Captain Ranty left this comment on Another crash course in banking:
You don't appear to understand fractional reserve lending practices.
My £100k is not shown as a liability on the banks' books. A liability indicates a risk, it indicates that the bank has offered something of equal value in the contract and they have not. They do not take an equal risk. Dig a little, my friend, a mortgage contract is easily defeatable in court. Actually, it is fraudulent, as full disclosure is never, ever given by the bank.
The simple indisputable facts of the matter are that the new loan which the bank "creates" is shown as an asset on the bank's balance sheet (because it is an asset, the precise valuation thereof is another matter); the borrower takes the money, buys a house, gives the money to the vendor; the vendor deposits the money back in the bank and the vendor's deposit is shown as a liability (from the bank's point of view).
So a split second after the transaction, the bank's net asset position is unchanged - it has additional assets and an equal and opposite additional liability. That is how FRB works. I am not saying it is a good thing or a bad thing, I am merely describing what happens.
If you do not believe me, I invite you to download the balance sheets of a bank or building society and look for yourself - customer deposits are shown as liabilities (because that is what they are).
Wednesday, 27 January 2010
More banking fun
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29 comments:
Good on you for tackling this guff Mark. It is repeated too often.
I think captain ranty is correct, and you are correct. You're arguing about different things though. He's talking about money supply, and you're talking about accountancy.
Fractional reserve is about money, not about accounting. Of course the assets equal the liabilities, that's a universal accounting truth (modulo equity, retained profit and the like). The point is that the supply of money has been increased magically.
The bank is owed and owes the same amount, but the money has come into existence from nowhere -- it has been used by party A to buy party B's house, but you can't point at the cash (FRB only works because the currency is fiat, and the computers can make money just by altering a number or two).
Even better for the bank -- they're still at a net worth of zero. They can do the same thing again, each time they gain the difference between the interest rates.
Quite right, Mark.
There's a pretty good explanation on Wikipedia.
From which the quote: "For an individual bank, the deposit is considered a liability whereas the loan it gives out and the reserves are considered assets. Deposits will always equal to loans plus a bank's reserves, since loans and reserves are created from deposits. This is the basis for a bank's balance sheet."
'Andy: "FRB only works because the currency is fiat, and the computers can make money just by altering a number or two"
Not true. FRB could work equally well with just paper money and loan documents. You give your ten £10 notes to the bank for safekeeping. They lend eight of them to somebody else, who spends them. The person who receives them lends them back to the bank for safekeeping again.
Without FRB, you could not have interest on bank accounts, or bank loans paying interest.
This mans interpretation of FRB seems to make a lot of sense.
http://www.lewrockwell.com/rothbard/frb.html
Can I recommend the excellent online lectures at www.khanacademy.org for anyone getting too wrapped up in banking conspiracy guff.
Anon 1, AC, thanks for back up.
Andy, sort of thanks, but why do you say this: "but you can't point at the cash"?
Cash as in coins and notes is more or less irrelevant nowadays, and now that we have debit cards and so on we could manage perfectly well without physical cash.
Anon2, whoever wrote that is talking complete and utter shite. He claims that a bank can start off with $1,000 and lend $10,000, i.e. magicking $9,000 out of thin air. Bollocks. It can only lend $10,000 if it can borrow an additional $9,000; raise an additional $9,000 in share capital; or persuade the person who received the cash proceeds of the loan to deposit it back with the same bank.
S_L, maybe, maybe not. There is a 'conspiracy', but that goes no further than governments bailing out banks with taxpayers' money and/or bankers running the country, there is no more or less to it than that.
But the politicians know that the Home-Owner-Ist voters want ever-rising house prices, so the politicians also need an ever larger banking system to keep the party going.
I can't see what all the fuss is about with FRB: the banks take the risk, they get the reward. The only thing worth shouting about is that the government have taken the risk element away, so now it's money for nothing, but that's got nothing to do with FRB AFAICS.
"we could manage perfectly well without physical cash"
I am not sure there are many outside the government revenue raisers that would agree with you on that one.
Talk about the smug and self righteous,there's enough of those here.Andy does a good job of balancing two conflicting arguments.
Why don't you deniers do a bit of reading of say Ann Pettifor's letter which started this latest bout of the banks are our friends they take enormous risks etc etc etc.You might also try the Green New Deal's latest report section 4 to which she contributed which takes account of the accounting conventions which mask the appearance of money.
Quote from Ann Pettifor's letter: "The bank does not need savings deposits or reserves to create credit.If this were the case there would only be as much credit as there are depoists in the bank" How does the credit exceed ther total value of deposits?Why is it called FRACTIONAL reserve banking?
