Financial Developments 45

Chart 5.1.1 Federal Debt Outstanding Held by Public

U.S. Sovereign Debt

The total amount of outstanding U.S. sovereign 

debt has risen to $11.0 trillion as of May 31, 

2012 (Chart 5.1.1). Despite this increase in 

supply, the U.S. sovereign yield curve flattened 

considerably since mid-2011, with a decline 

in longer-term yields driving this change 

(Chart 5.1.2). The historically low levels of 

longer-term yields are a reflection of both 

flight to quality and continued monetary policy 

accommodation associated with the weak 

pace of economic growth and the elevated 

unemployment rate. 

Foreign holdings of U.S. debt remain 

substantial, with over $2.2 trillion of U.S. 

Treasury securities held by China and Japan 

and almost $3 trillion across other foreign 

holders in April 2012 compared to about $2 

trillion and $2.4 trillion, respectively, in April 

2011 (Chart 5.1.3). Nearly three-quarters of 

these holdings are by foreign official entities.

5 Financial Developments

5.1 Major Financial Markets

5.1.1 Sovereign Debt Markets

Developments in sovereign debt markets during the 

last year were heavily influenced by the escalation 

of uncertainty in euro area sovereign and banking 

sectors and by continued concerns about the domestic 

and global growth outlook. While sovereign debt 

from the euro area periphery remains stressed, yields 

for sovereign debt from the United States, the United 

Kingdom, Germany, Switzerland, and Japan are 

at record or near-record lows, reflecting flight to 

quality and continued expectations of accommodative 

monetary policy.

Chart 5.1.2 Yield Curve

Chart 5.1.3 Foreign Holders of U.S. Federal Debt
46 2012 FSOC / / Annual Report

In addition to the U.S. sovereign rating, several other 

entities were downgraded shortly after August 5. These 

included clearinghouses, highly rated insurers, and various 

government related entities and their debt. 

There was little market reaction to a move by the Chicago 

Mercantile Exchange (CME) to increase haircuts on U.S. 

Treasury securities just before the downgrade, and most 

clearinghouses did not adjust their haircuts on Treasury 

securities even after the downgrade. 

BOX A: IMPACTS OF DOWNGRADE OF U.S. TREASURY SECURITIES 

On August 5, 2011, Standard & Poor’s (S&P) lowered their 

long-term sovereign credit rating on the United States of 

America to AA+ from AAA and reaffirmed their short-term 

rating of A-1+. S&P stated that the downgrade reflected 

their opinion that the Budget Control Act, which was 

signed into law on August 2, fell short of what would be 

“necessary to stabilize the government’s medium-term 

debt dynamics.” They further stated that, “More broadly, 

the downgrade reflects our view that the effectiveness, 

stability and predictability of American policymaking and 

political institutions had weakened at a time of ongoing 

fiscal and economic challenges.”

Before the downgrade, there was significant market 

focus on the debt ceiling debate in Congress. As the 

deadline approached, there were dislocations in the front 

end of the Treasury yield curve, and some T-Bill yields 

rose dramatically then normalized after the debt limit 

was raised.

Because of widespread speculation in the market that 

S&P would take action, and the relatively minor scale 

of the downgrade, Treasury market participants were 

prepared, and there were no reports of forced selling. 

Also, many institutions’ portfolio restrictions specifically 

carved out “obligations of the U.S. government” rather 

than specifying a level or degree of credit rating. 

Treasury yields fell immediately following the downgrade, 

while major stock indices declined, indicating that 

investors were less concerned with the inherent 

riskiness of Treasury securities than with the potential 

consequences of fiscal retrenchment for the near-term 

macroeconomic recovery. Specifically, on Monday August 

8 (the business day immediately following the downgrade), 

the 10-year Treasury yield closed down 24 basis points. 

The cumulative yield changes through August 11 for the 

two-year, five-year, and ten-year yields were -10 basis 

points, -23 basis points, and -22 basis points, respectively 

(Chart A.1). Risky securities lost value following news of 

the downgrade, with the S&P 500 index registering a 6.8 

percent decline and the Nikkei index falling by 2.2 percent 

by close of trading August 8 (Chart A.2). 

Chart A.1 S&P Downgrade of U.S. Debt: Flight to Quality

Chart A.2 S&P Downgrade of U.S. Debt: Effect on Equities
Financial Developments 47

Chart 5.1.4 Euro Area 10-Year Yield Spreads to German Debt European Sovereign Debt

Over the last 12 months, the European 

fiscal crisis intensified as concerns about the 

sustainability of public finances in peripheral 

European countries escalated and banks 

struggled to obtain financing. (See Section 4.4.) 

In July 2011, euro area authorities proposed a 

voluntary debt exchange on Greek sovereign 

bonds. This, along with weakening growth 

prospects and fiscal slippage, led to a surge in 

Greek government bond yields (Chart 5.1.4). 

As discussed in Section 4.4, European 

authorities responded to these developments 

with a number of policy measures. The private 

sector exchange of Greek sovereign debt, which 

was largely concluded in March of this year, 

involved a significant principal write-down 

and additional official disbursements of aid 

financing through early 2016. The insertion 

and triggering of collective action clauses for 

the purpose of the debt exchange caused credit 

default swaps (CDS) contracts written on Greek 

sovereign debt to be triggered, which occurred 

without any significant market disruptions. 

The participation rate in this exchange was 

over 95 percent. (See Box B: Greek Sovereign 

Debt Restructuring.)

More recently, market pressure on Spain 

intensified. On May 11, the Spanish government 

announced a series of measures to address 

vulnerabilities in the Spanish banking sector, 

including enhanced provisioning requirements 

on real estate related loans, clear separation of 

problem real estate assets into independently 

managed asset management vehicles, and plans 

to have independent external auditors evaluate 

the quality of bank assets. This was followed 

two weeks later by an unexpectedly large 

capital support request from Bankia, Spain’s 

fourth largest bank, and on June 9 by Spain’s 

announcement of its intent to request European 

support for bank recapitalization (for which 

European authorities agreed to provide up to 

€100 billion). (See Box C: Recent Fiscal and 

Banking Developments in Spain.)
48 2012 FSOC / / Annual Report

protection sellers subsequently paid out only an estimated 

$2.5 billion to protection buyers, reflecting the relatively 

small net exposure to outstanding CDS contracts. 

Chart B.2 Greece: Debt Exchange

As with all International Monetary Fund (IMF) programs, 

sustainable debt dynamics were a pre-condition for 

European Union (EU) and IMF lenders to disburse funds 

under a second official sector aid program. Greece’s debt 

restructuring helped to achieve this, putting Greece’s 

high public debt burden (165 percent of GDP in 2011) on 

a path toward 120 percent by 2020. Although the debt 

exchange substantially reduced Greece’s outstanding 

debt to private sector creditors, Greece’s overall debt 

burden is expected to remain quite heavy, reflecting 

continued borrowing from official sector creditors to 

finance the debt exchange, bank recapitalization costs 

related to losses resulting from the debt exchange and 

deteriorating asset quality, and continued deficit financing. 

As a result, public sector creditors are projected to 

hold nearly three-quarters of Greek sovereign debt by 

end of 2012. The new Greek bonds trade at distressed 

levels; yields hovering near 20 percent reflect Greece’s 

heavy indebtedness and the high degree of uncertainty 

about the outlook for implementation of Greece’s reform 

program. On June 17, parties supporting the EU/IMF aid 

program won enough seats in the Greek Parliament to 

form a governing majority, easing fears about a near-term 

exit from the euro and confirming Greece’s commitment 

to reform. 

BOX B: GREEK SOVEREIGN DEBT RESTRUCTURING 

In March and April 2012, Greece restructured 

approximately €199 billion in government and governmentguaranteed debt through a discounted exchange of 

instruments. Due to the use of collective action procedures, 

the restructuring was subsequently deemed a credit event 

by the International Swaps and Derivatives Association 

(ISDA), triggering payouts on Greek credit default swaps 

(CDS). In the aftermath of the Greek restructuring event, the 

CDS market largely functioned as intended. Despite early 

attempts to achieve a purely voluntary restructuring that 

would have circumvented a CDS trigger, low preliminary 

participation rates indicated a need to trigger collective 

action clauses to force higher participation, which in turn 

triggered CDS payouts (Chart B.1). 

Chart B.1 Greece: Average Bond Price and CDS

The exchange reduced Greece’s debt held by the private 

sector by €106 billion, equivalent to 53.5 percent of the 

tendered debt. Creditors participating in the exchange 

received a combination of new Greek government bonds 

(31.5 percent for a total of €63 billion) and short-term 

European Financial Stability Facility (EFSF) notes (15 

percent for a total of €30 billion) (Chart B.2). Participating 

creditors also received detachable GDP warrants, which 

pay up to 1 percent of the outstanding bonds’ face 

amount in years when real GDP growth and nominal 

GDP exceed specified targets. Taking into consideration 

the lower coupons and extended maturities of the new 

bonds, the exchange entailed net present value losses for 

participating creditors estimated at 75-80 percent. CDS 
Financial Developments 49

The strains in the peripheral euro area 

sovereign debt and bank funding markets 

also caused additional pressure in some core 

countries, such as France. In August 2011, the 

central banks of the euro system recommenced 

purchasing euro area sovereign bonds, 

including Spanish and Italian bonds, in the 

context of the Securities Markets Programme 

(SMP), to address the severe tensions in some 

market segments that had been hampering 

monetary policy transmission. This activity 

occurred in the context of intensified 

strains in peripheral sovereign debt markets, 

widening credit spreads and bid-ask spreads, 

particularly for Spanish and Italian sovereign 

debt, and sharply higher liquidity risk premia. 

As funding markets tightened further, euro 

area governments announced plans for 

enhanced fiscal and structural reforms, while 

central banks announced the extension and 

repricing of U.S. dollar swap lines, and the 

European Central Bank (ECB) implemented 

two unprecedented three-year longer-term 

refinancing operations (LTROs), as discussed 

in Section 4.4. 

These various measures helped stabilize 

markets in late 2011 and early 2012, as new 

governments were elected in Spain and Italy. 

However, general uncertainty over conditions 

in the euro area has increased once again over 

the past few months, as the sustainability of the 

strategies currently being undertaken in the 

hardest hit countries is called into question. 

Sovereign debt and bank credit spreads 

increased for Spain and Italy, after having 

narrowed over the first quarter of 2012. Credit 

spreads remain elevated in many sovereign 

debt and bank funding markets—notably 

for bank maturities beyond the ECB LTRO 

period of three years—and market functioning 

remains irregular with marked recent pressure 

on spreads in Italy and Spain. The primary 

buyers of Italian and Spanish sovereign debt in 

recent months have been their own domestic 

banks, which in turn rely on ECB financing and 

support. Private foreign investors, such as prime 

money market funds (see Section 5.3), have 

continued to reduce participation in euro area 
50 2012 FSOC / / Annual Report

BOX C: RECENT FISCAL AND BANKING DEVELOPMENTS IN SPAIN 

Spain announced on June 9 that it intends to request 

European Union (EU) assistance to recapitalize its 

troubled banking sector. Euro area finance ministers 

indicated they would support the request for up to €100 

billion (10 percent of GDP), which is expected to cover 

estimated stress-case capital needs plus an additional 

safety margin. On June 21, independent consultants 

engaged by the Spanish government estimated the 

recapitalization needs of Spanish banks at up to €62 

billion under an adverse macroeconomic scenario. The 

formal request is expected to follow this estimate, which is 

within the range of most private estimates of capital needs 

(€50 billion to €100 billion). Although the announcement 

stipulates that no additional explicit conditionality will be 

imposed with regards to fiscal policy, Spain must meet 

existing fiscal and structural reform commitments, which 

were previously agreed with the EU. 

On June 29, euro area heads of government agreed 

to use euro area funds to support Spanish banks. The 

region’s finance ministers subsequently announced that 

the agreement would be signed on July 20 and an initial 

tranche of €30 billion would be disbursed by the end 

of July. The funds will be channeled through the EFSF 

to the Spanish government, and then transferred to 

the European Stability Mechanism (ESM) once it is fully 

operational. Direct ESM funding to Spanish banks will 

become available only after the establishment of a single 

supervisory mechanism for euro area banks. It was 

further agreed that aid for the Spanish banking sector 

would not be subject to the preferred creditor status 

embedded in the ESM treaty.

Separately, Moody’s, S&P, and Fitch downgraded the 

Spanish sovereign by several notches into the BBB 

range within the last two months, largely reflecting 

concerns about the Spanish banking sector and fiscal 

performance. The sovereign downgrades were followed 

by downgrades of the banks themselves. Notably, the 

International Monetary Fund (IMF) concluded from 

its stress tests that Spain’s largest banks appear 

sufficiently capitalized to withstand a significantly weaker 

macroeconomic environment, given their substantial 

earnings generation from international operations.

Concern about Spanish fiscal performance has persisted, 

fueling doubts about the prudence of adhering to strict 

budget targets amid deepening recession. As a result, 

euro area finance ministers agreed on July 9 to ease 

Spain’s deficit objectives, raising the 2012 target by one 

percentage point to 6.3 percent of GDP and giving the 

government an additional year—to 2014—to lower the 

deficit below 3 percent of GDP. The agreement will be 

made official at the next Eurogroup meeting on July 20. 

