regulatory arbitrage

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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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To the relief of both parties, the US government came to the rescue, providing an extraordinary $85 billion to the failing insurer, which was thus able to meet its obligations in full. Significantly, Goldman had separately insured itself against the failure of AIG.13 But regulatory arbitrage was in place long before Brooke Masters, an executive at J.P. Morgan, invented credit default swaps. An early example of regulatory arbitrage was the circumvention of interest rate restrictions on current accounts under Regulation Q through the Eurodollar market. A different mechanism of regulatory arbitrage was created for retail customers – the money market fund. An investor in a US money market fund holds a share in a portfolio of debt, while the manager of the fund is expected to redeem the share at a fixed price and the income from the portfolio is paid to the investors (in effect, the depositors).

Thus begins a game of cat and mouse, in which the financial services companies are generally one or more steps ahead of the regulator. The outcome is regulation that becomes progressively more complex but which is rarely fully effective in achieving its intended purpose. Both the Eurodollar market and the market in credit default swaps had origins in regulatory arbitrage, but both acquired a life of their own. This is also a recurrent pattern. The ‘repo market’ is an example of a financial investment that began as a mechanism of regulatory arbitrage and has survived and prospered despite extensive attempts to remove its arbitrage benefit. A repo agreement is the means by which many large corporations make deposits with banks and other financial institutions. The depositor ‘buys’ a security, such as a government bond, from the bank. The bank signs an agreement to repurchase it the following day, at a small premium which is equivalent to one day’s interest.

Arbitrage is worthwhile if the tax saved is greater than the cost of engaging in the avoidance transaction. The company that saves tax gains, the advisers gain, the trader gains: the taxman loses a corresponding amount. Fiscal arbitrage is a means of taking money out of the pockets of the public and transferring it to advisers, traders and the firms that employ them. With regulatory arbitrage, the loser is the potential beneficiary of the regulation. If the regulation is useless, as may often be the case, the costs of regulatory arbitrage simply represent a transfer from the operating profits of the business to the financial professionals who make the arbitrage possible. If the regulation would have benefited customers, or protected taxpayers or other firms from potential loss, then these customers or taxpayers are losers from the efforts to avoid regulation.


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

There is a more bizarre and ruthless logic in the cynical way the Catholic Church tolerated usury on the basis that the Jews who carried out the business were going to hell anyway. (In Dante’s Inferno, usurers were consigned to the seventh circle of hell in the company of sodomites.) As time progressed, both Jewish and Christian merchants also became adept at finding ways around the Church’s usury laws through what would now be called regulatory arbitrage. For example, interest could be disguised if the lender issued an IOU, or a bill of exchange, at a discount while insisting on being paid back at face value. In some countries, the laws themselves also ceased to be enforced as the pre-Reformation Catholic Church became more lax. So, like the bank robber Willie Sutton, who reputedly said he robbed banks ‘because that’s where the money is’, the asset-rich, cash-poor European feudal elite went to such merchants because they were the only available source of money for the pursuit of war, grand projects or conspicuous consumption.

As so often happens, changes in the structure of the economy made the Bubble Act increasingly restrictive and damaging to economic growth. The rise of new, capital-intensive industries such as railways made capital demands that could only be satisfied by large numbers of investors. Entrepreneurs responded to legislative restraints in England by setting up companies in the US and in France to conduct operations in their home country. In recognition of the needs of industry and the reality of cross-border regulatory arbitrage, the Bubble Act was repealed in 1824. There followed another flurry of incorporations approved by Parliament. These stock promotions were all too often accompanied by fraud, as the temptation to make off with other people’s money became overwhelming. Anyone who wishes to understand this phenomenon should turn not to economic historians but to Dickens and, more specifically, Nicholas Nickleby (of which more in Chapter Five).

In the case of the British, they were also being urged by government ministers not to be too tough on the City of London, which appeared to have a unique capacity for creating employment and generating tax revenue in an industry where Britain appeared to enjoy a remarkable comparative advantage. The regulators will continue to struggle because they are locked in a vicious circle. Every time there is a financial crisis, a political backlash ensures a raft of ever more complex re-regulatory measures. Financial market practitioners react to these by engaging in regulatory arbitrage, which is relatively easy in a world of global capital flows without a global regulator – banks simply put their business through markets in countries that have less draconian rules. There is always some jurisdiction, after all, in which the rules are looser than in most of the countries where a given bank is domiciled. As risk accumulates in areas that watchdogs find hard to monitor, the seeds of another crisis are sown.


pages: 183 words: 17,571

Broken Markets: A User's Guide to the Post-Finance Economy by Kevin Mellyn

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banking crisis, banks create money, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, call centre, Carmen Reinhart, central bank independence, centre right, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, crony capitalism, currency manipulation / currency intervention, disintermediation, eurozone crisis, fiat currency, financial innovation, financial repression, floating exchange rates, Fractional reserve banking, global reserve currency, global supply chain, Home mortgage interest deduction, index fund, joint-stock company, Joseph Schumpeter, labor-force participation, labour market flexibility, liquidity trap, London Interbank Offered Rate, lump of labour, market bubble, market clearing, Martin Wolf, means of production, mobile money, moral hazard, mortgage debt, mortgage tax deduction, Ponzi scheme, profit motive, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, rising living standards, Ronald Coase, seigniorage, shareholder value, Silicon Valley, statistical model, Steve Jobs, The Great Moderation, the payments system, Tobin tax, too big to fail, transaction costs, underbanked, Works Progress Administration, yield curve, Yogi Berra

In the wake of the 2008 crisis, which required two trillion-pound banking groups to be bailed out by the government, it is hard to believe that this was a good bargain for the UK taxpayer. Broken Markets The Shell Game The vast expansion of both rules- and principles-based regulation at the expense of the subtler supervision of the markets and players by the Bank of England and its peers set off a game called regulatory arbitrage. At its crudest, this simply meant moving the legal locus of activities to the least-regulated jurisdictions, such as the Cayman Islands. However, there were clear limits to this. The more common practice was to game capital adequacy rules—both Basel standards and those set by national regulators. The most straightforward way of doing this was described in the last chapter, as banks put more and more emphasis on mortgages and trading activities among themselves.

w 163 I Index A C Anglo-Saxon capitalism, 84 Card Act, 68, 70 Anglo-Saxon-type banking systems, 156 CHIPS.See Clearing House Interbank Payment System Asset securitization, 66 Association of Community Organizers for Reform Now (ACORN), 65 Austerity definition, 98 Euro, real unification, 99 Germany, 99–101 B BankAmericard, 29 Bankcard association/card scheme, 29 Bank-centric system, 110 Bank for International Settlements (BIS), 108 Basel III process, 50–51 Basel process, 27–28 Basel standards, 61 Bipartisan government policy, 72 Boom optimistic entrepreneurs, 77 Bretton Woods system, 26, 111 Bureaucracies, 21 Civilization, 64 Clearing House Interbank Payment System (CHIPS), 106, 107 Committee of Payment and Settlement Systems (CPSS), 108 Community Reinvestment Act (CRA), 65–66 Consumer banking BankAmericard, 29 bankcard association/card scheme, 29 branch-based customer relationship, 29 credit card industry, 30 Depression-era Glass-Steagall Act, 33 “diseconomies of scale”, 35 FDIC, 34 four-party model, 29 institutional investors, 34 “market-centric” financial system, 33 merchant/customer relationship, 29 Pac-Man banking, 34 risky business, 31–33 RTC, 31 SEC, 33 S&L industry, 28, 30 1 166 Index Consumer banking (continued) statistical analysis, 30 US “flow-of-funds” data, 28 usury laws, 30 Consumer Finance Protection Bureau (CFPB), 68 Continuous Linked Settlement (CLS), 108 Creative destruction, 85 Credit-driven economy, 76–77 Crony capitalism, 85 Cross-Pacific economy, 97 D Debtor Nation, 64 Dirigisme, 83 Dollar-centric financial system, 112 Durbin Amendment, 70 E ECB.See European Central Bank Economic consequences, financial regulation, 55 bank P & Ls and balance sheets bureaucratic regulation, 59 capital allocation, 57 capitalism, 57 clearinghouse/transaction switch, 58 contradictory rules, 59 creative destruction, 63 free-market capitalism, 57 full-blown panic leading, 57 lender-of-last-resort function, 58 payments system, 58–59 private-sector banks, 58 consumer protection vs. access, 67–68 financial access restriction brick-and-mortar branches, 66 civilization, 64 clearinghouse, 63 CRA, 65–66 credit judgments, 65 economic enfranchisement, 64 government paternalism, 65 joint-stock banks, 63 loan securitization, 66 mass-market retail banking, 66 national and multilateral development agencies, 65 non-credit worthy segments, 66 ownership society, 66 paychecks, 64 premium/reward cards, 66 individual banker accountability, 55 interest reduction, 56 predatory lending, 56 product differentiation, 68–69 public utility, 55, 56 regulatory, capital, and litigation costs, 56 regulatory compliance and fraud losses, 56 savers and investors, 71–73 shell game asset-securitization process, 61 commercial and industrial loans, 62 credible assessment, 62 Dodd-Frank Act, 63 Federal Reserve Bank, 63 free-market creative destruction, 63 globalization, 62–63 Great Depression, 61 Great Moderation, 61 least-regulated jurisdictions, 61 regulatory arbitrage, 61 relationship banking, 62 retail banking revolution, 63 return-on-equity business, 62 rules-based regulation, 61 securitization and market-based funding, 63 supervision vs. rule making, 59–60 unbanking, 70–71 utility-style banking, 56 European Central Bank (ECB), 6, 99, 102–103 F Federal Deposit Insurance Corporation (FDIC), 34 Index Federal Reserve, 101 Finance consumers, 117 American Revolutionary War song, 118 bondholders and money market funds, 138 Bureau of Labor Statistics, 126 business-to-business commerce, 119 consumerism, 118 credit score, 120–121 debt free, 138–139 “dot-com” bubble, 1264 employment and consumer credit, 121–122 Gallup polling organization, 127 Great Society, 126 house prices, 133 “infrastructure”, 119 innovation and education, America advantage, 129 American living standards, 129 global success, 128 high-stakes examinations, 130 industrial policy, 128 student loans, 131 mass-market pottery, 119 money saving, 136–137 New Class, new elite educated caste, 132–133 non-tradable private sector, 127 one’s station in life, 118 overseas trade, 119 pent-up demand, 119 private-sector employment, 125 property taxes, 127 “self-liquidating”, definition, 119 shelter asset bubbles and distorts markets, 133 electoral process, 134 Japanese economy, 135–136 retirement plans and financial advisors, 134 Travellers Club, 133 wealth effect, 133 short-term insurance scheme, unemployment assistance, 127 stock market, 137–138 structural unemployment American economy, 123–125 labor force participation rate, 123 labor markets, Europe, 122 solidarity, 123 three-tiered system, 122 subsidy-based industries, 125 super-safe government debt, 125 technological creativity and economic progress, 117 unionized public-service employees, 125 US job growth, 126 “welfare to work” requirements, 126 You, Inc., 139 Finance-driven economy, 1, 72 anti-capitalism, 2 capitalism, 1 chronic debt crisis, 22 corporate America, 20 current movie artificial bank earnings, 7 asset prices, 6 banking implosions, 6 borrowers and investors connection, 10 borrowing demand, 7 catastrophic financial bubble, 10 civilization, 10 corporatism, 9 democratic crony capitalism, 9 Dodd-Frank act, 8 economic growth and social stability, 10 financial repression, 9 Glass-Steagall Act, 8 human ingenuity, 10 interbank funding markets, 6 low interest rates and easy money, 6 market collapse, 10 money market, 6 overexuberence, 6 overinvestment and speculation, 6 pre-crisis conditions, 8 printing money, 7 private capital, 7 167 168 Index Finance-driven economy (continued) profitability, 7 quantitative easing, 8 recovery, 8 regulation, 8 regulatory capital rules, 8 resources and tools, 9 shell-shocked enterprises and households, 8 end of employment, 21–22 financial leverage magic and poison CEO class, 14–15 consumer debt, 15–16 disconnection problem, 11–12 market bargain, 10 real economy, 10 wealth financialization, 13–14 working capital, 11 global financial crisis, 2 Great Moderation, 16–18 Great Panic, 18–19 household sector agony, 19–20 investor class, 22 Marx, Karl asset bubble, 5 cash nexus, 4 dot-com bubble, 5 economic revolution, 3 First World War, 4 free markets, 3 French Revolution, 3 globalization, 3 Great Depression, 5 liberalism, 3 normalcy, 4 overproduction and speculation, 3 Wall Street, 4, 5 revolutionary socialism, 2 sovereign debt, 8, 22 Finance reconstruction, 142 bank bashing, 146 “bankers”, 142 business model, challenges, 145 Citigroup, 145 cyclical businesses, 143 government management, 142 legitimacy bonus culture, 148–150 privileged opportunity, longestablished bank, 146 short-term share-price manipulation, 148 state and legal systems, 147 stock price, 147 mark-to-market price, 144 “producers”, 143 profession, definition, 163 prudence, 145, 161–163 root-and-branch transformation, 145 talent pool, 144 “the race for talent”, 143 trust cash management, 160 Financial Market Meltdown, 159 FSA, 159 hackneyed term, 159 information asymmetry, 159 non-bank financial service provider, 161 oversold/up-sold products, 159 utility Anglo-Saxon-type banking systems, 156 big data tools, 158 bills-of-exchange market, 150 branch and payment services, 157 clearinghouse creation, 158 core banking, 154 economic value transmission, 150 exchange of claims, 151 fee-income growth, 155 fiat money system, 151 financial intermediation, 150 financial transactions, 157 flexible contractor/subcontractor relationship, 158 information technology, 156 “liquidity premium”, 152 multidivisional/M-form organization, 153 non-interest income, 155 old-media companies, 157 Index overhead value analysis, 154 “privileged opportunity”, 152 quill pen–era practice, 158 sheer utility value, 155 silos, product business, 153 transaction accounts, 152 venture capital industry, 142 “War for Talent”, 143 Financial crises, 23 affordable housing, 24 banking “transmission” mechanism, 43 Basel III process, 50–51 basel process, 27–28 consumer banking(see Consumer banking) Dodd-Frank, 49–50 domestic banking system, 38 European Union, 51–53 FDIC, 40 finance-driven economy’s leverage machine, 43 Financial Market Meltdown, 25 GDP, 38 Government Policy and Central Banks, market meltdown(see Regulation process) government policy failure, 45 “government-sponsored” public companies, 24 Great Depression, 44 GSEs, 24 legal missteps, 47–48 New Deal, 43 panic-stricken markets, 40 political missteps, 45–47 Ponzi scheme, 42 postwar financial order, 25–27 printing money, 38 private profits and socialized losses, 40 private-sector demand, 43 public-sector demand, 42 quantitative approach, 25 TARP, 39 too-big-to-fail institutions, 41 Triple A bonds, 41 US Federal Reserve System, 38 Financial liberalization, 89 Financial Market Meltdown, 25, 61, 89, 109, 159 Financial repression, 9, 78, 111 Financial Services Authority (FSA), 60, 159 Food and Drug Administration (FDA), 69 Fordism, 68 Free-market capitalism, 89 Free markets, 3 French Revolution, 3 Front-end trading systems, 107 FSA.See Financial Services Authority G GDP, 11 “Giro” payments systems, 151 Global imbalance, 96 Globalization, 3 Global whirlwinds, 93 Asia, finance movement cultural differences, 110–111 Financial Market Meltdown, 109 Interest Equalization Tax, 109 language, law, and business culture, 109 primacy, 109 austerity(see Austerity) British Empire, 30 Chimerica, 97 China and United States cross-Pacific economy, 97 foreign interference and aggression, 98 headline growth rates, 97 repression revolution and series, 97–98 Second World War, 98 Smoot-Hawley Tariff, 98 surpluse trade, 97 sustainable development, 98 Chinese ascendancy, 113 clearing and settlement bottleneck, 106–107 Dynastic China, 112 169 Download from Wow!

