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Financial Intermediation and Monetary Policy
Tobias Adrian and Hyun Song ShinFederal Reserve Bank of New York and Princeton University
Central Bank of Argentina
Money and Banking ConferenceAugust 31‐ September 1, 2009, Buenos Aires
The views expressed in this presentation are those of the authors and do not necessarily represent those of the Federal Reserve Bank of New York or the Federal Reserve System.
References• Adrian and Shin (2007) “Liquidity and Leverage,” Journal of Financial Intermediation, forthcoming
• Adrian and Shin (2008) “ Financial Intermediaries, Financial Stability, and Monetary Policy,” Jackson Hole Economic Symposium Proceedings, Federal Reserve Bank of Kansas City.
• Adrian and Shin (2009) “Money, Liquidity, and Monetary Policy,” American Economic Review: Papers & Proceedings 2009, 99:2.
• Adrian and Shin (2009) “Prices and Quantities in the Monetary Policy Transmission Mechanism,” International Journal of Central Banking, forthcoming.
• Adrian and Shin (2009) “The Changing Nature of Financial Intermediation and the Financial Crisis of 2007 – 2009,” Annual Reviews, forthcoming.
• Adrian and Shin (2009) “Financial Intermediaries and Monetary Economics,” Handbook of Monetary Economics, forthcoming. 2
Stylized Financial System
ultimate claim holders
ultimateborrowers
Non-financial
firms
govt
Households Households
Pension funds
Insurance companies
Rest of worlddirect credit
Treasury & municipal bonds,corporate bonds, equities
3
Stylized Financial System
ultimate claim holders
ultimateborrowers
Non-financial
firms
govt
Households Households
Pension funds
Insurance companies
Rest of worlddirect credit
Treasury & municipal bonds,corporate bonds, equities
Banking (intermediary)
sectorintermediated
credit
equity
debt claims
depositsfinancial paperMBS, ABS…
mortgagescorporate credit…
4
Market Based and Bank Based Holding of Home Mortgages
5
0
1
2
3
4
5
6
719
80Q
1
1982
Q1
1984
Q1
1986
Q1
1988
Q1
1990
Q1
1992
Q1
1994
Q1
1996
Q1
1998
Q1
2000
Q1
2002
Q1
2004
Q1
2006
Q1
2008
Q1
$ T
rilli
on
0
1
2
3
4
5
6
7
Market-based
Bank-based
Growth of Assets of Four Sectors (March 1954 = 1) (Log scale)
6
1980Q1
1
10
100
1000
1954Q1
1957Q1
1960Q1
1963Q1
1966Q1
1969Q1
1972Q1
1975Q1
1978Q1
1981Q1
1984Q1
1987Q1
1990Q1
1993Q1
1996Q1
1999Q1
2002Q1
2005Q1
2008Q1
Non-financialcorporate
Households
Security BrokerDealers
CommercialBanks
7
Broker‐Dealer Asset Growth and Primary Dealer Repo Growth
-44
-22
0
22
44
-44
-22
0
22
44
1990 1995 2000 2005
Primary Dealer Repo Growth
Annual % Annual %
Source: Board of Governors of the Federal Reserve and Federal Reserve Bank of New York
Security Broker-Dealer Asset Growth
8
Shadow Bank and Commercial Bank Asset Growth
0
5
10
15
20
0
10
20
30
40
1985 1990 1995 2000 2005
Commercial Banks(right axis)
Annual % Annual %
Note: Shadow banks are ABS issuers, finance companies, and funding corporations.Source: Board of Governors of the Federal Reserve
Shadow Banks(left axis)
9
Shadow Bank Asset Growth and Commercial Paper Growth
-40
-20
0
20
40
-20
-10
0
10
20
30
1990 1995 2000 2005
Commercial Paper Outstanding Growth(right axis)
Annual % Annual %
Source: Board of Governors of the Federal Reserve
Shadow Bank Asset Growth(left axis)
Short Term Funding: CP, Repo, M1
500
1000
1500
2000
2500
3000
500
1000
1500
2000
2500
3000
1995 2000 2005
Reverse Repo
Billions of Dollars Billions of Dollars
Source: Federal Reserve Board
Commercial Paper
M1
10
Repos plus CP, and M2
1000
3000
5000
7000
9000
1000
3000
5000
7000
9000
1985 1990 1995 2000 2005
Money Stock M2
Billions of Dollars Billions of Dollars
Source: Board of Governors of the Federal Reserve and Federal Reserve Bank of New York
Primary Dealer Repo plus Commercial Paper Outstanding
11
Credit Demand
• Demand for credit– Investment by households (esp. housing) and non‐financial corporates
– Durable goods consumption (consumer loans)– Demand for financing by central and local governments
• Demand for credit depends on: – Interest rates and spreads– Household and Firm Net worth– Fiscal policy
12
Yield Curve (Credit Demand)
13
Credit Supply
• Delegation to financial intermediaries
• Credit supply determined by forces shaping financial intermediary balance sheets
• Monetary policy works through intermediation– Profitability of intermediation through yield curve– Lender of last resort operations determine availability of funding for intermediaries
14
Repo Haircuts
Haircuts SpreadsMay‐07 May‐08 May‐09 May‐07 May‐08 May‐09
Corporate Debt A 5 10 20 86 235 364
Corporate Debt Baa 5 20 30 115 278 508
ABS Aaa 10 25 35 73 327 350
Corporate Debt Ba 25 30 40 177 433 833
Corporate Debt B 25 40 50 239 618 996
Corporate Debt Caa 25 100 100 396 932 1573
Note: Credit spreads are option adjusted. Haircuts are for triparty repos.Source: DTCC, Bloomberg. 15
