financial crisis post COVID test

when u have a crisis, mutual funds not as safe as bank deposits cuz

u dont have depositors insurance

The debt burden of a nation is often cited but it is not always a good predictor of ______.

default -E.g., Brazil and Mexico defaulted in the early 1980s when their debt-to-GDP ratio was only 50%. Japan has not defaulted even though its debt burden has been over 100% since the mid-1990s.

what is the purpose of depository's insurancr

depository insurance so u know ur money is safe and u can use this money to pay your debt

what was the common ailment betweent he 08 crisis and the euro debt crisis (excessive debt owned)?

fear that debt would not be repaid (*in his words:* First crisis, in 2007-08, was centered on mortgage debt owed by households. The European sovereign debt crisis was driven by excessive government debt owed by countries) (*my words:* -§ 08: spike in delinquency in mortgages and also the fear other debts related to subprime will default § Euro: fear gvmnt debts would not be repaid...this did happen in greece tho)

Fed open market committee decides

fed funds rate

what does the amount of risk aversion of an agent mean?

how much she dislikes fluctuations in consumption

§ Primary grade interest rate:

if you (a bank) can get funding in the market, you can go to the fed and get a secure loan -stigma associated w it...might suggest ur in trouble, not totally ananymous

what is the advantage the US has with their dollar?

lots of ppl want US dollars...cuz lot sof transactions completed in US dollars so perceived as safe

and then came the dodd frank act...what was this?

requires the Fed to conduct an annual supervisory stress test of bank holding companies with $50 billion or greater in total consolidated assets

what was the 1997 Stability & Growth Pact

Deficit: The ratio of the annual government deficitto-GDP must not exceed 3% at the end of the preceding fiscal year. Debt: The ratio of gross government debt-to-GDP must not exceed 60% at the end of the preceding fiscal year.

how did the EU respond to the crisis?

EU leaders decided in May 2010 to provide €500 billion to ameliorate difficulties rolling over debt. The biggest contributors to the fund were Germany (€120 billion) and France (€90 billion). German banks hold 8% (about €24 billion) of Greek debt, and French banks hold about 5% (€15 billion). EU leaders feared that a default on Greek and Irish debt could instigate a bank run on their own banks. o Mostly cuz german and French banks had a lot of Greek debt... -Fund created that can be used to help roll over gvmnt debt

what was the Shaky Greek entry into the EMU

Greece won entry to join the Euro in 2000, taking effect January 2001. Greece was denied entry in 1998 because of: 1. Its high inflation (5.2%) 2. Large budget deficits (around 6%) 3. High long-term interest rate (9.8%) 4. It did not participate in the ERM In 2000, Greece's deficit-to-GDP ratio was 3.7% and debt-toGDP ratio was a 103%.

what important events happened in the aftermath of greek default?

May 6: a majority of Greeks vote in a general election for parties that reject the country's bailout agreement with the EU and IMF. May 25: Spain's fourth largest bank, Bankia, says it has asked the government for a bailout worth €19 billion. June 9: Spain announces that it will formally request up to €100 billion in loans from eurozone funds to try to help shore up its banks. June 25: Cyprus requests a bailout due to its exposure to Greek debt. July 5: ECB drops its key policy rate to 0.75% and lowers the interest on bank reserves to zero. July 26: Mario Draghi, president of the ECB, gives his "Whatever it takes" speech, arguably, a turning point in the eurozone crises. October 18: ECB announces it would lead the supervision of the eurozone's 6,000 banks. -o Weren't allowed to withdraw money from ur bank, only allowed to withdraw so much per day

how did markets react to these shocks?

No longer did financial markets view Italian, Greek, and Spanish debt as perfect substitutes for German bonds. (conversion rate supposed to be 1 but ppl didnt rly believe that anymore) Markets began hiking interest rates on sovereign debt to compensate for heightened risk of default. Between January 2008 and January 2012, the spreads between Greek and German debt increased 3,300 basis points.

On March 9, 2012, four-fifths of Greece's private creditors agreed to a bond swap...what was this?

This debt restructuring reduced obligations by about €100 billion. o Im not gonna pay my old debt...u give me my old debt and ill give u my new debt with some cuts The Greeks effectively defaulted on half of their debt and CDS were triggered accordingly -so whoever issued a CDS had to pay the ppl who held them accordingly

we see that right before a recession, the short term security yields more than long term securities...why? (=yield curve inversion btw)

(long term interest rates shorter than short term) u know market is expecting that a recession will hit -§ Prediction that the future interest rates will be lower cuz expecting short term interest rates to decline

what about conventional monetary policy responses?

(management of short-term interest rates and liquidity in financial sector) 1. target federal funds rate 2. primary credit rate (discount window) Discount window: rate at which bank borrows from the fed in exchange for collateral...stigma associated with that (can figure out which banks went to the discount window)..shows signal youre maybe having trouble § Had to open up so many credit facilities cuz the banks were not borrowing enough 4. Interest of reserves (deposits by the banks at the fed reserves) to promote liquidity 3. reserve requirement

so what happened to house prices during this whole shindig?

-*Subprime mortgages relied on refinancing every 2 or 3 years*, which in turn depended on house price appreciation. -House prices grew steadily since 1997 and reached their peak in 2006; prices declined throughout 2007-11. -Major subprime mortgage originators either went out of business or stopped making subprime loans unless GSE-conforming. Reason was lack of demand for subprime MBS.

what was the panic in the repo market>

-A repurchase agreement is a short-term loan in which the seller of a security agrees to buy it back at a specified price and time o But there was big uncertainty about counterparty intentions/if their securities were good or bad...worried u may not get your security back or get a security you don't want o Dried up market, prob cuz n more liquidity -Why not accept high-grade assets as collateral? Repo traders reported uncertainty about the ratings of structured products. Best response in a fast moving environment was to pull back from accepting anything structured.

The problem with AIG: Securities lending

-AIG lent securities collateralized by cash deposits. Short maturity. -Cash collateral used to buy MBS and CDOs. -Transformed low-risk assets (typical of insurance companies) into higher-risk and potentially illiquid portfolio (resembling banks). -Large accumulation of unrealized losses (due to "mark-to-market" accounting practice). -Desire of counterparties to unwind their exposure to AIG *resembled a bank run.*

then the nextx day, what happened with AIG/

-American International Group (AIG) is an American multinational insurance corporation. -o Gvmnt realized they had to adopt a whatever it takes approach...not just who's gonna win and lose -AIG's Life Insurance division engaged in securities lending, using the cash collateral to invest in mortgage-related securities. (But AIG started morphing into something that looked more like a financial company...largest part of company was engaging in security lending...start investing in long term assets...but maybe youre sitting on long term assets the market wants...huge demand for these securities) o So instead of just sitting on them, they decided to lend them out and they wanted some of that loan to be collateralized so then they just had some cash and used this to buy mortgage related securities (sitting on relatively risky assets) -AIG's Financial division had written over $400 billion of credit default swaps (CDS), which had to make payments when subprime MBS suffered losses. (a derivative that says pay me a premium and in the event of the default in some bonds im insuring, I'll pay you some money instead) so you're protected...cost of that protection is the premium (the risk)) -A day after Lehman's bankruptcy filing, AIG received $85 billion support from the Federal Reserve, and would later receive additional funds from the Treasury (eventually, total assistance rose to over $170 billion). -AIG collapse surprised government officials, regulators and markets -Event that marks the crisis as being a really bad thing

It became clear in 2011 that the initial round of assistance would not be enough to support Italian and Spanish debt...so then what did the EU do?

