NEW YORK Feb 13 (Reuters) - Market participants in a key short-term funding market are not addressing the risk of destabilizing "fire sales" of collateral in the event of a default by one of the market's big players, and regulators may be forced to step in to reduce that risk, the Federal Reserve Bank of New York said on Thursday.
The so-called tri-party repurchase, or repo, market is at particular risk of seizing up entirely, as it did in the 2008 financial crisis, because investors in the sector are "highly vulnerable" to liquidity pressures and credit losses that could force them to sell the collateral of a defaulted counterparty, the New York Fed said.
The bank is one of 12 regional banks in the Federal Reserve system and the one tasked with overseeing the Fed's open market operations. It said no mechanism currently exists or is being developed by the banks and institutional investors in that market to ensure that investors will act collectively and in a measured way in liquidating their collateral.
"As noted by Federal Reserve Bank of New York President (William) Dudley in a recent speech, in the absence of a market-based solution to this risk issue, regulators may be forced to use the tools they have to take steps to reduce this risk," the bank said in a statement.