F I N A N C I A L S T A B I L I T Y 

OVERSIGHT COUNCIL

2013 ANNUAL REPORT
Financial Stability Oversight Council i i

Financial Stability Oversight Council

The Financial Stability Oversight Council (Council) was established by the Dodd-Frank Wall 

Street Reform and Consumer Protection Act (Dodd-Frank Act) and is charged with three 

primary purposes:

1. To identify risks to the financial stability of the United States that could arise from the 

material financial distress or failure, or ongoing activities, of large, interconnected bank 

holding companies or nonbank financial companies, or that could arise outside the 

financial services marketplace.

2. To promote market discipline, by eliminating expectations on the part 

of shareholders, creditors, and counterparties of such companies that 

the U.S. government will shield them from losses in the event of failure.

3. To respond to emerging threats to the stability of the U.S. financial system.

Pursuant to the Dodd-Frank Act, the Council consists of ten voting members and five 

nonvoting members and brings together the expertise of federal financial regulators, state 

regulators, and an insurance expert appointed by the President.

The voting members are:

•	 the Secretary of the Treasury, who serves as the Chairperson of the Council;

•	 the Chairman of the Board of Governors of the Federal Reserve System;

•	 the Comptroller of the Currency;

•	 the Director of the Bureau of Consumer Financial Protection;

•	 the Chairman of the Securities and Exchange Commission;

•	 the Chairperson of the Federal Deposit Insurance Corporation;

•	 the Chairperson of the Commodity Futures Trading Commission;

•	 the Director of the Federal Housing Finance Agency;

•	 the Chairman of the National Credit Union Administration; and

•	 an independent member with insurance expertise who is appointed by the President 

and confirmed by the Senate for a six-year term.

The nonvoting members, who serve in an advisory capacity, are:

•	 the Director of the Office of Financial Research;

•	 the Director of the Federal Insurance Office;

•	 a state insurance commissioner designated by the state insurance commissioners;

•	 a state banking supervisor designated by the state banking supervisors; and

•	 a state securities commissioner (or officer performing like functions) designated by 

the state securities commissioners.

The state insurance commissioner, state banking supervisor, and state securities commissioner 

serve two-year terms.
ii 2013 FSOC // Annual Report

Statutory Requirements for the Annual Report

Section 112(a)(2)(N) of the Dodd-Frank Act requires that the annual report 

address the following:

i. the activities of the Council;

ii. significant financial market and regulatory developments, including 

insurance and accounting regulations and standards, along with an 

assessment of those developments on the stability of the financial system;

iii. potential emerging threats to the financial stability of the 

United States;

iv. all determinations made under Section 113 or Title VIII, and the 

basis for such determinations; 

v. all recommendations made under Section 119 and the result of such 

recommendations; and 

vi. recommendations—

I. to enhance the integrity, efficiency, competitiveness, and stability 

of United States financial markets;

II. to promote market discipline; and

III. to maintain investor confidence.

Approval of the Annual Report

This annual report was approved unanimously by the voting members of the 

Council on April 25, 2013. Except as otherwise indicated, data cited in this report 

is as of March 25, 2013.

Abbreviations for Federal Member Agencies of the Council

•	 Department of the Treasury (Treasury)

– Office of Financial Research (OFR)

– Federal Insurance Office (FIO)

•	 Board of Governors of the Federal Reserve System (Federal Reserve)

•	 Comptroller of the Currency (OCC)

•	 Bureau of Consumer Financial Protection (CFPB)

•	 Securities and Exchange Commission (SEC)

•	 Federal Deposit Insurance Corporation (FDIC)

•	 Commodity Futures Trading Commission (CFTC)

•	 Federal Housing Finance Agency (FHFA)

•	 National Credit Union Administration (NCUA)
Contents iii

Contents

1 Member Statement ...................................................... 1

2 Executive Summary ..................................................... 3

3 Annual Report Recommendations..............................11

3.1 Reforms to Address Structural Vulnerabilities ........................................11

3.2 Heightened Risk Management and Supervisory Attention ......................15

3.3 Progress on Financial Reform ...............................................................18

4 Macroeconomic Environment.................................... 21

4.1 U.S. Economic Activity..........................................................................21

4.2 Nonfinancial Balance Sheets.................................................................24

4.3 Government Finance.............................................................................30

BOX A: Macroeconomic and Financial Market Impacts 

of the Fiscal Cliff and Debt Ceiling ..........................................................32

4.4 External Environment............................................................................36

5 Financial Developments............................................. 43

5.1 Asset Valuations .................................................................................. 43

BOX B: Global Monetary Policy Actions ...............................................................48

5.2 Wholesale Funding Markets................................................................. 64

5.3 Bank Holding Companies and Depository Institutions ............................69

5.4 Nonbank Financial Companies ..............................................................81

BOX C: Convexity Event Risk...............................................................................88

5.5 Investment Funds ................................................................................ 90

5.6 Financial Market Infrastructure ............................................................ 99

BOX D: Collateral Availability............................................................................. 108

6 Regulatory Developments; Council Activities ..........111

6.1 Safety and Soundness........................................................................ 111

6.2 Financial Infrastructure, Markets, and Oversight.................................. 117

BOX E: International Coordination on Derivatives Reform, 

Including Global Margining ................................................................... 121
iv 2013 FSOC // Annual Report

6.3 Consumer and Investor Protection.......................................................123

6.4 Data Standards ..................................................................................126

6.5 Council Activities ................................................................................128

7 Potential Emerging Threats ..................................... 133

7.1 Fire Sales and Run Risk Vunerabilities.................................................133

7.2 Operational Risk .................................................................................135

7.3 Reliance Upon Reference Rates as a Vulnerability................................137

BOX F: Lessons Learned From Superstorm Sandy ............................................ 138

7.4 Financial System Vulnerability to Sudden Spikes 

in Fixed Income Yields ........................................................................142

7.5 Foreign Economic and Financial Developments ...................................144

7.6 Risk-Taking Incentives of Large, Complex, 

Interconnected Financial Institutions ...................................................146

BOX G: Bank Consolidation and Financial Stability Policy .................................. 148

References .....................................................................151

Abbreviations................................................................ 155

Glossary ........................................................................ 165

List of Charts ................................................................ 181

Endnotes ....................................................................... 187
1 

Member Statement 1

Member Statement

The Honorable John A. Boehner 

Speaker of the House 

United States House of Representatives

The Honorable Nancy Pelosi 

Democratic Leader 

United States House of Representatives

The Honorable Joseph R. Biden, Jr.

President of the Senate 

United States Senate

The Honorable Harry Reid 

Majority Leader 

United States Senate

The Honorable Mitch McConnell

Republican Leader 

United States Senate

In accordance with Section 112(b)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection 

Act, for the reasons outlined in the annual report, I believe that additional actions, as described below, 

should be taken to ensure financial stability and to mitigate systemic risk that would negatively affect 

the economy: the issues and recommendations set forth in the Council’s annual report should be fully 

addressed; the Council should continue to build its systems and processes for monitoring and responding 

to emerging threats to the stability of the United States financial system, including those described in the 

Council’s annual report; the Council and its member agencies should continue to implement the laws they 

administer, including those established by, and amended by, the Dodd-Frank Act, through efficient and 

effective measures; and the Council and its member agencies should exercise their respective authorities 

for oversight of financial firms and markets so that the private sector employs sound financial risk 

management practices to mitigate potential risks to the financial stability of the United States. 

Jacob J. Lew 

Secretary of the Treasury 

Chairperson, Financial Stability Oversight Council 

Ben S. Bernanke 

Chairman 

Board of Governors of the Federal Reserve System 

Thomas J. Curry 

Comptroller of the Currency 

Office of the Comptroller of the Currency 

Richard Cordray 

Director 

Bureau of Consumer Financial Protection 

Mary Jo White 

Chair 

Securities and Exchange Commission 

Martin J. Gruenberg 

Chairman 

Federal Deposit Insurance Corporation

Gary Gensler 

Chairman 

Commodity Futures Trading Commission 

Edward J. DeMarco 

Acting Director 

Federal Housing Finance Agency

Debbie Matz 

Chairman 

National Credit Union Administration

S. Roy Woodall, Jr. 

Independent Member with Insurance Expertise

Financial Stability Oversight Council 

Executive Summary 3

2 Executive Summary

Since the Council’s last annual report, the U.S. financial system has continued to strengthen, with 

increased capital and liquidity levels for core financial institutions and further improvements in financial 

market infrastructure. Market discipline has provided a tailwind for regulatory efforts to promote the 

conduct of financial transactions in a transparent and standardized fashion, particularly when compared 

to the opaque securitization techniques used in the run-up to the financial crisis. Investor confidence has 

also risen, as seen in further improvements of equity, fixed income, and housing markets. In addition, 

implementation of the Dodd-Frank Act and international coordination on G-20 reform priorities have 

brought significant progress towards establishing a more resilient and stable financial system, both 

domestically and globally. Despite these positive developments, significant risks to the financial stability 

of the United States remain. This year’s annual report is organized around seven themes, which recur 

throughout the sections of the report. 

The first theme concerns vulnerability to runs in wholesale funding markets that can lead to destabilizing 

fire sales. In the past year, the Council took concrete steps in supporting the implementation of structural 

reforms to reduce the likelihood of run risks of money market mutual funds (MMFs) by issuing proposed 

recommendations for reform under Section 120 of the Dodd-Frank Act. There has been some progress 

in reforming the tri-party repo market, though vulnerabilities to fire sales remain. Secondly, the housing 

finance system continues to rely heavily on government and agency guarantees, while private mortgage 

activity remains muted. The third theme concerns operational risks, which can cause major disruptions 

to the financial system. Such risks include technological and operational failures, natural disasters, 

and cyberattacks, and can arise from external or internal sources. The fourth theme consists of the 

reliance on reference interest rates, which recent investigations have demonstrated were manipulated, 

particularly in the case of the London Interbank Offered Rate (LIBOR). The international regulatory 

community is moving forcefully to reform the governance and integrity of LIBOR and to consider 

transitions towards alternative benchmarks. The fifth theme concerns the need for financial institutions 

and market participants to be resilient to interest rate risk. Yields and volatilities in fixed income markets 

are very low by historical standards, providing incentives for market participants to “reach for yield” by 

increasing leverage, by engaging in maturity transformation, or by investing in less creditworthy assets, 

thus potentially increasing exposure to risks of sudden spikes in yields. The sixth theme concerns longterm fiscal imbalances, as the absence of bipartisan agreement on U.S. fiscal adjustment has raised 

questions about whether long-term fiscal problems may be resolved smoothly. The seventh theme is about 

the United States’ sensitivity to possible adverse developments in foreign economies. Throughout the 

remainder of this executive summary, these seven themes are discussed in more detail.

Fire Sale and Run Vulnerabilities

Although many of the least stable funding structures that failed in the crisis have disappeared, 

important run risks in the financial system persist. The risks have been reduced in recent years due to 

regulatory action and the still relatively recent memories of the crisis: wholesale funding market activity 

is generally reduced, securities broker-dealers have markedly reduced leverage, and regulations have 

diminished sponsorship of off-balance sheet vehicles by large financial institutions. In other instances, 

severe investor losses during the crisis extinguished demand for some products and structures. However, 

run risks in sectors such as MMFs and broker-dealers continue to persist. As witnessed in the financial 
4 2013 FSOC // Annual Report

crisis, susceptibility to runs and reliance on confidence-sensitive funding by these entities can induce fire 

sales in times of market stress. 

MMFs’ susceptibility to runs could trigger fire sales of assets, impair the flow of short-term financing, and 

propagate strains throughout the financial system. In the past year, the Council took concrete steps in 

supporting the implementation of reforms to mitigate structural vulnerabilities of MMFs. In November 2012, 

the Council proposed recommendations for public consideration regarding MMF reform, under Section 

120 of the Dodd-Frank Act, with three alternatives: (1) a floating net asset value (NAV) for MMFs; or (2) the 

introduction of a NAV buffer and a minimum balance at risk (MBR) for investors; or (3) a risk-based NAV 

buffer of 3 percent in addition to other measures. The public comments on this proposal are currently under 

review by the Council and the SEC, which is also examining the characteristics of MMFs’ susceptibility to runs. 

The tri-party repo market remains vulnerable to runs by lenders in the event that concerns emerge regarding 

the financial condition of borrowers such as securities broker-dealers, who depend heavily on this channel 

for short-term funding. Additional risks stem from the continued heavy reliance on discretionary intraday 

credit in the settlement process, and the limited capacity of lenders to manage the ramifications of a default 

by a major borrower. Some progress has been made in increasing the resiliency of the tri-party market. The 

reliance on intraday credit extended by the clearing banks has begun to decline and, as additional changes 

are made to the settlement process, should be largely eliminated by the end of 2014. Nonetheless, a default 

of a large broker-dealer or other large borrower would leave lenders with large volumes of collateral that they 

would likely seek to liquidate quickly.

Housing Finance Reform

Housing market developments in 2012 were generally positive, with indicators showing a fragile but steady 

recovery. For example, housing prices have continued to rise since early 2012, while the percentage of 

properties with negative equity has declined. Mortgage delinquencies have also declined, as has the rate 

of new delinquencies and the inventory of properties in foreclosure, suggesting a slow return to a firmer 

market. However, the housing market remains vulnerable to macroeconomic trends, and a fair number 

of potential borrowers remain unable to obtain mortgage credit because of conservative underwriting 

standards with respect to low or negative equity or relatively low credit scores. Finally, though the 

inventory of bank-owned properties is generally declining, foreclosure timelines in some states remain 

extraordinarily long, resulting in a continued overhang of distressed properties.

The housing finance system continues to draw on significant federal government support. Increasing the 

presence of private capital in assuming credit risk in housing finance remains a priority. In spite of the 

apparent stabilization in U.S. housing markets, both new loan origination volumes (loans used to purchase 

homes, as opposed to refinancing existing loans) and the appetite to assume credit risk in mortgage 

markets remain quite subdued post-crisis. There is very limited new private mortgage securitization activity 

other than small-scale issuance of very-high-quality jumbo prime loans. Reduced purchase loan origination 

volumes in the wake of the crisis may be due, in part, to constraints on origination capacity, continued 

uncertainty over mortgage put-backs to lenders as litigation over legacy originations has increased the risk 

and cost to both originators and issuers, and some market participants’ unwillingness to provide capital 

except for agency- and government-guaranteed entities until certain regulations take effect.

In 2012, steps were taken towards establishing a new framework for housing finance and providing more 

clarity to market participants, though much remains to be done. The Treasury and FHFA announced new 

steps to expedite the wind-down of Fannie Mae and Freddie Mac, two government-sponsored enterprises 

(GSEs). The GSEs continued to increase their guarantee fees, or the price of insurance that they provide to 

protect bondholders from credit risk, in an effort to encourage private capital participation in the market. 
5

Keeping with this trend, the Federal Housing Administration (FHA) increased its mortgage insurance 

premia in 2012. The FHFA and the GSEs also announced a new representations and warranties framework 

to clarify originators’ purchase exposure and liabilities on new loans sold to the GSEs. The CFPB finalized 

the following significant rules: the loan originator compensation rule, the mortgage servicing rules, 

and the ability-to-repay rule, including the definition of a qualified mortgage (QM). These rulemakings 

represent first steps towards removing uncertainty surrounding underwriting and servicing practices and 

representations and warranties, which are critical to improving mortgage origination and securitization 

issuance volumes.

Operational Risks

Major disruptions to the financial system can also arise from operational risks. Technological failures, 

natural disasters, and cyberattacks can emanate from anywhere, at any time. Preparation and planning to 

address these potential situations are essential to maintain the strength and resilience of our financial system.

One area of particular concern is the potential for systems failures in an environment where trading activity 

is more dispersed and automated. The extremely high speeds at which markets operate today can compound 

the overall impact of even small operational failures by propagating errors quickly and widely. In 2012, 

equity markets experienced a number of control problems, highlighting the fragile relationship between 

technological infrastructure and market stability. While bringing many advantages, technological advances 

are not without risks. Recent significant systems issues include malfunctions in connection with the initial 

public offerings of BATS Global Markets, Inc. (BATS) and Facebook, Inc., as well as losses suffered by 

Knight Capital Group Inc. (Knight Capital) caused by errors in its systems related to routing orders. These 

events have occurred notwithstanding current regulatory requirements and oversight programs relating to 

technology standards and safeguards. The SEC is moving to help ensure robust system controls and, in March 

2013, proposed Regulation Systems Compliance and Integrity (Regulation SCI) to strengthen the automated 

systems of important market participants in the securities markets.

Financial infrastructure was also tested in 2012 by the impact of Superstorm Sandy. While the storm caused 

severe damage to energy, telecommunications, and transportation infrastructures upon which markets 

depend, critical post-trade financial utilities, including core settlement and clearing functions, operated 

normally from their primary or contingency sites. Certain trading venues, such as the New York Stock 

Exchange (NYSE) and NASDAQ, as well as over-the-counter (OTC) money and fixed income markets, were 

closed for various periods on October 29 and 30, 2012. On the retail services side, currency inventories were 

adequate, and ATMs generally were available outside the hardest hit areas. At the individual firm level, the 

majority of institutions successfully employed their contingency plans and disaster recovery vendors, and most 

contingency sites worked well. Effective governmental assistance through federal interagency coordination, 

federal-state coordination, public-private partnerships, and targeted financial regulatory relief helped to 

resolve issues and ensure adequate communication among affected parties. Despite the limited impact on 

the financial sector, post-Sandy assessments still identified a number of potential improvements in the areas 

of contingency planning and testing, incident management around market closures, and positioning of key 

management and staff, and improvements to further mitigate dependencies on power, transportation, and 

communications infrastructures. 

During 2012, more than a dozen financial institutions were subject to sustained and persistent cyberattacks. 

These attacks disrupted online access to consumer websites, causing inconvenience and annoyance to 

customers, increased costs, and significantly elevated demand for mitigation service providers. To date, we 

have not seen disruptions to market functioning or the health of the financial system from these attacks; 

ongoing vigilance is required, though. In addition, improved cooperation across firms and industries is 

necessary as the volume and sophistication of attacks increase. Public-private partnerships could further 

Executive Summary
6 2013 FSOC // Annual Report

improve the analysis and dissemination of robust information to facilitate real-time responses to cyberattacks. 

Furthermore, enhanced cybersecurity education directed to employees and consumers could improve 

protection, mitigation, and responses.

Reforms of Reference Rates

Investigations by regulators across the globe concerning manipulations of LIBOR have exposed the structural 

vulnerabilities of a voluntary and self-regulated regime for self-reported rates, particularly where underlying 

transactions are limited or nonexistent. These benchmark interest rates in various currencies are the basis 

for hundreds of trillions of dollars of swap transactions in notional amount, commercial and consumer loans, 

futures contracts, and other financial derivatives products traded in OTC markets and exchanges around 

the world. Approximately $350 trillion notional amount of interest rate swaps and $10 trillion of loans are 

indexed to LIBOR alone. Given the number of transactions that rely on LIBOR and similar rates, problems 

with these rates can more broadly threaten public confidence in the integrity of markets.

Recent investigations uncovered systematic manipulations of reference rate submissions, designed to increase 

potential profit and signal relative financial health by submitting firms. These schemes affected LIBOR 

submissions as well as similar rates such as the Euro Interbank Offered Rate (EURIBOR) and the Tokyo 

Interbank Offered Rate (TIBOR). In the United States, the CFTC issued orders against Barclays, UBS AG, 

and the Royal Bank of Scotland. The orders charged the banks with manipulating, attempting manipulation, 

and false reporting, resulting in penalties of more than $1.2 billion in the United States, and over $2.5 

billion globally. These manipulations were made possible in part by a decline in eligible transactions used to 

support rate submissions in recent years, most notably as short-term funding markets have moved away from 

unsecured lending between banking institutions. 

The international regulatory community is moving forcefully to reform the governance and integrity of 

LIBOR and to consider transitions towards alternative benchmarks. The CFTC and Department of Justice 

(DOJ) settlement included requirements for banks to take specified steps to ensure the integrity and 

reliability of their LIBOR and other benchmark interest rate submissions. In the United Kingdom, the 

Financial Services Authority (FSA) has implemented reforms of LIBOR based on the recommendations of 

the Wheatley Review, which include a number of major revisions to the system of governance, calculation, and 

oversight. Committees across multiple international regulatory agencies are further engaged in developing 

improved governance and reporting frameworks for reference rates and considering alternative benchmarks. 

These international groups include organizations spanning central banks and regulators, such as the Bank 

for International Settlements (BIS) and the International Organization of Securities Commissions (IOSCO).

Fixed Income Valuations and Low Interest Rate Environment

Fixed income markets are currently characterized by low yields across the maturity and credit spectrum. In 

addition, realized and implied volatilities in fixed income and equity markets are subdued and have reached 

levels not seen since early 2007. The current low level of yields reflects three underlying factors. The first 

factor is the market expectation of future short-term interest rates, which is driven by expected monetary 

policy. Globally, central banks have been easing monetary policy in order to aid recovery from the global 

financial crisis, and the Federal Reserve has provided explicit short-term rate guidance tied to economic 

conditions. The second factor keeping yields low is related to the pricing of interest rate risk. The pricing 

of risk can be gauged by term premia for Treasury securities, which are estimated to be at their lowest since 

the early 1960s. The pricing of risk reflects a gradual shift in the composition of buyers towards those who 

are less risk-sensitive, particularly due to the large-scale asset purchase programs of the Federal Reserve and 

other central banks. Finally, the third factor contributing to low yields is that investor appetite for credit risk 

in fixed income markets has been increasing, albeit from a low level. Credit losses and provisions have been 
7

declining over many months. Credit yields are thus low due to the low Treasury yields and the improved 

outlook for solvency risk. 

The implications of changes in asset prices for financial stability depend on how these assets are funded, the 

extent to which valuations are accompanied by leverage or maturity transformation, and whether investors 

have sufficient information about the risk-return tradeoffs in their decisions. Recent changes in asset prices 

have not been accompanied by the broad-based increases in leverage and maturity transformation that took 

place prior to 2007. Nevertheless, yield-seeking behavior, which is supported by low levels of market volatility, 

is apparent in several markets. In credit markets, the issuance of high-yield bonds reached a historical high 

in the fourth quarter of 2012, and leveraged loan issuance was also elevated. While underwriting standards 

remain conservative in many markets, there are some examples of loosening standards. For example, 

there are signs of weakening underwriting standards in the types of covenants employed in certain newly 

issued bonds and loans. The issuance of collateralized loan obligations (CLOs) is similarly close to peak 

levels, coinciding with the rise in high-yield loan and bond issuance. CLOs provide investors with leveraged 

exposure to non-investment grade corporate credit. In addition, assets under management for corporate 

bond mutual funds and exchange-traded funds have grown rapidly. Other investors, such as pension funds 

and hedge funds, have also absorbed much of the new supply in credit markets.

Adding duration risk by investing in longer-maturity assets is another form of yield-seeking behavior. In 

the commercial banking sector, publicly available data indicate that the mismatch between the average 

maturity of assets and average maturity of liabilities has increased recently at smaller banks, though not at 

large institutions. Insurance companies and pension funds are also exposed to interest rate risk. Certain real 

estate investment trusts (REITs), known as agency REITs, are REITs that invest in agency mortgage-backed 

securities (MBS) and are primarily funded through repo markets. Agency REITs are actively engaged in 

leveraged maturity transformation. While the sector has reduced leverage somewhat since the crisis and, 

at present its holdings are not very large compared to the overall MBS market, it has grown considerably in 

recent years. A shock to agency REITs could induce repo lenders to raise margins or pull back funding, which 

in turn could compel agency REITs to sell into a declining market, potentially impacting MBS valuations 

significantly. 

Yields and volatilities are expected to return to more normal levels over the long term. A gradual 

normalization in the context of a strengthening recovery does not pose a significant threat to financial 

stability. By contrast, a sudden spike in yields and volatilities could trigger a disorderly adjustment, and 

potentially create outsized risks. The threats to financial stability posed by reaching for yield are mitigated by 

the same improvements in the resiliency of the financial system that reduce vulnerability to other potential 

dangers. Greater resilience is the result of strong reform efforts in recent years, as well as still subdued risk 

taking by some market participants in the aftermath of the events of 2008. The capital and liquidity buffers of 

the banking system have continued to grow over the past year, and nonbank credit intermediation activity has 

declined since 2008. Overall, both the willingness and the ability of investors to take on leverage have been 

reduced for a variety of reasons. 

Market and Economic Impact of Fiscal Policy

Notwithstanding the overall improvement in the U.S. financial system, concerns persist about economic and 

financial market impacts of long-term fiscal imbalances. In particular, the process of U.S. fiscal adjustment 

has raised questions about the manner in which long-term fiscal issues will be resolved. In 2012, financial 

markets continued to respond to fiscal and political uncertainty, though market volatility was impacted less 

than was the case during the debt ceiling crisis in 2011. 

Executive Summary
8 2013 FSOC // Annual Report

A series of automatic tax increases and spending cuts, the so-called fiscal cliff, were set to take effect at 

the start of 2013. In addition, the statutory debt ceiling was reached on December 31, 2012 (although 

extraordinary measures authorized by law were available to postpone the date that the United States would 

otherwise default on its obligations by about two months). The passage of the American Taxpayer Relief 

Act of 2012 (ATRA) on January 1, 2013 reduced uncertainty for market participants by cancelling the tax 

increases for most U.S. households and deferring the budget cuts for several months. Furthermore, a number 

of business and personal tax measures were put in place, including a permanent resolution for Alternative 

Minimum Tax provisions. In February, the debt ceiling was suspended until mid-May. After the initial 

response to the legislation, the financial market impact of these fiscal developments has been minimal so far.

In financial markets, the consequences of failing to increase the debt ceiling were generally seen as distinct 

from and more immediately serious than the effects of the fiscal cliff. In particular, the effects of the 

fiscal cliff would accrue over time as households, businesses, and governments adjusted their spending 

and investment decisions. However, the inability of the Treasury to borrow might cause an interruption 

of principal and interest payments on U.S. sovereign debt, which financial markets regard as one of the 

safest assets. With these “flight to quality” characteristics in mind, the approach of the fiscal cliff had mixed 

effects on financial markets. Downside concerns increased the volatility of certain Treasury bills considered 

at risk for extension or missed payments. However, the prices of safe haven assets rose, including longerdated Treasury securities, though to a lesser extent than in August 2011, when Standard & Poor’s (S&P) 

downgraded its rating of U.S. debt. 

Foreign Financial Developments 

While sentiment in U.S. financial markets has improved, United States financial stability remains sensitive to 

possible adverse developments in global markets and among our major trading partners. Threats to financial 

stability in the United States from developments related to the euro area decreased in the latter part of 

2012, although recent developments in Cyprus indicate that significant downside risks remain. The markets’ 

perception of reduced tail risks relative to early 2012 is partially due to policy efforts in the euro area to 

restore financial stability. These actions have, at least temporarily, been successful in preventing significant 

dislocations in financial markets. 

Notably, the European Central Bank (ECB) created the Outright Monetary Transactions (OMT) program, 

allowing the ECB to purchase sovereign debt of member states that are in compliance with a reform program 

at the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM). The OMT 

helped to reverse the steep rise of peripheral sovereign debt yields, which have declined markedly since the 

program’s announcement. The European Union (EU) reached a political agreement to place euro-area 

banks, as well as banks in non-euro countries that opt in, under the overarching supervision of the ECB. 

Together these efforts helped to improve bank access to market funding and reduced reliance on ECB 

funding. Governments of vulnerable countries undertook important efforts to consolidate fiscal positions, 

strengthen banking systems, and advance reforms to boost growth prospects, and received support from the 

ESM and the International Monetary Fund (IMF). The Spanish government narrowed its fiscal deficit and 

made progress toward recapitalizing its banking system, while European authorities took additional actions 

to support Greece. However, Cyprus’ recent difficulties serve as a reminder that many countries within the 

euro area remain in a vulnerable position, and underscore the importance of moving forward with efforts to 

strengthen the foundations of a monetary union. Despite these aggressive policy actions and financial market 

recovery, substantial challenges remain. While fiscal austerity has narrowed euro-area countries’ deficits, 

this same fiscal austerity has contributed to a contraction in euro-area economies. Moreover, access to credit 

remains highly constrained across many vulnerable countries, as financial markets across the euro area 

remain fragmented. Many countries in Europe remain in the midst of deep and prolonged recessions. The 
9

European Commission forecasts reflect an anemic economic outlook, predicting a GDP contraction of 0.3 

percent across the euro area in 2013, following a contraction of 0.6 percent in 2012.

Countries outside the euro area also face tough policy tradeoffs. Confronted with recession, many 

governments face an uphill battle to reduce budget deficits and maintain the social consensus necessary to 

advance fiscal reforms. Such fiscal tightening may leave advanced economies vulnerable to new financial 

shocks and to slower economic growth. Just as in the euro area, real GDP also contracted in Japan and the 

United Kingdom. In Japan, the central bank adopted a 2 percent inflation target in coordination with the 

Ministry of Finance, as advocated for by the newly-elected Prime Minister, Shinzo- Abe, who pledged to 

enact stimulus to boost growth and end deflation. The yen depreciated by 8.7 percent against the dollar to 

¥/$ 86.7 during the second half of 2012, and depreciated by an additional 12.5 percent to ¥/$ 97.6 in 2013 

through early April. The U.S. has a strong financial stability interest in Japan finally escaping from deflation 

and securing more robust growth. Japan’s fiscal outlook remains challenging. Japan’s fiscal deficit is likely to 

remain at 10 percent of GDP in 2013, the same as 2012, as the fading of reconstruction spending is roughly 

offset by the Abe Administration’s fiscal stimulus. Foreign developments require continuous monitoring of 

the U.S. financial sectors’ vulnerabilities, capital and liquidity reserves and risk management practices.

Outline 

The remainder of the report is organized in five sections. Section 3 presents the recommendations of the 

Council. Section 4 reviews recent macroeconomic developments. Section 5 provides an update of financial 

developments, including asset valuations, wholesale funding, bank holding companies and depository 

institutions, nonbank financial companies, investment funds, and financial market infrastructures. Section 

6 reviews regulatory developments and summarizes Council activity since the 2012 annual report. Section 7 

discusses potential emerging threats, including threats from fire sale and run risk vulnerabilities, operational 

risks, reliance upon reference rates as a vulnerability, financial system vulnerability to sudden spikes in fixed 

income yields, foreign economic and financial developments, and risk-taking incentives of large, complex, 

interconnected financial institutions.

Executive Summary

Annual Report Recommendations 11

3 Annual Report Recommendations

The Dodd-Frank Act requires the Council to make annual recommendations to: (1) enhance the 

integrity, efficiency, competitiveness, and stability of U.S. financial markets; (2) promote market 

discipline; and (3) maintain investor confidence. In this section, we discuss the ongoing work of the 

Council, its members, and the private sector to address these important mandates and lay out concrete 

recommendations. 

3.1 Reforms to Address Structural Vulnerabilities

3.1.1 Reforms of Wholesale Funding Markets

Money Market Funds

The Council took concrete steps to support the implementation of structural reforms to mitigate the 

vulnerability of money market mutual funds (MMFs) to runs, a recommendation made by the Council 

in its 2011 and 2012 annual reports. In November 2012, the Council issued Proposed Recommendations 

Regarding Money Market Mutual Fund Reform, under Section 120 of the Dodd-Frank Act.1 This action 

followed the decision by SEC Commissioners not to move forward with the MMF reforms as proposed by 

their staff in August 2012.

The Council’s proposed recommendations included three alternatives for public consideration:

•	 Alternative One: Floating Net Asset Value. Require MMFs to have a floating net asset value 

(NAV) per share by removing the special exemption that currently allows MMFs to utilize 

amortized cost valuation and/or penny rounding to maintain a stable $1.00 NAV. 

•	 Alternative Two: Stable NAV with NAV Buffer and Minimum Balance at Risk. Require MMFs 

to have a NAV buffer with a tailored amount of assets of up to 1 percent to absorb day-to-day 

fluctuations in the value of the funds’ portfolio securities and allow the funds to maintain a 

stable NAV. The NAV buffer would be paired with a requirement that 3 percent of a shareholder’s 

highest account value in excess of $100,000 during the previous 30 days—a minimum balance 

at risk (MBR)—be made available for redemption on a delayed basis. In the event that an 

MMF suffers losses that exceed its NAV buffer, the losses would be borne first by the MBRs of 

shareholders who have recently redeemed, providing protection for shareholders who remain in 

the fund. 

•	 Alternative Three: Stable NAV with NAV Buffer and Other Recommended Measures. Require 

MMFs to have a risk-based buffer of 3 percent of NAV to provide explicit loss-absorption 

capacity that could be combined with other measures to enhance the effectiveness of the buffer 

and potentially increase the resiliency of MMFs. The other measures include more stringent 

investment diversification requirements, increased minimum liquidity levels, and more robust 

disclosure requirements. 

The public comment period on the Council’s proposed recommendations closed on February 15, 2013. 

The Council received approximately 150 comment letters on its proposed recommendations and is in 

the process of reviewing those comments. The SEC, by virtue of its institutional expertise and statutory 

authority, is best positioned to implement reforms to address the risk that MMFs present to the economy. 
12 2013 FSOC // Annual Report

If the SEC moves forward with meaningful structural reforms of MMFs before the Council completes its 

Section 120 process, the Council expects that it would not issue a final Section 120 recommendation to the 

SEC. The Council understands the SEC is currently in the process of considering further regulatory action. 

To inform this examination, SEC staff produced a report, requested by certain SEC Commissioners, on 

the causes of investor redemptions in prime MMFs during the 2008 financial crisis, on changes in certain 

characteristics of MMFs before and after the SEC’s 2010 modifications to MMF regulation, and on the 

potential effect of further reform of MMFs on investor demand for MMFs and alternative investments.2 

The Council also recommends that the SEC consider the views expressed by commenters on the Council’s 

proposed recommendations and by the Council as the SEC considers any regulatory action to improve 

loss-absorption capacity and mitigate MMFs’ susceptibility to runs. The Council further recommends that 

its members examine the nature and impact of any structural reform of MMFs that the SEC implements to 

determine whether the same or similar reforms are warranted for other cash-management vehicles, including 

non-Rule 2a-7 MMFs. Such an examination would provide for consistency of regulation while also decreasing 

the possibility of the movement of assets to vehicles that are susceptible to large-scale runs or otherwise pose 

a threat to financial stability. 

Tri-Party Repo 

In its 2012 annual report, the Council highlighted the tri-party repo market’s vulnerabilities and noted a lack 

of progress in addressing them. The vulnerabilities are as follows: 

•	 Heavy reliance by market participants on intraday credit extensions from the clearing banks. 

•	 Weakness in the credit and liquidity risk management practices of many market participants. 

•	 Lack of a mechanism to ensure that tri-party repo investors do not conduct disorderly, uncoordinated 

sales of their collateral immediately following a broker-dealer’s default. 

Reliance on intraday credit is beginning to decline. Two government securities clearing banks, JPMorgan 

Chase (JPM) and Bank of New York Mellon (BNYM), have made operational and technological changes 

that reduce the intraday credit they extend. As a result of these efforts, market participants have begun to 

adjust their behavior in ways that reduce market demand for intraday credit. Consequently, intraday credit 

has declined to approximately 80 percent of market volume, down from 100 percent as of the Council’s 2012 

annual report. 

JPM and BNYM plan to implement further technology and operational changes through 2013 and 2014. 

These changes will improve the resiliency of tri-party settlement by making clearing bank intraday credit 

available only on a pre-committed basis, and by reducing the intraday credit supplied by the clearing banks to 

no more than 10 percent of volume by late 2014. 

Some signs of improvement in broker-dealer liquidity risk management practices. With the active 

encouragement of relevant supervisors and regulators, broker-dealers have made progress in reducing 

their reliance on short-term secured funding. The proportion of overnight funding fell from 64 percent 

in December 2011 to 59 percent in December 2012 (non-government assets shifted from 41 percent to 

33 percent). 

The risk of fire sales in the event that a major broker-dealer faces default remains a financial stability 

concern. Reforms made since the financial crisis, such as higher capital and liquidity requirements, have 

reduced the risk of a dealer default. However, the Council recognizes that a major broker-dealer’s default 

could threaten financial stability as the broker-dealers’ creditors liquidate the collateral pledged against their 
tri-party repo lending. The fire sales of this collateral could destabilize financial markets and amplify the 

negative consequences of such a default. 

The Council acknowledges the work that has been done in the past year to reduce reliance on discretionary 

intraday credit extended by the clearing banks. The Council emphasizes the importance of the commitment 

on the part of all market participants toward achieving the longer-term goals in this area in accordance with 

the published timelines. However, the Council urges continued coordinated efforts by market participants 

and financial regulatory agencies with relevant authority to address the remaining risks associated with the 

tri-party repo market, notably by better preparing investors and other market participants to deal with the 

consequences of a dealer’s or other large borrower’s distress or default. 

3.1.2 Housing Finance Reform 

Last year saw signs of improvement in the residential housing market. Home prices increased, delinquency 

rates declined, and home sales reached 3-year highs. Despite these improvements, the housing finance system 

remains highly reliant on federal government support, with nearly 90 percent of newly originated mortgages 

carrying some form of government backing in 2012. Given this, the development and implementation of 

a broad reform plan for the housing finance system that supports the central objectives of bringing more 

private capital back to the housing finance market is critical. The Council recommends that the Treasury, 

HUD, and FHFA continue to work with Congress and other stakeholders to develop and implement a broad 

plan to reform the housing finance system. With this work ongoing, member agencies have advanced reform 

by taking initial measures to expedite the wind-down of the government-sponsored enterprises (GSEs), 

encourage private capital to take mortgage credit risk, improve borrower and investor protections, and help 

develop a new housing finance infrastructure. 

Review of 2012 Recommendations and 2013 Goals 

In the 2012 annual report, the Council recommended that member agencies continue to work on the 

development of a long-term housing finance reform framework that supports the central role of private 

capital while improving borrower and investor protections. Progress has been made and is highlighted by the 

following key actions: 

•	 Modification of the Treasury’s Preferred Stock Purchase Agreements (PSPAs) with the GSEs to
 

expedite the wind-down of the retained portfolios of Fannie Mae and Freddie Mac.
 

•	 Development and implementation of FHFA’s Strategic Plan for the operation of the GSE
 

conservatorships.
 

•	 Publication by the CFPB of final regulations under the Real Estate Settlement Procedures Act
 

(Regulation X) and the Truth in Lending Act (Regulation Z), which set forth standards for servicing
 

mortgage loan accounts and additional protections for borrowers who are delinquent.
 

•	 Finalization of the CFPB’s ability-to-repay/qualified mortgage rule. 

Notwithstanding the above, further progress needs to be made in 2013. Outlined below are steps Council 

member agencies plan to take in 2013 in order to help meet the Council’s housing finance goals. 

Reducing the GSEs’ Footprint 

Under its Strategic Plan, the FHFA announced priorities for 2013 of contracting GSE operations by setting 

objective targets. In particular, each GSE will provide an opportunity for private capital to re-enter the 

market through risk-sharing transactions and through further reductions in its mortgage investment 

portfolios. These efforts, combined with higher guarantee fees, are expected to help facilitate increased 

participation by the private sector in the mortgage markets. The Council recommends that the FHFA 

continue these efforts in order to help bring more private capital back into mortgage finance. 

Annual Report Recommendations 13 
14 2013 FSOC // Annual Report

participation by the private sector in the mortgage markets. The Council recommends that the FHFA 

continue these efforts in order to help bring more private capital back into mortgage finance. 

Facilitating Increased Private Mortgage Market Activity

A significant amount of work remains to foster increased levels of private activity in the mortgage finance 

market. To help facilitate this, the Council recommends that the relevant agencies continue their work to 

resolve the risk-retention rule, including the qualified residential mortgage (QRM) definition, to further 

encourage private capital to re-enter the mortgage finance market. More broadly, the FHFA, Treasury, HUD, 

CFPB, and Congress must continue to address the weaknesses that became evident in the recent housing 

crisis by promoting the development of standards and best practices in the mortgage market.

Building a New Housing Finance Infrastructure

The FHFA announced in March 2013 that a business entity would be established jointly by the GSEs to build 

a new secondary mortgage market infrastructure, including the development of a common securitization 

platform designed to function as an independent market utility. The Council recommends that the FHFA 

continue to explore changes to the country’s housing finance infrastructure that would lead to a more 

efficient and sustainable mortgage market. In addition to the work on the common securitization platform, 

this should include model legal agreements, improvements to the mortgage transfer system, and an improved 

compensation system for mortgage servicers. These processes should be coordinated with the measured 

wind-down of the GSEs and the implementation of a more sustainable structure for the government’s role in 

the housing finance system. 

3.1.3 Reforms Relating to Reference Rates

The Council recommends international cooperation for the development of high-level principles for 

financial benchmark governance, controls, data sufficiency, and oversight. Current efforts include the 

U.K. authorities’ work on the London Interbank Offered Rate (LIBOR), the International Organization of 

Securities Commissions’ (IOSCO) work on principles for financial benchmarks and transition to alternative 

benchmarks, and the Bank for International Settlements’ (BIS) Economic Consultative Committee’s work on 

the need for a reliable and robust framework for producing reference rates. Relevant member agencies should 

also cooperate with the Financial Stability Board (FSB) in any related work it may undertake.

The small number of transactions in the unsecured, interbank lending market underpinning reference 

rates like LIBOR and weak governance structures undermine market integrity and raise financial stability 

concerns. While ongoing international efforts are necessary to remediate deficiencies in governance, they 

cannot address the insufficient number of transactions, particularly in longer tenors, in the unsecured, 

interbank lending market. Investigations by regulators and law enforcement agencies across the globe 

concerning manipulations and false reporting of LIBOR and similar rates have exposed the structural 

vulnerabilities of these benchmarks. The shift away from banks funding each other in an unsecured market 

has led to a scarcity or outright absence in longer tenors of real transactions underpinning these benchmark 

rates and has exacerbated vulnerabilities of these benchmarks. Yet currently, hundreds of trillions of dollars 

in derivatives, loans, and other financial instruments reference these benchmarks. This situation leaves the 

financial system with benchmarks that are prone to and provide significant incentives for misconduct.

Given these vulnerabilities and the real risk that they will remain, in order to ensure market integrity and 

support financial stability, the Council recommends that U.S. regulators cooperate with foreign regulators, 

international bodies, and market participants to promptly identify alternative interest rate benchmarks that 

are anchored in observable transactions and are supported by appropriate governance structures, and to 

develop a plan to accomplish a transition to new benchmarks while such alternative benchmarks are being 

identified. The Council further recommends that steps be taken to promote a smooth and orderly transition 
15

to alternative benchmarks, with consideration given to issues of stability and to mitigation of short-term 

market disruptions.

3.2 Heightened Risk Management and Supervisory Attention

3.2.1 Operational Risk

Internal Controls

Strong internal control systems and processes for financial institutions and market utilities are essential 

safeguards against business disruptions and system failures that could adversely affect the flow of financial 

transactions among financial institutions, markets, consumers, and businesses. Failed operational processes 

were the root of many recent, high-profile problems within the financial system. The Council has previously 

highlighted the importance of improved risk management and controls in the context of high-speed and 

automated trading activities. The SEC has responded to these concerns in securities markets with a proposed 

rule to strengthen the automated systems of important market participants. The Council recommends 

continued engagement by regulators, market exchanges, and participants to explore durable solutions to the 

challenges of managing complex technology in trading environments and the vulnerabilities exposed by 

the operational malfunctions in 2012. In addition, the Council recommends that regulators continue to 

monitor the adequacy of internal control and corporate governance processes of financial institutions and 

market utilities.

Cybersecurity

Since the summer of 2012, financial services companies have experienced a series of coordinated distributed 

denial-of-service (DDoS) attacks against their public-facing websites. Among other things, the Treasury and 

financial regulators have facilitated the sharing of information between the government and the financial 

services sector in response to these attacks. The Council has received reports on the nature of these 

attacks and the threat posed to the financial system. The Council recommends that senior management at 

financial institutions remain engaged on these issues and commit to improve the flow of information both 

within individual firms and between firms, through appropriate channels. The Council recommends that 

government agencies enhance information sharing between the public and private sectors and work with the 

private sector to assess the effects of cyberattacks on business continuity and recovery. Financial regulators 

should continue to review and update their examination policies and guidance for information security in 

light of the evolving threat environment. 

Infrastructure 

Superstorm Sandy underscored the interdependencies between our nation’s financial system and other key 

infrastructures. The Council recommends that regulators assess their policies and guidance in the areas of 

contingency planning and testing, incident management around market closures, and positioning of key 

management and staff, and improvements to further mitigate dependencies on power, transportation, and 

communications infrastructures. Regulators should assess whether examinations are appropriately ensuring 

conformance with these requirements. 

3.2.2 Risk of Prolonged Period of Low Interest Rates

Depository Institutions, Broker-Dealers, and Bank Holding Companies

Sustained low levels of interest rates, combined with ample deposit and wholesale funding liquidity as well as 

low loan demand, may have led some firms to reach for yield without sufficient attention to the risk-return 

tradeoff. Supervisors and market participants should be particularly attuned to signs of heightened interest 

rate and credit risk at depository institutions, credit unions, broker-dealers, and bank holding companies 

Annual Report Recommendations
16 2013 FSOC // Annual Report

(BHCs). While duration extension and increased credit risk taking may boost near-term earnings, it could 

significantly increase losses in the event of a sudden yield curve steepening, a large rise in rates, or a 

significant widening of credit spreads. In addition, excessive risk posed by such strategies could be masked if 

an institution does not have appropriate risk management controls in place. The Council recommends that 

regulatory agencies and private sector risk managers continue their scrutiny of the ways in which potential 

changes in interest rates could adversely affect the risk profiles of financial firms. This should be done with 

regular assessments of interest rate and credit risk management strategies, including thorough assessments of 

how institutions will perform in a stressed or rapidly changing market environment. Established supervisory 

guidance by the prudential banking and credit union regulators directs that financial institutions have 

interest rate and credit risk management and measurement systems commensurate with the level and 

complexity of their risk profiles. 

Insurance Companies

Insurance companies are generally subject to interest rate risk, given their investments in fixed income assets; 

however, the life insurance sector is particularly sensitive to interest rate risk, as a result of its investment 

in longer-duration fixed income assets, which are typically held to maturity in order to match their longtail liabilities. Particular insurance products are more sensitive to interest rate risk, such as whole life, fixed 

annuities, and products with explicit guaranteed returns. 

State insurance regulators require life insurance companies in their states to perform annual asset adequacy 

testing to determine whether the assets backing liabilities provide sufficient cash flow to meet future 

contractual payments to policyholders and other expenses. As part of asset adequacy testing, life insurance 

companies are required to test the sensitivity of assets and liabilities to changes in interest rates and to 

adverse economic scenarios. 

The Council recommends that FIO and state insurance regulators continue to be vigilant in monitoring 

the impact of the low interest rate environment (see Section 5.4.2) on insurance companies and that state 

insurance regulators continue to ensure that the economic scenarios run by insurance companies 

are sufficiently robust and appropriately capture interest rate and other economic risks.

Pension Funds

The current interest rate environment presents challenges for pension funds. Both public and private 

defined benefit (DB) pension plans remain significantly underfunded relative to the present value of their 

liabilities due to inadequate contributions, losses incurred in 2007 and 2008, and, in the case of corporate 

plans, declines in liability discount rates. Low financial market returns have exacted a heavy toll on funding 

levels, while at the same time benefit costs have continued to rise. The Council recommends that appropriate 

authorities continue their scrutiny of the ways in which low interest rates could adversely affect the risk 

profiles of pension funds and continue to address the funding status of pension funds. A recent notable 

SEC enforcement case against the State of Illinois’s pension funds underscored the importance of greater 

transparency and accuracy in disclosures about risks associated with funding levels of pension funds.

3.2.3 Capital, Liquidity, Resolution

Capital and Liquidity

Capital and liquidity buffers form the most fundamental protection for the broader financial system and 

the economy against unexpected risks or failures of risk management at financial institutions. Considerable 

progress is being made on robust capital and liquidity planning at U.S. financial institutions. The Federal 

Reserve has conducted its Dodd-Frank Act-mandated supervisory stress tests and the 2013 Comprehensive 

Capital Analysis and Review (CCAR) exercise to ensure that the largest U.S. BHCs have sufficient capital and 
17

rigorous, forward-looking capital planning processes to allow these organizations to continue operations 

throughout periods of severe stress. The Council recommends that the Federal Reserve continue its efforts 

to promote forward-looking capital and liquidity planning. The Federal Reserve has proposed enhanced 

prudential standards, including capital and liquidity planning requirements, for the largest domestic BHCs, 

foreign banking organizations (FBOs) with a U.S. banking presence, and nonbank financial companies 

designated by the Council. In June 2012, the federal banking agencies invited public comment on 

proposed regulatory capital rules that, in part, would implement Basel III reforms that seek to improve the 

quantity, quality, and risk sensitivity of regulatory capital. The Council recommends that agencies continue 

coordinating their development of regulations to help ensure enhanced capital planning and robust capital 

for financial institutions. 

On liquidity planning, the Council recommends that supervisors and private sector risk managers closely 

monitor the risks inherent in short-term funding of longer-term assets. While some forms of maturity 

transformation are an integral part of the traditional banking model, such as using retail deposits to fund 

commercial loans, firms should diversify their funding base and place prudent limits on the volume of creditsensitive, short-term liabilities in order to reduce funding vulnerabilities. In October 2012, the SEC proposed 

a rule that would require the largest broker-dealers to perform a liquidity stress test at least monthly and, 

based on the results of that test, maintain liquidity reserves to address potential funding needs during a stress 

event. Furthermore, in July 2012, the NCUA issued a proposed rule on the need for federally insured credit 

unions to have contingency funding plans that clearly set out strategies for addressing liquidity shortfalls in 

emergency situations. Other agencies have also issued additional guidance regarding these issues. The Basel 

III liquidity framework, which the federal banking agencies expect to implement domestically through the 

rulemaking process, supplements the Federal Reserve’s recently proposed enhanced prudential standards 

for liquidity with quantitative measures of an institution’s liquidity position under a short-term period of 

liquidity stress. 

Resolution Plans

Resolution plans and the orderly liquidation authority, in conjunction with enhanced prudential standards, 

are critical elements of Dodd-Frank Act reform. Effective resolution planning for the largest financial 

institutions is an important tool to address the operational and legal complexity of these firms on an ongoing 

basis. All BHCs with total consolidated assets of $50 billion or more and nonbank financial companies 

designated by the Council for supervision by the Federal Reserve are required to develop, maintain, and 

periodically submit resolution plans, also known as living wills, that would facilitate these entities’ resolution 

under the Bankruptcy Code. Additionally, the FDIC requires FDIC-insured depository institutions with assets 

of $50 billion or more to file plans for their orderly resolution under the Federal Deposit Insurance Act.

The overarching goal of these resolution plans is to better prepare firms, supervisors, and resolution 

authorities for a potential firm resolution and to foster sound resolution-related contingency planning. If the 

Federal Reserve and the FDIC jointly determine that a resolution plan is not credible or would not facilitate 

orderly resolution under the Bankruptcy Code, then the company must resubmit the plan with revisions, 

including, if necessary, proposed changes in business operations or corporate structure. If the company fails 

to resubmit a credible plan that would result in orderly resolution under the Bankruptcy Code, the Federal 

Reserve and the FDIC may jointly impose more stringent capital, leverage, or liquidity requirements; 

growth, activities, or operations restrictions; or, after two years and in consultation with the Council, 

divestiture requirements. 

In 2012, 11 financial institutions, including those with nonbank assets greater than $250 billion, submitted 

their initial resolution plans. The Federal Reserve and FDIC are reviewing and analyzing those submissions. 

Annual Report Recommendations
18 2013 FSOC // Annual Report

In 2013, over 100 additional firms are expected to submit their initial resolution plans. Additionally, the 11 

financial firms that submitted initial plans in 2012 will be expected to refine and clarify their submissions in 

2013. The Council recommends that the Federal Reserve and FDIC implement their authority in a manner 

that fosters sound resolution planning and better prepares firms and authorities for a rapid and orderly 

resolution under the Bankruptcy Code.

3.3 Progress on Financial Reform

International coordination of financial regulation and macroprudential surveillance is essential to mitigate 

threats to financial stability by containing regulatory arbitrage and by formulating policies to preempt 

emerging risks to financial stability. Directly, and through its members and member agencies, the Council 

has pursued international financial regulatory coordination to promote regulatory consistency and financial 

system stability, with the aim of supporting sustainable real economic growth. The Council, its members, 

and its member agencies will continue to strengthen coordination of financial regulation both domestically 

and internationally. 

In recent years, the Group of 20 (G-20), a forum of 19 countries plus the European Union (EU), has led 

international economic policy coordination. In 2009, in the midst of the global financial crisis, the G-20 

outlined major pillars of a new international financial regulatory system. This agenda has been advanced by 

the FSB, which has worked closely with international standard-setting bodies and national authorities. Three 

Council member agencies represent the United States at the FSB: the Treasury, the Federal Reserve, and the 

SEC. In developing and implementing the international financial regulatory reform agenda, the Council 

supports the development of policies that promote a level playing field, mitigate regulatory arbitrage, and 

address the treatment of regulatory gaps. 

Assuring that banks are adequately capitalized, U.S. regulators are continuing to make significant progress 

in implementing capital and liquidity standards for large, complex financial institutions through the DoddFrank Act and the Basel III reforms. The Basel III accords, which are currently expected to be fully phased 

in by 2019, will set internationally agreed heightened capital and liquidity requirements. Basel III will also 

ensure far more consistency in the manner by which countries define capital for the purposes of measuring 

risk-weighted assets. The uniform application of these rules by supervisors is as important as the development 

of consistent rules. In 2013, the Council is particularly interested in the Basel Committee on Banking 

Supervision’s (BCBS) study on the consistency of measurement of risk-weighting practices in banking 

and trading portfolios. The results of the study will help regulators to standardize the currently disparate 

risk-weighting practices across jurisdictions. The BCBS’s broader goal of simplifying and improving the 

comparability of regulatory capital requirements for banking firms should remain a top priority.

Strengthening the Regulation of Large, Complex Financial Institutions

The FSB, in consultation with international standard setters, is in various stages of developing methodologies 

to identify financial institutions whose distress or disorderly failure, because of their size, complexity, and 

systemic interconnectedness, would cause significant disruption to the wider financial system and economic 

activity. The FSB, in consultation with IOSCO, plans to present a methodology to determine global 

systemically important nonbank non-insurers by the end of 2013. The FSB has established a comprehensive 

policy framework for global systemically important banks (G-SIBs) that includes: (1) a new international 

standard for resolution regimes; (2) more intensive and effective supervision; (3) requirements for crossborder cooperation, recovery, and resolution planning; and (4) additional loss absorbency for those banks 

determined to be G-SIBs. The FSB, in consultation with the BCBS, designates global systemically important 

financial institutions (G-SIFIs) for heightened supervision, including capital surcharges. Accordingly, 

the ability of G-SIBs to absorb losses will be increased, helping to reduce the probability of failure 
19

and internalizing the negative cross-border externalities not addressed by existing regulatory policies. 

The Council supports the G-SIB policy framework and encourages its consistent implementation 

across jurisdictions. 

The Dodd-Frank Act provides for the application of enhanced prudential standards to BHCs with $50 billion 

or more in total consolidated assets. In addition, the Council has authority to designate nonbank financial 

companies for Federal Reserve supervision and enhanced prudential. The Council currently is in the final 

stages of evaluating an initial set of nonbank financial companies for potential designation—an important 

priority for the Council in 2013. 

Developing a Framework for the Supervision of Large, Global Systemically Important Insurers

The FSB, in consultation with the International Association of Insurance Supervisors (IAIS), is continuing to 

create a new framework for the identification and effective supervision of large, global systemically important 

insurers. In addition, the IAIS is continuing to work on an integrated, multilateral, and multidisciplinary 

framework for the group-wide supervision of internationally active insurance groups (IAIGs), called the 

Common Framework for the Supervision of Internationally Active Insurance Groups, which is expected to 

be adopted by 2018. The Council recommends that FIO, representing the United States, and state insurance 

regulators, through the National Association of Insurance Commissioners (NAIC), continue to play their 

respective roles in international insurance matters.

Developing an International Framework to Resolve Global Financial Institutions 

The international benchmark for resolution regimes is the FSB’s 2011 Key Attributes of Effective Resolution 

Regimes for Financial Institutions. The United States has been working diligently with international 

counterparts to ensure that cross-border recovery and resolution plans are developed for major global 

financial institutions, that international authorities develop criteria to improve the “resolvability” of G-SIFIs, 

and that institution-specific, cross-border resolution cooperation arrangements are negotiated. The Council 

acknowledges that international coordination is particularly important in this area, and the Council 

welcomes the joint policy paper released by the FDIC and the Bank of England (BOE) in December 2012. 

The Council also welcomes the establishment of a joint working group between the European Commission 

and the FDIC to discuss issues related to deposit insurance and the resolution of large banks and systemically 

important financial institutions (SIFIs). In addition, the Council looks forward to the results of the FSB’s first 

peer review of existing resolution regimes led by the FDIC, evaluating FSB jurisdictions and their existing 

resolution regimes using the Key Attributes as a benchmark.3

 The report of this review has recently been 

issued, and provides recommendations for future work by the FSB and its members in support of effective and 

credible resolution regimes for SIFIs. Effective cross-border cooperation will be essential to implementing the 

FDIC’s orderly liquidation authority under Title II of the Dodd-Frank Act.

Increasing the Transparency and Regulation of Over-the-Counter (OTC) Derivatives

The United States, along with Japan, has led the way on implementation of the G-20 leaders’ commitment 

to centralized clearing and exchange trading of standardized derivatives contracts. The G-20 also called 

for the reporting of all derivatives contracts to trade repositories, as well as the application of higher capital 

requirements for non-centrally cleared contracts. While no jurisdiction met the end of 2012 deadline, 

the CFTC has already begun implementing its OTC derivatives rules, including certain registration and 

reporting requirements and limited clearing requirements. In parallel with continued coordination between 

the CFTC and SEC on domestic implementation of derivatives rules, the United States continues to work with 

other jurisdictions to build the internationally cohesive regulatory framework necessary to effectively reform 

this cross-border market. The Council encourages continued development of these reforms, as they are 

essential to increase transparency and to mitigate risk that could arise from the OTC derivatives market. 

Annual Report Recommendations
20 2013 FSOC // Annual Report

Improving the Oversight and Regulation of Nonbank Intermediaries

There is a considerable amount of work in progress to address potential risks in the area of shadow banking, 

a term that is often used to refer to the system of financial intermediaries and activities that conduct maturity, 

credit, and liquidity transformation without access to the Federal Reserve’s and FDIC’s backstops. Given the 

role nonbank financial intermediation played in amplifying the financial crisis, the FSB is developing an 

integrated framework of recommendations to strengthen oversight and regulation of the shadow banking 

system. In the United States, significant steps have already been taken to mitigate these potential risks. These 

steps include reforms to improve the resilience of MMFs, the tri-party repo market, and securitization. The 

Council, through its authority to designate nonbank financial companies for supervision by the Federal 

Reserve and enhanced prudential standards, can expand the regulatory perimeter to certain activities and 

entities in the shadow banking system.

