AP Economics Mr. Bernstein Module 26: The Federal Reserve System: History and Structure February 19, 2015

AP Economics Mr. Bernstein Federal Reserve System: History and Structure Objectives - Understand each of the following: The history of the Federal Reserve System The structure of the Federal Reserve System How the Federal Reserve System has responded to major crises 2

AP Economics Mr. Bernstein The Multiplier: An Informal Introduction Central Banks oversee and regulate the banking system, control the monetary base Our current Central Bank is the result of legislation following periods of financial crisis Laws are designed to protect borrowers and lenders and minimize risks of panic Federal Reserve System was Created in

AP Economics Mr. Bernstein Crisis in American Banking at Turn of 20 th Century Lack of trust could spark “runs” on banks and deplete their reserves, becoming a self-fulfilling prophecy The Panic of 1907 led to creation of Fed Centralized control of reserves Required all deposit-accepting institutions to maintain adequate reserves and open books for inspection by regulators Monopoly on ability to print money 4

AP Economics Mr. Bernstein Structure of the Federal Reserve System 14-person Board of Governors and 12 regional Federal Reserve Banks 5

AP Economics Mr. Bernstein Current Chairman of the Federal Reserve System Janet Yellen 6

AP Economics Mr. Bernstein Structure of the Federal Reserve System 14-person Board of Governors are appointed by the President and approved by the Senate Serve 14-year terms to reduce political pressure Chairman serves 4-year terms Federal Reserve Bank of New York conducts open market operations FOMC (Federal Open Market Committee) makes decisions about monetary policy; includes Board of Governors plus 5 regional bank presidents 7

AP Economics Mr. Bernstein Effectiveness of the Federal Reserve System Despite Fed, some bank runs and the Great Depression happened Further laws were created in 1930s and 40s Notable was the Glass-Steagall Act of 1932, separating banks from other financial activities Beginning in the 1980s, some of these safeguards were rolled back Use of leverage, new financial instruments often beyond Fed control and contribute to crises 8

AP Economics Mr. Bernstein Financial Crisis of 2008: Factors Beyond Fed Control Government policies encouraging bank lending in disadvantaged neighborhoods Mortgage bankers incentivized to close deals ARM mortgages offering low payments for 2-5 years only Low down payments allowing home buyers high leverage Fraud by both mortgage bankers and home buyers Low interest rates encouraging investors to purchase bundles of bad mortgages in complicated securities to gain yield Bond rating agencies incentivized to allow gaming of these complicated securities to achieve deceptively high ratings Wall Street compensation structures incentivizing executives to book short-term profits and take massive longer-term risks Ended badly when housing price bubble began to roll over 9

AP Economics Mr. Bernstein Financial Crisis of 2008: Fed Response Signal to markets intent to assist, reduce uncertainty Fed Balance Sheet used to protect banks and near-money funds from runs Bear Stearns, Lehman Brothers, and moral hazard Still fighting hangover 10