Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Роберт » Tue Apr 02, 2013 5:36 pm UTC

sardia wrote:
Zamfir wrote:
If you make a counterfeit $20 bill and pass it, that's theft. If your bank lends $200 million it does not have, how is that different from you counterfeiting? The difference is they have a license to do it....
They don't have such a license. Where did you get this idea? Banks with negative capital have to stop their operations. That's what's happening in Cyprus, the bank's loans were written down and their capital became negative.

Edit: apart from central banks, naturally

If I had to guess, he's talking about the fractional banking system. At worst, he's a libertarian who doesn't understand the implications of never lending more than cash on hand. If I were more lenient, he's saying we need to raise the capital reserves of banks.

A libertarian suggesting the government run an ATM system? Doubtful.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Tue Apr 02, 2013 7:02 pm UTC

Zamfir wrote:
If you make a counterfeit $20 bill and pass it, that's theft. If your bank lends $200 million it does not have, how is that different from you counterfeiting? The difference is they have a license to do it....
They don't have such a license. Where did you get this idea? Banks with negative capital have to stop their operations. That's what's happening in Cyprus, the bank's loans were written down and their capital became negative.


Say a US bank has $100 million. It can lend $400 million. It then has around $100 million in credit with the central bank, and $400 million in "assets", the money it has lent. But it has to have 20% as much money either on hand or deposited with the Fed as it says it has.

If you had $20 and you found a sneaky trick that let you "lend" $80 to other people and then claim you had $100, you would be guilty of fraud. But banks have a license to do it.

Edit: apart from central banks, naturally


Naturally, there are no rules like that for the US Federal Reserve. I don't know whether other central banks have special rules about what they can do and about who gets to audit them to decide whether they are breaking the rules.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Tue Apr 02, 2013 7:29 pm UTC

sardia wrote:
Zamfir wrote:
If you make a counterfeit $20 bill and pass it, that's theft. If your bank lends $200 million it does not have, how is that different from you counterfeiting? The difference is they have a license to do it....
They don't have such a license. Where did you get this idea? Banks with negative capital have to stop their operations. That's what's happening in Cyprus, the bank's loans were written down and their capital became negative.

Edit: apart from central banks, naturally

If I had to guess, he's talking about the fractional banking system. At worst, he's a libertarian who doesn't understand the implications of never lending more than cash on hand.


Yes, not understanding the implications of never lending more than cash on hand would be bad. We need a way to adjust the money supply. One possible way to do that is to let banks lend money they don't have. When we want more money circulating let them lend more. Otherwise restrict them to lending less. That is a possible way to do things, which has led to Cyprus's current situation.

I proposed an alternative approach.

If I were more lenient, he's saying we need to raise the capital reserves of banks.


I say, give people who want to keep their spending money in an ATM a good solid alternative to banks. Then if you like, you could have completely unregulated banks. Maybe it would be a good idea for the government to occasionally check their books and publish a summary.

"This bank today owes $500 million to depositors and to debtors who have not yet spent their loans. All of these can legally take their money from the bank today.

"The bank currently has $700,000 reserves, plus $105 million credit with the central bank. Debtors owe the bank $500 million in loans that will come due eventually.

"This bank is in excellent financial condition, for a bank. If its debts were to come due today it could pay back 21% of depositors' money. But if 79% of the money it has lent is recovered, it will eventually be able to pay all of its own debts."

If people had a decent alternative then we would not need any bank regulation. Anybody who put money in a bank would be just asking for it and would deserve no sympathy.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby firechicago » Tue Apr 02, 2013 7:46 pm UTC

J Thomas wrote:Say a US bank has $100 million. It can lend $400 million. It then has around $100 million in credit with the central bank, and $400 million in "assets", the money it has lent. But it has to have 20% as much money either on hand or deposited with the Fed as it says it has.


