Merv To Prop Up Housing If Q E Fails

[OnlyMe]

If I had deposited £1000 pounds with the bank, I would not be happy with them lending ANY of my money to anyone else, if there was a risk that I would not get my £1000 back on demand.

You can have it back, but now it comes the implicit threat that it will be devalued regardless (in particular the situation now) whilst the banks rake off benefit to make them better and allow them to continue gambling and take their bonus pots.

[easy2012]

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Thank you for your reasoned respond.

If everyone is defaulting on their debts, a small percentage of capital reserves isn't going to cover all of the deposits.

Then the bank goes into administration and what the depositors (and other creditors, employees) etc ultimately loss is the difference

between the (asset+capital reserve) and liability.

It sounds like you're confusing monetary reserves with capital reserves, as you mention narrow money.

When credit defaults, the losses will be soaked up by the capital reserves, but as long as they have sufficient capital reserves, future lending will be unaffected; low risk lending may even be encouraged, to rebuild capital reserves (from profits on safe loans).

Thinking again, you are right and I did mix up capital ratio and reserve ratio. Thanks for clarifying.

If the banks 'create money out of nothing', what is the percentage of held reserves related to? It's rhetorical - it's because they have a liability to repay the whole deposit, but only expect there to be a claim on a fraction of this. The rest they put to work by extending credit to others, which in turn allows them to pay more interest on your deposits, while paying for running costs and making a profit for shareholders.

The difference as academic; the more credit they extend, the smaller the fraction they have for covering withdrawals. They always need enough liquidity to cover the demands on liabilities. To say the banks 'create money' is untrue as otherwise, servicing these liabilities wouldn't be a problem - they could just create some more money.

Indeed that the more credit they extend, the smaller the fraction they have for covering withdrawals (except of course that if they run out of this, BoE will send them some more vis overnight lending). The difference isn't just academic because the credit money they created becomes interest bearing and increase the total purchase power in the economy immediately. So, bank is creating new purchasing power out of thin air, and I suppose it is not far off to call that purchasing power 'money'.

If a brand new bank just open with just £10 of deposit, I can walk into the bank and bank can credit my current account with £90.

So now, there is £10 + £90 of money like instrument in the new bank system. Now, say this is a small community and everybody bank with the bank only. I can then transfer the £90 to bank customer 2 to buy a cheese and customer 3 can then transfer the £90 to buy a goat. At the same time, the depositor of the £10 can transfer his £10 to buy a jam as well from another of the bank customer. So, with just £10 of initial government money, £100 worth of purchasing power is created.

Back to the old days, with a pound of gold deposit, the goldsmith could create an interest bearing instrument with 100 pound worth of purchasing power. The credit behaves like money.

Additionally, if this new credit defaults, it means they have to take a hit on their capital reserves. There is a very real need to only lend to those who appear able to pay it back, as otherwise the back risks insolvency, if it can't raise more capital again (through other good assets or by issuing shares).

Indeed.

The bank doesn't create money out of thin air, it extends credit, based on their assessment that it will be repaid.

I suppose you can put it this way, or you can say banks creates new purchasing power out of thin air, based on their assessment that the purchasing power will be 'repaid' from future earnings.

The more credit they extend, the fewer cash assets they have with which to service demand deposits. In effect, they are lending out your money, because they still have a liability to repay you (in full) on demand, but have swapped the cash assets (your deposited money) for interest yielding debt assets (loans).

Just because the banks promise to repay you your money, while giving it to someone else, it doesn't mean they are 'creating money'. They are just estimating that everyone with money on deposit, won't want all of it at once. They then use the remainder to loan out to others, creating multiple claims on the same money*.

(* This borrowed money may then be used to pay someone else, creating yet another claim on they money - increasing broad money. These chains of credit grow, regardless as to whether you have full reserve with timed savings or fractional reserve banking)

However, they don't really lend out your money because they can always get the additional liquidity from BoE (which caused new money to be created). So, bank creates bank credits out of thin air, and when conversion to BoE money is demanded upon, it causes BoE to create new BoE money out of thin air through the overnight lending facilities (or the bank can borrow from other bank via the LIBOR market).

As for 'estimating that everyone with money on deposit, won't want all of it at once ...', this is no longer quite true because of BoE's role. If you take out a mortgage, in effect, you are lending to yourself (time shifted).

Again, simplify this down to a mythical small bank with £10k of deposit, now you MEW your home for £100k cash. So bank 'credits' your account with £100k. Now you transfer the £100k to bank B to buy a something from another bank's customer, the mythical bank will either borrow from LIBOR (no new money) or from BoE overnight facilities (new money created).

