Fractional Reserve Banking Will Crash The System

[laurejon]

TRASH AND cash - it's the new investment strategy that everyone's talking about. Spread a rumour, buy some cheap stock, make a packet. So, let's try it out, shall we. I'll spread a rumour that the Royal Bank of Scotland is in a pickle - pass it on. That it's going cap in hand to the Bank of England for emergency cash - truly.

People are trying to get their money out because it hasn't got the cash reserves to meet its liabilities.

Now, wait for the share price of RBS to fall by £3 billion, and then buy, buy, buy. As the stock recovers, you make a fortune by selling your depressed shares at a higher rate than you bought them for. It's a steal.

It's also entirely legal. In fact, what happened to HBOS last week isn't just the ploy of a few rogue traders, but the way that investment in the stock market - indeed any market - works.

People buy and sell on rumour - that's what happened to Northern Rock and Bear Stearns. In both cases, the management and regulators insisted that nothing was wrong, that the bank was sound, that if people would just stop taking their money out, all would be well.

But here's the sting: the investors who led the Rock and Bear panics were right to do so. They were vindicated by events, because despite all the assurances from the politicians and the boards of these institutions, they both collapsed because people took their money out.

A few months ago, Bear Stearns was worth £20 billion; last week, it was sold to JPMorgan Chase for £260 million. Northern Rock is nationalised and its shares are worth nothing at all.

And here's another worrying thought. The rumours about HBOS last week - which led to its 15% share collapse - may be under investigation by the Financial Standards Authority but HBOS, along with the other big banks, did go to the Bank of England for emergency cash.

Depositors have been taking money out of the bank - I certainly have. And it is also true that HBOS - along with the other big banks - does not have sufficient reserves to meet all its obligations to depositors. This is called "fractional reserve banking".

The truth about banks, which we should all do well to remember in this crisis, is that their business is lending money that they don't actually have.

To repeat: if depositors in any bank, however well-established, all took their money out at once, the bank would collapse.

Banks are only required by law to have cash reserves to meet average withdrawals - it used to be 10% but this has fallen over the years, and the average cash reserve ration of British banks is now 3%. The problem arises when more than 3% want their cash back at the same time.

So, the trash and cash merchants have a bomb-proof business model here. They can spread ugly rumours about any bank they choose, safe in the knowledge that they are actually telling it like it is.

[Muswell Hillbilly]

Yes, a good article from today’s Sunday Herald (Scottish paper based in Glasgow). Iain Macwhirter in the Herald has generally been quite frank and bearish recently. I haven’t been reading the paper for long, though, so I don’t know what its stance was previously.

[InternationalRockSuperstar]

...and the derivatives market is really an extension of the fractional reserve system - it is not uncommon for hedge funds to have 32x leverage.

The contracts in the derivatives market currently have a notional value of $750 trillion (ie three quarters of a quadrillion dollars). This will be the death of the current fiat currencies of the world.

[carseller]

...and the derivatives market is really an extension of the fractional reserve system - it is not uncommon for hedge funds to have 32x leverage.

The contracts in the derivatives market currently have a notional value of $750 trillion (ie three quarters of a quadrillion dollars). This will be the death of the current fiat currencies of the world.

It's these things that have made the markets hold up after the internet bubble. It's the increasing leverage, making up for for less cash,and less average joe's being in the market. These instruments cannot stay afloat under a lot of volatility, and it's getting closer.

Edited March 23, 2008 by carseller

[Not Long Now]

...and the derivatives market is really an extension of the fractional reserve system - it is not uncommon for hedge funds to have 32x leverage.

The contracts in the derivatives market currently have a notional value of $750 trillion (ie three quarters of a quadrillion dollars). This will be the death of the current fiat currencies of the world.

Quite right. Its more this "shadow banking" system that has been created to side step the conditions imposed on Fractional Reserve banking that is causing the problems, and not fractional reserve banking per se.

[the_austrian]

Quite right. Its more this "shadow banking" system that has been created to side step the conditions imposed on Fractional Reserve banking that is causing the problems, and not fractional reserve banking perse.

How so?

[The Boffmeister]

And here's another worrying thought. The rumours about HBOS last week - which led to its 15% share collapse - may be under investigation by the Financial Standards Authority but HBOS, along with the other big banks, did go to the Bank of England for emergency cash.

The whole event is a shocking, HBOS did go cap in hand to the BOE meanwhile telling everyone they had enough liquidity just like NR.

