CHAPTER 21
I. THE IMPORTANCE OF MONEY.
LEARNING GOAL 1. Explain what money
is and the importance of the money supply to domestic and international
exchange.
A. THE AMERICAN ECONOMY DEPENDS UPON
MONEY: its availability, its value relative to other currencies, and its cost.
1. Money is so important that MANY
INSTITUTIONS HAVE EVOLVED TO MANAGE MONEY and to make it available to you when
you need it.
2. The banking system is so complex
because the flow of money FROM COUNTRY TO COUNTRY is as free as the flow FROM
STATE TO STATE.
3. What happens to any major
country's economy has an effect on the U.S. economy and vice versa.
B. WHAT IS MONEY?
1. MONEY is anything that people
generally accept as payment for goods and services.
2. BARTER is the trading of goods
and services for other goods and services directly.
a. Many people today still barter
goods and services, but transactions are difficult.
b. People need some object that's
more portable, divisible, durable, and stable so that they can trade without
having to carry the actual goods.
c. Coins meet all the standards for
a more useful money.
3. The STANDARDS FOR USEFUL MONEY:
a. PORTABILITY. Coins were easier to
take to market than goods.
b. DIVISIBILITY. Different-sized
coins could be made to represent different values.
c. STABILITY. Everybody agreed on
the value of coins so the value of money became relatively stable.
d. DURABILITY. Coins last for years.
e. DIFFICULT TO COUNTERFEIT. The
government has had to go to extra lengths to make real dollars readily
identifiable.
4. Coins and paper money thus became
UNITS OF VALUE and a means of making exchanges easier.
a. Most countries have their own
coins and paper that they use as money.
b. However, they are not always
equally stable-the text uses the example of Russian money.
C. WHAT IS THE MONEY SUPPLY?
1. The value of money depends on the
MONEY SUPPLY, how much money there is to buy available goods and services.
2. There are several DEFINITIONS OF
MONEY SUPPLY (M-1, M-2, and so on)
a. M-1 includes CURRENCY (coins and
paper bills), money that's available by writing checks, and money held in
traveler's checks; that is MONEY THAT IS QUICKLY AND EASILY RAISED.
b. M-2 includes everything in M-1
PLUS MONEY IN SAVINGS ACCOUNTS (time deposits), and money in money market
accounts, mutual funds, certificates of deposit, and the like; that is MONEY
THAT MAY TAKE A LITTLE MORE TIME TO OBTAIN THAN CURRENCY.
c. M-2 is the most commonly used
definition of money.
D. WHY DOES THE MONEY SUPPLY NEED TO
BE CONTROLLED?
1. The money supply needs to be
controlled because the prices of goods and services can be somewhat managed by
controlling the amount of money available in the economy.
2. If TOO MUCH MONEY is available,
prices go up-INFLATION.
3. If TOO LITTLE MONEY is available,
prices would go down resulting in RECESSION.
4. The money supply tools have an
effect on employment and economic growth and decline.
E. THE GLOBAL EXCHANGE OF MONEY.
1. FALLING DOLLAR means that the
amount of goods and services you can buy with a dollar goes down.
2. RISING DOLLAR means that the
amount of goods and services you can buy with a dollar goes up.
3. What makes the dollar weak or
strong is the position of the U.S. economy relative to other economies.
a. When the economy is strong,
people want to buy dollars and the value relative to other economies rises.
b. When a country's economy is
perceived as weakening, people no longer desire its currency and the currency's
value falls.
II. CONTROL OF THE MONEY SUPPLY.
LEARNING GOAL 2. Describe how the
Federal Reserve controls the money supply.
A. It is important to have an
organization that controls the money supply to try to keep the U.S. economy
from growing too fast or too slowly.
1. The FEDERAL RESERVE SYSTEM (THE
FED) is the organization in charge of monetary policy.
2. The head of the Federal Reserve
Alan Greenspan, is one of the most influential people in the world.
B. BASICS ABOUT THE FEDERAL RESERVE.
1. The Federal Reserve System
consists of five major parts:
a. The BOARD OF GOVERNORS
administers and supervises the 12 Federal Reserve System banks.
