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:
“Those people have no real interest in a science who only begin to get excited about it when they themselves have made discoveries in it.”
—Friedrich Nietzsche (1844–1900)
“One of the most important findings to come out of our research is that being where you want to be is good for you. We found a very strong correlation between preferring the role you are in and well-being. The homemaker who is at home because she likes that “job,” because it meets her own desires and needs, tends to feel good about her life. The woman at work who wants to be there also rates high in well-being.”
—Grace Baruch (20th century)
“Can you support the expense of a husband, hussy, in gaming, drinking and whoring? Have you money enough to carry on the daily quarrels of man and wife about who shall squander most?”
—John Gay (1685–1732)
“I have no doubt that they lived pretty much the same sort of life in the Homeric age, for men have always thought more of eating than of fighting; then, as now, their minds ran chiefly on the “hot bread and sweet cakes;” and the fur and lumber trade is an old story to Asia and Europe.”
—Henry David Thoreau (1817–1862)
“[How] the young . . . can grow from the primitive to the civilized, from emotional anarchy to the disciplined freedom of maturity without losing the joy of spontaneity and the peace of self-honesty is a problem of education that no school and no culture have ever solved.”
—Leontine Young (20th century)