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Economic Research

Liberty Street Economics
Credit Market Choice
Credit default swaps (CDS) are often cited as the cause of AIG’s collapse during the financial crisis, yet little is known about how individual financial institutions utilize CDS contracts on individual companies. Our bloggers assess the choice banks face when trading the idiosyncratic credit risk of a firm. They argue that banks’ participation decisions have been affected in the post-regulation period, either by direct changes in market structure or by changes in the relative cost of pursuing different strategies.
By Nina Boyarchenko, Anna M. Costello, and Or Shachar
The New York Fed DSGE Model Forecast—October 2018
Our bloggers present the latest update to the economic forecasts generated by the Federal Reserve Bank of New York’s dynamic stochastic general equilibrium (DSGE) model. The current GDP growth forecast of 3.1 percent is up from 2.3 percent in July. The model attributes this anticipation of stronger growth to higher productivity growth and accommodative monetary policy.
By Michael Cai, Marco Del Negro, Ethan Matlin, Reca Sarfati, and Argia Sbordone
Liquidity Effects of Post-Crisis Regulatory Reform
Post-crisis reforms to improve the capital and liquidity positions of regulated institutions provide incentives for banks to change both the structure of their own balance sheets and how they interact with customers and other market participants. This post provides an overview of three recent New York Fed staff reports that study the impact of post-crisis regulation on the willingness and ability of regulated firms to participate in U.S. over-the-counter markets.
By Nina Boyarchenko and Or Shachar
Did Banks Subject to LCR Reduce Liquidity Creation?
A lesson from the financial crisis is that banks need a liquidity cushion to cover unexpected cash outflows. To mitigate this risk, regulators implemented the liquidity coverage ratio (LCR), mandating that banks hold a buffer of liquid assets. Our bloggers find that a side effect of the regulation, however, is a reduction in liquidity creation by banks subject to LCR.
By Daniel Roberts, Asani Sarkar, and Or Shachar
Leverage Rule Arbitrage
Using difference-in-difference analysis, our bloggers find that after the supplementary leverage ratio (SLR) rule was imposed on the very largest U.S. banks, those banks shifted their portfolio toward riskier (risk-weighted) assets and higher-yielding securities compared with large banks not subject to the rule. Despite increased asset risk, overall bank risk did not increase, suggesting the higher capital required under the new rule offset the risk shifting.
By Dong Beom Choi, Michael Holcomb, and Donald P. Morgan
Recent Publications
Local Banks, Credit Supply, and House Prices
The author studies the effects of an increase in the supply of local mortgage credit on local house prices and employment by exploiting a natural experiment from Switzerland: Losses in U.S. security holdings triggered a migration of customers from a large, universal bank (UBS) to local mortgage lenders in mid-2008. He shows that house prices in neighborhoods immediately around exogenously shocked local banks grow over 50 percent more than house prices around unaffected banks. There was also an increase in the number of employees at small firms, reliant on real estate collateral, in these neighborhoods.
Kristian Blickle, Staff Report 874, November 2018
The Affordable Care Act and the Market for Higher Education
Obtaining health insurance in America is intimately connected to choosing whether and where to work. But the Affordable Care Act has changed this model and affected people’s incentives for further education. The authors employ a triple-difference strategy comparing counties with different levels of uninsurance pre-ACA, and in states with different Medicaid expansion decisions across time, to investigate changes in enrollment in different types of higher education institutions.
Rajashri Chakrabarti and Maxim Pinkovskiy, Staff Report 873, October 2018
Getting Ahead by Spending More? Local Community Response to State Merit Aid Programs
In more than half of U.S. states, implementation of merit-based aid programs has led to a large reduction in the net tuition expense of in-state college students. Using two different estimation strategies, the authors find that merit aid programs led to a statistically and economically significant increase in state funding for higher education while state funding for kindergarten through twelfth-grade education fell markedly. The authors argue that their findings have important implications because educators and policymakers should be aware of unintended consequences that might undercut the positive benefits of merit aid.
Rajashri Chakrabarti, Nicole Gorton, and Joydeep Roy, Staff Report 872, October 2018
Identifying Shocks via Time-Varying Volatility
This paper presents a general argument that structural shocks can be identified via time-varying volatility. The previous literature offers identification arguments based on a path of variances available for very few parametric models of the variance process. The author’s approach makes minimal assumptions on the variances as a stochastic process. This approach highlights a novel channel of identification based on heteroskedasticity that frees researchers from needing to assume a particular functional form—or any functional form—to obtain identifying moments.
Daniel J. Lewis, Staff Report 871, October 2018
Flighty Liquidity
The authors study the predictability of liquidity and the downside risk to the liquidity of U. S. investment-grade and high-yield corporate bonds. They find evidence of liquidity spillovers across credit rating categories: greater current liquidity of high-yield bonds is associated with lower uncertainty about the future liquidity of investment-grade bonds, while greater liquidity of investment-grade bonds is associated with greater uncertainty about the future liquidity of high-yield bonds.
Nina Boyarchenko, Domenico Giannone, and Or Shachar, Staff Report 870, October 2018
Review of New York Fed Studies on the Effects of Post-Crisis Banking Reforms
In 2017, the Federal Reserve Bank of New York Fed launched a project to assess the effects of regulatory reforms that affected banks following the financial crisis of 2007-08. This article reviews the resulting twelve studies, which analyzed the effects of the reforms on the cost of bank equity capital, on bank profitability and risk, and on liquidity. Most of the findings aligned with theoretical predictions or results of earlier studies of the reforms. However, some studies produced results which contrast with evidence in the academic literature.
Richard K. Crump and João A. C. Santos, Economic Policy Review Volume 24 Number 2, October 2018
Reducing Moral Hazard at the Expense of Market Discipline: The Effectiveness of Double Liability before and during the Great Depression
Prior to the Great Depression, regulators imposed double liability on bank shareholders to ensure financial stability and protect depositors. Under this rule, shareholders of failing banks lost their initial investment and had to pay up to the par value of the stock in order to compensate depositors. The authors find no evidence that the rule reduced bank risk prior to the Great Depression, but do find evidence that double-liability banks were less susceptible to runs during the Great Depression. These results suggest that the protection afforded depositors by the rule may have weakened market discipline and undermined the effectiveness of double liability as a regulatory tool for reducing Bank risk.
By Haelim Anderson, Daniel Barth, and Dong Beom Choi, Staff Report 869, October 2018