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1. Liquidity Shocks, Dollar Funding Costs, and the Bank Lending Channel During the European Sovereign Crisis

Author:
Ricardo Correa, Horacio Sapriza, and Andrei Zlate
Publication Date:
11-2012
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper documents a new type of cross-border bank lending channel. The deepening of the European sovereign debt crisis in 2011 restrained the financial intermediation of European banks in the United States. In this period, some of the U.S. branches of European banks faced a dollar liquidity shock—due to their perceived risk reflecting the sovereign risk of their countries of origin—which in turn affected the branches’ lending to U.S. entities. We use a novel dataset to analyze the operations of branches of foreign banks in the United States. Our results show that: (1) The U.S. branches of European banks experienced a run on their deposits, mainly from U.S. money market funds. (2) The branches with curtailed access to large time deposits relied more on funding from their own parent institutions, thus shifting from being net suppliers to being net receivers of dollar funding from their related offices. (3) Since the additional funding received from parent institutions was not enough to offset the decreased access to U.S. funding, such branches reduced their lending to U.S. entities.
Topic:
Regional Cooperation, European Union, Finance, Banking, and Liquidity
Political Geography:
Europe

2. International Capital Flows and the Returns to Safe Assets in the United States, 2003-2007

Author:
Ben S. Bernanke, Carol C. Bertaut, Laurie Pounder DeMarco, and Steve Kamin
Publication Date:
02-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
A broad array of domestic institutional factors--including problems with the originate-to-distribute model for mortgage loans, deteriorating lending standards, deficiencies in risk management, conflicting incentives for the GSEs, and shortcomings of supervision and regulation--were the primary sources of the U.S. housing boom and bust and the associated financial crisis. In addition, the extended rise in U.S. house prices was likely also supported by long-term interest rates (including mortgage rates) that were surprisingly low, given the level of short-term rates and other macro fundamentals--a development that Greenspan (2005) dubbed a "conundrum." The "global saving glut" (GSG) hypothesis (Bernanke, 2005 and 2007) argues that increased capital inflows to the United States from countries in which desired saving greatly exceeded desired investment--including Asian emerging markets and commodity exporters--were an important reason that U.S. longer-term interest rates during this period were lower than expected. This essay investigates further the effects of capital inflows to the United States on U.S. longer-term interest rates; however, we look beyond the overall size of the inflows emphasized by the GSG hypothesis to examine the implications for U.S. yields of the portfolio preferences of foreign creditors. We present evidence that, in the spirit of Caballero and Krishnamurthy (2009), foreign investors during this period tended to prefer U.S. assets perceived to be safe. In particular, foreign investors--especially the GSG countries--acquired a substantial share of the new issues of U.S. Treasuries, Agency debt, and Agency-sponsored mortgage-backed securities. The downward pressure on yields exerted by inflows from the GSG countries was reinforced by the portfolio preferences of other foreign investors. We focus particularly on the case of Europe: Although Europe did not run a large current account surplus as did the GSG countries, we show that it leveraged up its international balance sheet, issuing external liabilities to finance substantial purchases of apparently safe U.S. "private-label" mortgage-backed securities and other fixed-income products. The strong demand for apparently safe assets by both domestic and foreign investors not only served to reduce yields on these assets but also provided additional incentives for the U.S. financial services industry to develop structured investment products that "transformed" risky loans into highly-rated securities. Our findings do not challenge the view that domestic factors, including those listed above, were the primary sources of the housing boom and bust in the United States. However, examining how changes in the pattern of international capital flows affected yields on U.S. assets helps provide a deeper understanding of the origins and dynamics of the crisis.
Topic:
Finance, Capital Flows, Securities, and Capital
Political Geography:
North America and United States of America

3. U.S. International Equity Investment and Past Prospective Returns

Author:
Stephanie E. Curcuru, Charles Thomas, Francis E. Warnock, and Jon Wongswan
Publication Date:
02-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Counter to extant stylized facts, using newly available data on country allocations in U.S. investors' foreign equity portfolios we find that (i) U.S. investors do not exhibit returns-chasing behavior, but, consistent with partial portfolio rebalancing, tend to sell past winners; and (ii) U.S. investors increase portfolio weights on a country's equity market just prior to its strong performance, behavior inconsistent with an informational disadvantage. Over the past two decades, U.S. investors' foreign equity portfolios outperformed a value-weighted foreign benchmark by 160 basis points per year.
Topic:
Economics, Finance, Investment, Stock Markets, and Equity
Political Geography:
North America and United States of America

