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Central Bank Liquidity Tools and Perspectives on Regulatory Reform ECONOMIC POLICY REVIEW

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Central Bank Liquidity Tools and Perspectives on Regulatory Reform ECONOMIC POLICY REVIEW Federal Reserve Bank of New York August 2010 August Economic Volume 16 Number 1 16 Number Volume Policy Review Special Issue: Central Bank Liquidity Tools and Perspectives on Regulatory Reform ECONOMIC POLICY REVIEW EDITOR Kenneth D. Garbade COEDITORS Meta Brown Marco Del Negro Jan Groen Stavros Peristiani Asani Sarkar EDITORIAL STAF F Valerie LaPorte Mike De Mott Michelle Bailer Karen Carter PRODUCTION STAFF Carol Perlmutter David Rosenberg Jane Urry The Economic Policy Review is published by the Research and Statistics Group of the Federal Reserve Bank of New York. Articles undergo a comprehensive refereeing process prior to their acceptance in the Review. The views expressed are those of the individual authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. www.newyorkfed.org/research EDITOR’S NOTE The papers in this special volume of the Economic Policy Review all focus on the theme of a 2009 conference on central bank liquidity tools organized by the Federal Reserve Bank of New York: the evaluation of central bank programs implemented to address funding shortages in the markets. Indeed, readers interested in detailed summaries of the conference papers and their discussions will find the overview by Matthew Denes and his coauthors very informative. Two of the papers presented at the conference are included in this volume: the studies by Stephen G. Cecchetti and Piti Disyatat and by Erhan Artuç and Selva Demiralp. Both papers examine the past actions of central banks in the financial crisis. Cecchetti and Disyatat consider the implications that recent financial developments may have for the fundamental nature of central banks’ lender-of-last-resort function and whether the traditional tools at policymakers’ disposal remain effective in the face of modern liquidity crises. Artuç and Demiralp investigate whether changes to the Federal Reserve’s discount window borrowing facility represent a fundamental shift in the way the Fed traditionally provided liquidity through the primary credit facility as well as whether the Fed would be well served to retain these changes to its borrowing facility indefinitely. A third paper, submitted separately for this volume, also addresses the role of central banks during the financial turmoil. Asani Sarkar and Jeffrey Shrader examine the Federal Reserve’s recent actions in terms of the financial amplification literature. Three other papers, solicited for this volume, broaden the discussion by providing perspectives on the future course of financial policy in the post-crisis era. Matthew Pritsker offers a theoretical view on the important topic of how regulators can improve the availability of information; Viral V. Acharya, João A. C. Santos, and Tanju Yorulmazer analyze ways to incorporate systemic risk into deposit insurance premiums; and John Geanakoplos discusses implications of the leverage cycle—whereby leverage is excessive prior to the crisis and too low during the crisis—for regulatory policy and reform. We hope you enjoy the rich perspectives offered in this special volume of the Review. —The Economic Policy Review Editorial Board Federal Reserve Bank of New York Economic Policy Review August 2010 Volume 16 Number 1 Special Issue: Central Bank Liquidity Tools and Perspectives on Regulatory Reform Contents Conference Proceedings 3 Central Bank Liquidity Tools Conference Agenda 7Conference Opening Remarks Patricia C. Mosser 9 Conference Overview and Summary of Proceedings Matthew Denes, Daniel Greenwald, Nicholas Klagge, Ging Cee Ng, Jeffrey Shrader, Michael Sockin, and John Sporn Central Bank Liquidity Tools Papers: 29 Central Bank Tools and Liquidity Shortages Stephen G. Cecchetti and Piti Disyatat 43 Provision of Liquidity through the Primary Credit Facility during the Financial Crisis: A Structural Analysis Erhan Artuç and Selva Demiralp 55 Financial Amplification Mechanisms and the Federal Reserve’s Supply of Liquidity during the Financial Crisis Asani Sarkar and Jeffrey Shrader Perspectives on Regulatory Reform Papers: 77 Informational Easing: Improving Credit Conditions through the Release of Information Matthew Pritsker 89 Systemic Risk and Deposit Insurance Premiums Viral V. Acharya, João A. C. Santos, and Tanju Yorulmazer 101 Solving the Present Crisis and Managing the Leverage Cycle John Geanakoplos Conference Proceedings Central Bank Liquidity Tools Conference Agenda Conference Opening Remarks Patricia C. Mosser Conference Overview and Summary of Proceedings Matthew Denes, Daniel Greenwald, Nicholas Klagge, Ging Cee Ng, Jeffrey Shrader, Michael Sockin, and John Sporn Central Bank Liquidity Tools A