Yeah, I don’t think there was anything there I didn’t know.
Wut? Maybe YOU should watch the video that WillFarnaby suggested I watch. Banks in our system don’t create money, they lend money they have borrowed from others or that they have raised as equity.
I don’t think that’s right. A bank can’t make a loan of $100,000 unless it is sitting on $100,000 (plus whatever the reserve requirement is). The federal reserve can do it but not private banks.
IIRC the treasury raises almost all its borrowing through the auction process, not by borrowing it from the central bank.
There is the concept of intra-government debt (social security trust fund for example).
I’m pretty sure that the “debt” in this case is largely a bank’s liability to its depositors.
You realize that bank B will not honor a check just because bank A wrote it out to a borrower right? Bank A has to have the money to transfer to bank B when the borrower deposits the loan check in bank B, right?
2008 seemed to be a good time to reinstitute the concept of trustbusting. I don’t know how many times I heard people say “well perhaps too big to fail just means you are too big” and then we did nothing about it.
If the only loan on your books was a 100 $1000 loans to the local busiensses and the only asset was 100 deposits of $1000 into a CD, I do not think you would meet the reserve requirement.
Or does fractional banking only apply when you have demand deposits?
Hasn’t the full faith and credit reduced the number of bank runs dramatically?
To be fair, you can’t really expect FDIC insurance to reduce the frequency of runs on things that are not FDIC insured, can you?
Outright fraud is not as common as bad business practices that wear away at a bank’s capital base over a long period of time. You can generally see bank failures coming and the FDIC tells the bank how to avoid them.
I would totally try to get my money out of a bank that was going to be taken over by the FDIC. Not because I am afraid i would lose the money but because I am afraid that it would get tied up for months or years.
This would all be potentially neat, but it has nothing to do with the purpose of the Fed. Again, these aren’t long term loans so that banks can extend you new credit. It’s money that they have to pay back to the Fed tomorrow, in full, with interest.
As far as I know, the Fed gets $0 from the Treasury.
Here’s the acutal net flow. I believe if the arrows went any other way, the system wouldn’t work. Mind you, every group is getting something in return for the money heading away from them.
Treasury<- Federal Reserve <- Banks <- People
The Fed turns a profit from the loans it makes to the banks, and pays the surplus to the Treasury. They’re lending the banks their own money, same as normal banks are lending you and I each other’s money, not money they’ve borrowed from the Fed.*
As far as being the bank’s bank, the Fed is the banks bank. However, they don’t want to go there. The actual term is “Lender of Last Resort”. The handle this through the “Discount Window”. The rate that the Fed loans them money is actually higher than the rate for banks to loan each other money, if the bank can get another bank to loan them money for the night. If not, they go hat in hand to the Fed, where the rates are higher, but they will survive the night.
They are undoubtedly insurmountably high because the Fed needs to have money to lend. Again, they’re lending the banks each other’s money, not yours. Also, remember that Treasury is your treasury, even if you can’t go directly draw from it. So, in the end, the banks pay you through the Fed. Pity the government isn’t run at a profit.
*Again, in normal circumstances, QEI+II were/are very strange.
Well, at least you’re willing to admit some banks (central banks) create money out of nothing. So we’ve established that much. So why is it that regular banks - when they make loans - aren’t doing the same thing?
I’m not sure why you say “theoretically”. I thought we were talking theoretically. But if you want to talk about the Basel Accords, or reserve requirement, or whatever, that’s fine. It makes it more complicated, but it doesn’t change anything fundamentally.
Anyway, the Bank of Rick wouldn’t hand out leaves to random passers by. That would be stupid. It would hand out pieces of paper, engraved with the heads of dead presidents, to people who were credit-worthy customers, who signed promissory notes promising to pay them back (plus interest). Also, it would likely want collateral.
Well, you’ll have to argue with Hellestal about that.
The amount a bank can lend has nothing reserve requirements (I assume you’re talking about the US - other countries don’t have them). The amount a bank can lend is controlled capital requirements. Reserve requirement refer the amount of customers’ money banks are required to keep at the Fed (or in the form of currency). In other words, they relate to deposits, not to loans.
