Hi, I’m new here, pleased to meet you. Could you demonstrate the mechanism by which the economy would be fucked if a TBTF bank went under?
I’m confused. You say the Fed poofing money out of thin air based on an interest bearing asset isn’t how frac reserve banking works? But I seem to recall seeing a piece written by people from the Bank of England that claims exactly that. Here, let me find it… Ah, here it be…
Could you explain to me how you can claim that’s not how frac reserve banking works, in light of the BoE’s contrary explanation?
I find it fundamentally disturbing that the word “sustainable” is linked with debt in a debt-backed monetary system. This is a ponzi scheme designed to burst at various times, with “our” putative government making sure the rich bankers aren’t hurt, while millions suffer.
Hi JoeTheBartender: welcome to the Straight Dope Message Board. You ask a good and fair question. You seem to grasp the concept that if a robber has your balls in a vice, you hand him your wallet and call him sir. But would things be that bad if a TBTF firm went bust?
They would and they were. At the most general level, businesses throughout the year often have a mismatch between cash coming in and cash going out. That’s the key function of financial intermediation: it links up savers with short and long term borrowers.
When a TBTF company goes bust, lots of things happen at once. Those firms were often acting as middlemen, so that borrowers and lenders were counting on the continued solvency of such firms as Lehman and AIG. But these weren’t simple loans: they were highly complex financial instruments, making it pretty much impossible to just cut out the middleman and go on with business as usual. Worse, you get contagion: when Lehman and AIG fail, people wonder who is going next. The result is savers (money market funds actually) don’t want to lend to anyone (they don’t want to buy commercial paper. That’s a recipe for depression, 1930s style. No credit, no goods.
Details of the 2007-2008 clusterf%$# are here: 2007–2008 financial crisis - Wikipedia
As for the British Central Bank paper, I think this is what they’re getting at. “Certain textbooks” take the example of an individual depositing cash in a bank, thereby triggering a chain of loans via the money multiplier. If I understand them, the paper is pointing out that this sort of story is a little outdated. Cash is a small share of liquid forms of money, and most deposits are made from other institutions as opposed to with funny pieces of paper with pictures of the Queen. I’m not sure why they emphasized this though: maybe I misunderstand.
Okay, you know how the current economic slump has been largely perpetuated by everyone wanting to save money and nobody wanting to spend or borrow money? Well, imagine if a very large number of people additionally lost most or all of their money, and one of the major institutions that would lend money out goes belly-up. That’s pretty bad, and that’s not even considering the possibility of bank runs, where people think, “Shit, what if mine’s next,” and people try to pull out their money. This has happened before. It wasn’t pretty.
There have been attempts at a non-debt based system. The prohibition of “usury” meant that debt was not allowed (practically speaking) during the Middle Ages. So they had to bring in the Jews. Debt is not allowed in Islam, and they have to hack together a way of getting around this prohibition. So debt of some sort is absolutely necessary for economic growth.
I’m not sure if your objection is to consumer debt or government debt. Government debt had no part in causing the crash. Fear of adding too much to it might have slowed the recovery. Consumer debt - bad consumer debt - was a cause, but that was from lying about risky debt with high yields in order for the finance sector to make money, and the encouragement of this debt by the administration to get growth despite slow wage growth.
And we see that in Europe attempts to reduce government debt are failing because austerity measures hurt the economy so much that deficits don’t decrease because of a drop in tax revenue. While in the US the deficit has fallen, not from spending cuts, but from economic growth.
So deficit reduction has nothing to do with the spending stimulus tapering off or tax increases? If you wish to argue economic growth has been a factor in the reduced deficit then I would agree. However, it’s far more complicated than simply due to economic growth.
Stimulus spending ended long before the growth kicked in. The tax increase is relatively small. Spending decreases when unemployment drops and tax revenues increase without a tax increase when employment increases.
California is a great example. The tax increase we voted ourselves helped balance the budget, but the recovery did a hell of a lot more.
