money market fund

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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

Managers of money market funds that have loaned to banks may become concerned about the solvency of those banks and attempt to withdraw their money. They can do this by not renewing the short-term loans they gave to the bank. At the same time, the money market funds’ own investors may become concerned about the money market funds themselves and rush to take their money out. Therefore, runs can occur in two ways—the money market funds can run to withdraw their funds from the banks, and the money market funds’ investors can run to withdraw their money from the funds. A double run of this sort actually happened in the fall of 2008. Money market fund investors suddenly wanted to move their money into safer assets, such as government bonds or even just cash. This forced the money market funds to withdraw their funding from banks.

Within days, Reserve Primary lost some $60 billion of its $62 billion in funds, and it was closed shortly afterward.9 At the time, investors in other money market funds, even those not directly affected by the Lehman bankruptcy, treated the fates of Lehman Brothers and Reserve Primary as a signal that other investment banks and money market funds might also be at risk. To protect themselves, many investors abruptly withdrew their money. The run on money market funds was stopped only when a few days later the U.S. Treasury offered them a scheme for government-guaranteed deposit insurance.10 The run forced money market funds to reduce their investments. Many of these investments were short-term loans that the money market funds had made to banks, sometimes just for a day or a few days. The value of these short-term loans had become highly suspect after the Lehman bankruptcy.11 Reductions in money market fund lending affected not only U.S. investment banks, which were at the center of the storm, but also European banks, some of which were heavily dependent on borrowing in the money market.

Legally, the promise might not be binding, but when a money market fund “breaks the buck”—that is, when the value of its shares falls below $1—its “depositors” are likely to run in just the same way as the depositors of a bank. Money market funds are not explicitly insured by the deposit insurance system. Sponsoring institutions routinely provide them with backing. In the Lehman crisis, however, money market funds suffered a panic anyway until the federal government provided them with the analog of deposit insurance. Even primary money market funds take nontrivial risks in their investments without the ability to absorb losses on their own. See Acharya et al. (2010, Chapter 10), Brady et al. (2012), and Rosengren (2012). Money market funds in the United States are supervised by the SEC, as investment funds that have little to do with banking.


The Permanent Portfolio by Craig Rowland, J. M. Lawson

Andrei Shleifer, asset allocation, automated trading system, backtesting, bank run, banking crisis, Bernie Madoff, buy and hold, capital controls, correlation does not imply causation, Credit Default Swap, diversification, diversified portfolio, en.wikipedia.org, fixed income, Flash crash, high net worth, High speed trading, index fund, inflation targeting, margin call, market bubble, money market fund, new economy, passive investing, Ponzi scheme, prediction markets, risk tolerance, stocks for the long run, survivorship bias, technology bubble, transaction costs, Vanguard fund

See Fund manager risks Margin loans Market panics: stable portfolios avoiding stock market crashes causing Market predictions, unreliability of Market timing: challenges of, impacting financial safety Permanent Portfolio avoidance of Market volatility: bond cash gold stability vs. stock using, to avoid volatility Merrill Lynch MF Global Middle East, economy and investments in Money market funds: cash investments in Fidelity Select Money Market fund Fidelity Treasury Money Market Fidelity US Treasury Money Market Gabelli U.S. Treasury Money Market implementation of investments using Vanguard Admiral Treasury Money Market Fund Vanguard Prime Money Market Fund Vanguard Tax-Free Municipal Money Market Fund Vanguard Treasury Money Market Morningstar Mortgage bonds Municipal bonds Mutual funds: Fidelity Spartan 500 Index Mutual Fund Fidelity Spartan International Index Mutual Fund Fidelity Spartan Treasury Long-Term Bond Fund implementation of investments using iShares Short Treasury Bond Fund Schwab S&P 500 Index Mutual Fund trading costs associated with Vanguard FTSE ex-U.S.

Chasing yield often leads investors to take on additional risk that easily outweighs the tiny amount of additional interest that may be earned. Treasury money market funds currently yield around 0 percent. Many investors believe that these low returns justify chasing after a higher yield with their cash. Don't. Cash should be kept very safe. The rest of the portfolio will earn enough that you don't need to take risks with your cash allocation. Cash should be kept very safe. The rest of the portfolio will earn enough that you don't need to take risks with your cash allocation. During the financial crisis of 2008, it was the high-yield assets in many money market funds that faced problems, not T-Bills. Some of these funds even “broke the buck,” meaning that they fell below the $1 a share price that money market funds maintain. In fact, the first money market fund ever created, The Reserve Fund, broke the buck and locked up investor's assets for years.

Even with the enticement of apparently higher yields, in many cases a riskier non-Treasury money market fund may not outperform the safer T-Bill fund at all. Take a look at a comparison of the Fidelity Select Money Market fund (a popular money market fund) versus the U.S. T-Bill average versus the Industry Money Market benchmark from Morningstar. The longest period they cover is from 1985 to 2012 for this fund. Table 8.9 shows that over this 27-year period the difference between the higher-risk Fidelity Select fund versus the safer and lower-risk T-Bill earned an investor a paltry $108. Or about an extra $4 a year! Seems not worth taking the extra risk for an extra $4 a year on every $10,000 invested in that fund. Table 8.9 Fidelity Select versus T-Bills versus Industry Benchmark Money Market Fund. Asset Growth of $10K from 1985 to 2012 Fidelity Select $29,539 T-Bills $29,431 Industry Benchmark Money Market $27,475 An investor taking more risk in an average money market fund only received lower performance out of the arrangement and no extra profits.


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

Asset-backed securities issuance (eligible classes) and amount pledged to TALF Sources: Federal Reserve Bank of New York based on data from JP Morgan, Bloomberg Finance L.P., and the Federal Reserve Board of Governors U.S. STRATEGY The U.S. government put in place a mix of guarantees to backstop critical parts of the financial system. U.S. STRATEGY Treasury agreed to guarantee about $3.2 trillion of money market fund assets to stop the run on prime money market funds. Daily U.S. money market fund flows Sources: iMoneyNet; authors’ calculations based on Schmidt et al. (2016) U.S. STRATEGY The FDIC expanded its deposit insurance coverage limits on consumer and business accounts in an effort to prevent bank runs. Share of total deposits FDIC insured Source: U.S. Treasury, “Reforming Wall Street, Protecting Main Street” Note: Does not include non-interest-bearing transaction account amounts insured by Dodd-Frank through the end of 2012.

Ben got an email from the baseball statistics guru Bill James urging him to hang in there: “At some point the people who are saying it can’t get any worse HAVE to be right.” It was still getting worse, and a new disaster erupted on Tuesday while we were finalizing the terms of our support for AIG. The Reserve Primary Fund, a money market fund that had invested heavily in Lehman’s commercial paper, announced it could no longer pay its investors 100 cents on the dollar and was halting redemptions. Investors afraid that other money market funds would also “break the buck” and freeze their cash scrambled to pull $230 billion out of the industry that week, a scary run on quasi-banks that had operated without insurance for their quasi-deposits. Meanwhile, as money funds pulled back from risk to reassure their investors, they bought even less commercial paper and lent even less in the repo markets, intensifying the liquidity crisis for banks and nonbanks.

PRE-CRISIS LIMITATIONS Limited reach of prudential limits on leverage Limited deposit insurance coverage No resolution authority for largest bank holding companies and nonbanks No ability to inject capital into financial firms No authority to stabilize GSEs ESSENTIAL CRISIS AUTHORITIES Fed expanded lender of last resort Broader FDIC debt and money market fund guarantees GSE conservatorship Capital injections into financial firms POST-CRISIS TOOLS Stronger capital requirements Stronger liquidity and funding requirements Living wills, bankruptcy, and resolution authority POST-CRISIS LIMITATIONS Limitations on Fed lender of last resort No money market fund guarantees or FDIC debt guarantees without congressional action No authority to inject capital OUTCOMES This was a terribly damaging crisis. It did not need to be so bad.


pages: 593 words: 189,857

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

Five: The Fall 1 “TED spread”: The three-month Treasury-Eurodollar, or TED, spread measures the difference in borrowing costs on three-month Treasury bills and the cost that banks pay to borrow from each other for three months, as reflected in the London Interbank Offered Rate (LIBOR). 2 prime money market funds: There are three primary types of money market funds: Treasury and government funds that buy Treasury and agency securities; tax-exempt funds, which invest in short-term municipal securities; and prime funds, which typically pay higher rates of interest by investing in a broader range of riskier securities, including unsecured commercial paper and asset-backed commercial paper. Institutional investors use money market funds for cash-management purposes and are often more likely to move their money at the first sign of stress than individuals or retail investors. The $300 billion outflow was primarily shifted out of riskier prime funds into the other, safer types of money market funds. 3 a four-fifths stake: This equity stake was delivered to a trust that existed independently of the government and operated for the benefit of the taxpayer.

Meanwhile, U.S. depositors were withdrawing about $2 billion a day from WaMu, twice as much as they had withdrawn after the run on IndyMac. The “TED spread,” a measuring stick for fear in the banking system, was about to surpass the record set after the 1987 stock market crash. Tuesday’s most chilling development outside AIG was a money market fund “breaking the buck,” which meant it could no longer promise investors 100 cents on the dollar. Money market funds were widely viewed as virtually indistinguishable from insured bank deposits, as similarly safe vehicles for storing cash with slightly better interest rates. But many money market funds had invested in commercial paper and other instruments that turned out to be riskier than they had thought. One fund, the Reserve Primary Fund, had even added to its stash of Lehman paper over the summer while everyone else was unloading it, which sparked a run on the fund after Lehman fell.

The legislation punted money market fund reforms to the SEC, which has so far failed to produce reforms that could prevent future runs. In 2012, after the SEC’s Mary Schapiro announced that her fellow commissioners had refused to support her reform proposals, I wrote a letter as chairman of the new Financial Stability Oversight Council proposing options for the council to pursue. “Four years after the instability of money market funds contributed to the worst financial crisis since the Great Depression, with the failure of the SEC to act, the Council should now move forward,” I wrote. Mary welcomed the letter to help her push for action at the SEC, which soon began a process to consider reforms. But more than five years after the Reserve Primary Fund broke the buck, money market funds have so far been able to block significant changes to the status quo.


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

Their duty is to their own firm and so it is easy to see why the reluctance to deal would grow. Money Market Funds: From Safe Harbor to Live Wire Beyond repo agreements, financial institutions need a stable place to keep their cash that is not invested in the market. They don’t open a checking account at the local bank, however. In order to achieve a slightly higher interest rate than they could with a normal bank account, they keep their funds in what is called a money market fund (as do other big institutions). The attraction of these funds is that they have virtually the same liquidity as a bank account (meaning immediate access to your money) while paying a higher interest rate. Money market funds have become the principal means by which large institutions hold their ready cash, and its importance is reflected in the fact that some $3.5 trillion moves through this market every business day.

Some of these funds are available to retail investors and some only to institutions, but they share essentially the same characteristics: safety of principal, high liquidity, and higher interest rates. Retail money market funds should not be confused with money market accounts at banks, which are simply a way of paying interest on what would otherwise be a checking account (by law, actual checking accounts are not permitted to pay interest). These accounts are general obligations of the bank and as such are not backed by assets in the way that a money market fund is. SEC regulations restrict what a money market fund may invest in. These restrictions specify that the investment must meet specific standards with respect to quality (the law requires that the fund invest only in something that is deemed to present ‘‘minimal risk,’’ as evidenced by its credit rating among other things), and maturity (13 months or less, with a weighted average of 90 days or less).

The two exceptions to the 5 percent concentration rule are government securities and, as fate would have it, repo agreements. Thus, money market funds had no statutory limit to prevent them from loading up on repo agreements from one or two investment banks. Since money market funds are one of the main places for financial firms to place their funds, their ability to load up on repo agreements from a small number of banks is one of the main mechanisms of interdependency in the financial industry. It is also one of the least transparent, C01 06/16/2010 8 11:13:51 & Page 8 Meltdown in the Markets: Systemic Risk since it is hard to know in which funds a particular firm is holding its cash, and what those funds are buying. Money market funds have been the norm for decades as a means through which financial institutions and other large firms have managed their cash.


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

By noon, European stocks had tumbled, the U.S. markets were starting to dip, and the news was about to get worse. Lehman’s failure and AIG’s escalating difficulties had begun to roil money market funds. Typically, these funds invested in government or quasi-government securities, but to produce higher yields for investors they had also become big buyers of commercial paper. All morning we heard reports that nervous investors were pulling their money out and accelerating the stampede into the Treasury market. The Reserve Primary Fund, the nation’s first money market fund, had been particularly hard-hit because of substantial holdings of now-worthless Lehman paper. Many Americans had grown accustomed to thinking that money market funds were as safe as their bank accounts. Money funds lacked deposit insurance but investors believed that they would always be able to withdraw their money on demand and get 100 percent of their principal back.

While we were with the president, the Reserve had announced that it would halt payment of redemptions for one week on its Primary Fund, a $63 billion money market fund that was caught with $785 million in Lehman short-term debt when the investment bank entered bankruptcy. On Monday, investors had flooded the company with requests for redemptions; by mid-afternoon Tuesday, $40 billion had been pulled. The fund had officially broken the buck, the first to do so since 1994, when the Denver-based U.S. Government Money Market Fund, which had invested heavily in adjustable-rate derivatives, fell to 96 cents. The sense of panic was becoming more widespread. Dave McCormick and Ken Wilson came in to tell me that they had heard from their Wall Street sources that a number of Chinese banks were withdrawing large sums from the money market funds. They had also heard that the Chinese were pulling back on secured overnight lending and shortening the maturity of their holdings of Fannie and Freddie paper—all signs of their battening the hatches.

But most important, over the next six months I watched the yuan, which was trading at 7.43 to the dollar in December, strengthen to about 6.81 by mid-July. China’s sudden flexibility not only benefited that country but would help forestall protectionist sentiment in the U.S. Congress. On the financial side, however, the bad news piled up day by day. In mid-November, Bank of America and Legg Mason said they would spend hundreds of millions of dollars to prop up their faltering money market funds, which had gotten burned buying debt from SIVs. Although the public considered money market funds among the safest investments, some funds had loaded up on asset-backed commercial paper in hopes of raising returns. Meantime, the credit markets relentlessly tightened as banks grew increasingly reluctant to lend to one another. One key measure of the confidence banks had in one another, the LIBOR-OIS spread—which measures the rate they charge each other for funds—had begun to widen dramatically.


pages: 305 words: 69,216

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

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

But then business depositors took to practicing "sweeps" —moving the money in their bank accounts into investment funds until they needed it to pay bills, at which point they moved it back. And money market funds arose to provide people with checkable accounts, just like bank accounts (though uninsured) —except that they paid interest. Banks responded by supplementing deposits as a source of bank capital with loans from other sources, on which they had to pay interest— and hence had to lend their capital out at a higher interest rate than they were paying for the capital furnished by their depositors. This required them to make riskier loans. The deregulatory strategy of allowing nonbank financial intermediaries to provide services virtually indistinguishable from those of banks, such as the interest-bearing checkable accounts offered by money market funds, led inexorably to a complementary deregulatory strategy of freeing banks from the restrictions that handicapped them in competing with unregulated (or very lightly regulated) financial intermediaries — nonbank banks, in effect.

Lehman defaulted on some $165 billion in unsecured debt, but that was the least of the problem. It was the number-one dealer in commercial paper, a form of debt that seemed safe because of who the issuers were (large, blue-ribbon corporations) and because it was short term. The major customers for commercial paper were money market funds, which pay low interest rates because they are (or rather were) considered utterly safe. Lehman was the middleman between the issuers of commercial paper and the money market funds, and when it unexpectedly collapsed, the commercial-paper market—a significant part of the overall credit market—froze. Lehman's collapse showed that commercial paper wasn't so safe after all, so money markets stopped buying it and as a result issuers of commercial paper stopped issuing it. They had standby lines of credit at banks, however, and when all at once they tried to draw on them this further reduced the banks' ability to make new loans.

Bank capital would consist mainly of zero-interest demand deposits and federal securities and would be used mainly to make short-term commercial loans. But we know that this model of banking would not be viable if other financial intermediaries were permitted, as they are today, to offer close substitutes for bank products. Does this mean, however, that money market funds, hedge funds, and all the other nonbank banks must be placed under the same regulatory controls as commercial banks? Should they for example be required to have reserves? To pay zero interest to the lenders of their capital? If the answer to these questions is yes, that is the end of hedge funds, of money market funds, etc. If the answer is no, it is unclear how much reregulation of commercial banks is possible. If there is another answer, it will take much thought to work out. There is a further and very serious complication. As far as I know, no one has a clear sense of the social value of our deregulated financial industry, with its free-wheeling banks and hedge funds and private equity funds and all the rest.


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

But by the end of Tuesday, with Lehman debt now priced at zero cents on the dollar, they concluded they could not, and announced that Reserve’s shares were now priced at 97 cents instead of one dollar. Federal Reserve and Treasury officials had spent the weekend trying to imagine and prepare for every collateral effect of a Lehman bankruptcy. One thing they apparently did not consider was that a money market fund might break the buck. That announcement arguably sowed as much panic as Lehman’s bankruptcy itself. Within a week, investors yanked a total of $349 billion from almost every money market fund not invested solely in Treasury bills, regardless of whether it had exposure to Lehman. Some thirty-six of the one hundred largest U.S. prime money market funds were eventually supported. Meanwhile, the funds themselves stopped buying commercial paper, the short-term IOUs that everyone from General Electric to obscure investment funds had come to rely on to fund everything from equipment inventory to subprime mortgage-backed securities.

It later emerged that, between 1972 and the lead-up to the crisis, there had been 146 instances of a fund sponsor intervening to preserve the dollar per share value of a money market fund. As I mentioned earlier, only once had a fund actually broken the buck and been forced to liquidate. The sponsors in these cases were doing the right thing for themselves and their investors, but in the grand scheme of things, these backstage interventions worsened the eventual crisis, because they reinforced the illusion that investors would never lose money in money market funds. Over the course of the next five years, other institutions would suffer the same fate as money market funds: the illusion of safety would be abruptly torn away from European government debt during the euro crisis, as we will see in Chapter 5, and the same thing very nearly happened to U.S.

The failure of Lehman shattered assumptions about the safety of all the major financial institutions. If Lehman wasn’t too big to fail, nobody was: not Goldman Sachs, Morgan Stanley, Citigroup, or any other institution. The second assumption that had been allowed to take root was that money market funds were basically the same as bank deposits. That, more or less, was how their shareholders treated them. Rate of return was much less important than safety and immediate access to funds. “We could get our cash any day that we would need it,” explained one investor in Reserve. “And it gave us safety because the money market fund was a dollar in, you get your dollar out.” Of course, these investments weren’t bank deposits. Funds were not legally obligated to maintain the dollar per share value. But in practice, the reputational damage of breaking the buck was so great that sponsors—the management companies who ran the funds—almost always put their own capital in rather than allow it to happen.


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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

Neither the funds nor federal officials considered them in any way insured by the government. But suddenly the economy was as vulnerable to a run on money market funds as it was to runs on banks. And it wasn’t only ordinary savers who stood to get trampled. Scores of brand-name industrial companies — General Electric, Caterpillar, Dow Chemical — relied on the money market funds for their short-term borrowing, often issuing the funds IOUs called commercial paper that were backed only by the companies’ promise to pay. The Fed and the Treasury decided that to avoid a stampede out of money market funds, they had to find a way to assure consumers that the Reserve Primary Fund wouldn’t be followed by scores of other money market funds breaking the buck. At the Fed, Don Kohn took charge of the response while Bernanke went to Capitol Hill and Warsh to New York.

BREAKING THE BUCK The turmoil in the financial markets during the week of September 15 didn’t revolve only around newfangled financial instruments, cross-border sophisticated bets, or the collapse of major financial institutions. In fact, the biggest surprise of Lehman’s collapse came from money market funds, the $1-a-share mutual funds that Americans had come to consider as safe as bank accounts. Money market funds had been on the Fed list of things to worry about for months, dating back to the fragility of the tri-party repo market and the Bear Stearns episode. But with so much advance speculation about Lehman’s frailties, it didn’t occur to Bernanke, Geithner, or Paulson — or any of their staff — that a major money market fund would hold a significant chunk of Lehman’s short-term debt. But the Reserve Primary Fund, the oldest of all the money market mutual funds, had 1.2 percent of its $63 billion in Lehman — holdings that would prove devastating and which couldn’t wait for Congress to act.

At the Treasury, the job fell to David Nason, the assistant secretary for financial institutions. Nason recently had recused himself to look for a job. After AIG imploded, he dropped the job hunt and returned to work. In the frantic search for a solution, talk bubbled up about the Fed lending directly to the money market funds. It turned out SEC rules forbid the funds from borrowing. There was talk about asking the Federal Deposit Insurance Corporation to insure the money market fund deposits; that went nowhere. There was talk about allowing industrial companies to come directly to the Fed for loans, an idea that resurfaced a few weeks later. The money market fund industry itself was split on the question of government aid. The biggest funds thought they could protect themselves and the $1-a-share value and didn’t want to pay for government insurance or invite politicians into their business.


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

Funds that invest in municipal bonds come with tax advantages (page 130). • Money market funds invest either in very short-term bonds or in a collection of investments that simulate the returns of short-term fixedincome investments. If you’re looking for a place to stash your savings, a money market fund makes sense because they’re reasonably safe, but pay more interest than bank accounts. Money market funds are safe, but they aren’t bulletproof. In 2008, the nation’s oldest mutual money market fund broke the buck—its net asset value fell below $1 a share. The federal government guaranteed the value of all money market funds to prevent a panic, but that guarantee ended early in 2010. Today, federal deposit insurance protects only money market deposit accounts (not money market funds) in banks, savings and loans, and credit unions.

When your child starts senior year and then goes off to college, look for a money market or FDIC savings account option. • Packaged funds offer a basket of mutual funds to suit different levels of risk tolerance: aggressive, moderate, and conservative. Aggressive packages contain mostly stock funds with some bond or money market funds. The allocation is usually 100% stock or 90% stock/10% bonds. Moderate packages are approximately 60% stock/30% bonds/10% money market funds. Conservative packages give the lead to bond funds with small amounts of stock and money market funds, usually 60% bonds/40% stock. The packaged fund option you choose remains in place unless you change it. • With single funds, you choose several funds from a menu of individual mutual funds with different investment objectives. You can allocate your money to several funds by percentages or dollar amounts, or put all your eggs in one basket.

. $160,000 $149,745 $140,000 $120,000 Dollars $100,000 Compounding Simple $80,000 $60,000 $40,000 $38,000 $20,000 $0 18 Chapter 1 0 5 10 15 20 25 30 35 40 Years As you’ve seen with inflation, compounding is a powerful force, even when the rate is small. But this technique really shines when you earn higher returns, like the 7% from a diversified portfolio, and give your portfolio time to mature. The graph below shows how a $10,000 nest egg grows when you put your money in diversified investments, bonds, money market funds, and savings accounts. Compare the line for inflation to see how investing can help you beat the steady rise in prices. You can see below how investments start to take off after 15 years. That’s compounding at work, and that’s why it’s important to start investing for long-term goals as early as you can. $160,000 $140,000 Diversified portfolio $120,000 Bonds Inflation Dollars $100,000 Money Market $80,000 Savings $60,000 $40,000 $20,000 $0 0 5 10 15 25 20 Years 30 35 40 Investing for the Long Term Although well-diversified investing works like magic when you give it time, it doesn’t make sense for short-term goals.


pages: 263 words: 89,368

925 Ideas to Help You Save Money, Get Out of Debt and Retire a Millionaire So You Can Leave Your Mark on the World by Devin D. Thorpe

asset allocation, buy and hold, call centre, diversification, estate planning, fixed income, Home mortgage interest deduction, index fund, knowledge economy, money market fund, mortgage tax deduction, payday loans, random walk, risk tolerance, Skype, Steve Jobs, transaction costs, women in the workforce, zero-sum game

Some brokerages will put your cash into a money market fund automatically, even if you don’t ask for that. Others will give you the option to automatically sweep your cash into a money market fund. Some only make that option available for people with large accounts. Even if you can’t sweep all of your balances into a money market account, you can move money into a money market fund just like you move money into a mutual fund that invests in stocks or bonds. Because of the low returns on money market mutual funds, you want to be sure to avoid any transaction fees at all (unless you have lots and lots of money invested). Today, a $1,000 investment in a money market fund might only earn $10 in a year. If you have to pay $10 to get in and $10 to get out of a money market fund, you’ll lose ten dollars. You’d be better off to have your cash sit idle for a year earning nothing.

Over time, this should have the effect of reducing the percentage of your portfolio invested in other assets. In this way, you never need to sell assets just to shift your allocation. Thoughtful adjustments to your asset allocation will better prepare you for retirement. What Is A Money Market Fund And How Do I Use One? Learning about money market funds and how to use them in your investing programs can help you make better investment decisions, both protecting your assets and allowing you to earn more in the long run. A money market mutual fund (bit.ly/Z1uvGU) is a mutual fund that invests in assets that are so stable that the fund maintains a constant price of $1 per share. Money market funds are not FDIC insured (though some banks have offered savings accounts or even checking accounts with the name “money market” but they are FDIC insured and are not mutual funds). The money market refers to the instruments the fund invests in.

The money market refers to the instruments the fund invests in. The investments include mostly the sorts of instruments that consumers and small investors don’t normally buy directly. These include short term treasury obligations (T-bills) and commercial paper (short term corporate obligations). Everything in the portfolio of a money market fund would be expected to mature within a few months. The cash is then reinvested. Money market funds earn low returns but are generally considered safe despite their lack of a formal guaranty. The industry is carefully regulated and investor losses in this space have been tiny. You can reasonably expect to get your money back with interest. Most investors look at three primary types of assets for their long term investments. Stocks, bonds and cash.


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

Savvy investors can take advantage of the lag between yield changes on open market paper and yields on money market funds, particularly when interest rates fall. Many investors apparently recognize the opportunities that arise on such occasions, as there have been sharp swings in the amount of money held in money market funds, particularly institutional money market funds, when the Federal Reserve’s interest rate policies have spurred movement in short-term interest rates. In early 2001, for example, when the Fed began to aggressively lower interest rates, inflows into money market funds increased sharply. Investors recognized that yields on money market funds would remain high relative to yields that could be obtained on market instruments such as T-bills and commercial paper, and henceforth shifted money to these instruments. FIGURE 26.4 Changes in yields on money market funds tend to lag T-bills CONSUMERS’ USES OF MONEY FUNDS For consumers, money funds are a convenient, safe, and liquid investment for tucking away temporary excess funds and a liquidity reserve.

Whether an institutional investor does or does not use a money fund, the yield it could achieve using one makes a good benchmark against which to compare the yield it achieves over time on its liquidity portfolio, provided, that is, that it adjusts that yield for the full investment expenses it incurs. Capturing Rising Rates with Money Market Funds It is a simple fact that when interest rates rise bond prices fall. When such seems likely and when there’s much uncertainty about whether interest rates will continue to rise, money market funds can be an attractive instrument if used strategically to simultaneously capture the rate rise and avoid capital losses on longer-dated maturities. With money market funds, there’s not much risk to principal, as the principal invested in money market funds is almost always constant at $1 per share. This is unlike owning longer-dated maturities where investors would encounter a capital loss. For some investors, shifting to money market funds is not an option, as they must stay fully invested at a relatively fixed maturity.

But for those with greater flexibility, if interest rates are steadily rising as a result of interest rate increases from the Federal Reserve, investing in money market funds enables investors to capture the yield rise without incurring much risk to principal. A caveat: if one bets wrong and short rates stop rising, investors deploying such a strategy will miss opportunities to lock in rates on longer-dated maturities and possibly miss capital gains opportunities. Using Money Market Funds to Capture Shifts in Market Sentiment Money market funds can provide useful information about investor sentiment. It was notable, for example, when in 2001 and 2002 money market funds saw extremely high inflows of capital despite sharp declines in money market rates. In 2001 alone, institutional money funds grew by 50% to $1.2 trillion despite 11 interest rate cuts from the Federal Reserve.


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

The current T-bill rate is a good proxy for the interest an investor will earn in a money market fund because T-bills are frequently purchased in money market funds. Understanding Investment Risk 27 T-bills are often called a “risk-free” investment in the financial world because of their short maturity and government guaranteed return. However, risk-free may be an inappropriate choice of words. T-bills do have a reliable positive return; however, that return is subject to the corrosive effects of taxes and inflation. Figure 2-1 highlights the year-over-year T-bill return minus 25 percent income tax and the inflation rate. There have been many years when the rate of return on T-bills has not kept pace with the inflation rate after taxes. Investors in T-bills and money market funds are losing purchasing power in the years when the bar in Figure 2-1 is below 0 percent.

FIGURE 1-1 The Investment Pyramid Discretionary speculative (commodities, individual stocks) 5 Nondiscretionary assets (restricted stock, pension, Social Security) 4 Discretionary long-term illiquid assets (home, properties, businesses, collectibles) 3 Discretionary long-term liquid investments (mutual funds, ETFs, CDs, bonds, annuities) 2 1 Cash accounts for living expenses and emergencies (checking account, savings account, money market fund) CHAPTER 1 10 Here are brief descriptions of the five levels: 1. Level one is the base of the pyramid. It is characterized by highly liquid cash and cash types of investments that are used for living expenses and emergencies. This money is typically in checking accounts, savings accounts, and money market funds. This cash is not part of your long-term investment allocation, and you should not be overly concerned that your rate of return is low. The amount to keep in cash varies with your circumstances. I recommend 3 to 4 months in cash if you are single, 6 to 12 months in cash if you have a family, and 24 months when you retire. 2.

Younger investors will develop asset allocations from a perspective that’s different from that of older investors because they are different, but that does not mean that young investors will have a more aggressive allocation than older people. It depends on each person’s unique situation. Asset allocation is personal. There is an appropriate allocation for your needs at every stage in life. Your mission is to find it. HOW ASSET ALLOCATION WORKS Asset classes are broad categories of investments, such as stocks, bonds, real estate, commodities, and money market funds. Each asset class can be further divided into categories. For example, Planning for Investment Success 19 stocks can be categorized into U.S. stocks and foreign stocks. Bonds can be categorized into taxable bonds and tax-free bonds. Real estate investments can be divided into owner-occupied residential real estate, rental residential real estate, and commercial properties. The subcategories can be further divided into investment styles and sectors.


pages: 482 words: 121,672

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

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, beat the dealer, Bernie Madoff, bitcoin, butter production in bangladesh, buttonwood tree, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Detroit bankruptcy, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, financial repression, fixed income, framing effect, George Santayana, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond, zero-sum game

Issued and guaranteed by the U.S. government, T-bills are auctioned with maturities of four weeks, three months, six months, or one year. They are sold at a minimum $1,000 face value and in $1,000 increments above that. T-bills offer an advantage over money-market funds and bank CDs in that their income is exempt from state and local taxes. In addition, T-bill yields are often higher than those of money-market funds. For information on purchasing T-bills directly, go to www.treasurydirect.gov. Tax-Exempt Money-Market Funds If you find yourself lucky enough to be in the highest federal tax bracket, you will find tax-exempt money-market funds to be the best vehicle for your reserve funds. These funds invest in a portfolio of short-term issues of state and local government entities and generate income that is exempt from both federal and state taxes if the fund confines its investments to securities issued by entities within the state.

Addresses and phone numbers are given for each listing, and you can call to confirm that the deposits are insured and learn what current rates of return are being offered. Internet Banks Investors can also take advantage of online financial institutions that reduce their expenses by having neither branches nor tellers and by conducting all their business electronically. Thanks to their low overhead, they can offer rates significantly above both typical savings accounts and money-market funds. And, unlike money-market funds, those Internet banks that are members of the Federal Deposit Insurance Corporation can guarantee the safety of your funds. To find an Internet bank, go to the Google search engine and type in “Internet bank.” You will also see many of them popping up when you do a rate search on www.bankrate.com for the banks with the highest yields. The Internet banks generally post the highest CD rates available in the market.

Those willing to accept somewhat more risk in the hope of greater reward could increase the proportion of equities. Those who need a steady income for living expenses could increase their holdings of real estate equities and dividend growth stocks, because they provide somewhat larger current income. A SPECIFIC INDEX-FUND PORTFOLIO FOR AGING BABY BOOMERS Cash (5%)* Fidelity Money Market Fund (FXLXX) or Vanguard Prime Money Market Fund (VMMXX) Bonds and Bond Substitutes (27½%)† 7½% U.S. Vanguard IntermediateTerm Bond (VICSX) or iShares Corporate Bond ETF (LQD) 7½% Vanguard Emerging Market Government Bond Fund (VGAVX) 12½% Wisdom Tree Dividend Growth Fund (DGRW) or Vanguard Dividend Growth Fund (VDIGX)† Real Estate Equities (12½%) Vanguard REIT Index Fund (VGSIX) or Fidelity Spartan REIT Index Fund (FRXIX) Stocks (55%) 27% U.S.


pages: 350 words: 103,270

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

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

Although Deutsche denies Linares’s involvement, the lure of the financial iPhone caught the attention of Justo Palma, a fund manager for a mutual fund company called BZ Gestion in the city of Saragossa, northeast of Madrid, in 2001.9 Palma invited several banks to propose a structured product for one of BZ Gestion’s money market funds, and Deutsche Bank won the tender, selling a REPON-style product containing a single slice of a synthetic CDO. Unfortunately, a money market fund is not the same as an insurance company, which holds its assets at book value. Palma’s purchase was marked to market once a month, and as the provider of the product, Deutsche was obliged to provide its valuation. This quickly exposed a significant difference between the price Palma had paid and what the CDO was worth, even without any defaults in the portfolio.

Big corporate borrowers wanted to reduce the cost of bank loans, and the newly invented commercial paper or IOU market was a great way of doing that. Money market mutual funds sprang up to give shortchanged bank depositors a better deal. Like Smith, these money market funds bought commercial paper because the extra returns gave them an edge over traditional bank deposits. Over time, the money funds started investing in short-term repo agreements as well, helping to prop up the growing balance sheets of investment banks like Goldman Sachs and Lehman Brothers. Looking at this upstart market, the traditional lending banks could argue that if their depositors took those green spectacles off, Uncle Sam would be there to protect them in the form of the FDIC’s guarantee, which stood at $100,000 per customer in 2007. Money market funds responded that they didn’t need this protection because they weren’t “borrowing short and lending long,” as banks did—IOUs and repos were only short-term investments, not long-term loans.

Partridge-Hicks and Sossidis soon realized that a ready-made solution was the army of depositors that had already been assembled by U.S. money market funds, and other institutions looking for places to park their cash. If their new bank could sell IOUs to these funds, then it would have, in effect, outsourced its deposit taking to the likes of Schwab or Fidelity. With this final spark of inspiration, Partridge-Hicks and Sossidis were ready, and in September 1988, the world’s first shadow bank, Alpha, began operations. An up-and-coming Moody’s analyst, Raymond McDaniel, worked with the Citibank duo to ensure that Alpha achieved the top “A-1+/P-1” commercial paper rating for its IOUs. Another shadow bank, Beta, followed a year later. In the same way that money market funds were not officially deposit-taking banks, Alpha and Beta were not officially banks.


pages: 311 words: 99,699

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

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

Citi itself had created seven shadow banks, and by 2007 these held almost $100 billion of assets. The SIVs were also entwined with America’s vast $3 trillion money-market fund sector. Most ordinary Americans assumed that money-market funds were as safe as bank deposits. The funds marketed themselves on the mantra that no fund had ever “broken the buck,” or returned less than 100 percent of money invested. However, these money-market funds were now holding large quantities of notes issued by SIVs and were not covered by any federal safety insurance. That created the potential for a chain reaction; if SIVs collapsed, the worry went, money-market funds would suffer losses and consumers would then suddenly discover that their supersafe investments were not so safe after all. Citi hoped to avoid a panic by persuading American banks to act, en masse, to avert widespread SIV collapse.

Another unexpected shock hit the $3 trillion American money-market fund sector. In the months before the Lehman collapse, many of these funds had purchased debt issued by Lehman Brothers, assuming that the US government would never let Lehman collapse. Now those funds were nursing substantial losses. On September 16, the $62 billion Reserve Primary Fund, the country’s oldest money-market fund, posted a somber statement on its website: “The value of the debt securities issued by Lehman Brothers Holdings (face value $785 million) and held by the Primary Fund has been valued at zero effective as of 4:00 p.m. New York time today.” That threatened to spark more panic. America’s money-market fund industry had prided itself on never “breaking the buck,” and the Reserve had just done so. A run on the money-market funds now seemed likely.

Corporate treasurers often bought commercial paper, since those notes tended to produce a return a fraction better than anything found in a bank account. Pension funds sometimes bought commercial paper, too. One of the biggest sources of demand for commercial paper, though, came from the giant $3 trillion money-market fund sector. These funds typically raised money from ordinary retail investors or companies, which tended to treat money-market funds as similar to a bank account: they placed cash there assuming they could always withdraw it, and on short notice. Precisely because money-market funds knew that investors might redeem their cash with little notice, such funds usually wanted to purchase only assets that had a short duration and were safe. Commercial paper fit the bill perfectly. The specific corner of the market where IKB raised funds was one subset of this world, a mutation known as the asset-backed commercial paper (ABCP) sphere.


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

The rapid move upward in LIBOR came in reaction to new SEC regulations that went into effect in October 2016 in the money-market fund industry, as well as to other changes in how banks are regulated that were expected to take effect in December 2016 and January 2017. Banks are starting to charge each other much more for short-term loans, which is an ominous sign, and stands in stark contrast to the new highs being achieved in the stock market and the rally in Treasury securities (before it sold off dramatically in the wake of Trump’s unexpected victory). The SEC’s new rules for money-market funds require that they represent to investors that the funds are “money good,” or worth what they say they are worth. The problem being addressed by the SEC, at the instigation of the Federal Reserve, occurred in September 2008 when the Reserve Fund, a money-market fund—which is supposed to be as safe as a savings account—“broke the buck,” meaning that $1 invested in the fund, which was supposed to always be worth $1, was no longer worth $1.

But more important to the confidence of the financial system was the fact that because of the turmoil in the markets, a money-market fund was no longer considered prudent. The reason the Reserve Fund “broke the buck” is that it didn’t just keep the money investors gave it in cash; it invested the money, in an effort to give investors a slightly higher yield, or financial return on the money invested, than could be found in a savings account. The Reserve Fund generated those slightly higher returns by investing in something that seemed to be rated AAA—the AAA tranches of securitizations, the funky and creative securities created by Lew Ranieri—that turned out not to be really AAA after all (as we all know). Understandably, the Federal Reserve doesn’t want that to happen again, hence the new rules about money-market funds that took effect last year. The problem, as usual, is not the honorable goal of trying to prevent a money-market fund from ever again breaking the buck; the problem is the unintended consequences of trying to make sure that doesn’t happen.

