Ch.13 (Saving, Banking, Debt, and Credit Issues)

According to studies, once you go further up in the income scale...

...the connection between income an happiness is less clear *A reason for this may be nexting

From 1980 to 1994, how many banks or S&Ls were closed or received government assistance?

1 in 6

Historical development of the Banking Industry

1. Federal Reserve 2. FDIC 3. Office of the Comptroller of the Currency 4. State Banking Authorities. They do the bank inspections The history had one other significant outcome: Multiple Regulatory Agencies

CAMELS ratings, *exam

1. Sound in every respect 2. Fundamentally sound, but with modest weaknesses that can be corrected 3. Moderately severe to unsatisfactory weaknesses; vulnerable if there is a business downturn 4. Many serious weaknesses that have not been addressed; failure is possible but not imminent 5. High probability of failure in the short term

2 types of credit scores

1. the FICO score is the score most widely used by lenders and you have to pay to see this. 2. Similar but available online, like FreeCreditReport.com

On average, from 1980 to 1994, a bank or S&L failed every...

15 days

What year was the modern commercial banking industry begun?

1782, when the Bank of North America was chartered in Philadelphia

Important dates

1782- Bank of North America was chartered 1791- Bank of the United States was chartered 1811- Bank of United States charter is allowed to lapse 1816- Second Bank of United States was chartered 1832- Andrew Jackson vetoes rechartering of Second Bank of United States; charter lapses in 1836 **1863- National Bank Act of 1863 establishes national banks and Office of the Comptroller of the Currency*** **1913- Federal Reserve Act of 1913 creates Federal Reserve System** ***1933- Banking Act of 1933 (Glass-Steagall) creates Federal Deposit Insurance Corporation (FDIC) and separates banking and securities industries

What year was the Office of the Comptroller of Currency Office (OCC) created?

1863

What year was the Federal Reserve System created and who was President?

1913 President Woodrow Wilson

What year was FDIC created?

1933

From 1980 to 1994, how many banks and S&Ls failed?

2,900

What is an emergency fund?

3 to 6 months of salary set aside as savings, this is recommended for a financial goal. These funds should be kept in a liquid interest-bearing account such as money market fund, short term certificates or deposit (CDs) or savings account.

How many commercial banks in the US serve the businesses and consumer's needs?

7,500 This puts US in a class by itself, in most other developed nations only a handful of banks dominate the landscape.

What is a budget?

A budget is a financial plan based on income and expenditures in a month. Budgets show how much money is flowing in and how much is flowing out. Budgets have fixed expenses and variable expenses. - Fixed expense = rent - Variable expense = food and entertainment

What is a divorce planner?

A certified divorce planner is a specialist who is trained to focus on who gets the assets in divorces and who works alongside attorneys who handle legal documents and child custody issues. Divorce planners help couples divvy up retirement accounts and stock options, divide up businesses, calculate alimony payments, and decide who keeps the primary house and vacation home.

What is a "bank holding company"?

A firm that owns one or more banking firms

What is tax avoidance?

A legal money management strategy to reduce one's taxes through investments such as tax-deferred individual retirement accounts (IRAs) or charitable donations, which are allowed under the tax code and should deb properly documented.

What is a loan?

A loan is a sum of money lent at interest. Loans come from universities, stores, car dealerships, brokerage firms, banks, S&Ls, credit unions, consumer finance companies, sales finance companies, and life insurance companies.

What is a time deposit

A safe way to store money from seven days to several years (ex. certificates of deposit). CDs is a type of time deposit

What is self-worth?

A system of thoughts and feelings concerning or focused on self. Debts can lower self worth.

Financial innovation: Electronic Banking

ATMs were the first innovation on this front. Automated Banking Machines combine ATMs, the internet, and telephone technology to provide "complete" service

What does e-cash refer to?

An account on the internet used to make purchases

How is electric money, or stored cash, accessed?

Can only be accessed through stored value card or smart card

CAMELS from bank examination *exam

Capital adequacy Asset quality Management Earnings Liquidity Sensitivity to market risk

Capital Requirements, also known as Regulatory Capital

Capital requirements = Regulatory capital When there is deposit insurance, banks have an incentive to hold too little capital Therefore, the government imposes capital requirements to ensure that banks hold sufficient capital It is also important to note the ratio of the bank's equity to its debt

What is an excise tax?

