Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

The investment bank would buy $100 million in securities and repo them with a mutual fund or another investment bank, with the party repoing the paper paying a small interest charge to the investor it was repoing with. It also accepted a haircut. In exchange for $100 million in Treasurys, it did not receive full value, but only $98 million in cash. It would also repurchase them for $98 million. In the meantime, the haircut determined how much of its own money the investment bank would have to put into holding the securities, and thus the leverage in the deal.47 A 2 percent haircut meant that to fund the purchase of $100 million of securities and to receive the interest paid on those bonds, a bank would need $2 million of its own money. The rest it could get out of the repo transaction. Using this mechanism, a small amount of capital could support a far bigger balance sheet, provided, of course, that the repo could be repeatedly “rolled” and that the haircut did not suddenly increase.