Financial Crisis, Temporary Liquidity Guarantee Program, and the Impacts on the Fixed Income Markets

Abstract

In this paper, we study the FDIC’s Temporary Liquidity Guarantee Program to examine the effectiveness of this government sponsored solution to the current banking crisis. We explore the impact of the program on the liquidity and credit crisis in the debt markets and the market value of the FDIC guarantee. Interestingly, we find a negative and significant 2-day abnormal stock return of -1.53% around FDIC-backed debt issue dates, suggesting stockholders held pessimistic views on the future prospects of these banks. Bondholders reacted positively to the issuances with a 2-day excess return of 0.32%, confirming the positive liquidity and credit effects in the debt market.

We find a significant drop in yield spreads of AAA debt issues around the announcements of FDIC guarantee debt issues. Using multiple regressions, we confirm the drop in yield spreads of AAA financial bonds after the program started. Both findings suggest that the program effectively encouraged liquidity and confidence. Finally, FDIC backed debt trades at a discount of 132 bps to non-guaranteed debt, implying that the guarantee is valuable.

Keywords: FDIC, Temporary Liquidity Guarantee, Financial Crisis, Fixed Income

JEL Classification: G21, G28