Stressed, Not Frozen: The Federal Funds Market in the Financial Crisis

We examine the importance of liquidity hoarding and counterparty risk in the U.S. overnight interbank market during the financial crisis of 2008. Our findings suggest that counterparty risk plays a larger role than does liquidity hoarding: the day after Lehman Brothers' bankruptcy, loan terms b...

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Bibliographic Details
Published in:The Journal of finance (New York) 2011-08, Vol.66 (4), p.1109-1139
Main Authors: AFONSO, GARA, KOVNER, ANNA, SCHOAR, ANTOINETTE
Format: Article
Language:English
Subjects:
Bank assets
Bank liquidity
Bank loans
Bank markets
Bank reserves
Banking crises
Banking system
Bankruptcy
Borrowing
Capital market
Commercial banks
Credit market
Economic crisis
Federal funds
Federal funds rate
Federal Reserve Bank
Financial crisis
Interest rates
Lenders
Liquidity
Loans
Money market
Studies
U.S.A
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Summary:We examine the importance of liquidity hoarding and counterparty risk in the U.S. overnight interbank market during the financial crisis of 2008. Our findings suggest that counterparty risk plays a larger role than does liquidity hoarding: the day after Lehman Brothers' bankruptcy, loan terms become more sensitive to borrower characteristics. In particular, poorly performing large banks see an increase in spreads of 25 basis points, but are borrowing 1% less, on average. Worse performing banks do not hoard liquidity. While the interbank market does not freeze entirely, it does not seem to expand to meet latent demand.
ISSN:0022-1082
1540-6261
DOI:10.1111/j.1540-6261.2011.01670.x