6 ms·

I might have an inkling of what this comment is saying, but I'm not sure. As written it almost sounds like the description of a ponzi scheme or a more pedantic

I might have an inkling of what this comment is saying, but I'm not sure. As written it almost sounds like the description of a ponzi scheme or a more pedantic means of saying "they lend out the money given to them by depositors" ... anyone around who could clarify this a bit?

kurthr 7y ago
It's called fractional reserve lending... and it works until it doesn't. As long as your "divedsified" losses are less than (~10% of loans) your reserve collateral (actual Treasuries and Rentable real estate) which generate cash or can be used to pay taxes... then you're solvent. If not then assume the Fed will bail you out... they did last time. Meanwhile, you can lever your "low risk" loan income 10x so that 1-3% marginal yield looks like 10-30% profit. Hard to give up that crack pipe!
- neffy 7y ago
  Sorry to be the bearer of bad news.. The fault tolerance of banks using FRB, is approximately 1% of loan capital per year. Any more than that, and they are driven into regulatory incompliance - which then has monetary significance. Reserves don't actually play a roll in loss management, bad loans have to be written off against loss provisions and/or profits - liability/equity accounts. Basel 3 has put mandatory limits on how much loss provisions/capital has to be held, but it hasn't solved the fundamental problem with the interaction with the money supply.
nunb 7y ago
Yes it's a multiplier scheme and if you squint just right, it's pretty much a ponzi too. But it isn't a pedantic way of restating "lend out". Discussion of the issue is often fraught with accusations of conspiracy theory. Austrian economists (widely regarded as kooky by the establishment) have a bunch of books related to these issues perhaps the best of which is Rothbard. _0 https://mises.org/library/mystery-banking https://mises.org/library/mystery-banking _1 http://www.bundesbank.de/download/bildung/geld_sec2/geld2_gesamt.pdf http://www.bundesbank.de/download/bildung/geld_sec2/geld2_ge... _2 http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf http://www.bankofengland.co.uk/publications/Documents/quarte... _3 https://www.youtube.com/watch?v=CvRAqR2pAgw https://www.youtube.com/watch?v=CvRAqR2pAgw
- SantalBlush 7y ago
  Austrian economists make a few valid criticisms of mainstream economic theory. The thing is, that's very easy to do. What's not so easy is to offer a superior economic model. Their ideas, last I checked, don't involve any math; that is fine, but it makes Austrian theory unfalsifiable, and therefore it can't really be shown to be a valid alternative.
  - yeahitslikethat 7y ago
    Remember, fractional reserve banking started when the Rothschildren decided it was OK to tell their depositors their deposits were in the safe, when the bank had actually given it to other people. Our banking system is founded on a lie. I suggest a valid alternative is the truth. If someone gives you their money and it's your job to store it safely you should to that. For 100% of that money. Not 10% of it.
    - rlucas 7y ago
      There's a banking product for that, it's called a safe deposit box.
      - yeahitslikethat 7y ago
        No. Those are for jewels and other goods that can't be represented with a number typed into a computer.
    - Nasrudith 7y ago
      That is both historically untrue and stinks of anti-Semitic slander passed as fact - following the age old tradition of blaming the Jews for mismanagement by nobles and royals because that wouldn't get you executed. The Rothschildren were certainly /not/ the first being established in the 18th century. Given that the more reputable central Swedish bank used it in the 15th century - let alone the shadier practices of other banknote institutions that predated them. As for the 100% retention idea it is like complaining that a car isn't a faster horse. There may be some fringe cases when the horse is better but most of the time the primary use was going fast across paved roads. To be a good steward involves investment - just any asset sitting stored is a waste of value and will not even preserve it against inflation. It is the red queen's race.
Mirioron 7y ago
>a more pedantic means of saying "they lend out the money given to them by depositors" As the other commenter mentioned: they lend out more money than the depositors gave them. It works roughly along these lines: depositors give the bank $10 million. The bank can now make loans worth $100 million (or some such number depending on the type of debt). They're creating money "out of thin air". Neffy probably knows more about how it actually works, but what I described is the basic principle of fractional reserve banking.
- dd36 7y ago
  It’s important to understand that they don’t typically lend out 10x. My business banker (WF) said they have trouble lending out 0.5x. There’s just not enough high quality lending opportunities.
- neilwilson 7y ago
  There's no limit to the multiple. The 'fractional reserve banking' model is just wrong. (That there are no real reserve requirements in places like Canada or the UK, should really tell people this). In reality it works like this. Loans create deposits. So you lend $10 million and end up with $10 million of loans and $10 million of deposits. The regulator then says you have insufficient capital, so you issue equity or bonds to the tune of $1 million and convince 10% of your depositors to swap their deposits (that you created) for that equity/bond by setting an appropriate interest rate on it. Rinse and repeat until you run out of people to lend to at a price they are prepared to pay. Neither deposits, nor equity have a quantity control function. It's all about the price, not the quantity. In other words the amount of money in the system floats at the current price of money.
  - cm2187 7y ago
    > There's no limit to the multiple. That is factually wrong. You have significant capital requirement both in term of RWA or Leverage Exposure (the latter is more likely to be binding for mortgages), particularly in the UK which along with Switzerland gold pleated every international (BIS, EU) regulations. Banks cannot extend their balance sheet indefinitely, and if you look at UK banks, they significantly deleveraged since the financial crisis, as they adapted to new regulations. In fact these capital requirements, along with increased liquidity requirement are probably why the multiplier effect considerably reduced after the crisis.

