0:00:00.254,0:00:03.854
♪ [music] ♪

0:00:14.353,0:00:16.655
[Alex] On September 15, 2008,

0:00:16.655,0:00:20.320
the world's financial system[br]was shaken to its core

0:00:20.320,0:00:22.167
when the investment bank,[br]Lehman Brothers,

0:00:22.167,0:00:24.122
filed for bankruptcy.

0:00:24.122,0:00:27.543
The impact was great not simply[br]because Lehman was big,

0:00:27.543,0:00:31.818
but also because it was[br]an important financial intermediary,

0:00:31.818,0:00:34.681
an institution that[br]helps bridge the gap

0:00:34.681,0:00:37.791
between savers and borrowers.

0:00:37.791,0:00:41.494
The failure of Lehman marked[br]the beginning of a series of events

0:00:41.494,0:00:44.058
that signaled[br]the worst economic downturn

0:00:44.058,0:00:46.524
since the Great Depression.

0:00:46.524,0:00:48.310
And while there's several[br]significant angles

0:00:48.310,0:00:49.738
to the Great Recession,

0:00:49.738,0:00:52.733
one of them was[br]the decreased efficacy

0:00:52.733,0:00:55.181
of financial intermediation.

0:00:55.181,0:00:57.032
Now, some later videos[br]are going to go through this

0:00:57.032,0:00:58.491
in more detail.

0:00:58.491,0:01:02.324
But for now, we want to start[br]with some basic observations

0:01:02.324,0:01:06.434
as to why financial intermediation[br]is so important.

0:01:06.434,0:01:08.360
We'll start[br]with the supply of savings

0:01:08.360,0:01:09.896
and the demand to borrow,

0:01:09.896,0:01:12.325
and the market[br]which brings them together --

0:01:12.325,0:01:14.455
the Market for Loanable Funds --

0:01:14.455,0:01:16.209
and then we'll work our way up

0:01:16.209,0:01:18.813
to an examination[br]of The Great Recession.

0:01:20.603,0:01:24.080
So why do people borrow[br]and save at all?

0:01:24.505,0:01:27.960
Well, let's imagine a world[br]without borrowing and saving.

0:01:27.960,0:01:32.528
Most people's incomes[br]don't stay flat their entire lives.

0:01:32.528,0:01:34.923
They change in predictable ways.

0:01:34.923,0:01:37.173
Here's a typical pattern,

0:01:37.173,0:01:39.454
showing a person's income[br]over their life,

0:01:39.454,0:01:41.491
with their income[br]on the vertical axis

0:01:41.491,0:01:44.098
and time on the horizontal axis.

0:01:44.098,0:01:46.371
When you're young[br]and still in school,

0:01:46.371,0:01:48.175
you might make[br]a little bit of money,

0:01:48.175,0:01:51.384
waiting tables[br]or occasionally mowing lawns.

0:01:51.384,0:01:54.118
Your first job out of school,[br]it's going to pay more,

0:01:54.118,0:01:56.126
and after a few years[br]of experience

0:01:56.126,0:01:58.386
and hopefully[br]a few raises along the way,

0:01:58.386,0:02:00.781
you make more than you ever have.

0:02:00.781,0:02:03.129
Then, as you age,[br]you look forward to retirement,

0:02:03.129,0:02:04.841
when your income falls.

0:02:04.841,0:02:06.194
But you're no longer working

0:02:06.194,0:02:08.819
and you could really enjoy [br]your golden years.

0:02:10.434,0:02:12.522
[Estelle from “Seinfeld” TV series] [br]“We're moving to Florida!”

0:02:12.522,0:02:15.858
[George] “What?[br]You're moving to Florida?

0:02:15.858,0:02:20.595
Ah-hah! That's wonderful![br]I'm so happy!

0:02:20.595,0:02:23.701
For you! I'm so happy for you!”

0:02:23.701,0:02:24.781
[Alex] Now, let's imagine

0:02:24.781,0:02:29.969
if your consumption followed[br]the same path as your income

0:02:29.969,0:02:32.365
and you never saved or borrowed.

0:02:32.365,0:02:34.099
You'd struggle when young,

0:02:34.099,0:02:37.724
and you'd be unable[br]to invest in an education.

0:02:37.724,0:02:39.490
Then, you'd spend[br]every cent you make

0:02:39.490,0:02:41.791
during your prime working years.

0:02:41.791,0:02:43.689
Well, that sounds[br]like a lot of fun.

