The Federal Reserve Bank of New York posted a blog entry yesterday entitled, "Uncertainty, Liquidity Hoarding, and Financial Crises." NY Fed Staffer Tanju Yorulmazer writes, "One of the most interesting phenomena marking the recent financial crisis was the disruptions in the interbank market, where banks borrow and lend reserves to each other. This post draws upon my paper with Douglas Gale, "Liquidity Hoarding," to discuss this practice by banks during times of increased uncertainty about future liquidity needs and its consequences for the efficient transfer of liquidity in the interbank market." On "Disruptions in the Interbank Market," he says, "As early as fall 2007, following the collapse of the market for asset-backed commercial paper, European banks reported an inability to borrow in the interbank market. At the same time, interbank borrowing rates reached record-high levels. Furthermore, there was a dramatic change in markets for the sale of repurchase agreements (repos) -- a major source of funding for financial institutions that borrow money in exchange for securities, agreeing to buy them back at a later date. These markets, which are typically highly liquid, shrank dramatically and experienced unprecedented high "haircuts" -- markdowns in the market value of collateral being used for the loans -- in all asset classes, including nonsubprime-related classes (Gorton and Metrick offer interesting papers on repo runs and haircuts). Difficulty obtaining liquidity in the interbank market was subsequently experienced in many countries. As a result, central bank borrowing facilities became an essential source of liquidity for financial institutions."
