberals who represent
London constituencies).

Labour must also find a happy relationship with patriotism, which lies beneath many of the other gripes made against Mr Corbyn: his discomfort with the institutions of the British state, his peacenik tendencies, his dislike of Nato and military alliances, his natural inclination towards transnational or foreign liberation movements, rather than seeking to evolve a popular national politics.

New Labour certainly knew how to wave the flag, even if the results made many on the left uncomfortable: on page 33, we republish our Leader from 2 May 1997, which complained about the “bulldog imagery” of Labour’s election campaign. Yet those heady weeks that followed Labour’s landslide victory were a time of optimism and renewal, when it was possible for people on the left to feel proud of their country and to celebrate its achievements, rather than just apologise for its mistakes. Today, Labour has become too reliant on misty invocations of the NHS to demonstrate that it likes or even understands the country it seeks to govern. A new patriotism, distinct from nationalism, is vital to any Labour revival.

That Tony Blair and his government have many detractors hardly needs to be said. The mistakes were grave: the catastrophic invasion of Iraq, a lax attitude to regulating the financial sector, a too-eager embrace of free-market globalisation, and the failure to impose transitional controls on immigration when eastern European states joined the EU. All contributed to the anger and disillusionment that led to the election as Labour leader of first the hapless Ed Miliband and then Jeremy Corbyn, a long-time rebel backbencher.

However, 20 years after the victory of the New Labour government, we should also acknowledge its successes, not least the minimum wage, education reform, Sure Start, a huge fall in pensioner poverty and investment in public services. Things did get better. They can do so again.

The far right halted

For once, the polls were correct. On 23 April, the centrist Emmanuel Macron triumphed in the first round of the French election with 24 per cent of the vote. The Front National’s Marine Le Pen came second with 21.3 per cent in an election in which the two main parties were routed. The two candidates will now face off on 7 May, and with the mainstream candidates of both left and right falling in behind Mr Macron, he will surely be France’s next president.

“There’s a clear distinction to be made between a political adversary and an enemy of the republic,” said Benoît Hamon, the candidate of the governing Parti Socialiste, who had strongly criticised Mr Macron during the campaign. “This is deadly serious now.” He is correct. Mr Macron may be a centrist rather than of the left but he is a democratic politician. Ms Le Pen is a borderline fascist and a victory for her would herald a dark future not just for France but for all of Europe. It is to Donald Trump’s deep shame that he appeared to endorse her on the eve of the vote.

This article first appeared in the 27 April 2017 issue of the New Statesman, Cool Britannia 20 Years On

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