The relaxation of fiscal targets follows two revisions to the 

2011 fiscal deficit. On May 20, the Spanish government 

revised its 2011 budget deficit upward to 8.9 percent 

of GDP from a previous 8.5 percent estimate, a major 

deviation from the 6 percent target. Both the overrun and 

the latest revision were driven by the deficits of regional 

governments, exposing the difficulty of reining in these 

regional deficits. Market reaction to developments in 

Spain subsequent to the assistance request was generally 

negative, with yields on 10-year Spanish sovereign debt 

exceeding 7 percent, a euro era high.
Financial Developments 51

sovereign and bank funding markets. European 

pension funds and insurance companies also 

have reduced exposures to the periphery, 

including to Spanish and Italian sovereign debt.

Other Sovereign Debt

The decline in yields across a range of 

developed countries’ sovereign bonds has 

been further reinforced by strong investor 

interest in high credit quality assets and more 

accommodative monetary policies. Through 

early July 2012, 10-year nominal U.S. Treasury 

yields had declined more than 150 basis points 

since July 2011, in part reflecting both the 

lower expected path of short-term interest 

rates and a fall in the term premium. The 

pattern of decline in yields has been similar 

for German, Swiss, and U.K. sovereign debt. In 

Japan, 10-year sovereign debt yields, which were 

already close to 115 basis points, declined more 

modestly to just below 85 basis points over the 

same period (Chart 5.1.5). 

Emerging European market spreads to 

Treasury yields as measured by the Emerging 

Markets Bond Index Plus (EMBI+), have 

widened over 100 basis points over the past 

year through early July—largely in line with 

U.S. BBB corporate credit spreads—reflecting 

global growth concerns and the pull-back in 

risk appetite, as well as specific developments 

in certain countries. The spreads on bonds 

for other emerging markets also fluctuated in 

response to stresses and policies in external 

markets (Chart 5.1.6). Some differences 

across emerging market economies are 

likely associated with country risk and 

growth prospects, as well as their policies for 

managing capital inflows and outflows. 

5.1.2 Other Asset Markets

Asset markets outside of sovereign debt have also been 

heavily influenced by developments in the euro area 

and the growth outlook, with the notable exception of 

agricultural land and some commodities. Corporate 

debt spreads widened over the past 12 months, with 

spreads for financial firms increasing more than for 

nonfinancial firms. The dollar appreciated against 

the euro, reflecting continued concerns with euro area 

peripheral sovereign debt.

Chart 5.1.5 10-Year Sovereign Debt Yields

Chart 5.1.6 Emerging Market Bond Spreads
52 2012 FSOC / / Annual Report

Chart 5.1.8 Global Equities

Equities

U.S. equity markets outperformed other major 

equities markets from mid-year 2011 through 

early July 2012 after a period of considerable 

volatility (Chart 5.1.7). Equity markets in 

advanced and emerging economies fell sharply 

in the third quarter of 2011 as numerous 

concerns—including the unfolding European 

crisis, the sustainability of U.S. fiscal policy, 

and a slowdown in global growth—weighed 

on sentiment (Charts 5.1.8). By early October 

2011, the S&P 500 was around 17 percent below 

its level at the end of June 2011. The Euro 

Stoxx index declined around 27 percent over 

the same period, reflecting outsized declines 

in peripheral equity markets. As concerns 

subsequently eased during the first quarter of 

2012, buoyed in part by global central bank 

actions and ongoing signs of economic recovery 

in the United States, U.S. equity markets 

reported strong gains. However, much of these 

recent gains in the United States have reversed 

following weaker than expected data on the 

U.S. recovery, weak global economic data and 

renewed concerns about the European crisis. As 

of July 6, 2012, the S&P 500 was nearly 4 percent 

lower than at the end of the first quarter of 

2012, and European stocks fell almost 10 

percent over the same period.

Corporate Bonds

Corporate bond spreads to sovereign 

equivalents in the United States and Europe 

have generally widened since mid-2011, 

although this development has been less 

pronounced in the United States. A particular 

feature has been the large divergence between 

spreads on debt issued by financial firms 

versus nonfinancial firms, as investors focus 

on risks associated with the financial sector 

(Chart 5.1.9). A similar pattern can be found in 

the relative increase in CDS spreads of financial 

firms over nonfinancial firms. Issuance of 

covered bonds has outpaced unsecured debt 

issuance in a number of European banking 

systems, reflecting increased concerns about the 

creditworthiness of these institutions. Overall, 

U.S. dollar corporate bond issuance has 

rebounded strongly in 2012, particularly among 

nonfinancial issuers. 

Chart 5.1.7 Price Changes in Selected Equities Indices

Chart 5.1.9 U.S. Corporate Bond Spreads—Investment Grade
Financial Developments 53

Foreign Exchange 

Over the past 12 months, foreign exchange 

markets were strongly influenced by euro 

area developments and monetary policy 

expectations. The euro broadly declined over 

the second half of 2011 and first half of 2012, 

with downside pressure against the major 

currencies particularly evident late in 2011 

and 2012:Q2. In dollar-euro markets, bid-ask 

spreads widened slightly and options markets 

placed above average value on protection from 

further euro depreciation. Within Europe, 

the sharp depreciation against the safe haven 

of the Swiss franc prompted a strong market 

intervention by the Swiss National Bank in 

August and early September 2011, culminating 

with the establishment of a floor for the eurofranc exchange rate. Downside pressure on 

the euro against major currencies abated 

somewhat in early 2012, particularly against 

the yen. The Bank of Japan had intervened 

in foreign exchange markets in late October 

through early November 2011, selling yen and 

buying dollars, and also engaged in further 

monetary easing through the end of April 2012. 

The improvement in risk tone over that period 

was also associated with a partial rebound in 

many emerging market currencies, after they 

had depreciated sharply in the second half 

of 2011 as reflected in the other important 

trading partners (OITP) and broad dollar 

indices (Chart 5.1.10). More recently many 

emerging market currencies fell against the 

dollar, prompting intervention by some of these 

countries to support their currencies.

Overall, between July 2011 and July 2012, the 

U.S. dollar appreciated by nearly 15 percent 

against the euro, was broadly unchanged 

against the yen, and appreciated against most 

emerging markets currencies. Options markets 

are again placing a relatively high value on 

protection against euro depreciation, as 

measured by the price differential between outof-the-money puts and calls.

Commodities

Commodity prices have displayed elevated 

volatility for the past several years, driven by 

Chart 5.1.10 U.S. Dollar Exchange Rates
54 2012 FSOC / / Annual Report

market-specific fundamental factors as well 

as broader global growth concerns and risk 

sentiment. Oil prices were near their three-year 

highs early in 2012, with continued geopolitical 

uncertainty in the Middle East raising concerns 

over global supply and limited spare capacity. 

More recently, however, prices moderated 

slightly. In the United States, nominal gasoline 

prices were also near historic highs early in 

2012 but have likewise moderated. Natural 

gas prices almost halved over the past year 

on expectations of increased supply arising 

from hydraulic fracturing technology (Chart 

5.1.11), though prices increased again through 

July 6, albeit from quite a low base, as result of 

announced cutbacks in drilling and some signs 

of accelerated coal-to-gas switching activity. 

Industrial metal prices have also declined 

since June 2011, with the majority of the fall 

occurring in the third quarter of 2011, when 

global growth fears were most pronounced. This 

period was also associated with marked strength 

in gold prices. Commodity markets continued 

to function well with only limited impact from 

the bankruptcy of MF Global*, despite its role 

as a futures clearing merchant in these markets. 

(See Box D: MF Global Bankruptcy.)

Agricultural Land

Agricultural land values are estimated to have 

increased further through mid-2011, driven 

by increasing crop yields, rising commodity 

prices, favorable crop export conditions, and 

low interest rates (Chart 5.1.12). Adjusting for 

commodity prices and improvements in crop 

yields, agricultural land values have retreated 

somewhat from the record highs reached in 2005 

and 2006. Price-to-rent ratios for agricultural 

land are at multi-decade highs for a number of 

Corn Belt and Plains states but have moderated 

from peaks for the United States as a whole.

Currently, aggregate incomes in the U.S. 

farm sector are performing well, forecasts 

for production and demand are positive, and 

debt levels in general do not appear to have 

Chart 5.1.11 Commodities

Chart 5.1.12 Farm Land Prices and Value of Crop Yield

Chart 5.1.13 Agricultural Real Estate Debt Outstanding

* Chairman Gensler did not participate in the preparation 

or review of the portions of this report specifically regarding 

MF Global.
Financial Developments 55

been rising sharply. Adjusting for inflation, 

current agricultural real estate debt levels 

remain significantly below the levels of the 

late 1970s (Chart 5.1.13). The Farm Credit 

System and community banks that specialize in 

agriculture lending have the bulk of exposures 

to agricultural land. Delinquency rates on real 

estate farm loans at commercial banks declined 

in recent quarters to about 3 percent at the end 

of 2011, slightly above the historical average of 

about 2.6 percent over the past 20 years.

5.1.3 Wholesale Funding Markets 

Use of short-term wholesale funding has dropped 

significantly, with declines in outstanding volumes of 

both repurchase agreements and corporate paper. This 

development is likely to enhance stability of funding 

for financial institutions, as these entities shift to 

more stable funding sources such as retail deposits. 

However, this shift is partially due to market reaction 

to uncertainty and flight to safety, and it could be 

retraced as these uncertainties abate.

Short-Term Wholesale Funding Markets Overview

Short-term wholesale funding markets, 

which include large time and checking 

deposits, repurchase agreements (repos), 

and commercial paper, provide financial 

intermediaries with funds that supplement 

retail deposits to support their activities (Chart 

5.1.14). Sources of lending in the wholesale 

short-term funding markets are largely 

wholesale cash pools, including cash on the 

balance sheets of nonfinancial companies, 

reinvestments of cash collateral from securities 

lending, cash held by long-term mutual funds, 

and money market funds. These sources of 

funds have grown markedly as a percentage of 

GDP over the past two decades, although this 

percentage has been declining through the first 

quarter of 2012 (Chart 5.1.15). Nonfinancial 

corporate cash, in particular, has been growing 

at an accelerating rate, a pattern that continued 

through early 2012.

Measures of reliance on short-term wholesale 

funding of domestic banking firms continue 

to decline and remain well below their peaks 

in 2008 (Chart 5.1.16). Slow growth in loans 

Chart 5.1.14 Large Bank Holding Company Liability Structure

Chart 5.1.15 Wholesale Cash Investors

Chart 5.1.16 Retail Deposits vs. Short-Term Wholesale Funding
56 2012 FSOC / / Annual Report

relative to large deposit inflows, which have 

been bolstered by the FDIC’s temporary 

unlimited insurance coverage for noninterest-bearing transaction deposits, also 

supported this decline. 

Recent LIBOR Investigations 

Recent investigations into possible manipulation 

of the London Interbank Offered Rate (LIBOR) 

underscore the importance of effective control 

processes to help ensure the integrity of funding 

markets. LIBOR rates serve as reference rates 

for most interest rate derivatives and variable 

rate loans. However, LIBOR rates are not 

transaction rates. Rather, the LIBOR rate for a 

given currency and tenor is calculated based on 

the rates submitted by a panel of member banks 

each morning to the British Bankers’ Association 

(BBA). The accuracy of LIBOR as a measure of 

interest rates in the London interbank market 

depends crucially on the accuracy of banks’ 

responses to the BBA survey. 

While media reports of anomalies in the 

LIBOR rates have surfaced as far back as 

2007, concerns with the integrity of the 

LIBOR process escalated in late June 2012. 

Specifically, on June 27, in an internationally 

coordinated enforcement effort, the CFTC, U.S. 

Department of Justice (DOJ) and the United 

Kingdom Financial Services Authority (FSA) 

each announced actions finding that Barclays 

had provided false information to the BBA 

surveys and attempted to manipulate LIBOR 

and another benchmark, the Euro Interbank 

Offered Rate (Euribor), on numerous occasions 

and sometimes on a daily basis over a four-year 

period, commencing as early as 2005. In 

addition, certain Barclays euro swaps traders, 

led at the time by a senior trader, coordinated 

with and aided and abetted traders at other 

banks in attempts to manipulate Euribor. 

Among other things, Barclays improperly made 

submissions both to benefit its derivatives 

trading positions and to protect against 

negative perceptions of the bank’s health. 

Barclays entered into settlement agreements 

with the CFTC, DOJ and FSA. The CFTC 
Financial Developments 57

imposed a $200 million penalty and issued 

an Order requiring Barclays to implement 

measures to help ensure that its submissions 

are transaction focused, based upon a rigorous 

and honest assessment of information and 

not influenced by conflicts of interest. Among 

other undertakings in the CFTC Order, in 

making submissions, Barclays transactions will 

be given the greatest weight subject to certain 

specified adjustments and considerations. In 

addition, Barclays was ordered to implement 

firewalls to prevent improper communications 

and submissions. As part of a non-prosecution 

agreement, the DOJ ordered Barclays to pay 

a $160 million penalty. In its action, the FSA 

imposed a penalty of £59.5 million.

Repo Markets

The overall repo market is composed of both 

bilateral transactions negotiated between 

two market participants and tri-party repo 

transactions in which the exchange of cash and 

collateral is administered by a clearing bank. 

The size of the overall repo market is difficult 

to measure, due to issues related to netting and 

accounting conventions. Additionally, existing 

data do not provide adequate visibility into 

the composition of repo activity. Chart 5.1.17

displays two measures of the size of the repo 

market: tri-party repos and primary dealer 

repos, which include both tri-party and bilateral 

repos. According to both measures, the overall 

volume of repo activity remains substantially 

below that seen in the run-up to the crisis. In 

particular, tri-party repo activity peaked in 2008 

at $2.7 trillion and fell below $1.8 trillion in the 

years since the end of the recession, well below 

pre-crisis levels. 

