Chapter 12Chapter 12

What Financial Institutions Do

Security-Market Security-Market InstitutionsInstitutions

Two categories:Two categories: Investment banks act as agents in Investment banks act as agents in

primary markets by primary markets by underwritingunderwriting new new security issuessecurity issues

Brokers and dealers serve as agents in Brokers and dealers serve as agents in secondary markets, helping buyers and secondary markets, helping buyers and sellers to deal with each othersellers to deal with each other Brokers arrange transactions between Brokers arrange transactions between

buyers and sellersbuyers and sellers Dealers hold inventories of specific Dealers hold inventories of specific

securities, which they buy and sell to securities, which they buy and sell to brokers and othersbrokers and others

Example of UnderwritingExample of Underwriting XYZ Corporation wishes to issue new stockXYZ Corporation wishes to issue new stock It doesn’t know who would buy its stock at the It doesn’t know who would buy its stock at the

best price, and it is expensive for it to find outbest price, and it is expensive for it to find out Investment banks specialize in having such Investment banks specialize in having such

information and profit from doing soinformation and profit from doing so An investment bank would usually buy new An investment bank would usually buy new

stock from XYZ at a negotiated price and resell stock from XYZ at a negotiated price and resell it to the buyers who will pay the most for itit to the buyers who will pay the most for it

The investment bank earns the average The investment bank earns the average spreadspread between the negotiated price, which it pays, between the negotiated price, which it pays, and the best prices, which it receives.and the best prices, which it receives.

Two Other Methods of Two Other Methods of UnderwritingUnderwriting

All-or-noneAll-or-none The investment bank first determines The investment bank first determines

whether it can make a profit and can back whether it can make a profit and can back out if notout if not

Best effortsBest efforts It negotiates the spread and then sells the It negotiates the spread and then sells the

new issue at the best prices it can findnew issue at the best prices it can find

Another Method: Dutch Another Method: Dutch AuctionAuction

Bids and quantities demanded are solicited.Bids and quantities demanded are solicited. The bids are listed in descending order and The bids are listed in descending order and

the running sum of the quantities bid is the running sum of the quantities bid is calculated.calculated.

The first bid on the list is found at which the The first bid on the list is found at which the running sum exceeds the size of the new running sum exceeds the size of the new issue.issue.

The entire new issue exchanges at that price.The entire new issue exchanges at that price. Google used this method.Google used this method.

Illustration of a Dutch Auctionb

id p

rice

bid quantity

p* x

Accepted bids ______

Sum of accepted bids= quantity to be sold

p* = price for all successful bidders

How Investment Banks How Investment Banks ProfitProfit

Investment banks earn their livelihoods byInvestment banks earn their livelihoods by Being well informed about the security marketsBeing well informed about the security markets Having excellent long-term relationships with both Having excellent long-term relationships with both

sides of the marketsides of the market The relationships largely eliminate moral The relationships largely eliminate moral

hazardhazard The investment banks were:The investment banks were:

Very profitable in the 1980s — hostile takeovers etc.Very profitable in the 1980s — hostile takeovers etc. Unprofitable in the early 1990sUnprofitable in the early 1990s Very profitable in late 1990s — deleveragingVery profitable in late 1990s — deleveraging Very profitable through 2006 — housing financeVery profitable through 2006 — housing finance Extremely unprofitable since then — financial crisisExtremely unprofitable since then — financial crisis

BrokersBrokers The buyer’s broker contacts the seller’s The buyer’s broker contacts the seller’s

broker; or vice versabroker; or vice versa If the two brokers agree on a price, they If the two brokers agree on a price, they

carry out the transaction at that price.carry out the transaction at that price. Most such transactions are arranged Most such transactions are arranged

electronical-ly, but the telephone still electronical-ly, but the telephone still plays a small roleplays a small role

Brokers do not hold inventories of Brokers do not hold inventories of securities; they are merely go-betweenssecurities; they are merely go-betweens

They earn their livelihoods from the They earn their livelihoods from the commissionscommissions they charge their they charge their customerscustomers

DealersDealers

Dealers are Dealers are specialistsspecialists, who hold , who hold inventories of specific securities and inventories of specific securities and stand ready to sell them at an stand ready to sell them at an askedasked price and to buy them at a price and to buy them at a bidbid price price

They make their livelihoods from the They make their livelihoods from the bid-bid-asked spreadasked spread; i.e., they buy lower and ; i.e., they buy lower and sell highersell higher

