financial intermediation

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pages: 305 words: 69,216

A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression by Richard A. Posner

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Andrei Shleifer, banking crisis, Bernie Madoff, collateralized debt obligation, collective bargaining, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, diversified portfolio, equity premium, financial deregulation, financial intermediation, Home mortgage interest deduction, illegal immigration, laissez-faire capitalism, Long Term Capital Management, market bubble, moral hazard, mortgage debt, oil shock, Ponzi scheme, price stability, profit maximization, race to the bottom, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, savings glut, shareholder value, short selling, statistical model, too big to fail, transaction costs, very high income

There is first the extraordinary diversity and complexity of modern financial intermediation. Commercial banks conduct little more than half the financial intermediation in the American economy. If they are forced to be safe, their competitors will eat them alive. But can hedge funds, private equity funds, investment banks, and all the other nonbank banks be placed under the identical regulatory regime as commercial banks? If not, won't the differences distort competition? It is easier to deregulate an industry than to reregulate it. Deregulation has a built-in momentum: allow an unregulated firm to compete with a regulated one and the regulated firm will have a convincing case that it must be deregulated so that it can compete. One ends with a competitive industry. The competitive financial-intermediation industry that deregulation has created is complex and varied.

A choice under profound uncertainty is not adding a column of numbers but firing a shot in the dark, and so we should consider the character traits (not character flaws) that make some people willing to act on such a basis. They will be people who have a below-average aversion to uncertainty and, since we are speaking of business, an above-average love of making money. They were bound to swarm into financial intermediation in the era created by Alan Greenspan's monetary policy that offered prospects of great wealth to smart people willing to take large risks. Such people are not irrational, but their clustering in financial intermediation when the wraps are taken off risky lending enhances the inherent instability of that business. Similarly, it is not irrational, though often thought to be, to allow oneself to be influenced by what other people are doing. You may doubt that the price of some tradable asset will continue to rise, but the fact that it is rising means that other people disagree with you.

The case against reorganization is the clearer: experience, as with the Department of Homeland Security, teaches that a major federal reorganization (not to mention a reorganization that would encompass both state and foreign regulation of financial intermediation as well) takes years to gel, and during those years of growing pains the efficiency with which the mission entrusted to the reorganized entity will be performed will be lower than it was in the pre-reorganization regime. And this is apart from the fact that in the present instance the same small knot of senior economic officials that would design and supervise the reorganization have their hands full dealing with an economic emergency. The case against trying to reregulate financial intermediation at this time is a bit subtler and requires me to distinguish between two senses of "regulation." In one sense it refers to the regulatory framework — the laws that establish the powers and limits of the regulatory body.


pages: 478 words: 126,416

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

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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

Systemic instability in the financial system is the result of the interdependencies inherent in an industry that deals mainly with itself. The growth in the scale of resources devoted to financial intermediation is not to any large degree (or, in most cases, at all) the result of any change in the needs of users of intermediary services. The growth of financial activity has come from a massive expansion in the packaging, repackaging and trading of existing assets. The finance sector today does many things that do not need to be done, and fails to do many things that do need to be done. Financial intermediation that meets the needs of the real economy should not be a game in which professional intermediaries compete to outwit each other. Competition between financial intermediaries is valuable and necessary, but – as with competition in other industries – success in that competition should follow from effectiveness in meeting the demands of customers.

The common sense that suggests that the activity of exchanging bits of paper cannot make profits for everyone may be a clue that much of this profit is illusory: much of the growth of the finance sector represents not the creation of new wealth but the sector’s appropriation of wealth created elsewhere in the economy, mostly for the benefit of some of the people who work in the financial sector. And yet, although the finance industry today displays many examples of egregious excess, the majority of those engaged in it are not guilty or representative of that excess. They are engaged in operating the payments system, facilitating financial intermediation, enabling individuals to control their personal finances and helping them to manage risks. Most people who work in finance are not aspiring Masters of the Universe. They are employed in relatively mundane processing activities in banking and insurance, for which they are rewarded with relatively modest salaries. We need them, and we need what they do. So the third part of this book will be concerned with reform.

Some enthusiasts have claimed that new technologies will eliminate intermediary functions. But connectedness, which the internet delivers so effectively, is only one of the functions of the intermediary. The greater ease of making connections increases the need to monitor these connections. Facebook illustrates how a broader range of relationships diminishes their average quality. Recent financial innovations, such as crowd-funding and peer-to-peer lending, cannot eliminate financial intermediation. If savers are to obtain returns that match the risks they take, they need to be able to judge how their money is used and how the assets purchased with that money are managed. Few have the time, knowledge or experience to do this. Cynicism born of experience is required to find the few viable opportunities among many optimistic business plans. Or to identify those who are likely to repay their debts, among compelling promises and persuasive hard luck stories.


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

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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

In addition, Hamid always made sure he had $2 in his pocket to deal with anything that might befall him on the road. 8 THE PORTFOLIOS OF THE PO OR Table 1.2 Hamid and Khadeja’s Closing Balance Sheet, November 2000 Financial assets Microfinance savings account Savings with a moneyguard Home savings Life insurance Remittances to the home villagea Loans out Cash in hand $174.80 Financial liabilities Microfinance loan account Private interest-free loan Wage advance Savings held for others Shopkeeper credit Rent arrears 16.80 8.00 2.00 76.00 $223.34 153.34 14.00 10.00 20.00 16.00 10.00 30.00 40.00 2.00 Financial net worth $48.54 Note: US$ converted from Bangladeshi takas at $1 50 takas, market rate. a In the Bangladesh and Indian diaries remittances to the home village are treated as assets, given that for the most part the remittances entail debt obligations on the part of the recipients or are used to create assets for use by the giving households. In South Africa, remittances are treated as expenses given that they were mostly used to support the daily needs of family members living at a distance. Their active engagement in financial intermediation also shows up clearly on the liabilities side of their balance sheet. They are borrowers, with a debt of $153 to a microfinance institution and interest-free private debts from family, neighbors, and employer totaling $24. They also owed money to the local grocery store and to their landlord. Khadeja was even acting as an informal banker, or “moneyguard,” holding $20 at home that belonged to two neighbors seeking a way to keep their money safe from their more spendthrift husbands and sons.

In South Africa, social welfare pays out monthly grants to the elderly, children, and the disabled.4 The system reaches down to many poor households: in our South African sample of 152 households, 27 percent had grant support as their main source of income. Within our sample, these government grants made up 48 percent of the 35 CHAPTER T WO average household income in the rural areas and 10 percent in the townships. These monthly payments certainly make income more regular, and we later show that this regularity does make it easier to engage in higher levels of financial intermediation. But these incomes are small: in the rural areas, a grant meant to support one person supports, on average, a family of four. As a result, grants are rarely enough to cover costs, and most households supplement them with small business, casual work, and remittances from working relatives. Moreover, having come to rely on regular monthly payments, grantdependent households are left particularly vulnerable when they don’t arrive on time.

A formal sector job, then, doesn’t necessarily translate to more reliable income in South Asia. In South Africa, however, labor laws are much more rigorously enforced, and when households do manage to find a waged job, they tend to have a fairly reliable source of income. Even grant recipient households could depend on regular monthly grant income. In our study, these households were able to “leverage” their more regular sources of income to engage in larger-scale financial intermediation: with a regular income, they were more comfortable taking on higher levels of debt and lenders were more willing to provide loans. As table 2.4 shows, regular wage earners in South Africa are usually better off in terms of both absolute income and income per capita than those earning irregularly (those whose income 44 T H E DA I LY G R I N D Table 2.4 Regular versus Irregular Income Households, South Africa Wage-earning households Share of sample in profile Financial statistics Average monthly income Average monthly income per capita Debt/service ratio Debt/equity ratio Grant-receiving households Irregular income households 49% 27% 21% $635 $188 $235 $219 13% 22% $61 17% 23% $87 7% 19% Note: US$ converted from South African rand at $ = 6.5 rand, market rate.


pages: 159 words: 45,073

GDP: A Brief but Affectionate History by Diane Coyle

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Asian financial crisis, Berlin Wall, big-box store, Bretton Woods, BRICs, clean water, computer age, conceptual framework, crowdsourcing, Diane Coyle, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Fall of the Berlin Wall, falling living standards, financial intermediation, global supply chain, happiness index / gross national happiness, income inequality, income per capita, informal economy, John von Neumann, Kevin Kelly, Long Term Capital Management, mutually assured destruction, Nathan Meyer Rothschild: antibiotics, new economy, Occupy movement, purchasing power parity, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, Silicon Valley, Simon Kuznets, The Wealth of Nations by Adam Smith, Thorstein Veblen, University of East Anglia, working-age population

As the OECD GDP statistics manual puts it: “Measurement using the general formula [for constructing GDP] would result in their value added being very small, if not negative; in other words, their intermediate consumption would be greater than their sales!”9 Unable to imagine when this was written that banking could be subtracting value from the economy, statisticians sought to find a way of measuring these earnings from financial intermediation. So for many years the convention was to count financial services as the negative output of an imaginary segment of the economy. It is, to use a phrase from Alice in Wonderland, curiouser and curiouser. As the financial services industry grew throughout the 1980s, the approach changed again, and the 1993 update of the UN System of National Accounts introduced the concept of “financial intermediation services indirectly measured,” or FISIM. This current measure compares banks’ borrowing and lending rates on their loan and deposit portfolios to a risk-free “reference rate” such as the central bank’s policy rate, and multiplies the difference by the stock of outstanding balances in each case.

See United Kingdom environmentalism, 60, 68–71, 115–16, 133–34 European Commission, 2–4 European Union (EU), 1 Eurozone, 101 exchange rates, 48–49. See also purchasing power parity expenditures: categories of, 27–28; as GDP measure, 25, 26t, 27 factor cost, 30 famines, 73 Federal Reserve Bank of Dallas, 121, 123–25 Federal Reserve Board, 83, 88, 94 financial crisis (2008–), 93–97 financial intermediation services indirectly measured (FISIM), 100–104, 136 financial sector, 40, 97–105 fiscal policy, 15, 19, 23, 77 fiscal stimulus, 23 FISIM. See financial intermediation services indirectly measured Fitoussi, Jean-Paul, 118, 139 Fleming, Alexander, 63 Ford, Henry, 45 France, 8–9, 103 Frank, Robert, 112 free market ideology, 93 Friedman, Thomas, 95–96 Gagarin, Yuri, 47 Geary-Khamis dollars, 52 Genuine Progress Indicator (GPI), 116, 137 Georgiou, Andreas, 1–2, 4 Germany, 17, 41–42, 71 Ghana, 32, 53, 94, 107 Gilbert, Milton, 15, 50 globalization, 93–94 global supply chains, 125 Golden Age, 43, 56 Gosplan, 29 government expenditures (G), 27–29 government role in economy, 14–17, 19–21, 23, 63–66, 77–78.

The original SNA (in 1953) had shown the financial services industry as making either a negative or a small positive contribution to GDP. Finance was a more or less “unproductive” activity because the interest flows (now measured by the FISIM construct) were broadly treated as an intermediate input of the finance sector and therefore netted out of the sector’s final value-added contribution to GDP. In the United States from 1947 to 1993, the net interest revenue from financial intermediation (labeled the imputed bank service charge, IBSC) was counted as an input to other sectors of the economy. This approach was formalized worldwide in the revised 1968 SNA, when the IBSC was “considered wholly intermediate consumption and, more pointedly, as the input/expense exclusively of a notional industry sector with no output of its own. That is correct: an imaginary industry supplying no products or services was theorized into being as the ‘buyer’ of banks’ intermediation.


pages: 430 words: 109,064

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

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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

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. Much recent “innovation” in credit cards, for example, has simply made the pricing of credit more complex. Card issuers have lowered the “headline” price that they advertise to consumers while increasing the hidden prices that consumers are less aware of, such as late fees and penalty rates. These tactics have increased the profits of credit card issuers, but have not increased financial intermediation—except insofar as they helped consumers underestimate the cost of credit and therefore borrow excessive amounts of money.56 Innovation that increases the availability of credit can also be harmful.