As the volume of tri-party activity has declined, 

so has the level of traditional and nontraditional collateral in tri-party since July 

2008. Traditional collateral consists of Treasury 

securities, agency mortgage-backed securities 

(MBS), agency debentures, and agency 

collateralized mortgage obligations (CMOs). 

Non-traditional collateral includes corporate 

bonds, equities, private label CMOs, assetbacked securities (ABS), commercial paper 

Chart 5.1.17 Estimated Value of the Repo Market
58 2012 FSOC / / Annual Report

(CP), other money market instruments, whole 

loans, and municipal bonds. Non-traditional 

collateral accounts for only 16 percent of triparty collateral as of May 2012 (Chart 5.1.18), 

down from 21 percent of the total in May 2011 

and 25 percent in July 2008. Among traditional 

collateral in the tri-party repo market, the 

share of Treasury securities has increased at 

the expense of agency paper, consistent with 

relative shifts in supply and flight-to-quality 

in recent years. Most types of non-traditional 

collateral have fallen significantly, with private 

CMOs declining the most.

There are considerable concerns about 

structural weaknesses in the tri-party repo 

market. (See Box G: Ongoing Vulnerabilities in 

the Tri-Party Repo Market.)

Commercial Paper and Asset-Backed 

Commercial Paper 

CP outstanding peaked at $2.2 trillion in July 

2007 and stood at $1.0 trillion at May-end 2012 

(Chart 5.1.19). As of May 2012, asset-backed 

commercial paper (ABCP) accounts for 32 

percent of the market, financial commercial 

paper accounts for 48 percent, and nonfinancial 

corporate commercial paper accounts for 

20 percent. Financial CP and certificates of 

deposit (CDs) outstanding are around 40 to 

50 percent below their pre-crisis peaks and, 

in recent months, financial commercial paper 

outstanding has continued to decline, largely 

due to reduced demand from investors for 

foreign bank commercial paper.

ABCP was only about 6 percent of the total 

commercial paper market in 1990, but it 

accounted for about 60 percent of the total 

market in mid-2007, or approximately $1.2 

trillion. The market has shrunk steadily and, 

as of the beginning of July 2012, it is currently 

at about $311 billion outstanding, with foreign 

bank sponsored conduits comprising the 

majority of the market. The Moody’s downgrade 

of 15 large U.S. and European banks in June 

2012, discussed in Section 5.2, also resulted 

in the downgrade of 18 ABCP conduits that 

rely on these banks for liquidity support. The 

Chart 5.1.18 Tri-Party Repo Collateral Distribution

Chart 5.1.19 Commercial Paper Outstanding
Financial Developments 59

affected conduits have a combined value of 

almost $70 billion. These downgrades elicited a 

noticeable market response, with an increase in 

the cost of funding these conduits.

Securities Lending

Securities lending is a transaction involving 

the temporary transfer of a security by one 

party (the lender) to another (the borrower), 

in exchange for collateral in the form of either 

cash or non-cash instruments. Institutions 

may want to borrow securities to facilitate 

short selling, for derivative hedges, or to 

avoid failing on a delivery. The main lenders 

of securities are institutional investors, such 

as pension plans, investment funds, and 

insurance companies. The main borrowers are 

hedge funds, broker-dealers, asset managers, 

derivatives traders, and market makers. Most 

domestic securities lending is done against cash 

collateral. Typically, the lender of a security 

pays an interest rate to the borrower for the 

cash collateral. Lenders, in turn, seek to earn 

an additional return by investing this cash in a 

variety of instruments. 

The global value of securities lending 

transactions remained fairly flat through June 

2012 at an average value below $2 trillion 

(Chart 5.1.20). The total market value of 

securities on loan in the United States was 

about $820 billion at the end of the second 

quarter of 2012. About 50 percent of the total 

U.S. market is represented by U.S. government 

securities, about 40 percent by equities, and the 

rest by fixed income securities. Reinvestment 

of cash collateral from securities lending 

declined in volume over the past year from $775 

billion in 2011:Q1 to $670 billion in 2012:Q1. In 

addition, the weighted average maturity of such 

cash reinvestment declined markedly in late 

2011, likely in response to concerns associated 

with the euro area debt situation (Chart 5.1.21).

5.1.4 Housing Markets

The housing market remains stressed. However, 

national home prices show signs of stabilizing after 

a long-term decline, and some measures of house 

prices have shown upticks recently. Housing markets 

Chart 5.1.20 Value of Securities on Loan

Chart 5.1.21 Securities Lending Cash Reinvestment
60 2012 FSOC / / Annual Report

continue to be weighed down by elevated inventories of 

foreclosed homes, homes in the foreclosure process, and 

homes in danger of foreclosure, although the latter 

has been decreasing over the past year. In addition, 

the inventory of existing homes for sale has continued 

to decline and now stands at levels comparable to 

2004. Despite the overall improvement in economic 

and financial market conditions and historically low 

interest rates, access to residential mortgages remains 

constrained. The public sector continues to offer 

solutions aimed at stabilizing the housing markets by 

providing refinancing and modification options to 

prevent additional foreclosures. 

Housing Market Overview 

Housing activity remains at a historically 

low level. Home prices continued to decline 

through late 2011, though early 2012 showed 

signs of stabilization, including a rise in some 

housing price indices (Chart 5.1.22). National 

house prices are still as much as 30 percent 

below their peak in 2006. Going into the second 

quarter of 2012, nearly 13 million homeowners 

had mortgage balances exceeding the values 

of their homes, a condition known as “negative 

equity” (Chart 5.1.23). Although housing starts 

and existing home sales remain significantly 

below pre-crisis highs, they have risen by more 

than 30 percent from their respective 2009 and 

2010 lows through April 2012. The inventory 

of existing homes for sale has declined 

significantly over the last two years and is 

currently comparable to levels last seen in 2004. 

Indicators of credit quality in the residential 

mortgage sector continue to reflect the 

challenges confronting homeowners and 

lenders. The fraction of mortgages that 

are delinquent more than 90 days but not 

yet in foreclosure is sometimes referred 

to as the “shadow inventory” of homes in 

danger of foreclosure. This measure has 

declined from a high of 5 percent to around 

3 percent; however, it remains at elevated 

levels. Moreover, there has been little change 

in the fraction of mortgages that are in 

foreclosure, which remains around 4.4 percent 

(Chart 5.1.24). The inventory of mortgages 

Chart 5.1.23 Mortgages with Negative Equity

Chart 5.1.22 National Repeat Sales Home Price Indices

Chart 5.1.24 Mortgage Delinquency and Foreclosure
Financial Developments 61

that are in some stage of the foreclosure 

process remains high (Chart 5.1.25).

Mortgage Credit Flows

Mortgage credit flows remain quite constrained. 

High unemployment and heightened 

uncertainty contributed to weak provision of 

housing credit, but tighter credit standards 

have also been a major factor. In particular, 

the credit quality of new originations—both 

purchases and refinances—is far higher than 

prior to the crisis (Chart 5.1.26). According 

to the Senior Loan Officer Opinion Survey 

(SLOOS) data, the persistent net tightening 

in mortgage credit standards from 2007 

through 2009 has only recently begun to 

ease, and only for prime residential loans. 

When asked to indicate their willingness to 

originate government-sponsored enterprise 

(GSE) eligible mortgages relative to 2006 for 

borrowers across a range of creditworthiness, 

banks were less likely to lend to all credit 

categories except those with pristine credit. 

While higher credit scores and larger down 

payments tended to increase banks’ willingness 

to lend, many banks were unwilling to provide 

mortgage credit even when the loans were 

within GSE requirements. Higher “put-back 

risk” (the risk that the mortgage originator may 

have to repurchase the loan if it violates the 

GSE’s requirements) and borrower costs, along 

with difficulty in obtaining mortgage insurance, 

were cited as important factors contributing to 

banks’ reluctance to originate such loans. The 

events of the last several years also exposed 

severe deficiencies in the nation’s housing 

finance infrastructure. In areas ranging 

from the securitization process to servicing 

of delinquent mortgages to the foreclosure 

process, a system that was designed for a rising 

market was shown to function poorly in a 

declining price environment. This increased 

the level of uncertainty among market 

participants, contributing to constrained 

credit availability.

Measures to Strengthen the Housing Market

To strengthen the housing market, the 

government developed a number of programs 

Chart 5.1.26 Median Credit Score at Mortgage Origination

Chart 5.1.25 Foreclosure Pipeline
62 2012 FSOC / / Annual Report

aimed at providing relief to struggling 

homeowners, including Making Home 

Affordable (MHA), the Home Affordable 

Refinance Program (HARP) and the Hardest 

Hit Fund. MHA, which was announced in 2009, 

was enhanced in January 2012, with expanded 

eligibility to reach a broader pool of distressed 

borrowers. As of April 2012, MHA has granted 

over 1.1 million homeowner assistance 

actions, mostly through the Home Affordable 

Modification Program (HAMP), which 

provides first lien permanent modifications. 

Additional MHA programs include a secondlien modification program, an unemployment 

forbearance program, and a short-sale or 

deed-in-lieu-of-foreclosure program. The 

end-date of MHA, based on the January 2012 

enhancements, is December 31, 2013.

In April of 2009, the Home Affordable 

Refinance Program (HARP) was established 

to help homeowners refinance their GSEguaranteed mortgages if they had a loan-tovalue ratio (LTV) higher than 80 percent. As 

of March 2012, 1.2 million loans had been 

refinanced out of an estimated 3 to 4 million 

HARP-eligible homeowners. In October of 

2011, the FHFA announced modifications to 

HARP in an effort to increase efficiency and 

expand the eligible universe of borrowers who 

can benefit from refinancing. The revisions 

extended the expiration until December 2013, 

removed the 125 percent LTV cap in order to 

accommodate more borrowers with negative 

equity, and provided additional representation 

and warranty relief for same-servicer refinances. 

These changes seem to have led to increased 

HARP refinancing in early 2012 (Chart 5.1.27). 

In 2010, the Hardest Hit Fund was announced, 

which provides $7.6 billion to Housing Finance 

Authorities in the 18 states most affected by 

price declines and unemployment as well as 

in the District of Columbia. These funds have 

been used to develop a range of programs 

tailored to their local housing markets, 

including mortgage payment assistance 

for unemployed borrowers, reinstatement 

Chart 5.1.27 HARP Refinancings
Financial Developments 63

programs, principal reduction, and transition 

assistance for borrowers.

In addition to these programs, the government 

agencies have made substantial efforts to 

address loan servicing and foreclosure abuses. 

In early 2012, 49 states and the federal 

government announced a $25 billion settlement 

with the five largest loan servicers. Under the 

terms of the settlement agreement, servicers 

are required to pay $5 billion to be allocated to 

states, borrowers, and the FHFA. In addition, 

servicers are also required to dedicate $20 

billion toward various forms of financial 

relief to borrowers, including reduction of 

principal balances on loans with negative 

equity and assistance in refinancing. These 

actions complement consent orders and other 

actions already being taken by the OCC, the 

FDIC, the Federal Reserve, and the FHFA to 

address and correct deficiencies in mortgage 

foreclosure processing.

Government-Sponsored Housing Enterprises 

Government support to Fannie Mae and 

Freddie Mac has helped keep mortgage credit 

markets functioning, as private securitization 

largely remains absent. At the end of 2011, GSE 

mortgage credit flow accounted for 71 percent 

of total mortgage origination (Chart 5.1.28), 

considerably higher than pre-crisis levels, with 

most of the remaining originations coming 

from the Federal Housing Administration 

(FHA) and Department of Veterans Affairs 

(VA). Residential mortgage-backed securities 

(RMBS) continue to be issued solely by housingrelated GSEs and Ginnie Mae (GNMA), with 

negligible issuance of securities by non-agency 

entities (Chart 5.1.29). 

The financial position of the GSEs has 

improved recently. In 2012:Q1, Fannie Mae 

earned $2.7 billion income, and it did not 

request additional capital support from the 

government. In contrast, Freddie Mac reported 

a net income gain of $577 million for the same 

quarter and is seeking an additional $19 million 

in capital from the Treasury (Chart 5.1.30). 

Although the loss rate from single-family 

Chart 5.1.29 Issuance of RMBS

Chart 5.1.28 Mortgage Originations

Chart 5.1.30 GSE Net Income and Losses
64 2012 FSOC / / Annual Report

loans has been declining, this activity is still 

the main driver of losses at the GSEs. As of 

March 31, 2012, Fannie Mae and Freddie Mac 

reported single-family mortgage delinquency 

rates of 3.7 percent and 3.5 percent respectively, 

representing the lowest delinquency rates 

since 2009.

5.2 Bank Holding Companies and 

Depository Institutions

5.2.1 Bank Holding Companies

Bank holding companies (BHCs) continue to 

enhance their overall strength with improved capital 

and liquidity positions. Both the quality and 

amount of capital at BHCs continue to improve due 

to positive operating results, capital raising, and 

regulatory changes. Most of the largest BHCs have 

resumed capital distributions after undergoing stress 

testing and capital planning under the enhanced 

supervision of the Federal Reserve. However, 

revenues at the largest BHCs remain challenged by 

general market uncertainty, slowing global growth, 

and the low interest rate environment; credit default 

swap (CDS) spreads remain elevated, and increases 

in pretax income continue to be driven largely by 

non-recurring items.