B, agreed.
DBC "... this latest bout of the banks are our friends they take enormous risks etc etc etc."
I never said that. Point me to wherever I have said that. I have never said that 'banks are our friends' any more than farmers are our friends or hi-fi manufacturers. That is quite different from explainining how crops grow or how electronics works.
I have always said, to paraphrase Bayard "in the absence of taxpayer funded bailouts, banks' recklessness would be contained by their aversion to risk".
"Quote from Ann Pettifor's letter: "The bank does not need savings deposits or reserves to create credit.If this were the case there would only be as much credit as there are depoists in the bank"
Well, that makes AF a smug self-righteous and deluded hectoring cow, I am afraid. As a simple fact, (before we take into account write-downs on reckless lending) total loans = total deposits plus shareholders' capital.
"How does the credit exceed ther total value of deposits? Why is it called FRACTIONAL reserve banking?"
If anything, as at today's date, it's the other way round - total value of deposits taken by banks is greater than total value of credit (i.e. loans made by banks) for the simple reason that deposits are a fixed monetary value but the value of loans can go down -> this is what leads to runs on banks, which you mentioned elsewhere.
If, in the parallel universe inhabited by the likes of Anne Petit-Fours, banks could always create more credit then they had deposits, there would never be runs on banks!
Well, I worried.
Andy answered most of it and DBC Reed(via Ann pettifor supporting the rest).
In your example, you are of course, right: if the money being borrowed is used to
purchase an asset then the bank is only being a middleman and can only profit on the
%age applied to the loan, less costs(which does not explain where that extra money
comes from-in a closed circle i.e. there is x money in the world, what constitutes the
interest? It has to be made up/created/?).
If, on the other hand most people who save with a bank expect at most times to
withdraw e.g. 10% of their capital the banks can lend 90% of their(that is the
depositors) capital(the bank's liability)with very little risk, ad arithmeticum(whit? 90%
of 90% etc).
As I said your argument is right in the case you propose but it does not answer the
argument that FRB is a long con that has to end in tears.
I could also argue that putting eggs, flour and milk together to make a cake increases
wealth by adding value. It does not neccesarily lead to FRB, inflation, interest and the
destruction of wealth by the very interest applied.
Perhaps if we approach from another way: JFK tried to introduce a silver based dollar
guaranteed by the State which really meant that the State would lend an amount
(+costs-which would incidentally also mean inflation but not usury) which must
undercut the Fed's etc. lending practises, then inflation would be at at such a low base
as to be meaningless.
How did that work out again?
Mark, you have very fine ideas but when I am PM you will only be allowed to have
some of them put into practice(ok, most but I will be supreme...)but to be a tad
disrespectful and to mention something I found out years ago, it is sometimes better to
listen to those who have thought about these things than to declare your
righteousness and suffer the consequences.
That sounds(and is!) so pompous that I am not about to change it!
STB.
So for a simpleton among you...
WTF is money?
Does it have any bloody value?
Why do banknotes promise to pay the bearer and the friggin coins don't
WTF is credit?
Does it have any value?
IS The country broke or does it simply create more credit?
Short answers please.
You, Mark answered between my post and I have no idea how it ended looking like that but hey-ho!
'If anything, as at today's date, it's the other way round - total value of deposits taken by banks is greater than total value of credit (i.e. loans made by banks) for the simple reason that deposits are a fixed monetary value but the value of loans can go down -> this is what leads to runs on banks, which you mentioned elsewhere.'
That says there is no FRB 'cos simply there cannot be. If the simple reason is there cannot be a loan that rises in value it is a total nonsense. Why do Govts. inflate if not that the value of the loan exceeds their ability to repay and ergo it makes sense to deflate? Are you honestly saying that the value of loans cannot go up? Try telling that to BreakALeg R Us Inc. Runs on banks can be simply dealt with as you have shown time after time, after time, after...
And this I do question more 'total value of deposits taken by banks is greater than total value of credit (i.e. loans made by banks) for the simple reason that deposits are a fixed monetary value but the value of loans can go down'.
See point whatever above about deflation and deposits being a fixed monetary value. And then look at why those who buy bonds or whatever they are currently called from the government are insisting on inflation proofing in the small print.
'If, in the parallel universe inhabited by the likes of Anne Petit-Fours, banks could always create more credit then they had deposits, there would never be runs on banks!'
Boll-loks! There will be runs on banks because smart peeps move out of banks, just as smart peeps move out of housing/telecoms/ energy etc.