Collected from the manufacturer of a product. You pay an excise tax every time you purchase a gallon of gas; these taxes are considered "regressive taxes", meaning they take a smaller share of people's incomes as their income grows

What do "banks" include?

Commercial banks (ex. Wells Fargo, Bank of America) Savings and loan associations (S&Ls), also sometimes called "thrifts" or "thrift institutions". These predominately give mortgages. Credit Unions (nonprofits where members pay to join and can borrow $ at low interest rates)

Federal Deposit Insurance Corporation (FDIC)

Congress created FDIC in 1933 after the bank failures in the Great Depression. Today the FDIC gaurantees each bank depositor up to a maximum of $250,000 FDIC insurance is funded by a small fee paid by banks based on their deposits (banks cannot opt out of FDIC, have to pay fee) **How did FDIC allow bank to be bad? -----It reduced banks' incentives to avoid risks

What are debts?

Debts are what is wed. Ex. bonds, notes, mortgages and other forms of paper evidencing amounts owed and payable on specified dates or on demand A DEBTOR is a person who owes money.

Alan Greenspan

Former Federal Reserve Chairman "Authorities should not interfere with pollinating bees of Wall Street. Regulation is harmful" Ideology that markets can regulate themselves....leading to 21st century and the deregulation of banking He is bad! He had authority to regulate mortgages but refused to use it.

Magnitude of the 1980s Banking Crisis

From 1980 through 1994, over 2,900 banks and S&L's failed On average, a bank or S&L failed every 15 days from 1980 to 1994 During this period, about 1 of 6 banks or S&L's (holding a total of 20% of the assets of the system) was closed or received government assistance *Note: S&L's mainly engaged in giving loans and mortgages

At the same time: US stock market 2006-2008

GDP increased by only 5% ($650 billion). Yet, the stock market increased by 35% ($3.5 trillion). So, $3.5 trillion was added to the value of US corporations in one year.

Moral Haard, Exam*

General insight: agents who are insured will tend to take fewer precautions to avoid the risk they are insured against. The insurance provided by central bank and governments gave bankers strong incentives to take more risks. To counter this, authorities have to supervise and regulate. They did this for most of post war period *Example of moral hazard: Skydiving, have insurance so can take these risks

What is tax evasion?

It is illegal because of the methods involved, such as not paying taxes or not reporting all income

Deregulation and the 21st century: What did deregulation do?

It opened up the competition for consumers. It also led to new banks forming, without main offices or branches. Erosion of Glass-Steagall Allowed commercial banks to take on all the activities investment banks had been taking. Thus, banks were allowed to take on same risky activities that they had prior to Depression.

What is lien?

Legal rights to take and hold property if the person does not pay the debt. Ex) your house can have a lien put on it if you are not paying your car off. When the house gets sold, the car loan servicer gets paid before you make any money off of the house.

Gramm-Leach-Bliley Act of 1999

Legislation to eliminate Glass-Steagall States retain insurance regulation, while SEC oversees securities activities. Fed still oversees bank holding companies.

Step 3: Evaluating and Revising Plans

Looking back at home plans went, may be least attractive step but may be most important

What is a financial planner?

Looks at a person's or family's total financial picture, helps that person or family define and prioritize goals, and then works out a plan to achieve goals. Largely unregulated industry, so a good credential to have is Certified Financial Planner (CFP)

Consumer reporting agencies (CRAs)

More commonly known as credit bureaus Have files that contain information about your income, debt, and credit payment history as well as information on whether you have ben sued or arrested or filed for bankruptcy. A CREDIT SCORE is given and includes all of this info plus assets, length of employment, and length of living in one place.

What contributed to the increase of the stock market?

Nothing! Only reasonable answer is excessive optimism on the part of consumers

Who are the primary bank regulators in the US?

Office of the Comptroller of the Currency Office (OCC) (part of the US Dept. of Treasury) Federal Reserve System- The US central bank Federal Deposit Insurance Corporation (FDIC) State bank regulators

Regulators can take action against bank if unfavorable CAMELS ratings

Require banks to disclose unfavorable info in their public financial statements Issue a "cease and desist" order requiring the bank to stop doing things that cause financial troubles and to correct problems Impose fines of up to 1 mill a day

Truth in Lending Act

Requires financial institution to reveal annual percentage yield/rate, fees charged, info about loan balance, payment due, total amount charged

Truth in Savings Act

Requires financial institutions to reveal the annual percentage yield (interest), fees charged, and information about rules regarding maintaining a minimum balance.

