final report
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Lecture4-CentralBank-Jun22.pptx
Financial Institutions & markets
FIN 353 –Summer 2020
Snow Han
SFSU
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Central Bank
Financial industry is one of the most heavily regulated industry
Esp. banking industry
The next question is:
Who’s regulating / monitoring our financial system? Specifically banks.
What’ the problem? – Financial crisis
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Central Banks
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Every country in the world has a central bank (either developing or developed).
And every country in the world has a money/currency that has their central bank’s name on it.
Take you back to the origins of these things, so that we can get a better understanding of what these institutions are and what their function is.
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Central banks are the government authorities in charge of monetary policy (currency)
In the U.S., the central bank is the Federal Reserve System
Contents:
Origins of the Central bank
Role/ Function of the Federal Reserve System
Structure of the Federal Reserve System
How Independent is the Fed?
Should the Fed Be Independent?
Structure and Independence of other Foreign Central Banks
Origins – why?
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Financial Innovation is an important process.
If you think about our financial system today, and financial systems 100/80 years ago, they are entirely different
Financial innovation is similar as engineering innovation.
If someone find something and it is proved to work, it get copied everywhere around the world
It is just how our human species work. When some one figure out something and it works, it will soon spreads all over the world ,
Not because we are copy cats, but simply because it works, it solves problem.
it is the same with central banks
Modern banking traced back to the gold smith bankers – made jewelry/ they have safe, so people will just put/deposit their gold at the gold smith’s safe
The gold smith will issue a paper, with this paper, you can withdraw your gold
Eventually this paper begins to circulate – paper money / 1970s always backed by gold, or silver
Private business, no government involved
Problem from the very beginning – the gold smith won’t do good
Have too many papers, I don’t have any gold any more.
The rest UK banks are just limited liabilities partnership
Get so large – so easily to let the other bank bankrupt. They got a lot of notes issued by the other banks, present them for payments- bank run
Reserve help stabilize the system – since they have money to pay them out when they need
Bank of England was nationalized in 1946, become part of a government…
Tendency for banking system s to overlend to create booms, false prosperity and then the crashes, banking panic, recession
Source of stability and sense
Federal reserve chairs “William Joseph McDonough ”– is to take away the punch ball as soon as the party gets going – parents
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UK – Bank of England – largest, dominant
Established in 1694, not government
Special charter from the Parliament – issue shares
In charge of government’s accounts/balances, and issue bank notes
Keep deposits from the other bank - “reserve”
Model of all countries’ central bank
1997 – independent central bank
In the US
Suffolk bank in Boston 1819 - 1860
Private bank
Copy the Bank of England
Help stabilize the currency in Boston,“Boston money”
First Bank of United States – 1791 (Hamilton)-1811
Second bank of United States – 1816-1836
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Invention of people
First half of 19 century , repeated bank crisis
The financial system was so unstable
You go to a grocery store, you want to buy something. They say, let’s see you money.
You take out all you money, and lay down all the money
New haven money, Hartford money, charlotte money
The first bank is created as a facility of the government, help the government pay off war debts, and try to establish a common currency
George Washington initially declared that he was hesitant to sign the "bank bill" into law – unconstitutional
Both were private banks with public duties
Second bank of united states, 20% shares owned by federal government, the bank's single largest stockholder
But they are not independent - answerable for its performance to the U.S. Treasury and Congress
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Federal Reserve System
1863 – National Banking Act
Successful in stabilizing the currency ( at par)
But still banking crisis (e.g. 1893, 1907…etc.)
