Opinion ID: 2600495
Heading Depth: 4
Heading Rank: 1

Heading: The Nature of a Repo

Text: Repurchase agreements, commonly known as `repos,' sound esoteric and can be quite complicated. They are, however, in essence nothing more than financing arrangements by which one party provides funds to another for a short period of time. There are two parties to a repurchase agreement: one has money to lend, the other needs cash and has securities. The repurchase agreement itself consists of two transactions that are agreed to simultaneously, but are performed at different times: (1) the seller-borrower agrees to transfer securities to the buyer-lender in exchange for cash; and (2) the seller-borrower agrees to repurchase the securities from the buyer-lender at the original price plus `interest' on a specified future date or upon demand. ( Bewley v. Franchise Tax Bd., supra, 9 Cal.4th at p. 529, 37 Cal.Rptr.2d 298, 886 P.2d 1292.) The seller-borrower who transfers the securities and agrees to buy them back is said to be engaged in a repo; the buyer-lender who provides the cash and agrees to sell the securities back is said to be engaged in a reverse repo. ( Resolution Trust Corp. v. Aetna Casualty & Sur. Co. (7th Cir.1994) 25 F.3d 570, 572; In re Bevill, Bresler & Schulman Asset Management Corp. (D.N.J.1986) 67 B.R. 557, 567; but see Gov.Code, § 53601, subd. (i)(5)(A), (C) [reversing terms].) It appears General Motors principally engaged in reverse repos, but the distinction between the two transactions is unimportant in this case; thus, we will occasionally refer to both repos and reverse repos generically as repos. Repos serve at least four critical functions. First, the Federal Reserve uses repos to make short-term adjustments in the money supply and carry out the government's monetary policy. To restrict the money supply, it enters repos, selling securities and withdrawing cash from the economy; conversely, to expand the money supply, it enters reverse repos, buying securities and injecting cash into the economy. (Note, Lifting the Cloud of Uncertainty over the Repo Market: Characterization of Repos as Separate Purchases and Sales of Securities (1984) 37 Vand. L.Rev. 401, 403-404.) Second, repos are used by securities dealers to finance their underwriting of new government debt issues. A liquid, well-functioning repo market allows dealers to sell current securities holdings for cash (as part of the front end of a repo) and use the cash to acquire new government securities, thereby reducing the federal government's financing costs. ( Bevill, Bresler & Schulman Asset Management Corp. v. Spencer Sav. & Loan Assn. (3d Cir.1989) 878 F.2d 742, 746; Granite Partners, L.P. v. Bear Stearns & Co. (S.D.N.Y. 1998) 17 F.Supp.2d 275, 299 ( Granite Partners ).) Third, repos contribute to the domestic housing market. Mortgage-backed securities guaranteed by government agencies such as the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) become more attractive to investors when they can be repackaged and resold in an active repo market. These agencies can thus raise funds more cheaply, which in turn means residential home buyers can obtain lower rate mortgages. ( Granite Partners, supra, 17 F.Supp.2d at p. 299; In re Bevill, Bresler & Schulman Asset Management Corp., supra, 67 B.R. at p. 568.) Fourth, repos are a valuable investment tool for the public, institutional investors, large corporations, and state and local governments. Because repos can be structured with a maturity date tailored to the needs of the individual investor, they provide a high degree of liquidity and flexibility. ( Securities & Exchange Com. v. Miller (S.D.N.Y.1980) 495 F.Supp. 465, 471.) This liquidity and flexibility, combined with high yields, makes them an attractive financial management tool for entities (such as General Motors here) with large amounts of idle cash seeking secure short-term investments. (See Granite Partners, supra, 17 F.Supp.2d at pp. 299, 302; Securities & Exchange Com. v. Miller, at p. 471; Comment, The Need for a Uniform Classification of Repurchase Agreements: Reconciling Investor Protection with Economic Reality (1987) 36 Am. U. L.Rev. 669, 670-671.)