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Lecture 07 GEB1011 Chapter 15 Money and the Financia !

y"te#

Rev. 01/12/13

Money de$ined% Money i" anythin& that i" 'generally accepted( in e)chan&e $or &ood" and "ervice". Many "ocietie" have u"ed #any di$$erent thin&" over ti#e to inc ude "he "* "a t* +ead". roc,"* &o d* "i ver* and paper #oney. Function" o$ Money% Mediu# o$ e)chan&e Mea"ure o$ va ue !tore o$ va ue Characteri"tic" o$ Money% -ccepta+i ity .ivi"i+i ity /orta+i ity !ta+i ity "a#e a" !tore o$ 0a ue .i$$icu ty to counter$eit 1ype" o$ Money Co##odity Money 2 #oney that i" #ade $ro# preciou" #eta "* and the ori&ina 3ei&ht va ue o$ the coin and the #oney va ue o$ the coin 3ere e4ua * +ut thi" ratio can chan&e over ti#e. !pecie Money 2 paper #oney that derive" i" va ue $ro# a "upp y o$ a preciou" #eta "uch a" &o d he d in the 1rea"ury o$ a country. Fiat Money 2 paper #oney that ha" no connection to any preciou" #eta . 5t" va ue a" ' e&a tender( i" decreed +y '$iat( to +e "o +y the &overn#ent i""uin& it. C a""i$ication" 3ithin the Money !upp y% M1 6 -#ount o$ coin* paper currency* and chec,in& account +a ance" 7n y M61 i" 1rue Money i.e. accepted in e)chan&e $or &ood" and "ervice". M62 i" con"idered 'near #oney( "ince it i" ea"i y and 4uic, y converted into M61. M2 6 -#ount o$ coin. /aper currency* chec,in& account +a ance"* "avin&" account"* #oney #ar,et account"* and C.8" under 9100*000.00 M3 6 -#ount o$ coin* paper currency* chec,in& account +a ance"* "avin&" account"* #oney #ar,et account"* a C.("* Eurodo ar"* non6 +an, pu+ ic ho din&" o$ :.!. !avin&" Bond"* 1rea"ury Bi "* and other "hort ter# "ecuritie". 1hi" i" the ea"t i4uid o$ the three +ecau"e there i" a on&er 3aitin& period $or conver"ion to M61.

.eve op#ent o$ 'Fractiona Re"erve( Ban,in& Go d"#ith" o$ the Midd e -&e" 1he Ban, o$ En& and :nited !tate" Evo ution o$ Ban,in& in the :.!. 1he Fir"t Ban, o$ the :nited !tate" 17;1 2 1<11 1he !econd Ban, o$ the :nited !tate" 1<1= 2 1<3= /rior to 1<3< a +an, charter cou d +e o+tained on y +y a "peci$ic e&i" ative act* +ut in that year >e3 ?or, adopted the Free Ban,in& -ct a o3in& anyone that co#p ied 3ith the charter provi"ion" to receive a +an, charter 1<3= 6 1<=3 a +an,in& 3a" done +y "tate chartered +an," a@ :.!. 1rea"ury #inted coin +ut had no authority to print paper #oney +@ /aper #oney durin& thi" ti#e 3a" printed under !tate authority +y "tate chartered +an," and even private co#panie". 1he va ue o$ thi" currency 3a" &reat y "u"pect out"ide the oca area o$ +u"ine"" "o the :nited !tate" had no rea e$$ective nationa paper currency. 1<=3 Con&re"" pa""ed the '>ationa Ban, -ct( e"ta+ i"hin& $edera y chartered +an," &ivin& ri"e to the '.ua Ban,in& !y"te#( a@ >o3 the"e nationa y charted +an," cou d print paper currency +@ Ao3ever the"e nationa y chartered +an," on y 3ere oca in "cope +y a3 and did not have nationa +ranche". c@ 1here$ore* a rea and e$$ective nationa printed currency "ti did not e)i"t. d@ >ation3ide +u"ine"" activity 3a" ha#pered. 7ver the year" /anic o$ 1;07 B5n tho"e day" /anic 3a" u"ed a" 3e u"e Rece""ion today@ a@ !y"te#ic cau"e" o$ the panic o$ 1;07 i. 1here 3a" no centra +an,in& authority in the :.!.. ii. >e3 ?or, +an," 3ere the ar&e"t +an," and "erved a" i4uidity +ac,up $or "#a er +an," throu&h the country. iii. 1he :.!. a&ricu tura harve"t and tran"portation to the ea"tern #ar,et" and Europe put i4uidity pre""ure" on the >e3 ?or, +an," each $a harve"t "ea"on iv. 5n nor#a year" thi" 3ou d cau"e the >e3 ?our +an," to rai"e intere"t" paid to depo"itor" attractin& a ne3 depo"it o$ &o d $ro# En& and into >e3 ?or, +an," increa"in& the :.!. #oney "upp y to "upport thi" harve"t activity. v. 1he 1;0= 2 07 ti#e period 3a" not nor#a 1. -pri 1;0= the !an Franci"co earth4ua,e "truc, puttin& e)tra pre""ure on the >e3 ?or, +an," to $inance the recon"truction".

