1. Crisis US money market
18 marzo 2015

2. Crisis liquidity

3. Response to the crisis

4. 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.

5. Shadow banks

6. Repo financing
Shadow banks used repo as means of financing because it was cheap.

7. taxonomy
Money market rates

8. Short term Rates spread
Befor the crisi erupted the spread between these rates were a few basis
A basis point = 0.01

9. 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:

10. repo REPO SONO LA MAGGIORE FONTE DI FIN.
PER I DEALERS NEI TITOLI CHE FANNO IL MERCATO.
Se un dealer acquista un titolo si finanzia per mezzo di un repo in cui offre come garanzia il titolo acquistato. La controparte e’ un altro dealer o un’impresa non finanziaria.

11. 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.

12. Le banche che non hanno accesso ai fed funds devono invece pagare il libor.
Fed funds and libor prestiti non sono assicurati ma le banche osservano con attenzione i bilanci delle controparti.
Questi tassi sono allineati dall’arbitragggio. Gli operatori che possono farlo prendono a prestito al tasso piu’ economico e danno a prestito al tasso piu’ elevato.

13. Questa struttura e’ antecedente la nascita dello shadow banking ma lo shadow banking l’ha utilizzata cosicche’ durante la crisi essa ne’ stata influenzata.
Il crollo delle relazioni di arbitraggio tra i tassi durante la crisi e’ la prova EVIDENTE dei problemi di liquidita’ ad essa collegati.

14. overnight money market rates

15. Vertical lines
Vertical lines show when Bear Stearns and Lehman failed.

16. 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%).

17. Fed funds rate and target

18. 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.

21. 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.

22. 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.

23. 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.

24. fed assets

25. fed liabilities

26. Comment graph
The Fed used open market operations as policy tool until the end of From the spring of 2008 onwards it started using special facilities and this has changed the composition of its balance sheet .

27. 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.

30. International considerations
The crisis was centered in US dollar funding markets. Disruptions mainly spread to other countries via investments in these dollar markets.

31. Dollar funding
The crisis was a shortage of dollar funding

32. 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.

33. 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.

34. 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.

35. 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.

36. 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.

37. 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.

38. 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).

39. 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.

40. 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.

41. 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.

43. 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.

44. These assets were one side of a maturity transformation,funded as they were by short-term US dollar liabilitie McGuire and von Peter (2009)
measure this transformation by computing a \dollar funding gap"|the amount of long-maturity US
dollar assets supported by short-maturity US dollar liabilities|which they calculate to be $1.1{$1.3
trillion at its peak in early European banks had also extended guaranteed US dollar credit
lines in support of conduits in the US (Baba et al., 2008), apparently under the assumption that
Eurodollar funds would be available to fund these extensions of credit if necessary.6
As the crisis deepened and the money markets dried up, European SIVs experienced funding s.

45. Dollar funding gap
A dollar funding gap the amount of long-maturity US dollar assets supported by short-maturity US dollar liabilities,
$1.1--$1.3 trillion dollar early 2007

46. 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.

47. 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.

48. 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.

49. 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.

50. 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.

53. 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.

54. 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.

55. 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 Banks responded by drawing on several sources of funds.

56. The Eurodollar market, which had served as a lender of last resort for European banks' US
dollar operations, broke down.

57. 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.

59. 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, 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.

60. 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.

61. 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.

62. European repo market
In this phase the european repo market worked better than the uS one.

66. Graph balance sheet ecb
The shift from short- to long-term refinancing is evident as early as August 2007.

67. 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.

68. 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.

69. 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-last-resort operations are suited to a bank-credit financial system, in which banks fund loans with deposits.

70. 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).

71. 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.

72. 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.

73. 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.