eBook <www.wowebook.com> 170 Index Global whirlwinds (continued) economic primacy, 113 European banking crisis ECB, 102–103 federal funds market, 102 Federal Reserve, 103 global money market, 102 interbank market, 101 interbank-lending market, 102 interest rate and currency risks, 101 investment-banking industry, 101 recession, 103 short-and medium-term credit, 101 short-term funding and liquidity, 101 sovereign risk, 102 steroids, 103 globalization, 113 global money pump, 103–105 global trade, zero-sum game ants and grasshoppers, 96 cheap TV deal, 94–95 Chinese Central Bank, 94 currency manipulation, 95–96 multilateral trade, 94 political demagoguery, 94 hegemon, 113–116 sustainable development, 112 technology vs. friction, 105–106 US global economic leadership, 112 US losing clout, 111–112 war, settlement risk, 108–109 Western decline acceleration, 113 Government-sponsored enterprises (GSEs), 17 Graham-Leach-Bliley Act, 36 Great Depression, 5, 44, 61 Great Moderation, 16–18, 21, 61 “Green” economy, 85 Growth-killing austerity, 111 H Home equity lines of credit (HELOCs), 16 I Industrial Revolution, 77 Infinite customization, 68 J Joint-stock banking, 63, 76 L Laissez-faire economy, 84–86 Liberal arts, 132 Life after finance, 75 credit-driven economy, 76–77 death knell, consumer credit American optimism, 90 big data, 90 entrepreneurs starvation, 91–92 loan factories, 90 per-account/per-transaction, 90 securitization, 90 unbanking, 91 financial repression Bretton Woods system, 79 capital exports and foreignexchange transactions, 79 captive domestic audience, 79 debt restructuring, 78 GDP, 79 government banks ownership, 79 industrial policy, 86 monopolies, 86 negative real interest rates, 78, 79 prudential regulation, 79 rules, 80 subsidized green energy, 86 tax raising and lowering, 81–82 World War II, 79 Government expenditure, 75–76 low interest rates, 77–78 political direction, credit and investment formal taxation, 82 government-run utility, 83 Japanese banks, 83 laissez-faire economy myth, 84–86 Index market-driven banking system, 83 winners and losers, 83–84 risky business amalgamation, 88 coincidence, 88 competition, 89–90 joint-stock banks, 87 often-contradictory rules and requirements, 88 private partnerships, 87 separation of functions, 87 shareholder-owned banks, 87 small-town banks, 87 Life-line banking, 70 R Liquidity trap, 72 Ring fencing, 88 London Interbank Offered Rate (LIBOR), 102 Rules-based regulation, 59, 61 M S “Market-centric” financial system, 110 Real Time Gross Settlement (RTGS), 108 Regulation process “Anglo-Saxon” world, 36 balance sheets and trading desks, 35 definition, 36 finance deregulation, 35–36 Graham-Leach-Bliley Act, 36 Triple A–rated bonds, 37 “ultra-safe” money market mutual fund, 37 Regulatory arbitrage, 61 Resolution Trust Corporation (RTC), 31 Savings-and-loan (S&L) industry, 28, 30 Mass-market retail banking, 66 Securities and Exchange Commission (SEC) rules, 33 McKinsey Global Institute (MGI), 110 S&L industry.See Savings-and-loan industry Micro-regulation, 92 Ministry of International Trade and Industry (MITI), 83 Society for Worldwide Interbank Financial Telecommunications (SWIFT), 107 Moral hazard, 18 Straight-through procession, 107 N National Bank Act, 49 National Bureau of Economic Research (NBER), 78 O Outsourcing, 13 P Personal Consumption Expenditure (PCE), 90 Price discovery, 104 Principles-based regulation, 59 Printing money, 78 Professional/proprietary trading, 12 Subprime mortgage market, 66 T The Dodd-Frank Act, 49 Trillion-pound banking groups, 60 Troubled Asset Relief Program (TARP), 39 U US Federal Reserve, 6 V Volcker rule, 88 W Working capital, 11 171 Broken Markets A User’s Guide to the Post-Finance Economy Kevin Mellyn Broken Markets: A User’s Guide to the Post-Finance Economy Copyright © 2012 by Kevin Mellyn All rights reserved.


pages: 524 words: 143,993

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

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

Ensure that ‘compensation structures would be “consistent with firms” long-term goals and prudent risk-taking’. Improve standards for valuation of financial instruments. Make oversight of credit-rating agencies more effective. This indicates the immediate regulatory response to the crisis. This, in turn, reflected a consensus that almost everything had gone wrong: inadequate oversight; insufficient capital; regulatory arbitrage; irresponsible behaviour; misleading accounts; and misleading credit ratings. Subsequently, the authorities added yet more objectives: structural change (altering the way banks are allowed to organize themselves internally), stress tests (assessments of the ability of banks to survive extreme conditions), resolution regimes (new legal mechanisms for reorganizing the finances of failing financial institutions), changes to market structure (shifting trading from over-the-counter markets towards exchanges and clearing houses); and reforms of regulatory structures.

If taking on more risk does not raise risk-adjusted returns, shareholders should flee. If it does raise risk-adjusted returns, it should have happened anyway. Moreover, with substantially higher equity, banks could take on more risk safely. Finally, the disaster came from what banks wrongly thought to be safe. Risk-weighting is extremely unreliable, because the samples from which the weights are derived are always too small or irrelevant. A similar objection arises over regulatory arbitrage: with high levels of equity imposed on banks, risk would migrate elsewhere, as happened prior to the crisis of 2007–08. It would be extremely important, therefore, to ensure that the balance sheets of significant financial institutions are fully consolidated. It would be equally important to ensure oversight over the system as a whole, to check where risks might be emerging. That is part of macroprudential regulation, to which we turn in the next section.

Similarly, it will be important to impose constraints, in the form of charges or higher capital requirements, on extreme maturity transformation – that is the funding of ultra long-term and risky assets with short-term and safe liabilities. Much of this can, in principle, be done automatically. But there are some things that cannot be done in a mechanical way. One of the most obvious is watching over regulatory arbitrage: if risks are migrating out of the formal system, regulators will need to remain very alert. Unfortunately, this is not the only area where discretion will be necessary. Another is being aware of the systemic risks created by regulation, particularly the tendency to force regulated institutions to take the same risks in the same way and so become more homogeneous and thus more exposed to identical surprises.


pages: 350 words: 103,270

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

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

Passing the Bucks The proposed Basel II bank capital rules, which had taken six years to compile, were ready in early 2004. They would incorporate Michael Gordy’s correlation model, hard-coding into bank capital requirements the same kind of actuarial diversification benefit that underpinned investment-grade corporate CDO ratings. And banks would be able to feed into the model their “internal ratings” for loans on their balance sheets, with the idea that this would reduce the pressure for regulatory arbitrage. Banks that weren’t sophisticated enough to build these lending radar systems would be allowed to use old-fashioned credit ratings. The interminable meetings about Basel II around the world took their toll. In its rush to finalize the new rules, the committee adopted a few shortcuts, overruling its technical experts. One such expert was William Perraudin, who, while working with the Bank of England, had been assigned the job of analyzing how banks should allocate capital to pieces of securitizations.

It was different from the way LB Kiel invested with UBS, where at least the Germans had a stated interest in getting exposure to the U.S. real estate market. Here, armed with a triple-A rating and the protection of a default swap, an investor had little incentive to investigate what they were buying. The larger European banks, such as Société Générale or UBS, were already buying triple-A-rated CDOs to cash in on this regulatory arbitrage and were asking dealers to sell them default swaps on their investments. The Goldman European sales force had a list of second-tier banking clients on the continent, firms like Germany’s cooperative savings bank Deutsche Zentral-Genossenschaftsbank, Switzerland’s Zürcher Kantonalbank, and Dutch agricultural lender Rabobank, and wanted to sell them an entire package of CDOs and default swaps.

