2 / MONEY AND THE MONETARY SYSTEM

This chapter discusses the roles of the major Federal and California financing agencies as they control the supply and costs of money for real estate finance. The topics covered here expand the student's definition of monetary theory as it applies to realty finance.

Beginning with a definition of money and its uses and purposes, this chapter looks at the three major federal agencies, the Federal Reserve System, the United States Treasury and the Federal Home Loan Banking System and how they control the supply and costs of money. The interrelated attributes of supply and costs as they affect real estate financing funds are also examined. This chapter also peers into the various state agencies established to oversee financial activities.

The effective presentation of the material in this chapter will vary with the instructor's background in money and banking. It is suggested that, where this background is limited, the presentation be enhanced by a team-teaching effort using someone well versed in the roles of these agencies.

Of significant interest to the students will be the Fed's open market activities, the impact of reserve requirements and the multiplier effects from the creation of new money based on the

amount of monies not required to be held in reserve. The role of the Treasury in issuing short- and long-term government securities and attempting to manage the enormous national debt in

the face of continued annual deficits should be analyzed. Keep in mind that it creates competition (with the Fed) for available funds. The implication is that these funds might otherwise be available for real estate loans.

Close attention should be paid to the effects on our banking system of the various agencies created to offset the recent banking crisis. All practicing and potential real estate professionals must become familiar with the California finance agencies and their areas of activities.

Upon completion of this chapter, the student should be able to:

1. Define money as a medium of exchange, a storehouse of purchasing power and a standard of value;
2. Understand the effects of the supply and costs of money on funds available for financing real estate;
3. Discuss the activities of the Federal Reserve System in establishing and enforcing the nation's monetary policies and supervising the nation's banking systems;
4. Identify the role of the U.S. Treasury as this nation's fiscal manager in balancing the collection of income tax and social security receipts with the payments required for the expenses of the federal government;
5. Recognize the impact on the U.S. banking system of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA);
6. Describe the increased responsibilities of the Federal Deposit Insurance Corporation (FDIC) as it becomes the only government agency guaranteeing depositors in both banks and thrifts;
7. Discuss the diminished role of the FHLB as it struggles to preserve the continuity of the thrifts;
8. Recognize the operations of the Office of Thrift Supervision as it regulates the thrifts;
9. Give reasons why the federal government has a regulatory role in the financial markets;
10. Define discount rate and prime rate;
11. Describe the various state agencies involved in regulating financial activities in California.

I. Introduction to Government's Role in Financing

A. What is money?

1. Medium of exchange or means of payment

2. Storehouse of purchasing power

3. Standard of value

B. Theory of social control

b. 1934 Gold Reserve Act

(1) Replacement of gold standard with gold exchange standard

(2) No gold could be redeemed for money after 1934

(1) Results achieved by infusion of more money into economy

a. The money supply

(1) M1 includes cash and checking accounts

(2) M2 adds savings accounts under $100,000

(3) M3 adds savings accounts over $100,000

II. Federal Agencies Empowered to Use Tools for Controlling

Supply and Cost of Money

A. The Federal Reserve System (Fed)

1. Purpose--a central banking system

(1) Maintains sound credit conditions

(2) Stimulates full employment

(3) Stabilizes values

(4) Raises levels of consumption

b. Combats inflationary and deflationary pressures

2. Organization

a. Twelve federal reserve districts

b. Each district includes federal reserve bank

c. Directed by board of governors

d. Membership open to all federally chartered banks and thrifts

3. Instruments of credit policy

a. Issues currency (see dollar bill)

b. Specifies reserve requirements

c. Clears members' checks

d. Establishes discount rates

(1) Define discount and prime rates

(2) Explain that lower discount rates lower mortgage rates

f. Open market operations

(1) Purchase and sale of government securities

(2) Can compete with U.S. Treasury

g. Supervises Truth-In-Lending Act, Regulation Z

B. The U.S. Treasury

1. Manages government fiscal operations

a. Manages national debt

(1) Bills: less than a year

(2) Notes: one to five years

(3) Bonds: more than five years

d. Collects and disburses social security payments

2. The Financial Institutions reform, Recovery and

Enforcement Act of 1989 (FIRREA)

b. Eliminated the FSLIC

C. The Federal Home Loan Bank System (FHLB)

2. Organization

a. Twelve regional home loan district banks

b. Directed by board of governors

3. Functions

a. Establishes reserve requirements

b. Provides insurance for depositors through the FDIC

c. Makes loans to member associations

d. Purchases securities from members

e. Regulates member activities

III. California Financial Agencies

A. Department of Savings and Loans

B. California Housing Finance Agency

C. Department of Banking

D. Department of Insurance

E. Department of Corporations

F. Department of Real Estate

G. Office of Real Estate Appraisers