asset-backed security

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The Global Money Markets by Frank J. Fabozzi, Steven V. Mann, Moorad Choudhry

asset allocation, asset-backed security, bank run, Bretton Woods, buy and hold, collateralized debt obligation, credit crunch, discounted cash flows, discrete time, disintermediation, fixed income, high net worth, intangible asset, interest rate derivative, interest rate swap, large denomination, locking in a profit, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, money market fund, moral hazard, mortgage debt, paper trading, Right to Buy, short selling, stocks for the long run, time value of money, value at risk, Y2K, yield curve, zero-coupon bond, zero-sum game

Mortgage-backed securities are securities backed by a pool of mortgage loans. The pool of loans is referred to as the collateral. While residential mortgages are by far the largest type of asset that has been securitized, other assets such as consumer loans, business loans and receivables have also been securitized. Securities backed by collateral other the mortgage loans are called asset-backed securities. The largest sectors of the asset-backed securities market in the United States are securities backed by credit card receivables, auto loans, home equity loans, manufactured housing loans, and student loans. Derivatives are financial instruments that derive their value from some underlying price, index, or interest rate. Money market practitioners use derivatives to control their exposure to risk by taking positions to either diminish or enhance this exposure.

CHAPTER 4 Agency Instruments .S. government agency securities can be classified by the type of issuer—those issued by federal agencies and those issued by government sponsored enterprises. Moreover, U.S. government agencies that provide credit for the housing market issue two types of securities: debentures and mortgage-backed/asset-backed securities. Our focus in this chapter is on debentures. We discuss short-term mortgage-backed securities and asset-backed securities in Chapters 9 and 10, respectively. Federal agencies are fully owned by the U.S. government and have been authorized to issue securities directly in the marketplace. They include the Export-Import Bank of the United States, the Tennessee Valley Authority (TVA), the Commodity Credit Corporation, the Farmers Housing Administration, the General Services Administration, the Government National Mortgage Association, the Maritime Administration, the Private Export Funding Corporation, the Rural Electrification Administration, the Rural Telephone Bank, the Small Business Administration, and the Washington Metropolitan Area Transit Authority.

(d) It is understood that this Agreement constitutes a “netting contract” as defined in and subject to Title IV of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) and each payment entitlement and payment obligation under any Transaction hereunder shall constitute a “covered contractual payment entitlement” or “covered contractual payment obligation”, respectively, as defined in and subject to FDI-CIA (except insofar as one or both of the parties is not a “financial institution” as that term is defined in FDICIA). CHAPTER 9 Short-Term Mortgage-Backed Securities n asset-backed security (ABS) is a security supported by a pool of loans or receivables. That is, the cash flow to pay the holders of the security comes from the cash flow of the underlying loans or receivables. A mortgage-backed security (MBS) refers to an ABS created by pooling mortgage loans on real estate property. While technically the MBS market is part of the ABS market, in the United States, the two markets are viewed as being separate. There are many short-term fixed-rate products and floating-rate products in this market that fall into the money market area. In this chapter we discuss mortgage-backed securities and in the next we focus on asset-backed securities. A MORTGAGE LOANS While any type of mortgage loans—residential or commercial—can be used as collateral for an MBS, most are backed by residential mortgages.


pages: 490 words: 117,629

Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

asset allocation, asset-backed security, buy and hold, capital controls, cognitive dissonance, corporate governance, diversification, diversified portfolio, fixed income, index fund, law of one price, Long Term Capital Management, market bubble, market clearing, market fundamentalism, money market fund, passive investing, Paul Samuelson, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, Steve Ballmer, stocks for the long run, survivorship bias, technology bubble, the market place, transaction costs, Vanguard fund, yield curve, zero-sum game

Alignment of Interests Holders of asset-backed securities sit across the table from some of the marketable securities world’s most sophisticated financial engineers. At best, asset-backed security investors buying newly minted securities should anticipate low returns from the issuer’s use of a complex structure to further the corporate objective of generating low-cost debt. At worst, the complexity of asset-backed securities leads to an opacity that prevents investors from understanding the intrinsic character of investment positions. In extreme situations, the Rube Goldberg nature of asset-backed security arrangements contributes to the potential for serious damage to investor portfolios. Market Characteristics At December 31, 2003, the market value of asset-backed securities totaled $138 billion.

Investors in longer-term tax-exempt securities gain a valuable tax advantage at the expense of the certain portfolio protection benefits of non-callable default-free U.S. Treasury securities. ASSET-BACKED SECURITIES Asset-backed securities consist of fixed-income instruments that rely on a broad range of underlying assets (the backing in asset-backed) to provide cash flows and security for payments to bondholders. While the most commonly used asset in asset-backed securities consists of home mortgages, bankers employ assets ranging from credit card receivables to commercial lease payments to automobile finance obligations as collateral for asset-backed deals. Asset-backed transactions share a high degree of sophisticated financial structuring. Driven by a security issuer’s desire to remove assets from the balance sheet and obtain low costs for the financing, the asset-backed security purchaser sits across the table from a formidable adversary.

Second, the GSE-induced investor complacency may mask significant risk of exposure to hard-to-understand options. Investors beware. Just as with other forms of fixed income, the issuer of asset-backed securities seeks cheap financing. Cheap financing for issuers translates into low returns for investors. Combine low expected returns with high complexity and investor interests suffer. As with many other segments of the fixed-income markets, investors in asset-backed securities appear not to have reaped rewards for accepting credit and call risk. For the ten years ending December 31, 2003, the Lehman Brothers Asset-Backed Security Index returned 7.2 percent per annum, falling short of the Lehman Brothers U.S. Treasury Index return of 7.5 percent per annum. Like other comparisons of bond index returns, the numbers do not account for differences in index composition.


pages: 422 words: 113,830

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

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

FIGURE 4.1 The Shrinkage of Family Discretionary Income Source: Elizabeth Warren, “The Middle Class on the Precipice,” Harvard Magazine, January-February 2006, p. 30. Inflation-adjusted. Updated from sources cited in Warren and Tyagi, The Two-Income Trap. PROFIT APPETITES AND RISK REFLUX For an interested layman, one of the first things to ponder about mortgage- and asset-backed securities and credit-related derivatives, two huge product categories, is that despite their importance, even the inventors, architects, and marketers of these products didn’t (or couldn’t) entirely understand how the new creations would fare in a major liquidity crisis. Asset-backed securities, for example, had been weak in the 1998 Russian debt imbroglio, when credit markets seized up. However, proponents insisted, that was a decade earlier, when such products were new and their volume was small. By year’s end, the more critical 2007-8 test was going even less well, as witness the angry description of Financial Times associate editor Wolfgang Munchau:The reason why this crisis is so nasty has to do with the deep inter-linkages within the credit market, and between the credit market and the real economy.

To put a further exclamation mark after the home-mortgage focus of the big banks and investment banks, consider these statistics from the Mortgage Bankers Association. For 2006, total mortgage origination was about $2.5 trillion, three times what it had been in 1997. Of this $2.5 trillion, three-quarters had been securitized into mortgage-backed securities. For asset-backed securities, a distinct and different category, the home-equity loan component back in 2002 had represented about 35 percent of all asset-backed securities, barely ahead of auto loans. But by 2006, home-equity loans had ballooned to 65-70 percent of the ABS total, shrinking auto loans and credit card debt to a combined share just over 20 percent. What is more, opportunity was also global. In 2003, the United States had accounted for 90 percent of worldwide securitization issuance, and as recently as 2005, that share was 83 percent.

Hacker, The Great Risk Shift: The Assault on American Jobs, Families, Health Care, and Retirement and How You Can Fight Back (New York: Oxford University Press, 2006), pp. 2, 31. 4 Elizabeth Warren, “The Middle Class on the Precipice,” Harvard Magazine, January-February 2006, p. 28. 5 “The Federal Reserve Must Prolong the Party,” Financial Times, August 21, 2007. 6 “Back to the Future for Asset-Backed Securities,” Financial Times, September 4, 2007. 7 “Introduction: New Players Join the Credit Game,” Financial Times, March 13, 2007. 8 “Banks See Growing Share of Profits from Use of Asset-Backed Securities,” Financial Times, June 4, 2007. 9 John Crudele, “No Freedom of Information on the Plunge Protection Team,” New York Post, May 15, 2007. 10 “Next in Line for Subprime Hit: Bonds?” Associated Press, September 9, 2007. 11 Michael J. Panzner, “Eau de Liquidity,” www.financialsense.com, May 21, 2007.


Firefighting by Ben S. Bernanke, Timothy F. Geithner, Henry M. Paulson, Jr.

Asian financial crisis, asset-backed security, bank run, Basel III, break the buck, Build a better mousetrap, business cycle, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Doomsday Book, financial deregulation, financial innovation, housing crisis, Hyman Minsky, income inequality, invisible hand, Kenneth Rogoff, labor-force participation, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, pets.com, price stability, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, savings glut, short selling, sovereign wealth fund, special drawing rights, The Great Moderation, too big to fail

Overnight issuance: Based on Figure 7, Lorie Logan, William Nelson, and Patrick Parkinson, “The Fed’s Novel Lender of Last Resort Programs,” in Ben S. Bernanke, Timothy F. Geithner, and Henry M. Paulson, Jr., with Nellie Liang, eds., First Responders: Inside the U.S. Strategy for Fighting the 2007–2009 Global Financial Crisis (New Haven: Yale University Press, forthcoming). Asset-backed securities issuance: Based on Chart 5, Adam Ashcraft, Allan Malz, and Zoltan Pozsar, “The Federal Reserve’s Term Asset-Backed Securities Loan Facility,” Federal Reserve Bank of New York Economic Policy Review 18(3) (November 2012): 29-66, https://www.newyorkfed.org/medialibrary/media/research/epr/2012/EPRvol18n3.pdf. Daily U.S. money market fund flows: Based on Panel A, Lawrence Schmidt, Allan Timmermann, and Russ Wermers, “Runs on Money Market Mutual Funds,” American Economic Review 106(9) (2016): 2625–57, www.aeaweb.org/articles?

We figured this approach would be much cheaper than injecting all the capital Citi needed or buying all its bad assets, unless the entire system collapsed—and in that case our problems would be much bigger than Citi. At the same time, consumer credit markets were paralyzed, and the Fed and the Treasury had developed a program to revive them by jump-starting the markets for securities backed by consumer credit. So Ben and his Fed colleagues invoked 13(3) one more time to create the Term Asset-Backed Securities Loan Facility (TALF), which created demand for securities backed by credit card loans, student loans, car loans, and small business loans by accepting them as collateral for Fed loans to investors. The TALF program was backed by another $20 billion TARP investment in case the Fed suffered any losses on those securities, but it wouldn’t end up absorbing any—and the program would help counteract the trend of banks restricting credit on Main Street when it was needed most.

The stress test would provide a more accurate picture of the health of banks—and then would make sure the sick ones got the capital they needed, either voluntarily from investors or forcibly from TARP. Tim and Ben also agreed on a dramatic expansion of TALF into a trillion-dollar Fed program backed by TARP funds, a move intended to broadcast the government’s determination to resurrect the market for asset-backed securities. (As it turned out, this extra capacity would not be needed.) And Tim’s team devised a new Treasury partnership with the private sector to buy troubled assets, adapting some of the ideas that Hank had put on hold in the rush to get TARP out the door. The Public-Private Investment Program (PPIP) would provide TARP loans to private investment firms that would decide which assets to buy and how much to pay, so the government wouldn’t have to do it—but the investors would also have to put their own money at risk and share any profits with the government.


pages: 353 words: 88,376

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

Albert Einstein, asset allocation, asset-backed security, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, clean water, collateralized debt obligation, computerized markets, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, fixed income, implied volatility, index fund, intangible asset, interest rate swap, inventory management, London Interbank Offered Rate, margin call, money market fund, mortgage debt, Myron Scholes, passive investing, performance metric, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

It also The Investopedia Guide to Wall Speak 15 reflects pricing strategy; companies with low profit margins tend to have high asset turnover, whereas those with high profit margins have low asset turnover. Related Terms: • Fundamental Analysis • Inventory Turnover • Net Sales • Revenue • Turnover Asset-Backed Security (ABS) What Does Asset-Backed Security (ABS) Mean? A financial security backed by a loan, a lease, or receivables other than real estate and mortgage-backed securities. Asset-backed securities are an alternative to investing in corporate debt. Investopedia explains Asset-Backed Security (ABS) An ABS is essentially the same thing as a mortgage-backed security except that the securities backing it are assets such as loans, leases, credit card debt, a company’s receivables, or royalties but not mortgage-based securities. Related Terms: • Asset • Corporate Bond • Derivative • Mortgage-Backed Securities—MBS • Securitization Average Directional Index (ADX) What Does Average Directional Index (ADX) Mean?

In margin stock trading, the securities in the account act as collateral against the margin loan. 44 The Investopedia Guide to Wall Speak Related Terms: • Asset • Margin • Regulation T • Asset-Backed Security • Margin Call Collateralized Debt Obligation (CDO) What Does Collateralized Debt Obligation (CDO) Mean? An investment-grade security that is backed by a pool of bonds, loans, and other assets. CDOs represent various debt obligations but are often nonmortgage loans or bonds. Investopedia explains Collateralized Debt Obligation (CDO) Similar in structure to a collateralized mortgage obligation (CMO) or a collateralized bond obligation (CBO), CDOs are unique in that they represent different types of debt and credit risk. In the case of CDOs, these different types of debt often are referred to as tranches or slices. Each slice has a different maturity and risk associated with it. The higher the risk is, the more the CDO pays. Related Terms: • Asset-Backed Security • Bond • Collateralized Mortgage Obligation—CMO • Debt • Tranches Collateralized Mortgage Obligation (CMO) What Does Collateralized Mortgage Obligation (CMO) Mean?

Each class receives principal payments in a different order but receives interest payments until it is paid off completely. Class A investors are paid out first with prepayments and repayments until they are paid off. Next come class B investors, The Investopedia Guide to Wall Speak 45 followed by class C investors. In a situation like this, class A investors bear most of the prepayment risk and class C investors bear the least. Related Terms: • Asset-Backed Security • Collateralized Debt Obligation—CDO • Mortgage-Backed Securities—MBS • Mortgage • Tranches Commercial Paper What Does Commercial Paper Mean? An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories, and short-term liabilities. Maturities on commercial paper rarely are longer than 270 days, and commercial paper usually is issued at a discount to prevailing market interest rates.


pages: 358 words: 106,729

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

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

Financial firms also took on other kinds of default risk, such as the securities issued by the collateral loan obligations where they had parked the loans made to finance acquisitions and buyouts. To top it all, many of these investments were financed with extremely short-term debt, ensuring that if problems emerged with the asset-backed securities, the financial firms would have immense problems rolling over their debt. Why did financial firms take on both the default risk associated with highly rated asset-backed securities and the liquidity risk associated with funding long-term assets with short-term borrowing? As I explain in this chapter, the particular way these risks were constructed made them especially worth taking for large banks—indeed, perverse as it may seem, it made sense for banks to combine both risks.

The Swiss banking giant UBS ran into trouble because its investment banking unit became entranced by the profit it was making from borrowing at the AA-rated bank’s low cost of funding and investing the funds in higher-return, high-rated asset-backed securities.4 The regulatory requirements for bank capital to be set aside to back such a strategy were minimal because the underlying investments were highly rated. The resulting interest spread was small, but multiplied by the $50 billion the unit invested in the strategy, it made a tidy profit for the bank while the going was good and resulted in large bonuses for the unit. Needless to say, this practice of picking up pennies in front of a steamroller was successful only until the subprime catastrophe rolled all over UBS’s profits. Some smart traders in a number of banks understood and grew increasingly concerned by the risks that were being taken by the units creating and holding asset-backed securities. At Lehman, for example, fixed-income traders started selling these securities short, even while the real estate and mortgage unit loaded up on them.5 Clearly, any unit that is focused on creating and holding a certain kind of asset is naturally reluctant to declare an end to the boom it has ridden.

When the crash eventually came, the government and the Federal Reserve, unable to stand by and see homeowners suffer, stepped in to prop up the price of homes and of mortgage-backed securities, validating much of the extraordinary insouciance of the market. In this chapter, I explain why the fault lines we have examined earlier, acting on an amoral financial sector with a finely honed eye for opportunity, combined to cause a steady deterioration in the quality of mortgage lending. In the next, I explain why banks held on to so many of the risky asset-backed securities on their own balance sheets. Pecunia Non Olet Most of us do not work for money alone. Some want to change the world, others to create objects of art and culture that will endure. Some strive to gain fame, while others are content to do good anonymously. For many people, though, the visible effects of one’s work are its greatest reward. For the teacher, witnessing the eureka moment when understanding finally dawns on a student; for the doctor, the incredible joy of saving a patient’s life; for the farmer, the sight of acres and acres of golden wheat swaying gently with the breeze—for all these people, their primary motivation is the knowledge that their work makes the world a better place.


pages: 478 words: 126,416

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

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

The agencies began to charge issuers of securities for their services as well as – or, increasingly, instead of – investors; and they achieved regulatory recognition as ‘Nationally Recognised Statistical Rating Organisations’.6 Many financial institutions and regulatory bodies restricted investments to securities that met standards laid down by a rating agency. Ratings determined the regulatory risk-weighting of securities. The banks that created asset-backed securities paid the rating agencies – which appreciated that there was a competitive business in supplying such accreditation – and banks ‘reverse-engineered’ their products to fit the agencies’ models. Many investors and traders did not care much what was in the package so long as it achieved the required credit rating. The collapse of the asset-backed securities market would be at the centre of the global financial crisis. The elements of the new trading culture – based around fixed income, currency and commodities, and turbo-charged by derivatives – were now in place.

There was no alchemy through which a collection of loans on weak security to unreliable borrowers could be anything other than just that.9 The simple observation that the list of banks which bought these securities was little different from the list of banks that sold them should have provided a warning that the Greenspan doctrine was not the whole story – or even a large part of it. The development of asset-backed securities and subsequently collateralised debt obligations vastly expanded the market for credit ratings. Soon the majority of debt securities that qualified for the highest ‘triple A’ rating were not, as traditionally, the bonds of Exxon Mobil and the government of Germany but tranches of asset-backed securities. The value of credit default swaps (and hence the bonds that they insured) depended on the credit rating of the guarantor. Thus a downgrading of the status of AIG was devastating in its consequences for the safety of bond portfolios. What was it all for?

This idea could be applied not just to mortgages but also to other consumer loans – credit card balances, for example – and to small business loans. Credit and interest rate exposures, traditionally managed within banks, could be reduced or eliminated through markets. Swap markets enabled banks to manage interest rate risk: a loan whose rate was variable annually might be exchanged for a loan fixed for ten years. These markets received a boost later in the 1980s, when the Basel rules on bank lending tended to treat asset-backed securities more favourably than the assets that went into them. Rating agencies – businesses such as Moody’s and Standard & Poor’s (S & P) – had diversified from their original business of commercial credit assessment into assessment of the credit quality of bonds. In the 1970s two changes occurred that gave rating agencies a central place in the financialisation process. The agencies began to charge issuers of securities for their services as well as – or, increasingly, instead of – investors; and they achieved regulatory recognition as ‘Nationally Recognised Statistical Rating Organisations’.6 Many financial institutions and regulatory bodies restricted investments to securities that met standards laid down by a rating agency.


pages: 459 words: 118,959

Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff by Christine S. Richard

activist fund / activist shareholder / activist investor, Asian financial crisis, asset-backed security, banking crisis, Bernie Madoff, Blythe Masters, buy and hold, cognitive dissonance, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, family office, financial innovation, fixed income, forensic accounting, glass ceiling, Long Term Capital Management, market bubble, money market fund, moral hazard, old-boy network, Ponzi scheme, profit motive, short selling, statistical model, white flight, zero-sum game

In his meeting with Brown at the company’s headquarters that August, Ackman took notes, jotting down Brown’s description of MBIA’s two core businesses. “Structured finance is analyzable, understandable,” Ackman noted as Brown explained the business of insuring asset-backed securities, bonds backed by everything from credit-card bills to mortgages and even other bonds. Bankers often use the analogy of a waterfall to explain how asset-backed-securities holders are paid. Each month, payments on mortgages or credit cards flow into a trust that has issued various securities to fund the purchase of the loans. The cash is used to pay the highest-rated asset-backed-securities holders first before the overflow spills down to the next highest-rated level of securities holders and so on. Defaults on the underlying loans reduce the amount of cash available to pay securities holders.

It was almost certainly a conservative guess. Greg Peters, head of credit strategy at Morgan Stanley, summed it up. “We shudder to think of the ramifications,” he told me. It would be “a huge destabilizing force.” For several weeks, the financial world waited for the credit-rating companies to rule. “We’re all rooting for the bond insurers,” a banker on the asset-backed securities desk of a bank in London told me. Without bond insurance, underwriters were going to find it next to impossible to sell asset-backed securities. Everyone’s job depended on the market picking up again. “Believe me,” he added, before leaving me with an indelible image of Wall Street’s support for MBIA and its competitors, “we come into work every morning with our pom-poms.” ON NOVEMBER 8, the day ACA Capital, the smallest bond insurer, announced results, it became clear just how devastating a credit-rating downgrade could be.

At a glance, investors can compare whether it’s riskier to lend to the government of Indonesia or to Mattress Discounters. By 2003, the credit-rating business was less about confidence in men or in the companies they ran than it was about models that attempted to predict the probability of loan defaults. Moody’s and its only two serious competitors, Standard & Poor’s and Fitch Ratings, were earning an ever-larger share of their profits from rating asset-backed securities (ABS). To create these securities, investment banks bundle hundreds and even thousands of mortgages, credit-card receivables, or other types of loans into special-purpose vehicles (SPVs), which sell bonds to finance the purchase of these assets. The key to assessing the credit of these securities is in modeling how the underlying loans will perform under various economic scenarios. The Holy Grail for Wall Street is finding ways to manufacture triple-A-rated securities out of higher-risk assets.


pages: 543 words: 157,991

All the Devils Are Here by Bethany McLean

Asian financial crisis, asset-backed security, bank run, Black-Scholes formula, Blythe Masters, break the buck, buy and hold, call centre, collateralized debt obligation, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Exxon Valdez, fear of failure, financial innovation, fixed income, high net worth, Home mortgage interest deduction, interest rate swap, laissez-faire capitalism, Long Term Capital Management, margin call, market bubble, market fundamentalism, Maui Hawaii, money market fund, moral hazard, mortgage debt, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative trading / quantitative finance, race to the bottom, risk/return, Ronald Reagan, Rosa Parks, shareholder value, short selling, South Sea Bubble, statistical model, telemarketer, too big to fail, value at risk, zero-sum game

While at Prudential Securities in the mid-1990s, worked on one of the first mortgage-backed CDOs. Osman Semerci Installed as global head of fixed income, reporting to Kim, in 2006. Fired in 2007. Arshad Zakaria Head of global markets and investment banking. Considered a close ally of O’Neal until forced out in August 2003. Moody’s Mark Adelson Longtime Moody’s analyst and co-head of the asset-backed securities group whose skepticism was at odds with Brian Clarkson’s vision for the agency. Quit in 2000. Brian Clarkson Co-head of the asset-backed securities group who aggressively pursued market share. Named president in 2007. Eric Kolchinsky Managing director in charge of rating asset-backed CDOs. Oversaw the rating process for John Paulson’s Abacus deal. Raymond McDaniel CEO. THE PIONEERS Larry Fink Devised the idea of “tranching” mortgage-backed securities to parcel out risk.

Published a research paper entitled “A Home without Equity Is Just a Rental with Debt” in 2001. KEY ACRONYMS ABCP: Asset-backed commercial paper. Very short-term loans, allowing firms to conduct their daily business, backed by mortgages or other assets. Part of the “plumbing” of Wall Street. ABS: Asset-backed securities. Bonds comprising thousands of loans—which could include credit card debt, student loans, auto loans, and mortgages—bundled together into a security. AIG: American International Group. ARM: Adjustable-rate mortgage. CDOs: Collateralized debt obligations. Securities that comprise the debt of different companies or tranches of asset-backed securities. CDOs Squared: Collateralized debt obligations squared. Securities backed by tranches of other CDOs. CFTC: Commodities Futures Trading Commission. Government agency that regulates the futures industry. CSE: Consolidated supervised entities.

Although Moody’s had been reluctant to rate mortgage-backed securities when first approached by Lew Ranieri in the 1980s, that reluctance was long gone. By the time Moody’s became a stand-alone company, its structured finance business was growing much faster than its traditional bond rating business. Structured financial products needed more than just a rating, though. They needed a high rating. The whole purpose of an asset-backed security was to take assets that could never merit a triple-A rating on their own and transform them into products safe enough to be rated that highly. Triple-A securities could be bought by investors like money market funds and pension funds. They could be used by banks to reduce capital requirements. The combination of tranching—with its cascading levels of risk that used the riskier tranches in the capital structure to protect the higher-rated tranches—and the other credit enhancement techniques that fortified the triple-As made that possible.


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

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

The second important change in the financial sector began during the 1990s when private-sector issuers of asset-backed securities began to replicate the business model of the GSEs. They issued debt and bought up assets such as traditional mortgages, subprime mortgages, credit card receivables, and student loans. They then combined, repackaged, and resold those assets to other investors in tranches with varying degrees of risk. Although they started later and even though the government clearly did not back their debt, they still managed to increase their indebtedness eightfold to $4.5 trillion in only 13 years. By the time the credit crisis began in 2007, the debt issued (and the credit extended) by the GSEs and the asset-backed security (ABS) issuers had radically altered the size and structure of the U.S. economy.

Exhibit 1.7 provides a snapshot of the country’s credit structure in 1945 and in 2007. EXHIBIT 1.7 Total Credit Market Debt Held by the Creditors Source: Federal Reserve, Flow of Funds 1945 2007 Total $ billions $355 $50,043 Household Sector 26% 8% Financial Sector 64% 73% including: Commercial banks 33% 18% Life insurance companies 12% 6% Savings institutions 7% 3% GSEs & GSE-backed mortgages 1% 15% Issuers of asset-backed securities 0% 9% Money market funds 0% 4% Mutual funds 0% 4% Others financial sector 11% 14% Rest of the World 1% 15% Miscellaneous 9% 4% 100% 100% At the end of World War II, the credit structure of the United States was simple and straightforward. It became vastly more complicated and leveraged, however, as time went by and new kinds of financial entities were permitted to extend credit.

Five years later, they moved into second place, overtaking the savings institutions. In 2002, they came very close to overtaking commercial banks as well. In other words, they came very close to being the largest suppliers of credit in the United States. (See Exhibit 1.8.) EXHIBIT 1.8 The Suppliers of Credit from the Financial Sector Source: Federal Reserve, Flow of Funds Issuers of asset-backed securities (ABSs) also became major credit providers. ABS issuers acquired funding by selling bonds. They used the proceeds to buy mortgage loans, credit card loans, student loans, and some other credit instruments, which they then bundled together in a variety of ways and sold to investors as investment vehicles with different degrees of credit risk. They were not significant players in the credit markets until the second half of the 1980s.


pages: 414 words: 101,285

The Butterfly Defect: How Globalization Creates Systemic Risks, and What to Do About It by Ian Goldin, Mike Mariathasan

"Robert Solow", air freight, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, barriers to entry, Basel III, Berlin Wall, Bretton Woods, BRICs, business cycle, butterfly effect, clean water, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, connected car, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deglobalization, Deng Xiaoping, discovery of penicillin, diversification, diversified portfolio, Douglas Engelbart, Douglas Engelbart, Edward Lorenz: Chaos theory, energy security, eurozone crisis, failed state, Fellow of the Royal Society, financial deregulation, financial innovation, financial intermediation, fixed income, Gini coefficient, global pandemic, global supply chain, global value chain, global village, income inequality, information asymmetry, Jean Tirole, John Snow's cholera map, Kenneth Rogoff, light touch regulation, Long Term Capital Management, market bubble, mass immigration, megacity, moral hazard, Occupy movement, offshore financial centre, open economy, profit maximization, purchasing power parity, race to the bottom, RAND corporation, regulatory arbitrage, reshoring, Silicon Valley, six sigma, Stuxnet, supply-chain management, The Great Moderation, too big to fail, Toyota Production System, trade liberalization, transaction costs, uranium enrichment

Put simply, “globally integrated markets and innovation … led to a transformation of the financial landscape.”22 Growing Complexity The rise of securitization and structured financial products was one of the most striking features of the Golden Decade. Figure 2.1 shows the issuance of corporate debt and asset-backed securities between 1990 and 2009. Until 2002, banks issued more corporate debt than asset-backed securities. In 2005, however, banks issued almost twice as much in complex asset-backed securities as in corporate debt. The same trend can be observed when looking at the global issuance of collateralized debt obligations, which increased by a factor of five between 2002 and 2006 (see figure 2.2). Box 2.1. Glossary of Securitization Derivative: A financial product governed by a contract that specifies the conditions under which payments are made between the parties.

Collateralized debt obligation (CDO): An investment security composed of a wide range of assets that is passed on to different classes or tranches of owners who face varying degrees of risk. Credit default swap (CDS): A financial swap agreement that transfers the credit link of a financial product between parties. It usually involves the seller compensating the buyer in return for a payoff in the event of a default. Asset-backed security (ABS): A security collateralized or backed by combining pools of assets (such as car loans, credit card debt, or royalty payments). Figure 2.1. Issuance of corporate debt and asset-backed securities (US$ trillions), 1990–2009. Excludes debt issued by federal government agencies and government-sponsored enterprises. Garry B. Gorton and Andrew Metrick, 2010a, “Regulating the Shadow Banking System,” Brookings Papers on Economic Activity 41 (2): 260–312, 271, accessed 5 February 2013, http://www.brookings.edu/~/media/projects/bpea/fall%202010/2010b_bpea_gorton.pdf.

Civil aviation traffic, 2004 16 Figure 1.4. Domestic air traffic, Europe and China, 1990 and 2010 17 Figure 1.5. Dominant flows in global trade, 1960 and 2000 18 Figure 1.6. Fedwire interbank payment network, 2004 19 Figure 1.7. Financial integration in industrial and developing countries, 1970–98 20 Figure 1.8. Comparing recent capital flows, 1980–2012 21 Figure 2.1. Issuance of corporate debt and asset-backed securities (US$ trillions), 1990–2009 43 Figure 2.2. Total global CDO issuance (US$ billions), 2000–2010 44 Figure 2.3. Leverage ratios of large commercial banks, 2005–11 46 Figure 2.4. Dividend payments for U.S. banks (US$ billions), 2007 Q1–2009 Q4 47 Figure 2.5. Wall Street bonuses, 2002–11 48 Figure 2.6. Estimated yearly reduction in funding costs due to implicit guarantees per country where banks are headquartered (US$ billions), March 2012 51 Figure 2.7.


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

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

Morgan’s proprietary name for the idea of creating CDOs out of credit derivatives. It was first launched in 1997 and was the forerunner of the synthetic CDO structure that later became widespread. Collateralized Debt Obligations (CDOs): A form of asset-backed security. They are typically created by bundling together a portfolio of fixed-income debt (such as bonds) and using those assets to back the issuance of notes. Such notes usually carry varying levels of risk. Cash CDOs are created from tangible bonds, bonds, or other debt; synthetic CDOs sare created from credit derivatives. Collateralized Debt Obligations of Asset Backed Securities (CDO of ABS): CDOs built out of asset-backed securities, which are usually (but not always) types of mortgage-backed bonds. Collateralized Loan Obligations: CDOs built out of loans, which are usually “leveraged loans” (those extended to companies whose debt is rated noninvestment grade).

By late 2004, the bank could still claim a leading position in the trading of interest-rate derivatives, foreign exchange, and corporate loans, and a respectable operation in the arena of corporate bonds, too. But the situation in securitization—or the selling of asset-backed securities—looked poor. When J.P. Morgan and Chase had merged, both sides believed the combined bank would dominate the securitization business. Chase was a leader in the business of lending money to low-rated companies (an activity known as leveraged finance) and repackaging those loans into bonds, while J.P. Morgan was a preeminent blue-chip lender and was skilled at bundling together pools of derivatives to create structures such as BISTRO. Chase also had extensive experience repackaging other forms of debt, such as mortgages, credit cards, and student loans, into asset-backed securities. But the dream of dominating the securitization market had not gone according to plan. In the fast-expanding asset-backed CDO and CDS business, J.P.

Morgan team considered that logo—and its associations with the lowly water business—unbearably tacky. As they reeled in shock, Hancock’s former acolytes tried to work out what the merger meant for their derivatives dreams. On paper, most of them seemed well placed to flourish. Mindful of the need to hang on to J.P. Morgan’s derivatives skills, Harrison had agreed to put the innovation stars into seemingly plum positions. Demchak was named a cohead of credit; Masters was a cohead of asset-backed securities; Feldstein was named head of the global credit portfolio. In London, Bill Winters was named cohead of fixed income, and Tim Frost was appointed cohead of European credit. Technically, that gave them all positions as good as in the old J.P. Morgan bank, but now in a firm that was a true powerhouse. These developments might have been appealing. Chase Manhattan had always had a formidable sales force, covering numerous corners of the financial world that J.P.


pages: 430 words: 109,064

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

American ideology, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bernie Madoff, Bonfire of the Vanities, bonus culture, break the buck, business cycle, buy and hold, capital controls, Carmen Reinhart, central bank independence, Charles Lindbergh, collapse of Lehman Brothers, collateralized debt obligation, commoditize, corporate governance, corporate raider, 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, information asymmetry, interest rate derivative, interest rate swap, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, market bubble, market fundamentalism, Martin Wolf, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, sovereign wealth fund, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

The result was a financial services industry dominated by one set of very large financial holding companies centered on a large commercial bank and another set of very large financial institutions not subject to prudential regulation.90 These megabanks, whether based downtown, in midtown, or in North Carolina, were the new Wall Street. * To create asset-backed securities, a new legal entity buys and holds some assets (such as mortgages) and then issues new bonds that are backed by those assets. So the assets behind asset-backed securities are in addition to the assets on the balance sheets of commercial and investment banks. * Depositing money in a savings account is the same as lending money to your bank; buying short-term commercial paper is lending money to a company; buying a Treasury bill is lending money to the U.S. government.

When John Gutfreund became CEO of Salomon in 1978, all commercial banks together held $1.2 trillion of assets, equivalent to 53 percent of U.S. GDP. By the end of 2007, the commercial banking sector had grown to $11.8 trillion in assets, or 84 percent of U.S. GDP. But that was only a small part of the story. Securities broker-dealers (investment banks), including Salomon, grew from $33 billion in assets, or 1.4 percent of GDP, to $3.1 trillion in assets, or 22 percent of GDP. Asset-backed securities such as collateralized debt obligations (CDOs), which hardly existed in 1978, accounted for another $4.5 trillion in assets in 2007, or 32 percent of GDP.* All told, the debt held by the financial sector grew from $2.9 trillion, or 125 percent of GDP, in 1978 to over $36 trillion, or 259 percent of GDP, in 2007.13 Some of this growth was due to an increase in borrowing by the nonfinancial sector—the “real economy.”

By contrast, banks engineer structured products to have any set of properties (maturity, yield, risk, and so forth) that they want.2 Structured products include pure derivatives, discussed in chapter 3, which are side bets on other financial assets. For example, an investor can pay $100 to a bank and get back, one year later, an amount that is calculated based on the performance of several currencies and interest rates. They can also be built by buying actual financial assets (mortgages, student loans, credit card receivables, and so on), combining them, and taking them apart in various ways to create new “asset-backed” securities. Or they can combine real assets with derivatives in increasingly complicated mixes. Structured finance, in principle, serves two main purposes. First, it creates new assets that people can invest in. Instead of being limited to publicly traded stocks and bonds, investors can choose from a much broader menu of assets, each with unique characteristics to attract a particular investor; for example, securities can be manufactured to help investors match the timing of their assets and their liabilities.* Second, by creating assets that are more attractive to investors, structured finance should make it easier for businesses to raise money.


pages: 368 words: 32,950

How the City Really Works: The Definitive Guide to Money and Investing in London's Square Mile by Alexander Davidson

accounting loophole / creative accounting, algorithmic trading, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Big bang: deregulation of the City of London, buy and hold, capital asset pricing model, central bank independence, corporate governance, Credit Default Swap, dematerialisation, discounted cash flows, diversified portfolio, double entry bookkeeping, Edward Lloyd's coffeehouse, Elliott wave, Exxon Valdez, forensic accounting, global reserve currency, high net worth, index fund, inflation targeting, intangible asset, interest rate derivative, interest rate swap, John Meriwether, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Nick Leeson, North Sea oil, Northern Rock, pension reform, Piper Alpha, price stability, purchasing power parity, Real Time Gross Settlement, reserve currency, Right to Buy, shareholder value, short selling, The Wealth of Nations by Adam Smith, transaction costs, value at risk, yield curve, zero-coupon bond

The UK, like the United States, Italy and the Netherlands, does not yet have a national legal framework in place. Instead it has a ‘structured covered bonds’ regime in which it uses contractual agreements to replicate issuance under a legal framework. In July 2007, the UK government said it was to publish proposals for a new covered bond regime, which it said would help lenders to finance long-term fixed-rate domestic mortgages of up to 25 years. Asset-backed securities Asset-backed securities (ABS) are bonds backed by assets such as mortgages or credit card receivables, including US sub-prime mortgages, a market that in mid-2007 was experiencing defaults. The bonds are issued in different classes of risk and return, and the classes are rated by the credit rating agencies. The issuer of the ABS pays interest to investors from the income arising from mortgage or finance payments.

In June 2007, it was announced that Bear Stearns had agreed an emergency $3.2 billion (£1.6 billion) loan for one of the funds. The crisis at the Bear Stearns hedge funds has led to widespread concerns about how CDOs of asset-backed securities are priced. The market for CDOs is not particularly liquid, and huge sell-offs of bonds can cause a significant repricing. This can be triggered by downgrades from the credit rating agencies, a process that was starting to happen in mid-2007. Many CDOs are not marked to market, which means losses are not shown for long periods of time. Collateralised loan obligation The collateralised loan obligation (CLO) is a form of CDO. It is an asset-backed security constructed from securitised loans. The CLO creates pools of the debt and sells it as securities with different levels of risk to investors. CLOs offer a higher yield than similarly rated fixed-income investments.

The investor would then be left with money to reinvest in a world where interest rates are low. To compensate for this reinvestment risk, the callable bond will often pay a high coupon. 12 Credit products Introduction In this chapter, we will cover credit products, as distinct from the interest rate products covered in Chapter 11. We will focus on corporate bonds, international debt securities, junk bonds, asset-backed securities, zero-coupon bonds and equity convertibles. We will consider credit derivatives. Overview Credit products are integral to financial markets and help to fuel merger and acquisition activity, which, as we saw in Chapter 7, can keep equity market activity high. A predator will often finance a company takeover partly out of cheap debt, which has helped to keep credit markets buoyant. Credit products may be seen as parts of a larger whole.


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House of Cards: A Tale of Hubris and Wretched Excess on Wall Street by William D. Cohan

asset-backed security, call centre, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Deng Xiaoping, diversification, Financial Instability Hypothesis, fixed income, Hyman Minsky, Irwin Jacobs, John Meriwether, Long Term Capital Management, margin call, merger arbitrage, money market fund, moral hazard, mortgage debt, mutually assured destruction, Myron Scholes, New Journalism, Northern Rock, Renaissance Technologies, Rod Stewart played at Stephen Schwarzman birthday party, savings glut, shareholder value, sovereign wealth fund, too big to fail, traveling salesman, Y2K, yield curve

“What became clear is that this fund was 60 percent exposed to the subprime mortgage market,” Sharon said. As best he could explain it to Solender and Taub, Sharon said he informed them that Cioffi had loaded up the fund—which had been marketed as a safe, low-risk fund—with a host of risky securities. On Cioffi's monthly summaries, Sharon told the lawyers, “the asset-backed securities bucket was up to 80 percent. Now, when I grew up in the bond market, asset-backed securities were credit cards and auto loans. Turns out the asset-backed securities bucket was filled up with subprime-backed CDOs, and they were not under the subprime label because that wasn't known at the time when I was having the meeting with the lawyers. But I'm explaining to them this whole manager commentary [about] Armageddon, and they said, ‘Well, but these things all say “internal use only” on them.'

At the end of July 2006, the High-Grade Fund reported a net return of 0.83 percent and showed investors that 50.5 percent of the fund was invested in “asset-backed securities” (ABS) and 6 percent in subprime. “Despite the significant downturn in the housing market and deterioration in sub prime credit fundamentals overall structured credit spreads remained tight and the credit performance of the Fund assets remains strong,” Cioffi wrote investors. “And [we] have not seen any significant market price weakness in any of our particular asset sectors.” There had been a fair amount of confusion among the fund's investors about what types of securities were actually “asset-backed securities.” This subject came up on both the January 2007 and March 2007 investor conference calls. For instance, in January 2007, one investor asked Cioffi what specifically the assets were in the “ABS CDO” column on the monthly investor reports—except that the actual reports only said “ABS” on them, not “ABS CDO,” an important distinction that confused many of the fund's investors, to the point where in a meeting with one of them Tannin wrote “ABS CDO” above the column where “ABS” had been printed.

There was the stock market crash of 1987, the Asian and Mexican meltdowns in the 1990s, the dot-com implosion of 2000 and, most recently, the aftermath of Sept. 11, 2001. We may now be living on both borrowed money and borrowed time.” By January 2007, the statement said the High-Grade Fund had a return of 1.09 percent for the month and had 77 percent of its collateral in asset-backed securities. For February 2007, Cioffi reported to investors that the fund's net return was 1.38 percent and the collateral in asset-backed securities was an astounding 81 percent of the total, with subprime being 6.1 percent. In his monthly commentary, Cioffi acknowledged February had been a rough month—for others. “February was a volatile month in the structured credit markets,” he wrote, “particularly in any credit associated with subprime mortgages. Over the course of February there were a number of failures in subprime originators as well as historically high levels of early delinquencies in subprime securitizations originated in 2006.


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

affirmative action, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bernie Madoff, Black-Scholes formula, business cycle, 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, John Meriwether, Kickstarter, 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, Mitch Kapor, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, 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, Sam Peltzman, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, survivorship bias, systematic trading, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

This is another important link between Main Street and Wall Street. Mortgage- and Asset-Backed Securities The mortgage- and asset-backed securities group generated lots of profits for Lehman Brothers throughout the decade, but would also be the reason for Lehman’s demise. In 2006, Lehman Brothers was the world’s number-one underwriter of subprime mortgages. Freddie and Fannie bought mortgage portfolios, securitized them, and sold them to investors. Investment banks, including Lehman, did the same thing. They packaged these mortgage pools—especially subprime mortgage pools—and sold them to investors. They also traded mortgage-backed securities on behalf of clients and for their proprietary trading groups. At Lehman, this group was also heavily involved in securitizing and trading asset-backed securities (ABS). An asset-backed security, not surprisingly, is any security backed by an asset.

The case was eventually settled in 1999, with Bear Stearns paying $51 million in fines and restitution.3 Bear Stearns grew rapidly and did well mainly due to its prime brokerage and clearance business. It offered a wide suite of services and products to hedge funds, broker-dealers, and registered investment advisors, and had made itself as a large player in mortgage- and asset-backed securities. In 2005, Bear’s Tom Morano, head of mortgage- and asset-backed securities, increased the firm’s mortgage market exposure by doing its own securitizations. If the [traditional players] want to take on the risk of carrying all of these securities, and we’re going to see a reduction of supply [to securitize], we decided we needed to get closer to the source of the collateral. —Tom Marano, January 10, 2005 (Sargent 2005) Many Bear Stearns senior executives were early LTCM investors, including Jimmy Cayne, Vinny Mattone, and firm co-president Warren Spector.

This was intended to bring liquidity to Main Street by purchasing short-term asset-backed commercial paper directly from eligible issuers. This was another example of the Fed using unconventional measures to provide liquidity to the system, since banks were not funding the short-term borrowing needs of U.S. corporations. On November 25, 2008, the Federal Reserve created the Term Asset-Backed Securities Lending Facility (TALF), which allowed the Fed to lend up to $200 billion on a nonrecourse basis to holders of AAA-rated asset-backed securities. Quantitative Easing On November 25, 2008, the Fed announced perhaps its most unusual program of quantitative easing.3 Rather than simply manipulate the short-term Fed Funds rate, the Federal Reserve announced that it would purchase directly mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae.


When Free Markets Fail: Saving the Market When It Can't Save Itself (Wiley Corporate F&A) by Scott McCleskey

Asian financial crisis, asset-backed security, bank run, barriers to entry, Bernie Madoff, break the buck, call centre, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, financial innovation, fixed income, information asymmetry, invisible hand, Isaac Newton, iterative process, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, place-making, Ponzi scheme, prediction markets, risk tolerance, shareholder value, statistical model, The Wealth of Nations by Adam Smith, time value of money, too big to fail, web of trust

Tighten Oversight of Credit Rating Agencies We urge national authorities to enhance their regulatory regimes to effectively oversee credit rating agencies (CRAs), consistent with international standards and the G-20 Leaders’ recommendations. E1BINDEX 06/16/2010 11:28:9 Page 187 Index A AARP. See American Association of Retired Persons (AARP) ABSs. See asset backed securities (ABSs) AIG CDS exposure and insufficient collateral, 39 credit default swaps, 5 Federal Reserve, 29, 39 government bailout of, 25 liquidity crisis was tipping point for, 39 performance pay, government bailout money for, 48 taxpayers’ funds collateralized, 39 American Association of Retired Persons (AARP), 105 American Bankers Association, 58, 61–62 Anti-Trust Division of Justice, 17–18 Asian financial crisis, 16 asset backed securities (ABSs), 32–33, 36, 181 Associated Press, 87, 171 Australia, 97, 136 B Bank for International Settlements, 38, 43, 185 Bank of America, 16–17, 77 Basel Committee for Banking Supervision (BCBS), 140 BCBS.

The SPV then issued bonds backed by your mortgage and all the other mortgages in the pool, and ultimately the SPV acts as a conduit for the mortgage payments to pay the interest on the bonds. This is what is called a residential mortgage-backed security (RMBS); similar instruments are made for commercial real estate (commercial mortgage-backed securities—CMBSs). Indeed, the same arrangement can be done with any asset that creates a stream of income and these are collectively called asset-backed securities (ABSs). Now comes the interesting part. Since the bank knows it is going to sell a mortgage to an arranger virtually as soon as it closes, it has very little risk in making the loan to the home buyer. After all, who defaults on a mortgage within a few months? That means that the bank can extend loans to people less creditworthy than it had in the past. It has been pointed out that the banking industry was in fact encouraged and mandated to do so by federal laws passed to broaden homeownership to those traditionally left out of the market.

The question of whether the rating process for structured finance instruments constitutes an advisory service is an area of contention between the rating agencies and regulators (and courts) worldwide, and is not likely to be definitively settled any time soon. As bad as the collapse of the housing market was, it probably would not have led to the near collapse of the financial system if the market for securitized products had not taken off in the way that it did. The explosion in the growth of asset-backed securities, and especially RMBSs, reflected their popularity among big institutions. Many financial institutions, large and small, gobbled up the securities as fast as they could be created—faster, in fact, given that a secondary market developed for trading the securities. Some institutions invested so heavily in them that their value became a large part of their risk exposure—including Bear Stearns and Lehman.


pages: 566 words: 155,428

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

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

As described in the previous chapter, the Treasury, the Fed, and the FDIC teamed up to accept or insure mountains of dodgy assets from those two sick behemoths, with the Fed taking them as collateral for nonrecourse loans. That means that the Fed half-owned them—specifically, it owned only the downside. If the troubled assets rose in value, the banks owned the gains. Right after the Citi bailout, the Fed, working closely with the Treasury, announced plans to create yet another unprecedented lending facility, the Term Asset-Backed Securities Loan Facility (TALF). The purpose of the TALF was to make nonrecourse loans to institutions willing to buy certain asset-backed securities (ABS)—the stuff no one seemed to want—up to $200 billion. You might call these “troubled assets.” In fact, the Treasury backstopped the TALF with $20 billion of TARP money. Notice the risk-sharing ratio: $20 billion from the Treasury, $180 billion from the Fed. On that same day, the Fed started buying debt obligations of Fannie Mae and Freddie Mac—marking the beginning of what would eventually be called QE1 (quantitative easing one).