Both prices are highly sensitive to market Both prices are highly sensitive to market news and supply/demand conditionsnews and supply/demand conditions

Venues for Trading of Venues for Trading of SecuritiesSecurities

ExchangesExchanges

Over-the-counter (OTC) marketsOver-the-counter (OTC) markets

ExchangesExchanges Specialists make markets in the Specialists make markets in the

securities traded on the exchangesecurities traded on the exchange

They primarily match bid and asked They primarily match bid and asked prices and quantities submitted by prices and quantities submitted by brokersbrokers

They also sell into and out of their They also sell into and out of their inventories, adding liquidity to the inventories, adding liquidity to the market as well as making profits for market as well as making profits for themselvesthemselves

Over-the-Counter Over-the-Counter MarketsMarkets

Brokers and dealers find each other Brokers and dealers find each other by telephone and electronically; e.g., by telephone and electronically; e.g., NASDAQ (NASDAQ (NNational ational AAssociation of ssociation of SSecurities ecurities DDealers ealers AAutomated utomated QQuotation)uotation)

ExamplesExamples Treasury securities — very thick Treasury securities — very thick

markets, highly liquid, razor-thin bid-markets, highly liquid, razor-thin bid-asked spreads; OTCasked spreads; OTC

Equities of large and many middle-sized Equities of large and many middle-sized companies — very thick markets, very companies — very thick markets, very liquid, small bid-asked spreads; almost liquid, small bid-asked spreads; almost entirely on exchangesentirely on exchanges

Equities in some mid-sized and most Equities in some mid-sized and most small companies — less thick markets, small companies — less thick markets, less liquid, larger bid-asked spreads; less liquid, larger bid-asked spreads; OTCOTC

Most corporate bonds — thin markets, Most corporate bonds — thin markets, illiquid, large bid-asked spreads; OTCilliquid, large bid-asked spreads; OTC

Investment InstitutionsInvestment Institutions

They borrow funds, which they They borrow funds, which they relend to othersrelend to others

The most important examples are:The most important examples are:

Mutual fundsMutual funds

Finance companiesFinance companies

Mutual FundsMutual Funds They borrow from large numbers of They borrow from large numbers of

savers, mostly households, and savers, mostly households, and acquire portfolios of securitiesacquire portfolios of securities

Ideally, they enable households to hold Ideally, they enable households to hold highly diversified portfolios indirectlyhighly diversified portfolios indirectly

There are three common types of There are three common types of mutual fundsmutual funds Open-endOpen-end Closed-endClosed-end Hedge fundsHedge funds

Equity, Not DebtEquity, Not Debt

Mutual funds issue shares that give their Mutual funds issue shares that give their owners a property right to a share of:owners a property right to a share of: The portfolio held by the mutual fundThe portfolio held by the mutual fund The income that the portfolio generatesThe income that the portfolio generates

Example. You own X% of Vanguard’s 500 Example. You own X% of Vanguard’s 500 Index Fund. You have a property right to:Index Fund. You have a property right to: X% of the 500 stocks it holds for youX% of the 500 stocks it holds for you X% of any dividends and capital gains that X% of any dividends and capital gains that

the portfolio earns in excess of expensesthe portfolio earns in excess of expenses

Open-End Mutual FundsOpen-End Mutual Funds An open-end MF stands ready to purchase An open-end MF stands ready to purchase

back its shares at the current market value back its shares at the current market value of the underlying assets in the portfolioof the underlying assets in the portfolio

It can do so because it can sell these It can do so because it can sell these securities at that pricesecurities at that price

It also accepts new funds and issues new It also accepts new funds and issues new shares that are claims to the additional shares that are claims to the additional assets that it obtained with the new fundsassets that it obtained with the new funds

Open-end MFs have expanded rapidly Open-end MFs have expanded rapidly since the 1970s because of the computer since the 1970s because of the computer revolutionrevolution

Example: Vanguard 500 Example: Vanguard 500 FundFund

AssetsAssets Net WorthNet Worth

$100 B of 500 stocks$100 B of 500 stocks $100 B of shares$100 B of shares

$10,000 in 500 $10,000 in 500 stocksstocks

$10,000 in shares$10,000 in shares

Closed-End Mutual Closed-End Mutual FundsFunds

A closed-end MF raises a certain amount of A closed-end MF raises a certain amount of funds funds onceonce and buys certain assets and buys certain assets onceonce

Thereafter, its shares trade in OTC marketsThereafter, its shares trade in OTC markets

The MF does nothing other than hold the The MF does nothing other than hold the assets and send checks to the owners of assets and send checks to the owners of sharesshares

The prices of closed-end MFs fluctuate over The prices of closed-end MFs fluctuate over time, reflecting the value of the underlying time, reflecting the value of the underlying assetsassets

Hedge FundsHedge Funds

They are variants of open-end mutual They are variants of open-end mutual funds.funds.

