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taxes assessed where they're incurred |
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taxes only assessed where someone has residency |
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ways to alleviate double taxation |
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-treaties -exemption of foreign source income -foreign tax credits or deductions |
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Cosmopolitan View -Capital Export Neutrality: taxes shouldn't distort US companies seeking to invest abroad -Capital Import Neutrality: treat foreign companies the same in the US that you'd like US firms to be treated abroad Nationalistic View -US should be just as well off as if firms invested domestically |
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taxes eligible for credit |
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-revenue or sales tax deducted as a business expense -income tax credited -withholding taxes are income taxes |
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-when losses occur in one year and can be carried-forward to another
-It may be recorded only if the management considers there will be sufficient future taxable profits to use the tax loss within the permissible carry‐forward period |
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-to fund the bank -to provide a buffer against loss -to reassure creditors and clients -to satisfy the regulators |
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why do regulators require capital? |
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-To safeguard deposit insurance funds (and, implicitly) taxpayers – To provide time to detect and remediate a faltering bank – To control risk‐taking – To constrain asset growth |
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What factors determine the optimal capital structure? |
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-Tax Deductibility of Interest -Costs of Financial Distress -Explicit and Implicit Guarantees & Regulatory Costs |
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Why do deposits appear on the liability side?
Why do loans appear on the asset side? |
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Deposits: Accounts payable
Loans: Accounts receivable |
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a sustained departure from long‐run equilibrium (fundamental) prices |
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housing price performance 1975-2005 |
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Definition
real increase is ~1%, below the T-Bill. Should have just invested in the S&P 500 |
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Property markets are prone to booms because...? |
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Definition
-Imperfect information: no central exchange where current prices are instantly recorded -Illiquidity: assets are heterogeneous, transactions costs are high, trading is infrequent -No short selling: no organized futures or options markets -Inelastic supply in the short‐ to medium‐ term -Nominal prices tend to ratchet up |
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fundamental determinants of property prices |
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Definition
DEMAND... -growth in income (and dist of income) -cost and availability of credit -demographics (population growth, immigration, household formation trends) -THE EXPECTATION OF HIGHER PRICES
SUPPLY... -amount and quality of buildable land -planning restrictions and zoning laws -construction costs -cost and availability of credit |
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Carey Model of Land Prices |
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Definition
-number of investors (N) UP, P UP -fundamental price (P*) UP, P UP -heterogeneity of beliefs (h) UP, P UP -supply of real estate (Z) UP, P UP -supply of resources to investors (L) UP, P UP |
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The relationship between housing costs & some ability to pay criteria
price-to-rent and price-to-income ratios |
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-interest costs -property taxes -depreciation or maintenance costs -opportunity cost of investment foregone -offset by anticipated capital gains on home |
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Take-away of determining overvaluation |
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No one can be sure whether the boom simply reflects favourable fundamentals, or a worrisome degree of overvaluation |
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Desired loan concentration increases when... |
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Definition
1.expected value of assets increases 2.capital requirement decreases 3.promised returns increase 4.EXPECTED PROBABILITY OF DEFAULT increases 5.PERCEIVED CORRELATION WITH REST OF PORTFOLIO DECREASES |
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Definition
Disaster myopia: -availability heuristic (people forget things that happened before the recent past) -threshold heuristic (busy decision-makers try and allocate their scarcest resource, time) -cognitive dissonance (people protect themselves by being less open to information critical to past decisions (securitization accelerated as the economy slumped)
Institutionally enabling factors... -recognition of fees upfront as revenue -bonuses tied to current revenues -high job mobility among risk-takers -intense competition drives out banks that are not myopic (banks cannot survive in the economic environment) |
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-High leverage and risk shifting -Explicit deposit insurance -Implicit deposit insurance –State‐owned banks –Lender of last resort operations –Purchase and assumption transactions -Principal/Agent conflicts between supervisors and taxpayers |
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Poor Information and Weak Analysis |
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Definition
-Inadequate data re: real estate market conditions -Inadequate appraisal techniques -Inadequate measures of exposure -Lack of transparency -Imprudent reliance on real estate collateral -Natural tendency to herd when uncertain |
