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No Exit for Emergency Nationalization

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  • Tue, Feb 03, 2009 - 02:07pm



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    No Exit for Emergency Nationalization

Written by Dr. Henry C.K. Liu.

Complete article

A few excerpts.

The overview picture is discouraging. Those in whose hands we entrust to
restore health to the global financial system appear to have no clear view of
how to correct the mess our global financial system has evolved into except
jumping from crisis to crisis to keep the overly complex structure from
collapsing. So far each move to respond to a crisis has only led to another
crisis. The distressing part is that there seems to be a complacent view that
nationalization is the panacea for when all else fails. We should realize that
nations too can go bankrupt, even nations who were once superpowers.

Rescuing One Market at a time

There are talks that
some in government are thinking of rescuing one market at a time, such as the
commercial paper market, by creating a new bank along the line of Hamilton’s
First Bank of the United States
to buy up all toxic assets, instead of “ring fencing” toxic asset one bank at a
time. The objective is not to reduce the need for further write down, but to
find out once and for all how deep the loss will turn out to be to stop the
continuing loss of confidence. Until confidence is restored, private capital
will not return to the market.

Impact on State and Local Government Finance

The repo market is the biggest financial market today. Domestic and
international repo markets have grown dramatically over the last few years due
to increasing need by market participants to take and hedge short positions in
the capital and derivatives markets; a growing concern over counterparty credit
risk; and the favorable capital adequacy treatment given to repos by the market.
Most important of all is a growing awareness among market participants of the
flexibility of repos and the wide range of markets and circumstances in which
they can benefit from using repos. The use of repos in financing and leveraging
market positions and short-selling, as well as in enhancing returns and
mitigating risk, is indispensable for full participation in today’s financial

The Repo Market now Big and Dangerous

Created to raise funds to
pay for the flood of securities sold by the US government to finance growing
budget deficits in the 1970’s, the repo market has grown into the largest
financial market in the world, surpassing stocks, bonds, and even

At a time around 1998 when the world’s biggest
government bond market was shrinking because of a temporary
US fiscal
surplus, the market where investors financed their long bond purchases with
short-term loans continued to grow by leaps and bounds.  The $2 trillion daily
repo market in 1998 became the place where bond firms and investors raise cash
to buy securities, and where corporations and money market funds park trillions
of electronic dollars daily to lock in risk-free attractive returns. That market
has since grown to over $5 trillion a day, almost 50% of GDP.

The repo
market grew exponentially as it came to be used to raise short-term money at
lower rates for financing long-term investments such as bonds and equities with
higher returns. The derivatives markets also require a thriving financing
market, and repos are an easy way to raise low-interest funds to pay for
securities needed for arbitrage plays.  It used to be that the purchase of
securities could not be financed by repos, but those restrictions have long been
relaxed along with finance deregulation. Repos were used first to raise money to
finance only government bonds, then corporate bonds and later to finance
equities. The risk of such financing plays lies in the unexpected sudden rise in
short-term rates above the fixed returns of long-term assets. For equities,
rising short-term rates can directly push equity prices drastically down,
reflecting the effect of interest rates on corporate profits.


  • Tue, Feb 03, 2009 - 07:57pm



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    Re: No Exit for Emergency Nationalization

The word Nationalization alone is sobering.

Now I have to go study up on repos.

Thanks alot Cat.  Tongue out

  • Tue, Feb 03, 2009 - 09:38pm



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    Re: No Exit for Emergency Nationalization

I just read the wikipedia section on repos. It looks like another snake pit to me.

  • Tue, Feb 03, 2009 - 09:44pm



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    Re: No Exit for Emergency Nationalization

From Investopedia…

What Does Repurchase Agreement – Repo

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 explains Repurchase Agreement –

Repos are classified as a money-market
instrument. They are usually used to raise short-term capital.


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