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[Alex] On September 15, 2008,

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the world's financial system[br]was shaken to its core

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when the investment bank,[br]Lehman Brothers,

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filed for bankruptcy.

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The impact was great not simply[br]because Lehman was big,

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but also because it was[br]an important financial intermediary,

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an institution that[br]helps bridge the gap

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between savers and borrowers.

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The failure of Lehman marked[br]the beginning of a series of events

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that signaled[br]the worst economic downturn

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since the Great Depression.

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And while there's several[br]significant angles

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to the Great Recession,

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one of them was[br]the decreased efficacy

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of financial intermediation.

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Now, some later videos[br]are going to go through this

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in more detail.

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But for now, we want to start[br]with some basic observations

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as to why financial intermediation[br]is so important.

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We'll start[br]with the supply of savings

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and the demand to borrow,

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and the market[br]which brings them together,

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the Market for

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So why do people borrow[br]and save at all?

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Well, let's imagine a world[br]without borrowing and saving.

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Most people's incomes[br]don't stay flat their entire lives.

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They change in predictable ways.

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Here's a typical pattern,

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showing a person's income[br]over their life,

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with their income[br]on the vertical axis

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and time on the horizontal axis.

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When you're young[br]and still in school,

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you might make[br]a little bit of money,

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waiting tables[br]or occasionally mowing lawns.

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Your first job out of school,[br]it's going to pay more,

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and after a few years[br]of experience

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and hopefully[br]a few raises along the way,

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you make more than you ever have.

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Then, as you age,[br]you look forward to retirement,

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when your income falls.

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But you're no longer working

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and you could really enjoy [br]your golden years.

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[Estelle from “Seinfeld” TV series] [br]“We're moving to Florida!”

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[George] “What?[br]You're moving to Florida?

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Ah-hah! That's wonderful![br]I'm so happy!

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For you! I'm so happy for you!”

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[Alex] Now, let's imagine

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if your consumption followed[br]the same path as your income

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and you never saved or borrowed.

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You'd struggle when young,

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and you'd be unable[br]to invest in an education.

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Then, you'd spend[br]every cent you make

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during your prime working years.

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Well, that sounds[br]like a lot of fun.

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But without savings,[br]your income will drop suddenly

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when you retire,[br]and so will your consumption.

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Your golden years[br]wouldn't be so golden.

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[Doug from “King of Queens” TV series]

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[Kevin] If you're so smart,

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why don't you tell them that [br]you live in my basement?

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[Arthur] Why don't you tell them [br]you're enormous?

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[Doug] Why don't you tell them

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that your total salary[br]last year was $12?

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[Arthur] That was after taxes.

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[Alex] So instead,[br]people tend to follow

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a life cycle theory of savings.

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A person can start out consuming[br]more than she makes,

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borrowing to fill that gap --

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and to pay for things[br]like an education.

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Then, during[br]her prime working years,

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she makes more than she consumes,[br]paying down her debt

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and saving the extra income[br]for retirement.

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And when retirement comes,[br]she can spend those savings

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and enjoy the golden years[br]even without working.

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Now of course, many people[br]deviate from this exact path,

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depending on details.

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Most people, for example,[br]they consume less in college

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than they do as professionals.

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Ramen noodles are no longer[br]a staple of my diet.

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But generally speaking,[br]many people follow a pattern

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of borrowing, saving,[br]and dissaving

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to smooth their consumption path[br]over their lifetime.

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Of course, just like some people[br]can't wait until after dinner

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to reach for that cookie jar,

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not everyone saves and spends[br]in the same way.

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How much you save and borrow[br]depends upon your time preference.

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Some people -- they're more[br]impatient than others.

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We all know someone[br]who spends everything they've got

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and doesn't save enough.

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On the other hand,[br]if you're keeping to a budget

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and not spending too much[br]so that you can go to college,

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well that's an example[br]of being patient

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and waiting[br]for higher consumption later.

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We've also learned[br]from behavioral economics

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that saving is not just a matter[br]of weighing costs and benefits.

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Nudges can matter.

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If your employer automatically[br]enrolls you in a retirement plan,

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or sets a high[br]default contribution rate,

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you'll probably end up saving more

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than if you have to choose yourself,

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even if choosing yourself[br]would only take a few hours of work

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once in your lifetime.

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Another important reason to borrow[br]is to make big investments.

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Just as students borrow[br]to invest in education,

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businesses borrow[br]to invest in big projects.

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Entrepreneurs with great ideas[br]but not much money,

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they may have to borrow[br]or sell a stake in their idea

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just to get their venture[br]off the ground.

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For example, Howard Schultz[br]built Starbucks into a global brand

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by borrowing and raising capital

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through several different types[br]of financial intermediaries.

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We'll talk more about that[br]in upcoming videos.

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As with any other good,

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we're going to use[br]supply and demand

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to analyze the market[br]for saving and borrowing,

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known as the Market[br]for Loanable Funds.

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As we've seen, there are[br]lots of good reasons

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to save and to borrow.

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But we have failed to mention[br]one big factor -- price.

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What's the price[br]of saving and borrowing?

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It's the interest rate.

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So here's the supply curve[br]showing the supply of savings.

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As the interest rate goes up,

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the quantity[br]of savings supplied increases,

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and here's the demand curve[br]showing the demand to borrow.

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Lower interest rates[br]incentivize borrowing,

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so as the interest rate falls,

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the quantity[br]of borrowing demanded increases.

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As with any other[br]supply and demand graph,

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different factors[br]will shift the curves.

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If a lot of people decide[br]that it'd be a good idea

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to increase their savings,[br]for example,

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then the supply of savings[br]will shift outward.

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As you can see, this would[br]cause interest rates to fall.

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This is what we saw in countries[br]like South Korea and China,

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as their populations saved more.

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On the demand side,[br]if investors, say

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became less optimistic[br]for some reason,

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the demand to borrow[br]would shift inward,

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causing the interest rate to fall.

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But if, say an investment tax credit[br]from the government

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increased the demand to invest,

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then the demand curve will shift[br]in the opposite direction,

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up and to the right,[br]pushing interest rates up.

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Thinking about the Market[br]for Loanable Funds helps us

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to see the big picture[br]and understand the raw factors

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that determine interest rates

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and the quantity[br]of borrowing and lending.

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But there isn't actually[br]one market

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called the Market[br]for Loanable Funds.

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It's not like the New York[br]Stock Exchange.

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Instead, there are many,[br]many, many markets

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for different kinds of borrowers[br]and different kinds of lenders.

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And there are different types[br]of institutions like banks,

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bond markets, and stock markets

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that connect[br]the two sides of the market.

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We're going to delve more deeply

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into the different kinds[br]of financial intermediaries,

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[Narrator] If you want[br]to test yourself,

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click "Practice Questions."

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Or, if you're ready to move on,

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you can click [br]"Go to the Next Video."

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You can also visit MRUniversity.com

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to see our entire library[br]of videos and resources.

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