31

Money, Banking, and Financial Institutions

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

AGENDA Tues 3/15

• Team Teaching: CH 31-32

• P3: Allan, Ezra, George

• P5: Ms. K (no surprise)

• On Deck: CH 33 (after spring break)

• P3: Dulce, Fatima

• P5: Ms. K (we’ll see…) • QOD # 23: Money, money, money

• HW: Read pp 655-667 Q#4,5,6 Due Thurs 3/17

• Review CH 32 P#4,5 (Due Mon 3/21)

• Study for Midterm 3/24

LO1 29-2

QOD #23: Money Money Money

• Assume that the following asset values (in millions of

dollars) exist in Ironmania: • Federal Reserve Notes in circulation = $700;

• Money market mutual funds (MMMFs) held by individuals = $400;

• Corporate bonds = $300;

• Iron ore deposits = $50;

• Currency in commercial banks = $100;

• Savings deposits, including money market deposit accounts (MMDAs) =

$140;

• Checkable deposits = $1500;

• Small-denominated (less than $100,000) time deposits = $100;

• Coins in circulation = $40.

• a. What is M1 in Ironmania? b. What is M2 in Ironmania

QOD #23: Money Money Money Solution

• (a) M1 = $2240 (= $700 Federal Reserve Notes +

$1500 checkable deposits + $40 coins)

• (b) M2 = $2880 (= $2240 M1 + $140 savings and

MMDAs + $100 small-denominated time deposits +

$400 MMMFs)

Functions of Money

• Medium of exchange

• Used to buy/sell goods

• Unit of account

• Goods valued in dollars

• Store of value

• Hold some wealth in money form

• Money is liquid-what is most liquid?

LO1 31-5

Money Definition

LO1

M1 M2

•Currency

•Checkable deposits

•Institutions offering

checkable deposits

•Commercial banks

•Savings and loan

associations

•Mutual savings banks

Credit unions

•M1 plus near-monies-??

•Savings deposits

including money market

deposit accounts (MMDA)

•Small-denominated time

deposits

•Money market mutual

funds (MMMF)

31-6

What “Backs” the Money Supply?

• Guaranteed by government’s ability to keep value stable

• Money as debt

• Paper money is the circulating debt of the Federal Reserve.

• Checkable deposits are the debts of commercial banks and

thrift institutions.

• NOT BACKED BY GOLD

• The supply of money would vary with the amount of

gold available.

• Monetary authority attempts to provide the amount of

money needed for the volume of business activity

that will promote full employment.

• Why is money valuable?

• Acceptability-we accept it

• Legal tender-valid and LEGAL means of payment

• Relative scarcity- to be exchanged for goods and services in the

future-WHAT IF IT WAS UNLIMITED?? LO2 31-7

What “Backs” the Money Supply?

• Prices affect purchasing power of money- V=1/P

• Price Level=1 Price Level=1.03

• Hyperinflation renders money unacceptable

• Stabilizing money’s purchasing power

• Intelligent management of the money supply –

monetary policy

• Appropriate fiscal policy-coincides with

monetary policy of limiting inflation.

LO2 31-8

Federal Reserve - Banking System

• Historical background

• Board of Governors

• 12 Federal Reserve Banks

• Serve as the central bank

• Quasi-public banks-owned by the

private commercial banks in its

district, but regulated by the Board

of Governors.

• Banker’s bank

LO3 31-9

Federal Reserve – Banking System

Commercial Banks

Thrift Institutions

(Savings and Loan Associations,

Mutual Savings Banks,

Credit Unions)

The Public

(Households and

Businesses)

12 Federal Reserve Banks

Board of Governors

Federal Open Market Committee

LO3 31-10

Federal Reserve – Banking System

LO3

The 12 Federal Reserve Banks

31-11

Federal Reserve – Banking System

• Federal Open Market Committee

• Aids Board of Governors in

setting monetary policy

• Conducts open market

operations

• Commercial banks and thrifts

• 6,800 commercial banks

• 8,700 thrifts

LO3 31-12

Federal Reserve Functions

• Issue currency

• Set reserve requirements

• Lend money to banks

• Collect checks

• Act as a fiscal agent for U.S.

government

• Supervise banks

• Control the money supply

LO4 31-13

Federal Reserve Independence

• Established by Congress as an

independent agency

• Protects the Fed from political

pressures

• Enables the Fed to take actions to

increase interest rates in order to

stem inflation as needed

LO4 31-14

Financial Institutions

World’s 12 Largest Financial Institutions, 2009

Royal Bank of Scotland (UK)

Barclays (UK)

Deutsche Bank (Germany)

BNP Paribas (France)

HSBC Holdings (UK)

JPMorgan Chase (US)

Credit Agricole (France)

Citigroup (US)

Mitsubishi UFJ (Japan)

UBS (Switzerland)

ING Group (Netherlands)

Bank of America (US)

0 1.5 2.5 3.5

Source: Forbes Global 2000, http://www.forbes.com

Assets (Trillions of U.S. Dollars)

LO4 31-15

The Financial Crisis of 2007 and 2008

• Mortgage Default Crisis

• Many causes

• Government programs that encouraged home

ownership

• Declining real estate values

• Bad incentives provided by mortgage-backed

bonds

• Sub-prime loans?

• Banks

• Sold mortgages to investors

• Lent the money to the investor

• Bought them as well

• AIG-insured them with default swaps

LO5 31-16

The Financial Crisis of 2007 and 2008

• Securitization: the process of slicing

up and bundling groups of loans into

new securities

• As loans defaulted, the system

collapsed

• “Underwater” homeowners

abandoned homes and mortgages

LO5 31-17

The Financial Crisis of 2007 and 2008

• Failures and near-failures of financial

firms

• Countrywide: second largest lender

• Washington Mutual: largest lender

• Wachovia

• Other firms came close

LO5 31-18

The Financial Crisis of 2007 and 2008

• Troubled Asset Relief Program

(TARP)

• Allocated $700 billion to make

emergency loans

• Saved several institutions from

failure

LO6 31-19

The Financial Crisis of 2007 and 2008

• The Fed’s lender-of-last-resort

activities

• Primary Dealer Credit Facility

• Term Securities Lending Facility

• Asset-Backed Commercial Paper

Money Market Mutual Fund

Liquidity Facility

• Commercial Paper Funding Facility

LO6 31-20

The Financial Crisis of 2007 and 2008

• Money Market Investor Funding

Facility

• Term Asset-Backed Securities Loan

Facility

• Interest Payments on Reserves

LO6 31-21