This was a key element in Donald Regan’s strategy to provide a full spectrum of financial services; as he said, “I wanted to get into banking, and CMA was the way to do it.”82 Cash management accounts competed directly with traditional savings and checking accounts for deposits, and enabled securities firms to sweep up a larger share of their clients’ assets. Investment banks also benefited from the general shift in financial intermediation (the movement of money from people who have it to people who need it) from banks into the capital markets. Traditionally, households and businesses would put their excess cash in deposit accounts at commercial banks or S&Ls, which would lend the cash out as mortgages and commercial loans. However, the high interest rates of the 1970s convinced investors to move their savings from bank accounts to money market funds, which invested in short-term bonds and commercial paper.

Risks are spread more widely, across a more diverse group of financial intermediaries, within and across countries. These changes have contributed to a substantial improvement in the financial strength of the core financial intermediaries and in the overall flexibility and resilience of the financial system in the United States. And these improvements in the stability of the system and efficiency of the process of financial intermediation have probably contributed to the acceleration in productivity growth in the United States and in the increased stability in growth outcomes experienced over the past two decades.47 Even in April 2009, after the financial crisis, Greenspan’s successor, Ben Bernanke, said, “Financial innovation has improved access to credit, reduced costs, and increased choice. We should not attempt to impose restrictions on credit providers so onerous that they prevent the development of new products and services in the future.”48 The fact that Bernanke, a brilliant and widely respected academic, would sing the praises of financial innovation even after the financial crisis shows the powerful hold this ideology exerted on both economists and policymakers.


pages: 209 words: 13,138

Empirical Market Microstructure: The Institutions, Economics and Econometrics of Securities Trading by Joel Hasbrouck

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barriers to entry, conceptual framework, correlation coefficient, discrete time, disintermediation, distributed generation, experimental economics, financial intermediation, index arbitrage, interest rate swap, inventory management, market clearing, market design, market friction, market microstructure, martingale, price discovery process, price discrimination, quantitative trading / quantitative finance, random walk, Richard Thaler, second-price auction, short selling, statistical model, stochastic process, stochastic volatility, transaction costs, two-sided market, ultimatum game

Allen Spivey, and William J. Wrobleski, 1977, On the structure of moving average prices, Journal of Econometrics 6, 121–34. Arnold, Tom, Philip Hersch, J. Harold Mulherin, and Jeffry Netter, 1999, Merging markets, Journal of Finance 54, 1083–107. Bacidore, Jeffrey M., 1997, The impact of decimalization on market quality: An empirical investigation of the Toronto Stock Exchange, Journal of Financial Intermediation 6, 92–120. Bacidore, Jeffrey M., 2002, Depth improvement and adjusted price improvement on the New York stock exchange, Journal of Financial Markets 5, 169–95. Bacidore, Jeffrey, Katharine Ross, and George Sofianos, 2003, Quantifying market order execution quality at the New York Stock Exchange, Journal of Financial Markets 6, 281. Back, Kerry, 1992, Insider trading in continuous time, Review of Financial Studies 5.

., 1997a, Do competing specialists and preferencing dealers affect market quality?, Review of Financial Studies 10, 969–93. Battalio, Robert H., 1997b, Third market broker-dealers: Cost competitors or cream skimmers?, Journal of Finance 52, 341–52. Battalio, Robert H., 1998, Order flow distribution, bid-ask spreads, and liquidity costs: Merrill Lynch’s decision to cease routinely routing orders to regional stock exchanges, Journal of Financial Intermediation 7, 338–58. Battalio, Robert H., 2003, All else equal?: A multidimensional analysis of retail, market order execution quality, Journal of Financial Markets 6, 143–62. Bertsimas, Dimitris, and Andrew W. Lo, 1998, Optimal control of execution costs, Journal of Financial Markets 1, 1–50. Bessembinder, H., 2004, Does an electronic stock exchange need an upstairs market?, Journal of Financial Economics 73, 3–36.

Grossman, and Jiang Wang, 1993, Trading volume and serial correlation in stock returns, Quarterly Journal of Economics 108, 905–39. CFA Institute, 2002, Trade Management Guidelines, CFA Institute (formerly the American Institute for Management Research), available online at http://www.cfainstitute.org/standards/pdf/trademgmt_ guidelines.pdf. Chakravarty, Sugato, and Craig W. Holden, 1995, An integrated model of market and limit orders, Journal of Financial Intermediation 4, 213–41. Challet, Damien, and Robin Stinchcombe, 2003, Non-constant rates and over-diffusive prices in a simple model of limit order markets, Quantitative Finance 3, 155–62. Chan, Louis K. C., and Josef Lakonishok, 1993, Institutional trades and intraday stock-price behavior, Journal of Financial Economics 33, 173–99. Chan, Louis K. C., and Josef Lakonishok, 1995, The behavior of stock prices around institutional trades, Journal of Finance 50, 1147–74.


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

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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

For a fuller discussion of the literature on this topic, see David Pitt-Watson, Christopher Sier, Shyam Moorjani, and Hari Mann, Investment Costs—An Unknown Quantity, Financial Services Consumer Panel (November 2014), https://www.fscp.org.uk/sites/default/files/investment_david_pitt_watson_et_al_final_paper.pdf. 6. Private study obtained by the authors prepared for Her Majesty’s Treasury, November 2011. 7. Thomas Philippon, “Has the US Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation,” National Bureau of Economic Research Working Paper no. 18077 (May 2012), http://www.nber.org/papers/w18077. 8. Ronald Gilson and Jeffrey Gordon, “Capital Markets, Efficient Risk Bearing and Corporate Governance: The Agency Costs of Agency Capitalism,” Columbia Law School Coursewebs (2012), https://coursewebs.law.columbia.edu/coursewebs/cw_12S_L9519_001.nsf/0f66a77852c3921f852571c100169cb9/C52A6786C57B3B52852579830053479F/$FILE/GilGor+Oxford+Prelim+Draft.Conf+Final.011012.pdf?

For example, Canadian economist Richard Lipsey wrote of perfect competition that “it is a pity it corresponds in so few aspects to reality as we know it.” Richard Lipsey, Positive Economics (Weidenfeld and Nicholson, 1973), 299. 1 What’s the Financial System For? 1. See discussion in Thomas Philippon, “Has the US Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation,” National Bureau of Economic Research, Working Paper 18077 (May 2012), 6–9, http://www.nber.org/papers/w18077. 2. See World Bank data at data.worldbank.org/indicator/NV.ARG.TOTL.ZS. 3. For current figures see New York Stock Exchange data at www.nyse.com/about/listed/nya_characterstics.shtml (August 21, 2013). 4. Note that it is not just our deposits at the bank, or safe deposit boxes, that involve safe keeping.

The abusive sale of indulgences was such a problem in the thirteenth century, the era of our time traveler, that reform of the system was a subject of the fourth Lateran council of 1215. See text of fourth Lateran council (1215), 63–66, https://www.ewtn.com/library/COUNCILS/LATERAN4.HTM. 2 Incentives Gone Wild 1. Thomas Philippon, “Has the US Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation,” National Bureau of Economic Research Working Paper no. 18077 (May 2012), http://www.nber.org/papers/w18077 http://www.nber.org/papers/w18077. 2. During the same period, GDP per capita, which is an approximate measure of productivity, increased about tenfold. See http://www.worldeconomics.com/Data/MadisonHistoricalGDP/Madison%20Historical%20GDP%20Data.efp. Of course, different industries have made different contributions to that increase.


pages: 346 words: 101,763

Confessions of a Microfinance Heretic by Hugh Sinclair

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accounting loophole / creative accounting, Bernie Madoff, colonial exploitation, en.wikipedia.org, financial innovation, financial intermediation, Gini coefficient, high net worth, illegal immigration, inventory management, microcredit, Northern Rock, peer-to-peer lending, pirate software, Ponzi scheme, principal–agent problem, profit motive

This is not a fear unique to poor African countries: consider the recent collapse of Northern Rock in England during the financial crisis, with queues of people withdrawing their funds from the bank, and the government doing everything it could to persuade the rest that their savings were safe. Or of Argentines queuing up for days outside banks in 2001. I needed to find out if FCC was allowed to take savings, and what it was doing with these deposits. Some MFIs are essentially full-fledged banks. They take savings from some customers and make loans to other customers, just like Deutsche Bank, Bank of America, or Barclays Bank in developed countries. This is so-called “financial intermediation.” Such MFIs make money by charging interest to borrowers at greater rates than the interest they pay to savers. However, in exchange for this margin, the bank has to manage its reserves in such a way that it can return funds to the savers when required. Even if the bank’s borrowers do not repay the funds to the bank, the bank is still legally obliged to return savings to the general public, and thus the bank must assume and manage this risk.

Even if the bank’s borrowers do not repay the funds to the bank, the bank is still legally obliged to return savings to the general public, and thus the bank must assume and manage this risk. And naturally, the banks have to cover their operating costs from this margin. This is a risky business and is regulated. All commercial retail banks across the planet operate on variants of this model: take money from A, lend to B, manage the risk and operating costs efficiently, and hope to make a profit in the meantime. Most MFIs do not engage in such financial intermediation, since most are not allowed to take deposits. Their business model is fairly simple: get money from investors, usually incurring some interest charge, lend money to clients at a higher interest rate, cover all administration costs and costs of defaults of borrowers who do not repay. What is left over is profit for the MFI and its owners. However, there is a third type of MFI that is somewhere between these two extremes, and here occurs much of the abuse: MFIs that make loans and take some savings, known as forced guarantees, or forced savings.

There are two main ways MFIs use to manipulate this system. First, they can quietly use the client savings for other activities. This may involve lending the savings to other clients, who in turn are obliged to make forced deposits in an ever-growing pyramid. Or the MFI may simply use the savings to cover its own operating costs. Both strategies are usually prohibited for MFIs not licensed to engage in full financial intermediation, but local regulators are often not sophisticated enough to detect this or fail to enforce the rules. The second way MFIs can manipulate this system to their advantage is by blurring the difference between forced savings and voluntary savings. The MFI is able to justify capturing forced savings as a guarantee, but then may also discreetly capture voluntary savings, which are deposited into the same account.


pages: 354 words: 26,550

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Irene Aldridge

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algorithmic trading, asset allocation, asset-backed security, automated trading system, backtesting, Black Swan, Brownian motion, business process, capital asset pricing model, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, diversification, equity premium, fault tolerance, financial intermediation, fixed income, high net worth, implied volatility, index arbitrage, interest rate swap, inventory management, law of one price, Long Term Capital Management, Louis Bachelier, margin call, market friction, market microstructure, martingale, New Journalism, p-value, paper trading, performance metric, profit motive, purchasing power parity, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic trading, trade route, transaction costs, value at risk, yield curve

AI Expert 31, 53–59. Chaboud, Alain P. and Jonathan H. Wright, 2005. “Uncovered Interest Parity: It Works, but Not for Long.” Journal of International Economics 66, 349–362. Chakravarty, Sugato, 2001. “Stealth Trading: Which Traders’ Trades Move Stock Prices?” Journal of Financial Economics 61, 289–307. Chakravarty, Sugato and C. Holden, 1995. “An Integrated Model of Market and Limit Orders.” Journal of Financial Intermediation 4, 213–241. Challe, Edouard, 2003. “Sunspots and Predictable Asset Returns.” Journal of Economic Theory 115, 182–190. Chambers, R.G., 1985. “Credit Constraints, Interest Rates and Agricultural Prices.” American Journal of Agricultural Economics 67, 390–395. Chan, K.S. and H. Tong, 1986. “On estimating Thresholds in Autoregressive Models.” Journal of Time Series Analysis 7, 179–190. Chan, L.K.C., Y.