If you buy something from the same bank's customer, then as above, additional purchasing power is created out of thin air (or you can say from one's future earning power).

It doesn't affect the original assertion - the assets (cash, debt etc) back the liabilities (savings, bonds etc). If you write off all debts (ie. make those underlying assets you talk of, worthless), a relative slither of capital reserves isn't going to save all deposits. At current levels, it would save about 8p in the £1.

I'm not sure what is phoney about credit giving multiple claims on money either.

However, what is backing the debt? Businesses, production facilities, properties and government borrowings. So, if the debts are defaulted (as opposed to write off/forgiven), then the banks creditors will own the real values (shops, houses, government bonds etc.). The figure will be far higher than 8p per £ - but does the number matters or is the real productive capacity that matters (admitted, the process is going to be very chaotic, which present another problem). I looked at NR account before nationalisation and they got £4bn of capital and £100bn of loan. Not sure how much have they lost now, but certainly no where near £96bn (which is needed to reduce the total creditor claim to 8p per £).

The credit is phoney (I accept that this is totally subjective ) exactly because of credit's multiple claims on the ultimate real values, abit like a option for an CDS on a CDS of another CDS.

Edited September 19, 2010 by easybetman

[Alan B'Stard MP]

Then the bank goes into administration and what the depositors (and other creditors, employees) etc ultimately loss is the difference

between the (asset+capital reserve) and liability.

EBM - not sure why you adding "capital" to assets?

Capital is the residue of the assets once the liabilities have been removed.

A = C + L

Edited September 19, 2010 by Alan B'Stard MP

[easy2012]

BTW, as a thought experiment - if the individual chose how much money could loaned to others, rather than the bank, would this mean the bank was 'creating money from thin air'? Or, alternatively, would it mean the individual had just decided to allow the bank to loan a proportion of their money out?

Interesting. How about if I am a car rental company with 10 cars but I sell 100 full time car rentals contracts and telling the customers they can have their car at anytime? Should some of the rental contracts be considered phoney because they represent multiple claims on the 10 cars ?

I suppose I can do that if I am backed by Toyota who agrees to supply me with unlimited number of cars at 1.5% overnight.

In the absence of Toyota, I think this would be a case for the trading standards?

So, basically, Banks are allowed to do things that no other businesses are allowed to do, ultimately because it is backed by BoE (Toyota)..

Further, imagine if there are landlords who allow to 'fractionally' rent out at 100% of the time tenancy their flats and the government agrees to supply unlimited number of flats for a small fees whenever the landlord needs a temporary access to extra flats.

Edited September 20, 2010 by easybetman

[easy2012]

EBM - not sure why you adding "capital" to assets?

Capital is the residue of the assets once the liabilities have been removed.

A = C + L

I know what you mean in a conventional sense but I think in Banking the term 'asset' (or more accurately, the term Banking Asset) is used to refer to for papers that the bank own isn't it?

Asset (loan papers, gilts, Bank's own deposit) = Liability (what the bank owes to depositors) [on papers make to believe values anyway]

________________________________________

Tier 1/2 capital supporting it to absorb lost

That is why you got this Risk Weighted Asset : Capital ratio. Otherwise, if capital is part of the A then it makes not sense to do a RWA : Capital

ratio.

So, assuming a bank with £100 of capital and an £200 deposit and £1000 mortgage, the balance sheet would be:

[Asset:] | [Liabilities]

£200 [deposit received] | -£200 [depositor current account balance]

£1000[83.3% LTV mortgage trust deed on £1200 property] | -£1000 mortgage advance in current account

----------------------------------------------------------------------------------------------------------

£100 Capital (or maybe £105 capital now and £195 depositor balance as bank charge fees for mortgage).

Edited September 20, 2010 by easybetman

[Riedquat]

.

If a brand new bank just open with just £10 of deposit, I can walk into the bank and bank can credit my current account with £90.

So now, there is £10 + £90 of money like instrument in the new bank system. Now, say this is a small community and everybody bank with the bank only. I can then transfer the £90 to bank customer 2 to buy a cheese and customer 3 can then transfer the £90 to buy a goat. At the same time, the depositor of the £10 can transfer his £10 to buy a jam as well from another of the bank customer. So, with just £10 of initial government money, £100 worth of purchasing power is created.