-An additional €340 billion of funding was provided. In December 2011, the ECB poured €1 trillion worth of liquidity into the banking system. These actions were successful, with short-term interest rates declining substantially

what are the 2 distinct phases of the financial crisis?

-August 2007 to August 2008 (start having probs in subprime market, leads to collapse of stuff) -September 2008 to June 2009: where there are big events that prompted a bigger response from the gvmmt and this lasted until June 09

critical dates: August 7, 2007: December 2007: March 14, 2008: September 15, 2008: September 16, 2008: October 3, 2008: June 2009:

-August 7, 2007: BNP Paribas suspends redemption on some of its money market funds -December 2007: start of the "Great Recession" -March 14, 2008: JPMorgan Chase purchases Bear Stearns: fixed through a commercial bank buying it...this resolved the first phase of the market...less stress -September 15, 2008: Lehman Brothers files for bankruptcy -September 16, 2008: AIG collapses and there is a run on the Reserve Primary Fund money market fund -October 3, 2008: TARP is signed into law -June 2009: end of recession

but then thye let some countries slide because they rly just wanted to create a currency (euro) that could compete with the US dollar

-Several eurozone members didn't meet the criteria but were moving in the right direction. In reality, Greece was moving in the wrong direction. Its debt-to-GDP ratio increased from about 70% in 1990 to over 100% in 2000. Alas, the euphoria of creating a single currency to compete with the U.S. dollar let Greece in.

what about the debt to GDP ratios?

-Some of the original EU members didn't meet the criteria! -Greece, Italy, and almost Spain failed to meet the criteria

fed funds rate:

rate at which banks lend reserves to each other...this is the rate the fed target to conduct policy

what happened with bear stearns?

-Bear Stearns was an intermediate-sized investment bank: -*important underwriter of mortgage-related securities* -market maker in secondary trading -sponsor of various investment vehicles -Income stream from MBS was split up into senior (low-risk) and junior (high-risk) claims. -Given regulations, low-risk tranches required little bank capital. -*High-risk tranches were more difficult to sell; instead, some holdings were moved to sponsored investment vehicles to remove them off the balance sheet.* -From 2004 to 2007, Bear Stearns assets grew substantially: 54%. cuz of nincrease in huose prices -which is HUGE but how would they finance this growth? they financed it with short term liabilities (debt that you have to roll over all the time...if the market refuses to recover than you're in trouble) -Growth was financed mostly with short-term liabilities. -Equity did not grow as much: leverage ratio went from 28.5 to 33.5 (o Equity position is similar to the money you put down on a house...as you start losing money your equity gets reduced cuz it's absorbing those losses...so then eventually creditors lose once you declare bankruptcy à don't have money to pay out all of your debts) -With drop in house prices and increase in delinquency rates, concern grew over banks borrowing short-term to fund illiquid long-term mortgage-related assets. -*Creditors became increasingly reluctant to roll over Bear Stearns' short-term debt*

what did the dodd frank act allow the FSOC (Financial Stability Oversight Council) to do?

-Council decides on which banks are too big to fail: Bank holding companies with more than $50 billion are automatically classified as systematically important. -for non-bank institutions, they're considered as systematically important if they meet certain criteria... -*the FSOC does the following: monitors financial markets for threats, identifies gaps in regulation, advises governmental agencies and Congress, suggests enhancements to regulatory and supervisory standards*

why did the financial crisis in europe cause such a stir?

-Defaulting on sovereign debt is not new, but (before Greece) we had not seen an outright default by a developed nation since 1946. But European countries had been in debt for decades and with relatively high debt-to-GDP ratios...*BUT perceived willingness to pay back debt prob dropped*

then there was trouble with GSEs...

-During the summer of 2008, Fannie Mae and Freddie Mac came under heavy market scrutiny. -Both GSEs had considerable, often complicated, exposures to the U.S. housing sector in their portfolios, financed short-term and with large leverage. -o Concerns for solvency increased (short term debt increasing) it would be more cvostly for firms to operate -Thus far, both institutions had benefited from the impression among many investors that their debt was (implicitly) guaranteed by the Treasury. -As concerns about the solvency of these firms increased, the government made this implicit guarantee explicit with the Housing and Economic Recovery Act.

what did the dodd frank act to the FDIC (Federal Deposit Insurance Corporation)?

-FDIC endowed with "orderly liquidation authority" to intervene when systemically important nonbank institutions risk insolvency In order for the FDIC to act on this new authority, the FDIC, Federal Reserve, and -Treasury must agree that a nonbank institution is in danger of failing. -*their actions may include: providing loans to the firm (§ Can now use funds to intervene: now bear stearns and lehman brothers would be protected by this) I selling or transferring the firm's assets and operations I imposing losses on shareholders* -idea was to react before bankruptcy comes into the picture

how did monetary policy change after the financial crisis?

-Fed started paying interest on excess reserves. -o Since facilities were temporary (which were designed to echange diff assets), and designed to exchange debt for bank reserves...kinda worked like a discount window but was open to all banks (not as much stigma tho) -"Quantitative Easing" implied the purchase of significant amounts of financial assets and a corresponding increase in bank reserves. -Excess reserves implied the Fed moved to a floor system. -In principle, Fed can achieve FFR target by setting IOER. -In practice, FFR has been persistently below IOER rate. -Resolved with a subfloor: overnight reverse repos (ON-RRP

notable stuff about european countries and how they converged to the agreed upon long term interest rate:

-Founding nations converged relatively quickly -others higher originally but then eventually converged except for Greece failed to meet the convergence criteria

what about the second phase timeline?

-GSEs are placed under government conservatorship -o They had a guarantee by gvmnt...if they were in trouble there's no guarantee the gvmnt would help, but this is how it was perceived by the ppl -Lehman Brothers files for bankruptcy -AIG collapses -Run on the Reserve Primary Fund -First proposal of TARP

what was the subprime panic?

