Sources of Funding in a Crisis: Evidence from Investment Banks

In this paper, we evaluate changes in investment bank balance sheets to determine how these firms respond to shocks in a financial crisis. Contrary to theories that emphasize liquidity problems, we find that most investment banks maintain funding levels during these downturns. Investment banks typically respond to shocks with a shift into deposits or by raising equity, rather than selling assets at a loss. We do not find strong evidence of fire sales, as asset declines mainly reflect write-downs rather than sales at unusually low prices. Write-downs are combined with strategic use of Level 3 assets, suggesting that banks mask insolvency. Investment banks often rely on cherry picking of assets in order to boost reported capital in a downturn.