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Financial Stability Report

November 2020

B o a r d o f G o v e r n o r s o f t h e F e d e r a l R e s e rv e S y s t e m

Financial Stability Report

November 2020

B o a r d o f G o v e r n o r s o f t h e F e d e r a l R e s e rv e S y s t e m

This and other Federal Reserve Board reports and publications are available
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iii

Contents
Purpose . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
1. Asset Valuations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
2. Borrowing by Businesses and Households . . . . . . . . . . . . . . . . . . . . . . . . . 23
3. Leverage in the Financial Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
4. Funding Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Near-Term Risks to the Financial System . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
Figure Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

Boxes
Federal Reserve Actions and Facilities to Support Households, Businesses,
and Municipalities during the COVID-19 Crisis . . . . . . . . . . . . . . . . . . . . . 9
Federal Reserve Actions to Stabilize Short-Term Funding Markets during
the COVID‑19 Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
A Retrospective on the March 2020 Turmoil in Treasury and
Mortgage-Backed Securities Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
LIBOR Transition Update . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
The Implications of Climate Change for Financial Stability . . . . . . . . . . . . . 58
Salient Shocks to Financial Stability Cited in Market Outreach . . . . . . . . . . . 62
Note: This report generally reflects information that was available as of October 26, 2020.

Purpose
This report presents the Federal Reserve Board’s current assessment of the resilience of the
U.S. financial system. By publishing this report, the Board intends to promote public understanding and increase transparency and accountability for the Federal Reserve’s views on
this topic.
Promoting financial stability is a key element in meeting the Federal Reserve’s dual mandate
for monetary policy regarding full employment and stable prices. In an unstable financial
system, adverse events are more likely to result in severe financial stress and disrupt the
flow of credit, leading to high unemployment and great financial hardship. Monitoring and
assessing financial stability also support the Federal Reserve’s regulatory and supervisory
activities, which promote the safety and soundness of our nation’s banks and other impor
tant financial institutions. Information gathered while monitoring the stability of the financial system helps the Federal Reserve develop its view of the salient risks to be included in
the scenarios of the stress tests and its setting of the countercyclical capital buffer (CCyB).1
The Board’s Financial Stability Report is similar to those published by other central banks
and complements the annual report of the Financial Stability Oversight Council (FSOC),
which is chaired by the Secretary of the Treasury and includes the Federal Reserve Board
Chair and other financial regulators.

More information on the Federal Reserve’s supervisory and regulatory activities is available on the Board’s website; see
Board of Governors of the Federal Reserve System (2020), Supervision and Regulation Report (Washington: Board of
Governors, May), available at https://www.federalreserve.gov/publications/supervision-and-regulation-report.htm as well
as the webpages for Supervision and Regulation (https://www.federalreserve.gov/supervisionreg.htm) and Payment Systems
(https://www.federalreserve.gov/paymentsystems.htm). Moreover, additional details about the conduct of monetary policy
are also on the Board’s website; see the Monetary Policy Report (https://www.federalreserve.gov/monetarypolicy/mpr_
default.htm) and the webpage for Monetary Policy (https://www.federalreserve.gov/monetarypolicy.htm).

Framework
A stable financial system, when hit by adverse events, or “shocks,” continues to meet the
demands of households and businesses for financial services, such as credit provision and
payment services. In contrast, in an unstable system, these same shocks are likely to have
much larger effects, disrupting the flow of credit and leading to declines in employment and
economic activity.
Consistent with this view of financial stability, the Federal Reserve Board’s monitoring
framework distinguishes between shocks to and vulnerabilities of the financial system.
Shocks, such as sudden changes to financial or economic conditions, are typically surprises
and are inherently difficult to predict. Vulnerabilities tend to build up over time and are the
aspects of the financial system that are most expected to cause widespread problems in times
of stress. As a result, the framework focuses primarily on monitoring vulnerabilities and
emphasizes four broad categories based on research.2
1. Elevated valuation pressures are signaled by asset prices that are high relative to economic fundamentals or historical norms and are often driven by an increased willingness
of investors to take on risk. As such, elevated valuation pressures imply a greater possibility of outsized drops in asset prices.
2. Excessive borrowing by businesses and households leaves them vulnerable to distress
if their incomes decline or the assets they own fall in value. In the event of such shocks,
businesses and households with high debt burdens may need to cut back spending
sharply, affecting the overall level of economic activity. Moreover, when businesses and
households cannot make payments on their loans, financial institutions and investors
incur losses.
3. Excessive leverage within the financial sector increases the risk that financial institutions will not have the ability to absorb even modest losses when hit by adverse shocks.
In those situations, institutions will be forced to cut back lending, sell their assets, or, in
extreme cases, shut down. Such responses can substantially impair credit access for households and businesses.
4. Funding risks expose the financial system to the possibility that investors will “run” by
withdrawing their funds from a particular institution or sector. Many financial institutions raise funds from the public with a commitment to return their investors’ money on
short notice, but those institutions then invest much of the funds in illiquid assets that
are hard to sell quickly or in assets that have a long maturity. This liquidity and maturity
2

For a review of the research literature in this area and further discussion, see Tobias Adrian, Daniel Covitz, and Nellie Liang
(2015), “Financial Stability Monitoring,” Annual Review of Financial Economics, vol. 7 (December), pp. 357–95.

4 Framework

transformation can create an incentive for investors to withdraw funds quickly in adverse
situations. Facing a run, financial institutions may need to sell assets quickly at “fire
sale” prices, thereby incurring substantial losses and potentially even becoming insolvent.
Historians and economists often refer to widespread investor runs as “financial panics.”
These vulnerabilities often interact with each other. For example, elevated valuation pressures tend to be associated with excessive borrowing by businesses and households because
both borrowers and lenders are more willing to accept higher degrees of risk and leverage
when asset prices are appreciating rapidly. The associated debt and leverage, in turn, make
the risk of outsized declines in asset prices more likely and more damaging. Similarly, the
risk of a run on a financial institution and the consequent fire sales of assets are greatly
amplified when significant leverage is involved.
It is important to note that liquidity and maturity transformation and lending to households,
businesses, and financial firms are key aspects of how the financial system supports the
economy. For example, banks provide safe, liquid assets to depositors and long-term loans
to households and businesses; businesses rely on loans or bonds to fund investment projects;
and households benefit from a well-functioning mortgage market when buying a home.
The Federal Reserve’s monitoring framework also tracks domestic and international developments to identify near-term risks—that is, plausible adverse developments or shocks that
could stress the U.S. financial system. The analysis of these risks focuses on assessing how
such potential shocks may play out through the U.S. financial system, given our current
assessment of the four areas of vulnerabilities.
While this framework provides a systematic way to assess financial stability, some potential
risks do not fit neatly into it because they are novel or difficult to quantify. In addition, some
vulnerabilities are difficult to measure with currently available data, and the set of vulnerabilities may evolve over time. Given these limitations, we continually rely on ongoing research
by the Federal Reserve staff, academics, and other experts to improve our measurement of
existing vulnerabilities and to keep pace with changes in the financial system that could create new forms of vulnerabilities or add to existing ones.

Federal Reserve actions to promote the resilience of the financial system
The assessment of financial vulnerabilities informs Federal Reserve actions to promote the
resilience of the financial system. The Federal Reserve works with other domestic agencies
directly and through the FSOC to monitor risks to financial stability and to undertake supervisory and regulatory efforts to mitigate the risks and consequences of financial instability.
Actions taken by the Federal Reserve to promote the resilience of the financial system
include its supervision and regulation of financial institutions—in particular, large bank
holding companies (BHCs), the U.S. operations of certain foreign banking organizations,

FINANCIAL STABILITY REPORT: NOVEMBER 2020 5

and financial market utilities. Specifically, in the post-crisis period, for the largest, most systemically important BHCs, these actions have included requirements for more and higherquality capital, an innovative stress-testing regime, new liquidity regulation, and improvements in the resolvability of such BHCs.
In addition, the Federal Reserve’s assessment of financial vulnerabilities informs the design
of stress-test scenarios and decisions regarding the CCyB. The stress scenarios incorporate
some systematic elements to make the tests more stringent when financial imbalances are
rising, and the assessment of vulnerabilities also helps identify salient risks that can be
included in the scenarios. The CCyB is designed to increase the resilience of large banking
organizations when there is an elevated risk of above-normal losses and to promote a more
sustainable supply of credit over the economic cycle.

Overview
This report reviews conditions affecting the stability of the financial system by analyzing vulnerabilities related to valuation pressures, borrowing by businesses and households, financial
leverage, and funding risk. It also highlights several near-term risks that, if realized, could
interact with such vulnerabilities.
Since the May 2020 Financial Stability Report was issued, asset prices have continued to
move up, on balance, amid periods of volatility. Business and household earnings have fallen
and business borrowing has risen, which leave households and firms more vulnerable to
future shocks. Banks absorbed large losses related to the pandemic but remained well capitalized throughout; moreover, capital ratios have since generally recovered to pre-pandemic
levels. However, the COVID-19 shock highlighted how vulnerabilities related to leverage and
funding risk at nonbank financial institutions could amplify shocks in the financial system in
times of stress.
Our view of the current level of vulnerabilities is as follows:
1. Asset valuations. Asset prices have generally increased since May of this year. The elevated levels of asset prices in various markets likely reflect the low level of Treasury yields,
and measures of the compensation for risk appear roughly aligned with historical norms.
Given the high level of uncertainty associated with the pandemic, assessing valuation
pressures is particularly challenging, and asset prices remain vulnerable to significant
declines should investor risk sentiment fall or the economic recovery weaken.
2. Borrowing by businesses and households. Debt owed by businesses, which was already
historically high relative to gross domestic product (GDP) before the pandemic, has risen
sharply as businesses increased borrowing to weather the period of weak earnings. The
general decline in revenues associated with the severe reduction in economic activity has
weakened the ability of businesses to service these obligations. Household debt was at a
moderate level relative to income before the public health shock, but many households
have lost jobs and seen their earnings fall. As many households continue to struggle, loan
defaults may rise, leading to material losses. So far, strains in the business and household
sectors have been mitigated by significant government lending and relief programs and
by low interest rates. That said, some households and businesses have been substantially
more affected to date than others, suggesting that the sources of vulnerability in these
sectors are unevenly distributed.
3. Leverage in the financial sector. The pandemic stressed the resilience of banks, but they
remain well capitalized. Leverage at broker-dealers also remains low. In contrast, meas
ures of leverage at life insurance companies are at post-2008 highs and remain elevated at

8 Overview

hedge funds relative to the past five years. Some nonbank financial institutions felt significant strains amid the acute period of extreme market volatility, declining asset prices, and
worsening market liquidity earlier this year. Pressures eased as a result of policy actions,
including Federal Reserve asset purchases and repurchase agreement (repo) operations,
regulatory relief for dealers affiliated with BHCs, and support from the emergency lending facilities.
4. Funding risk. Bank funding risk remains low, as they rely only modestly on short-term
wholesale funding and maintain large amounts of high-quality liquid assets, which has
helped banks manage heightened liquidity pressures. Banks also benefited from a surge
in deposit inflows through the second quarter of 2020. In contrast, the large redemptions
from money funds and fixed-income mutual funds, as well as the need for extraordinary
support from emergency lending facilities, highlighted vulnerabilities in these sectors.
While in place, those facilities substantially mitigate these vulnerabilities.
The report also details how near-term risks have changed since the May 2020 report. The
outlook for the pandemic and economic activity is uncertain. In the near term, risks associated with the course of COVID-19 and its effects on the U.S. and global economies remain
high. In addition, there is potential for stresses to interact with preexisting vulnerabilities
in dollar funding markets or those stemming from financial systems or fiscal weaknesses in
Europe, China, and emerging market economies (EMEs). These risks have the potential to
interact with the vulnerabilities identified in this report and pose additional risks to the U.S.
financial system.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 9

Federal Reserve Actions and Facilities to Support Households,
Businesses, and Municipalities during the COVID-19 Crisis
Since the beginning of the pandemic, the Federal Reserve has taken forceful actions to support the
continued flow of credit to households, businesses, and state and local governments. At the onset
of the pandemic, it became clear that businesses and families would face an extended period during
which many forms of economic activity were curtailed for public health reasons. During this period,
revenues and incomes would be sharply lower. Employers faced the prospect of being unable to pay
wages and other obligations, which could force them to shut down permanently and, in turn, restrain
the economy’s recovery. At the same time, the availability of credit sharply worsened, with many lending markets commonly tapped by employers effectively shut.
Supported by funds provided by the CARES Act, the Federal Reserve created, with the authorization
of the U.S. Treasury Department, a number of emergency lending facilities.1 Collectively, the facilities
support the flow of credit throughout the economy both by providing backstop measures that give
investors confidence that lending support is available should conditions deteriorate substantially and
by supplying funding that is more directly used to meet credit demand.2

Backstops for larger firms and municipalities
The Primary Market Corporate Credit Facility (PMCCF), Secondary Market Corporate Credit Facility
(SMCCF), and Municipal Liquidity Facility (MLF) were established to improve the flow of credit through
bond markets, where large firms and municipalities obtain most of their long-term funding.3 The
PMCCF stands ready to purchase new bonds and loans issued by investment-grade U.S. corporations
so that they can maintain business operations and employment during the pandemic. The SMCCF
supports trading in the bonds that corporations previously issued. The MLF helps state and local governments as well as certain multistate or revenue bond issuers manage their cash flow needs, which
may be particularly acute given the potential mismatch between delayed or diminished tax receipts
and higher-than-normal spending for unemployment insurance and other essential services.
The announcements of the PMCCF, SMCCF, and MLF in late March and early April led to rapid
improvements in corporate and municipal bond markets well ahead of the facilities’ actual opening.
Spreads across a variety of debt markets quickly narrowed, permitting businesses and municipalities
to borrow at sharply lower costs (figures A, B, and C). SMCCF purchases to date amount to about
(continued on next page)
1

The CareS act (Coronavirus aid, relief, and economic Security act) authorized the Treasury’s equity contribution to many of the
facilities, which collectively can support up to $2.6 trillion of credit to firms of all sizes and to state and local governments.

In addition, backstop facilities may also implicitly affect the prices at which credit is intermediated. For additional information on
facilities’ price effects, see Sam Schulhofer-wohl (2020), “The Influence and Limits of Central Bank Backstops,” Federal reserve Bank
of Chicago, Chicago Fed Insights (blog), august 17, https://www.chicagofed.org/publications/blogs/chicago-fed-insights/2020/theinfluence-and-limits-of-central-bank-backstops.
Though borrowers must meet eligibility standards and funds are not unlimited, these programs are designed to be broad based; taken
together, they facilitate credit provision for sectors that account for more than 97 percent of all u.S. employment. See ryan Decker,
robert kurtzman, Byron Lutz, and Chris Nekarda (forthcoming), “across the universe: Policy Support for employment and revenue
in the Pandemic recession,” Finance and economics Discussion Series (washington: Board of Governors of the Federal reserve
System).

For more details on the facilities, see the box “The Federal reserve’s monetary Policy actions and Facilities to Support the economy
since the CoVID-19 outbreak” in Board of Governors of the Federal reserve System (2020), Financial Stability Report (washington:
Board of Governors, may), pp. 9–15, https://www.federalreserve.gov/publications/files/financial-stability-report-20200515.pdf.

10 OVERVIEW

Federal Reserve Actions and Facilities (continued)
$13 billion—just more than 0.2 percent of the $5.5 trillion of outstanding nonfinancial corporate bonds.
The MLF has, to date, purchased two issues totaling just more than $1.6 billion. However, since
the announcement of the backstop facilities and funding market stabilization measures, more than
$1 trillion in new nonfinancial corporate bonds and more than $250 billion in municipal debt have been
issued, purchased almost entirely by the private sector (figures D and E).
Figure a. Corporate Bond Spreads to 10-Year Treasury
750
650

Basis points

Daily
High-yield (right scale)
Triple-B (left scale)

550
450

PMCCF/
SMCCF
PMCCF/
SMCCF
expanded

2200
1800
1400

350

1000

250

600

Oct.
26

150
50
2008

2010

2012

2014

2016

2018

200

2020

Source: ICe Data Indices, LLC, used with permission.

Figure C. municipal Bond Spreads, by rating

Figure B. municipal Bond Yields, by rating
Percent
Daily

Oct.
16
Triple-A
Triple-B
2018

2019

Source: ICe Data Indices, LLC.

2020

5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0

Basis points
Daily

500

Triple-A

400

Triple-B

300
200

Oct.
16

100
0
−100
−200

Feb.

Apr.

June Aug.
2020

Oct.

Source: ICe Data Indices, LLC.

The Term Asset-Backed Securities Loan Facility (TALF) provides additional support for consumers
and businesses. The TALF supports the issuance of asset-backed securities (ABS) backed by student
loans, auto loans, credit card loans, loans backed by the Small Business Administration (SBA), and
certain other assets. A key market that benefits from the TALF is commercial real estate (CRE), as
legacy commercial mortgage-backed securities (CMBS) and SBA securitizations collateralized by CRE
mortgages are eligible for the TALF and have represented the bulk of the assets pledged as collateral
for TALF loans. Similar to the other backstop facilities, while outstanding balances in the TALF have
remained modest, spreads in ABS markets have narrowed considerably, and private market issuance
has resumed (figure F).
(continued)

FINANCIAL STABILITY REPORT: NOVEMBER 2020 11

Figure D. Cumulative Corporate Credit Issuance
2400
2200
2000
1800
1600
1400
1200
1000
800
600
400
200
0

Billions of dollars

550
500
450
400
350
300
250
200
150
100
50
0

Investment-grade (2020 YTD, left scale)
High-yield (2020 YTD, right scale)
Average investment-grade (2015–19, left scale)
Average high-yield (2015−19, right scale)

25
29
Week number

Source: S&P Global, Leveraged Commentary & Data.

Figure e. 2020 weekly municipal Bond Issuance, by rating
Billions of dollars
Double-A

28
24

Triple-A
A

Triple-B

< Triple-B

12
8
4

Jan.

Feb.

Mar.

Apr.

May

June

July

Aug.

Sept.

2020
Source: Bloomberg.

Figure F. Consumer aBS Spreads (3-Year Triple-a)
Basis points
Weekly
TALF announcement

350
300

FFELP student loans
Fixed credit card
Fixed prime auto

250
200
150
Oct.
22

Feb.

Mar.

Apr.

May

June
2020

July

Aug.

Sept.

Oct.

100
50
0

Source: JPmorgan Chase & Co.

