0:00:00.555,0:00:03.555 ♪ [music] ♪ 0:00:14.300,0:00:19.440 - [Alex] On September 15, 2008, the[br]world's financial system was shaken to its 0:00:19.440,0:00:24.780 core when the investment bank, Lehman[br]Brothers, filed for bankruptcy. The impact 0:00:24.780,0:00:30.080 was great not simply because Lehman was[br]big, but also because it was an important 0:00:30.080,0:00:36.240 financial intermediary, an institution[br]that helps bridge the gap between savers 0:00:36.240,0:00:41.700 and borrowers. The failure of Lehman[br]marked the beginning of a series of events 0:00:41.700,0:00:46.970 that signaled the worst economic downturn[br]since the Great Depression. And while there's 0:00:46.970,0:00:52.060 several significant angles to the Great[br]Recession, one of them was the decreased 0:00:52.060,0:00:55.290 efficacy of financial intermediation. 0:00:55.290,0:00:59.840 Now, some later videos are going to go[br]through this in more detail. But for now, 0:00:59.840,0:01:03.840 we want to start with some basic[br]observations as to why financial 0:01:03.840,0:01:08.620 intermediation is so important. We'll[br]start with the supply of savings and the 0:01:08.620,0:01:12.980 demand to borrow, and the market which[br]brings them together, the Market for 0:01:20.770,0:01:26.430 So why do people borrow and save at all?[br]Well, let's imagine a world without 0:01:26.430,0:01:31.580 borrowing and saving. Most people's[br]incomes don't stay flat their entire 0:01:31.580,0:01:37.610 lives. They change in predictable ways.[br]Here's a typical pattern, showing a 0:01:37.610,0:01:42.220 person's income over their life, with[br]their income on the vertical axis and time 0:01:42.220,0:01:46.820 on the horizontal axis. When you're young[br]and still in school, you might make a 0:01:46.820,0:01:52.440 little bit of money, waiting tables or[br]occasionally mowing lawns. Your first job 0:01:52.440,0:01:56.250 out of school, it's going to pay more, and[br]after a few years of experience and 0:01:56.250,0:02:01.170 hopefully a few raises along the way, you[br]make more than you ever have. Then, as you 0:02:01.170,0:02:05.630 age, you look forward to retirement, when[br]your income falls. But you're no longer 0:02:05.630,0:02:10.500 working and you could really enjoy [br]your golden years. 0:02:10.500,0:02:13.090 - [Estelle from “Seinfeld” TV series] [br]“We're moving to Florida!” 0:02:13.090,0:02:19.390 - [George] “What? You're moving to Florida?[br]Ah-hah! That's wonderful! I'm so happy! 0:02:19.390,0:02:23.370 For you! I'm so happy for you!” 0:02:23.370,0:02:29.720 - [Alex] Now, let's imagine if your consumption[br]followed the same path as your income and 0:02:29.720,0:02:35.140 you never saved or borrowed. You'd[br]struggle when young, and you'd be unable 0:02:35.140,0:02:39.930 to invest in an education. Then, you'd[br]spend every cent you make during your 0:02:39.930,0:02:45.490 prime working years. Well, that sounds[br]like a lot of fun. But without savings, 0:02:45.490,0:02:50.910 your income will drop suddenly when you[br]retire, and so will your consumption. 0:02:50.910,0:02:52.500 Your golden years wouldn't be so golden. 0:02:52.500,0:02:53.940 - [Doug from “King of Queens” TV series][br][Kevin] If you're so smart, 0:02:53.940,0:02:55.430 why don't you tell them that [br]you live in my basement? 0:02:55.430,0:02:56.900 - [Arthur] Why don't you tell them [br]you're enormous? 0:02:56.900,0:03:00.570 - [Doug] Why don't you tell them that [br]your total salary last year was $12? 0:03:00.570,0:03:03.730 - [Arthur] That was after taxes. 0:03:03.730,0:03:10.990 - [Alex] So instead, people tend to follow a life[br]cycle theory of savings. A person can 0:03:10.990,0:03:17.960 start out consuming more than she makes,[br]borrowing to fill that gap - and to pay for 0:03:17.960,0:03:23.620 things like an education. Then, during her[br]prime working years, she makes more than 0:03:23.620,0:03:30.470 she consumes, paying down her debt and[br]saving the extra income for retirement. 0:03:30.470,0:03:36.600 And when retirement comes, she can spend those[br]savings and enjoy the golden years even 0:03:36.600,0:03:41.860 without working. Now of course, many[br]people deviate from this exact path, 0:03:41.860,0:03:43.690 depending on details. 