History of Finance II

Network effects

countries who shared the same monetary system (like the gold standard) traded more due to the inherent standards set forth therein as well as increased confidence

Federal Deposit Insurance Corporation

created under Glass-Steagall: FDIC insured the deposits in member banks against bank failure up to a limit (initially $2,500; raised to $5,000 in 1935) Act extended unprecedented fed. oversight of banks But it also served to preserve a decentralized banking system based on local ―unit‖ banks (Steagall's influence) FDIC was conservative compared to other possible approaches, inc. bank nationalization

The "Rube Goldberg machine" of regulated finance [Krippner]

"Financial regulation created a Rube Goldberg structure of levers and pulleys, in which restrictions on the activities of functionally differentiated institutions ensured the flows of capital would remain approximately balanced between" By late ‗60s, and esp. in ‗70s, the ―Rube Goldberg‖ machine of regulation appeared to be functioning less smoothly Major problem was inflation: restrictions on capital (e.g. Reg Q) meant some institutions—esp. S&Ls—came under severe strain in inflationary ‗70s

steam powered grain elevator

(1842) - multi-story warehouse which used steam machinery to move, weigh, and sort grain. made it cheaper to transport grain: ½¢ to move one bushel from delivery to ship (1/10 cost at St. Louis)

mortgage-backed securities

(MBS) were created when bank bought and bundled together pool of mortgages Typical pool might involve 2,000-5,000 mortgages, worth $500 mm-$1 bn+ in total, generally from same year From that pool, bank would issue securities that promised to pay a certain interest rate Interest paid on the mortgage-backed securities would come out of the payments borrowers made on their mortgages

Populists

(aka The People's Party) - campaigned against perceived ways in which eastern, urban, corporate elites controlled and profited from the efforts of farmers

binder

(non-refundable % down payment)paid to roving salesmen in Florida or by mail for investment properties - many people never set foot in Fl or saw the properties (ca. mid 20's)

contingent factors that contributed to rise of gold

1. Mining: Rising silver production (e.g. in Nevada) from 1860s lowered value of silver 2. Technology: steam-powered presses made it possible to mint small, precise gold coins 3. Political economy: creditors' class preferred gold's stability 4. Geopolitics: In early 1870s, e.g., France goes off silver to make life hard on Germany 5. Network effects: Most importantly, countries benefitted from being on the same money as their key trading partners

ways in which gold standard exacerbated effects of the great depression

1.The gold standard transmitted US effects worldwide 2.Commitment to the gold standard led central bankers to respond to Depression in destructive ways 3.The "gold standard mentality" created a perverse set of goals among many political and economic leaders

period of the ascendance of gold

1870-1900

The Treaty of Versailles

1919 - laid entire blame for war on Germany and its allies

Consequences of the Peace

1919 book by JM Keynes. argued harsh peace would damage global economy

Pecora Committee

1932-1933 - Ferdinand Pecora took over investigations into the factors that led to the great depression and found several key factors and players

Fannie Mae

1938: Federal National Mortgage Association (―Fannie Mae‖) founded to create a ―secondary market‖ for mortgages and encourage local banks to lend 1968: Fannie becomes private (non-gov't) company Business of Fan/Fred was not ―originating mortgages, but buying mortgages originated by S&Ls and banks Some mortgages Fan/Fred bought they would ―keep on their books; others they would resell in mortgage-backed securities

Chicago Board Options Exchange

1973 - CBOT and supporters of Options Exchange drew upon arguments by financial economists in contending options trading was not gambling - led to the creation of CBOE for trading options

Employee Retirement Income Security Act (ERISA)

1974: interest in academic finance spurred by pension reform, including new fiduciary standards for private pension managers

Depository Institutions Deregulation and Monetary Control Act

1980 - lifted many limits on S&Ls, inc.: Allowing adjustable rate mortgages Expanded lending/ investment capacity Reduced oversight The 1980 acted (passed under Pres. Carter!) was first major financial deregulatory act S&Ls gained many capacities of banks without the oversight

