By Jonathan Spicer and Dan Burns
NEW YORK Feb 13 The banks and big funds in a
key short-term funding market have not even begun to address the
risk of destabilizing "fire sales," and the lack of action may
force regulators to step in with new rules, the Federal Reserve
Bank of New York warned on Thursday.
The market for so-called tri-party repurchases, or repos,
is at particular risk of seizing up entirely, as it did in the
2008 financial crisis, if a big player defaults, the New York
Fed said. It added investors are "highly vulnerable" to
liquidity pressures and credit losses that could force them to
dump collateral in a fire sale.
The stern warning from the branch of the U.S. central bank
suggested regulators are growing frustrated with the lack of
industry action to fix a problem that was at the heart of the
financial crisis more than five years ago.
The New York Fed, which is tasked with overseeing the Fed's
open market operations, said no mechanism currently exists or is
being developed by the banks and funds in the tri-party 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.
"Fire sale risk remains a critical policy concern of the
Federal Reserve and other members of the U.S. regulatory
In repurchase agreements lenders, such as money funds, make
short-term loans to banks or other borrowers and receive
collateral such as Treasuries or other bonds. Banks then often
make similar loans to far more leveraged investors such as hedge
A fire sale can happen when a dealer comes under stress and
dumps assets in a bid to shore up its liquidity, depressing
asset values that hurt other firms then have to sell in an
Worries over a fire sale of collateral against repos at Long
Term Capital Management (LTCM) when it almost defaulted in 1998
led to a group of banks having to purchase the fund and then
slowly unwind the firm. Then in September 2008, the repo market
rapidly dried up when investment bank Lehman Brothers failed.
The two clearing banks for tri-party transactions, JP Morgan
Chase & Co and Bank of New York Mellon, have
adjusted systems in the last two years to reduce the use of
intra-day credit, but the New York Fed said little has been done
to better manage risk.
The regulator made that recommendation two years ago; in
October, Dudley said government agencies may need to intervene.
While it is unclear what the Fed and other U.S. market
regulators could do, the threat of new rules has alarmed members
of a European capital markets association, which worries the
Americans will adopt an ill-suited solution.
Fed Governor Jeremy Stein said in October that regulators
have tools they can employ to help shore up liquidity at
individual companies such as banks, including risk-based
capital, liquidity and leverage requirements. He noted, however,
that none are a comprehensive solution to the problem of repo
market fire sales.