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Case: Easy Money, Empty Buildings
During the 1980s, banks and thrifts provided real estate developers
with a ready supply of financing, even for admittedly shaky projects.
Why? Among other reasons, deposit insurance provided unmerited
confidence in depositors and consequently allowed banks and thrifts
to take unwarranted risks. To learn more about deposit insurance,
and banks in general, visit the Federal
Deposit Insurance Corporation (FDIC).
There have been instances in history when a country's money supply increased so fast that the inflation rate became astronomical. One of the best examples was the hyperinflation in Germany after World War I. The inflation rate was so great that workers demanded to be paid several times a day and would give their pay to family members so that they could buy products before the prices increased again. Prior to World War I, the value of all home mortgages in Germany was 40 million marks. During the height of the hyperinflation in the early 1920s, 40 million marks could buy a postcard.
Question to Think About: How could relative prices be determined in such a situation?
The Gold Standard
Some politicians today are advocating a return to the gold standard. Under a gold standard, the dollar and other currencies are convertible into gold at a fixed price. For many years the official price of gold in the United States was $35 an ounce. That is, if you had an ounce of gold you could get $35 for it from the government, or you could buy an ounce of gold from the government for $35. When a currency is fully backed by gold, the money supply is determined by the amount of gold the government has.
In the past, the United States was not on a true gold standard because the government did not have enough gold to back all the dollars that had been printed. Instead, the government kept enough gold to back a fraction of the money supply. In this way, the money supply was still related to the gold stock but not on a one-for-one basis. The United States officially abandoned the gold standard in 1973.
Question to Think About: What price would be set for gold if the United States returned to the gold standard?
On November 30, 1998, Deutsche Bank AG announced it would acquire Bankers Trust for $10.1 billion in a deal that would create the world's largest financial institution with combined assets of more than $800 billion. Deutsche Bank is Germany's largest bank, with assets of $675 billion, and Bankers Trust is the eighth-largest U.S. bank, with $156 billion in assets. The combined assets would exceed those of the existing number one bank in the world, UBS AG of Switzerland. Citigroup, currently ranking second in the world, would rank third after the acquisition. Deutsche Bank's goal in the acquisition is to reach markets in North America. In the process, 5,500 employees, mostly in New York and London, would be laid off. The deal, which is expected to close next May, must be approved by New York and U.S. banking regulators. The home page for Deutsche Bank can be found at http://info.deutsche-bank.de/.
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Topic: Deutsche Bank Acquires Bankers Trust To Form Worlds Largest Financial Institution
(Updated 12/1/98)
Topic: "Big Bang" Sounds as Japan Begins Opening Up Financial Markets
Banks in Japan have been repeating the troubled history of U.S. banks during the 1980s. As a result of financial deregulation of banks, Japanese banks in the 1980s became more aggressive in attracting deposits and more willing to make riskier loans, particularly in the real estate sector. But when Japanese property values collapsed in the early 1990s, banks there were in big trouble. As the bad loans piled up (amounting now to about $600 billion), Japan experienced that country's first bank failures since World War II. On April 1, 1998, Japan began a long-awaited series of reforms that would open up Japanese financial markets to more market scrutiny and greater foreign competition. The series of measures, dubbed collectively the "Big Bang," may ultimately break down the cozy relationship in Japan between banks and borrowers. Because financial regulations had limited the savings alternatives of households (for example, compared to the United States, Japanese households have less access to mutual finds or to foreign markets), most households dutifully saved their money in banks earning relatively low interest rates. Banks would lend money to corporations or real estate developers. All bank lending in Japan exceeds 100 percent of the GDP, compared to only about 20 percent for lending by U.S. banks.. The cost of borrowing was therefore "cheap" in Japan. Worse yet, there was little oversight of how the borrowed funds were used. The initial wave of reforms under "Big bang" came with the lifting of most constraints on foreign-exchange trading and with the deregulation of commissions on stock sales. But some observers argue that the government has not yet fully acknowledged the weakness of the financial sector and has continued to prop up weak banks with government funds.
(Updated 4/7/98)
Topic: Wave of Bank Mergers Continues
Nationsbank, already one of the nation's largest banks, will acquire Barnett Banks, the dominant bank in Florida and the nation's 20th largest bank. Florida is considered an attractive market because of its millions of weathy retirees. The $15.5 billion deal is the largest acquisition in American banking history. The acquisition will make Nationsbank the third-largest U.S. bank in terms of assets, or deposits, which will total $285 billion. The price tag Nationsbank paid amounts to four times the book value of Barnett Banks (book value is the value of its assets minus its liabilities). The typical price tag for a well-run bank is about two time book value, so Nationsbank is paying a pretty penny to grow through acquisition. Since both banks have a presence in Florida, Nationsbank will have to close some branches in those markets now served by both banks. Nationbank's stock price declined 9% in the week following the acquisition announcement, so the stock market thinks the acquisition price is too high. Last year Wells Fargo acquired First Interstate for $11.6 billion but has had trouble absorbing the new acquisition, as layoffs and branch closings have caused customers to flee to competitors.
(Updated 9/9/97)
Topic: Big Bank Acquires Securities Firm
Ever since the Great Depression, banking regulations prevented commercial banks from merging with securities firms. In 1933, the Glass-Steagall Act banned banks from underwriting stocks. The thinking was that such activity was too risky for banks, which at the time were failing at record rates. In April, Bankers Trust New York, a major bank, took advantage of a recent change in bank regulations by acquiring Alex. Brown & Sons, the nation's oldest brokerage firm. The deal, estimated at $1.7 billion, is expected to touch off a flurry of similar mergers involving banks and brokerage firms. The Federal Reserve has gradually eased up on regulations involving such mergers, thereby allowing banks to provide a broader range of financial services. Most recently the Fed has eased restrictions on underwriting, which involves selling the initial offerings of stocks and bonds to raise funds for firms. The Fed now allows commercial banks to derive up to 25% of their revenue from the underwriting business of a bank affiliate. The point is that regulations are now allowing banks to offer customers a broader array of financial services.
(Updated 4/20/97)