Money, Banking, Saving, and Investing

Objectives:

Money has three basic functions:

Money has six main characteristics

Commodity money was used for thousands of years before the creation of banks. Banknotes replaced commodity money and were eventually replaced by fiat money.

The money supply is made of these assets:

Credit cards and debit cards can be used to make purchases, but they are not part of the money supply.

DEBT IS BAD FOR YOU!!!!!!!!!!!

Saving is any form of putting money aside for later use.

Banks are financial institutions that provide two main services: receiving deposits from savers and making loans to borrowers. Banks charge interest on the loan principal. They profit by charging more interest on loans than they pay on deposits.

Banks are required to keep a fraction of deposits in reserve and can make loans with the rest. The Federal Reserve System regulates and manages the nation’s banks.

Saving helps the economy grow by supplying the funds that financial institutions lend out for business investment.

Putting money aside today can help one:

Retirement is often funded by three sources of money:

These include both traditional defined pension plans and 401K’s (company sponsored plans based on voluntary employee contributions)

Investing involves using money that has been saved to earn more money, usually through compounding.

Investment options have different risks and returns.

In the fall of 2008, the World financial markets went into catastrophic meltdown. The crisis was so severe, it threatened the stability of economies all around the world. Capitalism itself, as we know it, was at the brink of collapse.

What went wrong? What caused such a sudden, steep, and severe financial crisis? And why was it (and still is) a global phenomenon?

Traditionally, asset allocation involves dividing the assets in a portfolio among different types of investments. This diversification of investments involves balancing various investments to hedge (avoid) losses. For most of the 20^th century, this simple strategy was used by individuals, corporations, and governments to avoid risk (losses).

In the late 80’s and early 90’s, there were many changes in the investment world. First, the banking and financial industry was de-regulated with the Finance Modernization Act of 2000. It repealed the Glass-Stegal Act which had regulated the industry since the New Deal. Second, derivatives (equities that represent a combination of pieces of various stocks) became wide-spread. Third, a new kind of investor became major players in the market. ..hedge funds.

Hedge funds are open-ended investment companies organized as limited partnerships for the sole purpose of investing clients money to obtain large profits. Hedge funds often use use high-risk speculative methods and “risk management” formulas to maximize rate of return. Huge profits are made with small margins and large margins (debt). This strategy was extremely successful. Great wealth was made by a few without any real value being added to the economy.

 The strategy became a catastrophe when C.D.O.’s (collateralized debt obligations), whose real risk was not accounted for began to default. Hedge funds were forced to satisfy their enormous margins, selling off perfectly good equities (in such large quantities), stock prices went into a free fall across the national and global markets. Thus a crisis was born. The ripple effects of the financial markets meltdown spread quickly. The effects of “Wall Street” were quickly felt on “Main Street”