(i) There are seven members who are
appointed by the President.
(ii) The primary function is to set
monetary policy.
b. The FEDERAL OPEN MARKET COMMITTEE
has 12 voting members and is the policy-making body.
c. The 12 FEDERAL RESERVE BANKS.
d. THREE ADVISORY COUNCILS.
(i) The advisory councils offer
suggestions to the board and the FOMC.
(ii) The councils represent the
various banking districts, consumers, and member institutions.
e. The MEMBER BANKS of the system.
2. The Federal Reserve:
a. Buys and sells foreign
currencies.
b. Regulates various types of
credit.
c. Supervises banks.
d. Collects data on the money supply
and other economic activities.
3. The tools used to regulate the
money supply include: reserve requirements, open-market operations, and the
discount rate.
C. THE RESERVE REQUIREMENT.
1. The RESERVE REQUIREMENT is a
percentage of commercial bank's checking and savings accounts that must be
physically kept in this bank (for example, as cash in the vault) or a
non-interest-bearing deposit at the local Federal Reserve district bank.
2. Changing the reserve requirement
is the Fed's most powerful tool.
3. When the Fed INCREASES THE
RESERVE REQUIREMENT, banks have LESS MONEY FOR LOANS and make fewer loans,
which tends to reduce inflation.
4. When the Fed DECREASES THE
RESERVE REQUIREMENT, banks have MORE MONEY AVAILABLE FOR LOANS and make more
loans, which tends to stimulate the economy RISKING INFLATION.
5. Because this tool is so potent,
and can cause such major changes in the U.S. economy, it is rarely used.
D. OPEN-MARKET OPERATIONS.
1. OPEN-MARKET OPERATIONS (the most
commonly used tool) involves the buying and selling of U.S. government
securities by the Fed with the goal of regulating the money supply.
2. When the fed wants to DECREASE
THE MONEY SUPPLY, it SELLS GOVERNMENT SECURITIES.
3. When the fed wants to INCREASE
THE MONEY SUPPLY, it BUYS GOVERNMENT SECURITIES from individuals, corporations,
or organizations willing to sell.
E. THE DISCOUNT RATE.
1. The Fed is called the BANKER'S
BANK.
2. Member banks can borrow money
from the Fed and then pass it on to their customers.
3. The DISCOUNT RATE is the interest
rate that Fed charges for loans to member banks.
4. INCREASING THE DISCOUNT RATE
discourages banks from borrowing and consequently reduces the number of
available loans, resulting in a DECREASE IN THE MONEY SUPPLY.
5. DECREASING THE DISCOUNT RATE
encourages banks borrowing and increases the amount of funds available for
loans, resulting in an INCREASE IN THE MONEY SUPPLY.
F. The whole banking industry is
affected by actions taken by the Federal Reserve System.
III. THE DEVELOPMENT OF THE FEDERAL
RESERVE SYSTEM.
LEARNING GOAL 3. Trace the history
of banking and the Federal Reserve System.
A. EARLY BANKING HISTORY.
1. There were NO BANKS IN EARLY
COLONIAL AMERICA.
a. Strict laws limited the number of
coins that could be brought to the colonies.
b. Colonists were forced to barter.
2. MASSACHUSETTS issued its OWN
PAPER MONEY in 1690 and soon other colonies did as well.
a. LAND BANKS made loans to farmers.
b. England stopped these practices
by 1741.
3. ALEXANDER HAMILTON convinced
Congress to form a CENTRAL BANK in 1781.
a. The bank had so much OPPOSITION
that it CLOSED in 1811.
b. An attempt to replace the bank in
1816 failed again by 1836.
4. By the time of the CIVIL WAR,
BANKING WAS A MESS.
a. Different banks issued different
currency.
b. Often the coins were worth more
as gold or silver than as coins.
5. The chaos reached a climax in
1907 when many BANKS FAILED.
6. People withdrew their funds from
the bank until there was no cash left and money could no longer be given to
depositors.
7. To avoid another cash shortage,
the FEDERAL RESERVE SYSTEM was formed.
a. All Federally chartered banks
must join; state chartered banks may join.
b. The Federal Reserve became the
BANKERS' BANK.