It’s Broke, Let’s Fix It: The Need for Financial Reform 11. Watching a Sausage Being Made 12. The Great Foreclosure Train Wreck 13. The Backlash PART V. LOOKING AHEAD 14. No Exit? Getting the Fed Back to Normal 15. The Search for a Fiscal Exit 16. The Big Aftershock: The European Debt Crisis 17. Never Again: Legacies of the Crisis Notes Sources Index LIST OF ACRONYMS AND ABBREVIATIONS ABCP: asset-backed commercial paper ABS: asset-backed securities AIG: American International Group AIG FP: AIG Financial Products AMLF: Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility ANPR: Advance Notice of Proposed Rulemaking ARM: adjustable-rate mortgage ARRA: American Reinvestment and Recovery Act (2009) BofA: Bank of America CBO: Congressional Budget Office CDO: collateralized debt obligation CDS: credit default swaps CEA: Council of Economic Advisers CEO: Chief Executive Officer CFMA: Commodity Futures Modernization Act (2000) CFPA: Consumer Financial Protection Agency CFPB: Consumer Financial Protection Bureau CFTC: Commodity Futures Trading Commission CME: Chicago Mercantile Exchange CP: commercial paper CPFF: Commercial Paper Funding Facility CPI: Consumer Price Index CPP: Capital Purchase Program DTI: debt (service)-to-income ratio ECB: European Central Bank EMH: efficient markets hypothesis ESF: Exchange Stabilization Fund FCIC: Financial Crisis Inquiry Commission FDIC: Federal Deposit Insurance Corporation FHA: Federal Housing Administration FHFA: Federal Housing Finance Agency FICO: Fair Isaac Company FOMC: Federal Open Market Committee FSA: Financial Services Authority (UK) FSLIC: Federal Savings and Loan Insurance Corporation FSOC: Financial Stability Oversight Council G7: Group of Seven (nations) GAAP: generally accepted accounting principles GAO: Government Accountability Office GDP: gross domestic product GLB: Gramm-Leach-Bliley Act (1999) GSE: government-sponsored enterprise H4H: Hope for Homeowners HAFA: Home Affordable Foreclosure Alternatives Program HAMP: Home Affordable Modification Program HARP: Home Affordable Refinancing Program HAUP: Home Affordable Unemployment Program HHF: Hardest Hit Fund HOLC: Home Owners’ Loan Corporation HUD: Department of Housing and Urban Development IMF: International Monetary Fund ISDA: International Swaps and Derivatives Association LIBOR: London Interbank Offer Rate LTCM: Long-Term Capital Management LTRO: Longer-Term Refinancing Operations LTV: loan-to-value (ratio) MBS: mortgage-backed securities MOM: my own money NBER: National Bureau of Economic Research NEC: National Economic Council NINJA (loans): no income, no jobs, and no assets NJTC: new jobs tax credit OCC: Office of the Comptroller of the Currency OFHEO: Office of Federal Housing Enterprise Oversight OMB: Office of Management and Budget OMT: Outright Monetary Transactions OPM: other people’s money OTC: over the counter OTS: Office of Thrift Supervision PDCF: Primary Dealer Credit Facility PIIGS: Portugal, Ireland, Italy, Greece, and Spain QE: quantitative easing Repo: repurchase agreement S&L: savings and loan association S&P: Standard and Poor’s SEC: Securities and Exchange Commission Section 13(3): of Federal Reserve Act SIFI: systemically important financial institution SIV: structured investment vehicle SPV: special purpose vehicle TAF: Term Auction Facility TALF: Term Asset-Backed Securities Loan Facility TARP: Troubled Assets Relief Program TBTF: too big to fail TED (spread): spread between LIBOR and Treasuries TIPS: Treasury Inflation-Protected Securities TLGP: Temporary Liquidity Guarantee Program TSLF: Term Securities Lending Facility UMP: unconventional monetary policy WaMu: Washington Mutual PREFACE When the music stops . . . things will be complicated.

Never Again: Legacies of the Crisis Notes Sources Index LIST OF ACRONYMS AND ABBREVIATIONS ABCP: asset-backed commercial paper ABS: asset-backed securities AIG: American International Group AIG FP: AIG Financial Products AMLF: Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility ANPR: Advance Notice of Proposed Rulemaking ARM: adjustable-rate mortgage ARRA: American Reinvestment and Recovery Act (2009) BofA: Bank of America CBO: Congressional Budget Office CDO: collateralized debt obligation CDS: credit default swaps CEA: Council of Economic Advisers CEO: Chief Executive Officer CFMA: Commodity Futures Modernization Act (2000) CFPA: Consumer Financial Protection Agency CFPB: Consumer Financial Protection Bureau CFTC: Commodity Futures Trading Commission CME: Chicago Mercantile Exchange CP: commercial paper CPFF: Commercial Paper Funding Facility CPI: Consumer Price Index CPP: Capital Purchase Program DTI: debt (service)-to-income ratio ECB: European Central Bank EMH: efficient markets hypothesis ESF: Exchange Stabilization Fund FCIC: Financial Crisis Inquiry Commission FDIC: Federal Deposit Insurance Corporation FHA: Federal Housing Administration FHFA: Federal Housing Finance Agency FICO: Fair Isaac Company FOMC: Federal Open Market Committee FSA: Financial Services Authority (UK) FSLIC: Federal Savings and Loan Insurance Corporation FSOC: Financial Stability Oversight Council G7: Group of Seven (nations) GAAP: generally accepted accounting principles GAO: Government Accountability Office GDP: gross domestic product GLB: Gramm-Leach-Bliley Act (1999) GSE: government-sponsored enterprise H4H: Hope for Homeowners HAFA: Home Affordable Foreclosure Alternatives Program HAMP: Home Affordable Modification Program HARP: Home Affordable Refinancing Program HAUP: Home Affordable Unemployment Program HHF: Hardest Hit Fund HOLC: Home Owners’ Loan Corporation HUD: Department of Housing and Urban Development IMF: International Monetary Fund ISDA: International Swaps and Derivatives Association LIBOR: London Interbank Offer Rate LTCM: Long-Term Capital Management LTRO: Longer-Term Refinancing Operations LTV: loan-to-value (ratio) MBS: mortgage-backed securities MOM: my own money NBER: National Bureau of Economic Research NEC: National Economic Council NINJA (loans): no income, no jobs, and no assets NJTC: new jobs tax credit OCC: Office of the Comptroller of the Currency OFHEO: Office of Federal Housing Enterprise Oversight OMB: Office of Management and Budget OMT: Outright Monetary Transactions OPM: other people’s money OTC: over the counter OTS: Office of Thrift Supervision PDCF: Primary Dealer Credit Facility PIIGS: Portugal, Ireland, Italy, Greece, and Spain QE: quantitative easing Repo: repurchase agreement S&L: savings and loan association S&P: Standard and Poor’s SEC: Securities and Exchange Commission Section 13(3): of Federal Reserve Act SIFI: systemically important financial institution SIV: structured investment vehicle SPV: special purpose vehicle TAF: Term Auction Facility TALF: Term Asset-Backed Securities Loan Facility TARP: Troubled Assets Relief Program TBTF: too big to fail TED (spread): spread between LIBOR and Treasuries TIPS: Treasury Inflation-Protected Securities TLGP: Temporary Liquidity Guarantee Program TSLF: Term Securities Lending Facility UMP: unconventional monetary policy WaMu: Washington Mutual PREFACE When the music stops . . . things will be complicated. But as long as the music is playing, you’ve got to get up and dance.


pages: 545 words: 137,789

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

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

The true measure of them was the expansion in the Fed’s balance sheet, which saw it go from roughly $900 billion in August 2007 to $2.1 billion in May 2009. In September 2008, the Fed started lending to money market mutual funds that faced redemptions; in the following couple of months, it said it would help finance the purchase of commercial paper, provide loans to buyers of asset-backed securities, and purchase mortgage securities issued by Fannie and Freddie. In January 2009, it announced it would start buying Treasuries, and in March it said it would extend its asset-backed securities lending program, an attempt to revive the securitization markets, to up to $1 trillion. None of these schemes was an overt giveaway, but many of them involved allowing financial firms to raise money on assets that other lenders wouldn’t accept as collateral, with the Fed taking most of the downside risk.

In 1983, Freddie Mac marketed the first collateralized mortgage obligation (CMO)—a sort of bond mutual fund in which the cash flows from a pool of mortgages and mortgage-backed securities were divided into a number of different layers, or “tranches.” The purchasers of the senior tranches got first claim on the underlying cash flows; the buyers of the mezzanine tranches got second dibs; the holders of the junior tranches were entitled to whatever was left. Two years later, a company called Sperry Lease Finance Corporation created the first asset-backed security (ABS) when it issued a set of bonds backed by the cash flows from a pool of computer equipment leases. With the development of a secondary market in mortgages and other types of credits, banks were able to sell many of the loans they made. The “originate-to-distribute” model of banking gradually replaced the “originate-to-hold” model. If a mortgage holder whose loan has been securitized falls behind on his monthly payments, it is the buyers of the mortgage securities who lose out rather than the bank that issued the loan.

In January 2004, he acknowledged that there had been cases in the past when excessive leverage had “brought down numerous, previously vaunted banking institutions, and precipitated a financial crisis that led to recession or worse,” but he dismissed the possibility of another such calamity. “[R]ecent regulatory reform coupled with innovative technologies has spawned rapidly growing markets for, among many other products, asset-backed securities, collateral loan obligations, and credit derivative default swaps,” he said. “These increasingly complex financial instruments have contributed, especially over the recent stressful period, to the development of a far more flexible, efficient, and hence resilient financial system than existed just a quarter-century ago.” Greenspan hadn’t always sounded like such a naïf. During his first ten years at the Fed, he was a successful and fairly orthodox chairman.


pages: 561 words: 87,892

Losing Control: The Emerging Threats to Western Prosperity by Stephen D. King

Admiral Zheng, asset-backed security, barriers to entry, Berlin Wall, Bernie Madoff, Bretton Woods, BRICs, British Empire, business cycle, capital controls, Celtic Tiger, central bank independence, collateralized debt obligation, corporate governance, credit crunch, crony capitalism, currency manipulation / currency intervention, currency peg, David Ricardo: comparative advantage, demographic dividend, demographic transition, Deng Xiaoping, Diane Coyle, Fall of the Berlin Wall, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, full employment, G4S, George Akerlof, German hyperinflation, Gini coefficient, hiring and firing, income inequality, income per capita, inflation targeting, invisible hand, Isaac Newton, knowledge economy, labour market flexibility, labour mobility, liberal capitalism, low skilled workers, market clearing, Martin Wolf, mass immigration, Mexican peso crisis / tequila crisis, Naomi Klein, new economy, old age dependency ratio, Paul Samuelson, Ponzi scheme, price mechanism, price stability, purchasing power parity, rent-seeking, reserve currency, rising living standards, Ronald Reagan, savings glut, Silicon Valley, Simon Kuznets, sovereign wealth fund, spice trade, statistical model, technology bubble, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Wealth of Nations by Adam Smith, Thomas Malthus, trade route, transaction costs, Washington Consensus, women in the workforce, working-age population, Y2K, Yom Kippur War

Capital market participants – bankers, fund managers, private- equity investors and other ‘go-betweens’ – package their products in all sorts of ways, ranging from simple bank deposits and loans through to the ever-more complex instruments that make up the lexicon of international finance: syndicated loans, equities, corporate bonds, commercial paper, asset-backed securities, collateralized debt obligations and structured products. Ultimately, each of these products offers a claim on future economic wealth (or, put another way, a reward for abstinence today). Banks provide loans in exchange for an interest payment. Shareholders hold equities because they expect a dividend or a capital gain. Issuers of asset-backed securities provide a return in exchange for the apparent protection associated with the underlying asset. That most people have no idea of what these products are is one of the wonderful tricks of modern international finance.

And with emerging economies building up ever-larger savings surpluses, distortions in global capital markets got worse, not better. The belief in the pot of gold refused to go away. Since equities couldn’t deliver the necessary returns, and government bond yields were ludicrously low, investors went in search of other assets that might do the trick. As with any other market, an increase in demand for high-returning non-equity assets was met with an increase in supply. Asset-backed securities, mortgage-backed securities, collateralized debt obligations and so on became the investments du jour. Banks packaged up vast quantities of loans into these securities and either tucked them away under the mattress as off-balance-sheet items in the form of conduits and special investment vehicles (SIVs) or, instead, sold them off to other investors – insurance companies, pension funds, hedge funds and, in some cases, local councils – who, collectively, became known as the ‘shadow banking system’.

Ten years later, at the height of the technology bubble in 1999, American and European boomers found themselves in a similar state of fervour. Even when stock prices slumped in 2000, house prices carried on rising, creating the false impression that people genuinely owned assets that would support them in their impending retirements. Other, more esoteric, assets became increasingly popular. Pension funds loaded up on asset-backed securities, which too often were linked to poor-quality loans in the US housing market. Ten years later, with equity markets still hobbled and with house prices having persistently declined for the first time in US post-war history, it turned out that the boomers were not so wealthy after all. Even worse, many Americans and British citizens had borrowed heavily against inflated asset values, leaving them awash with debt at precisely the wrong demographic moment.


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

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

Every minute of every hour of every day of every week, someone, somewhere, is trading. And all the time new financial life forms are evolving. In 2006, for example, the volume of leveraged buyouts (takeovers of firms financed by borrowing) surged to $753 billion. An explosion of ‘securitization’, whereby individual debts like mortgages are ‘tranched’ then bundled together and repackaged for sale, pushed the total annual issuance of mortgage backed securities, asset-backed securities and collateralized debt obligations above $3 trillion. The volume of derivatives - contracts derived from securities, such as interest rate swaps or credit default swaps (CDS) - has grown even faster, so that by the end of 2007 the notional value of all ‘over-the-counter’ derivatives (excluding those traded on public exchanges) was just under $600 trillion. Before the 1980s, such things were virtually unknown.

Nor was the US stock market’s performance exceptional. In the five years to 31 July 2007, all but two of the world’s equity markets delivered double-digit returns on an annualized basis. Emerging market bonds also rose strongly and real estate markets, especially in the English-speaking world, saw remarkable capital appreciation. Whether they put their money into commodities, works of art, vintage wine or exotic asset-backed securities, investors made money. How were these wonders to be explained? According to one school of thought, the latest financial innovations had brought about a fundamental improvement in the efficiency of the global capital market, allowing risk to be allocated to those best able to bear it. Enthusiasts spoke of the death of volatility. Self-satisfied bankers held conferences with titles like ‘The Evolution of Excellence’.

However, when the original mortgages reset at higher interest rates after their one- or two-year ‘teaser’ periods expired, the borrowers began to default on their payments. This in turn signalled that the bubble in US real estate was bursting, triggering the sharpest fall in house prices since the 1930s. What followed resembled a slow but ultimately devastating chain reaction. All kinds of asset-backed securities, including many instruments not in fact backed with subprime mortgages, slumped in value. Institutions like conduits and structured investment vehicles, which had been set up by banks to hold these securities off the banks’ balance sheets, found themselves in severe difficulties. As the banks took over the securities, the ratios between their capital and their assets lurched down towards their regulatory minima.


pages: 468 words: 145,998

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

asset-backed security, bank run, banking crisis, break the buck, Bretton Woods, buy and hold, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Doha Development Round, fear of failure, financial innovation, fixed income, housing crisis, income inequality, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, 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

About 40 percent of consumer loans were packaged and sold as securities, but that market had all but shut down, making it much harder for American families to buy cars, pay for college tuition, or even purchase a television with a credit card. Steve began work with the Fed on a program in which TARP funds would be used to help create a Fed lending facility that would provide nonrecourse senior secured funding for asset-backed securities collateralized by newly made auto loans, credit card loans, student loans, and loans guaranteed by the Small Business Administration. The risk to the government was expected to be minimal, as losses would be borne by TARP only after issuers and investors had taken losses. This work would lead to what became known as the Term Asset-Backed Securities Loan Facility, or TALF. Another group—including Dave McCormick, Bob Hoyt, Kevin Fromer, Michele Davis, Jim Wilkinson, Brookly McLaughlin, Deputy Assistant Secretary for Business Affairs Jeb Mason, Public Affairs Officer Jennifer Zuccarelli, Deputy Executive Secretary Lindsay Valdeon, and Christal West—accompanied me to Little St.

Price and Curl explained that after poring over Lehman’s books, Bank of America now believed that to get a deal done it would need to unload between $65 billion and $70 billion worth of bad Lehman assets. BofA had identified, in addition to $33 billion of soured commercial mortgages and real estate, another $17 billion of residential mortgage-backed securities on Lehman’s books that it considered to be problematic. In addition, its due-diligence team had also raised questions about other Lehman assets, including high-yield loans and asset-backed securities for loans on cars and mobile homes, as well as some private-equity holdings. The likely losses on all of those bad assets, they estimated, would wipe out Lehman’s equity of $28.4 billion. We asked if they would be willing to finance any of the assets they wanted to leave behind or take more losses. They said no. To say the least, it was a disappointing session. Price and Curl weren’t even working off paper—they simply sat back in their chairs, reeling off ranges of huge numbers that would require an enormous private-sector bailout.

Of the first $350 billion, we had already allocated $250 billion to the capital purchase program; half of that was committed to the nine big banks. We estimated that AIG could require a whopping $40 billion. That brought us up to $290 billion. And we could easily tally a list of potential demands on our resources, from the increasingly distressed commercial real estate market to the monoline insurers. We would need funds to help restart the consumer side of the asset-backed securities market. After what we’d gone through in the past few weeks, I could easily invent doomsday scenarios that would require hundreds of billions of dollars. On Saturday evening, after dinner, we gathered in a small room in the main lodge that doubled as a natural history museum—complete with mounted ducks and tarpon, turtle shells, and the skeletons of alligators and dolphins—to hash out the policy and political considerations.


pages: 469 words: 132,438

Taming the Sun: Innovations to Harness Solar Energy and Power the Planet by Varun Sivaram

addicted to oil, Albert Einstein, asset-backed security, autonomous vehicles, bitcoin, blockchain, carbon footprint, cleantech, collateralized debt obligation, Colonization of Mars, decarbonisation, demand response, disruptive innovation, distributed generation, diversified portfolio, Donald Trump, Elon Musk, energy security, energy transition, financial innovation, fixed income, global supply chain, global village, Google Earth, hive mind, hydrogen economy, index fund, Indoor air pollution, Intergovernmental Panel on Climate Change (IPCC), Internet of things, M-Pesa, market clearing, market design, mass immigration, megacity, mobile money, Negawatt, off grid, oil shock, peer-to-peer lending, performance metric, renewable energy transition, Richard Feynman, ride hailing / ride sharing, Ronald Reagan, Silicon Valley, Silicon Valley startup, smart grid, smart meter, sovereign wealth fund, Tesla Model S, time value of money, undersea cable, wikimedia commons

Beginning in the 1970s, banks began to securitize mortgage loans, bundling them together to create mortgage-backed securities, which investors then could purchase. In subsequent decades, these securities gave rise to the more general category of asset-backed securities, which offer investors an opportunity to invest in everything from auto and student loans to Domino’s Pizza franchise royalties. In the run-up to the financial crisis, Wall Street abused securitization by packaging subprime mortgage-backed securities together into an arcane entity known as a “collateralized debt obligation.” But since the crash, federal regulators have reined in these abuses, and asset-backed security markets are thriving again. Today, the U.S. mortgage-backed security market is worth about $9 trillion, and the asset-backed security market is worth $1.4 trillion. Attracting these enormous sums of capital has made it possible for Americans to engage in activities with an up-front cost they wouldn’t normally be able to afford.

Attracting these enormous sums of capital has made it possible for Americans to engage in activities with an up-front cost they wouldn’t normally be able to afford. For example, only 14 percent of consumers bought cars outright in 2015. Instead, 55 percent took out an auto loan, and a further 31 percent drove off the lot without actually owning the car, thanks to an auto lease.24 Car companies finance loans and leases for consumers and then sell asset-backed securities on bond markets, freeing up capital to provide even more loans and leases. (Some analysts have warned, however, that rising subprime auto lending has inflated a dangerous auto asset-backed security bubble, waiting to pop.25) The auto industry’s success in promoting car leases and loans could be a model for the solar industry—provided that it scrupulously avoids risky lending practices. Indeed, the two asset categories are comparably valued—in 2015, the average U.S. car sold for a little more than $30,000, and the average residential solar installation in California cost around $20,000.26,27 And as is true in the auto industry, both leases and loans play important roles in financing distributed solar installations.

In several states, utilities have lobbied furiously to amend net metering to reduce the rate at which excess solar power is compensated for or add charges to solar owners’ bills to cover the costs of the grid. In some places, such as Arizona, they have succeeded, dampening the growth of residential solar. If more states roll back net metering, consumers in those states would save less money on their monthly utility bills by installing solar power. That reduction might make it harder for them to make their monthly loan or lease payments, lowering the income that an asset-backed security might generate for investors. In this way, regulatory changes might reduce the appeal of new securitizations. A final risk facing securitization is counterintuitive: the price of solar installations actually might be falling too fast. The price of a U.S. residential solar installation halved between 2009 and 2015, from $8 to $4 per watt.38 If this trend continues, customers may be unwilling to continue paying loan payments on an asset whose market value has plunged only a few years after it was installed.


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

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

In the US experience post-­ Lehman, these bonds initially included a large amount of consumer and automobile debt – stuff that had become increasingly toxic during the subprime crisis – while, in the UK, the focus of attention was largely on government bonds (gilts) – primarily because the UK asset-­backed securities market was still in its infancy. Increased central bank asset purchases boost demand for those assets and, hence, raise their price. As the price is, in effect, the inverse of the yield, a higher price necessarily implies a lower yield. And if yields on asset-­backed securities and government bonds are heading lower, the current holders may decide to look elsewhere for higher returns. Demand for riskier assets – equities, real estate – may then increase. Listed companies can then raise funds more cheaply – via the stock market – and households can, in theory, borrow more easily against the – now-­rising – value of their properties.

Based on our collective belief in continuously rising living standards, we have spent the last half-­century watching our financial wealth and our political and economic ‘rights’ accumulate at an incredible pace. We all, directly or indirectly, own pieces of paper or rely on political promises that make claims on future economic prosperity. The pieces of paper range from cash through to government bonds, from equities through to property deeds and from asset-­backed securities through to collateralized debt obligations. 34 4099.indd 34 29/03/13 2:23 PM Taking Progress for Granted The language deployed may vary from the very simple to the incredibly complicated but these pieces of paper all have one thing in common: they represent claims on assumed future economic success. They are all manifestations of the same act of faith: namely that the future will be better than the present and vastly superior to the past.

The government will then blame the central bank for undermining the nation’s economic health and the central bank’s independence will then be under threat. Far better, then, simply to continue with quantitative easing or even, perhaps, to expand the central bank’s remit. There are two ways of doing so. The first is for the central bank to buy a much wider range of assets – not just government paper but also asset backed-­securities, corporate bonds, foreign currency or maybe even equities. Central banks have dabbled in all of these areas in the past and many continue to do so today.14 There is, however, an obvious drawback. A central bank simply doesn’t have the resources to manage credit risk. Allocating capital is supposed to be the job of the invisible hand, not the long arm of the central banker. Widening the range of assets to be purchased turns a central bank slowly but surely into the financial equivalent of a state planner.


pages: 741 words: 179,454

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

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, business cycle, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, 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, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Fall of the Berlin Wall, financial independence, financial innovation, financial thriller, 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, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, John Meriwether, joint-stock company, Jones Act, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, 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, mega-rich, merger arbitrage, Mikhail Gorbachev, Milgram experiment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, negative equity, NetJets, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, 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 Thaler, Right to Buy, 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, Satyajit Das, 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, survivorship bias, 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 new new thing, 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, zero-sum game

Mark Zandi (2009) Financial Shock: A 360° Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis, Pearson Education, New Jersey. Index NUMBERS 13 Bankers, 294 60 Minutes, 343 401(k) plans, 48 1720 Bubble Act, 53 A AAA tranches, 203 Abacus transactions, 197-199, 339 Abbey, Edward, 362 ABN-Amro, 197 ABS CP (asset-backed securities commercial paper), 190 ABS PAYG CDS (asset-backed securities pay-as-you-go credit default swaps), 196 Absolute Strategy Research, 357 ABX.HE (asset-backed securities home equity), 196 Abyssinian Baptist Church, 164 ACA Capital, 197 accounting ark-to-market, 56 errors, 285 mark-to-market (MtM), 286-288 rules, 81, 349 standards, 289 value, 286-287 accreting interest rate swaps, 160 accumulator contracts, 219 Ackoff, Russell, 309 acquisitions, 57-59, 310 General Electric (GE), 61 Adelphia, 154 adjustable rate bonds, 213 adjustable rate mortgages (ARMs), 148, 182-184 adjusted model prices, 289 Aeneid, 338 affinity fraud, 313 Affluent Society, The, 43 affluenza, 46 Africa, 22 Against The Gods: The Remarkable History of Risk, 129 Age of Turbulence, The, 302 Agnelli, Giovanni, 222 AIG, 230-234, 270 Airline Partners Australia (APA), 156 airlines, leveraged buyouts (LBO), 156-157 airports, 158, 161 Albanese, Tom, 59 Alcan, 59 Alcar, 124 alchemy, 131-132 algorithmic trading, 242 Alice in Wonderland, 31 Allco Equity Partners, 156 Allco Finance Group, 156 Allen, Paul, 179 Allied Signal, 60 alpha (outperformance), 241 Alt A (Alternative A) mortgages, 182 alternatives assets, 154 investments, 252 paper money, 35 Altman, Edward, 143 amakudari (descent from heaven), 316 Amaranth, 227 hedge funds, 250-252 Amazon.com, 97 America.

Securitization was a bacchanalian feast of unprecedented size for bankers and their acolytes. The structure is set out in Figure 11.1. Lenders sell loans they made to an SPV, not associated with the seller. The SPV, a trust or a company located in the tax-efficient balmy Cayman Islands, pays the lender for the purchase from the proceeds of bonds it issues to investors, asset-backed securities (ABSs). ABS investors, indirectly via the SPV, own the loans, relying on the cash flows from the underlying loans for the interest and principal they are entitled to receive. Figure 11.1. Asset-backed security structure When sold to the SPV, the original loans and any associated borrowing disappear from the balance sheet of the original lender. As the loans are sold off, the lender can make new loans, freeing the lending institution from constraints of capital and funding resources. Lenders also raise long-term funds matching the life of loans and so reducing risk.

The normal CDS was designed for companies where payment was triggered by bankruptcy or failure to make interest and principal repayments on loans. In June 2005, ABS PAYG CDS (asset-backed securities pay-as-you-go credit default swaps) were introduced. Under this form of credit insurance, buyers of insurance received payments where there was simply a permanent write down in the underlying loans, a downgrade to CCC credit rating or extension of maturity. Traders benefited from any deterioration in the quality of the underlying loans, making it easier to short the housing market. In 2006, the ABX.HE (asset-backed securities home equity), an index of MBSs similar to a stock index, was created. The ABX allowed trading in portfolios of virtual mortgages—bets on the price of mortgages going up (less defaults and lower loss) or down (more defaults and more losses).


pages: 165 words: 48,594

Democracy at Work: A Cure for Capitalism by Richard D. Wolff

asset-backed security, Bernie Madoff, business cycle, collective bargaining, Credit Default Swap, declining real wages, feminist movement, financial intermediation, Howard Zinn, income inequality, John Maynard Keynes: technological unemployment, laissez-faire capitalism, means of production, moral hazard, mortgage debt, Occupy movement, Ponzi scheme, profit maximization, quantitative easing, race to the bottom, Ronald Reagan, too big to fail, trickle-down economics, wage slave, women in the workforce, Works Progress Administration

Even so, despite repeated claims to the contrary, the crash was not primarily caused by a working class that could no longer earn, borrow, or spend more, as I will explain. 1.4 Capitalism, 1970s–2007: The Crisis Building from Above While household debts and the housing bubble had indeed become unsustainable, the crash resulted largely from the huge financial speculation that employers, top executives, and professionals had built up on the foundation of consumer debt. The mechanism here was straightforward. First, banks packaged consumer debts (mortgages, credit card debt, auto loans, and student loans) into a new kind of financial investment: asset-backed securities (ABS). Where regular stocks and bonds were investments in and thus claims on companies that produced goods or services, ABS were different. ABS gave those who bought them a claim on the principal or interest payments of consumer loans. Those who invested in ABS received in return a portion of the regular flow of consumers’ payments servicing their debts. Successful businesses were among the main investors in ABS and derivative financial instruments associated with them.

Nonetheless, it is instructive to study the first few years of the US government’s response as the economic downturn gathered speed and force in early 2008 and then intensified into full-fledged collapse between September 2008 and April 2009. The collapse occurred most dramatically in the credit system, where it took the form of a credit freeze—lending stopped. It had become clearer in 2008 that the number of mortgages that could no longer be serviced by borrowers was larger and growing faster than had been expected. Therefore, the owners of mortgage-backed securities (MBS) and other asset-backed securities (ABS) faced not only their declining values but also great uncertainty about what price they might fetch if and when a holder tried to sell them to anyone else. Uncertainty can destabilize markets even more than rapid price declines. Two huge investment banks, long active in the MBS market and large owners of MBS, collapsed in 2008. Bear Stearns was forced into a massively discounted handover of its assets to JPMorgan Chase, and Lehman Brothers was forced to declare bankruptcy.

Their creditors, fearing the implications of the declining values of such investment banks’ ABS assets, demanded repayment of their loans and in other cases said they would not renew loans that were coming due. The investment banks could not manage or survive the loan stoppage they faced because of the declining values and prospects of their ABS holdings. These dramatic events, among others that received less publicity, sufficed to freeze credit markets by autumn 2008. Few banks could or would lend to others because every bank knew that other banks held unknown amounts of asset-backed securities whose values were falling, uncertain, or both. To lend to any bank—even overnight—meant risking being told the next morning, week, or month that the borrowing bank could not repay because its ABS values were collapsing and its access to credit had vanished. Other financial enterprises were likewise drawn into the credit freeze. Some held ABS or depended on banks that did. Others had hedged their holdings of ABS—as many banks did—by purchasing credit default swaps (CDS) as insurance against the defaults that were proliferating in 2008 and 2009.


pages: 280 words: 79,029

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

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

Lending that does not have any collateral associated with it is called unsecured lending and will carry a higher interest rate. In derivatives transactions, more collateral (or “margin”) can be demanded as the values of specific contracts go up and down. Collateralized-debt obligations: The next step in the securitization process after the creation of asset-backed securities is the CDO. CDOs are instruments made up of the riskier slices of a lot of ordinary asset-backed securities. They are then sliced into different tranches: the most senior tranches of CDOs of mortgage-backed securities were given high ratings during the most recent US housing boom because the performance of all the different mortgages in the pool was thought to be diversified. Counterparty risk: The risk that the other party to a contract will not live up to its obligations.

The bonds did so by specifying their value in terms of their purchasing power: “Both Principal and Interest to be paid in the then current Money of said state, in a greater or less sum, according as Five Bushels of corn, Sixty-eight Pounds and four-seventh Parts of a Pound of beef, Ten Pounds of sheeps wool, and Sixteen Pounds of sole leather shall then cost, more or less than One Hundred and Thirty Pounds current money, at the then current Prices of said articles.”19 The majority of new products that stream out of finance today are also refinements to existing securities. Often these “new” products are no more than tweaks. Ask a banker what he’s proudest of in his career, and the chances are he’ll go misty-eyed recalling an arcane first—a new kind of “step-up coupon” on an asset-backed security in Paraguay or something equally obscure.20 *** BY THE TIME OF THE RAILROAD revolution in the nineteenth century, finance had evolved to the point where it could support large-scale industrial enterprises. It was also drawing in more and more people, as wealth and political power became more diffuse. This process of democratization took different forms in different societies. In Japan, for example, finance was an important part of the changing political economy.

So even though the securities were not defaulting in great numbers, huge losses still materialized because people were selling out when prices had dropped. The gap between perception and reality for the top-rated tranches was still wide enough to cause huge damage, but it was not a chasm. Collateralized-debt obligations were a very different story. CDOs are instruments made up of the riskier slices of a lot of ordinary asset-backed securities. CDOs were supposed to benefit from diversification: mortgages pulled from different mortgage-backed securities were expected to perform differently, rather than undergo a synchronized swoon. That is why the senior tranches of CDOs were able to command AAA ratings when their raw materials were bits of mortgage-backed securities that had a lower rating. Abacus, a 2007 brew of subprime mortgages arranged by Goldman Sachs, was made up of 90 Baa2-rated mortgage-backed securities.


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

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

A college student would receive a solicitation, and if that graduate had secured a “career-oriented job paying $12,000 or more a year,” possessed a “permanent Wisconsin home address,” and attended a Wisconsin school, then the bank would give that student a credit card, even though the student did not “qualify for credit under [the] usual criteria.”134 The alma mater frequently got a cut of revenue from such cards for providing access and mailing lists.135 While class identity flagged, perhaps, as a way to organize labor, it rejuvenated the organization of capital among the professional classes. 1986: Tax Reform and Securitization In 1986, two events made debt more expensive for consumers to borrow and cheaper for banks to lend. While these two events, the Tax Reform Act of 1986 and the first credit card asset-backed security, had nothing to do with one another, they both pushed all forms of consumer debt, in unexpected ways, toward complete interchangeability. Though the Tax Reform Act sought to differentiate credit card debt from mortgage debt, market forces and financial innovation like asset-backed securities pushed them back together. By the middle of the 1980s, credit cards and other non-mortgage debts were starting to be seen as something not to be encouraged. Owning a house, arguably, served a valuable social function by rooting home owners in a community, but auto loans, much less credit cards, did not.

These networks of resale enabled the flow of capital from investors to borrowers, but these channels of resale were necessarily limited to networks of skilled buyers and sellers. While borrowers and lenders referred to “debt markets,” these highly structured, highly regulated networks bore little resemblance to the chaos of a market. After the 1970s, however, new financial instruments, asset-backed securities, allowed these networks to become markets. Credit markets were deep, anonymous, and global. Capital could come from anywhere or anyone and be invested in consumer debt. This financial marvel, born of both Washington and Wall Street, midwifed the grand expansion of late-twentieth-century borrowing, enabling Americans to borrow more even while their incomes became more precarious. Capitalist structures changed more than consumers’ thriftiness.6 Because of the clever structuring of the financial instruments, the supply of lending capital was nearly limitless.

While these two different financial practices—borrowing against a home’s value and borrowing on SECURING DEBT 221 a credit card—appeared very different for consumers, the business logic and financial practices that underpinned them both grew more and more similar over time. By the late 1980s, these two different debts converged and become financially indistinguishable in how they were funded—by asset-backed securities. By the mid-1990s, even consumers began to use home mortgages and credit cards interchangeably, consolidating the debt of credit cards into the debt of mortgages. How the mortgage and credit became indistinguishable defined a key aspect of the financial transformation of this post-1970s world, reshaping the relationships of lenders and borrowers. As lenders sought to expand their loans, consumers had new reasons to borrow.


pages: 265 words: 93,231

The Big Short: Inside the Doomsday Machine by Michael Lewis

Asperger Syndrome, asset-backed security, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, facts on the ground, financial innovation, fixed income, forensic accounting, Gordon Gekko, high net worth, housing crisis, illegal immigration, income inequality, index fund, interest rate swap, John Meriwether, London Interbank Offered Rate, Long Term Capital Management, medical residency, money market fund, moral hazard, mortgage debt, pets.com, Ponzi scheme, Potemkin village, quantitative trading / quantitative finance, Robert Bork, short selling, Silicon Valley, the new new thing, too big to fail, value at risk, Vanguard fund, zero-sum game

"In the course of trying to figure it out, we realize that there's a reason why it doesn't quite make sense to us. It's because it doesn't quite make sense." The subprime mortgage market had a special talent for obscuring what needed to be clarified. A bond backed entirely by subprime mortgages, for example, wasn't called a subprime mortgage bond. It was called an ABS, or asset-backed security. When Charlie asked Deutsche Bank exactly what assets secured an asset-backed security, he was handed lists of abbreviations and more acronyms--RMBS, HELs, HELOCs, Alt-A--along with categories of credit he did not know existed ("midprime"). RMBS stood for residential mortgage-backed security. HEL stood for home equity loan. HELOC stood for home equity line of credit. Alt-A was just what they called crappy mortgage loans for which they hadn't even bothered to acquire the proper documents--to verify the borrower's income, say.

And the answer that kept coming back to us was, 'It's the CDOs.'" Which of course just raised another question: Who, or what, was a CDO? Typically when they entered a new market--because they'd found some potential accident waiting to happen that seemed worth betting on--they found an expert to serve as a jungle guide. This market was so removed from their experience that it took them longer than usual to find help. "I had a vague idea what an ABS [asset-backed security] was," said Charlie. "But I had no idea what a CDO was." Eventually they figured out that language served a different purpose inside the bond market than it did in the outside world. Bond market terminology was designed less to convey meaning than to bewilder outsiders. Overpriced bonds were not "expensive" overpriced bonds were "rich," which almost made them sound like something you should buy.

In its lower Manhattan office, the SEC met with them and listened, but politely. "It was almost like a therapy session," said Jamie. "Because we sat down and said, 'We've just had the most crazy experience.'" As they spoke, they sensed the audience's incomprehension. "We probably had like this wild-eyed we've-been-up-for-three-days-straight look in our eyes," said Charlie. "But they didn't know anything about CDOs, or asset-backed securities. We took them through our trade but I'm pretty sure they didn't understand it." The SEC never followed up. Cornwall had a problem more immediate than the collapse of society as we know it: the collapse of Bear Stearns. On June 14, 2007, Bear Stearns Asset Management, a CDO firm, like Wing Chau's, but run by former Bear Stearns employees who had the implicit backing of the mother ship, declared that it had lost money on bets on subprime mortgage securities and that it was being forced to dump 3.8 billion dollars' worth of these bets before closing the fund.


pages: 316 words: 117,228

The Code of Capital: How the Law Creates Wealth and Inequality by Katharina Pistor

"Robert Solow", Andrei Shleifer, Asian financial crisis, asset-backed security, barriers to entry, Bernie Madoff, bilateral investment treaty, bitcoin, blockchain, Bretton Woods, business cycle, business process, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, colonial rule, conceptual framework, Corn Laws, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Donald Trump, double helix, Edward Glaeser, Ethereum, ethereum blockchain, facts on the ground, financial innovation, financial intermediation, fixed income, Francis Fukuyama: the end of history, full employment, global reserve currency, Hernando de Soto, income inequality, intangible asset, investor state dispute settlement, invisible hand, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Rogoff, land reform, land tenure, London Interbank Offered Rate, Long Term Capital Management, means of production, money market fund, moral hazard, offshore financial centre, phenotype, Ponzi scheme, price mechanism, price stability, profit maximization, railway mania, regulatory arbitrage, reserve currency, Ronald Coase, Satoshi Nakamoto, secular stagnation, self-driving car, shareholder value, Silicon Valley, smart contracts, software patent, sovereign wealth fund, The Nature of the Firm, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, trade route, transaction costs, Wolfgang Streeck

It shifts attention from class identity and class struggle to the question of who has access to and control over the legal code and its masters: the landed elites; the long-distance traders and merchant banks; the shareholders of corporations that own production facilities or simply hold assets behind a corporate veil; the banks who grant loans, issue credit cards, and student loans; and the non-bank financial intermediaries that issue complex financial assets, including asset-backed securities and derivatives. The craftsmanship of their lawyers, the code’s masters, explains the adaptability of the code to the ever-changing roster of assets; and the wealth-creating benefits of capital help explain why states have been only too willing to vindicate and enforce innovative legal coding strategies. With the best lawyers at their service, asset holders can pursue their self-interests with only few constraints.

As we have seen, NC2’s tranches ran the gamut from “AAA” all the way down to lower B ratings.19 Rating agencies used the same nomenclature they had used for decades to rate government or corporate bonds to rate MBS and their derivatives.20 This created the appearance to investors that the credit risk they were assuming was indeed comparable with these familiar assets, but in fact disguised the most important difference between these different assets. Whereas for government and most corporate bonds, historical data exist for m i nti n g d e Bt 87 many years, even decades, similar long-term data did not and could not exist for asset-backed securities (ABS) or collateralized debt obligations (CDOs), which had only recently seen the light of day. Any comparison was therefore misleading. Yet, rating agencies have largely escaped liability for the use of misleading labels, for their willingness to work closely with the sponsoring entity to ensure that the right mix of safe versus risky assets would emerge once they were done with their ratings, or for their failure to downgrade their ratings when markets began to turn.

The early statutes were eventually incorporated into domestic law and ultimately found their way into an international convention, adopted in 1930 under the auspices of the League of Nations.32 By that time, however, a new payment system was on the rise and the bill started its slow decline as the first debt instrument with transnational reach; other private assets soon took its place, among them asset-backed securities and their derivatives.33 From Bills to Securitized Assets Notes and bills were designed to facilitate trade and commerce. They could also be flipped into assets that were used purely for financial speculation, as the example of the “dry exchange” given above suggests. When banks made their first appearance, they did not offer deposits, but rather notes, to willing takers, using the proceeds to make their own investment, even as they promised noteholders prompt payment in species (i.e., gold or silver) upon demand.


pages: 1,066 words: 273,703

Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze

Affordable Care Act / Obamacare, Apple's 1984 Super Bowl advert, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, Boris Johnson, break the buck, Bretton Woods, BRICs, British Empire, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, dark matter, deindustrialization, desegregation, Detroit bankruptcy, Dissolution of the Soviet Union, diversification, Doha Development Round, Donald Trump, Edward Glaeser, Edward Snowden, en.wikipedia.org, energy security, eurozone crisis, Fall of the Berlin Wall, family office, financial intermediation, fixed income, Flash crash, forward guidance, friendly fire, full employment, global reserve currency, global supply chain, global value chain, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, housing crisis, Hyman Minsky, illegal immigration, immigration reform, income inequality, interest rate derivative, interest rate swap, Kenneth Rogoff, large denomination, light touch regulation, Long Term Capital Management, margin call, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, mittelstand, money market fund, moral hazard, mortgage debt, mutually assured destruction, negative equity, new economy, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shale / tar sands, old-boy network, open economy, paradox of thrift, Peter Thiel, Ponzi scheme, predatory finance, price stability, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, reserve currency, risk tolerance, Ronald Reagan, savings glut, secular stagnation, Silicon Valley, South China Sea, sovereign wealth fund, special drawing rights, structural adjustment programs, The Great Moderation, Tim Cook: Apple, too big to fail, trade liberalization, upwardly mobile, Washington Consensus, We are the 99%, white flight, WikiLeaks, women in the workforce, Works Progress Administration, yield curve, éminence grise

The largest user of the system was the troubled Swiss giant UBS, which soaked up 10 percent of the Fed’s funds. Another 7.3 percent went into Dexia, and 5 percent each into Fortis and RBS. Some of the most severely stressed European banks received 27 percent of the entire program. In total, the European share cannot have been much less than 40 percent. Alongside the mortgage market, the broader market for asset-backed securities had frozen up. To reenergize lending, on November 25, 2008, the Fed introduced the Term Asset-Backed Securities Loan Facility, which became the vehicle for the most mixed bag of lending sponsored by the Fed and the Treasury. It offered five-year nonrecourse loans to a select group of borrowers collateralized through the purchase of highly rated securitizations of consumer credit, such as auto loans, student loans, credit card loans and lending to small businesses for equipment and building construction.

Instead, they could apply standardized financial mathematics to a population of mortgages that was assumed to have well-known statistical properties. If you knew default rates and could make assumptions about the degree of correlation between them, once you assembled enough mortgages and tranched them, the likelihood of the top tranches not paying was infinitesimal. Tens of thousands of asset-backed securities thus qualified for ultrasafe AAA ratings. What happened to the tranches lower down the pile was another matter altogether. There the risk of failure was much higher than if one simply held the mortgage pool. But at the right yield they too would find a buyer. The idea, in the wake of the savings-and-loans disaster, was to spread risk outward from those immediately involved in lending to mortgage borrowers and to attract investors by turning mortgages into securities that offered a wide range of yield-risk profiles.

Source: Zoltan Pozsar, “Institutional Cash Pools and the Triffin Dilemma of the US Banking System,” Financial Markets, Institutions & Instruments 22, no. 5 (2013): 283–318, figure 5. But once again we have to be careful. The shuffling of global demand for dollar-denominated safe assets helps to explain why the mortgage pipeline did not result in an oversupply of AAA securities. But to the extent that private label asset-backed securities were actually sold off to investors, little more was heard of them. When the market turned bad, they would sit on balance sheets as an illiquid entry. They were no longer counted as safe assets. There would be lawsuits against investment banks that had knowingly repackaged unsafe mortgages. Certainly the losses would have an impact on investment allocation and on the spending decisions of millions of pensioners.


Risk Management in Trading by Davis Edwards

asset allocation, asset-backed security, backtesting, Black-Scholes formula, Brownian motion, business cycle, computerized trading, correlation coefficient, Credit Default Swap, discrete time, diversified portfolio, fixed income, implied volatility, intangible asset, interest rate swap, iterative process, John Meriwether, London Whale, Long Term Capital Management, margin call, Myron Scholes, Nick Leeson, p-value, paper trading, pattern recognition, random walk, risk tolerance, risk/return, selection bias, shareholder value, Sharpe ratio, short selling, statistical arbitrage, statistical model, stochastic process, systematic trading, time value of money, transaction costs, value at risk, Wiener process, zero-coupon bond

These all work similarly and are typically referred to by the name Treasuries. Zero Coupon Bonds. As their name implies, zero coupon bonds do not have a coupon payment. Instead, they are issued at a discount to their par value. Asset‐Backed Securities (ABS). An asset‐backed security is a type of collateralized bond that has an asset or pool of assets pledged to (Continued) 50 RISK MANAGEMENT IN TRADING KEY CONCEPT: (Continued ) help repay the bond. The asset backing the loan might be a physical asset (like manufacturing equipment) or an expected stream of income (like taxes or rental income). Mortgage‐Backed Securities (MBS). A mortgage‐backed security is a special type of asset‐backed security that is secured by a pool of real estate mortgages. Unlike many other bonds, borrowers have the ability to repay their mortgages at any time. As a result, MBS lenders face pre‐payment risk—borrowers repaying their loans early (refinancing) if interest rates fall.