Citigroup

1997-'98: Travelers (insurance co.) merges with Salomon Bros (i-bank); pair then merges with Citicorp (c-bank) to form Citigroup in $70 bn merger

"tranching"

A piece, portion or slice of a deal or structured financing. This portion is one of several related securities that are offered at the same time but have different risks, rewards and/or maturities. Tranche is a term often used to describe a specific class of bonds within an offering wherein each tranche offers varying degrees of risk to the investor.

stock options

A stock option gives an investor the option (but not obligation) to buy or sell a given stock at a given price (the strike price) within a specified time period A call option gives the right to buy the stock A put option gives right to sell

shareholder democracy

A theory of corporate management that favors making management more responsive to shareholders by giving shareholders greater voting power and by making it easier for shareholders to sue managers.

index fund

A type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.

Benoit Mandlebrot and "fat tails"

Beginning in the late 1950s, French mathematician Benoit Mandelbrot (at IBM Research Center) began constructing more systematic challenge to the efficient-markets paradigm - he challenged Fama's notion under EMH that market prices follow normal distribution/bell curve - he argued that prices followed a Levy Distribution with "fat tails", i.e., more extreme events

Adolf Berle and "economic statesmanship"

Berle was a Columbia Law professor "economic statesmanship": notion that major business leaders should accept position of responsibility toward shareholders and society this was because: B&M argued that American business was largely controlled by 200 largest corps., which themselves were controlled by executives, not shareholders B&M advocated greater bus. transparency and more gov't oversight of corp. governance

monetarism

Monetarism is a school of economic thought that emphasizes the role of governments in controlling the amount of money in circulation

Federal Reserve Act

Dec. 22, 1913 - created a hybrid public-private system. Consisted of: One publicly-selected oversight body, the Federal Reserve Board of 7 members (selected by Pres., approved by Senate) 12 private, regional Federal Reserve banks with their own branches, directors, districts Regional feds given autonomy to set local interest rates Act also established single currency - Federal Reserve Note - and empowered regional Feds as fiscal agents for U.S. gov't

Capital Asset Pricing Model

Developed by Markowitz's student William Sharpe (published 1963-70). showed that it was possible to determine efficient portfolio by looking only at how correlated each stock was to the market as a whole. showed a stock's expected return was a linear function of its beta (the correlation of a particular stock to the market as a whole)

moral suasion

Fed practice of using interest rate manipulations to slow down the bubble

what standards the gold standard facilitated

GS fixed exchange rates GS forced countries to show monetary discipline GS required watchful guidance of central bankers following regular rules

zero stroke or cipheritis

German media reported new nervous condition in which patients wished to write endless zeros

Senator Carter Glass

Glass especially had been a naysayer about .20s bull market Believed commercial banks should make only safe loans designed business Criticized banks for lending to speculators (brokers¡¥ loans) and for underwriting worthless securities

Benjamin Graham

Graham develops techniques of balance-sheet analysis - namely, good stocks were those issued by companies with strong assets Graham believed that by 1932, stock market was heavily under-valuing stocks of many comps 2nd in his class at Columbia; passes up jobs in math, English, philosophy to... work on Wall St. Returns to Columbia (while still working) to teach investments course at Business School

Harry Markowitz and "Portfolio Selection"

He developed modern portfolio theory (MPT) while a grad student at UChicago. Investigated the mathematical problem of choosing an optimal investment portfolio. HIs paper "Portfolio Selection from the Journal of Finance (1952) was the only paper published with equations

Comptroller of the Currency

In the US - regulated banking/currency under 1863-4 National Banking acts (us entered 20th century without a central bank)

Stock options and volatility

Intuitively, the value of an option has something to do with the likely future behavior of the underlying stock For options that are ―out of the money,‖ the option ought to be more valuable the more likely it is that the underlying stock breaks through the strike price This depends on a few key factors: The current price and the exercise price (and how close they are) The time to maturity of the option How volatile (erratic, spiky) the stock is

investment trust

Inv. trusts purchased a wide range of stocks; then sold their own stocks and bonds to investing public, often at a considerable mark-up over underlying stocks Inv. trusts gave investors a way to buy into a wide-range of different companies

