Stressed, Not Frozen: The Federal Funds Market In The Financial Crisis
Source: Federal Reserve Bank of New York
The authors examine the importance of liquidity hoarding and counterparty risk in the U.S. overnight interbank market during the financial crisis of 2008. The findings suggest that concerns about counterparty risk play a much larger role than liquidity hoarding: In the two days after Lehman Brothers' bankruptcy, loan amounts and spreads became much more sensitive to borrower characteristics. In particular, poorly performing large banks saw an increase in spreads of 24 basis points, while borrowing 1 percent less, on average. Once the government support of American International Group was announced, these spreads returned to precrisis levels, likely as a response to the government's implicit support.