4. Limited Market Participation and Asset Prices in the Presence of Earnings Management

Author:
Bo Sun
Publication Date:
06-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We examine the role of earnings management in explaining the properties of asset prices and stock market participation. We demonstrate that investors' uncertainty about the extent of manipulation can cause excess movements in stock price relative to fluctuations in output. When faced with information asymmetry about fundamentals in the presence of earnings management, investors demand a higher equity premium for bearing the additional risk associated with their payoffs. In addition, when investors have heterogeneous beliefs about managerial manipulation, the dispersion in belief endogenously gives rise to limited stock market participation. Our model suggests that the increasing stringency of corporate governance and varying composition of investors may have played a role in the contemporaneous run-up of market participation rates in the recent years.
Topic:
Markets, Finance, Investment, and Stock Markets
Political Geography:
Global Focus

5. Financial Frictions, Trade Credit, and the 2008-09 Global Financial Crisis

Author:
Brahima Coulibaly, Horacio Sapriza, and Andrei Zlate
Publication Date:
06-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper studies the role of the credit crunch in the severe contraction of economic activity during the 2008-09 global financial crisis, using firm-level data from six emerging Asian economies. After controlling for the effect of falling demand, we find that sales declined by less for firms with better pre-crisis financial conditions. Amid the decline in external financing opportunities, some firms relied more on trade credit from suppliers during the crisis, which allowed them to post relatively better sales. Export-intensive firms resorted less to trade credit as an alternative source of finance, which contributed to their larger declines in sales.
Topic:
Finance, Global Financial Crisis, Trade, and Credit
Political Geography:
Global Focus

6. Liquidity and Reserve Requirements in Brazil

Author:
Patrice Robitaille
Publication Date:
06-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The international reform initiative that followed the global financial crisis of 2008-09 has resulted in the introduction of liquidity requirements for banks. Under one requirement, the Liquidity Coverage Ratio (LCR), banks will need to hold enough highly liquid assets to survive for a month in a stress scenario. Banks' required reserve balances can be used to fulfill this liquidity requirement and this may be seen as an attractive option for emerging market economies, where financial sectors are often underdeveloped. In this paper, I examine the Brazilian experience prior to and during the global crisis as a case study that can shed light into the challenges of using reserve requirements as a liquidity management tool. Brazilian reserve requirements did not ensure adequate liquidity, in part because the smallest banks were exempted from the requirements. Financial innovations were also used by banks to circumvent reserve requirements. In Brazil, the use of reserve requirements as a liquidity management tool is often justified by the argument that reserve requirements fulfilled a critical liquidity provision role in the fall of 2008. I argue that Brazilian reserve requirements did not actually serve well the liquidity provision goal.
Topic:
Finance, Investment, Banking, and Liquidity
Political Geography:
Brazil and South America

7. Optimal Monetary Policy in an Operational Medium-Sized DSGE Model

Author:
Malin Adolfson, Stefan Laseen, Jesper Linde, and Lars E.O. Svensson
Publication Date:
07-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We show how to construct optimal policy projections in Ramses, the Riksbank's open-economy medium-sized DSGE model for forecasting and policy analysis. Bayesian estimation of the parameters of the model indicates that they are relatively invariant to alternative policy assumptions and supports our view that the model parameters may be regarded as unaffected by the monetary policy specification. We discuss how monetary policy, and in particular the choice of output gap measure, affects the transmission of shocks. Finally, we use the model to assess the recent Great Recession in the world economy and how its impact on the economic development in Sweden depends on the conduct of monetary policy. This provides an illustration on how Rames incoporates large international spillover effects.
Topic:
Development, Economics, Monetary Policy, and Finance
Political Geography:
Global Focus

