A study forthcoming in the Federal Reserve Bank of New York’s Economic Policy Review examines how contracting conventions for repos changed in one key decade.
In The Evolution of Repo Contracting Conventions in the 1980s, author Kenneth D. Garbade examines the evolution of the repo market, which in the 1980s grew considerably in both size and complexity, prompting market participants to revise their contracting conventions. A repo is a sale of securities coupled with an agreement to repurchase the securities at a specified price on a later date.
Garbade writes that in the 1950s and 1960s, repos, or repurchase agreements, were used by dealers to borrow money; in the 1970s, dealers began engaging in more complex repo operations, also borrowing securities to cover short-selling and thus adding risk to the system. Also, rising interest rates and growing Treasury indebtedness attracted many new, smaller, and less sophisticated creditors, according to the author.
He observes that contracting conventions that were satisfactory in the context of the repo markets in the 1950s and 1960s—including neglect of accrued interest on repo securities, ambiguity about whether repos were loans or transactions, and relatively costly mechanisms for removing repo securities from the control of borrowers—proved inadequate by the early 1980s. As a result, Garbade says, repo conventions changed to include the recognition of accrued interest, Congress amended the application of federal bankruptcy law to repos, and tri-party repo—a new, operationally less costly form of repo—became increasingly popular.
Kenneth D. Garbade is a vice president at the Federal Reserve Bank of New York.