Interest Rates, the Markets, and the New Financial World

by Henry Kaufman

The executive director and chief economist of Salomon Brothers identifies new and key financial indicators, proposes actions to stabilize the financial markets, and forcefully criticizes recent monetary policy in an analysis that looks to the decade ahead

Genres: Finance, Economics

258 pages, Hardcover

First published May 12, 1986

Reviews

[Matthew · Rating 3 out of 5]

What can one say about a book on the markets written over 25 years ago in 1984, since when the markets have changed so dramatically? Kaufman's book, written at the end of a long and successful career as economist at Salomon Brothers, is interesting less for its predictions -- although here there are some long term ones about debt levels and the nature of finance that came true -- than for the glimpse it provides into an industry that predates the current paradigm.

Kaufman spends time discussing the why interest rates became more volatile from the time he entered Wall Street -- as an economist, in 1962, moving over from the Fed -- to when he retired over 20 years later. Much of this discussion is interesting:

-allowing banks to charge high interest rates on loans, which means that when rates go up, banks can raise rates. Before, apparently, banks couldn't do this, so having a large deposit base to reduce cost of funds was less important than having a very high quality loan book. After deregulation, banks could raise rates and keep lending, so it meant that banks with large deposit bases did better. It shifted bank's strategic emphasis from the asset side to the liability side of their balance sheet. In addition, securitisation enabled banks to sell off loans, which enabled them to keep lending even as rates rose. All this meant that rising rates didn't have as much of an impact on bank profitability, and thereby the credit creation process, as before. This meant that rates had to go higher, before the same cooling effect on credit was felt. (This point was most interesting to me: imagine, when we discuss deregulation, we think derivatives -- when Kaufman discusses deregulation, he thinks basic lending rates! that's how far back his historical questions reach, and that's how different the world was!)

-creation of non-bank financial intermediaties, such as money market funds, which were a reaction to when interest rates rose to 9-10%, significantly above deposit ceilings of 4-5%; the money market funds were created to enable depositors to earn higher interest rates

-a shift in central bank thinking from Keynesianism, to monetarism, that latter which emphasises control of base money supply and not credit

Separately Kaufman offers some thoughts on credit markets in 1995 (10 years on for him writing at that time) and proves presicent on some points and falsified on others. What is most interesting here is how much the themes of today -- too big to fail, securitisation and weak governance over asset quality, rising use of derivatives, the limits of econometrics and pure quantitative statistical analysis, accelerating US debt levels -- were already very much present in the 1980s.

(On debt: I've heard this before, actually -- how the US was already faltering in the 1980s, and basically engineered Japan's crazy 90s cycle in a bid to get new buyers of its debt, to facilitate a further credit driven boom. Then China. Then... Brazil? Russia? When there aren't enough players left who want to play... the game stops?)

[André Morais · Rating 4 out of 5]

An insightful journey into the world of financial instruments and markets. I’ve particularly enjoyed the author’s considerations on credit/debt and/vs equity.