0:03:43.690,0:03:47.310 Most people, for example, they consume[br]less in college than they do as 0:03:47.310,0:03:53.860 professionals. Ramen noodles are no longer[br]a staple of my diet. But generally 0:03:53.860,0:04:02.250 speaking, many people follow a pattern of[br]borrowing, saving, and dissaving to smooth 0:04:02.250,0:04:07.100 their consumption path over their[br]lifetime. Of course, just like some people 0:04:07.100,0:04:11.720 can't wait until after dinner to reach for[br]that cookie jar, not everyone saves and 0:04:11.720,0:04:16.800 spends in the same way. How much you save[br]and borrow depends upon your time 0:04:16.800,0:04:22.250 preference. Some people - they're more[br]impatient than others. We all know someone 0:04:22.250,0:04:27.050 who spends everything they've got and[br]doesn't save enough. On the other hand, if 0:04:27.050,0:04:31.420 you're keeping to a budget and not[br]spending too much so that you can go to 0:04:31.420,0:04:38.640 college, well that's an example of being patient [br]and waiting for higher consumption later. 0:04:38.640,0:04:42.800 We've also learned from behavioral[br]economics that saving is not just a matter 0:04:42.800,0:04:49.520 of weighing costs and benefits. Nudges can[br]matter. If your employer automatically 0:04:49.520,0:04:55.330 enrolls you in a retirement plan, or sets[br]a high default contribution rate, you'll 0:04:55.330,0:04:59.870 probably end up saving more than if you[br]have to choose yourself, even if choosing 0:04:59.870,0:05:05.070 yourself would only take a few hours of[br]work once in your lifetime. Another 0:05:05.070,0:05:10.360 important reason to borrow is to make big[br]investments. Just as students borrow to 0:05:10.360,0:05:16.370 invest in education, businesses borrow to[br]invest in big projects. Entrepreneurs with 0:05:16.370,0:05:21.950 great ideas but not much money, they may[br]have to borrow or sell a stake in their 0:05:21.950,0:05:27.450 idea just to get their venture off the[br]ground. For example, Howard Schultz built 0:05:27.450,0:05:33.280 Starbucks into a global brand by borrowing[br]and raising capital through several 0:05:33.280,0:05:39.690 different types of financial intermediaries. [br]We'll talk more about that in upcoming videos. 0:05:39.690,0:05:43.660 As with any other good, we're going to use[br]supply and demand to analyze the market 0:05:43.660,0:05:48.140 for saving and borrowing, known as the[br]Market for Loanable Funds. As we've seen, 0:05:48.140,0:05:52.800 there are lots of good reasons to save and[br]to borrow. But we have failed to mention 0:05:52.800,0:06:00.650 one big factor - price. What's the price of[br]saving and borrowing? It's the interest 0:06:00.650,0:06:06.660 rate. So here's the supply curve showing[br]the supply of savings. As the interest 0:06:06.660,0:06:12.110 rate goes up, the quantity of savings[br]supplied increases, and here's the demand 0:06:12.110,0:06:18.010 curve showing the demand to borrow. Lower[br]interest rates incentivize borrowing, so 0:06:18.010,0:06:24.500 as the interest rate falls, the quantity of[br]borrowing demanded increases. As with any 0:06:24.500,0:06:30.560 other supply and demand graph, different[br]factors will shift the curves. If a lot of 0:06:30.560,0:06:34.930 people decide that it'd be a good idea to[br]increase their savings, for example, then 0:06:34.930,0:06:40.070 the supply of savings will shift outward.[br]As you can see, this would cause interest 0:06:40.070,0:06:45.300 rates to fall. This is what we saw in[br]countries like South Korea and China, 0:06:45.300,0:06:48.080 as their populations saved more. 0:06:48.080,0:06:54.060 On the demand side, if investors, say[br]became less optimistic for some reason, 0:06:54.060,0:07:00.820 the demand to borrow would shift inward,[br]causing the interest rate to fall. But if, 0:07:00.820,0:07:05.720 say an investment tax credit from the[br]government increased the demand to invest, 0:07:05.720,0:07:09.720 then the demand curve will shift in the[br]opposite direction, up and to the right, 0:07:09.720,0:07:12.050 pushing interest rates up. 0:07:12.050,0:07:16.790 Thinking about the Market for Loanable[br]Funds helps us to see the big picture and 0:07:16.790,0:07:21.430 understand the raw factors that determine[br]interest rates and the quantity of 0:07:21.430,0:07:26.390 borrowing and lending. But there isn't[br]actually one market called the Market for 0:07:26.390,0:07:32.160 Loanable Funds. It's not like the New York[br]Stock Exchange. Instead, there are many, 0:07:32.160,0:07:37.660 many, many markets for different kinds of[br]borrowers and different kinds of lenders. 0:07:37.660,0:07:42.190 And there are different types of[br]institutions like banks, bond markets, and 0:07:42.190,0:07:47.180 stock markets that connect the two sides[br]of the market. We're going to delve more 0:07:47.180,0:07:51.000 deeply into the different kinds[br]of financial intermediaries, 0:07:54.530,0:08:00.000 - [Narrator] If you want to test yourself,[br]click "Practice Questions." Or, if you're 0:08:00.000,0:08:04.800 ready to move on, you can click [br]"Go to the Next Video." 0:08:04.800,0:08:12.000 You can also visit MRUniversity.com to see [br]our entire library of videos and resources.