A majority of commercial banks are owned 

by BHCs, which include the bank and any 

nonbank subsidiaries such as broker-dealers, 

investment companies, or insurance companies. 

As of year-end 2011, there were 4,743 top tier 

BHCs in the United States (excluding Puerto 

Rico), with aggregate assets of about $17.4 

trillion. Aggregate pretax income in 2011 

totaled $148 billion, an increase of 26 percent 

from 2010 (Chart 5.2.1).

Capital and Liquidity

In aggregate, capital ratios for BHCs improved 

from 2010:Q4 to 2012:Q1, with the tier one 

common capital ratio under current riskbased capital rules (“Basel I”) increasing 1.4 

percentage points to 11.1 percent as of 2012:Q1. 

Increases in retained earnings, primarily 

from positive operating results, contributed 

1.1 percentage points to this increase, while 

Chart 5.2.1 Aggregate BHC Pre-Tax Income
Financial Developments 65

additional capital raising contributed 0.4 

percentage points (Chart 5.2.2). 

For the 19 largest U.S. BHCs, capital ratios 

continue to improve from post-crisis levels, 

with the aggregate tier one common capital 

ratio under Basel I improving 1.5 percentage 

points from 2010:Q4 to 2012:Q1 to 10.9 

percent (Chart 5.2.3). These 19 BHCs also 

underwent additional stress testing as part 

of the Comprehensive Capital Analysis and 

Review 2012 (CCAR 2012). Similar to the 2011 

exercise, CCAR 2012 was a forward-looking 

cross-sectional analysis designed to examine the 

capital planning processes at these firms. A key 

part of the Federal Reserve’s examination was 

a supervisory assessment of capital adequacy 

under a hypothetical stress scenario. This stress 

scenario was intended to help ensure a rigorous 

assessment of the BHCs’ capital plans and was 

significantly more severe than prior stress tests. 

For example, one of the macroeconomic factors 

used in the stress scenario is the unemployment 

rate, which peaks at just over 13 percent for 

CCAR 2012—considerably higher than the 

comparable stress scenarios in both the 2009 

Supervisory Capital Assessment Program (SCAP) 

and the prior year’s CCAR exercise (Chart 5.2.4). 

In the hypothetical stress scenario, the Federal 

Reserve projected that the 19 BHCs would 

have a total of $438 billion in tier one common 

capital, implying an aggregate tier one common 

ratio under Basel I of 6.3 percent at the end of 

the nine-quarter projection period—well above 

the 5 percent target established in the Capital 

Plans Rule issued by the Federal Reserve in 

November 2011. The pro forma capital level 

under the stress scenario actually exceeded 

the BHCs’ aggregate tier one common ratio 

at the start of the 2009 SCAP, reflecting the 

more than $300 billion increase in tier one 

common equity at these BHCs since early 2009 

(Chart 5.2.5). However, 4 of the 19 BHCs had 

one or more projected regulatory capital ratios 

fall below regulatory minimum levels at some 

point over the stress scenario horizon.

Chart 5.2.3 Change in Tier 1 Common Ratios for 19 Largest BHCs

Chart 5.2.2 Change in Tier 1 Common Ratios for Aggregate 

U.S. BHCs

Chart 5.2.4 U.S. Unemployment Rate: Actual vs. Stress Scenarios
66 2012 FSOC / / Annual Report

Along with higher capital levels, balance sheets 

at the largest BHCs continue to be more robust, 

as assets became more liquid and liabilities 

more stable following the financial crisis. 

In particular, the fraction of assets on BHC 

balance sheets consisting of highly liquid assets 

is more than two standard deviations above its 

average from 1995 to the end of 2011 (Chart 

5.2.6). Less reliance on short-term wholesale 

funding (Chart 5.2.7), combined with an 

increase in core deposits, offers a more stable 

and resilient funding base. 

Since some of this rebalancing away from 

short-term funding across all banks is a result of 

flight to quality by wholesale funding suppliers 

and since some of the increase in core deposits 

may be associated with the expanded FDIC 

guarantee that is scheduled to expire at the 

end of 2012, the longer-run persistence of these 

balance sheet improvements is unresolved. 

Moreover, some banks have large amounts of 

wholesale funding that are not necessarily fully 

covered by liquidity buffers. 

For U.S. BHCs with assets less than $50 billion, 

the tier one common ratio under Basel I 

improved by approximately 1.6 percentage 

points to 12.6 percent over the 2010:Q4 to 

2012:Q1 period, primarily due to capital raising 

(1.4 percentage points) and positive operating 

results contributing to retained earnings 

(1 percentage point) (Chart 5.2.8). These 

increases were somewhat mitigated by the 

increase in risk-weighted assets that reduced the 

tier one common capital ratio under Basel I by 

0.7 percentage point.

Many BHCs continue to engage in moderate 

share repurchases and dividend payouts in spite 

of continued economic uncertainty, forthcoming 

higher regulatory capital requirements, and 

enhanced regulatory scrutiny. Although many 

of the 19 largest BHCs that participated in the 

CCAR resumed distributions of capital in the 

form of dividends and share repurchases in 

2011, U.S. BHCs saw only a slight increase in 

dividends and a net issuance of common equity 

in aggregate (Chart 5.2.9).

Chart 5.2.7 Short-Term Wholesale Funding at Largest BHCs

Chart 5.2.6 Consolidated Liquidity Ratio* for Top 50 BHCs

Chart 5.2.5 Initial and Stressed Tier 1 Common Capital Ratios
Financial Developments 67

As noted in the Council’s 2011 Annual Report, 

the Basel Committee on Banking Supervision 

(BCBS) agreed in December 2010 to a further 

revised set of capital and liquidity standards 

collectively referred to as Basel III. In June 

2012, the Federal Reserve, FDIC, and OCC 

invited public comment on three proposed 

rules that would revise and replace the agencies’ 

current capital rules. These proposals would 

implement, in the United States, the Basel 

III regulatory capital reforms from the BCBS 

and the changes required by the Dodd-Frank 

Act. Among other minimum standards, the 

proposals would establish a tier one common 

equity requirement equal to 4.5 percent of 

risk-weighted assets. It would also establish a 

capital conservation buffer above the minimum 

risk-based capital requirements, which must 

be maintained to avoid restrictions on capital 

distributions and certain discretionary bonus 

payments. As proposed, and consistent with 

Basel III, banking organizations generally 

would begin implementing the proposed capital 

reforms on January 1, 2013, and would be fully 

subject to the new standards by January 1, 2019. 

Concurrently, the agencies also approved a 

final rule to implement changes to the market 

risk capital rule, including those made by the 

BCBS in 2005 and 2010, to better capture 

positions for which the market risk capital rule 

is appropriate. The final rule will be effective 

on January 1, 2013. 

In November 2011, the BCBS released its 

framework and assessment methodology to 

identify globally systemically important banks 

(G-SIBs) that are subject to an additional 

common equity tier one capital buffer ranging 

from 1.0 to 3.5 percent of risk-weighted assets. 

Eight U.S. BHCs were designated as G-SIB and 

would be subject to the higher capital standards 

beginning in 2016, with full implementation 

by 2019. As with Basel III standards, the G-SIB 

framework would be incorporated by member 

jurisdictions into their local capital rules.

Performance

Despite strengthened balance sheets and 

liquidity, BHC market indicators have been 

Chart 5.2.9 BHC Dividends and Repurchases

Chart 5.2.8 Change in Tier 1 Common Ratios for BHCs < $50B
68 2012 FSOC / / Annual Report

weighed down by concerns around potential 

contagion from Europe, among other 

vulnerabilities, discussed further in Section 7. 

Within the subset of 69 BHCs with assets greater 

than $10 billion, aggregate pretax income 

increased by 20 percent in 2011 to $138 billion, 

but return on assets still remains lower than the 

levels that prevailed in the 10 years before the 

crisis (Chart 5.2.10). Trading revenue in 2011 

was negatively affected by sharply lower client 

activity and volumes amid fears of European 

contagion and concerns of slowing global 

economic growth. Earnings were also adversely 

affected by the interest rate environment 

characterized by both low short-term rates and 

low term premiums. Furthermore, approximately 

40 percent of this pretax income for 2011 was 

due to two non-recurring accounting items: (1) 

increased releases of reserves against losses on 

loans and leases due to improved credit quality; 

and (2) so-called “debt valuation adjustments” 

(DVAs), whereby decreases in the mark-to-market 

value of a BHC’s liabilities is booked as a profit. 

It is unclear to what degree these non-recurring 

items will contribute to the profitability of U.S. 

BHCs going forward, as the pace of reserve 

releases continues to decline, and potentially 

tightening credit spreads would result in 

reversals of these mark-to-market DVA gains. 

On June 21, 2012, Moody’s announced the 

results of its review of the credit ratings of 

large international banks with global capital 

markets operations. Fifteen global banks were 

downgraded, with 10 of these banks incurring a 

two-notch downgrade to their long-term ratings; 

Credit Suisse was downgraded three notches. 

(In addition, two dealer banks, Nomura and 

Macquarie, had been downgraded in March.) 

These downgrades reflected a re-assessment by 

Moody’s of heightened uncertainties associated 

with capital market operations. However, 

Moody’s continues to rate more highly those 

banks seen to have superior risk-management 

capabilities, more conservative funding profiles, 

and/or lower reliance on capital markets 

activities. These ratings actions were generally 

in line with market expectations and with prior 

guidance provided by Moody’s in February. 

Chart 5.2.10 Return on Average Assets
Financial Developments 69

Market Indicators

Following the heightened level of duress in 

capital markets during the second half of 

2011, market indicators for BHCs reflected an 

improved investor sentiment and greater risk 

appetite in early 2012. These improvements 

later receded during the second quarter of 

2012. The market capitalization weighted priceto-book ratio of the six largest BHCs improved 

in 2012, but market valuations remained at a 

more than 25 percent discount to book value 

in July 2012, which is below both the pre-crisis 

level and the average level over the past 12 years 

(Chart 5.2.11). In late 2011, an equally weighted 

average of CDS spreads for the six largest 

BHCs reached levels last seen during the crisis. 

Spreads remain elevated relative to early 2011 

levels (Chart 5.2.12).

5.2.2 Insured Depository Institutions 

Performance within the commercial banking 

industry continues to rebound, coinciding with the 

general improvement in credit quality within the 

economy. Despite the rate of bank failures declining, 

the commercial banking sector has become more 

concentrated, as larger banks have seen higher levels 

of profitability and rebounded faster post-crisis.

Insured Commercial Banks and Savings 

Institutions

The banking industry is composed of more 

than 7,300 commercial banks and savings 

institutions. Of these, approximately 6,600 

institutions have assets under $1 billion, 88 

institutions have assets between $10 billion and 

$100 billion, and 19 institutions have assets over 

$100 billion. Failures, mergers, and a decline in 

chartering activity have contributed to further 

consolidation over the past several years. 

Failures of insured depository institutions 

continue to decline from crisis levels, as 92 

institutions representing $35 billion in assets 

failed in 2011 (Chart 5.2.13). An additional 

31 insured institutions have failed thus far in 

2012 (through July 6) representing $7.6 billion 

in assets. As of March 31, 2012, some 772 

institutions, accounting for 10.6 percent of all 

institutions, were on the FDIC’s problem bank 

Chart 5.2.11 Price-to-Book Ratio of 6 Large Complex BHCs

Chart 5.2.12 CDS Spreads of 6 Large Complex BHCs

Chart 5.2.13 FDIC-Insured Failed Institutions
70 2012 FSOC / / Annual Report

list, with financial, operational, or managerial 

weaknesses that threatened their continued 

financial viability. 

Pretax net income for U.S. commercial banks 

and savings institutions totaled $169.3 billion 

in 2011, representing a significant increase 

over 2010 and a continuation of the rebound 

following the crisis. A rebound in credit quality 

with the associated reduction of loan loss 

provisions and other expenses continues to 

drive the improvements in pretax net income 

since 2009 (Chart 5.2.14). Although the largest 

institutions and community banks benefited 

from reductions in loan loss provisions, 

community banks have experienced a smaller 

increase in net revenue than large banks. In 

addition, community banks continue to deal 

with credit problems associated with relatively 

outsized concentrations in the commercial 

real estate sector, which remains depressed 

(Chart 5.2.15).

Credit Unions

The number of credit unions declined to 

7,094 institutions by year-end 2011, down 

from 7,339 at year-end 2010. This 3 percent 

decline in the number of credit unions is in 

line with recent trends. As in other parts of 

the banking system, assets in the credit union 

system have become more concentrated, with 

the top 100 credit unions increasing their 

share of total credit union assets to 39 percent 

(Chart 5.2.16). Corporate credit unions—

which provide critical services to the broader 

credit union system—are consolidating and 

deleveraging as they refocus their business 

models on providing operational support to 

consumer credit unions, raising capital, and 

adjusting to the new regulatory environment. 

As of year-end 2011, there are 24 corporate 

credit unions with $34 billion in assets—a 

decline from 27 corporate credit unions with 

$96 billion in assets in 2007.

The credit union system experienced an 

improved return on assets (ROA) in 2011 of 67 

basis points, an increase from 50 basis points 

in 2010. Improved credit conditions were the 

Chart 5.2.14 Commercial Bank and Thrift Pre-Tax Income

Chart 5.2.16 Concentration of Credit Union Assets

Chart 5.2.15 Commercial Property Price Indices
Financial Developments 71

primary driver behind the provision for loan 

losses declining from 0.8 percent of assets in 

2010 to 0.5 percent of assets in 2011 (Chart 

5.2.17). Aggregate net income increased to $6.3 

billion, a 39 percent improvement from 2010. 