How? Were people sitting on those commodities before, all wanting to exchange them but being unable to because of a lack of means? I don't really see how this scenario has done anything other than devalue the money (i.e. cause inflation) and give the bank an excuse to grab a portion of it. In such a small scenario I would imagine that the value of money would very quickly adjust to whatever real wealth is available, in a much bigger one it's far easier to hide that fact. If it doesn't adjust quickly enough then someone might end up buying most of the commodities themselves, leaving others with money that's now not worth anything simply because there's nothing left to spend it on. Meanwhile, the person "owning" what's there ends up having to give a large chunk of it to the bank in interest. Result - bank does well, most others suffer.

[easy2012]

How? Were people sitting on those commodities before, all wanting to exchange them but being unable to because of a lack of means? I don't really see how this scenario has done anything other than devalue the money (i.e. cause inflation) and give the bank an excuse to grab a portion of it. In such a small scenario I would imagine that the value of money would very quickly adjust to whatever real wealth is available, in a much bigger one it's far easier to hide that fact. If it doesn't adjust quickly enough then someone might end up buying most of the commodities themselves, leaving others with money that's now not worth anything simply because there's nothing left to spend it on. Meanwhile, the person "owning" what's there ends up having to give a large chunk of it to the bank in interest. Result - bank does well, most others suffer.

Obviously the real world is more complex (preferences, additional capacities etc) but you can see that effect in House price rise.

And yup, bank credit expansion (i.e M4) above real value growth is highly inflationary.

And yup, bank does well until there is lots of defaults not make good by the government...

[Alan B'Stard MP]

I know what you mean in a conventional sense but I think in Banking the term 'asset' (or more accurately, the term Banking Asset) is used to refer to for papers that the bank own isn't it?

Asset (loan papers, gilts, Bank's own deposit) = Liability (what the bank owes to depositors) [on papers make to believe values anyway]

________________________________________

Tier 1/2 capital supporting it to absorb lost

That is why you got this Risk Weighted Asset : Capital ratio. Otherwise, if capital is part of the A then it makes not sense to do a RWA : Capital

ratio.

So, assuming a bank with £100 of capital and an £200 deposit and £1000 mortgage, the balance sheet would be:

[Asset:] | [Liabilities]

£200 [deposit received] | -£200 [depositor current account balance]

£1000[83.3% LTV mortgage trust deed on £1200 property] | -£1000 mortgage advance in current account

----------------------------------------------------------------------------------------------------------

£100 Capital (or maybe £105 capital now and £195 depositor balance as bank charge fees for mortgage).

The balance sheet of any bank is no different to your average Joe Blow company.

It consists of accounts of varying "types"

Balance Sheet:

Capital / Owners' equity accounts

Liability accounts

Asset Accounts

Profit and Loss:

Revenue Accounts

Expense accounts.

The balance sheet doesn't even exist as a financial statement - until it prepared at the closing of a period. All activity occurs against the P & L - and the sub-ledgers - which feed it.

The "regulatory capital requirement" is a measure of balance sheet 'instruments' - and of course can only be calculated if a balance sheet exists.

Going to your example:

Why would an investor buy existing stock in a bank if the liquidation value of the assets (+ your definition capital) would only cover the normal liabilities - and leave nothing for anyone else?

Also, your balance sheet doesn't "balance". Not easy with double-entry bookkeeping !

For the "bank entity" - capital is the claim of the owners on the residual value of the asset once the liabilites are taken care of.

It's a picture of solvency put in the context of "liquidation value". The "value" can only be Assets.

Edited September 20, 2010 by Alan B'Stard MP

[easy2012]

The balance sheet of any bank is no different to your average Joe Blow company.

It consists of accounts of varying "types"

Balance Sheet:

Capital / Owners' equity accounts

Liability accounts

Asset Accounts

Profit and Loss:

Revenue Accounts

Expense accounts.

The balance sheet doesn't even exist as a financial statement - until it prepared at the closing of a period. All activity occurs against the P & L - and the sub-ledgers - which feed it.

The "regulatory capital requirement" is a measure of balance sheet 'instruments' - and of course can only be calculated if a balance sheet exists.

Thanks for your clarification. Right, so the RWA ratio would have included bank's capital (but charged at 0%) - is that right ?

And of course day to day operation are put through to P&L, and as you said, feed into the BL.

Why would an investor buy existing stock in a bank if the liquidation value of the assets (+ your definition capital) would only cover the normal liabilities - and leave nothing for anyone else?

