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Sean Hundtofte, Michael Lee, Antoine Martin, and Reed Orchinik
Having witnessed the dramatic rise and fall in the value of cryptocurrencies over the past year, we wanted to learn more about what motivates people to participate in this market. To find out, we included a special set of questions in the May 2018 Survey of Consumer Expectations, a project of the New York Fed’s Center for Microeconomic Data. This blog post summarizes the results of that survey, shedding light on U.S. consumers’ depth of participation in cryptocurrencies and their motives for entering this new market.
Marco Del Negro, Domenico Giannone, Marc P. Giannoni, Andrea Tambalotti, Brandyn Bok, and Eric Qian
Long-term government bond yields are at their lowest levels of the past 150 years in advanced economies. In this blog post, we argue that this low-interest-rate environment reflects secular global forces that have lowered real interest rates by about two percentage points over the past forty years. The magnitude of this decline has been nearly the same in all advanced economies, since their real interest rates have converged over this period. The key factors behind this development are an increase in demand for safety and liquidity among investors and a slowdown in global economic growth.
The term “operational risk” often evokes images of catastrophic events like hurricanes and earthquakes. For financial institutions, however, operational risk has a broader scope, encompassing losses related to fraud, rogue trading, product misrepresentation, computer and system failures, and cyberattacks, among other things. In this blog post, we discuss how operational risk has come into greater focus over the past two decades—to the point that it now accounts for more than a quarter of financial institutions’ regulatory capital.
Dong Beom Choi, Fernando Duarte, Thomas M. Eisenbach, and James Vickery
In the wake of the 2007-09 financial crisis, a wide range of new regulations have been introduced to improve the stability of the banking system. But has the banking system become safer since the crisis? In this post, we provide a new perspective on this question by employing four analytical models, each measuring a different aspect of banking system vulnerability, to evaluate how system stability has evolved over the past decade.
Nina Boyarchenko, Thomas M. Eisenbach, Pooja Gupta, Or Shachar, and Peter Van Tassel
Since the 2007-09 financial crisis, the prices of closely related assets have shown persistent deviations—so-called basis spreads. Because such disparities create apparent profit opportunities, the question arises of why they are not arbitraged away. In a recent Staff Report, we argue that post-crisis changes to regulation and market structure have increased the costs to banks of participating in spread-narrowing trades, creating limits to arbitrage. In addition, although one might expect hedge funds to act as arbitrageurs, we find evidence that post-crisis regulation affects not only the targeted banks but also spills over to less regulated firms that rely on bank intermediation for their arbitrage strategies.
Nina Boyarchenko, Anna M. Costello, and Or Shachar
Credit default swaps (CDS) are frequently credited with being the cause of AIG’s collapse during the financial crisis. A Reuters article from September 2008, for example, notes “[w]hen you hear that the collapse of AIG […] might lead to a systemic collapse of the global financial system, the feared culprit is, largely, that once-obscure […] instrument known as a credit default swap.” Yet, despite the prominent role that CDS played during the financial crisis, little is known about how individual financial institutions utilize CDS contracts on individual companies. In a recent New York Fed staff report, we assess the choice banks face when trading the idiosyncratic credit risk of a firm, and argue that banks’ participation decisions have been affected in the post-regulation period, either by direct changes in market structure or by changes in the relative cost of pursuing different strategies.
The post-crisis regulatory reform efforts to improve capital and liquidity positions of regulated institutions provide incentives for banks to change not only the structure of their own balance sheets but also how they interact with their customers and other market participants more generally. A 2015 PwC study on global financial market liquidity, for example, noted that “[a]s banks respond to the new regulatory environment, they have sought to make more efficient use of capital and liquidity resources, by reducing the markets they serve and streamlining their operations.” In this blog post, we provide an overview of three recent New York Fed staff reports that study the impact that post-crisis regulation has had on the willingness and ability of regulated firms to participate in U.S. over-the-counter (OTC) markets.
Banks traditionally provide loans that are funded mostly by deposits and thereby create liquidity, which benefits the economy. However, since the loans are typically long-term and illiquid, whereas the deposits are short-term and liquid, this creation of liquidity entails risk for the bank because of the possibility that depositors may “run” (that is, withdraw their deposits on short notice). To mitigate this risk, regulators implemented the liquidity coverage ratio (LCR) following the financial crisis of 2007-08, mandating banks to hold a buffer of liquid assets. A side effect of the regulation, however, is a reduction in liquidity creation by banks subject to LCR, as we find in our recent paper.
Dong Beom Choi, Michael Holcomb, and Donald P. Morgan
Classic arbitrage involves the same asset selling at different prices; the leverage rule arbitrage we study here involves assets of different risk levels requiring the same amount of capital. The supplementary leverage ratio (SLR) rule, finalized by U.S. regulators in September 2014, requires a minimum ratio of capital to assets at the largest U.S. banks. The floor is higher for more systemically important banks, but not for banks with riskier assets. That non-risk-based aspect of SLR was intentional, since the leverage limit was meant to backstop (“supplement”) risk-based capital rules in case banks underestimate their asset risk and overstate their capital strength. As policymakers have noted and bankers have warned, if the leverage rule is the binding capital requirement, banks can “arbitrage” the rule by selling safer assets and replacing them with riskier, higher-yielding ones. The findings of our recent staff report are consistent with those concerns.
Many market participants believe that large financial institutions enjoy an implicit guarantee that the government will step in to rescue them from potential failure. These “Too Big to Fail” (TBTF) issues became particularly salient during the 2008 crisis. From the government’s perspective, rescuing these financial institutions can be important to avoid harm to the financial system. The bailouts also artificially lower the risk borne by investors and the financing costs of big banks. The Dodd-Frank Act attempts to remove the incentive for governments to bail out banks in the first place by mandating that each large bank file a “living will” that details its strategy for a rapid and orderly resolution in the event of material distress or failure without disrupting the broader economy. In our recent New York Fed staff report, we look at whether living wills are effective at reducing the cost of implicit TBTF bailout subsidies.
Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.
The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.
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