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Investment banks assist a company in selling new shares of stock, or bonds, or other securities to raise capital. For corporations, they will advise on mergers, acquisitions, and divestitures, and then do the financial legwork to execute these transactions. As securities dealers, most investment banks act as dealer, buying and selling shares in the open market on their own behalf or on behalf of clients.
The days of separate and individual investment banks are almost over with the 2008 demise of Bear Stearns and Lehman Brothers, two of the last independent investment banks. Most have been combined into larger holding companies as an arm of a larger, combined commercial/investment banking company, like Credit Suisse or Barclays. These so-called “universal banks” took center stage in the 2008 banking crisis, although in the case of JPMorgan Chase and others, well-managed banking diversification has proven beneficial.
Why You Should Care
You will generally not run into investment banks, or the investment-banking arm of larger universal banks, in your ordinary business. Investment banks have traditionally made huge amounts of money facilitating transactions (a quarter or a half percent “crumb” off of a billion-dollar transaction is still a lot of money). It remains to be seen what the future of investment banking is to become, and how much the regulatory environment will change. For most consumers, it may prove to have little effect.
29. CENTRAL BANK
As the name implies, a “central bank” is central to the banking and monetary system of a nation. The central bank plays several key roles in the economy, including setting and carrying out monetary policy, maintaining the stability of the nation’s currency, and supporting and regulating individual banks and the banking system. The Federal Reserve (see #30 Federal Reserve) functions as the central bank in the United States, while the European Central Bank (ECB) is the central bank for the sixteen member states of the so-called Eurozone. Other central banks include the Bank of Japan, the People’s Bank of China, and the Bank of England.
What You Should Know
Central banks control money supply and currency stability through monetary policy (see #56 Monetary Policy). That is done by setting target interest rates (see #31 Target Interest Rates) and more directly through open market operations (see #32 Fed Open Market Operations), where they buy and sell government bonds to inject cash into or remove it from the economy. Central banks also control the amount of currency—paper and coin—in the economy.
Central banks lend money to other banks when needed, and act as a “lender of last resort” during financial crises. The financial crisis that triggered the Great Recession saw the Federal Reserve, in coordination with the U.S. Treasury, take a more activist role in propping up not only banks but also other players in the economy. While the “propping up” scenario is largely past, today’s Fed continues to boost the economy through open market operations—still in mid-2013 buying about $85 billion in bonds every month to infuse more cash into the economy through its “quantitative easing” programs—so-called “QE3” and “QE4.” Central banks may make these operations “public,” declaring them in the media and in their own published minutes to achieve maximum economic effect (in the most recent case, optimism)—and they may also conduct open market operations “under the radar” so as not to affect or disturb the markets. The Fed and other central banks may also project and communicate future activities, as seen with the so-called “tapering” of bond purchases widely prognosticated, also in mid-2013.
Central banks also set and enforce important banking and finance ground rules. These rules and requirements include governing how much capital banks must keep in reserve (see #36 Reserve Requirements), and how much equity stock investors must have in a stock transaction involving borrowing, or margin (see #86 Margin and Buying on Margin). In some countries, like China, central banks actively manage the country’s foreign currency exchange and exchange rates.
Notably, most central banks operate somewhat independently of the nation’s political authority to avoid political gridlock and to be able to do what’s best for the economy on short notice. The U.S. Federal Reserve can create money “with the stroke of a keyboard” without Congressional approval.
Why You Should Care
The health and welfare of any economy is carefully monitored and controlled by a country’s central bank. Observing the central bank’s actions will give you a forward look into what’s ahead for the economy. If the central bank is raising target interest rates, for instance, a slowdown is intended and likely on the horizon. If the central bank is lowering interest rates and injecting money into the system, that signals that the slowdown is at hand and the central bank is acting to reverse a slumping economy. It is also worth listening to comments made by the leaders of the central banks—Ben Bernanke (soon to be Janet Yellen) of the U.S. Federal Reserve and Jean-Claude Trichet of the ECB—for signs of economic health or concern.
30. FEDERAL RESERVE
The Federal Reserve functions as the U.S. central bank. The Federal Reserve System was created by the Federal Reserve Act of 1913 in response to the Panic of 1907, earlier panics in 1873 and 1893, and an accepted need for a stronger central banking system. Known simply as “the Fed,” the Federal Reserve carries out a broad range of activities to ensure the stability and prosperity of the U.S. economy.
What You Should Know
The Federal Reserve is not a single bank or institution but rather a system of committees, advisory councils, and twelve member banks located through the United States. The details of this structure aren’t important, but you’ll hear about the Board of Governors, of which Ben Bernanke was the chair through February 2014, and the twelve-member Open Market Committee (FOMC), which meets eight times a year and makes policy decisions affecting target interest rates and ultimately, money supply (see #31 Target Interest Rates, #17 Money Supply, and #56 Monetary Policy).
The Federal Reserve was created to address banking panics, but in the modern era has taken on a more active role in managing and moderating the economy. Most visible is the management of money supply through monetary policy, toward the stated and often conflicting goals of maximum employment and stable prices (translation: avoidance of inflation and deflation). The Fed regulates banking and banking institutions and other credit instruments, including the credit rights of consumers. Credit protection regulations are created and enforced by the Fed through laws passed by Congress, including the Truth in Lending, Equal Credit Opportunity, and Home Mortgage Disclosure acts (see #48 Credit Protection). The Fed manages the relationships between the banks and government, banks and consumers, and banks with each other.
The Fed has roles beyond managing the banking system and money supply too numerous to recount here. Among those goals are managing financial stability in times of crisis and improving the financial standing of the United States in the world economy. The Fed played a very active role in preventing systemic meltdown in the 2008–2009 financial crisis, acting as “lender of last resort” in addition to its traditional role in providing financial stimulus. The Fed a
Critics contend that the Fed may be playing too active a role in managing the economy; in its zeal to create stability and manage the business cycle, it is making us as a nation more vulnerable to unintended consequences that may have far-reaching and much more serious effects. Through monetary policy and the new lending facilities, the Fed injected huge and unprecedented amounts of money into the economy; many worry about the long-term inflationary effects of this massive injection (see #34 Reflation).