Financial Intermediation and Monetary Policy

Tobias Adrian and Hyun Song ShinFederal Reserve Bank of New York and Princeton University

Central Bank of Argentina

Money and Banking ConferenceAugust 31‐ September 1, 2009, Buenos Aires

The views expressed in this presentation are those of the authors and do not necessarily represent those of the Federal Reserve Bank of New York or the Federal Reserve System.

References• Adrian and Shin (2007) “Liquidity and Leverage,” Journal of Financial Intermediation, forthcoming

• Adrian and Shin (2008) “ Financial Intermediaries, Financial Stability, and Monetary Policy,” Jackson Hole Economic Symposium Proceedings, Federal Reserve Bank of Kansas City.

• Adrian and Shin (2009) “Money, Liquidity, and Monetary Policy,” American Economic Review: Papers & Proceedings 2009, 99:2.

• Adrian and Shin (2009) “Prices and Quantities in the Monetary Policy Transmission Mechanism,” International Journal of Central Banking, forthcoming.

• Adrian and Shin (2009) “The Changing Nature of Financial Intermediation and the Financial Crisis of 2007 – 2009,” Annual Reviews, forthcoming.

• Adrian and Shin (2009) “Financial Intermediaries and Monetary Economics,” Handbook of Monetary Economics, forthcoming. 2

Stylized Financial System

ultimate claim holders

ultimateborrowers

Non-financial

firms

govt

Households Households

Pension funds

Insurance companies

Rest of worlddirect credit

Treasury & municipal bonds,corporate bonds, equities

3

Stylized Financial System

ultimate claim holders

ultimateborrowers

Non-financial

firms

govt

Households Households

Pension funds

Insurance companies

Rest of worlddirect credit

Treasury & municipal bonds,corporate bonds, equities

Banking (intermediary)

sectorintermediated

credit

equity

debt claims

depositsfinancial paperMBS, ABS…

mortgagescorporate credit…

4

Market Based and Bank Based Holding of Home Mortgages

5

0

1

2

3

4

5

6

719

80Q

1

1982

Q1

1984

Q1

1986

Q1

1988

Q1

1990

Q1

1992

Q1

1994

Q1

1996

Q1

1998

Q1

2000

Q1

2002

Q1

2004

Q1

2006

Q1

2008

Q1

$ T

rilli

on

0

1

2

3

4

5

6

7

Market-based

Bank-based

Growth of  Assets of Four Sectors (March 1954 = 1) (Log scale)

6

1980Q1

1

10

100

1000

1954Q1

1957Q1

1960Q1

1963Q1

1966Q1

1969Q1

1972Q1

1975Q1

1978Q1

1981Q1

1984Q1

1987Q1

1990Q1

1993Q1

1996Q1

1999Q1

2002Q1

2005Q1

2008Q1

Non-financialcorporate

Households

Security BrokerDealers

CommercialBanks

7

Broker‐Dealer Asset Growth and Primary Dealer Repo Growth

-44

-22

0

22

44

-44

-22

0

22

44

1990 1995 2000 2005

Primary Dealer Repo Growth

Annual % Annual %

Source: Board of Governors of the Federal Reserve and Federal Reserve Bank of New York

Security Broker-Dealer Asset Growth

8

Shadow Bank and Commercial Bank Asset Growth

0

5

10

15

20

0

10

20

30

40

1985 1990 1995 2000 2005

Commercial Banks(right axis)

Annual % Annual %

Note: Shadow banks are ABS issuers, finance companies, and funding corporations.Source: Board of Governors of the Federal Reserve

Shadow Banks(left axis)

9

Shadow Bank Asset Growth and Commercial Paper Growth

-40

-20

0

20

40

-20

-10

0

10

20

30

1990 1995 2000 2005

Commercial Paper Outstanding Growth(right axis)

Annual % Annual %

Source: Board of Governors of the Federal Reserve

Shadow Bank Asset Growth(left axis)

Short Term Funding: CP, Repo, M1

500

1000

1500

2000

2500

3000

500

1000

1500

2000

2500

3000

1995 2000 2005

Reverse Repo

Billions of Dollars Billions of Dollars

Source: Federal Reserve Board

Commercial Paper

M1

10

Repos plus CP, and M2

1000

3000

5000

7000

9000

1000

3000

5000

7000

9000

1985 1990 1995 2000 2005

Money Stock M2

Billions of Dollars Billions of Dollars

Source: Board of Governors of the Federal Reserve and Federal Reserve Bank of New York

Primary Dealer Repo plus Commercial Paper Outstanding

11

Credit Demand

• Demand for credit– Investment by households (esp. housing) and non‐financial corporates

– Durable goods consumption (consumer loans)– Demand for financing by central and local governments

• Demand for credit depends on: – Interest rates and spreads– Household and Firm Net worth– Fiscal policy

12

Yield Curve (Credit Demand)

13

Credit Supply

• Delegation to financial intermediaries 

• Credit supply determined by forces shaping financial intermediary balance sheets

• Monetary policy works through intermediation– Profitability of intermediation through yield curve– Lender of last resort operations determine availability of funding for intermediaries

14

Repo Haircuts

Haircuts SpreadsMay‐07 May‐08 May‐09 May‐07 May‐08 May‐09

Corporate Debt A 5 10 20 86 235 364

Corporate Debt Baa 5 20 30 115 278 508

ABS Aaa 10 25 35 73 327 350

Corporate Debt Ba 25 30 40 177 433 833

Corporate Debt B 25 40 50 239 618 996

Corporate Debt Caa 25 100 100 396 932 1573

Note: Credit spreads are option adjusted. Haircuts are for triparty repos.Source: DTCC, Bloomberg. 15

