A Proposal for the Resolution of Systemically Important Assets and ...

Consider for instance the “run” onBear Stearns. 18 As an intrinsic part of its business,
Bear Stearns relied daytoday on its ability to obtain shortterm finance through secured
borrowing. At this time, Bear was reported to be financing $85 billion of assets, primarily
mortgagebacked securities (MBS), on the overnight market (Cohan, 2009). Beginning late
Monday,March10 th ,rumorsspreadaboutliquidityproblemsatBearStearns.Counterparties
became unwilling to lend on customary terms. In particular, Federated and Fidelity – two
moneymarketsusuallyrollingover$5billioneachofrepofinancingtoBear–didnotrollover.
ThisunwillingnesstofundonasecuredbasisplacedenormousstressontheliquidityofBear
Stearns.OnTuesday,March11,theholdingcompanyliquiditypooldeclinedfrom$18.1billion
to$11.5billion(seeFigure5).OnThursday,March13,BearStearns'liquiditypoolfellsharply
andcontinuedtofallonFriday.Intheend,thefearofrepofinanciersthattheywouldbeleft
withhighlyilliquidMBScollateraltosellinthemarketledtoa“run”andthenearfailureofthe
firmandwaseventuallysoldwithassistanceoftheFederalReservetoJPMorgan.Incontrast
tothesmoothlyrisinghaircutsinthebilateralrepomarketshowninFigure4,financingterms
for Bear Stearns in the triparty repo system did not rise dramatically, but it experienced a
sudden freeze or a “run” from some of its largest repo financiers who feared acquiring the
underlyingcollateralandfiresellingitinanilliquidmarket.
AfterBearStearnscollapsedinMarch2008,theFedintroduceditsmostradicalchange
inmonetarypolicysincetheGreatDepressionbyextendingitslenderoflastresortsupportto
the systemically important primary dealers through the new Primary Dealer Credit Facility
(PDCF).However,eventhisextensionofthelenderoflastresortfacilitydidnotpreventtherun
on Lehman Brothers, as investors realized that this support was not unconditional and
unlimited(seeAcharyaetal,2009). 19
Indeed, using data collected by the FRBNY to document quantitative features of this
market, Copeland, Martin and Walker (2010) studied the triparty repo market and
demonstratedthathaircutsinthetripartyrepomarketbarelymovedduringthecrisis.They
foundthatboththelevelofhaircutsandtheamountoffundingweresurprisinglystableinthis
marketduringtheperiodfromJuly2008toearly2010forwhichtheyhaddata. 20 Althoughthe
stability of the margins was in contrast to evidence from other repo markets, they provided
evidence that “this apparent stability did not prevent the triparty repo market from
contributing to the problems experienced by Lehman Brothers, … The available evidence
suggeststhatrunsinthetripartyrepomarketmayoccurprecipitously,moreliketraditional
bankruns,ratherthanmanifestthemselvesintheformoflargeincreasesinmargins.”Figure6,
18 The discussion that follows is based on the Securities and ExchangeCommission press release on March 20,
2008 entitled, “Chairman Cox Letter to the Basel Committee in Support of New Guidance on Liquidity
Management,”availableat:http://www.sec.gov/news/press/2008/200848.htm
19 WhilethelargesthaircutjumpinFigure4correspondstothecollapseofLehmanonSeptember15,2008,the
secondlargestjump,whichcameinthesummerof2008,correspondstotraditionalbankrunsonlikelyinsolvent
bankinginstitutions,suchasIndyMac,WashingtonMutualandWachovia.
20 This finding is also corroborated in Krishnamurthy, Nagel and Orlov (2011), who also attribute the relative
stabilityofthetripartyrepomarkettothesubstituteforrepofundingprovidedbyFedinitiatedliquidityfacilities
againstilliquidcollateral,especiallyfollowingthecollapseofBearStearns.
21