Say that bank A has $1 with a 10 percent reserve requirement. Bank A lends $10 to bank B. Then, bank A dissolves and gifts everything to B.
Does the $10 lent to B somehow dissapear? Or because it remains, and Bank B can have no liability to a nonexistent Bank A, was $10 in free money just created?
Bank A can’t lend $10 to B because it doesn’t have $10. It only has $1. It can lend $0.90, keeping $0.10 as its reserve.
If Bank A can convince other parties to deposit money with them, then maybe it can scratch together enough cash to lend the $10 to B.
If that’s the case, then when A dissolves, any buyer is going to inherit the assets and liabilities. One of these assets are the future payments from the money it lent B. B comes out as net even if it buys the party it owes money to.
If A just dissolves into nothing, then FDIC insurance will pay back those depositors that otherwise lost their money. This insurance was paid for already, and the money didn’t come from nothing–it came out of the interest that would otherwise go to those depositors.
If there’s a more serious crisis, past the limit of what the FDIC fund can pay for, then presumably the Fed will get involved in some way. It can also borrow money from the Treasury.
I dont see the fed being involved either. A doesn’t fail, it just becomes abandoned, dissolved or some other limbo state. The liabilities for B have to be recorded somewhere and if the entity owning those becomes ambiguous infinite monetary growth occurs.
No, you can’t lend money you don’t have. If I borrow $X from a bank, I plan on immediately using it to pay off someone else. I won’t accept a note that says they owe me $X.
The reason for the money amplification is that the bank can lend out the money from deposits (up to the fractional reserve limit). These deposits themselves came from borrowed money. This is real money, and (although it would rarely happen this way in practice), someone could have carried a briefcase full of greenbacks from one bank to another.
The trick is that you don’t need this real money all the time, only during movement. Most of the time the money is deposited in the bank.
If there’s only one bank in the world, with $1 of deposits, then it can loan out $0.90 (assuming 10% reserve). It can expect that $0.90 to be deposited back to itself. It can then loan out another $0.81, which again comes back, and then $0.73, and so on. If you do the sum, you’ll find it can loan out $9 in total.
But note that this required the deposits to come back to it. If a bank can’t attract depositors for whatever reason, it can’t just invent money out of thin air. So your bank with $1 in deposits can only loan out $0.90 in total. Some other bank, which did receive those deposits, will be the one to loan out the money.
There is a reason for that, and it’s not stupidity. The problem is that under the current crisis there was effectively no way for many banks to maintain many of the normal requirements no matter what they did. It was easier to suspend some regulations rather than, y’know, explode the entire global banking system. Plus, the problem right now is not exactly that banks are too free with their lending.
COVID-19 caused the REPO crisis in September of 2019.
COVID-19 caused the corporate debt crisis (and “fallen angels” peril) over the course of the last decade.
COVID-19 shut down in March caused the recession… that officially started in February.
COVID-19 created a derivatives bubble 10x the size of the 2008 bubble as of… 2019.
But I’m sure 0% reserve requirements has nothing to do with negative interest rates. Because the fed said negative interest rates wont happen! Except the fed hasn’t set interest rates in years, the market has, and the target rate has trailed the effective rate. Don’t take my word for it, Federal Funds Effective Rate (FEDFUNDS) | FRED | St. Louis Fed is a really easy chart system - add the Effective Fed Funds Rate to the bounds of the Target (Upper Limit) and Target (Lower Limit) rates and observe which moves first. Every. Time.
But no, let’s just keep up the mantra: debt good. More debt better! Most debt best debt!
Dr. Strangelove is correct, Bank A could only loan $0.90. If Bank A then failed and the Fed was unable to arrange for a buyer, then Bank A’s depositors would be made whole by liquidating Bank A’s assets and via FDIC funds. The loan of $0.90 to Bank B on Bank A’s books is an asset, and would be sold off. Bank B doesn’t get a free lunch here.
I have a lot of issues with the current financial system we live with, but it wasn’t built by chance or even humans being jerks. It was made to deal with practical problems of what people do, in fact, want. Some people want to sell risk, other want to buy it. That’s literally what banks are: institutions that try to measure, codify, package, and sell risk. Banks by definition will have debts or liabilities, but these are also others’ assets.
But more to the point, what you’re discussing here isn’t particularly about banks. It sounds as though you have an axe to grind and don’t care what you chop as long as it sounds good, whether or not it’s even related to your complaint.
My problem with your argument is that it relies on bank A demanding to be paid. If A doesnt care or isnt able to record what it is supposed to be demanding then liabilities dissapear and infinite growth occurs. The whole system relies on people demanding to be paid what they are owed, if they stop caring then the debtor can just have unlimited funds.
Theres actually a way thos would happen. If bank B obtains a legal judgment against A for $10, then Bank A could settle by releasing its liability. Therefore the legal judgment creates free money by offsetting preexisting debt.