(continued on next page)

12 OVERVIEW

Federal Reserve Actions and Facilities (continued)
Funding for small and medium-sized businesses
The Federal Reserve has taken actions to support lending by banks and nonbanks that specialize in
small business loans. The Paycheck Protection Program Liquidity Facility (PPPLF) was established
to extend credit to lenders that participate in the SBA’s Paycheck Protection Program (PPP), which
provides payroll support for small businesses. The PPP provides forgivable loans to small businesses
in order for them to keep workers on their payrolls. The Main Street Lending Program (Main Street)
targets firms that are often too small to issue corporate bonds or access capital markets.
Through September 30, the Federal Reserve had made more than 11,000 PPPLF advances to nearly
800 banking institutions, totaling around $70 billion. Small community banks account for 50 percent
of the advances and 90 percent of active borrowers. Moreover, 80 community development financial
institutions and minority development institutions, which serve communities in distress and minority
communities, have received PPPLF advances supporting nearly $17 billion in loans. The average PPP
loan size that the advances support was just more than $100,000, suggesting that the PPPLF funds
were mostly directed to lenders that helped support small business employment. The $669 billion
advanced under the PPP earlier this year may have restrained small business demand for bank loans,
with many borrowers reportedly using the funds to pay down lines of credit.
Main Street established five types of loans: three for for-profit businesses and two for nonprofit organizations. Banks originate the loans, and the Federal Reserve, in turn, purchases 95 percent participation
in them. Eligibility requirements and terms differ across loan types, but borrowers must have fewer
than 15,000 employees or 2019 revenues of less than $5 billion. Main Street loans are designed specifically to help borrowers weather a period of sharply reduced revenues, featuring interest and principal
payments that are deferred over the first two years, underwriting criteria that generally look back to
borrowers’ pre-pandemic financial circumstances and post-pandemic prospects, and other elements.
As of October 5, Main Street had purchased 303 loan participations, totaling nearly $3 billion.
To date, Main Street loans appear to be flowing to borrowers from the hardest-hit areas of the country. For example, more loans are going to firms in states that experienced larger unemployment rate
increases during the height of the pandemic. Loans have also covered a wide range of industries.
Importantly, small and medium-sized banks, which tend to supply credit to small and medium-sized
businesses, make up the majority of the loan participants. Community banks (defined as institutions
with less than $10 billion in assets) have originated roughly 61 percent of the dollar value of extended
loans. Main Street provides an important backstop should the recovery falter and a larger number of
businesses need more access to credit.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 13

Federal Reserve Actions to Stabilize Short-Term Funding Markets
during the COVID-19 Crisis
At the onset of the pandemic in late March 2020, investors rapidly moved into cash and the most liquid
financial instruments, causing acute stresses in some short-term funding markets. Dislocations in markets for U.S. Treasury securities occurred, and market functioning was unusually strained (see figure A
and the box “A Retrospective on the March 2020 Turmoil in Treasury and Mortgage-Backed Securities
Markets”). Investors shortened the horizon over which they would lend to companies in the commercial paper (CP) market. In addition, some prime money market funds (MMFs) experienced historically
large redemptions. These stresses had the potential to amplify the shock of the pandemic, because a
breakdown in short-term funding markets could leave companies unable to meet near-term obligations
and households and businesses unable to access accounts they routinely use to make payments.
Figure a. Indicative u.S. Treasury Bid-ask Spreads
60
50

Cents per $100
Daily

Billions of dollars

Asset
purchases
announced

Cumulative Fed UST purchases since March 1 (right scale)
On-the-run bid-ask spread (left scale)
First off-the-run bid-ask spread (left scale)

Asset
purchases
expanded

2800
2400
2000
1600

1200

800

400

0
Mar.
6

Mar.
27

Apr.
17

May
8

May
29

June
19

July
10

July
31

Aug.
21

Sept. Sept.
11
25

Source: Federal reserve Bank of New York.

The Federal Reserve, with the support of the Department of the Treasury, quickly responded and
announced the Commercial Paper Funding Facility (CPFF), the Money Market Mutual Fund Liquidity
Facility (MMLF), and the Primary Dealer Credit Facility (PDCF) to stabilize funding markets, backstop
against further stress, and improve the flow of credit to households and businesses. The facilities gave
investors confidence that they could access their cash when needed and that companies would be
able to roll over CP when needed, relieving selling pressures. Consequently, redemptions among prime
MMFs fell dramatically, spreads on corporate CP narrowed, and term CP volumes of five days and
greater stabilized (figure B). Although balances in the PDCF, CPFF, and MMLF have fallen from their
initial highs to very low levels, the facilities continue to serve as important backstops against further
market stress and support the flow of credit as the pandemic persists (figure C).
(continued on next page)

14 OVERVIEW

Federal Reserve Actions to Stabilize Funding Markets (continued)
Figure B. 1-month Funding market Spreads for Investment-Grade Nonfinancial Corporations
Basis points
AA nonfinancial CP
A2/P2 nonfinancial CP

Daily
CPFF and MMLF
terms adjusted

600
500
400
300
200
100
0

Feb. 14

Apr. 4

May 25

July 16

Sept. 5

Oct. 26

Source: Board of Governors of the Federal reserve System; DTCC Solutions LLC, an affiliate of the Depository Trust & Clearing
Corporation.

Figure C. outstanding Balances of emergency Lending Facilities
Billions of dollars
Weekly

PDCF
60

MMLF
CPFF

40
20
0
Mar.
25

Apr.
15

May
6

May
27

June
17

July
8

July
29

Aug.
19

Source: Federal reserve Board, Statistical release H.4.1, “Factors affecting reserve Balances.”

Sept.
9

Sept.
30

1. Asset Valuations
Asset prices have generally increased since May, and, when adjusted for low interest
rates, valuation pressures appear roughly in line with their historical norms
At the time of the May Financial Stability Report, improvements in investor risk sentiment
and market functioning had started to boost asset prices. Over the past six months, asset
prices in key markets have continued to rise in light of the rebound in economic activity,
policy actions to mitigate the financial amplification of the COVID-19 shock, and investor optimism. The U.S. broad-market stock price index has risen substantially from its low
point this year and touched record highs in recent months, although volatility remains high
and there is considerable uncertainty about the path of earnings. Spreads on corporate
bonds and leveraged loans have decreased significantly. After accounting for the low level of
interest rates, however, measures of the compensation for risk are roughly in line with their
historical norms.
Prices for commercial properties have started to fall, although they remain elevated relative
to incomes. Low transaction volumes—especially for distressed properties—make commercial property valuations particularly difficult to judge. Farmland prices remain elevated relative to rents and incomes. Supported by low mortgage rates, housing prices have increased
along with strong home sales.

Asset prices remain vulnerable to significant declines, given a high degree of uncertainty
around the course of the pandemic and the pace of the recovery
Prompt and forceful policy responses—including fiscal stimulus, lower interest rates, and
various asset purchase and emergency lending programs—have supported a strongerthan-expected economic recovery. However, uncertainty remains high, and investor risk
sentiment could shift swiftly should the economic recovery prove less promising or progress
on containing the virus disappoint. Some segments of the economy, such as energy as well
as travel and hospitality, are particularly vulnerable to a prolonged pandemic. Within CRE,
retail, office, and lodging properties exhibit the highest vulnerability.
Table 1 shows the size of the asset markets discussed in this section. The largest asset
markets are those for residential real estate, corporate public equities, CRE, and Treasury
securities.

16 Asset Valuations

Table 1. Size of Selected Asset Markets
Outstanding
(billions of dollars)

Growth,
2019:Q2–2020:Q2
(percent)

Average annual growth,
1997–2020:Q2
(percent)

Residential real estate

39,290

4.6

5.6

Equities

37,188

4.5

8.0

Commercial real estate

20,444

2.0

7.0

Treasury securities

19,867

25.1

8.8

Investment-grade corporate bonds

6,354

8.7

8.6

Farmland

2,561

1.3

5.3

High-yield and unrated corporate bonds

1,572

20.0

7.6

Leveraged loans*

1,185

–.6

14.3

Commercial real estate**

–.9

2.5

Residential real estate***

3.7

2.1

Item

Price growth (real)

Note: The data extend through 2020:Q2. Growth rates are measured from Q2 of the year immediately preceding the period through Q2 of
the final year of the period. Equities, real estate, and farmland are at market value; bonds and loans are at book value.
* The amount outstanding shows institutional leveraged loans and generally excludes loan commitments held by banks. For example, lines
of credit are generally excluded from this measure. Average annual growth of leveraged loans is from 2000 to 2020:Q2, as this market was
fairly small before then.
** One-year growth of commercial real estate prices is from June 2019 to June 2020, and average annual growth is from 1998:Q4 to
2020:Q2. Both growth rates are calculated from value-weighted nominal prices deflated using the consumer price index.
*** One-year growth of residential real estate is from June 2019 to June 2020, and average annual growth is from 1997:Q4 to 2020:Q2.
Nominal prices are deflated using the consumer price index.
Source: For leveraged loans, S&P Global Market Intelligence, Leveraged Commentary & Data; for corporate bonds, Mergent, Inc., Corporate
Fixed Income Securities Database; for farmland, Department of Agriculture; for residential real estate price growth, CoreLogic; for commercial
real estate price growth, CoStar Group, Inc., CoStar Commercial Repeat Sale Indices; for all other items, Federal Reserve Board, Statistical
Release Z.1, “Financial Accounts of the United States.”

Treasury yields are near historical lows
Treasury yields across the maturity spectrum have generally changed little since May and
are near historical lows (figure 1-1). Model estimates of Treasury term premiums remain at
record lows (figure 1-2).3 The low yields of longer-dated Treasury securities and historically
low term premiums are consistent with market expectations for interest rates to be low for
a long time. In addition, a forward-looking measure of Treasury market volatility derived
from options prices dropped to a historical low, in sharp contrast to the turmoil in March
(figure 1-3).
3

Treasury term premiums capture the difference between the yield that investors require for holding longer-term Treasury
securities—for which realized returns are more sensitive to risks from future inflation or volatility in interest rates than the
realized returns of shorter-term securities—and the expected yield from rolling over shorter-dated ones.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 17

Federal Reserve actions, including asset purchases, continue to sustain the functioning of
Treasury markets. Measures that capture the market’s ability to absorb large orders without
significant price disruptions, such as the quantity of outstanding offers to buy and sell Treas
ury securities, have largely recovered to pre-pandemic levels (figure 1-4).
1-1. Yields on Nominal Treasury Securities
Percent, annual rate
monthly

2-year
10-year

8
7
6
5
4
3

oct.

2
1
0

2000

2004

2008

2012

2016

2020

Source: Federal Reserve Board, Statistical Release H.15, “Selected Interest Rates.”

1-2. Term Premium on 10-Year Nominal Treasury
Securities
Percentage points
monthly

1-3. Implied Volatility of 10-Year Swap Rate
Basis points
monthly

2.5

250

2.0

oct.

1.5

200

1.0

150

0.5

100

0.0
−0.5

oct.

−1.0
2004

2008

2012

2016

50
0

−1.5
2000

300

2005

2020

2008

2011

2014

2017

2020

Source: Barclays.

Source: Department of the Treasury; Wolters Kluwer, Blue Chip
Financial Forecasts; Federal Reserve Bank of New York; Federal
Reserve Board staff estimates.

1-4. Treasury Market Depth
35
30

millions of dollars

5-day moving average

5-year (right scale)
10-year (right scale)
30-year (left scale)

350
300
250

oct.
26

200
150

100

0
Feb.

apr.

June

aug.

2019
Source: Repo interdealer broker community.

oct.

Dec.

Feb.

apr.

June
2020

aug.

oct.

18 Asset Valuations

Corporate debt market spreads returned to historical norms, market functioning
improved, and issuance resumed
Supported by very low Treasury yields, yields
on corporate bonds dropped to historically
24
monthly
22
low levels (figure 1-5). Spreads of yields on
20
corporate bonds over comparable-maturity
18
High-yield
16
Treasury yields narrowed considerably and
Triple-B
14
12
stand at about their historical medians
oct.
10
(figure 1-6).4 However, spreads in sectors
8
6
heavily affected by the pandemic, such as the
4
2
energy, airline, and leisure industries, remain
0
quite elevated. Reflecting a pickup in risk
2000
2004
2008
2012
2016
2020
appetite, the excess bond premium—measured
Source: ICE Data Indices, LLC, used with permission.
as the gap between corporate bond spreads
and expected credit losses—fell below its historical median (figure 1-7).5
1-5. Corporate Bond Yields

Percent

1-7. Corporate Bond Premium over Expected
Losses

1-6. Corporate Bond Spreads to Similar-Maturity
Treasury Securities
12
11
10
9
8
7
6
5
4
3
2
1
0

Percentage points

monthly
Triple-B
(left scale)
High-yield
(right scale)
oct.

2000

2004

2008

2012

2016

2020

Source: ICE Data Indices, LLC, used with permission.

24
22
20
18
16
14
12
10
8
6
4
2
0

Percentage points
monthly

5
4
3
2
1
0

Sept.

−1
−2
−3

2000

2004

2008

2012

2016

2020

Source: Federal Reserve Board staff calculations based
on Lehman Brothers Fixed Income Database (Warga);
Intercontinental Exchange, Inc., ICE Data Services; Center for
Research in Security Prices, CRSP/Compustat Merged Database,
Wharton Research Data Services; S&P Global Market Intelligence,
Compustat.

The announcement of a range of measures to support market functioning and the flow of
credit in late March, particularly the corporate credit facilities, led to significant improvement
in corporate bond market functioning and provided a backstop to support borrowing by corporations (see the box “Federal Reserve Actions and Facilities to Support Households, Businesses, and Municipalities during the COVID-19 Crisis”). Bid-ask spreads have tightened.
4

Spreads between yields on corporate bonds and comparable-maturity Treasury securities reflect the extra compensation
investors require to hold debt that is subject to corporate default or liquidity risks.

For a description of the excess bond premium, see Simon Gilchrist and Egon Zakrajšek (2012), “Credit Spreads and Business Cycle Fluctuations,” American Economic Review, vol. 102 (June), pp. 1692–720.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 19

Corporate bond issuance by both investment- and speculative-grade firms has been very
strong, as companies have increased their cash buffers and refinanced their debt
at lower interest rates and longer maturities. Despite the decline in spreads and the increase
in new issuance, corporate credit quality has deteriorated since May—as evidenced by
defaults and firm ratings downgrades—though it has shown some signs of stabilization in
recent months.
Spreads on leveraged loans in the secondary market have tightened significantly since the
spring and are now close to their post-2008 medians (figure 1-8). Spreads on newly issued
leveraged loans have also tightened.
1-8. Secondary Market Spreads of Leveraged Loans
Basis points
weekly
B

3000
2500

2000
1500
oct.
30

1000
500
0

2000

2004

2008

2012

2016

2020

Source: S&P, Leveraged Commentary & Data.

Equity prices rose sharply, with higher valuations supported, in part, by low interest rates
Valuations in equity markets have risen substantially as equity prices have continued to move
up since the previous Financial Stability Report. Prices relative to forecasts of corporate
earnings have also risen considerably and are
1-9. Forward Price-to-Earnings Ratio of
currently near the top of their historical distriS&P 500 Firms
bution, even though there is significant uncerratio
tainty in the earnings outlook among market
30
monthly
27
participants (figure 1-9). However, while the
24
oct.
gap between the forward earnings-to-price ratio
21
18
and the expected real yield on 10-year Treasury
median
15
securities—a rough measure of the premium
12
9
that investors require for holding risky cor6
porate equities—has declined since May, it
3
remains above its historical median due to the
0
1990
1995
2000
2005
2010
2015
2020
low level of Treasury yields (figure 1-10). This
Source: Federal Reserve Board staff calculations using Refinitiv
development suggests that investor risk appe(formerly Thomson Reuters), Institutional Brokers Estimate
System Estimates.
tite, though higher since May, is still within
historical norms.

20 Asset Valuations

1-10. Spread of Forward Earnings-to-Price Ratio of S&P 500 Firms to 10-Year Real Treasury Yield
Percentage points
monthly

10
8

oct.

median

6
4
2
0
−2

1995

2000

2005

2010

2015

2020

Source: Federal Reserve Board staff calculations using Refinitiv (formerly Thomson Reuters), Institutional Brokers Estimate System Estimates;
Department of the Treasury; Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters.

While equity price volatility has fallen since the late spring, it remains elevated by historical
standards. Further, option-implied volatility, a close proxy for expected volatility, did not fall
as much as realized volatility (figure 1-11). Elevated volatility and the divergence between
expected and realized volatility suggest investors are pricing in concerns about downside
risks and considerable uncertainty about future outcomes.
1-11. S&P 500 Return Volatility
Percent
monthly

option-implied volatility
realized volatility

70
60
50

oct.

40
30
20
10
0

2000

2004

2008

2012

2016

2020

Source: Bloomberg Finance L.P.

Prices of commercial properties are still elevated relative to incomes
Since the May Financial Stability Report, CRE prices have declined moderately (figure 1-12).
However, capitalization rates, which measure annual income relative to prices for recently
transacted commercial properties, have remained near historically low levels, suggesting elevated valuation pressures may still exist (figure 1-13).6

Capitalization rates reflect the reported incomes used for underwriting loans on new transactions. They therefore represent
a selected sample of properties and, as transaction volumes remain depressed, may not reflect the loss of income other data
sources are reporting.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 21

1-12. Commercial Real Estate Prices (Real)
Jan. 2001 = 100
monthly
equalweighted

1-13. Capitalization Rate at Property Purchase
Percent

200

monthly

180
160

Valueweighted

aug.

140
120
100
80

Sept.

60
40
2004

2008

2012

2016

2020

Source: CoStar Group, Inc., CoStar Commercial Repeat Sale
Indices; Bureau of Labor Statistics, consumer price index via
Haver Analytics.

Evidence of significant strains are present in
other data sources. Vacancy rates have turned
higher, and rent growth has either slowed or
turned negative. Prices of real estate investment trusts (REITs) that invest in lodging
and retail properties remain well below their
pre-pandemic levels, although prices of those
that invest in industrial properties have somewhat recovered since the spring. Additionally,
delinquency rates on CMBS, which normally
contain riskier loans, have spiked. Finally,
the July Senior Loan Officer Opinion Survey
on Bank Lending Practices (SLOOS) indicated that a major fraction of banks reported
weaker demand for CRE loans and tighter
lending standards, on net, in the second quarter of 2020 (figure 1-14).

Farmland prices remain high relative
to rents
According to data through the second quarter
of 2020, farmland prices continued to decline
modestly at the national level and at a slightly
faster pace in several midwestern states,
where prices were more elevated (figure 1-15).
Despite the declines, farmland prices remain
high relative to rents (figure 1-16).

2000

2004

2008

2012

2016

2020

Source: Real Capital Analytics; Andrew C. Florance, Norm G.
Miller, Ruijue Peng, and Jay Spivey (2010), “Slicing, Dicing, and
Scoping the Size of the U.S. Commercial Real Estate Market,”
Journal of Real Estate Portfolio Management, vol. 16 (May–
August), pp. 101–18.

1-14. Change in Bank Standards for Commercial
Real Estate Loans
Net percentage of banks reporting
Tightening

2000

Quarterly

easing

1996

10.0
9.5
9.0
8.5
8.0
7.5
7.0
6.5
6.0
5.5

2000

2004

2008

2012

2016

100
80
60
40
20
0
−20
−40
−60
−80
−100

2020

Source: Federal Reserve Board, Senior Loan Officer Opinion
Survey on Bank Lending Practices; Federal Reserve Board staff
calculations.

1-15. Farmland Prices
2019 dollars per acre
annual

7000
6000

midwest index
united States

5000
4000

median

3000
2000
1000

1970

1980

1990

2000

2010

2020

Source: Department of Agriculture; Federal Reserve Board staff
calculations.

22 Asset Valuations

1-16. Farmland Price-to-Rent Ratio
ratio
annual

midwest index
united States

30
25
20
median

15
10

1970

1980

1990

2000

2010

2020

Source: Department of Agriculture; Federal Reserve Board staff
calculations.

House price growth accelerated over the
summer, while the price-to-rent ratio
remains slightly above its long-run trend
Since the previous Financial Stability Report,
average house price growth has accelerated
somewhat (figure 1-17). Nationwide, prices
appear to be a little above their long-run
average relationship with property rents
(figure 1-18). Housing price-to-rent ratios
continued to vary significantly across regional
markets (figure 1-19).

1-17. Growth of Nominal Prices of Existing Homes
12-month percent change
monthly

Zillow
CoreLogic

1-18. Housing Price-to-Rent Ratio
Trend at July 2020 = 100
monthly

10
5

aug.

