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Tri Vi Dang Columbia University
td2332@columbia.edu Spring 2022
Money and Banking (ECON UN3265)
Meeting time: Tu, Th 2.40 - 3. Meeting place: Mathematics 207
Office address: IAB 1002 Office hours: Th 11.30 - 12.45 and other times by appointment
Course Objective
The modern banking and financial system is highly interconnected and characterized by many different types of players and institutions as well as a high pace of innovations. This course provides a comprehensive view on the evolution of banking, from the eighteen century to the most recent financial innovations in wholesale banking and interbank funding markets and discusses two main themes.
The first central theme will be that the fundamental principle of money and banking is the same despite all financial innovations and the evolution of institutions and markets in the last two hundred or so years. The second and reoccurring theme is about the causes of a financial crisis. An opinion often articulated in popular and policy discussions is that the financial crisis in 2007/08 and previous financial crises were caused by the misbehavior of bankers.
This course employs different methodologies to approach these two main themes. In order to understand the working of the banking system and its benefits and costs for society a historical perspective and conceptual frameworks are needed. History and economic theory will highlight the (few) fundamental principles of money and banking and can provide a broader context to discuss the question whether a financial crisis is caused by financial greed and excessive risk
taking and whether bankers are more entrenched and self-centered than corporate managers, tax advisors, lawyers, politicians or other professionals. A better understanding of these two main themes will have significant implications for the management and internal governance of banks, the use of technology and big data in financial services, policy design, banking and financial regulations as well as interventions during a financial crisis.
The course is divided into two broad sections. Section I discusses money and banking since the 18th century. Section II focuses on policy responses and banks’ reactions to regulations since the financial crisis in 2007/08 as well the most recent trends and the impact of technology and big data on banking and finance. In particular, the following topics are covered.
I.1. Evolution of the Banking System I.2. Bank Holding Companies I.3. New Forms of Money and Banking I.4. The Financial Crisis in 2007/
II.1. Central Bank Policies and Interventions II.2. New Regulation and Unintended Liquidity Consequences II.3. Market Making and Risk Management of Banks II.4. Most Recent Trends
Methodologies
The course employs four different methodologies to understand the fundamental as well as specific issues of money and banking. These approaches will provide different but complementary perspectives on the same subject matter.
Institutional Analysis
The institutional analysis focuses on the structural aspects of institutions, markets and products. We will analyze the banking structure during the Free Banking Era and the National Banking Era as well as the modern commercial, investment and wholesale banking industries. We discuss new forms of money and banking and have a detailed description of the players and products in the money market fund (MMF) industry, the syndicated loan markets, the securitization markets for mortgage-backed securities (MBS), asset-backed securities (ABS), asset-backed commercial papers (ABCP), collateralized debt obligations (CDO) and collateralized loans obligations (CLO) as well as the sales and repurchase agreement (repo) markets. These are multi trillion dollar markets each and they constitute fundamental parts of the modern financial system. In
Case Studies
We will discuss a number of specific cases to highlight institutional details. (1) The JPMorgan and Goldman Sachs business model case illustrates the structure and complexity of modern bank holding companies. (2) The Goldman Sachs Abacus case illustrates the complex structure of a synthetic CDO which combines techniques used in securitization and credit default swaps markets and highlights conflicts of interests between issuers and investors. (3) The Lehman Brothers Bankruptcy case illustrates the management of the balance sheet, the use of repo 105, and global contagion. (4) The JPMorgan London Whale case illustrates risk models, risk management practices and hedging versus proprietary trading. (5) The Basel III case illustrates how banks respond to regulation and minimize the impact of the liquidity coverage ratio by developing new financial products such as callable commercial papers. (6) The Volker Rule case illustrates how CLO issuers respond to the risk retention rule in securitization by creating new vehicles such as a Majority Owned Affiliate (MOA) or capitalized MOA and shows how new regulation leads to new financial innovations. (7) The Sears, Roebuck case illustrates the discussion of fintech in 1970s. (8) The JPMorgan digital strategy case illustrates the importance of mobile payment as a gateway to technology driven banking. (9) The Alibaba Ant Financial case illustrates the state of the art usage of big data and machine learning technology in banking and finance and why Chinese fintechs are innovation leaders in this field. (10) The Stablecoins case highlights that crypto money and bank notes in the Free Banking Era are basically the same and potential issues of this new innovation.
