Last week, the Federal Reserve Bank of New York published a "Staff Reports" paper on "Repo and Securities Lending" which discusses the market for repurchase agreements and securities lending and calls for more disclosure and data on the sector. Written by Tobias Adrian, Brian Begalle, Adam Copeland, and Antoine Martin, the paper says, "We provide an overview of the data requirements necessary to monitor repurchase agreements (repos) and securities lending markets for the purposes of informing policymakers and researchers about firm-level and systemic risk. We start by explaining the functioning of these markets, then argue that it is crucial to understand the institutional arrangements. Data collection is currently incomplete. A comprehensive collection should include six characteristics of repo and securities lending trades at the firm level: principal amount, interest rate, collateral type, haircut, tenor, and counterparty."
The Fed staffers explain, "The markets for repurchase agreements (repos) and securities lending (sec lending) are part of the collateralized U.S. dollar-denominated money markets. While smaller than other money market instruments, the markets for repos and sec lending are crucial for the trading of fixed income securities and equities.3 Repos are especially important for allowing arbitrage in the Treasury, agency, and agency mortgage-backed securities markets, thus enhancing price discovery and market liquidity. Securities lending markets play crucial roles for allowing shorting, both in fixed income and equity markets. Given the essential role of these markets to the functioning and efficiency of the financial system, it is important to better understand and monitor repo and sec lending."
They continue, "The main purpose of this paper is to provide an overview of data requirements necessary to monitor repo and sec lending markets, and so inform policymakers and researchers about firm-level and systemic risk. One of the conclusions emerging from the paper is the need to better understand the institutional arrangements in these markets. To that end, we find that existing data sources are incomplete. More comprehensive data collection is worthwhile to both deepen our understanding of the repo and sec lending markets and also monitor firm-level and systemic risk in these markets. Specifically, we argue that six shared characteristics of repo and sec lending trades need to be collected at the firm level: 1. principal amount, 2. interest rate, 3. collateral type, 4. haircut, 5. tenor, and 6. counterparty."
The NY Fed writes, "In addition to the above, we believe there would be value in collecting data at the firm level on the instruments in which securities lending cash collateral is invested. These data would create a complete picture of the repo and sec lending trades in the market, and so allow for a deeper understanding of the institutional arrangements in these markets, and for accurate measurement of firm-level risk. Further, these data would allow for measures of the interconnectedness of the repo and sec lending markets, which allow for better gauges of the systemic risk in these markets."
Their Conclusion says, "In a recent speech on the "Implications of the Financial Crisis for Economics," Chairman Bernanke distinguished between Economic science, Economic engineering, and Economic management. Specifically, "Economic science concerns itself primarily with theoretical and empirical generalizations about the behavior of individuals, institutions, markets, and national economies. Most academic research falls in this category. Economic engineering is about the design and analysis of frameworks for achieving specific economic objectives. Examples of such frameworks are the risk-management systems of financial institutions and the financial regulatory systems of the United States and other countries. Economic management involves the operation of economic frameworks in real time--for example, in the private sector, the management of complex financial institutions or, in the public sector, the day-to-day supervision of those institutions." He goes on to add that "With that taxonomy in hand, I would argue that the recent financial crisis was more a failure of economic engineering and economic management than of what I have called economic science."
It adds, "Our argument in this paper is consistent with the Chairman's view and suggests that we need both better data and a better understanding of the institutional arrangements and the economic engineering in which key economic actors operate. The two go hand in hand. Good data helps to illuminate market functioning and can be useful to detect changes in market practices that could increase risk. A good understanding of institutional arrangements may be necessary to make sense of the patterns identified by the data and can suggest the need for new data as market infrastructure evolves."
Finally, the New York Fed paper says, "Better data is particularly important for understanding repo and securities lending markets and monitoring developments that may be indicative of stress. Such early warning signals can be the basis for policy decisions that aim at stabilizing the financial system. These are the money markets at the heart of the market based financial system. While repo markets are primarily enhancing the efficiency of fixed income markets, securities lending markets play central roles for both fixed income and equity markets. Repo and securities lending markets are especially important for allowing arbitrage in the Treasury, agency, and agency MBS markets, thus enhancing price discovery, efficiency, and market liquidity. Securities lending markets play crucial roles for allowing shorting of securities. However, both markets also perform liquidity transformation roles and are thus exposed to the drying up of liquidity. The repo market experienced such liquidity shortages in the week prior to the Bear Stearns crisis, and the securities lending portfolio in Maiden Lane II illustrates the risk in liquidity mismatches of securities lending. The differences in behavior between the tri-party and the bilateral repo market underscore this point. In the bilateral market, stress manifested itself in the form of a large and rapid increase in haircuts, creating a generalize run on the market. In the tri-party repo market, haircut barely moved but some firms experienced dramatic decrease in the amount of financing they obtained in this market. Hence, the structure of each market, and the nature of their participants, appears to have an impact on how stress manifested itself. Understanding these differences remains important."
