Securitized Banking and the Run on Repo (NBER Working Paper 15223, August 2009)

Claims Supported by This Source

1. The panic of 2007-2008 was a run on the repo market (sale and repurchase agreements). A traditional bank run occurs through deposit withdrawals, while a run on securitized banking occurs through the withdrawal of repos.
2. Large funds, for which deposit insurance was capped at $100,000, turned to collateralized repos instead of deposits. The equivalents of reserves, deposit insurance, and deposit rates in traditional banking are haircuts, collateral, and repo rates in the repo market.
3. The repo haircut index (an equally weighted average of 9 types of collateral, excluding Treasury securities) rose from 0 at the beginning of 2007 to nearly 50% at its peak at the end of 2008. Some collateral ceased trading entirely (equivalent to a 100% haircut).
4. Table I, Panels D & E: The average haircut index was 0.0% in the first half of 2007, 3.9% in the second half, 2.0% for all of 2007, and 27.2% in 2008. "Unpriced ABS/MBS/Subprime general" averaged 68.0% in 2008, "Unpriced CLO/CDO" was 57.3%, and "AA to AAA CDO" was 53.5%.
5. Example: If the repo market size is $10 trillion, a weighted average haircut of 20% would result in a $2 trillion funding shortfall for banks. The sale of collateral drives down prices, reducing collateral value, increasing solvency concerns, and leading to a cycle of even higher haircuts.
6. The LIBOR-OIS spread (the difference between 3-month LIBOR and OIS, a proxy for counterparty credit risk) surged from around 8 bp in August 2007 and surged again in September 2008. The first systemic event was in August 2007, the second was the Lehman collapse in September 2008. The weakening of subprime itself was not the shock that caused the systemic problem.
7. Empirical conclusion: Rising repo rates correlate with counterparty credit risk (LIBOR-OIS), and rising haircuts correlate with uncertainty in collateral value (expected volatility). Both occurred simultaneously, and causality cannot be disentangled.

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