Data Resources and Analytics

The Council continues to recommend that improvement in data standards should be a high priority for 

financial firms as part of their risk management process and for the regulatory community—not just in the 

United States, but globally. The development and forthcoming implementation of the Legal Entity Identifier 

(LEI) is a valuable first step, one that will help to precisely identify the parties to particular financial 

transactions. It will also enable a more accurate and consistent understanding of legal entity hierarchies, 

which is essential for effective counterparty risk management. The Council recommends that the OFR 

continue to work with the Council’s member agencies to promote the use of, and establish where necessary, 

data standards for identification of legal entities, financial products, and transactions, and to improve the 

quality of and facilitate the access to standardized, aggregate data by the regulators. Finally, the Council 

recommends that cross-border exchange of supervisory data among supervisors, regulators, and financial 

stability authorities be facilitated in a manner that safeguards the confidentiality and privilege of such 

information. This will help provide comprehensive oversight of financial institutions and markets with a 

global reach and improve coordination on financial stability.

Since the 2007 to 2008 financial crisis, the United States has worked effectively through the G-20 and FSB 

to develop and implement a new global financial regulatory architecture designed to enable a more stable, 

robust, and transparent financial system. Considerable progress has already been made, but much more 

work remains to be done. The Council will continue to pursue a reform agenda, both domestically and 

internationally, to support these goals.
Macroeconomic Environment 21

This section provides an overview of 

macroeconomic developments since the start of 

2012, by reviewing (1) U.S. economic activity; 

(2) nonfinancial balance sheet developments; 

(3) government finance; and (4) the external 

economic environment. Furthermore, the 

macroeconomic and financial market impacts 

of the fiscal cliff and debt ceiling are discussed. 

4.1 U.S. Economic Activity

4.1.1 Real Gross Domestic Product

Economic growth was moderate in 2012, with 

real GDP expanding 1.7 percent (Chart 4.1.1). 

Concern about the future pace of the economic 

recovery and the sustainability of fiscal policy 

likely restrained the demand of businesses 

and households. Tighter underwriting 

standards in some sectors, especially in home 

mortgage lending, together with the overhang 

of foreclosed and underwater mortgages, 

weighed on the recovery of the housing 

sector and consumer spending. Reductions 

in government spending negatively affected 

domestic demand, and the fiscal and financial 

difficulties in Europe weighed on external 

demand. Economic activity was held down in 

the second half of the year by some temporary 

factors including a severe drought in much 

of the country and the disruptions caused by 

Superstorm Sandy. 

Consumption and Residential Investment

Real personal consumption expenditures 

(PCE) increased at a moderate pace of about 

2 percent in 2012 (Chart 4.1.2), supported 

partly by growth in household net worth and 

some improvement in labor market conditions 

and consumer sentiment. However, consumer 

sentiment remains below pre-crisis norms, 

weighed down by concern about the economic 

environment and limited access to credit for 

many households. Growth in real disposable 

income was modest over most of the year, 

4 Macroeconomic Environment

Chart 4.1.1 Change in Real Gross Domestic Product

-4 

-2 

0 

2 

4 

-4 

-2 

0 

2 

4 

2006 2007 2008 2009 2010 2011 2012 

Source: BEA, Haver Analytics 

Percent As Of: 2012 Q4 

4.1.1 Change in Real Gross Domestic Product 

Note: Annual changes are Q4/Q4. 

Percent 

Chart 4.1.2 Change in Real Personal Consumption Expenditures

-4 

-2 

0 

2 

4 

-4 

-2 

0 

2 

4 

2006 2007 2008 2009 2010 2011 2012 

Source: BEA, Haver Analytics 

Percent As Of: 2012 Q4 

4.1.2 Change in Real Personal Consumption Expenditures 

Note: Annual changes are Q4/Q4. 

Percent 
22 2013 FSOC / / Annual Report

before jumping in the fourth quarter, when 

a large number of firms issued special or 

accelerated dividends and employee bonuses 

in anticipation of higher marginal tax rates on 

high-income households in 2013.

Housing activity continued to show signs of 

gradual improvement last year, but remained 

weak relative to longer-run norms. Housing 

starts (Chart 4.1.3), sales of new and existing 

homes, and home prices all increased, spurred 

in part by historically low mortgage rates. 

However, tighter underwriting standards on 

mortgages, especially for individuals with lower 

credit scores (see Section 4.2.3), low or negative 

levels of home equity among many households, 

and elevated unemployment continue to 

restrain the demand for housing. Moreover, the 

shadow inventory of homes held off the market 

due to vacancy or reduced homeowner’s equity 

remained elevated.

Business Fixed Investment

Real business fixed investment (BFI) rose at a 

moderate pace in 2012, following rapid growth 

in 2010 and 2011, while BFI as a share of GDP 

remained below its pre-recession level. Business 

investment in equipment and software (E&S) 

decelerated in 2012 as the pent-up demand 

for investment projects deferred during the 

recession has diminished since the earlier stages 

of the recovery. E&S investment is likely further 

restrained by concerns about the pace of global 

economic growth. Meanwhile, investment in 

nonresidential structures remained subdued, 

as high vacancy rates, low commercial real 

estate prices, and tighter credit for builders 

continued to hamper growth. However, there 

were some gradual signs of improvement in 

the commercial real estate (CRE) sector (see 

Section 5.1.4).

Chart 4.1.3 Private Housing Starts

0.0 

0.1 

0.2 

0.3 

0.4 

0.5 

0.0 

0.5 

1.0 

1.5 

2.0 

2002 2004 2006 2008 2010 2012 

Source: Census Bureau, 

Haver Analytics 

Millions of Units As Of: Feb-2013 

4.1.3 Private Housing Starts 

Note: Seasonally adjusted at an annualized 

rate. Gray bar signifies NBER recession. 

Millions of Units 

Multifamily 

(right axis) 

Single-family 

(left axis) 
Macroeconomic Environment 23

Government Purchases

On net, real government expenditures at 

the federal, state, and local levels continued 

to contract in 2012. Real state and local 

government purchases fell at an annual rate 

of about 1.5 percent in the first half of the 

year and were about flat in the second half, 

held down by ongoing budgetary pressures, 

though those pressures appear to have lessened 

since earlier in the recovery as state and local 

tax revenues have increased. Real federal 

government purchases fell almost 3 percent 

during the year, reflecting large declines in 

federal defense spending at the end of the 

year and the wind down of the fiscal stimulus 

provided during the recession.

Imports and Exports

Real exports of goods and services rose very 

modestly last year, held down by a fall off in 

demand from the euro area. Imports of goods 

and services were about flat, consistent with the 

pace of final aggregate demand and the rise 

in the dollar. Altogether, net exports made a 

very small but positive contribution to real GDP 

growth last year. 

4.1.2 The Labor Market

The labor market improved slowly in 2012, but 

remains weak. Nonfarm payroll employment 

increased at an average monthly rate of about 

159,000 jobs in the 12 months ending March 

2013 (Chart 4.1.4). The private sector added 

166,000 jobs per month, while government 

payrolls dropped at an average rate of about 

6,000 per month.

These job gains helped reduce the 

unemployment rate from 8.5 percent at the 

end of 2011 to 7.6 percent in March 2013 

(Chart 4.1.5). However, the unemployment 

rate continues to be much higher than it was 

before the crisis, and long-term unemployment 

remains elevated. In March 2013, about 40 

percent of unemployed workers had been 

out of work for more than six months (Chart 

4.1.6). Meanwhile, labor force participation 

edged down 0.5 percentage point in the 12 

months ending March 2013, and has fallen 3.1 

Chart 4.1.4 Net Change in Nonfarm Payroll Employment

-1000 

-800 

-600 

-400 

-200 

0 

200 

400 

600 

-1000 

-800 

-600 

-400 

-200 

0 

200 

400 

600 

2006 2007 2008 2009 2010 2011 2012 2013 

Source: BLS, Haver Analytics 

Thousands of Jobs As Of: Mar-2013 

4.1.4 Net Change in Nonfarm Payroll Employment 

Note: Gray bar signifies NBER recession. 

Thousands of Jobs 

Monthly Change 

3-Month Moving 

Average 

Chart 4.1.5 Civilian Unemployment Rate

3 

6 

9 

12 

3 

6 

9 

12 

1982 1987 1992 1997 2002 2007 2012 

Source: BLS, Haver Analytics 

Percent As Of: Mar-2013 

4.1.5 Civilian Unemployment Rate 

Note: Gray bars signify NBER recessions. 

Percent 

Chart 4.1.6 Long-Term Unemployment

0 

10 

20 

30 

40 

50 

0 

10 

20 

30 

40 

50 

1982 1987 1992 1997 2002 2007 2012 

Source: BLS, 

Haver Analytics 

Percent As Of: Mar-2013 

4.1.6 Long-Term Unemployment 

Note: Long-term unemployment as a 

percent of total unemployment. Gray 

bars signify NBER recessions. 

Percent 
24 2013 FSOC / / Annual Report

percentage points since the beginning 

of 2007 (Chart 4.1.7), in part due to ongoing 

demographic change as the baby boomers 

retire. Wage growth for those employed 

remains subdued. 

The high rate of unemployment in the current 

economic expansion has raised concerns that 

the level of structural unemployment has risen 

over the past few years in the United States. 

However, recent research suggests that the rise 

in structural unemployment is modest.4

4.2 Nonfinancial Balance Sheets

4.2.1 Nonfinancial Corporate Sector

Corporate balance sheets remained strong 

in 2012. The ratio of liquid assets to total 

assets of the sector was near its highest level 

in more than 20 years, and debt has declined 

significantly relative to total assets over the 

past few years (Chart 4.2.1). Cash flows were 

solid, helping to support further increases in 

the equity market valuations of nonfinancial 

corporations and allowing them to boost capital 

through retained earnings (see Section 5.1.3 

for equity market valuations).

Robust credit quality and corporate profits, 

as well as the low level of interest rates and 

declining spreads on corporate debt, supported 

substantial gross borrowing in corporate 

bond markets by nonfinancial firms (see 

Section 5.1.1). Total outstanding loans to the 

nonfinancial corporate sector, which includes 

loans from bank and nonbank sources, 

increased modestly in 2012. Commercial 

and industrial (C&I) loans funded by banks 

continued to rise, and over the course of 2012, 

respondents to the Federal Reserve’s Senior 

Loan Officer Opinion Survey on Bank Lending 

Practices (SLOOS) reported less stringent 

underwriting standards and increased demand 

for C&I loans to large and medium-sized firms 

(Chart 4.2.2). 

Chart 4.1.7 Labor Force Participation Rate

63 

64 

65 

66 

67 

68 

63 

64 

65 

66 

67 

68 

1982 1987 1992 1997 2002 2007 2012 

Source: BLS, Haver Analytics 

Percent As Of: Mar-2013 

4.1.7 Labor Force Participation Rate 

Note: Gray bars signify NBER recessions. 

Percent 

Chart 4.2.1 Financial Ratios for Nonfinancial Corporations

4.5 

5.0 

5.5 

6.0 

6.5 

22 

24 

26 

28 

30 

2000 2003 2006 2009 2012 

Source: Flow of Funds, 

Haver Analytics 

Percent As Of: 2012 Q4 

4.2.1 Financial Ratios for Nonfinancial Corporations 

Note: Gray bars signify NBER recessions. 

Percent 

Debt to Total 

Assets (left axis) 

Liquid Assets to 

Total Assets 

(right axis) 

Chart 4.2.2 Bank Business Lending Standards and Demand

-100 

-50 

0 

50 

100 

-100 

-50 

0 

50 

100 

2000 2002 2004 2006 2008 2010 2012 

Source: SLOOS, 

Haver Analytics 

Percent As Of: Jan-2013 

4.2.2 Bank Business Lending Standards and Demand 

Note: Gray bars signify NBER recessions. Data 

includes firms with annual sales of $50 million or more. 

Percent 

Reporting Stronger 

Demand from Large and 

Medium-Sized Firms 

Reporting Tighter 

Standards for Large and 

Medium-Sized Firms 
Macroeconomic Environment 25

Available indicators of corporate credit quality 

point to further improvement. The default rate 

on nonfinancial corporate bonds fluctuated in 

2012 at low levels by historical standards (Chart 

4.2.3), and delinquency rates on C&I loans 

declined further last year (Chart 4.2.4). As will 

be discussed in Section 7.4, other indicators, 

such as the prevalence of more relaxed 

underwriting and covenants in recent leveraged 

lending originations, suggest that investors and 

lenders have begun to take on more risk.

4.2.2 Noncorporate Business Sector

Compared to conditions in the nonfinancial 

corporate sector, conditions in the nonfinancial 

noncorporate business sector have improved 

at a much slower pace. This sector, composed 

primarily of small businesses, accounts for 

slightly less than one-third of total nonfinancial 

business debt outstanding. However, since small 

businesses generally have access to a narrower 

range of financing options than corporations, 

the majority of small business debt is composed 

of bank loans, usually tied to the personal credit 

score of the owners or secured by real estate. 

Therefore, developments in the noncorporate 

business sector are especially important for the 

health of many banks’ balance sheets, especially 

at smaller banks.

Real estate represents the majority of assets 

owned by noncorporate businesses (Chart 

4.2.5), and since the beginning of the financial 

crisis, lower real estate collateral values and 

stress in the banking sector have constrained 

credit availability to the sector. However, 

there are signs that credit conditions for 

small businesses are gradually improving. 

Net borrowing by nonfinancial noncorporate 

businesses, which had dropped dramatically 

through 2010, was slightly positive in 2012 

(Chart 4.2.6). Small loans to businesses on 

bank balance sheets grew modestly in 2012, 

but much of this growth, concentrated at the 

end of the year, may have been transitory in 

nature due to an increase in bonuses and 

other special distributions before higher tax 

rates took effect for some households in 2013. 

Respondents to the SLOOS noted some easing 

Chart 4.2.3 Nonfinancial Corporate Bond Default Rate 4.2.3 Nonfinancial Corporate Bond Default Rate 

Percent Percent 

Source: MoodyĀs 

Investors Service 

Note: Default rates are annual rates calculated on a 

quarterly basis. Gray bars signify NBER recessions. 

As Of: 2012 Q4 

Chart 4.2.4 Noncurrent Commercial and Industrial Loans

0 

1 

2 

3 

4 

0 

1 

2 

3 

4 

2000 2002 2004 2006 2008 2010 2012 

Source: FDIC, Haver Analytics 

Percent As Of: 2012 Q4 

4.2.4 Noncurrent Commercial and Industrial Loans 

Note: Percent of total C&I loans. 

Gray bars signify NBER recessions. 

Percent 

Chart 4.2.5 Noncorporate Assets

1990 1994 1998 2002 2006 2010 

Source: Flow of Funds, Haver Analytics 

Share of Total Assets As Of: 2012 Q4 

4.2.5 Noncorporate Assets 

Share of Total Assets

Other Assets 

Cash and Securities 

Nonresidential Real Estate 

Accounts Receivable 

Residential Real Estate 

0.0

0.2

0.4

0.6 

0.8

1.0

0.0

0.2

0.4

0.6

0.8

1.0
26 2013 FSOC / / Annual Report

on loan standards and spreads, and stronger 

demand for C&I loans last year (Chart 4.2.7). 

The fraction of firms surveyed by the National 

Federation of Independent Businesses (NFIB) 

which reported that credit had become more 

difficult to obtain also trended down in recent 

years, despite an uptick at the end of 2012 

(Chart 4.2.8), and less than 5 percent 

of respondents reported that financing was 

their top problem. That said, the fraction 

of firms that reported difficulty in obtaining 

credit remained elevated relative to the 

pre-crisis period.

4.2.3 Household Sector

Household debt increased sharply in the years 

leading up to the financial crisis, reaching a 

high of 130 percent of disposable personal 

income in the third quarter of 2007. Since 

then, households have been deleveraging. By 

the end of last year, the ratio of household debt 

to disposable income declined to its 2003 level 

(Chart 4.2.9), largely due to lower mortgage 

debt outstanding. 

Continuing reductions in home mortgages, 

which account for about three-fourths of 

outstanding household debt, more than 

offset an increase in consumer credit last year 

(Chart 4.2.10). The reduction in outstanding 

mortgage debt reflects a low volume of 

mortgage originations for new home purchases, 

household efforts to pay down their existing 

debt, and the effects of foreclosures and short 

sales. Despite a pick-up in housing activity 

and low mortgage rates, the volume of new 

mortgage originations remained subdued, 

largely due to tighter underwriting standards, 

including lower loan-to-value ratios, as will 

be discussed in Section 5.1.4. In particular, 

reduced origination capacity and continued 

uncertainty over mortgage put-backs to lenders 

contributed to reduced access to mortgage 

credit. More conservative underwriting 

standards and depressed home values 

have also resulted in a low volume of 

cash-out refinancings. 

Chart 4.2.6 Net Borrowing by Nonfinancial Noncorporate 

Businesses

-400 

-200 

0 

200 

400 

600 

-400 

-200 

0 

200 

400 

600 

2000 2002 2004 2006 2008 2010 2012 

Source: Flow of Funds, 

Haver Analytics 

Billions of US$ As Of: 2012 Q4 

4.2.6 Net Borrowing by Nonfinancial Noncorporate Businesses 

Note: Seasonally adjusted at an annual rate. 

Gray bars signify NBER recessions. 

Billions of US$ 

Chart 4.2.7 Bank Business Lending Standards and Demand

-100 

-50 

0 

50 

100 

-100 

-50 

0 

50 

100 

2000 2002 2004 2006 2008 2010 2012 

Source: SLOOS, 

Haver Analytics 

Percent As Of: Jan-2013 

4.2.7 Bank Business Lending Standards and Demand 

Note: Gray bars signify NBER recessions. Data includes 

firms with annual sales of less than $50 million. 

Percent 

Reporting Stronger 

Demand from Small Firms 

Reporting Tighter 

Standards for Small Firms 

Chart 4.2.8 Small Businesses’ Difficulty Obtaining Credit

0 

4 

8 

12 

16 

0 

4 

8 

12 

16 

2000 2002 2004 2006 2008 2010 2012 

Source: NFIB, Haver Analytics 

Percent As Of: 2012 Q4 

4.2.8 Small Businesses' Difficulty Obtaining Credit 

Note: Net Percent = small businesses reporting credit harder to get than three months prior minus those 

reporting credit easier to get than three months prior. For the population borrowing at least once every 

three months. Depicts quarterly averages of monthly data. Gray bars signify NBER recessions. 

Percent 

Net Percent of Small 

Businesses Reporting Credit 

Harder to Get than Three 

Months Prior 
Macroeconomic Environment 27

Household deleveraging, low interest rates, 

and modest increases in employment and 

income reduced the household debt service 

ratio (the ratio of debt service payments to 

disposable personal income) to a historic low 

(Chart 4.2.11). Reduced debt burdens allowed 

households to slowly but steadily become 

more current on their debts. Since 2009, the 

percentage of delinquent household debts has 

decreased from 11.9 percent to 8.6 percent, but 

remains significantly above pre-crisis levels; 

however, the share of seriously delinquent 

debts remains stubbornly high (Chart 4.2.12). 

While aggregate measures of the debt burden 

improved, many households continue to 

struggle to meet their financial obligations and 

many are still underwater on their mortgages.

Looking at the entire balance sheet of the 

sector, aggregate household net worth (the 

difference between assets and debts) rose 

about $5.5 trillion in 2012, to an estimated 

$66.1 trillion (Chart 4.2.13), and the ratio of 

household net worth to disposable personal 

income increased over the year. Price increases 

of corporate equities, and to a lesser extent 

of homes, accounted for most of the increase 

in net worth. Active saving, and the declines 

in outstanding debt discussed above, also 

contributed in smaller part. Due to reductions 

in mortgage debt and increases in home prices, 

the share of owners’ equity in housing started 

to move up last year, although it still remains 

very low: roughly 13 percentage points below its 

1990 to 2005 average (Chart 4.2.14). However, 

renters and lower-income households with 

smaller exposures to the stock market have not 

benefitted much from the recovery in equity 

and home prices over the past few years. 

Unlike mortgage debt, non-mortgage consumer 

credit, which accounts for slightly more than 

20 percent of total household debt, has been 

growing over the past two years. During 2012, 

non-mortgage consumer credit outstanding 

increased nearly 6 percent to $2.8 trillion. 

Non-revolving credit, which consists primarily 

of auto loans and student loans and is over twothirds of total consumer credit, accounted for 

Chart 4.2.9 Household Debt as a Percent of Disposable 

4.2.9 Household Debt as a Percent of Disposable Personal Income Personal Income

Percent Percent 

Source: BEA, Flow of Funds, 

Haver Analytics 

As Of: 2012 Q4 

Note: Other Household Debt includes 

debts of both households and nonprofits. 

Chart 4.2.10 Private Nonfinancial Debt

0 

50 

100 

150 

200 

0 

50 

100 

150 

200 

1992 1996 2000 2004 2008 2012 

Source: BEA, Flow of Funds, 

Haver Analytics 

Percent of Nominal GDP As Of: 2012 Q4 

4.2.10 Private Nonfinancial Debt 

Percent of Nominal GDP 

Consumer and Other Household Debt 

Nonfinancial Noncorporate Debt 

Nonfinancial Corporate Debt 

Mortgages 

Note: Other Household Debt includes 

debts of both households and nonprofits. 

Chart 4.2.11 Household Debt Service Ratio

10 

11

12 

13 

14 

15 

10 

11

12 

13 

14 

15 

1980 1985 1990 1995 2000 2005 2010 

Source: Federal Reserve, 

Haver Analytics 

Percent As Of: 2012 Q4 

4.2.11 Household Debt Service Ratio 

Note: Ratio of debt service payments to disposable 

personal income. Seasonally adjusted. Gray bars 

signify NBER recessions. 

Percent 
28 2013 FSOC / / Annual Report

most of this increase. Federal student loans are 

the dominant source of student loans, which 

continue to expand at a rapid pace (Chart 

4.2.15). Federal student loans are administered 

based on statutory eligibility criteria, and 

origination decisions are generally not based 

on a borrower’s credit characteristics. Interest 

rates on new federal student loan issuance are 

currently fixed in statute and generally range 

from 3.4 percent to 7.9 percent, depending on 

the federal loan program for which the student 

or their parents are eligible. Federal student 

loans currently comprise over 90 percent of 

annual issuance and approximately 85 percent 

of the outstanding portfolio of student loans.

Growth in auto loans also picked up last year, 

reflecting widespread availability of credit and 

rising consumer demand for motor vehicles. 

About $90 billion of auto loan asset-backed 

securities (ABS) were issued in 2012—the 

most since 2006. Subprime auto loan ABS 

issuance reemerged, although reportedly 

with stronger credit support than in most 

pre-crisis structures. 

Indicators of changes in the demand for 

credit were mixed last year. Respondents to 

the SLOOS reported stronger demand for 

credit by consumers, on net, especially for auto 

loans. However, credit applications decreased 

slightly over the past year and remained largely 

subdued relative to the pre-crisis period 

(Chart 4.2.16). 

Delinquency rates for most types of consumer 

credit continued to decline from the high rates 

experienced during the crisis. In particular, 

the increases in delinquency rates on credit 

card and auto loans during the crisis were 

largely driven by a sharp rise in the delinquency 

rate of subprime borrowers, which remains 

significantly above historical levels. Lower 

delinquency rates for revolving credit and 

auto loans in 2012 likely reflected, in part, 

the composition shift toward higher-quality 

borrowers. The delinquency rates on these 

loans to super prime and prime consumers were 

Chart 4.2.12 Share of Household Debt by Delinquency Status

0 

3 

6 

9 

12 

15 

0 

3 

6 

9 

12 

15 

2003 2006 2009 2012 

Source: FRBNY Consumer Credit 

Panel, Equifax, Haver Analytics 

Percent As Of: 2012 Q4 

4.2.12 Share of Household Debt by Delinquency Status 

Note: Derogatory loans are loans for which 

there are reports of a repossession, 

charge off to bad debt, or foreclosure. 

Percent 

Derogatory 

120+ Days Late 

90 Days Late 

60 Days Late 

30 Days Late 

Chart 4.2.13 Household and Nonprofit Balance Sheets

-40 

-20 

0 

20 

40 

60 

80 

100 

-40 

-20 

0 

20 

40 

60 

80 

100 

2000 2002 2004 2006 2008 2010 2012 

Source: Flow of 

Funds, Haver 

Analytics 

Trillions of US$ As Of: 2012 Q4 

4.2.13 Household and Nonprofit Balance Sheets 

Note: *Noncorporate equities, mutual fund shares, security credit, life insurance and pension 

fund reserves, tangible assets excluding real estate, miscellaneous assets. **Security credit, 

trade payables, unpaid life insurance premiums, other credit market instruments. 

Trillions of US$ 

Other Assets* 

Equities 

Credit Market Instruments 

Cash Instruments 

Real Estate 

Mortgages 

Consumer Credit 

Other Debt** 

Net Worth 

Chart 4.2.14 Share of Owners’ Equity in Household Real Estate

30 

40 

50 

60 

70 

30 

40 

50 

60 

70 

2000 2002 2004 2006 2008 2010 2012 

Source: Flow of Funds, 

Haver Analytics 

Percent As Of: 2012 Q4 

4.2.14 Share of Owners' Equity in Household Real Estate 

Note: Gray bars signify NBER recessions. 

Percent 

1990-2005 

Average 
Macroeconomic Environment 29

more stable through the crisis and are currently 

near their historical averages.

While households are becoming more current 

on most types of debt, the propensity for 

student loans to become delinquent increased 

in 2012, with 11.7 percent of student loans more 

than 90 days delinquent at the end of the year 

(Chart 4.2.17). Large and growing student debt 

burdens and a poor job market have pushed 

many borrowers into delinquency, especially 

among younger borrowers. About half of all 

loans to borrowers under 30 years old are in 

periods of payment deferral or forbearance 

and cannot become delinquent, but 35 percent 

of borrowers under 30 who are required to 

make principal-reducing payments are more 

than 90 days delinquent on their student loans. 

However, risk to lenders is mitigated by the 

fact that both federal and private student loans 

are difficult to discharge in bankruptcy, and 

that the federal government has extraordinary 

collection authorities. Federal student loans 

also have a number of flexible payment terms 

that act as loan modifications for distressed 

borrowers. High student debt burdens may 

impact demand for housing, as young 

borrowers may be less able to access mortgage 

credit. Student debt levels may also lead to 

dampened consumption.

Chart 4.2.15 Components of Consumer Credit

0 

200 

400 

600 

800 

1000 

0 

200 

400 

600 

800 

1000 

2003 2006 2009 2012 

Source: FRBNY Consumer Credit 

Panel, Equifax, Haver Analytics 

Billions of US$ As Of: 2012 Q4 

4.2.15 Components of Consumer Credit 

Note: Gray bar signifies 

NBER recession. 

Billions of US$ 

Credit Card Debt 

Auto Loans 

Student Loans 

Other Household 

Debt 

Chart 4.2.16 Applications for Credit

100 

150 

200 

250 

300 

100 

150 

200 

250 

300 

2000 2002 2004 2006 2008 2010 2012 

Source: FRBNY Consumer Credit 

Panel, Equifax, Haver Analytics 

Millions of Inquiries As Of: 2012 Q4 

4.2.16 Applications for Credit 

Note: Number of Equifax inquiries within 6 

months. Gray bars signify NBER recessions. 

Millions of Inquiries 

Chart 4.2.17 90+ Day Delinquency Rate by Loan Type

0 

3 

6 

9 

12 

15 

0 

3 

6 

9 

12 

15 

2003 2006 2009 2012 

Source: FRBNY Consumer Credit 

Panel, Equifax, Haver Analytics 

Percent As Of: 2012 Q4 

4.2.17 90+ Day Delinquency Rate by Loan Type 

Note: Gray bar signifies NBER recession. Student loan 

delinquency rates in 2012 Q3 are inflated by the reposting 

of a large number of delinquent loans by a single servicer. 

Percent 

Mortgage 

Loans 

HELOC Auto Loans 

Credit Card Loans 

Student Loans 
30 2013 FSOC / / Annual Report

4.3 Government Finance

4.3.1 Federal Government

The deficit in the federal unified budget 

widened significantly during the recession 

and has since gradually narrowed. In the 2012 

fiscal year, the deficit was 7 percent of nominal 

GDP—1.7 percentage points lower than in 2011 

but substantially above the average value of 1.3 

percent of GDP during the pre-crisis fiscal years 

of 2000 to 2007 (Chart 4.3.1). This appreciable 

increase in the deficit mostly reflects the usual 

cyclical response of revenues and spending to a 

weak economy, as well as the fiscal actions taken 

to ease the effects of the recession and aid 

the recovery. 

The budget outlook over the medium term is 

subject to considerable uncertainty with respect 

to both the performance of the economy 

and the path of future fiscal policy. In the 

Congressional Budget Office’s (CBO) February 

2013 baseline projection, which assumes 

current laws generally remain unchanged, the 

deficit shrinks appreciably over the next several 

years. The deficit is then forecasted to drift up 

through the end of the projection in 2023, as 

federal health care and entitlement spending 

increase, along with the number of retirees. 

Consistent with this projection for the deficit, 

federal debt held by the public is expected to 

move in a fairly narrow range, hovering around 

75 percent of GDP through 2023 (Chart 4.3.2).

Rating agencies’ assessments of Treasury 

debt are unchanged since late 2011. Moody’s 

and Fitch give U.S. sovereign debt their top 

ratings, while Standard & Poor’s (S&P) issued 

a one-notch downgrade in mid-2011. All three 

ratings agencies have negative outlooks on U.S. 

sovereign debt. Demand for Treasury securities 

appears well maintained, as market participants 

continue to purchase U.S. debt for its relative 

safety and liquidity. Bid-to-cover ratios at 

auctions of Treasury securities remain at the 

top end of historical ranges, and indicators of 

foreign participation have remained on trend 

with recent years. 

Chart 4.3.1 Federal Unified Budget Surplus/Deficit

-12 

-8 

-4 

0 

4 

-12 

-8 

-4 

0 

4 

2000 2004 2008 2012 2016 2020 

Source: CBO, 

Haver Analytics 

Percent of GDP As Of: Feb-2013 

4.3.1 Federal Unified Budget Surplus/Deficit 

Note: Negative values denote a deficit. Data for 

fiscal years. Years after 2012 are projected. 

Percent of GDP 

CBO Baseline 

Projection 

Chart 4.3.2 Federal Debt Held by the Public as a Percent of GDP

0 

30 

60 

90 

120 

150 

0 

30 

60 

90 

120 

150 

1940 1950 1960 1970 1980 1990 2000 2010 2020 

Source: CBO, Haver Analytics 

Percent of GDP As Of: Feb-2013 

4.3.2 Federal Debt Held by the Public as a Percent of GDP 

Note: Data for fiscal years. 

Years after 2012 are projected. 

Percent of GDP 

CBO Baseline 

Projection 
Macroeconomic Environment 31

Despite the sizable increase in public debt 

outstanding, net interest costs have only 

amounted to about 1.5 percent of GDP in recent 

years, in line with their average over the past 

decade, but considerably lower than during 

the 1990s, when net interest costs were about 3 

percent of GDP (Chart 4.3.3). Historically low 

interest rates have allowed net interest costs to 

decline relative to GDP even as outstanding 

federal debt grew rapidly. The average maturity 

of public debt outstanding has risen sharply 

since late 2008 and is close to its 30-year 

average, although the Federal Reserve has 

taken on an increasing amount of longer-term 

debt since the initiation of its Treasury 

Large-Scale Asset Purchase programs 

(LSAPs) in March 2009. 

The economic and financial market impacts 

of the fiscal cliff and debt ceiling are discussed 

in Box A.

Chart 4.3.3 Interest Outlays and Average Maturity 

of U.S. Public Debt

40 

44 

48 

52 

56 

60 

64 

68 

72 

1.0 

1.4 

1.8 

2.2 

2.6 

3.0 

3.4 

1981 1986 1991 1996 2001 2006 2011 

Source: BEA, OMB, 

Haver Analytics 

Percent of GDP As Of: 2012 Q4 

4.3.3 Interest Outlays and Average Maturity of U.S. Public Debt 

Note: Gray bars signify NBER recessions. 

Months 

Average Maturity of 

Outstanding Debt 

(right axis) 

Interest Outlays 

(left axis) 
32 2013 FSOC / / Annual Report

BOX A: MACROECONOMIC AND FINANCIAL MARKET IMPACTS OF THE FISCAL 

CLIFF AND DEBT CEILING

Last year, a series of automatic tax increases and 

spending cuts—referred to as the fiscal cliff—were set 

to take effect at the start of 2013; it is likely that the 

magnitude of this fiscal retrenchment would have been 

sufficient to send the economy into recession. Specifically, 

income tax rate reductions enacted in 2001 and 2003, 

the payroll tax cut authorized in late 2010, extended 

unemployment benefits, and a number of other tax 

provisions were all scheduled to expire on December 31, 

2012. In addition, the Budget Control Act of 2011 put in 

place $85 billion in across-the-board spending cuts to the 

federal budget for fiscal year 2013, effective January 2, 

2013. Taken together, the CBO estimated that the fiscal 

tightening resulting from these policies was close to $500 

billion in fiscal year 2013, or roughly 3.25 percent of GDP. 

Complicating matters, the statutory debt ceiling was 

reached on December 31, 2012, although extraordinary 

measures authorized by law were available to postpone 

the date that the United States would otherwise default 

on its obligations by about two months.5

 

Last-minute legislation mitigated the full impact of the 

fiscal cliff; the passage of the American Taxpayer Relief 

Act of 2012 (ATRA) on January 1, 2013, extended existing 

tax rates for the majority of taxpayers while raising rates 

on the highest earners. ATRA also delayed the federal 

budget cuts until March 1. Separately in February, 

legislation suspended the federal debt ceiling through 

May 18. Because the public and financial markets largely 

anticipated the emergence of similar policy solutions, the 

observable effects of these fiscal developments on the 

economy and financial markets have so far been minimal; 

however uncertainty about the resolution of budget cuts 

and the debt ceiling remains.

The observable economic impact of the fiscal cliff 

negotiations was limited. The average pace of growth 

of real, seasonally adjusted personal consumption 

expenditures in the second half of the year was roughly 

unchanged from the first half, suggesting households did 

not significantly adjust their spending habits in advance 

of the fiscal cliff. Business investment in E&S was also 

roughly unchanged over 2012. However, increased tax 

rates on higher-income households may have accelerated 

some economic decisions. For example, corporate 

dividend payments increased 20 percent in the fourth 

quarter, likely in an effort to bring forward tax liabilities 

before higher rates became effective in 2013.

The consequences of failing to increase the debt ceiling 

were generally seen by financial markets as more 

immediately serious than the effects of the fiscal cliff, 

largely because the effects of the fiscal cliff would accrue 

over time whereas the inability of the Treasury to borrow 

after extraordinary measures were exhausted would be 

felt in markets immediately. Moreover, a failure to increase 

the debt ceiling would have called into question the U.S. 

government’s ability to honor its existing obligations.

Market reaction to the political uncertainty surrounding 

the debt ceiling was more sanguine in 2012 than during 

the previous episode in the spring and summer of 2011. 

At that time, an S&P downgrade of the U.S. sovereign 

credit rating in the context of the escalating European 

debt crisis caused substantial market impacts: risk assets 

sold off dramatically, while Treasury securities rallied in a 

flight-to-quality trade (Chart A.1). By contrast, in the more 

recent episode in 2012, the movements in Treasury yields 

and credit spreads were not nearly as dramatic, in part 

because the debt ceiling was suspended well before the 

Treasury had exhausted its extraordinary measures. 

Chart A.1 10-Year Treasury Yield and Corporate 

Bond Spreads

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

4.0 

0 

50 

100 

150 

200 

250 

300 

Mar:11 Jul:11 Nov:11 Mar:12 Jul:12 Nov:12 Mar:13 

A.1 10-Year Treasury Yield and Corporate Bond Spreads 

Basis Points Percent 

Source: U.S. Department 

of Treasury, Barclays 

As Of: 25-Mar-2013 

U.S. Corporate 

Investment Grade - OAS 

(left axis) 

Treasury 10Y Yield 

(right axis) 

Debt ceiling 

increased 

Debt ceiling 

temporarily suspended 

Note: Debt ceiling increased on 2-Aug-2011 

and temporarily suspended on 4-Feb-2013. 
Macroeconomic Environment 33

Nevertheless, asset prices reflected a small probability 

that Congress might not raise the debt ceiling before 

the Treasury’s extraordinary measures were exhausted. 

Prices on Treasury bills perceived to be at risk for 

extension or missed payments declined relative to other 

Treasury bills. Some market participants avoided these 

specific securities in the weeks leading up to the debt 

ceiling deal in the House—a similar dynamic took place in 

July 2011. These movements gave clear indications that 

segments of the market were concerned about the debt 

ceiling, although the price action was relatively muted.

The approach of the fiscal cliff also had a transient effect 

on financial markets. During the last week in December, 

the implied volatility on S&P 500 futures contracts (the 

VIX) spiked to a level not reached since the first half 

of the year, and the prices of safe haven assets rose, 

including longer-dated Treasury securities and agency 

mortgage-backed securities (MBS) (Chart A.2). Over 

three trading days surrounding passage of the ATRA 

on January 1, 2013, the S&P 500 rose 4 percent and 

the yield on 10-year Treasury securities jumped 21 

basis points, as the threat of widespread tax increases 

was averted.

Chart A.2 10-Year Treasury Yield and Market Volatility

1.0 

1.3 

1.5 

1.8 

2.0 

2.3 

2.5 

10 

15 

20 

25 

30 

Jan:12 Apr:12 Jul:12 Oct:12 Jan:13 

A.2 10-Year Treasury Yield and Market Volatility 

Percent Percent 

Source: U.S. Department of Treasury, Capital IQ 

As Of: 25-Mar-2013 

VIX 

(left axis) 

Treasury 10Y Yield 

(right axis) 
34 2013 FSOC / / Annual Report

4.3.2 State and Local Governments

The fiscal position of state and local 

governments continues to improve, although 

many budgets are still strained. State and 

local governments are replenishing their cash 

reserves, and aggregate nominal tax revenues 

continued to grow modestly after declining 

in the aftermath of the financial crisis (Chart 

4.3.4). Net credit flows to state and local 

governments were also mostly positive in 2012. 

Long-term municipal bond funds experienced 

inflows 49 weeks out of the year in 2012 (Chart 

4.3.5), and long-term bond issuance was up 

31 percent to $376 billion in 2012—the highest 

level since 2010, when the Build America Bond 

program expiration led to a wave of 

new issuance.

However, the resources available to state and 

local governments to finance their spending 

remain constrained. An uneven level of 

unemployment, disparate property tax revenue, 

and ongoing spending pressure from Medicaid 

and pension liabilities continue to challenge the 

outlook at the state and local level. Additionally, 

the federal stimulus grants provided under the 

American Recovery and Reinvestment Act of 

2009 have largely wound down, leading to a 

substantial decline in nominal federal transfers 

to state and local governments (Chart 4.3.6). 

States have also reduced capital expenditures, 

which have fallen to their lowest levels since 

the late 1990s. The reduction in real capital 

expenditures can be seen in declining public 

construction spending, the vast majority 

of which is undertaken by state and local 

governments (Chart 4.3.7).

Ongoing fiscal challenges have also led to 

a rising number of municipal defaults and 

Chapter 9 bankruptcy filings in 2012. However, 

the number of Chapter 9 filings remains very 

low and recent bankruptcies have been caused 

by a variety of challenges, such as regions hit 

hard by the financial crisis, poorly planned 

financing of public works projects, one-time 

legal judgments, or obligations related to 

large unfunded pension liabilities. While total 

municipal bond issuance was robust in 2012, 

Chart 4.3.4 State and Local Government Tax Revenues 4.3.4 State and Local Government Tax Revenues 

Trillions of US$ Trillions of US$ 

Source: Census Bureau 

As Of: 2012 Q4 

Note: Gray bars signify NBER recessions. 

Revenue shown represents the trailing 4 quarters. 

Chart 4.3.5 Long-Term Mutual Fund Flows: Municipal Bonds

-15 

-10 

-5 

0 

5 

10 

15 

-15 

-10 

-5 

0 

5 

10 

15 

2007 2008 2009 2010 2011 2012 2013 

Source: ICI, Haver Analytics 

Billions of US$ As Of: Feb-2013 

4.3.5 Long-Term Mutual Fund Flows: Municipal Bonds 

Billions of US$ 

Chart 4.3.6 Federal Grants-in-Aid to State 

and Local Governments

200 

300 

400 

500 

600 

200 

300 

400 

500 

600 

2000 2002 2004 2006 2008 2010 2012 

Source: BEA, 

Haver Analytics 

Billions of US$ As Of: 2012 Q4 

4.3.6 Federal Grants-in-Aid to State and Local Governments 

Note: Gray bars signify NBER recessions. 

Billions of US$ 
Macroeconomic Environment 35

net new municipal bond issuance remains well 

below historical averages (Chart 4.3.8). Net 

new issuance is depressed due to decreased 

issuer appetite for debt following the financial 

crisis and expectations that interest rates will 

remain low for the foreseeable future, allowing 

issuers to delay financing. Municipal interest 

rates also reached historic lows in 2012, which 

bolstered incentives to refinance. This is seen 

in the cost of municipal bonds—as measured 

by the yield ratio to similar maturity Treasury 

securities—which has been falling across the 

credit spectrum since the summer of 2012 

(Chart 4.3.9). 

Finally, state and local governments will need to 

continue addressing the underfunded status of 

their pension plans. A decade of low financial 

market returns and low economic growth 

since 2008 has exacted a heavy toll on funding 

levels, while at the same time benefit costs 

have continued to rise. Greater transparency 

in this area is also needed, as exemplified by 

the SEC’s recent enforcement case against the 

State of Illinois. A similar challenge applies 

to other post-employment benefits, as many 

municipalities have not yet set aside funding for 

their ongoing obligations to provide health care 

to retired state and local municipal employees.

Chart 4.3.7 Total Public Construction Spending

200 

250 

300 

350 

200 

250 

300 

350 

2006 2007 2008 2009 2010 2011 2012 2013 

Source: Census Bureau, 

Haver Analytics 

Billions of US$ As Of: Feb-2013 

4.3.7 Total Public Construction Spending 

Note: Gray bar signifies NBER recession. 

Billions of US$ 

Chart 4.3.8 Municipal Bond Issuance 4.3.8 Municipal Bond Issuance 

Billions of US$ Billions of US$ 

Source: Thomson 

Reuters, SIFMA 

As Of: 2012 

Note: Excludes maturities of 13 months 

or less and private placements. 

Chart 4.3.9 Municipal Tax-Exempt Bond Yield Ratios

60 

100 

140 

180 

220 

260 

60 

100 

140 

180 

220 

260 

2007 2008 2009 2010 2011 2012 2013 

Source: Bloomberg, L.P. 

Percent As Of: 25-Mar-2013 

4.3.9 Municipal Tax-Exempt Bond Yield Ratios 

Percent 

Illinois 

California 

New York 

Generic A-rated 

Generic AAA-rated 

Note: General obligation 10-year municipal 

bond yields to 10-year Treasury yields. 
36 2013 FSOC / / Annual Report

4.4 External Environment 

4.4.1 Advanced Foreign Economies

In the aggregate, GDP growth in the advanced 

economies slowed in 2012 (Chart 4.4.1). The 

euro area fell back into recession, and growth 

was subdued in other advanced economies. 

Among the major foreign advanced economies 

(the euro area, Japan, the United Kingdom, 

Canada), real GDP is estimated to have 

contracted 0.3 percent from the fourth quarter 

of 2011 to the fourth quarter of 2012 on a 

GDP-weighted basis. Severe financial stress 

in the euro area over the summer restrained 

business and consumer spending in the core 

and periphery, and weighed on global growth 

more broadly. In Japan, exports and industrial 

production slumped in the third quarter 

of 2012, producing a sizeable contraction 

in output. 

Foreign economic activity appears to have 

stabilized in early 2013, reflecting an easing 

of financial stresses in the euro area, signs of 

stable trade flows among major economies, 

and ongoing accommodative monetary policies 

(see Box B: Global Monetary Policy Actions). 

The International Monetary Fund (IMF) 

projects major foreign advanced economies 

to expand a modest 1.2 percent from the 

fourth quarter of 2012 to the fourth quarter 

of 2013 on a real basis. Growth in the foreign 

advanced economies is expected to remain 

sluggish over the medium term, reflecting fiscal 

consolidation and deleveraging in the wake of 

the global financial crisis (Chart 4.4.2).

European authorities at the country and 

regional level responded to the crisis in 2012 

through ongoing policy reform; actions to 

provide financial support to countries under 

stress pursuing reform and adjustment policies; 

establishment of the Single Supervisory 

Mechanism (SSM); and from the European 

Central Bank (ECB), the creation of a 

program to reduce financial fragmentation by 

purchasing sovereign debt. Cumulatively, these 

policy actions have served to reduce concerns 

about a systemic event in the euro area and 

Chart 4.4.1 Real GDP Growth

-6 

-4 

-2 

0 

2 

4 

6 

8 

10 

-6 

-4 

-2 

0 

2 

4 

6 

8 

10 

2000 2002 2004 2006 2008 2010 2012 2014 

Source: IMF, Haver Analytics 

Percent As Of: Jan-2013 

4.4.1 Real GDP Growth 

Note: IMF estimates are used when actual 

data is unavailable. Year-over-year percent 

change. Data after 2012 is projected. 

Percent 

Advanced 

Economies 

Emerging 

Economies 

Chart 4.4.2 Advanced Economies Real GDP Growth

-6 

-4 

-2 

0 

2 

4 

6 

-6 

-4 

-2 

0 

2 

4 

6 

2000 2002 2004 2006 2008 2010 2012 2014 

Source: IMF, Haver Analytics 

Percent As Of: Jan-2013 

4.4.2 Advanced Economies Real GDP Growth 

Note: Year-over-year percent change. 

Data after 2012 is projected. 

Percent 

United States 

Canada 

United Kingdom 

Euro Area 

Japan 
Macroeconomic Environment 37

have substantially eased severe market pressures 

since mid-2012. Sentiment particularly turned 

in August, after the ECB announced its 

willingness to purchase sovereign debt (subject 

to a formal request and policy conditionality), 

through the Outright Monetary Transactions 

(OMT) program. Although the OMT has 

not been utilized, periphery sovereign debt 

spreads have narrowed sharply, equity markets 

have rebounded, and bank debt markets have 

partially reopened (see Section 5.1.2 for a 

discussion of sovereign markets). Improved 

confidence and the return of some private 

capital is expected to gradually ease the deep 

recession in the periphery over the course of 

this year, along with a modest easing in the 

pace of fiscal tightening and strengthened 

external demand, though downside risks to the 

economic forecast remain (Chart 4.4.3).

At the same time, countries across the euro 

area periphery continued to implement fiscal 

consolidation to shrink their fiscal deficits and 

reduce public debt burdens, structural reforms 

to reshape their economies and improve 

competitiveness, and banking sector repair 

and restructuring. Altogether, governments 

are estimated to have reduced fiscal deficits by 

2.5 to 8.0 percentage points of GDP from 2009 

peak levels by the end of 2012, demonstrating 

meaningful progress on their medium-term 

adjustment plans. Euro area periphery public 

debt levels are now projected to peak over the 

period from 2013 to 2015 (Chart 4.4.4). 

In the case of Greece, after political 

uncertainties and plunging output pushed 

the adjustment program off-track in mid2012, European Union (EU) and IMF lenders 

agreed at the end of 2012 to provide Greece 

with two extra years to build to a primary 

budget surplus of 4.5 percent of GDP, and to 

a number of initiatives to ease the terms of 

official loans to Greece. Greek sovereign debt 

sustainability was enhanced through a debt 

buyback in December, which followed its debt 

exchange in March. Ireland and Portugal 

continued to make progress implementing 

their EU/IMF programs and both countries 

Chart 4.4.3 Euro Area Real GDP Growth

-6 

-4 

-2 

0 

2 

4 

6 

-6 

-4 

-2 

0 

2 

4 

6 

2002 2005 2008 2011 2014 

Source: IMF, Haver Analytics 

Percent As Of: Jan-2013 

4.4.3 Euro Area Real GDP Growth 

Note: Year-over-year percent change. 

Data after 2012 is projected. 

Percent 

Spain 

France 

Euro Area 

Italy 

Germany 

Chart 4.4.4 Peripheral Europe: Gross Public Debt

0 

40 

80 

120 

160 

200 

0 

40 

80 

120 

160 

200 

2006 2008 2010 2012 2014 2016 

Source: IMF, Haver Analytics 

Percent of GDP As Of: Oct-2012 

4.4.4 Peripheral Europe: Gross Public Debt 

Note: Data after Oct-2012 is projected. 

Percent of GDP 

Greece 

Italy 

Portugal 

Ireland 

Spain 
38 2013 FSOC / / Annual Report

have issued their first long-term bond offerings 

since they lost international market access in 

late 2010 and early 2011; however, a recent court 

decision striking down part of Portugal’s deficit 

reduction program for 2013 could complicate 

the process in that country. The Spanish and 

Italian governments have pressed on with their 

fiscal and structural reform agendas and, to 

support the Spanish bank restructuring, the 

EU approved a bank recapitalization program 

covering financing needs of up to €100 billion. 

At year end, Spain’s weakest state-controlled 

banks (holding 18 percent of bank assets) 

were recapitalized with €37 billion (equivalent 

to 4 percent of GDP) of European Stability 

Mechanism (ESM) funding, and their real 

estate-related assets were transferred to a 

centralized asset management company. As 

will be discussed in Section 5.1.2, the Cypriot 

government restructured its two largest banks, 

forcing losses on their senior bond holders and 

uninsured depositors, in order to meet the 

requirements for a loan package.

Meanwhile, European authorities pledged to 

pursue deeper financial, economic, fiscal, and 

political integration to enhance the resilience 

of the monetary union. Leaders agreed to 

establish a SSM for banks by mid-2014, housed 

at the ECB, and to consider a proposal for a 

single bank resolution mechanism applicable 

to the member states participating in the SSM. 

Under this agreement, the ECB—working with 

national supervisory authorities—would have 

direct oversight responsibilities for the largest 

financial institutions and for those institutions 

receiving official sector support. The European 

Council has called for legislators to further 

advance proposals for a single resolution 

mechanism in 2013, although progress 

toward a legislative agreement is expected 

to be challenging. With respect to fiscal and 

economic integration, the focus has been on 

strengthening the EU’s governance framework 

through enhanced rules, stronger euro-level 

enforcement authority, and ex-ante policy 

coordination. In December 2012, the President 

of the European Council was charged with 

preparing proposals for the June 2013 
Macroeconomic Environment 39

summit to explore modest financial 

incentives to support contractually agreed 

competitiveness reforms.

4.4.2 Emerging Market Economies

In 2012, economic growth across the emerging 

market economies (EMEs), including China, 

India, Brazil, and Russia, slowed as earlier 

policy tightening and weakened external 

demand for exports weighed on performance 

(Chart 4.4.5). Indeed, 2012 EME growth was 

the lowest since 2002, with the exception of the 

2008 to 2009 crisis period. A gradual recovery 

now appears underway across the EMEs, 

according to recent high frequency indicators, 

such as exports, industrial production, 

and purchasing manager surveys. This year, 

the IMF forecasts a modest acceleration in 

EME growth to 5.9 percent (Q4/Q4) from 

5.5 percent in 2012.

The EMEs continue to be a significant source 

of global growth. Over the past year, EMEs 

contributed four times as much to world growth 

compared to advanced economies (Chart 

4.4.6). Chinese growth remains a critical factor, 

contributing 37 percent alone to total real 

global growth in 2012. Indications that trend 

growth has slowed across the largest EMEs are 

of potential concern for the medium term: the 

IMF now forecasts EME real GDP trend growth 

at 6 percent. In this context, structural reforms, 

such as measures to improve the investment 

regime for infrastructure, improvement of 

public services and the business climate, and 

efforts to overhaul tax systems, could enhance 

medium-term growth prospects. 

EME inflation pressures eased modestly in 

2012. Most recent inflation prints remain well 

below 2008 and 2010 peaks, but still stand 

above inflation in the advanced economies 

(Chart 4.4.7). Moreover, inflation generally 

remains near the upper end of emerging 

market (EM) monetary authorities’ inflation 

targets or tolerance zones. Food prices, given 

their large weight in EME CPI baskets, remain 

a risk for inflation dynamics and have social 

ramifications. India, in particular, has to 

Chart 4.4.5 Emerging Market Economies Real GDP Growth

-10 

-5 

0 

5 

10 

15 

-10 

-5 

0 

5 

10 

15 

2005 2007 2009 2011 2013 

Source: IMF, Haver Analytics 

Percent As Of: Jan-2013 

4.4.5 Emerging Market Economies Real GDP Growth 

Note: Year-over-year percent change. 

Data after 2012 is projected. 

Percent 

China 

Mexico 

Brazil 

India 

Russia 

Chart 4.4.6 Contribution to World GDP Growth

-4 

-2 

0 

2 

4 

6 

-4 

-2 

0 

2 

4 

6 

2000 2002 2004 2006 2008 2010 2012 

4.4.6 Contribution to World GDP Growth 

Percent Percent 

Source: IMF 

As Of: Oct-2012 

Advanced Economies Ex-US 

BRIC 

United States 

Emerging Economies Ex-BRIC 

Note: IMF estimates are used when actual data 

is unavailable. Data after Oct-2012 is projected. 

Chart 4.4.7 BRIC and U.S. Inflation Rates

-4 

0 

4 

8 

12 

16 

-4 

0 

4 

8 

12 

16 

2007 2008 2009 2010 2011 2012 2013 

Source: Haver Analytics 

Percent As Of: Feb-2013 

4.4.7 BRIC and U.S. Inflation Rates 

Percent 

Brazil 

United States 

Russia 

China 

India 
40 2013 FSOC / / Annual Report

cope with elevated inflation at the same time 

economic growth has slowed to its weakest pace 

in a decade. Additionally, property sectors in 

some Asian EMEs are undergoing sharp price 

increases, which policy makers are attempting 

to contain via imposition of macroprudential 

measures. Given the forecasts for only modest 

growth rebounds and elevated inflation, market 

expectations generally forecast limited shifts in 

EM monetary policy stances this year.

Capital flows to the EMEs have rebounded 

substantially from the 2008 to 2009 crisis lows, 

attracted by higher EME growth rates and a 

large interest rate differential with advanced 

economies. Foreign direct investment (FDI) 

inflows into EMEs remained relatively robust. 

Beginning in late 2011, however, portfolio 

capital flows were volatile, reflecting sudden 

reversals in risk appetite due to concerns 

about the euro area and the strength of the 

global recovery. Pullbacks were evident in 

portfolio inflows to EMEs as well as reduction 

in European bank lending, stemming from 

home-market liquidity and capital pressures. 

Still, many of the larger EMEs possess ample 

reserve cushions, partially mitigating risks 

associated with capital flow volatility (Chart 

4.4.8). Currency appreciation pressures also 

moderated across EMEs and the pace of reserve 

accumulation slowed.

Despite the reductions in European bank 

lending, short-term trade finance appears 

to have held up, due in part to increased 

lending activity by local EM banks. Financing 

availability has been reduced for longer-term 

trade and commodity transactions, and for 

project finance, but increased bond financing 

has helped EM corporations meet longer 

term financing needs. The volume of foreign 

currency bonds sold by EM companies and 

banks reached more than $360 billion in 

2012—a nearly 65 percent increase over 2011 

issuances. This trend could create risks of 

currency mismatch if EM borrowers fail to place 

prudent limits on their currency risk exposures. 

Chart 4.4.8 Inflows to EMEs 4.4.8 Inflows to EMEs 

Billions of US$ Billions of US$ 

Source: EMED 

As Of: 2012 Q3 
Macroeconomic Environment 41

China

The Chinese economy appears to have 

experienced a soft landing in 2012, with average 

annual growth slowing to 7.8 percent from 9.3 

percent in 2011. Contributing factors include 

the lagged effects of prudential tightening in 

2010 and 2011 targeting speculative property 

and local government infrastructure investment 

which continued to filter through the economy, 

and sluggish external demand in the advanced 

economies (particularly Europe) which 

contributed to lower growth via weakened 

exports (Chart 4.4.9). China’s current account 

surplus declined from 10.1 percent of GDP in 

2007 to under 3.0 percent last year, driven by 

factors such as exchange rate appreciation, 

weak external demand, and increased imports 

for domestic investment purposes. Faced 

with the risk of a sharper-than-expected 

growth downturn in the first half of 2012, the 

authorities shifted footing by mid-year, lowering 

administered interest rates, and accelerating 

the pace of new infrastructure project 

approvals. These measures effectively placed a 

floor under Chinese growth and contributed 

to a modest growth re-acceleration toward year 

end, following seven consecutive quarters of 

slowdown. Signs of a growth re-acceleration 

also appear to have firmed external market 

sentiment towards China, with the pace of 

net non-FDI financial outflows abating in the 

fourth quarter of 2012.

A source of concern related to China’s domestic 

economy is the flow of new credit, which has 

increased notably in recent years. Growth 

in nonbank financing channels (off-balance 

sheet lending, trust loans, and corporate 

bond issuance) has comprised an increasing 

share of the flow of new credit (Chart 4.4.10). 

Moreover, incremental increases in new 

credit have significantly outpaced increases in 

nominal GDP growth, raising questions about 

the efficiency of credit allocation and the 

potential for defaults over the medium term. 

The rise in nonbank finance in China has also 

coincided with the rapid proliferation of wealth 

management products and the potential risks 

associated with new financial innovation.

Chart 4.4.9 China Real GDP Growth 4.4.9 China Real GDP Growth 

Percent Percent 

Source: CEIC Data 

As Of: 2012 Q4 

Note: Quarterly data. Percentage change 

on the same quarter of the previous year. 

Chart 4.4.10 China: Annual Increases in Credit and GDP 4.4.10 China: Annual Increases in Credit and GDP 

Trillions of Renminbi Trillions of Renminbi 

Source: Haver Analytics, 

CEIC Data 

As Of: 2012 

Note: Additional sources of credit include the following components 

of "total social financing" as reported by the People's Bank of 

China: trust loans, entrusted lending, undiscounted bankers' 

acceptances, and net new corporate bond issuance. 

Incremental Increase in 

Nominal GDP 

Financial Developments 43

5 Financial Developments

This section provides an overview of financial 

market developments by reviewing (1) asset 

valuations; (2) wholesale funding markets; 

(3) bank holding companies and depository 

institutions; (4) nonbank financial companies; 

(5) investment funds; and (6) financial market 

infrastructure. Special topics in this section 

include global monetary policy actions, 

convexity event risks, and collateral availability.

5.1 Asset Valuations

5.1.1 Fixed Income Valuations

Across many of the fixed income markets, 

benchmark rates, spreads, and volatilities have 

remained low and tended to decline, including 

investment grade corporate, high-yield 

corporate, and mortgage-backed (CMBS and 

MBS) securities. Asset purchases by the Federal 

Reserve and lowered investor perceptions of 

solvency risk for credit products led to further 

declines in Treasury and credit yields. Fixed 

income valuations were also supported by 

improved performance amongst financials and 

corporates, and changes in demand and supply 

across the credit and interest rate spectrum. 

The level of U.S. 10-year Treasury yields 

averaged 1.8 percent during the past year, 

down from its 2011 average of 2.8 percent 

(Chart 5.1.1). While the slope of the 2- year to 

10-year Treasury curve remains upward sloping 

at around 165 basis points, it is below the 

recent historical average of 205 basis points 

(Chart 5.1.2). Corporate bond yields are also 

quite low relative to longer-run historical 

averages. As of March 2013, investment grade 

debt (rated BBB- and above) traded at a 

spread of 175 basis points, while speculative 

grade spreads (rated BB+ and lower) exceeded 

500 basis points. Although spreads on these 

instruments relative to Treasury securities are 

not excessively narrow, the low base level of 

yields suggests institutions can obtain funding 

Chart 5.1.1 Treasury Yields

Percent As Of: 25-Mar-2013 

5.1.1 Treasury Yields 

Source: U.S. Department of Treasury 

Percent As Of: 25-Mar-2013 Percent 

2Y 

5Y 

10Y 

Chart 5.1.2 Slope of the Treasury Yield Curve

Basis Points Basis Points

5.1.2 Slope of the Treasury Yield Curve 

As Of: 25-Mar-2013 Basis Points 

Source: U.S. Department of Treasury 
44 2013 FSOC / / Annual Report

on relatively inexpensive terms. At the same 

time, the low rate environment might constitute 

a risk for investors (see Section 7.4 for 

elaborations on these risks).

