1. Chapter 13
Nonbank Finance

2. Insurance Life insurance Property and Casualty
Permanent (whole, universal, and variable)
Term
Property and Casualty
Hold more liquid assets than life insurance companies
Reinsurance

3. Insurance (cont’d) Competitive threat from the banking industry
Credit insurance
Credit default swaps
AIG case.
Monoline insurance

4. Table 1 Relative Shares of Total Financial Intermediary Assets, 1970–2010 (percent)

5. Application: Insurance Management
To lower moral hazard and adverse selection
Screening
Risk-based premiums
Restrictive provisions
Prevention of fraud
Cancellation of insurance
Deductibles
Coinsurance
Limits on the amounts of insurance

6. Pension Funds Defined-contribution plan Defined-benefit plan
Fully-funded; underfunded
Private pension plans
Employee Retirement Income Security Act (ERISA) of 1974
Pension Benefit Guarantee Corporation (PBGC, Penny Benny)

7. Pension Funds (cont’d)
Public pension plans
Social Security
Pay as you go system.
Massive underfunding.
Possible reforms proposed.

8. Finance Companies
Virtually unregulated compared to commercial banks and thrifts institutions
Sales finance companies
Consumer finance companies
Business finance companies
Factoring
Leasing equipment

9. Securities Market Operations
Financial facilitators
Investment banks
Securities brokers and dealers
Organized exchanges

10. Investment Banking Assist in the sale of securities
Advise the corporation on whether it should issue bonds or stock.
Bonds: advise on maturity and interest payments
Stocks: advice on price
Seasoned issues or initial public offering
Underwrites

11. Investment Banking (cont’d)
Regulated by SEC
Registration statement
Provide potential investors with a prospectus
20 day waiting period

12. Securities Brokers and Dealers
Securities brokers and dealers conduct trading in secondary markets
Brokers
Agents for investors, match buyers and sellers
Paid brokerage commission
Dealers
Stand ready to buy and sell
Hold inventories
Paid by the ‘spread’
Brokerage firms
Act as brokers, dealers, and investment bank
Regulated by SEC

13. Organized Exchanges NYSE: largest organized exchange in the world.
Hybrid of auction market and dealer market.
Specialist
Regulated by SEC
Authority to impose regulation and to alter the rules set by the exchanges
Securities Amendments Act of 1975
Growing internationalization

14. Mutual Funds
Pool the resources of many small investors by selling shares and using the proceeds to buy securities
Sovereign wealth funds
Estimated to hold $3 trillion in assets
Concerns
Size (can cause market instability)
National security issues
Provide very little information about their operations
Open-end fund and closed-end fund

15. Mutual Funds (cont’d) Load funds and no-load funds
Regulated by Securities and Exchange Commission
Money market mutual funds
Function as checkable deposits that earn interest.

16. Hedge Funds Similar to mutual funds but:
Minimum investment typically $1 million
No more than 99 investors
Net worth requirement for investors
Long-term commitment
Speculates on spreads

17. Private Equity and Venture Capital Funds
Private equity fund
Long-term investments in companies that are not traded in public markets.
Two types
Venture capital funds
Capital buyout funds (leveraged buyout)
Carried interest

18. Government Financial Intermediation
Mortgage market
GNMA, Ginnie Mae
FNMA, Fannie Mae (GSE)
FHLMC, Freddie Mac (GSE)
Farm Credit System
Federal Credit Reform Act of 1990
The creation of GSEs has led to conflict of interest and moral hazard problems.