Have you never heard of Black Friday/White Thursday?
Also, referring to my point about %ages why would banks care? This is casino politics- it is always in their favour in the long term.
STB.
STB: "what constitutes the interest? It has to be made up/created/?"
Nope. Interest is just rent of money. Value is constantly be created by people going out to work, new things being invented etc, and that is what pays the rent/interest.
"FRB is a long con that has to end in tears"
Agreed, it usually ends in tears, but that is because of the corresponding asset price bubbles which always burst. If we deal with asset price bubbles (e.g. by liberalising planning laws, introducing Land Value Tax and preventing monopolies from arising) then there wouldn't be credit bubbles either, so it wouldn't necessarily end in tears.
And I do listen to people, that's why I 'blog, but there is no point going round saying things about FRB that are simply not true, merely because a bizarre coalition of economically illiterate lefties, faux-libertarians, politicians and Home-Owner-Ists go round saying them.
Befuddled, your guess is as good as anybody else's.
STB: "That says there is no FRB 'cos simply there cannot be"
Nope. A bank run is when depositors stop trusting them because they think that the total value of the bank's assets is less than the total liabilities.
If there were no FRB, in other words, banks would have to choose between being:
a) Allowed to make loans, 100% financed by share capital and not allowed to take deposits, or
b) Allowed to take deposits, but not allowed to make loans and had to keep all the cash in a safe in case the depositors wanted to withdraw all at once
then there would never be a bank run.
That is how FRB works. I am not saying it is a good thing or a bad thing, I am merely describing what happens.
FRB is the devils' child - creating exponentially more than there was in the first place. Good stuff with fiat money.
Intriguing chaps but I don't get this bit.
"It can only lend $10,000 if it can borrow an additional $9,000; raise an additional $9,000 in share capital; or persuade the person who received the cash proceeds of the loan to deposit it back with the same bank."
So in the first instance who or what is the base lender which has the $9,000 capital to lend the bank assuming no-one buys its shares or the person with the cash sticks it under their mattress?
'Value is constantly be created by people going out to work, new things being invented etc, and that is what pays the rent/interest.'
No, no, nono, no. This is where we disagree. Value does not pay the rent/interest.
The rent/interest is always greater then the value and thus the value never catches up with the interest(you know exactly how much it costs to become established in any shopping mall and the risks therein). You argue that rents have to be the same otherwise rates will make them so or, rates have to be the same otherwise rents make them so. There never will be a pragmatic compromise in which both accept that to achieve prosperity they must compromise. And that compromise means that they will never achieve ultimate profit. Then less profit means ultimately, more profit. Why? Because if you have a High Street exempt of good shops people go elsewhere and what happens? The town centre dies. It they both compromise then they will eventually raise rents and have the people back..
I know most of this is an argument in dichotomy but they have tried so much before that has not worked that eventually you have to ask why they cannot think beyond their ideology.
And with that I think/no, know I just answered my own question.
STB.
Historically, banking began as a warehousing service for money (usually gold) for which service the bank received a small fee. The bank would issue receipts for the gold deposited in its care. Over time these receipts were traded in lieu of the cumbersome process of retrieving one’s gold from the bank, exchanging it for a good or service, and re-depositing the gold back into the same or competing bank. These receipts were not money themselves. They were money substitutes. The real money was always the gold itself.
Eventually bankers realized that at any one time only a few depositors actually demanded to reclaim their gold. So these bankers began to issue false warehouse receipts to borrowers, who agreed to repay the gold with interest. Thusly, the ratio of gold to warehouse receipts no longer bore a one-to-one relationship with gold on deposit but only a “fractional” one. Thusly was born the “fractional reserve” banking system.
But notice that the banker created the warehouse receipt that he issued to the borrower in a fraudulent manner. The bank’s depositors did not know that their gold had been lent and now would be claimed by more than one person. When this revelation became widespread, the depositors would rush to the bank to withdraw their gold—creating a “bank run”. Therefore, bank runs were completely avoidable by honest bankers who maintained a one-to-one relationship of gold to deposits.
JH, FRB is like booze. It's good stuff in the proper amounts.
AD: "So in the first instance who or what is the base lender which has the $9,000 capital to lend the bank assuming no-one buys its shares or the person with the cash sticks it under their mattress?"
I might as well ask where does the $1,000 come from, or where does the $10,000 go? If the bank can't raise the extra $9,000 then it rapidly goes to the wall.
STB, that all sounds like good arguments for LVT to me, but I thought you opposed that?
