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6.5. “Too Big to Fail”

Course video 51 of 55

Week 6, the final week of the Course covers securitization and CMO’s. We will reveal the role of the CMO market in the development of the world financial meltdown that peaked in 2008 and, as many believe, is not yet over. We will study the details of the role of CMO’s in the development of the crisis. We will consider the measures taken by the regulators, the “too big to fail” phenomenon, and will understand why the governments so actively helped the biggest international investment banks found to have been on the verge of bankruptcy. We will also talk about the globalization of capital markets and the first signals of a counter-trend – de-globalization. We will clearly see how modern geopolitical and technological trends contribute to the ascent of moral hazard that is now a global problem. Finally, some clear and useful recommendations are provided. As a result, you will be able to successfully apply the obtained knowledge and skills not only in finance but also in your career and life in general.

Capital Markets and Financial Institutions – How to Survive Them

莫斯科物理科学与技术学院

课程 1（共 5 门，Understanding Modern Finance 专项课程）

Capital markets and financial institutions are all around us. This is an enormous industry in which powerful players oftentimes challenge investors and the public at large and expose them to significant risks. This Course provides for the deep understanding of the core ideas, concepts, and mechanisms of the modern capital market in a learner-friendly way. We will analyze the market’s most fundamental problems, realize the intrinsic interests of the market participants, reveal the true meaning of certain financial terms, and uncover credible signals of the likely behavior of economic agents – all that with little math and a lot of fun. The learners will be much better positioned with respect to the financial environment. They will see through the financial news, reveal the risks of the financiers’ wishful thinking promises, and protect themselves against dangerous adventures. The learners will get the opportunity to use the obtained knowledge, skills, and understanding for the successful professional career in the financial and other business areas, as well as in their day-to-day life.

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教学方

Konstantin Kontor
Director and Professor of Finance and Strategy

脚本

Now I'd like to say a few words about the famous concept of too big to fail.

That is closely linked to what people observed to be the result

of the recent crisis.

And this concept really was up to the surface and drew a lot of interest.

Well, first of all, at the first glance it seems to be, like I said before,

political blackmail.

So the big bank says, if you allow me to fail,

then I will bury a lot of people under what remains from me.

And that will be a much more damaging situation in the capital market compared

to the cost of this check that you have to inject in me in order to keep me afloat.

Well, it really produced this idea that

there are these big fat cats that dictate the markets and the people of what to do.

And then they say, for any reason, if they agreed and

if their poor risk management result in fundamental potential losses and damages.

And then say, well, now you help us.

And they obviously go to the government as the lender of last resort.

And it seems to be sort of unfair.

And a lot of people who participated in this Occupy Wall Street movement said,

well, we don't need them.

These guys are really ripping us off, so

they're not doing their job in the right way.

Now let's see what would happen if we

allowed all them to crash.

Well, we are back to our classic picture.

So these are investors, here are various kinds of borrowers.

And here are these,

Now I will put a bank and then the investment bank together.

You can say, why?.

Well, because there is no longer Glass-Steagall.

A few words about that in just a moment.

So we can see what's going on.

And if this is the case, we remove these guys.

We are back to the stone age of capital market.

So these guys should deal with those directly.

Well, some people say, well, we have to be back to roots.

But this is really in a wishful thinking case.

You cannot rewind all this market development over the last

couple of decades.

And go back to what was the case 50 or 100 years ago.

It would be a too huge a damage for the economy.

To say nothing of this,

we can keep in mind that actually right now we have these markets global.

And we have technology developments.

So you can really not take this progress back again.

But that's not it, there is something else to be observed here.

We saw that the key objection to the behavior of

these big banks was the fact that they were together.

Now, in the previous episode when I was showing that there's a bank, and

there's the investment bank that buys the mortgages from it.

But oftentimes this was one in the same structure.

Remember, there was no longer Glass-Steagall.

So banks were now in reality enjoying both commercial and investment banking.

And that, as we know, produces some temptations and

then produces some adverse incentives.

And that was happening at a very large scale.

So, basically, a lot of people said, worry not for

the repealing of the Glass-Steagall act.

Then all this maybe would have happened, but at a lower scale.

And some very well-known specialists in the area, they directly blame

the sort of relaxed regulation for the depth and the scale of the crisis.

So soon after that happened,

there were some new pieces of legislation put in place.

And some of them were actually aimed at making sure that

small investors are not damaged that much.

And the famous Dodd-Frank Act of the 2010 to 2012 all this development.

It just showed that, some people said, we are bringing back

basically this Glass-Steagall back again with the but it's not exactly the same.

You cannot really come back and down to the waters of the river twice.

But the spirit was sort of brought back, so this market discipline.

The responsibility of large institutions, it was really brought in the center.

And the people said that without that we can not

really afford to support these too big to fail, these bulge bracket banks,

with all the money that we accumulate in the economy.

That would be unfair, and, in this case, the check would be probably

way too high to justify the positive services that they provide.

And now I would like to conclude that with the following idea.

We can see that the concept of too big to fail really

is close to the moral hazard problem at a higher level.

At the global level, and at the level of combined instruments and institutions.

So we can say that starting from the very famous and

very simple thing without these banks from here.

We've been developing throughout this course this idea of recognizing

moral hazard problems, not only them, but primarily them.

And then trying to cope with them to some extent.

And then we saw that these problems always would find a way

to go up at the next level.

That was the case from individuals to banks, then from banks to bank insurers.

And here it came up to the level of too big to fail at a global scale.

So we can sort of metaphorically claim that this whole course is

about the ascent of moral hazard.

Now I'm quoting the title of the very well known book by Niall Ferguson

that's called The Ascent of Money, when he tells the stories of various segments

of capital markets and the history of developments in a very nice way.

But this is a book that is not a sort of specialized course,

it's just nice to read.

But we here try to analyze what was going on.

And therefore, we see that the crisis,

by recognizing the problems caused by private information at a new global level,

we came to a challenge, what can be done?

And we will study that in the next episodes, but

before we have to say a few words about this globalization.

I've mentioned that many times that the crisis was at a global scale.

But now I'll just say a few words, what we mean by globalization.

How it has developed, and how it has been the background of capital markets for

the last couple of decades.

So in the next episode, we will discuss globalization.

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