-House price declines and foreclosures do not explain the panic. -o We saw the house price alone doesn't explain the panic cuz investors and dealer banks involved in the market that buy structured products like MBSs, MBS info was pretty good but in the case of CDOs the info was more complicated cuz you were repackaging diff tranches of asset backed securities from other tranches...risk if house prices started declining --Since house prices started increasing, way to provide mortgages to riskier borrowers but short term type of mortgages and exploiting the rising house prices -Dealer banks had information about subprime-related structures. However, there was no way to learn the consensus value of sub-prime bonds and structures. --No mechanism for the revelation and aggregation of information about how the effects of house price decline and foreclosures. -Pivotal role of ABX index, which started trading in early 2006, around the same time house prices began to fall...Captured derivatives

notable stuff about european countries and how they converged to the agreed upon inflation:

-Inflation rates also converged quickly for founding countries -other countries also converged but Greece failed to meet the convergence criteria

what has the monetary policy response been?

-New lending facilities to stop runs on callable debt: money market funds, commercial paper, etc. -Whatever-it-takes: Fed expanded types of assets it is ready to buy. (*Buying assets creaters depositor insurance for fiannvial sector*...don't worry about other financial markets drying up...o All of the buying of assets in the financial market was to prevent runs) -Effectively, deposit insurance for the institutional financial sector.

simialrtiies between covid and 08 crisis:

-Stress in equity and debt markets (o drying up of money available to corporations to invent and operatre (equity market)) -Flight-to-safety (o selling off of risky assets and moving to safe assets like US treasuries) -No bank runs, well functioning payments and credit systems

what was the bear stearns discount loan?

-The Fed acquired securities at a marked-down price at the outset as repayment of the loan, rather than a traditional advance (or loan) in which securities serve as collateral and where these securities would be repaid on the return of funds o So this was an intervention that carried a default risk...fed could have lost its investments...they took a risk?

what was the rationale of intervention with the GSEs?

-The rationale for intervention was similar to Bear Stearns. -Both GSEs were thought to be subject to liquidity pressures because of the temporary undervaluation of their mortgage assets (o Liquidity crisis...interest rate went up cuz of concerns with solvency); thus, public support would reassure investors at what was expected to be no cost to the government. -Despite this reassurance, the backstop was called upon quickly and on September 7, 2008 the two GSEs were put into government conservatorship. -So whatever losses they would have they would be covered by taxpayer money

what are Large-Scale Asset Purchases (LSAPs)?

-With short-term interest rate near zero, the Fed decided to focus on lowering long-term rates through large-scale purchases of Treasury and GSE-backed securities. o Return on treasury is 1/price o So when u buy treasuries, u bid the price up which Is equivalent to lowering interest rates o Basically these methods lower long term interest rates o These large purchases were in 3 rounds

notable stuff about european countries and how they converged to the agreed upon Deficit-to-GDP Ratios

-bigger variation -founding countries coverged obvi -for the other countries: o riskier countries (Italy and Greece) had higher debt...Greece did not meet the criteria o Ireland worked rly hard to bring numbers down to meet criteria

differences btwn the 2 crises:

-can telecommute very easily...like rn he is providing a service to us remotely by teaching -o Basic services are still fully operational: water, heat, internet, postal service -Can pay bills online, can earn money online so this keeps things kind of moving -o System cant rly react to the surge in demand of hospital beds...in a business they will jack up their prices...u could do this is a medical industry but we don't so u see rationing -policy response slow so far and procedure of drug approval is also slow -o Supply chain probs: the fact we don't produce everything domestically Is a major probbbbb -

what's up with this COVID 19 crisis?

-certain parts of economy beign shut down (restaurants) -lots closed down voluntarily -will be large economic contraction -so much uncertainty -the shutdown happened very quickly -no bank runs in this crisis: no big lines of ppl trying to get money back

why dont corporations use depository insurance?

-corporations are dealing w millions of dollars and they don't leave their money at the bank cuz there's a limit on depository insurance so it's riskier for them -so, they use cash equivalence: short term and liquid financial instruments (mutual funds, short term paper)

from 2000-2011, what happened to: Greece Ireland Italy Portugal Spain's debt to GDP ratio and deficit to gdp ratio?

-debt: Ratios become alarmingly high -deficit: Ratios surge during 2007-08 financial crisis

important differences between covid and 08 crisis:

-fundamentals likely to play a bigger role now (certain companies are affected that have to shut down operations, and other firms are not suffering, but a big chunk of economy shut down, less output produced, numbers are inconsistent but only thing we know is that the crisis will be large and will hit certain sectors more than others) -things that played a big role during 08 crisis that may not play as big of a role now: -Uncertainty about the value of (subprime-related) structured products (house market crash, spike in delinqincy, uncertainty regarding value of assets related to downprime, maqny were downgraded/stopped performing well, uncertainty about which will survive, runs on institutions perceived to be exposed to subprime risk) -Run on funds/institutions (perceived to be) exposed to subprime risk -Counterparty risk (o banks started distrusting each other which caused short term credit to dry up)

what was the purpose of the · 1992 maastricht treaty convergence criteria?

-if u wanna join, need to look sensible, have discipline in gvmnt accounts, also some fiscal requirements, monetary requiresments 1. long term interest rate between 2% of 3 best EU members...u cant be a risky country 2. Inflation: Within 1.5 percentage points of the average of the three best performing EU members 3. Exchange Rate: Applicant countries must have been in the exchange-rate mechanism (ERM) for two consecutive years and without having devalued its currency

IOER has acted as a ceiling on overnight interest rates

-interest rate on excess reserves o Below until interest became large...not rly understood while this happened...banks can offer stuff at lower rates? o Suggests wrinkles exist when u conduct policy

how investment banks are diff from commercial banks:

-invest banks: *doesn't give out mortgage loans or accept deposits from the gvmnt* § They're an artifact from an act that resulted from the great depression...banks had limited set of actions they could do...had to choose if they wanted to be commercial or investment o *Investment banks issue short term debt* § Can underwrite mortgage backed securities through an investment vehicle and can also sell securities (a company wanting to issue bonds for ex/) § Also do brokerage activities § Do their own investments

what did the dodd frank act do to the CFPB (Consumer Financial Protection Bureau)?

-it created it lol -an independent bureau housed within and funded by the Federal Reserve -primary focus on consumer protection and education on consumer financial products -provides broad consumer education counseling about financial products through the Office of Financial Literacy -investigates consumer complaints -identifies risks to consumers from financial products -supervises consumer financial services offered by large financial institutions and issues rules to implement consumer financial law -he says this is a controversial institution tho

then what was the purpose of introducing expectations management?

-just better communication so investors knwo how to react -Communication from the central bank can help make monetary policy more effective by helping economic agents better understand policy goals and better anticipate future policy actions. -Guidance to investors and the public about how the Fed expects to adjust the federal funds rate in the future, given current information about the economic outlook. -In January 2012, the FOMC announced that a 2% annual inflation, as measured by the annual change in the price index for personal consumption expenditures (PCE), is most consistent over the longer run with the Federal Reserve's price stability mandate.