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How to combat disaster myopia? |
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Definition
-measure risk exposure and confront board and management -encourage diversification -discourage institutional factors that facilitate disaster myopia |
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How to diminish perverse incentives? |
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Definition
-raise capital requirements -apply minimum loan/value ratios -institute prompt corrective action/lease cost resolution reforms |
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-focuses on balance sheet -reduce debt relative to equity (enhance solvency) -often includes a change in ownership/control |
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Operational Restructuring |
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-focuses on the income statement -adjusting the business model to achieve greater profitability |
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regulatory intervention of a bad bank |
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Definition
1.assisted merger with healthy bank 2.continuance under temporary regulatory control 3.restructuring 4.liquidation |
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Definition
-no official aid or intervention -expanded into international lending, retail expansion, acquired Girard Bank -failed to control expenses -new management, flattened structure, reorganized credit, raised capital |
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Advantages of splitting into good/bad bank structure |
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Definition
Increased transparency: – May reduce cost of funding Good Bank – May reduce cost of funding Bad Bank by tailoring securities to specific preferences
Sharpen strategic focus, increase returns: – Managers of Good Bank not encumbered by legacy of past blunders, more accountable – Managers of Bad Bank can focus on maximizing liquidation value of NPLs |
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Pitfalls in restructuring |
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Definition
Delays in exit of insolvent institutions may undermine prospects for Good Bank: – Excess capacity cause weak profitability If financial restructuring is not accompanied by an effective operational restructuring: – It may be impossible to get financing – In any event, it is pointless – merely delaying insolvency, not averting it |
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Definition
Chartering Authority Prudential Supervision Termination Authority Deposit Insurance Lender of Last Resort Monetary Authority |
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Definition
Attempts to bar imprudent, incompetent & dishonest banks: –Fit & proper tests –Tests for continuance -High barriers -> safe, but inefficient -Low barriers -> competitive, but riskier |
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Attempts to prevent excessive insolvency exposure -Two sources of insolvency exposure: –1. Leverage: capital adequacy –2. Risk of portfolio: credit risk, market risk, and liquidity risk -The CAMELS approach in the US |
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Definition
Capital adequacy Asset quality Management Earnings Liquidity Sensitivity to market risk |
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-Level and quality of capital relative to risk profile -Ability to raise new capital -Trend in asset quality -Quality and strength of earnings -Prospects for growth |
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-Focus on credit risk -Adequacy of underwriting standards and credit risk management process -Loan classifications and adequacy of reserves -Diversification -Adequacy of internal controls and management information systems |
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Definition
-Quality and extent of oversight by board of directors and management -Accuracy, timeliness and effectiveness of management information systems -Adequacy of audits and internal controls -Management depth and succession plans -“Reasonableness” of compensation policies -Overall performance |
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-Level, trend and stability of earnings -Ability to generate retained earnings -Level of expenses relative to operations |
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-Ability to meet liquidity needs without adversely affecting earnings or net worth -Holdings of liquid assets -Access to money markets -Diversification of funding sources -Ability to securitize assets -Trend and stability of deposits -Ability to measure, monitor & control liquidity position |
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Sensitivity to Market Risk |
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Definition
-Sensitivity of earnings or economic value to adverse changes in market prices -Ability to measure, monitor and control exposure to market risk -Nature and complexity of exposure in trading and non‐trading positions |
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-Attempts to close failing banks before they cause loss to depositors -Accounting and disclosure issues -Political / legal issues -Forbearance |
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-Implicit deposit insurance –Purchase & assumption transactions -Attempts to prevent the contagious transmission of bank runs -Explicit deposit insurance –Extent of coverage? Deductible or coinsurance? –Which depositors should be covered? -Importance of credibility |
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Definition
-Attempts to prevent illiquidity‐induced failures -Classic view: Lend freely to solvent institutions at a penalty rate -Collateral as a substitute for solvency determination -Danger of perverse signals |
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-Attempts to prevent bank runs from reducing the reserve base -Tension between banking stability objectives and inflation objectives -The disastrous example of the Fed during the 1930s |