Working paper, Carnegie Mellon University. Kyle, A., 1985. “Continuous Auctions and Insider Trading,” Econometrica 53, 1315–1335. Le Saout, E., 2002. “Intégration du Risque de Liquidité dans les Modèles de Valeur en Risqué.” Banque et Marchés, No. 61, November–December. Leach, J. Chris and Ananth N. Madhavan, 1992. “Intertemporal Price Discovery by Market Makers: Active versus Passive Learning.” Journal of Financial Intermediation 2, 207–235. References 317 Leach, J. Chris and Ananth N. Madhavan, 1993. “Price Experimentation and Security Market Structure.” Review of Financial Studies 6, 375–404. Lechner, S. and I. Nolte, 2007. “Customer Trading in the Foreign Exchange Market: Empirical Evidence from an Internet Trading Platform.” Working paper, University of Konstanz. Lee, C. and M. Ready, 1991. “Inferring Trade Direction from Intraday Data.”

“The Adjustment of Exchange Rates to Macroeconomic Information: The Role of Order Flow.” Journal of Financial and Quantitative Analysis 43, 467–488. Lyons, Richard K., 1995. “Tests of Microstructural Hypotheses in the Foreign Exchange Market.” Journal of Financial Economics 39, 321–351. 318 REFERENCES Lyons, Richard K., 1996. “Optimal Transparency in a Dealer Market with an Application to Foreign Exchange.” Journal of Financial Intermediation 5, 225–254. Lyons, Richard K., 2001. The Microstructure Approach to Exchange Rates. MIT Press. MacKinlay, A.C., 1997. “Event Studies in Economics and Finance.” Journal of Economic Literature XXXV, 13–39. Mahdavi, M., 2004. “Risk-Adjusted Return When Returns Are Not Normally Distributed: Adjusted Sharpe Ratio.” Journal of Alternative Investments 6 (Spring), 47–57. Maki, A. and T. Sonoda, 2002.


pages: 935 words: 267,358

Capital in the Twenty-First Century by Thomas Piketty

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accounting loophole / creative accounting, Asian financial crisis, banking crisis, banks create money, Berlin Wall, Branko Milanovic, British Empire, capital controls, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, central bank independence, collapse of Lehman Brothers, conceptual framework, corporate governance, correlation coefficient, David Ricardo: comparative advantage, demographic transition, distributed generation, diversification, diversified portfolio, European colonialism, eurozone crisis, Fall of the Berlin Wall, financial intermediation, full employment, German hyperinflation, Gini coefficient, high net worth, Honoré de Balzac, immigration reform, income inequality, income per capita, index card, inflation targeting, informal economy, invention of the steam engine, invisible hand, joint-stock company, Joseph Schumpeter, market bubble, means of production, mortgage debt, mortgage tax deduction, new economy, New Urbanism, offshore financial centre, open economy, pension reform, purchasing power parity, race to the bottom, randomized controlled trial, refrigerator car, regulatory arbitrage, rent control, rent-seeking, Robert Gordon, Ronald Reagan, Simon Kuznets, sovereign wealth fund, Steve Jobs, The Nature of the Firm, the payments system, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, trade liberalization, very high income, We are the 99%

The Notion of the Pure Return on Capital The other important source of uncertainties, which leads me to think that the average rates of return indicated in Figures 6.3 and 6.4 are somewhat overestimated, so that I also indicate what might be called the “pure” rate of return on capital, is the fact that national accounts do not allow for the labor, or at any rate attention, that is required of anyone who wishes to invest. To be sure, the cost of managing capital and of “formal” financial intermediation (that is, the investment advice and portfolio management services provided by a bank or official financial institution or real estate agency or managing partner) is obviously taken into account and deducted from the income on capital in calculating the average rate of return (as presented here). But this is not the case with “informal” financial intermediation: every investor spends time—in some cases a lot of time—managing his own portfolio and affairs and determining which investments are likely to be the most profitable. This effort can in certain cases be compared to genuine entrepreneurial labor or to a form of business activity.

The complex question of government debt and the nature of the wealth associated with it is no less important today than it was in 1800, and by studying the past we can learn a lot about an issue of great contemporary concern. Although today’s public debt is nowhere near the astronomical levels attained at the beginning of the nineteenth century, at least in Britain, it is at or near a historical record in France and many other countries and is probably the source of as much confusion today as in the Napoleonic era. The process of financial intermediation (whereby individuals deposit money in a bank, which then invests it elsewhere) has become so complex that people are often unaware of who owns what. To be sure, we are in debt. How can we possibly forget it, when the media remind us every day? But to whom exactly do we owe money? In the nineteenth century, the rentiers who lived off the public debt were clearly identified. Is that still the case today?

Obviously, there can be situations in which the landlord is in a monopoly position when it comes to renting land and tools or purchasing labor (in the latter case one speaks of “monopsony” rather than monopoly), in which case the owner of capital can impose a rate of return greater than the marginal productivity of his capital. In a more complex economy, where there are many more diverse uses of capital—one can invest 100 euros not only in farming but also in housing or in an industrial or service firm—the marginal productivity of capital may be difficult to determine. In theory, this is the function of the system of financial intermediation (banks and financial markets): to find the best possible uses for capital, such that each available unit of capital is invested where it is most productive (at the opposite ends of the earth, if need be) and pays the highest possible return to the investor. A capital market is said to be “perfect” if it enables each unit of capital to be invested in the most productive way possible and to earn the maximal marginal product the economy allows, if possible as part of a perfectly diversified investment portfolio in order to earn the average return risk-free while at the same time minimizing intermediation costs.


pages: 695 words: 194,693

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

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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

Wealth was explicitly a condition for belonging to the ruling class, and the Roman financial system evolved to generate, document, and display this wealth. Laws separating governance from direct economic interests at first created a sophisticated system of credit markets. Senators could lend, but they could not directly engage in business. However, financial intermediation provides an infinite variety of ways to conceal investment or to put it at arm’s length. The legal form of the peculium was one solution to the problem—there were many others. Modern scholarship has recently documented the amazing sophistication of the Roman economy, particularly with respect to financial intermediation. In fact, sometimes the Roman financial system seems shockingly familiar to the modern eye. The degree to which we can actually compare modern institutions like banks to Roman institutions has been regularly debated. However, institutional labels are less important than function.

Deserters from the disaffected Persian regulars soon joined them, and when Ochus rode into the city of Susa, it was not as Sogdianus’s prisoner but as his successor. The usurper was usurped. Ochus took the royal title of Darius II. The overthrow of Sogdianus may be the first war we know of to have been fought on borrowed money, but it certainly was not the last. The Persian rulers following Darius II frequently resorted to tax levies in later years to finance wars. Financial intermediation was a crucial link—some firm or agent that could turn a contractual promise into money in a hurry. In the fifth century BCE, the Murašu firm provided this essential line of credit, and it probably turned the tide of victory. But fate is not always kind. The landholders who supported Ochus remained mired in debt, and many faced foreclosure. The story of the Murašu is important, because it shows how finance could rapidly and powerfully focus economic assets in one time and place for political gain.

Our modern perspective suggests there are a range of financial services Athenians needed: from a basic institution that took deposits and relieved patrons of keeping their money under the mattress in coin, to an entity that could transfer large sums to and from counterparties in transactions, to a source of temporary cash buffer against economic shocks. Bankers also may have served as facilitators of economic investments—either because they profited economically or because this enhanced their reputations and connections. As business opportunities and personal investment needs scaled up with the Athenian economy, the need for financial intermediation inevitably scaled up as well. FINANCIAL LITERACY As a young man, Demosthenes sued his relatives. His uncles were appointed as his guardians after his father’s death, and they stole his inheritance. The financial details in the trial were extremely complex. They involved two businesses, inventories, loans, and other assets. The trial, like all others, took place before a randomly selected jury of Athenian citizens.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

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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

And if not, they can expect to reap what follows. Surely Jack Bogle and others inside the industry have done enough to raise the alarm. Never is this clearer than in his insistence that fees and costs are draining all the promised value out of the pockets of investors. 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.

It called attention to the even higher levels of speculation that had come to distort our markets and ill-serve our investors. To understand why speculation is a drain on the resources of investors as a group, one need only understand the tautological nature of the markets: Investors, as a group, inevitably earn the gross return of, say, 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. How often we forget the power of these “relentless rules of humble arithmetic” (a phrase used in another context by former Supreme Court Justice Louis Brandeis a century ago), when we bet against one another, day after day—inevitably, to no avail—in the stock market.

Owning the entire stock market is the ultimate diversifier for the stock allocation of the portfolio. When you understand how hard it is to find that needle, simply buy the haystack. Rule 6: Minimize the Croupier’s Take The resemblance of the stock market to the casino is hardly far-fetched. Both beating the stock market and gambling in the casino are zero-sum games—but only before the costs of playing the game are deducted. After the heavy costs of financial intermediation (commissions, spreads, management fees, taxes, etc.) are deducted, beating the stock market is inevitably a loser’s game for investors as a group. In the same way, after the croupiers’ wide rakes descend, beating the casino is inevitably a loser’s game for gamblers as a group. (What else is new?) I reiterate what I’ve emphasized often in this book, investors as a group must and do earn the market’s return before costs, and lose to the market by the exact amount of those costs.


pages: 370 words: 102,823

Rethinking Capitalism: Economics and Policy for Sustainable and Inclusive Growth by Michael Jacobs, Mariana Mazzucato

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3D printing, balance sheet recession, banking crisis, Bernie Sanders, Bretton Woods, business climate, Carmen Reinhart, central bank independence, collaborative economy, complexity theory, conceptual framework, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, decarbonisation, deindustrialization, dematerialisation, Detroit bankruptcy, double entry bookkeeping, Elon Musk, energy security, eurozone crisis, factory automation, facts on the ground, fiat currency, Financial Instability Hypothesis, financial intermediation, forward guidance, full employment, Gini coefficient, Growth in a Time of Debt, Hyman Minsky, income inequality, Internet of things, investor state dispute settlement, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, labour market flexibility, low skilled workers, Martin Wolf, Mont Pelerin Society, neoliberal agenda, Network effects, new economy, non-tariff barriers, paradox of thrift, price stability, private sector deleveraging, quantitative easing, QWERTY keyboard, railway mania, rent-seeking, road to serfdom, savings glut, Second Machine Age, secular stagnation, shareholder value, sharing economy, Silicon Valley, Steve Jobs, the built environment, The Great Moderation, The Spirit Level, Thorstein Veblen, too big to fail, total factor productivity, transaction costs, trickle-down economics, universal basic income, very high income

If we restrict our analysis to the five largest sectors (agriculture, manufacturing, wholesale/retail trade, financial intermediation and real estate), which comprise over 92,000 firms and cover more than 90 per cent of total corporate assets in the sample, the result is even more dramatic. Private firms in these five sectors appear to have built even larger stocks of fixed assets relative to their profits than quoted firms—the investment multiplier from being a private firm is 5.2. When we have taken into account additional factors in our analysis, such as the age of companies and the sector in which they operate, the estimated investment multiplier of private firms remained very relevant and statistically significant. Relative to the median sector,33 private firms in the sectors of manufacturing; transport, storage and communication; financial intermediation; real estate; health and social work; and community services exhibit positive multipliers on their investment relative to quoted firms, with multipliers ranging from 4 to 15.

