Bank of Canada Review - Autumn 2009

September 11, 2009
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Autumn 2009
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Bank of Canada liquidity actions in response to the financial market turmoil; understanding corporate bond spreads using credit default swaps; review of the conflicts of interest between participants in the securitization process highlighting the most recent policy measures and potential solutions for ameliorating these agency issues.
Content Type(s): Publications, Bank of Canada Review
September 11, 2009

Bank of Canada Liquidity Actions in Response to the Financial Market Turmoil

Bank of Canada Review - Autumn 2009 Lorie Zorn, Carolyn A. Wilkins, Walter Engert
In response to the financial crisis of 2007-09, the Bank of Canada intervened repeatedly to stabilize the financial system and limit the repercussions of the crisis on the Canadian economy. This article reviews the extraordinary liquidity measures taken by the Bank during this period and the principles that guided the Bank's interventions. A preliminary assessment of the term liquidity facilities provided by the Bank suggests that they were an important source of liquidity support for some financial institutions and, on a broader basis, served to reduce uncertainty among market participants about the availability of liquidity, as well as helping to promote a return to well-functioning money markets.
Content Type(s): Publications, Bank of Canada Review articles Topic(s): Financial institutions, Financial markets, Financial stability
September 11, 2009

Understanding Corporate Bond Spreads Using Credit Default Swaps

Bank of Canada Review - Autumn 2009 Alejandro García, Jun Yang
Corporate bond spreads worldwide have widened markedly since the beginning of the credit crisis in 2007. This article examines default and liquidity risk–the main components of the corporate bond spread–for Canadian firms that issue bonds in the U.S. market, focusing in particular on their evolution during the credit crisis. They find that, during this period, the liquidity component increased more for speculative-grade bonds than it did for investment-grade bonds, consistent with a "flight-to-quality" phenomenon. An important implication of their results for policy-makers seeking to address problems in credit markets is that the liquidity risk in corporate spreads for investment and speculative bonds behaves differently than the default risk, especially during crisis episodes.
Content Type(s): Publications, Bank of Canada Review articles Topic(s): Econometric and statistical methods, Financial markets, Financial stability
September 11, 2009

Agency Conflicts in the Process of Securitization

Bank of Canada Review - Autumn 2009 Teodora Paligorova
Recent evidence finds a positive association between the prevalence of loans of inferior quality and the growth in securitized products. Some attribute this development to the lack of incentives for originators to screen and monitor the performance of securitized loans; others stress that certain factors, such as balance-sheet management, also contributed to the problem, making it difficult to pin down the reason for the proliferation of such loans during the period of high securitization growth. The author reviews the conflicts of interest between participants in the securitization process that contributed to the ongoing financial turmoil and highlights the most recent policy measures and potential solutions for ameliorating these agency issues.
Content Type(s): Publications, Bank of Canada Review articles Topic(s): Financial institutions, Financial markets