Financial Intermediaries in the United States:

What they are. What they do.

Why the Banking Industry Is Regulated• Banks hold money. Banks provide credit.

• The government focuses on information problems and liquidity risk.

• Bank run: many depositors withdraw their deposits and the bank’s funds are exhausted.

• Contagion: spreading of bad news about one bank to include other banks.

• Bankers’ private information limits depositors’ ability to sort out weak banks.

Government Intervention in the Banking Industry

• Federal Reserve was created to serve as a lender of last resort and issue currency.

Since 1863 limits on banks’ ability to open branches have been imposed.

• Numerous bank failures led to the creation of the Federal Deposit Insurance Corporation.– Moral hazard problems caused by bank insurance

increased the need for monitoring.

• Interest rate ceilings (Regulation Q) were intended to buttress bank profits.

Crisis and ResponseFinancial Crises We Have Known

• Stock Market Crash, 1929

• Britain off Gold, Sept. 1931

• Banking Crises, 1932-33

• Credit Crunch, 1966

• Penn Central Bankruptcy, 1970

• Continental Illinois, 1975

• Hunt Brothers Silver Corner

• Franklin National Bank, 1984

• LDC Debt Crisis, 1980s

• Stock Market Crash, 1987

• S & L Debacle, 1989 – 91

• Penn Square/Oil Patch/Junk Bonds

• Tequila Crisis, 1994-5

• Asian Contagion, 1997 – 8

• Long – Term Capital Management, 1998

• 911

• Enron, 2001

• Argentina, 2001

International Banking ServicesBranches, Agency Offices, Edge Act Corps, IBFs

Eurodollar Markets (LIBOR)

The Money Supply ProcessM = C + D and B = Bnon + BR = C + R

so M = {[1 + (C/D)] / [(C/D) + (R/D) + (ER/D)]} x B = m x B

The Effect of Open Market Operations

Multiple Deposit Creation