Liquidating illiquid collateral
Furthermore, neither was the Reserve Primary Fund "too-big-to-fail" despite its .8 billion worth of assets prior to its shut down, nor was it even an SIFI on its own right.What was systemically important in September, 2008, was the .5 trillion financial sector of MMMFs. law (which was changed later), these assets became Lehman's creditors take.Therefore, any mechanism set up by the regulators to deal with the insolvency of SIFIs must follow at least four basic principles (Acharya, Adler, Richardson and Roubini, 2010): When the collapse or near collapse of such financial institutions as Bear Stearns, Lehman Brothers, AIG and the like after the onset of the global financial crisis in 2007 made the inability of the existing resolution mechanisms to deal with the failure of SIFIs clear, the U. However, as it is stated fairly clearly in Title II of the DFA, the OLA is not a resolution but liquidation mechanism.Putting aside the question of whether such liquidation - rather than a resolution - authority focusing on individual financial institutions is sufficient to achieve the DFA-stated goals of inducing market discipline and mitigating moral hazard, the question of whether the OLA can address the systemic risk associated with such systemically important markets as the sale and repurchase agreement ("repo") market or such systemically important sectors of small institutions as the money market mutual funds remains debatable.Furthermore, because of our focus on SIALs, our proposed resolution mechanisms would be easier to implement at the global level compared to mechanisms that operate at the level of individual institutional forms.We, then, outline how our approach can be specialized to the repo market and propose a repo resolution authority for reforming this market.Systemic risk can be defined broadly as the expected losses from the risk that the failure of a significant part of the financial sector leads to a reduction in credit availability with the potential for adversely affecting the real economy.There are at least two contesting views on the causes of systemic risk.
Taking the micro-prudential view, both the Dodd-Frank Wall Street Regulation and Consumer Protection Act (DFA) signed into law by President Obama in July 2010 in the U. and, internationally, Basel III focus on single financial institutions.Examples of SILs include deposits, repos and over-the-counter (OTC) derivatives.Similarly, systemically important assets (SIAs) can be defined broadly as those assets that are either SILs of other highly-leveraged entities or potentially illiquid, high risk assets financed through SILs.Given that the investors of MMMFs were offered stable NAV and promised that they could redeem anytime at par, it is evident that a liquidation authority such as the OLA - which with its focus on eliminating the moral hazard associated with the "too-big-to-fail" status recovers from creditors any amounts received in excess of what they would have received in an ordinary liquidation - neither could have nor will have stopped the slide in such an episode.An orderly liquidation of the assets of the Reserve Primary Fund was not even an issue then.