Interest rate volatility, both implied and 

realized, have continued to decline towards 

pre-2008 levels in spite of the range of 

uncertainties faced by market participants in 

recent years (Chart 5.1.3). There are several 

factors contributing to the decline in volatility. 

First, the Federal Reserve’s asset purchases 

reduced the amount of aggregate duration risk 

held by the public. Second, communications 

by the Federal Reserve’s Federal Open Market 

Committee (FOMC) around its forward rate 

guidance might contribute to reduced market 

volatility and hedging activity on short-term 

interest rates. Third, nominal yields are close 

to the zero lower bound, which limits downside 

volatility. An important driver of implied 

volatility is the reduced hedging activity of 

government-sponsored enterprises (GSEs) and 

mortgage originators—traditional natural 

buyers of rate volatility—who have reduced 

demand significantly. Active selling of volatility 

by hedge funds, money managers, and banks 

for yield enhancement, and the perception of 

decreased tail-risk emanating from Europe, also 

contributed to downward pressure on implied 

volatility. Implied volatility can be gauged from 

the Merrill Lynch Option Volatility Estimate 

Index (MOVE), which measures market 

sentiment of future interest rate volatility. In 

October 2008, at the height of the financial 

crisis, the MOVE reached its historical peak 

in excess of 200 basis points. Currently, the 

MOVE is at about 60 basis points, a level last 

seen in spring 2007. A similar decline in market 

expectations of future volatility is apparent 

for options on interest rate swaps as gauged by 

the Merrill Lynch Swaption Volatility Estimate 

Index (SMOVE) (Chart 5.1.4).

Credit markets experienced strong issuance 

and declining spreads (Charts 5.1.5). 

Declining solvency risk and greater demand 

for investment and speculative grade 

credit products contributed to the strong 

Chart 5.1.3 Realized and Implied Interest Rate Volatility

0 

50 

100 

150 

200 

250 

300 

0 

50 

100 

150 

200 

250 

300 

2006 2007 2008 2009 2010 2011 2012 2013 

5.1.3 Realized and Implied Interest Rate Volatility 

Basis Points Basis Points 

Source: JP Morgan estimates 

Option-Implied Volatility, 10-Year 

Swap Rate, 1-Year Expiry 

Realized Volatility, 10-Year 

Swap Rate, 1-Year Forward 

As Of: 25-Mar-2013 

Chart 5.1.4 Implied Volatility

0 

50 

100 

150 

200 

250 

0 

50 

100 

150 

200 

250 

2005 2007 2009 2011 2013 

Source: Bank of America Merrill 

Lynch, Haver Analytics 

Points As Of: Feb-2013 

5.1.4 Implied Volatility 

Note: MOVE and SMOVE are the yield curve 

weighted indices of the normalized implied 

volatility on 1-month interest rate options. 

Points 

MOVE Index SMOVE Index

Chart 5.1.5 U.S. Corporate Bond Spreads – Investment Grade 5.1.5 U.S. Corporate Bond Spreads – Investment Grade 

Basis Points As Of: 25-Mar-2013 

Source: Barclays 

Basis Points As Of: 25-Mar-2013 Basis Points 

Non-financials 

Financials 
Financial Developments 45

performance. Corporate bonds and leveraged 

loans (loans provided to companies with noninvestment grade credit metrics) experienced 

record or near-record issuance (Charts 5.1.6, 

5.1.7, and 5.1.8), while issuance of collateralized 

loan obligations (CLOs) picked up markedly 

(Chart 5.1.9). Simultaneously, market sentiment 

over tail risks in the second quarter improved 

considerably following actions by the Federal 

Reserve, the European Central Bank (ECB), 

and other central banks in response to weak 

economic growth. That is, yield differentials 

between these credit instruments and risk free 

equivalents have fallen. 

The consequences of a search for (and 

compression of) yield manifested in a variety 

of ways. In some cases, investors shifted 

down the credit spectrum, from AA- to BBBrated bonds, or increased duration through 

investment in longer maturity bonds. In recent 

quarters, credit terms and conditions for newly 

issued institutional loans and high-yield bonds 

loosened further along certain dimensions. 

The share of loan issuance without financial 

maintenance covenants, known as covenant-lite 

loans, has risen steeply over the past two years, 

accounting for about 30 percent of institutional 

loan issuance in the fourth quarter of 2012. For 

loans with maintenance covenants, looser terms 

and conditions were evident in the persistent 

decline in the average number of covenants. 

As an additional consequence of the search 

for yield, issuance of Payment-In-Kind (PIK) 

bonds—which allow the issuer to capitalize 

and defer interest through an increase of face 

value—increased sharply in 2012, though 

levels are still noticeably lower than those 

seen in 2007. Reach for yield also expanded 

to peripheral credits, such as in CMBS, where 

issuance increased from $30 billion in 2011 to 

$45 billion in 2012. Such compensatory shifts by 

investors imply a trade-off between increasing 

near-term income and more severe price risk to 

their portfolios in the event of a steep increase 

in yields. 

Changes of pricing across other asset classes 

were attributable to demand and supply factors. 

Chart 5.1.6 U.S. Corporate Bond Issuance 5.1.6 U.S. Corporate Bond Issuance 

Billions of US$ Billions of US$ 

Source: Thomson 

Reuters, SIFMA 

As Of: 2012 

Note: Includes all non-convertible corporate debt, MTNs, and 

Yankee bonds, but excludes all issues with maturities of one 

year or less and CDs. 

Chart 5.1.7 High-Yield Bonds: Issuance and Market Size 5.1.7 High-Yield Bonds: Issuance and Market Size 

Billions of US$ Billions of US$ 

Source: Bank of America Merrill 

Lynch Global Research, S&P LCD 

Market Size 

(right axis) 

As Of: 2012 

Total Issuance (left axis) 

Net Issuance (left axis) 

Chart 5.1.8 Institutional Loans: Issuance and Market Size 5.1.8 Institutional Loans: Issuance and Market Size 

Billions of US$ Billions of US$ 

Source: Bank of America Merrill 

Lynch Global Research, S&P LCD 

Market Size 

(right axis) 

As Of: 2012 

Gross Issuance (left axis) 

Net Issuance (left axis) 
46 2013 FSOC / / Annual Report

The primary investors in CLOs, particularly 

for AAA tranches, are currently Japanese and 

U.S. banks. Other CLO investors include large 

financial accounts such as money manager, 

insurance companies, and pension funds. 

Hedge funds and private equity funds as well 

as specialized CLO managers are primarily 

reported to be buying mezzanine and equity 

tranches. Spreads also fell for MBS as the 

Federal Reserve’s renewed purchases of MBS 

sharply reduced the available supply, causing 

the spread between yields on MBS and 10-year 

Treasury notes to narrow significantly 

(Chart 5.1.10). Within corporate credit, cash 

bond spreads decreased significantly as the 

result of strong investor demand against the 

expectation of little downside risk. Evidence 

of this appetite is found in the CDS-bond 

basis, the spread of credit default swaps over 

comparable cash bonds, which has tightened 

recently. Although the basis was strongly 

negative during the financial crisis, reflective 

of financial intermediaries’ unwillingness to 

hold corporate bonds, it has since returned to 

nearly zero. U.S. dollar interest rate swap rates, 

at maturities greater than 10 years, remained 

negative to Treasury yields over the course 

of 2012. Market participants attribute these 

negative swap spreads to overwhelming demand 

by both investors and corporate issuers to 

receive fixed rates on interest rate swaps. 

Chart 5.1.9 CLOs: Issuance and Market Size

5.1.9 CLOs: Issuance and Market Size 

Billions of US$ Billions of US$ 

Source: Bank of America Merrill 

Lynch Global Research, Intex 

Outstanding 

(right axis) 

As Of: 2012 

Gross Issuance (left axis) 

Net Issuance (left axis) 

Chart 5.1.10 Agency MBS Spreads to Treasuries

0 

50 

100 

150 

200 

250 

0 

50 

100 

150 

200 

250 

2006 2007 2008 2009 2010 2011 2012 2013 

Source: Bloomberg, L.P. 

Basis Points As Of: 25-Mar-2013 

5.1.10 Agency MBS Spreads to Treasuries 

Note: Fannie Mae 30-year MBS 

spreads to 10-year Treasuries. 

Basis Points 
Financial Developments 47

5.1.2 Sovereign Debt and Foreign Exchange

U.S. Sovereign Debt

The total amount of outstanding U.S. 

sovereign debt held by the public, (including 

Federal Reserve holdings, but not other 

intragovernmental debt), rose to $11.8 trillion 

as of February 28, 2013 (Chart 5.1.11). Despite 

this increase in supply, long-term Treasury 

yields declined in the first half of 2012. Longterm yields, at historical lows, are a reflection 

of both residual flight to quality and continued 

monetary policy accommodation associated 

with the below-trend pace of economic growth. 

The Federal Reserve’s flow-based purchases 

of both agency MBS and Treasury securities, 

and the introduction of language in the FOMC 

statement linking changes in the federal funds 

rate to economic variables, are reflective of 

accommodative monetary policy. 

Longer-term Treasury yields have risen since 

the summer of 2012 against a backdrop 

of factors relating to European sovereign 

and U.S. domestic considerations. Specific 

factors include the ECB’s announcement of 

the Outright Monetary Transactions (OMT) 

program to purchase European sovereign 

debt, a somewhat improved outlook for U.S. 

growth, and the passage of the American 

Taxpayer Relief Act of 2012 (ATRA), which 

prevented substantial tax increases for most 

U.S. households. 

Foreign holdings of U.S. Treasury securities 

continue to grow, with the largest investors—

China and Japan—collectively accounting for 

$2.3 trillion of U.S. Treasury securities, while 

other foreign accounts held $3.3 trillion as of 

February 2013. While the share of Treasury 

holdings attributed to China and Japan 

decreased somewhat since year end 2011, as 

their holdings were roughly flat, other countries 

added about $540 billion to their stocks 

of U.S. sovereign debt since year end 2011 

(Chart 5.1.12).

Chart 5.1.11 Publically Held Federal Debt Outstanding

0 

3 

6 

9 

12 

15 

0 

3 

6 

9 

12 

15 

2001 2003 2005 2007 2009 2011 2013 

Source: U.S. Department of Treasury, 

Haver Analytics 

Trillions of US$ As Of: Feb-2013 

5.1.11 Publically Held Federal Debt Outstanding 

Trillions of US$ 

Chart 5.1.12 Foreign Holders of U.S. Federal Debt 5.1.12 Foreign Holders of U.S. Federal Debt 

Share Share 

Source: U.S. Department of Treasury,

Haver Analytics 

As Of: Feb-2013 

China 

Japan 

Euro Area 

Other 
48 2013 FSOC / / Annual Report

BOX B: GLOBAL MONETARY POLICY ACTIONS

The global financial crisis led central banks in a number of 

the advanced economies to cut their policy rates to near 

zero. Furthermore, the continued weakness of the global 

recovery has led many of them to adopt unconventional 

policies involving asset purchases to further promote 

economic growth. Monetary policy normally influences 

longer-term interest rates by affecting market expectations 

of future short-term rates. Unconventional monetary 

policies can also affect long-term interest rates through 

expectations of future short rates, but also lower yields 

by compressing term premia (see Section 7.4). The 

purchase of longer-term assets by a central bank 

increases overall demand for duration and may therefore 

induce investors seeking duration to accept lower yields 

on longer-term securities (the duration channel). Another 

possible channel is through purchases that reduce the 

supply of specific securities preferred by certain investors 

(the preferred habitat channel). Unconventional monetary 

policies have likely worked through all of these channels 

to lower long-term interest rates, and along with the 

weak recovery in the many advanced economies and the 

restrained levels of inflation, have left long-term rates near 

record lows. Even though low long-term interest rates 

have helped to support economic growth, they may also 

encourage investors to reach for yield and take excessive 

risks in order to increase their investment returns. 

Accordingly, central banks and other authorities must 

monitor financial markets and institutions closely to ensure 

that low rates do not threaten financial stability. 

Over the past year, the Bank of England (BOE) increased 

the size of its asset purchase programs. The BOE 

expanded its limit for outright purchases under its Asset 

Purchase Facility from £275 billion to £375 billion. In June 

2012, the BOE, in conjunction with the U.K. Treasury, 

created a temporary Funding for Lending Scheme 

designed to reduce the cost of funding new net lending to 

the private sector by banks and building societies. 

Throughout 2012, the Bank of Japan (BOJ) increased the 

size of its Asset Purchase Program from ¥20 to ¥76 trillion 

and conducted a funds-supplying liquidity operation of 

¥25 trillion. In January 2013, the BOJ announced plans 

to begin a new series of open-ended asset purchases 

in conjunction with its adoption of a 2 percent price 

stability target. The BOJ also established a new facility to 

increase lending more directly, offering long-term funds 

to financial institutions against new net lending. On April 

4, 2013, the BOJ Policy Board approved a new policy 

framework comprised of four main components: (1) 

shifting the policy operating target from the overnight call 

money rate to the quantity of the monetary base, with a 

target of ¥60 to ¥70 trillion annual growth; (2) expanding 

the BOJ’s purchases of long-term Japanese government 

bonds (JGBs) to an annual pace of about ¥50 trillion on 

a net basis (roughly ¥7 trillion in monthly purchases), and 

extending the average remaining maturity of JGB holdings 

from the current nearly three years to about seven years; 

(3) purchasing more risk assets, such as exchange-traded 

funds (ETFs) and Japanese real estate investment trusts 

(REITs); and (4) committing to maintain the new policy 

framework as long as necessary to maintain 2 percent 

inflation “in a stable manner.”

In the United States, the FOMC of the Federal Reserve 

System provided additional monetary accommodation 

over the past year by undertaking additional purchases 

of longer-term assets and by modifying its forward 

guidance regarding the federal funds rate. The FOMC 

took these actions to promote its objectives of maximum 

employment and price stability. With respect to purchases 

of longer-term assets, the FOMC completed a program 

that had begun in the fall of 2011, under which it ultimately 

purchased $667 billion in longer-term Treasury securities, 

while selling or redeeming an equal amount of shorterterm Treasury securities. In September it announced 

additional purchases of MBS at a pace of $40 billion 

per month, and in December it announced additional 

purchases of longer-term Treasury securities, initially 

at a pace of $45 billion per month. With respect to 

forward guidance about the federal funds rate, at the 

close of its September meeting the FOMC stated that 

exceptionally low levels for the federal funds rate were 

likely to be warranted at least through mid-2015, longer 

than had been indicated in previous FOMC statements. 

In December, the FOMC dropped the date-based 

guidance and instead indicated that it anticipates that 

exceptionally low levels for the federal funds rate would 
Financial Developments 49

remain appropriate at least as long as the unemployment 

rate remains above 6.5 percent, inflation between one 

and two years ahead is projected to be no more than 

0.5 percentage point above the Committee’s 2 percent 

longer-run goal, and longer-term inflation expectations 

continue to be well-anchored.

The ECB has taken conventional as well as 

unconventional policy actions. The ECB eased monetary 

policy by reducing its main refinancing rate by 25 basis 

points to 0.75 percent in July 2012 and cut its deposit 

facility rate to zero. The central bank also conducted the 

second of two 3-year refinancing operations in February, 

which helped alleviate concerns about liquidity in the 

context of imminent maturities of bank debt through a 

significant increase in excess liquidity in the euro area 

banking system. In 2012, the ECB eased collateral rules 

in order to maintain or improve counterparty access 

to the Eurosystem’s liquidity-providing operations. To 

address more directly the financial fragmentation that had 

developed in the peripheral euro area economies and the 

resulting fears about the future of the currency union, the 

ECB announced in August 2012 the Outright Monetary 

Transactions (OMT) program. Under the program, the 

ECB would make outright secondary-market purchases 

of the sovereign debt of any member country establishing 

and remaining in compliance with a new program with 

the European Financial Stability Facility (EFSF) and the 

European Stability Mechanism (ESM) (see Section 5.1). 

Sovereign debt with maturities up to three years would 

be eligible for the program, with the majority of purchases 

concentrated in the 1- to 3-year sector, and all purchases 

would be sterilized. Although no country has requested 

support under the OMT, its announcement has helped to 

significantly lower financial stress within the currency area. 

Although central banks in the emerging market 

economies have not had to resort to unconventional 

monetary policies, many (notably, the central banks of 

China, South Korea, and Brazil) cut their policy rates over 

the last year in response to the weak global recovery. 
50 2013 FSOC / / Annual Report

European Sovereign Debt

European sovereign debt markets dramatically 

improved following the announcement of the 

ECB’s OMT program. The spreads on Spanish 

and Italian 10-year government bonds to 

relatively low yielding German equivalents were 

respectively 611 and 518 basis points on the 

eve of a July 26 speech in which ECB President 

Draghi signaled the creation of the sovereign 

debt purchase program, and vowed to “do 

whatever it takes” to prevent the breakup of 

the euro area. By the end of 2012, Spanish and 

Italian spreads to German bonds had dropped 

210 and 193 basis points, respectively, and 

other peripheral debt spreads also narrowed 

substantially (Chart 5.1.13). The response 

was even more pronounced in OMT-eligible 

tenors of up to three years. For example, 2-year 

benchmark spreads fell by 348 and 300 basis 

points in Spain and Italy respectively.

Additional measures to promote European 

stabilization further supported European 

sovereign debt markets (see Section 4.4.1). 

These measures include a European Council 

agreement to create a unified banking 

supervision framework for the euro area, 

actions to reduce or restructure the sovereign 

debt of vulnerable countries, and several 

accommodative monetary policy actions by 

the ECB (see Box B: Global Monetary Policy 

Actions). A second extension of 3-year credit 

by the ECB improved the outlook for French 

banks, and allowed yields on French 10-year 

government bonds to fall 98 basis points 

over the course of 2012. Increased appetite 

for higher yielding assets broadly attracted 

investors to peripheral European sovereign 

debt, as official actions to support European 

governments reduced the risk of defaults. 

Finally, TARGET2 balances, which are related 

to cross-border flows within the euro area and 

to ECB actions to support the periphery, halted 

a multi-year increase and began to gradually 

decline, an indication that capital flight 

from periphery to core countries has begun 

to reverse. 

Chart 5.1.13 Euro Area 10-Year Yield Spreads to German Debt

0 

6 

12 

18 

24 

30 

36 

0 

3 

6 

9 

12 

15 

18 

2010 2011 2012 2013 

Source: Bloomberg, L.P. 

Percent As Of: 25-Mar-2013 

5.1.13 Euro Area 10-Year Yield Spreads to German Debt 

Percent 

Greece (right axis) 

Portugal (left axis) 

Spain (left axis) 

Italy (left axis) 

France (left axis) 
Financial Developments 51

Although considerable progress has been 

made, recent political events in Italy and 

Cyprus have served to remind markets that 

the situation in the euro area remains volatile. 

February elections in Italy resulted in a split 

parliament that has thus far been unable to 

form a governing coalition, casting doubt on 

whether a new government, if formed, would 

be strong enough to pursue further reforms. 

More recently, the Cypriot government has 

agreed to restructure its two largest banks by 

forcing losses on their senior bond holders and 

uninsured deposits. It also enacted temporary 

capital controls in order to stem the potential 

for widespread deposit flight. Although the 

restructuring met requirements set by the 

European Union (EU) and the International 

Monetary Fund (IMF) for a new aid package 

and protects insured depositors, the imposition 

of both capital controls and losses on senior 

bondholders and depositors may carry lasting 

implications for the funding costs of other 

European banks that investors consider 

vulnerable. At least initially, developments 

in Cyprus resulted in adverse asset price 

movements in peripheral European countries 

for bank equity prices and funding spreads.

Other Sovereign Debt

Emerging Market sovereign debt spreads 

to U.S. Treasury yields, as measured by the 

Emerging Market Bond Index Plus (EMBI+), 

compressed during the second half of 2012, 

reflecting reduced risks in emerging markets 

and the improvement in risk appetite. Given 

emerging Europe’s tight financial and economic 

links with the euro area, the creation of the 

OMT and subsequent improvement in euro 

area market conditions led emerging Europe’s 

sovereign debt spreads to tighten more than in 

other emerging market regions (Chart 5.1.14).

Foreign Exchange

Changes in the value of the U.S. dollar this 

year followed themes in other financial 

markets. While macroeconomic concerns (both 

foreign and domestic) weighed heavily on 

markets in the summer of 2012, the U.S. dollar 

strengthened slightly on a trade-weighted basis, 

Chart 5.1.14 Emerging Market Bond Spreads

0 

200 

400 

600 

800 

1000 

0 

200 

400 

600 

800 

1000 

Jul:08 Jul:09 Jul:10 Jul:11 Jul:12 

Source: JP Morgan, 

Haver Analytics 

Basis Points As Of: 25-Mar-2013 

5.1.14 Emerging Market Bond Spreads 

Note: JP Morgan EMBI+ Sovereign 

Spreads indices for each region. 

Basis Points 

Latin America 

Europe 

Asia 
52 2013 FSOC / / Annual Report

while dollar volatility has declined significantly 

since last summer (Chart 5.1.15). A notable 

increase in implied volatility occurred recently 

for dollar-yen (Chart 5.1.16).

Since the Japanese party leadership elections 

in September 2012, and through mid-April 

2013, the yen has depreciated sharply against 

all major and other Asian currencies, including 

more than 20 percent against the U.S. dollar 

(Chart 5.1.17). In January, the BOJ announced 

three major policy actions: adoption of a 2 

percent price stability target, plans to begin a 

new “open-ended asset purchasing method” 

starting in 2014, and a joint statement by the 

BOJ and Japanese government on measures 

to overcome deflation and achieve sustainable 

economic growth. In April, the BOJ Policy 

Board approved a new policy framework 

comprised of four main components: (1) 

shifting the policy operating target to the 

quantity of the monetary base; (2) expanding 

the BOJ’s purchases of long-term JGBs and 

extending the average remaining maturity of 

JGB holdings; (3) purchasing more risk assets; 

and (4) committing to maintain the new policy 

framework as long as necessary to maintain 2 

percent inflation “in a stable manner” (see Box 

B: Global Monetary Policy Actions).

Between April and late July 2012, the euro 

depreciated by roughly 9 percent against 

the dollar on concerns about political 

uncertainty in the euro area. Since ECB 

President Draghi spoke in late July about 

stemming redenomination risk and the ECB’s 

subsequent announcement of the OMT, the 

euro appreciated by about 12 percent through 

January 2013, before easing again by the end of 

the first quarter. 

5.1.3 Equities, Commodities, and Agriculture

Equities 

Equity markets in the major economies 

performed well over the past year (Chart 

5.1.18). All major indices in developed 

economies exhibited significant gains, with 

Chart 5.1.15 Dollar Index Volatility 5.1.15 Dollar Index Volatility 

Percent Percent 

Source: Bloomberg, L.P.

As Of: 25-Mar-2013 

Note: Dollar index represents 

30-day historical volatility.

Chart 5.1.16 Currency Implied Volatility

0 

5 

10 

15 

20 

0 

5 

10 

15 

20 

Jan:11 May:11 Sep:11 Jan:12 May:12 Sep:12 Jan:13 

Source: Bloomberg, L.P. 

Percent As Of: 25-Mar-2013 

5.1.16 Currency Implied Volatility 

Percent 

Currency VIX 

1-Month Dollar-Yen 

1-Month Euro-Dollar 

Chart 5.1.17 U.S. Dollar Exchange Rates

70 

80 

90 

100 

110 

120 

130 

140 

150 

70 

80 

90 

100 

110 

120 

130 

140 

150 

Jul:08 Jul:09 Jul:10 Jul:11 Jul:12 

Source: Federal Reserve, 

Haver Analytics 

Index As Of: 25-Mar-2013 

5.1.17 U.S. Dollar Exchange Rates 

Note: 1-Jul-2008 = 100. *Other Important Trading Partners – 

a weighted average of the FX values of the dollar against a 

subset of currencies in the broad index that do not circulate 

widely outside the country of issue. 

Index 

Euro-Dollar 

Major Dollar Index 

OITP* 

Yen-Dollar 
Financial Developments 53

only the IBEX in Spain and FTSE MIB in Italy 

reflecting losses of 2 percent and 5 percent, 

respectively. The rise in equity markets was 

bolstered by an improved global outlook and 

expansionary monetary policy (see Box B: 

Global Monetary Policy Actions). In the United 

States, the price performance of equity indices 

was positive in 2012, with a year-over-year gain 

of nearly 11 percent for the S&P 500. Corporate 

equity valuations improved, as the price-toearnings (P/E) ratio for the S&P 500 rose 

slightly. Still, valuations remain below historical 

averages, reflecting geopolitical uncertainty, 

sluggish economic growth, and event risk 

related to fiscal concerns (Chart 5.1.19). 

Equity markets in emerging economies rose 

considerably through year end 2012, but pulled 

back at the start of 2013, resulting in substantial 

year-over-year declines for Brazil and Russia 

as of March 2013. China experienced mixed 

results due to economic headwinds and growth 

concerns. The Shanghai index fell 1 percent, 

while the Hang Seng returned 8 percent yearover-year through March 2013. Despite the poor 

performance in emerging markets, the rebound 

in equity markets for developed economies 

continues into 2013 (Chart 5.1.20). The S&P 

500 has gained over 45 percent since year end 

2011, while the Euro Stoxx 50 has gained over 

20 percent.

During the first quarter of 2013, expectations of 

U.S. equity market volatility, as measured by the 

VIX, fell to levels not reached since April 2007. 

In 2012, volatility of the major stock indices 

of developed economies was high during the 

summer, but fell significantly in early August 

with the announcement of ECB support for 

euro area debt markets. Volatility rose again 

in the fall, before receding significantly at 

year end following the passage of legislation 

averting the fiscal cliff (Chart 5.1.21). The 

term structure of the VIX, which measures the 

difference between near-term and long-term 

market expectations of volatility, flattened 

markedly around year end, in a similar manner 

Chart 5.1.18 Returns in Selected Equities Indices

Change from 

25-Mar-2012 to 

25-Mar-2013 

Change from 

5-Year Low to 

25-Mar-2013 

Major Economies

U.S. (S&P) 11% 129% 

Euro (Euro Stoxx) 5% 46% 

Japan (Nikkei) 25% 78% 

U.K. (FTSE) 9% 82% 

Selected Europe 

Germany (DAX) 13% 115% 

France (CAC) 7% 48% 

Italy (FTSEMIB) -5% 27% 

Spain (IBEX) -2% 37% 

Emerging Markets 

Brazil (Bovespa) -17% 86% 

Russia (RTS) -12% 193% 

India (Sensex) 8% 129% 

China (Shanghai SE) -1% 36% 

Hong Kong (Hang Seng) 8% 102% 

5.1.18 Returns in Selected Equities Indices 

Source: Capital IQ 

Chart 5.1.19 S&P 500 Key Ratios 5.1.19 S&P 500 Key Ratios 

Percent Percent 

Source: Bloomberg, L.P.

P/B Ratio 

(right axis) 

P/E Ratio 

(left axis) 

As Of: 25-Mar-2013 

Chart 5.1.20 Selected Equities Indices

40 

60 

80 

100 

120 

140 

40 

60 

80 

100 

120 

140 

Jul:08 Jul:09 Jul:10 Jul:11 Jul:12 

Source: Haver Analytics 

Index As Of: 25-Mar-2013 

5.1.20 Selected Equities Indices 

Note: 1-Jul-2008 = 100. 

Index 

S&P 500 

MSCI EM 

Euro Stoxx 50 

Nikkei 225 
54 2013 FSOC / / Annual Report

as in August 2011 during the height of the 

debt ceiling debate. This flattening of the term 

structure suggested that as a result of increased 

fiscal cliff concerns, expectations of near-term 

volatility were rising while long-term volatility 

expectations remained relatively unchanged 

(Chart 5.1.22). With market expectations of 

equity volatility declining to pre-crisis levels, 

investors may take on increased risk that could 

expose them to significant losses in the event 

of a severe reversal (see Section 7.4).

Commodities

Oil prices continued to exhibit heightened 

volatility in 2012, as increasing geopolitical 

uncertainty in the Middle East caused oil 

prices to increase significantly early in the 

year. Specifically, in July the Iran oil sanctions 

took full effect, sharply reducing oil exports 

from the country. Later in the year, substantial 

production increases in the U.S. and in 

members of the Organization of Petroleum 

Exporting Countries (OPEC) (Chart 5.1.23), 

coupled with concerns of decreasing global 

demand, caused a sharp decline in oil prices 

in the summer, with prices moderating by year 

end. Unleaded gasoline prices in the United 

States also sharply increased in early 2012, and 

after moderating in December 2012, advanced 

early this year following sharp increases in 

crude oil futures prices (Chart 5.1.24). Natural 

gas and agricultural prices were volatile 

throughout 2012, but ended the year nearly 

unchanged and have remained stable in early 

2013 (Chart 5.1.25). Industrial metal prices 

dropped severely around mid-year, only to 

rise again through the fall, and close the year 

with only a slight increase. Gold prices rose 

dramatically early in the year, but eventually 

subsided, increasing only slightly over the 

course of 2012 (Chart 5.1.26). 

Agriculture

Strong agricultural conditions have spurred 

farmland values to rise to record levels. Across 

the United States, the average price per acre 

of farm real estate increased by 108 percent 

over the past decade (Chart 5.1.27). The 

most significant drivers of U.S. agricultural 

Chart 5.1.21 Market Volatility 5.1.21 Market Volatility 

Percent Percent 

Source: Capital IQ 

As Of: 25-Mar-2013 

Chart 5.1.22 VIX Term Premium

-1500 

-1000 

-500 

0 

500 

1000 

1500 

-1500 

-1000 

-500 

0 

500 

1000 

1500 

2010 2011 2012 2013 

Source: Bloomberg, L.P. 

Basis Points As Of: 25-Mar-2013 

5.1.22 VIX Term Premium 

Basis Points 

Spread between 8-Month 

and 1-Month Forward Rates 

Chart 5.1.23 Oil Production

2 

3 

4 

5 

6 

7 

8 

24 

28 

32 

36 

40 

2002 2004 2006 2008 2010 2012 

Source: Energy Intelligence, Haver Analytics 

Millions of Barrels/Day As Of: Feb-2013 

5.1.23 Oil Production 

Millions of Barrels/Day 

OPEC (left axis) 

United States (right axis) 

Iran (right axis) 
Financial Developments 55

prosperity, including commodity prices, export 

levels, and interest rates, have been near cyclical 

bests for a few years. A number of Corn-Belt 

and Plains states, where a major stock of corn, 

soybeans, and wheat are grown, experienced 

relatively large crop price increases. These 

crops all experienced price spikes in June and 

July and remained elevated for most of the year 

(Chart 5.1.28). 

The current high price of farmland raises 

concerns about a repeat of the early 1980s 

agricultural crisis, when several hundred 

farm banks failed. However, compared to the 

early 1980s, the recent increase in farmland 

prices have not coincided with a shift towards 

higher leverage of either lenders or borrowers. 

Although total agricultural real estate debt 

outstanding increased by 65 percent over the 

past decade, it still remains well below the 

levels seen in the early 1980s (Chart 5.1.29). 

Moreover, evidence suggests that the most 

frequent buyers of farmland are farmers who 

are looking to expand their current capacity, 

rather than investors who could be speculating 

on land prices. 

While agricultural debt and farmland lending 

continues to grow, many of the farm banks 

operating in the United States that are issuing 

this debt tend to be small, rural, communitybased lenders that have been characterized 

as more conservative lenders. Many of these 

banks require that the borrower’s existing 

farmland also be taken as collateral, limiting 

the potential increase in the borrower’s loan-tovalue ratio (LTV) and the bank’s exposure to 

a future decline in farmland prices. Although 

farmland lending is important to a significant 

number of these rural community banks, it 

does not represent a significant share of credit 

in large U.S. banks. Furthermore, various crop 

insurance programs mostly mitigated crop 

losses due to the drought during the summer of 

2012. Still, increasing farmland values and the 

willingness of banks to provide financing based 

on those values, warrants increased monitoring. 

Chart 5.1.24 S&P GSCI Unleaded Gasoline Index 5.1.24 S&P GSCI Unleaded Gasoline Index 

Index Index 

Source: Capital IQ 

As Of: 25-Mar-2013 

Chart 5.1.25 Commodities

0 

20 

40 

60 

80 

100 

120 

140 

0 

20 

40 

60 

80 

100 

120 

140 

Jul:08 Jul:09 Jul:10 Jul:11 Jul:12 

Source: Energy Information Administration, 

S&P, Wall Street Journal, Haver Analytics 

Index As Of: 25-Mar-2013 

5.1.25 Commodities 

Note: 01-Jul-2008 = 100. 

Index 

Agriculture (S&P GSCI Agricultural Spot Index) 

Industrial Metals (S&P GSCI Industrial Metals Spot Index) 

Crude Oil 

Natural Gas 

Chart 5.1.26 Gold Prices

1200 

1300 

1400 

1500 

1600 

1700 

1800 

1900 

2000 

1200 

1300 

1400 

1500 

1600 

1700 

1800 

1900 

2000 

Jan:11 May:11 Sep:11 Jan:12 May:12 Sep:12 Jan:13 

Source: Wall Street Journal, Haver Analytics 

Dollars/Troy Oz. As Of: 25-Mar-2013 

5.1.26 Gold Prices 

Dollars/Troy Oz. 
56 2013 FSOC / / Annual Report

5.1.4 Real Estate Markets

Housing Market Overview

The past year witnessed a fragile, but steady, 

recovery in the housing market. Home prices 

rose 5.5 percent in 2012 according to the 

FHFA (Chart 5.1.30). However, house prices 

on a national basis remain approximately 30 

percent below their 2006 peak, according to 

the CoreLogic Home Price Index. A number of 

factors continue to affect the recovery in home 

prices, including elevated unemployment, large 

shadow inventories of distressed homes, and 

lingering concerns about economic growth. 

At the end of 2012, the fraction of residential 

properties with mortgages in negative equity 

declined significantly to 21.5 percent, from over 

25 percent at the end of 2011 (Chart 5.1.31). 

New and existing home sales are rising, though 

they remain below pre-crisis highs. According 

to the National Association of Realtors, the 

seasonally adjusted annual pace of existing 

home sales was approximately 4.98 million units 

as of February 2013, up 10.2 percent from one 

year prior. Census Bureau statistics show the 

seasonally adjusted annual pace of new single 

family home sales was 411,000 units in February 

2013, representing a 12.3 percent increase 

from one year prior. These figures suggest that 

housing is rebounding, albeit off low levels of 

activity, and contributed to economic growth 

throughout 2012.

Indicators of credit quality in the residential 

mortgage sector continue to improve. As of 

fourth quarter 2012, there was a decline in the 

number of loans 90 or more days delinquent 

but not in foreclosure, continuing a trend that 

began in late 2009. Mortgage delinquencies in 

this category have declined from a high of 5.1 

percent of all mortgages to 3 percent, but the 

share of mortgages in the foreclosure process 

has declined only modestly and is currently 

about 3.7 percent of all mortgages (Chart 

5.1.32). Both foreclosures and reductions in 

newly-delinquent loans during 2010, 2011, and 

2012 have contributed to the decline in 90+ day 

Chart 5.1.27 Farmland Prices and Value of Crop Yield 5.1.27 Farmland Prices and Value of Crop Yield 

US$ Per Acre US$ Per Acre 

Source: USDA, 

FSOC calculations 

Farmland 

(left axis) 

Crop Yield* 

(right axis) 

As Of: 2012 

Note: *US$ value of crops grown per 

acre for corn, wheat, and soybeans. 

Land values estimated as of Aug-2012. 

Chart 5.1.28 Agricultural Prices

0 

200 

400 

600 

800 

0 

200 

400 

600 

800 

2002 2004 2006 2008 2010 2012 

Source: S&P, Haver Analytics 

Index As Of: Feb-2013 

5.1.28 Agricultural Prices 

Index 

S&P GSCI Soybean Spot Index 

S&P GSCI Wheat Spot Index 

S&P GSCI Corn Spot Index 

Chart 5.1.29 Agricultural Real Estate Debt Outstanding

0 

50 

100 

150 

200 

250 

300 

350 

0 

50 

100 

150 

200 

250 

300 

350 

1967 1975 1983 1991 1999 2007 

Source: BLS, Federal Reserve, 

Haver Analytics 

Billions of US$ As Of: 2012 

5.1.29 Agricultural Real Estate Debt Outstanding 

Note: Dollars are presented 

using 2011 prices. 

Billions of US$ 

Commercial Banks 

Other 

Life Insurance Companies 

Farm Credit System 
Financial Developments 57

delinquency rates. Loans originated in 2009 

and 2010 experienced much lower rates of early 

delinquency, compared to loans originated 

in the middle of the decade. The number 

of properties in foreclosure is declining, but 

remains high compared to historical levels.

Home Mortgage Originations and Access to Credit

Prior to the financial crisis, private portfolios 

and securitizations funded more than half 

of all home mortgage originations. This 

pattern reversed after the financial crisis, with 

mortgages eligible for government and agency 

guarantee programs accounting for no less than 

three-fourths of annual originations. During 

2012, this trend continued with government 

and agency guarantees backing approximately 

89 percent of all originated mortgages (Chart 

5.1.33), 69 percent of which were guaranteed 

by the GSEs. 

In 2012, the Federal Housing Administration 

(FHA) and the Department of Veterans Affairs 

(VA) guaranteed 20 percent of originated 

mortgages. FHA- and VA-guaranteed loans 

make up a majority of Ginnie Mae MBS 

issuances. Between 2001 and 2007, FHA lending 

accounted for less than 5 percent of annual 

originations. The market share for FHA lending 

was small at the time because eligible borrowers 

were primarily receiving non-agency loans 

funded through securitization. After secondarymarket investors retreated from private-label 

securities after the crisis, FHA lending became 

the dominant avenue for low- to middle-income 

mortgage market credit. 

The private capital assuming credit risk in 

the marketplace today comes predominantly 

from depository institutions through portfolio 

lending in mostly prime credit for jumbo loans, 

or loans that are larger than conforming limits. 

There is, however, growing demand amongst 

non-depository private capital for both new and 

older issues of non-agency loans and securities. 

In a related development, many large depository 

institutions are reducing their mortgage 

Chart 5.1.30 National Repeat Sales Home Price Indices

100 

120 

140 

160 

180 

200 

220 

100 

120 

140 

160 

180 

200 

220 

2000 2002 2004 2006 2008 2010 2012 

Source: CoreLogic, FHFA, 

FSOC calculations 

Index As Of: Jan-2013 

5.1.30 National Repeat Sales Home Price Indices 

Note: Gray bars signify NBER recessions. 

Index 

CoreLogic 

(including 

distressed sales) CoreLogic 

(excluding 

distressed sales) 

FHFA 

Chart 5.1.31 Mortgages with Negative Equity 5.1.31 Mortgages with Negative Equity

Billions of US$ Percent 

Source: CoreLogic 

As Of: 2012 Q4 

Chart 5.1.32 Mortgage Delinquency and Foreclosure

0 

1 

2 

3 

4 

5 

6 

0 

1 

2 

3 

4 

5 

6 

2000 2002 2004 2006 2008 2010 2012 

Source: Mortgage Bankers Association, 

Haver Analytics 

Percent As Of: 2012 Q4 

5.1.32 Mortgage Delinquency and Foreclosure 

Note: Percent of all mortgages. 

Percent 

Mortgage Foreclosure 

Inventory 

Mortgage Payments 

Past-Due 90+ Days 
58 2013 FSOC / / Annual Report

servicing activity and removing potential risk 

from their balance sheets by selling servicing 

rights to nonbank servicers, which are not 

subject to the same capital requirements 

as banks. Mortgage servicing rights at U.S. 

commercial banks and thrifts have declined by 

more than half since their peak in mid-2008 

(Chart 5.1.34). Driven by refinancing activity, 

mortgage origination volumes in 2012 exceeded 

$1.8 trillion for the first time since 2009. Over 

the past four years, refinances have accounted 

for over two-thirds of total originations. With 

mortgage interest rates at historic lows during 

2012, refinance activity increased from $880 

billion in 2011 to $1.4 trillion in 2012, which 

represented over 75 percent of all originations 

(Chart 5.1.35). Purchase volumes continued to 

contract during 2012, falling to $437 billion, the 

lowest level in over a decade.

For the fifth year in a row, the average FICO 

credit score for borrowers at origination rose in 

2012, exceeding 750, with purchase borrowers 

with FICO scores above 760 accounting for 45 

percent of originations (Chart 5.1.36). The 

share of purchase borrowers with a FICO score 

below 600 dropped from 14 percent in 2008 to 

less than 2 percent in 2012. 

Back-end debt-to-income (DTI), which is the 

ratio of all debt payments including the new 

mortgage payment— inclusive of principal, 

interest, insurance and taxes— to the 

borrower’s gross monthly income, declined 

across all major loan programs during 2012 

(Chart 5.1.37). The back-end DTI for GSEguaranteed loans declined from a year end 

2007 peak of nearly 39 percent to 33 percent at 

year end 2012. The average DTI on the smaller 

set of purchase loans originated and retained 

in bank portfolios declined from 38 percent in 

2011 to 34 percent in 2012. 

Overall, current mortgage market conditions 

indicate reduced access to credit for many 

potential U.S. borrowers. As average 

underwriting standards have tightened 

considerably, the lower bound of credit 

characteristics on approved loans is much more 

Chart 5.1.33 Mortgage Originations by Program 5.1.33 Mortgage Originations by Program 

Share of Originations Share of Originations 

Source: Inside Mortgage Finance 

As Of: 2012 

VA FHA 

GSE 

Private 

Portfolio and 

Securitized 

2002 2004 2006 2008 2010 2012 

0.0 

0.2 

0.4 

0.6 

0.8

1.0

0.0

0.2

0.4

0.6

0.8

1.0

Chart 5.1.34 Mortgage Servicing Rights at U.S. Commercial 

Banks and Thrifts 5.1.34 Mortgage Servicing Rights at U.S. Commercial Banks and Thrifts 

Billions of US$ Billions of US$ 

Source: SNL Financial 

As Of: 2012 Q4 

Chart 5.1.35 Mortgage Originations by Type 5.1.35 Mortgage Originations by Type 

Trillions of US$ Trillions of US$ 

Source: Inside Mortgage 

Finance, HUD, CoreLogic 

As Of: 2012 
Financial Developments 59

stringent than the minimum requirements set 

by the GSEs and FHA. For example, according 

to the FHA guidelines for manual underwriting 

of a loan with the maximum 96.5 percent LTV, 

borrowers must have a FICO score greater than 

580 and a DTI of less than 43 percent (Chart 

5.1.38). Despite this minimum requirement, 

the fifth percentile FICO score of FHA first 

lien purchase loans originated during 2012 

was 635, with the average DTI and LTV 

associated with those loans at 36 percent 

and 95 percent, respectively.

In addition, for manual underwriting of a 

one-unit, fixed rate loan with no minimum 

reserves, the GSEs require that borrowers have 

a minimum FICO score of 620, a DTI of less 

than 36 percent, and a LTV of less than 75 

percent. But during 2012, the fifth percentile 

of first lien GSE purchase loans by FICO score 

at origination was 686, while the average DTI 

on those loans was 35 percent. Current market 

requirements that exceed the minimums set by 

the GSEs limit credit availability for borrowers 

at the lower end of the FICO distribution. 

Federal Government Programs to Strengthen the 

Housing Market

The government has developed a number of 

programs to strengthen the housing market, 

primarily by providing relief to struggling 

homeowners. These programs include 

Making Home Affordable (MHA), the Home 

Affordable Refinance Program (HARP), the 

FHA Streamline Refinance program, and the 

Hardest Hit Fund (HHF). MHA provides first 

lien modifications primarily through the Home 

Affordable Modification Program (HAMP), 

and also includes a second-lien modification 

program, an unemployment forbearance 

program, and a short-sale or deed-in-lieu-offoreclosure program.

As of December 2012, MHA has granted 

nearly 1.5 million homeowner assistance 

actions. HAMP has enrolled over 1.1 million 

borrowers as of December 31, 2012, and 

servicers have offered substantial concessions 

to borrowers through modifications that 

Chart 5.1.36 Origination Volume by Credit Score 5.1.36 Origination Volume by Credit Score 

Share of Origination Volume Share of Origination Volume 

Source: CoreLogic 

As Of: 2012 

Note: Includes first lien purchases only. 

<600 

600-660 

660-700 

700-720 

720-760 

>760 

Chart 5.1.37 Average Debt-to-Income Ratio at Origination 5.1.37 Average Debt-to-Income Ratio at Origination 

Percent Percent 

Source: CoreLogic 

GSE 

All Loans 

Portfolio

GNMA

As Of: 2012 

Note: Includes first lien purchases only. 

Chart 5.1.38 Minimum Eligibility Standards for Government 

Purchase Loans 5.1.38 Minimum Eligibility Standards for Government Purchase Loans 

Source: HUD Handbook, Fannie Mae Eligibility Matrix 

FHA FANNIE MAE 

Minimum Manual 

Underwriting Standards 

Minimum Manual 

Underwriting Standards 

Purchase, 1-unit, Fixed-rate 

with No Minimum Reserves 

Purchase, 1-unit, Fixed-rate 

with No Minimum Reserves 

FICO* ≥ 580 FICO ≥ 620 

Debt-toIncome ≤ 43% Debt-toIncome ≤ 36% 

Loan-toValue ≤ 96.5% Loan-toValue ≤ 75% 

*Required for a maximum LTV of 96.5%. FHA will accept FICO 

scores between 500 and 579 with a maximum LTV of 90%. 
60 2013 FSOC / / Annual Report

reduce the borrowers’ monthly payments. 

The incidence of principal reduction in 

HAMP modifications increased in 2012, 

with approximately three-fourths of eligible 

underwater homeowners who entered HAMP 

that year receiving some form of principal 

reduction. According to the OCC, payment 

reduction is strongly correlated with permanent 

modification sustainability, and HAMP 

modifications exhibit lower delinquency and 

re-default rates than industry modifications. In 

addition, the FHA has offered more than 1.5 

million loss mitigation and early delinquency 

interventions. The Administration’s programs 

continue to encourage improved standards and 

processes in the industry, with HOPE Now (a 

foreclosure prevention outreach effort) lenders 

offering more than three million proprietary 

modifications through November 2012. Since 

2009, over six million mortgage modifications 

have been made, and homeowner assistance 

actions have outpaced foreclosures by a 

two-to-one ratio.

The HARP and FHA Streamline Refinance 

programs, both of which target underwater 

borrowers, provided approximately $300 billion 

in refinances during 2012. In early 2012, FHFA 

expanded HARP eligibility by eliminating the 

125 percent LTV cap. As a primary result of 

this change, HARP originations grew from 

$85 billion in 2011 to $230 billion during 2012, 

comprising over 12 percent of all originations. 

The FHA’s Streamline Refinance program, 

which also aims to help underwater borrowers 

lock in lower rates, provided an additional $65 

billion in originations during 2012.

The Treasury’s HHF, announced in 2010, 

provides $7.6 billion to housing finance 

authorities in the 18 states and the District of 

Columbia that were most affected by house 

price declines and high unemployment. 

These funds have been used to develop 

programs tailored to local housing markets, 

including mortgage payment assistance 

for unemployed borrowers, reinstatement 

programs, principal reduction, and transition 

assistance for borrowers.
Financial Developments 61

Government-Sponsored Enterprises

As housing and mortgage market conditions 

improved this past year, the financial strength 

of Fannie Mae and Freddie Mac increased. 

For the fourth quarter of 2012, Freddie Mac 

reported net income of $4.5 billion, the fifth 

quarter in a row that its net income was positive. 

Fannie Mae reported significant net income 

for the fourth quarter of 2012, and net income 

was positive for each quarter of the year 

(Chart 5.1.39). In 2012, Fannie Mae did not 

request additional capital support from the 

government while Freddie Mac requested 

additional capital support from the government 

of $19 million; both institutions have returned 

to profitability. 

The GSEs and Ginnie Mae continued to 

account for essentially all issuances of 

residential mortgage-backed securities (RMBS) 

(Chart 5.1.40). In 2012, the GSEs accounted 

for 77 percent of RMBS issuances, considerably 

higher than pre-crisis levels, with almost all 

of the remaining RMBS issuances coming 

from Ginnie Mae. As of January 2013, Fannie 

Mae and Freddie Mac both reported serious 

delinquency rates for single-family mortgages 

(90+ day delinquencies and in-process 

foreclosures) of 3.2 percent, representing their 

lowest rates since 2009. This decline in serious 

delinquencies, which has occurred over the past 

10 quarters, is driven in part by the reduction in 

2005 to 2008 vintage mortgages relative to their 

portfolios, and is consistent with the decline in 

delinquencies and new delinquencies seen in 

the broader mortgage market in 2012. 

In 2012, the Treasury and FHFA made key 

changes to support provided under the Senior 

Preferred Stock Purchase Agreements (PSPAs) 

between the Treasury and the GSEs. Three 

key changes were made to the agreements with 

respect to dividend payments, GSE portfolio 

reduction, and additional taxpayer protections. 

First, dividends payable to the Treasury are 

now a quarterly net worth sweep, or a payment 

of income earned in the quarter by the GSEs, 

rather than the original terms, which consisted 

of a 10 percent dividend on outstanding senior 

Chart 5.1.39 GSE Net Income

-35 

-30 

-25 

-20 

-15 

-10 

-5 

0 

5 

10 

-35 

-30 

-25 

-20 

-15 

-10 

-5 

0 

5 

10 

2006 2007 2008 2009 2010 2011 2012 

Source: SNL Financial 

Billions of US$ As Of: 2012 Q4 

5.1.39 GSE Net Income 

Billions of US$ 

Fannie Mae 

Freddie Mac 

Chart 5.1.40 Issuance of RMBS 5.1.40 Issuance of RMBS 

Trillions of US$ Trillions of US$ 

Source: Thomson Reuters, Dealogic, 

Fannie Mae, Freddie Mac, SIFMA 

As Of: 2012 
62 2013 FSOC / / Annual Report

preferred stock. This change was made to 

eliminate the possibility of the GSEs having 

to borrow from the Treasury to pay dividends, 

which could have eroded market confidence in 

the GSEs. Second, the GSEs are now required 

to contract their portfolios at an annual rate of 

15 percent— an increase from the 10 percent 

annual reduction called for previously. This 

change implies that the GSEs will reduce their 

portfolios to $250 billion four years earlier than 

previously scheduled. Third, each GSE, under 

the direction of the FHFA, will be required 

to submit to the Treasury an annual risk 

management plan that will outline the steps 

that the GSEs are taking to reduce taxpayer 

exposure to mortgage credit risk within the 

GSEs’ guarantee books of business and 

retained portfolios. 

In 2012, FHA continued to play a critical role 

in supporting the ongoing recovery of the 

nation’s housing market and broader economy. 

FHA insured nearly 1.2 million single-family 

mortgage loans during the year, with a total 

dollar value of approximately $213 billion. 

The services that FHA single-family programs 

provide to the nation’s housing sector are made 

possible through FHA’s Mutual Mortgage 

Insurance Fund. On November 16, 2012, 

the U.S. Department of Housing and Urban 

Development (HUD) released its fiscal year 

2012 Report to Congress on the Financial 

Status of the FHA Mutual Mortgage Insurance 

Fund. That report summarized the results of an 

independent actuarial measure of the economic 

net worth of FHA’s portfolio— essentially, the 

total value of the portfolio after FHA pays all 

expected claims for the next 30 years in a runoff scenario in which no new loans are insured. 

According to this Report to Congress, in fiscal 

year 2012 the capital reserve ratio of the Fund 

fell to negative 1.44 percent, and the Fund’s 

economic value stands at negative $16.3 billion. 

Earlier books of business are the primary 

source of stress to the Mutual Mortgage Fund, 

with approximately $70 billion in claims 

attributable to the 2007 to 2009 vintage books 

alone. While the actuary attests to the high 

quality and profitability of books insured since 
Financial Developments 63

2010, significant unrecognized risks may remain 

in the portfolio. Work is ongoing to mitigate 

the impacts to the Mutual Mortgage Fund of 

losses stemming from the 2007 to 2009 books, 

which were those most severely impacted by the 

recession, declines in home prices, and other 

risk factors.

Commercial Real Estate

The commercial real estate sector has 

improved, with prices rising slightly and CMBS 

issuance gaining strength in 2012. The past year 

witnessed the strongest post-crisis credit flows 

for commercial real estate (CRE), with almost 

$100 billion in CMBS issuance (Chart 5.1.41). 

This amount of issuance represents an increase 

of approximately 50 percent over the prior 

year, although these levels are still much lower 

than pre-crisis amounts. Given the low interest 

rate environment, investor demand has been 

quite strong, with non-agency credit spreads 

for the most senior debt tightening by about 90 

basis points in 2012 (Chart 5.1.42). The loans 

underlying these CMBS are mainly backed by 

multi-family, office, retail, and other related 

properties. Credit performance, as measured 

by the ratio of rating upgrades to downgrades, 

has risen in recent years. However, the sector 

remains vulnerable to refinancing risks in the 

event of a sharp rise in interest rates, in which 

event some currently-profitable properties 

might no longer support their financing 

payments, potentially leading to increased 

defaults. The greater uncertainty surrounding 

interest rates in later years is compounded by 

the fact that over $1.2 billion in CRE loans will 

be maturing in 2016 to 2018, compared to less 

than $1 billion in 2013 to 2015 (Chart 5.1.43).

Market participants have expressed concern 

that most commercial real estate credit flows 

to date have been concentrated too heavily on 

the trophy properties in major markets. While 

possibly reflective of differential demand, 

this trend is seen in recent commercial 

property price indices, which reflect moderate 

improvements on the national level since 

2010, but more significant price gains in major 

Chart 5.1.41 CMBS New Issuance 5.1.41 CMBS New Issuance 

Billions of US$ Billions of US$ 

Source: Commercial Mortgage Alert 

As Of: 2012 

Chart 5.1.42 CMBS Senior Debt Spreads 5.1.42 CMBS Senior Debt Spreads 

Basis Points Basis Points 

Source: Barclays 

As Of: 21-Mar-2013 

Note: Spread of Non-Agency 3.0 

AAA 5-Year CMBS to Swaps. 

Chart 5.1.43 CRE Refinancing 5.1.43 CRE Refinancing 

Billions of US$ Billions of US$ 

Source: Flow of Funds, 

Barclays, Trepp 

As Of: 2012 

Note: Issuance and distribution of maturities for 

commercial banks and savings institutions, insurance 

companies, and GSEs and Fed-related mortgage 

pools are estimated. 
64 2013 FSOC / / Annual Report

markets. In 2012, non-distressed markets 

continued to outperform the national average 

(Chart 5.1.44). The variation in credit flows 

to different property types can be seen in 

the MBA Commercial/Multifamily Bankers 

Originations Index, which shows that while 

originations across all types of properties rose 

in 2012, they rose to significantly different 

degrees. Hotel originations led all other groups, 

rising 61 percent over the prior year, followed by 

multifamily originations, which rose 36 percent 

over the prior year. In contrast, health care 

originations, which fell significantly during the 

crisis, rose only 6 percent over the prior year. 

5.2 Wholesale Funding Markets

5.2.1 Interbank Markets

Short-term wholesale funding markets provide 

financial intermediaries with funds that 

supplement retail deposits and long-term 

debt issuance (Chart 5.2.1). These funds 

include large time deposits, certificates of 

deposit, repurchase agreements (repos), and 

commercial paper. Sources of funds in these 

markets are largely wholesale cash pools, 

including cash on the balance sheets of 

nonfinancial companies, reinvestments of cash 

collateral from securities lending, and cash 

held by long-term mutual funds, money market 

mutual funds, pension funds, and sovereign 

wealth funds. These sources of funds have 

grown markedly as a percentage of GDP over 

the past two decades, although this percentage 

has been declining since early 2008 (Chart 

5.2.2). Cash on nonfinancial corporate balance 

sheets, in particular, has been growing at an 

accelerating rate, a pattern that continued 

through the fourth quarter of 2012. 

Domestic banking firms’ reliance on short-term 

wholesale funding continued to decline in 

2012, as retail deposits grew (Chart 5.2.3). The 

longer-term stability and cost of deposit inflows 

during this low interest rate period will be key 

Chart 5.1.44 Commercial Property Price Indices 5.1.44 Commercial Property Price Indices 

Index Index 

Source: Real Capital Analytics, 

MoodyĀs Investors Service 

MoodyĀs/RCA CPPI – Non-Distressed, National 

MoodyĀs/RCA CPPI – National 

MoodyĀs/RCA CPPI – Non-Distressed, Major Markets 

Note: Mar-2008 = 100. 

MoodyĀs/RCA CPPI – Major Markets 

As Of: Oct-2012 

Chart 5.2.1 Large Bank Holding Company Liability Structure 5.2.1 Large Bank Holding Company Liability Structure 

Source: FDIC, 

FR Y-9C 

Share of Total Share of Total 

Capital 

Debt >1yr 

Insured Deposits 

Uninsured Domestic Deposits 

Foreign Deposits 

Debt <1yr 

Repo 

Other* 

As Of: 2012 Q4 

Note: *Other = commercial paper, derivative payables, securities sold 

short and everything categorized as Other reported in FR Y-9C. 

Chart 5.2.2 Wholesale Cash Investors

0 

1000 

2000 

3000 

4000 

5000 

6000 

7000 

0 

10 

20 

30 

40 

50 

1990 1994 1998 2002 2006 2010 

Source: Flow of Funds, ICI, U.S. 

Department of Treasury, Haver Analytics 

Percent As Of: 2012 Q4 

5.2.2 Wholesale Cash Investors 

Billions of US$ 

Long-Term Mutual Funds 

Securities Lending Reinvestments 

Nonfinancial Corporations 

Money Market Mutual Funds 

Wholesale Cash Pools 

as a Percent of GDP 

(left axis) 

right axis 
Financial Developments 65

to funding and interest rate risk projections in 

the future. 

Enhanced central bank provisions of liquidity, 

combined with a significant reduction of 

European banks’ dollar funding needs as they 

deleverage their balance sheets, has contributed 

to a reduction in the premium for borrowing 

dollars via foreign exchange (FX) swap markets 

to the lowest level since early 2011 (Chart 

5.2.4). This overall normalization in the FX 

swap market and the improved access to dollar 

funding for European banks, was supported by 

the November 2011 decrease in the interest rate 

charged on central bank liquidity swaps and 

the ECB’s two 3-year longer-term refinancing 

operations, along with other actions to 

strengthen the euro area’s institutional and 

fiscal framework. The decision to include a 

levy on bank deposits in the Cyprus bailout 

terms was associated to a modest uptick in the 

premium for borrowing U.S. dollars against the 

euro in March 2013. 

5.2.2 Commercial Paper and Asset-Backed 

Commercial Paper

Commercial paper (CP) outstanding peaked 

at $2.2 trillion in July 2007 and stood at $1.0 

trillion in February 2013, primarily due to the 

continuing decline in asset-backed commercial 

paper (ABCP) outstanding (Chart 5.2.5). As of 

February 2013, ABCP accounts for 28 percent 

of all outstanding CP, financial CP accounts 

for 51 percent, and nonfinancial corporate 

CP accounts for 21 percent. Financial CP and 

certificates of deposit (CDs) outstanding are 

around 40 to 50 percent below their pre-crisis 

peaks. After contracting sharply in 2011, largely 

due to investor concerns about European 

debt, CP outstanding at financial institutions 

with European parents remained stable in the 

second half of 2012 and has increased notably 

in early 2013. Even so, financial CP outstanding 

with European parents remains well below the 

levels seen in early 2011. 