Governments want to issue debt with short-term maturities due to the ____ _____ ____

-lower interest rates. o Incentive to issue short term securities cuz cost is so much lower but u are more subject to rollover risk -This increases default risk if investors choose not to purchase new debt, or demand much higher rates -and this can be especially bad if investors start to believe that the gvmnt cannot meet its debt obligations. o A bank that issues deposits is an extreme version of this...they mature everyday...u can go and get money back every day...same w money market mutual bonds (ex of short term that mature everyday)

Who buys sovereign debt? and why was this a prob in greece>

-o Foreigners and locals (local banks)... o The riskier assets of the bank the higher capital it needs to hold: provision criteria § If u hold your own countries' debt, it was unrisky and u didn't need to have a potential loss in the debt of capital u had to hold...incentive to hold local debt § *20% Greek debt held by its own banks (a Greek default would dramatically weaken their balance sheets) ...so when it defaults maybe there are bank runs, economy fails, harder to pay stuff that it was before* In response, markets stopped rolling over these banks' debt due to fears that they would no longer honor obligations. This in turn meant that Greek banks could not roll over funding of Greek government debt.

what does the · US treasury yield curve show about the relationsip between yield and time to maturity?

-positive relationship -o Interest rate of gvmnt bonds as a fxn of maturity o Compensated for extra risk: represented as a premium on the risk § Short term interest pays interest and longer term interest pays more interest o *Curve shape has to do with expectations and info* § Tradeoff: if u issue a 30 yr bond don't have to worry about it maturing for 30 yrs...some other gvmnt will have to worry about rolling it over...but it will lock you into a high interest rate for a longer time...short term debt requires that u pay less interest but u have to worry more frequently about repaying/rolling over the debt § *Tradeoff between maturity and cost*

what about commercial paper

-short term debt -provides liquidity -o The ppl doing this type of intermediation are financial companies, not banks -o Collapse in the commercial paper market in 07...now it's flat...this market basically dried up

critical events that happen during first phase:

-the subprime panic in the second half of 2007 -the assisted purchase of Bear Stearns in March 2008

o With bear stearns we saw that as long as there's a bank in the operation, the fed will allow _____ o W a ______ bank, not a big issue normally, cuz they have other things the bank could value (branches and employees, contacts)

-this bank to absorb this bankrupt company -commercial

what is the retail market?

-way individuals invest in the market through market vehicles -o operate largely through the formal banking sector: like bank of America -nice thing about retail market, if you move from one bank to the next, the whole bank web stays liquid

what are the other 2 additions of the dodd frank act?

1. Durbin Amendment: limits the fee a business pays to a card issuer for each consumer transaction that uses a debit card ("interchange fee"). 2. Volcker Rule: prohibits banks and bank holding companies from engaging in proprietary trading, and from owning or investing in a hedge fund or private equity fund, and limits the liabilities that the largest banks can hold.

The case for non-intervention Mishkin (2011) describes why, at the time, there was a case for letting Lehman go into bankruptcy. (3)

1. Government had no authority to put Lehman into a conservatorship (as with GSEs) (they couldn't just grab it like they could with the GSEs); only possible solution was a brokered purchase (as with Bear Stearns), which did not work out. 2. Bailout of Bear Stearns extended the safety net to investment banks; government officials and regulators were concerned about increasing moral hazard in the financial sector. 3. Lehman's vulnerability was well-known; its bankruptcy would provide incentives to market participants to take measures to protect themselves and avoid taking excessive risk.

policy intervention: 1. fed 2. gvmnt

1. conventional monetary policy, liquidity provision, Quantitative Easing 2. Economic Stimulus Act, Housing and Economic Recovery Act, made some suspervision agencies, "stress tests", Dodd-Frank Act

some big drivers of the 07 crisis

1. uncertainty in subprime related securities 2. counterparty risk: repo agreements...but one side may be worried someone will not hold up to their promises that they will reverse the operation soon so ppl think do I rly want to keep this MBS/collateral cuz you don't want it for a long time...have to do something with it like sell it

Pre-COVID Monetary Policy

2 main instruments: 1. *I Interest rate: focused on inflation and yield curve management* 2. *Balance sheet: ample reserves for an effective floor system...§ how big the size of the fed's balance sheet is determines how large the bank's reserves will be* concerns: Concerns: I Low inflation I Yield curve inversion I Impact of fiscal policy I Short-term liquidity markets

what about the fed reserve bank's liabilities

8o B4 crisis, most liabilities of the fed were cash o The number of cash banks used to hold was very low...so now the reserves of banks are growing o Most of growth of cash is by foreign demand (high demand of US dollar bills) o So most of money was at reserves (stayed at the banks) o *Ppl feared at the tim that all the intervention by the fed were helicopter drops which could lead to inflation...did not happen cuz purchases of assets were transformations of assets held. Allowed them to provide liquidity services in return...none of it materialized in the form of cash* (good thing cuz no inflation) o Currency in circulation did not grow that much. All growth was fueled by foreign demand o Big thing that explains the growth in liabilities of fed is the increasing reserves (deposits of banks at the fed reserve bank)

what is the summary of the bank model/the purposes of banks?

A model that justified why financial institutions who invest in long term assets issue debt in short term (cuz there is demand for liquidity insurance)...prob w that: exposes to fragility and bank run behavior...for no good reason everyone loses...just need ppl to coordinate on the runs

big driver of COVID crisis

At least for now, the bigger issue is fundamentals=no ability to evaluate risk...some firms have to shut down cuz policy affects them like restaurant or hotels or they voluntarily close -we know airlines will suffer more than a bank

what does the graph showing counterparty risk in the banking sector show for this covid crisis?

Covid: not as high as before, but there is a perception of elevated risk even tho the financial sector doesn't seem to be suffering (no bank runs and such

creditors will refuse to roll over debt when:

Creditors refuse to roll over debt when they perceive a government as unwilling rather than unable to meet their debt obligations.

so basically, o Subprime panic about...

Loss of info cuz of complex length of securitization chain

summary of 08 crisis big pts

Fed responded to the Financial Crisis of 2007-09 using conventional and unconventional policy tools. The Fed "footprint" in the economy increased substantially. Policy intervention had lasting effects. Adjustments were necessary in the post-crisis period. Significant changes to regulation & supervision of financial sector.

policy response to covid so far:

Many similarities with response to the financial crisis: ad hoc liquidity facilities, deficit spending. -Burden is unequally distributed. -Social insurance (and creative solutions) are key. -Temporary shocks like this are best financed with debt instead of current taxation. -Flight-to-safety works in our favor: keeps the cost on government debt low **o When u have a temp increase in deficits, spending money to provide insurance, it's like a war, proper way to do this is through debt, not taxation

difference between corporate debt spreads showing AAA and BBB represents:

Diff between the 2 gives u perception of risk of the market

o If you have a market, the security will be priced so that the investments are perf substitutes...why is this

Everyone same at beginning, but a competitive market has to ensure you have ppl on both sides of the market (security cant be too cheap or too expensive)

were Lehman bros saved by the bell (fed)?

