![]() By August 2007, market fears reached a critical mass that led to the first run on repo. This was exacerbated by the forced selling of underlying collateral, which in turn reinforced the cycle of declining asset values and increasing haircuts. Although some banks raised capital by issuing new securities in response, those efforts soon fell short because of slumping real estate, and mortgage, prices. Changes in the LIB-OIS spread represent counterparty risk, which is strongly correlated with changes in credit spreads and repo rates for securitized bonds.īased on their analysis, the authors hypothesize that when the subprime real estate market weakened early in 2007, repo market buyers grew anxious about the quality of the securitized assets in the bonds and the increasing haircuts on deals. That LIB-OIS spread is believed to be a proxy for fears about bank solvency. Among the market variables that they follow are ABX indices, which track the fundamentals of the subprime market, and the "LIB-OIS" spread, that is, the interest rate difference between the 3-month LIBOR (London Interbank Overnight Rate), which tracks the interest rate paid on unsecured interbank loans, and the overnight index swap (OIS) rate, which tracks the derivatives used in repo transactions. They track these market prices, over the period 2007-8. The authors study spreads on 392 securitized bonds and related assets that are typically used in repo transactions. The percentage earned by the investor on that collateral, which sometimes is made up of other securitized bonds, is analogous to the interest rate on a bank deposit it is known as the "repo rate." Typically, the total amount of the deposit will be somewhat less than the value of the underlying asset, with the difference called a "haircut." That liability forces banks to keep some fraction of their assets in reserve when they borrow money through the repo markets. Buyers of securitized bonds, often made up of mortgages, receive protection from the seller in the form of a repo agreement: the investor buys some asset representative of collateral from the bank for a set amount and the bank agrees to repurchase that same asset some time later at an agreed upon price. Morgan, and Bank of America, as a supplement to their traditional banking activities. ![]() Prior to the panic, securitized banking was a $12 trillion business practiced by the nation's largest investment houses, including Bear Stearns, Lehman Brothers, Morgan Stanley, and Merrill Lynch, as well as by commercial banks such as Citigroup, J.P. 15223), they argue that securities created from loans that originated in the subprime mortgage market played a major role in inciting the event, but that ultimately it was the loss of liquidity at the firms that were the biggest players in the securitized banking system that led to the financial crisis. In Securitized Banking and the Run on Repo (NBER Working Paper No. The authors define "securitized banking" as the creation of structured bonds from bank loans, such as mortgages, which are then used as collateral for repo. Repo is a form of banking in which firms and institutional investors "deposit" money, by lending for interest, short term, and receive collateral as a guarantee. The financial panic of 2007-8 stemmed from a run on the repurchase or "repo" market - the primary source of funds for the securitized banking system - rather than a run on monetary deposits as in earlier banking panics, according to a recent study by Gary Gorton and Andrew Metrick. The loss of liquidity at the firms that were the biggest players in the securitized banking system. Transportation Economics in the 21st Century.Training Program in Aging and Health Economics.The Roybal Center for Behavior Change in Health.Retirement and Disability Research Center.Measuring the Clinical and Economic Outcomes Associated with Delivery Systems.Improving Health Outcomes for an Aging Population.Early Indicators of Later Work Levels, Disease and Death.Conference on Research in Income and Wealth.Boosting Grant Applications from Faculty at MSIs.Productivity, Innovation, and Entrepreneurship.International Finance and Macroeconomics.
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