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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 o

by 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%.

caf 14y ago
8%? There's no way the rates would be that low if you required your 10 year mortgage to be entirely backed by 10 year bonds. I do agree that house prices would necessarily fall, but the new point on the price/demand curve would see both lower prices and lower levels of home ownership. Much worse would be the effects on businesses that could no longer secure debt funding. It's got nothing to do with the fractional reserve system, by the way - a 100% reserve bank still borrows short and lends long and still is subject to bank runs. Rather than a race-condition, a better way to look at it is as an unstable equilibrium. The bank isn't assuming it can keep your deposit for any length of time; instead, it's assuming that in aggregate over all its depositors a certain amount of money will be left on deposit at any given time. Obviously this assumption goes out the window if the depositors act together to remove their deposits - as long as they don't, the system is in equilibrium (it's not rational to withdraw your deposit and forego the interest). As soon as the equilibrium is disturbed and a run starts though, the risk increases sharply and it becomes rational to withdraw your deposit. Government-backed deposit insurance stabilises the equilibrium.
- pdonis 14y ago
  > It's got nothing to do with the fractional reserve system, by the way - a 100% reserve bank still borrows short and lends long and still is subject to bank runs. How is this possible? If the bank has to keep 100% of its deposits in reserve, how can it lend at any longer term than the deposits are borrowed for?
  - nhaehnle 14y ago
    You're right, this is not possible. What caf may have been thinking of is that banks may borrow money subject to other conditions, such as by emitting bonds, to which the 100% reserve requirement doesn't apply. Of course, such a system is also subject to bank runs, just via a different mechanism ("run on bonds" by lenders refusing to roll the bonds over instead of run on deposits).

by arohner 14y ago

caf 14y ago

8%? There's no way the rates would be that low if you required your 10 year mortgage to be entirely backed by 10 year bonds. I do agree that house prices would necessarily fall, but the new point on the price/demand curve would see both lower prices and lower levels of home ownership. Much worse would be the effects on businesses that could no longer secure debt funding. It's got nothing to do with the fractional reserve system, by the way - a 100% reserve bank still borrows short and lends long and still is subject to bank runs. Rather than a race-condition, a better way to look at it is as an unstable equilibrium. The bank isn't assuming it can keep your deposit for any length of time; instead, it's assuming that in aggregate over all its depositors a certain amount of money will be left on deposit at any given time. Obviously this assumption goes out the window if the depositors act together to remove their deposits - as long as they don't, the system is in equilibrium (it's not rational to withdraw your deposit and forego the interest). As soon as the equilibrium is disturbed and a run starts though, the risk increases sharply and it becomes rational to withdraw your deposit. Government-backed deposit insurance stabilises the equilibrium.

pdonis 14y ago
> It's got nothing to do with the fractional reserve system, by the way - a 100% reserve bank still borrows short and lends long and still is subject to bank runs. How is this possible? If the bank has to keep 100% of its deposits in reserve, how can it lend at any longer term than the deposits are borrowed for?
- nhaehnle 14y ago
  You're right, this is not possible. What caf may have been thinking of is that banks may borrow money subject to other conditions, such as by emitting bonds, to which the 100% reserve requirement doesn't apply. Of course, such a system is also subject to bank runs, just via a different mechanism ("run on bonds" by lenders refusing to roll the bonds over instead of run on deposits).