Course Requirements
The main course requirements are homework assignments (four exercise sets), a midterm exam and a final exam. Grades will be allocated based on the following weights:
Exercise sets: 15% Midterm exam: 40% Final exam: 45%.
Students are allowed to work together on exercise sets. However, students must submit their homework individually. In case of collaboration, the names of students working together should be stated on the first page of the solution sheet.
Working on the homework assignments is an important part of this course. Students are expected to spend a considerable amount of time working through lecture notes and exercise sets.
It is important to be regular in preparations for this course. Important concepts will be developed through both lectures and exercise assignments.
Some of the background material and institutional details are not covered in the lectures but can be found in the recommended readings.
Please ask questions during the lectures. Critical comments are highly appreciated.
Also, students can talk to me if they need career advice and want to hear my opinion.
Readings
Lecture notes (Slides)
For each session students will obtain comprehensive lecture notes that can be downloaded from Courseworks typically before class.
Textbooks (recommended but not required)
Gorton, G. (2010): Slapped by the Invisible Hand: The Panic of 2007; Oxford University Press.
Gorton, G. (2012): Misunderstanding Financial Crises; Oxford University Press.
Gorton, G. (2015): The Maze of Banking: History, Theory, Crisis; Oxford University Press.
Optional readings
The following extensive list of papers can be downloaded from JStor or ScienceDirect and the most relevant papers will be provided online.
Akerlof, G. (1970): The Market for Lemons: Qualitative Uncertainty and the Market Mechanism, Quarterly Journal of Economics 84, 488-500.
Anderson, H and A. Copeland (2019): Information Management in Times of Crisis, working paper.
Anderson, R. and C. Gascon (2009): The Commercial Paper Market, the Fed, and the 2007- Financial Crisis, Federal Reserve Bank of St. Louis Review 91, 589-612.
Ares (2018): Market Insights: Investing in CLOs.
Bond Market Association (2004a): CDO Primer.
Bond Market Association (2004b): Corporate Bond Operational Underwriting Process, Research Quarterly.
Boyarchenko, N., A. Kovner and O. Shachar (2020): It's What You Say and What You Buy: A Holistic Evaluation of the Corporate Credit Facilities, working paper
Brancati, E. and M. Macchiavelli (2019): The Information-Sensitivity of Debt in Good Times and Bad Times, Journal of Financial Economics 133, 99-112.
Cashin, D., E. E. Syron-Ferris, and E. Klee (2020): Treasury safety, liquidity, and money premium dynamics: Evidence from recent debt limit impasses, working paper.
Cetorelli, N. and S. Peristiani (2012): The Role of Banks in Asset Securitization, FRBNY Economic Policy Review July, 47-63.
Cifrino, D., M. Mandel and C. Reicin (2014): The IPO and Public Company Primer.
Cipriani, M. and G. La Spada (2019): Investors’ Appetite for Money-Like Assets: The Money Market Fund Industry after the 2014 Regulatory Reform, Journal of Financial Economics, forthcoming.
Comptroller of the Currency Administrator of National Banks (1997): Asset Securitization, Comptroller’s Handbook.
Copeland, A., A. Martin and M. Walker (2014): Repo Runs: Evidence from the Tri-Party Repo Market, Journal of Finance 69, 2343-2380.
Covitz, D., N. Liang and G. Suarez (2013): The Evolution of a Financial Crisis: Panic in the Asset-Backed Commercial Paper Market, Journal of Finance 68, 815- 848.
