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Dealers and the Dealer of Last Resort: Evidence from the Agency MBS Markets in the COVID-19 Crisis
When market disruptions began in March 2020, dealers maintained their usual liquidity provision in the agency MBS market by absorbing cash inventory and hedging inventory risk with forward contracts. Nevertheless, cash and forward prices diverged sharply and began to converge only after the Federal Reserve implemented nonstandard purchase operations that promptly removed MBS from dealers’ balance sheets. Further cross-dealer analyses identify the post-2008 leverage ratio requirements as a key source of dealers’ balance sheet constraints. Finally, customer selling increased precisely when ...