financial innovation

165 results back to index


pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, Mark Zuckerberg, McMansion, mortgage debt, mortgage tax deduction, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

François Velde and David Weir, “The Financial Market and Government Debt Policy in France, 1746–1793,” Journal of Economic History (March 1992). 15. For more on the role of technology in propelling financial innovation, see Stelios Michalopoulos, Luc Laeven, and Ross Levine, “Financial Innovation and Endogenous Growth” (NBER Working Paper 51356, September 2009). 16. Richard Sylla, “A Historical Primer on the Business of Credit Ratings” (paper prepared for a conference of the World Bank, Washington, DC, March 2001). 17. Andrew Odlyzko, “Collective Hallucinations and Inefficient Markets: The British Railway Mania of the 1840s,” SSRN Electronic Journal (2010). 18. Peter Tufano, “Business Failure, Judicial Intervention and Financial Innovation: Restructuring US Railroads in the Nineteenth Century,” Business History Review (1997). 19. Robert Shiller, “The Invention of Inflation-Indexed Bonds in America” (NBER Working Paper 10183, December 2003).

Oscar Gelderblom and Joost Jonker, “Completing a Financial Revolution: The Finance of the Dutch East India Trade and the Rise of the Amsterdam Capital Market, 1595–1612,” Journal of Economic History (2004). 4. Peter Tufano, “Financial Innovation and First-Mover Advantages,” Journal of Financial Economics (1989); Peter Tufano, “Financial Innovation,” Handbook of the Economics of Finance (2003). 5. “The Dojima Rice Market and the Origins of Futures Trading” (Harvard Business School Case Study, November 2010). 6. Minos Zombanakis, “The Life and Good Times of Libor,” Financial World (June 2012). 7. Nicola Gennaioli, Andrei Shleifer, and Robert Vishny, “Neglected Risks, Financial Innovation and Financial Fragility,” Journal of Financial Economics (2012). 8. “Financial Globalisation: Retreat or Reset?” (McKinsey Global Institute, February 2013). 9.

The thread running through the financial crisis of 2007–2008 was bad information—about the quality of borrowers, about who had exposure to whom, about how a default in one place would affect other loans—and it brought down every type of institution, simple and complex.2 The second misconception concerns the benefits of financial creativity. Few areas of human activity now have a worse image than “financial innovation.” The financial crisis of 2007–2008 brought a host of arcane financial processes and products to wider attention. Paul Volcker, one former chairman of the Federal Reserve whose postcrisis reputation remains intact, has implied that no financial innovation of the past twenty-five years matches up to the automatic teller machine in terms of usefulness. Paul Krugman, a Nobel Prize–winning economist-cum-polemicist, has written that it is hard to think of any major recent financial breakthroughs that aided society.3 A conference held by the Economist in New York in late 2013 debated whether talented graduates should head to Google or Goldman Sachs.


pages: 430 words: 109,064

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bernie Madoff, Bonfire of the Vanities, bonus culture, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Gordon Gekko, greed is good, Home mortgage interest deduction, Hyman Minsky, income per capita, interest rate derivative, interest rate swap, Kenneth Rogoff, laissez-faire capitalism, late fees, Long Term Capital Management, market bubble, market fundamentalism, Martin Wolf, moral hazard, mortgage tax deduction, Ponzi scheme, price stability, profit maximization, race to the bottom, regulatory arbitrage, rent-seeking, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, sovereign wealth fund, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

Eventually even Greenspan was forced to admit his mistake in a congressional hearing.55 The recent orgy of financial innovation turned out so badly because financial innovation is not like technological innovation. There are financial innovations that do benefit society, such as the debit card. And derivatives, as discussed earlier, can be useful tools to help companies hedge their operational risks. But there is no law of physics or economics that dictates that all financial innovations are beneficial, simply because someone can be convinced to buy them. The core function of finance is financial intermediation—moving money from a place where it is not currently needed to a place where it is needed. The key questions for any financial innovation are whether it increases financial intermediation and whether that is a good thing.

Finance had become a complex, highly quantitative field that only the Wall Street bankers and their backers in academia (including multiple Nobel Prize winners) had mastered, and people who questioned them could be dismissed as ignorant Luddites. No conspiracy was necessary. Even Summers, a brilliant and notoriously skeptical academic economist (later to become treasury secretary and eventually President Obama’s chief economic counselor), was won over by the siren song of financial innovation and deregulation. By 1998, it was part of the worldview of the Washington elite that what was good for Wall Street was good for America. The aftermath is well known. Although Born’s concept paper did not cause a financial crisis, the failure to regulate not only derivatives, but many other financial innovations, made possible a decade-long financial frenzy that ultimately created the worst financial crisis and deepest recession the world has endured since World War II. Free from the threat of regulation, OTC derivatives grew to over $680 trillion in face value and over $20 trillion in market value by 2008.

Particularly severe episodes of wrongdoing often lead to the implementation of new rules that at least close the particular barn door that had been left open in the past; the most important example was the new regulatory scheme created during the Great Depression. The failures and scandals of the late 1980s and 1990s were closely linked to recent deregulatory policies or financial innovations: expansion of savings and loans into new businesses; junk bonds and leveraged buyouts; quantitative arbitrage trading; and over-the-counter derivatives. Someone familiar with the history of the financial system might have expected this record of disaster to lead to greater skepticism of financial innovation and closer oversight of the industry. Instead, the 1990s witnessed the final dismantling of the regulatory system constructed in the 1930s. The Riegle-Neal Act of 1994 practically eliminated restrictions on interstate banking, allowing bank holding companies to acquire banks in any state and allowing banks to open branches in new states.


pages: 695 words: 194,693

Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, Cass Sunstein, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, Louis Bachelier, mandelbrot fractal, market bubble, means of production, money: store of value / unit of account / medium of exchange, moral hazard, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, too big to fail, trade liberalization, trade route, transatlantic slave trade, transatlantic slave trade, tulip mania, wage slave

“Records from a Seventh Century Pawn Shop,” in William N. Goetzmann and K. Geert Rouwenhorst (eds.), The Origins of Value: The Financial Innovations That Created Modern Capital Markets. Oxford: Oxford University Press, pp. 56–64. 4. Goetzmann, William N., and K. Geert Rouwenhorst. 2005. The Origins of Value: The Financial Innovations That Created Modern Capital Markets. Oxford: Oxford University Press, p. 62. 5. Elman, Benjamin A. 2013. Civil Examinations and Meritocracy in Late Imperial China. Cambridge, MA: Harvard University Press, p. 176. 6. Von Glahn, Richard, “The Origins of Paper Money in China,” in William N. Goetzmann and K. Geert Rouwenhorst (eds.), The Origins of Value: The Financial Innovations That Created Modern Capital Markets. Oxford: Oxford University Press, pp. 65–90. 7. For an excellent account of the role of government enterprise in the Song, see Smith, Paul J. 1991.

Ukhov, Andrey. 2003. Financial Innovation and Russian Government Debt before 1918. Yale ICF Working Paper 03–20, May 5. Van De Mieroop, Marc. 1986. “Tūram-ilī: An Ur III merchant.” Journal of Cuneiform Studies 38(1): 1–80. ———. 1992. Society and Enterprise in Old Babylonian Ur. Berlin: Dietrich Reimer Verlag. ———. 1997. The Ancient Mesopotamian City. Oxford: Oxford University Press. ———. 2005. “The Invention of Interest: Sumerian Loans,” in William N. Goetzmann and K. Geert Rouwenhorst (eds.), The Origins of Value: The Financial Innovations That Created Modern Capital Markets. Oxford: Oxford University Press, pp. 17–30. ———. 2014. “Silver as a Financial Tool in Ancient Egypt and Mesopotamia,” in Peter Bernholz and Roland Vaubel (eds.), Explaining Monetary and Financial Innovation: A Historical Analysis.

“China would of herself have developed slowly into a capitalist society even without the impact of foreign capitalism,” proclaimed Mao Zedong [毛澤東] in 1939.1 Was Mao correct? Left to its own, without the incursion of Western powers in the nineteenth century, would China ever have become a capitalist power? China has a long history of financial innovation. The Chinese invented metallic coinage, paper money, bills of exchange, transferable rights certificates, sophisticated accounting and management systems, and securitized lending. Examples of wealthy entrepreneurs, financial institutions, private partnerships, and business organizations can be found throughout China’s history. Given all these financial innovations, why were the first global corporations European in origin, not Chinese? I argue in Part II of this book that the answer is rooted fundamentally in the relationship between government and private enterprise in Chinese history.


pages: 662 words: 180,546

Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown by Philip Mirowski

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Andrei Shleifer, asset-backed security, bank run, barriers to entry, Basel III, Berlin Wall, Bernie Madoff, Bernie Sanders, Black Swan, blue-collar work, Bretton Woods, Brownian motion, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, constrained optimization, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, dark matter, David Brooks, David Graeber, debt deflation, deindustrialization, Edward Glaeser, Eugene Fama: efficient market hypothesis, experimental economics, facts on the ground, Fall of the Berlin Wall, financial deregulation, financial innovation, Flash crash, full employment, George Akerlof, Goldman Sachs: Vampire Squid, Hernando de Soto, housing crisis, Hyman Minsky, illegal immigration, income inequality, incomplete markets, invisible hand, Jean Tirole, joint-stock company, Kenneth Rogoff, knowledge economy, l'esprit de l'escalier, labor-force participation, liquidity trap, loose coupling, manufacturing employment, market clearing, market design, market fundamentalism, Martin Wolf, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Nash equilibrium, night-watchman state, Northern Rock, Occupy movement, offshore financial centre, oil shock, payday loans, Ponzi scheme, precariat, prediction markets, price mechanism, profit motive, quantitative easing, race to the bottom, random walk, rent-seeking, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, school choice, sealed-bid auction, Silicon Valley, South Sea Bubble, Steven Levy, technoutopianism, The Chicago School, The Great Moderation, the map is not the territory, The Myth of the Rational Market, the scientific method, The Wisdom of Crowds, theory of mind, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, War on Poverty, Washington Consensus, We are the 99%, working poor

Of course, MacKenzie realized that the narrative of “technological error” seems on its face implausible (pp. 1830–32); but by focusing so intently upon the narrowly confined world of the low-level analysts and traders, he misses most of the action surveyed in this volume. 43 Shiller, Finance and the Good Society, p. 13. 44 In Norris, “The Crisis Is Over, but Where’s the Fix?” 45 See Litan, “In Defense of Much, but Not All, Financial Innovation” and The Derivatives Dealer’s Club and Derivates Markets Reform; Litan and Wallison, Competitive Equity; Eichengreen, “The Crisis in Financial Innovation”; Shiller, “Radical Financial Innovation,” “In Defense of Financial Innovation,” and Finance and the Good Society. 46 Shiller, “Radical Financial Innovation” and “In Defense of Financial Innovation.” 47 Shiller, Interview on Finance and the Good Society. 48 Ibid. 49 Ibid. 50 The fact that Shiller has a conflict of interest in promoting the Case-Shiller index and his other financial contraptions is revealed by the mission statement of his company, at www.macromarkets.com/index.shtml.

The prospect of the government serving as market-maker of last resort presumably cannot be extended indefinitely, which brings us to the final long-game component of the full-spectrum brace of policies: the crisis analogue of geoengineering for neoliberals is the equally science-fiction prospect of financial innovation as the mode of ultimate deliverance from economic stagnation. Just as with geoengineering, the policy consists more of insubstantial promise than in demonstrated capabilities; but it plays an important pivotal political role nonetheless. The prophets of financial innovation are at pains to portray the invention of new pecuniary instruments, practices, and products as on a par with the science-based innovation of new physical technologies; in other words, it is the very apotheosis of the market coming to terms with an evolving nature. Indeed, one of the first people to promote the notion of financial innovation as a phenomenon commensurate with technological change was the Chicago neoliberal economist Merton Miller, again demonstrating direct affiliations with the thought collective.40 Miller himself admitted that much of the motive for this innovation was to avoid or circumvent prior regulations; but later discussions tended instead to stress purported improvements in general welfare, on the same footing as welfare gains from enhanced solar cells or combustion engines.

See, for instance, Chang, “The Revival—and the Retreat—of the State?” 39 See MacKenzie and Demos, “Credit Default Swap Trading Drops.” This estimate may be limited in its geographic range, and is probably too low. 40 Miller, “Financial Innovation.” 41 Some examples of the “social studies of finance” are MacKenzie, An Engine, Not a Camera; MacKenzie et al., Do Economists Make Markets?; and Preda and Knorr-Cetina, Handbook of the Sociology of Finance. The critique of the role of science studies in helping reify this interpretation of financial innovation can be found in Engelen et al., “Reconceptualizing Financial Innovation.” 42 I refer here to a paper by Donald MacKenzie (“The Credit Crisis as a Problem in the Sociology of Knowledge”), who argues that a shift in cultures of evaluation within the ratings agencies, from older corporate collateralized debt obligations to the newer CDOs composed of mortgage-backed securities, accounted for a number of “slips” when it came to evaluation of the dangers posed by the latter.


pages: 350 words: 103,270

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again by Nicholas Dunbar

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

asset-backed security, bank run, banking crisis, Basel III, Black Swan, Black-Scholes formula, bonus culture, capital asset pricing model, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, delayed gratification, diversification, Edmond Halley, facts on the ground, financial innovation, fixed income, George Akerlof, implied volatility, index fund, interest rate derivative, interest rate swap, Isaac Newton, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, Nick Leeson, Northern Rock, offshore financial centre, price mechanism, regulatory arbitrage, rent-seeking, Richard Thaler, risk tolerance, risk/return, Ronald Reagan, shareholder value, short selling, statistical model, The Chicago School, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, yield curve

Extine would politely send them on their way, but Smith was intrigued by their pitches for commercial paper issued by unfamiliar finance companies with odd names like Rhineland, Tango, McKinley Funding, and Mainsail II.2 The ratings agencies wrote approvingly about these IOUs, which were known as asset-backed commercial paper (ABCP). Little did he know that he was about to be a guinea pig for the latest tricks of love-to-win investment bankers and their ratings agency accomplices. Driven by short-term gains, they found in people like Smith the ultimate twist in a challenge that had spurred financial innovation for centuries. The assurance of liquidity that Extine and Smith craved—the idea that their investments could be redeemed, dollar for dollar, whenever cash was needed—was nothing new. It was behind one of the oldest financial innovations of all, the invention of banking. How do banks get away with taking depositors’ cash and lending it out to borrowers who won’t pay the money back for years? Like the Cowardly Lion, the Scarecrow, and the Tin Man getting green spectacles from the Wizard of Oz, the depositors happily walk around thinking their cash is available whenever they want it.

Next came their easy seduction of traditional bankers and consumers, which led to a corruption of the ratings agencies, all of which was encouraged—either openly or through benign neglect—by the regulatory agencies charged with monitoring these people. Add several trillion dollars, and you have a recipe for disaster. It took a final, crucial ingredient—a catalyst, an ingenious and insidious financial innovation that made it all possible. A helpful tool that upended the distinction between banking and markets. An enabler of a massive shift of power toward love-to-win traders that traditionalists barely understood despite their insistence that they too were “sophisticated.” A mechanism for replicating reality and synthesizing financial robots that allowed complexity to go viral. It’s time to meet our first derivatives.

Back in the late 1990s, such back-and-forths may have been good fodder for academic debate but didn’t seem to matter much in the real world. But business pressures suddenly put the two worlds at odds. There was the pressure on senior bankers such as Chase’s Marc Shapiro and J.P. Morgan’s Peter Hancock to shift credit risk off their balance sheets, and the pressure on investment banks to respond to the threat of commercial banks’ breaking into the securities business. But what really rocked both of these worlds was a radical financial innovation: credit derivatives. Imagine a bank looking to make corporate loans or to own bonds—but without the credit risk. How does it strip out the risk? Easy: think of the loan as two separate parts. Pretend the loan is made to a borrower as safe as the government, which will repay the money without fail, and pays a “risk-free” rate of interest in compensation. Then there is an “insurance policy” or indemnity, for which the risky borrower pays an additional premium to compensate the lender for the possibility of not repaying the loan (although they might have to hand over some collateral).


pages: 225 words: 11,355

Financial Market Meltdown: Everything You Need to Know to Understand and Survive the Global Credit Crisis by Kevin Mellyn

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

asset-backed security, bank run, banking crisis, Bernie Madoff, bonus culture, Bretton Woods, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, disintermediation, diversification, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Francis Fukuyama: the end of history, global reserve currency, Home mortgage interest deduction, Isaac Newton, joint-stock company, liquidity trap, London Interbank Offered Rate, margin call, market clearing, moral hazard, mortgage tax deduction, Northern Rock, offshore financial centre, paradox of thrift, pattern recognition, pension reform, pets.com, Plutocrats, plutocrats, Ponzi scheme, profit maximization, pushing on a string, reserve currency, risk tolerance, risk-adjusted returns, road to serfdom, Ronald Reagan, shareholder value, Silicon Valley, South Sea Bubble, statistical model, The Great Moderation, the payments system, too big to fail, value at risk, very high income, War on Poverty, Y2K, yield curve

As soon as both banks and Wall Street realized that the securitization ‘‘financial sausage machine’’ could be tweaked to manufacture marketable debt securities out of almost any type of loan, a wholesale migration of credit from bank balance sheets into the financial 57 58 FINANCIAL MARKET MELTDOWN markets was set off. In the late twentieth century, the big brains in finance all thought that financial market intermediation had permanently gained the upper hand on bank balance sheet intermediation through the ‘‘financial innovation’’ that started with mortgages. They were wrong. It turns out that the asset securitization model provided the explosives to blow up the global economy. 3 t FINANCIAL INNOVATION MADE EASY ‘‘The business of banking ought to be simple; if it is hard it is wrong. The only securities which a banker, using money that he may be asked at short notice to repay, ought to touch, are those which are easily saleable and easily intelligible.’’ —Walter Bagehot, The Economist, January 9, 1869.

Box 1911 Santa Barbara, California 93116-1911 This book is printed on acid-free paper Manufactured in the United States of America To my wife Judy, who has always patiently supported my writing ventures and both typed the handwritten drafts of the text and suggested important changes in direction and tone throughout the project, and to my historian daughter Elizabeth who offered great encouragement and good advice to her dad. CONTENTS t INTRODUCTION: Money, Markets, Manias, and You ix CHAPTER 1: A Tour of the Financial World and Its Inhabitants CHAPTER 2: The Financial Market Made Simple 29 CHAPTER 3: Financial Innovation Made Easy 59 CHAPTER 4: How We Got Here 75 CHAPTER 5: The Fed Demystified 101 CHAPTER 6: The Limits of Financial Regulation 117 CHAPTER 7: The Natural History of Financial Folly 135 CHAPTER 8: What Should Be Done? 161 Conclusion 179 Index 191 vii 1 INTRODUCTION Money, Markets, Manias, and You t The purpose of this book is to help you understand what is happening in the global financial economy, why it is happening, and what can be done about it.

If things turn out as badly as it looks like they might, people will also wonder why somebody didn’t stop it in its tracks. The answer is, in part, because ‘‘innovation’’ is genuinely viewed as a good thing in our culture— change is a good word. The other answer is that this was a quarter century of remarkably benign financial circumstances. Above all, it was a great party, and lots of people got very rich. Financial Innovation Made Easy BANKS DISCOVER CONSUMER LENDING The early 1980s witnessed something that has been called the retail banking revolution. This started in the United States and spread to the United Kingdom and other rich countries. Traditionally, banks only looked to consumers like you and me for deposits. Classic banking turned our OPM into ‘‘working capital’’ for business and industry. Lending money to consumers was always left to retailers, finance companies, and savings banks.


pages: 309 words: 95,495

Foolproof: Why Safety Can Be Dangerous and How Danger Makes Us Safe by Greg Ip

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, Air France Flight 447, air freight, airport security, Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, capital controls, central bank independence, cloud computing, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, Daniel Kahneman / Amos Tversky, diversified portfolio, double helix, endowment effect, Exxon Valdez, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, global supply chain, hindsight bias, Hyman Minsky, Joseph Schumpeter, Kenneth Rogoff, London Whale, Long Term Capital Management, market bubble, moral hazard, Network effects, new economy, offshore financial centre, paradox of thrift, pets.com, Ponzi scheme, quantitative easing, Ralph Nader, Richard Thaler, risk tolerance, Ronald Reagan, savings glut, technology bubble, The Great Moderation, too big to fail, transaction costs, union organizing, Unsafe at Any Speed, value at risk

Attendees included Ben Bernanke and Mervyn King, future heads of the Fed and Bank of England, respectively, and Paul Krugman, future Nobel laureate. None needed convincing that finance had become more treacherous. The puzzle was why the economy kept humming. Larry Summers, who would later serve as Treasury secretary to Bill Clinton and adviser to Barack Obama, had a theory. Technological and financial innovation, he told the group, had indeed made finance more bubble-prone. He sketched out a scenario of how a crisis and deep recession could recur. Still, he concluded, since the Great Depression, the federal government had erected firewalls between the financial system and the real economy where ordinary people worked and invested: the vast federal budget, deposit insurance, and, most important, an activist Federal Reserve: “It is now nearly inconceivable that there would be no active lender of last resort in time of crisis.”

As a graduate student at Harvard he worked closely with both Schumpeter, a leading scholar of the Austrian school, and Alvin Hansen, Keynes’s most influential disciple. Minsky agreed with Keynes that the economy needed a big, active government to avoid depressions. But he also thought Keynesian models gave short shrift to the financial system. They assumed that the central bank had full control of the money supply, credit, and interest rates. Minsky argued that the volume of money and credit didn’t depend just on the central bank but on financial innovation. If, to control inflation, the Fed restricted the growth of lending by banks, then Wall Street’s innovators would come up with mechanisms to go around banks and get credit to those who wanted to borrow. Innovation, he predicted, proceeded through three stages: the first, “hedge” stage, when it served business’s legitimate need to manage risk; the second, “speculative” phase, when it served mostly to finance rising asset prices; and a final, “Ponzi” stage, when investors had to borrow more simply to pay the interest on past borrowings.

So securities firms began using mortgage-backed securities that were designed to be as safe as Treasurys, and had the same top AAA rating. In 2008 lenders were nervous enough about AAA-rated MBSs to refuse to refinance repo loans that used them. Bear Stearns collapsed in 2008 largely because it couldn’t refinance its maturing repo loans, which, given the lessons learned from Drexel, simply wasn’t supposed to happen. Drexel’s experience amply illustrated how a financial innovation that seemed at the time to reduce risk once it became widespread enough, did the opposite, and raised risk throughout the system. Another example was the use of mortgage-backed securities. Because American banks tended to be regional, they were acutely vulnerable to localized housing busts. Deep downturns in Massachusetts and Texas had sent many local banks over the edge. MBSs made it possible to pool loans from around the country, diluting the effect of a housing bust in any region on the overall portfolio.


pages: 311 words: 99,699

Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe by Gillian Tett

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, asset-backed security, bank run, banking crisis, Black-Scholes formula, Bretton Woods, business climate, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, easy for humans, difficult for computers, financial innovation, fixed income, housing crisis, interest rate derivative, interest rate swap, locking in a profit, Long Term Capital Management, McMansion, mortgage debt, North Sea oil, Northern Rock, Renaissance Technologies, risk tolerance, Robert Shiller, Robert Shiller, short selling, sovereign wealth fund, statistical model, The Great Moderation, too big to fail, value at risk, yield curve

Morgan management was resisting strongly, and Hancock sketched out its alternative vision for revitalizing the bank, maintaining its hallowed role as an independent player. Morgan would continue harnessing the power of financial innovation, such as derivatives, to make itself into a sharp, focused investment bank that could continually serve its clients with new products. His listeners were unmoved. At the end of the meeting, another electronic vote was conducted, and the proportion in the crowd who believed in the bank’s strategy had not risen at all. Most of the staff—the junior staff at least—shared Hancock’s belief in the power of financial innovation. But they also knew that the rest of Wall Street was making much higher returns from the internet and financial merger boom than J.P. Morgan was producing with derivatives, and the senior managers came across as increasingly out of touch.

The first of these results was what attracted Hancock and his team to the pursuit. It would be the second feature that would come to dominate the business a decade later, eventually leading to a worldwide financial catastrophe. [ TWO ] DANCING AROUND THE REGULATORS There was a critical juncture, around the time that Peter Hancock’s team seized on the idea of credit derivatives, when financial innovation might have followed a subtly different path. In the few years leading up to Hancock’s Boca off-site, regulators and many prominent banking experts grew concerned about the boom in derivatives and the proliferation of exotic new types. They fiercely debated whether regulations should be imposed. Peter Hancock found himself at the heart of this debate. In 1991, three years before the Boca Raton meeting, he had received an unexpected summons from Morgan CEO Dennis Weatherstone.

If they had just managed to stay independent for a few more months, the share price of Chase would have crashed. Events would have turned out quite differently. They felt as if the fates were laughing at them. But even as they reeled from the carnage, the innovation cycle was about to heat up again, and with the wonders of dot-coms soundly repudiated, attention would turn anew to the marvelous potential of credit derivatives and other forms of financial innovation. On January 3, 2001, the US Federal Reserve suddenly announced a 50-basis-point cut in interest rates, reducing them to 6 percent. That news stunned the markets almost as much as the internet collapse. In the prior eight years, Alan Greenspan had made a virtue out of running monetary policy in a calm, controlled manner, decreasing rates steadily but slowly at just 25 basis points a shot.


pages: 356 words: 103,944

The Globalization Paradox: Democracy and the Future of the World Economy by Dani Rodrik

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

affirmative action, Asian financial crisis, bank run, banking crisis, bilateral investment treaty, borderless world, Bretton Woods, British Empire, capital controls, Carmen Reinhart, central bank independence, collective bargaining, colonial rule, Corn Laws, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, Doha Development Round, en.wikipedia.org, eurozone crisis, financial deregulation, financial innovation, floating exchange rates, frictionless, frictionless market, full employment, George Akerlof, guest worker program, Hernando de Soto, immigration reform, income inequality, income per capita, joint-stock company, Kenneth Rogoff, labour market flexibility, labour mobility, land reform, Long Term Capital Management, low skilled workers, margin call, market bubble, market fundamentalism, Martin Wolf, Mexican peso crisis / tequila crisis, microcredit, Monroe Doctrine, moral hazard, night-watchman state, non-tariff barriers, offshore financial centre, oil shock, open borders, open economy, price stability, profit maximization, race to the bottom, regulatory arbitrage, savings glut, Silicon Valley, special drawing rights, special economic zone, The Wealth of Nations by Adam Smith, Thomas L Friedman, Tobin tax, too big to fail, trade liberalization, trade route, transaction costs, tulip mania, Washington Consensus, World Values Survey

Indeed, the mortal blow to the “collateral benefits” argument was struck by the subprime mortgage meltdown, which demonstrated finance’s remarkable ability to undermine governance—and to do so in the richest and oldest democracy in the world. In its wake, it would be very difficult to argue that banking interests contribute to better institutions. The Seductions of Financial Innovation In the aftermath of the subprime mortgage meltdown no one has to break a sweat to be a finance skeptic. But we should give hedgehog economists their due. To most of us, their narrative on the financial innovation that led to the crisis seemed quite compelling when we first heard it. Everyone wanted credit markets to serve the cause of home ownership, so we started by introducing real competition into the mortgage lending business. We allowed non-banks to make home loans and let them offer creative, more affordable mortgages to prospective homeowners who were not well served by conventional lenders.

And just in case anyone was still nervous, we created derivatives that allowed investors to purchase insurance against default by issuers of those securities. If we had wanted to showcase the benefits of financial innovation, we could not have devised a better set of arrangements. Thanks to them, millions of poorer and hitherto excluded families were made homeowners, investors made high returns, and financial intermediaries pocketed the fees and commissions. It might have worked like a dream—and until the crisis struck, many financiers, economists, and policy makers thought that it did. The narrative they all relied on was appealing. Financial innovation can allow people to access credit in ways they could not before by pooling risk and passing it on to those in the best position to bear it. If some people and institutions make mistakes and get over-stretched in the process, they will pay the price for it.

The crisis that engulfed financial markets in 2007 buried Wall Street and humbled the United States. The gigantic multi-trillion-dollar bailout of troubled financial institutions which the U.S. Treasury and Federal Reserve had to mount makes emerging market crises look like footnotes by comparison. And the benefits of financial innovation? They were hard to see amidst the rubble. As Paul Volcker would say afterwards in all seriousness, the automated teller machine had brought far more gains to most people than any asset-backed bond.19 Or as Ben Bernanke put it, much more diplomatically, “One would be forgiven for concluding that the assumed benefits of financial innovation are not all they were cracked up to be.”20 Where exactly did it all go wrong? The subprime mortgage crisis demonstrated once again how difficult it is to tame finance, an industry which is both the lifeline of all modern economies and the gravest threat to their stability.


pages: 471 words: 124,585

The Ascent of Money: A Financial History of the World by Niall Ferguson

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Admiral Zheng, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collateralized debt obligation, colonial exploitation, Corn Laws, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, German hyperinflation, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, interest rate swap, Isaac Newton, iterative process, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, labour mobility, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Naomi Klein, Nick Leeson, Northern Rock, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, structural adjustment programs, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Malthus, Thorstein Veblen, too big to fail, transaction costs, value at risk, Washington Consensus, Yom Kippur War

Despite our deeply rooted prejudices against ‘filthy lucre’, however, money is the root of most progress. To adapt a phrase from Jacob Bronowski (whose marvellous television history of scientific progress I watched avidly as a schoolboy), the ascent of money has been essential to the ascent of man. Far from being the work of mere leeches intent on sucking the life’s blood out of indebted families or gambling with the savings of widows and orphans, financial innovation has been an indispensable factor in man’s advance from wretched subsistence to the giddy heights of material prosperity that so many people know today. The evolution of credit and debt was as important as any technological innovation in the rise of civilization, from ancient Babylon to present-day Hong Kong. Banks and the bond market provided the material basis for the splendours of the Italian Renaissance.

In the five years to 31 July 2007, all but two of the world’s equity markets delivered double-digit returns on an annualized basis. Emerging market bonds also rose strongly and real estate markets, especially in the English-speaking world, saw remarkable capital appreciation. Whether they put their money into commodities, works of art, vintage wine or exotic asset-backed securities, investors made money. How were these wonders to be explained? According to one school of thought, the latest financial innovations had brought about a fundamental improvement in the efficiency of the global capital market, allowing risk to be allocated to those best able to bear it. Enthusiasts spoke of the death of volatility. Self-satisfied bankers held conferences with titles like ‘The Evolution of Excellence’. In November 2006 I found myself at one such conference in the characteristically luxurious venue of Lyford Cay in the Bahamas.

By making their bank bigger and more diversified than any previous financial institution, they found a way of spreading their risks. And by engaging in currency trading as well as lending, they reduced their vulnerability to defaults. The Italian banking system became the model for those North European nations that would achieve the greatest commercial success in the coming centuries, notably the Dutch and the English, but also the Swedes. It was in Amsterdam, London and Stockholm that the next decisive wave of financial innovation occurred, as the forerunners of modern central banks made their first appearance. The seventeenth century saw the foundation of three distinctly novel institutions that, in their different ways, were intended to serve a public as well as a private financial function. The Amsterdam Exchange Bank (Wisselbank) was set up in 1609 to resolve the practical problems created for merchants by the circulation of multiple currencies in the United Provinces, where there were no fewer than fourteen different mints and copious quantities of foreign coins.


pages: 478 words: 126,416

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, corporate governance, Credit Default Swap, cross-subsidies, dematerialisation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, income inequality, index fund, inflation targeting, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, London Whale, Long Term Capital Management, loose coupling, low cost carrier, M-Pesa, market design, millennium bug, mittelstand, moral hazard, mortgage debt, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, regulatory arbitrage, Renaissance Technologies, rent control, Richard Feynman, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, Schrödinger's Cat, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, Washington Consensus, We are the 99%, Yom Kippur War

The ineffectiveness and inefficiency of this process contributed directly to the dismal economic performance of these states. A country can be prosperous only if it has a well-functioning financial system, but that does not imply that the larger the financial system a country has, the more prosperous it is likely to be. It is possible to have too much of a good thing. Financial innovation was critical to the creation of an industrial society; it does not follow that every modern financial innovation contributes to economic growth. Many good ideas become bad ideas when pursued to excess. And so it is with finance. The finance sector today plays a major role in politics: it is the most powerful industrial lobby and a major provider of campaign finance. News bulletins report daily on what is happening in ‘the markets’ – by which they mean securities markets.

Third, finance enables us to manage our personal finances across our lifetimes and between generations. Fourth, finance helps both individuals and businesses to manage the risks inevitably associated with everyday life and economic activity. These four functions – the payments system, the matching of borrowers and lenders, the management of our household financial affairs and the control of risk – are the services that finance does, or at least can, provide. The utility of financial innovation is measured by the degree to which it advances the goals of making payments, allocating capital, managing personal finances and handling risk. The economic significance of the finance industry is often described in other ways: by the number of jobs it provides, the incomes that are earned from it, even the tax revenue derived from it. There is a good deal of confusion here, discussed in Chapter 9.

Banks specialised in what I will call the deposit channel, diverting short-term savings into relatively low-risk activities. There has always been a need for a parallel investment channel, to facilitate the deployment of longer-term savings. In 1812, with Britain at war with both Napoleon and the USA, some public-spirited Edinburgh gentlemen founded the Scottish Widows’ Fund to make provision for their dependants. Scotland has played a disproportionately large role in the history of financial innovation for a small country on Europe’s periphery. The Bank and the Royal Bank of Scotland are among the oldest surviving institutions in the deposit channel (even if their survival was a close call). The Bank of England, which saved them, was also founded by a Scot. My parents and teachers, believing my destiny was to be an actuary, sent me to work at Scottish Widows in the school holidays. I reported to a building in St Andrew’s Square that faced the imposing headquarters of the Royal Bank.


pages: 288 words: 16,556

Finance and the Good Society by Robert J. Shiller

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

bank run, banking crisis, barriers to entry, Bernie Madoff, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial innovation, full employment, fundamental attribution error, George Akerlof, income inequality, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, Steven Pinker, telemarketer, The Market for Lemons, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, Zipcar

Arjun Jayadev and Samuel Bowles have estimated that 19.7% of the U.S. labor force in 2002—supervisors, security personnel, members of the military—was involved in guarding in some form.17 The high percentage of our citizens paid to guard us and our installations and possessions is at its essence surely more troubling than the percentage engaged in the substantially productive activities of nance. Yet relatively few of us seem bothered by this statistic. Financial Capitalism and the Challenge of Financial Innovation While nancial capitalism inevitably must be made to serve the good society, it cannot be summarized in simple terms. This is so because it represents a bewilderingly broad and cross-cutting array of institutions, instruments, and markets, each element of which evolved through a process of invention not unlike the processes that produced our automobiles and airplanes, and through which they continue to evolve. Financial innovation is an underappreciated phenomenon. According to Google Ngrams, the term nancial innovation was hardly ever used until the late 1970s and 1980s. The term seems to have been applied rst to the controversial nancial futures markets that developed around that time.

By 2007 this decline had brought prices of home mortgage securities down far enough to create a crisis for investors in these securities. It was called the subprime crisis because the price falls were especially striking among mortgages issued to subprime borrowers, that is, home buyers who are judged more likely to default because of factors including their past payment and employment histories. Financial innovations related to these subprime loans were blamed for the crisis. But the crisis did not remain con ned to subprime mortgages; that was only the initial shock in a vast catastrophe. The consequence was a drop in real estate prices and the collapse of nancial institutions, not only in the United States but also in Europe and elsewhere. By the spring of 2009 the crisis was so severe that it was described as the biggest nancial calamity since the Great Depression of the 1930s—bigger than the Asian nancial crisis of the 1990s and bigger than the oil-price-induced crises of 1974–75 and 1981–82.

The Inexorable Spread of Financial Capitalism At the time of this writing we are still stuck in the severe nancial crisis that began in 2007. As such we tend to associate nance with recent problems, such as the mortgage and debt hangovers in the United States and Europe, and with the legal and regulatory errors that preceded these events. But we should not lose sight of the bigger picture. The more important story is the proliferation and transformation of successful nancial ideas. Financial innovations emanating from Amsterdam, London, and New York are developing further in Buenos Aires, Dubai, and Tokyo. The socialist market economy, with its increasingly advanced nancial structures, was introduced to China by Deng Xiaoping starting in 1978, adapting to the Chinese environment the examples of other highly successful Chinese-speaking cities: Hong Kong, Singapore, and Taipei. The economic liberalization of India, which allowed freer application of modern nance, was inaugurated in 1991 under Prime Minister P.


pages: 76 words: 20,238

The Great Stagnation by Tyler Cowen

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Asian financial crisis, Bernie Madoff, en.wikipedia.org, financial innovation, Flynn Effect, income inequality, indoor plumbing, life extension, liquidity trap, Long Term Capital Management, Mark Zuckerberg, meta analysis, meta-analysis, Peter Thiel, RAND corporation, school choice, Tyler Cowen: Great Stagnation, urban renewal

Contemporary innovation often takes the form of expanding positions of economic and political privilege, extracting resources from the government by lobbying, seeking the sometimes extreme protections of intellectual property laws, and producing goods that are exclusive or status related rather than universal, private rather than public; think twenty-five seasons of new, fall season Gucci handbags. The dubious financial innovations connected to our recent financial crisis are another (perhaps less obvious) example of discoveries that benefit some individuals but are not public goods more generally. A lot of the gains from recent financial innovations are captured by a relatively small number of individuals. Top American earners are increasingly concentrated in the financial sector of the economy. For 2004, nonfinancial executives of publicly traded companies comprised less than 6 percent of the top 0.01 percent income bracket.

In that same year, the top twenty-five hedge fund managers combined earned more than all of the CEOs from the entire S&P 500. The number of Wall Street investors earning over $100 million a year was nine times higher than the public-company executives earning that amount. When I look back at the last decade, I think the following: There are some very wealthy people, but a lot of their incomes are from financial innovations that do not translate to gains for the average American citizen. The slowdown in ideas production mirrors the well-known rise in income inequality. Labor and capital are fairly plentiful in today’s global economy, and so their returns have been somewhat stagnant. Valuable new ideas have become quite scarce, and so the small number of people who hold the rights to new ideas—whether it be the useful Facebook or the more dubious forms of mortgage-backed securities—earned higher relative returns than in earlier periods.

GDP, and that figure had been rising throughout the 2000-2004 “productivity boom” period. I know what the numbers say, but what was the financial sector really producing during those years? The published figures do not pick up the problematic nature of financial sector growth, which of course culminated in a major crash. What we measured as value creation actually may have been value destruction, namely too many homes and too much financial innovation of the wrong kind. Keep in mind that median income growth has been slow, and stock prices—the valuation of capital—haven’t made lasting progress in a long time. As of the fall of 2010, the S&P 500 is more or less back where it had been in the mid-1990s. As economist Michael Mandel puts it, if neither labor nor capital is reaping much gain, can we really trust the productivity numbers?


pages: 741 words: 179,454

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial independence, financial innovation, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, Kevin Kelly, labour market flexibility, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, merger arbitrage, Mikhail Gorbachev, Milgram experiment, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Naomi Klein, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, pets.com, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, Richard Thaler, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond

Much of the activity did not generate true value or represent direct additions to the goods and services produced in the economy. It increased debt and the circulation of money, as well as trading and speculation. In 2009 Paul Volcker, a former chairman of the Federal Reserve, questioned the role of finance: “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth—one shred of evidence.... [U.S. financial services increased its share of value-added from 2 percent to 6.5 percent] Is that a reflection of your financial innovation, or just a reflection of what you’re paid?”2 The only financial innovation over the past 20 years that impressed Volcker was the automated teller machine. In the financial centers, high rewards enjoyed by people associated with finance trickled down. Entire cities and districts became gentrified, with bustling streets, chi-chi restaurants, trendy bars, and luxury label retailers.

Louis Aunchincloss in his 1954 novel A World of Profit, quoted in Robert Sobel (1993) Dangerous Dreamers: The Financial Innovators from Charles Merrill to Michael Milken, John Wiley, New York: 29. 2. ©Lucy Prebble, Enron, and Methuen Drama, an imprint of Bloomsbury Publishing Plc., London: 106. 3. John Lanchester (2010) Whoops! Why Everyone Owes Everyone and No One Can Pay, Allen Lane, London. 4. John Kenneth Galbraith “The 1929 parallel” (January 1987) Atlantic Monthly: 62. 5. Thomas Philippon and Ariell Reshef “Wages and human capital in the financial industry: 1909–2006” (December 2008), Working Paper, New York University and University of Virginia. 6. Quoted in Gillian Tett “Silos and silences: why so few people spotted the problems in complex credit and what that implies for the future” (July 2010) Financial System Review—Derivatives: Financial Innovation and Stability, Banque de France: 122. 7.