Cumming, C. (1987): The Economics of Securitization. FRBNY Quarterly Review Autumn, 11-
D’Amico, S., V. Kurakula, and S. Lee (2020): Impacts of the Fed Corporate Credit Facilities through the Lenses of ETFs and CDX, working paper.
Dang, T.V. (2008): Bargaining with Endogenous Information, Journal of Economic Theory 140, 339-354.
Dang, T.V. (2013): Information Acquisition, Noise Trading and Speculation in Double Auction Markets, working paper.
Dang, T.V. and M. Felgenhauer (2012): Information Provision in Over-the-Counter Markets, Journal of Financial Intermediation 21, 79-96.
Dang, T.V., G. Gorton and B. Holmstrom (2013): Haircuts and Repo Chains, working paper.
Dang, T.V., G. Gorton and B. Holmstrom (2015a): Ignorance, Debt and Financial Crises, working paper.
Dang, T.V., G. Gorton and B. Holmstrom (2015b): The Information Sensitivity of a Security, working paper.
Dang, T.V., G. Gorton and B. Holmstrom (2020): The Information View of Financial Crises, Annual Review of Financial Economics 12, 39-65.
Dang, T.V., G. Gorton, B. Holmstrom and G. Ordonez (2017): Banks as Secret Keepers, American Economic Review 107, 1005-1029.
Dang, T.V., W. Li, and Y. Wang (2022): The Empirical Information Sensitivity of Treasury Bonds and Stocks, working paper.
Dang, T.V., L. Liu, H. Wang and A. Yao (2019): Shadow Banking Modes: The Chinese versus US System, working paper.
Dang, T.V., X. Liu and F. Morath (2021): Taxation, Information Acquisition and Trade in Decentralized Markets: Theory and Test, working paper.
Dang, T.V., J. Mo, and Y. Li (2020): Bad Apples and Loan Pricing in Affected Industries: Evidence from a Corporate Fundraising Scandal, working paper.
Dang, T.V., H. Wang and A. Yao (2014): Chinese Shadow Banking: Bank-Centric Misperceptions, HKIMR working paper No. 22/2014.
Diamond, D. (1984): Financial Intermediation and Delegated Monitoring, Review of Economic Studies 51, 393-414.
Diamond, D. (1997): Liquidity, Banks, and Markets, Journal of Political Economy 105, 928-956.
Diamond, D. (2007): Banks and Liquidity Creation: A Simple Exposition of the Diamond- Dybvig Model, Federal Reserve Bank of Richmond Economic Quarterly, 93, 189-200.
Diamond, D. and P. Dybvig (1983): Bank Runs, Deposit Insurance, and Liquidity, Journal of Political Economy, 91, 401-419.
Gorton, G. and A. Metrick (2013): Securitization, chapter 1 in the Handbook of the Economics of Finance, volume 2, Part A, edited by G. Constantinides, M. Harris, and R. Stulz, 1-70.
Gorton, G. and A. Metrick (2014): The Federal Reserve and Financial Regulation: The First Hundred Years, Journal of Economic Perspectives.
Gorton, G. and J. Zhang (2021): Taming Wildcat Stablecoins, working paper.
Hammerling S.N. (2019): Information, insurance, and interaction: the municipal bond market after the monolines, working paper.
Holmstrom, B. (2014): Understanding the Role of Debt in the Financial System, BIS working paper 479.
Iannota, G. (2006): Testing for Opaqueness in the European Banking Industry: Evidence from Bond Credit Ratings, Journal of Financial Services Research 30, 287-309.
International Monetary Fund (2017): Fintech and Financial Services: Initial Considerations, Staff Discussion Notes, No. 17/05.
Iorgova, S. and C. P. Ross (2021): Investor Information and Bank Instability during the European Debt Crisis, IMF working paper.
Järvenpää, M. and A. Paavola (2021): Investor monitoring, money-likeness and stability of money market funds, Bank of Finland Research Discussion Papers.
Johnston R, S. Markov, and S. Ramnath (2009): Sell-side analysts, Journal of Accounting and Economics, 47, 91-107.
