Repo markets play a huge role in the “shadow” banking system. They provide big banks with low-cost, short-term collateralized funding for their securities inventories, which increases liquidity. In return, lenders to repo transactions, frequently money market funds, get a low-risk, short-term investment vehicles.So it’s a big deal when there’s a disruption in the repo market, like the one that occurred during the financial crisis.
And a new Fitch study warns that the potential for another disruption in the credit markets has recently grown.
According to its data, the amount of riskier debt contained in repo transactions has steadily increased since the first half of 2009, and now stands at levels close to those prior to the ’08 market crash.
Structured finance now represents 20 per cent of total repo collateral.
The two main structured finance instruments should sound familiar: collateralized debt obligations and mortgage-backed securities.
And Fitch says subprime and Alt-A residential MBS now comprise nearly half the instruments in structured finance’s chunk of repo collateral.
Some of the largest issuers of this collateral, the agency adds, are financial institutions that nearly went under during the recession.
Of course, one could take away from this that the increase in risky assets on the market means confidence has increased.
But the memory of how these instruments contributed to the meltdown has not exactly faded.