John Maynard Keynes

Keynes disputed many central assumptions of classical economic thinking: Self-regulating nature of economy, particularly with regard to employment Virtue of the gold standard Belief that budget deficits are always to be avoided Instead, Keynes emphasized the hardships caused by the inability of the economy to automatically adjust to negative events

"subprime" mortgage lending

Lending to poor-credit customers was seen as both risky and morally suspect (akin to a kind of loan-sharking) Most of the companies willing to lend to subprime customers were not banks but ―consumer finance companies‖ (Beneficial Finance, Long Beach Mortgage) Subprime lenders generally had to borrow money themselves to them re-lend it at (substantially) higher rates to customers Subprime lending began to become more prominent in 1980s and esp. mid-1990s

"The money changers have fled from their high seats"

Line from FDR's first inaugural speech

Henry Manne and "the market for corporate control"

Manne was a staunch Chicago "free marketer" and pioneer of the field of "law and economics" His "Mergers and the Market for Corporate Control" published in the Jour. of Political Economy (1965) He argued the best tool for assuring that execs. acted in the interest of shareholders was the stock market itself - Poor management would be punished with low stock prices - Poorly-run, low-price companies would be susceptible to takeovers by other companies Manne contended that execs should be themselves subjected to a competitive market - the ―"market for corporate control" Manne argued that threat of takeover was far more powerful protection to shareholders than SEC or shareholder lawsuit

"bank holiday"

March 6, 1933: new Pres. F. D. Roosevelt calls "bank holiday" to stops all banking operations to help stop panics and give a chance to both strategize and calm the public

brokers' loans

Money borrowed by brokers from banks or other brokers for a variety of uses. It may be used by specialists to help finance inventories of stock they deal in; by brokerage firms to finance the underwriting of new issues of corporate and municipal securities; to help finance a firm's own investments; and to help finance the purchase of securities for customers who prefer to use the broker's credit when they buy securities.

Knickerbocker Trust Co.

NY‟s third largest investment trust - lent money to Heinze and Morse for their effort to corner the stock of United Copper Company

Federal Reserve interest-rate increase, fall 1931

Need to maintain GS & prevent inflation led to counter-productive moves—like when Fed raised rates (!) in Fall 1931 When the US economy began to contract in 1929 and price of US goods fell, other countries risked losing gold to US Euro. central banks forced to raise interest rates and contract money supply to preserve their currencies on GS Similarly, when US Fed. raised interest rates (as in Sep. 1931),

The housing bubble (late 1990s-early 2000s)

One of the major macro-economic contexts behind '07-'08 crash was a big, sustained bubble in residential real estate 1996-2006: Avg. house prices nationwide rose by 129% Unlike many earlier American real estate booms—So. CA in the 1880s, or FL in the 1920s, e.g.—this boom was nationwide RE bubble was aided by a sustained period of low interest rates, following .com boom collapse, mini-recession in 2001

1892 Hatch Bill

Populists tried - and nearly succeeded - to outlaw future's trading

"Liquidate labor, liquidate stocks, liquidate farmers purge the rottenness out of the system."

Quote by US Treas. Sec. Andrew Mellon who thought that what was needed: Mechanics of the GS dictated that, in times of declining prices and monetary contraction, wages had to fall necessarily As people learned to live more thrifty and "moral" lives, the system would automatically correct itself Lower wages would mean lower demand, incl. for imports, reducing gold outflows, etc

"Dow Theory"

