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Investment Banking

Remember The Global Financial Crisis?! – Panic

Repo – A New Type of Banking

  • A sale and repurchase agreement (“repo”) is a deposit of cash at a “bank” which is short-term, receives interest, and is backed by collateral. Depositor takes legal ownership of the collateral.
  • Carved out of Bankruptcy Code; unilateral termination by non-defaulting party.
  • Two types of repo: bilateral and tri-party. Both types caused trouble in the crisis.
  • Collateral may be “rehypothecated”.
  • Collateral value typically exceeds the amount of cash deposited, this is called a haircut For example, deposit $98, receive a bond worth $100—a 2% haircut.


Lehman Brothers

  • As of March 2008, the situation at Lehman Brothers was just as precarious as it was at Bear Stearns, and perhaps Lehman only survived longer than Bear because some shady accounting made them look better than reality.
  • After the government-supported rescue of Bear Stearns in March 2008, the Federal Reserve created the Primary Dealer Credit Facility (PDCF) to provide liquidity to non-bank dealers like Lehman.
  • The PDCF was critical to Lehman’s survival over the next six months, as they tried to get rid of their worst assets and improve their capital and liquidity position.


Lehman Weekend – September 2008

  • On September 10, 2008, Lehman reported $28 billion in shareholder equity, $4 billion higher than a year earlier. But it was simply impossible to know if this equity cushion was accurate.
  • For one thing, Lehman reported $54 billion in real estate assets. Some market participants thought the true value was closer to half of that, which would effectively wipe out Lehman’s equity.
  • At the same time, Lehman’s counterparties in derivatives, commercial paper, and repo were pulling back, shortening terms, and demanding more collateral.
  • Most notably, JP Morgan, Lehman’s clearing bank in the tri-party repo market, demanded $5 billion and received $3.6 billion on 9/9, and demanded and received $5 billion on 9/12.


Lehman Weekend – September 12-14, 2008

  • Over the weekend of 9/12 – 9/14, the U.S. government tried unsuccessfully to arrange a private rescue for Lehman.
  • The government insisted there would be no public money spent on the rescue.
  • Bank of America chose to buy Merrill Lynch instead of Lehman.
  • On Saturday, Barclays agreed to buy Lehman, but by Sunday the deal was effectively blocked by UK regulators.
  • Without sufficient liquidity to operate the next day, and otherwise out of options, Lehman filed for bankruptcy early in the morning on September 15.



  • Money-Market Mutual Funds (MMMFs) are a specific type of investment company that is only permitted to own a narrow range of securities. In return for accepting this narrow investment range, they had the right (at this time) to report “stable values” for their share prices.
  • On September 16, 2008, Reserve Primary Fund “broke the buck” due to exposure to Lehman Brothers commercial paper. This led to a run on many MMMFs – mostly by institutional investors – and then quickly to an explicit guarantee from the U.S. government.
  • We really should have seen this coming – but we did not. Because MMMFs had significant problems in August 2007 as a result of the Asset-Backed Commercial Paper (ABCP) runs.
  • McCabe (2010) shows that MMMFs assets under management grew during the ABCP runs of 2007, but that is because the implicit promises of many sponsors were honored: 43 MMMFs were bailed out by their sponsors/fund-families. This level of support was unprecedented.
  • In September 2008, this support was not possible, and the resulting runs transferred more than $400 billion from prime MMMFs (which support many components of private finance) to government-only MMMFs (which do not).



Main weaknesses:

  • Credit-default-swap (CDS) mark-to-market losses and collateral calls.
  • Cash collateral investment losses in securities lending business.
  • Funding pressure in CP and repo.
  • Ratings downgrade triggers additional collateral calls.
  • Liquidity puts on CDOs.

After Lehman, markets are in turmoil and no private rescue is possible.

Fed led rescue of $85 billion, later supplemented by more from Fed and TARP.


The Run on Repo

  • $350 billion of short-term funding ran away from ABCP.
  • From MMMFs, about the same amount.
  • Combine these drains with uncertainty about the subprime exposure on balance sheets, and there is massive pressure on repo markets.
  • This pressure manifests in spreads (on underlying ABS), repo rates, and haircuts.
  • The statistical evidence in Gorton and Metrick (2012) confirms a significant relationship between LIBOR-OIS and ABS spreads.
  • Regression evidence also suggests that the main driver of haircuts was uncertainty about future spreads on the ABS collateral.


