How does fed interest rate affect investment bankers ?

Question

how does fed interest rate affect investment bankers (Goldman Sachs, Merril Lynch, Morgan Stanley, etc.)?

are they going to get hurt because of the decrease in liquidity? I

Answer 1

Lower interest rate = Greater supply of money.

Higher interest rate = lesser supply of money.

Why?

The cheaper it is to borrow money, the more people will borrow it. The more you (or organizations) borrow money, the more supply you have of money.

What does this cause?

Food, oil and other commodities are finite in number. When you increase the availability of cash, you have more money competing for fewer resources. This is basically why reducing the interest rate can result in inflation.

How does the interest rate affect investment banks?

Well for one when the interest rate is reduced, the expenses of most companies are also reduced. The reduction in expenses (interest on liabilities) results in more profitability. Increased profitability results in an increase in stock price. This is one of the reasons the stock market likes interest cuts.

Is this really good?

Devaluing our currency to increase the price of stocks? What does it do? If stocks increase in value by 5% and our currency decreases in value by 5% we are back at square one. Actually, we are worse off because a lot of our assets (house, car, etc) are not in stocks.

How are investment banks affected?

They have cheaper access to money. Bear Sterns collapsed because its short term liabilities were significantly greater than its short term assets. A lot of investment banks have significant short term liabilities and their collateral assets are worth drastically less (who wants to buy a sub-prime loan?). Reduced interest rates and the new fed move to allow investment banks to borrow directly from the discount window allow the investment banks to remain liquid and reduce the likelihood of bankruptcy.

I mean Bear Sterns was worth a lot more than it sold for. The problem is when your debtors come calling you need money now and a 1 billion dollar building is not going to help you much unless you can sell it immediately. The fed hopes that increased liquidity will result in investment banks doing okay without another bail out.

Answer 2

First you have to understand what an investment banker is. An investment banker is the middleman between the investor and investment. A pure investment banker would not make any investment themselves. Usually they get paid per hour or a % of the total value of the transaction.

When there is a decrease in liquidity, fewer deals happen and they have less work to do.

Sometimes the investment banker develops a "product" where they buy assets with money they borrow themselves (typical example: they borrow money to buy portfolios of outstanding mortgages). Under normal situations this would mean that the cashflow obtained from the assets is sufficient to pay all obligations from the outstanding loans, however if for some reason this is no longer true the bank might be held liable and has to come with the money themselves (this is called a "margin call") and then a lack of liquidity might bring even the most profitable bank into problems.

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Every business has (1) to make a profit and (2) need the cashflow to pay your debts. You need both. Even a profitable business wihtout sufficient cashflow will go south very quickly. The bank businessmodel is based ont he premisse that they would FIND cashflow if and when needed. If for some reason casfhlow cannot be found (because no1 is willing to give them cash) the bank will not be able to pay her own obligations and has to file for bankruptcy. To prevent this the central bank/Federal Reserve will always increase the liquidity (by lowering the fed interest rates).