14
Money, Banking, and Financial
Institutions
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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
LO1
Liquidity
Refers to ability to use an asset as a
medium of exchange. The easier it is
to convert to a medium of exchange,
the more liquid.
LO1
Money Supply
Money Supply
Refers to the money actually in circulation
LO1
Money Definition M1
• M1
• Currency in the hands of the public
• Checkable deposits
• Currency = Coins + Paper Money
• Currency is token money
LO1
Money Definition M1
• Institutions offering checkable
deposits
• Commercial banks
• Savings and loan associations
• Mutual savings banks
• Credit unions
LO2
LO1
Money Definition M1 - Exclusions
1. Currency held by U.S.Treasury , the
Federal Reserve banks, commercial
banks, and thrift institutions
2.
LO2
Checkable deposits of the
government (U.S. Treasury) or the
Federal Reserve that are held by
commercial banks or thrift institutions
Money Definition M2
• M2 = M1 + near-monies (easily
converted to be used as medium of
exchange).
• Savings deposits including money
market deposit accounts (MMDA)
• Small-denominated time deposits
• Money market mutual funds
(MMMF)
LO1
Money Definition
Currency
+
Demand
Deposits
=
Total
M1
+
Time Deposits
& Money
Market Accts.
=
Total M2
Money Definitions
LO1
What “Backs” the Money Supply?
• Guaranteed by government’s ability to
keep value stable
• Money as debt
• Why is money valuable?
• Acceptability
• Designated as Legal tender
• Relative scarcity (supply and demand)
LO3
LO2
What “Backs” the Money Supply
• Prices affect purchasing power of
money – inverse relationship
• Purchasing power: amount of goods and
services a unit of money will buy
• Hyperinflation renders money
unacceptable
• Stabilizing money’s purchasing power
• Intelligent management of the money
supply – monetary policy
• Appropriate fiscal policy
LO2
• The Central Bank of the United States
The
Federal
Reserve
• The Banker’s Bank
– Holds the deposits of commercial banks and
makes loans to banks that need additional
funds
• Buys/Sells Foreign Currency
• Regulates Credit
• Supervises Banks
• Processes Checks
• Collects Data on Money
Supply/Economic Activities
• Regulates Money Supply
Federal Reserve - Banking System
Historical Background
LO3
Federal Reserve – Banking System
Board of Governors
Federal Open Market Committee
12 Federal Reserve Banks
Commercial Banks
Thrift Institutions
(Savings and Loan Associations,
Mutual Savings Banks,
Credit Unions)
The Public
(Households and
Businesses)
LO3
Federal Reserve - Banking System
• Board of Governors – central authority
• Basic policy making body of U.S.
banking system.
• 7 members appointed by president
• 14 year terms, staggered
• Chair/Vice Chair 4 year terms.
LO3
Federal Reserve - Banking System
• 12 Federal Reserve Banks
• Serves as the central bank
• Quasi-public banks
• Public control, private ownership
• Banker’s bank
LO3
Federal Reserve – Banking System
Source: Federal Reserve Bulletin
Federal Reserve – Banking System
• Federal Open Market Committee
• Aids Board of Governors in setting
monetary policy
• Conducts open market operations
• Includes Board of Governors and 5
presidents of Federal Reserve
Banks
LO4
LO3
Federal Reserve – Banking System
• Commercial banks and thrifts
•
•
•
•
LO4
LO3
6,000 commercial banks
8,500 thrifts
Monetary control by Fed
Subject to regulation by other agencies,
e.g., FDIC, NCUA
Federal Reserve Functions
• Issues currency
• Sets discount rate
• Sets reserve requirements
• Lends money to banks
• Check collection
• Fiscal agent for U.S. government
• Supervises banks
• Controls the money supply
LO4
Federal Reserve Independence
• Established by Congress as
•
•
LO4
independent agency
Protects the Fed from political
pressures
Enables Fed to take actions to
increase interest rates to stem
inflation as needed
The Financial Crisis of 2007 and 2008
LO5
The Financial Crisis of 2007 and 2008
• Mortgage Default Crisis
• Many causes
• Government programs
encouraged home ownership
• Declining real estate values
• Bad incentives provided by
mortgage-backed bonds
LO5
The Financial Crisis of 2007 and 2008
• Securitization- the process of slicing
•
•
•
LO5
up and bundling groups of loans into
new securities
As loans defaulted the system
collapsed
AIG sold collateralized default swaps
to insure loans
“Underwater” homeowners
abandoned homes and mortgages
The Financial Crisis of 2007 and 2008
http://crisisofcredit.com
LO5
The Financial Crisis of 2007 and 2008
• Failures and Near-Failures of
•
LO5
Financial Firms
• Washington Mutual-largest lender
• Countrywide-second largest lender
• Wachovia
Other firms came close
Post-crisis U.S. Financial Services
• Industry consolidation
• More than 200 banks shut down by
•
•
LO7
FDIC
Assets transferred
Major investment banks opted to
become commercial banks
The Financial Crisis of 2007 and 2008
• Troubled Asset Relief Program-2008
(TARP)
• Allocated $700 billion to U.S. Treasury
to make emergency loans
• Saved several institutions from failure
• Created moral hazard
LO6
Post-crisis U.S. Financial Services
• Wall Street Reform and Consumer
•
•
LO7
Protection Act – 2010
Passed to help prevent many of the
practices that led to the crisis
Critics say it adds heavy regulatory
costs
Major Categories of Financial Institutions
LO8
LO7
Institution
Description
Examples
Commercial Banks
State and national banks that provide checking and savings
accounts and make loans
JP Morgan Chase, Bank
of America, Citibank,
Wells Fargo
Thrifts
Savings and loan associations, mutual savings banks, credit
unions that offer checking and savings accounts and make
loans
Charter One, New York
Community Bank
Insurance
Companies
Firms that offer policies through which individuals pay
premiums to insure against lose
Prudential, New York
Life, Northwestern
Mutual, Hartford
Mutual Fund
Companies
Firms that pool customer deposits to purchase stocks or
bonds
Fidelity, Vanguard,
Putnam, Janus, T Rowe
Price
Pension Funds
Institutions that collect savings from workers throughout their
working years and then invest the funds to pay retirement
benefits
TIAA-CREF, Teamsters’
Union, CalPERs
Securities Firms
Firms that offer security advice and buy and sell stocks and
bonds for clients
Merrill Lynch, Smith
Barney, Charles Schwab
Investment Banks
Firms that help corporations and governments raise money by
selling stocks and bonds
Goldman Sachs, Morgan
Stanley, Deutsche Bank,
Nomura Securities