Some key differences:Some key differences: Very large initial investments; e.g. $1 millionVery large initial investments; e.g. $1 million Virtually unregulatedVirtually unregulated Usually borrow many times their owners’ Usually borrow many times their owners’

investment to acquire highly risky assetsinvestment to acquire highly risky assets Very large management feesVery large management fees Informationally opaqueInformationally opaque Can restrict or halt redemption of sharesCan restrict or halt redemption of shares

Hypothetical Balance Hypothetical Balance SheetSheet

of a Hedge Fundof a Hedge Fund

AssetsAssets Liabilities + Net Liabilities + Net WorthWorth

$1 billion of opaque,$1 billion of opaque,

very risky assetsvery risky assets $750 million of bank $750 million of bank

loansloans

$250 million of $250 million of shares shares

Finance CompaniesFinance Companies

Finance companies raise funds by Finance companies raise funds by selling commercial paper and other selling commercial paper and other securities and making loans with the securities and making loans with the fundsfunds

There are three types depending on There are three types depending on the type of loan:the type of loan: Consumer finance companiesConsumer finance companies Business finance companiesBusiness finance companies Sales finance companiesSales finance companies

How Finance Companies How Finance Companies DifferDiffer

Consumer finance companies make Consumer finance companies make installment loans — cars, furniture, installment loans — cars, furniture, appliances, etc.appliances, etc.

Business finance companies engage in Business finance companies engage in factoring; i.e., they buy accounts factoring; i.e., they buy accounts receivable from businesses at a discount.receivable from businesses at a discount.

Sales finance companies are affiliated with Sales finance companies are affiliated with manufacturers of big-ticket items like cars manufacturers of big-ticket items like cars and finance loans to households for buying and finance loans to households for buying these items. Example: GMAC finances car these items. Example: GMAC finances car loans that GM dealerships sellloans that GM dealerships sell

Contractual Saving: Contractual Saving: InsuranceInsurance Insurance companies are intermediaries Insurance companies are intermediaries

that help households and others to that help households and others to reduce the risk of future misfortunesreduce the risk of future misfortunes

They do so by collecting premia from the They do so by collecting premia from the many who wish to reduce risk and paying many who wish to reduce risk and paying out the funds to the few who suffer bad out the funds to the few who suffer bad outcomesoutcomes

We consider two major types of We consider two major types of insurance:insurance: Life insuranceLife insurance Property and casualty insuranceProperty and casualty insurance

Insurance ReservesInsurance Reserves In 2003, insurance reserves were about In 2003, insurance reserves were about

$4.3 trillion, consisting mostly of stocks, $4.3 trillion, consisting mostly of stocks, bonds, mortgages and direct loans.bonds, mortgages and direct loans.

Positive reserves result because bad Positive reserves result because bad outcomes occur on average after premia outcomes occur on average after premia are paid.are paid.

So insurance companies lend the premia So insurance companies lend the premia and earn returns in the interim.and earn returns in the interim.

This enables them to pay out more on This enables them to pay out more on claims and other costs than they receive as claims and other costs than they receive as premiapremia

The assets are typically bought only once The assets are typically bought only once and held to maturity.and held to maturity.

More on InsuranceMore on Insurance Life insurance makes payments to Life insurance makes payments to

spouses, children and others if the spouses, children and others if the insured diesinsured dies

Property and casualty insurance makes Property and casualty insurance makes payments if property is damaged; e.g. payments if property is damaged; e.g. homes, automobiles, factories, etc.homes, automobiles, factories, etc.

Insurance policiesInsurance policies are contracts that are contracts that specify what payments will be made and specify what payments will be made and under what conditions; e.g. what the under what conditions; e.g. what the premia are, when they are due, what the premia are, when they are due, what the claims procedures are, etc.claims procedures are, etc.

