Final Segment of Money, Banking and Finance with Raymond Stone

Yield curve

a plot of the yield on bonds with differing terms to maturity but the same risk, liquidity and tax considerations

Facts that the Theory of the Term Structure of Interest Rates Must Explain

1.Interest rates on notes and bonds of different maturities move together over time

2.When short-term interest rates are low, yield curves are more likely to have an upward slope; when short-term rates are high, yield curves are more likely to slope downward and be inverted

3.Yield curves generally slope upward

Three Yield Curve Theories

1.Expectations theory explains the first two facts but not the third

2.Segmented markets theory explains fact three but not the first two

3.Liquidity premium theory combines the two theories to explain all three facts

Expectations Theory

•The interest rate on a long-term bond will equal the average of expected short-term interest rates over the life of the bond

•Buyers of bonds do not prefer bonds of one maturity over another; they will not hold any quantity of a bond if its expected return is less than that of another bond with a different maturity

•Bonds like these are said to be perfect substitutes

Liquidity Premium & Preferred Habitat Theories

•The interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a liquidity premium that responds to supply and demand conditions for that bond

•Bonds of different maturities are substitutes but not perfect substitutes

Preferred Habitat Theory

•Investors have a preference for bonds of one maturity over another

•They will be willing to buy bonds of different maturities only if they earn a somewhat higher expected return

•Investors are likely to prefer short-term bonds over longer-term bonds

Operation Twist--1961

•The Fed attempted to employ Operation Twist by buying longer-term Treasury Securities, and by selling short-term Treasury Bills, thereby twisting the yield curve—This was in support of economic activity

•The Treasury issued more bills and less longer-term Treasuries, inducing higher short-term rates in support of the Balance of Payments.

Was Operation Twist a Success? Most say no.

Charles Hamlin

First chairman (governor) of the Federal Reserve Board (1893-1897)

Benjamin Strong

First (gov) president of FRBNY (Nov 16, 1914)

most powerful individual in the system

Name two cities that tried to get a fed reserve bank

Baltimore, New Orleans

Why did preferences of the national banks matter in the placement of fed reserve banks?

They had to become a part of the Fed, and if they didn't like the placement, they might well have made themselves state charters

Why was Kansas City chosen for a Fed location?

It had a great railroad system

Treasury Secretary William McAdoo

Thought that the Fed as a whole should interact with European banks, not just FRBNY

Knickerbocker Trust

Headed by Charles Barney until resignation Monday, Oct. 21

Center of panic in 1907: On Tuesday, Oct. 22, so many depositors showed up that the police were called in to keep order

National Monetary Commission

Created by congress to find ways to stop financial panics (1908)

Led by Nelson W Aldrich

The resulting plan called for a National Reserve Association (met with skepticism)

November 1910

secret meeting on Jekyll Island

Federal Reserve Act

a 1913 law that set up a system of federal banks and gave government the power to control the money supply

•The Federal Reserve Act presented by Congressman Carter Glass and Senator Robert L. Owen incorporated modifications by Woodrow Wilson and allowed for a regional Federal Reserve System, operating under a supervisory board in Washington, D.C. Congress approved the Act, and President Wilson signed it into law on December 23, 1913. The Act, "Provided for the establishment of Federal Reserve Banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.

The Reserve Bank Organization Committee

•The Act provided for a Reserve Bank Organization Committee that would designate no less than eight but no more than twelve cities to be Federal Reserve cities, and would then divide the nation into districts, each district to contain one Federal Reserve City.

money trusts

•In 1912, the House Banking and Currency Committee held hearings to examine the control of the banking and financial resources of the nation. The Committee concluded that America's banking and financial system were in the hands of a "money trust." The Committee's report defined a "money trust" as "an established and well defined identity and community of interest between a few leaders of finance . . .which has resulted in a vast and growing concentration of control of money and credit in the hands of a comparatively few men." The public's awareness of a monopoly on the banking system was crucial in leading to America's financial reform.

