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Understanding Finance: Essentials of Money, Investment, and Banking

This lecture covers fundamental finance concepts including money, investment, credit, assets, capital gains, securities, and more. Explore banking history, risks in loans, financial crises, and the core solutions. Gain insights into the U.S. financial system trends and key banking ideas like creating money.

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Understanding Finance: Essentials of Money, Investment, and Banking

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  1. Lecture 10 Thursday, February 16 Finance

  2. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  3. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  4. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  5. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  6. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  7. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  8. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  9. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  10. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  11. Some Basic Concepts • Money • Investment • Credit • Assets and Capital gains • Securities: Stocks, bonds, derivatives, etc. • Leverage • Speculation • Bubbles

  12. BANKS • A key idea: Banks create money. How? • A problem: inherent risks in loans • Banking panics: a run on the bank • Solution: deposit insurance + regulation • Investment banks • Bank speculation & Financial Crisis • Core solution in the 1930s: Glass-Steagall act separating commercial and investment banking

  13. BANKS • A key idea: Banks create money. How? • A problem: inherent risks in loans • Banking panics: a run on the bank • Solution: deposit insurance + regulation • Investment banks • Bank speculation & Financial Crisis • Core solution in the 1930s: Glass-Steagall act separating commercial and investment banking

  14. BANKS • A key idea: Banks create money. How? • A problem: inherent risks in loans • Banking panics: a run on the bank • Solution: deposit insurance + regulation • Investment banks • Bank speculation & Financial Crisis • Core solution in the 1930s: Glass-Steagall act separating commercial and investment banking

  15. BANKS • A key idea: Banks create money. How? • A problem: inherent risks in loans • Banking panics: a run on the bank • Solution: deposit insurance + regulation • Investment banks • Bank speculation & Financial Crisis • Core solution in the 1930s: Glass-Steagall act separating commercial and investment banking

  16. BANKS • A key idea: Banks create money. How? • A problem: inherent risks in loans • Banking panics: a run on the bank • Solution: deposit insurance + regulation • Investment banks • Bank speculation & Financial Crisis • Core solution in the 1930s: Glass-Steagall act separating commercial and investment banking

  17. BANKS • A key idea: Banks create money. How? • A problem: inherent risks in loans • Banking panics: a run on the bank • Solution: deposit insurance + regulation • Investment banks • Bank speculation & Financial Crisis • Core solution in the 1930s: Glass-Steagall act separating commercial and investment banking

  18. BANKS • A key idea: Banks create money. How? • A problem: inherent risks in loans • Banking panics: a run on the bank • Solution: deposit insurance + regulation • Investment banks • Bank speculation & Financial Crisis • Core solution in the 1930s: Glass-Steagall act separating commercial and investment banking

  19. BANKS • A key idea: Banks create money. How? • A problem: inherent risks in loans • Banking panics: a run on the bank • Solution: deposit insurance + regulation • Investment banks • Bank speculation & Financial Crisis • Core solution in the 1930s: Glass-Steagall act separating commercial and investment banking

  20. The U.S. Financial System

  21. Trend #1:Financialization

  22. Real Corporate Profits, financial versus nonfinancial sectors Financial sector profits 1980=100 Nonfinancial profits

  23. 2009

  24. 20,000 Down Jones Stock Index 1947- 2017 2009

  25. Trend #2:Rapid growth of earnings in the financial sector

  26. Trend #3:Declining regulation

  27. Trend #4:Growth in size and concentration of financial institutions

  28. Changes over time in concentration of banking, 1935-2007 Repeal of Glass-Steagall banking restrictions Total assets of top three U.S. banks as a percent of total commercial banking assets

  29. Asset Concentration of the 5 largest banks in the United States: Continued concentration after the Great Recession Percent

  30. Trend #5:Financial Innovation

  31. The Financial Crisis of 2007-2009

  32. The nature of the housing market • Mortgage loans • Risks and Foreclosures • Derivatives: Mortgage-backed securities • Speculative markets in housing & in derivatives

  33. What happened? • Changes in the mortgage market fueled house price rise. • Key innovation was the derivatives market in Mortgage-backed securities • Result was rapid growth in sub-prime mortgages among other instruments • Investment banks got heavily into the speculative market • The speculation became increasingly leveraged (borrowing to invest) • When prices started declining, the whole structure unraveled, beginning with Lehman Brothers • Bailout needed to prevent total financial system collapse

  34. What happened? • Changes in the mortgage market fueled house price rise. • Key innovation was the derivatives market in Mortgage-backed securities • Result was rapid growth in sub-prime mortgages among other instruments • Investment banks got heavily into the speculative market • The speculation became increasingly leveraged (borrowing to invest) • When prices started declining, the whole structure unraveled, beginning with Lehman Brothers • Bailout needed to prevent total financial system collapse

  35. What happened? • Changes in the mortgage market fueled house price rise. • Key innovation was the derivatives market in Mortgage-backed securities • Result was rapid growth in sub-prime mortgages among other instruments • Investment banks got heavily into the speculative market • The speculation became increasingly leveraged (borrowing to invest) • When prices started declining, the whole structure unraveled, beginning with Lehman Brothers • Bailout needed to prevent total financial system collapse

  36. What happened? • Changes in the mortgage market fueled house price rise. • Key innovation was the derivatives market in Mortgage-backed securities • Result was rapid growth in sub-prime mortgages among other instruments • Investment banks got heavily into the speculative market • The speculation became increasingly leveraged (borrowing to invest) • When prices started declining, the whole structure unraveled, beginning with Lehman Brothers • Bailout needed to prevent total financial system collapse

  37. What happened? • Changes in the mortgage market fueled house price rise. • Key innovation was the derivatives market in Mortgage-backed securities • Result was rapid growth in sub-prime mortgages among other instruments • Investment banks got heavily into the speculative market • The speculation became increasingly leveraged (borrowing to invest) • When prices started declining, the whole structure unraveled, beginning with Lehman Brothers • Bailout needed to prevent total financial system collapse

  38. What happened? • Changes in the mortgage market fueled house price rise. • Key innovation was the derivatives market in Mortgage-backed securities • Result was rapid growth in sub-prime mortgages among other instruments • Investment banks got heavily into the speculative market • The speculation became increasingly leveraged (borrowing to invest) • When prices started declining, the whole structure unraveled, beginning with Lehman Brothers • Bailout needed to prevent total financial system collapse

  39. What happened? • Changes in the mortgage market fueled house price rise. • Key innovation was the derivatives market in Mortgage-backed securities • Result was rapid growth in sub-prime mortgages among other instruments • Investment banks got heavily into the speculative market • The speculation became increasingly leveraged (borrowing to invest) • When prices started declining, the whole structure unraveled, beginning with Lehman Brothers • Bailout needed to prevent total financial system collapse

  40. What happened? • Changes in the mortgage market fueled house price rise. • Key innovation was the derivatives market in Mortgage-backed securities • Result was rapid growth in sub-prime mortgages among other instruments • Investment banks got heavily into the speculative market • The speculation became increasingly leveraged (borrowing to invest) • When prices started declining, the whole structure unraveled, beginning with Lehman Brothers • Bailout needed to prevent total financial system collapse

  41. Magnitude of the crisis

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