Quiz 2 money and banking

Why was the US banking system run-and panic-prone, 1863-1913?

1) virtual cap on note-issue led to reserve drains 2)tiered reserve requirements 3) branching restrictions

To make and account not run-prone:

1)equity claim 2)conditional redeemability 3)solvency assurances

When was the Federal reserve act?

1913; to provide the nation with a safer, more flexible, and more stable monetary and financial system

Federal deposit insurance (the FDIC Act) was enacted during the

1930s

Suppose we find that a bank approves only 70% of mortgage applications from people in group A, but 80% of applications from people in demographic groups. What other information would we need in order to know whether banks are discriminating against group A members for reasons other than creditworthiness?

All info on borrower characteristics that is relevant to creditworthiness (employment history, credit score, ect.)// default rates for the two groups.

(b) As represented by the 1894 "Baltimore Plan" proposed by the American Bankers Association, what was the main alternative to a Federal Reserve System that Congress might have adopted to address the problem?

Allowed de-regulation and emulated the Canadian banking system.

Which of the following was not among the reasons why the US banking system was run- and panic-prone, 1863-1913?

As Canadian experience also shows, any agricultural economy is prone to runs and panics

Survivorship evidence

Clear; banks are larger in other countries. Smaller US banks have had a higher failure rate.

The FDIC (1991) crisis

Commercial banks losses, falling equity ratios, reduction in asset share of cash and investment grade securities. FDIC went broke.

The federal law under which banks are monitored for "redlining" practices is

Community reinvestment act, 1977

Citi group 1998 consisted of:

Consumer brands, Emerging markets brand, specialty brands, corporate and Institutional brands.

What is the main complaint against $100 bills by economists who want to end them?

Criminals using them to fund their criminal enterprises and tax evasion.

What is an important potential advantage to allowing commercial banks to undertake a wider range of financial activities?

Economies of scope(synergies)// diversification of risks// easier acquisitions of troubled financial firms

when are runs bad?

If depositors can't always tell when a bank is insolvent, and they run on a solvent bank

What is the main counter-argument by defenders of $100 bills?

Keeps privacy, convenience, and law-abiding citizens use 100 dollar bills as well.

Banks FDIC or FED is unlikely to:

Liquidate even if insolvent

The FDIC either:

Liquidates the bank, or arranges a purchase and assumption

The number of small banks in the US has been shrinking in the last 2 decades principally because

Mergers

Riegel-Neal Interstate Banking Act 1994

Phase 1: out-of-state BHCs allowed to aquire banks in any state phase 2, now in effect: banks may Branch across state lines, and may legally consolidate BHC banks into one.

An important piece of historical evidence that is inconsistent with the "sunspot" explanation of runs is

Runs are not a problem in all countries// Runs are not random in time but clustered at outset of recessions.

Which of the following contributes to making an uninsured bank deposit more run-prone?

The bank has limited liability for shareholders

what is the 'sunspot theory'

banks are inherently run-prone

What happens if nobody runs on an insolvent bank?

becomes a 'zombie' bank, and can continue squandering wealth until regulators notice

Name two contract features that ordinary insurance uses to limit moral hazard that FDIC deposit insurance does not use

deductibles // copayments// cap on overall coverage// full risk-adjusted premiums

Unlike ordinary insurance FDIC lacks:

deductibles, coinsurance, and effective cap

a "bank" is an intermediary that gathers funds from_____and______.

depositors; lends the funds

Uninsured deposits are:

deposits that have more money in them than $250,000

Define "redlining"

draw red lines around poor neighborhoods on a map and then refusing to loan within the lines.

Which of the following is not a measure of bank profitability?

duration gap

The "moral hazard" problem created by deposit insurance is that banks with insured deposits have less incentive to attract customers by

holding adequate capital and advertising it

to possibly fix a run-prone deposit contract:

if a bank is worth saving, there's a profit to be made by the lender. The lender needs immediate information on whether the borrowing bank is solvent.