The top 1 percent of households accounted for more than 30 percent of net worth, greater than the entire bottom 90 percent of households put together. Writer Robert Frank observed that the wealthy inhabited a different country—Richistan.3 Gains from recent economic growth flowed disproportionately to the wealthy, who benefited from market-friendly governments, favorable tax regimes, protection of property rights, globalization, and technological change, and financial innovation and deregulation. The top 10 percent of earners received the majority of the benefits of the productivity miracle of 1996–2005.4 Wealthy plutocrats both powered and benefited from economic growth. The Forbes 400 richest people in 2006 controlled $1,250 billion, up $92 billion from 1982. To make it on to the list in 2006 you had to have a billion, compared to $75 million in 1982. This money was invested, making more money to fund consumption or simply to attest to wealth.


pages: 586 words: 159,901

Wall Street: How It Works And for Whom by Doug Henwood

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, affirmative action, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, capital asset pricing model, capital controls, central bank independence, corporate governance, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, interest rate swap, Internet Archive, invisible hand, Isaac Newton, joint-stock company, Joseph Schumpeter, kremlinology, labor-force participation, late capitalism, law of one price, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, Louis Bachelier, market bubble, Mexican peso crisis / tequila crisis, microcredit, minimum wage unemployment, moral hazard, mortgage debt, mortgage tax deduction, oil shock, payday loans, pension reform, Plutocrats, plutocrats, price mechanism, price stability, prisoner's dilemma, profit maximization, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

But that can't be the only reason; clearly there's a demand, not always fully thought through, for whizbang new tools to "manage risk," have a fling, or indulge some other lust for moneymaking. John D. Finnerty, who compiled the Whitmanic catalogue of financial innovations since the 1960s reproduced on page 51, listed 10 stimuli to such creative enterprise. They include risk reduction or the shifting of risk towards one party or the other, reduction of agency costs (lender supervision of management) and issuance costs, tax angles, compliance with or evasion of regulation, changes in the level and volatility of interest and exchange rates, "academic and other research that result in advances in financial theories," accounting gimmickry, and technological advances. This little survey of financial innovation would be incomplete without notice paid to the ease with which nearly anything can be absorbed into the circuit of money.

Most of the nearly 100 instruments shown nearby are merely hybrid products assembled from several basic building blocks — conversion of fixed to floating interest rates or vice versa; maturity transformation (turning long-term obligations into shorter-term ones, or the reverse) instruments crafted to move in the direction opposite some other price (inverse floaters, which pay less as interest rates rise and more as they fall); the creation of hermaphrodite securities (bond-stock warrant, bond-gold, bond-an-other country's currency, bond-stock future); tax, accounting, and regulatory footwork; the splitting of income streams ("stripped" bonds, ones divided into interest and principal sub-bonds, and then perhaps divided again between high- and low-risk); the swapping of income streams (interest rate swaps); the pooling of funds or of obligations into larger wholes to diversify against individual risks (mutual funds, securitization); schemes for increasing leverage (options, futures, payment-in-kind securities) or controlling volatility (options, futures, swaps). From these elements, however, infinitely strange creatures can be made. Or, "Rather than developing new generic instruments," "financial innovation since the mid-1980s has tended to take the form of novel combinations of existing products to support complex and highly sophisticated investment strategies.... At the same time, a growing range of 'custom-tailored' investment products has been developed to maximise possibilities for matching actual portfolio structures to theoretically-based invesment models" (Bank for International Settlements 1993, P- 86). The more reality INSTRUMENTS financial innovations adjustable rate convertible notes • adjustable rate preferred stock • adjustable/variable rate mortgages • All-Saver certificates • Annericus trust • annuity notes • auction rate capital notes • auction rate notes/debentures • auction rate preferred stock • bull and bear CDs • capped floating rate notes • collateralized connmercial paper • collateralized nnortgage obligations/real estate mortgage investment conduits • collateralized preferred stock • commercial real estate-backed bonds • commodity-linked bonds • convertible adjustable preferred stock • convertible exchangeable preferred stock • convertible mortgages/reduction option loans • convertible reset debentures • currency swaps • deep discount/zero coupon bonds • deferred interest debentures • direct public sale of securities • dividend reinvestment plan • dollar BILS • dual currency bonds • employee stock ownership plan (ESOP) • Eurocurrency bonds • Euronotes/Euro-commercial paper • exchangeable auction rate preferred stock • exchangeable remarketed preferred stock • exchangeable variable rate notes • exchange-traded options • extendible notes • financial futures • floating rate/adjustable rate notes • floating rate extendible notes • floating rate, rating sensitive notes • floating rate tax-exempt notes • foreign-currency-denominated bonds • foreign currency futures and options • forward rate agreements • gold loans • high-yield (junk) bonds • increasing rate notes • indexed currency option notes/ principal exchange linked securities • indexed floating rate preferred stock • indexed sinking fund debentures • interest rate caps/collars/floors • interest rate futures • interest rate reset notes • interest rate swaps • letter of credit/surety bond support • mandatory convertible/equity contract notes • master limited partnership • medium-term notes • money market notes • mortgage-backed bonds • mortgage pass-through securities • negotiable CDs • noncallable long-term bonds • options on futures contracts • paired common stock • participating bonds • pay-in-kind debentures • perpetual bonds • poison put bonds • puttable/adjustable tender bonds • puttable common stock • puttable convertible bonds • puttable-extendible notes • real estate-backed bonds • real yield securities • receivable-backed securities • remarketed preferred stock • remarketed reset notes • serial zero-coupon bonds • shelf registration process • single-point adjustable rate stock • Standard & Poor's indexed notes • state rate auction preferred stock • step-up put bonds • stock index futures and options • stripped mortgage-backed securities • stripped municipal securities • stripped U.S.

"Andre could peel people like bananas," said Rohatyn (Reich 1983, p. 19). But financial innovations are more than mere bankers' fancy; hard issues of power and risk are settled through them. Floating rate instruments shift the risk of rising interest rates from lender to borrower. Adjustable rate notes protect bondholders against imprudent or capital-risking actions by management, like taking on gobs of new debt. Looser regulations on issuance like shelf registration, which allows corporations to file general prospectuses to be kept on file, rather than prepare custom prospectuses for a specific stock or bond issue, allow firms to hawk their paper when the market looks friendly. Joseph Schumpeter (1939, vol. 2, p. 613), writing during a decade when financial innovation was deeply out of fashion, observed that "it is one of the most characteristic features of the financial side of capitalist evolution so to 'mobilize' all, even the longest, maturities as to make any commitment to a promise of future balances amenable to being in turn financed by any sort of funds and especially by funds available for short time, even overnight, only.


pages: 369 words: 94,588

The Enigma of Capital: And the Crises of Capitalism by David Harvey

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, anti-communist, Asian financial crisis, bank run, banking crisis, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business climate, call centre, capital controls, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, deskilling, equal pay for equal work, European colonialism, failed state, financial innovation, Frank Gehry, full employment, global reserve currency, Google Earth, Guggenheim Bilbao, illegal immigration, indoor plumbing, interest rate swap, invention of the steam engine, Jane Jacobs, joint-stock company, Joseph Schumpeter, Just-in-time delivery, land reform, liquidity trap, Long Term Capital Management, market bubble, means of production, megacity, microcredit, moral hazard, mortgage debt, new economy, New Urbanism, Northern Rock, oil shale / tar sands, peak oil, place-making, Ponzi scheme, precariat, reserve currency, Ronald Reagan, sharing economy, Silicon Valley, special drawing rights, special economic zone, statistical arbitrage, structural adjustment programs, the built environment, the market place, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, Thorstein Veblen, too big to fail, trickle-down economics, urban renewal, urban sprawl, white flight, women in the workforce

The demand problem was temporarily bridged with respect to housing by debt-financing the developers as well as the buyers. The financial institutions collectively controlled both the supply of, and demand for, housing! The same story occurred with all forms of consumer credit on everything from automobiles and lawnmowers to loading down with Christmas gifts at Toys ‘R’ Us and Wal-Mart. All this indebtedness was obviously risky, but that could be taken care of by the wondrous financial innovations of securitisation that supposedly spread the risk around and even created the illusion that risk had disappeared. Fictitious financial capital took control and nobody wanted to stop it because everyone who mattered seemed to be making lots of money. In the US, political contributions from Wall Street soared. Remember Bill Clinton’s famous rhetorical question as he took office? ‘You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of fucking bond traders?’

Meanwhile, Bankers Trust, without checking his figures, put out reassuring statements on its profitability to prop up its share value. Krieger’s figures turned out to be faulty by $80 million but, rather than admit its profitability had disappeared, the bank tried all manner of ‘creative’ accounting practices to cover over the discrepancy before finally having to admit that it had been wrong. Notice the elements in this tale. First, unregulated over-the-counter trading permits all sorts of financial innovation and shady practices which nevertheless make a lot of money. Secondly, the bank supports such practices, even though they don’t understand them (the mathematics in particular), because they are often so profitable relative to their core business and hence improve share value. Third, creative accounting enters the picture, and fourth, the valuation of assets for accounting practices is extremely uncertain in volatile markets.

Global shifts in production capacity accompanied by highly competitive technological innovations, many of which were labour-saving, contributed further to the disciplining of global labour. The United States still retained immense financial power, even as it lost its earlier dominance (though not significance) in the realm of production. Increasingly, the US relied upon the extraction of rents, either on the basis of its advantages in technological and financial innovation or from intellectual property rights. But this meant that finance should not be burdened by excessive regulation. The crash of the US financial sector in 2008–9 has jeopardised US hegemony. The ability of the US to launch a go-it-alone debt-financed recovery plan is limited politically by staunch conservative opposition at home as well as by the huge debt-overhang accumulated from the 1990s on.


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, Joseph Schumpeter, labour market flexibility, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, means of production, Menlo Park, moral hazard, moveable type in China, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Plutocrats, plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, We are the 99%, Wolfgang Streeck

To Stephanie, Tom, Olivia, Celia, Richard and Robin CONTENTS Title Page Dedication Acknowledgements Introduction Chapter One: The Root of All Evil (Or Not, as the Case May Be) Chapter Two: Animal Spirits Chapter Three: Hijacked by Bankers Chapter Four: Industrial Shrinkage, Financial Excess Chapter Five: Sophisters, Economists and Calculators Chapter Six: Trade and the Fatal Embrace Chapter Seven: Speculation – The Missing Shame Gene Chapter Eight: The Dynamics of Debt Chapter Nine: Gold: The 6,000-Year-Long Bubble Chapter Ten: High-Minded about Art Chapter Eleven: Tax and the Division of the Spoils Chapter Twelve: Capitalism, Warts and All Notes Index Copyright ACKNOWLEDGEMENTS This book draws on the wisdom of so many people and so much reading over the years that it would be impossible to thank all my sources individually. What I can do is acknowledge the long-standing support and stimulus from my colleagues at the Financial Times, the enthusiastic encouragement of David Marsh, managing director of the Official Monetary and Financial Institutions Forum, and of Andrew Hilton, director of the Centre for the Study of Financial Innovation. Anyone who writes about capitalism from a historical and cultural perspective also has to acknowledge a debt to Jerry Z. Muller, whose book The Mind and the Market: Capitalism in Western Thought has been an inspiration and a delight. I offer heartfelt gratitude to my old friend Brian Reading of Lombard Street Research, who read the manuscript. He saved me from numerous errors and made characteristically thoughtful suggestions, most of which I have taken up.

They were the folk who believed that trade was a zero-sum game and that the way to enhance the prosperity and strength of a country was to boost exports and restrain imports in order to accumulate reserves of gold. His economic writings, of which A Discourse of Trade was the most important, were admired by Keynes, Schumpeter and Marx. He was also a pioneer of fire insurance after the Great Fire of London in 1666 and helped found England’s first mortgage bank. Barbon combined these remarkable financial innovations with a role as the biggest speculative builder in London, creating the districts around what is now the Strand, and rebuilding the Temple after a fire in 1678. He also developed much of London’s Bloomsbury. His building activities relied heavily on credit, yet he was notoriously reluctant to pay his creditors, even stipulating in his will that his debts should not be met. He ignored restrictions imposed by Acts of Parliament on new building and often demolished existing structures without permission.

It is reasonably clear now that this theory has left a large number of poorer stockholders, especially including employee stockholders, not only unconvinced, but understandably disillusioned and angry. The policy of vastly increasing executive compensation was also, at least with the brilliant vision of hindsight, terribly bad social policy and perhaps even bad morals.42 A similar if less spectacular progression was under way in Europe. The escalation coincided with a power shift within banking whereby traders replaced conventional bankers at the top. They genuinely believed that financial innovations that involved packaging products such as subprime mortgages into bundles of securities that could be sold to investors were both useful and lucrative, as did the credit rating agencies that awarded triple-A status to these securitised products. So, too, did a growing band of mathematicians and scientists who left other research-intensive industries to share in the banking bonanza. At the same time, financial and human resources were diverted away from retail banking, which provides services for households and small businesses, into investment banking.


pages: 280 words: 73,420

Crapshoot Investing: How Tech-Savvy Traders and Clueless Regulators Turned the Stock Market Into a Casino by Jim McTague

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

algorithmic trading, automated trading system, Bernie Madoff, Bernie Sanders, Bretton Woods, buttonwood tree, credit crunch, Credit Default Swap, financial innovation, Flash crash, High speed trading, housing crisis, index arbitrage, locking in a profit, Long Term Capital Management, margin call, market bubble, market fragmentation, market fundamentalism, naked short selling, pattern recognition, Ponzi scheme, quantitative trading / quantitative finance, Renaissance Technologies, Ronald Reagan, Sergey Aleynikov, short selling, Small Order Execution System, statistical arbitrage, technology bubble, transaction costs, Vanguard fund, Y2K

In the midst of the journalistic feeding frenzy, it wasn’t long before reporters discovered Arnuk and Saluzzi’s white paper and launched the pair into the limelight. Saluzzi was invited to discuss his findings on Bloomberg television, a cable business channel. The interview was apparently seen by somebody at the SEC, because shortly after the broadcast, Arnuk received an invitation from Henry Hu, chief of the SEC’s Division of Risk, Strategy, and Financial Innovation, to visit Washington, DC with Saluzzi and address the SEC staff. This was exactly the audience that the two traders wanted to reach. Saluzzi and Arnuk brought along a PowerPoint presentation and assumed that they would be addressing a small group of people. Much to their surprise, they were ushered into a heavily populated conference room. The audience included some of the agency’s other division heads and some of its top PhD economists.

What do we really know about the cumulative effect of all these changes on the stability of our capital markets?” When the SEC published its concept release in January 2010, it specifically raised Kaufman’s questions. The concept release also reflected agency concern about the allegations that Arnuk and Saluzzi made. This relatively quick response was unusual for the SEC and tribute to Schapiro’s decision some months earlier to create a new Division of Risk, Strategy, and Financial Innovation. She had populated it with economists and MBAs with real Wall Street experience and academics like Henry Hu of the University of Texas whose studies had focused on market risk. This was the first new division within the SEC since the Great Depression, and it was meant to inject the agency with some vigor. So Kaufman had made a difference. The SEC was going to shine a light on HFT. Yet Kaufman remained dissatisfied.

Schapiro had seen her salary rise from $2.1 million annually to $3 million during her tenure, and she received a severance package valued at $7.8 million upon leaving, giving some people the impression that the task of lining her own pockets had distracted her from the task of regulating her charges. Adeptly dealing with the Flash Crash was an opportunity for her to make up for past sins, both real and perceived. In fact, she had taken one exceptionally imaginative step upon arriving at the SEC to make sure a Madoff-style scandal never again blindsided her: She had created a new division, the first since the agency’s founding in 1934. The Division of Risk, Strategy and Financial Innovation was staffed with risk specialists, economists, and even some physicists to anticipate threats to the markets posed by new and existing investment activities and products. Schapiro recruited University of Texas professor Henry Hu to head the division. A renaissance man with degrees in science and law, Hu in 1993 had written a forward-looking piece for the Yale Law Review predicting that big financial institutions would make significant mistakes employing relatively new products called derivatives.


pages: 543 words: 147,357

Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Andrei Shleifer, asset-backed security, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, corporate governance, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, diversification, double helix, Edward Glaeser, financial deregulation, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, George Akerlof, Gini coefficient, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, Long Term Capital Management, Louis Pasteur, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, means of production, Mikhail Gorbachev, millennium bug, moral hazard, mortgage debt, new economy, Northern Rock, offshore financial centre, open economy, Plutocrats, plutocrats, price discrimination, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, Rory Sutherland, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, unpaid internship, value at risk, Washington Consensus, working poor, éminence grise

Today, it is even more so. In their defence, bankers and financiers usually point to ‘financial innovation’ as an attribute that society should desire and value, but their arguments are hamstrung by their own astonishing inability to distinguish between innovation that is economically and socially useful and that which is not. For example, James Kwak argues it was this blindness that lay behind the crisis in so-called ‘sub-prime’ mortgages – financing offered to ‘sub-prime’ borrowers. The bankers boasted that they were promoting home-ownership, but they were not. They were actually promoting home-buyership, which the buyers, with low or sometimes zero incomes, could not sustain – a socially toxic financial innovation. Other innovations that allegedly better managed risk or liquidity turned out to be illusory, as I discuss in Chapters 6 and 7.

Then there is the three-masted sailing ship, which allowed large vessels to sail close to the wind, permitted the Portuguese and then their European imitators to sail around the world. Without this GPT, there would have been no circumnavigation of the globe; no discovery of the Americas, leading to new centres of power and productive capacity; no European colonisation; no long-distance sea trade; no rich European merchant class; no consequent financial innovations, such as joint stock companies and marine insurance, to deal with the risk and uncertainty of long voyages; and less possibility of the principles of magnetism being understood. Similarly, in the nineteenth century, the railway was much more than just a transport technology. It transformed companies, creating both mass consumption and mass production. It turned local, fragmented markets into powerful, national markets, and thereby enabled the United States to achieve previously unimaginable scale economies – with seismic ramifications for global industrial leadership.

In this respect, the 1992 defeat overshadowed the next decade and a half in much the same way as 1945’s and 1979’s victories had. This meant that New Labour in office did not have the ideological conviction or the political will to check the increasingly reckless expansion of British finance and the City of London. Indeed, by 2007, City Minister Ed Balls and Chancellor Gordon Brown had become articulate advocates of ‘light-touch regulation’ and ‘financial innovation’, regarding finance as a sector in which Britain had an apparent comparative advantage that the state should actively promote. After 1992, Labour politicians were convinced that while they might win a mandate for social investment, notably in health and education, no mandate could be won for social democratic intervention in the economy. In any case, they had stopped believing in the intellectual argument for such an intervention.

How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business process, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, discounted cash flows, disintermediation, diversification, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, full employment, George Akerlof, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, John von Neumann, linear programming, Loma Prieta earthquake, Long Term Capital Management, margin call, market friction, market microstructure, martingale, merger arbitrage, Nick Leeson, P = NP, pattern recognition, pensions crisis, performance metric, prediction markets, profit maximization, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Richard Feynman, Richard Feynman, Richard Stallman, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

I took as my dissertation topic monetary issues in Europe, where several industrial economies still remained. Years passed, and the fascination of watching the dollar and the price of oil fall began to fade. I switched to a different department at the New York Fed, this one tasked with studying financial innovation. It had its origin in a Bank for International Settlements group that also had a quaint name, the Eurodollar Standing Committee. The Committee dated back to concerns about one of the first great financial innovations of the postwar financial system, the Eurodollar market. Today the Eurodollar market would hardly evoke a yawn from most observers, but at the time the central bankers meeting in Basel took an interest, it was considered a great mystery and even a threat. The Eurodollar market had arisen as a side effect of the U.S. current account deficits that had brought down the original Bretton Woods system, it JWPR007-Lindsey 298 May 7, 2007 17:27 h ow i b e cam e a quant appeared to threaten a loss of the Federal Reserve’s ability to limit the U.S. money supply, and to top things off, the Soviet Union and later the oil exporters were among the largest depositors.

Early twentiethcentury financial market participants in Chicago and New York actively JWPR007-Lindsey May 7, 2007 18:27 Introduction 5 traded commodity and equity options during regular time periods, albeit off the exchange floors, and prices were reported in the papers. Like Fermat, what Fischer Black and Myron Scholes (and Robert Merton) added, was a way to determine the “fair” value of an option (subject to various caveats related to the reasonableness of the model’s assumptions). Once adopted, their solution replaced the prior ad hoc pricing approach. Fermat is not the only historical example of a scientist devising a financial innovation that today would label him as a quant. A particularly striking example is the role quants played in improving government finance practices as far back as the sixteenth century. A common means of financing municipal and state debt in the Renaissance was the issuance of life annuities. In return for providing a sum to the government, the provider could designate that a regular annual payment go to a designee for life.

The Eurodollar market had arisen as a side effect of the U.S. current account deficits that had brought down the original Bretton Woods system, it JWPR007-Lindsey 298 May 7, 2007 17:27 h ow i b e cam e a quant appeared to threaten a loss of the Federal Reserve’s ability to limit the U.S. money supply, and to top things off, the Soviet Union and later the oil exporters were among the largest depositors. In my new role, I searched for reasons to worry about financial innovations that, like the Eurodollar market in its time, were poorly understood, and that with some imagination could be seen as potentially harmful. In particular, I studied newfangled currency options such as average-rate, basket and barrier options. And, like the Eurodollar market, these now seem about as threatening to financial stability as a plate of pasta. This was my first encounter with modern finance.


pages: 251 words: 76,128

Borrow: The American Way of Debt by Louis Hyman

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

asset-backed security, barriers to entry, big-box store, cashless society, collateralized debt obligation, credit crunch, deindustrialization, deskilling, diversified portfolio, financial innovation, Ford paid five dollars a day, Home mortgage interest deduction, housing crisis, income inequality, market bubble, McMansion, mortgage debt, mortgage tax deduction, Network effects, new economy, Plutocrats, plutocrats, price stability, Ronald Reagan, statistical model, technology bubble, transaction costs, women in the workforce

Banks of every size had credit card programs, but it was the largest banks that had the most clients and thus the largest initial networks. Bank of America, in particular, had a long history of consumer finance across California and easily transitioned into this new form of lending. In September 1967, for instance, 58 percent of all credit card debt was in the California Federal Reserve district. New York, that long-standing bastion of financial innovation, had only 13 percent of the balances.10 Bank of America (BofA) launched BankAmericard in 1959. It was a disaster. It grew too quickly, and its explosion meant that good as well as bad credit risks received cards. There was widespread fraud. Bank of America, confident in the program’s promise, kept up despite losses and by 1961 was able to run it profitably, proving the viability of bank credit cards.11 Regional banks looked to the BofA as a model for their programs.

The percentage of households with credit cards rose from 35 percent in 1980 to 65 percent in 1991.9 These new borrowers were poorer and riskier than any before, but credit card companies had, so they believed, figured out a way to handle all the risk. They also believed they had found a nearly endless source of capital. Though the credit departments of department stores of the 1950s and ’60s had collapsed under their scarcity of capital, credit card and mortgage companies of the 1970s and ’80s faced no such obstacle because of a financial innovation that underpinned this debt expansion. Securitization had come to the credit card and, through its ability to repackage risk, facilitated this new group of high-risk borrowers. After John and Priscilla Myers moved into their split-level in 1984, they might have watched a shopping channel on their newly installed cable television. Relatively new, the shopping channels of the 1980s offered retail in the living room.

Its largest subsidiary, City National Bank & Trust, wasn’t even among the top 150 banks when it became the second bank—after Bank of America—to offer BankAmericard in 1966. Over the 1960s and ’70s, City National became one of the leading credit card processors, offering its services to other banks, credit unions, and even finance companies. By 1977, it handled 33 million transactions annually—90 percent of which were on behalf of other banks.10 Its actual banking assets remained small, but it became a hotbed of financial innovation, always at the edge of new technologies such as point-of-sale machines, ATMS, and electronic banking. For years Banc One had offered credit cards to traditional upper-middle-class borrowers. The profits of their credit cards in the early 1980s emboldened lenders like Banc One to push into new markets such as television shopping. Banc One agreed to the deal, expecting the channel’s customers to have a high but manageable default rate of 5 to 6 percent.11 Banc One even expected the default rates, at first, to be much higher, before the portfolio was “seasoned” and the good risks were sorted out from the bad.


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, laissez-faire capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund

To employ all the money they had borrowed, banks had to search out marginal customers and extend themselves into new, riskier areas. As Minsky put it, “[T]he leverage ratio of banks and the import of speculative and Ponzi financing in the economy are two sides of a coin.” Another shortcoming in the traditional view of banking that Minsky highlighted was its failure to take adequate account of financial innovation. “Like all entrepreneurs in a capitalist economy, bankers are aware that innovation assures profits,” Minsky wrote. “Thus, bankers, whether they be brokers or dealers, are merchants of debt who strive to innovate in the assets they acquire and the liabilities they market.” One quick way for a bank to expand its revenues is by extending credit to people and firms that previously it would have turned down for loans because of doubts about their ability to repay.

One quick way for a bank to expand its revenues is by extending credit to people and firms that previously it would have turned down for loans because of doubts about their ability to repay. In the era when banks ordinarily held on to the loans they issued until they matured, pursuing such a risky lending strategy generally didn’t make sense: the extra income from the new loans wasn’t enough to cover the increased probability of defaults. But, beginning in the 1970s, a series of financial innovations transformed the incentive structure that banks faced. The key development was the rise of “securitization.” In 1970, the Government National Mortgage Association (Ginnie Mae), one of three government-sponsored agencies that guarantee certain types of home loans—the other two are the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)—issued a new type of bond known as a residential mortgage-backed security (RMBS).

Thus conceived, the so-called shadow banking system would grow to elephantine proportions while remaining largely beyond the purview of regulators, bank stockholders, and journalists. Minsky didn’t realize the full implications of securitization—nobody did—but he was one of the few economists to draw attention to it. After his death in 1996, some of his colleagues in the small but dedicated post-Keynesian school pursued his interest in financial innovation. In his 2002 book, Financial Markets, Money and the Real World, Paul Davidson, of the University of Tennessee, pointed out that almost half the loans that U.S. banks initiated in 2001 had subsequently been transferred to nonbank entities, mostly through securitization. “The downside aspect of this shift in the source of bank profits from interest earnings to originating and servicing fees is that bank loan officers do not worry as much about the creditworthiness of borrowers as long as there is a strong market for these loans,” Davidson wrote.

Investment: A History by Norton Reamer, Jesse Downing

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, moral hazard, mortgage debt, Network effects, new economy, Nick Leeson, Own Your Own Home, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

Surely, it did not help—the Crash drove negative wealth effects in some consumers as they saw an erosion of value of their assets, and that surely did not inspire confidence. Nonetheless, the Crash was not the cause of the Depression. Today, however, the situation is rather different. Virtually all parts of the real economy are dependent to some degree upon the financial markets, and most important, the conditions of creditworthiness. Progress in Managing Cyclical Crises 223 There is a little irony to the effects of financial innovation. Financial innovation, of which securitization is a part, serves to socialize risk. It spreads risk from the balance sheets of a few to the balance sheets of many. In this regard, financial innovation on the whole has been a positive force; it has been the force behind vigorous insurance markets and higher loan volumes. However, in socializing risk, financial innovation has also done something else: it has created a common source of risk for many more economic agents than would otherwise be involved.

The question on the minds of many when it first arose was simple: who has exposure to this? Of course, because of financial innovation, the answer was that many more people had exposure to the risk who were otherwise far removed from the original lending apparatus: banks, foreign governments, municipalities, pensions, individuals, and other institutions. They all had to endure the financial shock at once because of this common source of risk. Financial innovation, for all the good it normally does, had now created a situation not unlike the outbreak of a deadly virus: at first, nobody was quite sure who may have contracted the virus, so agents tried to avoid contact with one another by ceasing to further interlink their balance sheets through the credit market. The lesson behind financial innovation is clear: there are many benefits of socializing risk, but if we are not exceedingly careful to understand the potential nature and magnitude of that risk, we may impair an array of institutions at once.

Hong, Financial history of China. Ibid. Liu, “First look at usury capital.” Hong, Financial history of China. Quigen Liu, “䆎Ё೑সҷଚϮǃ催߽䌋䌘ᴀ㒘㒛Ёⱘÿড়䌘ÿϢÿড়ӭ’” [Joint-stock partnerships in business and usury capital organization in ancient China], Hebei Academic Journal (Hebei University), no. 5 (1994): 86–91. Valerie Hansen and Ana Mata-Fink, “Records from a Seventh-Century Pawnshop in China,” in The Origins of Value: The Financial Innovations That Created Modern Capital Markets, eds. William N. Goetzmann and K. Geert Rouwenhorst (Oxford: Oxford University Press, 2005), 54–58; Homer and Sylla, History of Interest Rates, 614. Hansen and Mata-Fink, “Records from a Pawnshop,” 58–59. Michael T. Skully, “The Development of the Pawnshop Industry in East Asia,” in Financial Landscapes Reconstructed: The Fine Art of Mapping Development, eds.


pages: 394 words: 85,734

The Global Minotaur by Yanis Varoufakis, Paul Mason

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

banking crisis, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, business climate, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, declining real wages, deindustrialization, eurozone crisis, financial innovation, first-past-the-post, full employment, Hyman Minsky, industrial robot, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market fundamentalism, Mexican peso crisis / tequila crisis, mortgage debt, new economy, Northern Rock, paper trading, planetary scale, post-oil, price stability, quantitative easing, reserve currency, rising living standards, Ronald Reagan, special economic zone, Steve Jobs, structural adjustment programs, systematic trading, too big to fail, trickle-down economics, urban renewal, War on Poverty, Yom Kippur War

After the Crash of 2008, Wall Street’s bosses went into damage-control mode, desperately trying to stem the popular demand for stringent regulation of their institutions. Their argument, predictably, was that too much regulation would stifle ‘financial innovation’, with dire consequences for economic growth (a little like the mafia warning against law enforcement because of its deflationary consequences). In a plush New York conference setting, on a cold December night in 2009, all the big Wall Street institutional players were assembled to hear Paul Volcker address them. Attendance was high because President Obama had entrusted him with the planning of the new regulatory framework for the banks. Volcker lost no time in lashing out with the words: ‘I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth; one shred of evidence.’ One hapless banker retorted that the financial sector in the United States had increased its share of value-added from 2 per cent to 6.5 per cent.

One hapless banker retorted that the financial sector in the United States had increased its share of value-added from 2 per cent to 6.5 per cent. Volcker responded with a killer question: ‘Is that a reflection of your financial innovation, or just a reflection of what you’re paid?’ To finish off the banker, he added: ‘The only financial innovation I recall in my long career was the invention of the ATM.’ The combination of options to buy, hedging and leveraging is such risky business that, had it been a pharmaceutical, never in a million years would it have secured approval from the US Food and Drug Administration. This is now well understood. Much less well understood is the fact that, without the Global Minotaur guaranteeing a steady torrent of capital into the United States (often via London), these practices would never have taken off as a systemic practice – not even in Wall Street.

The British Academy’s answer grudgingly confessed to the combined sins of smug rhetoric and linear extrapolation. Together, these sins fed into the self-congratulatory conviction that a paradigm shift had occurred, enabling the world of finance to create unlimited, benign, riskless debt. The first sin, which took the form of a mathematized rhetoric, lulled authorities and academics into a false belief that financial innovation had engineered risk out of the system; that the new instruments allowed a new form of debt with the properties of quicksilver. Once loans were originated, they were then sliced up into tiny pieces, blended together in packages that contained different degrees of risk,3 and sold all over the globe. By thus spreading financial risk, so the rhetoric went, no single agent faced any significant danger that they would be hurt if some debtors went bust.


pages: 338 words: 106,936

The Physics of Wall Street: A Brief History of Predicting the Unpredictable by James Owen Weatherall

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Asian financial crisis, bank run, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, butterfly effect, capital asset pricing model, Carmen Reinhart, Claude Shannon: information theory, collateralized debt obligation, collective bargaining, dark matter, Edward Lorenz: Chaos theory, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial innovation, George Akerlof, Gerolamo Cardano, Henri Poincaré, invisible hand, Isaac Newton, iterative process, John Nash: game theory, Kenneth Rogoff, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, martingale, new economy, Paul Lévy, prediction markets, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical arbitrage, statistical model, stochastic process, The Chicago School, The Myth of the Rational Market, tulip mania, V2 rocket, volatility smile

Still, it’s not as though market crashes or speculative bubbles are a new phenomenon — after all, the largest market collapse in modern times occurred in 1929, long before derivatives became important. What’s more, for the past forty years, essentially the period over which financial innovation has been most important, the financial services sector has buoyed Western economies. In the United States, for instance, the financial services industry has grown six times faster than the economy as a whole. This rapid growth has occurred at the same time that other industries, such as manufacturing, have either declined or grown much more slowly. Financial innovation, like other technological innovation, has thus played a major role in buoying the U.S. and other Western economies over the past three decades. Moreover, there is broad agreement among economists that a large, well-developed financial sector generally spurs growth in other areas of the economy — at least to a point.

The final part of the book will show how models have continued to evolve outside of mainstream finance, as physicists have imported newer and more sophisticated ideas to finance and economics, identifying the problems with our current models and figuring out how to improve them. Black was instrumental in producing a new status quo on Wall Street, but his ideas were just the beginning of the era of financial innovation. 6 The Prediction Company WHEN THE SANTA FE TRAIL was first pioneered in 1822, it stretched from the westernmost edge of the United States — Independence, Missouri — through Comanche territory and into the then-Mexican state of Nuevo Mexico. From there it passed over the high plains of what is now eastern Colorado and then took the Glorieta Pass through the Sangre de Cristo Mountains, the southernmost subrange of the Rockies.

But the process that I have described in this book is the best way we have ever come up with for addressing our biggest challenges. We shouldn’t abandon it here. There’s a third criticism of financial modeling that one sometimes hears. This one is a little deeper. It has been made most influentially by Warren Buffett, who has famously warned of “geeks bearing formulas.” This view has it that financial innovation is a dangerous thing because it makes financial markets inherently riskier. The excesses of the 2000s that led to the recent crash were enabled by physicists and mathematicians who didn’t understand the real-world consequences of what they were doing, and by profit-hungry banks that let these quants run wild. There is much that is right in this criticism. The idea that derivatives, including options, are a manufactured “financial product” has proved extremely powerful — and profitable.

When the Money Runs Out: The End of Western Affluence by Stephen D. King

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, Asian financial crisis, asset-backed security, banking crisis, Basel III, Berlin Wall, Bernie Madoff, British Empire, capital controls, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, congestion charging, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cross-subsidies, debt deflation, Deng Xiaoping, Diane Coyle, endowment effect, eurozone crisis, Fall of the Berlin Wall, financial innovation, financial repression, floating exchange rates, full employment, George Akerlof, German hyperinflation, Hyman Minsky, income inequality, income per capita, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, London Interbank Offered Rate, loss aversion, market clearing, moral hazard, mortgage debt, new economy, New Urbanism, Nick Leeson, Northern Rock, Occupy movement, oil shale / tar sands, oil shock, price mechanism, price stability, quantitative easing, railway mania, rent-seeking, reserve currency, rising living standards, South Sea Bubble, sovereign wealth fund, technology bubble, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Tobin tax, too big to fail, trade route, trickle-down economics, Washington Consensus, women in the workforce, working-age population

With world trade and international financial relationships nurtured by newly created international institutions, the protectionism and isolationism of the interwar years became but a distant memory: economic activity in the industrialized world thus began to flourish thanks to the unleashing of huge trade multipliers, with exports from Japan to the US, for example, rising at an annual rate of approaching 20 per cent throughout the 1950s and 1960s. Financial innovations that had first appeared in the 1920s – most obviously, the arrival of consumer credit – began to spread far and wide, allowing consumers to spend today and pay 11 4099.indd 11 29/03/13 2:23 PM When the Money Runs Out tomorrow. US household debt rose from less than 40 per cent of household income at the beginning of the 1950s to almost 140 per cent of household income before the onset of the financial crisis.

This difficulty must fall somewhere and must necessarily be severely felt by a large portion of mankind.2 As it turned out, Malthus wrote his Essay at just the wrong time. The nineteenth century witnessed the arrival of the Industrial Revolution, an extraordinary leap forward in economic and financial affairs. New steam-­related technologies emerged to deliver enormous productivity gains. Financial innovations – the growth of the joint-­stock company, the development of banks and other financial institutions – allowed savings to be channelled more effectively into the new investment opportunities. Back-­breaking work slowly disappeared, the children of labourers – on the land and in the factories – became the aspirational middle classes and per capita incomes went through the roof: between 1820 and 1900, the incomes of British citizens rose 167 per cent.

Underneath all this, however, was a key assumption, namely that the ultimate ‘real’ assets underpinning all of this paper wealth – in the main, US housing – were actually worth something. Specifically, the belief was that US housing would never fall in value: after all, it had never done so since the Second World War, so there was, apparently, little reason to think that a sudden decline was imminent. Yet, as a consequence of financial innovation, combined with political momentum in favour of a wider property-­owning democracy, the nature of the US housing market was changing: borrowers were becoming increasingly ‘subprime’ and, thus, were slowly but surely becoming a bigger credit risk. Yet, with the system slicing and dicing credit risk into so many tiny parts, it was difficult for any one observer to spot the risk to the system as a whole.


pages: 226 words: 59,080

Economics Rules: The Rights and Wrongs of the Dismal Science by Dani Rodrik

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

airline deregulation, Albert Einstein, bank run, barriers to entry, Bretton Woods, butterfly effect, capital controls, Carmen Reinhart, central bank independence, collective bargaining, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Edward Glaeser, Eugene Fama: efficient market hypothesis, Fellow of the Royal Society, financial deregulation, financial innovation, floating exchange rates, fudge factor, full employment, George Akerlof, Gini coefficient, Growth in a Time of Debt, income inequality, inflation targeting, informal economy, invisible hand, Jean Tirole, Joseph Schumpeter, Kenneth Rogoff, labor-force participation, liquidity trap, loss aversion, low skilled workers, market design, market fundamentalism, minimum wage unemployment, oil shock, open economy, price stability, prisoner's dilemma, profit maximization, quantitative easing, randomized controlled trial, rent control, rent-seeking, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, school vouchers, South Sea Bubble, spectrum auction, The Market for Lemons, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, trade liberalization, trade route, ultimatum game, University of East Anglia, unorthodox policies, Washington Consensus, white flight

With a few, but notable, exceptions, such as the future Nobel Prize winner Robert Shiller and the future governor of India’s Central Bank and Chicago economist Raghu Rajan, economists overlooked the extent of problems in housing and finance. Shiller had long argued that asset prices were excessively volatile and had focused on a bubble in housing prices.5 Rajan had fretted about the downside of what was then praised as “financial innovation” and warned as early as 2005 that bankers were taking excessive risks, earning a rebuke from Larry Summers, then president of Harvard, as a “Luddite.”6 That economists were mostly blind-sided by the crisis is undeniable. Many interpreted this as evidence of a fundamental breakdown in economics. The discipline needed to be rethought and reconfigured. But what makes this episode particularly curious is that there were, in fact, plenty of models to help explain what had been going on under the economy’s hood.

Excessive reliance on EMH, to the neglect of models of bubbles and other financial-market pathologies, betrayed a broader set of predilections. There was great faith in what financial markets could achieve. Markets became, in effect, the engine of social progress. They would not only mediate efficiently between savers and investors; they would also distribute risk to those most able to bear it and provide access to credit for previously excluded households, such as those with limited means or no credit history. Through financial innovation, portfolio holders could eke out the maximum return while taking on the least amount of risk. Moreover, markets came to be viewed not only as inherently efficient and stable, but also as self-disciplining. If big banks and speculators engaged in shenanigans, markets would discover and punish them. Investors who made bad decisions and took inappropriate risks would be driven out; those who behaved responsibly would profit from their prudence.

