non-banking financial intermediaries
DESCRIPTION
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NBFI and Securities Market Institutions
Nonbank Financial Intermediaries (NBFI) -- Financial Intermediaries other than banks.
Experiences same fundamental “nightmares” as banks.
Also covers Securities Market Institutions (e.g. investment banks)
Less regulated than banks better able to handle problems? disadvantages of not being banks
(investment banks)
Securities Market Institutions
Investment Banks -- buy and sell securities on the primary market
Profits come from underwriting -- buying the entire issue then selling it in the market when they choose
Securities Brokers and Dealers -- conduct trading in the secondary market
Brokers -- arrange sales between buyers and sellers
Dealers -- “play the market” with bonds as well as stock
Brokerage Firms -- engage in investment banking, brokering, and dealing
The Securities Industry Versus the Banking Industry
The Glass-Steagall Act (1933) -- separation of banking industry from the securities industry
Arguments to Repeal Glass-Steagall
Brokerage firms have invaded banking industry with “bank-type” accounts (MMMFs, Cash Management Accounts).
Benefits from increased competition.Financial markets are more
sophisticated and liquid today.
Arguments to Keep Glass-Steagall
Banks would have unfair advantage -- FDIC.
Securities market activity is risky, could mean significant losses for banks.
Potential conflicts of interest between banking department and securities department
Financial Services in the Post Glass-Steagall Era
2000 -- Repeal of the Glass-Steagall Act.
Some large banks merging with securities market institutions to increase economies of scale (e.g. Chase and J.P. Morgan).
In general much more overlap between banks and securities market institutions.
Nonbank Financial Intermediaries
Structured as a financial intermediary – pooling small savers’ funds (liabilities) to make large loans to borrowers (assets).
Makes profits off the difference in liquidity and default risk between their assets and liabilities.
Can experience the “bank nightmares” of disintermeidation and loan default.
Insurance Companies
Life Insurance Companies
-- Assets: Corporate Bonds,
Commercial Mortgages, Stock
-- Liabilities: promised payouts
upon death
Property and Casualty Insurance Companies
-- Assets: Municipal Bonds,
Treasury Bonds, Corporate
Bonds, Stock
-- Liabilities: promised payouts
upon fire, accidents, etc.
Pension Funds
Assets: different types of Bonds or Stocks
Liabilities: promised payouts upon retirement
Defined Contribution PensionsDefined Contribution Pensions --
Employee contributes amounts over his/her working years to an identified fund, with possibly employer contributions as well. Upon retirement or leaving the firm, employee receives the fund. Taxes are typically deferred until the fund is withdrawn from.
Examples of Defined Contribution Pensions
Individual Retirement Accounts (IRAs) -- Classic IRAs and Roth IRAs
Keough Plans -- Self-Employed individuals
401(k) Plans (and 403(b) Plans) -- increasing in frequency
Defined Benefit Pensions
Defined Benefit Pensions -- Employee does not contribute over his/her working years, is promised a fixed monthly payment upon retirement.
Characteristics of Defined Benefit Plans
Vesting -- How long the employee has to work at the firm to be eligible for pension.
Fully Funded Versus Underfunded
-- Fully Funded: employer
contributions plus returns fully
cover promised benefits
-- Underfunded: employer
contributions plus returns do not
cover promised benefits
Employee Retirement Income Security Act (ERISA)Regulates Pensions
-- degree of underfunding
-- how pension is invested
-- reporting and examinationCreation of Pension Benefit
Guarantee Corporation -- pension insurance
Examples of Defined Benefit Pensions
Some Corporate, Federal and State and Local Government Pension Plans
Social Security -- “pay as you go” plan
The Trend Toward Defined Contribution Pensions
Employers moving away from defined benefit to defined contribution plans, largely for convenience.
To the employee – potential losses and (big) wins.
Will it affect the retirement decision of individuals?
Finance Companies
Assets -- Consumer loansLiabilities -- (their own)
Commercial Paper, Stock, and Corporate Bonds
Not subject to bank regulationNot eligible for Discount Window
Mutual Funds
Assets -- bonds, stocks, as advertised in prospectus
Liabilities -- mutual fund shares
Regulated by Securities Exchange Commission (SEC)
Some have insurance against dishonest practices (SIPC), most are not insured.
Mutual Funds
Can offer unique features based upon characteristics of asset portfolio
Tax-exempt mutual fundsCheckability and money market
mutual funds (MMMF)
Subprime Mortgages, NBFI, and Investment Banks
Large amount of high default risk mortgage-backed securities (MBS) held by investment banks and other NBFI.
Defaults in MBS adversely affects entire industry
2008 – collapse of Bear Stearns, Lehman Brothers (investment banks), and AIG (insurance company).
The Federal Reserve, Financial Firms,and the Credit Crunch
2008 – established a lending service between the Fed, investment banks, and some other nonbanks -- analogous to the Discount Window.
Arrangement of mergers with some investment banks with banks (e.g. Bear Stearns and Chase-JP Morgan)
Bailout of AIG, Fannie Mae, and Freddie Mac.Granted bank holding company status to some
NBFI (GMAC) and investment banks (Goldman Sachs, Morgan Stanley)
Underlying Issues: The Credit CrunchBailouts -- necessary or increasing Moral
Hazard/Adverse Selection?Consistency in response – Bear Stearns versus
Lehman Brothers.The end of stand-alone investment banks?Where is the SEC?Harsher regulations after the crisis passes for
banks and others (like FIRREA)?Possibly other players entering banking?Time for a totally revamped regulatory structure for
banking, NBFI, and securities market institutions?