2. 5n Cu y 1;0= the 5nter"tate Co##erce Co##i""ion -ct 3a" pa""ed "ettin& up the 5CC to re&u ate rai road $rei&ht rate". 1hi" depre""ed the va ue o$ rai road "toc,". 3. 5n Cu y an o$$erin& o$ >e3 ?our City +ond" $ai . D. 5n the $a o$ 1;0= the Ban, o$ En& and rai"ed it intere"t" rate" paid depo"itor" to cover in"urance o"e" in the :.!. ,eepin& #ore #oney in En& and and e"" to +e depo"ited in >e3 ?or, +an,". 5. Bet3een !epte#+er 1;0= to March 1;07 "toc," " id o"in& 7.7E o$ their capita iFation and another ;.<E +e$ore the end o$ March 1;07. 1he :nion /aci$ic R.R* "toc, 3hich 3a" u"ed a" co atera +y +an," $e +y 50E in it va ue. =. By !epte#+er 1;07 the "toc, #ar,et 3a" 2D.DE o3er than in Canuary. 7. Ban, run" 3ere occurrin& out"ide the :nited !tate" in E&ypt* Capan* and Chi e vi. 1he /anic o$ 1;07 o$$icia y +e&in" in 7cto+er 3hen 7tto AeinFe." "che#e to #anipu ate :nited Copper8" "toc, on Ga !treet $ai ed. 7tto8" +rother F. -u&i"tu" AeinFe 3a" head o$ :nited Copper Co. in Butte and 3ho 3ho had Hu"t re ocated hi" per"ona re"idence $ro# Butte* Montana to >e3 ?or, City in 1;0=. 5n >e3 ?or, he $or#ed a c o"e re ation"hip 3ith Char e" G. Mor"e the notoriou" >e3 ?or, +an,er and the head o$ the >e3 ?our 5ce 1ru"t that contro ed the "upp y o$ ice in >e3 ?or, and cau"ed the death" o$ hundred" o$ peop e in the heat 3ave o$ 1<;7. 1o&ether F. -u&u"tu" AeinFe and Char e" G. Mor"e contro ed "i) nationa +an,"* ten "tate +an,"* $ive tru"t co#panie"* and $our in"urance co#panie". 7tto* -u&u"tu"* and Char e" 1. Barney #et to di"cu"" $inancin& 7tto8" "che#e 3ith Barney* the pre"ident o$ the city8" third ar&e"t tru"t* the Inic,er+oc,er. Barney had previou" y $inanced "che#e" $or Mor"e +e$ore. Barney dec ined to $inance thi" "che#e +ecau"e he thou&ht it 3a" too ri",y. 7tto decide" to &o $or3ard any3ay.

vii.