Such thinking by economists had legitimized and enabled a great wave of financial deregulation that set the stage for the crisis. And it didn’t hurt that these views were shared by some of the top economists in government, such as Larry Summers and Alan Greenspan. In sum, economists (and those who listened to them) became overconfident in their preferred models of the moment: markets are efficient, financial innovation improves the risk-return trade-off, self-regulation works best, and government intervention is ineffective and harmful. They forgot about the other models. There was too much Fama, too little Shiller. The economics of the profession may have been fine, but evidently there was trouble with its psychology and sociology. Errors of Commission: The Washington Consensus In 1989, John Williamson convened a conference in Washington, DC, for major economic policy makers from Latin America.


pages: 422 words: 113,830

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism by Kevin Phillips

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

algorithmic trading, asset-backed security, bank run, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, collateralized debt obligation, computer age, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, diversification, Doha Development Round, energy security, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, George Gilder, housing crisis, Hyman Minsky, imperial preference, income inequality, index arbitrage, index fund, interest rate derivative, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, large denomination, Long Term Capital Management, market bubble, Martin Wolf, Menlo Park, mobile money, Monroe Doctrine, moral hazard, mortgage debt, new economy, oil shale / tar sands, oil shock, peak oil, Plutocrats, plutocrats, Ponzi scheme, profit maximization, Renaissance Technologies, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, sovereign wealth fund, The Chicago School, Thomas Malthus, too big to fail, trade route

Mohamed El-Erian, president of the Harvard Management Company, observed in 2007 that “Over the past two years, markets have developed powerful liquidity factories . . . as more investors have embraced debt in an attempt to increase the impact of their investments.” He cited hedge funds and private equity firms. Bond manager Bill Gross reminded clients that much as circa 1950 economics texts had described how money deposited at a local bank could be multiplied five- or sixfold by the operations of the banking system, latter-day financial innovators had done an “end run” around the banks: “Derivatives and structures with three- and four-letter abbreviations—CDOs, CLOs, ABCP, CPDOs, SIVs (the world awaits investment banking’s next creation: IOU?)—can now take a ‘depositor’s’ dollar and multiply it ten or twenty times” (see pages 108-111). It makes sense, although none of the materials I have read precisely explain the new mechanics.

Most of it still stands, and now we can look further ahead. Doing so is just as important in 2009 as it was in 1933. ONE Introduction The Panic of August We are living through the first crisis of our brave new world of securitised financial markets. It is too early to tell how economically important this upheaval will prove. But nobody can doubt its significance for the financial system. Its origins lie with credit expansion and financial innovation in the U.S. itself. It cannot be blamed on “crony capitalism” in peripheral economies, but rather on irresponsibility in the core of the world economy. —Martin Wolf, Financial Times, September 2007 The “crack cocaine” of our generation appears to be debt. We just can’t seem to get enough of it. And, every time it looks like the U.S. consumer may be approaching his maximum tolerance level, somebody figures out how to lever on even more debt using some new and more complex financing.

Not unless, as the old adage says, God once again took particular care of fools, drunks, and the United States of America. It is the thesis of this book that far-reaching economic and political events and consequences began to unfold in midsummer’s melee—developments that at least in part followed the direction that many specialists had foreseen—regarding U.S. housing prices, credit-bubble risk, the instability of so many financial innovations never crisis-tested, the ever-more-apparent inadequacy of global oil production, the related vulnerability of the dollar, and, behind it all, the false assurance of American “imperial” hubris. The administration of George W. Bush, rarely known for strategic grasp, miscued again in the early days of the crisis. Statements by the president, the secretary of the treasury, and the chairman of the Federal Reserve Board that the low-quality-mortgage meltdown would be short-lived and safely contained were disproved almost overnight.


pages: 593 words: 189,857

Stress Test: Reflections on Financial Crises by Timothy F. Geithner

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, asset-backed security, Atul Gawande, bank run, banking crisis, Basel III, Bernie Madoff, Bernie Sanders, Buckminster Fuller, Carmen Reinhart, central bank independence, collateralized debt obligation, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, David Brooks, Doomsday Book, eurozone crisis, financial innovation, Flash crash, Goldman Sachs: Vampire Squid, housing crisis, Hyman Minsky, illegal immigration, implied volatility, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Nate Silver, Northern Rock, obamacare, paradox of thrift, pets.com, price stability, profit maximization, pushing on a string, quantitative easing, race to the bottom, RAND corporation, regulatory arbitrage, reserve currency, Saturday Night Live, savings glut, short selling, sovereign wealth fund, The Great Moderation, The Signal and the Noise by Nate Silver, Tobin tax, too big to fail, working poor

In fact, economists were starting to debate whether America’s long stretch of stability constituted a new normal, a Great Moderation, a quasi-permanent era of resilience to shocks. There was growing confidence that derivatives and other financial innovations designed to hedge and distribute risk—along with better monetary policy to respond to downturns and better technology to smooth out inventory cycles—had made devastating crises a thing of the past. I did not share that confidence. I had no particular knowledge or insight into whether the new financial innovations were stabilizing or destabilizing, but I was reflexively skeptical of excess conviction in any form, especially excess optimism. My dominant professional experiences had involved financial failures. I had seen during the emerging-market crises of the previous decade how long periods of stability and growth could breed instability and disaster.

I spent more time with smart executives such as Deryck Maughan, a Salomon Brothers banker I knew in Japan who later became CEO, and smart investors such as Stan Druckenmiller, a hedge fund billionaire I sometimes consulted about markets, than I spent with the sordid elements of the financial industry. And working for Secretary Rubin surely affected my view of Wall Street competence, because he was as competent as anyone I knew. I did come of age professionally at a time when financial innovation and the freer flow of capital across borders were widely seen as good things. As a young international negotiator, I pushed for open markets for the U.S. financial industry, even though I sometimes had misgivings that we were pushing too hard. I greatly admired Rubin, Summers, and Greenspan, and I shared their general approval of markets and financial innovation. But the common broad-brush caricature of that trio as unswerving free-market ideologues is unfair. For example, during the Clinton years, they all pushed for stricter regulation of the mortgage giants Fannie Mae and Freddie Mac, the “government-sponsored enterprises” (GSEs) that were exploiting their implicit federal backstop to load up on low-priced leverage.

I had seen during the emerging-market crises of the previous decade how long periods of stability and growth could breed instability and disaster. Confidence had always been an evanescent thing, and in this new age of mobile capital, trauma in one part of the world or one corner of the financial system could spread quickly. I didn’t see how a few years of calm or some clever financial innovations would cure the basic human tendency toward mania and self-delusion. History suggests that financial crises are usually preceded by proclamations that crises are a thing of the past. In my very first public speech at the New York Fed in March 2004, I tried to push back against complacency, telling a room full of bankers that the wonders of the new financial world would not necessarily prevent catastrophic failures of major institutions, and should not inspire delusions of safety on Wall Street.


pages: 358 words: 106,729

Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, barriers to entry, Bernie Madoff, Bretton Woods, business climate, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, diversification, Edward Glaeser, financial innovation, floating exchange rates, full employment, global supply chain, Goldman Sachs: Vampire Squid, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, market bubble, Martin Wolf, medical malpractice, microcredit, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, price stability, profit motive, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, school vouchers, short selling, sovereign wealth fund, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

We should not worry so much about rugged individualism as about undifferentiated groupthink, for that is the primary source of systemic problems. A competitive system is also likely to produce the financial innovation necessary to broaden access and spread risk. Financial innovation nowadays seems to be synonymous with credit-default swaps and collateralized debt obligations, derivative securities that few outside Wall Street now think should have been invented. But innovation also gave us the money-market account, the credit card, interest-rate swaps, indexed funds, and exchange-traded funds, all of which have proved very useful. So, as with many things, financial innovations span the range from the good to the positively dangerous. Some have proposed a total ban on offering a financial product unless it has been vetted, much as the Food and Drug Administration vets new drugs.

Some progressive economists dispute whether the recent crisis was at all related to government intervention in low-income housing credit.49 This certainly was not the only factor at play, and to argue that it was is misleading. But it is equally misleading to say it played no part. The private financial sector did not suddenly take up low-income housing loans in the early 2000s out of the goodness of its heart, or because financial innovation permitted it to do so—after all, securitization has been around for a long time. To ignore the role played by politicians, the government, and the quasi-government agencies is to ignore the elephant in the room. I have argued that an important political response to inequality was populist credit expansion, which allowed people the consumption possibilities that their stagnant incomes otherwise could not support.

Rich professional organizations have little incentive to give up their rents, so public pressure may be required for them to reexamine their certification requirements. Another factor restricting mobility, certainly in the current downturn, is home ownership. Anecdotal evidence suggests that hard-to-sell homes, and homes that are worth less than the debt that is owed, are weighing down workers and preventing them from looking elsewhere for employment. A number of financial innovations that would allow households to purchase insurance against home-price declines have been proposed, and in light of the recent crisis, demand for these instruments may increase.33 This is also a reason why the government’s focus on encouraging home ownership needs to be revisited. Although the modern economy needs some workers to specialize, workers like Badri, encountered in chapter 4, may tend to grow overly specialized in one industry.


pages: 223 words: 10,010

The Cost of Inequality: Why Economic Equality Is Essential for Recovery by Stewart Lansley

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

banking crisis, Basel III, Big bang: deregulation of the City of London, Bonfire of the Vanities, borderless world, Branko Milanovic, Bretton Woods, British Empire, business process, call centre, capital controls, collective bargaining, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, deindustrialization, Edward Glaeser, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, Goldman Sachs: Vampire Squid, high net worth, hiring and firing, Hyman Minsky, income inequality, James Dyson, Jeff Bezos, job automation, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, laissez-faire capitalism, Long Term Capital Management, low skilled workers, manufacturing employment, market bubble, Martin Wolf, mittelstand, mobile money, Mont Pelerin Society, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, Plutocrats, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, Tyler Cowen: Great Stagnation, Washington Consensus, Winter of Discontent, working-age population

Despite a series of economic, business and financial crises in the immediate postmillennium years—from the bursting of the dot-com bubble to the collapse of the energy-trading giant, Enron—the belief in markets proved remarkably resilient. Across the globe, regulators, politicians and financiers had come round to the view that, after a shaky decade and a half, the market model had finally triumphed. According to Kenneth Rogoff, chief economist at the IMF from 2001 to 2003, ‘the policy community has developed a smug belief that enhanced macroeconomic stability at the national level combined with continuing financial innovation at the international level have obviated any need to tinker with the (international financial) system’.206 The prophets of market ideology made grand claims for their beliefs. The medicine of the markets had at last overturned the failings of post-war welfare capitalism. The rise of finance to a more central place in the economy had lowered financial risk. The de-regulation of financial and labour markets had brought greater economic stability and dynamism.

They became the base for the record levels of liquidity that led to a larger and larger banking sector, while injecting much higher, and ultimately unsustainable, levels of risk into the global financial system. As David Moss described it, ‘The rise of these massive [American banking] institutions represented a profound change in our financial system and a powerful new source of systemic risk.’251 Far from improving the efficiency with which resources were allocated, as banking executives liked to claim, ballooning levels of liquidity, fed by more and more complex forms of financial innovation, merely fuelled a series of unsustainable financial and asset bubbles. While it was the role of government to put a cap on risk, a fourth mechanism then came into play. In more equal societies, the financial sector is more circumscribed and much less able to capture regulators and politicians. As wealth became more concentrated, so did the distribution of power. From the early 1990s, the finance industry and its lobbyists were able to exercise an increasingly disproportionate degree of influence at the highest levels to ensure weak financial regulation by the state, lower taxes on the wealthy and inaction on tax havens.

But gradually other interest groups with legitimate claims for a share of the influence, from trades unions and town halls to manufacturers and small businesses, became at best marginalised, at worst, ignored. The only voices that came to count, it seemed, were those coming from corporate boardrooms and City offices. The Treasury itself became little more than an outpost of the City. A torrent of City lobbying secured Treasury support for the idea that financial innovation was good for the economy, that the City was a key generator of social value and should be the central engine of economic growth. As Manchester University academics have described it, ‘The new Treasury doctrine is the impossibility of upsetting the City.’260 The forces that drove economic instability were not external shocks that could not have been foreseen, but ones implicit to the great shifts in policy direction instituted from the late 1970s.


pages: 249 words: 66,383

House of Debt: How They (And You) Caused the Great Recession, and How We Can Prevent It From Happening Again by Atif Mian, Amir Sufi

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Andrei Shleifer, asset-backed security, balance sheet recession, bank run, banking crisis, Ben Bernanke: helicopter money, Carmen Reinhart, collapse of Lehman Brothers, debt deflation, Edward Glaeser, en.wikipedia.org, financial innovation, full employment, high net worth, Home mortgage interest deduction, housing crisis, Joseph Schumpeter, Kenneth Rogoff, liquidity trap, Long Term Capital Management, market bubble, Martin Wolf, moral hazard, mortgage debt, paradox of thrift, quantitative easing, Robert Shiller, Robert Shiller, school choice, shareholder value, the payments system, the scientific method, tulip mania, young professional

If the investors are convinced that their loan will be repaid even if the business manager steals some money from the cash drawer, then the investors are willing to ignore the stealing. In contrast, if the investors are equity investors, meaning that they share the profits of the business, they will have a strong incentive to detect theft. Debt convinces investors that they don’t have to worry about fraud because their senior claim on the asset protects them. In a world of neglected risks, financial innovation should be viewed with some degree of skepticism. If investors systematically ignore certain outcomes, financial innovation may just be secret code for bankers trying to fool investors into buying securities that look safe but are actually extremely vulnerable. * * * In a cruel twist of irony, Kindleberger passed away in 2003 at the age of ninety-two, just as the mortgage-credit boom was starting. He did an interview with the Wall Street Journal the year before he died.

In our research, we directly linked these two patterns by showing that the rate of securitization was much stronger in low credit-quality zip codes compared to high credit-quality zip codes. Securitization transformed global capital inflows into a wild expansion of mortgage credit to marginal borrowers. But it was only possible if the lenders were sure their funds were protected. Manufacturing Safe Debt A cynical view of financial innovation sees it merely as bankers fooling investors into buying very risky securities that are passed off as safe. There is substantial research demonstrating that this is exactly what private-label securitization was during the housing boom. Josh Coval, Jakub Jurek, and Erik Stafford show that when investors buying mortgage-backed securities made small mistakes in assessing their vulnerability, securitization enabled banks to amplify the effect of these mistakes.

Daron Acemoglu, Kenneth Rogoff, and Michael Woodford (Chicago: University of Chicago Press, 2010), 1–65. 9. This can be confirmed by noting that 100 × $125,000 = $12.5 million. 10. See, for example, Edward Glaeser, Joshua Gottlieb, and Joseph Gyourko, “Can Cheap Credit Explain the Housing Boom?” (working paper no. 16230, NBER, July 2010). 11. Nicola Gennaioli, Andrei Shleifer, and Robert Vishny, “Neglected Risks, Financial Innovation, and Financial Fragility,” Journal of Financial Economics 104 (2012): 452–68. 12. Solow, foreword to Manias, Panics and Crashes. 13. Jon Hilsenrath, “A 91-Year-Old Who Foresaw Selloff is ‘Dubious’ of Stock-Market Rally,” Wall Street Journal, July 25, 2002. Chapter Nine 1. Euronews, “Spain’s Unforgiving Eviction Law,” December 11, 2012; Suzanne Daley, “In Spain, Homes Are Taken but Debt Stays,” New York Times, October 27, 2010. 2.


pages: 304 words: 80,965

What They Do With Your Money: How the Financial System Fails Us, and How to Fix It by Stephen Davis, Jon Lukomnik, David Pitt-Watson

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Admiral Zheng, banking crisis, Basel III, Bernie Madoff, Black Swan, centralized clearinghouse, clean water, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crowdsourcing, David Brooks, Dissolution of the Soviet Union, diversification, diversified portfolio, en.wikipedia.org, financial innovation, financial intermediation, Flash crash, income inequality, index fund, invisible hand, London Whale, Long Term Capital Management, moral hazard, Northern Rock, passive investing, performance metric, Ponzi scheme, principal–agent problem, rent-seeking, Ronald Coase, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, Steve Jobs, the market place, The Wealth of Nations by Adam Smith, transaction costs, Upton Sinclair, value at risk, WikiLeaks

But mathematical economics and statistics suggested that this was a good thing. That was the view of the IMF, the global institution charged with warning of instability, whose “banner message was one of continued optimism within a prevailing benign global environment.” In evaluating why it had made such a gigantic mistake, the IMF subsequently reflected, “To a large extent this was due to the belief that, thanks to the presumed ability of financial innovations to remove risks off banks’ balance sheets, large financial institutions were in a strong position, and thereby, financial markets in advanced countries were fundamentally sound.”19 In other words, banks’ borrowing and lending had increased dramatically, but their understanding of risk was thought to reduce the threat of a breakdown. While those financial instruments worked in theory, they didn’t take into account the phenomena one finds in the real world.

“Public Funds Take Control of Assets, Dodging Wall Street,” New York Times, August 19, 2013. 62. Ibid. 63. US Department of Labor, “Fact Sheet: Final Rule to Improve Transparency of Fees and Expenses to Workers in 401(k)–Type Retirement Plans” (US Department of Labor, February 2012). 64. Ibid. 3 The Return of Ownership 1. Robert Monks and Allen Sykes, “Capitalism without Owners Will Fail: A Policymaker’s Guide to Reform” (Center for the Study of Financial Innovation, 2002). 2. Merriam-Webster.com defines capitalism as “an economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decision, and by prices, production, and the distribution of goods that are determined mainly by competition in a free market.” Other dictionaries similarly cite private ownership as central to the definition of capitalism. www.merriam-webster.com/dictionary/capitalism, accessed September 27, 2013.

Anat Admati, and Martin Hellwig, The Bankers’ New Clothes: What Is Wrong with Banking and What to Do about It (Princeton University Press, 2013). 33. John Sutherland, discussion at ICGN Annual Conference, Amsterdam, 2014. 8 Capitalism 1. One area where banks can claim to have made substantial productivity improvements is in transferring money. Indeed, Paul Volcker, former chairman of the US Federal Reserve, declared that in the past generation, “the ATM is the only financial innovation he [Volcker] can think of which has improved society.” Alan Murray, “Paul Volcker: Think More Boldly,” Wall Street Journal, December 14, 2009. 2. For example, a US federal court found that an electrical engineering company and the record keeper of its 401(k) plan had violated fiduciary duty. The result: $37 million less in savings than there should have been. John F. Wasik, “Finding, and Battling, Hidden Costs of 401(k) Plans,” New York Times, November 7, 2014. 3.


pages: 246 words: 74,341

Financial Fiasco: How America's Infatuation With Homeownership and Easy Money Created the Economic Crisis by Johan Norberg

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, bank run, banking crisis, Bernie Madoff, Black Swan, capital controls, central bank independence, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Brooks, diversification, financial deregulation, financial innovation, helicopter parent, Home mortgage interest deduction, housing crisis, Howard Zinn, Hyman Minsky, Isaac Newton, Joseph Schumpeter, Long Term Capital Management, market bubble, Martin Wolf, Mexican peso crisis / tequila crisis, millennium bug, moral hazard, mortgage tax deduction, Naomi Klein, new economy, Northern Rock, Own Your Own Home, price stability, Ronald Reagan, savings glut, short selling, Silicon Valley, South Sea Bubble, The Wealth of Nations by Adam Smith, too big to fail

How the U.S. central bank (the Fed) and the surpluses of fast-growing emerging economies made money cheaper than ever in the past decade, and why that money ended up in people's homes. Chapter 2: Housing policy. The story of how U.S. politicians-both Democrats and Republicans-worked systematically to increase the share of families who owned their homes, even when that undermined traditional requirements of creditworthiness. Chapter 3: Financial innovations. How to transform big risks into smaller risks by repackaging them, labeling them, and selling them. How regulations and bonuses caused everybody to flock into the market for mortgage-backed securities, and why even cows could have made a fortune from such securities. Chapter 4: The crisis. The story of how the fall of an investment bank gave the global economy cardiac arrest, a CEO was knocked to the floor by a subordinate, and a country went belly-up.

James Grant once wrote a book entitled The Trouble with Prosperity, and U.S. economist Hyman Minsky claimed that "stability leads to instability." Their point is that nothing is more dangerous than good times because they encourage investors to borrow more and take bigger risks. If things look good, they are going to get worse. "Investors said, `I don't want to be in equities anymore, and I'm not getting any return in my bond positions,"' explains a financier who is the author of many financial innovations: "Two things happened. They took more and more leverage, and they reached for riskier asset classes. Give me yield, give me leverage, give me return."" It's the Deficit, Stupid U.S. households were not alone in opening wide their pocketbooks and bankbooks: The U.S. government did the same. By 2002, the Bush administration had turned a $127 billion surplus into a $158 billion deficit.

., 36, 38 Fannie Mae (Federal National Mortgage Association), 25-28, 147 aggressive risk-taking, 40-43 collapse of, 36-43, 77-79 Cuomo and, 32 early repayment penalties, 34 exposure to housing market, 42-43 flexible standards and procedures, 31-32, 40, 43 fraud and abuse scandal, 37-39, 40 "junk loans," 42 monitoring of loans, 34 nationalized, 79 political contributions and other favors from, 30, 38-39 securitized mortgages, 47 special privileges for Countrywide, 30 stockholder dividends, 77 subprime project rollout, 32-34 Farley, James, 107 Federal Housing Administration (FHA), 34-36, 127-28 Federal Housing Enterprise Oversight, Office of, 36, 38 Federal Reserve Bank Greenspan on, I interest rates and, 2, 3-5, 12-13, 14, 21 lending to investment banks, 79-80 as a model, 3-4 short- and long-term interest rate behaviors, 17-18 Federal Reserve Bank of Boston, flexible underwriting standards and, 31-32, 43 Federal Reserve Board, monetary policy control, 103-4 federal spending, 19-20 Ferguson, Niall, 130 FHA. See Federal Housing Administration (FHA) financial innovations for risk pooling, 7 adjustable-rate mortgages, 7, 71 liberalization of financial markets and, 131 nonrecourse mortgages, 9 See also mortgage-backed securities; risk-taking, excessive financial markets, 129-31 confidence and cooperation, 131-38 false sense of security and, 138-45 regulation and supervision responsibilities, 145 fines for discrimination in lending, 31 First Boston, 47 First Union, oversubscribed securitized mortgages, 27 Fitch, 60, 61 fixed-rate mortgages, 7 Fixing Global Finance, 16 "flipping" real estate, 8-9 foreclosures, 24-25 Fortis, 119, 146 fraud and abuse, 144-45 Fannie Mae and Freddie Mac, 37-39, 40 Subprime XYZ package, 65-68 Freddie Mac (Federal Home Loan Mortgage Corporation), 25-28, 147 aggressive risk-taking, 40-43 collapse of, 36-43, 77-79 Cuomo and, 32 exposure to housing market, 42-43 flexible standards and procedures, 31-32, 40, 43 fraud and abuse scandal, 37-39, 40 "junk loans," 42 monitoring of loans, 34 nationalized, 79 political contributions and other favors from, 30, 38-39 securitized mortgages, 27, 47 stockholder dividends, 77 subprime project rollout, 33-34 free-market system, Bush (G.


pages: 424 words: 121,425

How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy by Mehrsa Baradaran

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

access to a mobile phone, affirmative action, asset-backed security, bank run, banking crisis, banks create money, barriers to entry, British Empire, call centre, Capital in the Twenty-First Century by Thomas Piketty, cashless society, credit crunch, David Graeber, disintermediation, diversification, failed state, fiat currency, financial innovation, financial intermediation, Goldman Sachs: Vampire Squid, housing crisis, income inequality, Internet Archive, invisible hand, Kickstarter, M-Pesa, McMansion, microcredit, mobile money, moral hazard, mortgage debt, new economy, Own Your Own Home, payday loans, peer-to-peer lending, price discrimination, profit maximization, profit motive, quantitative easing, race to the bottom, rent-seeking, Ronald Reagan, Ronald Reagan: Tear down this wall, savings glut, the built environment, the payments system, too big to fail, trade route, transaction costs, unbanked and underbanked, underbanked, union organizing, white flight, working poor

As such, Congress responded forcefully. The BHCA prohibited any commercial nonbank company from controlling a bank. The act, although anticompetitive and even inefficient, was a follow-through of Brandeis and Roosevelt’s desire to keep banks from getting too powerful. The act reinforced the long-held policy of the government stepping in to halt the natural movement of banks toward conglomeration. These hard-line rules stifled financial innovation and banking efficiency, but that was a tradeoff policymakers were willing to make to protect community banks and the public from too much bank power. Because the economy was booming, neither the government nor the banking industry agitated for a change of policy. That is, until the banking world was transformed in the 1970s. CIVIL RIGHTS AND THE SOCIAL CONTRACT FOR EQUALITY The social contract initiated during the Great Depression, whereby the federal government enlisted banks to further policy goals, was amended during the civil rights era to achieve the state’s goals of racial equality.

THE BANKING TRANSFORMATION AND DEREGULATION Beginning in the late 1970s and 1980s, the banking sector started facing an identity crisis. After years of operating a safe and boring model dictated by the regulations imposed during the New Deal, the model began to fall apart. Unit banking and the restrictions and prohibitions of the fifty years following the Great Depression had allowed banks to profit modestly by keeping their balance sheets focused on deposits and loans. But suddenly, technological advances, financial innovation, capital markets, and commercial paper markets started to offer safe and enticing alternatives to banks. Banks started hemorrhaging customers, a process called disintermediation, which means cutting out the middleman. Deposits went directly to high-yield markets and sidestepped highly regulated banks.99 Concerns about banks’ waning profitability led to growing pressure on the government to deregulate banks and allow them to compete more freely with other institutions.

Paul Tucker, “Regimes for Handling Bank Failures—Redrawing the Banking Social Contract,” remarks, British Bankers’ Association Annual International Banking Conference “Restoring Confidence—Moving Forward,” London, June 30, 2009, accessed January 18, 2015, www.bis.org/review/r090708d.pdf. 21. Gary Gorton, “Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007,” conference, Federal Reserve Bank of Atlanta’s 2009 Financial Markets Conference: Financial Innovation and Crisis, May 9, 2009, accessed March 13, 2015, www.frbatlanta.org/news/conferences/09-financial_markets_agenda.cfm. 22. See “Adding Up the Government’s Total Bailout Tab,” New York Times, July 24, 2011, accessed March 13, 2015, www.nytimes.com/interactive/2009/02/04/business/20090205-bailout-totals-graphic.html?_r=0. As of April 30, 2011, the government had made bail-out commitments of 12.2 trillion dollars.

Debtor Nation: The History of America in Red Ink (Politics and Society in Modern America) by Louis Hyman

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

asset-backed security, bank run, barriers to entry, Bretton Woods, card file, central bank independence, computer age, corporate governance, credit crunch, declining real wages, deindustrialization, diversified portfolio, financial independence, financial innovation, Gini coefficient, Home mortgage interest deduction, housing crisis, income inequality, invisible hand, late fees, London Interbank Offered Rate, market fundamentalism, means of production, mortgage debt, mortgage tax deduction, p-value, pattern recognition, profit maximization, profit motive, risk/return, Ronald Reagan, Silicon Valley, statistical model, technology bubble, the built environment, transaction costs, union organizing, white flight, women in the workforce, working poor

For Great Society policymakers and promoters, the problems of inequality were framed as a problem of credit access rather than job access. More credit, and not higher wages, would be enough to solve the problems of America’s cities. Toward that end, federal policy fashioned the financial innovation that made possible America’s debt explosion—the asset-backed security—that expanded well beyond its original purpose. Solving the urban crisis would require solving the housing crisis. But to fix the housing crisis, radical financial innovation would have to occur to maintain the capital flows into mortgages. As the urban riots became the urban crisis, however, mortgage markets had a crisis of their own. American mortgage markets had abruptly frozen—the so-called Credit Crunch of 1966—as investors rapidly withdrew their deposits from banks and put their money in the securities markets.

As automobile production exploded in the 1920s, so too did the need for automobile financing for both consumers and dealers alike.61 The capital requirements of more expensive, mass-produced goods led retailers and entrepreneurs to explore new options in consumer finance and, in the process of meeting their own immediate needs, created a novel financial institution that was neither an informal lender nor a commercial bank—the finance company. Modern, pervasive installment credit found its institutional bedrock in the financial innovation of the early automobile industry. The financial infrastructure of installment credit grew out of the very requirements of heavy capital manufacturing for mass production, but once created, finance companies found other markets outside of the automobile industry. They turned to less capital-intensive retail sectors, which enabled the expansion of installment credit throughout the American economy.

While the expansion of debt occurred because consumers were less and less able, on average, to pay back what they borrowed, the massive investment necessary to roll over that outstanding debt required lenders to use capital markets in innovative ways. Moving beyond the resale networks of the mid-twentieth century, new ways to sell debt anonymously on national and even international capital markets inaugurated a new relationship between consumer credit and investor capital. In an insecure world, unsecured debt came of age. Mortgage-backed Securities and the Great Society The financial innovation that ultimately allowed capital markets to directly fund any form of debt began with the federal government, not business. In the late 1960s, the federal government sought a way to 224 CHAPTER SEVEN channel capital into America’s rioting cities. Capital would make possible the Great Society ambitions of saving America’s cities and the newly rising pension funds needed to invest. Ironically, pension funds borne of strong union movements helped provide the justification for policies based on remedying poverty through better access to capital, rather than better access to wages.


pages: 348 words: 99,383

The Financial Crisis and the Free Market Cure: Why Pure Capitalism Is the World Economy's Only Hope by John A. Allison

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, bank run, banking crisis, Bernie Madoff, clean water, collateralized debt obligation, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, fiat currency, financial innovation, Fractional reserve banking, full employment, high net worth, housing crisis, invisible hand, life extension, low skilled workers, market bubble, market clearing, minimum wage unemployment, moral hazard, obamacare, price mechanism, price stability, profit maximization, quantitative easing, race to the bottom, reserve currency, risk/return, Robert Shiller, Robert Shiller, The Bell Curve by Richard Herrnstein and Charles Murray, too big to fail, transaction costs, yield curve

They were also misled by the artificial economic environment created by the Federal Reserve. In addition, as discussed earlier, they had a significant economic incentive to rate the bonds as highly as possible to increase their revenues. This is where the investment banks (Goldman Sachs, Morgan Stanley, Bear Stearns, Merrill Lynch, and Lehman Brothers) magnified the misallocation of credit to the housing market. They created a series of financial “innovations” (collateralized debt obligations [CDOs], derivatives, swaps, and others, which I discuss later) that leveraged an already overleveraged product. The explanation typically given for these ultimately very bad decisions by investment bankers is greed. However, there was plenty of greed on Wall Street before the bubble. In fact, in my almost 40-year career in banking, there has always been greed on Wall Street.

See The State of the Nation’s Housing 2009, Joint Center for Housing Studies, Harvard University, http://www.jchs.harvard.edu/publications/markets/son2009/index.htm. 5. In October 2010, as an ex-CEO, Mozilo settled out of court on civil fraud charges for misleading investors on risky mortgages, but Countrywide’s buyer (Bank of America) ended up paying most of the $67 million to the SEC. Bank of America also paid $600 million to settle a class-action lawsuit filed by Countrywide’s robbed shareholders. 6. See Bert Ely, “Financial Innovation and Deposit Insurance: The 100% Cross-Guarantee Concept,” Cato Journal (Winter 1994), pp. 413–445, and Bert Ely, “Regulatory Moral Hazard: The Real Moral Hazard in Federal Deposit Insurance,” Independent Review (Fall 1999), pp. 241–254. 7. See Michael Keeley, “Deposit Insurance, Risk, and Market Power in Banking,” American Economic Review (1980), pp. 1183–1200, and Gary Gorton and Richard Rosen, “Corporate Control, Portfolio Choice and the Decline of Banking,” Journal of Finance (1995), pp. 1377–1420. 8.