He is a regular speaker on the topic of financial modeling and mathematics applied to real world problems. He is the author of the books Energy Trading and Investingg and Energy Investing Demystified. d Davis is director of the Houston chapter of the Global Association of Risk Professionals. 299 Index A ABS. See asset-backed securities acceptance, risk, 29, 267–268 accredited investor, 5 accuracy of simulations, 98 accurate data, 112–115 ADR. See American Depository Receipts American Depository Receipts, 45 American options, 213 approximations, limitations of, 224 arbitrage, 26–27 Asay, 209 asset-backed securities, 49–50 assets financial, 37 real, 35–36 at-close orders, 20 at-open orders, 20 avoidance, risk, 28–29, 267 B back office, 14 backtesting, 1–2, 10 historical, 99 basis, 42 basis points, 48 bid/ask spread, 103 Black 76, 209 Black Scholes formula, 207–212 bond prices, 46 bonds, 45–48 C calculating portfolio value-at-risk, 161–164 profits and losses, 2, 10–11 calculus, 82–83 calculus derivatives, 87–89 calculus integration, 85–87 carrying costs, 234 cash flows, mismatched, 186–187 CDF.


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

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, break the buck, business cycle, 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, fixed income, George Akerlof, Growth in a Time of Debt, income inequality, information asymmetry, invisible hand, Jean Tirole, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Larry Wall, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, margin call, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, negative equity, Nick Leeson, Northern Rock, open economy, peer-to-peer lending, regulatory arbitrage, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Satyajit Das, shareholder value, sovereign wealth fund, technology bubble, The Market for Lemons, the payments system, too big to fail, Upton Sinclair, Yogi Berra

We use the term mortgage-related securities for a broad class of securities containing not only mortgage-backed securities (MBS) but also securities resulting from the securitization of MBS. MBS themselves might serve as collateral for collateralized debt obligations (CDOs) (see, for example, Das 2010, Chapter 9). The idea and the procedure are the same as those for the creation of a mortgage-backed security out of a package of mortgages except that the collateral consists of MBS or more general asset-backed securities (ABS) rather than mortgages. The resulting MBS CDOs or, more generally, ABS CDOs—collateralized debt obligations with MBS or ABS as collateral—might even be securitized further to create ABS CDOs2, CDOs whose collateral consists of ABS CDOs. For the loss estimates, see IMF (2008b). The estimated total losses of financial institutions from the financial crisis in this report are higher than just the losses on subprime-mortgage-related securities ($1.4 trillion), but this larger estimate already includes significant follow-on losses. 3.

Alan Feurer, in “Appeals Court Rules Fed Must Release Loan Reports” (New York Times, March 19, 2010), describes the lengthy legal battle over the information. According to this story, the Federal Reserve, helped by The Clearing House, a consortium of the largest banks, fought to keep the information from becoming public. Barofsky (2012, 88) writes regarding one of the Fed support programs, the so-called Term Asset-Backed Securities Loan Facility (TALF), that “under the terms of one TALF-eligible bond issued by Ford’s finance company, an issuer could take out a TALF loan for $100 million that required him to pay the New York Fed 3.0445 percent interest (about $3 million) for a bond that paid out 6.07 percent (about $6 million), allowing the investor to pocket the difference of 3 percent (about $3 million) each year.

The Independent Commission on Banking proposed the imposition of significantly stricter regulation than the Basel Committee on Banking Supervision, and Adair Turner, head of the Financial Services Authority, has been a strong advocate for the type of reform we propose in this book (see, e.g., Turner 2010, 2012). Many calls for higher capital requirements have also come from the Bank of England (e.g., Miles et al. 2011, Haldane 2012a,c, and Jenkins 2012a,b). 54. Johnson and Kwak (2010), Dunbar (2011), Barth et al. (2012), and Kane (2012a). 55. These entities had practically no equity. They were funded by short-term borrowing and held various asset-backed securities. An extreme example is Sächsische Landesbank, with more than €40 billion in guarantees to conduits and SIVs when its equity was less than €4 billion. See Acharya et al. (forthcoming). 56. On revolving doors, see Kristina Cooke, Pedro da Costa, and Emily Flitter, “The Ties That Bind at the Federal Reserve,” Reuters, September 30, 2010, and Brooke Masters, “Enter the Revolving Regulators,” Financial Times, April 23, 2012.


pages: 429 words: 120,332

Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens by Nicholas Shaxson

Asian financial crisis, asset-backed security, bank run, battle of ideas, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business climate, call centre, capital controls, collapse of Lehman Brothers, computerized trading, corporate governance, corporate social responsibility, creative destruction, Credit Default Swap, David Ricardo: comparative advantage, Double Irish / Dutch Sandwich, failed state, financial deregulation, financial innovation, Fractional reserve banking, full employment, high net worth, income inequality, Kenneth Rogoff, laissez-faire capitalism, land reform, land value tax, light touch regulation, Long Term Capital Management, Martin Wolf, money market fund, New Journalism, Northern Rock, offshore financial centre, oil shock, old-boy network, out of africa, passive income, plutocrats, Plutocrats, Ponzi scheme, race to the bottom, regulatory arbitrage, reserve currency, Ronald Reagan, shareholder value, The Spirit Level, too big to fail, transfer pricing, Washington Consensus

But in the real world, when the volume of this dealing is a hundred times bigger than the underlying volume of real trade, the results can be catastrophic. “Experience is accumulating,” he said, “that remoteness between ownership and operation is an evil in the relations among men, likely or certain in the long run to set up strains and enmities which will bring to nought the financial calculation.” His words seem more apt than ever in a world where credit derivatives, asset-backed securities, and other products of financial engineering have placed ingenious but impenetrable barriers between investors and the assets they own, becoming great financial tinsel that is repackaged and resold down chains of investors across the planet, at each step being distanced further from the people and businesses who populate the real world. Now consider the offshore system in light of this.

By the time Margaret Thatcher and Ronald Reagan came to power in 1979 and 1981, the political classes in Britain and the United States were losing faith in manufacturing and genuflecting toward finance. Wall Street and the City of London were at the forefront of a global trend of financialization: the reengineering of manufacturing firms as highly leveraged investment vehicles and, soon, the packaging of mortgages into risky asset backed securities for offloading into global markets. Everything was for sale: school playing fields, post offices, army services, and old fish markets. In the offshore centers, the very sovereign laws of nation-states had become available for sale or rent. After Thatcher’s giant deregulatory “Big Bang” of 1986 deepened London’s offshore status as a freewheeling, anything-goes financial center, “light-touch London” broadcast ever stronger antiregulatory impulses around the world, deregulating other economies and their banking systems as if by remote control.

Biondi’s team also wrote the Bank and Trust Company Insurance Powers Act of 1989, authorizing banks to sell and underwrite insurance.20 The Delaware Statutory Trust Act of 1988, giving huge flexibility to people setting up such trusts, and “the protection of trust assets from creditors,” made Delaware the top jurisdiction for setting up so-called Balance Sheet CDOs, which allowed banks to offload their assets onto other investors and were another important contributor to the crisis.21 A new act in January 2000 allowed Limited Liability Partnerships: a major contributor to the degradation of corporate governance, which I will soon explore in detail. There was also the Asset-Backed Securities Facilitation Act of 2002, which further opened the securitization spigots. All these helped Delaware become, as one expert put it, “The Jurisdiction of Choice in Securitisation.”22 Even more broadly, Delaware has played a central role in transforming global banking from its traditional fare of funneling savings into productive investments toward more speculative, risky, fee-based banking models.


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

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

-affiliated areas savings institutions credit unions bank personal trusts life insurance companies other insurance companies private pension funds state and local government retirement funds money market mutual funds mutual funds closed- end funds government-sponsored enterprises brokers/dealers U.S. agency securities total $3,778.3 100.0% $2,848.2 100.0% by type budgetary agencies government-sponsored enterprises federal-related mortgage pools creditors households nonfinancial corporations state and local governments rest of world monetary authority (Fed) commercial banks U.S -chartered foreign banks, US branches bank holding companies banks in US -affiliated areas savings institutions credit unions bank personal trusts life insurance companies other insurance companies WALL STREET owners and issuers of financial instruments, 1997 (cont.) U.S. agency securities (cont.) private pension funds state and local retirement funds money-market mutual funds mutual funds government-sponsored enterprises asset-backed security issuers brokers and dealers total U.S. Treasury and U.S. agency 6,626.5 corporate and foreign bonds total outstanding $3,338.4 100.0% debtors nonfinancial corporations U.S. holdings of foreign issues financial sectors commercial banks savings institutions asset-backed security issuers finance companies real-estate investment trusts brokers and dealers funding corporations creditors households state and local governments foreign holdings of U.S. issues commercial banks savings institutions bank personal trusts life insurance companies other insurance companies private pension funds state and local government retirement funds money market mutual funds mutual funds closed-end funds government-sponsored enterprises brokers and dealers funding corporations APPENDIX owners and issuers of financial instruments, 1997 (cont.)

Treasury market in size — but doesn't trade anywhere near as frenetically, and hasn't made much news since the junk bond boom and bust of the 1980s. Annual turnover amounts to only a few days' worth of Treasury action. While nonfinancial corporate bond debt has grown impressively — from an amount equal to 13% of GDP in 1980 to 18% in 1997 — financial firms were busier issuers, rising from 3% of GDP to 17% over the same period. Much of this was accounted for by the growth in asset-backed securities (ABS) — credit card receivables and mortgages packaged into bonds and sold on the markets rather than remaining with the banks originating the loans). Nonexistent in 1983, ABS issuers' bonds outstanding were worth 9% of GDP in 1997. Such securitization has shifted risk from banks to the institutional investors who buy asset-backed bonds, and has created vast new pots of money to fund the consumer credit boom.

It must be acknowledged that it's a bit misleading to focus on debts without taking note of assets. On debts alone, households, for example, are deep in the red — but households also have assets like durable goods, houses, mutual funds, and stock in unincorporated businesses. Businesses WALL STREET who owes, who's owed credit market debt, end-1997 GSEs: government-sponsored enterprises. ABS: asset-backed securities issuers. Source: flow of funds accounts. PLAYERS have substantial physical assets as well. There's no level of debt that's magically fatal; debts only become insupportable when the incomes or assets underlying them aren't sufficient to cover interest and principal. For every borrower, there must be a lender. A chart of who holds these debts would lack the visual drama of the borrowers' charts.


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

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, break the buck, Bretton Woods, business cycle, 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, creative destruction, 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, information asymmetry, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandatory minimum, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, negative equity, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, Paul Samuelson, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, 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, zero-sum game

It created new forms of non-deposit near-money – notably, money-market funds, predominantly held by households, which financed supposedly safe short-term securities, and repos (repurchase agreements), a form of secured lending by corporate treasurers to investment banks and the investment-banking operations of universal banks (banks that provide both retail and investment-banking services).35 It allowed companies increasingly to issue commercial paper instead of relying on conventional bank loans. It converted conventional loans into tradeable asset-backed securities and CDOs (versions of asset-backed securities in which the repayments were ‘tranched’ or divided, with the highly rated paper receiving the first payments and the lower-rated paper receiving the later payments, if any). It created instruments that insured such assets, known as credit-default swaps, often deemed an adequate substitute for the capital required by regulators, even though they did not in any way increase the capital in the system.

With more debt relative to equity, and overvalued asset prices, the outcome was extreme vulnerability to crisis. In addition, the market-based financial system embedded an enormous amount of leverage inside financial instruments. Collateralized debt obligations (CDOs) are an excellent example, with leverage inherent in the process of tranching cash inflows. Synthetic CDOs, which are created by pooling and tranching credit-default swaps on asset-backed securities and other bonds, involve much the same process. Think of the simplest possible CDO, one in which the underlying interest payments and mortgage repayments are divided into just two securities: the lower risk of these two securities would be entitled to receive the first 50 per cent of all the payments and repayments; the higher risk of these securities would get the rest. Even if half the underlying borrowings ended up in default, the lower-risk security would remain serviced, but the higher-risk security would be wiped out.

This panic could have been avoided in two ways: by saving Lehman or by putting in place immediately after its failure comprehensive and unconditional guarantees for other financial institutions, which governments all over the world introduced anyway, but a crucial month too late.73 The view that there was a panic that could – and should – have been prevented is consistent with what we know about financial crises in general and this crisis in particular. It is also consistent with evidence on the pricing of assets that were at the heart of the crisis. As Figure 28 shows, a substantial recovery of the AAA-rated tranches has occurred since the huge collapse in the price of subprime asset-backed securities. The panic, which saw values of these tranches fall to 60 per cent of par in early 2009, was overdone, as is usual. At the same time, the panic was due to something real, as the pricing of lower tranches shows. This also is usual. But it was a panic and that, as Bagehot had argued, had to be halted. It was halted, in the end, but only after it had caused huge damage. Many argued, both at the time and afterwards, that the panic should have been allowed to take its course, anything else being a ‘bailout’.


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

Affordable Care Act / Obamacare, asset-backed security, Atul Gawande, bank run, banking crisis, Basel III, Bernie Madoff, Bernie Sanders, break the buck, Buckminster Fuller, Carmen Reinhart, central bank independence, collateralized debt obligation, correlation does not imply causation, creative destruction, 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, Kickstarter, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, Nate Silver, negative equity, 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, selection bias, short selling, sovereign wealth fund, The Great Moderation, The Signal and the Noise by Nate Silver, Tobin tax, too big to fail, working poor

One reason Americans can usually get a credit card or borrow at reasonable rates to buy a car or grow a business is that lenders can package the loans into “asset-backed securities” and sell them to investors. But after the Lehman panic, when no one knew what anything was worth, these securitization markets shut down. Investors stopped buying the loans, so many lenders stopped making them. The spreads on auto loans and student loans quickly tripled. In November 2008, the Fed had announced a new program designed to bypass the banks to kick-start the securitization markets: the Term Asset-Backed Securities Loan Facility. We designed TALF to create investor demand for high-quality asset-backed securities by accepting them as collateral for Fed loans. There was also a twist: Treasury would provide $20 billion from TARP to absorb losses on the securities, and the Fed would leverage that capital to provide $200 billion in financing to help investors buy them.

TALF wouldn’t get much media attention, but it would be remarkably effective, reviving stalled credit markets that were vital to the American Dream. The securitization markets for auto loans, student loans, and other consumer loans that had disappeared after Lehman quickly rebounded after the launch of TALF. It would be one of the least controversial planks of our strategy, because it wasn’t about the banks. But we still had to figure out what to do about the banks. TALF Revived Consumer Lending Markets Consumer Asset-Backed Securities Issuance The markets for auto loans, credit cards, and other consumer credit (excluding mortgages) that could be packaged into securities averaged nearly $20 billion per month in 2007 before grinding to a halt after Lehman fell. The Fed-Treasury TALF program brought these securitization markets back to life. They averaged about $13 billion per month after TALF launched in March 2009.

I saw her point—I sometimes told the Germans that I was more German than they realized—but the lines she was drawing in the sand were limiting Europe’s options. Our preferred solution was for Europe to expand the firepower of its rescue fund by using it to leverage the ECB’s balance sheet. The central bank could provide much more aggressive financing, with the government fund protecting it against potential losses. We had done something similar with the Term Asset-Backed Securities Lending Facility during our crisis, jump-starting U.S. consumer credit markets by using a little government money to leverage a lot of Fed financing. The central bankers for Canada and Switzerland, Mark Carney and Philipp Hildebrand, pitched the idea of a TALF for Europe, but the German government and especially its central bank, the Bundesbank, still didn’t like the idea. At one point, the Europeans began reaching out to Asian governments for financing they could use to augment their rescue fund, a pretty amazing spectacle.


Principles of Corporate Finance by Richard A. Brealey, Stewart C. Myers, Franklin Allen

3Com Palm IPO, accounting loophole / creative accounting, Airbus A320, Asian financial crisis, asset allocation, asset-backed security, banking crisis, Bernie Madoff, big-box store, Black-Scholes formula, break the buck, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, carried interest, collateralized debt obligation, compound rate of return, computerized trading, conceptual framework, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-subsidies, discounted cash flows, disintermediation, diversified portfolio, equity premium, eurozone crisis, financial innovation, financial intermediation, fixed income, frictionless, fudge factor, German hyperinflation, implied volatility, index fund, information asymmetry, intangible asset, interest rate swap, inventory management, Iridium satellite, Kenneth Rogoff, law of one price, linear programming, Livingstone, I presume, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, market friction, money market fund, moral hazard, Myron Scholes, new economy, Nick Leeson, Northern Rock, offshore financial centre, Ponzi scheme, prediction markets, price discrimination, principal–agent problem, profit maximization, purchasing power parity, QR code, quantitative trading / quantitative finance, random walk, Real Time Gross Settlement, risk tolerance, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, Silicon Valley, Skype, Steve Jobs, The Nature of the Firm, the payments system, the rule of 72, time value of money, too big to fail, transaction costs, University of East Anglia, urban renewal, VA Linux, value at risk, Vanguard fund, yield curve, zero-coupon bond, zero-sum game, Zipcar

On average, investors in these bonds can expect to recover nearly two-thirds of the amount of the loan. At the other extreme, recovery rates for junior unsecured bondholders are only 15% of the face value of the debt. FIGURE 24.2 Ultimate percentage recovery rates on defaulting debt by seniority and security, 1987–2010. Source: Moody’s “Moody’s Ultimate Recovery Database.” Asset-Backed Securities Instead of borrowing money directly, companies sometimes bundle up a group of assets and then sell the cash flows from these assets. This issue is known as an asset-backed security, or ABS. The debt is secured, or backed, by the underlying assets. Suppose your company has made a large number of mortgage loans to buyers of homes or commercial real estate. However, you don’t want to wait until the loans are paid off; you would like to get your hands on the money now. Here is what you do.

23-2 The Option to Default How the Default Option Affects a Bond’s Risk and Yield/A Digression: Valuing Government Financial Guarantees 23-3 Bond Ratings and the Probability of Default 23-4 Predicting the Probability of Default Credit Scoring/Market-Based Risk Models 23-5 Value at Risk Summary Further Reading Problem Sets Finance on the Web 24 The Many Different Kinds of Debt 24-1 Long-Term Bonds Bond Terms/Security and Seniority/Asset-Backed Securities/Sinking Funds/Call Provisions/Bond Covenants/Privately Placed Bonds/Foreign Bonds, Eurobonds, and Global Bonds 24-2 Convertible Securities and Some Unusual Bonds The Value of a Convertible at Maturity/Forcing Conversion/Why Do Companies Issue Convertibles?/Valuing Convertible Bonds/ A Variation on Convertible Bonds: The Bond–Warrant Package/Innovation in the Bond Market 24-3 Bank Loans Commitment/Maturity/Rate of Interest/Syndicated Loans/Security/Debt Covenants 24-4 Commercial Paper and Medium-Term Notes Commercial Paper/Medium-Term Notes Summary Further Reading Problem Sets Mini-Case: The Shocking Demise of Mr.

Remember the saying, “A million dollars here and a million there—pretty soon it begins to add up to real money.”1 Figure 24.1 provides a road map through this chapter. Our initial focus is on the long-term bond market. In Section 24-1 we concentrate on the more standard bonds. We examine the differences between senior and junior bonds and between secured and unsecured bonds, including a special kind of secured bond called an asset-backed security. We describe how bonds may be repaid by means of a sinking fund and how the borrower or the lender may have an option for early repayment. As we review these different features of corporate debt, we try to explain why sinking funds, repayment options, and the like exist. They are not simply matters of custom or neutral mutations; there are generally good reasons for their use. In Section 24-2 we look at some less common bonds, starting with convertible bonds and their close relative, the package of bonds and warrants.


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

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

And on and on; a cascading waterfall of cash thrown off by debtors each month as they sat down to pay their credit card bills, home mortgages, car loans, and student loans; the cash bucket—minded by investment bankers as trustees—filling up and then spilling into different pools to pay different investors (maybe even some of the same investors who were writing the checks). After all, asset-backed securities were then widely held by mutual funds, money market funds, and pension funds, which in turn were invested in by ordinary savers. The principle of securitization has remained the same since the eighteenth century. If you pool enough risky debt together, and the risk of default is sufficiently uncorrelated, then you can structure part of the resulting cash flow into a safer security. An asset-backed security also has the extra benefit of a claim on an underlying real asset. It is not like the holder of a mortgage-backed security must simply rely on the earnest promises of a homeowner. If the homeowner fails to pay, you can foreclose.

REIGN OF TERROR In France, the theory of a land bank—of paper currency collateralized by property—became a bloody reality during the Reign of Terror. Despite the long shadow of John Law and France’s aversion to financial engineering after the Mississippi Bubble, the revolutionary Jacobin government had few means of financial support and no convincing basis for issuing fiat money. It turned instead to asset-backed securities. Money backed by property. The French government seized the property of the Catholic Church and then began to pay its bills in paper vouchers (assignats), which could be used in public auctions to purchase the nationalized church properties. In some ways, the assignats were a realization of John Law’s earlier vision of a currency based on property rather than on gold or silver reserves (see Chapter 20).

Merchants in Amsterdam and other major Dutch cities devised methods for financing their commodity trade. The plantation loan system began as a means to finance transatlantic commodity trade, but the merchants who led the way in this financial innovation ultimately developed into the world’s first investment bankers. Although they continued merchant trade, they discovered that the underwriting and issuance of asset-backed securities was extremely profitable. The American Revolution played a key part in the development of a new transatlantic financial system. We saw how Americans sidestepped the regulatory backlash in Europe against equity markets and paper money. The chronic lack of hard currency in the colonies meant that some financial engineering was crucial—a key insight of John Law. America was currency poor but land rich, and this inexorably led to the use of property as collateral—as the underlying source of value—in the financial system.


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End This Depression Now! by Paul Krugman

airline deregulation, Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, business cycle, capital asset pricing model, Carmen Reinhart, centre right, correlation does not imply causation, credit crunch, Credit Default Swap, currency manipulation / currency intervention, debt deflation, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, full employment, German hyperinflation, Gordon Gekko, Hyman Minsky, income inequality, inflation targeting, invisible hand, Joseph Schumpeter, Kenneth Rogoff, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, low skilled workers, Mark Zuckerberg, money market fund, moral hazard, mortgage debt, negative equity, paradox of thrift, Paul Samuelson, price stability, quantitative easing, rent-seeking, Robert Gordon, Ronald Reagan, Upton Sinclair, We are the 99%, working poor, Works Progress Administration

More broadly, policies to reduce the burden of debt one way or another, such as mortgage relief, could and should be a part of achieving a lasting exit from depression. But that’s getting ahead of ourselves. Before taking on the full outlines of a recovery strategy, I want to spend the next few chapters delving more deeply into how we got into this depression in the first place. CHAPTER FOUR BANKERS GONE WILD [R]ecent regulatory reform, coupled with innovative technologies, has stimulated the development of financial products, such as asset-backed securities, collateral loan obligations, and credit default swaps, that facilitate the dispersion of risk. . . . These increasingly complex financial instruments have contributed to the development of a far more flexible, efficient, and hence resilient financial system than the one that existed just a quarter-century ago. —Alan Greenspan, October 12, 2005 IN 2005 ALAN GREENSPAN was still regarded as the Maestro, a source of oracular economic wisdom.

The wizards of Wall Street, said Greenspan, had ensured that nothing like the great financial disruptions of the past could happen again. Reading those words now, one is struck by how perfectly Greenspan got it wrong. The financial innovations he identified as sources of improved financial stability were precisely—precisely—what brought the financial system to the brink of collapse less than three years later. We now know that the sale of “asset-backed securities”—basically, the ability of banks to sell bunches of mortgages and other loans to poorly informed investors, instead of keeping them on their own books—encouraged reckless lending. Collateralized loan obligations—created by slicing, dicing, and pureeing bad debt—initially received AAA ratings, again sucking in gullible investors, but as soon as things went bad, these assets came to be known, routinely, as “toxic waste.”

academic sociology, 92, 96, 103 AIG, 55 airlines, deregulation of, 61 Alesina, Alberto, 196–99 American Airlines, 127 American Recovery and Reinvestment Act (ARRA): cost of, 121 inadequacy of, 108, 109–10, 116–19, 122–26, 130–31, 212, 213 Angle, Sharron, 6 anti-Keynesians, 26, 93–96, 102–3, 106–8, 110–11, 192 Ardagna, Silvia, 197–99 Argentina, 171 Arizona, housing bubble in, 111 Asian financial crisis of 1997–98, 91 asset-backed securities, 54, 55 auction rate securities, 63 Austerians, 188–207 creditors’ interests favored by, 206–7 supposed empirical evidence of, 196–99 austerity programs: alarmists and, 191–95, 224 arguments for, 191–99 economic contraction and, 237–38 in European debt crisis, 46, 144, 185, 186, 188 as ineffective in depressions, xi, 213 state and local governments and, 213–14, 220 unemployment and, xi, 189, 203–4, 207, 237–38 Austrian economics, 150 automobile sales, 47 babysitting co-op, 26–28, 29–30, 32–33, 34 Bakija, Jon, 78 balance of trade, 28 Ball, Laurence, 218 Bank for International Settlements (BIS), 190, 191 Bank of England, 59 Bank of Japan, 216, 218 bankruptcies, personal, 84 bankruptcy, 126–27 Chapter 11, 127 banks, banking industry: capital ratios in, 58–59 complacency in, 55 definition of, 62 deregulation of, see deregulation, financial European, bailouts of, 176 government debt and, 45 “haircuts” in, 114–15 incomes in, 79–80 lending by, 30 money supply and, 32 moral hazard in, 60, 68 1930s failures in, 56 origins of, 56–57 panics in, 4, 59 political influence of, 63 receivership in, 116 regulation of, 55–56, 59–60, 100 repo in, 62 reserves in, 151, 155, 156 revolving door in, 86, 87–88 risk taking in, see risk taking runs on, 57–58, 59, 60, 114–15, 155 separation of commercial and investment banks in, 60, 62, 63 shadow, 63, 111, 114–15 unregulated innovations in, 54–55, 62–63, 83 Barro, Robert, 106–7 Bebchuck, Lucian, 81 Being There (film), 3 Bernanke, Ben, 5, 10–11, 32, 76, 104, 106, 151, 157, 159–60, 210 recovery and, 216–19 on 2008–09 crisis, 3–4 “Bernanke Must End Era of Ultra-low Rates” (Rajan), 203–4 Black, Duncan, 190 Blanchard, Olivier, 161–63 Bloomberg, Michael, 64 BNP Paribas, 113 Boehner, John, 28 bond markets: interest rates in, 132–41, 133 investor confidence and, 132, 213 bonds, high-yield (junk bonds), 115, 115 bond vigilantes, 125, 132–34, 138, 139, 140 Bowles, Erskine, 192–93 Brazil, 171 breach of trust, 80 Bretton Woods, N.H., 41 Broder, David, 201 Brüning, Heinrich, 19 Buckley, William F., 93 Bureau of Labor Statistics, U.S.


pages: 1,202 words: 424,886

Stigum's Money Market, 4E by Marcia Stigum, Anthony Crescenzi

accounting loophole / creative accounting, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Black-Scholes formula, Brownian motion, business climate, buy and hold, capital controls, central bank independence, centralized clearinghouse, corporate governance, credit crunch, Credit Default Swap, currency manipulation / currency intervention, David Ricardo: comparative advantage, disintermediation, distributed generation, diversification, diversified portfolio, financial innovation, financial intermediation, fixed income, full employment, high net worth, implied volatility, income per capita, intangible asset, interest rate derivative, interest rate swap, large denomination, locking in a profit, London Interbank Offered Rate, margin call, market bubble, market clearing, market fundamentalism, money market fund, mortgage debt, Myron Scholes, offshore financial centre, paper trading, pension reform, Ponzi scheme, price mechanism, price stability, profit motive, Real Time Gross Settlement, reserve currency, risk tolerance, risk/return, seigniorage, shareholder value, short selling, technology bubble, the payments system, too big to fail, transaction costs, two-sided market, value at risk, volatility smile, yield curve, zero-coupon bond, zero-sum game

Worldwide, existing commercial paper markets are growing and new ones are being created; in the United States, the original home of this market, commercial paper outstanding now exceeds T-bills outstanding (Chapter 22). The markets have also seen sharp growth in the market for medium-term notes, domestic and European (Chapter 24). Yet another example of securitization is the packaging of receivables, such as car loans, into negotiable securities known as asset-backed securities (ABS), dubbed CARS in the case of auto loans. Home equity loans, mortgage loans, student loans, and credit card debts have also been packaged as asset-backed securities. The asset-backed securities market has seen sharp growth in recent years, with record issuance in each of the five years ended in 2005, according to the Bond Market Association. The biggest part of the $2 trillion ABS market in the middle of 2006 was the market for home equity loans, followed by credit card receivables.

BANK SALES OF ASSET-BACKED PAPER The market for asset-backed paper has grown substantially, with issuance topping $3 trillion for the first time ever in 2006, at $3.2 trillion (note that in April 2006, the Federal Reserve began reporting asset-backed commercial paper as a separate classification rather than as part of financial commercial paper). Investors have been drawn to the asset-backed securities (ABS) market in recent years for its attractive yield spreads and relatively good credit quality. For the money market, the growth of the asset-backed market has created a vast new pool of instruments for investors to choose from. For example, the money market investor can choose to buy short-term receivables from a credit card issuer and from a wide variety of issuers with a wide variety of terms. For issuers, the growth of the asset-backed securities market has significantly expanded the pool of funding sources to include the broad array of fixed-income investors, a market consisting of $26 trillion in mid-2006.

Ford Motor Credit might, for example, have a lot of auto loan receivables that it wants to finance. It could go to JPMorgan and have Morgan create and sell a registered asset-backed security for them. For some, that can be too expensive an alternative. For companies such as Ford, the securitization of loans can help them to remove receivables from their balance sheets, which is a good idea from an accounting perspective. Although the costs of securitization are prohibitive for smaller companies, innovations in trust structures, such as the master trusts and issuance trusts that are created just prior to the issuance of asset-backed securities such as credit card ABS, have enabled issuers to lower issuance costs and thus increase the appeal of ABS issues to investors. An alternative for those that do not securitize their loans is to go to a bank like Morgan and arrange a bank-purchased deal.


pages: 397 words: 112,034

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

affirmative action, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Black Swan, Bretton Woods, business cycle, capital controls, Cass Sunstein, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate social responsibility, creative destruction, 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, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Just-in-time delivery, Kenneth Rogoff, Long Term Capital Management, Mahatma Gandhi, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, money market fund, 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, Westphalian system, WikiLeaks, women in the workforce, yield curve

Source: Federal Reserve The overall conclusion is that, as far as the United States is concerned, many executives in the commercial banking sector have had excusable difficulty understanding why international regulators were able to persuade themselves that extra capital was needed. The investment banks did indeed have a serious problem in 2008, because most of them (including the most risky tranches of asset-backed securities) had been manufacturing inordinate quantities of “structured products” during the boom and still held large amounts of inventory when the crisis broke. They did suffer losses running into many tens of billions of dollars. In this sense the post-2007 crisis was specific to this particular type of institution and, in fact, largely to the well-known names (Lehman Brothers, Bear Stearns, Citigroup, and Merrill Lynch, plus some specialist mortgage lenders in the commercial banking sector).

According to the Wall Street Journal, President Obama said that it was “shameful” that Wall Street workers received more than $18 billion in bonuses in 2008 while their firms were receiving taxpayer help.7 Five principles have been enunciated by the US Treasury Department regarding compensation: compensation plans should properly measure and reward performance; compensation should be structured to account for the time horizon of risk; compensation practices should be aligned with sound risk management; golden parachutes and supplemental retirement packages should be reexamined to determine whether they align the interests of executives and shareholders; and promote transparency and accountability in the process of setting compensation. The Government’s Role in Creating a Culture of Ethics The government has a crucial role in creating a culture of ethics within corporations, particularly now in the era of the Troubled Asset Relief Program (TARP) and the Term Asset-Backed Securities Loan Facility (TALF). The US government, at the federal, state, and local levels, needs to provide vigilant enforcement of all applicable laws and regulations. As set forth in Malcolm Gladwell’s Tipping Point,8 in the “broken window” scenario, minor infractions of the law can signal that much larger violations are in fact occurring. Therefore, by fixing the “broken windows” and charging violators who break the windows, law enforcement signals that those who violate the law through minor infractions (such as breaking windows or drinking alcohol in public) will not be tolerated by the police and will lead to arraignment and conviction for so-called petty crimes.

MONETARY BASE: The currency in circulation and reserves that commercial banks hold in their accounts with the central bank. It expresses the relations of the central bank with the other sectors of the economy. MONETARY UNION: Two or more countries that share a common currency. MONETIZING DEBT: A two-step process in which the government issues debt to finance its spending and the central bank purchases the debt from the public. MORTGAGE-BACKED SECURITY (MBS): A type of asset-backed security that is secured by a mortgage or collection of mortgages that originate from a regulated or authorized financial institution. MULTILATERAL DEBT REDUCTION INITIATIVE: A G-8 agreement from 2006 that relieved the debt burden of certain Highly Indebted Poor Countries through debt write-offs. Other countries would be eligible for debt write-offs contingent upon the meeting of certain conditions.


pages: 479 words: 113,510

Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America by Danielle Dimartino Booth

Affordable Care Act / Obamacare, asset-backed security, bank run, barriers to entry, Basel III, Bernie Sanders, break the buck, Bretton Woods, business cycle, central bank independence, collateralized debt obligation, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, George Akerlof, greed is good, high net worth, housing crisis, income inequality, index fund, inflation targeting, interest rate swap, invisible hand, John Meriwether, Joseph Schumpeter, liquidity trap, London Whale, Long Term Capital Management, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, moral hazard, Myron Scholes, natural language processing, negative equity, new economy, Northern Rock, obamacare, price stability, pushing on a string, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, short selling, side project, Silicon Valley, The Great Moderation, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, yield curve

For others, Lehman’s collapse proved a death knell. The Fed had been forced by its own mistakes into creating an elaborate alphabet soup of backstops for the shadow banking system, which included: The Commercial Paper Funding Facility (CPFF), to backstop commercial paper and asset-backed commercial paper (ABCP) issuance of loan originators and loan warehouses. The Term Asset-Backed Securities Loan Facility (TALF), to backstop asset-backed securities (ABSs). (This is not to be confused with the Term Securities Lending Facility [TSLF], which provided twenty-eight-day liquidity to primary dealers.) Maiden Lane LLC, to backstop Bear Stearns’s ABS warehouse. Maiden Lane II LLC, to backstop AIG’s various mortgage-backed securities. Maiden Lane III LLC, to backstop AIG’s toxic credit default swaps and CDOs.

The resurrection of OBS vehicles had been made possible because banking had been reshaped by deregulation, innovation, and competition. Then the Fed lowered interest rates, creating “an abundance of credit for borrowers and a scarcity of yield for investors.” (Thank you, Alan Greenspan!) Pozsar pinpointed the 1988 Basel I Accord as the main catalyst for the growth and advances of “credit risk transfer instruments” like CDOs, MBSs, asset-backed securities (ABS), asset-backed commercial paper (ABCP), commercial mortgage-backed securities (CMBS), and so on. Issued after the banking crises of the late 1980s, the new Basel rules required that banks meet a minimum capital requirement and hold even more against riskier assets. For investment bankers seeking to maximize profits, and thus their own compensation, the changes created the need to hide liabilities in the shadows.

., 109 Stiglitz, Joseph, 199, 260 stock buybacks, 7 Stockman, David, 196 stock market Bernanke’s “additional stimulus” speech in August 2010 and, 193 Black Monday, 64–65 end of QE2 and, 217–18 flash crash, 189–90 low conviction rallies, 2010, 185, 188 9/11 terrorist attacks impact on, 223–24 percentage of U.S. adults invested in, 8–9 rally of, in April–May 2009, 174 reaction to bad news, late 2009, 181, 184 record lows, in March 2009, 171 TARP bailout bill and, 143 VIX and, 187, 188 Stockton, David, 194 Stress Test (Geithner), 52 stress tests, 170–71 Strong, Benjamin, 53 structured investment vehicles (SIVs), 123–24 subprime mortgages, 21, 22, 27, 28 Summers, Larry, 15–17, 53, 95, 234–35 Supervisory Capital Assessment Program (SCAP), 171 synthetic collateralized debt obligations, 124 systemic risk, 26, 28, 252 System Open Market Account (SOMA), 29, 52 taper tantrum, 233 Tarullo, Daniel, 43, 211, 258–59 Taylor, John, 82, 198 Term Asset-Backed Securities Loan Facility (TALF), 167, 168 Term at the Fed, A (Meyer), 153 Term Auction Facility (TAF), 168 Term Securities Lending Facility (TSLF), 154 Tett, Gillian, 192 Thain, John, 135, 136, 146 Tice, David, 21 Time, 15, 182 Tishman Speyer, 133 Tobin, James, 85–86 Toyota, 241 tri-party repo agreements, 127 troubled asset relief program (TARP), 142–43 Trump, Donald, 9 Tyco, 107 UBS, 120, 168 unemployment, 171, 192, 195, 210 Vasiliauskas, Vitas, 261 Verizon, 169 Vitner, Mark, 40 VIX, 187, 188 Volcker, Paul, 48, 53, 60, 62, 93, 187–88, 219–20, 238 Volcker Rule, 226 Von Mises, Ludwig, 88 Wachovia, 121 Waldman, Maryanne, 222 Wall Street Journal, 106, 119, 167, 175, 177, 217 Warren, Elizabeth, 246, 258 Warsh, Kevin, 113, 181, 193, 197–98, 211, 234 Washington Mutual, 121, 143 wealth effect, 6–7 Wealth of Nations, The (Smith), 125–26 Weill, Sanford, 29, 110 Weintraub, Robert E., 60 Wells Fargo, 178 “When Does Narcissistic Leadership Become Problematic?”


pages: 823 words: 206,070

The Making of Global Capitalism by Leo Panitch, Sam Gindin

accounting loophole / creative accounting, active measures, 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, business cycle, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collective bargaining, continuous integration, corporate governance, creative destruction, 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, Kickstarter, land reform, late capitalism, liberal capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, manufacturing employment, market bubble, market fundamentalism, Martin Wolf, means of production, money market fund, money: store of value / unit of account / medium of exchange, Monroe Doctrine, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, 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, zero-sum game

As Ralph Nader put it, referring especially to the tax deduction allowed on mortgage-interest payments, Fannie and Freddie “swiftly and skillfully managed to pick up the roughshod tactics of the private corporate world and at the same time cling tightly to the federal government’s deepest and most lucrative welfare troughs.”23 Above all, given the implicit guarantee the federal government gave to GSE securities, financial markets regarded them as virtually as safe as Treasury securities while yielding a higher return—no small consideration at a time when interest rates on Treasuries were effectively negative. Commercial banks competed to extend residential mortgages in order to bundle them and transfer them to investment banks as well as to Fannie Mae and Freddie Mac. Between 1990 and 2006, the amount of residential debt held by issuers of asset-backed securities increased from $55 billion to over $2 trillion. As house prices increased after 2000 especially (by 60 percent more than inflation—the most in over half a century), banks increasingly shifted the debt on their books to the financial marketplace. This allowed them to minimize the constraints posed by Basel capital standards, and made them more willing to increase their exposure to low-income households.

As the Fed began to raise interest rates in mid 2004 (to over 5 percent by mid 2006), partly in an effort to gradually deflate the housing bubble, it faced what Greenspan called a “conundrum.”28 Housing prices peaked in 2005, accompanied by a dramatic rise in the number of mortgage defaults; yet since foreign capital was attracted all the more by the higher interest rates, there was no drying up of mortgage credit, and house-building starts only peaked at the beginning of 2006. But the end was nigh: between the last quarter of 2005 and mid 2007, residential investment fell by 22 percent, along with a sharp reduction in the number of subprime borrowers. As the rise in the default rate of non-prime borrowers started to exceed projections, the issuance of asset-backed securities slumped by almost 30 percent. Securitization everywhere quickly lost a lot of its luster, as banks ended up holding assets that they were unable to value, and rating agencies now fueled the problem by downgrading the risky securities they had previously treated as virtually equivalent to US Treasury bonds. It was now clear that once a debt had been sold on, sliced up, and mixed with a variety of other debts, there was little hope of establishing in any meaningful way the value of the resulting asset.

But it was the special value and liquidity of US Treasury bonds for both governments and private investors that was the main factor driving the international flight to the dollar. By early 2009, the market for US Treasury debt was virtually the only financial sector marked by vigorous growth and trading.61 Investment firms that had spent most of the past decade playing the markets for corporate stock and asset-backed securities now shifted their attention and resources to government bond trading, in large part to exploit some of the bountiful opportunities offered by the mammoth expansion of Treasury debt sales (this was also a hedge against the very real threat of deflation).62 It was not only financial linkages that were at work here. US consumption had accounted for over a third of the growth in global consumption between 2000 and 2007.63 Through 2007, global exports increased at more or less the same rate as in the period since 1994 (an average of 7.4 percent per year); then, in 2008, global export growth slowed to 3.4 percent; and in 2009 global exports decreased by an unprecedented 11.3 percent (the last decrease was in 1975, when, amid the twinned economic and energy crises, global exports fell by 2.9 percent).


pages: 263 words: 80,594

Stolen: How to Save the World From Financialisation by Grace Blakeley

"Robert Solow", activist fund / activist shareholder / activist investor, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, basic income, battle of ideas, Berlin Wall, Big bang: deregulation of the City of London, bitcoin, Bretton Woods, business cycle, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collective bargaining, corporate governance, corporate raider, credit crunch, Credit Default Swap, cryptocurrency, currency peg, David Graeber, debt deflation, decarbonisation, Donald Trump, eurozone crisis, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, fixed income, full employment, G4S, gender pay gap, gig economy, Gini coefficient, global reserve currency, global supply chain, housing crisis, Hyman Minsky, income inequality, inflation targeting, Intergovernmental Panel on Climate Change (IPCC), Kenneth Rogoff, Kickstarter, land value tax, light touch regulation, low skilled workers, market clearing, means of production, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, negative equity, neoliberal agenda, new economy, Northern Rock, offshore financial centre, paradox of thrift, payday loans, pensions crisis, Ponzi scheme, price mechanism, principal–agent problem, profit motive, quantitative easing, race to the bottom, regulatory arbitrage, reserve currency, Right to Buy, rising living standards, risk-adjusted returns, road to serfdom, savings glut, secular stagnation, shareholder value, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, the built environment, The Great Moderation, too big to fail, transfer pricing, universal basic income, Winter of Discontent, working-age population, yield curve, zero-sum game

., Lindner, P. and Blankenheim, J. (2013) “Securitization: Lessons Learned and the Road Ahead”, IMF Working Paper 13/255. https://www.imf.org/external/pubs/ft/wp/2013/wp13255.pdf; Ashcraft, A. and Schuermann, T. (2008) “Understanding the Securitisation of Subprime Mortgage Credit”, Federal Reserve Bank of New York Staff Reports No 318; Lewis, M. (2011) The Big Short: Inside the Doomsday Machine, London: Penguin; National Audit Office (2016) “Introduction to Asset-Backed Securities”, Briefing Paper November 2016. https://www.nao.org.uk/wp-content/uploads/2016/07/Introduction-to-asset-backed-securities.pdf; Bank of England (2008) Financial Stability Report No. 23, April 2008 https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2008/may-2008; Bank of England (2007) Financial Stability Report No. 22, October 2007. 9 This account draws on: Tooze (2018); Fligstein, N. and Goldstein, A. (2012) “A Long Strang Trip The State and Mortgage Securitisation, 1968-2010”, in Preda, A. and Knorr-Cetina, K.

The securities that were tumbling in value had often been used as collateral for this lending. Combined with the general climate of fear and uncertainty as to who was solvent and who wasn’t, banks and their counterparts in the shadow banking system suddenly lost access to funding. When banks could no longer rely on borrowing from other financial institutions to finance their liabilities, they started to sell their assets. Fire sales of asset-backed securities sent their prices tumbling even further. The repo markets that had developed before the crash, which allowed banks to borrow from one another using debt-based securities as collateral, seized up. Adam Tooze puts it succinctly: “Without valuation these assets could not be used as collateral. Without collateral there was no funding. And if there was no funding all the banks were in trouble, no matter how large their exposure to real estate”.


pages: 460 words: 122,556

The End of Wall Street by Roger Lowenstein

Asian financial crisis, asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, break the buck, Brownian motion, Carmen Reinhart, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fear of failure, financial deregulation, fixed income, high net worth, Hyman Minsky, interest rate derivative, invisible hand, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Martin Wolf, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, Ponzi scheme, profit motive, race to the bottom, risk tolerance, Ronald Reagan, Rubik’s Cube, savings glut, short selling, sovereign wealth fund, statistical model, the payments system, too big to fail, tulip mania, Y2K

The government also invested more capital. Finally, in February 2009, the U.S. converted its preferred stock in Citigroup to common, thus relieving the company of the burden of dividend payments and boosting its common equity. 5 Hank Paulson, interview with the author. 6 The Fed’s assets rose from $900 billion in September 2008 to more than $2 trillion a year later. The Fed purchased asset-backed securities via the Term Asset-backed Securities Loan Facility, or TALF, created in November 2008. Commercial paper holdings peaked in January 2009; after that its holdings diminished. However, its inventory of mortgage-backed securities kept growing, reaching $860 billion by September 2009. 7 As the S&P 500 is the mostly widely used barometer of stock market performance, that is the index generally relied on in this book (such as in stating that “stocks” fell 11 percent from New Year’s Day to January 20).

It lent to small businesses, car buyers, consumers. It partially offset the collapse in corporate liquidity by purchasing $350 billion of commercial paper. It stocked up on Treasury bonds in a deliberate attempt to hold down interest rates, lest the government’s borrowing drive rates higher. The Fed’s own assets ballooned two and a half times, as it scooped up mortgages and government bonds and financed investments in asset-backed securities such as student loans, credit card debts, mortgages—all of the unwanted detritus of the bubble years.6 Still the economy kept shrinking. From October of ’08 to the following March, GDP fell at an astounding annualized rate of 6 percent, the worst six-month stretch in fifty years. Fed governors, as well as private economists, were stunned by the sharpness of the downturn. Credit had been in ample supply for so long, it was forgotten that business couldn’t function without it.

Thereafter foreclosures continued at abnormally high rates.11 (One foreclosed dwelling was the ranch house on East Jefferson Street in Dillon, South Carolina, that had been the childhood home of Ben Bernanke.) Commercial real estate remained in a severe downturn. Commercial paper outstanding did not hit bottom until late July. In August, the economy was still so weak that the Fed grimly extended its facility for purchasing asset-backed securities. Bank lending and consumer credit were declining well into the autumn of 2009.12 Even after the crisis had ended, the federal government remained deeply involved in the ordinary business of American households and firms. As late as a year after the Lehman failure, government spending accounted for 26 percent of the U.S. economy—its biggest share since the Truman administration—and Washington continued to provide the financing for nine out of ten new home loans.13 As an indicator of its far-flung reach, the government was actively overseeing General Motors, AIG, Citigroup, Fannie Mae, and Freddie Mac—respectively the country’s biggest car company, biggest insurer, former biggest bank, and the bulwarks of the mortgage industry.bt And the Fed, as of September 30, remained swollen with $2.144 trillion in assets, including roughly $700 billion in the mortgage-backed securities that private investors no longer wanted.


