Bernanke, Ben, Mark Gertler and Simon Gilchrist, 1996, “The Financial Accelerator and the Flight to Quality,” The Review of Economics and Statistics, MIT Press, Vol. 78(1), pp. 1–15, February.
Carpenter, Seth, Selva Demiralp, Jane Ihrig, Elizabeth Klee (2013), “Analyzing Federal Reserve Asset Purchases: From whom does the Fed buy?” April. Staff paper No. 2013-32.
Copeland, Adam, Antoine Martin, and Michael Walker, 2010, “The Tri-Party Repo Market before the 2010 Reforms,” FRBNY Staff Report No. 477 (New York: Federal Reserve Bank of New York).
CGFS (Committee on the Global Financial System), 2013, Asset Encumbrance, Financial Reform and Demand for Collateral Assets, May. Paper No.49.
Fegatelli, P., 2010, “The Role of Collateral Requirements in the Crisis: One Tool for Two Objectives,” Working Paper No. 44 (Luxembourg: Banque Central du Luxembourg).
Greenwood, Robin, Samuel Hanson, and Jeremy Stein. 2010, “A Comparative-Advantage Approach to Government Debt Maturity,” Harvard Business School Working Paper 11-035.
IMF (International Monetary Fund), 2012, “Safe Assets: Financial System Cornerstone?” Chapter 3 in Global Financial Stability Report, April (Washington).
Tarullo, Daniel, 2013, Testimony, Dodd-Frank Implementation, Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.
The paper was written when the author was visiting the Research Department at the IMF and has been presented at various forum including ISDA’s Board, ICAP Repo Conference; CASS, Beijing; Barclay’s Rates Conference; Global Fixed Income Institute; and within the IMF. The author wishes to thank Olivier Blanchard, Stijn Claessens, Karl Habermeier, Peter Stella, James Aitken, Phil Prince, David Bicarregui, Michael Manna and Jon Kinderlerer. Views expressed are those of the author and any remaining errors are mine.
The horizontal axis represents output or real GDP and is labeled Y. The vertical axis represents the real interest rate, i. Since this is a non-dynamic model, there is a one-to-one relationship between the nominal interest rate and the real interest rate; therefore variables such as money demand, which actually depend on the nominal interest rate, can equivalently be expressed as depending on the real interest rate. The point where these schedules intersect represents a short-run equilibrium in the real and monetary sectors. This equilibrium yields a unique combination of the nominal/real interest rate and real GDP.
Following the Lehman failure, the Fed introduced paying interest on excess reserves (IOER) for depository institutions. This was intended to place a “floor” (minimum bid) on short-term liquidity in the corridor system. However, Fannie and Freddie cannot access IOER (25 basis points) that banks can only receive, and, therefore, GSE cash positions (and cash positions of other home loan banks) have largely determined the Federal Funds rate—which trades below the IOER “floor.”
Despite the European Central Bank’s (ECB) efforts to take in lower-grade collateral, actions of the Swiss National Bank (SNB) (and other central banks) are diluting this objective. After the Swiss franc/€ peg, the SNB balance sheet is now almost €500 billion with half of the assets comprising of “core” € bonds and equities. However SNB’s bond purchases withdraw the best and most liquid collateral from the Eurozone; this reduces the collateral reuse rate since these bonds are silo-ed at SNB and not pledged in the financial markets. Silo-ed collateral has zero velocity by definition.
See Fegatelli (2010) on Eurozone collateral market.
In the US, it remains to be seen if cash shifts from repo to bank deposits when overnight GC goes negative in. There’s a big psychological barrier between explicitly paying for protection and “accepting a lower return” to get protection.
The stock of collateral can decline as investors become more concerned about counterparty risk, making them less willing to lend securities and making collateral safely sit idle in segregated accounts. It can also be affected by central bank measures, such as large-scale asset purchases which drain good quality collateral from the system, or a widening of the pool of collateral-eligible assets which increases the pledge-ability of these assets as collateral to the central banks (Singh and Stella, 2012). Collateral velocity—defined as the volume of secured transactions divided by the stock of source collateral—is affected by counterparty concerns and general risk aversion (due to higher haircuts), which then manifest as restrictions on the re-use of collateral
The term re-pledged is a legal term and means that the dealer receiving the collateral has the right to re-use it in its own name (i.e. recipient has title transfer). Title transfer is essential to collateral velocity. In the bilateral pledged collateral market, contracts that straddle repo, securities lending, OTC derivatives and customer margin loans have title transfer.