Think you misunderstood me here. So if bank has:

(1) £100 capital

(2) £100 mortgage trust deed (LTV 83.3% on a £120 property)

(3) Owe me £100 (of bank credit) in my current account whcih I have just MEW from the above property

On liquidation, (2),(3) would set off leaving the £100 capital to be distributed by the shareholders (that is why people buy bank stock)

Say if I spend the £100 I just obtained from the MEW with another customer2 of the bank (to keep it simple) and then defaulted,

then the bank would sell the property to customer2 (at a knocked down price of £100) and take the £100 back.

And of course if the property can only be sold for £80k and the bank still owe customer2 £100k, then the £20 will come through

on the BL and hit the £100 capital.

Also, your balance sheet doesn't "balance". Not easy with double-entry bookkeeping !

OK...balanced now.

Asset side: £100 mortgage, (secured against £120 property) + £100 capital

Liability : £100 in current account, £100 to shareholders.

Edited September 20, 2010 by easybetman

[Alan B'Stard MP]

\Think you misunderstood me here. So if bank has:

(1) £100 capital

(2) £100 mortgage trust deed (LTV 83.3% on a £120 property)

(3) Owe me £100 (of bank credit) in my current account whcih I have just MEW from the above property

This doesn't fit the accounting id A = C + L.

asset = $100 mortgage

liabilities = $100 bank credit

capital = $100

$100≠ $100 + $100.

On liquidation, (2),(3) would set off leaving the £100 capital to be distributed by the shareholders (that is why people buy bank stock)

Is your "capital", cash? Cash is an asset recorded in "Cash at Bank" asset account. It is not a capital account on the balance sheet.

Say if I spend the £100 I just obtained from the MEW with another customer2 of the bank (to keep it simple) and then defaulted,

then the bank would sell the property to customer2 (at a knocked down price of £100) and take the £100 back.

Okay. What happens when customer2 withdraws and takes his cash with him? Why has the bank suddenly become insolvent? Why have the shareholders lost value when no asset revaluation has occured? Banks hold very little cash - are they to become insolvent because of a heavy christmas?

[easy2012]

This doesn't fit the accounting id A = C + L.

asset = $100 mortgage

liabilities = $100 bank credit

capital = $100

$100≠ $100 + $100.

Is your "capital", cash? Cash is an asset recorded in "Cash at Bank" asset account. It is not a capital account on the balance sheet.

Okay. What happens when customer2 withdraws and takes his cash with him? Why has the bank suddenly become insolvent? Why have the shareholders lost value when no asset revaluation has occured? Banks hold very little cash - are they to become insolvent because of a heavy christmas?

See if I can fix it.

So, on a balance sheet you got:

Asset

Liabilities

--------------

Net asset ( asset - liabilities )

------------

Then you got shareholder fund which are:

Accumulated PL (minus dividend payout)

Share capital (including share premium)

Requirement: Net Asset = Shareholderfund+PL

So, if you have £100 capital, £100 mortgage trust deed and credited the MEWing customer £100, the balance sheet would be:

Asset : £100 (cash from share subscription) + £100 (mortgage trust deed)

Liability : £100 (owed to mewing customer)

Net Asset = £100

On sharecapital side:

PL : 0 (first day trading)

Share capital : £100

Looks balanced to me.

Why would the bank becomes insolvent when customer2 withdraw the cash? If customer2 withdraw the cash and transfer it to bankB customer3,

what bank A does is to take the mortgage paper to bankB and say credit customer3 account with £100 please and you can have this customerA mortgage paper.

CustomerA now indirectly owe money to BankB (customer still make payment to bankA, bankA pass it on. This is done via repo or securitisation). Bank B now owes money to customer3 (current account balance). When Customer1 fully repaid the mortgage, the mortgage loan is extinguished and so customer1 owes no more, and so bankA owes no more as well, having pass all the payement through . ( Any spread made is credited to P&L, of course, omitted for simplicity).

BankB now owes customer3 £100, but it also have £100 on its cash account (at BoE) having received the payment from Customer1 via bankA.

(In reality again, of course, Bank A probably takes this paper to BoE / wholesale funder via Repo, BoE gives bankA BoE money and Bank A gives BoE money, instead of the paper to Bank B. ).

At end of the transaction

Balance sheet: of Bank A

Asset : Cash £100 (capital) + 0 (mortgage paper gone via Repo)

Liability : 0 (because it has paid customer3 on behalf of customer 2 behalf - that is what withdrawal/transfer really means anyway)

Net asset: £100

shareholder fund/PL : £100

Balance sheet of BankB:

Asset: Cash £100 (total repayment from the mortgage paper) + whatever capital it got, say Y + cash from accumulated PL

Liability: £100 owed to customer3.