If confidence in Merrill Lynch is faltering, you can solve the problem by joining it to, say, Bank of America. However, the governance mechanism underlying private sector confidence in bank equity had been fatally undermined by the fall of 2008. Regulators initially hoped that they could seize banks and “shoot the hostage”—punish investors for lax governance. But the tricks of financial innovation and regulatory arbitrage meant that these investors held them hostage instead. That’s how they made themselves “too big to fail.” In the United States, the only regulator courageous enough to stick to the principles of the free market after Lehman collapsed was the FDIC’s Sheila Bair, who seized Washington Mutual bank, sold its deposits to J.P. Morgan, and punished debt holders along with shareholders. For what she described as a “textbook play,” Bair was hammered by Geithner for not being a “team player.”


pages: 356 words: 103,944

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

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

The fly in the ointment is that maintaining regulatory differences when finance can freely cross national boundaries is quite difficult. Banks and investment houses can simply move to jurisdictions with less onerous restrictions. Financial globalization in effect neutralizes differences in national regulations. This is what is known in the trade as “regulatory arbitrage,” a race to the bottom in finance.15 For this reason, a commitment to regulatory diversity has a very important corollary: the need for restrictions on global finance. The rules of the game have to allow for restrictions on cross-border finance designed to counter regulatory arbitrage and protect the integrity of national regulations. Governments should be able to keep banks and financial flows out—not for financial protectionism but to prevent the erosion of national regulations. None of the leading governments has acknowledged this need explicitly to date, yet without such restrictions domestic regulations would have little effect and domestic firms would stand little chance to compete with financial services exported from lax jurisdictions.

September 26, 2009, http://baselinescenario.com/2009/09/ 26/was-the-g20-summit-actually- dangerous/#more–5085. 14 Ibid. 15 Bankers are indeed quick to make this point when they are threatened by tighter regulations. In an October 2009 interview with the Financial Times, the chairman of Barclays warned about adverse implications for Britain’s financial sector if “regulators are too rigorous in their implementation of a global crackdown on bonuses and capital requirements while other nations, such as the US, are lax.” “There is the real risk of regulatory arbitrage,” he added. “This is a global financial system. It is fungible. So I am very concerned there should be a level playing field.” See http://www.ft.com/cms/s/0/47fd0f82- bc23-11de-9426-00144feab49a.html. 16 These ideas were first outlined in Dani Rodrik, “A Plan B for Global Finance,” The Economist, March 12, 2009. 17 There is much debate among economists about whether a tax of this sort would also serve to curb destabilizing short-term speculation.


pages: 237 words: 50,758

Obliquity: Why Our Goals Are Best Achieved Indirectly by John Kay

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Andrew Wiles, Asian financial crisis, Berlin Wall, bonus culture, British Empire, business process, Cass Sunstein, computer age, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, discovery of penicillin, diversification, Donald Trump, Fall of the Berlin Wall, financial innovation, Gordon Gekko, greed is good, invention of the telephone, invisible hand, Jane Jacobs, Long Term Capital Management, Louis Pasteur, market fundamentalism, Nash equilibrium, pattern recognition, purchasing power parity, RAND corporation, regulatory arbitrage, shareholder value, Simon Singh, Steve Jobs, The Death and Life of Great American Cities, The Predators' Ball, The Wealth of Nations by Adam Smith, ultimatum game, urban planning, value at risk

Of course, you can improve the result by refining the targets—you might prescribe the number of nails as well as their weight, for example. But they will probably still not provide the outcome you seek. From 1987 the Basel agreements prescribed the amount of capital that banks must hold to support their lending and deposit taking activities. These agreements do so in some detail—the accords of Basel II run to four hundred pages. The effect, we now realize, was to make banks riskier, not safer. Banks engaged in regulatory arbitrage—a mortgage-backed security might have a lower capital requirement than a mortgage, for example, even though the underlying risk was the same. Worse still, the targets relieved managers from making their own judgments. Since the crash of 2007–8, bankers who were paid millions a year have, with evident seriousness, blamed regulators for failing to impose sufficient constraints on their own risk taking.

“hedgehogs” Franklin’s gambit for goals of by governments historical analysis of information for intention in judgment in leadership and limited comparison in maximization in in military affairs models for oblique approach to, see obliquity outcomes of political process of psychology of quantification in rationality in rules for scientific simplification in social in sports trust in types of uncertainty in profits profit-seeking paradox Pruitt-Igoe housing project psychology Pursuit of Happyness, The puzzles quantification Quebec Quiller-Couch, Arthur railroads RAND Corp. randomness Rawls, John Reed, John reengineering Reengineering the Corporation (Hammer and Champy) regulatory arbitrage religion Rembrandt van Rijn Renaissance retail sector Ricks, Christopher risk management RiskMetrics Rockefeller, John D. Roosevelt, Franklin D. root method Rotella, Bob Rousseau, Jean-Jacques rules Saint-Gobain salesmen Salomon Brothers Samuelson, Paul Santa Maria del Fiore cathedral Scholes, Myron science scorecard Scottish Enlightenment Sculley, John Sears securities selfish gene September 11 attacks (2001) shareholder value share options Sieff, Israel Sierra Leone Simon, Herbert simplification Singapore Singer Smith, Adam Smith, Ed Smith, Will SmithKline soccer (English football) social contract socialism social issues socialist realism sociopaths Solon Sony Sony Walkman Soros, George Soviet Union sports Stalin, Joseph “Still Muddling, Not Yet Through” (Lindblom) Stockdale, James Stockdale Paradox stock prices Stone, Oliver successive limited comparison sudoku Sugar, Alan Sunbeam Sunstein, Cass Super Cub motorcycles superstition surgery survival sustainability Taleb, Nassim Nicholas Tankel, Stanley target goals teaching quality assessment technology see also computers teleological fallacy telephones Tellus tennis Tetlock, Philip Tet Offensive (1968) Thales of Miletus Thornton, Charles Bates “Tex” tic-tac-toe Tolstoy, Leo transnational corporations transportation Travelers Treasury, U.S.


pages: 701 words: 199,010

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

Its deductions were crude and imprecise. For example, longer maturity instruments are generally more risky than shorter maturity instruments, but Basel I doesn't account for this. The guidelines didn’t consider risk diversification. In Basel I, a pool of credit risks with well-diversified counterparty correlation has the same risk weight as one with heavily concentrated counterparties. Basel I let banks engage in regulatory arbitrage. Many instruments’ true measured risk was different than their assigned risk under the regulatory requirements, so banks might replace assets with lower true risk with assets carrying higher true risk. That gave a lower measured risk, according to the BIS ratio, but meant that banks could look healthier than they actually were. Banking capital ratios can be very effective if assets and liabilities, and therefore equity capital, are measured accurately.

Lowering mortgage weights encouraged banks to load up on more real estate and related investments. Basel II’s risk weightings didn’t correlate entirely with the actual differential default rates of different type of bonds. For example, a typical B-rated bond’s default rate might be 100 times higher than that of a typical BBB-rated bond, yet the difference in credit weights was just 150% versus 100% (a difference of 1.5 times). This was an inconsistency and an opportunity for regulatory arbitrage. Although Basel II considered how hard it is for outsiders to monitor banks’ true risks, the standard reporting items it required were not sufficient to truly expose bank risks. This, in part, led to runs on banks that may have otherwise been healthy. Basel II let banks use a VaR structure with simplified minimum requirements. These requirements let banks use different methodologies (short term instead of long term measurement periods, for instance).

Furthermore, they suggested that firms involved in CDOs should make sure they understand their risks.14 The committee missed this one.15 In the future, the Basel Committee and other regulators must be more ambitious, not so much in the number of rules they create, but perhaps by substituting forward-thinking talent for risk-averse bureaucrats. Regulators need stronger incentives to attract top talent, talent that is motivated to keep up as the markets innovate around specific guidelines. By reducing the risk weighting for mortgages and allowing banks a relatively high amount of leverage assisted by regulatory arbitrage, the Basel Committee encouraged banks to load up on mortgage-backed securities. That fueled the boom. When the mortgage market crashed and Lehman failed, the financial turbulence washed away the last intermediaries: the relative-value hedge funds. One of the casualties was JWMP, Meriwether’s new hedge fund. Notes 1. Its official name is the Basel Committee on Banking Supervision. The committee’s members come from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.


pages: 431 words: 132,416

No One Would Listen: A True Financial Thriller by Harry Markopolos

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backtesting, barriers to entry, Bernie Madoff, call centre, centralized clearinghouse, correlation coefficient, diversified portfolio, Emanuel Derman, Eugene Fama: efficient market hypothesis, family office, fixed income, forensic accounting, high net worth, index card, Long Term Capital Management, Louis Bachelier, offshore financial centre, Ponzi scheme, price mechanism, quantitative trading / quantitative finance, regulatory arbitrage, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, statistical arbitrage, too big to fail, transaction costs

Relying on several separate regulators working independently to spot problems is like trying to rein in a beehive with a chain-link fence. If the SEC can’t coordinate two examinations within its own agency, there is little reason to believe that five separate agencies can successfully coordinate their examinations. It seems to me that the existence of so many financial regulators leaves gaping holes for financial predators to engage in what I called regulatory arbitrage. They find those regulatory gaps where no agency is looking or there is some question about which agency has the oversight responsibility, and they exploit them. I’ve seen corporations in which employees have two very different business cards. One card identifies them as a registered investment adviser, which falls under SEC regulation, while the other card has their bank title, which falls under the control of banking regulators.

If both the Fed and the SEC were to show up to search for fraud in the company’s pension accounts under management, that company could claim, “I’m sorry, but those are Employee Retirement Income Security Act (ERISA) accounts and they fall under the Department of Labor, so unfortunately you don’t have jurisdiction.” Obviously this structure allows firms to play regulators against each other, and literally to choose to be regulated by that agency least likely to pose any problems. The objective should be to combine regulatory functions into as few agencies as possible to prevent regulatory arbitrage, centralize command and control, ensure unity of effort, eliminate expensive duplication of effort, and minimize the number of regulators to whom American corporations must respond. It seems logical to me that one super-regulatory agency be formed, perhaps called the Financial Supervisory Authority (FSA). It should have all of the security and capital markets and financial regulators underneath it.

Spread the knowledge, share the experience, be bigger than the biggest bad guys. Bernie Madoff got caught for the first time in 1992, but apparently none of the investigators after the turn of the century knew about it. Cross-functional teams of regulators from the SEC, the Fed, a national insurance regulator, and the Treasury or Department of Justice should be sent together on audits whenever possible to prevent regulatory arbitrage. The SEC, the Fed, and the national insurance regulator would be responsible for the inspections, while the Treasury or Department of Justice would be responsible for taking legal action against offenders. American businesses need and deserve a simple, easy-to-follow set of rules and regulations, and they deserve to have competent regulation. Financial institutions currently pay high fees to support regulation, but neither they nor the public are getting their money’s worth.


pages: 457 words: 128,838

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

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

Indeed, as the elation generated by the FinCEN hearings in November gave way to dismay at New York’s initially ham-fisted handling of the BitLicense, some U.S.-initiated bitcoin businesses started making this happen. They moved. * * * It’s an axiom of finance that in a globalized economy, businesses will respond to regulation and tax burdens by moving operations to where they are less inhibiting. The phenomenon is known as regulatory arbitrage, because it allows businesses to leverage one location’s lax posture to extract an easier stance from another. In 2014, the problem became a political lightning rod in the United States as company after company engineered “inversion” mergers, acquiring competitors overseas and then co-opting their corporate headquarters to lower their U.S. corporate tax bill. Island nations in the Caribbean and autonomous British territories in the English Channel have built entire economic models around such ideas, with somewhere between $5 trillion and $32 trillion said to be held offshore in such tax havens.

