Analysis: Wall Street clashes with regulators over repo market reforms

Fri Aug 16, 2013 12:54pm EDT
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By Douwe Miedema and Lauren Tara LaCapra

WASHINGTON/NEW YORK (Reuters) - Wall Street banks are arguing that a proposal from U.S. regulators intended to rein in risk taking could severely hurt the $7 trillion repurchase market, a critical source of short-term loans in the financial system.

A new rule, known as the supplemental leverage ratio, is being proposed by the Federal Reserve, but also globally, as regulators seek to control a market they see as unstable enough to cause a new financial crisis.

But the banks are arguing that the rule, and a host of related proposals expected from regulators in coming months, could drain appetite for the U.S. Treasuries market and raise costs of funding for many institutions, senior Wall Street executives said in interviews.

Rather than reducing dangers in the system the rule could increase them by providing banks with an incentive to hold higher-risk securities, the executives claim.

"It's crazy: a government bond looks as risky as a triple-C bond," one senior Wall Street executive said, referring to how the banks would have to treat all assets on their balance sheets alike. In other words, a super-safe U.S. Treasury would be valued on par with a far-riskier and lower-rated "junk bond."

One other executive at a Wall Street bank said that Treasury bonds are "innocent bystanders, getting killed" by the regulators' action.

But U.S. regulators are not in a mood to change course, meaning that a collision with Wall Street is likely. In interviews, several regulators said they are determined to reform the repo market.

One senior regulatory source said U.S. bank supervisors are wary that the repo market is unstable when put under pressure. A run on Lehman Brothers in the repo market in 2008 was one of the main reasons why the investment bank collapsed.   Continued...

A street sign for Wall Street hangs in front of the New York Stock Exchange May 8, 2013. REUTERS/Lucas Jackson