Simple Fractional Reserve/loan Default Question

[juvenal]

Why is it it that whenever I read Injin threads I pray for the clarity of the late Professor Stanley Unwin?

[Injin]

Why is it it that whenever I read Injin threads I pray for the clarity of the late Professor Stanley Unwin?

Deep thocus on this, all a tremblode.

Are you talking about the actual pieces of paper?

Yup.

But if my previous post is correct, then they did stop owning their deposit -- the moment they handed it over to the bank

They never, ever owned it. Think about it - all money is loaned into existence. if you loan your best mate your car - who owns it?

Does that change if he gives it to someone else to look after?

[benj]

We might 'know' this from experience, but my understanding is that if you pay your money into a bank, it's no longer your money but an asset of yours instead. It's actually the bank's money. This is why, if a bank goes bust, you don't necessarily get that money back; in other words, under these circumstances your asset has been devalued, maybe to zero.

Quite true! I should rephrase. When everything is working smoothly, money in the bank is as good as money in your hand. When your bank runs into difficulty, this property no longer holds. But it's precisely because we treat money in our current accounts as being identical to money in our wallets that they are both counted as money, and that's the root of the whole banks-create-money confusion.

[benj]

Erm...you need to read the second paragraph in the text book then.

Hmmm... you need to read the subsequent posts I made on this thread then!

[Ologhai Jones]

They never, ever owned it. Think about it - all money is loaned into existence. if you loan your best mate your car - who owns it?

Does that change if he gives it to someone else to look after?

There are different philosophical levels of discussion. Ultimately, I could be a brain in a jar, and nothing else exists.

In that kind of rarefied sense, then all money is imaginary...

But slightly more prosaically, in the ordinary course of things, cash that I hold in my hand is mine, whereas cash paid into my bank account belongs to the bank.

I think perhaps the difficulty that some people experience in discussions with you, Injin, is that you seem to operating at the brain-in-a-jar level a lot of the time, and, although what you say may indeed be correct, it doesn't necessary help clear matters up, or actually impact people's lives all that much. Not every discussion needs to be so, for the want of a better phrase, 'out there'...

At least that's the way it seems to me.

[Injin]

There are different philosophical levels of discussion. Ultimately, I could be a brain in a jar, and nothing else exists.

In that kind of rarefied sense, then all money is imaginary...

But slightly more prosaically, in the ordinary course of things, cash that I hold in my hand is mine, whereas cash paid into my bank account belongs to the bank.

I think perhaps the difficulty that some people experience in discussions with you, Injin, is that you seem to operating at the brain-in-a-jar level a lot of the time, and, although what you say may indeed be correct, it doesn't necessary help clear matters up, or actually impact people's lives all that much. Not every discussion needs to be so, for the want of a better phrase, 'out there'...

At least that's the way it seems to me.

Got any debts?

Then you might want to think again.

So..

Got any debts?

Or...

Does anyone have any debts?

[Tiger Woods?]

Hmmm... you need to read the subsequent posts I made on this thread then!

Sorry...started reading from where I left off.

[Ologhai Jones]

Got any debts?

Then you might want to think again.

So..

Got any debts?

Or...

Does anyone have any debts?

In the sense that most people mean debts, then no, I don't have any... but I suspect this is going to turn out to be a trick question where we'll be using some 'brain in a jar' meaning of the word 'debt'...

[Injin]

In the sense that most people mean debts, then no, I don't have any... but I suspect this is going to turn out to be a trick question where we'll be using some 'brain in a jar' meaning of the word 'debt'...

nope.

I mean mortgages, credit cards, loans etc. No one owes a penny.

The bankers have all their money back, no one owes them anything. Equally, all depositors are owed nothing as well.

[AteMoose]

nope.

I mean mortgages, credit cards, loans etc. No one owes a penny.

The bankers have all their money back, no one owes them anything. Equally, all depositors are owed nothing as well.

extending this all property owned and bought through loans doesn't exist and should cease to exist?

[benj]

extending this all property owned and bought through loans doesn't exist and should cease to exist?

Along with this thread?

[Injin]

extending this all property owned and bought through loans doesn't exist and should cease to exist?

That would be up to the people who made those deals to sort out between themselves, but broadly speaking, yes.

And that depends what you mean by property - the real world things are there, the ownership of them is what is in question.

[AteMoose]

Along with this thread?

Possibly, but honestly why are people so disinterested in money? You get a couple of interested people, but 'what is money' threads tends to make peoples eyes glaze over, where is eric for example, what is money is the root cause of liar loan, fractional reserve requires liar loans...

