Transcript Chapter 1 - robertrooks.org

Chapter 1
Then and Now:
A Short History of Finance
I. Lending in Ancient Times
A. THE ROMAN INFLUENCE
FIDUCIARY
MONEY
B. MEDIEVAL INFLUENCES
LIFE ESTATE
CHATTEL
PLEDGE
USURY
C. THE END OF FEUDALISM IN ENGLAND
II. Banking in the Renaissance
 In the rest of Europe, both the forces of the Renaissance and the
Reformation would gradually allow the formation of modern
banking practices.
 Wars were expensive and monarchs were often forced to borrow
from the new wealthy merchant class to finance their wars.
 Two wealthy merchant families in particular would rise to
prominence in this period as lenders.
Medici family in Italy
Fugger family in Germany
UNDERWRITER makes loans based on assessment of risk.
THE HISTORY OF CREDIT

The History of Credit was first used in Assyria, Babylon, and Egypt 3000 years ago.

The first advertisement for credit was placed in 1730 by Christopher Thornton, who
offered furniture for sale that could be paid off weekly.

From the 18th century until the early part of the 20th, tallymen sold clothes in return
for small weekly payments.

In the 1920s, a shopper’s plate—a “buy now, pay later” system—was introduced in
the USA. They could only be used in the shops that issued them.

In 1950, Diners Club and American Express launched their charge cards in the USA,
the first “plastic money.”

It wasn’t until the establishment of standards for the magnetic strip in 1970 that the
credit card became part of the information age.
From “Did You Know?” www.didyouknow.cd/creditcards.htm
A. BRITISH INFLUENCES
 By the 17th Century, England was an
established trading nation with the
beginnings of a colonial empire abroad.
FEE SIMPLE ESTATE
1. Goldsmith Accounts: The Birth
of English Banking
BEARER NOTE - Goldsmiths’ bearer notes
marked the beginning of the first circulating
paper currency.
2. Stocks and Bonds
STOCK is an ownership interest in an
institution or company.
BONDS are debt instruments that bear a
stated “face value” or principal amount
payable to the bearer in a specified time.
3. The Bank of England
In 1694, a consortium of bankers, led by
William Patterson, established the Bank of
England.
CENTRAL BANK - controls the economy of a
nation. The Federal Reserve System is a
central bank.
III. The American Colonies
 The American Colonies were a mixture of proprietary land grants
and direct royal holdings.
 The land office banks would make loans to colonists against a
mortgage on their land. The mortgage moneys were paid out in
the form of bearer notes issued in the name of the colony.
A. A NEW NATION
 The issue of fiat paper money by the colonies and the
Continental Congress financed the American
Revolution.
FIAT MONEY is issued by decree of the state, often in
times of war.
LEGAL TENDER is money that is legally required to be
accepted by the public in payment of any debt.
B. THE BANK OF THE UNITED
STATES
 The first Treasurer of the United States was
Alexander Hamilton and he persuaded
congress to establish a central bank to ensure
that the new nation would commence on a
sound financial footing.
 The first 40 years of the bank’s charter were
unstable, with many problems, thus leading to
it’s demise.
C. STATE CHARTERED BANKING
 The era that ensued after the demise of the Bank of
the United States in 1837 was a period of great
territorial and business expansion in the United
States.
 After a great depression from 1837-1840, a sub-
treasury system was established for federal funds
which provided security and safety for the
governments monies.
 After 1841, the nation would experience inflationary
conditions until another depression in 1857.
1.The Wildcat Era
 With no central bank and a lack of federal or, in most cases, state
regulation, banks proliferated like rabbits.
 Many of these institutions were fraudulent and were located where it was
impossible to find them if someone desired to redeem one of the many
beautifully engraved notes that they issued.
 The first building and loan societies started up during the 1830’s and
provided a safe haven for workers’ deposits and functioned in a similar way
to today’s credit unions.
D.THE NATIONAL BANKING ACT
OF 1863
 The Civil War (1861-1865) was the most costly war in the nation’s
history up to that time.
 Gold and silver were hoarded by the population, forcing the
government to ask the banks for large loans of currency.
 The NATIONAL BANKING ACT OF 1863, which set minimum
capitalization and reserves for any bank that applied for a National
Bank Charter. It established a uniform note issue for the entire
nation.
 Perhaps the most troubling aspect was that national banks were
not allowed to engage in mortgage lending.
MORTGAGE LENDING
MORTGAGE LIEN.
BALLOON PAYMENT
IV. The Federal Reserve Act of
1913
 The passage of the Federal Reserve Act of 1913 attempted to
solve the existent problems of the banking system.
 The original purpose of the system was to discount commercial
paper and provide additional bank regulation.
 A positive aspect of this law was that it allowed the member
national banks of the system to engage in mortgage lending.
 For the first time since the demise of the Bank of the United
States in 1837, the nation had a central banking system.
A. THE ROLE OF THE FEDERAL
RESERVE
 The FEDERAL RESERVE is a central bank. For its
member banks, it is the “lender of last resort” or “the
banker’s banker.”

Made up of thousands of member banks

12 Federal Reserve Districts across the nation.

A District Federal Reserve Bank represents each.