Overall loan levels within the credit union system 

rebounded by 1.2 percent to $571 billion after 

experiencing a decline of 1.4 percent in 2010. In 

2011 loan growth was driven by increases in real 

estate, credit cards, and auto loans. 

Profitability continues to vary based on the size 

of the institution, with smaller credit unions 

historically lagging behind larger credit unions. 

The industry still faces some uncertainty over 

future losses associated with failed corporate 

credit unions; with future resolution costs 

projected to total between $2.7 billion and $6.0 

billion over the coming years, these assessments 

are not likely to curtail industry growth and 

profitability. Larger concerns for the industry 

are challenges related to the low interest 

rate environment and managing through a 

transition into a higher rate environment. As 

Chart 5.2.18 shows, fixed-rate real estate as a 

share of loans and long-term assets as a share of 

assets have risen over the past several years. 

5.2.3 U.S. Branches and Agencies of 

Foreign Banks

U.S. branches and agencies of foreign banks support 

lending activity in the United States, but also tend 

to rely on a funding mix that is less stable than that 

of most U.S. commercial banks. These branches and 

agencies are sensitive to the funding and liquidity 

needs of their parent organizations and depend on 

access to uninsured deposits that pose a heightened 

flight risk. Stresses on parent banks and constrained 

access to short-term dollar funding impinged on 

branch lending and investment in the United States 

over the past year, especially by the European branches 

and agencies. 

In addition to the U.S. BHCs, foreign bank 

families have a large presence within the United 

States. Together, the U.S. branches and agencies 

of foreign banks account for close to $2 trillion 

of banking assets, over 15 percent of total U.S. 

Chart 5.2.17 Federally Insured Credit Union Income

Chart 5.2.18 Credit Union Fixed Rate Real Estate and 

Long-Term Assets
72 2012 FSOC / / Annual Report

banking assets. These entities represent an 

important source of credit for U.S. borrowers.

There are different business models in the 

operations of branches in the United States, 

with a mix of targeted investment and asset 

strategies and a range of different funding 

approaches. On average, branches and 

agencies generally dedicate about 30 percent 

of their balance sheets to loans, but can differ 

substantially in the composition of their lending 

across commercial and industrial (C&I) activity 

versus other U.S. domestic customers. Direct 

C&I loans outstanding by these banks, which 

represents a major source of financing for U.S. 

businesses and investment projects, has been 

as high as $365 billion, but more recently has 

fallen closer to $260 billion, out of total loans 

of over $500 billion (Chart 5.2.19). Other 

securities held as assets have risen sharply 

from about $300 billion pre-crisis to closer to 

$1 trillion by 2012:Q1. Some of these branches 

and agencies also send dollar flows to their 

parent organizations and related affiliates, 

as indicated by the levels of Net Due from 

Related Depository Institutions in the balance 

sheet decompositions in Chart 5.2.19. These 

flows support dollar lending and investment 

activities in the United States and elsewhere. 

European parent banks in particular have 

actively used their branches to source dollar 

funding. Outstanding positions vis-à-vis parent 

banks currently are a smaller percentage of 

branch and agency assets than at any point in 

recent history.

The liability side of balance sheets of the U.S. 

branches and agencies of foreign banks also has 

bearing on financial stability (Chart 5.2.20). 

Most of these U.S. branches are not allowed to 

offer deposits insured by FDIC and thus lack 

access to the stable source of funds represented 

by households’ checking, savings, and other 

transaction accounts. Instead, money market 

funds and other noninsured deposits provide 

the majority of funding for these institutions. 

When such funds and depositors withdraw 

from particular banks, which occurred in the 

summer of 2011 when European banks were 

Chart 5.2.19 U.S. Branches and Agencies of Foreign 

Banks: Assets

Chart 5.2.20 U.S. Branches and Agencies of Foreign 

Banks: Liabilities
Financial Developments 73

viewed as particularly risky, it can destabilize 

the balance sheets of those banks, leading to 

deleveraging or potential reversals of support 

to the parent organization. (See Box H: 

Money Market Fund Responses to Euro Area 

Uncertainty.) Such dynamics are masked, to 

some extent, in the aggregate statistics, as 

these deposits may be reoriented to other U.S. 

branches and agencies. However, the recent 

increases in Net Due to Related Depository 

Institutions shows a greater degree of support 

from foreign parent banks than previously 

had been the case, as investments are made 

to maintain the presence of these banks in 

U.S. asset classes and reduce contractions of 

lending activity and asset sell-offs that could 

otherwise occur. 

5.3 Other Financial Institutions

5.3.1 Insurance

Despite a substantial net decline in income in 2011, 

capital levels within the insurance industry improved. 

The life insurance industry continues to play a 

significant role in long-term funding of assets through 

the investment of premium income. The low interest 

rate environment has proved challenging for life life 

insurers to generate sufficient investment returns to 

meet high guaranteed benefits promised in prior years. 

Property and casualty insurers faced historically 

higher catastrophe losses that impeded performance 

in 2011. 

For life insurance companies, which sell 

retirement products such as traditional life 

insurance contracts and annuities, book capital 

grew modestly, despite net income declining 

by over 50 percent or $13.6 billion in 2011 

compared to 2010 (Chart 5.3.1). The spread 

between the yield that life insurers earn on their 

investments and a measure of the interest rate 

necessary to maintain policyholder reserves, 

also known as the required interest rate, has 

narrowed since 2007 (Chart 5.3.2). If this spread 

had stayed at 2007 levels, net income would have 

been $13.0 billion higher during the period 

from 2008 through 2011—$1.2 billion higher in 

2011 alone. 

Chart 5.3.1 Life and Other Insurance: Capital and Income

Chart 5.3.2 Life Insurers: Impact of Low Rate Environment
74 2012 FSOC / / Annual Report

The low interest rate environment poses a 

significant challenge for life insurers with 

sizable blocks of liabilities incorporating 

embedded interest rate guarantees, such as 

annuities or universal life insurance policies. 

The industry has reduced its minimum 

guarantees over time, but products sold when 

interest rates were higher represent a continued 

drag on profits. The share of life and annuity 

product account values subject to a minimum 

guaranteed rate of return of 5 percent or 

higher fell from 20 percent to 10 percent 

over the 2006-2010 period, but more than 40 

percent of account values were still subject to 

a minimum guaranteed rate of return of 3.5 

percent or higher in 2010. Life insurers have 

exited selected markets due to the inability 

to meet the minimum guaranteed returns 

associated with the underlying products in this 

low rate environment. Of note, life insurers 

have increased their use of non-traditional 

investments, such as hedge funds and private 

equity, perhaps as a response to the low interest 

rates that currently prevail.

The role of the life insurance industry in 

funding new commercial mortgages has 

increased since the collapse of conduit activity 

in 2008. Life insurers funded roughly 25 

percent of new commercial mortgages in 2011, 

compared to 10 percent in 2007 (Chart 5.3.3). 

Although the industry is playing a larger role 

in financing new loans, commercial mortgages 

as a share of total life insurance assets have 

decreased modestly from 2007 to 2011 to less 

than 1 percent of assets. 

Property and casualty insurers, who sell 

insurance on homes, cars, and businesses, 

are less affected by the low interest rate 

environment because they underwrite shorter 

duration liabilities without embedded interest 

rate guarantees. However, property and casualty 

insurers were pressured by large catastrophe 

losses in 2011. Insured catastrophe losses were 

$33.6 billion in 2011, 135 percent higher than 

in 2010 and exceeded only by the extraordinary 

losses associated with Hurricane Katrina in 

2005. Property and casualty assets fell slightly 

Chart 5.3.3 Commercial Mortgage Origination by Lender Type
Financial Developments 75

during 2011, although book capital levels were 

largely unchanged despite a 46 percent decline 

in net income from 2010 to 2011 (Chart 5.3.4). 

5.3.2 Money Market Funds

Total money market fund (MMF) assets declined 

over calendar year 2011, reflecting low yields and 

concerns over European exposures. Low rates also 

reduced revenue flows to fund managers. Substantial 

redemptions from MMFs in the summer of 2011 in 

response to heightened financial market uncertainty 

associated with euro area stresses and federal budget 

negotiations in the United States illustrates the 

extent to which MMFs are still subject to pro-cyclical 

redemption pressures.

Total U.S. MMF assets declined from $2.80 

trillion at year-end 2010 to $2.56 trillion as of 

May 2012. Prime MMF assets declined from 

$1.62 trillion to $1.42 trillion, while government 

and Treasury MMF assets increased from $855 

billion to $872 billion during this period. 

Tax-exempt funds also declined from $330 

billion to $272 billion (Chart 5.3.5). During 

July and August of 2011, there was significant 

redemption activity due to the European debt 

crisis and the political uncertainty in the United 

States leading up to the debt limit extension 

in early August 2011. Between the end of May 

and the end of August 2011, prime MMF assets 

fell by more than $160 billion (9.8 percent) 

(Chart 5.3.6), with some funds diminished by 

as much as 50 percent over this period. Prime 

fund bank holdings in France continued to 

decline through the end of 2011. (See Box H: 

Money Market Fund Responses to Euro Area 

Uncertainty.) Since that period, prime MMFs 

have bolstered their liquidity levels to better 

handle redemptions, with daily liquidity levels 

ranging from 26 percent to over 30 percent and 

weekly liquidity levels holding at over 40 percent 

in late 2011 and early 2012 (Chart 5.3.7). MMFs 

also reduced maturities since the summer of 

2011, with the weighted average life for prime 

MMFs falling to around 70 days (Chart 5.3.8). 

Chart 5.3.4 Property and Casualty Insurance: Capital and Income

Chart 5.3.5 Money Market Mutual Fund Assets by Fund Type

Chart 5.3.6 Institutional vs. Retail Money Market Fund Assets
76 2012 FSOC / / Annual Report

The low interest rate environment also affected 

revenues of MMF managers. Total expense 

ratios for MMFs have fallen from 49 basis points 

to 25 basis points for retail MMFs and from 26 

basis points to 18 basis points for institutional 

MMFs from 2009 to 2011. This significant drop, 

particularly among retail MMFs, is primarily 

due to fee waivers by MMF sponsors to preserve 

a positive net yield for MMF investors. As 

the extended low interest rate environment 

continues to put pressure on MMF yields, some 

MMFs have shown a willingness to take on 

additional portfolio risk (Chart 5.3.9), which 

increases MMF gross yields and offsets the 

pressure to provide fee waivers. Thus, while 

on average MMFs have shown a decreased risk 

appetite in 2012, some funds have sought to 

increase their risk profile.

5.3.3 Broker-dealers

The broker-dealer (BD) industry contracted 

significantly while reducing leverage. Concentration 

in the industry increased.

As of year-end 2011, there were 4,679 domesticand foreign-owned BDs operating in the United 

States. Coinciding with a sharp decline in 

leverage within the industry, assets held within 

the U.S. BD industry fell sharply to $4.8 trillion 

at 2012:Q1—a decline of 25 percent since 2007 

(Chart 5.3.10).

The U.S. BD sector is relatively concentrated; at 

year-end 2011, 60 percent of industry assets were 

held by the top 10 BDs, the largest of which 

are affiliated with foreign banks and domestic 

BHCs. By contrast, the top 10 independent BDs 

represented only 6 percent of industry assets. In 

late 2011, the third largest independent BD, MF 

Global, filed for bankruptcy. (See Box D: MF 

Global Bankruptcy.) 

Aggregate pretax income declined by 59 

percent in 2011 to $14 billion, as trading 

revenues declined sharply (Chart 5.3.11).

Chart 5.3.7 Prime Funds Liquidity

Chart 5.3.8 MMF WAL*

Chart 5.3.9 Gross Yield of 5 Outlier MMF Families
Financial Developments 77

5.3.4 Specialty Lenders

Specialty lenders continue to play a critical role in 

providing credit to those markets not served by the 

traditional banking industry and providing necessary 

funding in certain segments of the mortgage markets. 

The specialty lending sector is composed of 

a wide range of entities, ranging from real 

estate investment trusts (REITs) who invest 

a majority of their capital in mortgage and 

mortgage-related holdings, to captive finance 

arms of major manufacturers who facilitate 

the financing of the parent firm’s products. 

As of April 2012, specialty lenders owned 

approximately $654 billion of consumer loans, 

$330 billion of real estate loans, and $434 

billion of business loans. Aside from consumer 

credit revolving loans and retail business loans 

(Charts 5.3.12 and 5.3.13), specialty lenders 

experienced a slight decline in loan balances 

across a wide variety of loan categories, which 

was consistent with overall trends in the 

traditional banking industry. 

As the GSEs have reduced their investment 

portfolios, REITs have been a rapidly 

growing source of investment capital for 

agency mortgage-backed securities (MBS). 

As of 2012:Q1, REITs held $299.4 billion of 

agency MBS, a 109 percent increase from 

2010 and roughly five times pre-crisis levels 

(Chart 5.3.14).

5.3.5 Investment Funds

Across the various types of investment companies, 

fund flows seem to reflect a general shift towards 

deleveraging and risk reduction by households 

and corporations within the uncertain financial 

environment. Performance in this low interest rate 

environment tended to be lackluster. 

