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How Did Too Big to Fail Become Such a Problem for Broker-Dealers?

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How Did Too Big to Fail Become Such a Problem for Broker-Dealers? How did Too Big to Fail become such a problem for broker-dealers? Speculation by Andy Atkeson March 2014 Proximate Cause • By 2008, Broker Dealers had big balance sheets • Historical experience with rapid contraction of broker dealer balance sheets and bank runs raised unpleasant memories for central bankers • No satisfactory legal or administrative procedure for “resolving” failed broker dealers • So the Fed wrestled with the question of whether broker dealers were too big to fail Why do Central Bankers care? • Historically, deposit taking “Banks” held three main assets • Non-financial commercial paper • Government securities • Demandable collateralized loans to broker-dealers • Much like money market mutual funds (MMMF’s) today • Many historical (pre-Fed) banking crises (runs) associated with sharp changes in the volume and interest rates on loans to broker dealers • Similar to what happened with MMMF’s after Lehman? • Much discussion of directions for central bank policy and regulation • New York Clearing House 1873 • National Monetary Commission 1910 • Pecora Hearings 1933 • Friedman and Schwartz 1963 Questions I want to consider • How would you fit Broker Dealers into the growth model? • What economic function do they perform in facilitating trade of securities and financing margin and short positions in securities? • What would such a theory say about the size of broker dealer value added and balance sheets? • What would be lost (socially) if we dramatically reduced broker dealer balance sheets by regulation? • Are broker-dealer liabilities the “right” asset for “banks” to hold? • Chari-Phelan/Farhi-Golosov-Tsyvinski/Jacklin on tradable assets in Diamond Dybvig Example: how do we put real estate brokers into the growth model? • Households have a motivation to trade houses • Real Estate Broker adds value in facilitating transaction • Measured in NIPA as broker’s commissions as part of residential investment • Real estate brokers typically do not provide financing of transactions so they have small balance sheets • Real Estate Developers do need to finance new construction (typically with bank loans) RealRICompQ32013.jpg 1,066× 760Estate pixels Brokers in NIPA3/28/14, 7:20 AM http://1.bp.blogspot.com/-jMk790p2xu4/Un-9FI61bNI/AAAAAAAAc1s/mQvIra4AT4U/s1600/RICompQ32013.jpg Page 1 of 1 Securities Broker Dealers vs. Real Estate Brokers • Traditional Investment Banking (underwriting and mergers and acquisitions) • Brokerage commissions and fees • Dealers bid-ask spreads Value Added of Securities, Commodities Contracts, and Investments industry as a 1.8# 1.6# 1.4# 1.2# percentage of GDP 1.0# 0.8# 0.6# 0.4# 0.2# 0.0# 1997# 1998# 1999# 2000# 2001# 2002# 2003# 2004# 2005# 2006# 2007# 2008# 2009# 2010# 2011# 2012# Facts to be presented today • Since the founding of the Fed, most of the time, securities broker dealers have small balance sheets • Two episodes of big increase and decrease in the size of the balance sheet of broker dealers • the past 20 years • Crash of 1929 Outline of the talk • Structure of a modern big bank (Citibank and Goldman Sachs) • Growth of balance sheets of Securities Broker Dealers (Flow of Funds 1952-now) • A look at a broker dealer’s balance sheet by function (What does a broker-dealer do?) • Comparison to data on broker dealer balance sheets, funding sources, and failures from 1918 - 1941 including the Crash of 1929 What do big banks do these days? • Holding Company • Traditional Retail Banking • Traditional Investment Banking • Asset Management • Securities Brokering and Dealing 11/28/13, 2:35 PM As describedWhat above, Citigroup is manageddoes pursuant to the followinga segments:Big Bank do? The following are the four regions in which Citigroup operates. The regional results are fully reflected in the segment results above. (1) North America includes the U.S., Canada and Puerto Rico, Latin America includes Mexico, and Asia includes Japan. 5 http://www.sec.gov/Archives/edgar/data/831001/000120677413000852/citigroup_10k.htm Page 8 of 483 11/28/13, 2:35 PM As describedTraditional above, Citigroup is managed pursuant to the followingRetail segments: Banking The following are the four regions in which Citigroup operates. The regional results are fully reflected in the segment results above. (1) North America includes the U.S., Canada and Puerto Rico, Latin America includes Mexico, and Asia includes Japan. 5 http://www.sec.gov/Archives/edgar/data/831001/000120677413000852/citigroup_10k.htm Page 8 of 483 11/28/13, 2:35 PM As describedSecurities above, Citigroup is managed pursuant Brokering to the following segments: and Dealing The following are the four regions in which Citigroup operates. The regional results are fully reflected in the segment results above. (1) North America includes the U.S., Canada and Puerto Rico, Latin America includes Mexico, and Asia includes Japan. 