B. THE GREAT DEPRESSION.
1. The STOCK MARKET CRASH OF 1929
led to bank failures in the early 1930s.
2. In 1933 and 1935, the federal
government passed LAWS to strengthen the banking system.
3. One move established FEDERAL DEPOSIT
INSURANCE (discussed later in the chapter).
C. THE FEDERAL RESERVE AND THE
BANKING INDUSTRY.
1. During the 1990s, there has been
much debate about the Fed's actions.
a. In the early 1990s the Fed pumped
up the money supply and lowered interest rates to get the economy moving.
b. The Fed increased short-term
interest rates in 1994, threatening the stock market.
c. Some applauded hiking the
interest rates saying it would cut inflation and let the economy grow slowly.
d. Others said there was no threat
of inflation and higher interest rates would slow the economy to the point of
recession.
2. Businesses are concerned because
higher bank rates mean a higher cost of borrowing.
3. STAGFLATION, the combination of
slow growth and inflation, is possible.
IV. THE AMERICAN BANKING SYSTEM.
LEARNING GOAL 4. Classify the
various institutions in the U.S. banking system.
A. The AMERICAN BANKING SYSTEM
consists of commercial banks, savings and loan associations, credit unions,
mutual savings banks, and NONBANKS (nondeposit institutions that perform
several banking functions.)
B. COMMERCIAL BANKS.
1. A COMMERCIAL BANK is a
profit-making organization that receives deposits from individuals and
corporations in the form of checking and savings accounts and uses some of
these funds to make loans.
2. Commercial banks have two types
of customers: DEPOSITORS and BORROWERS.
3. Commercial banks make a profit if
the revenue generated by loans exceeds the interest paid to depositors.
C. SERVICES PROVIDED BY COMMERCIAL BANKS.
1. A DEMAND DEPOSIT is the technical
name for a checking account; the money can be withdrawn on demand at any time
by the owner.
2. In the past, checking accounts
paid no interest, but interest-bearing checking accounts (NOW and SUPER NOW
accounts) have grown in recent years.
3. A NOW (NEGOTIABLE ORDER OF
WITHDRAWAL) ACCOUNT pays an annual interest rate, but imposes a minimum
balance.
4. A SUPER NOW account pays higher
interest and requires a large minimum balance.
5. A TIME DEPOSIT is the technical
name for a SAVINGS ACCOUNT for which the bank requires prior notice before
withdrawal.
a. A CERTIFICATE OF DEPOSIT is a
note issued by a bank that earns a guaranteed interest rate for a fixed period
of time.
b. The CD cannot be withdrawn
without penalty until the maturity date.
6. Some other services include
CREDIT CARDS and ATMs.
a. AUTOMATED TELLER MACHINES (ATMs)
give customers the convenience of 24-hour banking.
b. Commercial banks may also offer
credit cards, brokerage services, financial counseling, automatic payment of
bills, safe deposit boxes, tax-deferred IRAs, travelers' checks, and overdraft
privileges.
7. SERVICES TO BORROWERS.
a. Banks screen loan applicants
carefully to ensure that the loan plus interest will be paid back on time.
b. Small businesses and minority
businesses often search out banks that cater to their needs.
8. BUSINESS LOANS.
a. SHORT-TERM LOANS are those that
have to be paid in one year or less.
b. Businesses can establish a line
of credit before they actually need money.
c. LONG-TERM LOANS are those payable
in a period that exceeds one year.
d. The interest charged for most
long-term loans to large corporations is negotiated.
e. Most loans require COLLATERAL,
some object of value.
D. SAVINGS AND LOAN ASSOCIATIONS.
1. SAVINGS AND LOAN ASSOCIATIONS are
financial institutions that accept both savings and checking deposits and
provide home mortgage loans.
a. Samp;Ls are often known as thrift
institutions since their original purpose was to promote consumer thrift and
home ownership.
b. Thrifts were permitted to offer
slightly higher interest rates to attract funds.
c. These funds were then used to
offer long-term fixed rate mortgages.
