Transcript The Federal Reserve - Minds on the Markets

The Federal Reserve (FED)
The Fed is an independent agency of the
U.S. Government. Its structure assures
that its actions are not dominated by a
political party or a geographical area.
Early History
Goals of the Federal Reserve
System
The Federal Reserve was commissioned to
make decisions to achieve the following
goals for the US economy:
1. Price Level
Stability (low
inflation)
2. High
Employment (low
unemployment)
3. Promote
Economic Growth
4. Stability in
Foreign Exchange
Rates
Functions of the Federal
Reserve System
The Federal Reserve works to achieve the above
goals through the following functions:
1. Control monetary policy to reduce the risk of
inflation
– Monetary policy: How the Fed influences the amount
of money and credit in the U.S. economy. Controlling
the supply of money in the financial system can create
economic prosperity, while avoiding recessions, and
ensure price stability, while avoiding inflation. The Fed
can either inject money into the economy or take it
out to help stimulate or slow down the economy.
Functions of the Federal
Reserve System
2. Regulate federally chartered banks and bank holding
companies
3. Intervene in the foreign exchange market to promote
stability of foreign exchange rates
4. Provide the mechanism for clearing checks and
processing transactions
Functions of the Federal
Reserve System
Act as a “Lender
of Last Resort” to
commercial banks
The Fed acts as the Lender of Last Resort
to institutions that do not have any other
means of borrowing and are
experiencing financial difficulty. They are
required to lend money to these
institutions when private institutions will
not the institutions are considered very
risky and near collapse. The Fed will lend
to these institutions because, if they did
not, their failure would dramatically
affect the economy. Commercial banks
avoid borrowing from the Fed because
such action indicates that the bank is
experiencing financial crisis.
Structure of the Federal Reserve
The structure of the Fed
is based on the concept
that control of monetary
policy should not be
politically or
geographically
concentrated/dominated
Structure of the Federal Reserve
The Federal Reserve System of the United States
Chairperson
Appointed by the President of the US. Serves 4 year term. Ben Bernanke is current chairperson.
7 Members of Board of Governors
Appointed by President. Each serves 14 year terms. Terms are staggered so there is not an entirely new
board every 14 years.
12 District Banks
Each district bank is headed by a President who is elected by the other member banks. District Banks: NY,
San Francisco, Kansas City, Cleveland, Boston, Philadelphia, Richmond, Atlanta, St. Louis, Dallas, Chicago and
Minneapolis.
Federal Open Market Committee (FOMC)
A branch of the Federal Reserve that formulates monetary policy by setting a target for the Federal funds rate. The FOMC is
made up of the 7 members of the boards of governors, the NY Federal Reserve President and 4 rotating District Bank
Presidents.
Structure of the Federal Reserve
The 12 District Banks and their Geographic Boundaries
How the Federal Reserve
Controls Monetary Policy
Printing currency
Raising or lowering the amount of
reserves that banks are required to hold.
Increasing reserves requirement means
banks have to hold onto more money,
which tends to tighten credit, making
fewer funds available for lending.
Reserve Requirement: Percentage of deposits that banks are required to keep in noninterest bearing accounts.
How the Federal Reserve Controls
Monetary Policy
• Open Market Operations: When the Fed buys or sells
government securities to primary dealers in order to
increase or decrease the amount of money in the banking
system.
Primary dealers: A bank or broker-dealer that is able to
buy and sell directly with the Federal Reserve. They act as
market makers. Primary Dealers are very large banks such
as JP Morgan, Goldman Sachs, and UBS.
A full list of the primary dealers can be found on the Federal
Reserve Bank of New York’s website:
http://www.newyorkfed.org/markets/pridealers_listing.html
How the Federal Reserve Controls
Monetary Policy
Open Market Operations Continued
To Decrease the Money Supply:
The Fed will sell bonds and
securities. This reduces the
dollars in the economy because
they sell bonds in exchange for
dollars.
To Increase the Money Supply:
The Fed will buy existing bonds.
This increases the money
supply because it injects dollars
into the economy.
As a result of Open Market Operations, short term interest rates will increase or decrease.
If the economy is not running efficiently, the Fed can cut the interest rate in order to
encourage borrowing. If the economy is too strong, the Fed can raise rates, which
discourages borrowing. Too much money in the banking system can be negative and
lead to inflation.
Fed’s Open Market Operations in a
RECESSION
Fed’s Open Market Operations during
INFLATION
Other Regulatory Agencies
The goal of a regulatory agency is to protect
individual investors. The most highly regulated
business in the U.S. is the securities industry.
SEC (Securities And Exchange Commission):
The top government regulatory
agency in the securities industry. The
SEC is responsible for overseeing the
securities industry and ensuring that
markets work efficiently. The SEC
regulates the securities market and
protects investors against fraudulent
and manipulative practices.
SEC (Securities And Exchange Commission):
Securities cannot be sold to investors
without a prospectus.
Oversees all of the stock exchanges
and any organization connected with
the selling of securities.
Has a strong anti-fraud unit that
monitors advertising and marketing to
make sure companies comply with
strict rules concerning the sale of
securities.