However, what was more alarming was the fact that the BOE's 5 Billion pound loan facility was over subscribed x5, So there's many more distressed financial houses out there. I'm sure they'll be many more rumors doing the rounds soon, no smoke without fire springs to mind.

[Bloo Loo]

How so?

simple.

Banks ARE restricted on what they can lend based on their capital adequacy.

eg have 10 cap and lend 5 ( to avoid money creation posts)

so when they have lent their 5, thats it. finished, until theyve had a few monthly subs in that is.

so what do they do.

they pass on the 5 lent to another sub company called an SIV.

the loans are not now on the books so now the bank looks like this:

10 cap 0 loans but Interest coming in.

they can now lend another 5.

The SIV then packages up the loans and sells them to hedge funds, governments and pension funds.

Risk is now gone from the bank and its SIV- oh, THATS because house prices only ever go up.

Its the unwinding of the above thats causing the troubles.

so they bring 2 back onto the books because the SIV cant sell them and is stuck for cash itself.

they now have 8 cap can only lend 4

But they have the 5 in loans still on their books becuase the SIV couldnt sell them

so their books look like this:

8 cap 5 loans.

They are now ILLEGAL. they need a bailout of 2 to make the ratio 10:5 again.

they cant sell their assets ( they bought some CDOs too) so they need the central bank to supply this dosh.

Edited March 24, 2008 by Bloo Loo

[Guest vicmac64]

...and the derivatives market is really an extension of the fractional reserve system - it is not uncommon for hedge funds to have 32x leverage.

The contracts in the derivatives market currently have a notional value of $750 trillion (ie three quarters of a quadrillion dollars). This will be the death of the current fiat currencies of the world.

this is 100% correct as far as I can see. This is the instrument of fraud that will see our econonies destroyed.

[laurejon]

From what I can see today, the Banks are crying like spoilt babies and requesting the Central Banks take their bad loans as security to bring in more cash.

In my mind the Central Banks constant drip feeding of cash to prop up the failed business model will only excacerbate the situation.

The simple facts are that Banks have lent out money the do not have, at a rate in many cases that is lower than the rate they have to pay to refinance the loan on the wholesale markets as they have moved into the very dangerous territory of leveraging their lending way over what could be termed reasonable.

I suspect that with a US election, and a UK election looming, the game plan is to limp to the finishing line before owning up to the reality of the situation and crashing the markets which is exactly what is going to happen, sooner or later.

[Optobear]

this is 100% correct as far as I can see. This is the instrument of fraud that will see our econonies destroyed.

Agree, and I think that the politicians just didn't understand what securitisation was about. The smart boys in the city told Gordon and his fellow inadequate Alistair, that the new economy promised untold riches, and the proof was in the shiny Canary Wharf offices and the bankers buying up houses for millions. St. Tony was too busy saving the world for god, and healing the internecine rift in Northern Ireland, to be concerned about the UK economy. Although St Tony was a little scared of clunking Gordon, he was smart enough to jump ship just before it hit the rocks.

The only reason for securitisation is to circumvent capital adequacy rules. It is also massively inflationary (by taking away the limit to money creation).

Gordon has PhD on "The Labour Party and Political Change in Scotland 1918-29". Note the date, it is significant. His understanding of the world is based on the "good times" pre-depression. Alistair Darling has a law degree. I'd be interested to know whether either of them has the slightest understanding of maths or economics?

These guys have sold our economy down the river, and they still don't understand how it happened, or probably, given the cocoon they live in, even accept that it has happened.

I don't blame the bankers, their job is to invent new ways of making money. The economy needs them to do that, it is one of the engines of growth. However, we need equally bright people to see what the bankers are doing, and make sure it is not at the expense of the wider economy. Gordon the bully's personality effectively meant that no one in the treasury could speak up, and so no one did anything to curb the bankers. They just took the sweeties from the bankers, and basked in the sun.

Gordon and co, are probably the smuggest set of self-serving useless politicians in the history of UK politics. The one small shred of consolation for me, is that Dr G. Brown, PhD in history, must now understand that history will judge him as one of the absolute worst prime-ministers of all time.

[Optobear]

Excellent post. It is a problem that Parliament is increasingly dominated by professional politicians trained as lawyers. You can on the surface understand it in the 'legislature'. However, it becomes apparently less sensible when you think of it in the context of managing the tax system, or economic policy or even the efficiency of extremely large public enterprises. No offence to hairdressers, but you wouldn't put a hairdresser in charge of the new nuclear development programme.

Thanks hotairmail.

Agree totally. The trouble is, who would you pick? Bankers? I think not.

