Tag Archives: Collateral

Fed Balance Sheet Policy and Collateral

On his blog, Stephen Williamson discusses the Fed’s plan to maintain a much larger balance sheet in the future than before the crisis. He is not convinced that this plan is a good one.

But what’s the harm in a large Fed balance sheet? The larger the balance sheet, the lower is the quantity of Treasury securities in financial markets, and the higher is reserves. Treasuries are highly liquid, widely-traded securities that play a key role in overnight repo markets. Reserves are highly liquid – for the institutions that hold them – but they are held only by a subset of financial institutions. Thus, a large Fed balance sheet could harm the operation of financial markets. … it would be reflected in a scarcity of collateral in overnight financial markets – in market interest rates. Before early 2018, T-bill rates and repo rates tended to be lower than the fed funds rate, and the fed funds rate was lower than IOER. Now, all those rates are about the same. The Fed thinks the difference is more Treasury debt, but I think the end of the Fed’s reinvestment program mattered, in that it increased the stock of on-the-run Treasuries. Whichever it was, apparently the quantity of Treasuries outstanding matters for the smooth – indeed, efficient – operation of financial markets, and the Fed should not mess with that. My prediction would be that, if we get to the end of the year and the Fed is again buying Treasuries, that we’ll see repo rates and T-bill rates dropping below IOER. Watch for that.

ECB Collateral Framework

In an ECB occasional paper, Ulrich Bindseil, Marco Corsi, Benjamin Sahel, and Ad Visser review the European Central Banks’s collateral framework.

From the executive summary, on misconceptions:

… differences e.g. with interbank repo markets: first, central banks are not subject to liquidity risk in the way “normal” market participants are, and can therefore accept less liquid collateral. Second, as the central bank has a zero default probability in its domestic market operations, collateral providers are willing to accept severe haircuts to obtain credit. …

According to the authors the ECB is the most transparent central bank when it comes to its collateral framework. But the latter is also complicated:

However, it is true that the ESCF is relatively broad in terms of the scope of eligible collateral and rather complicated. This is inevitable because of the diversity of financial institutions and markets in the euro area.

Collateral Values in ECB Operations

In the NZZ, Kjell Nyborg questions whether the collateral values of the securities the ECB accepts in monetary policy operations reflect market values. He argues that the valuation is discretionary and politicized.

Meine Analyse macht deutlich, dass der Besicherungsrahmen in der Euro-Zone in unterschiedlicher Ausprägung unter all diesen Problemen leidet. Das öffentliche Verzeichnis der zulässigen notenbankfähigen Sicherheiten enthält 30 000 bis 40 000 verschiedene Wertpapiere, von Staatsanleihen bis hin zu unbesicherten Bankanleihen und forderungsbesicherten Wertpapieren (Asset-Backed Securities). Die überwiegende Mehrheit dieser Wertpapiere hat keinen Marktpreis. Ungefähr ein Drittel all dieser Sicherheiten wird in nichtregulierten Märkten gehandelt. Zudem können Banken nichtmarktfähige Anlagen und Wertpapiere mit «privaten Ratings» verwenden, die nicht im öffentlichen Verzeichnis sind. Daher basieren die Werte der Sicherheiten mehrheitlich auf Modell- statt auf Marktpreisen. Interessanterweise ziehen Banken es vor, Sicherheiten zu benutzen, bei denen häufiger theoretische Preise verwendet werden. Generell tendiert die Besicherungspolitik der Euro-Zone zu risikoreichen und illiquiden Sicherheiten. Die untergeordnete Rolle des Marktes sieht man auch an der Häufigkeit, mit welcher die Sicherheitsabschläge für die Repo-Geschäfte des Euro-Systems aktualisiert werden: Dies geschieht lediglich alle drei bis vier Jahre.

Im Kern des Geldsystems in der Euro-Zone gibt es somit wenig Spielraum für Marktkräfte oder Marktdisziplin. Insgesamt kann die Besicherungspolitik des Euro-Systems als expansiv beschrieben werden. Die Liste notenbankfähiger Sicherheiten ist äusserst umfangreich und oft auf die «Bedürfnisse» von Banken in verschiedenen Ländern zugeschnitten. Sicherheiten können, zum Beispiel, durch Staatsgarantien aufgewertet werden. … Weil es im Kern des Euro-Geldsystems an Marktkräften und Marktdisziplin fehlt, entsteht ein Vakuum, das von anderen Kräften, wie Rating-Agenturen und der Politik, aufgefüllt wird.