July

Price-to-rent ratio

0
−5

Long-run
trend

−10
−15
2012

2014

2016

2018

2020

Source: CoreLogic Real Estate Data; Zillow, Inc., Zillow Real
Estate Data.

1984

1990

1996

2002

2008

2014

150
140
130
120
110
100
90
80
70
60

2020

Source: For house prices, CoreLogic; for rent data, Bureau of
Labor Statistics.

1-19. Selected Local Housing Price-to-Rent Ratio Indexes
Jan. 2010 = 100
monthly
Phoenix
miami
Los angeles
median
middle 80 percent of markets

aug.

240
220
200
180
160
140
120
100
80
60
40

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Source: For house prices, CoreLogic Real Estate Data; for rent data, Bureau of Labor Statistics.

The strength in the housing sector reflects robust demand from households and is being supported by the low level of interest rates. However, downside risk remains, given the unusually
large number of mortgage loans in forbearance programs and the uncertainty around their
ultimate repayment.

2. Borrowing by Businesses and Households
Historically high levels of business debt and the weakening in household finances could
pose a significant medium-run vulnerability for the financial system
Vulnerabilities arising from business debt, which were already elevated at the start of the
pandemic, have grown further. Business debt levels increased notably earlier this year as
businesses borrowed heavily to weather the pandemic-related shutdowns. However, some of
that debt was extended through the PPP and may be eligible for forgiveness, and the low level
of interest rates means that businesses can carry more debt. In contrast to business borrowing, household borrowing advanced more slowly than overall economic activity before
the COVID-19 crisis and remained heavily concentrated among borrowers with high credit
scores. As a result, vulnerabilities arising from household debt were at more modest levels on
the eve of the shock; nonetheless, a substantial number of households are facing increasing
financial distress.
Table 2 shows the amounts outstanding and recent historical growth rates of forms of debt
owed by nonfinancial businesses and households as of the end of the second quarter of 2020.
Total outstanding private credit was split about evenly between businesses and households,
with businesses owing $17.6 trillion and households owing about $16.1 trillion.

Accelerating debt growth and the decline in gross domestic product in the second
quarter led to a sharp increase in the ratio of credit to gross domestic product
Before the onset of the pandemic, the combined total debt owed by businesses and households expanded at a pace similar to that of nominal GDP for several years. Between the end
of 2019 and June, credit growth accelerated and reached about 9 percent in annualized terms,
mostly reflecting strong business borrowing. The precipitous drop in GDP following the
outbreak and the increase in business borrowing have caused a dramatic rise in the creditto-GDP ratio to historical highs (figure 2-1). The household debt-to-GDP ratio had fallen
steadily over the long expansion but has jumped recently, returning to levels last seen in 2012
(figure 2-2).

Business debt outstanding has grown rapidly so far in 2020 as companies take
advantage of low interest rates to bolster cash reserves needed to manage through
the pandemic
Borrowing by businesses, likely seeking to bridge pandemic-related interruptions to revenues,
was extremely high in the first half of 2020 (figure 2-3). Most of the growth in the first quarter was driven by a surge in bank credit-line draws in March, while the growth in the second
quarter was driven by very strong corporate bond issuance and by approximately $500 billion in loans extended under the PPP. However, a significant fraction of the PPP loans may
be eligible for forgiveness, as noted earlier, and banks’ loan extensions not tied to the PPP

24 Borrowing by Businesses and Households

Table 2. Outstanding Amounts of Nonfinancial Business and Household Credit
Outstanding
(billions of dollars)

Item

Growth,
2019:Q2–2020:Q2
(percent)

Average annual growth,
1997–2020:Q2
(percent)

Total private nonfinancial credit

33,669

6.7

5.7

Total nonfinancial business credit

17,604

10.5

6.2

11,041

11.2

5.6

Bonds and commercial paper

7,126

9.4

6.1

Bank lending

1,684

25.7

4.5

Leveraged loans*

1,126

−.6

14.3

Noncorporate business credit

6,564

9.3

7.6

Commercial real estate

2,551

5.7

6.2

16,065

2.8

5.2

10,592

3.0

5.4

Consumer credit

4,079

4.8

Student loans

1,677

4.0

8.9

Auto loans

1,198

3.1

4.9

954

−8.0

2.3

19,487

−6.0

3.7

Corporate business credit

Total household credit
Mortgages

Credit cards
Nominal GDP

Note: The data extend through 2020:Q2. Growth rates are measured from Q2 of the year immediately preceding the period through Q2 of
the final year of the period. The table reports the main components of corporate business credit, total household credit, and consumer credit.
Other, smaller components are not reported. The commercial real estate (CRE) row shows CRE debt owed by both corporate and noncorporate
businesses. The total household-sector credit includes debt owed by other entities, such as nonprofit organizations. GDP is gross domestic
product.
* Leveraged loans included in this table are an estimate of the leveraged loans that are made to nonfinancial businesses only and do not
include the small amount of leveraged loans outstanding for financial businesses. The amount outstanding shows institutional leveraged loans
and generally excludes loan commitments held by banks. For example, lines of credit are generally excluded from this measure. The average
annual growth rate shown for leveraged loans is computed from 2000 to 2020:Q2, as this market was fairly small before 2000.
Source: For leveraged loans, S&P Global, Leveraged Commentary & Data; for GDP, Bureau of Economic Analysis, national income and
product accounts; for all other items, Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States.”

2-1. Private Nonfinancial-Sector Credit-to-GDP Ratio
ratio

2.0

Quarterly
Q2

1.7
1.4
1.1
0.8

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017

2020

Source: Federal Reserve Board staff calculations based on Bureau of Economic Analysis, national income and product accounts, and
Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States.”

FINANCIAL STABILITY REPORT: NOVEMBER 2020 25

2-2. Nonfinancial Business- and Household-Sector Credit-to-GDP Ratios
1.1

ratio

ratio
Quarterly

1.0
0.9
0.8
0.7

0.6

Nonﬁnancial business
(right scale)
Household (left scale)

0.5
0.4
0.3
1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017

0.95
0.90
0.85
0.80
0.75
0.70
0.65
0.60
0.55
0.50
0.45
0.40

2020

2-3. Growth of Real Aggregate Debt of the
declined in the second and third quarters as
Business Sector
some firms started to repay their credit lines
Percent change, annual rate
and as the loan supply tightened. Firms’ liquid
20
Quarterly
Q2
assets increased notably in the first and second
15
quarters, suggesting that firms were keeping
10
their borrowed funds largely as a buffer. More5
over, historically low interest rates continue to
somewhat mitigate investor concerns about
0
default risks arising from high leverage. The
−5
net issuance of riskier forms of business debt—
−10
high-yield bonds and institutional leveraged
2002
2008
2014
2020
loans—had remained high overall through 2019
Source: Federal Reserve Board, Statistical Release Z.1,
“Financial Accounts of the United States.”
but slowed during the acute market strains
earlier this year. In the second quarter, net
issuance of high-yield bonds rebounded, while leveraged loan net issuance contracted. In
the third quarter, both high-yield bond and leveraged loan net issuances returned to roughly
average historical levels (figure 2-4).

2-4. Net Issuance of Risky Business Debt
Billions of dollars
Quarterly

Institutional leveraged loans

110
90

High-yield and unrated bonds

70
Q3

50
30
10
−10
−30
−50

2004

2006

2008

2010

2012

2014

2016

Source: Mergent, Fixed Income Securities Database; S&P Global, Leveraged Commentary & Data.

2018

2020

26 Borrowing by Businesses and Households

After significantly increasing in the aftermath of the pandemic, business debt
vulnerabilities have moderated more recently but appear high relative to their
historical range
An indicator of the leverage of large businesses—the ratio of debt to assets for all publicly
traded nonfinancial firms—was at its highest level in 20 years at the end of the second quarter (figure 2-5).7 An alternative indicator of business leverage that subtracts cash holdings
from debt—net leverage—also remains near 20-year highs, but it ticked down in the second
quarter as firms’ cash position improved.
2-5. Gross Balance Sheet Leverage of Public Nonfinancial Businesses
Percent
Quarterly

55
50

75th percentile

45
Q2

40
35

all ﬁrms

30
25
20

2002

2005

2008

2011

2014

2017

2020

Source: Federal Reserve Board staff calculations based on S&P Global, Compustat.

Despite lower interest rates, the ratio of earnings to interest expenses (the interest coverage
ratio) dropped sharply in the second quarter. The decrease was driven by the significant
earnings declines as a result of the COVID-19 outbreak. The interest coverage ratio for the
median firm is now down to its historical median, and the ratio is negative for many firms
because of negative earnings (figure 2-6).
2-6. Interest Coverage Ratios for Public Nonfinancial Businesses
ratio
median
25th percentile

Quarterly

5
4
3
2

1
0
−1
−2

2002

2005

2008

2011

2014

2017

2020

Source: Federal Reserve Board staff calculations based on S&P Global, Compustat.

The dashed sections in the series in the first quarter of 2019 reflect a structural break due to a new accounting standard that
requires operating leases, previously considered off-balance-sheet activities, to be included in measures of debt and assets.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 27

In part reflecting the declines in earnings, credit quality deteriorated notably after the
onset of the pandemic but showed signs of stabilization, particularly among large firms,
in the third quarter. The pace of corporate bond downgrades was elevated through the
spring but slowed considerably in the summer. At the end of the third quarter, about half
of nonfinancial investment-grade debt outstanding was rated in the lowest category of the
investment-grade range (triple-B)—near an all-time high. As has been mentioned in previous Financial Stability Reports, widespread downgrades of investment-grade bonds to
speculative-grade ratings could lead investors to accelerate the sale of downgraded bonds,
possibly generating market dislocations and downward price pressures in a segment of the
corporate bond market known to exhibit relatively low liquidity. Expected bond defaults
rose sharply in March to the highest post-crisis levels and, while they have moved down since
then, remain above their long-term medians. However, only about 5 percent of outstanding
bonds are due within one year, and less than 20 percent of outstanding bonds are due within
three years.
Vulnerabilities in the leveraged loan market appear to have lessened somewhat since May,
especially for sectors less affected by COVID-19 and for large firms. The share of newly
issued loans to large corporations with high leverage—defined as those with ratios of debt
to earnings before interest, taxes, depreciation, and amortization greater than 6—dropped
in the first quarter but returned in the second and third quarters to the historical highs
reached in recent years (figure 2-7). While realized defaults have increased since May, there is
some evidence that expected future defaults have decreased over this time frame (figure 2-8).
Moreover, downgrades of leveraged loans, which rose sharply in the second quarter, slowed
significantly in the third quarter and have returned to pre-pandemic levels. This evidence
suggests a more stable outlook for future defaults than in May.
2-7. Distribution of Large Institutional Leveraged
Loan Volumes, by Debt-to-EBITDA Ratio
Percent
Debt multiples ≥ 6x
Debt multiples 5x−5.99x
Debt multiples 4x−4.99x
Debt multiples ≤ 4x

2-8. Default Rates of Leveraged Loans
Percent
160

monthly

140
Q3

120

100

80
60

Sept.

40
0
2005

2008

2011

2014

2017

2020

Source: S&P Global, Leveraged Commentary & Data.

4
2
0

20
2002

−2
1999 2002 2005 2008 2011 2014 2017 2020

Source: S&P Global, Leveraged Commentary & Data.

Small businesses have been substantially more affected to date by the effects of
COVID-19, and strains associated with the performance of small business debt may
worsen significantly
Credit quality for small businesses has worsened notably since the COVID-19 outbreak
and has not yet stabilized, with many small businesses closing or scaling back operations

28 Borrowing by Businesses and Households

significantly during the crisis. Short- and long-term delinquencies at small businesses in
August were at elevated levels last seen in 2011. Many small businesses relied on PPP loans
to weather the pandemic-related period of low earnings, but the PPP ceased extending
loans in August. Survey evidence suggests that credit availability has tightened for small
businesses. Moreover, many small businesses report having scarce cash on hand and anticipate financial strains in coming months as they exhaust PPP funds and as accommodation
measures expire.

While stresses on households have grown, credit quality has been supported by new and
expanded government programs that have lifted household incomes
Although households were generally in sound financial condition before the pandemic, they
have experienced a significant loss in earnings due to the spike in unemployment and business closures. Moreover, job losses were heavily concentrated among the most financially
vulnerable, including lower-wage workers, young people, women, and minorities. The deterioration in household credit quality to date was mitigated by new and enlarged government
programs that have supported household incomes—including expanded unemployment
insurance and direct stimulus payments in the CARES Act—and by a moderate improvement in economic activity. However, most COVID-related support for households has
already expired or will expire in the coming months, which risks increasing financial stress
for many low- to moderate-income households. Strains associated with the performance of
household debt may worsen significantly and affect lenders throughout the financial system.

Borrowing by households continued rising at a modest pace in the first half of 2020,
with new extensions of credit skewed toward prime-rated borrowers . . .
2-9. Total Household Loan Balances
Billions of dollars (real)

10600
9800
9000
8200
7400
6600
5800
5000
4200
3400
2600
Q3
1800
1000

Quarterly

Prime
Near prime
Subprime
2000

2004

2008

2012

2016

2020

Source: Federal Reserve Bank of New York Consumer Credit
Panel/Equifax; Bureau of Labor Statistics, consumer price index
via Haver Analytics.

Through September of this year, household debt (after an adjustment for general
price inflation) edged higher, on net, with
debt owed by households with prime credit
scores continuing to account for most of
the growth. By contrast, inflation-adjusted
loan balances for the remaining one-half of
borrowers with near-prime and subprime
credit scores have changed little since 2014
(figure 2-9).

. . . but the sudden increase in unemployment in the spring and sharp decline in earnings
have led to a sharp rise in the share of mortgages that are either delinquent or in loss
mitigation . . .
Mortgage debt accounts for roughly two-thirds of total household credit, with mortgage
extensions skewed toward prime borrowers in recent years (figure 2-10). Although many
households are facing substantial losses in earnings, widespread loss-mitigation measures

FINANCIAL STABILITY REPORT: NOVEMBER 2020 29

2-10. Estimate of New Mortgage Volume to Households
Billions of dollars (real)
annual

Subprime
Near prime
Prime

1400
1200
1000
800
600
400
200
0

2002
2005
2008
2011
2014
2017
2020
Source: Federal Reserve Bank of New York Consumer Credit Panel/Equifax; Bureau of Labor Statistics, consumer price index via Haver
Analytics.

2-11. Mortgage Loss Mitigation and Delinquency
have helped damp the effect of COVID-19 on
8
Percent
mortgage delinquencies (figure 2-11). The
10
Delinquent/loss
mitigation
percentage of mortgages that are either delinQuarterly/monthly
8
quent or in loss mitigation stood at 7 percent
6
in August, below the 2007–09 financial crisis
peak of 9 percent, with the caveat that, unlike
Delinquent
4
aug.
during the Great Recession, most are currently
2
in a loss-mitigation program rather than being
0
delinquent. Note also that some borrowers in
loss mitigation have kept making mortgage
2002 2005 2008 2011 2014 2017 2020
payments. Although the severe decline in
Source: Federal Reserve Bank of New York Consumer Credit
Panel/Equifax.
economic activity and tightening of lending
standards originating from the COVID-19
shock might put downward pressure on house prices, at the end of the second quarter, the
estimated share of outstanding mortgages with negative equity is very low (figure 2-12).
The ratio of outstanding mortgage debt to home values at the end of the second quarter
remains at the level seen in the relatively calm housing market of the late 1990s (figure 2-13).
2-12. Estimate of Mortgages with Negative Equity
Percent
Zillow
CoreLogic

40
30

2-13. Estimates of Housing Leverage
1999:Q1 = 100
Quarterly

150
140

relative to modelimplied values

relative to
market value

130
120

110
100

June

0
2012

2014

Source: CoreLogic; Zillow.

2016

2018

2020

90
70

2000

2004

2008

2012

2016

2020

Source: Federal Reserve Bank of New York Consumer Credit
Panel/Equifax; CoreLogic; Bureau of Labor Statistics via Haver
Analytics.

Loss mitigation is a broad term that describes a variety of loan relief programs implemented by banks to help borrowers
cope with payments, including the loan forbearance programs described in the May Financial Stability Report, payment
deferrals (including partial payment deferrals), loan modifications (including federal government plans), and loans with zero
scheduled payments and a nonzero balance.

30 Borrowing by Businesses and Households

Higher levels of homeowner equity generally reduce the likelihood of borrower defaults
and provide lenders with a degree of protection against credit losses even as borrowers take
advantage of loss-mitigation measures. These considerations lessen concerns that a deterioration in lenders’ balance sheets might impede future credit issuance and further worsen the
economic outlook.

. . . and some households are struggling to make debt payments
2-14. Consumer Credit Balances
Billions of dollars (real)
Quarterly

1800
1600

Student loans

1400
Q3

1200
1000
800

Credit cards

auto loans

600
400

The remaining one-third of total debt owed
by households, commonly referred to as consumer credit, consists mainly of student loans,
auto loans, and credit card debt (figure 2-14).
Table 2 shows that consumer credit rose
0.8 percent over the year ending in the second
quarter and currently stands at a little more
than $4 trillion.

200

Borrowers with subprime credit scores
accounted for about one-fifth of outstanding auto loan balances as of the end of the
third quarter (figure 2-15). Despite the long
economic expansion and low interest rates,
delinquency rates on auto loans for subprime borrowers were elevated during the past several years. In response to the COVID-19 outbreak, the share of auto loans that were either
delinquent or in loss mitigation jumped and, by August, was about 50 percent higher than
the share observed in January, although this share is notably down from May and June
(figure 2-16). Similar to mortgage borrowers, many—but not all—auto loan borrowers in
loss mitigation have stopped making payments. As of August, 4.5 percent of all auto loan
borrowers had not made a payment since at least April.
2000

2004

2008

2012

2016

2020

Source: Federal Reserve Bank of New York Consumer Credit
Panel/Equifax; Bureau of Labor Statistics, consumer price index
via Haver Analytics.

2-16. Auto Loss Mitigation and Delinquency

2-15. Auto Loan Balances
Billions of dollars (real)
Quarterly

Q3
Near prime

Prime

Subprime
2000

2004

2008

2012

2016

750
700
650
600
550
500
450
400
350
300
250
200
150

2020

Source: Federal Reserve Bank of New York Consumer Credit
Panel/Equifax; Bureau of Labor Statistics, consumer price index
via Haver Analytics.

Percent

Quarterly/monthly

8
Delinquent/loss mitigation

6
4

Delinquent

aug.

2
0

2002

2005

2008

2011

2014

2017

2020

Source: Federal Reserve Bank of New York Consumer Credit
Panel/Equifax.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 31

Consumer credit card balances contracted sharply in response to depressed consumer spending and declines in credit card utilization rates (figure 2-17). Subprime and near-prime borrowers, taken together, account for about half of consumer credit card balances. The share of
credit card balances in delinquency fell since May (figure 2-18). This improved performance
is likely driven in part by COVID-related accommodations provided by lenders.
2-17. Credit Card Balances

2-18. Credit Card Delinquency Rates

Billions of dollars (real)
Quarterly

Prime

Near prime

Subprime

2000

2004

2008

2012

2016

500
450
400
350
300
250
200
150
100
50

2020

Source: Federal Reserve Bank of New York Consumer Credit
Panel/Equifax; Bureau of Labor Statistics, consumer price index
via Haver Analytics.

Percent
Quarterly

30
25
20
15

Subprime
Near prime

Prime

5
0

2002

2008

2014

2020

Source: Federal Reserve Bank of New York Consumer Credit
Panel/Equifax.

