November 24, 1997 THE FINANCIAL INTERMEDIATION GAME The probability of a recession is 1/3 and, separately, the probability of Protectionism is 1/3. (Use 8x11 pages, to make printing them out easier. For everything--bonds too. Dear Colleagues and PhD Students, I would like to try out a new money creation game in my G100 freshman class. I need to test the mechanics first. If anybody is interested in learning about this, they can help me out as test subjects on Monday 10-11am. Let me know ifyou can come, and I'll tell you the room. I might recruit MBA students, etc. too. My notes on this are below. By Monday, I'll have to fix this up to be workable. Comments are welcomed. novmber 24, after runthough. Give to Kelly, Paul Sharkey. Handouts: each student gets 3 projects, including the bank team students. The bank, however, must sell its projects. Each student will get multiple balance sheets too. Years: December 31, 1999. December 31, 2000. December 31, 2001. Practice. At the end of the practice, find out equity values that students have. Object: Maximize Owner's Equity. Have forms for checks. PROJECTS: These are labelled ``IDEAS''. Have them be of various denominations. The blaance sheets are NOT consolidated. Label currency as Currency. Make the writing fancy. Use different colors. Make Bonds colored too, but full pages. Give them lots of 1000 dollar bills. Secured loans are possible. Make Deposit Slips Loan Forms--- allow for senior debt, secured debt. Label the example balance sheets as ILLUSTRATIONS. Lable everything with a title in big black type for ease of reference. 1. Beforehand, each student decides whether to be an individual entrepreneur, or part of a 3-student bank. Those who want to be banks, email me. I'll tell you how many banks there are, and you can back out. There will be a 3-point quiz bonus score for the most profitable bank,and for the top 3 most profitable entrepreneurs. (This will teach about competitive entry.) 2. Banks start with 300, 000 dollars each. They should assign one member to be Bookkeeper, one to be Loan Officer, and one to be Deposit Manager. 3. Entrepreneurs start with 5-10,000 dollar government bonds, 50,000 in cash, and 3 investment projects. Each bond says what the interest amount is. They say 1000 dollars. These are 30 year bonds. Each investment card says what the project will earn in 4 states of the world: 1. Normal/Free Trade 2. Normal/Protectionism 3. Recession/Free Trade 4. Recession/Protectionism You can buy information on the probability of a recession and separately, the probability of Protectionism. I will charge 10,000 dollars for this information. Also, you buy info of the average return in each state of the world over all the investment projects. You can resell information, but you need not be truthful if you do. I will set a price for the info, and show the buyers a card with the info, secretly in a corner. The investment ideas are: Bloomington Jet Engines III. 40, 20, 20, 0. This investment depends heavily on export success and on avoiding a recession. Bloomington Medical Devices II. 20, 10, 20, 10. This investment relies on exports to a large extent, but demand for its product does not vary much over the business cycle. Bedford Bean Cannery III. 15, 15, 15, 15. This is a boring investment. Entrepreneurs would sleep easier if investments were all like this. 5 percent. Elletsville Videos I. 50, 50, 0, 0. This is a highly speculative investment which does badly if consumer purchasing power falls. 10 percent. Seymour Shoes I. 10, 20, 0, 15. This investment does best if protected from foreign competition. 40 percent. Martinsville Monitors II. 25, 20, 15, 10. This is a typical investment, where general macroeconomic conditions are most important to its success, but the amount of export sales matters too. EXPLANATION. The teacher will begin with an explanation of the accounting. Each student will have two sample balances sheets already filled out, for a manufacturer and for a bank. The teacher will explain the Accounting Equation again: Owner's Equity = Assets- Liabilities Also, he will explain that investment ideas and investment projects are valued at cost in the accounts. PRACTICE. Start with a practice period in which even the banks act as entrepreneurs. This does not count towards the bonus. No bank deposits are available, but anyone can make loans. FIRST PERIOD 1. The Fed (the teacher) does nothing except perhaps sell information. In G100, the Fed will give out the information for free. 2. Banks and entrepreneurs do their stuff, as follows: (2a) Banks can trade bonds, trade in investment ideas, and make loans and accept deposits. A bank must maintain a 10 percent reserve of cash. Thus, if it has 800,000 in deposits, it must have 80,000 in cash on hand. Also, at any instant a bank must quote an interest rate on deposits and accept all deposits at that rate until it changes its rate. Also, it must permit withdrawals at any time. Loan deals, however, are fixed unless altered by mutual consent. Both deposits and loans must have written receipts for both sides. A bank may buy and sell investment ideas, but it cannot own an investment itself, and must immediately auction the investment off if it acquires it after a bankruptcy. (2b) Entrepreneurs can buy and sell bonds, and make deposits in banks. They can also borrow money from banks. They can also make investments, taking cash and giving it to the Workers (the teacher) with an investment card that has their name attached to it on a post-it. (2c) The Workers (the teacher) will deposit all funds received into the banks, looking for the best interest rate. Anyone can buy and sell investment cards and bonds too. 3. When the buzzer goes off, all trading stops. 4. Everybody fills out their balance sheets for December 31, 1999. 5. The teacher will then roll dice to find the state of the world. Then everyone will receive their investment returns, pay back their loans, receive their bond interest, possibly declare bankruptcy, and do their annual reports. All bank deposits are government insured, so if the bank goes bankrupt, depositors get their money and interest anyway, unless a government investigation finds collusion (e.g., a bank agrees to pay a depositor 5000 percent interest, knowing it will go bankrupt but the government will pay). 6. Everybody fills out their balance sheets again, for March 31, 2000. 7. The Fed buys bonds in an auction. It buys 500,000 dollars in bonds. 8. Manufacturers and Banks do their business as before. 9. When the buzzer goes off, all trading stops. 10. Everybody fills out their balance sheets for December 31, 2000. 11. The teacher will then roll dice to find the state of the world. Then everyone will receive their investment returns, pay back their loans, receive their bond interest, possibly declare bankruptcy, and do their annual reports. 12. Everybody fills out their balance sheets again, for March 31, 2001. Investment projects last forever. Banks may ask that their loans be repaid after one period, or renew their loans at the same or a different interest rate. Deposit rates in banks are fixed for that year once the money is deposited. Other depositors might get a different rate for the same year. WRAP UP. WHAT TO NOTICE. 1. Effect of money supply creation. 2. Setting th interest rate. What affects it? 3. Dviersification. Negative beta investments. . 4. Some investments do well in recessions. 5. Which is better, being a bank or being an entrepreneur? 6. Why are banks helpful? In the Great Depression, the banks all went bankrupt.