Econ 3330 Test 3

Unit bank

A bank with one location, usually in a small town or rural area, that serves local customers, tends to invest locally, and knows the challenges of the local community.

Banking act of 1863

Created national bank charters which placed a 10% tax on state chartered banks notes

Intent of the banking act of 1863

Elimate state banks and notes

Actual results of the banking act of 1863

State chartered banks innovate and create checkable deposits and avoid the tax

Unintended consequence of the Banking act of 1863

Dual banking system (State and nationally chartered banks coexist)

McFadden act (1927)

prevented BRANCH BANKS across state lines
banks must meet the branching restrictions of the state where located

Intent of McFadden Act

Prevent a banking monopoly

Actual result of the Mcfadden act

"Good banks" are unable to branch and compete with "bad banks"
banks lend less to reduce risk
banks cant grow and local economies suffer

Unintended consequenses of the Mcfadden act

Localized monopolies

What repealed the mcfadden act?

The Reigle-neal act

How did banks get around the McFadden Act?

Banks formed Bank-holding companies

Bank Holding companies

company that owns and controls one or more banks

Glass-Steagall act 1933

Restricts the services that banks offered: No stocks, no investment banking, no insurance.

Intent of the Glass-Steagall act

Lower banks risk after the great depression

Actual results of glass steagall act

Banks become less profitable because they were less diversified (more likely to fail)

unintended consequences of the glass steagall act

Banks form financial holding companies to avoid service restrictions

Financial Holding Companies

Firms that own multiple financial intermediaries

What act repealed the glass steagal act

Gramm leach biley in 1999

Universal bank

An institution that engages in all aspects of financial intermediation, including banking, insurance, real estate, brokerage services, and investment banking.

Why we should allow banks to become larger?

Diversification
Economies of scale
Economies of scope

Diversification

Larger banks have more revenue streams

Economies of scope

Cost savings of being a one stop shop

Why shouldnt we allow banks to become larger

banks might become too big to be allowed to fail and a bail out is more likely

Term Life Insurance

Policy covers a person for a specified term - usually 20 years

Cons of term life insurance

Might die outside of coverage

Pros of term life insurance

Inexpensive, renewable till age 65 (Expires at 65)

Whole life insurance

Insurance that is kept in force for a person's entire life and pays a benefit upon the person's death, whenever that may be.

Pros of Whole life insurance

Guaranteed payoff which generates "cash value"

Con of whole life insurance

very high premiums, grows at CD rates, you cant afford enough coverage

Goal of life insurace

Replace your income

Who should have life insurance

anyone with dependents

Powdered butt syndrome

why do parents not want to talk to their kids about long term care insurance

Defined benefit pension

Retirement income based on vesting

Vesting in defined benefit

Years of work and top salary

Pros of Defined Benefit Plan

Maximum possible payout is top salary

Cons of defined benefit

All benefits are tied to the company you work for so you cant move

Defined contribution plan

Retirement income based on workers contribution plus interest earned

Pro of defined contribution plan

More flexible to move
vested immediately

Con to defined contribution

Income is the employees responsibility

Types of loans a finance company makes

Consumer Finance
Sales Finance
Business Finance

Consumer finance

Small loans on appliances, furniture, etc

Sales Finance

Credit for auto's, RV, boat, ATV

Business Finance

Helps firms w/ cash flow needs
inventory needs
accounts recievable loan

Government Sponsored Enterprises (GSEs)

Quasi-public created by congress but publicly held

Mortgage

Frannie Mae, freddie Mac, Ginny mae

Student loans

Sallie Mae

What do GSE's do?

Help combat discrimination among underserved populations

Why do banks get extra attention

They play a central role in the economy

Bank run

aka illiquidity
many depositors make simultaneous withdrawals

What is insolvency

a financial state that occurs if liabilities are greater than assets

Contagion

Run on one bank can lead to runs on other banks too

Government role

Protect depositors
prevent monopoly
promote competition but not too much
promote financial stability

How is the government a safety net

Lender of last resort
Deposit insurance

Lender of last resort

Central bank lends to solvent but illiquid banks
if they are insolvent and illiquid, pull the plug

How does the govenrment avoid contagion, what happens?

lend to all banks —> banks take more risk

Deposit insurance

Refunds deposits for any bank that fails

Methods to close a failed bank

Purchase and assumption
Payoff method

Purchase and assumption

FDIC finds a "buyer" bank for failed bank that assumes all assets and liabilities
-Buyer gets paid the negative price
-its cheapest
-better PR

Payoff method

Failed banks assets sold, deposits refunded and FDIC covers the difference
-expensive
-scares people

Why do banks take more risk with deposit insurance?

