Collateral Damage

Abstract

A financial crisis is an event in which the holders of short-term debt come to question the collateral backing that debt. So, the resiliency of the financial system depends on the quality of that collateral. We show that there is a shortage of high-quality collateral by examining the convenience yield on short-term debt, which summarizes the supply and demand for short-term safe debt, taking into account the availability of high-quality collateral. We then show how the private sector has responded by issuing more (unsecured) commercial paper at shorter maturities. The results suggest that there is a shortage of safe debt now compared to the pre-crisis period, implying that the seeds for a new shadow banking system to grow exist.

Mobile Collateral versus Immobile Collateral

“…We show that repo fails were increasing because of the scarcity and resulting mobility of U.S. Treasury and Agency bonds. Consistent with recent work by Gorton and Laarits (2018), we find that the convenience yield remains positive. We further find that the convenience yield has been elevated since the introduction of the LCR, and that repo fails responded strongly to the recent spike in the convenience yield during the covid pandemic.…”

“…He finds that issuance of ABCP also responds to a shortage of T‐bills as evidenced by the convenience yield. This evidence is replicated and extended in Gorton and Laarits (2018).…”

Safe-Asset Shortages: Evidence from the European Government Bond Lending Market

“…A second option to deal with a safe-asset shortage is for financial institutions to issue assets with safety attributes similar to those of government bonds (see, e.g., Sunderam (2015), Gennaioli et al (2012), Gorton and Laartis (2018), and Kacperczyk et al (2021)). In principle, privately produced safe assets will have many of the features of publicly produced safe assets.…”

The Regulation of Private Money*

“…Currently, there is a shortage of safe debt (see Gorton and Laarits 2018). So the liquidity coverage ratio of Basel which reintroduces the backing collateral requirement will likely have the same problems as occurred during the National Banking Era, namely, a shadow banking system will develop (see Gorton, Laarits, and Muir 2020).…”