Accounting: loan loss reserves, 152–154 principles-based, 109 private accounting systems, 177–178 rules-based, 109 (See also Fair-value accounting) AEI (American Enterprise Institute), 64 Affordable housing efforts, 43, 216 Afghanistan, 198 African Americans, 43, 55 AIG: bailout, 128–130, 164 CDSs of, 126–127 TARP funds for, 168 Ally Financial, 178 Alt-A portfolios, 64 Altruism, 215–218, 222–223, 252 Ambac, 86 American Enterprise Institute (AEI), 64 Antitrust laws, 174–175 Argentina, 8 Arthur Andersen, 109 Asian Americans, 43 Assets, valuation of, 106–108 Atlas Shrugged (Ayn Rand), 225 Auction-rate municipal bond market, 85–87 Authority, of regulatory agencies, 46–47 Auto finance market, 178–180 Bank bailout (see Troubled Asset Relief Program (TARP)) Bank of America, 116, 150, 237 counterparty risk at, 124 credit decisions at, 238 funding of shadow banking system, 120 “too-big-to-fail” firms, 173 Bank runs, 75–76 Banking industry, 67–72 competition with risk-taking financial institutions, 39–40 economic role of, 67–69 and Federal Reserve, 22–23 fractional reserve banking, 69–70 in Great Depression vs. recent financial crisis, 70–72 (See also Shadow banking system) Banking industry reforms, 187–193 Dodd-Frank bill, 193 and Federal Reserve, 187–188 and gold standard, 188–189 reducing risk of economic cycles with, 189–193 Banking regulation, 133–147 in Bush administration, 133–136 effects on small businesses, 144–147 impact of, 147 and lending policies of banks, 138–146 and mathematical modeling for risk management, 136–138 reform of, 190 Bankruptcy, 8, 124 Banks: capital requirements for, 190 economic forecasting by, 28 FDIC and risk-taking by, 38–41 healthy, effects of TARP on, 172–174 lending policies of, 138–146 leverage ratios of, 70–72 misinvestment effects on, 12–14 private, 97–99, 187–188 self-insurance at, 48–52 start-up, 38–39 stress tests for, 171 (See also Investment banks) Barclays Bank, 164 Basel Accords, 51, 71, 125, 137, 151 BB&T Corporation, 23–24 and AIG bailout, 128 auditors of, 134 in auto finance market, 178 bonds of, 76, 84–85 competition with risk-taking financial institutions, 39–40, 98 conservatism of, 30 culture of, 240–241 failed bank takeover by, 38–39, 47–48 financial crisis for, 1–2 and flight to quality, 87, 105 home mortgages by, 97–98 and Lehman Brothers failure, 162–163 and liquidity crisis, 105–106 loan loss reserves of, 153–154 and mathematical modeling, 136–137 and misinvestment in residential real estate, 12–14 mortgage servicing rights, 111–112 and pick-a-payment mortgages, 91–92 post-crisis lending policies, 139–140, 142–145 racial discrimination in lending accusation, 42–45 selling of mortgages by, 113 TARP participation by, 170–172 trader principle of, 223 underwriting standards of, 141 use of derivatives, 122, 123 wellness program of, 202–203 Bear Stearns, 70, 71 bailout of, 104, 162 Cdss on bonds of, 127–128 counterparty risk at, 124 derivatives from, 123 financial “innovations” of, 101 Bernanke, Ben: and 2008 panic, 164, 167 and development of TARP, 76, 169–171 monetary policy of, 27–31, 33, 35, 40, 125, 213 response to financial crisis, 7, 70 Blair, Tony, 164 Bond insurance, 86–87 bonds: auction-rate municipal bond market, 85–87 effects of FDIC for, 40–41 fair-value accounting for, 105 subprime mortgage, 82–84 of Washington Mutual, 75–76 Borrowers: CRA, 56–57 of pick-a-payment mortgages, 90–91 post-crisis treatment of, 142–145 and racial discrimination in lending, 42–45 regulated changes in grading for, 140–141 Borrowing for consumption, 57–58 Boston Federal Reserve bank, 42 Budget, federal, 182–183 Bush, George W., and administration: action in financial panic, 161, 167 banking regulations, 133–136 economic proposals, 15 Patriot Act, 45, 46 regulation of Fannie Mae and Freddie Mac, 63 California, 21, 74, 90 CalPERS (California Public Employees’ Retirement System), 93, 116, 121, 131 Canada, 192 Capital: against GSE loans, 137 and leverage, 70–71 and loan loss reserves, 153 misinvestment of, 9–11, 14 wasting of, 159–160 Capital markets, 85–87, 101 Capital standards: for banks, 190 for loans, 51–52 and TARP, 170–171 Capitalism: crony, 6, 102, 129, 179 and freedom, 253–254 at universities, 231–233 Capitalism (Alan Greenspan), 32 Carter, Jimmy, 161, 179 Cash basis accounting, 110 Cash flows, 106–107, 115 Cato Institute, 201 CDOs (collateralized debt obligations), 124–126 CDSs (credit default swaps), 126–128 CEOs (Chief Executive Officers): behavior of, 2–3 decisions of Federal Reserve vs., 34 and rules-based accounting, 109 wage rates of, 210 China: currency standard, 77 demographics, 205 education, 230 GDP of U.S. vs., 183 government debt in, 200 manufacturing in, 10, 25–26, 161 market-based pricing in, 34 military spending in, 198 stimulus fund use, 181–182 trade with, 204–205 U.S. investment by, 29, 159 Chrysler, 130, 179–180 Citigroup: bailout of, 50, 104, 130, 177 CDOs of, 125–126 credit decisions, 238 crony capitalism, 6 funding of shadow banking system, 120 long-term debt of, 71 and panic during financial crisis, 163 pragmatism at, 217–218 reason at, 245 “too-big-to-fail” firms, 173 Clearing, 104 Clinton, Bill: lending reforms, 42–44, 56 subprime lending requirements, 58–60 Collateralized debt obligations (CDOs), 124–126 Colonial Bank, 47–48 Commercial real estate, 11, 97 Common good, 215–216 Community Reinvestment Act (CRA), 42, 55–57, 59 Compensation, 50, 83–84, 197–198 Confidence, 84–87, 184–185 Conservatives, 108 Consumer compliance, 193 Consumer Price Index (CPI), 26–27 Consumption: borrowing for, 57–58 housing as, 9–12, 54–55, 73–74 Contagion risk, 123 Corporate debt, 107 Counterparty risk, 123, 124 Countrywide: crony capitalism at, 6 and fair-value accounting change, 114, 118 and FDIC insurance, 39, 41, 46 necessary failure of, 159 pick-a-payment mortgages of, 91–93 subprime business at, 99 thrift history of, 98 CPI (see Consumer Price Index) CRA (see Community Reinvestment Act) Creativity, 7, 247 Credit default swaps (CDSs), 126–128 Credit rating agencies (see Rating agencies) Crony capitalism, 6, 102, 129, 179 Cross-guarantor insurance fund, 48–52 Cuba, 34, 247, 252 Cuomo, Andrew, 58 Currency, debasing, 22 Debt, 21–22, 107 Declaration of Independence, 220, 252 Defaults, 90–91, 126–128 Defense spending, 198–199, 227 Deflation, 22 Demand, supply and, 104, 185, 209, 210 Department of Housing and Urban Development (HUD), 15, 58 Deposits, disintermediation of, 120–121 Derivatives, 3, 120, 122–124 Disclosure requirements, 150–152 Dodd, Christopher, 7, 46, 61, 63, 64 Dodd-Frank Wall Street Reform and Consumer Protection Act: deficiencies of, 193 introduction of, 63–64, 183 as misregulation, 147 results of, 130 and TARP, 173, 174 Dollar, U.S., 77, 188, 229 Durbin amendment, 193 Earnings, operating, 103–106 East Germany, 34, 247 Eastern Europe, 34, 252 Economic cycles, 108, 189–193 Economic health, 159–161 Economic recovery, 1, 207–208 Economy, banking industry in, 67–69 Edison, Thomas, 19, 158–159 Education, 230–235, 247 Egypt, ancient, 230 Elitism, 7 Ely, Bert, 48 Employee Retirement Income Security Act (ERISA), 82, 149 Enron, 60, 109, 133, 149 Entitlement programs, reforms for, 199–204 Equal Credit Opportunity Act, 42, 55 ERISA (Employee Retirement Income Security Act), 82, 149 Ethical incentives, lending, 57–58 Euro, 189 European banking crisis, 51–52, 137 Expensing (stock options), 114–117 Experiential learners, 244–245 Fair Housing Act, 55 Fair-value accounting, 103–118 asset valuation in, 106–108 and expensing of stock options, 114–117 and losses on CDSs, 126–127 private accounting systems vs., 177–178 SEC involvement in, 151–152 for selling vs. servicing mortgages, 113–114 Fannie Mae: accounting scandal, 112–113, 149 in current environment, 251 and disintermediation of deposits, 121 failure of, 61–65, 164 and fair-value accounting, 118 in housing policy, 58–61 misallocation of resources by, 14 misleading of rating agencies by, 83 mortgage lending by, 97–101 reforms for, 190–192 selling mortgages to, 113–114 subprime lending by, 58, 99–101 FASB (see Financial Accounting Standards Board) FDIC (see Federal Deposit Insurance Corporation) FDIC insurance, 37–52 and bank liquidity, 171 and failing banks, 140 and fractional reserve banking, 68–69 and pick-a-payment mortgages, 91 reform of, 190 and S&L failures, 97 Federal Deposit Insurance Corporation (FDIC), 37–38 as external auditors, 134 and failing banks, 47–48 misallocation of resources by, 14 and pick-a-payment mortgages, 91 as regulator, 41–48, 143 take over of Washington Mutual, 75–77 Federal Housing Administration (FHA), 15, 190–192, 252 Federal Reserve, 22–23, 102, 189 antitrust policy, 174 bailouts by, 120–121, 190, 192 and banking industry reforms, 187–188 as external auditors, 134 and federal debt, 21–22 and leverage, 72 mathematical modeling by, 136 misallocation of resources by, 14, 208 misleading information from, 46, 83, 101, 125 monetary policy of, 17–20, 31–35, 96 overreaction by, 154 stimulus from, 152, 153, 208 and TARP, 165, 167–168, 171 and unemployment, 213 and Washington Mutual, 75 Federal Reserve Board, 18 Federal Reserve Open Market Committee, 31 Federal Savings and Loan Insurance Corporation (FSLIC), 37–38, 50, 96 FHA (see Federal Housing Administration) Financial Accounting Standards Board (FASB), 105, 106, 114–117 Financial crisis (2007-2009), 1–3, 251–254 banking industry in, 70–72 derivatives in, 122–124 Freddie Mac and Fannie Mae in, 65 free-market response to, 177–186 and Great Depression, 25 lessons from, 251–252 SEC role in, 154–155 Financial reporting requirements, SEC, 150–152 Financial Services Roundtable (FSR), 32, 61–62 First Horizon, 237 Fitch, John Knowles, 150 Fitch Ratings: investor confidence in, 84–87 misratings by, 82–84, 101, 125, 126 and SEC, 81–82, 149–150 Flat tax, 197 Forbes, Steve, 197 Ford, 179 Foreclosure laws, 77–80 Fractional reserve banking, 69–70 Frank, Barney, 7, 61, 63, 64 Fraud, 109–113 Freddie Mac: accounting scandal, 112–113, 149 current environment, 251 and disintermediation of deposits, 121 failure of, 61–65, 164 in housing policy, 58–61 misallocation of resources by, 14 misleading information from, 83 mortgage lending by, 97–101 reforms for, 190–192 selling mortgages to, 113–114 subprime lending by, 58, 99–101 Free markets: experimentation in, 19 justice in, 92, 177 market corrections in, 157–159 and monetary policy, 31–35 risk taking by banks in, 40–41 wage rates in, 210–211 Free trade, 204–205 Friedman, Milton, 20, 189 FSLIC (see Federal Savings and Loan Insurance Corporation) FSR (Financial Services Roundtable), 32, 61–62 GAAP accounting, 116, 117 Gates, Bill, 216 GDP, 183, 197–199 General Electric, 168, 169 General Motors (GM), 169, 178–180 General Theory of Employment, Interest and Money, The (Keynes), 181 Germany, 52 GM (General Motors), 169, 178–180 GMAC, 168, 169, 178–180 Gold standard: and deflation, 25–26 and economic future of U.S., 188–189 Greenspan’s view of, 32 Golden West, 39, 91, 92, 98, 159 Goldman Sachs, 71, 173 as AIG counterparty, 128–129 bailout of, 104, 164, 179 CDSs of, 126 counterparty risk at, 124 crony capitalism at, 6 financial “innovations” of, 101 Government policy: as cause of financial crisis, 1, 5–6, 251 and residential real estate bubble, 6 (See also Housing policy; Policy reforms) Government regulation, 5–8, 41–48, 204 Government spending, 180–183, 197–199 Government-sponsored enterprises (GSEs), 59, 64–65, 98, 137 (See also Fannie Mae; Freddie Mac) Great Depression: and avoidance of stock market, 74 banking industry in, 70–72 economic policies after, 161 and Federal Reserve, 19–20, 24, 188 and gold standard, 188 and government interference, 170 and Smoot-Hawley Tariff Act, 205 Great Recession, 1, 251–254 and Federal Reserve, 188 Freddie Mac and Fannie Mae in, 65 and interest-rate variation, 33 market corrections and depth of, 160 and monetary policy, 17 and residential real estate, 9–15 Great Society, 6, 55, 96 Greece, 51, 52, 137, 228 Greenspan, Alan, 23–30, 32, 33, 160 Gross domestic product, 183, 197–199 Hamilton, Alexander, 19 Harvard University, 43, 131 Hayek, Friedrich, 31 Health insurance, 201–202 High-net-worth shareholders, 93 Home Builders Association, 60 Home foreclosure laws, 77–80 Homeownership, 53–55 Hoover, Herbert, 24, 161, 205 Housing: as consumption, 9–12, 54–55, 73–74 government support of, 12 Housing policy, 53–65 HUD (Department of Housing and Urban Development), 15, 58 Human Action (von Mises), 238 Immigration, 19, 205–206 India, 10, 25, 205 IndyMac, 39, 75, 98 Inflation: CPI as indicator of, 26–27 and fair-value accounting, 103 and Federal Reserve, 21–22 and prices, 24–25 (See also Monetary policy) Initial public offerings, 150 Insurance: bond, 86–87 cross-guarantor, 48–52 FDIC (see FDIC insurance) health, 201–202 private deposit, 48–52 self-insurance at banks, 48–52 unemployment, 212–213 Interest rates, 26–27, 31–35 Inverted yield curves, 27–29 Investment banks: disclosure requirements for, 151 government bailout of, 162 “innovations” of, 101–102 leverage ratios of, 71–72 IPOs, 150 Iran, 198, 199, 227 Iraq, 198 Ireland, 77 Isaac, Bill, 107–108, 161–162 Italy, 51, 52 Japan, 159, 200, 205 Jefferson, Thomas, 19, 220 Johnson, Lyndon Baines, 6, 55, 96, 161, 188 JPMorgan Chase, 75 and Bear Stearns, 162 and shadow banking system, 120 as “too-big-to-fail” firm, 173 and Washington Mutual, 163 Keynes, John Maynard, 181 Labor: allocation of, 10–11, 14 minimum-wage laws, 209–212 Lehman Brothers, 71, 76, 101, 104, 129, 164 and Bear Stearns bailout, 162–163 corporate debt at, 107 counterparty risk at, 124 derivatives from, 123 Limited government, 182–183, 195, 231, 253 Liquidity: of banks, 68–69 and FDIC insurance, 171 and financial crises, 70–72 and housing prices, 74–75 and TARP, 171–172 Loan loss reserves accounting, 152–154 Loans: capital standards for, 51–52 qualified, 98 substandard, 140–141 Madoff, Bernie, 149, 225 March of Dimes, 241 Market corrections, 157–165 Federal Reserve’s prevention of, 23, 32 prevention of, 13 residential real estate, 78 and response to financial crisis, 177–180 Market discipline, 21, 38 Market-based monetary policy, 31–35 Market-clearing price, 209 Mathematical modeling: for loan loss reserves, 152–153 by ratings agencies, 82–83 for risk management, 136–138 MBIA, 86 Medicaid, 6, 55, 201 Medicare, 6, 8, 55, 201, 203 Meltdown (Michaels), 35 Merrill Lynch, 101, 124–125 Michaels, Patrick J., 35 Microsoft, 217 Military spending, 198–199, 227 Minimum-wage laws, 209–212 Mises, Ludwig von, 34, 238 Monetary policy, 17–35 of Bernanke, 27–31, 33, 35, 40, 125, 213 and federal debt, 21–22 and Federal Reserve, 17–23 of Greenspan, 23–27 market-based, 31–35 and unemployment, 208–209 Money market mutual funds, bailout of, 120–121, 192 Money supply, 21–22, 24, 189 Moody, John, 83, 150 Moody’s, 81–87 investor confidence in, 84–87 misratings by, 82–84, 101, 125, 126 and SEC, 81–82, 149–150 Morgan Stanley, 71, 101, 124, 173 Mortgage lending, 95–102 by Fannie Mae and Freddie Mac, 97–101 and investment bank innovations, 101–102 prime, 59, 97–99 by private banks, 97–99 savings and loan industry in, 95–97 subprime, 43, 56–57, 99–101 Mortgages: by BB&T Corporation, 97–98 jumbo, 62 pick-a-payment (see Pick-a-payment mortgages) selling vs. servicing, 113–114 Mozilo, Angelo, 46 Multiplier effect, 181 Naked shorting, 127–128, 151 Nationally recognized statistical rating organizations, 82 Negative real interest rates, 26–27 Neo-Keynesian response to financial crisis, 185–186 Neutral taxes, 197 New Deal, 53, 170, 232 Nixon, Richard, 96, 161, 188 North Korea, 34, 198, 227, 247, 252 NRSROs, 82 Obama administration, 142–144: and Dodd-Frank Act, 64 economic policies of, 15, 161 healthcare bill, 183, 201 and Patriot Act, 45 stimulus plan, 181–182 Office of the Comptroller of the Currency (OCC), 40, 154 Office of Thrift Supervision, 40, 41, 45–46 Operating earnings, 103–106 OTS, 40, 41, 45–46 Panics, 137–138, 161–165 Patriot Act, 45, 46, 48, 133–136, 147 Paulson, Henry: in 2008 panic, 164, 167 and AIG bailout, 128, 129 credibility of, 164 development of TARP, 76, 168–170, 172 Pick-a-payment mortgages, 89–93 borrowers using, 90–91 and FDIC, 91 and rise of Fannie Mae/Freddie Mac, 98 Policy reforms, 195–206 for entitlement programs, 199–204 and free trade, 204–205 and government regulations, 204 for government spending, 197–199 for immigration, 205–206 for political system, 206–207 and tax rate, 196–197 Politics: in banking regulation, 42–46 and crony capitalism, 129 and failure of Fannie Mae/Freddie Mac, 59–62 and Federal Reserve appointments, 18 policy reforms for, 206–207 Poor, Henry Varnum, 150 Portugal, 51 Price fixing, 31, 193 Price setting, 31–32 Prime lending, 59, 97–99 Prince, Charlie, 217 Principles-based accounting, 109 Privacy Act, 133, 135 Private accounting systems, 177–178 Private banks, 97–99, 187–188 Private deposit insurance, 48–52 Public schools, 228, 233–235 Racial discrimination (in lending), 42–45 Raines, Frank, 59 Rand, Ayn, 225, 231 Rating agencies, 81–87 investor confidence in, 84–87 mathematical modeling by, 136 and subprime mortgage bonds, 82–84 and “too-big-to-fail” firms, 173 and SEC, 81–82, 149–150 Real estate: commercial, 11, 97 residential (see Residential real estate market) Recessions, 28, 29, 160 Recovery (see Economic recovery) Reforms: banking industry (see Banking industry reforms) government policy (see Policy reforms) Regions Bank, 237 Regulation: of banking industry (see Banking regulation) by government (see Government regulation) Reporting, financial, 150–152 Reserve currency, U.S. dollar as, 77, 188, 229 Residential real estate market: economics of, 73–74 misinvestment in, 9–15 Residential real estate market bubble, 73–80 and government policy, 6 international impact of, 77 and job creation, 80 and state home foreclosure laws, 77–80 Risk: contagion, 123 counterparty, 123, 124 with derivatives, 122–124 diversification of, 67–69 and economic cycles, 189–193 and FDIC insurance, 38–41 and government regulation, 50–51 liquidity, 68–70 mathematical modeling for, 136–138 and “originate and sell” model, 100 systemic, 50–51 RMBS (residential mortgage-backed securities), 81 Roman empire, fall of, 230 Roosevelt, Franklin D., 24, 37, 103, 161 Rules-based accounting, 109 Russia, 198 Samuelson, Paul, 238 Sarbanes-Oxley Act, 133–134 and fair-value accounting, 106 and Fannie Mae/Freddie Mac, 99 misregulation by, 48, 147 and SEC, 150 violations of, 136 SARs (Suspicious Activity Reports), 136 Satchwell, Jack, 57 Savings and loan (S&L) industry, 95–97, 110, 191 Securities and Exchange Commission (SEC), 149–155 capital ratio guidelines, 71–72 and complexity of accounting rules, 116–117 and expensing of stock options, 114, 115 loan loss reserves accounting for, 152–154 misallocation of resources by, 14 and rating agencies, 81–82, 149–150 requirements for shorting stock, 127–128, 151 and rules-based accounting, 109, 110 and Sarbanes-Oxley Act, 150 Self-insurance, 48–52 Selgin, George, 189 Senate Banking Committee, 46 Shadow banking system, 119–131 and AIG bailout, 128–130 credit default swaps in, 126–128 and derivatives, 122–124 Federal Reserve’s role in, 30 losses from, 131 S&L industry, 95–97, 110, 191 Small businesses, 144–147, 183–184 Smoot-Hawley Tariff Act, 205 Social Security, 8, 199–204 South Financial, 237 South Korea, 247 Soviet Union, 34, 195–196, 252, 254 S&P (see Standard & Poor’s) Spain, 51, 52, 77 Spitzer, Eliot, 71, 134–135, 151 Stagflation, 181, 208 Standard & Poor’s (S&P), 81–87 investor confidence, 84–87 misratings by, 82–84, 101, 125, 126 and SEC, 81–82, 149–150 Standard of living, 6–7, 10, 161, 177 Start-up banks, 38–39 State home foreclosure laws, 77–80 Stimulus plan, 181–182 Stock options, expensing of, 114–117 Stocks, shorting, 127–128, 151 Stress tests, banks, 171 Subprime lending: and CRA, 56–57 by Fannie Mae and Freddie Mac, 99–101 and racial discrimination in lending study, 43 Subprime mortgage bonds, 82–87 Substandard loans, 140–141 SunTrust, 152, 237 Suspicious Activity Reports (SARs), 136 Tails (mathematical models), 137 TARP (see Troubled Asset Relief Program) Tax rate, 196–197 Tea Party Movement, 218, 231 Technology industry, 5 “Too-big-to-fail” firms, 130, 173, 193 Trader principle, 92, 223–224 Troubled Asset Relief Program (TARP), 167–175 and 2008 panic, 165 and FDIC, 37 Underwriters Laboratories, 117, 150 Unemployment, 207–213 in economic recovery, 207–208 and minimum-wage laws, 209–212 and misinvestment in residential real estate, 10–11 and monetary policy, 208–209 Unemployment insurance, 212–213 Unions, 179, 180, 212 United Auto Workers, 179, 180 United States: demographic problem in, 228 economic future of, 8, 227–230, 252–253 educational system of, 230–235 founding concepts of, 219–220 as free trade zone, 204–205 GDP of China vs., 183 mixed economy of, 5–6 public schools of, 233–235 university system of, 230–233 United Way, 224, 241 University system, 230–233 U.S.


pages: 397 words: 112,034

What's Next?: Unconventional Wisdom on the Future of the World Economy by David Hale, Lyric Hughes Hale

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

affirmative action, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Black Swan, Bretton Woods, capital controls, Cass Sunstein, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, debt deflation, declining real wages, deindustrialization, diversification, energy security, Erik Brynjolfsson, Fall of the Berlin Wall, financial innovation, floating exchange rates, full employment, Gini coefficient, global reserve currency, global village, high net worth, Home mortgage interest deduction, housing crisis, index fund, inflation targeting, invisible hand, Just-in-time delivery, Kenneth Rogoff, labour market flexibility, labour mobility, Long Term Capital Management, Mahatma Gandhi, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, mortgage tax deduction, Network effects, new economy, Nicholas Carr, oil shale / tar sands, oil shock, open economy, passive investing, payday loans, peak oil, Ponzi scheme, post-oil, price stability, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, sovereign wealth fund, special drawing rights, technology bubble, The Great Moderation, Thomas Kuhn: the structure of scientific revolutions, Tobin tax, too big to fail, total factor productivity, trade liberalization, Washington Consensus, women in the workforce, yield curve

Louis-Vincent Gave notes that Asian stock markets are now discounting high growth expectations, and thus are trading at premiums to traditional OECD markets. Gave reviews the four key factors that have driven economic performance in the West over the past decade, and suggests that some of the factors are still driving Asian growth. These factors are the emergence of three billion new producers, creation of a global economy, and the great moderation of steady low-inflation economic growth, and financial innovation. The financial revolution that drove markets in New York and London is still evolving in East Asia. East Asia is also free of two problems that now loom over the old industrial countries—a legacy of private debt that financed asset inflation and large fiscal deficits. Gave’s new concern is that China could soon confront labor shortages. He is also concerned that China has excess savings, but understands how the excess has resulted from robust profits, not just deferred consumption.

And in Europe, that limit may well be exceeded in the coming years, both because of an overly aggressive fiscal tightening and because of an overcautious response by the ECB. Monetary Policy in Europe Is Tighter and Less Pragmatic Than in the United States While it is widely believed that monetary policy has “always” been traditionally tighter in Europe than in America, the figures do not bear this out. In the years before the crisis, the ECB was generally somewhat more expansive than the Fed, probably because Europe was experiencing a slower rate of financial innovation and remained more of a cash economy. Money supply grew more rapidly in Europe whether attention focused on the monetary base, which is directly controlled by central banks, or at broad money, which is the monetary gauge that has correlated best with long-term inflation and GDP growth (see Figure 5.8). After the crisis, however, this relationship abruptly reversed. While the Fed did its utmost to provide monetary stimulus for more than a year after Lehman, the ECB reversed course much more quickly—encouraging both the monetary base and broad money to contract from the middle of 2009.

• A Financial Revolution: This resulted from the adoption of a free-market philosophy, the buildup of savings in the rapidly growing Asian economies, and the stability created by globalization and successful demand management. With risks of bankruptcy and unemployment diminished in the stabilized economies of the 1990s, businesses and consumers felt that they could borrow more than ever before, and banks were more willing to lend. Meanwhile, the demystification of money meant that debt ceased to be a moral or theological issue and became just another consumer product. Financial innovation also meant that savings that were previously locked up in property and other illiquid assets could be used as collateral to support consumer and business borrowing. This attractive new feature of property, summed up in the saying “My home is an ATM machine,” led to an increase in the value of homes relative to other more traditional investments such as stocks and bonds. The result of this revolution was that ordinary home-owners and small businesses gained opportunities to smooth their spending over their entire lifetimes and to manage their finances in ways that had been available only to large multinational companies and wealthy family trusts.


pages: 484 words: 136,735

Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis by Anatole Kaletsky

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, bonus culture, Bretton Woods, BRICs, Carmen Reinhart, cognitive dissonance, collapse of Lehman Brothers, Corn Laws, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, deglobalization, Deng Xiaoping, Edward Glaeser, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, F. W. de Klerk, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, global rebalancing, Hyman Minsky, income inequality, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Rogoff, laissez-faire capitalism, Long Term Capital Management, mandelbrot fractal, market design, market fundamentalism, Martin Wolf, moral hazard, mortgage debt, new economy, Northern Rock, offshore financial centre, oil shock, paradox of thrift, peak oil, pets.com, Ponzi scheme, post-industrial society, price stability, profit maximization, profit motive, quantitative easing, Ralph Waldo Emerson, random walk, rent-seeking, reserve currency, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, statistical model, The Chicago School, The Great Moderation, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, Washington Consensus

Four, a financial revolution resulted from the adoption of a free-market philosophy, the buildup of savings in the rapidly growing Asian economies, and the stability created by globalization and successful demand management. With risks of bankruptcy and unemployment diminished in the stabilized economies of the 1990s, businesses and consumers felt that they could borrow more than ever before and banks were more willing to lend. Meanwhile, the demystification of money meant that debt ceased to be a moral or theological issue and became just another consumer product. Financial innovation also meant that savings previously locked up in property and other illiquid assets could be used as collateral to support consumer and business borrowing. This attractive new feature of property, summed up in the saying “my home is an ATM machine,” led to an increase in the value of homes in relation to other more traditional investments such as stocks and bonds. The result of this revolution was that ordinary homeowners and small businesses gained opportunities to smooth their spending over their entire lifetimes and to manage their finances in ways that had been available only to large multinational companies and wealthy family trusts.

Prolonged stability caused by the Great Moderation suppressed financial risk, as explained by Minsky, and thereby transformed expectations, creating the herd behavior and reflexive changes in reality described by Soros. At the same time, the long period of low interest rates due to excess savings in Asia encouraged Austrian-style malinvestment in low-income housing, as well as the aggressive financial innovation predicted by Minsky. This happened despite the fact that low-income consumers and homeowners were becoming less creditworthy because of the widening income inequality anticipated by Kalecki and the New Keynesians. The boom in finance, meanwhile, interacted with the ideological super-bubble described by Soros and, through the process of reflexivity, created an excessive faith in markets that changed political realities.

If that sounds like a parody from the Academy in Laputa in Gulliver’s Travels,15 consider the following tribute to Friedman’s theories about inflation and monetary growth. It was delivered, appropriately enough, to celebrate the fiftieth anniversary of Free to Choose, Friedman’s political credo, which could be described as the intellectual bible of Capitalism 3.3. The speaker was one of the world’s top academic economists, one Ben Bernanke: “For reasons of financial innovation and institutional change, the rate of money growth does not seem to be an adequate measure of the stance of monetary policy, and hence a stable monetary background for the economy cannot necessarily be identified with stable money growth. Nor are there other instruments of monetary policy whose behavior can be used unambiguously to judge this issue . . . Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.


pages: 607 words: 133,452

Against Intellectual Monopoly by Michele Boldrin, David K. Levine

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, agricultural Revolution, barriers to entry, cognitive bias, David Ricardo: comparative advantage, Dean Kamen, Donald Trump, double entry bookkeeping, en.wikipedia.org, Ernest Rutherford, experimental economics, financial innovation, informal economy, interchangeable parts, invention of radio, invention of the printing press, invisible hand, James Watt: steam engine, Jean Tirole, John Harrison: Longitude, Joseph Schumpeter, linear programming, market bubble, market design, mutually assured destruction, Nash equilibrium, new economy, open economy, pirate software, placebo effect, price discrimination, profit maximization, rent-seeking, Richard Stallman, Silicon Valley, Skype, slashdot, software patent, the market place, total factor productivity, trade liberalization, transaction costs, Y2K

Thompson, B. (1847), Inventions, Improvements, and Practice of Benjamin Thompson, in the Combined Character of Colliery Engineer and General Manager. Newcastle. Thurston, R. (1878), “A History of the Growth of the Steam-Engine,” in The Cambridge History of Science, Vol. 4, ed. R. Porter et al., 854. New York: Cambridge University Press. Tirole, J. (1988), The Theory of Industrial Organization. Cambridge, MA: MIT Press. Tufano, P. (1989), “First-Mover Advantages in Financial Innovation,” Journal of Financial Economics 3, 350–70. Tufano, P. (2003), “Financial Innovation,” in The Handbook of the Economics of Finance, ed. G. Constantinides, M. Harris, and R. Stulz. Amsterdam: North Holland. Urban, T. N. (2000), “Agricultural Biotechnology: Its History and Future,” available at http://www.dieboldinstitute.org. U.S. Patent and Trademark Office (1994), “USPTO Public Hearings,” available at http://www.uspto.gov/web/offices/com/hearings/index.html.

The rapid pace of innovation in financial securities prior to 1998 is well documented, for example by Tufano.17 Tufano estimates that roughly 20 percent of new security issues involve an innovative structure. He reports P1: KNP head margin: 1/2 gutter margin: 7/8 CUUS245-03 cuus245 978 0 521 87928 6 May 8, 2008 13:56 58 Against Intellectual Monopoly developing a list of some 1,836 new securities over a twenty-year period and remarks: [This] severely underestimate[s] the amount of financial innovation as it includes only corporate securities. It excludes the tremendous innovation in exchange traded derivatives, over-the-counter derivative stocks (such as the credit derivatives, equity swaps, weather derivatives, and exotic over-the-counter options), new insurance contracts (such as alternative risk transfer contracts or contingent equity contracts), and new investment management products (such as folioFN or exchange traded funds.)18 Three features of this market particularly deserve note.

It excludes the tremendous innovation in exchange traded derivatives, over-the-counter derivative stocks (such as the credit derivatives, equity swaps, weather derivatives, and exotic over-the-counter options), new insurance contracts (such as alternative risk transfer contracts or contingent equity contracts), and new investment management products (such as folioFN or exchange traded funds.)18 Three features of this market particularly deserve note. The first is that innovating in the financial securities industry is very costly, as those that create new securities are highly paid individuals with Ph.D.’s in economics, mathematics, and theoretical physics. The second is that competitors quickly imitate financial innovations. The third is that there is a pronounced advantage of being first, with the innovator retaining a market share between 50 percent and 60 percent even in the long run. Accounts in the popular press of investment banking in the 1980s, such as Lewis’s vivid portrayal, also document that innovation was widespread, despite the complete lack of intellectual monopoly. We are all well aware that, for good or for bad, but mostly for the first, the investment banking industry grew tremendously between the late 1970s and the late 1990s, bringing economic growth to the whole of the nation and increased welfare to millions of consumers.


pages: 504 words: 143,303

Why We Can't Afford the Rich by Andrew Sayer

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, Albert Einstein, asset-backed security, banking crisis, banks create money, Bretton Woods, British Empire, call centre, capital controls, carbon footprint, collective bargaining, corporate social responsibility, credit crunch, Credit Default Swap, crony capitalism, David Graeber, David Ricardo: comparative advantage, debt deflation, decarbonisation, declining real wages, deglobalization, deindustrialization, delayed gratification, demand response, don't be evil, Double Irish / Dutch Sandwich, en.wikipedia.org, Etonian, financial innovation, financial intermediation, Fractional reserve banking, full employment, Goldman Sachs: Vampire Squid, high net worth, income inequality, investor state dispute settlement, Isaac Newton, James Dyson, job automation, Julian Assange, labour market flexibility, laissez-faire capitalism, low skilled workers, Mark Zuckerberg, market fundamentalism, Martin Wolf, means of production, moral hazard, mortgage debt, neoliberal agenda, new economy, New Urbanism, Northern Rock, Occupy movement, offshore financial centre, oil shale / tar sands, patent troll, payday loans, Plutocrats, plutocrats, predatory finance, price stability, pushing on a string, quantitative easing, race to the bottom, rent-seeking, Ronald Reagan, shareholder value, short selling, sovereign wealth fund, Steve Jobs, The Nature of the Firm, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transfer pricing, trickle-down economics, universal basic income, unpaid internship, upwardly mobile, Washington Consensus, Winter of Discontent, working poor, Yom Kippur War

Yet Apple is famously quick to litigate against any companies who borrow or appear to borrow Apple’s ideas. As Ferguson puts it, ‘Most of us have no problem with copying (as long as we’re the ones doing it).’27 In recent decades, the scope of ‘intellectual property’ claims has expanded these sources of rent extraction, most notably in seeds,28 software and business methods and in so-called ‘financial innovations’ such as new types of derivatives. Whereas patent law protected specific inventions, software claims can be much looser and broader in their coverage as designers have sought to expand the range of their claims. Sixty-two per cent of all patent disputes are now over software. As intellectual property rights have grown, litigation has itself become big business, not only extracting huge rents but stifling the emulation and adaptation of ideas that are so important for the growth of knowledge and culture.29 You can come up with an idea and sue someone for reproducing it, even if you had no intention of using it yourself.

But although there has certainly been extraordinary irresponsibility, mismanagement, irrational exuberance, not to mention greed and indeed criminality, the basic causes go back decades, and they weren’t all to do with finance. The problems are not merely technical, to be fixed by an engineering approach that takes for granted the legitimacy and rationality of the basic institutions and practices and merely identifies malfunctions. The crisis is also a product of economic injustice. To understand it requires more than the usual narrative of who did what in a sequence of financial innovation and euphoria followed by disaster: we need to identify the basic mechanisms of wealth extraction that are involved. TWELVE The roots of the crisis There are scores of different accounts of the origins of the crisis. The causes are complex, and different experts give different emphasis to them. Many of the elements are mutually reinforcing so it’s often hard to say what came first:1 but I will at least provide a sketch of the main elements and processes, highlighting the role of the rich.

It was introduced in a series of reports, the last of which was called The Plutonomy Symposium – Rising Tides Lifting Yachts.143 It was sent only to Citigroup’s wealthiest customers, but leaked to the press. It claims that the US, Canada, UK and Australia are the only plutonomies; much of continental Europe and Japan, which haven’t experienced such major upturns in wealth controlled by the rich, are ‘the Egalitarian Bunch’. According to the report, plutonomies have three key characteristics: 1. They are all created by ‘disruptive technology-driven productivity gains, creative financial innovation, capitalist friendly cooperative governments, immigrants … the rule of law and patenting inventions. Often these wealth waves involve great complexity exploited best by the rich and educated of the time.’ 2. There is no ‘average’ consumer in Plutonomies. There is only the rich ‘and everyone else’. The rich account for a disproportionate chunk of the economy, while the non-rich account for ‘surprisingly small bites of the national pie’.


pages: 322 words: 77,341

I.O.U.: Why Everyone Owes Everyone and No One Can Pay by John Lanchester

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black-Scholes formula, Celtic Tiger, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial innovation, fixed income, George Akerlof, greed is good, hindsight bias, housing crisis, Hyman Minsky, interest rate swap, invisible hand, Jane Jacobs, John Maynard Keynes: Economic Possibilities for our Grandchildren, laissez-faire capitalism, liquidity trap, Long Term Capital Management, loss aversion, Martin Wolf, mortgage debt, mortgage tax deduction, mutually assured destruction, new economy, Nick Leeson, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative easing, reserve currency, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, South Sea Bubble, statistical model, The Great Moderation, the payments system, too big to fail, tulip mania, value at risk

But that model no longer applied. This is where we finally encounter the consequences arising from the fact that the invention of securitization broke banking by separating lender from borrower via selling the loan to somebody else. People wanted to find the money to buy houses, and the money in turn wanted to find a way to get to the people. The result was a huge wave of mortgage-linked financial innovation. So what now happens when the money is looking for new borrowers and the circuit breaker of risk assessment is no longer in place? Answer: the lending goes on regardless. A terrible changeover happens, in which the process of lending no longer is driven by the legitimate desire of poor-but-reliable people to own a house but is instead a manufactured process driven by capital, which is set loose looking for people to sign loans.

Regulatory bodies should have access to the perspective of outsiders looking in at the industry from its periphery and prepared to ask obvious, which sometimes means obviously unpopular, questions. The FSA wasn’t like that: it didn’t have somebody saying “I don’t understand, please explain.” It was dedicated to what was often called the principle of “light touch” regulation. As Adair Turner, the head of the FSA, said in his postcrash report: An underlying assumption of financial regulation in the US, the UK and across the world, has been that financial innovation is by definition beneficial, since market discipline will winnow out any unnecessary or value destructive innovations. As a result, regulators have not considered it their role to judge the value of different financial products, and they have in general avoided direct product regulation, certainly in wholesale markets with sophisticated investors.4 This didn’t mean that nobody at the FSA, the Bank, or the Treasury—the third pillar of the “tripartite” regulatory system supposed to run the British financial system—had a clue what was happening.

This is his summary of what the bankers asked for and got: From this confluence of campaign finance, personal connections, and ideology there flowed, in just the past decade, a river of deregulatory policies that is, in hindsight, astonishing: • insistence on free movement of capital across borders • the repeal of Depression-era regulations separating commercial and investment banking • a congressional ban on the regulation of credit-default swaps • major increases in the amount of leverage allowed to investment banks • a light (dare I say invisible?) hand at the Securities and Exchange Commission in its regulatory enforcement • an international agreement to allow banks to measure their own riskiness • and an intentional failure to update regulations so as to keep up with the tremendous pace of financial innovation7 The undoing of the Depression-era banking legislation was a critical component in this. In the aftermath of the Great Depression, the populist anger at banks and the financial system led to a series of laws designed to ensure that nothing like the crash would ever happen again. That is a generally applicable historic pattern: societies tend to regulate their financial systems only in the aftermath of a scary failure.


pages: 261 words: 64,977

Pity the Billionaire: The Unexpected Resurgence of the American Right by Thomas Frank

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, bank run, big-box store, bonus culture, collateralized debt obligation, collective bargaining, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Deng Xiaoping, financial innovation, housing crisis, invisible hand, Naomi Klein, obamacare, payday loans, profit maximization, profit motive, road to serfdom, Ronald Reagan, shareholder value, strikebreaker, The Chicago School, The Myth of the Rational Market, Thorstein Veblen, too big to fail, union organizing, Washington Consensus, white flight, Works Progress Administration

Those were the golden years of libertarianism, a time when our choice and master spirits agreed on the uselessness of big government and took the benevolent rationality of markets for granted. And while they did so, the American financial establishment proceeded to cheat the world to the very edge of the abyss. Indeed, what brought the nation down were the very aspects of business practice that our choice and master spirits admired the most—the financial innovation and risk-taking that were routinely described as America’s unique offerings to the world. We didn’t manufacture much anymore, but we could sure dream up awesome ways to securitize debt and slice up the risk in every imaginable situation. One testament to the zesty innovativeness of markets was the industry that had sprung up to supply credit to “subprime” borrowers, selling off the loans thus made to the investment banking industry on Wall Street.

But now this comatose, money-hole of a corporation—AIG was being kept alive only so its bad bets could be unwound in an orderly way—showed us that the bonus-grabbing culture of the trader would not die. It was an inconceivable ripoff. The people who had nearly succeeded in shoving the world off a cliff were now going to walk away rich. Wall Street pay, we suddenly understood, had never been a reward for “performance” or a grateful recognition of what financial innovation did for the nation—it was strictly about what Wall Streeters could get away with. The AIG bonus scandal thus became a symbol for the larger scandal of the crisis/bailout, another one of those moments that shreds people’s faith. The public’s disgust was volcanic this time; it seemed to erupt more violently with each passing day. A Bloomberg story that appeared on March 18 observed that “Americans want to see heads roll.

., The Great Depression (Englewood Cliffs, NJ: Prentice-Hall, 1960), p. 125. A South Dakota participant in the farm strike told Studs Terkel in 1970 that “it was close in spirit to the American Revolution.” Hard Times: An Oral History of the Great Depression (New York: Pantheon, 1970), p. 256. Chapter 2. 1929: The Sequel 1. Joshua Cooper Ramo, “The Three Marketeers,” Time, February 15, 1999. 2. On financial innovation and its application to real estate, see Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (New York: Pantheon, 2010), pp. 105–13. 3. These examples are all drawn from the first eighty pages of the Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (New York: Public Affairs, 2011). 4.


pages: 524 words: 143,993

The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

air freight, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, Bretton Woods, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, forward guidance, Fractional reserve banking, full employment, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen: Great Stagnation, very high income, winner-take-all economy

A working paper from the International Monetary Fund in 2012 summarized what happened: in recent decades, with the advent of securitization and electronic means of trading and settlement, it became possible to expand greatly the scope of assets that could be transformed directly, through their use as collateral, into liquid or money-like assets. The expansion in the scope of the assets that could be securitized was in part facilitated by the growth of the shadow financial system, which was largely unregulated, and the ability to borrow from non-deposit sources.41 In the event, central banks were driven to intervene. Yet, at its core, the failure was quite traditional: the excesses of a combination of financial innovation with mismanaged risk-taking generated a panic that devastated liquidity. As recounted in Part I, the markets froze. Leverage A fourth dimension of increased fragility, emphasized in a marvellous book, The Bankers’ New Clothes, by Anat Admati of Stanford University and Martin Hellwig of the Max Planck Institute for Research on Collective Goods, was unprecedented leverage or gearing (by which is meant ways of funding investments that multiply the returns to investors on the upside and the losses to investors on the downside).42 Leverage increased on three dimensions: leverage of non-financial borrowers, such as house buyers, who borrowed more relative to the value of houses; leverage embedded in new instruments, particularly derivatives; and leverage inside the financial sector itself, which became extraordinarily high in many institutions.

(ii) The development of securitised credit, since [it is] based on the creation of new and more liquid markets, has improved both allocative efficiency and financial stability. (iii) The risk characteristics of financial markets can be inferred from mathematical analysis, delivering robust quantitative measures of trading risk. (iv) Market discipline can be used as an effective tool in constraining harmful risk taking. (v) Financial innovation can be assumed to be beneficial, since market competition would winnow out any innovations which did not deliver value added. Each of these assumptions is now subject to extensive challenge on both theoretical and empirical grounds, with potential implications for the appropriate design of regulation and for the role of regulatory authorities.58 Behind all this was the assumption that self-interest would, via Adam Smith’s invisible hand, ensure a stable, dynamic and efficient financial system.

During the explosions it creates excessive confidence, credit and leverage, not to mention excessive behaviour, legal, shady and downright illegal. During the implosions, it creates panic, collapsing credit, de-leveraging and hunts for scapegoats and villains. It was ever thus. Indeed, contrary to the views of many academic Panglossians, informed observers have long known this (see Chapter Six). But it seems that, given contemporary information and communication technologies, modern financial innovations and globalization, the capacity of the system to generate complexity and fragility, surpasses anything seen historically, in its scope, scale and speed. Fortunately, the willingness and ability to respond has also increased. But it was quite a close-run thing in 2008 globally, and after 2009 in the Eurozone. Without the policy response, the outcome would have been worse than in the 1930s.


pages: 497 words: 153,755

The Power of Gold: The History of an Obsession by Peter L. Bernstein

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, Atahualpa, Bretton Woods, British Empire, California gold rush, central bank independence, double entry bookkeeping, Edward Glaeser, falling living standards, financial innovation, floating exchange rates, Francisco Pizarro, German hyperinflation, Hernando de Soto, Isaac Newton, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, large denomination, liquidity trap, money: store of value / unit of account / medium of exchange, price stability, profit motive, random walk, rising living standards, Ronald Reagan, seigniorage, the market place, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, trade route

Kenneth Galbraith has phrased the same thing more eloquently: "Men possessed of money, like men earlier favoured by noble birth and great title, have infallibly imagined that the awe and admiration that money inspires were really owing to their own wisdom or personality."26 Galbraith's characteristically acerbic wit contains much truth, but Croesus and the Lydians may be the exception that proves his rule. The political and financial innovations of the Lydians were remarkable enough in their own time. Viewed from the perspective of the 2500 years since the death of Croesus, however, their accomplishments were truly extraordinary. It was their wisdom and personality that inspired the awe and admiration for their money, not the other way around. Most important, they demonstrated that you don't have to be bad just because you are rich.

The fiscal problems of financing these wars were intensified by the character of the sixteenth-century tax systems, which put almost all the burden on the lower classes. As it was the lower classes who fell furthest behind in the inflationary process, government revenues lagged even as inflationcum-warfare was constantly driving government expenditures higher. Jumbo fiscal deficits and exploding government indebtedness were the inevitable consequences. Two resulting financial innovations were Spain's asientos and France's Grand Parti, both of which were forms of borrowing in the capital markets-the modern convention-which supplemented the traditional method of privately negotiated debts that piled up on the accounts of the bankers in Italy, Germany, and Holland. There was another method of royal finance that was by now an old trick: increasing the supply of money through devaluation of the currency.

