5 ms·

> Central banks need to act as the "lender of last resort" Central banks act as lender of last resort because fractional reserve banking is broken by design. I

by arohner 14y ago

> Central banks need to act as the "lender of last resort" Central banks act as lender of last resort because fractional reserve banking is broken by design. It's essentially very similar to a race condition in software. Bank runs are a very bad situation that happens only under "hypothetical", or "very rare" situations. The central bank is trying to patch things after the fact. Imagine trying to resolve a race condition that corrupts memory by undoing the corruption after the fact. Insanity. Rather than put a bandaid over the race condition, eliminate the race. The race happens because customers put a large pile of money into the bank, and don't specify when they need it back. The bank assumes the customer will leave it in the bank for a certain amount of time. Then if customers get spooked because of something they hear on the news, they'll want to take all their money out. The result? Only 10% of it is liquid, and the rest is tied up in loans that won't be repaid for years. If the next customer wants to take their cash out, the bank is forced to sell short the loans it issued (which could be entirely legitimate and profitable). The bank now faces bankruptcy. In this situation, the bank run is rational, because the first N customers will get 100% of their money out, but the N+1th might only get 90% of their cash back. It's worth pointing out this flaw is present, and exploitable in any fractional reserve bank at any time, regardless of how good its finances are. All you need is enough customers taking their money out at the same time. The solution is really very simple. Require the customer to specify when they'll need their money back, and the bank is not allowed to loan out that money for shorter periods of time than the customer specified. i.e. if I have an account at a bank, I'd say "I will always need access to $1000 in cash at any time of the day. Then I'll save $5000 for a vacation in six months, and won't need to touch the rest for 10 years." The bank then matches up the money you stored with available loans. i.e. your $5k in vacation money can only be loaned to other clients at terms of six months or shorter, so you and the bank have a clear understanding of when the money is available. What this means is bank runs are not rational (nor possible, because you have a contractual obligation about when you get your money back). No central bank nor lender of last resort is necessary now.