Savings

Savings provide a safety net and helpful for putting money together for future needs such as down payment on home.

What works against the idea that we are headed towards a cashless society?

Several things work against this - Equipment to accept e-money is not in all locations - Security and privacy concerns

What are other names for smart cards?

Smart cards Chip cards Stored value cards

What is interest?

The cost of using money. The rate of interest is determined by the supply and demand.

What is securitization?

The transformation of illiquid assets into marketable capital market instruments. Today, almost any kind of private debt can be securitized. This includes home mortgages, credit card debt, student loans, car loans, etc.

2 reasons for bank failure in Banking Crisis of 1930s

The value of bank assets/investments/holdings falls, so assets are less than liabilities DEPOSIT OUTFLOW: a large number of depositors withdrew their funds from the bank, exhausting the bank's cash (reserves) and other liquid assets *Keep in mind, there was no FTIC yet to protect your $ in the bank...

What did the 2008 collapse of stock prices mean?

This collapse eroded the wealth and endangered the retirement savings of many Americans

How do people borrow money?

Through the use of credit and loans

What is a credit card?

Used to purchase something or to get cash now with the promise of future payment. The typical cardholder carries 8 to 10 cards and owes over $4,000 Came in 1973

What is nexting?

When people buy or attain something, their minds are already thinking of the next purchase or goal.

Are there penalties on early withdrawals of CDs (certificates or deposit)?

Yes

A number of laws, mostly the Consumer Credit Protection Act of 1968, have been assed to reduce problems and confusion about consumer credit...

You cannot be denied a credit card because you are a single woman. You can limit your risk if a credit card is lost or stolen. You can resolve errors in your monthly bill without damage to your credit rating. You cannot have credit shut off just bc you are 62.

Who does bank examinations?

banks are visited on regular schedule by bank examiners from OCC, Federal Reserve System, FDIC, or other agencies Bank examiners review the bank's financial statements and its confidential accounts *The results are summarized in a CAMELS rating given to the bank

students and credit cards

credit card companies target students before their freshman year and hit them again before graduation

What is personal finance?

An umbrella term that covers the spending, saving, investing, and protecting of financial resources.

Joint credit cards

Are revolving open lines of credit* You don't want to have this. You are both reliable for the debt even if relationship dissolves. Credit card document trumps divorce decree.

Who paid the cost of the 1980s banking crisis?

Bank and S&L stockholders Some depositors who had large deposits that exceeded the deposit insurance limits Taxpayers, who ultimately will pay higher taxes to pay off bonds that were issued to fund the cost of the crisis

What does CAMEL look at?

Bank's financial statements AND its confidential accounts

Reasons for bank regulation

Banks are less stable than other businesses

What role do banks play in the economy?

Banks facilitate borrowing and lending. Banks facilitate payments. They serve as risk management - issue financial assets that allow firms to share risks - provide guarantees and lines of credit

Debit cards *EXAM

Banks or credit card companies offer debit cards and smart cards (chip cards or stored value cards)

Why are banks less stable than other businesses?

Because bank debts tend to be SHORT TERM--many depositors could withdrawal their funds with little notice (remember, consumer deposits are "loans" to banks, so they pay us interest on those loans) Because the behavior of depositors depends on their confidence that the bank is sound, and this confidence can be easily shaken

Why is the large number of banking firms decreasing in US?

Because of mergers between banks

How is FDIC insurance funded?

By a small fee paid by banks based on their deposits

Who can and can't see CAMELS ratings?

CAMELS ratings are disclosed to bank managment but not to the public

Incentive effects of deposit insurance

Deposit insurance increases the supply of deposits from consumers Banks attract deposits pay lower interest rates on their deposits EVEN AS they pursue risky strategies that increase risk of bank failure As a result, deposit insurance reduces banks' incentives to avoid risks (*Ex of how FDIC allowed banks to be bad)

Financial innovation: E-Money

Electronic money only exists in electronic form. It is accessed via a stored value card or smart card. Online banking is the fastest growing Internet application.

What is a deduction?

Expenses subtracted from income before figuring out the amount of taxes owed.

What is FDIC (Federal Deposit Insurance Corporation)?