Because deposits are insured and depositors are indifferent to bank performance, this creates moral hazard

Goals of a central bank

1. Low stable inflation
2. High stable economic growth
3. Stable interest rates
4. Stable exchange rates
5.Stable financial system

Design principles of a Central Bank

Independence
Decision-making by committe
Accountability
Transparency
Policy framework

Independence

Monetary policy makers must be free from political influence as politicians bc they have do whats popular and not whats best
CB officers have 14 year terms to be free from influence (Yes, budgetarily, long terms, irreversible decisions)

Decision-making by committe

Group decisions to avoid one person with too much power (Yes —> 7 governors, 12 districts, 12 FOMC members)

Accountability

Make sure policy-makers follow through on goals (Yes & No —> Congressional Testimony & Speeches, but books published 5 yrs after)

Transparency

clearly stated objectives, methods, and progress reports (Yes & No —> Congressional Testimony & Speeches, but books published 5 yrs after)

Policy framework

Hierarchy of goals (No, vague at best)

Regulation

Banks are regulated by a combination of the FDIC, OCC, federal reserve system, and state authorities

supervision

General government oversight of financial institutions a combination of monitoring and inspection, banks are required to file reports
THEY USE CAMELS RATING TO DO THIS

examination

The formal process by which government specialists evaluate a bank's financial condition.

CAMELS rating

Capital adequacy
Asset quality
Management
Earnings
Liquidity
Sensitivity to market risk

3 Branches of the federal reserve

Board of governors
12 district banks
Federal open market comittee

12 district banks decision maker

federal district presidents for 5 years (concurrently)

12 district banks Job

Manage currency for the government banks + regulate commercial banks
Ensure all economic interest are represented
manage fedwire: inter banks payment system

Federal board of governors jobs

Analyze Financial and Economic conditions
Regulate 12 district banks

Federal board of governors decision makers

7 members who serve 14 year terms and chairman serves a 4 year term

Chairman of the federal board of governors

single most powerful monetary policy-maker

FOMC Decision makers

12 members
7 Governors
1 NY Fed president
4 of 11 remaining district presidents

FOMC jobs

Set and maintain target for federal funds rate

Federal funds rate

Interest rate on overnight loans of excess fed deposits
banks with excess reserves lend to those w/ deficient reserves overnight

How does the federal funds rate effect the economy

expectations hypothesis, lt rates are the average of st rates

How many times does the fomc meet

8 times

Beige book

Economic report summarizing regional economic conditions.
made public immediately after meeting

Teal book

economic forecast and monetary policy options
made public after 5 years

Independence of federal reserve system

Policymakers are appointed to long terms, budgetarily independent, irreversible policy decisions

Decision making by committee in federal reserve system

yes, 7 governors
12 districts
12 fomc members

Accountability and transparency in the federal reserve

Books are not public for 5 years
congressional testimony is vague and complicated

Policy Framwork in the federal reserve

Vague at best as strict explicit guidlines take too long to adjust

simple money multiplier

change in deposits= 1/required reserve rate * change in reserves

How and when does the fomc change deposits

to induce a negative change they sell bonds to banks and to induce a positive change they buy bonds from banks

3 tools of the FED

Federal funds rate
Discount Lending
Reserve requirements

Federal funds rate as a tool of the fed

AKA Open market operations
To hit the target interest rate the fed adjusts the amount of funds by increasing supply if demand increases too much and vice versa

Discount lending

Seldom used, aka lender of last resort
Primary credit
secondary credit
seasonal credit

primary credit

banks w/ good collateratal and ratings

the rate is Fed funds rate+ 100 basis points

Secondary credit

banks w/ poor ratings and collateral
FFR+ 150 basis points

Seasonal credit

For banks w/ liquidity issues

Reserve requirements

almost never adjusts as even small changes lead to large ones

Taylor rule

Mathematical rule to replace federal discretion

Taylor rule for federal funds rate formula

Target FFR = Equilibrium FFR+ Current inflation + .5(output gap)+ .5(inflation gap)

What should FFR do when gdp growth is slower than expected

decrease