That would be up to the people who made those deals to sort out between themselves, but broadly speaking, yes.

And that depends what you mean by property - the real world things are there, the ownership of them is what is in question.

in the real world they are only there because of the debt, so they shouldn't exist in the first place. Fractional reserve is a system that's created everything and it is the best system we have as it beats up everyone else's system.

Edited August 26, 2008 by moosetea

[Injin]

Possibly, but honestly why are people so disinterested in money?

in the real world they are only there because of the debt..

I know.

I am only concerned with the truth of things and what I outlined above is true.

No one is going to agree to it on a large scale - depositors think they are owed, bankers want to con, debtors think they owe and governments want to keep the whole thing trucking along.

The only real benefit is likely to be to those rare "borrowers" who realise the con and decide to leave the system. Pull enough of those out of the game and everyone else will have to whistle - those who have been fooled into thinking they owe are doing all the work.

You edited, you naughty moose!

Fractional reserve is the best statist system for growth. The yanks neer used to have one and that system - free market with a bank merely a place to store valuables in a warehouse is the best system that there is or can be.

Edited August 26, 2008 by Injin

[Ologhai Jones]

Along with this thread?

Wishful thinking I'm afraid...

Well, I think this discussion has become a little too philosophical to be of any use, so maybe I should quit while I'm... er, miles behind!

[Guest Skint Academic]

Why is it it that whenever I read Injin threads I pray for the clarity of the late Professor Stanley Unwin?

I didn't think this was an Injin thread, I thought that this was a thread hijacked by Injin. Presumably through fraudulent use of an internet browser ...

[Guest Skint Academic]

Quite true! I should rephrase. When everything is working smoothly, money in the bank is as good as money in your hand. When your bank runs into difficulty, this property no longer holds. But it's precisely because we treat money in our current accounts as being identical to money in our wallets that they are both counted as money, and that's the root of the whole banks-create-money confusion.

The trouble is that modern day life expects us, forces us if you like, to have a bank account. Unless of course you can get paid cash in hand.

I suppose you could take all your wages out the day you get paid but then utility bills expect to be paid by cheque or online.

[RufflesTheGuineaPig]

It gets ccreated when everyone goes to the bank on the same day for it - at that point either the banks go insolvent or the presses run.

Which is why we are going to have hyperinflation.

I promise £1 to 76 trillion people and when they all arrive for it then I add 76 trillion pounds to the economy. (Daft example but for emphasis.) Boom - hyperinflation.

I should make it clear he's refering to the bank of england and it's presses.

The BoE would have to issue more money and then lend it to the banks... ala northern rock.

The commercial banks wouldn't be printing as they can't.

[Injin]

I should make it clear he's refering to the bank of england and it's presses.

The BoE would have to issue more money and then lend it to the banks... ala northern rock.

The commercial banks wouldn't be printing as they can't.

There is only the Bank of England. Commercial banks are just franchises of it.

[RufflesTheGuineaPig]

There is only the Bank of England. Commercial banks are just franchises of it.

They arn't at the moment, but they should be in a few months.

[Sinking Feeling]

Here's a question to ponder - Which grows quickest, a country's money supply based upon fractional reserve/capital adequacy banking or a thread on HPC regarding the subject?

[the_austrian]

I did ask something similar a while back, but I really want to understand the following simple scenario properly.

Today again I have read something, somewhere (on a forum) stating bank lends x, loan defaults, bank cannot lend x * 10 in the future. I just want to know if this is true.

so:

1. Bank has $1 magic reserve money.

2. Bank loans $10 (=$1 + 9 x $1) - ie bank uses $1 of reserves to loan a total of $10

3. Borrower defaults completely on loan repayment.

the upshot:

The bank has lost $1 of its original reserves, and the $9 it created.

Has this reduced the banks future lending capacity by $10 or $100?

thanks.

A bad loan doesn't really affect the reserve ratio too much. The reserve ratio is all about the proportion of deposits that can be paid with cash. So if the bank has £5 cash and £100 customer deposits the reserve ratio is 5%.

If a debt goes bad, it has a bad impact on the profits of the bank but it doesn't change the quantity of deposits or cash held by the bank. If a borrower repays a debt with entirely cash (rather than bank credit) it can improve the reserve ratio.

No, it doesn't. It can't do that any more than you or I can. If the bank has $1, it can lend at most $1. If the bank lends $0.50 and the borrower defaults completely, the bank has $0.50 left and can now lend at most $0.50.

Yes that's absolutely right, with a 5% reserve ratio and £100 cash the bank can lend only £95 cash. But the bank could also open an account for the borrower... the account could be for as much as £2,000 for a reserve ratio of 5%.