5.2.3 Repo Markets 

A repurchase agreement (repo) is the sale 

of securities for cash with an agreement to 

Chart 5.2.3 Composition of Bank Short-Term Funding

40 

60 

80 

100 

120 

140 

160 

4 

5 

6 

7 

8 

9 

10 

2003 2005 2007 2009 2011 

Source: FDIC, Federal Reserve, 

Haver Analytics 

Trillions of US$ As Of: 2012 Q4 

5.2.3 Composition of Bank Short-Term Funding 

Percent 

Short-Term 

Wholesale Funding 

(left axis) 

Wholesale as a Percent 

of Retail Deposits 

(right axis) Retail Deposits 

(left axis) 

Chart 5.2.4 Premium for Borrowing Dollars for 1 Year 5.2.4 Premium for Borrowing Dollars for 1 Year 

Basis Points Basis Points 

Source: Bloomberg, L.P.

vs. Euros 

vs. Yen 

As Of: 25-Mar-2013 

Chart 5.2.5 Commercial Paper Outstanding

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

2005 2006 2007 2008 2009 2010 2011 2012 2013 

Source: Federal Reserve, Haver Analytics 

Trillions of US$ As Of: Feb-2013 

5.2.5 Commercial Paper Outstanding 

Trillions of US$ 

Corporate Issuers 

Financial Issuers 

ABCP 
66 2013 FSOC / / Annual Report

repurchase the securities at a specified date 

and price. This agreement effectively creates 

a secured loan with securities as collateral. 

Securities broker-dealers play a significant role 

in repo markets. There are three repo market 

segments: the tri-party market, in which brokerdealers obtain funding from cash investors and 

transact utilizing the collateral management 

and settlement services of the two tri-party repo 

clearing banks (JPMorgan Chase and Bank 

of New York Mellon); the General Collateral 

Finance (GCF) market, which primarily settles 

inter-dealer transactions on the tri-party 

repo platform; and bilateral repo, in which 

transactions are executed without the services 

of the two tri-party clearing banks.6

Repo activity continued to increase in 2012, 

both as measured in the tri-party repo statistics 

and in the primary dealer survey (Chart 5.2.6). 

Market participants have noted that some firms 

have extended maturities for certain repo 

collateral, indicating an increased willingness 

of some participants to provide longerterm funding in this market (Chart 5.2.7). 

However, haircuts in the tri-party market on 

collateral that is not eligible for use in open 

market operations (OMO) have not declined, 

indicating an unchanged stance towards 

collateral quality and potential price volatility.

The majority of tri-party repo financing 

remains collateralized by Treasury securities, 

agency MBS, agency debentures, and agency 

collateralized mortgage obligations (CMOs). 

As of February 2013, these types of collateral 

accounted for 84 percent of all tri-party repo 

collateral (Chart 5.2.8). The other 16 percent 

of collateral used in tri-party repo includes 

corporate bonds, equities, private label CMOs, 

ABS, CP, other money market instruments, 

whole loans, and municipal bonds. As is true 

in the securities lending market, repo markets 

can be used to effect collateral transformation 

(see Section 5.2.4 for more detail on collateral 

transformation trades).

Chart 5.2.6 Value of the Repo Market

Trillions of US$ illions of US$

5.2.6 Value of the Repo Market 

Trillions of US$ 

Note: Limited data were provided by clearing 

banks prior to April 2008. These figures are 

estimates based on the data provided. Gray bar 

signifies NBER recession. 

As Of: Feb-2013 

Tri-Party Repo 

Market 

FR 2004 Primary 

Dealer Repo 

Source: FRBNY, Haver Analytics 

Chart 5.2.7 Primary Dealer Repo Agreements 5.2.7 Primary Dealer Repo Agreements 

Trillions of US$ As Of: 20-Mar-2013 Trillions of US$ 

Source: FRBNY 

Chart 5.2.8 Tri-Party Repo Collateral Distribution 5.2.8 Tri-Party Repo Collateral Distribution 

Source: FRBNY,

Haver Analytics 

Treasury STRIPS 

(2.4%) 

Agency MBS 

(38.2%) 

Treasuries 

(32.4%) 

Equities (6.0%) 

ABS (2.2%) 

Private Label CMOs 

(1.9%) 

Corporate Debt 

(3.6%) 

Other 

(2.3%) 

Agency 

CMOs 

(5.6%) 

Agency Debt 

(5.4%) 

As Of: Feb-2013 
Financial Developments 67

5.2.4 Securities Lending

The largest component of securities lending 

this past year continued to be undertaken by 

long-term securities holders such as pension 

funds, mutual funds, and central banks (Chart 

5.2.9). The global value of securities lending 

transactions remained fairly flat through March 

2012, at an average value of around $1.7 trillion 

according to available estimates (Chart 5.2.10).

Reinvestment of cash collateral from securities 

lending has declined slowly over the past year, 

from $659 billion in the fourth quarter of 

2011 to $591 billion in the fourth quarter of 

2012. The weighted average maturity (WAM)

of cash reinvestment has also continued to 

decline, albeit not as markedly as in previous 

years (Chart 5.2.11). This decline represents 

a continued trend towards more conservative 

asset allocation since the financial crisis by cash 

collateral reinvestment pools.

Securities lending can be used as a vehicle for 

collateral transformation trades, also known 

as collateral swaps. In a collateral swap, a 

participant with the high-quality asset swaps it 

for a lower-quality one to earn fee income. The 

participant holding the lower-quality collateral 

pays a fee to exchange it temporarily for higherquality collateral that can then be used to meet 

margin requirements for derivative transactions 

or other liquidity or capital needs. Demand 

for high-quality collateral may increase with 

the implementation of regulatory regimes 

in different countries that require market 

participants to hold high-quality collateral 

for the purposes of margining and liquidity 

coverage ratios.

These trades present two risks: first, should 

the value of the lower-quality collateral fall 

more than anticipated by the haircut in the 

transaction, the lender of that collateral 

would have to reduce the size of the collateral 

swap or provide more collateral. If more 

collateral is unavailable, they may be forced 

to rapidly reduce the size of their related 

positions. Second, broker-dealers entering 

into collateral swaps might generate additional 

Chart 5.2.9 Securities Lending Loans by Industry 5.2.9 Securities Lending Loans by Industry 

Source: Markit 

Group Limited 

Central Banks 

(13%) 

Other 

(19%) 

Mutual Funds 

(18%) 

As Of: 25-Mar-2013 

Pension Funds 

(12%) 

Public Pension 

Funds 

(9%) 

Insurance 

Companies 

(8%) 

Banks (10%) 

U.S. Public 

Funds (6%) 

Quasi-Government 

Bodies (5%) 

Chart 5.2.10 Value of Securities on Loan 5.2.10 Value of Securities on Loan 

Trillions of US$ Trillions of US$ 

Source: Markit Group Limited 

Global Market 

(including U.S.) 

U.S. Market 

As Of: 25-Mar-2013 

Chart 5.2.11 Securities Lending Cash Reinvestment 5.2.11 Securities Lending Cash Reinvestment 

Trillions of US$ Days 

Source: The Risk Management Association 

Mean WAM 

(right axis) 

Median WAM 

(right axis) 

As Of: 2012 Q4 

Note: WAM = Weighted 

Average Maturity. 

Total Cash Reinvestment 

(left axis) 
68 2013 FSOC / / Annual Report

layers of counterparty and liquidity risk 

exposure, potentially mitigating the benefits of 

conservative collateral requirements.

Despite the increased attention paid to these 

trades, there is little evidence to suggest that 

their volume is presently large.

7

 For example, 

consider securities lending activity by pension 

funds. Pension funds hold large portfolios of 

high-quality assets, which they use to fund 

future liabilities. In the meantime, pension 

funds will lend securities in their portfolio to 

generate incremental returns on their existing 

investments, including high-quality Treasury 

securities. As such, pension funds would be 

expected to supply high-quality collateral into 

collateral transformation trades. However, while 

the volume of pension funds’ securities lending 

activity increased by around 5 percent over the 

past year, the majority of the increase occurred 

in lending against cash collateral as opposed to 

non-cash collateral. In fact, lending of Treasury 

securities against non-cash collateral by pension 

funds declined by nearly 8 percent over the 

past year. Regulatory limits on the types of 

collateral that pension funds can accept is likely 

inhibiting the growth of such transactions. 

In addition, indemnifications provided by 

securities lending agents, which commonly act 

on behalf of beneficial owners that lend their 

securities, are limited to the securities loaned. 

These indemnifications do not commonly 

extend to the lower-quality borrowed collateral 

and such one-sided indemnification might act 

as a further inhibitor for such activity. While 

available evidence has yet to suggest that a 

meaningful volume of collateral swap activity 

is taking place, it is an area that warrants 

continued monitoring as market practices and 

regulatory changes increase demand for highquality collateral.
Financial Developments 69

5.3 Bank Holding Companies and 

Depository Institutions

5.3.1 Bank Holding Companies and DoddFrank Act Stress Tests

Performance 

Bank holding companies (BHCs) are holding 

companies with at least one commercial bank 

subsidiary. Subsidiaries of BHCs may also 

include nonbanks such as broker-dealers, 

investment companies, or insurance companies. 

As of the fourth quarter of 2012, there were 

1,014 top-tier BHCs in the United States 

(excluding Puerto Rico), with aggregate assets 

of about $16.6 trillion. Aggregate pre-tax 

income of BHCs totaled $159 billion in 

2012 (Chart 5.3.1), an increase of 8 percent 

from 2011. 

The domestic banking sector entered 2012 

facing revenue pressure from a sluggish 

macroeconomic environment, new regulatory 

requirements, legal settlements, the challenging 

interest rate environment, and risks related 

to the euro area sovereign debt crisis. Despite 

the difficult operating environment, most 

banks grew revenues and earnings in 2012. 

For the 77 BHCs with assets greater than $10 

billion, aggregate pretax income increased 

14.2 percent in 2012 to $154.8 billion. Banks 

boosted earnings through controlled expenses 

and the release of reserves against losses on 

loans and leases, as credit quality continued to 

improve. However, the median growth in total 

noninterest expense was roughly 3 percentage 

points higher than the previous year (based on 

72 BHCs reporting data for the year end 2012 

and 2011). Noninterest income grew during the 

year led by record debt underwriting and strong 

mortgage banking revenues. Nevertheless, the 

return on average assets for BHCs remained 

lower than the levels that prevailed in the 10 

years before the crisis (Chart 5.3.2). 

Declining BHC net interest margins (NIMs), 

defined as net interest income divided by 

average interest-earning assets, decreased 

earnings in recent quarters (Chart 5.3.3). NIM 

Chart 5.3.1 Aggregate BHC Pre-Tax Income

-1200 

-900 

-600 

-300 

0 

300 

600 

900 

1200 

-1200 

-900 

-600 

-300 

0 

300 

600 

900 

1200 

2006 2007 2008 2009 2010 2011 2012 

Source: FR Y-9C 

Billions of US$ As Of: 2012 

5.3.1 Aggregate BHC Pre-Tax Income 

Billions of US$ 

Noninterest Income 

Net Interest Income 

Total Pre-Tax Income 

Provisions 

Noninterest Expense 

Realized Gains/Losses on Investments 

Chart 5.3.2 Return on Average Assets for BHCs > $10B

-1.5

-1.0

-0.5

0.0 

0.5 

1.0 

1.5 

-1.5 

-1.0 

-0.5 

0.0 

0.5 

1.0 

1.5 

1996 1998 2000 2002 2004 2006 2008 2010 2012 

Source: FR Y-9C 

Percent As Of: 2012 Q4 

5.3.2 Return on Average Assets for BHCs > $10B 

Percent 

1996-2012 Average 

Chart 5.3.3 Net Interest Margins for BHCs > $10B 5.3.3 Net Interest Margins for BHCs > $10B 

Percent Percent 

2000-2012 Average 

Net Interest Margin 

As Of: 2012 Q4 

Source: FR Y-9C 
70 2013 FSOC / / Annual Report

compression has been driven by increased 

competition, as well as cyclical factors including 

the extended low rate environment across the 

yield curve and slow loan growth. BHCs are 

susceptible to maturity mismatch, whereby 

longer duration assets reprice more slowly than 

shorter duration liabilities. BHCs typically have 

lower NIMs than insured depository institutions 

due to the inclusion of lower interest margin 

business lines of nonbank subsidiaries, which 

often rely more heavily on fee income than net 

interest income.

The low rate environment is particularly acute 

for NIMs during the current business cycle, 

as funding costs are near zero. BHCs have 

mitigated the effects of the compressed rate 

environment through various non-core revenue 

and cost cutting measures, including reserve 

releases, restructurings, and compensation 

reductions, although there is a limit to the 

sustainability of these measures. Supervisors 

are attentive to BHCs assuming additional 

credit or duration risk, but there does not 

appear to be evidence of a substantial move in 

this direction at commercial bank subsidiaries 

of large BHCs. However, some smaller banks 

appear to have lengthened the maturity of asset 

portfolios. Maturity extension at small banks 

can be observed in the estimates of the asset/

liability maturity and repricing interval gap. 

These estimates do not show material change 

at large banks from two years ago, and are also 

not noticeably different from the distribution 

in the third quarter of 2003, when interest 

rates were also unusually low (Charts 5.3.4 and 

5.3.5).

8

 However, at smaller banks, the same 

distribution has somewhat shifted upward over 

the past two years, as the average maturity (or 

next repricing date) of loans and securities has 

increased (not shown).

Although very low interest rates appear to be 

contributing to a compression of BHCs’ net 

interest margins, it is unclear whether the 

eventual reversal of the rate environment will 

benefit BHC profitability. BHCs have increased 

their holdings of Treasury and agency securities 

Chart 5.3.4 Maturity Gap at Large Banks

Density 

Source: Federal 

Reserve 

As Of: 2012 Q4 

0.00 

0.05 

0.10 

0.15 

0.20 

0.25 

0.00 

0.05 

0.10 

0.15 

0.20 

0.25 

-5 0 5 10 15 

2010: Q4 

2012: Q4 

2003: Q3 

Years 

Note: Large banks are defined as those with assets exceeding $50 billion. 

Approximations are based on the midpoint of the ranges available on Call 

Reports. Liquid deposits are assumed to have a maturity of 1 year. 

Density 

Chart 5.3.5 Maturity Gap at Small Banks

Density 

Source: Federal 

Reserve 

As Of: 2012 Q4 

0.00 

0.05 

0.10 

0.15 

0.20 

0.25 

0.00 

0.05 

0.10 

0.15 

0.20 

0.25 

-5 0 5 10 15 20 

Years 

2010: Q4 

2012: Q4 

2003: Q3 

Density 

Note: Small banks are defined as those with assets less than $50 billion. 

Approximations are based on the midpoint of the ranges available on Call 

Reports. Liquid deposits are assumed to have a maturity of 1 year. 

5.3.4 Maturity Gap at Large Banks 

5.3.5 Maturity Gap at Small Banks 
Financial Developments 71

amid historically high deposit inflows, so a 

rapid rise in rates would decrease the fair value 

of these securities. In addition, a rise in rates 

could also cause deposit disintermediation, 

resulting in higher funding costs pressuring 

margins. The more recent modest rise in term 

rates appears not to have boosted BHC NIMs, 

as growth expectations remain subdued and 

lending growth challenged. 

Large BHCs made progress in addressing 

legal uncertainty last year by settling a number 

of outstanding legal matters, highlighted by 

a settlement with the attorneys general and 

federal banking agencies related to improper 

mortgage foreclosure practices (see Section 

6.1.5). Banks adjusted their MBS repurchase 

reserves to reflect greater clarity surrounding 

GSE repurchase obligations, including 

Bank of America’s $4.9 billion agreement 

with Fannie Mae that resolved substantially 

all agency mortgage repurchase claims on 

loans originated and sold directly by Legacy 

Countrywide and Bank of America to Fannie 

Mae from 2000 through 2008. 

Market Indicators 

The heightened level of duress in capital 

markets that was present throughout the 

second half of 2011 receded in 2012, reflecting 

improved investor sentiment and greater risk 

appetite. Accommodative actions taken by 

the ECB were largely successful in reducing 

perceived tail risk from Europe, resulting in a 

large increase in capital markets activities from 

the prior year (see Box B: Global Monetary 

Policy Actions). Moreover, positive U.S. 

macroeconomic developments, particularly 

employment and housing data releases late 

in the year, boosted sentiment and helped 

drive loan growth. As a result of these positive 

developments, the outlook for the domestic 

financial sector improved significantly during 

the year. 

BHC shares, which began the year trading 

at or near historic low price/tangible book 

valuations, rallied sharply during the year. 
72 2013 FSOC / / Annual Report

The broad Keefe, Bruyette & Woods (KBW) 

bank index increased 30 percent and implied 

volatility steadily declined following a jump in 

June (Chart 5.3.6). The market capitalization 

of the six largest BHCs increased 43 percent 

in aggregate, but market valuations remained 

at a roughly 20 percent discount to book 

value in December 2012. This valuation is still 

below both the pre-crisis level and the average 

level over the past 12 years (Chart 5.3.7). The 

average of the 5-year credit default swap (CDS) 

spreads of the six largest BHCs entered 2012 at 

very elevated levels, due primarily to euro area 

sovereign debt fears. Despite these high levels 

during the first half of the year, CDS spreads 

narrowed sharply during the second half of the 

year and ended 2012 at their lowest levels in 

18 months (Chart 5.3.8). Academic measures 

of systemic risk for the six largest BHCs have 

continuously declined over the past year: these 

contemporaneous measures are now low by 

historical standards (Chart 5.3.9).

9

Capital

In aggregate, capital ratios for BHCs improved 

from the fourth quarter of 2011 to the fourth 

quarter of 2012, with the tier 1 common 

capital ratio under current risk-based capital 

rules (Basel I) increasing 0.79 percentage 

point to 11.46 percent. Increases in retained 

earnings, primarily from positive operating 

results, contributed to the bulk of this increase, 

with additional support from capital raising 

(Chart 5.3.10). In addition, risk-weighted assets 

decreased slightly, providing additional support 

to capital ratio trends. 

For the 18 largest U.S. BHCs, capital ratios 

continued to improve from post-crisis levels, 

with the aggregate tier 1 common capital ratio 

under Basel I improving 0.86 percentage point 

from the fourth quarter of 2011 to the fourth 

quarter of 2012 to 11.3 percent. For U.S. BHCs 

with assets less than $50 billion, the average 

tier 1 common ratio under Basel I improved 

by approximately 0.19 percentage point to 12.2 

percent from the fourth quarter of 2011 to the 

Chart 5.3.6 KBW Bank Index and Implied Volatility 5.3.6 KBW Bank Index and Implied Volatility 

Index Percent 

Source: Bloomberg, L.P.

KBW Bank Index 

(left axis) 

30-Day Implied Volatility 

of KBW Bank Index 

(right axis) 

As Of: 25-Mar-2013 

Chart 5.3.7 Average P/B and P/E Ratios of 6 Large 

Complex BHCs 5.3.7 Average P/B and P/E Ratios of 6 Large Complex BHCs

Source: Bloomberg, L.P.

P/B Ratio As Of: 25-Mar-2013 P/E Ratio 

P/B Ratio 

(left axis) 

Long-Term 

Average P/E 

(right axis) 

Long-Term 

Average P/B 

(left axis)

P/E Ratio 

(right axis) 

Note: Market-cap weighted average 

of BAC, C, GS, JPM, MS, WFC. 

Chart 5.3.8 CDS Spreads of 6 Large Complex BHCs

Basis Points Basis Points

5.3.8 CDS Spreads of 6 Large Complex BHCs 

As Of: 25-Mar-2013 Basis Points 

Source: Markit Group Limited 

Note: Equal-weighted average 

of BAC, C, GS, JPM, MS, WFC. 
73

fourth quarter of 2012 period, with gains 

from retained earnings and common stock 

issuance partially offset by increases in riskweighted assets.

During this period, many BHCs limited their 

capital distributions due to continued economic 

uncertainty, forthcoming increases in required 

regulatory capital, and enhanced regulatory 

scrutiny. Although capital distributions remain 

subdued relative to pre-crisis levels, the latter 

half of 2012 saw a shift from a net issuance of 

equity capital to a net payout in the form of 

share repurchases and dividends. 

Liquidity 

Along with higher capital levels, the average 

liquidity profile for the largest BHCs has 

improved since the financial crisis. In 

particular, the volume of liquid assets on 

BHC balance sheets is nearly two standard 

deviations above its average from the first 

quarter of 1995 to the fourth quarter of 2012 

(Chart 5.3.11). This increase in average liquidity 

partially reflects a change in the composition 

of BHCs. Among the six largest BHCs, two 

are primarily dealers (Goldman Sachs and 

Morgan Stanley), and two others (Bank of 

America and JPMorgan Chase) acquired major 

broker-dealers throughout 2008 (Merrill 

Lynch and Bear Stearns, respectively). Brokerdealers tend to hold a larger fraction of liquid 

assets, as the majority of their funding is in 

wholesale markets (Chart 5.3.12). In fact, the 

ratio of liquid assets to total assets is roughly 

proportional to the percentage of non-core 

funding to total liabilities. An additional factor 

explaining the higher liquidity ratios of BHCs is 

the anticipated implementation of the Liquidity 

Coverage Ratio (LCR) in the United States 

as part of the Basel III reforms (see Section 

6.1.1 for an update on the implementation of 

the LCR). Once implemented, the LCR would 

require banking institutions, including BHCs, 

hold a sufficient amount of liquid assets as 

protection against withdrawals of funding in 

stressed conditions. 

Chart 5.3.9 Systemic Risk Measures

Source: Federal Reserve, Markit Group 

Limited, Bloomberg, L.P., Compustat 

As Of: Feb-2013 

CoVaR 

SES 

DIP 

Index Index 

Note: Measures are standardized 

by their historical volatility.

Chart 5.3.10 Change in Tier 1 Common Ratios for Aggregate 

U.S. BHCs

10.67 

11.46 

0.19 

0.63 

0.78 

7 

8 

9 

10 

11

12 

13 

14 

7 

8 

9 

10 

11

12 

13 

14 

Tier1 Common 

(4Q11) 

RWA Change 

Impact 

Net Issuance 

of Stock 

Retained 

Earnings 

Other 

Adjustments 

Tier1 Common 

(4Q12) 

Source: FR Y-9C 

Percent of RWA As Of: 2012 Q4 

Note: Domestically owned BHCs. 

Percent of RWA 

(0.80) 

Chart 5.3.11 Consolidated Liquidity Ratio* for Top 50 BHCs

5.3.10 Change in Tier 1 Common Ratios for Aggregate U.S. BHCs 

10 

15 

20 

25 

10 

15 

20 

25 

1995 1998 2001 2004 2007 2010 

Source: FR Y-9C, SNL Financial, FSOC calculations 

Percent As Of: 2012 Q4 

Note: *Liquidity Ratio = sum of Cash & Due From, FFS, Repos, U.S. Treasuries, U.S. Gov. Agencies 

and U.S. Gov. Sponsored Agencies divided by Total Assets. Top 50 BHCs by asset size. 

Percent 

+2 Standard Deviation 

+1 Standard Deviation 

Average (17.3%) 

-1 Standard Deviation 

Liquidity Ratio* 

5.3.11 Consolidated Liquidity Ratio* for Top 50 BHCs 

5.3.9 Systemic Risk Measures 

Financial Developments
74 2013 FSOC / / Annual Report

Asset Quality

BHCs’ asset quality continued to improve in 

2012. For 18 large firms (the Comprehensive 

Capital Analysis and Review (CCAR) 2013 

participants, which account for over 75 percent 

of system assets), nonperforming loans declined 

in aggregate and across most categories. 

However, residential loan delinquencies 

remain high despite the decline in early-stage 

delinquencies (30-89 days past due) and a 

slowdown in the rate at which loans transition 

into delinquency status (Chart 5.3.13). 

Banks have been slow to reduce the stock of 

nonperforming residential loans through 

foreclosures, short-sales, or modifications, 

reflecting in part greater forbearance in light 

of the recovering housing market, as well 

as challenges in completing the foreclosure 

process (Chart 5.3.14).

It is worth noting that although net charge-offs 

have declined at the largest BHCs, noncurrent 

levels continue to remain elevated, especially 

among the BHCs with high exposure to singlefamily mortgages. For the largest BHCs, the 

allowance for loan and lease losses has been 

sufficient to absorb recent levels of net chargeoffs, although an increase in charge-offs to 

post-crisis peak levels in 2010 could erode this 

cushion considerably (Chart 5.3.15). Reserve 

levels remain above post-crisis lows relative 

to risk-weighted loans and commitments, but 

continue to decline. 

CCAR, CapPR, and DFAST

The Federal Reserve completed the latest 

round of its capital planning and stress testing 

program for 2013, which included CCAR 

and the supervisory stress tests mandated by 

the Dodd-Frank Act of 18 firms as well as the 

Capital Plan Review (CapPR) of an additional 

11 BHCs with $50 billion or more of total 

consolidated assets. The Dodd-Frank Act stress 

tests (DFAST) are forward-looking exercises 

conducted by the Federal Reserve to help assess 

whether institutions have sufficient capital to 

absorb losses and support operations during 

adverse economic conditions. While the 11 

Chart 5.3.12 Non-Core Funding* Relative to Liquid Assets** 5.3.12 Non-Core Funding* Relative to Liquid Assets** 

*Non-core funding includes time deposits > $100K, foreign deposits, brokered deposits < 100K, 

CP, other borrowed money, FF and repo, other liabilities. **Liquid assets includes cash and cash 

equivalents, trading assets, Treasury and Agency HTM and AFS securities, FF and reverse repo. 

As Of: 2012 Q4 

WFC 

Source: FR Y-9C 

Non-Core Funding as a % of Total Liabilities 

Liquid Assets as a % of Total Assets 

Percent 

Percent 

BAC 

C JPM 

MS 

GS 

Chart 5.3.13 Nonperforming Loans (30-89 Days) 5.3.13 Nonperforming Loans (30-89 Days) 

Source: FR Y-9C 

Percent Percent 

Residential 

As Of: 2012 Q4 

Other Consumer 

C&I 

Credit Card 

Total NPLs 

CRE 

Chart 5.3.14 Nonperforming Loans (90+ Days and Nonaccrual) 5.3.14 Nonperforming Loans (90+ Days and Nonaccrual) 

Source: FR Y-9C 

Percent Percent 

Residential 

As Of: 2012 Q4 

Other Consumer 

C&I 

Credit Card 

Total NPLs 

CRE 
75

BHCs submitting capital plans as part of the 

CapPR were evaluated on their submitted 

results, firms participating in the CCAR and 

DFAST were evaluated using both the BHC’s 

submitted plans and the results of the Federal 

Reserve’s supervisory stress tests. The aim of 

the CCAR is to ensure that large, complex 

banking institutions have robust, forwardlooking capital planning processes that account 

for their unique risks, and to help ensure 

that these institutions have sufficient capital 

to continue operations throughout times of 

economic and financial stress (Chart 5.3.16). 

Firms’ capital adequacy is assessed against a 

number of quantitative and qualitative criteria, 

including projected performance under 

scenarios provided by the Federal Reserve and 

the institutions’ internally-developed scenarios. 

In order to project post-stress capital ratios 

for the Board’s Dodd-Frank Act stress tests, 

the Federal Reserve uses a standardized set 

of capital action assumptions. In contrast, 

for the CCAR post-stress capital analysis, 

the Federal Reserve assessed whether a BHC 

would be capable of meeting the requirements 

under the Board’s capital plan rule, including 

minimum capital ratios under baseline and 

stressed conditions using the BHC’s planned 

capital actions. Specifically, under Dodd-Frank 

Act stress testing rules, firms are assumed to 

execute no common stock repurchases and 

maintain dividends at a rate consistent with 

their historical dividends paid on common 

shares outstanding. Thus, the key difference 

between capital levels and ratios determined 

under the CCAR and DFAST is the capital 

distributions. The comparative assumptions 

facilitate the Federal Reserve’s assessment of 

shareholder distributions and other actions on 

BHC capital adequacy. 

In a change from prior years, the Federal 

Reserve provided BHCs with an opportunity 

to adjust downward any planned capital 

distributions after receiving the Federal 

Reserve’s preliminary CCAR post-stress capital 

analysis. These adjusted capital actions were 

Chart 5.3.15 Allowance for Loan/Lease Losses as a Multiple 

5.3.15 Allowance for Loan/Lease Losses as a Multiple of Charge-offs of Charge-offs

Source: FR Y-9C 

0 

2 

4 

6 

8 

10 

0 

2 

4 

6 

8 

10 

2009 2010 2011 2012 

Multiple of Charge-offs Multiple of Charge-offs 

Allowance as a 

Multiple of Quarterly 

Charge-offs 

Allowance as a 

Multiple of Peak 

Charge-offs 

As Of: 2012 Q4 

Note: Charge-offs are quarterly. Peak charge-offs are 

from 2010 Q1. Data pertains to the 18 CCAR BHCs. 

Chart 5.3.16 U.S. Unemployment Rate: Actual vs. Stress 

Scenarios 5.3.16 U.S. Unemployment Rate: Actual vs. Stress Scenarios

Source: BLS, 

Federal Reserve 

S BLS

Percent As Of: 2012 Q4 Percent 

Note: Actual unemployment rate is quarterly average of 

monthly data. The remaining series are unemployment 

rate trajectories in the respective stress scenarios. 

Actual Unemployment Rate 

SCAP 

CCAR 2011 

CCAR 2012 

CCAR 2013 

Financial Developments
76 2013 FSOC / / Annual Report

then incorporated into the Federal Reserve’s 

projections to calculate the adjusted poststress capital levels and ratios. All BHCs but 

one maintained a minimum tier 1 common 

ratio greater than 5 percent under stressed 

conditions, inclusive of all adjusted planned 

capital actions, under the severely adverse 

scenario. Significant capital accretion during 

the last year bolstered the ability of BHCs that 

participated in CCAR to weather significant 

aggregate net losses, which were projected at 

$192 billion on a pre-tax basis in the severely 

adverse scenario. Assuming capital distributions

consistent with Dodd-Frank Act rules, the 

aggregate tier 1 common ratio for the 18 BHCs 

declined from an actual 11.1 percent in the 

third quarter of 2012 to a post-stress level of 

7.7 percent at the end of 2014. Using BHCs’ 

planned capital actions, the BHCs’ aggregate 

post-stress tier 1 common ratio was projected 

to be 6.6 percent in the fourth quarter of 2014. 

In both cases, aggregate BHC capital levels 

significantly exceeded the 5 percent target 

established under the capital plan rule and the 

aggregate tier 1 common ratio that existed at 

the start of the 2009 stress test (Chart 5.3.17). 

The results of the stress test included a nonobjection of capital actions for 14 of the 18 

participating BHCs. The Federal Reserve 

objected to the capital plans of two firms, 

Ally Financial Inc. and BB&T Corporation. 

An additional two firms, JPMorgan Chase 

& Co. and the Goldman Sachs Group, Inc., 

received conditional non-objections to their 

capital plan due to weaknesses in the capital 

plans or planning process that required 

immediate attention. 

Insured Commercial Banks and Savings 

Institutions

The banking industry was composed of 7,083 

commercial banks and savings institutions at 

the end of fourth quarter 2012. Approximately 

2,205 institutions had assets under $100 million, 

while 4,216 institutions had assets between $100 

million and $1 billion, and 662 institutions had 

assets over $1 billion. Failures, mergers, and a 

decline in chartering activity contributed 

5.3.18 FDIC-Insured Failed Institutions 

Chart 5.3.17 Initial and Stressed Tier 1 Common Capital Ratios

Percent Percent 

Source: Federal 

Reserve, FRBNY 

As Of: 25-Mar-2013 

Note: Aggregate ratios of 18 participating BHCs. 

Stressed estimates are supervisory estimates. 

Chart 5.3.18 FDIC-Insured Failed Institutions

5.3.17 Initial and Stressed Tier 1 Common Capital Ratios 

0 

1 

2 

3 

4 

5 

0 

100 

200 

300 

400 

500 

600 

1980 1985 1990 1995 2000 2005 2010 

Source: BEA, FDIC, 

Haver Analytics 

Number of Institutions As Of: 2012 

Note: No FDIC-insured institutions 

failed during 2005 and 2006. 

Percent 

Number of 

Institutions 

(left axis) 

Assets of Failed 

Institutions as a Percent 

of Nominal GDP 

(right axis) 
Financial Developments 77

to the decline in the number of insured 

depository institutions, as the industry lost 274 

firms in 2012.

However, failures of insured depository 

institutions continue to decline since the 

financial crisis; 51 institutions with $11.6 billion 

in total assets failed in 2012 (Chart 5.3.18). 

Four more insured institutions failed between 

January 1, 2013, and March 8, 2013, with 

$459 million in total assets. As of December 

31, 2012, 651 institutions, or 9.2 percent of 

all institutions, were on the FDIC’s problem 

bank list. These institutions had financial, 

operational, or managerial weaknesses that 

require corrective action in order to operate in 

a safe and sound manner. Pre-tax net income 

for all U.S. commercial banks and savings 

institutions totaled $199.8 billion in 2012, 

representing an 18.2 percent increase from 

2011, and further improvement in the industry 

following the crisis. A rebound in credit quality, 

with an associated reduction of loan loss 

provisions and other expenses, has driven the 

improvement in pretax net income since 2009 

(Chart 5.3.19). Overall asset quality continued 

to improve as net-charge offs and non-current 

loans declined across the industry (Chart 

5.3.20). Higher asset quality led to a reduction 

in portfolio risk and sustained the improvement 

in both earnings and capital positions at 

commercial banks and savings institutions 

(Chart 5.3.21).

Temporary Liquidity Guarantee Program

The end of the FDIC’s unlimited guarantee on 

noninterest-bearing transaction deposits on 

December 31, 2012, raised concerns that some 

portion of the $1.5 trillion in newly uninsured 

deposits would rotate into conservative, shortterm asset classes or shift from smaller banks 

to larger banks with perceived guarantees of 

sovereign support.10 However, Transaction 

Account Guarantee (TAG)-related withdrawals 

as the guarantee approached its end date 

appear to have been modest, as the amount 

over $250,000 in noninterest-bearing accounts 

remained at $1.5 trillion during the third and 

fourth quarters of 2012. According to Federal 

Chart 5.3.19 Commercial Bank and Thrift Pre-Tax Income 5.3.19 Commercial Bank and Thrift Pre-Tax Income 

Billions of US$ Billions of US$ 

Source: FDIC 

Note: Includes all FDIC-insured 

commercial banks and thrifts. 

As Of: 2012 

Noninterest Income 

Net Interest Income 

Noninterest Expense 

Provisions 

Realized Gains/Losses on Investments 

Total Pre-Tax Income 

Chart 5.3.20 Net Charge-offs and Noncurrent Loans

0 

10 

20 

30 

40 

50 

60 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

1984 1988 1992 1996 2000 2004 2008 2012 

Source: FDIC, Haver Analytics 

Percent As Of: 2012 Q4 

5.3.20 Net Charge-offs and Noncurrent Loans 

Note: All FDIC-insured institutions. 

Percent 

Net Charge-offs to 

Loans and Leases 

(left axis) 

Noncurrent Loans and Leases to 

Tier 1 Capital and Reserves 

(right axis) 

Chart 5.3.21 Risk-Weighted Assets and Return on Assets

63 

66 

69 

72 

75 

78 

-1.5 

-1.0 

-0.5 

0.0 

0.5 

1.0 

1.5 

2.0 

1990 1994 1998 2002 2006 2010 

Source: FDIC, Haver Analytics 

Percent As Of: 2012 Q4 

5.3.21 Risk-Weighted Assets and Return on Assets 

Note: All FDIC-insured institutions. 

Percent 

Risk-Weighted Assets as a Percent of 

Total Assets (right axis) 

Return on Assets (left axis) 
78 2013 FSOC / / Annual Report

Reserve’s H.8 release, the category containing 

TAG-eligible deposits declined by $60 billion 

in the first few weeks of 2013, an amount well 

below estimates of market analysts, before 

stabilizing in early February 2013. 

Credit Unions

The number of credit unions declined from 

7,094 at year end 2011 to 6,819 institutions 

in the fourth quarter of 2012. This 4 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. 

However, this concentration growth has seen 

only a slight increase with the top 100 credit 

unions growing their share of total credit union 

assets to 39 percent (Chart 5.3.22). Corporate 

credit unions—which provide critical services 

to the broader credit union system—continue 

to consolidate and deleverage 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 November 2012, there were 

17 corporate credit unions with $22.74 billion 

in assets serving consumer credit unions—a 

decline from 27 corporate credit unions with 

$96 billion in assets in 2007.

The credit union system experienced return 

on assets (ROA) in 2012 of 86 basis points 

(annualized YTD), an increase from 67 basis 

points in 2011, and 50 basis points in 2010. 

Reduced provisions for loan losses drove 

much of the improvement in ROA. Improved 

credit conditions were the primary driver 

behind the provision for loan losses declining 

to an annualized 0.3 percent of assets from 

0.5 percent of assets in 2011 and 0.8 percent 

of assets in 2010 (Chart 5.3.23). Aggregate 

annualized net income increased to $8.5 

billion, a 35 percent improvement from 2011. 

Outstanding loans within the credit union 

system increased by 3.5 percent to $591 billion 

after experiencing weak growth in 2011, and 

declines in 2010. 

Chart 5.3.22 Concentration of Credit Union Assets 5.3.22 Concentration of Credit Union Assets 

Source: NCUA 

Percent As Of: 2012 Q4 Billions of US$ 

Assets of 100 

Largest CUs 

(right axis) 

Assets of 10 

Largest CUs 

(right axis) 

Assets of 10 Largest CUs 

as a Percent of Total 

(left axis) 

Assets of 100 Largest 

CUs as a Percent of Total 

(left axis) 

Note: Largest by asset size. 

Chart 5.3.23 Federally Insured Credit Union Income 5.3.23 Federally Insured Credit Union Income 

Billions of US$ Billions of US$ 

Source: NCUA 

As Of: 2012 
Financial Developments 79

Profitability continued to vary by asset class 

based on the size of the institution, with 

smaller credit unions historically lagging 

behind larger credit unions. The industry faces 

lower uncertainty over future losses associated 

with failed corporate credit unions as future 

resolution costs are currently projected to total 

between $1.9 billion and $4.8 billion over the 

coming years. Larger concerns for the industry 

include challenges related to the low interest 

rate environment and, eventually, the transition 

process to a higher rate environment. However, 

long-term assets, including fixed-rate real 

estate loans, (as a share of total assets) have 

ranged from flat to slightly down over the past 

18 months, and the share of interest sensitive 

deposits has also declined since the third 

quarter of 2009 (Chart 5.3.24). Nevertheless, 

these levels remain elevated relative to historic 

levels and warrant an increased emphasis on 

managing interest rate risk.

5.3.2 U.S. Branches and Agencies 

of Foreign Banks 

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

families have a large presence in the United 

States. Together, the U.S. branches and 

agencies of foreign banks account for more 

than $2 trillion of banking assets, or about 

13 percent of total U.S. banking assets. These 

entities represent an important source of credit 

to U.S. businesses.

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 25 percent 

of their balance sheets to loans, but can differ 

substantially in the composition of their 

lending. Direct commercial and industrial 

(C&I) loans outstanding by these banks, which 

represent a major source of financing for U.S. 

businesses and investment projects, have been 

as high as $365 billion, but more recently have 

fallen closer to $270 billion at the end of 2012, 

out of over $500 billion in total loans (Chart 

5.3.25). Other assets rose sharply from about 

Chart 5.3.24 Credit Union Deposits 5.3.24 Credit Union Deposits 

Percent Percent 

Source: NCUA 

Interest Sensitive 

Deposit Share 

(left axis) 

Money Market and 

IRA Deposit Share 

(right axis) 

As Of: 2012 Q4 

Chart 5.3.25 U.S. Branches and Agencies of Foreign Banks: 

Assets

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

2004 2005 2006 2007 2008 2009 2010 2011 2012 

Source: Federal Reserve, 

Haver Analytics 

Trillions of US$ As Of: 2012 Q3 

5.3.25 U.S. Branches and Agencies of Foreign Banks: Assets 

Note: *Includes government securities, assetbacked securities, and other trading assets. 

Trillions of US$ 

Non C&I Loans 

C&I Loans 

Net Due From Related 

Depository Institutions 

Other Assets* 

Securities Purchased 

with Repurchase 

Agreements & Fed 

Funds Sold 
80 2013 FSOC / / Annual Report

$400 billion pre-crisis to about $1.2 trillion by 

the third quarter of 2012, as some branches and 

agencies increased their holdings of cash and 

liquid securities as protection against potential 

liquidity strains. 

The liabilities of U.S. branches and agencies of 

foreign banks also bear on financial stability 

(Chart 5.3.26). Most of these U.S. branches 

are not allowed to offer deposits insured by the 

FDIC and thus lack access to the stable source 

of funds represented by households’ checking, 

savings, and other transaction accounts. 

Instead, wholesale funding provides the 

majority of funding for these institutions. 

Some foreign bank branches and agencies, 

especially those associated with European 

banks, obtain dollar deposits in the United 

States, and use those deposits to provide dollar 

funding to their parent organizations and 

related affiliates, which in turn use the funds 

for lending and investment. If deposits are 

withdrawn from branches and agencies, the 

balance sheets of the affected banks can be 

destabilized, leading to deleveraging or a need 

for parents to provide dollar-denominated 

funding to their U.S. branches and agencies 

rather than receiving funding from them. 

This occurred at some European banks in the 

summer of 2011, leading to a dramatic increase 

in funding from parents to branches and 

agencies. Subsequent improvements in 

the European situation led to marginal 

declines in the level of funding support from 

parent banks to their U.S. branches and 

agencies. Nevertheless, funding from parents 

remains elevated relative to levels seen over 

the past 10 years.

Proposed Enhanced Prudential Requirements for 

Foreign Banking Organizations

In December 2012 (as noted in Section 6.1), the 

Federal Reserve invited comment on proposed 

rules to implement enhanced prudential 

standards and early remediation requirements 

for foreign banking organizations (FBOs) 

as mandated under Sections 165 and 166 of 

Chart 5.3.26 U.S. Branches and Agencies of Foreign Banks: 

Liabilities

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

2004 2005 2006 2007 2008 2009 2010 2011 2012 

Source: Federal Reserve, 

Haver Analytics 

Trillions of US$ As Of: 2012 Q3 

5.3.26 U.S. Branches and Agencies of Foreign Banks: Liabilities 

Note: *Includes transaction accounts, nontransaction accounts, and other borrowed money. 

Trillions of US$ 

Deposits & Credit Balances 

Net Due to Related 

Depository Insitutions 

Other Liabilities* 

Securities Sold with 

Repurchase 

Agreements & Fed 

Funds Purchased 
Financial Developments 81

the Dodd-Frank Act. The proposal is generally 

consistent with the set of enhanced prudential 

standards that the Board proposed for large U.S. 

banking organizations in December 2011, but would 

also require FBOs with a large U.S. presence to form 

a U.S. intermediate holding company (IHC) over its 

U.S. bank and nonbank subsidiaries, which would 

be subject to capital and liquidity requirements. The 

U.S. operations of FBOs with combined U.S. assets 

of $50 billion or more would be required to meet 

enhanced liquidity risk management standards, 

conduct liquidity stress tests, and hold a 30-day 

buffer of highly liquid assets.

Many of the core elements of the Federal Reserve’s 

existing approach to the supervision and regulation 

of FBOs were designed more than a decade ago, 

when U.S. operations of FBOs were focused largely 

on traditional banking activities. Since the 

mid-1990s, the U.S. operations of FBOs have 

become increasingly concentrated, interconnected, 

and complex. 

For example, trends in the global balance sheets 

of FBOs for this period reveal that short-term U.S. 

dollar funding raised in the United States was used 

to provide long-term U.S. dollar-denominated 

project and trade finance around the world, as well 

as to finance non-U.S. affiliates’ investments in 

U.S. dollar-denominated asset-backed securities. 

The associated material increase in intra-firm flows 

during this period also created vulnerabilities for 

the U.S. operations of FBOs. The financial stability 

risks associated with the increased capital markets 

activity and shift in funding practices of the U.S. 

operations of FBOs in the period preceding the 

financial crisis became apparent during and after 

the recent financial crisis. 

While some FBOs were aided by their ability to 

move liquidity freely during the crisis, this behavior 

created a degree of cross-currency funding risk 

and heavy reliance on swap markets that proved 

destabilizing. In many cases, FBOs that relied 

heavily on short-term U.S. dollar liabilities were 

forced to sell U.S. dollar assets and reduce lending 

rapidly when that funding source evaporated. This 

deleveraging imposed further stress on financial 

market participants, thereby compounding the risks 

to U.S. financial stability. Although the United States 

did not experience a destabilizing failure of an FBO 

during the crisis, some FBOs required extraordinary 

support from home and host country central banks 

and governments. 

Beyond the United States, events in the global 

financial community underscored the risks posed 

by the operations of large multinational banking 

organizations to host country financial sectors. The 

failure of several internationally active financial 

firms during the crisis revealed that the location 

of capital and liquidity is critical in a resolution. 

In some cases, capital and liquidity related to 

operations abroad were trapped at the home entity. 

Actions by government authorities during the crisis 

period highlighted the fact that, while a foreign 

bank regulatory regime designed to accommodate 

centralized management of capital and liquidity 

can promote efficiency during good times, it 

can also increase the chances of home and host 

jurisdictions placing restrictions on the cross-border 

movement of assets at the moment of a crisis, as local 

operations come under severe strain and repayment 

of local creditors is called into question. Resolution 

regimes and powers remain nationally based, 

complicating the resolution of firms with large 

cross-border operations. In response to the financial 

stability risks highlighted by the crisis, and ongoing 

challenges associated with the resolution of large 

cross-border firms, other national authorities have 

adopted modifications, or considered proposals, to 

enhance their regulation of internationally active 

banks within their geographic boundaries.

5.4 Nonbank Financial Companies

5.4.1 Securities Broker-Dealers

As of the fourth quarter of 2012, there were 4,358 

domestic and foreign-owned securities brokerdealers operating in the United States. The U.S. 

broker-dealer sector is relatively concentrated; 

approximately 60 percent of industry assets were 

held by the top 10 broker-dealers at the end of last 

year, the largest of which were affiliated with foreign 

banks and domestic BHCs. Aggregate annual 

pretax income of broker-dealers more than doubled 
82 2013 FSOC / / Annual Report

in 2012 to $32 billion, as trading revenues 

increased almost three times over the previous 

year (Chart 5.4.1). Trading revenue increased 

primarily due to increased debt trading, led by 

near record levels of debt issuance, and gains in 

other trading, such as currencies, commodities, 

and derivatives.

The broker-dealer industry doubled in size 

between 2001 and 2007 before shrinking 

abruptly following the financial crisis. Assets 

held within the U.S. broker-dealer industry have 

stabilized at a post-financial crisis level of about 

25 percent below the 2007 peak, reaching $4.8 

trillion in the fourth quarter of 2012 (Chart 

5.4.2). Broker-dealer leverage also declined 

markedly after the crisis, and has stabilized 

over the past four years at 10-year lows. 

Broker-dealers operate at 22 times leverage 

in aggregate, which is significantly higher 

than leverage at commercial banks. Brokerdealers obtain leverage primarily through the 

use of secured lending arrangements, such as 

reverse repurchase agreements and secured 

borrowing arrangements. Since the financial 

crisis, the broker-dealer sector underwent a 

notable decline in asset size—from a peak of 

nearly $7 trillion to current total assets just 

under $5 trillion—and leverage—from a peak 

near 40 to the current level of 22. The run-up 

and subsequent decline in balance sheet size 

and leverage of the broker-dealers sector was 

also accompanied by a notable change in the 

types of assets that they hold (Chart 5.4.3). 

Primary dealers—the broker-dealers that have a 

trading relationship with the Federal Reserve—

experienced a marked decline in the holdings 

of corporate securities, agency securities, and 

agency MBS. At the same time, net holdings by 

primary dealers of U.S. government securities 

moved from negative to positive. This switch 

in net positions of broker-dealers indicates 

a decline in risk appetite and balance sheet 

capacity for the sector. 

Market participants remain attuned to the 

liquidity risks associated with the brokerdealer model, as will be discussed in Section 

7.1. Trading and financing undertaken by 

Chart 5.4.1 Broker-Dealer Revenues 5.4.1 Broker-Dealer Revenues 

Billions of US$ Billions of US$ 

Source: SIFMA DataBank, FINRA 

As Of: 2012 

Chart 5.4.2 Broker-Dealer Assets and Leverage 5.4.2 Broker-Dealer Assets and Leverage 

Trillions of US$ Leverage Ratio 

Source: SIFMA DataBank, FINRA 

Note: Leverage is total assets 

as a multiple of equity.

Leverage 

(right axis) 

As Of: 2012 Q4 

Chart 5.4.3 Primary Dealer Securities 5.4.3 Primary Dealer Securities 

Billions of US$ Billions of US$ 

Source: FRBNY 

Primary Dealer Net Outright Corporate Securities 

Primary Dealer Net Outright U.S. Government Securities 

Primary Dealer Net Outright Federal Agency Securities and Agency MBS 

As Of: 20-Mar-2013 
Financial Developments 83

broker-dealers is typically short-duration, and 

the profitable execution of these activities 

requires a flexible and inexpensive funding 

profile, typically executed through shortterm secured financing arrangements. While 

short-term funding is stable under normal 

market conditions, heavy reliance on shortterm funding leaves broker-dealers vulnerable 

to liquidity runs during periods of stress. If a 

broker-dealer’s secured creditors pull away, its 

ability to quickly replace lost funding sources 

may be limited. Reduced funding might 

cause fire sales with potentially system-wide 

implications. Although a broker-dealer’s shortterm liabilities are typically supported by a 

very liquid asset base, broker-dealers may be 

unable to reduce assets quickly enough to 

pay-off liabilities.

5.4.2 Insurance Companies

Flat or declining investment portfolio returns 

continued to pressure net incomes at life 

insurers in 2012. Nevertheless, net income 

of life insurance companies increased $26.5 

billion in 2012 compared to 2011, after 

declining by over $13.6 billion from 2010 to 

2011. Increased premium revenue and lower 

increases in reserves contributed to increased 

net income, aggregate statutory capital, and 

surplus (Chart 5.4.4). 

The prospect of continued low interest rates 

for a prolonged period poses a challenge to 

life insurers seeking to balance investment 

risks and returns, especially while trying to 

build capital and expand product offerings 

(Chart 5.4.5). Life insurers earn a spread on 

products with guaranteed benefits (such as 

fixed annuities, universal life insurance, and 

guaranteed investment contracts) from the 

excess of the investment yield earned over 

the credited rate offered to policyholders. 

A protracted low interest rate environment 

may stress life insurers’ profits as this spread 

compresses. While insurers have responded to 

the low interest rate environment by decreasing 

crediting rates, the flexibility to lower these 

rates is often limited given the guaranteed 

minimums on many products. Although the life 

Chart 5.4.4 Life and Other Insurance: Capital and Net Income 5.4.4 Life and Other Insurance: Capital and Net Income 

Billions of US$ Billions of US$ 

Source: NAIC 

Capital (right axis) 

Net Income (left axis) 

Note: Includes accident and health. 

As Of: 2012 

Chart 5.4.5 Life Insurers: Impact of Low Rate Environment 5.4.5 Life Insurers: Impact of Low Rate Environment 

Percent Percent 

Source: NAIC, SNL Financial 

Investment Yield 

(left axis)

Required Interest Rate 

(left axis) 

Investment Yield Minus 

Required Interest Rate 

(right axis)

As Of: 2012 
84 2013 FSOC / / Annual Report

insurance industry has reduced its minimum 

guarantees over time, products with minimum 

guarantees still represent a large share of 

existing life and annuity products outstanding. 

Aside from cutting the crediting rates on their 

insurance products, life insurers have also 

responded to the low interest rate environment 

by reducing exposure to, and increasing 

policyholder fees on, interest-sensitive 

businesses such as guaranteed investment 

products, variable annuities, and long-term 

care insurance. Life insurers also pursued 

new revenue sources by acquiring businesses 

in new markets such as Latin America, and by 

acquiring fee-earning pension and retirement 

assets. Some life insurers also increased revenue 

by leveraging their pre-existing real estate and 

private placement platforms to offer investment 

opportunities to other institutional investors. To 

offset the declining new money yields on their 

assets, some life insurers increased portfolio 

duration and marginally increased their 

allocation to hedge funds, private equity funds, 

BBB-rated bonds, and commercial mortgage 

loans over the last few years, though total 

exposures by life insurers to these assets are 

generally below peak levels. 

In addition to adversely affecting investment 

returns, the current low interest rate 

environment affects the present value of life 

insurers’ contract obligations. As interest 

rates have decreased, the present values of 

future obligations have increased. As a result, 

life insurers have increased reserve levels, 

adding further downward pressure to reported 

financial results. Moreover, the increase in 

reserves can also be attributed to the asset 

adequacy testing of liquid assets and change in 

policyholder lapse assumptions at life insurance 

companies. The increase in reserves was less 

of a factor in 2012 than in 2011 as the decline 

in interest rates slowed. Although life insurers 

could increase premiums on new products, this 

response may affect product sales and is likely to 

lag the accounting impact of reserve increases 

on existing products. However, premium 

revenues increased in 2012. 
Financial Developments 85

Life insurers could also be adversely impacted 

by a sudden increase in interest rates, which, 

under Generally Accepted Accounting 

Principles (GAAP), would increase unrealized 

losses in insurers’ fixed income portfolios. 

Higher interest rates could also entice 

policyholders to surrender contracts for higher 

yield elsewhere. Thus, in order to fund contract 

surrender payments, insurers could be forced to 

seek other facilities for liquidity or to liquidate 

fixed income investments just as the market 

value has declined.

Property and casualty insurers, which sell 

insurance on homes, cars, and businesses, 

underwrite products that result in liabilities 

that are generally much shorter in duration 

(with the exception of workers’ compensation 

insurance) as compared to life insurers, and, 

therefore, are affected less by the low interest 

rate environment. However, property and 

casualty insurers continued to be pressured 

by large catastrophe losses in 2012. A.M. Best 

estimates that insured catastrophe losses 

were $43.0 billion in 2012, down from $44.2 

billion in 2011. The high losses were driven by 

Superstorm Sandy, a post-tropical storm system 

that struck the most densely-populated areas 

of the U.S. eastern seaboard in October 2012. 

Current estimates suggest that Superstorm 

Sandy may have caused $25 billion in insured 

losses, and up to $50 billion in total economic 

damages. Despite Superstorm Sandy, property 

and casualty insurers were able to increase net 

income and statutory capital and surplus 

(Chart 5.4.6). 

Interest Rate Risk Management of Insurance 

Companies

State insurance regulators require the 

appointed actuary to comply with the Actuarial 

Standards of Practice promulgated by the 

Actuarial Standards Board. These actuarial 

standards require that insurance companies 

run a range of scenarios that reflect the 

variability of the relevant cash flows being 

tested. In light of these actuarial standards, 

most companies currently use an economic 

scenario generator (such as the economic 

Chart 5.4.6 Property and Casualty Insurance: Capital and 

Net Income 5.4.6 Property and Casualty Insurance: Capital and Net Income 

Billions of US$ Billions of US$ 

Source: NAIC 

Capital 

(right axis) Net Income 

(left axis) 

As Of: 2012 
86 2013 FSOC / / Annual Report

scenario generator developed by the American 

Academy of Actuaries) to generate a large 

number of economic scenarios. In addition, 

state insurance regulations traditionally have 

prescribed seven scenarios for the potential 

path of interest rates in order to test the ability 

of insurers’ portfolios to withstand moderate 

shocks. These scenarios are often called the 

New York 7, since they were established by a 

1986 regulation by the New York insurance 

regulator. The New York 7 include jumps 

300 bps up and down, gradual increases and 

decreases of 500 bps, and a level path. Each 

scenario is applied as a parallel shift to the 

prevailing yield curve and therefore doesn’t 

include any change to the slope of the yield 

curve, or in the convexity of the curve. This 

deterministic approach of the New York 

7 scenarios therefore differs from that of 

stochastic scenario models, which allow for 

changes to the slope of the yield curve and for 

periods where the yield curve is inverted. 

New York’s requirement to use the seven 

scenarios for asset adequacy testing was later 

incorporated into model actuarial and opinion 

memorandum regulations that were adopted 

by the various states, and as a result, most U.S. 

life insurers were subjected to such testing even 

though they may not have been domiciled or 

licensed in New York. Beginning in 2009, the 

majority of states have amended their actuarial 

and opinion memorandum regulations 

to eliminate the prescribed deterministic 

scenario requirements of the New York 7. 

Under the revised regulations, the New York 

7 was replaced by a requirement that each 

insurance company run scenarios (stochastic 

or deterministic) that provide a wider array of 

tests of the adequacy of reserves held, given 

the assets the company currently holds. A 

number of states (irrespective of whether they 

have yet adopted the amended regulation), 

also continue to require domiciled insurance 

companies to run the New York 7; other 

insurance companies also generally run these 

scenarios as a matter of practice.
Financial Developments 87

5.4.3 Specialty Finance Companies

Credit activity in the specialty-lending sector 

has moderately improved in the past year, 

yet remains below pre-crisis levels. Nonbank 

financial companies involved in credit activity 

across various segments include issuers of 

equipment leases, credit cards, student loans, 

and auto finance. Overall, nonbank financial 

companies owned approximately $840 billion 

of consumer loans, $180 billion of real estate 

loans, and $421 billion of business loans at 

year end 2012 (Charts 5.4.7 and 5.4.8). 

The securitization market for these credit types 

originated by both bank and nonbank financial 

companies has improved, with significant yearover-year increases in auto ABS issuance (30 

percent), credit card issuance (150 percent), 

and equipment leasing (100 percent). Although 

these increases are large, they follow a period 

of low post-crisis issuance. For instance, a 

large proportion of the increase in credit card 

lending replaced Term Asset-Backed Securities 

Loan Facility (TALF)-era issuance that matured 

in 2012 (Chart 5.4.9). Credit spreads on these 

types of ABS continue to tighten as a result of 

a growing appetite for securitized products, a 

lower perception of credit risk, and increased 

demand for yield by investors (Chart 5.4.10).

5.4.4 Agency REITs

Agency MBS REITs use short-term debt in 

the form of repurchase agreements to fund 

the purchase of agency MBS and earn the 

difference between the yield on the underlying 

MBS and the cost of financing. As a REIT, 

these earnings are not taxed at the corporate 

level but are only taxed when equity holders 

receive the earnings in the form of a dividend. 

To maintain their REIT status, these entities 

return in excess of 90 percent of their earnings 

to equity holders. Agency REITs structure their 

operations to be excluded from regulation 

under the Investment Company Act of 1940.

The market for agency MBS REITs continued 

its trend of strong asset growth this past year. 

Much of this growth can be attributed to 

the high dividend yield that agency REITs 

Chart 5.4.7 Consumer Loans Outstanding

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

2001 2003 2005 2007 2009 2011 2013 

Source: Federal Reserve, 

Haver Analytics 

Trillions of US$ As Of: Feb-2013 

5.4.7 Consumer Loans Outstanding 

Note: Loans owned and securitized. Series break in December 2010 

for consumer loans outstanding at finance companies due to change 

in data collection methodology. Gray bars signify NBER recessions. 

