ECON 304
Money and Banking
Instructor:
Bernard Malamud
–Office: BEH 502
Phone (702) 895 –3294
Fax:
895 – 1354
»Email: bernard.malamud@unlv.edu
Website: www.unlv.edu/faculty/bmalamud
Office hours: TR 11:30 -12:30pm; 2:30 - 3:30 pm;
and by appointment
Headline: Obama to nominate Bernanke to second term.
WASHINGTON — President Obama on Tuesday will nominate Ben S. Bernanke to a
second term as chairman of the Federal Reserve, administration officials said. The
announcement is a major victory for Mr. Bernanke, a Republican who was appointed
by President George W. Bush almost four years ago and who had briefly served as
chairman of Mr. Bush’s Council of Economic Advisers.
A top White House official said Mr. Obama had decided to keep Mr. Bernanke at
the helm of the Fed because he had been bold and brilliant in his attempts to
combat the financial crisis and the deep recession.
“The president thinks that Ben’s done a great job as Fed chairman, that he
has helped the economy through one of the worst experiences since the
Great Depression and that he has essentially been pulling the economy back
from the brink of what would have been the second Great Depression,” the
White House chief of staff, Rahm Emanuel, said Monday night.
When Mr. Obama was elected, many Democrats considered one of the most likely
contenders for Fed chairman to be Lawrence H. Summers, a former Treasury
secretary under President Bill Clinton and currently director of the National Economic
Council in Mr. Obama’s White House.
Other rumored candidates included Alan S. Blinder, a professor of economics at
Princeton and a former vice chairman of the Federal Reserve under Alan Greenspan;
Janet L. Yellen, president of the Federal Reserve Bank of San Francisco; and Roger
Ferguson, another former vice chairman of the Federal Reserve who is currently
president of TIAA-CREF, the giant pension fund company.
• In the spring of 2007, Henry Paulson, the US Treasury secretary had told
Congress that the subprime problem “appears to be contained. Bernanke,
the Federal Reserve governor, repeatedly echoed that line. “Given the
fundamental factors in place that should support the demand for housing,
we believe the effect of the troubles in the subprime sector on the broader
housing market will likely be limited.”
In May, he continued, “Importantly, we see no serious broader spillover to
banks or thrift institutions from the problems in the subprime market;
troubled lenders, for the most part, have not been institutions with
federally insured deposits.”
In early June, after the collapse of Bear Stearns funds, Bernanke changed
his tune slightly. “Rising delinquencies and foreclosures are creating
personal, economic, and social distress for many home owners and
communities – problems that likely will get worse before they get better…It
seems very far-fetched to make any parallels with Japan’s crisis. The key
thing to remember is that those loses are not just held by American banks,
as bad as the loans were in Japan, but they are dispersed.”
Money, Banking, and Financial Markets
• The role of money and monetary policy
TRUST
• How financial markets work
TRUST
• How financial institutions such as banks and
insurance companies work
TRUST
• How the shadow banking system operates
TRUST?
• A security (financial instrument) is a claim on the
issuer’s future income or assets
• A bond is a debt security that promises to make
specified payments over time
– An interest rate is the cost of borrowing or the price
paid for the rental of funds
Interest Rates on Selected Bonds, 1950–2008
Sources: Federal Reserve Bulletin; www.federalreserve.gov/releases/H15/data.htm.
• A security (financial instrument) is a claim on the
issuer’s future income or assets
• A bond is a debt security that promises to make
specified payments over time
– An interest rate is the cost of borrowing or the price
paid for the rental of funds
• Common stock represents a share of ownership
in a corporation
– A share of stock is a claim on the earnings and assets
of the corporation
Banking and Financial Institutions
• Financial Intermediaries—institutions that borrow funds
from people who have saved and make loans to other
people and businesses
• Banks—accept deposits and make loans
• Other Financial Institutions—insurance companies,
finance companies, pension funds, mutual funds and
investment banks
• Financial Innovation
– The information age and e-finance
– Derivatives
– Securitization
From Gillian Tett, Fool’s Gold
The sun slipped slowly down the cerulean Spanish sky….[S]everal hundred
bankers stood on the elegant terrace of a futuristic, gleaming white hotel,
staging a so-called champagne salute in celebration of the fact that investment
banks had just enjoyed their most lucrative year in history. The date was June
11, 2007 and the occasion was the annual meeting of the European
Securitisation…The meeting carried a lofty title: “Global Asset Backed
Securitization; Toward a New Dawn.” An exuberant crowd including smooth
talking, white toothed salesmen from large American banks, eagerly selling
repackaged mortgage debt; self-deprecating British traders; and earnest, chainsmoking representatives from German insurance companies and banks. Their
prey included asset managers from Italy, Spain, Germany, and Greece…A silent
gaggle of Chinese and Singaporeans circulated. It was rumored that they were
furtively buying CDOs to find a home for foreign exchange reserves. A few
regulators could also be spotted, conspicuous in looking generally dowdier than
the bankers. Some of the biggest delegations, though, came from the three
credit rating agencies that were drawing fat profits from the CDO boom…Lively
debate ensued about the American mortgage backed bond market, the CDO
sector, the SIVs, the state of the Spanish mortgage market and the outlook for
Russian ABS. There was even a high-profile debate on Islamic finance [which]
some hoped would be a hot new growth area for securitization…
Innovation: Alphabet Soup
ABCP – asset backed commercial paper
ABS – asset backed security
CD – credit derivative, e.g., CDS
CDO – collateralized debt obligation
CDO2 – a CDO backed by CDOs
CDS – credit default swap
SIV – structured investment vehicle
SPV – special purpose vehicle
Money Growth (M2 Annual Rate) and the Business
Cycle in the United States, 1950–2008
Note: Shaded areas represent recessions.
