| NEW YORK
NEW YORK May 7 Next to nothing stands in the
way of a destabilizing fire sale in a vast part of U.S.
financial markets if a dealer were to default, top Federal
Reserve researchers warned in a paper that aims to rejuvenate
debate over supervising the industry.
The paper on the triparty repo market, published Tuesday,
finds regulators have "limited" tools to stop dealers from
rapidly selling off these assets when they face default, and,
once a dealer defaults, they have "no established" tools to stop
investors from dumping the assets.
The paper is co-authored by the head of research at the New
York Fed, James McAndrews, and could help kick-start stalled
discussions on how to safeguard the nearly $2-trillion triparty
repurchase agreement market, known as triparty repo.
Reforms have only inched forward since the 2007-2009
financial crisis when the repo market came under severe stress
as investors liquidated holdings, prompting the U.S. central
bank to launch emergency lending facilities.
Yet triparty's problems were first laid bare back in 1998
when Long Term Capital Management (LTCM) collapsed and needed a
bailout after a fire sale at the fund sapped liquidity and
rocked U.S. markets.
The case of LTCM "underscores the need for a
well-established arrangement to be set up in advance," argue the
New York Fed researchers, who include McAndrews, Brian Begalle,
Antoine Martin and Susan McLaughlin.
"Because of the size of this market and the fact that some
of its participants are vulnerable to runs, fire sales are
particularly likely," they say.
The repos are a prime source of short-term bank funding and
are backed by Treasuries or riskier collateral, including
Large, rapid sales of the assets could depress their prices
and lead to even more losses and dwindling capital for firms
facing defaults, possibly forcing others to dump assets too.
Last summer the New York Fed unveiled reforms that would
force banks to reduce their reliance on the short-term loans.
And in February, New York Fed President William Dudley advocated
expanding the U.S. central bank's backstop to triparty dealers
doing "socially useful" business or forcing them to rely more on
Last month the country's top financial stability group, the
Financial Stability Oversight Council, singled out triparty
repos in an annual report warning that short-term funding
markets for banks remain susceptible to runs.
The landmark 2010 Dodd-Frank U.S. financial reform law
includes some tools to wind down a so-called systemically
important broker dealer, "but these might not be invoked,
creating possibly damaging uncertainties," the paper argues.
Stopping a post-default fire sale requires a pre-established
mechanism for the "orderly liquidation of triparty collateral,
including by funding such instruments for a period of time and
clarifying the incidence of any losses," it says, adding dealers
will likely need to be actively engaged in the process.