2/26 Banking notes

Financial institutions
What sorts of things can or cannot be insured? The difference between insurance and gamble
Insurance is a method of displacing unavoidable risks. Gambling is a method of inviting risks. With or without insurance, you have the same risks - the same is not true of gambling. Insurance companies use law of large number to pool the known risks. For gambling, it bets on one specific incidence.

IT is not true that insurance is about letting rich people pay poor people.
Deposit insurance:
Adverse selection and moral hazard
Central banks charge every bank premiums and provide protection. Risky banks will consider FDIC premium requirement a good deal
Possible ways to reduce adverse selection: Screening.
Charge different premiums towards people with different backgrounds, may exclude certain kinds of people.

Moral hazards: In financial market, when lenders are protected by deposit insurance, they put less monitor work on bank behavior and induce bank to make more risky investments.
Possible ways to reduce the moral hazard:
let lenders pay deductible, supervision or threat of cancellation
Credit default swap: what's the nature? Gamble or insurance?

Federal Credit agency: Freddie Mac (Federal Home Loan Mortgage Corporation), Fannie Mae (Federal National Mortgage Association), Sallie Mae (Student Loan Marketing Association), Ginnie Mae (Government National Mortgage Association), Farmer Mac
Lending institutions set up or sponsored by the U.S. federal government, such as Small Business Administration (SBA), Federal Housing Administration (FHA), Rural Housing Service, and Veteran Affairs' Loan Program. These agencies borrow from the U.S. Treasury (through the Federal Financing Bank) in order to offer below market rate loans to individuals, businesses, and other types of organizations. These loans are offered as a means of developmental support to those who do not have ready access to the financial markets.

The reason to set up Freddie and Fannie was to make housing more affordable, but today the reason why we keep them is that we want to the houses price up.

The brief history of Fannie Mae and Freddie Mac
http://www.time.com/time/business/article/0,8599,1822766,00.html

1970 California shortage of loanable funds reasons
(1) a high demand of loanable funds pushed up the interest rate

Ginne Mae http://www.investopedia.com/terms/g/ginniemae.asp#axzz2M33qLKEh

Balance sheet of Freddie Mac
A                                                                              L
Cash 50                                                                  Mortgage backed security 1250
Mortgage 1450                                                       Asset debt 200
                                                                              Ownership equity 50
Suppose I have a 10 bad loan, then Freddie will take 10 cash out of its account and pay the investors, and they will write down the mortgage security value by 10, then MBS will be down by 10 and equity will be down by 10. Freddie is over leveraged.

China eats asset debts.

Two types of pension plans
(1) Defined benefit plan

the employer guarantees that the employee will receive a definite amount of benefit upon retirement, regardless of the performance of the underlying investment pool



(2) Contribution plan

the employer makes predefined contributions for the employee, but the final amount of benefit received by the employee depends on the investment's performance.



Social security system is not a pension plan, it is just a pay-as-you-go plan. Social securities itself is not a financial intermediary