Monday, April 27

• Welcome back! I hope you had a great weekend!

• Senior countdown: • Bellringer:– What are the three functions of money? List and

describe each. (You can use a chart format, if you like.)

– Alt. bellringer: Give three examples of things that would not be accepted as currency. Describe specific reasons why they would not be accepted.

Functions of money

• What are the three functions of money? Complete this chart in your notes

Medium of exchange anything that is used to determine value during the exchange of goods and services

Unit of account a means for comparing the values of goods and services

Store of value something that keeps its value if it is stored instead of used

American banking

• Bank: an institution for receiving, keeping, and lending money

• Like everything else, banks and banking services have developed to meet the changing needs of a growing and changing population

U.S. banking history

• Five time periods

Colonial times – Civil War

Late 1800s

Early 1900s

Later 1900s

History of American banking

• Before the Civil War–Merchants performed the functions of banks• For a small fee, customers could deposit

money for safekeeping• For a small fee, customers could take out a

loan– But it was risky …• If a merchant-bank went out of business …

Framers agreed on the main goals:

Safe, stable banking system

• Increasing trade with other countries

• Ensuring economic growth of the U.S.

Two views of banking

Antifederalists: T. JeffersonStronger state governments

Decentralized banking systemStates would regulate banks

Federalists: A. HamiltonStrong central governmentCentralized banking system

National bank

First Bank of the United States

• Chartered in 1791• Purposes:– Hold tax money the government collected– To help tax, borrow money in the public interest,

and regulate foreign and interstate commerce– Issue bank notes backed by gold and silver– Oversee state-chartered banks to be sure that

they held enough gold and silver for bank note exchange

First Bank of the United States

• Proponents celebrated its success in bringing order and stability to American banking

• But opponents continued to jeer:– Would the bank loan to ordinary folks, or just

wealthy people and large businesses?– Banking is not an enumerated power of the

national government

First Bank of the United States

• Hamilton was killed in a duel in 1804• The bank’s charter ran out in 1811, leaving

state-chartered banks to fill the void• Things went sour …– Banks issues notes they couldn’t back up– They chartered banks with questionable financial

footing

Chaos ensued!

• Prices rose• No one trusted the paper money in circulation• Currencies differed• Banks printed without regard for what they

could actually back up• Merchants began distinguishing between notes

they trusted, which they would accept, and those they didn’t, which they would refuse

Second Bank of the United States

• Congress chartered it in 1816• Twenty-year charter• People began to regain trust in the system• The Supreme Court ruled it constitutional in

1819• But Andrew Jackson vetoed the new charter in

1832, leading to the Free Banking Era

The Free Banking Era

• Also known as the “Wildcat” Era• State-chartered banks regained dominance– Lots of bank runs– Wildcat banks: Located in rural areas, on

settlement outposts, they failed often– Fraud: Unscrupulous bankers took gold and silver

in exchange for worthless notes, then disappeared– Currency carousel: Pretty much everyone could

issue currency, and much of it was counterfeit

The Civil War

• By 1860, there were about 8,000 different banks circulating currency

• When the Civil War broke out, both sides needed to raise money to finance war efforts:

• 1861: U.S. Treasury issues demand notes,

or “greenbacks”• This was the first

paper currency since the Continental

• The Confederacy issued currency

backed by cotton• But the currency

dwindled to worthlessness over

the course of the war

The Civil War

• National Banking Acts of 1863 and 1864–Designed to restore confidence in paper

currency–Gave federal government specific powers:• Charter banks• Require banks to hold enough gold and silver

reserves to cover their bank notes• Issue a single national currency

The gold standard

• In the 1870s, the country adopted the gold standard–Advantages of the gold standard:• The dollar has a definite value: People

were more confident about what the paper money stood for– Increasing acceptability!

• No gold in reserve, no printing new notes

Banking in the early 1900s

• The gold standard helped stabilize the system• But it didn’t bestow central decision-making

authority• Panic of 1907: Banks had to quit exchanging

gold for paper money– Bank failures– Job losses

Banking in the early 1900s

• Federal Reserve System was created in 1913• “The Fed,” for short• Created under President Woodrow Wilson,

this was the first central bank in the U.S.–Central bank: a bank that can lend to other

banks in times of need

Banking in the early 1900s

• The Fed reorganized the federal banking system:– Member banks: 12 regional Federal Reserve banks

around the country– Federal Reserve Board, appointed by the

President– Short-term loans to member banks by region: To

help relieve pressure when many depositors withdrew at once

Banking in the early 1900s

• The Fed reorganized the federal banking system:– Federal Reserve notes: a/k/a, the money you use

today• If it is consistent, the government can control

the supply of it• How it’s made!

Investigate• Read this (“What to watch in economic news this week,”

from USA Today, 4/26/2015), then answer (with research):– WHO is the chairman of the Federal Reserve?– WHAT is the current benchmark rate?– WHEN is the next meeting of the Federal Reserve Board?– WHERE are the 12 regional banks of the Federal Reserve?– WHY does the Federal Reserve Board set a benchmark rate?

• This is due on Wednesday, 4/29.

The Great Depression

• During the (roaring) 1920s, banks loaned big– High-risk businesses– Farmers faced crop failures– After the 1929 crash, nervous investors rushed to

withdraw their money

• Thousands of banks failed across the U.S.

