Repo repurchase rate is the rate at which the central bank lends shortterm money to the banks against securities. Gorton and metrick 2012 describe this run as a run on repo since it took place within the securitised banking system and was driven by the withdrawal of repos repurchase agreements. We document that the financial crisis of 20072008 was a repo run in. The interbank lending market is a market in which banks lend funds to one another for a specified term. Securitized banking and the run on repo, journal of financial economics, elsevier, vol. Securitized banking and the run on repo american economic. They were arguing that the crisis was connatural to a traditional banking panic, but was instead triggered by a run on the repo market as a part of the securitized banking sector. The dealer sells the underlying security to investors and buys them back shortly afterwards, usually the following day, at a slightly higher price. Macroeconomic determinants of shadow banking evidence. The analogue in securitized banking is the repo haircut, which forces banks to keep some fraction of their assets in reserve when they borrow money through repo markets.
Market institutions and financial market risk, national bureau of economic research, inc. A reduction in the repo rate will help banks to get money at a cheaper rate. Securitized banking, which is the name that yale economist gary gorton has given to the combination of repurchase agreements and securitization, was the witches brew that erupted in 2007 and 2008. Using a large sample of banks, we find that increases in repurchase agreements repos were recognized by external capital markets to increase bank risk in the precrisis period. The expectations hypothesis is a fundamental theory of the term structure of interest rates. One such market is the multitrillion dollar saleandrepurchase repo mark. It is more applicable when there is a liquidity crunch in the market. Central banking before, during and after the crisis. Securitized banking, or, the shadow banking system the need for lowrisk secure, shortterm lending between giant financial institutions gave rise to what is called the shadow banking system, also known as the parallel banking system.
The establishment of the fdic largely ended commercial bank runs. Although there was no wholesale run on the traditional banking system in this period, we effectively observed a run on shadow banks that led to the demise of a significant part of the shadow banking system. Jul 30, 2009 the panic of 20072008 was a run on the sale and repurchase market the repo market, which is a very large, shortterm market that provides financing for a wide range of securitization activities and financial institutions. The role of securitized lending and shadow banking in the 2008 financial crisis essay debora dyankova student number. Explaining the ecbs support for repo and securitization markets by the central banks dependence on these financial infrastructures, the article adds an important piece to the puzzle of how finance wins, while at the same time highlighting policymaking as a facet of central banking that, at a time of heightened concerns about central bank. These facilities allowed banks to bring collateral to the fed in. Gorton and metrick 2012 describe this run as a run on repo since it took place within the securitisedbanking system and was driven by the withdrawal of repos repurchase agreements. Developments in repo markets during the financial turmoil. Gorton andrew metrick countryies or regions united states source. Securitized banking and the run on repo, journal of financial. So while the run on repo may have contributed to the problems of a few repo borrowers that were relying heavily on repo with riskier collateral, in general, the run on repo was a sideshow, nagel said. The authors stated the massive deleveraging in the financial system, enforced by the deepened haircuts reducing the value of collateral to a great extent, as a major.
Repurchase agreement where a seller of a security agrees to buy it back from a buyer investor at a higher price on a specified date. When the repo rate increases, borrowing from the central bank becomes more expensive. The reinvestment of cash collateral as practiced by securities lending agents potentially introduces a source of risk in addition to the run risk that also exists in repo markets. Securitized banking and the run on repo sciencedirect.
For example, a brokerdealer could sell a security to a moneymarket mutual fund and agree to repurchase the security the. May 05, 2011 the underbelly of securitized banking is showing, as investors and traders fight over the scraps left after the financial crisis of 20072008. The shadow banking system is an essential part of the process of credit creation in modern banking. Evermotion archmodel 102 pdf soho rep writers lab app. Both episodes, in 1 th e risk assessments reported in this analysis were undertaken with the valuecalc banking system risk modeling software, finsoft, inc. Gorton and metrick 2009 have documented these crisisinduced phenomena across securities, as well as interbank, markets. Securitized banking and the run on repo, nber working papers 15223, national bureau of economic research, inc. The financial crisis began and accelerated in shortterm money markets. But financial institutions have been repoing and securitizing for years.
