July 17, 2018

Fair Game: After a Financial Flood, Pipes Are Still Broken

Many of the nation’s bankers, lawmakers and regulators might well say yes, arguing that safeguards have been put in place to protect against another cataclysm. The voluminous Dodd-Frank law, with its hundreds of rules and new regulatory regimes, was the centerpiece of these efforts.

And yet, for all the new regulations governing derivatives, mortgages and bank holding companies, a crucial vulnerability remains. It’s found in our vast and opaque securities financing system, known as the repurchase obligation or repo market. Now $4.6 trillion in size, it is where almost every financial crisis since the 1980s has begun. Little has been done, however, to reduce its risks.

The repo market, also known as the wholesale funding market, is the plumbing of the financial system. Without it, money could not flow freely, and banks, brokerage firms and asset managers would not be able to conduct their trades and open for business each day.

When institutions sell securities in this market, they do so with the promise that they can be repurchased the next day — hence the “repo market” name. By using this market, banks can finance their securities holdings relatively cheaply, money market funds can invest cash productively and institutions can borrow securities so they can sell them short or deliver them in other types of trades.

Among the biggest participants that provide funding in this market are the money market mutual funds; they lend their cash to banks and other institutions, accepting collateral like mortgage securities in exchange. The money market funds accept a small amount of interest on these overnight loans in exchange for being able to unwind the transactions daily, if need be.

When markets are operating smoothly, most wholesale funding trades are not unwound the next day. Instead, they are rolled over, with both parties agreeing to renew the transaction. But if a participant decides not to renew because of concerns about a trading partner’s potential failure, trouble can arise.

In other words, this is a $4.6 trillion arena operating on trust, which can disappear in an instant.

Both Bear Stearns and Lehman Brothers collapsed after their trading partners in the repo market became nervous and stopped lending them money. For decades, the firms had financed their holdings of illiquid and long-term assets — like mortgage securities and real estate — in the overnight repo markets. Not only was the repo borrowing low-cost, it also allowed them to leverage their operations. Best of all, accounting rules let repo participants set aside little in the way of capital against the trades.

“It was a very unstable form of funding during the crisis and it is still a problem,” said Sheila Bair, former head of the Federal Deposit Insurance Corporation, and chairwoman of the Systemic Risk Council, a nonpartisan group that advocates financial reforms, in an interview. “The repo market is also highly interconnected because the trades are done between financial institutions.”

Some government officials have also voiced concerns recently about risks in the repo market. William C. Dudley, president of the Federal Reserve Bank of New York, referred to the issue in a February speech and Ben S. Bernanke, the Fed chairman, discussed the problems with wholesale funding in a speech in May. The Securities and Exchange Commission published a bulletin in July on the vulnerabilities in the repo market as they relate to money market funds.

Another problem in this market is that only two banks — Bank of New York Mellon and, to a lesser degree, JPMorgan Chase — dominate the business. There used to be a number of clearing banks, as the banks that stand in the middle of the trades are known, but the ranks have dwindled because of industry consolidation.

Unfortunately, these weaknesses remain. “A lot of things have been done to address a lot of specific problems but it doesn’t seem like anything has been done to address the overall problem of institutions losing access to financing,” said Scott Skyrm, a repo market veteran and author of “The Money Noose — Jon Corzine and the Collapse of MF Global.”

Mr. Skyrm said regulators appeared to be tackling the problem through a back door involving capital requirements. For example, new leverage ratios proposed by the international Basel Committee and United States financial regulators would require banks for the first time to set aside capital against the assets they finance in the repo markets. A recent report from J.P. Morgan estimates that under the Basel proposal, the eight largest domestic banks would have to raise $28 billion to $34 billion in capital relating to their repo business.

Banks are likely to consider an alternative: shrinking their repo operations. But the liquidity in this titanic market is essential for the government’s financing of its debt. As the J.P. Morgan report noted, trading volumes in the United States government bond market are closely linked to the amount of repos outstanding. So any contraction in the arena may reduce liquidity in the Treasury market.

SOME experts think that the answer to the repo problem lies in creating a central clearing platform that would allow all participants, not just the banks, to trade directly. Similar platforms have been mandated for derivatives under Dodd-Frank and could be constructed to support the wholesale funding market.

While such an entity would be a too-big-to-fail institution, so are the two banks now serving as intermediaries. And a central clearing platform could be set up as a utility, with officials monitoring transactions and requiring margin payments to finance bailouts in the event of a participant’s default.