William Jennings Bryan

Another key event leading to America's financial reform was the election of Woodrow Wilson as President in 1912. Wilson and his Secretary of State William Jennings Bryan, forcefully opposed "any plan which concentrates control in the hands of the banks.

Glass-Willis proposal

•On December 26, 1912, the Glass-Willis proposal was submitted to President-elect Wilson. Instead of suggesting the creation of a central bank, the proposal called for the creation of twenty or more privately controlled regional reserve banks, which would hold a portion of member banks' reserves, perform other central banking functions and issue currency against commercial assets and gold. Wilson approved of this idea, but also insisted upon the creation of a central board to control and coordinate the work of the regional reserve banks.

Between 1930 and 1933 ___ of the Banks in the US Closed

40%

Glass-Steagall Act 1933

•Following the Great Crash of 1929, one of every five banks in America fails. Many people, especially politicians, see market speculation engaged in by banks during the 1920s as a cause of the crash.

•In 1933, Senator Carter Glass (D-Va.) and Congressman Henry Steagall (D-Ala.) introduce the historic legislation that bears their name, seeking to limit the conflicts of interest created when commercial banks are permitted to underwrite stocks or bonds. In the early part of the century, individual investors were seriously hurt by banks whose overriding interest was promoting stocks of interest and benefit to the banks, rather than to individual investors. The new law bans commercial banks from underwriting securities, forcing banks to choose between being a simple lender or an underwriter (brokerage).

•The act also establishes the Federal Deposit Insurance Corporation (FDIC), insuring bank deposits, and strengthens the Federal Reserve's control over credit.

Morgan Stanley/JP Morgan and Glass Steagall

•Morgan Stanley was established in 1935 as a separate entity from J.P. Morgan following the enactment of the 1933 Glass-Steagall Act, which required the separation of banks and securities houses. Henry Morgan, grandson of J.P. Morgan, and Harold Stanley led the new investment bank.

Eccles, FDR, the New Deal and a Restructured Federal Reserve

•Dr. Rexford G. Tugwell, one of Roosevelt's closest advisors, invited Eccles to Washington for a number of conferences. While there he testified before the Senate Finance Committee, advocating many of the measures that would become cornerstones of the New Deal. While traditional economics stressed a hands-off, open market approach from government and balanced budgets, Eccles proposed public works to relieve unemployment and direct relief measures, as well as a minimum wage, unemployment insurance, and old age pensions.

A.P. Giannini

•Amadeo Peter Giannini opened the Bank of Italy in a former San Francisco, California saloon on 17 October 1904. Deposits on that first day totaled $8,780.

•An early difficulty to overcome was the San Francisco earthquake of 1906. Giannini was forced to run his bank from a plank across two barrels in the street for a time.

•By 1916 Giannini had expanded and opened several other branches. It became the Bank of America in 1928 and continued under Giannini's chairmanship until his retirement in 1945.

•Giannini was one of the first bankers to offer banking services to middle-class Americans, rather than simply the upper class.

In 1928 Giannini's Bank of Italy became the Bank of America

•Giannini representing the banking industry outside of NYC was a strong advocate of the New Deal.

•He was a supporter of a Federal Reserve System that provided a better balance between the interest of NYC banks and the rest of the country

•He supported Marriner Eccles and the Banking Act of 1935, which reorganized the Federal Reserve

Marriner Eccles and the Banking Act of 1935

•Eccles sponsored the Banking Act of 1935. It centralized control of the Federal Reserve within the Board of Governors.

•The support of Giannini was key to the passage of the Act

•FDR appointed Eccles as Chairman of the Fed

The Banking Act of 1935

•The Banking Act of 1935 eliminated the requirement for the secretary of the Treasury and the comptroller to serve on the Board.

•The Act also renamed the Federal Reserve Board as the Board of Governors of the Federal Reserve System

•The Act shifted power from the Reserve Banks to the Board of Governors

•Reformulated the FOMC to include the 7 Governors and only 5 of the 12 Reserve Bank Presidents, giving the Governors the majority vote