Net asset - liability = Y

Shareholderfund = Y + accumulated PL

Can't see a problem with that...

Edited September 20, 2010 by easybetman

[Alan B'Stard MP]

Asset : £100 (cash from share subscription) + £100 (mortgage trust deed)

Liability : £100 (owed to mewing customer)

Net Asset = £100

On sharecapital side:

PL : 0 (first day trading)

Share capital : £100

Can't see a problem with that...

Now you've changed your story ! Where did this extra $100 come from !

Your share capital is not a "thing of value" btw - it's a claim on the $100 asset. You can't "deposit" balance-sheet capital at the central bank because the "asset" might not be cash. The "capital" is just a post-it note.

Edited September 20, 2010 by Alan B'Stard MP

[easy2012]

Now you've changed your story ! Where did this extra $100 come from !

Your share capital is not a "thing of value" btw - it's a claim on the $100 asset. You can't "deposit" balance-sheet capital at the central bank because the "asset" might not be cash. The "capital" is just a post-it note.

Please explain - don't think I get you fully.

When the bank sell shares, it receives cash (or cash like instrument such as gilts, if bank directors wants to accept that ) in return.

The bank can lock the cash up in a vault of course rather than depositing it at the central bank - that is not important. What is important

is that this is something readily convertible to BoE money.

If you want to compare this to small Ltd companies where the share owner put in a 'post it note' to say it owes the company £100, that is fine

too. In this case, your balance sheet has:

Shareholder pledge £100 (or you can have this limited by a guarantee of £100 for some companies)

Asset : mortgage £100

Liability : £100 to customer 1

Net asset is still the £100 shareholder pledge

Shareholder fund (what the company owes to the shareholder on liquidation)

£100

still can't see a problem with that. If the Ltd company goes bust, the shareholder is liable to pay that £100 into the comnpany.

[Traktion]

If I had deposited £1000 pounds with the bank, I would not be happy with them lending ANY of my money to anyone else, if there was a risk that I would not get my £1000 back on demand.

Whenever money is loaned out, there is always a risk that it won't be repaid.

[Alan B'Stard MP]

Please explain - don't think I get you fully.

When the bank sell shares, it receives cash (or cash like instrument such as gilts, if bank directors wants to accept that ) in return.

The bank can lock the cash up in a vault of course rather than depositing it at the central bank - that is not important. What is important

is that this is something readily convertible to BoE money.

If you want to compare this to small Ltd companies where the share owner put in a 'post it note' to say it owes the company £100, that is fine

too. In this case, your balance sheet has:

Shareholder pledge £100 (or you can have this limited by a guarantee of £100 for some companies)

Asset : mortgage £100

Liability : £100 to customer 1

Net asset is still the £100 shareholder pledge

Shareholder fund (what the company owes to the shareholder on liquidation)

£100

still can't see a problem with that. If the Ltd company goes bust, the shareholder is liable to pay that £100 into the comnpany.

The investor puts in his $100 cash and receives his stock / IOU share certificate. The post-it-note is the book entry for this - the claim of the shareholders on the company "personage" or the obligation of the company personage to the owners - which ever takes your fancy. The $100 becomes an asset and recorded as such.

The value of the certificate floats according to the value or equity in the company which is calculated as the value of the assets minus the normal liabilities. It is the liquidation value, the residual value. It is the balance sheet capital.

If such a company used that $100 to buy Land or another asset - there is still plenty of capital recorded on the balance sheet - just no cash - and so it can't deposit "capital" at a bank. The capital valuation will now float with the land market. The best place for capital in this context is in your lawyers safe. Conversely, a company could have wafer thin capital - but loads of cash and so could make such a deposit.

Not sure why you are talking about pledges?

Edited September 21, 2010 by Alan B'Stard MP

[Traktion]

Indeed that the more credit they extend, the smaller the fraction they have for covering withdrawals (except of course that if they run out of this, BoE will send them some more vis overnight lending). The difference isn't just academic because the credit money they created becomes interest bearing and increase the total purchase power in the economy immediately. So, bank is creating new purchasing power out of thin air, and I suppose it is not far off to call that purchasing power 'money'.

That purchasing power was always there, it just wasn't being used. That it wasn't being used, is precisely why they can extend credit.

You could argue that savings (or financial capital) are just being stored for a rainy day, but most people put their savings in a high interest account, to 'put it to work' as they say.

If a brand new bank just open with just £10 of deposit, I can walk into the bank and bank can credit my current account with £90.