Special thanks to Timothy F. Geithner (Lecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury, Yale School of Management) and Andrew Metrick (Michael H. Jordan Professor of Finance and Management, Yale School of Management)


Remember The Global Financial Crissis?! – Anxiety

Some Notable Events in 2007

April 2007

New Century: 4/2/07 (REIT with market cap of $1.75 billion on 1/1/07, delisted 3/13, filed for bankruptcy 4/2)

June 2007

S&P/Moody’s significant downgrades beginning in June 2007 Bear Stearns suspends redemptions: 6/7/07

July 2007

Bear Stearns liquidates funds: 7/31/07

August 2007

BNP Paribas funds: 8/9/07



The ABX-HE (or just “ABX”), is an index of credit default swaps (CDS) written on subprime mortgage securitizations. The price of the ABX index is essentially a measure of perceived value of subprime securities with various ratings; the return (or spread) on the ABX is essentially a risk premium for subprime.

The index was created by the firm Markit, and first released in January 2006 covering the 20 largest subprime securitizations that closed in the last six months of 2005. These indices were denoted as ABX-HE 2006-1. Subsequent releases were denoted 2006-2, 2007- 1, and 2007-2 before subprime activity became too small for index construction.

The launch of ABX in 2006 was a notable event, as it allowed everyone to see, speculate, and hedge – for the first time – market expectations about subprime.


How Could We Be So Wrong?

“… given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.” – Chairman Bernanke in a speech on May 17, 2007


Anxiety Spreads

The bad news in subprime was well-known by the time of Chairman Bernanke’s speech. Indeed, the news events in the spring of 2007 seem uncorrelated with the movements in the ABX.

Instead, the problem became the uncertainty about the location of subprime risk. Which securitized bonds were exposed to subprime? Which financial institutions would need to support their investment vehicles?

The financial system is not equipped to analyze “safe” investments. The resources for deep analysis of information are not there.

Consider what you would do if you had uninsured deposits at a bank, and you became nervous about the bank’s solvency. Is it rational to analyze the bank’s balance sheet, or to just take your money out?



The London Interbank Offered Rate (LIBOR) is a measure of the interest rates that banks charge each other for unsecured dollar funding over various time periods (overnight, one-month, threemonth etc.)

The Overnight Index Swap (OIS) is a fixed-floating interest-rate swap for various time periods. Because the amounts owed daily are small and counterparties must continuously post collateral for expected payments, the fixed leg of this swap is considered to be a good proxy for risk-free interest rates.

The LIBOR-OIS spread is thus a good measure for the riskiness of banks’ unsecured borrowing. Historically, this spread was very small (around ten basis points).


Asset-Backed Commercial Paper

Asset-backed commercial paper (ABCP) is primarily a method of maturity transformation – funding a pool of long-term assets with short-term liabilities.

ABCP is designed to meet specific needs of investors (often money-market mutual funds), and includes credit enhancement and liquidity support to achieve this goal.


ABCP vs. Securitization

ABCP may appear similar to securitization, but there are many differences:

  • Investments can be revolving and fluctuate in size
  • Conduits may invest in various asset types
  • Typically engage in maturity transformation, with backup liquidity support
  • No scheduled amortization of assets and liabilities



ABCP programs grew rapidly in the 1990s, and then again in the crucial 2003-2007 period.

As of 2007, ABCP programs took many forms, and were not dominated by any particular type of sponsor.


ABCP “Runs”

Covitz, Liang and Suarez define an ABCP “run” as a week when the program does not issue new CP despite having at least 10% of outstanding CP mature.

Runs became endemic in August 2007, and once a program experienced a run it was unlikely to ever leave that state. By December 2007 more than 40% of programs were in a run state.



The problems in subprime were clear to all market participants in early 2007.

These problems were not expected to infect the whole financial system, but uncertainty about the location of risks led to a spread of anxiety beginning in the middle of 2007.

The anxiety is driven by a financial system ill-equipped to analyze risks in seemingly “safe” assets. This sets the stage for a good oldfashioned bank run, but now taking place in the shadow banking markets.


Special thanks to Timothy F. Geithner (Lecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury, Yale School of Management) and Andrew Metrick (Michael H. Jordan Professor of Finance and Management, Yale School of Management)

Remember the Global Financial Crisis?! – Safe Assets and the Global Savings Glut

Shadow Banking

“Runnable debt” is effectively “money”, and it comes in many forms.

In its simplest form, such debt was produced by banks in the form of demand deposits.


Safe Assets

What Are Safe Assets?