Jones K. and T. Critchfield (2005): Consolidation in the U.S. Banking Industry: Is the “Long, Strange Trip” About to End?, FDIC Banking Review 17, 31-61.
Julliard, C., Z. Liu, S. E. Seyedan, K. Todorov and K. Yuan (2021): What Drives Repo Haircuts? Evidence from the UK Market, working paper.
Kacperczyk, M. and P. Schnabl (2010): When safe proved risky: commercial paper during the financial crisis of 2007-2009. Journal of Economic Perspectives 24, 29-50.
Kacperczyk, M. T., C. Pérignon and G. Vuillemey (2020). The Private Production of Safe Assets, Journal of Finance 76, 495-535.
Kashyap, A., R. Raghuram and J. Stein (2002): Banks as Liquidity Providers: An Explanation for the Coexistence of Lending and Deposit Taking, Journal of Finance 57, 33-73.
Li, L., Y. Li, M. Machiavelli, and X. Zhou (2020): Runs and interventions in the time of COVID-19: Evidence from money funds, working paper.
McNamara, C., R. Bennett and A. Metrick (2014): Basel III F: Callable Commercial Paper, Yale Program on Financial Stability Case Study 2014-1F-V1.
McNamara, C., M. Wedow and A. Metrick (2014): Basel III B: Basel III Overview, Yale Program on Financial Stability Case Study 2014-1B-V1.
Moody’s Investors Service (1993): Asset-Backed Commercial Paper: Understanding the Risks, Special Report.
Moody’s Investors Service (2003): The Fundamentals of Asset-Backed Commercial Paper, Structure Finance Special Report.
Morgan, D. (2002): Rating Banks: Risk and Uncertainty in an Opaque Industry, American Economic Review 92, 874-888.
Perignon, C., D. Thesmar and G. Vuillemey (2018): Wholesale Funding Dry-Ups, Journal of Finance 73, 575-617.
Price Waterhouse Cooper (2016): Blurred lines: How FinTech is shaping Financial Services, Global FinTech Report.
Report of the President’s Working Group on Financial Markets (2010): Money Market Fund Reform Options.
Rolnick A. J. and W. E. Weber (1984): The Causes of Free Bank Failures, Journal of Monetary Economics 14, 267-291.
Rolnick A. J. and W. E. Weber (1985): Free Banking, Wildcat Banking, and Shinplasters. Federal Reserve Bank of Minneapolis Quarterly Review 6, 10-20.
Schmidt, L, A.Timmerman and R. Wermers (2016): Runs on Money Market Mutual Funds, American Economic Review 106, 2625-2657.
Securities and Exchange Commission (2010): Plaintiff, v. Goldman Sachs & Co. and Fabrice Tourre, Defendants.
Standard & Poor’s (2011): A Guide to the Loan Market.
Thornton, D. (2012): The Federal Reserve’s Response to the Financial Crisis: What It Did and What It Should Have Done, Federal Reserve Bank of St. Louis, working paper.