So now, there is £10 + £90 of money like instrument in the new bank system. Now, say this is a small community and everybody bank with the bank only. I can then transfer the £90 to bank customer 2 to buy a cheese and customer 3 can then transfer the £90 to buy a goat. At the same time, the depositor of the £10 can transfer his £10 to buy a jam as well from another of the bank customer. So, with just £10 of initial government money, £100 worth of purchasing power is created.

That would be very irresponsible though, as the bank would be plunged into a liquidity crisis, as soon someone tried to withdraw the the newly extended credit (or 'test' their new purchasing power). You're then a slave to the short term money markets or central bank assistance (if offered) - this sounds very much like the problems Northern Rock ended up with.

I suppose you can put it this way, or you can say banks creates new purchasing power out of thin air, based on their assessment that the purchasing power will be 'repaid' from future earnings.

They're using idle money to give to others. You can argue that the idle money should be just that, but risking money for a return isn't (nor should be) illegal. But we're starting to get to the heart of the problem - that bank savings are considered 'risk free', when they can't be.

In reality, much of the savings should have been lost during this crisis. The fact it hasn't been and the central banks and governments acted to save these gives validity to the claim that banks 'create money' - it's not FRB which does this, it's the central bank printing the money up afterwards.

However, they don't really lend out your money because they can always get the additional liquidity from BoE (which caused new money to be created). So, bank creates bank credits out of thin air, and when conversion to BoE money is demanded upon, it causes BoE to create new BoE money out of thin air through the overnight lending facilities (or the bank can borrow from other bank via the LIBOR market).

There's nothing wrong with creating credit out of thin air - promises can be made any time, any where. It's the fact that money is at risk when these promises are challenged, which isn't realised. As you point out, it's the BoE which prints money to replace credit when things go wrong, which shouldn't be the case - all bank savings are investments, carrying risk. If people want to be risk free, they shouldn't put their money in a bank who use it to extend credit to others.

As for 'estimating that everyone with money on deposit, won't want all of it at once ...', this is no longer quite true because of BoE's role. If you take out a mortgage, in effect, you are lending to yourself (time shifted).

Indeed - the role of the central banks are central to the problem.

Again, simplify this down to a mythical small bank with £10k of deposit, now you MEW your home for £100k cash. So bank 'credits' your account with £100k. Now you transfer the £100k to bank B to buy a something from another bank's customer, the mythical bank will either borrow from LIBOR (no new money) or from BoE overnight facilities (new money created).

Again, it's not the FRBs creating money here, but the central banks. If the FRBs can't get hold of liquidity, they could be liquidated with savers taking a hair cut.

If you buy something from the same bank's customer, then as above, additional purchasing power is created out of thin air (or you can say from one's future earning power).

There is no guarantee the money will not be withdrawn or will go to another bank though. Even if banks lend to one another, you can quickly end up playing musical chairs, with the losers being liquidated. This hasn't been allowed to happen, but it would destroy this purchasing power as quickly as it was created - ultimately, there is (or should be) only a limited amount of cash in the system.

FRB is risky, yes, but not magical. Only the central banks have the power to create money. The fact that this risk is pasted over with printed money from the central banks is the problem.

However, what is backing the debt? Businesses, production facilities, properties and government borrowings. So, if the debts are defaulted (as opposed to write off/forgiven), then the banks creditors will own the real values (shops, houses, government bonds etc.). The figure will be far higher than 8p per £ - but does the number matters or is the real productive capacity that matters (admitted, the process is going to be very chaotic, which present another problem). I looked at NR account before nationalisation and they got £4bn of capital and £100bn of loan. Not sure how much have they lost now, but certainly no where near £96bn (which is needed to reduce the total creditor claim to 8p per £).

I thought we were discussing a jubilee - the removal of debt, but not the assets from the indebted. Obviously, if we have mass defaults, that's a different thing and you would have value in the assets the loans were secured on.

The credit is phoney (I accept that this is totally subjective ) exactly because of credit's multiple claims on the ultimate real values, abit like a option for an CDS on a CDS of another CDS.

Credit is just a promise. I can give you a million pounds in credit any time I like, but it doesn't mean that I'll have it when you come to withdraw it (I'll have my own personal liquidity crisis! ).

This is different if I'm more careful - Bob could give me £100 to invest, under the agreement that I promise they can have it back any time. If they only tended to ask for a tenner now and again, I could give you £50 of credit and be unlikely to suffer a liquidity crisis. If both parties wanted the cash, then there wouldn't be enough. Bob would take a hair cut (as his money was at risk) and I would be out of the banking business.

There are many things wrong with our financial system, but accusing FRBs of creating money isn't really the correct diagnosis.

