If you have a moment, read this Bloomberg article. ?The brokers are utterly dishonest when they say:
Brokers contend that their borrowing is generally less risky than bank lending. Repo borrowing, for instance, is backed by collateral that can be readily sold to raise cash in case the other party defaults, said Steven Lofchie, co-chairman of the financial services group at Cadwalader, Wickersham & Taft LLP.
?If you think about a bank that is lending 90 percent against a house, versus a broker-dealer taking in 102 percent against a loan of a security, the broker-dealer?s credit risk is exponentially less,? Lofchie said.
This is true under ordinary circumstances, but not in a crisis, as we saw in 2008. ?Seemingly safe securities were no longer safe, because too many overleveraged parties could not hold their positions when the prices of their seemingly safe securities started to fall. ?This led to a panic, because of the structural error of financing long-dated securities with short-dated funding. ?In a crisis, that is the fatal flaw of repo financing.
I think the proposals of the SEC are decent, and those that the broker-dealers propose are not. ?I would go further and abolish repo markets. ?They are crisis-bait. ?The asset-liability mismatch invites trouble.
The proposal of the broker-dealers is flawed, because they don’t adopt a model where they match assets and liabilities. ?Stable systems match assets and liabilities. ?Until they do so, they should not be taken seriously. ?The math of risk control wars against them.
I grant that markets can move rather quickly, but repo’ed securities are marked to market daily, with increased cash payment required as a security drops in price. For security, I’d prefer to have a repo than an unsecured piece of paper.
The problems that occurred in 2008 aren’t likely to be the source of the next crisis. Like all generals, we’re great at fighting the last war! So there are no NINJA loans and little flaky collateral underlying repo -been there done that…
We now have little actual loan demand in the economy, so the rules requiring higher bank capital, and other capital increase requirements are benign. They will, however, choke off any budding expansion. The next shortage won’t be liquidity; it will be sufficiency of regulatory capital to support loans.