The underbelly of securitized banking is emerging repowatch. Securitized banking and the run on repo, nber chapters, in. Since repo financing was the basis of most of the leveraged positions of the shadow banks, a large part of the run occurred in the repo market. Depositor takes physical possession of the collateral. The macroeconomics of shadow banking macroeconomic dynamics. We refer to the combination of securitization plus repo finance as securitized. Repo transactions are collateralized, frequently with securitized bonds. Repo council, eurex repo, icap and the federal reserve bank of new york for providing. A repurchase agreement, also known as a repo, rp, or sale and repurchase agreement, is a form of shortterm borrowing, mainly in government securities. What changed in the 21 st century, to make securitized banking so lethal. Most interbank loans are for maturities of one week or less, the majority being overnight. One battle that has gotten media attention is a class action against jp morgan chase, where pension funds that were clients of jp morgan are claiming that officials of the giant bank, up to and including ceo. By packaging them into diversified bonds origination, which can be sold, they get more liquid.
The panic of 20072008 was a run on the sale and repurchase market the. New demand for banking a sale and repurchase agreement repo is a deposit of cash at a bank which is short. The pillar of the shadow banking system is the repo. Securitization is the process of taking an illiquid asset or group of assets and, through financial engineering, transforming it or them into a security. Investment banking, securities dealers, repurchase agreements, triparty repo, bilateral repo, money market mutual. In the shadow banking system aka securitized banking. Macroeconomic determinants of shadow banking evidence from. The next row, deposit insurance, is a promise made by the government to pay depositors in the event of default. Fung w and d a hsieh 1997 empirical characteristics of.
Securitized banking and the run on repo ideasrepec. Securitized banking and the run on repo view document back to search results media type document media date 2012 content type research paper publishers elsevier. Fung w and d a hsieh 1997 empirical characteristics of dynamic trading from ma 02 at georgia institute of technology. These agreements are in effect loans or short term swaps between investors to sellers the difference between the buying and selling prices being the investors earnings, and are used usually for. The coefficient estimates for dealers and collateral class have been ranked from smallest to largest. In step a, depositors transfer money to the bank, in return for a checking or savings account from which withdrawals can be made at any time.
Securitized banking and the run on repo researchgate. The extant literature suggests that one of the main causes of the recent financial crisis was the excessive use of shortterm debt by banks. These data would create a complete picture of the repo and sec lending trades in the. Securitized lending, asymmetric information, and financial. Shortterm debt and bank risk journal of financial and. Central banking and the infrastructural power of finance. A repo transaction is a combination of an agreement to sell a security at a given price and an agreement to repurchase the security at a later date, typically at a higher price. The panic of 20072008 was a run on the sale and repurchase market the repo market, which is a very large, shortterm market that provides. Asset pricing, corporate finance, economic fluctuations and growth, monetary economics the panic of 20072008 was a run on the sale and repurchase market the repo market, which is a very large, shortterm market that provides financing for a wide range. Jan 14, 2015 the role of securitized lending and shadow banking in the 2008 financial crisis essay 1. Section v concludes with a discussion of related topics in regulation and monetary policy an appendix supplements the text with a glossary of shadow banking terminology used in the paper. To provide background for our analysis, we illustrate the differences between traditional banking and securitized banking in fig. Securitized banking and the run on repo, journal of.
Deposit insurance is a promise made by the government to pay depositors in the event of default. Feb 18, 2019 securitization is the process of taking an illiquid asset or group of assets and, through financial engineering, transforming it or them into a security. Such loans are made at the interbank rate also called the overnight rate if the term of the loan is overnight. Securitized banking and the run on repo, journal of financial economics, 1043.
The vast majority of repos were collateralized by safe government securities, they say, not riskier securitized mortgage products. The federal reserve bank of new york works to promote sound and wellfunctioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support to international institutions. Peso problems and term structure anomalies of repo rates. We measure the repo funding extended by money market funds mmf and securities lenders to the shadow banking system, including quantities, haircuts, and repo rates by type of underlying collateral. It states that the yield on a long bond is equal to the average expectation of the short yield over the life of the long bond plus a constant risk premium. Journal of financial economics authorscreators gary b. G1,g19 abstract the panic of 20072008 was a run on the sale and repurchase market the repo market, which is a very large, shortterm market that provides financing for a wide range of securitization activities. The underbelly of securitized banking is showing, as investors and traders fight over the scraps left after the financial crisis of 20072008. Investment banking, securities dealers, repurchase agreements, triparty repo, bilateral repo, money market mutual funds, assetbacked commercial paper, bank runs. Securitized banking and the run on repo, yale school of management working papers amz2358, yale school of management, revised 01 sep 2009.
The next row, deposit insurance, is a promise made by the government to pay depositors in the event of. A sharp decline in transaction volume in this market was a major contributing factor to. A traditionalbanking run is driven by the withdrawal of deposits, while a securitizedbanking run is driven by the withdrawal of repurchase repo agreements. Repo and securities lending federal reserve bank of new york.