FDIC is a government insurance of bank or savings and loan (S&L) accounts (up to $100,000 per account), **currently up to $250,000 per depositor per bank FDIC guaranteed bank deposits up to a certain amount *Protects us when banks close

Who regulates commercial banks?

Federal Reserve FDIC Office of the Comptroller of the Currency State banking authorities

Banking Act of 1933 (Glass-Steagall)

Glass-Steagall allowed commercial banks to sell on-the-run government securities, but prohibited underwriting and brokerage services. It also prohibited real estate and insurance business. But it did protect commercial banks by not allowing other financial intermediaries to offer commercial banking activities It created the Federal Deposit Insurance Corporation (FDIC) It separates banking and securities industries (commercial banking and investment banking)

Step 1: Setting and prioritizing financial goals & creating plans

Goals are based on values (principles that guide behavior), attitudes (likes and dislikes), and resources (source of wealth) and are affected by decision making. To be successful, goals should be flexible, action oriented, specific and realistic. The number of people age 16 to 24 engaged in volunteer work is significantly rising. People in their 40s may have the following long-range goals: 1) Provide college education for 2 kids 2) Move to a more expensive house 3) Buy vacation home 4) Retire at age 62

Chart on bank failures in the Great depression

Highest in 1933, then SIGNIFICANTLY goes down following years. Why? Policies that changed that led to this.

How many ATMs service the US?

Over 250,000

What are taxes?

Payments of money to federal, state and local governments

Step 2: Activating Plans

Plans are actually carried out here. Individuals make calls, go on appointments, open up a savings account, or put a down payment on house. Flexibility is important in this stage.

Why is a good credit rating important?

Potential employers may check credit history, landlords check to see if they will give you a lease

What is collateral?

Property used to secure a LOAN. This is what you lose if you cannot pay the loan.

How did FDIC allow banks to be bad?

Reduced banks' incentives to avoid risk When banks have deposit insurance, there is an incentive to hold too little capital. (So government imposes requirements)

Banking Crisis of 1980s

Starting in the late 1970s, banks grew fast, with lots of loans to businesses because of... - poor quality loans* (to NINJAS) -too many loans to risky firms* There was a high cost of funds (banks borrowing from other banks at high interest rates) *Grew fast bc they deregulated CAUSES: - *banking industry was partially deregulated in early 1980s, S&Ls had mostly been restricted to home mortgage lending before but now allowed to invest in commercial real estate and stocks -as a result, S&Ls held more risky assets resulting in huge loan losses -Since S&L deposits were protected by federal deposit insurance, depositors had little incentive to monitor S&L risks(*again, why FDIC allowed banks to be bad) - Bank's troubles---by 1984 bank's nonperforming loans (loans on which payments were late) rose to $5.2 billion (over 10% of total loans) -May 1984: an electronic "bank run"- depositors withdrew billions of dollars in deposits

Personal finance involves 3 steps

Step 1: Setting and prioritizing financial goals & creating plans Step 2: Activating Plans Step 3: Evaluating and Revising Plans

What was the central bank of the United States?

The Federal Reserve System. It was created by Congress to provide a safer, more flexible and stable financial system.

What was the FDIC created in response to?

The Great Depression

What US Department is the Office of the Comptroller of the Currency (OCC) apart of?

The US Department of the Treasury

Banking Crisis 1930s

The bank collapse of the 1930s and the ensuing Great Depression had introduced some institutional changes aimed at making banking systems less fragile... These were: -Central bank as lender of last resort -Deposit insurance -Separatin of commercial banking and investment banking (Glass-Steagall Act of 1933)* Most economists thought that this would be sufficient to produce safety and to prevent large scale banking crisis, but it was not.

What is bank failure?

The bank goes out of business bank depositors may lose some of their funds bank creditors might lose some of their investment bank owners may lose some of their capital

According to FTC, under Fair Credit Reporting Act (FCRA) your rights are as follows...

You have the right to receive a copy of your credit report. You have the right to know the name of anyone who received your credit report in past year for employment purposes. Companies that deny your application must supply the name and address of the CRA. You have the right to a free copy of your credit report when your application has been denied. If you disagree with the accuracy of info, you can file a dispute with the CRA and the company that furnished the info. After you should receive a summary explanation of the settling of the dispute.

The federal income tax...

is Progressive The more you make, the more you pay