NY Fed on Dealer Borrowing in '07-'08
The Federal Reserve Bank of New York's Liberty Street Economics blog writes, "Which Dealers Borrowed from the Fed's Lender-of-Last-Resort Facilities?" They tell us, "During the 2007-08 financial crisis, the Fed established lending facilities designed to improve market functioning by providing liquidity to nondepository financial institutions -- the first lending targeted to this group since the 1930s. What was the financial condition of the dealers that borrowed from these facilities? Were they healthy institutions behaving opportunistically or were they genuinely distressed? In published research, we find that dealers in a weaker financial condition were more likely to participate than healthier ones and tended to borrow more.... In response to the difficulties dealers faced in borrowing in short-term funding markets, the Fed created two lender-of-last-resort (LOLR) facilities—the Term Securities Lending Facility (TSLF) and the Primary Dealer Credit Facility (PDCF)." The piece also says, "Borrowing from the TSLF grew quickly, from an initial Schedule 2 auction size of $75 billion in March 2008 to a peak of $200 billion (Schedules 1 and 2 combined) after the crisis intensified with the Lehman bankruptcy in September 2008.... Demand for TSLF borrowing declined as private funding markets improved, and then dropped to zero after the July 16, 2009, auction. The last TSLF auction was held January 7, 2010, and authorization for lending officially expired on February 1, 2010." It adds, "Central banks limit borrowing by establishing standards for collateral quality, by charging a penalty rate, and by monitoring borrowers' financial health. However, in a crisis, when financial conditions change rapidly, regulators face the difficult challenge of knowing which signals to rely on. Our results show that market signals of financial health (such as equity prices) predicted how much dealers borrowed from the Fed's liquidity facilities during the crisis and that financially weaker firms, rather than opportunistic ones, were the heaviest users."