Interestingly, Germany has a chancellor who is a physicist. I think we need more physicists and engineers in government.

The problem is that a spell as an MP would be disaster to a practising scientist or engineer, but to a lawyer it is a quick route to becoming a QC.

Now, if I could get an automatic FRS just for becoming an MP - that would be a more interesting career opportunity... trouble is it wouldn't be worth being an FRS if they were given out for that...

[oracle]

Gordon and co, are probably the smuggest set of self-serving useless politicians in the history of UK politics. The one small shred of consolation for me, is that Dr G. Brown, PhD in history, must now understand that history will judge him as one of the absolute worst prime-ministers of all time.

certainly one of the worst chancellors of all time,but whatever made people think he was in charge of the economy in the first place??

We are,at the very least,heading for 1970's style stagflation,and the only heavily unionised sectors left are social services...ie NHS,local government and the "caring" professions.

On the plus side,he's pissed off the police and the army so much that I think when it comes to the crunch they will be with the people,and most likely bidding for the rights to be in the firing squad on Ebay.

[the_austrian]

simple.

Banks ARE restricted on what they can lend based on their capital adequacy.

eg   have 10 cap and lend 5 ( to avoid money creation posts)

so when they have lent their 5, thats it. finished, until theyve had a few monthly subs in that is.

so what do they do.

they pass on the 5 lent to another sub company called an SIV.

the loans are not now on the books so now the bank looks like this:

10 cap 0 loans but Interest coming in.

they can now lend another 5.

The SIV then packages up the loans and sells them to hedge funds, governments and pension funds.

Risk is now gone from the bank and its SIV- oh, THATS because house prices only ever go up.

Its the unwinding of the above thats causing the troubles.

so they bring 2 back onto the books because the SIV cant sell them and is stuck for cash itself.

they now have 8 cap can only lend 4

But they have the 5 in loans still on their books becuase the SIV couldnt sell them

so their books look like this:

8 cap 5 loans.

They are now ILLEGAL. they need a bailout of 2 to make the ratio 10:5 again.

they cant sell their assets ( they bought some CDOs too) so they need the central bank to supply this dosh.

The question was about the derivatives market not SIVs.

[Bloo Loo]

The question was about the derivatives market not SIVs.

I thought it was about how the shadow market was used to evade the Capital Adequacy Requirements.

Never mind, I hope the post was useful to somebody.

[RobK]

To repeat: if depositors in any bank, however well-established, all took their money out at once, the bank would collapse.

So, banks borrow short and lend long? Surely not?

[Optobear]

On the plus side,he's pissed off the police and the army so much that I think when it comes to the crunch they will be with the people,and most likely bidding for the rights to be in the firing squad on Ebay.

I think that point about the army is very salient.

Do you recall a couple of years ago, General Dannant appearing in the press.

http://www.guardian.co.uk/politics/2006/oct/15/uk.iraq

Absolutely unprecedented for a senior military figure to present in that way. It was probably the closest to a military coup that Britain has seen, and was very much a warning shot across the bow of the government.

The army is a major (excuse the pun) force in all countries. The UK is no different. That is why royals are always Colonel in Chiefs of regiments, and why the royal sons have to be sent into the forces.

I suspect Brown is not liked at all by the army, and if things did go very badly wrong with the economy (to the extent of a collapse in confidence of sterling) then the army and royal family would have a lot of say in what happened next.

[the_austrian]

So, banks borrow short and lend long? Surely not?

If a bank did this in a free market they would go out of business.

[Methinkshe]

I think that point about the army is very salient.

Do you recall a couple of years ago, General Dannant appearing in the press.

http://www.guardian.co.uk/politics/2006/oct/15/uk.iraq

Absolutely unprecedented for a senior military figure to present in that way. It was probably the closest to a military coup that Britain has seen, and was very much a warning shot across the bow of the government.

The army is a major (excuse the pun) force in all countries. The UK is no different. That is why royals are always Colonel in Chiefs of regiments, and why the royal sons have to be sent into the forces.

I suspect Brown is not liked at all by the army, and if things did go very badly wrong with the economy (to the extent of a collapse in confidence of sterling) then the army and royal family would have a lot of say in what happened next.

I'm banking on it...'scuse pun!

[Optobear]

I'm banking on it...'scuse pun!

There seems to be a very General tendency to look for Private sector solutions, a bit like knee jerk reactions calling for a return to Corporal punishment. The winners in all this will be those who sell to rent, because they will be Left Tenants.