Better-capitalized firms, he continued, tended “to hoard” their financial resources “in light of their uncertainty as to whether their balance sheets might come under greater stress and their reluctance to catch the proverbial falling knife by purchasing assets whose prices were plummeting with no obvious floor.” Tarullo’s postcrisis effort to “protect financial stability” remains focused on regulating “runnable securities.” Hence his mandate that money-market funds, in which millions of Americans park billions of their dollars believing them to be safe and secured, could no longer invest in the AAA tranche of securitizations. In Tarullo’s world, they were no longer considered “safe” investments. 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.


pages: 354 words: 105,322

The Road to Ruin: The Global Elites' Secret Plan for the Next Financial Crisis by James Rickards

"Robert Solow", Affordable Care Act / Obamacare, Albert Einstein, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Bayesian statistics, Ben Bernanke: helicopter money, Benoit Mandelbrot, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, bitcoin, Black Swan, blockchain, Bonfire of the Vanities, Bretton Woods, British Empire, business cycle, butterfly effect, buy and hold, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, cellular automata, cognitive bias, cognitive dissonance, complexity theory, Corn Laws, corporate governance, creative destruction, Credit Default Swap, cuban missile crisis, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, debt deflation, Deng Xiaoping, disintermediation, distributed ledger, diversification, diversified portfolio, Edward Lorenz: Chaos theory, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, fiat currency, financial repression, fixed income, Flash crash, floating exchange rates, forward guidance, Fractional reserve banking, G4S, George Akerlof, global reserve currency, high net worth, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Isaac Newton, jitney, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Rogoff, labor-force participation, large denomination, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, mutually assured destruction, Myron Scholes, Naomi Klein, nuclear winter, obamacare, offshore financial centre, Paul Samuelson, Peace of Westphalia, Pierre-Simon Laplace, plutocrats, Plutocrats, prediction markets, price anchoring, price stability, quantitative easing, RAND corporation, random walk, reserve currency, RFID, risk-adjusted returns, Ronald Reagan, Silicon Valley, sovereign wealth fund, special drawing rights, stocks for the long run, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transfer pricing, value at risk, Washington Consensus, Westphalian system

Depositors now realized their money in the bank was not money, and not theirs. Their so-called money was actually a bank liability and could be frozen at any time. The Brisbane G20 ice-nine plan was not limited to bank deposits. That was just a beginning. On Wednesday, July 23, 2014, the U.S. Securities and Exchange Commission (SEC) approved a new rule on a 3–2 vote that allows money market funds to suspend investor redemptions. The SEC rule pushes ice-nine beyond banking into the world of investments. Now money market funds could act like hedge funds and refuse to return investor money. Fund managers dutifully included glossy flyers in the mail and online notices to investors about this change. No doubt investors threw the flyer in the trash and skipped the notice. But the rule is law, and notice has been given. In the next financial panic, not only will your bank account be bailed in, your money market account will be frozen.

Until big banks meet the capital surcharge requirement, they are prohibited from paying cash to stockholders in the form of dividends and stock buybacks. This prohibition is ice-nine applied to bank stockholders. The ice-nine in Cat’s Cradle threatened every water molecule on earth. The same is true for financial ice-nine. If regulators apply ice-nine to bank deposits, there will be a run on money market funds. If ice-nine is applied to money market funds also, the run will move to bond markets. If any market is left outside the ice-nine net, it will immediately become the object of distress selling when other markets are frozen. In order for the elite ice-nine plan to work, it must be applied to everything. Not even trading contracts can escape ice-nine. Parties to a trade with a failed firm are normally frozen in place if that firm files for bankruptcy.

Behind that bland language is a separate: See “Adequacy of Loss-Absorbing Capacity of Global Systemically Important Banks in Resolution,” Financial Stability Board, November 10, 2014, accessed August 7, 2016, www.fsb.org/2014/11/adequacy-of-loss-absorbing-capacity-of-global-systemically-important-banks-in-resolution/. The report says bank losses: Ibid., 5 (emphasis added). On Wednesday, July 23, 2014, the U.S. Securities and Exchange Commission: See “SEC Adopts Money Market Fund Reforms,” Harvard Law School Forum on Corporate Governance and Financial Regulation, August 16, 2014, accessed August 7, 2016, https://corpgov.law.harvard.edu/2014/08/16/sec-adopts-money-market-fund-reforms/. On December 8, 2014, The Wall Street Journal: See Kirsten Grind, James Sterngold, and Juliet Chung, “Banks Urge Clients to Take Cash Elsewhere,” The Wall Street Journal, December 7, 2014, accessed August 7, 2016, www.wsj.com/articles/banks-urge-big-customers-to-take-cash-elsewhere-or-be-slapped-with-fees-1418003852.


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

And Goldman Sachs and Morgan Stanley came under the government’s legal authority to provide a blanket of protection by voluntarily becoming bank holding companies, giving them greater access to the Fed’s lending channels. The Treasury also unveiled a creative new move to shore up troubled money market funds, which held $3.5 trillion. Money market funds had become very popular as an alternative to bank deposits for both retail and institutional investors. Most investors were attracted by their high interest rates and undeterred by their lack of FDIC protection; they didn’t appreciate that they were delivering those higher interest rates by investing in higher-yielding and higher-risk loans. They also believed that they would not lose money in them as their principal was protected. Prime money-market funds had been a crucial source of liquidity for all kinds of businesses, since they buy commercial paper, a type of short-term debt that businesses use to fund their operations.

So Paulson got his general counsel to give him an opinion that he could use that $45 billion, since if the whole economy went down it wouldn’t be good for the dollar.45 Some of Paulson’s colleagues questioned whether $45 billion would be enough, given that there were $3.5 trillion worth of money-market funds. Paulson didn’t know if it would be, but he didn’t have a better idea. The Treasury team was moving so fast that Sheila Bair (the head of the FDIC) called and complained that not only was she not consulted, but because of the guarantee all of the money would now go from bank deposits to Money-Market Funds. That was a good point. So the Treasury clarified that the guarantee was only applicable to money-market funds that were in trouble as of September 19. The guarantee worked incredibly well and markets immediately turned. According to Paulson, this was because when you say something is a guarantee and not just a backstop, it is much more reassuring to investors.

After the Reserve Fund broke the buck, Ken Wilson, who was at Treasury at the time, had gotten a call at 7 a.m. from Northern Trust, followed by others from Black Rock, State Street, and Bank of New York Mellon. All of them reported runs on their money-market funds. Meanwhile, GE had been in the news, explaining that they couldn’t sell their paper. Then Coca-Cola CFO Muhtar Kent called and said they were going to be unable to make their $800 million quarterly dividend payment at the end of the week because they couldn’t roll their paper. Even AAA-rated industrial- and consumer-products companies couldn’t roll their paper! The situation was very quickly metastasizing from Wall Street to Main Street. To stop the run on money-market funds, Paulson decided to guarantee them outright. The only problem was that the funds would need a substantial backstop and the Treasury couldn’t immediately find the cash.


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 financial crisis in the fall of 2008 had an added complication because banks were funding themselves with very short-term financing instruments that weren’t deposits. Much of this short-term financing was being provided by money-market funds, which were not explicitly guaranteed by the Federal Reserve or the FDIC. When investors began running from money-market funds in September 2008, the Treasury Department stepped in to guarantee these funds. Their blanket guarantee immediately calmed the market, which shows that the government can and should prevent runs in the financial sector. We view these policies as advisable and fitting within the appropriate role of the government and central bank in preventing crippling bank runs. Preventing runs requires lending by the Federal Reserve, and in the case of money-market funds during the fall of 2008, it even required lending by the U.S. Treasury. However, this kind of support should not be viewed as a bailout.

We readily admit that there is substantial evidence that investors show an extreme desire to hold what appear to be super-safe assets. But this is likely driven by the same government subsidies to debt financing we have already mentioned. For example, when the financial crisis peaked in September 2008, the U.S. Treasury stepped in to guarantee money-market funds. Now all investors know that money-market funds enjoy an implicit guarantee from the government. Their “desire” to put cash into a money-market fund is not some primitive preference. They are simply responding to a government subsidy. Also, even if investors do exhibit innate preferences for super-safe assets, the government should directly cater to the demand, not the private sector. The closest thing most economies have to a truly super-safe asset is government debt.

First, they had a lot less debt coming into the recession. The richest 20 percent of home owners had a leverage ratio of only 7 percent, compared to the 80 percent leverage ratio of the poorest home owners. Second, their net worth was overwhelmingly concentrated in non-housing assets. While the poor had $4 of home equity for every $1 of other assets, the rich were exactly the opposite, with $1 of home equity for every $4 of other assets, like money-market funds, stocks, and bonds. Figure 2.1 shows these facts graphically. It splits home owners in the United States in 2007 into five quintiles based on net worth, with the poorest households on the left side of the graph and the richest on the right. The figure illustrates the fraction of total assets each of the five quintiles had in debt, home equity, and financial wealth. As we move to the right of the graph, we can see how leverage declines and financial wealth increases.


One Up on Wall Street by Peter Lynch

air freight, Apple's 1984 Super Bowl advert, buy and hold, corporate raider, cuban missile crisis, Donald Trump, fixed income, index fund, Irwin Jacobs, Isaac Newton, large denomination, money market fund, prediction markets, random walk, shareholder value, Silicon Valley, Y2K, Yom Kippur War, zero-sum game

Then the bond funds were invented, and regular people could invest in debt right along with tycoons. After that, the money-market fund liberated millions of former passbook savers from the captivity of banks, once and for all. There ought to be a monument to Bruce Bent and Harry Browne, who dreamed up the money-market account and dared to lead the great exodus out of the Scroogian thrifts. They started it with the Reserve Fund in 1971. My own boss, Ned Johnson, took the idea a thought further and added the check-writing feature. Prior to that, the money-market was most useful as a place where small corporations could park their weekly payroll funds. The check-writing feature gave the money-market fund universal appeal as a savings account and a checking account. It’s one thing to prefer stocks to a stodgy savings account that yields 5 percent forever, and quite another to prefer them to a money-market that offers the best short-term rates, and where the yields rise right away if the prevailing interest rates go higher.

This was a possibility for which I’d been preparing since the day we arrived. Frankly, I’d let the upsets get to me. THE LESSONS OF OCTOBER I’ve always believed that investors should ignore the ups and downs of the market. Fortunately the vast majority of them paid little heed to the distractions cited above. If this is any example, less than three percent of the million account-holders in Fidelity Magellan switched out of the fund and into a money-market fund during the desperations of the week. When you sell in desperation, you always sell cheap. Even if October 19 made you nervous about the stock market, you didn’t have to sell that day—or even the next. You could gradually have reduced your portfolio of stocks and come out ahead of the panic-sellers, because, starting in December, the market rose steadily. By June of 1988 the market recovered some 400 points of the decline, or more than 23%.

The current price is $34⅞ and the original price was $25. “Excellent,” he exclaims to Doggle. Fortunately for Doggle there is no date attached to these purchases, so Flint never realizes that Xerox and Sears have been in the portfolio since 1967, when bell-bottom pants were the national rage. Given how long Xerox has been sitting there, the return on equity is worse than it would have been in a money-market fund, but Flint doesn’t see that. Then Flint moves along to Seven Oaks International, which happens to be one of my all-time favorite picks. Ever wonder what happens to all those discount coupons—fifteen cents off Heinz ketchup, twenty-five cents off Windex, etc.—after you clip them from the newspapers and then turn them in at your supermarket checkout counter? Your supermarket wraps them up and sends them off to the Seven Oaks plant in Mexico, where piles of coupons are collated, processed, and cleared for payment, much as a check is cleared through the Federal Reserve banks.


pages: 416 words: 118,592

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

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, butter production in bangladesh, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

Issued and guaranteed by the U.S. government, T-bills are auctioned with maturities of four weeks, three months, six months, or one year. They are sold at a minimum $1,000 face value and in $1,000 increments above that. T-bills offer an advantage over money-market funds and bank CDs in that their income is exempt from state and local taxes. In addition, T-bill yields are often higher than those of money-market funds. For information on purchasing T-bills directly, go to www.treasurydirect.gov. Tax-Exempt Money-Market Funds If you find yourself lucky enough to be in the highest federal tax bracket, you will find tax-exempt money-market funds to be the best vehicle for your reserve funds. These funds invest in a portfolio of short-term issues of state and local government entities and generate income that is exempt from both federal and state taxes if the fund confines its investments to securities issued by entities within the state.

Addresses and phone numbers are given for each listing, and you can call to confirm that the deposits are insured and learn what current rates of return are being offered. Internet Banks Investors comfortable with the wide world of the Web might wish to take advantage of online financial institutions that reduce their expenses by having neither branches nor tellers and by conducting all their business electronically. Thanks to their low overhead, they can offer rates significantly above both typical savings accounts and money-market funds. And, unlike money-market funds, those Internet banks that are members of the Federal Deposit Insurance Corporation can guarantee the safety of your funds. To find an Internet bank, go to the Google search engine and type in “Internet bank.” You will also see many of them popping up when you do a rate search on www.bankrate.com for the banks with the highest yields. The Internet banks generally post the highest CD rates available in the market.

Remember also that you may want to alter the percentages somewhat depending on your personal capacity for and attitude toward risk. Those willing to accept somewhat more risk in the hope of greater reward could cut back on the proportion in bonds. Those who need a steady income for living expenses could increase their holdings of real estate equities, because they provide somewhat larger current income. A SPECIFIC INDEX-FUND PORTFOLIO FOR AGING BABY BOOMERS Cash (5%)* Fidelity Money Market Fund (FORXX), or Vanguard Prime Money Market Fund (VMMXX) Bonds (27½%)† Vanguard Total Bond Market Index Fund (VBMFX) Real Estate Equities (12½%) Vanguard REIT Index Fund (VGSIX) Stocks (55%) U.S. Stocks (27%) Fidelity Spartan (FSTMX), T. Rowe Price (POMIX), or Vanguard (VTSMX) Total Stock Market Index Fund Developed International Markets (14%) Fidelity Spartan (VSIIX), or Vanguard (VDMIX) International Index Fund Emerging International Markets (14%) Vanguard Emerging Markets Index Fund (VEIEX) Remember also that I am assuming here that you hold most, if not all, of your securities in tax-advantaged retirement plans.


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

“I don’t think they thought this God-damned thing through, to figure out what the ripple effects would be.” Lehman’s demise triggered a tsunami that swept the globe in waves. “Lehman Brothers begat the Reserve collapse, which begat the money-market run, so the money-market funds wouldn’t buy commercial paper,” a Treasury official told the New Yorker. “The commercial-paper market was on the brink of destruction. At this point, the banking system stops functioning. You’re pulling four trillion [dollars] out of the private sector [money-market funds] and giving it to the government in the form of T-bills. That was commercial paper funding GE, Citigroup, FedEx, all the commercial-paper issues. This was systemic risk. Suddenly, you have a global bank holiday.” At this juncture, I was producing not one but two briefings a day for Fisher.

Why was Yellen so insistent? Concurrent with the rate hike, the Fed quietly lifted the cap on a recently created lending facility to $2 trillion, insuring that in case of future disruption, the Fed’s balance sheet would act as a backstop to the financial system. Yellen had to hike the rate into positive territory to engage that lending option, which requires money market fund participation. With interest rates at the zero bound, money market funds have been operating in the red for years. As her fame has grown, Janet Yellen is recognized in restaurants and airports around the world. But her world has narrowed. Because the Fed chairman can so easily move markets with a few casual words, Yellen can’t get together regularly and shoot the breeze with businesspeople or analysts who follow the Fed for a living.

Japan had been wallowing in a zero-interest-rate environment for years. By following its lead, the Fed risked fostering zombie corporations and banks. “I have worked and lived in Japan and we have learned from what they’ve done,” Fisher said. “But the fact is that we have no sustained experience in the modern era in the United States with T-bill rates and the effective fed funds rate trading near zero. We do know that money market funds will become unprofitable if rates get much lower. Let me just say to those who sort of dismiss that”—meaning Yellen—“I think we might look a little foolish if we drove some of them out of business, especially after creating two special facilities to support their continued intermediation functions on the basis that they were critically needed for their roles in the commercial paper market.”


pages: 335 words: 94,657

The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

asset allocation, buy and hold, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial independence, financial innovation, high net worth, index fund, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, market bubble, mental accounting, money market fund, passive investing, Paul Samuelson, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, stocks for the long run, survivorship bias, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

Companies that issue junk bonds promise to pay higher yields in order to attract buyers who otherwise might purchase safer bonds. Load fund: A mutual fund that levies a sales charge. Long-term capital gain: Profit on the sale of a security held at least one year that generally results in lower tax. Market timing: Attempting to forecast market direction and then investing based on the forecasts. Money market fund: A mutual fund that invests in very-short-term securities. Money market funds attempt to maintain a constant $1 net asset value (NAV). Mortgage-backed securities: Bond-type securities representing an interest in a pool of mortgages. Municipal bond fund: A mutual fund that invests in tax-exempt bonds. These funds are best suited for higher-income taxpayers in taxable accounts. Nominal return: The return on an investment before adjustment for inflation.

It's not how much you make, its how much you keep. The measure of wealth is net worth: the total dollar amount of the assets you own minus the sum of your debts. So, the first thing we want you to do is calculate your net worth. Calculating your net worth is very simple. First, add up the current dollar value of everything you own. Such items include the following: • Cash in checking and savings accounts, credit unions, or money market funds The cash value of your life insurance • Your home and any other real estate holdings • Any stocks, bonds, mutual funds, certificates of deposit, government securities, or other investments • Pension or retirement plans • Cars, boats, motorcycles, or other vehicles • Personal items such as clothing, jewelry, home furnishings, and appliances • Collectibles such as art or antiques • Your business, if you own one and were to sell it • Anything else of value that you own Once you have the total current value of what you own, add up the total amount of all debts that you currently owe.

As an investor in a mutual fund, you actually own a small fractional interest in the underlying pool of securities purchased by the managers of your mutual fund. Mutual funds are governed by the Investment Company Act of 1940, and in most cases by the states where they do business. Mutual funds are available in many varieties. There are equity mutual funds that invest in stocks, bond funds that invest in (you guessed it!) bonds, and funds that invest in a combination of both stocks and bonds (hybrid or balanced funds). There are also money market funds, whose goal is to offer a stable $1 per share value. Within each type of mutual fund (equity fund, bond fund), there are a number of funds with differing investment objectives. For instance, equity mutual funds include these funds: Aggressive growth funds • Growth funds • Growth and income funds • International funds Sector and specialty funds (such as REITs (Real Estate Investment Trusts) and health care) Just as with equity mutual funds, bond fund investors have a wide range of bond mutual funds to choose from.


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

And they certainly have no reason to run on the Second National Bank next door. Not so with money funds. Shareholders in the Reserve Primary Fund did lose money, even if only 3 percent. They, therefore, did have a reason to run on the Reserve. And the resulting fears of losses at other money market funds quickly led to runs elsewhere. This was serious business. Within days, “it was overwhelmingly clear that we were staring into the abyss—that there wasn’t a bottom to this—as the outflows [from money funds] picked up steam on Wednesday and Thursday.” In just a week, investors withdrew about $350 billion from prime money market funds. That meant, of course, that fund managers had to liquidate an equal volume of commercial paper, T-bills, and so on in order to meet redemption calls. But after the Lehman-induced losses at the Reserve, no fund manager wanted to buy CP—and not just Lehman’s CP, anyone’s.

But the episode didn’t instill confidence in the United States Treasury. The Fed pitched in, too, by establishing the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. (AMLF, if you must know. And try saying the full title fast.) The AMLF was created to extend nonrecourse loans at low interest rates to banks willing to purchase high-quality asset-backed commercial paper from money market funds—who needed to sell it desperately because they were experiencing runs. Let’s dwell on the awkward word nonrecourse for a moment, because it’s important and this is not the last time you’ll see it. “Nonrecourse” means that if the assets in question (in this case, commercial paper) default, the lender (in this case, the Federal Reserve) can claim back only the collateral on the loans. It cannot go after any other assets owned by the borrowers—who, in the case of the AMLF, were banks.

Furthermore, it was not until January 30, 2009, that the Fed got around to announcing the detailed rules governing the AMLF. Yes, it was another case of “leap before you look.” But together, the Treasury’s modified money market guarantee program and the Fed’s AMLF successfully ended the run on the money funds. On February 1, 2010, the Fed shut the facility down, netting a small profit on the operation. The balances had long since dwindled to zero, anyway. But the battles to save the money market funds and the commercial paper markets did not end on September 22. On October 7, with the financial panic in full swing, the Board again invoked Section 13(3) to justify creation of the Commercial Paper Funding Facility (CPFF) to, in the Fed’s words, “provide a liquidity backstop to U.S. issuers of commercial paper.” Let’s parse those words carefully, because the CPFF proved to be a turning point: A “liquidity backstop”?


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

Issues related to tax-rate uncertainty, credit risk, call optionality, and trading costs combine to diminish in dramatic fashion the utility of tax-exempt bonds. For shorter-term maturities, the negative factors cause investors far less concern. In the case of a tax-exempt money-market fund, the near-dated maturity of the underlying securities obviates concerns regarding tax regime changes and mitigates concerns regarding credit risk. Money-market instruments carry no call options and trade in relatively efficient transparent markets. Short-term tax-exempt money-market funds deserve serious consideration. As term to maturity increases, the troubling aspects of tax-exempt debt increase in lock step. Changes in marginal tax rates and changes in credit quality possess the power to alter the value, positively or negatively, of longer-term tax-exempt bonds.

Investors benefit from taking the broadest view of their financial circumstances. Financial and nonfinancial liabilities further influence portfolio decisions. Home mortgages and personal loans comprise the largest components of most individual financial liabilities. From a portfolio perspective, liabilities act like negative assets. In other words, borrowing by an individual offsets lending (ownership of bond or money-market funds) by that individual. In fact, wealth-maximizing individuals compare the after-tax costs of debt with the after-tax returns from bonds, liquidating bond positions to pay off loans when the costs of debt exceed the returns from bonds. Rational investors consider liability positions when making asset allocations. Truly extraordinary expertise deserves consideration in portfolio decision making.

To accommodate multiple goals, investors specify a hoped-for schedule of future financial flows, thereby defining the relevant investment horizon. By aggregating various needs and desires, a full picture of the investor’s time horizon emerges. The appropriate degree of investment risk depends on the time available until funds are needed. For periods of one to two years or less, investors ought to favor bank deposits, money-market funds or short-term bond funds. By avoiding material credit risk and searching for low management expenses, investors solve the simple problem of short-term investing. For terms of eight to ten years or more, investors face much more interesting, more daunting, and potentially more rewarding investment alternatives. An equity-oriented, diversified asset allocation provides the most likely framework for longer-term success.


pages: 246 words: 74,341

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

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

Its commercial paper now became worthless, causing problems for all those who had bought it expecting to get their money back soon. At about the same time as the family with children at Esperanto were served their tarred pigeon with pastella classique and almond, a money-market fund of great renown yet obscure to the general public, the Reserve Primary Fund, posted a message on its website: The value of the debt securities issued by Lehman Brothers Holdings, Inc. (face value $785 million) and held by the Primary Fund has been valued at zero effective as of 4:00PM New York time today. As a result, the NAV [net asset value] of the Primary Fund, effective as of 4:00PM, is $0.97 per share 2 This message may not sound very dramatic, because money-market funds are not-or are at least not supposed to be-dramatic. Investing in such a fund is a way of lending short term to a diversified group of stable institutions, such as governments, banks, and large corporations.

Investing in such a fund is a way of lending short term to a diversified group of stable institutions, such as governments, banks, and large corporations. Most people see investing in them as a more profitable version of keeping their money under their mattress. In almost 40 years of history, hardly any money-market fund had ever lost money. Now that the Primary Fund's loss on Lehman paper had caused its funds to drop in value from $1.00 to $0.97, it had happened again-but on a huge scale. The upshot was a mass flight from money-market funds, on which many institutions were dependent for their financing, not least the special companies that the banks had crammed full of mortgage-backed securities and put outside their balance sheets. The message posted on the Reserve Primary Fund's website was tantamount to crying "Fire!" in a crowded theater. Panicking investors trampled one another as they tried desperately to get to the exits.

They finally concluded that it should work, there would be no systemic crisis, it was not the end of the world. And there would have been no systemic crisis had it not been for that money-market fund announcing a loss while the family with children was being served their pigeon at the Stockholm restaurant. The money markets, which had seemed unsafe as far back as August 2007 because of mortgage-backed securities, now came across as downright lethal. By that Wednesday night, institutional investors had withdrawn almost $150 billion from them, more than one-twentieth of their total value. Panic-stricken money-market funds were selling commercial paper to be able to give investors their money back. On Thursday, Putnam Investments had to liquidate a $15 billion fund to cope with the pressure for repayments.


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

The commercial paper got a top rating from the rating agencies, making it possible for money market funds to buy it. However, in order to obtain that all-important top rating, the sponsoring bank, or another bank, invariably had to provide some kind of guarantee, in the event that the vehicle found itself unable to replace the commercial paper when it came due. As the market got crazier, money market funds became more and more enamored of this paper; they, too, were competing for that extra little bit of yield. Although money market funds were serving the role of the old-fashioned bank—they were ultimately the real lender—they weren’t regulated the way banks were. Since they were holding highly rated securities—as SEC rules required them to do—no one in the government was concerned with the quality of the collateral. But what would happen if the money market funds all started questioning the quality of the assets backing their paper at the same time?

For the Bear guys, this was indeed a savvy way to get low-cost, low-risk leverage; among other things, lenders couldn’t simply yank cash from the funds, the way repo lenders could. But the risk was still there—in this case, it resided at the bank that underwrote the CDO. That’s because instead of selling long-dated debt, the new CDOs sold very short-term, low-cost commercial paper. This paper, in turn, was bought by money market funds around the country. In order to make the commercial paper palatable for money market funds, the bank that underwrote the CDO—often Citigroup and, later, Bank of America—would issue what was called a liquidity put. That meant that if buyers for paper became scarce—in the event, say, of a disruption in the market—the banks would step in and buy it themselves. Cioffi raised as much as $10 billion this way, according to BusinessWeek, while Citigroup earned $22.3 million in fees for underwriting the CDOs and was paid another $40 million a year for providing the liquidity put.

This worry was exacerbated by the fact that the main provider of mortgages, the savings and loan, or thrift, industry, was in terrible straits. The thrifts financed their loans by offering depositors savings accounts, which paid an interest rate set by law at 5¾ percent. Yet because the late 1970s was also a time of high inflation and double-digit interest rates, customers were moving their money out of S&Ls and into new vehicles like money market funds, which paid much higher interest. “The thrifts were becoming destabilized,” Ranieri would later recall. “The funding mechanism was broken.” Besides, the mortgage market was highly inefficient. In certain areas of the country, at certain times, there might be a shortage of funds. In other places and other times, there might be a surplus. There was no mechanism for tapping into a broader pool of funds.


pages: 597 words: 172,130

The Alchemists: Three Central Bankers and a World on Fire by Neil Irwin

"Robert Solow", Ayatollah Khomeini, bank run, banking crisis, Berlin Wall, Bernie Sanders, break the buck, Bretton Woods, business climate, business cycle, capital controls, central bank independence, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, currency peg, eurozone crisis, financial innovation, Flash crash, George Akerlof, German hyperinflation, Google Earth, hiring and firing, inflation targeting, Isaac Newton, Julian Assange, low cost airline, market bubble, market design, money market fund, moral hazard, mortgage debt, new economy, Northern Rock, Paul Samuelson, price stability, quantitative easing, rent control, reserve currency, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, savings glut, Socratic dialogue, sovereign wealth fund, The Great Moderation, too big to fail, union organizing, WikiLeaks, yield curve, Yom Kippur War

Not every program his administration undertook did much good, but there was a spirit of experimentation, of throwing everything the government had against the wall to see what would stick. As the money market funds trembled, Bernanke directed his troops to adopt the same approach: Try everything. First, just three days after the Reserve Fund broke the buck, came the Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, or AMLF. With Fed staffers in New York and Washington already stretched thin with crisis fighting, the program was administered by the Federal Reserve Bank of Boston, which had particular expertise in money market funds: The city is home to a number of the major mutual fund groups, as well as State Street, a bank that carries out transactions for many of the funds. The idea was to use infrastructure that had long been in place to channel money to banks to back up the money market funds instead. The Fed would lend money to banks, which could then buy the securities the money market funds were selling off and pledge them to the Fed, with the banks themselves taking no financial risk for their role as intermediary.

The Fed would lend money to banks, which could then buy the securities the money market funds were selling off and pledge them to the Fed, with the banks themselves taking no financial risk for their role as intermediary. The program lent out $24 billion on its first day of operation, September 22, 2008, and $217 billion before the panic wound down, routing money through banks like State Street and J.P. Morgan Chase to mutual funds run by household-name companies such as Janus and Oppenheimer. To satisfy the Fed’s lawyers, the program could accept commercial paper backed only by specific assets, such as credit card loans due. But with a buyer in the market for even just a subset of the securities they owned, the money market funds could raise enough money to avoid breaking the buck. It took a little longer to come up with the next mode of attack.

But Madigan hadn’t yet received word of the ECB’s action. It was nearly half an hour later, as Bernanke’s black Cadillac sped along Independence Avenue, driven by an officer of the Federal Reserve’s own police force, before the chairman received the first word that the ECB had done something unusual. A 7:16, an e-mail arrived from David Skidmore, an official in the Fed’s press office: “Apparently Deutsche Bank had two money market funds fail and the ECB is making tender offers for dollar-denominated assets. Glenn Somerville of Reuters, who I’ve been talking to, is heading to the Treasury press room early.” The details were wrong: It was BNP Paribas, not Deutsche Bank, three funds, not two, and the tender offers were denominated in euros, not dollars. But the gist was right: The ECB had intervened in markets in a way it never had before.


pages: 407 words: 114,478

The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein

asset allocation, Bretton Woods, British Empire, business cycle, butter production in bangladesh, buy and hold, buy low sell high, carried interest, corporate governance, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, diversification, diversified portfolio, Edmond Halley, equity premium, estate planning, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, George Santayana, German hyperinflation, high net worth, hindsight bias, Hyman Minsky, index fund, invention of the telegraph, Isaac Newton, John Harrison: Longitude, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, new economy, pattern recognition, Paul Samuelson, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, South Sea Bubble, stocks for the long run, stocks for the long term, survivorship bias, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

Your money market owns “commercial paper” issued by large corporations, which is not insured and can default, whereas your bank accounts are federally insured. So you are being rewarded for taking this risk with extra return. It’s also true that the mutual fund industry does its best to soft pedal this inconvenient fact. No major fund company’s money market fund has ever “broken the buck,” even though commercial paper does occasionally default. In 1990, paper issued by Mortgage and Realty Trust, held by many large money market accounts, fell into default. Passing these losses onto the shareholders would have resulted in a devastating loss of confidence, and without exception, the fund companies reimbursed their money market funds. One company alone—T. Rowe Price—spent about $40 million repairing the damage. But there is no guarantee that they will always be able to do this. In addition, banks’ yields are hobbled by the necessity of holding reserves—funds that cannot be loaned out.

The sooner your children become acquainted with the risk/return nexus and the benefits of diversification, and the earlier they experience financial loss in a protective, supportive environment, the better. I suggest that at approximately age ten you set up a small portfolio with two or three asset classes, as well as a money market fund in the child’s name. Have him or her learn how to sort and file the statements properly as they arrive in the mail and teach the child how to track the value of each fund. Every quarter, sit down with all involved siblings and have an “investment conference” during which the performance of each account is discussed. Their reward for these chores will be the dividends from the stock and money market funds, as well as half of the remaining increase in investment value, if any, each December 31. Table 13-9. “Young Yvonne’s” Investment Path: Vanguard Funds. Note: Funds are added from left to right, in $5,000 increments.

Long-duration bonds are generally a sucker’s bet—they are quite volatile, extremely vulnerable to the ravages of inflation, and have low long-term returns. For this reason, they tend to be bad actors in a portfolio. Most experts recommend keeping your bond maturities short—certainly less than ten years, and preferably less than five. From now on, when we talk about “stocks and bonds,” what we mean by the latter is any debt security with a maturity of less than five to ten years—T-bills and notes, money market funds, CDs, and short-term corporate, government agency, and municipal bonds. For the purposes of this book, when we use the term “bonds” we are intentionally excluding long-term treasuries and corporate bonds, as these do not have an acceptable return/risk profile. I’ll admit that this is a bit confusing. A more accurate designation would be “stocks and relatively short-term fixed-income instruments,” but this wording is unwieldy.


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

They called it the “break the glass” plan, to be activated only in the most dire crisis. What exacerbated the problem was that the SIVs had funded themselves by selling short-term IOUs (“commercial paper,” in the parlance of Wall Street), often to money market funds. Money funds, regarded as the least risky of investments, were owned by millions of ordinary savers. In other words, financial engineers had contrived to connect safety-minded moms and pops to the mad cow of the financial world—exactly the stuff of which systemic crises are made. As the value of SIV paper plunged, the money market funds themselves became imperiled. Roughly a dozen of them were on the verge of “breaking the buck”—that is, the net asset value of these funds was about to fall below the par value of $1 that investors had come to assume was guaranteed.

Financiers had discovered the key to limiting risk, and central bankers, adherents to the cult of the market, had mastered the mysterious art of heading off depressions and even the normal ups and downs of the economic cycle. Or so it was believed. Then, Lehman’s collapse opened a trapdoor on Wall Street from which poured forth all the hidden demons and excesses, intellectual and otherwise, that had been accumulating during the boom. The Street suffered the most calamitous week in its history, including a money market fund closure, a panic by hedge funds, and runs against the investment firms that still were standing. Thereafter, the Street and then the U.S. economy were stunned by near-continuous panics and failures, including runs on commercial banks, a freezing of credit, the leveling of the American workplace in the recession, and the sickening drop in the stock market. The first instinct was to blame Lehman (or the regulators who had failed to save it) for triggering the crisis.

While the latter worried about default risk, stock traders, by nature and trade, were more bullish. In early December they lifted the Dow into the upper 13,000s, within 5 percent of its all-time peak. Why such renewed enthusiasm? Traders believed or hoped that Merrill, perhaps even Citigroup, would prosper under new leadership. As for Lehman Brothers, it had thus far escaped with only a modest write-down. The crisis in money market funds had passed, and Citi and other banks had retrieved some of their orphaned SIV assets—a sign to the hopeful that the market could cure itself. The trouble, which bond traders saw more clearly, was that banks were not manufacturing fresh credits; they were refusing to lend. The cycle described by Rodriguez—falling securities prices leading to losses and thus lessened capital ratios—was, inexorably, putting a damper on credit.


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

A different mechanism of regulatory arbitrage was created for retail customers – the money market fund. An investor in a US money market fund holds a share in a portfolio of debt, while the manager of the fund is expected to redeem the share at a fixed price and the income from the portfolio is paid to the investors (in effect, the depositors). Cheques can be written on the money market fund, so that in the eyes of the saver, but not of the regulator, the money market fund is a bank account. In the USA these funds have come to rival conventional bank deposits in scale. The role of money market funds is almost entirely confined to countries that have, or once had, significant restrictions on interest on current accounts. In the UK, where no equivalent of Regulation Q has ever existed, money market funds have negligible market share. Since money market funds were not technically deposits, they did not qualify for deposit insurance.

This understatement is much greater under US GAAP than European IFRS, so that US figures are too low relative to the European ones. Fig. 8 summarises flows through the deposit channel. Total deposits everywhere amount to about one year’s national income. The differences between the USA and the three European countries are more apparent than real. In the USA money market funds (which are effectively deposits) total around $4 trillion, and the main holdings of these money market funds are very short-term securities issued by banks, or the quasi-banks that are the Treasury operations of large corporations such as Apple or Exxon Mobil. This American exceptionalism is one aspect of the general tendency for more intermediation to take place through securities markets in the USA than in Europe. Deposits are mostly savings and transactions balances of households, although the short-term cash holdings of businesses are also significant.

However, when the very large Reserve Primary Fund – which held some Lehman debt – ‘broke the buck’ (was unable to offer redemption at the fixed price) in 2008, pressure from aggrieved investors and fear of a run on other funds led to an extension of government guarantees of deposits to such investments. Since 2008 there has been extended – and still inconclusive – discussion of an appropriate new regulatory framework for money market funds. Regulation Q was gradually weakened and became ineffective after 1980, although it was not finally abolished until 2011. But regulators rarely remove otiose or ineffective regulations. The more usual response is to elaborate the regulation in an attempt to remove or reduce the arbitrage opportunity. Thus begins a game of cat and mouse, in which the financial services companies are generally one or more steps ahead of the regulator.


The 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

New York. 5 Information in this paragraph was obtain from “Update on Short-Term Putable Funding Agreements,” Moody’s Investors Service, October 2001. Debt Obligations of Financial Institutions 99 they are not publicly traded. Seven of the largest institutional money market funds held FAs as of mid 2001. The top four issuers of FAs sold to institutional money market funds are Transamerica Occidental Life, Monumental Life, New York Life, Allstate Life, and Jackson National Life. The major issuers of FAs sold to retail-oriented money market funds are Monumental Life, Travelers, Metropolitan, GE Life and Annuity Assurance Co., and Pacific Life. Five of the top ten retail-oriented money market funds invest in FAs as of mid 2001. A study by Moody’s in October 2001 investigated the reasons why money market mutual funds invest in FAs.6 The following reasons were cited: 1. FAs are attractive short-term investments. 2.

Treasury, agencies, money center banks, etc.) seeking short-term funding as well as large institutional investors with excess cash willing to supply funds short-term. Typically, the only contact retail investors have with the money market is through money market mutual funds, known as unit trusts in the United Kingdom and Europe. Money market mutual funds are mutual funds that invest only in money market instruments. There are three types of money market funds: (1) general money market funds, which invest in wide variety of short-term debt products; (2) U.S. government short-term funds, which invest only in U.S. Treasury bills or U.S. government agencies; and (3) short-term municipal funds. Money market mutual funds are a popular investment vehicle for retail investors seeking a safe place to park excess cash. In Europe, unit trusts are well-established investment vehicles for retail savers; a number of these invest in short-term assets and thus are termed money market unit T 1 2 THE GLOBAL MONEY MARKETS trusts.

