Repurchase Agreement

A repurchase agreement (repo) is a short-term transaction in which one party sells securities to another with an agreement to repurchase them at a specified date and price. Economically, it is a collateralized loan: the seller borrows cash, the buyer lends cash, and the securities serve as collateral.

Repo is the plumbing of the Treasury market:

• Dealers finance their inventory through repo, borrowing cash overnight against their Treasury holdings
• Short sellers borrow securities through reverse repo, lending cash and receiving the securities they need to deliver
• The Fed implements monetary policy through repo operations, adding or draining reserves from the banking system

Key repo concepts:

• General collateral (GC): the standard repo rate for any Treasury security. Typically tracks the Fed funds rate closely.
• Special: a repo rate below GC for specific high-demand securities (usually on-the-run issues). Going "special" means the security is in such demand that its borrower accepts a below-market interest rate.
• Haircut: the difference between the collateral's market value and the loan amount, protecting the cash lender against price declines.

The Lehman Brothers Repo Manual (reviewed on this site under Papers) provides the definitive practitioner guide to repo mechanics, covering tri-party repo, fails, margining, and the role of repo in dealer financing.

The repo market's importance was highlighted during the September 2019 repo crisis, when overnight rates spiked to 10% due to reserve scarcity, forcing the Fed to intervene with emergency lending facilities.