This is very much not how the fractional reserve banking system works. If a bank gets $100 million in deposits, it is required to keep $10 million as reserve and can only lend out $90 million. This is called a 10% reserve requirement. Now, if the person who was lent the money turns around and puts it back in the bank the back can then lend out another $81 million and keep $19 million on hand as reserves, so this does result in a multiplication of money, but this is a good thing, because each time that money multiplies it has to go through the hands of someone who thinks that they can invest that money in a way that will generate a return, and that makes more money available for investment in the real economy.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Tue Apr 02, 2013 8:52 pm UTC

firechicago wrote:
J Thomas wrote:Say a US bank has $100 million. It can lend $400 million. It then has around $100 million in credit with the central bank, and $400 million in "assets", the money it has lent. But it has to have 20% as much money either on hand or deposited with the Fed as it says it has.


This is very much not how the fractional reserve banking system works. If a bank gets $100 million in deposits, it is required to keep $10 million as reserve and can only lend out $90 million. This is called a 10% reserve requirement. Now, if the person who was lent the money turns around and puts it back in the bank the back can then lend out another $81 million and keep $19 million on hand as reserves, so this does result in a multiplication of money, but this is a good thing, because each time that money multiplies it has to go through the hands of someone who thinks that they can invest that money in a way that will generate a return, and that makes more money available for investment in the real economy.


I was talking about a 20% reserve requirement. You describe a 10% reserve requirement. Is that so important?

With a 10% reserve requirement, where people keep most of their money in banks, the result is that up to 90% of the money that the banks say is circulating, is in fact loans the banks made.

So anyway, how much difference is there between what you said and what I said?
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Zamfir » Tue Apr 02, 2013 8:58 pm UTC

If a bank has 100 million in money and 400 million in other assets, then it had to raise 500 million originally, from long term investors and short term deposit holders. Not 100 million. It has lend out 400 of that 500, not 400 out of 100.

Banks can act as money multipliers, but not because individual banjs lend out more than they got in. The multiplication happens because short term claims on a bank act as money to third parties. Which is neat, but it is not 'lending money they don't have'.

Edit: firechicago, that multiplication example might be misleading. After all, banks also have capital requirements. If it has reached those at the original 100 million of deposits, then it cannot accept further deposits. If it hasn't yet, then it can grow its sheet regardless whether it is multiplying money or not.

Banks grow their sheet by leveraging their original capital, which is basically unrelated to fractional reserve banking.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby CorruptUser » Tue Apr 02, 2013 9:07 pm UTC

I don't think you understand banking. Sure, the money multiplier means each dollar is duplicated, but that also means that your paycheck is also duplicated.

Imagine if, instead of depositing money in the bank, you decided to lend it to your neighbor. He then spent it, and the person he spent it on then re-lent it. Then that person spent and the next re-lent. This would be functionally equivalent to a no reserve bank. If instead of spending all of it, your neighbor only spends 80%, then it's the same thing as 20% reserve.

The fact that the lending is done through a bank rather than directly does not affect the money multiplier. The bank itself does have a role to play; you might not know if your neighbor really is 'good for it', but the bank sort of knows. You might want your loan repaid now, but your neighbor doesn't have the money, but the bank does, so long as everyone isn't demanding their money back at once.

The fact that the banks charge interest on the money doesn't mean that all the money will be owned by banks; they will only be able to collect on 'good' loans and the banks that lent to people that can't pay back, well, their 'assets' are worth less and they go under. Unless the government dies something idiotic like bail out a bank that was giving out loans to people with obviously no way of ever paying it back. But no government would ever be that stupid. Noooooope.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby firechicago » Tue Apr 02, 2013 9:20 pm UTC

J Thomas wrote:I was talking about a 20% reserve requirement. You describe a 10% reserve requirement. Is that so important?

With a 10% reserve requirement, where people keep most of their money in banks, the result is that up to 90% of the money that the banks say is circulating, is in fact loans the banks made.

So anyway, how much difference is there between what you said and what I said?

The way you wrote it implied that a bank could raise $100 million in capital and immediately turn around and lend out $400 million, lending out money it did not have. That's simply not true.