0:02:43.689,0:02:47.077
But without savings,[br]your income will drop suddenly

0:02:47.077,0:02:50.685
when you retire,[br]and so will your consumption.

0:02:50.685,0:02:52.884
Your golden years[br]wouldn't be so golden.

0:02:52.884,0:02:54.195
[Doug from “King of Queens” TV series][br][Kevin] If you're so smart,

0:02:54.195,0:02:55.545
why don't you tell them that [br]you live in my basement?

0:02:55.545,0:02:58.162
[Arthur] Why don't you tell them [br]you're enormous?

0:02:58.162,0:02:58.918
[Doug] Why don't you tell them

0:02:58.918,0:03:01.818
that your total salary[br]last year was $12?

0:03:01.818,0:03:03.339
[Arthur] That was after taxes.

0:03:04.088,0:03:07.083
[Alex] So instead,[br]people tend to follow

0:03:07.083,0:03:09.647
a life cycle theory of savings.

0:03:09.647,0:03:14.984
A person can start out consuming[br]more than she makes,

0:03:14.984,0:03:17.290
borrowing to fill that gap --

0:03:17.290,0:03:19.809
and to pay for things[br]like an education.

0:03:19.809,0:03:22.360
Then, during[br]her prime working years,

0:03:22.360,0:03:26.490
she makes more than she consumes,[br]paying down her debt

0:03:26.490,0:03:30.238
and saving the extra income[br]for retirement.

0:03:30.238,0:03:34.480
And when retirement comes,[br]she can spend those savings

0:03:34.480,0:03:38.526
and enjoy the golden years[br]even without working.

0:03:38.526,0:03:42.076
Now of course, many people[br]deviate from this exact path,

0:03:42.076,0:03:43.540
depending on details.

0:03:43.540,0:03:46.424
Most people, for example,[br]they consume less in college

0:03:46.424,0:03:48.855
than they do as professionals.

0:03:48.855,0:03:52.743
Ramen noodles are no longer[br]a staple of my diet.

0:03:52.743,0:03:56.712
But generally speaking,[br]many people follow a pattern

0:03:56.712,0:04:00.777
of borrowing, saving,[br]and dissaving

0:04:00.777,0:04:05.301
to smooth their consumption path[br]over their lifetime.

0:04:05.301,0:04:08.543
Of course, just like some people[br]can't wait until after dinner

0:04:08.543,0:04:10.259
to reach for that cookie jar,

0:04:10.259,0:04:13.881
not everyone saves and spends[br]in the same way.

0:04:13.881,0:04:17.947
How much you save and borrow[br]depends upon your time preference.

0:04:17.947,0:04:21.203
Some people -- they're more[br]impatient than others.

0:04:21.203,0:04:23.646
We all know someone[br]who spends everything they've got

0:04:23.646,0:04:25.688
and doesn't save enough.

0:04:25.688,0:04:28.197
On the other hand,[br]if you're keeping to a budget

0:04:28.197,0:04:31.984
and not spending too much[br]so that you can go to college,

0:04:31.984,0:04:34.704
well that's an example[br]of being patient

0:04:34.704,0:04:38.662
and waiting[br]for higher consumption later.

0:04:38.662,0:04:40.767
We've also learned[br]from behavioral economics

0:04:40.767,0:04:45.200
that saving is not just a matter[br]of weighing costs and benefits.

0:04:45.200,0:04:47.168
Nudges can matter.

0:04:47.168,0:04:51.849
If your employer automatically[br]enrolls you in a retirement plan,

0:04:51.849,0:04:55.091
or sets a high[br]default contribution rate,

0:04:55.091,0:04:56.690
you'll probably end up saving more

0:04:56.690,0:04:58.736
than if you have to choose yourself,

0:04:58.736,0:05:02.036
even if choosing yourself[br]would only take a few hours of work

0:05:02.036,0:05:04.347
once in your lifetime.

0:05:04.347,0:05:08.809
Another important reason to borrow[br]is to make big investments.

0:05:08.809,0:05:11.393
Just as students borrow[br]to invest in education,

0:05:11.393,0:05:14.998
businesses borrow[br]to invest in big projects.

0:05:14.998,0:05:19.495
Entrepreneurs with great ideas[br]but not much money,

0:05:19.495,0:05:22.589
they may have to borrow[br]or sell a stake in their idea

0:05:22.589,0:05:24.826
just to get their venture[br]off the ground.

0:05:24.826,0:05:30.298
For example, Howard Schultz[br]built Starbucks into a global brand

0:05:30.298,0:05:32.591
by borrowing and raising capital

0:05:32.591,0:05:35.885
through several different types[br]of financial intermediaries.