Information Insensitivity

  • No incentive to produce information about the asset
  • Can also think of this as “no adverse selection”
  • Not the same thing as “risk free” — this is tricky!


  • Currency
  • Government bonds of stable countries
  • Insured deposits in banks


  • Stocks
  • Private debt of third parties
  • Government bonds of unstable countries


Why do we need safe assets?


  • Investment portfolio for consumers, institutions, and other capital pools


  • Collateral for financial transactions

These are the same functions we often ascribe to traditional money


The Global Savings Glut Hypothesis

Between 2003 and 2007, short-term interest rates in the United States increased, which would normally also increase long-term rates.

That didn’t happen. Ten-year rates stayed about the same.

Ben Bernanke proposed that one cause of this “conundrum” was a “global savings glut” (GSG) from emerging-market and commodity rich countries with large current-account surpluses.


Supply of Safe Assets

  • Precious metals
  • Debt and currency of stable countries: U.S., U.K., Germany

By 2007, we were running out of U.S. securities for to serve as safe assets.

  • Insured deposits in commercial banks can act like safe assets… but there aren’t enough insured bank deposits.

When there is excess demand for something, we can expect somebody to try to make it.


“Manufacturing” Safe Assets

  • The key principle is to use only part of an asset as collateral.
  • A house is purchased for $1 million in cash. How safe would a security be that is based on getting at least $1,000 on that property? How much work would you need to do to figure that out?
  • A large tech company has a market capitalization of $100 billion in equity, with zero debt.
  • How safe would be the first $1 million of debt? The key here is to set the debt to value ratio low enough that nobody has an incentive to analyze default probabilities.

This is not the same thing as “default is impossible”!

Why do it this way?

Agency Risk

  • Risk that bank’s management makes a mistake and harms the rest of their business operations
  • But since these assets don’t require maintenance – they just collect cash payments –you don’t need the bank’s management to be involved any longer

Market Risk

  • If the value of the assets fall far enough, the special purpose vehicle has unique bankruptcy rules which are much cheaper than usual bankruptcy costs


Special thanks to Timothy F. Geithner (Lecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury, Yale School of Management) and Andrew Metrick (Michael H. Jordan Professor of Finance and Management, Yale School of Management)


Remember the Global Financial Crisis?! – Housing and Mortgages

Housing Bubbles and Financial Crises

Reinhart and Rogoff (2008) identify the “big five” crises since WWII – Spain (1977), Norway (1987), Finland (1991), Sweden (1991), and Japan (1992) – plus 13 other bank-centered crises in developed countries.

Housing price appreciations are a standard feature of financial crises, and as of 2007 the United States appeared to be in great danger.


Mortgages: Fixed and Adjustable

The standard mortgage in the United States has a 30-year term, with fixed interest rates. Every year you pay interest and an amortization of the loan.

Alternative structures have adjustable interest rates for all or part of the term (“ARMs”, 2/28, 5/25 or 5/1, 7/23 or 7/1 etc.), with the adjustable rate set to some spread above a reference rate. •

  • Initial fixed rate will typically be lower than for 30-year fixed mortgage, sometimes called a “teaser”.
  • These alternative structures are more popular outside the United States.

More complex structures allow for flexible payment sizes: negative amortization, balloon payments, pre-payment penalties, and other elements that can reduce payment sizes in early years.


Prime Mortgages


This is the core category of mortgages in the United States, used for loans that “conform” to Government Sponsored Enterprise (“GSE”, or just “agency”) standards for:

  • loan-to-value (LTV)
  • credit score
  • maximum loan size
  • occupancy rules
  • income limits and documentation

Such loans are eligible to be purchased, guaranteed, and combined into agency Mortgage Backed Securities. Loans that would satisfy these criteria except for being too large are called “jumbo” or “super-jumbo” mortgages, and cannot be guaranteed by the GSEs.


Nonprime Mortgages

Subprime: “Although categories are not rigidly defined, subprime loans are generally targeted to borrowers who have tarnished credit histories and little savings available for down payments.” (Mayer, Pence, and Sherlund, 2009)

Near-prime or “Alt-A”: “Near prime mortgages are made to borrowers with more minor credit quality issues or borrowers who are unable or unwilling to provide full documentation of assets or income …” (Ibid)

Together, subprime and Alt-A are known as “nonprime”. Nonprime mortgages are not new products, but their use in the United States increased dramatically in the 2000s.


Are Subprime Mortgages “Designed to Fail”?

