Download CH. 20 - Bakersfield College

The Money
Supply and
Banking Systems
Chapter 20
Business in
Action 6e
Bovée/Thill
The Many Faces 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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20-2
The Many Faces of Money (cont.)
 Money Supply
 The amount of money in circulation at any
given point in time
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20-3
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
 Discount Rate
 The interest rate that member banks pay
when they borrow funds from the Fed
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20-5
The Federal Reserve System
 Reserves
 Sums of money, equal to a certain
percentage of their deposits, that banks are
legally required to keep on hand
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20-6
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.
 Our funds are protected ($250,000.00).
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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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20-8
The Financial Services Industry
 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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20-9
The Financial Services Industry (cont.)
 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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20-10
The Financial Services Industry (cont.)
 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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20-11
The Financial Services Industry (cont.)
 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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20-12
The Financial Services Industry (cont.)
 Independent
Mortgage
Companies
 Nonbank
companies that use
their own funds to
offer mortgages
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 Mortgage Brokers
 Nonbank
companies that
initiate loans on
behalf of a
mortgage lender in
exchange for a fee
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The Financial Services Industry (cont.)
 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 (Standard & Poor’s, Moody’s and
Fitch Group).
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20-14
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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20-15
The Housing Bubble
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20-16
Changing the Rules in
Mortgage Lending
 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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Changing the Rules in
Mortgage Lending (cont.)
 Adjustable Rate
Mortgage (ARM)
 A mortgage that
features variable
interest rates over
the life of the loan
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 Option ARM
 A type of ARM that
lets borrowers
choose from
several repayment
options
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Subprime Mortgages
 Prime Mortgages
 Home loans offered to the most creditworthy
customers
 Subprime Mortgages
 Home loans for borrowers with low credit scores
 Default
 A situation in which borrowers stop making
payments on a loan
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The Securitization of Debt
 Securitization
 A process in which debts such as mortgages
are pooled together and transformed into
investments
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20-20
The Securitization of Debt (cont.)
 Asset-Backed
 Mortgage-Backed
Securities (ABSs)
Securities (MBSs)
 Credit derivatives
based on auto
loans, credit card
debts, and other
loan assets
 Credit derivatives
based on home
mortgages
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20-21
Shock to the System
 Foreclosures
 Situations in which lenders take possession
of homes after borrowers default on their
mortgage payments
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20-22
The Meltdown of 2008
The Bubble bursts
Giants fall and markets freeze
The great recession
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20-23
Giants Fall and Markets Freeze
 Liquidity Crisis
 A severe shortage of liquidity (Cash)
throughout a sector of the economy or the
entire economy, during which companies
can’t get enough cash to meet their operating
needs
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20-24
Giants Fall and Markets Freeze (cont.)
 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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20-25
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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20-26
Lessons to Learn from the
Subprime Meltdown (cont.)
 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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20-27
Lessons to Learn from the
Subprime Meltdown (cont.)
 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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20-28
Efforts to Prevent another
Banking Crisis
 Dodd-Frank Act
 Legislation passed in 2010 aimed at
reforming the banking industry and offering
consumers greater protection (Bank accounts
and on loans).
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20-29
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
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20-30