Trillions of US$ 

Commercial Banks 

Finance Companies 

Chart 5.4.8 Business Loans Outstanding

0.0 

0.3 

0.6 

0.9 

1.2 

1.5 

1.8 

0.0 

0.3 

0.6 

0.9 

1.2 

1.5 

1.8 

2001 2003 2005 2007 2009 2011 2013 

Source: Federal Reserve, 

Haver Analytics 

Trillions of US$ As Of: Feb-2013 

5.4.8 Business Loans Outstanding 

Trillions of US$ 

Commercial Banks 

Finance Companies 

Note: Loans owned and securitized. Series break in December 2010 

for business loans outstanding at finance companies due to change 

in data collection methodology. Gray bars signify NBER recessions. 

Chart 5.4.9 ABS Issuance 5.4.9 ABS Issuance 

Billions of US$ Billions of US$ 

Source: Thomson Reuters, SIFMA 

As Of: 2012 
88 2013 FSOC / / Annual Report

BOX C: CONVEXITY EVENT RISK

Hedging and relative value trading often involves basis 

risk, or the risk that changes in prices on closely related 

products may suddenly diverge from historical norms 

or market expectations. Portfolios exposed to basis risk 

tend to have fat-tailed distributions, that is, their shortterm profit-and-loss volatility may be quite low, but may 

be susceptible to infrequent but extreme losses. In the 

case of large positions, such mark-to-market losses may 

compel firms to rapidly unwind, thus creating a vicious 

circle of fire sales that can strain market liquidity.

Basis risks are particularly pertinent in the market for 

MBS. MBS investors, broadly speaking, fall into two 

categories: those holding MBS on an unhedged or 

infrequently hedged basis and those that actively hedge 

the interest rate risk exposures of MBS. Unhedged 

or infrequently hedged investors include the Federal 

Reserve, foreign sovereign wealth funds, community 

banks, and mutual funds benchmarked against an MBS 

index. MBS holders who actively hedge include pension 

funds and insurance companies that endeavor to match 

the duration of their assets to that of their liabilities. 

The interest rate risk of MBS differs from the interest 

rate risk of Treasury securities due to the embedded 

prepayment option in conventional residential mortgages. 

The purchaser of an MBS is effectively selling an interest 

rate option to each home loan borrower, because if 

interest rates fall, the borrower is incentivized to refinance 

into a lower rate mortgage, thus prepaying or accelerating 

payment of their higher rate mortgage into a lower rate 

loan. Conversely, if interest rates rise, the borrower is 

incentivized to maintain their current mortgage and not 

prepay. For the MBS investor a lack of prepayment, or 

extension in a rising environment, causes the loan and 

thus the MBS, to increase in duration and decrease in 

price. When interest rates increase, the price of Treasury 

securities falls, but it falls less and less sharply as the level 

of yields increases, a feature called positive convexity. The 

price of MBS on the other hand behaves very differently 

from Treasury securities as rates change. As interest rates 

rise, the price of MBS falls at an accelerating rate, that is, 

it displays negative convexity (Chart C.1). 

MBS are negatively convex because the likelihood that a 

borrower prepays depends on the current level of interest 

rates relative to the rate that he pays on his mortgage. As 

rates rise from a low level, fewer and fewer households 

have an incentive to refinance their mortgages. Increasing 

rates thus result in an extension of the duration of MBS, 

causing the price of MBS to fall at an ever faster pace. 

Managing the interest rate risk sensitivity of MBS 

necessitates dynamic hedging to maintain a desired 

exposure of the position to movements in yields. The 

hedging of the interest rate risk exposure of MBS is often 

called duration hedging, as the effective duration of the 

MBS changes with the level of yields. The amount of 

hedging depends on whether MBS are in the negatively 

or positively convex region. When rates decline, hedgers 

will seek to increase the duration of their position. This 

can be achieved by buying Treasury notes or bonds, 

or by receiving fixed payments in interest rate swaps. 

Conversely, hedgers will find themselves long duration 

when rates increase, which can be achieved by selling 

Treasury notes or bonds or by paying fixed in interest 

rate swaps. 

Chart C.1 Convexity Risk C.1 Convexity Risk 

Note: At low yields (relative to the coupon), MBS display negative convexity because price increases are 

more limited as market yields fall, due to borrowers prepayment options being in the money. This

contrasts with the positive convexity of non-callable bonds, for which price gains increase as market 

yields fall. 

Yield 

Price 

Positive Convexity 

Negative Convexity 

Mortgage Treasury 
Financial Developments 89

Convexity event risk is the risk of a sudden, selfreinforcing increase in long- to medium-term rates caused 

by hedged investors in MBS trying to decrease duration 

risk by selling Treasury securities or entering into payfixed interest rate swaps. This hedging activity in turn can 

cause interest rates to rise further, which may increase 

the duration hedging need for other MBS holders, 

inducing another round of duration sell offs. Due to its 

self-reinforcing nature, a convexity event could be sparked 

by a relatively modest initial increase in medium- to longterm interest rates. In the current environment of yields 

near zero, even a modest yield increase may significantly 

extend mortgage portfolio durations, potentially forcing 

hedgers to sell duration, or to sell the underlying MBS. 

Any of these actions will tend to drive yields higher, 

increasing the need for further hedging. 

While the current low rate environment has arguably 

set the stage for a convexity event, a key factor in the 

likelihood of such an event is who owns the convexity 

risk, as the amount of MBS held by hedged investors 

determines the intensity of the selloff (Chart C.2). 

GSEs are important duration hedgers, but their portfolios 

have been shrinking compared to the pre-crisis period, 

when they were the dominant investors in MBS. The 

Federal Reserve, through its asset purchase programs, 

is currently the dominant MBS buyer and holds a sizable 

portion of the convexity risk. Also, many of the largest 

holders of MBS have access to sufficient sources of 

liquidity and funding, even in extreme market conditions, 

and in contrast to highly levered investors, are less likely to 

be forced sellers. 

Whether the current environment is more or less 

susceptible to a convexity event than the 2003 episode is 

ambiguous (Chart C.3). On the one hand, the GSEs are 

smaller, and the Federal Reserve has a larger presence, 

making a convexity event risk less likely. On the other 

hand, there are fewer natural providers of protection 

against convexity and rate volatility risk in the market. In 

particular, a potentially amplifying factor in a rates selloff 

is the reduced liquidity in fixed income markets since the 

crisis, with broker-dealers less active in market making. 

Chart C.2 Outstanding Agency MBS by Holders

C.2 Outstanding Agency MBS by Holders 

Source: Fannie Mae, 

Freddie Mac, SIFMA, 

Federal Reserve, FSOC 

calculations 

Federal Reserve 

(15.5%) 

Depository 

Institutions* 

(24.3%) 

Mutual Funds 

(17.0%) Foreign 

(13.9%) 

Pension Funds 

(5.5%) 

Agency REITs 

(4.8%) 

Insurance 

(6.1%) 

Other 

(4.6%) 

Note: *Includes foreign 

banking offices in the 

U.S. and banks in U.S.-

affiliated areas. 

State and 

Local Gov’t 

(4.2%) 

GSEs 

(4.1%) 

As Of: 2012 Q3 

Chart C.3 2003 Convexity Event

180 

200 

220 

240 

260 

280 

0 

1 

2 

3 

4 

5 

Jan:03 Mar:03 May:03 Jul:03 Sep:03 Nov:03 

Treasury 10Y Yield 

(left axis) 

Treasury 2Y Yield 

(left axis) 

10Y/2Y Spread 

(right axis) 

C.3 2003 Convexity Event 

Basis Points 

Source: U.S. Department of Treasury 

Percent As Of: 31-Dec-2003 
90 2013 FSOC / / Annual Report

offer which has generated strong demand by 

investors. Although the asset levels of agency 

REITs have grown, the amount of leverage 

has been relatively stable post-crisis (Chart 

5.4.11). The relatively stable level of leverage 

can be partially attributed to structural changes 

in the requirements for margin on agency 

MBS. That is, haircuts on agency MBS have 

remained at fairly elevated levels post-crisis and 

have prevented agency REITs from increasing 

leverage to pre-crisis levels. 

Near-term returns on assets for agency REITs 

are tightly linked to the slope of the yield curve 

(Chart 5.4.12). These vehicles hold agency MBS 

funded in the bilateral repo market. They earn 

longer-term yields paying short-term money 

market rates to obtain leverage. This investment 

behavior of agency REITs exposes them to 

interest rate slope and convexity risk (see Box 

C: Convexity Event Risk and Section 7.4 on 

risks from fixed income asset valuations). 

Convexity event risk is particularly acute for 

agency MBS REITs, since their earnings and 

capital are most sensitive to a sharp increase 

in interest rates. Moreover, agency REITs are 

exposed to rollover risk. The financing of 

long-term assets with short-term debt in the 

form of repurchase agreements is sensitive 

to either an increase in financing costs or a 

pullback in the willingness of lenders to extend 

credit. A significant pullback in financing 

availability could put pressure on agency REITs 

to sell MBS, which could itself pressure MBS 

valuations and further reduce the availability 

of short-term financing for agency REITs. The 

potential for such negative feedback loops 

becomes stronger as the share of agency MBS 

financed by short-term debt increases. 

5.5 Investment Funds 

5.5.1 Money Market Funds

MMFs are open-ended mutual funds permitted 

to use certain valuation methods that generally 

allow them to redeem shares at a fixed $1 per 

share. Among other instruments, MMFs invest 

in short-term debt securities and repo. As of 

Chart 5.4.10 Selected ABS Spreads 5.4.10 Selected ABS Spreads 

Basis Points Basis Points 

Source: Barclays 

Auto Fixed 

BBB 3-Year 

Credit Card Fixed 

BBB 3-Year 

Auto Fixed 

AAA 3-Year

Credit Card Fixed AAA 3-Year

As Of: 21-Mar-2013 

Note: Spreads to Treasury securities. 

Chart 5.4.11 Total Agency REIT Assets

As Of: 2012 Q4 As Of: 2012 Q4

5.4.11 Total Agency REIT Assets 

Billions of US$ Percent 

Source: Bloomberg, L.P.

Assets to Equity Ratio* 

(right axis) 

Total Assets (left axis) 

Note: *Weighted by market capitalization.

Chart 5.4.12 Agency REITs: Return on Assets 5.4.12 Agency REITs: Return on Assets 

Percent Basis Points 

2Y/10Y Treasury Spread 

(right axis) 

Average ROA* 

(left axis) 

As Of: 2012 Q4 

Source: Bloomberg, L.P. Note: *Weighted by market capitalization.
Financial Developments 91

the end of February 2013, MMFs totaled $3.0 

trillion assets under management (AUM), 

according to SEC data. Total U.S. MMF 

assets increased slightly by $51.8 billion from 

February 29, 2012 to February 28, 2013. MMF 

assets remain far below their 2009 peak. Prime 

MMF assets increased from $1.7 trillion to $1.8 

trillion, while government and Treasury MMF 

assets decreased from $936.5 billion to $929.3 

billion during this period. Tax-exempt funds 

also declined from $302.8 billion to $289.4 

billion (Chart 5.5.1). Comparatively, MMFs 

comprised 20 percent of total mutual fund 

AUM, according to the Investment Company 

Institute (ICI). Consolidation in the number of 

MMFs continued in 2012, with 54 MMFs ceasing 

operations. In order to prevent MMFs’ net 

yields paid to investors from falling below zero 

in the sustained low-interest rate environment, 

some managers decided to waive management 

fees, a practice in place throughout the MMF 

industry since 2009. This sustained fee-waiving 

practice has continued to erode the profitability 

of funds, possibly leading to some managers’ 

decision to close their MMFs. Other postcrisis factors such as concerns about pressure 

on sponsors to cover MMFs’ losses as well 

as declining AUM may have pushed some 

participants out of the MMF market. 

Concerns about the debt crisis in Europe 

continued to be a focus of MMF investment 

activities in the first half of 2012. MMF 

holdings of overall euro area bank-related 

securities reached a low of 11.6 percent of 

prime MMF assets in December 2011 and 

were still relatively low at 11.9 percent in June 

2012. Following ECB indications of a strong 

commitment to maintaining the single euro 

currency, MMF managers began returning to 

euro area bank-related securities in July 2012 

(see Box B: Global Monetary Policy Actions). 

By February 28, 2013, holdings in euro area 

financial institutions comprised 18.7 percent 

of prime MMF assets. Throughout 2012, euro 

area exposure remained below 2010 levels, 

which marked the peak of euro area exposures. 

Another indicator of this increased optimism 

is the gradual increase in the weighted average 

Chart 5.5.1 MMF Assets by Fund Type 5.5.1 MMF Assets by Fund Type 

Trillions of US$ Trillions of US$ 

Source: SEC 

Prime 

Government 

and Treasury 

Tax-Exempt

As Of: Feb-2013 
92 2013 FSOC / / Annual Report

maturity and weighted average life of MMF 

managers’ fund portfolios, which allowed 

liquidity levels to decline slightly (Charts 

5.5.2 and 5.5.3). This gradual decrease in 

concerns regarding Europe’s debt crisis in 

2012, as demonstrated by MMFs’ increased 

euro area exposure, was corroborated by the 

broader-based improvement in the outlook for 

European resolution of the sovereign debt and 

banking sector crisis given such public sector 

support as the ECB’s OMT program (see Box 

B: Global Monetary Policy Actions). Although 

euro area concerns ebbed in the second half of 

2012, early 2013 euro area incidents—such as 

the decision to impose levies on Cypriot bank 

deposits and the uncertainty related to the 

February 2013 Italian election results—have 

kept euro area debt issues in focus as risks for 

MMFs. However, currently, those two early 2013 

incidents have not had a significant impact 

on MMFs.

Prime MMFs increased their exposure to 

non-traditional geographies in 2012. Most 

notably, prime MMFs more than doubled 

their geographical exposure to Asian 

countries compared to 2010 levels, particularly 

in Japanese holdings. The increase in 

Japanese exposure of prime MMFs has been 

concentrated in U.S. dollar-denominated CDs. 

Over the past few years, average maturities 

of Japanese and U.S. CDs have been similar, 

while yields of average Japanese CDs in prime 

MMF portfolios have been higher than those 

of U.S. banks. Furthermore, Japanese CDs have 

been considered by market participants to be 

both high in quality and limited in their euro 

area exposures. These factors contribute to an 

increased exposure of MMFs to Japanese CDs. 

Japanese assets comprise U.S. MMFs’ fourth 

largest country exposure after the United 

States, Canada, and France. MMFs’ Japanese 

exposure suggests a potential vulnerability 

given the challenging growth outlook for Japan 

(see Section 7.5 for further detail on the 

Japanese economy).

MMF flows continue to fluctuate with transitory 

developments in prime money markets; two 

Chart 5.5.2 Prime Funds Liquidity 5.5.2 Prime Funds Liquidity 

Percent of Total Assets Percent of Total Assets 

Source: SEC 

As Of: Feb-2013 

Daily Liquidity 

Weekly Liquidity 

Chart 5.5.3 MMF Weighted Average Life*

 Note: *Weighted average lives, weighted by size of fund. 

5.5.3 MMF Weighted Average Life* 

Source: SEC 

Days Days 

Prime 

All Funds 

As Of: Feb-2013 
Financial Developments 93

examples are the temporary effects of the 

expiration of the FDIC Temporary Unlimited 

Coverage for Noninterest-Bearing Transaction 

Accounts as well as then-ongoing fiscal cliff 

negotiations. The effects of the expiration 

of the Temporary Unlimited Coverage for 

Noninterest-Bearing Transaction Accounts, 

known colloquially as the Transaction Account 

Guarantee (TAG) program, were demonstrative 

of transitory effects on MMFs. Leading up to 

the TAG expiry, market participants expected 

that the expiry would lead to material inflows 

to MMFs. Though flows to MMFs did fluctuate 

visibly in response to the expiration of TAG, 

these inflows coincided with year end and 

seasonal effects. Thus, the net impact of TAG 

expiration on MMFs on these inflows is difficult 

to isolate. One such coinciding, and large, 

driver of flows into MMFs over the fourth 

quarter of 2012 was the result of equity investors 

liquidating positions ahead of an expected 

increase in capital gains taxes in 2013 (due to 

then-ongoing fiscal cliff negotiations). Proceeds 

from these stock sales were then invested in 

MMFs. Additionally, some market participants 

noted that accelerated corporate dividend 

payments ahead of 2012’s year end contributed 

to the increase in MMF assets, as investors 

parked the dividend payments in MMFs 

(at least temporarily). Though the net impact 

of the TAG expiry appears to be minimal, 

it demonstrates how market developments 

might induce temporary fluctuations in the 

MMF space. 

In January 2013, a number of large MMF 

managers announced that they would begin 

voluntarily and publicly releasing some or all 

of their MMFs’ market-based net asset values on 

a daily basis. Under SEC rules this information 

was available only on a monthly basis with a 

60-day delay.

5.5.2 Mutual Funds

Mutual funds are open-end investment vehicles 

made up of a pool of funds for investment 

purposes. As of the end of February 2013, longterm mutual funds comprised 80 percent, or 

over $10.8 trillion, of total mutual fund AUM, 
94 2013 FSOC / / Annual Report

according to ICI (Chart 5.5.4). Commensurate 

with global market gains, mutual funds have 

recovered value post-crisis. Mutual fund flows 

for the 12 months ending February 2013 

reflected current investor preference for capital 

preservation, income generation, and lower 

volatility. Mutual funds had an estimated 

$305 billion net inflow for the period, largely 

attributable to taxable bond funds, which 

received a net $256 billion (Chart 5.5.5). From 

March 2012 through February 2013, the net 

asset outflows from government funds and 

relatively higher inflows to high-yield funds and 

emerging market bond funds likely demonstrate 

investor preference for yield among lowervolatility fixed income products (Chart 5.5.6). 

In contrast, U.S. equity funds had net outflows 

of $72 billion, with net outflows occurring 

every month since March 2012. Globally, fixed 

income funds saw large inflows (Chart 5.5.7). 

Equity and hybrid inflows in the first month 

of 2013 picked up significantly, totaling $51 

billion, possibly compounded by year end U.S. 

legislative action on tax reform as compromise 

on financial assets ameliorated some concerns, 

including avoiding more severe dividend and 

capital gain tax rate hikes. 

Among mutual funds, corporate bond holdings 

have grown substantially since 2009. While 

the Securities Industry and Financial Markets 

Association (SIFMA) reports that the total U.S. 

investment grade and high-yield corporate 

bond market increased by 28 percent from 2009 

to 2012, over the same period, corporate and 

foreign bond holdings among mutual funds 

increased by 54 percent (Chart 5.5.8). Mutual 

fund holdings of high-yield bonds and loans 

have grown even more quickly, at 74 percent 

and 169 percent, respectively. The yields 

of corporate bond and loan mutual funds, 

relatively attractive in comparison to Treasury 

mutual funds, are likely the main reason 

for these flows. The rapid rise in AUM, 

particularly in high-yield bonds, may result in 

dislocations in response to a sharp sell-off in 

credit assets. This risk could be exacerbated by 

Chart 5.5.4 Total Assets of Mutual Funds

0 

2 

4 

6 

8 

10 

12 

14 

0 

2 

4 

6 

8 

10 

12 

14 

2000 2002 2004 2006 2008 2010 2012 

Source: ICI, Haver Analytics 

Trillions of US$ As Of: Feb-2013 

5.5.4 Total Assets of Mutual Funds 

Trillions of US$ 

Hybrid Funds 

Total Bond Funds 

Money Market Funds 

Equity Funds 

Chart 5.5.5 Mutual Fund Flows by Asset Class (Mar-2012 

5.5.5 Mutual Fund Flows by Asset Class (Mar-2012 to Feb-2013) to Feb-2013)

Billions of US$ Billions of US$ 

Source: Morningstar 

As Of: Feb-2013 

Note: *Includes sector stock 

funds with intĀl exposure. 

Chart 5.5.6 Mutual Fund Taxable Bond Flows (Mar-2012 

to Feb-2013) 5.5.6 Mutual Fund Taxable Bond Flows (Mar-2012 to Feb-2013) 

Billions of US$ Billions of US$ 

Source: Morningstar 

As Of: Feb-2013 
Financial Developments 95

dealer balances in corporate bonds that remain 

quite low by historical standards and may signal 

less willingness to deploy capital to corporate 

bond trading.

5.5.3 Pension Funds

As of the third quarter 2012, the combined 

AUM of private and public pensions, including 

federal pensions and defined contribution 

(DC) plans, were over $16 trillion (Chart 5.5.9). 

While some large pension plans manage their 

own portfolios without outside help, others 

may invest some portion of their portfolios with 

investment managers. 

Both public and private defined benefit (DB) 

plans remain significantly underfunded relative 

to the present value of their liabilities due to 

inadequate contributions, losses incurred in 

2007 and 2008, and, in the case of corporate 

plans, declines in liability discount rates. 

Estimates of aggregate funded status vary. 

Some estimate that public DB plans were 75 

percent funded in aggregate as of year end 

2012, while private DB plans were 78 percent 

funded (Chart 5.5.10). Some private pension 

funds have received contributions to make 

up for shortfalls or have been able to adjust 

their benefit plans to reduce future outlays. 

Even more underfunded are multiemployer 

private sector DB plans, which are only 48 

percent funded. Recent projections issued by 

the Pension Benefit Guaranty Corporation 

(PBGC) substantiate these concerns. Based 

on these projections, which assume no 

changes either in multiemployer plans or in 

PBGC’s multiemployer program, there is a 36 

percent probability of insolvency in PBGC’s 

multiemployer program by 2022 and a 91 

percent probability of insolvency by 2032. 

In July 2012, the Governmental Accounting 

Standards Board (GASB) released 

modifications to accounting standards for 

public pensions. Among the most notable 

changes were valuation methods for pension 

assets and liabilities as well as enhanced 

disclosure requirements. As a result, industry 

analysts expect most public pension plans to 

Chart 5.5.7 Annual Net Worldwide Fund Flows

Billions of US$ Billions of US$

5.5.7 Annual Net Worldwide Fund Flows 

Billions of US$

Source: Morningstar 

As Of: 2012

Chart 5.5.8 Mutual Fund Holdings 5.5.8 Mutual Fund Holdings 

Billions of US$ Billions of US$ 

Source: Flow of Funds, S&P LCD, Lipper 

Corporate and Foreign Bonds (right axis) 

As Of: 2012 

High-Yield Bonds (left axis) 

Institutional Loans (left axis) 

Chart 5.5.9 Retirement Fund Assets by Plan Type

0 

4 

8 

12 

16 

20 

0 

4 

8 

12 

16 

20 

Dec:06 Dec:07 Dec:08 Dec:09 Dec:10 Dec:11 

Source: Flow of Funds, Haver Analytics 

Trillions of US$ As Of: 2012 Q3 

5.5.9 Retirement Fund Assets by Plan Type 

Trillions of US$ 

Private Defined Benefit Plans 

Individual Accounts 

Private Defined Contribution Plans 

State and Local 

Federal 
96 2013 FSOC / / Annual Report

report a larger underfunded status despite 

unchanged plan economics; this is due mostly 

to the lower liability discount rate for already 

under-funded plans. Many analysts also 

anticipate that public pension funding status 

will become more volatile year-on-year. Plans 

are beginning to adapt gradually to these 

changes, though full GASB implementation 

is not expected to begin until fiscal years 2014 

and 2015.

5.5.4 Private Equity

U.S. private equity AUM increased to nearly 

$2 trillion in 2012 (Chart 5.5.11). Although 

leveraged buyout funds account for 39 percent 

of U.S. private equity AUM, advisers continue 

to diversify their investment strategies into such 

areas as real estate, natural resources, distressed 

assets, and emerging market opportunities 

(Chart 5.5.12). Following the 2005 to 2007 

period of robust deal activity, advisers remain 

focused on realizing returns on historically 

high levels of existing portfolio investments. 

Given the tepid environment for initial public 

offerings (IPOs), exits remain concentrated in 

sales to corporate buyers and to other private 

equity firms. In addition, private equity advisers 

continue to seek investment opportunities 

for over $500 billion in undeployed capital 

commitments stemming from record levels of 

fundraising during 2005 to 2007.

5.5.5 Hedge Funds

Hedge fund industry assets continued to 

grow in 2012, fueled by a balance of positive 

investment performance and net asset flows 

into the industry of $34.4 billion (Chart 5.5.13). 

As of year end 2012, hedge funds managed 

approximately $2.22 trillion in assets, a 14 

percent increase from 2011 (Chart 5.5.14). 

Flow data indicate that larger, more established 

funds continued to receive a disproportionate 

share of capital inflows in 2012 (Chart 5.5.15). 

Institutional investors continued to show 

interest in hedge funds as an asset class in 

part because of the perception that they offer 

attractive volatility adjusted returns with less 

correlation to traditional asset classes. On 

an absolute basis, major hedge fund strategy 

Chart 5.5.10 Public and Private Pension Funding Level 5.5.10 Public and Private Pension Funding Level 

Source: Goldman Sachs Asset Management, 

Public Fund Survey, NASRA, NCTR 

Source: Goldman Sachs Asset Management, 

Percent Percent 

Public Defined 

Benefit Plans 

Private Defined 

Benefit Plans 

As Of: 2012 

Note: 2012 figures 

are preliminary.

Chart 5.5.11 U.S. Private Equity AUM 5.5.11 U.S. Private Equity AUM 

Trillions of US$ Trillions of US$ 

Source: Preqin 

As Of: 2012 Q3 

YTD 

Chart 5.5.12 U.S. Private Equity AUM by Strategy 5.5.12 U.S. Private Equity AUM by Strategy 

Source: Preqin 

Venture Capital 

(13%) 

Leveraged 

Buyouts 

(39%) 

Real Estate 

(17%) As Of: 30-Sep-2012. 

Distressed 

Capital 

(10%) 

Infrastructure 

(5%) 

Mezzanine 

(5%) 

Other 

(9%) 

Growth 

(1%) 
Financial Developments 97

returns lagged some broader equity indices, 

such as the S&P 500, although, when adjusted 

for volatility, most strategies outperformed 

their benchmarks (Chart 5.5.16). According to 

available data, aggregate hedge fund balance 

sheet leverage remained in a modest range 

during calendar year 2012, in-line with the 

reduced levels of leverage observed since the 

2008 financial crisis. Hedge fund managers 

noted global and domestic risk events as well as 

concerns regarding the global economic growth 

outlook as factors subduing risk appetites.

5.5.6 Exchange-Traded Products

Early 2013 marked the twentieth anniversary of 

the creation of the first U.S. exchange-traded 

fund (ETF). Most ETFs are registered under the 

Investment Company Act of 1940 (Investment 

Company Act) and may track a securitiesbased index or be actively managed. ETFs are 

part of a broader category of exchange-traded 

investment products (ETPs), which may include 

not only funds that track commodities or other 

non-securities based indices, but also exchangetraded notes. Currently, all ETPs trade at an 

intra-day market price. 

Since their creation, ETPs have expanded 

from covering primarily equity markets to also 

include investments in commodities, currencies, 

and other non-securities instruments, such 

as precious metals. As of February 2013, ETFs 

comprised over 90 percent of ETP AUM. ETPs 

remain a popular investment vehicle, primarily 

used as a means to achieve exposure to a market 

sector or index in a manner potentially more 

efficient and cost-effective than a traditional 

mutual fund, investment product, or financial 

instrument. 

While the ETP industry is still a fraction of 

the size of the traditional open-end mutual 

fund industry, ETPs continue to outpace the 

growth of similar investment vehicles in overall 

asset accumulation. In 2012, the number 

of U.S.-listed ETFs grew to 1,131 products 

and ETF assets grew by 22 percent to $1.29 

Chart 5.5.13 Change in Hedge Fund AUM 5.5.13 Change in Hedge Fund AUM 

Billions of US$ Billions of US$ 

Source: Hedge Fund Research, Inc. 

As Of: 2012 

Chart 5.5.14 Hedge Fund Assets and Net Asset Flows 5.5.14 Hedge Fund Assets and Net Asset Flows 

Billions of US$ Thousands of Funds 

Source: Hedge Fund Research, Inc. 

As Of: 2012 

Chart 5.5.15 Hedge Fund Net Asset Flows by AUM 5.5.15 Hedge Fund Net Asset Flows by AUM

Billions of US$ Billions of US$ 

Source: Hedge Fund Research, Inc. 

As Of: 2012 Q4 
98 2013 FSOC / / Annual Report

trillion (Chart 5.5.17). ETPs saw net inflows 

in 2012 (Chart 5.5.18); fixed income-based 

ETFs and international equity funds had 

particularly high growth relative to existing 

asset bases, consistent with asset inflows to 

similar investment vehicles. As discussed in the 

Council’s 2011 annual report, fixed income 

was widely viewed by industry observers as a 

likely avenue of growth for the ETP industry; 

this view materialized primarily in the highyield and investment-grade credit space as 

investors searched for yield in an environment 

of low interest rates. Combined, high-yield and 

investment grade ETPs saw a $39.3 billion net 

inflow in 2012.

The U.S. ETP market remains heavily 

dominated by passively-managed products that 

track widely-followed indices in equity, fixed 

income, and commodity markets. Furthermore, 

concentration among ETF fund sponsors 

remains high, with the top three sponsors 

of ETFs accounting for about 80 percent of 

industry assets. Both asset growth and trading 

volumes are concentrated and the top 10 funds 

account for 36 percent of net ETP assets. As 

the landscape for passive index and sector 

funds has become more saturated, product 

sponsors have begun to focus on alternative 

strategies. For instance, some fund complexes 

have recently launched products focusing 

on volatility-adjusted returns, lower beta 

(volatility), and short-dated active fixed income 

strategies (a potential alternative to traditional 

money market funds), among others. 

There have been some regulatory developments 

in the U.S.-listed ETP space. In late 2012, the 

SEC lifted a 3-year moratorium on the use 

of derivatives by actively-managed ETFs and 

the fund industry. This may have an effect on 

hedging activities and investor disclosures. The 

SEC is reviewing applications for products that 

make extensive use of derivatives. Additionally, 

some ETP providers have approached the SEC 

with proposals for new ways to operate activelymanaged ETPs, such as disclosing holdings less 

frequently or disclosing a mirror portfolio daily, 

thereby balancing the need for protecting the 

Chart 5.5.16 Hedge Fund Performance by Strategy 5.5.16 Hedge Fund Performance By Strategy 

Percent Percent 

Source: Hedge Fund Research, Inc. 

As Of: 2012 

Chart 5.5.17 ETP Net Assets by Product Type 5.5.17 ETP Net Assets by Product Type 

Trillions of US$ Trillions of US$ 

Source: Morningstar 

As Of: Feb-2013 

Exchange-Traded Fund 

Exchange-Traded Vehicle 

Exchange-Traded Note 

Chart 5.5.18 ETP Net Flows by Product Type 5.5.18 ETP Net Flows by Product Type 

Billions of US$ Billions of US$ 

Source: Morningstar 

As Of: Feb-2013 
Financial Developments 99

provider’s active strategy with the need to create 

both a transparent as well as liquid basket of assets. 

Currently, actively-managed ETFs and certain indexbased ETFs disclose their holdings daily. 

As the global ETP market continues to grow, market 

participants remain attentive to potential risks of 

ETPs, particularly synthetic European-listed ETPs, 

the risks of which may not yet be fully understood. A 

synthetic ETP typically aims to replicate the return 

of an index through a total return swap with a bank, 

whereas a physical-based ETP holds the actual index 

constituents. Some market participants continue to 

highlight the synthetic ETP structure as a potential 

transmission mechanism for risks. Furthermore, 

some regulators and market participants are 

concerned about the potential liquidity mismatch 

between the index that a synthetic ETP tracks and 

the securities pledged as collateral by its sponsor’s 

swap counterparty. Synthetic ETPs are not common 

in the United States, due largely to the Investment 

Company Act’s prohibition of affiliated transactions, 

and represent a declining share of the European 

market. In fact, synthetic ETPs now comprise less 

than 40 percent of European ETP assets, down 

from about 45 percent of all European ETP assets in 

2009 to 2010. Some market participants continue to 

voice concerns about the potential for the affiliation 

between the ETP’s derivatives counterparty and 

the ETP sponsor to amplify counterparty risks. 

For example, European-based synthetic ETPs have 

traditionally had counterparties that are historically 

affiliates of the sponsor. As noted above, U.S.-listed 

ETFs are prohibited by the Investment Company Act 

from having affiliated derivatives counterparties.

The continued development of new types of 

ETPs and similar products, such as leveraged and 

inverse-leveraged ETPs, is an ongoing trend in the 

market and a focus of regulators. Another focus for 

regulators is ETFs with less liquid underlyings, such 

as fixed income products discussed above. Finally, 

as the ETP market continues to evolve, the ongoing 

trend of concentration in the ETP market remains 

of interest. 

5.6 Financial Market Infrastructure 

5.6.1 Payment, Clearing, and Settlement

U.S. payment systems, central counterparties 

(CCPs), securities settlement systems, and central 

securities depositories are the building blocks of 

the U.S. financial market infrastructure. Payment 

systems include wire transfer networks, automated 

clearinghouses, check clearing services, and 

payment card networks. On the securities settlement 

side, Fedwire Securities Service and the Depository 

Trust Company provide services.

In new developments, the Fixed Income Clearing 

Corporation’s (FICC) Mortgage-Backed Securities 

Division (MBSD) launched CCP services for 

U.S. MBS in April 2012. MBSD processes passthrough MBS issued by Ginnie Mae, Fannie Mae, 

and Freddie Mac. MBSD also processes options 

trades for to-be-announced (TBA) transactions. 

Through netting and guarantees, the MBSD CCP 

reduces overall costs and risks in the MBS market. 

MBSD guarantees the completion of matched 

MBS trades in the event that a counterparty to 

the trade defaults. In the final step of MBSD’s 

clearance process, it nets and novates certain pool 

delivery obligations, which further reduces the 

amount of securities and payments to be delivered, 

and interposes itself as the counterparty to those 

obligations. The CCP is required to have an 

effective risk management framework to protect 

itself from the risks associated with the provision 

of its services, including the risks associated with a 

member default. While the new MBSD CCP cleared 

a significant $104 trillion of transactions in agency 

MBS in 2012, the overall market is larger, and many 

bilateral agency MBS transactions are not submitted 

to the MBSD. Because most bilateral agency 

MBS transactions settle once a month, trading is 

conducted months in advance of the settlement 

date, the size of unsettled positions is substantial, 

and the transactions are not typically margined, 

unsettled MBS transactions can represent significant 

counterparty risk. To address this risk, the Treasury 

Market Practices Group, an industry group 

sponsored by the Federal Reserve Bank of New York, 

has recommended that bilateral MBS transactions 

be margined appropriately. 
100 2013 FSOC / / Annual Report

Pursuant to Title VIII of the Dodd-Frank Act, 

in July 2012, the Council designated eight 

U.S.-based financial market utilities (FMUs) 

as systemically important. These FMUs are 

The Clearing House Payments Company 

LLC, on the basis of its role as operator of 

the Clearing House Interbank Payments 

System, CLS Bank International (CLS), 

Chicago Mercantile Exchange, Inc. (CME), 

The Depository Trust Company (DTC), 

Fixed Income Clearing Corporation (FICC), 

ICE Clear Credit LLC (ICE Clear Credit), 

National Securities Clearing Corporation, 

and The Options Clearing Corporation 

(OptionsCC). The designation subjects 

these FMUs to enhanced risk-management 

standards, including stronger risk management 

requirements and annual examinations. The 

FMUs are subject to enhanced oversight by the 

appropriate Supervisory Agency, meaning the 

federal agency with primary jurisdiction over 

the designated FMU under federal banking, 

securities, or commodity futures laws. Title VIII 

also provides the Federal Reserve discretionary 

authority to permit Federal Reserve Banks to 

establish accounts for and provide financial 

services to designated FMUs. In addition, 

FMUs that are clearing agencies must register 

with the SEC under the Securities and 

Exchange Act of 1934. FMUs that are derivatives 

clearing organizations must register with the 

CFTC under section 5b of the Commodity 

Exchange Act.

Under Section 807 of Title VIII of the DoddFrank Act, the CFTC and SEC are required 

to consult annually with the Federal Reserve 

regarding the scope and methodology for any 

examination of a designated FMU conducted 

under Section 807. The Federal Reserve is 

authorized to participate in any examination 

conducted under Section 807 of a designated 

FMU for which it is not the supervisory agency. 

The CFTC is the supervisory agency for both 

the CME and ICE Clear Credit, and has 

accordingly engaged the Federal Reserve for a 

consultation for the first Title VIII examination 

of a designated FMU. The SEC is separately 

required by the Exchange Act to conduct 
Financial Developments 101

periodic examinations of registered clearing 

agencies, including those dual-registered as 

designated clearing organizations for swaps. 

In addition, the three agencies continue 

to participate in discussions about current 

risk management of swaps for systemically 

important derivative clearing organizations.

The Basel Committee on Banking Supervision/

Committee on Payment and Settlement Systems 

(BCBS/CPSS) issued updated supervisory 

guidance in February 2013 on the settlement 

of FX transactions to supervisors and banks, 

which replaces guidance from 2000.11 Since 

the 2000 guidance, payment-versus-payment 

(PVP) settlement systems, such as CLS, have 

significantly mitigated FX settlement risk; 

however, further FX settlement risks remain 

due to rapid market growth and undisciplined 

market practices. For enhanced risk reduction 

effectiveness, the revised supervisory 

guidance offers seven guidelines that focus on 

governance, replacement cost, and principal 

risk among other FX settlement-related risks. 

5.6.2 Derivatives Infrastructure

G-20 leaders committed at the 2009 Pittsburgh 

Summit to improve the governance of 

derivatives market activities by year end 2012. 

The four resulting reforms focus on central 

clearing, trade repositories, electronic trading, 

and higher capital and margin on non-centrally 

cleared derivatives. Progress on the initiatives 

has been mixed globally, with the U.S. having 

enacted the Dodd-Frank Act and established 

many regulations. In face of these broad 

transformations, notional outstandings of overthe-counter (OTC) derivatives and exchangetraded derivatives have moderated.

Global Derivatives Volumes

In the 12 months ending June 30, 2012, the size 

of the OTC derivatives market declined by 9.6 

percent to $639 trillion, while exchange-traded 

derivatives declined by 28 percent to $60 trillion 

according to the BIS survey of global market 

activity (Charts 5.6.1 and 5.6.2). Derivatives 

notional volumes declined in the first half of 

2012, with exchange-traded derivatives falling 

Chart 5.6.1 Global OTC Derivatives Market

0

100

200

300

400

500

600

700

800

0

100

200

300

400

500

600

700

800

2000 2002 2004 2006 2008 2010 2012

Source: BIS, Haver Analytics

Trillions of US$ As Of: 2012 Q2

5.6.1 Global OTC Derivatives Market

Trillions of US$

Credit Default Swaps

FX Contracts

Equity-linked Contracts

Commodity Contracts

Interest Rate Contracts

Unallocated

Note: Notional values.

Chart 5.6.2 Global Exchange-Traded Derivatives

0

20

40

60

80

100

0

20

40

60

80

100

2000 2002 2004 2006 2008 2010 2012

Source: BIS, Haver Analytics

Trillions of US$ As Of: 2012 Q4

5.6.2 Global Exchange-Traded Derivatives

Note: Notional values.

Trillions of US$

Equity-linked Contracts

Foreign Exchange Contracts

Interest Rate Contracts
102 2013 FSOC / / Annual Report

by a greater percentage than OTC derivatives 

(Chart 5.6.3). The BIS OTC global survey 

reported gross notional outstandings of $494 

trillion in interest rate derivatives, $66 trillion 

in FX derivatives, and $27 trillion in credit 

derivatives as of June 30, 2012. 

Data on the geographic trading locations 

of derivatives is limited, yet available data 

suggests that trading within the U.S. accounts 

for about one-third of derivatives activity on 

exchanges and OTC markets. As measured by 

number of contracts, two-thirds of exchangetraded derivatives were traded outside of North 

America in 2012 (Chart 5.6.4). The share 

of derivatives volume traded on non-North 

American exchanges continued to increase 

over the past several years until 2012, when 

it declined to 66 percent from 69 percent. 

The most recent BIS Triennial Survey (2010) 

indicated that more than two-thirds of turnover 

in OTC interest rate derivatives took place in 

two countries, with the U.S. share trailing the 

U.K. share, 24 percent to 46 percent. Further 

market information from the BIS derivatives 

market survey at June 30, 2012 estimates that 

outstanding credit derivative trades where both 

sides occur in the home country are 20 percent 

of trades, meaning that cross-border trades 

total 80 percent of all credit derivative trades. 

These figures highlight the importance of 

international coordination in derivatives market 

reforms. 

Trade Repositories 

In the United States, Title VII of the DoddFrank Act implements the G-20 trade reporting 

commitment. Prior to the Dodd-Frank 

Act, international major derivatives market 

participants in derivatives collaborated with 

global regulators to establish certain trade 

repositories that receive voluntary reports on 

credit, equity, and interest rates derivatives 

trades. Continued efforts resulted in a 

commodities trade repository in 2012 and an 

FX trade repository in 2013. Under Dodd-Frank 

and related rules, the details of cleared and 

non-centrally cleared U.S. activity-related swaps 

are required to be reported to a registered 

Chart 5.6.3 G lobal OTC and Exchange-Traded 

Derivatives Growth

0 

200 

400 

600 

800 

1000 

0 

200 

400 

600 

800 

1000 

1998 2002 2006 2010 

Source: BIS, Haver Analytics 

Indexed Growth As Of: 2012 Q4 

Note: Notional values, indexed 

such that 1998 Q2 = 100. 

Indexed Growth

OTC 

Exchange Traded 

5.6.3 Global OTC and Exchange-Traded Derivatives Growth 

Chart 5.6.4 Exchange-Traded Derivatives Globalization

Billions of Contracts Traded Billions of Contracts Traded 

Source: Futures Industry Association 

As Of: 2012 

5.6.4 Exchange-Traded Derivatives Globalization 
Financial Developments 103

Swap Data Repository or Security-Based Swap 

Data Repository (SDR) or to the CFTC or 

SEC, as appropriate, if no SDR is available. 

The CFTC established a phase-in period that 

staggers the reporting requirement for different 

market participants and products during 2012 

and 2013. The SEC is finalizing rules related 

to swap reporting for the products it oversees. 

Survey reports to the Financial Stability Board 

(FSB) indicate there are 14 trade repositories 

operating globally. Aggregation and 

understanding of derivatives data by regulators 

could be made more difficult if numerous 

trade repositories arise. The development of 

trade repositories in various jurisdictions may 

be due in part to concerns about privacy and 

information sharing that would need to be 

overcome for regulators to develop the most 

complete understanding of global activity in the 

derivatives markets. 

According to the Depository Trust & Clearing 

Corporation’s (DTCC) public trade repository 

data, $23.7 trillion (notional) credit derivative 

contracts were outstanding on March 22, 2013 

(Chart 5.6.5). The trade repository shows that 

credit derivatives are comprised of 55 percent 

single-name credit derivatives and 45 percent 

credit indices and tranches. For complete credit 

derivative trade records, the trade repository’s 

copper (incomplete legal record and more 

bespoke) trades of about $3.7 trillion (last 

reported at December 31, 2010) need to be 

added to the $23.7 trillion gold (complete legal 

record) trades. This implies total notional 

value of credit derivatives outstanding is 

approximately $27.4 trillion. Finally, public data 

show interest rate derivatives trades outstanding 

as of March 22, 2013 tallied $536.8 trillion, of 

which only 15 percent were dealer-to-dealer, 

while 58 percent were dealer versus CCP, and 

27 percent were dealer versus non-dealer 

transactions (Chart 5.6.6).

Through portfolio compression, market 

participants reduce (or compress) the size of 

their respective swap portfolios. This results 

in fewer outstanding derivatives contracts and 

a lower gross notional size of their portfolio. 

Chart 5.6.5 Credit Derivatives Market 5.6.5 Credit Derivatives Market 

Source: DTCC 

Non Dealer vs 

Non Dealer 

(1%) 

Dealer vs Dealer 

(61%) 

Dealer vs Non Dealer 

(38%) 

As Of: 22-Mar-2013 

Note: Percentages based off 

of total notional outstanding. 

Total = $23.7 Trillion 

Chart 5.6.6 Interest Rate Derivatives Market 5.6.6 Interest Rate Derivatives Market 

Source: DTCC 

Dealer vs 

Non Dealer 

(27%)

Dealer vs CCP

(58%)

Dealer vs Dealer 

(15%)

As Of: 22-Mar-2013 

Note: Percentages based off 

of total notional outstanding. 
104 2013 FSOC / / Annual Report

Several benefits accrue from reducing the 

number of individual bilateral transactions, 

including lower operational risk and reduced 

capital requirements. In the first half of 2012, 

rates derivatives were compressed by $25.7 

trillion and credit derivatives by $2.5 trillion.12 

The industry reports that the cumulative effect 

of compression over the past several years has 

led to the elimination of nearly $230 trillion in 

notional value of credit and rates derivatives. 

Central Clearing of Derivatives 

The anticipation of Dodd-Frank requirements 

and G-20 commitments mandating central 

clearing of certain OTC derivatives transactions 

has led to an increase in the number of 

transactions concentrated in CCPs. A 

CCP reduces risks to participants through 

multilateral netting of trades and by imposing 

risk controls on its participants. Critical 

components needed to reduce risk through a 

CCP include robust risk management practices 

and adequate financial resources. 

The FSB Fourth Progress Report on 

Implementation of OTC Derivatives Market 

Reforms indicates that at mid-year 2012, there 

were approximately 12 OTC derivatives CCPs 

globally, including some that clear multiple 

asset classes. At mid-year 2012, the notional 

amounts outstanding in those CCPs had 

risen by about 23 percent from year end 2010 

levels, reflecting movement of some activity to 

centralized clearing (Chart 5.6.7). Global policy 

initiatives seek to increase these shares and to 

implement central clearing by firms on behalf 

of their clients. 

CCP data show that 45 percent of rates and 

11 percent of credit derivatives trades were 

centrally cleared at June 30, 2012 at LCH.

Clearnet and IntercontinentalExchange (ICE), 

respectively. The OTC derivatives market, 

as mentioned previously, is predominately 

compromised of interest rate derivative (IRD) 

contracts. The majority of those contracts are 

cleared on London-based LCH.Clearnet, which 

has been clearing rates contracts for more than 

a decade. At mid-year 2012, LCH.Clearnet’s 

Chart 5.6.7 Notional Amounts Outstanding on CCPs 

by Asset Class 5.6.7 Notional Amounts Outstanding on CCPs by Asset Class 

Notional Amounts Outstanding on CCPs 

(as reported by CCPs participating in FSB survey) 

(USD equivalents, in billions) 

ASSET CLASS 31-Dec-2010 31-Dec-2011 30-June-2012 

Credit 1,231 1,645 1,800 

Commodities 25 17 13 

Equity 11 2.8 2.4 

FX 73 93 124 

Interest Rates 124,398 142,088 152,972 

TOTAL 125,738 143,846 154,911 

Source: FSB 

Note: Not all CCPs participating in survey provided data for all time 

periods. Where conversion to USD was necessary, exchange rates for a 

given currency on 31-Dec-2010, 31-Dec-2011, and 30-June-2012 were 

used. 
Financial Developments 105

SwapClear indicates trade sides notional 

amounts of about $305 trillion against a total 

rates market size per BIS of $494 trillion (Chart 

5.6.8). Trade sides are both novated contracts 

resulting from the CCP interposing itself 

between a seller and buyer. LCH.Clearnet’s 

SwapClear further reports that the outstanding 

notional value of cleared IRDs has grown from 

about $70 trillion in 2007 to over $372 trillion 

in February 2013. The number of new IRDs 

cleared per month has risen from slightly over 

20,000 in 2007 to almost 188,000 in February 

2013. The credit derivatives market clearing 

volumes have also continued to grow, with 

U.S.-based ICE Clear Credit’s open interest 

increasing to $842 billion as of December 2012, 

with similar trends at ICE Clear Europe (Charts 

5.6.9 and 5.6.10).

Given the increase in activity at CCPs, it is 

important that CCPs have in place robust risk 

management standards that keep pace with 

current and future growth. U.S. regulators 

have worked with other members of CPSSIOSCO to revise international principles for 

all financial market infrastructures (FMIs) 

to enhance risk management standards for 

payment, clearing, and settlement systems, 

culminating in the publication of the Principles 

for Financial Market Infrastructures (PFMI).13 

The PFMI, which were finalized in April 2012, 

seek to address the potential risks resulting 

from increased use of infrastructure such 

as CCPs. The CFTC, Federal Reserve, and 

SEC are taking into consideration the PFMI, 

consistent with Title VIII of the Dodd-Frank 

Act, in assessing whether further rulemaking 

is needed with respect to risk management 

standards applicable to the FMUs designated as 

systemically important.

Many of the largest globally active financial 

institutions are members of CCPs or act 

as agent banks and/or liquidity providers 

to CCPs. As a result, it is critical that these 

institutions fully understand their potential 

liability in the event of a default by one or 

more members of a CCP. To help ensure that 

members understand and can anticipate 

Chart 5.6.8 SwapClear Volume 5.6.8 SwapClear Volume 

Thousands of Trade Sides Trillions of US$ 

Source: LCH.Clearnet 

Monthly Registration (left axis) 

As Of: Feb-2013 

Chart 5.6.9 ICE Clear Credit

0 

200 

400 

600 

800 

1000 

0 

5 

10 

15 

20 

25 

Mar:09 Mar:10 Mar:11 Mar:12 Mar:13 

Source: ICE, Bloomberg, L.P., 

FSOC calculations 

Thousands of Trades As Of: 25-Mar-2013 

5.6.9 ICE Clear Credit 

Note: Only trading days shown. Nondollar denominated contracts converted 

using end of day exchange rates. 

Billions of US$ 

Open Interest (right axis) 

Monthly Registration 

(left axis) 

Chart 5.6.10 ICE Clear Europe

0 

150 

300 

450 

600 

750 

0 

5 

10 

15 

20 

25 

Jul:09 Mar:10 Nov:10 Jul:11 Mar:12 Nov:12 

Source: ICE, FSOC calculations 

Thousands of Trades As Of: 25-Mar-2013 

5.6.10 ICE Clear Europe 

Note: Only trading days shown. 

Billions of Euros 

Open Interest (right axis) 

Monthly Registration 

(left axis) 
106 2013 FSOC / / Annual Report

potential losses from participating in CCPs, CPSSIOSCO finalized a framework requiring an FMI14

to disclose information about its activities, risk 

profile, and risk management practices to facilitate 

a comprehensive understanding of the FMI. In 

addition, the Payments Risk Committee, an industry 

group sponsored by FRBNY, developed a set of 

recommendations in support of a clearing member’s 

due diligence of CCPs to further address this issue.15 

In the event of a CCP member default, the CCP 

uses the defaulting member’s initial margin and 

guarantee fund contribution to cover any losses. If 

losses exceed these amounts, the CCP may use its 

own resources and/or the default fund contribution 

of non-defaulting members. These pre-funded 

resources are required to be sufficiently sized to 

cover the one or two largest exposures created 

by the participants in stress tests of extreme but 

plausible circumstances. Should that prefunded 

amount prove insufficient to cover losses, CCPs may, 

to the extent permitted by their rules, then require 

non-defaulting members to contribute additional 

funds. This mutualization of losses across nondefaulting members underscores the importance of 

members using the information made available to 

estimate their potential obligations in stress periods.

Electronic Trading of Cleared Derivatives

Dodd-Frank set forth requirements that align with 

the G-20 commitment to electronically trade and 

clear derivatives that are subject to clearing. Under 

the Dodd-Frank Act, transactions that are subject 

to clearing will be executed by counterparties on 

designated contract markets, exchanges, or the 

newly-developed security-based swap, or swap 

execution facilities (SEFs) unless the derivatives are 

not made available to trade. A SEF must register and 

may have dual registration with the CFTC and SEC. 

To promote more pre- and post-trade transparency, 

the Dodd-Frank Act requires the CFTC and SEC 

to establish rules that define which swaps can be 

cleared and SEF core principles. Core principles 

focus on position limits, timely publication of 

trading information, and recordkeeping. CFTC 

transparency initiatives such as a proposed rule 

on a request-for-quote system to provide no fewer 

than five quotes to counterparties have proved to be 

problematic. Compliance with certain SEF-related 

rules applies to registered persons, so until release 

of final rules on SEF registration, the related rules 

will not come into effect.

Margin and Capital Initiatives for Non-CentrallyCleared Derivatives

In the United States, global coordination continues 

to inform the federal prudential regulators’ 

(OCC, Federal Reserve, FDIC, Farm Credit 

Administration (FCA), and FHFA), CFTC’s, and 

SEC’s review of their proposed rules on the G-20 

margin and capital commitments for non-centrally 

cleared derivatives. The BCBS/IOSCO Working 

Group on Margin Requirements (WGMR) Second 

Consultative Document (Febuary 2013), prepared in 

consultation with the CPSS and the Committee on 

the Global Financial System (CGFS), recommends 

that all financial firms and systemically important 

nonfinancial entities that engage in non-centrally 

cleared derivatives exchange two-way initial 

and variation margin for non-centrally cleared 

derivatives, to be applied on a prospective basis. 

Industry practice has been to exchange variation 

margin and to collect initial margin only in some 

circumstances. In drafting the Consultative 

Document, global regulators have been mindful that 

the collateral requirements for non-centrally cleared 

derivatives should be stricter than those of CCPs, to 

reflect the less liquid nature of bilateral derivative 

contracts and as a means to incentivize use of 

CCPs. The initial margin proposal could potentially 

have a material quantitative impact (see Box D: 

Collateral Availability). The WGMR has engaged in 

a quantitative impact study (QIS) to gauge the need 

for collateral that the proposed rule would require.

Some market participants have voiced concerns 

about the potential shortage or scarcity of collateral 

and its impact on market functioning and pricing. 

In response to potential collateral scarcity, various 

initiatives have emerged. For example, many have 

suggested that regulators broaden the types of 

assets that qualify as eligible collateral (subject to 

appropriate haircuts) to assist market participants 

in collateralization alternatives. In the case of 

non-centrally cleared OTC derivatives margin, 

80 percent is posted in cash according to the 

International Swaps and Derivatives Association’s 

(ISDA) margin survey.16 However, incremental 
107

initial margin is anticipated to include a 

higher fraction of non-cash eligible collateral. 

Furthermore, collateral transformation trades 

such as collateral swaps (see Section 5.2.4 

for an explanation of such trades) might 

lead to wider collateral availability. Collateral 

transformation could channel risk in new ways, 

resulting in additional counterparty exposures 

and increased market interconnectedness while 

concentrating lower-quality assets with banks or 

providers of collateral transformation services. 

Margin requirements have the potential to 

be procyclical. This is because margins and 

collateral haircuts increase when market 

volatility rises. As a result, demand for eligible 

collateral could jump significantly in response 

to market stress, forcing market participants 

to exit positions quickly if they do not have 

continued access to eligible collateral, which 

exacerbates volatility. Some industry experts 

anticipate that margin requirements under 

stressed market conditions could perhaps raise 

collateral requirements by multiples, not just 

percentages. Through-the-cycle margining 

to stressed market conditions can potentially 

alleviate such procyclicality, but it comes at 

the cost of lower leverage in benign periods. 

Initial margins fixed at the trade date can 

also help to mitigate procyclicality. While 

reform efforts have attempted to reduce the 

procyclicality of margin setting, they do not 

prohibit market participants from behaving in a 

procyclical manner.

Financial Developments
108 2013 FSOC / / Annual Report

BOX D: COLLATERAL AVAILABILITY

The availability of global non-cash eligible collateral for 

certain transactions is likely to be affected by financial 

market reforms. Such reforms include the mandatory 

clearing of certain derivatives, margin requirements for 

many non-centrally cleared derivatives, restrictions on 

the ability to re-hypothecate collateral, and the Basel III 

liquidity standards. Eligible collateral refers to a pool of 

liquid assets that can be pledged for the purchase and 

sale of risky assets or derivatives by financial market 

participants. Non-cash eligible collateral is estimated 

at $74 trillion (Chart D.1). The increased demand for 

collateral proposed by these reforms will be phased into 

the market over an extended time period; there is no 

immediate collateral cliff overshadowing the market.

Compilation of several international regulatory studies 

suggests increased eligible collateral needs will be 

approximately $3.5 trillion globally, amounting to a material 

4.8 percent of the $74 trillion estimate of outstanding 

global eligible collateral (Chart D.2). However, the 

incremental eligible collateral estimates are likely 

conservative, and the full impact of the reforms is not 

expected until the end of 2019. In addition, the estimates 

do not yet account for the downward revision of Basel 

liquidity requirements that was announced in January 

2013. Though the cost of financing these incremental 

uses of eligible collateral may be substantial, the modest 

percentage use of the large stock of eligible collateral, 

efforts by banks to reduce their LCR requirements by 

reducing their estimated 30-day net cash outflow, 

and the market’s flexibility to adjust the supply of available 

eligible collateral, is expected to mitigate some of 

these pressures. 

Chart D.1 Outstanding Amounts of Marketable Potentially 

Safe Assets

Note: Data for government and corporate debt are as of 2011 Q2. 

Data for supranational debt, covered bonds, and gold are as of 

end-2010. Data for U.S. agency debt and securitization are as of 2011 

Q3. 

Source: IMF citing BIS, 

Dealogic, ECBC, SIFMA, S&P, 

WGC, IMF staff estimates 

Supranational Debt 

(1%) 

AAA/AA OECD 

Government 

Securities 

(45%) 

A/BBB OECD 

Government 

Securities (7%) 

U.S. Agency 

Debt (3%) 

Covered Bonds 

(4%) 

Corporate Debt 

(Investment Grade) 

(11%) 

ABS, MBS, Other 

Securitization 

(17%) 

Gold 

(11%) 

Total = $74.4 Trillion 

Supranational Debt 

U.S. 

Debt (3%)

Covered Bonds 

(Investment Grade)

(11%)

(11%) 

Trillion 

Chart D.2 Compilation of Potential Impact on Global 

Eligible Collateral

D.2 Compilation of Potential Impact on Global Eligible Collateral 

Regulatory Change 

Estimate 

(in trillions 

of US$) 

Proportion of 

Global 

Collateral 

Stock ($74T) Comments 

1 

CCP Swap Market – 

Incremental Initial 

Margin 

-$0.3 -0.3% 

Incremental cleared swaps $252T. Initial 

margin on cleared derivatives equals roughly 

0.1% of gross against $252T newly clearable 

derivatives. 

2 Non-Centrally Cleared 

– New Initial Margin -$0.9 -1.3% 

Based on survey of 2012 Q2 and future state. 

Future non-centrally cleared, globalized equals 

$295T. Compiled where thresholds are €50 

million. Initial margin estimate based on 

modeled calculations and as if all non-cleared 

came under margin immediately. 

3 Basel III LCR Liquidity 

– Needs -$2.3 -3.1% 

Available regulatory 30-Jun-2011 estimate of 

dollar impact would overestimate eventual 

application of January 2013 revised LCR. 

Ongoing new QIS. 

Compilation of 

Incremental 

Collateral Needs – A 

Net Use 

-$3.5 -4.8% 

Margin assumes a short range future state 

with zero thresholds and rule applied at once. 

This LCR overestimates eventual impact of 

January 2013 revisions and is applied at once. 

Source: FSB, 

BIS, IOSCO Note: Negative numbers indicate uses, or 

demands, of collateral. $1.32 = €1 at 31-Dec-2012. 

D.1 Outstanding Amounts of Marketable Potentially Safe Assets 

Note: Data for government and corporate debt are as of 2011 Q2. 

