Ch. 14 Notes
Ch. 14 Notes Econ 1051
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This 4 page Class Notes was uploaded by Lauren Pike on Sunday November 8, 2015. The Class Notes belongs to Econ 1051 at University of Missouri - Columbia taught by George Chikhladze,Martha Steffens in Fall 2015. Since its upload, it has received 29 views. For similar materials see General Economics in Economcs at University of Missouri - Columbia.
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Date Created: 11/08/15
Ch. 14: Money, Banking, and Financial Institutions Functions of Money ● medium of exchange ○ used of buy and sell goods ● unit of account ○ goods valued in dollars ○ relative worth of goods and services ● store of value ○ hold some wealth in money form ● different degrees of liquidity ○ liquidity: east w/ which an asset can be converted into cash; cash is perfectly liquid Money Definition M1 ● M1 includes: ○ currency: coins and paper money ■ token money: currency has greater face value than materials used to make it ○ checkable deposits: everything in checking account ● Institutions offering checkable deposits: ○ commercial banks: firms that engage in the business of banking ○ savings and loan associations ○ mutual savings banks ○ credit unions ■ THESE THREE ARE CALLED THRIFTS AS WELL Money Definition M2 ● M2 includes: ○ M1 and nearmonies ○ savings deposits including money market deposit accounts (MMDA) ○ smalldenominated time deposits (certificate of deposit, CD) ○ money market mutual funds (MMMF) ○ money market instruments; short term, very liquid debt securities (financial asset, paper) ■ ex.) treasury bills ○ ALL imply substantial liquidity What Backs Money Supply? ● backed by gov’s ability to keep value of money stable; no intrinsic value alone ○ money not backed w/ anything tangible (fiat/token money) ○ gov. free to manage nation’s money supply ● value of money ○ acceptability ○ legal tender: legal designation of a nation’s official currency (bills and coins) ○ relative scarcity: money derives value from its scarcity relative to utility ● money and prices: purchasing power of money is the amount of g/s it can buy ○ purchasing power of the dollar ■ amount money can buy varies inversely with price level ■ when CPI increases, purchasing power decreases ○ inflation and acceptability ■ runaway inflation depreciates purchasing power The Federal Reserve Banking System ● Fed. Reserve system: central component of US banking system consisting of the Board of Governors of the Fed. Reserve and 12 regional Fed. Res. banks ○ major goal: to control supply of money; insuring stability of banking system ● Board of Governors: 7member group that supervises and control the money and banking system of US; headquarters in DC ○ appointed by pres, but approved by senate ○ 14 yr terms ○ staggered so one member replaced every 2 yrs ○ chairperson and vice chairperson every 4 yrs ● 12 Fed. Res. Banks: banks chartered by US gov to control money supply and perform other functions ○ central banks: most countries have one, but US divides it in 12 ■ banks is areas based on population when established ○ quasipublic banks ■ blend private ownership and public control ■ not motivated by profit ■ policies designed by Board of Governors ○ banker’s banks ■ Fed. Res. banks ■ perform some functions of banks and thrifts ■ “lender of last resort” ■ issue currency ● Federal Open Market Committee (FOMC) ○ 12 voting members: 7 govs + 5 pres. of district banks ○ makes imp monetary policy decisions ○ meets 8 times per yr ● commercial banks and thrifts ○ 6,800 comm. banks ○ 8,700 thrifts ● Fed. Res. functions and responsibilities: ○ issue currency ○ set reserve requirements ○ lend money to banks (discount window) ○ collect checks ○ act as fiscal agent for US gov (provider of financial services) ■ hold a gov bank account ○ supervise banks ○ control money supply ● Fed. Res. Independence ○ Congress purposely made Fed ind. from gov to protect from political pressures ■ political business cycles ○ Fed policies can’t be reverse ○ freedom to pursue own objectives ○ enables Fed to take actions to increase interest rates in order to stem inflation as needed (not always politically popular) ○ opponents say: ■ undemocratic ■ unaccountable ■ not transparent Financial Crisis of 20072009 ● the mortgage default crisis ○ causes: ■ subprime mortgage loans: highinterestrate loans to buyers w/ higherthan average risk ● borrowers not likely to pay back loans ■ gov programs that encouraged home ownership ■ declining real estate values ■ bad incentives provided by mortgage lenders ○ biggest indirect investors had been banks ○ when borrowers defaulted on their loans investment funds “blew up” and couldn’t repay their loans ○ banks had to “write off” loans, reducing reserve and ability to generate new loans ● securitization: process of slicing up and bundling groups of loans, mortgages, corporate bonds/other financial debts into distinct new securities; shadow banking system; ended up everywhere ○ mortgagebacked securities (MBS): bonds backed by mortgage payments; bonds that represent claims to all part of monthly mortgage payments from pools of mortgage loans made by lenders to borrowers ○ insurance co.’s insured those securities ○ severe conflict of interest ■ credit rating agencies assigned AAA ratings to lots of MBS ○ when interest rates increase and real estate values fell, lots of homeowners defaulted on mortgage loans ○ defaults happened on a massive scale and the system collapsed ○ triggered bankruptcy ● Why no one saw it coming ○ failure to predict massive defaults across country ○ exposure and interconnectedness of many large financial institutions ○ importance of many nonbank institutions (shadow banks) and lack of regulation ■ (investment banks assisting private co. going public is called underwriting) ○ free riding ○ insurance ○ many securities were traded overthecounter (no regulations) ■ overthecounter vs centralized exchanges ● ex.) centralized market/exchange = NYSE ● ex.) overthecounter = NASDAQ ■ exotic derivative: security that derives value from some kind of underlying event or asset ● investors and regulators failed to ask 3 ?’s: ○ what would happen if value of loans suddenly plunged? ○ what if largest holders of securities based on these mortgages were major US financial institutions vital to keeping econ. running smoothly? ○ what would happen if main insurer of these securities was largest insurance co. in world (AIG)? ■ ALL occurred ● Failures and nearfailures of financial firms ○ ex.) Countrywide to B of A: second largest lender ○ Washington Mutual to JPMorgan Chase; largest lending ○ Wachovia (4th largest bank) to Wells Fargo ○ other firms filed for bankruptcy (Lehman Bros.) ○ Goldman Sachs, Morgan Stanley are now bank holding companies ○ Merrill Lynch was acquired by B of A
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