R. GLENN HUBBARD ANTHONY PATRICK O BRIEN

1. R. GLENNHUBBARDANTHONY PATRICKO’BRIEN Money,Banking, andthe Financial System

2. Financial Crises andFinancial Regulation

12. For simplicity, ignore the interest the bank receives from the securities, the interest it pays on funds it borrows to finance the purchase of the securities, and any taxes the bank must pay.For simplicity, ignore the interest the bank receives from the securities, the interest it pays on funds it borrows to finance the purchase of the securities, and any taxes the bank must pay.

18. Higher budget deficits result from declines in tax revenues as incomes and profits fall as a result of the recession Higher budget deficits result from declines in tax revenues as incomes and profits fall as a result of the recession

21. The Financial Crisis of the Great Depression

30. The Financial Crisis of 2007–2009

31. Bear Sterns was acquired by the bank JPMorgan Chase at a price of $10 per share; one year earlier, Bear’s shares had sold for $170.Bear Sterns was acquired by the bank JPMorgan Chase at a price of $10 per share; one year earlier, Bear’s shares had sold for $170.

33. The Treasury began to lend directly to corporations through the Commercial Paper Funding Facility.The Treasury began to lend directly to corporations through the Commercial Paper Funding Facility.

36. Financial Crises and Financial Regulation

39. Central banks should provide short-term loans to banks that are illiquid but not insolvent. By lending to insolvent banks, the Fed increases the level of moral hazard in the system.Central banks should provide short-term loans to banks that are illiquid but not insolvent. By lending to insolvent banks, the Fed increases the level of moral hazard in the system.

44. With less competition, banks paid relatively little for deposits, and could charge lower interest rates on loans. They were the leading lenders to households and firms. But whenever market interest rates rose above the Regulation Q interest rate ceilings, large and small savers had an incentive to withdraw money from bank deposits, thereby starving banks of the funds they needed to make loans.With less competition, banks paid relatively little for deposits, and could charge lower interest rates on loans. They were the leading lenders to households and firms. But whenever market interest rates rose above the Regulation Q interest rate ceilings, large and small savers had an incentive to withdraw money from bank deposits, thereby starving banks of the funds they needed to make loans.

45. Negotiable certificates of deposit provided competition to commercial paper. Automatic transfer system (ATS) accounts allowed customers to earn interest by “sweeping” a customer’s checking account balance at the end of the day into an interest-paying overnight repurchase agreement.Negotiable certificates of deposit provided competition to commercial paper. Automatic transfer system (ATS) accounts allowed customers to earn interest by “sweeping” a customer’s checking account balance at the end of the day into an interest-paying overnight repurchase agreement.

46. Depositors were allowed to write only six checks per month. The costs of these deposits to banks were low because the banks did not have to hold reserves against them or process many checks, so the banks could afford to pay higher interest rates on them than on NOW accounts. The combination of market interest rates and the safety and familiarity of banks made the new accounts instantly successful with depositors.Depositors were allowed to write only six checks per month. The costs of these deposits to banks were low because the banks did not have to hold reserves against them or process many checks, so the banks could afford to pay higher interest rates on them than on NOW accounts. The combination of market interest rates and the safety and familiarity of banks made the new accounts instantly successful with depositors.

48. Beginning in 1979, sharply rising market interest rates increased the cost of funds for S&Ls, decreased the present value of their existing mortgage assets, and caused their net worth to decline precipitously. S&Ls were also highly leveraged, with their capital often being as little as 3% of their assets, which magnified the impact of losses on their equity. A wave of S&L failures during the 1980s was ended only by a costly federal government bailout. Many commercial banks also suffered losses during the 1980s, although the damage was limited by lower leverage and their lesser concentration in mortgage lending. Beginning in 1979, sharply rising market interest rates increased the cost of funds for S&Ls, decreased the present value of their existing mortgage assets, and caused their net worth to decline precipitously. S&Ls were also highly leveraged, with their capital often being as little as 3% of their assets, which magnified the impact of losses on their equity. A wave of S&L failures during the 1980s was ended only by a costly federal government bailout. Many commercial banks also suffered losses during the 1980s, although the damage was limited by lower leverage and their lesser concentration in mortgage lending.

49. As we saw in Chapter 10, banks set aside part of their capital as a loan loss reserve to anticipate future loan losses. Using a loan loss reserve enables a bank to avoid large swings in its reported profits.As we saw in Chapter 10, banks set aside part of their capital as a loan loss reserve to anticipate future loan losses. Using a loan loss reserve enables a bank to avoid large swings in its reported profits.

50. When banks sell bonds, some of the bonds are senior debt, while others are subordinated debt, or junior debt. If the bank were to fail, the investors owning senior debt would be paid before the investors owning junior debt. Because the investors owning junior debt have a greater incentive to monitor the behavior of bank managers, junior debt was included in Tier 2 capital under the Basel accord. When banks sell bonds, some of the bonds are senior debt, while others are subordinated debt, or junior debt. If the bank were to fail, the investors owning senior debt would be paid before the investors owning junior debt. Because the investors owning junior debt have a greater incentive to monitor the behavior of bank managers, junior debt was included in Tier 2 capital under the Basel accord.

51. Holding relatively risky assets, such as mortgage-backed securities, required banks to hold additional capital.Holding relatively risky assets, such as mortgage-backed securities, required banks to hold additional capital.