In early September 2008, Lehman suffered losses in the subprime market and faced serious funding problems. -Government investigated the possibility of brokering a buyout similar to Bearn Stearns. -Barclays was interested in buying Lehman, but British bank regulators were skeptical and the FRB refused to take more bad assets onto its balance sheet. -In the end, support was not offered and Lehman filed for bankruptcy protection on September 16, 2008. -It remains the largest bankruptcy in U.S. history.

what were the stress tests?

In the Spring of 2009, the Fed led stress tests of the 19 largest U.S. banks to help restore investor confidence and allow banks to raise capital. Stress tests consider "What If" scenarios for macroeconomic and financial variables to ensure that banks have enough capital to continue operating under extremely trying economic conditions. -o Might expose areas where the bansk need to diversify more

what was the reality of greece's financial situation

In the summer of 2009, a new Greek government took power. At the time, Greece's deficit-to-GDP ratio was viewed as just under 4% and the debt-to-GDP ratio, around 125%. In reality, the deficit-to-GDP ratio was not just under 4%, but rather just under 16%!

what info was understood at the time and what invention helped resolve some info probs?

It was widely understood that subprime-backed securities were sensitive to house prices and that there was likely a bubble in the housing market. Different views on extent of bubble and on when or whether it would burst. Lack of common knowledge about the effects and timing of house price changes and about the increases in delinquency. -The introduction of the ABX indices in 2006 played a key role in resolving the information problem: -provided a transparent price of subprime risk -allowed for efficiently shorting thesubprime market (both for speculative and hedging reasons)

Challenges for the future (pre-COVID)

Monetary policy: balance sheet normalization; interest rate policy o regulation: rollbank of dodd frank: some things scaled down o always a tension between regulation from gvmnt and from the market o competition like bitcoin lol (cryptocurrencies; "fedwire" = operated by the United States Federal Reserve Banks that allows financial institutions to electronically transfer funds)

what is the act of rolling over debt?

Rolling over the debt means paying off old debt by issuing new debt. -o So as the economy grows, initial burden u have to pay back isn't as bad...they just pay off the interest of debt -Nearly all nations in the world have outstanding sovereign debt, and they typically roll over the debt when it comes due...this is what companies do too -Government debt is issued at different maturities, which determines when the debt is to be repaid. (and the interest rate paid on this debt is dependent on the maturity of the debt)

what did the · STL FRB financial stress index show

Runup of stress at the beginning of the crisis

what's up with how the fed has targeted inflation?

Since 2012, Fed has targeted inflation at 2% annual PCE inflation has remained mostly below 2%

how was monetary policy prior to the crisis (conventional)

The Fed sets three interest rates, either as a target or by administrative fiat: -Federal funds rate (FFR)=rate at which banks lend to each other over night -Discount rate=rate at which u can go to fed and get loan in exchange for high quality collateral (not used as much cuz of stigma) -Interest on excess reserves (IOER) -the fed used a channel system with these rates: -Lower limit: IOER, which was set to zero -Upper limit: discount rate -Target: FFR

bear stearns consequences of intervention

The government widened the perimeter of its safety net for systemically important financial institutions to include a mid-sized investment bank. Bear Stearns shareholders suffered, but the Fed structured the purchase so that it protected creditors, insured and uninsured Government showed a willingness to act quickly. The intervention was mostly well received by the public and media (e.g., equity prices rallied) -o The gvmnt widened the perimeter of its safety net § There was an expectation that the fed would maybe step in a protect the nieman brothers...it didn't...saying I have a safety net but im not gonna be consistent -o Perceived to be a strong measure that happened bear stearns...creative way to rescue it with minimal disruption to markets -Gmvnt/fed showed they were capable of saving things, well received by markets

just define debt rly quick lol

When governments spend more than they receive in taxes --> deficit -opposite is a surplus, which it can use to pay off its existing debt -The national debt is the sum of the current and all past deficits/surpluses.

what did these shocks do?

These fiscal shocks woke up the financial markets to the risk of default on sovereign debt.

what was the Policy response to COVID shock

Widespread shutdown measures to combat the spread of the virus. Large contraction in economic activity for an uncertain period. Speed of contraction and level of uncertainty are unprecedented. Some parallels with Financial Crisis of 2007-09

wy would investors invest in a firm they knew was prob gonna eventtually fail

You think youre protected from taking risky endeavors cuz you think youll be rescued after...their actions to invest are rational

what does this greek example show in relation to our crisis?

not all suffering countries had housing bubbles...like in Greece it was all about debt and stuff -the EU shouldve made a fiscal union too to better deal with these probs instead of just a monetary union (EMU)

but the V shape isnt gonna tell the whole outcome prob...why is that?

o *We need to worry about debt markets* o Like these places may go bankrupt...cant ask for more debt cuz they don't have revenue o So policy makers have to get more creative asappppp baby o Also a lot of firms have been tapping out their credit lines but banks may decide to make them tighter cuz of the uncertainty and risks

· S&P 500 index (taken from FRED)

o 07-09: Overall fall in stock market was 50% from peak to trough o Today, 33% fall in the stock market for pandemic -dont know how much further it'll go

graph showing 10 and 1 year treasuries

o 1 yr follows fed funds rate rly close o 10 yr bond has its own trend, it's downward, cuz the liquidity of this market has increased a lot over time so ppl can use it in cash like way in institutional operations

what can policy do to prevent bank runs?

o 1. Deposit insurance § If a bank goes belly up, can withdraw from insurance pool and pay to depositors, get money back, no incentive to run § Not depositor insurance for other funds (money market mutual funds for ex) so u see bank run behaviors o 2. Lender of last resort § Gvmnt comes and buys mortgages for cash, then use it to pay out ur depositors § This is what happened with bear stearns § Worked cuz assets were good 9triple A securities) o 3. Regulation § Related more to a fundamental run § Prob assets go bad is lower by restricting how much risk u can take on

Two official rationales for non-intervention w lehman bros:

o 2008 Rationale: probs of lehman were known for a long time, investors were aware of these probs, so they said investors and counterparties had time to take their investments elsewhere...telling investors they should take their precautions...said they expected investors to properly hedge their investments by then o 2010 rationale: we know it was a big deal but there was nothing we could do...bear stearsn worked cuz of the structure of the bank and the collateral, but for lehman it wasn't the same...no one rly wanted to absorb lehman

what about delinquincy rates?

o =loans that are late for payments 30 days or more o See direct evidence on the probs w mortgages o Spike in delinquency...that part of the prob is real o Could be related to the fact house prices were falling and then you had a mortgage that did not reflect the value of your home so you wanted to get rid of your loan or it could be that you lost your job and had to make a late payment

what was the run on SIVs?