Midas, gold is not money either. If it suddenly rained gold coins from heaven and everybody picked up a few dozen, the price of gold would fall by 99%. It is only widely used as money because it is scarce, nice to look at and doesn't rust.
As to your "honest bankers", that is my option (b) in my comment above, which is fine if you like that sort of thing. Most people would rather earn interest on their savings (knowing that the bank is on-lending the money) than to pay a fee for safekeeping.
See you clever peeps cannot be arsed answering my simple questions then.
Same thing happens whenever a simple question is put anyone who assumes they know how things work.
How the hell are dummies like me supposed to learn?
@Anonymous said
What simple questions? Or is it the usual problem with pseudonyms that we have two contributors bravely (and so wittily) calling themselves "anonymous"? As someone who uses his own name I cannot begin to understand this bloggers' convention of pseudonyms,except for those who want to lob mudpies over the fence and then tricycle furiously home. Not in expressing views which are not actionable anyway.
@MW
Quick get over to H.P.C. There is another outbreak of heresy.This time Mervyn King and his guru are saying that banks multiply their reserves to inflate the money supply ( and their own profits not BTW)They seem to think that the banks control the money supply.Even own it.This will never do.Two attacks on the banks as middlemen in two days!
Hi Mark your points about fractional reserve banking are right assets = liabilities, so there is no fraud. However like you said the bank has to make a margin (to pay for running costs, profits etc.) between what it pays out in interest to the depositors and what it receives from its debtors, eg pay 3% and loan at 6% for a difference of 3%. This is compounding so over a year or two there is not much difference but over a 30 year mortgage it is huge.
In the example you used of 100000 pounds, after 30 years you have 235,000 pounds in your savings account but the debtor has paid 541,000 pounds to the bank. If the debtors (the economy as a whole) do not increase their earnings by 6% a year then we have shortfall between interest charged and the actual growth.
This is the reason for the deleveraging happening now. The debts have to be written down until we reach equilibrium again. Any system where interest is charged means there must be equal growth in the economy if we want to avoid busts.
dbcreed
Sorry forgot that being anonymous is bad form.
befuddled
befuddled, I'll have a go.
"What is money?"
"Legal tender money" is notes and coins. "Legal tender" means you can pay your debts with them; if I have an IOU that says "£1000", then 100 ten-pound notes will cancel that debt no matter what. This means that £10 notes have value as long as there are debts in the economy for them to pay. After that their value depends on how much each person wants to sell you in exchange for a £10 note, which probably depends on how fast they're being printed.
"Bank money" is not legal tender. It's the amount of "money" in your bank account. It has value because it can be converted to "legal tender money" at will; just visit an ATM. You can pay your debts/purchases with bank money as long as people expect the bank to pay out legal tender money, or just as long as people want bank money.
"Why do notes say 'pay the bearer on demand', not coins?"
I guess it's a legacy of the time when coins were "legal tender", but notes weren't. You could always pay your debts with coin, but if you wanted to pay with notes, you might have to exchange them for coin first. Hence "I promise to pay..." to make sure that notes and coins had the same value.
"What is credit? Does it have value?"
"Bank money" is credit. Credit is anything you can pay your purchases with, but isn't actually legal tender. It only has value because it can be converted to legal tender, or because people agree it has value.
"Is the country broke or does it simply create more credit?"
"Creating credit" can only be done if you create debt for yourself at the same time. It can't stave off bankruptcy. The government is probably broke, and by extension anyone that holds government bonds is probably in a worse position than he thinks. If the government tries to raise taxes or print money in order to pay its debt, it will face revolt, and cutting services to the extent that is necessary probably won't be too popular either.
Also Mark, further thanks for taking on the common fallacies of money and banking.
Richard, and thank you for the sane and level-headed reply :)
@RICHARD + befuddled
The promise to pay the bearer... is a left-over from the time Midas describes above: you could go into a bank and they would have to pay you in gold or other precious metal how much it said on the note.Obviously if you had gold and silver coins as we did,there was no need for this kind of conversion.
On the contrary from what Richard says, a bank can issue cheques as loans and not debit any depositors' accounts,otherwise if they did what they say they do (on-lend depositors money) your account would be constantly empty,there being an excess of loans over deposits.
Governments are at present engaged in much the same thing issuing cheque or virtual payments with nothing whatsoever behind them for bonds .This is called quantitative easing and although we were all assured that the sky would fall in and such things were lunatic fantasies, nothing much has happened really.
Thank you Richard. I now have a start point to sort the wheat from the chaff for myself.
befuddled
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