Lecture 10Thursday, October 2

Finance

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The U.S. Financial SystemThe U.S. Financial System

Trend #1:Trend #1:FinancializationFinancialization

1980=100

Financial sector profits

Nonfinancial profits

Real Corporate Profits, financial versus nonfinancial sectors

2009

Trend #2:Trend #2:Rapid growth of earnings Rapid growth of earnings

in the financial sectorin the financial sector

Trend #3:Trend #3:Declining regulationDeclining regulation

Trend #4:Trend #4:Growth in size of financial Growth in size of financial

institutionsinstitutions

Repeal of Glass-Steagall banking restrictions

Changes over time in concentration of banking, 1935-2007

Total assets of top three U.S. banks as a percent of total commercial banking assets

Trend #5:Trend #5:Financial InnovationFinancial Innovation

The Financial Crisis of The Financial Crisis of 2007-20092007-2009

The nature of the housing marketThe nature of the housing market

•Mortgage loans Mortgage loans •Risks and ForeclosuresRisks and Foreclosures•Mortgage backed securities Mortgage backed securities •Speculative markets in housing & Speculative markets in housing & Mortgage backed securitiesMortgage backed securities

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

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

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

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

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

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

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

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

Magnitude of the crisisMagnitude of the crisis

What Can be done?

1.Strengthen and enforce Dodd-Frank regulations,

2.End Too-Big-To-Fail: break up the Monster Banks.

3.Build a more community-rooted financial system.

What Can be done?

1.Strengthen and enforce Dodd-Frank regulations.

2.End Too-Big-To-Fail: break up the Monster Banks.

3.Build a more community-rooted financial system.

What Can be done?

1.Strengthen and enforce Dodd-Frank regulations.

2.End Too-Big-To-Fail: break up the Monster Banks.

3.Build a more community-rooted financial system.

What Can be done?

1.Strengthen and enforce Dodd-Frank regulations.

2.End Too-Big-To-Fail: break up the Monster Banks.

3.Build a more community-rooted financial system.

http://www.youtube.com/watch?feature=player_embedded&v=qOP2V_np2c0