+@ >on6!y"te#ic Cau"e" and 1i#e ine o$ the panic. 1. Monday* 7cto+er 1D 2 7tto AeinFe +e&in" hi" "toc, #anipu ation "che#e and increa"e" the "toc, price $ro# 93; to 952. 2. 1ue"day* 7cto+er 15 2 the price reache" 9=0. -$ter 7tto de#and" that '"hort "e er"( o$ the "toc, return their "hare" thin,in& he and hi" $a#i y had the corner on the "upp y o$ out"tandin& "toc,

3. D.

5. =.

7.

and cou d $orce the "hort "e er" into e)or+itant price". 1he "che#e $ai " and the "toc, drop" to 930 at the c o"e on 1ue"day. Gedne"day* 7cto+er 1= 2 AeinFe8" +ro,era&e hou"e* Gro"" J I ee+er& i" $orced to c o"e. 1hur"day* 7cto+er 17 2 1he >e3 ?or, !toc, E)chan&e "u"pend" 7tto8" tradin& privi e&e". -" a re"u t the co ap"e :nited Copper* the !tate !avin&" Ban, o$ Butte Montana Bo3ned +y F. -u&u"tu" AeinFe@ announced it" in"o vency. 1he Montana +an, had he d :nited Copper "toc, a" co atera a&ain"t "o#e o$ it" oan" and it had +een a corre"pondent +an, $or the Mercanti e >ationa Ban, in >e3 ?or, City* o$ 3hich F. -u&u"tu" AeinFe 3a" no3 pre"ident. Ban, run" +e&in at the Mercanti e and other +an," o$ -u&u"tu" and hi" a""ociate Char e" Mor"e. !unday* 7cto+er 20 2 1he >e3 ?or, C earin&hou"e $orce" -u&u"tu" and Mor"e to re"i&n $ro# a their +an,in& intere"t". Monday* 7cto+er 21 2 Char e" 1. Barney i" $orced to re"i&n $ro# the Inic,er+oc,er 1ru"t Co. +ecau"e o$ hid tie" to Mor"e and AeinFe. 1he >ationa Ban, o$ Co##erce "ay" it 3i no on&er "erve a" c earin& hou"e $or the Inic,er+oc,er. 1ue"day* 7cto+er 22 2 - +an, run $orce" the Inic,er+oc,er to "u"pend operation". 7ther +and" and tru"t co#panie" 3ere re uctant to end any #oney. 1he "toc, +ro,er" una+ e to &et any #oney "een "toc, price" $a to o3" not "een "ince +e$ore 1;00. 1he panic "pread to t3o other ar&e tru"t"* 1ru"t Co#pany o$ -#erica and Linco n 1ru"t.

<. Gedne"day* 7cto+er 23 2 C./. Mor&an per"uade" a+out 20 o$ the other tru"t and +an, pre"ident" pre"ident" to provide i4uidity to the 1ru"t Co#pany o$ -#erica. to carry it throu&h the cri"e". ;. 1hur"day* 7cto+er 2D 2 C./. Mor&an per"uade" +an, pre"ident" to /rovide 923 #i ion to the >e3 ?or, !toc, E)chan&e to prevent an ear y c o"ure. By thi" ti#e the $ai ed +an," in >e3 ?or, +e"ide" the one" a ready #entioned inc ude the $o o3in&% i. 13e $th Gard Ban, ii. E#pire City !avin&" Ban, iii. Aa#i ton Ban, o$ >e3 ?or, iv. Fir"t >ationa Ban, o$ Broo, yn v. Borou&h Ban, o$ Broo, yn vi. Cen,in" 1ru"t Co#pany o$ Broo, yn vii. 5nternationa 1ru"t Co#pany o$ >e3 ?or, viii. Gi ia#"+ur& 1ru"t Co. o$ Broo, yn i). :nion 1ru"t Co. o$ /rovidence

