Bankruptcy Exemption of Repo Markets: Too Much Today for Too Little Tomorrow?

Viral V. Acharya, V. Ravi Anshuman and S. Viswanathan

Journal of Political Economy Macroeconomics, 2025, vol. 3, issue 4, 457 - 524

Abstract: A safe harbor for repo financiers—in the form of an exemption from automatic stay in bankruptcy—enables financial intermediaries to raise greater liquidity during normal times but also induces excessive leverage. An adverse economic shock triggers excessive collateral liquidations by highly leveraged intermediaries. Financial arbitrage by less leveraged financial intermediaries equilibrates returns from acquiring collateral at fire sale prices and making new loans to the real sector, inducing higher lending rates, a deterioration in endogenous asset quality, and possibly even a credit crunch. Taming the leverage cycle by not granting safe harbors can be not only ex post optimal but also ex ante optimal.

Date: 2025
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