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
Real Corporate Profits, financial versus nonfinancial sectors

Financial sector profits

1980=100
Nonfinancial profits
2009
 Trend #2:
Rapid growth of earnings
in the financial sector
 Trend #3:
Declining regulation
 Trend #4:
Growth in size of financial
institutions
 Changes over time in concentration of banking, 1935-2007

Total assets
Repeal of Glass-Steagall banking restrictions
of top three
U.S. banks
as a percent
of total
commercial
banking
assets
 Trend #5:
Financial Innovation
The Financial Crisis of
2007-2009
The nature of the housing market

• Mortgage loans
• Risks and Foreclosures
• Mortgage backed securities
• Speculative markets in housing &
Mortgage backed securities
 What happened?
• Changes in the mortgage market fueled house price rise.
• Key innovation was the derivatives market in Mortgage-
backed securities
• Result was rapid growth in sub-prime mortgages among
other instruments
• Investment banks got heavily into the speculative market
• The speculation became increasingly leveraged (borrowing
to invest)
• When prices started declining, the whole structure
unraveled, beginning with Lehman Brothers
• Bailout needed to prevent total financial system collapse
 What happened?
• Changes in the mortgage market fueled house price rise.
• Key innovation was the derivatives market in Mortgage-
backed securities
• Result was rapid growth in sub-prime mortgages among
other instruments
• Investment banks got heavily into the speculative market
• The speculation became increasingly leveraged (borrowing
to invest)
• When prices started declining, the whole structure
unraveled, beginning with Lehman Brothers
• Bailout needed to prevent total financial system collapse
 What happened?
• Changes in the mortgage market fueled house price rise.
• Key innovation was the derivatives market in Mortgage-
backed securities
• Result was rapid growth in sub-prime mortgages among
other instruments
• Investment banks got heavily into the speculative market
• The speculation became increasingly leveraged (borrowing
to invest)
• When prices started declining, the whole structure
unraveled, beginning with Lehman Brothers
• Bailout needed to prevent total financial system collapse
 What happened?
• Changes in the mortgage market fueled house price rise.
• Key innovation was the derivatives market in Mortgage-
backed securities
• Result was rapid growth in sub-prime mortgages among
other instruments
• Investment banks got heavily into the speculative market
• The speculation became increasingly leveraged (borrowing
to invest)
• When prices started declining, the whole structure
unraveled, beginning with Lehman Brothers
• Bailout needed to prevent total financial system collapse
 What happened?
• Changes in the mortgage market fueled house price rise.
• Key innovation was the derivatives market in Mortgage-
backed securities
• Result was rapid growth in sub-prime mortgages among
other instruments
• Investment banks got heavily into the speculative market
• The speculation became increasingly leveraged (borrowing
to invest)
• When prices started declining, the whole structure
unraveled, beginning with Lehman Brothers
• Bailout needed to prevent total financial system collapse
 What happened?
• Changes in the mortgage market fueled house price rise.
• Key innovation was the derivatives market in Mortgage-
backed securities
• Result was rapid growth in sub-prime mortgages among
other instruments
• Investment banks got heavily into the speculative market
• The speculation became increasingly leveraged (borrowing
to invest)
• When prices started declining, the whole structure
unraveled, beginning with Lehman Brothers
• Bailout needed to prevent total financial system collapse
 What happened?
• Changes in the mortgage market fueled house price rise.
• Key innovation was the derivatives market in Mortgage-
backed securities
• Result was rapid growth in sub-prime mortgages among
other instruments
• Investment banks got heavily into the speculative market
• The speculation became increasingly leveraged (borrowing
to invest)
• When prices started declining, the whole structure
unraveled, beginning with Lehman Brothers
• Bailout needed to prevent total financial system collapse
 What happened?
• Changes in the mortgage market fueled house price rise.
• Key innovation was the derivatives market in Mortgage-
backed securities
• Result was rapid growth in sub-prime mortgages among
other instruments
• Investment banks got heavily into the speculative market
• The speculation became increasingly leveraged (borrowing
to invest)
• When prices started declining, the whole structure
unraveled, beginning with Lehman Brothers
• Bailout needed to prevent total financial system collapse
Magnitude of the crisis
 U.S. recession employment losses. Indexed job loss for four recessions, 1981-2007
% of employment at official beginning of recession

1981 recession 1990 recession 2001 recession 2007 recession

100%

98%

96%

94%

92%

90%
-3 0 3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48 51 54 57 60 63 66 69 72 75 78

Months since official beginning of recession

 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