In any event, a bank can always meet its reserve requirements by borrowing from other banks, or from the Fed. Attracting depositors is one way to meet reserve requirements, but not the only way.
Capital requirements govern the amount a bank is allowed to lend. Currently the ratio (I think) for Tier 1 capital is 6% of risk-adjusted assets (loans). So, for example, if a bank wanted to lend $1 million, it would need to own $60,000 of government bonds. Or less, depending on the risk adjustment.
No, you’re right: the Treasury sells the bonds to the public, and the Fed buys them through approved vendors. So in this case the public and/or the vendors, are the middle men. It changes nothing fundamentally about the process.
Banks use the Fed to clear checks. You and I use banks to do our banking. Banks use the Fed.
The S&L crisis had nothing to do with the FDIC or the federal reserve AFAICT.
The most recent crisis was AFAICT the result of lax regulation more than bank fraud. The banks were credited with high capital weighting for things like Fannie and freddie preferred stock and securities.
You must have the worst luck. I seem to remember people getting money stuck in Indymac bank when there was a run and the FDIC shut them down. Maybe not months but several days.
I think he is saying that they “create money” in the same sense that short selling stock “creates” more shares of that stock.
I should be saying capital requirement not reserve requirement.
I’m confused. Are you trying to say that I can start a bank, fund it with $60,000 and make a $1,000,000 loan on that $60,000 worth of capital? I’m almost positive that is wrong. I’m pretty sure I have to at least borrow the other $940,000 to make the $1,000,000 loan.
Right and a bank’s check will not clear unless it has the money in its account just like my checks won’t clear if there isn’t money in my account.
Now that I think about it, Its not exactly clear to me how the central bank “creates” money either.
Well, whatever he’s saying, banks create money in the same way bees create honey. Money comes from banks, and nowhere else. It doesn’t come from depositors, because they wouldn’t have any money to deposit, if banks hadn’t created it in the first place.
I don’t know exact rules for starting a bank, but that’s the basic idea. The shareholders, because of regulatory requirements, have to put up a certain amount of money. They can then make loans as a multiple of that capital. A “well capitalized” bank has a rate of 6% (for Tier 1 capital). That means their capital is equal to 6% of the loans outstanding.
I imagine the amount of of capital you need for starting a bank is more than 60 thousand. In fact, I suspect it’s in the millions. But as far as banks that are up and running are concerned, a bank with a 6% capitalization rate would be considered “well capitalized”.
No. Which is why (or one of the reasons why) there’s a market for federal funds. Banks that have too little in their federal reserve accounts borrow from those who have too much. (More than they need.) Which is why all the checks clear. If it really needed to, a bank could go to the Fed, and borrow from the source.
The Fed itself sets the federal funds rate (the amount banks have to pay to borrow from each other) by deciding the total amount of funds available in the system. It increases the amount by buying things like Treasury bonds, and decreases the amount by selling. In other words, it creates money by lending. For example, by lending to the US government, when it buys Treasuries.
Central banks create money the same way any bank does: by lending. It buys an asset (like a Treasury bond) and credits someone’s account. The crediting of the account means nothing more or less than changing the number, to make it bigger.
There’s nothing more complicated, or mysterious, about it than that.
What’s interesting, is that because banks create money, and because they charge interest, the total amount of money owed to banks is always greater than the total amount of money in existence. Ordinarily, that’s not a problem, because not everybody pays off their loans at the same time, and new people are always borrowing.
But if something happens, the underlying truth emerges: it’s impossible for everyone to pay off all their debts. Then you get a banking crisis, and a recession or depression.
RickJay and Damuri Ajashi, why do you think it’s called “Fractional” Reserve Banking? I would have thought anyone who knows the term would know that banks only have a fraction of what they are lending.
Of course. That goes without saying. It remains the fact however that the loan must be backed up by a deposit.
You deposit $100. The Bank of Rick loans out $90 to Damuri Ajashi. He deposits the $90 in the Bank of Rick, and I loan $81 to Hellestal. Now I have liabilities of $190 (the deposits owed to you and Damuri Ajashi) and assets of $200, though I only have nineteen dollars on hand. That’s fractional reserve banking.