… Ich dokumentiere, dass DBRS eine ausschlaggebende Rolle innehatte, indem sie über eine lange Zeit hinweg Italien und Spanien ein Rating von A– und Portugal ein solches von BBB– gab. Das hob den Wert der in diesen Ländern begebenen Sicherheiten um ungefähr bis 200 Mrd. € an und kann als unterstützende Massnahme für indirekte Bail-outs interpretiert werden.

Im Dezember 2011 und Februar 2012 hat die EZB eine ihrer wichtigsten geldpolitischen Massnahmen vor dem Beginn des Quantitative Easing implementiert. … Um aus dieser Möglichkeit Vorteil zu schlagen, hat die italienische Regierung gleichzeitig eine präzedenzlose Anzahl von Garantien für Bankanleihen mit niedrigem oder gar keinem Rating gesprochen. Damit erhöhte sie deren Besicherungswert. Darüber hinaus hat die EZB mehr als 10 000 unbesicherte, auf nichtregulierten Märkten gehandelte Bankanleihen der öffentlichen Liste notenbankfähiger Sicherheiten hinzugefügt, obwohl der aggregierte Wert notenbankfähiger Sicherheiten die Nachfrage von Banken nach Zentralbankgeld schon bei weitem überstieg.

Pawn Shops, Information Insensitivity, and Debt-on-Debt

In a BIS working paper (January 2015), Bengt Holmstrom summarizes some of the implications of the research on information insensitive debt. He cautions against moves to increase transparency in debt markets and defends the shadow banking system. He explains why opacity and information insensitivity are valuable and argues that debt-on-debt arrangements are (privately) optimal.

It all started with pawn shops:

The beauty lies in the fact that collateralised lending obviates the need to discover the exact price of the collateral. …

Today’s repo markets … are close cousins of pawn brokering with similar risks for the parties involved. … the buyer of the asset (the lender) bears the risk that the seller (the borrower) will not have the money to repurchase the asset and just like the pawnbroker, has to sell the asset in the market instead. The seller bears the risk that the buyer of the asset may have rehypothecated (reused) the posted collateral and cannot deliver it back on the termination date. … the risk that a pawnbroker may sell or lose the pawn was a big issue in ancient times and could explain why the Chinese pawnbrokers were Buddhist monks. …

People often assume that liquidity requires transparency, but this is a misunderstanding. What is required for liquidity is symmetric information about the payoff of the security that is being traded so that adverse selection does not impair the market. …

… stock markets are in almost all respects different from money markets …: risk-sharing versus liquidity provision, price discovery versus no price discovery, information-sensitive versus insensitive, transparent versus opaque, large versus small investments in information, anonymous versus bilateral, small unit trades versus large unit trades. … money markets operate under much greater urgency than stock markets. There is generally very little to lose if one stays out of the stock market for a day or longer. This is one reason the volume of trade is very volatile in stock markets. In money markets the volume of trade is very stable, because it could be disastrous if, for instance, overnight debt would not be rolled over each day. …

… debt-on-debt is optimal … . It is optimal to buy debt as collateral to insure against liquidity shocks tomorrow and it is optimal to issue debt against that collateral tomorrow. In fact, repeating the process over time is optimal, too, so debt is in a very robust sense the best possible collateral. This provides a strong reason for using debt as collateral in the shadow banking system. …

Panics always involve debt. Panics happen when information insensitive debt (or banks) turns into information-sensitive debt.

A Plan for Greece

In the FT, Willem Buiter proposes a 5 point plan for a way out of the Greek debt crisis:

  • Greece effectively regains sovereignty and can do whatever it pleases, with some exceptions, see below.
  • Greek debt held by the ECB is bought by the ESM: The ESM extends long-term, low-interest financing to Greece which Greece uses to repay the ECB debt. “Since most of Greece’s other sovereign liabilities have long maturities and deferred interest payments, payments to creditors would fall sharply.”
  • No further financing by the IMF, the ESM or other official sources is extended to Greece.
  • The ECB does no longer accept any Greek government debt paper as collateral or for purchase.
  • Commercial banks in Greece are recapitalized or restructured using funds from the Hellenic Financial Stability Fund and other sources. The ECB bars Greek banks from accepting any Greek government debt paper.

The plan would require additional European taxpayer money for the ECB-ESM debt swap and the bank recapitalization. It would isolate the Greek banks from the mayhem triggered by government default.

Update: 7 July 2015

A related proposal by Willem Buiter and Ebrahim Rahbari.