August 21, 2015 / 1:07 PM / 4 years ago

Housing bust, competition restrain U.S. dealers -N.Y. Fed blog

NEW YORK, Aug 21 (Reuters) - The hangover from the bursting of the housing bubble and competition from electronic trading have helped restrain U.S. dealers from growing their balance sheets and taking more risks, the New York Federal Reserve said in a blog post on Friday.

Some traders and analysts have blamed tighter regulations in response to the 2007-2009 global credit crisis for discouraging dealers to make markets for corporate bonds and other risky assets and provide liquidity for these products. Less ease to buy and sell assets, they said, contributed to “flash” events such as what happened on Oct. 15, 2014, when prices of U.S. Treasuries swung wildly for about 15 minutes.

New York Fed analysts Tobias Adrian, Michael Fleming, Daniel Stackman, and Erik Vogt said in the blog that it is unclear whether the 2010 Dodd-Frank financial reform law and Basel III banking regulatory framework, which raised capital requirements in a bid to avert excessive risk-taking, played a predominant role in limiting dealers’ appetite for holding risky assets on their balance sheets.

“Our findings suggest that business-cycle factors (the hangover from the housing boom and bust and subsequent risk aversion) and secular trends (electronification and competitive entry) should be considered alongside tighter regulation in explaining stagnating dealer balance sheets,” they wrote.

The sum of assets held by bond dealers soared from 1990 through 2008, hitting a peak near $5 trillion. It contracted after the 2008 collapse of Lehman Brothers and has stalled at about its 2005 level of $3.5 trillion.

Dealers’ leverage, a gauge of their risk-taking, peaked at 48 in the first quarter of 2008, just before the near failure of Bear Stearns. Within 15 months, their leverage dropped to 25. It is now at about 20.

“(It) is unclear to what extent regulations constrain growth in dealer leverage and risk-taking today, over and above a lingering lack of risk appetite,” the analysts said.

They also said electronification - the growing role of electronic trading and its effect on dealer balance sheets - has cut profit margins for dealers to make markets for bonds, stocks and other assets, reducing their need to own big balance sheets.

The blog post entitled “What’s Driving Dealer Balance Sheet Stagnation?” is the fifth in a series from the New York Fed examining the “evolving nature of market liquidity.”

For details on the blog post, see: (Reporting by Richard Leong; Editing by Paul Simao)

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