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**The safety net may work too well – Bank creditors have no incentive to monitor and price bank risk taking –Banks find that they can increase returns to shareholders by taking larger risks -Banking system becomes more vulnerable to crisis -Increased pressure on supervisory function |
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How do you identify the good assets to put into a new 'good' bank? |
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Definition
Good assets have a verifiable price, even if its below par. |
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How should the “bad bank” be financed? Under what circumstances will it not be possible to move any of the old bank’s uninsured liabilities to the good bank? |
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Definition
All remaining claims on old bank transferred to the bad bank. If good assets fall short of the insured deposits, all of the uninsured creditors go to the bad bank. |
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Government subsidizes a good bank... |
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Definition
if the market hasn't yet warmed to it, but it will as it becomes transparent. |
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Easier and cheaper to recapitalize good bank? |
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Definition
transparent...the old bank was paying a substantial opacity premium |
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How to make sure creditors are just as well off as in bankruptcy? |
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Definition
give them absolute repayment priority for the liquidation of the bad bank. |
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How does FDIC protect itself while acting as the lender of last resort? |
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Definition
it acts as a collateralized lender |
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How does central bank lending through the discount window give de facto deposit insurance to uninsured depositors? |
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Definition
Because it means they can support uninsured depositors while increasing the burden to unsecured creditors and the deposit agency. |
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Why did Continental experience a run in 1982? How did it manage to survive without recourse to official assistance? |
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Definition
Penn Square National Bank failed in 1982, from which it had purchased 1.1 billion in loans that if defaulted like they did at Penn Square would have eaten-up its equity. It borrowed from the Eurodollar market |
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After the run in 1982, what did Continental do to reduce its vulnerability to a funding shock? What else could it have done? |
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Definition
It sold its credit card subsidiary, but it should have completed an operational and financial restructuring instead of selling the 'family jewels' |
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Why was the 1984 run so devastating? |
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Definition
Because it was a run on the Euromarket, where it had secured its funding. It had to go to the Fed finally. |
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Why did the Fed save Continental? |
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Definition
Because it feared the risk of contagion as foreign sourced fled from banks with similar balance sheets and was worried that the other banks that it had been loaned to by would go under as well.
It could have allowed Continental to have gone under while guaranteeing deposits elsewhere for a period of 2 years. |
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Why did Continental's competitors help it out? |
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Definition
Because they wanted to reduce the worries of the market which had caused the spread between CDs and T-bills to increase by more than 100 points. |
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Why was Bank of America OK even as people worried that it wasn't solvent? |
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Definition
Because it had a large retail banking deposit base that was completely insured by the FDIC...no one was worried about default or closure of the bank. Continental did not have insured deposits. |
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Evaluate: Can a bank increase ROE? |
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Definition
Look at: -leverage -credit risk -liquidity risk |
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Evaluate: asset utilization rate |
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Evaluate: How do you boost non-interest income? |
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increase: -trading income -fees |
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Evaluate: Which bank has the higher credit risk? |
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Definition
Look at gross interest income |
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increase of heterogeneity of beliefs causes an increase in RE prices because... |
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Definition
the # of optimists increases who will bid and drive-up prices |
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Equation for pre/post-tax cost of equity capital |
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Pre-tax cost of equity capital * (1-tax rate) = after cost |
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Why have 100% equity banks? |
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Definition
There's no incentive to be at the front of the line for bank runs (everyone shares losses equally) |
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= gross int. income - gross loan provision |
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when the costs of managing conflicts of interest overwhelm synergies |
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