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Page 1: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

14

Money and Banking

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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 14-2

Page 3: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Money Definition M1

• M1

• Currency

• Checkable deposits

• Institutions offering checkable deposits

• Commercial banks

• Savings and loan associations

• Mutual savings banks

• Credit unions

LO1 14-3

Page 4: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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 14-4

Page 5: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Money Definitions

January 2010

Source: Federal Reserve System

LO1 14-5

Page 6: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

What “Backs” the Money Supply?

• Guaranteed by government’s ability to keep value stable

• Money as debt

• Why is money valuable?

• Acceptability

• Legal tender

• Relative scarcity

LO2 14-6

Page 7: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

What “Backs” the Money Supply?

• Prices affect purchasing power of money

• Hyperinflation renders money unacceptable

• Stabilizing money’s purchasing power• Intelligent management of the money

supply – monetary policy• Appropriate fiscal policy

LO2 14-7

Page 8: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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 14-8

Page 9: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

LO3 14-9

Page 10: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Federal Reserve – Banking System

LO3

The 12 Federal Reserve Banks

14-10

Page 11: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Federal Reserve – Banking System

• Federal Open Market Committee

• Aids Board of Governors in setting monetary policy

• Conducts open market operations

• Commercial banks and thrifts

• 6,800 commercial banks

• 8,700 thrifts

LO3 14-11

Page 12: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Federal Reserve Functions

• Issue currency

• Set reserve requirements

• Lend money to banks

• Collect checks

• Act as a fiscal agent for U.S. government

• Supervise banks

• Control the money supply

LO4 14-12

Page 13: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Federal Reserve Independence

• Established by Congress as an 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

LO4 14-13

Page 14: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Financial Institutions

World’s 12 Largest Financial Institutions, 2009

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)

0 1.5 2.5 3.5

Source: Forbes Global 2000, http://www.forbes.com

Assets (Trillions of U.S. Dollars)

LO4 14-14

Page 15: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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 14-15

Page 16: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

• “Underwater” homeowners abandoned homes and mortgages

LO5 14-16

Page 17: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

LO5 14-17

Page 18: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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 14-18

Page 19: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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 14-19

Page 20: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

The Financial Crisis of 2007 and 2008

• Money Market Investor Funding Facility

• Term Asset-Backed Securities Loan Facility

• Interest Payments on Reserves

LO6 14-20

Page 21: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Post-Crisis U.S. Financial Services

• Major Categories of Financial Institutions• Commercial Banks

• Thrifts

• Insurance Companies

• Mutual Fund Companies

• Pension Funds

• Securities Firms

• Investment BanksLO7 14-21

Page 22: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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

Major Categories of Financial Institutions

LO7 14-22

Page 23: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

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 14-23

Page 24: 14 Money and Banking McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

Electronic Banking

• Electronic-based payment systems have pushed aside currency and checks• Credit/debit cards

• Fedwire transfers

• ACH transactions

• Electronic money

• Stored-value cards

14-24


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1 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter Seven McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc.,

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