Lecture 10 Thursday, February 16 Finance

1. Lecture 10 Thursday, February 16 Finance

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

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

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

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

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

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

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

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

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

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

12. 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

13. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. The U.S. Financial System

22. Trend #1:Financialization

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

25. 2009

26. 20,000 Down Jones Stock Index 1947- 2017 2009

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

29. Trend #3:Declining regulation

32. Trend #4:Growth in size and concentration of financial institutions

34. Changes over time in concentration of banking, 1935-2007 Repeal of Glass-Steagall banking restrictions Total assets of top three U.S. banks as a percent of total commercial banking assets

35. Asset Concentration of the 5 largest banks in the United States: Continued concentration after the Great Recession Percent

36. Trend #5:Financial Innovation

37. The Financial Crisis of 2007-2009

38. The nature of the housing market • Mortgage loans • Risks and Foreclosures • Derivatives: Mortgage-backed securities • Speculative markets in housing & in derivatives

39. 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

40. 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

42. 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

43. 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

44. 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

45. 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

46. 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

47. 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

48. Magnitude of the crisis