Money and Government: The Past and Future of Economics by Robert Skidelsky

anti-globalists, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, barriers to entry, Basel III, basic income, Ben Bernanke: helicopter money, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, constrained optimization, Corn Laws, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Graeber, David Ricardo: comparative advantage, debt deflation, Deng Xiaoping, Donald Trump, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, Financial Instability Hypothesis, forward guidance, Fractional reserve banking, full employment, Gini coefficient, Growth in a Time of Debt, Hyman Minsky, income inequality, incomplete markets, inflation targeting, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, law of one price, liberal capitalism, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, market clearing, market friction, Martin Wolf, means of production, Mexican peso crisis / tequila crisis, mobile money, Mont Pelerin Society, moral hazard, mortgage debt, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, open economy, paradox of thrift, Pareto efficiency, Paul Samuelson, placebo effect, price stability, profit maximization, quantitative easing, random walk, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, rising living standards, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, secular stagnation, shareholder value, short selling, Simon Kuznets, structural adjustment programs, The Chicago School, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, too big to fail, trade liberalization, value at risk, Washington Consensus, yield curve, zero-sum game

It is the process of bundling together illiquid assets such as car loans, student loans, credit card debt, mortgages and so on to form ‘asset-backed securities’ (ABSs) which are then sold to various investors for ‘cash’. All of these assets have in common the fact that they are associated with a cash flow – borrowers have to repay the loan which backs the security to the security’s buyer. The explosion of securitization was made possible by the huge increase in computing power, 33 and was a classic case of banks creating credit money out of almost nothing. The different kinds of ABS are: 322 w h at wa s w rong w i t h t h e b a n k s? Mortgage Backed Securities (MBSs) This is a type of asset-backed security that is secured by a collection of mortgages. It made possible the banks’ ‘originate and distribute’ model of mortgage-lending, which played a fateful role in igniting the crisis.

Legally, the SPV, not the bank, was the issuer of the securities. The idea was that, once a bank transferred its risky assets to its SPV, it could effectively count them as off its balance sheet and take more risk – e.g. issue more loans – without breaching leverage rules. SPVs were what enabled banks to conceal their embedded leverage. Asset-backed securities, including MBSs and CDOs, had to be moved off banks’ balance sheets using SPVs before they could be sold to investors. SPVs then repackaged asset-backed securities into different tranches to create even more complex securities. What investors failed to notice, however, is that even the safest ‘senior’ tranche was not risk-free. This is because SPVs engaged in ‘re-securitization’. Take the example of CDOs. An SPV could take tranches from two CDOs and bundle them together to form a new CDO of CDOs.

London: Centre for Policy Studies. 460 Index Italic figures refer to graphs and charts Abramovitz, Moses, 157, 158 the Acadamy and scholarship, 11–12, 13 ageing populations, 301–2, 371 AIG bail-out (2008), 325 Albermarle, Duke of, 78 Alesina, Alberto, 192, 231, 233, 241 anthropology, classical, 24 anti-Semitism, 30–31, 131 ‘Aquarius’ CDO structure, 326 Aquinas, Thomas, 28–9 Aristotle, 22, 23, 31 Asian Development Bank Institute, 327 ‘asset-backed commercial paper’ (ABCP), 326 ‘asset-backed securities’ (ABSs), 322–6, 327, 330 Attwood, Thomas, 48 austerity policy, 3, 49, 84, 114, 219, 225 and Bocconi School, 192, 231 and comparative recovery patterns, 241–4, 242, 243, 273, 273–4 cost of to British economy, 243–4, 244, 245 and financial folklore, 235–6 and inequality, 245–6 neo-classical errors, 232–3 Osborne’s crucial mistake, 229–30 Reinhart-Rogoff work, 232 theory behind, 228–35, 236–9 Austria, 91, 92 Austrian School, 46, 104, 192, 226, 296, 349–50 automation, 299, 370–71 Bagehot, Walter, Lombard Street (1873), 50 balance of payments, 103, 142, 143, 144, 145, 150, 152, 153, 159–60, 165, 332 balanced budget theory and gold standard, 56–7 and Keynesian economics, 126–7, 137–8, 142, 143–4, 146, 149–50, 151, 155 as mainstream until Keynes, 76, 95, 98 mandated by EU fiscal rules, 242–3 neo-Victorian reassertion of (from 1980s), 76, 114, 185, 193, 215, 221–2 nineteenth-century fiscal policy, 9, 29, 43, 76, 85, 87–8, 92 and post-2008 austerity policies, 223–4, 227–39, 242–6 461 i n de x balanced budget theory – (cont.) post-W W1 attempts to return to, 106–14 Roosevelt on, 130 Stiglitz’s balanced-budget multiplier, 235* Baldwin, Stanley, 108 Balogh, Thomas, 169 Bank of England 1950s view on monetary policy, 146 actions during 2008 crisis, 234–5, 253–4, 254, 257 Bank Charter Act (1844), 50 Bank Rate, 58, 101–2, 113, 115, 116, 145, 146, 249, 251, 253–6, 254, 261–2, 276 ‘Consols’ (consolidated debt), 43, 80–81 Currency School vs Banking School debate, 49–50 founding of (1694), 42–3, 80 given ‘operational independence’ (1998), 249, 272–3 imposes ‘Corset’ (1973), 168 inflation targeting, 188, 189, 249–53 and ‘law of reflux’, 46 as ‘lender of last resort’, 50, 249 ‘loss function’ for inflation target, 252 macroeconomic model (2004–10), 233, 310, 310–11 Monetary Policy Committee (MPC), 249, 254, 265, 275 during Napoleonic wars, 45–8 power over credit conditions, 105, 115–16 Prudential Regulatory Authority, 363 quantitative easing (QE) by, 254, 257, 259–62, 263–73, 274, 275–7, 276 Bank of International Settlements, 342–3 Bank of Japan, 271 Bank Rate after 2007–8 crisis, 254, 261–2, 279 during 2008 crisis, 253–6, 254, 278 and Bank of England, 58, 101–2, 113, 115, 116, 145, 146, 249, 251, 253–6, 254, 261–2, 276 and broad money monetarism, 186 in Cunliffe’s model, 54, 54–5, 102, 145 after First World War, 101–2 and inflation targeting, 188, 249, 251, 252, 358–9 and Keynes, 101, 102, 115, 166, 255* and managed gold standard, 71 in pre-crash USA, 340 and Radcliffe Report (1959), 146 set by independent central banks, 188, 249–50 and Thornton, 47, 278 transmission mechanism of, 250, 250–51 and Wicksell, 69, 70, 358–9 Banking School, 49–50 banks Austrian School’s 100 per cent reserve requirement, 350, 367 bail-outs, 30, 217, 223, 319–20, 364–5 ‘bank lending channel’, 64 Basel I (1988) and Basel II (2003), 320, 363 Basel III, 363, 364 capital adequacy requirements, 320, 363–4 capital/collateral requirements weakened, 320 collapse of in 2008 crisis, 217, 223, 319 and consolidated debt, 43, 80–81 continued bonuses after crash, 319–20 462 i n de x continued complaints by over regulation, 363–4, 367 creation of money by, 27, 34, 61, 67–8, 71, 311 damage inflicted by, 361–2 deposit and joint-stock banking, 92 deregulation, 307–9, 310–16, 318–22, 328, 332–3 development of modern system, 34 functional separation proposals, 362–3 funding of CR As by, 326–7, 329 Glass–Steagall overturned in USA (1999), 319 growth of unregulated sector, 168 late-medieval rediscovery of, 33–4 leverage concept, 317–18, 322 liquidity concept, 316–17 ‘living wills’, 365 LTROs (long-term refinancing operations), 257 macroprudential regulation, 363–5 maturity mismatch of SPVs, 326 ‘money multiplier’, 35, 64, 146, 179, 185, 258–9, 268–9, 277–8, 280 off balance-sheet assets, 318, 324, 325–6 post-crash reform agenda, 361–8 pre-crash orthodoxy, 5, 308–11 and quantity theory, 61, 64, 65–6, 67–70 reasons for regulation of, 316 reserve or liquidity requirements, 364 root of problem as greed, 365–6 solvency concept, 316–17 ‘stress testing’, 364 see also financial system Barber, Anthony, 167 Barings Bank demise of (1995), 366 rescue of (1890), 50 basic income guarantee, 371 Bavarian Banking Association, 266 Bayes’ theorem, 209 Bear Stearns, 217 ‘behavioural economics’, 388–90 Bernanke, Ben, 105, 179, 188, 248, 256, 275, 278, 334, 344 Besley, Tim, 226, 235 Bible, 30 Bismarck, Otto, 89, 92 Blanchard, Olivier, 230–31, 239 BNDES (Brazilian Development Bank), 354 Bocconi School, 192, 231 Bodin, Jean, 33 Boer War, 86 bond markets, 7, 90–92, 148, 186, 218, 219, 235, 246, 287, 341 Borio, C., 342–3 Brash, Donald, 188 Bretton Woods system, 16, 139, 159, 374–3, 381 collapse of in 1970s, 16–17, 162, 164–5, 166–7, 184 Brexit vote (June 2016), 257, 316*, 373 Britain, xviii adoption of Keynesian policy, 141, 142–3 austerity policy see austerity policy: cost to British economy bullionist vs ‘real bills’ controversy, 44, 45–9 centralization of tax collection, 80 Currency School vs Banking School debate, 44, 49–50 debate on post-crash policy, 225–8 deficit and public sector borrowing statistics (1956–2013), 156 Employment White Paper (1944), 141, 142 463 i n de x Britain – (cont.) final suspension of gold standard (1931), 113, 125 First World War borrowing, 95 fiscal experience (1692–2012), 77 forced out of ERM (1992), 188 GDP per capita growth (1919–2007), 154 ‘Geddes Axe’ (1920s), 108 and gold standard, 9, 42, 43, 44, 45–50, 53, 57–9, 80, 101 and Great Depression, 97, 98, 110–13 growth Keynesianism (1960–70), 148–9, 150–51, 152 industrial relations system, 147, 167–8, 169 inflation peak (1975), 166 inter-war cyclical downturns, 107, 113 and mercantilism, 78–81, 82 monetarism in, 185, 186–8, 189, 192–3, 249 nationalization in post-war period, 142, 158 post-crash bank liquidity ratios, 364 pre-crash housing bubble, 304 ‘prices and incomes policy’ in, 147, 150, 151, 167–8 public finances before 2008 crash, 224, 225 Public Sector Borrowing Requirement (PSBR), 155–6 public spending and tax revenue (1950–2000), 157 rearmament in late 1930s, 113 recession of early 1980s, 186–7 recoinage debate (1690s), 40, 41–3 return to gold standard (1925), 102, 103, 107 sharp rise in inequality since 1970s, 288–9, 299–300, 300 slow recovery from 2008 crash, 241, 242, 243–4, 245, 273, 273–4 ‘stop-go’ in post-war period (‘fine tuning’), 142–3, 145–6, 150, 152 victories over France (eighteenthcentury), 43, 80, 81 see also Bank of England; Conservative Party; Labour Party British Empire, 57, 58, 80 Brittan, Samuel, 225 Brown, Gordon, 193, 220, 221–3, 354, 357 and 2008 crash, 220, 223, 224 declares era of ‘boom and bust’ over, 215 ‘prudence’ as watchword, 226 Bryan, William Jennings, 52 budget deficit see balanced budget theory Buchanan, James, 198 Buffett, Warren, 326 Bundesbank, 140, 154, 257, 275 Bush, George W., 242 business schools, financing of, 13 Cairncross, A.


pages: 443 words: 98,113

The Corruption of Capitalism: Why Rentiers Thrive and Work Does Not Pay by Guy Standing

3D printing, Airbnb, Albert Einstein, Amazon Mechanical Turk, Asian financial crisis, asset-backed security, bank run, banking crisis, basic income, Ben Bernanke: helicopter money, Bernie Sanders, Big bang: deregulation of the City of London, bilateral investment treaty, Bonfire of the Vanities, Boris Johnson, Bretton Woods, business cycle, Capital in the Twenty-First Century by Thomas Piketty, carried interest, cashless society, central bank independence, centre right, Clayton Christensen, collapse of Lehman Brothers, collective bargaining, credit crunch, crony capitalism, crowdsourcing, debt deflation, declining real wages, deindustrialization, disruptive innovation, Doha Development Round, Donald Trump, Double Irish / Dutch Sandwich, ending welfare as we know it, eurozone crisis, falling living standards, financial deregulation, financial innovation, Firefox, first-past-the-post, future of work, gig economy, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, housing crisis, income inequality, information retrieval, intangible asset, invention of the steam engine, investor state dispute settlement, James Watt: steam engine, job automation, John Maynard Keynes: technological unemployment, labour market flexibility, light touch regulation, Long Term Capital Management, lump of labour, Lyft, manufacturing employment, Mark Zuckerberg, market clearing, Martin Wolf, means of production, mini-job, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, Neil Kinnock, non-tariff barriers, North Sea oil, Northern Rock, nudge unit, Occupy movement, offshore financial centre, oil shale / tar sands, open economy, openstreetmap, patent troll, payday loans, peer-to-peer lending, plutocrats, Plutocrats, Ponzi scheme, precariat, quantitative easing, remote working, rent control, rent-seeking, ride hailing / ride sharing, Right to Buy, Robert Gordon, Ronald Coase, Ronald Reagan, Sam Altman, savings glut, Second Machine Age, secular stagnation, sharing economy, Silicon Valley, Silicon Valley startup, Simon Kuznets, sovereign wealth fund, Stephen Hawking, Steve Ballmer, structural adjustment programs, TaskRabbit, The Chicago School, The Future of Employment, the payments system, The Rise and Fall of American Growth, Thomas Malthus, Thorstein Veblen, too big to fail, Travis Kalanick, Uber and Lyft, Uber for X, uber lyft, Y Combinator, zero-sum game, Zipcar

In the USA, the average cost of a college degree has doubled in the past fifteen years, largely due to withdrawal of public funding. Nearly 70 per cent of 2014 graduates had student debt, averaging $29,000 per borrower. Rising default rates and slowing repayments have prompted US federal programmes to ease repayment schedules and make them more affordable. But most students have private loans in addition or instead. It is these that are being bundled into investment assets, known as SLABS (student loan asset-backed securities), and sold off to financial institutions, which earn rental income from the debt repayments. Even so, slower rates of repayment and higher rates of prospective default have hit the price of bonds backed by student debt as the assets are seen as riskier and less attractive to financial investors. Symptomatic of an emerging crisis, in September 2015 US Bancorp dropped an effort to sell a $3 billion portfolio of student loans because the bids were too low.27 As many portfolios are sold to raise money for making further loans to students or consumers, this incipient crisis may drive up the price of loans to students, or even result in a shortage of loans to fill the contrived secondary market.

Encore Capital and Portfolio Recovery Associates, the industry leaders, each collect $1 billion from US consumers every year. Roughly half of that comes from filing hundreds of thousands of court cases against often poor unrepresented debtors, without the means to challenge payment demands that may leave them short of money for food, utility bills and other essentials.34 SLABS (student loan asset-backed securities), mentioned earlier, are an even more speculative form of debt asset. Starting in the USA in a modest way in 1992, SLABS have exploded in size, enabling several venture capital-backed companies to become financial giants. As of 2015, the largest such company was SoFi (Social Finance), which in that year re-financed over $1 billion in student debt held by 13,500 graduates in 2,200 colleges.

W. 1 Phillips curve 1 ‘pig cycle’ effects 1 Piketty, Thomas 1, 2 Pinochet, Augusto 1, 2, 3 platform debt 1 Plato 1 plutocracy 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13 Polanyi, Karl 1 policing 1 political consultancy 1 Politico magazine 1 Ponzi schemes 1 Poor Law Amendment Act (1834) 1 POPS (privately owned public spaces) 1 Portfolio Recovery Associates 1 ‘postcapitalism’ 1 poverty traps 1, 2, 3 precariat and commons 1, 2, 3, 4, 5 and debt 1, 2 and democracy 1, 2 emergence of 1 growth of 1, 2 and rentier platforms 1, 2, 3 revolt of see revolt of precariat predatory creditors 1 ‘primitive rebel’ phase 1 Private Landlords Survey (2010) 1 privatisation and commons 1, 2, 3, 4, 5, 6, 7, 8, 9 and debt 1, 2 and democracy 1 and neo-liberalism 1 and rentier platforms 1 and revolt of precariat 1 and shaping of rentier capitalism 1, 2, 3, 4, 5, 6, 7 professionalism 1 ‘profit shifting’ 1 Property Law Act (1925) 1 Proudhon, Pierre-Joseph 1 Public and Commercial Services Union 1 PricewaterhouseCoopers (PwC) 1, 2, 3. 4, 5, 6 QE (quantitative easing) 1, 2, 3, 4, 5, 6 Quayle, Dan 1 QuickQuid 1 Reagan, Ronald 1, 2 reCAPTCHA security system 1 ‘recognition’ phase 1 ‘redistribution’ phase 1 Regeneron Pharmaceuticals 1 rentier platforms and automation 1 and cloud labour 1 and commodification 1 and ‘concierge’ economy 1 ecological and safety costs 1 and occupational dismantling 1 and on-call employees 1 and precariat 1, 2, 3 and revolt of precariat 1, 2 and ‘sharing economy’ 1, 2, 3, 4 and underpaid labour 1 and venture capital 1 rentiers ascendency of 1, 2 and British Disease 1 classical images of 1 and commons see commons and debt 1, 2, 3, 4, 5, 6, 7 and democracy 1, 2, 3, 4, 5, 6, 7 digital/tasking platforms see rentier platforms ‘euthanasia’ of 1, 2, 3, 4, 5, 6, 7 lies of rentier capitalism 1, 2, 3 revolt of precariat see revolt of precariat shaping of see shaping of rentier capitalism subsidies for 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 ‘representation’ phase 1 ‘repression effect’ 1 Research of Gartner 1 revolt of precariat and basic income systems 1 and commons 1, 2, 3, 4, 5 ‘euthanasia’ of rentiers 1, 2, 3, 4, 5 inequality of rentier capitalism 1, 2, 3 and intellectual property 1, 2, 3 and neo-liberalism 1, 2, 3, 4, 5, 6 organisational forms 1 potential growth of movement 1 progressive political reengagement 1, 2 and rentier platforms 1, 2 rights as demands 1 sovereign wealth funds 1 wage and labour regulation 1, 2 ‘right to buy’ schemes 1, 2, 3, 4 Robbins, Lionel 1 Rockefeller, David 1 Rockefeller, John D. 1 Rolling Stone 1 Romney, Mitt 1 Roosevelt, Franklin D. 1 Ross, Andrew 1 Ross, Michael 1 Rothermere, Viscount 1, 2 Royal Bank of Scotland 1, 2 Royal Mail 1 Royal Parks 1 Rubin, Robert 1, 2 Rudd, Amber 1 Ruralec 1 Ryan, Conor 1 Sainsbury, Lord 1 Samsung 1, 2, 3 Sanders, Bernie 1, 2, 3 Sassen, Saskia 1 school–business partnerships 1 Schröder, Gerhard 1 Schwab Holdings 1 Schwarz, Dieter 1 Scottish Water 1 Second Gilded Age 1, 2, 3 Securitas 1 securitisation 1, 2, 3 selective tax rates 1 Selma 1 shaping of rentier capitalism branding 1 Bretton Woods system 1, 2, 3 and copyright 1 and ‘crony capitalism’ 1, 2, 3 dispute settlement systems 1, 2, 3 global architecture of rentier capitalism 1 lies of rentier capitalism 1 and neo-liberalism 1, 2 patents 1 and privatisation 1, 2, 3, 4, 5, 6, 7 and ‘shock therapy’ 1, 2 trade and investment treaties 1 ‘sharing economy’ 1, 2, 3, 4, 5, 6 Shelter 1 ‘shock therapy’ 1, 2, 3, 4 Shore Capital 1 Sierakowski, Slawomir 1, 2, 3, 4 silicon revolution 1 Simon, Herbert 1 Sirius Minerals 1 Skoll Centre for Social Entrepreneurship 1 Sky UK 1, 2 SLABS (student loan asset-backed securities) 1, 2 Slim, Carlos 1, 2 Smith, Adam 1 Snow, John 1 Social Care Act (2012) 1 social commons 1, 2, 3 social dividend systems 1, 2 social housing 1 ‘social income’ 1, 2, 3, 4, 5, 6, 7, 8 social strike 1 SoFi (Social Finance) 1 Solidarność (Solidarity) movement 1 South West Water 1 sovereign wealth funds 1 spatial commons 1, 2 Speenhamland system 1, 2, 3 Spielberg, Steven 1 Springer 1 ‘squeezed state’ 1 Statute of Anne (1710) 1 Statute of Monopolies (1624) 1 StepChange 1 Stevens, Simon 1 ‘strategic’ debt 1 strike action/demonstrations 1, 2, 3 student debt 1, 2 subsidies 1 and austerity 1, 2 and bank ‘bailouts’ 1 and charities 1 and ‘competitiveness’ 1 direct subsidies 1 and moral hazards 1 and ‘non-dom’ status 1 and quantitative easing 1, 2 for rentiers 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 selective tax rates 1 and sovereign wealth funds 1 subsidised landlordism 1 tax avoidance and evasion 1 tax breaks 1, 2, 3, 4, 5 tax credits 1 Summers, Larry 1, 2 Sun, The 1, 2 Sunday Telegraph 1 Sunday Times 1 Sutton Trust 1 ‘sweetheart deals’ 1 tasking platforms see rentier platforms TaskRabbit 1, 2, 3, 4, 5 Tatler magazine 1 tax avoidance/evasion 1 tax breaks 1, 2, 3, 4, 5 tax credits 1, 2, 3 Tax Justice Network 1 Tax Research UK 1 Taylor & Francis 1 Tennessee Valley Authority 1 ‘tertiary time’ regime 1 Tesco 1 Texas Permanent School Fund 1 Textor, Mark 1 Thames Water 1 Thatcher, Margaret 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 The Bonfire of the Vanities 1 The Constitution of Liberty 1 The General Theory of Employment, Interest and Money 1 The Innovator’s Dilemma 1 think tanks 1 ‘thinner’ democracy 1 ‘Third-Way’ thinking 1, 2, 3 Times, The 1 TISA (Trade in Services Agreement) 1 Tottenham Court Road underground station 1 TPP (Trans-Pacific Partnership) 1, 2, 3 Trades Union Congress 1, 2 ‘tragedy of the commons’ 1 ‘tranching’ of loans 1 Treaty of Detroit (1950) 1, 2 Treuhand 1 TRIPS (Agreement on Trade-Related Aspects of Intellectual Property Rights) 1, 2, 3, 4 trolling (of patents) 1 Trump, Donald 1, 2 TTIP (Trans-Atlantic Trade and Investment Partnership) 1, 2, 3, 4 Turnbull, Malcolm 1 Turner, Adair 1 Twain, Mark 1 Uber 1, 2, 3, 4, 5, 6, 7 ‘ultra-loose’ monetary policy 1 underpaid labour 1 UNESCO (UN Educational, Scientific and Cultural Organization) 1 UNHCR (UN refugee agency) 1 Unison 1 Unite 1 UnitedHealth Group 1 universal credit scheme 1 universal justice 1 UpCounsel 1 Upwork 1, 2 Uruguay Round 1, 2, 3 USPTO (US Patent and Trademark Office) 1 Vattenfall 1 Veblen, Thorstein 1 venture capital 1 Veolia 1 Vero Group 1 Victoria, Queen 1 Villeroy de Galhau, François 1 Vlieghe, Gertjan 1 Warner Chappell Music 1 Watt, James 1 welfare abuse/fraud 1 Wilde, Oscar 1 Wilson, Fergus 1 Wilson, Judith 1 WIPO (World Intellectual Property Organization) 1, 2, 3, 4, 5, 6 Wolf, Martin 1, 2 Wolfe, Tom 1 Wonga 1, 2 Work Capability Assessment 1 Work Programme 1 World Bank 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 World Economic Forum 1 world heritage sites 1 Wriglesworth Consultancy 1 WTO (World Trade Organization) 1, 2, 3, 4, 5, 6 Y Combinator 1 Yanukovych, Viktor 1 Yukos 1 de Zayas, Alfred-Maurice 1 van Zeeland, Marcel 1 Zell, Sam 1 zero-hours contracts 1, 2, 3 Zipcar 1 Copyright First published in Great Britain in 2016 by Biteback Publishing Ltd Westminster Tower 3 Albert Embankment London SE1 7SP Copyright © Guy Standing 2016 Guy Standing has asserted his right under the Copyright, Designs and Patents Act 1988 to be identified as the author of this work.


All About Asset Allocation, Second Edition by Richard Ferri

activist fund / activist shareholder / activist investor, asset allocation, asset-backed security, barriers to entry, Bernie Madoff, buy and hold, capital controls, commoditize, commodity trading advisor, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, equity premium, estate planning, financial independence, fixed income, full employment, high net worth, Home mortgage interest deduction, implied volatility, index fund, intangible asset, Long Term Capital Management, Mason jar, money market fund, mortgage tax deduction, passive income, pattern recognition, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, Sharpe ratio, stocks for the long run, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve

Table 4-2 is a sampling of period returns from the Barclays Capital Intermediate Term Treasury Index and the Barclays Capital U.S. Intermediate Credit Index. “Intermediate” generally means that the bonds in the index mature in 6 to 10 years. For all practical purposes the word credit means “corporate.” The reason the word credit is used rather than “corporate” in bond indexes is a matter of semantics. Corporations do issue all bonds in a credit index; however, a small portion of these bonds are asset-backed securities and commercial mortgages. Assetbacked bonds are backed by receivables such at credit card debt rather than by the corporation that issued the bond. An assetbacked security is its own entity that has its own credit rating. If an Multi-Asset-Class Investing TA B L E 73 4-2 Treasury and Corporate Bond Indexes Year Barclays Intermediate T-Notes Barclays Intermediate Credit Index Credit Return Less T-Note Return 1985 17.8 18.5 0.7 1986 13.0 13.5 0.5 1987 3.6 3.9 0.3 1988 6.3 8.0 1.7 1989 12.7 12.9 0.3 1990 9.5 7.6 –1.8 1991 14.1 16.6 2.5 1992 6.9 8.2 1.2 1993 8.2 11.1 2.9 1994 –1.8 –2.6 –0.9 1995 14.4 19.2 4.8 1996 4.0 4.0 0.0 1997 7.7 8.4 0.7 1998 8.6 8.3 –0.3 1999 0.4 0.2 –0.2 2000 10.3 9.4 –0.8 2001 8.2 9.8 1.6 2002 9.3 10.1 0.8 2003 2.1 6.9 4.8 2004 2.0 4.1 2.1 2005 1.6 1.4 –0.1 2006 3.5 4.5 1.0 2007 8.8 5.6 –3.2 2008 11.4 –2.8 –14.1 2009 –1.4 15.9 17.3 asset-backed bond were to default, the company that packaged the assets into a bond would not be in default and would not be obligated to make the interest and principal payments on the security.

Different categories exhibit unique risks and returns. A diversified fixed-income portfolio enhances return. Low-cost bond mutual funds are an ideal way to invest. There is no lack of diversification potential in the bond market. Fixed-income categories abound with unique investment opportunities. They include government bonds, investment-grade and high-yield corporate bonds, mortgage-backed bonds, asset-backed securities, and foreign debt. Using a broadly diversified fixedincome strategy can increase portfolio return without additional risk. Fixed-income asset allocation is often overlooked in the investment advice industry. Books and articles on asset allocation tend to devote a significant amount of time to the benefits of equity asset diversification while largely ignoring fixed-income selection. It is common for investment managers to place their clients’ entire fixed-income allocation in government bonds only and ignore all other fixed-income categories.

Federal, state, and local governments U.S. government backed Treasury-issued securities (bills, notes, bonds) Government agency issues insured by the Federal Deposit Insurance Corporation (FDIC) Certificates of deposit Fixed-Income Investments 2. 3. 4. 5. 149 State and local government municipal bonds General obligation backed by taxes Revenue bonds backed by income other than taxes Build America bonds (interest is subject to federal income tax) Corporate fixed income Corporate bonds Investment-grade corporate (rated BBB to AAA) Non-investment-grade corporate (rated BB and lower) Industrial revenue bonds (municipal bonds subject to the alternative minimum tax) Convertible bonds Preferred stock and convertible preferred stock Mortgages Government National Mortgage Association (GNMA) Federal Home Loan Mortgage Corporation (FHLMC) Federal National Mortgage Association (FNMA) Asset-backed securities Pooled credit card receivables (Bank One, CitiGroup) Pooled auto loans (Ford, GM) Pooled home equity loans and other bank receivables Foreign bonds Developed markets (sovereign and corporate) Emerging markets debt (sovereign, Brady, and corporate) FIXED-INCOME RISK AND RETURN The expected risk and return of various U.S. fixed-income investments can be categorized on a two-axis Morningstar Fixed-Income Style Box, as illustrated in Figure 8-1.


pages: 391 words: 97,018

Better, Stronger, Faster: The Myth of American Decline . . . And the Rise of a New Economy by Daniel Gross

2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, Affordable Care Act / Obamacare, Airbnb, American Society of Civil Engineers: Report Card, asset-backed security, Bakken shale, banking crisis, BRICs, British Empire, business cycle, business process, business process outsourcing, call centre, Carmen Reinhart, clean water, collapse of Lehman Brothers, collateralized debt obligation, commoditize, creative destruction, credit crunch, currency manipulation / currency intervention, demand response, Donald Trump, Frederick Winslow Taylor, high net worth, housing crisis, hydraulic fracturing, If something cannot go on forever, it will stop - Herbert Stein's Law, illegal immigration, index fund, intangible asset, intermodal, inventory management, Kenneth Rogoff, labor-force participation, LNG terminal, low skilled workers, Mark Zuckerberg, Martin Wolf, Maui Hawaii, McMansion, money market fund, mortgage debt, Network effects, new economy, obamacare, oil shale / tar sands, oil shock, peak oil, plutocrats, Plutocrats, price stability, quantitative easing, race to the bottom, reserve currency, reshoring, Richard Florida, rising living standards, risk tolerance, risk/return, Silicon Valley, Silicon Valley startup, six sigma, Skype, sovereign wealth fund, Steve Jobs, superstar cities, the High Line, transit-oriented development, Wall-E, Yogi Berra, zero-sum game, Zipcar

In October 2008 the Fed offered to guarantee this vital short-term credit market, in exchange for fees paid by borrowers. The Commercial Paper Funding Facility, which held more than $350 billion at its peak in January 2009, expired in February 2010 and generated $5 billion in profits for the Fed. The Fed backstopped the market for newly issued asset-backed securities like car loans and credit card receivables by creating the Term Asset-Backed Securities Loan Facility in late 2008. TALF’s assets peaked at $48 billion in March 2010 and steadily declined to about $9 billion at the end of 2011. In 2009 and 2010, through fees and interest, TALF generated $721 million in profits for the Fed, which didn’t pay out a dime in guarantees.4 These efforts were short-term emergency interventions to unclog the nation’s—and the world’s—financial plumbing.

., 124 Stiglitz, Joseph, 6, 9 stimulus, 23, 57, 81 economic decline and, 5–6 infrastructure and, 209–10, 212 timely policy decisions and, 28, 30–32 stocks, stock markets, 1–2, 7–8, 12–13, 15–18, 109, 180, 185 capitalization of, 22, 25, 198–99, 204 declines and collapse of, 18, 56, 81, 171 inports and, 133, 136, 147 Internet and, 15, 21–22, 82 restructuring and, 51–52 timely policy decisions and, 35, 37–38, 42–43 Stoffel, Bob, 77 stress tests, 37 Subaru, 173 Subramanian, Arvind, 8 subways, 212–13 suicides, 8 Summers, Lawrence, 3–4, 10, 26 infrastructure and, 205, 208 Super Cool Biz campaign, 9, 60–61 Super Girl, 20 supersizing, 199–214, 216 ability to scale in, 204, 207–8, 214 Apple and, 199–201 employment and, 199–201, 203–7, 209–11 infrastructure and, 202–14 networks and, 199, 201–4, 206–9, 211–13 superstar cities thesis, 212–13 Swift, Earl, 207 Syria, 227 Taphandles, 177–78 Target, 58, 177 Tata, Ranan, 117 Tata Consultancy Services, 172 taxes, taxpayers, 46, 83, 109, 175, 212 on carbon, 61, 75, 103–4, 217 on corporations, 146–47, 163 cutting of, 10, 30–31, 150, 157, 181, 218, 221–22 economic policy proposals and, 217–18 efficiency economy and, 61, 75 efficient consumers and, 181, 191 employment and, 163, 166 infrastructure and, 205, 208 inports and, 133, 136–37, 146–47 North Dakota and, 150, 152, 157 timely policy decisions and, 30–36, 38–42 Taylor, Frederick Winslow, 61 TD Bank, 92 technology, 3, 7–8, 10, 14–15, 48–49, 96, 104, 108, 121–22, 164, 170, 195, 211 efficiency economy and, 77, 79–80 efficient consumers and, 184, 192 FDI and, 84, 86 North Dakota and, 151, 160 telegraph, 206, 209, 214 Temporary Liquidity Guarantee Program (TLGP), 34 Term Asset-Backed Securities Loan Facility (TALF), 34, 48 Terminator, The, 134 Tesla, 79 Texas, 5, 86, 118, 141–42, 206 Barnett Shale in, 79, 151 Thain, John, 48 This Time Is Different (Rogoff and Reinhart), 5, 17 Three Gorges, Three Gorges Dam, 7, 202 timely policy decisions, 28–44, 60, 80 auto industry and, 33, 40–43 bailouts and, 28, 31–43 banks and, 32–34, 36–40, 43 housing and, 29, 32, 34–35, 42–43, 54–55 restructuring and, 44, 58–59 stimulus and, 28, 30–32 TARP and, 36–38, 40 TMD Friction Group, 88 Tokyo, 8–9, 29, 67, 138, 168 Super Cool Biz campaign in, 9, 60–61 Toledo, Allan, 95 total quality management, 61–62 tourism, 82, 208, 215 exports and, 116, 121–26, 164 inports and, 132, 137–38, 144–45 medical, 125–26, 145 retrofitting Empire State Building and, 69, 71–72 Toyota, 79, 87 Toys“R”Us, 141 trade, 3, 14, 19, 22, 24, 26, 94, 106, 152 deficits in, 102, 107, 168, 221–22 surpluses in, 101, 122 see also exports Transformers, 129 transportation, 72, 101, 105, 167, 169, 224, 226 efficiency economy and, 76, 158, 223 North Dakota and, 152, 158 supersizing and, 205, 208, 210–13 see also autos, automakers Transportation Department, NYC, 192–93 Treasury Department, U.S., 21, 26, 47, 133, 218 TARP and, 37–38, 54 timely policy decisions and, 32–38, 42 Troubled Asset Relief Program (TARP), 47, 54 bailouts and, 36–38, 40–42 Trust Bank, 129 Tsongas, Paul, 14 Tung Chee Hwa, 22 Turkey, 26, 71, 117, 123, 126, 129 inports and, 132, 139 Twitter, 204, 227 U.K.


pages: 1,073 words: 302,361

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

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

It’s got to be free of conflicts of interest. It needs a cop on the beat and it’s got to get back on Wall Street.” Shortly after the hearing, along with Senator Jeff Merkley (D-Oregon), Senator Levin introduced an amendment to the huge financial reform bill that would prevent Wall Street firms from engaging “in any transaction that would involve or result in any material conflict of interest with respect to any investor” in an asset-backed security, such as a CDO. A version of the amendment was included in the Dodd-Frank Act President Obama signed on July 21, 2010. The senators raised a good question. How could Goldman keep on selling increasingly dicey mortgage-related securities, even though sophisticated investors wanted them, at the same time the firm itself had pretty much become convinced—and was betting—the mortgage market would collapse?

Of course, Goldman had no intention of keeping the mortgages itself but rather bought them for the sole purpose of packaging them together and selling them off to investors for a fee determined by the difference between the price it paid for them and the price it sold them for. In other words, pretty standard Wall Street practice. By the spring of 2006, Goldman was considered a respectable underwriter of mortgage-backed securities, ranking twelfth worldwide in 2005 in the underwriting of so-called structured finance deals—those for asset-backed securities, residential and commercial mortgage-backed securities, and collateralized debt obligations—worth $102.8 billion. By 2006, Goldman had moved up to tenth in the league tables—underwriting 204 deals globally, worth $130.7 billion—but still was far behind Lehman Brothers, Deutsche Bank, Citigroup, Merrill Lynch, and Bear Stearns. These other firms were coining money underwriting mortgage-backed securities and became so concerned about having access to a steady flow of mortgages to package up and sell that they all bought mortgage origination firms—Bear bought EMC Mortgage; Merrill bought First Franklin Financial Corp. from National City Bank in December 2006—at the top of the market—for $1.7 billion.

He then explained the steps the firm had taken but added that he thought the cleanup had been ongoing “for years” and took credit himself for moving “residuals out of origination and into traders” for them to sell. But there were plenty of crosscurrents buffeting the mortgage market in February 2007 and plenty of people who disagreed with Goldman’s decision to get short the mortgage market. For instance, the next day—February 12—Gyan Sinha, a senior managing director at Bear Stearns in charge of the firm’s market research regarding asset-backed securities and collateralized debt obligations, held a conference call for some nine hundred investors where he spelled out his beliefs about the market’s reaction to the news that New Century, the mortgage lender, was having financial trouble. To that point, Sinha had been very well respected and had even testified in front of Congress about the subprime mortgage market. “It’s time to buy the [ABX] index,” he said, adding that based on his modeling, “the market has overreacted” and predictions of rising problems in the mortgage market should be taken “with a large grain of salt.”


pages: 202 words: 58,823

Willful: How We Choose What We Do by Richard Robb

activist fund / activist shareholder / activist investor, Alvin Roth, Asian financial crisis, asset-backed security, Bernie Madoff, capital asset pricing model, cognitive bias, collapse of Lehman Brothers, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, delayed gratification, diversification, diversified portfolio, effective altruism, endowment effect, Eratosthenes, experimental subject, family office, George Akerlof, index fund, information asymmetry, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, lake wobegon effect, loss aversion, market bubble, market clearing, money market fund, Pareto efficiency, Paul Samuelson, Peter Singer: altruism, principal–agent problem, profit maximization, profit motive, Richard Thaler, Silicon Valley, sovereign wealth fund, survivorship bias, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, transaction costs, ultimatum game

Applying Peirce’s rules, we can see why institutional investors hesitated to buy low-priced, complex, illiquid bonds. The fourth, purposeful rule—one applies the scientific method; the belief corresponds to data in the world—couldn’t justify these investments. There were no data on similar events because nothing like this had ever happened before. Many looked to the Great Depression for precedent, but conditions were so different back then (asset-backed securities hadn’t even been invented) that it couldn’t provide much guidance. The rules I’ve categorized as for-itself—those that deal with acting in character —would have been equally useless: 1.A new belief X is consistent with the things one already knows. Senior executives started with the view that bonds like this were dangerous. 2. An authority to which one has committed tells one that X is so.

., 210–211n2 Alexander the Great, 140, 180–181 alienation, 205, 207 alpha, 75 altruism, 4 apparently irrational, 28–29, 206 care altruism, 38, 104, 108–114, 115, 120, 135, 201 effective, 110–112, 126, 130, 135–136 in for-itself model, 19, 104, 123, 129 love altruism, 104, 116, 123–125, 203 manners and ethics in, 104, 106–108, 135 observed care altruism, 108–112 purposeful choice compatible with, 104, 113–114, 115–116 selfish, 104, 105–106, 109, 123, 125, 135 types of, 104, 123, 130 utility maximized by, 5–6 vaccination as, 59. See also mercy ambiguity effect, 24 American Work-Sports (Zarnowski), 191 Anaximander, 190 anchoring, 168 angel investors, 212–213n1 “animal spirits,” 169 Antipater of Tarsus, 134–135, 137 “anxious vigilance,” 73, 82 arbitrage, 70, 78 Aristotle, 200, 220n24 Asian financial crisis (1997–1998), 13 asset-backed securities, 93–95 asset classes, 75 astrology, 67 asymmetric information, 96, 210n2 authenticity, 32–37, 114 of challenges, 176–179 autism, 58, 59 auto safety, 139 Bank of New York Mellon, 61 Battle of Waterloo, 71, 205 Bear Stearns, 85 Becker, Gary, 33, 108–109 behavioral economics, 4, 10, 198–199 assumptions underlying, 24 insights of, 24–25 rational choice complemented by, 6 Belgium, 191 beliefs: attachment to, 51 defined, 50 evidence inconsistent with, 54, 57–58 formation of, 53, 92 persistence of, 26–28, 54 transmissibility of, 92–93, 95–96 Bentham, Jeremy, 127, 197–198 “black swans,” 62–64 blame aversion, 57, 72 brain hemispheres, 161 Brexit, 181–185 “bull markets,” 78 capital asset pricing model, 64 care altruism, 38, 104, 108–114, 115, 120, 135, 201 Casablanca (film), 120, 125 The Cask of Amontillado (Poe), 126–127 challenges, 202–203 authenticity of, 176–179 staying in the game linked to, 179–181 changes of mind, 147–164 charity, 40, 45–46, 119, 128 choice: abundance of, 172–174 intertemporal, 149–158, 166 purposeful vs. rational, 22–23 Christofferson, Johan, 83, 86, 87, 88 Cicero, 133–134 Clark, John Bates, 167 cognitive bias, 6, 23, 51, 147–148, 167, 198–199 confirmation bias, 200 experimental evidence of, 10–11, 24 for-itself behavior disguised as, 200–201 gain-loss asymmetry, 10–11 hostile attribution bias, 59 hyperbolic discounting as, 158 lawn-mowing paradox and, 33–34 obstinacy linked to, 57 omission bias, 200 rational choice disguised as, 10–11, 33–34, 199–200 salience and, 29, 147 survivor bias, 180 zero risk bias, 24 Colbert, Claudette, 7 Columbia University, 17 commitment devices, 149–151 commodities, 80, 86, 89 commuting, 26, 38–39 competitiveness, 11, 31, 41, 149, 189 complementary skills, 71–72 compound interest, 79 confirmation bias, 57, 200 conspicuous consumption, 31 consumption planning, 151–159 contrarian strategy, 78 cooperation, 104, 105 coordination, 216n15 corner solutions, 214n8 cost-benefit analysis: disregard of, in military campaigns, 117 of human life, 138–143 credit risk, 11 crime, 208 Dai-Ichi Kangyo Bank (DKB), 12–14, 15, 17, 87, 192–193 Darwin, Charles, 62–63 depression, psychological, 62 de Waal, Frans, 118 Diogenes of Seleucia, 134–135, 137 discounting of the future, 10, 162–164 hyperbolic, 158, 201 disjunction effect, 174–176 diversification, 64–65 divestment, 65–66 Dostoevsky, Fyodor, 18 drowning husband problem, 6–7, 110, 116, 123–125 effective altruism, 110–112, 126, 130, 135–136 efficient market hypothesis, 69–74, 81–82, 96 Empire State Building, 211–212n12 endowment effect, 4 endowments, of universities, 74 entrepreneurism, 27, 90, 91–92 Eratosthenes, 190 ethics, 6, 104, 106–108, 116, 125 European Union, 181–182 experiential knowledge, 59–61 expert opinion, 27–28, 53, 54, 56–57 extreme unexpected events, 61–64 fairness, 108, 179 family offices, 94 Fear and Trembling (Kierkegaard), 53–54 “felicific calculus,” 197–198 financial crisis of 2007–2009, 61, 76, 85, 93–94, 95 firemen’s muster, 191 flow, and well-being, 201–202 Foot, Philippa, 133–134, 135 for-itself behavior, 6–7, 19, 21, 27, 36, 116, 133–134, 204–205, 207–208 acting in character as, 51–53, 55–56, 94–95, 203 acting out of character as, 69, 72 analyzing, 20 authenticity and, 33–35 charity as, 39–40, 45–46 comparison and ranking lacking from, 19, 24, 181 consequences of, 55–64 constituents of, 26–31 defined, 23–24 difficulty of modeling, 204 expert opinion and, 57 extreme unexpected events and, 63–64 flow of time and, 30 free choice linked to, 169–172 in groups, 91–100 incommensurability of, 140–143 in individual investing, 77–78 in institutional investing, 76 intertemporal choice and, 168, 175, 176 job satisfaction as, 189 mercy as, 114 misclassification of, 42, 44, 200–201 out-of-character trading as, 68–69 purposeful choice commingled with, 40–43, 129, 171 rationalizations for, 194–195 in trolley problem, 137 unemployment and, 186 France, 191 Fuji Bank, 14 futures, 80–81 gain-loss asymmetry, 10–11 Galperti, Simone, 217n1 gambler’s fallacy, 199 gamifying, 177 Garber, Peter, 212n1 Germany, 191 global equity, 75 Good Samaritan (biblical figure), 103, 129–130, 206 governance, of institutional investors, 74 Great Britain, 191 Great Depression, 94 Greek antiquity, 190 guilt, 127 habituation, 201 happiness research (positive psychology), 25–26, 201–202 Hayek, Friedrich, 61, 70 hedge funds, 15–17, 65, 75, 78–79, 93, 95 herd mentality, 96 heroism, 6–7, 19–20 hindsight effect, 199 holding, of investments, 79–80 home country bias, 64–65 Homer, 149 Homo ludens, 167–168 hostile attribution bias, 59 housing market, 94 Huizinga, Johan, 167–168 human life, valuation of, 138–143 Hume, David, 62, 209n5 hyperbolic discounting, 158, 201 illiquid markets, 74, 94 index funds, 75 individual investing, 76–82 Industrial Bank of Japan, 14 information asymmetry, 96, 210n2 innovation, 190 institutional investing, 74–76, 82, 93–95, 205 intergenerational transfers, 217n1, 218n4 interlocking utility, 108 intertemporal choice, 149–159, 166 investing: personal beliefs and, 52–53 in start-ups, 27 Joseph (biblical figure), 97–99 Kahneman, Daniel, 168 Kantianism, 135–136 Keynes, John Maynard, 12, 58, 167, 169, 188–189 Kierkegaard, Søren, 30, 53, 65, 88 Knight, Frank, 145, 187 Kranton, Rachel E., 210–211n2 labor supply, 185–189 Lake Wobegon effect, 4 lawn-mowing paradox, 33–34, 206 Lehman Brothers, 61, 86, 89, 184 leisure, 14, 17, 41, 154, 187 Libet, Benjamin, 161 life, valuation of, 138–143 Life of Alexander (Plutarch), 180–181 Locher, Roger, 117, 124 long-term vs. short-term planning, 148–149 loss aversion, 70, 199 lottery: as rational choice, 199–200 Winner’s Curse, 34–36 love altruism, 104, 116, 123–125, 126, 203 lying, vs. omitting, 134 Macbeth (Shakespeare), 63 MacFarquhar, Larissa, 214n6 Madoff, Bernard, 170 malevolence, 125–127 Malthus, Thomas, 212n2 manners, in social interactions, 104, 106, 107, 116, 125 market equilibrium, 33 Markowitz, Harry, 65 Marshall, Alfred, 41, 167 Mass Flourishing (Phelps), 189–191 materialism, 5 merchant’s choice, 133–134, 137–138 mercy, 104, 114–116, 203 examples of, 116–120 inexplicable, 45–46, 120–122 uniqueness of, 119, 129 mergers and acquisitions, 192 “money pump,” 159 monks’ parable, 114, 124 Montaigne, Michel de, 114, 118 mortgage-backed securities, 93 Nagel, Thomas, 161 Napoleon I, emperor of the French, 71 neoclassical economics, 8, 10, 11, 22, 33 Nietzsche, Friedrich, 21, 43, 209n5 norms, 104, 106–108, 123 Norway, 66 Nozick, Robert, 162 observed care altruism, 108–112 Odyssey (Homer), 149–150 omission bias, 200 On the Fourfold Root of the Principle of Sufficient Reason (Schopenhauer), 209n5 “on the spot” knowledge, 61, 70, 80, 94, 205 Orico, 13 overconfidence, 57, 200 “overearning,” 44–45 The Palm Beach Story (film), 7 The Paradox of Choice (Schwartz), 172 parenting, 108, 141, 170–171 Pareto efficiency, 132–133, 136, 139–140 Peirce, Charles Sanders, 53–54, 67, 94 pension funds, 66, 74–75, 93, 95 permanent income hypothesis, 179 Pharaoh (biblical figure), 97–99 Phelps, Edmund, 17, 189–191 Philip II, king of Macedonia, 181 planning, 149–151 for consumption, 154–157 long-term vs. short-term, 148–149 rational choice applied to, 152–158, 162 play, 44–45, 167, 202 pleasure-pain principle, 18 Plutarch, 180–181 Poe, Edgar Allan, 126 pollution, 132–133 Popeye the Sailor Man, 19 portfolio theory, 64–65 positive psychology (happiness research), 25–26, 201–202 preferences, 18–19, 198 aggregating, 38–39, 132, 164 altruism and, 28, 38, 45, 104, 110, 111, 116 in behavioral economics, 24, 168 beliefs’ feedback into, 51, 55 defined, 23 intransitive, 158–159 in purposeful behavior, 25, 36 risk aversion and, 51 stability of, 33, 115, 147, 207, 208 “time-inconsistent,” 158, 159, 166, 203 present value, 7, 139 principal-agent problem, 72 Principles of Economics (Marshall), 41 prisoner’s dilemma, 105 private equity, 75 procrastination, 3, 4, 19, 177–178 prospect theory, 168 protectionism, 185–187 Prussia, 191 public equities, 75 punishment, 109 purposeful choice, 22–26, 27, 34, 36, 56, 133–134, 204–205 altruism compatible with, 104, 113–114, 115–116 commensurability and, 153–154 as default rule, 43–46 expert opinion and, 57 extreme unexpected events and, 62–63 flow of time and, 30 for-itself behavior commingled with, 40–43, 129, 171 mechanistic quality of, 68 in merchant’s choice, 135, 137–138 Pareto efficiency linked to, 132 rational choice distinguished from, 22–23 regret linked to, 128 social relations linked to, 28 stable preferences linked to, 33 in trolley problem, 135–136 vaccination and, 58–59 wage increases and, 187.


pages: 398 words: 105,917

Bean Counters: The Triumph of the Accountants and How They Broke Capitalism by Richard Brooks

accounting loophole / creative accounting, asset-backed security, banking crisis, Big bang: deregulation of the City of London, blockchain, BRICs, British Empire, business process, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Strachan, Deng Xiaoping, Donald Trump, double entry bookkeeping, Double Irish / Dutch Sandwich, energy security, Etonian, eurozone crisis, financial deregulation, forensic accounting, Frederick Winslow Taylor, G4S, intangible asset, Internet of things, James Watt: steam engine, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, light touch regulation, Long Term Capital Management, low cost airline, new economy, Northern Rock, offshore financial centre, oil shale / tar sands, On the Economy of Machinery and Manufactures, Ponzi scheme, post-oil, principal–agent problem, profit motive, race to the bottom, railway mania, regulatory arbitrage, risk/return, Ronald Reagan, savings glut, short selling, Silicon Valley, South Sea Bubble, statistical model, supply-chain management, The Chicago School, too big to fail, transaction costs, transfer pricing, Upton Sinclair, WikiLeaks

It would be ‘“on call” 24 hours a day, seven days a week, to offer you the immediacy your transaction demands and the responsiveness you require’. PwC claimed to be ‘clear-cut leaders in the securitization marketplace’. Deloitte had worked on ‘more than 14,000 securitized offerings with an aggregate principal amount of more than $5 trillion’. It served ‘leading players in the MBS [mortgage-backed securities], ABS [asset-backed securities], CDO [collateralized debt obligation] and CMBS [commercial-mortgage-backed security] markets’ with ‘state-of-the-art products and expert services in financial modeling, analytics, technology, operations, due diligence, accounting and tax’.17 Whatever Paul Sarbanes and Mike Oxley thought they had achieved in eliminating accountants’ conflicts of interests with their post-Enron legislation, a major new one had emerged in the form of the Big Four’s reliance on the financial markets.