And I used 10% because that's the actual number in the US.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Alexius » Tue Apr 02, 2013 10:04 pm UTC

J Thomas wrote:
Zamfir wrote:
If you make a counterfeit $20 bill and pass it, that's theft. If your bank lends $200 million it does not have, how is that different from you counterfeiting? The difference is they have a license to do it....
They don't have such a license. Where did you get this idea? Banks with negative capital have to stop their operations. That's what's happening in Cyprus, the bank's loans were written down and their capital became negative.


Say a US bank has $100 million. It can lend $400 million. It then has around $100 million in credit with the central bank, and $400 million in "assets", the money it has lent. But it has to have 20% as much money either on hand or deposited with the Fed as it says it has.

If you had $20 and you found a sneaky trick that let you "lend" $80 to other people and then claim you had $100, you would be guilty of fraud. But banks have a license to do it.

It would be 100% legal for me to go overdrawn by $80 (i.e. take out a loan) in order to lend my friend $100. I could even keep a $20 bill for myself. I now have assets of $100, as I have a $20 bill in my wallet plus my friend's $80 debt. The thing is, I also have an $80 liability I didn't have before (my debt to the bank).

And that's pretty much what a bank does, on a bigger scale. It borrows money from its depositors, and then lends that same money out to other people. The bank makes money because the interest it charges when it lends people money is less than the interest it pays when it borrows money.

The "reserve" is the amount of money that the bank isn't allowed to lend out because it may be needed RIGHT NOW (due to depositors withdrawing their money). The system is founded on the assumption that all of a bank's depositors won't demand their money back immediately. If they do, it's a run on the bank and is catastrophic- they can't get their money, as the bank has lent it out and isn't allowed to immediately call in those loans.

There's no "multiplication" or "creation of fake money" involved- fractional reserve banking would work (and has worked) perfectly well with physical money and probably even gold coins! Without it, it would be much harder to get a loan (impossible if you need a big one)- not to mention that any banks would have to charge you a fee to store your money, rather than paying you interest.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby jules.LT » Tue Apr 02, 2013 11:08 pm UTC

firechicago wrote:The way you wrote it implied that a bank could raise $100 million in capital and immediately turn around and lend out $400 million, lending out money it did not have. That's simply not true.
I learned about this stuff from the Money As Debt video, so pardon my cluelessness. It talks about two different things (at 13:10):
- The bank has to keep 10% of the money ot receives as deposits and can lend out the rest (what you were just saying).
- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

Where's the mistake?
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Tue Apr 02, 2013 11:37 pm UTC

Alexius wrote:It would be 100% legal for me to go overdrawn by $80 (i.e. take out a loan) in order to lend my friend $100. I could even keep a $20 bill for myself. I now have assets of $100, as I have a $20 bill in my wallet plus my friend's $80 debt. The thing is, I also have an $80 liability I didn't have before (my debt to the bank).

And that's pretty much what a bank does, on a bigger scale. It borrows money from its depositors, and then lends that same money out to other people. The bank makes money because the interest it charges when it lends people money is less than the interest it pays when it borrows money.

The "reserve" is the amount of money that the bank isn't allowed to lend out because it may be needed RIGHT NOW (due to depositors withdrawing their money). The system is founded on the assumption that all of a bank's depositors won't demand their money back immediately. If they do, it's a run on the bank and is catastrophic- they can't get their money, as the bank has lent it out and isn't allowed to immediately call in those loans.

There's no "multiplication" or "creation of fake money" involved- fractional reserve banking would work (and has worked) perfectly well with physical money and probably even gold coins! Without it, it would be much harder to get a loan (impossible if you need a big one)- not to mention that any banks would have to charge you a fee to store your money, rather than paying you interest.


Interesting! Let me make sure I have this. I'll tell a story.

You are running a distillery in an isolated community. The only money in the whole community is one $20 gold piece, which you have.

A woodcutter comes to sell you firewood. You pay $20 for the firewood. Then he buys a jug of whiskey with it and you get it back. He wants another one and you let him have it on credit. "I know you're good for it."