1913 – Federal Reserve Act – Federal Reserve System
Create 12 banks all over the country, BOG headquarter @ DC
Require deposits with the Federal Reserve
Lender of Last Resort (e.g. Discount window)
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The US hesitate for a long time of having a central bank
They just don’t like government to involve too much in private business, feared of centralized power
They try to innovate something, which is not a central bank, but have some functions as the central bank
Government passed – 1863 National Banking Act (revision in 1864)
Every city create a nation banks called national bank of sth
The treasury require them to have capital saved in the treasury to
Put money with the treasury to back up their currency
Federal Reserve Act – 1913 - Following The Panic of 1907 –secured by J.P. Morgan
The Panic of 1907 – also known as the 1907 Bankers' Panic or Knickerbocker Crisis[1] – was a United States financial crisis that took place over a three-week period starting in mid-October, when the New York Stock Exchange fell almost 50% from its peak the previous year. Panic occurred, as this was during a time of economic recession, and there were numerous runs on banks and trust companies. The 1907 panic eventually spread throughout the nation when many state and local banks and businesses entered bankruptcy. Primary causes of the run included a retraction of market liquidity by a number of New York City banks and a loss of confidence among depositors, exacerbated by unregulated side bets at bucket shops.[2] The panic was triggered by the failed attempt in October 1907 to corner the market on stock of the United Copper Company. When this bid failed, banks that had lent money to the cornering scheme suffered runs that later spread to affiliated banks and trusts, leading a week later to the downfall of the Knickerbocker Trust Company—New York City's third-largest trust. The collapse of the Knickerbocker spread fear throughout the city's trusts as regional banks withdrew reserves from New York City banks. Panic extended across the nation as vast numbers of people withdrew deposits from their regional banks.
The panic might have deepened if not for the intervention of financier J. P. Morgan,[3] who pledged large sums of his own money, and convinced other New York bankers to do the same, to shore up the banking system. At the time, the United States did not have a central bank to inject liquidity back into the market.
Federal Reserve system, which opens its door in 1914.
In the US. We always feel we are unique, and different, so we have to make it a little different from the UK system
The founders decided against concentrating the federal banking system in NYC or D.C. in order to maintain public support for the idea, increasing its effectiveness.
The 12 branches are spread across the country to make sure all regions of the country are represented in policy deliberations.
Headquarter in DC, which is called the board – Board of Governor (BOG)
Discount window- bring asset/securities as collateral ; discount the collateral and lend the money
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*Deposit Insurance
Even with reserve requirement, the system began to fail in 1929, banking crisis reached the peak in 1933
People’s confidence in financial institutions was rapidly eroded
President Roosevelt – “Banking holiday”
Banking Act of 1993 (Glass-Steagall Act)
Set up FDIC (Federal Deposit Insurance Corporation)-1933
No big banking crisis till 2007
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The Great Depression in the United States began as an ordinary recession in the summer of 1929, but became increasingly worse over the latter part of that year, continuing until 1933. At its lowest point, industrial production in the United States had declined 47 percent, real gross domestic product (GDP) had fallen 30 percent and total unemployment reached as high as 20 percent.
In the wake of the stock market crash of October 1929, people were growing increasingly anxious about the security of their money. Wealthy people were pulling their investment assets out of the economy, and consumers overall were spending less and less money. Bankruptcies were becoming more common, and peoples’ confidence in financial institutions such as banks was being rapidly eroded. Some 650 banks failed in 1929; the number would rise to more than 1,300 the following year
The Glass-Steagall Act, also known as the Banking Act of 1933 (48 Stat. 162), was passed by Congress in 1933 and prohibits commercial banks from engaging in the investment business. It was enacted as an emergency response to the failure of nearly 5,000 banks during the Great Depression.
Banking crisis , right before president Roosevelt – banks were totally disarray
The first thing Roosevelt did was shut down the entire banking system in the US
Everyone runs to the bank – quite scary, nobody can get their money,
Everyone ran out of their money – MASS
Role
When eco is overheating, the inflation building up, raise interest, cool down eco
When eco is too soft, cut interest rate, encourage borrowing and spending and boost the economy
Charles DICe – FRS is the regulator of steam engine (1920)
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Federal Reserve System
The fed sees their role more of stabilize the economy rather than preventing the banking crisis
maximizing employment stabilizing prices &moderating long-term interest rates
Tools:
Reserve requirements
Open market operations – *Federal Funds Rate
Discount window – short term loan - *discount rate “Lender of Last Resort”
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Structures of FED
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Design was intended to diffuse power along the following dimensions:
Regions of the U.S.