philanthropy Philippines Philo Pierce, Brock Piper pizza Plug and Play Tech Center Polis, Jared political donations Ponzi schemes Portugal poverty Powell, Jesse Prasad, Eswar Pretty Good Privacy printing press privacy private key proof of burn proof of stake proof of work property rights ProtonMail public key Purse QuickCoin Quigley, William Rabois, Keith Radar Capital Radtke, Autumn Raspberry Pi Ratha, Dilip Reagan, Ronald Realcoin Reddit Reed, John regulation regulatory arbitrage remittance business Renaissance revolutions Ripple Rivest, Ron Robbins, Scott Robinson, Scott Rolling Stone Roman Empire Rosen, Sholom Rossiello, Elizabeth Roszak, Matthew Roubini, Nouriel RSA Rulli, Francesco Russia Sacramento Kings Safaricom Saggers, Laura Salomon Smith Barney Salt Lake City San Francisco, Calif. 20Mission in SAP satellites SatoshiDice Schechter, Joshua Schmidt, Eric Schopenhauer, Arthur Schumer, Chuck Sclavos, Stratton scrypt Sean’s Outpost SecondMarket Secure Electronic Transactions (SET) Securities and Exchange Commission (SEC) securities contracts seigniorage Selkis, Ryan Serrano, Sebastian sharing economy Shasky Calvery, Jennifer Shavers, Trendon Shiller, Robert Shrem, Charlie Silbert, Barry Silent Circle Silicon Valley accelerator programs Silicon Valley Silk Road Simpson, David Singapore Sirer, Emin Gün Skype smart contracts smartphones smart property Smith, Adam Smith, Peter Snowden, Edward societal changes Softcard Spain spam bitcoin and Square stagflation Stanford, Leland Starbucks Starfish and the Spider, The: The Unstoppable Power of Leaderless Organizations (Brafman and Beckstrom) staters Stein, Josh Stellar Stockholm Stockman, Steve Strauss, Levi StrictlyVC Stripe Summers, Larry Sutter, John Sutter’s Mill Swarm Sweden Switzerland Szabo, Nick Taaki, Amir Tally Capital Target taxes capital-gains regulatory arbitrage and taxi services technology(ies) bitcoin as disruptive Tel Aviv Tencent Holdings Terpin, Michael TerraMiner terrorism Tesla Texas 37Coins Thornburg, Jonathan Time Times (London) T-Mobile Toronto trade Tradehill Tradenet transaction fees bitcoin and Travelers Group Treasury Department, U.S.

philanthropy Philippines Philo Pierce, Brock Piper pizza Plug and Play Tech Center Polis, Jared political donations Ponzi schemes Portugal poverty Powell, Jesse Prasad, Eswar Pretty Good Privacy printing press privacy private key proof of burn proof of stake proof of work property rights ProtonMail public key Purse QuickCoin Quigley, William Rabois, Keith Radar Capital Radtke, Autumn Raspberry Pi Ratha, Dilip Reagan, Ronald Realcoin Reddit Reed, John regulation regulatory arbitrage remittance business Renaissance revolutions Ripple Rivest, Ron Robbins, Scott Robinson, Scott Rolling Stone Roman Empire Rosen, Sholom Rossiello, Elizabeth Roszak, Matthew Roubini, Nouriel RSA Rulli, Francesco Russia Sacramento Kings Safaricom Saggers, Laura Salomon Smith Barney Salt Lake City San Francisco, Calif. 20Mission in SAP satellites SatoshiDice Schechter, Joshua Schmidt, Eric Schopenhauer, Arthur Schumer, Chuck Sclavos, Stratton scrypt Sean’s Outpost SecondMarket Secure Electronic Transactions (SET) Securities and Exchange Commission (SEC) securities contracts seigniorage Selkis, Ryan Serrano, Sebastian sharing economy Shasky Calvery, Jennifer Shavers, Trendon Shiller, Robert Shrem, Charlie Silbert, Barry Silent Circle Silicon Valley accelerator programs Silicon Valley Silk Road Simpson, David Singapore Sirer, Emin Gün Skype smart contracts smartphones smart property Smith, Adam Smith, Peter Snowden, Edward societal changes Softcard Spain spam bitcoin and Square stagflation Stanford, Leland Starbucks Starfish and the Spider, The: The Unstoppable Power of Leaderless Organizations (Brafman and Beckstrom) staters Stein, Josh Stellar Stockholm Stockman, Steve Strauss, Levi StrictlyVC Stripe Summers, Larry Sutter, John Sutter’s Mill Swarm Sweden Switzerland Szabo, Nick Taaki, Amir Tally Capital Target taxes capital-gains regulatory arbitrage and taxi services technology(ies) bitcoin as disruptive Tel Aviv Tencent Holdings Terpin, Michael TerraMiner terrorism Tesla Texas 37Coins Thornburg, Jonathan Time Times (London) T-Mobile Toronto trade Tradehill Tradenet transaction fees bitcoin and Travelers Group Treasury Department, U.S. Financial Crimes Enforcement Network trust in Argentina bitcoin and breakdown of middlemen and money and Mt.


pages: 741 words: 179,454

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

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

Basel 1 required banks to maintain capital, a buffer or reserves (shareholders’ money), against loss. They were required to hold cash or securities that could be readily sold to raise funds to meet the needs of depositors wanting to take out their money. The eighteenth-century English playwright Susannah Centlivre observed that: “Tis my opinion every man cheats in his own way, and he is only honest who is not discovered.” Regulatory arbitrage—the process of exploiting gaps in bank regulations—evolved into a business model. Banks reduced the amount of expensive capital, transferring loans, investments, and trading into a network of unregulated off-balance-sheet vehicles, which did not need to hold as much capital as the bank itself. Frequently, the real risk remained with the banks. Banks reduced real capital—common shares—by substituting creative hybrid capital instruments that were cheaper.

As one commentator put it: “it’s no longer an act, it’s word processors gone mad.”12 In 2010, 500 central bankers and regulators from 27 nations produced Basel III, 440 pages of new rules. The frenetic activity recalled Italian author Giuseppe di Lampedusa: “everything must change so that everything can stay the same.” As before, the revised rules were susceptible to being manipulated, through regulatory arbitrage. Many of the rules had little to do with improving regulation, instead focusing on familiar regulatory turf wars or battles for power, staff and budgets, as well as settling of old scores. Regulatory initiatives did little to address the quality of regulators and the acuity of oversight or enforcement of breaches of the law. The case for greater oversight of the financial system was not helped by the fact that the U.S.

., 196 re-re-securitizations, 191 re-securitizations, 191 Reagan, Ronald, 65-66, 97, 101, 298, 364 real estate, 179-182 adjusted rate mortgages (ARMs), 183-184 reals, 21 recessions, 350 recovery, 359-360 rates, 171 recruitment of finance candidates, 310 recycling in Japan, 39 Red Force, 264 Redline, 186 Reed, John, 71, 75 reflexivity, 327 Regnault, Jules, 118 regulations, 81 banks, 65-67 Basel 1, 74 Basel 2, 200 central banks, 279-281 self-regulating markets, 102 synthetic securitization, 176 regulators preparation for financial crises, 264-278 understanding of securitization, 282 regulatory arbitrage, 75 Reid, Harry, 299 relative value funds arb (arbitrage) market inefficiencies, 242 religious prohibitions on usuries, 32 remote risk of loss, 220 renminbi, 21 rentiers, 33 repackaging corporate debt, 173 repos (repurchase agreements), 288 reserves banking, 32 gold, 30 resources, financial news, 89-99 restructures, corporations, 57 retirement, 20, 46, 48 Japan, 49-50 pension plans, 50 self-funded savings, 180 returns benchmarking, 123 on capital, 57 hedge funds, 243-244 private equity, 162 Revco drug stores, 150 Reykjavík, Iceland, 275 as a financial center, 84 Reynolds, Glenn, 283 Reynolds/Tube, 58 Rhodesia.


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

If Kate makes risky investments with the funds, then of course how she will end up doing depends on how these investments turn out, but clearly, having no money in the house and experiencing only the upside from it is a highly beneficial situation for Kate. 10. This represents a recent increase in the eligible amount. Placing a higher amount under deposit insurance is easy if one divides it across multiple accounts or multiple banks. There are even deposit brokers who would help in this process. Kane (2012b) describes a regulatory arbitrage created by a deposit-swap market in which one can place practically any amount under deposit insurance. Malysheva and Walter (2010) discuss the expansion of the safety net in the United States in recent years. 11. See Acharya et al. (2010) and ASC (2012). 12. For more information on the use of implicit guarantees and recapitalization, see Laeven and Valencia (2010, 2012). 13. On the cost of the bailouts and the recent crisis in the United States, see Better Markets (2012).

For an overview of the shadow banking system, which includes hedge funds, special-purpose vehicles, and other entities, see Poszar et al. (2010), Acharya et al. (2010, Part III), and FCIC (2011, Chapter 2), and FSB (2012). As discussed in Chapter 4 (see note 27) and Chapter 10 (see note 46), money market mutual funds were developed in the 1970s in order to get around the regulation of commercial banks and savings banks. These funds are regulated by the SEC, which means that they are very lightly regulated relative to banks and operate with few restrictions. The concern with shadow banking and so-called regulatory arbitrage can be traced to the establishment of money market funds. Since that time, regulators have feared that regulating banks might lead to the displacement of regulated banks with new unregulated institutions. The problem of enforcement is particularly challenging in the United States because the regulatory system is highly fragmented. Under the Dodd-Frank Act, the Financial Stability Oversight Council is authorized to provide “comprehensive monitoring to ensure the stability” of the U.S. financial system, with the idea of closing regulatory gaps (see http://www.treasury.gov/initiatives/fsoc/Pages/default.aspx, accessed October 22, 2012). 54.

See credit rating real estate bubbles, 56, 287n8, 314n71, 330n18 real estate finance: as a cause of banking crises, 56; as a cause of financial crisis of 2007–2009, 65. See also mortgage(s) recessions (downturns): of 2008–2009, 5, 11, 233n19; associated with financial crises, history of, 233n19; duration of recovery after, 172, 304n16; fears of, in delay of regulation, 171–72; and risks of lending, 56 referees, home-team bias of, 205, 326n59 Regalia, Martin A., 248n2 regulation. See banking regulation Regulation Q, 53, 251n26, 299n46 regulatory arbitrage, 288n10, 308n47, 335n53. See also shadow banking regulatory capture, 203–7; causes of, 204–5; definition of, 194; effects of, 206; example of, 319n9; in financial crisis of 2007-2009, 204; revolving door and, 204–5, 325n56. See also lobbying rehypothecation, 301n55, 317n88 Reichsbank, in banking crisis of 1931, 272n45, 294n14 Reilly, David, 266n13 Reinhart, Carmen M., 65, 239n1, 244n3, 249n15, 258n22, 258n24, 276n6, 295n16, 296n26, 297n38, 322n34, 323n37, 331n19 repo (repurchase) agreements: in bankruptcy, exceptions for, 164, 227, 236n35, 300n54, 301n55, 336n57; collateral in, 164, 300n54, 301n55; definition of, 164; runs, 300n54 repurchase agreements.


pages: 468 words: 145,998

On the Brink: Inside the Race to Stop the Collapse of the Global Financial System by Henry M. Paulson

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asset-backed security, bank run, banking crisis, Bretton Woods, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Doha Development Round, fear of failure, financial innovation, housing crisis, income inequality, London Interbank Offered Rate, Long Term Capital Management, margin call, moral hazard, Northern Rock, price discovery process, price mechanism, regulatory arbitrage, Ronald Reagan, Saturday Night Live, short selling, sovereign wealth fund, technology bubble, too big to fail, trade liberalization, young professional

The recent crisis demonstrated that our financial markets had outgrown the ability of our current system to regulate them. Regulatory reforms alone would not have prevented all of the problems that emerged. However, a better framework that featured less duplication and that restricted the ability of financial firms to pick and choose their own, generally less-strict, regulators—a practice known as regulatory arbitrage—would have worked much better. And there is no doubt in my mind that the lack of a regulator to identify and manage systemic risks contributed greatly to the problems we faced. We need a system that can adapt as financial institutions, financial products, and markets continue to evolve. Before the crisis forced us to shift from making long-range recommendations to fighting fires, Treasury conducted a thorough analysis of the proper objectives of financial services regulation, and this exercise led us to sweeping proposals for fundamental reforms.

Before the crisis forced us to shift from making long-range recommendations to fighting fires, Treasury conducted a thorough analysis of the proper objectives of financial services regulation, and this exercise led us to sweeping proposals for fundamental reforms. These recommendations were controversial when they were issued in March 2008, but in retrospect seem quite prophetic. Among other things, we proposed a system that created a government responsibility for systemic risk identification and oversight. We recommended strengthening and consolidating safety and soundness regulation to eliminate redundancy and counterproductive regulatory arbitrage. Acknowledging the proliferation of financial products—and the abuses that have accompanied them—we also proposed a separate and distinct business conduct regulator to protect consumers and investors. There is a well-recognized need for a global accord requiring banks to have higher levels of better-quality capital. This will be more difficult to achieve for some of the more highly leveraged European banks, but consistency here is important, and a stronger capital position will allow the banks to lend more in a downturn, when credit is most needed.


pages: 349 words: 134,041

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

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

Sadly, as it turned out, that really wasn’t the answer either. The cash settled and off-balance nature of derivatives poses another problem. You can now simulate an investment without actually ever owning anything. Our wheat speculator could create the same effect as buying wheat by using wheat forwards. He didn’t actually ever need to own the wheat. It is deliciously ambiguous, opening up a whole new frontier – ‘reg arb’ (regulatory arbitrage). It is illegal for you to own shares in other countries because of limits on foreign ownership. You just do a forward on the share or an equity swap. You have shares in a company that has done a hugely successful IPO (initial public offering). Can’t sell your shares as you have agreed not to sell for 12 months? You just sell forward or do an equity swap. The bank will even lend you funds against the stock you own, hedged by the forward sale or equity swap.