Thank you for your welcome, Measure. If you mean the robber is the banking system, so we hand them our wallets every day, I totally agree.
Well, the BoE paper specifically says banks DON’T act as intermediaries between savers and borrowers, since banks create the money out of the debt.
And let’s be frank, any business that depends on short term borrowing for operating expenses isn’t that well run.
Well, I just think that what you’re describing is a symptom of frac reserve banking. All of that money at risk was created from loans, ultimately, and would have to be paid back with interest. Which is what drives the self-destructive quest for constant growth.
But I think the main point here is you’re saying it would destroy confidence in the system. I actually heard that said by a few politicians during the bailouts. You certainly implied it. You have heard of another occupation that requires the confidence of the marks in order to be successful, I’m sure. IMVHO, the private central bank/fractional reserve banking system is the biggest confidence game in history.
No, deposits are deposits, paper or bytes. What the paper is trying to say is that contrary to popular belief, banks do not lend out deposits, they lend money they created by accepting a debt instrument from a borrower.
Yeah, why wasn’t it pretty? Cause the damn banks don’t actually have the money to give them. Banks that practice fractional reserve banking are fundamentally bankrupt. That’s why they need a “lender of last resort”, namely the Fed, who can create money by buying worthless MBOs and CDOs from its owners(the banks). Gee, I thought George Bailey explained it quite well.
Yeah. Banks that actually take saver’s money for a time to invest in local business, with the understanding that the capital is at risk and also function as checking/ATM/Debit card clearing houses. You know, their proper function in a truly free market. Not as the creators of just about as much money as they want, only to be bailed out by their victim’s taxes.
Well, they create money when they lend. As I see it the article was basically shaving away part of the standard textbook story.
No, no. Consider a toy company. Big revenue during Xmas. Ramps up production in the summer to cover it. There’s a lot of pretty routine borrowing that happens seasonally, which the commercial paper market addresses.
Well… I don’t think so. Bank books are balanced: banks accept legitimate deposits, set aside a little as reserves and loan out the rest. (Some of the loans are highly liquid though - they buy treasury bills for example). The trick is that any new loan becomes a new deposit, upon which you can set aside a little and lend it out… The process winds down IIRC according to the formula 1/x, where x is the amount set aside for reserves, 1/x being the maximum money multiplier.
Anyway fractional reserve banking has been around for literally hundreds of years. While I admit that it’s odd… well so are those pieces of paper with Presidents in your pocket. Heck, so is gold. It’s disturbing to think that they have value because people think they have value (also scarcity) but what’s the alternative? If barter wasn’t so gawdawful inefficient we wouldn’t bother with money.
Incidentally, that sounds something like Islamic banking, which is heavily influenced by anti-usury sentiments.
Your recommendation is a non-mainstream one. My problem is that it throws out the baby with the bathwater: plenty of banks that follow basic due diligence rules perform pretty well. The problem as I see it is that the big boys evaded regulations and essentially leveraged themselves to the hilt. I think Bear Sterns had asset/capital ratios well above 30. I would respectfully suggest that basic remedies should be tried before radical ones.
Even mild reforms are difficult to pass. The Dodd-Frank law (2010) isn’t trivial. We know this because big corps are working hard to divest themselves of parts of their business that will make them categorized as TBTF. But it still doesn’t go far enough in many ways. Money funds are still vulnerable to crisis, the ratings agency problem hasn’t been addressed meaningfully and debit cards still lack the protections of credit cards. To name a few problems, not necessarily the largest ones.
The stimulus ending long before growth kicked in has no bearing on what reduced the deficit as a whole. All it tells us is that recent reductions in the deficit have been due to growth and taxation rather than a cut off of stimulus spending. If government decided to stop spending $x billion on shovel ready projects then thats $x billion saved in the next years Federal budget. I do agree that increased taxation was of lesser importance. However, it would be wrong to give it no importance.
It should be noted though that growth and deficits have been helped by the cutting of prolonged unemployment benefits just over a year ago. At times austerity does work.