A farmer comes to sell you corn. You pay him $20 for the corn. He buys 2 jugs of whiskey, one on credit. "I know you're good for it."

A younger son comes looking for work. You pay him $20 to turn today's corn into mash, and to boil another day's mash. He buys 2 jugs of whiskey, one on credit.

Another younger son needs work. You pay him $20 to run the second distillation and bottle the whiskey. He buys 2 jugs of whiskey, one on credit.

At the end of the week, you have 50 more bottles of whiskey than you did before, you have a $20 gold piece, and everybody in town owes you $20 more than they did before. The amount of money you can lend has nothing whatsoever to do with the amount of money that exists.

And it's the same for banks. If an isolated community had one bank, and the bank could depend on people to keep their money in the bank, then it wouldn't matter at all how much money there was in that community -- it could be a single gold coin that the bank kept in its vault. The bank could lend out as much money as it wanted to, with no limit at all except their sense of what could be extracted from their debtors. If the local farms appeared to be worth a million dollars total, the bank could easily lend half a million dollars to farmers. As long as the banker could depend on people to keep their money in the bank. He doesn't have to make or sell whiskey. He doesn't have to make anything, he can just rent out money that people bring to him.

And with plastic money, the bank can mostly depend on people to bring it back! Anybody who has large amounts of cash is liable to have it taken from him as a suspected drug dealer. The government does regulate it, but there's still a lot of room to expand the money supply.

Banking looks like a great profession to be in. I want to try my hand at it. I have some money together, I can start my own bank ... ... no, I can't. I can't get a banking license. The government doesn't trust me to do it right. They only trust responsible, competent bankers like the ones we have now.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Rysto » Wed Apr 03, 2013 1:31 am UTC

jules.LT wrote:- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

This is a flat-out lie. Banks cannot lend out money that they do not have.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby firechicago » Wed Apr 03, 2013 2:09 am UTC

jules.LT wrote:- The bank has to keep 10% of the money ot receives as deposits and can lend out the rest (what you were just saying).
- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

Where's the mistake?
No, no, no, no, no, no.

As Zamfir points out, there are two different requirements here: capital requirements, which require that a bank have a certain percentage of equity, defined as equity = assets - liabilities, and reserve requirements, which require that of the assets a bank holds, a certain percentage must be reserves, generally either in the form of physical cash in the vaults or as deposits with the central bank.

If we assume both a ten percent capital requirement and a ten percent reserve requirement your example looks like this:

If you raise $100 million in capital to start a bank and deposit it with the federal reserve to start a bank, the federal reserve doesn't turn around and let you print $900 million in new money.

Your balance sheet at this point is:

Assets:
$100 million in reserves

Liabilities:
None

Equity (Assets - Liabilities):
$100 million

All that $100 million gives you is the right to go out and solicit $900 million in deposits. If you go and find those depositors your balance sheet looks like:

Assets:
$1,000 million in reserves ($100 from shareholders + $900 from depositors)

Liabilities:
$900 million in deposits

Equity (Assets - Liabilities):
$100 million

Now you're allowed to take that $1bn of cash you have on hand and lend out 90% of it, after which your balance sheet looks like:

Assets:
$900 million in loans made
$100 million in reserves

Liabilities:
$900 million in deposits

Equity (Assets - Liabilities):
$100 million

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Wed Apr 03, 2013 3:00 am UTC

Rysto wrote:
jules.LT wrote:- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

This is a flat-out lie. Banks cannot lend out money that they do not have.


And yet, they do.