As recent events have shown, the most visible and violent of those costs are experienced at times of financial crisis. These costs, for example in foregone output, have been extensively studied.5 But there is a second potential cost of modern capital markets—the cost of short-termism. Although it has no off-the-shelf definition, short-termism is generally taken to refer to the tendency of agents in the financial intermediation chain to weight too heavily near-term outcomes at the expense of longer-term opportunities.6 This has opportunity costs, for example in foregone investment projects and hence future output. Unlike crises, these opportunity costs are neither violent nor visible. Rather, they are silent and invisible. Perhaps for that reason, there have been very few attempts to capture the potential costs of short-termism in quantitative terms.


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

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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

Money market funds offer almost the same services as deposit institutions, but legally their investors hold shares rather than fixed claims. The trillions of dollars that they raise are invested in short-term debt of nonfinancial companies and banks.30 When money market funds invest in the debt of nonfinancial companies, they are competing with banks that might also lend to these companies. When money market funds make short-term loans to banks, they create an additional layer of financial intermediation between investors who want services like those associated with deposits and banks seeking short-term funding. Borrowing from money market funds increases the risk of liquidity problems and runs. Without deposit insurance, the situation is similar to that of George Bailey in the movie It’s a Wonderful Life, which we discussed in Chapter 4. Managers of money market funds that have loaned to banks may become concerned about the solvency of those banks and attempt to withdraw their money.

Stern School of Business, New York University, New York, and European School of Management and Technology, Berlin. Acharya, Viral V., and Tanju Yorulmazer. 2008. “Information Contagion and Bank Herding.” Journal of Money, Credit, and Banking 40: 215–231. Acharya, Viral V., Demos Gromb, and Tanju Yorulmazer. 2007. “Too Many to Fail—An Analysis of Time-Inconsistency in Bank Closure Policies.” Journal of Financial Intermediation 16 (1): 1–31. Acharya, Viral V., Thomas F. Cooley, Matthew P. Richardson, and Ingo Walter, eds. 2010. Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance. New York: John Wiley and Sons. Acharya, Viral V., Matthew Richardson, Stijn van Nieuwerburgh, and Lawrence J. White. 2011a. Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance.

“A Market-Based Study of the Cost of Default.” Review of Financial Studies 25 (10): 2599–2999. Dell’Ariccia, Giovanni, Luc Laeven, and Deniz Igan. 2008. “Credit Booms and Lending Standards: Evidence from the Subprime Mortgage Market.” IMF Working Paper 08/106. International Monetary Fund, Washington, DC. Demirgüç-Kunt, Asli, Edward J. Kane, and Luc Laeven. 2008. “Determinants of Deposit-Insurance Adoption and Design.” Journal of Financial Intermediation 17 (3): 407–438. Demirgüç-Kunt, Asli, Enrica Detragiache, and Ouarda Merrouche. 2010. “Bank Capital: Lessons from the Financial Crisis.” Policy Research Working Paper 5473. World Bank, Washington, DC. De Mooij, Ruud A. 2011. “Tax Biases to Debt Finance: Assessing the Problem, Finding Solutions.” IMF staff discussion note. International Monetary Fund, Washington, DC. May 3. Demyanyk, Yuliya, and Otto Van Hemert. 2009.


pages: 448 words: 142,946

Sacred Economics: Money, Gift, and Society in the Age of Transition by Charles Eisenstein

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Albert Einstein, back-to-the-land, bank run, Bernie Madoff, big-box store, Bretton Woods, capital controls, clean water, collateralized debt obligation, credit crunch, David Ricardo: comparative advantage, debt deflation, deindustrialization, delayed gratification, disintermediation, diversification, fiat currency, financial independence, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, global supply chain, happiness index / gross national happiness, hydraulic fracturing, informal economy, invisible hand, Jane Jacobs, land tenure, Lao Tzu, liquidity trap, lump of labour, McMansion, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, new economy, oil shale / tar sands, Own Your Own Home, peak oil, phenotype, Ponzi scheme, profit motive, quantitative easing, race to the bottom, Scramble for Africa, special drawing rights, spinning jenny, technoutopianism, the built environment, Thomas Malthus, too big to fail

Here, suffice it to say that the proposals of this book can fit into either system. Overall I am more sympathetic to a system that includes private credit, first because it allows organic, endogenous money creation independent of a central authority; second because it more easily incorporates exciting new modes of economic cooperation such as commercial barter rings and mutual-credit systems; third because it allows for much more flexibility in financial intermediation and capital formation; and fourth because it simplifies interbank credit clearing. Moreover, as some of Irving Fisher’s associates began realizing in the mid-1930s, it is nearly impossible to prevent fractional-reserve deposits from appearing in covert forms.6 I draw this point out in the appendix, but consider: even if you issue an IOU to a friend, and your friend gives it to another friend in lieu of cash, you are increasing the money supply.

With fractional-reserve banking, a bank can “borrow short and lend long”; that is, it can hold demand deposits, which could be withdrawn anytime, and lend most of them out as long-term loans. With full-reserve banking this is not allowed. Banks could still lend money, but only if that money has been given to them in the form of time deposits. For example, if a depositor buys a six-month certificate of deposit (CD), those funds could be lent out for a term of six months. One of the main criticisms of full-reserve banking is that it makes financial intermediation—the connection of lenders and borrowers—much more difficult. Instead of issuing loans based purely on creditworthiness, the bank would have to find a depositor willing to commit his money for the term of the loan. However, closer examination reveals this criticism to be for the most part invalid. In fact, banking would be almost the same as it is today. Let’s think about bank deposits first.

Alternatively, given sufficient lead time, it could issue stock or bonds to investors. In general, liquidity would be no more a restraint on lending than it is today. Random fluctuations in the level of deposits happen every day and are no big deal because banks can cover any shortfall in reserves by borrowing from the Fed Funds market or the Fed’s own overdraft facility. Equivalent mechanisms could easily operate in a full-reserve system. Besides financial intermediation, another apparent difference between the two systems is that in a full-reserve system, banks would supposedly have no capacity to alter the money supply, which would be dependent on the monetary authority. However, this difference too is an illusion. In the present system, the money supply increases when banks lend more, such as during an economic expansion when there are lots of safe lending opportunities.


pages: 515 words: 132,295

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

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3D printing, accounting loophole / creative accounting, additive manufacturing, Airbnb, algorithmic trading, Asian financial crisis, asset allocation, bank run, Basel III, bonus culture, Bretton Woods, British Empire, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial intermediation, Frederick Winslow Taylor, George Akerlof, gig economy, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, interest rate derivative, interest rate swap, Internet of things, invisible hand, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, knowledge economy, labor-force participation, labour mobility, London Whale, Long Term Capital Management, manufacturing employment, market design, Martin Wolf, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, pensions crisis, Ponzi scheme, principal–agent problem, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, sovereign wealth fund, Steve Jobs, technology bubble, The Chicago School, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund

The financial industry is the world’s ultimate power and information hub, the tiny middle portion of an hourglass that represents the larger global economy. All the money in the world, and all the information about who’s making and taking it, passes through that tiny middle. Financiers sit in what is the most privileged position, extracting whatever rent they like for passage. It’s telling that technology, which usually decreases industries’ operating costs, has failed to deflate the costs of financial intermediation. Indeed, finance has become more costly and less efficient as an industry as it deployed new and more advanced tools over time.16 It’s also telling that during the last few decades financiers have earned three times as much as their peers in other industries with similar education and skills.17 As Thomas Piketty put it in Capital in the Twenty-First Century, financiers are, in some ways, like the landowners of old.

The result was that Coke and other product manufacturers, desperate not to run out of supplies, were being forced to pay not only a higher price for the metal but also a premium for delivery.11 “The situation has been organized artificially to drive premiums up,” said Dave Smith, Coke’s head of strategic procurement, at an industry conference in June 2011. “It takes two weeks to put aluminum in, and six months to get it out.”12 Guess who Coke, Coors, and their thirsty consumers were paying that premium to? Goldman Sachs. It’s an amazing tale that provides a window into the complex and costly shenanigans that can result when banks move too far out of their traditional purview of simple lending and financial intermediation and into other types of business. While the Goldman aluminum-hoarding scandal has less human significance than the food and fuel bubbles of 2008 and 2010, it has received significant legal attention and documentation. It thus provides a sharp lens through which to understand the confluence of events that created the dysfunctional system in which financial institutions are allowed to both make the market and be the market.

McKinsey Global Institute, “Debt and (Not Much) Deleveraging,” February 2015, 98–99. 22. Greenwood and Scharfstein, “The Growth of Finance,” 21. 23. Financial efficiency is defined here as the amount of money and engagement that finance provides to Main Street, rather than to the capital markets themselves. 24. Thomas Philippon, “Has the U.S. Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation,” American Economic Review 105, no. 4 (2015): 1408–38. 25. Robert D. Atkinson and Stephen J. Ezell, Innovation Economics: The Race for Global Advantage (New Haven, CT: Yale University Press, 2012), 21. 26. Victoria Williams, US Small Business Administration, Office of Advocacy, “Small Business Lending in the United States 2013,” December 2014. 27. John Haltiwanger, Ron Jarmin, and Javier Miranda, “Business Dynamics Statistics Briefing: Where Have All the Young Firms Gone?”


pages: 363 words: 107,817

Modernising Money: Why Our Monetary System Is Broken and How It Can Be Fixed by Andrew Jackson (economist), Ben Dyson (economist)

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bank run, banking crisis, banks create money, Basel III, Bretton Woods, call centre, capital controls, cashless society, central bank independence, credit crunch, David Graeber, debt deflation, double entry bookkeeping, eurozone crisis, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, Hyman Minsky, inflation targeting, informal economy, land reform, London Interbank Offered Rate, market bubble, market clearing, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Northern Rock, price stability, profit motive, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, risk-adjusted returns, seigniorage, shareholder value, short selling, South Sea Bubble, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, unorthodox policies

What have banks been lending for? Figure 3.4 shows the total sterling amounts of loans outstanding in the UK since 1997. By far the greatest proportion of bank lending is to the property market: In 2010, 45% of the value of total loans outstanding in the UK was to individuals (and secured on property), with an additional 15% to commercial real estate companies.14 A further 20% of lending was for financial intermediation,15 7% was unsecured personal debt, 1% went to insurance companies and pension funds and 9% was to ‘public and other services’. Meanwhile, the value of loans outstanding to the productive part of the economy (i.e. those sectors which contribute to GDP) accounted for just 8% of total lending. Footnotes 1. Banks operate as the middlemen between the Bank of England and everyone else for cash, so that even to obtain cash at least one person in the economy must have a bank account with a positive bank balance, which means that somebody else must be in debt. 2.