o All fund were funding themselves with short term debt...but investors thought they were investing in subprime products and they didn't want to take the risk anymore (investors stopped rolling over these notes) o These vehicles absorbed by their sponsor banks -SIV sector disappeared during the panic o But it turns out a lot of these vehicles weren't rly exposed to subprime, just exposed to financial sector cuz of the investments they had...so not only real risk matters, so does perceived risk

what does the graph of interest rates show?

o At 07, fed lowers rate rapidly, then it drops down o 3 mo treasury bills were earning essentially no interest rate from 2009 to 2016 Tried to push long term rate down (can be represented by 10 yr

what was the dodd frank act?

o Banks supervised by variety of federal and state agencies, prob with lack of coordination/information...the act streamlined this communication basically -justified by the need to identify and supervise systemically important financial institutions—those with the potential to cause another financial crisis ("too big too fail") -established the 15-member Financial Stability Oversight Council (FSOC) to identify systemically important institutions

what about bank loans?

o Before crisis, big runup in loans o Insider outsider theory: not that banks were issuing mortgages and then getting rid of them...they were exposed to them so you see a drop o Exposure to real estate declined over time, so they start to rise again

relationhip btwn SIVs and commercial paper:

o Big in commercial paper o Idea was you collect fund and invest in some portfolio of assets o Issuing short term debt and invest in high paying assets o These SIVs are managed by a fund manager and their assets are all at market price o SIV lite: Larger portion in Asset backed commercial paper o Unlike some other funds like SPVs, these did not have committed liquidity lines to banks...riskier -Money market mutual funds did invest in SIVs: *so why do we have these chains of funds of securitization? Cuz our risk tolerance and liquidity needs are very diff*

what was TARP (Troubled Asset Relief Program)?

o Big policy response prompted by these above big events o As all of this is happening, now treasury had the funds to step in a react using taxpayer money to buy bad assets from companies so their balance sheets looked better o Worry that if you assist one bank it would stigmatize it, so all banks had to pay money to this to prevent stigmatization so it wouldn't single out any bank...tried to prevent bank runs -Not long after passage, TARP resources were redirected to inject capital directly into financial institutions. -In the end, the U.S. government became a co-owner of some of the largest financial institutions in the country.

what do the asset prices of bitcoin, tesla, home price and crude oil show?

o Bitcoin pure bubble cuz no intrinsic value o Tesla: bubble or expectation will be high in future...it crashed but still high o Home prices: have been increasing since financial crisis 08...faster than inflation o Crude oil § Very volatile...collapse in oil prices, trading at negative values today...in part cuz of futures...didn't have capacity to store the stuff they bought on the futures market

what dies the yield spreads between soverign and german 10 yr bonds show?

o Btwn euro countries, interest rate supposed to be basically 0...paid the same from country to country o Spread went up a TON for greece o 500=pay 5% more than a german bond on your debt o Difference is pure default risk -(greece was at 3500! by the end of 2012

how did CDS prices reflect the greater risk of default?

o CDS: pays out when the debt gets defaulted on (so Debt holders can insure themselves by purchasing Credit Default Swaps (CDS).) o If debt doesn't fall, u have to pay but if it defaults, u get premium *The price demanded by a CDS seller reflects the probability of default.* The higher the probability of default, the higher the price charged to acquire the insurance. -*Greek CDS basically stop trading in the market (cuz prob of default was way too high!) (=price is infinite)*

the 2 types of conventional and unconvential monetary policy and how they interacted in the fianncial crisis 08 (short summary lol)

o Conventional monetary policy: changing interest rates (when things get worse, fed lowers interest rate) o This didn't do much, so the fed turned to unconventional monetary policy. did liquidity provision

how have interest rates changed during covid?

o Covid § Yield curve flat, so 2 interest rates similar § Lowering to 0 happened quickly (within weeks)...10 yr is also low now cuz lfight to safety thing § Investor moving to safer assets

what about gvmnt debt graph/

o Debt is rly high as of late, as a response to the crisis o He said it's def a big number o Interest rates are low cuz theres a huge demand for this debt o Huge shift in quality,...risky into high quality assets...positive is that the gvmnt could cheaply issue debt so they could finance the recovery cuz huge demand for US debt

what does the graoh that shows total Government Expenditure and Revenuefrom 1995 to 2015 show?

o Drop in revenue cuz of tax cuts etc., they lasted a long time, and expenditure went down by quite a lot

why did the EU and EMU pop up?

o EU main idea was political: to not rehash WWII...and they get some economic benefits o 92: idea of a monetary union popped up...start building conditions necessary for monetary union: a trade union (also allow for more labor mobility) § Idea of creating a common currency with an independent central bank

what does the inflation graph show?

o Effect on inflation is minimal o Price of oil makes the blue line volatile...nothing to do w monetary policy o So he takes out volatile stuff

prob with this index tho?

o Even tho you have an index, you don't know the position of entities, like u don't know exactly who's long and who's short

whaqt about the great shock to ireland's financial situation?

o For Ireland, tried to bail out banking sector in 2008 through the gvmnt...huge deficit § Before crisis Ireland worked hard to improve accounts, but after, debt over 30% cuz of gvmnt bailout § Meant investors got nervous for certain gvmnts to pay off their debt In 2007, Ireland's debt-to-GDP ratio was just 25%, and its deficit was zero. By 2010, Ireland's debt-to-GDP ratio was almost 100%, and its deficit-to-GDP ratio was over 30%.

whats a major issue w the EU and keeping members?

o How to handle once countries are admitted if they don't meet the criteria...can u kick them out? Contingency plans? For political reasons, didn't rly meet the table..pretty lax once you join § U can see how that happened with Brexit...very complicated event when someone wanted to leave

why do ppl think COVID will look like a v-shaped recession?

o Idea that we will Shut down lights for a while then go back to where we are Shutting down hrs (like restaurant is still there and we still know how to do these things in the same way)

what did bear stearns assets look like?

o In 2007, 400B dollars...medium-sized bank o They grew more than 100B dollars in four yrs which is significant...mostly grew in financial instruments owned (60B) that were mortgage related for the most part

how does the assets of commercial banks change from 1997 to 2017?

o In between 1997 and 2007 nothing rly happened...not like banks became increasingly risky o But what changed in the 10 yrs after: loans contracted significantly in proportion o Cash assets increased...in thr forms of reserves...this is cuz of the fed intervention of buying assets of banks o Banks move to more safe and liquid assets

what about gvmnt transfers graph?

o Increased amount of transfers, reaction during crisis: huge increase o Transfers doesn't rly drop down to levels before crisis cuz Defense expenditure went down in terms of GDP (everything is in terms of GDP)

what is the function of national debt?

o Issuing debt=issuing dividends basically -Historically, nations have borrowed to finance wars, civil works projects, and less tangible items (education, pensions and medical care.) Why not just dramatically raise taxes immediately? It is better to borrow resources and slowly repay the debt over time with permanently higher taxes. --> smoother consumption bundles over time Similar to a mortgage—borrow a lot of money to buy a house now and slowly pay it off over time

what was bear stearns intervention?

