Repos, Fire Sales, and Bankruptcy Policy

26 Pages Posted: 15 Dec 2012

See all articles by Gaetano Antinolfi

Gaetano Antinolfi

Washington University in St. Louis - Department of Economics

Francesca Carapella

Board of Governors of the Federal Reserve System

Charles M. Kahn

University of Illinois, Urbana-Champaign; Bank of Canada; Feseral Reserve Bank of Saint Louis

Antoine Martin

Federal Reserve Bank of New York - Research and Statistics

David C. Mills

Board of Governors of the Federal Reserve System

Ed Nosal

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Date Written: November 30, 2012

Abstract

The events from the 2007–09 financial crisis have raised concerns that the failure of large financial institutions can lead to destabilizing fire sales of assets. The risk of fire sales is related to exemptions from bankruptcy's automatic stay provision enjoyed by a number of financial contracts, such as repo. An automatic stay prohibits collection actions by creditors against a bankrupt debtor or his property. It prevents a creditor from liquidating collateral of a defaulting debtor, since collateral is a lien on the debtor's property. In this paper, we construct a model of repo transactions, and consider the effects of changing the bankruptcy rule regarding the automatic stay on the activity in repo and real investment markets. We find that exempting repos from the automatic stay is beneficial for creditors who hold the borrowers' collateral. Although the exemption may increase the size of the repo market by enhancing the liquidity of collateral, it can also lead to subsequent damaging fire sales that are associated with reductions in real investment activity. Hence, policymakers face a trade-off between the benefits of investment activity and the benefits of liquid markets for collateral.

Keywords: Fire Sales, Repos, Bankruptcy Policy

JEL Classification: G10, G33

Suggested Citation

Antinolfi, Gaetano and Carapella, Francesca and Kahn, Charles M. and Martin, Antoine and Mills, David C. and Nosal, Ed, Repos, Fire Sales, and Bankruptcy Policy (November 30, 2012). FRB of Chicago Working Paper No. 2012-15, Available at SSRN: https://ssrn.com/abstract=2189583 or http://dx.doi.org/10.2139/ssrn.2189583

Gaetano Antinolfi

Washington University in St. Louis - Department of Economics ( email )

One Brookings Drive
St. Louis, MO 63130
United States
314-935-7335 (Phone)
314-935-4156 (Fax)

Francesca Carapella

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Charles M. Kahn

University of Illinois, Urbana-Champaign ( email )

Department of Finance
340 Wohlers Hall
Champaign, IL 61820
United States

HOME PAGE: http://kahnfrance.com/cmk/

Bank of Canada

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Feseral Reserve Bank of Saint Louis

411 Locust St
Saint Louis, MO 63011
United States

Antoine Martin

Federal Reserve Bank of New York - Research and Statistics ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-6943 (Phone)

David C. Mills

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-530-6265 (Phone)
202-872-7533 (Fax)

Ed Nosal (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

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