Likewise, the allocation of new lending is not determined by the relative returns on different projects. Rather, it is determined by the likelihood of repayment, and the ability to collateralise loans to ensure that non-repayment does not result in a loss to the bank. In fact, less than 10% of all bank lending today goes to businesses that contribute to GDP – the vast majority goes towards mortgages, real estate companies, and financial intermediation. If these lending decisions had been made by local bank managers who were in touch with the local economy and knew where any investment could be most productive, then banks having greater ‘spending power’ than government may not be such a matter for concern. However, lending decisions are not made by local branch managers, instead they are made by senior managers at the head offices of the banks, based on a statistical analysis of the relative likelihoods of repayment.


pages: 274 words: 93,758

Phishing for Phools: The Economics of Manipulation and Deception by George A. Akerlof, Robert J. Shiller, Stanley B Resor Professor Of Economics Robert J Shiller

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Andrei Shleifer, asset-backed security, Bernie Madoff, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, Credit Default Swap, Daniel Kahneman / Amos Tversky, dark matter, David Brooks, en.wikipedia.org, endowment effect, equity premium, financial intermediation, full employment, George Akerlof, greed is good, income per capita, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Rogoff, late fees, loss aversion, Menlo Park, mental accounting, Milgram experiment, moral hazard, new economy, payday loans, Ponzi scheme, profit motive, Ralph Nader, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, Silicon Valley, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, theory of mind, Thorstein Veblen, too big to fail, transaction costs, Unsafe at Any Speed, Upton Sinclair, Vanguard fund, wage slave

ACKNOWLEDGMENTS Akerlof.indb 179 179 6/19/15 10:24 AM Akerlof.indb 180 6/19/15 10:24 AM b i b l i o g r a p hy “200 West Street.” Wikipedia. Accessed October 22, 2014. http://en.wikipedia .org/wiki/200_West_Street. Abramson, John. Overdosed America: The Broken Promise of American Medi­ cine. 3rd ed. New York: Harper Perennial, 2008. Adrian, Tobias, and Hyun Song Shin. “Liquidity and Leverage.” Journal of Financial Intermediation 19, no. 3 (July 2010): 418–37. Agarwal, Sumit, John C. Driscoll, Xavier Gabaix, and David Laibson. “The Age of Reason: Financial Decisions over the Life Cycle and Implications for Regulation.” Brookings Papers on Economic Activity (Fall 2009): 51–101. Akerlof, George A., and Rachel E. Kranton. “Economics and Identity.” Quar­ terly Journal of Economics 115, no. 3 (August 2000): 715–53. —.

Especially useful was the remarkably clear and well-documented Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (Washington, DC: Government Printing Office, 2011), http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/ GPO-FCIC.pdf. All of these books served as important background for the interpretive story that we are telling in this chapter. 2. Carl Shapiro, “Consumer Information, Product Quality, and Seller Reputation,” Bell Journal of Economics 13, no. 1 (1982): 20–35. 3. Tobias Adrian and Hyun Song Shin, “Liquidity and Leverage,” Jour­ nal of Financial Intermediation 19, no. 3 (July 2010): 418–37. Adrian and Shin calculated average balance sheets from sometime in the 1990s (varying by the bank) to the first quarter of 2008 for the five leading investment banks: Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley. They held total assets averaging $345 billion; had average liabilities of $331 billion, with average equity of $13.3 billion.


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

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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

A central function of any financial system is to recycle the savings of those with no immediate use for them to those who can put them to good use. As a result, to take an obvious example, young people with a lifetime’s earning power ahead of them, but no significant savings, can borrow for house purchase through the good offices of banks from people in their fifties and sixties who are saving for retirement. The banking system brings the two groups together in the process known as financial intermediation. Yet this is more common in the English-speaking countries than elsewhere. In much of continental Europe, regulations hinder borrowing for house purchase by requiring the borrower to save a significant amount as a pre-condition of the loan or by imposing tough loan-to-value ratios and short repayment periods. This is one of the reasons why over 80 per cent of Italian men between eighteen and thirty live at home with their parents.

S. 1, 2 Elizabeth II 1 Engels, Friedrich 1, 2, 3, 4, 5 Enlightenment 1, 2, 3, 4, 5 Enron 1 entrepreneurs 1 environmental damage 1 Epistle to Allen Lord Bathurst (Alexander Pope) 1 Esterházy, Prince Nikolaus 1 European Monetary Union 1 European Union 1, 2, 3, 4 eurozone 1, 2, 3, 4, 5 Faber, Marc 1 Fable of the Bees, The (Bernard Mandeville) 1, 2, 3, 4, 5, 6 Facebook 1 Faerie Queene, The (Spenser) 1 Fama, Eugene 1, 2, 3, 4, 5 Farmers’ State Alliance (US) 1 fatal embrace 1, 2 Faust (Goethe) 1, 2, 3, 4 Federal Reserve (Fed) 1, 2, 3, 4 Federal Reserve Act (US 1913) 1 Ferguson, Niall 1 feudalism 1, 2, 3 fiat currencies 1 Fidelity Magellan fund 1 financial crisis (2007–08) 1, 2, 3, 4, 5, 6, 7, 8 financial intermediation 1 financial services 1 financial weapons of mass destruction 1 Finley, Moses 1 Fitzgerald, F. Scott 1 Ford, Henry 1, 2 Fors Clavigera (John Ruskin) 1 fractional reserve banking 1 France 1, 2, 3 art market 1 taxation 1, 2, 3, 4 François I of France 1, 2, 3 Frankel, Jeff 1, 2 Franklin, Benjamin 1 Frederick the Great of Prussia 1, 2 Freeland, Chrystia 1 French Revolution 1, 2 Frick, Henry Clay 1, 2 Friedman, Milton 1, 2 Fukushima nuclear spill 1 Fuld, Dick 1 fund managers 1, 2, 3 Fürstenberg, Carl 1 Galbraith, J.


pages: 357 words: 110,017

Money: The Unauthorized Biography by Felix Martin

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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

Their defences were finally breached, and New Keynesian, dynamic, stochastic, general equilibrium models rapidly came to dominate the policy planning of the world’s leading central banks. But at a fundamental level, all these modifications had been mere mopping-up operations. The real battle fought by Bagehot and Keynes had long ago been lost. The elephant in the room—the fact that the primary analytical workhorse of academics and policy-makers was not a theory of a monetary economy and “lacks an account of financial intermediation, so money, credit, and banking play no meaningful role,” as the Governor of the Bank of England put it in 2012—had, as Lawrence Summers lamented, long since been forgotten.20 Such was the Lazarus-like destiny of the moneyless economics of the classical school. The fate of Bagehot’s original concerns with the central importance of money, banking, and finance was initially less happy. Once their second coming in the hands of Keynes had been rebuffed by the mainstream, they languished in the backwaters of economic thought.

Above all, it is financial stability that is the stated goal of all the new legislation.14 Yet for all the sound and fury, there remains a deafening silence when it comes to the obvious question this raises: what exactly is financial stability? It is a question to which neither of the dominant intellectual frameworks for contemporary economic policy-making are equipped to provide a sensible answer. As the Governor of the Bank of England has pointed out, modern, orthodox macroeconomics “lacks an account of financial intermediation, so money, credit, and banking play no meaningful role.”15 So as one of the founding members of the Bank of England’s Monetary Policy Committee has lamented, it “excludes everything relevant to the pursuit of financial stability.”16 But neither does the modern theory of finance, with its blind spot for money’s macroeconomic role, supply any new and specialised theory of financial stability to slake the thirst of the expectant reformers.


pages: 250 words: 87,722

Flash Boys: A Wall Street Revolt by Michael Lewis

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automated trading system, bash_history, Berlin Wall, Bernie Madoff, collateralized debt obligation, Fall of the Berlin Wall, financial intermediation, Flash crash, High speed trading, latency arbitrage, pattern recognition, risk tolerance, Sergey Aleynikov, Small Order Execution System, Spread Networks laid a new fibre optics cable between New York and Chicago, too big to fail, trade route, transaction costs, Vanguard fund

The minute you went to buy or sell at the stated market price, the price moved. What Scalpers Inc. did was to hide an entirely new sort of activity behind the mask of an old mental model—in which the guy who “makes markets” is necessarily taking market risk and providing “liquidity.” But Scalpers Inc. took no market risk.§ In spirit Scalpers Inc. was less a market enabler than a weird sort of market burden. Financial intermediation is a tax on capital; it’s the toll paid by both the people who have it and the people who put it to productive use. Reduce the tax and the rest of the economy benefits. Technology should have led to a reduction in this tax; the ability of investors to find each other without the help of some human broker might have eliminated the tax altogether. Instead this new beast rose up in the middle of the market and the tax increased—by billions of dollars.

IEX had built an exchange to eliminate the possibility of predatory trading—to prevent investors from being treated as prey. In the first two months of its existence, IEX had seen no activity from high-frequency traders except this. It was astonishing, when you stopped to think about it, how aggressively capitalism protected its financial middleman, even when he was totally unnecessary. Almost magically, the banks had generated the need for financial intermediation—to compensate for their own unwillingness to do the job honestly. Brad opened the floor for questions. For the first few minutes, the investors vied with each other to see who could best control his anger and exhibit the sort of measured behavior investors are famous for. “Do you think of HFT differently than you did before you opened?” asked one. That question might have been better answered by Ronan, who had just returned from a tour of the big HFT firms, and now leaned against a wall on the side of the room.


pages: 119 words: 10,356

Topics in Market Microstructure by Ilija I. Zovko

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Brownian motion, continuous double auction, correlation coefficient, financial intermediation, Gini coefficient, market design, market friction, market microstructure, Murray Gell-Mann, p-value, quantitative trading / quantitative finance, random walk, stochastic process, stochastic volatility, transaction costs

Brock and B. LeBaron. A dynamic structural model for stock return volatility and trading volume. The Review of Econoics and Statistics, 78(1):94–110, 1996. J. Carlson and M. Lo. One minute in the life of the dm/usd: Public news in an electronic market. Journal of International Money and Finance, Jan 2006. S. Chakravarty and C. W. Holden. An integrated model of market and limit orders. Journal of Financial Intermediation, 4(3):213– 41, 1995. D. Challet and R. Stinchcombe. Analyzing and modeling 1+1d markets. Physica A, 300(1-2):285–299, 2001. C. Chiarella and G. Iori. A simulation analysis of the microstructure of double auction markets. Quantitative Finance, 2:346–353, 2002. 100 BIBLIOGRAPHY W. S. Choi, S. B. Lee, and P. I. Yu. Estimating the permanent and transitory components of the bid/ask spread.

The Age of Turbulence: Adventures in a New World (Hardback) - Common by Alan Greenspan

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air freight, airline deregulation, Albert Einstein, asset-backed security, bank run, Berlin Wall, Bretton Woods, business process, call centre, capital controls, central bank independence, collateralized debt obligation, collective bargaining, conceptual framework, Corn Laws, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cuban missile crisis, currency peg, Deng Xiaoping, Dissolution of the Soviet Union, Doha Development Round, double entry bookkeeping, equity premium, everywhere but in the productivity statistics, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, full employment, Gini coefficient, Hernando de Soto, income inequality, income per capita, invisible hand, Joseph Schumpeter, labor-force participation, labour market flexibility, laissez-faire capitalism, land reform, Long Term Capital Management, Mahatma Gandhi, manufacturing employment, market bubble, means of production, Mikhail Gorbachev, moral hazard, mortgage debt, new economy, North Sea oil, oil shock, open economy, pets.com, Potemkin village, price mechanism, price stability, Productivity paradox, profit maximization, purchasing power parity, random walk, reserve currency, risk tolerance, Ronald Reagan, shareholder value, short selling, Silicon Valley, special economic zone, the payments system, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, total factor productivity, trade liberalization, trade route, transaction costs, transcontinental railway, urban renewal, working-age population, Y2K

They were all products of Soviet schools, I assumed, and deeply indoctrinated with Marxism. What did they know of capitalist institutions or market competition? Whenever I addressed a Western audience, I could judge its interests and level of knowledge and pitch my remarks accordingly. But at Spaso House, I had to guess. The lecture I had prepared was a dry, diffuse presentation on banks in market economies. It delved into such topics as the value of financial intermediation, various types of risk commercial banks face, the pluses and minuses of regulation, and the duties of central banks. The talk was very slow going, especially as I had to pause paragraph by paragraph for the translator to render my words into Russian. Yet the audience was quite attentive—people stayed alert throughout, and several seemed to be taking detailed notes. Hands went up when I finally reached the end and Ambassador Matlock opened the floor for questions.