In Europe, unit trusts are well-established investment vehicles for retail savers; a number of these invest in short-term assets and thus are termed money market unit T 1 2 THE GLOBAL MONEY MARKETS trusts. Placing funds in a unit trust is an effective means by which smaller investors can leverage off the market power of larger investors. In the UK money market, unit trusts typically invest in deposits, with a relatively small share of funds placed in money market paper such as government bills or certificates of deposit. Investors can invest in money market funds using one-off sums or save through a regular savings plan. THE MONEY MARKET The money market is a market in which the cash requirements of market participants who are long cash are met along with the requirements of those that are short cash. This is identical to any financial market; the distinguishing factor of the money market is that it provides for only short-term cash requirements. The market will always, without fail, be required because the needs of long cash and short cash market participants are never completely synchronized.


pages: 248 words: 57,419

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

In the 1980s, they began to look for a broader definition of money that would encompass other money-like instruments in addition to cash and demand deposits. New monetary aggregates were devised: M1 was the name given to the traditional definition of money, i.e., currency plus demand deposits. M2 includes M1 plus time deposits and money market funds. M3 includes M2 plus time deposits and term repos. MZM, money zero maturity, includes M2 less time deposits, but including money market funds. And there were others. It had been hoped that some broader definition of money would produce the stable relationship between the quantity of money and the price level that the quantity theory of money asserted should exist. None of the new monetary aggregates succeeded in generating the results anticipated, however.

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. In 1945, the household sector supplied 26 percent of the country’s credit.

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. By 2007, however, ABS issuers supplied 12 percent of the credit provided by the financial sector or 9 percent of all credit outstanding. Mutual funds and money market funds had also come of age during the 1980s, and by 2007, they provided 6 percent and 5 percent, respectively, of all credit supplied by the financial sector. Credit without Reserves By 2007, the GSEs and the issuers of ABSs provided 24 percent of all the credit in the country. Their rise made the financial system much more leveraged and complex than when it had been dominated by the commercial banks.


pages: 183 words: 17,571

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

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

S&Ls were allowed to pay 1/4 percent more Broken Markets than banks, so they had an inside track on collecting household savings to fund mortgages.When Federal Reserve Chairman Paul Volcker pumped up rates to break the fever of the Great Inflation, the bank prime rate hit 21.5 percent. Banks were only allowed to pay depositors 5 percent and S&Ls 5 1/4 percent. Depositors fled both, as the brokerage industry invented money market funds, which offered market rates. Congress phased out Regulation Q in the early 1980s (though the prohibition on paying interest on demand accounts remained until recently) and materially raised deposit insurance. This set off a dangerous competition for deposits based on high rates, a competition that attracted a lot of opportunistic and fickle hot money into the banks offering them. Congress also allowed the S&L industry to enter more lines of business, including commercial real estate lending.

When the players know that they are going to be paid what is owed to them, they will pay what they owe others, and stark fear will subside while the authorities “resolve” the hopeless cases, winding down the businesses or selling off the bits. When banks in the euro zone are stuffed with toxic dollar paper sold to them by investment banks, and other banks won’t give them overnight loans and the money market funds won’t buy their IOUs either, things get more than a little complicated. The markets are too seamlessly interconnected— too big for the old playbook to work. When it was first spelled out by Walter Bagehot in Lombard Street, the idea that one bank (in his case, the Bank of England) could hold the reserves of the whole banking system and lend without stint in a panic against all valid claims (commonly called the “lender of last resort” role) was controversial but highly practical.

Under normal circumstances, the whole global banking and finance system operates like one big happy family in which everyone trusts one another. Banks can lend money in excess of their deposits not only because they can issue medium- and long-term debt in the market, but because they can borrow funds overnight from one another in the interbank market. European banks can lend their clients dollars because they can issue short-term paper to US money market funds.They can also hedge their interest rate and currency risks 101 102 Chapter 5 | Global Whirlwinds with each other and to customers by doing swaps and trading other derivatives with each other.These activities are all absolutely routine and essential to making the system work.They are also global, with the same big banks operating in multiple centers, including New York, London, Tokyo, and Singapore.


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

The industry has been made more fragile by creating what Gennaioli, Shleifer, and Vishny term false substitutes—securities that investors believe to be riskless that turn out to be risky. As bad as things got during the worst of the financial crisis, for example, bank customers remained generally calm. There were runs at a few troubled institutions, but often they were the self-policed kind, as large depositors reduced their balances below the limit for federal deposit insurance. Money-­market fund investors were altogether more skittish. A day after Lehman Brothers went bust, the Reserve Primary Fund, the oldest money-market fund, broke the buck when it wrote off its holdings of Lehman debt. Some $300 billion fled the funds in the days following Lehman’s bankruptcy, as investors suddenly realized that they were less protected than they had thought. Talk to regulators about the events of September 2008, and they will tell you that nothing was more alarming than this stampede.

An annual survey by McKinsey & Company of the world’s capital markets shows that in 2012, the value of global financial assets (excluding derivatives and physical assets such as property) stood at $225 trillion, $50 trillion of which were “riskier” equities and $175 trillion of which were “safer” loans and bonds.8 The precrisis development of America’s mortgage market conformed to this model: securitizing mortgages and tranching them created a supply of debt instruments that appeared to be as safe as the limited amount of US Treasuries and managed to deliver a little bit more income than normal government debt. So too did the money-market fund, a financial instrument that offered investors the money-like properties of a bank deposit—in other words, the ability to get your cash back immediately without any loss of ­principal—but managed to deliver higher income. It is not the dash for risk that lands the world’s financial system in trouble; it is the hunt for safe returns. These new instruments are attended by risks that are different from those of the old ones they are substituting for, however.

Putting money into highly rated “collateralized-debt obligations” (CDOs), which bundle up the lower tranches of existing securitizations, was an opaque bet that America would not suffer a national housing-market meltdown. Similarly, putting your money into a bank account is a decision that is informed by an explicit system of deposit insurance: you will get your money back because the government guarantees it. For many, investing in a money-market fund is also a bet on a promise, but this time by a private actor not to “break the buck”—in other words, to give a dollar back for each dollar invested. These new products may look like the old ones, in other words, but there are differences that investors do not fully appreciate. As a result, when those underappreciated risks do surface, they come as a shock to market participants and prompt panic.


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

.* On Tuesday, with the collateral damage caused by Lehman’s failure beginning to spread, the Fed stepped in with an $85 billion credit line to keep AIG afloat, fearing that if the insurer defaulted on its hundreds of billions of dollars in credit default swaps, its counterparties would suffer devastating losses—or, at the least, fear of those losses would cause the financial markets to grind to a halt. Also on Tuesday, the Reserve Primary Fund, one of the largest money market funds, announced that it would “break the buck”; because of losses on Lehman debt, it could not return one dollar for each dollar put in by investors. As a result, money flooded out of money market funds, forcing Treasury to create a new program to provide insurance for those funds. The flight from money market funds dried up demand for the commercial paper used by corporations to manage their cash, raising the specter that major corporations might not be able to make payroll. This forced the Fed to establish a program to buy commercial paper from issuing corporations—in effect lending money not just to banks, but directly to nonfinancial companies.

Traditionally, households and businesses would put their excess cash in deposit accounts at commercial banks or S&Ls, which would lend the cash out as mortgages and commercial loans. However, the high interest rates of the 1970s convinced investors to move their savings from bank accounts to money market funds, which invested in short-term bonds and commercial paper. Increasing affluence also fed the growth of mutual funds and pension funds, which sought out higher-yield investments. This demand for yield created the opportunity for investment banks to raise money for corporate clients by issuing commercial pa-per and bonds and selling them directly to large institutional inves-tors. Money still flowed from households to corporations, but instead of passing through commercial banks, now it could pass through a money market fund or mutual fund—with a helping hand from Wall Street. Mortgage-backed securities had a similar effect. Institutional investors bought mortgage-backed securities created by investment banks; the cash flowed to mortgage lenders, who no longer needed to be affiliated with traditional banks, because they did not rely on deposits for funding.

Certain financial institutions are so big, or so interconnected, or otherwise so important to the financial system that they cannot be allowed to go into an uncontrolled bankruptcy; defaulting on their obligations will create significant losses for other financial institutions, at a minimum sowing chaos in the markets and potentially triggering a domino effect that causes the entire system to come crashing down. The bankruptcy of Lehman Brothers in September 2008 accelerated the collapse of American International Group, forcing it into the arms of the Federal Reserve; Lehman’s failure also forced the Reserve Primary Fund to “break the buck,” causing a sudden loss of confidence in all money market funds; in turn the flood of money out of money market funds caused the commercial paper market to freeze, endangering the ability of many corporations to operate on a day-to-day basis. The failure of Lehman also caused large cash outflows from the remaining stand-alone investment banks, Goldman Sachs and Morgan Stanley. The sequence of falling dominoes was only stopped by massive government rescue measures, and the panic that occurred despite the government’s intervention helped transform a mild recession into the most severe recession of the postwar period.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

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

Today, following years of generous interest rates and the introduction of municipal bond funds in the late 1970s, combined assets of tax-free and taxable bond funds total $3 trillion, 25 percent of the fund industry’s total assets. As the dominance of equity funds waned, money market funds, the fund industry’s great innovation of the mid-1970s, quickly became the industry’s most powerful engine of growth. In 1984, money fund assets of $235 billion were three times equity fund assets. Their growth didn’t let up until 2008, when money fund assets reached $3.8 trillion. With the failure of a giant money fund in 2008, followed by challenges to the money fund structure by federal regulators, assets retreated to $2.6 trillion, now 21 percent of the mutual fund industry total. With the rise of bond funds and money market funds, nearly all of the large fund managers—which for a half-century had primarily operated as professional investment managers of a single equity fund or a handful of equity funds—became business managers offering a wide range of investment options, financial department stores that focused heavily on administration and marketing.

(Only about 50—all equity funds—were large enough to have their returns reported in the annual Wiesenberger Investment Companies manual, issued each year from 1938 until 1995.) Today, the total number of equity funds comes to a staggering 5,091. Add to that another 2,262 bond funds and 595 money market funds, and there now are 7,948 traditional mutual funds, plus another 1,446 exchange-traded index funds. It remains to be seen whether this huge increase in investment options—ranging from the simple and prudent to the complex and absurd—will serve the interest of fund investors. I have my doubts, and so far the facts seem to back me up. The good news is that many of the new funds were bond funds and money market funds, which for decades have provided generous premium yields over stocks and also over traditional bank savings accounts, where yields were constrained by federal government regulation until 1980.

What we need is transparency: ways for investors to see information, understand it, and weigh the potential risks and opportunities of their investment options. Transparency is at the core of effective market regulation, precisely because it empowers investors. Sadly, most efforts to improve transparency are fought by a well-funded mutual fund lobby and its related allies. One recent SEC proposal, to have money market funds mark to market their holdings every day, is one such example. This basic idea would not only give investors greater insight into their holdings. It would also impose a healthy appreciation for liquidity among mutual fund managers. Yet the mutual fund industry predictably has fought the idea. The industry would be wise to consider what Jack Bogle and others observe: If investors do not feel that mutual funds are protecting their interests, they will not participate in markets—and the markets themselves will suffer.


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

In the early 1990s, the estimates were that the losses to the US taxpayers would amount to $150 billion but the increase in the US growth rate meant that the RTC received more money than anticipated from the sale of collateral and bad loans so the losses totaled a bit more than $100 billion.61 There was some question whether a portion of this cost to the taxpayers could be reduced by increasing the insurance premiums on bank deposits – a suggestion resoundingly opposed by sound banks.62 During the 2008 crisis the US government extended deposit insurance to the money market funds; the fear was that otherwise the owners of these funds would transfer their money to banks whose deposits were guaranteed by the FDIC. The money market funds then would be obliged to sell assets, and the rapid sale of assets would depress their prices. Some money market funds then would ‘break the buck’; the net asset value per share would decline below $1.00 – which would trigger a massive, self-justifying run. Exchequer bills One ancient device short of lending money to a firm in trouble was to issue marketable securities to the firm against appropriate collateral.

The parallel financial system developed alongside the traditional system in response to the regulations imposed on traditional banks; thus money market funds, offshore banking, and special investment vehicles are components of this system. Fannie Mae and Freddie Mac had a cost advantage relative to traditional mortgage lenders because of the implicit government guarantee of their bonds, but they also had an advantage because they had much lower capital requirements. During the financial crisis, the money market funds were brought under the umbrella of the federal deposit insurance guarantees to staunch incipient runs – a free lunch for the owners of money market funds and for the firms that issue these IOUs. It is too soon to determine whether the increase in the costs of regulation that will follow from the Dodd-Frank Law will lead to a significant expansion in the roles of firms in the parallel financial system.

The Eurocurrency deposit market surged in the 1960s as an end-run around the regulations imposed on US banks by the Federal Reserve and the Federal Deposit Insurance Corporation; the US dollar deposits produced by the branches of US banks in London and other offshore centers were not subject to interest rate ceilings, reserve requirements, and deposit insurance premiums. The US stock brokerage firms developed money market funds that were a close substitute for bank deposits in the 1970s and paid interest on these deposits (the deposits were not guaranteed by any agency of the US government – at least not until the financial crisis in the autumn of 2008). Currency school vs banking school One feature of the history of monetary theory is a continuing debate between two different views – the Currency School and the Banking School – about how to manage the growth of the money supply.


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

The Monetary Ramifications of the Carry Regime 109 Money is defined as being a means of payment, or assets that are readily and easily convertible into a means of payment without being subject to possible capital losses. Generally, the most acceptable means of payment is cash. A savings deposit in a bank can easily be converted into cash at a one-to-one rate without risk of capital loss and therefore is considered to be money. Money market funds, for example, are included in broader measures of money, but potentially there is somewhat less ease in converting a money market fund into a direct means of payment than there is a bank savings deposit. Also, although money market funds are generally assumed to have little risk of capital loss, the financial crisis of 2008 indicated this may not necessarily always be so. Because some classes of monetary asset—balances in checking accounts, for instance—are clearly closer to the pure definition of money than others, there are different statistical measures of money supply.

Furthermore, what if central banks can control, or at least strongly influence, the traditional supply of money but there are other financial assets, over which they have no or much more limited control, which nevertheless function effectively as money? The concept of Divisia money is a measure of money derived as a weighted average, in which different monetary assets are accorded a weighting based on their degree of “moneyness,” the appropriate weights usually being derived from the structure of interest rates. Cash, which pays no interest, would have the highest weight in the aggregate and assets such as money market funds a much lower weight. Measures of Divisia money calculated for the United States in the post–global financial crisis period tended to show the growth rate of money on this basis to be low. However, it can be argued that what really distinguishes the purer forms of money from less money-like substitutes or nonmonetary assets is the latter’s price volatility with respect to cash. The definition of money includes the concept of assets that can be converted into a means of payment at some time in the future.

Ultimately, it has to be the case that the degree of moneyness of an asset will be crucially dependent on the degree to which the central bank—or possibly the government—supports, or underwrites, the asset. Without that implicit, or even explicit, support, it would be difficult for investors, or the public as a whole, to accept that various formerly nonmonetary assets were The Monetary Ramifications of the Carry Regime 113 now as good as money. In 2008, at the height of the financial crisis, the US government introduced a temporary guarantee for money market funds. In Europe, at the height of the euro area crisis, the European Central Bank announced its “whatever it takes” approach, interpreted as a statement of preparedness to guarantee the values of peripheral European government debt. These and all the other post–crisis and “experimental” monetary policy measures could be argued to have increased the moneyness of a whole range of financial assets.


pages: 201 words: 62,593

The Automatic Millionaire, Expanded and Updated: A Powerful One-Step Plan to Live and Finish Rich by David Bach

asset allocation, diversified portfolio, financial independence, index fund, job automation, late fees, money market fund, Own Your Own Home, risk tolerance, transaction costs, Vanguard fund

GETTING AROUND THE MINIMUMS Many brokerage firms may tell you that in order to open a money market account with them you need to make an initial deposit of at least $2,000. If that seems pretty steep to you, don’t give up—there is often a way around it. Ask the brokerage if they offer a money market fund that takes systematic investments. Most do, and generally speaking, as long as you sign a form agreeing to make regular monthly investments, they’ll let you open a brokerage account to invest in a money market fund with as little as $100. (Keep in mind, however, that if you open an account this way, you generally don’t get check-writing privileges or an ATM card.) NOW MAKE IT AUTOMATIC Ultimately, you will want to keep your rainy day fund separate from your checking account. While you could put your rainy day money in the same account you use to pay your bills, you really shouldn’t.

The point is that whatever you do with your emergency money, find a bank you can trust that will take care of your money but will also make it grow. What you want to do with your emergency money is put it in a money market account that pays reasonable interest. A money market account is one of the simplest and most secure alternatives around for anyone who wants to put aside some cash and earn a reasonable return on it. When you make a deposit in a money market account, you are actually buying shares in a money market fund—a mutual fund that invests in the safest and most liquid securities there are: very short-term government bonds and sometimes highly rated corporate bonds. Just a few years ago, you generally needed a minimum of as much as $10,000 to open a money market account. Because of this, many people still mistakenly think these accounts are for the rich. In fact, you can now open most money market accounts with a minimum deposit of between $1,000 and $2,000—and in a few selected cases with as little as one dollar.

I would expect you’ll see these rates finally increase over the next few years…at least slightly. Let’s hope. FINDING THE RATE MONEY MARKET ACCOUNTS ARE PAYING To get an up-to-date look at what rates are available, here is what you should do. 1. Get a copy of a financial publication such as the Wall Street Journal, Investor’s Business Daily, or Barron’s. They all offer extensive lists of what interest rates different money market funds are paying. Similar information (though not quite so detailed) can also be found in USA Today or possibly even your local paper. 2. Go to www.​bankrate.​com. This web site not only allows you to compare money market rates being offered by different institutions but also indicates the minimum deposit each requires to open an account. In addition, it allows you to sort banks by state, which is important since some banks can offer tax-free checking and money market accounts, depending on which state they—and you—happen to be in.


pages: 840 words: 202,245

Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick

accounting loophole / creative accounting, Asian financial crisis, bank run, Bretton Woods, business cycle, capital controls, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, disintermediation, diversified portfolio, Donald Trump, financial deregulation, fixed income, floating exchange rates, Frederick Winslow Taylor, full employment, George Akerlof, Hyman Minsky, income inequality, index fund, inflation targeting, inventory management, invisible hand, John Meriwether, Kitchen Debate, laissez-faire capitalism, locking in a profit, Long Term Capital Management, market bubble, minimum wage unemployment, MITM: man-in-the-middle, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, new economy, North Sea oil, Northern Rock, oil shock, Paul Samuelson, Philip Mirowski, price stability, quantitative easing, Ralph Nader, rent control, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Ronald Reagan: Tear down this wall, shareholder value, short selling, Silicon Valley, Simon Kuznets, technology bubble, Telecommunications Act of 1996, The Chicago School, The Great Moderation, too big to fail, union organizing, V2 rocket, value at risk, Vanguard fund, War on Poverty, Washington Consensus, Y2K, Yom Kippur War

The creditors absorbed little of the losses, only the U.S. taxpayers did. Money market funds were also in crisis, perhaps the most dangerous problem of all. They were generally considered as safe as U.S. Treasury bills by their investors, even when their charters allowed them to invest in bank CDs, which many now did. But some had bought Lehman CDs for the higher yield. On Monday, the Reserve Primary Fund, run by the once highly cautious founders of the very first money market fund (see Chapter 6), announced that it had more than 1 percent of its assets in Lehman commercial paper. Its investors, stunned they could lose money at all, immediately began to withdraw what could have amounted to $5 billion from the fund. If investors in other money market funds followed, the consequences were unimaginable. Money market funds would sell their commercial paper willy-nilly.

Many bankers were furious that the Reserve Fund took low-cost savers from them, restricted as they were by Regulation Q. At a dinner at the Waldorf-Astoria in New York, John McGillicuddy, the chairman of Manufacturers Hanover, “had to be physically restrained from attacking me,” recalled Bent. But Wriston saw an opportunity. For one thing, such funds invested in his large CDs. More important, the growth of the Reserve Fund and the quick entry into the market of other money market funds encouraged some bankers at smaller institutions to join Wriston’s lobbying efforts against Regulation Q. Until then, small banks supported Regulation Q because it limited the large big-city competitors, which might be willing to pay more for depositor money than the smaller banks could afford. The impact of another major new development that profoundly changed the financial community was not clear until the 1980s.

He hired traders in a variety of new derivatives markets to exploit opportunities. What it boiled down to was borrowing at the low rates fostered by Greenspan’s Fed in the early 1990s—which were almost zero after inflation—and investing the funds in high-paying securities, especially the new kinds backed by mortgages and aggressively peddled by First Boston and Salomon Brothers, in particular, to mutual funds, pension funds, and some money market funds, as well as municipalities. For all the supposed hedging and sophisticated measures of risk, most of these trades were heavy bets that interest rates would stay low. Another subsidiary of the bank, BT Securities, started creating complex ways for banking clients to borrow funds based on derivatives. BTC’s clients, particularly Gibson Greetings and Procter & Gamble, used these derivatives-based transactions to reduce their borrowing costs, without fully understanding their risks.


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

To participate in the profitable American securitization wave, European banks exchanged part of their euro funding for dollars (option 1), holding a long dollar position or hedging by way of swap agreements (option 2). Or the German bank could borrow directly in the United States (option 3), for instance from an American money market fund eager to earn slightly more than the returns offered by Treasurys, now that the Chinese were buying them. The result would be a German bank with a balance sheet that featured liabilities and assets of different maturities and denominated in a variety of currencies. And its counterparts would include a bank or other business that had lent dollars in exchange for euros (if it had chosen funding options 1 or 2), or an American money market fund holding dollar-denominated debt issued by a German bank (option 3). In the national balance of payments statistics one would see both borrowing from and lending to America happening within the accounts of the same bank.

The authoritative account of the AIG disaster is Congressional Oversight Panel, “The AIG Rescue, Its Impact on Markets, and the Government’s Exit Strategy,” June Oversight Report (June 10, 2010). 23. G. Morgenson and L. Story, “Testy Conflict with Goldman Helped Push A.I.G. to Edge,” New York Times, February 6, 2010. 24. Ibid.; https://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0701-Goldman-AIG-Collateral-Call-timeline.pdf. 25. P. E. McCabe, “The Cross Section of Money Market Fund Risks and Financial Crises” (FEDS Working Paper 2010-51, September 12, 2010). 26. M. T. Kacperczyk and P. Schnabl, “How Safe Are Money Market Funds?,” Quarterly Journal of Economics 128 (2013), 1073–1122. 27. Board of Trustees of the Primary Fund-In Liquidation, “Additional Information Regarding Primary Fund-In Liquidation,” September 23, 2014. 28. Gorton and Metrick, “Securitized Banking and the Run on Repo.” 29. Goldman’s self-justificatory official narrative hastens to add that this was an artifact of self-imposed new accounting rules.

You borrowed the dollars on Wall Street to fund your holdings of mortgages from all over the United States. The ABCP market was a showcase for this transatlantic system. The ABCP conduits organized bundles of securitized assets from the United States and Europe.13 With those securities as collateral they then issued short-term commercial paper, which was bought by the managers of cash pools in the United States. In 2008, $1 trillion, or half of the prime nongovernment money market funds in the United States, were invested in the debt and commercial paper of European banks and their vehicles.14 A large portion of this simply moved from one office on Wall Street to another, with one address being adorned with the name of a European bank. But hundreds of billions of dollars took a more circuitous route. They flowed out of the United States from the branches of foreign banks in New York to the head offices of European banks, from which they returned for investment in the United States, sometimes by way of an offshore tax haven such as Dublin or the Cayman Islands.15 It was the spinning motion of this transatlantic financial axis that impelled the surge in financial globalization in the early twenty-first century.


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The Simple Path to Wealth: Your Road Map to Financial Independence and a Rich, Free Life by J L Collins

"side hustle", asset allocation, Bernie Madoff, buy and hold, compound rate of return, diversification, financial independence, full employment, German hyperinflation, index fund, money market fund, nuclear winter, passive income, payday loans, risk tolerance, Vanguard fund, yield curve

I suggest you keep as little as possible on hand, consistent with your needs and comfort level. We used to keep ours in VMMXX (Vanguard Prime Money Market Fund). At the time interest rates were higher and money market funds typically offered better interest rates than bank savings accounts. But with interest rates currently at historic lows, money market funds pay close to zero percent. Bank interest rates are now slightly higher. Plus they come with FDIC insurance on accounts up to $250,000. For these reasons, we now keep our cash in our local bank and in our online bank, which happens to be Ally. Should interest rates rise and money market funds again offer better rates, we’ll switch back. So that’s it. Three simple tools. Two index mutual funds and a money market and/or bank account.

Treasury Bonds—what the Trust Fund holds—are considered the safest investments in the world. Backed, as the saying goes, by “the full faith and credit of the United States Government.” Of course, that’s us, the U.S. taxpayers and the same folks owed most of the 2.7 trillion. So the U.S. Treasury Bonds held by the Trust Fund are real things with real value, just like the U.S. Treasury Bonds held by the Chinese, the Japanese, numerous bond and money market funds and countless numbers of individual investors. Yeah, but I’d still feel better if they hadn’t spent the money I contributed and if it really was cold hard cash in a lock box I could draw on. Well, OK, but cash is a really lousy way to hold money long term. Little by little inflation destroys its spending power. It is important to understand that any time you invest money, that money gets spent.


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

US Department of Labor, Bureau of Labor Statistics, Tables and Calculators by Subject; Unemployment Rates by Month, http://data.bls.gov/pdq/SurveyOutputServlet. 8. Council of Economic Advisors, Economic Report of the President 2013, table B-73, column 9. 9. The money market funds held almost zero assets in 1980. See graph in “The Future of Money Market Funds,” September 24, 2012, http://www.winthropcm.com/TheFutureofMoneyMarketFunds.pdf. The numbers in this graph accord with data from the Investment Company Institute’s 2014 Fact Book. The data do not include the years 1980 to 1984, but they do show that by 1990 money market fund assets had reached $498 billion. http://www.icifactbook.org/fb_data.html. Last accessed January 1, 2015. 10. Akerlof and Romer, “Looting,” p. 23. 11. Ibid., p. 34, calculation of resolution cost of $20 billion to $30 billion in 1993 dollars, brought up to date. 12.

It was no longer the firm centered in a cramped office building at 20 Broad Street notable for its turret trading desk with 1,920 private telephone lines to its traders.17 It had expanded worldwide: not only to have offices in New York, London, and Tokyo; in due course it would include such financial hot spots as Bangalore, Doha, Shanghai, and even tiny Princeton, New Jersey.18 All of this is symbolized by its “sleek” new headquarters, opened in 2009:19 forty-three stories in height; two city blocks in length; and described by architecture critic Paul Goldberger as an “understated palazzo.” Goldman Sachs has become an empire.20 Financially, Goldman’s, like the other investment banks, is now a “shadow bank.” A good share of its liabilities is rolled over every night. It takes in “deposits” from large investors with large amounts of liquid assets looking for a haven. Those investors might be commercial banks, money market funds, hedge funds, pension funds, insur ance companies, or other large corporations. Every night they give (we might say “deposit”) literally billions of dollars, with the investment banks’ promise to repay the very next day. This arrangement is known as buying and selling “repos” (repurchase agreements). The depositor is doubly protected. Not only can it claim its money back the very next day, but if Goldman’s should fail, it need hardly skip a heartbeat.

He let interest rates soar; the rate on three-month US Treasury bills, the world’s safest bonds, went to 14 percent in 1981.6 In the fall of 1982 and the spring of 1983 the unemployment rate rose above 10 percent.7 In this war against inflation the country’s S&Ls—quiet, nice banks where people kept their savings, which also financed home purchases—were collateral damage. They had been giving out thirty-year fixed-rate mortgages at 5, 6, 7 percent.8 They needed deposits to back those mortgages. And how were they to meet the competition from the rapidly rising money market funds, which were an alternative convenient place for consumers to store their savings dollars?9 Any economist would say that the S&Ls were bankrupt: not necessarily in the accounting sense—that would depend on the accounting rules—but in the economic sense. The money flowing in from the payments on the S&Ls’ investments (almost entirely in the form of those fixed-rate mortgages) could not meet the money needed to go out to attract the deposits needed to fund those mortgages.10 As a complication, the FSLIC—the Federal Savings and Loan Insurance Corporation, which was the guarantor of the S&L accounts—did not have enough in its trust fund to make up the difference between what the S&Ls had and what they owed.


file:///C:/Documents%20and%... by vpavan

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, asset allocation, Berlin Wall, business cycle, buttonwood tree, buy and hold, corporate governance, corporate raider, disintermediation, diversification, diversified portfolio, Donald Trump, estate planning, fixed income, index fund, intangible asset, interest rate swap, margin call, money market fund, Myron Scholes, new economy, price discovery process, profit motive, risk tolerance, shareholder value, short selling, Silicon Valley, Small Order Execution System, Steve Jobs, stocks for the long run, stocks for the long term, technology bubble, transaction costs, Vanguard fund, women in the workforce, zero-coupon bond, éminence grise

In fact, one of the problems many participants face with their 401(k) accounts is the tendency to invest too conservatively. To avoid the ups and downs of stocks, they are seeking the safety of bonds, slow-growing money market funds, and so-called stable value funds, which invest in guaranteed investment contracts, or securities offered by many insurance companies with a low fixed rate of return. While such fixed-rate investments have a place in your portfolio, you might not have enough money on which to retire if you altogether avoid the higher returns of equities. What New Types of Plans Are Being Considered to Help Workers Make Smarter Choices? In the early days of 401(k) plans, choices were slim. A company might offer a handful of simple investment choices— perhaps a bond fund, a money market fund, and a general-purpose equity fund. Today, the average 401(k) participant can choose from at least ten investment options.

By the way, I didn't do these calculations in my head. I used the SEC's mutual fund calculator, available at www.sec.gov. When you get to the site, click on "interactive tools," and then click on "mutual fund calculator." The calculator allows you to run similar numbers on bond and money market mutual funds, and to plug in any assumptions you wish. Just be careful not to compare apples with oranges, or a low-cost money market fund with a high-cost international stock fund. Here's another trick to help you put mutual fund expenses in context. Don't look at the 1 percent or 2 percent expense ratio in isolation, but rather as a percentage of what you expect your returns to be. Here's an example: If a fund advertises its expense ratio as 1.5 percent, and you are reasonably expecting the fund to return 7.5 percent after one year, the true expense ratio is 20 percent (1.5 divided by 7.5 = 20 percent).

Who Decides How My Money Will Be Invested? Once money starts flowing into your 401(k) account, it needs to be managed. You should play an active role in deciding how that is done. Many studies show that workers aren't doing a terribly good job with their 401(k) investments. A recent John Hancock survey offered these scary statistics: Nearly half of 401(k) participants thought stocks are included in money market funds (they aren't). About 80 percent didn't know that the best time to buy bonds is when interest rates fall. One-half expected stocks to average an astounding 20 percent annual return over the next twenty years. Most experts believe that stocks are likely to produce less than half that. Since 1926, stocks have returned 10.7 percent a year, according to Ibbotson Associates, a Chicago-based research firm.


pages: 464 words: 139,088

The End of Alchemy: Money, Banking and the Future of the Global Economy by Mervyn King

"Robert Solow", Andrei Shleifer, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bretton Woods, British Empire, business cycle, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, centre right, collapse of Lehman Brothers, creative destruction, Credit Default Swap, crowdsourcing, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Doha Development Round, Edmond Halley, Fall of the Berlin Wall, falling living standards, fiat currency, financial innovation, financial intermediation, floating exchange rates, forward guidance, Fractional reserve banking, Francis Fukuyama: the end of history, full employment, German hyperinflation, Hyman Minsky, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labour market flexibility, large denomination, lateral thinking, liquidity trap, Long Term Capital Management, manufacturing employment, market clearing, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Nick Leeson, North Sea oil, Northern Rock, oil shale / tar sands, oil shock, open economy, paradox of thrift, Paul Samuelson, Ponzi scheme, price mechanism, price stability, purchasing power parity, quantitative easing, rent-seeking, reserve currency, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Satoshi Nakamoto, savings glut, secular stagnation, seigniorage, stem cell, Steve Jobs, The Great Moderation, the payments system, The Rise and Fall of American Growth, Thomas Malthus, too big to fail, transaction costs, Tyler Cowen: Great Stagnation, yield curve, Yom Kippur War, zero-sum game

In the run-up to the crisis, new institutions grew up to form a so-called ‘shadow banking’ system. In the US it became larger in terms of gross assets than the traditional banking sector, especially between 2002 and 2007, largely because it was free of much of the regulation that applied to banks. There is no clear definition of what constitutes ‘shadow banking’, but it clearly includes money market funds – mutual funds that issued liabilities equivalent to demand deposits and invested in short-term debt securities such as US Treasury bills and commercial paper. Money market funds were created in the United States as a way of getting around so-called Regulation Q, which until 2011 limited the interest rates that banks could offer on their accounts. They were an attractive alternative to bank accounts. Such funds – and hence the owners of their liabilities – were exposed to risk because the value of the securities in which they invested was liable to fluctuate.

By the time the crisis hit, such funds had total liabilities repayable on demand of over $7 trillion. And they lent significant amounts to banks, both directly and indirectly through other intermediaries. It was because they were a significant source of funding for the conventional banking system that the Federal Reserve took action to prevent the failure of money market funds in the autumn of 2008 when, after the failure of Lehman Brothers, concern about the ability of such funds to hold their value led to a run on them.32 In Europe and Japan, money market funds did not grow to the same extent because banks had more freedom to pay interest, and since the crisis, unlike in the US, such funds have had to choose between being regulated as banks or becoming genuine mutual funds with a risk to the capital value of investors’ money. At one time or another, almost all non-bank financial institutions have been described as shadow banks.

But on 15 September the long-established investment bank Lehman Brothers failed – its large losses on real-estate lending combined with very high leverage prompted a loss of confidence among the financial institutions that provided it with access to cash. Although hardly surprising given the growing appreciation of the system’s underlying fragility over the previous twelve months, the failure of Lehman Brothers was such a jolt to market sentiment that a run on the US banking system took off at extraordinary speed. The runners were not ordinary depositors but wholesale financial institutions, such as money market funds. The run soon spread to other advanced economies – and so the Great Panic began. Already extremely chilly, the financial waters froze solid. Banks around the world found it impossible to finance themselves because no one knew which banks were safe and which weren’t. It was the biggest global financial crisis in history. Where banks could still borrow, it was only at a very high premium to official rates.


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

“For the last couple of years,” noted Michael Gordon, global head of fixed income at Fidelity International, “everyone seemed so comforted that debt and risk were spread so widely. . . . Now everyone is panicking because they don’t know where it is.”13 That same uncertainty about what had been dispersed to where also fed “contagion.” If CDOs and mortgage-backed securities were radioactive, and some had turned up to great dismay in money market funds run by BNP Paribas in France, then money market funds in general became suspect. By mid-August, the most severe of the contagion problems all but froze the commercial paper market. The Swiss-based and tradition-conscious Bank for International Settlements had issued its cautions in June, and Austrian School economist Kurt Richebächer had been even more damning in earlier warnings. Some of the August crisis gestated in banks within the Federal Reserve Board’s regulatory and rate-reduction orbit, but at least as much of the reckless behavior originated in the burgeoning financial sector’s less-regulated “Wild West”—the phalanx of mutual funds, hedge funds, private equity firms, mortgage entities, conduits, and “liquidity factories” sometimes called the “shadow banking system.”

Reserve banking, and the Federal Reserve that regulates the system, appear anemic in comparison.21 These pseudomonetary products fit neither of the two current definitions of money employed by Washington—the narrow M1 (essentially cash, traveler’s checks, and checking accounts) and the slightly broader M2 ( M1 plus most savings accounts, retail money market fund balances, and time deposits under $100,000). However, some think that the new moneylike debt instruments overlap with the definition of M3, the broader money supply that formerly reached measurement into the innards of the financial sector. By definition, M3 includes all of M2 plus large time deposits, institutional money market funds, bank repo agreements, and some overseas Eurodollars. This is the money-supply data that the Federal Reserve decided to stop reporting in early 2006. Let me stipulate: this nomenclature is nerdspeak. The average American would take M1 to mean the standard U.S.

The once-sought-after CDOs could no longer be valued or “marked to market,” or even marked to model, the next resort, but only, as skeptics remarked, marked to make-believe, a poisonous perception. Investors heard talk of the possible deleveraging of the global credit bubble—the privately feared “great unwind.” Recession and deflation might be just over the hill. Other financial shivers—trembling municipal bonds, money market funds, and plain vanilla stocks—added to the worst August market chills since the mobilizations of 1914 had shut down bourses on both sides of the Atlantic. (The New York Stock Exchange, closed on July 31, 1914, did not resume full trading for four months.) The 2007 crisis quickly revealed watershed characteristics. The great credit bubble, over two decades in its shaping, had since the 1980s been kept aloft and generally expanding by uplifts of monetary expansion from the U.S.


pages: 1,242 words: 317,903

The Man Who Knew: The Life and Times of Alan Greenspan by Sebastian Mallaby

"Robert Solow", airline deregulation, airport security, Andrei Shleifer, anti-communist, Asian financial crisis, balance sheet recession, bank run, barriers to entry, Benoit Mandelbrot, Bretton Woods, business cycle, central bank independence, centralized clearinghouse, collateralized debt obligation, conceptual framework, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, energy security, equity premium, fiat currency, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, Hyman Minsky, inflation targeting, information asymmetry, interest rate swap, inventory management, invisible hand, Kenneth Rogoff, Kickstarter, Kitchen Debate, laissez-faire capitalism, Long Term Capital Management, low skilled workers, market bubble, market clearing, Martin Wolf, money market fund, moral hazard, mortgage debt, Myron Scholes, new economy, Nixon shock, Northern Rock, paper trading, paradox of thrift, Paul Samuelson, plutocrats, Plutocrats, popular capitalism, price stability, RAND corporation, rent-seeking, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, Saturday Night Live, savings glut, secular stagnation, short selling, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, unorthodox policies, upwardly mobile, WikiLeaks, women in the workforce, Y2K, yield curve, zero-sum game

The Reserve Primary Fund, the oldest money-market fund in the country, held Lehman paper that was now in default: as a result, a dollar deposited in the Primary Fund was now worth only ninety-seven cents. This was the first time in history that a money-market fund had “broken the buck”—puncturing the myth that money-market accounts were as safe as federally insured bank deposits. Investors who had parked around $3 trillion in money-market funds woke up to the horrifying prospect that their cash might go up in smoke; they rushed to yank their money out, forcing the funds to liquidate their portfolios of Treasury bills and other short-term paper. After years in which the Fed’s reassuring policies had made short-term credit plentiful and cheap, the run on money-market funds cut off the supply almost completely.