Peter Nowicki, the former head of several large bank repo desks, is an advocate of this idea. “Repo is the last over-the-counter market that’s not headed toward central clearing and the Fed should mandate a change,” he said. “Should a large dealer have a problem or the clearing banks have an issue, the repo market could shut down.”

And that, five years after the Lehman collapse, would be an unconscionable failure.

Article source: http://www.nytimes.com/2013/09/15/business/after-a-financial-flood-pipes-are-still-broken.html?partner=rss&emc=rss

High & Low Finance: Foreign Banks in U.S. Face Greater Restrictions

Those days are gone. Despite a lot of talk about the need for international cooperation in regulation, it now appears that American regulators intend to assure that foreign banks operating in the United States have adequate capitalization.

It was not always such. Until the financial crisis, the Federal Reserve was happy to allow American subsidiaries of foreign banks to have no capital at all, and some did not. At the end of 2007, Deutsche Bank’s American operations reported having a negative $8.8 billion in capital.

How could any regulator allow that? The idea was that the presumably well-capitalized parent back home would stand behind the American operation if it ran into trouble. And the United States could, of course, rely on home countries to both regulate their banks and, if something went badly wrong anyway, provide bailouts.

But as the crisis approached, some funny things were happening. Until the turn of the century, American operations of foreign banks tended to receive financing from home. But as the credit party grew after 2003, those banks increasingly borrowed in America’s short-term markets and sent the money back home to the parent.

When the credit crisis appeared, that financing — a significant part of which had come from selling short-term securities to United States money market funds — dried up.

“Foreign banks that relied heavily on short-term U.S. dollar liabilities were forced to sell U.S. dollar assets and reduce lending rapidly when that funding source evaporated, thereby compounding risks to U.S. financial stability,” Daniel K. Tarullo, a Fed governor, said in a speech late last year.

The foreign banks ended up needing a disproportionate share of loans the Fed handed out to stabilize banks. And since then the ability, let alone the willingness, of some countries, particularly in Europe, to provide what the Fed delicately calls “backstops” — a term that sounds much less harsh than “bailouts” — appears to have diminished.

In December, the Fed proposed new rules that have set off loud protests from overseas and are likely to provoke a flood of complaints before the comment period ends on Tuesday.

The rules would require that American subsidiaries of each foreign bank be put together in a holding company that would have to maintain capital, and liquidity, in the United States. In some cases the requirements would be greater than home countries require of the parent institutions.

In a letter to the Fed, Michel Barnier, the European commissioner in charge of internal markets, complained that the proposal was “a radical departure” from internationally accepted policies. He darkly warned that if the Fed did not back down and accept that Europe will do a perfectly good job of regulating its own banks, the new rules “could spark a protectionist reaction” from other countries and bring on “a fragmentation of global banking markets and regulatory frameworks.”

The proposed rules seem to be particularly objectionable to some European banks in two ways. The first is the introduction of an effective 5 percent leverage ratio — calculated as the equity capital of the operation divided by the total amount of assets.

To banks with a lot of securities market activities, that sounds like a harsh rule. Deutsche Bank is particularly upset.

Some other European banks seem to be worried by the application of rules requiring an adequate level of very liquid assets relative to the bank’s short-term financing. The idea there is that if the short-term financing dries up again, the bank will be able to cope for at least a brief period without having to either conduct a fire sale of assets or turn to the Fed for help.

These rules might not actually require the banks to raise a lot of cash, or invest a lot of money in low-returning assets. To meet the liquidity rules, a bank could add more superliquid securities, like United States Treasury or agency securities. Or it could change its financing. Rather than borrowing huge sums overnight, it could borrow at longer maturities, perhaps 45 days. Then it would not need as many liquid assets.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2013/04/26/business/foreign-banks-in-us-face-greater-restrictions.html?partner=rss&emc=rss

Economix Blog: From Lehman to Cyprus

FLOYD NORRIS

FLOYD NORRIS

Notions on high and low finance.

The European decision not to honor deposit insurance in Cyprus, by making all depositors contribute to the cost of a bailout, reminds me of the decision to let Lehman Brothers go under. Moral hazard is being avoided. The question is what that will cost.

