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:
“Whoever lives for the sake of combating an enemy has an interest in the enemy’s staying alive.”
—Friedrich Nietzsche (1844–1900)
“Families suffered badly under industrialization, but they survived, and the lives of men, women, and children improved. Children, once marginal and exploited figures, have moved to a position of greater protection and respect,... The historic decline in the overall death rates for children is an astonishing social fact, notwithstanding the disgraceful infant mortality figures for the poor and minorities. Like the decline in death from childbirth for women, this is a stunning achievement.”
—Joseph Featherstone (20th century)
“They have given us into the hand of new unhappy lords,
Lords without anger and honour, who dare not carry their swords.
They fight by shuffling papers; they have bright dead alien eyes;
They look at our labour and laughter as a tired man looks at flies.”
—Gilbert Keith Chesterton (1874–1936)
“a highly respectable gondolier,
Who promised the Royal babe to rear
And teach him the trade of a timoneer
With his own beloved brattling.”
—Sir William Schwenck Gilbert (1836–1911)
“To see self-sufficiency as the hallmark of maturity conveys a view of adult life that is at odds with the human condition, a view that cannot sustain the kinds of long-term commitments and involvements with other people that are necessary for raising and educating a child or for citizenship in a democratic society.”
—Carol Gilligan (20th century)