2. In the early 1980s Samp;Ls ran
into trouble.
a. To help relieve the pressure, the
federal government permitted Samp;LS to offer NOW and SUPER NOW ACCOUNTS, to
allocate up to 10% of their funds to COMMERCIAL LOANS, and to offer mortgage
loans with ADJUSTABLE INTEREST RATES.
b. Samp;Ls became similar to
commercial banks.
3. Congress decided to guarantee
Samp;L savings up to $100,000 per account.
a. Banks and Samp;Ls made risky
loans in the 1980s, with the thought that such loans were guaranteed by the
government.
b. Banks and Samp;Ls made many loans
that failed, costing the government about $500 billion.
c. Many Samp;L directors were
sentenced to prison for defrauding investors and mismanaging funds.
E. CREDIT UNIONS.
1. CREDIT UNIONS are nonprofit,
member- owned financial cooperatives that offer basic banking service.
2. Credit unions offer members
interest-bearing checking accounts at relatively high rates, short-term loans
at relatively low rates, financial counseling, life insurance, and home
mortgage loans.
3. As not-for-profit institutions,
credit unions enjoy an exemption from federal income taxes.
F. OTHER FINANCIAL INSTITUTIONS.
1. NONBANKS are financial
organizations that accept no deposits, but offer many of the services provided
by other banks.
a. NONBANKS INCLUDE life insurance
companies, pension funds, brokerage firms, and commercial finance companies.
b. The diversity of financial
services offered by nonbanks has caused banks to expand their services.
2. LIFE INSURANCE COMPANIES provide
financial protection for policyholders who periodically pay premiums.
3. PENSION FUNDS are amounts of
money designated by corporations, nonprofit organizations, or unions to cover
part of the financial needs of members when they retire.
a. Pension funds typically invest in
low-return but safe corporate stocks or government securities.
b. Many large pension funds are
becoming a force in U.S. financial markets.
4. BROKERAGE FIRMS are organizations
that buy and sell securities for their clients and provide other financial
services.
5. COMMERCIAL AND CONSUMER FINANCE
COMPANIES are institutions that offer short-term loans to individuals at higher
interest rates than commercial banks.
a. The primary customers are new
businesses and individuals with no credit history.
b. One should be careful when borrowing
from such institutions because the interest rates can be quite high.
6. CORPORATE FINANCIAL SYSTEMS are
financial services offered to customers of major corporations such as GE,
Sears, and GM.
V. HOW THE GOVERNMENT PROTECTS YOUR
FUNDS.
LEARNING GOAL 5. Explain the
importance of the Federal Deposit Insurance Corporation and other organizations
that guarantee funds.
A. As a result of the depression of
the 1930s, several organizations evolved to protect your money.
1. The three major sources of
financial protection are the FDIC, the SAIF, and the NCUA.
2. All three insure deposits in
individual accounts up to $100,000.
B. THE FEDERAL DEPOSIT INSURANCE
CORPORATION (FDIC) is an independent government agency that insures accounts in
banks against bank failures (up to a limit of $100,000 per account).
1. If a bank were to fail, the FDIC
would arrange to have its accounts transferred to another bank.
2. The idea is to maintain
confidence in banks so that others don't fail if one falls.
C. THE SAVINGS ASSOCIATION INSURANCE
FUND (SAIF) (Formerly Federal Savings and Loan Insurance Corporation)
1. SAIF insures holders of accounts
in savings and loan associations.
2. For 50 years the FSLIC was
successful in covering losses from Samp;Ls.
3. In the 1980s, as more Samp;Ls
failed, the FSLIC became INSOLVENT as well.
4. In 1989 the government created
the Resolution Trust Corporation to sell the Samp;L's assets.
D. NATIONAL CREDIT UNION
ADMINISTRATION (NCUA).
1. The NCUA provides up to $100,000
cover age per depositor.
2. Additional protection can be
obtained by holding accounts jointly or in trust.
VI. THE FUTURE OF BANKING.
LEARNING GOAL 6. Weigh the future of
the U.S. banking system.
A. The U.S. economy appears to be in
the best shape in years.
1. However, federal debt and
personal debt keep rising.
a. Over a million people are
declaring bankruptcy each year.
b. The banking system may not be as
strong as it appears.