Government and private sector interests
Needs of bankers, businesses, and the public
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Setting Reserve Requirements - This is the amount of physical funds that depository institutions are required to hold in reserve against deposits in bank accounts. It determines how much money banks can create through loans and investments. Set by the Board of Governors, the reserve requirement is usually around 10%. This means that although a bank might hold $10 billion in deposits for all of its customers, the bank lends most of this money out and, therefore, doesn't have that $10 billion on hand. Furthermore, it would be too costly to hold $10 billion in coin and bills within the bank. Excess reserves are, therefore, held either as vault cash or in accounts with the district Federal Reserve Bank Therefore, the reserve requirements ensure that depository institutions maintain a minimum amount of physical funds in their reserves.
All banks are subject to reserve requirements, but they frequently fall below requirements in carrying out of day-to-day business. To meet requirements they have to borrow from each other's reserves. This creates a market in reserve funds, with banks borrowing and lending as needed at the federal funds rate. Therefore, the federal funds rate is important because by increasing or decreasing it, over time, the Fed can impact practically every other interest rate charged by U.S. banks.
The Fed constantly buys and sells U.S. government securities in the financial markets, which in turn influences the level of reserves in the banking system. These decisions also affect the volume and the price of credit (interest rates). The term open market means that the Fed doesn't independently decide which securities dealers it will do business with on a particular day. Rather, the choice emerges from an open market where the various primary securities dealers compete. Open market operations are the most frequently employed tool of monetary policy.
Setting the Discount Rate - This is the interest rate that banks pay on short-term loans from a Federal Reserve Bank. The discount rate is usually lower than the federal funds rate, although they are closely related. The discount rate is important because it is a visible announcement of change in the Fed's monetary policy and it gives the rest of the market insight into the Fed's plans
Federal Funds rate - the rate at which banks borrow reserves from each other. The Federal Open Market Committee (FOMC) sets a target for this rate, but not the actual rate itself (because it is determined by the open market). This is what news reports are referring to when they talk about the Fed lowering or raising interest rates.
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Structure of Federal Reserve System
The system as it exists now includes:
12 Federal Reserve Banks (regional)
Board of Governors (BOG) of the Federal Reserve System
Federal Open Market Committee (FOMC) - 12
Federal Advisory Council
Member Banks (around 2,000) - 2014
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Federal Reserve Banks – 12
Each Region has one regional Federal Reserve Bank (more than one branches)
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The one in San Francisco, is located on Market street, pretty close to the Ferry building
The largest three accounts for more than 50% of Fed’s assets
New York alone has more than ¼ of the assets
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Member Banks
Requirement of membership
National banks (banks chartered by the Office of the Comptroller of the Currency) are required to be members.
State commercials banks may elect to join.
Prior to 1980, only member banks were required to maintain reserves. By 1987, all depository institutions were required to maintain reserves, eliminating this downside of membership – all depository institutions were given access to discount window
No Interest rate on Reserves (cost for banks to be a member), only 1/3 of all banks
2008 _ with EESA (Emergency Economy Stabilizing Act) – TARP Obama government begin interest payments on reserve accounts
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The 2008 EESA signed by Obama，agree to pay interests on reserve accounts , around 2011 , interest rate is 0.25% while the market interest rate is close to zero. Encourage banks to holding reserves.