A young monk takes advantage of this situation to make advances on the merchant's lusty wife, who bangs on her husband's door crying, Nevertheless, the money changers were much less involved with developments in coinage than with the increasing substitution of papermoney instruments for the inconvenience and complications of payment in coin. The principal vehicle for these kinds of payment was the bill of exchange, an instrument developed by the Italians in the thirteenth century, perhaps earlier. This was a remarkable financial innovation that lent itself to a wide variety of uses and formats.se Here is a simple example of how a bill of exchange worked.* Two transactions take place: Franco in Italy buys wool from Berthold in Flanders, while David in Flanders buys wine from Carlo in Italy. Franco, however, does not pay Berthold directly, and David does not pay Carlo directly. Instead, Carlo "draws" a bill of exchange on David, a sheet of paper declaring that David owes him such-and-such an amount of Italian money for the wine.


pages: 515 words: 126,820

Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business, and the World by Don Tapscott, Alex Tapscott

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Airbnb, altcoin, asset-backed security, autonomous vehicles, barriers to entry, bitcoin, blockchain, Bretton Woods, business process, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, clean water, cloud computing, cognitive dissonance, corporate governance, corporate social responsibility, Credit Default Swap, crowdsourcing, cryptocurrency, disintermediation, distributed ledger, Donald Trump, double entry bookkeeping, Edward Snowden, Elon Musk, Erik Brynjolfsson, ethereum blockchain, failed state, fiat currency, financial innovation, Firefox, first square of the chessboard, first square of the chessboard / second half of the chessboard, future of work, Galaxy Zoo, George Gilder, glass ceiling, Google bus, Hernando de Soto, income inequality, informal economy, interest rate swap, Internet of things, Jeff Bezos, jimmy wales, Kickstarter, knowledge worker, Kodak vs Instagram, Lean Startup, litecoin, Lyft, M-Pesa, Mark Zuckerberg, Marshall McLuhan, means of production, microcredit, mobile money, Network effects, new economy, Oculus Rift, pattern recognition, peer-to-peer lending, performance metric, Peter Thiel, planetary scale, Ponzi scheme, prediction markets, price mechanism, Productivity paradox, quantitative easing, ransomware, Ray Kurzweil, renewable energy credits, rent-seeking, ride hailing / ride sharing, Ronald Coase, Ronald Reagan, Satoshi Nakamoto, Second Machine Age, seigniorage, self-driving car, sharing economy, Silicon Valley, Skype, smart contracts, smart grid, social graph, social software, Stephen Hawking, Steve Jobs, Steve Wozniak, Stewart Brand, supply-chain management, TaskRabbit, The Fortune at the Bottom of the Pyramid, The Nature of the Firm, The Wisdom of Crowds, transaction costs, Turing complete, Turing test, Uber and Lyft, unbanked and underbanked, underbanked, unorthodox policies, X Prize, Y2K, Zipcar

Clippinger, CEO, ID3, Research Scientist, MIT Media Lab Bram Cohen, Creator, BitTorrent Amy Cortese, Journalist, Founder, Locavest J-F Courville, Chief Operating Officer, RBC Wealth Management Patrick Deegan, CTO, Personal BlackBox Primavera De Filippi, Permanent Researcher, CNRS and Faculty Associate at the Berkman Center for Internet and Society at Harvard Law School Hernando de Soto, President, Institute for Liberty and Democracy Peronet Despeignes, Special Ops, Augur Jacob Dienelt, Blockchain Architect and CFO, itBit and Factom Joel Dietz, Swarm Corp Helen Disney, (formerly) Bitcoin Foundation Adam Draper, CEO and Founder, Boost VC Timothy Cook Draper, Venture Capitalist; Founder, Draper Fisher Jurvetson Andrew Dudley, Founder and CEO, Earth Observation Joshua Fairfield, Professor of Law, Washington and Lee University Grant Fondo, Partner, Securities Litigation and White Collar Defense Group, Privacy and Data Security Practice, Goodwin Procter LLP Brian Forde, Former Senior Adviser, The White House; Director, Digital Currency, MIT Media Lab Mike Gault, CEO, Guardtime George Gilder, Founder and Partner, Gilder Technology Fund Geoff Gordon, CEO, Vogogo Vinay Gupta, Release Coordinator, Ethereum James Hazard, Founder, Common Accord Imogen Heap, Grammy-Winning Musician and Songwriter Mike Hearn, Former Google Engineer, Vinumeris/Lighthouse Austin Hill, Cofounder and Chief Instigator, Blockstream Toomas Hendrik Ilves, President of Estonia Joichi Ito, Director, MIT Media Lab Eric Jennings, Cofounder and CEO, Filament Izabella Kaminska, Financial Reporter, Financial Times Paul Kemp-Robertson, Cofounder and Editorial Director, Contagious Communications Andrew Keys, Consensus Systems Joyce Kim, Executive Director, Stellar Development Foundation Peter Kirby, CEO and Cofounder, Factom Joey Krug, Core Developer, Augur Haluk Kulin, CEO, Personal BlackBox Chris Larsen, CEO, Ripple Labs Benjamin Lawsky, Former Superintendent of Financial Services for the State of New York; CEO, The Lawsky Group Charlie Lee, Creator, CTO; Former Engineering Manager, Litecoin Matthew Leibowitz, Partner, Plaza Ventures Vinny Lingham, CEO, Gyft Juan Llanos, EVP of Strategic Partnerships and Chief Transparency Officer, Bitreserve.org Joseph Lubin, CEO, Consensus Systems Adam Ludwin, Founder, Chain.com Christian Lundkvist, Balanc3 David McKay, President and Chief Executive Officer, RBC Janna McManus, Global PR Director, BitFury Mickey McManus, Maya Institute Jesse McWaters, Financial Innovation Specialist, World Economic Forum Blythe Masters, CEO, Digital Asset Holdings Alistair Mitchell, Managing Partner, Generation Ventures Carlos Moreira, Founder, Chairman, and CEO, WISeKey Tom Mornini, Founder and Customer Advocate, Subledger Ethan Nadelmann, Executive Director, Drug Policy Alliance Adam Nanjee, Head of Fintech Cluster, MaRS Daniel Neis, CEO and Cofounder, KOINA Kelly Olson, New Business Initiative, Intel Steve Omohundro, President, Self-Aware Systems Jim Orlando, Managing Director, OMERS Ventures Lawrence Orsini, Cofounder and Principal, LO3 Energy Paul Pacifico, CEO, Featured Artists Coalition Jose Pagliery, Staff Reporter, CNNMoney Stephen Pair, Cofounder and CEO, BitPay Inc.

The first era of the Internet, rather than bringing transparency and impairing violations, seems to have done little to increase security of persons, institutions, and economic activity. The average Internet user often has to rely on flimsy passwords to protect e-mail and online accounts because service providers or employers insist on nothing stronger. Consider the typical financial intermediary: it doesn’t specialize in developing secure technology; it specializes in financial innovation. In the year that Satoshi published his white paper, data breaches at such financial firms as BNY Mellon, Countrywide, and GE Money accounted for over 50 percent of all identity thefts reported that year, according to the Identity Theft Resource Center.24 By 2014, that figure had fallen to 5.5 percent for the financial sector, but breaches in medical and health care jumped to 42 percent of the year’s total.

Masters said, “The entire life cycle of a trade including its execution, the netting of multiple trades against each other, the reconciliation of who did what with whom and whether they agree, can occur at the trade entry level, much earlier in the stack of process, than occurs in the mainstream financial market.”25 Greifeld put it this way: “We currently settle trades ‘T+3’ (that is, three days). Why not settle in five to ten minutes?”26 Wall Street trades in risk, and this technology can materially reduce counterparty risk, settlement risk, and thus systemic risk across the system. Jesse McWaters, financial innovation lead at the World Economic Forum, told us, “The most exciting thing about distributed ledger technology is how traceability can improve systemic stability.” He believes these “new tools allow regulators to use a lighter touch.”27 The blockchain’s public nature—its transparency, its searchability—plus its automated settlement and immutable time stamps, allow regulators to see what’s happening, even set up alerts so that they don’t miss anything.


pages: 296 words: 87,299

Portfolios of the poor: how the world's poor live on $2 a day by Daryl Collins, Jonathan Morduch, Stuart Rutherford

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Cass Sunstein, clean water, failed state, financial innovation, financial intermediation, income per capita, informal economy, job automation, M-Pesa, mental accounting, microcredit, moral hazard, profit motive, purchasing power parity, RAND corporation, randomized controlled trial, The Fortune at the Bottom of the Pyramid, transaction costs

Both involve steady, incremental pay-ins—saving week after week in small amounts, say, or paying back loans week after week in small amounts. The same is true of the way that common informal devices are designed, like the local savings and credit clubs described below—and, indeed, it is similar to the way that many richer people pay for insurance or contribute to pensions. It is one of the features that microcredit pioneers adapted to form new financial innovations. We pay attention to this and other special features of the devices and strategies used by the diary households. We focus first on the borrowing side (the “accelerators”) and then turn to the various savings devices (the “accumulators”). In both their borrowing and their lending, households have discovered ways to deal with the economic, psychological, and social forces that make the job of amassing large sums of money so difficult. accelerators We started this chapter with the idea that large sums are formed by patching together resources—putting luck, skill, and assets together to amass a needed lump.

In Bangladesh the purpose of microfinance has always been seen as the eradication of poverty, and its microfinance providers remain focused on the poor. They have shown an astonishing capacity to develop products and take them quickly to scale. That combination—a focus on poverty plus the capacity to scale up quickly—should enable them to exploit new ideas and technologies that can improve quality and build on the foundations laid by Grameen II, again providing a model of financial innovation from which the rest of the world can learn. 173 Chapter Seven BETTER PORTFOLIOS N ot having enough money is only one part of what it is to be poor. Households like those who feature in our diaries face many challenges of poverty that go beyond the lack of money. They may face discrimination because of their ethnicity or class, find that their legal rights are poorly enforced, or have to struggle with low-quality public services and low skill levels.

See World Bank 2008, chap. 1. 3. Foreign investment in microfinance, for example, more than tripled between 2004 and 2006, to $4 billion. See Reille and Forester 2008. 4. For a review of early experiences with branchless banking, see Ivatury and Mas 2008. 5. New field research adapts methods from medical research, particularly the use of randomized controlled trials, to test the value and logic of financial innovations. Recently, the Financial Access Initiative, a consortium of researchers at New York University, Yale, Harvard, and Innovations for Poverty Action, has been formed to extend field trials in Latin America, Africa, and Asia. Working with microfinance providers, researchers are investigating, for example, how sensitive borrowers are to changes in interest rates, the value of structured savings devices, and the impact of business training alongside credit.


pages: 350 words: 109,220

In FED We Trust: Ben Bernanke's War on the Great Panic by David Wessel

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, Black Swan, central bank independence, credit crunch, Credit Default Swap, crony capitalism, debt deflation, Fall of the Berlin Wall, financial innovation, financial intermediation, full employment, George Akerlof, housing crisis, inflation targeting, London Interbank Offered Rate, Long Term Capital Management, market bubble, moral hazard, mortgage debt, new economy, Northern Rock, price stability, quantitative easing, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, savings glut, Socratic dialogue, too big to fail

., a Boston money manager with a taste for timber, bought more than 5 percent of the land in the state of Maine. To be sure, Fed policy during this first part of the decade kept the economy chugging along, but there is a potential downside to sustained very low interest rates — a downside that goes far beyond overpaying for assets. As economic historian Charles Calomiris of Columbia University observed, “The most severe financial crises typically arise when rapid growth in untested financial innovations” — such as complicated securities invented to invest in mortgages — “coincided with … an abundance of the supply of credit.” This is exactly what happened during the last years of the Greenspan Fed. With interest rates low, investors took greater and greater risks to get higher returns. This risky investing is called “reaching for yield” — and in the mid-2000s, there was a lot of reaching.

GREENSPAN PUT TOO MUCH FAITH IN MARKETS AND THE CAPACITY OF BIG-MONEY PLAYERS TO POLICE THE MARKETS IN THEIR OWN SELF-INTEREST Greenspan’s libertarian leanings were well known, and his skepticism about the capacity of government regulators openly expressed. He often referred to the ten years he spent as a director of J. P. Morgan before going to Washington in 1987, making a point of how much more knowledgeable the bank’s loan officers were about borrowers than Fed regulators. Greenspan generally celebrated the benefits of financial innovation and downplayed the risks. In his memoirs, he says he took the Fed job committed to enforcing the laws of the United States — even those with which he didn’t agree — but “planned to be largely passive” in matters of regulation. The surprise, he wrote, was that the Fed staff wasn’t nearly as eager to regulate as he had feared — a fact that other bank regulators in Washington often attributed to the dominance of market-loving economists at the Fed.

The new financial instruments, he said in a reprise of the Greenspan years at a 2005 Fed conference at Jackson Hole, Wyoming, “enable risk and return to be divided and priced to better meet the needs of borrowers and lenders … permit previously illiquid obligations to be securitized and traded, and … make obsolete previous divisions among types of financial intermediaries and across the geographical regions in which they operate.” Financial innovation made banks and other financial institutions “more robust” and made the financial system “more resilient and flexible” and “better able to absorb shocks without increasing the effects of such shocks on the real economy.” A more apt description might have been “originate and hide.” Banks hadn’t distributed nearly as much risk as even sophisticated observers thought. The bad loans — and massive losses — would end up with the banks, eroding their capital cushions to the point where, eventually, their only option for survival was a government bailout.


pages: 357 words: 110,017

Money: The Unauthorized Biography by Felix Martin

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, British Empire, call centre, capital asset pricing model, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, credit crunch, David Graeber, en.wikipedia.org, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, Fractional reserve banking, full employment, Goldman Sachs: Vampire Squid, Hyman Minsky, inflation targeting, invention of writing, invisible hand, Irish bank strikes, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, mobile money, moral hazard, mortgage debt, new economy, Northern Rock, Occupy movement, Plutocrats, plutocrats, private military company, Republic of Letters, Richard Feynman, Richard Feynman, Robert Shiller, Robert Shiller, Scientific racism, seigniorage, Silicon Valley, smart transportation, South Sea Bubble, supply-chain management, The Wealth of Nations by Adam Smith, too big to fail

It was not just brassed-off account-holders and exasperated taxpayers who expressed their doubts, but some of the leading lights of the financial industry itself. Adair Turner, Chairman of the U.K. Financial Services Authority, put it diplomatically in August 2009 when he said that at least some of the previous decade of financial innovation had been “socially useless.”5 Paul Volcker, the grand old man of global financial regulation, was more direct. The only financial innovation of the previous two decades that had added any genuine value to the broader economy, he said with withering contempt, was the ATM.6 The result of this powerful and widespread reaction to the crisis is that today, for the first time in decades, there are serious campaigns in progress in virtually all of the world’s most developed economies to reform banking, finance, and the entire framework of monetary policy and financial regulation.

Journal of Law and Economics 10, 1–13. —(1991), “The Island of Stone Money.” Hoover Institution Working Papers in Economics E91–3. Furness, W. (1910), The Island of Stone Money: Uap of the Carolines. Philadelphia, PA: Washington Square Press. Genovese, M., ed. (2009), The Federalist Papers. New York, NY: Palgrave Macmillan. Goetzmann, W.N., and Rouwenhorst, K.G., eds (2005), The Origins of Value: The Financial Innovations that Created Modern Capital Markets. Oxford: Oxford University Press. Goodhart, C. (1998), “The two concepts of money: implications for the study of optimal currency areas.” European Journal of Political Economy 14, 407–432. Goody, J., ed. (1968), Literacy in Traditional Society. Cambridge: Cambridge University Press. Graeber, D. (2011), Debt: The First 5,000 years. Brooklyn, NY: Melville House Publishing.

The End of Accounting and the Path Forward for Investors and Managers (Wiley Finance) by Feng Gu

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, barriers to entry, business process, Claude Shannon: information theory, Clayton Christensen, conceptual framework, corporate governance, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, double entry bookkeeping, Exxon Valdez, financial innovation, fixed income, hydraulic fracturing, index fund, inventory management, Joseph Schumpeter, knowledge economy, moral hazard, new economy, obamacare, quantitative easing, quantitative trading / quantitative finance, QWERTY keyboard, race to the bottom, risk/return, Robert Shiller, Robert Shiller, shareholder value, Steve Jobs, The Great Moderation, value at risk

In particular, economists recorded a shift in the mid-1980s toward stabilization of economic activity: It has been estimated that, since 1984, the variance (a statistical measure of volatility) of GDP growth has declined by an astounding 50 percent. The search for a full understanding of this phenomenon goes on, but stabilizing factors like improved inventory management by companies, better control of firms’ operations brought about by information technology, smarter government interventions in crises, and the increased use by companies of stabilizing (risk hedging) financial innovations are among the volatility-reducing factors already identified. And what about the substantial business disruptions caused by the 2007−2008 crisis, you ask? Just a hiccup. A 2014 study by Furman shows that the pre-crisis declining volatility was resumed after the financial crisis (“ . . . but overall volatility still appears to be at a lower level than in the past.”)9 So, our documented declining usefulness of financial information cannot be blamed on an increasingly turbulent business environment.

See Financial Accounting Standards Board Field, Marshall 4 Financial Accounting Standards Board (FASB) 6, 18, 181, 222 regulatory record, examination 213–214 Financial capital 82 Financial crisis, real estate (depression) 32–33 Financial data estimates 124 relevance, decrease 36 Financial indicators, impact (share) 36f 252 Financial information basis, problems 35–36 damage, accounting/nonaccounting (impact) 90 deterioration, accounting estimates (impact) 98–100 interpretation, experts (usage) 62 irrelevance 37 market, competition 41–42 quality 68 role 37 stock prices, contrast 29 usefulness decline 56, 67–68, 206 loss, investor interest 68–70 measurement 29–31 Financial innovations 71 Financial reporting direction, change 214 purpose (FASB) 30 Financial reports 46f contextual role 47 contribution 47 estimation, statistical methodology (usage) 44–45 economic condition 62 estimate-related terms, frequency (increase) 99f indicators, role 67 opaqueness 86–87 performance 62 performance-related information source 44 structure, freezing 8 structure/information, similarity 2 timelines, measurement 43–45 Firm operations, bottom line 154 Firm-specific errors 54 First-in-class product (Pfizer) 169–170 Follow-on patenting 166 Footprint size 187 Ford, Henry 52, 116 Ford Motor Company, car production 1 Forecasts, verification (enabling) 220–221 Fortune Global 500 Companies, 180 SUBJECT INDEX Full revelation, economic principle 202 Fundamentals 51 Funds decrease 69–70 sources 32 uses 32 Future earnings (prediction), earnings reporting ability (decline) 55f Geico advertising 147 brand, re-creation (impossibility) 148 General Electric, earnings per share (EPS) uncertainty/vagueness 94–95 Generally accepted accounting principles (GAAP) 96, 115 information 204 mandate 217 non-GAAP customer information 137 non-GAAP disclosure, problem 169 non-GAAP earnings, merits 205 non-GAAP measure 176 reforming 218 ROE 216 total sales, relevance (limitation) 174–175 Gilead, product pipeline 170–171 Goldman Sachs, investment dominance 83 Goodwill 109 GAAP mandate 217 value, impairment 61 write-offs 96, 219 Google car streaming market 140 intangible investment, increase 85 Great Depression 71 Great Moderation 71 Gross Domestic Product (GDP) growth 232 Gross margin ratio 154 Hedge fund managers, returns 17 Hewlett-Packard, Autonomy acquisition 84 Historical values 96–98 Subject Index Human capital, development 86–87 Hurricane Sandy claims 158 I/B/E/S data 23–24 First Call 48 IBM shares, decline 20 turnaround 122 IFRS.

See Financial information backward-looking information 52 company-related information sources 44 competition/litigation concerns 205–206 contribution 44 disagreement 63 quantification 63–65 importance 42 increase, requirement 87–88 intermediaries 62 manager cooperation 204–205 problems 84–86 proposed information, elicitation process 199–200 regulatory burden, lightening 206–208 253 SEC role 203 sources 68–69 alternative 70 ranking 30 theory (communication theory) 42 timelines, issue 43 uniformity 169 usefulness, measurement 30 uselessness 32 vagueness 63 Infringement 123 In-line products box 169–170 Innovation 166, 168 disruption 123 financial innovations 71 investment 164–165 revenues 176 In-process-R&D (IPRD) 96 balance sheet value 97 Insurance company operations 154f operations, risk 158 Intangible assets accounting problems 83–84 relevance, loss 88–90 rules, change (demand) 90 treatment 77–78 acquisition 85–86 amortization 216 asset treatment 214–217 capitalization 216 conspiracy of silence, application 86 disclosure, improvement 217–219 economic role, increase 37 emergence 37–38 increase 81–83 information increase, requirement 87–88 problems 84–86 investment, Google increase 85 nontradability 87–88 revolution 82f treatment, problem 78 uniqueness 87–88 valuation 215 254 Intangible capital increase 83 U.S. private sector investment 82f Intangible investments, expensing 216 Intellectual assets, economic role (increase) 37 Intellectual capital reports 113 Internal controls, gross inadequacies 123–124 International Financial Reporting Standard (IFRS) 217 Internet chat rooms 7 Internet service providers, patents 234 Inventory account 233 contribution 78 improvement 72 taking 233–235 Investments 156 efficiency 122 mapping 121–123 returns 18–19 risk, diversification 158 Investors agreement 63 contribution, example 45–46 decisions erosion 37–38 reported financial information, role 37 triggering 30 disagreement 63 fault 50 importance 119 information contribution 46f demand, SEC role 203 needs 114 relevance 185 investor-relevant information system 159 irrationality 50–51 necessity 142–144 operating instructions, Strategic Resources & Consequences Report issue 197, 230 SUBJECT INDEX reaction, measurement 43–44 usefulness 122 valuation process 219–220 IPRD.


pages: 248 words: 57,419

The New Depression: The Breakdown of the Paper Money Economy by Richard Duncan

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

asset-backed security, bank run, banking crisis, banks create money, Ben Bernanke: helicopter money, Bretton Woods, currency manipulation / currency intervention, debt deflation, deindustrialization, diversification, diversified portfolio, fiat currency, financial innovation, Flash crash, Fractional reserve banking, income inequality, inflation targeting, Joseph Schumpeter, laissez-faire capitalism, liquidity trap, market bubble, market fundamentalism, Mexican peso crisis / tequila crisis, money: store of value / unit of account / medium of exchange, mortgage debt, private sector deleveraging, quantitative easing, reserve currency, Ronald Reagan, savings glut, special drawing rights, The Great Moderation, too big to fail, trade liberalization

Approximately 75 percent of that money, roughly $5 trillion, went into the United States and, by 2007, supplied 10 percent of total credit market debt (TCMD) there. That flood of foreign capital threw fuel on the credit boom that was already underway there thanks to the elimination of the requirement that dollars be backed by gold and the near elimination of the requirement for the financial system to hold liquidity reserves. Thus, the creation of foreign fiat money and its investment into the United States was the third “financial innovation” responsible for the extraordinary proliferation of credit in the United States in recent decades. EXHIBIT 2.1 Total Foreign Exchange Reserves, 1948 to 2007 Source: IMF Fed Chairman Ben Bernanke blamed the flood of foreign capital entering the country on a global savings glut. That is nonsense. The citizens of other countries did not save so much that they were unable to find profitable investment opportunities at home and therefore were compelled to invest in the United States, as Bernanke’s theory suggests.

Credit, by contrast, was merely an obligation to repay a certain amount of money. After 1968, that distinction vanished. Dollars no longer represent a claim on a real commodity. Today, if a person attempts to redeem a dollar by presenting it to the Treasury Department, the government has no obligation to give that person anything other than another dollar. Dollars now, therefore, are simply credit instruments that do not pay interest. Meanwhile, because of financial innovation, credit has become more like money. Most credit instruments have long met the three criteria that define money. They can serve as a medium of exchange, they are a store of value, and they are a unit of account. In the past, however, they were not liquid. Now they are. The repo market makes them liquid. The repurchase market allows the owner of any credit instrument to obtain cash immediately by agreeing to repurchase that asset at a specified date in the future.


pages: 552 words: 168,518

MacroWikinomics: Rebooting Business and the World by Don Tapscott, Anthony D. Williams

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, airport security, Andrew Keen, augmented reality, Ayatollah Khomeini, barriers to entry, bioinformatics, Bretton Woods, business climate, business process, car-free, carbon footprint, citizen journalism, Clayton Christensen, clean water, Climategate, Climatic Research Unit, cloud computing, collaborative editing, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, corporate social responsibility, crowdsourcing, death of newspapers, demographic transition, distributed generation, don't be evil, en.wikipedia.org, energy security, energy transition, Exxon Valdez, failed state, fault tolerance, financial innovation, Galaxy Zoo, game design, global village, Google Earth, Hans Rosling, hive mind, Home mortgage interest deduction, interchangeable parts, Internet of things, invention of movable type, Isaac Newton, James Watt: steam engine, Jaron Lanier, jimmy wales, Joseph Schumpeter, Julian Assange, Kevin Kelly, knowledge economy, knowledge worker, Marshall McLuhan, medical bankruptcy, megacity, mortgage tax deduction, Netflix Prize, new economy, Nicholas Carr, oil shock, online collectivism, open borders, open economy, pattern recognition, peer-to-peer lending, personalized medicine, Ray Kurzweil, RFID, ride hailing / ride sharing, Ronald Reagan, scientific mainstream, shareholder value, Silicon Valley, Skype, smart grid, smart meter, social graph, social web, software patent, Steve Jobs, text mining, the scientific method, The Wisdom of Crowds, transaction costs, transfer pricing, University of East Anglia, urban sprawl, value at risk, WikiLeaks, X Prize, young professional, Zipcar

He concludes that “An open mathematical algorithm, or even published software, would far better describe the waterfalls, and associated payment structures.” This is not such a crazy idea, and other serious players agree. Rick Bookstaber was the former head of risk management for Salomon Brothers and Moore Capital, and is the author of A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation.10 He currently has a fulltime job at the SEC as a senior policy adviser for risk, strategy, and financial innovation and knows as much about the weird, opaque world of derivatives as anyone. Bookstaber calls for opening up derivatives to understand their value. “If we want to go down the path of standardized valuation and comparability in these complex portfolios, we need open derivatives models,” he says. “One thing we should have learned from the rating agency debacle is that even if we put aside the issues of monopoly power and conflict of interest, we cannot stop with having the proprietor of such models say, ‘Trust me, I know what I’m doing.’”

Those that are willing to subject their valuations to public vetting will be trusted, and those that are not will soon find their cost of funds increasing and their customers going someplace else. Banks once spoke of their fiduciary responsibilities, and through that their behavior established trust. Today it will take actions, not words. A process such as that proposed by Open Models to vet complex assets could go a long way toward restoring confidence in the system. Indeed, if financial innovation got the industry into trouble in the first place, perhaps forward-thinking initiatives such as Open Models may show a way out by challenging long-standing practices and assumptions. To be sure, Open Models is facing an uphill battle and success is far from assured. But any amount of transparency and openness that permeates the modus operandi of the industry will have a positive influence.

And it’s an alternative to the whack-a-mole game that regulators are forced to play in the ever changing financial services landscape. Innovators such as Open Models, VenCorps, and the myriad of P2P lenders are just the first sign of what’s to come. Opportunities for wikinomics-style collaborations abound. Financial regulators, investors, entrepreneurs, and banking customers are increasingly seeing the benefits of transparency, openness, and sharing. While financial innovation earned a bad name during the crisis, we feel that at the end of the day innovation will help the industry overcome its current challenges. As Gord Nixon puts it, “developing new products where you lend money to people who don’t have income is not innovation, that’s just bad risk management and faulty regulation. Developing new products to find better and less expensive ways to service your customers, that to me is innovation.” 4.


pages: 726 words: 172,988

The Bankers' New Clothes: What's Wrong With Banking and What to Do About It by Anat Admati, Martin Hellwig

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Andrei Shleifer, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, bonus culture, Carmen Reinhart, central bank independence, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, diversified portfolio, en.wikipedia.org, Exxon Valdez, financial deregulation, financial innovation, financial intermediation, George Akerlof, Growth in a Time of Debt, income inequality, invisible hand, Jean Tirole, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, margin call, Martin Wolf, moral hazard, mortgage debt, mortgage tax deduction, Nick Leeson, Northern Rock, open economy, peer-to-peer lending, regulatory arbitrage, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, sovereign wealth fund, technology bubble, The Market for Lemons, the payments system, too big to fail, Upton Sinclair, Yogi Berra

In the 1980s in Latin America and again since 2010 in Europe, banks have found that even governments can have problems paying their debts if they cannot print the money they owe. In Latin America in the 1980s, support for debtor countries from the IMF got most of the banks off the hook. In Europe, support from the IMF and from other Eurozone countries since 2010 has also limited the damage. The Belgian-French bank Dexia and Germany’s Hypo Real Estate, however, would have been insolvent without direct government support.39 Financial Innovation to the Rescue? As we have seen, the traditional model of deposit banking has important weaknesses. Activities might be disrupted by runs, the renewal of funding might be impossible or too costly, or returns from investments might not be sufficient to pay depositors. Deposit insurance has all but eliminated the problem of runs by depositors, but it has not addressed the other problems. From the 1930s to the early 1970s, these problems did not play much of a role, but since then the economy has become less stable and interest rates have become much more volatile.

Banks’ risks from changes in refinancing costs and from changes in returns on loans and other investments have increased.40 In the early 1980s and again in the late 1980s, traditional depository institutions turned out to be very vulnerable to these risks. In this risky new world, the 3-6-3 model of specialized savings banks that take deposits and make mortgage loans was no longer viable.41 In this much riskier world, the needs of savings banks like the Bailey Building and Loan Association drove financial innovations in the 1980s and 1990s. Many tools were developed to transfer risks from savings banks to other investors. In this context a major role was played by what is called securitization, a procedure that allows commercial banks and savings banks to sell their loans and mortgages to other investors. The word securitization refers to the fact that a group of loans that are not directly tradable in a market can be bundled together and turned into bonds, that is, securities that are tradable.

For several reasons, however, this is problematic. First, the equity levels of recent decades were artificially low because banks and their creditors had become used to the government safety net. Second, the increases in the intensity of competition in financial markets that we have seen since the 1970s have decreased the banks’ ability to withstand shocks. Third, the high degree of interconnectedness in the system that has come with financial innovation and with globalization has magnified the potential fallout from the failure of a systemically important financial institution for the global economy. Moreover, institutions tend to be exposed to the same shocks and therefore run into trouble at the same time. All these concerns lead to the conclusion that the levels of equity banks have had in recent decades do not provide appropriate guidance as to what bank equity should be.55 Since 2010, when we became more outspoken about the need for an ambitious reform of capital regulation, we have engaged in many discussions on the subject, yet we have never received a coherent answer to the question of why banks should not have equity levels between 20 and 30 percent of their total assets.56 (A caveat on providing specific ratios is that their meaning will depend on accounting conventions.)


pages: 823 words: 206,070

The Making of Global Capitalism by Leo Panitch, Sam Gindin

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, airline deregulation, anti-communist, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Basel III, Big bang: deregulation of the City of London, bilateral investment treaty, Branko Milanovic, Bretton Woods, BRICs, British Empire, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collective bargaining, continuous integration, corporate governance, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, currency peg, dark matter, Deng Xiaoping, disintermediation, ending welfare as we know it, eurozone crisis, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, full employment, Gini coefficient, global value chain, guest worker program, Hyman Minsky, imperial preference, income inequality, inflation targeting, interchangeable parts, interest rate swap, Kenneth Rogoff, land reform, late capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, manufacturing employment, market bubble, market fundamentalism, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, Monroe Doctrine, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, Northern Rock, oil shock, precariat, price stability, quantitative easing, Ralph Nader, RAND corporation, regulatory arbitrage, reserve currency, risk tolerance, Ronald Reagan, seigniorage, shareholder value, short selling, Silicon Valley, sovereign wealth fund, special drawing rights, special economic zone, structural adjustment programs, The Chicago School, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transcontinental railway, trickle-down economics, union organizing, very high income, Washington Consensus, Works Progress Administration, zero-coupon bond

As a paper prepared for the Federal Reserve of Boston in 1971 put it: “This asymmetry appears to be appropriate, for it corresponds to an asymmetry in the real world.”57 Far from necessarily representing a diminution of American power, the outflow of capital from the US and the balance-of-payments deficits that had so concerned economic and political elites through the 1960s had actually laid the basis for further dollar-based credit expansion and financial innovation both domestically and internationally in the 1970s. This is what Jeremy Seabrooke later would aptly term the “diffusion of power through the dollar.”58 Indeed, one could also speak of the concentration of US power through the dollar, as more and more capital flowed into the US in the wake of the demise of Bretton Woods. The capacity to achieve this, however, still rested not only on the international activities of the American state, but also on the material base of the American empire at home.

While the currency crisis destabilized the EMS and forced the adoption of a much looser Exchange Rate Mechanism, the embrace of these measures by Europe’s states meant that the march towards the single currency could be resumed with the assurance that “discipline” would prevail. Especially significant in this respect, and indeed for the overall shift in the balance of class forces in Europe, was the transformation of European financial markets along US lines.18 The City of London, which had since the 1960s served US banks “as a laboratory for financial innovation” at the center of the Euromarkets, was the leading site of this Americanization.19 The removal of UK capital controls in 1979, the City of London’s own “big bang” in 1987, and the new stock exchange system modeled on the automated NASDAQ in the US, were all about trying to compete with New York on a level playing field, reinforced by direct pressures from the Wall Street investment banks operating in London.

But, as was pointed out in the New York Times in the wake of the containment of the LTCM crisis: “so far, the combination of large capital cushions, diversified loans, stress tests and prompt regulatory action has been enough to keep banks healthy. The system is not well equipped to handle what one Government official calls ‘financial Armageddon’ . . . but the fallout from Armageddon is exactly what the Federal Reserve is designed to solve.”88 The increasingly enhanced role for the state as financial firefighter had evolved through the 1990s alongside regulatory changes that encouraged financial innovation, integration, and expansion. It was the goal of advancing this even further that led to the victory of the Treasury and the Fed in the very wake of the 1998 crisis in finally getting Congress to repeal the 1933 and 1935 banking rules. By this time, as we have seen, the old compartmentalization of banking hardly existed in its original form. As a result, the Gramm-Leach-Bliley Act of 1999 repealing the Glass-Steagall Act was more about completing a long regulatory process than about ushering in a completely new legal environment.


pages: 275 words: 82,640

Money Mischief: Episodes in Monetary History by Milton Friedman

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Bretton Woods, British Empire, currency peg, double entry bookkeeping, fiat currency, financial innovation, floating exchange rates, full employment, German hyperinflation, income per capita, law of one price, oil shock, price anchoring, price stability, transaction costs

In addition, inflation in the United States produced a rise in nominal interest rates that converted the government's control, via Regulation Q, of the interest rates that banks could pay from a minor to a serious impediment to the effective clearing of credit markets. One response was the invention of money-market mutual funds as a way to enable small savers to benefit from high market interest rates. The money-market funds proved an entering wedge to financial innovation that forced the prompt relaxation and subsequent abandonment of control over the interest rates that banks could pay, as well as the loosening of other regulations that restricted the activities of banks and other financial institutions. Such deregulation as has occurred came too late and has been too limited to prevent a sharp reduction in the role of banks, as traditionally defined, in the U.S. financial system as a whole.

For a modern society in which government taxes and spending have mounted to between 30 percent and 50 percent—occasionally even more—of the national income, this component is perhaps the least important of the three. Even if inflation did not reduce the ratio of the base to national income (which it unquestionably would do), a 10 percent annual increase in the base would currently yield as revenue to the U.S. government only about seven-tenths of 1 percent of national income. Further financial innovation is likely to reduce still further the ratio of base money to national income, even aside from the effect of inflation, making this source of revenue still less potent. I believe that the same tendencies have been present in many other countries, so that this source of revenue has become less important for them as well. The second component of revenue—bracket creep—has very likely been far more important than the first.


pages: 268 words: 74,724

Who Needs the Fed?: What Taylor Swift, Uber, and Robots Tell Us About Money, Credit, and Why We Should Abolish America's Central Bank by John Tamny

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Airbnb, bank run, banks create money, Bernie Madoff, bitcoin, Bretton Woods, Carmen Reinhart, correlation does not imply causation, Credit Default Swap, crony capitalism, crowdsourcing, Donald Trump, Downton Abbey, fiat currency, financial innovation, Fractional reserve banking, full employment, George Gilder, Home mortgage interest deduction, Jeff Bezos, job automation, Joseph Schumpeter, Kenneth Rogoff, Kickstarter, liquidity trap, Mark Zuckerberg, market bubble, moral hazard, mortgage tax deduction, NetJets, offshore financial centre, oil shock, peak oil, Peter Thiel, price stability, profit motive, quantitative easing, race to the bottom, Ronald Reagan, self-driving car, sharing economy, Silicon Valley, Silicon Valley startup, Steve Jobs, The Wealth of Nations by Adam Smith, too big to fail, Uber for X, War on Poverty, yield curve

That’s exactly why government should never act as an investor or a savior. Business sectors and economies don’t grow if the laggards are given a lifelong lifeline. Lest we forget, Silicon Valley’s wealth is not a function of all of its businesses succeeding. It thrives precisely because most of its start-ups fail. Failure is the driver of perfection. While Wall Street and the banks remain an important source of financial innovation, logic tells us that freedom to fail would make both even healthier. As discussed in chapter 13, the argument in favor of saving failed financial institutions was most prominently made by Ben Bernanke in 2008. As this book mentioned previously, he told then House Speaker Nancy Pelosi, “I spent my career as an academic studying great depressions. I can tell you from history that if we don’t act in a big way, you can expect another great depression, and this time it is going to be far worse.”

Government is the opposite of innovation, of credit creation, and of market discipline. Washington’s involvement with Wall Street has changed Wall Street, and more realistically it has deformed Wall Street. The seen is a fairly prosperous financial sector, but the unseen is how much more prosperous it would be, how many more companies it would take public, how many more companies it would be merging, and how many more financial innovations it would be achieving absent government meddling. Government’s tight relationship weakens Wall Street, it realistically discredits Washington, and the combination weakens the economy by virtue of it limiting the flow of credit to the best ideas. It’s well past time to end a mutually abusive relationship that is neutering—and politicizing—a source of credit creation. Greater prosperity will be the reward if the banks and investment banks that have grown too close to Washington are allowed to succeed or fail on their own, and with no cushion for the failures.


pages: 602 words: 120,848

Winner-Take-All Politics: How Washington Made the Rich Richer-And Turned Its Back on the Middle Class by Paul Pierson, Jacob S. Hacker

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, affirmative action, asset allocation, barriers to entry, Bonfire of the Vanities, business climate, carried interest, Cass Sunstein, clean water, collective bargaining, corporate governance, Credit Default Swap, David Brooks, desegregation, employer provided health coverage, financial deregulation, financial innovation, financial intermediation, full employment, Home mortgage interest deduction, Howard Zinn, income inequality, invisible hand, knowledge economy, laissez-faire capitalism, Martin Wolf, medical bankruptcy, moral hazard, Nate Silver, new economy, night-watchman state, offshore financial centre, oil shock, Ralph Nader, Ronald Reagan, shareholder value, Silicon Valley, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, union organizing, very high income, War on Poverty, winner-take-all economy, women in the workforce

As for financial professionals, who make up a much larger proportion of the top 0.1 percent (nearly two in ten taxpayers), it strains credulity to say they are merely the talented tamers of technological change. After all, plenty of the so-called financial innovations that their complex computer models helped spawn proved to be just fancier (and riskier) ways of gambling with other people’s money, making quick gains off unsophisticated consumers, or benefiting from short-term market swings. Moreover, most of these “innovations” could occur only because of the failure to update financial rules to protect against the resulting risks—much to the chagrin of the rest of Americans who ended up bailing the innovators out. Former Fed chairman Paul Volcker was no doubt channeling a widespread sentiment when he said in 2009 that the last truly helpful financial innovation was the ATM.7 What is more, government policy not only failed to push back against the rising tide at the top in finance, corporate pay, and other winner-take-all domains, but also repeatedly promoted it.

Technological innovation made possible the development of new financial instruments and facilitated spectacular experiments with securitization. Computers helped Wall Street transform from million-share trading days in the 1980s to billion-share trading days in the late 1990s, magnifying the possibilities for gains—and losses.63 The shredding of the post–New Deal rule book for financial markets did not, however, simply result from the impersonal forces of “financial innovation.” In Canada, for instance, government effectively resisted many of the efforts of financial interests to rewrite the rules—and Canada was largely spared the financial debacle of the past few years. The transformation of Wall Street reflected the repeated, aggressive application of political power. Some of that power was directed at removing existing regulations designed to protect against speculative excess and conflicts of interest.


pages: 402 words: 110,972

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

AI winter, algorithmic trading, asset allocation, banking crisis, barriers to entry, Big bang: deregulation of the City of London, butterfly effect, buttonwood tree, buy low sell high, capital asset pricing model, citizen journalism, collateralized debt obligation, corporate governance, Craig Reynolds: boids flock, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, Emanuel Derman, en.wikipedia.org, experimental economics, financial innovation, Gordon Gekko, implied volatility, index arbitrage, index fund, information retrieval, Internet Archive, John Nash: game theory, Khan Academy, load shedding, Long Term Capital Management, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, moral hazard, mutually assured destruction, natural language processing, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Renaissance Technologies, Richard Stallman, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, semantic web, Sharpe ratio, short selling, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, too big to fail, transaction costs, Turing machine, Upton Sinclair, value at risk, Vernor Vinge, yield curve, Yogi Berra

The book is humorously written but it is serious and insightful. It makes an important contribution to our understanding of financial innovation and the evolution of the capital markets.” —André F. Perold, George Gund Professor of Finance and Banking, Harvard Business School “ Finally, a book that rightly honors the pocket-protected, RPN-loving, object-oriented, C-compatible, self-similar Wall Street quant! This is a delightfully entertaining romp across the trading floors and through the research departments of major financial institutions, told by one of the early architects of automated trading and a self-made nerd.” —Andrew W. Lo, Professor of Finance, MIT Sloan School of Management “ David Leinweber is one of the great financial innovators of our time. David possesses a unique combination of expertise in the fields of money management, artificial intelligence, and computer science.”

