The Miller-Moore amendment’s not that bad!

By Felix Salmon
November 20, 2009
John Jansen reprints some BarCap research on the Miller-Moore amendment, and now I think I understand why so many finance types are so scared by it: they've misread it!

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John Jansen reprints some BarCap research on the Miller-Moore amendment, and now I think I understand why so many finance types are so scared by it: they’ve misread it!

Here’s BarCap:

Proposed by Reps. Miller (D) and Moore (D), it would effectively replace existing repo and secured funding with unsecured borrowing subject to a margin, or haircut, of up to 20%. Specifically, in the case that a large systemically important institution is put into receivership by the FDIC and there are not enough assets to cover the cost of unwinding it to the government, all secured claims would be automatically converted into unsecured loans with a haircut of up to 20%…

No secured lender will want to be left in a trade with a bank in receivership where the regulators have converted the transaction into an unsecured loan at 80% of the original amount.

But that’s not what the amendment is proposing. Here it is:

An allowed claim under a legally enforceable or perfected security interest (that became a legally enforceable or perfected security interest after the date of the enactment of this clause), other than a legally enforceable or perfected security interest of the Federal Government, in any of the assets of the covered financial company in receivership may be treated as an unsecured claim in the amount of up to 20 percent as necessary to satisfy any amounts owed to the United States or to the Fund. Any balance of such claim that is treated as an unsecured claim under this subparagraph shall be paid as a general liability of the covered financial company.

Let’s say you have a secured claim of $1 million on a bank which has been taken over by the FDIC, and let’s say that unsecured creditors of that bank end up being paid only 70 cents on the dollar.

If the BarCap reading were right, the FDIC would first impose a 20% haircut on the $1 million, turning it into $800,000, and then convert it into an unsecured loan — which, at 70 cents on the dollar, would be worth just $560,000. The net effective haircut would be a whopping 44%. But of course this makes no conceptual sense at all, because unsecured creditors would end up being treated better, under this scheme, than secured creditors.

The way I read it, however, the Miller-Moore amendment allows up to 20% of the secured debt to be converted into unsecured debt; the rest of it is untouched. So you retain $800,000 of secured debt, worth $800,000, and now the remaining $200,000 is unsecured debt, worth $140,000. All in all your $1 million claim is worth $940,000 — a net effective haircut of just 6%.

No one likes losing 6% of their money, of course, but that’s a hell of a lot better than losing 44% of your money. And maybe if the sell side begins to understand how Miller-Moore really works, they might be less averse to it.

(HT: Alloway)


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“they” haven’t misread at all. repos are a form of super senior secured debt and where there is a “perfected security interest” would be subject to the 20% haircut, but that’s not always the case. so some changes will be needed in the repo market as this definition increases uncertainty (for the repo market) more then anything else. it’s not the 20% haircut that’s the problem, you can price that, it’s the uncertainty over what is a “perfected security interest” and what is not.

I am not a lawyer and I think I am getting confused here:

Economically repos are just secured debt, but aren’t repos usually done by transfers of legal title to the collateral rather than creating a equitable interest in the collateral?

I thought the whole point of the way repos were set up is that the legal documentation to perfect a security interest ‘in equity’ while leaving legal title with the borrower was too long and potentially complex to be of any use for short-term money-market operations. Instead there is a straightforward ‘sale’ of collateral with transfer of legal title to the lender and another pre-arranged sale at the end of the repo term (assuming the borrower has not collapsed during the repo).

Would such transactions count as ‘a claim under a security interest’ for the purposes of the amendment? I must be missing something here. Surely it is the borrower who has the equitable interest in the collateral, if for some strange reason the lender refused to honour the second sale?

Posted by JH | Report as abusive

the legal title is transferred in a repo but this is to facilitate liquidation if cash is not returned (default) at the repo maturity, it’s not enough to make it a “perfected security interest” and doesn’t mean the buyer has control, that depends on clearing/custodian arrangements.
for ex. repos don’t have a “perfected security interest” if the collateral can be substituted because a specific security has to be identified and under the control of the cash provider, so some repos would be 80% secured 20% unsecured if they represent a “perfected security interest” and the bulk of them that aren’t, would be 100% unsecured.
making repos compatible with the fdic view of “perfected security interest” would disrupt (i.e. slow down velocity) money markets and likely require massive reserves injection by the fed to compensate.

It’s not even that bad. Secured creditors would lose nothing until shareholders and unsecured creditors had lost everything. So the haircut provision wouldn’t apply when a systemically significant financial firm teeters over into insolvency, it will only apply in spectacular, catastrophic collapses. Think of the Hindenberg.

It wouldn’t take a lot of underwriting to see something like that coming. The most likely candidates for the haircut would be existing creditors who demanded more and more collateral as the firm collapsed, jumping queue and exacerbating the liquidity crisis at the collapsing firm.

Also, the haircut would be discretionary. The FDIC could allow secured creditors who had taken collateral when the firm was solvent their full security interest, and just impose the haircut on creditors who had grabbed collateral from a firm that should already have been in receivorship.

I liked your calling the amendment a “spectaculary good idea” more than “not that bad,” but I’ll take it.

Posted by brad miller | Report as abusive