Interest Rates Carry Trade / Maturity Transformation
See also: Interest ratesFor instance, the traditional income stream from commercial banks is to borrow cheap (at the low overnight rate, i.e., the rate at which they pay depositors) and lend expensive (at the long-term rate, which is usually higher than the short-term rate).
This works with an upward-sloping yield curve, but it loses money if the curve becomes inverted. Many investment banks, such as Bear Stearns, have failed because they borrowed cheap short-term money to fund higher interest bearing long-term positions. When the long-term positions default, or the short-term interest rate rises too high (or there are simply no lenders), the bank cannot meet its short-term liabilities and goes under.
According to a popular anecdote, traditional commercial banking was characterized as a "3-6-3" business: bankers gathered deposits at 3%, lent them at 6% (thus earning the 3% spread), and were on the golf course by 3 pm in the afternoon. While this may have been close to the truth in the market of the 1950s to the 1970s, the modern competitive market ensures that profits are kept more in line with perceived risks.
Read more about this topic: Carry (investment)
Famous quotes containing the words interest, rates, carry, trade and/or maturity:
“Good breeding and good nature do incline us rather to help and raise people up to ourselves, than to mortify and depress them, and, in truth, our own private interest concurs in it, as it is making ourselves so many friends, instead of so many enemies.”
—Philip Dormer Stanhope, 4th Earl Chesterfield (1694–1773)
“In the U.S. for instance, the value of a homemaker’s productive work has been imputed mostly when she was maimed or killed and insurance companies and/or the courts had to calculate the amount to pay her family in damages. Even at that, the rates were mostly pink collar and the big number was attributed to the husband’s pain and suffering.”
—Gloria Steinem (20th century)
“Mothers who are strong people, who can pursue a life of their own when it is time to let their children go, empower their children of either gender to feel free and whole. But weak women, women who feel and act like victims of something or other, may make their children feel responsible for taking care of them, and they can carry their children down with them.”
—Frank Pittman (20th century)
“We are the trade union for pensioners and children, the trade union for the disabled and the sick ... the trade union for the nation as a whole.”
—Edward Heath (b. 1916)
“When a man reaches his maturity in understanding and in years, the feeling comes over him that his father was wrong to beget him.”
—Friedrich Nietzsche (1844–1900)