Thing That Killed Lehman (and Almost GE) Popular Again

NEW YORK ( TheStreet) -- Wall Street is jumping back into the risky $1.6 trillion "repo" market with some of the biggest U.S. banks -- including Bank of America ( BAC), JPMorgan Chase ( JPM) and Wells Fargo ( WFC) -- leading the charge.

Shunned after the 2008 financial crisis after killing Lehman Brothers -- and nearly cutting General Electric's ( GE) financial throat -- repos, or repurchase agreements, are enjoying a Wall Street renaissance, according to a report released Friday by Fitch Ratings.

"Since the peak of the U.S. financial crisis, risk appetite in the repo market is gradually recovering," Fitch said in its report. "Repo markets, once viewed as a relatively mundane utility within the financial system architecture, are the subject of growing public interest in "shadow" banking."

A repurchase agreement is the practice of lending a stock or bond to another party with a promise to buy it back. Banks and asset managers sell repos to increase returns on the securities they hold, while money market funds buy them as another source of fixed income and cash investment.

Relatively low yields on U.S. Treasury and corporate bonds are pushing investors back into the market, Fitch says, adding that money market fund buyers enjoy the higher yields paid on nongovernment repos while banks are looking to "finance lower-quality securities inventories" that have built up through years of capital building since the crisis.

Bank of America ( BAC), JPMorgan Chase ( JPM) and Wells Fargo ( WFC) currently rank in the top 10 of repo users, or "counterparties," in the current market according to Fitch.

Repos were a primary source of pain for the financial industry during the 2008 financial crisis. Lehman Brothers declared bankruptcy after it was cut off from the short-term debt market when repos began to fail. General Electric ( GE) faced its own near-death experience when, following the Lehman bankruptcy, it was shut out of the repo market.

In fact, some of the same issues that caused problems in the repo market in 2008 remain today, the Fitch report says. The 10 largest repo counterparties account for nearly 80% of transactions, meaning if one bank were to face a liquidity event the problems could quickly spread through the rest of the system. Fitch, however, did add that counterparty concentration has declined since 2008.

Another worry is the use of so-called "tri-party" repos. A tri-party repo adds a new layer of complexity, inserting a bank in the middle of the transaction to act as a referee between the two sides. The banks also manage the "collateral" of the loans and make sure interest is paid on timely basis.

With so many banks involved in the growing tri-party repo market -- including seller, buyer and collateral manager -- the market is creating a "wrong way" risk, Fitch argues, adding that financial services companies represent more than 20% of the repo collateral pool while they also are the majority of the traders.

"Repo market disruptions could also impair the liquidity and valuation of assets that lose acceptance as collateral, affecting not only repo market participants, but also cash investors that take long positions without deploying leverage," Fitch said.

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