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*Chapter Twenty

Money, Financial

Institutions, and the Federal Reserve

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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• A former economics professor at Princeton.

• Former President George W. Bush appointed him Chairman of the Federal Reserve in 2006.

• Almost every factor related to the economy is influenced by the choices he makes.

BEN BERNANKEFederal Reserve

Profile

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• Money -- Anything people generally accept as payment for goods and services.

WHAT’S MONEY? What is Money?

LG1

• Barter -- The direct trading of goods or services for other goods or services.

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• Portability

• Divisibility

• Stability

• Durability

• Uniqueness

STANDARDS for a USEFUL FORM of MONEY

What is Money?

LG1

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• Money Supply -- The amount of money the Federal Reserve makes available for people. The money supply is referred to as:

- M1 -- Money that can be accessed quickly (coins, paper money, travelers’ checks, etc.).

- M2 -- M1 + money that may take a little time to obtain (savings accounts, mutual funds, etc.).

- M3 -- M2 + big deposits like institutional money market funds.

The MONEY SUPPLYWhat is the Money Supply?

LG2

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*HOW LONG DOES

PAPER MONEY LAST?LG2

What is the Money Supply?

Bill How Long it Lasts

$1 21 Months

$5 16 Months

$10 18 Months

$20 24 Months

$50 55 Months

$100 89 Months

Source: Federal Reserve, www.federalreserve.gov. 20-6

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*MONEY MILESTONES

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What is the Money Supply?

Year Milestone

1956 Congress set the minimum wage at $1 an hour

1960 $10 million presidential campaign by candidate Richard Nixon

1985 $100,000 bottle of wine sold at auction at Christie’s

1995 $1 million cost for a 30-second commercial during Super Bowl XXIX

2001 $10 movie ticket in New York

2004 $100 million Picasso painting sold at Sotheby’s

2007 $1 billion stadium built in London (Wembly)

Source: Conde Nast Portfolio20-7

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• Falling dollar value: The amount of goods and services you can buy with a dollar decreases.

• Rising dollar value: The amount of goods and services you can buy with a dollar increases.

• What makes the dollar fall or rise is the position of the U.S. economy relative to other global economies.

EXCHANGING MONEY GLOBALLYThe Global Exchange of Money

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*The IMPACT of a

FALLING DOLLARLG2

The Global Exchange of Money

• Overseas demand for U.S. products rise.

• A favorable exchange rate for U.S. companies earning profits in foreign markets is provided.

• U.S. tourism increases which is good for hotels, resorts, theme parks, and retailers that serve international travelers.

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1. The Board of Governors

2. The Federal Open Market Committee

3. 12 Federal Reserve Banks

4. 3 Advisory Councils

5. The member banks of the system

FIVE MAJOR PARTS of the FEDERAL RESERVE SYSTEM

Basics About the Federal Reserve

LG2

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*The 12 FEDERAL RESERVE

DISTRICT BANKS

Basics About the Federal Reserve

LG2

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• The Fed uses three basic tools:

1. Reserve Requirement -- A percentage of commercial banks’ checking and savings accounts they must keep in the bank or in non-interest-bearing deposits at the local Federal Reserve district bank.

2. Open-Market Operations -- The buying and selling of government bonds.

3. Discount Rate -- The interest rate the Fed charges for loans to member banks.

MANAGING the MONEY SUPPLYBasics About the Federal Reserve

LG2

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• What’s money?

• What are the five characteristics of useful money?

• What’s the money supply, and why is it important?

• How does the Federal Reserve control the money supply?

• What are the major functions of the Federal Reserve? What other functions does it perform?

PROGRESS ASSESSMENTProgress Assessment

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*CHECK-CLEARING PROCESS

THROUGH the FEDERAL RESERVE

Basics About the Federal Reserve

LG2

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• A cash shortage problem in 1907 led to the creation of the Federal Reserve System.

The ESTABLISHMENT of the FEDERAL RESERVE SYSTEM

The History of Banking and the Need for the Fed

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• Under the Federal Reserve Act of 1913, all federally chartered banks had to join the Federal Reserve.

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*LARGEST BANK FAILURES

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Bank Year Assets

Washington Mutual Bank 2008 $307 Billion

Continental Illinois NB&T 1984 $67 Billion

First Republic Bank Corp 1986 $49 Billion

American Savings & Loan Assn 1988 $45 Billion

IndyMac Bank 2008 $32 Billion

The History of Banking and the Need for the Fed

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• Commercial banks

• Savings and loan associations

• Credit unions

• Nonbanks

The U.S. BANKING SYSTEMThe U.S. Banking System

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• Commercial Bank -- A profit-seeking organization that receives deposits from individuals and corporations in the form of checking and savings accounts and uses those funds to make loans.

