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Special Feature: Collateral

Repurchase agreements and the (de)construction of financial markets

Pages 315-341
Published online: 29 Jul 2019
 
Translator disclaimer

The safety of repurchase agreements (repos) depends on the neoclassical premise that markets are reliable sources of liquidity; repos in practice disprove the theory by generating collateral calls, collateral sales, liquidity events, and liquidity-driven losses for repo-borrowing funds and their end investors. As repo-type lending now dominates money markets, borrowers’ self-protective preference for ‘safe assets’ as collateral has distorted financial markets, disrupting private investment, and economic performance. Using a balance sheet approach this paper explains the liquidity-supporting role of the traditional banking system and contrasts it with the liquidity-demanding repo-based financial system. The paper also argues that contractual structure determines the balance of power in private sector loans, that no private loan is ‘safe’ for both borrower and lender, and that repo has shifted the balance of safety decisively in favour of lenders.

Additional information

Author information

Carolyn Sissoko

Carolyn Sissoko has a PhD in economics from UCLA and a JD from the University of Southern California. She has taught at the University of Southern California’s Gould School of Law and Occidental College.

Acknowledgements

I thank Nina Boy for her extraordinary, demanding commentary on multiple revisions. I also thank Daniela Gabor, Charles Goodhart, Geoff Miller, and participants in the NYU-ETH Law & Bank/Finance Conference for excellent comments. All errors are, of course, my own.

Disclosure statement

No potential conflict of interest was reported by the author.

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