In his attack on Regulation Q interest caps in 1970, James Tobin had emphasized their inefficiency but also their injustice. Wealthy Americans could find their way around regulatory constraints, whereas ordinary citizens were helpless.50 Besides, Nixon’s financial reform commission favored deregulation because there was really no choice but to do so. Since 1970, Americans had been pouring savings into money-market funds, which mimicked the properties of bank accounts but which were not subject to Regulation Q.51 If the government kept the regulatory screws on banks and S&Ls, capital would migrate to these money-market funds; and if the government responded by extending interest-rate caps to the funds, capital would migrate to Europe. Already, a booming trade in dollar-denominated bonds had sprung up in London, and if the government tried to regulate onshore credit markets more aggressively, Europe would gobble up more of the business.

And yet this non-outcome proved more significant than it appeared, for it anticipated the story of financial reform during Greenspan’s Fed tenure. Finance did change in the 1970s, but it was shaped not by the deliberate planning of an expert commission but by market pressures and crises. The fact that Greenspan and his fellow commissioners proposed to phase out Regulation Q did not matter in the end; Regulation Q was neutered anyway as savings flooded into the new money-market funds, as unregulated dollar bonds multiplied in London, and as the Fed dealt with the panic following Penn Central by scrapping the Regulation Q cap on the interest that banks could pay to attract very large deposits. The pattern was the same in later years. Finance changed dramatically in the 1990s and early 2000s, but the change was not dictated by the deliberations of experts; earnest working committees pondered the meaning of the new swaps market or the rise of shadow banks, but Greenspan declined to throw his weight behind their ideas, and their findings failed to alter policy.


pages: 524 words: 143,993

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

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

A more likely reason is that Mr Paulson believed (wrongly, as it turned out) that the markets would take Lehman’s failure in their stride, but was sure the same would not be true for AIG, given its role as a seller of ‘credit default swaps’ – insurance contracts on bonds, including the securitized assets that had become increasingly toxic. Then, on 17 September, one of the money-market funds managed by Reserve Management Corporation (a manager of mutual funds) ‘broke the buck’ – that is, could no longer promise to redeem money invested in the fund at par (or dollar for dollar) – because of its exposure to loss-making loans to Lehman. That threatened a tsunami of redemptions from the $3.5tn invested in money-market funds, a crucial element in funding McCulley’s ‘Shadow Banking System’.19 PriceWaterhouseCoopers, the UK’s bankruptcy administrator for Lehman, seized the failed company’s assets in the UK, including the collateral of those who traded with it.20 This came as a shock to many hedge funds and US policymakers.

Worse, conventional banks were also implicated in central aspects of shadow banking, the creation of – and trading in – complex securities and borrowing in short-term, collateralized debt markets, which replaced conventional bank deposits for many big lenders. As is true of most revolutionary systems, the implications of shadow banking were widely misunderstood. 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.

These valuable privileges allow banks to expand their lending in good times with next to no constraint. It is easy, after all, for banks to hold on to the deposits they need to fund their expanded lending, precisely because of the public confidence generated by the support provided to banks by the government and central bank. Banks are explicitly part of the government’s monetary system. Of course, once the Federal Reserve offered equivalent support to money-market funds in September 2008, the latter came to have much the same characteristics as banks. What then stops the bank-led financial system from expanding credit and money without limit? The obvious answer would be that it would stop when participants ran out of profitable opportunities. But this is not a convincing answer if the activities of the hyperactive intermediaries in aggregate create the perceived opportunities: credit growth breeds asset-price bubbles that in turn breed credit growth.


pages: 278 words: 82,069

Meltdown: How Greed and Corruption Shattered Our Financial System and How We Can Recover by Katrina Vanden Heuvel, William Greider

Asian financial crisis, banking crisis, Bretton Woods, business cycle, buy and hold, capital controls, carried interest, central bank independence, centre right, collateralized debt obligation, conceptual framework, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, declining real wages, deindustrialization, Exxon Valdez, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, full employment, housing crisis, Howard Zinn, Hyman Minsky, income inequality, information asymmetry, John Meriwether, kremlinology, Long Term Capital Management, margin call, market bubble, market fundamentalism, McMansion, money market fund, mortgage debt, Naomi Klein, new economy, offshore financial centre, payday loans, pets.com, plutocrats, Plutocrats, Ponzi scheme, price stability, pushing on a string, race to the bottom, Ralph Nader, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, sovereign wealth fund, structural adjustment programs, The Great Moderation, too big to fail, trade liberalization, transcontinental railway, trickle-down economics, union organizing, wage slave, Washington Consensus, women in the workforce, working poor, Y2K

But neither of Paulson’s strategies has thus far helped to stabilize the situation, with global stock and currency markets gyrating wildly and investors dumping risky business loans in favor of safe Treasury bonds. The crisis has even hit the previously staid world of money market mutual funds, where the fainthearted once could park their savings safely in exchange for low returns. Money market fund holders have been panic-selling since mid-September, dumping $500 billion worth of these accounts. To stanch a money market fund collapse, Bernanke announced on October 21 that, on top of the Paulson bailout plan, the Fed stands ready to purchase $540 billion in certificates of deposit and private business loans from the money market funds. This action is in addition to two previous initiatives committing the Fed to buy up, as needed, business loans from failing banks. Until this crisis, the Fed had conducted monetary policy almost exclusively through the purchase and sale of Treasury bonds, rarely buying directly the debts of private businesses or banks.

Whole fleets of spaceships then immediately began attacking AIG, Wachovia, Washington Mutual, even Morgan Stanley and Goldman Sachs. Now desperate, the Men in Black switched back to their old tactics and rescued AIG, but the damage had been done. The aliens had learned from Lehman and AIG how vulnerable Wall Street really was. Soon interbank markets everywhere in the world locked up. With financiers preferring treasuries that paid essentially nothing to every other asset in the world, huge runs started on money market funds. In response, the Men in Black have now gone to Congress. They have put a check for $700 billion and a loaded gun on the table. Sign the check, they insist, and give us unreviewable power to buy bad assets, or take responsibility for the collapse of the whole financial system and, likely, the world economy. In America’s money-driven political system, leaders of both parties love to pretend that the sound of money talking is the voice of the people.

In sum, the less that is bought, the lower the demand for goods and services and the only thing that goes up on the graphs is unemployment. As the construction industries, among our largest employers, go down the toilet, unemployment rises. Fear—Franklin D. Roosevelt’s nameless, unreasoning, un-justified terror—is also at work here. It is driving countless people to take what money they have left out of money market funds, cash in stocks at a loss and withdraw money from savings accounts to put it in government notes which, for practical purposes, pay no interest. Money stuck away in government notes and bonds is unproductive money, money that will not be spent to generate wealth. Stagnant money makes for a scum-pond economy and fewer jobs. Fear has made it next to impossible to borrow for anything—working capital for one’s business, for new ventures, for investment in new equipment.


pages: 401 words: 109,892

The Great Reversal: How America Gave Up on Free Markets by Thomas Philippon

airline deregulation, Amazon Mechanical Turk, Amazon Web Services, Andrei Shleifer, barriers to entry, bitcoin, blockchain, business cycle, business process, buy and hold, Carmen Reinhart, carried interest, central bank independence, commoditize, crack epidemic, cross-subsidies, disruptive innovation, Donald Trump, Erik Brynjolfsson, eurozone crisis, financial deregulation, financial innovation, financial intermediation, gig economy, income inequality, income per capita, index fund, intangible asset, inventory management, Jean Tirole, Jeff Bezos, Kenneth Rogoff, labor-force participation, law of one price, liquidity trap, low cost airline, manufacturing employment, Mark Zuckerberg, market bubble, minimum wage unemployment, money market fund, moral hazard, natural language processing, Network effects, new economy, offshore financial centre, Pareto efficiency, patent troll, Paul Samuelson, price discrimination, profit maximization, purchasing power parity, QWERTY keyboard, rent-seeking, ride hailing / ride sharing, risk-adjusted returns, Robert Bork, Robert Gordon, Ronald Reagan, Second Machine Age, self-driving car, Silicon Valley, Snapchat, spinning jenny, statistical model, Steve Jobs, supply-chain management, Telecommunications Act of 1996, The Chicago School, the payments system, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, transaction costs, Travis Kalanick, Vilfredo Pareto, zero-sum game

The only ways to guarantee that your $1 is completely safe is either to invest it entirely in short-term government bills or insure it. That’s why bank deposits are insured, and that’s why banks pay insurance premia to the Federal Deposit Insurance Corporation (FDIC). The money market fund industry wanted to attract savings away from the banks—which is totally fair, that’s just competition—and they knew that people loved the idea of fixed, safe, dollar-for-dollar deposits. They then decided to report fixed NAVs, pricing their shares at $1 at all times, to make it look like they were offering deposits. But they were not investing in safe, short-term government bills. In September 2008, the Reserve Primary Money Market Fund (a large money market fund) “broke the buck” (that is, admitted that the value of its shares was less than $1) because it had invested in Lehman Brothers commercial paper. Lehman declared bankruptcy and the Reserve Fund posted a loss, triggering a run as investors pulled their money out to avoid further losses.

It shrinks to less than 4 percent in 1950, grows slowly to 5 percent in 1980, and then increases rapidly to almost 8 percent in 2010. Why are we spending more on financial intermediation today than 100 years ago? To answer that question, let us construct the amount of intermediation. For the corporate sector, we need to look at stocks and bonds, and for stocks, we want to distinguish between seasoned offerings and IPOs. We also need to look at the liquidity benefits of deposits and money market funds. The principle is to measure the instruments on the balance sheets of nonfinancial users, households, and nonfinancial firms. This is the correct way to do the accounting, rather than looking at the balance sheet of financial intermediaries. After aggregating the various types of credit, equity issuances, and liquid assets into one measure, I obtain the quantity of financial assets intermediated by the financial sector for the nonfinancial sector, displayed as the shaded line in Figure 11.2.

Lehman declared bankruptcy and the Reserve Fund posted a loss, triggering a run as investors pulled their money out to avoid further losses. The fund was forced to freeze redemptions and the US Treasury Department had to create a temporary guarantee program for the entire money market fund industry! So much for a safe investment … After the crisis, regulators proposed a set of reforms to force funds to float the NAV of their portfolios and avoid the illusion of safety. It did not go well. The industry fought back, and it took years to arrive at a mediocre compromise. My point here is that implementing these regulations would have been a relatively straightforward process when the industry was small, and they would have guided market evolution and encouraged innovations consistent with sound principles of finance.


pages: 825 words: 228,141

MONEY Master the Game: 7 Simple Steps to Financial Freedom by Tony Robbins

3D printing, active measures, activist fund / activist shareholder / activist investor, addicted to oil, affirmative action, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, backtesting, bitcoin, buy and hold, clean water, cloud computing, corporate governance, corporate raider, correlation does not imply causation, Credit Default Swap, Dean Kamen, declining real wages, diversification, diversified portfolio, Donald Trump, estate planning, fear of failure, fiat currency, financial independence, fixed income, forensic accounting, high net worth, index fund, Internet of things, invention of the wheel, Jeff Bezos, Kenneth Rogoff, lake wobegon effect, Lao Tzu, London Interbank Offered Rate, market bubble, money market fund, mortgage debt, new economy, obamacare, offshore financial centre, oil shock, optical character recognition, Own Your Own Home, passive investing, profit motive, Ralph Waldo Emerson, random walk, Ray Kurzweil, Richard Thaler, risk tolerance, riskless arbitrage, Robert Shiller, Robert Shiller, self-driving car, shareholder value, Silicon Valley, Skype, Snapchat, sovereign wealth fund, stem cell, Steve Jobs, survivorship bias, telerobotics, the rule of 72, thinkpad, transaction costs, Upton Sinclair, Vanguard fund, World Values Survey, X Prize, Yogi Berra, young professional, zero-sum game

Other tools for cash equivalents include money market funds—there are three types, and if you want to learn more, see the box for details. For larger amounts of money that we need to keep safe and liquid, you can buy into ultra-short-term investments called cash equivalents. The most well-known are good old money market funds. You may even already own one. These are basically mutual funds made up of low-risk, extremely short-term bonds and other kinds of debt (which you’ll learn more about in a moment). They can be great because you get a somewhat higher rate of return than a boring old bank account, but you still get immediate access to your cash 24 hours a day—and there are some that even let you write checks. By the way, most banks offer money market deposit accounts, which are not the same as money market funds. These are like savings accounts where the banks are allowed to invest your money in short-term debt, and they pay you a slightly better interest rate in return.

These are like savings accounts where the banks are allowed to invest your money in short-term debt, and they pay you a slightly better interest rate in return. There’s usually a minimum deposit required or other restrictions, low rates, and penalties if your balance falls too low. But they are insured by the FDIC, which is a good thing. And that sets them apart from money market funds, which are not guaranteed and could potentially drop in value. But if you want to keep your money safe, liquid, and earning interest, one option is a US Treasury money market fund with checking privileges. True, these funds aren’t insured by the FDIC, but because they are tied only to US government debt and not to any corporations or banks that might default, the only way you can lose your money is if the government fails to pay its short-term obligations. If that happens, there is no US government, and all bets are off anyway!

Keep in mind that at this point, TDFs were just a concept. A glimmer in the eye of the industry. In his study for the Department of Labor, conducted with two other professors, one of whom was trained by two Nobel laureates, Babbel compared TDFs to stable value funds. Stable value funds are ultraconservative, “don’t have losses and historically have yields [returns] at two percent to three percent greater than money market funds.” According to Babbel, the industry-sponsored study, which painted TDFs in the best possible light, was riddled with flaws. To make TDFs look better than stable value funds, they pumped out more fiction than Walt Disney. For example, they made an assumption that stocks and bonds have no correlation. Wrong. Bonds and stocks do indeed move in step to a degree and they move even closer during tough times.


pages: 293 words: 88,490

The End of Theory: Financial Crises, the Failure of Economics, and the Sweep of Human Interaction by Richard Bookstaber

"Robert Solow", asset allocation, bank run, bitcoin, business cycle, butterfly effect, buy and hold, capital asset pricing model, cellular automata, collateralized debt obligation, conceptual framework, constrained optimization, Craig Reynolds: boids flock, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, dark matter, disintermediation, Edward Lorenz: Chaos theory, epigenetics, feminist movement, financial innovation, fixed income, Flash crash, Henri Poincaré, information asymmetry, invisible hand, Isaac Newton, John Conway, John Meriwether, John von Neumann, Joseph Schumpeter, Long Term Capital Management, margin call, market clearing, market microstructure, money market fund, Paul Samuelson, Pierre-Simon Laplace, Piper Alpha, Ponzi scheme, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, Richard Feynman, risk/return, Saturday Night Live, self-driving car, sovereign wealth fund, the map is not the territory, The Predators' Ball, the scientific method, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, tulip mania, Turing machine, Turing test, yield curve

They were funded mostly through medium-term notes that were liquid, and unlike many of the mortgage products, the fact that they traded frequently meant that they could be marked to actual market trades. But at this point, a whiff of mortgage exposure was enough. With funding already restricted in the repo market by higher margins and demands for higher-quality collateral, with the ABCP market seizing up and SIVs dead in the water, the fall of 2007 reached a panic point when money market funds started to face problems. SIVs were a particular issue here, because these were held widely by money market funds. The money market funds were a prime source of the raw material—they were the ultimate cash provider—that found its way through the SIVs and other instruments. Another funding source that got clobbered came through trouble with monoline insurers. The two largest monoline bond insurers, MBIA and Ambac, had taken $265 billion of guarantees on mortgage-backed securities and related structured products.

AGENTS An ABM does not start with axioms; it starts with the reality of the situation. If we are going to look at financial crises, the first step is to recognize that we have a specific financial system with real institutions, organized in a defined way. There are banks like JP Morgan Chase (JPM) and Citi, hedge funds like Citadel and Bridgewater, security lenders, asset managers, pension funds, money market funds. Each one interacts with others; some are sources of funding, others use funding; some are intermediaries and market makers; some act as conduits for collateral, others take on counterparty risk. Each one takes actions based on the world around it, based on its business interests and operational culture, and how it acts—these are big enough institutions that what they do has consequences for the system—in turn changes the environment and affects how others act.

Hedge funds are on both sides of figure 11.1 because when they are holding assets short they provide funds to the bank/dealer; when they are going long they borrow. Agents in the hedge funds space include Bridgewater, Citadel, and D. E. Shaw. There are several thousand hedge funds in total, though fewer than one hundred of any note. Cash Providers. Cash providers are agents that include asset managers, pension funds, insurance companies, securities lenders (who receive cash from lending securities), and, most important, money market funds. The cash providers fuel the financial system. Without funding, the system—or any part of the system that does not have funding—comes to a halt in as little as a day. The collateral passes from the borrowers to the cash providers, usually with the bank/dealer as an intermediary. Securities Lenders. Like the cash providers, the securities lenders provide the bank/dealer with securities and funding.


pages: 351 words: 102,379

Too big to fail: the inside story of how Wall Street and Washington fought to save the financial system from crisis--and themselves by Andrew Ross Sorkin

affirmative action, Andy Kessler, Asian financial crisis, Berlin Wall, break the buck, BRICs, business cycle, collapse of Lehman Brothers, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Emanuel Derman, Fall of the Berlin Wall, fear of failure, fixed income, Goldman Sachs: Vampire Squid, housing crisis, indoor plumbing, invisible hand, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Mikhail Gorbachev, money market fund, moral hazard, naked short selling, NetJets, Northern Rock, oil shock, paper trading, risk tolerance, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, savings glut, shareholder value, short selling, sovereign wealth fund, supply-chain management, too big to fail, value at risk, éminence grise

He was most anxious about the latest shocking development: A giant money market fund, Reserve Primary Fund, had broken the buck a day earlier (which meant that the value of the fund’s assets had fallen to below a dollar per share—in this case, 97 cents). Money market funds were never supposed to do that; they were one of the least risky investments available, providing investors with minuscule returns in exchange for total security. But the Reserve Primary Fund had chased a higher yield—a 4.04 percent annual return, the highest in the industry—by making risky bets, including $785 million in Lehman paper. Investors had started liquidating their accounts, which in turn forced managers to impose a seven-day moratorium on redemptions. Nobody, Geithner worried, knew just how extensive the damage could end up being. Between the money-market funds being under pressure, Geithner thought, and billions of dollars of investors’ money locked up inside the now-bankrupt Lehman Brothers, that means only one thing: the two remaining broker-dealers—Morgan Stanley and Goldman Sachs—could actually be next.

CHAPTER EIGHTEEN Hoarse and a little haggard, Paulson made his way to the podium in the press room of the Treasury Building the morning of Friday, September 19, 2008, to formally announce and clarify what he had dubbed earlier that morning the Troubled Asset Relief Program, soon known as TARP, a vast series of guarantees and outright purchases of “the illiquid assets that are weighing down our financial system and threatening our economy.” He also announced an expansive plan to guarantee all money market funds in the nation for the next year, hoping that that move would keep investors from fleeing them. But he had already gotten an earful that morning about that effort from Sheila Bair, chairwoman of the FDIC, who had called, furious she wasn’t consulted and anxious that the guarantee plan would backfire and investors would perversely start moving their money out of otherwise healthy banks and into the guaranteed money market funds. Paulson just shook his head; he couldn’t win. As he stood in front of the press corps he did his best to sell the centerpiece of his plan, the TARP. “The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded.

Although the conversation agitated Fuld slightly, they’d had similar discussions before, so he took Paulson’s advice in stride. The group took their seats, and as each of the speakers rose to talk, the perilous state of the economy became ever clearer. The credit crisis wasn’t just a U.S. problem; it had spread globally. Mario Draghi, Italy’s central bank governor and a former partner at Goldman Sachs, spoke candidly of his worries about global money-market funds. Jean-Claude Trichet told the audience that they needed to come up with common requirements for capital ratios—the amount of money a firm needed to keep on hand compared to the amount it could lend—and, more important, leverage and liquidity standards, which he thought were much more telling indicators of a firm’s ability to withstand a “run on the bank.” That night, after Fuld had finally found his car and driver outside the Treasury Building, he thumbed out an e-mail on his BlackBerry to Russo.


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

In fact, world GDP was only about $45 trillion or so in 2007. This vast accumulated wealth of households fell into two large buckets: First, tangible assets of $28 trillion, including over $21 trillion in real estate and $4 trillion in durable goods like cars; and second, financial assets of $50 trillion. Of these, only about $7 trillion was ‘‘money in the bank’’ such as in checking and savings accounts or money market funds. Most household financial assets are what are called ‘‘market instruments.’’ These will be described in detail in the next chapter, but in general, a market instrument is either an IOU for borrowed money or an ownership share in a corporation. In other A Tour of the Financial World and Its Inhabitants words, what we know as bonds and stocks. Households owned abut $4 trillion in bonds of various types and $15 trillion in stock, about a third of it through mutual funds.

A Tour of the Financial World and Its Inhabitants Together, these sums of money make the deposit money in the banking system proper seem modest. YOUR PENSION FEEDS THE MARKET At the end of 2007, U.S. households had about $6 trillion in the bank, mostly in various types of savings accounts. However, the actual reserves (that is, real money, not just promises) for pension funds was $13 trillion. Households also held $5 trillion in mutual funds and another $1.4 trillion in money market funds. Their life insurance policies held another $1.2 trillion in reserves. The ‘‘buy side’’ is huge, and for a very good reason. The only way anyone can continue to have an income after they stop working is to put aside money today that they can use later in life. If the average person needs $40,000 a year to live in retirement and will on average live twenty years, that means that they need $800,000 over that period.

Second, CP had been a building block in a Rube Goldberg scheme called ‘‘asset securitization,’’ another ugly phrase, this time relating to complicated financial machinery that transforms bank loans into marketable ‘‘financial instruments.’’ Asset securitization is what allowed the great credit bubble of recent decades to inflate and then collapse, with asset securitization causing the bubble to pop and tank the real economy in the process. Commercial paper was an essential ingredient in the whole witches brew, as we will see later. Who bought all these naked IOUs? The short answer is that you did. Money market funds, which so many of us used to get higher returns on our savings, were among the biggest buyers of CP. The riskier the CP issuer, the higher the rate they paid us. Nobody questioned this when times were good. BONDS If you watch the TV money shows, you will see how much drama surrounds the trading floor the New York Stock Exchange. People clap when the bell goes off at 9:30. People run around.


pages: 269 words: 70,543

Tech Titans of China: How China's Tech Sector Is Challenging the World by Innovating Faster, Working Harder, and Going Global by Rebecca Fannin

Airbnb, augmented reality, autonomous vehicles, blockchain, call centre, cashless society, Chuck Templeton: OpenTable:, cloud computing, computer vision, connected car, corporate governance, cryptocurrency, data is the new oil, Deng Xiaoping, digital map, disruptive innovation, Donald Trump, El Camino Real, Elon Musk, family office, fear of failure, glass ceiling, global supply chain, income inequality, industrial robot, Internet of things, invention of movable type, Jeff Bezos, Kickstarter, knowledge worker, Lyft, Mark Zuckerberg, megacity, Menlo Park, money market fund, Network effects, new economy, peer-to-peer lending, personalized medicine, Peter Thiel, QR code, RFID, ride hailing / ride sharing, Sand Hill Road, self-driving car, sharing economy, Shenzhen was a fishing village, Silicon Valley, Silicon Valley startup, Skype, smart cities, smart transportation, Snapchat, social graph, software as a service, South China Sea, sovereign wealth fund, speech recognition, stealth mode startup, Steve Jobs, supply-chain management, Tim Cook: Apple, Travis Kalanick, Uber and Lyft, Uber for X, uber lyft, urban planning, winner-take-all economy, Y Combinator, young professional

Shortly after Alibaba scored its mega IPO in New York in 2014, Alipay’s financial services business was rebranded Ant Financial in a new push into financial services, and then in 2018, Alibaba crawled back in, buying a 33 percent stake in Ant Financial. Alibaba’s fintech affiliate is shaking up the financial sector with internet technology and big data for wealth management, mobile payments, insurance, microloans, money market funds, and blockchain for cryptocurrencies. Its money market fund, Yu’e Bao, promising returns of more than 4 percent, became the world’s largest fund in just four years after its 2013 launch, with $211 billion in assets and 370 million account holders, who needed only 15 cents to open an account. The fund’s assets have since downsized to $168 billion following pressure by Chinese regulators and concerns of systemic liquidity risks to the entire banking market.10 Ant Financial made big news again when it hauled in the largest-ever single fund-raising by a private company: an eye-popping $14 billion investment in 2018 at a valuation of about $150 billion from US private equity firms Carlyle Group, Silver Lake Partners, Warburg Pincus, and General Atlantic, as well as Singaporean sovereign wealth fund GIC.

Alibaba’s futuristic Freshippo grocery stores employ robots and are more advanced and extensive than Amazon Go’s limited number of automated convenience stores in the United States. •Mobile payments: China today is a cashless society. China’s mobile payments market led by WeChat Pay and Alipay already exceeds US credit and debit card usage. •Fintech: Alibaba affiliate Ant Financial is a one-stop financial services giant that uses big data and machine learning to dominate in money market funds, lending, insurance, mobile payments, wealth management, and blockchain services. •Social credit: China’s new, controversial social credit system judges a citizen’s trustworthiness through technological surveillance and encourages compliance by giving ratings that can determine access to loans, jobs, schools, and travel. •Sharing economy: China-invented business models for shared bikes, battery chargers, umbrellas, basketballs, and takeout kitchens have been popularized by dozens of startups.

Elsewhere, Xiaomi is playing catch-up to Samsung’s lead in the large Indonesian market and has become among the top five smartphone brands in Russia, Greece, Egypt, Poland, Bulgaria, Czech Republic, and Kazakhstan as well as several markets in Asia. What’s next for Xiaomi? It’s getting into fintech. A new subsidiary, Xiaomi Finance, under the leadership of Xiaomi engineering cofounder Hong Feng is leveraging the company’s data to offer microloans, money transfers, bill payments, internet banking, a money market fund, and financial services for small companies in its supply chain. Xiaomi is preinstalling these financial services into its smartphones. It’s also investing in Indian lending startups. These moves plant Xiaomi within the turf of Alibaba and Tencent. Whether it’s too much of a stretch to compete in a brand-new field and against the original tech titans is a valid question. But it seems clear that getting into the United States, where it could compete directly with Apple, does remain a stretch, particularly given the current tech and trade frictions.


pages: 466 words: 127,728

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

Affordable Care Act / Obamacare, Asian financial crisis, asset allocation, Ayatollah Khomeini, bank run, banking crisis, Ben Bernanke: helicopter money, bitcoin, Black Swan, Bretton Woods, BRICs, business climate, business cycle, buy and hold, capital controls, Carmen Reinhart, central bank independence, centre right, collateralized debt obligation, collective bargaining, complexity theory, computer age, credit crunch, currency peg, David Graeber, debt deflation, Deng Xiaoping, diversification, Edward Snowden, eurozone crisis, fiat currency, financial innovation, financial intermediation, financial repression, fixed income, Flash crash, floating exchange rates, forward guidance, G4S, George Akerlof, global reserve currency, global supply chain, Growth in a Time of Debt, income inequality, inflation targeting, information asymmetry, invisible hand, jitney, John Meriwether, Kenneth Rogoff, labor-force participation, Lao Tzu, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market clearing, market design, money market fund, money: store of value / unit of account / medium of exchange, mutually assured destruction, obamacare, offshore financial centre, oil shale / tar sands, open economy, plutocrats, Plutocrats, Ponzi scheme, price stability, quantitative easing, RAND corporation, reserve currency, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Satoshi Nakamoto, Silicon Valley, Silicon Valley startup, Skype, sovereign wealth fund, special drawing rights, Stuxnet, The Market for Lemons, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, too big to fail, trade route, undersea cable, uranium enrichment, Washington Consensus, working-age population, yield curve

In September 1998 global capital markets were hours away from total collapse before the completion of a $4 billion, all-cash bailout of the hedge fund Long-Term Capital Management, orchestrated by the Federal Reserve Bank of New York. In October 2008 global capital markets were days away from the sequential collapse of most major banks when Congress enacted the TARP bailout, while the Fed and Treasury intervened to guarantee money-market funds, prop up AIG, and provide trillions of dollars in market liquidity. In neither panic did the Fed’s imaginary bargain hunters show up to save the day. In short, the Treasury and Fed view of financial warfare exhibits what intelligence analysts call mirror imaging. They assume that since the United States would not launch a financial attack on China, China would not launch an attack on the United States.

This caused Korea to cut interest rates to cheapen its currency, and so on around the world, in a blur of rate cuts, money printing, imported inflation, and knock-on effects triggered by Fed manipulation of the world’s reserve currency. The result is not effective policy; the result is global confusion. The Federal Reserve defends its market interventions as necessary to overcome market dysfunctions such as those witnessed in 2008 when liquidity evaporated and confidence in money market-funds collapsed. Of course, it is also true that the 2008 liquidity crisis was itself the product of earlier Fed policy blunders starting in 2002. While the Fed is focused on the intended effects of its policies, it seems to have little regard for the unintended ones. ■ The Asymmetric Market In the Fed’s view, the most important part of its program to mitigate fear in markets is communications policy, also called “forward guidance,” through which the Fed seeks to amplify easing’s impact by promising it will continue for sustained periods of time, or until certain unemployment and inflation targets are reached.

A sound euro is an important attraction for Chinese capital because a stable currency mitigates exchange-rate risk to investors. Indeed, capital inflows from China provided support for the euro—an example of a positive feedback loop between a sound currency and capital flows. Increasing capital inflows to the Eurozone were not limited to those coming from China. The U.S. money-market industry has also been investing heavily in the Eurozone. After panicked outflows in 2011, the ten largest money-market funds in the United States almost doubled their investments in the Eurozone between the summer of 2012 and early 2013. The Berlin Consensus is taking root in Europe, based on the seven pillars and directed as much from the EU in Brussels as from Berlin, to mitigate resentment of Germany’s economic dominance. The consensus is powered by a virtuous troika of German technology, periphery youth labor, and Chinese capital.


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

Instead, it merely protects individual banks from market discipline. Put differently, with implicit government guarantees all over the place, should we not strive to remove explicit government guarantees where we can? One reason for insuring deposits was to provide a safe means of savings to households where none existed. Today, this rationale is archaic—a money-market fund invested in Treasury bills can provide that safety. A well-diversified money-market fund invested in highly rated commercial paper and marked every day to market is almost as safe and should not experience the kinds of runs experienced by funds that were not marked to market during this crisis.20 Another important reason for insuring deposits was to ensure that the payment system would be relatively safe: unregulated, unsafe, uninsured entities could not pollute it and cause the system to freeze.

Stein, “Rethinking Capital Regulation,” paper prepared for the Federal Reserve Bank of Kansas City symposium “Maintaining Stability in a Changing Financial System,” Jackson Hole, WY, August 21–23, 2008. 16 See Aaron Wildavsky, Searching for Safety (New Brunswick, NJ: Transaction Books, 1988). 17 See Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, “Perspectives on the Recent Financial Market Turmoil,” speech at the 2008 Institute of International Finance Membership Meeting, Rio de Janeiro, Brazil, March 5, 2008. 18 See, for example, the proposed House Financial Regulatory Reform Bill of 2009. 19 See Sorkin, Too Big to Fail, 490. 20 Prime Reserves, a money-market fund, suffered losses on its Lehman debt holdings after the Lehman collapse. Because it paid out $1 for every dollar invested instead of the $0.97 or so that the investments were now worth, investors rushed to the exit to avoid being forced to bear the losses. If the fund had marked its assets to market and paid out only $0.97, there would have been less of a panic. Again, in a crisis, perhaps no asset is safe without a government guarantee, including money-market funds that are invested in anything other than Treasury bills. 21 I thank Viral Acharya for suggesting this term. 22 Louis D. Brandeis to Robert W. Bruere, Columbia Law Review 31 (1922): 7. 23 Louis D.

See health care; physicians medical malpractice Medicare Merrill Lynch Mexico: conditional cash transfers financial crisis of Mian, Atif microcredit middle class migration mobility: economic factors restricting of workers models, economic Mohamad, Mahathir monetary policy: credit expansion and financial stability and housing market and improvements in Japanese Keynesian lags in political influences on reforms of of United States, See also central banks; interest rates money-market funds moral hazard Morgan, J. P., See also JP Morgan Morrice, Brad mortgage-backed securities: credit risk of Fannie Mae and Freddie Mac issues federal purchases of held by banks investors in ratings of risks of, subprime mortgages in tail risks of tranches of mortgage brokers mortgage insurance mortgages: defaults on deregulation of thrift industry FHA foreclosures of historical evolution of interest rates on predatory lending traditional lending process for, See also subprime mortgage market motivations multilateral financial institutions: influence of lending by reforms of See also International Monetary Fund; World Bank mutual fund management companies national home ownership strategy, See also home ownership nationalism Nehru, Jawaharlal New Century Financial New Deal New York City No Child Left Behind Act of noncognitive skills Northern Rock Obama, Barack Obama administration Office of Thrift Supervision O’Neal, Stanley opportunities organizational capital ownership society, See also home ownership Park Chung Hee Paulson, Henry J.


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

Most large corporations manage their own money-market investments, but small companies sometimes find it more convenient to hire a professional investment management firm or to put their cash into a money-market fund. This is a mutual fund that invests only in low-risk, short-term securities.16 Despite its large cash surplus, Apple invested a small proportion of its money in money-market funds. The relative safety of money-market funds has made them particularly popular at times of financial stress. During the credit crunch of 2008 fund assets mushroomed as investors fled from plunging stock markets. Then it was revealed that one fund, the Reserve Primary Fund, had incurred heavy losses on its holdings of Lehman Brothers’ commercial paper. The fund became only the second money-market fund in history to “break the buck,” by offering just 97 cents on the dollar to investors who cashed in their holdings. That week investors pulled nearly $200 billion out of money-market funds, prompting the government to offer emergency insurance to investors.

For mutual funds that invest in stocks, fees and expenses typically add up to nearly 1% per year. Most mutual funds invest in shares or in a mixture of shares and bonds. However, one particular type of mutual fund, called a money-market fund, invests only in short-term safe securities, such as Treasury bills or bank certificates of deposit. Money-market funds offer individuals and small- and medium-sized businesses a convenient home in which to park their spare cash. There are about 1,000 money-market funds in the United States. Some of these funds are huge. For example, the JP Morgan Prime Money Market Fund has over $100 billion in assets. Mutual funds are open-end funds—they stand ready to issue new shares and to buy back existing shares. In contrast, a closed-end fund has a fixed number of shares that are traded on an exchange.

The fear was that depositors would run off in search of higher yields, causing a cash drain that savings institutions would not be able to meet. Interest-rate regulation provided financial institutions with an opportunity to create value by offering money-market funds. These are mutual funds invested in Treasury bills, commercial paper, and other high-grade, short-term debt instruments. Any saver with a few thousand dollars to invest can gain access to these instruments through a money-market fund and can withdraw money at any time by writing a check against his or her fund balance. Thus the fund resembles a checking or savings account that pays close to market interest rates. These money-market funds have become enormously popular. By 2011 their assets were $2.6 trillion.8 Long before interest-rate ceilings were finally removed, most of the gains had gone out of issuing the new securities to individual investors.


pages: 348 words: 82,499

DIY Investor: How to Take Control of Your Investments & Plan for a Financially Secure Future by Andy Bell

asset allocation, bank run, buy and hold, collapse of Lehman Brothers, credit crunch, diversification, diversified portfolio, estate planning, eurozone crisis, fixed income, high net worth, hiring and firing, Isaac Newton, Kickstarter, lateral thinking, money market fund, Northern Rock, passive investing, place-making, quantitative easing, selection bias, short selling, South Sea Bubble, technology bubble, transaction costs, Vanguard fund

Corporate bonds are generally perceived as being less risky than equities, and investing in corporate bonds through a corporate bond fund reduces your overall risk. Capital protection Funds in the capital protection grouping of IMA sectors include money market or cash funds and funds offering capital protection by locking in gains, or guaranteeing capital and linking returns to an index. Some people refer to money market funds as cash funds, which is not strictly correct. Money market funds invest in cash, bonds with only a short term to maturity and other ‘debt instruments’. There is some capital risk to these funds. Specialist The IMA’s specialist sector grouping covers a range of sectors that do not fall into any of the others. Funds investing in specialist sectors, such as Technology & Telecommunications and Property, fall into this category.

The Isle of Man’s bank deposit guarantee scheme compensated investors up to 100 per cent of the first £30,000 and then 90 per cent of the next £20,000 of deposits, up to a maximum of £48,000. Cash funds Cash funds are pooled investments run by fund managers who invest in ‘cash-like’ assets with the very loose aim of giving ‘attractive’ returns with a high level of security. They are also called money market funds. These funds have come under scrutiny from the FSA in recent years because the assets they have invested in have, in some cases, not reflected the risk profile of cash. Some have also suffered from negative yields. Cash funds are usually far less volatile than equity or bond funds but they still carry risks, and can post negative returns in times of exceptional market volatility. Don’t go into these funds for decent long-term cash returns – cash funds are purely for holding short-term cash on your investment platform while you think about where else you are going to invest it.

