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Please conduct a thorough and thorough examination of all my communications with the bank to see what the matter and the phenomenon mean and make sure that this is not a fraud on the part of A person who is not the owner of the account or who is not a proxy in my account and you will reply to me with a return message to this address of written service to the banker. I'm waiting as long as necessary and | don't care how long it takes you to answer this request Hillary@jllszeder.com. LTA YITZHAK MUALLEMI TAX CONSULTANT EMAIL: MUALLEMIS3@GMAIL.COM ON BEGIN MENACHEM ST. 9 KIRYAT ONO ISRAEL ZIP CODE 5552356 Ale Real Esiaie Invesimenis Online Mobile Phone +393899421726 Additional Mobile Phone +972533978920 Email sandra.yankova@gmail.com http://margaritanason.comLeverage Stacks and the Financial System John Moore Edinburgh University and London School of Economics Presidential Address, 9 June 2011, Econometric Society significantly revised for: Ross Prize Lecture, 15 October 2011, Foundation for the Advancement of Research in Financial Economics latest revision: 2 March 2012entrepreneur entrepreneur entrepreneur entrepreneur entrepreneur entrepreneur uo bank 2 bank 1 ss, ' Financial System ; “s bank 1 bank2 household household household household household householdTwo questions: Q1 “Why hold mutual gross positions?” Why should a bank borrow from another bank and simultaneously lend to that other bank (or to a third bank), even at the same rate of interest? Is there a social benefit? Q2 “Do gross positions create systemic risk?” Is a financial system without netting — where banks lend to and borrow from each other (as well as to and from outsiders) — more fragile than a financial system with netting?investment opportunities assets 4 lending to entrepreneurs lending to other banks lending to other banks > time (discrete) borrowing from ‘ other banks orrowing from other banks liabilities missing: borrowing from householdsbank most bank least assets vulnerable vulnerable lending to other banks > time (discrete) borrowing from other banks liabilitiesProposition: If economy with mutual gross positions is hit by a productivity shock just big enough to cause the most vulnerable banks to fail, then, under plausible parameter restrictions, all banks fail. cf. with netting, no other banks would fail This answers Q2: gross positions do create systemic risk But what about Q1? Why hold gross positions?Numerical Example of Leverage Stack: entrepreneurs #------- interest rate 5% €-cn---- interest rate 3% Geeseces interest rate 2% households where, at each level, borrower can credibly pledge at most 9/10 of returnA bank has two feasible strategies: Lend to entrepreneurs, levered by borrowing from another bank: lend at 5%, 9/10 levered by borrowing at 3%, yields net return ~ 23% (see Appendix) Lend to another bank, levered by borrowing from households: lend at 3%, 9/10 levered by borrowing at 2%, yields net return ~ 12% (see Appendix)Crucial assumption: it is not feasible to lend to entrepreneurs, levered by borrowing from households: lend at 5%, 9/10 levered by borrowing at 2%, would yield net return ~ 32% Why not? When lending to bank 1, say, a householder can’t rely on entrepreneurs’ bonds as security, because she does not know enough to judge them. But she can rely on a bond sold to bank 1 by bank 2 that is itself secured against entrepreneurs’ bonds which bank 1 is able to judge (and bank 1 has “skin in the game”).levered lending to entrepreneurs (@ 23%) > levered lending to banks (@ 12%) = all banks should adopt 23% strategy But, in formal model, not all banks can do so: entrepreneurial lending opportunities are periodic specifically, we assume: at each date, with probability x < 1 a bank has an opportunity to lend to entrepreneurs In effect, banks take turns to be “lead banks”:e.g. five banks and x = 2/5: households ———* bank bank ——> entrepreneurs lead bank" crucial: 4 mutual gross positions among non-lead banksWhy do non-lead banks privately choose to hold mutual gross positions? (Q1 again) assume loans to entrepreneurs are long-term (though depreciating) = every bank has some of these old assets on its balance sheet (from when, in the past, it was a lead bank)Should non-lead bank spend its marginal dollar on paying down (= not rolling over) old interbank debt secured against these old assets => return of 3% or on buying new interbank debt @ 3%, levered by borrowing from households @ 2% => effective return of 12% Y This answers Q1socially, mutual gross positions among non-lead banks “certify” each others’ entrepreneurial loans and thus offer additional security to households = more funds flow in to the banking system, from households => more funds flow out of the banking system, to entrepreneurs => greater investment & aggregate activity but though the economy operates at a higher average level, it is susceptible to systemic failureMODEL discrete time, dates t= 0, 1, 2, ... at each date, single good (numeraire) fixed set of agents (“inside” banks) in background: outside suppliers of funds (households; “outside” banks)Apply Occam’s Razor to top of leverage stack: ‘entrepreneurs __ replace this by ~ “capital investment” bank ] cece { interest rate r, credit limit 6 < 1 bank | --- . household bonds issued (< 0*b,) interbank bond holdings (b,) own equitylead bank’s flow-of-funds rollover a It < ark, ~ [ Ea +E a] OD capital returns payments to other banks investment + [ Ea, + DEG | b, — [ E44, + DEG: | 8*b, payments from other banks payments to households _- rollover + @OOK)+ 4) sale of new interbank bondsHence, for a lead bank starting date t with (k,, b,), bi, =0 and k.,, = Ak, + i, where i, is given by (a, — 9E,,a,)k, + (1-6*)[ E,.a, + XE, Jb, + O(g,— E..14) kK, 1 — 8q,non-lead bank’s flow-of-funds 1 Dist < ak, purchase of other returns banks’ bonds + [ Ea, + DEG | b, - payments from other banks rollover : + sale of new interbank bonds rollover ? , - ~ [Ea + B64] 8 payments to other banks [ Ea + DEG: | 8*b, payments to households + G°0*,, sale of new household bondsHence, for a non-lead bank starting date t with (k,, b,), Keer = Aki and b,,, is given by (a, — 9E,.,a,)k, + (1-6*)[ E,,a, + \E,..q; ]b, + O(q,- E..4,) rk, q, — 8*q,*assets 4 investment investment liabilities . net interbank bond holding = b, — 6k,each bank has its personal history of, at each past date, being either a lead or a non-lead bank = in principle we should keep track of how the distribution of {k,, b,}’s evolves (hard) however, the great virtue of our expressions for K..1 and b,,, is that they are linear in k, and b, = aggregation is easyAt the start of date t, let K, = banks’ stock of capital investment B, = banks’ stock of interbank bonds Kur = 4K, + i where I, = banks’ capital investment = Investment is v sensitive to falls in the bond price w ) (a, — BE,a)K, + (1-0*)[ E,,a, + \E,,4, ]B, ] : + B@- E..a)\«K, | 1 — 0G) SHand B,,, is given by (1—n) { (a, ~ 9, .a)K, + (1-0*)| E.4a + E14, IB, + 6(q,— E,..q,)\K, O ~~ 6*q,"Market clearing Price q, clears the market for interbank bonds at each date t: interbank banks’ bond demand = B,,, interbank banks’ bond supply = OK,,, Posit additional demand from outside banks: De = or (0K.., ~ Beat ) _— t outside banks’ supply of loanable funds is increasing in risk-free interest rate r,The following results hold near to steady-state Assume that most interbank loans come from the other inside banks, not from outside banks: GBu, >> D(r,) We need to confirm that inside (non-lead) banks will choose to lever their interbank lending with borrowing from households: Lemmai r,>r iff (A.1): 8 > xOO* + (1-n)(1-4d8) + (1—2)(1-98")r*Lemma 2a A fall in a, raises the current interest rate r, Intuition: a,4 raises bond supply/demand ratio: TT inside banks’ bond supply a(n, 7 oat) inside banks’ bond demand 1-1 g,-8*q," which implies r,t where W, = \@-a OE,.,a,)K (1-0" ME Ea + XE. JB, + O(q,-E E.a)K,Lemma 2b Fors >0, arise in f,,, raises tigi Intuition. 1,7 => (1 +y4.)D(tu.) t 1 debt (inclusive of interest) owed by inside banks to outside banks at date t+s+1 => Wusi1 + (debt overhang) => Tus ft (cf. Lemma 2a)Lemma 2c A rise in future interest rates raises the current interest rate if (A.2): O*x > (1 — » + dn)? Intuition. arise in any of E,ti.,, Eas, Eva, «+ 1- > Eur) > q"= af Eats + NEA. | 1 => ratio of inside banks’ bond supply/demand @(dK, + 7555.) = —,_ a t > I, Tt i-—n sa WV, 0 t qi Q*a,) _-under (A.2), this channel dominates (borrowing from households })amplification through interest rate cascades:collateral-value multiplier: -————_ interbank bond prices | collateral values | borrowing from households | net interbank lending by non-lead banks J \_______ interbank interest rates Tbroad intuition: negative shock = interbank interest rates T and bond prices | = banks’ household borrowing limits tighten = funds are taken from banking system, just as they are most neededfall in interbank bond prices = banks may have difficulty rolling over their debt, and so be vulnerable to failure “most vulnerable” banks: banks that have just made maximal capital investment (because they hold no cushion of interbank bonds) Failure of these banks can precipitate a failure of the entire banking system:Proposition (systemic failure) In addition to Assumption (A.1), assume (A.3): @* > (1-n)X If the aggregate shock is enough to cause the most vulnerable banks to fail, then a// banks fail (in the order of the ratio of their capital stock to their holding of other banks’ bonds). NB In proving this Proposition, use is made of the steady-state (ergodic) distribution of the {k,, b,}’s across banksCorollary At each date t, the probability of default, 4,, is the same for all inside banks We implicitly assumed this earlier — in effect, we have been using a guess-and-verify approach Banks make no attempt to self-insure — e.g. by lending to “less risky” banks (because there are none: all banks are equally risky)Parameter consistency? Assumptions (A.1), (A.2) and (A.3) are mutually consistent: e.g. n=0.1 = 0.975 8 = 8*=0.9 rm =0.02key point: non-lead banks are both borrowers and lenders in the interbank market new interbank borrowing at r (rollover) non-lead bank new interbank lending a atr new household borrowing at r* ee “">>+..__ secured --against notice multiplier effect: if for some reason bank’s value of new interbank borrowing J} (by x dollars, say) = bank’s value of new interbank lending JJ (by >> x dollars, because of household leverage) = bank’s net interbank lending |lead bank lead bank lead bank 5 r E r non-lead r non-lead r non-lead C bank bank bank ie ry i households households households if the “household-leverage multiplier” exceeds the “leakage” to lead banks then we get amplification along the chainAPPENDIX borrower has net worth w and has constant-returns investment opportunity: net rate of return on investment = lender has lower opportunity cost of funds: net rate of interest on loans = r* invest i= 1000 r=3% = gross return = 1030 r=2% = gross debt repayment = 918 = netreturn = 112 ie. net rate of return on levered investment = 12%—— J <7 i a Draghi SignaturH if that