However, the text is different. 6 ‘What Worries Warren’ (3 March 2003) Fortune. 13_INDEX.QXD 17/2/06 4:44 pm Page 325 Index accounting rules 139, 221, 228, 257 Accounting Standards Board 33 accrual accounting 139 active fund management 111 actuaries 107–10, 205, 289 Advance Corporation Tax 242 agency business 123–4, 129 agency theory 117 airline profits 140–1 Alaska 319 Allen, Woody 20 Allied Irish Bank 143 Allied Lyons 98 alternative investment strategies 112, 308 American Express 291 analysts, role of 62–4 anchor effect 136 Anderson, Rolf 92–4 annuities 204–5 ANZ Bank 277 Aquinas, Thomas 137 arbitrage 33, 38–40, 99, 114, 137–8, 171–2, 245–8, 253–5, 290, 293–6 arbitration 307 Argentina 45 arithmophobia 177 ‘armpit theory’ 303 Armstrong World Industries 274 arrears assets 225 Ashanti Goldfields 97–8, 114 Asian financial crisis (1997) 4, 9, 44–5, 115, 144, 166, 172, 207, 235, 245, 252, 310, 319 asset consultants 115–17, 281 ‘asset growth’ strategy 255 asset swaps 230–2 assets under management (AUM) 113–4, 117 assignment of loans 267–8 AT&T 275 attribution of earnings 148 auditors 144 Australia 222–4, 254–5, 261–2 back office functions 65–6 back-to-back loans 35, 40 backwardation 96 Banca Popolare di Intra 298 Bank of America 298, 303 Bank of International Settlements 50–1, 281 Bank of Japan 220 Bankers’ Trust (BT) 59, 72, 101–2, 149, 217–18, 232, 268–71, 298, 301, 319 banking regulations 155, 159, 162, 164, 281, 286, 288 banking services 34; see also commercial banks; investment banks bankruptcy 276–7 Banque Paribas 37–8, 232 Barclays Bank 121–2, 297–8 13_INDEX.QXD 17/2/06 326 4:44 pm Page 326 Index Baring, Peter 151 Baring Brothers 51, 143, 151–2, 155 ‘Basel 2’ proposal 159 basis risk 28, 42, 274 Bear Stearns 173 bearer eurodollar collateralized securities (BECS) 231–3 ‘behavioural finance’ 136 Berkshire Hathaway 19 Bermudan options 205, 227 Bernstein, Peter 167 binomial option pricing model 196 Bismarck, Otto von 108 Black, Fischer 22, 42, 160, 185, 189–90, 193, 195, 197, 209, 215 Black–Scholes formula for option pricing 22, 185, 194–5 Black–Scholes–Merton model 160, 189–93, 196–7 ‘black swan’ hypothesis 130 Blair, Tony 223 Bogle, John 116 Bohr, Niels 122 Bond, Sir John 148 ‘bond floor’ concept 251–4 bonding 75–6, 168, 181 bonuses 146–51, 244, 262, 284–5 Brady Commission 203 brand awareness and brand equity 124, 236 Brazil 302 Bretton Woods system 33 bribery 80, 303 British Sky Broadcasting (BSB) 247–8 Brittain, Alfred 72 broad index secured trust offerings (BISTROs) 284–5 brokers 69, 309 Brown, Robert 161 bubbles 210, 310, 319 Buconero 299 Buffet, Warren 12, 19–20, 50, 110–11, 136, 173, 246, 316 business process reorganization 72 business risk 159 Business Week 130 buy-backs 249 ‘call’ options 25, 90, 99, 101, 131, 190, 196 callable bonds 227–9, 256 capital asset pricing model (CAPM) 111 capital flow 30 capital guarantees 257–8 capital structure arbitrage 296 Capote, Truman 87 carbon trading 320 ‘carry cost’ model 188 ‘carry’ trades 131–3, 171 cash accounting 139 catastrophe bonds 212, 320 caveat emptor principle 27, 272 Cayman Islands 233–4 Cazenove (company) 152 CDO2 292 Cemex 249–50 chaos theory 209, 312 Chase Manhattan Bank 143, 299 Chicago Board Options Exchange 195 Chicago Board of Trade (CBOT) 25–6, 34 chief risk officers 177 China 23–5, 276, 302–4 China Club, Hong Kong 318 Chinese walls 249, 261, 280 chrematophobia 177 Citibank and Citigroup 37–8, 43, 71, 79, 94, 134–5, 149, 174, 238–9 Citron, Robert 124–5, 212–17 client relationships 58–9 Clinton, Bill 223 Coats, Craig 168–9 collateral requirements 215–16 collateralized bond obligations (CBOs) 282 collateralized debt obligations (CDOs) 45, 282–99 13_INDEX.QXD 17/2/06 4:44 pm Page 327 Index collateralized fund obligations (CFOs) 292 collateralized loan obligations (CLOs) 283–5, 288 commercial banks 265–7 commoditization 236 commodity collateralized obligations (CCOs) 292 commodity prices 304 Commonwealth Bank of Australia 255 compliance officers 65 computer systems 54, 155, 197–8 concentration risk 271, 287 conferences with clients 59 confidence levels 164 confidentiality 226 Conseco 279–80 contagion crises 291 contango 96 contingent conversion convertibles (co-cos) 257 contingent payment convertibles (co-pays) 257 Continental Illinois 34 ‘convergence’ trading 170 convertible bonds 250–60 correlations 163–6, 294–5; see also default correlations corruption 303 CORVUS 297 Cox, John 196–7 credit cycle 291 credit default swaps (CDSs) 271–84, 293, 299 credit derivatives 129, 150, 265–72, 282, 295, 299–300 Credit Derivatives Market Practices Committee 273, 275, 280–1 credit models 294, 296 credit ratings 256–7, 270, 287–8, 297–8, 304 credit reserves 140 credit risk 158, 265–74, 281–95, 299 327 credit spreads 114, 172–5, 296 Credit Suisse 70, 106, 167 credit trading 293–5 CRH Capital 309 critical events 164–6 Croesus 137 cross-ruffing 142 cubic splines 189 currency options 98, 218, 319 custom repackaged asset vehicles (CRAVEs) 233 daily earning at risk (DEAR) concept 160 Daiwa Bank 142 Daiwa Europe 277 Danish Oil and Natural Gas 296 data scrubbing 142 dealers, work of 87–8, 124–8, 133, 167, 206, 229–37, 262, 295–6; see also traders ‘death swap’ strategy 110 decentralization 72 decision-making, scientific 182 default correlations 270–1 defaults 277–9, 287, 291, 293, 296, 299 DEFCON scale 156–7 ‘Delta 1’ options 243 delta hedging 42, 200 Deming, W.E. 98, 101 Denmark 38 deregulation, financial 34 derivatives trading 5–6, 12–14, 18–72, 79, 88–9, 99–115, 123–31, 139–41, 150, 153, 155, 175, 184–9, 206–8, 211–14, 217–19, 230, 233, 257, 262–3, 307, 316, 319–20; see also equity derivatives Derman, Emmanuel 185, 198–9 Deutsche Bank 70, 104, 150, 247–8, 274, 277 devaluations 80–1, 89, 203–4, 319 13_INDEX.QXD 17/2/06 4:44 pm Page 328 328 Index dilution of share capital 241 DINKs 313 Disney Corporation 91–8 diversification 72, 110–11, 166, 299 dividend yield 243 ‘Dr Evil’ trade 135 dollar premium 35 downsizing 73 Drexel Burnham Lambert (DBL) 282 dual currency bonds 220–3; see also reverse dual currency bonds earthquakes, bonds linked to 212 efficient markets hypothesis 22, 31, 111, 203 electronic trading 126–30, 134 ‘embeddos’ 218 emerging markets 3–4, 44, 115, 132–3, 142, 212, 226, 297 Enron 54, 142, 250, 298 enterprise risk management (ERM) 176 equity capital management 249 equity collateralized obligations (ECOs) 292 equity derivatives 241–2, 246–9, 257–62 equity index 137–8 equity investment, retail market in 258–9 equity investors’ risk 286–8 equity options 253–4 equity swaps 247–8 euro currency 171, 206, 237 European Bank for Reconstruction and Development 297 European currency units 93 European Union 247–8 Exchange Rate Mechanism, European 204 exchangeable bonds 260 expatriate postings 81–2 expert witnesses 310–12 extrapolation 189, 205 extreme value theory 166 fads of management science 72–4 ‘fairway bonds’ 225 Fama, Eugene 22, 111, 194 ‘fat tail’ events 163–4 Federal Accounting Standards Board 266 Federal Home Loans Bank 213 Federal National Mortgage Association 213 Federal Reserve Bank 20, 173 Federal Reserve Board 132 ‘Ferraris’ 232 financial engineering 228, 230, 233, 249–50, 262, 269 Financial Services Authority (FSA), Japan 106, 238 Financial Services Authority (FSA), UK 15, 135 firewalls 235–6 firing of staff 84–5 First Interstate Ltd 34–5 ‘flat’ organizations 72 ‘flat’ positions 159 floaters 231–2; see also inverse floaters ‘flow’ trading 60–1, 129 Ford Motors 282, 296 forecasting 135–6, 190 forward contracts 24–33, 90, 97, 124, 131, 188 fugu fish 239 fund management 109–17, 286, 300 futures see forward contracts Galbraith, John Kenneth 121 gamma risk 200–2, 294 Gauss, Carl Friedrich 160–2 General Motors 279, 296 General Reinsurance 20 geometric Brownian motion (GBM) 161 Ghana 98 Gibson Greeting Cards 44 Glass-Steagall Act 34 gold borrowings 132 13_INDEX.QXD 17/2/06 4:44 pm Page 329 Index gold sales 97, 137 Goldman Sachs 34, 71, 93, 150, 173, 185 ‘golfing holiday bonds’ 224 Greenspan, Alan 6, 9, 19–21, 29, 43, 47, 50, 53, 62, 132, 159, 170, 215, 223, 308 Greenwich NatWest 298 Gross, Bill 19 Guangdong International Trust and Investment Corporation (GITIC) 276–7 guaranteed annuity option (GAO) contracts 204–5 Gutenfreund, John 168–9 gyosei shido 106 Haghani, Victor 168 Hamanaka, Yasuo 142 Hamburgische Landesbank 297 Hammersmith and Fulham, London Borough of 66–7 ‘hara-kiri’ swaps 39 Hartley, L.P. 163 Hawkins, Greg 168 ‘heaven and hell’ bonds 218 hedge funds 44, 88–9, 113–14, 167, 170–5, 200–2, 206, 253–4, 262–3, 282, 292, 296, 300, 308–9 hedge ratio 264 hedging 24–8, 31, 38–42, 60, 87–100, 184, 195–200, 205–7, 214, 221, 229, 252, 269, 281, 293–4, 310 Heisenberg, Werner 122 ‘hell bonds’ 218 Herman, Clement (‘Crem’) 45–9, 77, 84, 309 Herodotus 137, 178 high net worth individuals (HNWIs) 237–8, 286 Hilibrand, Lawrence 168 Hill Samuel 231–2 329 The Hitchhiker’s Guide to the Galaxy 189 Homer, Sidney 184 Hong Kong 9, 303–4 ‘hot tubbing’ 311–12 HSBC Bank 148 HSH Nordbank 297–8 Hudson, Kevin 102 Hufschmid, Hans 77–8 IBM 36, 218, 260 ICI 34 Iguchi, Toshihude 142 incubators 309 independent valuation 142 indexed currency option notes (ICONs) 218 India 302 Indonesia 5, 9, 19, 26, 55, 80–2, 105, 146, 219–20, 252, 305 initial public offerings 33, 64, 261 inside information and insider trading 133, 241, 248–9 insurance companies 107–10, 117, 119, 150, 192–3, 204–5, 221, 223, 282, 286, 300; see also reinsurance companies insurance law 272 Intel 260 intellectual property in financial products 226 Intercontinental Hotels Group (IHG) 285–6 International Accounting Standards 33 International Securities Market Association 106 International Swap Dealers Association (ISDA) 273, 275, 279, 281 Internet stock and the Internet boom 64, 112, 259, 261, 310, 319 interpolation of interest rates 141–2, 189 inverse floaters 46–51, 213–16, 225, 232–3 13_INDEX.QXD 17/2/06 4:44 pm Page 330 330 Index investment banks 34–8, 62, 64, 67, 71, 127–8, 172, 198, 206, 216–17, 234, 265–7, 