Principles ofPrinciples ofInsurance ManagementInsurance Management

Law of Large NumbersLaw of Large Numbers: In large : In large populations average outcomes are virtually populations average outcomes are virtually certain even if individual outcomes are certain even if individual outcomes are highly uncertain.highly uncertain.

Example: The lifetime of any given person is Example: The lifetime of any given person is uncertain. The average lifetime of 100 uncertain. The average lifetime of 100 million persons is virtually certain and can be million persons is virtually certain and can be calculated extremely accurately by an calculated extremely accurately by an insurance insurance actuaryactuary..

Result: Insurance companies can diversify Result: Insurance companies can diversify away almost all risk by insuring enough away almost all risk by insuring enough persons.persons.

Two Problems:Two Problems:Adverse Selection and Adverse Selection and

Moral HazardMoral Hazard Example of adverse selection. Someone Example of adverse selection. Someone

with terminal cancer obtains a life-with terminal cancer obtains a life-insurance policy. Result: The insurance insurance policy. Result: The insurance company pays out more than it takes in.company pays out more than it takes in.

Example of moral hazard. Having Example of moral hazard. Having obtained lifetime auto insurance at a obtained lifetime auto insurance at a fixed annual premia, a driver become a fixed annual premia, a driver become a speed-demon. Result: More accidents speed-demon. Result: More accidents take place than without insurance. take place than without insurance.

Combating Adverse Combating Adverse SelectionSelection

Insurance companies carefully screen Insurance companies carefully screen policyholders in many ways; e.g.policyholders in many ways; e.g. Sell insurance to groups on more favorable Sell insurance to groups on more favorable

terms than to individualsterms than to individuals Require medical exams and medical records Require medical exams and medical records

from applicants for life insurancefrom applicants for life insurance Examine past driving records for auto Examine past driving records for auto

insuranceinsurance Use all observable data to set premia; e.g. Use all observable data to set premia; e.g.

higher premia for young male drivers with higher premia for young male drivers with traffic tickets than for old female drivers traffic tickets than for old female drivers withoutwithout

Combating Moral HazardCombating Moral Hazard DeductiblesDeductibles require the insured to pay a require the insured to pay a

fixed amount per claim before the insurance fixed amount per claim before the insurance company is liable. The idea: If the insured company is liable. The idea: If the insured have some of their own wealth at stake, have some of their own wealth at stake, they’ll take more carethey’ll take more care

CoinsuranceCoinsurance requires insured to pay a requires insured to pay a fraction of the claim beyond the deductible; fraction of the claim beyond the deductible; e.g. 10 or 20%. Some wealth of the insured is e.g. 10 or 20%. Some wealth of the insured is at stake.at stake.

Restrictive covenantsRestrictive covenants specify behavior that specify behavior that would lead to claims being denied.would lead to claims being denied.

Experience ratingExperience rating raises premia if claims raises premia if claims occuroccur

Insurance investigatorsInsurance investigators look for fraud. look for fraud.

Life InsuranceLife Insurance

Reserves were $3.3 trillion in 2003.Reserves were $3.3 trillion in 2003.

Two broad typesTwo broad types

Whole lifeWhole life

Term lifeTerm life

1. Whole Life Insurance1. Whole Life Insurance The premia on whole life insurance are The premia on whole life insurance are

constant across the lifecycleconstant across the lifecycle Expected claims cost rises over the lifecycleExpected claims cost rises over the lifecycle Insurance reserves build up initially and Insurance reserves build up initially and

then decline to zerothen decline to zero

age

premia

expclaims +othercosts

reserves

max life

2. Whole Life Insurance2. Whole Life Insurance The premium is set so that its expected The premium is set so that its expected

present value over the insured’s lifetime present value over the insured’s lifetime equals the expected present value of equals the expected present value of claims plus the cost of running the claims plus the cost of running the insurance company per insured.insurance company per insured.

Whole life combines insurance with what Whole life combines insurance with what is effectively a savings account.is effectively a savings account.

Whole life may permit the insured to Whole life may permit the insured to borrow against reserves.borrow against reserves.

Whole life was once very important but is Whole life was once very important but is now near extinction since its “saving now near extinction since its “saving account” paid, and continues to pay, a account” paid, and continues to pay, a poor return.poor return.