Finally, the already elevated delinquency rates on student loans highlight the state of
finances for some households going into the COVID-19 outbreak. The risk that student loan
debt poses to the financial system appears limited at this time; the majority of loans were
issued through government programs, and protections originally introduced in the CARES
Act, which were later extended, guarantee payment forbearance and stop interest accrual
through December 31.

32 Borrowing by Businesses and Households

A Retrospective on the March 2020 Turmoil in Treasury and MortgageBacked Securities Markets
The U.S. Treasury market and the market for agency residential mortgage-backed securities (RMBS)
are among the most liquid securities markets in the world. These markets are critical to the overall
functioning of the financial system and to the effective transmission of monetary policy to the broader
economy. Many companies and investors treat Treasury securities as risk-free assets, almost as cash,
and expect to be able to quickly sell them to raise money to meet any need for liquidity. In mid-March,
however, as the effects of the COVID-19 pandemic on financial markets intensified, Treasury and
RMBS markets experienced severe dislocations and market functioning became unusually strained.
Intense and widespread selling pressures in a context of unprecedented uncertainty appeared to strain
dealers’ intermediation capacity or willingness to absorb further sales and intermediate in both markets. The Federal Reserve responded through a series of policy actions aimed at supporting smooth
market functioning. Following these actions, the acute stresses receded, and market functioning has
since largely been restored. We look back at the March events and examine the roles of some institutional participants—in particular, foreign institutions, hedge funds, mortgage REITs (mREITs), principal
trading firms (PTFs), and dealers—which have all been reported as having contributed significantly to
the March turmoil. A range of other institutional investors, such as mutual funds, may also have contributed to the turmoil and is the subject of ongoing analysis.

The March turmoil
In late February and early March, as fears about the economic effects of the coronavirus intensified
and investors moved into the safety of U.S. Treasury securities, Treasury yields fell sharply, and agency
RMBS spreads widened (figure A). Daily trading volumes in both on- and off-the-run securities in the
Treasury market increased substantially, and daily volumes in the agency RMBS market also spiked.1
Consistent with previous episodes of heightened volatility, measures of trading costs increased notably; for example, indicative bid-ask spreads for the 10-year on-the-run and first and second off-the-run
Treasury securities began to rise sharply (figure B).
Figure a. Yields on Nominal Treasury Securities and agency rmBS Spread
4

Percent

Basis points

Daily

200

10-year yield (left scale)
30-year yield (left scale)
Agency RMBS spread (right scale)

150

100

Jan.

Feb.

2020

Mar.

Apr.

Source: Federal reserve Bank of New York; Federal reserve Board staff calculations; JPmorgan Chase & Co.

(continued)

In general, the most recently issued Treasury securities are the most frequently traded and thus the most liquid. These securities are
known as “on the run” securities, while less recent issues are called “off the run” securities.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 33

Figure B. 10-Year Indicative Bid-ask Spreads
Cents per $100

Asset
Asset
purchases purchases
announced expanded

Daily

On-the-run bid-ask spread
First off-the-run bid-ask spread
Second off-the-run bid-ask spread

40
30
20
10

Jan.

Feb.

Mar.

Apr.

2020
Source: Federal reserve Bank of New York, New Price Quote System.

Trading conditions deteriorated rapidly in the second week of March as a range of investors sought to
sell Treasury securities, particularly those viewed as less liquid, in order to raise cash. Amid unusually
poor market functioning and extreme volatility, Treasury yields increased (as shown in figure A), while
agency RMBS spreads widened sharply. While trading volumes of both securities remained robust,
bid-ask spreads widened dramatically, particularly for off-the-run Treasury securities (as shown in
figure B). Stresses soon spilled over into the more liquid on-the-run segment of the Treasury market as
well as into the Treasury futures market. Stresses were also evident in a breakdown of the usually tight
link between Treasury cash and futures prices, with the Treasury cash–futures basis—defined as the
difference between prices of Treasury futures contracts and prices of Treasury cash securities eligible
for delivery into those futures contracts—widening notably.

The Federal Reserve’s actions to support market functioning
The Federal Reserve took a number of steps to support smooth market functioning. First, between
March 9 and March 17, the Federal Reserve expanded its overnight and term repo operations to
address disruptions in Treasury financing markets and ensure that the supply of reserves remained
ample. Second, on March 15, the Federal Open Market Committee (FOMC) authorized the purchase of
at least $500 billion and $200 billion of Treasury securities and agency RMBS securities, respectively,
and on March 23, the FOMC announced it would expand the size of asset purchases in the amounts
needed to support smooth market functioning. Third, on March 17, the Federal Reserve established
the PDCF to support dealer-intermediated markets by expanding primary dealers’ access to term
funding against a wide range of collateral. Fourth, on March 31, the Federal Reserve established the
FIMA (Foreign and International Monetary Authorities) Repo Facility to give central banks and other
international monetary authorities the ability to access dollars for liquidity purposes without having to
sell their Treasury securities outright. This facility complemented the additional provision of dollar funding through the expansion and enhancement of dollar liquidity swap lines announced by the Federal
Reserve and several other central banks during the third week of March. Finally, on the regulatory front,
on April 1, the Federal Reserve announced a temporary change in its supplementary leverage ratio rule
by excluding U.S. Treasury securities and reserve balances from the calculation of the ratio for BHCs.2
(continued on next page)
2

For an overview of these and other Federal reserve actions to mitigate the economic effects of the CoVID-19 pandemic, see the box
“The Federal reserve’s monetary Policy actions and Facilities to Support the economy since the CoVID-19 outbreak” in Board of
Governors of the Federal reserve System (2020), Financial Stability Report (washington: Board of Governors, may), pp. 9–15,
https://www.federalreserve.gov/publications/files/financial-stability-report-20200515.pdf.

34 Borrowing by Businesses and Households

A Retrospective on the March 2020 Turmoil (continued)
While these actions helped support smooth market functioning, it is important to identify and better
understand the drivers behind the March turmoil. To do so, we next provide a (necessarily preliminary)
discussion of the likely roles played by several important groups of market participants as the March
events unfolded.

The role of foreign institutions
Large-scale sales of U.S. Treasury securities by foreign investors likely contributed to the March
turmoil. Indeed, based on Treasury International Capital data, foreign investors are estimated to have
sold a record amount of more than $400 billion of Treasury securities in March.3 More than half of this
decline reflected liquidations by foreign official institutions, as foreign central banks sought to raise
U.S. dollar cash in order to hold precautionary liquidity and to intervene in foreign exchange (FX) markets. The precautionary demand was reflected in a sizable March increase in deposits in the Federal
Reserve’s foreign repo pool. The introduction of the temporary FIMA Repo Facility helped broaden the
reach of the Federal Reserve’s provision of U.S. dollar liquidity overseas beyond its dollar swap lines
and contributed to the stabilization in the U.S. Treasury market.

The role of hedge funds
Treasury market functioning over this period may also have been affected by the activities of hedge
funds, particularly those engaged in relative value (RV) trades. These trades, which generally involve
trading to take advantage of small price differences between Treasury cash securities and futures,
between on-the-run and off-the-run Treasury securities, and between Treasury securities and MBS,
align the relative prices of these assets and typically promote market functioning. They usually entail
investors being long in one instrument and short in the other.4 For instance, the Treasury cash–futures
basis trade consists of a long cash Treasury position and a short position in a Treasury futures contract
with a similar maturity. These trades often involve significant leverage, which is obtained by financing
the cash Treasury position in repo markets. Under normal circumstances, this type of trading activity
acts to keep the cash–futures basis narrow.
In late February and early March, as Treasury market volatility increased, repo rates rose, and the
Treasury cash–futures basis began to widen, many RV hedge funds reportedly reduced their Treasury
positions as they unwound their basis trades, which may have contributed to further basis widening.5
Indeed, market commentary has pointed to the sale of Treasury positions by RV funds exiting their
basis trades and their sudden role reversal from net buyers of less liquid Treasury securities to net sellers as principal factors contributing to the Treasury market dislocations in mid-March. However, due
to a lack of comprehensive data on hedge funds’ Treasury cash and derivatives positions, it is unclear
what the actual volume of Treasury sales by RV hedge funds was in March and how large a role RV
funds played in amplifying the March Treasury market illiquidity.
(continued)

See also Carol Bertaut and ruth Judson (2014), “estimating u.S. Cross-Border Securities Positions: New Data and New methods,”
International Finance Discussion Papers 1113 (washington: Board of Governors of the Federal reserve System, august),
https://www.federalreserve.gov/pubs/ifdp/2014/1113/ifdp1113.pdf.

If investors have a long position, they have bought and own the asset, while if they have a short position, they have sold the asset but
do not yet own it.

Hedge fund deleveraging was reportedly due in part to a combination of factors, including increased margin requirements on futures
positions, margin calls on losing trades, and compliance with internal risk-management practices.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 35

That said, a set of proxy indicators can be used to shed some light on hedge funds’ arbitrage activity
in March. For instance, a measure of U.S. hedge funds’ holdings of Treasury securities published in
the Enhanced Financial Accounts of the United States indicates that hedge funds reduced their cash
Treasury positions by about $35 billion (or 3 percent) in the first quarter of the year, consistent with the
narrative that hedge fund selling contributed to the Treasury market selloff.6
On the futures side of the basis trade, data from the Commodity Futures Trading Commission show
that leveraged funds, including hedge funds, had sizable net short positions in Treasury futures contracts before the COVID-19 outbreak. In March, leveraged funds reduced their net short futures positions by about $80 billion, suggesting that hedge funds unwound some of their Treasury cash–futures
basis trades.7
In addition, most RV funds’ basis trades require funding, which is typically provided by dealers through
repo. Supervisory data indicate that hedge fund Treasury financing from dealers increased in late February through late March, suggesting that dealers continued to finance hedge fund Treasury activities
even as market volatility spiked. Similarly, in the June Senior Credit Officer Opinion Survey on Dealer
Financing Terms (SCOOS), dealers reported no changes in funding volume collateralized by Treasury
securities to RV funds in mid-March relative to mid-February volumes. However, about one-fourth of
dealers reported that demand for Treasury financing by these funds increased during the selloff, while a
similar fraction of dealers indicated that the availability of such financing decreased. Together, supervisory data and the SCOOS results suggest that the decline in hedge funds’ Treasury holdings, in the
aggregate, was likely not driven by their inability to finance these positions.
In sum, the reduction in hedge fund Treasury positions may have contributed notably to Treasury market volatility in mid-March amid a massive repositioning by a wide range of investors. However, so far,
the evidence that large-scale deleveraging of hedge fund Treasury positions was the primary driver of
the turmoil remains weak.

The role of mortgage real estate investment trusts
Similar to the Treasury market, liquidity in the agency RMBS market deteriorated significantly in March.
Reportedly contributing to the March turmoil were mREITs, which are leveraged investment companies that invest in pools of agency RMBS and other mortgage-backed assets.8 Such firms primarily
fund their holdings of these long-maturity assets using short-term borrowing in the agency RMBS
repo market through dealers. At the same time, they typically hedge their interest rate risk by taking
short positions in Treasury securities or swaps (or both). As a result, mREITs have leveraged exposures
to RMBS–Treasury spreads and RMBS–swap spreads, financed by repo loans that can be rapidly
withdrawn.
As RMBS spreads began to widen in late February and spread volatility rose, mREITs’ hedges fell in
value, triggering margin calls. Because mREITs generally maintain low levels of unencumbered assets
that can be used to satisfy the increased margin requirements, the margin calls likely precipitated the
(continued on next page)
6

Quarterly hedge fund balance sheet estimates in the enhanced Financial accounts are based on the Securities and exchange Commission Private Funds Statistics form and reflect hedge funds’ positions in cash Treasury securities. See Board of Governors of the
Federal reserve System (2020), “enhanced Financial accounts: Hedge Funds,” webpage, https://www.federalreserve.gov/releases/
efa/efa-hedge-funds.htm.

of note, although the decline in leveraged funds’ Treasury futures positions was significant, it was not outsized relative to the volatility
of the positions in previous months.

mBS holdings of mreITs predominantly consist of agency securities.

36 Borrowing by Businesses and Households

A Retrospective on the March 2020 Turmoil (continued)
unwinding of some of the mREITs’ agency RMBS positions. The substantial forced selling and rapid
deleveraging intensified stresses in the agency RMBS market and contributed to a further widening
of spreads, creating a feedback loop between spread widening and forced deleveraging of mREITs’
portfolios. However, following the Federal Reserve’s March 23 announcement of increased purchases
of Treasury securities and agency RMBS, agency RMBS market functioning improved considerably,
with agency RMBS spreads rapidly tightening and spread volatility slowly diminishing. By late March,
the pace of agency RMBS selling from mREITs and other levered investors had slowed substantially.

The role of principal trading firms
PTFs are active in the electronic segments of the Treasury cash and futures markets, where trading
takes place using a central limit order book (CLOB).9 In the cash market, PTFs predominantly transact
in the most liquid on-the-run Treasury securities. PTFs, along with some dealers, are known to adopt
high-speed automated trading strategies that account for a significant share of trading and liquidity
provision.10 The 2015 Joint Staff Report showed that in previous periods of market stress, PTFs have
contributed to keeping quoted bid-ask spreads in these parts of the Treasury market relatively tight.11
More precisely, PTFs—and dealers employing high-speed trading technology—are able to keep
spreads tight by reducing posted depth and replenishing the order book faster to manage their exposure to volatility.
During the March turmoil, however, unprecedented strains were also witnessed in the on-the-run
segment of the Treasury market, with market depth plummeting and quoted bid-ask spreads widening
sharply, raising questions about the role of PTFs in the turmoil (figure C). Some research suggests that
the observed widening in bid-ask spreads for on-the-run Treasury securities during the March events
points to an unusual reduction in the speed with which high-speed trading entities were replenishing
quotes on the order book in response to trades.12 Order book replenishment was not sufficiently fast
to avoid significantly heightened bid-ask spread levels and increased volatility as PTFs and other
high-speed trading entities scaled down Treasury market-making activity, in aggregate. The reduction
in high-speed market-making activity appears to have contributed to the spread of pandemic-related
stresses to even the most liquid segments of financial markets. The reasons behind this reduction
(continued)
9

on a CLoB, participants can post quotes for buying and selling securities, with incoming orders matched to outstanding quotes using
an electronic matching engine.

PTFs have become increasingly important in electronic Treasury markets over the past several years. They now account for the majority of traded volumes on electronic interdealer broker platforms in the Treasury market, playing an important role in the provision of
liquidity by posting quotes and replenishing those quotes quickly. See Doug Brain, michiel De Pooter, Dobrislav Dobrev, michael Fleming, Pete Johansson, Collin Jones, Frank keane, michael Puglia, Liza reiderman, Tony rodrigues, and or Shachar (2018), “unlocking
the Treasury market through TraCe,” FeDS Notes (washington: Board of Governors of the Federal reserve System, September 18),
https://www.federalreserve.gov/econres/notes/feds-notes/unlocking-the-treasury-market-through-trace-20180928.htm; and James
Collin Harkrader and michael Puglia (2020), “Principal Trading Firm activity in Treasury Cash markets,” FeDS Notes (washington: Board
of Governors of the Federal reserve System, august 4), https://www.federalreserve.gov/econres/notes/feds-notes/principal-tradingfirm-activity-in-treasury-cash-markets-20200804.htm.

For further details, see u.S. Department of the Treasury, Board of Governors of the Federal reserve System, Federal reserve Bank of
New York, u.S. Securities and exchange Commission, and u.S. Commodity Futures Trading Commission (2015), Joint Staff Report:
The U.S. Treasury Market on October 15, 2014 (washington: Treasury, Board of Governors, FrBNY, SeC, and CFTC, July),
https://www.treasury.gov/press-center/press-releases/Documents/Joint_Staff_report_Treasury_10-15-2015.pdf.

See Dobrislav Dobrev and andrew meldrum (2020), “what Do Quoted Spreads Tell us about machine Trading at Times of market
Stress? evidence from Treasury and FX markets during the CoVID-19-related market Turmoil in march 2020,” FeDS Notes (washington: Board of Governors of the Federal reserve System, September 25), https://www.federalreserve.gov/econres/notes/feds-notes/
what-do-quoted-spreads-tell-us-about-machine-trading-market-stress-march-2020-20200925.htm.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 37

Figure C. on-the-run market Depth
250

Millions of dollars
Daily

Millions of dollars
5-year (left scale)

10-year (left scale)

30-year (right scale)

200

150

100

0
Jan.

Feb.

Mar.

Apr.

2020

Source: repo interdealer broker community.

merit further analysis but would most likely include the considerably elevated economic uncertainty in
mid-March, the exceptionally high volatility of Treasury yields, and the breakdown in typical correlations within the Treasury market as well as between the prices of Treasury securities and other assets.

The role of dealers
Dealers play a central role in U.S. Treasury and agency RMBS markets by participating in primary
markets, buying and selling securities from clients, and providing Treasury and agency RMBS financing
to other market participants. Dealers were holding unusually high levels of these securities even before
the pandemic, reflecting in part strong Treasury issuance over recent years. Beginning in late February, as a wide range of investors, both domestic and foreign, rushed to obtain liquidity or to rebalance
their portfolios in the face of the pandemic, dealers absorbed large amounts of less liquid securities,
including off-the-run Treasury securities and agency RMBS, onto their balance sheets. By the second
week of March, amid expanding inventories, imbalanced client trading flows, and heightened volatility, some dealers reportedly reached their intermediation capacity or became increasingly unwilling to
absorb further sales.13 At the same time, investor demand for repo financing rose sharply, in particular
against Treasury collateral, putting further pressure on dealer balance sheets and pushing up dealer
funding costs.14 Market commentary pointed to dealer balance sheet constraints and their reluctance
to intermediate as important factors behind the deterioration in the functioning of Treasury and agency
RMBS markets in early March.
Following the expansion of the Federal Reserve’s asset purchases, dealer balance sheet pressures
eased in late March as dealers were able to offload some of their inventories, and Treasury and agency
RMBS market functioning improved. Indeed, dealer inventory holdings of U.S. Treasury securities
declined from their mid-March peak as the Federal Reserve’s Treasury purchases picked up, suggesting that asset purchases absorbed some of the Treasury securities that might have otherwise been
(continued on next page)

Limits on dealers’ intermediation capacity may be driven by their internal capital, liquidity, and risk-management practices; their compliance with regulations; or concerns over their profit and loss statements.

Dealers typically use repo to fund both their cash Treasury positions and their lending to clients through Treasury reverse repos. Thus,
the ability and willingness to engage in repo, which increases the size of dealers’ balance sheets, will affect their willingness to take on
additional inventories and provide lending through reverse repos.

38 Borrowing by Businesses and Households

A Retrospective on the March 2020 Turmoil (continued)
held on dealer balance sheets (figure D). Similarly, the increase in agency RMBS purchases following
the March 23 announcement coincided with some reduction in dealer inventories of agency RMBS
securities toward the end of March, indicating that the agency RMBS purchases also helped alleviate
balance sheet constraints related to agency RMBS.
Figure D. Fed uST Purchases and Dealer uST Inventory
280

Billions of dollars
Daily

260

Billions of dollars
Cumulative Fed UST purchases since March 1 (right scale)
UST inventory (left scale)

240
220
200
180
160

Mar. 5

Mar. 12

Mar. 19

Mar. 26

Apr. 2

Apr. 9

Apr. 16

Apr. 23

Apr. 30

1800
1600
1400
1200
1000
800
600
400
200
0

Source: Federal reserve Board, Form Fr 2052a, Complex Institution Liquidity monitoring report.