[QUOTE=LinusK]
No. Which is why (or one of the reasons why) there’s a market for federal funds. Banks that have too little in their federal reserve accounts borrow from those who have too much. (More than they need.) Which is why all the checks clear. If it really needed to, a bank could go to the Fed, and borrow from the source.
[/QUOTE]
But you’re not at all answering Damuri’s central point; the bank’s check MUST be backed up by money in their accounts. Yes, they could, in order to cover that check, borrow from another bank, or from the central bank. ** But they still have to borrow it. ** The money has to be there; commercial banks cannot just poof! money into existence. Central banks can create money from absolutely nothing. Commercial banks cannot. (The government could also just print lots of extra cash, though that is not a practical way to expand the money supply faster than the economy.)
But, that is giving 3 people access to $271 from only $100, so in effect it’s creating money. Right? I mean a shell game is played - if required- so that more money isn’t directly printed to do it, but 100 became 271.
Yes, this story appears in the textbooks. The textbooks are wrong. That is not the process. This is the process.
Central banks create the monetary base, the MB, from nothing.
Commercial banks create the broader forms of money, the M1 or M2 or MZM or whatever, from nothing.
As far as the accounting goes, the process that the central bank uses to create the monetary base is exactly identical to the process that commercial banks use to create the broader forms of money. If we glanced at the accounting books only, we would simply not see a difference. It looks exactly the same. I cannot emphasize this enough. I will write it again: Looking at the pure bookkeeping mechanics of the situation, commercial banks create the M1 in exactly the same way that central banks create the MB.
In practical terms, the MB is a very very different kind of money from the M1. (Technically, from the non-currency component of the M1.) They work so differently that they hardly both deserve the label of “money”. But there it is.
The monetary base has to be there. Commercial banks cannot just poof! the monetary base into existence.
You’re conflating the “monetary base” with “money”. I understand why you’re doing this, since in practical terms the base is very different from everything else. But you’re still engaged in an equivocation.
Normal companies have an accounts payable. This is debt for the company. This is money that the company owes to other people. This is simple enough. I can say that a normal company can create a new entry in accounts payable out of nothing. Poof! All the company has to do is buy something without paying for it immediately. The company might buy a computer on credit, and make an entry in accounts payable. It will give the computer store an IOU. Or the company might buy some stationery at the office supply store, and put it on credit. It can write the supply store an IOU. This process can continue at dozens of different places, with each place receiving an IOU. With every purchase, the company makes a new note in its accounts payable. Or hell, if we get really freaky with it, maybe the company could even make a loan to someone to buy a new house. But rather than paying for this loan right away with monetary base, the company might first write up an IOU in accounts payable.
This transaction is a little weird. The company is making a loan to a client, but there are IOUs moving in both directions. The client promises to pay the loan back. The client signs the mortgage document saying, hey, I’m going to receive 100,000 and I’ll be sure to pay back that 100,000 plus 5% interest over the next thirty years. And company also writes an IOU. The company says, hey, I’m giving you a loan right now and I’ll be happy to give you the monetary base for that loan as soon as you want it. You can claim it anytime, and that’s fine. But as long as you don’t claim it right away, I’ll pay 1% interest on this IOU I’m giving you.
Here’s the weird thing. The IOU that the company writes never actually has to be paid out. I mean, sure, it can be. But it doesn’t have to be. As long as people are content to sit on their IOUs, the company never has to pay out its accounts payable. It can just keep putting it off for month after month, year after year, It can just sit on its accounts payable indefinitely. It will receive 5% for the loan, and pay 1% on its accounts payable. It will be earning a spread. (In this context, earning a spread refers to the difference in interest rates, and not to impressing a date.)
