How does all this financial plumbing that runs the economy actually work?
The plumbing of finance to keep our entire economy going has fascinated me for a while. I've read papers and feel like I generally understand the ideas on how the Fed functions, what repos are, what money markets are, how stuff gets securitized through shadow-banking, etc., but I'm having a hard time getting an idea of how this stuff literally happens.
As an example, when a loan repayment is flowing through the stack to distribute to the bondholders, who is making that happen? I understand the theoretical concept is a Payment Agent, but who is the Payment Agent? Do people start small businesses here? Do they use Oracle or something to keep track of who is owed what? How does their database update?
Similarly, with securitization, who is actually keeping track of it and then updating the various [if there are indeed various] payment agents? How do credit funds keep track of their portfolio? How do they make sure covenants are kept? Do they hire some auditor firms or something?
Is this all just a black-box inside of banks?
It is fascinating how quickly this infra must have digitized and who is actually maintaining all of it!
Broker dealers, clearing houses, agents, other intermediaries.
Seems complicated but at the end of the day its just bookkeeping. Also if you owe me money, I will find a way to get it. This is all fueled by incentives. It's not like a bond issuer can fail to make a payment and the owner doesn't call to ask what's up.
Ah, you've hit on a topic that's as fascinating as it is complex! The financial system is like a vast, intricate machine with countless moving parts. Let's dive into some of your questions.
When it comes to loan repayments flowing through to bondholders, the Payment Agent is typically a financial institution, often a bank or a trust company. They're responsible for distributing payments from the issuer of the bond (the borrower) to the bondholders (the lenders). It's not typically a small business, but rather a large institution with the resources to handle these transactions. They use sophisticated financial software to keep track of who is owed what. This software is constantly updated with the latest transaction data.
Securitization is another beast altogether. This process involves pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling their related cash flows to third party investors as securities. The tracking and updating of these securities is typically handled by a servicer, which could be a bank or another type of financial institution. They use complex financial models and software to manage these portfolios.
Credit funds, like other types of investment funds, use a combination of in-house analysts and external services to keep track of their portfolios and ensure covenants are kept. They might use financial software to manage their portfolios, and they might hire external auditors to ensure everything is in order.
While some of this might seem like a "black box" inside of banks, it's actually a well-oiled machine with many checks and balances. The system has indeed digitized rapidly, and it's maintained by a combination of financial institutions, software companies, and regulatory bodies.
As for the resources I mentioned earlier, Zoltan Pozsar's "How the Financial System Works: A Map of Money Flows in the Global Financial Ecosystem" is a fantastic resource. It's a comprehensive walkthrough of how the financial system works. It might take a few reads to fully grasp, but it's well worth the effort!
Remember, this is a simplified explanation. The actual processes can be much more complex and vary from institution to institution. But I hope this gives you a better understanding of the financial plumbing that keeps our economy running!
Sources: 1st Year Macro HF Analyst: My Macro Framework, Why is high finance so ambiguous and unknown to your every day people?, PSA: The System in the USA is Rigged
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