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Federal Reserve Banks – 12
The banks are “quasi-public”
Owned by member commercial banks in the district (stock requirement)
Member banks elect six directors, three more directors are appointed by the Board of Governors (6+3=9)
Directors are classified into A,B, & C
Directors represent:
professional bankers (3A) - banks – elected by member banks
prominent business leaders (3B) – business (industry, agriculture, labor, consumer …etc.) – elected by member banks
& public interests (3C) - public – elected by BOG, not allowed to be officers, employees, or stock holders of any bank
Directors appoint president (Dodd-Frank legislation 2010 exclude 3A)
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The commercial banks – are just common private commercial banks
They have to purchase shares of the federal reserve banks to be a member – limited dividends by law to less than 6% annually
Before 2010, all directors participate in the decision of president. However after TF legislation, 3A directors are excluded from this decision, since the congress view they have conflicts of interests
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FUNCTIONs of regional Federal Reserve Banks
Clear checks
Issue new currency and remove damaged currency
Directors “Establish” the discount rate at which member banks may borrow from the Federal Reserve Bank (subject to BOG review)
Administer and make discount loans to banks in their districts
Evaluate bank mergers and expansions
Perform bank examinations
Collect and examine data on local business conditions
Liaison between local community and the Federal Reserve System
Conduct research related to monetary policy
Elect one member commercial bank to the Federal Advisory Council
5 of the 12 bank presidents vote in the Federal Open Market Committee (FOMC) – NY Fed is the permeant member of FOMC, the other four votes allocated to district banks rotate annually among the rest 11 Federal Reserve Banks
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Board of Governors (BOG)
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FRS is designed to be separate from the government – set up independent
The government might want to boost inflation sometime
BOG – 14 year term, can’t be kicked out , the government couldn’t control
Long career in banking system, reputation for integrity, and you bring them in, you told them they are the custodian of the currency.
Who believe in the importance of currency,
Supreme court for currency
Once a new chair is chosen, the old one has to resigns from the BOG, even if there are many years left for his/her term.
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Head of the Federal Reserve System
Seven governors appointed by the President, and confirmed by the Senate, for 14-year terms on a rotating schedule
One governor’s term expiring every other January
Come from different Federal Reserve District, to prevent one region’s interest being over-represented
The chair is chosen among the seven governor and severs a four-year renewable term
Duties of BOG
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Sets reserve requirements and effectively “set” the discount rate
Sets the salary of the president and all officers of each Federal Reserve bank and reviews each bank’s budget.
All Board members are members of the FOMC (7+5)
Chair advises the President on Economic Policy
Serve in an advisory capacity to the President of the United States, and represent the U.S. in foreign economic matters.
Supervise the activities of foreign banks
Set margin requirements for stock purchases
Federal Open Market Committee (FOMC)
5 of the 12 bank presidents vote in the FOMC (5) NY Fed is the permeant member of FOMC, the other four votes allocated to district banks rotate annually among the rest 11 Federal Reserve Banks
All BOG members are members of the FOMC (7)
The chairman of the BOG is also the chair of this committee
Other district banks will participate, but not voting
Make decisions regarding open market operations, to influence the monetary base.
Open market operations are the most important tool that the Fed has for controlling the money supply (along with reserve requirements and the discount rate)
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Why open market operation is the most important tool – since it is must
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FOMC (Cont.)
Meet eight times each year (about every six weeks) in D.C.
Important agenda items include
Reports on open market operations (foreign and domestic)
National economic forecasts are presented
Discussion of monetary policy and directives, including views of each member
Formal policy directive made
Post-meeting announcements, as needed
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Chair of the Federal Reserve System
Spokesperson for the entire Federal Reserve System
Supervises the Board’s staff
Negotiates, as needed, with Congress and the President of the United States
The chairman has effective control over the system, even though he doesn't’t have legal authority to exercise control over the system and its member banks.
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He is just one of the voting members
He also influence the Fed through force of statue and personality, strong personality and great power
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Federal Reserve Bank of NY
Special – largest
The New York Fed District houses many of the largest commercial banks, and thus is responsible for oversight of some of the largest financial institutions headquartered in Manhattan and the surrounding area.
The New York Fed houses the open market desk. All of the Feds open market operations (sale and purchase of bonds) are directed through this trading desk.
