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The Federal Reserve (FED) The Fed is an independent agency of the U.S. Government. Its structure assures that its actions are not dominated by a political party or a geographical area.

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Early History

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Goals of the Federal Reserve System The Federal Reserve was commissioned to make decisions to achieve the following goals for the US economy: 1. Price Level Stability (low inflation) 2. High Employment (low unemployment) 3. Promote Economic Growth 4. Stability in Foreign Exchange Rates

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Functions of the Federal Reserve System The Federal Reserve works to achieve the above goals through the following functions: 1. Control monetary policy to reduce the risk of inflation Monetary policy: How the Fed influences the amount of money and credit in the U.S. economy. Controlling the supply of money in the financial system can create economic prosperity, while avoiding recessions, and ensure price stability, while avoiding inflation. The Fed can either inject money into the economy or take it out to help stimulate or slow down the economy.

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Functions of the Federal Reserve System 2. Regulate federally chartered banks and bank holding companies 3. Intervene in the foreign exchange market to promote stability of foreign exchange rates 4. Provide the mechanism for clearing checks and processing transactions

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Functions of the Federal Reserve System Act as a Lender of Last Resort to commercial banks The Fed acts as the Lender of Last Resort to institutions that do not have any other means of borrowing and are experiencing financial difficulty. They are required to lend money to these institutions when private institutions will not the institutions are considered very risky and near collapse. The Fed will lend to these institutions because, if they did not, their failure would dramatically affect the economy. Commercial banks avoid borrowing from the Fed because such action indicates that the bank is experiencing financial crisis.

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Structure of the Federal Reserve The structure of the Fed is based on the concept that control of monetary policy should not be politically or geographically concentrated/dominated

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Structure of the Federal Reserve The Federal Reserve System of the United States Chairperson Appointed by the President of the US. Serves 4 year term. Ben Bernanke is current chairperson. 7 Members of Board of Governors Appointed by President. Each serves 14 year terms. Terms are staggered so there is not an entirely new board every 14 years. 12 District Banks Each district bank is headed by a President who is elected by the other member banks. District Banks: NY, San Francisco, Kansas City, Cleveland, Boston, Philadelphia, Richmond, Atlanta, St. Louis, Dallas, Chicago and Minneapolis. Federal Open Market Committee (FOMC) A branch of the Federal Reserve that formulates monetary policy by setting a target for the Federal funds rate. The FOMC is made up of the 7 members of the boards of governors, the NY Federal Reserve President and 4 rotating District Bank Presidents.

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Structure of the Federal Reserve The 12 District Banks and their Geographic Boundaries

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How the Federal Reserve Controls Monetary Policy Printing currency Raising or lowering the amount of reserves that banks are required to hold. Increasing reserves requirement means banks have to hold onto more money, which tends to tighten credit, making fewer funds available for lending. Reserve Requirement: Percentage of deposits that banks are required to keep in non- interest bearing accounts.

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How the Federal Reserve Controls Monetary Policy Open Market Operations: When the Fed buys or sells government securities to primary dealers in order to increase or decrease the amount of money in the banking system. Primary dealers: A bank or broker-dealer that is able to buy and sell directly with the Federal Reserve. They act as market makers. Primary Dealers are very large banks such as JP Morgan, Goldman Sachs, and UBS. A full list of the primary dealers can be found on the Federal Reserve Bank of New Yorks website: http://www.newyorkfed.org/markets/pridealers_listing.html http://www.newyorkfed.org/markets/pridealers_listing.html

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How the Federal Reserve Controls Monetary Policy As a result of Open Market Operations, short term interest rates will increase or decrease. If the economy is not running efficiently, the Fed can cut the interest rate in order to encourage borrowing. If the economy is too strong, the Fed can raise rates, which discourages borrowing. Too much money in the banking system can be negative and lead to inflation. To Decrease the Money Supply: The Fed will sell bonds and securities. This reduces the dollars in the economy because they sell bonds in exchange for dollars. To Increase the Money Supply: The Fed will buy existing bonds. This increases the money supply because it injects dollars into the economy. Open Market Operations Continued

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Feds Open Market Operations in a RECESSION

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Feds Open Market Operations during INFLATION

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Other Regulatory Agencies The goal of a regulatory agency is to protect individual investors. The most highly regulated business in the U.S. is the securities industry.

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SEC (Securities And Exchange Commission): The top government regulatory agency in the securities industry. The SEC is responsible for overseeing the securities industry and ensuring that markets work efficiently. The SEC regulates the securities market and protects investors against fraudulent and manipulative practices.

