BIOM 121 1nd Edition Lecture 53 Outline of Last Lecture I. Types of Wealth II. Barter and the Invention of Money III. Commodity Money IV. The Functions of Money V. Fiat Money VI. Definitions of Money Outline of Current Lecture I. Securitization Comes to BankingII. The Shadow Banking System III. The Financial Crisis of 2007-2009Current LectureI. Securitization Comes to Bankinga. Traditionally, when a bank made a residential mortgage loan to a household or a commercial loan to a business, the bank would keep the loan and collect the payments until the loan was paid off b. Security i. A financial asset, such as a stock or bond, that can be bought and sold in afinancial market ii. When a financial asset is first sold, the sale takes place in the primary market, while subsequent sales take place in the secondary market. MBS = mortgage based securities 1. Prior to 1970 most loans were not securitized because they could not be resold. There was no secondary market for them, but then a growing number of loans began to securitize c. Securitizationi. The process of transforming loans or finances to sell to other investors II. The Shadow Banking System a. Investment banks differ from commercial banksi. They do no accept depositsii. They rarely lend directly to householdsiii. They have traditionally concentrated on providing advice to firms issuing stocks and bonds or considering mergers with other firms. These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.b. In 1990s, investment banks expanded their buying or mortgages by bundling large numbers of them together as bonds, known as mortgage-backed securities often having higher interest rates than other securities with comparable default risk and reselling them to investorsc. Types of Investment Banksi. Money Market Mutual Funds1. Sell shares to investors use the money to buy short-term securitiessuch as Treasury bills and commercial paper issued by corporations ii. Hedge Funds1. Raise money from wealthy investors and use sophisticated investment strategies that often involve significant riskIII. The Financial Crisis of 2007-2009 a. The firms in shadow banking system differed from commercial banks in two important ways:i. The government agencies that regulated the commercial banking system, including the Federal Reserve, did not regulate these firms ii. These firms were more leverages than were commercial banks, that is, they relied more on borrowed money to finance their operations, increasing both the potential for larger profits and the potential for larger losses. 1. Beginning in 2007, firms in the shadow banking system were quitevulnerable to runs as housing prices fell and borrowers defaulted on their mortgages b. As the underlying cause of the crisis, problems in the US housing market led to a myriad of troubles in the financial system i. Mortgage-backed securities lost value and their investors suffered heavy lossesii. Many investment banks and other financial firms without deposit insurance that had borrowed short term and invested long term had to sell their holdings of securities, which continued to lose value iii. In 2008, the failure of the investment bank Lehman Brothers set off a panic and the process of securitization nearly ground to a halt 1. A wave of withdrawals from money market mutual funds disabled their ole as buyers of corporate commercial paper 2. As banks and other financial firms sold assets and cut back on lending to shore up their financial positions, the flow of funds from savers to borrowers was disrupted and the resulting credit crunch significantly worsened the recession. c. The Fed’s Responsei. Under the Troubled Asset Relief Program (TARP) in the fall of 2008, the Fed and the US Treasury began attempting to stabilize the commercial banking system by providing funds to banks in exchange for stockii. The Fed also modified its discount policy by setting up several new “lending facilities” enabling it to grant discount loans to financial firms that were previously ineligible iii. In addition, the Fed addressed problems in the commercial paper market by directly buying commercial paper for the first time since the 1930s iv. Although these actions of the Treasury and Fed appeared to have stabilized the financial system, the recession continued into 2009 and by late 2011, the flow of funds from savers to borrowers still hadn’t returnedto normal
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