In the case of Lehman, the cost turned out to be far greater than anyone expected. Suddenly the crisis was affecting money market funds. We learned to our discomfort just how interrelated the world’s markets were. I doubt anyone involved in making the decision thought about money market funds until they learned one had just blown up, thanks to the Lehman failure.

In the wake of all the bailouts that followed Lehman, something of a consensus has evolved — at least among non-central bankers — that those who fund bad banks should suffer. Bank bondholders are clearly at risk.

But Cyprus banks apparently don’t have many bonds. If someone is going to suffer, it will be the depositors. So the clever idea of a one-time tax on bank deposits was adopted. It did not help the cause of the depositors that a lot deposits seem to come from Russian moguls, not exactly a sympathetic group.

But Europe should have learned from Britain’s fiasco at Northern Rock that deposit insurance matters, particularly for relatively small accounts. If they can wipe out such insurance in Cyprus, why not Spain? Or Italy? Or even France?

There is a risk that a lot of money will flow out of troubled countries’ banks. Those flows had started to reverse last year, after the European Central Bank stepped up to print money and reassure investors in government bonds. Now, there is every reason for depositors to seek out banks in the safest countries — and that means Germany.

Europe stands to save $7 billion out of the $17 billion a Cyprus bailout would cost. How does that compare with the cost of a run on Italian banks? There is no evidence the Europeans weighed that. Just as there is no evidence that the United States Treasury had any idea at all just how disastrous it would be if Lehman were allowed to fail.

The time to avoid moral hazard is when there is none. How is it that Cyprus banks were allowed to have capital structures that meant depositors had to suffer? How was it that Lehman had no liquidity when it needed it? Bad regulation is the answer.

Markets are down on Monday, but not disastrously. Perhaps it will turn out my fears are overstated, and that depositors will not panic in other countries. Let’s hope so.

Article source: http://economix.blogs.nytimes.com/2013/03/18/from-lehman-to-cyprus/?partner=rss&emc=rss

Common Sense: An Unthinkable Risk at a Brokerage Firm

Until the collapse of MF Global, that’s a question I thought I’d never have to ask.

Brokerage firms are required by law to maintain segregated accounts holding all client assets, including stocks, bonds, mutual funds, money market funds and cash. The law was passed after the 1929 crash, in the depths of the Depression, to make sure that customer assets were there at all times, ready to be disbursed even if everyone asked for their money at once.

This obligation to protect customer assets “is considered sacrosanct,” Robert Cook, director of the division of trading and markets at the Securities and Exchange Commission, told me this week. “It’s considered a sacred obligation.”

Lehman Brothers may have engaged in many foolhardy practices, but even in the firm’s last days, when officials were desperate for cash, no one dared touch customer assets, which remained safely segregated despite the firm’s collapse.

And then came the revelation that an estimated $1.2 billion in customer assets had vanished at MF Global, the large brokerage and futures trading firm headed by Jon S. Corzine, the former Goldman Sachs executive and Democratic politician, that collapsed in late October after a catastrophic bet on European sovereign debt.

How could such a thing happen? I had always assumed it was impossible and that strict internal controls existed at all brokerage firms so that firm officials couldn’t tap segregated customer funds even if they were willing to break the law. Thanks to MF Global, it’s now apparent that isn’t necessarily true. “If people are determined to misuse customer funds, they will misuse them,” said Ananda Radhakrishnan, the director of the division of clearing and risk at the Commodities Futures Trading Commission.

That’s because the commodities and securities industry is mostly self-regulating, and self-regulation ultimately depends on the integrity of the regulated. Broker-dealers — securities firms that execute trades of stocks, bonds and other assets for customers — are overseen by the S.E.C., while futures commission merchants, which trade commodities, derivatives and futures, are regulated by the C.F.T.C. Like most large brokerage firms, MF Global was both a broker-dealer and a futures commission merchant, though its primary business was commodities futures trading.

The federal regulators issue and enforce the rules, but day-to-day oversight for securities firms is delegated to the Chicago Board Options Exchange, a for-profit company, and the Financial Industry Regulatory Authority, or Finra, a nonprofit organization financed by the brokerage industry. For commodity dealers, it’s the National Futures Association and the Chicago Mercantile Exchange. They conduct periodic examinations and audits and, in addition, member firms are required to have internal controls and compliance mechanisms to make sure that customer assets remain safely segregated at all times.

