The Money Supply and Banking

1. The Money Supply and Banking

2. M1 http://www.globalmortgage.com/images/ROLLOVERS/cash.jpg http://www.crk.umn.edu/academics/Acct/CHECKS.gif http://lfd.uiuc.edu/misc/visitors/coins.jpg jpghttp://www.nassauboatcharters.com/travelerscheck.gif Coins Travelers’ Checks Cash Checks (Demand Deposits)

3. M2 M1 + http://www.catlinbank.com/images/acct/WG-PASSBOOK.gif http://www.cpaofc.com/images/mutualfunds.gif http://www.pinnbank.com/gifs/photo_moneymarket.gif Savings Accounts Money Market (CD’s) Mutual Funds

5. Types of Financial Institutions • Commercial Banks • Commercial banks offer checking services, accept deposits, and make loans. • Savings and Loan Associations (S & L’s) • Savings and Loan Associations were originally chartered to lend money for home-building in the mid-1800s. • Savings Banks • Savings banks traditionally served people who made smaller deposits and transactions than commercial banks wished to handle. • Credit Unions • Credit unions are cooperative lending associations for particular groups, usually employees of a specific firm or government agency. • Finance Companies • Finance companies make installment loans to consumers.

6. Banking Services • Banks perform many functions and offer a wide range of services to consumers. Storing Money (Service #1) Banks provide a safe, convenient place for people to store their money. Credit Cards Banks issue credit cards — cards entitling their holder to buy goods and services based on each holder's promise to pay later. Saving Money: (Service #2: Earn Money) Four of the most common options banks offer for saving money are: 1. Savings Accounts 2. Checking Accounts 3. Money Market Accounts 4. Certificates of Deposit (CDs) Loans (Service #3: Borrow Money) By making loans, banks help new businesses get started, and they help established businesses grow. Mortgages A mortgage is a specific type of loan that is used to purchase real estate.

7. How Banks Make a Profit Money leaves bank Money enters bank Interest and withdrawals to customers Deposits from customers Money loaned to borrowers: • business loans •home  mortgages • personal loans BANK Interest from borrowers Fees for services Bank’s cost of doing business: • salaries • taxes • other costs Bank retains required reserves How Banks Make a Profit • The largest SOURCE OF INCOME for banks is the INTEREST they receive from customers who have taken loans. • Interest is the price paid for the use of borrowed money.

8. How Do Banks Make Loans? • FRACTIONAL RESERVE BANKING • A bank keeps only a fraction of funds on hand and lends out the remainder. $8,000 LoanableFunds Reserve Requirement 20% ($2,000 Retained) $10,000 Deposit

10. Banking Deregulation • Bank Mergers • Deregulation led to mergers; no more restrictions on interstate banking • Advantages: more competition meant low interest rates, more services • also more branches; economies of scale, especially for technology • Disadvantages: fewer banks to choose from • fear larger banks uninterested in small customers, local communities

12. Banking Deregulation • Banking Services • Financial Services Act of 1999 lifted last restriction on banks • Banks, insurance companies, investment companies compete • sell stocks, bonds, insurance, traditional banking services • Customers continue to use different companies for different services

13. Housing Boom and Bust • From 2000 to 2006, house prices in the U.S. skyrocketed. Many factors contributed to this boom, but bank lending practices played a major role. • Deregulation changed banks from local institutions into national megabanks. Instead of collecting payments on a mortgage for 30 years, banks began to sell these loans to other financial institutions for a quick profit.

14. Housing Boom and Bust • Banks became less interested in verifying that clients could repay a mortgage and more interested in making as many mortgage loans as possible. The easy money fueled the housing price bubble.