FDR• FDR moved to restore public confidence in the

banking system• “Bank holiday,” March 5, 1933: All banks closed for

inspection … and only financially sound ones would reopen

• Federal Deposit Insurance Corporation (FDIC): Insures deposits up to $250,000

• People were restricted from exchanging dollars for gold

• Currency became fiat money

Banking in the later 20th century

• Bank closures continued through the 1960s• Banks were heavily restricted– Interest rates for depositors– Loan rates– Loan clientele

• These rules regulated banks at the expense of their profits

• They began clamoring for expanded freedom of operation

Banking in the later 20th century

• Deregulation began in the late 1970s-early 1980s• The Savings and Loans (S&L) crisis:– Deregulation: S&Ls were unprepared for competition– High interest rates: S&Ls had to pay high rates to

their depositors, but they were receiving low rates on money loaned out before deregulation

– Bad loans: Risky businesses– Fraud: Large loans to obviously weak ventures

Banking in the later 20th century

• As a result of the S&L crisis, Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA)–Abolished the independence of the S&L

industry– Transferred insurance responsibilities to the

FDIC

Recent trends

• 1999: Glass-Steagall Act was repealed–Banks could sell assets, like stocks and

bonds–Banks could set new rules for customer

data• Bank mergers

Banking today

• Money supply: All the money available in the United States economy– Currency– Traveler’s checks– Checking account deposits– Other things …

Banking today

• Money supply– M1: Money people can gain access to easily and

immediately to pay for goods and services• Liquidity: the ability to be used as, or directly

converted to, cash• Demand deposits: the money in checking

accounts• See Figure 10.5, p. 259

Banking today

• Money supply– M2: All of the assets in M1, PLUS funds that

cannot be used as cash directly, but can be converted to cash fairly easily• Money market mutual fund: a fund that pools

money from small savers to purchase short-term government and corporate securities

• Which is larger, M1 or M2?

Functions of financial institutions

• Storing money: Safe, convenient• Saving money– Savings accounts– Checking accounts– Money market accounts– Certificates of deposit (CDs)

Method DescriptionSavings accounts • Most common

• Good for frequent withdrawals• Pay a small amount of interest at an annual rate

Checking accounts

Money market accounts

• Higher rate of interest than savings and checking accounts• Save and write a limited number of checks• Interest rates move up and down

Certificates of deposit (CDs)

• Higher rate of interest than savings and checking accounts• Guaranteed rate of interest over a certain period of time• Funds can’t be removed until the end of the time period without a penalty

Functions of financial institutions

• Loans– Fractional reserve banking: a banking system that

keeps only a fraction of funds on hand and lends out the remainder• Home improvements• College tuition• Business expansion

– More money loaned out = higher interest rate charged to borrowers = more profit

– Default: failure to pay back a loan

Functions of financial institutions

• Mortgage: A specific type of loan used to buy real estate– Involves a down payment– Interest rate based on credit– 15-, 25-, 30-year terms– … plus interest!

Functions of financial institutions

• Credit card: a card entitling its holder to buy goods and services based on the holder’s promise to pay for those goods and services– Mini-loans, monthly– You get instant gratification– The bank gets interest– Watch out!

Functions of financial institutions

• Interest: The price paid for the use of borrowed money

• Principle: the amount of money borrowed• Simple interest = P x I x N– P is the loan amount– I is the interest rate– N is the duration of the loan, using number of

periods

Functions of financial institutions• Compound interest: Interest calculated on the initial

principal and also on the accumulated interest of previous periods of a deposit or loan; ‘interest on interest’

• Compound Interest = [P (1 + i)n] – P• = P [(1 + i)n – 1]– P = Principal, i = nominal annual interest rate in percentage

terms, and n = number of compounding periods

• This is the bad and scary kind, as it relates to credit cards. See Figure 10.7, p. 261.

Functions of financial institutions

• Banks and profit– Banks pay out interest on customers’ savings and

most checking accounts– Banks’ largest source of income is loan interest– Profit = Loan interest - Savings/Checking account

interest

Types of financial institutions

• Commercial banks• Savings and loan associations• Savings banks• Credit unions• Finance companies

Types of financial institutions

• Create a chart in which you compare the functions and characteristics of the five types of financial institutions

• Consider purposes, products offered, clients targeted, protections available, interest rates, and any other defining characteristic

• This is due on Wednesday, April 29.

Electronic banking

• Automated Teller Machines (ATMs)– Convenience– Replacing bank tellers– Cost for access

• Debit card: A card used to withdraw money– PINs for security– Works like a checkbook– You can overdraw!

Electronic banking

• Home banking– Via the Internet– Cell phones apps can scan your check!

• Automatic Clearing Houses (ACHs)– Federal Reserve Banks and branches– Customers can transfer funds directly, without writing

checks• Creditor: a person or institution to whom money is

owed

–Good for regular bills, like mortgages

Electronic banking

• Stored value cards (smart cards)– Similar to debit cards– Account balance information– Prepaid cards for various purposes– States are using them for benefits programs

Banking info

• Due Wednesday: The two exercises on slides 19 and 38

• Be sure to check Moodle tomorrow if you aren’t in class!

• Test Thursday!