5 http://www.sec.gov/Archives/edgar/data/831001/000120677413000852/citigroup_10k.htm Page 8 of 483 Form 10-K 2/8/14, 5:18 PM Table of Contents THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES PART I Item 1. Business Introduction As of December 2012, we had offices in over 30 countries and 49% of our total staff was based outside the Americas (which includes Goldman Sachs is a leading global investment banking, securities the countries in North and South America). Our clients are located and investment management firm that provides a wide range of worldwide, and we are an active participant in financial markets financial services to a substantial and diversified client base that around the world. In 2012, we generated 41% of our net revenues includes corporations, financial institutions, governments and high- outside the Americas. For more information on our geographic net-worth individuals. results, see Note 25 to the consolidated financial statements in When we use the terms “Goldman Sachs,” “the firm,” “we,” “us” Part II, Item 8 of this Form 10-K. and “our,” we mean The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation, and its consolidated subsidiaries. References to “this Form 10-K” are to our Annual Report on Our Business Segments and Segment Form 10-K for the year ended December 31, 2012. All references Operating Results to 2012, 2011 and 2010 refer to our years ended, or the dates, as the We report our activities in four business segments: Investment context requires, December 31, 2012, December 31, 2011 and Banking, Institutional Client Services, Investing & Lending and December 31, 2010, respectively. Investment Management. The chart below presents our four Group Inc. is a bank holding company and a financial holding business segments. company regulated by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Our U.S. depository institution subsidiary, Goldman Sachs Bank USA (GS Bank USA), is a New York State-chartered bank.And Goldman Sachs http://www.sec.gov/Archives/edgar/data/886982/000119312513085474/d446679d10k.htm Page 4 of 280 Form 10-K 2/8/14, 5:18 PM Table of Contents THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES PART I Item 1. Business Introduction As of December 2012, we had offices in over 30 countries and 49% of our total staff was based outside the Americas (which includes Goldman Sachs is a leading global investment banking, securities the countries in North and South America). Our clients are located and investment management firm that provides a wide range of worldwide, and we are an active participant in financial markets financial services to a substantial and diversified client base that around the world. In 2012, we generated 41% of our net revenues includes corporations, financial institutions, governments and high- outside the Americas. For more information on our geographic net-worth individuals. results, see Note 25 to the consolidated financial statements in When we use the terms “Goldman Sachs,” “the firm,” “we,” “us” Part II, Item 8 of this Form 10-K. and “our,” we mean The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation, and its consolidated subsidiaries. References to “this Form 10-K” are to our Annual Report on Our Business Segments and Segment Form 10-K for the year ended December 31, 2012. All references Operating Results to 2012, 2011 and 2010 refer to our years ended, or the dates, as the We report our activities in four business segments: Investment context requires, December 31, 2012, December 31, 2011 and Banking, Institutional Client Services, Investing & Lending and December 31, 2010, respectively. Investment Management. The chart below presents our four Group Inc. is a bank holding company and a financial holding business segments. company regulated by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Our U.S. depository institution subsidiary, GoldmanTraditional Sachs Bank USA (GS Bank USA), I-Banking is a New York State-chartered bank. http://www.sec.gov/Archives/edgar/data/886982/000119312513085474/d446679d10k.htm Page 4 of 280 Form 10-K 2/8/14, 5:18 PM Table of Contents THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES PART I Item 1. Business Introduction As of December 2012, we had offices in over 30 countries and 49% of our total staff was based outside the Americas (which includes Goldman Sachs is a leading global investment banking, securities the countries in North and South America). Our clients are located and investment management firm that provides a wide range of worldwide, and we are an active participant in financial markets financial services to a substantial and diversified client base that around the world. In 2012, we generated 41% of our net revenues includes corporations, financial institutions, governments and high- outside the Americas. For more information on our geographic net-worth individuals. results, see Note 25 to the consolidated financial statements in When we use the terms “Goldman Sachs,” “the firm,” “we,” “us” Part II, Item 8 of this Form 10-K. and “our,” we mean The Goldman Sachs Group, Inc.
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