Rolling Back the Repo Safe Harbors
Harvard Law School Center for Law, Economics, and Business, Discussion Paper No. 793
34 Pages Posted: 23 Aug 2014 Last revised: 2 Jun 2017
Date Written: August 21, 2014
Recent decades have seen substantial expansion in exemptions from the Bankruptcy Code’s normal operation for repurchase agreements. These repos, which are equivalent to very short-term (often one-day) secured loans, are exempt from core bankruptcy rules such as the automatic stay that enjoins debt collection, rules against prebankruptcy fraudulent transfers, and rules against eve-of-bankruptcy preferential payment to favored creditors over other creditors. While these exemptions can be justified for United States Treasury securities and similarly liquid obligations backed by the full faith and credit of the United States government, they are not justified for mortgage-backed securities and other securities that could prove illiquid or unable to fetch their expected long-run value in a panic. The exemptions from baseline bankruptcy rules facilitate this kind of panic selling and, according to many expert observers, characterized and exacerbated the financial crisis of 2007-2009. The exemptions from normal bankruptcy rules should be limited to United States Treasury and similarly liquid securities, as they once were. The more recent expansion of the exemption to mortgage-backed securities should be reversed.
Keywords: safe harbors, bankruptcy, financial crisis, contagion, bank run, qualified financial contracts, derivatives, orderly liquidation authority, repo, Lehman Brothers, wholesale money market
JEL Classification: G20, G28, G32, G33, G38, K22
Suggested Citation: Suggested Citation