Anatomy of the UK Money Markets Before and During the Sub-prime Crisis (FEVIR)

FEVIR is a study contract with the Europlace Institute of Finance, led by Viral Acharya.

The sub-prime crisis begs several important questions: Why have the inter-bank markets, which in normal times act as lubricant to financial flows amongst banks, dried up so suddenly? What was the impact of such drying up on the liquidity hoardings of banks and on the substitution in the money markets between secured and unsecured borrowing? Were the price and quantity effects in money markets coincident or did quantity effects exhibit a threshold pattern once the financial sector appeared to have sustained a critical level of losses? Is there any evidence of market power given the private, bilateral nature of inter-bank transactions and the generally concentrated nature of flows?4 What has been the impact of the traditional forms of central bank's lender-of-last-resort facilities and of the recent innovations on the money markets and in distributing liquidity to places where it is most needed? Our paper is an attempt to provide answers to some of these questions based on an empirical investigation of the UK overnight money markets since January 2007.