But what's wrong with this? If you think of it as people rather than banks- Tim has £10 and lends £9 to Tom. Tom lends this £9 on to Dave who then lends it to Tim. Tim then lends this £9 he has out to someone else. Just because Tim has lent out £19, it doesn't mean we've magically created money somewhere.

The magically created money comes from the fact that the people that lend the money still have use of the money themselves. The central bank allows deposits to be available for withdrawal on demand even though the lending bank does not has sufficient liquidity to allow this.

We might 'know' this from experience, but my understanding is that if you pay your money into a bank, it's no longer your money but an asset of yours instead. It's actually the bank's money. This is why, if a bank goes bust, you don't necessarily get that money back; in other words, under these circumstances your asset has been devalued, maybe to zero.

This is quite different than, say, a safety deposit box, where you pay the bank to hold something of yours (which may be money). In this case, you have a 'custodial' arrangement with the bank where the contents of the safety deposit box remains yours, and in this case if the bank goes bust, you're entitled to the contents of your safety deposit box, i.e. it doesn't become part of the value of the bank to be apportioned to the bank's various creditors by the receivers.

It doesn't really make any different to the central point of this thread, but I thought it was an interesting little snippet nonetheless...

(If anyone knows different, I'd be interested to be corrected.)

The point is that you will always get your money back because the deposits are guaranteed by the State. Roughly 98% of the money supply is made up of commercial bank money. Without the State guarantee prices would be 98% lower than they are now.

I should make it clear he's refering to the bank of england and it's presses.

The BoE would have to issue more money and then lend it to the banks... ala northern rock.

The commercial banks wouldn't be printing as they can't.

Commercial bank money can be thought of as a receipt for central bank money. They don't print central bank money but commercial banks do print receipts for central bank money.

[uncle rogi]

Without the State guarantee prices would be 98% lower than they are now.

interesting as that is the loss in purchasing power of one pound since WWI "forced" the abandonment of the gold standard.

[JustYield]

Excellent - haven't seen one of these for a while. Still as confused as ever.

Bank rules for lending. (You should be able to answer the question yourself by the end.)

Rule 1. A bank can lend as long as the regulator's 'Capital Adequacy Ratio' is not breached.

Capital Ratio is the value of capital (mainly shareholder equity) divided by loans. (note Capital IS NOT deposits - in simple terms it's basically what the shareholders own)

Rule 2. A bank cannot lend more money than it has in funds. Funds can come from a variety of sources: deposits, interbank lending, issuing bonds etc.

Rule 3: Does not currently exist in UK, but does in China for instance. The regulator sets a figure for the percentage of deposits that must be available on demand and therefore cannot be leant out by the bank - this is the reserve. Banks manage this for themselves in the UK based upon expected requirements. The reserve is not the same as bank capital...they look at different sides of the balance sheet - one at the lending side and the other, funding.

Broken Rule 4: Bank wants to lend as much money as possible but is constrained by the Capital Adequacy Ratio set by the regulator. Sets up a Special Purpose Investment Vehicle to which it moves its mortgage liabilities. This way it frees up its capital and allows it to lend many times more than it normally would be able to. Like magic really.

Funny how everyone apparently just ignored this post.

The confusion between capital (shareholder equity) and deposits lies at the heart of most of the misunderstanding of bank lending.

That and the fact that for every loan made, someone has committed to repay the interest (new money!) and fully expects to be able to do so from their future income / cash flows. Finding that money becomes their (and ultimately the lender's *) problem and they usually have to do something value added in the economy to be able to repay the loan and interest. More money in circulation in proportion to more value added economic activity. What is the problem?

* The banks build in protection against default in their interest rate, so they are covered. If defaults rise beyond this cover, then there is a deflationary effect as the banks take the hit directly in their capital, thus reducing their lending capability (by a multiple of the write-off).

[mattyboy1973]

A bad loan doesn't really affect the reserve ratio too much. The reserve ratio is all about the proportion of deposits that can be paid with cash. So if the bank has £5 cash and £100 customer deposits the reserve ratio is 5%.

If a debt goes bad, it has a bad impact on the profits of the bank but it doesn't change the quantity of deposits or cash held by the bank. If a borrower repays a debt with entirely cash (rather than bank credit) it can improve the reserve ratio.

thanks.

Does this mean that loan defaults are less deflationary in and of themselves than some doomsters on the blogosphere are saying? I often see it written for example, that a default on a loan of $10 will stop the bank lending $90-100(whatever) - from your explanation this simply is not the case. Not only this of course but the original loan money is still in circulation somewhere.