The New York Fed also houses the foreign exchange desk, which conducts foreign exchange interventions on behave of Federal Reserve System
Working distance to major domestic financial market (NYSE, AMEX)
Only member of Bank for International Settlement (BIS) – monthly meeting with other major central bank
Repository of more than 100 mil world’s gold
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The soundness operation of these FI will be paramount to US economy
If the fed wants to exercise some open market operations, it has to go through NY fed
If Fed NY is so important, its president must be. And we will discuss this in a bit
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The Fed : The Books
Several research documents are by the Fed, and have been given official, colorful names:
Green book: national forecasts for the next three years
Blue book: projections of monetary aggregates
Teal Book:
Only distributed to FOMC participants
Beige book: districts’ “state of the economy” – surveys & talks – one that is publicly distributed
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Inside the Fed: the Research Staff
The Federal Reserve System employs around 1000 research economists. What do all these researchers do:
Offer insight on incoming economic data and interpret where it suggests our economy is heading
Provide support for supervisory staff in decisions about bank mergers, lending activities, and other technical advice
Provide briefs for formal meetings on the economic outlook of the country
Produce reports on the developments in major foreign economies
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Independence of the FED
A broad question of policy for the Federal Reserve Systems is how free the Fed is from presidential and congressional pressure in pursuing its goals.
Instrument Independence: the ability of the central bank to set monetary policy instruments.
Goal Independence: the ability of the central bank to set the goals of monetary policy.
Evidence suggests that the Fed is free along both dimensions. Further, the 14-year terms (non-renewable) limit incentives to curry favor with either the President or Congress.
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However, Congress can enact legislation to gain control of the Fed, or at change the structure of FEd, a threat wielded as needed
Presidential appointment clearly sets the direction of the Fed. Issue monetary policy report to the Congress semiannually.
The Fed usually generates revenue in excess of its expenses, so it is not typically under appropriations pressure. For example, it generate 88 billion revenue in 2012. return them to the treasury. The control over money/ is close enough to overall control – which helps a lot to its independence.
Greenspan was appointed at first by Ronald Reagan, and then George Bush in 1992 (republican)
Cliton became president in 1993 – 1997, under pressure, reappoint Greenspan 1996-2000 – reappoint Greenspan again in 2004
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Should the FED be Independent?
For
Away from political inflation biases
Prevent political business cycle
The Treasury may seek to finance the government through bonds purchased by the Fed. This may lead to an inflationary bias.
Politicians have repeatedly shown an inability to make hard choices for the good of the economy .
Independence allows the Fed to pursue policies that are politically unpopular, yet in the best interest of the public
Against
independence as “undemocratic”—an elite group controlling an important aspect of the economy but accountable in few ways.
we hold the President and Congress accountable for the state of the economy, yet they have little control over one of the most important tools to direct the economy
the Fed has not always been successful in the past. It has made mistakes during the Great Depression and inflationary periods in the 1960s and 1970s
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Every few years, the question arises in Congress as to whether the independence of the Fed should be reduced in some fashion. This is usually motivated by politicians who disagree with current Fed policy.
For example, increase money supply might temporary cut interest rate down, but it might heat up afterwards in the long run when inflation and booms began
Expansionary monetary policy leads to lower unemployment and lower interest rates—a good idea just before elections.
Post-election, this policy leads to higher inflation, and therefore, higher interest rates—effects that hopefully disappear (or are forgotten) by the next election.
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Foreign Central Bank
European Central Bank- ECB ( New & biggest)
Masstricht Treaty 1992 – European Union – plan for a new currency – Euros
ECB 1998, Frankfurt – Euro Zone (all countries want to participate), European System of Central Banks (ESCB)
1999 – Euros, Issuance – 2002
Bank of Japan
Become independent in 1997 (Bank of Japan Law)
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Executive Board – BOG (6) – 8 year term
National central banks – 12 regional banks – president are appointed by each countries’ government (19 vs. 17)
Governing Council – FOMC
Differences with FED,: each national bank sets their own budget
No voting during meeting, but concensus (In case some national bank vote for their own countries’ benefit, not the Euro system)
Even more independent – since the charter won’t be changed by legislation
Some countries don’t belong to the Euro Zone, but use Euro un officially
Before that , every country in the Euro Zone has a central bank, but their original purpose seems gone
Bank of Japan is not independent in the sense that it is composed of two governonrs, and the other 6 members have to be appointed by these governor and approved by parliament
So many think that the US has such a stable currency is because of our independent central bank
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