The Dow theory on stock price movement is a form of technical analysis that includes some aspects of sector rotation. At core of Dow's ideas was notion that stock prices were ―sufficient in themselves‖ to reveal business conditions This was a major departure from a traditional belief that stock price stemmed from co. value Dow argued that price generally followed a primary, underlying trend (―bull‖ or ―bear‖ markets) Key to stock price analysis was assessing when these driving trends would shift direction

finance as an academic discipline

Thomas Kuhn calls normal science around an efficient-markets paradigm - Research attention turned, e.g., to empirical confirmation of the efficient-markets view using computational tools (e.g. CRSP) - Scholars worked to explain stubborn patterns that violated market efficiency (―small firm‖ ―turn-of-new-year‖ effects)

Bretton Woods Conference

Toward end of WWII (1944), allied forces meet at Bretton Woods, NH to lay plans for new international financial system. created system of fixed exchange rates: all currencies pegged to US$, which was pegged to gold But instead of relying on abstract operations of GS, Bretton Woods system was based on int'l cooperation through institutions International Monetary Fund (IMF) created to provide loans to help countries preserve exch. rates and navigate ―balance of payments‖ problems Int'l Bank for Reconstruction and Development (now part of World Bank) set up to provide loans to aid post-war recovery

Enron Corporation

a hybrid energy, commodities, and financial services company that claimed over $100 bn in revenue in 2000 Enron was, arguably, the corporate embodiment of the late-20th c. trends of financial-ization and deregulation 2001: Revealed that Enron had used myriad accounting deceptions to inflate perceived profitability, inc. hiding losses in ―off-books‖ accounts

.com bubble

a problem with deregulation was that financial actors pursuing rational, self-interested goals did not always combine to put rational prices on things The .com bubble of the late ‗90s provided visible evidence of this ‗95: Netscape IPO begins mania Bubble began in earnest in 1998 (GeoCities, Ebay, etc.) Hit peak March 2000; tech-heavy NASDAQ index high over 5,000 May 1999 Barron's poll: 72% of prof. money mgrs. thought .com stocks were a bubble... ...But that didn't stop anyone from trying to ―ride the bubble‖

portfolio insurance

a source of the 10/19/1987 crash Portfolio insurance techniques, like those first developed by Leland and Rubinstein, were popular among institutional money managers at the time Portfolio insurance techniques required that managers sell stocks at precise times according to mechanical rules to manage risk in overall portfolio The prevalence—or at least the perceived prevalence—of managers relying on the same insurance techniques meant that a decline in the stock markets could trigger a massive sell-off

Key mechanism for upholding GS standards

adjusting interest rates at which they lent money to other domestic banks - If a nation's gold reserves were getting too low, central bankers would raise interest rates - If country were flush with gold, central bank might lower rates

commission merchants

agents who would take wheat that was unsold at local markets to NYC or New Orleans

Ed Thorp

analyzed the empirical correlations between prices of stocks and options Published some in Beat the Market: A Scientific Stock Market System (1967) Thorp uses strategies to start the first ¢wquant¡ü hedge fund in 1969: Convertible Hedge Associates

Alfred Cowles, "Can Stock Market Forecasters Forecast?"

answer: it appears not - NEED MORE ON THIS

Michael Milken

at Drexel Burnham Lambert, Milken began to create new market for junk bonds For clients who needed to raise capital by selling bonds, Milken arranged to underwrite an issue of junk bonds, and then sold bonds to network of investorsThe ―Predator's Ball‖: an annual conference on high-yield bonds held by Milken in LA, which became a major meeting point for corporate raiders

Monetary History of the United States (1963)

book by Miltron Friedman and Anna Schwartz in which they argued that failed monetary policy led to the great depression

expected deflation

during the depression many consumers were reluctant to borrow in fear of potential deflation

debenture bonds

early form of mortgage-backed securities

Performativity

economic principle whereby the use of theory in practice makes the world look more like the theory - term coined by Donald MacKenzie largely due in part to how the use of the Black-Scholes Model in trading options made the options market behave as the model predicted it would

Eugene Fama

economist who put forward the efficient market hypothesis and held that stock prices are random