Fischer Black, after leaving MIT for Goldman Sachs, said, “Markets look a lot more efficient from the banks of the Charles than from the banks of the Hudson.”3 Someone gets to pick up that $100 bill. Back on the banks of the Charles in Boston 25 years later, Andy Lo wrote,“Profits may be viewed as the economic rents which accrue to [the] competitive advantage of . . . superior information, superior technology, financial innovation. . . .”4 If this conjures up images of ever faster, better, larger computing engines at giant quantitative hedge funds, you are getting the message. But this idea is not suddenly true today; it has been true forever. Innovations used to use less electricity, though. In 1790, the technology that produced vast alpha for innovative traders was boats. After the American Revolution, war bonds were trading for less than a nickel on the dollar.


pages: 538 words: 121,670

Republic, Lost: How Money Corrupts Congress--And a Plan to Stop It by Lawrence Lessig

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

asset-backed security, banking crisis, carried interest, cognitive dissonance, corporate personhood, correlation does not imply causation, crony capitalism, David Brooks, Edward Glaeser, Filter Bubble, financial deregulation, financial innovation, financial intermediation, invisible hand, jimmy wales, Martin Wolf, meta analysis, meta-analysis, Mikhail Gorbachev, moral hazard, place-making, profit maximization, Ralph Nader, regulatory arbitrage, rent-seeking, Ronald Reagan, Silicon Valley, single-payer health, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, WikiLeaks, Zipcar

By calling this a “bet,” however, and by invoking remote American villages, I quiRobustdon’t mean to question the economic wisdom behind derivatives. To the contrary: Derivatives serve a valuable purpose. As with any contract, their aim is to shift risk within a market to someone better able to carry it. That’s a good thing, for the market, and the economy generally. That we’ve just seen an economy detonated by derivatives gone wild shouldn’t lead us to ban (as if we could) these financial innovations. It should, however, lead us to be more careful about them. At the birth of this innovation, however, no one was thinking much about being careful. Nor thinking clearly. Too many made an error of aggregation: even if derivatives enabled individuals to diversify risk, they couldn’t reduce the risk for the system as a whole.7 That didn’t matter much at first, since the market for derivatives was initially tiny.

Too many made an error of aggregation: even if derivatives enabled individuals to diversify risk, they couldn’t reduce the risk for the system as a whole.7 That didn’t matter much at first, since the market for derivatives was initially tiny. A collapse in a tiny market doesn’t do much systemic harm. Technology soon changed all this, making it possible for the market in derivatives to explode. With the digital revolution distributing computing power to the masses, masses of financial analysts on Wall Street were able to use this computing power to concoct ever-more-complicated financial “innovations.” With each of these concoctions, a new and fiercely competitive market would race to catch up. For a brief time, the innovator had an edge (and huge profit margin). But very quickly, others copied and improved on his invention, driving down profits, and driving innovators to find new derivative markets. (Here was a market with no real intellectual property protection, yet an insanely strong drive to innovate.)

It is instead a kind of wealth that is almost unimaginable to the vast majority of Americans. The biggest winners here are financial executives. As Nobel Prize–winning economist Joseph Stiglitz writes, “Those who have contributed great positive innovations to our society—from the pioneers of genetic understanding to the pioneers of the Information Age—have received a pittance compared with those responsible for the financial innovations that brought our global economy to the brink of ruin.”106 In 2004, “nonfinancial executives of publicly traded companies accounted for less than 6% of the top .01 percent of the income bracket. In that same year, the top 25 hedge fund managers combined appear to have earned more than all of the CEOs from the entire S&P 500.”107 The next big winners were the top executives from the S&P 500 companies.


pages: 457 words: 128,838

The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order by Paul Vigna, Michael J. Casey

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

3D printing, Airbnb, altcoin, bank run, banking crisis, bitcoin, blockchain, Bretton Woods, California gold rush, capital controls, carbon footprint, clean water, collaborative economy, collapse of Lehman Brothers, Columbine, Credit Default Swap, cryptocurrency, David Graeber, disintermediation, Edward Snowden, Elon Musk, ethereum blockchain, fiat currency, financial innovation, Firefox, Flash crash, Fractional reserve banking, hacker house, Hernando de Soto, high net worth, informal economy, Internet of things, inventory management, Julian Assange, Kickstarter, Kuwabatake Sanjuro: assassination market, litecoin, Long Term Capital Management, Lyft, M-Pesa, Mark Zuckerberg, McMansion, means of production, Menlo Park, mobile money, money: store of value / unit of account / medium of exchange, Network effects, new economy, new new economy, Nixon shock, offshore financial centre, payday loans, peer-to-peer lending, pets.com, Ponzi scheme, prediction markets, price stability, profit motive, RAND corporation, regulatory arbitrage, rent-seeking, reserve currency, Robert Shiller, Robert Shiller, Satoshi Nakamoto, seigniorage, shareholder value, sharing economy, short selling, Silicon Valley, Silicon Valley startup, Skype, smart contracts, special drawing rights, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, supply-chain management, Ted Nelson, The Great Moderation, the market place, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, Turing complete, Tyler Cowen: Great Stagnation, Uber and Lyft, underbanked, WikiLeaks, Y Combinator, Y2K, Zimmermann PGP

If somebody was ever looking for a moment to launch an alternative monetary system, the person could not have picked a better time. Let’s not forget, also, that Nakamoto launched his project with a reminder that his new currency would require no government, no banks, and no financial intermediaries, “no trusted third party.” It offered the antithesis to the core problem of that moment in history. For all the technical and legal wizardry employed by Wall Street’s denizens, for all the financial innovation practiced by the Street’s bankers, trust was the most important element of capital markets—trust that counterparties were good for the money they pledged; trust that market prices really did reflect all available information at the time; trust that if an asset was represented on the balance sheet as being worth X amount of dollars, it actually was worth X amount of dollars. The collapse of Lehman and AIG shattered all that.

Even in the United Kingdom, which is within the European Union but often goes its own way on tax and regulatory rules, the prospect is for an easier hand for cryptocurrency. In August 2014, Chancellor of the Exchequer George Osborne said the United Kingdom would launch a comprehensive study to figure out how to take advantage of cryptocurrency technology and devise rules to turn Britain into “the global center for financial innovation.” Though some worried about a repeat of New York’s BitLicense disappointment, Osborne’s words certainly sounded encouraging. He said digital-currency-based “alternative payment systems are popular as they are quick, cheap, and convenient” and that he wants to “see if we can make more use of them for the benefit of the U.K. economy.” Even before then, various bitcoin firms had chosen to make London their home, including Blockchain and Coinfloor, a high-tech, fully regulated bitcoin exchange.

Many forms of goods and services can be traded without needing a medium of exchange such as a dollar or a bitcoin. By extension, we end up with less need for central banks and certainly no need for centralized interest rates, as everything’s price would float against that of everything else, which—if the market is allowed to function—would mean all things ultimately find some equilibrium. Zurich-based investment manager and high-tech financial innovator Richard Olsen has talked up the prospect of this “digital barter society” with bankers, hedge fund managers, and anyone else who’ll listen. He says that as foreign as it sounds, it resonates with lots of people on Wall Street. Why? “Because it’s the only way out of the mess we’ve gotten ourselves into,” he says. Olsen argues that because prices, especially wages, have not been allowed to find their natural level, economic distortions have arisen, leading to crises like those of 2008 and the euro crisis after it.


pages: 566 words: 155,428

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, banks create money, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial innovation, fixed income, friendly fire, full employment, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, market clearing, market fundamentalism, McMansion, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, price mechanism, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, working-age population, yield curve, Yogi Berra

In trade parlance, deals like those are called “naked CDS” because neither party owns the bond. And look what happens. Prior to the CDS, neither Smith nor Jones had any stake in whether GM defaulted. But after the transactions, they do. If GM defaults, Smith wins and Jones loses; and the reverse occurs if GM pays on time. Risk has been created, not extinguished. This evolution from hedging to gambling is typical of financial innovation. New instruments that are originally—or perhaps allegedly—designed to hedge away risk typically become innovative ways to create risk where none existed before. Total risk taking in society rises. Three other key features of CDS are worth noting because they, too, are typical of derivatives. First, the deal embeds huge synthetic leverage. If the CDS buyer makes just a few premium payments before GM defaults, she wins a huge multiple of her investment, and the CDS seller suffers a commensurate loss.

Looking back ruefully eleven years later, Bill Clinton wrote, “I can be fairly criticized for not making a bigger public issue out of the need to regulate financial derivatives.” Of course, his Treasury Department did make it a big public issue. They were just on the wrong side. Warren Buffett and Paul Volcker weren’t. Buffett famously termed derivatives “financial weapons of mass destruction” in 2003. Volcker, who had been decrying financial engineering for years, once sarcastically asserted, “The most important financial innovation I’ve seen in the last 25 years is the automatic teller machine.” In the Buffett-Volcker view, derivatives were not very useful but were very dangerous, which certainly suggests that they ought to be highly regulated. That’s quite a range of opinion, and both views contain elements of truth. But after hundreds, if not thousands, of derivatives exploded during the financial crisis—acting much like the financial WMDs Buffett had warned of—the antiregulation view was put to rout, at least temporarily.

Thou Shalt Keep It Simple, Stupid Modern finance thrives on complexity; indeed, you might say that the central idea of financial engineering is complexity. But ask yourself whether all those fancy financial instruments actually do the economy any good. Or are they perhaps designed to enrich their designers? Economists are accustomed to thinking of innovation as unambiguously good; it raises standards of living. But is that always true in finance? Is it even usually true? I do not mean to imply that all financial innovations are harmful; as Paul Volcker pointed out, the ATM did a lot of good. So, most likely, did mutual funds, money market funds, and plain-vanilla mortgage pools. But who needed CDO-squared? What did those monstrosities contribute to the betterment of mankind? Of course, simplicity and complexity are in the eye of the beholder. They can’t be legislated, probably not even regulated. So we may have to rely on good judgment, transparency, and—here comes that phrase again—market discipline.


pages: 425 words: 122,223

Capital Ideas: The Improbable Origins of Modern Wall Street by Peter L. Bernstein

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, asset allocation, backtesting, Benoit Mandelbrot, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buy low sell high, capital asset pricing model, debt deflation, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, full employment, implied volatility, index arbitrage, index fund, interest rate swap, invisible hand, John von Neumann, Joseph Schumpeter, law of one price, linear programming, Louis Bachelier, mandelbrot fractal, martingale, means of production, new economy, New Journalism, profit maximization, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, stochastic process, the market place, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, transfer pricing, zero-coupon bond

We are fascinated by innovation and lionize the innovators. We are partial to tinkerers and make folk-heroes out of people like Thomas Edison, Henry Ford, and Benjamin Franklin. But sometimes change seems to run amuck and things appear to be out of control. Then fear takes over and spoils our appetite for novelty. That is what has happened in Wall Street over the past fifteen or twenty years. The complexity and speed of financial innovation have reached a point where it is hard to grasp what is happening from moment to moment. Amateur investors and many professionals are wary of space-age trading strategies and kinky financial instruments that seem beyond their understanding. Individual investors grumble that they are the last to receive information about the stocks they own and the last to find buyers when security prices are dropping.

Tall, thin, and prematurely bald, as befits a deep thinker, he is a quiet, serene, soft-spoken man who claims, “I sincerely do like virtually everyone I meet.” He engages in Buddhist meditation and can read Tibetan. His wife, June, who has a master’s degree in psychology and trained as an opera singer, joins him in these devotions. For most of Rosenberg’s career, he has considered himself more of an econometrician than an authority in finance. He nominates John McQuown as “the prototype financial innovator, who believed intensely in the new ideas and would unswervingly push them.” Rosenberg insists, “I’ve made no major contributions to the literature. There is nothing intrinsically new in the system,” He told me that he sees many of his ideas as “just great attention to details but very obvious . . . must seem very uninviting.” He believes that, had the technology and patience been available, they could all have been developed by someone else thirty years before he developed them.

Fischer Black, Myron Scholes, and Robert Merton change the whole world of finance by staring at differential equations. Through it all, the only sound we hear is the clanking of primitive computers. They surveyed the scene from the top of the ivory tower. Let us now share their perspective, which reaches beyond the dickering business of eighths and quarters on a block trade and the flashing numbers on a computer screen. As the derring-do of Michael Milken and his cohorts fades from view, as financial innovation advances, and as the global economy fosters increasingly competitive financial markets, the vitality and flexibility of the capital markets come into sharp focus. These markets are the marvel of the capitalist system that the world yearns to emulate. The clatter of the computer and the roar of the trading floor are the sounds of a great battle in which investors compete with one another to determine who can buy at the lowest and sell at the highest.


pages: 461 words: 128,421

The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, bank run, Benoit Mandelbrot, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, card file, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discovery of the americas, diversification, diversified portfolio, Edward Glaeser, endowment effect, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, floating exchange rates, George Akerlof, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, invisible hand, Isaac Newton, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market design, New Journalism, Nikolai Kondratiev, Paul Lévy, pension reform, performance metric, Ponzi scheme, prediction markets, pushing on a string, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, South Sea Bubble, statistical model, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, value at risk, Vanguard fund, volatility smile, Yogi Berra

For just about everybody in finance besides Gene Fama, though, the concept of the rational financial market was about more than just stocks. Securities markets in general were believed to have near-magical properties of speed and randomness and correctness. The mortgage market had become a securities market. Yet it got things terribly wrong on the way up, and ceased to function on the way down. This reign of error could be attributed in part to the inevitable perils of financial innovation. Almost every great financial market bubble and crash through history has involved some new financial product or technology that market participants, without experience to call on, vastly underestimate the risks of. From tulip bulbs in seventeenth-century Holland to CDOs built around subprime mortgages, newness has always been a danger sign. Nothing new there, except that quantitative risk modeling may have made people even more blind to the potential downside than usual.

He knew all about Fisher’s bad 1920s market advice and his economic theories, but he didn’t know so much about Fisher’s reams of financial inventions and would-be inventions. Back upstais in Shiller’s office, we continued the discussion. Fisher’s belief in better data and better financial instruments squared pretty well with his economic theories. But Shiller had been arguing for decades that even well-designed markets populated by well-informed investors were prone to manias and panics—which made his belief in progress through financial innovation a bit paradoxical. At least, that’s what I told him. “I don’t think it’s a paradox,” he responded. “These are inventions that have to be human-engineered, and inventions can get people in trouble. When they first invented airplanes, there were a lot of crashes. I think it’s really the same thing.” That reminded me of a headline I had seen in The Onion the previous year: “AMA: Plastic Sugery ‘Only A Few Years Away’ From Making Someone Look Better.”21 Shiller laughed at that, adding that he had read that medicine had crossed that threshhold of doing more good than harm sometime around 1865.

The subsequent account of Long-Term Capital Management’s fall is, except where otherwise attributed, taken from the two books: Nicholas Dunbar, Inventing Money: The Story of Long-Term Capital Management and the Legends Behind It (New York: John Wiley & Sons, 2000); Roger Lowenstein, When Genius Failed: The Rise and Fall of Long-Term Capital Management (New York: Random House, 2000). 22. Joe Kolman, “LTCM Speaks,” Derivatives Strategy (April 1999): www.derivativesstrategy.com/magazine/archive/1998/0499fea1.asp. 23. Robert Litzenberger speech, Society of Quantitative Analysts. 24. Richard Bookstaber, A Demon of Their Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation (Hoboken, N.J.: John Wiley & Sons, 2007), 97. 25. The LTCM partner whose lecture Markowitz attended was David Modest. 26. The most detailed description of Greenspan’s and Corrigan’s actions is in Bob Woodward, Maestro: Greenspan’s Fed and the American Boom (New York: Touchstone, 2001), 36–47, but better accounts of the market’s malfunctioning on the twentieth can be found in the Brady report and in James B.


pages: 584 words: 187,436

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, Bretton Woods, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, market clearing, market fundamentalism, merger arbitrage, moral hazard, natural language processing, Network effects, new economy, Nikolai Kondratiev, pattern recognition, pre–internet, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, technology bubble, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs

In this way, the forecasters would speed up the workings of the market while working themselves out of a job. As Jones concluded in his Fortune piece, the price trends would cease. The market would be left to “fluctuate in a relatively gentle, orderly way to accommodate itself to fundamental economic changes only.” To an extent that he could not possibly have foreseen, Jones was anticipating the history of hedge funds. Over the succeeding decades, wave upon wave of financial innovators spotted opportunities to profit from markets, and many of them found that once their insight had been understood by a sufficient number of investors, the profit opportunity faded because the markets had grown more efficient. In the 1950s and 1960s, Jones himself was destined to impose a new efficiency upon markets. But the nature of that change was not at all what he expected. BY THE TIME THE FORTUNE ESSAY APPEARED IN MARCH 1949, Jones had launched the world’s first hedge fund.

The engineers had created a destabilizing feedback loop: A fall in the market triggered insurance-based selling, which in turn triggered a further fall in the market and another insurance-based sell-off. Mark Rubinstein, a Berkeley economics professor and coinventor of portfolio insurance, descended into what he would later recognize as a clinical depression. He fretted that the weakening of American markets might tempt the Soviet Union to attack, making him personally responsible for a nuclear conflict.62 Not for the first time, financial innovation was being blamed too eagerly. Soros had believed that portfolio insurance created Black Monday; but markets had crashed periodically throughout history, and foreign markets, in which there was far less portfolio insurance, also suffered precipitous falls. Even in the United States, the postmortems on the crash found that of the $39 billion worth of stock sold on October 19 via the futures and the cash markets, only about $6 billion worth of sales were triggered by portfolio insurers.

If Simons refused, they would quit and join a rival.31 Simons refused to be blackmailed, and the Russians left to join another hedge fund. On the face of it, this looked like a catastrophic blow. Because of the open structure at Renaissance, the Russians understood a lot about how the system worked. If they started trading on Renaissance’s signals, they would siphon off part of its profits; it would be as though pirates were making generic copies of a pharmaceutical company’s blockbuster therapy. Patents do not protect financial innovations in the way that they protect medical ones, so Simons’s legal remedies were uncertain. And yet the remarkable thing was that Medallion’s performance continued to leave rivals in the dust. Like the magician who drinks poison and survives, Simons emerged looking more mysterious than ever. How could this survival act be possible? Part of the answer may lie with Renaissance’s lawyers: By suing the Russians and their new employer, Simons may have deterred them from rolling out a rival system at full speed; and in 2006 a settlement laid down that the Russians would cease trading.32 But lawyers are not the whole answer, since the Russians did operate a rival system for two or three years, and during those years Medallion did extremely well—even if its profits would probably have been higher still without the alleged theft of intellectual property.


pages: 725 words: 221,514

Debt: The First 5,000 Years by David Graeber

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Admiral Zheng, anti-communist, back-to-the-land, banks create money, Bretton Woods, British Empire, carried interest, cashless society, central bank independence, colonial rule, corporate governance, David Graeber, delayed gratification, dematerialisation, double entry bookkeeping, financial innovation, full employment, George Gilder, informal economy, invention of writing, invisible hand, Isaac Newton, joint-stock company, means of production, microcredit, money: store of value / unit of account / medium of exchange, moral hazard, oil shock, payday loans, place-making, Ponzi scheme, price stability, profit motive, reserve currency, Ronald Reagan, seigniorage, short selling, Silicon Valley, South Sea Bubble, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, transatlantic slave trade, transatlantic slave trade, tulip mania, upwardly mobile, urban decay, working poor

In the wake of this, there was not only public rage and bewilderment, but the beginning of an actual public conversation about the nature of debt, of money, of the financial institutions that have come to hold the fate of nations in their grip. But that was just a moment. The conversation never ended up taking place. The reason that people were ready for such a conversation was that the story everyone had been told for the last decade or so had just been revealed to be a colossal lie. There’s really no nicer way to say it. For years, everyone had been hearing of a whole host of new, ultra-sophisticated financial innovations: credit and commodity derivatives, collateralized mortgage obligation derivatives, hybrid securities, debt swaps, and so on. These new derivative markets were so incredibly sophisticated, that—according to one persistent story—a prominent investment house had to employ astrophysicists to run trading programs so complex that even the financiers couldn’t begin to understand them. The message was transparent: leave these things to the professionals.

If it was only China that developed paper money in the Middle Ages, this was largely because only in China was there a government large and powerful enough, but also, sufficiently suspicious of its mercantile classes, to feel it had to take charge of such operations. The Near West: Islam (Capital as Credit) Prices depend on the will of Allah; it is he who raises and lowers them. —Attributed to the Prophet Mohammed The profit of each partner must be in proportion to the share of each in the adventure. Islamic legal precept For most of the Middle Ages, the economic nerve center of the world economy and the source of its most dramatic financial innovations was neither China nor India, but the West, which, from the perspective of the rest of the world, meant the world of Islam. During most of this period, Christendom, lodged in the declining empire of Byzantium and the obscure semi-barbarous principalities of Europe, was largely insignificant. Since people who live in Western Europe have so long been in the habit of thinking of Islam as the very definition of “the East,” it’s easy to forget that, from the perspective of any other great tradition, the difference between Christianity and Islam is almost negligible.

It seems significant here that in the Middle East, in the first round, those popular movements that most directly challenged the global status quo tended to be inspired by Marxism; in the second, largely, some variation on radical Islam. Considering that Islam has always placed debt at the center of its social doctrines, it’s easy to understand the appeal. But why not throw things open even more widely? Over the last five thousand years, there have been at least two occasions when major, dramatic moral and financial innovations have emerged from the country we now refer to as Iraq. The first was the invention of interest-bearing debt, perhaps sometime around 3000 bc; the second, around 800 ad, the development of the first sophisticated commercial system that explicitly rejected it. Is it possible that we are due for another? For most Americans, it will seem an odd question, since most Americans are used to thinking of Iraqis either as victims or fanatics (this is how occupying powers always think about the people they occupy), but it is worthy of note that the most prominent working-class Islamist movement opposed to the U.S. occupation, the Sadrists, take their name from one of the founders of contemporary Islamic economics, Muhammad Baqir al-Sadr.


pages: 1,073 words: 302,361

Money and Power: How Goldman Sachs Came to Rule the World by William D. Cohan

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

asset-backed security, Bernie Madoff, buttonwood tree, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, fear of failure, financial innovation, fixed income, Ford paid five dollars a day, Goldman Sachs: Vampire Squid, Gordon Gekko, high net worth, hiring and firing, hive mind, Hyman Minsky, interest rate swap, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, merger arbitrage, moral hazard, mortgage debt, paper trading, passive investing, Ponzi scheme, price stability, profit maximization, risk tolerance, Ronald Reagan, Saturday Night Live, South Sea Bubble, time value of money, too big to fail, traveling salesman, value at risk, yield curve, Yogi Berra

“And the management of the trusts could be expected to have a far better knowledge of companies and prospects in Singapore, Madras, Capetown and the Argentine, places to which British funds regularly found their way, than the widow in Bristol or the doctor in Glasgow,” Galbraith wrote. “The smaller risk and better information well justified the modest compensation of those who managed the enterprise.” Soon the idea was exported to the United States, primarily under the guise that this was a financial innovation worth imitating, lest Wall Street be seen as falling behind the City of London as a repository of brilliant new ideas. At first, the trickle of such trusts to the New World was slow. In 1921, an SEC report of the phenomenon put the number at “about forty.” At the beginning of 1927, the same report noted there were 160 such trusts, and another 140 were established during the course of the year.

Of the 7.25 million shares Blue Ridge offered to the public, Shenandoah bought all but 1 million of them. “Goldman Sachs by now was applying leverage with a vengeance,” Galbraith observed. And why not? At the time of the Blue Ridge offering, according to the New York Times, Goldman Sachs Trading Corporation was worth $500 million, up fivefold in nine months, and Shenandoah had doubled in value in less than a month. Blue Ridge had the additional financial innovation that it allowed investors to exchange shares in a select group of twenty-one other blue-chip New York Stock Exchange companies—among them AT&T and General Electric—at fixed prices for shares in Blue Ridge. Why anyone would want to do this was not made clear, of course, especially if the fixed price offered for, say, a share of General Electric by Blue Ridge was less than where GE was trading in the market.

According to Institutional Investor, the firm’s new leaders established an “Ad Hoc Profit Maximization Committee,” whose members were “intelligent men from Mars,” according to Friedman, and the purpose of which was “to bring new perspectives to the firm’s various businesses by questioning how things are run … without threatening the ethos.” Then there was the “bevy” of new consultants who showed up at the firm. Marketing consultant Anthony Buzan—a “creative provocateur,” Geoff Boisi said—had been hired to counter the perception that Goldman was a follower, not a leader, when it came to financial innovation. At an investment banking retreat in upstate New York, Buzan tagged along and got the Goldman bankers to engage in a little finger painting while also getting their creative juices flowing. Indeed, Boisi had implemented an annual award for financial creativity—$25,000 plus a slab of Baccarat crystal—that was won in 1989 by a woman banker whose name has been lost to history who created Goldman’s business in employee stock-ownership plans (then all the rage on Wall Street in facilitating employee buyouts of companies).


pages: 276 words: 82,603

Birth of the Euro by Otmar Issing

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, Bretton Woods, business climate, capital controls, central bank independence, currency peg, financial innovation, floating exchange rates, full employment, inflation targeting, labour market flexibility, labour mobility, market fundamentalism, moral hazard, oil shock, open economy, price anchoring, price stability, purchasing power parity, reserve currency, Y2K, yield curve

I was once also of the opinion – at the time it was harmless, as I was only a professor and couldn’t do any damage, except perhaps to people’s heads, but not in actual decisions – that Milton Friedman’s idea of letting the money supply grow by a constant percentage year in year out, that is, adhering to the famous ‘k-per cent rule’, was the solution to the problems of monetary policy. I have changed my mind since. The facts have convinced me that financial innovations alter the content of monetary aggregates economically. You have to bear that in mind, we couldn’t foresee it at that time. You have to take account of the facts. Economics is not a matter of faith, but a science that has to be measured against The countdown begins • 41 real outcomes over and over. We have not come to the end of the debate, neither Alan Blinder nor I nor many others – they were only two names that happened to be picked out here – and there is no place for intellectual arrogance in a central bank.

Friedman, and others, ascribed this to resistance on the part of central bankers, who feared for their prestige and did not wish to be downgraded to mere ‘machines’ bound slavishly to follow the instructions of a strict rule. Besides other objections, the following argument and actual experience provide grounds for rejecting this rule: the money supply in question has to be defined in terms of a specific monetary aggregate; changes in payment behaviour and the emergence of new payment instruments (e.g. credit cards) – in short, financial innovations of all kinds – can radically change the economic content of a concrete monetary aggregate and hence reduce the predetermined growth rate ad absurdum.41 Other strict rules also call forth serious objections. Pursuing this analysis further42 would transcend the scope of this book. However, the discussion surrounding monetary policy rules does highlight the problem that faced the ECB – just like other central 40 41 42 M.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

asset allocation, collateralized debt obligation, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, mortgage debt, new economy, Occupy movement, passive investing, Ponzi scheme, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam

Investors must know that they inevitably earn the gross return of the stock market, but only before the deduction of the costs of financial intermediation are taken into account. If beating the market is a zero sum game before costs, it is a loser’s game after costs are deducted. Which is why costs must be made clear to investors, and, one hopes, minimized. Pointing this out routinely surely cannot earn Jack Bogle many friends among Wall Street, which depends on the mystery surrounding financial innovations—as they are called euphemistically. But Bogle doesn’t care much about “stirring the pot.” His friends have long learned to appreciate that his truth-telling is the key to his personality. Jack Bogle has spent a lifetime in study and active participation in financial markets. The amount of self-dealing and self-enrichment he has seen qualifies him to bear witness against not just a few individuals, but entire firms and certainly an entire industry.

Yes, today’s financial system also creates value—innovation, real-time information, vast liquidity, and a certain amount of capital formation. But technology cannot eliminate the frictional costs of the system. While unit-trading costs have plummeted, trading volumes have soared, and total costs of the financial system continue to rise. Too many innovations have served Wall Street at the expense of its client/investors. Pressed to identify useful financial innovations created during the past quarter-century, Paul A. Volcker, former Federal Reserve Chairman and recent chairman of President Obama’s Economic Recovery Board, could single out only one: “The ATM.” (Mr. Volcker recently told me that if the period of evaluation had been the past 40 years, he would have also included the creation of the index mutual fund in 1975 as an important and positive innovation that has served investors well.)


pages: 385 words: 111,807

A Pelican Introduction Economics: A User's Guide by Ha-Joon Chang

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, bilateral investment treaty, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collateralized debt obligation, colonial rule, Corn Laws, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, discovery of the americas, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Francis Fukuyama: the end of history, Frederick Winslow Taylor, full employment, George Akerlof, Gini coefficient, global value chain, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Haber-Bosch Process, happiness index / gross national happiness, high net worth, income inequality, income per capita, interchangeable parts, interest rate swap, inventory management, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, knowledge economy, laissez-faire capitalism, land reform, manufacturing employment, Mark Zuckerberg, market clearing, market fundamentalism, Martin Wolf, means of production, Mexican peso crisis / tequila crisis, Northern Rock, obamacare, offshore financial centre, oil shock, open borders, post-industrial society, precariat, principal–agent problem, profit maximization, profit motive, purchasing power parity, quantitative easing, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, Scramble for Africa, shareholder value, Silicon Valley, Simon Kuznets, sovereign wealth fund, spinning jenny, structural adjustment programs, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade liberalization, transaction costs, transfer pricing, trickle-down economics, Washington Consensus, working-age population, World Values Survey

.* These new financial products became popular among investment banks because, to put it bluntly, they let them make more money than did ‘traditional’ businesses, such as selling shares and bonds or advising on M&A. Exactly how they do so is rather complicated, as I shall explain below. Securitized debt products are created by pooling individual loans into a composite bond In the old days, when someone borrowed money from a bank and bought something, the lending bank owned the resulting debt and that was that. But ‘financial innovations’ in the last few decades have led to the creation of a new financial instrument called asset-backed securities (ABSs) out of these debts. An ABS pools thousands of loans – for homes, cars, credit cards, university fees, business loans and what not – and turns them into a bigger, ‘composite’, bond. If you are dealing with an individual loan, its repayment would dry up if the particular borrower defaulted.

.* Using different data sources, Lapavitsas estimates that the UK number rose from around 700 per cent in the late 1980s to over 1,200 per cent by 2009 – or 1,800 per cent, if we included assets owned abroad by UK citizens and companies.11 James Crotty, using American government data, calculated that the ratio of financial assets to GDP in the US fluctuated between 400 and 500 per cent between the 1950s and 1970s, but that it started to shoot up from the early 1980s, following financial deregulation. It broke through the 900 per cent mark by the early 2000s.12 The New Financial System and Its Consequences The new financial system was to be more efficient and safer All this meant that a new financial system has emerged in the last three decades. We have seen the proliferation of new and complex financial instruments through financial innovation, or financial engineering, as some people prefer to call it. This process was enormously facilitated by financial deregulation – the abolition or the dilution of existing regulations on financial activities, as I shall discuss later. This new financial system was supposed to be more efficient and safer than the old one, which was dominated by slow-witted commercial banks dealing in a limited range of financial instruments, unable to meet increasingly diverse demands for financial risk.


pages: 484 words: 104,873

Rise of the Robots: Technology and the Threat of a Jobless Future by Martin Ford

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

3D printing, additive manufacturing, Affordable Care Act / Obamacare, AI winter, algorithmic trading, Amazon Mechanical Turk, artificial general intelligence, autonomous vehicles, banking crisis, Baxter: Rethink Robotics, Bernie Madoff, Bill Joy: nanobots, call centre, Capital in the Twenty-First Century by Thomas Piketty, Chris Urmson, Clayton Christensen, clean water, cloud computing, collateralized debt obligation, computer age, debt deflation, deskilling, diversified portfolio, Erik Brynjolfsson, factory automation, financial innovation, Flash crash, Fractional reserve banking, Freestyle chess, full employment, Goldman Sachs: Vampire Squid, High speed trading, income inequality, indoor plumbing, industrial robot, informal economy, iterative process, Jaron Lanier, job automation, John Maynard Keynes: technological unemployment, John von Neumann, Khan Academy, knowledge worker, labor-force participation, labour mobility, liquidity trap, low skilled workers, low-wage service sector, Lyft, manufacturing employment, McJob, moral hazard, Narrative Science, Network effects, new economy, Nicholas Carr, Norbert Wiener, obamacare, optical character recognition, passive income, performance metric, Peter Thiel, Plutocrats, plutocrats, post scarcity, precision agriculture, price mechanism, Ray Kurzweil, rent control, rent-seeking, reshoring, RFID, Richard Feynman, Richard Feynman, Rodney Brooks, secular stagnation, self-driving car, Silicon Valley, Silicon Valley startup, single-payer health, software is eating the world, sovereign wealth fund, speech recognition, Spread Networks laid a new fibre optics cable between New York and Chicago, stealth mode startup, stem cell, Stephen Hawking, Steve Jobs, Steven Levy, Steven Pinker, strong AI, Stuxnet, technological singularity, telepresence, telepresence robot, The Bell Curve by Richard Herrnstein and Charles Murray, The Coming Technological Singularity, Thomas L Friedman, too big to fail, Tyler Cowen: Great Stagnation, union organizing, Vernor Vinge, very high income, Watson beat the top human players on Jeopardy!, women in the workforce

Perhaps the most colorful articulation of this accusation came from Rolling Stone’s Matt Taibbi in his July 2009 takedown of Goldman Sachs that famously labeled the Wall Street firm “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”54 Economists who have studied financialization have found a strong correlation between the growth of the financial sector and inequality as well as the decline in labor’s share of national income.55 Since the financial sector is, in effect, imposing a kind of tax on the rest of the economy and then reallocating the proceeds to the top of the income distribution, it’s reasonable to conclude that it has played a role in a number of the trends we’ve looked at. Still, it seems hard to make a strong case for financialization as the primary cause of, say, polarization and the elimination of routine jobs. It’s also important to realize that growth in the financial sector has been highly dependent on advancing information technology. Virtually all of the financial innovations that have arisen in recent decades—including, for example, collateralized debt obligations (CDOs) and exotic financial derivatives—would not have been possible without access to powerful computers. Likewise, automated trading algorithms are now responsible for nearly two-thirds of stock market trades, and Wall Street firms have built huge computing centers in close physical proximity to exchanges in order to gain trading advantages measured in tiny fractions of a second.

Between 2005 and 2012, the average time to execute a trade dropped from about 10 seconds to just 0.0008 seconds,56 and robotic, high-speed trading was heavily implicated in the May 2010 “flash crash” in which the Dow Jones Industrial Average plunged nearly a thousand points and then recovered for a net gain, all within the space of just a few minutes. Viewed from this perspective, financialization is not so much a competing explanation for our seven economic trends; it is rather—at least to some extent—one of the ramifications of accelerating information technology. In this, there is a strong cautionary note as we look to the future: as IT continues its relentless progress, we can be certain that financial innovators, in the absence of regulations that constrain them, will find ways to leverage all those new capabilities—and, if history is any guide, it won’t necessarily be in ways that benefit society as a whole. Politics In the 1950s, more than a third of the US private sector workforce was unionized. By 2010, that number had declined to about 7 percent.57 At the height of its power, organized labor was a powerful advocate for the middle class as a whole.


pages: 329 words: 95,309

Digital Bank: Strategies for Launching or Becoming a Digital Bank by Chris Skinner

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

algorithmic trading, Amazon Web Services, Any sufficiently advanced technology is indistinguishable from magic, augmented reality, bank run, Basel III, bitcoin, business intelligence, business process, business process outsourcing, call centre, cashless society, clean water, cloud computing, corporate social responsibility, credit crunch, crowdsourcing, cryptocurrency, demand response, disintermediation, don't be evil, en.wikipedia.org, fault tolerance, fiat currency, financial innovation, Google Glasses, high net worth, informal economy, Infrastructure as a Service, Internet of things, Jeff Bezos, Kevin Kelly, Kickstarter, M-Pesa, margin call, mass affluent, mobile money, Mohammed Bouazizi, new economy, Northern Rock, Occupy movement, platform as a service, Ponzi scheme, prediction markets, pre–internet, quantitative easing, ransomware, reserve currency, RFID, Satoshi Nakamoto, Silicon Valley, smart cities, software as a service, Steve Jobs, strong AI, Stuxnet, trade route, unbanked and underbanked, underbanked, upwardly mobile, We are the 99%, web application, Y2K

The ECB goes on to say that the concept of Bitcoin stems from the Austrian school of economics, where business cycle theory developed by Mises, Hayek and Bohm-Bawerk floated the idea that virtual currencies could be the starting point for ending central bank money monopolies. Why does the ECB bother to write a report and an in-depth analysis of Bitcoin and other virtual currencies? Because they are worried that they are unregulated value exchanges that could represent a challenge for public authorities and have a negative impact on the reputation of central banks. On the other hand, they do make note that “these schemes can have positive aspects in terms of financial innovation and the provision of additional payment alternatives for consumers.” To be honest, whether Bitcoin takes off or not, virtual currencies are going to explode thanks to in-app gaming on the mobile internet, something the ECB report misses. Most of us already top-up or bling our gaming on our iPhones and iPads via iTunes. That is virtual currency in operation. You may disagree, but the aggregation of large amounts of small payments is effectively building a virtual currency system.

The third driver is that we should always keep asking the banks if they are going to be doing all this again, where all the banks are running their own home banking systems, their own corporate banking systems and such like. Shouldn’t there be more ways to pool resources and make use of the SIWFT cooperative for more than it is now? This is especially important as we move towards mobile payment services and more, and this is what drove the Innotribe program in terms of proving that SWIFT could be used for much more than just messaging. What do you see as the big things happening in the future from a financial innovation viewpoint? I know for a fact that the new economies and new values that we discuss within Innotribe are driven by social media. Social media is creating new currencies and new economic models, and this will be very big and very important in the two to three years downstream from now. The question for the banks is how will they position in this new world of peer-to-peer currencies in social media.


pages: 438 words: 109,306

Tower of Basel: The Shadowy History of the Secret Bank That Runs the World by Adam Lebor

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

banking crisis, Basel III, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business climate, central bank independence, corporate governance, corporate social responsibility, deindustrialization, eurozone crisis, fiat currency, financial independence, financial innovation, forensic accounting, Goldman Sachs: Vampire Squid, haute cuisine, IBM and the Holocaust, Occupy movement, offshore financial centre, Ponzi scheme, price stability, quantitative easing, reserve currency, special drawing rights, V2 rocket

The United States above all, Germany and Britain to a minor extent. There is a very strong sense of pecking order.” But like all self-referential groups that rely on each other for mutual advice and reinforcement, the central bankers, cocooned in luxury and discretion at the BIS, can easily forget that they are public servants, said Andrew Hilton, the director of the Centre for the Study of Financial Innovation, a think-tank based in London. “It’s a tricky one because you don’t want them to be affected by day-to-day populist pressures. On the other hand, you do want them to know how much a pint of milk costs. The fine line you have to draw is between not being pressured by what’s happening on the street, but also being aware of it. It’s all too easy as a central banker to float over the political economy and throw bread to the masses.