‘The relationship between Fred Goodwin and Deloitte & Touche was inappropriate, ineffective and incestuous,’ one senior RBS executive from the time later recalled.49 Numbers that emerged in the wake of the crash certainly suggested this was one of the less demanding auditor–client relationships. When in 2011 the Financial Services Authority reported on the failure of RBS, it revealed that the bank had been consistently valuing CDOs and other asset-backed securities more generously than its peers. At the end of 2007, with the credit crunch now gripping the markets, European banks were assessing so-called ‘super senior’ CDO tranches (once considered safe) as worth 72% of their nominal value, while US banks were marking them at just 53%. RBS had them on its books at 90%. The regulator concluded that ‘there was a bias to optimism by RBS senior management in its approach to CDO valuation issues at end 2007 and the start of 2008, and an acceptance of that optimism by RBS’s auditors . . . which with hindsight is difficult to justify’.50 This was, however, insufficient to warrant any sanction for the bankers ‘in light of Deloitte’s sign-off of the accounts’.

., 72–4, 75, 77–8, 81, 97, 102–8, 112–13, 188 auditing, 4, 72–4, 85, 97, 102–8, 109, 117 collapse (2002), 5, 7, 11, 90, 108, 110, 121 and computing, 77–8 consultancy, 77–8, 79, 81, 103 and Enron, 4, 7, 11, 74, 102–8, 113, 117 global operations, 234 and HIH, 240 and Labour Party, 184, 188 and Lincoln Savings and Loan, 85 ‘One Firm’ philosophy, 74, 275 and subprime mortgages, 112–13, 116 and Sunbeam, 97 and United States Steel, 62 and WorldCom, 109, 110 Arthur Young & Co., 63, 71, 85–7 asset-backed securities (ABS), 121 Associated Electrical Industries, 66 Aston Martin, 2 AT&T, 109 Atchison, Jack, 85–6 Atlantic Ocean, 39 Atter, Lewis, 197–8 Audit Company of Illinois, 72 auditing, 2, 5, 6, 10–16, 68–9, 79–80, 259–61, 276, 280–84 1960s ‘Go-Go’ era, 63–5, 67 1980s deregulation era, 85–91 1990s/2000s ‘numbers game’ era, 95–110, 114 2007–8 financial crisis, 4, 13–14, 17, 18, 90, 111–50, 210, 241, 256–9, 265 2010s post-crisis era, 259–61 Barnier proposals (2010), 253–5, 280 Davey committee (1894), 52 and class action, 92 Companies Act (1900), 52 competing on price, 79 compulsory rotation, 5 and consultancy, 82, 97–8 and corruption, 211–32 and deregulation, 85–7 expectations gap’, 65, 257 global operations, 235–46 and Joint Stock Companies Acts (1844, 1856), 47, 50 and Levitt, 96–8, 104 limited companies, 13 limited liability, 91–5, 114 Lincoln Savings and Loan, 85–6 Maxwell, 87–8 Medici system, 27 New York Stock Exchange, 55 public, 280–82 and Railway Regulation Act (1844), 45–7 Australia, 48, 51, 127, 170, 240 Avignon, France, 29 Avis Rent-a-Car, 59 Ayrshire, Scotland, 42 Babbage, Charles, 70 BAE Systems, 213–14, 219 Bagley, Gaenor, 268–71 Bahamas, 222, 236 Bain & Co., 263 Bainbridge, Guy, 141 Bank of America, 118 Bank of Credit and Commerce International, 91 Bank of England, 38, 91, 126, 273 Bank of Scotland, 140 Bank of Tokyo-Mitsubishi, 230–31 Bankia, 241 Banking Act (1879), 51 bankruptcy, 30, 45, 46, 49, 50–51 Barclays, 6, 121, 149, 256, 258 Baring Brothers, 92 Barkley, Alben, 58 Barlow, Ian, 181, 182 Barlow Clowes, 89–90, 136, 209 Barnes, David, 258–9, 276, 277 Barnier, Michel, 253–5, 280 Bass, Carl, 105–7 BCCI, 136 Bear Stearns, 121, 139, 145 Belfield, Gary, 192, 193 Benci, Giovanni, 27, 28, 29, 31 Bennett, Robert, 161 Berkshire Hathaway, 135 Bettel, Xavier, 170 Bevis, Herman, 62 Big Bang (1986), 156 Big Eight, 62, 80, 81, 82, 86, 87, 89, 136, 235, 283–4 Big Five, 95, 97, 236 Big Four, 2, 5–21, 110, 114, 283–4 alumni system, 17 auditing, see under auditing business advisory, 114 charity, 16–17 client relationship partners, 12 compulsory rotation, 5 consultancy, 6, 10–12, 114, 183–210, 261–7 and corruption, 211–32 cyber-security, 272–3 export earnings, 6 federal structure, 7–8 and financial crisis (2008), 111–50 global operations, 235–52 governments, advice to, 6, 180, 183–210, 248–50 growth, 9, 10 integrated reporting, 18 key performance indicators, 12 mark-to-model, 124 and media, 7 partners, 8, 11, 14, 15, 16 professional services, 11 recruits, 14–15 revolving door, 206–8, 272 and scandals, 7–8 and securitization, 121–3 tax avoidance, 156–82, 246–8 thought leadership, 12 Big Short, 112 Big Six, 81, 91–3, 95, 235, 236 Big Three, 110, 161 bills of exchange, 25, 26 Birmingham, West Midlands, 43 Bischoff, Winfried, 209 Black, Conrad, 154–5 Black, William, 60–62 Blackbeard (Edward Teach), 39 Blair, Anthony ‘Tony’, 184, 188, 191, 213 Blatter, Joseph ‘Sepp’, 221, 222, 225–8 BLIPS (Bond Linked Issue Premium Structures), 159–62, 181 Blockbuster, 106 Blunt, John, 39, 44 Board of Trade, 45 Book of Disquiet (Pessoa), 1 Book-keeping Methodiz’d (Mair), 53 Booz & Co., 264 Boston Consulting, 191 Boulton, Matthew, 43 Bower, Marvin, 75 Boy Scouts of America, 149 Bradford & Bingley, 141–2, 149 Brazil, 220, 238, 239, 242–3, 246 Breedon, Richard, 154 Brexit, 195, 203–4, 273 bribery, 211–28, 240 BRIC (Brazil, Russia, India and China), 238 Bristol, England, 49 Britannia Building Society, 142 British Academy, 111–12 British Aerospace, 212–14, 219 British Airways, 148 British American Tobacco, 148 British Broadcasting Corporation (BBC), 169, 197, 220 British Empire, 233 British Home Stores (BHS), 260–61 British Virgin Islands, 213, 220, 246 Britnell, Mark, 192–3, 208 Brown, Gordon, 157, 184, 185, 186, 196 Bruges, 31 BT, 149 Bubble Act (1720), 44 Budgetary Control (McKinsey), 74–5 Buffett, Warren, 63, 135 Building Public Trust Awards, 256 Bureau d’Imposition Sociétés VI, 168 Bureau of Supplies and Accounts, US Navy, 77 Burgundy, Duchy of (1032–1477), 31 Bush, George Walker, 98, 114, 145, 253 Bush, Tim, 126, 127, 147 Butler, Stephen, 181 Byrne, Liam, 184 Byzantine Empire (285–1453), 21 Cabinet Office, 200, 201 Cable & Wireless, 215 Caesar, John, 54, 55, 56 Calcutta, India, 233 Cambridge, Cambridgeshire, 194 Cambridge University, 55, 268 Cameron, David, 192, 195, 203 Campaign Against the Arms Trade, 265 Canada, 246 Canary Wharf, London, 256 Cape Coast Castle, Gold Coast, 37 Capita, 201–2 capital, 3 Carell, Steve, 112 Caribbean Football Union, 221, 223, 224, 225 Carnegie, Andrew, 55, 71 Carter, Arthur, 58 Cash Investigation, 168, 171 Caterpillar, 178 Catholic Church, 3, 24–5, 26, 29, 34, 38 Cattles plc., 142 Causey, Rick, 104 Cayman Islands, 104, 164, 214, 239, 246, 247 Celanese, 60 Celler–Kefauver Act (1950), 59, 61 Celluloid Corporation, 60 certified public accountants, 53 CFO, 101, 109 Chaplin, Charlie, 71 Chappell, Dominic, 260 Charles the Bold, Duke of Burgundy, 31 chartered accountancy, 14, 16, 45, 47–8, 49, 53 Chelsea Flower Show, 200 Chicago School, 84–5, 183 Chicago Sun-Times, 154 Chicago, Illinois, 54, 72–4, 101, 105 child labour, 44 China, 17, 111, 204, 238, 243–5, 251–2, 272, 274 China Integrated Energy, 244 Chirac, Jacques, 127 Christianity, 3, 24–5, 26, 34, 35, 38 Catholicism, 3, 24–5, 26, 29, 34, 38 Protestantism, 3, 42, 43 Christoffels, Jan Ympyn, 36 Churchill, John, 1st Duke of Marlborough, 41 Circle Health, 194 Citigroup, 149, 258 City of Glasgow Bank, 51, 147 City of London, 46, 49, 156, 249 Civil Rights Movement, 64 Claridges, London, 122 Clarke, Charles, 207 class-action lawsuits, 64–5, 92 Cleese, John, 15 climate change, 18 CloseMore University, 115 Clowes, Peter, 88–90, 91, 136, 209 Co-operative Bank, 142, 149, 150 Cohen, Manuel ‘Manny’, 80 Cold War, 95 Cole, Margaret, 208 Colin, Bernard, 173 collateralized debt obligations (CDOs), 120–21, 129–30, 133, 136–40, 265 Collier-Keywood, Richard, 182 Collins, Simon, ix, 11, 204, 218, 255–9, 264–7, 276, 277–8, 279 Colombia, 229 colonialism, 37 Comey, James, 161 commercial-mortgage-backed security (CMBS), 121 common accounting standards, 73, 123–5 common law, 39 Companies Act 1862: 51 1900: 52 1929: 58 1948: 66 1989: 93 compulsory rotation, 5 computing, 77–8 Comroad, 240 conflicts of interest, 18, 60, 82, 91, 98, 187, 254–5 Arthur Andersen & Co., 73–4, 78, 105, 277 and Barnier proposals, 254–5 in China, 274 and data, 271 Deloitte, 241 KPMG, 202, 228 Price Waterhouse & Co., 73, 277 PricewaterhouseCoopers (PwC), 143 and Sarbanes–Oxley Act (2002), 122 Connolly, John, 89–90, 136, 137, 139, 146, 148, 150, 201 Conservative Party, 95, 185, 186 consultancy, 6, 10–12, 69, 70–83, 97, 114, 183–210, 261–7, 284–5 Continental Baking, 59 Continental Bank, 101 convergence, 123 Cook, Martin, 16 ‘cooking the books’, 36 Cooper, Cynthia, 109 Cooper, William and Arthur, 49 Coopers & Lybrand, 49, 56, 65, 87–8, 95, 185, 216 Coopers Brothers, 87 Copeland, James, 239 Corbyn, Jeremy, 201 Cornwall, England, 43 corruption, 211–32, 240 cost accounting, 42–4, 70–71, 76 cost–profit calculus, 3 Cotswolds, England, 26 Countrywide Financial Corporation, 48, 118, 257 Court of Appeal, 211 credit default swaps (CDSs), 120, 122, 134–5 credit rating agencies, 130, 149 Cruickshank, David, 166 Crystal Park, Luxembourg, 170 Cuba, 239 Cuomo, Andrew, 133 currency swaps, 156–7 cyber-security, 272–3 Daily Mirror, 88 Daniel, Vincent, 112–13 Dante, 33 Dassler, Horst, 220 Datini, Francesco di Marco, 25 Davey, Horace, Baron Davey, 52 Davos, see World Economic Forum Defoe, Daniel, 38 DeLany, Clarence Martin, 72 Delaware, United States, 8, 57, 92, 236, 284 Deloitte, 2, 5, 8, 12–13, 82, 90, 98, 276, 277 and Adelphia, 109 and bankers’ bonuses, 158 and Bankia, 241 in Brazil, 242–3 Brexit memo (2017), 195, 203 charity, 16–17 in China, 244, 251–2 client relationship partners, 12–13 cyber-security, 272 and Deutsche Bank, 158 dot after name, 12 and Duke Energy, 109 and Financial Crisis Inquiry Commission, 145 Global Impact Report, 17 global operations, 236 and Gol, 242–3 government, advice to, 187, 189, 190, 191, 193, 194 and GPT, 216 and Hong Kong protests (2014), 251–2 and House of Lords committee (2010), 146 integrated reporting, 18 Journey Declaration, 275 and National Health Service (NHS), 193, 194 and Parmalat, 239, 243 and private finance initiative (PFI), 187, 189, 190, 191, 203 and Public Company Accounting Oversight Board (PCAOB), 145 revolving door, 207, 208 and Royal Ahold, 238–9 and Royal Bank of Scotland, 47, 90, 136–40, 142, 147, 241, 259 and securitization, 121 and Standard Chartered Bank, 230 and tax avoidance, 157, 158, 166, 203 and technology, 271 and thrifts, 87 and World Economic Forum, 18 Deloitte, Haskins & Sells, 89 Deloitte, William Welch, 46–7, 49, 158 Deloitte & Touche, 89, 91, 136–40 Deloitte Touche Tohmatsu, 239 Deltour, Antoine, 166–8, 171, 173–4, 175, 175 Democratic Party, 58, 80, 159 Deng Xiaoping, 243 Department for Business, UK, 201 Department for Exiting the EU, 204 Department of Health, UK, 188, 191, 192 Department of Justice, US, 144, 161, 223 deregulation, 84, 85, 95, 112, 163, 273–4 derivatives, 117, 119–23, 125, 129–31, 133–40, 148, 265 Desmond, Dermot, 163 Deutsche Bank, 158, 166, 258 Deutsche Treuhand-Gesellschaft, 235 Devon, England, 73 Dickinson, Arthur, 55, 62, 73, 82 DiPiazza, Sam, 242 dirty pooling, 63 discrezione, 26, 29 Disney, 171 Dissenters, 43 dividends, 31, 39, 45 Donovan, John, 116–17 Doty, James, 260 ‘Double Irish’ scheme, 164 double-entry bookkeeping, 3–4, 6, 18, 22–41, 42–4, 96 Bank of England, 38 and Catholicism, 24–5, 26, 29, 34 Christoffels, 36 East India Company, 37 Goethe, 235 Japan, 235 Medicis, 26–32, 36 Pacioli, 32–6, 100, 124 and Protestantism, 42 Royal African Company, 37 South Sea Company, 39–41, 42 Washington, 53 Watt, 42–3, 44 Wedgwood, 43, 44 Dow Jones, 5, 95 Drucker, Jesse, 164, 165 drug trafficking, 229, 231 Dublin, Ireland, 163 Duke Energy, 109 Duncan, David, 103–4, 105, 106, 107, 108 Duranton International Ltd, 214 EADS, 216 East India Company, 37 Economist, The, 67, 238 EDF (Électricité de France), 205 Edinburgh, Scotland, 54 Edinburgh Society of Accountants, 47 Edison, Thomas, 55 Edward IV, king of England, 30 Edward VII, king of the United Kingdom, 68 Egypt, 21 Einzelunterschrift, 221 Eisenhower, Dwight, 76 Eisman, Steve, 112 Electronic Data Systems, 82 Elizabeth II, queen of the United Kingdom, 111–12 Elkind, Peter, 101 Ellis, Kevin, 256, 258 Enfield rifles, 71 England Bank of England, 38 East India Company, 37 Royal African Company, 37 slave trade, 37 Wars of the Roses (1455–1487), 30 woollen industry, 26, 30 see also United Kingdom Ennis, Jessica, 196 Enron, 16, 40, 99–108, 110, 130, 186, 190, 209, 221, 240, 261, 264 and Arthur Andersen & Co., 4, 7, 11, 74, 102–8, 113, 117 and consultancy arms, sale of, 262 and mark-to-market, 99–102, 113 and regulation, 6, 10, 122, 162, 222, 274, 279 Ernst & Ernst, 63, 71, 87 Ernst & Whinney, 86, 87 Ernst & Young, 2, 56, 91, 97, 132–3, 148–9 alumni system, 17 and Anglo Irish Bank, 144 Arthur Andersen structured finance purchase (2002), 121 ‘Building a Better Working World’, 12 and Civil Service Awards, 200 and Financial Crisis Inquiry Commission, 145 global operations, 236 government, advice to, 180, 187, 199, 202 and HealthSouth, 109 and Hong Kong protests (2014), 251–2 integrated reporting, 18 in Japan, 240–41 and Lehman Brothers, 12, 13, 132–3, 145, 148–9 and limited liability partnerships, 94, 95 and Lincoln Savings and Loan, 86–7 mark-to-model, 124 Panama Papers scandal (2016), 247 and private finance initiative (PFI), 187 and Public Company Accounting Oversight Board (PCAOB), 144–5 ‘Quality in Everything We Do’, 12 revolving door, 206, 207, 208 and securitization, 121 and Sino-Forest, 244 Tate sponsorship, 16 and tax avoidance, 7, 156–7, 162, 180, 182, 246, 247 tax policy development team, 180, 199 thought leadership, 12 and VAT avoidance, 7 and Warner, 224 Weinberger’s leadership, 17–18 and World Economic Forum, 17 European Central Bank, 10 European Commission, 170, 253–5, 268, 280 European Union (EU), 168, 170, 203, 253–5 eurozone, 273 Evans, Jonathan, 207 Evening Standard, 256 Everson, Mark, 159 executive pay, 76 ‘expectations gap’, 65, 257 ‘Eye of the Tiger’ (Survivor), 103 Facebook, 164 fair value, 123–5, 126 Fairhead, Rona, 230 Faisaliah Tower, Riyadh, 217 Falcon 900 jets, 100–101 Farah, Mohamed ‘Mo’, 196 Farrar, Michael, 208 Fastow, Andrew, 101–3, 104–5, 108, 109 Federal National Mortgage Association (‘Fannie Mae’), 118–19, 145, 257 Federal Reserve, 122, 133 Federal Trade Commission, 79 Fiat, 170 Fibonacci, Leonardo, 21–2, 32 FIFA (Fédération Internationale de Football Association), 219–28 Fife, Scotland, 48 Financial Conduct Authority, 140, 149, 281 financial crisis (2007–8), x, 4, 7, 10, 13–14, 18, 111–50, 210, 253, 256–9, 265 American International Group bailout, 133–5, 144, 145, 148 Anglo Irish Bank bailout, 144 Bear Stearns bailout, 139, 145 and China, 111 Fannie Mae crisis, 118–19, 145, 257 HBOS bailout, x, 140–41, 142–3, 149, 257 Lehman Brothers collapse, 12, 13, 92, 131–3, 138, 144, 145, 148–9 and IAS39 rules, 123–5, 126, 127, 147 and mark-to-market, 129–31 New Century Financial Corporation collapse, 115–18, 257 Northern Rock collapse, 125–9, 142–3, 148 Royal Bank of Scotland bailout, 47, 136–40, 142, 241 and securitization, 119–23, 129–31, 133–40, 265 and subprime mortgages, x, 10, 36, 48, 111–22, 126, 130, 133, 136, 142, 274 Washington Mutual collapse, 145 Financial Crisis Inquiry Commission, 134, 135, 144, 145 Financial Reporting Council, 138, 142, 144, 149, 182, 209–10, 213–14, 259, 261 Financial Services Authority, 127, 128, 137, 138, 140 Financial Times, 17, 94, 169, 275 Finland, 246 First World War (1914–18), 71 Flint, Douglas, 229 FLIP (Foreign Leveraged Investment Program), 159, 162, 181 Florence, Republic of (1115–1532), 16, 21, 25, 26–32 Flynn, Timothy, 149 Ford, 71, 181 Ford, Henry, 71 Fortune, 62 fossil fuels, 18 Foul!


Manias, Panics and Crashes: A History of Financial Crises, Sixth Edition by Kindleberger, Charles P., Robert Z., Aliber

active measures, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Black Swan, Bonfire of the Vanities, break the buck, Bretton Woods, British Empire, business cycle, buy and hold, Carmen Reinhart, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, Corn Laws, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, death of newspapers, debt deflation, Deng Xiaoping, disintermediation, diversification, diversified portfolio, edge city, financial deregulation, financial innovation, Financial Instability Hypothesis, financial repression, fixed income, floating exchange rates, George Akerlof, German hyperinflation, Honoré de Balzac, Hyman Minsky, index fund, inflation targeting, information asymmetry, invisible hand, Isaac Newton, joint-stock company, large denomination, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, new economy, Nick Leeson, Northern Rock, offshore financial centre, Ponzi scheme, price stability, railway mania, Richard Thaler, riskless arbitrage, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, special drawing rights, telemarketer, The Chicago School, the market place, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, very high income, Washington Consensus, Y2K, Yogi Berra, Yom Kippur War

Moreover, such bills were written for odd amounts to suggest an underlying commercial transaction. Claims were sometimes made (for example, by German banks drawing on Dutch and American banks after the halt in American lending) that the banks knew it was finance paper disguised as commercial bills.36 Securitization Securitization contributed to the bubble in US real estate between 2002 and 2006; the investment banks created new Asset Backed Securities (ABSs) which were claims to the interest and principal of securities with similar attributes that had been placed in trusts. Mortgages, credit card debt, and student loans were securitized. Mortgage Backed Securities (MBSs) were one type of ABS; they were much more liquid than the individual mortgages that were in the trust. Moreover they provided a way for firms to diversify the credit risks attached to individual mortgages.

Securitization was a central feature of the bubble in US real estate between 2002 and 2007; the investment banks issued new bonds, which were claims on the interest income and principal of mortgages, credit card debt, and student loans that they had placed in a trust. The new bonds were much more liquid than the individual securities that were placed in the trust. The investment banks earned fees from securitization; their fee income soared. They then issued asset backed securities (ABSs), which were claims to the interest income and principal of the segments of the ABSs that had been deposited in the trust. The investment banks earned a second round of fees from creating these new instruments, which had been based on ‘slicing and dicing’ the MBSs into three, four, or five different tranches, which differed in terms of their risk characteristics – one set of trusts contained the tranches that had the first claim on the interest income of the MBSs and hence they were the least risky, while another set of trusts constrained the tranches that had the last claim on the interest income of the MBSs, and they were the most risky.

The investment banks had indicated to the credit rating agencies that if they could not get rankings that would help them sell these securities, they would take their business to one of the other firms that provided ratings. Was this illegal? Who knows? Was it corrupt? You bet. Is anyone from a credit rating agency likely to go to jail? Are you kidding? In the end there was some crude justice, since the investment banks were done in by the declines in the market value of their holdings of asset-backed securities that they could not sell. The temptation of banks There are no firm data that permit comparisons of financial chicanery and fraudulent behavior across several centuries. The development of journalism as a profession may mean that any untoward activities are much more likely to be exposed today (although the activities themselves may not have changed). Exposure is the risk side of the equation; the reward is that the gains in wealth can be much greater.


pages: 387 words: 119,244

Making It Happen: Fred Goodwin, RBS and the Men Who Blew Up the British Economy by Iain Martin

asset-backed security, bank run, Basel III, beat the dealer, Big bang: deregulation of the City of London, call centre, central bank independence, computer age, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, deindustrialization, deskilling, Edward Thorp, Etonian, Eugene Fama: efficient market hypothesis, eurozone crisis, falling living standards, financial deregulation, financial innovation, G4S, high net worth, interest rate swap, invisible hand, joint-stock company, Kickstarter, light touch regulation, London Whale, Long Term Capital Management, moral hazard, negative equity, Neil Kinnock, Nick Leeson, North Sea oil, Northern Rock, old-boy network, pets.com, Red Clydeside, shareholder value, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, value at risk

In 2006, the average pay of the top twenty-five hedge fund managers was $363m according to the Institutional Investor’s Alpha report, and lower-paid managers on the list, those outside the top twenty-five, made $40m.4 A good proportion of that money washed ashore in Greenwich or nearby. It was here, on the waterfront, that RBS did its business in a four-storey concrete block set in a landscaped park on Steamboat Road. RBS’s Greenwich Capital was not an exotic hedge fund. Its main business was more mundane, in the trading and underwriting of US Treasuries, government debt. Greenwich Capital also ‘securitised’ mortgages, creating asset-backed securities (ABS), in effect bonds made up of pools of mortgages assembled from lenders who wanted to transfer the risk of their loans and in the process generate more money that they could then use to lend even more. Yet even though they were not running a hedge fund – they were part of a regulated bank headquartered more than 3000 miles away in Edinburgh – the top managers at RBS in Greenwich were based in a town where the prevailing ethos among their friends was predominantly ‘hedgie’.

It did not directly offer loans to customers who wanted to buy a house and then wait while they paid it back in instalments over twenty-five years. However, it was moving beyond basic mortgage securitisation and into the market for collateralised debt obligations (CDOs), which had been developed on Wall Street in the late 1980s and then refined by a team from J. P. Morgan in the late 1990s.7 The architects of the CDO took existing mortgage securitisations (batches of Asset Backed Securities) and repackaged them into new structures. Investors liked CDOs because they provided a stream of income, based on the distant homebuyer making his or her repayments each month. At the top of the structure of a CDO sits a tranche that is labelled triple-A or even better, super-senior debt. This means that whoever holds such stuff is first in the queue for money. If there is a problem they get what income there is before those holding the lower-rated parts of the CDO.

Index (the initials FG in subentries refer to Fred Goodwin) ABN Amro, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9, ref 10 and low RBS liquidity, ref 1 Adam & Co., ref 1, ref 2 Agnew, Jonathan, ref 1 AIG, ref 1 Alemany, Ellen, ref 1 Allan, Iain, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7 and CDOs, ref 1, ref 2, ref 3, ref 4 Antonveneta, ref 1 Argus, Don, ref 1 Argyll, 2nd Duke of, ref 1 Armitstead, Louise, ref 1 Arsenal FC, ref 1 Arthur Andersen, ref 1, ref 2 asset-backed securities (ABSs), ref 1, ref 2 AstraZeneca, ref 1, ref 2 Aviva, ref 1 Ayr Bank, ref 1, ref 2 BAA, ref 1 Bailey, Andrew, ref 1, ref 2, ref 3 Bailie Gifford, ref 1 Balfour Beatty, ref 1 Balls, Ed, ref 1, ref 2, ref 3 Bank of America, ref 1 Merrill Lynch sold to, ref 1 Bank Bosses are Criminals, ref 1 Bank of China, ref 1, ref 2 Bank of Credit and Commerce International (BCCI), ref 1, ref 2, ref 3 Bank of England: and banking supervision, see banks: regulation of; Financial Services Authority and County NatWest, ref 1 culpability of, ref 1 Darling reassurance to RBS concerning, ref 1 founding of, ref 1, ref 2 Gieve role in, ref 1 house prices ignored by, ref 1 independence of, ref 1, ref 2, ref 3, ref 4, ref 5 King becomes governor of, ref 1, ref 2 Monetary Policy Committee of, ref 1, ref 2, ref 3 and RBS collapse, ref 1, ref 2 and RBS privatisation, ref 1 and Scottish banks’ own notes, ref 1 and tripartite regulation, ref 1, ref 2, ref 3, ref 4, ref 5; see also Financial Services Authority Bank of Scotland, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6 founding of, ref 1, ref 2 as joint stock-bank, ref 1 modern British banking pioneered by, ref 1 national networks developed by, ref 1 and NatWest, ref 1, ref 2, ref 3, ref 4, ref 5 RBS early rivalry with, ref 1 ‘sues for peace’, ref 1 Whigs distrust, ref 1 see also Halifax; HBOS bankers: accountants versus, ref 1 ‘“canny” Scottish’, ref 1 Labour honours and ennobles, ref 1 large remuneration of, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9, ref 10, ref 11, ref 12, ref 13 prosecution avoided by, ref 1 banks: auditing of, ref 1; see also banks: regulation/supervision of bailouts of, ref 1, ref 2, ref 3, ref 4, ref 5 passim, ref 1 and Basel regulation, ref 1 and Big Bang, ref 1, ref 2, ref 3, ref 4 Brown wish for competition among, ref 1 Darling promises support for, ref 1 Darling meeting with CEOs of, ref 1 deregulation of, ref 1 foreign investment, presence of, in UK, ref 1 globalised nature of, ref 1 growing profits of, ref 1 innovative activities embraced by, ref 1; see also individual banks and interest rates, ref 1, ref 2, ref 3, ref 4, ref 5 lighter scrutiny of, ref 1; see also Financial Services Authority more credit offered by, ref 1 proposed ring fence for, ref 1, ref 2 regulation/supervision of, ref 1, ref 2, ref 3; see also banks: auditing of; Basel; Financial Services Authority reluctance of, to deal with RBS, ref 1 remodelling of, ref 1 revelations about conduct of, ref 1 ‘too big to fail’, ref 1 tripartite regulation of, ref 1, ref 2, ref 3, ref 4, ref 5; see also Basel; Financial Services Authority UK, balance sheets of, ref 1, ref 2, ref 3, ref 4 UK, clearing, balance sheets of (since 1960), ref 1 UK, growth of, ref 1 UK, steady fall in number of, ref 1 and Value at Risk (VaR), ref 1, ref 2 see also City of London Banque de France, ref 1 Barclays, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9 and ABN Amro, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8 FG hates, ref 1 fines paid by, ref 1 growing profits of, ref 1 Barclays Capital, ref 1, ref 2 Barings, ref 1, ref 2 Basel, ref 1 Bear Stearns, ref 1 Better Regulation Action Plan, ref 1 see also banks: regulation of Better Regulation Task Force, ref 1 Big Bang, ref 1, ref 2, ref 3, ref 4, ref 5 Birmingham and Midshires, ref 1 Black, Joseph, ref 1 Blair, Cherie, ref 1 Blair, Tony, ref 1, ref 2, ref 3 and 1997 election, ref 1 and bank regulation, ref 1 bankers fêted by, ref 1 Brown wants to oust, ref 1 FG Chequers meal with, ref 1 and Gaddafi, ref 1 leadership won by, ref 1 Blank, Victor, ref 1 Bloomberg, ref 1 Blue Arrow affair, ref 1 Blunkett, David, ref 1 BNP Paribas, ref 1, ref 2 boom and bust, ‘end’ of, ref 1, ref 2, ref 3, ref 4, ref 5 Botín, Emilio, ref 1, ref 2, ref 3, ref 4 BP, ref 1 Bradford & Bingley, ref 1, ref 2 Braveheart, ref 1, ref 2, ref 3 Briault, Clive, ref 1, ref 2 Brown, Andrew, ref 1 Brown, Gordon, ref 1, ref 2 passim and 1997 election, ref 1 ‘appalled’ by RBS crisis, ref 1 and bank bailouts, ref 1, ref 2, ref 3 and bank regulation, ref 1, ref 2, ref 3 bankers fêted by, ref 1 becomes Chancellor, ref 1 and BoE independence, ref 1, ref 2, ref 3 boom–bust conference speech of, ref 1 and boom and bust, ‘end’ of, ref 1, ref 2, ref 3, ref 4, ref 5 Chancellorship aspirations of, ref 1 Darling joint press conference with, ref 1 economic growth under, ref 1 father influence on, ref 1 FG compared to, ref 1 and Greenspan, see Greenspan, Alan house prices rise under, ref 1 and interest-rate control, ref 1, ref 2 King relationships with, ref 1 last Mansion House speech of, ref 1 leadership bid lost by, ref 1 and Lloyds–HBOS, ref 1 RBS bailout announced by, ref 1, ref 2 and RBS collapse, ref 1, ref 2 Smith influence on, ref 1 and socialism, ref 1 at university, ref 1 and US politics, ref 1, ref 2 Brown, John, ref 1 Brown, John Ebenezer, ref 1, ref 2 Buccleuch, Duke of, ref 1 Buchan, Colin, ref 1, ref 2, ref 3, ref 4, ref 5 Buffet, Warren, ref 1 Burlington Resources, ref 1 Burns, Robert, ref 1 Burns, Terry, ref 1 Burnside, Howard, ref 1 Burt, Peter, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6 Bush, George H.W., ref 1, ref 2 Bush, George W., ref 1, ref 2, ref 3 Bush, Laura, ref 1 Butler, Lord, ref 1 Cable, Vince, ref 1 Caledonia, naming of, ref 1 Cameron, Donald, ref 1 Cameron, Johnny, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7 passim, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9 passim, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7 and ABN Amro, ref 1, ref 2, ref 3, ref 4 FG stands by, ref 1 FSA investigates, ref 1, ref 2 at Gogarburn opening, ref 1 and hedging exposure, ref 1 and worsening liquidity situation, ref 1 Camerons of Locheal, ref 1, ref 2, ref 3, ref 4 Campbell, Archibald, see Ilay, Earl of Campbell, John, ref 1, ref 2, ref 3 Canary Wharf, ref 1 Caplan, Rick, ref 1, ref 2, ref 3, ref 4, ref 5 Carpenter, Ben, ref 1, ref 2, ref 3 Charles, Prince of Wales, ref 1, ref 2, ref 3 Charter One, ref 1, ref 2 Chase, ref 1 Chirac, Jacques, ref 1 Chisholm, Andy, ref 1 Churchill, ref 1, ref 2 Churchill, Winston, ref 1 Cicutto, Frank, ref 1, ref 2, ref 3 Citibank, ref 1 Citigroup, ref 1, ref 2, ref 3 Citizens Bank, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9, ref 10, ref 11, ref 12 and Mellon, ref 1 new CEO for, ref 1 City of Glasgow Bank, ref 1 City of London, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9, ref 10, ref 11, ref 12, ref 13, ref 14, ref 15 modernisation of, ref 1 see also banks Clarke, Charles, ref 1 Clarke, Ken, ref 1 Clinton, Bill, ref 1, ref 2, ref 3 Clydesdale Bank, ref 1, ref 2, ref 3, ref 4, ref 5 away days of, ref 1 celebrations at, as FG leaves, ref 1 FG becomes CEO of, ref 1 Cochrane, Alan, ref 1 Cole-Hamilton, Richard, ref 1 Coleman, David, ref 1, ref 2 collateralised debt obligations (CDOs), ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9, ref 10, ref 11 index of, ref 1 varieties of, ref 1 see also sub-prime mortgages Commonwealth Bancorp, ref 1 Community Bancorp, ref 1 Compagnie Bancaire, ref 1 Company of Scotland, ref 1 founding of, ref 1 ‘Competition in UK Banking’, ref 1 Connolly, John, ref 1, ref 2, ref 3, ref 4, ref 5 ConocoPhillips, ref 1 Conservatives, see Tories consumer debt, ref 1 Conti, Tom, ref 1 Cooper, Yvette, ref 1, ref 2 Corbett, R.Y., ref 1 Cornwall, Duchess of, ref 1 Countrywide Financial, ref 1 County NatWest, ref 1, ref 2 Coutts, ref 1, ref 2, ref 3, ref 4, ref 5 Cox, Archie, ref 1 credit crunch, see financial crisis credit default swaps (CDSs), ref 1 Crosby, James, ref 1, ref 2, ref 3, ref 4, ref 5 knighthood lost by, ref 1 Crowe, Brian, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9, ref 10, ref 11, ref 12 and CDOs, ref 1 and hedging exposure, ref 1 moved to ABN Amro, ref 1 ordination of, ref 1, ref 2 withdrawn from ABN Amro, ref 1 and worsening liquidity situation, ref 1 Crowe, Russell, ref 1 Cruickshank, Don, ref 1 Crutchley, John-Paul, ref 1 Cryan, John, ref 1, ref 2 Cummings, Peter, FSA fines, ref 1 Cummins, John, ref 1 Currie, Jim, ref 1 Daily Telegraph, ref 1, ref 2 Daniels, Eric, ref 1 Darien Scheme, ref 1, ref 2, ref 3, ref 4 Caledonia emerges from, ref 1 Darling, Alistair, ref 1, ref 2 and bank bailouts, ref 1, ref 2, ref 3 banks’ CEOs meet with, ref 1 and Brown–George spat, ref 1 Brown joint press conference with, ref 1 at ECOFIN meeting, ref 1 and FG knighthood, ref 1 and FG pension, ref 1, ref 2, ref 3 FSA and BoE meet with, ref 1 at Gogarburn opening, ref 1 Goodwin meets (2007), ref 1 King follows plan of, ref 1 King relationships with, ref 1 memoirs of, ref 1 MPs briefed on financial crisis by, ref 1 RBS bailout announced by, ref 1, ref 2 and RBS collapse, ref 1 Treasury meeting called by, ref 1 UK banks supported by, ref 1 Darroch, Kim, ref 1 Davidson, Joanna, ref 1, ref 2 Davies, Howard, ref 1, ref 2 Davos, ref 1 de la Renta, Oscar, ref 1 deficit, sharp rise in, ref 1 Deloitte & Touche, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7 Deutsche Bank, ref 1, ref 2 Dewar, Donald, ref 1 Diamond, Bob, ref 1, ref 2, ref 3 forced out of post, ref 1 Dickinson, Alan, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9, ref 10, ref 11, ref 12, ref 13 Dime Bancorp, ref 1 Direct Line, ref 1, ref 2, ref 3 District Bank, ref 1 Dixon Motors, ref 1 Dixon, Paul, ref 1 Dixon, Simon, ref 1 dotcom bubble, ref 1 Dow Jones, ref 1 Drake-Brockman, Symon, ref 1 Dresdner Kleinwort Wasserstein, ref 1, ref 2 ‘Drivers for Growth’ conference, ref 1 Drummond Bank, ref 1, ref 2, ref 3 Dundas, Lawrence, ref 1 Dundee Banking Company, ref 1 Dutch Central Bank, ref 1 Duthie, Robin, ref 1 East India Company, ref 1 Economic and Financial Affairs Council (ECOFIN), ref 1, ref 2 Economist, ref 1, ref 2 Eden, James, ref 1, ref 2 Elizabeth II, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7 emerging economies, ref 1 Emirates Stadium, ref 1 Enron, ref 1, ref 2 Equitable Life, ref 1 Equivalent Company, ref 1 Ernst & Young, ref 1 euro, see single currency Exchange Rate Mechanism (ERM), ref 1, ref 2 ‘failure of the Royal Bank of Scotland, The’ (FSA), ref 1, ref 2 Fastow, Andy, ref 1 Federal Reserve, ref 1, ref 2, ref 3 Ferguson, Adam, ref 1 Ferguson, Alex, ref 1 Ferguson, William, ref 1 Ferrovial, ref 1 Fidelity, ref 1 Fildes, Christopher, ref 1 Financial Conduct Authority., ref 1 financial crisis: beginning of, ref 1 Darling updates Commons on, ref 1 government spending at start of, ref 1 insurers crack under weight of, ref 1 recessions follow, ref 1 spreads to UK high street, ref 1 studies and reports of, ref 1 Financial Services Authority (FSA), ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9, ref 10, ref 11, ref 12 ‘Arrow’ reports of, ref 1 and auditors, ref 1 and RBS collapse, ref 1 RBS on watch-list of, ref 1 self-investigation by, ref 1 successors to, ref 1 and tripartite regulation, ref 1, ref 2, ref 3, ref 4, ref 5; see also Bank of England Financial Times, ref 1, ref 2 First Active, ref 1 Fish, Larry, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9 chairs RBS Americas, ref 1 criticised, ref 1 pension of, ref 1 Fisher, Mark, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7 at Gogarburn opening, ref 1 moved to ABN Amro, ref 1 Fitch Ratings, ref 1, ref 2 Fleming, Ian, ref 1 Fletcher, Andrew, ref 1 Forbes, ref 1 foreign exchange, ref 1, ref 2 Formula 1, ref 1, ref 2 Fortis, ref 1, ref 2, ref 3 Fountain Workshop, ref 1 Franklyn Resources, ref 1 Freshfields, ref 1 Friedrich, Bill, ref 1, ref 2 Fuld, Dick, ref 1 Gaddafi, Muammar, ref 1 Gartmore, ref 1 GE, ref 1 George II, ref 1 George, Eddie, ref 1, ref 2, ref 3, ref 4 Gibson, Mel, ref 1, ref 2 Gieve, John, ref 1 Giles, Chris, ref 1 Gladiator, ref 1 Glass–Steagall Act, ref 1 global financial crisis, see financial crisis Global Transaction Services, ref 1, ref 2 Glyn, Mills & Co., ref 1, ref 2 Goldman Sachs, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6, ref 7, ref 8, ref 9 Goodwin, Andrew (brother), ref 1 Goodwin, Dale (sister), ref 1 Goodwin, Fred: affair of, ref 1, ref 2, ref 3, ref 4 after RBS, ref 1 and away days, ref 1, ref 2 bailout terms heard by, ref 1 Barclays hated by, ref 1 becomes Clydesdale CEO, ref 1 becomes RBS CEO, ref 1 birth of, ref 1 Brown compared to, ref 1 Brown likes, ref 1 Bush dinner guest, ref 1 and car dealership, ref 1 CDO presentation by, ref 1 at CEOs–Darling meeting, ref 1 at CEOs meeting, ref 1 Chequers invitation to, ref 1 ‘classic bully’, ref 1 cleanliness campaigns of, ref 1 at Clydesdale, see Clydesdale Bank colleagues testify to abilities of, ref 1 cult status of, ref 1 at Darling 2008 meeting, ref 1 Darling visited by (2007), ref 1 document criticises management of, ref 1 early life of, ref 1, ref 2 extraordinary general meeting appearance of, ref 1 face-to-face firing disliked by, ref 1, ref 2, ref 3 first job of, ref 1 fixation on detail by, ref 1, ref 2, ref 3, ref 4, ref 5, ref 6 and Forbes, ref 1 ‘Fred the Shred’ nickname of, ref 1, ref 2, ref 3, ref 4 and FSA, ref 1, ref 2 at Gogarburn opening, ref 1 Harvard study on, ref 1, ref 2 ‘has shut out the world’, ref 1 Hester view of, ref 1 ‘I want to be bigger than J.


pages: 249 words: 66,383

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

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

The Fed also expanded the definition of who could borrow and what classified as acceptable collateral. An entire alphabet soup of new programs was initiated. There was the $150 billion Term Auction Facility (TAF); $50 billion in swap lines for foreign central banks; the $200 billion Term Securities Lending Facility (TSLF); the $20 billion Primary Dealer Credit Facility (PDCF); the $700 billion Commercial Paper Funding Facility (CPFF); and the $1 trillion Term Asset-Backed Securities Loan Facility (TALF).11 The largest and longest-lasting program introduced by the Fed was the Large-Scale Asset Purchase (LSAP) program. Also known as “quantitative easing,” it involves the Fed buying long-term assets that include agency debt, mortgage-backed securities, and long-term treasuries from banks. It has been enormous by any standard. By the middle of 2013, these Fed purchases had increased the size of its balance sheet from around $800 billion in 2007 to a whopping $3.3 trillion.