Overall, asset purchases were effective in freeing up dealer balance sheet capacity and improving
dealers’ willingness to intermediate these markets. Funding conditions for dealers also gradually
improved following the expansion of repo operations and the announcement of the PDCF, with borrowing rates for dealers declining notably. In addition, dealer Treasury financing volumes increased in
late March, indicating that dealers were able to use their spare balance sheet capacity to support their
clients’ activities.

Looking ahead
The functioning of Treasury markets, including the capacity of dealer balance sheets to absorb extraordinary flows, was discussed extensively at a recent conference sponsored by the members of the
interagency working group (the Board of Governors of the Federal Reserve System, the Commodity
Futures Trading Commission, the Federal Reserve Bank of New York, the Securities and Exchange
Commission, and the U.S. Treasury Department).15 Participants discussed a number of proposals to
ensure that dealer capacity could be used effectively in an environment of growing Treasury supply,
including the possibility of wider clearing in Treasury cash and repo markets and the potential for use
of “all to all” trading platforms that allow buyers and sellers to trade without a dealer intermediary.
Meanwhile, the Securities and Exchange Commission has proposed changes to Treasury market regulation that could encourage wider access to Treasury market trading platforms and thereby promote
forms of all-to-all trading.16

See Federal reserve Bank of New York (2020), “The 2020 u.S. Treasury market Conference,” press release, September 29,
https://www.newyorkfed.org/newsevents/events/markets/2020/0929-2020.

See Securities and exchange Commission (2020), “SeC Proposes rules to extend regulations aTS and SCI to Treasuries and other
Government Securities markets,” press release, September 28, https://www.sec.gov/news/press-release/2020-227.

3. Leverage in the Financial Sector
Leverage at banks and broker-dealers remains low; in contrast, measures of leverage
at life insurance companies are at post-2008 highs and remain elevated at hedge funds
relative to the past five years
Table 3. Size of Selected Sectors of the Financial System, by Types of Institutions and Vehicles
Total assets
(billions of dollars)

Growth,
2019:Q2–2020:Q2
(percent)

Average annual growth,
1997–2020:Q2
(percent)

Banks and credit unions

22,780

16.7

6.6

Mutual funds

16,776

9.1

Insurance companies

11,553

7.4

6.0

Life

8,828

7.7

6.1

Property and casualty

2,725

6.2

5.6

Hedge funds*

7,623

−3.0

7.3

Broker-dealers

3,507

4.8

10,492

5.3

5.4

Agency

9,725

5.2

5.9

Non-agency**

1,217

6.2

3.2

Item

Outstanding
(billions of dollars)
Securitization

Note: The data extend through 2020:Q2. Growth rates are measured from Q2 of the year immediately preceding the period through Q2 of the
final year of the period. Life insurance companies’ assets include both general and separate account assets.
* Hedge fund data start in 2012:Q4 and are updated through 2020:Q1.
** Non-agency securitization excludes securitized credit held on balance sheets of banks and finance companies.
Source: Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States”; Federal Reserve Board, “Enhanced
Financial Accounts of the United States.”

Banks continue to be well capitalized, though challenging conditions remain
The pandemic has tested the resilience of banks. The ratio of tangible capital—a measure of
bank equity that excludes items such as goodwill—to total assets at large banks decreased in
the first half of the year (figure 3-1). The common equity Tier 1 (CET1) ratio—a regulatory
risk-based measure of bank capitalization—also declined significantly in the first quarter
as many firms tapped credit lines at the onset of the pandemic, but the ratio recovered to
pre-pandemic levels in the second quarter for most banks as demand for bank credit waned
and earlier drawdowns were generally repaid. The initial decline in the CET1 capital ratio

40 Leverage in the Financial Sector

was also driven by a temporary pickup in risk-weighted assets related to banks’ trading operations amid heightened volatility in many financial markets. The CET1 capital ratio at both
the largest banks and other BHCs remained well above required minimum levels (figure 3-2).
3-1. Ratio of Tangible Bank Equity to Assets
Percent of total assets
Quarterly
Q2

12
10
8
6
4

other BHCs
Large non–G-SIBs
G-SIBs

2
0

1990

1996

2002

2008

2014

2020

Source: Federal Financial Institutions Examination Council, Consolidated Reports of Condition and Income (Call Report).

3-2. Common Equity Tier 1 Ratio of Banks
Percent of risk-weighted assets
Preliminary
Q3

Quarterly

16
14
12
10
8
6

other BHCs
Large non–G-SIBs
G-SIBs

4
2
0

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

Source: Federal Reserve Board, Form FR Y-9C, Consolidated Financial Statements for Holding Companies; Federal Reserve Board staff
calculations based on S&P Global Market Intelligence.

In June, the Federal Reserve released the results of the 2020 Dodd-Frank Act stress tests
and the Comprehensive Capital Analysis and Review along with a sensitivity analysis to
assess the resilience of large banks under three hypothetical downside scenarios that could
have resulted from the coronavirus event. The analysis under the more severe downside
scenarios, which did not incorporate the effects of planned capital distributions, showed
that most banks would remain well capitalized but several would approach their minimum
capital levels.9 Given the heightened uncertainty in the economy and markets at that time,
the Federal Reserve announced that it would require banks to resubmit their capital plans in
the fourth quarter of 2020. The scenarios to be used for the resubmission were released on
September 17, 2020, and the Federal Reserve will release bank-specific results of its inde-

See Board of Governors of the Federal Reserve System (2020), “Federal Reserve Board Releases Results of Stress Tests for
2020 and Additional Sensitivity Analyses Conducted in Light of the Coronavirus Event,” press release, June 25, https://www.
federalreserve.gov/newsevents/pressreleases/bcreg20200625c.htm.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 41

pendent assessment by the end of the year.10 The Federal Reserve also took steps in June
to restrict capital distributions in the third quarter by banks with more than $100 billion in
assets, including prohibiting share repurchases and limiting dividends based on the previous
four quarters of earnings. On September 30, the Federal Reserve voted to extend restrictions
to the fourth quarter.11
As of the second quarter of 2020, the credit quality of bank loans had deteriorated considerably. Commercial and industrial (C&I) and CRE loans in loss-mitigation programs increased
sharply in the second quarter and remain elevated, despite some recent moderation. The
credit quality of firms taking C&I loans continued to deteriorate through June, as measured
3-3. Borrower Leverage for Bank Commercial and
by credit rating downgrades, and remained one Industrial Loans
Debt as percent of assets
of the largest drivers of the increase in loan loss
36
Quarterly
provisions. Furthermore, as of the second quar34
ter of 2020, the leverage of firms that obtained
Q2
32
C&I loans from the largest banks stood at his30
torically high levels (figure 3-3). Credit quality
28
of CRE loans also continued to deteriorate, as
Non-publicly-traded ﬁrms
26
rental income declined, vacancies increased,
Publicly-traded ﬁrms
and consumer spending weakened, particularly
24
2014
2016
2018
2020
in COVID-affected properties such as hotels
Source: Federal Reserve Board, Form FR Y-14Q
and retail establishments. Consumer loans and
(Schedule H.1), Capital Assessments and Stress Testing.
mortgages in loss-mitigation programs also
increased.
Because of the implementation of loss-mitigation programs, government stimulus payments, and PPP loans, the true status of credit quality is not reflected in loan delinquencies.
As these programs expire, some of these accounts in loss mitigation could roll into and be
reflected in higher bank delinquency rates later this year and early next year, followed by
higher charge-off rates and losses. All told, a great deal of uncertainty about the future path
of these losses remains.
Allowances for loan losses surged in the first half of 2020 as large banks implemented the
current expected credit losses (CECL) accounting standard and reassessed their losses (especially in credit card loans and corporate lending) in light of the COVID-19 shock.12 Under
10

See Board of Governors of the Federal Reserve System (2020), “Federal Reserve Board Releases Hypothetical Scenarios for
Second Round of Bank Stress Tests,” press release, September 17, https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20200917a.htm.

See Board of Governors of the Federal Reserve System (2020), “Federal Reserve Board Announces It Will Extend for an
Additional Quarter Several Measures to Ensure That Large Banks Maintain a High Level of Capital Resilience,” press
release, September 30, https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200930b.htm.

Under accounting rules, banks prepare for possible loan losses before they actually occur. Loan loss provisions, in the bank’s
income statement, are expenses set aside for uncollected loan payments and are added to the allowance for loan and lease

42 Leverage in the Financial Sector

CECL accounting standards, banks must set aside allowances for the expected losses over
the life of a loan. Under the previous method, banks were not able to provision for loan
losses until later in a credit cycle, when the losses were incurred.
The increase in loan loss allowances along with the expectation that interest rates will remain
low for a longer time weakened the bank profitability outlook, a key factor in banks’ ability to accumulate equity capital. Net income contracted sharply in the first half of the year
because banks set aside a higher fraction of revenues as loan loss provisions and net interest
margins were compressed. An increase in trading and investment banking revenues partly
offset these downward pressures on income.

easing

Tightening

Data from the July 2020 SLOOS indicate that banks continued to tighten standards on C&I
loans in the second quarter (figure 3-4). Banks cited the uncertain economic outlook and
industry-specific problems as the main reasons. More broadly, banks reported tightening
across all loan types. In particular, nearly all
major credit card lenders reported lending
3-4. Change in Bank Lending Standards for
Commercial and Industrial Loans
standards becoming stricter. While most
Net percentage of banks reporting
banks reported that the level of C&I lending
100
Quarterly
Q2
80
standards is on the tighter end of the range
60
of standards that has prevailed since 2005,
40
20
only a modest share reported standards as
0
being at the tightest point. This information
−20
suggests that banks’ strong capital positions at
−40
−60
the onset of the pandemic may have mitigated
−80
some of the disruption in credit availability
−100
2000 2004 2008 2012 2016 2020
relative to during the 2007–09 financial crisis.
Source: Federal Reserve Board, Senior Loan Officer Opinion
The contraction in credit availability was also
Survey on Bank Lending Practices; Federal Reserve Board staff
calculations.
mitigated by the PPP, under which approximately $500 billion in PPP loans were placed
on banks’ balance sheets at the end of the second quarter. However, tighter lending standards may make obtaining credit difficult for some creditworthy businesses and households.
Credit availability contributes to a more robust recovery, which, in turn, improves credit
quality and thus leads to better financial stability outcomes.
Based on preliminary earnings data, CET1 capital ratios at the U.S. global systemically
important banks slightly increased above pre-pandemic levels in the third quarter (as shown
losses (ALLL), which is renamed to allowance for credit losses for banks adopting CECL. On a bank’s balance sheet, total
loans are reported net of ALLL. For more details, see Board of Governors of the Federal Reserve System (2020), “Allowance for Loan and Lease Losses (ALLL),” webpage, https://www.federalreserve.gov/supervisionreg/topics/alll.htm.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 43

in figure 3-2), as the required restrictions on capital payouts continued. Declines in riskweighted assets, driven in part by slowed loan demand and tighter lending standards, also
contributed to the rise in CET1 capital ratios. Large banks improved earnings relative to the
first two quarters of 2020, predominantly because of lower loan loss provisions. As a result,
allowances for losses remained about the same at large banks in the third quarter.

Leverage is at historically low levels at broker-dealers . . .
Leverage at broker-dealers changed little in the
3-5. Leverage at Broker-Dealers
ratio of assets to equity
first half of 2020 and stayed at historically low
50
Quarterly
levels (figure 3-5). The deterioration in liquidity
40
in March across dealer-intermediated markets
demonstrated that, despite dealers’ low lever30
age, fragilities still remain and pose a concern
20
for financial stability (see the box “A RetrospecQ2
tive on the March 2020 Turmoil in Treasury
10
and Mortgage-Backed Securities Markets”).
0
Dealer usage of the PDCF, established in
1996 2000 2004 2008 2012 2016 2020
March 2020 amid an extraordinary increase in
Source: Federal Reserve Board, Statistical Release Z.1,
“Financial Accounts of the United States.”
demand for dealer intermediation and financing, has steadily declined to less than $1 billion. Dealers reported strong earnings in the third
quarter, after having had record earnings in the second quarter, driven by high underwriting
and trading revenues. Net borrowing of primary dealers is unchanged since May but remains
high relative to recent years. Primary dealers’ Treasury positions declined slightly, on net,
during the same period but remain at the upper end of their historical range.

. . . but is at post-2008 highs at life insurance companies . . .
Leverage at life insurance companies rose to
post-2008 highs (figure 3-6). This leverage
measure is calculated using the book value of
assets and thus does not immediately reflect the
decrease in asset market values—notably, of
corporate bonds—in the first quarter and the
subsequent improvement. Life insurers hold a
sizable proportion of their assets as corporate
bonds and remain vulnerable to significant
decreases in corporate bond prices. In addition,
poor performance of CRE debt in life insurers’ general accounts could harm their capital

3-6. Leverage at Insurance Companies
ratio of assets to equity
Quarterly

Life
Property and casualty

15
12
9

6
3
0

2002

2005

2008

2011

2014

2017

2020

Source: S&P Global Market Intelligence, regulatory filings of
large insurance groups.

44 Leverage in the Financial Sector

positions. Meanwhile, based on information through the second quarter of 2020, leverage at
property and casualty insurers stayed at lower levels relative to historical averages.

. . . and remains elevated at hedge funds relative to the past five years
Gross leverage of hedge funds decreased somewhat in the second half of 2019, the most
recent data available, but still remained near the upper end of its historical distribution
(figure 3-7).13 More recently, in the SCOOS, most dealers reported that the use of leverage by
hedge fund clients declined between February and May, but few dealers reported additional
changes in the use of leverage by hedge funds between May and August (figure 3-8). Moreover, several indicators of leverage intermediated by dealers on behalf of hedge funds have
reverted to their pre-pandemic levels near the upper ends of their historical distributions.
The COVID-19 shock exposed vulnerabilities at hedge funds. Extreme market volatility
and lower liquidity in asset markets led to substantial losses at some hedge funds and sizable margin calls (see the box “A Retrospective on the March 2020 Turmoil in Treasury and
Mortgage-Backed Securities Markets”). As a result of these losses and, to a lesser extent,
3-7. Gross Leverage at Hedge Funds
ratio

monthly

8
7
6

mean

Dec.

4
3

median

2
1
2014

2015

2016

2017

2018

2019

Source: Federal Reserve Board staff calculations based on Securities and Exchange Commission, Form PF, Reporting Form for Investment
Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors.

3-8. Change in the Use of Financial Leverage
Net percentage

Quarterly

40
20

0
−20

Hedge funds
Trading reITs
Insurance companies
mutual funds

−40
−60
−80

2012

2013

2014

2015

2016

2017

2018

2019

2020

Source: Federal Reserve Board, Senior Credit Officer Opinion Survey on Dealer Financing Terms.

Comprehensive data on hedge fund leverage are available only with a long lag. The Federal Reserve supplements these data
with more timely but less comprehensive measures.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 45

outflows, hedge funds’ assets dropped substantially in the first quarter. In the second quarter,
hedge funds’ assets partially recovered from these losses as market conditions improved, but
outflows continued, albeit at a slower pace.

Securitization volumes increased after coming to a halt in March but remain
significantly below 2019 levels . . .
Securitization allows financial institutions to bundle loans or other financial assets and sell
claims on the cash flows generated by these assets as tradable securities, much like bonds.
This process often involves the creation of securities with different levels of seniority, or
“tranches,” and thus represents a form of credit risk transformation whereby some highly
rated securities can be produced from a pool of lower-rated underlying assets. Examples
of the resulting securities include collateralized loan obligations (CLOs), ABS, CMBS,
and RMBS. Issuance volumes of non-agency securities—that is, those not guaranteed by a
government-sponsored enterprise (GSE) or by the federal government—have resumed after
coming to a halt from mid-March to early April but remain about 20 percent lower through
September of this year compared with the same period in 2019 (figure 3-9). The recovery,
facilitated by the reestablishment of the TALF by the Federal Reserve in March, was uneven
across asset classes. Securities backed by asset classes perceived to be less risky, such as auto
and credit card ABS, recovered earlier than other securities, such as CMBS, and have experienced more robust issuance amid strong investor demand. However, the September SCOOS
showed easing in credit conditions for non-agency CMBS.
3-9. Issuance of Non-agency Securitized Products, by Asset Class
Billions of dollars (real)
annual

other
Private-label rmBS
Non-agency CmBS
auto loan/lease aBS
CDos (including aBS, CDo, and CLo)

2800
2400
2000
1600
1200
800
400
0

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

Source: Green Street Advisors, LLC, Commercial Mortgage Alert (cmalert.com) and Asset-Backed Alert (abalert.com); Bureau of Labor
Statistics, consumer price index via Haver Analytics.

. . . and bank lending to nonbank financial firms decreased in the second quarter, as
credit drawdowns in the first quarter were repaid quickly
The outstanding amount of bank loans to financial institutions operating outside the banking sector—such as finance companies, asset managers, securitization vehicles, and REITs—
increased $113 billion (about 15 percent) in the first quarter of 2020, reflecting drawdowns
of credit lines. The outstanding amount then declined $89 billion in the second quarter
(about 10 percent) as nonbank financial institutions repaid the drawn amounts. Committed

46 Leverage in the Financial Sector

lines of credit from large banks to nonbank financial firms, which include undrawn amounts,
edged down slightly in the second quarter of 2020 but remained close to $1.5 trillion
(figure 3-10).14
3-10. Large Bank Lending to Nonbank Financial Firms: Committed Amounts
Billions of dollars
Quarterly
1. Financial transactions processing
2. Private equity, BDCs, and credit funds
3. Broker-dealers
4. Insurance
5. reITs
6. open-end investment funds

7. Special purpose entitites, CLos, and aBS
8. other ﬁnancial vehicles
9. real estate lenders and lessors
10. Consumer lenders, other lenders, and lessors

Q2
3
4
6
7
8
9
10

2013

2014

2015

2016

2017

2018

2019

1
2
5

2500
2250
2000
1750
1500
1250
1000
750
500
250
0

2020

Source: Federal Reserve Board, Form FR Y-14Q (Schedule H.1), Capital Assessments and Stress Testing.

Data on this type of bank lending can be informative about the use of leverage by nonbanks and shed light on the credit
exposures of banks to these institutions. The Federal Reserve is able to monitor the exposures of the largest U.S. banks to
businesses more closely than in the past because those banks now report detailed information about their loan commitments
on regulatory form FR Y-14Q. See Board of Governors of the Federal Reserve System (2020), “Report Forms: FR Y-14Q,”
webpage, https://www.federalreserve.gov/apps/reportforms/reportdetail.aspx?sOoYJ+5BzDZGWnsSjRJKDwRxOb5Kb1hL.