298, 309 investment managers 43–4 investment styles 111–14 irrational decisions 136 Italy 106–7 Ito’s Lemma 194 Japan 39, 43, 82–3, 92, 94, 98–9, 101, 106, 132, 142, 145–6, 157, 212, 217–25, 228, 269–70 Jensen, Michael 117 Jett, Joseph 143 JP Morgan (company) 72, 150, 152, 160, 162, 249–50, 268–9, 284–5, 299; see also Morgan Guaranty junk bonds 231, 279, 282, 291, 296–7 JWM Associates 175 Kahneman, Daniel 136 Kaplanis, Costas 174 Kassouf, Sheen 253 Kaufman, Henry 62 Kerkorian, Kirk 296 Keynes, J.M. 167, 175, 198 Keynesianism 5 Kidder Peabody 143 Kleinwort Benson 40 Korea 9, 226, 278 Kozeny, Viktor 121 Krasker, William 168 Kreiger, Andy 319 Kyoto Protocol 320 Lavin, Jack 102 law of large numbers 192 Leeson, Nick 51, 131, 143, 151 legal opinions 47, 219–20, 235, 273–4 Leibowitz, Martin 184 Leland, Hayne 42, 202 Lend Lease Corporation 261–2 leptokurtic conditions 163 leverage 31–2, 48–50, 54, 99, 102–3, 114, 131–2, 171–5, 213–14, 247, 270–3, 291, 295, 305, 308 Lewis, Kenneth 303 Lewis, Michael 77–8 life insurance 204–5 Lintner, John 111 liquidity options 175 liquidity risk 158, 173 litigation 297–8 Ljunggren, Bernt 38–40 London Inter-Bank Offered Rate (LIBOR) 6, 37 ‘long first coupon’ strategy 39 Long Term Capital Management (LTCM) 44, 51, 62, 77–8, 84, 114, 166–75, 187, 206, 210, 215–18, 263–4, 309–10 Long Term Credit Bank of Japan 94 LOR (company) 202 Louisiana Purchase 319 low exercise price options (LEPOs) 261 Maastricht Treaty and criteria 106–7 McLuhan, Marshall 134 McNamara, Robert 182 macro-economic indicators, derivatives linked to 319 Mahathir Mohammed 31 Malaysia 9 management consultants 72–3 Manchester United 152 mandatory convertibles 255 Marakanond, Rerngchai 302 margin calls 97–8, 175 ‘market neutral’ investment strategy 114 market risk 158, 173, 265 marketable eurodollar collateralized securities (MECS) 232 Markowitz, Harry 110 mark-to-market accounting 10, 100, 139–41, 145, 150, 174, 215–16, 228, 244, 266, 292, 295, 298 Marx, Groucho 24, 57, 67, 117, 308 13_INDEX.QXD 17/2/06 4:44 pm Page 331 Index mathematics applied to financial instruments 209–10; see also ‘quants’ matrix structures 72 Meckling, Herbert 117 Melamed, Leo 34, 211 merchant banks 38 Meriwether, John 167–9, 172–5 Merrill Lynch 124, 150, 217, 232 Merton, Robert 22, 42, 168–70, 175, 185, 189–90, 193–7, 210 Messier, Marie 247 Metallgesellschaft 95–7 Mexico 44 mezzanine finance 285–8, 291–7 MG Refining and Marketing 95–8, 114 Microsoft 53 Mill, Stuart 130 Miller, Merton 22, 101, 194 Milliken, Michael 282 Ministry of Finance, Japan 222 misogyny 75–7 mis-selling 238, 297–8 Mitchell, Edison 70 Mitchell & Butler 275–6 models financial 42–3, 141–2, 163–4, 173–5, 181–4, 189, 198–9, 205–10 of business processes 73–5 see also credit models Modest, David 168 momentum investment 111 monetization 260–1 monopolies in financial trading 124 moral hazard 151, 280, 291 Morgan Guaranty 37–8, 221, 232 Morgan Stanley 76, 150 mortgage-backed securities (MBSs) 282–3 Moscow, City of 277 moves of staff between firms 150, 244 Mozer, Paul 169 Mullins, David 168–70 multi-skilling 73 331 Mumbai 3 Murdoch, Rupert 247 Nabisco 220 Napoleon 113 NASDAQ index 64, 112 Nash, Ogden 306 National Australia Bank 144, 178 National Rifle Association 29 NatWest Bank 144–5, 198 Niederhoffer, Victor 130 ‘Nero’ 7, 31, 45–9, 60, 77, 82–3, 88–9, 110, 118–19, 125, 128, 292 NERVA 297 New Zealand 319 Newman, Frank 104 news, financial 133–4 News Corporation 247 Newton, Isaac 162, 210 Nippon Credit Bank 106, 271 Nixon, Richard 33 Nomura Securities 218 normal distribution 160–3, 193, 199 Northern Electric 248 O’Brien, John 202 Occam, William 188 off-balance sheet transactions 32–3, 99, 234, 273, 282 ‘offsites’ 74–5 oil prices 30, 33, 89–90, 95–7 ‘omitted variable’ bias 209–10 operational risk 158, 176 opinion shopping 47 options 9, 21–2, 25–6, 32, 42, 90, 98, 124, 197, 229 pricing 185, 189–98, 202 Orange County 16, 44, 50, 124–57, 212–17, 232–3 orphan subsidiaries 234 over-the-counter (OTC) market 26, 34, 53, 95, 124, 126 overvaluation 64 13_INDEX.QXD 17/2/06 4:44 pm Page 332 332 Index ‘overwhelming force’ strategy 134–5 Owen, Martin 145 ownership, ‘legal’ and ‘economic’ 247 parallel loans 35 pari-mutuel auction system 319 Parkinson’s Law 136 Parmalat 250, 298–9 Partnoy, Frank 87 pension funds 43, 108–10, 115, 204–5, 255 People’s Bank of China (PBOC) 276–7 Peters’ Principle 71 petrodollars 71 Pétrus (restaurant) 121 Philippines, the 9 phobophobia 177 Piga, Gustavo 106 PIMCO 19 Plaza Accord 38, 94, 99, 220 plutophobia 177 pollution quotas 320 ‘portable alpha’ strategy 115 portfolio insurance 112, 202–3, 294 power reverse dual currency (PRDC) bonds 226–30 PowerPoint 75 preferred exchangeable resettable listed shares (PERLS) 255 presentations of business models 75 to clients 57, 185 prime brokerage 309 Prince, Charles 238 privatization 205 privity of contract 273 Proctor & Gamble (P&G) 44, 101–4, 155, 298, 301 product disclosure statements (PDSs) 48–9 profit smoothing 140 ‘programme’ issuers 234–5 proprietary (‘prop’) trading 60, 62, 64, 130, 174, 254 publicly available information (PAI) 277 ‘puff’ effect 148 purchasing power parity theory 92 ‘put’ options 90, 131, 256 ‘quants’ 183–9, 198, 208, 294 Raabe, Matthew 217 Ramsay, Gordon 121 range notes 225 real estate 91, 219 regulatory arbitrage 33 reinsurance companies 288–9 ‘relative value’ trading 131, 170–1, 310 Reliance Insurance 91–2 repackaging (‘repack’) business 230–6, 282, 290 replication in option pricing 195–9, 202 dynamic 200 research provided to clients 58, 62–4, 184 reserves, use of 140 reset preference shares 254–7 restructuring of loans 279–81 retail equity products 258–9 reverse convertibles 258–9 reverse dual currency bonds 223–30 ‘revolver’ loans 284–5 risk, financial, types of 158 risk adjusted return on capital (RAROC) 268, 290 risk conservation principle 229–30 risk management 65, 153–79, 184, 187, 201, 267 risk models 163–4, 173–5 riskless portfolios 196–7 RJ Reynolds (company) 220–1 rogue traders 176, 313–16 Rosenfield, Eric 168 Ross, Stephen 196–7, 202 Roth, Don 38 Rothschild, Mayer Amshel 267 Royal Bank of Scotland 298 Rubinstein, Mark 42, 196–7 13_INDEX.QXD 17/2/06 4:44 pm Page 333 Index Rumsfeld, Donald 12, 134, 306 Rusnak, John 143 Russia 45, 80, 166, 172–3, 274, 302 sales staff 55–60, 64–5, 125, 129, 217 Salomon Brothers 20, 36, 54, 62, 167–9, 174, 184 Sandor, Richard 34 Sanford, Charles 72, 269 Sanford, Eugene 269 Schieffelin, Allison 76 Scholes, Myron 22, 42, 168–71, 175, 185, 189–90, 193–7, 263–4 Seagram Group 247 Securities and Exchange Commission, US 64, 304 Securities and Futures Authority, UK 249 securitization 282–90 ‘security design’ 254–7 self-regulation 155 sex discrimination 76 share options 250–1 Sharpe, William 111 short selling 30–1, 114 Singapore 9 single-tranche CDOs 293–4, 299 ‘Sisters of Perpetual Ecstasy’ 234 SITCOMs 313 Six Continents (6C) 275–6 ‘smile’ effect 145 ‘snake’ currency system 203 ‘softing’ arrangements 117 Solon 137 Soros, George 44, 130, 253, 318–19 South Sea Bubble 210 special purpose asset repackaging companies (SPARCs) 233 special purpose vehicles (SPVs) 231–4, 282–6, 290, 293 speculation 29–31, 42, 67, 87, 108, 130 ‘spinning’ 64 333 Spitzer, Eliot 64 spread 41, 103; see also credit spreads stack hedges 96 Stamenson, Michael 124–5 standard deviation 161, 193, 195, 199 Steinberg, Sol 91 stock market booms 258, 260 stock market crashes 42–3, 168, 203, 257, 259, 319 straddles or strangles 131 strategy in banking 70 stress testing 164–6 stripping of convertible bonds 253–4 structured investment products 44, 112, 115, 118, 128, 211–39, 298 structured note asset packages (SNAPs) 233 Stuart SC 18, 307, 316–18 Styblo Bleder, Tanya 153 Suharto, Thojib 81–2 Sumitomo Corporation 100, 142 Sun Tzu 61 Svensk Exportkredit (SEK) 38–9 swaps 5–10, 26, 35–40, 107, 188, 211; see also equity swaps ‘swaptions’ 205–6 Swiss Bank Corporation (SBC) 248–9 Swiss banks 108, 305 ‘Swiss cheese theory’ 176 synthetic securitization 284–5, 288–90 systemic risk 151 Takeover Panel 248–9 Taleb, Nassim 130, 136, 167 target redemption notes 225–6 tax and tax credits 171, 242–7, 260–3 Taylor, Frederick 98, 101 team-building exercises 76 team moves 149 technical analysis 60–1, 135 television programmes about money 53, 62–3 Thailand 9, 80, 302–5 13_INDEX.QXD 17/2/06 4:44 pm Page 334 334 Index Thatcher, Margaret 205 Thorp, Edward 253 tobashi trades 105–7 Tokyo Disneyland 92, 212 top managers 72–3 total return swaps 246–8, 269 tracking error 138 traders in financial products 59–65, 129–31, 135–6, 140, 148, 151, 168, 185–6, 198; see also dealers trading limits 42, 157, 201 trading rooms 53–4, 64, 68, 75–7, 184–7, 208 Trafalgar House 248 tranching 286–9, 292, 296 transparency 26, 117, 126, 129–30, 310 Treynor, Jack 111 trust investment enhanced return securities (TIERS) 216, 233 trust obligation participating securities (TOPS) 232 TXU Europe 279 UBS Global Asset Management 110, 150, 263–4, 274 uncertainty principle 122–3 unique selling propositions 118 unit trusts 109 university education 187 unspecified fund obligations (UFOs) 292 ‘upfronting’ of income 139, 151 Valéry, Paul 163 valuation 64, 142–6 value at risk (VAR) concept 160–7, 173 value investing 111 Vanguard 116 vanity bonds 230 variance 161 Vietnam War 182, 195 Virgin Islands 233–4 Vivendi 247–8 volatility of bond prices 197 of interest rates 144–5 of share prices 161–8, 172–5, 192–3, 199 Volcker, Paul 20, 33 ‘warehouses’ 40–2, 139 warrants arbitrage 99–101 weather, bonds linked to 212, 320 Weatherstone, Dennis 72, 268 Weil, Gotscal & Manges 298 Weill, Sandy 174 Westdeutsche Genosenschafts Zentralbank 143 Westminster Group 34–5 Westpac 261–2 Wheat, Allen 70, 72, 106, 167 Wojniflower, Albert 62 World Bank 4, 36, 38 World Food Programme 320 Worldcom 250, 298 Wriston, Walter 71 WTI (West Texas Intermediate) contracts 28–30 yield curves 103, 188–9, 213, 215 yield enhancement 112, 213, 269 ‘yield hogs’ 43 zaiteku 98–101, 104–5 zero coupon bonds 221–2, 257–8