Appendix Annuity factors for capped drawdown Source: Government Actuary’s Department Index AER (annual equivalent rate) Alternative Investment Market (AIM), 2nd, 3rd, 4th, 5th, 6th, 7th annuities, 2nd, 3rd, 4th, 5th, 6th guaranteed annuity rates income drawdown or lifetime, 2nd tax asset allocation, 2nd, 3rd, 4th bankruptcy banks, 2nd, 3rd, 4th bank accounts see cash fixed-rate bonds, 2nd, 3rd Bed and breakfast, 2nd Bed and ISA, 2nd Bed and SIPP Bed and spouse bonds see corporate bonds and gilts borrowing, 2nd, 3rd building societies accounts see cash fixed-rate bonds, 2nd, 3rd PIBS, 2nd buyer beware, 2nd Canadian shares capital gains tax, 2nd annual exemption, 2nd, 3rd, 4th, 5th, 6th, 7th Bed and breakfast, 2nd Bed and ISA, 2nd Bed and SIPP Bed and spouse corporate bonds Dealing Account, 2nd death equities, 2nd ETFs, 2nd exempt assets, 2nd funds, 2nd gifts to spouse or civil partner, 2nd, 3rd gilts investment trusts, 2nd ISAs, 2nd, 3rd, 4th, 5th, 6th losses, 2nd, 3rd, 4th rates of, 2nd, 3rd SIPPs, 2nd, 3rd, 4th, 5th takeovers venture capital trusts capital protection funds cash, 2nd, 3rd, 4th, 5th best-buy savings accounts bonus rates cash/money market funds, 2nd, 3rd inflation risk, 2nd investment platforms, 2nd, 3rd, 4th, 5th, 6th ISAs, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th merged banks and building societies, 2nd NS&I, 2nd overseas banks security of cash accounts, 2nd caveat emptor (buyer beware), 2nd charges and costs Bed and ISA bond funds bonds, retail corporate cash funds comparison sites: pricing of platforms, 2nd equities, 2nd, 3rd, 4th ETFs, 2nd, 3rd, 4th funds see charges under funds investment trusts, 2nd, 3rd ISAs, 2nd, 3rd, 4th, 5th Level 2 market data re-registration, 2nd SIPPs, 2nd, 3rd, 4th stakeholder pensions tracker funds children civil partner, 2nd, 3rd, 4th gifts to, 2nd, 3rd closed-end funds, 2nd investment trusts see separate entry commercial property, 2nd, 3rd, 4th SIPPs, 2nd, 3rd company pension schemes, 2nd final or career average salary scheme, 2nd, 3rd contracts for difference (CFDs) corporate bonds and gilts, 2nd, 3rd, 4th, 5th, 6th, 7th funds, 2nd, 3rd, 4th, 5th gilts, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th, 10th, 11th history of mechanics of buying, holding and selling research, 2nd risks of bonds and impact on value, 2nd, 3rd tax, 2nd terminology costs see charges and costs Crown employees, 2nd currency risk, 2nd de-rampers Dealing Account, 2nd, 3rd, 4th Bed and breakfast Bed and ISA, 2nd Bed and SIPP charges investment platforms, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th joint names tax, 2nd, 3rd what you can invest in, 2nd, 3rd, 4th workings of death annuities, 2nd SIPPs, 2nd tax, 2nd defined benefits/final salary schemes, 2nd, 3rd defined contribution/money purchase schemes company scheme SIPP see separate entry diary notes, 2nd directors’ share purchases and sales discount brokers, 2nd diversification, 2nd, 3rd dividends, 2nd, 3rd, 4th, 5th dividend yield ratio, 2nd investment trusts payout ratio reinvesting, 2nd, 3rd, 4th, 5th, 6th tax, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th divorce double taxation agreements, 2nd DYOR (Do Your Own Research) efficient market hypothesis emerging markets, 2nd, 3rd, 4th, 5th, 6th, 7th emigration emotional investing, avoiding, 2nd employment contracts EMS (exchange market size), 2nd enterprise investment schemes (EISs), 2nd, 3rd equities, 2nd, 3rd, 4th, 5th AIM-listed, 2nd, 3rd, 4th, 5th, 6th, 7th charges, 2nd, 3rd, 4th convertibles dividends, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th exchange market size (EMS) financial ratios, 2nd, 3rd FTSE 100, 2nd, 3rd FTSE 250/mid-cap stocks FTSE 350 FTSE SmallCap history of Level 2 market data, 2nd liquidity, 2nd, 3rd open offer ordinary shares overseas markets, 2nd, 3rd preference shares, 2nd price, 2nd research, 2nd, 3rd, 4th rights issues risks of settlement period shareholder perks, 2nd spreads, 2nd stop loss and limit orders takeover tax, 2nd, 3rd, 4th, 5th tips in financial press, 2nd, 3rd, 4th types who’s who is trading process ethical investor ex-dividend date exchange market size (EMS), 2nd exchange-traded funds (ETFs), 2nd, 3rd, 4th, 5th, 6th, 7th costs and charges, 2nd, 3rd, 4th default history of major players mechanics of buying and selling ‘reporting status’ risks tax, 2nd websites exchange-traded products (ETPs), 2nd, 3rd ETFs see exchange-traded funds executive pension plans, 2nd exit charges: ISAs final or career average salary schemes, 2nd, 3rd financial advisers, 2nd, 3rd, 4th, 5th, 6th, 7th Financial Conduct Authority (FCA) financial crisis, 2nd Financial Ombudsman Service financial ratios, 2nd, 3rd, 4th Financial Services Compensation Scheme (FSCS), 2nd, 3rd, 4th, 5th France, 2nd FTSE 100, 2nd, 3rd FTSE 250/mid-cap stocks FTSE 350 FTSE SmallCap fund supermarkets, 2nd funds, 2nd, 3rd, 4th changes to structure of charges and costs, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th, 10th, 11th, 12th, 13th ‘clean’ and ‘dirty’ share classes, 2nd, 3rd, 4th, 5th, 6th, 7th conversions, share class fraud history information overload insolvency of fund manager mechanics of buying, holding and selling money market/cash, 2nd, 3rd multi-manager negligence OEICs, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th, 10th, 11th, 12th, 13th, 14th, 15th, 16th passive or active management performance fees RDR, 2nd, 3rd, 4th, 5th, 6th, 7th sectors share classes, 2nd, 3rd, 4th, 5th, 6th, 7th soft-closing star fund managers, 2nd, 3rd tax, 2nd, 3rd, 4th types of unit trusts, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th, 10th, 11th, 12th, 13th valuation point, 2nd websites, 2nd, 3rd see also tracker funds Funds & Shares Account see Dealing Account gearing/borrowing, 2nd, 3rd General Investment Account (GIA) see Dealing Account Germany gilts/government bonds see corporate bonds and gilts Google alerts gross rate (interest) group personal pension schemes growth funds guaranteed annuity rates holiday homes, 2nd hyperbolic discounting incapacity/serious ill-heath and SIPPs income drawdown from SIPPs, 2nd, 3rd, 4th capped, 2nd, 3rd flexible, 2nd, 3rd, 4th, 5th income funds income tax bonds and gilts dividends, 2nd, 3rd, 4th, 5th EISs, 2nd funds gifts to spouse or civil partner interest income, 2nd, 3rd investment trusts, 2nd onshore life insurance investment bonds pension income venture capital trusts index-linked gilts, 2nd, 3rd inflation, 2nd, 3rd, 4th, 5th cash on deposit, 2nd index-linked gilts, 2nd, 3rd inflation-linked corporate bonds inheritance tax, 2nd, 3rd, 4th AIM shares, 2nd Junior ISAs SIPPs, 2nd, 3rd insolvency of product providers insurance interest cover ratio interest rates, 2nd bonds: effect of, 2nd cash ISAs, 2nd investment platforms, 2nd intestacy investment accounts Dealing Account see separate entry ISA see separate entry SIPP see separate entry investment grade bonds, 2nd, 3rd investment platforms, 2nd, 3rd, 4th cash accounts, 2nd, 3rd, 4th, 5th, 6th charges, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th, 10th, 11th, 12th choosing complaints dividends, 2nd, 3rd equities, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th ETFs initial charge on funds, 2nd, 3rd, 4th, 5th insolvency, 2nd investment trusts, 2nd, 3rd ISAs, 2nd, 3rd, 4th, 5th, 6th Level 2 market data management charge: commission to, 2nd, 3rd, 4th, 5th, 6th, 7th model portfolios, 2nd, 3rd, 4th overseas equities, 2nd, 3rd rebates to investors, 2nd, 3rd, 4th, 5th, 6th retail corporate bonds RNS alerts by email or text shareholder perks, 2nd SIPPs, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th stop losses and limit orders venture capital trusts investment trusts, 2nd, 3rd, 4th, 5th, 6th, 7th borrowing/gearing, 2nd charges, 2nd, 3rd corporate actions discounts, 2nd, 3rd, 4th, 5th, 6th dividends exchange market size (EMS) history mechanics of buying and selling net asset value (NAV), 2nd performance premiums, 2nd, 3rd REITs research risks, 2nd sectors covered by share price split-capital trusts, 2nd, 3rd, 4th structure subscription shares tax, 2nd venture capital trusts, 2nd, 3rd warrants, 2nd investments advanced DIY investor cash see separate entry corporate bonds and gilts see separate entry equities see separate entry funds see separate entry investment trusts see separate entry ISAs: permitted, 2nd, 3rd, 4th, 5th, 6th, 7th SIPPs, 2nd, 3rd, 4th, 5th, 6th, 7th tracker funds see separate entry ISA (Individual Savings Account), 2nd, 3rd, 4th, 5th, 6th Bed and, 2nd cash, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th charges, 2nd, 3rd, 4th, 5th finding a provider history of investment platforms, 2nd, 3rd, 4th, 5th, 6th Junior paying money in permitted investments, 2nd, 3rd, 4th, 5th, 6th, 7th SIPP or, 2nd, 3rd stocks and shares, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th tax, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th, 10th, 11th, 12th, 13th, 14th, 15th transferring existing, 2nd who can pay into why have workings of ISIN number junk bonds, 2nd, 3rd KIID (Key Investor Information Document) life expectancy, 2nd, 3rd, 4th life insurance investment bonds long-term buy and hold, 2nd long-term investing market makers, 2nd, 3rd medium-term investing model portfolios, 2nd, 3rd, 4th money market/cash funds, 2nd, 3rd money purchase schemes company schemes SIPP see separate entry Morningstar, 2nd National Insurance contributions SIPPs, 2nd, 3rd National Savings & Investments (NS&I), 2nd Newcits nominees, 2nd, 3rd objectives portfolio building occupational pension schemes see company pension schemes OEICs (open-ended investment companies) see funds onshore and offshore life insurance investment bonds open-ended funds exchange-traded funds (ETFs) see separate entry unit trusts and OEICs see funds ORB (Order Book for Retail Bonds), 2nd overseas banks overseas investments, 2nd, 3rd SIPPs overseas residents P/E ratio, 2nd, 3rd P60 form passive funds see tracker funds pensions annuities, 2nd, 3rd, 4th auto-enrolment into workplace bankruptcy calculators on internet final or career average salary schemes, 2nd, 3rd impact on fund of charges money purchase schemes see separate entry objectives overseas schemes SIPP see separate entry stakeholder, 2nd Pensions Advisory Service Pensions Ombudsman PEPs (Personal Equity Plans) performance fees, 2nd permanent interest bearing shares (PIBS), 2nd perpetual sub bonds (PSBs), 2nd personal pension schemes SIPP see separate entry political and regulatory risk portfolio construction, 2nd pound-cost averaging, 2nd property commercial see separate entry residential, 2nd, 3rd, 4th QROPS (Qualifying Recognised Overseas Pension Scheme) quantitative easing rampers rating agencies, 2nd, 3rd, 4th ratios, financial, 2nd, 3rd, 4th re-registration investment platforms ISAs SIPPs, 2nd Real Estate Investment Trusts (REITs) reckless caution regulatory and political risk resident abroad residential property holiday homes, 2nd REITs Retail Distribution Review (RDR), 2nd, 3rd, 4th, 5th, 6th, 7th, 8th retirement, 2nd pensions see separate entry rights issues risk appetite, 2nd objectives, strategy and risks, 2nd AIM shares building risk adjusted portfolio cash and inflation, 2nd corporate bonds and gilts, 2nd, 3rd, 4th, 5th equities, 2nd, 3rd, 4th ETFs FTSE SmallCap investment trusts, 2nd overseas equities pound-cost averaging, 2nd structured products RNS (Regulatory News Service) alerts by email or text salary sacrifice scrip dividend Section 32 plan, 2nd SEDOL number self assessment tax return, 2nd, 3rd, 4th shares see equities ‘shelf-space’ deals SIPP (Self-Invested Personal Pension), 2nd, 3rd, 4th, 5th Bed and benefits see SIPP, taking benefits from borrowing charges, 2nd, 3rd, 4th complaints contributions death and assets in, 2nd divorce full or full fat, 2nd, 3rd history investment platforms, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th investments, 2nd, 3rd, 4th, 5th, 6th, 7th ISA or, 2nd, 3rd loans by overview, 2nd reasons to have or not recycling, 2nd salary sacrifice tax and SIPPs see separate entry transferring existing pensions into/out of see separate entry VAT SIPP, taking benefits from capped drawdown, 2nd, 3rd flexible drawdown, 2nd, 3rd, 4th, 5th incapacity, 2nd income drawdown, 2nd, 3rd, 4th, 5th, 6th, 7th lifetime allowance, 2nd lifetime annuities see annuities normal minimum pension age overview partial drawdown protected pension age protected tax-free lump sum protection from lifetime allowance serious ill-health small funds withdrawal tax on pensions tax-free lump sum, 2nd, 3rd, 4th transitional protection, 2nd smaller companies, 2nd, 3rd, 4th, 5th, 6th specialist funds split-capital trusts, 2nd, 3rd, 4th spouse, 2nd, 3rd, 4th, 5th gifts to, 2nd, 3rd income drawdown, 2nd spread betting stamp duty, 2nd, 3rd, 4th, 5th, 6th AIM shares ETFs, 2nd investment trusts star fund managers, 2nd stock transfer form stockbrokers, 2nd, 3rd stocks see equities stop loss and limit orders, 2nd strategies for investing, 2nd growth income long-term buy and hold, 2nd objectives, risk appetite and passive value structured products takeovers tax, 2nd, 3rd AIM shares Bed and breakfast, 2nd Bed and ISA, 2nd Bed and SIPP Bed and spouse Dealing Account, 2nd, 3rd death, 2nd dividends, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th EISs, 2nd equities, 2nd, 3rd, 4th, 5th ETFs, 2nd funds, 2nd, 3rd, 4th gifts to spouse or civil partner, 2nd interest income, 2nd, 3rd, 4th, 5th investment trusts, 2nd ISA or SIPP, 2nd ISAs, 2nd, 3rd, 4th, 5th, 6th, 7th, 8th, 9th, 10th, 11th, 12th, 13th, 14th, 15th Junior ISAs and inheritance National Savings certificates onshore and offshore life insurance investment bonds overseas equities PIBS rebates of commission to investors, 2nd, 3rd REITs SIPPs see tax and SIPPs stamp duty see separate entry takeovers VAT, 2nd venture capital trusts, 2nd withholding tax and SIPPs, 2nd, 3rd, 4th, 5th, 6th Bed and SIPP bond income or gains contributions and tax relief, 2nd, 3rd, 4th death, 2nd enhanced protection, 2nd excess over lifetime allowance fixed protection interest on cash, 2nd, 3rd investments, 2nd pension income, 2nd serious ill-health tax-free lump sum, 2nd, 3rd, 4th, 5th unlisted shares TESSAs (Tax-Exempt Special Savings Accounts) time commitment tips in financial press, 2nd, 3rd, 4th total expense ratio (TER), 2nd, 3rd, 4th tracker funds, 2nd, 3rd, 4th, 5th, 6th active vs passive debate, 2nd emotion taken out of investing exchange-traded funds (ETFs) see separate entry indices, 2nd structure of transferring existing pensions into/out of SIPP charges and transfer penalty, 2nd defined benefits, 2nd guaranteed annuity rates in-specie transfers, 2nd issues to consider options at retirement overseas schemes partial transfers pensions in payment, 2nd protected pension age rules on pension transfers transitional protection, 2nd types of pension scheme with-profits investments, 2nd Trustnet, 2nd, 3rd, 4th UCIS (Unregulated Collective Investment Schemes), 2nd, 3rd, 4th UCITS (Undertakings for Collective Investments in Transferable Securities), 2nd, 3rd, 4th unit trusts see funds United States, 2nd unquoted shares SIPPs, 2nd, 3rd, 4th, 5th, 6th value investor VAT (value added tax), 2nd venture capital trusts (VCTs), 2nd, 3rd warrants, 2nd websites, 2nd, 3rd, 4th, 5th advanced DIY investor equities, 2nd, 3rd ETFs funds, 2nd, 3rd gilts investment trusts, 2nd ISAs PIBS pricing of platforms, 2nd retail corporate bonds risk-profiling tools savings accounts, 2nd PEARSON EDUCATION LIMITED Edinburgh Gate Harlow CM20 2JE United Kingdom Tel: +44 (0)1279 623623 Web: www.pearson.com/uk First published 2013 (print and electronic) © Andy Bell 2013 (print and electronic) The right of Andy Bell to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988.


pages: 586 words: 159,901

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

Orange County, California, lost millions on derivatives, and filed for bankruptcy rather than tax its rich citizens enough to make good on their debts,'^ and a small army of Wall Street hotdogs were either badly wounded or driven (at least temporarily) out of business. To avoid embarrassment and possible runs, several prominent mutual fund companies had to subsidize derivatives losses in bond and money-market funds. People heard and said bad things about derivatives without too clear a sense of what they are. The word refers to a broad class of securities — though securities seems too tangible a word for some of them — whose prices are derived from the prices of other securities or even things. They range from established and standardized instruments like futures and options, which are very visibly traded on exchanges, to custom-made things like swaps, collars, and swaptions.

No other industrial country offered fixed-rate loans, since they put all the financial risk of higher interest rates onto the lender; with floating-rate or adjustable loans, the borrower bears all the risk (Lomax 1991; U.S. Congressional Budget Office 1993)- Thrifts were insulated from competition by limits on commercial bank deposits Thrifts prospered during the housing boom that followed World War IL Deposits and mortgage loans soared, though capital ratios sank as profits lagged growth. Growing competition from banks for both deposits and mortgage loans in the 1960s and money market funds for deposits in the 1970s drew customers away from thrifts. Worse, the inflation and high interest rates of the later 1970s exposed the S&Ls' tragic flaw, borrowing short to lend long: depositors tempted by higher rates in the unregulated world were free to withdraw on a whim, but their funds had been committed by thrift managers to 30-year mortgages. As rates rose, the value of outstanding mortgages sank (like bonds, loan values move in the opposite direction of interest rates).

(Major central banks, that is; the Fed and the Bundesbank are mighty, but the Bank of Mexico is weak and the Bank of Zaire little more than a joke.) Since financial asset prices are built largely of expectations about the future, stimuli or depressants to those expectations bear very directly on their prices. Optimism boosts prices, and pessimism depresses them. Relative attractiveness of alternative investments. When interest rates are low or falling, people despair of the earnings on their Treasury bills, bank deposits, or money market funds; they search for juicier profits, and plunge into stocks or long-term bonds, which typically pay higher interest rates than short-term instruments. But when rates are rising, the relative attractiveness of short-term investments rises. If you can earn 7% on a CD, it may not be worth taking the extra risk of holding stocks; but at 2% interest rates, stocks seem much less intimidating — irresistible even.


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

Once Lehman Brothers declared bankruptcy on September 15, 2008, the bonds issued by this venerable 158-year-old investment bank became nearly worthless. The next day, the Reserve Primary Fund, a money market fund with about $65 billion in assets, announced that they were “breaking the buck”—shares in their fund that were supposed to be valued at $1.00 were now worth 97 cents. Many customers treat their money market funds like a bank’s checking account; what would you do if your bank told you that the assets in your checking account just lost 3 percent in value overnight? The difference is that the Federal Deposit Insurance Corporation (FDIC) insures the assets in your checking account up to $100,000, while money market funds were not insured at that time (now they are). By Thursday, September 18, 2008, Federal Reserve Chair Ben Bernanke was telling key legislators that without immediate action, “we may not have an economy on Monday.”3 There’s very little evidence he was mistaken.

It’s meant for the so-called “qualified” or “sophisticated” investor—meaning the investor must have enough money not to worry about losing it all. Currently, the legal definition of a sophisticated investor is someone with at least $2.5 million in net worth. Because such investors can withstand significant financial losses, and are assumed to understand the risks of a private investment partnership, hedge funds are under much less stringent regulation than a mutual fund or a money market fund. Hedge funds used to be almost completely unregulated, but under the Dodd-Frank Act of 2010, hedge funds are now required to register with the Securities and Exchange Commission (SEC) and provide a certain amount of information to the government. Even so, there are still very few restrictions on what a hedge fund can or can’t do. They can take on all sorts of investment opportunities across different asset classes, in different countries, buying long, selling short, at lightning speed or more slowly, and so on.

The short answer is: everybody. At least while housing prices were rising and interest rates were falling. The particular species of the financial ecosystem that benefited from the real estate boom were (in alphabetical order): central bankers; commercial banks; credit rating agencies; economists; government-sponsored enterprises; hedge funds; homeowners; insurance companies; investment banks; investors; money market funds; mortgage lenders, brokers, servicers, and trustees; mutual funds; regulators; and politicians. Everyone had an incentive to keep the bubble growing, since a rising tide lifts all boats. As Warren Buffett warned, however, it’s only when the tide goes out that you find out who’s swimming naked. Apparently a great deal of skinny-dipping had been going on. CLEAR AS RASHOMON Given these facts, making sense of the financial crisis is an ongoing challenge.


pages: 345 words: 87,745

The Power of Passive Investing: More Wealth With Less Work by Richard A. Ferri

asset allocation, backtesting, Bernie Madoff, buy and hold, capital asset pricing model, cognitive dissonance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, endowment effect, estate planning, Eugene Fama: efficient market hypothesis, fixed income, implied volatility, index fund, intangible asset, Long Term Capital Management, money market fund, passive investing, Paul Samuelson, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve, zero-sum game

Marlena Lee, a research associate at Dimensional Fund Advisors with a Ph.D. from the University of Chicago wrote an unpublished study on bond fund returns in 2009. Lee analyzed 2,353 bond funds over the period from January 1991 to December 2008. The data included investment-grade, high-yield, and government bond funds from the CRSP Survivor-Bias-Free U.S. Mutual Fund Database. It excluded municipal bond funds, money market funds, index funds, and asset-backed funds.4 Lee used a five-factor risk model for her analysis. The five-factor model was based on the Fama-French Three-Factor Model plus two bond specific risk factors: term risk and default risk. This model was modified from an earlier five-factor model introduced by Fama and French in 1993.5 Lee concluded that the average underperformance of actively managed bond funds was 0.9 percent after adjusting for risk.

The plan sponsor should have a well articulated policy for selecting investment options and a method for reviewing those options on an annual basis. Later chapters make a detailed case for passive investing for institutional investors. Chapter 12 covers charities and private trusts, while Chapter 13 covers pension funds and self-directed employer-sponsored plans such as 401(k) plans. Step 2: Study Market Risk and Estimate Returns Asset classes are broad categories of investments such as stocks, bonds, real estate, commodities, and money market funds. Each asset class can be further divided into categories. For example, stocks can be categorized into U.S. stocks and foreign stocks. Bonds can be categorized into taxable bonds and tax-free bonds. Real estate investments can be divided into owner-occupied residential real estate, rental residential real estate, and commercial properties. The subcategories can be further divided into investment styles and sectors.

A good way to look at asset allocation is as if an investor has two portfolios: a short-term portfolio for current cash needs plus emergency money and a long-term portfolio that provides cash for long-term liabilities and builds wealth. This approach is no different than a corporate balance sheet where current assets and current liabilities are separate from long-term assets and long-term liabilities plus owner’s equity. The short-term portfolio should be in safe assets such as money market funds, certificates of deposit, and short-term bond funds. The return on these investments won’t be high, but a high return is not the primary reason for investing this money. Safety is the most important objective. No investor should risk this capital because it’s needed to pay bills over the next year. The investments in the long-term portfolio should be more aggressive. Time is on the side of these assets, and it’s appropriate to take some risk in equities and perhaps higher risk fixed income to potentially earn a higher return.


pages: 435 words: 127,403

Panderer to Power by Frederick Sheehan

"Robert Solow", Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, British Empire, business cycle, buy and hold, call centre, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversification, financial deregulation, financial innovation, full employment, inflation targeting, interest rate swap, inventory management, Isaac Newton, John Meriwether, margin call, market bubble, McMansion, Menlo Park, money market fund, mortgage debt, Myron Scholes, new economy, Norman Mailer, Northern Rock, oil shock, Paul Samuelson, place-making, Ponzi scheme, price stability, reserve currency, rising living standards, rolodex, Ronald Reagan, Sand Hill Road, savings glut, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, stocks for the long run, supply-chain management, supply-chain management software, The Great Moderation, too big to fail, transaction costs, trickle-down economics, VA Linux, Y2K, Yom Kippur War, zero-sum game

A History of the Boom, 1982–1999 (New York: HarperBusiness, 2003), p. 114. 22Food and beverage inflation was 4.6 percent in 1990; www.bls.Gov/opub/ted/1999/ Jun/wk5/art01.txt. This does not seem like the time the population at large would embrace the stock market. The recession led to a slowing of consumer borrowing, yet net cash flows into stock mutual funds rose from $8 billion in 1985 to $13 billion in 1990 to $79 billion in 1992 and to $127 billion in 1993. In 1992 and 1993, money market funds suffered net outflows.23 The stock market was about to replace the bank deposit system (and money market funds) as the backbone of household wealth. The Recovery: Cutting Workers and Investment The economists declared the recession was over in March 1991, but there was little evidence of a recovery. Moreover, the large layoffs that followed were different from previous recessions; now, management was dismissed en masse. When 70,000 workers were laid off from General Motors in December 1991, CEO Robert Stempel announced that GM’s salaried workforce (that is, management) was being cut from 140,000 in 1985 to 70,000 by 1995.24 The median household income fell from $46,670 in 1989 to $44,665 in 1994.

At the August 16 meeting, Greenspan expressed satisfaction: “I think we clearly demonstrated that the bubble for all practical purposes has been defused.”37 The FOMC raised the funds rate another 0.50 percent at this meeting, to 4.75 percent. (It would follow with two more rate increases, to 6.0 percent, by February 1, 1995.) Greenspan was also forthright in public. On May 27, 1994, he told Congress that depositors had shifted their money out of banks and from money market funds into stocks and bonds, “and some of those buying the funds perhaps did not fully appreciate the exposure of their new investments to the usual fluctuations in bond and stock prices.”38 The Federal Reserve chairman was obviously well versed in the novice investor’s exposure to unfamiliar territory. Derivative Lessons Greenspan witnessed derivative mayhem when he raised the funds rate from 3.00 percent to 3.25 percent.

The Federal Reserve—or, rather, central banking as a whole—is not the sole cause of disturbances, but neither is it what it pretends to be. Alan Greenspan condemned asset inflation during the 1950s and 1960s; by the 1990s, he claimed that it didn’t exist, and even if it did, there was nothing that the Federal Reserve could do, since it could not recognize a bubble. The oldest generation was not up to running these personal hedge funds; it earned 1 percent on money market funds and ate cat food. Ben Bernanke has driven short-term interest rates below zero (after subtracting price inflation) to refloat the financial system that the Fed has overindulged and mismanaged at every turn. Now, suffering another asset deflation—following another asset bubble—the Federal Reserve is driving the young and old to cat food. Only Congress can dissolve the Federal Reserve. It is time to do so. 53 Sidney Homer and Richard Eugene Sylla, A Profile of Interest Rates, 4th ed.


pages: 701 words: 199,010

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

Morgan Stanley also started making some of its financial statements more transparent by specifying the contents of corporate and other debt, which it had not done in previous financial statements. CHAPTER 12 The Absurdity of Imbalance Next to love, balance is the most important thing. —John Wooden When Lehman Brothers went into bankruptcy, the first sign of trouble happened in a money market fund called the Reserve Primary Fund (RPF). With $65 billion in assets, the RPF was one of the largest money market funds in the United States. Money market funds are a short-term savings vehicle and are considered extremely safe, because they invest in short-term, safe assets. One of RPF’s investments was in Lehman Brothers commercial paper, which companies issue for short-term financing. When Lehman Brothers went bankrupt, the RPF lost $785 million from its Lehman exposure.

CHAPTER 11 The Lehman Bankruptcy There’s no doubt that things feel better today, by a lot, than they did in March…the worst is likely to be behind us… —Hank Paulson, Treasury Secretary, May 6, 2008 Seven days after the government rescued Freddie Mac and Fannie Mae, Lehman Brothers declared bankruptcy. Their failure made commercial paper markets falter, making it difficult for companies to borrow short-term funds. It caused a run on money market funds, created an imbalance in the bond and swap markets, and depressed the stock market. Lehman failed because of its large real estate exposure and because of a market that didn’t trust its solvency, leading to a run on the bank and guaranteeing its failure. The government did nothing to rescue Lehman. To understand Lehman’s failure and its place in the subprime debt crisis, it’s important to also understand the intricate details of the investment banking business, as well as major investment banks’ leverage and real estate exposures.

When Lehman Brothers went bankrupt, the RPF lost $785 million from its Lehman exposure. The fund “broke the buck,” meaning its net asset value was less than $1 a share. It was losing money, which is nearly unheard of in a short-term, almost riskless investment. Investors began to panic. The RPF had a total of $39 billion in withdrawals, and other crowds withdrew money from other money market funds, pulling a total of $172 billion from a $3.45 trillion market. The market stopped trusting commercial paper. Commercial paper yields shot up, going from 10 basis points over the Federal Funds rate to 150 basis points over the Fed Funds rate in just two days. Large U.S. companies fund themselves through the commercial paper market, and the yield spike made it too costly for them to finance their activities. The Federal Reserve moved quickly and launched new programs to help resolve the mess that they had created by letting Lehman fail.1 The price of short-term lending between banks also soared as trust between banks weakened.


pages: 368 words: 145,841

Financial Independence by John J. Vento

Affordable Care Act / Obamacare, Albert Einstein, asset allocation, diversification, diversified portfolio, estate planning, financial independence, fixed income, high net worth, Home mortgage interest deduction, money market fund, mortgage debt, mortgage tax deduction, oil shock, Own Your Own Home, passive income, risk tolerance, the rule of 72, time value of money, transaction costs, young professional, zero day

If you fear that your job is in jeopardy, or you think it will c01.indd 6 26/02/13 11:18 AM Committing to Living within Your Means 7 take you longer than six months to get back on your feet financially should you lose your job, you should try to have even more in savings. Also, if you are saving for anything other than the proverbial rainy day, such as for a house, wedding, new car, or special trip, count these funds as extra. (It might even be helpful to open a separate savings account for these larger separate items you are saving for.) Given the relatively low interest rates offered at this time on cash instruments (which include savings accounts, money market funds, and certificates of deposit, or CDs), and the fact that the current rate of inflation is higher than the interest rate, you may actually be losing money on the ultimate purchasing power of your savings. However, do not let this alarm you too much. Saving in this way is still an essential part of getting to point X. Also, these savings come with Federal Deposit Insurance Corporation (FDIC) insurance of up to $250,000 per depositor, so your money is safe.

You should consult with your representative before making any investment decision. c03.indd 32 26/02/13 4:52 PM Determining Your Financial Position 33 $750,000. Furthermore, James’ investment portfolio, variable annuity, and IRA accounts are 100 percent invested in stock. This is not a well-balanced portfolio, and he may be taking on too much risk. Conversely, Patricia has 100 percent of her IRA account in money market funds, which are currently paying 0 percent! It seems clear that they need professional guidance and management from a financial advisor to help them diversify their investments so that they can both minimize their risks and maximize their returns.2 With regard to their retirement accounts, they have a total of only $55,500, which includes a variable annuity and their IRA accounts. As a couple, they always had an excuse for not funding their retirement account and instead chose to buy an expensive home, go into private practice, and purchase an office building.

Investments in prepaid tuition plans are also sometimes guaranteed by the sponsoring state government. Savings 529 tuition plans generally allow you to establish an account for a beneficiary for the purpose of paying the beneficiary’s qualified educational costs. As the account holder, you typically have several investment choices for your contributions in the 529 savings plan, which typically include stock and bond mutual funds as well as money market funds. Some also offer age-based portfolios. You can usually use the distributions from 529 savings plans at any U.S. college or university. Your beneficiary has the flexibility of choosing any college or university he or she gets accepted to, in any state. It is important to note that the investments in these 529 savings plans are not guaranteed by state governments. Prepaid 529 plans are treated differently than 529 savings plans because they are considered resources rather than assets.


No Slack: The Financial Lives of Low-Income Americans by Michael S. Barr

active measures, asset allocation, Bayesian statistics, business cycle, Cass Sunstein, conceptual framework, Daniel Kahneman / Amos Tversky, financial exclusion, financial innovation, Home mortgage interest deduction, income inequality, information asymmetry, labor-force participation, late fees, London Interbank Offered Rate, loss aversion, market friction, mental accounting, Milgram experiment, mobile money, money market fund, mortgage debt, mortgage tax deduction, New Urbanism, p-value, payday loans, race to the bottom, regulatory arbitrage, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, the payments system, transaction costs, unbanked and underbanked, underbanked

Savings Percent unless otherwise noted All Banked Unbanked Savings horizona This year Next year In five years In ten years In more than ten years 47.6 33.9 17.4 7.3 14.2 47.8 33.7 17.9 7.3 14.9 46.3 34.8 14.9 7.1 10.8 Facing major expense for which unable to save Feels in deep financial trouble 37.0 18.4 36.7 14.6 37.7 28.0 Saving is not “worth it” Agree Disagree 16.4 83.4 16.6 83.3 16.4 83.6 Hard to save because money goes to necessities Agree Disagree 85.1 14.6 81.7 17.9 93.5 6.5 Hard to save because hard to resist spending Agree Disagree 64.9 34.6 61.3 38.3 73.8 25.6 Frequency of saving In past year More than once a month Every month Most months About half of months A few months Once or twice Never 54.1 10.4 19.2 4.0 3.7 5.5 11.3 45.9 62.7 12.8 23.2 4.0 4.6 6.3 12.0 37.3 32.8 4.5 9.4 4.0 1.7 3.7 9.5 67.2 Mean amount contributed (dollars)b Median amount contributed (dollars) 2,474 (385) 1,000 2,825 (447) 1,000 Asset holdings Savings account Retirement savings Life insurance Money market funds Jewelry, electronics Car Home 49.2 48.2 30.3 17.0 15.3 73.0 45.4 67.8 51.1 35.7 22.9 14.9 79.6 53.4 Reasons to save Financial security Emergency or medical costs Unanticipated job loss Special events Home improvements 78.2 69.9 50.9 52.8 49.3 79.1 68.7 48.1 49.3 49.1 12864-02_CH02_3rdPgs.indd 39 949 (202) 300 0.0 34.9 16.9 2.4 16.5 56.5 25.7 74.3 75.8 64.3 69.2 50.3 (continued) 3/23/12 11:55 AM 40 michael s. barr Table 2-5.

Asset Holding among LMI Households Despite the difficulty of asset accumulation, many LMI households are able to build savings. About 90 percent of the LMI households accumulate physical and financial assets in both formal and informal ways; 75 percent hold formal or informal financial assets. Nearly half have a savings account, 36 percent have retirement savings, and 30 percent have life insurance, while only 17 percent have money market funds, bonds, or CDs, and 15 percent save through holding cash, jewelry, gold, appliances, or electronics. Nonfinancial assets are more valuable than financial assets for LMI households. Roughly 75 percent of respondents own a car, and 45 percent own a home. Owning a car and home significantly increases the median value of assets for respondents—to about 12864-02_CH02_3rdPgs.indd 42 3/23/12 11:55 AM managing money 43 $68,000—but that amount falls to $2,500 when the value of homes and automobiles is excluded.

Assets, Debts, and Income, by Bankruptcy Filing a Dollars unless otherwise noted Ever declared Declared, but not recently 1,636 43.9 490 39.2 627 43.0 96 28.2 1,843 44.7 44,614 40.3 8,274 6.4 10,338 3,000 73.9 876 3.3 7,495 11.0 9,525 28.0 4,485 14.0 4,277 13.7 1,282 14.0 15,527 24.8 190 1.5 108,520 38,400 89.2 40,958 37.6 7,620 6.4 13,406 6,000 94.3 565 3.5 5,720 12.8 10,761 32.6 3,173 14.2 7,291 12.8 1,690 14.9 25,543 29.8 16 2.1 117,234 52,900 91.7 46,531 40.0 7,489 5.7 14,342 8,000 92.4 305 2.9 5,265 11.4 12,499 31.4 4,086 14.3 9,685 12.4 2,200 16.2 31,114 27.0 21 2.9 134,164 60,200 94.6 24,989 28.9 7,998 7.9 10,724 3,400 94.7 1,311 5.3 7,025 15.8 5,781 34.2 560 13.2 432 13.2 227 10.5 9,581 36.8 0 0 68,722 50,000 83.5 45,344 35.0 8,415 5.9 9,775 3,000 90.8 934 3.1 7,834 10.6 9,330 20.4 4,646 9.4 3,753 10.0 1,213 13.7 13,664 20.2 222 1.6 106,972 31,600 88.7 3.0 3.2 3.3 2.8 3.0 1,548 38.1 16,941 26.6 461 2.0 1,257 44.9 22,126 30.0 882 5.7 1,424 48.6 24,761 32.4 1,190 7.7 780 34.5 14,576 22.9 0 0 All Asset Amount in checking and savings accounts Value of house Other real estate Vehicles Business or farm Stocks or investments IRAs Retirement account Money market funds Jewelry, gold, other goods Other assets Additional savings Total assets Has at least one asset Mean number of assets Debt Credit card Mortgage Second mortgage 12864-08_CH08_2ndPgs.indd 190 Declared in past twelve months Never declared 1,602 36.1 16,047 26.0 387 1.3 (continued) 3/23/12 11:57 AM living on the edge of bankruptcy 191 Table 8-3. Assets, Debts, and Income, by Bankruptcy Filing (continued ) Dollars unless otherwise noted Equity loan Other home loan Car loan Title loan Student loan Medical bills Legal bills Other loan Total debt Has at least one debt Mean number of debts Income Respondents’ monthly earnings Total household monthly income Annual household income in 2004 Debt-to-income ratio Sample size All Ever declared Declared, but not recently Declared in past twelve months 1,120 5.0 457 2.7 2,428 24.7 1.62 0.19 2,093 15.5 637 20.8 106 1.9 877 11.6 26,490 3,394 74.2 855 3.8 763 5.5 3,338 33.6 0 0 4,310 24.2 591 27.0 113 2.3 1,291 10.9 37,143 11,500 85.4 1,141 5.0 937 6.9 4,080 39.7 0 0 3,752 23.7 588 28.7 138 0.7 1,579 12.3 41,379 18,000 87.3 0 0 263 1.6 1,213 16.2 0 0 5,892 29.4 600 22.1 40 7.1 453 6.9 24,534 5,000 79.9 2.5 2.8 1.9 2.0 Never declared 1,170 5.3 404 2.2 2,250 23.0 1.91 0.20 1,649 13.8 647 19.7 105 1.9 806 10.1 24,964 3,000 72.3 1.9 1,337 1,288 1,392 970 1,350 2,249 1,977 2,150 1,443 2,306 28,435 34,023 36,341 27,124 27,358 1.17 0.20 938 1.67 0.54 141 1.81 0.54 105 1.19 0.29 37 1.08 0.18 794 Source: Detroit Area Household Financial Services study. a.


pages: 515 words: 132,295

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

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

By the late 1960s, companies were touting “hot” fund managers and treating them like Hollywood stars. Volatility in such funds was increasing dramatically, but the growth of inflation in the 1970s meant that investors were desperate to earn a decent return. Despite the risks, they began moving money from bank deposit accounts to money market funds and mutual funds. This shift, as we have seen, had the domino effect of encouraging the banking industry to push for deregulation that would allow it more access to the consumer market, contributing to debacles like the 2008 subprime crisis. “With the rise of bond funds and money market funds, nearly all of the major fund managers—which for a half-century had primarily operated as professional investment managers for one or two equity funds—became business managers, offering a smorgasbord of investment options,” says Bogle.12 Suddenly the primary goal of funds wasn’t to earn steady returns for clients, but to earn profits for the firm.