• A commercial bank has two types of customers:

1. Depositors

2. Borrowers

COMMERCIAL BANKSCommercial Banks

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• Demand Deposit -- The technical name for a checking account; money is available on demand from the depositor.

• Time Deposit -- A savings account; a bank can require a prior notice before you make a withdrawal.

• Certificate of Deposit -- A savings account that earns interest, to be delivered on the certificate’s maturity date.

COMMERICAL BANKS’ SERVICES

Services Provided by Commercial Banks

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• The bank teller mistakenly gives you $320 instead of the $300 you asked for.

• You bring the error to her attention, but she disagrees she miscounted the money.

• You wonder whether to just keep the extra $20 even though you know her accounts will not balance at the end of the day.

• What are your alternatives? What do you do?

WHAT to TELL the TELLERMaking Ethical Decisions

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• Savings and Loan Associations (S&Ls) -- A financial institution that accepts both savings and checking deposits and provides home mortgage loans.

• Often known as thrift institutions because their original purpose was to promote customer thrift and home ownership.

SAVINGS and LOAN ASSOCIATIONS

Savings and Loan Associations

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• Credit Unions -- Nonprofit, member-owned financial cooperatives that offer the full variety of banking services to their members.

CREDIT UNIONS Credit Unions

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• As nonprofits, credit unions enjoy an exemption from federal income taxes.

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• Nonbanks -- Financial institutions that accept no deposits, but offer many of the services provided by regular banks. Nonbanks include:

- Life insurance companies

- Pension funds

- Brokerage firms

- Commercial finance companies

- Corporate financial services

NONBANKSOther Financial Institutions

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*WHAT ATTRACTS CUSTOMERS

to ONLINE BANKINGLG4

• Free identity theft protection

• Free credit score monitoring

• Personal financial management

• Instant messaging service

• Bank’s blog

Source: www.comscore.com.

Other Financial Institutions

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• Why did the U.S. need a Federal Reserve Bank?

• What’s the difference between a bank, a savings and loan association, and a credit union?

• What’s a consumer finance company?

PROGRESS ASSESSMENTProgress Assessment

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• The tightening of loan money led small businesses to seek alternative sources of funds.

• Angel investors can be a source of funds for some firms, especially high-growth firms in technology or biotech.

• Peer-to-peer lending is an alternative source of capital.

HOW the BANKING CRISIS AFFECTED SMALL BUSINESS

Spotlight on Small Business *

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• The Federal Deposit Insurance Corporation (FDIC) -- An independent agency of the U.S. government that insures bank deposits up to $100,000 ($250,000 until December 2013).

• The Savings Association Insurance Fund (SAIF) -- Insures holders of accounts in savings and loan associations.

• The National Credit Union Administration (NCUA) -- Provides up to $100,000 coverage per individual depositor per institution.

PROTECTING DEPOSITORS’ MONEY

Protecting Your Funds

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• The banking crisis of 2008-2009 wasn’t limited to the U.S., even high growth nations felt the pinch.

• The International Monetary Fund (IMF) has received requests from countries like Pakistan, Ukraine, Hungary, Turkey, and Bahrain.

• Many nations are wondering where future funds will come from.

The BANKING CRISIS GOES GLOBAL

Reaching Beyond Our Borders

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• Electronic Funds Transfer System -- Messages about a transaction are sent from one computer to another so firms can transfer funds quickly and more economically.

• Debit Card -- Serves the same function as a check; it withdrawals funds from a checking account.

TECHNOLOGICAL ADVANCEMENTS in BANKING

Using Technology to Make Banking More Efficient

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• Smart Card -- A combination of a credit card, debit card, phone card, driver’s license, and more.

SMART CARDSUsing Technology to Make Banking More Efficient

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• Letter of Credit -- A promise by the bank to pay the seller a given amount if certain conditions are met.

• Banker’s Acceptance -- A promise the bank will pay some specified amount at a particular time.

• Money exchange allows companies to go to a bank and exchange currencies to use in a particular country (i.e. dollars for euros).

MAKING TRANSACTIONS in OTHER COUNTRIES

International Banking and Banking Services

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• World Bank -- Lends most of its money to less-developed nations to improve their productivity and help raise standards of living and quality of life.

• International Monetary Fund (IMF) -- Fosters cooperative monetary policies that stabilize the exchange of one national currency for another. About 185 countries are a part of the IMF.

LEADING INSTITUTIONS in INTERNATIONAL BANKING

LG7

International Banking and Banking Services

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• What are some of the causes for the banking crisis of 2008-2009?

• What’s the role of the FDIC?

• How does a debit card differ from a credit card?

• What’s the World Bank and what does it do?

• What’s the IMF and what does it do?

PROGRESS ASSESSMENTProgress Assessment

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