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

For not only would secrecy weaken the efficiency of the market as a whole (since the public signal of price helps discipline a market),26 but it would also lead to a kind of regulatory arbitrage: because regulation is costly, deals that were subject to the New Deal regulations would be recast into a form that could evade those regulations. Indeed, that’s what happened: financial instruments that were “economically equivalent to many other financial instruments”27 were substituted for those “other financial instruments,” because unlike those “others,” they were unregulated. As the Financial Crisis Inquiry Commission concluded, “[G]iven these circumstances, regulatory arbitrage worked as it always does: the markets shifted to the lowest-cost, least-regulated havens.”28 Evading regulation has its own value. This led Nobel Prize–winning economist Merton Miller to the “insight that “companies would do swaps not necessarily because swaps allocated risk more efficiently, but rather because they were unregulated.


pages: 288 words: 16,556

Finance and the Good Society by Robert J. Shiller

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

That mistake, and not any flaw in the logic of Claire Hill’s theory, was the real problem. And that is the problem that so often plagues nance. We can build beautiful models and theories about what kinds of nancial products to provide, but thanks to human foibles we are always vulnerable to bubbles and their bursting. The enormous growth of mortgage securitization in the United States also arose in part from regulatory arbitrage, that is, from businesses trying to please the regulators as e ciently as possible, and from bureaucrats who were not thinking deeply about the rules they were enforcing. Ever since the Basel I agreement in 1988, which set the rst important international bank regulatory standards, banks around the world have been subject to capital requirements that are tied by a formula to their so-called risk-weighted assets.

See also housing Reconstruction Finance Corporation, 109, 216 Recourse Rule, 55 Redleaf, Andrew, 29 reforms: broadening ownership, 214–18; debt, 158; dispersal of control, 210–11; of financial system, 114, 157, 177, 235; of fiscal policy, 116; increasing access to legal and financial advice, 85–86; information availability, 235; lobbying, 92–93; in tax treatment of contributions, 202–3, 254n19 registered representatives, 80, 97 regulation, financial: bubble prevention, 184–85; capital requirements, 40, 55, 155, 163, 244n3 (Chapter 3); consumer protection, 9, 154; Dodd-Frank Act, 23, 43, 51, 114, 154, 184, 217; of executive compensation, 22–23; G20 statements, 184; improving, 157; of monopolies, 217; need for, 9, 238; securities regulations, 35–36, 46, 80, 96–97, 161; of shadow banking, 42–43 regulations: enforcement, 94; growth of, 95; occupational licensing, 95; positive effects, 210. See also self-regulatory organizations regulators: civil servants, 95; criticism of, 94–96; errors, 96, 184–85; importance, 94; industry capture of, 95; motives, 96, 98–99, 225; public perceptions, 97–98; roles, 99; slow adoption of change, 148 regulatory arbitrage, 55 Reinhart, Carmen, 2 religions: callings, 141; caste systems and, 232–33; legal systems, 83, 157; negative views of debt, 157; Shakers, 120 religious organizations, contributions to, 205 reparations payments, 156–57, 221–22 repurchase agreements, 43, 239, 244n7 Reshef, Ariell, 189 residential mortgage–backed securities (RMBSs), 51, 52–55. See also mortgage securities rewards: dopamine system, 59–60, 139–40; financial, 20–26, 38, 58–60, 63, 231.

Global Financial Crisis by Noah Berlatsky

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accounting loophole / creative accounting, asset-backed security, banking crisis, Bretton Woods, capital controls, Celtic Tiger, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, deindustrialization, Doha Development Round, energy security, eurozone crisis, financial innovation, Food sovereignty, George Akerlof, Gordon Gekko, housing crisis, illegal immigration, income inequality, market bubble, market fundamentalism, moral hazard, new economy, Northern Rock, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, reserve currency, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, South China Sea, structural adjustment programs, too big to fail, trade liberalization, transfer pricing, working poor

We need more financial “innovation” like a hole in the head. The other argument is that regulation (and 50 per cent tax rates) will undermine the City’s “competitiveness” and “drive away” banking and non-bank financial institutions. This argument has to be met head-on; the idea of a regulatory race to 48 Causes of the Global Financial Crisis the bottom does not square with political and economic reality. Co-operation rather than regulatory arbitrage between the main jurisdictions will always be best, but if that cooperation does not materialise, the UK should not chase business by offering low standards that create wider risks for the UK economy. The arguments about City “competitiveness” are bogus, self-serving and dangerous. It is profoundly to be hoped that Brown, Alistair Darling, Ed Balls and others who fell for them so haplessly in the past have now learned their lesson.


pages: 172 words: 54,066

The End of Loser Liberalism: Making Markets Progressive by Dean Baker

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Asian financial crisis, banking crisis, Bernie Sanders, collateralized debt obligation, collective bargaining, corporate governance, currency manipulation / currency intervention, Doha Development Round, financial innovation, full employment, Home mortgage interest deduction, income inequality, inflation targeting, invisible hand, manufacturing employment, market clearing, market fundamentalism, medical residency, patent troll, pets.com, pirate software, price stability, quantitative easing, regulatory arbitrage, rent-seeking, Robert Shiller, Robert Shiller, Silicon Valley, too big to fail, transaction costs

Not only have we experienced extraordinary volatility in the stock and housing markets over the last 15 years, but we are also less secure because we are far less likely today to have defined-benefit pensions at our workplaces. In the 1960s and 1970s, roughly half of all private-sector workers had a defined-benefit pension; by 2011 the share was less than 20 percent and falling. The financial sector thrives on a huge amount of economic rent, which means it makes money through tax and regulatory arbitrage that provides no real benefit to society. For example, it became common in the 1980s and 1990s for government agencies like transit departments to sell off equipment, such as buses and subway cars, to private companies, and then lease it back. The logic of these deals is that the private company can take the depreciation on the equipment as a tax write-off, whereas as the state or local government agency cannot.


pages: 257 words: 71,686

Swimming With Sharks: My Journey into the World of the Bankers by Joris Luyendijk

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bank run, barriers to entry, Bonfire of the Vanities, bonus culture, collapse of Lehman Brothers, collective bargaining, credit crunch, Credit Default Swap, Emanuel Derman, financial deregulation, financial independence, Flash crash, glass ceiling, Gordon Gekko, high net worth, hiring and firing, inventory management, job-hopping, London Whale, Nick Leeson, offshore financial centre, regulatory arbitrage, shareholder value, sovereign wealth fund, the payments system, too big to fail

You look at the degree of ‘reputation risk’. Using loopholes in the tax code to help big corporations and rich families evade taxes is ‘tax optimisation’ with ‘tax-efficient structures’. Financial lawyers and regulators who go along with whatever you propose are ‘business-friendly’, cases of proven fraud or abuse become ‘mis-selling’ and exploiting inconsistencies between two countries’ regulatory systems is ‘regulatory arbitrage’. Once you tune your ear in to it, examples abound, because the vocabulary available to people in finance to talk and think about their own actions is stripped of terms that could provoke an ethical discussion. Hence the biggest compliment in the City is ‘professional’. It means you do not let emotions get in the way of work, let alone moral beliefs – those are for home. In most conversations the word ‘ethic’ came up only in combination with ‘work’, referring to an almost absolute obedience to one’s boss.


pages: 593 words: 189,857

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

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

The Fed also shared responsibility for the U.S. affiliates of foreign banks with state regulators, as well as home-country supervisors in London, Zurich, Frankfurt, and around the world. These divisions of labor evoked the parable of the blind men and the elephant, with nobody accountable for seeing the full picture of a corporation, much less the interconnections of the entire system. This glut of watchdogs with overlapping jurisdictions encouraged regulatory arbitrage. Banks often reorganized as thrifts to get the notoriously weak OTS as their supervisor, or shopped for another regulator they thought would give them favorable treatment. The OTS and OCC were both funded by fees they collected from their member banks, which gave them an incentive to try to woo banks into their orbit by offering lighter enforcement. At the time, Republicans controlled Congress as well as the White House, and the prevailing mood in Washington was averse to regulation; the FDIC’s 2003 annual report featured a photo of bank representatives helping regulators slash “red tape” with a chain saw.

We faced a similar quandary with bank supervision. The Fed oversaw the holding companies that owned banks, while an individual bank might be regulated by the Fed, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, a state banking supervisor, or some awkward combination of those choices. This led to venue shopping and other forms of regulatory arbitrage, as well as blind-men-and-the-elephant problems where no regulator had a truly comprehensive view of an institution or the responsibility for monitoring it. Ideally, we would have liked to consolidate the OCC, FDIC, and OTS into a single national regulator for depository institutions, with a dominant ongoing role for the Fed. But we decided that politically, that was another nonstarter. I was uneasy about the distractions of trying to reorganize the military while we were fighting a war.


pages: 678 words: 216,204

The Wealth of Networks: How Social Production Transforms Markets and Freedom by Yochai Benkler

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affirmative action, barriers to entry, bioinformatics, Brownian motion, call centre, Cass Sunstein, centre right, clean water, dark matter, desegregation, East Village, fear of failure, Firefox, game design, George Gilder, hiring and firing, Howard Rheingold, informal economy, invention of radio, Isaac Newton, iterative process, Jean Tirole, jimmy wales, market bubble, market clearing, Marshall McLuhan, New Journalism, optical character recognition, pattern recognition, pre–internet, price discrimination, profit maximization, profit motive, random walk, recommendation engine, regulatory arbitrage, rent-seeking, RFID, Richard Stallman, Ronald Coase, Search for Extraterrestrial Intelligence, SETI@home, shareholder value, Silicon Valley, Skype, slashdot, social software, software patent, spectrum auction, technoutopianism, The Fortune at the Bottom of the Pyramid, The Nature of the Firm, transaction costs

Their model more closely hews to the OSI layers, and is tailored to being more specifically usable for a particular legal principle--never regulate at a level lower than you need to. I seek a higherlevel abstraction whose role is not to serve as a tool to constrain specific rules, but as a map for understanding the relationships between diverse institutional elements as they relate to the basic problem of how information is produced and exchanged in society. 158. The first major treatment of this phenomenon was Michael Froomkin, "The Internet as a Source of Regulatory Arbitrage" (1996), ‹http://www.law.miami.edu/froomkin/articles/arbitr.htm›. 159. Jonathan Krim, "AOL Blocks Spammers' Web Sites," Washington Post, March 20, 2004, p. A01; also available at ‹http://www.washingtonpost.com/ac2/wp-dyn?page› name article&contentId A9449-2004Mar19&notFound true. 160. FCC Report on High Speed Services, December 2003 (Appendix to Fourth 706 Report NOI). 161. 216 F.3d 871 (9th Cir. 2000). 162.