The very riskiest portion of the markets, derivatives trading, actually grew following the crisis. Globally, it was 20 percent bigger in late 2013 than in late 2007 (and US regulators are trying to police it with budgets that haven’t increased much since then).6 And that’s just what we can see. Shadow banking, the portion of the financial industry that remains largely unregulated (and includes hedge funds, money market funds, and financial arms of big companies like GE), has grown like kudzu: swelling by more than $1.3 trillion per year since 2011 and reaching $36 trillion today.7 Through it all, low interest rates set by the Federal Reserve, which were supposed to help individuals, ended up making the rich richer by inflating the stock market rather than improving the ability of real people to refinance their homes.

Just think of the demise of the hedge fund Long-Term Capital Management and the global market ripples it created; the government’s intervention to offset the impact of the fund’s failure belies the notion that shadow banking entities don’t enjoy federal backstopping of the Too Big to Fail kind, albeit implicitly rather than explicitly. Since the financial crisis of 2008, it’s the shadow banking sector rather than the federally guaranteed banks that has grown like kudzu, as risk migrates to the darkest parts of the system. While the share of formal bank assets has declined as a percentage of the total global financial system, shadow banks (which include not only private equity but also hedge funds, money market funds, structured finance vehicles, real estate investment trusts, and other exotic, acronym-wielding creatures) grew by 10 percent in 2014 alone, reaching $36 trillion, or more than twice the size of the U.S. economy.45 It’s telling that as regulators have tried with varying degrees of success to shine a light on the formal banking sector, money, talent, and risk have quickly fled to the informal sector.


Work Less, Live More: The Way to Semi-Retirement by Robert Clyatt

asset allocation, backtesting, buy and hold, delayed gratification, diversification, diversified portfolio, employer provided health coverage, estate planning, Eugene Fama: efficient market hypothesis, financial independence, fixed income, future of work, index arbitrage, index fund, lateral thinking, Mahatma Gandhi, McMansion, merger arbitrage, money market fund, mortgage tax deduction, passive income, rising living standards, risk/return, Silicon Valley, Thorstein Veblen, transaction costs, unpaid internship, upwardly mobile, Vanguard fund, working poor, zero-sum game

Stock Fund on January 1, 2008 has actually grown to $400,000, the holding is overallocated by $400,000 – $348,150, or $51,850. By selling $51,850 worth of the U.S. Stock Fund, money is available not only to restock the money market fund, but also to buy either REIT Funds or U.S. Bond Funds, both of which are underallocated. The buying and selling in these four funds and the money market will net out to zero—meaning you will have raised just enough selling winners to purchase the additional amounts you need in the funds that have declined. Note that putting about 2% in the money market fund at the beginning of each year, when added to the 2% to 2.5% that most portfolios produce in interest and dividends over the course of the year, together neatly fund annual spending needs at a 4% to 4.5% safe withdrawal level

And Dimensional Fund Advisors (DFA) offers a variety of funds called enhanced index funds that track asset classes and tilts rather than an index per se. These will give you, for instance, funds tracking the International Small or International Large Value asset classes, making them a good fit for investors following the Rational Investing Method. Know Your Required Return It is possible to create portfolios with almost no risk—for example, those composed of bank CDs or money market funds—but they will generally lack sufficient return. The semi-retiree’s portfolio must remain substantially intact or grow against the triple assault of inflation (assume 3% per year), fees and trading costs (0.5% or so each year), and a 4% to 5% annual withdrawal over short periods as well as over the long run. In other words, adding together these three demands on your portfolio, you know that you need at least a 7.5% expected annual return to keep the real value of your portfolio intact each year.

Most funds invested in Small International Stocks are closed to new investors now after years of stellar results. Top funds from Vanguard, Fidelity, Oakmark, and Artisan all closed in the 332 | Work Less, Live More last few years. However, the DFA Small International funds remain open to those with access to these DFA funds through an adviser. Bonds Short-Term Bonds/Cash This is the typical money market fund in which cash is swept or left while awaiting investing, spending, or rebalancing. An alternative that might have slightly higher yield would be Vanguard’s Short-Term Investment grade Corporate Bond fund. Treasuries For this asset class, buy Treasury Bonds or inflation-adjusted I-Bonds directly through Treasury Direct at www.treasurydirect.gov, buy a U.S. Treasury bond mutual fund, or buy Treasury Inflation-Protected Securities (TIPS).


pages: 363 words: 98,024

Keeping at It: The Quest for Sound Money and Good Government by Paul Volcker, Christine Harper

anti-communist, Ayatollah Khomeini, banking crisis, Bretton Woods, business cycle, central bank independence, corporate governance, Credit Default Swap, Donald Trump, fiat currency, financial innovation, fixed income, floating exchange rates, forensic accounting, full employment, global reserve currency, income per capita, inflation targeting, liquidationism / Banker’s doctrine / the Treasury view, margin call, money market fund, Nixon shock, Paul Samuelson, price stability, quantitative easing, reserve currency, Right to Buy, risk-adjusted returns, Ronald Reagan, Rosa Parks, secular stagnation, Sharpe ratio, Silicon Valley, special drawing rights, too big to fail, traveling salesman, urban planning

So was the failure in October 1974 of the fast-growing Franklin National Bank in Long Island, New York, a victim of fraud. So it wasn’t too long before Chairman Patman, the congressional archenemy of the Fed, got his way. Financial crises became the order of the day. By the end of the 1970s, the financial world I’d always known was beginning to break down. The unique role of commercial banks was challenged by new rivals. Proliferating money market funds, free of regulation, offered higher yields than bank deposits. Investment banks increasingly began trading to generate revenue and competed to finance ambitious corporate takeovers and leveraged buyouts. Traditionally conservative “thrift” institutions—savings and loans and mutual savings banks—became more aggressive, taking advantage of lax regulation and higher interest-rate ceilings than those enforced on commercial banks.

The financial markets settled down again after the Bear Stearns affair, but I was increasingly uneasy. Given our past experience, former Bush Treasury secretary Nick Brady and I would, from time to time, put our heads together. We were both concerned that Bear Stearns would be only the leading edge of the gathering crisis. The two big mortgage agencies, Fannie Mae and Freddie Mac, were under pressure. Money market funds seemed vulnerable and strange excesses seemed to be appearing in the derivatives market. Along with Gene Ludwig, the former comptroller of the currency, we formulated a plan: establish a governmental agency other than the Fed that would be equipped to buy assets and inject capital into vulnerable institutions, following the pattern of the Resolution Trust Corporation that helped clean up the savings and loans in the later 1980s and early 1990s (itself modeled on the Reconstruction Finance Corporation established in 1932 by the conservative Republican Hoover administration).

In June, President Obama proposed a sweeping overhaul of the US financial regulatory system, including the cherished new consumer financial protection agency. He also emphasized the need for greater Federal Reserve oversight of the major financial institutions and more effective interaction among the various agencies. To my mind, several key issues were unresolved, including really effective reorganization of the regulatory structure, the appropriate role of money market funds, and, critically, restraints on speculative trading by government-protected commercial banks, which now included major investment banks that had been allowed to convert to banks with Fed supervision and support at the height of the crisis. I’d lived through enough financial crises, and enough Federal Reserve Boards and chairmen, to know that there had been repeated lapses in attention paid to potential threats to financial stability.


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

By the mid-2000s, this business and the institutions behind it had grown exponentially to form a shadow banking system with twin operations in the interdependent New York and London markets. Simultaneously, they had paved the way for the new financial industries of hedge funds – investment vehicles constructed solely to take high-risk positions in the quest for unprecedented gain – private equity and money market funds. But many of the new institutions – the money market funds, the hedge funds and even the investment banks themselves – did not have access to a central bank acting as lender of last resort; nor did they have any form of deposit insurance. Furthermore, in the guidelines for the 2004 Basel prudential banking rules – so-called Basel 2 – the international regulators amazingly handed back to the banks responsibility for assessment of their own risk and thus left them to decide the amount of capital they should hold.

If they can build up a position of leveraged lending to a portfolio of borrowers, especially in a class of assets that are appreciating in value, there are fortunes to be made for both financiers and their shareholders. Nor does greed play a particularly overwhelming role. The natural pressures of competition alone drive down the returns on lending while the demand to show good and rising returns mounts – forces on their own that encourage riskier lending. From the 1970s through to the 2000s, banks faced ever more competition for depositors’ cash: money market funds in the United States and demutualised building societies in the UK offered ever more attractive rates to depositors while large corporations built up treasury departments whose sole raison d’être was to maximise the interest on their cash. At the same time, transient, footloose shareholders demanded higher and quicker profits. Caught in this pincer, even the most conservative banks started to consider higher leverage or investing in riskier assets as the only means to survive.20 Unregulated nineteenth-century banking witnessed Northern Rock-type bank runs aplenty.

China was already in the process of proving that all of this was bunk by financing its world-beating growth through tightly controlled and regulated banks, but that did not stop the advocates of deregulation touting their theories with ever more zeal.24 Nothing could shake the consensus that lifting controls was good for everyone, and any costs were but transient blips on the road to the Nirvana of a competitive, deregulated banking system. The problem was that there was no steady-as-she-goes middle way. Deregulation was unstable. Once it had begun in one field, its logic demanded that it should be extended to others. Allow money market funds to compete for deposits, for example, and soon policy-makers had to allow banks to fight fire with fire by lifting controls on their interest rates. A level playing field demanded that the entire terrain had to become deregulated. The first British experiment in deregulation gave a warning of what was to come. In 1971 the banks were given greater freedom to borrow and lend. They instantly all lent more money to homebuyers, relaxed credit-worthiness terms and saw house prices rocket.


pages: 665 words: 146,542

Money: 5,000 Years of Debt and Power by Michel Aglietta

bank run, banking crisis, Basel III, Berlin Wall, bitcoin, blockchain, Bretton Woods, British Empire, business cycle, capital asset pricing model, capital controls, cashless society, central bank independence, collapse of Lehman Brothers, collective bargaining, corporate governance, David Graeber, debt deflation, dematerialisation, Deng Xiaoping, double entry bookkeeping, energy transition, eurozone crisis, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, forward guidance, Francis Fukuyama: the end of history, full employment, German hyperinflation, income inequality, inflation targeting, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invention of writing, invisible hand, joint-stock company, Kenneth Arrow, Kickstarter, liquidity trap, margin call, means of production, money market fund, moral hazard, Nash equilibrium, Network effects, Northern Rock, oil shock, planetary scale, plutocrats, Plutocrats, price stability, purchasing power parity, quantitative easing, race to the bottom, reserve currency, secular stagnation, seigniorage, shareholder value, special drawing rights, special economic zone, stochastic process, the payments system, the scientific method, too big to fail, trade route, transaction costs, transcontinental railway, Washington Consensus

Macroprudential Policy Since the 1970s, there has been an enormous explosion of financial assets. This was particularly true during the financial globalisation of the 1990s. This flourishing array of funding instruments constitutes a wholesale liquidity market ruled by the broker dealers (investment banks and the trading departments of universal banks). These new forms of liquidity are largely detached from retail banking and thus from deposit insurance. Fed by ‘money market funds’, this wholesale market provides a basis for shadow banking with enormous leverage and a systematic ‘mismatch’ of maturities, without any liabilities-side stability. Up until the general crisis in 2008, this market intermediation system operated through opaque risk transfer chains, unknown to market regulators and central banks. Trends in credit drive far-reaching cycles in the prices of financial assets.

Forms of risk exposed to the failures of coordination are the nests of systemic risk. These include synthetic, not completely replicated ETFs (Exchange Traded Funds); tripartite Repurchase Agreements (repos) exposed to forced collateral sales and excessively dependent on clearing banks’ intra-day credit to broker dealers; uninsured ABCP (Asset-Backed Commercial Paper) and FCP (Fonds communs de placement); aggressively yield-seeking money market funds, whose liabilities are presumed to be equivalent to money; and the products of non-standard securitisation, negotiated in opaque over-the-counter chains. Dynamic vulnerabilities refer to the high leverage of shadow banks (broker dealers, hedge funds, special purpose vehicles and conduits) and the maturity transformations incorporated into derivatives products. In the case of options, repos and short sales, leverage and maturity transformations operate in concert.

Macroprudential policy has a longer reaction time, and the channels through which it is transmitted are less well known than those of monetary policy. In principle, structural vulnerabilities are dealt with by static, or permanent, means: these include more demanding capital and liquidity obligations for the big banks, an authority that can resolve bank collapses in an orderly way, the centralised clearing of derivatives, and means of avoiding runs on money market funds. Yet even all of this is not enough to bypass the financial cycle. Innovations always exceed the limits established by the existing regulations. As we have seen, the financial system is strongly pro-cyclical and thus develops dynamic vulnerabilities of a macroeconomic character. It is necessary to be able to keep watch over the variations in the price of risk that result from lenders’ and borrowers’ strategic interactions.


pages: 275 words: 82,640

Money Mischief: Episodes in Monetary History by Milton Friedman

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

How they use that power depends on all the complex pressures listed in the previous paragraph. But that does not alter the fact that they and they alone have the arbitrary power to determine the quantity of what economists call base or high-powered money—currency plus the deposits of banks at the Federal Reserve banks, or currency plus bank reserves. And the entire structure of liquid assets, including bank deposits, money-market funds, bonds, and so on, constitutes an inverted pyramid resting on the quantity of high-powered money at the apex and dependent on it. Who are these nineteen people? They are seven members of the Board of Governors of the Federal Reserve System, appointed by the president of the United States for fourteen-year nonrenewable terms, and the presidents of the twelve Federal Reserve banks, appointed by their separate boards of directors, subject to the veto of the Board of Governors.

Credit at the local grocery store is not likely to be as readily available to smooth over discrepancies between receipts and expenditures. At the other extreme, in financially advanced and complex societies, such as the United States today, a wide array of assets is available that can serve as more or less convenient temporary abodes of purchasing power. These range from cash in pocket, to deposits in banks transferable by generally accepted check, to money-market funds, credit-card accounts, short-term securities, and so on, in bewildering variety. They reduce the demand for real cash balances narrowly defined, such as currency, but they may increase the demand for real cash balances more broadly defined by making temporary abodes of purchasing power useful in facilitating shifts between various assets and liabilities.* (2) Cost. Cash balances are an asset and, as such, an alternative to other, kinds of assets, ranging from other nominal assets, such as mortgages, savings accounts, short-term securities, and bonds, to physical assets, such as land, houses, machines, or inventories of goods, which may be owned either directly or indirectly, via equities, or common stocks.

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


pages: 236 words: 77,735

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

affirmative action, asset allocation, backtesting, barriers to entry, Bernie Madoff, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fiat currency, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, High speed trading, housing crisis, index fund, joint-stock company, money market fund, moral hazard, Myron Scholes, passive investing, Ponzi scheme, price discovery process, random walk, risk tolerance, risk-adjusted returns, risk/return, stocks for the long run, stocks for the long term, too big to fail, trade route, Vanguard fund, walking around money

Apparently you need to have at least one physical location, but nobody was ever expected to visit it. Want to know something more outrageous? The firm sent out a letter to all of their clients that held individual retirement accounts (IRA) accounts that year. It was a friendly letter informing them that their money market fund, which was where excess cash in the brokerage accounts was held, would be changed over to the “Bank Sweep” feature. On the surface this sounded great. You would have FDIC insurance on what was before just a money market fund, not insured by anything but the assets in that fund. But what was really happening? The brokerage firm was switching tons of assets from the brokerage side to the banking side to boost the bank’s deposits. It was nuts. Overnight, a bank that had nothing but a call center and a single location in Reno was now ready to start borrowing money from the Federal Reserve based on deposits that were created overnight with the click of a mouse.

You can’t concentrate all of your money into one illiquid sector of the market just because the rates are above normal. They are high for a reason. Here is the classic rigged system where well-meaning people rig themselves. In order to keep up with the competition during the housing bubble, credit unions had to attract more money from depositors to make loans. They juiced up returns like banks and money market funds with questionable pools of residential mortgages. We know the rest of the story. So, after the warm and fuzzy people-before-profits system was in place, it rigged itself out of billions of dollars and had to be bailed out just like the evil for-profit bankers. This doesn’t mean you shouldn’t support your local credit union if you have the opportunity. It does mean that we are still trapped by the larger institution of Wall Street no matter what our intentions are as consumers.


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

To distinguish them from the retail markets, the money markets are often known as the wholesale markets and the deposits or bills involved are usually denominated in large amounts. A typical deal might involve a loan of tens of millions of pounds. Investors in the markets tend to be anyone with short-term funds – banks, companies and fund management companies. Retail investors can get involved via money market funds – unit trusts which offer returns that are competitive with bank and building society accounts. This is a huge business which normally works very well, but broke down spectacularly in the summer of 2007. Transactions in the money markets have traditionally been in the form of either deposits or bills. Deposits are made (with the exception of money-at-call) for set periods of time at an agreed rate of interest.

Rates will rise very quickly if, for example, dealers think that inflation is increasing or that the pound is about to fall. Foreign investors can quickly withdraw their funds if they are worried about the UK economy. The flight of this so-called ‘hot money’ can put real pressure on a government. The money markets were at the heart of the credit crunch. Banks became reluctant to lend to each other, and outside investors (such as money market funds) were also unwilling to lend to banks. The result was that Libor rose sharply. Instead of being a few hundredths of a percentage point above base rates, Libor was two or three percentage points higher. This raised the cost of borrowing for everyone, and prompted central banks to lend directly in the money markets to try to ease the pressure. The central banks had some limited success but the difficulty of obtaining money at a reasonable price was one reason why the credit crunch became so serious.

The hope is that a diversified mix of such assets can deliver better returns than government bonds, but with less volatility than equities. The spare cash of the investment institutions goes into the money markets. Although their immediate outgoings are usually met by the premiums and contributions, the institutions still need liquid funds to meet any disparities. So they invest in bank certificates of deposit and money market funds. At certain times, when shares seem unsafe investments, the proportion invested in the money markets increases. OVERSEAS INVESTMENTS Nowadays, institutional portfolios are very international. In 1979, the government abolished exchange controls. This allowed the institutions to invest substantial sums abroad. In 1979, the proportion of pension fund portfolios held in the form of overseas equities was 6 per cent; by 2008, it was almost 30 per cent.


pages: 426 words: 115,150

Your Money or Your Life: 9 Steps to Transforming Your Relationship With Money and Achieving Financial Independence: Revised and Updated for the 21st Century by Vicki Robin, Joe Dominguez, Monique Tilford

asset allocation, Buckminster Fuller, buy low sell high, credit crunch, disintermediation, diversification, diversified portfolio, fiat currency, financial independence, fixed income, fudge factor, full employment, Gordon Gekko, high net worth, index card, index fund, job satisfaction, Menlo Park, money market fund, Parkinson's law, passive income, passive investing, profit motive, Ralph Waldo Emerson, Richard Bolles, risk tolerance, Ronald Reagan, Silicon Valley, software patent, strikebreaker, Thorstein Veblen, Vanguard fund, zero-coupon bond

Look for old bankbooks that you may have forgotten about, and that account that you opened with the minimum $100 to get the Free Bonus Digital Doohickey. ◆Checking accounts. ◆Savings certificates or certificates of deposit. ◆ U.S. savings bonds (including that one you got as a graduation gift and have since forgotten). ◆Stocks. List at current market value. ◆Bonds. List at current market value. ◆Mutual funds. List at current market value. ◆Money market funds. List at current market value. ◆Brokerage account credit balance. ◆Life insurance cash value. Fixed Assets In listing these, start with the obvious: the market value of your major possessions—e.g., your house, your car (or cars). Contact a realtor for the current market value of your house. Consult the “blue book” (available online or at your library) for the going price on the make, model and year of your car.

A dispassionate and compassionate attitude can go a long way toward making this step truly enlightening—i.e., able to lighten the physical and emotional loads you’ve been toting around for so many years. CHECKLIST FOR CREATING YOUR BALANCE SHEET Assets, Liquid Cash on hand Savings accounts Checking accounts Savings certificates or certificates of deposit U.S. savings bonds Stocks Bonds Mutual funds Money market funds Brokerage account credit balance Life insurance cash value Assets, Fixed House Vacation home Car(s) Furniture Antiques Art Clothes Sound system TV(s), DVD(s) Wedding dress Shoes/handbags Lamps Jewelry Debts owed you Security deposits Computer(s), printer Sports equipment Bicycle/motorcycle Silverware Kitchen: refrigerator, stove, microwave Power tools Digital camera, video camera Liabilities Bank loans School loans Credit-card debts Loans from friends Unpaid bills: medical, dental Balance on house Balance on car Other time payments With the completion of this step you have entered the here and now.

◆Easiest availability—directly from the federal government (Treasury Direct) and through most brokers and many banks anywhere in the world. ◆Cheapest availability—no middlemen, no commissions, no loads. ◆Duration—the range of maturities available is extensive; you can buy a note or bond that will mature in a few months or one that won’t come due for thirty years. ◆Absolute stability of income over the long run—ideal for FI. Avoids the income fluctuations that would occur with money market funds, rental real estate, etc. Treasury Bonds Treasury bonds are the ideal investment vehicle for FIers with a low risk tolerance because they protect principal, provide a steady stream of income and are relatively easy to understand. In addition, they are exempt from local and state taxes, can be bought and sold almost instantly with minimal handling charges, and are protected by the full faith and trust of the U.S. government.


pages: 354 words: 118,970

Transaction Man: The Rise of the Deal and the Decline of the American Dream by Nicholas Lemann

Affordable Care Act / Obamacare, Airbnb, airline deregulation, Albert Einstein, augmented reality, basic income, Bernie Sanders, Black-Scholes formula, buy and hold, capital controls, computerized trading, corporate governance, cryptocurrency, Daniel Kahneman / Amos Tversky, dematerialisation, diversified portfolio, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, fixed income, future of work, George Akerlof, gig economy, Henry Ford's grandson gave labor union leader Walter Reuther a tour of the company’s new, automated factory…, index fund, information asymmetry, invisible hand, Irwin Jacobs, Joi Ito, Joseph Schumpeter, Kenneth Arrow, Kickstarter, life extension, Long Term Capital Management, Mark Zuckerberg, mass immigration, means of production, Metcalfe’s law, money market fund, Mont Pelerin Society, moral hazard, Myron Scholes, new economy, Norman Mailer, obamacare, Paul Samuelson, Peter Thiel, price mechanism, principal–agent problem, profit maximization, quantitative trading / quantitative finance, Ralph Nader, Richard Thaler, road to serfdom, Robert Bork, Robert Metcalfe, rolodex, Ronald Coase, Ronald Reagan, Sand Hill Road, shareholder value, short selling, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, TaskRabbit, The Nature of the Firm, the payments system, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, too big to fail, transaction costs, universal basic income, War on Poverty, white flight, working poor

Just as there are subprime mortgages, there are subprime auto loans, with higher interest rates, and they had been a booming business during the period before the financial crisis. Also, GM and other auto companies manage their payments to hundreds of thousands of parts suppliers by borrowing money in the overnight markets—often from money market funds, which are not covered by federal deposit insurance. The same week that Morgan Stanley almost failed, one of the biggest money market funds, the Prime Reserve Fund, announced that it would no longer let depositors withdraw their money at full value. That led to a wave of panicked withdrawals from money market funds, which dried up the overnight lending system, which meant that GM couldn’t pay its suppliers, which meant that they were in danger of failing too. An old auto business maxim has it that you can sleep in your car, but you can’t drive your house to work—meaning that most people, in a real pinch, will stop making house payments before they’ll stop making car payments.

Metcalfe, Bob Metcalfe’s law Mexico: factories moved to; immigrants from microeconomics; see also corporations Microsoft middle class; corporations as benefit to; corporations as hindrance to; regulation to support; as stockholders; see also Chicago Lawn Middle-earth liberalism Milgram, Stanley Milken, Michael Miller, Merton Mills, C. Wright Mind Dynamics MIT Mitsubishi mobile devices Modern Corporation and Private Property, The (Berle and Means) Modigliani, Franco Moley, Raymond Mondelez money market funds money trust Mont Pelerin Society Moreno, Jacob Morgan, Henry Morgan, J. P.; Morgan Stanley and Morgan, J. P., Jr. Morgan Stanley; bailout of; board of; changes to in 1970s; commercial banks vs.; compensation at; in competition with its clients; corporate clients of; debt of; deregulation and; derivatives and; diversity at; elitism of; expansion of; fixed-income department at; founding of; as global company; government employees from; IPO of; Jensen honored by; junk-bond department of; largest loss at; mergers and acquisitions at; mortgaged-backed securities and; price setting by; prime brokerage at; research department at; shareholders as clients of; Silicon Valley and; size of; syndicate system at; trading at; in 2008 financial crisis Morison, Samuel Eliot mortgages; adjustable-rate; collapse of subprime market of, see 2008 financial crisis; federal involvement in; loan modifications for; predatory; racial politics of; securities backed by; state regulation of; as unregulated; see also 2008 financial crisis Moss, John Musk, Elon mutual funds; inflation and; statistical study of My Years with General Motors (Sloan) Nabisco Nader, Ralph Napster Nashashibi, Rami Nation, The National Automobile Dealers Association National Economic Council National Industrial Recovery Act (NIRA) National Labor Relations Board “Nature of the Difficulty, The” (Berle) “Nature of the Firm, The” (Coase) Nazis; in U.S.


pages: 287 words: 81,970

The Dollar Meltdown: Surviving the Coming Currency Crisis With Gold, Oil, and Other Unconventional Investments by Charles Goyette

bank run, banking crisis, Ben Bernanke: helicopter money, Berlin Wall, Bernie Madoff, Bretton Woods, British Empire, Buckminster Fuller, business cycle, buy and hold, California gold rush, currency manipulation / currency intervention, Deng Xiaoping, diversified portfolio, Elliott wave, fiat currency, fixed income, Fractional reserve banking, housing crisis, If something cannot go on forever, it will stop - Herbert Stein's Law, index fund, Lao Tzu, margin call, market bubble, McMansion, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, oil shock, peak oil, pushing on a string, reserve currency, rising living standards, road to serfdom, Ronald Reagan, Saturday Night Live, short selling, Silicon Valley, transaction costs

The consequences for individual investors and the economic health of the country are almost too painful to contemplate. The financial markets reeled as they absorbed all the news. Gold had its biggest one-day move in history on Wednesday, September 17, roaring up $70 in the market, up a total of $84 in after-market trading; Reserve Primary Fund, the nation’s oldest money market firm, “broke the buck,” its share value falling below the $1.00 money market fund standard, thanks to losses from its holdings of Lehman securities; that day the Commerce Department reported housing starts hit a seventeen-year low in August, down 33 percent from a year earlier. In the midst of events, Treasury Secretary Henry Paulson and Ben Bernanke met with President Bush. It was Thursday, September 18. The New York Times reported months later that Bush wondered aloud that day, “How did we get here?”

Even as Bush was meeting with Bernanke and Paulson and wondering what happened, the Federal Reserve came up with $280 billion to provide liquidity to the markets. By seven o’clock in the evening, the secretary and the chairman were meeting with congressional leaders to discuss what eventually became the $700 billion taxpayer-funded bailout. The next morning, Friday, September 19, Paulson announced the establishment of a U.S. guarantee program for the money market fund industry, funded with $50 billion from the Exchange Stabilization Fund, a government fund used for currency manipulation. On Saturday, September 20, an overnighted bailout bill was in the hands of lawmakers. It was a simple, three-page, $700 billion package which raised the debt ceiling to $11.315 trillion. And it included a little self-referential, Constitution-upending twist that maintained that decisions by the secretary under that act “may not be reviewed by any court of law or any administrative agency.”

Other currency ETFs include:Brazilian Real: BZF New Zealand Dollar: BNZ Indian Rupee: ICN Chinese Yuan: CYB The foregoing are WisdomTree Dreyfus currency ETFs. Reading the prospectus of any fund is recommended before investing. These may be found at www.wisdomtree.com. There are a couple of things to bear in mind about currency ETFs. Although the expense ratios are reasonably low, generally around 0.4 percent, you will pay a commission to buy and sell them just as you would any other ETF. This can make them an expensive substitute for a money market fund. The interest rate is not fixed but can change from day to day just as does a money market account. Remember that if you invest in a foreign currency ETF in an account here in the United States, you still have an investment in the United States and you should not mistakenly believe you have money out of the country. There are also leveraged and bundled currency ETFs, packaging different currencies together.


pages: 598 words: 169,194

Bernie Madoff, the Wizard of Lies: Inside the Infamous $65 Billion Swindle by Diana B. Henriques

accounting loophole / creative accounting, airport security, Albert Einstein, banking crisis, Bernie Madoff, break the buck, British Empire, buy and hold, centralized clearinghouse, collapse of Lehman Brothers, computerized trading, corporate raider, diversified portfolio, Donald Trump, dumpster diving, Edward Thorp, financial deregulation, financial thriller, fixed income, forensic accounting, Gordon Gekko, index fund, locking in a profit, mail merge, merger arbitrage, money market fund, plutocrats, Plutocrats, Ponzi scheme, Potemkin village, random walk, Renaissance Technologies, riskless arbitrage, Ronald Reagan, short selling, Small Order Execution System, source of truth, sovereign wealth fund, too big to fail, transaction costs, traveling salesman

The Treasury announced a rescue package for AIG this morning, but unexpected cracks from the impact of Lehman Brothers’ collapse are showing up elsewhere. Today, The Reserve fund, the nation’s oldest money market fund, “breaks the buck” by reporting a net asset value of less than a dollar a share. The news feeds the growing panic. If this financial crisis can infect even supposedly secure money funds, for decades the middle-class substitute for a bank account, there is no safe haven. At Fairfield Greenwich Group, whose wealthy investors have long thought of Madoff as a sort of plutocratic money market fund, clients are seeking clarity and comfort. Today the group sends out a reassuring “Dear Investor” letter from Amit Vijayvergiya, the chief risk officer. He quickly mentions that the Sentry fund has no exposure to Lehman, Bank of America, or Merrill Lynch.

The financial system is already reeling with bankruptcies and bailouts. The year 2008 challenges 1929 as the most frightening and frenzied in the long history of Wall Street. The Bear Stearns brokerage house has failed. Fannie Mae and Freddie Mac, two US government-sponsored mortgage giants, have been bailed out; the venerable Lehman Brothers firm wasn’t. Within a day of Lehman’s bankruptcy, the nation’s oldest money market fund was swept away by a tsunami of panicky withdrawals. Before that day ended, regulators were scrambling to rescue the insurance giant AIG, fearing that another titanic failure would shatter whatever trust continued to hold the fragile financial system together. People are already furious, shaking their fists at the arrogant plutocrats who led them into this mess. Then, in a camera flash, Bernie Madoff is transformed from someone whom no one but Wall Street insiders and friends would recognize into a man who is headline news around the world.

It didn’t seem possible for this rule to have been so widely and so catastrophically ignored, even by nonprofit trustees and pension plans with fiduciary obligations. Typically, the failure of a legitimate midsize brokerage firm like Madoff’s would not wipe out every single penny its customers had. Plenty—or, at least, something—would be left in a company pension plan or a bank account or a money market fund. As for the hedge funds, they supposedly catered only to wealthy, sophisticated people who were, by definition, too smart to hazard their entire fortune on one investment. Indeed, this had been one of the reasons for not regulating hedge funds more tightly over the years. Fires, earthquakes, and hurricanes were readily recognized as events that required an emergency response to alleviate human suffering; the Madoff fraud was not.


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

Regulators overlooked the fact that a substantial fraction of this new lending was short term (especially interbank funding) and devoted to propping up a property bubble rather than to the promotion of new investment opportunities. Ireland and Spain in particular were the recipients of substantial bank-intermediated capital flows, which served primarily to fund the construction and acquisition of property. Second, European banks significantly expanded their global activities, raising dollar-denominated funding from US money market funds (MMFs). Moreover, large universal banks became increasingly important market makers on global capital and derivatives markets. This heightened activity engendered a substantial increase in the riskiness of the European banking system. Because the ECB cannot—at least, not without a backup swap line from the US Federal Reserve—provide dollar liquidity to its banks, European banks’ reliance on MMF dollar funding added another dimension of systemic risk.

For some time, this process may appear as if it is capable of generating endless prosperity. But, like a rubber band being gradually stretched, the tension builds until the rubber band—and the repo market—finally snaps. German Landesbanken and French Banks The public in Germany and France was outraged when American-style financial problems appeared in their banks. French banks became very dependent on dollar funding from US money market funds. In Germany, some of the most costly problems appeared in the Landesbanken.6 Public sector banks, such as the Landesbanken in Germany, became active players in the modern banking landscape. Such banks have special principal-agent problems: with their downside risk limited by extensive public guarantees, bank managers have an incentive to take on excessive risks to generate short-term profits.

Interestingly, this occurred not just in the euro area: the West Balkan countries, Albania, Bosnia and Herzegovina, Croatia, the former Yugoslav Republic, Macedonia, Montenegro, and Serbia, most of which were not even in the European Union, experienced similar inflows, with large current account deficits and strong economic growth up to 2008, and a massive problem afterward.8 A large fraction of the capital flows were short-term credit flows involving cross-border wholesale funding—lending from bank to bank in the interbank market. To picture more clearly the main thrust of these flows, consider the following stylized example featuring Germany and Spain as our representative core and periphery countries. Spanish banks drew parts of their fund from their domestic deposit base. In the years leading up to the crisis, German financial institutions (banks or money market funds) provided their Spanish counterparts with additional cheap, short-term wholesale funding mostly through the interbank market. Spanish banks then duly extended more loans to domestic borrowers (in particular homeowners), usually at flexible rates (typically at the floating LIBOR/Euribor rate plus some fixed surcharge). The borrowed funds were in part used to pay for German products: suppose the Spanish borrowers purchased, for example, German appliances such as elevators or dishwashers.


pages: 419 words: 130,627

Last Man Standing: The Ascent of Jamie Dimon and JPMorgan Chase by Duff McDonald

bank run, Blythe Masters, Bonfire of the Vanities, centralized clearinghouse, collateralized debt obligation, conceptual framework, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Exxon Valdez, financial innovation, fixed income, G4S, housing crisis, interest rate swap, Jeff Bezos, John Meriwether, Kickstarter, laissez-faire capitalism, Long Term Capital Management, margin call, market bubble, money market fund, moral hazard, negative equity, Nelson Mandela, Northern Rock, profit motive, Renaissance Technologies, risk/return, Rod Stewart played at Stephen Schwarzman birthday party, Saturday Night Live, sovereign wealth fund, statistical model, Steve Ballmer, Steve Jobs, technology bubble, The Chicago School, too big to fail, Vanguard fund, zero-coupon bond, zero-sum game

It was not sold—it went bust. The world’s stock markets crashed as a result. The Dow Jones fell by 504 points on Monday, September 15. (Barclays later bought a number of Lehman’s assets, but not the entire firm.) Lehman’s failure set off a chain reaction. Reserve Primary Fund, a $64 billion money market fund that had been heavily invested in Lehman’s debt, broke the buck—its net asset value fell below the crucial level of $1 per share—and nearly collapsed, sparking mass withdrawals. About $500 billion was withdrawn from money market funds in the two weeks that followed Lehman’s collapse. On Tuesday, September 16, the government chose to rescue the insurance giant AIG with an $85 billion loan, just one day after Lehman had been deprived of such largesse. (By April 2009, the total amount thrown at AIG was $162.5 billion and climbing.)

It established Dimon as Wall Street’s banker of choice, and buffed JPMorgan Chase’s reputation to such a high shine that the firm was still benefiting a year later, even as its business continued to deteriorate along with the economy. “In the end, it was a tough deal,” recalls the head of asset management, Jes Staley. “With one exception. What it did for our reputation was worth every penny. It was unbelievable. Absolutely.” The result of this enhanced reputation was tangible. The company had $400 billion in money market funds under management at the end of 2007. It took in another $200 billion in 2008 alone. Other divisions experienced similar gains. JPMorgan Chase’s commercial banking division, for example, saw 2008 net income surge 27 percent to $1.4 billion even as recession gripped the country. As Bear had proved, reputation is everything on Wall Street. As Bear’s own standing was diminished, Jamie Dimon’s rose to towering heights.