4. Funding Risk
The COVID-19 shock exposed vulnerabilities at nonbank financial firms that
contributed to market turmoil and required the Federal Reserve to establish
emergency facilities to restore the functioning of markets for short-term funding
and corporate bonds
As of the second quarter of 2020, the total amount of liabilities most vulnerable to runs,
including those of nonbanks, had increased 17.1 percent over the past year to $17.3 trillion
(table 4). Banks rely only modestly on short-term wholesale funding and maintain large
amounts of high-quality liquid assets, in part because of liquidity regulations and supervisory programs introduced after the 2007–09 financial crisis and the improved understanding
and management by banks of their liquidity risks.15
Table 4. Size of Selected Instruments and Institutions
Growth,
2019:Q2–2020:Q2
(percent)

Average, annual growth,
1997–2020:Q2
(percent)

17,349

17.1

4.8

Uninsured deposits

6,229

28.9

11.7

Domestic money market funds**

4,635

44.8

6.3

762

13.8

Government

3,743

56.2

16.0

Tax-exempt

130

−4.9

−1.3

Repurchase agreements

3,884

−1.9

5.5

Commercial paper

1,006

−7.7

2.3

649

7.4

4,445

7.0

9.0

Item
Total runnable money-like liabilities*

Prime

Securities lending***
Bond mutual funds

Outstanding/
total assets
(billions of dollars)

Note: The data extend through 2020:Q2. Growth rates are measured from Q2 of the year immediately preceding the period through Q2
of the final year of the period. Total runnable money-like liabilities exceeds the sum of listed components. Items not included in the table are
variable-rate demand obligations (VRDOs), federal funds, funding-agreement-backed securities, private liquidity funds, offshore money market
funds, and local government investment pools.
* Average annual growth is from 2003:Q2 to 2020:Q2.
** Average annual growth is from 2001:Q2 to 2020:Q2.
*** Average annual growth is from 2000:Q2 to 2020:Q2.
Source: Securities and Exchange Commission, Private Funds Statistics; iMoneyNet, Inc., Offshore Money Fund Analyzer; Bloomberg Finance
L.P.; Securities Industry and Financial Markets Association: U.S. Municipal Variable-Rate Demand Obligation Update; Risk Management Association, Securities Lending Report; DTCC Solutions LLC, an affiliate of the Depository Trust & Clearing Corporation: commercial paper data;
Federal Reserve Board staff calculations based on Investment Company Institute data; Federal Reserve Board, Statistical Release H.6, “Money
Stock and Debt Measures” (M3 monetary aggregate); Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States”;
Federal Financial Institutions Examination Council, Consolidated Reports of Condition and Income (Call Report); Morningstar, Inc., Morningstar
Direct; Moody’s Analytics, Inc., CreditView, Asset-Backed Commercial Paper Program Index.

The large increase in uninsured deposits shown in table 4 is mostly excluded from this definition of short-term wholesale
funding.

48 Funding Risk

As noted in previous Financial Stability Reports, the financial system’s vulnerability to
funding risks had increased because of the renewed growth in prime MMFs during 2018 and
2019 as well as the increase in corporate debt held by long-term mutual funds since 2008.
These developments, discussed in more detail later in this section, contributed to considerable funding strains in March. These strains, in turn, prevented a range of employers from
obtaining access to credit markets during a period when borrowing needs were particularly
acute; in response, the Federal Reserve undertook several actions, including establishing
emergency lending facilities and providing regulatory relief, to ensure the smooth functioning of various markets and to support the flow of credit to households and businesses.
For more information, see the boxes “Federal Reserve Actions to Stabilize Short-Term
Funding Markets during the COVID-19 Crisis” and “Federal Reserve Actions and
Facilities to Support Households, Businesses, and Municipalities during the COVID-19
Crisis.” Going forward, regulatory agencies, including the Federal Reserve, are exploring
reforms that will address structural vulnerabilities in the nonbank financial institutions sector that have required emergency interventions during both the 2007–09 financial crisis and
the COVID-19 crisis.

Banks continue to have high levels of liquid assets and stable funding
At most large banks, liquid asset positions increased substantially in the second quarter,
reflecting an increase in reserves (figure 4-1). In addition, their liquidity ratios are well above
regulatory requirements. At the onset of the pandemic, bank reliance on the most unstable
sources of funding stood at historically low levels (figure 4-2). Strong capital and liquidity buffers enabled banks to accommodate drawdowns when businesses relied heavily on
their lines of credit as the COVID-19 shock hit. Banks also managed liquidity pressures by
increased borrowing from the discount window and Federal Home Loan Banks. In addition, banks experienced heavy deposit inflows, consistent with investors becoming more risk
averse and credit-line borrowers depositing the proceeds from line draws taken as precautionary measures. Core deposits continued to increase across the banking system through
September 2020.
4-1. Liquid Assets Held by Banks

4-2. Short-Term Wholesale Funding of Banks

Percent of assets
Quarterly

other BHCs
Large non−G-SIBs
G-SIBs

32
28

Percent of assets
Quarterly

40
35

15
Q2

4
0
2004

2008

2012

2016

2020

Source: Federal Reserve Board, Form FR Y-9C, Consolidated
Financial Statements for Holding Companies; Federal Financial
Institutions Examination Council, Consolidated Reports of
Condition and Income (Call Report).

5
2002

2005

2008

2011

2014

2017

2020

Source: Federal Reserve Board, Form FR Y-9C, Consolidated
Financial Statements for Holding Companies.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 49

Funding strains on mortgage servicers eased after policy actions, but uncertainties remain
As discussed in the May Financial Stability Report, mortgage servicers are responsible for
advancing payments on behalf of a borrower that requests forbearance under the CARES
Act. This responsibility can cause strains for nonbank mortgage servicers because they do
not have the kinds of strong capital and liquidity buffers that banks have built to weather
shocks or access to the same sources of liquidity as banks. Instead, nonbanks have relied on
their internal cash or, in some cases, fairly expensive private-market financing to fund these
payments. Liquidity pressures on nonbank mortgage servicers eased in April, as Ginnie Mae
established a facility to lend against advances of principal and interest (but not taxes and
insurance) and the Federal Housing Finance Agency limited servicing advances up to four
months. Mortgage servicer liquidity positions also benefited from an increase in refinancing
activity through the second quarter. However, strains may emerge again if mortgage forbearance take-up increases substantially or the fiscal support provided to households under the
CARES Act that enables them to continue to make mortgage payments is not extended.

Money markets have stabilized but would be vulnerable without the emergency facilities
in place
Money-like liabilities that are prone to runs—an aggregate measure of private short-term
debt that can be rapidly withdrawn in times of stress—increased substantially and stood at
about 92 percent of GDP in the second quarter of 2020 (figure 4-3). The growth in runnable
liabilities over the first half of 2020 was largely attributable to a surge in domestic MMFs
and uninsured deposits.
4-3. Runnable Money-Like Liabilities as a Share of GDP, by Instrument and Institution
Percent of GDP
Quarterly

1. other
2. Securities lending
3. Commercial paper

4. Domestic money market funds
5. repurchase agreements
6. uninsured deposits

120
100

1
2
3

80
60

0
2002

2005

2008

2011

2014

2017

2020

Source: Securities and Exchange Commission, Private Funds Statistics; iMoneyNet, Inc., Offshore Money Fund Analyzer; Bloomberg
Finance L.P.; Securities Industry and Financial Markets Association: U.S. Municipal Variable-Rate Demand Obligation Update; Risk Management
Association, Securities Lending Report; DTCC Solutions LLC, an affiliate of the Depository Trust & Clearing Corporation: commercial paper
data; Federal Reserve Board staff calculations based on Investment Company Institute data; Federal Reserve Board, Statistical Release H.6,
“Money Stock and Debt Measures” (M3 monetary aggregate); Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United
States”; Federal Financial Institutions Examination Council, Consolidated Reports of Condition and Income (Call Report); Moody’s Analytics,
Inc., CreditView, ABCP Asset-Backed Commercial Paper Program Index; Bureau of Economic Analysis, gross domestic product via Haver
Analytics.

50 Funding Risk

Prime MMFs, particularly institutional funds, experienced runs in March, with outflows
reaching the same proportion of assets redeemed during the run on MMFs in 2008. Heavy
redemptions from these funds were prompted in part by investor concerns about the possibility of liquidity fees and redemption gates. Retail prime funds and tax-exempt funds also
suffered heavy redemptions. As investors fled to safety, short-term funding markets became
severely dislocated. Actions by the Federal Reserve were required to slow redemptions and
restore the functioning of short-term funding markets (see the box “Federal Reserve Actions
to Stabilize Short-Term Funding Markets during the COVID-19 Crisis”). Assets under management at prime MMFs regained most of the decrease in late March and remained stable
from May through August 2020 (figure 4-4).
4-4. Domestic Money Market Fund Assets
Billions of dollars (real)
monthly
1. Government only
2. Tax exempt

6000
5250

3. retail prime
4. Institutional prime

aug.

4500
3750
3000

2250
1500

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2
3

750
0

2020

Source: Federal Reserve Board staff calculations based on Investment Company Institute data; Bureau of Labor Statistics, consumer price
index via Haver Analytics.

Emergency measures undertaken by the Federal Reserve with the support of the Treasury
have temporarily lowered the risk of adverse events associated with vulnerabilities in the
nonbank sector in the near term, but remaining vulnerabilities call for structural fixes in
the longer term. In addition, other cash-management vehicles similar to institutional prime
funds, such as dollar-denominated offshore funds and short-term investment funds, do not
directly benefit from the backstop provided by the MMLF. Between $400 billion and $1 trillion of these vehicles’ assets under management closely mirror institutional U.S. prime funds,
and heavy redemptions may destabilize short-term funding markets even in the presence of
the MMLF. Depressed asset prices due to fire sales could lead to mark-to-market losses for
other investors, including U.S. prime funds.

Outflows from long-term mutual funds that hold less liquid assets have mostly reversed,
but the redemption waves had run-like characteristics that highlighted significant
structural vulnerabilities in the sector
U.S. corporate bonds held by mutual funds increased substantially in the second quarter
of 2020 and reached $1.7 trillion after contracting in the first quarter (figure 4-5). Mutual

FINANCIAL STABILITY REPORT: NOVEMBER 2020 51

funds are estimated to hold about one-sixth of
outstanding corporate bonds. These open-end
mutual funds engage in liquidity transformation by offering daily redemptions to investors, notwithstanding the liquidity profile of
a fund’s underlying assets. Funds investing
substantially in corporate bonds and bank
loans may be particularly exposed to liquidity
transformation risks given the relative illiquidity of such assets.

4-5. U.S. Corporate Bonds Held by Mutual Funds
Billions of dollars (real)
Q2

Quarterly

1800
1500
1200
900
600
300
0

2002

2005

2008

2011

2014

2017

2020

Source: Federal Reserve Board staff estimates based on
Federal Reserve Board, Statistical Release Z.1, “Financial

The record outflows from fixed-income
Accounts of the United States”; Bureau of Labor Statistics,
consumer price index via Haver Analytics.
mutual funds in March caused considerable
strains for the affected funds, and their forced
sales contributed to a deterioration in liquidity in fixed-income markets. The magnitude of
investor redemptions was unprecedented, and heavy redemptions occurred among a wide
range of funds, including investment-grade corporate bond funds and municipal bond funds.
There were no reports of mutual funds failing to meet investor redemptions, but funds were
forced to sell assets under worsening market conditions, further draining liquidity from corporate bond markets.
The announcement of a number of emergency
lending facilities, including those designed to
support corporate borrowing, improved bond
market liquidity significantly and eased strains
faced by mutual funds. Investment-grade and
high-yield bond funds received inflows since
May, and assets under management now
exceed their pre-pandemic levels (figure 4-6).
Bank loan mutual funds, which faced record
redemptions in March, subsequently had more
modest outflows through August (figure 4-7).
Their total assets under management have
decreased about 25 percent since February
and stood at $64 billion in August.

4-6. Bank Loan and High-Yield Bond Mutual Fund
Assets
Billions of dollars (real)
monthly

525
450

Bank loan mutual funds
High-yield
bond mutual funds

aug.

375
300
225
150
75
0

2000

2004

2008

2012

2016

2020

Source: Investment Company Institute; Bureau of Labor
Statistics, consumer price index via Haver Analytics.

The fire-sale dynamics in March associated with open-end mutual funds concentrated in
fixed-income assets demonstrated the severity of structural vulnerabilities highlighted in
previous Financial Stability Reports. By providing a backstop in the corporate bond market,
the emergency lending facilities significantly alleviated the stress of large outflows faced by
investment-grade corporate bond funds, and the backstop’s effect has also flowed through
to high-yield bond funds and bank loan funds. Even so, the March turbulence demonstrated

52 Funding Risk

4-7. Mutual Fund Net Flows
Billions of dollars
Monthly

Investment-grade bond mutual funds
Bank loan mutual funds
High-yield bond mutual funds

Mutual fund assets under management
(as of Aug. 2020)
Investment grade
High yield
Bank loan
Feb.

Aug.
May
2017

Nov.

Feb.

$2,393B
$268B
$63B
Aug.
May
2018

Nov.

Feb.

Aug.
May
2019

Nov.

Feb.

Aug.
May
2020

100
80
60
40
20
0
−20
−40
−60
−80
−100
−120
−140

Source: Investment Company Institute.

that fixed-income mutual funds continue to be vulnerable to large, sudden redemptions, and
sizable outflows can still lead to a deterioration in market liquidity of underlying assets. This
structural vulnerability may call for structural reforms.

Central counterparties continue to manage risks amid elevated volatility
Meanwhile, driven largely by increased clearing of over-the-counter derivatives, central counterparties (CCPs) intermediate a larger share of transactions across more markets than at the
time of the 2007–09 financial crisis. CCPs have supported market functioning throughout
the pandemic, effectively managing the increased risks posed by elevated volatility and mitigating counterparty risks. However, the volatile environment continues to imply heightened
tail risks for clearinghouses and their members. Further market stresses, as well as resulting
increases in cash and collateral requirements by CCPs, could increase liquidity pressures on
market participants, potentially even beyond the heightened pressures met during the acute
phase of the COVID-19 shock.

Collateralized loan obligation fundamentals have improved in recent months but are still
weak compared with pre-pandemic levels
CLO issuance declined about 33 percent through September 2020 compared with the same
period in 2019. These securities fund more than 50 percent of outstanding institutional leveraged loans—loans that have been under significant price pressures, as previously discussed.
Unlike open-end mutual funds, CLOs do not generally permit early redemptions or rely on
funding that must be rolled over before the underlying assets mature. As a result, CLOs avoid
the run risk associated with a rapid reversal in investor sentiment. Overall, CLO fundamentals have improved in recent months but are still weak compared with pre-pandemic levels,
and some risks remain. For example, the surge in underlying loan downgrades and defaults
led to a spike in the number of CLOs that failed collateral tests in recent months. Managers of CLOs that failed overcollateralization tests typically attempted to cure those failures
by selling risky collateral. To the extent that CLO managers fail to remedy impairments
in junior CLO tranches, the resulting downgrades of those tranches may force some CLO

FINANCIAL STABILITY REPORT: NOVEMBER 2020 53

investors, including leveraged funds, to sell their CLO holdings. Such sales have the potential
to put pressure on the prices of junior CLO tranches.

Liquidity risks at life insurers are at post-2008 highs and have been increasing
Over the past decade, life insurers have widened the gap between the liquidity of their assets
and the liquidity of their liabilities, potentially making it harder for them to meet sudden
claims. Life insurers have been increasing the share of illiquid, risky assets on their balance
sheets. These assets—including CRE loans, less liquid corporate debt, and alternative investments—edged up to 35 percent of general account assets, the same level as just before the
2007–09 financial crisis (figure 4-8). Meanwhile, the share of liquid liabilities remains above
its level during the financial crisis, in part because of increasing nontraditional liabilities
(figure 4-9).
4-8. Less Liquid General Account Assets Held by U.S. Insurers
Percent share
1. other asset-backed securities

2. Commercial real estate
3. Commercial real estate,
securitized

Billions of dollars

4. alternative investments

Share of life insurer assets

5. Illiquid corporate debt
6. Illiquid corporate debt,
securitized

Share of P&C insurer assets

30
20
10
0
2007

2009

2011

2013

2015

2017

2750
2500
2250
2000
1750
1500
1250
1000
750
500
250
0

2019

Source: Staff estimates based on data from Bloomberg Finance L.P. and NAIC Annual Statutory Filings.

4-9. Nontraditional Liabilities of U.S. Life Insurers, by Liability Type
Billions of dollars (real)
Quarterly

FHLB advances
Funding-agreement-backed
securities

Billions of dollars (real)

300
250

repurchase agreements
Securities lending
Q2

Quarterly

200

100
80
60

150
40

100

50
0
2006

2008

2010

2012

2014

2016

2018

2020

0
2012

2014

2016

2018

2020

Source: Bureau of Labor Statistics, consumer price index via Haver Analytics; Moody’s Analytics, Inc., CreditView, Asset-Backed Commercial
Paper Program Index; Securities and Exchange Commission, Forms 10-Q and 10-K; National Association of Insurance Commissioners,
quarterly and annual statutory filings accessed via the S&P Global Market Intelligence platform; Bloomberg Finance L.P.

54 Funding Risk

LIBOR Transition Update
Recognizing the potential instability in LIBOR (London interbank offered rate) and other similar interbank offered rates (IBORs), the Group of Twenty asked the Financial Stability Board’s (FSB) Official
Sector Steering Group in 2012 to identify more robust potential alternative rates, while seeking to
strengthen the existing IBORs to the extent possible. Although LIBOR has undergone substantial
reforms since that time, most panel banks are forced to base their submissions on expert judgment
because their reliance on the type of wholesale unsecured funding that LIBOR is meant to represent
has declined significantly. In 2017, after some banks had started leaving IBOR panels, the LIBOR regulator, the U.K. Financial Conduct Authority (FCA), brokered a voluntary agreement with the remaining
panel banks to continue their participation through the end of 2021. The FCA has warned that market
participants should prepare for the possibility that LIBOR will end at that time or thereafter. The FSB
has stated that the LIBOR transition remains a priority even during the COVID-19 crisis.

Overview
The pace of preparation for the cessation of LIBOR publication has picked up in recent months.
Changes to infrastructure are now in place or expected to be ready soon. Although disruptions from
COVID-19 caused many firms to slow some transition activities temporarily, a recent survey of financial
institutions by Moody’s indicates that most surveyed firms believe they are on track in their preparations for LIBOR cessation.1 However, LIBOR use remains predominant despite continued warnings
from the official sector that participants should prepare for the risk that it will cease to be published
after the end of 2021, and critical work is still needed to ensure that LIBOR cessation does not cause
significant financial market disruptions.
The Alternative Reference Rates Committee (ARRC) released Best Practices for Completing the Transition from LIBOR in May.2 The document provides guiding steps and timelines for a smooth transition
from LIBOR for floating-rate notes, business loans, consumer loans, securitizations, and derivatives,
including recommendations that no new LIBOR floating-rate debt be issued after 2020 and no new
LIBOR loans be issued after June 2021. While LIBOR-submitting banks have made a commitment to
providing rates through the end of 2021, many of the steps necessary for a smooth transition need to
occur much sooner.
Two important milestones in the derivatives market have been reached recently. First, on October 16,
2020, the two main interest rate derivatives clearinghouses (CME and LCH) switched from discounting
cleared U.S. dollar swaps using the federal funds rate to using the Secured Overnight Financing Rate
(SOFR). The switch has been associated with increased SOFR-based trading activity as market participants seek to hedge discounting exposures. Second, the International Swaps and Derivatives Association (ISDA) supplemented its protocol for derivatives contracts to facilitate the use of risk-free reference
rates upon the cessation or nonrepresentativeness of LIBOR. The ISDA protocol has been promoted as
the most efficient way for derivatives market participants to mitigate the risks associated with LIBOR
discontinuation. These two events will solidify the transition away from LIBOR for derivatives.
(continued)
1

See moody’s Investors Service (2020), IBOR Phaseout 15 Months Away, but Hurdles Could Stretch beyond Finish Line, sector
in-depth report (New York: moody’s, September 22).