Source: Federal Reserve Bulletin, p. A4, Table 1.10; www.federalreserve.gov/releases/h6/hist/h6hist1.txt.
Money and Inflation
• The aggregate price level is an average price of
goods and services in an economy
• A continual rise in the price level (inflation) affects
all economic players
Money Growth (M2 Annual Rate) and Interest Rates
(Long-Term U.S. Treasury Bonds), 1950–2008
Sources: Federal Reserve Bulletin, p. A4, Table 1.10; www.federalreserve.gov/releases/h6/hist/h6hist1.txt.
Monetary and Fiscal Policies
• Monetary policy is the management of the money supply
and interest rates
– Conducted by the Federal Reserve Bank (Fed)
• Fiscal policy is government spending and taxation
– Any deficit must be financed by borrowing …
government borrowing affects interest rates
Bernanke’s Focus
• Survival – Lender of last resort responsibility
• Inflation Targeting
– Adjust “real” rate of interest with eye on preannounced target rate of inflation
– Wiggle room for other objectives/emergencies
– Transparency and accountability
• Joined by Mishkin on Board of Governors for while
• Other Governors:
www.federalreserve.gov/bios
– Oppose Deflation
• Great Depression and clogged credit channel
Core Principles of Money and Banking
• Time has Value  Interest rate
• Risk Requires Compensation
• Financial decisions are based on
Information and on TRUST
• Markets set prices and allocate resources
• Stability reduces risk and spurs enterprise
Where to Find the Numbers
•
•
•
•
•
http://research.stlouisfed.org/fred2/
www.federalreserve.gov/releases/
www.economist.com
www.bea.doc.gov
http://www.gpoaccess.gov/eop/
Functions of Financial Markets 101
• Channel funds from those who have saved surplus
to those who need to borrow
Win - Win
• Promotes economic efficiency by producing
an efficient allocation of capital
– increases production
• Improves consumer well-being
– allows them to time purchases better
Structure of Financial Markets:
Address adverse selection & moral hazard problems
• Debt and Equity Markets
Short-term (maturity<1yr) /intermediate term/long-term (>10yrs)
• Primary and Secondary Markets
– Investment Banks underwrite securities in primary markets
• Are any “investment banks” left?
– Brokers and dealers work in secondary markets  liquidity
• Exchanges and Over-the-Counter (OTC) Markets
• Money and Capital Markets
– Money markets short-term debt instruments
– Capital markets longer-term debt and equities (stocks)
Principal Money Market Instruments
Principal Capital Market Instruments
Internationalization of Financial Markets
• Foreign Bonds—sold in a foreign country and
denominated in that country’s currency: £ bonds in UK
• Eurobond—bond denominated in a currency other than
that of the country in which it is sold: $ bond in UK
• Eurocurrencies—foreign currencies deposited in banks
outside the home country
– Eurodollars—U.S. dollars deposited in foreign banks outside
the U.S. or in foreign branches of U.S. banks
– Euroeuro – euros deposited in a British bank
• World Stock Markets
Indexes: USS&P 500/UKFTSE 100/GermanDAX/JapanNikkei
Function of Financial Intermediaries: Indirect Finance
• Lower transaction costs
– Economies of scale
– Liquidity services
• Reduce Risk
– Risk Sharing (Asset Transformation: Risky  less risky)
– Diversification
• Asymmetric Information in Finance
– Adverse Selection (before the transaction)—more likely to select
risky borrower
– Moral Hazard (after the transaction)—less likely borrower will
repay loan
Principal Financial Intermediaries and Value of Their Assets
Regulation of the Financial System
• To increase the information available to investors:
– Reduce adverse selection and moral hazard problems
– Reduce insider trading
• To ensure the soundness of financial intermediaries:
– Restrictions on entry: “upstanding citizens with impeccable
credentials” … and lots of capital upfront
– Disclosure
– Restrictions on Assets and Activities  SIVs as end-run
– Deposit Insurance
– Limits on Competition/branching regulation as history
– Restrictions on Interest Rates/Regulation Q as history
 Disintermediation