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Discussion Paper
On Fire-Sale Externalities, TARP Was Close to Optimal
Eisenbach, Thomas M.; Duarte, Fernando M. (2014-04-15)
Imagine that many large and levered banks suffer heavy losses and must quickly sell assets to reduce their leverage. We expect the market price of the assets sold to decline, at least temporarily. As a result, any other financial institutions that happen to hold the same assets will experience balance sheet losses through no fault of their own —a negative fire-sale externality. In this post, we show that the vulnerability to fire-sale externalities was high during the crisis and that the capital injections of the government’s Troubled Asset Relief Program (TARP) helped reduce it ...
Liberty Street Economics , Paper 20140415

Report
Fragility of Safe Asset Markets
Phelan, Gregory; Eisenbach, Thomas M. (2022-07-01)
In March 2020, safe asset markets experienced surprising and unprecedented price crashes. We explain how strategic investor behavior can create such market fragility in a model with investors valuing safety, investors valuing liquidity, and constrained dealers. While safety investors and liquidity investors can interact symbiotically with offsetting trades in times of stress, liquidity investors’ strategic interaction harbors the potential for self-fulfilling fragility. When the market is fragile, standard flight-to-safety can have a destabilizing effect and trigger a “dash-for-cash” by ...
Staff Reports , Paper 1026

Report
Cournot Fire Sales
Eisenbach, Thomas M.; Phelan, Gregory (2018-02-01)
In standard Walrasian macro-finance models, pecuniary externalities due to fire sales lead to excessive borrowing and insufficient liquidity holdings. We investigate whether imperfect competition (Cournot) improves welfare through internalizing the externality and find that this is far from guaranteed. Cournot competition can overcorrect the inefficiently high borrowing in a standard model of levered real investment. In contrast, Cournot competition can exacerbate the inefficiently low liquidity in a standard model of financial portfolio choice. Implications for welfare and regulation are ...
Staff Reports , Paper 837

Report
Runs and Flights to Safety: Are Stablecoins the New Money Market Funds?
Macchiavelli, Marco; Eisenbach, Thomas M.; Anadu, Kenechukwu E.; Cipriani, Marco; La Spada, Gabriele; Wang, J. Christina; Huang, Catherine; Malfroy-Camine, Antoine; Azar, Pablo D.; Landoni, Mattia (2023-09-01)
Similar to the more traditional money market funds (MMFs), stablecoins aim to provide investors with safe, money-like assets. We investigate similarities and differences between these two investment products. Like MMFs, stablecoins suffer from “flight-to-safety” dynamics: we document net flows from riskier to safer stablecoins on days of crypto-market stress and estimate a discrete “break-the-buck” threshold of $1, below which stablecoin redemptions accelerate. We then focus on two specific stablecoin runs, in 2022 and 2023, showing that the same flight-to-safety dynamics also ...
Staff Reports , Paper 1073

Discussion Paper
Factors that Affect Bank Stability
Yorulmazer, Tanju; Eisenbach, Thomas M. (2014-02-26)
In a previous Liberty Street Economics post, we introduced a framework for thinking about the risks banks face. In particular, we distinguished between asset return risk and funding risk that can interact and cause a bank to fail. In our framework, a bank can fail for two reasons: 1-Low asset returns: Fundamental insolvency due to erosion of equity by low asset returns that don’t cover a bank’s debt burden. 2-Loss of funding: Costly liquidation of assets that erode equity.
Liberty Street Economics , Paper 20140226

Discussion Paper
What Makes a Bank Stable? A Framework for Analysis
Yorulmazer, Tanju; Eisenbach, Thomas M. (2014-02-24)
One of the major roles of banks and other financial intermediaries is to channel funds from savings into valuable projects. In doing so, banks engage in “liquidity and maturity transformation,” since they finance long-term, illiquid projects while funding themselves with short-term, liquid liabilities. By performing this important role, banks expose themselves to the risk of runs: If depositors or other short-term creditors worry about their claims, they may withdraw funds en masse and cause the bank to fail. The recent financial crisis once again highlighted the fragility associated with ...
Liberty Street Economics , Paper 20140224

Discussion Paper
Mission Almost Impossible: Developing a Simple Measure of Pass-Through Efficiency
Afonso, Gara; Eisenbach, Thomas M.; Biesenbach, Adam (2017-11-06)
Short-term credit markets have evolved significantly over the past ten years in response to unprecedentedly high levels of reserve balances, a host of regulatory changes, and the introduction of new monetary policy tools. Have these and other developments affected the way monetary policy shifts “pass through” to money markets and, ultimately, to households and firms? In this post, we discuss a new measure of pass‑through efficiency, proposed by economists Darrell Duffie and Arvind Krishnamurthy at the Federal Reserve’s 2016 Jackson Hole summit.
Liberty Street Economics , Paper 20171106

Discussion Paper
Banking System Vulnerability: 2022 Update
Crosignani, Matteo; Eisenbach, Thomas M.; Fringuellotti, Fulvia (2022-11-14)
To assess the vulnerability of the U.S. financial system, it is important to monitor leverage and funding risks—both individually and in tandem. In this post, we provide an update of four analytical models aimed at capturing different aspects of banking system vulnerability with data through 2022:Q2, assessing how these vulnerabilities have changed since last year. The four models were introduced in a Liberty Street Economics post in 2018 and have been updated annually since then.
Liberty Street Economics , Paper 20221114

Report
Anxiety and pro-cyclical risk taking with Bayesian agents
Schmalz, Martin C.; Eisenbach, Thomas M. (2015-02-01)
We provide a model that can explain empirically relevant variations in confidence and risk taking by combining horizon-dependent risk aversion (?anxiety?) and selective memory in a Bayesian intrapersonal game. In the time series, overconfidence is more prevalent when actual risk levels are high, while underconfidence occurs when risks are low. In the cross section, more anxious agents are more prone to biased confidence and their beliefs fluctuate more. This systematic variation in confidence levels can lead to objectively excessive risk taking by ?insiders? with the potential to amplify ...
Staff Reports , Paper 711

Discussion Paper
Runs on Stablecoins
Macchiavelli, Marco; Eisenbach, Thomas M.; Cipriani, Marco; La Spada, Gabriele; Landoni, Mattia; Wang, J. Christina; Huang, Catherine; Anadu, Kenechukwu E.; Malfroy-Camine, Antoine; Azar, Pablo D. (2023-07-12)
Stablecoins are digital assets whose value is pegged to that of fiat currencies, usually the U.S. dollar, with a typical exchange rate of one dollar per unit. Their market capitalization has grown exponentially over the last couple of years, from $5 billion in 2019 to around $180 billion in 2022. Notwithstanding their name, however, stablecoins can be very unstable: between May 1 and May 16, 2022, there was a run on stablecoins, with their circulation decreasing by 15.58 billion and their market capitalization dropping by $25.63 billion (see charts below.) In this post, we describe the ...
Liberty Street Economics , Paper 20230712

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