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The repurchase market and shadow banking: An introduction

shadow banking

Business reporters need to investigate where the money comes from. Use these tips to dive into covering the repurchase market.

By Mary Fricker

Covering the repurchase market is not hard at all. We reporters just have to start asking different questions when we write business stories.

In addition to asking what a company, financial institution or other organization does to make a profit – for example, make mortgages, sell cars, grow corn, manufacture widgets, manage investments, run governments, or make business loans – we have to ask where they’re getting the money to operate.

In other words, in addition to asking where money goes to, we need to ask where it comes from.

Often, the money is borrowed. We should write about that, which means we’ll be reporting on the credit markets. Hooray.

As we look at borrowings, we will sometimes find that the organization gets money by getting repurchase loans. Or we may find that it’s borrowing from a financial institution that gets money by getting repurchase loans. Often, the chain of debt will go back to the repurchase market.

And if we look at what the organization does with its cash, we may find that it’s earning interest by making repurchase loans.

This is not hard work. Repurchase agreements are listed on financial statements and elaborated upon in the notes. We just need to understand what we’re seeing.

What we’re seeing are very short-term loans that the lenders can withdraw in a flash, often overnight, leaving the borrower desperate for cash flow and headed for bankruptcy. Think Bear Stearns, Countrywide, Lehman Brothers and Long-Term Capital Management.

Here’s how a repurchase loan works: The borrower puts up securities as collateral, gets cash from the lender, and promises to repay the loan soon – to “repurchase” the securities – often the next day.

That’s it. This is not rocket science.

MORE on COVERING
THE REPURCHASE MARKET
AND SHADOW BANKING

An introduction
Resources
Story ideas
Tips for localizing

Repo borrowers have securities and want cash. Repo lenders have cash and want to use it to make money. Often participants in the repurchase market are both borrowers and lenders.

In 2007 and 2008, repo lenders lost faith in the ballooning pile of mortgage securities they were taking as collateral, and then they lost faith in the borrowers. They started calling their repo loans and stopped other short-term lending. Almost overnight, credit markets ground toward a halt, thrusting the economy into the worst recession since the Great Depression. Now that’s a great story.

I like to think that if we business reporters had been looking at where mortgage lenders were suddenly getting all that money to make home loans, we would have seen they were getting a lot of it by borrowing very short term – mainly getting repo loans and selling asset-backed commercial paper – and we would have warned our readers about the danger.

Footnote: If this can happen with repo, it can happen with any other large financial market built on short-term debt (except deposits that have FDIC insurance). We must keep a critical eye for exuberant growth in any short-term credit instruments. We do this by covering the credit markets on a daily basis, by always understanding where the organizations on our beats are getting their money.

About the Author

The Reynolds Center, created through generous grants from the Donald W. Reynolds Foundation of Las Vegas and operated by ASU’s Walter Cronkite School of Journalism and Mass Communication, is dedicated to improving the quality of business and economics coverage through training programs for business reporters and editors.

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