Lecture 10 Thursday, 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 System

Trend #1: Financialization

1980=100 Financial sector profits Nonfinancial profits Real Corporate Profits, financial versus nonfinancial sectors

2009

Trend #2: Rapid growth of earnings in the financial sector

Trend #3: Declining regulation

Trend #4: Growth in size of financial institutions

Repeal of Glass-Steagall banking restrictions Changes over time in concentration of banking, Total assets of top three U.S. banks as a percent of total commercial banking assets

Trend #5: Financial Innovation

The Financial Crisis of

The nature of the housing market Mortgage loans Mortgage loans Risks and Foreclosures Risks and Foreclosures Mortgage backed securities Mortgage backed securities Speculative markets in housing & Mortgage backed securities Speculative markets in housing & Mortgage backed securities

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 securities Key innovation was the derivatives market in Mortgage- backed securities Result was rapid growth in sub-prime mortgages among other instruments Result was rapid growth in sub-prime mortgages among other instruments Investment banks got heavily into the speculative market Investment banks got heavily into the speculative market The speculation became increasingly leveraged (borrowing to invest) The speculation became increasingly leveraged (borrowing to invest) When prices started declining, the whole structure unraveled, beginning with Lehman Brothers When prices started declining, the whole structure unraveled, beginning with Lehman Brothers Bailout needed to prevent total financial system collapse Bailout needed to prevent total financial system collapse

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 securities Key innovation was the derivatives market in Mortgage- backed securities Result was rapid growth in sub-prime mortgages among other instruments Result was rapid growth in sub-prime mortgages among other instruments Investment banks got heavily into the speculative market Investment banks got heavily into the speculative market The speculation became increasingly leveraged (borrowing to invest) The speculation became increasingly leveraged (borrowing to invest) When prices started declining, the whole structure unraveled, beginning with Lehman Brothers When prices started declining, the whole structure unraveled, beginning with Lehman Brothers Bailout needed to prevent total financial system collapse Bailout needed to prevent total financial system collapse

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 securities Key innovation was the derivatives market in Mortgage- backed securities Result was rapid growth in sub-prime mortgages among other instruments Result was rapid growth in sub-prime mortgages among other instruments Investment banks got heavily into the speculative market Investment banks got heavily into the speculative market The speculation became increasingly leveraged (borrowing to invest) The speculation became increasingly leveraged (borrowing to invest) When prices started declining, the whole structure unraveled, beginning with Lehman Brothers When prices started declining, the whole structure unraveled, beginning with Lehman Brothers Bailout needed to prevent total financial system collapse Bailout needed to prevent total financial system collapse

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 securities Key innovation was the derivatives market in Mortgage- backed securities Result was rapid growth in sub-prime mortgages among other instruments Result was rapid growth in sub-prime mortgages among other instruments Investment banks got heavily into the speculative market Investment banks got heavily into the speculative market The speculation became increasingly leveraged (borrowing to invest) The speculation became increasingly leveraged (borrowing to invest) When prices started declining, the whole structure unraveled, beginning with Lehman Brothers When prices started declining, the whole structure unraveled, beginning with Lehman Brothers Bailout needed to prevent total financial system collapse Bailout needed to prevent total financial system collapse

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 securities Key innovation was the derivatives market in Mortgage- backed securities Result was rapid growth in sub-prime mortgages among other instruments Result was rapid growth in sub-prime mortgages among other instruments Investment banks got heavily into the speculative market Investment banks got heavily into the speculative market The speculation became increasingly leveraged (borrowing to invest) The speculation became increasingly leveraged (borrowing to invest) When prices started declining, the whole structure unraveled, beginning with Lehman Brothers When prices started declining, the whole structure unraveled, beginning with Lehman Brothers Bailout needed to prevent total financial system collapse Bailout needed to prevent total financial system collapse

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 securities Key innovation was the derivatives market in Mortgage- backed securities Result was rapid growth in sub-prime mortgages among other instruments Result was rapid growth in sub-prime mortgages among other instruments Investment banks got heavily into the speculative market Investment banks got heavily into the speculative market The speculation became increasingly leveraged (borrowing to invest) The speculation became increasingly leveraged (borrowing to invest) When prices started declining, the whole structure unraveled, beginning with Lehman Brothers When prices started declining, the whole structure unraveled, beginning with Lehman Brothers Bailout needed to prevent total financial system collapse Bailout needed to prevent total financial system collapse

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 securities Key innovation was the derivatives market in Mortgage- backed securities Result was rapid growth in sub-prime mortgages among other instruments Result was rapid growth in sub-prime mortgages among other instruments Investment banks got heavily into the speculative market Investment banks got heavily into the speculative market The speculation became increasingly leveraged (borrowing to invest) The speculation became increasingly leveraged (borrowing to invest) When prices started declining, the whole structure unraveled, beginning with Lehman Brothers When prices started declining, the whole structure unraveled, beginning with Lehman Brothers Bailout needed to prevent total financial system collapse Bailout needed to prevent total financial system collapse

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 securities Key innovation was the derivatives market in Mortgage- backed securities Result was rapid growth in sub-prime mortgages among other instruments Result was rapid growth in sub-prime mortgages among other instruments Investment banks got heavily into the speculative market Investment banks got heavily into the speculative market The speculation became increasingly leveraged (borrowing to invest) The speculation became increasingly leveraged (borrowing to invest) When prices started declining, the whole structure unraveled, beginning with Lehman Brothers When prices started declining, the whole structure unraveled, beginning with Lehman Brothers Bailout needed to prevent total financial system collapse Bailout needed to prevent total financial system collapse

Magnitude 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.