Mutual Funds

Mutual fund flows from year-end 2010 to 

2012:Q1 reflect growing investor preference for 

capital preservation, income generation, and 

lower volatility. Mutual funds had an estimated 

$202 billion net inflow for the period, largely 

attributable to taxable bond funds, which 

received a net $217 billion (Chart 5.3.15). Of 

Chart 5.3.10 Aggregate Broker-Dealer Assets and Leverage

Chart 5.3.11 Broker-Dealer Revenues

Chart 5.3.12 Consumer Loans Outstanding
78 2012 FSOC / / Annual Report

BOX D: MF GLOBAL BANKRUPTCY

MF Global Holdings Ltd. (MFG) and MF Global Finance 

USA Inc. filed on a consolidated basis for relief under 

Chapter 11 bankruptcy protection on October 31, 2011. 

Of particular interest in the United States was the jointly 

registered broker-dealer (BD) and futures commission 

merchant (FCM), operating as MF Global Inc., which 

entered liquidation proceedings under the Securities 

Investor Protection Act (SIPA). 

The jointly registered BD-FCM was a clearing member 

at several domestic central counterparty (CCP) 

clearinghouses, including the Chicago Mercantile 

Exchange (CME), the Options Clearing Corporation, and 

National Securities Clearing Corporation (NSCC). The BD 

was also a primary dealer in government securities with 

the Federal Reserve Bank of New York. The BD-FCM 

conducted business for its own account, as well as for 

customers. 

A series of events led to the bankruptcy of MFG. 

Between March 2010 and March 2011, MFG entered 

into repurchase agreement transactions collateralized to 

maturity with European sovereign debt securities. During 

2011, the company continued its almost uninterrupted 

series of quarterly operating losses (9 of 11 quarters 

through September 2011) that resulted partly from 

declining interest income earned from investing customer 

funds. On October 24, Moody’s downgraded MF Global 

Holdings Inc., citing exposure to European sovereign debt, 

high leverage, and its likely inability to achieve financial 

targets. The following day, MFG announced a $192 

million quarterly loss. MF Global Holdings Inc.’s debt was 

subsequently downgraded to junk. Industry observers 

believe that the ratings downgrade also precipitated the 

lowering of the collateral advance rate on the term to 

maturity repurchase agreements, prompting a margin call. 

The earnings report and credit-rating downgrade also 

impacted MFG’s liquidity, as certain counterparties and 

clearing organizations assessed their credit exposure to 

MFG and imposed increased collateral requirements. 

On the day of the bankruptcy, the company did not 

default to the CME, the Options Clearing Corporation, 

or NSCC. However, later on the same day, the company 

reported a shortfall in customer-segregated assets.

The full extent of the shortfall in commodities customer 

funds will not be known until the Trustee managing MFG’s 

liquidation completes its efforts to recover assets and 

finalizes the customer claims process. The Trustee has 

distributed approximately $3.9 billion to date to customers 

who were trading primarily on U.S. futures markets. This 

represents approximately 72 percent of such customers’ 

account balances. The Trustee also received the approval 

of the Bankruptcy Court on April 26, 2012, to distribute 

up to an additional $685 million, including $600 million 

to customers with claims for accounts trading on U.S. 

contract markets.

The Trustee, however, has stated that there is an 

approximate $1.6 billion gap between the value of the 

Trustee’s estimate of potentially allowable commodities 

claims and the assets that are currently under the 

Trustee’s control. A significant component of the gap in 

customer funds is attributable to approximately $700 

million of customer assets that were deposited with 

MF Global UK Limited, an MFG affiliate in the United 

Kingdom, for trading on non-U.S. markets. The Trustee 

is disputing the treatment of these funds under English 

law with the Joint Special Administrators of MF Global 

UK Limited, and the likelihood of such assets being 

repatriated is uncertain at this time and is expected to be 

subject to future litigation or further United Kingdom court 

action. In addition, multiple federal agencies are reviewing 

the circumstances surrounding the transfers of monies 

out of customer-segregated bank accounts (particularly 

certain transfers that occurred during the week prior to 

the bankruptcy filing).

An SIPC-led liquidation was initiated on October 31. The 

firm had 200 to 300 securities accounts totaling less 

than $500 million in assets and over 38,000 commodity 

customer accounts totaling over $7 billion. The SIPA 

Trustee managing the liquidation is responsible for returning 

customers’ property as quickly as possible, including 

both securities and commodities customers. As stated 

previously, approximately 72 percent of U.S. segregated 
Financial Developments 79

customer property has been distributed to commodities 

customers trading on U.S. designated futures markets as 

of April 25 on a pro rata basis. As a result of a distribution 

of funds recently approved by the bankruptcy court, that 

number should increase to over 80 percent. 

The missing customer money highlights the issue of 

customer protection for commodities accounts. FCM 

accounts at custodians that contain customer property 

are under the control of the account holder, the FCM. 

FCMs routinely keep substantial amounts of their own 

capital in their customer accounts in order to protect 

against any possibility of a shortfall in customer accounts 

that may result from daily market moves, margin 

requirements, and other activity. Accordingly, it is critical 

for custodians to monitor the transfer of any money out of 

segregated accounts. 

The CFTC has taken steps to enhance customer 

protection. In December 2011, the CFTC amended its 

regulations governing derivatives clearing organizations 

(DCOs) and FCM investment of customer funds. Among 

other things, the CFTC eliminated from the list of 

permitted investments BD-FCM in-house transactions that 

are the economic equivalent of repurchase agreements, 

repurchase agreements with affiliates, corporate notes 

and bonds that are not federally guaranteed, and foreign 

sovereign debt instruments. The amended regulations 

also imposed asset-based concentration limits and repo 

counterparty concentration limits, in addition to mandating 

stricter issuer-based concentration limits than had been 

applied previously. 

The CFTC has also issued a new rule for customer 

segregation of cleared swaps, called legal segregation 

with operational commingling (LSOC). Under this model, 

each FCM will provide the DCO with position and 

collateral valuation information at the customer account 

level. The DCO can hold customer collateral provided by 

FCMs in the same commingled manner as it holds margin 

assets for exchange traded products. In a situation of 

“double default,” where the default of an FCM customer 

causes the FCM to default to the DCO, the DCO would 

be able to then identify and access the collateral of the 

defaulting customers of the FCM but not the collateral of 

the non-defaulting customers, as is permitted today with 

exchange-traded futures. 
80 2012 FSOC / / Annual Report

note, the strong asset growth rates in highyield funds (17 percent growth rate, relative to 

2011 year-end net assets) and emerging market 

bonds (55 percent growth rate) over this period 

may reflect investor preference for yield among 

lower volatility fixed income products (Chart 

5.3.16). In contrast, U.S. equity funds had 

net outflows of $86 billion, with net monthly 

outflows since May 2011. 

Pension Funds

As of the fourth quarter 2011, the combined 

assets under management of private and public 

pensions were over $15.3 trillion (Chart 5.3.17). 

Both public and private defined benefit plans 

remain significantly underfunded relative 

to the present value of their liabilities due to 

inadequate past contributions, low interest 

rates, and losses incurred in 2007 and 2008. 

As of year-end 2011, public defined benefit 

plans were only 76 percent funded, while 

private defined benefit plans were 79 percent 

funded (Chart 5.3.18). Some private pension 

funds have received contributions to make up 

shortfalls or have been able to adjust their plans 

to reduce future outlays. 

A number of state and local pension funds 

continue to grapple with structural shortfalls 

between their assets and liabilities. While 

these pension funds face pressure to reduce 

their expected return assumptions, many 

are reluctant to change assumptions in a 

meaningful way, reducing expected returns 

by only 25 to 50 basis points over the past 

three years. Currently the median assumed 

expected return across public plans is 8 

percent, while private sector estimates of 

returns are closer to 6 percent. 

Over the past three years, many states and 

localities have increased efforts to address 

long-term pension funding issues by curtailing 

benefits and increasing employee contributions, 

among other measures. Analyst views on the 

impact of these changes on pension funding 

profiles differ, with some viewing them as 

positive for long-term plan sustainability, while 

Chart 5.3.13 Business Loans Outstanding

Chart 5.3.14 Real Estate Investment Trust (REIT) Assets

Chart 5.3.15 Mutual Fund Flows by Asset Class (2011 to 2012 Q1)
Financial Developments 81

others regard them as insufficient to address 

medium-term funding needs. To reduce fiscal 

pressures, state and local pension funds may 

seek to further curtail benefits for current 

and future retirees or seek increased financial 

support from their respective sponsors. If 

successful, these developments could lead to 

lower expected payouts for employees, reduced 

services, higher taxes, or some combination of 

all three. However, public pension benefits are 

often legally guaranteed, and amending them 

remains challenging.

Private Equity Funds

U.S. private equity assets under management 

increased to $1.7 trillion in 2011 (Chart 5.3.19). 

The growth in assets continued to be supported 

by allocations from institutional investors such 

as pension funds, which comprise 43 percent of 

U.S. private equity capital. Although leveraged 

buyouts and venture capital account for over 

half of private equity assets under management, 

advisers continue to diversify their investment 

strategies into areas such as real estate, natural 

resources, distressed assets, and emerging 

market opportunities (Chart 5.3.20). 

The high volume of fund-raising and robust 

deal activity that signified pre-crisis private 

equity activity created the conditions that 

currently prevail, with advisers now focused 

on exiting existing investments and deploying 

committed capital. Given the constrained initial 

public offering (IPO) environment and tepid 

mergers and acquisitions activity amid ongoing 

economic uncertainty, private equity firms are 

focused on realizing returns on historically 

high levels of existing portfolio investments. 

They are also seeking investment opportunities 

for over $500 billion in undeployed capital 

commitments stemming from record 

levels of fund-raising from 2005 to 2007. 

(See Chart 5.3.19.)

Hedge Funds 

Institutional investors continue to be interested 

in hedge funds as an asset class in part because 

of the perception that the correlations between 

hedge funds and broad asset classes are low. 

Chart 5.3.16 Mutual Fund Taxable Bond Flows (2011 to 2012 Q1)

Chart 5.3.17 Retirement Funds by Type

Chart 5.3.18 Public and Private Pension Funding Level
82 2012 FSOC / / Annual Report

At year-end 2011, assets managed by hedge 

funds were approximately $2.13 trillion, which 

represents a 3.5 percent increase from year 

2010. This growth in assets under management 

primarily reflected inflows, rather than fund 

performance in 2011 (Chart 5.3.21). In fact, 

hedge funds had lackluster performance across 

the major strategies for the calendar year 

(Chart 5.3.22). Similar to other investment 

options, hedge fund performance has 

rebounded slightly in early 2012. 

Following the crisis, institutional investor 

preferences for larger, more established funds 

with longer track records led to a greater 

concentration of industry assets at larger 

firms. This trend continued through 2011 and 

into 2012 as larger funds benefitted from the 

perception of increased stability.

Exchange Traded Funds 

Exchange traded funds (ETFs) remain a 

popular means of achieving exposure to various 

market indices, as evidenced by their continued 

growth in terms of product launches and asset 

growth (Chart 5.3.23). In 2011, the number of 

U.S.-listed ETFs grew by 28 percent to 1,353 

products, and ETF assets grew by 6 percent to 

$1.06 trillion. Compared to 2010, net inflows 

in 2011 remained flat at $121 billion with 

higher concentrations of funds moving into 

ETFs with taxable bond, U.S. stock, and sectorspecific strategies. 

The U.S. ETF market remains populated 

predominately by passively managed 

products that track widely followed indexes 

in equity, fixed income, and commodity 

markets. Recently, alternative index strategies 

have emerged as ETF providers adapt to 

an increasingly saturated market. These 

“fundamental indexing” products rebalance 

their holdings according to proprietary 

methodologies that seek to extract value that is 

either not captured, or is obscured by, existing 

index construction. For example, among equitybased ETFs, such products may focus on lower 

volatility, lower beta to the broader market, 

higher earnings quality, higher dividend yield, 

Chart 5.3.19 U.S. Private Equity AUM

Chart 5.3.20 U.S. Private Equity AUM by Strategy

Chart 5.3.21 Change in Hedge Fund AUM
Financial Developments 83

and so forth. On a related note, fixed income is 

widely viewed by industry observers as a likely 

avenue of growth for passively managed funds. 

In addition to the growth of fundamental 

indexing, actively managed ETFs are cited 

by some as a potential new avenue for the 

ETF industry to grow. ETFs are required to 

disclose their holdings daily, while traditional 

mutual funds generally disclose their holdings 

quarterly. The requirement for daily disclosure 

is a matter of concern to some active managers, 

who fear the exposure of their strategies in 

the ETF structure may adversely affect the 

values of their funds. However, 2012 has seen 

notable launches of and filings for new actively 

managed ETFs, particularly for fixed income 

products, indicating that active management 

may indeed overcome the disclosure issue. 

Despite the continued robust growth of the 

global ETF market, market participants remain 

attentive to some potential risks pertaining to 

ETFs, which may not yet be fully understood. In 

particular, some market participants continue 

to highlight the synthetic ETF structure as a 

potential transmission mechanism for risks 

between the United States and European 

financial systems. A synthetic ETF generates 

the return of an index through a total return 

swap with a bank, whereas a “physical” ETF 

holds the actual index constituents. Synthetic 

ETFs are common in Europe but not in the 

United States. Synthetic ETFs may manage 

to track indexes with lower trading costs and 

lower tracking error—particularly for less 

liquid markets—compared to an ETF. However, 

despite their potential advantages, some market 

participants continue to voice concerns over the 

potential for this structure to amplify financial 

market stresses in the event that a bank 

engaging in swaps with a synthetic ETF sponsor 

should be unable to meet its obligation. In 

addition, the emergence of new types of ETFs 

and similar products, such as leveraged and 

inverse-leveraged ETFs, actively managed ETFs, 

and ETFs based on very particularized asset 

classes, is a growing trend in the market and a 

focus of regulators.