Data for supranational debt, covered bonds, and gold are as of 

end-2010. Data for U.S. agency debt and securitization are as of 2011 

Q3. 

D.1 Outstanding Amounts of Marketable Potentially Safe Assets 

Source: IMF citing BIS, 

Dealogic, ECBC, SIFMA, S&P, 

WGC, IMF staff estimates 

(1%) 

AAA/AA OECD 

Government 

Securities 

(45%) 

A/BBB OECD 

Government 

Securities (7%) 

Agency 

(4%) 

Corporate Debt 

ABS, MBS, Other 

Securitization 

(17%)

Gold 

Total = $74.4 
Financial Developments 109

The CCP cleared swap market’s incremental initial margin 

need of $0.3 trillion draws from the WGMR’s Second 

Consultative paper which identified future increases 

in cleared swaps and a rule of thumb for related initial 

margin amounts. The $0.9 trillion incremental demand 

for non-centrally cleared derivatives assumes a threshold 

for counterparties of €50 million. Much of the incremental 

margin will likely be held in the form of non-cash collateral. 

Industry and regulatory entities have considered whether 

stressed margins would actually reflect the marketimposed margins in a time of extreme financial stress. 

The Basel III QIS for the LCR suggests that banks will 

need to raise up to $2.3 trillion in additional world-wide 

high-quality liquid assets (HQLA). The ongoing QIS on 

the revised standard is likely to result in lower incremental 

estimates. A number of global banks may already meet 

the revised minimum standards, suggesting that the 

estimated additional HQLA may be overstated in 

this sense.

The non-regulatory external factors, such as increased 

OECD and supranational debt, central bank monetary 

intervention, and a decreased pool of U.S. GSE debt, may 

have a net positive material incremental impact on the 

supply of eligible collateral. The combined impact of these 

factors is estimated to add approximately $2.5 trillion 

of additional eligible collateral over coming years, thus 

mitigating the increased collateral demand arising from 

regulatory initiatives.

Regulatory Developments; Council Activities 111

6 Regulatory Developments; Council Activities

Since the Council’s 2012 annual report, Dodd-Frank Act implementation included further 

strengthening of supervision, capital, and risk-management standards for financial institutions and 

financial market utilities; procedures for periodic supervisory and company-run stress tests; rulemakings 

related to the orderly liquidation authority; regulation of the derivatives markets to reduce risk and 

increase transparency; new standards to protect mortgage borrowers and reduce risks in the mortgage 

market; and other measures to enhance consumer and investor protection.

In addition, the Council has continued to fulfill its mandate. In particular, the Council is evaluating 

nonbank financial companies for potential designation for Federal Reserve supervision and enhanced 

prudential standards, and the Council issued a proposed recommendation on money market mutal 

fund (MMF) reforms. The Council also continued to monitor potential risks to U.S. financial stability 

and served as a forum for discussion and coordination among the member agencies. The following 

is a discussion of the significant implementation progress the Council and its member agencies have 

achieved since the Council’s 2012 annual report. 

This section covers (1) the safety and soundness of financial institutions; (2) financial infrastructure, 

markets, and oversight; (3) consumer and investor protection; (4) data standards; and (5) Council 

activities. A special topic discussed in this section covers international coordination on derivatives 

reform, including global margining.

6.1 Safety and Soundness

6.1.1 Enhanced Prudential Standards, Supervision, and Capital Standards

Framework for Consolidated Supervision of Large Financial Institutions 

The Federal Reserve issued a new framework for the consolidated supervision of large financial 

institutions in December 2012. This framework strengthens traditional microprudential supervision and 

regulation to enhance the safety and soundness of individual firms, and incorporates macroprudential 

considerations to reduce potential threats to the stability of the financial system. 

The new framework has two primary objectives:

•	 Enhancing the resiliency of a firm to lower the probability of its failure or inability to serve as 

a financial intermediary. Each firm is expected to ensure that the consolidated organization 

(or the combined U.S. operations, in the case of foreign banking organizations (FBOs)) and its 

core business lines can survive under a broad range of internal or external stresses. This requires 

financial resilience by maintaining sufficient capital and liquidity, and operational resilience by 

maintaining effective corporate governance, risk management, and recovery planning. 

•	 Reducing the impact on the financial system and the broader economy in the event of a firm’s 

failure or material weakness. Each firm is expected to ensure the sustainability of its critical 

operations and banking offices under a broad range of internal or external stresses. This 

requires, among other things, effective resolution planning that addresses the complexity and 

the interconnectivity of the firm’s operations. 
112 2013 FSOC // Annual Report

The framework is designed to support a tailored supervisory approach that accounts for the unique risk 

characteristics of each firm and applies to (1) Large Institution Supervision Coordinating Committee 

(LISCC) firms, which are the largest, most complex U.S. and foreign financial organizations subject to 

consolidated supervision by the Federal Reserve; (2) other large domestic bank and savings and loan holding 

companies (SLHCs); and (3) FBOs with combined assets of U.S. operations of $50 billion or more. 

The consolidated supervision framework for large financial institutions is being implemented in a 

multi-stage approach.

Enhanced Prudential Standards and Early Remediation Requirements for Foreign Banking Organizations 

In December 2012, the Federal Reserve issued a notice of proposed rulemaking (NPR) to implement the 

enhanced prudential standards and early remediation requirements in Sections 165 and 166 of the DoddFrank Act for large FBOs. The proposal generally applies to FBOs with a U.S. banking presence and total 

global consolidated assets of $50 billion or more. More stringent standards were proposed for FBOs with 

combined U.S. assets of $50 billion or more. 

The proposal would implement:

•	 A U.S. intermediate holding company requirement. An FBO with both $50 billion or more in global 

consolidated assets and U.S. subsidiaries with $10 billion or more in total assets would generally be 

required to organize its U.S. subsidiaries under a single U.S. intermediate holding company (IHC). 

Direct U.S. branches and agencies of FBOs would remain outside the U.S. IHC. 

•	 Risk-based capital and leverage requirements. IHCs of FBOs would be subject to the same risk-based 

and leverage capital standards applicable to U.S. bank holding companies (BHCs). 

•	 Liquidity requirements. The U.S. operations of FBOs with combined U.S. assets of $50 billion or 

more would be required to meet enhanced liquidity risk-management standards, conduct liquidity 

stress tests, and hold a 30-day buffer of high-quality liquid assets. 

•	 Other requirements: The proposal also includes measures regarding capital stress tests, singlecounterparty credit limits, risk management, and early remediation. 

Under the proposal, FBOs with global consolidated assets of $50 billion or more on July 1, 2014 would be 

required to meet the new standards on July 1, 2015. 

Revised Basel III Liquidity Coverage Ratio 

The Basel Committe on Banking Supervision (BCBS) issued the full text of the revised Liquidity Coverage 

Ratio (LCR) on January 7, 2013. The LCR is one of the BCBS’s key reforms to strengthen global capital and 

liquidity regulations with the goal of promoting a more resilient banking sector. The LCR was first published 

in December 2010. The LCR generally requires a bank’s unencumbered high-quality liquid assets to equal or 

exceed 100 percent of its stressed net cash outflows over a 30-day period. 

The revisions issued in January 2013 incorporated amendments to broaden the definition of high-quality 

liquid assets and relaxed liquidity run-off assumptions used to calculate stressed net cash outflows. These 

revisions would generally moderate the impact of the earlier version but made some parameters more 

stringent. The BCBS has agreed to a revised timetable for the standard to be implemented by January 1, 

2015. In the first year, banking organizations would be subject to a LCR requirement of 60 percent. The 

LCR requirement would increase by 10 percentage points each year, reaching a 100 percent requirement on 
Regulatory Developments; Council Activities 113

January 1, 2019. However, the BCBS also allows for a more accelerated phase-in. The exact phase-in for the 

United States has not been determined. 

In the spring of 2013, the BIS updated the ongoing LCR quantitative impact study (QIS) to assess global 

impact estimates on which the January 2013 revisions were based. The next QIS is expected to be completed 

in the summer of 2013. The FDIC, the Federal Reserve, and the OCC are working jointly to develop a 

proposed rule that would implement the LCR in the United States. 

Risk-Management Standards for Designated FMUs 

Title VIII of the Dodd-Frank Act establishes a new supervisory framework for financial market utilities 

(FMUs) designated by the Council as systemically important. FMUs manage or operate multilateral systems 

for the purpose of transferring, clearing, or settling financial transactions. The new framework includes 

holding designated FMUs to enhanced risk-management standards. In July 2012, the Council designated 

eight FMUs as systemically important. 

Section 805(a)(1) of the Dodd-Frank Act requires the Federal Reserve, in consultation with the Council and 

the supervisory agencies, to prescribe risk-management standards for designated FMUs that are supervised 

by the Federal Reserve under Title VIII. Under Section 805(a)(2), the CFTC and SEC may each prescribe 

regulations, in consultation with the Council and the Federal Reserve, containing risk-management 

standards for designated clearing entities they supervise. Risk-management standards prescribed under 

Section 805 must (1) promote robust risk management; (2) promote safety and soundness; (3) reduce 

systemic risks; and (4) support the stability of the broader financial system. Furthermore, Section 805 also 

directs the supervisory agencies to take into consideration relevant international standards and existing 

prudential requirements when prescribing Title VIII risk-management standards.

Section 806 of the Dodd-Frank Act requires the supervisory agencies to prescribe regulations regarding 

a requirement for designated FMUs to provide a 60-day advance notice to its supervisory agency of any 

proposed changes to its rules, procedures, or operations that could materially affect the nature or level of 

risks presented by that FMU. 

On July 30, 2012, the Federal Reserve adopted Regulation HH implementing the risk-management standards 

and advance notice provisions of Title VIII. The Federal Reserve coordinated closely with the CFTC and 

SEC in developing its rules in order to promote consistency and consulted with other member agencies. 

Regulation HH establishes the minimum expectations in areas of risk management, including counterparty 

credit risk, settlement finality, default management, operational reliability, and governance for designated 

FMUs for which the Federal Reserve is the supervisory agency. To date, two of the eight FMUs designated by 

the Council are payment systems to which Regulation HH applies.

Short-Term Investment Funds

The OCC adopted a final rule in October 2012 to revise requirements for national banks, federal savings 

associations, and federal branches of foreign banks that act as a fiduciary and manage short-term 

investment funds (STIFs). The final rule, which becomes effective on July 1, 2013, was informed by the 

SEC’s amendments in 2010 to Rule 2a-7 under the Investment Company Act. The final rule adds safeguards 

designed to address the risk of loss to a STIF’s principal, including measures governing the nature of a STIF’s 

investments, ongoing monitoring of its mark-to-market value, and forecasts of potential changes in a STIF’s 

mark-to-market value under adverse market conditions. The final rule also requires greater transparency and 

regulatory reporting on a STIF’s holdings, as well as procedures to protect fiduciary accounts from undue 

dilution of their participating interests in the event that the STIF loses the ability to maintain a stable net 

asset value. 
114 2013 FSOC // Annual Report

Leveraged Lending

On March 21, 2013, the OCC, the Federal Reserve, and the FDIC adopted, after notice and comment, 

updated guidance for leveraged lending by the banking agencies’ supervised entities. While leveraged 

lending declined during the crisis, volumes have since increased and underwriting practices have loosened. 

The revised guidance provides greater clarity regarding supervisory expectations for a sound risk 

management framework, clear underwriting standards, effective pipeline management, strong reporting and 

credit analytics, and appropriate risk grading. The guidance applies to all financial institutions supervised by 

the banking agencies that engage in leveraged lending activities.

6.1.2 Dodd-Frank Stress Tests and Comprehensive Capital Analysis and Review

In 2012, the Federal Reserve, OCC, and FDIC finalized rules to implement the stress testing requirements of 

Section 165 of the Dodd-Frank Act for financial companies with over $10 billion in total consolidated assets. 

Section 165 sets forth two stress testing regimes: a supervisory stress test framework that is conducted by 

the Federal Reserve and is discussed more fully in Section 5.3.1, and company-run stress tests that certain 

financial companies are required to conduct annually, pursuant to regulations prescribed by the company’s 

primary financial regulator. BHCs with $50 billion or more in total consolidated assets and nonbank financial 

companies supervised by the Federal Reserve are also required to conduct semi-annual company-run stress 

tests. The federal banking agencies collaborated extensively on their rules to help ensure that they were 

consistent and comparable. The rules define “stress test,” establish methods for the conduct of the companyrun stress tests that must include at least three different scenarios (baseline, adverse, and severely adverse), 

establish the form and content of reporting, and compel the covered institutions to publish a summary of the 

stress test results. 

The Dodd-Frank Act supervisory stress tests and the annual company-run stress tests are conducted under 

common scenarios (baseline, adverse, and severely adverse), provided by the Federal Reserve with respect to 

the supervisory stress test and the appropriate federal banking agencies with respect to the annual companyrun stress tests. The mid-cycle, company-run stress test required for covered companies uses scenarios 

designed by the firms. Certain institutions with total consolidated assets of $50 billion or more were required 

to start their company-run stress testing under these rules in 2012, while covered companies with more than 

$10 billion but less than $50 billion in total consolidated assets, as well as BHCs with total consolidated assets 

of $50 billion or more that did not participate in the 2009 Supervisory Capital Assessment Program (SCAP), 

are not required to start stress testing until 2013. The company-run stress tests began with the release of stress 

scenarios by the federal banking agencies on November 15, 2012, and were recently concluded, with covered 

companies releasing a summary of their results in March 2013.

The annual company-run stress test is conducted concurrently with the Federal Reserve’s Comprehensive 

Capital Analysis and Review (CCAR) of the largest BHCs. The Federal Reserve has aligned the timing of the 

Dodd-Frank Act stress tests and CCAR, which facilitates comparative analysis of the results of the Dodd-Frank 

Act supervisory stress test and CCAR post-stress analysis. On March 7, the Federal Reserve released the results 

of the Dodd-Frank Act supervisory stress tests. In particular, the Federal Reserve disclosed the results of its 

stress test conducted under the supervisory severely adverse scenario, which included firm-specific results 

based on the projections made by the Federal Reserve of each BHC’s losses, revenues, expenses, and capital 

ratios over a nine-quarter planning horizon. On March 14, the Federal Reserve disclosed the summary results 

of the CCAR 2013 exercise. The Federal Reserve approved the capital plans of 14 BHCs. Two other BHCs 

received conditional approval, while the Federal Reserve objected to the plans of two other BHCs.
Regulatory Developments; Council Activities 115

6.1.3 Orderly Liquidation Authority and Resolution Plans

Orderly Liquidation Authority

Title II of the Dodd-Frank Act establishes a new framework, the orderly liquidation authority (OLA), to 

address the potential failure of a BHC or other financial company when the failure of the financial company 

and its resolution under the Bankruptcy Code or otherwise applicable federal or state law would have serious 

adverse effects on financial stability in the United States. Under OLA, the FDIC would generally act as 

receiver of the financial company and would resolve the company as provided in OLA.

Section 210 of the Dodd-Frank Act also requires the FDIC “to coordinate, to the maximum extent possible” 

with appropriate foreign regulatory authorities in the event of a resolution of a covered company with 

cross-border operations. The FDIC and U.K. authorities have made substantial progress in identifying and 

overcoming impediments to resolution, and in December 2012, the FDIC and the Bank of England (BOE) 

published a joint paper that detailed their respective approaches to the resolution of a systemically important 

financial institution with operations in both jurisdictions. The FDIC is continuing to negotiate memoranda 

of understanding with certain foreign counterparts that provide a formal basis for information sharing and 

cooperation relating to resolution planning and implementation under the legal framework of the DoddFrank Act. In recent months, the FDIC concluded such memoranda with regulatory authorities in three 

jurisdictions. In addition, the FDIC and the European Commission have formed a senior staff-level working 

group to discuss issues related to deposit insurance and the resolution of banks and systemically important 

financial institutions. The group convened its initial meeting in February 2013 and plans additional meetings 

in 2013. 

In October 2012, the FDIC adopted, after notice and comment, a final rule clarifying the conditions and 

requirements governing the FDIC’s exercise of its authority to enforce certain contracts of subsidiaries or 

affiliates of a financial company placed into OLA notwithstanding contract clauses that purport to terminate, 

accelerate, or provide for other remedies based on the insolvency, financial condition, or receivership of the 

financial company. In addition, the FDIC will be proposing additional rules to implement or clarify certain 

other aspects of OLA, as necessary. 

Section 210 of the Dodd-Frank Act requires promulgation of regulations requiring financial companies to 

maintain records with respect to qualified financial contracts (QFCs) that are determined to be necessary 

or appropriate to assist the FDIC as the receiver of a financial company. QFCs include securities contracts, 

commodity contracts, forward contracts, repurchase agreements, swap agreements, and any similar 

agreement determined by the FDIC. It is expected that a proposed QFC recordkeeping rule will be issued in 

the near future.

Resolution Plans

Section 165(d) of the Dodd-Frank Act requires nonbank financial companies designated by the Council for 

supervision by the Federal Reserve and BHCs (including FBOs treated as BHCs) with total consolidated assets 

of $50 billion or more (covered companies) to report periodically to the Federal Reserve, the FDIC, and the 

Council with plans—also referred to as living wills—for their rapid and orderly resolution under the U.S. 

Bankruptcy Code in the event of material financial distress or failure. The Federal Reserve and the FDIC 

must review each plan and may jointly determine that a resolution plan is not credible, or would not facilitate 

an orderly resolution of the company under the U.S. Bankruptcy Code. If the Federal Reserve and FDIC 

jointly determine that a resolution plan is not credible or would not facilitate an orderly resolution under the 

Bankruptcy Code, then the company must resubmit the plan with revisions, including any proposed changes 

in business operations or corporate structure, that demonstrate that the plan is credible and would result in 

orderly resolution under the Bankruptcy Code.
116 2013 FSOC // Annual Report

In November 2011, the FDIC and the Federal Reserve published a joint final rule that implements the 

resolution plan requirement. In accordance with the joint final rule, covered companies with $250 billion 

or more in total nonbank assets (or, in the case of a foreign-based covered company, $250 billion or more in 

total U.S. nonbank assets) were required to submit their resolution plans to the Federal Reserve and the FDIC 

by July 1, 2012. Covered companies with at least $100 billion (but less than $250 billion) in total nonbank 

assets (or at least $100 billion, but less than $250 billion in total U.S. nonbank assets, for a foreign-based 

covered company) must submit their initial plans by July 1, 2013. Covered companies with less than $100 

billion in total nonbank assets must submit their initial plans by December 31, 2013. 

Eleven covered companies filed resolution plans with the Federal Reserve and the FDIC in 2012. The Federal 

Reserve and the FDIC have reviewed these plans and on April 15, 2013, issued guidance to the companies 

based on the agencies’ review of the plans submitted in 2012. The Federal Reserve and the FDIC also 

extended the deadline for filing updated reports, from July 1, 2013 to October 1, 2013, to give companies 

additional time to address the guidance.

6.1.4 Insurance

FIO and state regulators serve on the International Association of Insurance Supervisors (IAIS) Executive 

Committee and other IAIS committees and subcommittees, including the Technical Committee and the 

Financial Stability Committee (FSC). One of the responsibilities of the Technical Committee is to direct the 

development of the Common Framework for the Supervision of Internationally Active Insurance Groups 

(IAIGs), which will be an integrated, multilateral, and multidisciplinary framework for the group-wide 

supervision of IAIGs. Also, through service on the FSC, FIO, state regulators, and the NAIC participate 

extensively in the process of identifying global systemically important insurers (G-SIIs) and the policy 

measures to be applied to any designated insurer. The IAIS released a proposed methodology in May 2012 

and proposed policy measures in October 2012. As directed by the FSB, the IAIS will finalize its list of G-SIIs, 

methodology, and policy measures in 2013. 

In early 2012, FIO hosted the insurance leadership of state regulators, the European Commission, and the 

European Insurance and Occupational Pensions Authority to partner in a dialogue and related project. The 

goal of this project is to increase mutual understanding and enhance cooperation between the European 

Union (EU) and the United States in order to promote business opportunity, consumer protection, and 

effective supervision. The steering committee for the project assembled separate technical committees to 

analyze and compare the EU and U.S. regimes on seven topics: (1) professional secrecy and confidentiality; 

(2) group supervision; (3) solvency and capital requirements; (4) reinsurance and collateral requirements; 

(5) supervisory reporting, data collection, and analysis; (6) supervisory peer reviews; and (7) independent 

third party review and supervisory on-site inspections. In December 2012, the steering committee published 

an agreed-upon way forward that defines common objectives and initiatives leading to improved convergence 

and compatibility between the EU and the United States.

Insurance regulators, through the NAIC, continue work on updating the Insurance Financial Solvency 

Framework. NAIC adopted the Own Risk and Solvency Assessment (ORSA) Model Law last year to establish 

the ORSA filing requirement and the Valuation Manual, which will allow states to consider adoption of 

the Standard Valuation Law to implement principles-based reserving. The NAIC continues to work on 

implementation of the revised Credit for Reinsurance Model Law and Regulation, and state regulators are 

implementing the revised Holding Company Model Law and Regulation, including the Enterprise Risk 

Report, upon adoption by state legislatures. 

The Council will also continue to monitor relevant domestic and international financial regulatory proposals 

and developments involving insurance. 
Regulatory Developments; Council Activities 117

6.1.5 Mortgage-related Litigation/Settlements 

In January 2013, the OCC and the Federal Reserve announced a $9.3 billion agreement with 

13 mortgage loan servicers to resolve the 13 servicers’ obligations to conduct an independent 

foreclosure review. The review was required by enforcement actions taken against the 13 servicers 

by the Federal Reserve, the OCC, and the Office of Thrift Supervision (OTS) in 2011 and 2012 to 

address deficiencies in mortgage foreclosure processing. The $9.3 billion in settlement funds will be 

allocated as follows: 

•	 Approximately 4.2 million borrowers who went through foreclosure from 2009 to 2010 

at the 13 servicers will receive cash payments totaling $3.6 billion.

•	 The remaining $5.7 billion will go to providing other assistance to borrowers, such as 

forgiveness of deficiency judgments, loan modifications, and principal reductions, support 

for borrower counseling and education, and other foreclosure prevention activities.

On January 6, 2013, Bank of America and Fannie Mae reached a settlement that resolved 

Fannie Mae’s currently-outstanding and expected repurchase requests arising from breaches of 

representations and warranties on loans sold to Fannie Mae by Bank of America and Countrywide 

from 2000 to 2008. Bank of America will pay Fannie Mae approximately $10.3 billion, attributed as 

follows:

•	 Cash payment to Fannie Mae ($3.55 billion).

•	 Repurchase of approximately 30,000 loans ($6.75 billion).

On February 9, 2012, the Department of Justice (DOJ), Department of Housing and Urban 

Development (HUD), and 49 states announced a $25 billion settlement (the National Mortgage 

Settlement) with Bank of America, Wells Fargo, JPMorgan Chase, Citigroup, and Ally Financial/

GMAC. Under the settlement, the five banks would be released from liabilities related to 

robo-signing and other forms of servicer abuses. In exchange, the five servicers must comply with 

new servicing standards and provide for about $25 billion in assistance towards the following: 

•	 Principal reduction and other assistance to borrowers ($17 billion).

•	 Refinancing underwater borrowers ($3 billion).

•	 Making direct cash payments to foreclosed borrowers ($1.5 billion).

•	 Funding government consumer protection and foreclosure prevention efforts ($3.5 billion).

In conjunction with the announcement of the National Mortgage Settlement, the Federal Reserve 

and the OCC announced penalty actions against the same five servicers for deficiencies in mortgage 

foreclosure processing that were addressed in the agencies’ April 2011 enforcement actions against 

those servicers. The Federal Reserve’s penalties were just under $770 million, while the OCC’s action 

levied approximately $400 million in penalties.

6.2 Financial Infrastructure, Markets, and Oversight

6.2.1 Over-the-Counter Derivatives Reform

Title VII of the Dodd-Frank Act establishes a comprehensive new regulatory framework for swaps 

and security-based swaps. Among other things, the legislation: (1) provides for the registration and 

comprehensive regulation of swap dealers, security-based swap dealers, major swap participants 
118 2013 FSOC // Annual Report

(MSPs), and major security-based swap participants; (2) imposes clearing and trade execution requirements 

on standardized derivative products; and (3) creates robust recordkeeping and real-time reporting 

requirements with respect to swaps and security-based swaps. Title VII provides that the CFTC will regulate 

“swaps,” the SEC will regulate “security-based swaps,” and the CFTC and SEC will jointly regulate “mixed 

swaps.”

In July 2012, the SEC and CFTC approved foundational joint final rules to further define the terms “swap,” 

“security-based swap,” “mixed swap,” and “security-based swap agreement.” This effort followed the CFTC’s and 

the SEC’s April 2012 adoption of joint final rules, which further defined the terms “swap dealer,” “security-based 

swap dealer,” major swap participant,” “major security-based swap participant,” and other terms. The entity and 

product definitional rules went into effect in July and October 2012, respectively, and triggered compliance with 

other final rules adopted previously by the CFTC. The effectiveness of these rules did not trigger compliance 

with certain other rules the SEC is adopting under Title VII. 

Swap and Security-Based Swap Regulatory Reform

A number of significant elements of the CFTC’s swap regulatory regime became effective in the fourth 

quarter of 2012 and in the first quarter of 2013. Swap dealer registration began in advance of December 

31, 2012, and 73 swap dealers and 2 MSPs provisionally registered with the CFTC as of March 2013. Other 

entities are expected to register over the course of 2013 once they exceed the de minimis threshold for swap 

dealing activity. Swap dealers (and MSPs) are subject to a number of specific regulatory standards, including 

internal and external business conduct, recordkeeping and documentation requirements, and real-time and 

regulatory reporting obligations. 

The CFTC adopted a final rule in July 2012 implementing an exception to the clearing requirement for 

nonfinancial entities and small financial institutions that use swaps to hedge or mitigate commercial risk, 

known as the end-user exception. The final rule exempts banks, savings associations, farm credit institutions, 

and credit unions with total assets of $10 billion or less from the definition of “financial entity,” making 

such “small financial institutions” eligible for the end-user exception. The CFTC also proposed a rule in 

August 2012 that would exempt swaps between certain affiliated entities within a corporate group from the 

clearing requirement. The proposed rule details specific conditions that counterparties must satisfy to elect 

the proposed inter-affiliate clearing exemption. The proposed rule also includes reporting requirements for 

affiliated entities that would use the proposed exemption. In December 2012, the CFTC also adopted further 

proposed guidance on cross-border issues relating to the implementation of Title VII of the Dodd-Frank Act. 

On December 31, 2012, swap dealers began reporting swap transaction data to swap data repositories (SDRs) 

for the purposes of real-time public reporting and regulatory reporting of interest rate swap transactions and 

credit default swap (CDS) transactions based on broad-based indices. Reporting to SDRs by swap dealers and 

certain MSPs for the purposes of real-time public reporting and regulatory reporting in the interest rates, 

credit, equity, foreign exchange (FX), and other commodity (including agricultural and energy swaps) swap 

asset classes continued, or began, on February 28, 2013. An April 2013 CFTC staff no-action letter established 

relief for real-time and regulatory reporting deadlines for non-swap dealer and non-MSP counterparties. 

Those that are financial entities (per CEA section 2(h)(7)(C)) began reporting swap transaction data on April 

10, 2013 for interest rate and credit default swaps and will report data beginning May 29, 2013 with respect 

to equity, FX, and commodity swaps. Non-swap dealer and non-MSP counterparties, that are not financial 

entities, will begin swap data reporting on a staggered basis in the second half of 2013. 

A third key milestone in swap regulatory reform was achieved in November 2012, with the CFTC’s adoption 

of the first clearing requirement determinations. A significant portion of interest rate and credit default 

swaps will be brought into central clearing, such as four classes of interest rate swaps (fixed to floating, basis, 
Regulatory Developments; Council Activities 119

forward rate agreements, and overnight index swaps) and two classes of CDS indices (North American 

and European untranched credit derivatives indices). Compliance for central clearing will be phased 

in throughout 2013. Swap dealers and the largest hedge funds were required to begin clearing certain 

standardized swaps on March 11, 2013, and other financial entities will follow on June 10. Accounts managed 

by third-party investment managers and Employee Retirement Income Security Act (ERISA) pension plans 

will have until September 9, 2013 to begin clearing. 

The CFTC previously adopted a comprehensive set of rules for risk management by swap clearing houses, 

and in June 2012 published rules to implement the core principles and other requirements for designated 

contract markets, where both futures and swaps may be listed for trading. The compliance dates for the 

CFTC’s January 2012 rules governing the protection of cleared swap customer funds occurred in November 

2012. In the second half of 2012, the SEC also completed the proposal of substantially all of the rules 

required by Title VII and adopted certain rules pertaining to clearing infrastructure. In June 2012, the SEC 

adopted rules that establish procedures for its review of certain actions undertaken by clearing agencies. 

These rules detail how clearing agencies will provide information to the SEC about the security-based 

swaps that the clearing agencies plan to accept for clearing, which will then be used by the SEC to aid in 

determining whether those security-based swaps are required to be cleared. The adopted rules also include 

rules requiring clearing agencies that are designated as systemically important by the Council under Title 

VIII of the Dodd-Frank Act to submit advance notice of changes to their rules, procedures, or operations if 

such changes could materially affect the nature or level of risk at those clearing agencies. In October 2012, 

the SEC adopted a rule that establishes operational and risk-management standards for clearing agencies, 

including clearing agencies that clear security-based swaps. The rule is designed to ensure that clearing 

agencies will be able to fulfill their responsibilities in the multi-trillion dollar derivatives market as well 

as in more traditional securities markets. In addition to these efforts to improve the resiliency of central 

counterparties (CCPs), U.S. regulators continue to actively participate with international regulators, the FSB, 

and CPSS-IOSCO to address resolution of CCPs, as well as other financial market infrastructure issues. 

In October 2012, the SEC proposed capital, margin, and segregation requirements for security-based swap 

dealers and major security-based swap participants. Among other things, the proposed rules would set 

minimum capital requirements for nonbank security-based swap dealers and nonbank major security-based 

swap participants, establish margin requirements for nonbank security-based swap dealers and nonbank 

major security-based swap participants with respect to non-centrally cleared security-based swaps, and 

establish segregation requirements for security-based swap dealers and notification requirements with respect 

to segregation for security-based swap dealers and major security-based swap participants.

In December 2012, the SEC issued an order providing exemptive relief in connection with a program to 

commingle and portfolio margin customer positions in cleared CDS, which include both swaps and securitybased swaps. Portfolio margining may be of benefit to investors and the market by promoting greater 

efficiency in clearing, helping to alleviate excessive margin calls, improving cash flow and liquidity, and 

reducing volatility.

In addition to its work to propose and adopt Title VII rules, the SEC issued in June 2012 a policy statement 

describing and requesting public comment upon the order in which it expects compliance would be 

required with the final rules to be adopted by the SEC under Title VII. The aim of this policy statement is to 

establish an appropriate sequence in which compliance with these rules would be required so as to avoid the 

disruption and cost that could result if compliance with all of the rules were required simultaneously or in a 

haphazard order.
120 2013 FSOC // Annual Report

Foreign Exchange Swap and Forward Determination

In November 2012, the Secretary of the Treasury made a determination that FX swaps and forwards should 

be exempt from the definition of “swap” in, and thus exempt from most of the provisions of, the Commodity 

Exchange Act (CEA), as amended by the Dodd-Frank Act. Prior to issuing this determination, as authorized 

in provisions of Sections 721 and 722 of the Dodd-Frank Act, the Treasury solicited public comment in 

2010 and 2011, on a range of issues relating to whether FX swaps or forwards should be exempt from the 

definition of “swap” in the CEA. In addition to evaluating the statutory factors, the Treasury reviewed public 

comments, consulted with regulators, and conducted extensive outreach. The Secretary concluded that 

this determination is appropriate given the important differences and risk profiles between FX swaps and 

forwards—which are narrowly defined by the CEA—and other types of derivatives. Unlike most other swaps, 

FX swaps and forwards have fixed payment obligations that are settled by the exchange of actual currency, 

and are predominantly short-term instruments. Even though FX swaps and forwards are not subject to certain 

requirements under the CEA as a consequence of the determination, FX swaps and forwards still remain 

subject to reporting and business conduct requirements. Moreover, the determination does not extend to 

other FX derivatives, such as FX options, currency swaps, and non-deliverable forwards.

Credit Exposures

Section 610 of the Dodd-Frank Act, which became effective on July 21, 2012, amends the definition of 

“loans and extensions of credit” in the national bank lending limit statute (also applicable to savings 

associations) to include credit exposures arising from derivative transactions and from certain securities 

financing transactions. The OCC published an interim final rule on June 21, 2012 to implement the statutory 

amendment. The rule adopts a flexible approach that enables institutions to select from a number of 

measurement methods suitable to the size and complexity of that institution’s activities and credit exposures, 

while reserving for the OCC the discretion to direct individual institutions to use a specific method to 

measure credit exposures when safety and soundness requires it. The OCC continues to review comments 

received on the interim final rule.

State banking regulators also continue to implement the mandate under Section 611 of the Dodd-Frank Act 

to consider derivative exposure in state lending limit laws.

Capital and Margin Requirements

Federal prudential regulators (Federal Reserve, FDIC, OCC, FHFA, and the Farm Credit Administration), 

the CFTC, and the SEC issued proposed rules on capital and margin requirements for non-centrally cleared 

swaps. The proposed margin requirements would require swap dealers, security-based swap dealers, MSPs, 

and major security-based swap participants to collect initial and variation margin on non-centrally cleared 

swap transactions from their counterparties. 

The United States is currently engaged in an international effort being led by the BCBS and the IOSCO to 

establish recommendations for margin requirements on non-centrally cleared swaps to help ensure robust 

regulation of derivatives markets and prevent regulatory arbitrage (see Box E: International Coordination 

on Derivatives Reform, including Global Margining). The international effort may inform the timing and 

nature of the rulemakings being advanced by the federal prudential regulators, the CFTC, and the SEC.
121

BOX E: INTERNATIONAL COORDINATION ON DERIVATIVES REFORM, INCLUDING 

GLOBAL MARGINING

The recent financial crisis exposed the large, opaque overthe-counter (OTC) derivatives market as a transmission 

mechanism for financial distress, demonstrating that 

the OTC market posed significant systemic risk in its 

existing form. In response, the leaders of the G-20 nations 

committed in 2009 to improve transparency and risk 

mitigation in this market by mandating reporting, requiring 

clearing and public trading of certain derivatives, and 

setting additional capital requirements for non-centrally 

cleared transactions. In 2011, the G-20 agreed to add 

margin requirements on non-centrally cleared derivatives 

to the derivatives reform program and called upon the 

BCBS and IOSCO to develop consistent global standards 

for these margin requirements. 

On July 6, 2012, the BCBS/IOSCO-chaired, international 

Working Group in Margin Requirement (WGMR), which 

includes bank and securities regulators from the major 

jurisdictions whose institutions currently play a significant 

role in the derivatives market (such as the European 

Union, Hong Kong, Japan, Singapore, Switzerland, the 

United Kingdom, and the United States) released its 

first consultation document proposing global margin 

requirements on non-centrally cleared derivatives for 

public comment. After considering the initial comments 

and consulting with the BCBS and IOSCO boards, as well 

as other international standard-setting bodies, a second 

consultative document was issued on February 15, 2013 

to request further comment. 

The February 15 consultation document generally 

proposes that all financial firms and systemically important 

nonfinancial entities (excluding sovereigns and central 

banks) should exchange variation margin regularly (daily 

where possible) in amounts reflecting the full existing 

exposure associated with a given derivative. With respect 

to initial margin, subject to a €50 million threshold, all 

market participants with over €8 billion in gross notional 

amount of transactions outstanding (again excluding 

sovereigns and central banks) would be required to 

exchange initial margin on a gross basis calibrated 

according to certain technical standards, whether using 

regulator-approved modeling or standardized look-up 

tables. Initial margin payments would be segregated in 

a manner that maximizes their ready availability in the 

event of a party’s default, and protects them, to the 

extent legally possible, from seizure in the bankruptcy of 

the collecting party. The permissible collateral for margin 

exchange would include a broad range of liquid assets 

(including high-grade corporate bonds and equities 

traded on major exchanges), subject to appropriate 

risk-sensitive haircuts.

The WGMR used information provided by major derivative 

market participants around the globe to complete a 

QIS on the predicted impact of these initial margin 

requirements. The study, which was published on 

February 15, 2013, found that the proposed initial margin 

requirement (with the €50 million threshold) would require 

roughly €700 billion globally in additional segregated 

margin collateral using internal model-based calculations. 

Comparing the size of this estimated collateral 

requirement to the notional size of the entire derivatives 

market, the study estimated that the proposed initial 

margin rules would require margin equal to 0.5 percent 

of the total notional amount of outstanding non-centrally 

cleared derivatives. By comparison, current market 

practice varies widely and is estimated to require 

initial margin equal to 0.03 percent of total notional 

amounts outstanding. 

Currently, one of the largest unresolved issues is how to 

calibrate initial margin in a way that balances the benefits 

of margin, while mitigating counterparty risk against the 

liquidity cost of maintaining large levels of segregated 

initial margin. The WGMR’s study found that, assuming 

wide use of internal models to estimate margin, the 

proposed initial margin requirements would require 

roughly 8 percent of all currently unallocated liquid assets. 

Regulatory Developments; Council Activities
122 2013 FSOC // Annual Report

6.2.2 Office of Financial Research

The Dodd-Frank Act established the OFR to support the Council and its member agencies by collecting 

and standardizing financial data, performing essential research, and developing new tools to measure and 

monitor risks to the financial system.

The OFR complements the efforts of Council member agencies by filling gaps in data and analysis to assess 

threats to financial stability. In recent work to support the Council, the OFR has been conducting research on 

the risks of wholesale funding markets. The OFR has also provided data and analysis for the Council’s work 

on nonbank financial company designations.

The OFR is playing a central role in the international initiative to establish a global Legal Entity Identifier 

(LEI), a code that uniquely identifies parties to financial transactions and links to their basic “business 

card” information. The LEI will give regulators a better view of interconnected markets and will generate 

considerable cost savings for the financial industry in collecting, cleaning, and aggregating data 

(see Section 6.4.1). 

In 2012, the OFR released its Strategic Framework, issued its inaugural annual report, unveiled the first 

three papers of its collaborative Working Paper series with top researchers and academics, and launched a 

Financial Research Advisory Committee.

As provided by the Dodd-Frank Act, the OFR is led by a Director appointed by the President and confirmed 

by the Senate for a 6-year term. In January 2013, the Senate confirmed Richard B. Berner to serve as the 

OFR’s first Director.

6.2.3 Accounting Standards

Under the Dodd-Frank Act, the Council’s annual report is required to address financial market and 

regulatory developments, including accounting regulations and standards.

In December 2012, the Financial Accounting Standards Board (FASB) issued for public comment a proposal 

to improve financial reporting on expected credit losses of loans and other financial assets held by banks, 

financial institutions, and other public and private organizations. The proposal, Financial Instruments—

Credit Losses (Subtopic 825-15), is intended to require more timely recognition of credit losses, while also 

providing additional transparency about credit risk. In releasing the proposal, the FASB stated that the recent 

financial crisis highlighted the need for improvements in the accounting for credit losses on loans and other 

financial instruments, and stated that the proposal would require more timely recognition of expected credit 

losses and more transparent information about the reasons for any changes in those estimates. Currently, 

under U.S. Generally Accepted Accounting Principles (GAAP), credit losses are generally not reflected in 

financial statements until it is probable that the losses have been incurred. Under the proposal, a firm’s 

balance sheet would reflect management’s current estimate of expected credit losses at the reporting date (as 

an allowance for credit losses), and the income statement would reflect the effects of credit deterioration or 

improvement that has taken place during the period (as a provision for bad debt expense).

In February 2013, the FASB issued for public comment a proposal to improve financial reporting by providing 

a comprehensive measurement framework for classifying and measuring financial instruments held by banks, 

financial institutions, and other entities. The proposal, Recognition and Measurement of Financial Assets and 

Financial Liabilities (Subtopic 825-10), responds to feedback the FASB received on its May 2010 proposal that 

would have required a much greater use of fair value measurement for financial assets and liabilities than 

currently exists in U.S. GAAP. Under the new proposal, the classification and measurement of a financial 

asset would be based on the asset’s cash flow characteristics and the entity’s business model for managing the 
123

asset, rather than on its legal form, that is, whether the asset is a loan or a security. Based on this assessment, 

financial assets would be classified into one of three categories: Amortized Cost, for financial assets 

comprised solely of payments of principal and interest that are held for the collection of contractual cash 

flows; Fair Value through Other Comprehensive Income, for financial assets comprised solely of payments of 

principal and interest that are both held for the collection of contractual cash flows and for sale; or Fair Value 

through Net Income, for financial assets that do not qualify for measurement at either amortized cost or fair 

value through other comprehensive income. The proposal also would require financial liabilities to generally 

be carried at cost. For most financial assets and financial liabilities measured at amortized cost, public 

companies would be required to disclose their fair values, but non-public entities would not be required to 

disclose such information.

6.2.4 Operational Risks for Technological Systems 

On March 7, 2013, the SEC proposed Regulation Systems Compliance and Integrity, or Regulation SCI, 

which would replace the voluntary standards of the existing Automation Review Policy Inspection Program 

with enforceable rules designed to help ensure that the core technology of national securities exchanges, 

significant alternative trading systems, clearing agencies, and plan processors meet certain standards and 

therefore be better insulated from and more resilient to the vulnerabilities posed by systems technology 

issues.17 If approved by the SEC, Regulation SCI would require, among other things, that each SCI entity: (1) 

establish policies and procedures relating to the capacity, integrity, resiliency, and security of its technology 

systems; (2) establish policies and procedures designed to ensure its systems operate in the manner intended, 

including in compliance with relevant federal securities laws and rules; (3) take timely corrective action in 

response to systems problems; (4) notify and provide the SEC with detailed information when such systems 

issues occur, as well as when there are material changes in its systems, and inform its members or participants 

about certain systems problems; (5) conduct an annual review of its compliance with Regulation SCI, 

and submit a report of the annual review to its senior management and to the SEC; (6) designate certain 

individuals or firms to participate in the testing of its business continuity and disaster recovery plans at least 

annually, and coordinate such testing with other entities on an industry- or sector-wide basis; and (7) provide 

SEC representatives with access to its systems to assess compliance with Regulation SCI.

6.3 Consumer and Investor Protection

6.3.1 Mortgage Transactions and Housing

In January 2013, the FDIC, Federal Reserve, OCC, NCUA, CFPB, and FHFA issued a final rule to implement 

Section 129H of the Truth in Lending Act as added by Section 1471 of the Dodd-Frank Act. The rule 

establishes appraisal requirements applicable to higher-risk mortgages, referred to as higher-priced mortgage 

loans (HPMLs). An HPML is a residential mortgage loan secured by a principal dwelling with an annual 

percentage rate that exceeds an average prime offer rate by certain specified percentages. Before making an 

HPML, a creditor must: (1) obtain a written appraisal by a certified or licensed appraiser who has physically 

visited the interior of the mortgaged property; (2) obtain an additional appraisal from a different appraiser 

that analyzes any difference in sales prices, changes in market conditions, and any improvements made to the 

property if the property was acquired at a lower price by the seller within 180 days of the current transaction 

and the property is being sold at a price that exceeds certain thresholds; (3) provide the borrower with a 

statement that any appraisal is for the creditor’s sole use and that the borrower may have a separate appraisal 

conducted at personal expense; and (4) provide the borrower with a copy of the appraisal without charge at 

least three days prior to closing. The final rule exempts certain transactions from the appraisal requirements. 

The final rule becomes effective on January 18, 2014. 

Regulatory Developments; Council Activities
124 2013 FSOC // Annual Report

In January 2013, the CFPB issued a final rule setting forth certain minimum requirements for creditors 

making determinations regarding a consumer’s ability to repay a mortgage loan (the Qualified Mortgage 

Rule). Under the rule’s ability-to-repay requirements, creditors generally must consider eight underwriting 

factors set forth in the rule. However, certain qualified mortgages are entitled to a presumption of 

compliance with the ability-to-repay requirements. In order to be a qualified mortgage, a loan is generally 

prohibited from having certain product features (such as negative amortization, interest-only payment, or 

balloon payment) and it generally must satisfy certain affordability underwriting requirements (such as a 

43 percent back-end debt-to-income (DTI) limit and other requirements). The 43 percent DTI limit and 

other underwriting requirements do not apply to loans that are eligible for certain government guaranty 

or insurance programs or to loans that satisfy the requirements for a balloon payment qualified mortgage 

(which is available only to small, portfolio lenders operating predominately in rural or underserved areas). 

Loans that meet the definition of a “qualified mortgage” and are not higher-priced (generally, prime loans) 

receive a safe harbor presumption of compliance with the ability-to-repay requirements. Loans that meet the 

definition of a “qualified” mortgage, but are higher priced (generally, subprime loans) receive a rebuttable 

presumption of compliance with the ability-to-repay requirements. At the same time it issued the final 

qualified mortgage rule, the CFPB issued a proposed rule requesting public comment on certain adjustments 

to the qualified mortgage requirements. The CFPB anticipates that the proposed rule will be finalized and 

effective by the time the final rule takes effect in January 2014.

In January 2013, the CFPB also issued mortgage servicing rules containing nine significant requirements. 

Five of these requirements address servicing of all mortgage loan accounts (including accounts for borrowers 

that are current or delinquent on their mortgage loan obligations). These include requirements relating 

to periodic billing statements, interest rate adjustment notices, payment crediting and payoff statements, 

force-placed insurance restrictions, and procedures for error resolution and information requests. The 

mortgage servicing rules also include four sections setting forth additional protections for borrowers who 

are delinquent on their mortgage loan obligations. These protections include requirements for servicers 

to engage in early intervention outreach with borrowers, to provide borrowers with servicer personnel that 

provide continuity of borrower contact and information, to evaluate borrower applications for loss mitigation 

options pursuant to certain loss mitigation procedures, and to adopt policies and procedures to achieve 

certain operational objectives. Many of the servicing requirements include an exemption for small mortgage 

servicers.

The CFPB also issued a final rule regulating loan originator compensation that strengthens and clarifies 

existing regulations and commentary on loan originator compensation. Specifically, this final rule clarifies 

that a loan originator employee may not receive compensation based on any term of a transaction. The rule 

also sets forth requirements to prevent evasion, prohibits dual compensation of brokers by another party to 

a broker that has been compensated by a consumer, establishes loan originator qualification standards, and 

requires disclosure of a loan originator’s unique identifier number. The final rule also prohibits mandatory 

arbitration clauses or financing single premium credit insurance. 

The CFPB also issued a final escrow rule that requires creditors to maintain escrow accounts for at least five 

years after originating a “higher-priced mortgage loan.” This rule exempts creditors operating predominantly 

in rural or underserved areas. 

Additionally, the CFPB’s Home Ownership and Equity Protection Act (HOEPA) rule expands the types of 

loans that can be subject to HOEPA’s restrictions. Further, the rule revises the existing triggers for HOEPA 

coverage, which are based on interest rates, points, and fees, and adds a new trigger based on certain 

prepayment penalty features.
Regulatory Developments; Council Activities 125

The CFPB also issued a final rule implementing requirements under the Equal Credit Opportunity Act 

(ECOA) regarding appraisals. This rule also provides that a consumer is entitled to receive a copy of an 

appraisal conducted for the origination of a first lien mortgage loan. 

6.3.2 Consumer Protection

In August 2012, the CFPB published a final rule that provides a “safe harbor” from its remittance rule 

for providers of 100 or fewer remittance transfers per year. In December 2012, the CFPB proposed three 

amendments to its remittance rule, which would temporarily delay the February 7, 2013 effective date of that 

rule and provide additional clarity regarding disclosures and error resolution procedures. In November 2012, 

the CFPB proposed amendments to rules implementing the credit card ability-to-pay provisions of the Truth 

in Lending Act.

The Dodd-Frank Act also charges the CFPB with collecting, investigating, and responding to consumer 

complaints with respect to certain consumer financial products and financial institutions. In 2012, the 

CFPB received approximately 91,000 consumer complaints. Of these complaints, 50 percent were related to 

mortgages, the majority of which were related to the ongoing challenges faced by consumers who could not 

make payments. The CFPB provides the public with access to a database of complaints. 

In July 2012, the CFPB and the Department of Education issued a report on private student loans as required 

by the Dodd-Frank Act. The report assesses the market for private student loans, and the impact of these 

loans on consumers, and provides a set of recommendations to improve consumer protections. The CFPB has 

also released a Financial Aid Shopping Sheet and a Financial Aid Comparison Shopper to help students and 

their families better understand the student loan process. 

Among its authorities, the CFPB has supervision authority over certain nonbank entities, including 

mortgage companies, private education lenders, payday lenders, and “larger participants” of a market for 

other consumer financial products or services. In July 2012, the CFPB issued a final rule to define larger 

participants in the consumer credit reporting market, and in October 2012, the CFPB issued a final rule to 

define larger participants in the consumer debt collection market. The CFPB has started examinations of 

both types of entities.

In the course of its supervisory and enforcement activities, the CFPB has discovered numerous violations 

of federal consumer financial law. In each case, it has directed the financial institution that committed the 

violations to take corrective action. Where warranted, restitution or other relief to consumers has also been 

provided. In particular, the CFPB, OCC, FDIC, and Federal Reserve have brought enforcement actions 

against three credit card issuers with respect to the marketing of “add-on” products such as debt protection 

and credit monitoring. These practices include using deceptive marketing, misleading consumers about fees 

or the benefits associated with such products, retaining customers who attempted to cancel such products, 

and enrolling customers in products without their knowledge or consent. As a result of these actions, $435 

million in relief was provided to approximately 5.75 million consumers. 

6.3.3 Investor Protection

Section 952 of the Dodd-Frank Act requires the SEC by rule to direct the national securities exchanges 

and national securities associations to prohibit the listing of any equity security of a company that does not 

comply with the new requirements regarding the compensation committees and compensation consultants 

to such committees. In June 2012, the SEC adopted rules to implement Section 10C of the Securities and 

Exchange Act of 1934 and this provision that will (among other things) direct the exchanges to establish 

listing standards that will require each member of a listed company’s compensation committee to be a 

member of the board of directors and to be “independent.” The exchanges are also required to adopt listing 
126 2013 FSOC // Annual Report

standards that identify factors that affect the independence of compensation consultants to the committee, 

including other services provided by the consultant to the issuer, the amount of fees received, and the policies 

and procedures that are designed to prevent conflicts of interest. To implement the new requirements, 

each relevant national securities exchange, including the New York Stock Exchange (NYSE) and NASDAQ, 

filed proposed rule changes with the SEC; the SEC issued final orders in January 2013 approving these 

changes. Under the rules, all listed companies must expand the authority of their compensation committees 

with respect to the oversight of compensation consultants to the committee by July 1, 2013. Thereafter 

a compensation committee may select or receive advice from a consultant only after conducting an 

independence assessment. Listed companies will be required to comply with the remaining provisions of the 

new exchange rules, including enhanced independence standards of compensation committee members, by 

the earlier of their first annual meeting after January 15, 2014, or October 31, 2014.

In August 2012, SEC staff released a study regarding financial literacy. The study, which was mandated by 

Section 917 of the Dodd-Frank Act, was intended to identify the existing level of financial literacy among 

retail investors, and the methods and efforts to increase investors’ financial literacy. The study found that 

investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid 

investment fraud. The study identifies several methods to improve financial disclosures and transparency.

In 2012, the SEC made the first payout under its Whistleblower Program, which was established in 2011. The 

individual who received the payout provided high-quality, significant information that helped stop a multimillion dollar fraud. The whistleblower received an award of 30 percent of the amount collected in the SEC’s 

enforcement action, which is the maximum percentage payout allowed by law. In fiscal year 2012, the SEC 

received approximately 3,000 tips, complaints, and referrals from whistleblowers.

6.4 Data Standards

Data standards improve the quality of data by providing for their unambiguous and universally accepted 

meaning, thus increasing confidence in them, and enabling data comparison, aggregation, sharing, and 

exchange. Adoption of data standards also reduces the need for costly conversion and manual intervention 

when exchanging data. Building, adopting, and using standards for financial data will facilitate improved 

financial stability monitoring and better risk management by firms. 

6.4.1 Legal Entity Identifier (LEI)

Although the financial services industry and financial regulators have long employed data standards, 

these data standards have not been adopted on a global basis or even universally within the United States. 

Consequently, existing standards are plagued by gaps and overlaps. Fortunately, the standards landscape is 

beginning to change. In 2012, the global regulatory and supervisory community made significant progress 

toward the launch of the global LEI system. Representing the Treasury in this initiative, the OFR has played 

a key leadership role, with strong support from the Federal Reserve, the CFTC, the SEC, and other federal 

financial regulatory agencies with an interest in data standards. 

The LEI is a code that uniquely identifies parties to financial transactions. It is designed to be the first 

global and unique entity identifier, enabling risk managers and regulators to identify parties to financial 

transactions instantly and precisely. The LEI is expected to generate considerable cost savings for the 

financial industry in collecting, cleaning, and aggregating data. Additionally, adoption of the LEI system 

should reduce the regulatory reporting burden, allowing industry to use the same data more readily for its 

internal business operations and risk-management processes as it uses for reporting to regulators.
Regulatory Developments; Council Activities 127

In November 2012, the G-20 endorsed the charter for the Regulatory Oversight Committee (ROC), which is 

acting as the governing body for the global LEI system. The ROC, which was established in January 2013, met 

for the first time in January 2013. The ROC is composed of financial regulators and authorities from around 

the world and is overseeing establishment of a global LEI foundation that will govern the Central Operating 

Unit (COU) for the system. With authority over a global federation of Local Operating Units (LOUs) that 

will issue and maintain the LEIs, the COU will ensure adherence with LEI governing principles, protocols, 

and standards, including reliability, quality, and uniqueness, to produce “one golden standard” for the LEI. 

To date, several organizations have been issued prefixes to the 20-digit LEI code to enable them to begin 

preparations to issue LEIs. Indeed, tens of thousands of standard-compliant “pre-LEIs” are already in use, 

and will converge to be global LEIs. Sponsoring authorities for these organizations include the CFTC and 

authorities in Germany, Ireland, Palestine, and Turkey. 

The OFR has played a key role throughout the LEI development process, leading work streams, and working 

with other regulators and industry to provide recommendations to the G-20 to guide the governance, 

development, and implementation of the global LEI system. Earlier in the implementation phase, the OFR 

served as a Vice Chair on the LEI Implementation Group and the OFR’s Chief Counsel currently serves as 

the Chair of the ROC. The OFR has also worked with other U.S. regulators to embed the concept of the LEI 

into rulemakings, and will continue to do so. Mandatory reporting uses of the LEI will facilitate the rapid 

deployment of the LEI as the global system becomes more widely available. 

Initiatives for the Next Set of Standards

With the LEI on the path toward implementation, the OFR is assessing other critical gaps in data standards. 

First is the development and use of entity hierarchies that will facilitate understanding of parent-subsidiary 

relationships and promote better analysis of intra-firm exposures. Next are product identifiers, including 

those for loans and derivatives—these identifiers will help define attributes for financial instruments. For 

example, the Universal Product Identifier (UPI) categorizes swaps according to the underlying reference 

in them. The Unique Swap Identifier (USI) identifies a particular swap throughout its existence. The LEI, 

UPI, and USI are required for use under CFTC’s swap reporting rules. The Dodd-Frank Act amended the 

Home Mortgage Disclosure Act to allow the CFPB to require a unique mortgage loan identifier, if deemed 

appropriate. As with LEIs, adoption of such standards offers the benefits of improved data quality, increased 

data sharing among regulators, and decreased costs for regulatory reporting by the industry.

6.4.2 Swap Data Repositories

The CFTC reporting rules require that swap transactions be reported to an SDR “as soon as technologically 

practicable,” after trade execution for the purposes of real-time public reporting and regulatory reporting. As 

of December 31, 2012, swap dealers were required to report interest rate and credit default swap transactions 

to SDRs. Registered swap dealers began reporting the other three swap asset classes to SDRs on the required 

date of February 28, 2013. Certain MSPs initiated reporting to SDRs for all five asset classes for the purpose 

of real-time public reporting and regulatory reporting beginning February 28, 2013. The CFTC phase-in 

period staggers the reporting requirements for other swap counterparties.

SDRs for interest rate, credit, equity, FX, and other commodity asset classes are required to publicly 

disseminate real-time swap transaction data for these swap transactions “as soon as technologically 

practicable” after the SDR receives such data, unless the transaction is subject to a time delay. Time delays for 

large trades are based on type of execution, underlying asset, and market participant. Additionally, all trades 

are subject to delays during the phase-in of the CFTC reporting rules. Thus far, market participants 

have not indicated that the reporting requirements are causing any adverse market conditions such as 

reduced liquidity. 
128 2013 FSOC // Annual Report

The DTCC’s Data Repository LLC operates a multi-asset class SDR in the United States. The CFTC 

provisionally approved the DTCC Data Repository LLC to operate as an SDR for credit, equity, interest rate, 

FX, and commodity derivatives. ICE and CME have also provisionally registered as multi-asset class SDRs 

but are not yet reporting data. DTCC, the CME, and ICE are currently publicly disseminating swap data. 

The Trade Information Warehouse reports that $24.1 trillion (notional) of credit derivative contracts were 

reported, of which $15.0 trillion (approximately 62 percent) are dealer-to-dealer. 

The SEC is finalizing the rules related to swap reporting for the products it oversees.

6.4.3 Private Fund Data

The annual and quarterly filings of form PF will provide the Council with a new window into the activities 

of private funds. The SEC estimates that the activities of approximately 650 private fund advisors, which 

collectively manage over an estimated 80 percent of the U.S. hedge fund industry and an estimated 75 

percent of the U.S. private equity industry, will be reported quarterly on form PF. 

6.4.4 Mortgage Market Data

Capturing consistent and accurate data is essential to strengthening the risk-management capabilities of 

the government-sponsored enterprises (GSEs) and other housing finance institutions, along with improving 

transparency and creating operational efficiencies that simplify the exchange of data and improve responses 

to changing requirements and market conditions and trends. The Uniform Mortgage Data Program is 

an ongoing initiative implemented by the FHFA and the GSEs to improve the consistency, quality, and 

uniformity of data collected at the beginning of the lending process, as well as for servicing data. Developing 

standard terms, definitions, and industry standard data reporting protocols will decrease costs for originators 

and appraisers and reduce repurchase risk. It will also allow new entrants to use industry standards 

rather than having to develop their own proprietary data systems to compete with other systems already 

in the market. 

In November 2012, the FHFA and the CFPB announced that they had agreed to partner on the creation 

of a National Mortgage Database (NMDB)—the first comprehensive repository of detailed mortgage loan 

information. Although the mortgage market is the single largest market for consumer finance, there is a 

lack of comprehensive data available on a complete, national scale. The creation of the NMDB will be the 

first step in a broader strategy to help streamline data for research and policy analysis and to make accurate, 

comprehensive information accessible to regulators.

The SEC also has a rule proposal outstanding that, if adopted, would require the filing of tagged, computerreadable, standardized information about the specific assets or loans backing asset-backed securities offered 

and sold in transactions registered with the SEC. The SEC has requested public comment on whether the 

proposal appropriately implements the Dodd-Frank Act requirement to adopt regulations requiring issuers 

of asset-backed securities to disclose asset-level or loan-level data if such data is necessary for investors to 

independently perform due diligence.

