Stanton Champion

Yesterday I wrote about the Bear Stearns meltdown and I mentioned how they were felled by Repurchase Agreements or “repos.” I wanted to elaborate really quickly on what these are and why they are important.

Repos get used for a lot of purposes, but in summary they are short term loans. For banks, they’re useful because they let a bank tie their capital against very short terms securities that produce interest. This way, spare capital is put to use while still being accessible when needed.

For example, let’s say you put some money in a savings account with your local bank. Your bank may not have a use for that capital right away, so rather than have it languish while producing no return, your bank will repo the funds to someone else in exchange for some kind of collateral. A day later, a longer term loan may come through the bank that requires funding; so the bank will reclaim the capital from the repo along with a small amount of interest and then lend the funds to the third party.

Repos are important because they let banks, hedge funds, and corporations tie up their short term capital in interest producing securities. For many organizations, it’s normal that they may have excess cash one day and insufficient cash the next day, while on average they are cash positive. Repos provide a convenient way of managing that up and down flow while usually snagging some extra interest.

The repo market is hugely critical to the normal operations of a good chunk of the global economy, and letting Bear fail would have had a terrible effect on repo trading. At the very least, it would have made it tougher to reclaim capital from Bear’s counterparties, stalling many global banks and companies. At the worst it would have ground the global repo market to a halt, slaughtering a number of other banks and corporations in the process.