Typically, this requires transfers from segregated accounts (other than at the customer’s request) to be approved by multiple officials, including in many cases, the firm’s chief financial officer and chief compliance officer.

“It’s not a low-level functionary,” a regulator said. “It’s someone who has real standing. Most customer assets are held at the biggest firms and they have scores of people involved in this process.”

Susan Thomson, a spokeswoman for Merrill Lynch, the nation’s largest brokerage firm, said that any transfer from segregated accounts there required “at least three checks and possibly more.” Officials from operations, regulatory reporting and collateral are usually involved and sometimes compliance officials, as well. “There are multiple streams of responsibility. You have management accountability in each of those streams on a daily basis,” she said.

MF Global also had internal controls and a chief compliance officer, which raises the question: How did the customer assets ever leave the segregated accounts to begin with? In testimony on Capitol Hill on Thursday, Mr. Corzine only added to the mystery. He said that transferring customer funds was “a complex process” and, asked who could execute such a transfer, said “I wouldn’t know probably who that person is.”

Article source: http://feeds.nytimes.com/click.phdo?i=fb13460a3454317f6627dceb6cbe237b

Economix Blog: Why Do Foreign Banks Need Dollars?

Karen Bleier/Agence France-Presse — Getty Images

The announcement Wednesday that the Federal Reserve, working with other central banks, will offer dollars to foreign banks at cut-rate prices surely raises the question: Why do foreign banks need dollars?

The simple answer is that foreign banks really like the things that dollars can buy. They liked investing in American government debt, and lending money to American corporations, and most of all they liked buying American mortgages and all manner of crazy investments derived from those mortgages.

Bank holdings of assets denominated in foreign currencies ballooned from $11 trillion in 2000 to $31 trillion by mid-2007, according to a 2009 report by the Bank for International Settlements. European banks posted the fastest growth, and that growth was concentrated in dollar-denominated assets. By the eve of the crisis, the dollar exposure of European banks exceeded $8 trillion.

Many of these investments were funded on a short-term basis. The paper from the Bank for International Settlements estimates that European banks had a constant need for $1.1 trillion to $1.3 trillion in short-term funding. The banks raised that money mostly by borrowing domestically and then acquiring dollars through foreign-currency swaps. Banks also sold short-term debt to American money-market funds.

The financial crisis happened in large part because investors stopped providing banks with short-term funds. They lost confidence in their ability to discern which banks could repay such loans.

In response, the Fed started offering dollar loans to foreign banks in December 2007. At the peak of the lending program, in December 2008, foreign banks held more than $580 billion provided by the Fed. The European Central Bank accounted for half the peak total, $291 billion. Loans to the Bank of Japan peaked at $123 billion, but most of the rest of the dollars also went to Europe, to the Bank of England, the Swiss National Bank and the central banks of Sweden, Norway and Denmark.

An analysis by the Federal Reserve Bank of New York, published earlier this year, found that the dollar loans played an important role in stabilizing foreign banks during the financial crisis. (Those banks also borrowed directly from the Fed, in large quantities, through American subsidiaries.)

Forward to the present moment: European banks have tried to reduce their dollar exposure since 2008 by shedding dollar-denominated investments and avoiding new ones. The Bank for International Settlements said in a 2010 paper that the short-term dollar needs of European banks might have declined to as little as $800 billion by the end of 2009. It is likely that banks have made some additional progress over the last two years. But the funding need remains considerable, and once again private investors like money-market mutual funds are pulling back from lending.

And once again the Fed is stepping in, although so far it has lent only $2.4 billion.

Article source: http://feeds.nytimes.com/click.phdo?i=447ced4469ec7997e24a3d7961cabeeb

News Analysis: Banks Reassured by Euro Deal, but Italy Remains a Worry

The mandatory recapitalization was one of the main achievements of European leaders’ summit meeting that ran into the early hours Thursday in Brussels. But it will not be enough to erase doubts about banks’ creditworthiness and restore their access to international money markets, analysts said.

The big problem is that Italy, with its dysfunctional politics and nearly €2 trillion, or around $2.8 trillion, in outstanding debt, has supplanted Greece as the biggest threat to European banks and the biggest source of investor anxiety. If Italy were to have trouble servicing its debt, no amount of fresh capital could protect the European banking system.

“Everything depends on Italy,” said Lüder Gerken, director of the Center for European Policy in Freiburg, Germany. “If Italy goes under, a recapitalization won’t do anything.”

