Download Crisis money market

Crisis US money market
18 marzo 2015
Crisis liquidity
Response to the crisis
Mbs
• Main problem: MBS collateral in repo
• The dealers in MBS were damaged by the lack
of liquidity so they had to be replaced by the
public sector.
Shadow banks
Repo financing
• Shadow banks used repo as means of
financing because it was cheap.
taxonomy
• Money market rates
LiBor  federalFunds  repo
Short term Rates spread
• Befor the crisi erupted the spread between
these rates were a few basis
• A basis point = 0.01
BASIS POINT
• Smallest measure of quoting the yield on a bond, note, or
other debt instrument. One basis point is equal to one
hundredth of one percent (0.01%): one percent of a yield
equals 100 basis points. For example, an interest rate of 5
percent is 50 basis point higher than the interest rate of 4.5
percent. Similarly, a spread of 50 basis points (between the
bid price and offer price of a bond) means the investor
must pay 0.5 percent more to buy it than he or she could
realize from selling it.
Read more:
http://www.businessdictionary.com/definition/basispoint.html#ixzz2wVQGCcpu
Federal funds market
• The fed. funds is an inter-bank market where
banks that borrow fed funds receive deposits
at the Fed and pay an interest.The Federal
funds rate is determined by the supply of and
demand for funds. The fed however tries to
keep it within a certain range and in order to
make it converge to the desired target it lends
against collateral.
overnight money market rates
Vertical lines
• Vertical lines show when Bear Stearns and
Lehman failed.
First period
• In the first period from july 2007 to march
2008 the spread between the libor rate and
the federal funds rate increased while the
spread between treasury repos and federal
funds rate decreased. In this period the fed
intervened every day in the market to stabilize
the federal funds rate at its target rate which
was 2% (falling from 5%).
Fed funds rate and target
Second period
• In the second period overnight rates go back
to the pre-crisis standards.
• The reason for this behaviour is not that
problems in markets have vanished but rather
the fed intervention exchanging Treasuries
with MBS and facilities TAF . Fed acts as public
lender of last resort.
Figure explanation
• As wealth holders attempt to get rid of their
MBS the dealers must buy them. The Fed
supports them with various facilities. PDCF
provides funds to dealers while TAF provides
fund to banks. The Fed finances these loans by
selling treasuries.
third period
• After Lehman’s collapse the spread between
repo rates and fed funds rates and that
between Libor rates and federal funds rate
have increased. In this period the Fed
intervened as dealer di last resort.
Expansion fed’s balance
• This intervention made the balance sheets of
the fed double within some weeks. Rates fell
from 2% to 0%. The most important thing
however is the expansion of the Fed’s balance
sheet.
fed assets
fed liabilities
Comment graph
• The Fed used open market operations as
policy tool until the end of 2007. From the
spring of 2008 onwards it started using special
facilities and this has changed the composition
of its balance sheet .
Third period
• After Lehman’s colapse the fed’s balance sheet
has dramatically expanded. On the assets side
we can see the various new facilities
introduced by the Fed. These facilities were
just temporary. When they expired in 2010
the Fed used the sums reimbursed to buy
directly in the market MBS. On the liabilities’
side we can see that reserves have increased.
International considerations
• The crisis was centered in US dollar funding
markets. Disruptions mainly spread to other
countries via investments in these dollar
markets.
Dollar funding
• The crisis was a shortage of dollar funding
Eurodollar market
• Eurodollar market, paying term dollar LIBOR if
• you can get it, or borrowing in some other
currency and swapping into dollars if you
can't.
eurodollar
• U.S.-dollar denominated deposits at foreign
banks or foreign branches of American banks.
By locating outside of the United States,
eurodollars escape regulation by the Federal
Reserve Board.
Eurodollar market
• Originally, dollar-denominated deposits not
subject to U.S. banking regulations were held
almost exclusively in Europe; hence the name
eurodollars. These deposits are still mostly
held in Europe, but they're also held in such
countries as the Bahamas, Canada, the
Cayman Islands, Hong Kong, Japan, the
Netherlands Antilles, Panama and Singapore.
• Regardless of where they are held, such
deposits are referred to as eurodollars.
Since the eurodollar market is relatively free
of regulation, banks in the eurodollar market
can operate on narrower margins than banks
in the United States. Thus, the eurodollar
market has expanded largely as a means of
avoiding the regulatory costs involved in
dollar-denominated financial intermediation.
Libor-ois spread
• The return to such an approach is the
LIBOR{OIS spread, shown in Figure 13. If we
think of OIS as the market's expectation of
future short rates, we can interpret the spread
of LIBOR over OIS as a reflection of the
pressure for term financing.
ois
• OIS as the market's expectation of future short
rates, we can interpret the spread of LIBOR
over OIS as a reflection of the pressure for
term financing.
Interest rate swap
• An agreement between two parties (known as
counterparties) where one stream of future
interest payments is exchanged for another
based on a specified principal amount.
Interest rate swaps often exchange a fixed
payment for a floating payment that is linked
to an interest rate (most often the LIBOR).
OIS
• An interest rate swap involving the overnight
rate being exchanged for a fixed interest rate.
An overnight index swap uses an overnight
rate index, such as the Federal Funds Rate, as
the underlying for its floating leg, while the
fixed leg would be set at an assumed rate.
profit
• The figure shows the ex ante profit incentive
for anyone with access to Fed Funds to supply
term financing to anyone without such access,
ex ante because you can lock in the cost of
funds with the OIS swap. 100 basis points did
the trick in stage 1, but not in stage 3.
OIS
• Overnight index swaps are popular amongst
financial institutions for the reason that the
overnight index is considered to be a good
indicator of the interbank credit markets, and
less risky than other traditional interest rate
spreads.
