In the ten years between mid-1996 and mid2006, house prices in the US almost tripled, growing on average at an annual rate of 11%. 6 An important development during the house price boom was the deterioration of lending standards, which can be traced back to the “originate-to-distribute” financial intermediation model. Originate-to-distribute (as opposed to originate-to-hold) is a process whereby new loans are not held by the bank, but bundled, sliced, repackaged, and sold to investors. While the incentives in the originate-to-hold process favour the origination of good loans which can be expected to be serviced and paid back, the incentives in the originate-to-distribute process favour the origination of as many loans as possible, in order to profit from the fees involved in the underwriting and securitisation process. It is thus not surprising that credit standards decreased during the boom. After house prices had peaked in 2006, it became more and more obvious to some market participants that many sub-prime borrowers would soon be unable to service their debt. Prices of sub-prime-backed securities started easing in 2007. As 2007 progressed, the deteriorating sub-prime market began affecting the confidence in related structured finance products and, in August 2007, led to a general repricing of risk and the deterioration of liquidity in many market segments, not least in the money market. As banks became more concerned about their own liquidity and more cautious about counterparty risk, they became less willing to lend, especially on the unsecured money market, at maturities longer than a few days.

Due to the persistent strains in the money market, the swap lines were increased in March and again in May. Currently the SNB is providing a total of 12 billion US dollars of liquidity to its counterparties through bi-weekly auctions of six billion dollars each. These repo transactions will continue to be renewed until conditions  4  BIS Review 71/2008  improve. For Switzerland, the motivation for participating in this coordinated action is twofold. First, our counterparties obtain easier access to dollar liquidity. Second, money markets in different currencies are highly interrelated. Fewer tensions in the dollar market also mean fewer tensions in the Swiss franc market. The Federal Reserve’s swap line is only the most visible result of the intense cooperation between central banks that has taken place since the outbreak of the crisis. In general, international consultation among central banks has proved very useful in managing the financial market crisis. A further important action taken by central banks was the introduction of facilities that allow banks to swap collateral that is less liquid for securities that are highly liquid, such as government bills. In March, the Federal Reserve introduced a Term Securities Lending Facility (TSLF), which allows to lend up to USD 200 billion of Treasury securities to primary dealers in exchange for a broad range of collateral, including asset-backed securities. In April, the Bank of England introduced its “Special Liquidity Scheme”, a new facility which allows banks to temporarily swap their mortgage-backed and other securities for UK Treasury Bills.