The Federal Reserve Bank of New York's Liberty Street Economics blog writes, "How Large Are Default Spillovers in the U.S. Financial System?" They comment, "When a financial firm suffers sufficiently high losses, it might default on its counterparties, who may in turn become unable to pay their own creditors, and so on. This 'domino' or 'cascade' effect can quickly propagate through the financial system, creating undesirable spillovers and unnecessary defaults. In this post, we use the framework that we discussed in 'Assessing Contagion Risk in a Financial Network,' the first part of this two-part series, to answer the question: How vulnerable is the U.S. financial system to default spillovers? The main challenge in estimating the expected value of default spillovers is that it requires knowledge of all the bilateral claims between each pair of nodes. Such granularity of data is not publicly available. Moreover, for some financial firms in less regulated parts of the financial system, such data may not even exist, except in fragmented form inside the firms themselves." The blog adds, "Both worst-case and best-case networks show large bank holding companies, broker-dealers, and AIG being highly interconnected. However, the worst-case network has more connections, with AIG, JPMorgan Chase, and especially Lehman Brothers, having a large exposure to Citibank. The two networks thus illuminate how the failure of a single firm such as Lehman Brothers could have vastly different default spillover effects depending on the particular firms with which it is connected."

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