Edited September 21, 2010 by Traktion

[Traktion]

Interesting. How about if I am a car rental company with 10 cars but I sell 100 full time car rentals contracts and telling the customers they can have their car at anytime? Should some of the rental contracts be considered phoney because they represent multiple claims on the 10 cars ?

Why would they be phoney? If only 5 of the cars is usually in use, what's the problem? If the rental company promised to deliver you a car, but there wasn't enough, then you would be disappointed, but would you expect them to hold 100 cars when only a few were used at a time? It would certainly make accessing the cars more expensive.

I suppose I can do that if I am backed by Toyota who agrees to supply me with unlimited number of cars at 1.5% overnight.

In the absence of Toyota, I think this would be a case for the trading standards?

It would seem like a very good deal for the rental company - how could they lose? If Toyota could print up cars, clearly there would be room for abuse here.

IIRC, that overnight rate would be the one going negative with NIRP implemented.

So, basically, Banks are allowed to do things that no other businesses are allowed to do, ultimately because it is backed by BoE (Toyota)..

Bullseye! So we agree where the problem lies? The central banks with their magic printing presses!

[easy2012]

Bullseye! So we agree where the problem lies? The central banks with their magic printing presses!

Oh yes !

[easy2012]

That purchasing power was always there, it just wasn't being used. That it wasn't being used, is precisely why they can extend credit.

You could argue that savings (or financial capital) are just being stored for a rainy day, but most people put their savings in a high interest account, to 'put it to work' as they say.

That would be very irresponsible though, as the bank would be plunged into a liquidity crisis, as soon someone tried to withdraw the the newly extended credit (or 'test' their new purchasing power). You're then a slave to the short term money markets or central bank assistance (if offered) - this sounds very much like the problems Northern Rock ended up with.

They're using idle money to give to others. You can argue that the idle money should be just that, but risking money for a return isn't (nor should be) illegal. But we're starting to get to the heart of the problem - that bank savings are considered 'risk free', when they can't be.

In reality, much of the savings should have been lost during this crisis. The fact it hasn't been and the central banks and governments acted to save these gives validity to the claim that banks 'create money' - it's not FRB which does this, it's the central bank printing the money up afterwards.

There's nothing wrong with creating credit out of thin air - promises can be made any time, any where. It's the fact that money is at risk when these promises are challenged, which isn't realised. As you point out, it's the BoE which prints money to replace credit when things go wrong, which shouldn't be the case - all bank savings are investments, carrying risk. If people want to be risk free, they shouldn't put their money in a bank who use it to extend credit to others.

Indeed - the role of the central banks are central to the problem.

Again, it's not the FRBs creating money here, but the central banks. If the FRBs can't get hold of liquidity, they could be liquidated with savers taking a hair cut.

There is no guarantee the money will not be withdrawn or will go to another bank though. Even if banks lend to one another, you can quickly end up playing musical chairs, with the losers being liquidated. This hasn't been allowed to happen, but it would destroy this purchasing power as quickly as it was created - ultimately, there is (or should be) only a limited amount of cash in the system.

FRB is risky, yes, but not magical. Only the central banks have the power to create money. The fact that this risk is pasted over with printed money from the central banks is the problem.

I thought we were discussing a jubilee - the removal of debt, but not the assets from the indebted. Obviously, if we have mass defaults, that's a different thing and you would have value in the assets the loans were secured on.

Credit is just a promise. I can give you a million pounds in credit any time I like, but it doesn't mean that I'll have it when you come to withdraw it (I'll have my own personal liquidity crisis! ).

This is different if I'm more careful - Bob could give me £100 to invest, under the agreement that I promise they can have it back any time. If they only tended to ask for a tenner now and again, I could give you £50 of credit and be unlikely to suffer a liquidity crisis. If both parties wanted the cash, then there wouldn't be enough. Bob would take a hair cut (as his money was at risk) and I would be out of the banking business.

There are many things wrong with our financial system, but accusing FRBs of creating money isn't really the correct diagnosis.

Yap - as long as banks can be held responsible for the "unlikely to be realisable at all time" promise, then there is less of an issue. Think a low ratio of FRB (say 1:5)

would be less riskly than 1:10 FRB or 1:25 FRB. Banks are behaving recklessly simply because of they are backed by the big boss !

[easy2012]

The investor puts in his $100 cash and receives his stock / IOU share certificate. The post-it-note is the book entry for this - the claim of the shareholders on the company "personage" or the obligation of the company personage to the owners - which ever takes your fancy. The $100 becomes an asset and recorded as such.

