“A lack of good quality collateral, which market participants use to secure loans, has crippled the single currency area’s short-term funding (“repo”) markets.”
Brokers are helping two parties to get together and make a deal. They take a commission for that without barring any risk. They just bring together the person searching for a car and the one looking for a car. Whereas dealers are buyers and sellers at the same time. A dealer is like a car dealer, who owns cars. He tries to buy them at a cheap price and sell them at a higher price to make a profit. He barriers the risk of not being able to sell his cars.
What are Repos?
Repos are repurchasing agreements. Imagine I really need money to fund my party, but I am not a bank, therefore, I can not borrow money in the Fed Funds market (more about Fed Funds in the blog post before) or directly from the Fed.
Fortunately, I have a rich friend who would lend me some money. He is a little skeptical about lending money to me because he is afraid I am not going to pay him back. That is the reason why I give him the expensive watch I got for my birthday as collateral (dt. Pfand), so he can be sure that I will pay him back. The watch is worth 1000 $ and my rich friend is willing to borrow me 950$. I sign a contract with him that I buy my watch back for 1000 $ after my party, where I hopefully get money for presents.
In the finance world, repos are collateralized overnight loans that are legally constructed. Two parties have exchanged money and collateral directly but there could have been a dealer in between that takes money and collateral and then give away the loan.
The pension funds that normally have too much money are able to borrow money to a dealer to earn an interest rate and the banks, who often need money, would borrow it paying an interest rate. The bank has many assets, which it can use as collateral for example mortgage back securities or bonds. The dealers are helping to keep the balance in the markets, by giving both parties what they want and they earn a profit with that. So dealers are acting like banks, they provide liquidity and borrow money and lend money.
Collateral --------------> < --------------Money
Financial Times Quote: To get funding banks need collateral like loans or bonds to get money. The problem here is that the European Central Bank is buying bonds to help to boost the economy. So prices for bonds are going up and banks do not own as many anymore, so there is less collateral so the repo market is having a hard time at the moment.
The first article: The hierarchy of money
The second article: Why do we need banks?
The third article: Why we need a central bank?
The fourth article: How can banks create money out of thin air?
The fifth article: Why do we need central banks especially in a crisis?
The sixth article: What are clearing houses?
The seventh article: What are Fed Funds?
The ninth article: Quantitative easing and open market operation
The tenth article: Eurodollars
The eleventh article: Discounts, Discounts, Discounts
The twelfth article: Why dealers provide liquidity
Written by: Philine Paschen