The writer Matt Taibbi once memorably described Goldman Sachs, the giant investment bank, as a “vampire squid.”8 The BIS is now the vampire squid of the regulatory world, hosting a myriad of committees that in turn spawn a raft of subcommittees, many of which are composed of the same central bankers and officials, each producing reams of reports that are passed back and forth from Basel to national central banks and governments in an endless merry-go-round of resolutions and recommendations. Others argue that the answer to the banking crisis is not more insider committees and regulatory bodies hosted at the BIS, or anywhere else, but much less, or none at all. “Banking should become a normal industry, like manufacturing bicycles,” said Andrew Hilton, of the Centre for the Study of Financial Innovation. “Banking should be regulated to protect against fraud, to protect consumers, and to protect the banks’ integrity, but nothing else. That sounds crazy because everyone says that banking is special. Banking is only special because the sums of money flowing through these institutions are so large they can bring society down. If the banks were smaller, if they did simpler things and they were not a systemic threat, either individually or within a cluster, you would not have to regulate them.


pages: 325 words: 90,659

Narconomics: How to Run a Drug Cartel by Tom Wainwright

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Airbnb, barriers to entry, bitcoin, business process, call centre, collateralized debt obligation, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, failed state, financial innovation, illegal immigration, Mark Zuckerberg, microcredit, price mechanism, RAND corporation, Ronald Reagan, Skype

Regulators always struggle when it comes to industries that are based on innovation. In the tech business, new services and inventions created by the likes of Google and Facebook present legal and moral dilemmas about privacy and data protection faster than courts can rule on them. In the banking industry, the pace of financial innovation in the run-up to the meltdown of 2007 made it hard for the authorities to notice that the pileup of credit-default swaps, collateralized-debt obligations, and other inventive products represented an accident waiting to happen. Even now, the regulators lag far behind the financial innovators. The Dodd-Frank Act, a mammoth piece of legislation designed to prevent bankers from taking the kinds of risks that nearly capsized the world economy in 2007, had still not been fully implemented five years after it was passed in 2010. In the meantime, the whiz kids of Wall Street have zoomed ahead with complex new financial products, of unknown riskiness.

Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America by Matt Taibbi

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

affirmative action, Affordable Care Act / Obamacare, Bernie Sanders, Bretton Woods, carried interest, clean water, collateralized debt obligation, collective bargaining, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, desegregation, diversification, diversified portfolio, Donald Trump, financial innovation, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, illegal immigration, interest rate swap, laissez-faire capitalism, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, medical malpractice, moral hazard, mortgage debt, obamacare, passive investing, Ponzi scheme, prediction markets, quantitative easing, reserve currency, Ronald Reagan, Sergey Aleynikov, short selling, sovereign wealth fund, too big to fail, trickle-down economics, Y2K, Yom Kippur War

In other words, Americans in just two years had borrowed the equivalent of two hundred years’ worth of savings. Any sane person would have looked at these numbers and concluded that something was terribly wrong (and some, like Greenspan’s predecessor Paul Volcker, did exactly that, sounding dire warnings about all that debt), but Greenspan refused to admit there was a problem. Instead, incredibly, he dusted off the same old “new era” excuse, claiming that advances in technology and financial innovation had allowed Wall Street to rewrite the laws of nature again: Technological advances have resulted in increased efficiency and scale within the financial services industry … With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. The kinds of technological advances Greenspan was talking about were actually fraud schemes.

The mechanism involved in these operations—whose real mission was to filter out the unredeemable crap from the merely temporarily distressed crap and stick the taxpayer with the former and Geithner’s buddies with the latter—would be enormously complex, a kind of labyrinthine financial sewage system designed to stick us all with the raw waste and pump clean water back to Wall Street. The AIG bailout marked the end of a chain of mortgage-based scams that began, in a way, years before, when Solomon Edwards set up a long con to rip off an unsuspecting sheriff’s deputy named Eljon Williams. It was a game of hot potato in which money was invented out of thin air in the form of a transparently bogus credit scheme, converted through the magic of modern financial innovation into highly combustible, soon-to-explode securities, and then quickly passed up the chain with lightning speed—from the lender to the securitizer to the major investment banks to AIG, with each party passing it off as quickly as possible, knowing it was too hot to hold. In the end that potato would come to rest, sizzling away, in the hands of the Federal Reserve Bank. Eljon Williams is still in his house.


pages: 383 words: 108,266

Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions by Dan Ariely

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

air freight, Al Roth, Bernie Madoff, Burning Man, butterfly effect, Cass Sunstein, collateralized debt obligation, computer vision, corporate governance, credit crunch, Daniel Kahneman / Amos Tversky, David Brooks, delayed gratification, endowment effect, financial innovation, fudge factor, Gordon Gekko, greed is good, housing crisis, invisible hand, lake wobegon effect, late fees, loss aversion, market bubble, Murray Gell-Mann, payday loans, placebo effect, price anchoring, Richard Thaler, second-price auction, Silicon Valley, Skype, The Wealth of Nations by Adam Smith, Upton Sinclair

For at least the last decade, the globalization of markets has been promoted by many as a good thing. The belief has been that a move from multiple and semi-independent markets toward one big market increases liquidity, encourages financial innovation, and allows friction-free trade. As a consequence, today, in case you haven’t noticed, there is not much difference between the Japanese, British, German, and American stock markets. We see them rise and fall almost in unison, if to varying degrees. But as we witness the effects of increased globalization, we should ask ourselves what are the benefits and the costs of having one large market. I suspect that one large market can, in fact, reduce financial innovation, be dangerous to our financial health, and ultimately fail to protect us against financial meltdowns. To help us think about how one large market can become inefficient, consider the following few paragraphs from The Lost World by Michael Crichton.35 A character named Malcolm (the chaos-theory scientist played in the movie by Jeff Goldblum) goes on a pessimistic rant against cyberspace—pointing out that a world where everyone is connected could bring about the end of creativity, innovation, and evolution.


pages: 344 words: 93,858

The Post-American World: Release 2.0 by Fareed Zakaria

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

affirmative action, agricultural Revolution, airport security, anti-communist, Asian financial crisis, battle of ideas, Berlin Wall, Bretton Woods, BRICs, British Empire, call centre, capital controls, central bank independence, centre right, collapse of Lehman Brothers, conceptual framework, Credit Default Swap, currency manipulation / currency intervention, delayed gratification, Deng Xiaoping, double entry bookkeeping, failed state, Fall of the Berlin Wall, financial innovation, global reserve currency, global supply chain, illegal immigration, interest rate derivative, knowledge economy, Mahatma Gandhi, Martin Wolf, mutually assured destruction, new economy, oil shock, open economy, out of africa, postindustrial economy, purchasing power parity, race to the bottom, reserve currency, Ronald Reagan, Silicon Valley, Silicon Valley startup, South China Sea, Steven Pinker, The Great Moderation, Thomas L Friedman, Thomas Malthus, trade route, Washington Consensus, working-age population, young professional

Goldman Sachs originally projected that the combined GDP of the four BRIC economies—Brazil, Russia, India, China—could overtake the combined GDP of the G-7 countries by 2039. These days, they say it could happen by 2032.11 The current global recession makes them more, not less, confident. Global power is, above all, dominance over ideas, agendas, and models. The revelation that much of the financial innovation that occurred in the last decade created little more than a house of cards erodes American power. Selling American ideas to the rest of the world will require more effort from here on out. Developing countries will pick and choose the economic policies that best suit them, and with growing confidence. “The U.S. financial system was regarded as a model, and we tried our best to copy whatever we could,” said Yu Yongding, a former adviser to China’s central bank, in late September 2008.

China’s lending was also essentially a massive stimulus program for the United States. During the go-go years of the mid-aughts, it kept interest rates low and encouraged homeowners to refinance, hedge fund managers to ramp up leverage, and investment banks to goose their balance sheets. China’s lending created cheap money, says the Financial Times columnist Martin Wolf, and “cheap money encouraged an orgy of financial innovation, borrowing and spending.” It was one of the major contributors to the global financial crisis, and the cycle continues even in its aftermath. Everyone agrees the status quo is unsustainable. “There can be no return to business as usual,” Wolf wrote after the financial collapse. But in the short term, we seem destined for more of the same. President Obama has warned of the prospect of “trillion-dollar deficits for years to come,” as his administration boosts spending on everything from green technology to health care; most of that money will have to be borrowed from China.

The Future of Money by Bernard Lietaer

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

agricultural Revolution, banks create money, barriers to entry, Bretton Woods, clean water, complexity theory, dematerialisation, discounted cash flows, diversification, fiat currency, financial deregulation, financial innovation, floating exchange rates, full employment, George Gilder, German hyperinflation, global reserve currency, Golden Gate Park, Howard Rheingold, informal economy, invention of the telephone, invention of writing, Lao Tzu, Mahatma Gandhi, means of production, microcredit, money: store of value / unit of account / medium of exchange, Norbert Wiener, North Sea oil, offshore financial centre, pattern recognition, post-industrial society, price stability, reserve currency, Ronald Reagan, seigniorage, Silicon Valley, South Sea Bubble, the market place, the payments system, trade route, transaction costs, trickle-down economics, working poor

Emergence of a Global Corporate Scrip (1960-2020) 1960s: Development of large-scale professional barter by Western corporations with the Comecon (‘Communist Bloc') countries. 1970’s: Extension of barter to Less Developed Countries whenever ‘hard currencies' are in scarce supply. 1974: In the US, 100 small barter exchanges facilitate trade valued at $45 million among 17,000 corporations. 1980s: Generalisation of barter in international exchanges, as consequence of the Latin American debt crisis. 1982: The VS Congress recognises barter as a legitimate domestic commercial process, and sets up reporting requirements. All barter income is treated as normal income by the IRS. 1990s: Expansion of barter within all developed countries. In parallel, Internet commerce starts taking off. 1997: Alan Greenspan, Chairman of the Federal Resave Board, gives implicit OK to corporate currency initiatives: 'If we wish to foster financial innovation, we must be careful not to impose rules that inhibit it.' The cyber economy is estimated at $35.6 billion per year. 1998: In the VS no fewer than 400,000 businesses are members of 686 barter exchanges, totalling a volume of $8.5 billion in domestic exchanges. Annual growth rate is 15%, three times faster than commercial exchanges facilitated by dollars. 1999: Internet traffic doubles every 100 days. 2000: The cyber economy reaches 5200 billion per year, about half of which is between corporations.

The bulk of the speculative volume is due to banks' own currency trading departments. However, it is predictable that the hedge funds - mutual funds specialising in currency speculation - will be the ones that will bear the brunt of the public relations backlash if a global meltdown occurs, as they are the 'last kid on the block'. In all financial crisis - from the Dutch tulips in 1637 to the US stock market crash of 1987 - it is invariably the most recent financial innovation which bears the brunt of the blame. Figure P.3 provides a synthetic overview of the currency flows which triggered three crises between 1983 and 1998. A monetary crisis can be seen as the result of sudden ebb of the global cash flow out of the target country, brutally reversing an earlier inflow. Notice that the scale of the swings between monetary high and low tides keeps growing - they mirror the increase of speculative flows in Figure P.2.


pages: 471 words: 97,152

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof, Robert J. Shiller

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, collateralized debt obligation, conceptual framework, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, Deng Xiaoping, Donald Trump, Edward Glaeser, en.wikipedia.org, experimental subject, financial innovation, full employment, George Akerlof, housing crisis, Hyman Minsky, income per capita, inflation targeting, invisible hand, Isaac Newton, Jane Jacobs, Jean Tirole, job satisfaction, Joseph Schumpeter, Long Term Capital Management, loss aversion, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, new economy, New Urbanism, Plutocrats, plutocrats, price stability, profit maximization, purchasing power parity, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, South Sea Bubble, The Chicago School, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, working-age population, Y2K, Yom Kippur War

There were insufficient safeguards to make sure that those who promised to take up risk had the capital to pay up when confidence failed. It can only be surmised that the regulators were asleep at the switch, dozing off in the confident but wrong minded notion that capitalist markets would police themselves because people would watch out for their own interest. Stricter regulation is needed; at the same time, however, any new financial rules have to be open to genuine financial innovation. • Bankruptcy Law. This should be a major agenda pursued by governments around the world. Some enterprises seem to have remarkably little difficulty going into bankruptcy, and then emerging out of it after a reorganization of debts and (sometimes) labor contracts. In the United States, Chapter 11 of the bankruptcy code allows them to continue to operate, and the difference between the bankrupt operations and the solvent ones seems to be almost negligible.

Moreover, even the Federal Reserve System as it existed at the beginning of 2007 was apparently not up to the task of preventing behavior that looked very much like bank runs, as one financial institution after another failed. In response the Fed had to reinvent itself, with new lending facilities that went far beyond its original turf of depository institutions. The increasing complexity of our financial system makes it hard for economic institutions like deposit insurers or central banks to stay ahead of financial innovation. Central banks today are concerned about deflation, and they are unlikely to let it happen. But they are not necessarily going to stop it entirely—witness the deflation in Japan in the late 1990s and early 2000s.40 If there were deflation today, would we be more enlightened about nominal wage cuts than we were in the 1930s? It is hard to say that we would. Simple economic truths can get lost in the heat of emotion.


pages: 314 words: 101,452

Liar's Poker by Michael Lewis

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

barriers to entry, Bonfire of the Vanities, cognitive dissonance, corporate governance, financial independence, financial innovation, Home mortgage interest deduction, interest rate swap, London Interbank Offered Rate, margin call, mortgage tax deduction, nuclear winter, Ponzi scheme, The Predators' Ball, yield curve

The irony is that it achieved precisely what Ranieri had hoped: It made home mortgages look more like other bonds. But making mortgage bonds conform in appearance had the effect, in the end, of making them only as profitable as other kinds of bonds. Larry Fink, the head of mortgage trading at First Boston who helped create the first CMO, lists it along with junk bonds as the most important financial innovation of the 1980s. That is only a slight overstatement. The CMO burst the dam between several trillion investable dollars looking for a home and nearly two trillion dollars of home mortgages looking for an investor. The CMO addressed the chief objection to buying mortgage securities, still voiced by everyone but thrifts and a handful of adventurous money managers. Who wants to lend money not knowing when he'll get it back?

The rest of the ozone layer of management at Salomon Brothers had never really been in touch. Therefore, the trading risks were managed by mere tykes, a few months out of a training program, who happened to know more about Ginnie Mae 8 percent IOs than anyone else in the firm. That a newcomer to Wall Street should all of a sudden be an expert wasn't particularly surprising, since the bonds in question might have been invented only a month before. In a period of constant financial innovation, the youngest people assumed power (and part of the reason young people got rich was that the 1980s was a period of constant change). A young brain leaped at the chance to know something his superiors did not. The older people were too busy clearing their desktops to stay at the frontiers of innovation. By 1986 Ranieri wasn't even sitting on the trading desk. He was busy ministering to the affairs of the firm.


pages: 103 words: 32,131

Program Or Be Programmed: Ten Commands for a Digital Age by Douglas Rushkoff

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

banking crisis, big-box store, citizen journalism, cloud computing, East Village, financial innovation, Firefox, hive mind, Howard Rheingold, invention of the printing press, Kevin Kelly, Marshall McLuhan, Silicon Valley, statistical model, Stewart Brand, Ted Nelson, WikiLeaks

Digital society may always be biased toward sharing, but a real understanding of the codes through which it has been built makes stealing a nonstarter. * * * 6. See the LETSystems home page at http://www.gmlets.u-net.com/ for some simple explanations of how this works. Or see the currency chapter in my own Life Inc: How Corporatism Conquered the World and How We Can Take it Back (New York: Random House, 2009). 7. See Alan Greenspan, “Fostering Financial Innovation: The Role of Government” in The Future of Money in the Information Age (Washington, DC: Cato Institute, 1997). Or watch any of Greenspan’s later testimonies to Congress. 8. See CreativeCommons.org for more detailed descriptions of these choices for publication without traditional copyright. X. PURPOSE Program or Be Programmed Digital technology is programmed. This makes it biased toward those with the capacity to write the code.


pages: 124 words: 30,520

Rebooting Democracy: A Citizen's Guide to Reinventing Politics by Manuel Arriaga

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

banking crisis, business climate, David Graeber, financial innovation, first-past-the-post, Occupy movement, principal–agent problem, Slavoj Žižek

And that, I would argue, is what “post-ideological” should actually mean. Conclusion Until now we have had such a low level of democracy, that it is about time we try something else.—Jón Trausti Reynisson, editor-in-chief of the Icelandic daily Dagbladid & Visir, interviewed in 2011 In 2008, Iceland found itself in a dire situation. Its banking sector, which had been too eager to participate in the global debt folly and other forms of “financial innovation,” collapsed and threatened to force Iceland into national bankruptcy. Financial chaos ensued, and the country is, to this day, still recovering from the resulting economic crisis. Over this period, Icelanders took to the streets and, eventually, the government fell. Along the way, however, something more curious happened. The protests did not culminate merely in the resignation of Prime Minister Geir Haarde and the scheduling of a new election (two achievements that, alone, would have constituted a surprising feat of political accountability in most “democratic” nations).


pages: 126 words: 37,081

Men Without Work by Nicholas Eberstadt

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Carmen Reinhart, centre right, deindustrialization, financial innovation, full employment, illegal immigration, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Rogoff, labor-force participation, low skilled workers, moral hazard, Ronald Reagan, secular stagnation, Simon Kuznets, War on Poverty, women in the workforce, working-age population

Our examination of modern America’s “men without work” problem, however, has yet to touch upon the role of momentous changes in the postwar U.S. economy in exacerbating this problem—or perhaps in creating it altogether. Any account of America’s growing male work problem that does not recognize that macroeconomic changes have played a part in this troubling dynamic cannot help but be incomplete. Therefore, it’s important to summarize some of the thinking and evidence suggesting that long-term structural forces (including such things as international trade, technological and financial innovation, outsourcing, the rise of the on-demand economy, temporary work, and other trends shaping aggregate demand) may be responsible for much, if not most, of the decline in work for men in postwar America. A 2016 report by the president’s Council of Economic Advisers (CEA) did a good job of laying out this case.1 After documenting the long-term decline in prime-age male workforce participation rates and sorting out some of its components, the report rightly suggested that these long-term labor force trends can be explained in terms of three different kinds of effect: (1) supply side, (2) demand side, and (3) institutional.


pages: 700 words: 201,953

The Social Life of Money by Nigel Dodd

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, bank run, banking crisis, banks create money, Bernie Madoff, bitcoin, blockchain, borderless world, Bretton Woods, BRICs, capital controls, cashless society, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, computer age, conceptual framework, credit crunch, cross-subsidies, David Graeber, debt deflation, dematerialisation, disintermediation, eurozone crisis, fiat currency, financial innovation, Financial Instability Hypothesis, financial repression, floating exchange rates, Fractional reserve banking, German hyperinflation, Goldman Sachs: Vampire Squid, Hyman Minsky, illegal immigration, informal economy, interest rate swap, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, Joseph Schumpeter, Kula ring, laissez-faire capitalism, land reform, late capitalism, liquidity trap, litecoin, London Interbank Offered Rate, M-Pesa, Marshall McLuhan, means of production, mental accounting, microcredit, mobile money, money: store of value / unit of account / medium of exchange, mortgage debt, new economy, Nixon shock, Occupy movement, offshore financial centre, paradox of thrift, payday loans, Peace of Westphalia, peer-to-peer lending, Ponzi scheme, post scarcity, postnationalism / post nation state, predatory finance, price mechanism, price stability, quantitative easing, quantitative trading / quantitative finance, remote working, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Satoshi Nakamoto, Scientific racism, seigniorage, Skype, Slavoj Žižek, South Sea Bubble, sovereign wealth fund, special drawing rights, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transaction costs, Wave and Pay, WikiLeaks, Wolfgang Streeck, yield curve, zero-coupon bond

., the relationship between national currencies) (Strange 1994a: 49).44 Strange’s core thesis was that the emergence of money substitutes such as derivatives—Minsky’s private money—were taking finance increasingly beyond the control of national governments (Strange 1994a: 49). These money substitutes—“strange money”—undermine monetary policy. Central banks have long been grappling with the implications of financial innovation for measuring and controlling the aggregate money supply, seeking rather to influence the demand for money through “channels” such as interest rates and capital reserve requirements. Monetarism lapsed for this reason. In the United States, the 1982 Banking Act, allowing banks to pay interest on basic deposit accounts was a key moment in the Federal Reserve’s move away from seeking to control M3 directly because it broadened the funds available for transaction purposes.

“Demystifying Micro-Credit: The Grameen Bank, NGOs, and Neoliberalism in Bangladesh.” Cultural Dynamics 20 (1): 5–29. Kaufman, E. (2001). The Delirium of Praise: Bataille, Blanchot, Deleuze, Foucault, Klossowski, Baltimore, Johns Hopkins University Press. Kaufmann, W. A. (1975). Nietzsche: Philosopher, Psychologist, Antichrist, Princeton, NJ, Princeton University Press. Kay, J. (2009). Narrow Banking: The Reform of Banking Regulation, London, Centre for the Study of Financial Innovation. Kay, J. (2010). “Should We Have ‘Narrow Banking’?” London, London School of Economics and Political Science, www.johnkay.com/2011/06/02/should-we-have-‘narrow-banking’, accessed 28 March 2014. Kellermann, P. (2008). “Soziologie des Geldes.” Handbuch der Wirtschaftssoziologie, A. Maurer, Ed. Wiesbaden, Germany, VS Verlag für Sozialwissenschaften: 320–40. Kelly, K. (1995). Out of Control: The New Biology of Machines, Social Systems, and the Economic World, New York, Basic Books.

See state fiat money fiction, and economic expectations, 16; and language, 36; and the free market, 338; and money, 6, 235, 317; and monetary policy, 110; in Simmel, 317; and truth, 36 fictitious capital, 55, 56, 58, 62, 65, 68–69, 70, 83, 194, 243; Marx’s definition of, 57n16; in Ricardo, 59n finance, etymology, 201; versus money, 61–62, 66, 125; social study of, 295 finance capital, 60, 64, 68, 74, 232, 249 financial engineering, 124 financial expropriation, 79 financial innovation, 121 financial instability hypothesis, 117, 124 financial repression, 69 financial system, 3; and crisis formation, 69; expansion of, 114; relationship to GDP, 114. See also capitalism; Wall Street system financialization, 10, 36, 61n22, 66–67, 391; and banking, 114; and the Eurozone crisis, 79; of money, 245, 298; as privatized Keynesianism, 76 First World War, 50, 59, 103, 225, 245, 256, 356, 362 fiscal cliff, 90, 386 fiscus, 261–62 Fisher, Irving, 120n41, 314; on the paradox of thrift, 347; on stamp scrip, 314, 349 Fisher, Mark, 193 floating money, 191, 244 flow, 227, 232, 233–34, 244; and financial markets, 233n Fond-des-Nègres marketplace, 302 Foster, William, 347 Foucault, Michel, 25, 238, 239, 391; death of “man,” 389–90; desire, 229; on homo economicus, 390; on Nietzsche, 389–90, 391; The Order of Things, 228 Fourcade, Marion, 91 Fourier, Charles, 324 fractional reserve lending, 95, 111, 113, 116, 199n26 Frank, Thomas, 315 Frankfurt School, 322, 326–27 Franklin, Benjamin, 176 fraud, 113, 117n, 120, 132, 137, 199, 313, 368 Freddie Mac, 123 free credit, 352 free labor, 98 free market money, 360, 362 free money, 348 free trade 281 Freicoin, 348n, 349n, 370–71 French Revolution, 84, 355 Freud, Sigmund, 150, 228, 332, 334; Civilization and Its Discontents, 152; on money and saving, 151, 336 Friedman, Milton, 131, 330–31 Frisby, David, on Nietzsche, 136–37, 141–42; on Simmel, 137 Fromm, Erich, 14, 85n45, 345, 356, 372, 382; on economic democracy, 338–39; Escape from Freedom, 331; on having versus being, 315, 331–38; on hoarding, 336, 340–41, 350–51; on the humanistic utopia, 315, 333–34, 338–39, 374; on language, 332; Man for Himself, 331, 341; on Marx, 339; “Medicine and the Ethical Problem of Modern Man,” 340; on Messianic time, 335, 338; on money, 334, 339–40, 341, 346; on the Shabbat, 334–35, 338; on spiritual poverty, 334; To Have or To Be?


pages: 819 words: 181,185

Derivatives Markets by David Goldenberg

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Black-Scholes formula, Brownian motion, capital asset pricing model, commodity trading advisor, compound rate of return, conceptual framework, Credit Default Swap, discounted cash flows, discrete time, diversification, diversified portfolio, en.wikipedia.org, financial innovation, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, law of one price, locking in a profit, London Interbank Offered Rate, Louis Bachelier, margin call, market microstructure, martingale, Norbert Wiener, price mechanism, random walk, reserve currency, risk/return, riskless arbitrage, Sharpe ratio, short selling, stochastic process, stochastic volatility, time value of money, transaction costs, volatility smile, Wiener process, Y2K, yield curve, zero-coupon bond

Directional Trades 371 11.3 The Dominance Principle 373 11.4 Implications of the Dominance Principle, ROP for Puts and Calls 374 11.4.1 Lower Bound for an American Call Option on an Underlying with no Dividends (LBAC) 374 11.4.2 Lower Bound for a European Call Option on an Underlying with no Dividends (LBEC) 375 11.4.3 Lower Bound for an American Put Option on an Underlying with no Dividends (LBAP) 378 11.4.4 Lower Bound for a European Put Option on an Underlying with no Dividends (LBEP) 380 11.4.5 Lower Bound for a European Call Option on an Underlying with Continuous Dividends (LBECD) 382 11.4.6 Lower Bound for an American Call Option on an Underlying with Continuous Dividends (LBACD) 383 11.4.7 Lower Bound for a European Put Option on an Underlying with Continuous Dividends (LBEPD) 386 xvi DETAILED CONTENTS 11.4.8 Lower Bound for an American Put Option on an Underlying with Continuous Dividends (LBAPD) 11.5 Static Replication and European Put-Call Parity (No Dividends) 387 388 11.5.1 Partially Replicating a European Call Option (the Embedded Forward Contract) 388 11.5.2 Fully Replicating a European Call Option (the Embedded Insurance Contract) 391 11.5.3 From Strategies to Current Costs and Back 393 11.5.4 Working Backwards from Payoffs to Costs to Derive European Put-Call Parity 393 11.6 Basic Implications of European Put-Call Parity 394 11.6.1 What is a European Call Option? 394 11.6.2 The Analogue of the Basic American Option Pricing Model for European Options 396 11.6.3 What is a European Put Option? 398 11.7 Further Implications of European Put-Call Parity 11.7.1 Synthesizing Forward Contract from Puts and Calls 399 399 11.8 Financial Innovation using European Put-Call Parity 401 11.8.1 Generalized Forward Contracts 401 11.8.2 American Put-Call Parity (No Dividends) 403 11.9 Postscript on ROP CHAPTER 12 OPTION TRADING STRATEGIES, PART 2 405 415 12.1 Generating Synthetic Option Strategies from European Put-Call Parity 416 12.2 The Covered Call Hedging Strategy 419 12.2.1 Three Types Of Covered Call Writes 420 DETAILED CONTENTS xvii 12.2.2 Economic Interpretation of the Covered Call Strategy 12.3 The Protective Put Hedging Strategy 426 427 12.3.1 Puts as Insurance 427 12.3.2 Economic Interpretation of the Protective Put Strategy 429 CHAPTER 13 MODEL-BASED OPTION PRICING IN DISCRETE TIME, PART 1: THE BINOMIAL OPTION PRICING MODEL (BOPM, N=1) 435 13.1 The Objective of Model-Based Option Pricing (MBOP) 437 13.2 The Binomial Option Pricing Model, Basics 437 13.2.1 Modeling Time in a Discrete Time Framework 437 13.2.2 Modeling the Underlying Stock Price Uncertainty 438 13.3 The Binomial Option Pricing Model, Advanced 440 13.3.1 Path Structure of the Binomial Process, Total Number of Price Paths 440 13.3.2 Path Structure of the Binomial Process, Total Number of Price Paths Ending at a Specific Terminal Price 442 13.3.3 Summary of Stock Price Evolution for the N-Period Binomial Process 444 13.4 Option Valuation for the BOPM (N=1) 445 13.4.1 Step 1, Pricing the Option at Expiration 445 13.4.2 Step 2, Pricing the Option Currently (time t=0) 446 13.5 Modern Tools for Pricing Options 448 13.5.1 Tool 1, The Principle of No-Arbitrage 448 13.5.2 Tool 2, Complete Markets or Replicability, and a Rule of Thumb 449 13.5.3 Tool 3, Dynamic and Static Replication 450 xviii DETAILED CONTENTS 13.5.4 Relationships between the Three Tools 13.6 Synthesizing a European Call Option 450 453 13.6.1 Step 1, Parameterization 454 13.6.2 Step 2, Defining the Hedge Ratio and the Dollar Bond Position 455 13.6.3 Step 3, Constructing the Replicating Portfolio 456 13.6.4 Step 4, Implications of Replication 462 13.7 Alternative Option Pricing Techniques 464 13.8 Appendix: Derivation of the BOPM (N=1) as a Risk-Neutral Valuation Relationship 467 CHAPTER 14 OPTION PRICING IN DISCRETE TIME, PART 2: DYNAMIC HEDGING AND THE MULTI-PERIOD BINOMIAL OPTION PRICING MODEL, N>1 14.1 Modeling Time and Uncertainty in the BOPM, N>1 473 475 14.1.1 Stock Price Behavior, N=2 475 14.1.2 Option Price Behavior, N=2 476 14.2 Hedging a European Call Option, N=2 477 14.2.1 Step 1, Parameterization 477 14.2.2 Step 2, Defining the Hedge Ratio and the Dollar Bond Position 478 14.2.3 Step 3, Constructing the Replicating Portfolio 478 14.2.4 The Complete Hedging Program for the BOPM, N=2 484 14.3 Implementation of the BOPM for N=2 485 14.4 The BOPM, N>1 as a RNVR Formula 490 14.5 Multi-period BOPM, N>1: A Path Integral Approach 493 DETAILED CONTENTS xix 14.5.1 Thinking of the BOPM in Terms of Paths 493 14.5.2 Proof of the BOPM Model for general N 499 CHAPTER 15 EQUIVALENT MARTINGALE MEASURES: A MODERN APPROACH TO OPTION PRICING 15.1 Primitive Arrow–Debreu Securities and Option Pricing 507 508 15.1.1 Exercise 1, Pricing B(0,1) 510 15.1.2 Exercise 2, Pricing ADu() and ADd() 511 15.2 Contingent Claim Pricing 514 15.2.1 Pricing a European Call Option 514 15.2.2 Pricing any Contingent Claim 515 15.3 Equivalent Martingale Measures (EMMs) 517 15.3.1 Introduction and Examples 517 15.3.2 Definition of a Discrete-Time Martingale 521 15.4 Martingales and Stock Prices 15.4.1 The Equivalent Martingale Representation of Stock Prices 15.5 The Equivalent Martingale Representation of Option Prices 521 524 526 15.5.1 Discounted Option Prices 527 15.5.2 Summary of the EMM Approach 528 15.6 The Efficient Market Hypothesis (EMH), A Guide To Modeling Prices 529 15.7 Appendix: Essential Martingale Properties 533 CHAPTER 16 OPTION PRICING IN CONTINUOUS TIME 539 16.1 Arithmetic Brownian Motion (ABM) 540 16.2 Shifted Arithmetic Brownian Motion 541 16.3 Pricing European Options under Shifted Arithmetic Brownian Motion with No Drift (Bachelier) 542 xx DETAILED CONTENTS 16.3.1 Theory (FTAP1 and FTAP2) 542 16.3.2 Transition Density Functions 543 16.3.3 Deriving the Bachelier Option Pricing Formula 547 16.4 Defining and Pricing a Standard Numeraire 551 16.5 Geometric Brownian Motion (GBM) 553 16.5.1 GBM (Discrete Version) 553 16.5.2 Geometric Brownian Motion (GBM), Continuous Version 559 16.6 Itô’s Lemma 562 16.7 Black–Scholes Option Pricing 566 16.7.1 Reducing GBM to an ABM with Drift 567 16.7.2 Preliminaries on Generating Unknown Risk-Neutral Transition Density Functions from Known Ones 570 16.7.3 Black–Scholes Options Pricing from Bachelier 571 16.7.4 Volatility Estimation in the Black–Scholes Model 582 16.8 Non-Constant Volatility Models 585 16.8.1 Empirical Features of Volatility 585 16.8.2 Economic Reasons for why Volatility is not Constant, the Leverage Effect 586 16.8.3 Modeling Changing Volatility, the Deterministic Volatility Model 586 16.8.4 Modeling Changing Volatility, Stochastic Volatility Models 16.9 Why Black–Scholes is Still Important CHAPTER 17 RISK-NEUTRAL VALUATION, EMMS, THE BOPM, AND BLACK–SCHOLES 17.1 Introduction 17.1.1 Preliminaries on FTAP1 and FTAP2 and Navigating the Terminology 587 588 595 596 596 DETAILED CONTENTS xxi 17.1.2 Pricing by Arbitrage and the FTAP2 597 17.1.3 Risk-Neutral Valuation without Consensus and with Consensus 598 17.1.4 Risk-Neutral Valuation without Consensus, Pricing Contingent Claims with Unhedgeable Risks 599 17.1.5 Black–Scholes’ Contribution 601 17.2 Formal Risk-Neutral Valuation without Replication 601 17.2.1 Constructing EMMs 601 17.2.2 Interpreting Formal Risk-Neutral Probabilities 602 17.3 MPRs and EMMs, Another Version of FTAP2 605 17.4 Complete Risk-Expected Return Analysis of the Riskless Hedge in the (BOPM, N=1) 607 17.4.1 Volatility of the Hedge Portfolio 608 17.4.2 Direct Calculation of S 611 17.4.3 Direct Calculation of C 612 17.4.4 Expected Return of the Hedge Portfolio 616 17.5 Analysis of the Relative Risks of the Hedge Portfolio’s Return 618 17.5.1 An Initial Look at Risk Neutrality in the Hedge Portfolio 618 17.5.2 Role of the Risk Premia for a Risk-Averse Investor in the Hedge Portfolio 620 17.6 Option Valuation Index 624 17.6.1 Some Manipulations 624 17.6.2 Option Valuation Done Directly by a Risk-Averse Investor 626 17.6.3 Option Valuation for the Risk-Neutral Investor 631 637 This page intentionally left blank FIGURES 1.1 1.2 1.3 1.4 2.1 2.2 2.3 2.4 3.1 3.2 3.3 3.4 5.1 5.2 5.3 5.4 6.1 6.2 6.3 6.4 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 Canada/US Foreign Exchange Rate Intermediation by the Clearing House Offsetting Trades Gold Fixing Price in London Bullion Market (USD$) Graphical Method to Get Hedged Position Profits Payoff Per Share to a Long Forward Contract Payoff Per Share to a Short Forward Contract Profits per bu. for the Unhedged Position Profits Per Share to a Naked Long Spot Position Payoffs Per Share to a Naked Long Spot Position Payoffs (=Profits) Per Share to a Naked Long Forward Position Payoffs Per Share to a Naked Long Spot Position and to a Naked Long Forward Position Order Flow Process (Pit Trading) The Futures Clearing House Offsetting Trades Overall Profits for Example 2 Long vs.

Directional Trades 371 11.3 The Dominance Principle 373 11.4 Implications of the Dominance Principle, ROP for Puts and Calls 374 11.4.1 Lower Bound for an American Call Option on an Underlying with no Dividends (LBAC) 374 11.4.2 Lower Bound for a European Call Option on an Underlying with no Dividends (LBEC) 375 11.4.3 Lower Bound for an American Put Option on an Underlying with no Dividends (LBAP) 378 11.4.4 Lower Bound for a European Put Option on an Underlying with no Dividends (LBEP) 380 11.4.5 Lower Bound for a European Call Option on an Underlying with Continuous Dividends (LBECD) 382 11.4.6 Lower Bound for an American Call Option on an Underlying with Continuous Dividends (LBACD) 383 11.4.7 Lower Bound for a European Put Option on an Underlying with Continuous Dividends (LBEPD) 386 11.4.8 Lower Bound for an American Put Option on an Underlying with Continuous Dividends (LBAPD) 387 370 OPTIONS 11.5 Static Replication and European Put-Call Parity (No Dividends) 388 11.5.1 Partially Replicating a European Call Option (the Embedded Forward Contract) 388 11.5.2 Fully Replicating a European Call Option (the Embedded Insurance Contract) 391 11.5.3 From Strategies to Current Costs and Back 393 11.5.4 Working Backwards from Payoffs to Costs to Derive European Put-Call Parity 393 11.6 Basic Implications of European Put-Call Parity 394 11.6.1 What is a European Call Option? 394 11.6.2 The Analogue of the Basic American Option Pricing Model for European Options 396 11.6.3 What is a European Put Option? 398 11.7 Further Implications of European Put-Call Parity 11.7.1 Synthesizing Forward Contract from Puts and Calls 11.8 Financial Innovation using European Put-Call Parity 399 399 401 11.8.1 Generalized Forward Contracts 401 11.8.2 American Put-Call Parity (No Dividends) 403 11.9 Postscript on ROP 405 11.1 MODEL-INDEPENDENT VS. MODEL-BASED OPTION PRICING In Chapter 9, section 9.4, we introduced a basic American option pricing model which says that the value of an American call or put option is the sum of intrinsic value and time premium, also known as the delayed exercise premium.

On the other hand, if ST<E, the buyer of the put will exercise the put forcing you to buy the underlying commodity for $E. You won’t exercise the call because it is out-of-the-money in this case. So no matter what state of the world prevails, you will end up having to buy the underlying commodity for $E. But that is exactly what a long forward contract is; the obligation to buy the underlying commodity for $E, no matter what happens at time T. RATIONAL OPTION PRICING 401 11.8 FINANCIAL INNOVATION USING EUROPEAN PUT-CALL PARITY 11.8.1 Generalized Forward Contracts Using these ideas linking forward contracts to European puts and calls, we can do a little financial innovation. When you take a long position in a ‘normal’ forward contract, the forward price must equal Ft,T=er St in order to avoid arbitrage. There is no up-front payment required because, at this forward price, the current value of the forward contract to all longs and shorts is zero.


pages: 488 words: 144,145

Inflated: How Money and Debt Built the American Dream by R. Christopher Whalen

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, bank run, banking crisis, Black Swan, Bretton Woods, British Empire, California gold rush, Carmen Reinhart, central bank independence, conceptual framework, corporate governance, cuban missile crisis, currency peg, debt deflation, falling living standards, fiat currency, financial deregulation, financial innovation, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, global reserve currency, housing crisis, interchangeable parts, invention of radio, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mutually assured destruction, non-tariff barriers, oil shock, payday loans, Plutocrats, plutocrats, price stability, pushing on a string, quantitative easing, rent-seeking, reserve currency, Ronald Reagan, special drawing rights, The Chicago School, The Great Moderation, too big to fail, trade liberalization, transcontinental railway, Upton Sinclair, women in the workforce

In the former group (United States, United Kingdom, Ireland, Spain, Iceland, Australia, and New Zealand) the response was one of democratization of credit that allowed households to borrow and spend beyond their means: the boom in mortgage and consumer credit (credit cards, auto loans, student loans, payday loans, subprime loans, and so on) led to a massive increase in private household debts that found it matching in the rising leverage of the financial sector (banks and shadow banks). This financial system leverage was abetted by reckless financial deregulation—repeal of Glass Steagall, non-regulation of derivatives, explosion of toxic financial innovation, rise of a subprime financial system, explosion of the shadow banking system. Since households, and the country, were spending more than their incomes, all of these Anglo-Saxon countries run large current account deficits financed by over-saving countries (China and emerging markets, as well as Germany and Japan). The explosion of private debt and foreign debt eventually became unsustainable, and led to the financial crisis of 2007 to 2009.

