- 13 October 2011
- From the section Business
The current financial crisis has thrown terminology from the business pages onto the front pages of newspapers, with jargon now abounding everywhere from the coffee bar to the back of a taxi.
Here is a guide to many of the business terms currently cropping up regularly, as well as some of the more exotic words coined to describe some of the social effects of the financial crisis.
Securities lending When one broker or dealer lends a security (such as a bond or a share) to another for a fee. This is the process that allows short selling.
Securitisation Turning something into a security. For example, taking the debt from a number of mortgages and combining them to make a financial product, which can then be traded (see mortgage backed securities). Investors who buy these securities receive income when the original home-buyers make their mortgage payments.
Security A contract that can be assigned a value and traded. It could be a share, a bond or a mortgage-backed security.
Separately, the term "security" is also used to mean something that is pledged by a borrower when taking out a loan. For example, mortgages in the UK are usually secured on the borrower's home. This means that if the borrower cannot repay, the lender can seize the security - the home - and sell it in order to help repay the outstanding debt.
Shadow banking A global financial system - including investment banks, securitisation, SPVs, CDOs and monoline insurers - that provides a similar borrowing-and-lending function to banks, but is not regulated like banks. Prior to the financial crisis, the shadow banking system had grown to play as big a role as the banks in providing loans. However, much of shadow banking system collapsed during the credit crunch that began in 2007, and in the 2008 financial crisis.
Short selling A technique used by investors who think the price of an asset, such as shares or oil contracts, will fall. They borrow the asset from another investor and then sell it in the relevant market. The aim is to buy back the asset at a lower price and return it to its owner, pocketing the difference. Also known as shorting.
Spread (yield) The difference in the yield of two different bondsof approximately the same maturity, usually in the same currency. The spread is used as a measure of the market's perception of the difference in creditworthiness of two borrowers.
SPV A Special Purpose Vehicle (also Special Purpose Entity or Company) is a company created by a bank or investment bank solely for the purpose of owning a particular set of loans or other investments, and distributing the risk to investors. Before the financial crisis, SPVs were regularly used by banks to offload loans that they owned, freeing the banks up to lend more. SPVs were a major part of the shadow banking system, and were used in securitisation and CDOs.
Stability pact A set of rules demanded by Germany at the creation of the euro in the 1990s that were intended among other things to limit the borrowing of governments inside the euro to 3% of their GDP, with fines to be imposed on miscreants. The original stability pact was abandoned after Germany itself broke the rules with impunity in 2002-05. More recently, the German government has called for an even stricter system of rules and fines to be introduced in response to the eurozone debt crisis.
Stagflation The dreaded combination of inflation and stagnation - an economy that is not growing while prices continue to rise. Most major western economies experienced stagflation during the 1970s.
Sticky prices A phenomenon observed by Depression-era economist John Maynard Keynes. Workers typically strongly resist falling wages, even if other prices - and therefore the cost of living - is falling. This can mean that, particularly during deflation, wages can become uncompetitive, leading to higher unemployment. The implication is that periods of deflation usually go hand-in-hand with very high unemployment. Many economists warn that this may be the fate of Greece and other struggling economies within the eurozone.
Stimulus Monetary policy or fiscal policy aimed at encouraging higher growth and/or inflation. This can include interest rate cuts, quantitative easing, tax cuts and spending increases.
Sub-prime mortgages These carry a higher risk to the lender (and therefore tend to be at higher interest rates) because they are offered to people who have had financial problems or who have low or unpredictable incomes.
Swap A derivativethat involves an exchange of cashflows between two parties. For example, a bank may swap out of a fixed long-term interest rate into a variable short-term interest rate, or a company may swap a flow of income out of a foreign currency into their own currency.
TARP The Troubled Asset Relief Program - a $700bn rescue fund set up by the US government in response to the 2008 financial crisis. Originally the TARP was intended to buy up or guarantee toxic debts owned by the US banks - hence its name. But shortly after its creation, the US Treasury took advantage of a loophole in the law to use it instead for a recapitalisation of the entire US banking system. Most of the TARP money has now been repaid by the banks that received it.
Tier 1 capital A calculation of the strength of a bank in terms of its capital, defined by the Basel Accords, typically comprising ordinary shares, disclosed reserves, retained earnings and some preference shares.
Tobin tax A tax on financial transactions, originally proposed by economist James Tobin as a levy on currency conversions. The tax is intended to discourage market speculators by making their activities uneconomic, and in this way, to increase stability in financial markets. The idea was originally pushed by former UK Prime Minister Gordon Brown in response to the financial crisis. More recently it has been formally proposed by the European Commission, with some suggesting the revenue could be used to tackle the financial crissi. It is now opposed by the current UK government, which argues that to be effective, the tax would need to be applied globally - not just in the EU - as most financial activities could quite easily be relocated to another country in order to avoid the tax.
Toxic debts Debts that are very unlikely to be recovered from borrowers. Most lenders expect that some customers cannot repay; toxic debt describes a whole package of loans that are unlikely to be repaid. During the financial crisis, toxic debts were very hard to value or to sell, as the markets for them ceased to function. This greatly increased uncertainty about the financial health of the banks that owned much of these debts.
Troika The term used to refer to the European Union, the European Central Bank and the International Monetary Fund - the three organisations charged with monitoring Greece's progress in carrying out austerity measures as a condition of bailout loans provided to it by the IMF and by other European governments. The bailout loans are being released in a number of tranches of cash, each of which must be approved by the troika's inspectors.
Underwriters The financial institution pledging to purchase a certain number of newly-issued securitiesif they are not all bought by investors. The underwriter is typically aninvestment bank who arranges the new issue. The need for an underwriter can arise when a company makes a rights issue or a bondissue.
Unwind To unwind a deal is to reverse it - to sell something that you have previously bought, or vice versa, or to cancel a derivative contract for an agreed payment. When administratorsare called in to a bank, they must do the unwinding before creditors can get any money back.
Vickers Report See Independent Commission on Banking
Volcker Rule A proposal by former US Federal Reserve chairman Paul Volcker that US commercial banks be banned or severely limited from engaging in risky activities, such as proprietary trading (taking speculative risks on the markets with their own, rather than clients' money) or investing in hedge funds. The Volcker Rule follows similar logic to the Glass-Steagall Act and the UK ring-fenceproposal, and a modified version of the rule was included in the Dodd-Frankfinancial regulation law passed in the wake of the financial crisis.
Warrants A document entitling the bearer to receive shares, usually at a stated price.
Working capital A measure of a company's ability to make payments falling due in the next 12 months. It is calculated as the difference between the company's current assets (unsold inventories plus any cash expected to be received over the coming year) minus its current liabilities (what the company owes over the same period). A healthy company should have a positive working capital. A company with negative working capital can experience cashflow problems.
World Bank Set up after World War II along with the IMF, the World Bank is mainly involved in financing development projects aimed at reducing world poverty. The World Bank is traditionally headed by an American, while the IMF is headed by a European. Like the IMF and OECD, the World Bank produces economic data and research, and comments on global economic policy.
Write-down Reducing the book value of an asset, either to reflect a fall in its market value (see mark-to-market) or due to an impairment charge.
Yield The return to an investor from buying a bond implied by the bond's current market price. It also indicates the current cost of borrowing in the market for the bond issuer. As a bond's market price falls, its yield goes up, and vice versa. Yields can increase for a number of reasons. Yields for all bonds in a particular currency will rise if markets think that the central bank in that currency will raise short-term interest rates due to stronger growth or higher inflation. Yields for a particular borrower's bonds will rise if markets think there is a greater risk that the borrower will default.