You have a lot of thinking on the reform of the Bank recently. Here is the crux of the problem: ordinary deposits are sticky moments, especially when you guarantees of deposits such as the FDIC. But for some banks, look in other funding in the short term, if it is a short CD or repurchase financing agreements.
Now my lot is asset-liability mismatch. Banks borrow short and lend long. This leads to banking panics. Financing illiquid assets with liquid is unstable and pleading for bankruptcy in the first major loss of confidence.
But there is a greater discrepancy this, and I want to explore. Each asset is financed with a liability or equity. And, all liability is another asset, but not vice versa, because assets are owned free and clear is financed by equity.
Assets financed by short-term debt often are mismatched. Long is rare due to discrepancies in financing costs too high. Now, if discrepancies are small, short is not a problem. There is sufficient flexibility in financial balance sheets, to accept small discrepancies. Real disasters occur when long assets financed in a way that there is a risk that the financing will fail before the assets is rewarded.
The fundamental mismatch debts Fund assets is that the end financed assets is no longer-date from finance. We fund land, houses, buildings, plant and equipment, and take off of deposits, savings accounts and CDS. Some companies off of Repo finance financial short-funded. The reason for this discrepancy is difficult to avoid is that average people are saving want assets that may be used in short-date transactions. That does not fit well within the long-term assets financing requirement.
The same problem exists in the Municipal bond market. Much more money to invest in short, while municipalities want to borrow it for a long time. This leads to a steep yield curve muni. Commercial insurers writing business, long tail and wealthy who can bear interest rate volatility eventually buy the long end, and lower taxes in the process.
If banks were required to fit around the cash flows for assets not financed by equity will steepen, yield curves for other sectors of the fixed income markets. Areas of the financial market where there are long/strong balance sheets, such as life insurers, insurance brokers, commerical defined benefit pensions and bequests will receive higher yields for longer commitments. Banks will become lower ROE operation, and that it would be good, as there are many fewer failures, and there will be fewer banks. We are over-banked. Time to listeyontas bankers for more productive activities.
Long dated floating-rate loans can be a solution for banks financing loans off short-dated loans or, with interest rate swaps in order to achieve the same result. The danger is that a bank lock in what proved to be a low spread on the asset, while the cost of financing is volatile.
A few final notes: 1) the standard of asset and liability cash flows matching in General should apply to all regulated financial institutions, including investment banks. Only surplus assets that do not need to match liabilities can be used for investments in equity-like risks. 2) there must be an unpacking complex vehicles with on-board lever to manage it assets-liability. As examples:
SecuritizationsRepo FundingPrivate EquityHedge FundsMargin loansSIVs and similarshould be expressed as looking through the evidence ultimately financed. For example, the portion of a securitisation Senior AAA-sub is long loans and sold the rest of the share certificates.
Repo finance has its own issues. In the event of a crisis, cuts increased as asset prices fall. Institutions based on funding often fails in these hours and leaves damage for the creditor repurchase agreements. There should be something that reflected the risk of market failure of repurchase agreements, although the grand majority of debtor's losses go, not the lender.
3) even in the short term loans, quick loans not fully amortize, should be reflected as loans that are no longer-date, because of the risk of higher rates, and it is not possible to refinancing.
I must say, but it is to hit the post now. Comments are welcome.
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