kurthr 7y ago

It's called fractional reserve lending... and it works until it doesn't. As long as your "divedsified" losses are less than (~10% of loans) your reserve collateral (actual Treasuries and Rentable real estate) which generate cash or can be used to pay taxes... then you're solvent. If not then assume the Fed will bail you out... they did last time. Meanwhile, you can lever your "low risk" loan income 10x so that 1-3% marginal yield looks like 10-30% profit. Hard to give up that crack pipe!

neffy 7y ago
Sorry to be the bearer of bad news.. The fault tolerance of banks using FRB, is approximately 1% of loan capital per year. Any more than that, and they are driven into regulatory incompliance - which then has monetary significance. Reserves don't actually play a roll in loss management, bad loans have to be written off against loss provisions and/or profits - liability/equity accounts. Basel 3 has put mandatory limits on how much loss provisions/capital has to be held, but it hasn't solved the fundamental problem with the interaction with the money supply.

nunb 7y ago

Yes it's a multiplier scheme and if you squint just right, it's pretty much a ponzi too. But it isn't a pedantic way of restating "lend out". Discussion of the issue is often fraught with accusations of conspiracy theory. Austrian economists (widely regarded as kooky by the establishment) have a bunch of books related to these issues perhaps the best of which is Rothbard. _0 https://mises.org/library/mystery-banking https://mises.org/library/mystery-banking _1 http://www.bundesbank.de/download/bildung/geld_sec2/geld2_gesamt.pdf http://www.bundesbank.de/download/bildung/geld_sec2/geld2_ge... _2 http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf http://www.bankofengland.co.uk/publications/Documents/quarte... _3 https://www.youtube.com/watch?v=CvRAqR2pAgw https://www.youtube.com/watch?v=CvRAqR2pAgw

SantalBlush 7y ago
Austrian economists make a few valid criticisms of mainstream economic theory. The thing is, that's very easy to do. What's not so easy is to offer a superior economic model. Their ideas, last I checked, don't involve any math; that is fine, but it makes Austrian theory unfalsifiable, and therefore it can't really be shown to be a valid alternative.
- yeahitslikethat 7y ago
  Remember, fractional reserve banking started when the Rothschildren decided it was OK to tell their depositors their deposits were in the safe, when the bank had actually given it to other people. Our banking system is founded on a lie. I suggest a valid alternative is the truth. If someone gives you their money and it's your job to store it safely you should to that. For 100% of that money. Not 10% of it.
  - rlucas 7y ago
    There's a banking product for that, it's called a safe deposit box.
    - yeahitslikethat 7y ago
      No. Those are for jewels and other goods that can't be represented with a number typed into a computer.
  - Nasrudith 7y ago
    That is both historically untrue and stinks of anti-Semitic slander passed as fact - following the age old tradition of blaming the Jews for mismanagement by nobles and royals because that wouldn't get you executed. The Rothschildren were certainly /not/ the first being established in the 18th century. Given that the more reputable central Swedish bank used it in the 15th century - let alone the shadier practices of other banknote institutions that predated them. As for the 100% retention idea it is like complaining that a car isn't a faster horse. There may be some fringe cases when the horse is better but most of the time the primary use was going fast across paved roads. To be a good steward involves investment - just any asset sitting stored is a waste of value and will not even preserve it against inflation. It is the red queen's race.

Mirioron 7y ago

>a more pedantic means of saying "they lend out the money given to them by depositors" As the other commenter mentioned: they lend out more money than the depositors gave them. It works roughly along these lines: depositors give the bank $10 million. The bank can now make loans worth $100 million (or some such number depending on the type of debt). They're creating money "out of thin air". Neffy probably knows more about how it actually works, but what I described is the basic principle of fractional reserve banking.

dd36 7y ago
It’s important to understand that they don’t typically lend out 10x. My business banker (WF) said they have trouble lending out 0.5x. There’s just not enough high quality lending opportunities.
neilwilson 7y ago
There's no limit to the multiple. The 'fractional reserve banking' model is just wrong. (That there are no real reserve requirements in places like Canada or the UK, should really tell people this). In reality it works like this. Loans create deposits. So you lend $10 million and end up with $10 million of loans and $10 million of deposits. The regulator then says you have insufficient capital, so you issue equity or bonds to the tune of $1 million and convince 10% of your depositors to swap their deposits (that you created) for that equity/bond by setting an appropriate interest rate on it. Rinse and repeat until you run out of people to lend to at a price they are prepared to pay. Neither deposits, nor equity have a quantity control function. It's all about the price, not the quantity. In other words the amount of money in the system floats at the current price of money.
- cm2187 7y ago
  > There's no limit to the multiple. That is factually wrong. You have significant capital requirement both in term of RWA or Leverage Exposure (the latter is more likely to be binding for mortgages), particularly in the UK which along with Switzerland gold pleated every international (BIS, EU) regulations. Banks cannot extend their balance sheet indefinitely, and if you look at UK banks, they significantly deleveraged since the financial crisis, as they adapted to new regulations. In fact these capital requirements, along with increased liquidity requirement are probably why the multiplier effect considerably reduced after the crisis.