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Regulatory reforms since the financial crisis have sought to make the financial system safer and severe financial crises less likely. But by limiting the ability of regulated institutions to increase their balance sheet size, reforms—such as the Dodd-Frank Act in the United States and the Basel Committee's Basel III bank regulations internationally—might reduce the total intermediation capacity of the financial system during normal times. Decreases in intermediation capacity may then lead to decreased liquidity in markets in which the regulated institutions intermediate significant trading activity. While recent commentary by market participants claims that this is indeed the case—a Wall Street Journal article [subscription required] notes that “[t]hree-quarters of institutional bond investors say that liquidity provided by bond dealers has declined in the past year...”—empirical studies have struggled to find evidence supporting this narrative. In this post, we summarize the findings of our recent article in the Journal of Monetary Economics that addresses the apparent disconnect between the market-participant commentary and the empirical evidence by focusing on the relationship between bond-level liquidity and financial institutions’ balance sheet constraints.
Quantitative easing (QE)—the Federal Reserve’s effort to provide policy accommodation lowering long-term interest rates at a time when the federal funds rate was near its lower bound—has generated a great deal of research, both about its impact and about the frictions that might limit that impact. For example, this recent study finds that weak competition in local mortgage markets limited the pass-through from QE to mortgage rates for borrowers, and another study suggests that QE expanded banks’ mortgage lending while crowding out their commercial lending. In this post, we look into a different friction—whether banks’ limited risk-taking capacity after the crisis led them to favor refinance mortgages over new mortgage originations.
Catherine Chen, Marco Cipriani, Gabriele La Spada, Philip Mulder, and Neha Shah
On October 14, 2016, amendments to Securities and Exchange Commission (SEC) rule 2a-7, which governs money market mutual funds (MMFs), went into effect. The changes are designed to reduce MMFs’ susceptibility to destabilizing runs and contain two principal requirements. First, institutional prime and muni funds—but not retail or government funds—must now compute their net asset values (NAVs) using market-based factors, thereby abandoning the fixed NAV that had been a hallmark of the MMF industry. Second, all prime and muni funds must adopt a system of gates and fees on redemptions, which can be imposed under certain stress scenarios. This post studies the effect of the amendments on the size and composition of the MMF industry and, in particular, whether MMF investors shifted their assets from prime and muni funds toward government funds in anticipation of the tighter regulatory regime.
Debt in China has increased dramatically in recent years, accounting for roughly one-half of all new credit created globally since 2005. The country’s share of total global credit is nearly 25 percent, up from 5 percent ten years ago. By some measures (as documented below), China’s credit boom has reached the point where countries typically encounter financial stress, which could spill over to international markets given the size of the Chinese economy. To better understand the associated risks, it is important to examine the drivers of China’s expansion in credit, the increasing complexity of its financial system, and evidence that its supply of credit may be growing more rapidly than reported. Note, however, that there are several features of China’s financial system that reduce the threat of a financial disruption.
Every quarter, senior loan officers at selected large banks around the United States are asked by Fed economists how their standards for approving business loans changed compared with the quarter before. Of all the questions in the Senior Loan Officer Opinion Survey (SLOOS), responses to that question about standards usually attract the most attention from the financial press and researchers. Relatively ignored by comparison are loan officers’ reports on how they changed interest spreads, collateral requirements, and other terms on loans they are willing to approve. Lenders can clearly expand or contract credit by altering those terms even without changing their standards for approving loans, so we investigate whether the reports on loan terms collected in the SLOOS are also informative.
Andreas Fuster, Eilidh Geddes, Benedict Guttman-Kenney, and Andrew Haughwout
Housing is by far the most important asset for most households, and, not coincidentally, housing debt dwarfs other household liabilities. The relationship between housing debt and housing values figures significantly in financial and macroeconomic stability, as events during the housing bust of 2006-12 clearly demonstrated. This week, Liberty Street Economics presents five posts touching on various aspects of housing, from the changing relationship between mortgage debt and housing equity to the future of homeownership. In today’s post, we provide estimates of housing equity and explore how vulnerable households are to declines in house prices, using methods introduced in our paper “Tracking and Stress Testing U.S. Household Leverage.”
Alexandra Altman, Kathryn Bayeux, Marco Cipriani, Adam Copeland, Scott Sherman, Brett Solimine
Editor’s note: In the data file originally released with this post, some repo volume figures were misaligned with their dates; the problem has been corrected. (December 19, 11:15 a.m.)
In its recent “Statement Regarding the Publication of Overnight Treasury GC Repo Rates,” the Federal Reserve Bank of New York, in cooperation with the U.S. Treasury Department’s Office of Financial Research, announced the potential publication of three overnight Treasury general collateral (GC) repurchase (repo) benchmark rates. Each of the proposed rates is designed to capture a particular segment of repo market activity. All three rates, as currently envisioned, would initially be based on transaction-level overnight GC repo trades occurring on tri-party repo platforms. The first rate would only include transactions in the tri-party repo market, excluding both General Collateral Finance Repo Service, or GCF Repo®, transactions and Federal Reserve transactions. (GCF Repo is a registered service mark of the Fixed Income Clearing Corporation.) Henceforth in this post, this segment will be referred to as tri-party ex-GCF/Fed. The second rate would build on the first by including GCF Repo trading activity while still excluding Federal Reserve transactions. Finally, the third rate would include tri-party ex-GCF/Fed transactions, GCF Repo transactions, and Federal Reserve transactions. The repo benchmark rates would be calculated as volume-weighted medians, as is currently the case for the production of the effective federal funds rate (EFFR) and the overnight bank funding rate (OBFR), and would be accompanied by summary statistics. The three proposed rate compositions result from staff analysis on the various market segments and characteristic trading behavior, though the New York Fed expects to work with the Board of Governors of the Federal Reserve System to seek public comment on the composition and calculation methodology for these rates before adopting a final publication plan.
Asset securitization is an important source of corporate funding in capital markets. Collateralized loan obligations (CLOs) are securitization structures that allow syndicated bank lenders and bond underwriters to repackage business loans and sell them to investors as securities. CLOs are actively overseen by a collateral manager that has the responsibility to trade loans in the portfolio to benefit from gains and mitigate losses from credit exposures. Because CLOs include a diverse portfolio of loans, a single firm that commingles its lending role with the collateral management role can reap information advantages stemming from its “originate-to-distribute” activities.
The panic of 1907 was among the most severe we’ve covered in our series and also the most transformative, as it led to the creation of the Federal Reserve System. Also known as the “Knickerbocker Crisis,” the panic of 1907 shares features with the 2007-08 crisis, including “shadow banks” in the form high-flying, less-regulated trusts operating beyond the safety net of the time, and a pivotal “Lehman moment” when Knickerbocker Trust, the second-largest trust in the country, was allowed to fail after J.P. Morgan refused to save it.
James Vickery, Lauren Thomas, and Ulysses Velasquez
Profits and employment in the oil and natural gas extraction industry have fallen significantly since 2014, reflecting a sustained decline in energy prices. In this post, we look at how these tremors are affecting banks that operate in energy industry–intensive regions of the United States. We find that banks in the “oil patch” have experienced a significant rise in delinquencies on commercial and industrial loans. So far though, there appears to be limited evidence of spillovers to other types of loans and no evidence of widespread bank losses or failures in these regions.
Liberty Street Economics features insight and analysis from economists working at the intersection of research and policy. The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Donald Morgan.
The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.
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