The Global Capital Market
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Transcript The Global Capital Market
The Global Capital
Market
Hill, Chapter 11
Review: Basic Economics
Economists teach that the most efficient use of
resources can be achieved by free competition
“Every individual seeks the most advantageous
employment for his capital….
“Study of his own advantage necessarily leads
him to prefer that employment most
advantageous to society”
- Adam Smith, 1776
Banks
Commercial banks – take deposits from savers,
pay interest, and lend money to borrowers
at slightly higher interest
Can grow very large
Most employees make <$150,000/year
Investment banks – create securities (stocks, bonds,
derivatives) for companies and sell them
Also arrange mergers
Many employees make $1 million or more a year
How do you know when
you’ve made money…
at a commercial bank?
There are many businesses where it takes a long time
to know if you’ve made money
Real estate
Cattle breeding
But banking is probably the biggest and most
important
Does this create any
dangers?
What to do about the dangers
of banking?
For centuries there has been disagreement
Free enterprise banking – let people create and run
banks freely
Advocates believe most problems of banking are caused by
government mistakes
They fear regulation will reduce efficiency
Government-regulated banking – government sets
rules about who can start a bank and how they can run it
Advocates believe government can reduce the dangers
without greatly reducing efficiency
A brief history of banking
Traditionally, governments regulated banking tightly
In 19th century in US and UK, much freedom of banking
was introduced
Helped cause rapid economic growth
Also contributed to many ‘panics’
Banking scandals were believed to have contributed to
Great Depression of 1930s
When free trade was promoted in 1940s, 50s, banking
was tightly regulated
In 1970s, tight regulations in many industries
(banking, trucking, airlines) were believed to be
preventing economic innovation and growth
Much deregulation in late 70s, 80s, 90s, 2000s
Functions Of A Generic
Capital Market
Figure 11.1: The Main Players in a Generic Capital Market
Attractions Of The Global Capital Market
Borrowers benefit from:
the additional supply of funds global capital markets provide
the associated lower cost of capital (the price of borrowing
money or the rate of return that borrowers pay investors)
The cost of capital is lower in international markets because
the pool of investors is much larger than in the domestic
capital market
Attractions Of The Global Capital Market
Figure 11.3: Risk Reduction
through Portfolio
Diversification
Growth Of The Global Capital
Market
Global capital markets have been growing at a rapid pace
In 1990, the stock of cross-border bank loans was just
$3,600 billion
By 2006, the stock of cross border bank loans was $17,875
billion
The international bond market shows a similar pattern with
$3,515 billion in outstanding international bonds in 1997,
and $17, 561 billion in 2006
International equity offerings were $18 billion in 1997 and
$377 billion in 2006
Manias and Crashes
Unfortunately, the world economy since the time of the
Holy Roman Empire (800 years ago!!!) has been
plagued by
Manias – periods when everyone believes they can make
money doing something that turns out not to be so great
after all
Example – the dotcom boom of the early 2000s.
Crashes – periods when the economy has huge
problems as the problems of the mania period unravel
Kindelberger, Manias, Panics, and Crashes,
1998
Mid 2000s: The world had a
lending & investing mania
Deregulation
Excess savings in developing countries (China, Taiwan)
and Japan
It’s hard to spend money in a fast-growing economy
“Easy money” in the developed countries
U.S. government allowed money supply to grow
Banks, most of all in U.S., issued ‘sub-prime’
mortgages
Banks did not want to own them, but packaged pieces
of many mortgages into bonds
Banks said the mortgages underlying the bonds wouldn’t
all default at once
Rating agencies (firms resembling Consumer Reports) agreed
Developing country & Japan investors bought
Eventually the pile got so bad people saw the problems
The Crash of 2008
Many banks have so many hard-to-evaluate
investments that no one knows if their assets are
worth more than their liabilities
Would you invest in your bank if your deposits weren’t
government guaranteed?
Governments…
Lent huge amounts of money to banks
Took over dying banks
Launched huge stimulus packages (deficit spending)
So what do we do?
Do we increase regulation?
If so, how?
What do we do about dying banks?