2. Banks as we've traditionally
known them will change.
B. INTERSTATE BANKING.
1. Businesses, including banks, are
reorganizing to become more efficient and effective through a series of mergers
and acquisitions.
2. However, there is a counter trend
toward the opening of community banks that are more user-friendly and convenient.
C. EXPANDING WHAT BANKS DO.
1. State banks are taking the lead
in giving banks freedom to go into other businesses.
2. Today banks are taking on new
roles in insurance, securities (stocks and bonds), and real estate.
D. ELECTRONIC BANKING TAKES ON TRADI
TIONAL BANKING.
1. The whole banking system is on
the brink of a major revolution.
a. The way things were done was
expensive.
b. One step in the past was to issue
credit cards.
c. The next step was to create the
electronic exchange of money.
2. ELECTRONIC FUNDS TRANSFER SYSTEM
(EFTS) is a computerized system that electronically performs financial
transactions such as making purchases, paying bills, and receiving paychecks.
3. EFTS frees banks from processing
checks and managing credit card fraud and bad checks.
4. Some workers receive no
paycheck-their employers transfer funds from the employer's account to the
worker's account.
5. Smart cards are an advanced
version of the cards used in EFTS, more prevalent overseas than in America.
E. ELECTRONIC BANKING ON THE
INTERNET.
1. Soon all of the top 200 banks in
America will have some kind of online banking.
2. The latest in technology makes it
safer than giving your credit card to a retailer.
VII. INTERNATIONAL BANKING AND BANK
ING SERVICES.
LEARNING GOAL 7. Evaluate the role
and importance of international banking and the role of the World Bank and the
International Monetary Fund.
A. Banks help businesses conduct
business in other countries by providing three services.
1. A LETTER OF CREDIT is a promise
by the bank to pay the seller a given amount if certain conditions are met.
2. A BANKER' ACCEPTANCE promises
that the bank will pay some specified amount at a particular time.
3. CURRENCY EXCHANGE is the exchange
of one country's currency for another country's currency.
B. LEADERS IN INTERNATIONAL BANKING.
1. In the future, many crucial
financial issues will be international in scope.
2. Today's money markets are GLOBAL
MARKETS.
a. American firms must compete for
funds with firms all over the world.
b. The success of American business
is tied to the success of businesses throughout the world.
3. Banking is no longer a domestic
issue.
4. What has evolved is a world
economy financed by international banks.
C. THE WORLD BANK AND THE
INTERNATIONAL MONETARY FUND (IMF).
1. The World Bank and the IMF are
twin pillars that support the structure of the world's banking community.
2. The WORLD BANK is responsible for
financing economic developing.
a. It is also known as the
International Bank for Reconstruction and Development.
b. Today, most of the money is lent
to poor nations to raise productivity and raise the standard of living.
3. The INTERNATIONAL MONETARY FUND
(IMF) was established to assist the smooth flow of money among nations.
a. It requires members to allow
their currency to be exchanged for foreign currencies freely and keep the IMF
in formed about changes in monetary policy.
b. The IMF is not primarily a
lending institution, rather an overseer of member countries monetary and
exchange rate policies.
4. The IMF's goal is to maintain a
global monetary system that works best for all nations.
D. BANKS THROUGHOUT THE WORLD ARE
FINANCIALLY WEAK.
1. In the 1990 Asian countries
experienced currency problems.
a. The IMF bailed them out, but they
were not forced to suffer the full consequences.
b. IMF policies are thus being
challenged.
2. Asian countries are also eager
for U.S. dollars and intend to sell their products to the U.S. at greatly
reduced prices.
3. U.S. producers will have trouble
selling goods and services in Asia because people have less money to spend.
4. The effects of the 'Asian Crisis'
have not been fully realized around the world.
5. A major failure in any one
country has an effect on all countries.
E. THE YEAR 2000 PROBLEM.
1. The problem, that computer
systems that will read 1900 instead of 2000 on January 1, 2000, will be a major
problem for banks.
2. Most large banks are trying to
fix the problem before it occurs, but many banks are behind.