o Its size is why there needed to be intervention o This is *a funding run: investors not rolling over on short-term debt* § Even tho this is not a commercial bank, this was equivalent to a bank run § Conceptually exactly the same thing o Financial authorities stepped in...JP morgan chase agreed to absorb bear stearns for the first 1B of liabilities o But bear stearns was not a depository institution...so the FDIC could not step in o The treasury and the SEC needed funds appropriated by congress to resolve... o But now the fed could intervene when JP morgan chase absorbed them cuz of the type of bank they are o So the 30B of problematic assets that were taken out of bear stearns portfolio and the rest were absorbed by JP morgan chase...so the fed put 29B in the loan for exchange for those securities and JP morganput 1B in the loan collateralized by the securities held by this fund...JP acquired the healthy part of bear stearns o So they removed the bad parts of the assets to a special entity ( usually this would be the FDIC for a bank, but in this case they had to create a special entity which was financed by a loan from JP morgan and the FDIC)

what did the private nonfinancial liabilites graph show? (referring to response of households?)

o Loans to households did not rly come back (red)....overhang...households indebting themselves too much o So, this is the response of households

why are yields on treasuries whith longer maturities higher?

o Long term higher than 3 mon. treasury rates cuz of liquidity risks

The problem with AIG: (credit default swaps)

o Not registered on the balance sheet...didn't know how exposed they were o CDS and CDOs were the most troublesome and AIG had no offsetting hedging position o AIG had to come up with the cash to pay the margins on the CDSs o So demand for cash coming from 2 diff places, at the worst possible time

what did bear stearns liabilities and equity look like?

o On the liabilities side, they grew of course o *Basically there was an investment bank that had exposure to subprime risk and would finance with short term liabilities...that wouldn't roll over so the bank would be stuck with no ability to raise funds to finance it...liquidity dried up* o Even if the assets were sold you would lose a lot of money right away and would not be able to pay debts

what happened to Lehman bros?

o Parallels with bear stearns: both investment banks, lehman bros bigger bank, old entity, large in terms of employees (not just assets) 25,000 employee firm o So it was an open secret that they would likely run into trouble...cuz of bear stearsn and investors have access to balance sheets of companies (u know what types of exposure they have) (one of the most leveraged of the major investment banks I unwilling to raise capital I poor reputation for risk management I high exposure to losses in subprime market) o Very little capital to absorb potential losses o Known they would take some risky operatins not properly hedged and known they had some exposure to the subprime market

what was the most recent inversion caused by?

o Recently, the inversion caused by the fed making the interest rate too high ebven tho there was no expected recession -then the yield curves basically flattened off o The market was telling the fed interest rates shouldn't be as high

how did · Commercial banks: liabilities and equity change from 1997 to 2017?

o See a similar movement o Deposits grew substantially as a proportion of total liabiltiies o So to this pt, we have seen fed Intervention by providing liquidity trying to affect long term rates, promote lending by banks

what did the federal reserve bank asset sheet show after the buying of LSAPs?

o Shows the extent of intervention o Nothing rly happens until the middle of '07 Eventually the blue intervention had to be closed out (temporary liquidity facilities) and then switched to red which was LSAPs—outright buy those assets

so what's the summary in how/why the gvmnt stepped in in a big way?

o So overall pic: both fed and fed gvmnt stepped in in a big way to basically solve what was a liquidity and solvency crisis following failure of certain institutions, but most of these actions were permanent. On fed side, created huge deficit, didn't go down that much and has not come back down to previous levels...no reason to lower it given interest rates on that debt is pretty low...no incentives for gvmnt to pay back that debt

the recovery of covid will likely involve...

o Still lots of uncertainty o One thing: the shutdown is mostly a contracting in hours worked o Prob for startups: New companies that were tying to open will have a harder time getting loans and investors...delay entry of new firms o Companies still have to pay rent and stuff even if they shut down...pay or go bankrupt o The more firms that fail, the more trouble there will be nd longer recovery o Like when will normal econ activity occur? o what things will make recovery longer: -Reassessment of international trade, labor mobility and the global supply chain -*Trade-off productivity for insurance* -Possible second wave in 2021

what happened to the reserve primary fund (money market mutual fund)?

o The Reserve Primary Fund was a large money market mutual fund § can get money quickly like a deposit, very liquid safe assets o so commercial paper were also part of the assets (held $785 million of Lehman paper) o this fund had huge exposure to lehman...after bankruptcy you had tons of lehman paper which you can not collect...Lehman's bankruptcy implied the fund could no longer redeem its shares at the par value of $1 ("breaking the buck"). o so the money market mutual fund suffered a run...everyone went an tried to redeem their shares and the fund shrunk by 90%...interesting cuz this used to be viewed as very safe -A run on other money market funds followed, which put pressure on banks as a significant amount of funding came from bank commercial paper and certificates of deposits held by these funds.

what is synthetic subprime risk? (explains what ABX index does)

o The idea is that you can trace subprime risk o If you're exposed to subprime cuz you buys an MBS or CDO backed by subprime assets...back yourself by a credit default swap...pays when there is credit default...a way of hedging against the possibility of default...you pay a prime (if no default, just pay the prime) but if there is a default you get a huge payout o So there was a market that created an index of these derivatives: ABX index o So the idea was lets get a market price out there for ppl W derivatives you can start trading risk without the position/owning the asset...bet on what will happen

how are gvmnts and corporations diff when it comes to debt?

o This is where gvmnts and corporations are diff: gvmnts can tax their citizens...firms cannot § Gvmnt may have the potential to get the money but are just unwilling to § Corporations just may not have the money simply

Greek and Irish governments developed unpopular austerity measures to remedy fiscal woes and combat rising interest rates...what did these do lol?

o To solve interest probs and stop paying such high rates on their debt o Ireland more successful than Greece o Greece remained in the danger zone Through tax increases and reductions in spending, Greece's deficit-to-GDP ratio fell from 16% in 2009 to a projected 8% for 2011. Ireland's fell from a peak 30% in 2010 to a projected 10% in 2011.

what has the FEDs response been so far to COVID?

o Trying to stop runs on callable debt like commercial paper o So the fed is willing to buy whatever asset at this point to stop the run and the collapse in financial markets o This is exactly what the fed did during the financial crisis Basically supplies depository insurance to the corporate level

what did market expectations of near term volatility show?

o What market participants are thinking about volatility...gives u a sense of uncertainty in the market o Volatility spiked up in a big way at the worse part of the crisis...not only prices were falling but uncertainty was increasing

what happens when a bank starts having trouble?

o When a bank has trouble, FDIC steps in and tries to make the bank viable...so the FDIC may portion off the healthy part of the bank...so accounts moved to diff banks o So the bad parts are put in trusts which are managed...so as things start maturing, the bank collestcs money and starts paying off other deposits

what happened to the ted spread?

