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Securitized banking and the run on repo

  • Gorton, Gary
  • Metrick, Andrew

The panic of 2007–2008 was a run on the sale and repurchase market (the repo market), which is a very large, short-term market that provides financing for a wide range of securitization activities and financial institutions. Repo transactions are collateralized, frequently with securitized bonds. We refer to the combination of securitization plus repo finance as “securitized banking” and argue that these activities were at the nexus of the crisis. We use a novel data set that includes credit spreads for hundreds of securitized bonds to trace the path of the crisis from subprime-housing related assets into markets that had no connection to housing. We find that changes in the LIB-OIS spread, a proxy for counterparty risk, were strongly correlated with changes in credit spreads and repo rates for securitized bonds. These changes implied higher uncertainty about bank solvency and lower values for repo collateral. Concerns about the liquidity of markets for the bonds used as collateral led to increases in repo haircuts, that is the amount of collateral required for any given transaction. With declining asset values and increasing haircuts, the US banking system was effectively insolvent for the first time since the Great Depression.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 104 (2012)
Issue (Month): 3 ()
Pages: 425-451

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Handle: RePEc:eee:jfinec:v:104:y:2012:i:3:p:425-451
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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