1. 2 Importance of Securitization The mortgage-related market is by far the largest fixed-income...
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Importance of Securitization
• The mortgage-related market is by far the largest fixed-income market in the U.S. by issuance.
• Restricting attention to non-mortgage instruments, the asset-backed market is very large, exceeding the issuance of all corporate debt in 2004, 2005, and 2006.
• Overall, securitization is a very large, significant, part of the U.S. capital markets.
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The Financial Crisis
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Run on the Repos
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The Financial Crisis
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Regression Results
• Roughly same results for repo spreads. – Rise in LIB-OIS (proxy for counterparty credit risk
in banking system) leads to increase in spreads.• Repo haircuts depend on expected volatility in
underlying collateral– More expected volatility implies larger haircuts.
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Implications
• Problems in sub-prime market led to higher LIB-OIS.• Higher LIB-OIS lead to larger credit spreads on
securitized paper and repos. • Higher credit spreads led to more uncertainty about
bank solvency and lower values for repo collateral. • Concerns about liquidity of bonds used for repo
collateral led to rising repo haircuts (equivalent to a bank run).
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Reforming the Repo Marketfrom REGULATING WALL STREET
Combination of government-guarantee scheme and a market-discipline scheme:• When borrower defaults, repo counterparties on government paper
take collateral. Repo counterparties for risky collateral are paid by repo resolution fund (RRF) based on a conservative assessment of the collateral in return for possession of that collateral.
• RRF liquidates collateral over six months. Surplus paid to repo lender; deficit “clawed back.”
• RRF manages credit risk by:– Charging repo lenders ex ante fee.– Limiting program to high quality collateral.– Impose solvency criteria on repo lenders for eligibility.
Just like discount window!