Apr 28, 2014

Sources of Funding

When amidst the Great Depression in 1931 John Rockefeller, Jr. found himself saddled with over two hundred old brownstones in midtown Manhattan, shortly after the Metropolitan Opera had withdrawn its plans for building a new opera house on the land where the brownstones were located, it looked as if the lack of funding was going to ruin yet another visionary project. To everyone's surprise, the stream of funding resumed shortly after because Junior had decided to turn unfortunate circumstances into an opportunity, make the best use of the land, and personally finance the construction of a new massive project, to be later known as the Rockefeller Center (Chernow, 1999). In the next several years, Junior was able to see the project completed to the end throughout very difficult economic times not so much because he had deep pockets, but because he did not waiver in front of the unpredictable future and the capital continued flowing in.

During financial crises, the type and composition of funding is what distinguishes a firm that fails from a firm that stays afloat. The following analysis looks at how key, yet soon-to-be-defunct firms financed their operations during various historical crises. The structure of this piece is as follows:

1980s Savings & Loan crisis
Securitization of late the 1990s
2008 Financial crisis

The 1980s Savings & Loan crisis
At the outbreak of the Savings and Loan crisis, thrifts that experienced annual growth rates of less than 15 percent obtained 80 percent of their funding from retail deposits, while thrifts with annual growth rates in excess of 50 percent were only 59 percent reliant on traditional deposits, while receiving another 28 percent of funding from uninsured large-denomination deposits and flimsy repurchase agreements. As an extreme case, Empire Savings & Loan Association of Mesquite, one of the most aggressive growers, procured as much as 90 percent of its funding from large certificates of deposits (FDIC, 1997).

As it turned out, the institutions that relied on short-term, non-depositor funding the greatest were the most likely candidates for failure.

Securitization of late 1990s
Although already forgotten, mortgage securitization was proliferating in the US in the mid and late 1990s. In 1997 a series of currency devaluations in Asia led to a global recession, which in turn resulted in the collapse of oil prices. This in turn led to falling tax revenues in Russia and the country's default on its foreign debt. The Russian troubles triggered a further drop in investor confidence, as investors fled for safety to US government securities, away from structured products. This resulted in the collapse of Long-Term Capital Management, a famous hedge fund, in August 1998, and the withdrawal of cash provision by investors from mortgage originators. Unable to finance the origination of new loans, mortgage lenders started going bankrupt one after another. In the two years after the Russian default, 8 out of the top 10 subprime lenders closed doors (FCIC, 2011).

Generally, mortgage lenders obtained around 50 percent of their funding from short-term financing. Some notable examples included the failure of Southern Pacific Funding, which closed doors in August 1998. The firm's short-term liabilities constituted 59 percent of its total borrowings. For Green Tree Financial, another leading finance company, that figure was 49 percent; for Associates First Capital it was 44 percent; finally, United Companies received 47 percent of its financing in the form of short-term borrowing (Corresponding quarterly statements, various dates).

The 2008 Financial crisis
Fast forwarding ten years to another mortgage securitization crisis, in which the subprime lender Countrywide Financial Corporation obtained as much 72 percent of its funding from short-term and medium financing. The household name New Century Financial was 60 percent financed by short- and medium-term lenders (Corporate quarterly statements). Then there were the bulge bracket American investment banks with their five-star credit ratings and deep borrowing capacities. At the time, Goldman Sachs obtained 60 percent of its funding from short-term and medium financing. The corresponding figure for Morgan Stanley was 59 percent; for Merrill Lynch it was 58 percent; 57 percent for Bear Stearns; and 66 percent for Lehman Brothers (Corresponding quarterly statements, various dates).

A very LT investor will prudently note that in a serious crisis, even a mere 30 percent reliance on short- and medium-term funding can be detrimental for some firms, while a 50 percent mark and above leads to a guaranteed failure.


Associates First Capital Corporation. (1998, Aug. 14). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/7974/0000007974-98-000067.txt

Bear Stearns Companies Inc. (2008, Feb. 29). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/777001/000091412108000345/be12550652-10q.txt

Chernow, R. (1999). Titan: The Life of John D. Rockefeller, Sr. New York, NY: Vintage Books.

Countrywide Financial Corporation. (2007, June 30). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/25191/000110465907060931/a07-19124_110q.htm

Federal Deposit Insurance Corporation. (1997). The Savings and Loan Crisis and Its Relationship to Banking. Washington, D.C.: Federal Deposit Insurance Corporation.

Goldman Sachs Group, Inc. (2008, Feb. 29). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/886982/000095012308003960/y51267e10vq.htm

Green Tree Financial Corporation. (1998, Aug. 14). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/890175/0000890175-98-000004.txt

Lehman Brothers Holdings Inc. (2008, May 31). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/806085/000110465908045115/a08-18147_110q.htm

Merrill Lynch & Co., Inc. (2008, March 28). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/65100/000095012308005157/y56688e10vq.htm

Morgan Stanley. (2008, Feb. 29). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/895421/000119312508077429/d10q.htm

New Century Financial Corporation. (2006, Sep. 30). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/1287286/000089256906001359/a24944e10vq.htm

Southern Pacific Funding Corporation. (1998, Aug.14). Quarterly Report. Retrieved from http://www.sec.gov/Archives/edgar/data/1011836/0000892917-98-000071.txt

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