Their model more closely hews to the OSI layers, and is tailored to being more specifically usable for a particular legal principle--never regulate at a level lower than you need to. I seek a higherlevel abstraction whose role is not to serve as a tool to constrain specific rules, but as a map for understanding the relationships between diverse institutional elements as they relate to the basic problem of how information is produced and exchanged in society. 158. The first major treatment of this phenomenon was Michael Froomkin, "The Internet as a Source of Regulatory Arbitrage" (1996), ‹http://www.law.miami.edu/froomkin/articles/arbitr.htm›. 159. Jonathan Krim, "AOL Blocks Spammers' Web Sites," Washington Post, March 20, 2004, p. A01; also available at ‹http://www.washingtonpost.com/ac2/wp-dyn?page› name article&contentId A9449-2004Mar19&notFound true. 160. FCC Report on High Speed Services, December 2003 (Appendix to Fourth 706 Report NOI). 161. 216 F.3d 871 (9th Cir. 2000). 162.


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

Given the political constraints, it is unlikely that these powers would actually be used to significantly reduce the size and riskiness of megabanks. Whatever the final form of the legislation, the problem of too big to fail will probably remain with us. But this does not mean that it cannot be solved. It only means that it may take several years, and several sessions of Congress, to solve. The solution must be economically simple, so it can be effectively enforced; the more complex the scheme, the more susceptible it is to regulatory arbitrage, such as reshuffling where assets are parked within a financial institution’s holding company structure. And the solution must change the balance of political power, so it will last. The simplest solution is a hard cap on size: no financial institution would be allowed to control or have an ownership interest in assets worth more than a fixed percentage of U.S. GDP.* Determining the exact percentage is a technical problem that we do not claim to have solved, but the problem can be simply stated: the percentage should be low enough that banks below that threshold can be allowed to fail without entailing serious risk to the financial system.


pages: 397 words: 112,034

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

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

The Australian banking system was also, for the most part, more effectively supervised and regulated from the standpoint of avoiding the risks that precipitated the North Atlantic financial crisis. In the late 1990s Australia’s system of prudential supervision and regulation of financial institutions was reconfigured along the lines of the Canadian system. The new system established a single regulator for all approved deposit-taking intermediaries, thus limiting the scope for “regulatory arbitrage” that the US system of multiple regulators provides. In 2001 the collapse of HIH Insurance, the largest Australian insurance company, prompted the Australian Prudential Regulation Authority (APRA) to take a more skeptical and assertive approach to its task. Following the HIH collapse, the APRA could in no sense be described as “light-handed” after the fashion of the UK Financial Services Authority.


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

Collateralised loans can be made to those who cannot afford them (for example, sub-prime/NINJA mortgages), safe in the knowledge that even if the borrower defaults, the assets (houses) can be repossessed and sold for a profit. Secondly, the increased demand for lending increases profits as long as banks are able to meet the increased demand for loans. This puts pressure on banks to innovate in order to increase their lending as much as possible (e.g. through ‘regulatory arbitrage’).7 The ability to profit from speculating on asset prices leads to the emergence of the ‘ponzi unit’ (which borrows to invest in rising asset prices). Because the cash flows generated by the assets are not enough to cover either the interest or principle repayments on the loan, the loan can only be repaid if the assets can be sold for more than what is owed. The longer the euphoric stage of the economy lasts and the longer assets prices continue to rise, the more units will shift to ponzi positions, relying on rising asset prices in order to be able to service debts.


pages: 376 words: 109,092

Paper Promises by Philip Coggan

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accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, joint-stock company, Kenneth Rogoff, labour market flexibility, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, Plutocrats, plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Wealth of Nations by Adam Smith, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce

The finance industry was also a huge taxpayer, once one allowed for income taxes on bonus payments, capital-gains tax on share-price gains, stamp duty on property and share deals and all the rest. In Britain, even the Blair/Brown Labour governments pursued a light-touch regulatory regime for fear of driving the big banks away to foreign countries. They trumpeted the fact that London appeared to be catching, or even overtaking, New York as a global financial centre. The prospect of regulatory arbitrage – companies migrating to countries where they would be treated more leniently – may also explain why regulators were unwilling to crack down on the banks and why post-crisis reform programmes have been so mild. In the US, the 1929 crash was followed by the passing of the Glass – Steagall Act, which separated commercial (deposit-taking) banking from investment banking. Nothing so radical has been attempted this time round.


pages: 375 words: 88,306

The Sharing Economy: The End of Employment and the Rise of Crowd-Based Capitalism by Arun Sundararajan

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3D printing, additive manufacturing, Airbnb, Amazon Mechanical Turk, autonomous vehicles, barriers to entry, bitcoin, blockchain, Burning Man, call centre, collaborative consumption, collaborative economy, collective bargaining, corporate social responsibility, cryptocurrency, David Graeber, distributed ledger, employer provided health coverage, Erik Brynjolfsson, ethereum blockchain, Frank Levy and Richard Murnane: The New Division of Labor, future of work, George Akerlof, gig economy, housing crisis, Howard Rheingold, Internet of things, inventory management, invisible hand, job automation, job-hopping, Kickstarter, knowledge worker, Kula ring, Lyft, megacity, minimum wage unemployment, moral hazard, Network effects, new economy, Oculus Rift, pattern recognition, peer-to-peer lending, profit motive, purchasing power parity, race to the bottom, recommendation engine, regulatory arbitrage, rent control, Richard Florida, ride hailing / ride sharing, Robert Gordon, Ronald Coase, Second Machine Age, self-driving car, sharing economy, Silicon Valley, smart contracts, Snapchat, social software, supply-chain management, TaskRabbit, The Nature of the Firm, total factor productivity, transaction costs, transportation-network company, two-sided market, Uber and Lyft, Uber for X, universal basic income, Zipcar

The complexity of this ongoing transition—part of a broader set of changes that Professor Klaus Schwab, the founder of the World Economic Forum calls the “fourth industrial revolution,” may explain society’s struggle to come up with a shared label for the phenomenon I call crowd-based capitalism.2 Perhaps, like most interesting things in life, the sharing economy is shaped by its internal contradictions. Capitalist or socialist? Commercial economy or gift economy? Market or hierarchy? Global or local economic impact? Regulatory arbitrage or self-regulatory expression? Centralized or decentralized value capture? Empowered entrepreneur or disenfranchised drone? Job destruction or work creation? Isolated or connected societies? As you may have realized by now, the answer to each of these questions in the sharing economy is “yes.” Notes 1. Michael Spence, “The Inexorable Logic of the Sharing Economy,” Project Syndicate, September 28, 2015. https://www.project-syndicate.org/commentary/inexorable-logic-sharing-economy-by-michael-spence-2015-09. 2.


pages: 345 words: 86,394

Frequently Asked Questions in Quantitative Finance by Paul Wilmott

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Albert Einstein, asset allocation, Black-Scholes formula, Brownian motion, butterfly effect, capital asset pricing model, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discrete time, diversified portfolio, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, iterative process, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, martingale, Norbert Wiener, quantitative trading / quantitative finance, random walk, regulatory arbitrage, risk/return, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, transaction costs, urban planning, value at risk, volatility arbitrage, volatility smile, Wiener process, yield curve, zero-coupon bond

The traditional, simple VaR measure is not coherent since it does not satisfy the sub-additivity condition. Sub-additivity is an obvious requirement for a risk measure, otherwise there would be no risk benefit to adding uncorrelated new trades into a book. If you have two portfolios X and Y then this benefit can be defined as Sub-additivity says that this can only be non negative. Lack of sub-additivity is a risk measure and can be exploited in a form of regulatory arbitrage. All a bank has to do is create subsidiary firms, in a reverse form of the above example, to save regulatory capital. With a coherent measure of risk, specifically because of its sub-additivity, one can simply add together risks of individual portfolios to get a conservative estimate of the total risk. Coherent measures Straightforward, no-nonsense, standard deviation is coherent.


pages: 320 words: 87,853

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

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

People were misunderstanding Trending Topics.112 But at what point does a platform have to start taking responsibility for what its algorithms do, and how their results are used? These new technologies affect not only how we are understood, but also how we understand. Shouldn’t we know when they’re working for us, against us, or for unseen interests with undisclosed motives? Dizzying shifts in the ways Internet platforms characterize themselves amount to a form of regulatory arbitrage, evading the spirit of classic legal obligations.113 When faced with copyright and defamation lawsuits, they claim not to be media companies (that is, producers of content), but only conduits (that is, pipelines for content).114 A conduit does not enjoy the most robust First Amendment protection, but it gains freedom from liability in cases of defamation.115 (For example, the phone company can’t refuse to serve me on First Amendment grounds, but it also can’t be sued by someone I defame using the phone.)


pages: 455 words: 138,716

The Divide: American Injustice in the Age of the Wealth Gap by Matt Taibbi

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banking crisis, Bernie Madoff, butterfly effect, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, Edward Snowden, ending welfare as we know it, forensic accounting, Gordon Gekko, greed is good, illegal immigration, information retrieval, London Interbank Offered Rate, London Whale, naked short selling, offshore financial centre, Ponzi scheme, profit motive, regulatory arbitrage, short selling, telemarketer, too big to fail, War on Poverty

Where once you had a Boeing or a Hershey’s keep its factories and headquarters snuggled decade after decade in the same state or company town, you now had huge multinational firms peppering China and India with factories, and banking havens like Antigua and Jersey with corporate offices, as they raced around the earth in search of tax, labor, and other advantages. The whole world with its myriad sets of laws and rules presented endless opportunities for regulatory arbitrage. It would be harder for the cop on the beat to chase an offender that simultaneously existed everywhere and nowhere. Moreover, even within the United States there had been intentional, lobbied-for changes in corporate structure: the repeal of the Glass-Steagall Act, which had prevented the mergers of commercial banks, investment banks, and insurance companies (this repeal led to the creation of megafirms like Citigroup), and Supreme Court decisions rolling back bans on interstate banking (which led to a string of mergers, resulting in the formation of giant national banks like Wachovia and Bank of America).


pages: 475 words: 155,554

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

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

For them, ‘the new opportunities in Europe were hard to resist, so they set up London-based companies’. According to Dunbar, the FSA boasted that ‘international firms that have established their operations here welcome the flexibility of the UK regulatory regime’. New York regulators began to fret about London’s light touch, so the Wall Street firms extracted from the SEC ‘broker dealer lite’ rules that meant the rubberstamping of internal risk models. Regulatory arbitrage meant one thing: massive transfers of credit risk from a bank’s loan book to its trading book. Still, at least models of copula base correlation made some sense in relation to the corporate debts. The slicing and repackaging of these debts passed risks from one side of a bank’s balance sheet where they used up part of the bank’s precious capital to another part where it did not. But it was the move into mortgages that was to stretch the models designed to shift corporate risk to breaking point.


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

The move abroad by US finance was in fact part and parcel of a long process whereby Wall Street would gradually bring the Eurodollar market home, as “the very same practices, strategies and techniques that drove the international expansion of American finance also laid the foundation for its continued domestic expansion.”24 And what this clearly portended was the process of international regulatory arbitrage which would soon become so central to the making of global capitalism, in which less onerous regulations in one financial center (in this case London’s Eurodollar market) would be exploited to undermine stronger regulations in another (in this case the US’s own New Deal banking regulations). By the early 1960s, with the securitization of commercial banking and the enormous expansion of investment banking already in train (including Morgan Stanley’s creation of the first viable computer model for analyzing financial risk), the erosion of the New Deal’s watertight financial compartments was well underway.


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%

Indeed, balance sheets structured in this way subject small countries, especially in Europe, to an important vulnerability, in that small “errors” in the valuation of financial assets and liabilities can lead to enormous variations in the net foreign asset position.30 Furthermore, the evolution of a country’s net foreign asset position is determined not only by the accumulation of trade surpluses or deficits but also by very large variations in the return on the country’s financial assets and liabilities.31 I should also point out that these international positions are in substantial part the result of fictitious financial flows associated not with the needs of the real economy but rather with tax optimization strategies and regulatory arbitrage (using screen corporations set up in countries where the tax structure and/or regulatory environment is particularly attractive).32 I come back to these questions in Part Three, where I will examine the importance of tax havens in the global dynamics of wealth distribution. What Will the Capital/Income Ratio Be in the Twenty-First Century? The dynamic law β = s / g also enables us to think about what level the global capital/income ratio might attain in the twenty-first century.