Term LifeTerm Life At each date, the premium is set to cover At each date, the premium is set to cover

the expected claim of the person covered the expected claim of the person covered plus the cost of running the insurance plus the cost of running the insurance company per insured. Therefore, no company per insured. Therefore, no reserves are built up.reserves are built up.

age

premia

expectedclaims

Cost of runningIns. company

AnnuitiesAnnuities Life insurance companies now sell many Life insurance companies now sell many

annuities.annuities. A person retiring pays the insurance A person retiring pays the insurance

company a fixed sum and then receives fixed company a fixed sum and then receives fixed monthly payments over, say, her remaining monthly payments over, say, her remaining lifetimelifetime

The initial required payment equals the The initial required payment equals the present value of expected monthly payments present value of expected monthly payments + the costs of running the insurance + the costs of running the insurance company per annuitantcompany per annuitant

Because the initial payment is paid earlier Because the initial payment is paid earlier than the monthly payments, reserves are than the monthly payments, reserves are accumulatedaccumulated

Property and Casualty Property and Casualty InsuranceInsurance

On average, the time between receipt of On average, the time between receipt of premia and payment of claims is shorter premia and payment of claims is shorter than for life insurance companies.than for life insurance companies.

Result: P&C companies tend to hold Result: P&C companies tend to hold intermediate-term bonds as well as stock.intermediate-term bonds as well as stock.

Their tax treatment is also different, Their tax treatment is also different, leading them to hold tax-exempt leading them to hold tax-exempt municipal bonds rather than corporate municipal bonds rather than corporate bonds.bonds.

More on P&C InsuranceMore on P&C Insurance

P&C companies also hold more liquid P&C companies also hold more liquid assets as the timing of claims is less assets as the timing of claims is less predictable.predictable.

Reinsurance is also important.Reinsurance is also important.

For example, insurance policies written on For example, insurance policies written on Miami property by a local company are Miami property by a local company are sold to other companies by an sold to other companies by an intermediary called a reinsurance intermediary called a reinsurance company.company.

Contractual Saving: Contractual Saving: Pension FundsPension Funds

Pension reserves were about $5.5 trillion Pension reserves were about $5.5 trillion in 2003in 2003

Two types of pension funds:Two types of pension funds: Defined-contribution plansDefined-contribution plans Defined-benefit plansDefined-benefit plans

They differ in:They differ in: Who owns themWho owns them The nature of the contributions to themThe nature of the contributions to them The nature of the pensions they payThe nature of the pensions they pay

Defined-Contribution Defined-Contribution PlansPlans They are owned by the person who will They are owned by the person who will

receive the pension.receive the pension. The owner contributes a fixed amount The owner contributes a fixed amount

to the fund over time, often also to the fund over time, often also matched by an employermatched by an employer

The size of the pension depends on The size of the pension depends on how much the accumulated assets are how much the accumulated assets are worth at retirementworth at retirement

For example, a fund invested in stock For example, a fund invested in stock is worth whatever the stock is worth; is worth whatever the stock is worth; it is like a mutual fund in this regard.it is like a mutual fund in this regard.

1. Defined-Benefit Plans1. Defined-Benefit Plans They are owned by a company, union, state They are owned by a company, union, state

government, etc. (Termed “employer” government, etc. (Termed “employer” below)below)

The employer owns all previously The employer owns all previously accumulated assets and owes the present accumulated assets and owes the present value of all promised benefitsvalue of all promised benefits

Contributions are provided each period by Contributions are provided each period by employees and the employer as stipulated employees and the employer as stipulated contractuallycontractually

The net worth (NW) of the pension fund, if The net worth (NW) of the pension fund, if positive, can be used as the employer positive, can be used as the employer pleasespleases

2. Defined-Benefit Plans2. Defined-Benefit Plans

The pension fund is The pension fund is overfundedoverfunded if if NW > 0 and NW > 0 and underfundedunderfunded if NW < 0. if NW < 0.

The pensions paid are fixed amounts The pensions paid are fixed amounts as contractually promisedas contractually promised

In recent years, defined-contribution In recent years, defined-contribution plans have proliferated while defined-plans have proliferated while defined-benefit plans have diminished rapidlybenefit plans have diminished rapidly

401(k) plans have been the leading 401(k) plans have been the leading edge of this change.edge of this change.

