Let’s talk Repos – since it’s a topic under discussion in the Nevada Legislature, specifically in AB 196 being heard by the Assembly Committee on Government Affairs today. AB 196 is relatively straight forward:
There’s this part:
“Sections 1-3 of this bill authorize the investment of the money of this State, the State Permanent School Fund, the State Insurance Fund and the governing bodies of local governments in reverse-repurchase agreements if those agreements meet certain requirements, which are similar to the requirements on repurchase agreements, to avoid a violation of Section 3 of Article 9 of the Nevada Constitution. Sections 1-3 also impose additional requirements on reverse- repurchase agreements which depend upon the purpose for which the reverse- repurchase agreement is made.”
If the reaction to this verbiage is “Huh?” Let’s back up a step. Repurchase agreements (repos) and reverse repurchase agreements are defined as:
“A form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day.
For the party selling the security (and agreeing to repurchase it in the future) it is a repo; for the party on the other end of the transaction, (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement.” [Investopedia]
Still baffled? Here’s another way to explain the gamble:
“In a repo, borrowers agree to sell primarily government-backed bonds to another party for cash, with the promise to repurchase the bonds at a slightly higher price in the future. Borrowers are often hedge funds, and lenders are typically money-market funds. Banks stand in the middle, moving cash between the two.” [WSJ]
That “future” is tomorrow morning (more or less) and those government backed bonds are municipal bonds, state bonds, and/or federal treasuries of some form. If, say, the state insurance fund decided to buy securities of this type and sell them off almost immediately, that would be a “reverse repo” deal. The next question, of course, is why on God’s Green Earth we’d want to do this?
We really need to ask this question in light of the divestment in “repos” by the major banks, and the instability “repos” tend to create in financial markets. Gaze back in time, back to 2008, when Lehman Brothers was for all intents and purposes out of securities it could use as collateral to back up the short term loans it needed for its own survival. Lehman’s mad scramble to stay alive put a spotlight on the Repo Market on Wall Street. What lit up wasn’t pleasant.
Enter the Dodd Frank Act, which required banks to maintain more capital in order to absorb potential losses in the Repo Market. The banks, in turn, have cut back on their participation in the Repo Market game. [WSJ] However, the Repo Market at present isn’t all rose blossoms, there are still some thorns. As of August 2014, the Boston Fed chief was calling for still more capital reserves to maintain stability in the Repo Market. [NYT Dealbook] (see also: BFR pdf)
Thus we have a Repo Market which is still too volatile for the comfort of the Boston Federal Reserve, in which the major banks are diminishing their participation, and in which the sponsors of AB 196 would have our state and local governments dabble more vigorously. And, then there’s this:
“Section 3 eliminates the requirement that, when the governing body of a local government purchases commercial paper issued by certain corporations or depository institutions as an investment of its money, the purchase must be made from a registered broker-dealer. Section 3 also eliminates the prohibition against investing the money of the governing body of a local government in a repurchase agreement which involves securities that have a term to maturity at the time of purchase in excess of 10 years.” [AB 196]
Get that? AB 195 eliminates the requirement that the purchases must be made from a registered broker-dealer. Excuse me, but I get a bit nervous when state and local officials are informed that they can use unregistered broker dealers when those folks have been under SEC scrutiny since 2013. [Dinsmore] [Kurth] A registered broker-dealer has to submit to an SEC investigation, and oversight by the SEC and the Financial Industry Regulatory Authority – and yet AB 196 eliminates the need for such certification and oversight when state and local government funds are involved?
When a bill such as AB 196 allows such actions by county commissions, school boards, and county treasurers are invited to indulge in a bit of Wall Street Casino gaming without benefit of a certified, regulated, supervised broker-dealer – What could possibly go wrong? Other than Everything?