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Claudia M. Buch, James Chapman, and Linda Goldberg
Over the past thirty years, the typical large bank has become a global entity with subsidiaries in many countries. In parallel, financial liberalization has increased the interconnectedness of banking systems, with domestic banking systems becoming more exposed to shocks transmitted through foreign banks. This globalization of banking propagated liquidity risk during the global financial crisis and subsequent euro area crisis. Unfortunately, little is known about how cross-border operations of global banks transmit liquidity shocks between countries. The seminal work by Peek and Rosengren (1997, 2000) provides early examples of how bank-level data can help identify the specific transmission channels. There are, however, two limitations to conducting this line of research. First, there is a lack of public data on the balance sheets of global banks. Second, it is difficult to compare the results of different research projects that use sensitive supervisory data collected by banking supervisors and central banks. Together with other scholars, we established the International Banking Research Network (IBRN) to overcome these limitations.
Michael Fleming, Frank Keane, Antoine Martin, and Michael McMorrow
In June of this year—as we noted in the preceding post—settlement fails in U.S. Treasury securities spiked to their highest level since the implementation of the fails charge in May 2009. Our first post reviewed what fails are, why they arise, and how they can be measured. In this post, we dig into the fails data to identify possible explanations for the high level of fails in June. We observe that sequential fails of several benchmark securities accounted for the lion’s share of fails in June, but that fails in seasoned securities—which have been trending upward for some time—were also elevated.
Michael Fleming, Frank Keane, Antoine Martin, and Michael McMorrow
In June 2014, settlement fails of U.S. Treasury securities reached their highest level since the implementation of the Treasury fails charge in May 2009, attracting significant attention from market participants. In this post, we review what fails are, why they are of interest, and how they can be measured. In a companion post following this one, we evaluate the particular circumstances of the June 2014 fails.
Dong Beom Choi, Patrick de Fontnouvelle, Thomas Eisenbach, and Michael Fleming
The Federal Reserve Banks of Boston and New York recently cosponsored a workshop on the risks of wholesale funding. Wholesale funding refers to firm financing via deposits and other liabilities from pension funds, money market mutual funds, and other financial intermediaries. Compared with stable retail funding, the supply of wholesale funding is volatile, especially during financial crises. For instance, when a firm relies on short-term wholesale funds to support long-term illiquid assets, it becomes vulnerable to runs by its wholesale creditors, as seen during the recent financial crisis. The workshop was organized to promote a better understanding of the risks posed by wholesale funding and to explore policy options for minimizing these risks.
Marco Del Negro, Marc Giannoni, Raiden Hasegawa, and Frank Schorfheide
Since the financial crisis of 2007-08 and the Great Recession, many commentators have been baffled by the “missing deflation” in the face of a large and persistent amount of slack in the economy. Some prominent academics have argued that existing models cannot properly account for the evolution of inflation during and following the crisis. For example, in his American Economic Association presidential address, Robert E. Hall called for a fundamental reconsideration of Phillips curve models and their modern incarnation—so-called dynamic stochastic general equilibrium (DSGE) models—in which inflation depends on a measure of slack in economic activity. The argument is that such theories should have predicted more and more disinflation as long as the unemployment rate remained above a natural rate of, say, 6 percent. Since inflation declined somewhat in 2009, and then remained positive, Hall concludes that such theories based on a concept of slack must be wrong.
In a recently released New York Fed staff report, we present a forward-looking monitoring program to identify and track time-varying sources of systemic risk. Our program distinguishes between shocks, which are difficult to prevent, and the vulnerabilities that amplify shocks, which can be addressed. Drawing on a substantial body of research, we identify leverage, maturity transformation, interconnectedness, complexity, and the pricing of risk as the primary vulnerabilities in the financial system. The monitoring program tracks these vulnerabilities in four sectors of the economy: asset markets, the banking sector, shadow banking, and the nonfinancial sector. The framework also highlights the policy trade-off between reducing systemic risk and raising the cost of financial intermediation by taking pre-emptive actions to reduce vulnerabilities.
Adam Copeland, Isaac Davis, Eric LeSueur, and Antoine Martin
The repurchase agreement (repo), a contract that closely resembles a collateralized loan, is widely used by financial institutions to lend to each other. The repo market is divided into trades that settle on the books of the two large clearing banks (that is, tri-party repo) and trades that do not (that is, bilateral repo). While there are public data about the tri-party repo segment, there is little to no information on the bilateral repo segment. In this post, we update a methodology we developed earlier to estimate the size and composition of collateral posted for bilateral repos, and find that U.S. Treasury securities are the dominant form of collateral for bilateral repos. This new finding implies that the collateral posted for bilateral repos is of higher quality than the collateral posted for tri-party repos.
Currency forwards do include useful information about the future value of the U.S. dollar, but any messages are hard to decipher without tools. Just as the yield curve reflects expected short rates as well as
foreign exchange forwards embed not only anticipated depreciation but also premiums for currency risk. This complicates life for both central bankers, who routinely tease information from asset prices, and portfolio managers, who need to estimate expected returns and beat benchmarks. Most analyses of market quotes suggest that forwards as well as interest rate differentials largely comprise noise rather than information about anticipated currency returns. However, drawing on my recent
a new method, analogous to common arbitrage-free term structure models and based solely on observable prices, suggests that forwards provide lucid clues about the expected path of the U.S. dollar.
One of the lessons from the recent financial crisis is the need for securities dealers to have durable sources of funding. As evidenced by the demise of Bear Stearns and Lehman Brothers, during times of stress, cash lenders may pull away from firms or funding markets more broadly. Lengthening the tenor of secured funding is one way for a dealer to mitigate the risk of losing funding when market conditions are strained. In this post, we use clearing bank tri-party repo data to examine the degree to which dealers are lengthening the maturities of their sources of funding. (Aggregate statistics using these data are available here.) We focus on less liquid securities because it is for these assets that the durability of funding matters the most. We find substantial progress overall, with the weighted-average maturity (WAM) of funding of the less liquid securities more than doubling from January 2011 to May 2014. Nevertheless, there is currently a wide dispersion in dealer-level WAM, raising questions as to whether all dealers have enough durability in their funding of risk assets.
The spot term premium is the extra compensation investors require, today, to own long-term as opposed to short-term risk-free debt. The expected term premium is what they anticipate demanding later. Notably, the two don’t necessarily move in the same direction. Just as near-term expected short rates could decline with surprisingly easy monetary policy, while simultaneously more distant-horizon expected rates could increase if that action boosts expected longer-run inflation or growth, so too could investors require less duration compensation immediately, perhaps as the central bank announces plans to buy assets, yet build in greater risk premiums for later amid allowances for a bumpy withdrawal of the punchbowl. Why is this distinction relevant? Nearly everyone agrees that historically low term premiums coincided with unconventional measures, but we know less about how long investors expected low premiums to prevail. Drawing on my staff report, formal models suggest that expected term premiums did drop along with spot measures, but a survey-based estimate notably increased since 2007. This hardly means the Federal Open Market Committee (FOMC) didn’t provide extraordinary support beyond the standard short rate channel, but perhaps investors weren’t insouciant and instead fathomed a possibly tricky exit from prolonged policy accommodation.
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