By late fall, JPMorgan Chase had $60 billion in the interbank loan market, increased its commercial loan balances by 18 percent through the year’s end, and also increased both student loans and credit card loans. He also repeated, whenever given the chance, that in the era after World War II, banks had accounted for 60 percent of lending in the economy, but by the turn of the twenty-first century that portion had fallen to just 20 percent. The rest was provided by Wall Street and the so-called “shadow banking” industry, which includes hedge funds, money market funds, and creators of securitized debt. The seizing up of credit that crippled the global economy in 2007 and 2008, in other words, could not be explained simply by saying that a bunch of banks decided to stop lending. According to a study by the consultancy Oliver Wyman, bank lending decreased by $400 billion from 2007 to 2008, while capital markets lending fell by $950 billion. Given that total net bank lending in 2007 was just $850 billion, the study observes, “it is obvious that banks would never be able to make up for the shortfall from capital markets.”


pages: 517 words: 139,477

Stocks for the Long Run 5/E: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies by Jeremy Siegel

Asian financial crisis, asset allocation, backtesting, banking crisis, Black-Scholes formula, break the buck, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, carried interest, central bank independence, cognitive dissonance, compound rate of return, computer age, computerized trading, corporate governance, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Deng Xiaoping, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Financial Instability Hypothesis, fixed income, Flash crash, forward guidance, fundamental attribution error, housing crisis, Hyman Minsky, implied volatility, income inequality, index arbitrage, index fund, indoor plumbing, inflation targeting, invention of the printing press, Isaac Newton, joint-stock company, London Interbank Offered Rate, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, Myron Scholes, new economy, Northern Rock, oil shock, passive investing, Paul Samuelson, Peter Thiel, Ponzi scheme, prediction markets, price anchoring, price stability, purchasing power parity, quantitative easing, random walk, Richard Thaler, risk tolerance, risk/return, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, the payments system, The Wisdom of Crowds, transaction costs, tulip mania, Tyler Cowen: Great Stagnation, Vanguard fund

The Lender of Last Resort Springs to Action After the Lehman bankruptcy, the Fed did provide the liquidity the market desired. On September 19, three days after the Reserve Primary Fund announced it would break below a dollar, the Treasury announced that it was insuring all participating money market funds to the full amount of the investor’s balance. The Treasury indicated that it was using the money in its Exchange Stabilization Fund, normally used for foreign exchange transactions, to back its insurance plan. But since the Treasury had only $50 billion in its fund, less than 2 percent of the assets in money market funds, the Treasury would have had to rely on an unlimited line of credit to the Fed to make good on its pledge. The Fed itself created a credit facility to extend nonrecourse loans to banks buying commercial paper from mutual funds,27 and a month later the Money Market Investor Funding Facility was established.

Indeed, after the close of trading, the Fed announced that it had loaned $85 billion to AIG, avoiding another market-shaking bankruptcy. The Fed’s decision to bail out AIG was a dramatic turnaround, as Chairman Ben Bernanke had rejected the giant insurer’s request for a $40 billion loan just a week earlier. But the crisis was far from over. After the markets closed on Tuesday, the $36 billion Reserve Primary Money Market Fund made a most ominous announcement. Because the Lehman securities that the money fund held were marked down to zero, Reserve was going to “break the buck” and pay investors only 97 cents on the dollar.3 Although other money funds reassured investors that they held no Lehman debt and that they were honoring all withdrawals at full value, it was clear that these declarations would do little to calm investor anxiety.

The Fed lowered the funds target rate from 2 to 1.5 percent in an emergency meeting on October 23, 2008 and lowered it further to 1 percent at its regular November meeting. On December 16, as conditions continued to worsen, the Federal Open Market Committee reduced the federal funds rate to an all-time low of between zero and 0.25 percent; and at the end of 2013, the funds rate remains at this level, the longest period since World War II that the rate has remained unchanged. Even though the Federal Reserve guarantees on bank deposits and money market funds stopped the liquidity panic, the Fed could not prevent the shock waves that reverberated through the credit markets. While long-term Treasury rates fell substantially, interest rates on non-Treasury debt rose. The spread between the lowest investment-grade corporate bond and the 10-year Treasury reached 6.1 percent in November 2008, the highest since the record 8.91 percent spread in May 1932 that was reached near the bottom of the Great Depression.


pages: 357 words: 91,331

I Will Teach You To Be Rich by Sethi, Ramit

Albert Einstein, asset allocation, buy and hold, buy low sell high, diversification, diversified portfolio, index fund, late fees, money market fund, mortgage debt, mortgage tax deduction, prediction markets, random walk, risk tolerance, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, survivorship bias, the rule of 72, Vanguard fund

Barry Schwartz writes about this in The Paradox of Choice: Why More Is Less: . . . As the number of mutual funds in a 401(k) plan offered to employees goes up, the likelihood that they will choose a fund—any fund—goes down. For every 10 funds added to the array of options, the rate of participation drops 2 percent. And for those who do invest, added fund options increase the chances that employees will invest in ultraconservative money-market funds. You turn on the TV and see ads about stocks, 401(k)s, Roth IRAs, insurance, 529s, and international investing. Where do you start? Are you already too late? What do you do? Too often, the answer is nothing—and doing nothing is the worst choice you can make, especially in your twenties. As the table on the next page shows, investing early is the best thing you can do. Look carefully at that chart.

Well, the companies that offer 401(k)s take this to an extreme: They offer a few investment funds for you to choose from—usually the options are called something like aggressive investments (which will be a fund of mostly stocks), balanced investments (this fund will contain stocks and bonds), and conservative investments (a more conservative mix of mostly bonds). If you’re not sure what the different choices mean, ask your HR representative for a sheet describing the differences in funds. Note: Stay away from “money market funds,” which is just another way of saying your money is sitting, uninvested, in cash. You want to get your money working for you. As a young person, I encourage you to pick the most aggressive fund they offer that you’re comfortable with. As you know, the more aggressive you are when younger, the more money you’ll likely have later. This is especially important for a 401(k), which is an ultra-long-term investment account.

., 220–21 Pyramid of Investing Options and, 167 in real estate, 182, 202, 251, 253–54, 256 rebalancing portfolio and, 180, 181, 189, 203–5, 206–7, 209 Roth IRAs and, 83, 186–95, 198, 209 for specific goal, 215 starting early and, 4–5 summary of advantages of, 81 tax concerns and, 205, 209, 210–11, 215 time to double money and, 187 underperformance and, 212–15 young people’s poor attitudes and behaviors and, 71–75 in your own career, 77 see also Bonds; Index funds; Lifecycle funds; Mutual funds; Stocks Investment brokerage accounts: automatic transfers to, 87, 88, 89, 90, 129, 132, 137, 187, 188, 195 choosing, 86–88 keeping track of, 88 IRAs, 81, 141, 209 see also Roth IRAs j Jenkins, Richard, 107 JLP at AllFinancialMatters, 152 Job offers: multiple, salary negotiations and, 235, 238, 239 negotiating, 236–37 l Ladder of Personal Finance, 76–77 Late fees, of credit cards, 22, 23, 24 Leasing cars, 246 Leverage, 256 Lifecycle funds (target-date funds), 167, 180–85, 186, 189, 203, 205, 211 buying into, 188, 198 choosing, 187–88, 198 Life insurance, 216–17 Loads, of mutual funds, 156, 177 Lynch, Peter, 149 m Malkiel, Burton G., 150 Materialism, 74 Media, personal advice and, 5–6 Millionaires, behaviors of, 73–74 Money-market funds, 4, 170, 186 Moody’s, 150 Morningstar, 148–50, 152 Mortgages, 50, 216, 253, 255, 258 credit scores and, 16–17, 256–57 paying extra on, 77, 258 tax deductions and, 256 Mutual funds, 167, 176–77, 180 active vs. passive management and, 155–58, 177, 178 fees of, 155–56, 157, 163, 176, 177, 178, 179 managers’ inability to predict or beat market and, 144–51, 155, 177, 178 ratings of, 148–50 see also Index funds n Negotiating: with car dealers, 248–49 for job offers, 236–37 for salary in new job, 120, 234–44 Newsletters, market-timing, 147 “Next $100” concept, 128 Nickel (of www.fivecentnickel.com), 208–9 o O’Neal, Edward S., 158 Online banks, 51 checking accounts of, 62, 68 high-interest savings accounts of, 51–52, 53, 54, 59, 62–63, 65, 68, 69–70 Online shopping, 135 Overdrafts, 50–51, 65–67, 110, 116 p Parents, 222–24 managing their kids’ money, 222–23 in severe debt, helping, 223–24 Partners.


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

That fact alone was enough to make everyone wonder at once how much more of this stuff was out there, and who owned it. The Fed and the Treasury were doing their best to calm investors, but on Wednesday no one was obviously calm. A money market fund called the Reserve Primary Fund announced that it had lost enough on short-term loans to Lehman Brothers that its investors were not likely to get all their money back, and froze redemptions. Money markets weren't cash--they paid interest, and thus bore risk--but, until that moment, people thought of them as cash. You couldn't even trust your own cash. All over the world corporations began to yank their money out of money market funds, and short-term interest rates spiked as they had never before spiked. The Dow Jones Industrial Average had fallen 449 points, to its lowest level in four years, and most of the market-moving news was coming not from the private sector but from government officials.

Only the ardor of the Wall Street firms, desperate to buy fire insurance on their burning home, remained undimmed. "It's the first time we're seeing any prices that reflect anything close to like what they're really worth," said Charlie. "We had positions that were being valued by Bear Stearns at six hundred grand that went to six million the next day." By eleven o clock Thursday night Ben was finished. It was August 9, the same day that the French bank BNP announced that investors in their money market funds would be prevented from withdrawing their savings because of problems with U.S. subprime mortgages. Ben, Charlie, and Jamie were not clear on why three-quarters of their bets had been bought by a Swiss bank. The letters U B S had scarcely been mentioned inside Cornwall Capital until the bank had started begging them to sell them what was now very high-priced subprime insurance. "I had no particular reason to think UBS was even in the subprime business," said Charlie.


pages: 584 words: 187,436

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

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

Since 1900, U.S. banks have tripled their leverage from around four to twelve; they have taken more liquidity risk by using short-term borrowing to purchase long-term assets; and they have focused more of their resources on high-risk proprietary trading.5 The 2007–2009 crisis, in which governments extended the reach of deposit insurance, guaranteed savings held in supposedly uninsured money-market funds, and bent over backward to pump emergency liquidity into all corners of the markets, is likely to induce even more recklessness in the future. Put simply, government actions have decreased the cost of risk for too-big-to-fail players; the result will be more risk taking. The vicious cycle will go on until governments are bankrupt. There are two standard responses to this scary prospect. The first is to argue that governments should not bail out insurers, investment banks, money-market funds, and all the rest: If financiers were made to pay for their own risks, they would behave more prudently. For example, if investors had been forced to absorb the cost of the Bear Stearns bankruptcy in early 2008, rather than having the blow softened by a Fed-subsidized rescue, they might have prepared themselves better to absorb the costs of Lehman’s failure some months later.

The clearest problem is “too big to fail”—Wall Street behemoths load up on risk because they expect taxpayers to bail them out, and other market players are happy to abet this recklessness because they also believe in the government backstop. But this too-big-to-fail problem exists primarily at institutions that the government has actually rescued: commercial banks such as Citigroup; former investment banks such as Goldman Sachs and Morgan Stanley; insurers such as AIG; the money-market funds that received an emergency government guarantee at the height of the crisis. By contrast, hedge funds made it through the mayhem without receiving any direct taxpayer assistance: There is no precedent that says that the government stands behind them. Even when Long-Term Capital collapsed in 1998, the Fed oversaw its burial but provided no money to cover its losses. At some point in the future, a supersized hedge fund may prove to be too big to fail, which is why the largest and most leveraged should be subject to regulation.

The next day President Bush visited the Treasury to meet with his economic advisers. “[I]f the market functions normally, it will lead to a soft landing,” he said hopefully. On Thursday the tone from Washington began to change, but less because of the carnage at quantitative funds than because of trouble from Europe: The giant French bank BNP Paribas had suspended redemptions from three internal money-market funds, citing “the complete evaporation of liquidity.” Subprime losses were clearly scaring the markets, and the European Central Bank responded with $131 billion in emergency liquidity. By Thursday afternoon, the Fed’s chairman, Ben Bernanke, had turned his office into a makeshift war room, and his chief lieutenants dialed in from various vacation locations. Early the next morning, the Fed reversed its earlier emphasis on inflation, pledging to provide enough cash “to facilitate the orderly functioning of financial markets.”


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

As credit markets reflated, Maiden Lane recovered sufficient value and income from those assets to pay down the debt—and turn a profit for the Federal Reserve. By the end of 2011 the $30 billion loan had been reduced to $4 billion, and Maiden Lane still had assets worth about $7.2 billion. The week that Lehman Brothers failed, the Treasury Department started a program to guarantee the $3.4 trillion money market fund industry. It collected $1.2 billion in fees from operators of money market funds and didn’t pay a single claim before the guarantee was lifted in September 2009. In November 2008 the Federal Deposit Insurance Corporation, an independent agency ultimately backstopped by taxpayers, threw a huge lifeline to the banking industry by offering to guarantee the debt of financial services companies—for a fee. Banks took advantage of the low rates and quickly issued more than $313 billion in debt under the Temporary Liquidity Guarantee Program.

.), 166–67 Magaziner, Ira, 70 Magnolia Bakery, 144–45 Magrath, Joan, 67 Maiden Lane transactions, 32–33, 36 Major League Soccer, 126 Mak, Paul, 142–43 Malinowski, Diva, 161–62 Malkin Properties, 69–72 management consulting, 61 Mankiw, Gregory, 193 manufacturing, 20, 26 of autos, 21, 26, 79, 134–36, 173–74, 210, 227 efficiency economy and, 61–62, 64, 67–68, 77–80, 178, 227 employment and, 166–68 exports and, 98–99, 107, 109–10, 112, 116 factory closings and, 9, 15, 79 FDI and, 82–83, 85–91, 96–97 inports and, 134–36, 140, 227 North Dakota and, 159–60 recoveries and, 18, 21 reshoring and insourcing of, 164–78 restructuring and, 45, 51 supersizing and, 199–201, 211 Marbury, Stephon, 126–27, 227 Marcellus Shale, 79, 86 Marchionne, Sergio, 87 Marfrig, 95 markets, 5, 7, 198–99, 221, 224 autos and, 41–42, 79, 192 for credit, 33–34, 36, 43, 49 efficiency economy and, 62–63, 68, 70–71, 75, 79, 227 efficient consumers and, 190–93 employment and, 53–54, 62–63, 167–68, 190, 204 exports and, 99, 105, 112–13, 116, 121–22, 127, 129–31, 154–55, 159 FDI and, 82–84, 86–88, 90, 93–94 forecasts and, 17–18, 28 global, 22, 106 in history, 24–25 and housing and real estate, 12, 18, 42, 53–54, 70–71, 84, 105, 111, 156, 171, 191, 212 inports and, 133–34, 136–40, 146 North Dakota and, 154–56, 159, 161–62 recovery and, 21, 215–16 restructuring and, 48–51, 54, 136 supersizing and, 199, 201–4, 206 timely policy decisions and, 31–36, 41–43 see also emerging markets; stocks, stock markets Mary Kay, 132, 141–43, 227 Mayer, Christopher, 212 MDU Resources, 152–53 Meeker, Mary, 21–22 Mercer Consulting, 168 Merrill Lynch, 47–48, 53 methane gas, 66 Mexico, 65, 89, 154, 159 exports and, 100, 104, 122 FDI and, 84–85 inports and, 138, 145 and reshoring and insourcing, 172–74 supersizing and, 202–3 Miami, Fla., 2, 82, 89, 91, 95, 144 Michigan, 15, 118–19, 135–36, 169, 174 Microsoft, 143, 160 middle class, 20, 25, 94, 127, 144 Middle East, 21, 203, 228 exports and, 108–9, 112–13, 123 inports and, 132, 145 Millennium Bulk Terminals, 103 Millward Brown, 143 Milner, Yuri, 84 Mittleider, John, 154 Moinian Organization, 94 monetary policy, 19, 30, 32 money market fund industry, 33–34 Moody’s, Moody’s Analytics, 1, 31, 190, 207 Morgan Stanley, 21–22, 37, 53, 74 mortgage-backed securities, 34–36 mortgage equity withdrawal (MEW), 54, 56 mortgages, 2, 12, 24, 156, 164, 212, 219, 225 efficient consumers and, 190–91 and Fannie Mae and Freddie Mac bailout, 42–43 refinancing of, 34–35, 54, 190 restructuring and, 45, 50, 53–55, 57–58 subprime, 16–18, 39, 82 timely policy decisions and, 30, 32, 34–36, 39, 42–43 Motion Picture Association of America, 128 Mountain Area Information Network (MAIN), 209–10 Mubadala Healthcare, 145 Murck, Christian, 166–67 Murphy, Roger, 169 MVP RV, 96–97 National Foundation for American Policy, 117 natural gas, 79, 86, 102 exports of, 105–6 in North Dakota, 151–53, 157 NBC/ Wall Street Journal poll, 3 NCR, 174–76, 178 Ness, Ron, 152 Nest Learning Thermostat, 195–96 Netherlands, 14, 81–82, 86, 198 networks, networking, 66, 71, 77, 96, 176, 197 supersizing and, 199, 201–4, 206–9, 211–13 New Deal, 14, 18 New England Smart Energy, 187–88 New Jersey, 50, 111, 211–12, 216, 225 New Jersey Nets, 85, 126 Newsweek, 3, 15–16, 19, 93, 229–30 New York, 8, 19, 26, 41, 47, 89, 108, 111, 141, 148, 154, 156, 172, 224–25, 228 efficiency economy and, 61, 68–72, 74 efficient consumers and, 192–93, 195 exports and, 118, 121–22, 125, 127 FDI and, 82, 84–85, 92–95 inports and, 144–46 restructuring and, 49–50 supersizing and, 204–6, 211–13 New York City marathon, 228 New Yorker, 183–84 New York Federal Reserve Bank, 32, 55–56 New York Stock Exchange, 7, 12–13, 48, 133 New York Times, 6, 9, 19, 72, 85, 100, 119, 141, 174, 178 Next Convergence, The (Spence), 100 Nike, 119, 140, 168–69 9/11, 18, 109, 118, 120–21, 145 Nishimura, Kiyohiko, 29–30 Nixon, Richard, 26, 218 Noah, Timothy, 199–200 Nooyi, Indra, 117–18 Normandy Real Estate Partners, 50 Norris, Floyd, 19 North Dakota, 148–63, 212 agriculture in, 149, 153–58, 162 demographics of, 149, 159–62 economic decline of, 149–50 education in, 153, 157–58, 160–62 efficiency economy and, 158–59 housing in, 150–52, 155–56, 158 oil in, 79, 148, 151–53, 157, 160, 162, 223 sovereign wealth fund of, 156–57 nuclear power, 7, 24, 74, 109 NUMMI, 79 Obama, Barack, 2, 77, 99, 205, 222 economic decline and, 3, 5–6, 10, 15 financial crisis and, 6, 12–13 restructuring and, 54–55 timely policy decisions and, 30, 33, 54–55 “Obama’s Radicalism Is Killing the Dow” (Boskin), 5 Odake, Shin, 93 offshoring, 83, 94, 98, 110, 133, 147, 164, 167–68, 171–73, 175 oil, 26, 100, 102, 165, 217 domestic production of, 79–80, 86, 148, 151–53, 157, 160, 162, 222–23 efficiency economy and, 75, 77, 79–80, 222–23 efficient consumers and, 188–89 FDI and, 86, 95 price of, 15, 75, 77, 153, 172, 188 On China (Kissinger), 127 O’Neill, Jim, 23 Organization for International Investment (OFII), 83, 95–97 output gap, 9 Outrageous Fortunes (Altman), 141 Outsourced, 171 outsourcing, 26, 62, 98, 169, 171–72, 175 Panama Canal, 208 Paris, 68, 109, 137, 144 Parish, Robert, 170–71 Paulson, Henry, 32–33 Peabody Coal, 103 pecans, 100 Peek, Jeff, 47 Peerless Industries, 178 Peisach, Alberto, 88–90 pensions, 91, 132, 181, 216 inports and, 136–37, 147 Pepsi, PepsiCo, 117, 133, 143 Petrobras, 95 Philadelphia, Pa., 65–66, 110 Philadelphia Federal Reserve Bank, 17 Plastic Omnium, 68 Plaza Hotel, 84 politics, politicians, 21–23, 25–26, 61, 148, 163, 167, 218–19, 221 crises and, 15, 29 economic decline and, 5–6 infrastructure and, 205, 211 and reshoring and insourcing, 175–76 timely policy decisions and, 28–31, 40, 43 pools, 185–87 Popper, Deborah Epstein and Frank J., 149–50 Porter’s Fabrication, 176 Poss, Jim, 64–65, 68 Post-American World, The (Zakaria), 19 Poughkeepsie-Highland Bridge, 225–26 poverty, 16, 19, 25, 100, 124, 141, 164, 225 Power, Thomas M., 103 power plants, 7, 72–74 Prague, 139–40, 144 Pratt & Whitney, 108 Principles of Economics (Mankiw), 193 procyclicality, 45, 58, 72–73 production, productivity, 81, 96–103, 215 in agriculture, 100–101, 122 efficiency economy and, 60, 62–63, 65, 73, 78–80, 107, 223–24 efficient consumers and, 181–82, 184, 189, 195 employment and, 163–64, 166–69 exports and, 98–101, 103, 105–7, 109–13, 115–16, 122–23, 131, 226 FDI and, 86–87, 89–90, 96–97 inports and, 131–32, 134–37, 140–43 North Dakota and, 150, 153–54, 157, 159 and reshoring and insourcing, 169–73, 175–79 supersizing and, 199–202, 206–8, 210 U.S. economic importance and, 227–28 profits, profit, 16, 81, 198, 204, 215, 225 efficiency economy and, 62, 65, 76, 78 efficient consumers and, 183, 193–94 exports and, 104, 128–29 inports and, 133, 136, 140, 146–47 restructuring and, 44, 52–53, 58 timely policy decisions and, 33–36, 38–39 Prokhorov, Mikhail, 85 propane, 185–86 Pulaski County, Va., 88–91 Pulpy, 138 Qatar, 108, 145 quantitative easing (QE), 30, 34, 57 railroads, 110, 200, 224–25 FDI and, 13, 81–82, 90, 95 supersizing and, 206, 208–9, 211–12 Ratner, Bruce, 85 Rawlings, 169–70 real estate, 89, 105, 167, 171, 204, 226 efficiency economy and, 68–74, 80 FDI and, 83–85, 92–94, 96 in Japan, 8, 30 restructuring and, 45, 49–51 supersizing and, 212–13 see also houses, housing RealtyTrac, 55 recessions, 9, 13, 23, 26, 180, 221 see also Great Recession recoveries, 4, 9, 17–19, 21, 26, 28, 57, 60, 75, 99, 162, 180, 199, 218, 225 economic pessimism and, 22–23 restructuring and, 45, 51, 80 slowness of, 17–18 strengthening of, 215–17 recycled paper, 107 reengineering, 61–62, 69–70, 113 Regional Plan Association, 211 Regions Financial, 38 regulations, regulation, 2, 10, 16, 19, 25, 29, 52–53, 102, 212 Reid, T.


pages: 361 words: 97,787

The Curse of Cash by Kenneth S Rogoff

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

The problem, emphasized in Princeton professor Steve Goldfeld’s 1976 paper “The Case of the Missing Money” was not hard to ascertain.12 Thanks to a mix of new technologies (the growth of credit cards), financial liberalization (particularly the end of restrictions on the interest rates banks could pay), and deregulation that created new instruments like money market funds, the relationship between Friedman’s notion of “money” and inflation began to fray badly. For a time, the Federal Reserve tried to find a link between money and prices by developing ever more expansive measures of “money,” for example, incorporating money market funds in addition to checking and savings accounts, with the aim of trying to find some notion of money that still had a stable reliable relationship with the price level. But such efforts were largely to no avail. In the event, Friedman’s measure of money grew far more slowly at times than inflation, because as the economy adjusted to new technologies, it simply was not necessary to have as much currency (or any form of older payment technology, e.g., checking accounts) to achieve the same level of transactions.

Even if paper money revenue disappeared completely, the central bank would still earn money from electronic bank reserves, with the exact profits depending on the interest rate paid to banks relative to the interest rate the central bank earns on its assets. One imagines that in a fully electronic world (with all low-income individuals receiving heavily subsidized debit accounts), demand for reserves at the central bank would rise, potentially quite sharply. And this process is hardly exogenous. The government has numerous regulatory levers it can pull, for example, taking more forceful steps than it has in the past to pull the plug on money market funds, which in the current environment remain a regulatory end-around. In the extreme case, the government could adopt a version of the 1930s “Chicago plan,” which would essentially allow banks to issue money-like instruments only if they were 100% backed by government debt, which presumably can include central bank reserves.10 The name relates to Chicago economists Henry Simon, Frank Knight, Milton Friedman, and Irving Fisher (the last actually a Yale professor), who advocated the idea of “narrow banking” to mitigate moral hazard problems and eliminate bank runs (assuming that the government itself is fully solvent).


pages: 411 words: 98,128

Bezonomics: How Amazon Is Changing Our Lives and What the World's Best Companies Are Learning From It by Brian Dumaine

activist fund / activist shareholder / activist investor, AI winter, Airbnb, Amazon Web Services, Atul Gawande, autonomous vehicles, basic income, Bernie Sanders, Black Swan, call centre, Chris Urmson, cloud computing, corporate raider, creative destruction, Danny Hillis, Donald Trump, Elon Musk, Erik Brynjolfsson, future of work, gig economy, Google Glasses, Google X / Alphabet X, income inequality, industrial robot, Internet of things, Jeff Bezos, job automation, Joseph Schumpeter, Kevin Kelly, Lyft, Marc Andreessen, Mark Zuckerberg, money market fund, natural language processing, pets.com, plutocrats, Plutocrats, race to the bottom, ride hailing / ride sharing, Sand Hill Road, self-driving car, shareholder value, Silicon Valley, Silicon Valley startup, Snapchat, speech recognition, Steve Jobs, Stewart Brand, supply-chain management, Tim Cook: Apple, too big to fail, Travis Kalanick, Uber and Lyft, uber lyft, universal basic income, wealth creators, web application, Whole Earth Catalog

Amazon has amassed mountains of data on what its 300 million shoppers buy, which gives it a huge advantage in e-commerce. Facebook’s algorithms keep getting better at collecting and interpreting data on the habits and preferences of the 2.4 billion people on the company’s social media site, which makes it a favorite place for advertisers. Alibaba and its affiliate Ant Financial know so much about their customers’ financial habits that they have created one of China’s largest money market funds. Tencent’s WeChat, which started out as a mobile messaging app, now allows its billion monthly users to hail cabs, book flights, and pay for purchases. It is using the data to move into new industries like health care. All these companies have armies of world-class programmers and data scientists toiling around the world to monetize data. As these tech platforms move aggressively into new industries, the incumbents will scramble to keep their own data out of the hands of the usurpers.

At the same time, more and more retailers who sell on their own sites are using Amazon Pay because of the trustworthiness that comes with the Amazon name. The business model that Amazon is pursuing in many ways resembles that of Ant Financial, the Alibaba affiliate that operates Alipay, the largest mobile payments service in the world, with some 1 billion users. Ant Financial is expanding into credit scoring, wealth management, insurance, and lending. It even offers a money market fund called Tianhong Yu’e Bao, which as of 2018 had $211 billion in deposits. An October 2018 report by the research firm CB Insights pointed out that Ant Financial had a stock market valuation of $150 billion, higher at the time than that of Goldman Sachs, Morgan Stanley, Banco Santander, or the Royal Bank of Canada. Amazon would be hard put to crack the mobile payment business in China because Ant Financial and Tencent, with its WeChat Pay, together control 92 percent of that market.

This means Amazon would avoid the heavy fees it currently pays credit card companies. Bain estimates that in the U.S. alone, Amazon would save more than $250 million in annual credit card fees. Once Amazon builds a basic banking service, Bain’s Gerard du Toit and Aaron Cheris foresee the e-tailer moving “steadily but surely into other financial products, including lending, mortgages, property and casualty insurance, wealth management (starting with a simple money market fund to hold larger balances), and life insurance.” Bain believes that Amazon could end up with 70 million banking customers—about as many as Wells Fargo—by the mid-2020s. When a company spends more than any other company in the world on R&D, it gets to do a lot of experimentation. Amazon, as we’ve seen, is making major pushes into advertising, health care, and finance, but that’s just the beginning.


pages: 554 words: 158,687

Profiting Without Producing: How Finance Exploits Us All by Costas Lapavitsas

"Robert Solow", Andrei Shleifer, asset-backed security, bank run, banking crisis, Basel III, borderless world, Branko Milanovic, Bretton Woods, business cycle, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, computer age, conceptual framework, corporate governance, credit crunch, Credit Default Swap, David Graeber, David Ricardo: comparative advantage, disintermediation, diversified portfolio, Erik Brynjolfsson, eurozone crisis, everywhere but in the productivity statistics, financial deregulation, financial independence, financial innovation, financial intermediation, financial repression, Flash crash, full employment, global value chain, global village, High speed trading, Hyman Minsky, income inequality, inflation targeting, informal economy, information asymmetry, intangible asset, job satisfaction, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, liberal capitalism, London Interbank Offered Rate, low skilled workers, M-Pesa, market bubble, means of production, money market fund, moral hazard, mortgage debt, Network effects, new economy, oil shock, open economy, pensions crisis, price stability, Productivity paradox, profit maximization, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, race to the bottom, regulatory arbitrage, reserve currency, Robert Shiller, Robert Shiller, savings glut, Scramble for Africa, secular stagnation, shareholder value, Simon Kuznets, special drawing rights, Thales of Miletus, The Chicago School, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, total factor productivity, trade liberalization, transaction costs, union organizing, value at risk, Washington Consensus, zero-sum game

Banking capital has benefited from successive waves of mergers and acquisitions among non-financial enterprises; from channelling personal savings to stock markets at the behest of the state; and from lifting of controls on interest rates and capital flows that has encouraged growth of financial markets. Third, perhaps the most striking aspect of the recent period has been the financialization of the personal revenue of workers and households across social classes.73 This phenomenon refers both to increasing debt (for mortgages, general consumption, education, health) and to expanded holdings of financial assets (for pensions, insurance, money market funds). Household financialization is associated with rising income inequality but also with the retreat of public provision across a range of services, including housing, pensions, education, health, transport, and so on. In this context, the consumption of workers and others has become increasingly privatized and mediated by the financial system. Banks and other financial institutions have facilitated household consumption but also the channelling of household savings to financial markets, thus extracting financial profits.74 Note that relations between banks and households are qualitatively different from relations between banks and industrial capitalists.

Net external sources for each type of finance are calculated as the difference between the corresponding liabilities and assets. Liabilities Assets Bank credit Depository institution loans n.e.c., other loans and advances, mortgages Checkable deposits and currency, total time and savings deposits, private foreign deposits Market funding Net new equity issues, commercial paper, municipal securities, corporate bonds Money market fund shares, security RPs, commercial paper, Treasury securities, agency- and GSE-backed securities, municipal securities, mortgages, mutual fund shares Trade credit Trade payables Trade receivables, consumer credit Other Miscellaneous liabilities, taxes payable Miscellaneous assets Statistical discrepancy is calculated as a sum of all net sources of finance as percentage of capital expenditures less 100 percent. 2.

Gross capital formation is calculated as the sum of gross fixed capital formation and changes in inventories. Internal funds = gross saving. Net external sources for each type of finance are calculated as the difference between the corresponding liabilities and assets. Liabilities Assets Bank credit loans by private financial institutions, loans by public financial institutions, depositsmoney currency and deposits, deposits with the Fiscal Loan Fund, deposits money Market funding repurchase agreements and securities lending transactions, securities other than shares, shares and other equities, financial derivatives repurchase agreements and securities lending transactions, securities other than shares, shares and other equities, financial derivatives Other loans by the non-financial sector, instalment credit (not included in consumer credit), trade credits and foreign trade credits, accounts receivable/payable, other external claims and debts, others call loans and money, loans by the non-financial sector, instalment credit (not included in consumer credit), trade credits and foreign trade credits, accounts receivable/payable, outward direct investment, outward investment in securities, other external claims and debts, others Statistical discrepancy is calculated as the sum of all net sources of finance as percentage of gross capital formation less 100 percent.


pages: 444 words: 151,136

Endless Money: The Moral Hazards of Socialism by William Baker, Addison Wiggin

Andy Kessler, asset allocation, backtesting, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, Branko Milanovic, break the buck, Bretton Woods, BRICs, business climate, business cycle, capital asset pricing model, commoditize, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crony capitalism, cuban missile crisis, currency manipulation / currency intervention, debt deflation, Elliott wave, en.wikipedia.org, Fall of the Berlin Wall, feminist movement, fiat currency, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, housing crisis, income inequality, index fund, inflation targeting, Joseph Schumpeter, Kickstarter, laissez-faire capitalism, land reform, liquidity trap, Long Term Capital Management, McMansion, mega-rich, money market fund, moral hazard, mortgage tax deduction, naked short selling, negative equity, offshore financial centre, Ponzi scheme, price stability, pushing on a string, quantitative easing, RAND corporation, rent control, reserve currency, riskless arbitrage, Ronald Reagan, school vouchers, seigniorage, short selling, Silicon Valley, six sigma, statistical arbitrage, statistical model, Steve Jobs, stocks for the long run, The Great Moderation, the scientific method, time value of money, too big to fail, upwardly mobile, War on Poverty, Yogi Berra, young professional

States, municipalities, agriculture, and other borrowers have borrowed excessively because money has been cheap. Banks have invested heavily in long-time bonds. A great volume of short-time money market funds has been diverted to capital uses . . . For the world as a whole, capital is scarce after ten years of war and disorganization. Its apparent abundance is due to abnormal money market conditions, both in the United States and abroad, and to the fact that capital is unwilling to venture into many countries and great industries which badly need it, and which, with a restoration of confidence, would be effective bidders for it. Men who use money market funds at low rates for capital purposes may expect a rude awakening when the tide turns . . . Capital in London and New York prefers the 2% or 3% it can get with safety to the 10%, 15%, or 30% which it might have in these countries under existing conditions of grave risk . . . 44 Although, for example, the investing public in New York did eventually snap up bonds marketed at high interest rates and face value discounts ($200 million of German bonds sold out in one day after the 62 ENDLESS MONEY Dawes plan was approved), generally the debt saddling the world was intergovernmental and related to the triangle of the United States, the allies, and the Germans.

Internally, Fed officers called this the “finger in the dyke” strategy, implying that the 100-year flood of bad credit might magically recede in a reasonable period of time. During the year, the financial community’s perception of the crisis would change. Initially problems were thought to be contained in the subprime sector or within specific institutions. Once the equity market collapsed beginning in September, bank deposits took flight, some money market funds had failed, and it became clear a systemic meltdown had occurred. As of March 31, 2008, only $170 billion of what the IMF and others projected as likely losses of nearly $1 trillion on subprime assets had been recognized. The perception of the extent of the credit crisis steadily worsened through the year. In early March 2008, Standard & Poor’s pegged total losses at only $285 billion; later in that month Goldman Sachs economists bumped this to $400 billion and then $500 billion.9 By August 2008, Bloomberg reported that U.S. bank losses from the credit crunch crossed the $500 billion mark, but this had been offset somewhat by the raising of $358 billion of capital.

Bear Stearns and Lehman were large, but not dominant forces in 2008. Their failure at any other time would have been easily contained. Some 38 percent of total deposits nationwide of $7 trillion were uninsured because they exceed the $100,000 limit, yet less than 15 years ago only 23 percent were.8 With the passage of TARP, the ceiling was reset at $250,000, but this leaves 27 percent of depositor funds unprotected.9 With money market funds losing assets, it is possible that new deposits above the limit could enter the banking system. Since the Great Depression, credit grew relative to GDP by an order of magnitude. Private debt was just 57 percent of GDP in 1944, with only 14 percent of this being mortgages. By 1954 it would be 71 percent, with 28 percent of this financing residential dwellings. These statistics would not skip a beat in the 1970s, despite a shakeout in the stock market, because inflation would be raging.


pages: 398 words: 108,889

The Paypal Wars: Battles With Ebay, the Media, the Mafia, and the Rest of Planet Earth by Eric M. Jackson

bank run, business process, call centre, creative destruction, disintermediation, Elon Musk, index fund, Internet Archive, iterative process, Joseph Schumpeter, market design, Menlo Park, Metcalfe’s law, money market fund, moral hazard, Network effects, new economy, offshore financial centre, Peter Thiel, Robert Metcalfe, Sand Hill Road, shareholder value, Silicon Valley, Silicon Valley startup, telemarketer, The Chicago School, the new new thing, Turing test

While nothing like the X.com plans for a financial supermarket, this optional service enabled users to earn interest on the balance in their PayPal accounts. Although called the PayPal Money Market Fund, the fund was owned and managed by Barclays Bank, an arrangement which allowed our company to again steer clear of activities that could land us with a commercial bank classification. Sacks hoped that providing our users with an interest-bearing incentive to keep cash in PayPal would decrease their reliance on expensive credit cards to fund payments. The one-two punch of international accounts and the money market fund didn’t completely repair all the damage that our brand sustained during the upgrade campaign, but it went a long way toward reassuring our customers that we’d continue to innovate and improve our service at a faster rate than Billpoint.

Harris bragged to The Wall Street Journal that he had received CEO offers from more than one hundred startups but chose X.com because he saw it as “a blank canvas upon which to write new rules on the delivery of financial services.”2 X.com also generated some additional buzz toward the end of 1999 with a no-fee, no-minimum balance S&P 500 index fund, the only one of its kind.3 This loss leader product had been rationalized as a way to attract new users who could be up-sold to X.com’s other financial products, including its bond and money market funds, interest-bearing checking accounts, and low APR credit lines. X.com certainly seemed eager to become a financial services supermarket, but Confinity had not seen any sign that it held an interest in following PayPal into person-to-person payments. Yet here it was. Sometime over the previous month, X.com had quietly built an e-mail-based payment feature on top of its existing bank account service and had turned itself into a formidable competitor.


Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, high net worth, hiring and firing, index fund, invisible hand, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, mental accounting, money market fund, Myron Scholes, paper trading, passive investing, Paul Samuelson, price anchoring, price stability, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

Investors in the early 1990s had not even a glimmer of today’s f lood of information by means of the computer and the Internet; the instruments bern_c04.qxd 3/23/07 9:02 AM Page 49 Robert C. Merton 49 being traded; the reality of computerized trading in place of exchange f loors; the management of the stock exchanges themselves; the global interlocks; the size, sophistication, and orientation of the larger investors; the proliferation of money market funds, mutual funds, and hedge funds; the development of risk-sharing instruments blurring distinction between the commercial banks or insurance companies and the capital markets; or the transformation of pension funding from defined-benefit to defined-contribution. Even this extended listing of innovations is far from complete. Merton emphasizes that form follows function. These novel institutional impulses do not change the theory of finance, but they do extend its range of applications in revolutionary fashion.