Similarly in Japan, when the real estate price bubble burst, the refusal of banks to foreclose on borrowers compounded the economic problem. With the real estate market at a virtual standstill, banks could not make realistic estimates of the value of the collateral that supported their assets, and hence could not judge whether they themselves were still solvent. Caution accordingly dictated that bank lending to new customers be constrained, and, since banks dominated Japan's financial system, the financial intermediation so vital to any large developed economy virtually dried up. Deflationary forces took hold. It was not until the long decline in real estate prices bottomed out in 2006 that reasonable judgments of bank solvency were possible. Only then were new loans forthcoming, producing a marked resurgence of economic activity. While I have spent much of this chapter tracing the impact of economic forces on the larger economies, much the same set of forces is at play, for example, in Canada, Scandinavia, and the Benelux countries.

T H E AGE OF T U R B U L E N C E nate an increase in liquidity. These paper claims represent purchasing power that can quite readily be used to buy a car, say, or a company. The market value of stock and the liabilities of nonfinancial corporations and governments is the source of investments and hence the creation of liabilities by banks and other financial institutions. This process of financial intermediation is a major cause of the overwhelming sense of liquidity that has suffused financial markets for a quarter century. If interest rates start to rise and asset prices broadly fall, "excess" liquidity will dry up, possibly fairly quickly. Remember, the market value of an income-earning security is its expected future income leavened by a discount factor that changes according to euphoria and fear as well as more rational assessments of the future.


pages: 589 words: 147,053

The Age of Em: Work, Love and Life When Robots Rule the Earth by Robin Hanson

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8-hour work day, artificial general intelligence, augmented reality, Berlin Wall, bitcoin, blockchain, brain emulation, business process, Clayton Christensen, cloud computing, correlation does not imply causation, demographic transition, Erik Brynjolfsson, ethereum blockchain, experimental subject, fault tolerance, financial intermediation, Flynn Effect, hindsight bias, job automation, job satisfaction, Just-in-time delivery, lone genius, Machinery of Freedom by David Friedman, market design, meta analysis, meta-analysis, Nash equilibrium, new economy, prediction markets, rent control, rent-seeking, reversible computing, risk tolerance, Silicon Valley, smart contracts, statistical model, stem cell, Thomas Malthus, trade route, Turing test, Vernor Vinge

We sometimes even cry for help, to show who will come running. Today, we spend a large fraction of our energy and wealth on such “signaling,” both because humans naturally care greatly about gaining status and respect in the eyes of others, and because being rich allows us to attend more to such concerns. As mentioned in Chapter 2, Era Values section, in terms of simple functionality, we seem today to spend excessive amounts on schools, medicine, financial intermediation, and huge projects. In contrast, while ems share most of our desires for respect, they live in a more competitive world, where they can less afford to indulge such desires. Thus ems are likely to spend less of their energies signaling to gain status. However, as signaling has functional value in assigning ems to tasks and teams, and as it can be hard to coordinate to discourage signaling, ems will likely still do a lot of signaling.

Sleep 37(8): 1327–1336. Perkins, Adam, and Philip Corr. 2005. “Can Worriers be Winners? The Association between Worrying and Job Performance.” Personality and Individual Differences 38(1): 25–31. Pfeffer, Jeffrey. 2010. Power: Why Some People Have It—and Others Don’t. HarperCollins. September 14. Philippon, Thomas. 2015. “Has the US Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation.” American Economic Review 105(4): 1408–1438. Pickena, David, and Ben Ilozora. 2003. “Height and Construction Costs of Buildings in Hong Kong.” Construction Management and Economics 21(2): 107–111. Piller, Frank. 2008. “Mass Customization.” In The Handbook of 21st Century Management, edited by Charles Wankel, 420–430. Thousand Oaks, CA: Sage Publications. Pindyck, Robert. 2013. “Climate Change Policy: What Do the Models Tell Us?”


pages: 221 words: 55,901

The Globalization of Inequality by François Bourguignon

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Berlin Wall, Branko Milanovic, Capital in the Twenty-First Century by Thomas Piketty, collective bargaining, Credit Default Swap, deglobalization, deindustrialization, Doha Development Round, Edward Glaeser, European colonialism, Fall of the Berlin Wall, financial deregulation, financial intermediation, gender pay gap, Gini coefficient, income inequality, income per capita, labor-force participation, minimum wage unemployment, offshore financial centre, open economy, purchasing power parity, race to the bottom, Robert Gordon, Simon Kuznets, structural adjustment programs, The Spirit Level, too big to fail, very high income, Washington Consensus

At the same time, we might think that by increasing the demand for credit, and financial capital in general, liberalization also increased its remuneration, which would naturally benefit the high end of the scale. Based on this simple theoretical interpretation, the total impact would seem to be ambiguous.13 But financial liberalization has had other effects that have been more clearly inegalitarian. Even if the initial aim was to encourage competition, today the financial sector as a whole is clearly oligopolistic, if only because of economies of scale in financial intermediation, which are themselves partly tied to innovations in information and communications technology. The existence of substantial rents and the nature of the financial sector’s activities have made 13  For a review of the ties between the development of finance and income distribution, see Asli Demirguc-­Kunt and Robert Levine, “Finance and Inequality: Theory and Evidence,” Annual Review of Financial Economics 1 (2009): 287–318.


pages: 225 words: 61,388

Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa by Dambisa Moyo

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affirmative action, Asian financial crisis, Bretton Woods, colonial rule, correlation does not imply causation, credit crunch, diversification, diversified portfolio, en.wikipedia.org, European colonialism, failed state, financial innovation, financial intermediation, Hernando de Soto, income inequality, invisible hand, M-Pesa, market fundamentalism, Mexican peso crisis / tequila crisis, microcredit, moral hazard, Ponzi scheme, rent-seeking, Ronald Reagan, sovereign wealth fund, The Chicago School, trade liberalization, transaction costs, trickle-down economics, Washington Consensus, Yom Kippur War

(China invested US$900 million in Africa in 2004, compared with just US$20 million in 1975.) Third, they should continue to press for genuine free trade in agricultural products, which means that the US, the EU and Japan must scrap the various subsidies they pay to their farmers, enabling African countries to increase their earnings from primary product exports. Fourth, they should encourage financial intermediation. Specifically, they need to foster the spread of microfinance institutions of the sort that have flourished in Asia and Latin America. They should also follow the Peruvian economist Hernando de Soto’s advice and grant the inhabitants of shanty towns secure legal title to their homes, so that these can be used as collateral. And they should make it cheaper for emigrants to send remittances back home.


pages: 225 words: 11,355

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

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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 we saw in the last chapter, the bank gets to lend or invest any deposit money you leave with it without your specific knowledge or permission. That is why the contract is one sided: You agree to the terms setting out how you can operate your account, and you may even agree to pay certain fees, but the bank can do what it wants. The Financial Market Made Simple BANK INTERMEDIATION Once you understand a financial contract between you and the bank this way, it is fairly easy to grasp the concept of ‘‘financial intermediation.’’ In theory, you or anyone with surplus deposit money or cash at a given time could find somebody somewhere in the world who at the same moment needed to use that money more than you did and was willing to pay you for its use. In reality, most of us want to get on with our lives and have neither the time nor the knowledge to find people who will pay for us for the use of our extra money.


pages: 318 words: 77,223

The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse by Mohamed A. El-Erian

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Airbnb, balance sheet recession, bank run, barriers to entry, Bretton Woods, British Empire, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, collapse of Lehman Brothers, corporate governance, currency peg, Erik Brynjolfsson, eurozone crisis, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, Flash crash, forward guidance, friendly fire, full employment, future of work, Hyman Minsky, If something cannot go on forever, it will stop, income inequality, inflation targeting, Jeff Bezos, Kenneth Rogoff, Khan Academy, liquidity trap, Martin Wolf, megacity, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, oil shale / tar sands, price stability, principal–agent problem, quantitative easing, risk tolerance, risk-adjusted returns, risk/return, Second Machine Age, secular stagnation, sharing economy, sovereign wealth fund, The Great Moderation, The Wisdom of Crowds, too big to fail, University of East Anglia, yield curve

In doing so, it feels that it would be well placed to continue to influence private sector expectations and thus align both private and public actions. Indeed, as noted by Ben Bernanke, “the more guidance a central bank can provide the public about how policy is likely to evolve, the greater the chance that market participants will make appropriate inferences.”2 — Meanwhile, less hindered by concerns about subdued financial intermediation fueling economic growth, regulation and supervision will be strengthened and expanded. Specifically, it will continue to encompass a larger set of institutions (including nonbanks) and seek to take into account a greater array of risks (including, as discussed earlier, the liquidity delusion that leads to periods of patchy liquidity, especially during shifts in market consensus). At the other end, the ECB will venture even deeper into unconventional policy terrain and, like the Bank of Japan, stay there for quite a while.


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

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Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, New Journalism, oil shock, p-value, passive investing, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond

• Although neoclassical models do not emphasize this, it seems plausible that financial crises are important “high MU” environments, especially if financial institutions have a major role in setting asset prices. If we can equate bad times with stock market losses we get back the old CAPM, but “bad times” are likely to be more multi-dimensional. Sometimes other aspects of financial crises—a bond or housing market selloff, vanishing liquidity, de-leveraging spirals, a breakdown in financial intermediation, spiking volatility, high correlations that limit diversification—boost MU even when stock markets are relatively stable. • The worst times are characterized by both financial and economic turbulence. Table 5.1 lists some periods that, in Justice Stewart’s spirit, were manifestly bad times. One might formalize the definition but there is no (academic or practitioner) consensus on how to do this.

.; Yakov Amihud; and Sreedhar T. Bharath (2010), “Liquidity risk of corporate bond returns,” New York University Stern School of Business working paper, available at SSRN: http://ssrn.com/abstract=1612287 Acharya, Viral; and Lasse H. Pedersen (2005), “Asset pricing with liquidity risk,” Journal of Financial Economics 77, 375–410. Adrian, Tobias; Emanuel Moench; and Hyun Song Shin (2010), “Financial intermediation, asset prices and macroeconomic dynamics,” Federal Reserve Bank of New York, Staff Report 422. Agarwal, Vikas; Gurdip S. Bakshi; and Joop Huij (2007), “Do higher-moment equity risks explain hedge fund returns?” Robert H. Smith School, Research Paper 06-066 available at SSRN: http://ssrn.com/abstract=1108635 Agarwal, Vikas; Naveen Daniel; and Narayan Y. Naik (2009) “Role of managerial incentives and discretion in hedge fund performance,” Journal of Finance 64, 2221–2256.


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The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

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affirmative action, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bernie Madoff, Black-Scholes formula, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, labour mobility, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low skilled workers, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Northern Rock, Occupy movement, oil shock, price stability, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, systematic trading, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

Such a firm should avoid directional bets, profiting instead from temporary supply and demand imbalances. PGAM worked to find imbalances, hedge away all unwanted or little-understood risk, and focus on the core risk that interested the firm. It used leverage to amplify returns, as most of its strategies had high Sharpe ratios and small absolute returns. The LTCM disaster had pointed to a key problem with financial intermediation: It contained tail risks during financial crises, including the August 1998 Russian crises that sealed LTCM’s fate. PGAM used about a quarter of the leverage that LTCM had used. Less leverage meant lower returns. PGAM’s returns were also about a quarter of LTCM’s returns before the 1998 crisis. Before 1998, LTCM’s average annual return was 27.76%. Before 2008, PGAM’s average annual return was 8.98% (see Table 14.1).

