Download CH. 20 - Bakersfield College

Business in
Action 7e
Bovée/Thill
The Money
Supply and
Banking Systems
Chapter 20
Business in
Action 7e
Bovée/Thill
Learning Objectives
1. List the four financial functions of money and
2.
3.
define two key measures of the money supply
Explain the major functions of the Federal
Reserve System and identify other key federal
financial institutions
Distinguish investment banks from commercial
banks and identify the three major types of
investment banks
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Learning Objectives
4. Identify the major types of commercial banks
5.
6.
and outline the impact of banking deregulation
over the past three decades
Identify the two major sets of economic forces
that triggered the meltdown of 2008 and sent
the economy into a global recession
Outline the efforts to reform the banking
industry in the wake of the subprime crisis
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The Meaning of Money
• Money
 Anything generally accepted as a means of
paying for goods and services
 serves as a medium of exchange, a unit of
accounting, a store of value, and a standard
of deferred value
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The Money Supply
• Money Supply
 The amount of money in circulation at any
given point in time
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Exhibit 20.1
Trends in the Money
Supply
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The Federal Reserve System
• Federal Reserve System
 The central banking system of the United
States
 Responsible for regulating banks and
implementing monetary policy
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The Federal Reserve System
(cont.)
• Federal Funds Rate
 The interest rate that member banks charge
each other to borrow money overnight from
the funds they keep in the Federal Reserve
accounts
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The Federal Reserve System
(cont.)
• Discount rate
 The interest rate that member banks pay
when they borrow funds from the Fed.
• Prime rate
 The interest rate a bank charges its best loan
customers.
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Other Government Banking Agencies
and Institutions
• Federal Deposit Insurance Corporation
(FDIC)
 The federal agency responsible for protecting
money in customer accounts and managing
the transition of assets whenever a bank fails
 Guarantee amount: $250,000 per account.
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Other Government Banking Agencies
and Institutions
• Fannie Mae
 The government-sponsored enterprise
responsible for guaranteeing and funding
home mortgages
• Secondary Mortgage Market
 The financial market in which mortgages are
bought and sold, providing much of the funds
that are loaned to home buyers
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Other Government Banking
Agencies and Institutions
• Freddie Mac
 A secondary mortgage institution similar to
Fannie Mae.
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Investment Banking
• Investment banks
 Firms that offer a variety of services related to
initial public stock offerings, mergers and
acquisitions, and other investment matters.
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Commercial Banking and Other
Financial Services
• Commercial Banks
 Financial institutions that accept deposits,
offer various types of checking and savings
accounts, and provide loans
• Retail Banks
 Banks that provide financial services to
consumers
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Commercial Banking and Other
Financial Services
• Merchant Banks
 Banks that provide financial services to
businesses
 can also refer to private equity management
• Thrift Banks
 Banking institutions that offer deposit
accounts and focus on offering home
mortgage loans
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Commercial Banking and Other
Financial Services
• Credit Unions
 Not-for-profit, member-owned cooperatives
that offer deposit accounts and lending
services to consumers and small businesses
• Private Banking
 Banking services for wealthy individuals and
families
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Other Financial Services
• Independent
Mortgage
Companies
 Nonbank
companies that use
their own funds to
offer mortgages
• Mortgage Brokers
 Nonbank
companies that
initiate loans on
behalf of a
mortgage lender in
exchange for a fee
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Other Financial Services
• Finance Companies
 Nonbank institutions
that lend money to
consumers and
businesses for cars
and other vehicles,
home
improvements,
expansion,
purchases, and
other purposes
• Credit Rating
Agencies
 Companies that
offer opinions about
the creditworthiness
of borrowers and of
specific investments
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Banking and Financial Bubbles
• Bubble
 A market situation in which frenzied demand
for an asset pushes the price of that asset far
beyond its true economic value
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Exhibit 20.2
The Housing Bubble
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The Housing Bubble
• Subprime mortgages
 Home loans for borrowers with low credit
scores
• Loan-to-Value (LTV)
 The percentage of an asset’s market value
that a lender is willing to finance when
offering a loan
 the rest of the purchase price has to be paid
by the buyer as a down payment
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Exhibit 20.3
Subprime Lending
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Changing the Rules in
Mortgage Lending
• Adjustable Rate
Mortgage (ARM)
 A mortgage that
features variable
interest rates over
the life of the loan
• Option ARM
 A type of ARM that
lets borrowers
choose from
several repayment
options
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The Securitization of Debt
• Securitization
 A process in which debts such as mortgages
are pooled together and transformed into
investments
• Mortgage-Backed Securities (MBSs)
 Credit derivatives based on home mortgages
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The Meltdown of 2008
• Defaults
 Situations in which borrowers stop making
payments on their loans.
• Foreclosures
 Situations in which lenders take possession
of homes after borrowers default on their
mortgage payments.
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The Meltdown of 2008
• Liquidity Crisis
 A severe shortage of liquidity throughout a
sector of the economy or the entire economy,
during which companies can’t get enough
cash to meet their operating needs
• Credit Freeze
 A situation in which credit has become so
scarce that it is virtually unavailable, at any
cost, to most potential borrowers
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Lessons to Learn from the
Subprime Meltdown
• Transferring risk does not reduce or
eliminate the risk—and sometimes it can
even increase risk.
• Decoupling risk from responsibility leads
to risky and irresponsible behavior.
• Individual short-term incentives can
overpower logic and collective long-term
consequences.
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Lessons to Learn from the
Subprime Meltdown
• Unregulated private contracts can have
damaging public consequences.
• If something seems too good to be true, it
is.
• Innovation can be dangerous if it
outpaces our ability to understand it or
control it.
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Lessons to Learn from the
Subprime Meltdown
• Leverage can be dangerous, and massive
•
•
•
leverage can be deadly.
The past is not always a reliable guide to the
future.
Computer models and quantitative analysis
must support experience and common sense,
not replace them.
Investors must understand the quality of the
information they use to make investment
decisions.
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Efforts to Prevent another
Banking Crisis
• Dodd-Frank Act
 Legislation passed in 2010 aimed at
reforming the banking industry and offering
consumers greater protection
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Dodd-Frank Act Points of
Emphasis
•
•
•
•
Monitoring for systemic risk
Protecting consumers
Closer scrutiny of the derivatives market
Ending taxpayer bailouts of companies
deemed “too big to fail.”
• Tougher regulation of credit rating
agencies
THE END
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