See consumer spending Stafford, Erik, 98, 101 standard asset pricing theory, 108–9 Steinsson, Jon, 163, 179 Stewart, Jon, 122 stimulus spending, 162–66, 205n19 student-loan debt, 167–69, 182–83, 206n9 Stulz, Rene, 129 subordinated debt, 123 subprime mortgages. See securitization market Suchanek, Gerry, 108–9 Summers, Lawrence, 136 supply-side view of resources, 47–49 Surowiecki, James, 38–39, 193n4 Swire, Peter, 148 TARP (Troubled Asset Relief Program), 136 tax policy, 164–65, 181, 205n20 Taylor, Alan, 8–9 Tea Party movement, 135, 165 tech bubble collapse, 43–44 Temin, Peter, 6, 156 Term Asset-Backed Securities Loan Facility (TALF), 125 Term Auction Facility (TAC), 125 Term Security Lending Facility (TSLF), 125 Thai/East Asian banking crisis of 1990s, 92–95 tradable jobs, 63–66, 195n3 tranching, 96–100 Trebbi, Francesco, 28, 131, 165–66, 176 Troubled Asset Relief Program (TARP), 136 Trust Indenture Act of 1939, 138 Turner, Adair, 206n8 underwater mortgages, 26, 51–52, 150; forgiveness programs for, 135–51; government programs for, 135–42; Obama’s bailout proposal for, 60, 137; refinancing rates and, 158–59; shared-responsibility mortgages and, 175–76 unemployment, 60–70; in bank-lending view of recession, 128–30; of college graduates, 167–68; foreclosures and, 2, 202n21; in fundamentals view of recession, 66–68; government policies on, 69; human consequences of, 2–3, 70; layoffs in, 1–2, 33, 128–30; in levered-losses framework, 56–66, 195n3; local banking risks and, 95–96; net-worth shock and, 63, 68; shared-responsibility mortgages and, 178–79; skills mismatch and, 68–69; in Tennessee, 61–62 unemployment-insurance payments, 69 U.S.


The Fix: How Bankers Lied, Cheated and Colluded to Rig the World's Most Important Number (Bloomberg) by Liam Vaughan, Gavin Finch

asset allocation, asset-backed security, bank run, banking crisis, Bernie Sanders, Big bang: deregulation of the City of London, buy low sell high, call centre, central bank independence, collapse of Lehman Brothers, corporate governance, credit crunch, Credit Default Swap, eurozone crisis, fear of failure, financial deregulation, financial innovation, fixed income, interest rate derivative, interest rate swap, Kickstarter, light touch regulation, London Interbank Offered Rate, London Whale, mortgage debt, Northern Rock, performance metric, Ponzi scheme, Ronald Reagan, social intelligence, sovereign wealth fund, urban sprawl

It was a scab King and his colleagues understandably didn’t want to pick. The New York Fed also eventually walked away, unwilling or unable to force the issue on an obdurate British establishment. If it had ongoing concerns about the benchmark, that did not stop it from pegging $85 billion of loans to beleaguered insurer American International Group to Libor in September 2008, or $1 trillion to banks and investment firms via the Libor-linked Term Asset-Backed Securities Loan Facility two months later. One group notable by its complete lack of engagement in the discussions was the FSA, the U.K. regulator ultimately responsible for overseeing the banks. Like the Bank of England, the FSA would later argue that Libor was unregulated and therefore fell through the cracks, but the body had the power to launch an investigation into allegations of improper behavior at any time.

Deb Baran 159 Gibson Dunn & Crutcher 128 Gilmour, James 148, 168, 169 Glands, Paul 67 Godsell, Astley & Pearce 27, 29, 67 198 IN DEX Goldman Sachs 62, 66, 70, 72, 73, 81, 91, 92, 97, 137 Goodman, Colin 28–30, 31, 32, 37, 61, 62, 67, 78, 85, 117, 168, 169 Green, David 150, 159 Green, Stephen 58 Greenspan, Alan 71 Gulf International Bank 163 Icelandic banking system, collapse of 146 Interest-rate swaps 10, 16 International Monetary Fund (IMF) 95, 101, 118 International Organization of Securities Commission 74–5 IOSCO 109 Hall, Will 35, 148 Hawes, Neil 160, 161, 163 Hayes, Joshua (son) 130 Hayes, Nick (father of Tom Hayes) 5 Hayes, Robin (brother of Tom Hayes) 5 Hayes, Sandra (mother of Tom Hayes) 5 Hayes, Thomas Alexander William (Tom) xi, xii, 1–3 Asperger’s syndrome 2, 6, 22, 158, 164, 168 early trading 8–11 extravagances 67–8, 77 family and early years 5–6 life as trader 21–3 love of football 79 marriage 123 personal hygiene 80 personal wealth 130–1, 155 personality 20 sentence 166, 167–8 temper 7, 80, 82, 154 trial 157–66 HBOS 95 hedge funds 92 Herbert Smith 38 Heywood, Jeremy 96 Holder, Eric 103, 104, 149 Hoshino, Hayato 112, 114, 118, 119, 120, 121 HSBC 35–6, 58, 95, 96, 117 Huertas, Thomas 57–8, 75 Jamies Wine Bar 66 Japanese central bank 9 Japanese Financial Services Agency 130 Johnson, Peter 88, 89, 93, 99, 100 Jones Day 170 Jonson, Lydia 148 JPMorgan 47, 63, 66, 92, 137, 140, 174 ICAP xi, 3, 27, 28, 29, 37, 61, 65–8, 78, 79, 85, 112, 116, 168 Keiser, Rolf 80 Kengeter, Carsten 82, 161 King, Mervyn 55, 56, 57, 95, 96, 143–4 Knight, Angela 49, 51, 52, 54, 58, 59–60 Lampert, Eddie 72 Lawyers’ Christian Fellowship 158 Lazard 138 Lehman Brothers 1–3, 62, 75, 77, 81, 82, 94, 111, 112, 146 Leigh-Pemberton, James 139 Libor ix-x, xi, xii, 2–3, 9, 10–11 growth of 15–17 manipulation of 18, 23, 26–32, 33–8 origins of 14, 15 Lloyds 94, 96 Lloyds Banking Group 95 London interbank offered rate see Libor London Stock Exchange 138 London Whale (French trader) 140 Lowe, Gretchen 42–3, 44, 46, 74, 102, 135, 170 Lucas, Chris 134, 139 Lugar, Richard 45 Index Lukken, Walt 45, 74 Lynam, Moira 121 Madden, Luke 117 Major, John 54 Mandelson, Peter 137 Mann, John 145 Manufacturers Hanover 13 Marsh, Luke 104–5 Maxwell, Robert 105 McCappin, Brian 83, 114, 121, 122, 124 McDermott Will & Emery 75, 76, 106, 107 McGonagle, Vince 39, 41, 42–4, 45, 74, 135, 157, 169 McInerney, Denis 102 Meister, David 135, 136 Merchant, Jay 88 Merrill Lynch 64, 84, 92 Messina, Jim 69 Miller, Avery 107 Mocek, Greg 43, 74, 75–6, 87, 107 Mollenkamp, Carrick 40, 59–60 Morgan Stanley 91 Morton, Andrew 111–12, 120, 121, 124 MSCI 171 New York Fed 56, 57 New York Stock Exchange 167 Newsday 42 Nixon, Richard 13 Northern Rock 38, 49, 53, 95 Oakeshott, Matthew 136 Obama, Barack 69, 70, 103 Obie, Steve 42, 43, 73–6, 87, 89, 102, 107, 109, 135, 170, 173 Office of the Comptroller of the Currency 45 O’Leary, Peter (step-brother) 35–7 Osborne, George 106, 144 overnight indexed swaps 10 199 Pain, Jon 106 Park, Robertson 102 Paulson, Hank 72 Payment Protection Insurance misselling 137 Peng, Scott 43 Perry Capital 72 Perry, Richard 72 Peston, Robert 142, 143 Pieri, Mike 63, 81–3, 86, 119, 126, 130, 161 Pitt, Harvey 45 Platts 41 Porter, Chris 36, 37 Porter, Laurence 114, 115, 116, 118, 120 Prince, Chuck 116 private equity 92 Protium deal (2010) 137 Qatar Investment Authority 97 Rabobank xi, 64, 134 Rain Man 7 Rake, Mike 141, 143, 144 RBC 10 RBS xi, 66, 93, 94, 95, 96, 104, 118 Read, Darrell 27–30, 31, 33, 37–8, 61–2, 67, 77–8, 85, 112, 116, 117, 165, 168, 169 Reagan, Ronald 15 Reich, Ryan 88 relative value trading 22 Ricci, Rich 98, 134, 142 Richardson, Gordon 98 Risk Capital 44 Robb, Richard 17 Robson, Anthony 9 Rouse, Pete 69 Royal Bank of Canada 8 Royal Bank of Scotland 6, 10, 148, 174 RP Martin xi, 30, 31, 37, 63, 64, 65, 66, 79, 117, 148–9, 168 200 IN DEX Rubin, Robert 70, 71 Ruh, Joachim 80 Salomon Brothers 17 Sanders, Bernie 71 Sants, Hector 106, 142–3 Sarbanes-Oxley Act 70 Schapiro, Mary 69, 70 Schiliro, Phil 69 Schroders 92 Securities and Exchange Commission (SEC) 45, 69, 70, 120, 129 Senate Banking Committee 45 Serious Fraud Office (SFO) 148–52, 155, 158, 160, 161, 165, 168, 169 Serious Organised Crime and Police Act (SOCPA) (2005) (U.K.) 151 Shah of Iran 13 Shearman & Sterling 38 Shelton, Mark 127, 128 Sherrard, Charles 154 Smith New Court 92 “Special Liquidity Scheme” (U.K.) 55 Spencer, Michael 28, 30 “spoof offers” 32 Spratling, Gary 128–9 Sprinzen, Nicole 104 Standard Chartered 65, 94 Stevens, Ted 104 Steyer, Tom 72 Stone, Jonathan 99 Storey, Miles 51, 162, 163 subprime mortgage crisis (U.S.) 18, 53, 56, 103, 111 Sullivan & Cromwell 108, 134 Summers, Larry 69 swaps 7, 10 T. Rowe Price Group 72 Tan, Stantley 113 Taylor, Martin 91–2 Tchenguiz, Robert 150 Tchenguiz, Vincent 150 Term Asset-Backed Securities Loan Facility 57 Termine, Anne 44, 46, 47, 74, 89, 102, 135, 169 al-Thani, Hamad bin Jassim bin Jabr, Sheikh 97 Thatcher, Margaret 16, 50 Thomas, Judge John 168 Thomson Reuters 162 Thursfield, Andrew 113–14, 115–16, 120 Tibor 23, 63, 112, 113, 130, 152 Tighe, Sarah (wife) 38, 67, 77, 83, 119, 123, 130, 149, 154, 155, 157–8, 164, 166 Title X Technology 132 traders cash 33 life of 20–1 Troubled Asset Relief Program (TARP) program 95 Tucker, Paul 55, 56, 94, 96–9, 106, 141, 143, 145, 146, 170 Tullett Prebon 65, 66, 78–9, 85, 168 “turn”, the 83 Turner, Adair 139, 142, 143 UBS x, xi, 1, 6, 9–10, 33, 37, 46, 47, 63, 67, 77, 80–3, 85, 86, 104, 109–12, 116, 117, 119, 126–9, 134, 135, 149, 153, 161, 164, 172, 174 Vadera, Shriti 95 Varley, John 92, 94, 95, 97, 145 Wall Street Journal, The 40, 46, 50, 52, 57, 59, 61, 73, 133, 151, 173 wash trade 63, 65–6, 68, 79, 129 Wells Fargo 103 Wells, H.G. 130 WestLB 29, 62 White, Paul 35, 118, 129, 148 Whitehouse, Mark 46 Index Wiley, Stuart 35, 63–4 Wilkinson, Danny 66–7, 78, 168, 169 Wink, Angus 79 WM/Reuters 172 World Bank 101 WorldCom 70, 116 201 Yamahara, Akiko 121, 122 Yen Libor 25 Zeigler, Tania 5 Zombanakis, Minos 13–15, 16, 18, 54 Zulauf, Urs 109


pages: 251 words: 76,128

Borrow: The American Way of Debt by Louis Hyman

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

First Boston Corporation and GMAC securitized auto loans in 1985, and it was only a short time before anything could become a bond.14 This more general category of securities became called “asset-backed securities,” or ABSs. Securitizing debt allowed financial institutions to move debts off their books and thus not have to hold reserves against them, allowing a far greater amount of credit to be extended.15 Financial institutions could lend far more than they owned. Once lenders’ need for capital was reduced, interest rates could be lowered, allowing loans to be made to a wider—and riskier—group of borrowers than ever before. In 1986, asset-backed securities seemed like a magical fix-all, lowering costs and risks, at least for the lenders, while helping people buy the things they most wanted. Important observers, such as James Connolly, the managing director of the investment bank Salomon Brothers, believed that securitization reduced the overall risk in the U.S. mortgage system: “What we’ve learned from the mortgage market is that you can reduce default risk still further by carefully underwriting pools of loans that are geographically dispersed.”


pages: 253 words: 79,214

The Money Machine: How the City Works by Philip Coggan

activist fund / activist shareholder / activist investor, algorithmic trading, asset-backed security, Bernie Madoff, Big bang: deregulation of the City of London, bonus culture, Bretton Woods, call centre, capital controls, carried interest, central bank independence, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, disintermediation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, endowment effect, financial deregulation, financial independence, floating exchange rates, Hyman Minsky, index fund, intangible asset, interest rate swap, Isaac Newton, joint-stock company, labour market flexibility, large denomination, London Interbank Offered Rate, Long Term Capital Management, merger arbitrage, money market fund, moral hazard, mortgage debt, negative equity, Nick Leeson, Northern Rock, pattern recognition, purchasing power parity, quantitative easing, reserve currency, Right to Buy, Ronald Reagan, shareholder value, South Sea Bubble, sovereign wealth fund, technology bubble, time value of money, too big to fail, tulip mania, Washington Consensus, yield curve, zero-coupon bond

Thus there is an incentive for the bank to get those loans off its balance sheet by selling them, provided it can still earn some sort of fee income from making the loan in the first place. Why would anyone want to buy such loans? Low inflation in the 1990s and 2000s drove the yields on government bonds down to very low levels. This made investors desperate for assets offering higher returns. Asset-backed securities, as they became known, offered such returns. They might be pools of mortgages, car loans or credit cards. In theory, because the pools were diversified, the losses would be predictable. This process of securitization has been going on for thirty years or so but it took off amazingly quickly in the early part of this century. Credit booms tend to be self-reinforcing. Say the average house price is £100,000 and banks are willing to lend 80 per cent of the home value.

The CDO is divided into tranches, offering different combinations of risk and return CERTIFICATE OF DEPOSIT Short-term interest-paying security CHAPS Clearing House Automated Payment System – an electronic system for settling accounts between the major clearing banks CHINESE WALL A theoretical barrier within a securities firm which is designed to prevent fraud. One part of the firm may not pass on sensitive information to another if it is against a client’s interest CLEARING BANKS Banks which are part of the clearing system, which significantly reduces the number of interbank payments COMMERCIAL BANKS Banks which receive a large proportion of their funds from small depositors CONDUIT Off balance sheet vehicle which banks used to house asset-backed securities COUPON The interest payment on a bond CREDIT DEFAULT SWAP Contract that allows one party to insure against default on a bond DEBENTURE A long-term bond issued by a UK company and secured on fixed assets DEBT CONVERTIBLE Bond which can be converted by an investor into another bond with a different interest rate or maturity DEBT CRISIS A generic term for the problems which some Third World and East European countries had in repaying loans in the 1980s.


pages: 461 words: 128,421

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

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

“That’s precisely the reason I was shocked, because I had been going for forty years or more with very considerable evidence that it was working exceptionally well.”1 During those forty years—especially the nineteen during which Greenspan was the world’s top central banker—financial markets grew to play an ever-larger and less-fettered role. The stock market boomed for most of Greenspan’s years at the Fed. Bond markets boomed too, and expanded into new territory as Wall Street whizzes took mortgage loans and auto loans and credit card debt off the balance sheets of banks and repackaged them into asset-backed securities sold to investors around the world. The most dizzying growth came in over-the-counter derivatives, custom-made financial instruments (options, futures, swaps) that tracked the movements of other financial instruments. With them, traders could insure against or bet on moves in currencies or interest rates or stocks. In recent years it had even become possible to use derivatives to insure against loans gone bad.

Treasury Bills” (Roll), 103 AQR Capital Management, 260 arbitrage and Buffett, 222 described, 116 and fund management, 225–26 and indexes, 230–31 limits of, 254–55, 280–81 and Merton, 148 and misinformation, 299–300 and “noise traders,” 252 and options, 220, 283 and the rational market hypothesis, 192 and S&P 500 mispricings, 249–50 and the tech bubble, 262 and value investing, 117 Aristotle, 30 Arrow, Kenneth, 77–78, 149–50, 181, 183, 198, 237, 302–4, 305, 344n. 9, 358n. 19, 322 Arthur, Brian, 303–5 Arthur D. Little (firm), 83–84, 85, 122, 141 Arthur Weisenberger & Co., 121 Asian currency crisis, 241 Asness, Cliff, 259–60, 260–61, 262 asset-backed securities, xii AT&T, 42, 220 Austrian School, 49, 301 Babson, Roger, 16–17, 19, 23–26, 31, 35, 204, 209, 263, 322 Bachelier, Louis, 6–8, 13–14, 27, 55–56, 65–66, 68, 71, 144, 148–49, 322 Bacon, Francis, 30 Baker, James, 230 Baker, Malcolm, 300 Ball, Ray, 205 Bänz, Rolf, 205–6, 225 Barclays Global Investors, 143 Barra, 139, 142, 224 Barron’s, 116, 265 Bass, Thomas, 304 The Battle for Investment Survival (Loeb), 57 bear markets, 5, 18, 338n. 16 Beard, Charles, 156 Beat the Dealer (Thorp), 217 Beat the Market (Thorp and Kassouf), 218, 219 Beaver, Bill, 135–36 behavioral finance and Black, 201 current state of, 298, 299–300 and economic decision making, 292–95, 295–97 and Friedman, 188 and media coverage, 200–201, 291–92, 358–59n. 23 and Skinner, 355n. 2 and Thaler, 186–87, 201, 288–89, 292–95, 296–97, 298 “Belief in the Law of Small Numbers” (Kahneman and Tversky), 177 Bell Labs, 42 Bellow, Saul, 89 Benartzi, Shlomo, 294 Benhamou, Eric, 262 Berkshire Hathaway, 216, 221–23, 260 Berle, Adolf, Jr., 154, 160, 165–66, 274, 352n. 3 Bernanke, Ben, xiii, 183 Bernoulli, Daniel, 51 beta, 87, 122–23, 126–27, 139, 152, 205, 207–8, 248–49, 345–46n. 30 Black, Fischer and asset pricing, 141, 149, 248, 322, 346–47n. 30 death, 235 and efficiency, 224 and Goldman Sachs, 224 and “joint hypothesis,” 105 and market crashes, 231 and market volatility, 138 and options, 144–47, 149, 277–78 and Ross, 150 and Shefrin and Statman, 358n. 25 and Summers, 199–201 and Thorp, 219 and Wells Fargo, 127 Black-Scholes formula, 147, 218–19, 233–34,237, 278–79, 280, 320 Bogle, John C., 112–13, 115, 122, 128–30, 306, 322 Bok, Derek, 169 bonds and bond markets, xi–xii, 13–14, 16, 21–22, 29, 38–39, 140–41, 167–68 book-to-price ratio, 208–9 Booth, David, 225 Bork, Robert, 158 Born, Brooksley, 244 Bossaerts, Peter, 297 Brealey, Richard, 355n. 38 Brennan, Michael, 284 Bretton Woods system, 92 Brinegar, Claude, 43–44 Brooks, John, 68, 118 Brown, Kathleen, 278 Brownian motion, 7, 13, 41, 65–69, 73 Bryan, William Jennings, 11 “Bubble Logic: Or, How I Learn to Stop Worrying and Love the Bull” (Asness), 261 Buchanan, James M., 159 Buffet, Warren, 118, 211–14, 214–16, 221–23, 229, 260, 271, 278–79, 323, 366n. 29 bull markets, 18, 61–62, 255, 279, 291 Burns, Arthur, 76, 217, 258 Bush, George W., 295 business cycle, 19–20, 28, 81, 309–10 Business Cycle Institute, 41 Business Week, 97–98 California Institute of Technology, 147 California Public Employees Retirement System (Calpers), 272, 273–74 Cambridge, University, 64 Camerer, Colin, 188 Cameron, David, 295 Campaign GM, 159 Campbell, John, 257 capital asset pricing model (CAPM).

See also behavioral finance Purchasing Agents Association, 24 Putnam Investors, 112 Quantitative Finance, 305 Quarterly Journal of Economics, 63 Rand, Ayn, 91, 258 RAND Corporation, 55, 59, 86 A Random Walk Down Wall Street (Malkiel), 129–30 random walk hypothesis and the business cycle, 26–28 and computing, 99–101 and Cowles, 35–39 and Fama, 96–97 and ideological debate, 29–35 and Malkiel, 129–30 and market uncertainty, 13 modeling, 28–29 and options, 146 and the public consciousness, 99 and Samuelson, 60–66, 67–70, 70–74 and social value of markets, 39–44 Rappaport, Alfred, 164, 271, 280 rational market hypothesis, xiii–xv, 35, 82–83, 107, 179–80, 197, 251, 287–88. See also efficient market hypothesis Read, Dillon, 114 Reader’s Digest, 91 Reagan, Ronald, 151, 168, 274–75 real estate markets, 256–57, 312–15 Reder, Melvin, 89–90 Reed, John, 187, 302 Regan, Donald, 168 Regan, Jay, 218 Remington Rand, 21, 22, 25 Renshaw, Edward F., 111 Ricardo, David, 193 risk and asset-backed securities, xii defining, 228–29 and derivatives, 150–51 and diversification, 54, 86–87 and executive compensation, 280 and market efficiency, 102 modeling, 58, 86–88, 208, 237–38, 243, 314, 316 and normal distribution of prices, 132 and options, 149 and the parable of talents, 84 and portfolio theory, 137 and price disparity, 184–85 and risk premiums, 141–43, 263–64 and risk-adjusted performance, xiv, 228 and variance, 138 Risk, Uncertainty, and Profit (Knight), 84–85 RiskMetrics, 238 The Road to Serfdom (Hayek), 90, 91 Roberts, Harry, 69, 70, 96, 100–101, 326 Robertson, Julian, 260 Rockefeller, John D., 31 Rockefeller Foundation, 155, 352n. 5 Roe, Mark, 365n. 18 Roll, Richard, 100, 103, 182, 202, 224–25, 259, 297–98, 326, 359–60n. 34, 361n. 8 Roosevelt, Franklin Delano, 33, 156 Rosenberg, Barr, 127, 138–39, 139–40, 151, 224, 326–327 Rosenfeld, Eric, 225 Ross, Steve, 149–50, 224–25, 235, 237, 327, 359–60n. 34 Roy, A.


The Trade Lifecycle: Behind the Scenes of the Trading Process (The Wiley Finance Series) by Robert P. Baker

asset-backed security, bank run, banking crisis, Basel III, Black-Scholes formula, Brownian motion, business continuity plan, business process, collapse of Lehman Brothers, corporate governance, credit crunch, Credit Default Swap, diversification, fixed income, hiring and firing, implied volatility, interest rate derivative, interest rate swap, locking in a profit, London Interbank Offered Rate, margin call, market clearing, millennium bug, place-making, prediction markets, short selling, statistical model, stochastic process, the market place, the payments system, time value of money, too big to fail, transaction costs, value at risk, Wiener process, yield curve, zero-coupon bond

Bob Steiner (2012) Mastering Financial Calculations: A Step-by-step Guide to the Mathematics of Financial Market Instruments, Financial Times/Prentice Hall. 377 Index 30/360 date calculation 350–1 ABSs see asset backed securities abusive behaviour, traders 223 acceptance testing see user acceptance testing accounting 161–9 balance sheet 161–4 financial reports 168–9 profit and loss account 164–8 accrual accrual convention 349–50 accrued profit and loss 165 actual/actual date calculation 350 advisory services 269, 370 aggregation of calculations 342 trades 101–2 agricultural commodities 56 algorithms 184 amendment to a trade 108 American options 29, 66 amortising bonds 47, 48 analytics 271–2 see also quantitative analysts animal products 56 application programming interface (API) 270 architects, IT 187 asset backed securities (ABSs) 47 asset classes 33–59 bonds and credit 46–53 commodities 29, 53–8 equities 44–5 foreign exchange 40–4 interest rates 33–40 and products 17 trade matrix 71–2 trading across 58–9 asset holdings see holdings asset managers 10, 168–9 at-the-money options 66 audit 191–2 average trades, exotic options 68 back book trading 132 back office (operations) 183, 227, 316 back testing 317 back-to-back trades 152 bad data 105, 317–20 balance sheet 161–4 banks culture and conduct 203 interbank systems 158 reasons for trading 9–10 retail banks 222 traders’ internal accounts 123 Barclays Capital 219 barrier options 68 base rate, interest rates 35 Basel II 144 Basel III 205 baskets exotic options 68 FX trades 41–2 BCP see business continuity planning bearer securities 124 Bermudan options 66 bespoke trades 69–70 bid/offer spread 310 binary options 68–9 black box (mathematical library) 238, 241, 270 black box testing 301 Black Scholes formula 346 board of directors 193–4 bond basis deltas 175 379 380 bonds 27, 28, 29, 46–53 coupon payments 47, 48, 106–7 RABOND project case study 225–35 sovereign debt 46 tradeflow issues 49 types 46–7 bonuses 220–1 booking of a trade 85, 93–4 bootstrapping 348–9 boundary testing 351 breaches, dealing with 155–6 breaks, settlement 356–7 brokers 5–6, 10, 75 buckets (time intervals) 148–9 bullying behaviour 223 business continuity planning (BCP) 373 calculation process 337–52 see also valuation process bootstrapping 348–9 calibration to market 351 dates 349–51 example 337–8 mark-to-market value 339–40 model integration 352 net present value 338–9, 343–8 risks 352 sensitivity analysis 347–8 calibration process, valuation 351 call options 62, 63 cancellation of a trade 109 capital adequacy ratio (CAR) 144 case studies 225–52 EcoRisk project 235–47 OTTC equity confirmation project 247–52 RABOND project 225–35 cash balance sheet item 162 exchange dates 86 exercise 111 settlement 98, 99 cashflows American options 30 asset holdings 117–24 bank within a bank 123 consolidated reporting 122 custody of securities 123–4 diversification 122–3 realised and unrealised P&L 122 INDEX reconciliation 121 risks 124 treatment of 119–20 value of 120–1 credit default swaps 31 deposits 23 discount curve 38–9 equity spot trades 26 fixed bonds 27, 28 floating bonds 27, 28 foreign exchange swaps 25 future trades 20–1 loans 22 options 27–30, 345–6 post booking 96–7 risks 367 spot trades 19 swap trades 24 unknown, options valuation 345–6 zero bonds 27, 29 CDSs see credit default swaps Central Counterparty Clearing (CCP) 210–12 change coping with 260–1, 284 to a trade 105–10 clearing 210–12 Cliquet (ratchet options) 68 collateral 108, 153–4, 156, 212–13 COM (common object model) 246 commodities 29, 53–8 cash settlement 99 characteristics 55–6 currency 57 definition 55 example 53–5 localised production 57 OTC commodities 56 physical settlement 57–8 profit curve 54–5 time lag 57 tradeflow issues 58 types 56 utility of 57 common object model (COM) 246 communication 188, 197–8, 254–5, 259–60, 305, 371 competition analysis 269 compliance officers 192–3 confirmation of a trade 94–6, 247–52, 355 conflicts and tensions 196–7, 198–9, 360–1 381 Index consolidated reporting 122 consolidation of processes 283–4 control see also counterparty risk control; market risk control people involved in 189–99, 224 of report generation 335 conversion, currency 344 correlation risk 131, 363 counterparties changes to a trade 108 correlation between 364 identification of 85 Counterparty Clearing, Central 210–12 counterparty risk control 147–60, 364–5 activities of department 154–7, 190–1 collateral 153–4, 156 counterparty identification 153 default consequences 148 limit imposition 152–3 management interface 157 measurement of risk 149–52, 155, 156 non-fulfilment of obligations 147–8 payment systems 158–60 quantitative analyst role 268 risks in analysing credit risk 157–8 settlement 356 time intervals 148–9 coupon payments, bonds 47, 48, 106–7 credit default swaps (CDSs) 30–1, 51–2, 65–6, 175, 209 credit exposure 150–1 credit quantitative analysts 274 credit rating companies 231–2 credit risk see also counterparty risk control; credit default swaps; credit valuation adjustment bonds 46–53 default 51 definition 50 documentation 50–1 market data 316 measurement of 209 recovery rate 52–3 risks in analysing 157–8 types of risk 131 credit valuation adjustment (CVA) 207–13 debt valuation adjustment 209 definition 208 funding valuation adjustment 209 measurement of 208 mitigation 210 netting 211–12 portfolio-based 213 rehypothication 212–13 credit worthiness 51–2, 155 creditors, balance sheet item 163 CreditWatch 232 culture of banks 203 currency conversion 344 exposure to 4 precious metals as 57 reporting currency 42 value of holdings 120–1 currency swaps, foreign exchange 41 current (live) market data 79, 314 curves, market data 310–13 custodians 98, 124 customer loyalty 199 CVA see credit valuation adjustment data 307–25 absence of 368 authentic data 368 back testing 317 bad data 105, 317–20 bid/offer spread 310 corrections to 321–2 data feeds 226 expectations 309–10 extreme values 317 implied data 323 integrity of 322–4 internal data 321 interpolation 319 market data 107–8, 180, 292, 308–17 processes 286 risks 324–5, 367–8 sources of 320–1, 323 storage 309 testing 302 time series analysis 320 types of 308–10 validity of 307 vendors 321 data cleaning 320 data discovery 319–20 data engineering 319 databases 250–1, 308 382 dates calculation of 349–51 exercise of trades 111 final settlement 113 internal and external trades 102 relating to a trade 86–7 settlement 101, 113 on trade tickets 102 debt, exposure to 127 debt valuation adjustment (DVA) 209 debtors, balance sheet item 162 default 51, 131, 148 see also credit default swaps delivery versus payment (DvP) 98 delta hedging 133 delta risk 130 deltas 175 deposits 23, 35 derivatives 61–72 see also futures and forwards; options; swaps digital options 68–9 directors, role of 193–4 discount curve, interest rates 38–9 discounting, NPV calculation 343–4, 345 diversification 122–3 dividends 105–6 documentation credit risk 50–1 EcoRisk project case study 240–1 legal documents 84–5 processes 287 risks 356, 374 settlement 98 Dodd–Frank Act 206–7 dreaming ahead 131–2 due diligence 192, 292 duties (fees) 97 DVA (debt valuation adjustment) 209 DVO1, risk measure 138 DvP (delivery versus payment) 98 economic data 84 EcoRisk project, case study 235–47 documentation 240–1 functionality 243–4 Graphical User Interface 237–8 mathematical library 238, 241 solution 238–40 testing 239–40 valuation problem debugging 242–3 INDEX electronic exchanges 6 electronic systems 92 email 92 EMIR (European Markets Infrastructure Regulation) 202–3 employees see people involved in trade lifecycle end of day roll 103, 181–2 end of month reports 182 energy products 56 equal opportunities 219–20 equities 26, 44–5, 247–52 errors confirmation process 95 in data 322 P&L corrections 171 post booking 97 in reports 333–4 European Markets Infrastructure Regulation (EMIR) 202–3 European options 29, 66 exceptions, processes 322 exchange price 75 exchanges 6, 86, 320 execution of a trade 89–93 exercise, option trades 64, 110–12, 357–8 exotic options 67–9, 109, 235–47, 346 expected loss 150 exposure 4, 125–8, 130–2, 150–1, 155, 156 fault logging 302–4 fees 97, 169 finance department 191, 316 financial products 17–31 bonds 27, 28, 29, 46–53, 106–7, 225–35 credit default swaps 30–1, 51–2, 65–6, 175, 209 deposits 23, 35 equities 26, 44–5, 247–52 futures 20–1, 35–6, 40–1, 61, 62, 77, 127, 311, 312 FX swaps 25, 41 loans 21–3 options 27–30, 61–9, 77, 109–12, 127, 235–47, 345–6, 357–8 spot trades 18–19, 40, 127 swaps 23–5, 30–1, 36–7, 41, 107, 312–13 financial reports 168–9 financial services industry 8–10 fixed assets, balance sheet item 161 fixed bonds 27, 28, 47, 48 fixed and floating coupons 127 383 Index fixed for floating swaps 23–4 fixed loans 22 fixing date 86 fixings 107–8 float for fixed/float for float 36 floating bonds 27, 28 floating loans 22 floating rate notes (FRNs) 47 flow diagrams 287 FoP (free of payment) 98 foreign exchange (FX) 40–4 baskets 41–2 FX drift 42–3 reporting currency 42 swaps 25, 41 tradeflow issues 43–4 forward rate agreement (FRA) 37–8 see also futures and forwards free of payment (FoP) 98 FRNs (floating rate notes) 47 front book trading 132 front line support staff 186 front office EcoRisk project, case 235–47 market risk control 142 risks 375–6 fugit 112 fund managers 10 funding valuation adjustment (FVA) 209 futures and forwards 20–1, 35–6, 40–1, 61, 62 gold futures 311, 312 leverage 77 risks 127 FVA (funding valuation adjustment) 209 FX see foreign exchange gamma risk 130 gearing 77–8 gold futures 311, 312 governance 204 Graphical User Interface (GUI) 237–8 hedge funds 10, 168–9, 212–13 hedging strategies 133–4 hedging trades 128 help desks 247 historical market data 314 holdings 117–24 asset types 118 bank within a bank 123 consolidated reporting 122 custody of securities 123–4 diversification 122–3 realised and unrealised P&L 122 reconciliation 121 risks 124 value 120–1 human resources see people involved in trade lifecycle human risks 194–9, 359–61 hybrid trades 69–70 identification details, trades 83–4 illiquid products 140 illiquid trades 339 in person trades 92 in-the-money options 66 incentives 195 industrial metals 56 information technology (IT) architects 187 case studies 225–52 communication 259–60 dependency on 284 EcoRisk project 235–47 equity confirmation project 247–52 infrastructure 186 IT divide 253–66 business functions 255–6 business requirements 261–3 coping with change 260–1 do’s and don’ts 263 IT blockers 258 IT requirements 263–4 misuse of IT 256–7 organisational blockers 257–8 problems caused by 255 project examples 265–6 solution 259–60 language of 254 legacy systems 282 operators 188 project managers 187–8 quality control 260 and quantitative analysts 271–4 RABOND project 225–35 risks 375–6 staff 185–9, 197, 217–18, 253–66 testers 188–9 and traders 258 384 infrastructure, IT 186 instantaneous risk measures 138 insurance 30–1, 50 integration testing 300 interbank systems 158 interbank trading (LIBOR) 39 interest rates 21–3, 33–40 base rate 35 credit effects 39 deltas 175 deposits 35 discount curve 38–9 forward rate agreement 37–8 futures 35–6, 311–12 market participants 34–5 option valuation 67 products 35–8 quantitative analysts 274 swaps 23–5, 36–7 time value of money 33–4 tradeflow issues 39–40 vegas 175 interim delivery of projects 259 internal audit 191–2 International Swaps and Derivatives Association (ISDA) 50 investment banks 9–10 investments, balance sheet item 161 ISDA (International Swaps and Derivatives Association) 50 IT see information technology kappa risk 130 knock in/knock out, barrier options 68 knowledge, risks 359–60 legacy IT systems 282 legal department 189, 293, 316 legal documents 84–5 legal risks 50, 369 leverage 64–6, 76–9 LIBOR (interbank trading) 39 libraries 184–5 lifecycle of a trade see trade lifecycle limit orders 129 limits and credit worthiness 155 imposing 152–3 market risk control 141 line managers 222 INDEX linear derivatives 61, 62 liquidity 73–5, 202, 375 litigation 370 live trading 7 loans 21–3 management see also project management; risk management of changes 109–10 counterparty risk control 157 fees 169 market data usage 317 new products 292 responsibilities of 193–4 risks 374 of teams 229–31 margin payments 156 mark-to-market value 339–40 market data 180, 292, 308–17 business usage 315–17 changes as result of 107–8 curves and surfaces 310–13 sets of 314 market participants 4–5 market risk control 135–45, 190, 363–4 allocation of risk 139 balanced approach 143 controlling the risk 140–1 human factor 143 limitations 142–3 market data usage 316 methodologies 135–9 monitoring of market risk 140 need for risk 139 quantitative analyst role 268 regulatory requirements 143–4 responsibilities 141–2 market sentiment 340 matching of records 94–5 mathematical libraries 238, 241, 270 mathematical models evolution of 343 new products 293 parameters 341 prototypes 238–9 quantitative analyst role 183–5 risks 373 validation team 189–90 maturity of a trade 8, 67, 86, 112–13 MBS see mortgage backed securities 385 Index metal commodities 56, 57 middle office (product control) market data usage 316 new products 293 RABOND project, case study 225–35 role of 180–2 missing data 317 mobile phones 92 models see mathematical models Monte Carlo technique 346–7 mortgage backed securities (MBS) 47 multilateral netting 211–12 NatWest Markets, EcoRisk project 235–47 net present value (NPV) 338–9, 343–8 netting 152, 211–12 new products 289–95 checklist 292–3 evolution of 294 market data 292 market risk control 140 process development/improvement 279–88 risks 194, 294–5, 369 testing 291–2 trial basis for 290–2 new trade types 156 nonlinear derivatives 62–9 nostro accounts 99 NPV see net present value official market data 314 offsetting of risks 128 OIS (overnight indexed swap) 39 operational risks 355–8 operations department 183, 227, 316 operators, IT 188 options 27–30, 61–9 credit default swaps 65–6 exercise 110–12 exotic options 67–9, 109, 235–47, 346 leverage 64–6, 77 risks 127, 357–8 terminology 66 trade process 64–6 valuation 67, 345–6 orders 90–1, 357 OTC see over-the-counter trading OTTC equity confirmation project, case study 247–52 out-of-the-money options 66 over-the-counter (OTC) trading 6–7 clearing 210 commodities 56 price 75 overnight indexed swap (OIS) 39 overnight processes 101–5 P&L see profit and loss parallel testing 301 pay 203, 220–1 payment systems 106–7, 158–60, 357 pension funds 10 people involved in trade lifecycle 177–200 see also working in capital markets back office 183, 227, 316 compliance officers 192–3 conflicts and tensions 196–9, 360–1 control functions 189–99 counterparty risk control department 190–1 finance department 191, 316 human risks 194–9 information technology 185–9, 197, 217–18, 253–66 internal audit 191–2 legal department 189, 293, 316 line managers 222 management 193–4 market risk control department 190 middle office 180–2, 225–35, 293, 316 model validation team 189–90 personality and outlook 194–5, 244–5, 273 programmers 187, 244–5 quantitative analysts 183–5, 267–75 researchers 179–80 revenue generation 177–89 sales department 179, 227, 315, 375 senior managers 126 staffing levels 195 structurers 179 supervisors 204 testers 298–9 traders 125–6, 177–8, 218–23, 226–7, 258, 268, 315, 361 trading assistants 178 trading managers 126, 193 training of staff 193 performance reports 169 personality and outlook 194–5, 244–5, 273 PFE (potential future exposure) 151 physical assets, exercise 111 386 physical commodities, settlement 57–8, 99 planning of processes 282–3 recovery plans 203–4 risks 360 post booking processes 96–7 postal trades 92–3 potential future exposure (PFE) 151 power, abuses of 220, 221–2 pre-execution of a trade 89–91 precious metals 56, 311, 312 premiums 31 price 75–6, 138–9 pricing methods EcoRisk project, case study 235–47 short-term pricing 183 process development/improvement 279–88 coping with change 284 current processes 285–7 evolution of processes 280–1 improving the situation 284–7 inertia 287–8 inventory of current systems 282–4 planning 282–3 timing 288 producers 5 product appetite 4 product control see middle office product development see new products profit curve, commodity trading 54–5 profit and loss (P&L) accounts 164–8 accrued and incidental 165 example 165–6 individual trades 166–7 realised and unrealised 165 responsibility for producing 167 risks associated with reporting 167–8 rogue trading 168 attribution reports 171–6 benefits of 171–2 example 173–6 market movements 173, 175 process 172–3 unexplained differences 173 balance sheet item 163 end of day 182 realised and unrealised 122, 165 programmers 187, 244–5 see also quantitative analysts INDEX project management 225–47, 259, 262 project managers 187–8 proprietary (‘prop’) trading 203 prototypes, IT projects 238–9 provisional trades 89–90, 357–8 put options 62, 63 PVO1, risk measure 138 quality control, IT 260 see also testing quantitative analysts (quants) 183–5, 267–75 and IT professionals 271–4 role of 267–9, 270 seating arrangements 270–1 working methods 269–70 RABOND project, case study 225–35 management 229–31 outcome 233–5 reports 227–9 team management 229–31 traders 226–7 random market data 314 rapid application development (RAD) 260, 281 ratchet options (Cliquet) 68 ratings companies 231–2 raw data 323 raw reporting 331 real world of capital markets see working in capital markets realised P&L 122 receipts 156 reconciliation 121 recovery plans 203–4 recovery rates 52–3, 176 redundancy, processes 282 reform of banks 203 registered securities 123–4 regression testing 302 regulation 201–13, 223–4 authorities 202 Basel II and III 144, 205 credit valuation adjustment 207–13 external 192 internal 224 market risk control 143–4 new products 293 problems 204–5 requirements 202–4 387 Index risk-weighted assets 205–7 risks 369 rehypothication 212–13 remuneration 203, 220–1 reporting currency 42 reports 327–36 accuracy 330–1, 368 calculation process 342 configuration 331–2 consolidated reporting 122 content 328–9 control issues 335 dimensions 333 distribution 329–30, 335, 369 dynamic reports 332–3 end of month reports 182 enhancements 335 errors in 333–4 false reporting 375 financial reports 168–9 frame of reference 333 middle office role 180–1 OTTC equity confirmation project 250, 251 performance reports 169 presentation 329 problems 333–4 profit and loss 167, 171–6 RABOND project 227–9 raw reporting 331 readership 328, 329, 368–9 redundancy of 334–5 requirements 328–33 risks 335–6, 368–70 security issues 335, 368 timing 330 types of 330 reputation, risk to 356, 370 research 268, 375 researchers 179–80 reserve accounts 141 reset date 86 resettable strike, exotic options 68 retail banks 222 revenue generation, people involved in 177–89 rho risk 130 risk 13–16 see also counterparty risk control; market risk control advisory services 370 appetite for 4 business continuity planning 373 calculation process 352 cashflows 124, 367 changes to a trade 110 communication 371 confirmation 95–6, 355 control departments 224 correlation 363 data 324–5, 367–8 definition 13 documentation 356, 374 exercise 112 front office 375–6 human risks 194–9, 359–61 information technology 375–6 instantaneous measures 138 legal risks 369 liquidity 74–5, 375 litigation 370 management risks 374 measures 130, 138, 149–52, 155, 156 model approval 373 new products 140, 194, 294–5, 369 operational risks 355–8 orders 91 origin of risks 126–8 payment systems 357 provisional trades 90, 357–8 quantifying 14 regulation 369 reports 335–6, 368–70 reputation 356, 370 risk-weighted assets 205–7 sales 375 settlement 100, 355–7 short-term thinking 360 straight through processing 357 support activities 376 systematic 202–3, 375–6 testing 304–5, 370–1 types 130–2 unexpected charges 356 unforeseen 16, 353 valuation process 352, 373 risk management 13, 15, 125–34 in absence of trader 128–9 dreaming ahead 131–2 EcoRisk project case study 235–47 hedging strategies 133–4 hedging trades 128 388 risk management (continued) offsetting of risks 128 senior managers 126 traders 125–6, 361 trading managers 126 trading strategies 132 rogue trading 168 sales data 84 sales department 179, 227, 315, 375 SBC Warburg, equity confirmation project, case study 247–52 scenario analysis 136, 198–9, 341 scope creep 187, 264 scrutiny of trades 96 securities, custody of 123–4 security issues 181, 335, 368 semi-static data 309 senior managers 126 sensitivity analysis 138, 347–8 settlement 97–101, 147–8 breaks 101, 356–7 commodities 99 dates 101, 113 nostro accounts 99 quick settlement 101 risks 100, 355–7 shares 44–5 see also equities short selling 65 short-term pricing 183 short-term thinking 195–6, 360 silo approach 257 simple products 70–1 smoke testing 301 sovereign debt 46 speculators 5 spot prices 61, 62, 63, 67, 76–7 spot testing 301 spot trades 18–19, 40, 127 spread of bid/offer 310 spreadsheets 184, 238 staff see people involved in trade lifecycle stale data 105, 318 Standard & Poor’s (S&P) ratings 231–2 static data 309 stop-loss hedging 133–4 stop orders 129 storage of data 309 straight through processing (STP) 93–4, 357 INDEX stress, staff 222, 244–5 stress testing 302 strike price, options 67 structured trades 69–70 structurers 179 supervisors 204 support activities, risks 376 surfaces, market data 310–13 swaps credit default 30–1, 51–2, 65–6, 175, 209 fixings 107 foreign exchange 25, 41 interest rate 23–5, 36–7 yield curves 312–13 swaptions 66 synthetic equities (index) 45 systems see also information technology amalgamation 104–5 analytics 271–2 electronic systems 92 integrated 261 legacy IT systems 282 risks 375–6 testing 251–2, 300 tail behaviour, predicting 143, 364 team management 229–31 telephone transactions 91–2 tensions and conflicts 196–9, 360–1 testing 297–305 back testing 317 boundary testing 351 extreme values 352 fault logging 302–4 importance of 298 mathematical models 239 new products 291–2 risks 304–5, 370–1 stages 300–1 testers 188–9, 298–9 types of 301–2 unit testing 300 user acceptance testing 237, 239–40, 252, 264, 301 when to perform 299–300 theft 355 theta risk 130 time intervals (buckets) 148–9 time lag, commodities 57 389 Index time series analysis 320 timeline of a trade 79, 86–7 trade blotters 93 trade lifecycle 89–115 booking 93–4 business functions 11 changes during lifetime 105–10 confirmation 94–6 equity trades 45 example trade 113–15 execution 91–3 exercise 110–12 maturity 112–13 new products 293 overnight processes 101–5 post booking 96–7 pre execution 89–91 settlement 97–101 trade tickets 102 trade/trading 3–12 see also trade lifecycle anatomy 83–7 business functions 11 complicated trades 340 consequences of 7–8 definition 10–12 financial products 17–31 live trading 7 matching of records 94–5 policies 8 reasons for 3, 9–10 timeline 79, 86–7 transactions 5–7 types 132 tradeflow issues bonds 49 commodities 58 foreign exchange 43–4 interest rates 39–40 traders 177–8, 218–22, 223, 226–7, 258, 268 bonuses 220–1 market data usage 315 risk management 125–6, 361 trading assistants 178 trading desks 70–1, 256–7 trading floor 217–18, 235–6 trading managers 126, 193 training of staff 193 tranche correlation 131 treasury desk 71 trials for new products 290–2 trust 197, 222 UAT see user acceptance testing underlying 83 unexplained differences, P&L reports 173 unforeseen risk 16, 353 unit testing 300 unknown cashflows 345–6 unrealised P&L 122 unwinding a trade, cost of 76 user acceptance testing (UAT) 237, 239–40, 252, 264, 301 validation of models 189–90 valuation process see also calculation process calibration to market 351 mark-to-market value calculation 339–40 middle office role 181 NPV calculation 338–9, 343–8 options 67 problem debugging 242–3 risks 352, 364, 373 valuation systems 269 value at risk (VaR) 136–8, 341 vega (kappa) risk 130 vegas 175 vendors, data services 321 volatility 67, 130 volume of a trade, price effect 76 white box testing 301 workarounds 303 working in capital markets 217–24 see also case studies; people involved in trade lifecycle in 1990s 217–19 culture clashes 219 equal opportunities 219–20 office politics 220–2, 246 positive/negative aspects 222–3 yield curves 312–13 zero bonds 27, 29, 47 Index compiled by Indexing Specialists (UK) Ltd WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley’s ebook EULA.

