Working Paper: NBER ID: w15223
Authors: Gary B. Gorton; Andrew Metrick
Abstract: The Panic of 2007-2008 was a run on the sale and repurchase market (the "repo" market), which is a very large, short-term market that provides financing for a wide range of securitization activities and financial institutions. Repo transactions are collateralized, frequently with securitized bonds. We refer to the combination of securitization plus repo finance as "securitized banking", and argue that these activities were at the nexus of the crisis. We use a novel data set that includes credit spreads for hundreds of securitized bonds to trace the path of crisis from subprime-housing related assets into markets that had no connection to housing. We find that changes in the "LIB-OIS" spread, a proxy for counterparty risk, was strongly correlated with changes in credit spreads and repo rates for securitized bonds. These changes implied higher uncertainty about bank solvency and lower values for repo collateral. Concerns about the liquidity of markets for the bonds used as collateral led to increases in repo "haircuts": the amount of collateral required for any given transaction. With declining asset values and increasing haircuts, the U.S. banking system was effectively insolvent for the first time since the Great Depression.
Keywords: No keywords provided
JEL Codes: G1; G19
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| changes in the libois spread (P39) | changes in credit spreads (G19) |
| changes in the libois spread (P39) | changes in repo rates (E43) |
| increased uncertainty regarding bank solvency (F65) | lower values for repo collateral (E43) |
| withdrawal of repurchase agreements (E49) | panic of 2007-2008 (F65) |
| financial crisis beginning in August 2007 (G01) | rising repo haircuts (F31) |
| financial crisis beginning in August 2007 (G01) | cessation of repo lending on many forms of collateral (G33) |
| increases in repo rates (E43) | deterioration of the interbank markets (F65) |
| rising repo haircuts (F31) | systemic insolvency (G33) |