Federal Regulation of DB Federal Regulation of DB PlansPlans

After some large defined-benefit pension After some large defined-benefit pension funds failed in the 1960s, Congress funds failed in the 1960s, Congress enacted the enacted the Employee Retirement Employee Retirement Security ActSecurity Act (ERISA) in 1974 (ERISA) in 1974

ERISA requires employers with ERISA requires employers with underfunded pension funds to make underfunded pension funds to make contributions large enough to push NW to contributions large enough to push NW to zero over some periodzero over some period

It also established the Pension Benefit It also established the Pension Benefit Guarantee Corporation (PBGC—Penny Guarantee Corporation (PBGC—Penny Benny) to insure defined-benefit pensionsBenny) to insure defined-benefit pensions

Depository InstitutionsDepository Institutions Bank-like financial intermediaries that Bank-like financial intermediaries that

borrow from large numbers of depositors borrow from large numbers of depositors and lend to large numbers of borrowers.and lend to large numbers of borrowers.

Functions:Functions: Provide access to the payments systemProvide access to the payments system Reduce transaction and information costs, Reduce transaction and information costs,

which cause adverse selection and moral which cause adverse selection and moral hazardhazard

Three main categories:Three main categories: Commercial banksCommercial banks Saving institutionsSaving institutions Credit unionsCredit unions

Commercial BanksCommercial Banks

They specialize in providing loans to They specialize in providing loans to businesses, especially small and mid-sized businesses, especially small and mid-sized ones.ones.

They have expertise in evaluating risk and They have expertise in evaluating risk and monitoring borrowers.monitoring borrowers.

Large businesses now mostly use Large businesses now mostly use commercial paper rather than bank loans.commercial paper rather than bank loans.

Saving InstitutionsSaving Institutions

This category comprises savings and loan This category comprises savings and loan associations and mutual savings banks.associations and mutual savings banks.

They specialize in providing mortgages They specialize in providing mortgages mostly to households and small mostly to households and small businesses.businesses.

They have the most expertise of all They have the most expertise of all lenders in this niche. lenders in this niche.

Credit UnionsCredit Unions

They mostly engage in consumer They mostly engage in consumer lending.lending.

They receive favorable treatment They receive favorable treatment under the tax law and might not exist under the tax law and might not exist otherwise.otherwise.

1. Gov’t Financial 1. Gov’t Financial InstitutionsInstitutions The US federal government The US federal government

participates both directly and participates both directly and indirectly in the financial markets.indirectly in the financial markets.

Special credit agencies borrow directly Special credit agencies borrow directly in the financial markets and relend the in the financial markets and relend the funds to favored borrowers.funds to favored borrowers.

Agriculture:Agriculture: Regional Banks for CooperativesRegional Banks for Cooperatives Federal Land BanksFederal Land Banks Federal Intermediate Credit BanksFederal Intermediate Credit Banks Farm Credit SystemFarm Credit System Farmers Home Administration (FmHA)Farmers Home Administration (FmHA)

2. Gov’t Financial 2. Gov’t Financial InstitutionsInstitutions

Housing:Housing: Federal National Mortgage Association Federal National Mortgage Association

(FNMA — Fannie Mae)(FNMA — Fannie Mae) Federal Home Loan Mortgage Corporation Federal Home Loan Mortgage Corporation

(FHLMC — Freddie Mac)(FHLMC — Freddie Mac) Government National Mortgage Government National Mortgage

Corporation (GNMA — Ginnie Mae)Corporation (GNMA — Ginnie Mae)

Higher Education: Student Loan Higher Education: Student Loan Marketing Association (SLMA — Sallie Marketing Association (SLMA — Sallie Mae)Mae)

Blurring LinesBlurring Lines For some time, financial institutions For some time, financial institutions

have been moving toward “one-stop have been moving toward “one-stop shopping” for financial services.shopping” for financial services.

Initially, financial institutions had to Initially, financial institutions had to circumvent regulations to do so.circumvent regulations to do so.

The The Gramm-Leach-Bliley Financial Gramm-Leach-Bliley Financial Services Act of 1999Services Act of 1999 eliminated many eliminated many of the regulations.of the regulations.

So we should expect this move to So we should expect this move to accelerate in the future, especially given accelerate in the future, especially given the fallout from the financial crisis.the fallout from the financial crisis.

Fragmentation of Fragmentation of FinanceFinance

At the same time, the computer At the same time, the computer revolution has permitted functions that revolution has permitted functions that had to be carried out together to be had to be carried out together to be separated and spun off.separated and spun off.

Many small, highly specialized financial Many small, highly specialized financial firms now exist that could never have firms now exist that could never have existed in 1970.existed in 1970.

This trend will no doubt also accelerate in This trend will no doubt also accelerate in the future.the future.