This means the issuer does not have to worry about having to find intermediate income to service the coupon payments. Amortising bonds Sometimes the capital borrowed is repaid to investors in instalments, rather than all at the end. Then the notional of the coupon is reduced over time. Although the fixed coupon rate remains at say 8%, the notional might have reduced from 200,000,000 to 100,000,000, resulting in a lower coupon payout. Asset backed securities Some bonds are secured using debts owed to the issuer itself. These commonly arise from mortgages (mortgage backed securities or MBS) or credit card repayments. They are amortising bonds, but the amortisation is unknown at time of issue. If the underlying debtors, such as homeowners, repay their mortgages early, then the debt outstanding on the bonds is reduced accordingly. For simplicity in this example, the payments assume a very crude calculation of dividing the annual rate in half to get the semi-annual payment.


pages: 408 words: 85,118

Python for Finance by Yuxing Yan

asset-backed security, business cycle, business intelligence, capital asset pricing model, constrained optimization, correlation coefficient, distributed generation, diversified portfolio, implied volatility, market microstructure, P = NP, p-value, quantitative trading / quantitative finance, Sharpe ratio, time value of money, value at risk, volatility smile, zero-sum game

The reader could spend the next 40 minutes typing, correcting typos, and retyping those 13 lines. With less than 2 hours, they should be able to run the program to price a call option. The cost of adopting a new computer language includes many aspects such as annual license cost, maintenance costs, available packages, and support. Another example is related to an SEC proposal. In 2010, the SEC proposed that all financial institutions are to accompany their new Asset-Backed Security (ABS) with a computer program showing the contractual cash flows of the securities (www.sec. gov/rules/proposed/2010/33-9117.pdf). The proposed computer language is Python. Obviously, any investor can access Python because it is free. [ 10 ] Chapter 1 For bond analytics or credit risks, Roger Ehrenberg (2007) argues for an open source approach. Whether or not ratings should be required for institutional investors to buy certain securities is not the issue; the essential point is getting better transparency and analysis of instruments constituting the investable universe.

[ 374 ] Index Symbols _ expression 36 52-week high and low trading strategy 196 %d 40 % operator 29 A ActivatePython installation URL 124 American call used, for estimating implied volatility 288, 289 American option about 242 versus European option 242 Amihud's model for illiquidity (2002) 198 Anaconda Python, launching from 96, 97 URL 96 Anaconda command prompt used, for launching Python 169 Anaconda installation URL 125 Anderson-Darling test 349 annotate() function 142 annualized return distribution estimating 319, 320 annual percentage rate (APR) 55, 99 annual returns daily returns, converting to 190, 191 annuity estimating 54, 55 ARCH about 347, 363, 364 ARCH (1) process, simulating 364 ARCH (1) process simulating 364 arithmetic average 336 arithmetic mean versus geometric mean 332 array logic relationships 110 looping through 108, 293 working with 104 performing 105 array operations item by item multiplication operation, performing 107 matrix multiplication operation, performing 105, 106 minus operation, performing 105 plus operation, performing 105 Asian options about 336 advantages 336 Asset-Backed Security (ABS) 10 AutoRegressive Conditional Heteroskedasticity. See ARCH B barrier options Down-and-out option 337 pricing, Monte Carlo simulation used 337, 338 Up-and-in option 337 Up-and-out option 337 bear spread with calls trading strategy 251 bear spread with puts trading strategy 251 binary file data, reading from 222 data, saving to 222 binary search 290, 291 binomial_grid() function 249, 263, 265 binomial tree (CRR) method about 261 for American options 268, 269 for European options 268 graphical representation 262-267 Black-Scholes-Merton option model 242, 247, 248 Bondsonline URL 174 bootstrapping without replacements 317, 318 with replacements 317, 318 Breusch 355-358 bs_call() function 248, 279 built-in functions listing 32 bull spread with calls trading strategy 251 bull spread with puts trading strategy 251 Bureau of Labor Statistics URL 174 butterfly with calls trading strategy 251, 256, 257 butterfly with puts trading strategy 251 C calendar spread 254 calendar spread trading strategy 251 call pricing, simulation used 334, 335 call buyer 243 call option 243 candlesticks used, to represent daily price 151, 152 Capital asset pricing model.


pages: 309 words: 95,495

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

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

This didn’t eliminate sovereign debt crises such as the Asian financial crisis, but it made them less likely to be a threat to America’s financial system; American banks’ exposure to Mexico in 1994, and East Asia in 1997, was far smaller than in 1982. A similar feat was accomplished with securitization. Banks had always been able to sell individual loans, usually to other banks. But starting in the 1970s Lewis Ranieri of Salomon Brothers hit upon the idea of packaging many mortgages, and later credit card receivables or auto loans, together into a single “mortgage-backed security” (MBS) or “asset-backed security” (ABS) and selling it to investors just like a corporate bond. The original purpose was to increase the supply of mortgages by enabling banks and thrifts—a sort of bank with more restrictions on its lending—to make loans, sell them, and use the proceeds to make new ones. Regulators found that securitization served another purpose: it removed potentially risky loans from the hands of both damaged and healthy banks.

When Gorton and two coauthors tracked the history of safe assets, they learned that the assets remained remarkably constant from 1952 to 2010, at about 33 percent of total assets. Some of those safe assets were public, such as Treasury bonds, and some were private, such as bank deposits. What was really striking was the transformation within the private category. Bank deposits slid from about 80 percent in the 1950s and ’60s to 27 percent on the eve of the crisis. What took their place? Money market mutual funds, asset-backed securities, and commercial paper. The difference was critical. Bank deposits, up to the federal deposit insurance limit, truly are safe. These new assets had been engineered to seem as safe as bank deposits, but they really weren’t, and that distinction would prove critical during the crisis. But Gorton would not make the connection until the crisis had begun. In 1984 Gorton began teaching at the Wharton School, where he began studying the practice of banks “securitizing” their loans.


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

activist fund / activist shareholder / activist investor, 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, business cycle, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, creative destruction, 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, God and Mammon, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, labour market flexibility, liberal capitalism, light touch regulation, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, mass immigration, means of production, Menlo Park, money market fund, moral hazard, moveable type in China, Myron Scholes, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Paul Samuelson, 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, Veblen good, We are the 99%, Wolfgang Streeck, zero-sum game

On one view, first advanced by the economist Charles Dumas of Lombard Street Research and subsequently embraced by Alan Greenspan’s successor at the Fed, Ben Bernanke, in the run-up to the crisis, the bankers were working in a world of global imbalances. Asia, the petro-economies and much of northern Europe were running up big balance-of-payments surpluses on current accounts and saving far more than they were investing. As a result, these excess savings were depressing yields on all investments around the world. Pension funds and other investors were desperate for income. By creating all those structured products, such as asset-backed securities, collateralised mortgage obligations and the rest, banks were responding to their clients’ need for assets that yielded a higher income than that available on conventional government bonds. At the same time, the Basel capital regime was encouraging them to bump up their mortgage lending by according mortgages an unrealistically low-risk status that called for less capital backing than in, say, small business lending.

Kennedy proved to be one of history’s most effective poachers turned gamekeepers in a period when the Hamilton–Jefferson debate on the morality of speculation resurfaced against a background of widespread bank failures and virulent Main Street antipathy for Wall Street. Today’s speculators more often than not operate under the guise of hedge fund managers. Huge killings were made, for example, from the collapse in the value of asset-backed securities and the subsequent collapse in equities in 2007–09 by such red-in-tooth-and-claw hedge fund men as John Paulson. Yet to say that speculation has finally achieved respectability would be pushing the case too far. In Western culture, the Christian legacy means that many people still feel uncomfortable about profiting from the misfortunes of others and making money out of money – something that does not trouble, say, the Chinese, who are more at ease with speculation.


pages: 586 words: 160,321

The Euro and the Battle of Ideas by Markus K. Brunnermeier, Harold James, Jean-Pierre Landau

Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, battle of ideas, Ben Bernanke: helicopter money, Berlin Wall, Bretton Woods, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, collective bargaining, credit crunch, Credit Default Swap, currency peg, debt deflation, Deng Xiaoping, different worldview, diversification, Donald Trump, Edward Snowden, en.wikipedia.org, Fall of the Berlin Wall, financial deregulation, financial repression, fixed income, Flash crash, floating exchange rates, full employment, German hyperinflation, global reserve currency, income inequality, inflation targeting, information asymmetry, Irish property bubble, Jean Tirole, Kenneth Rogoff, Martin Wolf, mittelstand, money market fund, Mont Pelerin Society, moral hazard, negative equity, Neil Kinnock, new economy, Northern Rock, obamacare, offshore financial centre, open economy, paradox of thrift, pension reform, price stability, principal–agent problem, quantitative easing, race to the bottom, random walk, regulatory arbitrage, rent-seeking, reserve currency, road to serfdom, secular stagnation, short selling, Silicon Valley, South China Sea, special drawing rights, the payments system, too big to fail, union organizing, unorthodox policies, Washington Consensus, WikiLeaks, yield curve

The ECB, for example, throughout the crisis, decided to lend against a wide range of collateral and reduce haircuts for particular asset classes. The list of specific changes is too long to elaborate here, but to gain a rough understanding of the ECB’s actions, it suffices to note that the credit threshold for most assets to qualify as collateral was over time reduced from A– to BBB–. In particular, the policy changes were designed to make it easier for banks to use asset-backed securities as collateral for borrowing. These measures drew harsh criticism in the German media, where one story in particular received a lot of attention: the use of professional soccer players as collateral. As reported by El País (and quoted in the German newspaper Handelsblatt), the transfer rights to Cristiano Ronaldo and Kaka, two soccer players for Real Madrid, were part of the collateral underlying credit extended to the Spanish banking conglomerate Bankia.11 In the case of default, the rights to Ronaldo and Kaka would in principle have been claimed by the ECB, leading to jokes about whether the ECB intended to create its own soccer team.

The ECB in particular wanted to use the program to affect business conditions and was worried that the small and medium enterprise (SME) sector that was vital to the economy in many European countries (especially in Northern Italy and Spain) had been locked out of bank lending by the effects of the bank crisis. An asset-based securities purchasing program might thus be a way of galvanizing the European financial sector. Overall, however, the asset-backed securities markets stayed small, and the quantitative impact of the program remained limited. THE JACKSON HOLE SPEECH A decisive turn was taken by Mario Draghi at the end of August 2014, in a speech that he gave in Jackson Hole, Wyoming, a scenic meeting ground where senior central bankers from across the world meet every year. As in his June 2012 London speech, the ECB president inserted crucial remarks at the last moment that were not included in the prepared (written) text.

By virtue of the Jackson Hole speech, it has almost become an intermediate objective of ECB monetary policy. QE ANNOUNCEMENT BY THE ECB In January 2015, amid continued deflationary pressures, the ECB announced its own large-scale QE program. The size of the program turned out to be larger than the market expected: €60 billion bonds per month were to be purchased, comprising €45 billion of sovereign debt, €5 billion of bonds issued by institutions and agencies, and €10 billion for asset-backed securities and covered bonds (an extension of the previously existing program). The price movements during the minutes of the QE announcements revealed the extent to which markets perceived the impact of the program. The German bund (ten year) yield dropped by 0.13 percentage points (even though the announcement was widely expected). More interestingly, the US Treasury (ten year) also dropped by 0.10 percentage points.


pages: 350 words: 109,220

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

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

“Will such interventions only take place in recessions, or will Fed officials use them in the future to try to make economic expansions stronger or to assist certain sectors and industries for other reasons?” In fact, though, the Fed was already far down the road to picking winners and losers. Bernanke and Paulson had negotiated a novel approach that turned auto, student, credit card, and small-business loans into securities. Paulson was so enthusiastic about the innovation that he publicly announced it before the Treasury and the Fed had agreed on details. Called TALF, for Term Asset-Backed Securities Loan Facility, the program was targeted at the 40 percent of all U.S. consumer lending that didn’t stay on the books of banks — the shadow banking system, again. Before the Great Panic, outfits like Ford Motor Credit turned consumer loans for cars and trucks into securities that it then sold to investors. By the fall of 2008, the market for those securities had disappeared, apparently because investors feared a recession so deep that more than the usual number of consumers wouldn’t be able to pay back their loans.

Primary Dealer Credit Facility Created by the Fed in March 2008 to expand the discount window to provide loans to securities firms, not only banks. repurchase agreement Loan in which one side agrees to buy a security from the other and sell it back at a fixed date and a fixed price. Known as “repo.” securitization Practice of turning loans made by banks and others into securities that can be held and traded by investors. Term Asset-Backed Securities Loan Facility (TALF) Launched In March 2008 by the Fed and Treasury to lend to investors who buy securities backed by loans to consumers and businesses. Term Auction Facility (TAF) Created by the Fed in December 2008 for banks to borrow from the Fed as an alternative to the discount window; rate set in auctions. tri-party repo Loan — or repurchase agreement — in which a bank serves as a middleman between the borrower and lender.


pages: 274 words: 93,758

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

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

If they could not themselves tell apart the good avocados (securities) from the mediocre, and in some cases, truly rotten, the new-avocado growers (the financial producers of the new securities) had little incentive to produce good new avocados. They could, more cheaply, produce bad new avocados (complex derivative packages backed with securities with high chances of default), and take them to the ratings agencies, which would mine their reputations by rating them AAA. In parable, regarding avocados—and in reality, regarding mortgage-based asset-backed securities—that is what happened. Not only did it happen, it is just what we would expect in a phishing equilibrium, in which a grower of delicious avocados would be unable to compete. He would have to sell his perfect avocados at the price of the overrated mediocre ones. If the costs for producing perfect ones were greater than the costs for producing mediocre ones, his orchard could be put to more profitable use.

., 117, 194n3, 219n1, 220n3, 220nn10–13, 220n15, 220n17, 221n22 alcohol: abuse and dependence, xv–xvi, 109–10, 111–14; advertising, 110; consumption rates of, 116; driving under influence of, 112, 115–16; easy availability of, xvi, 116; effects on lives, 111–14; health risks of, xv–xvi, 109–11, 114; industry interests, 114, 115; legal drinking age, 115; moderate use of, 103; psychological effects of, 111, 113; research on, 114; taxes on, 114–15 Alessi, Christopher, 192n26 Aleve (naproxen), 86–87, 88, 92 Alexander, Raquel Meyer, 81, 206nn37–38 Alito, Samuel, 160 Altman, Edward, 130 American International Group (AIG), 38–40 American Jobs Creation Act (AJCA), 81 American National Standards Institute, 138–39 Anders, George, 221n5 Annear, Steve, 213n9 Ansolabehere, Stephen, 77, 205nn21–22 Armour, J. Ogden, 207n2 Armstrong, Gary, 195n4 Arnold, Dan, 122 Arrow, Kenneth J., 186n18 Arthur, Anthony, 207n1 Aspin, Leslie, 78, 79, 80, 205n24 Asquith, Paul, 130–31, 222n21, 222n23, 223n24 asset-backed securities, 24–25. See also mortgage-backed securities asset prices: bubbles in, xiv, 134; fundamental values and, 168; irrational exuberance and, 134; volatility of, 133–34, 168. See also housing markets; stocks Astra Zeneca, 211n53 attention-deficit hyperactivity disorder (ADHD), 93–94 Auerbach, Oscar, 104–5, 215n13 Austen, Jane, Pride and Prejudice, 46, 195n6 automobile dealers: financing by, 62–63; phishing by, 60–63; service profits of, 63 automobile industry, federal bailouts of, 75–76 automobiles: driving under the influence, 112, 115–16; safety of, 136, 142 avocados analogy, 23, 24–25, 34 Ayres, Ian, 60–62, 198nn3–6, 198n8 Bachenheimer, Doria, 158 Baer, Justin, 226n38 Bank of America, 157 bankruptcies: corporate, 27–28, 35–36; court roles in, 118; credit card debt and, 70; personal, 18–19, 70, 188–89n10; of savings and loans, 117, 119–20 banks: bailouts of, 75–76, 204–5n16; failures of, 29, 164–65; mortgage business of, 32.


pages: 782 words: 187,875

Big Debt Crises by Ray Dalio

Asian financial crisis, asset-backed security, bank run, banking crisis, basic income, Ben Bernanke: helicopter money, break the buck, Bretton Woods, British Empire, business cycle, capital controls, central bank independence, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, declining real wages, European colonialism, fiat currency, financial innovation, German hyperinflation, housing crisis, implied volatility, intangible asset, Kickstarter, large denomination, manufacturing employment, margin call, market bubble, market fundamentalism, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Northern Rock, Ponzi scheme, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, refrigerator car, reserve currency, short selling, sovereign wealth fund, too big to fail, transaction costs, universal basic income, value at risk, yield curve

It also provided incentives to lenders to alter the terms of their loans to troubled borrowers to make them more affordable. And it gave Fannie Mae and Freddie Mac an additional $200 billion in financing. Over the course of February, US policy makers also announced or expanded other policies—including the Term Asset-Backed Securities Loan Facility (TALF). TALF was a Fed policy which helped stimulate various types of consumer loans by lending up to $1 trillion on a non-recourse basis to holders of AAA asset-backed securities. It was set to begin on March 5 as an extension of a number of liquidity programs set to expire at the end of April. Despite all this stimulation, markets continued to fall, as shown in the chart below. Reports of ongoing weakness in the financial sector and economy continued to pile up. On Sunday March 1, news broke that AIG planned to report a $62 billion 4th quarter loss (the largest quarterly loss in US corporate history), and that the Treasury and Fed had agreed to provide AIG with an additional $30 billion in capital and loosen the terms of its earlier loan to the insurer.

–New York Times May 1, 2009 Citi Is Said to Require New Capital -New York Times May 1, 2009 Fed to Begin Lending Program in June “The Federal Reserve announced Friday that it would start a much-awaited program in June to encourage commercial real estate lending...The goal is to expand the availability of these loans, help prevent defaults on commercial properties like office parks and malls and make the sale of distressed properties easier, the Fed said...The new commercial real estate component is part of a broader program introduced in March, called the Term Asset-Backed Securities Loan Facility, or TALF, that aims to jump-start lending to consumers and small businesses.” –New York Times May 4, 2009 Existing-Home Sales Rise for a Second Month -New York Times May 6, 2009 Banks Gain Ahead of Stress-Test Results “Some of the big banks may need billions of dollars in additional capital, but Wall Street decided Wednesday to view the glass of the financial system as half full...Investors bought shares of major banks and regional banks as the government prepared to release the results of its stress tests of 19 major financial companies.


pages: 662 words: 180,546

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

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

The more that retirement provisions and social insurance schemes have been hollowed out, the more this market grew. The new owner of the insurance contract assumes the premium payments, wagering that the impending death minimizes the cost relative to the policy payoff: these are known in the trade as “viatical settlements.” This secondary market has grown dramatically over the last three decades.60 Policies purchased are often bundled together, and turned into derivative asset-backed securities that are then retailed to all manner of institutional investors, often ignorant of the underlying unsavory ghoulish trade. Hence, contrary to economic pundritry, ABSs, CDOs, and CDSs were not just the narrow preserve of Wall Street, but reached down into the very recesses of everyday life (and death). In this instance, we observe that the terminally ill are exhorted to redouble their “entrepreneurial” efforts regarding their dwindling assets, while the firms that securitize the policies and exercise surveillance (aka deathwatch) do not assume neoliberal risk, but operate solely in the realm of actuarial categories and fixed client identities.

This is one primary reason most outside analysts trace the housing bubble to the private sector, and in particular, specialized subprime originators such as Countrywide and Ameriquest and the banking firms that repackaged them into baroque securities; it even corrupted profitable subsidiaries of “industrial firms” such as GMAC and GE Capital; consequently, “the biggest factor contributing to the subprime boom was securitization.”156 Another argument against the neoliberal story is that there was in parallel a bubble in commercial real estate, which had nothing whatsoever to do with the GSEs.157 This trend dovetailed with another trend in the big banks, a transition from deriving much of their profit from loans to deriving it from fees for packaging mortgages (and other loans, such as credit card, auto loan, and student debt) into asset backed securities (ABS), selling ABSs and MBSs, creating dummy Structured Investment Vehicles (SIVs) to further reprocess MBSs into CDOs, and so forth. One estimate suggests that income from fee-related activities at commercial banks increased from 24 percent of total revenue in 1980 to 31 percent in 1990 to 48 percent in 2003.158 Combined with stunning increases in concentration in the mortgage origination market, such that the top 25 mortgage originators controlled 90 percent of the market in 2007, the consensus interpretation of events was that the mortgage boom was an adjunct to bigger changes in the private financial sector, and not prompted by some outbreak of rabid mendacity amongst the newly conniving population of home purchasers.

One might regard this incident as another illustration of the themes adumbrated in Mirowski, ScienceMart. 29 This was nicely captured in a cartoon that came out around the time of the Occupy movement. A stereotyped banker is looking out the window at a protester with a sign, “The Sky Is Falling!” The banker spins around and shouts, “Buy the Sky!” 30 Recall Klein’s attack on Inside Job discussed in chapter 1; or see Andrew Haldane’s speech at Jackson Hole in August 2012, “The Dog and the Frisbee.” 31 The best description of such programs (as P-PIP and Term Asset-Backed Securities Loan Facility) and their dodgy nature can be found in Barofsky, Bailout; but see also the various Special Inspector General for TARP reports at www.sigtarp.gov and U.S. Government Accountability Office, Opportunities Exist to Strengthen Policies and Processes. 32 This is the interpretation of Ferguson and Johnson, “Too Big to Bail,” for instance. It was later denied in Paulson, On the Brink. 33 Ferguson and Johnson, “Too Big to Bail: Part II,” p. 16. 34 Barofsky, Bailout, pp. 129–31. 35 Perry Mehrling (The New Lombard Street) has been one of the few to highlight these recent alterations in functions, only to praise them as an obvious extension of Bagehot’s principle of central banks acting as lenders of last resort.


EuroTragedy: A Drama in Nine Acts by Ashoka Mody

"Robert Solow", Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Basel III, Berlin Wall, book scanning, Bretton Woods, call centre, capital controls, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, credit crunch, Daniel Kahneman / Amos Tversky, debt deflation, Donald Trump, eurozone crisis, Fall of the Berlin Wall, financial intermediation, floating exchange rates, forward guidance, George Akerlof, German hyperinflation, global supply chain, global value chain, hiring and firing, Home mortgage interest deduction, income inequality, inflation targeting, Irish property bubble, Isaac Newton, job automation, Johann Wolfgang von Goethe, Johannes Kepler, Kenneth Rogoff, Kickstarter, liberal capitalism, light touch regulation, liquidity trap, loadsamoney, London Interbank Offered Rate, Long Term Capital Management, low-wage service sector, Mikhail Gorbachev, mittelstand, money market fund, moral hazard, mortgage tax deduction, neoliberal agenda, offshore financial centre, oil shock, open borders, pension reform, premature optimization, price stability, purchasing power parity, quantitative easing, rent-seeking, Republic of Letters, Robert Gordon, Robert Shiller, Robert Shiller, short selling, Silicon Valley, The Great Moderation, The Rise and Fall of American Growth, too big to fail, total factor productivity, trade liberalization, transaction costs, urban renewal, working-age population, Yogi Berra

Through much of the year, the Italian unemployment rate stood at or above 12.5 percent, a postwar high.105 In contrast, Germany’s real interest rate was turning negative, the economy had rebounded nicely, and the unemployment rate was plummeting. Simply put, the ECB’s monetary policy was adding to the pace of economic divergence. The ECB’s purchases of asset-​backed securities, intended to boost lending, proved to be a dud. As Felix Blomenkamp and Rachit Jain of PIMCO reported, the ECB mainly bought asset-​backed securities from banks in the “core” countries, such as Germany, which did not need the help.106 The greater long-​term damage was to the ECB’s credibility. The ECB had wasted thirteen long months with mainly cheap talk. From November 2013 to December 2014, it had reduced the policy interest rate at a glacial pace by 0.20 percent (one-​fifth of one percent).

On September 4, when the ECB’s Governing Council met for its monthly monetary policy decision, the strong euro was still impeding eurozone economic recovery. The Governing Council delicately lowered the main policy interest rate by an additional 10 basis points, from 0.15 percent to 0.05 percent, and it increased the fee charged to banks for depositing their funds at the ECB. The ECB also announced a small program to buy so-​called asset-​backed securities, such as packages of bank loans. This was yet another step to encourage banks to lend at lower interest rates. Draghi repeated that inflation expectations “continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%.” And he said again that the ECB remained committed “to using also unconventional instruments,” although only if it became necessary to counter the “risks of too prolonged a period of low inflation.”83 After having recited his monthly mantra, Draghi made it clear that the Governing Council remained deeply divided on the pace at which the ECB should move.

See also specific countries distrust of disciplining powers of financial markets, 85–86 “falling forward” narrative, 5–12 fascination with banks, 161–164 fixed-​exchange rate breakdown, 105 fragility of “fixed” exchange rates, 9 “Groundhog Day” discussions, 273 “incomplete monetary union” in, 4 Italy’s loss of trust in, 389f Kohl’s goal of unity for, 109–110 lack of political accountability, 21, 88, 160, 267, 281–282, 364–365, 444, 451, 459, 461 leadership meeting, Amsterdam, 113–114 leadership meeting, Nice, 137 Merkel’s distancing Germany from, 322–326 Nobel Committee’s honoring of, 335 “permissive consensus” frays and breaks down, 10, 97, 191, 321, 333 “political union” mantra, 3, 75f post-​1950 spirit of reconciliation, 60 post-​WWII economic recovery, 163f proposed constitution for “citizens and states,” 187 index 623 Europe (cont.) rebellion against single currency, 95–101 Schäuble/​Lamers warning on problems of, 108 unemployment rates, 90 U.S. growth differential, 127 wealth-​to-​income ratio, 164 European Banking Authority (EBA), 372, 378 European Central Bank, 121, 127–128, 129–130 European Central Bank (ECB) Asmussen’s disagreement with Draghi, 319 asset-​backed securities purchases, 364 Bundesbank and, 311 commitment to price stability, 11 concerns on Greece’s interest rates, 134 conflict with Denmark, 136 crises prevention efforts (2012), 310–315 defense of SGP rules, 146–147 Draghi and, 17, 292–293, 303–310, 335 Duisenberg’s presidency, 145, 173 eurozone politics influence, 362–365 Fed’s policy differences with, 138–140, 198–202, 291–293 Germany and, 297, 320 Governing Council, 139, 203–204, 296, 304, 320, 329, 343, 357, 359, 361 government debt repayments by, 310–311 Greek crisis and, 236, 243, 245, 249, 252, 262, 416–417 hyper-​independence of, 160 IMF’s impatience with, 301 interest rates and, 14–15, 17, 139, 146, 291, 304, 307, 319, 337 internal conflicts, 353–361 624   i n d e x Italian situation and, 18–19 Krugman’s criticism of, 297, 360 lack of political accountability, 90 lagging/​loss of credibility of, 221–226 loans to banks, 172, 271f longer-​term refinancing options (LTROs), 304–306 loss of credibility, 364 loss of global influence, 362 lowering of deposit rate, 307 lowering of long-​term interest rates, 19 lowering of policy rates, 142 LTRO funds and, 306 mandate of, 88–91, 199–201, 462 Modigliani/​Solow’s warning about, 90–91 monetary policy, 18, 90–91, 100, 129, 139, 142, 152–153, 174, 192, 204, 210, 283, 290–293, 295–297, 299–302, 342–343, 356–358 OMT program, 311–315, 317, 320, 341–342, 373, 385–386, 426, 446 Padoa-​Schioppa’s compliment on, 160–161, 173 policy interest rates, 149, 301f, 315 political accountability, lack of, 160 powerlessness in dealing with inflation, 174–175 price deflation and, 315–321 pushback against Schröder, 143 QE (quantitative easing) by, 381–385, 383f raising of policy rates, 200f recessions and, 18, 202, 212, 230, 304, 307, 315, 357 reduction of bond purchases, 384 response to Irish crisis, 267, 270, 271f Schröder’s attack on, 129–130, 144 Spain and, 299, 300, 307–308 stability ideology, 11, 14–15, 90, 161, 173 subprime crisis response, 196–205, 218–219, 222–226, 223f tightening of monetary policy, 210–212 Trichet’s presidency, 303 triggering of financial crisis, 299–303 2011 interest rate hike, 17 Weidmann’s opposition to, 311–312, 319 European Coal and Steel Community, 27–28, 30, 44, 108, 116, 466, 471 European Commission (EC) on bailing out Greek banks, 217, 232 country representation, 106, 137 effort to gain taxation authority, 32 exchange rates and, 56 as High Authority replacement, 30 Italy’s banks and, 377–378 Maastricht Treaty and, 84 monetary union, alternative considerations, 107 “One Market, One Money” report, 71b opposition of Greek entry to the EEC, 130–131 Prodi’s presidency of, 146 response to Greek crisis, 248 Schäuble-​Lamers proposal to, 109 Single European Act (SEA) and, 77 SGP and, 145 “study group” of, 55 welcome of Greece to eurozone, 134 European Competition Commission, 376 European Constitutional Treaty, 334 European Court of Justice (ECJ), 151 European Defense Community (EDC), 50, 75–76 European Department (IMF), 285 European Economic Community (EEC) Brittan’s comment on, 48 commerce among members, 32 evolution of, 116 exchange rates and, 59 formation of, 30 Great Britain’s membership, 44 Greece/​Spain/​Portugal entrance, 106 Mann’s comment on, 70 Milward’s comment on, 29–30 Pompidou’s push for links within, 42 tariffs and, 31 Treaty of Accession with Greece, 131 European Financial Stability Facility (EFSF), 257, 266–267, 275, 281, 309, 313, 478 European Financial Stability Mechanism (EFSM), 257 European Monetary System (EMS), 8, 9, 57, 59, 84–85 European Parliament, 21, 137, 187 European Reserve Fund, 43–44 European Stability Mechanism, 313 European Union.


pages: 113 words: 37,885

Why Wall Street Matters by William D. Cohan

Apple II, asset-backed security, bank run, Bernie Sanders, Blythe Masters, bonus culture, break the buck, buttonwood tree, corporate governance, corporate raider, creative destruction, Credit Default Swap, Donald Trump, Exxon Valdez, financial innovation, financial repression, Fractional reserve banking, Gordon Gekko, greed is good, income inequality, Joseph Schumpeter, London Interbank Offered Rate, margin call, money market fund, moral hazard, Potemkin village, quantitative easing, secular stagnation, Snapchat, South Sea Bubble, Steve Jobs, Steve Wozniak, too big to fail, WikiLeaks

Preventing money-market funds from investing in the top tranche of securitizations will definitely make them safer, especially as the funds replace these purchases with those of genuinely safer Treasury securities. The unintended consequence of Tarullo’s decision, though, is to stick a dagger in the heart of the securitization market because a key buyer of the top tranche of the securities has been regulated away and without that buyer, the market fades. In the first half of 2016, the issuance of asset-backed securities by Wall Street banks—outside of those backed by the government-controlled entities Fannie Mae and Freddie Mac—fell 36 percent from the same period the previous year. The issuance of mortgage-backed securities fell 42 percent in the same period. Needless to say, Tarullo is detested on Wall Street. One Wall Street CEO told me Tarullo was “like a law unto himself.” He said that “everybody in the business completely hates” Tarullo.


pages: 434 words: 114,583

Faster, Higher, Farther: How One of the World's Largest Automakers Committed a Massive and Stunning Fraud by Jack Ewing

1960s counterculture, Asilomar, asset-backed security, Berlin Wall, cognitive dissonance, collapse of Lehman Brothers, corporate governance, crossover SUV, Fall of the Berlin Wall, full employment, hiring and firing, McMansion, self-driving car, short selling, Silicon Valley, sovereign wealth fund, Steve Jobs

The European Central Bank was effectively printing money in an attempt to stimulate the moribund eurozone economy. The monetary policy measures pushed rates for highly rated corporate debt close to zero, and kept Volkswagen’s borrowing costs low even after the downgrades. Still, there were indications that investors would demand higher interest rates to buy Volkswagen debt than they might have otherwise. In November, Volkswagen sold asset-backed securities tied to leased vehicles in Germany. The securities are bundles of debt whose purchasers are entitled to proceeds from the payments. Volkswagen had to pay investors about half a percentage point more than it had the previous May for similar debt. Volkswagen had plenty of cash and was not in danger of going bankrupt, at least not right away. But the financial burden forced the company to cut back on research and development just when the car industry was on the cusp of major technological change.

“acoustic function,” 120–21, 123–24, 178, 227, 246; See also defeat device AdBlue solution, 167, 180, 227 AdBlue tank, 152, 170 advertising “clean diesel” campaign, 145–47, 208, 266 “Think Small” campaign, 34–35 and VW’s legal exposure, 255 aerodynamics, 109 aftermath of emissions cheating revelations, 211–23 air-cooled engines, 29 air pollution; See also nitrogen oxide (NOx) emissions in California, 168 emissions controls and, 251–52 European emissions rules, 162 premature deaths in Europe, 161 Alexandria, Virginia, EPA lab, 70–73, 75 Ambrosio, Aniello, 239–41 Angola, 104 Ann Arbor, Michigan, EPA lab, 68, 70, 72, 75 annual meetings, VW, 98–99, 243 Apple, 205, 222 asset-backed securities, 221 asthma, NOx and, 2, 160, 252 Audi Daimler alliance, 114, 126–27 defeat device origins, 123 defeat device revelations, 267–68 EA 189 diesel engine, 158 emissions control software, 120 EPA’s second notice of violation, 217 “Green Police” commercial, 145–46 losses after Piëch’s departure, 59 NOx emissions, 254 Piëch as CEO, 46–47, 190 Piëch as department head, 31–32 Piëch as head of development, 38–42 Piëch’s development of diesel engine for, 43–44 Piëch’s maneuverings against Wolfgang Habbel, 45 Porsche 924 production, 38 road testing of diesels, 184 search of Ingolstadt offices, 272–73 as source of VW profit, 189 Martin Winterkorn and, 118 Audi A3, 53, 146, 148, 167 Audi A8, 88, 184 Audi 80, 41 Audi 100, 39, 44 Audi Q7 SUV, 127–28 Audi TT, 53 Audi workers council, 45–46 Auschwitz, 12, 13 autobahn, 5 Autobahn (Kraftwerk), 36 Autostadt, 108 AutoUni, 222 auxiliary engine control devices, 73 Ayala, Alberto meetings with Schmidt and Johnson about defeat device, 197–99 VW’s obfuscation on emissions anomalies, 181–82, 184 WVU test of emissions controls, 168, 169, 174–75 Bach, David, 151 Baden-Baden, Germany, 17 Bad Nauheim, Germany, internment camp, 17 BaFin, 212, 243–44 Barclays, 136 Barra, Mary, 255, 256 battery-powered cars, 204–5 Baudet, Jean, 15 Bavaria project, 136 Bear, Stearns, 136 Beetle, See Volkswagen Beetle Behles, Franz, 40 Bensinger, Jörg, 41 Bentley, 82, 83, 85 Bentley, Walter Owen, 83 Bentley Arnage, 85 Bentley Bentayga, 202 Bentley Continental GT, 85 Benz, Carl, 4, 5 Berlin Wall, fall of, 52, 56 Bernbach, Bill, 34 Bernhard, Wolfgang, 110, 113, 119 Besch, Marc, 1, 169, 171–73 Bliley, Tom, 74–75 BlueMotion emissions technology, 151–52 BlueTec emissions technology, 113–14, 119, 127, 151–52 BMW (corporation), 100, 119 BMW SUV, 2, 3, 169, 170, 173, 176–77 BNP Paribas, 238 Bode, Jörg, 155 body gaps, 54, 90 Böhm, Fritz, 45–46 Boies, David, 233 bonuses executive, 242, 247, 257 worker, 260 Bosch and common rail, 116–17 EDC17 ECU, 124, 226–27 legal settlement, 266 meeting that included discussion of defeat device, 177–78 request for indemnity clause in VW contract, 124 VW defeat device specifications, 124 Martin Winterkorn and, 118 Bratislava, Slovakia, 95 Braun, Wernher von, 17, 28 Brazil, 156, 206, 218, 245 Breton, Leo diesel truck engine emissions test, 72 doubts about laboratory testing, 68–69 ignition timing tester, 72–73 road testing, 70–71, 74, 255 WVU mobile testing unit, 79 Breyer, Charles R., 232–36, 265–66 bribery scandals Siemens, 257–58 Skoda, 102–3 Brooks, Philip, 236 Bugatti, 82–87 Bugatti, Ettore, 83, 86 Bugatti Type 41 Royale, 83 Bugatti Veyron, 86–87 Bundeswehr, 41 buybacks, 235 Cabraser, Elizabeth J., 233 Cadillac emissions scandal, 68–71 California; See also Los Angeles, California EPA threat to withhold approval of VW sales, 193–95 NOx pollution in, 168–69 WVU road test of VW vehicles, 1–4, 166–75 California Air Resources Board (CARB) Audi test results, 184 demands for software code from VW, 192–94 early discussions with VW about emissions control equipment, 125, 126 importance of cooperation with, 195–96 initial WVU test of emissions controls, 168–70, 173–75 intention to do further tests, 177 June 2015 Passat test, 192 pressure on VW to explain emissions anomalies, 181–85 testing garage, 3 threat to withhold approval of VW sales in CA, 193–95 tougher tests devised by, 184 VW’s stonewalling of, 178, 255 California Plug-In Electric Vehicle Collaborative, 205 call options, 137, 138 Canada, 55, 245, 266 carbon dioxide (CO2) emissions diesel vehicles, 159 European Parliament regulations, 164 global warming and, 54, 75, 126, 147 passenger diesel in Europe, 75 VW diesels, 154 carbon monoxide (CO) emissions, 69 Carder, Dan ICCT contract for emissions testing, 166, 167 reaction to news of EPA findings against VW, 209–10 on Time magazine 2016 list of 100 most influential people, 265 WVU road tests, 2, 78–80, 172–74 catalytic converters, 75, 114; See also lean NOx trap (LNT) Caterpillar Inc., 73, 125 Center for Alternative Fuels, Engines, and Emissions (CAFEE) Carder as director, 166 Carder’s concern over finances of, 265 development of road testing, 78–81 origins, 77–78 road test of VW vehicles in California, 1–4, 166–75 Center for Automotive Research conference, 197 certification for US sales, 192–94 Chaos Communication Conference, 227 Chattanooga, Tennessee, VW plant, 167, 181, 188, 206, 217, 273 Cheap Trick (band), 145 children NOx and, 160, 161, 207 at Volkswagenwerk in WWII, 13–14 China as competitor to VW, 56, 222 declining sales, 218 Carl Hahn and, 48 lack of extensive VW legal exposure in, 245 as market for Porsche SUVs, 94 VW sales in, 206 Chrysler, 90 civil lawsuits, 229 class action suits, 195, 232, 237 Clean Air Act amendments (1990), 64, 67 Cadillac emissions scandal, 70 carbon monoxide/hydrocarbon reduction mandate, 39 charges against Oliver Schmidt, 268 charges against VW, 247 diesel truck engine violations, 73–74 “clean diesel,” 2–3, 145–59, 208, 225, 247, 253, 256, 266 climate change, See global warming climate control systems, 69 Clinton, Bill, and administration, 75 code of conduct, 151 Cold War, 22, 48 Commerce Committee (U.S.


pages: 430 words: 140,405

A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers by Lawrence G. Mcdonald, Patrick Robinson

asset-backed security, bank run, business cycle, collateralized debt obligation, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, diversification, fixed income, high net worth, hiring and firing, if you build it, they will come, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, naked short selling, negative equity, new economy, Ronald Reagan, short selling, sovereign wealth fund, value at risk

We were now in mid-September, and there was developing a feeling of disquiet throughout Wall Street. Yet more evidence was emerging about the stresses on the housing market. And I have to say, our trip to the West Coast was becoming more public than we anticipated, and so were the huge short positions. There was no word from the mortgage guys, at least no formal word, but there was a buzz about the Asset-Backed Securities Index, or ABX. That’s the index that tracks the prices being asked and paid for the subprime mortgage bonds, the CDOs. The ABX was a system of quivering sensitivity, programmed to practically suffer a thrombosis if those bonds moved a couple of ticks downward. And what made the situation that fall even more jumpy was that no one could remember the son of a bitch twitching a tendon, never mind moving a muscle.

“Our highest priority,” they confirmed, “is to continue to earn your trust and confidence, each and every day, consistent with the Firm’s proud history of achievement.” Then they added, “Please contact us if we can be of service.” This last bit was presumably aimed at specific investors who felt like dropping another $100 million in the world’s worst mortgage-backed securities. Another casualty of that black July was United Capital, a large hedge fund out of Key Biscayne, Florida, and a leading player in the asset-backed securities (ABS) market. By the eleventh of the month all four of their funds were closed down with combined losses of $630 million. This was doubtless a shuddering blow to their investors, but the toughest break was to its thirty-eight-year-old founder and CEO, John Devaney, a man who had ridden the subprime wave and then crashed high and dry onto the sun-kissed but rock-hard Key Biscayne beach with a severely broken ego.


pages: 537 words: 144,318

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

Albert Einstein, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, business process, buy and hold, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, commoditize, Commodity Super-Cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, family office, fiat currency, fixed income, follow your passion, full employment, George Santayana, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, invisible hand, Kickstarter, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, market microstructure, moral hazard, Myron Scholes, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, purchasing power parity, quantitative easing, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, stocks for the long run, stocks for the long term, survivorship bias, The Great Moderation, Thomas Bayes, time value of money, too big to fail, transaction costs, unbiased observer, value at risk, Vanguard fund, yield curve, zero-sum game

How did you foresee the land mines of 2008 and react in time? It comes down to market experience, having traded through past crises over the last 20 years. This time, we began seeing signs and issues popping up in 2007, and we really started to get nervous about the economic situation globally. We were especially nervous about some financial instruments getting out of control, such as LIBOR basis blowing out and ABX (asset-backed securities index) and other credit spreads widening dramatically. We concluded that it was inappropriate to have a large gross derivative book which was something we had been thinking about for some time, at least a year in advance. So we made the decision to drastically reduce our leverage and then Bear Stearns happened, which caused a lot of volatility. After Bear was sold in a fire sale, there was a lot of excess trading due to the unwinding of positions, and we used that period of high liquidity to get out of our derivatives quicker than we had originally planned.

Index Absolute return, generation Accounting leverage, economic leverage (contrast) Active management, passive management (combination) Active managers, search process Active risk allocation, importance Active risk management, dedication Adaptability call Agricultural commodities, prices Agricultural futures (1977-2009) AIG, bailout Alchemy of Finance, The (Soros) Allocators, future adaptability Alpha beta, contrast central bank source extraction, zero-sum game generation policy change, impact providing, policy error (usage) risk-adjusted measure Alpha-seeking macro fund Alternative energy source, supply (increase) Annual cash demands, short-term constraints Annual cash flows, importance AOL-Time Warner deal Armageddon scenario, extrapolation Asia crisis (1997) repeat Asia crisis (1998-1999) Asia currencies, bullishness Asian equities impact perspective Asia performance Asset-backed securities index (ABX), problem Asset/liability matching Assets allocation, function collapse deflation, renewal expected return generation purchase (Buffett) Asymmetric bet example structure Back tests Backwardation Bacow, Larry Bailouts, usage Balance sheets availability strength Baltic dry shipping rate (1998-2009) Bank capital ratios, Basel II framework (usage) Bank of International Settlements (BIS), turnover data Banks balance sheets, problems implosion leverage ratios Bayesian methods Bear market Bear Stearns bailout government bond leverage change perspective (Bernanke) Beauty contest, concept Benchmark Beneficiaries, payments (impact) Bernanke, Ben actions Bear Stearns perspective debt deflation perspective success/error Beta alpha, contrast correlation portfolio Beta-plus domination Big Oil Black box applications, naivete Black swan Bolton, Anthony Bond option positions, leverage Bond repurchase agreement (repo) Bonds attractiveness Bond Trader perspective collapse fixed interest markets, rout (1994) perspective (Drobny Global Conference) portfolio purchase, leverage (usage) traders vigilantes Bond Trader, The capital allocation determination central banks, alpha source diversification firm-level risk management fixed income trading hedge fund/prop desk, contrast inputs, usage interview liquidity, measurement process market change focus positioning, importance money managers, meeting options, usage performance positions, scaling sizing determination time horizon traders control hiring trades consideration miss worst-case scenario trading ideas wealth maximization Brazil, Russia, India, and China (BRIC) Break-even inflation Brent crude British Telecom, pension fund (Commodity Trader hiring) Bubbles.


pages: 457 words: 143,967

The Bank That Lived a Little: Barclays in the Age of the Very Free Market by Philip Augar

activist fund / activist shareholder / activist investor, Asian financial crisis, asset-backed security, bank run, banking crisis, Big bang: deregulation of the City of London, Bonfire of the Vanities, bonus culture, break the buck, call centre, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, family office, financial deregulation, financial innovation, fixed income, high net worth, hiring and firing, index card, index fund, interest rate derivative, light touch regulation, loadsamoney, Long Term Capital Management, Martin Wolf, money market fund, moral hazard, Nick Leeson, Northern Rock, offshore financial centre, old-boy network, out of africa, prediction markets, quantitative easing, Ronald Reagan, shareholder value, short selling, Sloane Ranger, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, too big to fail, wikimedia commons, yield curve

In public, it remained committed. Barclays announced half-yearly profits growth of 12 per cent on 2 August, referring to a strong performance in the very businesses where sub-prime mortgage problems would surface. A week later the dam broke. On Tuesday 7 August, afterwards widely acknowledged to be the start of the 2007 credit crunch, West LB Asset Management suspended investor redemptions from one of its asset backed securities funds and two days later BNP Paribas froze three of its hedge funds, indicating that they had no way of valuing the complex mortgage related derivatives in them. On 22 August, the credit agency S&P cut the rating on two mortgage backed funds arranged by Barclays and managed by Solent Capital Partners and Avendis Group, after investors refused to buy their debt.14 The funds were wound down and the securities that comprised them sold at a loss.

The Financial Times Alphaville column described it as ‘a panic move’ but added: ‘Barclays had to do something – it simply cannot afford to have another session like Friday, when its market value plunged by a quarter.’2 The board spent an anxious weekend wondering how investors would react when the markets reopened. MINISTERS TAKE A LOOK Monday 19 January 2009 was a wet and miserable winter morning in London, fitting the mood in Parliament as Chancellor Darling announced the government’s second rescue package for the banks. The Bank of England was given £50 billion to buy assets such as corporate bonds, commercial paper and some asset backed securities to strengthen the banks’ balance sheets. When this operation began in March 2009 it became known as ‘quantitative easing’. In addition, various credit guarantees to encourage inter-bank lending were extended and access to the Bank’s short-term liquid funds was facilitated. An Asset Protection Scheme was announced by which, in return for a fee, the government offered future protection against credit losses to banks lending to business and private customers.3 It was a powerful package designed to improve confidence, liquidity and capital ratios and to encourage lending to the real economy.


pages: 515 words: 126,820

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

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

Individuals need not rely on banks as the primary stores of value or as providers of savings and checking accounts, and institutions will have a more efficient mechanism to buy and hold risk-free financial assets. 4. Lending Value: From household mortgages to T-bills, financial institutions facilitate the issuance of credit such as credit card debt, mortgages, corporate bonds, municipal bonds, government bonds, and asset-backed securities. The lending business has spawned a number of ancillary industries that perform credit checks, credit scores, and credit ratings. For the individual, it’s a credit score. For an institution, it’s a credit rating—from investment grade to junk. On the blockchain, anyone will be able to issue, trade, and settle traditional debt instruments directly, thereby reducing friction and risk by increasing speed and transparency.