Conference Sponsored by the Federal Reserve Bank of New York February 19-20, 2009 Agenda Thursday, February 19 8:45 a.m. Opening Remarks Patricia C. Mosser, Federal Reserve Bank of New York 9:00 a.m. Session 1: Overview of Recent Problems in Liquidity Provision Chair: Tobias Adrian, Federal Reserve Bank of New York Central Bank Tools and Liquidity Shortages Stephen G. Cecchetti, Bank for International Settlements Piti Disyatat, Bank for International Settlements Discussant: Bengt Holmstrom, Massachusetts Institute of Technology 10:30 a.m. Session 2: Funding Liquidity and Market Liquidity Chair: Til Schuermann, Federal Reserve Bank of New York Leverage, Moral Hazard, and Liquidity Viral V. Acharya, New York University and London Business School S. “Vish” Viswanathan, Duke University Discussant: Patrick Bolton, Columbia University Interbank Market Liquidity and Central Bank Intervention Franklin Allen, University of Pennsylvania Elena Carletti, European University Institute Douglas Gale, New York University Discussant: Adriano A. Rampini, Duke University Bank Liquidity, Interbank Markets, and Monetary Policy Xavier Freixas, Universitat Pompeu Fabra Antoine Martin, Federal Reserve Bank of New York David Skeie, Federal Reserve Bank of New York Discussant: Franklin Allen, University of Pennsylvania 2:00 p.m. Session 3: Policy Responses to Illiquidity Chair: James J. McAndrews, Federal Reserve Bank of New York Illiquidity and Interest Rate Policy Douglas W. Diamond, University of Chicago and National Bureau of Economic Research Raghuram G. Rajan, University of Chicago and National Bureau of Economic Research Discussant: Guido Lorenzoni, Massachusetts Institute of Technology Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk Florian Heider, European Central Bank Marie Hoerova, European Central Bank Cornelia Holthausen, European Central Bank Discussant: Gaetano Antinolfi, Washington University FRBNY Economic Policy Review / August 2010 3 Agenda Thursday, February 19 (Continued) 3:40 p.m. Session 4: Collateral and Haircuts Chair: Simon M. Potter, Federal Reserve Bank of New York Rollover Risk and Market Freezes Viral V. Acharya, New York University and London Business School Douglas Gale, New York University Tanju Yorulmazer, Federal Reserve Bank of New York Discussant: Michael Manove, Boston University Central Bank Haircut Policy James Chapman, Bank of Canada Jonathan Chiu, Bank of Canada Miguel Molico, Bank of Canada Discussant: Mitchell Berlin, Federal Reserve Bank of Philadelphia 6:00 p.m. Keynote Address John Geanakoplos, Yale University Agenda Friday, February 20 9:00 a.m. Session 5: Empirical Evaluation of Central Bank Liquidity Programs—Part I Chair: Seth B. Carpenter, Board of Governors of the Federal Reserve System Do Central Bank Liquidity Facilities Affect Interbank Lending Rates? Jens H. E. Christensen, Federal Reserve Bank of San Francisco Jose A. Lopez, Federal Reserve Bank of San Francisco Glenn D. Rudebusch, Federal Reserve Bank of San Francisco Discussant: Pierre Collin-Dufresne, Columbia University Repo Market Effects of the Term Securities Lending Facility Michael Fleming, Federal Reserve Bank of New York Warren Hrung, Federal Reserve Bank of New York Frank Keane, Federal Reserve Bank of New York Discussant: Lasse H. Pedersen, New York University 4 Conference Agenda Agenda Friday, February 20 (Continued) 10:40 a.m. Session 6: Empirical Evaluation of Central Bank Liquidity Programs—Part II Chair: James Vickery, Federal Reserve Bank of New York Funding Liquidity Risk: Definition and Measurement Mathias Drehmann, Bank for International Settlements Kleopatra Nikolaou, European Central Bank Discussant: Marie Hoerova, European Central Bank Provision of Liquidity through the Primary Credit Facility during the Financial Crisis: A Structural Analysis Erhan Artuç, Koc University Selva Demiralp, Koc University Discussant: Carolyn Wilkins, Bank of Canada 1:15 p.m. Panel Discussion Chair: Patricia C. Mosser, Federal Reserve Bank of New York Panel: Louis Crandall, Wrightson ICAP Andrew W. Lo, Massachusetts Institute of Technology Paul Mercier, European Central Bank Lasse H. Pedersen, New York University W. Alexander Roever, J.P. Morgan Chase FRBNY Economic Policy Review / August 2010 5 Patricia C. Mosser Conference Opening Remarks elcome to the Federal Reserve Bank of New York, and We tend to group the Fed’s liquidity tools into three broad Wthank you for coming to this conference on central bank categories. In the first group, we have facilities that provide liquidity tools. term liquidity to financial institutions—particularly to large, As acting manager of the Federal Reserve’s System Open systemically important ones. These exist to reduce the systemic Market Account (SOMA), I am responsible for reporting to risk associated with the inability of a financial institution to get policymakers
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