money, banking, and financial institutions 14 mcgraw-hill/irwincopyright © 2012 by the mcgraw-hill...
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Money, Banking, and Financial Institutions
14
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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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
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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.
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Money Definition M1
• M1• Currency & coins• Checkable deposits
• Only the most liquid assets are included.
• Coins are token money• Excludes money held by government
and banks.
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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)
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Money Definitions
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What “Backs” the Money Supply
• Money as debt
• Stable value of money
• Acceptability
• Legal tender
• Relative scarcity
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What “Backs” the Money Supply
• Prices affect purchasing power of money – inverse relationship• Hyperinflation renders money
unacceptable
• Stabilizing money’s purchasing power• Intelligent management of the money
supply – monetary policy• Appropriate fiscal policy
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Federal Reserve - Banking System
• Historical background
• Board of Governors
• Basic policy making body of U.S. banking system.
• 7 members appointed by president
• 14 year terms, staggered
• Chair/Vice Chair 4 year terms.
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Federal Reserve - Banking System
• 12 Federal Reserve Banks
• Serve as the central bank
• Quasi-public banks
•Public control, private ownership
• Banker’s bank
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Federal Reserve – Banking System
Commercial BanksThrift Institutions
(Savings and Loan Associations,Mutual Savings Banks,
Credit Unions)
The Public(Households and
Businesses)
12 Federal Reserve Banks
Board of Governors
Federal Open Market Committee
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Federal Reserve – Banking System
The 12 Federal Reserve Banks
Source: Federal Reserve Bulletin
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Federal Reserve – Banking System
• Federal Open Market Committee
• Conducts open market operations
• Includes Board of Governors and 5 presidents of Federal Reserve Banks
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Federal Reserve Functions
• Issue currency• Set reserve requirements• Lend money to banks • Check collection• Fiscal agent for U.S. government• Supervise banks• Control the money supply
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Federal Reserve Independence
• Established by Congress as independent agency
• Protects the Fed from political pressures
• Enables Fed to take actions to increase interest rates to stem inflation as needed
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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
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The Financial Crisis of 2007 and 2008
• Securitization- the process of slicing up and bundling groups of loans into new securities
• As loans defaulted the system collapsed
• AIG sold collateralized default swaps to insure bad loans
• “Underwater” homeowners abandoned homes and mortgages
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The Financial Crisis of 2007 and 2008
• Failures and Near-Failures of Financial Firms
• Countrywide-second largest lender
• Washington Mutual-largest lender
• Wachovia
• Other firms came close
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The Financial Crisis of 2007 and 2008
• Troubled Asset Relief Program (TARP)• Allocated $700 billion to make
emergency loans
• Saved several institutions from failure
• Created moral hazard
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Post-crisis U.S. Financial Services
• Wall Street Reform and Consumer Protection Act
• Passed to help prevent many of the practices that led to the crisis
• Critics say it adds heavy regulatory costs
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