Since cross-border funding is important for large banks, the state of the pledged collateral market needs to be considered when setting monetary policy (Debelle, 2012).
This is a mark-to-market view (and thus different from the “limit pro-cyclicality” school that endorses a floor on C2 type collateral during crisis). The “limit pro-cyclicality” school and their proposed use of ex-ante min/max haircuts may presently “stretch” collateral valuations in some places—triparty repo in the U.S., ECB or similar collateral facilities, and some local CCPs (see Copeland et al 2010; Fegatelli, 2010). Draft proposals to reduce pro-cyclicality via ex-ante haircut schedule are not clear. Credit Support Annexes that support OTC derivative contracts, or master agreements that underpin cross border repo and securities lending are privately negotiated bilateral agreements that regulators cannot temper with. Such contracts include the “legal wheels of title transfer” and are designed to make financial collateral akin to money so that markets settle accounts/margins by “cash or cash equivalent
See exit strategy minutes as per June 2011 FOMC meeting.
In the U.S., the repo rate could differ from IOER depending on the rate of release of collateral via reverse repos, an important unwinding avenue that has been suggested by the Fed. If Fed unwinds, the eligible parties for reverse repo (RRs) now include not only banks but also nonbanks such as GSEs (i.e. Fannie and Freddie) and selected MMMF etc. So the repo rate will be determined by the size of RRs, along with the broader supply/demand of the market. Various reforms under the rubric of shadow banking (e.g., in the U.S.) include trimming the MMMFs by removing the “par” NAV tag; Fannie Freddie reform, and the Tri-party repo system. But the nonbank world’s balance sheet space is necessary if collateral needs to be unwound from central banks. Even if there is balance sheet space, the ability of the Fed to engage in RRs may be limited as sizable RRs could lead the repo rates to significantly exceed the IOER; this may lead to inflationary dynamics or expectations thereof. So collateral release rate to the market will be “measured” since the price of money (IOER) versus the price of collateral (repo rate) will need to strike a balance (Singh, 2013).
Carpenter et al (2013, April), “Analyzing Federal Reserve Asset Purchases: From whom does the Fed buy?”
The Fed set up ‘reverse’ repo with major MMMFs (and limited asset managers) in part so that any unwind would require less bank balance sheet space (than the excess reserves do now). The excess reserves are assets of banks now and they have corresponding liabilities; the reverse repo will move MMMFs out of a bank liability of some kind into a Federal Reserve liability. So the bank loses a liability to the MMMF and the reserve asset at the same time and the bank balance sheet shrinks.
If we look at the collateral chains, at one end is the MMMF investor - the household and corporate wealth pool. At the other end, after a couple of loops for transformation, and some haircuts and subordination for extra capital, lies the promise to pay made by the borrower - household (mortgage) or corporate. The recent Fed’s proposal short-circuits the chain, depositing that household wealth directly back at the Fed. The household and corporate wealth pool is better off; they get a deposit alternative that is superior to anything available now. The borrower pool is worse off; that pool of wealth won’t be transformed into any lending to them. D does not become C1. http://www.federalreserve.gov/monetarypolicy/fomcminutes20130731.htm
TBAC’s slides (July 30, 2013): http://www.treasury.gov/resource-center/data-chart-center/quarterly-refunding/Documents/Charge_3.pdf.
BIS working paper 399, “Global Safe Assets,” Gourinchas and Jeanne, 2013. Also Gorton et al (2013); Greenwood et al (2010); Duffee (1996); IMF (2012).
http://www.rba.gov.au/publications/bulletin/2012/sep/pdf/bu-0912-6.pdf This committed liquidity facility (CLF) is akin to paying a fee to get the guarantee of contingent collateral transformation from the RBA at a penalty rate.
As discussed, nonbanks will not be able to rehypothecate, or onward re-pledge collateral they receive via reverse repos (Fed’s proposed unwind facility). So collateral released to nonbanks will not convert D to C1.