10. !unday* 7cto+er 27 K 1he City o$ >e3 ?or, te " Mor&an a""ociate Geor&e /er,in" that i$ they cannot rai"e 920 to 930 #i ion +y >ove#+er 1* the city 3i +e in"o vent. 11. 1ue"day* 7cto+er 2; 2 Mor&an +uy" 930 #i ion in city +ond" avertin& +an,ruptcy $or the city. 12. !aturday* >ove#+er 2 2 Moore J !eh ey* a #aHor +ro,era&e $ir#* near" co ap"e +ecau"e it" oan" 3ere +ac,ed +y the 1enne""ee Coa * iron* J Rai road Co.* a "toc, 3ho"e va ue i" no3 uncertain. C/ Mor&an put to&ether a propo"a $or :.!. !tee * a co#pany he created in 1;01 $ro# the purcha"e o$ Carne&ie !tee to purcha"e the 1enne""ee Coa * 5ron* and Rai road Co. 13. Monday* >ove#+er D 2 C/ Mor&an &oe" to Ga"hin&ton to &et /re"ident 1eddy Roo"eve t8" approva $or the #er&er. 1D. 1ue"day* >ove#+er 5 2 the #ar,et" are c o"ed $or E ection .ay 15. Gedne"day* >ove#+er = 2 #ar,et" +e&in to recover and the +an, run" do not occur a&ain. c@ - o$ thi" a ar#" Con&re"" 1;0< Con&re"" $or#ed the >ationa Monetary Co##i""ion to inve"ti&ate the +an,in& and currency $ie d" and to reco##end e&i" ation 1;13 the Federa Re"erve !y"te# 3a" created

1he Federa Re"erve !y"te#% Correction to the te)t+oo,% 'the Federa Re"erve !y"te# i" >71 an independent a&ency o$ the $edera &overn#ent a" "tated in the te)t+oo,( 1he Federa Re"erve !y"te# 3a" created +y Con&re"" in 1;13 a" a private non6&overn#ent "y"te# o$ 12 independent and private y o3ned .i"trict Ban," &overned +y a 7 #e#+er Board o$ Governor" appointed +y the /re"ident and rati$ied +y the !enate. 7nce rati$ied the +oard o$ &overnor" act independent o$ po itica pre""ure"* and on y report the "tatu" o$ the econo#y to Con&re"" on a re&u ar +a"i". Each .i"trict Ban, i" o3ned +y the #e#+er +an," o$ that di"trict 1he Federa Re"erve !y"te# i" not "upported +y the &overn#ent8" +ud&et - thou&h private y o3ned +y it" #e#+er +an,"* the FE. i" not a pro$it #a,in& corporation $or the +ene$it o$ it" o3ner" FE. pro$it" are di"tri+uted to the :.!. 1rea"ury 5n 200< the FE. contri+uted pro$it" o$ over 931.7 +i ion to the :.!. 1rea"ury 1he pri#ary "ource B;0E@ o$ the Federa Re"erve" revenue" i" $ro# it" open #ar,et operation". 1he other 10E i" derived $ro# $ee" "uch a" the

$ee +an," pay to u"e it" chec, c earin& and e ectronic $und" tran"$er "y"te#". Gho are the #e#+er +an,"% a@ - nationa chartered +an," #u"t +e #e#+er" +@ -ny "tate chartered +an, 3antin& to +e F.5C in"ured #u"t +e #e#+er" c@ 7ther "tate chartered +an," #ay app y $or #e#+er"hip +ut are not re4uired to do "o Every #e#+er +an, #u"t purcha"e a "tipu ated a#ount o$ "toc, in it" di"trict8" Federa Re"erve Ban,. 1hi" "toc, can not +e "o d* traded* or p ed&ed a" co atera $or a oan. Me#+er" vote $or = o$ the ; +oard o$ director"* the other 3 are cho"en +y the FE. Board o$ Governor".