See alternative reference rates Committee (2020), “arrC announces Best Practices for Completing Transition from LIBor—
Provides Date-Based Guidance, Including when No New LIBor activity Should Be Conducted,” press release, may 27, https://www.
newyorkfed.org/medialibrary/microsites/arrc/files/2020/arrC_Press_release_Best_Practices.pdf.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 55

Official-sector actions
Efforts by the U.S. official sector have removed potential impediments to the transition away from
LIBOR. Swap margin rules have been amended to permit swaps entered into before an applicable
compliance date to retain their legacy status if they are modified to replace LIBOR. Similarly, the Financial Accounting Standards Board provided optional expedients and exceptions for applying generally
accepted accounting principles to contract modifications and hedging relationships that reference
LIBOR, and the U.S. Department of the Treasury is nearing similar measures in its final rules for tax
relief. Consumer-oriented agencies such as the Consumer Financial Protection Bureau (CFPB) and the
U.S. Department of Housing and Urban Development have proposed regulatory amendments to facilitate the transition. The CFPB has also updated its consumer handbook for adjustable-rate mortgages
(ARMs) to provide guidance to consumers about reference rates.

Issuance and trading activity
Issuance and trading of SOFR-referencing instruments have grown but remain clearly lower than
activity referencing LIBOR, although GSEs have been successfully moving to issuance of SOFR-based
products. Issuance in the floating-rate note market, in which GSEs have a large presence, was mostly
SOFR based in the first half of 2020 (figure A). Fannie Mae and Freddie Mac are accepting SOFRreferenced ARMs and have announced that they will no longer accept LIBOR-referenced ARMs after
2020; Ginnie Mae has announced similar restrictions that will be enacted in early 2021. Loan issuance
remains mostly LIBOR based, although inclusion of fallback language is growing.

Figure a. Floating-rate Notes Issuance, by reference rate
Billions of dollars
SOFR

Nov.

Dec.
2019

Jan.

Feb.

LIBOR

Mar.

Apr.

Fed funds

May

June
2020

T−bill

July

Aug.

Sept.

220
200
180
160
140
120
100
80
60
40
20
0

Oct.

Source: Bloomberg.

The trading volume of SOFR derivatives reached a high point in March 2020, as interest rate volatility
led to increased derivatives market activity (figures B and C). Since then, the reduction in policy rates
and the high degree of certainty that interest rates will stay near zero have contributed to less trading
of all types of short-term interest rate derivatives, including SOFR derivatives. Derivatives trading in
SOFR-based products increased in October with the switch to SOFR discounting. Market participants
appear to be prepared for this switch: Awareness is high, trading systems have been updated, and
SOFR trading volumes as a share of total volumes have been growing in the swaps and futures markets, albeit slowly.
(continued on next page)

56 Funding Risk

LIBOR Transition Update (continued)
Figure B. monthly SoFr Swap Volumes
Billions of dollars
Outright

Nov.
Dec.
2019

Jan.

Fed funds
basis

Feb.

Mar.

LIBOR
basis

Apr.

Cross
currency

May

June
2020

Swaption

July

Aug.

Sept.

200
180
160
140
120
100
80
60
40
20
0

Oct.

Source: Bloomberg Finance L.P., Bloomberg Valuation Service (BVaL); Federal reserve Bank of New York staff calculations.

Figure C. average Daily Notional SoFr Futures
Units
CME 1M

CME 3M

ICE 1M

ICE 3M

300
250
200
150
100
50

Nov.

Dec.

Jan.

Feb.

2019

Mar.

Apr.

May

June

July

Aug.

Sept.

Oct.

2020

Source: Cme and ICe via Bloomberg.

Legacy contracts
The ARRC has had recommended fallback language for new LIBOR issuances in the most commonly
used products in place for some time. Use of the ARRC recommendations, or similar language, has
been prevalent in floating-rate debt issuance for more than a year and in most syndicated loans. For
contracts that either do not address a permanent end to LIBOR or have ambiguous fallback language,
interest payment uncertainty could lead to complex problems for parties or courts to sort out and create uncertainty in financial markets. Many financial products and agreements that reference LIBOR are
governed by New York law. As a result, the ARRC has proposed New York State legislation that would
substitute the recommended benchmark replacement in legacy contracts where the contract language
is silent or the fallback provisions prescribe LIBOR use.

Near-Term Risks to the Financial System
The course of the pandemic and the ultimate extent and duration of the resulting economic
and financial consequences remain one of the most significant risks to the financial system. The realization of this risk continues to depend largely on the success of public health
measures and other government actions to contain the spread of COVID-19, on the steps
households and businesses take to resume economic activity, and on the duration of the government lending and relief programs that have, so far, ameliorated the most adverse potential
economic outcomes.
The Federal Reserve routinely engages in discussions with domestic and international policy
makers, academics, community groups, and others to gauge the set of risks of particular
concern to these groups. As noted in the box “Salient Shocks to Financial Stability Cited
in Market Outreach,” contacts were mostly focused on the risks associated with the evolution
of the pandemic and the policy support to contain its effects as well as on the uncertainties
related to the elections in November. The following analysis considers possible interactions of
existing vulnerabilities with four broad categories of risk, some of which were also raised in
these discussions: a prolonged slowdown in U.S. economic growth, disruptions in dollar funding markets, risks emanating from Europe, and risks originating in China and other EMEs.

The effects of the pandemic have increased the vulnerabilities of the financial system to
future shocks, including additional waves of substantial COVID-19 outbreaks
Most forecasters expect a moderate recovery in economic output in the United States and
abroad following a global recession, but uncertainty surrounding this outcome is unusually high. The sharp slowdown in economic activity has disproportionately affected some
businesses and households, and a further weakening in the balance sheets of those that are
especially vulnerable could affect the financial system. Furthermore, monetary and fiscal policy tools have limited ability to moderate some dimensions of what is fundamentally a public
health shock.
If the pandemic persists for longer than anticipated—especially if there are extended delays
in the production or distribution of a successful vaccine—downward pressure on the U.S.
economy could derail the nascent recovery and strain financial markets and financial institutions, particularly if many businesses are shuttered again and many workers are laid off and
left without a normal income for a long period. If that were the case, a number of the vulnerabilities identified in this report could grow further, making them more likely to amplify negative shocks to the economy. Investor risk appetite and asset prices have increased in recent
months but could suffer significant declines should the pandemic take an unexpected course
or the economic recovery prove less sustainable. Given the generally high level of leverage
in the nonfinancial business sector, prolonged weak profits could trigger financial stress and
defaults. In addition, a protracted slowdown could further harm the finances of even highcredit-score households, which could lead to defaults and place financial pressure on banks

58 Near-Term Risks to the Financial System

The Implications of Climate Change for Financial Stability
Climate change refers to the trend toward higher average global temperatures and accompanying
environmental shifts such as rising sea levels and more severe weather events. Climate change adds
a layer of economic uncertainty and risk that we have only begun to incorporate into our analysis of
financial stability. Different sectors of the economy and geographic regions face different risks that will
diverge from historical patterns. In this discussion, we focus on how climate change, which increases
the likelihood of dislocations and disruptions in the economy, is likely to increase financial shocks and
financial system vulnerabilities that could further amplify these shocks.
These climate risks are present over various horizons. The figure illustrates how these risks become
financial stability risks. Acute hazards, such as storms, floods, droughts, or wildfires, can quickly alter,
or reveal new information about, future economic conditions or the value of real or financial assets.
Moreover, in the presence of rapid shifts in public perceptions of risk, chronic hazards (like a slow rise
in sea levels) have the potential to produce similar abrupt repricing events. These repricing events
and direct losses associated with climate hazards can result in an increased frequency and severity of
financial shocks; the timing and repercussions of these shocks are difficult to predict in advance.
Possible Transmission from Climate-related risks to Financial System Vulnerabilities

Acute climate
hazards

Nonlinear effect
on financial risks
and models

Chronic climate
shifts
Climate policies
Technological
advances
Investor/consumer
perceptions

Increased severity

Examples of climatechange-related features

Increased frequency

Climate-related
risks

Vulnerabilities
Asset valuations

Timing uncertainty

Borrowing by
businesses and
households

Incomplete contracts

Leverage in the
financial sector

Opacity of exposures

Funding risks

Source: Federal reserve Board staff.

Features of climate change can also increase financial system vulnerabilities, as illustrated in the figure.
Opacity of exposures and heterogeneous beliefs of market participants about exposures to climate
risks can lead to mispricing of assets and the risk of downward price shocks. Similarly, uncertainty
about the timing and intensity of severe weather events and disasters, as well as the poorly understood relationships between these events and economic outcomes, could lead to abrupt repricing of
assets. Climate risks thus create new vulnerabilities associated with nonfinancial and financial lever(continued)

FINANCIAL STABILITY REPORT: NOVEMBER 2020 59

age. In regions affected by severe events, households and businesses could become overlevered if
the value of their assets or income prospects become impaired. Levered financial institutions may be
exposed to losses from disasters made more likely by climate change that are not accurately reflected
in current financial models; for example, financial models may lack sufficient geographical granularity to accurately connect local physical damages to financial exposures. The financial system is also
vulnerable to amplification effects of these damages if contracts are incomplete and do not capture all
damages and if poorly understood financial exposures cause spillover effects or financial contagion.
One example of how climate change is likely to increase financial stability risks is through real estate
exposures. Some residential and commercial properties will be subject to acute hazards such as storm
surges associated with rising sea levels and more intense and frequent hurricanes. Continued productive use of these properties would require investment and adaptation. As inundations or storm surges
become more frequent, the expected value of exposed real estate may decrease, which may in turn
pose risks to real estate loans, mortgage-backed securities, the holders of these loans and securities,
and the profitability of nonfinancial firms using such properties.
With perfect information, the price of real-estate-linked assets and the valuations of claims linked to
such assets—held by banks, insurers, investment funds, and nonfinancial firms—would already reflect
these climate-related risks. However, given the uncertain timing and severity of future climate-related
flooding and the associated opacity of asset exposures, investors in real-estate-linked assets may
react abruptly to new information about a region’s exposure to climate-related financial risks. A sharp
repricing, in turn, could create incentives to fire sale such assets by leveraged financial and nonfinancial firms. These asset valuation changes would be amplified by financial and nonfinancial leverage,
funding risks, and interconnections across holders of the collateral-based assets, thereby creating
risks to financial stability.
Several policies or other factors could moderate climate-related financial vulnerabilities or the likelihood of large shocks. Within the financial system, increased transparency through improved measurement and disclosure could improve the pricing of climate risks, such as an increase in the frequency
and severity of extreme weather events, thereby reducing the probability of sudden changes in asset
prices. Continued research into the interconnections between the climate, the economy, and the financial sector could strengthen knowledge of transmission, clarify linkages and exposures, and facilitate
more efficient pricing of risk. Outside the financial system, efforts to mitigate or adapt to the physical
effects of climate change through technological advances and policy changes could also reduce climate risks in the long run.
Staff members throughout the Federal Reserve System continue to research the relationships among
climate risks and economic and financial risks and, ultimately, to better identify the transmission
channels through which climate risks could affect the financial sector. This work is conducted in close
consultation with other U.S. agencies and international groups in an effort to strengthen the knowledge
and understanding of this growing economic and financial stability issue.
The Federal Reserve is evaluating and investing in ways to deepen its understanding of the full scope
of implications of climate change for markets, financial exposures, and interconnections between markets and financial institutions. It will monitor and assess the financial system for vulnerabilities related
to climate change through its financial stability framework. Moreover, Federal Reserve supervisors
expect banks to have systems in place that appropriately identify, measure, control, and monitor all of
their material risks, which for many banks are likely to extend to climate risks.

60 Near-Term Risks to the Financial System

and other lenders. Broader solvency issues could impair the ability of some financial institutions to lend or induce increased asset sales and redemptions of withdrawable liabilities.
Although leverage remains at modest levels at banks, broker-dealers, and other financial
institutions, the leverage of some nonbank financial institutions, such as life insurance companies and hedge funds, is high, exposing them to risks stemming from sharp drops in asset
prices and funding illiquidity risks. Furthermore, prime MMFs and fixed-income mutual
funds remain vulnerable to funding strains and sudden redemptions, as demonstrated during
the acute period of extreme market volatility and deteriorating asset prices earlier this year.
While government support has lowered the risk of adverse events associated with vulnerabilities in the nonbank sector, this sector would be vulnerable to funding risk should the government support be withdrawn.

Disruptions in global dollar funding markets remain an important source of risk
As was highlighted by the period of acute financial stress in March, disruptions in global
dollar funding markets are also an important risk to the U.S. financial system. In many
advanced foreign economies and EMEs, the reliance of banks and nonbank financial institutions on short-term dollar funding markets, including through off-balance-sheet instruments
such as FX swaps, remains a vulnerability.16 Disruptions in offshore dollar funding markets
can adversely affect these foreign financial institutions, which may reduce lending to U.S. residents and liquidate holdings of U.S. assets in order to obtain dollars, harming U.S. households and businesses. These risks are mitigated, however, by the Federal Reserve dollar swap
lines with other central banks and the FIMA Repo Facility.17

Stresses emanating from Europe also pose risks to the United States because of strong
transmission channels . . .
European financial institutions and businesses play an important role in global financial
intermediation and have notable financial and economic linkages with the United States.
Faced with the largest decline in economic activity in postwar history due to the COVID-19
pandemic, European authorities have used fiscal support, accommodative monetary policy,
and bank regulatory and supervisory measures to mitigate the effect of the pandemic on
households and businesses. However, if a material worsening of the pandemic suppresses
economic activity more than expected, continued regulatory forbearance and further expansionary policies may lead to concerns about debt sustainability in some countries. If debt
sustainability were to markedly deteriorate in some of the highly indebted European sovereigns and corporates, stresses could materialize in debt markets and credit losses could be
16

FX swaps are widely used by market participants to borrow dollars for fixed periods of time—for instance, to fund purchases
of U.S. securities. In such a transaction, a participant exchanges foreign currency for U.S. dollars at the current exchange rate
while contracting at the same time to reverse the transaction at a future date at an agreed-upon exchange rate (the “forward”
rate). In effect, such an FX swap is a dollar loan collateralized with foreign currency.
For more information, see the box “Federal Reserve Tools to Lessen Strains in Global Dollar Funding Markets” in Board
of Governors of the Federal Reserve System (2020), Financial Stability Report (Washington: Board of Governors, May),
pp. 16–18, https://www.federalreserve.gov/publications/files/financial-stability-report-20200515.pdf.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 61

realized in certain European financial institutions. Stresses in Europe could, in turn, affect
the U.S. economy and the financial system through a further deterioration in risk appetite
and losses due to direct and indirect credit exposures.
In addition to the risks related to COVID-19, the possibility of a no-trade-deal Brexit continues to pose risks to the European and U.S. financial systems. Although the United Kingdom
formally left the European Union (EU) in January, it remains under the EU’s trade rules and
financial regulations until the end of this year. The failure to reach a final trade agreement
could lead to supply chain disruptions in Europe, aggravate negative effects of COVID-19 to
the real economy, and increase losses at U.K. financial institutions. Accordingly, a no-tradedeal Brexit could lead to strains in global financial markets, resulting in a tightening of U.S.
financial conditions.

. . . and adverse developments in emerging market economies with vulnerable financial
systems could spill over to the United States
China entered the pandemic with elevated corporate and local government debt, high
financial-sector leverage, and stretched real estate prices. After an acute downturn, real activity in China has rebounded more sharply than in other countries in part because China was
able to contain the spread of the virus more quickly. Although policy continues to support
the broader economy, authorities have continued to introduce measures to tamp down on
speculation in real estate markets. A sudden price correction in domestic property markets,
along with weakened global demand from abroad due to a resurgence of COVID-19, could
put pressure on certain firms, particularly Chinese property developers, which are already
highly indebted. This development, in turn, could substantially stress the vulnerable financial
sector and local governments. This situation, along with heightened trade tensions, could
further strain global financial markets and disrupt regional supply chains and exports to and
from China. Moreover, a reduction in risk appetite, aggravated by other geopolitical risks,
could negatively affect the United States, given the size of China’s economy and financial
system, and its extensive trade linkages with the rest of the world.
Widespread stresses in EMEs have abated somewhat, in no small part because of an
improvement in global financial conditions, but faltering economic growth, both within
EMEs and elsewhere, could lead to a reemergence of financial strains in EMEs, with nontrivial repercussions for the United States. In particular, EMEs with vulnerable financial systems could see another wave of capital outflows because of a drop in global risk appetite or
an escalation of problems in their banking systems. Under these circumstances, authorities
may find it difficult to curb the possible amplification of financial stresses because of limited
fiscal capacity. For oil exporters, these dynamics could be exacerbated if oil prices fall precipitously because of weak demand or a marked increase in the supply of oil. Further dollar
appreciation due to widespread stresses in EMEs could potentially put additional strains
both on EME firms with currency mismatches and on U.S. firms that rely on exports and
supply chains for their business operations. Some U.S. financial institutions may be directly
affected by their exposures to these U.S. firms, in addition to the stressed EME firms and
sovereigns themselves.

62 Near-Term Risks to the Financial System

Salient Shocks to Financial Stability Cited in Market Outreach
As part of its market intelligence gathering for this report, the Federal Reserve staff solicited views from
a wide range of contacts on risks to U.S. financial stability. From early September to mid-October, the
staff surveyed 24 contacts at banks, investment firms, academic institutions, and political consultancies. As shown in the figure, respondents frequently cited concerns about U.S. political uncertainty
as well as the risk of a COVID-19 resurgence generating renewed restrictions. Relatedly, a large share
of respondents highlighted uncertainty surrounding the likelihood and efficacy of a policy response to
economic weakness as well as concerns over the potential for increased insolvencies among nonfinancial corporates and small businesses.
most Cited Potential Shocks over Next 12 to 18 months
U.S. political uncertainty
Corporate & SME stress/defaults
Insufficient fiscal stimulus
COVID resurgence
Stretched asset valuations
U.S.–China tensions
Inflation surprises
USD collapse/currency war
Monetary policy space/efficacy
Bank asset quality/bank profitability
CRE defaults/CMBS stress
Sharp rise in real interest rates
Geopolitical risks
Brexit
Cyber attacks

Percent

LIBOR transition
0

Source: Federal reserve Bank of New York survey of 24 market contacts from early September to mid-october.

U.S. political uncertainty
A significant share of respondents pointed to U.S. political uncertainty as a major source of risk. Many
contacts highlighted the prospect that a contested presidential election or delayed election result could
amplify investor uncertainty, and some pointed to increased market-implied volatilities covering the
election as signaling a relatively high degree of uncertainty over the path of asset prices.

COVID-19 resurgence
Contacts were also focused on the risk that a large COVID-19 wave in the fall and winter could lead
to new lockdown measures, inhibiting the recovery or causing another downturn. Several highlighted
related concerns regarding the risk of delays, or failures, in developing and deploying a vaccine, and a
few noted that market prices reflected excessive optimism in the timing of a vaccine and the ability to
avoid new restrictions.
(continued)

FINANCIAL STABILITY REPORT: NOVEMBER 2020 63

Policy fatigue or limits
A related concern was that recurring outbreaks would fail to galvanize a fiscal and monetary response
as forceful or effective as during the initial outbreak. A number of contacts worried that a deepening
political divide could delay timing or reduce the size of additional fiscal stimulus. Moreover, with policy
rates near zero, several respondents identified risks surrounding the limits and efficacy of monetary
policy stimulus in the event that the recovery stalls or reverses.

Increases in business defaults
Market participants noted the risk of sharply rising default rates among nonfinancial corporates and
small businesses, especially if the pandemic is prolonged or containment measures are reinstated.
Contacts referenced the elevated levels of leverage in the corporate sector and expressed concern
regarding the long-run effects of the virus on business models and consumer behavior. Several respondents noted that rising defaults could weaken bank asset quality and underpin a sharp retrenchment in
credit to businesses.

