Unintended Consequences of LOLR Facilities: The Case of Illiquid Leverage

Viral V. Acharya, Bruce Tuckman

NBER Working Paper No. 19773
Issued in December 2013
NBER Program(s):   CF   IFM   ME

While the direct effect of lender-of-last-resort (LOLR) facilities is to forestall the default of financial firms that lose funding liquidity, an indirect effect is to allow these firms to minimize deleveraging sales of illiquid assets. This unintended consequence of LOLR facilities manifests itself as excess illiquid leverage in the financial sector, can make future liquidity shortfalls more likely, and can lead to an increase in default risks. Furthermore, this increase in default risk can occur despite the fact that the combination of LOLR facilities and reduced asset sales raises the prices of illiquid assets.

The behavior of U.S. broker-dealers during the crisis of 2007-2009 is consistent with the unintended consequence just described. In particular, given the Federal Reserve's LOLR facilities, broker-dealers could afford to try to wait out the crisis. While they did reduce traditional measures of leverage to varying degrees, they failed to reduce sufficiently their illiquid leverage, which contributed to their failures or near failures.

Several mechanisms that might address this unintended consequence of LOLR facili--ties are explored: condition LOLR access and terms on the financial health of borrowers; condition LOLR access and terms on asset sales and deleveraging; and, especially, in--stead of supporting troubled financial firms, open LOLR facilities to financially sound, potential buyers of illiquid assets.

You may purchase this paper on-line in .pdf format from ($5) for electronic delivery.

Information about Free Papers

You should expect a free download if you are a subscriber, a corporate associate of the NBER, a journalist, an employee of the U.S. federal government with a ".GOV" domain name, or a resident of nearly any developing country or transition economy.

If you usually get free papers at work/university but do not at home, you can either connect to your work VPN or proxy (if any) or elect to have a link to the paper emailed to your work email address below. The email address must be connected to a subscribing college, university, or other subscribing institution. Gmail and other free email addresses will not have access.


Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w19773

Users who downloaded this paper also downloaded these:
Hautcoeur, Riva, and White w20083 Floating a "Lifeboat": The Banque de France and the Crisis of 1889
Reinhart and Rogoff w19823 Recovery from Financial Crises: Evidence from 100 Episodes
Hart and Zingales w20207 Banks Are Where The Liquidity Is
Yermack w19747 Is Bitcoin a Real Currency? An economic appraisal
Angrist w19774 The Perils of Peer Effects
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us