In a Liberty Street Economics post that appeared yesterday, we described the mechanics of the Federal Reserve’s balance sheet “runoff” when newly issued Treasury securities are purchased by banks and money market funds (MMFs). The same mechanics would largely hold true when mortgage-backed securities (MBS) are purchased by banks. In this post, we show what happens when newly issued Treasury securities are purchased by levered nonbank financial institutions (NBFIs)—such as hedge funds or nonbank dealers—and by households.
Does the performance of banks improve or worsen when banks enter into new business activities? And does it matter which activities a bank expands into, or retreats from, and when that decision is made? These important questions have remained unaddressed due to a lack of data. In a recent publication, we used a unique data set detailing the organizational structure of the entire population of U.S. bank holding companies (BHCs). In this post, we draw on that research to show that while scope expansion on average hurts performance, entering into activities that are highly synergistic with core banking at a given point in time yields net performance benefits.
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.
In response to the financial crisis nearly a decade ago, a number of regulations were passed to improve the safety and soundness of the financial system. In this post and our related staff report, we provide a new perspective on the effect of these regulations by estimating the cost of capital for banks over the past two decades. We find that, while banks’ cost of capital soared during the financial crisis, after the passage of the Dodd-Frank Act (DFA), banks experienced a greater decrease in their cost of capital than nonbanks and nonbank financial intermediaries (NBFI).
This is the first post in a series that details the steps taken by the Fed in its role as lender of last resort during the 2007-09 financial crisis.
It used to be simple: Asked how to describe financial intermediation, you would just mention the word “bank.”