In a typical subprime mortgage, an initial “teaser” rate will be set to adjust after two or three years, usually to be much higher than the original rate.

A borrower can get out of this higher rate by refinancing, but this action may incur a pre-payment penalty.

This sounds like a horrible trap, like a financial product that is “designed to fail”.

A subprime mortgage only makes sense if everyone expects housing prices to rise.

In this case, it can be a useful financial innovation, allowing borrowers to share the potential upside of their housing investment to get a lower overall rate.


Foreclosure: Localized But Global

In the United States, foreclosure was a national phenomenon, but was worst in the “sand states” of: Arizona California Florida Nevada

In the United States, foreclosure was a national phenomenon, but was worst in the “sand states” of Arizona, California, Florida, and Nevada.

All types of loans had elevated foreclosure rates in the crisis, with subprime loans and ARMs performing worse.

The United States had the worst foreclosure crisis, but some (not all) other developed countries also had problems.


Crisis Terminology

Some sources will refer interchangeably to the “housing crisis”, the “financial crisis” and the “Great Recession”, especially in the United States.

To be more precise, we should say that the housing crisis was a primary driver of the financial crisis, and that both were major contributors to the Great Recession.

To see how the housing crisis was a primary driver of the financial crisis, we must shift attention over to the “demand” side for mortgages.

Together, the crises in housing and in the financial sector deepened the real economic effects of what would later be called “The Great Recession”.



Housing crises and financial crises are intertwined, but are not exactly the same thing.

In the United States, foreclosure was a national phenomenon, but it was significantly worse in some regions and for some types of mortgages.


Special thanks to Timothy F. Geithner (Lecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury, Yale School of Management) and Andrew Metrick (Michael H. Jordan Professor of Finance and Management, Yale School of Management)

Remember the Global Financial Crisis?!

What is a Financial Crisis?

  • Almost all wealth is embodied in long-lived assets that pay off slowly over time.
  • Some fraction of that wealth is needed to back short-term safe assets used in transactions (“money”).
  • Collectively, we cannot all convert our long-term assets to money at the same time.
  • A “panic” happens when enough people get nervous and try to convert.
  • A “financial crisis” occurs when a panic (or fear of panic) affects the functioning of the financial system.


Why Study the Global Financial Crisis?

  • It is an important part of history, by far the most important economic event since the 1930s, and crucial for understanding the world that followed.
  • It could happen again.
  • We would like to prevent it from happening again.
  • If it happens again, we need to be prepared to fight the fire together.


Asset Bubbles

  • “This time is different …” (Reinhart and Rogoff, 2008).
  • Prior to all financial crises, there is a large increase in the price of at least one asset class. When this price later falls, we retroactively label the original increase to be a “bubble”.
  • In the Global Financial Crisis, the bubble was in housing.
  • Housing bubbles have been associated with every major financial crisis since WWII.


New Kinds of Money

  • Through most of the history of civilization, our monetary needs were met primarily by metal-based currencies.
  • The rise of the modern state has allowed for sovereign-backed “fiat” money.
  • But … even stable governments have limits and the demand for money can exceed the supply of metal and sustainable fiat money.
  • Additional monies are then “manufactured” by the financial system, using private debt backed by collateral.
  • The history of financial crises is a tour through sad stories of new monies gone bad.


The Anatomy of a Modern Panic

  • For hundreds of years, panics were easy to spot: depositors would “run” to banks to exchange their banknotes for gold, or to remove their deposits.
  • The Global Financial Crisis was different, with the panics occurring out of public sight, in the non-bank part of the financial sector. This area of the financial system is often called the “shadow banking” system.
  • To fully understand the Global Financial Crisis and the efforts required to fight the panic, it is important to understand the mechanics of this modern system.


Fighting the Panic

  • Going into the Global Financial Crisis, governments all over the world were underprepared, with the available tools built for fighting an old-fashioned bank run, not a modern crisis.
  • To fight this crisis, these tools – emergency lending, guarantees, capital injections – were extended to creative new uses.
  • The evidence shows that this panic-fighting was a success, but this success came at the cost of political backlash, in some cases reduced our firefighting capabilities for the next crisis.