Since the financial crisis, similar activities have destroyed other good firms, including MF Global and even Madoff Securities.5 Big firms enjoy economies of scale and are usually more diversified than smaller firms, but they take an inherent risk by mixing different lines of business, and particularly by mixing client businesses with capital management businesses. Maybe a broker-dealer should just be a broker-dealer, a bank should just be a bank, and an insurance provider should just be an insurance provider.6 Systemic risk is ultimately a bigger risk for the entire economy than are “too big to fail” firms. Systemic risk is the widespread failure of financial institutions, or frozen capital markets that impair both financial intermediation payment systems and lending to corporations and households. More generally, systemic risk is an event that leads to the widespread loss of significantly important, linked institutions associated with economic functioning. The 2008 financial crisis had its roots in real estate exposure, which was the common link between banking institutions, including regular banks, investment banks, hedge funds, insurance companies, and government-sponsored enterprises.


pages: 350 words: 109,220

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

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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

For instance, there was this 2005 passage in one of his speeches: “We are in the midst of an unusual dynamic in financial markets, in which low realized volatility in macroeconomic outcomes [Translation: everyone thinks we’ve licked the boom-bust cycle], low realized credit losses [Translation: even deadbeats are paying their loans], greater confidence in the near term path of monetary policy [Translation: everyone assumes the Fed will never surprise them], low uncertainty about future inflation and interest rate [Translation: everyone really believes the Fed will never surprise them], rapid changes in the nature of financial intermediation [Translation: the rise of finance outside the core banking system in the securities markets], and a large increase in the share of global savings that is willing to move across borders [Translation: the huge sums of money sloshing around the world economy], have worked together to bring risk premia down across many asset prices [Translation: all of which have led prices of stocks and other assets to rise awfully high].”

Crisis and Dollarization in Ecuador: Stability, Growth, and Social Equity by Paul Ely Beckerman, Andrés Solimano

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banking crisis, banks create money, barriers to entry, capital controls, Carmen Reinhart, carried interest, central bank independence, centre right, clean water, currency peg, declining real wages, disintermediation, financial intermediation, floating exchange rates, Gini coefficient, income inequality, income per capita, labor-force participation, land reform, London Interbank Offered Rate, Mexican peso crisis / tequila crisis, microcredit, money: store of value / unit of account / medium of exchange, offshore financial centre, open economy, pension reform, price stability, rent-seeking, school vouchers, seigniorage, trade liberalization, women in the workforce

In such circumstances debt stocks could grow more rapidly than ECUADOR UNDER DOLLARIZATION: OPPORTUNITIES AND RISKS 85 anticipated, for the dubious reason that anticipated depreciation failed to occur. Dollarization has several important advantages over conventional fixed exchange rates. Unless the permanence of the pegged exchange rate is extremely credible, residual fears of depreciation could affect financial intermediation. This is one reason why Latin American economies have generally been unable to place longer-term domestic-currency debt: Latin America’s longer-term financial markets are all dollar-denominated or index-linked, often leading to serious mismatches in corporations’ and individuals’ balance sheets. Dollarization reduces the scope for sharp relative price changes, of the kind that often accompany inflationary processes.


pages: 318 words: 85,824

A Brief History of Neoliberalism by David Harvey

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affirmative action, Asian financial crisis, Berlin Wall, Bretton Woods, business climate, capital controls, centre right, collective bargaining, crony capitalism, debt deflation, declining real wages, deglobalization, deindustrialization, Deng Xiaoping, Fall of the Berlin Wall, financial deregulation, financial intermediation, financial repression, full employment, George Gilder, Gini coefficient, global reserve currency, illegal immigration, income inequality, informal economy, labour market flexibility, land tenure, late capitalism, Long Term Capital Management, low-wage service sector, manufacturing employment, market fundamentalism, means of production, Mexican peso crisis / tequila crisis, Mont Pelerin Society, mortgage tax deduction, neoliberal agenda, new economy, phenotype, Ponzi scheme, price mechanism, race to the bottom, rent-seeking, reserve currency, Ronald Reagan, Silicon Valley, special economic zone, structural adjustment programs, the built environment, The Chicago School, transaction costs, union organizing, urban renewal, urban sprawl, Washington Consensus, Winter of Discontent

Heavy reliance upon foreign direct investment (a completely different economic development strategy to that taken by Japan and South Korea) has kept the power of capitalist class ownership offshore (Table 5.1), making it somewhat easier, at least in the Chinese case, for the state to control.4 The barriers erected to foreign portfolio investment effectively limit the powers of international finance capital over the Chinese state. The reluctance to permit forms of financial intermediation other than the state-owned banks—such as stock markets and capital markets— deprives capital of one of its key weapons vis-à-vis state power. The long-standing attempt to keep structures of state ownership intact while liberating managerial autonomy likewise smacks of an attempt to inhibit capitalist class formation. But the party also had to face a number of awkward dilemmas. The Chinese business diaspora provided key external links and Hong Kong, reabsorbed into the Chinese polity in 1997, was already structured along capitalistic lines.


pages: 361 words: 97,787

The Curse of Cash by Kenneth S Rogoff

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Andrei Shleifer, Asian financial crisis, bank run, Ben Bernanke: helicopter money, Berlin Wall, bitcoin, blockchain, Bretton Woods, capital controls, Carmen Reinhart, cashless society, central bank independence, cryptocurrency, debt deflation, distributed ledger, Edward Snowden, ethereum blockchain, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial intermediation, financial repression, forward guidance, frictionless, full employment, George Akerlof, German hyperinflation, illegal immigration, inflation targeting, informal economy, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, Kenneth Rogoff, labor-force participation, large denomination, liquidity trap, money: store of value / unit of account / medium of exchange, moral hazard, moveable type in China, New Economic Geography, offshore financial centre, oil shock, open economy, payday loans, price stability, purchasing power parity, quantitative easing, RAND corporation, RFID, savings glut, secular stagnation, seigniorage, The Great Moderation, the payments system, transaction costs, unbanked and underbanked, unconventional monetary instruments, underbanked, unorthodox policies, Y2K, yield curve

A Monetary History of China (in two volumes). Translated by Edward H. Kaplan. Bellingham, Washington: Western Washington University. Pew Research Center. 2014. “As Growth Stalls, Unauthorized Immigrant Population Becomes More Settled” (September). Washington, DC: Pew Foundation. Philippon, Thomas. 2015. “Has the US Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation.”American Economic Review 105 (4): 1408–38. Pissarides, Christopher A., and Guglielmo Weber. 1989. “An Expenditure-Based Estimate of Britain’s Black Economy.” Journal of Public Economics 39 (1): 17–32. Porter, Richard D. 1993. “Estimates of Foreign Holdings of U.S. Currency—An Approach Based on Relative Cross-Country Seasonal Variations.” In Nominal Income Targeting with the Monetary Base as Instrument: An Evaluation of McCallum’s Rule.


pages: 606 words: 87,358

The Great Convergence: Information Technology and the New Globalization by Richard Baldwin

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3D printing, additive manufacturing, Admiral Zheng, agricultural Revolution, air freight, Amazon Mechanical Turk, Berlin Wall, bilateral investment treaty, Branko Milanovic, buy low sell high, call centre, Columbian Exchange, Commodity Super-Cycle, David Ricardo: comparative advantage, deindustrialization, domestication of the camel, Edward Glaeser, Erik Brynjolfsson, financial intermediation, George Gilder, global supply chain, global value chain, Henri Poincaré, imperial preference, industrial robot, invention of agriculture, invention of the telegraph, investor state dispute settlement, Isaac Newton, Islamic Golden Age, James Dyson, knowledge economy, knowledge worker, Lao Tzu, low skilled workers, market fragmentation, New Economic Geography, out of africa, paper trading, Pax Mongolica, profit motive, rent-seeking, reshoring, Richard Florida, rising living standards, Second Machine Age, Simon Kuznets, Skype, Snapchat, Stephen Hawking, telepresence, telerobotics, The Wealth of Nations by Adam Smith, trade liberalization, trade route, Washington Consensus

It also decimated New World populations via the introduction of Old World diseases like smallpox, measles, and typhus. This set up a situation where the Old World had too many people and not enough land—an imbalance mirrored by the opposite imbalance in the New World. Note the scale for the Old World chart is about ten times that of the New World chart. DATA SOURCE: Maddison database (2013 version). The whole process was fostered by the rapid development of financial intermediation (centered on London). As a result, the British economy was reoriented from agriculture to manufacturing and the population shifted from rural to urban. The big changes were at first limited mostly to Britain, as the French Revolution of 1789 and decades-long Napoleonic Wars delayed the Industrial Revolution’s spread to the Continent. As David Landes puts it in his famous 1969 book The Unbound Prometheus, technological advances hit roadblocks on a continent suffering “capital destruction and losses of manpower; political instability and widespread social anxiety; the decimation of the wealthier entrepreneurial groups; all manner of interruptions to trade; violent inflations and alterations of currency.”11 In particular, trade was directly dampened during the Napoleonic Wars by competing trade blockades imposed by France and Britain.


pages: 488 words: 144,145

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

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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 fact it would not be until the late 1990s, or half a century later, when U.S. economic growth levels had begun to slow and financial speculation again grew to significant levels, that the amount of private debt to GDP would again reach 200 percent and then go even higher.14 The decline in the rate of private investment during the New Deal and the fact that private debt in the United States did not reach the levels of the Roaring Twenties until 1996 has implications for how to interpret the subsequent decades. Benjamin Friedman found that there were three major trends in the U.S. financial markets in the postwar period: an increase in private borrowing, the rise of the use of financial intermediaries, and the increased reliance upon government guarantees, regulation, and financial intermediation by government agencies.15 The sustained rise in private debt financing observed following the end of WWII was made more dramatic by the sharp decline in the previous 20 years. Likewise the introduction of government support for housing and other types of domestic infrastructure projects, such as roads, bridges and other improvements, slowly changed the nature of the U.S. economy and made possible the real estate boom of the 1990s and 2000s.


pages: 423 words: 149,033

The fortune at the bottom of the pyramid by C. K. Prahalad

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barriers to entry, business process, call centre, cashless society, clean water, collective bargaining, corporate social responsibility, deskilling, disintermediation, farmers can use mobile phones to check market prices, financial intermediation, Hernando de Soto, hiring and firing, income inequality, late fees, Mahatma Gandhi, market fragmentation, microcredit, new economy, profit motive, purchasing power parity, rent-seeking, shareholder value, The Fortune at the Bottom of the Pyramid, time value of money, transaction costs, working poor

Additionally, these MFIs were experiencing low savings to credit ratios, liquidity problems, high capacity-building costs and general The Fortune at the Bottom of the Pyramid 296 Represents value loss = Supply focus of MNCs = Economic pyramid Represents value opportunity Figure 3 Value opportunity and value loss. inefficiencies. ICICI saw a real opportunity in this area because many of the problems and risks with microfinance could be alleviated by the capital, expertise, scale, and reach of a major bank. By entering the microfinance field, ICICI has taken on the role of social mobilization as well as financial intermediation. In addition to looking at microfinance, ICICI also wanted to increase its banking presence in rural areas. To do this, the bank needed to rapidly proliferate its points-of-presence or distribution points. However, the traditional brick-and-mortar approach to expansion is prohibitively expensive given the vast and varied landscape of India. Additionally, it is very difficult to staff rural branches with competent bankers either because educated urbanites do not want to live in these areas or there is a paucity of qualified locals.


