Chapter 14: Money, Banking, and Financial Institutions

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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Money, Banking, and Financial InstitutionsMcGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Functions of Money Medium of exchangeUsed to buy/sell goodsUnit of accountGoods valued in dollarsStore of valueHold some wealth in money formMoney is liquidLO1Money Definition LO1M1M2CurrencyCheckable depositsInstitutions offering checkable depositsCommercial banksSavings and loan associationsMutual savings banksCredit unionsM1 plus near-moniesSavings deposits including money market deposit accounts (MMDA)Small-denominated time depositsMoney market mutual funds (MMMF)What “Backs” the Money Supply?Guaranteed by government’s ability to keep value stableMoney as debtWhy is money valuable?AcceptabilityLegal tenderRelative scarcityLO2What “Backs” the Money Supply?Prices affect purchasing power of moneyHyperinflation renders money unacceptableStabilizing money’s purchasing powerIntelligent management of the money supply – monetary policyAppropriate fiscal policyLO2Federal Reserve - Banking SystemHistorical backgroundBoard of Governors12 Federal Reserve Banks Serve as the central bankQuasi-public banksBanker’s bankLO3Federal Reserve – Banking SystemCommercial BanksThrift Institutions(Savings and Loan Associations,Mutual Savings Banks, Credit Unions)The Public(Households andBusinesses)12 Federal Reserve BanksBoard of GovernorsFederal Open Market CommitteeLO3Federal Reserve – Banking SystemLO3The 12 Federal Reserve BanksFederal Reserve – Banking SystemFederal Open Market CommitteeAids Board of Governors in setting monetary policyConducts open market operationsCommercial banks and thrifts6,800 commercial banks8,700 thriftsLO3Federal Reserve FunctionsIssue currencySet reserve requirementsLend money to banks Collect checksAct as a fiscal agent for U.S. governmentSupervise banksControl the money supplyLO4Federal Reserve IndependenceEstablished by Congress as an independent agencyProtects the Fed from political pressuresEnables the Fed to take actions to increase interest rates in order to stem inflation as neededLO4Financial InstitutionsWorld’s 12 Largest Financial Institutions, 2009Royal 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)0 1.5 2.5 3.5 Source: Forbes Global 2000, (Trillions of U.S. Dollars)LO4The Financial Crisis of 2007 and 2008Mortgage Default CrisisMany causesGovernment programs that encouraged home ownershipDeclining real estate valuesBad incentives provided by mortgage-backed bondsLO5The Financial Crisis of 2007 and 2008Securitization: the process of slicing up and bundling groups of loans into new securitiesAs loans defaulted, the system collapsed“Underwater” homeowners abandoned homes and mortgagesLO5The Financial Crisis of 2007 and 2008Failures and near-failures of financial firmsCountrywide: second largest lenderWashington Mutual: largest lenderWachoviaOther firms came closeLO5The Financial Crisis of 2007 and 2008Troubled Asset Relief Program (TARP)Allocated $700 billion to make emergency loansSaved several institutions from failureLO6The Financial Crisis of 2007 and 2008The Fed’s lender-of-last-resort activitiesPrimary Dealer Credit FacilityTerm Securities Lending FacilityAsset-Backed Commercial Paper Money Market Mutual Fund Liquidity FacilityCommercial Paper Funding FacilityLO6The Financial Crisis of 2007 and 2008Money Market Investor Funding FacilityTerm Asset-Backed Securities Loan FacilityInterest Payments on ReservesLO6