As Merton sees it, “You can bern_c04.qxd 52 3/23/07 9:02 AM Page 52 THE THEORETICIANS move from the unrealistic world of theory in which everybody agrees about asset prices and risks to the real world in which everybody agrees to use institutions.” The power of innovative institutions to change markets is clear from just a few examples, which Merton and Bodie place under the heading of “the financial innovation spiral.” Money market funds now compete with banks and thrifts for household savings. Securitization of auto loans and credit card receivables has intensified competition among financial institutions as sources for these purposes. High-yield bonds have liberated many companies from the icy grip of their commercial bankers. In national mortgage markets, many institutions have developed into major alternatives to thrifts as a source for residential mortgages.

.* In BondsPLUS, Pimco aims to invest the collateral to take advantage of inefficiencies in the market for short-term Treasury securities as a means to outperform the embedded financing rate in the futures contract. For example, Gross had noted that yields on the shortest-term paper in the money markets were significantly lower than the returns available in the six- to twelve-month portion of the market. He smelled a chance for alpha. As he explains the excessively large spread in yields, overnight liquidity was so essential for money market funds, and even some institutional equity managers, these investors had no choice but to accept yields deemed “too low” under more normal circumstances. Liquidity was more important than return in such cases. This insight was just one of several opportunities Gross perceived for outperforming the embedded interest rate in Treasury futures. By exploiting these kinds of inefficiencies, Pimco could deliver to its clients the return on Treasury issue they wanted to hold plus more than enough to cover the financing costs involved in the futures contract. * The f inancing rate is typically three-month LIBOR, which is the customary f inancing rate in many f inancial transactions similar to this one.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

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

Bank chiefs and financial regulators are currently working with a strategy that can be summarized as eyes shut and fingers crossed. These things haven’t exactly escaped the attention of the financial markets. All through 2011 there’s been a growing sense of jitteriness‌—‌mirroring to an uncanny degree the anxiety felt in the months between the collapse of Bear Stearns and the Lehman bankruptcy. That nervousness has manifested itself in an acute risk-aversion. American money market funds are pulling their cash out of Europe. Interbank loans have become ever shorter in duration, meaning that ever larger volumes of money have to roll over every week. French banks, indeed, have effectively lost their access to this market. And these things matter. As so often in this book, I find myself making statements that sound boringly technical. European bank funding is becoming more short-term: I mean, do you really care?

But these things are likely to affect you personally, and massively. Your job, your pension, your savings, your government may come to depend on these things. The disaster scenario is this. A big bank‌—‌let’s say a mythical French one, the Banque des Grandes Baguettes (BGB)‌—‌announces unexpectedly large losses on its sovereign loan portfolio. It has become highly reliant on short-term funding, but money market funds and the interbank market now cut it off completely. BGB is now totally reliant on funding from the European Central Bank, and the ECB in turn comes under acute pressure to force a restructuring or bankruptcy filing. Maybe the ECB caves into that pressure, maybe it doesn’t, but either way the market is in a panic. In Italy, the Banco Bunga Bunga announces that it too has lost the ability to fund itself.

If you don’t understand something, don’t invest in it. It’s a rule that has protected me for thirty years. It’s a rule I urge you to follow yourself. That said, the first and biggest moral of this book is that you need to throw out all the assumptions you’ll have lived with to this point. Sovereign debt is no longer so safe you don’t have to think about it. (Truth is, it never was.) Banks might fail, including large ones. Money market funds may ‘break the buck’‌—‌that is, lose money. Equally, you need to shed some of your Ponzi-ish optimism. House prices have fallen, but they may fall further. Stock market prices have fallen, but they may fall further. Some bond prices have already collapsed, but they could collapse further. The dollar has collapsed against the yen (falling by a third, from $1 = ¥120 in 2007 to less than ¥80 at the time of writing).


pages: 267 words: 71,123

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

But as far as the economics are concerned, a bank is any institution that borrows short and lends long, that promises people easy access to their funds, even as it uses most of those funds to make investments that can’t be converted into cash at short notice. Depository institutions—big marble buildings with rows of tellers—are the traditional way to pull this off. But there are other ways to do it. One obvious example is money market funds, which don’t have a physical presence like banks and don’t provide literal cash (green pieces of paper bearing portraits of dead presidents), but otherwise function a lot like checking accounts. Businesses looking for a place to park their cash often turn to “repo,” in which borrowers like Lehman Brothers borrow money for very short periods—often just overnight—using assets like mortgage-backed securities as collateral; they use the money thus raised to buy even more of these assets.

., 112 Mian, Atif, 47 Minsky, Hyman: financial instability hypothesis of, 43–44, 47 renewed appreciation of, 41, 42–43 Minsky moments, 48, 111, 146 bank runs as, 58 MIT, Billion Prices Project of, 161 monetarism, 101, 135 monetary base, 31, 32, 188 Monetary Control Act (1980), 61 monetary policy, 39, 105, 207 deficit spending and, 135 expansionary, xi, 151, 185, 188 short-term interest rates in, 216–17 “Monetary Theory and the Great Capitol Hill Baby Sitting Co-op Crisis” (Sweeney and Sweeney), 26–27 money market funds, 62 money supply: in babysitting co-op example, 27, 29, 32–33 Federal Reserve and, 31, 32, 33, 105, 151, 153, 155, 157, 183 liquidity traps and, 152, 155 Montgomery Ward, 148–49 Moody’s, 113, 194 moral hazard, 60, 68 Morgan, J. P., 59 Morgan Stanley, 131, 134 mortgage-backed securities, 62, 112, 114 mortgage relief, 53, 126–28, 219–21 Obama administration and, 220–21 mortgages, 30, 93 defaults on, 47–48, 172 foreclosure and, 45, 127–28 real value of, 163–64 subprime, 65, 99 “underwater,” 127, 220 see also household debt Mulligan, Casey, 6 Mundell, Robert, 172 Munk, Nina, 71, 72 Nakamura, Emi, 236 National Bureau of Economic Research, 4 National Institute for Economic and Social Research, 201 National Review, 25 natural experiments, 212, 233, 235 Nebraska, high employment in, 37 net international investment position, 44 Nevada, housing bubble in, 111, 172 New Deal, 38, 50 job-creation programs of, 39 New Keynesians, 103, 104 New Yorker, The, 125 New York Times, 80–81, 151 1930s, economic conditions in, xi Obama, Barack, 150 business confidence and, 95 deficit and, 130, 131, 134, 143 inflation under, 152 spending cuts and, 28, 131, 143 stimulus plan of, see American Recovery and Reinvestment Act and 2012 election, 226 worker redundancy and, 36 Obama administration, 116, 117, 210 and deficit reduction vs. job creation, 225, 228 household debt relief and, 128 and inadequacy of stimulus, 123–26, 130–31, 213 mortgage relief and, 220–21 unemployment and, 110, 117 Occupy Wall Street, 64, 74–75, 76 oil and gas industry, 37 deregulation of, 61 prices in, 159 optimum currency area, 171–72 Oracle Partners, 72 Organization for Economic Cooperation and Development (OECD), 189, 190, 191, 202 O’Rourke, Kevin, 236 Osborne, George, 178, 200, 201 panics, 59 euro as vulnerable to, 182–84, 186 of 1907, 59 in 2008 financial crisis, 4, 63 Parenteau, Rob, 189 Paul, Ron, 150–51 payroll tax credit, 229 Pearl Harbor, Japanese attack on, 38 Perry, Rick, 151, 218 Piketty, Thomas, 77–78, 81–82 Pimco, 131, 134 Pinto, Edward, 65–66 Plosser, Charles, 36–37 policy makers: Austerian influence on, 188–207 influence of financial elite on, 23–24, 96 informed public and, xii lessons of Great Depression ignored by, xi, 50, 92, 189 in 2008 financial crisis, 115–16 politics, politicians: anti-Keynesianism in, 93–96 influence of money in, 63, 77–78, 85–90 lessons of Great Depression ignored by, xi, 50 revolving door and, 86, 87–88 as roadblocks to recovery, 23–24, 123–24, 129, 130–31, 211, 218, 219, 222, 223 Poole, Keith, 88–89 poor, aid to, 89, 120, 144, 216 Portugal: debt crisis in, 18, 175, 175, 178, 186 debt to GDP ratio in, 178, 178 EEC joined by, 168 private debt: European crisis and, 182 overhang of, 39, 52, 53, 93, 163–64 private-equity firms, breach of trust and, 80–81 private sector: saving vs. investment in, 137 spending by, 25–26, 143–44, 235–36 prosperity, unemployment and, 9 pundit’s fallacy, 225 quantitative easing, 193, 218–19 Rajan, Raghuram, 190, 203–4 Reagan, Ronald: defense spending under, 236 deficit under, 142 deregulation under, 50, 60–61, 62, 67–68 inflation under, 152, 161, 162 real business cycle, 103 real estate loans, bad, 68, 80 real gross domestic product (real GDP), 12–14 CBO estimates of, 13–14 in 2008 financial crisis, 13 recessions, 13, 18, 172, 201 historical patterns of, 122, 128–29 long-term effects of, 17 Lucas project and, 102, 103 of 1937, 38 of 1979–82, 13, 31 of 1990–91, 31 of 2001, 31 see also depressions reconciliation, 124, 226–27 recovery, from depression of 2008–, ix–x, 208–22 aggressive action needed in, 216–19, 221–22 deficit and, 212 government spending and, 211–16 housing sector in, 219–21 inadequacy of stimulus in, 108, 109–10, 116–19, 122–26, 130–31, 165, 212, 213, 229–30 inflation and, 219 infrastructure investment and, 215 job creation and, 228–29, 238 lessons of Great Depression and, xi, 20, 22 long-term focus as mistaken in, 15 as moral imperative, 229–30 Obama administration and, 123–26, 210 political roadblocks to, 23–24, 123–24, 129, 130–31, 211, 218, 219, 222, 223 research-based policies for, xi, 212, 217 self-interest and distorted ideology as roadblocks to, 20 slow pace of, 4 supposed lack of projects in, 212, 213–16 will as key to, 20, 217, 218, 219–20 Reinhart, Carmen, 129 repo, 62, 114 Repubblica, La, 188, 196 Republicans, Republican Party, 107, 151, 228 austerity programs espoused by, 190, 218, 227 Big Lie of 2008 financial crisis espoused by, 64–65 extremism in, 19 financial elite and, 88–89 inflation and, 160 job-creation policies opposed by, 227, 228–29 scorched-earth policy of, 123–24, 131 stimulus and, 109 research, economic, 5–6, 10–11 correlation vs. causation in, 83, 198, 232–33, 237 misleading, 196–99 natural experiments in, 212, 233, 235 policies based on, xi, 212, 217, 231–38 “Rethinking Macroeconomic Policy” (Blanchard et al.), 161–63 Return of Depression Economics, The (Krugman), 31, 69, 91 returns on investment, liquidity vs., 57 Reynolds, Alan, 78 Ricardian equivalence, 107 Ricardo, David, 205–6 Riedl, Brian, 25–26, 29, 106 risk taking, 43, 54, 55 deregulation and, 61–62, 63–64, 80 limiting of, 60 Rogoff, Kenneth, 129 Romer, Christina, 104, 107, 108, 228, 237–38 Romney, Mitt, 80, 226, 227 “Rooseveltian resolve,” 217, 218, 219–20 Rosenthal, Howard, 88–89 Rubin, Robert, 86 Saez, Emmanuel, 77–78, 81–82 Samuelson, Paul, 43, 93 Sargent, Greg, 225 savings, personal: depletion of, 4, 10, 83–84 and spending drop, 41, 136 savings, private sector, investment vs., 137 savings and loan crisis (1980s), 60, 67–68, 72–73, 80 Say’s Law, 25, 106 Schäuble, Wolfgang, 23 Scheiber, Noam, 228 Schiff, Peter, 150 Schumpeter, Joseph, 204–5 self-esteem, unemployment and, 10–11 Senate, U.S.: Banking, Housing, and Urban Affairs Committee of, 85 filibusters in, 123 reconciliation in, 124, 226–27 and 2012 election, 226 see also Congress, U.S.; House of Representatives, U.S.


pages: 233 words: 64,702

China's Disruptors: How Alibaba, Xiaomi, Tencent, and Other Companies Are Changing the Rules of Business by Edward Tse

3D printing, Airbnb, Airbus A320, Asian financial crisis, barriers to entry, bilateral investment treaty, business process, capital controls, commoditize, conceptual framework, corporate governance, creative destruction, crowdsourcing, currency manipulation / currency intervention, David Graeber, Deng Xiaoping, disruptive innovation, experimental economics, global supply chain, global value chain, high net worth, industrial robot, Joseph Schumpeter, Lyft, money market fund, offshore financial centre, Pearl River Delta, reshoring, rising living standards, risk tolerance, Silicon Valley, Skype, Snapchat, sovereign wealth fund, special economic zone, speech recognition, Steve Jobs, thinkpad, trade route, wealth creators, working-age population

What China needed through the 1990s and 2000s was to be able to direct money into infrastructure and construction. What it needs through the rest of this decade and beyond is investment that raises productivity. Ultimately, commercial financial organizations will be the best judges of where money should be directed. To attract the funds of Noah’s investors or of the ordinary savers putting their money into Yu’e Bao, Alibaba’s online money-market fund, these companies will have to be better at finding the right investment opportunities. With the rise of private finance businesses, we are seeing the start of this shift. HELPING HEALTH CARE A similar process is unfolding in health care. Although China’s system will remain very much a publicly run system for the foreseeable future, private companies are extending the quality and range of services.

Alibaba’s total loan book stood at $2 billion: See “Alibaba’s Small Business Lending Moves Ahead,” Wall Street Journal, July 5, 2013, available at http://online.wsj.com/news/articles/SB10001424127887324260204578587451309343978 (accessed August 28, 2014). What made Yu’e Bao attractive: China’s central bank, the People’s Bank of China, restricts bank-demand deposits to paying annual interest of less than 1 percent, and time deposits to a maximum of just over 3 percent. Yu’e Bao, which can invest in higher-interest-earning money-market funds, has offered returns of up to 6 percent. Yu’e Bao’s arrival, followed shortly after by similar products from China’s two other Internet giants, Baidu and Tencent: See Gabriel Wildau, “China Banks Strike Back Against Threat from Internet Finance,” Reuters, February 23, 2014, available at http://uk.reuters.com/article/2014/02/23/uk-china-banks-online-idUK BREA1M12I20140223 (accessed February 25, 2014).


pages: 492 words: 118,882

The Blockchain Alternative: Rethinking Macroeconomic Policy and Economic Theory by Kariappa Bheemaiah

accounting loophole / creative accounting, Ada Lovelace, Airbnb, algorithmic trading, asset allocation, autonomous vehicles, balance sheet recession, bank run, banks create money, Basel III, basic income, Ben Bernanke: helicopter money, bitcoin, blockchain, Bretton Woods, business cycle, business process, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, cashless society, cellular automata, central bank independence, Claude Shannon: information theory, cloud computing, cognitive dissonance, collateralized debt obligation, commoditize, complexity theory, constrained optimization, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crowdsourcing, cryptocurrency, David Graeber, deskilling, Diane Coyle, discrete time, disruptive innovation, distributed ledger, diversification, double entry bookkeeping, Ethereum, ethereum blockchain, fiat currency, financial innovation, financial intermediation, Flash crash, floating exchange rates, Fractional reserve banking, full employment, George Akerlof, illegal immigration, income inequality, income per capita, inflation targeting, information asymmetry, interest rate derivative, inventory management, invisible hand, John Maynard Keynes: technological unemployment, John von Neumann, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, knowledge economy, large denomination, liquidity trap, London Whale, low skilled workers, M-Pesa, Marc Andreessen, market bubble, market fundamentalism, Mexican peso crisis / tequila crisis, MITM: man-in-the-middle, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, natural language processing, Network effects, new economy, Nikolai Kondratiev, offshore financial centre, packet switching, Pareto efficiency, pattern recognition, peer-to-peer lending, Ponzi scheme, precariat, pre–internet, price mechanism, price stability, private sector deleveraging, profit maximization, QR code, quantitative easing, quantitative trading / quantitative finance, Ray Kurzweil, Real Time Gross Settlement, rent control, rent-seeking, Satoshi Nakamoto, Satyajit Das, savings glut, seigniorage, Silicon Valley, Skype, smart contracts, software as a service, software is eating the world, speech recognition, statistical model, Stephen Hawking, supply-chain management, technology bubble, The Chicago School, The Future of Employment, The Great Moderation, the market place, The Nature of the Firm, the payments system, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, trade liberalization, transaction costs, Turing machine, Turing test, universal basic income, Von Neumann architecture, Washington Consensus

Stress tests Assess an institution capital plan and ability to continue providing financial services, without government assistance, following a specified shock Only for banks Living wills Only 1 bank Plan on how a SIFI would resolve itself if it failed. Based on that knowledge and in case of failure, the government would use Orderly Liquidation Authority to dismantle the firm so its losses would not affect others Money market fund rules Stress testing, disclosure, floating NAV, liquidity fee, and redemption gate Milestones Identification Conformance period ends on Oct. 14, 2016 (continued) 35 Chapter 2 ■ Fragmentation of Finance Table 2-1. (continued) Derivatives Dealing/ Securitization Activities Category Rules Milestones Volker Rule Targeted Outcome Implementation (as ofJune 2016) Prohibit entities holding customer deposits from engaging in speculative derivatives activity Conformance period extended to July 21, 2017 Derivatives Standardized derivatives Clearing transactions must be centrally Organization Rule cleared Swaps-related rules for banks and nonbanks Effective in January 9, 2012.

In July 7, 2012, two DCOs are denominated Systemically Important FMU Enhanced regulations and increased Work in progress, transparency of derivatives markets with 1/3 remaining regarding trade reporting, capital, and margin requirements for non-centrally cleared derivatives, exchange of electronic platform, cross-border activities Financial Stability and Systemic Risk monitoring Category Rules Milestones Enhanced Prudential Rules (liquidity, capital, leverage, concentration limits, risk management…) Targeted Outcome Implementation (as ofJune 2016) Enhance the stability and resilience of SIFIs Focus on banks, FMUs and money market funds Transparency and Simplify the US financial regulatory harmonization system FSOC, OFR (continued) 36 Chapter 2 ■ Fragmentation of Finance Table 2-1. (continued) Consumer and Investor Protection Category Rules Milestones Investment Adviser Registration Targeted Outcome To protect pensioners; requirement to make the data publicly available, even for exempt advisers, in order to increase transparency and access for prospective investors; created Consumer to promote clear information for Financial Protection Bureau consumers and protect them from unfair practices; promote fair, efficient, and innovative financial services for consumers; improve access to financial services.

Regulating Regulation The period after the crisis has been rife with regulation as bank and market-focused rules have been/are in the process of being implemented, notably in the US and in the EU, e.g., Dodd-Frank Act (2010), Volker Rule (2013), Third Basel Accord (2013), EU Commission’s Liikanen proposals (2012), European Market Infrastructure Regulation (EMIR) (2012), etc.… These regulations target liquidity and collateral requirements, money market funds, taxation, derivatives, and consumer protection rights, among others. As the scope of regulation is large, we will focus on the concept and role of regulation in the context of market players rather than entering the intricacies of specific regulations on different sectors. Markets are often cited to be the whipping boys of regulation. Time and time again, terms such as “stifling regulation” or “excessive regulation” are cited by the media as impediments to innovation and economic growth, and regulators are portrayed to be “asleep at the wheel” or detached or aloof from the markets that are in their supervisory charge.


pages: 425 words: 122,223

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

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

Reluctantly, they began to show interest in converting the abstract ideas of the academics into methods to control risk and to staunch the losses their clients were suffering. This was the motivating force of the revolution that shaped the new Wall Street. ••• Even an incomplete list of the innovations that have emerged since the mid-1970s reminds us of how profoundly the present differs from the past. The unfamiliarity of some of the new terminology suggests the magnitude of that break with tradition. Today there are money market funds, bank CDs for small savers, unregulated brokerage commissions, and discount brokers. There are hundreds of mutual funds specializing in big stocks, small stocks, emerging growth stocks, Treasury bonds, junk bonds, index funds, government-guaranteed mortgages, and international stocks and bonds from all around the world. There is ERISA to regulate corporate pension funds, and there are employee savings plans that enable employees to manage their own pension funds.

Errors shrank from 5 percent to less than 0.1 percent, and the necessary number of transactions held to acceptable levels. The first sales material for Leland-Rubinstein’s portfolio insurance product contained an example of protection against five market moves of 5 percent, with the protection in force until the maximum number of moves had taken place. Rubinstein set out to prove to the world that this splendid product really worked: he tried it out with his own money, shifting between a money market fund and a mutual fund that tracked the S&P 500 Index over a period of six months. Everything worked out exactly as expected. The experiment was so successful that Fortune magazine published an article about it. Marketing began in earnest in 1979. Armed with a letter from Barr Rosenberg endorsing the validity of the principles behind the product, Leland visited a number of bank trust departments in the East and Midwest, including Morgan Guaranty in New York and American National Bank in Chicago.

See also specific theories and types of securities competitive disaster avoidance invisible hand linear regression/econometric seasonal fluctuations stochastic process Mathematical economics Mathematical Theory of Non-Uniform Gases, The Maximum expected return concept McCormick Harvester Mean-Variance Analysis Mean-Variance Analysis in Portfolio Choice and Capital Markets (Markowitz) “Measuring the Investment Performance of Pension Funds,” report Mellon Bank Merck Merrill Lynch Minnesota Mining MIT MM Theory “Modern Portfolio Theory. How the New Investment Technology Evolved” Money Managers, The (“Adam Smith”) Money market funds Mortgages government-guaranteed prepaid rates on “‘Motionless’ Motion of Swift’s Flying Island, The” (Merton) Multiple manager risk analysis (MULMAN) Mutual funds individual investment in performance analysis of portfolio management and Value Line National Bureau of Economic Research National General Naval Research Logistics Quarterly New School for Social Research New York Stock Exchange volume of trading New York Times averages “Noise” (Black) Noise trading asset prices and inefficiency of October, 1987, crash OPEC countries Operations Research Optimal capital structure Optimal investment strategy: see Diversification; Portfolio(s), optimal “Optimization of a Quadratic Function Subject to Linear Constraints, The” (Markowitz) Optimization theory Options call contracts expected return on implicit out-of-the-money/in-the-money pricing formulas put valuation Options markets over-the-counter Pacific Stock Exchange Paul A.


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

Paul Asquith, a professor at Harvard Graduate School of Business, with his colleagues David Mullins and Eric Wolf, found that junk bond default rates were higher than previously stated. Around 30 percent of all junk bonds issued in 1977–9 had defaulted or been subject to a distressed exchange. Lipper Analytical Services, an investment firm, found that over 10 years junk bonds provided lower returns than government bonds, earning the same as money market funds. Altman published new research reaching similar conclusions.26 As Laurence J. Peter, author of The Peter Principle, stated: “Facts are stubborn things, but statistics are more pliable.” Fallen Angels Milken put Hickman’s theories to work at Drexel Harriman Ripley, an investment bank that had once partnered with JP Morgan. As head of fixed income research and subsequently sales and trading, Milken operated in the bond underworld, buying and selling fallen angels or Chinese paper—bonds issued by investment-grade companies that had their ratings downgraded and were trading at deep discounts.

Issued by a Cayman Islands’ SPV, Lehman Brothers’ Minibonds were marketed as simple bonds paying a high interest rate. In fact, they were complex, highly financially engineered derivatives, where the higher return required taking the risk that none of seven or eight companies would default or file for bankruptcy. The SPV invested the money subscribed by investors in high-quality AAA-rated securities, initially investments in money market funds. The investments secured a credit derivative known as a first-to-default (FtD) swap. The investors received an annual fee that together with the interest on the money invested gave the investors the higher return. The investors agreed to make a contingent payment if any one of the identified firms defaulted. Under the FtD swap, the investors were exposed to all seven or eight entities, although the loss was limited to the first entity to default and the face value of the Minibonds.

If the default correlation is 0, then the FtD is equivalent to selling insurance on all the entities within the basket with a limit on the maximum loss. Assuming low or zero default correlation, the risk of any one entity within a basket of eight well-rated firms defaulting is significantly higher than for any single entity defaulting. A FtD basket based on investment grade companies may be equivalent to noninvestment grade credit risk. Over time, instead of placing the investor’s money in money market funds, the cash was invested in CDOs and CDO2s, arranged and sold by Lehman, adding to the risk of the arrangements. In Hong Kong, in accordance with local superstitions, no series of Minibonds were issued with the number 4, considered unlucky in Chinese culture. Advertisements and flyers prominently featured symbols of potency, luck or profit—tigers, rhinoceroses, and whales. Investors were enticed with prizes, including video cameras and flat-screen televisions.


pages: 273 words: 78,850

The Millionaire Next Door: The Surprising Secrets of America's Wealthy by Thomas Stanley, William Danko

affirmative action, estate planning, financial independence, high net worth, index fund, money market fund, mortgage tax deduction, the market place, very high income, Yogi Berra

Excluding home equity, the median net worth for this group falls to less than $60,000. And what about our senior citizens? Without Social Security benefits, almost one-half of Americans over sixty-five would live in poverty. Only a minority of Americans have even the most conventional types of financial assets. Only about 15 percent of American households have a money market deposit account; 22 percent, a certificateof deposit; 4.2 percent, a money market fund; 3.4 percent, corporate or municipal bonds; fewer than 25 percent, stocks and mutual funds; 8.4 percent, rental property; 18.1 percent, U.S. Savings Bonds; and 23 percent, IRA or KEOGH accounts. But 65 percent of the households have equity in their own home, and more than 85 percent own one or more motor vehicles. Cars tend to depreciate rapidly. Financial assets tend to appreciate. The millionaires we discuss in this book are financially independent.

Conversely, employees are too often fully dependent on their employers. Thus they tend to be less self-reliant when it comes to planning their investments in a way that will facilitate accumulating wealth. There is another issue to consider in the planning equation: UAWs spend less time planning their investments than do PAWs, in part because of the nature of their investments. UAWs consider cash/near cash and equivalents, such as savings accounts, money market funds, and short-term treasury bills, to be investments. UAWs are nearly twice as likely as PAWs to hold at least 20 percent of their total wealth in cash/near cash. Most of these cash categories are federally insured. Most are easily accessed when consumption needs arise. And, of course, it takes less time to plan cash-related investments than it does to allocate wealth the way PAWs tend to do.


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

On Tuesday, September 16, the Reserve Primary Fund, a big money market mutual fund that had bought more than $700 million in short-term debt issued by Lehman, which was now worthless, announced that its customers would no longer be allowed to withdraw cash from their accounts because it didn’t have enough to pay them all: its net asset value had fallen below a dollar a share. Since the founding of the first money market fund in 1970, only one other fund had “broken the buck.” Fearing that other firms would find themselves in a similar position to the Reserve Primary Fund, private and institutional investors began pulling their money out of money market funds, raising the possibility of a full-scale run on the industry. In just a few days, almost $150 billion was withdrawn. This was a truly alarming development, and not just for the mutual fund industry. With about $3.5 trillion in assets, money market funds are major players in the financial system. Through investing in commercial paper and other short-term debts, they provide day-to-day funding for many financial and nonfinancial firms.


pages: 370 words: 129,096

Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future by Ashlee Vance

addicted to oil, Burning Man, cleantech, digital map, El Camino Real, Elon Musk, global supply chain, Hyperloop, industrial robot, Jeff Bezos, Kickstarter, low earth orbit, Mark Zuckerberg, Maui Hawaii, Menlo Park, Mercator projection, money market fund, multiplanetary species, optical character recognition, orbital mechanics / astrodynamics, paypal mafia, performance metric, Peter Thiel, pre–internet, risk tolerance, Ronald Reagan, Sand Hill Road, self-driving car, side project, Silicon Valley, Silicon Valley startup, Steve Jobs, technoutopianism, Tesla Model S, transaction costs, Tyler Cowen: Great Stagnation, We wanted flying cars, instead we got 140 characters, X Prize

It’s a little counterintuitive, but the easier you make it for people to get money out of PayPal, the less they’ll want to do it. But if the only way for them to spend money or access it in any way is to move it to a traditional bank, that’s what they’ll do instantly. The other thing was the PayPal money market fund. We did that because if you consider the reasons that people might move the money out, well, they’ll move it to either conduct transactions in the physical world or because they’re getting a higher interest rate. So I instituted the highest-return money market fund in the country. Basically, the money market fund was at cost. We didn’t intend to make any money on it, in order to encourage people to keep their money in the system. And then we also had like the ability to pay regular bills like your electricity bill and that kind of thing on PayPal.


pages: 504 words: 139,137

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

activist fund / activist shareholder / activist investor, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Black-Scholes formula, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, Eugene Fama: efficient market hypothesis, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, late capitalism, law of one price, Long Term Capital Management, margin call, market clearing, market design, market friction, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, price discovery process, price stability, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stocks for the long run, stocks for the long term, survivorship bias, systematic trading, technology bubble, time value of money, total factor productivity, transaction costs, value at risk, Vanguard fund, yield curve, zero-coupon bond

In this case, the foreign-currency-denominated feeder funds have a currency hedge in addition to their investment into the master fund. Another use of this structure is to have feeder funds at different risk levels. If the master fund has a volatility of 20% per year, one feeder fund might have the same volatility while another has half the volatility. The lower-risk feeder simply invests half its capital in a money market fund and the other half into the master fund, thus realizing half the risk. Figure 1.1. The master–feeder hedge fund structure. The master fund has a pool of money, and this is where all the trades are carried out. It has an investment management agreement (IMA) with the management company to provide investment services, including strategy development, implementation, and trading. Hence, the management company is where all the employees work—including the traders, research analysts, operations staff, business development people, compliance, and legal personnel—and the management company is owned by the hedge fund managers.

The securities that a hedge fund has sold short are liabilities (since the hedge fund eventually needs to return these shares). The cash proceeds from the sale are assets, but they are held as collateral by the securities lender. In addition, the securities lender requires additional cash as margin requirement and, hence, the hedge fund must use equity capital “supporting margin requirements for short positions.” Lastly, the hedge fund has additional equity invested in cash instruments (e.g., money market funds, Treasury bills, or margin excess with prime brokers), as seen in the balance sheet. This additional equity makes it able to sustain losses without having to immediately liquidate positions. Hedge funds also gain economic leverage by using derivatives and, though this economic leverage may not formally show up on the balance sheet, their notional exposures should also be considered when leverage is estimated.

Receiving a margin call is itself a negative. Even if the hedge fund successfully adds cash, repeated margin calls are a sign of problems and can eventually lead the prime broker to terminate the arrangement or increase margin requirements. Hence, hedge funds naturally try to keep excess margin capital. (Some hedge funds have all their capital in their margin account, while others have most of their cash in a money market fund, moving it into the margin account as needed.) The overall economics of funding a portfolio are quite general, but the specific institutional arrangements depend on the type of security. Let us briefly review the main forms of leverage, that is, the main ways that the overall economic principles discussed are put into practice. • Repo. Government bonds and other fixed-income securities are usually leveraged using what is called a repurchase agreement, or repo for short.


pages: 290 words: 84,375

China's Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle by Dinny McMahon

2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, American Society of Civil Engineers: Report Card, Andrei Shleifer, Asian financial crisis, bank run, business cycle, California gold rush, capital controls, crony capitalism, dark matter, Deng Xiaoping, Donald Trump, Edward Glaeser, eurozone crisis, financial innovation, fixed income, Gini coefficient, if you build it, they will come, income inequality, industrial robot, invisible hand, megacity, money market fund, mortgage debt, new economy, peer-to-peer lending, Ponzi scheme, Ronald Reagan, short selling, Silicon Valley, too big to fail, trickle-down economics, urban planning, working-age population, zero-sum game

More importantly, it has evolved in a way that now threatens the very sustainability of China’s economic miracle. 5 The Island of Misfit Toys CHINA’S FINANCIAL SYSTEM is a little like the Island of Misfit Toys in Rudolph the Red-Nosed Reindeer, the 1964 animated Christmas classic. From a distance everything looks familiar, but up close it becomes clear that things aren’t built the way you might expect. For example, China’s money-market funds are managed not by storied investors like Vanguard and Fidelity but by China’s equivalent of Amazon and Google. Insurance companies generate most of their premiums not from selling insurance but from selling investments that mature after only a year, insure nothing, and promise a fixed return a little higher than bank deposits. In the United States, trust companies help rich families preserve their wealth from one generation to the next, but in China trusts have become the second-biggest class of financial institution after the banks, facilitating loans to everyone from property developers to local governments.

But for the most part, WMPs are a blend of three things: corporate bonds, loans to banks (which banks then use to make their own loans), and corporate loans. The combination mixes risk and return. Loans to banks are extremely safe but have low interest rates; loans to companies are more risky but pay more. Put them together and you get a pretty safe investment with a decent return. Most of the fund-management industry—whether trusts, insurance companies, securities firms, money-market funds, or P2P portals—deploy their resources in similar ways. They’re a source of credit that has emerged as an alternative to traditional bank loans. Together they constitute a shadow-banking system. What We Do in the Shadows Broadly speaking, shadow banking includes any nonbank credit that isn’t subject to the same careful, thoughtful regulation that governments give to ordinary bank lending.


pages: 297 words: 84,009

Big Business: A Love Letter to an American Anti-Hero by Tyler Cowen

23andMe, Affordable Care Act / Obamacare, augmented reality, barriers to entry, Bernie Sanders, bitcoin, blockchain, Bretton Woods, cloud computing, cognitive dissonance, corporate governance, corporate social responsibility, correlation coefficient, creative destruction, crony capitalism, cryptocurrency, dark matter, David Brooks, David Graeber, don't be evil, Donald Trump, Elon Musk, employer provided health coverage, experimental economics, Filter Bubble, financial innovation, financial intermediation, global reserve currency, global supply chain, Google Glasses, income inequality, Internet of things, invisible hand, Jeff Bezos, late fees, Mark Zuckerberg, mobile money, money market fund, mortgage debt, Network effects, new economy, Nicholas Carr, obamacare, offshore financial centre, passive investing, payday loans, peer-to-peer lending, Peter Thiel, pre–internet, price discrimination, profit maximization, profit motive, RAND corporation, rent-seeking, reserve currency, ride hailing / ride sharing, risk tolerance, Ronald Coase, shareholder value, Silicon Valley, Silicon Valley startup, Skype, Snapchat, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, The Nature of the Firm, Tim Cook: Apple, too big to fail, transaction costs, Tyler Cowen: Great Stagnation, ultimatum game, WikiLeaks, women in the workforce, World Values Survey, Y Combinator

American equity markets are considered relatively fair and supportive of liquid trading, more or less on demand, with accurate record keeping. That means an investor can opt for higher-yielding assets without sacrificing much in the way of liquidity, and indeed, helping individuals liquefy their wealth is one of the main functions a financial sector should serve. For instance, cash management accounts and money market funds are easy to obtain and charge relatively low fees. It is also possible to hold stocks and have ready access to those funds. The American system performs well in this regard, as there is a dazzling array of investment products at virtually all levels of risk. Furthermore, Americans can borrow against relatively illiquid forms of wealth, such as homes, cars, and other possessions, with relative ease through a variety of competitive lenders.

Think of finance as an activity of wealth management, applied to our wealth overall and not just to our flow of current income. For instance, if you open up a brokerage account, typically you are charged management fees based on how much is in the account, not on your yearly income. As noted at the beginning of this section, finance as a share of measurable wealth has been pretty stable. By measurable wealth, I mean bonds, stocks, money market funds, and other forms of value that can be assigned market prices. It does not include the harder to measure value of human capital or the value of the items sitting around your house. Keep in mind that ratios of national wealth to national income vary over the course of history, and thus the size of the financial sector relative to income will vary too. Let’s say a nation experiences domestic peace for many decades on end.


pages: 302 words: 84,428

Mastering the Market Cycle: Getting the Odds on Your Side by Howard Marks

activist fund / activist shareholder / activist investor, Albert Einstein, business cycle, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, financial innovation, fixed income, if you build it, they will come, income inequality, Isaac Newton, job automation, Long Term Capital Management, margin call, money market fund, moral hazard, new economy, profit motive, quantitative easing, race to the bottom, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, secular stagnation, short selling, South Sea Bubble, stocks for the long run, superstar cities, The Chicago School, The Great Moderation, transaction costs, VA Linux, Y2K, yield curve

There’s no doubt that the recent credit crisis was as bad as it was because the credit markets froze up and capital became unavailable other than from governments. (“Open and Shut”) I truly believe a system meltdown—with ramifications like those seen in the Great Depression—could have occurred. Former Treasury secretary Timothy Geithner’s book Stress Test bears this out. Fortunately, however, the U.S. government took steps that turned the tide. These included the guaranteeing of commercial paper, mentioned earlier, as well as of money market funds. The bank bailouts showed that help was available, and the September 2008 bankruptcy of Lehman Brothers suggested that the government was differentiating between the banks that were worth saving and those that weren’t. Whereas panicky market participants were convinced that Morgan Stanley was next in line for collapse after Lehman—and that Goldman Sachs would follow that—the downward spiral was arrested when Japan’s Mitsubishi UFJ went through with a promised $9 billion investment in Morgan Stanley.

Although the sub-prime mortgage crisis originated in a small corner of the financial and investment world, the impact was soon felt widely, particularly by the financial institutions that had underestimated the risk in mortgage backed securities and thus invested too heavily in them. As a result of the threat to these essential institutions, the impact metastasized to the stock and bond markets in all countries—and then to economies all around the world—in the form of the Global Financial Crisis. Thus, as I described earlier, money market funds and commercial paper had to be guaranteed by the U.S. government. A number of prominent banks and financial institutions failed or had to be bailed out/rescued/absorbed. No one knew how far the carnage would spread. The equity and debt markets collapsed. Now the generalizing was on the negative side: “the financial system could totally melt down” in a vicious circle without end. Since the generalizations were on the downside, the error-making machine went into reverse.


pages: 394 words: 85,734

The Global Minotaur by Yanis Varoufakis, Paul Mason

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

Secretary Paulson, whose antipathy to Lehman’s CEO since his days at Goldman Sachs is well documented, says a rare ‘No’. Lehman Brothers thus files for bankruptcy, initiating the crisis’s most dangerous avalanche. Monday, 15 September 2008: the day Lehman Brothers dies. Lehman’s has been one of the main generators of CDOs. An independent money market fund holds Lehman CDOs and, since it has no reserves, it must stop redeeming its shares. Depositors panic. By Thursday a run on money market funds is in full swing. In the meantime, Merrill Lynch, which finds itself in a similar position, manages to negotiate its takeover by Bank of America at $50 billion, again with the taxpayer’s generous assistance – assistance that is provided by a panicking government, following the dismal effects on the world’s financial sector of its refusal to rescue Lehman Brothers.


pages: 285 words: 86,174