JumpCrisscross 14y ago
Actually the solution is simpler: deposit insurance. Strikingly, economists thought about these things before Hacker News. Restricting banks to time deposits pushes the liquidity problem onto the depositors (you need to break your time deposit for an emergency? Nope, can't do it). It is also similar to how post-war financial repression created the Eurodollar savings markets that produced much of the mess in the 1980s. P.S. shadow banks try to do this by raising money wholesale at fixed maturities. Problem is nobody wants to lend to a bank unsecured for long tenors. Hence, one constricts the yield curve to the short, volatile end.
- arohner 14y ago
  Deposit insurance can only safely and reliably be done by someone with access to a printing press. A central bank is hardly "simple". > you need to break your time deposit for an emergency? Nope, can't do it But you can. Just take a short sell on the asset. > Strikingly, economists thought about these things before Hacker News. That's a little snide. Economists discussed exactly what I just wrote 100 years ago. I'm not saying this design doesn't have tradeoffs, but it's laughable to suggest that our current banking system is anywhere close to perfect.
  - cma 14y ago
    There could still be runs on banks. If everyone takes their money out of banks, the money supply would collapse to 10x smaller. If you believed this was in the process of happening (rumors of a coming war, etc.), you'd want your money out as soon as possible, whether it had to be 6 months or 6 days, you'd still want out.
- anamax 14y ago
  > Actually the solution is simpler: deposit insurance. Canada didn't have deposit insurance until the late 1960s and has recently restricted its coverage. (It's now per depositor instead of per-account.) Of course, Canada is populated by Canadians, who are demonstrably different than Americans. (One example - Canadians don't smuggle guns, much.) > Strikingly, economists thought about these things before Hacker News. Yes they've thought about this, but if they've asserted that deposit insurance is "the solution" they're more ignorant than I thought. Please tell me that you're just making this up.
jacoblyles 14y ago
Or just have a system where depositors lose their money if the bank goes bust. They will become a lot more interested in the activities of their bank. As I recall, few people lost their money in the wildcat banking days before the Civil War.
mikeash 14y ago
It seems to me that your proposed system exists right now, with CDs playing the role of "I don't need this money back until time X." The trouble is that people don't want to play games like that with their money, and banks don't want to be limited to holding onto 100% reserves for every deposit that could potentially be withdrawn right now.
caf 14y ago
Borrowing short and lending long is the very definition of a bank. It's a service that people want, too - because there's a much larger number of people that want to lend short than borrow short, and conversely there's a much larger number of people that want to borrow long than lend long. If you instituted this then no-one would be able to afford to take out a mortgage - the cost of funds lend long would be far too high.
- seanp2k2 14y ago
  I lend short to my savings account, and in return I get 0.05% APY during a time of ~1.4% inflation on consumer goods. That's hardly a deal.
  - deleted 14y ago
    [deleted]
- seanp2k2 14y ago
  I lend short to my savings account, and in return I get 0.05% APY during a time of ~1.4% inflation on consumer goods. That's hardly a deal.
- seanp2k2 14y ago
  I lend short to my savings account, and in return I get 0.05% APY during a time of ~1.4% inflation on consumer goods. That's hardly a deal.
- arohner 14y ago
  There are lots of services I would like to have. For example, I would love to buy $10 for $5. That doesn't mean someone can provide that to me, long term. The only way for fractional reserve banking to be practiced "safely" is if there is a central bank backstopping it. That introduces a lot of regulation, and still ends up being very expensive for the taxpayers. What I'm proposing essentially separates "place to securely hold my cash, and provide ATM services" from "place to invest money long term". Now, I agree that long term interest rates would rise, but it doesn't follow that mortgages would become unaffordable. What's more likely IMO is that houses become a lot cheaper. The main "anchor" to the price of a house is your ability to pay a fixed percentage of your income. Rather than paying 25% of your monthly income on a 30 year mortage at 5%, you'd probably end up paying 25% of your monthly income on a 10 year mortgage at 8%.
einhverfr 14y ago
I forget who Steven Keen is quoting in this manner but he points out an early opponent of the gold standard said "In the real world, banks loan money, create deposits in the process, and look for the reserves later." As for your solution, suppose my kid has to go to the ER. I go to the bank to withdraw funds early because of unforeseen circumstances. Does the bank have to give them to me?
- pdonis 14y ago
  > suppose my kid has to go to the ER. I go to the bank to withdraw funds early because of unforeseen circumstances. Does the bank have to give them to me? This sort of situation is what insurance is for.
  - einhverfr 14y ago
    So insurance pays for 100% of the cost? Where do I find such insurance? Or suppose I need chemo and insurance will only cover 80% of the $100k cost? Do I have to keep $20k under my pillow?
    - pdonis 14y ago
      > So insurance pays for 100% of the cost? Where do I find such insurance? Remember we're talking about a very different world from the one we actually live in, a world where banks aren't allowed to lend at longer terms than they borrow. In such a world health insurance would presumably also be very different from what we're used to, since it would only be expected to insure against things that should be insurable, i.e., unforeseen circumstances. What we now call "health insurance" is something like auto insurance that would also be expected to pay for oil changes, replacing tires, checking your air cleaner and wiper blades, etc., etc. If we had health insurance that worked more like the way our actual auto insurance works, we would cleanly separate predictable health expenses from unpredictable ones, and only expect insurance for the latter. That would change things a lot. > Or suppose I need chemo and insurance will only cover 80% of the $100k cost? The big question here is, why do you need chemo? We're probably getting off topic, but I can see at least three distinct possibilities: (1) You need chemo because of something accidental and unforeseen that gave you cancer--say you were in an airplane that got irradiated with a burst of cosmic rays. This would be insurable, and these sorts of conditions are rare enough that I would expect an insurance company to pay the claim, with a reasonable deductible (you would trade off the deductible against the premiums, just as you do now with auto insurance--again, this is all in the light of the general comments I made above). (2) You need chemo because someone else's deliberate act or negligence caused your cancer--say your city water was contaminated by a factory's effluent. In this case the party responsible should be paying for your chemo, just as if someone else hits your car they are responsible for paying to get it fixed. (3) You need chemo because you didn't take care of yourself very well, didn't get regular checkups, and got a form of cancer that could have been diagnosed and prevented but wasn't. In this case your insurance company would still be obligated to pay, but your premiums would probably have been quite a bit higher, just as people with bad driving records have to pay more for auto insurance. Of course I understand that this kind of analysis is a lot more unpalatable when applied to health insurance vs. auto insurance. Our bodies are much more important to us than our cars. But that doesn't change the economics involved.
warfangle 14y ago
The penultimate paragraph sounds suspiciously like what Simple (formerly Bank Simple) is doing.

by arohner 14y ago

JumpCrisscross 14y ago

Actually the solution is simpler: deposit insurance. Strikingly, economists thought about these things before Hacker News. Restricting banks to time deposits pushes the liquidity problem onto the depositors (you need to break your time deposit for an emergency? Nope, can't do it). It is also similar to how post-war financial repression created the Eurodollar savings markets that produced much of the mess in the 1980s. P.S. shadow banks try to do this by raising money wholesale at fixed maturities. Problem is nobody wants to lend to a bank unsecured for long tenors. Hence, one constricts the yield curve to the short, volatile end.

arohner 14y ago
Deposit insurance can only safely and reliably be done by someone with access to a printing press. A central bank is hardly "simple". > you need to break your time deposit for an emergency? Nope, can't do it But you can. Just take a short sell on the asset. > Strikingly, economists thought about these things before Hacker News. That's a little snide. Economists discussed exactly what I just wrote 100 years ago. I'm not saying this design doesn't have tradeoffs, but it's laughable to suggest that our current banking system is anywhere close to perfect.
- cma 14y ago
  There could still be runs on banks. If everyone takes their money out of banks, the money supply would collapse to 10x smaller. If you believed this was in the process of happening (rumors of a coming war, etc.), you'd want your money out as soon as possible, whether it had to be 6 months or 6 days, you'd still want out.
anamax 14y ago
> Actually the solution is simpler: deposit insurance. Canada didn't have deposit insurance until the late 1960s and has recently restricted its coverage. (It's now per depositor instead of per-account.) Of course, Canada is populated by Canadians, who are demonstrably different than Americans. (One example - Canadians don't smuggle guns, much.) > Strikingly, economists thought about these things before Hacker News. Yes they've thought about this, but if they've asserted that deposit insurance is "the solution" they're more ignorant than I thought. Please tell me that you're just making this up.