So cutting benefits has hardly eliminated the problem. Do you have a cite that job growth has been due to cutting benefits as opposed to the long awaited improvement in consumer confidence and consumer spending?
The stimulus package made the worst of the downturn a bit better, especially because local and state governments cut during this recession instead of growing like during previous ones.
Eliminated the problem? I said nothing about eliminating the problem and you know I did not say that. Please stop massaging my quotes to fit what you want them to say.
A cite for the correlation between cuts in the duration of unemployment benefits and increased employment:
Did you ever hear of “If you don’t have it, don’t spend it”? Debt is unnecessary for mostly anything. In my lifetime I have seen an amazing brainwashing job on our society, where debt went from something you avoided to something you “need”.
During the MA, most currencies were precious metal based, meaning that banks could not poof money into existence until banker’s receipts for (supposedly) money on deposit became acceptable tender in third party transactions, and once that happened, the fraud began when the first banker realized no one ever came in to claim their money and started loaning out unbacked receipts.
Hence their consternation when someone would question their honesty and demand their money. And their utter dread of that attitude spreading since they didn’t have one fifth of the gold their receipts claimed they had.
Con men hate to be found out, you know. To this day banks dread a run. And today the run can happen electronically while they’re sleeping. Good thing there’s the lender of last resort there to create more electronic bank debt to help fool the sheep.
My objection is to a special class of artificial “persons” given the privilege of creating the nation’s money, in direct violation of the Constitution. Article I Section 8 says “[Congress shall have the power] to coin money and regulate the value thereof…”. “Coin money”. What do you suppose that means? Do you think it means palm off the money creation to a cabal of private banks?
Joe - I hope you are aware that your arguments derive from fringy folk. It’s ok for me to note that right? They know that their arguments aren’t widely accepted after all.
Banks have always created money. The First Bank of the US was chartered in 1791. It printed money - they called them banknotes. In fact the Federal Government only got into the money printing game in 1861, if you don’t count Continentals, printed before the constitution was passed. https://www.frbservices.org/fedfocus/archive_fedcash/fedcash_0413_01.html?elq=76f341601598453f8ec4655651ea9a4a Fuzzy Wuzzy - that Jan 2015 paper was interesting and very mainstream. If I read it correctly, they found that variation in unemployment benefit duration across states was related to cross-state differences in job growth in 2013-2014. That result isn’t especially surprising or new IIRC for an economy in full recovery - but it’s pretty interesting for an era where austerity policies had just tapered off (2014) and a little earlier. I wouldn’t have predicted their results.
The problem though is that the stimulating effects of government payments associated with unemployment benefits are not limited to the county where they are paid. Right? Cut a check for $100 and they will spend it on items typically produced outside of the county. That’s an effect that needs to be netted out if you want to draw policy conclusions. But hey, it’s a working paper.
I don’t think they are claiming that all job growth is due to the reduction in unemployment benefits, at least according to my skim. This site says that the change in job levels between Jan 2014 and Jan 2015 was 2.8 million. If I read it correctly the paper claims that the benefit cut lead to 1.8 million jobs created (again, without netting out the reduced stimulus of the unemployment checks).
I actually did my freshman macro term paper on fractional reserve banking, sort of. Actually, it was on the USA’s S&L crash in the 1980’s.
I’m bemused by the people who get offended by it. The alternatives to fractional reserves seem to be (one) banks that can’t actually lend money because they have to keep everything in reserve; (two) banks that can lend money but only out of specially designated capital reserves of their own, and thus have no creditors; and (three) what actually happened with badly managed thrifts like Silverado in the 1980’s: too many loans out, no reserves on hand.
I wonder what those who oppose fractional reserves want? Apparently never to have a savings account nor a certificate of deposit, that’s about all I can tell.
According to Richard Vague the run up in PRIVATE debt, not public debt, has a bigger impact.
The only problem with this theory is that even if it’s true, it won’t matter to many conservatives because you can’t ever focus on private maladies when there is a public/government boogeyman.