Money market funds or Treasury bills Payment mechanism combined with a reliable and safe store of value reduces need for typical financial services; bank savings and checking accounts will become obsolete Retail banking, brokerages, investment banking, asset management, telecommunications, regulators 4. Lending Value—credit card debt, mortgages, corporate bonds, municipal bonds, government bonds, asset-backed securities, and other forms of credit Debt can be issued, traded, and settled on the blockchain; increases efficiency, reduces friction, improves systemic risk. Consumers can use reputation to access loans from peers; significant for the world’s unbanked and for entrepreneurs Wholesale, commercial, and retail banking, public finance (i.e., government finance), microlending, crowdfunding, regulators, credit rating agencies, credit score software companies 5.


pages: 976 words: 235,576

The Meritocracy Trap: How America's Foundational Myth Feeds Inequality, Dismantles the Middle Class, and Devours the Elite by Daniel Markovits

"Robert Solow", 8-hour work day, activist fund / activist shareholder / activist investor, affirmative action, Anton Chekhov, asset-backed security, assortative mating, basic income, Bernie Sanders, big-box store, business cycle, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, carried interest, collateralized debt obligation, collective bargaining, computer age, corporate governance, corporate raider, crony capitalism, David Brooks, deskilling, Detroit bankruptcy, disruptive innovation, Donald Trump, Edward Glaeser, Emanuel Derman, equity premium, European colonialism, everywhere but in the productivity statistics, fear of failure, financial innovation, financial intermediation, fixed income, Ford paid five dollars a day, Frederick Winslow Taylor, full employment, future of work, gender pay gap, George Akerlof, Gini coefficient, glass ceiling, helicopter parent, high net worth, hiring and firing, income inequality, industrial robot, interchangeable parts, invention of agriculture, Jaron Lanier, Jeff Bezos, job automation, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, knowledge economy, knowledge worker, Kodak vs Instagram, labor-force participation, longitudinal study, low skilled workers, manufacturing employment, Mark Zuckerberg, Martin Wolf, mass incarceration, medical residency, minimum wage unemployment, Myron Scholes, Nate Silver, New Economic Geography, new economy, offshore financial centre, Paul Samuelson, payday loans, plutocrats, Plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, precariat, purchasing power parity, rent-seeking, Richard Florida, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, school choice, shareholder value, Silicon Valley, Simon Kuznets, six sigma, Skype, stakhanovite, stem cell, Steve Jobs, supply-chain management, telemarketer, The Bell Curve by Richard Herrnstein and Charles Murray, Thomas Davenport, Thorstein Veblen, too big to fail, total factor productivity, transaction costs, traveling salesman, universal basic income, unpaid internship, Vanguard fund, War on Poverty, Winter of Discontent, women in the workforce, working poor, young professional, zero-sum game

Nevertheless, the student body includes as many and in some years even more students from households in the top 1 percent of the income distribution than from the entire bottom half. Similarly, although elite incomes do swell on account of self-dealing, they remain overwhelmingly driven by elite industry. A bank might gain millions of dollars in fees from sharp or misleading practices—as when Goldman Sachs, in a deal called ABACUS that the Securities and Exchange Commission declared fraudulent, received $15 million for marketing asset-backed securities without disclosing that one of the portfolio’s principal architects (the hedge fund manager John Paulson) was betting against them. But these gains pale before Goldman’s total earnings, which amount to billions of dollars. More generally, while fraud accounts for billions of dollars of elite income, rising top income shares amount to trillions of dollars. Overall, the elite’s income growth remains principally driven by massive increases in performance-related pay.

The securities boom was overwhelmingly propelled by the growth of asset management services—with especially rapid growth in private equity firms, venture capital firms, and hedge funds—which by nature serve the wealthy whose assets they manage. Indeed, the most rapid growth within asset management came from fixed-income assets, typically produced by securitizing loans—securitized home mortgages alone accounted for roughly half of all asset-backed securities issued between 2000 and 2008—which show the flip side of rising household borrowing. (By contrast, the functions that traditionally generated the securities industry’s profits in the more equal midcentury—trading fees and commissions, trading gains, and securities underwriting fees—actually all generated declining shares of GDP over this period.) It is only a slight exaggeration to say, with one prominent commentator, that by the time of the 2007–8 crisis, the “entire edifice” of the U.S. financial market “rested on the housing market.”

For example, it mattered to the inflation of the housing bubble that it is not practicable to make money off falling house prices by selling short individual houses. It also mattered that the credit rating agencies failed remarkably to identify and publicize mortgage default risk: whereas fewer than 1 percent of all corporate bonds are typically rated AAA, at the height of the mortgage lending and securitization boom, roughly two-thirds of asset-backed securities achieved this rating. See Rajan, Fault Lines, 134. alongside other causes: Others included a change in how American companies paid for new ventures (shifting from using retained earnings to seeking outside capital) and a series of geopolitical developments (for example, the 1973 OPEC oil embargo and its effects on inflation and interest rates). Midcentury firms funded over 90 percent of their business investments from internal resources rather than new money raised on the capital markets.


pages: 543 words: 147,357

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

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

The argument went that such banks should be permitted to assess the riskiness of their own loans and then negotiate their capital needs with the regulator. In other words, Basel 2 gave the green light to an unchecked credit explosion. Nor was there any transparency in the so-called over-the-counter markets where the supposedly risk-minimising derivatives, notably credit default swaps, were traded. Yet shadow banking was a significant source of credit, and by far the fastest-growing part of the system. In 2000 just $500 billion of asset-backed securities were issued worldwide. By 2005, the figure had jumped to some $2.2 trillion. By 2000, having been in existence for a decade, the total stock of structured investment vehicles stood at $10 trillion. Over the next seven years, it jumped to $23 trillion.34 In 2000 just over 5 per cent of British mortgage lending was financed by securitised loans. By 2005, the proportion had jumped to 25 per cent.

Northern Rock was far from the only bank willing to lend more than 100 per cent of a house’s value and six times the borrower’s income. The whole financial sector drowned the property market in credit, so by summer 2007 it had cumulatively issued £257 billion of residential mortgage-backed securities in the new markets for securitised assets to top up normal sources of funding. In other words, more than a fifth of the total £1.2 trillion stock of British mortgage debt was being funded through an avenue – asset-backed securities – that had not even existed a decade earlier. The competition between the lenders drove down credit-worthiness terms, as it always does. The research firm Data Monitor suggests that 7 per cent of mortgages just before the crash went to people with a poor credit history, and another 5–6 per cent required no proof of income.24 Mortgages to the buy-tolet market expanded ten times in a decade as lenders believed they were on to fail-safe lending.


pages: 549 words: 147,112

The Lost Bank: The Story of Washington Mutual-The Biggest Bank Failure in American History by Kirsten Grind

asset-backed security, bank run, banking crisis, big-box store, call centre, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, fixed income, housing crisis, Maui Hawaii, money market fund, mortgage debt, naked short selling, NetJets, shareholder value, short selling, Shoshana Zuboff, Skype, too big to fail, Y2K

“It’s subprime day at the Wall Street Journal,” he wrote, copying and pasting both articles in the e-mail.11 The first one, “More Borrowers with Risky Loans Are Falling Behind,” was perhaps the most disturbing. It claimed 2006 was on track “to be one of the worst ever for subprime loans.” About 80,000 borrowers who had taken out subprime loans at lenders such as WaMu and Countrywide and New Century, and whose loans had been turned into securities, were behind on payments. “We are a bit surprised by how fast this has unraveled,” said the head of UBS’s asset-backed securities research in the article. The 2006 subprime borrowers were apparently going into foreclosure at a faster pace than in previous years.12 In the second article, the Journal wrote that more subprime lenders wanted to sell their companies but were having a hard time finding buyers.13 H&R Block wanted to off-load its subprime unit, Option One Mortgage. Roland Arnall’s Ameriquest, the company that Long Beach Mortgage had spun out of a decade earlier and that had later turned into a subprime mortgage “boiler room,” was up for sale.

Three years later over half of the mortgages would be delinquent and a quarter would be in foreclosure.24 None of this turmoil seemed to faze WaMu’s Capital Markets Group, which had ballooned to 200 employees, with offices in New York, Los Angeles, Chicago, and Seattle. The division presented plans to package and sell Collateralized Debt Obligations (CDOs), a type of security whose popularity had grown over the previous five years and which was even more complicated than a regular mortgage-backed security. CDOs were packaged with any kind of debt, causing the authors of a later book about the financial crisis to describe them as “asset-backed securities on steroids.”25 WaMu wanted to package its CDOs with home equity loans, credit card debt, and slices of mortgage-backed securities. It also wanted to sell synthetic CDOs (made up not of actual mortgages but of bonds made from mortgages held by someone else) and hybrid CDOs (which were made of a combination of the two). WaMu saw it as another way to off-load risk. The bank ultimately didn’t start a CDO division


pages: 475 words: 155,554

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

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, Boris Johnson, 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, G4S, ghettoisation, global rebalancing, global reserve currency, hiring and firing, inflation targeting, Irish property bubble, Just-in-time delivery, labour market flexibility, light touch regulation, 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, Myron Scholes, negative equity, North Sea oil, Northern Rock, offshore financial centre, open economy, paradox of thrift, Pearl River Delta, pension reform, price mechanism, price stability, profit motive, quantitative easing, quantitative trading / quantitative finance, race to the bottom, regulatory arbitrage, reserve currency, reshoring, Right to Buy, 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, WikiLeaks, working-age population, zero-sum game

Perhaps we are now at the point, where he, and others like him, no longer need our thank-yous. 5 The House Trap Dramatis personae Anonymous UK bank chief executive Esther Spick, thirty-something holder of Northern Rock Together mortgage Bertie Ahern, Irish Taoiseach (1997–2008) Jay Belleti (name changed), Caribbean hotel owner, former subprime banker John Muellbauer, Oxford University professor, expert in housing economics Adam Applegarth, chief executive of Northern Rock John Apicella, Mr Vigneswaran, Mr Thorogood, mortgage brokers Antony Elliott, former group risk director of Abbey National Louise Gowens, struggling with boom-time debts in 2006 Sir John Bond, former chairman of HSBC Shane O’Riordain, director of HBoS Brad Rosser, Inside Track property investment club Andrew Pellegrino, Newcastle buy-to-let property investor Naomi Jacobs, young first-time buyer in Newcastle, priced out The Faircloughs, a couple helped by the UK government’s Help to Buy scheme Peter Redfern, CEO of housebuilder Taylor Wimpey ‘What is the most dangerous toxic financial asset in the world?’ This was the question put to me by the chief executive of a leading European bank. Anxious to display my superior knowledge of the darkest corners of the shadow banking system, I replied: ‘Credit-default swaps on super-senior tranches of asset-backed, security-collateralised debt obligations.’ I thought I had come up with a pretty pithy answer. ‘No,’ he gently chided me. ‘The most dangerous financial product in the world,’ he paused a moment for effect, ‘is the mortgage.’ The mortgage: from the Old French words mort and gage. Disputed translation: ‘death contract’. Esther’s story In the middle of the credit-crunch crisis of 2008 I met Esther Spick, then a single 34-year-old mum with two kids living in a maisonette in Surrey.

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. In particular, it was the misuse of the Gaussian copula in relation to mortgages by ratings agencies that was to prove disastrous. ‘Empirically estimating the correlation between asset-backed securities is an even harder econometric problem than estimating corporate correlations,’ write MacKenzie and Spears. They go on to say that with little data to draw upon, the CDO groups at ratings agencies ‘employed largely judgement-based correlation estimates’. Standard & Poor’s CDO group, for example, simply used the same correlation (0.3) for mortgage securities as for companies in that industry.


Global Financial Crisis by Noah Berlatsky

accounting loophole / creative accounting, asset-backed security, banking crisis, Bretton Woods, capital controls, Celtic Tiger, centre right, circulation of elites, collapse of Lehman Brothers, collateralized debt obligation, corporate raider, 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, God and Mammon, Gordon Gekko, housing crisis, illegal immigration, income inequality, market bubble, market fundamentalism, mass immigration, 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

.), 203 criticisms, 186, 191, 201–206 Africa, 186–200 mortgage lenders, 18 debt, 193, 198–199 state models and processes, development control, 189–198 45, 63, 178 ending neoliberal economic Sweden’s case by case method, policies will solve crisis, 186– 225, 226–230 200 “too big to fail” argument, 46, migrant workers in Spain, 131 63, 223 AIG, 18, 176, 177, 191 Bajoria, Jayshree, 135–142 Almunia, Joaquín, 99 Baltic states, 95, 96, 99 Ambah, Faiza Saleh, 164–169 Ban Ki-moon, 26, 131 Americas Society/Council of the Bangko Sentral ng Pilipinas, 151 Americas, 158 Bank nationalization, 45, 188, 189, Anti-Defamation League, 125 222–223 Anti-Semitism, 125 Iceland, 18, 103 Appraisers, 33 Sweden, 219, 223–224, 225– Argentina, 161, 162 230 Arms producers, 124, 126 United Kingdom, 18, 43, 44, Arroyo, Gloria, 153 63, 222 Aso, Taro, 26 United States, 178, 219–224, Asset-backed securities, 88–89 225–226 Asset sales, 223 Bank of England, 43, 44, 47, 50, Australia, 85–91 97 economy bound with U.S. Bank of Japan, 207, 208–209, 211 economy, 85–91 Banks foreign debt, 89, 90 stimulus packages, 19 Canada, 83 Austria, 61, 93 failures, Japan, 208–211, 212 failures, Sweden, 225, 226–230 B failures, U.K., 44, 46 “Bad banks,” 221, 228–229 failures, U.S./global, 18, 24, Bad credit. See Credit risks 45, 87, 88–90, 178, 208, 211– 212 Bad debt Iceland, 18, 102–106 Japan, 1990s, 207 249 The Global Financial Crisis Islamic insulation, 164–169 Philippines, 151–153 regulation repeals/blockages as cause of crisis, 42–52, 205– 206 subprime mortgage dealings, 17–18 See also Bailouts; Bank nationalization; Capital ratios; Guaranteed deposits; Liquidity crises Barclays Capital bank, 44, 46, 47–48 Basis Capital, 88 Baugur, 105 Bear Stearns, 17–18, 49 Bernanke, Ben, 54, 173, 177 Boeri, Tito, 53–58 Bolivarian Alternative for the Americas, 184, 196 Bolivia, 161 Bonds corporate, within crisis, 175– 176, 220 Islamic banks, 167–168, 169 Japanese market, 214 suggestion for EU, 97, 99–100 Bonuses, executives, 29, 43, 45, 46, 49 Boom and bust cycles, 59, 61 “Boom thinking,” as cause of crisis, 32–41 Booth, Jenny, 22–26 Brazil, 161–162 BRIC meetings, 146–147 free trade, 180, 184 trade partners, 144, 184 BRIC summits, 146–147 Britain.


pages: 540 words: 168,921

The Relentless Revolution: A History of Capitalism by Joyce Appleby

1919 Motor Transport Corps convoy, agricultural Revolution, anti-communist, Asian financial crisis, asset-backed security, Bartolomé de las Casas, Bernie Madoff, Bretton Woods, BRICs, British Empire, call centre, Charles Lindbergh, collateralized debt obligation, collective bargaining, Columbian Exchange, commoditize, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, deskilling, Doha Development Round, double entry bookkeeping, epigenetics, equal pay for equal work, European colonialism, facts on the ground, failed state, Firefox, fixed income, Ford paid five dollars a day, Francisco Pizarro, Frederick Winslow Taylor, full employment, Gordon Gekko, Henry Ford's grandson gave labor union leader Walter Reuther a tour of the company’s new, automated factory…, Hernando de Soto, hiring and firing, illegal immigration, informal economy, interchangeable parts, interest rate swap, invention of movable type, invention of the printing press, invention of the steam engine, invisible hand, Isaac Newton, James Hargreaves, James Watt: steam engine, Jeff Bezos, joint-stock company, Joseph Schumpeter, knowledge economy, land reform, Livingstone, I presume, Long Term Capital Management, Mahatma Gandhi, Martin Wolf, moral hazard, Parag Khanna, Ponzi scheme, profit maximization, profit motive, race to the bottom, Ralph Nader, refrigerator car, Ronald Reagan, Scramble for Africa, Silicon Valley, Silicon Valley startup, South China Sea, South Sea Bubble, special economic zone, spice trade, spinning jenny, strikebreaker, the built environment, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thorstein Veblen, total factor productivity, trade route, transatlantic slave trade, transcontinental railway, union organizing, Unsafe at Any Speed, Upton Sinclair, urban renewal, War on Poverty, working poor, Works Progress Administration, Yogi Berra, Yom Kippur War

We might dub this the world of virtual investment whose material reality was a stream of electronic messages issuing from some sixty thousand terminals around the world. Technological advances made possible the increasing volume of financial transactions. There was also some double duping, when mortgage salesmen encouraged people to assume mortgages they couldn’t afford and financial firms talked pension fund managers and municipalities into buying their asset-backed securities without sharing information about the risk. During the last ten years, financial services grew from 11 percent of our gross national product to 20 percent. Some otherwise sober men and women were able to leverage at a ratio of 1:30 for money invested, spreading risk without tracking it. The really daring investor would nest several forms of leveraging into a single investment vehicle. More damaging to the nation in the long run, physicists, mathematicians, and computer experts were drawn away from their original work to join the high-earning financial wizards.

Credit-rating agencies like Standard & Poor’s and Moody’s were similarly disinclined to lower the ratings of bank customers that took on too much risk. In retrospect, people who were making decisions affecting the economies of dozens of countries were sealed into a cozy club of high-fiving camaraderie where there was no tomorrow.5 The wild card in this scenario was psychological and endemic: the feeling of confidence that encouraged people—in this case institutional investors and hedge fund managers—to purchase the new asset-backed securities. In retrospect, their misperception of the risk seems bizarre. Pretty mindless during an upswing, optimism is contagious. Working the other way around, rumors and foolish public statements can cause a precipitous fall in confidence just about as easily as reports of disappointing earnings or turbulence in foreign markets. Whether upbeat or downbeat, these responses from traders and investors introduced a degree of risk that impinged on the whole global economy because of the easy access the world’s investors had to these “good deals.”


pages: 265 words: 69,310

What's Yours Is Mine: Against the Sharing Economy by Tom Slee

4chan, Airbnb, Amazon Mechanical Turk, asset-backed security, barriers to entry, Berlin Wall, big-box store, bitcoin, blockchain, citizen journalism, collaborative consumption, congestion charging, Credit Default Swap, crowdsourcing, data acquisition, David Brooks, don't be evil, gig economy, Hacker Ethic, income inequality, informal economy, invisible hand, Jacob Appelbaum, Jane Jacobs, Jeff Bezos, Khan Academy, Kibera, Kickstarter, license plate recognition, Lyft, Marc Andreessen, Mark Zuckerberg, move fast and break things, move fast and break things, natural language processing, Netflix Prize, Network effects, new economy, Occupy movement, openstreetmap, Paul Graham, peer-to-peer, peer-to-peer lending, Peter Thiel, pre–internet, principal–agent problem, profit motive, race to the bottom, Ray Kurzweil, recommendation engine, rent control, ride hailing / ride sharing, sharing economy, Silicon Valley, Snapchat, software is eating the world, South of Market, San Francisco, TaskRabbit, The Nature of the Firm, Thomas L Friedman, transportation-network company, Travis Kalanick, Uber and Lyft, Uber for X, uber lyft, ultimatum game, urban planning, WikiLeaks, winner-take-all economy, Y Combinator, Zipcar

Some of Wall Street’s biggest names have joined the marketplace lenders as board members and investors, and investment banks vied to manage Lending Club’s initial public offering in December 2014.58 When peer-to-peer lending advocate Jonathan McMillan attended the industry conference LendIt 2015 he found that “The initial idea of connecting borrowers and lenders directly has been abandoned. Now, hedge-funds, asset managers and banks are using marketplace lending as a supplier of loans in their chase for yield . . . . Asset managers have started to securitize marketplace loans into asset-backed securities, and hedge-funds use large amounts of borrowed money to leverage their investments. Some investors are already talking about the need to create credit default swaps for marketplace loans.” 59 The problems of alienation, erosion, and distortion all sharpen as the scale of financial involvement grows. Sharing Economy advocates who seek to recapture the egalitarian, sustainable, and community focus that inspired many to join the movement can do so only by avoiding the temptations of believing in a technological fix for society, powered by venture capital and free markets.


pages: 272 words: 19,172

Hedge Fund Market Wizards by Jack D. Schwager

asset-backed security, backtesting, banking crisis, barriers to entry, beat the dealer, Bernie Madoff, Black-Scholes formula, British Empire, business cycle, buy and hold, Claude Shannon: information theory, cloud computing, collateralized debt obligation, commodity trading advisor, computerized trading, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, diversification, diversified portfolio, Edward Thorp, family office, financial independence, fixed income, Flash crash, hindsight bias, implied volatility, index fund, intangible asset, James Dyson, Jones Act, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, money market fund, oil shock, pattern recognition, pets.com, Ponzi scheme, private sector deleveraging, quantitative easing, quantitative trading / quantitative finance, Right to Buy, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Rubik’s Cube, Sharpe ratio, short selling, statistical arbitrage, Steve Jobs, systematic trading, technology bubble, transaction costs, value at risk, yield curve

Over the course of a couple of months, we went from having a probabilistic view that the markets were too confident that home price appreciation would continue indefinitely to having a very high level of conviction that a liquidity bubble existed that would inevitably provide the catalyst for its own demise. Some background explanation is required to understand the following portion of this interview, which deals with Mai’s trade in shorting mortgage-backed securitizations. A subprime mortgage bond is a type of asset-backed security (ABS) that combines multiple individual subprime mortgages into a security that pays investors interest income based on the proceeds from mortgage payments. These bonds typically employ a structure in which multiple tranches (or classes) are created from the same pool of mortgages. The highest rated class, AAA, gets paid off in full, then the next highest rated class (AA), and so on. The higher the class, the lower the risk, and hence the lower the interest rate it receives.

Schwager is a frequent seminar speaker and has lectured on a range of analytical topics including the characteristics of great traders, investment fallacies, hedge fund portfolios, managed accounts, technical analysis, and trading system evaluation. He holds a BA in Economics from Brooklyn College (1970) and an MA in Economics from Brown University (1971). Index Abstract factor analysis ABX Index Adapting Airlines All Weather fund (Bridgewater) Altria Amazon Apple Arnett, Bob Asset-backed securities (ABSs). See also Mortgage-backed securities (MBSs); Subprime mortgages/bonds Asymmetric strategies Baccarat system Balodimas, Jimmy Bamberger, Gerry Banyan Equity Management. See also Benedict, Larry Baring Asset Management Beat the Dealer (Thorp) Beat the Market (Kassouf and Thorp) Bender, John Benedict, Larry Berkshire Hathaway Betting systems. See also Gambling The Big Secret for the Small Investor (Greenblatt) The Big Short (Lewis) Blackjack system Black-Scholes option-pricing model Blue button BlueCrest.


pages: 733 words: 179,391

Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

"Robert Solow", Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business cycle, business process, butterfly effect, buy and hold, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, Sam Peltzman, Shai Danziger, short selling, sovereign wealth fund, Stanford marshmallow experiment, Stanford prison experiment, statistical arbitrage, Steven Pinker, stochastic process, stocks for the long run, survivorship bias, Thales and the olive presses, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

So let’s start with some basic facts. 298 • Chapter 9 FINANCIAL CRISIS 101 In the 1990s, a number of financial institutions besides traditional commercial banks began to participate in the housing market by underwriting mortgages directly to homeowners. These mortgage brokers then sold the loans they originated to the secondary (resale) market, where they were bought by government-sponsored enterprises like Fannie Mae and Freddie Mac, or by investment banks, which used the mortgages as raw material to create the alphabet-soup of new financial products such as ABSs (asset-backed securities) and CDOs (collateralized debt obligations). This ecological change didn’t take place in a political or a cultural vacuum. Politicians across the partisan spectrum encouraged mortgage lending to a variety of different buyers, many of whom had never considered owning a home before. Home ownership became part of the new American dream for more people. Lenders followed suit, and many even loosened their lending standards, encouraged by the so-called “ownership society” that a number of politicians espoused.

., 2, 198, 207–208, 214, 225; fi nancial crisis of 2008 and, 296–297, 318–319; in hedge fund industry, 222–248; high-frequency trading and, 246; maladaptation explained by, 188–189; moral reasoning and, 340–349; need for, 11; in portfolio management, 249, 254, 261–269, 277–282, 292, 293; predecessors of, 215–221; as prescriptive tool, 365, 388, 390, 393, 396, 415, 417, 420; probability matching explained by, 189–198; resistance to, 209–214; risk aversion and, 203–205; systematic risk and, 198–203 adaptive radiation, 227, 233, 240, 298 adaptive regulation, 368–371, 384, 387, 393 Addiction by Design (Schüll), 91 ADHD, 125 adjustable-rate mortgages, 298, 299, 323 Administrative Behavior (Simon), 177 Adoboli, Kweku, 61 adrenaline, 81, 85, 122 affect heuristic, 84 affi nity fraud, 334 Africa, 411, 412, 413 African grey parrot, 162 Agnelli, Gianni, 223 Ahmadi, Sheila, 338 AIDS, 403 AIG (American International Group), 300, 370–371, 376 Alchian, Armen, 216–217 Alex (parrot), 162 Alexa, 396 algorithmic trading, 41, 270, 276, 278, 356, 361 Allen, Woody, 141 Allied Irish Banks, 61 alpha (measure), 232, 249, 252, 269, 282 altruism, 168–169, 170, 196, 336 Alzheimer’s disease, 409 Ambac, 300 Amemori, Ken-ichi, 121–122 American Society of Safety Engineers, 379 American Stock Exchange (AMEX), 286, 289 amphetamines, 90 amygdala, 79, 81, 90, 91, 187, 319, 378; malfunctions of, 83, 107; in nonhuman species, 118; short-circuiting by, 96, 104, 122, 158; sublenticular extended, 89 amyotrophic lateral sclerosis (Lou Gehrig’s disease), 409 anterior cingulate cortex, 86, 105 anterior insula, 90, 91, 337 Antiques Roadshow, 341 Antoncic, Madelyn, 317–318 ants, 169, 170, 197 arbitrage, 112, 268, 281; fi xed-income, 243, 293; merger, 267; statistical, 284, 286, 288–291, 292–293, 362 Aristotle, 16–17 Armstrong, Neil, 12–13 Arthur, W. Brian, 218 470 • Index artificial intelligence, 4, 101, 131–133, 181, 182 artificial selection, 142–143 Asian fi nancial crisis (1997), 241 asset allocation, 249, 253, 255, 282 asset-backed securities (ABSs), 298 Asteroidea, 192 auditory pathway, 80–81 auditory thalamus, 81 Austin, J. L., 46–47 Australopithecus, 153 autism, 110–111 Automated Proprietary Trading (APT), 236, 237, 240 automated teller machines (ATMs), 400 automobile safety, 205 aviation safety, 85, 321, 379–383 Avnaim-Pesso, Liora, 166, 167 Awakenings (Sacks), 88 Azar, Pablo, 372 Bachelier, Louis Jean-Baptiste Alphonse, 18–20, 21, 234 back testing, 285 Ball, Lucille, 395 Bamberger, Gerry, 235–236 Bankers Trust, 320, 344 Bank of America, 386–387 Bank of England, 366–367 bank runs, 176 Barings Bank, 61 Barnea, Amir, 161 Baron-Cohen, Simon 111 Barrett, Majel, 396 Bartra, Oscar, 100 BATS Global Markets, 360 Bear Stearns, 304, 305, 307, 308, 309, 316, 317 Bechara, Antoine, 106 behavioral economics, 3, 6–7, 51, 71, 92, 220 Behavioral Investment Allocation Strategy (BIAS), 90 behavioral risk, 388–394 Beinhocker, Eric, 218 bell curve (Gaussian distribution), 22, 273 Benner, Samuel, 29 Benner’s Prophecies of Future Ups and Downs in Prices, 29 Benyamine, David, 60 Bernanke, Ben, 300 Bernoulli, Daniel, 57 Berns, Gregory, 97, 98 Berra, Yogi, 415 beta (measure), 232, 249, 251, 252, 268–269, 282 Between a Rock and a Hard Place (Ralston), 118 Beutler, Ernest, 419 Bezear Homes, 325 Biham, Eli, 238 Billio, Monica, 376 binary choice model, 190–199, 201–202, 220, 362 biodiversity, 148–149 biofeedback, 93 biological determinism, 170–172 Biological Economics (Lo and Zhang), 218 biotechnology, 401–410 birthday problem, 67–68 Bismarck, Otto von, 417 Biston betularia (peppered moth), 138–140, 141 Bitcoin, 356 Black, Fischer, 27, 97, 260, 274, 276, 356–357 Black-Scholes/Merton option pricing formula, 10, 27, 97, 211, 260, 356–357 Blinder, Alan, 7, 310 block trading, 235 Bloomberg terminals, 360 Bocskocsky, Andrew, 69 Bogle, John C., 6, 263–264, 265, 397, 398 bonds, 259, 409; for biotechnology, 407; government, 242, 249–250, 292; index funds for, 265 Bonfire of the Vanities, The (Wolfe), 322 Bonner, John, 371 bonobo, 162 bonuses, 303–305 Bossaerts, Peter, 101 bounded rationality, 36, 208, 215; Adaptive Markets Hypothesis likened to, 188; applications of, 185, 217; criticisms of, 181–182, 209, 213–214; informational limits acknowledged by, 34; optimization contrasted with, 180, 183 Boyle, Danny, 118 bracketology, 64–65 brain size, 152–53 brainstem, 81 Breiter, Hans, 88–89 Brennan, Tom, 182, 190, 196–197, 198, 203, 220, 362, 369 Brexit referendum, 377 Brodmann, Korbinian, 76 Index broker-dealers, 304–308, 311, 376 Bronze Age, 163 Brosnan, Sarah F., 337 Brownian motion, 19, 211 Buck v.


pages: 250 words: 77,544

Personal Investing: The Missing Manual by Bonnie Biafore, Amy E. Buttell, Carol Fabbri

asset allocation, asset-backed security, business cycle, buy and hold, diversification, diversified portfolio, Donald Trump, employer provided health coverage, estate planning, fixed income, Home mortgage interest deduction, index fund, Kickstarter, money market fund, mortgage tax deduction, risk tolerance, risk-adjusted returns, Rubik’s Cube, Sharpe ratio, stocks for the long run, Vanguard fund, Yogi Berra, zero-coupon bond

The rest of this section explains what you have to pay attention to and how to choose bonds wisely. You don’t have to hold onto a bond until it matures. However, the price you get when you sell a bond can vary, as you’ll learn on page 136. Many entities issue bonds: the federal government, municipalities, corporations, federal agencies, and foreign governments. You can also buy bonds backed by mortgages or assets (called mortgage-backed or asset-backed securities, because they use the mortgages or assets as collateral). Depending Bonds 129 on who issues the bond and the bond’s characteristics, you may see bonds referred to as bills, notes, debt securities, or debt obligations. If you hold bonds in a taxable account, you have to think about the tax implications when you choose which bonds to buy. For example, you don’t have to pay state or local income taxes on interest from U.S.


pages: 322 words: 77,341

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

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

“Irresponsible”: that’s a word President Obama has used several times about the actions of the bankers. It’s a good word. It should also be said that it doesn’t apply to all bankers. People in the City deeply resent the way they’ve all been associated with the actions of the (as they see it) relatively small number of people involved in the shenanigans which led to the credit crunch. Most of them don’t trade asset-backed securities or work for off-balance-sheet subsidiaries, and they don’t see why they are the target of such generalized anger and recrimination. There is truth in that, but there is also a failure to admit that this was a cultural issue, not just the result of a set of specific actions. In fact, the bankers have been careful not to show quite how much they’ve minded being the target of such generalized opprobrium.


pages: 225 words: 11,355

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

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

THE CYNICISM OF POLITICS Disgraced New York Governor Eliot Spitzer rose to power by abusing the power of his office as state Attorney General to conduct a series of vicious prosecutions by way of press conference (he never brought and sustained a single real criminal case). Fear of this tactic allowed him to shake down Wall Street for big cash settlements in the wake of the dot.com crash. It was pure political opportunism; it is hard to see how anyone benefited other than him. The man the press dubbed the ‘‘Sheriff of Wall Street’’ did nothing to head off the excesses behind the bubble in asset-backed securities that brought down Wall Street in 2008. In fact, by vindictively driving the one man from power who really understood AIG and who essentially managed its risk, its founder Hank Greenburg, Spitzer bears at least some responsibility for destabilizing a critical cog in the credit default swap market on the eve of the crisis. AIG’s default book may have proved fatal in any case but Spitzer weakened the company by arbitrarily using an arcane state law to undermine other key parts of its global business model such as finite risk contracts, a key product in the global reinsurance market.


pages: 300 words: 77,787

Investing Demystified: How to Invest Without Speculation and Sleepless Nights by Lars Kroijer

Andrei Shleifer, asset allocation, asset-backed security, Bernie Madoff, bitcoin, Black Swan, BRICs, Carmen Reinhart, cleantech, compound rate of return, credit crunch, diversification, diversified portfolio, equity premium, estate planning, fixed income, high net worth, implied volatility, index fund, intangible asset, invisible hand, Kenneth Rogoff, market bubble, money market fund, passive investing, pattern recognition, prediction markets, risk tolerance, risk/return, Robert Shiller, Robert Shiller, selection bias, sovereign wealth fund, too big to fail, transaction costs, Vanguard fund, yield curve, zero-coupon bond

But because it is small and you may already have this exposure indirectly elsewhere in your rational portfolio, and for the sake of simplicity, property investments have been excluded from the simple rational portfolio. So, the excluded asset classes discussed in this chapter are: propertydirect investments, private property funds residential property quoted property holdings private equity, venture capital and hedge funds commodities private investments collectibles. Mortgage-backed, mortgage-related and asset-backed securities, other types of quasi-government debt and other debt instruments issued by financial institutions are also excluded. This is because some of them fall into the property category, and others are alternatives to the minimal risk investment, particularly in cases where the investments are quasi government and there are tax advantages. Also, a lot of the exposures those kinds of debts give you are captured indirectly elsewhere in the portfolio, but they are without easy products to gain access to – so in the interest of simplicity and ease of implementation these additional investment possibilities do not add enough additional value to be included.


The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis by Tim Lee, Jamie Lee, Kevin Coldiron

active measures, Asian financial crisis, asset-backed security, backtesting, bank run, Bernie Madoff, Bretton Woods, business cycle, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, debt deflation, distributed ledger, diversification, financial intermediation, Flash crash, global reserve currency, implied volatility, income inequality, inflation targeting, labor-force participation, Long Term Capital Management, Lyft, margin call, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, negative equity, Network effects, Ponzi scheme, purchasing power parity, quantitative easing, random walk, rent-seeking, reserve currency, rising living standards, risk/return, sharing economy, short selling, sovereign wealth fund, Uber and Lyft, uber lyft, yield curve

In options markets, optionality—the property of trading with or against the market—is referred to by the Greek letter gamma. We extend the arguments outlined here in more detail in Chapter 9. The Fundamental Nature of the Carry Regime 95 in August 2007 speculators could lever a position in US high-yield credit as much as 10 times. One year later the maximum levered position was reduced to 4 times. Levered speculators in CDOs of asset-backed securities fared worse: in August 2007 a position in the highest-rated tranche of a CDO could be levered by 25 times; by August 2008 almost no leverage was available at all.5 Trading with the market, as a levered speculator is required to do, necessarily means demanding liquidity. A levered speculator will be willing to—or will have no choice but to—pay for that liquidity requirement. The profits of volatility selling can be seen, at least partially, as the payment for providing liquidity to levered speculators.


pages: 302 words: 86,614

The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja, Myron Scholes, Mohamed El-Erian

activist fund / activist shareholder / activist investor, Asian financial crisis, asset allocation, asset-backed security, backtesting, Bernie Madoff, Bretton Woods, business process, call centre, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, en.wikipedia.org, family office, fixed income, high net worth, interest rate derivative, Isaac Newton, Long Term Capital Management, Marc Andreessen, Mark Zuckerberg, merger arbitrage, Myron Scholes, NetJets, oil shock, pattern recognition, Ponzi scheme, quantitative easing, quantitative trading / quantitative finance, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, systematic trading, zero-sum game

As Paulson explained, referencing the lifeline TPG threw to Washington Mutual in the spring of 2008: “They put in $7 billion and they lost it all within six months. Investing in banks at the wrong time is very risky.” Paulson & Co. stayed away from investing on the long side of any banks until after the government commenced the stress tests and put forth an accurate appraisal of how much capital the banks needed. Paulson had been scrutinizing the industry closely since 2006. When Paulson’s team saw the first signs of the asset-backed security market falling, it tried to figure out which banks were most exposed to losses on these same securities. Paulson estimated the losses banks would take and then compared those losses to the common equity in each. Ranking them from high to low, the list revealed which banks were in the most trouble. “Fannie and Freddie were in the worst shape,” Paulson says. “We projected losses of 400 to 600 percent of their equity.


pages: 444 words: 86,565

Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions by Joshua Rosenbaum, Joshua Pearl, Joseph R. Perella

asset allocation, asset-backed security, bank run, barriers to entry, business cycle, capital asset pricing model, collateralized debt obligation, corporate governance, credit crunch, discounted cash flows, diversification, fixed income, intangible asset, London Interbank Offered Rate, performance metric, shareholder value, sovereign wealth fund, stocks for the long run, technology bubble, time value of money, transaction costs, yield curve

Traditionally, in an LBO, the sponsor has been required to provide certainty of financing and, therefore, had to pay for a bridge financing commitment even if it was unlikely that the bridge would be funded. 120 The fees associated with the commitment compensate the banks for their underwriting role and the risk associated with the pledge to fund the transaction in the event that a syndication to outside investors is not achievable. 121 The credit crunch has resulted in certain sellers loosening this requirement and accepting bids with financing conditions. 122 The primary investment banks responsible for marketing the bank debt, including the preparation of marketing materials and running the syndication, are referred to as “Lead Arrangers” or “Bookrunners.” 123 The lead investment banks responsible for marketing the high yield bonds or mezzanine debt are referred to as “Bookrunners.” 124 CDOs are asset-backed securities (“securitized”) backed by interests in pools of assets, usually some type of debt obligation. When the interests in the pool are loans, the vehicle is called a collateralized loan obligation (CLO). When the interests in the pool are bonds, the vehicle is called a collateralized bond obligation (CBO). 125 For particularly large or complex transactions, the target’s management may present to lenders on a one-on-one basis. 126 The bank book is a comprehensive document that contains a detailed description of the transaction, investment highlights, company, and sector, as well as preliminary term sheets and historical and projected financials.


pages: 285 words: 86,174

Twilight of the Elites: America After Meritocracy by Chris Hayes

affirmative action, Affordable Care Act / Obamacare, asset-backed security, barriers to entry, Berlin Wall, Bernie Madoff, carried interest, circulation of elites, Climategate, Climatic Research Unit, collapse of Lehman Brothers, collective bargaining, creative destruction, Credit Default Swap, dark matter, David Brooks, David Graeber, deindustrialization, Fall of the Berlin Wall, financial deregulation, fixed income, full employment, George Akerlof, Gunnar Myrdal, hiring and firing, income inequality, Jane Jacobs, jimmy wales, Julian Assange, Kenneth Arrow, Mark Zuckerberg, mass affluent, mass incarceration, means of production, meta analysis, meta-analysis, money market fund, moral hazard, Naomi Klein, Nate Silver, peak oil, plutocrats, Plutocrats, Ponzi scheme, Ralph Waldo Emerson, rolodex, The Spirit Level, too big to fail, University of East Anglia, Vilfredo Pareto, We are the 99%, WikiLeaks, women in the workforce

This, in turn, made them look like much better credit risks than they actually were and facilitated feeding the mortgages into the securitization machine that would then produce mortgage-backed securities that conferred a wellspring of money on everyone involved in the process. Within the immigrant communities in New York, the ready availability of massive mortgages was common knowledge, but those same communities were entirely removed from the inner circles of Wall Street where these mortgages were transubstantiated into the asset-backed securities that generated trillions of dollars of revenue for it. So it took a chance encounter between a multimillionaire hedge fund manager and his baby nurse to connect the dots. Like a disease at first confined to paupers, the plague of bad lending practices and fraud spread among working-class “subprime” borrowers, while the economic mainstream largely ignored their plight and forged ahead, either in ignorance or with unearned confidence that the disease couldn’t ever reach them.


pages: 262 words: 93,987

The Buy Side: A Wall Street Trader's Tale of Spectacular Excess by Turney Duff

asset-backed security, Berlin Wall, buy low sell high, collateralized debt obligation, fixed income, Gordon Gekko, high net worth, urban sprawl, white picket fence

The day before the announcement, aQuantive had a market cap of just $2.8 billion. The trade makes our firm a couple million dollars. This is too easy. But when Jeff calls me into the office, it isn’t about patting me on the back. Any success I’ve had is considered under his direction. I sit in the chair right in front of his desk. He tells me he sees a connection between subprime and credit. He starts talking about high-risk mortgages that were bundled and sold as asset-backed securities all over the world, particularly in Europe. I have no idea what he’s talking about. I think he means a derivative play on the underlying mortgages, but I’m not sure. But when he starts talking about collateralized debt obligations, I give up trying to figure it out. “What do you want me to do?” I ask. “Start monitoring the credit markets,” he tells me. “I’m a little worried.” The only thing I’m worried about is how to beat the traffic on the Long Island Expressway.


pages: 346 words: 90,371

Rethinking the Economics of Land and Housing by Josh Ryan-Collins, Toby Lloyd, Laurie Macfarlane

"Robert Solow", agricultural Revolution, asset-backed security, balance sheet recession, bank run, banking crisis, barriers to entry, basic income, Bretton Woods, business cycle, Capital in the Twenty-First Century by Thomas Piketty, collective bargaining, Corn Laws, correlation does not imply causation, creative destruction, credit crunch, debt deflation, deindustrialization, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, garden city movement, George Akerlof, ghettoisation, Gini coefficient, Hernando de Soto, housing crisis, Hyman Minsky, income inequality, information asymmetry, knowledge worker, labour market flexibility, labour mobility, land reform, land tenure, land value tax, Landlord’s Game, low skilled workers, market bubble, market clearing, Martin Wolf, means of production, money market fund, mortgage debt, negative equity, Network effects, new economy, New Urbanism, Northern Rock, offshore financial centre, Pareto efficiency, place-making, price stability, profit maximization, quantitative easing, rent control, rent-seeking, Richard Florida, Right to Buy, rising living standards, risk tolerance, Second Machine Age, secular stagnation, shareholder value, the built environment, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, transaction costs, universal basic income, urban planning, urban sprawl, working poor, working-age population

Property – In this book, property will be understood to refer to a spatially defined area of land and the structures on top of it that is legally owned by an individual or firm. Quantitative easing – An unconventional form of monetary policy where a central bank creates new money electronically to buy financial assets like government bonds from commercial banks and other financial institutions. Real estate – Property consisting of land or buildings. Residential mortgage-backed security (RMBS) – A type of asset-backed security that is secured by a collection of domestic mortgages. Section 106 – A section of the Town and Country Planning Act 1990 which allowed local planning authorities to enter into legally binding agreements with developers, with the latter having to provide certain public benefits as part of the development. Securitisation – A financial innovation undertaken by banks involving the pooling together and repackaging a number of illiquid loans – loans that cannot easily be sold or exchanged for cash – and issuing tradable debt securities against these loans that are sold to investors.


pages: 339 words: 95,270

Trade Wars Are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace by Matthew C. Klein

Albert Einstein, Asian financial crisis, asset allocation, asset-backed security, Berlin Wall, Bernie Sanders, Branko Milanovic, Bretton Woods, British Empire, business climate, business cycle, capital controls, centre right, collective bargaining, currency manipulation / currency intervention, currency peg, David Ricardo: comparative advantage, deglobalization, deindustrialization, Deng Xiaoping, Donald Trump, Double Irish / Dutch Sandwich, Fall of the Berlin Wall, falling living standards, financial innovation, financial repression, fixed income, full employment, George Akerlof, global supply chain, global value chain, illegal immigration, income inequality, intangible asset, invention of the telegraph, joint-stock company, land reform, Long Term Capital Management, Malcom McLean invented shipping containers, manufacturing employment, Martin Wolf, mass immigration, Mikhail Gorbachev, money market fund, mortgage debt, New Urbanism, offshore financial centre, oil shock, open economy, paradox of thrift, passive income, reserve currency, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Scramble for Africa, sovereign wealth fund, The Nature of the Firm, The Wealth of Nations by Adam Smith, Tim Cook: Apple, trade liberalization, Wolfgang Streeck

The flows of money from Europe to the United States, from the United States to Europe, and from European countries to each other were all much larger than any of the other major cross-border financial flows before 2008. The result was a genuinely transatlantic financial system. Many of the biggest investment banks involved in creating so-called private-label American mortgage bonds were European. Deutsche Bank underwrote more subprime mortgage bonds than Goldman Sachs, Bank of America, Citigroup, J. P. Morgan, or Countrywide. European investors owned about 20 percent of all the U.S. asset-backed securities outstanding on the eve of the crisis. During the panic of 2008, most of the Federal Reserve’s emergency loans went to banks based outside the United States, mainly in Europe. Writing in 2011, the economist Hyun Song Shin observed that, globally, “the U.S.-dollar denominated assets of banks outside the United States are comparable in size to the total assets of the U.S. commercial banking sector, peaking at over $10 trillion prior to the crisis.”28 Fig. 2.2 Foreign banks played a major role in the U.S. credit boom and bust (bank credit provided to the U.S. nonfinancial sector, by nationality of bank, USD trillions).


pages: 312 words: 93,836

Barometer of Fear: An Insider's Account of Rogue Trading and the Greatest Banking Scandal in History by Alexis Stenfors

Asian financial crisis, asset-backed security, bank run, banking crisis, Big bang: deregulation of the City of London, bonus culture, capital controls, collapse of Lehman Brothers, credit crunch, Credit Default Swap, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, fixed income, game design, Gordon Gekko, inflation targeting, information asymmetry, interest rate derivative, interest rate swap, London Interbank Offered Rate, loss aversion, mental accounting, millennium bug, Nick Leeson, Northern Rock, oil shock, price stability, profit maximization, regulatory arbitrage, reserve currency, Rubik’s Cube, Snapchat, the market place, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, Y2K

Even today, central bankers, regulators and other policy makers talk about measures that ought to be taken to avoid another ‘Lehman moment’. What they refer to is a situation in which the entire global financial system is on the brink of total collapse – when you stare into the abyss and realise that the world is about the re-enter the Stone Age. The trigger, but hardly the cause, was the demise of the US sub-prime mortgage market during the first half of 2007, which had a snowball effect. At first, some asset-backed securities markets that hardly anyone had heard of ran into trouble. The virus then spread to markets that had traditionally been seen as relatively safe. The crisis kept on coming closer to traders such as myself, and soon substantial losses were reported by names we were familiar with: the UBS hedge fund Dillon Read, two hedge funds run by Bear Stearns, and the US home loan lender Countrywide.4 The money market began to dry up and did so quickly.


pages: 1,088 words: 228,743