Primary Dealers During the 2007-08 Crisis: Assessing Risks and Vulnerabilities

We study key vulnerabilities of the US Primary Dealers during the 2007-08 financial crisis. Dealers’ exposure to risky assets drives the repo run; importantly, repos become sensitive to counterparty risk only at the height of the crisis. Further, the way in which dealers use repo funding exposes them to several risks: financing illiquid assets with overnight repos exposes dealers to significant fire-sale risk; dealers are also exposed to rollover risk due to the maturity mismatch they take when intermediating credit to clients. Finally, we show how quickly illiquidity can spread across dealers, via chains of settlement fails.