0:05:35.885,0:05:39.153
We'll talk more about that[br]in upcoming videos.

0:05:39.153,0:05:40.788
As with any other good,

0:05:40.788,0:05:42.532
we're going to use[br]supply and demand

0:05:42.532,0:05:45.116
to analyze the market[br]for saving and borrowing,

0:05:45.116,0:05:47.599
known as the Market[br]for Loanable Funds.

0:05:47.599,0:05:49.432
As we've seen, there are[br]lots of good reasons

0:05:49.432,0:05:51.156
to save and to borrow.

0:05:51.156,0:05:56.064
But we have failed to mention[br]one big factor -- price.

0:05:56.064,0:05:59.426
What's the price[br]of saving and borrowing?

0:05:59.426,0:06:01.632
It's the interest rate.

0:06:01.632,0:06:06.274
So here's the supply curve[br]showing the supply of savings.

0:06:06.274,0:06:07.670
As the interest rate goes up,

0:06:07.670,0:06:10.888
the quantity[br]of savings supplied increases,

0:06:10.888,0:06:14.340
and here's the demand curve[br]showing the demand to borrow.

0:06:14.340,0:06:17.716
Lower interest rates[br]incentivize borrowing,

0:06:17.716,0:06:19.475
so as the interest rate falls,

0:06:19.475,0:06:23.252
the quantity[br]of borrowing demanded increases.

0:06:23.252,0:06:26.288
As with any other[br]supply and demand graph,

0:06:26.288,0:06:29.221
different factors[br]will shift the curves.

0:06:29.221,0:06:32.188
If a lot of people decide[br]that it'd be a good idea

0:06:32.188,0:06:34.624
to increase their savings,[br]for example,

0:06:34.624,0:06:38.373
then the supply of savings[br]will shift outward.

0:06:38.373,0:06:41.752
As you can see, this would[br]cause interest rates to fall.

0:06:41.752,0:06:45.116
This is what we saw in countries[br]like South Korea and China,

0:06:45.116,0:06:48.105
as their populations saved more.

0:06:48.105,0:06:51.144
On the demand side,[br]if investors, say

0:06:51.144,0:06:53.963
became less optimistic[br]for some reason,

0:06:53.963,0:06:56.602
the demand to borrow[br]would shift inward,

0:06:56.602,0:06:58.941
causing the interest rate to fall.

0:06:58.941,0:07:03.585
But if, say an investment tax credit[br]from the government

0:07:03.585,0:07:05.963
increased the demand to invest,

0:07:05.963,0:07:08.606
then the demand curve will shift[br]in the opposite direction,

0:07:08.606,0:07:11.864
up and to the right,[br]pushing interest rates up.

0:07:11.864,0:07:14.670
Thinking about the Market[br]for Loanable Funds helps us

0:07:14.670,0:07:18.657
to see the big picture[br]and understand the raw factors

0:07:18.657,0:07:20.439
that determine interest rates

0:07:20.439,0:07:23.147
and the quantity[br]of borrowing and lending.

0:07:23.147,0:07:25.417
But there isn't actually[br]one market

0:07:25.417,0:07:27.669
called the Market[br]for Loanable Funds.

0:07:27.669,0:07:30.336
It's not like the New York[br]Stock Exchange.

0:07:30.336,0:07:33.519
Instead, there are many,[br]many, many markets

0:07:33.519,0:07:37.441
for different kinds of borrowers[br]and different kinds of lenders.

0:07:37.441,0:07:41.037
And there are different types[br]of institutions like banks,

0:07:41.037,0:07:43.103
bond markets, and stock markets

0:07:43.103,0:07:46.364
that connect[br]the two sides of the market.

0:07:46.364,0:07:48.003
We're going to delve more deeply

0:07:48.003,0:07:50.883
into the different kinds[br]of financial intermediaries,

0:07:50.883,0:07:53.502
and why they're so important, next.

0:07:55.752,0:07:57.235
[Narrator] If you want[br]to test yourself,

0:07:57.235,0:07:59.188
click "Practice Questions."

0:07:59.188,0:08:00.976
Or, if you're ready to move on,

0:08:00.976,0:08:03.049
you can click [br]"Go to the Next Video."

0:08:06.232,0:08:08.758
You can also visit MRUniversity.com

0:08:08.758,0:08:11.628
to see our entire library[br]of videos and resources.

0:08:11.840,0:08:14.644
♪ [music] ♪