Black-Scholes-Merton model

effectively created a new financial market where none had existed before A model of price variation over time of financial instruments such as stocks that can, among other things, be used to determine the price of a European call option. The model assumes that the price of heavily traded assets follow a geometric Brownian motion with constant drift and volatility. When applied to a stock option, the model incorporates the constant price variation of the stock, the time value of money, the option's strike price and the time to the option's expiry.

money trust

entwined banks and affiliated companies centered on J. P. Morgan

"Thus as the prime mover in recovery I lay overwhelming emphasis on governmental expenditure which is financed by Loans."

excerpt from Keynes's open letter to FDR

farm mortgages

financial instrument used to create capital for expenses of setting up a farm (e.g., equipment, seed, livestock). often had very tough terms: had to be repaid quickly (3-7 years), payments could never be missed/late, featured balloon payments at end

"financialization" of the US economy

financialization refers to the process by which finance comes to be the predominant activity in an economy Burgeoning trading activity in financial markets, esp. in new derivative markets Reorientation of business practices toward financial objectives - ―maximizing "shareholder value" Increasing share of finance as source of corporate profits and individual fortunes Rising attraction of finance as career path for talented, educated professionals

1890: Sherman Silver Purchase Act

forces US Fed. Gov't to issue new paper currency to buy set amounts of silver (repealed in 1893)

Chicago Board of Trade (CBOT)

founded 1848 by major grain trade reps. CBOT helped standardize measures, established trade guidelines CBOT trading pit or exchange increasingly served as major meeting point for grain traders

grain futures

grain contract set "to arrive" in a certain month, at a fixed price

characteristics of central banks

had a monopoly on issuing notes; carried out public services like lending to gov't Most CBs were private, profit-earning businesses CBs required by law to keep a certain amount or proportion of cash on reserve in gold

The problem of "credit allocation" in the 1970s

how to keep enough money flowing to each part of the financial machine Underlying belief was that there was not enough money to go around - so keeping all parts of the financial system going meant making hard trade-offs

elevator "receipts"

like a paper security for those who deposited wheat at the elevator. grain traders began to trade receipts and not trade actual physical grain

gold standard

monetary system in which all money must be backed by its equivalent quantity of gold

Bimetallism

movement that pushed for money to be backed by both gold and silver

William Jennings Bryan

populist/democratic presidential nominee who pushed for the monetization of silver.

Homestead Act (1862)

offered free federal grants of land in American west

"Sunshine Charley" Mitchell

one of Wall St.'s greatest prophets during ‗20s bull market March 1929: Mitchell advanced $25 mm in loans of National City money to keep easy money flowing to stock speculators ―Mitchell more than any 50 men is responsible for this stock crash.‖ (Carter Glass, Nov. 1929) Mitchell became prime icon of Wall St. excess and immorality 1933: Mitchell arrested for tax evasion for manipulations involving National City stock

"Lambs" of Wall St

outsider investors (i.e., not Wall St elite but more of the "Everyman" investor)

"This growth in the volume of capital has been the phenomenon of our generation"

passage from Conant's 1904 "Wall Street and the Country"

Bucket shops

private shops, linked to CBOT by telegraph, allowed anyone to make bets on commodities futures

Silverites

pushed for the free coining of silver at 16-1 (silver/gold) to boost $ supply

"America is a stronger country every single time a family moves into a home."

quote by George W. Bush in 2004 Both Clinton and Bush admins. had pressed Fannie and Freddie to increase funding of home loans to lower-income lenders 2002: Pres. G. W. Bush calls on mortgage lenders to make 5.5 mm minority homeowners by ‗10 2003: American Dream Down-payment Act offered up to $10,000 to low-income h'holds 2004: Homeownership rate hit all-time high of 69%; rate among minorities over 50% for first time

"stock prices have reached... a permanently high plateau"

quote by Irving Fisher right before the 1929 crash which turned out to be very, very incorrect

"Any power which he [the private banker] has comes... from the confidence of the people in his character and credit"

quote by JP Morgan. The character and responsibility of JPM and his partners was what justified the public‟s trust" - and therefore JPM‟s immense power

progressivism

reform movement which sought to address ills and inequalities that had emerged from boom in industrial capitalism. causes included: Aiding poor through social work and education Eliminating gov‟t corruption & improving gov‟t efficiency Regulating safety of products (food, drugs) and workplaces Environmental conservation