Special thanks to Timothy F. Geithner (Lecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury, Yale School of Management) and Andrew Metrick (Michael H. Jordan Professor of Finance and Management, Yale School of Management)

Family Office Services – Part A

At the heart of any family office is investment management. However, a fully developed family office can provide a number of other services, which range from training and education to ensuring that best practices are followed in family governance. First we will have a look at financial planning:

Investment Management Services

Typically this will be the main reason for setting up a family office, as it is central to ensuring wealth preservation. These services include:

  • Evaluation of the overall financial situation.
  • Determining the investment objectives and philosophy of the family.
  • Determining risk profiles and investment horizons.
  • Asset Allocation – deciding on the mix between capital market and non-capital market investments.
  • Supporting banking relationships.
  • Managing liquidity for the family.
  • Providing due dilligence on investments and external managers.

Philanthropic Management

An increasingly important part or the role of a family office is managing its philanthropic efforts. This might include the establishment and management of a foundation, and advice on donating to charitable causes. These services would typically involve:

  • Philanthropic planning.
  • Assistance with the establishment and administration of charitable institutions.
  • Guidance and planning a donation strategy.
  • Advice on the technical and operational management of charities.
  • Formation of grant-making foundations and trusts.
  • Organizing charitable activities and related due dilligence

Life management and budgeting

Some of these services are typically defined as concierge in nature, but they are broader in scope inasmuch as they also include budgetting services. Services under this heading include:

  • Club (golf, private,etc.) memberships.
  • Management of holiday properties, private jets and yachts.
  • Budget services, including wealth reviews, analysis of short- and medium-term liquidity requirements, and long-termm objectives

If you have questions regarding any of the mentioned points – don`t hesitate to contact us.

The Future of Family Offices – at least for 2015

As governments push to close taxation loopholes, the private wealth management industry has come under sharp scrutiny. Yet keen to remain competitive, family offices are innovating to better serve their clients, while keeping well within the limits of the law.


A plethora of new laws in the European Union and the US are forcing family offices to reassess their investment strategies. This is giving way to a new model office

Despite witnessing losses from the global economic crisis, family offices’ appetites for riskier, high yielding assets is on the rise.

While we see differences in the different regions the Family Offices (FO) are located in we see some similarities between the asset allocation in Europe (EU) and the Asia-Pacific (AP) region. The major differences are seen in Equities where the US has a moren than 30% higher Exposure to EU/AP and more than 40% higher than the Emerging Markets (EM). Real Estate and Fixed Income are up to 70% higher around the globe compared to the US while highest to be seen in the EM. Unsurprisingly the US is topping all other regions inn Private Equity investments – two times EM and still +25% compared to the EU. We also expected the US to top the Hedgefund Universe but the EM became first topping all other regions by up to 140%.

The difference in the differences in the Portfolios might be allocated to te regions but also to the average Total Family Net Worth held by the 2000 asked FO. The US came in first 1310m followed by the EU with  1270m, EM with 1000m and AP with 830m. The average cost of the investment activities range from 30-50+ basis points of the Assets under Management (AUM).

The top five services that are most likely to be performed in-house are the following: For General Advisory:

  • 60% Financial Planning
  • 35% Trust Management
  • 25% Estate Planning
  • 17% Tax Planning
  • 12% Insurance Planning

Family Professionals:

  • 81% Support for new Family Business
  • 69% Family Governance
  • 64% Management of Physical Assets
  • 62% Concierge Service & Security
  • 59% Family Counselling

Another major topic for most of the FO is currently new technicals standards influenced by new legislative challenges in 2015 that are not purely regulatory, however. The increasingly multinational and multigenerational make-up of families has meant finding one-stopshop outsourcing partners is also proving a headache for some, given the evolving regulatory environment. Paul Finn, head of global wealth management at Clarien Bank, says these families are finding it extremely difficult to find a wealth management organisation that will serve the family as a single relationship across multiple generations and regardless of nationalities.

As investments become increasingly complex to meet the high standards of the Families technology becomes becomes critical in mitigating risks.

Others trends that are seen over the last years are consolidation and philantrophy. Due to the big banks pushing more and more into the field of Multi Family Offices (MFO) cutting the prices to as low as hard to survive for the MFO. A fact that is mostly overseen is that banks have different revenue streams compared to independent MFO. Nontheless the pressure will stay high.

Philantrophy is an area in which family offices are increasingly helping their clients – not just for their clients’ benefit, but for others’. “I have seen an example of a charity that has a number of private equity investors using their skill of managing private equity funds to help other charities,” Grum notes. Philantrophy has become more visible over the past decade due to some initiatives encouraged by the ultra wealthy.

Sources: The Global Family Office Report, UBS, Campden Research, Major FO Zurich