1oo " o$ the Federa Re"erve% Re"erve Re4uire#ent Bappro). 20E@ .i"count Rate 2 thi" i" the rate the FE. char&e" #e#+er +an," to +orro3 #oney to cover their re"erve re4uire#ent" on a dai y +a"i" Federa Fund" Rate 2 thi" i" the rate #e#+er +an," 3ith e)ce"" re"erve" char&e other #e#+er +an," to +orro3 #oney to #eet their re"erve re4uire#ent". 7pen Mar,et Co##ittee #ade up o$ the 7 +oard o$ &overnor"* the /re"ident o$ the >e3 ?or, Re"erve Ban,* and D o$ the other 11 Re"erve .i"trict +an, pre"ident" on a rotatin& +a"i". a@ 3hen the FE. +uy" &overn#ent "ecuritie" B1rea"ury Bi "@ in the open #ar,et it i" increa"in& the #oney "upp y +@ 3hen the FE. "e " &overn#ent "ecuritie" in the open #ar,et it i" decrea"in& the #oney "upp y c@ re#e#+er in the circu ar $ o3 o$ the econo#y 'Money F o3 #u"t "upport '/roduct F o3(

Function" o$ the Federa Re"erve% /rovide" a "y"te# $or chec, co ection and c earin& -ct" a" the &overn#ent8" +an,er and $i"ca a&ent !upervi"e" #e#+er depo"itory in"titution" Re&u ate" the nation8" #oney "upp y to contro in$ ation Lender o$ a"t re"ort to #e#+er +an," /rovide i4uidity to the +an,in& "y"te# in ti#e" o$ $inancia cri"i" 5ntervene" in $orei&n currency #ar,et"

1ype" o$ Ban,in& 5n"titution"%

Co##ercia Ban," 2 #ain $unction i" to provide 3or,in& capita to +u"ine"" $ir#" a@ !tate Chartered +@ Federa or '>ationa ( Chartered !avin&" and Loan -""ociation" 2 ori&ina #ain $unction 3a" to provide "a$e depo"itory $or individua 8" "avin&" and provide ho#e oan" to individua " Mutua !avin&" Ban," Co##unity Ban," "erve the need" o$ a oca +u"ine"" co##unity co#pared to nation3ide +an,in& co#panie" that "erve ar&e +u"ine""e" and 3ea thy individua "

1he $o o3in& "ho3" ho3 a '$ractiona re"erve( +an,in& "y"te# 'create"( #oneyL
Ban, >e3 .epo"it 100*000 Re4. Re"erve 20*000 100*000.00 >e3 Loan" <0*000 D00*000.00 500*000.00 Ban, B <0*000 1=*000 =D*000 Ban, C =D*000 12*<00 51*200 Ban, . 51*200 10*2D0 D0*;=0 Ban, E D0*;=0 <*1;2 32*7=< B5 Ban, 1ota "@ Co#p ete !y"te# 1ota " =7*232.00 2=<*;2<.00

5n Hu"t the"e $ive +an," our ori&ina ne3 depo"it o$ 9100*000.00 ha" created another 92=<*;2<.00. Ghen circu ated thou&h out the entire +an,in& "y"te# +e can create a tota a#ount o$ ne3 #oney accordin& to the $or#u a o$ 1 ti#e" the reciproca o$ the re"erve re4uire#ent. 5$ the re"erve re4uire#ent i" 20E or 1/5th then the $or#u a i"% 1 ti#e" 5/1 K 5 !o a ne3 depo"it o$ 9100*000.00 ti#e" 5/1 i" 9500*000.00

5n"urance $or Ban,in& 5n"titution"% F.5C 2 co##ercia +an," ori&ina y* +ut "ince the ate 1;<08" !avin&" -nd Loan $inancia 5n"titution" too. F!L5C 2 "avin&" and oan a""ociation" Gent +an,rupt durin& the !avin&" J Loan "canda o$ the ate 1;<08" >C:- 2 credit union" >on6Ban,in& Financia 5n"titution"% 5n"urance Co#panie" /en"ion Fund" Mutua $und"