Figure Notes
Box: Federal Reserve Actions and Facilities to Support Households, Businesses, and
Municipalities during the COVID-19 Crisis
Figure A
The shaded area with a top cap represents an expanded window focusing on the period from
February 17 onward. The triple-B reflects the effective yield of the ICE Bank of America
Merrill Lynch triple-B U.S. Corporate Index (C0A4), and the high yield reflects the effective
yield of the ICE BofAML U.S. High Yield Index (H0A0). Treasury yields from smoothed
yield curve are estimated from off-the-run securities. Spreads over 10-year Treasury yield.
PMCCF is the Primary Market Corporate Credit Facility, and SMCCF is the Secondary
Market Corporate Credit Facility.
Figure C
Spreads on municipal bonds are relative to comparable-maturity Treasury yields.
Figure E
Key identifies bars in order from bottom to top.
Figure F
TALF is the Term Asset-Backed Securities Loan Facility. Spreads are to the swap rate for
credit card and auto asset-backed securities (ABS) and to 3-month LIBOR (London interbank offered rate) for student loans. FFELP is Federal Family Education Loan Program.
Box: Federal Reserve Actions to Stabilize Short-Term Funding Markets during the
COVID‑19 Crisis
Figure A
Indicative bid-ask spreads for 10-year Treasury note. The bid-ask spread for a security is
the difference between the bid price and the ask price, where the “bid” is the price to buy a
security and the “ask” is the price to sell it. On March 15, the Federal Open Market Committee announced an increase of its holdings of Treasury securities by at least $500 billion
and its holdings of agency mortgage-backed securities by at least $200 billion. On March
23, the Federal Reserve announced it would continue to purchase Treasury securities and
agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions. UST
is U.S. Treasury securities.
Figure B
All spreads are to overnight index swaps of the same tenor. CP is commercial paper and
CPFF is the Commercial Paper Funding Facility. MMLF is the Money Market Mutual
Fund Liquidity Facility. MMLF operations began on March 23. On the same day, the
Federal Reserve announced that the MMLF would be expanded to include negotiable
certificates of deposit and variable-rate demand notes. CPFF operations began on April 14.
Neither DTCC Solutions LLC nor any of its affiliates shall be responsible for any errors or

66 Figure Notes

omissions in any DTCC data included in this publication, regardless of the cause, and in no
event shall DTCC or any of its affiliates be liable for any direct, indirect, special, or consequential damages, costs, expenses, legal fees, or losses (including lost income or lost profit,
trading losses, and opportunity costs) in connection with this publication.
Figure C
PDCF is Primary Dealer Credit Facility. MMLF is the Money Market Mutual Fund Liquidity Facility. CPFF is the Commercial Paper Funding Facility.
Figure 1-1
The 2- and 10-year Treasury rates are the constant-maturity yields based on the most actively
traded securities.
Figure 1-2
Term premiums are estimated from a three-factor term structure model using Treasury yields
and Blue Chip interest rate forecasts.
Figure 1-3
Implied volatility on 10-year swap rate, 1 month ahead, derived from swaptions.
Figure 1-4
Market depth is defined as the average top three bid and ask quote sizes for on-the-run
Treasury securities.
Figure 1-5
The triple-B series reflects the effective yield of the ICE Bank of America Merrill Lynch
triple-B U.S. Corporate Index (C0A4), and the high-yield series reflects the effective yield of
the ICE BofAML U.S. High Yield Index (H0A0).
Figure 1-6
The triple-B series reflects the options-adjusted spread of the ICE Bank of America
Merrill Lynch triple-B U.S. Corporate Index (C0A4), and the high-yield series reflects the
options-adjusted spread of the ICE BofAML U.S. High Yield Index (H0A0).
Figure 1-8
The data show secondary-market discounted spreads to maturity. Spreads are the constant
spread used to equate discounted loan cash flows to the current market price.
Figure 1-9
Aggregate forward price-to-earnings ratio of S&P 500 firms. Based on expected earnings for
12 months ahead.
Figure 1-10
Aggregate forward earnings-to-price ratio of S&P 500 firms. Based on expected earnings
for 12 months ahead. Real Treasury yields are calculated from the 10-year consumer price
index inflation forecast and the smoothed nominal yield curve estimated from off-the-run
securities.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 67

Figure 1-11
Realized volatility estimated from 5-minute returns using an exponentially weighted moving
average with 75 percent of the weight distributed over the past 20 days.
Figure 1-12
Series deflated using the consumer price index and seasonally adjusted by Federal
Reserve Board staff. The data begin in 1998 for the equal-weighted curve and 1996 for the
value-weighted curve.
Figure 1-13
Data are a 12-month moving average of weighted capitalization rates in the industrial, retail,
office, and multifamily sectors, based on national square footage in 2009.
Figure 1-14
Banks’ responses are weighted by their commercial real estate loan market shares. The
shaded bars with top caps indicate periods of business recession as defined by the National
Bureau of Economic Research: March 2001–November 2001, December 2007–June 2009,
and February 2020–June 2020. Survey respondents to the Senior Loan Officer Opinion Survey on Bank Lending Practices are asked the changes over the quarter.
Figure 1-15
The data for the United States start in 1997. Midwest index is a weighted average of Corn
Belt and Great Plains states that comes from staff calculations. Values are given in real terms.
Data are through July 2020.
Figure 1-16
The data for the United States start in 1998. Midwest index is the weighted average of Corn
Belt and Great Plains states. Data are through July 2020.
Figure 1-18
Log of the price-to-rent ratio. Long-run trend is estimated using data from 1978 to 2001 and
includes the effect of carrying costs on the expected price-to-rent ratio. The last value of the
trend is normalized to equal 100.
Figure 1-19
The data are seasonally adjusted. The data for Phoenix start in 2002. Monthly rent values for
Phoenix are interpolated from semiannual numbers. Percentiles are based on 19 metropolitan
statistical areas.
Figure 2-1
The shaded bars with top caps indicate periods of business recession as defined
by the National Bureau of Economic Research: January 1980–July 1980,
July 1981–November 1982, July 1990–March 1991, March 2001–November 2001,
December 2007–June 2009, and February 2020–June 2020. GDP is gross domestic product.
Figure 2-2
The shaded bars with top caps indicate periods of business recession as defined by
the National Bureau of Economic Research: January 1980–July 1980, July 1981–

68 Figure Notes

ovember 1982, July 1990–March 1991, March 2001–November 2001, December 2007–
N
June 2009, and February 2020–June 2020. GDP is gross domestic product.
Figure 2-3
Nominal debt growth is seasonally adjusted and is translated into real terms after subtracting
the growth rate of the price deflator for core personal consumption expenditure price.
Figure 2-4
Institutional leveraged loans generally exclude loan commitments held by banks. Key identifies bars in order from top to bottom.
Figure 2-5
Gross leverage is an asset-weighted average of the ratio of firms’ book value of total debt to
book value of total assets. The 75th percentile is calculated from a sample of the 2,500 largest firms by assets. The dashed sections of the lines in the first quarter of 2019 reflect the
structural break in the series due to the 2019 compliance deadline for Financial Accounting
Standards Board rule Accounting Standards Update 2016-02.
Figure 2-6
The interest coverage ratio is earnings before interest and taxes over interest payments. Firms
with leverage less than 5 percent and interest payments less than $500,000 are excluded.
Figure 2-7
Volumes are for large corporations with earnings before interest, taxes, depreciation, and
amortization (EBITDA) greater than $50 million and exclude existing tranches of add-ons
and amendments as well as restatements with no new money. Key identifies bars in order
from top to bottom.
Figure 2-8
The data begin in December 1998. The default rate is calculated as the amount in default
over the past 12 months divided by the total outstanding volume at the beginning of the
12-month period. The shaded bars with top caps indicate periods of business recession
as defined by the National Bureau of Economic Research: March 2001–November 2001,
December 2007–September 2009, and February 2020–June 2020.
Figure 2-9
Subprime are those with an Equifax Risk Score below 620; near prime are from 620 to 719;
prime are greater than 719. Scores are measured contemporaneously. Student loan balances
before 2004 are estimated using average growth from 2004 to 2007, by risk score. The data
are converted to constant 2019 dollars using the consumer price index.
Figure 2-10
Year-over-year change in balances for the second quarter of each year among those households whose balance increased over this window. Subprime are those with an Equifax Risk
Score below 620; near prime are from 620 to 719; prime are greater than 719. Scores were
measured a year ago. The data are converted to constant 2019 dollars using the consumer
price index. Key identifies bars in order from left to right.

FINANCIAL STABILITY REPORT: NOVEMBER 2020 69

Figure 2-11
Loss mitigation includes tradelines that have a narrative code of forbearance, natural disaster, payment deferral (including partial), loan modification (including federal government
plans), and loans with zero scheduled payment and a nonzero balance. Delinquent includes
loans reported to the credit bureau at least 30 days past due. The line break represents the
data transitioning from quarterly to monthly beginning January 2020.
Figure 2-12
Estimated share of mortgages with negative equity according to CoreLogic and Zillow. For
CoreLogic, the data are monthly. For Zillow, the data are quarterly and, for 2017, are available only for the first and fourth quarters.
Figure 2-13
Housing leverage is estimated as the ratio of the average outstanding mortgage loan balance
for owner-occupied homes with a mortgage to (1) current home values using the CoreLogic
national house price index and (2) model-implied house prices estimated by a staff model
based on rents, interest rates, and a time trend.
Figure 2-14
The data are converted to constant 2019 dollars using the consumer price index.
Figure 2-15
Subprime are those with an Equifax Risk Score below 620; near prime are from 620 to 719;
prime are greater than 719. Scores are measured contemporaneously. The data are converted
to constant 2019 dollars using the consumer price index.
Figure 2-16
Loss mitigation includes tradelines that have a narrative code of forbearance, natural disaster, payment deferral (including partial), loan modification (including federal government
plans), and loans with zero scheduled payment and a nonzero balance. Delinquent includes
loans reported to the credit bureau as at least 30 days past due. The line break represents the
data transitioning from quarterly to monthly beginning January 2020.
Figure 2-17
Subprime are those with an Equifax Risk Score below 620; near prime are from 620 to 719;
prime are greater than 719. Scores are measured contemporaneously. The data are converted
to constant 2019 dollars using the consumer price index.
Figure 2-18
Delinquency is at least 30 days past due, excluding severe derogatory loans. The data are
four-quarter moving averages. Subprime are those with an Equifax Risk Score below 620;
near prime are from 620 to 719; prime are greater than 719. Credit scores are lagged four
quarters.
Box: A Retrospective on the March 2020 Turmoil in Treasury and Mortgage-Backed

Securities Markets
Figure A
Smoothed yield curve estimated from off-the-run Treasury coupon securities. Agency resi-

70 Figure Notes

dential mortgage-backed security (RMBS) spread is the difference between the yield on the
30-year 2.5 percent coupon uniform mortgage-backed security and the duration-matched
Treasury yield.
Figure C
Market depth is defined as the average top three bid and ask quote sizes.
Figure D
UST stands for U.S. Treasury. The volume of dealers’ non-rehypothecated Treasury repurchase agreements serves as a proxy for the total dealer securities inventory.
Figure 3-1
Bank equity is total equity capital net of preferred equity and intangible assets, and assets
are total assets. The data are seasonally adjusted by Federal Reserve Board staff. G-SIBs
are U.S. global systemically important banks. Large non–G-SIBs are bank holding companies (BHCs) and intermediate holding companies with greater than $100 billion in total
assets that are not G-SIBs. The shaded bars with top caps indicate periods of business
recession as defined by the National Bureau of Economic Research: July 1990–March 1991,
March 2001–November 2001, December 2007–June 2009, and February 2020–June 2020.
Figure 3-2
Sample consists of banks as of 2020:Q2, except for G-SIBs, for which 2020:Q3 weighted
average CET1 ratio is shown by the dot based on results announced by these banks during
earnings season. These ratios may vary from final figures submitted using form FR Y-9C.
The data are seasonally adjusted by Federal Reserve Board staff. Before 2014:Q1, the numerator of the common equity Tier 1 ratio is Tier 1 common capital for advancedapproaches bank holding companies (BHCs) and intermediate holding companies (IHCs)
(before 2015:Q1 for non-advanced-approaches BHCs). Afterward, the numerator is common equity Tier 1 capital. G-SIBs are U.S. global systemically important banks. Large
non–G-SIBs are BHCs and IHCs with greater than $100 billion in total assets that are not
G-SIBs. The denominator is risk-weighted assets. The shaded bars with top caps indicate
periods of business recession as defined by the National Bureau of Economic Research:
March 2001–November 2001, December 2007–June 2009, and February 2020–June 2020.
Figure 3-3
Weighted median leverage of nonfinancial firms that borrow using commercial and industrial loans from the 26 banks that have filed in every quarter since 2013:Q1. Leverage is
measured as the ratio of the book value of total debt to the book value of total assets of the
borrower, as reported by the lender, and the median is weighted by committed amounts.
Figure 3-4
Banks’ responses are weighted by their commercial and industrial loan market shares.
Survey respondents to the Senior Loan Officer Opinion Survey on Bank Lending Practices are asked about the changes over the quarter. Results are shown for loans to large and
medium-sized firms. The shaded bars with top caps indicate periods of business recession

FINANCIAL STABILITY REPORT: NOVEMBER 2020 71

as defined by the National Bureau of Economic Research: March 2001–November 2001,
December 2007–June 2009, and February 2020–June 2020.
Figure 3-5
Leverage is calculated by dividing total assets by equity.
Figure 3-6
Ratio is calculated as (total assets − separate account assets)/(total capital − accumulated
other comprehensive income) using generally accepted accounting principles. The largest
10 publicly traded life and property and casualty insurers are represented.
Figure 3-7
Leverage is computed as the ratio of hedge funds’ gross notional exposure to net asset value.
Gross notional exposure includes the nominal value of all long and short positions and
derivative notional exposures. Options are delta-adjusted, and interest rate derivatives are
reported at 10-year bond equivalents. Data are reported on a three-quarter lag.
Figure 3-8
Net percentage equals the percentage of institutions that reported increased use of financial leverage over the past three months minus the percentage of institutions that reported
decreased use of financial leverage over the past three months. REIT is real estate investment trust.
Figure 3-9
The data from the first, second, and third quarters of 2020 are annualized to create the 2020
bar. CMBS is commercial mortgage-backed securities; CDO is collateralized debt obligation;
RMBS is residential mortgage-backed securities; CLO is collateralized loan obligation. The
“Other” category consists of other asset-backed securities (ABS) backed by credit card debt,
student loans, equipment, floor plans, and miscellaneous receivables; resecuritized real estate
mortgage investment conduit (Re-REMIC) RMBS; and Re-REMIC CMBS. The data are
converted to constant 2020 dollars using the consumer price index. Key identifies bars in
order from top to bottom.
Figure 3-10
Committed amounts on credit lines and term loans extended to nonbank financial firms by
a balanced panel of 26 bank holding companies that have filed Form FR Y-14Q in every
quarter since 2013:Q1. Nonbank financial firms are identified based on reported North
American Industry Classification System (NAICS) codes. In addition to NAICS codes, a
name-matching algorithm is applied to identify specific entities such as real estate investment
trusts (REITs), special purpose entities, collateralized loan obligations (CLOs), and assetbacked securities (ABS). REITs incorporate both mortgage (trading) REITs and equity
REITs. Broker-dealers also include commodity contracts dealers and brokerages and other
securities and commodity exchanges. Other financial vehicles include closed-end investment
and mutual funds as well as financial planning and pension funds. BDC is business development company.

72 Figure Notes

Figure 4-1
Liquid assets are cash plus estimates of securities that qualify as high-quality liquid assets
as defined by the Liquidity Coverage Ratio requirement. Accordingly, Level 1 assets and
discounts and restrictions on Level 2 assets are incorporated into the estimate. G-SIBs are
U.S. global systemically important banks. Large non–G-SIBs are bank holding companies
(BHCs) and intermediate holding companies with greater than $100 billion in total assets.
Figure 4-2
Short-term wholesale funding is defined as the sum of large time deposits with maturity less
than one year, federal funds purchased and securities sold under agreements to repurchase,
deposits in foreign offices with maturity less than one year, trading liabilities (excluding
revaluation losses on derivatives), and other borrowed money with maturity less than one
year. The shaded bars with top caps indicate periods of business recession as defined by the
National Bureau of Economic Research: March 2001–November 2001, December 2007–
June 2009, and February 2020–June 2020.
Figure 4-3
The black striped area denotes the period from 2008:Q4 to 2012:Q4 when insured deposits
increased because of the Transaction Account Guarantee program. “Other” consists of
variable-rate demand obligations (VRDOs), federal funds, funding-agreement-backed securities, private liquidity funds, offshore money market funds, and local government investment
pools. Securities lending includes only lending collateralized by cash. GDP is gross domestic
product. Values for VRDOs come from Bloomberg beginning in 2019:Q1. See Jack Bao,
Josh David, and Song Han (2015), “The Runnables,” FEDS Notes (Washington: Board of
Governors of the Federal Reserve System, September 3), https://www.federalreserve.gov/
econresdata/notes/feds-notes/2015/the-runnables-20150903.html.
Figure 4-4
The data are converted to constant 2020 dollars using the consumer price index.
Figure 4-5
The data are converted to constant 2020 dollars using the consumer price index.
Figure 4-6
The data are converted to constant 2020 dollars using the consumer price index. Key identifies series in order from top to bottom.
Figure 4-7
Key identifies series in order from top to bottom. Mutual fund assets under management as
of August 2020 included $2,393 billion in investment-grade bond funds, $268 billion in highyield bond funds, and $63 billion in bank loan funds.
Figure 4-8
Securitized products include collateralized loan obligations for corporate debt, private-label
commercial mortgage-backed securities for commercial real estate, and private-label residential mortgage-backed securities and asset-backed securities backed by autos, credit cards,
consumer loans, and student loans for other asset-backed securities. Illiquid corporate debt

FINANCIAL STABILITY REPORT: NOVEMBER 2020 73

includes private placements, bank/syndicated loans, and high-yield bonds. Alternative investments include assets filed under Schedule BA. P&C is property and casualty. Key identifies
series in order from top to bottom.
Figure 4-9
The data are converted to constant 2020 dollars using the consumer price index. FHLB is
Federal Home Loan Bank. Key identifies series in order from top to bottom.
Box: LIBOR Transition Update
Figure A
Key identifies series in order from bottom to top. SOFR is the Secured Overnight Financing
Rate. LIBOR is the London interbank offered rate.
Figure B
Key identifies series in order from bottom to top. SOFR is the Secured Overnight Financing
Rate. LIBOR is the London interbank offered rate.
Figure C
Key identifies series in order from bottom to top. SOFR is the Secured Overnight Financing
Rate. CME is the formal name of what used to be the Chicago Mercantile Exchange. ICE is
the Intercontinental Exchange. 1M and 3M are 1-month and 3-month securities.
Box: Salient Shocks to Financial Stability Cited in Market Outreach
Figure
Responses are to the following question: “Over the next 12–18 months, which shocks, if
realized, do you think would have the greatest negative effect on the functioning of the U.S.
financial system?” SME is small and medium-sized enterprises. CRE is commercial real
estate. CMBS is commercial mortgage-backed security. LIBOR is London interbank
offered rate.

Board of Governors of the Federal Reserve System
www.federalreserve.gov
1120