“Italy has to make fundamental reforms,” he added. If not, “then the euro is history.”

Like most of what emerged from Brussels, the plan to strengthen banks was seen as good, but not quite good enough.

The measures start to address the fragility of the European banking system, one of the core elements of the debt crisis. Continental banks generally have lower reserves than their U.S. counterparts, making them less able to absorb losses from their holdings of government bonds or other troubled assets.

As a result, many European banks have been cut off by U.S. money market funds and other wholesale lenders, and have become dependent on emergency funds provided by the European Central Bank. The recapitalization plan would compel 70 European banks to raise an estimated €106 billion by mid-2012, according to the European Banking Authority, which will oversee the drive. They will be required to hold reserves equal to 9 percent of the money they have at risk. And they will be required to recognize market losses in their holdings of government bonds.

Banks would also get government guarantees to help them issue bonds for longer periods, though details remain to be worked out. Analysts said the guarantees were one of the most positive aspects of the plan because they would help provide banks with a steadier source of funds.

Banks can increase their reserves by hanging on to profits rather than distributing them to shareholders, or by selling assets to reduce overall risk. As a last resort, they can turn to their governments or the euro zone rescue fund. But most will do anything to avoid the government involvement and the accompanying restrictions on executive pay that would result.

“One thing goes without saying: We do not intend to make use of public funds,” Eric Strutz, the chief financial officer of Commerzbank in Frankfurt, said in a statement.

The potential losses from Greek debt are now easier to quantify, at least. As part of an agreement with representatives of banks and insurers, investors will accept a 50 percent cut in the face value of Greek bonds. Details remain unclear, but it appeared that Greek creditors would receive guarantees of some kind to protect them from further losses.

Christian Noyer, the governor of the Bank of France, said banks in that country and elsewhere in Europe can handle the 50 percent loss without problems, in most cases. Some had already factored it into their accounting. While a handful of banks in Greece will have to raise new capital, he said during an interview, Greek banks owned by Société Générale and Crédit Agricole are not among them. Fears about the exposure of the French banks’ Greek subsidiaries had weighed on their share prices in recent months.

Because the debt-relief plan is supposed to be voluntary, it would not trigger the payment of insurance, known as credit-default swaps, that some investors have purchased to protect against losses on Greek debt.

The swaps were in some ways a greater source of anxiety than the debt itself. Three years after American International Group required a $182 billion U.S. taxpayer bailout because of insurance it issued on mortgage-backed securities, the market for credit-default swaps remains opaque. There is a dearth of information on which companies might have insured Greek debt, and a risk that some banks or other issuers were overexposed.

The International Swaps and Derivatives Association, the official arbiter of whether a so-called credit event has occurred, said Thursday that the Greek debt-relief plan probably would not lead to debt insurance. “It does not appear to be likely that the restructuring will trigger payments under existing C.D.S. contracts,” the association said in a statement, though it cautioned that it was too early to make an official ruling.

Still, much of the uncertainty that has undermined European banks remains. The size of the bank recapitalization is at the low end of expectations, raising questions whether it is big enough. French banks will need to raise about €9 billion and German banks about €5 billion. Greek banks will need the most fresh money — about €30 billion — followed by those of Spain and Italy.

Some banks, meanwhile, complain that the sums are too high, requiring them to meet regulatory standards that were not supposed to apply until the end of the decade. They complain that they will have no choice but to curtail lending and sell assets at depressed prices to achieve the required capital ratios.

“What banks would have had by 2019 they want to see in six months, at a time when capital markets are closed,” said Herbert Stepic, chief executive of Raiffeisen Bank International in Vienna.

There remains a deep uneasiness among analysts and investors.

“Exposure of banks to Greek assets is not big enough to create a systemic risk,” said Stephane Deo, head of European economic research at UBS. “The problem is if the market starts to panic.”

Liz Alderman contributed reporting from Paris.

Article source: http://feeds.nytimes.com/click.phdo?i=bf0b3f348e32026f322a286c371586aa

DealBook: Debt Ceiling Impasse Rattles Short-Term Credit Markets

The Treasury building in Washington.Andrew Harrer/Bloomberg NewsThe Treasury building in Washington.

The reverberations of Washington’s impasse over a debt deal are already being felt in the short-term credit markets, a key artery of the economy that daily supplies trillions of dollars of credit.