Many savings and loan institutions were allowed to become 'zombies' in the period 1981-89. what does 'zombie' bank mean?

insolvent but still open

Consider a money warehouse that holds 100% reserves. Why would it be infeasible for the warehouse to issue claims to its reserves in the form of ordinary banknotes?

it wouldnt be able to collect storage fees

Which two of Walter Bagehot's classic rules for a "lender of last resort" did the Federal Reserve not follow in the 2007-9 financial crisis?

lent to insolvent banks; lent on non-penalty rates; (rules 3&4)

How does the FDIC resolve an insolvent bank?

liquidation or "payout" purchase and assumption

Econometric evidence

mixed; large banks classes are not always more profitable

The dodd-frank act of 2010 does all the following except

reform freddie mae and freddie mac

legislative result of Fed's failure FDIC Act (1933)

runs finally ended; banks failures fell to only about 12 per year until the 1980s.

the 'bad news' theory

runs happen when depositors receive bad news indicating that the bank might be already (pre-run) insolvent

Glass-Steagall Act 1933

separated commercial banking from investment banking, insurance, securities brokerage, mutual funds.

The chief advantage to a bank or other financial intermediary of "borrowing short and lending long" is that

short rates are typically lower than long rates

The passage of the FDIC Act was largely favored by

small banks but not large banks

what prevented interstate branch banking before the 1980s?

state governments refused to allow it (didn't recognize bank charters from other states)

The chief disadvantage of borrowing short and lending long is that

the combination increases the banks interest-rate risk

Competing banks historically began to pay interest on demand deposits when

they began to hold fractional reserves

in medieval europe, the two main advantages of payment by bank deposit transfer over payment in coin were that deposits were more

uniform and more portable

why was there so many US bank failures in the 1930s

weak banks due to anti-branching laws, Fed had disabled private clearinghouses, failed to be LOLR as they had been in 1893, 1907.

Canada and Scotland:

were less regulated and had fewer runs than the US and England

Banks historically began mutually to accept one another's notes at par

when they saw that it would benefit both banks

the 'bad news' theory explains:

why runs occurred at onsets of recessions; why countries with stronger banks experienced fewer runs

The 1999 Financial services Modernization act requires "firewalls" between a commercial bank (e.g.) Citibank and it's financial holding company affiliates (e.g. Travelers insurance, citi financial, ect.) mainly in order to avoid

widening the deposit insurance subsidy to risk-taking

What is the moral hazard problem?

with insurance banks can become riskier or weaker without losing customers (or being run upon)

what Dodd-Frank didn't do:

-Reform Freddie Mae and Freddie Mac -Limit "too big to fail" or deposit insurance ("safety net")

Interstate banking drawbacks:

-"drain" money from local communities(only when thats profitable/efficient). -Fewer banks in nation doesn't reduce number of banks in any town, and unrestricted branching can increase it.

Dodd-Frank Act, 2010:

-Financial Stability oversight council -Consumer financial protection bureau -Limitation of single-firm bailouts

Interstate banking benefits:

-Nationwide checking convenience -lower failure rate via better diversification -lower costs due to economies of scale -more competition at local levels -US banks more competitive internationally

Geographic restrictions

(anti-branching restrictions) restrict a bank's ability to gather deposits, grow large.

Are unregulated banks are / are not (circle one) inherently prone to runs and panics, as shown historically by: Scottish and Canadian banking system went unregulated, and had 0 bank runs.

(not)Canadian and Scottish banking system went unregulated and reported no bank runs.

What was the main problem that the Federal Reserve Act was intended to address?

Bank runs. Fed became the LOLR.

What does the FDIC do?

Banks pay "premiums"(taxes) into FDIC's fund. FDIC uses fund to "resolve" insolvent banks; pays depositors what the bank can't.

(b) Why was that alternative rejected by Congress?

Because of lobbying from smaller banks.

Why did US savings-and-loan institutions experience large loses in1979-1980?

They had large duration gaps and interest rates rose sharply

Revising activity restrictions, 1999:

Two models: -Universal banking (rejected) -Financial holding company

When is a bank run harmful?

When the bank is solvent and practicing good banking habits.

When is a bank run beneficial?

When the effected bank is insolvent, and if the insolvent bank is not run on it let's them continue operating but as a "zombie bank" which in effect, causes them to take more risks.

state the three parts of the "leading argument against unregulated banking"

a) banks are inherently run-prone(or panic-prone) b) Runs or panics are bad c) Regulation can reduce runs (panics) at a cost <benefit