[lets get it right]

I don't blame the bankers, their job is to invent new ways of making money. The economy needs them to do that, it is one of the engines of growth.

No, that's wrong. It is not a bank's role to invent new ways of making money. There is only one way to make money and that is to sell goods or services at a profit. The bank's role is to help fund the creation and expansion of businesses by prudently lending money to those who seem more likely to succeed than fail AND to protect its depositors by taking proper security against any loans made.

Once upon a time a bank would only lend you money to create/expand your business once it had had a good look at a detailed business plan and decided that, all things considered, it was viable AND it had a charge on your house and that your house was worth 50% more than the charge.

If banks act like that they can make good profits and stay secure.

But they got greedy and threw caution to the wind.

[lets get it right]

There seems to be a very General tendency to look for Private sector solutions, a bit like knee jerk reactions calling for a return to Corporal punishment. The winners in all this will be those who sell to rent, because they will be Left Tenants.

I was always hoping to rise a bit higher than a Left Tenant. A general at least.

[Bloo Loo]

There seems to be a very General tendency to look for Private sector solutions, a bit like knee jerk reactions calling for a return to Corporal punishment. The winners in all this will be those who sell to rent, because they will be Left Tenants.

its the captains of industry who will suffer the fall out what with the market entrenchment and banks tanking.

[vhawk]

TRASH AND cash - it's the new investment strategy that everyone's talking about. Spread a rumour, buy some cheap stock, make a packet. So, let's try it out, shall we. I'll spread a rumour that the Royal Bank of Scotland is in a pickle - pass it on. That it's going cap in hand to the Bank of England for emergency cash - truly.

People are trying to get their money out because it hasn't got the cash reserves to meet its liabilities.

Now, wait for the share price of RBS to fall by £3 billion, and then buy, buy, buy. As the stock recovers, you make a fortune by selling your depressed shares at a higher rate than you bought them for. It's a steal.

It's also entirely legal. In fact, what happened to HBOS last week isn't just the ploy of a few rogue traders, but the way that investment in the stock market - indeed any market - works.

People buy and sell on rumour - that's what happened to Northern Rock and Bear Stearns. In both cases, the management and regulators insisted that nothing was wrong, that the bank was sound, that if people would just stop taking their money out, all would be well.

But here's the sting: the investors who led the Rock and Bear panics were right to do so. They were vindicated by

oevents, because despite all the assurances from the politicians and the boards of these institutions, they both collapsed because people took their money out.

A few months ago, Bear Stearns was worth £20 billion; last week, it was sold to JPMorgan Chase for £260 million. Northern Rock is nationalised and its shares are worth nothing at all.

And here's another worrying thought. The rumours about HBOS last week - which led to its 15% share collapse - may be under investigation by the Financial Standards Authority but HBOS, along with the other big banks, did go to the Bank of England for emergency cash.

Depositors have been taking money out of the bank - I certainly have. And it is also true that HBOS - along with the other big banks - does not have sufficient reserves to meet all its obligations to depositors. This is called "fractional reserve banking".

The truth about banks, which we should all do well to remember in this crisis, is that their business is lending money that they don't actually have.

To repeat: if depositors in any bank, however well-established, all took their money out at once, the bank would collapse.

Banks are only required by law to have cash reserves to meet average withdrawals - it used to be 10% but this has fallen over the years, and the average cash reserve ration of British banks is now 3%. The problem arises when more than 3% want their cash back at the same time.

So, the trash and cash merchants have a bomb-proof business model here. They can spread ugly rumours about any bank they choose, safe in the knowledge that they are actually telling it like it is.

you've been watching money as debt and very good it is to

[tomwatkins]

Had Brown & Co had any sense they could have murdered the short-sellers. As "we" the taxpayer are de facto owners of the banks, why didn't the government just keep buying RBS shares and lead to a short squeeze? Short-interest on any stock is a matter of record, it's a not a bloody state secret. The state intervenes in the markets to buy currency, why not the stock market as well to protect their investment (and the freakin taxpayers)? I have no problem with short-selling which can lead to substantial gains for those who are long the market (I have done it myself). However, I do have a problem with naked short selling.

The other thing about short selling is this. Any stockholder (in this case the government) can say to their broker "dont allow my shares to be loaned out (in this case for short selling). Simple. I did it with my brokers at Ameritrade (along with a lot of others). The stock was thinly traded I admit but it staved off a short attack. I agree that any action like this would have very little influence on say Microsoft but anybody holding a majority position could have a huge influence. It's just something that is not widely known.