Chart 5.3.22 Hedge Fund Performance by Strategy

Chart 5.3.23 Growth in ETF Assets and Number of Funds
84 2012 FSOC / / Annual Report

provided unlimited deposit and share insurance coverage 

for non-interest-bearing transaction accounts beginning 

December 31, 2010, is scheduled to expire December 31, 

2012. As of March 31, 2012, $1.3 trillion in non-interestbearing accounts at over 7,000 institutions exceeded the 

basic coverage limit of $250,000 per account but was fully 

insured by temporary coverage. Under the TLGP, the FDIC 

guaranteed newly issued senior unsecured debt of insured 

depository institutions, their holding companies, and certain 

affiliates. No new debt can be guaranteed under the TLGP, 

but approximately $109 billion in guaranteed debt remained 

outstanding as of May 31, 2012. 

Term Asset-Backed Securities Loan Facility

The Term Asset-Backed Securities Loan Facility (TALF), 

which the Federal Reserve and Treasury began operating 

in 2009, was created to help market participants meet 

the credit needs of households and small businesses by 

supporting the issuance of asset-backed securities (ABS) 

collateralized by certain consumer and business loans. 

Under the TALF, the Federal Reserve provided eligible 

borrowers with three-year and five-year non-recourse loans, 

collateralized by ABS.

In total, $71 billion in loans were provided under the TALF, 

but many were repaid early. The outstanding amount of 

TALF loans fell from $24.7 billion at the start of 2011 to 

$5.3 billion as of June 20, 2012. As of the end of March 

2012, all collateral pledged against outstanding TALF loans 

maintained their AAA ratings, and all loans were performing 

as scheduled. Treasury committed to provide the Federal 

Reserve up to $20 billion under TARP in credit protection for 

the TALF. This amount was later reduced to $4.3 billion in 

July 2010 and subsequently reduced to $1.4 billion in June 

2012. Treasury expects to incur no losses on this balance.

Maiden Lane LLC 

Outside of and prior to TARP, the Federal Reserve Board 

authorized the Federal Reserve Bank of New York (FRBNY) 

to form Maiden Lane LLC (ML LLC) to facilitate the merger 

of Bear Stearns with JPMorgan Chase (JPM). The Federal 

Reserve Board authorized FRBNY to extend credit to 

ML LLC, which it did through a $28.8 billion senior loan, 

During the crisis, various federal agencies set up facilities 

to help stabilize the financial system when private market 

functioning was severely disrupted. While several of these 

facilities still hold net balances, most have been wound 

down in a manner that protects the U.S. taxpayer.

Troubled Asset Relief Program Bank Support Programs

Key parts of the federal government’s response to the 

financial crisis were carried out by Treasury under the 

Troubled Asset Relief Program (TARP). Among several 

TARP programs targeting the banking system, the largest 

was the Capital Purchase Program (CPP), under which 

Treasury invested approximately $205 billion in over 700 

banking organizations. The CPP is now closed. As of June 

29, 2012, repayments—along with interest, dividends, 

and other income—exceeded the original disbursement. 

Treasury estimates that the total gain to taxpayers from the 

$245 billion disbursed under all bank support programs 

under TARP will ultimately exceed $20 billion (Chart E.1).

Temporary Liquidity Guarantee Program

The federal government’s response to the financial crisis 

also included the FDIC’s Temporary Liquidity Guarantee 

Program (TLGP). The Transaction Account Guarantee 

(TAG) portion of the TLGP guaranteed deposits in 

non-interest-bearing transaction accounts at insured 

depository institutions. The TAG expired on December 

31, 2010. Section 343 of the Dodd-Frank Act, which 

BOX E: CURRENT STATUS OF REMAINING STABILIZATION FACILITIES 

INAUGURATED DURING THE CRISIS

Chart E.1 TARP Bank Support Program Status
Financial Developments 85

market by purchasing mortgage-backed securities (MBS) 

issued by Fannie Mae and Freddie Mac. In 2008 and 

2009, Treasury purchased MBS on the secondary market 

at a cost of $225 billion and completed the liquidation of 

these holdings in March 2012. The proceeds of sales, 

in addition to principal and interest received, were $250 

billion, exceeding the program’s cost by approximately 

$25 billion.

Auto Industry

Treasury created the Automotive Industry Financing 

Program (AIFP) in December 2008 to prevent a 

significant disruption of the U.S. automotive industry 

because of the risks such a disruption could pose to 

financial stability and the U.S. economy. Under the AIFP, 

Treasury invested approximately $80 billion in General 

Motors (GM), Chrysler, and their respective financing 

arms. As of 2012:Q1, GM and Chrysler, after substantial 

reorganizations, reported nine and five consecutive 

profitable quarters, respectively.

Treasury has made substantial progress toward exiting 

its investments in automotive companies and continues 

to monitor the performance of these firms and evaluate 

options to exit its investments. As of June 30, 2012, 

Treasury’s investment in GM stood at $23.39 billion and 

in Ally Financial at $13.75 billion. Treasury has fully exited 

its investment in Chrysler and Chrysler Financial, which 

resulted in a $1.3 billion loss unlikely to be fully recovered. 

to partially fund the purchase of certain assets and 

associated hedges from Bear Stearns. As of June 14, 

2012, ML LLC fully repaid the loan (including interest) made 

by FRBNY.

Assistance to American International Group 

The Federal Reserve Board and the Treasury provided 

a coordinated response to alleviate capital and liquidity 

pressures on American International Group (AIG). At its 

peak, the amount committed to support AIG through 

FRBNY and Treasury was approximately $180 billion. 

FRBNY support included a secured revolving credit facility 

to AIG, as well as the formation and extension of credit to 

Maiden Lane II LLC (ML II) and Maiden Lane III LLC (ML III). 

To date, all of FRBNY’s loans to AIG and to MLII and ML III 

have been repaid with interest. 

As of June 29, 2012, only Treasury’s TARP investment 

in AIG remained outstanding. The $30.44 billion unpaid 

balance is less than the $34 billion market value of the 

AIG common stock that Treasury holds. This stake and 

FRBNY’s residual interest in assets held by ML II and ML 

III holdings related to FRBNY’s investments in AIG are 

likely to produce an additional profit for the U.S. public 

(Chart E.2).

Mortgage-Backed Security Purchase Program

Using its authorities under the Housing and Economic 

Recovery Act of 2008, Treasury supported the housing 

Chart E.2 AIG Investments Committed and Returned
86 2012 FSOC / / Annual Report

5.4 Financial Market Infrastructure

5.4.1 Electronic Trading of Exchange-Traded 

Instruments

Technology has dramatically changed the market 

for exchange-traded instruments, with the growth 

in computerized trading algorithms resulting in 

smaller trade sizes, higher volumes, and potentially 

more complex trading strategies. At the same time, 

a proliferation of trading venues outside traditional 

exchanges has resulted in increased fragmentation of 

equities markets and could have broader implications 

for the financial system. 

Advances in computing and communication 

technology, along with regulatory changes, have 

transformed electronic trading. High-speed 

computerized trading has been a hallmark of 

modern equities, futures, and foreign exchange 

markets and has spread in recent years to 

markets for derivatives and fixed income 

instruments. Computerized trading is used to 

facilitate a wide array of activities, including 

automated order routing and so-called highfrequency trading. (See Box F: Algorithmic and 

High-Frequency Trading.) A vast expansion of 

market data supports these activities. 

Along with decimalization of U.S. equity and 

equity options markets, electronic trading has 

resulted in smaller tick sizes and decreasing 

trade sizes. In particular, a common use of 

computerized trading algorithms is to split 

trades into multiple smaller transactions. As 

seen in Chart 5.4.1, average size per trade 

in U.S. equities markets declined 81 percent 

since 1997, while volumes increased more than 

500 percent through May 2012. This practice 

of trade splitting has become increasingly 

evident over the past 15 years. Its likely 

purpose is to minimize the price impact of 

trading, but decreased trade sizes may also be 

a component of more complex computerized 

trading strategies.

More generally, liquidity has been fragmented 

among various equity trading modalities, 

including exchanges, alternative trading 

systems, broker-dealer internalizers, and 

Chart 5.4.1 Average Trade Size—U.S. Equities
Financial Developments 87

so-called “dark pools.” The latter are trading 

systems that are not openly available to the 

public in which buyers and sellers submit orders 

anonymously, with neither order size nor price 

revealed publicly until the trade has been 

completed. In May 2012, almost a third of all 

trading in the equities market occurred outside 

exchanges in such dark pools and brokerdealer internalizers, where customer orders 

are matched against each other or against 

proprietary orders of the internalizing brokerdealer (Chart 5.4.2).

More recently, equities exchanges have been 

competing for market share in an environment 

of narrowing spreads, lower commissions, 

greater competition, and declining share 

volumes. Specifically, average daily volume of 

U.S. shares trading has declined 20 percent 

since a peak of 9.82 billion shares in 2009 to 

7.83 billion at the end of 2011 (Chart 5.4.3). 

Also noteworthy is the growth of trading in 

the Asia Pacific region. From 2000 through 

2009, Asia’s share of global trading more than 

doubled (Chart 5.4.4). This growth in Asian 

trading is a by-product of the rapid economic 

growth in this region, with a concomitant 

growth in demand for financial services.

5.4.2 Wholesale Payments and Settlements

Activity within the wholesale payments utilities has 

rebounded as both volumes and values continue 

to increase since the crisis. Robustness for the 

largest of these utilities, the Fedwire® Funds 

Service, has improved, with earlier settlement times 

and reduced operational risk. In addition, new 

and more demanding international standards 

have been released for large value payments and 

settlement utilities, as well as for other financial 

market infrastructures. 

The major wholesale payments utilities 

supporting U.S. financial markets are the 

Fedwire Funds Service, a real-time gross 

settlement system operated by the Federal 

Reserve Banks, and the Clearing House 

Interbank Payments System (CHIPS), a 

continuous net settlement system operated 

by The Clearing House Payments Company 

Chart 5.4.2 Average Daily Volume Shares by Venue

Chart 5.4.3 U.S. Equities Share Volume

Chart 5.4.4 Regional Market Share of Trades
88 2012 FSOC / / Annual Report

BOX F: ALGORITHMIC AND HIGH-FREQUENCY TRADING

Advancements in technology have had a profound effect 

on trading, as activity has become faster, more complex, 

and highly automated. Although computer-based 

algorithms have been utilized in U.S. equities markets for 

quite a while, the expansion into other markets and the 

proliferation of high-speed algorithmic trading—along with 

the current fragmented market structure—could lead to 

unintended errors cascading through the financial system. 

Regulators and market participants must help ensure that 

adequate controls and risk-management practices are in 

place to mitigate these risks. 

High-speed algorithmic trading utilizes computer 

algorithms to determine the timing, price, and quantity 

of trades. High-frequency trading (HFT) is one particular 

type of algorithmic trading. While there is no standard, 

commonly accepted definition of HFT in the industry, HFT 

typically refers to the use of computerized trading to move 

in and out of positions rapidly, generally ending the day 

flat with little or no exposure to the market on an overnight 

basis. In contrast, other styles of algorithmic trading allow 

positions to be held over longer time horizons. HFT is 

widely used in U.S. equities, global futures, and global 

foreign exchange, accounting for nearly 56 percent, 52 

percent, and 35 percent of total trading, respectively, in 

2011 (Chart F.1).

Algorithms have long been used in U.S. equities markets, 

notably to route orders to the trading venue with the best 

execution price in compliance with the SEC’s Regulation 

National Market System (NMS). Over the past decade, 

algorithms have been adapted for trading in other 

asset classes. A notable class of computerized trading 

algorithms is so-called “black box” strategies, which are 

fully automated and preprogrammed, and which generally 

have trades initiated directly by the algorithm itself. Black 

box trading algorithms are capable of reacting to market 

data, transmitting thousands of order messages per 

second directly to electronic trading venues, cancelling 

and replacing orders based on changing market 

conditions, and capturing price discrepancies with little or 

no human intervention. 

Given the speed with which these transactions are 

executed, errors can propagate rapidly through systems 

and across markets. Such errors could include unintended 

accumulation of large positions, out-of-control algorithms, 

and erroneous “fat finger” trades. As a result, prudent 

and timely risk management is of paramount importance 

in these markets. Appropriate pre- and post-trade risk 

controls are desirable at all levels of the trade life cycle, 

from trade submission to trade matching, clearing, and 

settlement. Therefore, trading firms, exchanges, brokerdealers (BDs), future commission merchants (FCM), foreign 

exchange prime brokers (FXPB), service providers, and 

clearing organizations each have an important role to 

play in preventing, detecting, and responding to potential 

computer-generated trading errors.

The desire for faster execution has prompted changes 

within the marketplace to minimize latency. Latency is a 

measurement of the time it takes to send an order to a 

trading venue and for a trading venue to acknowledge 

the order. Participants seek to minimize latency in 

order to increase the chances of getting prompt 

order execution at the best price. Factors affecting 

latency include geographical distance and response 

time from the exchange’s matching engine and the 

speed at which market data and other signals from the 

marketplace are processed.