Each of these 12 banks has a nine-member board of directors and is
actually owned by the member banks in the district—all member banks
are required to buy stock in the district bank.

The 7 member BOARD OF GOVERNORS oversees the entire system. All 7
members are appointed by the President of the United States and
confirmed by the U.S. Senate.

The Federal Reserve controls the monetary policy of the United States in
a number of ways.
Figure 1-3
Figure 1-4
1. The Power of Currency Issue
 The POWER OF CURRENCY ISSUE is the legal authority to print
money.
 The banks are required by law to hold a percentage of the
customer’s deposits in ready cash or the equivalent of cash.
 The “Fed,” as the Federal Reserve is known, also controls the
RESERVE REQUIREMENTS of the member banks.
 By raising the “reserve requirement”, the Fed limits the amount of
money available for loans. By lowering the reserve requirement,
more money becomes available for loans.
2. Control of Interest Rates
 The Fed also controls interest rates throughout
the nation.
DISCOUNT RATE
PRIME RATE
FEDERAL FUNDS RATE
3. Open Market Operations
 OPEN MARKET OPERATIONS consist of the buying and
selling of United States Treasury bonds, as well as the
securities of federal agencies such as the Federal
Home Loan Bank System, Federal Housing
Administration (FHA), and Ginnie Mae.
 Sales of these securities have the effect of tightening
the money supply.
 Purchases of federal agencies’ securities increase the
money supply. This is perhaps the most important tool
in the Federal Reserve’s arsenal.
FEDERAL OPEN MARKET COMMITTEE
4. Truth in Lending Law
(Regulation Z)
 The Fed is also responsible for supervising the
Truth in Lending Law.
 The TRUTH IN LENDING LAW requires lenders
to inform borrowers of the total costs of
obtaining a loan.
 This law, passed by congress in 1968, is also
known as Regulation Z.
V. The Role of the Federal Government
and Government Agencies
 The actions of the federal government have a great
impact on the economic life of the nation.
 Increases in government spending beyond the
income taken in by the government in the form of
taxes require the U.S. Treasury to borrow funds on
the open market.
 This has the effect of making money less available for
private borrowers. It also creates higher interest
rates for private borrowers who are competing with
the government for available funds.
VI. The Future of Money
 Our forefathers could never have anticipated that
gold, silver, and finally paper money would one day
be replaced by credit and debit cards with magnetic
strip coding, let alone wireless banking and computer
chip technology.
 In order to understand some of the advances the
future may hold, it is necessary to look at how the
banking industry has changed recently.
A. AUTOMATED TELLER MACHINES
(ATMs)
 ATM machines, introduced in the 1970s, were seen by banks as a
way of saving money by reducing the need for tellers.
 To encourage customers to embrace the new technology and
overcome their fears about putting checks into an ATM rather
than a teller’s hands, banks did not initially charge customers any
fees for ATM use.
 Soon banks began imposing fees which irritated their customers.
The new fees supplemented the banks’ profit turn-around, which
started at about the same time.
 From 1996-98 at least two dozen states attempted to ban ATM
fees legislatively. All these efforts failed. What will happen to ATM
fees is not clear, but it is clear that ATMs are larger profit
machines than their promoters could have ever imagined 25 years
ago.
B. DEBIT CARDS
 Debit cards, also known as “check cards,” look like
credit cards or ATM cards, but operate like cash or a
personal check.
 Debit cards differ from credit cards in that credit cards
are a way to “pay later,” whereas a debit cards are a
way to “pay now.”
 More shoppers are using debit cards instead of cash,
according to a survey by the American Bankers
Association.
 Obtaining a debit card is often easier than obtaining a
credit card.
C. ELECTRONIC BANKING
 Consumers can now have their paychecks directly deposited
electronically to their checking or savings accounts.
 In addition, computers have made it possible to have the bank
pay their bills online.
 The banks also provide electronic copies of all transactions to their
consumers. This saves both the bank and the consumer time and
paperwork.
 Other banking services such as personal and mortgage loan
applications can be carried out online.
 At present, it appears that the speed and convenience of the
electronic medium outweighs any perceived problems (identity
theft) by consumers about the security of the online services.
D. ONLINE REAL ESTATE SALES AND
MORTGAGE LENDING SERVICES
 For some time now, consumers have been able to
shop for and purchase properties on-line through
online brokerage services.
 In addition, many lenders have set up proprietary
online loan programs.
 The newest wrinkle in this fast moving electronic
world is the concept of using Aggregation of services
to target Affinity Groups.
AGGREGATION
AFFINITY GROUP
VII. CHAPTER SUMMARY
 The roots of our modern financial system extend back to the Roman
Empire. These roots may be seen in the language of finance today.
 The United States based its system of laws, banking, finance, and
real estate ownership on British models.
 After the failure of the first central bank, neither the federal
government nor the states did much to regulate financial activity
before the Civil War.
 After the Civil War, and throughout the 20th Century, the federal
government assumed an increasing role in the national economy.
 Federal Reserve is the nation’s central banking system and is
capable of moderating severe swings in the business cycle. This
system, while not foolproof, is a role model for the world.