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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!