This is a strange company. It’s called a bank. One form of its accounts payable is called a deposit. Poof. So yes, a bank can create money out of nothing, in exactly the same sense that a regular company can create a new accounts payable out of nothing. The big difference is that a bank’s accounts payable is referred to as “money”. They get away with this because the rest of us aren’t in the habit of forcing banks to pay their accounts payable immediately. Instead of forcing the bank to pay out, we’d rather use their special IOUs to make our own payments. While it’s true that they need to have cash (monetary base) on hand whenever somebody wants to withdraw their IOU, the general condition is that most people are content to hold on to the IOUs indefinitely rather than cashing them in. And in fact, the entire banking system works very much like a single bank. One loan might go from Bank Alpha to Bank Beta, but then a loan the next day might go in the other direction. Most of these transactions will balance out.
A bank is a business that sits permanently on the majority of its accounts payable. The amount they have to pay out is a tiny fraction, almost always balanced by a new fraction coming in. And every time the bank creates a new loan, it will (by definition!) be creating new money. That new money might not last very long. It might get cashed out, or paid back, or whatever. But banks can create a new deposit out of nothing, because all that “deposit” means is a new accounts payable entry.
You’re right that I don’t hate him. I’m not sure “frustration” is the right word either. The general ineptness of his explanations often provides a surprisingly useful starting point for my own posts.
But here’s the thing. I’m fairly confident RickJay is going to grok what I’m saying here. He’s going to see that banks can poof money, based on the definition of “money” that’s been in use in this thread. The pieces will fit together. I’ve read his posts for years and there is quite obviously reason at work. The definitions are very strange, especially in the bizarre way they were initially presented in this thread – deliberately iconoclastic instead of explanatory. Sometimes it can take a long time before words that are this slippery and convoluted start to solidify and make sense, but I don’t really have much doubt that it will happen. It’s just a matter of time. Some people are just like this and use their brains to try to figure stuff out
And then there are other people. They might be the kind who are on the above-average section of any given standardized test. You can’t call them “dumb” in that sense, it’s just that they use all their mental energy in a concerted effort to make up convincing reasons why they shouldn’t change their mind or even pay attention to other people. Hating that kind of behavior would be like hating a puppy for pooping on the carpet. Some people are just like this.
I have stated very clearly what I think the causes were for the S&L crisis in a previous post. And while I stated very clearly that I don’t believe fraud was the major cause (which you seem to have completely ignored), there were several S&L’s that were brought down by fraud (such as Empire, which was widely attributed to fraud). I think anybody who has even a basic understanding of the S&L crisis would know that several S&Ls were indeed brought down by fraud.
There was outright fraud, particularly with loan origination. I never stated fraud was the only cause, but your attempt to remove fraud from the picture entirely is completely nonsensical. And again, we were talking about how incentives would work in a theoretical market. But the fact is that we have numerous real-world examples of fraud (which you seem to be wholly unaware of).
Why would I have the worst luck? In the aftermath of both the S&L crisis and the recent crisis, my banks changed hands several times after the FDIC move in. I really don’t think you understand what happened during these crises.
Quite honestly, I think the problem here is that I’m using the generic word “money” to describe things that I should probably be using different words for, because I’m agreeing with every word you’re saying and somehow coming off like I’m disagreeing. I’m just sucking at expressing myself.
I think LinusK is saying that commercial banks create the monetary base by lending money they don’t have. Just poofing the money they lend into existence.
They’re not creating it from nothing. They are lending money they actually have and leaving the depositor with a book entry amount in their account but the money isn’t there anymore, its been loaned out.
And in that sense, I wondered aloud whether central banks “create” money. How does the central bank “create” the monetary base?
I think some of the posters here don’t appreciate this.
I think we are starting to confuse ourselves with how we use the term money.
And what did the FDIC have to do with it?
Where do I completely ignore fraud in the S&L crisis?
You in fact seemed to indicate that it was entirely the result of fraud.
I am not trying to remove fraud from the picture but the fraud by itself would not have brought the crisis we had. The lax regulation would have resulted in a crisis sooner or later.
Fraud in loan origination would have been meaningless (would never have occurred) without the lax regulation of the upstream elements. This was not some cleverly disguised conspiracy by a network of mortgage brokers. It was a zillion mortgage brokers responding to the lack of underwriting and regulation to make more money than they had any right to expect to make with their GED and a nice suit.