8. U.S. Domestic and International Financial Reform Policy: Are G20 Commitments and the Dodd-Frank Act in Sync?

Author:
Daniel E. Nolle
Publication Date:
07-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The Dodd-Frank Act of 2010 is the keystone policy response directed at reforming U.S. financial system activities and oversight in the wake of the 2007-2009 financial crisis. The United States also has financial system reform policy commitments in the international arena, including in particular by virtue of its membership in the G20. This analysis considers U.S. policy initiatives related to a core dimension of financial system reform: risks posed by systemically important financial institutions ("SIFIs"). It provides a comparison of SIFI policy initiatives and timetables under both the Dodd-Frank Act and the G20 agenda, as reflected in the ongoing work plan of the Financial Stability Board (FSB), and poses the question "Are U.S. domestic and international financial system reform commitments in sync?" While finding that, fundamentally, the answer is "yes," the detailed comparison yields two caveats with potential policy implications. First, the two agendas differ in their relative emphasis on the coverage of both banks and nonbanks. The G20/FSB focus, at least over the near-term, is bank-centric compared with the Dodd-Frank Act, which consistently addresses both bank and nonbank financial firms. Second, implementation of Dodd-Frank Act provisions is subject to long-established U.S. law mandating that there be sufficient opportunity for public input into the rulemaking process, whereas the G20/FSB process has been less systematic and transparent on public consultation and feedback. The lesser emphasis on transparency and public input characterizing the G20/FSB policy development process may be attributable in part to the somewhat more rapid pace of the G20/FSB agenda relative to corresponding Dodd-Frank Act timelines. These observations may be relevant to the current debate over the speed and scope of Dodd-Frank Act implementation measures, and to the discussion about the future international competitiveness of U.S. banks and nonbank financial firms.
Topic:
Economics, Financial Crisis, Reform, and Finance
Political Geography:
North America and United States of America

9. The Revealed Competitiveness of U.S. Exports

Author:
Massimo Del Gatto, Flippo de Mauro, Joseph W. Gruber, and Benjamin R. Mandel
Publication Date:
08-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The U.S. share of world merchandise exports has declined sharply over the last decade. Using data at the level of detailed industries, this paper analyzes the decline in U.S. share against the backdrop of alternative measures of the competitiveness of the U.S. economy. We document the following facts: (i) only a few industries contributed to the decline in any meaningful way, (ii) a large part of the drop was driven by the changing size of U.S. export industries and not the size of U.S. sales within those industries, (iii) in a gravity framework, the majority of the decline in the U.S. export share within industries was due to the declining U.S. share of world income, and (iv) in a computed structural measure of firm productivity, average U.S. export productivity has generally maintained its high level versus other countries over time. Overall, our analysis suggests that the dismal performance of the U.S. market share is not a sufficient statistic for competitiveness.
Topic:
Economics, International Trade and Finance, Hegemony, Finance, and Exports
Political Geography:
North America and United States of America

10. ABS Inflows to the United States and the Global Financial Crisis

Author:
Carol C. Bertaut, Laurie Pounder DeMarco, Steve Kamin, and Ralph Tryon
Publication Date:
08-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The "global saving glut" (GSG) hypothesis argues that the surge in capital inflows from emerging market economies to the United States led to significant declines in long-term interest rates in the United States and other industrial economies. In turn, these lower interest rates, when combined with both innovations and deficiencies of the U.S. credit market, are believed to have contributed to the U.S. housing bubble and to the buildup in financial vulnerabilities that led to the financial crisis. Because the GSG countries for the most part restricted their U.S. purchases to Treasuries and Agency debt, their provision of savings to ultimately risky subprime mortgage borrowers was necessarily indirect, pushing down yields on safe assets and increasing the appetite for alternative investments on the part of other investors. We present a more complete picture of how capital flows contributed to the crisis, drawing attention to the sizable inflows from European investors into U.S. private-label asset-backed securities (ABS), including mortgage-backed securities and other structured investment products. By adding to domestic demand for private-label ABS, substantial foreign acquisitions of these securities contributed to the decline in their spreads over Treasury yields. Through a combination of empirical estimation and model simulation, we verify that both GSG inflows into Treasuries and Agencies, as well as European acquisitions of ABS, played a role in contributing to downward pressures on U.S. interest rates.
Topic:
Finance, Interest Rates, Housing, Securities, and Capital
Political Geography:
North America and United States of America