TY  - JOUR
AU  - Krishnamurthy,Arvind
TI  - How Debt Markets have Malfunctioned in the Crisis
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 15542
PY  - 2009
Y2  - November 2009
UR  - http://www.nber.org/papers/w15542
L1  - http://www.nber.org/papers/w15542.pdf
N1  - Author contact info:
Arvind Krishnamurthy
Kellogg School of Management
Northwestern University
2001 Sheridan Road
Evanston, IL 60208
Tel: 847/491-2671
Fax: 847/491-5719
E-Mail: a-krishnamurthy@northwestern.edu
AB  - This article explains how debt markets have malfunctioned in the crisis, with deleterious consequences for the real economy. I begin with a quick overview of debt markets. I then discuss three areas that are crucial in all debt markets decisions: risk capital and risk aversion, repo financing and haircuts, and counterparty risk. In each of these areas, feedback effects can arise, so that less liquidity and a higher cost for finance can reinforce each other in a contagious spiral. I document the remarkable rise in the premium that investors placed on liquidity during the crisis. Next, I show how these issues caused debt markets to break down: fundamental values and market values seemed to diverge across several markets and products that were far removed from the “toxic” subprime mortgage assets at the root of the crisis. Finally, I discuss briefly four steps that the Federal Reserve took to ease the crisis, and how each was geared to a specific systemic fault that arose during the crisis.
ER  -