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Banks Turn Cash Into Mortgages And Back Into Cash

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http://www.bloombergview.com/articles/2014-09-15/banks-turn-cash-into-mortgages-and-back-into-cash

Here is a quite wonderful post by Tracy Alloway at FT Alphaville about the Federal Home Loan Banks and the Liquidity Coverage Ratio. The issue, as it always is, is that:

  • everyone wants banks to be safe, but
  • everyone wants banks to do banking stuff.

The particular flavor of "safe" here is: Look, the big systemic risk of banks is runs on the bank. The way (a way) to reduce the risk of runs is for banks to just have a bunch of cash lying around. That way, if everyone comes into the bank yelling for their money back, you can just give them their money back.

But of course there'd be no point to a bank that just has a bunch of cash lying around. The whole point of a bank is to take cash from depositors and use it to do stuff. The particular flavor of stuff at issue here is mortgage loans. Banks take cash from depositors and lend it to people to buy houses. That's good, that's what they're supposed to do. But then the banks aren't safe, because if there's a run on the bank all the money is in mortgage loans, and you can't give depositors back mortgage loans, there is actually a movie about that.

So obviously what you should do is find a way for banks to take in cash, use it to make mortgage loans and then magically transmute it back into cash. And the U.S. financial system, being wonderful, has a way to do just that. It's called an advance from a Federal Home Loan Bank. Basically the FHLBs are government-sponsored enterprises that lend banks cash, at very low subsidized variable rates,1 secured by the banks' mortgages. The FHLBs get the money by selling bonds, which are implicitly government guaranteed.2

So the system is, schematically:

  1. Depositor deposits $1 at bank.
  2. Bank makes $1 mortgage loan.
  3. Bank borrows $1 against mortgage loan from FHLB.
  4. Bank has $1 in cash.
  5. FHLB borrows $1 from the market for safe agency bonds.

Here is a fake balance sheet for the system:3

iO6FFX.qK9YI.jpg

The magical result is that:

  • from a depositor's perspective, the bank is safe, because it has lots of cash;
  • from a mortgage borrower's perspective, the bank is nice, because it is giving the borrower a loan.

Everyone wins! ..

You can get outraged about this4 but to what end? Imagine that banks couldn't do this. Then they would either:

  1. make fewer mortgage loans (bad!),
  2. have less liquidity and be more vulnerable to runs (bad!), or
  3. find some other way to transform risky mortgages into safe cash.

The solution clearly is to keep giving the banks more free money to ensure they don't go bankrupt.

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Very few people understand this. The people that do go into banking. Since 2008 people have realised that banks aren't real businesses. They cannot go bust, they can never have too little cash - unless the state wants them to. But they get paid mega bonuses at the top and this is allowed because when the politicians need backing the banks give them political donations or help them implement more borrowing by hiding their liabilities through "magic such as this".

This is the way it has always been. In a 75 year lifespan you can either be reasonably well off as a banker and pass on something to your children or you can take the risk of working in an industry that can fail.

Banks are analogous to the large vents that pump the seas full of salts that provide life. The bacteria that hang around the vents and feed for free are effectively the same as the bankers taking their cut before the rest of the ocean has a chance to "feed". That's the way it will always be in a centralised system run by humans.

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Very few people understand this. The people that do go into banking. Since 2008 people have realised that banks aren't real businesses. They cannot go bust, they can never have too little cash - unless the state wants them to. But they get paid mega bonuses at the top and this is allowed because when the politicians need backing the banks give them political donations or help them implement more borrowing by hiding their liabilities through "magic such as this".

This is the way it has always been. In a 75 year lifespan you can either be reasonably well off as a banker and pass on something to your children or you can take the risk of working in an industry that can fail.

Banks are analogous to the large vents that pump the seas full of salts that provide life. The bacteria that hang around the vents and feed for free are effectively the same as the bankers taking their cut before the rest of the ocean has a chance to "feed". That's the way it will always be in a centralised system run by humans.

banks go bust all the time.

Its because they run out of liquid assets.

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not in this new normal they don't - this isn't the savings and loan crisis in the 70s when there were loads of little banks. Now, they have all consolidated into behemoths that are too big to fail. You will not see another bank fail unless the system itself is in peril.

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not in this new normal they don't -

That's what they were saying before the 2nd collapse in the railway mania.

Certainly if the government keeps throwing everything at the bankers the last thing they will need to worry about is going bust.

Show me a time in history when this sort of lunacy ended really well and the population decided to line in harmony with their oppressors ?

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.....rich people do not use their own money.....they borrow money at ultra low cost and with tax benefits to enable them to speculate and accumulate from......that is how the system is set up, hardly surprising why people act as they do.........those with access get what they ask for at the best price with little personal risk.....the rest are shut off completely, or pay dearly for little, at a higher personal risk.....relative. ;)

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http://www.bloombergview.com/articles/2014-09-15/banks-turn-cash-into-mortgages-and-back-into-cash

The solution clearly is to keep giving the banks more free money to ensure they don't go bankrupt.

One way or another the banks always end up with the money but one of the most important things is the route that the money takes.

The current system gives it direct to the banks to lend and spend first but they could give it to the people to give it to the banks as deposits or to spend it (for it still to end up in the banks) - however the latter option gives power to the people and puts them first in line to spend the money before it loses value. So the latter option would never do.

As the government doesn't really represent the wishes of all of the people (effectively they only represent the 1% which includes a lot of bankers) it's not equivalent to the people being given the money and the people using it.

Edited by billybong

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not in this new normal they don't - this isn't the savings and loan crisis in the 70s when there were loads of little banks. Now, they have all consolidated into behemoths that are too big to fail. You will not see another bank fail unless the system itself is in peril.

The self proclaimed wall street PR plant "liberal with a conscience" disagree's

http://krugman.blogs.nytimes.com/2010/01/11/too-big-to-fail-fail-2/?_r=0

The point is that breaking up the big players is neither necessary nor sufficient to protect us against financial crises.

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One way or another the banks always end up with the money but one of the most important things is the route that the money takes.

The current system gives it direct to the banks to lend and spend first but they could give it to the people to give it to the banks as deposits or to spend it (for it still to end up in the banks) - however the latter option gives power to the people and puts them first in line to spend the money before it loses value. So the latter option would never do.

As the government doesn't really represent the wishes of all of the people (effectively they only represent the 1% which includes a lot of bankers) it's not equivalent to the people being given the money and the people using it.

'the people' can't offer MP six figure non-exec positions once 'the people' tire of them.

MPs want to control things. Just dishing cash out to the public...well the public might spend it on the 'wrong' things. Like, not on houses.

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