6.5 Council Activities

6.5.1 Determination of Nonbank Financial Companies to be Supervised by the Federal Reserve

One of the Council’s statutory authorities is to determine that a nonbank financial company will be subject 

to supervision by the Federal Reserve and enhanced prudential standards if the company’s material financial 

distress—or the nature, scope, size, scale, concentration, interconnectedness, or mix of its activities—could 

pose a threat to U.S. financial stability.
Regulatory Developments; Council Activities 129

In April 2012, the Council issued a final rule and interpretive guidance that describes the three-stage process 

that the Council generally intends to use in evaluating nonbank financial companies. In non-emergency 

situations, before a Council vote on any proposed determination, the company under consideration will 

have an opportunity to submit written materials to the Council regarding the proposed determination. 

The proposed determination will proceed only if approved by two-thirds of the Council, including the 

affirmative vote of the Chairperson. After a proposed determination, a company may request a hearing, 

and the determination will be finalized only after a subsequent two-thirds vote of the Council, including 

the affirmative vote of the Chairperson. Any final determination will be subject to judicial review, and the 

Council must submit a report to Congress on all determinations made under Section 113 of the Dodd-Frank 

Act and the basis for such determinations.

The Council publicly announced that, in September and October 2012, it voted to advance a subset of 

nonbank financial companies to the third and final stage of the evaluation process. As of the date of this 

report, the Council had not made any determinations under Section 113 of the Dodd-Frank Act.

6.5.2 Proposed Recommendation on MMFs

The financial crisis of 2007 to 2008 demonstrated that MMFs are susceptible to runs and can be a source of 

financial instability with serious implications for broader financial markets and the economy. Section 120 

of the Dodd-Frank Act authorizes the Council to issue recommendations to regulatory agencies to apply 

new standards and safeguards to financial activities and practices that create the risk of problems spreading 

through U.S. financial markets.

In November 2012, the Council issued for public comment proposed recommendations to the SEC with 

three alternatives for reform to address the structural susceptibility of MMFs to run risk. The Council is 

currently considering the public comments on the proposed recommendations. Pursuant to the DoddFrank Act, if the Council issues a final recommendation to the SEC, the SEC would be required to adopt the 

recommended standards (or similar standards that the Council deems acceptable) or explain in writing to 

the Council, within 90 days, why it has determined not to follow the recommendation of the Council. The 

Council must then report to Congress on (1) the recommendation issued by the Council and (2) the SEC’s 

implementation of, or failure to implement, the recommendation. The proposed recommendations state 

that if the SEC moves forward with meaningful structural reforms of MMFs before the Council completes 

its recommendation under Section 120, the Council expects that it would not issue a final Section 120 

recommendation to the SEC.

6.5.3 Risk Monitoring and Regulatory Coordination

The Dodd-Frank Act charges the Council with responsibility to identify risks to U.S. financial stability, 

promote market discipline, and respond to emerging threats to the stability of the U.S. financial system. 

The Council also plays a role in further enhancing and facilitating the coordination that takes place 

among federal and state financial regulatory agencies. The Council regularly examines significant market 

developments and structural issues within the financial system. For example, over the past year, the Council 

has considered issues such as the sovereign fiscal developments in Europe and the United States, the multibillion dollar trading losses by JPMorgan, the state of mortgage foreclosures in the United States, the failure 

of MF Global, the impact of Superstorm Sandy on financial markets, weaknesses in the LIBOR process, and 

risks to financial stability arising from cybersecurity vulnerabilities. The Council will continue to monitor 

potential threats to financial stability and to coordinate regulatory responses, whether from external shocks 

or structural weaknesses.
130 2013 FSOC // Annual Report

To facilitate this risk monitoring process, the Council established the Systemic Risk Committee (SRC), 

composed primarily of member agency staff in supervisory, surveillance, examination, and policy roles. The 

SRC serves as a forum for member agency staff to identify and analyze potential risks that may extend beyond 

the jurisdiction of any one agency.

6.5.4 Operations of the Council

The Dodd-Frank Act requires the Council to convene no less than quarterly. In 2012, the Council met 

12 times.18 The meetings bring Council members together to discuss and analyze emerging market 

developments, threats to financial stability, and financial regulatory issues. The Council is committed to 

conducting its business as openly and transparently as practicable, given the confidential supervisory and 

sensitive information at the center of its work. Consistent with the Council’s transparency policy, the Council 

opens its meetings to the public whenever possible. The Council held a public session at three of its meetings 

in 2012.19

Approximately every two weeks, the Council’s Deputies Committee, which is composed of senior 

representatives of Council members, has convened to discuss the Council’s agenda and to coordinate and 

oversee the work of the SRC and the five other functional committees. The other functional committees 

are organized around the Council’s ongoing statutory responsibilities: (1) identification and consideration 

of nonbank financial companies for designation; (2) identification and consideration of financial market 

utilities for designation; (3) making recommendations to primary financial regulatory agencies regarding 

heightened prudential standards for financial firms; (4) consultation with the FDIC on orderly liquidation 

authority and review of the resolution plan requirements for designated nonbank financial firms and the 

largest BHCs; and (5) the collection of data and improvement of data-reporting standards.

In 2012, the Council approved hearing procedures for nonbank financial companies and FMUs subject to 

proposed designations. The Council amended its hearing procedures in April 2013 to apply to financial 

companies engaged in payment, clearing, or settlement activities subject to proposed designations. The 

Council also passed its third budget. In addition, the Council fulfilled its obligations under the Freedom of 

Information Act (FOIA) by responding to FOIA requests in accordance with the Council’s FOIA regulation, 

and complied with the Council’s transparency policy by conducting its business in an open and transparent 

manner whenever possible.20 The Council also re-launched its website, www.fsoc.gov, where members of 

the public can now register to receive e-mail notifications regarding the Council’s activities, including 

announcements of upcoming Council meetings.

Financial Research Fund Assessments 

Section 155 of the Dodd-Frank Act requires the Treasury, with the approval of the Council, to establish 

assessments to fund the OFR’s budget, which includes the expenses of the Council and certain FDIC 

implementation expenses associated with OLA. To implement this provision, the Treasury issued a final 

rule on May 21, 2012 that establishes an assessment schedule for semi-annual collections from BHCs with 

total consolidated assets of $50 billion or greater and an interim final rule that applies to nonbank financial 

companies supervised by the Federal Reserve. The first payments to the Financial Research Fund under the 

rule were made on July 20, 2012. Under the Treasury regulation, subsequent collections are scheduled each 

March 15 and September 15 to replenish the Financial Research Fund.
Regulatory Developments; Council Activities 131

6.5.5 Section 119 of the Dodd-Frank Act

Section 119 of the Dodd-Frank Act provides that the Council may issue non-binding recommendations to 

member agencies on disputes about the agencies’ respective jurisdiction over a particular BHC, nonbank 

financial company, or financial activity or product. (Certain consumer protection matters, for which another 

dispute mechanism is provided under Title X of the Act, are excluded). To date, no member agency has 

approached the Council to resolve a dispute under Section 119.

Potential Emerging Threats 133

7 Potential Emerging Threats

Financial stability is threatened when adverse 

shocks interact with financial system vulnerabilities. 

Adverse shocks potentially induce substantial losses 

on a class of assets over a short period of time and 

can emerge from, or be exacerbated by, the failures 

of specific firms, infrastructure weaknesses, or 

breakdowns in market functioning. Not all shocks 

necessarily affect the stability of the financial system 

or the real economy. However, if the financial system 

is particularly vulnerable to shocks due to excessive 

leverage, excessive maturity transformation, or 

excessive credit risk taking, a shock could threaten 

many institutions with insolvency. Vulnerabilities 

can also arise from weaknesses in reporting systems 

or the possibilities of runs.

In this section, we review six areas of vulnerabilities 

that could threaten the stability of the U.S. financial 

system if adverse shocks occur. Specifically, this 

section (1) provides a review of fire sale and run 

risk vulnerabilities; (2) describes operational risks 

and draws lessons learned from Superstorm Sandy; 

(3) explains why the reliance on reference rates is 

a potential vulnerability for the financial sector; 

(4) explores the financial system’s vulnerability to a 

sudden spike in fixed income yields; (5) lists threats 

from foreign economic and financial developments; 

and (6) explains the risk-taking incentives of large, 

complex, interconnected financial institutions, 

followed by financial stability considerations for 

bank merger policies.

7.1 Fire Sales and Run Risk Vulnerabilities

Market-based intermediation is exposed to fire sale 

and run vulnerabilities. This section investigates 

the vulnerabilities that arise along a particular 

chain of market-based intermediation. The chain 

begins with cash lenders, such as pooled cash 

management vehicles and others with excess cash 

to invest, including corporate and governmental 

entities. These cash lenders invest in tri-party repos 

with broker-dealers. The repos are collateralized 

by Treasury securities, agency mortgage-backed 

securities (MBS) and debt, or corporate bonds (see 

Section 5.2.3 for a breakdown of repo funding 

by collateral type). This intermediation chain 

allows participants to allocate funds to long-term 

investments while offering liquid investment 

products to investors. However, the intermediation 

conducted along this chain makes each step 

potentially vulnerable to runs and fire sales. If 

cash investors doubt the solvency or liquidity 

characteristics of their collateral or counterparty, 

they might rapidly unwind their investments. This in 

turn leaves broker-dealers who are funded through 

tri-party repo vulnerable to sudden collapses in 

sources of funding. 

Money market funds (MMFs) are among the largest 

cash investors in the tri-party repo market.21 Repo 

holdings of MMFs have steadily increased over 

recent quarters, and currently amount to $545 

billion (Chart 7.1.1). The share of MMF assets 

allocated to repo and the share of broker-dealer 

repo funded by MMFs have been steadily increasing 

since experiencing a sharp decline during the 

financial crisis. As of the end of 2012, MMFs allocate 

over 20 percent of their investments to repos and 

fund nearly 25 percent of total broker-dealer repos 

(Chart 7.1.2). Because MMFs are susceptible to 

runs, their relative importance in the repo market 

creates a source of vulnerabilities for the brokerdealer sector. 

In the tri-party repo market, a fire sale can occur if 

a broker-dealer under stress immediately needs to 

sell assets that it can no longer finance. Such predefault fire sales are a risk because broker-dealers 

perform maturity and liquidity transformation. As 

such, broker-dealers that obtain funding in the triparty repo market could be solvent but illiquid. The 

value of the securities they hold might exceed the 

face value of the repo if the securities are sold in a 

well-functioning market. If, however, the market for 

these securities becomes temporarily illiquid, the 

securities’ price might drop to a point at which—if 

a broker-dealer cannot provide additional collateral 
134 2013 FSOC / / Annual Report

to make up for the shortfall in the required 

coverage—the securities are worth less than 

the face value of the repo they collateralize. 

This dynamic makes a run by repo creditors 

potentially self-reinforcing. 

The risk of fire sales is heightened when 

collateral is less liquid. In particular, firms that 

have a large fraction of their repo transactions 

collateralized by illiquid securities tend to be 

more vulnerable. Lenders’ incentives to sell 

collateral quickly in case of dealer distress 

rather than to liquidate over a longer time 

horizon or hedge those positions also increase 

the risk of fire sales. Large broker-dealers’ repo 

books currently range between $100 and $200 

billion and, in some cases, reached peak levels 

in excess of $400 billion prior to the financial 

crisis. While haircuts place some constraint 

on the size of a firm’s repo book, so long as 

underlying collateral remains liquid, the size 

of a firm’s repo book could increase further. 

For very large repo books, even the liquidation 

of high-quality collateral such as agency 

MBS could prove challenging over a 

compressed timeframe. 

The fire sale risk in the tri-party repo market 

generates vulnerabilities for the securities 

broker-dealer sector. Although commercial 

banks benefit from access to the discount 

window and deposit insurance, broker-dealers 

do not have such backstop sources of funding. 

However, compared to activity before the 

crisis, broker-dealers have modestly reduced 

their reliance on overnight tri-party repo 

funding, instead relying on longer-term repo 

funding sources. Furthermore, large brokerdealers have reduced their reliance on MMFs 

for funding less liquid assets via repo. In 

addition, the largest broker-dealers are now 

part of bank holding companies (BHCs), and 

are thus subject to comprehensive prudential 

oversight at the holding company level. Despite 

these mitigating factors, the absence of direct 

and pre-specified sources of public liquidity 

and credit backstops makes broker-dealers, 

as compared to banks, more exposed to 

vulnerabilities in their funding sources.

Chart 7.1.1 Total MMF Repo Holdings 7.1.1 Total MMF Repo Holdings 

Billions of US$ Billions of US$ 

Source: Flow of Funds, Haver Analytics 

As Of: 2012 Q4 

Chart 7.1.2 Repo Funding by MMFs 7.1.2 Repo Funding by MMFs 

Percent Percent 

Source: Flow of Funds, Haver Analytics 

Share of MMF Funding 

of Dealer Repo 

Share of Repo in 

Total MMF Assets 

As Of: 2012 Q4 
135

7.2 Operational Risks

Market Infrastructure and Market Continuity 

Weaknesses

In 2012, equity markets experienced a number of 

systems issues, raising concerns over the impact of 

the markets’ technology infrastructure on market 

stability. Technological advances have brought many 

benefits to markets, but recent events demonstrate 

that those benefits are not without risks. When 

systems do not operate as intended, there may be 

significant consequences not only for the entities 

responsible for the errors, but also for a much wider 

group of market participants. Among the significant 

systems issues that affected U.S. securities markets in 

2012, there are three notable examples of the ways 

in which the technology failures of individual firms 

can potentially threaten market stability and investor 

confidence. These include systems malfunctions in 

connection with the initial public offerings (IPOs) 

of both BATS Global Markets, Inc. (BATS) and 

Facebook, Inc., as well as losses suffered by Knight 

Capital Group, Inc. (Knight Capital) caused by 

errors in its systems related to order routing.

•	 On March 23, 2012, a flaw in software code 

forced BATS, an equities exchange, to cancel the 

IPO of its own stock, which was to be listed on its 

own exchange. According to reports, a coding 

error caused the matching engine for certain 

ticker symbols to enter into an infinite loop, 

making certain securities symbols, including 

the symbol for BATS itself, inaccessible on the 

exchange.

•	 On May 18, 2012, issues with NASDAQ’s trading 

systems delayed the start of trading in the highprofile IPO of Facebook, Inc. According to public 

disclosures, NASDAQ’s IPO system encountered 

conditions that delayed the determination of 

an opening price in the IPO and resulted in 

some market participants experiencing delays in 

notifications over whether orders had been filled. 

•	 On August 1, 2012, the trading firm Knight 

Capital experienced a technology issue at 

the opening of trading at the New York Stock 

Exchange (NYSE) related to the installation of 

trading software that caused routing problems. 

These issues resulted in Knight Capital sending 

a significant number of unintended orders in 

NYSE-listed securities into the market. As a 

result of the error, Knight Capital accumulated 

large positions in certain securities that, when 

unwound, led to a substantial loss.

These events occurred notwithstanding current 

regulatory requirements and oversight programs 

relating to technology standards and safeguards. 

For example, under the SEC’s voluntary 

Automation Review Policy Inspection Program, 

SEC staff conducts inspections of the self-regulatory 

organizations’ trading and related systems, monitors 

planned significant system changes, and responds 

to reports of system failures, disruptions, and 

other problems. In addition, Rule 15c3-5 under 

the Exchange Act requires a broker-dealer with 

market access, or that provides a customer or 

any other person with access to an exchange or 

alternative trading system, to establish, document, 

and maintain a system of risk management controls 

and supervisory procedures reasonably designed to 

manage the financial, regulatory, and other risks 

of its business activity. Financial risk management 

controls and supervisory procedures must be 

reasonably designed to systematically limit the 

financial exposure of a broker-dealer that could 

arise as a result of market access.

The SEC, in conjunction with various market 

participants, is examining the relationship between 

the operational stability and integrity of the 

securities market and the ways in which market 

participants design, implement, and manage 

complex and interconnected trading technologies. 

In March 2013, the SEC proposed Regulation 

Systems Compliance and Integrity (Regulation SCI) 

to strengthen the automated systems of important 

participants in the securities markets. 

Market Infrastructure and Business Continuity

On October 29, 2012, the landfall of Superstorm 

Sandy caused a two-day closure of the NYSE 

and NASDAQ, while fixed income markets were 

closed for one day. Money markets experienced 

only minor disruptions, as market participants 

followed the Securities Industry and Financial 

Markets Association’s (SIFMA) recommendation 

to extend overnight trades to two-day trades. The 

Depository Trust & Clearing Corporation’s (DTCC) 

Potential Emerging Threats
136 2013 FSOC / / Annual Report

clearing and settlement services continued to 

operate throughout the storm from an alternate 

site, although physical certificate processing was 

damaged due to the flooding of its downtown 

Manhattan location (see Box F: Lessons Learned 

from Superstorm Sandy). 

Cybersecurity: Vulnerabilities to Attacks on 

Financial Services

Security threats in cyberspace are not bound by 

national borders and can range widely from low to 

high security risks. Such threats include mechanisms 

that compromise computer systems through 

software code, which may immediately exploit an 

application weakness, coordinate an attack across 

systems, or replicate on a single system to the point 

that performance is disrupted. Cyber risks can 

impact the confidentiality, integrity, and availability 

of the information and technologies essential for 

the provision of services, resulting in financial, 

compliance, and reputation risk. Moreover, cyber 

incidents that disrupt, degrade, or impact the 

integrity of critical financial infrastructure could 

have consequences on operations and efficiency. 

During 2012, more than a dozen financial 

institutions sustained distributed denial-of-service 

(DDoS) attacks to their public websites, all of which 

were attributable to a single group. These particular 

attacks, which began in September, were targeted, 

persistent, and recurring. These attacks targeted 

a number of the largest financial institutions, as 

well as a few large regional organizations. The 

knowledge and skill of the attackers appeared 

to increase over time, including incorporation 

of blended attacks, which can employ multiple 

vectors to ensure higher success rates, and the use 

of browser-specific attacks to allow compromises 

over multiple operating systems platforms. With 

this recent experience, the financial sector has 

become increasingly adept in identifying, assessing, 

preventing, and mitigating cyber risks. 

Financial sector services groups (such as the 

Financial Sector Information Sharing and Analysis 

Center), trade associations, and coordinating 

committees of the public sector (such as the 

Financial Services Sector Coordinating Council) 

are critical to understanding the risks, trends, and 

best practices for mitigation of cyber threats, and 

for disseminating timely information. Enhancing 

cross-sector cooperation, particularly with industries 

upon which the financial sector is dependent, 

such as energy, power, and telecommunications, 

is critical to resiliency. Public-private partnership 

improvements in the analysis and dissemination of 

robust information to improve real-time responses 

to cyberattacks will enhance incident management, 

mitigation, and recovery efforts. Enhanced 

cybersecurity education directed to employees 

and consumers, as well as efficient implementation 

and testing of response programs, will improve 

protection, mitigation, and response to cyberattacks.

Money Laundering

The scale, efficiency, sophistication, and complexity 

of the U.S. financial system make it a prime target 

for those who seek to conceal and move illicit 

money. Money launderers must often, at some 

point, rely on the U.S. financial system to move or 

launder the illicit funds supporting or derived from 

their operations. The technology, products, and 

services offered by institutions to give customers 

better and quicker access to financial services can 

also be used by criminals to instantaneously and 

anonymously move money throughout the world, 

sometimes through the simple click of a mouse or 

the use of a cell phone application. Furthermore, 

money laundering schemes are becoming more 

complex, involving entities and individuals located 

in numerous jurisdictions worldwide. To preserve 

the stability of the U.S. financial system, money 

laundering and other illicit financial activities need 

to be combated, and financial institutions should 

continually reassess and enhance their systems for 

detecting, reporting, and deterring potential money 

laundering activities accordingly.

Model Risk

Model risk presents an increasingly widespread 

and important form of operational risk. Just as 

technological progress has permitted faster and 

more complex transactions, it also has permitted 

more complex models for making investment 

decisions. Flawed models have been costly to some 

financial institutions, and distress due to flawed 

models can exert negative externalities onto other 

firms. Financial institutions can mitigate model 

risk by continuously monitoring and analyzing the 
137

validity of models, comparing alternative models, 

understanding the limitations of their models, and 

supplementing their models with other information 

and analysis. 

7.3 Reliance upon Reference Rates as 

a Vulnerability

Benchmark interest rates, including the London 

Interbank Offered Rate (LIBOR), the Euro 

Interbank Offered Rate (EURIBOR), and similar 

rates, are referenced in swaps transactions, 

commercial and consumer loans, futures contracts, 

and other financial derivatives products traded in 

over-the-counter (OTC) markets and exchanges 

around the world.22 Approximately $350 trillion 

notional amount of swaps and $10 trillion of loans 

are indexed to LIBOR alone. Furthermore, LIBOR 

is a reference rate for 70 percent of the U.S. futures 

market, a majority of the swaps market, and nearly 

half of U.S. adjustable-rate mortgages (ARMs).

LIBOR, EURIBOR, and other similar benchmarks 

play a key role in the financial system’s core 

functions of pricing and allocating capital and 

risk. The Council believes that the price signals 

derived from such benchmark interest rates must 

have integrity; be based upon competitive forces 

of supply and demand; and be free of fraud, 

manipulation, and other abuses. For capital and risk 

to be efficiently allocated within the economy and 

risk to be appropriately measured, such interest rate 

benchmarks should reflect actual price discovery 

anchored in observable transactions. 

The Decline in Unsecured, Interbank Lending

LIBOR and other similar rates reference a market 

that currently has few, and at times, no transactions, 

particularly in longer tenors. The decline in trading 

in unsecured bank funding markets is attributable 

to a significant structural shift in the funding of 

balance sheets and trading positions by market 

participants since the financial crisis. In particular, 

the funding market between banks has shifted 

from unsecured borrowing to borrowings that are 

secured by posting collateral. Furthermore, the 

deterioration in the perception of some banks’ 

credit risk since the beginning of the European debt 

crisis has exacerbated the reluctance of banks to 

engage in unsecured lending. The very large volume 

of excess reserves in the banking system provided by 

central banks has also contributed to significantly 

reduced activity in interbank lending markets. In 

addition, banks are more closely managing demands 

on their balance sheets. Recent changes to Basel 

capital rules also move banks even further from 

interbank lending on an unsecured basis. 

Weakness of Reference Rate Governance

Another key problem with LIBOR and other similar 

rate regimes that facilitated the malfeasance that 

occurred was the weakness of the governance 

structures that were in place. This weakness was 

evident both in the processes that existed within 

banks for determining their submissions and in the 

processes for administering the rates more broadly. 

Coupled with the scarcity of transactions in the 

unsecured, interbank market, these weaknesses 

created the opportunity for banks to manipulate 

and misreport rates over long periods of time. 

Manipulative Activity

Recent investigations uncovered systematic 

false reporting and manipulations of reference 

rate submissions dating back many years. This 

misconduct was designed to either increase the 

potential profit of the submitting firms or to convey 

a misleading picture of the relative health of the 

submitting banks. These actions were pervasive, 

occurred in multiple bank locations around the 

world, involved senior bank officials at several 

banks, and affected multiple benchmark rates and 

currencies, including LIBOR, EURIBOR, and the 

Tokyo Interbank Offered Rate (TIBOR). Each of the 

banks that faced charges engaged in a multi-year 

pattern of misconduct that involved collusion with 

other banks. These revelations have undermined the 

public’s confidence in these benchmarks.

In the United States, the CFTC issued orders 

bringing and settling charges against Barclays, 

UBS, and the Royal Bank of Scotland. The orders 

charged the banks with manipulation, attempted 

manipulation, and false reporting, resulting in 

penalties of more than $1.2 billion in the United 

States, and over $2.5 billion globally. The banks 

also reached resolutions with U.S. Department of 

Justice (DOJ) and foreign authorities. The CFTC’s 

Potential Emerging Threats
138 2013 FSOC / / Annual Report

BOX F: LESSONS LEARNED FROM SUPERSTORM SANDY

Financial sector infrastructure operates in an environment 

that is threatened daily by natural disasters, human error, 

and intentional acts. Core financial infrastructure firms, 

including providers of payment, settlement, trading, 

and clearing services, must ensure that their daily 

operations can function with a high level of confidentiality, 

integrity, and availability in the face of these threats. 

While these firms continue to successfully identify, 

prevent, mitigate, and respond to threats, wide-scale 

events still pose potential operational risks, including 

disruption or degradation of critical functions supporting 

financial transactions. 

Superstorm Sandy made landfall near Atlantic City, New 

Jersey on Monday, October 29, 2012, as a post-tropical 

cyclone. At its peak, the storm left over 6 million people in 

16 states without power. The financial services sector was 

most affected by the impact of the storm in New York City 

and New Jersey. The severe flooding and wind impact 

on energy, telecommunications, and transportation 

infrastructures highlighted the financial services sector’s 

dependency on those systems. 

Despite the severity of Sandy’s impact on people’s 

lives, the financial services sector continued to operate, 

albeit with some notable exceptions. Sandy’s impact on 

financial services was limited, with the worst impacts 

experienced during the initial two business days. The 

NYSE and NASDAQ were closed for two consecutive 

days beginning Monday, while money markets and 

fixed income markets experienced an early close on 

Monday, the day of the storm, and were closed on the 

following day. 

The most critical financial market utilities (FMUs), including 

core payment, clearing, and settlement functions, 

operated normally from their primary or contingency sites. 

On the retail services side, point-of-sale data flowed, 

currency inventories were adequate, and ATMs generally 

were available outside the hardest hit areas. The majority 

of institutions and third-party providers successfully 

leveraged their contingency plans, and disaster recovery 

vendors were able to meet extremely high demand. 

The financial services sector’s extensive efforts towards 

preparation and planning, and investment in failover, backup, and alternative operations, as well as the fortunate 

backdrop of an early warning of the impending storm, 

contributed to sector resiliency. Effective governmental 

assistance through federal interagency coordination, 

federal-state coordination, the public-private partnership 

for critical infrastructure protection, and targeted financial 

regulatory relief helped to resolve issues and assure 

communication among affected parties. 

As a result of the storm, several areas were identified 

where further improvement is needed to strengthen 

business continuity and resiliency, including:

• Planning and testing: It is important that all 

market participants, including firms, exchanges, 

service bureaus, vendors, and clearing houses, fully 

understand the functionality of contingency systems, 

and that key operations and business personnel 

communicate efficiently to assure enterprise-wide 

clarity. Expanded testing exercises would enhance 

market-wide assurance of failover reliability. Such 

testing should involve major market participants as 

well as exchanges, clearing houses, settlement and 

payment systems, and data repositories, and should 

also involve providers of essential services such as 

power, water, and telecommunications.

• Incident management: Protocols for assuring 

a timely decision on whether and when to close 

or open markets would benefit from review and 

streamlining by the responsible public-and privatesector entities. Likewise, protocols for assuring 

timely decisions within financial firms and service 

providers on whether and when to leverage back-up 

sites would benefit from continued regular testing. 

Furthermore, market interdependencies need to be 

fully incorporated in the decision-making process. 

• Personnel: The resilience of critical components 

of the financial system, including major market 
139

participants, requires geographic dispersal of both 

electronic systems and personnel sufficient to enable 

an organization to operate despite the occurrence 

of a wide-scale disruption affecting the metropolitan 

or geographic area of the organization’s primary 

operations, including communities economically 

integrated with, adjacent to, or within normal 

commuting distance of the primary operations 

area. Organizations, including major financial firms, 

need to continuously and rigorously analyze their 

routine positioning and emergency repositioning 

of key management and staff. This is an ongoing 

requirement as technology, market structure, and 

institutions evolve rapidly. Developed business 

continuity plans should be implemented, and key 

staff should be sent to disaster recovery sites when 

there is advance notice of events.

• Dependencies: Cross-industry interdependencies 

require constant review, reassessment, and 

improvement by organizations to mitigate the impact 

of energy, power, transport, and communications 

failures during severe incidents, and to help ensure 

reliable redundancy.

Potential Emerging Threats
140 2013 FSOC / / Annual Report

settlements with Barclays, UBS, and the Royal Bank 

of Scotland included measures requiring those 

three banks to take specified steps concerning 

their LIBOR and other benchmark interest 

rate submissions and to improve related 

internal controls.23 

Financial Stability Concerns

Council members believe that in the absence of both 

an explicit and transparent link between LIBOR 

and market transactions and strong governance 

of reference rates, price signals for capital and 

risk allocation and risk measurement may become 

distorted, possibly leading to misallocation of capital 

and risk and a mis-measurement of risk. Identifying 

alternatives anchored in observable transactions 

with appropriate governance structures, and 

determining how to achieve a smooth transition to 

them, would mitigate the risk of a significant threat 

to U.S. financial stability. 

Possible Distortions in Capital Markets by Continued Use 

of LIBOR

The continued publishing of LIBOR implicitly 

suggests that there is a liquid underlying market 

when, in fact, trading volumes are thin, and at 

times nonexistent, particularly in longer tenors. 

Referencing LIBOR and similar rates diminishes 

market integrity and will be unsustainable in the 

long run, inasmuch as these rates are not anchored 

in observable transactions. Furthermore, significant 

incentives for misconduct exist when a vast array of 

financial instruments reference a given benchmark 

based on a small or possibly nonexistent market. 

These incentives were noted by a recent Bank 

for International Settlements’ (BIS) Economic 

Consultative Committee report: “Cases of market 

manipulation have raised concerns about the 

appropriateness of the processes and methodologies 

used in formulating reference interest rates. These 

cases reflect both the incentives to manipulate 

submissions—e.g. the potential to profit in a large 

derivatives market that relies on reference rates and 

the desire during the financial crisis to avoid the 

stigma associated with relatively high submissions— 

and a relatively weak governance structure.”

Banks Withdraw from LIBOR Panels

In light of the litigation and reputational risk, there 

is a chance that banks currently participating in 

LIBOR panels may choose not to submit rates.24 

According to media reports, banks have considered 

withdrawing from LIBOR and other panels. To date, 

six banks have withdrawn from EURIBOR, and a 

number of banks, including Barclays, have pulled 

out of lesser-used LIBOR panels, such as LIBOR 

for the Australian dollar and the Canadian dollar. 

All 18 banks continue to report to the U.S. dollar 

LIBOR panel, but absent a smooth and orderly 

transition, if banks were to pull out of the U.S. 

dollar LIBOR panel, preventing LIBOR from being 

published, it could prove difficult to settle contracts 

or write new contracts. While some contracts 

contain language that allows for a backup rate in 

the event of temporary problems with LIBOR, it is 

not clear how an event would be treated if LIBOR 

ceased to exist.25 

A Rapid and Precipitous Move by Market Participants to 

Divest Contracts Tied to LIBOR

Another concern is if market participants were to 

rapidly and precipitously move to divest investments 

and contracts linked to LIBOR. While such an 

event is currently not expected, such an event 

could destabilize markets. If such a shift occurred 

gradually, it could be seen as market participants 

effectively solving their own problem. However, if 

appetite for LIBOR-linked investments and contracts 

was severely reduced and led investors to rapidly 

and precipitously shift out of these instruments, 

the normal functioning of a variety of markets, 

including business and consumer lending, could 

be impaired. 

Reform Efforts

In the wake of the investigations and settlements 

described above, multiple international regulatory 

bodies and supervisory agencies responded to 

concerns about reference rates and financial 

benchmarks by initiating reviews of various global 

benchmark activities and developing best practices 

to improve the governance of these benchmarks.

The U.K. government requested that the Financial 

Services Authority (FSA) review LIBOR and provide 

recommendations for its revision or replacement. 
141

The resulting Wheatley Review published a final 

report on September 28, 2012, which included a 

number of major and minor revisions to the thencurrent system of governance, calculation, and 

oversight. As examples, the Review recommended 

an explicit and clear use of transaction data to 

corroborate LIBOR submissions and a phasing 

out of all but 37 of the current 150 published 

rates.26 The Review recommended, for instance, 

that Canadian dollar LIBOR and Australian dollar 

LIBOR cease to exist. The Review concluded 

that transaction data should be explicitly used to 

support LIBOR submissions. It also emphasized 

the importance of sound governance in the 

determination of reference rates and, along the 

lines of the Review, recommended that both 

the administration and submission processes 

be regulated by the FSA. The Wheatley Review 

recommendations were incorporated in final 

legislation by the U.K. Parliament in December 

of 2012. On March 25, 2013, the U.K. FSA issued 

proposals for the regulation and supervision of 

LIBOR-related activities.27 LIBOR-related activities 

fall under regulation by the new Financial Conduct 

Authority (FCA) as of April 2, 2013. Benchmark 

administrators are required to corroborate 

submissions and monitor them for suspicious 

activities. Banks must put in place conflicts of 

interest policies, and benchmark administrators 

and submitters must be considered FSA-approved 

persons. 

The CFTC and the U.K. FCA are co-chairing 

the International Organization of Securities 

Commissions (IOSCO) Task Force on financial 

market benchmarks. In January 2013, the task force 

published its Consultation Report on Financial 

Benchmarks, with a final report scheduled to be 

published in mid-June.28 The consultation requested 

public input on a possible framework of principles 

to support the quality and credibility of benchmark 

administration and the resilience of benchmarks. In 

the report, the Task Force said, among other things, 

that in order to be credible, benchmarks should be 

anchored in observable transactions and be subject 

to clear governance and accountability mechanisms. 

The consultation report stated, “The Task Force 

is of the view that a benchmark should as a matter 

of priority be anchored by observable transactions 

entered into at arm’s length between buyers and 

sellers in order for it to function as a credible 

indicator of prices, rates or index values.” It went 

on to say, “However, at some point, an insufficient 

level of actual transaction data raises concerns as to 

whether the benchmark continues to reflect prices 

or rates that have been formed by the competitive 

forces of supply and demand.” The consultation 

report also discussed the need for benchmarks, 

as well as contracts and financial instruments 

that reference benchmarks, to have contingency 

provisions to address the possible cessation of a 

benchmark and the transition to alternatives.

The March 2013, the BIS Economic Consultative 

Committee report noted that greater use of 

transaction data combined with the transparent 

and appropriate use of expert judgment in the 

rate setting process would enhance the resilience 

of reference rates, and that steps should be taken 

to ensure that contracts have robust fallback 

arrangements for use in the event that the main 

reference rate is not produced.29 In addition, the 

report notes both the incentives to manipulate 

and a relatively weak governance structure. The 

report also discussed a range of options that central 

banks could use to promote additional benchmark 

choices, including a rebalancing away from current 

unsecured, interbank lending reference rates. 

Significantly, the report stressed that given the 

“public-good” nature of reference rates, it is “entirely 

appropriate that the official sector should play a 

role in ensuring the reliability and robustness of 

reference rates and facilitating a range of private 

sector solutions.”

International regulators and markets participants 

have begun to consider alternatives and possible 

arrangements to transition to alternative rates. For 

example, the BIS working group report lists the 

overnight swaps rate and short-term collateralized 

financing rates, such as general collateral repo rates, 

as possible alternatives. 

Regulators around the globe have taken steps 

toward reviewing their own local benchmarks. The 

European Securities and Markets Administration 

(ESMA) and European Banking Authority (EBA) 

published a joint consultation report in January 

Potential Emerging Threats
142 2013 FSOC / / Annual Report

2013, which focused on EURIBOR and other 

European benchmarks, detailing similar highlevel principles for benchmark administrators, 

calculation agents, and submitters. On the 

legislative front, the European Commission has 

started to revise current legislative authority 

over these widely used market instruments. 

All of these entities aim to establish systems of 

governance and administration, especially in 

the case of benchmarks with widespread use, 

that will perform robustly through 

a wide range of market conditions.

7.4 Financial System Vulnerability to 

Sudden Spikes in Fixed Income Yields

Treasury yields are at the lowest levels seen since 

the 1940s (Chart 7.4.1). Yields across the credit 

spectrum are also low by historical standards. 

The primary drivers for these exceptionally low 

levels are threefold: expectations of continued 

low short-term interest rates, compressed 

pricing of interest rate risk, and contained 

solvency risk for credit markets. 

•	 Market expectations of low short-term rates 

can be gauged from federal funds futures, 

which are at very low levels relative to recent 

years (Chart 7.4.2). Expectations for low 

future interest rates primarily reflect the 

stance of monetary policy, including the 

Federal Open Market Committee’s (FOMC) 

rate guidance. That policy stance, in turn, 

reflects the depth of the post-crisis recession 

and the moderate recovery since that time.

•	 The pricing of interest rate risk can be 

measured by term premia, or the excess 

compensation to investors of holding 

long-term Treasury securities compared 

to reinvesting in short-term securities 

periodically over time. Current estimates of 

term premia are quite compressed relative to 

historical averages (Chart 7.4.3).

30 The 1-year 

rate 9 years forward—another measure of 

the risk premium embedded in Treasury 

securities—is also very low. The pricing 

of risk is driven by the composition of 

investors and by risk appetite. An important 

factor in the composition of buyers is the 

Chart 7.4.1 Historical Bond Yields

0 

4 

8 

12 

16 

20 

0 

4 

8 

12 

16 

20 

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 

Source: Federal Reserve, Haver Analytics 

Percent As Of: Feb-2013 

7.4.1 Historical Bond Yields 

Percent 

Moody's Seasoned Baa 

Moody's Seasoned Aaa 

10-Year Constant Maturity Treasury 

3-Month Treasury Bills, Secondary 

Market 

Chart 7.4.2 Federal Funds Rate

7.4.2 Federal Funds Rate 

Percent Percent 

Implied Rate 

Effective Rate 

As Of: 25-Mar-2013 

Source: Federal Reserve, 

Haver Analytics 

Note: Implied Federal Funds 

Rate derived from OIS quotes. 
143

presence of the Federal Reserve’s large-scale 

asset purchase programs (LSAPs) as well 

as pension funds’ demand for long-term 

Treasury securities, both of which tend to 

compress term premia. The low rate volatility 

environment relaxes risk management 

constraints, resulting in higher risk appetite.

•	 The pricing of credit risk is measured by 

credit spreads, which are the difference 

in yields between corporate bonds and 

Treasury securities of the same duration 

for given credit qualities. Credit spreads 

have declined, but are not unusually low 

by historical standards (Chart 7.4.4). Highyield, or speculative grade, corporate 

credit spreads have also compressed. The 

compression in spreads can be attributed 

to a decline in the credit risk premium 

in response to robust demand for higheryielding assets, healthy corporate balance 

sheets, and a sanguine outlook for defaults.

The low level of interest rates provides 

incentives for institutions to reach for yield 

by extending their duration risk, investing in 

lower-quality credit, or increasing their degree 

of leverage. Pension funds, insurers, and asset 

managers face challenges in meeting targets 

for future obligations. Reaching for yield is 

supported by the low measured volatility across 

asset markets. Low term premia provide an 

incentive to move down the credit spectrum 

and earn higher spread. On the other hand, low 

term premia may be offsetting those incentives 

to some extent by reducing the profitability 

of maturity transformation and encouraging 

financial institutions to increase their longerterm funding. 

There is some evidence that investors are 

exhibiting reach for yield behavior. In primary 

markets, new issuance set highs in leveraged 

loans, high-yield bonds, and investment 

grade bonds. However, there is currently 

little evidence that high-yield bonds are 

being purchased by levered investors, or that 

they are being issued by excessively levered 

borrowers. Still, there is some evidence of 

deteriorating underwriting standards for highChart 7.4.3 Interest Rate Risk Premium Indicators 7.4.3 Interest Rate Risk Indicators 

Percent Percent 

1-Year Rate 9 

Years Forward 

(right axis) 

10-Year Treasury 

Term Premium 

(left axis) 

As Of: 1-Mar-2013 

Source: FRBNY calculations, Blue 

Chip Consensus, Federal Reserve 

Chart 7.4.4 Historical Credit Spreads

-100 

300 

700 

1100 

1500 

1900 

-100 

300 

700 

1100 

1500 

1900 

1954 1964 1974 1984 1994 2004 

Source: Bank of America Merrill Lynch, 

Federal Reserve, Haver Analytics 

Basis Points As Of: Feb-2013 

7.4.4 Historical Credit Spreads 

Note: Spread to 10-Year CMT. 

Basis Points 

BAML High-Yield Spread 

Moody’s Seasoned Baa Spread 

Moody’s Seasoned Aaa Spread 

Potential Emerging Threats
144 2013 FSOC / / Annual Report

yield bonds and leveraged loans. Collateralized loan 

obligations (CLOs) offer leveraged exposure to 

high-yield corporate credit. Additionally, increased 

competition among underwriters and limited 

volumes of merger and acquisition activity have led 

to an erosion of margins and other protections for 

lenders. 

The high volume of CLO issuance is indicative 

of broader issuance trends in the leveraged loan 

market, where financial conditions are getting less 

tight. Increased issuance of leveraged loans has 

historically served as an early warning indicator. 

However, since the financial crisis, rating agencies 

have revised criteria to require higher credit 

enhancements for rated CLO tranches, which 

provide additional protection for senior note 

investors. Today, CLO structures are generally less 

complex than they were before the crisis.31 While 

leverage and illiquidity were key vulnerabilities for 

structured products during the crisis, CLOs today 

are primarily funded either by non-levered investors 

or commercial banks, which tend to buy senior 

tranches. There is little evidence that CLOs are 

funded by leveraged, short-term funded investors 

outside of depository institutions. Besides banks, 

CLO investors are often long-term, fully capitalized 

entities whose holding periods are less sensitive 

to short-term funding conditions. Furthermore, 

many CLOs are floating rate, and as a result protect 

investors against interest rate risk.

Yields and risk premia are likely to rise from their 

current low levels. The speed of this adjustment is 

important to financial stability. While a transition 

to a more normal yield environment might occur 

gradually over years, there is a risk of a sudden 

spike in yields. A yield spike could be induced by 

changed views about the economic outlook, an 

adverse external shock, or a sudden change in risk 

appetite. Spikes in the pricing of risk occur when 

the risk appetite of institutions, or their ability to 

take risk, drops suddenly, triggering an adverse 

feedback loop of investor losses, forced asset sales, 

lower asset prices, higher market volatility, and 

further decreases in risk appetite. The vulnerability 

of the financial system to such shifts in risk 

appetite depends on the degree of leverage in the 

financial system, maturity transformation, and 

interconnectedness among financial institutions. 

In addition, a sharp increase in yields can be 

triggered by duration hedging of investors in the 

MBS market (see Box C: Convexity Event Risk). 

These vulnerabilities have been mitigated in recent 

years. The degree of leverage is generally lower 

due to tighter regulatory requirements and more 

stringent market discipline, maturity transformation 

in wholesale funding markets has been reduced due 

to the decline in shadow banking activity since the 

crisis, and vulnerabilities from interconnectedness 

of financial institutions have been reduced due to 

improvements in counterparty risk management. 

The combination of low returns and increasing 

appetite for risk warrants continued vigilance by 

regulators, investors, and lenders to the potential 

build-up of risks. Although counterparty risk 

management in many markets has improved, 

particularly in the swaps market, concerns remain 

that funding markets have not taken the necessary 

steps to appropriately reduce counterparty risk. 

Opaque chains of intermediation remain possible 

risk transmission channels, such as in short-term 

funding markets, securities lending, and 

derivative markets. 

7.5 Foreign Economic and Financial 

Developments

Though external threats appear to have decreased 

over the past year, they remain a risk to U.S. 

financial stability and economic activity. The 

euro area and Japan grapple with ways to reduce 

public debt burdens and promote growth. China 

has avoided an abrupt slowdown, but concerns 

persist about its ability to transition away from its 

investment-driven growth model. 

Policy actions undertaken by euro area governments 

and the European Central Bank (ECB) have 

improved stability in the euro area and eased 

severe market pressures, providing additional time 

for adjustments at the country and regional level 

(see Section 4.4.1). However, recent developments 

in Italy and Cyprus serve as a reminder that the 

euro area continues to be a source of shocks and 

vulnerabilities. Renewed stress could arise due 

to missed fiscal or structural reform targets and 
145

adverse political developments. Delays in financial, 

economic, and fiscal integration could make it 

difficult to reverse large intra-euro area economic 

disparities and leave the region vulnerable to new 

shocks over an extended period of time. Sustained 

economic weakness is also a possible source of 

renewed stress. The restoration of growth in the 

euro area remains essential, and will support 

a reduction of heavy debt burdens, lower high 

unemployment rates, and help maintain political 

support for the adjustment process within the 

core and periphery. In January, the International 

Monetary Fund (IMF) forecasted a sequential 

strengthening of growth over 2013, by 0.5 percent 

on a Q4/Q4 basis; however, headwinds to growth 

include substantial fiscal drag, private sector 

deleveraging, and a weak external environment. 

Medium-term growth prospects remain uncertain, 

given mixed progress with reforms to address 

challenges to competiveness and productivity. 

Financial fragmentation within the euro area 

continues to be a challenge. Private sector capital 

has started to return to the periphery, but remains 

sharply lower compared to pre-crisis levels. 

Meanwhile, despite the reduction in sovereign 

debt yields, there has been limited feed through 

to improved credit conditions for private sector 

borrowers in the periphery countries. European 

bank lending capacity continues to be constrained 

by balance sheet deleveraging, rising credit costs, 

and ongoing efforts to bolster capital buffers. 

The Japanese economy is marked by sluggish 

economic growth, persistent deflation, and high 

public sector indebtedness. Consistent with Prime 

Minister Abe’s campaign calls, in January, the Bank 

of Japan (BOJ) adopted a 2 percent inflation target 

as part of a joint statement with the government. 

The BOJ’s new policy framework, approved in 

April, shifted the policy operating target from 

the overnight call money rate to the quantity 

of the monetary base, with a target of ¥60-70 

trillion annual growth. The BOJ has committed to 

maintaining the new policy as long as necessary to 

maintain 2 percent inflation “in a stable manner.” 

The new government is seeking to establish a policy 

mix that boosts growth and ends deflation. A high 

public debt burden (gross public sector debt totals 

235 percent of GDP) and Japanese banks’ large and 

growing share of Japanese government bond (JGB) 

holdings remain vulnerabilities.

China has significant influence on financial market 

sentiment due to its large size and sustained rapid 

growth. A sharp deceleration of domestic demand 

could impact macroeconomic, trade, and financial 

activity among its trading partners, including 

the United States and other Group of 20 (G-20) 

countries. Recent Chinese economic data suggests 

that activity has stabilized, mitigating concerns that 

prevailed last year over an abrupt slowdown (see 

Section 4.4.2). However, concerns persist about the 

sustainability of China’s growth model, in which 

exports and fixed investment have played key roles, 

and about the prospects for gradually rebalancing 

the economy toward domestic consumption. 

Challenges include implementing a host of 

structural reforms, such as interest rate and capital 

account liberalization, and addressing banking and 

other financial sector risks, including the nonbank 

credit sector. China’s strong external position and 

demonstrated capacity for forceful policy actions 

may enable it to address these risks.

Potential Emerging Threats
146 2013 FSOC / / Annual Report

7.6 Risk-Taking Incentives 

of Large, Complex, Interconnected 

Financial Institutions

Financial institutions have incentives to take 

on excessive risk if they perceive a public sector 

guarantee. Risk-taking incentives can be further 

supported if the market perceives financial 

institutions as being too big, too complex, 

or too interconnected to fail. Such market 

perceptions of government support diminish 

market discipline by allowing institutions to 

take on more leverage at lower cost. In fact, 

some credit rating agencies continue to factor a 

systemic support uplift into the long-term credit 

ratings of the largest U.S. financial institutions 

(Chart 7.6.1). 

While the systemic uplift by credit rating 

agencies generally declined since the financial 

crisis due to improving credit assessments of 

the underlying company and a perception of 

decreased government support, the uplift has 

not disappeared completely. The justification 

by the credit rating agencies for the systemic 

support uplift is the perception that the actions 

of government authorities during the recent 

crisis imply a guarantee to large, complex, 

interconnected financial institutions. The 

uplifts for long-term credit ratings also tend to 

be reflected in the short-term ratings that help 

firms access short-term unsecured wholesale 

funding. Vulnerabilities can arise when a 

financial institution’s funding model depends 

in part on the belief that the government 

will provide support, rather than solely on the 

intrinsic strength of the institution and 

its portfolio.

The Dodd-Frank Act explicitly addresses the 

incentives and abilities of large, complex, 

interconnected institutions to engage in risk 

taking through a combination of policies. 

•	 The Act limits the ability of the government 

to provide extraordinary support to 

shareholders and creditors of large, complex 

financial institutions. Thus, by law, the 

Chart 7.6.1 Moody’s BHC Systemic Support Uplift

Source: MoodyĀs, FRBNY calculations 

7.6.1 MoodyĀs BHC Systemic Support Uplift 

Notches Notches 

C 

BAC 

JPM 

MS 

WFC 

GS 

As Of: 27-Mar-2013 

Chart 7.6.2 Number and Distribution of Subsidiaries: 

Selected Top 50 BHCs 7.6.2 Number and Distribution of Subsidiaries: Selected Top 50 BHCs 

BHC 

Rank Name Total Foreign 

% of Assets 

Outside Domestic 

Commercial 

Banks 

Consolidated 

Total Assets 

(Billions of US$) 

1.. JPMorgan Chase 3,409 449... 14.1%........... 2,359.1...... 

2.. Bank of America 1,838 429... 25.1%........... 2,212.0......

3.. Citigroup 1,642 682... 29.5%........... 1,864.7......

4.. Wells Fargo 1,331 90... 6.4%........... 1,423.0......

5.. Goldman Sachs Group 3,124 1,683... 87.4%........... 938.8......

6.. Morgan Stanley 3,093 1,398... 87.6%........... 781.0......

10.. Capital One Financial 115 14... 0.0%........... 313.0......

20.. Regions Financial 39 4... 0.8%........... 121.3......

30.. BBVA USA Bancshares 44 0... 0.0%........... 69.1......

40.. BOK Financial 35 0... 0.7%........... 28.1......

50.. Webster Financial 19 0... 0.2%........... 20.2......

Total 19,743 5,859... 24.9%........... 14,274.0......

Note: Subsidiary data are as of 2-Apr-2013. Financial data are as of 

2012 Q4. Capital One % of assets set to zero; raw figure is negative 

due to netting of related party transactions. Excludes data on SLHCs. 

Source: National Information 

Center, FR Y-9C, FR Y-6, 

FR Y-10, FFIEC 031, FFIEC 041 

Count 

Chart 7.6.3 BHC Subsidiaries by Industry 7.6.3 BHC Subsidiaries by Industry 

Source: National Information Center, FR Y-6, FR Y-10 

Number of Subsidiaries Number of Subsidiaries 

Bank of America 

JPMorgan Chase 

Citigroup 

Wells Fargo 

Goldman Sachs 

Morgan Stanley 

Remaining Top 50 BHCs 

As Of: 2-Apr-2013 
147

government is constrained in its ability to provide 

support after a crisis event. 

•	 The Act institutes enhanced prudential standards 

for the largest BHCs and designated nonbank 

financial companies (see Section 6.1.1). The 

enhanced prudential standards include riskbased capital and leverage requirements, liquidity 

standards, risk management and risk committee 

requirements, single-counterparty credit limits, 

and stress test requirements. The stringency of 

these requirements tends to increase with the 

size and complexity of the firm. In addition 

to these enhanced prudential standards, the 

Dodd-Frank Act provides the Council authority 

to impose a debt-to-equity limit for companies 

that it has determined pose a grave threat to 

financial stability. Together, these provisions put 

limits on certain types of risk taking by financial 

institutions, and thus reduce the probability of 

failure, though the provisions do not directly 

reduce perceptions of public guarantees.

•	 The Act authorizes the FDIC to resolve certain 

failing financial companies deemed to pose a risk 

to the financial system. The FDIC is developing 

a resolution strategy for such firms that will 

promote financial stability by minimizing 

contagion and requiring accountability by forcing 

the firms’ shareholders and creditors to bear 

losses and culpable management to be replaced. 

In addition, covered companies are required to 

develop their own resolution plans, which are 

jointly reviewed by the Federal Reserve and the 

FDIC (see Section 6.1.3). If the Federal Reserve 

and the FDIC jointly determine that a resolution 

plan is not credible or would not facilitate orderly 

resolution under the Bankruptcy Code, then the 

company must resubmit the plan with revisions, 

including, if necessary, proposed changes in 

business operations or corporate structure, 

that demonstrate that the plan is credible and 

would result in orderly resolution under the 

Bankruptcy Code. 

The complexity and international reach of BHCs 

is illustrated in Chart 7.6.2, which reflects the 

diverse business lines and locations in which 

these firms operate.32 BHC legal structures spread 

over hundreds, and in some cases thousands, of 

subsidiaries, many of which are domiciled abroad. 

For the six largest BHCs by total assets, the share 

of assets outside of domestic commercial bank 

subsidiaries ranges from 6.4 percent to 87.6 percent, 

illustrating that traditional banking is in some 

cases only a small fraction of BHCs’ activities. The 

largest share by industry of nonbank subsidiaries is 

accounted for by funds, trusts, and other financial 

vehicles (Chart 7.6.3). Many of these funds, 

trusts, and financial vehicles conduct credit 

intermediation via securitization outside of the 

commercial bank. For the largest BHCs, the biggest 

nonbank subsidiaries by asset size include securities 

broker-dealers. 

Market participants may continue to perceive that 

some institutions receive special treatment by virtue 

of their size. Such beliefs could be exacerbated by 

the degree of concentration in the financial services 

industry. While the approval process for bank 

consolidations now take into account the systemic 

risk footprint of the resulting firm (see Box G: 

Bank Consolidation and Financial Stability Policy), 

increased concentration can still be achieved via 

organic growth. However, in the past two years, 

the asset share of the 10 largest U.S. financial 

institutions has decreased, while the asset share of 

smaller institutions has increased (Chart G.1). 

Potential Emerging Threats
148 2013 FSOC / / Annual Report

BOX G: BANK CONSOLIDATION AND FINANCIAL STABILITY POLICY

Banking concentration in the United States has remained 

relatively stable in the years since the financial crisis. As 

is shown in Chart G.1, acquisitions by the largest firms in 

the years preceding the crisis had caused a substantial 

fraction of assets at the top 50 banking organizations to 

become consolidated among the 10 largest institutions. 

The crisis-related acquisitions that occurred during 2007 

to 2008 further raised the asset share of the 10 largest 

institutions to above 50 percent.33 In the past two years, 

the asset share of the 10 largest institutions has declined 

somewhat, while the share of the banks below the top 50 

has increased. Despite the trend towards consolidation 

prior to and during the financial crisis, the U.S. banking 

system remains relatively unconcentrated compared 

with that of many other advanced economies. The size 

distribution of banking firms is relatively broad, with 

regional or smaller banks conducting a substantial share 

of retail banking activity. 

For several years, the federal banking agencies have 

been prohibited from approving an interstate acquisition 

or merger in which a banking organization’s post-merger 

share of U.S. deposits would exceed 10 percent upon 

consummation.34 In addition to this limitation, prior to 

the financial crisis, federal banking agencies focused 

primarily on competitive, microprudential supervisory, and 

community and consumer considerations when reviewing 

bank and BHC mergers and applications, without specific 

regard to financial stability. For the competitive analysis—

which is still applied today—federal law prohibits the 

appropriate federal banking agencies from approving a 

bank merger or acquisition if it would result in a monopoly. 

The law also prohibits an agency from approving a 

proposal that would substantially lessen competition or 

tend to create a monopoly, unless the agency finds that 

the anticompetitive effects are clearly outweighed in the 

public interest by the probable effects in meeting the 

convenience and needs of communities served. 

In 2010, the Dodd-Frank Act incorporated additional 

provisions regarding banking acquisitions, including 

several sections that direct the Federal Reserve to 

consider financial stability in its review of banks, BHCs, 

and related nonbank acquisitions.35 The Dodd-Frank Act 

also requires the appropriate federal banking agency to 

consider the risks to U.S. financial stability in its review of 

a banking organization merger.36 In addition, the DoddFrank Act prohibits an insured depository institution, 

BHC, savings and loan holding company (SLHC), or 

nonbank financial company supervised by the Federal 

Reserve from merging with or acquiring control of 

another company if the total consolidated liabilities of 

the acquiring company upon consummation of the 

transaction would exceed 10 percent of the liabilities 

of all financial companies.

The new financial stability screens have been applied to 

several recent acquisitions, including PNC’s December 

2011 acquisition of Royal Bank of Canada’s U.S. banking 

subsidiary and the acquisition by Capital One of ING Bank 

(the U.S. thrift affiliate of ING Group) in February 2012. 

These two acquisitions left the acquiring firms among 

Chart G.1 Asset Shares of U.S. Financial Institutions

10 

20 

30 

40 

50 

60 

10 

20 

30 

40 

50 

60 

2005 2006 2007 2008 2009 2010 2011 2012 

G.1 Asset Shares of U.S. Financial Institutions 

Percent of Total Assets Percent of Total Assets 

Source: FR Y-9C, FR Y-9SP, SLHC, Call Reports, SEC 10Qs 

Top 10

Top 11-50

Below Top 50 

As Of: 2012 Q4 

Note: Includes U.S.-chartered independent banks and BHCs, SLHCs, independent thrifts, ILCs, credit card 

banks, FBO edge corporations, FBO nonbank affiliates, and FBO branches. Assets are adjusted to account 

for acquisitions and charter changes. Assets are as of 2012 Q4 except small-parent BHCs (2012 Q2), 

certain FBO nonbank affiliates that file annually (2011 Q4), and all other FBO nonbank affiliates (2012 Q3). 
149

the largest U.S. institutions in terms of deposits, but their 

shares of banking organization assets are still substantially 

smaller, leaving the two firms out of the top 10 (Chart 

G.2). The Federal Reserve stated that it will generally find 

a significant adverse effect “if the failure of the resulting 

firm, or its inability to conduct regular-course-of-business 

transactions, would likely impair financial intermediation 

or financial market functioning so as to inflict material 

damage on the broader economy.”37 

Chart G.2 Asset Shares of the Top 10 U.S. Financial Institutions

G.2 Asset Shares of the Top 10 U.S. Financial Institutions 

Share of U.S. Assets Assets 

Percent Billions of US$ 

JPMorgan Chase 10.5 2,359 

Bank of America 9.8 2,212 

Citigroup 8.3 1,865 

Wells Fargo 6.3 1,423 

Goldman Sachs 4.2 939 

Morgan Stanley 3.5 781 

Credit Suisse (U.S.) 2.6 575 

Deutsche Bank (U.S.) 2.3 509 

Barclays (U.S.) 2.2 501 

BoNY Mellon 1.6 359 

Source: FR Y-9C, FR Y-9SP, SLHC, Call Reports, SEC 10Qs 

As Of: 2012 Q4 

Note: Includes U.S.-chartered independent banks and BHCs, SLHCs, independent thrifts, ILCs, credit card 

banks, FBO edge corporations, FBO nonbank affiliates, and FBO branches. Assets are adjusted to account 

for acquisitions and charter changes. Assets are as of 2012 Q4 except small-parent BHCs (2012 Q2), 

certain FBO nonbank affiliates that file annually (2011 Q4), and all other FBO nonbank affiliates (2012 Q3). 

Potential Emerging Threats

The metrics applied by the Federal Reserve to assess 

the effects of the transactions on financial stability 

include measures of size, substitutability of critical 

services, interconnectedness, complexity, and crossborder activity. These metrics are conceptually similar to 

the global metrics applied by the Basel Committee on 

Banking Supervision (BCBS) in the designation of global 

systemically important banks (G-SIBs).

References 151

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Adrian, Tobias and Markus K. Brunnermeier (2011) “CoVaR,” NBER working 

paper 17454, available at http://newyorkfed.org/research/staff_reports/sr348.pdf.

Adrian, Tobias, Richard K. Crump, and Emanuel Moench (2013) “Pricing the 

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available at http://www.newyorkfed.org/research/staff_reports/sr340.pdf.

