14 Money, Banking, and Financial Institutions McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Chapter Objectives • • • • The functions of money Components of the money supply What “backs” the money supply The Federal Reserve and the U.S banking system • The functions and responsibilities of the Federal Reserve 31-2 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 LO1 14-3 Money Definition M1 • M1 • Currency • Checkable deposits • Institutions offering checkable deposits • Commercial banks • Savings and loan associations • Mutual savings banks • Credit unions LO1 14-4 Money Definition M2 • M2 • M1 plus near-monies • Savings deposits including money market deposit accounts (MMDA) • Small-denominated time deposits • Money market mutual funds (MMMF) LO1 14-5 Money Definitions January 2010 Source: Federal Reserve System LO1 14-6 What “Backs” the Money Supply? • Guaranteed by government’s ability to • • LO2 keep value stable Money as debt Why is money valuable? • Acceptability • Legal tender • Relative scarcity 14-7 What “Backs” the Money Supply? • Prices affect purchasing power of • • LO2 money Hyperinflation renders money unacceptable Stabilizing money’s purchasing power • Intelligent management of the money supply – monetary policy • Appropriate fiscal policy 14-8 Federal Reserve Video Federal Reserve - Banking System • Historical background • Board of Governors • 12 Federal Reserve Banks • Serve as the central bank • Quasi-public banks • Banker’s bank LO3 14-10 Federal Reserve Functions • Issue currency • Set reserve requirements • Lend money to banks • Collect checks • Act as a fiscal agent for U.S • • LO4 government Supervise banks Control the money supply 14-14 Federal Reserve Independence • Established by Congress as an • • LO4 independent agency Protects the Fed from political pressures Enables the Fed to take actions to increase interest rates in order to stem inflation as needed 14-15 Financial Institutions World’s 12 Largest Financial Institutions, 2009 Assets (Trillions of U.S Dollars) 1.5 2.5 3.5 Royal Bank of Scotland (UK) Barclays (UK) Deutsche Bank (Germany) BNP Paribas (France) HSBC Holdings (UK) JPMorgan Chase (US) Credit Agricole (France) Citigroup (US) Mitsubishi UFJ (Japan) UBS (Switzerland) ING Group (Netherlands) Bank of America (US) Source: Forbes Global 2000, http://www.forbes.com LO4 14-16 The Global Greenback • U.S currency circulating abroad – Russia $80 billion – Argentina $50 billion – $450 billion total – 60% of total US currency • • • • U.S profits from dollars leaving Black markets and illegal activities Dollar offers stable purchasing power Exchange rate risk 31-17 The Financial Crisis of 2007 and 2008 • Mortgage Default Crisis • Many causes • Government programs that encouraged home ownership • Declining real estate values • Bad incentives provided by mortgage-backed bonds LO5 14-18 The Financial Crisis of 2007 and 2008 • Securitization- the process of slicing • • LO5 up and bundling groups of loans into new securities As loans defaulted, the system collapsed “Underwater” homeowners abandoned homes and mortgages 14-19 The Financial Crisis of 2007 and 2008 • Failures and near-failures of financial • LO5 firms • Countrywide: second largest lender • Washington Mutual: largest lender • Wachovia Other firms came close 14-20 The Financial Crisis of 2007 and 2008 • Troubled Asset Relief Program (TARP) • Allocated $700 billion to make emergency loans • Saved several institutions from failure LO6 14-21 The Financial Crisis of 2007 and 2008 • The Fed’s lender-of-last-resort activities • Primary Dealer Credit Facility • Term Securities Lending Facility • Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility • Commercial Paper Funding Facility LO6 14-22 The Financial Crisis of 2007 and 2008 • Money Market Investor Funding Facility • Term Asset-Backed Securities Loan Facility • Interest Payments on Reserves LO6 14-23 Post-Crisis U.S Financial Services • Major Categories of Financial Institutions • Commercial Banks • Thrifts • Insurance Companies • Mutual Fund Companies • Pension Funds • Securities Firms • Investment Banks LO7 14-24 Major Categories of Financial Institutions LO7 Institution Description Examples Commercial Banks State and national banks that provide checking and savings accounts and make loans JP Morgan Chase, Bank of America, Citibank, Wells Fargo Thrifts Savings and loan associations, mutual savings banks, credit unions that offer checking and savings accounts and make loans Charter One, New York Community Bank Insurance Companies Firms that offer policies through which individuals pay premiums to insure against lose Prudential, New York Life, Northwestern Mutual, Hartford Mutual Fund Companies Firms that pool customer deposits to purchase stocks or bonds Fidelity, Vanguard, Putnam, Janus, T Rowe Price Pension Funds Institutions that collect savings from workers throughout their working years and then invest the funds to pay retirement benefits TIAA-CREF, Teamsters’ Union, CalPERs Securities Firms Firms that offer security advice and buy and sell stocks and bonds for clients Merrill Lynch, Smith Barney, Charles Schwab Investment Banks Firms that help corporations and governments raise money by selling stocks and bonds Goldman Sachs, Morgan Stanley, Deutsche Bank, Nomura Securities 14-25 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 LO7 14-26 Electronic Banking • Electronic-based payment systems have pushed aside currency and checks • Credit/debit cards • Fedwire transfers • ACH transactions • Electronic money • Stored-value cards 14-27 Key Terms • • • • • • • • • • • • • medium of exchange unit of account store of value M1 Federal Reserve Notes token money checkable deposits commercial banks thrift institutions near-monies M2 savings account money market deposit account (MMDA) • time deposits • money market mutual fund (MMMF) • legal tender • Federal Reserve System • Board of Governors • Federal Reserve Banks • Federal Open Market Committee (FOMC) • financial services industry • electronic payments 31-28 ... 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 LO1 14- 3 Money Definition... Prices affect purchasing power of • • LO2 money Hyperinflation renders money unacceptable Stabilizing money’s purchasing power • Intelligent management of the money supply – monetary policy •... Merrill Lynch, Smith Barney, Charles Schwab Investment Banks Firms that help corporations and governments raise money by selling stocks and bonds Goldman Sachs, Morgan Stanley, Deutsche Bank,