Four Reasons Financial Intermediaries Fail
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- Опубликовано: 25 июл 2016
- As we’ve discussed in previous videos, financial intermediaries bridge savers and borrowers. When these bridges crumble, the effects can be disastrous. For businesses, credit shortages can lead to bankruptcy, or layoffs. For individuals, they rely on credit to invest in education or a new home or car. These negative effects show you how crucial intermediaries are to our lives.
Still, what exactly causes failed intermediation? Four answers:
First, insecure property rights. Simply speaking, when you save money at a bank, you expect the ability to pull out your funds when needed. But what if your deposits are frozen? Or confiscated altogether? For instance, in 2013 amidst a financial crisis, the government in Cyprus confiscated bank deposits to help pay down the country’s budget shortfall. You can see how insecure property rights can scare away potential savers.
Second, controls on interest rates. Interest rates are the price of borrowing. Thus, controls on interest rates, often called usury laws, are effectively price ceilings-they set the interest rate lower than the market equilibrium interest rate. With this forced lowering of interest rates, borrowers will want to borrow more, but lenders won’t want to lend. The effect? A lending shortage.
Third, politicized lending. Banks profit by assessing risk, and then loaning, based on that assessment. Banks that excel at assessment succeed. Those poor at it die out. Problems arise when the government intervenes to prop up failing banks, resulting in what we call “zombie banks.” In such cases, intervention undercuts normal competition, and intervention tends to favor banks that are politically connected. In fact, it’s been shown that there’s an inverse correlation between government ownership in banks and a country’s GDP per capita and productivity growth.
Fourth, you have runs, panics, and scandals. Remember, trust is vital to the financial system. When trust erodes, depositors may rush to withdraw their money from banks, causing what is known as a “bank run.” This can cause banks to fail, as we saw during the Great Depression. Scandals can also depress market confidence. Enron, WorldCom and Bernie Madoff may come to mind.
So, which of these four factors contributed to the Great Recession of 2008?
We’ll discuss that in our next video.
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Oh man, the graphics. Informative and entertaining.
There is a fifth reason why intermediation (if not intermediaries themselves) fails. Iatrogenic disease.
That's when regulation grows beyond necessity, as when politicians seek to use the financial system for social engineering.
When constraints exceed free variables, we have over-determined equations. This situation guarantees contradictions and therefore arbitrage opportunities.
Today in the US, the financial sector is bigger than optimal. A simple example. Corporate income tax treats debt and equity inconsistently. So bankers find it more profitable to arb the definitions (high yield or trust preferreds anyone?) rather than do the hard work of finding and managing credit opportunities.
Same thing with trading. Finance is the handmaiden of commerce and industry. Investors need the opportunity to get out of investments (liquidity) while issuers/borrowers need committed capital to function. Investment banks manage this difference in preferences by finding substitute investors for those who wish to get out; the investor doesn't know or really care if investors swap places. That's the after-issuance service of trading that investment banks typically provide issuers. That service merits a profit margin both for the service and costs of inventory and capital.
But today, trading is a profit center in its own right and the banks seek to extract further margins from both investors and issuers. Hence the rise of high frequency trading, where banks intrude between buyers and sellers and scrape off a small but nearly riskless skim, in great numbers so that small nips add up.
Here's an interesting take on the idea we waste too much human capital on such unproductive uses: www.ft.com/content/4b70ee3a-f88c-11e4-8e16-00144feab7de
You forgot about demographic shifts. If more borrowers are entering or leaving the market than savers or vice versa, that can shake the markets.
Please make a video about Roth IRAs
Please do a video on the lost decade of Japan instead of leaving a footnote.
Also, Paul Krugman claimed that the Great Recession of USA was very much like Japan's lost decade, but the reason Japan had a lost decade instead of getting back on its feet was that they failed to recapitalized their banking system, a mistake that USA didn't do and made the bank bailout. One problem I have is that this video about zombie banks is very logical but Krugman's suggestion that the bank bailout in 2008 was useful also sounds logical. But that would imply Japan should have propped up the banks so that their counter parties and depositors don't lose. I can't figure out which is right.
That's an excellent question, dude. Still haunts me
I have a question:what if central bank steps in and inject money in that is demanded??.....and using window guidance direct that money towards...achieving specific goal like... opening up a new advance industry??that will help borrower's....and that nation can lead frog in terms of development....but what happens to savers??
please explain monetary policy system
5:55 Doesn't China's government own a lot of banks?
I think you can make a fair argument for usury laws above above say 100%. In economics we usually assume trades are mutually beneficial, hence why they are made in the first place! But sometimes human nature causes us to make trades that aren't beneficial to us.
Such as buying drugs, buying too many candy bars, gambling and taking super high interest loans (perhaps to fund those other things). A shortage in this case is exactly what we want.
trades include a sense of risk in them... this is where some companies may use asymmetric information to their advantage leading to things like adverse selection. human nature will not always benefit us due so yeah a lot of good arguments can be made here
India has around 19 banks in which the government has a majority stake, yet the country is among the fastest growing economies. Can you explain this anomaly ?
Large population growth? The banks in India are known for their production.
How about microeconomics ? I think a lot of people would interested in those entrepreneur thing
Hi Vicko,
We've got a whole micro course! :) Here's the playlist link: ruclips.net/video/g9uUIUqhrSQ/видео.html
Cheers,
Meg
The government should not bail out banks.
Its all a series of tubes.
uuuuuuuuuuuuh
ju just
Too libertarian for my taste! (At least don't show it).
this is bull crap
Load of rubbish.
Adam Blaknovski explain sir