Avraham, Dafna, Patricia Selvaggi, and James Vickery (2012) “A Structural View of 

U.S. Bank Holding Companies,” Federal Reserve Bank of New York Economic Policy 

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BCBS/CPSS (2013) “Supervisory Guidance for Managing Risks Associated with 

the Settlement of Foreign Exchange Transactions,” February 2013, available at 

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BCBS/IOSCO (2013), “Second Consultative Document: Margin requirements for 

non-centrally cleared derivatives,” February 2013, available at http://www.bis.org/

publ/bcbs242.pdf.

BIS (2012) “Statistical release: OTC derivatives statistics at end-June 2012,” 

November 2012, available at http://www.bis.org/publ/otc_hy1211.pdf.

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CPSS/IOSCO (2012a) “Principles for Financial Market Infrastructures,” available 

at http://www.bis.org/publ/cpss101a.pdf.

CPSS/IOSCO (2012b) “Disclosure Framework for Financial Market 

Infrastructures,” available at http://www.bis.org/publ/cpss101c.pdf.
152 2013 FSOC // Annual Report

CPSS/IOSCO (2013) “Financial Benchmarks,” available at http://www.iosco.org/

library/pubdocs/pdf/IOSCOPD399.pdf.

Daly, Mary C., Bart Hobijn, Aysegül Sahin, and Robert G. Valletta (2012) “A 

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feds/2012/201226/201226pap.pdf.

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newsevents/press/orders/order20120214.pdf.

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13/6, available at http://www.fsa.gov.uk/static/pubs/policy/ps13-06.pdf.

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financialstabilityboard.org/publications/r_130411a.pdf.

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2012.pdf.

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Member Due Diligence of Central Counterparties,” February 5, 2013, available at 

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and Gallagher,” Division of Risk, Strategy and Financial Innovation, November 

30, 2012, available at http://www.sec.gov/news/studies/2012/money-marketfunds-memo-2012.pdf.

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proposed/2013/34-69077.pdf.

Abbreviations 155

Abbreviations

ABCP Asset-Backed Commercial Paper

ABS Asset-Backed Security

AFS Available-for-Sale

ARM Adjustable-Rate Mortgage

ATRA American Taxpayer Relief Act of 2012

AUM Assets Under Management

BAC Bank of America

BATS BATS Global Markets, Inc.

BBA British Bankers’ Association

BCBS Basel Committee on Banking Supervision

BEA Bureau of Economic Analysis

BFI Business Fixed Investment

BHC Bank Holding Company

BIS Bank for International Settlements 

BLS Bureau of Labor Statistics 

BNYM Bank of New York Mellon

BOE Bank of England 

BOJ Bank of Japan

C Citigroup

C&I Commercial and Industrial 

CapPR Capital Plan Review 

CBO Congressional Budget Office
156 2013 FSOC // Annual Report

CCAR Comprehensive Capital Analysis and Review

CCP Central Counterparty

CD Certificate of Deposit

CDS Credit Default Swap 

CEA Commodity Exchange Act 

CFPB Bureau of Consumer Financial Protection

CFTC Commodity Futures Trading Commission 

CGFS Committee on the Global Financial System 

CLO Collateralized Loan Obligation 

CLS CLS Bank International

CMBS Commercial Mortgage-Backed Security

CME Chicago Mercantile Exchange

CMO Collateralized Mortgage Obligation

COU Central Operating Unit

CoVaR Conditional Value-at-Risk

CP Commercial Paper 

CPPI Commercial Property Price Index

CPSS Committee on Payment and Settlement Systems

CRE Commercial Real Estate 

CU Credit Union

DB Defined Benefit

DC Defined Contribution

DDoS Distributed Denial-of-Service

DFAST Dodd-Frank Act Stress Tests
Abbreviations 157

DIP Distress Insurance Premium

DOJ U.S. Department of Justice

DTC Depository Trust Company

DTI Debt-to-Income

DTCC Depository Trust & Clearing Corporation

E&S Equipment and Software

EBA European Banking Authority

ECB European Central Bank

ECOA Equal Credit Opportunity Act

EFSF European Financial Stability Facility

EM Emerging Market

EMBI+ Emerging Markets Bond Index Plus

EME Emerging Market Economy 

ERISA Employee Retirement Income Security Act

ESM European Stability Mechanism 

ESMA European Securities and Markets Administration 

ETF Exchange-Traded Fund

ETN Exchange-Traded Note

ETP Exchange-Traded Product

ETV Exchange-Traded Vehicle

EU European Union

EURIBOR Euro Interbank Offered Rate

FASB Financial Accounting Standards Board

FBO Foreign Banking Organization
158 2013 FSOC // Annual Report

FCA Farm Credit Administration

FDIC Federal Deposit Insurance Corporation

Federal Reserve Board of Governors of the Federal Reserve System

FFIEC Federal Financial Institutions Examination Council

FHA Federal Housing Administration

FHFA Federal Housing Finance Agency

FICC Fixed Income Clearing Corporation 

FICO Fair Isaac Corporation 

FINRA Financial Industry Regulatory Authority

FIO Federal Insurance Office 

FMI Financial Market Infrastructure

FMU Financial Market Utility

FOIA Freedom of Information Act

FOMC Federal Open Market Committee

FRBNY Federal Reserve Bank of New York

FSA Financial Services Authority

FSB Financial Stability Board

FSC Financial Stability Committee (IAIS)

FSOC Financial Stability Oversight Council

FX Foreign Exchange

G-20 The Group of Twenty Finance Ministers and Central Bank Governors

G-SIB Global Systemically Important Bank

G-SIFI Global Systemically Important Financial Institution

G-SII Global Systemically Important Insurer
Abbreviations 159

GAAP Generally Accepted Accounting Principles

GASB Governmental Accounting Standards Board

GCF General Collateral Finance

GDP Gross Domestic Product

GS Goldman Sachs

GSE Government-Sponsored Enterprise

HAMP Home Affordable Modification Program

HARP Home Affordable Refinance Program

HHF Hardest Hit Fund

HOEPA Home Ownership and Equity Protection Act

HPML Higher-Priced Mortgage Loan

HQLA High-Quality Liquid Asset

HTM Held-to-Maturity

HUD U.S. Department of Housing and Urban Development

IAIG Internationally Active Insurance Group

IAIS International Association of Insurance Supervisors 

ICE IntercontinentalExchange

ICI Investment Company Institute 

IHC Intermediate Holding Company

IMF International Monetary Fund

IOSCO International Organization of Securities Commissions

IPO Initial Public Offering

IRD Interest Rate Derivative

ISDA International Swaps and Derivatives Association
160 2013 FSOC // Annual Report

JGB Japanese Government Bond

JPM JPMorgan Chase

KBW Keefe, Bruyette & Woods

LCR Liquidity Coverage Ratio

LEI Legal Entity Identifier

LIBOR London Interbank Offered Rate

LISCC Large Institution Supervision Coordinating Committee 

LOU Local Operating Unit

LSAPs Large-Scale Asset Purchases

LTV Loan-to-Value Ratio

MBR Minimum Balance at Risk

MBS Mortgage-Backed Security

MBSD Mortgage-Backed Securities Division

MHA Making Home Affordable Program

MMF Money Market Mutual Fund

MOVE Merrill Lynch Option Volatility Estimate

MS Morgan Stanley

MSP Major Swap Participant

NAIC National Association of Insurance Commissioners 

NASDAQ NASDAQ Stock Market

NAV Net Asset Value

NBER National Bureau of Economic Research

NCUA National Credit Union Administration

NFIB National Federation of Independent Business
Abbreviations 161

NIM Net Interest Margin

NMDB National Mortgage Database

NPR Notice of Proposed Rulemaking

NYSE New York Stock Exchange

OAS Option-Adjusted Spread

OCC Office of the Comptroller of the Currency

OFR Office of Financial Research

OIS Overnight Index Swap

OLA Orderly Liquidation Authority

OMB Office of Management and Budget

OMO Open Market Operation

OMT Outright Monetary Transactions

OPEC Organization of Petroleum Exporting Countries

OptionsCC Options Clearing Corporation

ORSA Own Risk and Solvency Assessment 

OTC Over-the-Counter

OTS Office of Thrift Supervision

P/B Price-to-Book

P/E Price-to-Earnings

PBGC Pension Benefit Guaranty Corporation

PCE Personal Consumption Expenditures

PFMI Principles for Financial Market Infrastructures

PIK Payment-In-Kind

PSPAs Preferred Stock Purchase Agreements
162 2013 FSOC // Annual Report

PVP Payment-versus-Payment

Q4/Q4 Fourth Quarter over Fourth Quarter

QFC Qualified Financial Contract

QIS Quantitative Impact Study

QM Qualified Mortgage

QRM Qualified Residential Mortgage

REIT Real Estate Investment Trust 

Repo Repurchase Agreement 

RMBS Residential Mortgage-Backed Security

ROA Return on Assets

ROC Regulatory Oversight Committee

RWA Risk-Weighted Assets

S&P Standard & Poor’s 

SCAP Supervisory Capital Assessment Program

SCOOS Senior Credit Officer Opinion Survey on Dealer Financing Terms

SDR Swap Data Repository

SEC Securities and Exchange Commission

SES Systemic Expected Shortfall

SIFI Systemically Important Financial Institution 

SIFMA Securities Industry and Financial Markets Association

SLHC Savings and Loan Holding Company

SLOOS Senior Loan Officer Opinion Survey on Bank Lending Practices

SMOVE Merrill Lynch Swaption Volatility Estimate

SRC Systemic Risk Committee 
Abbreviations 163

SSM Single Supervisory Mechanism 

STIF Short-Term Investment Fund

STRIPS Separate Trading of Registered Interest and Principal Securities

TAG Transaction Account Guarantee

TALF Term Asset-Backed Securities Loan Facility

TBA To Be Announced

TIBOR Tokyo Interbank Offered Rate

TLGP Temporary Liquidity Guarantee Program 

USD U.S. Dollar

USDA U.S. Department of Agriculture

UPI Universal Product Identifier

USI Unique Swap Identifier

VA U.S. Department of Veterans Affairs

WAL Weighted Average Life

WAM Weighted Average Maturity

WFC Wells Fargo Company

WGMR Working Group on Margin Requirements

WTI West Texas Intermediate

Glossary 165

Glossary

Adjustable-Rate Mortgage (ARM) A mortgage that allows for the periodic adjustment of the interest 

rate on the basis of changes in a specified index or rate.

Agency Mortgage-Backed 

Security

A mortgage-backed security issued or guaranteed by federal 

agencies or government-sponsored enterprises. 

Asset-Backed Commercial Paper 

(ABCP)

Short-term debt that has a fixed maturity of up to 270 days and 

is backed by some financial asset, such as trade receivables, 

consumer debt receivables, securities, or auto and equipment 

loans or leases. 

Asset-Backed Security (ABS) A fixed income or other security that is collateralized by any type 

of self-liquidating financial asset that allows the holder of the 

security to receive payments that depend primarily on cash flows 

from the assets. 

Available-for-Sale (AFS) An accounting term for debt and equity securities that are 

accounted for at fair value on firms’ balance sheets and are not 

classified as trading securities or as held-to-maturity securities. 

Changes in fair value for AFS securities are recognized 

in stockholders’ equity as part of accumulated other 

comprehensive income. 

Bank Holding Company (BHC) Any company that has direct or indirect control of one or more 

banks and is regulated and supervised by the Federal Reserve in 

accordance with the Bank Holding Company Act of 1956.

Bank for International 

Settlements (BIS)

An international financial organization that serves central banks 

in their pursuit of monetary and financial stability, to foster 

international cooperation in those areas, and that acts as a bank 

for central banks. The BIS hosts the secretariat of the Basel 

Committeee on Banking Supervision (BCBS), the Committee on 

the Global Financial System (CGFS), the Committee on Payment 

and Settlement Systems (CPSS), the Markets Committee, the 

Central Bank Governance Group, and the Irving Fisher Committee 

on Central Bank Statistics. Other secretariats operating out 

of the BIS, but not reporting directly to the BIS or its member 

central banks, are those of the Financial Stability Board (FSB), 

the International Association of Deposit Insurers, and the 

International Association of Insurance Supervisors (IAIS). 
166 2013 FSOC // Annual Report

Basel Committee on Banking 

Supervision (BCBS)

An international forum for the cooperation of bank supervisors 

that aims to improve banking supervision worldwide. The 

BCBS develops guidelines and supervisory standards, such as 

standards on capital adequacy, the core principles for effective 

banking supervision, and the Concordat on cross-border banking 

supervision. Following the financial crisis, the BCBS developed 

new global capital and liquidity standards for the banking system 

that are collectively referred to as Basel III.

Broker-Dealer An entity that is engaged in the business of underwriting, buying, 

and selling securities for itself and others. 

Central Counterparty (CCP) An entity that interposes itself between counterparties to 

contracts traded in one or more financial markets, becoming the 

buyer to every seller and the seller to every buyer and thereby 

ensuring the performance of open contracts. 

Clearing Bank A bank holding company subsidiary that facilitates payment and 

settlement of financial transactions, such as check clearing, or 

facilitates trades between the sellers and buyers of securities or 

other financial instruments or contracts.

Clearing House An entity through which financial institutions agree to 

exchange payment instructions or other financial obligations 

(e.g., securities). The institutions settle for items exchanged 

at a designated time based on the rules and procedures of 

the clearing house. In some cases, the clearing house may 

assume significant counterparty, financial, or risk management 

responsibilities for the clearing system. Where a clearing house 

interposes itself between the initial participants to a bilateral 

transaction, and becomes the buyer to every seller and the seller 

to every buyer, it is known as a Central Counterparty (CCP). 

Collateralized Mortgage 

Obligation (CMO)

An obligation of a bankruptcy remote special purpose vehicle with 

claims to specific cash flows from a pool of mortgage-backed 

securities (MBS). The streams of principal and interest payments 

on the MBS underlying loans are distributed to the different 

classes of CMO interests, known as tranches, according to a deal 

structure. Each tranche may have different principal balances, 

coupon rates, prepayment risks, and maturity dates. 

Commercial Bank A chartered and regulated financial institution authorized to take 

deposits from the public, obtain deposit insurance from the FDIC, 

and engage in certain lending activities.
Glossary 167

Commercial Mortgage-Backed A security that is collateralized by a pool of commercial mortgage 

Security (CMBS) loans and makes payments derived from the interest and principal 

payments on the underlying mortgage loans.

Commercial Paper (CP) Short-term (maturity of up to 270 days), unsecured corporate debt.

Committee on the Global A committee comprised of senior officials of participating central 

Financial System (CGFS) banks that monitors developments in global financial markets 

to identify and assess potential sources of stress, to further 

the understanding of the structural underpinnings of financial 

markets, and to promote improvements to the functioning and 

stability of these markets. The CGFS fulfills this mandate by way 

of regular monitoring discussions among CGFS members, through 

coordinated longer-term efforts, including working groups 

involving central bank staff, and through the various reports that 

the CGFS publishes. The CGFS also oversees the collection of the 

Bank for International Settlements’ (BIS) international banking 

and financial statistics.

Committee on Payment and A standard-setting body for payment, clearing and securities 

Settlement Systems (CPSS) settlement systems. The CPSS also serves as a forum for central 

banks to monitor and analyze developments in domestic payment, 

clearing, and settlement systems as well as in cross-border and 

multicurrency settlement schemes.

Comprehensive Capital Analysis An annual exercise by the Federal Reserve to ensure that 

and Review (CCAR) institutions have robust, forward-looking capital planning 

processes that account for their unique risks and sufficient 

capital to continue operations throughout times of economic and 

financial stress.

Convexity Event Risk Risk that an initial increase in long-term interest rates can be 

significantly amplified by many MBS investors actively hedging 

the duration of their MBS. Convexity events can result in rapid 

changes in long-term interest rates, sharp increases in interest 

rate volatility, and reduced liquidity in fixed income markets. See 

Duration Hedging

Core Deposits Typically funds of local customers who also have a borrowing 

or other relationship with the bank. Core deposits are generally 

stable, lower cost, and reprice more slowly than other deposits 

when interest rates change.

Credit Default Swap (CDS) A financial contract in which one party agrees to make a payment 

to the other party in the event of a specified credit event, in 

exchange for one or more fixed payments.
168 2013 FSOC // Annual Report

Credit Rating Agency A private company that evaluates the credit quality of debt issuers 

as well as their issued securities and provides ratings on the 

issuers and those securities. Many credit rating agencies are 

Nationally Recognized Statistical Rating Organizations (NRSROs), 

the largest of which are Fitch Ratings, Moody’s Investors Service, 

and Standard & Poor’s.

Credit Union (CU) A member-owned, not-for-profit cooperative financial institution 

formed to permit members to save, borrow, and obtain related 

financial services. All federally chartered credit unions and most 

state-chartered credit unions provide federally insured deposits 

and are regulated by the NCUA.

Deed-in-Lieu-of-Foreclosure A document that transfers the right of ownership in a property 

from a borrower-in-default to the mortgage lender in order to 

avoid foreclosure proceedings.

Defined Benefit (DB) Plan A retirement plan in which the cost to the employer is based on a 

predetermined formula to calculate the amount of a participant’s 

future benefit. In DB plans, the investment risk is borne by the 

plan sponsor.

Defined Contribution (DC) Plan A retirement plan in which the cost to the employer is limited to 

the specified annual contribution. In DC plans, the investment risk 

is borne by the plan participant.

Depository Institution A financial institution that is legally permitted to accept deposits. 

Examples of depository institutions include savings banks, 

commercial banks, savings and loan associations, and credit 

unions.

Discount Window The Federal Reserve facility for extending credit directly to 

eligible institutions.

Duration The sensitivity of the prices of bonds and other fixed income 

securities to changes in the level of interest rates. 

Duration Hedging A process of dynamically changing portfolio allocation to fixed 

income instruments—such as Treasury securities or futures, or 

interest rate swaps or swaptions—so as to limit fluctuation of the 

portfolio interest rate duration.
Glossary 169

European Financial Stability 

Facility (EFSF) 

A European intergovernmental crisis-financing facility that was 

activated in May 2010. The EFSF’s mandate is to safeguard 

financial stability in Europe by providing financial assistance 

to euro area member states by issuing bonds or other debt 

instruments and lending the proceeds to countries within the 

framework of a macroeconomic adjustment program. Since the 

creation of the European Stability Mechanism (ESM), the EFSF 

is no longer the main mechanism for financing new programs, 

though it continues operating ongoing programs for Greece, 

Portugal, and Ireland.

European Stability Mechanism 

(ESM) 

A European intergovernmental crisis-financing facility that was 

activated in October 2012, following ratification of an amendment 

to the EU treaties. The ESM is authorized to provide assistance 

through: direct lending to sovereigns (including on a precautionary 

basis); purchases in the secondary government debt markets; 

and (once the EU’s Single Supervisory Mechanism (SSM) has 

been established) direct lending to financial institutions. All 

lending decisions must be approved by unanimous agreement by 

creditor states, and borrowers must be under a macroeconomic 

adjustment program or policy conditionality program approved by 

creditors and (in some cases) the IMF.

Federal Financial Institutions 

Examination Council (FFIEC)

An interagency body that prescribes uniform principles, 

standards, and reporting forms for the federal examination of 

financial institutions. The FFIEC makes recommendations to 

promote uniformity in the supervision of financial institutions. 

Members include the Federal Reserve, FDIC, NCUA, OCC, CFPB, 

and a representative of state financial supervisors.

Federal Funds Rate The interest rate at which depository institutions lend balances 

to each other overnight. The Federal Open Market Committee 

(FOMC) sets a target level for the overnight federal funds rate, 

and the Federal Reserve Bank of New York then uses open 

market operations to influence the overnight federal funds rate to 

trade around the policy target rate or within the target rate range. 

Fedwire Securities Service A book-entry securities transfer system operated by the Federal 

Reserve Banks that provides participants safekeeping, transfer, 

and delivery-versus-payment settlement services.

FICO Score A measure of a borrower’s creditworthiness based on the 

borrower’s credit data; developed by the Fair Isaac Corporation.
170 2013 FSOC // Annual Report

Financial Market Infrastructure 

(FMI)

A multilateral system among participating financial institutions, 

including the operator of the system, used for the purposes of 

recording, clearing, or settling payments, securities, derivatives, 

or other financial transactions. Under the Dodd-Frank Act, certain 

FMIs are recognized as Financial Market Utilities (FMUs).

Financial Market Utility (FMU) A Dodd-Frank defined entity, which, subject to certain exclusions, 

is “any person that manages or operates a multilateral system 

for the purpose of transferring, clearing, or settling payments, 

securities, or other financial transactions among financial 

institutions or between financial institutions and the person.”

Fire Sale The disorderly liquidation of assets to meet margin requirements 

or other urgent cash needs. Such a sudden sell-off drives down 

prices, potentially below their intrinsic value, when the quantities 

to be sold are large relative to the typical volume of transactions. 

Fire sales can be self-reinforcing and lead to additional forced 

selling by some market participants that, subsequent to an initial 

fire sale and consequent decline in asset prices, may also need to 

meet margin or other urgent cash needs.

Fiscal Consolidation Changes in government policy pertaining to taxes and 

spending intended to reduce deficits and slow the pace of debt 

accumulation.

Fiscal Year Any 12-month accounting period. The fiscal year for the federal 

government begins on October 1 and ends on September 30 of 

the following year; it is named after the calendar year in which it 

ends.

Forward A contract traded over-the-counter to buy or sell an asset in the 

future. Most forwards are standardized contracts, but they can be 

customized.

Future A standardized contract traded over exchanges to buy or sell an 

asset in the future.

Government-Sponsored 

Enterprise (GSE)

A corporate entity that has a federal charter authorized by law, 

but that is a privately owned financial institution. Examples 

include the Federal National Mortgage Association (Fannie Mae) 

and the Federal Home Loan Mortgage Corporation (Freddie Mac).

Gross Domestic Product (GDP) The broadest measure of aggregate economic activity, measuring 

the total value of all final goods and services produced within a 

country’s borders during a specific period.
Glossary 171

The Group of Twenty Finance 

Ministers and Central Bank 

Governors (G-20)

An international forum established in 1999 to bring together 

officials of systemically important industrialized and developing 

economies to discuss key issues in the global economy and 

promote financial stability.

Haircut The discount, represented as a percentage of par or market value, 

at which an asset can be pledged as collateral. For example, a 

$1,000,000 bond with a 5 percent haircut would collateralize a 

$950,000 loan. The purpose of a haircut is to provide a collateral 

margin for a secured lender.

Held-to-Maturity (HTM) An accounting term for debt securities held in portfolio and 

accounted for at cost less any impairment, under the proviso that 

the company has no intent to sell and it is more likely than not 

that it will hold those securities to maturity.

High-Quality Liquid Asset (HQLA) Assets such as government bonds that are considered eligible as 

liquidity buffers in Basel III’s liquidity coverage ratio (LCR). HQLA 

should be liquid in markets during times of stress and, ideally, be 

central bank eligible.

Household Debt Service Ratio An estimate of the ratio of debt payments to disposable personal 

income. Debt payments consist of the estimated required 

payments on outstanding mortgage and consumer debt.

Interest Rate Risk Management The management of the exposure of an individual’s or an 

institution’s financial condition to movements in interest rates.

Interest Rate Swap A derivative contract in which two parties swap interest rate cash 

flows on a periodic basis, referencing a specified notional amount 

for a fixed term. Typically one party will pay a predetermined fixed 

rate while the other party will pay a short-term variable reference 

rate that resets at specified intervals.
172 2013 FSOC // Annual Report

International Organization of 

Securities Commissions (IOSCO)

An international organization that develops, implements, and 

promotes adherence to internationally recognized standards 

for securities regulation. The member agencies currently 

assembled have resolved, through IOSCO’s permanent 

structures, to cooperate in developing, implementing, and 

promoting adherence to internationally recognized and consistent 

standards of regulation, oversight and enforcement in order 

to protect investors, maintain fair, efficient, and transparent 

markets, and seek to address systemic risks; to enhance 

investor protection and promote investor confidence in the 

integrity of securities markets, through strengthened information 

exchange and cooperation in enforcement against misconduct 

and in supervision of markets and market intermediaries; and 

to exchange information at both global and regional levels on 

their respective experiences in order to assist the development 

of markets, strengthen market infrastructure and implement 

appropriate regulation.

Large Bank Holding Company Any bank holding company (BHC) that files the FR Y-9C 

Consolidated Financial Statements for Bank Holding Companies. 

All BHCs with total consolidated assets of $500 million or more 

are required to file. BHCs meeting certain additional criteria 

determined by the Federal Reserve may also be required to file 

regardless of size.

Large-Scale Asset Purchases 

(LSAPs)

Purchases by the Federal Reserve of securities issued by the U.S. 

government or securities issued or guaranteed by governmentsponsored agencies (including Fannie Mae, Freddie Mac, Ginnie 

Mae, and the Federal Home Loan Banks) in the implementation of 

monetary policy.

Legal Entity Identifier (LEI) A 20-digit alpha-numeric code that connects to key reference 

information that enables clear and unique identification of 

companies participating in global financial markets. The LEI 

system is designed to facilitate many financial stability objectives, 

including: improved risk management in firms; better assessment 

of microprudential and macroprudential risks; expedition of 

orderly resolution; containment of market abuse and financial 

fraud; and provision of higher-quality and more accurate financial 

data.

Leveraged Buyout An acquisition of a company financed by a private equity 

contribution combined with borrowed funds, with debt comprising 

a significant portion of the purchase price.
Glossary 173

Loan-to-Value Ratio (LTV) The ratio of the amount of a loan to the value of the asset that 

the loan funds, typically expressed as a percentage. This is a 

key metric when considering the level of collateralization of a 

mortgage. 

Major Security-Based Swap 

Participant

A person that is not a security-based swap dealer and maintains 

a substantial position in security-based swaps, creates 

substantial counterparty exposure, or is a financial entity that is 

highly leveraged and not subject to federal banking capital rules.

Major Swap Participant (MSP) A person that is not a swap dealer and maintains a substantial 

position in swaps, holds outstanding swaps that create 

substantial counterparty exposure, or is a highly leveraged 

financial entity which is not otherwise subject to capital 

requirements.

Mark-to-Market The process by which the reported value of an asset is adjusted 

to reflect its fair value.

Maturity Gap The weighted-average time to maturity of financial assets less 

the weighted-average time to maturity of liabilities.

Maturity Transformation An activity in which a financial intermediary issues shorter-term 

liabilities to fund longer-term assets.

Model Risk Risk related to using an incorrect model specification. For 

example, misspecification model risk can be due to programming 

errors, technical errors, data issues, calibration errors, or 

conceptual mistakes.

Money Market Mutual Fund 

(MMF)

A type of mutual fund that invests in short-term, liquid securities 

such as government bills, certificates of deposit, commercial 

paper, or repurchase agreements.

Mortgage Servicer A company that acts as an agent for mortgage holders by 

collecting and distributing mortgage cash flows. Mortgage 

servicers also manage defaults, modifications, settlements, 

foreclosure proceedings, and various notifications of borrowers 

and investors.

Mortgage-Backed Security (MBS) An asset-backed security backed by a pool of mortgages. 

Investors in the security receive payments derived from the 

interest and principal payments on the underlying mortgages. 

This term typically applies to mortgage-backed securities issued 

or guaranteed by the GSEs; these securities can also be called 

“agency MBS.” 
174 2013 FSOC // Annual Report

Municipal Bond A bond issued by states, cities, counties, local governmental 

agencies, or certain nongovernment issuers to finance certain 

general or project-related activities.

Mutual Fund A type of investment company that issues redeemable securities, 

which the fund generally stands ready to buy back from investors 

at their current net asset value. Also called an open-end 

investment company or open-end fund.

Novation A process through which one of the original parties in a swap 

contract transfers its respective position or liability to another, 

unrelated party.

Option A financial contract granting the holder the right but not the 

obligation to engage in a future transaction on an underlying 

security or real asset. The most basic examples are an equity 

call option, which provides the right but not the obligation to 

buy a block of shares at a fixed price for a fixed period, and an 

equity put option, which similarly grants the right to sell a block 

of shares.

Outright Monetary Transactions 

(OMT)

An ECB program under which secondary market purchases of 

sovereign bonds can be made, with the aim of safeguarding 

appropriate monetary policy transmission and the singleness of 

the monetary policy. A necessary condition for OMT is a support 

agreement under which the EFSF or ESM program can make 

primary market purchases of sovereign debt. Such an agreement 

would include a range of policy conditions.

Over-the-Counter (OTC) A method of trading that does not involve an organized 

exchange. In over-the-counter markets, participants trade 

directly on a bilateral basis, typically through voice or 

computer communication and often with certain standardized 

documentation with counterparty-dependent terms.

Prudential Regulation Regulation aimed at ensuring the safe and sound operation of 

financial institutions, set by both state and federal authorities.

Public Debt All debt issued by Treasury and the Federal Financing Bank, 

including both debt held by the public and debt held in 

intergovernmental accounts such as the Social Security Trust 

Funds. Not included is debt issued by government agencies other 

than the Department of the Treasury.
Glossary 175

Qualified Mortgage (QM) A mortgage loan that meets certain underwriting criteria 

announced by the CFPB. An originator of a Qualified Mortgage is 

provided with certain protections from borrower lawsuits alleging 

that the originator failed to fulfill its duty under the Dodd-Frank 

Act to make a good faith and reasonable determination of the 

borrower’s ability to repay the loan.

Qualified Residential Mortgage 

(QRM)

A mortgage loan that is exempt from the Dodd-Frank Act’s 

securitization risk retention rule requiring securitization issuers to 

retain a portion of securitized risk exposure in transactions that 

they issue.

Ratings Uplift The difference between the stand-alone credit rating assigned 

by a credit rating agency to an issuer, based on that issuer’s 

intrinsic financial strength, and a higher credit rating assigned 

by the same credit rating agency that includes the possibility of 

government support.

Real Estate Investment Trust 

(REIT)

An operating company that manages income-producing real 

estate or real estate-related assets. Certain REITs also operate 

real estate properties in which they invest. To qualify as a REIT, a 

company must have three-fourths of its assets and gross income 

connected to real estate investment and must distribute at least 

90 percent of its taxable income to shareholders annually in the 

form of dividends.

Receiver A custodian appointed to maximize the value of the assets of a 

failed institution or company and to settle its liabilities.

Rehypothecation The reuse of collateral posted by clients of banks or brokerdealers. The collateral is used for securities lending, repurchase 

agreements, or as collateral for the bank’s or broker-dealer’s own 

borrowing.

Repurchase Agreement (Repo) The sale of a security combined with an agreement to repurchase 

the security, or a similar security, on a specified future date at a 

prearranged price. A repo is a secured lending arrangement.

Reserves Balances held by depository institutions at the central bank plus 

vault cash.

Residential Mortgage-Backed 

Security (RMBS)

A security that is collateralized by a pool of residential mortgage 

loans and makes payments derived from the interest and principal 

payments on the underlying mortgage loans.
176 2013 FSOC // Annual Report

Revolving Credit A lending arrangement whereby a lender commits to provide 

a certain amount of funding to a borrower on demand. The 

borrower may generally draw funds and repay the committed 

funding at any time over the term of the agreement.

Risk-Based Capital An amount of capital, based on the risk-weighting of various 

asset categories, that a financial institution is required to hold to 

protect against unexpected losses.

Risk-Weighted Assets (RWA) A risk-based concept used as the denominator of risk-based 

capital ratios with respect to Basel capital guidelines for banking 

organizations. The RWA is a weighted total asset value developed 

from assigned risk categories or modeled analysis. Broadly, 

total RWA are determined by calculating RWA for market risk 

and operational risk and adding the sum of RWA for on-balance 

sheet, off-balance sheet, counterparty, and other credit risks. 

Details vary, in part, depending upon the version of Basel capital 

guidelines to which the banking organization is subject.

Rollover Risk The risk that as an institution’s debt nears maturity, the 

institution may not be able to refinance the existing debt or may 

have to refinance at less favorable terms.

Run Risk The risk that investors lose confidence in an institution—due to 

concerns about counterparties, collateral, solvency, or related 

issues—and respond by pulling back their funding.

Securities Lending/Borrowing The temporary transfer of securities from one party to another for 

a specified fee and term, in exchange for collateral in the form of 

cash or securities.

Securitization A financial transaction in which assets such as mortgage loans 

are pooled, securities representing interests in the pool are 

issued, and proceeds from the underlying pooled assets are used 

to service and repay securities issued via the securitization.

Security-Based Swap Dealer A person that holds itself out as a dealer in security-based 

swaps, makes a market in security-based swaps, regularly enters 

into security-based swaps with counterparties, or engages in 

any activity causing it to be known as a dealer or market maker 

in security-based swaps; does not include a person entering into 

security-based swaps for such person’s own account.

Shadow Banking Maturity, credit, or liquidity transformation activities conducted by 

entities that are not regulated as banks and that unlike banks do 

not have access to a lender of last resort or to forms of 

liability guarantees.
Glossary 177

Short-Term Wholesale Funding Short-term funding instruments not covered by deposit insurance 

that are typically issued to institutional investors. Examples 

include large checkable and time deposits, brokered CDs, 

commercial paper, Federal Home Loan Bank borrowings, and 

repurchase agreements.

Single Supervisory Mechanism 

(SSM)

A proposed European bank supervision framework, under which 

the ECB will assume supervisory responsibility for euro area 

banks, working in cooperation with national authorities.

Supervisory Capital Assessment 

Program (SCAP)

A stress test, conducted from February-May 2009, designed to 

estimate the capital needs of U.S. bank holding companies with 

assets exceeding $100 billion under an adverse macroeconomic 

scenario; SCAP was administered by the Federal Reserve, the 

OCC, and the FDIC.

Supervisory Information Generally refers to information consisting of reports of 

examination and inspection, operating and condition reports, 

and any information derived from, relating to, or contained in 

them, and information gathered by agencies responsible for 

supervising financial institutions in the course of any investigation 

or enforcement action. Supervisory information is exempt from 

public disclosure.

Swap An exchange of cash flows with defined terms and over a fixed 

period, agreed upon by two parties. A swap contract may 

reference underlying financial products across various asset 

classes including interest rates, credit, equity, commodity, and 

foreign exchange.

Swap Data Repository (SDR) A person that collects and maintains information or records 

with respect to transactions or positions in, or the terms 

and conditions of, swaps entered into by third parties for the 

purpose of providing a centralized recordkeeping facility for 

swaps. In certain jurisdictions, SDRs are referred to as trade 

repositories. CPSS-IOSCO describes a trade repository as “an 

entity that maintains a centralized electronic record (database) of 

transaction data”.

Swap Dealer A person that holds itself out as a dealer in swaps, makes a 

market in swaps, regularly enters into swaps with counterparties, 

or engages in any activity causing it to be known as a dealer or 

market maker in swaps; does not include a person entering into 

swaps for such person’s own account.

Swaption An option granting the right to enter into a swap. See Option 

and Swap.
178 2013 FSOC // Annual Report

TARGET2 The real-time gross settlement system owned and operated 

by the Eurosystem. TARGET2 must be used for all payments 

involving the Eurosystem, as well as for the settlement of 

operations of all large-value net settlement systems and 

securities settlement systems handling the euro. Payment 

transactions are settled one by one on a continuous basis in 

central bank money with immediate finality.

Temporary Liquidity Guarantee 

Program (TLGP)

A program implemented in October 2008 (and which expired 

in December 2012) by the FDIC through a systemic risk 

determination to provide liquidity to the banking industry by 

restoring banks’ access to funding markets and by stabilizing 

bank deposits. The program had two components: the Debt 

Guarantee Program and the Transaction Account Guarantee 

(TAG) Program.

Term Asset-Backed Securities 

Loan Facility (TALF)

A Federal Reserve funding facility that issued loans with terms 

of up to five years to holders of eligible ABS. TALF was intended 

to assist financial markets in accommodating the credit needs 

of consumers and businesses by facilitating the issuance of ABS 

collateralized by a variety of consumer and business loans. TALF 

was also intended to improve market conditions for ABS more 

generally. The program was announced in November 2008. The 

facility ceased making loans collateralized by newly issued CMBS 

on June 30, 2010, and loans collateralized by all other types of 

TALF-eligible newly issued and legacy ABS on March 31, 2010.

Term Premium The excess compensation to investors for owning long-term 

Treasury securities compared to reinvesting short-term securities 

continually over time.

Term Spread The excess yield an investor must receive in order to purchase a 

longer-maturity bond over a shorter-maturity bond of the same 

issuer.

Thrift A financial institution that ordinarily possesses the same 

depository, credit, financial intermediary, and account 

transactional functions as a bank, but that is chiefly organized 

and primarily operates to promote savings and home mortgage 

lending rather than commercial lending. Also known as a savings 

bank, a savings association, or a savings and loan association.

Time Deposits Deposits which the depositor, generally, does not have the right 

to withdraw before a designated maturity date without paying an 

early withdrawal penalty. A certificate of deposit is a time deposit.
Glossary 179

To-Be-Announced (TBA) 

Transaction 

A forward transaction involving a purchase or sale of MBS 

with settlement occurring in the future, generally a period of 

up to three months from the purchase date. TBA transactions 

include solely agency-issued or agency-guaranteed MBS. MBS 

transacted in the TBA market use a few standardized contracts, 

which are grouped based on key characteristics such as the 

agency, term, coupon, or settlement date of the MBS security 

that will be delivered. At the settlement date, TBA sellers have 

the option to deliver any agency MBS that meet the contract 

requirements. 

Transaction Account Guarantee 

(TAG) Program

The Dodd-Frank Act-provided temporary, unlimited deposit 

insurance coverage for noninterest-bearing transaction 

accounts and IOLTAs (but not low-interest NOW accounts) from 

December 31, 2010 through December 31, 2012, regardless of 

the balance in the account and the ownership capacity of the 

funds. This coverage essentially replaced TAGP, which expired on 

December 31, 2010, and was available to all depositors, including 

consumers, businesses, and government entities. The coverage 

was separate from, and in addition to, the standard insurance 

coverage provided for a depositor’s other accounts held at an 

FDIC-insured bank.

Tri-Party Repo A repurchase agreement in which a clearing bank acts as thirdparty agent to provide collateral management services and to 

facilitate the exchange of cash against collateral between the two 

counterparties.

Underwater Mortgage A mortgage loan with a higher unpaid principal balance than the 

value of the home.

Underwriting Standards Terms, conditions, and criteria used to determine the extension of 

credit in the form of a loan or bond.

Yield Curve A graphical representation of the relationship between bond 

yields and their respective maturities.

List of Charts 181

List of Charts

Chart 4.1.1 Change in Real Gross Domestic Product...................................................................21

Chart 4.1.2 Change in Real Personal Consumption Expenditures..................................................21

Chart 4.1.3 Private Housing Starts............................................................................................22

Chart 4.1.4 Net Change in Nonfarm Payroll Employment..............................................................23

Chart 4.1.5 Civilian Unemployment Rate ....................................................................................23

Chart 4.1.6 Long-Term Unemployment......................................................................................23

Chart 4.1.7 Labor Force Participation Rate ................................................................................24

Chart 4.2.1 Financial Ratios for Nonfinancial Corporations............................................................24

Chart 4.2.2 Bank Business Lending Standards and Demand........................................................24

Chart 4.2.3 Nonfinancial Corporate Bond Default Rate.................................................................25

Chart 4.2.4 Noncurrent Commercial and Industrial Loans.............................................................25

Chart 4.2.5 Noncorporate Assets..............................................................................................25

Chart 4.2.6 Net Borrowing by Nonfinancial Noncorporate Businesses............................................26

Chart 4.2.7 Bank Business Lending Standards and Demand........................................................26

Chart 4.2.8 Small Businesses’ Difficulty Obtaining Credit .............................................................26

Chart 4.2.9 Household Debt as a Percent of Disposable Personal Income......................................27

Chart 4.2.10 Private Nonfinancial Debt........................................................................................27

Chart 4.2.11 Household Debt Service Ratio.................................................................................27

Chart 4.2.12 Share of Household Debt by Delinquency Status........................................................28

Chart 4.2.13 Household and Nonprofit Balance Sheets.................................................................28

Chart 4.2.14 Share of Owners’ Equity in Household Real Estate .....................................................28

Chart 4.2.15 Components of Consumer Credit.............................................................................29

Chart 4.2.16 Applications for Credit ............................................................................................29

Chart 4.2.17 90+ Day Delinquency Rate by Loan Type .................................................................29

Chart 4.3.1 Federal Unified Budget Surplus/Deficit......................................................................30

Chart 4.3.2 Federal Debt Held by the Public as a Percent of GDP .................................................30

Chart 4.3.3 Interest Outlays and Average Maturity of U.S. Public Debt ...........................................31

Chart A.1 10-Year Treasury Yield and Corporate Bond Spreads .................................................32

Chart A.2 10-Year Treasury Yield and Market Volatility ..............................................................33

Chart 4.3.4 State and Local Government Tax Revenues...............................................................34

Chart 4.3.5 Long-Term Mutual Fund Flows: Municipal Bonds .......................................................34

Chart 4.3.6 Federal Grants-in-Aid to State and Local Governments...............................................34

Chart 4.3.7 Total Public Construction Spending ..........................................................................35

Chart 4.3.8 Municipal Bond Issuance ........................................................................................35

Chart 4.3.9 Municipal Tax-Exempt Bond Yield Ratios...................................................................35

Chart 4.4.1 Real GDP Growth ..................................................................................................36
182 2013 FSOC // Annual Report

Chart 4.4.2 Advanced Economies Real GDP Growth ...................................................................36

Chart 4.4.3 Euro Area Real GDP Growth....................................................................................37

Chart 4.4.4 Peripheral Europe: Gross Public Debt .......................................................................37

Chart 4.4.5 Emerging Market Economies Real GDP Growth .........................................................39

Chart 4.4.6 Contribution to World GDP Growth...........................................................................39

Chart 4.4.7 BRIC and U.S. Inflation Rates ..................................................................................39

Chart 4.4.8 Inflows to EMEs.....................................................................................................40

Chart 4.4.9 China Real GDP Growth..........................................................................................41

Chart 4.4.10 China: Annual Increases in Credit and GDP ...............................................................41

Chart 5.1.1 Treasury Yields......................................................................................................43

Chart 5.1.2 Slope of the Treasury Yield Curve ............................................................................43

Chart 5.1.3 Realized and Implied Interest Rate Volatility .............................................................. 44

Chart 5.1.4 Implied Volatility.................................................................................................... 44

Chart 5.1.5 U.S. Corporate Bond Spreads – Investment Grade.................................................... 44

Chart 5.1.6 U.S. Corporate Bond Issuance ................................................................................45

Chart 5.1.7 High-Yield Bonds: Issuance and Market Size .............................................................45

Chart 5.1.8 Institutional Loans: Issuance and Market Size ............................................................45

Chart 5.1.9 CLOs: Issuance and Market Size..............................................................................46

Chart 5.1.10 Agency MBS Spreads to Treasuries .........................................................................46

Chart 5.1.11 Publically Held Federal Debt Outstanding ..................................................................47

Chart 5.1.12 Foreign Holders of U.S. Federal Debt .......................................................................47

Chart 5.1.13 Euro Area 10-Year Yield Spreads to German Debt......................................................50

Chart 5.1.14 Emerging Market Bond Spreads..............................................................................51

Chart 5.1.15 Dollar Index Volatility ..............................................................................................52

Chart 5.1.16 Currency Implied Volatility.......................................................................................52

Chart 5.1.17 U.S. Dollar Exchange Rates.....................................................................................52

Chart 5.1.18 Returns in Selected Equities Indices.........................................................................53

Chart 5.1.19 S&P 500 Key Ratios..............................................................................................53

Chart 5.1.20 Selected Equities Indices........................................................................................53

Chart 5.1.21 Market Volatility.....................................................................................................54

Chart 5.1.22 VIX Term Premium.................................................................................................54

Chart 5.1.23 Oil Production .......................................................................................................54

Chart 5.1.24 S&P GSCI Unleaded Gasoline Index.........................................................................55

Chart 5.1.25 Commodities.........................................................................................................55

Chart 5.1.26 Gold Prices...........................................................................................................55

Chart 5.1.27 Farmland Prices and Value of Crop Yield...................................................................56

Chart 5.1.28 Agricultural Prices..................................................................................................56

Chart 5.1.29 Agricultural Real Estate Debt Outstanding .................................................................56

Chart 5.1.30 National Repeat Sales Home Price Indices................................................................57

Chart 5.1.31 Mortgages with Negative Equity...............................................................................57
List of Charts 183

Chart 5.1.32 Mortgage Delinquency and Foreclosure....................................................................57

Chart 5.1.33 Mortgage Originations by Program...........................................................................58

Chart 5.1.34 Mortgage Servicing Rights at U.S. Commercial Banks and Thrifts................................58

Chart 5.1.35 Mortgage Originations by Type ................................................................................58

Chart 5.1.36 Origination Volume by Credit Score ..........................................................................59

Chart 5.1.37 Average Debt-to-Income Ratio at Origination .............................................................59

Chart 5.1.38 Minimum Eligibility Standards for Government Purchase Loans....................................59

Chart 5.1.39 GSE Net Income....................................................................................................61

Chart 5.1.40 Issuance of RMBS .................................................................................................61

Chart 5.1.41 CMBS New Issuance..............................................................................................63

Chart 5.1.42 CMBS Senior Debt Spreads....................................................................................63

Chart 5.1.43 CRE Refinancing....................................................................................................63

Chart 5.1.44 Commercial Property Price Indices ..........................................................................64

Chart 5.2.1 Large Bank Holding Company Liability Structure........................................................64

Chart 5.2.2 Wholesale Cash Investors.......................................................................................64

Chart 5.2.3 Composition of Bank Short-Term Funding .................................................................65

Chart 5.2.4 Premium for Borrowing Dollars for 1 Year .................................................................65

Chart 5.2.5 Commercial Paper Outstanding ...............................................................................65

Chart 5.2.6 Value of the Repo Market .......................................................................................66

Chart 5.2.7 Primary Dealer Repo Agreements............................................................................66

Chart 5.2.8 Tri-Party Repo Collateral Distribution ........................................................................66

Chart 5.2.9 Securities Lending Loans by Industry .......................................................................67

Chart 5.2.10 Value of Securities on Loan.....................................................................................67

Chart 5.2.11 Securities Lending Cash Reinvestment .....................................................................67

Chart 5.3.1 Aggregate BHC Pre-Tax Income ..............................................................................69

Chart 5.3.2 Return on Average Assets for BHCs > $10B.............................................................69

Chart 5.3.3 Net Interest Margins for BHCs > $10B .....................................................................69

Chart 5.3.4 Maturity Gap at Large Banks...................................................................................70

Chart 5.3.5 Maturity Gap at Small Banks...................................................................................70

Chart 5.3.6 KBW Bank Index and Implied Volatility......................................................................72

Chart 5.3.7 Average P/B and P/E Ratios of 6 Large Complex BHCs..............................................72

Chart 5.3.8 CDS Spreads of 6 Large Complex BHCs ..................................................................72

Chart 5.3.9 Systemic Risk Measures.........................................................................................73

Chart 5.3.10 Change in Tier 1 Common Ratios for Aggregate U.S. BHCs ........................................73

Chart 5.3.11 Consolidated Liquidity Ratio* for Top 50 BHCs ..........................................................73

Chart 5.3.12 Non-Core Funding* Relative to Liquid Assets** ..........................................................74

Chart 5.3.13 Nonperforming Loans (30-89 Days).........................................................................74

Chart 5.3.14 Nonperforming Loans (90+ Days and Nonaccrual) ....................................................74

Chart 5.3.15 Allowance for Loan/Lease Losses as a Multiple of Charge-offs....................................75

Chart 5.3.16 U.S. Unemployment Rate: Actual vs. Stress Scenarios................................................75
184 2013 FSOC // Annual Report

Chart 5.3.17 Initial and Stressed Tier 1 Common Capital Ratios.....................................................76

Chart 5.3.18 FDIC-Insured Failed Institutions................................................................................76

Chart 5.3.19 Commercial Bank and Thrift Pre-Tax Income .............................................................77

Chart 5.3.20 Net Charge-offs and Noncurrent Loans.....................................................................77

Chart 5.3.21 Risk-Weighted Assets and Return on Assets .............................................................77

Chart 5.3.22 Concentration of Credit Union Assets .......................................................................78

Chart 5.3.23 Federally Insured Credit Union Income......................................................................78

Chart 5.3.24 Credit Union Deposits.............................................................................................79

Chart 5.3.25 U.S. Branches and Agencies of Foreign Banks: Assets...............................................79

Chart 5.3.26 U.S. Branches and Agencies of Foreign Banks: Liabilities............................................80

Chart 5.4.1 Broker-Dealer Revenues.........................................................................................82

Chart 5.4.2 Broker-Dealer Assets and Leverage .........................................................................82

Chart 5.4.3 Primary Dealer Securities........................................................................................82

Chart 5.4.4 Life and Other Insurance: Capital and Net Income......................................................83

Chart 5.4.5 Life Insurers: Impact of Low Rate Environment...........................................................83

Chart 5.4.6 Property and Casualty Insurance: Capital and Net Income...........................................85

Chart 5.4.7 Consumer Loans Outstanding .................................................................................87

Chart 5.4.8 Business Loans Outstanding ...................................................................................87

Chart 5.4.9 ABS Issuance........................................................................................................87

Chart C.1 Convexity Risk.......................................................................................................88

Chart C.2 Outstanding Agency MBS by Holders.......................................................................89

Chart C.3 2003 Convexity Event............................................................................................89

Chart 5.4.10 Selected ABS Spreads...........................................................................................90

Chart 5.4.11 Total Agency REIT Assets .......................................................................................90

Chart 5.4.12 Agency REITs: Return on Assets..............................................................................90

Chart 5.5.1 MMF Assets by Fund Type......................................................................................91

Chart 5.5.2 Prime Funds Liquidity.............................................................................................92

Chart 5.5.3 MMF Weighted Average Life*..................................................................................92

Chart 5.5.4 Total Assets of Mutual Funds...................................................................................94

Chart 5.5.5 Mutual Fund Flows by Asset Class (Mar-2012 to Feb-2013)........................................94

Chart 5.5.6 Mutual Fund Taxable Bond Flows (Mar-2012 to Feb-2013) .........................................94

Chart 5.5.7 Annual Net Worldwide Fund Flows...........................................................................95

Chart 5.5.8 Mutual Fund Holdings.............................................................................................95

Chart 5.5.9 Retirement Fund Assets by Plan Type.......................................................................95

Chart 5.5.10 Public and Private Pension Funding Level..................................................................96

Chart 5.5.11 U.S. Private Equity AUM .........................................................................................96

Chart 5.5.12 U.S. Private Equity AUM by Strategy ........................................................................96

Chart 5.5.13 Change in Hedge Fund AUM...................................................................................97

Chart 5.5.14 Hedge Fund Assets and Net Asset Flows..................................................................97

Chart 5.5.15 Hedge Fund Net Asset Flows by AUM ......................................................................97
185

Chart 5.5.16 Hedge Fund Performance by Strategy......................................................................98

Chart 5.5.17 ETP Net Assets by Product Type..............................................................................98

Chart 5.5.18 ETP Net Flows by Product Type...............................................................................98

Chart 5.6.1 Global OTC Derivatives Market ..............................................................................101

Chart 5.6.2 Global Exchange-Traded Derivatives.......................................................................101

Chart 5.6.3 Global OTC and Exchange-Traded Derivatives Growth...............................................102

Chart 5.6.4 Exchange-Traded Derivatives Globalization ..............................................................102

Chart 5.6.5 Credit Derivatives Market......................................................................................103

Chart 5.6.6 Interest Rate Derivatives Market.............................................................................103

Chart 5.6.7 Notional Amounts Outstanding on CCPs by Asset Class............................................104

Chart 5.6.8 SwapClear Volume...............................................................................................105

Chart 5.6.9 ICE Clear Credit ...................................................................................................105

Chart 5.6.10 ICE Clear Europe .................................................................................................105

Chart D.1 Outstanding Amounts of Marketable Potentially Safe Assets......................................108

Chart D.2 Compilation of Potential Impact on Global Eligible Collateral.......................................108

Chart 7.1.1 Total MMF Repo Holdings.....................................................................................134

Chart 7.1.2 Repo Funding by MMFs........................................................................................134

Chart 7.4.1 Historical Bond Yields...........................................................................................142

Chart 7.4.2 Federal Fund Rate ...............................................................................................142

Chart 7.4.3 Interest Rate Risk Premium Indicators.....................................................................143

Chart 7.4.4 Historical Credit Spreads.......................................................................................143

Chart 7.6.1 Moody’s BHC Systemic Support Uplift....................................................................146

Chart 7.6.2 Number and Distribution of Subsidiaries: Selected Top 50 BHCs ...............................146

Chart 7.6.3 BHC Subsidiaries by Industry.................................................................................146

Chart G.1 Asset Shares of U.S. Financial Institutions...............................................................148

Chart G.2 Asset Shares of the Top 10 U.S. Financial Institutions...............................................149

List of Charts
186 2013 FSOC // Annual Report
Endnotes 187

Endnotes

1 See FSOC (2012).

2 See SEC (2012).

3 See FSB (2013). 

4 See, Daly, Hobijn, Sahin, and Valletta (2012).

5 The extraordinary measures available were (1) suspending sales of State and Local Government 

Series Treasury securities; (2) redeeming existing, and suspending new, investments of the Civil 

Service Retirement and Disability Fund and the Postal Service Retirees health Benefit Fund; (3) suspending reinvestment of the Government Securities Investment Fund and (4) suspending reinvestment of the Exchange Stabilization fund. In total, these measures would have freed up about $200 

billion in headroom under the debt ceiling.

6 Tri-party transactions are used to enable cash transactions against general collateral, and activity 

in this market is reported to the Federal Reserve Bank of New York. GCF repo is administered by 

the Fixed Income Clearing Corporation, which also provides aggregate data on outstandings. Data 

on bilateral repo transactions, which are typically used to obtain specific collateral, negotiate certain 

non-price terms, or enable firms to transact with counterparties who are not in the tri-party market, 

are not systematically collected. However, bilateral repo transactions conducted by primary dealers 

are reported in the aggregate with GCF and tri-party repo in the Federal Reserve Bank of New York’s 

FR2004 Primary Dealer survey.

7 See the Federal Reserve’s December 2012 Senior Credit Officer Opinion Survey on Dealer 

Financing Terms for additional evidence at http://www.federalreserve.gov/econresdata/releases/

SCOOS_201212.htm.

8 The estimation methodology is based on that described in English, Van den Heuvel, and Zakrajšek 

(2012). 

9 The figure represents the evolution of three normalized systemic risk measures averaged across 

JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley. 

Conditional Value-at-Risk (CoVaR) measures the contribution of each institution to overall systemic risk from the market value of total assets. The Distress Insurance premium (DIP) measures a 

hypothetical CDS implied insurance premium to protect institutions from a systemic event. Systemic 

Expected Shortfall (SES) is the equity shortfall contingent on market stress. CoVaR is by Adrian and 

Brunnermeier (2011); DIP is by Huang, Zhu, and Zhou (2009); and SES is by Acharya, Pedersen, 

Philippon, Richardson (2010).

10 The federal government’s response to the financial crisis included the FDIC’s Temporary Liquidity Guarantee Program (TLGP). The Transaction Account Guarantee (TAG) portion of the TLGP 

guaranteed deposits in noninterest-bearing transaction accounts of participating insured depository institutions. The TAG expired on December 31, 2010. Under the other portion of the TLGP, the 

Debt Guarantee Program, the FDIC guaranteed newly issued senior unsecured debt of participating 

insured depository institutions, their holding companies, and certain affiliates. This guarantee expired 

on December 31, 2012. Section 343 of the Dodd-Frank Act, which provided unlimited deposit and 

share insurance coverage for noninterest-bearing transaction accounts for all insured depository 

institutions beginning December 31, 2010, expired on December 31, 2012. 

11 See BCBS/CPSS (2013). 

12 See ISDA (2012a).

13 See CPSS/IOSCO (2012a).

14 See CPSS/IOSCO (2012b).

15 See Payment Risk Committee (2013).

16 See ISDA (2012b).

17 See SEC (2013).
188 2013 FSOC // Annual Report

18 In 2012, the Council met on February 1, April 3, May 22, June 11, July 18, September 28, October 18, October 29, October 30, November 13, December 3, and December 13.

19 In 2012, the Council held public sessions on April 3, July 18, and November 13.

20 The Council’s Freedom of Information Act regulation and its transparency policy are available at 

www.fsoc.gov.

21 See SEC (2012).

22 LIBOR comprises a set of unsecured lending rates for commercial banks based in London, with 

published rates for different currencies and tenors, ranging from overnight through twelve months. 

Every business day shortly before 11 a.m. London time, banks on the LIBOR panel submit the rates 

at which they could borrow funds “by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 a.m.” A trimmed averaging process is used to exclude the top and 

bottom quartile of the rates submitted, and the remaining rates are averaged for each tenor. That 

average rate becomes the official daily LIBOR.

23 Among other things, the banks were required to (1) make their submissions based on certain 

specified factors, with their own transactions given the greatest weight; (2) implement firewalls to 

prevent improper communications, including between traders and submitters; (3) prepare and retain 

documents concerning submissions, and retain relevant communications; (4) implement auditing, 

monitoring and training measures concerning their submissions and related processes; (5) make 

regular reports to regulators concerning compliance with the obligations under the respective 

orders; and (6) use best efforts to encourage the development of rigorous standards for benchmark 

interest rates.

24 See BBA (2012). 

25 See FSA (2013). 

26 CPSS/IOSCO (2013). 

27 BIS (2013). 

28 The term premium estimate is computed by the Federal Reserve Bank of New York based on the 

methodology of Adrian, Crump, and Moench (2013).

29 The Senior Credit Officer Opinion Survey on Dealer Financing Terms (SCOOS) provides additional 

information on underwriting standards in broker-dealer intermediated credit markets and recent 

special questions have included CLOs, see http://www.federalreserve.gov/econresdata/releases/

scoos.htm.

30 The underlying data for Charts 7.6.2 and 7.6.3 is described in more detail in Avraham, Selvaggi, 

and Vickery (2012).

31 Assets include consolidated assets of U.S.-chartered bank holding companies (BHCs), savings 

and loan holding companies (SLHCs); federally insured depository institutions (excluding credit 

unions) not held by a BHC or SLHC; and U.S.-domiciled affiliates (including nonbanking affiliates), 

branches, and agencies of FBOs. The denominators used for assets are merger-adjusted in the 

pre-crisis years to reflect the BHC charters that were granted to former nonbanks during the financial crisis (and thus drew in substantial aggregate assets and deposits to be included in the share 

calculations).

32 This restriction is a provision of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 

1994. 

33 Dodd-Frank Act Section 604(d), which covers acquisitions of banking organizations, requires that 

the Federal Reserve “take into consideration the extent to which a proposed acquisition, merger, or 

consolidation would result in greater or more concentrated risks to the stability of the United States 

banking or financial system.” Dodd-Frank Act Section 604(e), which covers nonbank acquisitions by 

bank holding companies, adds “risk to the stability of the United States banking or financial system” 

as a factor to be considered in the balancing test that the Federal Reserve is required to conduct. 

Dodd-Frank Act Section 163(b), which governs the acquisition of voting shares of a nonbank company with assets over $10 billion or more by a bank holding company with assets over $50 billion or 

more, states that the Federal Reserve “shall consider the extent to which the proposed acquisition 

would result in greater or more concentrated risks to global or United States financial stability or the 

United States economy.”
Endnotes 189

34 Dodd-Frank Act Section 604(f), which covers Bank Merger Act transactions, adds “risk to the stability of the United States banking or financial system” as a factor to be considered by the appropriate federal banking agency.

35 See Federal Reserve System (2012).