Financial Institutions & Markets thru Time

BusFin 4265
Class 2
 Agenda

 Periods Covered
 Early 20th Century including the Panic of 1907
 Early Federal Reserve days & the Stock Market Crash of 1929
 World War II & Postwar Boom
 The 1970s and Early 1980s
 Savings & Loans Crisis & the Junk Bonds (1980s)
 For each period, address 3 points:
1. The key events
2. The cases & consequences/results
3. Insights to understand current state and future of FI & markets
 Early 20th century

1. The Key Events

 US Business Sector and Financial Markets
 US business sector transformed from trust dominated markets towards
a sector with professional managers and shareholders
 Panic of 1907
 Earthquake in San Francisco 2006

 Financial Institutions
 National Banking Era (1863-1913): All commercial banks were “local”
and regulated on a state level
 Panic of 1907: J.P. Morgan, the Knickerbocker Trust, The Trust
Company of America, NY Clearinghouse and City of NY
 J.P. Morgan acted as central banker
 Early 20th century

2. Causes & Consequences 3. Insights about FI and FM

 Causes  Current state
 Politics
 Heinz corners the copper
market
 ?

 Consequences  Future?
 Need for a central bank
 Federal Reserve Bank of 1913
 ?
 ?
 Early FED days & the Stock Market of 1929

1. The Key Events

 Federal Reserve Act of 1913: created the Federal Reserve
 Quasi-government agency with 12 regional banks and the Federal
Reserve Board in DC
 Commercial banks were required to buy shares to raise capital to begin
operations
 Lender of last resort
 1923: Open Market Investment Committee NY Fed
 September 3, 1929:
 Stock Market Crash 1929
 Fall 1929, FRBNY takes no action
 Early FED days & the Stock Market of 1929

2. Causes & Consequences 3. Insights about FI and FM

 Causes  Current state
 Investor Behavior -margin %
Real Bills Doctrine

- bubbles
- regulation
 Consequences
 Economic downturn
 Bank runs of early 1930s
 Great Depression/New Deal  Future?
 Banking Act of 1933 (Glass-
Steagall)
- split commercial/ IB
- FDIC insurance
- Reg Q, no interest DD
 WWII & Postwar Boom

1. The Key Events

 1941- Roosevelt signs the Lend-Lease Act
 US ramps up military output
 Government takes control of both labor market, as well as wage and
price control and capital markets to finance the war
 Funding the US war Effort
1. War Bond (e.g. Liberty Bonds)
2. Government rationing
3. Wage and Price controls
 Changes in the Home Mortgage market

 Efforts to Economically & Financially integrate Europe after WWII

 WWII & Postwar Boom

2. Causes & Consequences 3. Insights about FI and FM

 US enters WWII after attack  Current state
on Pearl Harbor
 Consequences
 War bonds & gov’t rationing kept
inflation down
 Postwar period ushered in a
period of economic upturn
 20% down payment with 30yr
mortgages for housing
 Future?



-growth/regulation
-trade
 1970s – Early 1980s

1. The Key Events

 Stagflation: Unemployment and growing inflation AT THE SAME
TIME
 As the economy expanded, increased competition → higher wages.
 Higher labor costs get passed on to consumers → higher market prices.
 Oil Supply Shock of 1973

 Paul Volcker (1979): Appointed new FED Chairman by Pres. Carter

 Reagan, Thatcher and Volcker focused economic policies on long-

term issues

 Recession of 1981-1982: Worse since Great Depression

 1970s – Early 1980s

2. Causes & Consequences 3. Insights about FI and FM

 Causes  Current state

 Consequences

 Future?
 S&L Crisis and Junk Bonds (1980s)
1. The Key Events
 Inflation began to rise, causing interest rates to follow.

 Regulation Q law: Capped interest rates that S&L could pay.

 Money Market Mutual Funds paying “ market rate” on deposits

 DIDMCA (Depository Institution Deregulation and Monetary Control

Act): Allowed S&L to pay market interest rate on deposits.

 Garn-St. Germain Act of 1982: Reduce the amount of regulation

over the Savings & sLoan or thrift industry

 1980s: A push for deregulation of markets

 S&L Crisis and Junk Bonds (1980s)
2. Causes & Consequences 3. Insights about FI and FM
 Causes  Current state
 ?
 ?

 Consequences
 S&L lose deposits to Money
Market Mutual Funds.
 Start of Shadow Banking
 Future?
 Leverage Buyout (LBO) craze
 Junk bonds
 Strategic Issues

 Concentration  JPM $2.53 trillion

 Top 10 assets 90%  BOA 2.28
 Wells 1.95
 Citi 1.84
 GS .92
 MS .85
 USB .46
 PNC .38
 BoNY/M .37
 Cap One .36
 Concentration continued

 Systemic Risk  “ I believe that banking

 Too Big to Fail
 Necessary for
economies of scale &
innovation
 Risk of abuse of power
re retail customers  “A consumer protection
 State/federal
 Suspicion of power,
esp in NYC and D.C.
institutions are more
dangerous to our
liberties than standing
armies” Thomas
Jefferson 1802
agency is needed to
protect families from
the deceptive practices
of banks” Elizabeth
Warren
 Other strategic issues

 Level of regulation  Safety vs economic

growth
 Capital levels  Leverage risk vs ROE
 Activities allowed  Revenue vs risk (IB)
 Non-bank competition  Taking market share
/hurts bank revenue
growth
 Economy-interest
rates, recessions  Low rates/bubbles,
recession losses
greater than planned