Lecture 11 chpt 14 D2L 2011-1

Lecture 11 chpt 14 D2L 2011-1 - Fin 320 Chapter 14:...

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Fin 320 Chapter 14: Regulation of the Financial System Lecture 11 1
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Regulating the Financial System: 1. What are the sources and consequences of financial fragility? 2. What is the role of the government in the financial system? 3. How does financial regulation and supervision work? 2
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Regulating the Financial System: The Government Safety Net Regulation and Supervision 3
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Cost of Financial Crisis vs. Change in GDP Growth 4
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Bank Runs, Bank Panics, and Financial Crises Sources of Bank Runs: Promise depositors withdrawal on demand First come, first served Suppose depositors lose confidence? Concern over insolvency can lead to illiquidity. Bank run can be the result of both real and imagined problems The largest savings bank in the U.S., Washington Mutual, failed when depositors fled in September 2008. That same month, withdrawals from Wachovia Bank, at the time the fourth largest U.S commercial bank, led to its emergency sale. 5
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Bank Panics Run on a single bank can turn into a system-wide panic. Asymmetric information: Can’t distinguish good from bad banks. Concern about one bank can create panic about all banks. 6
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The Sources and Consequences of Runs, Panics, and Crises Quiet, invisible runs on shadow banks were even more dramatic as they punctuated the peaks of the financial crisis. In March 2008, repo lenders and other creditors stopped lending to Bear Sterns, the fifth largest U.S. investment bank. The run halted only when the Federal Reserve Bank of New York stepped in and JPMorgan Chase acquired Bear. 7
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The Sources and Consequences of Runs, Panics, and Crises What matters during a bank run is not whether a bank is solvent, but whether it is liquid. Solvency means that the value of the bank’s assets exceeds the value of its liabilities. It has positive net worth. Liquidity means that the bank has sufficient reserves and immediately marketable assets to meet depositors’ demand for withdrawals. 8
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The Sources and Consequences of Runs, Panics, and Crises While banking panics and financial crises can easily result from false rumor, they can also occur for more concrete reasons. Anything that affects borrowers’ ability to make their loan payments or drives down the market value of securities has the potential to imperil the bank’s finances. Bank panics usually start with real economic events, not just rumors. 9
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There are three reasons for the government to get involved in the financial system. 1. To protect investors.
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This document was uploaded on 10/26/2011 for the course FIN 320 at DePaul.

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Lecture 11 chpt 14 D2L 2011-1 - Fin 320 Chapter 14:...

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