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Collateralized debt obligations

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Asset-backed financing --- Investments --- Credit derivatives --- Collateralized debt obligations

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In global financial centers, short-term market rates are effectively determined in the pledged collateral market, where banks and other financial institutions exchange collateral (such as bonds and equities) for money. Furthermore, the use of long-dated securities as collateral for short tenors—or example, in securities-lending and repo markets, and prime brokerage funding—impacts the risk premia (or moneyness) along the yield curve. In this paper, we deploy a methodology to show that transactions using long dated collateral also affect short-term market rates. Our results suggest that the unwind of central bank balance sheets will likely strengthen the monetary policy transmission, as dealer balance-sheet space is now relatively less constrained, with a rebound in collateral reuse.

Collateralized debt obligations. --- CDOs (Collateralized debt obligations) --- Credit derivatives --- Accounting --- Banks and Banking --- Investments: General --- Industries: Financial Services --- Investments: Bonds --- Banks --- Depository Institutions --- Micro Finance Institutions --- Mortgages --- Financial Institutions and Services: Government Policy and Regulation --- International Monetary Arrangements and Institutions --- Corporation and Securities Law --- General Financial Markets: Government Policy and Regulation --- International Financial Markets --- Central Banks and Their Policies --- Public Administration --- Public Sector Accounting and Audits --- General Financial Markets: General (includes Measurement and Data) --- Finance --- Banking --- Financial reporting, financial statements --- Investment & securities --- Collateral --- Central bank balance sheet --- Financial statements --- Securities --- Financial institutions --- Central banks --- Public financial management (PFM) --- Bonds --- Loans --- Finance, Public --- Banks and banking --- Financial instruments --- United States

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Large banks and dealers use and reuse collateral pledged by nonbanks, which helps lubricate the global financial system. The supply of collateral arises from specific investment strategies in the asset management complex, with the primary providers being hedge funds, pension funds, insurers, official sector accounts, money markets and others. Post-Lehman, there has been a significant decline in the source collateral for the large dealers that specialize in intermediating pledgeable collateral. Since collateral can be reused, the overall effect (i.e., reduced ?source' of collateral times the velocity of collateral) may have been a $4-5 trillion reduction in collateral. This decline in financial lubrication likely has impact on the conduct of global monetary policy. And recent regulations aimed at financial stability, focusing on building equity and reducing leverage at large banks/dealers, may also reduce financial lubrication in the nonbank/bank nexus.

Collateralized debt obligations --- Bank loans --- CDOs (Collateralized debt obligations) --- Credit derivatives --- Bank credit --- Loans --- Econometric models. --- Accounting --- Banks and Banking --- Investments: General --- Industries: Financial Services --- Public Finance --- Banks --- Depository Institutions --- Micro Finance Institutions --- Mortgages --- Financial Institutions and Services: Government Policy and Regulation --- International Monetary Arrangements and Institutions --- General Financial Markets: Government Policy and Regulation --- International Financial Markets --- General Financial Markets: General (includes Measurement and Data) --- Pension Funds --- Non-bank Financial Institutions --- Financial Instruments --- Institutional Investors --- Public Administration --- Public Sector Accounting and Audits --- Social Security and Public Pensions --- Finance --- Investment & securities --- Financial reporting, financial statements --- Banking --- Pensions --- Collateral --- Securities --- Hedge funds --- Financial statements --- Financial institutions --- Public financial management (PFM) --- Pension spending --- Expenditure --- Financial instruments --- Financial services industry --- Finance, Public --- Banks and banking --- United States

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We study a dynamic economy where credit is limited by insufficient collateral and, as a result, investment and output are too low. In this environment, changes in investor sentiment or market expectations can give rise to credit bubbles, that is, expansions in credit that are backed not by expectations of future profits (i.e. fundamental collateral), but instead by expectations of future credit (i.e. bubbly collateral). During a credit bubble, there is more credit available for entrepreneurs: this is the crowding-in effect. But entrepreneurs must also use some of this credit to cancel past credit: this is the crowding-out effect. There is an "optimal" bubble size that trades off these two effects and maximizes long-run output and consumption. The “equilibrium” bubble size depends on investor sentiment, however, and it typically does not coincide with the “optimal” bubble size. This provides a new rationale for macroprudential policy. A lender of last resort can replicate the “optimal” bubble by taxing credit when the "equilibrium" bubble is too high, and subsidizing credit when the “equilibrium” bubble is too low. This leaning-against-the-wind policy maximizes output and consumption. Moreover, the same conditions that make this policy desirable guarantee that a lender of last resort has the resources to implement it.

Credit --- Collateralized debt obligations --- Business cycles --- CDOs (Collateralized debt obligations) --- Credit derivatives --- Borrowing --- Finance --- Money --- Loans --- Econometric models. --- Financial Risk Management --- Money and Monetary Policy --- Industries: Financial Services --- Production and Operations Management --- Current Account Adjustment --- Short-term Capital Movements --- International Lending and Debt Problems --- Financial Aspects of Economic Integration --- Open Economy Macroeconomics --- Economic Growth of Open Economies --- International Business Cycles --- Globalization: Finance --- International Financial Markets --- Banks --- Depository Institutions --- Micro Finance Institutions --- Mortgages --- Monetary Policy, Central Banking, and the Supply of Money and Credit: General --- Financial Institutions and Services: Government Policy and Regulation --- Macroeconomics: Production --- Monetary economics --- Economic & financial crises & disasters --- Macroeconomics --- Collateral --- Lender of last resort --- Productivity --- Financial institutions --- Financial crises --- Production --- Industrial productivity --- Banks and banking, Central --- Slovak Republic