Securities Exchange Act (1934)

regulated secondary market in securities Established the Securities and Exchange Commission (SEC), as regulatory agency The1933 and 1934 Acts laid out prohibitions against fraudulent practices, incl. ―insider‖ trading One provision prohibited short-swing profits by anyone owning more than 10% of a stock

Ile de France

ship that featured the first seaborne brokerage (Aug. 17, 1929)

The "Cross of Gold"

speech delivered by William Jennings Bryan, at the Democratic National Convention in Chicago on July 9, 1896. In the address, Bryan supported bimetallism or "free silver", which he believed would bring the nation prosperity. He decried the gold standard, concluding the speech, "you shall not crucify mankind upon a cross of gold".[1] Bryan's address helped catapult him to the Democratic Party's presidential nomination; it is considered one of the greatest political speeches in American history.

permanently high plateau

statement by Irving Fisher right before the 1929 stock market crash

"investors' republic" ideology

the "everyman investor" ideal and thought that "everybody ought to be rich" (see Raskob article)

aggregate demand

the total demand for final goods and services in the economy at a given time and price level - a massive decline in AD was an essential problem in the Great Depression

random walk

theory by Eugene Fama that stock markets are efficient and prices were random and followed no particular pattern and reflect all available information about them

commoditized

turned into abstract, uniform objects sold into anonymous markets

Board of Trade v. Christie (1905)

upheld futures trading in formal exchanges but bans bucket shops

John J. Raskob

wrote the Good Housekeeping article and argued that "everyone ought to be rich"

William "Coin" Harvey

wrote the pamphlet "Coin's Financial School" (1894) which promoted Populist ideas about global finance. Coin argued corporate, financial interests in eastern US and UK were sucking the wealth out of American farms

"exotic" mortgages

―"exotic" mortgages also great for those buying houses to resell ("flip") quickly Interest-only loans required borrowers to only pay the interest, and no principal, for a set period (usually 5 years) Stated-income loans (aka ―liar loans‖) only asked borrowers to state, but not prove, income; at first designed for self-employed 2/28 ARMs offered low fixed interest rate for first two years, then switches to floating rate

Lewis Ranieri

―"mortgages are math" Securitization of mortgages, particularly prime mortgages, pioneered by Lewis Ranieri the rise of securitization was essential to the growth of subprime lending (and mortgage lending generally) Generally, securitization refers to the process of packaging together assets (e.g. mortgages) and issuing securities backed by that bundle of assets

The Federal Reserve "reinterprets" Glass-Steagall (1986-'96)

1986-'87: Federal Reserve board reinterprets major part of Glass-Steagall Act ("Section 20") Allows comm. banks to earn up to 5% of revenues from inv. banking (10% in 1989) Allows comm. banks to engage in various kinds of underwriting, inc. municipal bonds, ―commercial paper and mortgage-backed secs.

Alan Greenspan

1987: major deregulation advocate, Alan Greenspan, becomes Fed. Res. Chairman

The Financial Services Modernization Act

1999: The Financial Services Modernization Act (or, Gramm-Leach-Bliley) repeals provision of Glass-Steagall requiring separation of i-banking, c-banking, and insurance

The Commodities Futures Modernization Act

2000: The Commodity Futures Modernization Act eliminates much fed. gov't oversight over ―over-the-counter‖ derivatives transactions carried out between ―sophisticated parties‖

hostile takeovers

A takeover often began when an investor bought up very large portion of a company's stock Investor would use voting power gained from large stock holding to try to enact changes at co., often against wishes of execs End goal was often to make a ―tender offer‖ to buy all shares of company, usually at premium After successful takeover, investors often took drastic measures to extract value from company, inc. downsizing or chopping co. and selling parts