Monitors any U.S. corporate takeovers.
Financial Industry Regulatory
Authority (FINRA)
A regulatory body that aims to eliminate
regulatory overlap and cost inefficiencies.
FINRA is responsible for governing business
between brokers, dealers and the investing
public.
Commodity Futures Trading
Commission (CFTC)
A U.S. federal agency established by the
Commodity Futures Trading Commission Act of
1974. It ensures the open and efficient operation
of the futures market. The CFTC protects
investors from abusive trade practices,
manipulation, and fraud. The CFTC ensures that
the markets are liquid and that both parties of
options or futures transactions are able to meet
their contractual obligations.
Self-Regulatory Organization (SRO):
A non-governmental organization that
has the power to create and enforce
industry regulations and standards.
The goal of all SROs is to protect
investors through the establishment
of rules that promote ethics and
equality.
What is a Stock Exchange?
A marketplace where people buy
and sell securities. The NASDAQ
and NYSE are two exchanges that
provide trading options for
investors and measure stock
performances through indexing.
Different companies’ stocks trade
on these exchanges. The
operations of these exchanges
also differ.
National Association of Securities Dealers
Automated Quotations (NASDAQ)
An exchange, entirely on the
Internet, where approximately
3,300 companies trade.
The National Association of Securities Dealers (NASD)
is responsible for the operation and regulation of the
NASDAQ stock market and over-the-counter markets.
The NASD watches over the NASDAQ to make sure the
market operates correctly.
Subject to supervision by the SEC.
New York Stock Exchange
(NYSE):
The world’s largest
stock exchange.
Subject to supervision
by the SEC.
Municipal Securities Rulemaking Board
(MSRB)
A self-regulating
organization that
creates rules and
policies for
investment
companies and
banks in the issuing
and sale of
municipal securities
(Example: notes,
bonds).
Regulates
underwriting,
trading and
selling of
municipal
securities.
Subject to
supervision by
the SEC.
National Futures Association (NFA):
A self-regulatory organization for the U.S. futures market.
NFA membership is mandatory for all participants in the
futures and commodities market, providing assurance to
the investing public that all firms, intermediaries and
associates who conduct business with them in the U.S.
comply with their regulations.
Oversees and protects investors from fraudulent
commodities and futures activities.
Conducts background checks and licensing exams,
regulates futures trading, provides information for
investors, and monitors how firms comply.
Dodd-Frank Wall Street Reform and
Consumer Protection Act
• The Dodd-Frank Wall Street Reform and
Consumer Protection Act promotes the
financial stability of the United States by
improving accountability and transparency of
the financial system.
Dodd-Frank Wall Street Reform and
Consumer Protection Act
Goals of the Dodd-Frank:
Protect American taxpayers
by ending bailouts.
Protect consumers from
abuse of financial services
practices.
Restrict the types of
proprietary trading that
financial institutions will be
able to do.
Proprietary Trading: The act of trading
stocks, bonds, commodities, or
derivatives with a firm’s own capital
rather than investor’s capital. It allows
a firm to make a profit for itself.
Establish government
agencies to monitor banking
practices and oversight of
troubled financial institutions
Protect borrowers against
abusive lending and
mortgage practices.
Dodd-Frank Wall Street Reform and
Consumer Protection Act
Reasons for Dodd-Frank:
Major financial institutions, such as Lehman Brothers, collapsed
in 2008.
The housing bubble burst.
Investment firms were packaging risky mortgages into Mortgage
Backed Securities and passing them off as safe bonds.
Dodd-Frank Wall Street Reform and
Consumer Protection Act
Historical Perspective:
The Dodd-Frank
This act made
Financial Regulatory
changes in the
Signed into
Reform Bill was
American financial
Federal law by
named after
regulatory
Senator Christopher
environment that
President Obama
J. Dodd and U.S.
affects all Federal
on July 21, 2010.
Representative
financial regulatory
Barney Frank.
agencies.
This was a
Represents the
reaction to the
most
late 2000’s
comprehensive
recession. It also
financial regulatory
sought to reduce
reform measures
banks from over
taken since the
leveraging
Great Depression
themselves.
Dodd-Frank Wall Street Reform and
Consumer Protection Act
Consequences of Dodd-Frank:
Affected the oversight of financial institutions.
Provided a new resolution procedure for large financial companies.
Resolution Procedure: A set of guidelines that spell out the proper steps
a financial company must make if they file for bankruptcy.
Created a new agency responsible for implementing and enforcing
compliance with consumer financial laws.
Made significant changes in the regulation of over-the-counter derivatives.
Reformed the regulation of credit rating agencies.
Dodd-Frank Wall Street Reform and
Consumer Protection Act
Impact on Hedge Funds
• The Dodd-Frank Act requires all large hedge fund advisers to
register with the SEC.
• The new rules on derivatives trading have an additional impact on
many hedge funds.
• Increase of compliance costs on funds and investors.
• Hedge fund advisors must maintain extensive records about their
investment and business practices. They must provide this
information to the SEC.