Over the last week, big banks and companies have withdrawn $37.5 billion from money market funds that invest in Treasury debt and other ultra-safe securities, the biggest weekly drop this year. Meanwhile, in the vast market for repurchase agreements, in which many financial firms make short-term loans to one another, borrowers are beginning to demand higher yields.

These moves underscore how companies and big financial institutions are beginning to rethink their traditional view that notes issued by the United States Treasury are indistinguishable from cash, even though many experts say they think it is unlikely that the government would miss payments on its obligations.

The $37.5 billion drop, reported Thursday in a weekly survey by the Investment Company Institute, echoed what other analysts were seeing.

In the first three days of this week, investors pulled $17 billion from funds that invested only in government securities, a reversal of the daily inflows of $280 million for much of July, said Peter Crane, the president of Crane Data, which tracks money market mutual funds.

“It’s big, no doubt about it,” he said. “Seventeen billion isn’t a run, but it’s definitely indicative that investors are shifting their assets. If this were to continue for another week or two, it would be very disturbing.”

Though lawmakers have been clashing all week on proposals to cut the deficit and raise the debt limit ahead of an Aug. 2 deadline set by the Treasury Department, bond markets have largely shrugged off the risk of a default or a downgrade of the Washington’s AAA credit rating.

Interest rates on longer-term Treasuries have held steady, but the yield on notes coming due next week, after the deadline, has moved sharply higher in recent days. The yield on Treasury bills coming due Aug. 4 jumped five basis points to 15 basis points, a significant move for a security that carried a yield close to zero earlier this month, said Jim Caron, head of interest rate strategy at Morgan Stanley.

“It’s a tell-tale sign of something that could reverberate if it spreads to other markets, and all the uncertainty with the debt ceiling is the functional equivalent of a tightening,” Mr. Caron said. “I don’t think there is a default risk at all but the market is saying it’s not going to take any chances.”

While money market fund managers say they are not seeing a sizable wave of redemptions yet, they are setting aside more cash, leaving it at custodial bank accounts in case investors demand their money back. At Fidelity, the Boston-based firm that has $442 billion in money market assets, managers are avoiding Treasury bills that come due on Aug. 4 and Aug. 11, however unlikely a technical default may be.

“We are positioning our portfolio to respond to a downgrade or a default and we are positioning the fund to respond to redemptions,” said Robert Brown, president of money markets at Fidelity. Mr. Brown would not say how much cash was being kept at hand, but said “it’s a higher balance than one would expect to see.”

In the commercial paper market, where companies raise funds for their short-term borrowing needs, buyers are also seeking shorter-term paper.

In the last week, investors have shown signs of wanting quick access to their money, with financial borrowers raising on Wednesday only $1 million in notes that come due in 81 days or more, according to the Federal Reserve. That is down from $479 million on July 22.

At the same time, the amount of commercial paper issued with a duration of just one to four days rose to $920 million, from $771 million.

“Investors are scrambling to bolster their liquidity profile,” said Chris Conetta, head of global commercial paper trading at Barclays Capital. “They understand that a default or downgrade could be a big, systemic event.”

In the repurchase market, known as the repo market, borrowers take loans and in exchange hand over a little more than the equivalent loan amount in securities. Because of their risk-free status, Treasuries are highly favored as collateral, estimated to account for about $4 trillion in the repo markets.

The fear is that if the United States credit rating drops, the value of those treasuries could respond in kind. Borrowers would then have to post more collateral to obtain their loans, effectively raising the cost of borrowing. That could ripple into the broader market, raising interest rates on all types of loans, analysts warn.

“The repo market is a pressure point because it can have an impact on overall credit availability, which bleeds through to mortgage rates,” said Robert Toomey, managing director at the Securities Industry and Financial Markets Association. “Treasuries become a little less attractive if they are more expensive to finance.”

The overnight repo rate, which started the week at about three basis points, was about 17 basis points Thursday evening, according to Credit Suisse. That means that to finance $100 million overnight in the repo market it would now cost about $472 per day, up from about $83 on Monday.

“It’s a bigger deal than a lot of people recognize,” said Howard Simons, a strategist at Bianco Research, a bond market specialist. “If you downgrade the securities you have to put more up for collateral and that affects pretty much everybody out there who has held these in reserve. I don’t care if you’re a bank, insurance company, exchange or clearinghouse.”

