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Discussion Paper
MBS Market Dysfunctions in the Time of COVID-19
The COVID-19 pandemic elevated financial market illiquidity and volatility, especially in March 2020. The mortgage-backed securities (MBS) market, which plays a critical role in the housing market by funding the vast majority of U.S. residential mortgages, also suffered a period of dysfunction. In this post, we study a particular aspect of MBS market disruptions by showing how a long-standing relationship between cash and forward markets broke down, in spite of MBS dealers increasing the provision of liquidity. (See our related staff report for greater detail.) We also highlight an innovative ...
Discussion Paper
Did Dealers Fail to Make Markets during the Pandemic?
In March 2020, as the COVID-19 pandemic disrupted a range of financial markets, the ability of dealers to maintain liquid conditions in these markets was questioned. Reflecting these concerns, authorities took numerous steps, including providing regulatory relief to dealers. In this post, we examine liquidity provision by dealers in several financial markets during the pandemic: how much was provided, possible causes of any shortfalls, and the effects of the Federal Reserve’s actions.
Report
Dealers and the Dealer of Last Resort: Evidence from the Agency MBS Markets in the COVID-19 Crisis
When market disruptions started in March 2020, dealers maintained the usual liquidity provision in the agency MBS market by taking cash inventory and hedging inventory risk with forward contracts. However, cash and forward prices significantly diverged and began to converge only after the Federal Reserve deployed nonstandard purchase operations to promptly take MBS off dealers’ balance sheets. Further cross-dealer analyses point to supplemental leverage ratio requirements as major constraints on dealers’ balance sheets. Customers’ selling increased when price divergence reverted, ...