Real money demand: Bloomberg on a bank run today in London. An excerpt:

Hundreds of Northern Rock Plc customers crowded into branches in London today to pull out their savings after the mortgage-loan provider sought emergency funding from the Bank of England.

``It's scary,'' said Peter Pye, 60, a retired university lecturer standing in a line of about 30 people outside the Moorgate branch in the financial district. ``I have my life's savings in Northern Rock.'' He said he would withdraw a ``six- figure'' sum and leave 5,000 pounds in the account.

The Bank of England said it will provide emergency cash to Northern Rock, Britain's third-largest mortgage provider, in the nation's biggest bailout of a financial institution in 30 years. The rising cost of credit left the lender unable to make new loans and stoked concern among customers about their money.

Read the whole article. This is the scenario that central bankers and banking regulators are trying to avert in the wake of the subprime lending crisis and its attendant credit crunch. Banks ensure (in part) that they have enough cash to satisfy withdrawals through their lending activities. If this activity slows as interest rates rise--think of that loanable funds supply curve shifting to the left--and if depositors perceive that certain banks are becoming insolvent as a result, how are (i) depositors, (ii) investors, and (iii) regulators likely to respond? I'd expect the Fed to increase the monetary base relative to the monetary measures.

Define: auction markets, over-the-counter markets, capital and derivative markets. See this article about Southwest's use of the derivative market to protect itself from risk.

Why do firms use derivative markets?

Why are money market assets typically more liquid than capital market assets? Does the relative illiquidity of capital market assets have any consequences for the banking system?

What factors explain the need for financial markets? (We discussed four today.) Who is more likely to use a stock broker (ceteris paribus): an active college professor in Alabama or a retired college professor in Florida? Why?

What are the benefits to savers and borrowers if financial markets communicate all available information about financial instruments via their prices?

Here is an interesting recent story about moral hazard. How does U.S. foreign aid promote moral hazard? What are some ways that ailing countries can be helped without creating it? Also, here is the story about the doctor's strike in Israel and its effect on death rates. How can a doctor's strike promote moral hazard?

Here is Sam Peltzman on seat belts and moral hazard. Don Cherry noted that when hockey players were forced to wear face masks, there was a higher incidence of high sticking and slashing calls. Explain how possible moral hazard problems can result from (i) financial regulation, (ii) general insurance, and (iii) deposit insurance.

Here is a new academic paper (by Livshits, MacGee, and Tertilt, "Accounting for the Rise in Consumer Bankruptcies") that ties increasing consumer bankruptcies with credit market innovations that have come about since 1970. Here's the abstract:

Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thousand working age population in 1970 to 8.5 in 2002. We use a heterogeneous agent life-cycle model with competitive financial intermediaries who can observe households' earnings, age and current asset holdings to evaluate several commonly offered explanations. We find that increased uncertainty (income shocks, expense uncertainty) cannot quantitatively account for the rise in bankruptcies. Instead, the rise in filings appears to mainly reflect changes in the credit market environment. We find that credit market innovations which cause a decrease in the transactions cost of lending and a decline in the cost of bankruptcy can largely accounting for the rise in consumer bankruptcy. We also argue that the abolition of usury laws and other legal changes are unimportant.

Question: Why would decreased transaction costs in loan contracts result in increased consumer bankruptcies? There is an adverse selection argument here (we have not yet covered adverse selection in class), but it seems weak in this case. (Note that in the early 2000s, former Fed Chairman Alan Greenspan encouraged the use of the subprime market.) One point we will discuss later in class is the lag between technological innovations and regulatory adjustment. Regulations are created to fit a specific banking environment, and when the environment changes, the regulations are often not adjusted until after a crisis of some sort develops. Also, the argument here is that lowered transaction costs leave lenders with decreased incentives to maintain minimum lending standards. Do you agree? Can you think of other likely--perhaps more likely--candidates for he increase in bankruptcies?

We'll discuss this in more detail in class. Also, here are some links to the full paper.

Define the loanable funds market and the production possibilities frontier as discussed today in class. What happens to each if (for instance) an economy is characterized with many productive baby boomers entering retirement?

Why do financial markets exist? What are financial instruments? Explain financial markets role in providing risk sharing, liquidity, and increases in information. Why are risk sharing, liquidity, and information valued by savers and borrowers?

Do banks and other financial intermediaries like high interest rates? Why or why not?

Differentiate between the primary and secondary, money and capital, and cash and derivative ways to analyze financial markets. What goods are associated with each?

The sound you here coming from Miami is of the condo crash. One advantage of a credit crunch is that those who have saved can now find good deals on housing. Consider the situation of the condo market in Miami, which rivaled Shanghai and Dubai in terms of new construction during the boom.

"It's painful and scary," Natalie Luongo, 31, said. "We saw the frenzy, and we bought in. Now we're paying the consequences."

Just how many other speculators face the same dilemma in the nation's most glutted condo market will become clear during the next two years. That is when 25,000 new condo units, most of them rising in or near Miami's downtown, will flood an area already saturated with 23,000 condos listed for sale. An additional 40,000 units have been approved, but analysts doubt the majority will break ground. (See map with condo locations.)

Orlando and other Florida cities -- Naples, Fort Myers, Tampa and Sarasota among them -- also have huge condo gluts. With 4,440 condos listed for sale, Orlando has an unprecedented 29-month supply, and last month sales plummeted 64 percent lower than a year ago.

[Full article here.]

See this short video from 1967 that predicts that by 1999, we will be shopping at home from our own computers. We'll also be paying our bills, accessing bank statements, and reading electronic mail. These are very interesting--and generally correct--musings from a time in which most transactions were conducted in cash, the dollar was weakly tied to gold, the euro existed only in theory, and banks earned money via fees from checking accounts and interest on commercial loans.