SeekerBlog

Yes — more important than uncertainty about the condition of borrowers, according to this presentation: Comments on Franklin Allen & Elena Carletti “The Role of Liquidity in Financial Crises” by BlackRock’s Managing Director Peter R. Fisher at the Federal Reserve Bank of Kansas City’s Symposium “Maintaining Stability in a Changing Financial System” Jackson Hole, Wyoming, August 23, 2008. The introduction:

Allen and Carletti provide an insightful review of the literature on liquidity and financial crises and a useful framework for considering the role of liquidity in the events of the past year. I find myself in fundamental agreement with what I take to be their two key points: first, on liquidity hoarding as the more significant explanation of the breakdown in inter-bank markets and, second, on the impact of cash-in-the-market pricing on asset values. As a consequence of this agreement, my comments will necessarily digress into quibbling about how one reaches these conclusions, how they should be characterized and into my own thoughts on the key puzzle of the past year, the Federal Reserve’s new facilities and suggested areas for further work.

Liquidity hoarding as “balance sheet defensiveness”



In their analysis of the drying up of inter-bank lending markets, the authors conclude that “liquidity hoarding” by banks has probably been the more-important factor than has uncertainty about the condition of borrowers. (Allen & Carletti, 20-21.) I certainly agree. (See Fisher 2008) In public, bankers would always prefer to blame uncertainty about their borrowers’ balance sheets than anxiety about their own balance sheets. However, in my own conversations with bank CFOs, Treasurers, and trading desks from August of 2007 through March of 2008, there was a frank acknowledgement of a defensive concern with their ability to finance their own positions and those of their key customers. The simultaneous and generalized widening of unsecured, inter-bank lending rates across U.S. Dollar, Sterling and Euro markets last August and the persistence of these wider spreads for the past year, also supports the idea of a lenders’ strike as the more useful explanation.

I see “liquidity hoarding” as a form of “balance sheet defensiveness” by bankers unwilling to rent space on their balance sheets to their competitors at traditional spreads.