o When this interest rate moves, your mortgage payments move o 3 mo. Treasury bill perceived as being rly safe...prob wont default, liquid market § Used as a reference rate o So the diff between these rates should capture credit risk o See a major increase...increase in risk o Then it calms down and there's a much bigger spike in risk and things were resolved rather quickly

rationale for fed's intervention with bear stearsn

o Would hurt other ppl if they didn't (ripple effects), bear stearns did serve a role that provided services that if disrupted would disrupt other fianncial activities, to avoid spreading a wide-spread panic, it's a liquidity crisis...investing in things the market is undervaluing rn so eventually if u wait, things will pay out o Turns out that this assessment was correct...these investments mostly paid out, but since they were subprime, deemed as very risky -Bear Stearns provided important brokering and clearing services to the financial industry; these functions might be impaired by disorderly closure of the firm -The assets acquired from Bear Stearns by the Fed were temporarily undervalued by irrational investor flight toward safe assets...so they were still good assets

why dont derivatives create any more risk

o cuz it's just ppl taking diff sides of a bet...but since ppl are taking certain sides it might make ripple effects

what does too big to fail mean?

o if it failed, it would cause another financial crisis so the gvmnt will prob do something about it

On sour note: despite the lessons from the crisis, there still is not a proper...

o info-insensitive payment system ( no system where u don't have to worry about the payment ability of the issuer)

whaqt are a couple factors that could make this recovery longer than last recession?

o reassessment of international trade and the supply train: shift to more domestic production probably, more restrictions of international trade for a lil while o Trade between productivity and insurance (may do things more inefficiently...like costs more to produce to make sure we have the materials we need) --Also expectation there will be a second wave of the disease in 2021 could hurt ppl's expectations and speculations

what does the fed funds rate show?

o short-term (rate at which banks trade at) o Any deviations from this might indicate risk o Fed response to drop interest rate until 04...some ppl said this was too low for too long § Some think it could explain some increase in house prices o During subprime panic: dripped interest rte to make borrowing credit cheaper for a little while o It stayed at zero until 2015 when we had a "lift off" o Increase in interest rate until 2019...some worries about possible recession § Cuz this rate was "too high" § So then the fed decided to lower it

what is · flight-to-safety

o shows the composition of safe assets in the financial sector o bank in 1955,main thing deemed as safe was currency o but over time, more things perceived as safe o but once the crisis hit, there was a reversal in this and now ppl think bank deposits and currency are safer lol

o Question is not how much debt u have but whether investors...

perceive whether u are willing to pay it back -some may not pay it back cuz they dont wanna tax their citizens

what was the American Recovery and Reinvestment Act of 2009...bascially how did fiscal policy respond to the recessiona nd what was the result of this?

tax cuts, tax credits, tax relief I unemployment insurance extension I subsidies (first-time home buyers and "cash for clunkers") I direct transfers I infrastructure spending (· Turns out infrastructure spending was a big bust: the infrastructure spending was almost nothing (even tho they said they were gonna have all this construction going on to stimulate economy)) -The resulting deficits implied a large increase in government debt.

o Permanent increase in gvmnt, finance that with ____ o Temporary increase in gvmt expenditure, cover that with ____

taxes, debt

Debt burdens of large European economies, such as Italy and Spain were the real threat. why?

their economies were way larger -Italy had over $2 trillion of debt outstanding, of which 50% was held externally. Italy needed to roll over more than €300 billion of debt in 2012, about the same as the entire Greek debt. Similarly, Spain's debt had reached about €700 billion, €175 billion maturing in less than a year. -o Issue: what type of gvmnt debt do u buy...german/Greek?

Mishkin's view on how to evaluate these events:

§ Brought a more insider pt of view § Bad news about the MBS since 07 § Look we all saw things were deteriorating but the market and the fed were surprised by the extent of the losses we suffered -AIG collapse and Reserve Primary Fund run revealed the financial system was engaged in a huge "carry trade". § Carry trade: you borrow and you lend short term and exploit some entities (diff in rates of return) short term so not perceived as a risky operation but it can fuk you up like it did with AIG (short term but unable to meet your obligations) **So 08 showed the fragility of the financial system -The events on September 2008 raised serious doubts that the government had the capability to manage the crisis. -Afterwards, banks began to hoard cash and were unwilling to lend to each other, despite massive injections of liquidity

so how has all of this stuff that was put in place after the 08 crisis dealt with the current crisis?

§ But this did not prevent this new crisis from stressing fianncial markets again: commercial paper and corporate debt markets suffered quickly with shutdown of market and these are markets that are supposed to provide safe funding...so all this regulation made banks safer (stress test, force them to be more risk averse)...but it is still a fragile sector subject to big stress in bad times, bank run like behavior (money market mutual fund redemptions)

what about unconventional monetary policy responses?

§ Teram auction facility: like the discount window but instead of waiting for banks to come, they hold an auction of reserves § All the credit facilities: each accessible by diff types of institutions and diff requirements on the assets you could come up for exchange of liquidity § In all of these cases, fed requiring high quality assets to be used as collateral (AAA)...like treasuries, AAA MBS... § Foreign currency swaps: banks might need dollars cuz their bank might have liabilities in US dollars, so u swap each other's currency § Banks can access these faciltieis, but they can still act on other ppl as well § Afterwards when they wanted to have a more stimulitive policy to get out of a recession is through large scale asset purchases...something u can do when interest rates are 0 § Maturity extension program: changed maturity sturucre of treasuries u=out there to lower long term interest rates -Expectations management: "forward guidance"; explicit inflation target

Reinhart's view on how to evaluate these events:

§ Very critical of bear stearns...bad for midsized back to be rescued and this changed everyone's calculus -Critical about the lack of consistency in some of these decisions **Focus on Lehman as the trigger for the crisis misses the moral hazard problems created by Bear Stearns' intervention.

what did the balance sheet of AIG show and CDS shortfall?

· Balance sheet of AIG o In 08 earnigns negative cuz to realized capital gains...deteriorating financial position of AIG leading up to 08 · Other graph o Describes the shortfall in CDS collateral o You see how much money AIG had to come up with the meet those requests o So basically this institution deteriorated very rapidly from many sources o so the fed just stepped in and found a way to assist...some clauses you can use for unusual circumstances

how has fed's balance sheet changed cuz of covid and where did it start?

· Started w 4 trillion dolars of assets at the fed(1/2 in form of treasuries and ½ GSE)...basically more liquid stuff · Fed comfortable to operate its floor system · *Increase in treasuries bought cuz now fed is buying assets in exchange for reserves*

why did liquidity dry up and how did the fed respond?

· trust between institutions diminished. Big amount of uncertainty which led to counterparty risk, idea was to step in and *provide more liquid and safe assets in the form of bank reserves* (what the fed did)