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SEC (Securities And Exchange Commission): Securities cannot be sold to investors without a prospectus. Oversees all of the stock exchanges and any organization connected with the selling of securities. Has a strong anti-fraud unit that monitors advertising and marketing to make sure companies comply with strict rules concerning the sale of securities. Monitors any U.S. corporate takeovers.

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Financial Industry Regulatory Authority (FINRA) A regulatory body that aims to eliminate regulatory overlap and cost inefficiencies. FINRA is responsible for governing business between brokers, dealers and the investing public.

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Commodity Futures Trading Commission (CFTC) A U.S. federal agency established by the Commodity Futures Trading Commission Act of 1974. It ensures the open and efficient operation of the futures market. The CFTC protects investors from abusive trade practices, manipulation, and fraud. The CFTC ensures that the markets are liquid and that both parties of options or futures transactions are able to meet their contractual obligations.

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Self-Regulatory Organization (SRO): A non-governmental organization that has the power to create and enforce industry regulations and standards. The goal of all SROs is to protect investors through the establishment of rules that promote ethics and equality.

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What is a Stock Exchange? A marketplace where people buy and sell securities. The NASDAQ and NYSE are two exchanges that provide trading options for investors and measure stock performances through indexing. Different companies stocks trade on these exchanges. The operations of these exchanges also differ.

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National Association of Securities Dealers Automated Quotations (NASDAQ) An exchange, entirely on the Internet, where approximately 3,300 companies trade. The National Association of Securities Dealers (NASD) is responsible for the operation and regulation of the NASDAQ stock market and over-the-counter markets. The NASD watches over the NASDAQ to make sure the market operates correctly. Subject to supervision by the SEC.

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New York Stock Exchange (NYSE): The worlds largest stock exchange. Subject to supervision by the SEC.

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Municipal Securities Rulemaking Board (MSRB) A self-regulating organization that creates rules and policies for investment companies and banks in the issuing and sale of municipal securities (Example: notes, bonds). Regulates underwriting, trading and selling of municipal securities. Subject to supervision by the SEC.

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National Futures Association (NFA): A self-regulatory organization for the U.S. futures market. NFA membership is mandatory for all participants in the futures and commodities market, providing assurance to the investing public that all firms, intermediaries and associates who conduct business with them in the U.S. comply with their regulations. Oversees and protects investors from fraudulent commodities and futures activities. Conducts background checks and licensing exams, regulates futures trading, provides information for investors, and monitors how firms comply.

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Dodd-Frank Wall Street Reform and Consumer Protection Act The Dodd-Frank Wall Street Reform and Consumer Protection Act promotes the financial stability of the United States by improving accountability and transparency of the financial system.

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Dodd-Frank Wall Street Reform and Consumer Protection Act Protect American taxpayers by ending bailouts. Protect consumers from abuse of financial services practices. Restrict the types of proprietary trading that financial institutions will be able to do. Proprietary Trading: The act of trading stocks, bonds, commodities, or derivatives with a firms own capital rather than investors capital. It allows a firm to make a profit for itself. Establish government agencies to monitor banking practices and oversight of troubled financial institutions Protect borrowers against abusive lending and mortgage practices. Goals of the Dodd-Frank:

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Dodd-Frank Wall Street Reform and Consumer Protection Act Major financial institutions, such as Lehman Brothers, collapsed in 2008. The housing bubble burst. Investment firms were packaging risky mortgages into Mortgage Backed Securities and passing them off as safe bonds. Reasons for Dodd-Frank:

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Dodd-Frank Wall Street Reform and Consumer Protection Act The Dodd-Frank Financial Regulatory Reform Bill was named after Senator Christopher J. Dodd and U.S. Representative Barney Frank. Represents the most comprehensive financial regulatory reform measures taken since the Great Depression Signed into Federal law by President Obama on July 21, 2010. This was a reaction to the late 2000s recession. It also sought to reduce banks from over leveraging themselves. This act made changes in the American financial regulatory environment that affects all Federal financial regulatory agencies. Historical Perspective:

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Dodd-Frank Wall Street Reform and Consumer Protection Act Consequences of Dodd-Frank: Affected the oversight of financial institutions. Provided a new resolution procedure for large financial companies. Resolution Procedure: A set of guidelines that spell out the proper steps a financial company must make if they file for bankruptcy. Created a new agency responsible for implementing and enforcing compliance with consumer financial laws. Made significant changes in the regulation of over-the-counter derivatives. Reformed the regulation of credit rating agencies.

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Dodd-Frank Wall Street Reform and Consumer Protection Act Impact on Hedge Funds The Dodd-Frank Act requires all large hedge fund advisers to register with the SEC. The new rules on derivatives trading have an additional impact on many hedge funds. Increase of compliance costs on funds and investors. Hedge fund advisors must maintain extensive records about their investment and business practices. They must provide this information to the SEC.