The repo market underpins much of the U.S. financial system, helping to make sure that banks have the liquidity to meet their daily operational needs and maintain enough reserves.
In a repo trade, Wall Street firms and banks offer U.S. Treasuries and other high-quality securities as collateral to raise cash, often overnight, to finance their trading and lending activities.
The next day, borrowers repay their loans plus what is typically a nominal rate of interest and get their bonds back.
In other words, they repurchase, or repo, the bonds.
The system typically hums along with the interest rate charged on repo deals hovering close to the Fed’s benchmark overnight rate.
But when investors get fearful of lending, as seen during the global credit crisis, or when there are just not enough reserves or cash in the system to lend out, it sends the repo rate soaring above the Fed Funds rate.
Trading in stocks and bonds can become difficult. It can also pinch lending to businesses and consumers and, if the disruption is prolonged, it can become a drag on a U.S. economy that relies heavily on the flow of credit.