Haircut Curve (Credit Supply)

Source: DTCC, Bloomberg 16

Procyclical Leverage ofFive US Investment Banks

1998-4

2007-3

2007-4

2008-1

-20

-10

010

20To

tal A

sset

Gro

wth

(% Q

uarte

rly)

-20 -10 0 10 20Leverage Growth (% Quarterly)

17Adrian and Shin (2007)

Primary Dealer Leverage

15

20

25

30

35

40

15

20

25

30

35

40

1986 1991 1996 2001 2006

Source: SEC

All Primary DealersRatio Ratio

1987Q2 1998Q3

2008Q1

18

Domestic US and Foreign Primary Dealer Leverage

10

14

18

22

26

10

14

18

22

26

1986 1991 1996 2001 2006

Source: SEC

Domestic Primary DealersRatio Ratio

1987Q21998Q3

2007Q4

15

25

35

45

55

65

15

25

35

45

55

65

1986 1991 1996 2001 2006

Source: SEC

Foreign BanksRatio Ratio

1998Q3

2008Q1

19Adrian and Shin (2009, AER)

Biggest Damage is Done in Contractions

ultimate claim holders

ultimateborrowers

Non-financial

firms

govt

Households Households

Pension funds

Insurance companies

Rest of world

Banking (intermediary)

sector

20

But Seeds of Crises Are Sown in Expansions

Banking (intermediary)

sector

ultimate claim holders

ultimateborrowers

Non-financial

firms

govt

Households Households

Pension funds

Insurance companies

Rest of world

21

Asset Backed Securities IssuanceThree Months Sum

0

50

100

150

200

250

300

350

Mar-00

Sep-00

Mar-01

Sep-01

Mar-02

Sep-02

Mar-03

Sep-03

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

$ B

illio

ns

Other

Non-U.S. ResidentialMortgages

Student Loans

Credit Cards

Autos

Commercial RealEstate

Home Equity(Subprime)

Source: JP Morgan 22

Impulse Response of Broker‐Dealer Asset Growth on Housing Investment Growth

-1

0

1

2

Hou

sing

Inve

stm

ent G

row

th

0 5 10 15

Impulse Response to Broker Dealer Asset Growth Shock

Quarters

Adrian and Shin (2008, Jackson Hole) 23

Central Bank Policy Rules

• Fed Funds TargetF(GDP, Inflation, Risk Appetite)

– Taylor rule, augmented with the risk appetite factor 

• Quantitative policy

Q(GDP, Inflation, Risk Appetite)– Superficial resemblance to monetary aggregate targeting

• Credit Easing (TALF, CPFF, etc.)– Form of by‐pass surgery…

24

By‐pass Surgery

ultimate claim holders

ultimateborrowers

Non-financial

firms

Households

Households

Pension funds

Insurance companies

Banking (intermediary)

sectorvintermediated

credit

equity

debt claims

depositsfinancial paperMBS, ABS…

Blocked artery

Central bank

Excess Reserves

CPFF etc

25

Central Bank Liquidity Backstops

26

• Commercial banks generally have discount window (DW) access and S&Ls have Federal Home Loan Bank funding access.

• However, institutions such as broker‐dealers, shadow banks, money market funds ‐‐‐who often perform bank like maturity and liquidity transformation‐‐‐do not generally have DW access.

• In the past two years, new temporary Federal Reserve 13(3) lending facilities have been introduced by the Federal Reserve to extend liquidity backstops to a broader set of institutions or markets, via :

– PDCF: DW for dealers and indirectly the repo market

– CPFF: backstop to the CP market

– FX swaps: backstop to foreign central banks

– TALF: liquidity provision to securitization markets

Discount Window (DW) and PDCF

27

0

50

100

150

0

50

100

150

Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09

Discount Window and PDCF BorrowingBillions of Dollars

Source: Federal Reserve Board

DW

Billions of Dollars

Jul 15: 34.46

Jul 15: 0.0

PDCF

Commercial Paper Funding Facility (CPFF)

28

0

200

400

600

1000

1300

1600

1900

Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09

CPFF and Commercial Paper OutstandingBillions of Dollars

Source: Federal Reserve Board, Haver

Total(left axis)

Billions of Dollars

Jul 17: 1096.7

Jul 17: 107.1

Federal ReserveNet Holdings(right axis) FDIC

TLGP(right axis)

Jun 30: 339.0

Central Bank Liquidity Swaps

29

0

200

400

600

0

200

400

600

Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09

Central Bank Liquidity SwapsBillions of Dollars

Source: Federal Reserve Board, Bloomberg

Billions of Dollars

Jul 15: 111.8

Term Securities Lending Facility (TSLF)

30

0

50

100

150

200

0

50

100

150

200

Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09

TSLF Total OutstandingBillions of Dollars

Source: Federal Reserve Bank of New York

Schedule 2

Billions of Dollars

Jul 16: 7.0

Jun 25: 0.0

Schedule 1

ABS Issuance and TALF

31

0

10

20

30

40

50

60

70

Q107 Q207 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309

$Bln2nd axis

Equipment TALF

Student Loan TALF

Credit Card TALF

Auto TALF

SBA non-TALF

Equipment non-TALFStudent Loan non-TALFCredit Card non-TALFAuto non-TALF

Source: JPMorgan

Central Bank Policy Tools

• Prices– Fed Funds Target.

• Balance Sheet Quantities– Credit easing using CB balance sheet (outright purchases of Treasury, MBS, CPs etc).

– Haircut/margin policy to influence balance sheet growth of financial intermediaries.

• Channels of Policy– Demand and supply of credit.– Expectations about the future path of prices and quantities.

32