European banks
• The epicenter of the crisis was in USD
mortgage lending, but this did not confine it
to US financial institutions. In the decade
leading up to 2007, European banks' US dollar
assets had grown significantly.
• Between 2000 and 2007, for example, they
grew from under $3 trillion to over $8 trillion.
• These assets were one side of a maturity
transformation,funded as they were by shortterm US dollar liabilitie McGuire and von Peter
(2009)
• measure this transformation by computing a
\dollar funding gap"|the amount of longmaturity US
• dollar assets supported by short-maturity US
dollar liabilities|which they calculate to be
$1.1{$1.3
Dollar funding gap
• A dollar funding gap the amount of longmaturity US dollar assets supported by shortmaturity US dollar liabilities,
• $1.1--$1.3 trillion dollar early 2007
example
• As a matter of comparison, the german trade
surplus in 2007 was around 180 billion dollars.
• In the narrative on the european crisis the
german trade surplus is interpreted as a sign
of the surplus capital that Germans invested in
other european countries (Inside the Eu
capital flows). It is totally neglected that
europeans banks were heavily indebted in
dollars.
European SIVs
• As the crisis deepened and the money
markets dried up, European SIVs experienced
funding problems similar to their US
counterparts. However, as their assets were
mainly dollar-denominated and greatly
exceeded the dollar deposits held by their
parent banks, the gap had to be funded
ineuros, which entailed exchange risk.
private lender-of-last-resort
Early in the crisis, private lender-of-last-resort
facilities were available to European banks. An
important channel for refinance was through
money market mutual funds (MMMFs).
European banks held about $8 trillion in USD
assets. MMMFs provided, by mid-2008, about
$1.2 trillion in USD .MMMFs appear to have
increased their lending to non-US banks
between August 2007 and August 2008.
Us MMMFs fund european banks
• Assets at MMMFs were increasing as investors
withdrew funds from the ABCP market and
elsewhere. In turn, MMMFs were drawing
down their holdings in the CP market and
shifting to CDs, including Eurodollar CDs. Since
European banks' share of issuance of the
latter is greater than that of the former, this
represents an increase in MMMF funding of
European banks.
Run on MMMFs
• Since European banks' share of issuance of the
latter is greater than that of the former, this
represents an increase in MMMF funding of
European banks. This avenue of funding
seems to have expanded until the collapse of
Lehman, when a run on MMMFs began.
• Generally, European financial institutions face
two options when trying to obtain dollar
funding. They can borrow directly in the dollar
cash market, or they can borrow in euros and
then swap these into dollars.
Euro/US dollar foreign-exchange
swap
• A Euro/US dollar foreign-exchange swap is a
fixed-term contract in which one exchanges
euros for dollars at the current spot rate with
the agreement to convert the dollars back into
euros at a later date; the future exchange rate
is given by the corresponding forward rate.
Eurodollar markets frozen
• The Eurodollar markets were increasingly
frozen as the crisis progressed, making it dicult
for European institutions to borrow dollars
directly (i.e. the right hand side of equation (2)
gradually became in a sense irrelevant). The
reduction in the availability of short-term
dollar funding intensified throughout 2007.
Banks responded by drawing on several
sources of funds.
• The Eurodollar market, which had served as a
lender of last resort for European banks' US
• dollar operations, broke down.
• Consequently, European banks increasingly
turned to obtaining funding in euros (which
they could do through ECB backstops) and
swapping them into dollars. Yet an FX swap is
not a fully collateralized transaction and
involves exposure to both counterparty and
liquidity risk.
Fed’s backstop
• In response to this US dollar shortage, the
Federal Reserve announced the establishment
of foreign-exchange swap lines with the ECB
on December 12, 2007. In this program, the
Fed provided US dollars to the ECB in the form
of foreign exchange swaps, providing the ECB
with dollar reserves. The ECB then lent out
these dollar funds through a program similar
to the Fed's Term Auction Facility.
Ecb intervention
• Apart from the coordination of US dollar swap
lines with the Federal Reserve, the ECB also
provided other backstops throughout the
financial turmoil.
refinancing operations
• in 2007, refinancing operations at 3 months
were initiated (as opposed to the pre-crisis
norm of 1-week operations), and their use had
increased. 6- and 12-month liquidity was also
eventually extended.
European repo market
• In this phase the european repo market
worked better than the uS one.
Graph balance sheet ecb
• The shift from short- to long-term refinancing
is evident as early as August 2007.
• The bright orange region (third from the top)
is reclassified into a peach-colored region in
July of 2009, which is simultaneous with the
implementation of a program to purchase
covered bonds as a means to refinance banks.
Dollar swap lines
• The dollar swap lines, shown in green,
increased gradually after their inception in
December 2008 and then rapidly after
Lehman's collapse.
bank-credit financial system,
• As the microstructure of the financial system
changes, the system's capacity to stabilize
itself must change as well. Lender-of-lastresort operations are suited to a bank-credit
financial system, in which banks fund loans
with deposits.
• When a solvent institution is faced with a
liquidity crisis (that is, a bank run), the right
thing to do is to provide funds against good
collateral (Bagehot).
capital-markets financial system
• In a capital-markets financial system, dealers
make markets in tradable securities that are
normally liquid, financing their positions in the
repo market. When holders of these securities
want to liquidate their positions, the
consequences are magnified because the
securities are serving as collateral for their
own financing. Liquidity vanishes quickly.
• The global credit crisis that began
• in 2007, demands a different kind of policy
response, it is the role of securities dealer that
• must be fulfilled by the public sector.
Fed as a dealer
• The private and public responses through
September 2008 were insufficient to stabilize
the system; it was only when the Fed finally
became a dealer that some resemblance of
order returned.