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

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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

In response to market failures on all these dimensions, the New Deal ushered in extensive new federal regulations designed to ensure investor confidence and align private ambitions more closely with broad economic goals such as financial stability.62 Over the last three decades, these relatively quiet and stable financial markets have given way to much more dynamic and unstable ones with far more pervasive effects on the rest of the economy. Some of the shift was clearly driven by changes in the nature of economic activity and the possibilities for financial intermediation. 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.”


pages: 471 words: 124,585

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

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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

From the nineteenth, futures and options offered more specialized and sophisticated instruments: the first derivatives. And, from the twentieth, households were encouraged, for political reasons, to increase leverage and skew their portfolios in favour of real estate. Economies that combined all these institutional innovations - banks, bond markets, stock markets, insurance and property-owning democracy - performed better over the long run than those that did not, because financial intermediation generally permits a more efficient allocation of resources than, say, feudalism or central planning. For this reason, it is not wholly surprising that the Western financial model tended to spread around the world, first in the guise of imperialism, then in the guise of globalization.1 From ancient Mesopotamia to present-day China, in short, the ascent of money has been one of the driving forces behind human progress: a complex process of innovation, intermediation and integration that has been as vital as the advance of science or the spread of law in mankind’s escape from the drudgery of subsistence agriculture and the misery of the Malthusian trap.


pages: 538 words: 121,670

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

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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

Here, too, technology was critical. Technology not only enabled the crafting of complex mortgage-backed securities, but it also allowed mortgage lenders to lend on the basis of a portfolio of borrowers rather than the judgment a che ex bout the creditworthiness of one borrower at a time. See, e.g., William R. Emmons and Stuart I. Greenbaum, “Twin Information Revolutions and the Future of Financial Intermediation,” in Y. Amihud and G. Miller, eds., Mergers and Acquisitions (1998), 37–56; and Mitchell Petersen and Raghuram G. Rajan, “Does Distance Still Matter? The Information Revolution in Small Business Lending,” Journal of Finance 57 (Dec. 2002): 2533–70. 9. Frank Partnoy, Infectious Greed: How Deceit and Risk Corrupted the Financial Markets (New York: Times Books, 2003), 110–13. The crisis was caused when the Fed surprised markets by raising interest rates. 10.


pages: 543 words: 147,357

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

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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

Harvey and Shiva Rajgopal (2005) ‘The Economic Implications of Corporate Financial Reporting’, Journal of Accounting and Economics 40: 3–73. 24 Sanjeev Bhojraj, Paul Hribar, Marc Picconi and John McInnis (2009) ‘Making Sense of Cents: An Examination of Firms That Marginally Miss or Beat Analysts Forecasts’, Journal of Finance 64: 2359–86. 25 Stephen Davis, Jon Lukomnik and David Pitt-Watson (2006) The New Capitalists: How Citizen Investors Are Reshaping the Corporate Agenda, Harvard Business School Press. 26 Peter Hall and David Soskice (2001) Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, Oxford University Press. See also Wendy Carlin and Colin Mayer, ‘Finance, Investment and Growth’, Journal of Financial Economics 69 (1): 191–226. 27 Franklin Allen, ‘Stock Markets and Resource Allocation’, in Colin Mayer and Xavier Vives (eds) (1993) Capital Markets and Financial Intermediation, Cambridge University Press. 28 Marcos Mollica and Luigi Zingales (2007) ‘The Impact of Venture Capital on Innovation and the Creation of New Businesses’, mimeo, University of Chicago. 29 Figures from Nottingham University Business School’s Centre for Management Buy-out Research, at http://www.nottingham.ac.uk/business/cmbor/Privateequity.html. 30 Nick Bloom, Raffaella Sadun and John Van Reenen (2009) ‘Do Private Equity Owned Firms Have Better Management Practices?’


pages: 545 words: 137,789

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

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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

If information were perfectly accurate and free, there wouldn’t be any need for intermediaries such as banks: businesses could borrow directly from savers. But the fact of the matter is that banks and other financial institutions provide more than half of the financing for American businesses. (The rest comes from the financial markets and from funds that corporations generate internally.) A quick mental experiment might help to explain the principle of financial intermediation. Imagine that you had $100,000 of surplus funds that you wanted to loan out at a reasonable interest rate, say 5 percent a year. If you placed an ad in the local newspaper, or on Craigslist, you would surely get plenty of responses, but would you trust your money to any of the people who replied? Probably not—and for two good reasons. The first one is the lemons problem. All of the potential borrowers who showed up at your door would have business ideas for which they wanted money, but you would have no way of telling which ones were genuine opportunities and which were likely to fail.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

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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

In 1996, the UK boasted a sophisticated, competitive and fully functional financial system. It didn’t need to catch up any more. What happened in the period after 1996 was historically unprecedented‌—‌and inherently implausible. And remember that value added is a measure of output, not profit. If you examine profits, rather than value added, Planet Ponzi’s London division appears even more distended. Between 1948 and 1978, financial intermediation (a subsection of the financial services sector) accounted for around 1.5% of profits in the total economy. By 2008, that ratio had risen tenfold to 15%. That’s such an extreme change as to be effectively impossible. Banks weren’t making those profits, they were simply pretending that they did: manipulating their books to show profits that weren’t, in truth, ever there. The financial bust of 2008–9 showed what happens when some of those wheels started to come off the wagon.


pages: 504 words: 143,303

Why We Can't Afford the Rich by Andrew Sayer

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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

(As we saw, even if it isn’t a rentier organisation, their position still allows them to take a bigger share than others, over and above what their contribution might warrant.) So the fact that they are smart and workaholic doesn’t mean that they deserve their huge salaries. In the UK, it’s no surprise that the biggest concentration of the top 0.1%, with gross incomes of over £351,137, is in jobs where wealth-extraction opportunities are prominent – in financial intermediation (30%) and real estate, renting and other business activities (39%). Bonus payments are heavily concentrated at the top of the income distribution; the top 1% of employees get 40% of their annual pay in bonuses, while the bottom 90% get only 5% of their pay in bonuses. In the financial sector, over 25% of pay is in the form of cash bonuses, again heavily concentrated at the top, and often supplemented by bonuses in shares and options.121 Nor is it a surprise that 34% of the top 0.1% are company directors, and 24% of those in the rest of the top 1% are too, for this is a job that allows control over the disposal of company revenues.122 Those at the top are always likely to look after themselves before others.


pages: 466 words: 127,728

The Death of Money: The Coming Collapse of the International Monetary System by James Rickards

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Affordable Care Act / Obamacare, Asian financial crisis, asset allocation, Ayatollah Khomeini, bank run, banking crisis, Ben Bernanke: helicopter money, bitcoin, Black Swan, Bretton Woods, BRICs, business climate, capital controls, Carmen Reinhart, central bank independence, centre right, collateralized debt obligation, collective bargaining, complexity theory, computer age, credit crunch, currency peg, David Graeber, debt deflation, Deng Xiaoping, diversification, Edward Snowden, eurozone crisis, fiat currency, financial innovation, financial intermediation, financial repression, Flash crash, floating exchange rates, forward guidance, George Akerlof, global reserve currency, global supply chain, Growth in a Time of Debt, income inequality, inflation targeting, invisible hand, jitney, Kenneth Rogoff, labor-force participation, labour mobility, Lao Tzu, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market clearing, market design, money: store of value / unit of account / medium of exchange, mutually assured destruction, obamacare, offshore financial centre, oil shale / tar sands, open economy, Plutocrats, plutocrats, Ponzi scheme, price stability, quantitative easing, RAND corporation, reserve currency, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Satoshi Nakamoto, Silicon Valley, Silicon Valley startup, Skype, sovereign wealth fund, special drawing rights, Stuxnet, The Market for Lemons, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, too big to fail, trade route, uranium enrichment, Washington Consensus, working-age population, yield curve

Min Zhu is helping the IMF to develop a working risk-management model based on complexity, one that is far more advanced than those used by individual central banks or private financial institutions. ■ Updating Keynes Zhu is showing traditional Keynesians how their model of policy action, in conjunction with an individual or corporate response, is obsolete. This two-part action-response model must be modified to place financial intermediation between the policy maker and the economic agent. This distinction is illustrated as follows: Classic Keynesian Model Fiscal/Monetary Policy > Individual/Corporate Response New IMF Model Fiscal/Monetary Policy > Financial Intermediary > Individual/Corporate Response While financial institutions in earlier decades had been predictable and passive players in policy transmission to individual economic actors, today’s financial intermediaries are more active and materially mute or amplify policy makers’ wishes.


pages: 424 words: 121,425

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

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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

However, once the industry becomes bigger and fraud inevitably sours some investors, it is likely that there will be calls for the sector to be regulated and required to comply with certain norms of borrowing and lending. Perhaps people will want some insurance to protect them against loan losses. Then, P2P companies begin to look much more like banks. In a way, P2P seems to be reinventing the wheel and substituting one financial intermediary for another. Perhaps the reinvention is necessary because the current wheel is broken, but P2P lending is just another form of financial intermediation for the Internet age. As such, it will likely face the same sorts of problems as banks face, such as profitability concerns for small loans and market pressure from other lenders. P2P lending has been and will likely continue to be a boon to small businesses—especially to artists, musicians, designers, and makers of all sorts who are too small for banks to bother with. But if P2P lending is to help the poor, it will require many socially minded lenders to lend charitably.


pages: 425 words: 122,223

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

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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

Journal of Finance, Vol. XXIX, No. 2 (May), pp. 449–470. Merton, Robert C. 1983. “Paul Samuelson’s Financial Economics.” In Paul Samuelson and Modern Economic Theory, Cary E. Brown and Robert M. Solow, eds. New York: McGraw-Hill Book Company. Merton, Robert C. 1988. Personal statement (unpublished manuscript). Merton, Robert C. 1989. “On the Application of the Continuous-Time Theory of Finance to Financial Intermediation and Insurance.” The Geneva Papers on Risk and Insurance, Vol. 14 (July), pp. 225–262. Merton, Robert C. 1990. Continuous-Time Finance. Cambridge, MA: Basil Blackwell. Miller, Merton H. 1986. “The Academic Field of Finance: Some Observations on Its History and Prospects.” Address at Katholieke Universiteit te Leuven, Leuven, Belgium, May 15. Miller, Merton H. 1987. “Behavioral Rationality in Finance: The Case of Dividends.”


pages: 584 words: 187,436

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

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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

See the introduction to Peter Blair Henry, “Capital Account Liberalization: Theory, Evidence and Speculation,” Journal of Economic Literature 45 (December 2007), pp. 887–935. For the sevenfold increase in manufacturing wages, see Peter Blair Henry and Diego Sasson, “Capital Account Liberalization, Real Wages and Productivity” (working paper, March 2008). Also relevant is Ross Levine, Norman Loayza, and Thorsten Beck, “Financial Intermediation and Growth: Causality and Causes,” Journal of Monetary Economics 46, no. 1 (2000). This paper finds that a doubling in the size of private credit in an average developing country is associated with a 2 percentage point rise in annual economic growth, meaning that after thirty-five years the economy would be twice as large as it would have been without ample opportunities to borrow. 7.


pages: 823 words: 206,070

The Making of Global Capitalism by Leo Panitch, Sam Gindin

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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

Nevertheless, the generally decentralized and fragmented nature of American finance remained, and, as Konings has shown, it was largely because of this feature that the US financial system “held together by intricate networks of domestically grown institutional relations . . . [and] a complex set of linkages between banks and the stock market . . . was marked by capacities for liquidity creation and a degree of dynamism that had never been available to British banks.”20 Although this distinctive kind of financial intermediation would leave the US economy more prone to financial crises and initially limit the international role of the dollar, it would prove important for the eventual global dominance of US finance. American capital had in fact begun to invest and accumulate abroad long before the 1890s, although the banks played a very small part in this, at least until World War I. Even before the Civil War, the US had become the world leader in machine tools, guns, reapers, and sewing machines (all already linked with mass production), and the decades after the war spawned a new communications revolution worldwide with the telegraph, the telephone, the phonograph, and the microphone.