To be sure, most observers say the ripples in the repo market will not be anything like those felt in the fall of 2008, when creditors lost faith in the ability of banks to pay back their short-term loans. That caused a problem for companies like General Electric, which struggled to finance its daily operations as a result. Back then, the sharp drop-off in repo lending helped bring the financial system to its knees.

“I think people are looking at the U.S. as the cleanest shirt in the dirty laundry pile,” said Jason New, a senior managing director at GSO Capital Partners.

“To me, the downgrade is not dropping a boulder in a still lake. This is dropping a pebble, but nevertheless there are still ripples.”

Article source: http://feeds.nytimes.com/click.phdo?i=c342672f0538473293124e47269fa13d

After a Deal, Only More Challenges

So far so good was the word on Wall Street Thursday as details emerged about Europe’s latest broad, sweeping effort to relieve Greece’s debt burden.

But, analysts said, it was unclear how the ambitious plan — which includes Greece changing the terms of its debt — would affect the markets in the coming days.

The conventional thinking had been that a Greek default would spur contagion in the financial markets, potentially roiling United States banks and mutual funds. But on Thursday, as details emerged of a plan that was characterized as a “selective default,” stocks on both sides of the Atlantic rose. The euro climbed to a two-week high against the dollar. And bonds in Spain, Greece and Italy ticked upward, while bets against Greece’s debt sunk.

What was behind the muted response, analysts said, was that Europe had avoided the trademarks of traditional sovereign defaults, which more typically involve bondholders and creditors taking sudden, definite losses. Greece’s problems are hardly a surprise, having been telegraphed for nearly a year and a half. And many of the losses connected to Greece’s debt, it turns out, will be shared by the euro zone and may not affect investors like United States money market funds as much as has been feared.

“This is the Europeanization of the Greek debt,” said Perry Mehrling, a senior fellow at the Morin Center for Banking and Financial Law at Boston University. “Everyone prefers to have Europe as their counterparty rather than Greece.”

But the markets may also be calm because it is simply not clear yet what all the repercussions of the deal will be. Many questions are left unanswered, including whether the credit ratings agencies will consider the deal a default or an action that should affect ratings across the Continent. And in the derivatives market — where traders have been swapping instruments that allow them to bet against Greek and other sovereign debt — it is unclear whether the industry association that makes rulings on those contracts will declare that the parties that bet against Greece should be paid, or not.

Also clouding the market is the question of whether Europe’s plan for Greece is more of a bailout or a default — selective default, the term being used to describe the plan, is a term few investors have ever heard before. The ratings agencies declined to discuss their thoughts on the deal after it was announced, but they have said in the past that measures similar to the ones announced, including extensions of the length of the debt, would qualify as a default. And Greece’s situation is an anomaly for derivatives traders, who are more used to settling up after defaults of corporations, rather than those of countries.

Details of Europe’s deal leaked out all day Thursday, but it was formally described in a four-page memorandum released in the evening. It has options including a bond swap that will relieve Greece’s bondholders — mostly banks in Greece, France and Germany — of short-term bonds in exchange for new longer-term bonds that will be guaranteed by the euro zone. It includes 109 billion euros ($157 billion) in aid to Greece. The memo says that a pan-European entity will make loans to individual countries so that those countries can work to recapitalize banks there that are hit by losses on the Greek debt.

Analysts said the deal resembled the federal bank bailout that occurred in the United States in 2008, because it included a way to aid institutions that were heavily stung by losses on Greece, much like the United States aided banks that were hard hit by mortgage bonds. Several analysts cheered simply because it was a sign of progress.

“The light at the end of tunnel just got a lot brighter,” said Chris Orndorff, a Western Asset portfolio manager who oversees more than $39 billion of European corporate and sovereign debt. “What they are really trying to do here is stop the contagion. It provides a degree of confidence to investors in Ireland, Portugal, Spain and Italy that it is not going to be a downward spiral.”

Others criticized European officials for trying to sugarcoat the plan. “I’m shocked they would use the term ‘selective default.’ Any adjective you put in front of the word default still means default,” said Zane Brown, fixed-income strategist at Lord Abbett.

Dogging all those countries are doubts over their credit ratings, which can drive the costs for them to borrow. To some degree, Europe’s backing of Greece may relieve some of the doubts that have driven the ratings agencies to issue warnings about several European countries — like Italy, Spain, Portugal, Ireland.

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