Bro,era&e Fir#" Finance Co#panie"

.eve op#ent" eadin& up to the +an,in& co ap"e o$ 200< 7ri&ina y +an," 3ere chartered to operate on y 3ithin a "in& e county 1hen a o3ed to &ro3 to adHoinin& countie" 1hen Ban, Ao din& Co#panie" 3ere a o3ed to o3n &eo&raphic diver"e +an, ocation" 1hi" a o3ed +an, ho din& co#panie" to &ro3 ar&e to co#pete 3ith $orei&n +an," .ere&u ation" to the +an,in& "y"te# a@ 1;<0 2 .epo"itory 5n"titution" .ere&u ation and Monetary Contro -ct i. /ha"ed out a nu#+er o$ re&u ation" on +an,"8 $inancia practice" ii. Broadened +an,8" endin& po3er" iii. - o3ed credit union" and !avin&" and Loan -""ociation" to o$$er chec,a+ e depo"it" iv. Rai"ed depo"it in"urance i#it $ro# 9D0*000 to 9100*000 e""enin& depo"itor concern" over +an, ri", #ana&e#ent po icie". +@ 1;<2 2 Garn6!t. Ger#ain .epo"itory 5n"titution" -ct a o3in& $or -dHu"ta+ e rate #ort&a&e" c@ 1;;; 2 repea o$ the Glass Steagall Act a o3" +an," once a&ain to en&a&e in non6+an,in& $inancia "ervice". Fro# 1;33 to 1;;; thi" act "eparated depo"itory co##ercia +an," $ro# inve"t#ent or "ecuritie" +an,". Ban," cou d +e one or the other +ut cou d not +e co#in& ed. d@ 2000 2 Co##odity Future" ModerniFation -ct a o3ed $or the '"e $6re&u ation( o$ the over6the6counter derivative" #ar,et. e@ 200D 2 !ecuritie" and E)chan&e Co##i""ion re a)ed the net capita ru e 3hich ena+ ed inve"t#ent +an," to "u+"tantia y increa"e the eve o$ de+t they 3ere ta,in& on* $ue in& the &ro3th o$ #ort&a&e6+ac,ed "ecuritie" "upportin& "u+pri#e #ort&a&e #ar,et". Greed 3ithin "ociety a@ 5ndividua +@ Corporate

Ea"y credit a@ Aou"eho d de+t +@ !econd #ort&a&e Aou"in& de#and +u++ e a@ -rti$icia de#and $ro# $ ipper" +@ 5ndividua de#and ri"e" i. Ai&her percenta&e o$ hou"e o3ner"hip in "ociety ii. 5n$ ate one8" i#a&e +y% 1. #ovin& into a +i&&er hou"e 2. !econd and even third hou"e o3ner"hip iii. >o3 or never #enta ity o$ o3nin& a hou"e !u+pri#e endin& a@ 7ri&ina y envi"ioned a" a 3ay* $or &ood hard 3or,in& individua 3ho had un$ortunate event" happen in their pa"t* to 4ua i$y $or a #ort&a&e +@ Beca#e +ait $or &reed +y #ort&a&e ender" and un"crupu ou" ho#e +uyer" c@ /redatory endin& practice" d@ Gea, and $raudu ent under3ritin& practice"

:.!. /aper Currency% 1;13 2 1;33 :nited !tate" >ote" Go d Certi$icate" >ationa Ban, >ote" !i ver Certi$icate" Federa Re"erve Ban, >ote" Federa Re"erve >ote" 1;3D 2 1;70 :nited !tate" >ote" !i ver Certi$icate" Federa Re"erve >ote" 1;70 to /re"ent Federa Re"erve >ote"