Tentative Course Outline
Lecture 1
Course Overview Introduction
Lecture 2 (Evolution of the Banking System)
The Relevance of History Historical Overview The Free Banking Era The Wildcat Banking Hypothesis
Rolnick and Weber (1985)
Lecture 3 (Evolution of the Banking System)
Empirical Test of the Wildcat Banking Hypothesis The National Banking Era Banking Panics during the National Banking Era Clearinghouse and Suspension of Convertibility
Rolnick and Weber (1984)
Lecture 4 (Evolution of the Banking System)
A Model of Bank Runs Information Sensitivity: A Measure of Default Risks
Diamond (2007); Diamond and Dybvig (1983); Dang, Gorton and Holmstrom (2015b)
Lecture 5 (Evolution of the Banking System)
Bank Diversification dominates Individual Diversification Banking Panics and Business Cycle The Great Depression Speeches and the Recreation of Confidence
Dang, Gorton and Holmstrom (2015b); Gorton (1988); FDIC (1998)
Lecture 6 (Evolution of the Banking System)
Federal Deposit Insurance Corporation (FDIC) Deposit Insurance, Information Sensitivity and Confidence Glass-Steagall Act and the 3-6-3 Rule in Commercial Banking The Rise of Debt Market Finance in 1980s
FDIC (1998); Walter (2006)
Lecture 7 (Evolution of the Banking System, Bank Holding Companies)
Bank Merger Waves and Industry Consolidation The Structure of Bank Holding Companies Case: Business Model of Goldman Sachs and JPMorgan Chase
Jones and Critchfield (2005); Avraham, Selvaggi and Vickery (2012)
Lecture 8 (Bank Holding Companies)
Investment Banking M&A Business Syndicated Loan Business
Armstrong (2003); Standard & Poor’s (2011)
Lecture 13 (New Forms of Money and Banking)
Agency MBS The Financial Infrastructure of Securitization The Markets for Private Label Securitized Products
Fannie Mae (2012); Cetorelli and Peristiani (2012); Bond Market Association (2004b)
Lecture 14 (New Forms of Money and Banking)
The Market for ABCPs CLO Managers: The Who is Who in Private Equity Empirical Test of the Wildcat CLO Hypothesis
Ares (2018); Fitch (2017); Benmelech, Dlugosz and Ivashina (2012)
Lecture 15 (New Forms of Money and Banking)
Synthetic CDOs Case: Goldman Sachs Abacus Deal Case: SEC versus Goldman (Abacus)
SEC (2010)
Lecture 16 (New Forms of Money and Banking)
Sales and Repurchase Agreement (Repo) A Theory of Repo Trading and Haircut Wholesale Funding Markets
Euroclear (2009); Dang, Gorton and Holmstrom (2013); BNY Mellon and PWC (2015)
Lecture 17 (New Forms of Money and Banking)
Chinese Shadow Banking Corporate Fundraising Scandal and Loan Pricing
Dang, Wang and Yao (2014); Dang, Liu, Wang and Yao (2019); Dang, Mo and Li (2019)
Lecture 18 (The Financial Crises in 2008)
The Housing Market, Subprime Loans and Subprime MBS The ABX.HE Index: Mechanics and Information Revelation A Chronology of Events
Ashcraft and Schuermann (2008)
Lecture 19 (The Financial Crises in 2008)
Run on ABCPs Run on Repos and Prime MMFs Liquidity, Accounting and Collateral Calls Case: Lehman’s Bankruptcy
Covitz, Liang and Suarez (2013); Gorton and Metrick (2012); Schmidt, Timmerman and Wermers (2016); Wiggins, Piontek and Metrick (2014)
Lecture 20 (The Financial Crises in 2008)
Case: Lehman’s Balance Sheet Management and Repo 105 Information Sensitivity and Optimal Security Design A Theory of Debt-on-Debt
Wiggins and Metrick (2014a,b,c); Dang, Gorton and Holmstrom (2015a)
Lecture 24 (New Regulation, Market Making and Risk Management of Banks)
Case: Risk Retention Rule and the Rise of MOA and CMOA Bank Risk Management Value at Risk (VaR) Case: JPM London Whale Case: JPM Risk Limits and Hedging versus Proprietary Trading
Zeissler, Arwin and Metrick (2014a,b,c); Zeissler, Bennett and Metrick (2014)
Lecture 25 (Most Recent Trends)
Information Insensitive Assets and Negative Interest Rate Funding Mix of Banks Alternative Asset Managers as Credit Providers Technology and Finance Case: Sears, Roebuck and Fintech in 1970s Case: JPMorgan Chase Digital Strategy
IMF (2017); BIS (2018)
Lecture 26 (Most Recent Trends)
Chinese Fintech as Innovation Leaders Case: Ant Financial Case: Stablecoins Innovation, Regulation and Information Sensitivity in Banking
Gorton and Zhang (2021)
