Repo Runs: Evidence from the Tri‐Party Repo Market

Abstract

The repo market has been viewed as a potential source of financial instability since the 2007 to 2009 financial crisis, based in part on findings that margins increased sharply in a segment of this market. This paper provides evidence suggesting that there was no system-wide run on repo. Using confidential data on tri-party repo, a major segment of this market, we show that, the level of margins and the amount of funding were surprisingly stable for most borrowers during the crisis. However, we also document a sharp decline in the tri-party repo funding of Lehman in September 2008. of the Task Force on Tri-Party Repo Infrastructure for helpful comments on an earlier draft. We would also like to thank an anonymous referee and Associate Editor for their helpful suggestions. All remaining errors are our own.The Journal of Finance R percentage, is called the "margin" and measures the extent to which the cash loan is overcollateralized. 1 The repo market is an important financial market because it is a key source of short-term funding for securities dealers and some of their clients. 2 This market is also critical for secondary market liquidity in Treasuries and other securities, and plays an important role in the pricing and price discovery of cash and derivatives instruments.The U.S. repo market comprises several segments. As we describe in detail in Section I, it is useful to distinguish the bilateral market, where the settlement of the repo is handled by the trading parties, from the tri-party repo market, where a third party provides settlement and collateral management services. These two segments behaved very differently during the crisis.Gorton and Metrick (2012) study data from a high-quality dealer trading with other high-quality dealers in the bilateral repo market. They show that margins increased dramatically, similar to the "margin spirals" modeled in Brunnermeier and Pederson (2009) (see also Adrian and Shin (2010)). Looking at data from another segment of the bilateral market, in which dealers lend to their clients (notably hedge funds), we find similar increases in margins.Hence, it appears that the bilateral repo market suffered from a tightening of financing conditions. In the tri-party repo market, however, margins for all but the lowest quality collateral changed very little, as shown in Figure 1.We discuss this figure in more detail later in the paper, but note here that margins for repos collateralized by U.S. Treasuries and agency debentures did not change throughout the crisis. Furthermore, margins for repos backed by the lowest quality collateral used in the tri-party repo market, labeled "nongovernment," increased by only two percentage points, from 5% to 7%. This increase is much less pronounced than in the bilateral market we study. Figure 2 shows the differences in the average margin for overnight repos between the segment of the bilateral market for which we have data and the tri-party repo market. These spreads are sizable for corporate bonds (over 10 percentage points in 2009) and en...

Wholesale Funding Dry‐Ups

“…To the best of our knowledge, this is the first empirical analysis of the CD market. Most papers to date study repo markets (Gorton and Metrick (2012), Krishnamurthy, Nagel, and Orlov (2014), Copeland, Martin, and Walker (2014), Mancini, Ranaldo, and Wrampelmeyer (2015), Boissel et al (2017)), and often find that these markets did not freeze during the recent financial crisis. In contrast to these studies, we focus on unsecured borrowing, which is arguably more fragile.…”

The Risk of Fire Sales in the Tri-Party Repo Market

“…Idiosyncratic loss of access to secured funding would typically occur when lenders run from a dealer because of concerns about its solvency. Copeland, Martin, and Walker (2014) provide evidence of a sharp reduction in the amount of triparty repo funding at Lehman in the days before the holding company declared bankruptcy. Their paper also provides evidence consistent with Gorton and Metrick (2012) and Krishnamurthy, Nagel, and Orlov (2014), suggesting that, in the bilateral repo market, investors appear more willing to increase margins when a repo becomes more risky because either the borrower or the collateral becomes more risky.…”

“…The largest dealers transact with a number of different tri-party repo lenders. Copeland, Martin, and Walker (2014) show that, until a few days before Lehman's declaration of bankruptcy, its U.S. broker-dealer subsidiary had more than 60 different cash investors. 32 Upon the default of a large dealer, many investors would have incentives to sell their assets quickly and might not take into account the combined effect of those sales on the market price of the assets.…”

The Macroeconomics of Shadow Banking

“…There is a smaller drift in χ t in the economy without shadow banking due to its nonlinearity (see (C1)).19 For evidence of collateral runs in the repo market during the 2008 financial crisis, seeGorton and Metrick (2012),Krishnamurthy, Nagel, and Orlov (2014),and Copeland, Martin, and Walker (2014).20 In fact, the destruction of capital has a dampening effect on asset prices because it lowers the risky capital share, pushing it closer to its target at high uncertainty (seeFigure 4). We also note that the initial drop in χ t is larger in the no-shadow banking economy because its steady-state value of χ t is closer to one-half, the point at which a given drop in asset a impacts χ t the most (see equation(C1)).…”