10-1 Financial Innovation and Banking Industry Structure Responses to Changes in Risk 1.Adjustable-rate mortgages 2.Financial Derivatives Responses to Changes in Technology Major change is improvement in computer technology – Increases ability to collect information – Lowers transaction costs Examples: 1.Bank credit and debit cards 2. Electronic banking facilities 3.Junk bonds 4.Commercial paper market 5.Securitization
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10-1 Financial Innovation and Banking Industry Structure Responses to Changes in Risk 1.Adjustable-rate mortgages 2.Financial Derivatives Responses to.
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10-1
Financial Innovation and Banking Industry Structure
Responses to Changes in Risk
1. Adjustable-rate mortgages
2. Financial Derivatives
Responses to Changes in Technology
Major change is improvement in computer technology
Why a Banking Crisis in 1980s?Early Stages1. Decreasing profitability: banks take risk to keep profits up2. Deregulation in 1980 and 1982, more opportunities for risk taking3. Innovation of brokered deposits enabled circumvention of
$100,000 insurance limit4. i , net worth of S&Ls
A. Insolvencies B. Incentives for risk taking
Result: Failures and risky loans
Later Stages: Regulatory Forbearance1. Regulators allow insolvent S&Ls to operate because
A. Insufficient fundsB. Sweep problems under rugC. FHLBB cozy with S&Ls
2. Huge increase in moral hazard for zombie S&Ls: now have incentive to “bet the bank”
Other InstitutionsPension Funds1. Rapid growth: encouraged by tax policy2. Bigger role in stock market3. Problem of underfunding4. Private: regulated by Dept. of Labor and insured by
Penny Benny under ERISA Act of 19745. Public Plans
A. Social SecurityB.State and local plans
Finance Companies1. Minimal regulation by states2. Rapid growth3. Three types:
A. Sales finance companiesB.Consumer finance companiesC. Business finance companies