Financial Crisis, Temporary Liquidity Guarantee Program, and Impacts on the Fixed Income Markets

Abstract

In this paper, we study the FDIC’s Temporary Liquidity Guarantee Program to examine the effectiveness of this government sponsored solution to the current banking crisis. We explore the impact of the program on the liquidity and credit crisis in the debt markets and the market value of the FDIC guarantee. We find a significant reduction in yield of AAA debt issues around the announcements of FDIC guarantee debt issues. In addition, using multiple regressions we confirm the drop in yield spreads of AAA financial bonds after the program started. Both findings suggest that the program effectively encouraged liquidity and confidence. We also find the FDIC guarantee valuable especially when we compare with the non-FDIC-backed debt issued by non-FDIC issuers. Interestingly, we find a negative and significant cumulative abnormal stock return around FDIC-backed debt issue dates, suggesting stockholders held pessimistic views on the future prospects of these banks. On the other hand, bondholders reacted positively to the issuances, confirming the positive liquidity and credit effects in the debt market.