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:
“The English public, as a mass, takes no interest in a work of art until it is told that the work in question is immoral.”
—Oscar Wilde (1854–1900)
“Good government cannot be found on the bargain-counter. We have seen samples of bargain-counter government in the past when low tax rates were secured by increasing the bonded debt for current expenses or refusing to keep our institutions up to the standard in repairs, extensions, equipment, and accommodations. I refuse, and the Republican Party refuses, to endorse that method of sham and shoddy economy.”
—Calvin Coolidge (1872–1933)
“But no matter how they make you feel, you should always watch elders carefully. They were you and you will be them. You carry the seeds of your old age in you at this very moment, and they hear the echoes of their childhood each time they see you.”
—Kent Nerburn (20th century)
“Until the end of the Middle Ages, and in many cases afterwards too, in order to obtain initiation in a trade of any sort whatever—whether that of courtier, soldier, administrator, merchant or workman—a boy did not amass the knowledge necessary to ply that trade before entering it, but threw himself into it; he then acquired the necessary knowledge.”
—Philippe Ariés (20th century)
“Our children do not want models of perfection, neither do they want us to be buddies, friends, or confidants who never rise above their own levels of maturity and experience. We need to walk that middle ground between perfection and peerage, between intense meddling and apathy—the middle ground where our values, standards, and expectations can be shared with our children.”
—Neil Kurshan (20th century)