The Collateral Trap

37 Pages Posted: 24 Nov 2014 Last revised: 2 Dec 2014

See all articles by Russell Cooper

Russell Cooper

University of Texas at Austin - Department of Economics; National Bureau of Economic Research (NBER)

Frédéric Boissay

Bank for International Settlements (BIS)

Date Written: November 2014

Abstract

Active wholesale financial markets help reallocate deposits across heterogeneous banks. Because of incentive problems these flows are constrained and collateral is needed. The composition of collateral matters. The use of inside assets (loans) creates a “collateral pyramid” in that cash flows from one loan can be pledged to secure another. Through collateral pyramids the financial sector creates safe assets, but at the cost of exposing the economy to systemic panics. Outside collateral (treasuries) serves as foundation of, and stabilises, the pyramid. There is a threshold for the volume of treasuries, below which investors panic and the pyramid collapses.

Suggested Citation

Cooper, Russell W. and Boissay, Frédéric, The Collateral Trap (November 2014). NBER Working Paper No. w20703. Available at SSRN: https://ssrn.com/abstract=2529876

Russell W. Cooper (Contact Author)

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Frédéric Boissay

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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