Whereas in the years immediately after WWII the United States had modest inflation but still higher levels of growth, today the situation is reversed, with persistent inflation and negative real levels of economic growth. “A nation that spends on itself is not spending on physical plant and equipment,” observes Vincent Reinhart, former director of the Federal Reserve Board’s Division of Monetary Affairs. “I don’t think it’s an accident that high savings rates and low deficits were associated with fast growth. We forgot that lesson in the 1960s. Financial innovation also made it easier for the government and households to spend more.”11 Changing Places Former Fed Governor Alan Blinder famously said in 1994: “The last duty of a central banker is to tell the public the truth.” But this, of course, assumes that our political leaders and central bankers know the truth in the first place. The basic question the Fed, the Congress, and the American people need to consider is whether the current load of public and private debt, combined with an over-valued dollar, makes stable, non-inflationary growth and job creation impossible.


pages: 416 words: 118,592

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, Bernie Madoff, BRICs, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, mortgage tax deduction, new economy, Own Your Own Home, passive investing, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, The Myth of the Rational Market, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

Innovations such as e-mail, the Internet, iPhones, iPads, Kindles, videoconferencing, social networks, and new medical advances ranging from organ transplants and laser surgery to nonsurgical methods of treating kidney stones and unclogging arteries have materially affected the way we live. Financial innovation over the same period has been equally rapid. In 1973, when the first edition of this book appeared, we did not have money-market funds, NOW accounts, ATMs, index mutual funds, ETFs, tax-exempt funds, emerging-market funds, target-date funds, floating-rate notes, volatility derivatives, inflation protection securities, equity REITs, asset-backed securities, Roth IRAs, 529 college savings plans, zero-coupon bonds, financial and commodity futures and options, and new trading techniques such as “portfolio insurance” and “flash trading,” to mention just a few of the changes that have occurred in the financial environment. Much of the new material in this book has been included to explain these financial innovations and to show how you as a consumer can benefit from them.


pages: 598 words: 140,612

Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier, and Happier by Edward L. Glaeser

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

affirmative action, Andrei Shleifer, Berlin Wall, British Empire, Broken windows theory, carbon footprint, Celebration, Florida, clean water, congestion charging, declining real wages, desegregation, diversified portfolio, Edward Glaeser, endowment effect, European colonialism, financial innovation, Frank Gehry, global village, Guggenheim Bilbao, haute cuisine, Home mortgage interest deduction, James Watt: steam engine, Jane Jacobs, job-hopping, John Snow's cholera map, Mahatma Gandhi, McMansion, megacity, mortgage debt, mortgage tax deduction, New Urbanism, place-making, Ponzi scheme, Potemkin village, Ralph Waldo Emerson, rent control, RFID, Richard Florida, Rosa Parks, school vouchers, Seaside, Florida, Silicon Valley, Skype, smart cities, Steven Pinker, strikebreaker, the built environment, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, trade route, transatlantic slave trade, upwardly mobile, urban planning, urban renewal, urban sprawl, William Shockley: the traitorous eight, Works Progress Administration, young professional

While there isn’t much sewing left in New York, there are still plenty of Calvin Kleins and Donna Karans, producing designs that will often be made on the other side of the planet. Honda may have brought heartache to Detroit’s Big Three, but managing the international flow of finance has earned vast sums for New York’s bankers. A more connected world has brought huge returns to the idea-producing entrepreneurs who can now scour the earth in search of profits. New York reinvented itself during the bleak years of the 1970s when a cluster of financial innovators learned from each other and produced a chain of interconnected ideas. Academic knowledge about trading off risk and return made it easier to evaluate and sell riskier assets, like Michael Milken’s high-yield (junk) bonds, which made it possible for Henry Kravis to use those bonds to get value out of underperforming companies through leveraged buyouts. Many of the biggest innovators acquired their knowledge not through formal training but by being close to the action, like mortgage-backed security magnate Lewis Ranieri of Liar’s Poker fame, who started in the Salomon Brothers mailroom.

The growth of finance in late-twentieth-century New York was encouraged by just such an innovation, the ability to quantify the trade-off between risk and return, which made it easier to sell investors riskier assets, from junk bonds to mortgage-backed securities, which in turn enabled riskier, high-return activities, like leveraged buyouts of underperforming companies such as RJR/ Nabisco. Today’s hedge-fund billionaires are only the latest links in a long chain of connected innovators. For the millions worldwide who look askance at all of New York’s financial innovation, Michael Bloomberg’s story, in which a smart trader became an entrepreneur in another sector, might be easier to embrace. In the 1970s, Bloomberg had been riding high at Salomon Brothers, running the firm’s trading floor, until he was exiled into the geeky world of systems development before being fired in 1981. Bloomberg then got into information technology, and over the next three decades he grew his company into a behemoth by supplying exactly what increasingly quantitative Wall Street traders wanted—jargon-free keyboards and a vast stream of information that was updated constantly.


pages: 483 words: 141,836

Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown, Eric Kim

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Benoit Mandelbrot, Bernie Madoff, Black Swan, capital asset pricing model, central bank independence, Checklist Manifesto, corporate governance, credit crunch, Credit Default Swap, disintermediation, distributed generation, diversification, diversified portfolio, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, financial innovation, illegal immigration, implied volatility, index fund, Long Term Capital Management, loss aversion, margin call, market clearing, market fundamentalism, market microstructure, money: store of value / unit of account / medium of exchange, moral hazard, natural language processing, open economy, pre–internet, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

These were among the most advanced firms in these techniques. I haven’t included the collateral damage from Wall Street abuses such as the Orange County bankruptcy, nor the non–Wall Street financial firms like Enron, nor the damage overseas as with the Asian financial crisis, nor the ones that entered more people’s homes like the Internet stock collapse and the mutual fund timing scandal. First, let me reiterate that the good from financial innovations far exceeds the damage. There were scandals and bankruptcies and disasters before quants came to Wall Street. Taking the good and bad together, the past 30 years have been the most extraordinarily good economic time for the globe in history. The horrendous times are decades of stagnation or totalitarian repression, not the exuberant and painful times of boom and bust. I know that not everyone shared in the fruits of this time, and even among those who shared the gains were unequal.

I start with the books that take on the subject of Red-Blooded Risk most directly. Nassim Taleb is best known for his Black Swan, but his earlier book, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, tackles many of the same issues as my book, with somewhat different results. We more or less agree on the problem, but go in opposite directions to find solutions. A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber comes at things from a third direction. Dylan Evans’s forthcoming Risk Intelligence: How to Live with Uncertainty focuses on similar ideas in settings beyond finance. Iceberg Risk: An Adventure in Portfolio Theory is Kent Osband’s brilliant and provocative communication of related ideas, and a pretty good novel to boot. The history of the Kelly criterion is told in Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone.


pages: 349 words: 134,041

Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, Albert Einstein, Asian financial crisis, asset-backed security, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business process, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, disintermediation, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, locking in a profit, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, mutually assured destruction, new economy, New Journalism, Nick Leeson, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, purchasing power parity, quantitative trading / quantitative finance, random walk, regulatory arbitrage, risk-adjusted returns, risk/return, shareholder value, short selling, South Sea Bubble, statistical model, technology bubble, the medium is the message, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond

A succession of leaders with contrasting hair styles tried unsuccessfully to revive the economy. For the investors, the only option was structured products like reverse dual currency bonds. There was the risk, but the insurance companies were trapped between a rock (do nothing and die) and a hard place (do something and probably die but with a small chance of survival). They did what anyone sensible would do. The state of the Japanese economy was leading to dazzling financial innovation. There was, for example, the 100-year mortgage that could be passed on to your children. It lent new meaning to the term ‘inheritance’. Japanese economic mandarins were unconvinced that there was a problem. One confessed that ‘things had improved’, he could now shop for a suit in the fashionable Ginza district without annoying crowds. The ordinary Japanese didn’t agree: individuals got 0% interest for their money at the bank.

The basic scheme offers high returns to investors and relies on using money from new investors to pay off earlier investors, until the whole thing collapses. 4 Quoted in Frank Partnoy (2004) Infectious Greed; Owl Books, New York, p. 83. 5 Morgan Stanley’s settlement is described in ‘Frustration’ (17 July 2004) The Economist, pp. 68–9. 6 Michael Lewis ‘How the Eggheads Cracked’ (24 January 1999) New York Times Magazine, pp. 24–42. Chapter 3 True lies – the ‘buy’ side 1 Truman Capote (1993) Breakfast at Tiffany’s, Vintage Books, New York. 2 Frank Partnoy (1999) FIASCO; New York, Penguin, p. 200. 3 Walt Disney case study is drawn from Scott Mason, Robert Merton, Andre Perhold and Peter Tufano (1995) Cases In Financial Engineering: Applied Studies of Financial Innovation; Prentic Hall, Upper Saddle River, New Jersey, pp. 567–579. See (5 September 1991) ‘The Walt Disney Company’s Yen Financing’; Harvard Business School, Boston, MA, p. 5. 12_NOTES.QXD 17/2/06 322 4:43 pm Page 322 Tr a d e r s , G u n s & M o n e y 4 Quoted in Antonio S. Mello and John E. Parsons (February 1995) Maturity Structure of a Hedge Matters: Lessons from the Metallgesellschaft Debacle, Columbia University, New York. 5 See ‘The Hondoyota GT89th’ (12 September 1987) IFR, 690. 6 Proctor & Gamble’s ‘Letter to P & G Shareholders’ (13 April 1994), quoted in Dawn Dimartino, Linda Ward, Janet Stevens and Winn Sargisson ‘Proctor & Gamble’s Derivative Loss: Isolated Incident or Wake-up Call?’


pages: 481 words: 120,693

Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else by Chrystia Freeland

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, algorithmic trading, banking crisis, barriers to entry, Basel III, battle of ideas, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Branko Milanovic, Bretton Woods, BRICs, business climate, call centre, carried interest, Cass Sunstein, Clayton Christensen, collapse of Lehman Brothers, conceptual framework, corporate governance, credit crunch, Credit Default Swap, crony capitalism, Deng Xiaoping, don't be evil, double helix, energy security, estate planning, experimental subject, financial deregulation, financial innovation, Flash crash, Frank Gehry, Gini coefficient, global village, Goldman Sachs: Vampire Squid, Gordon Gekko, Guggenheim Bilbao, haute couture, high net worth, income inequality, invention of the steam engine, job automation, joint-stock company, Joseph Schumpeter, knowledge economy, knowledge worker, linear programming, London Whale, low skilled workers, manufacturing employment, Mark Zuckerberg, Martin Wolf, Mikhail Gorbachev, Moneyball by Michael Lewis explains big data, NetJets, new economy, Occupy movement, open economy, Peter Thiel, place-making, Plutocrats, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, postindustrial economy, Potemkin village, profit motive, purchasing power parity, race to the bottom, rent-seeking, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, self-driving car, short selling, Silicon Valley, Silicon Valley startup, Simon Kuznets, Solar eclipse in 1919, sovereign wealth fund, stem cell, Steve Jobs, The Spirit Level, The Wealth of Nations by Adam Smith, Tony Hsieh, too big to fail, trade route, trickle-down economics, Tyler Cowen: Great Stagnation, wage slave, Washington Consensus, winner-take-all economy

One Bay Street financier summed it up more saltily: “Canadian regulators didn’t have penis envy.” With hindsight, that decision seems brilliant. At the time, though, to many it seemed, well, limp. One measure of how strongly the tide of world opinion was running against the Canucks is that the International Monetary Fund, meant to be the stern guardian of the global economy, chided Canada for not doing enough to promote securitization in its mortgage market—one of the American financial innovations that contributed to the crisis. Even communist China accused the Canadians of being too cautious about capitalism. Jim Flaherty, Canada’s finance minister, told me that on a visit to Beijing in 2007, “they were suggesting that maybe Canadian banks were too timid.” Canada’s bright young things were sympathetic to this critique. One newspaper columnist liked to write about “the tale of two Royals,” comparing the stodgy Royal Bank of Canada to its buccaneering, world-beating Edinburgh cousin, the Royal Bank of Scotland.

Philippon and Reshef call this the “finance wage premium” and estimate it at 30 percent to 40 percent. The second important piece of the puzzle is figuring out why the behavior of bankers followed this U-shape. Why was banking far less popular and prestigious than law and medicine for the Harvard men of 1970, while the class of 1990 flocked to Wall Street? The economists measure the impact of various changes, including globalization, the technological revolution, and financial innovations like the creation of mathematically complex credit derivatives. All of them have some impact, but they find that the change with the single greatest explanatory power is deregulation, which they calculate has driven nearly a quarter of the increase in incomes in finance and 40 percent of the increase in the education of workers in that sector. Volcker and his smartest classmates chose to become professors and civil servants.


pages: 289 words: 113,211

A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

affirmative action, Albert Einstein, asset allocation, backtesting, Black Swan, Black-Scholes formula, Bonfire of the Vanities, butterfly effect, commodity trading advisor, computer age, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, family office, financial innovation, fixed income, frictionless, frictionless market, George Akerlof, implied volatility, index arbitrage, Jeff Bezos, London Interbank Offered Rate, Long Term Capital Management, loose coupling, margin call, market bubble, market design, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, new economy, Nick Leeson, oil shock, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Shiller, rolodex, Saturday Night Live, shareholder value, short selling, Silicon Valley, statistical arbitrage, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, yield curve, zero-coupon bond

ffirs.qxd 3/1/07 3:33 PM Page i A DEMON OF OUR OWN DESIGN ffirs.qxd 3/1/07 3:33 PM Page ii ffirs.qxd 3/1/07 3:33 PM Page iii A DEMON OF OUR OWN DESIGN ~ ~ Markets, Hedge Funds, and the Perils of Financial Innovation RICHARD BOOKSTABER John Wiley & Sons, Inc. ffirs.qxd 3/1/07 3:33 PM Page iv Copyright © 2007 by Richard Bookstaber. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. Wiley Bicentennial Logo: Richard J. Pacifico No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our Web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Bookstaber, Richard M., 1950– A demon of our own design : markets, hedge funds, and the perils of financial innovation / Richard Bookstaber. p. cm. Includes bibliographical references and index. ISBN: 978-0-471-22727-4 (cloth) 1. Hedge funds. 2. Risk management. I. Title. HG4530.B66 2007 332.64'524—dc22 2006034368 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1 ffirs.qxd 3/1/07 3:33 PM Page v In memory of my son, Joseph Israel Bookstaber ffirs.qxd 3/1/07 3:33 PM Page vi ftoc.qxd 3/1/07 3:34 PM Page vii CONTENTS Acknowledgments ix About the Author xi CHAPTER 1 ~ Introduction: The Paradox of Market Risk 1 CHAPTER 2 ~ The Demons of ’87 7 CHAPTER 3 ~ A New Sheriff in Town 33 CHAPTER 4 ~ How Salomon Rolled the Dice and Lost 51 CHAPTER 5 ~ They Bought Salomon, Then They Killed It 77 CHAPTER 6 ~ Long-Term Capital Management Rides the Leverage Cycle to Hell 97 CHAPTER 7 ~ Colossus 125 CHAPTER 8 ~ Complexity, Tight Coupling, and Normal Accidents 143 CHAPTER 9 ~ The Brave New World of Hedge Funds 165 CHAPTER 10 ~ Cockroaches and Hedge Funds 207 CHAPTER 11 ~ Hedge Fund Existential Conclusion: Built to Crash?


pages: 320 words: 87,853

The Black Box Society: The Secret Algorithms That Control Money and Information by Frank Pasquale

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, algorithmic trading, Amazon Mechanical Turk, asset-backed security, Atul Gawande, bank run, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, bonus culture, Brian Krebs, call centre, Capital in the Twenty-First Century by Thomas Piketty, Chelsea Manning, cloud computing, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crowdsourcing, cryptocurrency, Debian, don't be evil, Edward Snowden, en.wikipedia.org, Fall of the Berlin Wall, Filter Bubble, financial innovation, Flash crash, full employment, Goldman Sachs: Vampire Squid, Google Earth, Hernando de Soto, High speed trading, hiring and firing, housing crisis, informal economy, information retrieval, interest rate swap, Internet of things, invisible hand, Jaron Lanier, Jeff Bezos, job automation, Julian Assange, Kevin Kelly, knowledge worker, Kodak vs Instagram, kremlinology, late fees, London Interbank Offered Rate, London Whale, Mark Zuckerberg, mobile money, moral hazard, new economy, Nicholas Carr, offshore financial centre, PageRank, pattern recognition, precariat, profit maximization, profit motive, quantitative easing, race to the bottom, recommendation engine, regulatory arbitrage, risk-adjusted returns, search engine result page, shareholder value, Silicon Valley, Snapchat, Spread Networks laid a new fibre optics cable between New York and Chicago, statistical arbitrage, statistical model, Steven Levy, the scientific method, too big to fail, transaction costs, two-sided market, universal basic income, Upton Sinclair, value at risk, WikiLeaks

But another health care model, designed to prevent overbilling and overtreatment, is simply to pay physicians salaries, rather than “per-procedure.” Imagine if this approach were to supersede the bonus culture of Wall Street (where, for most key players, annual pay is peanuts compared to the bounty available in a banner year of spectacularly successful risks). Sure, in health care, there are worries that salary-based pay will lead to shirking. But given how destructive financial innovation has been over the past decade, maybe bankers ought to work less, at least until they can better prove how their sector contributes to real productivity.82 Restoring Trust For too long, we have assumed that the core aim of fi nancial regulation is disclosure.83 When every consumer understands the consequences of his actions, we like to believe, and when every investor has the same key data about a security as its seller, the fi nancial playing field will fi nally be leveled.

Gosfield, Medicare and Medicaid Fraud and Abuse (New York: Thomson West, 2012), § 1:4. 151. Ibid. 152. For the “bust” model, see U.S. Department of Justice, Office of Public Affairs, “Dallas Doctor Arrested for Alleged Role in Nearly $375 Million Health Care Fraud Scheme,” February 28, 2012 (news release), http://www.justice.gov /opa /pr/2012/February/12-crm-260.html. 294 NOTES TO PAGES 181–182 153. See Eric Posner and E. Glen Weyl, “An FDA for Financial Innovation: Applying the Insurable Interest Doctrine to 21st Century Financial Markets,” Northwestern University Law Review 107 (2013): 1307–1358. (The agency would approve fi nancial products if they satisfy a test for social utility that focuses on whether the product will likely be used more often for insurance than for gambling. Other factors may be addressed if the answer is ambiguous.”) Saule T.


pages: 435 words: 127,403

Panderer to Power by Frederick Sheehan

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, British Empire, call centre, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversification, financial deregulation, financial innovation, full employment, inflation targeting, interest rate swap, inventory management, Isaac Newton, Long Term Capital Management, margin call, market bubble, McMansion, Menlo Park, mortgage debt, new economy, Northern Rock, oil shock, place-making, Ponzi scheme, price stability, reserve currency, rising living standards, rolodex, Ronald Reagan, Sand Hill Road, savings glut, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, supply-chain management, supply-chain management software, The Great Moderation, too big to fail, transaction costs, trickle-down economics, VA Linux, Y2K, Yom Kippur War

The bank credit system would recover, but it would not reclaim its predominant role in the economy. In 1980, banks handled 58 percent of savings and investment assets in the U.S. economy. This had faded to 33 percent by 1994.14 Since the Fed is directly involved in the money supplied to the banking system but has limited sway over the bond market, monetary policy would have less influence over the economy. Financial innovation played a larger role in nonfinancial corporations. Since the 1970s, corporate treasury departments had embraced derivatives to survive interest-rate and exchange-rate volatility (after the gold standard was abandoned). These were the real McCoy—derivatives used by a manufacturer to hedge against currency losses when, for instance, a company sold soap in a country other than where its production plant was located.

Large tracts of Queens, once home to factories and power plants, are being readied for apartment complexes[.]”41 Earlier in the summer, the Times alerted its readers: “For two months now, federal banking regulators have signaled their discomfort about the explosive rise in risky mortgage loans. . . . Then they expressed worry about the surge in no-money-down mortgages, interest only [mortgages] and ‘liar’s loans’ that require no proof of a borrower’s income. The impact so far? Almost nil.” 42 Why? Steve Fritts, associate director for risk management policy at the Federal Deposit Insurance Corporation (FDIC) explained: “We don’t want to stifle financial innovation. We have the most vibrant housing and housing-finance market in the world, and there is a lot of innovation.”43 That the Federal Reserve and alphabet soup bureaucracies encouraged, rather than warned, was unpardonable. That current proposed legislation would give such organizations more power is a disgrace. 38 Jim Christie, “California Home Buyers Stretch to Afford Homes,” Reuters, August 18, 2005. 39 Ross Wehrner, “Colorado Authorities Indict Real Estate Agent Loan Officer for Forgery,” Denver Post, July 14, 2005. 40 Noland, “Credit Bubble Bulletin,” July 15, 2005, p. 8. 41Jennifer Steinhauer, “Housing Boom Echoes in All Corners of the City,” New York Times, August 4, 2005. 42Edmund L.


pages: 386 words: 122,595

Naked Economics: Undressing the Dismal Science (Fully Revised and Updated) by Charles Wheelan

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

affirmative action, Albert Einstein, Andrei Shleifer, barriers to entry, Berlin Wall, Bernie Madoff, Bretton Woods, capital controls, Cass Sunstein, central bank independence, clean water, collapse of Lehman Brothers, congestion charging, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, Daniel Kahneman / Amos Tversky, David Brooks, demographic transition, diversified portfolio, Doha Development Round, Exxon Valdez, financial innovation, floating exchange rates, George Akerlof, Gini coefficient, Gordon Gekko, greed is good, happiness index / gross national happiness, Hernando de Soto, income inequality, index fund, interest rate swap, invisible hand, job automation, Joseph Schumpeter, Kenneth Rogoff, libertarian paternalism, low skilled workers, lump of labour, Malacca Straits, market bubble, microcredit, money: store of value / unit of account / medium of exchange, Network effects, new economy, open economy, presumed consent, price discrimination, price stability, principal–agent problem, profit maximization, profit motive, purchasing power parity, race to the bottom, RAND corporation, random walk, rent control, Richard Thaler, rising living standards, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, school vouchers, Silicon Valley, Silicon Valley startup, South China Sea, Steve Jobs, The Market for Lemons, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, transaction costs, transcontinental railway, trickle-down economics, urban sprawl, Washington Consensus, Yogi Berra, young professional

The details of these contracts can be mind-numbing, yet at bottom, most of what is going on is fairly straightforward. Financial instruments, like every other good or service in a market economy, must create some value. Both the buyer and seller must perceive themselves as better off by entering into the deal. All the while, entrepreneurs seek to introduce financial products that are cheaper, faster, easier, or otherwise better than what already exists. Mutual funds were a financial innovation; so were the index funds that Burt Malkiel helped to make popular. At the height of the financial crisis in 2008, it became clear that even Wall Street executives did not fully understand some of the products that their firms were buying and selling. Still, all financial instruments—no matter how complex the bells and whistles—are based on four simple needs: Raising capital. One of the fascinating things in life, particularly in America, is that we can spend large sums of money that don’t belong to us.

Unfortunately the Great Recession that began in 2007 had other aspects to it that spread the economic damage in virulent and scary ways. Many American households were “excessively leveraged,” meaning that they had borrowed far more than they could manage. The housing boom had encouraged ever bigger houses with ever bigger mortgages. Meanwhile, the down payments—the amount of their own money buyers had to spend to get a loan—were getting smaller relative to what was being borrowed. Subprime mortgages (a financial innovation, one must admit) made it easier for people to borrow who were otherwise not creditworthy and for other people to borrow in particularly aggressive ways (e.g., with no down payment at all). This all works fine when housing prices are going up; someone who falls behind on their mortgage payments can always sell the house to repay the loan. When the housing bubble burst, however, the numbers became a disaster.


pages: 415 words: 125,089

Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, Big bang: deregulation of the City of London, Bretton Woods, buttonwood tree, capital asset pricing model, cognitive dissonance, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Lloyd's coffeehouse, endowment effect, experimental economics, fear of failure, Fellow of the Royal Society, Fermat's Last Theorem, financial deregulation, financial innovation, full employment, index fund, invention of movable type, Isaac Newton, John Nash: game theory, John von Neumann, linear programming, loss aversion, Louis Bachelier, mental accounting, moral hazard, Nash equilibrium, probability theory / Blaise Pascal / Pierre de Fermat, random walk, Richard Thaler, Robert Shiller, Robert Shiller, spectrum auction, statistical model, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, trade route, transaction costs, tulip mania, Vanguard fund

Even though corporations could execute hedges in the liquid and active markets for options and futures-which now included interest rate and foreign exchange contracts as well as commodities and stock indexes-these contracts were expressly designed to appeal to as many investors as possible. The risk-management needs of most corporations are too specific in terms of both coverage and time spans to find ready customers in the public markets. Wall Street has always been a hothouse of financial innovation, and brokerage houses are quick to jump into the breach when a new demand for their talents arises. Major banks, insurance companies, and investment banking firms with worldwide business connections lost no time in establishing new units of specialized traders and financial engineers to design tailor-made risk-management products for corporate customers, some related to interest rates, some to currencies, and some to the prices of raw materials.

Everyone is aware of the dangers inherent in this situation, from the management of each institution on up to the governmental regulatory agencies that supervise the system. So-called "systemic risk" has become a parlor word in those circles and is the focus of attention at central banks and ministries of finance around the world. The measurement of the overall risk exposure in the system has been progressing in both comprehensiveness and sophistication.* But there is only a fine line between guaranteeing absolute safety and stifling the development of financial innovations that, properly handled, could reduce the volatility of corporate cash flows. Corporations that shelter their cash flows from volatility can afford to take greater internal risks in the form of higher levels of investment or expenditures on research and development. Financial institutions themselves are vulnerable to volatility in interest rates and exchange rates; to the extent that they can hedge that volatility, they can extend more credit to a wider universe of deserving borrowers.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bernie Madoff, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, disintermediation, diversification, Donald Trump, energy security, eurozone crisis, financial innovation, financial intermediation, Flash crash, floating exchange rates, frictionless, frictionless market, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, Long Term Capital Management, moral hazard, mortgage debt, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, too big to fail, trickle-down economics, value at risk, yield curve

Naturally enough, judges in the US, Britain, and elsewhere long ago evolved a sophisticated case law to handle any disputes. What happened if the bond issuer went bankrupt‌—‌the order in which creditors were paid out, how collateral was allocated‌—‌all these things and more were worked out in such a way that ordinary borrowing and lending became a smoothly operating machine. In the last ten or fifteen years, things have become vastly more complicated. Most of the financial innovation in that period has been driven, in the first instance, by mathematical possibility‌—‌the kind of thing that looks smart on a spreadsheet. But those spreadsheets are meaningless unless they turn into enforceable contracts and the contracts which emerge are often insanely complicated. Take, for example, the CDO-squared, a CDO backed by CDOs. Bearing in mind that many SIVs were created with multiple different tiers of debt, the legal language was forced to become ludicrously complex.

Indeed, putting those regulatory tweaks to one side, I’d argue that the fundamental position has grown worse, not better, since 2010. I don’t want to get too technical, but exchange traded funds‌—‌effectively, mutual funds that boast a stock market quotation‌—‌are, in many ways, following the trajectory of the mortgage market. A fundamentally good, useful, and value-creating idea is being gradually transformed‌—‌via ceaseless ‘financial innovation’‌—‌into a darkly menacing shadow extending over an ever larger section of the financial system.27 That shadow is spreading extremely fast: today the total asset value of ETFs runs to $1.5 trillion, up almost 50% in eighteen months. What’s more, the quality and fundamental liquidity of ETFs are declining all the time. Our weak-willed regulators know these things but aren’t taking the forceful steps that would be needed to control them.28 In short, if that ‘flash crash’ could happen in 2010, it could happen again now: the markets of 2011 and 2012 remain highly vulnerable.


pages: 632 words: 159,454

War and Gold: A Five-Hundred-Year History of Empires, Adventures, and Debt by Kwasi Kwarteng

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

accounting loophole / creative accounting, anti-communist, Asian financial crisis, asset-backed security, Atahualpa, balance sheet recession, bank run, banking crisis, Big bang: deregulation of the City of London, Bretton Woods, British Empire, California gold rush, capital controls, Carmen Reinhart, central bank independence, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, currency manipulation / currency intervention, Deng Xiaoping, discovery of the americas, Etonian, eurozone crisis, fiat currency, financial innovation, floating exchange rates, Francisco Pizarro, full employment, German hyperinflation, hiring and firing, income inequality, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, market bubble, money: store of value / unit of account / medium of exchange, moral hazard, new economy, oil shock, Plutocrats, plutocrats, Ponzi scheme, price mechanism, quantitative easing, rolodex, Ronald Reagan, South Sea Bubble, the market place, The Wealth of Nations by Adam Smith, too big to fail, War on Poverty, Yom Kippur War

In England, the year 1688 brought about a new settlement, in which King James II was deposed, largely for trying to introduce Roman Catholicism, and a new king, William III, Stadtholder of the Dutch Republic, was invited to take the throne. The first priority of William’s government was to engage Britain in a continental war against the power of France, under the reign of its vainglorious king, Louis XIV. The financial innovations introduced, particularly in the City of London, as a consequence of this development have been called collectively ‘the Financial Revolution’. More generally, ‘England was at war for twenty-nine of the sixty-six years between 1688 . . . and 1756.’ This prolonged state of war was waged on an unprecedented scale, involving enormous sums of money, unimaginable to earlier generations. As one historian has written, ‘the real cause of conflict was that both England and France were growing in wealth and ambition’ and there was ‘bitter rivalry’ between the two countries ‘for influence in Europe and for colonial markets’.1 The nature of the Nine Years’ War, which took place at the beginning of the period of intermittent warfare I have described, was such that England embarked on new forms of finance.

‘The decade immediately following the Civil War, because of its extraordinary happenings in speculative finance and in legislative and judicial corruption, has been called the fantastic era,’ wrote one observer in 1929.27 For all those who argue for a dynamic role to be adopted by government in stimulating economic growth, the history of money can afford some corroboration. We have seen how government borrowing stimulated such financial innovations as central banking in England in the last decade of the seventeenth century, and the conversion of debt into equity in both Paris and London in the early eighteenth century. In New York, the influence of government could be seen in the Wall Street of the 1860s. The issuance of government debt in the 1860s provided a platform which launched the careers of a ‘distinctively American class of financiers’.


pages: 482 words: 125,429

The Book: A Cover-To-Cover Exploration of the Most Powerful Object of Our Time by Keith Houston

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

clean water, Commentariolus, dumpster diving, Eratosthenes, financial innovation, invention of movable type, Islamic Golden Age, knowledge economy, means of production, Murano, Venice glass, paper trading, Ponzi scheme, wikimedia commons

The China that Marco Polo visited during the thirteenth century—Cathay, he called it, from the name of a Uighur dynasty that had ruled some centuries earlier—was a technological superpower.8 Gunpowder, invented in China sometime during the fifth or sixth century, had still not made it to Europe; the magnetic compass, in its infancy when Polo arrived, promised to revolutionize travel at sea; and the use of paper money whose value was determined by the state rather than being inherent in some precious substance—“fiat money,” as it is known—was perhaps the greatest financial innovation the world had ever seen.9 More vital than these technical and financial advances was the information revolution that had begun more than a thousand years earlier with the invention of paper. Barely 1 in 20 Western manuscripts of Polo’s time were written upon paper (to a European scribe, paper would have been scarcely less exotic than parchment is today), but in China the “paper of Marquis Cai” had long since replaced bamboo and silk as the writing material of choice.10 Polo told Rustichello of a stopover in the city of Chengdu, though he did not mention its shrine dedicated to the patron saint of Chinese paper, Cai Lun.11 But paper, though necessary to make the banknotes that Polo lauded so highly, was not all that was required.

Carter, Printing in China, 12; Tsien, Paper and Printing, 143–46; “The Making of a Chinese Rubbing,” The Field Museum, September 25, 2008, https://www.youtube.com/watch?v=ADfhgDRIhUk. 26. Tsien, Paper and Printing, 143–46; “Carved in Stone,” Art & Architecture Library, accessed October 31, 2014, http://lib.stanford.edu/art/exhibitions/carved-in-stone. 27. Richard von Glahn, “The Origins of Paper Money in China,” in The Origins of Value: The Financial Innovations That Created Modern Capital Markets, ed. William N. Goetzmann and K. Geert Rouwenhorst (Oxford: Oxford University Press, 2005), 79. 28. “Six Dynasties,” Encyclopaedia Britannica, accessed October 31, 2014, http://www.britannica.com/EBchecked/topic/547040/Six-Dynasties. 29. Xinjiang Rong, “Land Route or Sea Route? Commentary on the Study of the Paths of Transmission and Areas in Which Buddhism Was Disseminated During the Han Period,” ed.


pages: 475 words: 155,554

The Default Line: The Inside Story of People, Banks and Entire Nations on the Edge by Faisal Islam

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Big bang: deregulation of the City of London, British Empire, capital controls, carbon footprint, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, credit crunch, Credit Default Swap, crony capitalism, dark matter, deindustrialization, Deng Xiaoping, disintermediation, energy security, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, financial repression, floating exchange rates, forensic accounting, forward guidance, full employment, ghettoisation, global rebalancing, global reserve currency, hiring and firing, inflation targeting, Irish property bubble, Just-in-time delivery, labour market flexibility, London Whale, Long Term Capital Management, margin call, market clearing, megacity, Mikhail Gorbachev, mini-job, mittelstand, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, North Sea oil, Northern Rock, offshore financial centre, open economy, paradox of thrift, pension reform, price mechanism, price stability, profit motive, quantitative easing, quantitative trading / quantitative finance, race to the bottom, regulatory arbitrage, reserve currency, reshoring, rising living standards, Ronald Reagan, savings glut, shareholder value, sovereign wealth fund, The Chicago School, the payments system, too big to fail, trade route, transaction costs, two tier labour market, unorthodox policies, uranium enrichment, urban planning, value at risk, working-age population

But re-regulation of the world financial system was never going to start here in London: home to the most bankrupt floor of office space in the world that nearly bankrupted the whole European banking system; home of the worst bank takeover and the worst bank merger in world history; the manufacturer of toxic mortgage bonds for Lehman Brothers; home of the traders who nearly felled UBS; and base of the sober Treasury operation that cost J. P. Morgan billions. And then there was the systematic rigging of Libor, London’s inter-bank interest rate, the scandal that came to symbolise everything that was wrong with global finance. Why did all roads lead to London? London was, and still is, the global clearing house for socially useless financial innovation. In France and in Germany this has long been the accusation. But even in the USA, accusatory fingers began to be pointed at London. The ever-lengthening shadows in the world financial system were being cast by the ever-rising skyline of the City. Mis-selling mortgages to poor African Americans Cut to Baltimore, the setting for the greatest TV drama series of all time: The Wire. Through five seasons, The Wire shone its spotlight on the frailties of human nature by exposing the rotten core of five strands of life in the Maryland capital: its drug gangs, its police service, its declining dockyards, its schools and its local newspapers.

By contrast, in 2009, Angela Merkel responded to the collapse in world trade by spending two days in a hotel with union and business leaders, thrashing out a balanced engineered response to maintain employment and demand. It combined ‘right-wing’ policies on wage restraint with ‘left-wing’ policies on borrowed stimulus. The result was an economy that powered back to health, regaining all of the lost ground in one of the sharpest V-shaped recoveries in modern history. Germany engineers finances towards productive industry and innovation. Britain has financialised our engineers towards useless financial innovation. In the 1990s and noughties, the latter approach appeared to conquer all. However, financialising the housing market does not an economic strategy make. The German government sees a house and considers it a home. Successive British governments see a house and consider it a piggybank. Now Britain needs a broader economic plan, one that stretches beyond deficit reduction and financialisation.


pages: 1,205 words: 308,891

Bourgeois Dignity: Why Economics Can't Explain the Modern World by Deirdre N. McCloskey

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Admiral Zheng, agricultural Revolution, Albert Einstein, BRICs, British Empire, butterfly effect, Carmen Reinhart, clockwork universe, computer age, Corn Laws, dark matter, David Ricardo: comparative advantage, Donald Trump, Edward Lorenz: Chaos theory, European colonialism, experimental economics, financial innovation, Fractional reserve banking, full employment, George Akerlof, germ theory of disease, Gini coefficient, greed is good, Howard Zinn, income per capita, interchangeable parts, invention of agriculture, invention of air conditioning, invention of writing, invisible hand, Isaac Newton, James Watt: steam engine, John Maynard Keynes: technological unemployment, John Snow's cholera map, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, means of production, Naomi Klein, New Economic Geography, New Urbanism, purchasing power parity, rent-seeking, road to serfdom, Robert Gordon, Ronald Coase, Ronald Reagan, Scientific racism, Scramble for Africa, Shenzhen was a fishing village, Simon Kuznets, Slavoj Žižek, spinning jenny, Steven Pinker, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, total factor productivity, transaction costs, tulip mania, union organizing, Upton Sinclair, urban renewal, V2 rocket, very high income, working poor, World Values Survey, Yogi Berra

They got employment for unemployable twits from minor public schools. Above all — to go beyond the material realm — they got the great joy of seeing a quarter of the land area on world maps and globes shaded in British imperial red. Economically, materially, it did not matter. Standards of literacy exceeding those of Southern Europe mattered a great deal more to later British economic growth, as did a tradition of industrial and financial innovation exceeding those of Germany, and a free society in which to innovate exceeding that of Russia, and above all an early shift to a rhetoric of bourgeois virtues exceeding most of the world. Look at the accounting and the magnitudes. Most of British national income was and is domestic. This is true of all countries much larger than Luxembourg or Singapore. And what income there was from abroad was largely a matter of mutually advantageous trade having nothing to do with empire — Britain invested as much in places like the United States and Argentina as in comparable areas of the Empire, and there is no evidence in any case that returns to investment in the Empire were especially high.15 The British worried in 1776-1783 and in 1899-1902 and in 1947 about the loss of their various bits of empire.

In 1787 the professor of civil law at Glasgow, John Millar, had it more right than North does: the “energy and vigor which political liberty [my claim], and the secure possession and enjoyment of property [North and Weingast's claim], are wont to inspire. . . . was obtained by the memorable Revolution of 1688, which completed. . . a government of a more popular nature.”40 Secure possession of property is necessary. But it had little to do with the financial innovations that North and Weingast stress, because it had been established centuries before. A government of a more popular nature, and political liberty, and above all the energy and vigor that a new deal brought forth from England’s bourgeoisie, were what mattered. The figures of North and Weingast imply that total central government expenditureunder James I and Charles I was at most a mere 1.2 to 2.4 percent of national income.

Culture and Prosperity: The Truth About Markets - Why Some Nations Are Rich but Most Remain Poor by John Kay

Amazon: amazon.comamazon.co.ukamazon.deamazon.fr

Albert Einstein, Asian financial crisis, Barry Marshall: ulcers, Berlin Wall, Big bang: deregulation of the City of London, California gold rush, complexity theory, computer age, constrained optimization, corporate governance, corporate social responsibility, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, Donald Trump, double entry bookkeeping, double helix, Edward Lloyd's coffeehouse, equity premium, Ernest Rutherford, European colonialism, experimental economics, Exxon Valdez, failed state, financial innovation, Francis Fukuyama: the end of history, George Akerlof, George Gilder, greed is good, haute couture, illegal immigration, income inequality, invention of the telephone, invention of the wheel, invisible hand, John Nash: game theory, John von Neumann, Kevin Kelly, knowledge economy, labour market flexibility, late capitalism, Long Term Capital Management, loss aversion, Mahatma Gandhi, market bubble, market clearing, market fundamentalism, means of production, Menlo Park, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, Naomi Klein, Nash equilibrium, new economy, oil shale / tar sands, oil shock, pets.com, popular electronics, price discrimination, price mechanism, prisoner's dilemma, profit maximization, purchasing power parity, QWERTY keyboard, Ralph Nader, RAND corporation, random walk, rent-seeking, risk tolerance, road to serfdom, Ronald Coase, Ronald Reagan, second-price auction, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, Steve Jobs, telemarketer, The Chicago School, The Death and Life of Great American Cities, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, total factor productivity, transaction costs, tulip mania, urban decay, Washington Consensus, women in the workforce, yield curve, yield management

Britain and the Netherlands became major trading nations in the seventeenth and eighteenth centuries. While Spanish colonists were soldiers in search of gold, British and Dutch colonization was managed by businesses such as the East India Company and the VOC (Vereenigde Oostindische Compagnie) and its purpose was commercial exploitation. The beginning of the eighteenth century was a period of rapid financial innovation, which culminated in the boom and bust of the South Sea bubble. The Market Economy Crosses the Atlantic ••••••••••••••••••••••••••••••••••••• The Pilgrim fathers came to Plymouth from Britain via the Netherlands. Thus the connection with the two countries at the forefront of the development of economic institutions in the seventeenth and eighteenth centuries was established at the inception of modern America.

The financial center of the United States is located in the northeast corner of the country, and traditional industries are still predominantly based in Northern states. Market institutions were first imported into the United States from Western Europe, but the revolution was brought home, in an economic sense, before the end of the nineteenth century, as the United States became a center for new technology and financial innovation. And in the twentieth century, the United States was to become dominant in management theory and product innovation. By its end, Americans would sincerely believe that the market economy was an American invention, and a comparatively recent one. Thomas Friedman, a chronicler of globalization for the New York Times) would explain that "if one hundred years ago you had come to a visionary geo-architect and told him that in the year 2000 the world would be defined by a system called 'globalization,' what sort of country would he have designed to compete and win in that world?


pages: 237 words: 50,758