Leverage Is Dangerous If You Can’t Borrow in a Crisis

The post “Leverage Is Dangerous If You Can’t Borrow in a Crisis” was originally published on Alpha Architect blog.

A longstanding belief in market finance is that short-term funding markets like repo are relatively stable and transparent. But this new research turns that idea on its head. This analysis finds that the repo market—especially for less-liquid, non-Treasury collateral—was under enormous stress during the 2007–2009 financial crisis. In fact, haircuts on riskier collateral surged dramatically, volumes collapsed, and some firms lost access entirely. The study sheds new light on how repo market fragility helped amplify the crisis.

The Repo Market Over the Financial Crisis

• Adam Copeland, Darrell Duffie, Antoine Martin, Susan McLaughlin, and Elizabeth Walker
• The Journal of Finance, 2025
• A version of this paper can be found here
• Want to read our summaries of academic finance papers? Check out our Academic Research Insight category

Key Academic Insights

Repo Market Stability: Not All Collateral Is Created Equal

The paper uses proprietary data from the Tri-Party Repo Infrastructure Reform Task Force to reconstruct daily volumes and haircuts across collateral types during the 2007–2009 period. The key insight: Treasury-backed repo was stable throughout, but repo backed by riskier collateral (e.g., MBS, ABS, equities) experienced severe dislocations. Dealers facing runs on tri-party repo had to rapidly unwind positions, contributing to fire sales and further contagion. Haircuts on non-Treasury collateral rose sharply, often doubling or tripling. Repo volumes for some asset classes dropped by more than 50%

The “Run on Repo” Was Real—And Deeply Fragmented

Much of the systemic stress during the crisis came from a silent run on repo: investors began refusing to roll over repos backed by anything less than pristine collateral. This segmentation caused funding to evaporate overnight for many dealers relying on less liquid assets. Lehman’s collapse in September 2008 accelerated the retreat from risky collateral. The repo market became bifurcated, with Treasury repo acting like a “safe harbor” and everything else treated as toxic.

Tri-Party Infrastructure Created Hidden Risks

The paper highlights a structural fragility in the U.S. tri-party repo system:

• Clearing banks (JPMorgan Chase and BNY Mellon) had enormous discretion to allocate liquidity
• Dealers relied heavily on intraday credit from these banks, creating a systemic vulnerability
• Daily unwinds required clearing banks to fund the entire book for hours each day—exposing them to catastrophic losses if a dealer failed

This infrastructure flaw meant that problems at one dealer could ripple across the system, even if other institutions were solvent.

Practical Applications for Investment Advisors

Understand Hidden Risks in Client Holdings

Clients with exposure to hedge funds, private credit, or structured product strategies may be indirectly tied to repo funding structures. During periods of stress, strategies that rely on short-term borrowing can become illiquid, even if the underlying assets are sound. Advisors should look under the hood and ask: How are these assets funded?

Explain Liquidity Beyond the Asset Class Label

Clients often believe bonds or alternatives are “low risk” based on ratings or labels. This paper shows that in crisis conditions, funding source matters as much as the asset itself. For instance, MBS or ABS backed by repo became untradeable overnight—not because they defaulted, but because no one would lend against them. Helping clients understand this distinction builds trust and improves portfolio conversations around risk.

Prepare Clients for Illiquidity in Stress Scenarios

This study is a useful tool to help clients mentally model what happens when markets seize up. Use this research to frame conversations like:

“What if you wanted to sell or borrow against this asset in a crisis—could you?”

Helping clients simulate these scenarios makes risk management more concrete.

How to Explain This to Clients

“You might think that money markets and repo are boring and reliable—but in a crisis, that assumption can be dangerous. In 2008, firms that relied on repo funding for riskier assets suddenly found the doors closed. They had to dump assets at fire-sale prices, accelerating the downturn. That’s why we now pay close attention not just to how much leverage is used—but how it’s funded and with what kind of collateral.”

The Most Important Chart from the Paper

This table provides a snapshot of the tri-party repo market during 2008, breaking down:

• Collateral categories (e.g., U.S. Treasuries, agency debt, non-agency MBS, equities)
• Volume outstanding, number of participants, and
• Most critically, haircuts applied by lenders across collateral classes

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index.

Abstract

This paper uses new data to provide a comprehensive view of repo activity during the 2007-09 financial
crisis for the first time. We show that activity declined much more in the bilateral segment of the market
than in the tri-party segment. Surprisingly, we find that a large share of the decline in activity is driven by
repos backed by Treasury securities. Further, a disproportionate share of the decline in repo activity is
connected to securities dealer’s market-making activity in Treasury securities. In particular, the evidence
suggests that at least part of the decline is not driven by clients pulling away from securities dealers
because of counterparty credit concerns.