Chart F.1 HFT % Use in Various Asset Classes
Financial Developments 89

Reducing latency is particularly important for highfrequency traders because the passage of time, even for 

an instant, exposes them to market risk. Price makers 

are exposed to the risk that their orders could remain 

in the order book after the market has moved in the 

opposite direction of their trading strategy and before their 

cancellations are processed. Price takers are exposed 

to the risk that a resting order they want to capture could 

be cancelled prior to execution or could be captured by 

another, faster trader.

In response to demand for faster execution, some trading 

venues allow “direct access” (sometimes referred to 

as “sponsored access”), through which certain trading 

firms access the exchange’s matching engine directly, 

bypassing the systems of their sponsoring BD, FCM, or 

FXPB. It is important that sponsoring entities offering 

direct access have proper controls in place for monitoring 

their clients’ activity across the relevant platforms. Another 

way trading firms can reduce latency is to place (colocate) their servers as near as possible to the trading 

venue’s matching engine(s). An important policy issue 

is the extent to which trading firms have equal access 

to co-location or direct access services. BDs, FCMs, 

and FXPBs are financially responsible for the trades 

of all their customers, including those that engage in 

algorithmic trading. To help ensure prudent customer risk 

management in the equity market, the SEC implemented 

Rule 15c3-5 in July 2011, which (among other things) 

requires BDs to maintain a system of controls and 

supervisory procedures reasonably designed to limit 

the financial exposures arising from customers that 

access the markets directly. In addition, the SEC recently 

approved two proposals by the SRO and FINRA. The 

first proposal would update, on a pilot basis, the existing 

single-stock circuit breaker mechanism with an additional 

“limit-up” and “limit-down” mechanism that effectively 

prohibits trades from being immediately executed at 

prices outside of prescribed rolling bands. The second 

proposal would update, also on a pilot basis, the existing 

market-wide circuit breakers that, when triggered, halt 

trading in all exchange-listed securities throughout 

the U.S. markets. The proposed changes lower the 

percentage-decline threshold for triggering a market-wide 

trading halt and shorten the amount of time that trading 

is halted. Among other things, these mechanisms would 

help mitigate the impact of any algorithmic orders that 

could otherwise rapidly drive the price of a stock up or 

down. In the futures market, the CFTC has adopted rules 

to bolster risk management at the exchange, clearing firm 

and other levels. In the foreign exchange market, prime 

brokers are increasingly making use of post-trade services 

designed to help prime brokers manage client risk on a 

real-time, intraday basis across multiple trading venues.
90 2012 FSOC / / Annual Report

LLC. The Fedwire Securities Service 

provides securities issuance, settlement, 

and transfer services for the U.S. Treasury, 

U.S. government agencies and governmentsponsored enterprises, and certain 

international organizations.

There was a sharp decline in 2009 in annual 

payment clearing volume and value for the 

Fedwire Funds Service, CHIPS, and the 

Fedwire Securities Service from pre-crisis peaks 

(Charts 5.4.5 and 5.4.6). From 2009 through 

2011, volume and values continued to modestly 

decline for the Fedwire Securities Service and 

showed a moderate rebound for Fedwire Funds 

Service and CHIPS.

Two noteworthy developments in U.S. large 

value payment systems are the reduced use 

of daylight overdrafts (Chart 5.4.7) and the 

earlier submission of payments (Chart 5.4.8). 

Before 2008, only 20 percent of Fedwire Funds 

Service payments (by value) were settled by 

1:00 p.m. (Eastern), and only 50 percent were 

settled by 4:00 p.m. (Eastern). As of May 2012, 

some 20 percent of Fedwire Funds Service 

value settled by 10:00 a.m., and 50 percent 

settled before 2:00 p.m. (Eastern). Both of 

these developments appear to be driven largely 

by the increase in the quantity of reserves on 

bank balance sheets (Chart 5.4.9). From an 

operational risk perspective, earlier payment 

submission decreases the potential magnitude 

of liquidity dislocations and risk in the financial 

industry should an operational disruption 

occur near the close of the Fedwire day at 6:30 

p.m. (Eastern). An open question is whether 

payments will revert back to late-in-the-day 

settlements if and when reserve balances revert 

to the pre-crisis norm. 

A final noteworthy development in wholesale 

payments and settlements is the release by 

the Committee on Payment and Settlement 

Systems (CPSS) and the Technical Committee 

of the International Organization of Securities 

Commissions (IOSCO) of a new package of 

standards called Principles for Financial Market 

Infrastructures, subject to adoption by regulators 

Chart 5.4.5 Annual Payment Clearing Volumes

Chart 5.4.6 Annual Payment Clearing Values

Chart 5.4.7 Fedwire Funds Daylight Overdrafts
Financial Developments 91

in individual jurisdictions. The principles 

are intended to apply to all systemically 

important payment systems, central securities 

depositories, securities settlement systems, 

central counterparties, and trade repositories 

(collectively “financial market infrastructures”). 

These principles contain new and more 

demanding international requirements that are 

designed to help ensure that the infrastructure 

supporting global financial markets is more 

robust and thus well placed to withstand 

financial shocks. The CPSS and IOSCO 

members (including the Federal Reserve, the 

CFTC, and the SEC) will strive to implement the 

new standards by the end of 2012. 

5.4.3 Derivatives Infrastructure

Global use of over-the-counter (OTC) derivatives 

expanded in 2011. Increasingly, these derivatives are 

centrally cleared, and data on these derivatives trades 

are reported to trade repositories, developments which 

enhance robustness of these markets.

Global Derivatives Volumes

As measured by notional value, the global OTC 

market has grown considerably faster than the 

exchange-traded derivatives markets (Chart 

5.4.10). Comparing the second half of 2011 

to the second half of 2010, the OTC market 

grew at an 8 percent pace, reflecting continued 

strong demand by end users for customized 

risk-management products. In contrast, the 

exchange-traded markets declined by 17 

percent over this period. Notional volumes 

for both exchange-traded and OTC interest 

rate products declined sharply in the second 

half of 2011, with notional amounts for OTC 

interest rate swaps dropping from $553 trillion 

(U.S. dollars) to $504 trillion from 2011:H1 

to 2011:H2, and exchange-traded numbers in 

the same period declining from $76 trillion to 

$53 trillion (Chart 5.4.11). It is likely that these 

declines were due to less need for interest-rate 

hedging in an environment of low interest rates 

and diminished credit growth. 

As measured by number of contracts, over 

two-thirds of exchange traded derivatives 

were traded outside the United States in 

Chart 5.4.8 Deciles of Fedwire Value Time Distribution

Chart 5.4.9 Reserve Balances

Chart 5.4.10 Global OTC and Exchange-Traded Derivatives 

Growth
92 2012 FSOC / / Annual Report

2011 (Chart 5.4.12). The share of derivatives 

volume traded on non-U.S. exchanges has been 

increasing over the past several years.

Central Clearing of Derivatives

A major trend in OTC markets over the past 

few years is the increasing numbers of OTC 

derivatives cleared by central counterparty 

(CCP) clearinghouses. CCP provide credit risk 

mitigation for market participants by acting as 

buyer to every seller and seller to every buyer. 

Prior to 2009, there had been central clearing 

of OTC derivatives, including clearing of 

interest rate swaps (IRS) by LCH.Clearnet’s 

SwapClear and clearing of various energy 

derivatives by the ClearPort system operated 

by the New York Mercantile Exchange (now 

part of Chicago Mercantile Exchange, or CME) 

and by IntercontinentalExchange’s (ICE) 

ICE Clear Europe. In 2009, ICE Clear Credit 

(formerly known as ICE Trust) and ICE Clear 

Europe, as well as CME, began clearing credit 

default swaps (CDS). Since the 2009 G-20 

commitment, which calls for central clearing 

of all standardized OTC derivative contracts 

by the end of 2012, clearing activity has grown 

dramatically in all such asset classes. Subsequent 

legislation in the United States (the DoddFrank Act) and regulation in the European 

Union (the European Market Infrastructure 

Regulation) are consistent with the spirit of the 

G-20 commitment.

A good deal of progress has been made 

toward central clearing of standardized OTC 

derivatives contracts, although there is still 

progress to be made. LCH.Clearnet’s SwapClear 

reports that the outstanding notional value of 

cleared IRS has grown from about $70 trillion 

in 2007 to almost $300 trillion going into 

June 2012 (Chart 5.4.13). The number of new 

IRS contracts cleared per month (“monthly 

registration” in Chart 5.4.13) has risen from 

a bit over 20,000 in 2007 to nearly 150,000. 

SwapClear now estimates that 52 percent of new 

IRS trades are presented to it for clearing. As of 

June 29, 2012, 40 percent of the notional value 

of IRS cleared by SwapClear is denominated 

Chart 5.4.11 Global Exchange-Traded Derivatives

Chart 5.4.13 SwapClear Volume

Chart 5.4.12 Exchange-Traded Derivatives Globalization
Financial Developments 93

in euros, with 36 percent denominated in U.S. 

dollars (Chart 5.4.14). 

CDS markets also show a substantial increase 

in centrally cleared contracts. According to the 

International Swaps and Derivatives Association 

(ISDA), centrally cleared CDS contracts 

represented 10.6 percent of the notional 

amounts outstanding as of December 2011. The 

two major CCPs for CDS both show significant 

growth in clearing: ICE Clear Credit’s open 

interest has grown from de minimis amounts 

three years ago to $905 billion notional as of 

June 15, 2012, comprising $470 billion in index 

products, $390 billion in corporate singlename contracts, and $45 billion in sovereign 

single names. ICE Clear Europe reports similar 

growth (Charts 5.4.15 and 5.4.16). 

CCPs have added numerous new products to 

clearing. For example, the various clearing 

entities associated with the ICE added over 125 

new OTC derivatives to their lists of products 

accepted for clearing, including energy swaps, 

emission swaps, and additional index, singlename and sovereign CDS over the past few 

months. Eurex Clearing has announced its 

intention to begin clearing OTC IRS in the 

second half of 2012. In mid-March 2012, 

LCH.Clearnet’s ForexClear began clearing 

OTC foreign exchange (FX) non-deliverable 

forwards (NDFs). CME Group is also now 

clearing OTC FX, and NDFs. ICE announced 

their plans to begin NDF clearing as well. 

Finally, the Options Clearing Corporation is 

developing a Standard & Poor’s (S&P) 500 OTC 

option for clearing. 

One of the expected benefits of centralized 

clearing of OTC derivatives is the possibility 

of netting offsetting contracts that accumulate 

through repeated trading. LCH.Clearnet’s 

SwapClear reports a reduction of about 25 

percent of the notional value presented to it 

for clearing through netting, tearing up of 

offsetting contracts, and other processes to 

eliminate redundant contracts. ICE Clear 

Credit reports a much larger netting efficiency. 

They achieved a reduction of about 90 percent 

Chart 5.4.14 Outstanding SwapClear Volumes

Chart 5.4.15 ICE Clear Credit

Chart 5.4.16 ICE Clear Europe
94 2012 FSOC / / Annual Report

of the notional value of the original CDS trades 

presented for clearing through netting, tearups, and other compression processes. 

Trade Repositories

A relatively new feature in the market 

infrastructure for swaps is the development of 

trade repositories (TRs). Under Title VII of 

the Dodd-Frank Act, the details of all swaps 

(and security-based swaps) will have to be 

reported to a TR (or to the CFTC or SEC, as 

appropriate, if no TR is available). The major 

global swaps market participants are working to 

establish a trade repository for each asset class 

and have voluntarily provided information to 

the repositories on their ongoing and, in some 

instances, legacy trades. TRs are operational 

in the United States, United Kingdom, and/

or Luxembourg for interest rate swaps, credit 

default swaps, equities swaps, commodities 

swaps, and FX swaps. Additional TRs are 

expected to be operational by year-end 2012. 

TRs data can be used to measure the size and 

composition of different swaps markets. For 

example, according to TriOptima, a TR that 

served the interest rate derivatives market 

through mid-2012 (before being replaced 

by a unit of Depository Trust and Clearing 

Corporation), some $495.9 trillion (notional) 

interest rate derivatives contracts have been 

reported to the TR by the so-called G-14 

dealers, of which a bit over one-half are cleared 

by a CCP (Chart 5.4.17). The vast majority 

of these centrally cleared swaps are dealerto-dealer contracts. In addition, another 17 

percent reported as non-centrally cleared 

dealer-to-dealer contracts were among the 

G-14 major swaps dealers. Similarly, the Trade 

Information Warehouse, a TR for CDS, reports 

that $25.0 trillion (notional) CDS contracts 

were reported to the TR, of which $15.7 trillion 

(approximately 63 percent) are dealer-todealer (Chart 5.4.18). This preponderance of 

dealer-to-dealer swaps, especially those among 

the largest dealers, appears to be an ongoing 

feature of these markets. Industry contacts 

Chart 5.4.17 Interest Rate Derivatives

Chart 5.4.18 CDS and Other Credit Derivatives
Financial Developments 95

report that these interdealer trades are mostly 

for the purpose of hedging the risks associated 

with market-making activities. It is of interest 

that, in aggregate, dealer positions as seller 

of CDS protection ($20.343 trillion notional) 

approximately equal dealer positions as buyer of 

such protection ($20.341 trillion notional). In 

other words, the dealer community in aggregate 

has approximately a flat CDS book without a 

pronounced directional tilt.