JP Morgan and Bear Stearns
Background
In the last three decades, the US banking system has changed its investment procedures and its risk management due to changes in government regulation. Furthermore, external shocks, such as the inflationary period during the 70s and the recession in the 80s, led Banking institutions to alternative ways of investment in order to remain profitable.
The average annual inflation rate from 1900 to 1970 was approximately 2.5%. From 1970, however, the average rate hit about 6%, topping out at 13.3% by 1979. This period is also known for "stagflation", a phenomenon in which inflation and unemployment steadily increased. A loose monetary policy led to very low interest rates. Corporations were borrowing large amounts to finance leverage buyouts (LBOs), which led to higher and high interest burden.
One of the main instruments used was financial derivatives, which gave Banks additional profit. Moreover, this instruments represented off balance sheet activities, thus helping bank capital. Nonetheless, these instruments were risky and could led to enormous losses.
In the late 70’s and early 80’s saw the rise of a number of financial products such as derivatives, high yield an structured products, which provided lucrative returns for investment banks. Also in the late 1970s, the facilitation of corporate mergers was being hailed as the last gold mine by investment bankers who assumed that Glass-Steagall would someday collapse. At this time we could see the first efforts to loosen Glass-Steagall restrictions and some brokerage firms begin encroaching on banking territory by offering money-market accounts that pay interest, allow check-writing, and offer credit or debit cards.
Moreover, in 1974 NOW (Negotiable Order of Withdrawal) accounts were created by a small bank in Massachusetts, offering negotiable orders of withdrawal to permit payments on near-checking accounts at banks. In 1980, they were permitted for all institutions, with rate ceilings eliminated
In the last three decades, the US banking system has changed its investment procedures and its risk management due to changes in government regulation. Furthermore, external shocks, such as the inflationary period during the 70s and the recession in the 80s, led Banking institutions to alternative ways of investment in order to remain profitable.
The average annual inflation rate from 1900 to 1970 was approximately 2.5%. From 1970, however, the average rate hit about 6%, topping out at 13.3% by 1979. This period is also known for "stagflation", a phenomenon in which inflation and unemployment steadily increased. A loose monetary policy led to very low interest rates. Corporations were borrowing large amounts to finance leverage buyouts (LBOs), which led to higher and high interest burden.
One of the main instruments used was financial derivatives, which gave Banks additional profit. Moreover, this instruments represented off balance sheet activities, thus helping bank capital. Nonetheless, these instruments were risky and could led to enormous losses.
In the late 70’s and early 80’s saw the rise of a number of financial products such as derivatives, high yield an structured products, which provided lucrative returns for investment banks. Also in the late 1970s, the facilitation of corporate mergers was being hailed as the last gold mine by investment bankers who assumed that Glass-Steagall would someday collapse. At this time we could see the first efforts to loosen Glass-Steagall restrictions and some brokerage firms begin encroaching on banking territory by offering money-market accounts that pay interest, allow check-writing, and offer credit or debit cards.
Moreover, in 1974 NOW (Negotiable Order of Withdrawal) accounts were created by a small bank in Massachusetts, offering negotiable orders of withdrawal to permit payments on near-checking accounts at banks. In 1980, they were permitted for all institutions, with rate ceilings eliminated