jacoblyles 14y ago

Or just have a system where depositors lose their money if the bank goes bust. They will become a lot more interested in the activities of their bank. As I recall, few people lost their money in the wildcat banking days before the Civil War.

mikeash 14y ago

It seems to me that your proposed system exists right now, with CDs playing the role of "I don't need this money back until time X." The trouble is that people don't want to play games like that with their money, and banks don't want to be limited to holding onto 100% reserves for every deposit that could potentially be withdrawn right now.

caf 14y ago

Borrowing short and lending long is the very definition of a bank. It's a service that people want, too - because there's a much larger number of people that want to lend short than borrow short, and conversely there's a much larger number of people that want to borrow long than lend long. If you instituted this then no-one would be able to afford to take out a mortgage - the cost of funds lend long would be far too high.

seanp2k2 14y ago
I lend short to my savings account, and in return I get 0.05% APY during a time of ~1.4% inflation on consumer goods. That's hardly a deal.
- deleted 14y ago
  [deleted]
seanp2k2 14y ago
I lend short to my savings account, and in return I get 0.05% APY during a time of ~1.4% inflation on consumer goods. That's hardly a deal.
seanp2k2 14y ago
I lend short to my savings account, and in return I get 0.05% APY during a time of ~1.4% inflation on consumer goods. That's hardly a deal.
arohner 14y ago
There are lots of services I would like to have. For example, I would love to buy $10 for $5. That doesn't mean someone can provide that to me, long term. The only way for fractional reserve banking to be practiced "safely" is if there is a central bank backstopping it. That introduces a lot of regulation, and still ends up being very expensive for the taxpayers. What I'm proposing essentially separates "place to securely hold my cash, and provide ATM services" from "place to invest money long term". Now, I agree that long term interest rates would rise, but it doesn't follow that mortgages would become unaffordable. What's more likely IMO is that houses become a lot cheaper. The main "anchor" to the price of a house is your ability to pay a fixed percentage of your income. Rather than paying 25% of your monthly income on a 30 year mortage at 5%, you'd probably end up paying 25% of your monthly income on a 10 year mortgage at 8%.

einhverfr 14y ago

I forget who Steven Keen is quoting in this manner but he points out an early opponent of the gold standard said "In the real world, banks loan money, create deposits in the process, and look for the reserves later." As for your solution, suppose my kid has to go to the ER. I go to the bank to withdraw funds early because of unforeseen circumstances. Does the bank have to give them to me?

pdonis 14y ago
> suppose my kid has to go to the ER. I go to the bank to withdraw funds early because of unforeseen circumstances. Does the bank have to give them to me? This sort of situation is what insurance is for.
- einhverfr 14y ago
  So insurance pays for 100% of the cost? Where do I find such insurance? Or suppose I need chemo and insurance will only cover 80% of the $100k cost? Do I have to keep $20k under my pillow?
  - pdonis 14y ago
    > So insurance pays for 100% of the cost? Where do I find such insurance? Remember we're talking about a very different world from the one we actually live in, a world where banks aren't allowed to lend at longer terms than they borrow. In such a world health insurance would presumably also be very different from what we're used to, since it would only be expected to insure against things that should be insurable, i.e., unforeseen circumstances. What we now call "health insurance" is something like auto insurance that would also be expected to pay for oil changes, replacing tires, checking your air cleaner and wiper blades, etc., etc. If we had health insurance that worked more like the way our actual auto insurance works, we would cleanly separate predictable health expenses from unpredictable ones, and only expect insurance for the latter. That would change things a lot. > Or suppose I need chemo and insurance will only cover 80% of the $100k cost? The big question here is, why do you need chemo? We're probably getting off topic, but I can see at least three distinct possibilities: (1) You need chemo because of something accidental and unforeseen that gave you cancer--say you were in an airplane that got irradiated with a burst of cosmic rays. This would be insurable, and these sorts of conditions are rare enough that I would expect an insurance company to pay the claim, with a reasonable deductible (you would trade off the deductible against the premiums, just as you do now with auto insurance--again, this is all in the light of the general comments I made above). (2) You need chemo because someone else's deliberate act or negligence caused your cancer--say your city water was contaminated by a factory's effluent. In this case the party responsible should be paying for your chemo, just as if someone else hits your car they are responsible for paying to get it fixed. (3) You need chemo because you didn't take care of yourself very well, didn't get regular checkups, and got a form of cancer that could have been diagnosed and prevented but wasn't. In this case your insurance company would still be obligated to pay, but your premiums would probably have been quite a bit higher, just as people with bad driving records have to pay more for auto insurance. Of course I understand that this kind of analysis is a lot more unpalatable when applied to health insurance vs. auto insurance. Our bodies are much more important to us than our cars. But that doesn't change the economics involved.

warfangle 14y ago

The penultimate paragraph sounds suspiciously like what Simple (formerly Bank Simple) is doing.