Haircut Curve (Credit Supply)
Source: DTCC, Bloomberg 16
Procyclical Leverage ofFive US Investment Banks
1998-4
2007-3
2007-4
2008-1
-20
-10
010
20To
tal A
sset
Gro
wth
(% Q
uarte
rly)
-20 -10 0 10 20Leverage Growth (% Quarterly)
17Adrian and Shin (2007)
Primary Dealer Leverage
15
20
25
30
35
40
15
20
25
30
35
40
1986 1991 1996 2001 2006
Source: SEC
All Primary DealersRatio Ratio
1987Q2 1998Q3
2008Q1
18
Domestic US and Foreign Primary Dealer Leverage
10
14
18
22
26
10
14
18
22
26
1986 1991 1996 2001 2006
Source: SEC
Domestic Primary DealersRatio Ratio
1987Q21998Q3
2007Q4
15
25
35
45
55
65
15
25
35
45
55
65
1986 1991 1996 2001 2006
Source: SEC
Foreign BanksRatio Ratio
1998Q3
2008Q1
19Adrian and Shin (2009, AER)
Biggest Damage is Done in Contractions
ultimate claim holders
ultimateborrowers
Non-financial
firms
govt
Households Households
Pension funds
Insurance companies
Rest of world
Banking (intermediary)
sector
20
But Seeds of Crises Are Sown in Expansions
Banking (intermediary)
sector
ultimate claim holders
ultimateborrowers
Non-financial
firms
govt
Households Households
Pension funds
Insurance companies
Rest of world
21
Asset Backed Securities IssuanceThree Months Sum
0
50
100
150
200
250
300
350
Mar-00
Sep-00
Mar-01
Sep-01
Mar-02
Sep-02
Mar-03
Sep-03
Mar-04
Sep-04
Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
$ B
illio
ns
Other
Non-U.S. ResidentialMortgages
Student Loans
Credit Cards
Autos
Commercial RealEstate
Home Equity(Subprime)
Source: JP Morgan 22
Impulse Response of Broker‐Dealer Asset Growth on Housing Investment Growth
-1
0
1
2
Hou
sing
Inve
stm
ent G
row
th
0 5 10 15
Impulse Response to Broker Dealer Asset Growth Shock
Quarters
Adrian and Shin (2008, Jackson Hole) 23
Central Bank Policy Rules
• Fed Funds TargetF(GDP, Inflation, Risk Appetite)
– Taylor rule, augmented with the risk appetite factor
• Quantitative policy
Q(GDP, Inflation, Risk Appetite)– Superficial resemblance to monetary aggregate targeting
• Credit Easing (TALF, CPFF, etc.)– Form of by‐pass surgery…
24
By‐pass Surgery
ultimate claim holders
ultimateborrowers
Non-financial
firms
Households
Households
Pension funds
Insurance companies
Banking (intermediary)
sectorvintermediated
credit
equity
debt claims
depositsfinancial paperMBS, ABS…
Blocked artery
Central bank
Excess Reserves
CPFF etc
25
Central Bank Liquidity Backstops
26
• Commercial banks generally have discount window (DW) access and S&Ls have Federal Home Loan Bank funding access.
• However, institutions such as broker‐dealers, shadow banks, money market funds ‐‐‐who often perform bank like maturity and liquidity transformation‐‐‐do not generally have DW access.
• In the past two years, new temporary Federal Reserve 13(3) lending facilities have been introduced by the Federal Reserve to extend liquidity backstops to a broader set of institutions or markets, via :
– PDCF: DW for dealers and indirectly the repo market
– CPFF: backstop to the CP market
– FX swaps: backstop to foreign central banks
– TALF: liquidity provision to securitization markets
Discount Window (DW) and PDCF
27
0
50
100
150
0
50
100
150
Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09
Discount Window and PDCF BorrowingBillions of Dollars
Source: Federal Reserve Board
DW
Billions of Dollars
Jul 15: 34.46
Jul 15: 0.0
PDCF
Commercial Paper Funding Facility (CPFF)
28
0
200
400
600
1000
1300
1600
1900
Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09
CPFF and Commercial Paper OutstandingBillions of Dollars
Source: Federal Reserve Board, Haver
Total(left axis)
Billions of Dollars
Jul 17: 1096.7
Jul 17: 107.1
Federal ReserveNet Holdings(right axis) FDIC
TLGP(right axis)
Jun 30: 339.0
Central Bank Liquidity Swaps
29
0
200
400
600
0
200
400
600
Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09
Central Bank Liquidity SwapsBillions of Dollars
Source: Federal Reserve Board, Bloomberg
Billions of Dollars
Jul 15: 111.8
Term Securities Lending Facility (TSLF)
30
0
50
100
150
200
0
50
100
150
200
Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09
TSLF Total OutstandingBillions of Dollars
Source: Federal Reserve Bank of New York
Schedule 2
Billions of Dollars
Jul 16: 7.0
Jun 25: 0.0
Schedule 1
ABS Issuance and TALF
31
0
10
20
30
40
50
60
70
Q107 Q207 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309
$Bln2nd axis
Equipment TALF
Student Loan TALF
Credit Card TALF
Auto TALF
SBA non-TALF
Equipment non-TALFStudent Loan non-TALFCredit Card non-TALFAuto non-TALF
Source: JPMorgan
Central Bank Policy Tools
• Prices– Fed Funds Target.
• Balance Sheet Quantities– Credit easing using CB balance sheet (outright purchases of Treasury, MBS, CPs etc).
– Haircut/margin policy to influence balance sheet growth of financial intermediaries.
• Channels of Policy– Demand and supply of credit.– Expectations about the future path of prices and quantities.
32