The value of the certificate floats according to the value or equity in the company which is calculated as the value of the assets minus the normal liabilities. It is the liquidation value, the residual value. It is the balance sheet capital.

If such a company used that $100 to buy Land or another asset - there is still plenty of capital recorded on the balance sheet - just no cash - and so it can't deposit "capital" at a bank. The capital valuation will now float with the land market. The best place for capital in this context is in your lawyers safe. Conversely, a company could have wafer thin capital - but loads of cash and so could make such a deposit.

Not sure why you are talking about pledges?

Sorry... should have used the proper term of "Share Capital Called up but not paid" for the 'pledge'.

Agree with what you say but I think (and logically so), Banks are required to hold liquid capital. Don't think FSA let's bank keep their capital as collection of fine wine !

Anyway, the balance sheet now balanced (on paper) and the bank don't go bust (and again, not going bust is another paper event).

[Alan B'Stard MP]

Banks are required to hold liquid capital. Don't think FSA let's bank keep their capital as collection of fine wine !

They held reserves voluntarily under the sterling monetary framework. That was suspended due the crisis. They might be required to hold liquid assets - but only solvency and regulation determines what their "capital" needs to be.

Each reserves maintenance period runs between the monthly scheduled MPC meetings. Reserves scheme members undertake to maintain a level of reserves within a defined range around a target they choose,

http://www.bankofengland.co.uk/markets/money/reserves/index.htm

Edited September 22, 2010 by Alan B'Stard MP

[Bloo Loo]

(I'm afraid I haven't read the entire thread, pretty sure it's gone somewhere else - but would just like to comment to the OP.)

I think you are jumping to conclusions.

Whilst I agree 'housing IS the economy', given what Merv and the BoE have said about re-balancing and bank lending my expectation is that their top priority is lending to business. The statement quoted could just as easily be applied to focusing easing on this sector as it can to housing.

If you are correct, and I suspect you are, and housing IS the economy, Im afraid we are all living in the end game of a Ponzi..

[Traktion]

Yap - as long as banks can be held responsible for the "unlikely to be realisable at all time" promise, then there is less of an issue. Think a low ratio of FRB (say 1:5)

would be less riskly than 1:10 FRB or 1:25 FRB. Banks are behaving recklessly simply because of they are backed by the big boss !

There is the rub though - while there are deposit guarantees, no 'safe' (ie. no counter party risk) banks, central bank assistance, government bailouts (on goes the list...), we're going to have problems.

IMO, FRB can be useful for those who want to invest in this way, but it can't be sanitised or made safe. It is inherently risky. By trying to make it safe, they have just left savers and taxpayers with the bill.

If the support for FRB was removed, with its frailties laid bare, then I am sure the market would come up with safer alternatives. FRBs which advertise their reserve (liquidity) ratios, Limited Purpose Banks which pose no risk from bank runs, narrow 'safe' banks for those who just want safety deposit boxes with direct debits, cards, ATMs etc.

The current system not only causes all sorts of moral hazard and instability, but it also stifles the market from providing better alternatives.

[Realistbear]

http://www.bloomberg.com/news/2010-09-22/boe-voted-8-1-to-hold-rates-as-officials-said-economy-may-need-more-help.html

Related News:Europe · U.K. & Ireland · Economy .BOE Signals Moving Closer to More Stimulus as Growth Slows

By Svenja O’Donnell - Sep 22, 2010 10:33 AM GMT+0100

Bank of England policy maker Andrew Sentance said, “We have to distinguish between unevenness of the rate of growth which we often get at this stage of the economic cycle and a genuine double-dip recession.”

The Bank of England signaled that policy makers are moving closer to adding more stimulus to the economy, joining the Federal Reserve in contemplating further bond purchases to revive a flagging recovery.

The last simulus has worked its way through the system and has long since petered out. The next round of stimulus will last for awhile and then do the same thing. Its ineffective simply because the black hole is to be measured in the tens of trillions not a few hundred billion. Given the choice between hyperinflation and a decade or more of deflation the latter course should be taken as the pain will be shorter and actually create a stronger foundation for propserity 20 years hence. If we take the former route we will simply have another Browe-style boom and bust with a much bigger bust as a result.

The house markets MUST be allowed to collapse and die so that we can build on a solid foundation and not try to do it on the vestiges of a bubble.

[Mega]

Just seen my accountant, claimed most of my Tax from last year back, watch LOTS of blokes whom are suddenly out of work, most self-employed....the Goverment must be handing back VAST ammounts of cash............