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:
“Treading the soil of the moon, palpating its pebbles, tasting the panic and splendor of the event, feeling in the pit of one’s stomach the separation from terra ... these form the most romantic sensation an explorer has ever known ... this is the only thing I can say about the matter. The utilitarian results do not interest me.”
—Vladimir Nabokov (1899–1977)
“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)
“The mountain sheep are sweeter,
But the valley sheep are fatter;
We therefore deemed it meeter
To carry off the latter.”
—Thomas Love Peacock (1785–1866)
“...to many a mother’s heart has come the disappointment of a loss of power, a limitation of influence when early manhood takes the boy from the home, or when even before that time, in school, or where he touches the great world and begins to be bewildered with its controversies, trade and economics and politics make their imprint even while his lips are dewy with his mother’s kiss.”
—J. Ellen Foster (1840–1910)
“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)