The "sacred formula" of the Gold Standard and the Great Depression

For many politicians, incl. US Pres. Hoover, deviating from "sacred formula" of GS was tantamount to "collectivism" Major problem in many countries was, though, that wages did not "adjust" down as easily as GS model demanded Rise of labor politics, unions, collective bargaining, meant wages were "sticky" Therefore, when deflation set in, result was not a "natural" readjustment in wages, but massive unemployment (~20%)

Gordon Gekko

Gordon Gekko is supposed to be the villain in Stone's Wall Street, but Gekko—and his mantra of "Greed is Good"-- turned out to be far more heroic than perhaps intended

leveraged buyout

In 1980s, takeovers were increasingly carried out through borrowed money, in a leveraged buyout or LBO By using borrowed money, LBOs magnified profits to be gained Mechanics of LBOs prompted new ideas about what made a company a good investment  Key feature of a good co. was not long-term profits, but whether it had high enough cash flow to service debt

Common practices of Investment Trusts

Investment trusts often magnified their gains through leverage, borrowing money (in addition to that raised from selling stock) to buy shares Trusts often repeated process, creating new trusts (with new stock) to buy stock of pre-existing trusts Inv. trusts often touted the financial experts behind their investments, incl. professor (e.g. Princeton Prof. Edwin Kemmerer at American Founders Group)

The Banking Act of 1933 ("Glass-Steagall")

It combined two major projects that transform American finance: 1.Deposit insurance and federal banking oversight 2.Separation of commercial and investment banking

Michael Jensen

Late ‗60s-70s: Jensen contributed to empirical studies of CAPM; invented measure of investment performance (―alpha‖) "There is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis"(1978) Most influential contribution was a new theoretical treatment of publicly-owned businesses

"shadow banking" system

MBS had become critical component in a shadow-banking system that had emerged in deregulatory environment, esp. since 2000 The shadow banking system describes the complex network of transactions by which financial institutions deposited cash with one another, sometimes as collateral for short term loans, in an attempt to profit from cash being held One key component of shadow banking was the "repo" (purchase and resale) market where a depositor could withdraw its money by not renewing the loan and demanding cash back For this to work collateral for repo had to be large, uniform, easy to resell, and not requiring much analysis (MBS were great source of such)

October 28-29, 1929

Oct. 28 ("Black Monday"): news of Thursday sell-off spreads; many investors try to flee; Dow loses record 13% (38.33 points) Oct. 29 ("Black Tuesday"): record 16 mm shares traded; Dow loses another 12% (30 points)

October 19, 1987

On "Black Monday" October 19, 1987, the Dow Jones Ind. Avg. dropped 508 points (22.6%) 1987 had been a roaring year for the stock market Signs of concern developed in mid-October: a major decline Oct. 14-15; military tensions with Iran; the closing of the London stock market on

Arthur Andersen

Private accounting firms like A.A. provided vital function to investors by verifying accuracy of company accounting info. But, A.A.—was a paid client of Enron—had considerable incentives to assist the company in carrying out frauds

1980s Savings & Loan Crisis

S&Ls became targets for control fraud, whereby crooked execs sought to gain control of S&Ls as vehicle for fraudulent profits -1980-95: 747 of 3,234 US S&Ls failed; total cost estimated to be $360 billion, inc. $341 bn from taxpayers 1984: Lincoln purchased by Charles Keating, a construction co. magnate, for $51 million - financed by Milken-backed high-yield bonds Keating fired Lincoln execs and used Lincoln as a vehicle

The "AAA" tranche of mortgage-backed securities

The "Senior" or "AAA" tranche had highest priority and was paid out first and therefore had lowest risk and paid investors lowest returns

The Efficient Markets Hypothesis: three levels

Weak efficiency: prices completely reflect all info contained in previous prices (You can't predict future prices by looking at past...) Semi-strong efficiency: prices reflect all ―publicly available‖ info, incl. SEC filings, news reports, etc. (You can't beat the market using the same info everyone else has...) Strong efficiency: prices reflect all information, incl. that only known to company insiders