Try this thought experiment. You deposit a dollar into a bank account. You write your name on it, and you sort of imagine the bank is keeping it for you in their safe. But really, they lend your dollar to Anthony. Anthony spends it and Bob gets it. Bob deposits it in some bank. Now you can spend your dollar with your debit card, and so can Bob. The bank then lends your dollar to Carl, who spends it and Dan gets it. Dan deposits it in a bank. You, Bob, and Dan can spend it. The bank lends your dollar to Ed, who spends it and Frank deposits it in a bank. The bank lends it to George who spends it, and Harry deposits it in the bank. Ida spends it and Jerry deposits it, Katherine spends it and Larry deposits it. Soon ten people think they have your dollar, and any of them can spend it any time they want. Other things equal (like the speed that people spend money, and GDP, etc, other things never stay equal but what should we assume?) the banks have reduced the value of your dollar by 90%. For anything you want to buy, there are now 10 times as many people with the money to buy it. The effect is almost the same as if counterfeiters passed so much bad money that 90% of the money in circulation was bad.

How is this not the bankers stealing money? How is it not bankers lending money they don't have? "Well, they created it and after they created it they had it after all." Oh, yeah.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Derek » Wed Apr 03, 2013 3:16 am UTC

jules.LT wrote:
firechicago wrote:The way you wrote it implied that a bank could raise $100 million in capital and immediately turn around and lend out $400 million, lending out money it did not have. That's simply not true.
I learned about this stuff from the Money As Debt video, so pardon my cluelessness. It talks about two different things (at 13:10):

Money as Debt is a horrible video that is largely responsible for spreading these misconceptions about the fractional reserve system (I suspect J Thomas has also seen it). I suggest you just forget everything you heard in that video and go read the Wikipedia article.

And yet, they do.

Try this thought experiment. You deposit a dollar into a bank account. You write your name on it, and you sort of imagine the bank is keeping it for you in their safe. But really, they lend your dollar to Anthony. Anthony spends it and Bob gets it. Bob deposits it in some bank. Now you can spend your dollar with your debit card, and so can Bob. The bank then lends your dollar to Carl, who spends it and Dan gets it. Dan deposits it in a bank. You, Bob, and Dan can spend it. The bank lends your dollar to Ed, who spends it and Frank deposits it in a bank. The bank lends it to George who spends it, and Harry deposits it in the bank. Ida spends it and Jerry deposits it, Katherine spends it and Larry deposits it. Soon ten people think they have your dollar, and any of them can spend it any time they want. Other things equal (like the speed that people spend money, and GDP, etc, other things never stay equal but what should we assume?) the banks have reduced the value of your dollar by 90%. For anything you want to buy, there are now 10 times as many people with the money to buy it. The effect is almost the same as if counterfeiters passed so much bad money that 90% of the money in circulation was bad.

How is this not the bankers stealing money? How is it not bankers lending money they don't have? "Well, they created it and after they created it they had it after all." Oh, yeah.

Ten people think they have your dollar, but only Larry can spend it. Why is this? Because only Larry's bank has any reserve left. The other banks have lent out their entire reserves. If anyone other than Larry tries to withdraw or spend their dollar, their bank will immediately default because it has no reserves to give back. This is why there is a reserve requirement, so a bank cannot lend out all of it's money at once. If the banks had a 10% reserve requirement, then your bank would have 10 cents in reserves, so you could withdraw up to 10 cents without causing your bank to default.

This obviously is kind of silly when discussing banks with $1 of assets and 10 cents of reserves, but it works well for real banks with thousands of depositors, because it is incredibly unlikely that 10% of the depositors will all withdraw their money at the same time.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby LaserGuy » Wed Apr 03, 2013 3:23 am UTC

J Thomas wrote:
Rysto wrote:
jules.LT wrote:- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

This is a flat-out lie. Banks cannot lend out money that they do not have.


And yet, they do.

Try this thought experiment. You deposit a dollar into a bank account. You write your name on it, and you sort of imagine the bank is keeping it for you in their safe. But really, they lend your dollar to Anthony. Anthony spends it and Bob gets it. Bob deposits it in some bank. Now you can spend your dollar with your debit card, and so can Bob. The bank then lends your dollar to Carl, who spends it and Dan gets it. Dan deposits it in a bank. You, Bob, and Dan can spend it. The bank lends your dollar to Ed, who spends it and Frank deposits it in a bank. The bank lends it to George who spends it, and Harry deposits it in the bank. Ida spends it and Jerry deposits it, Katherine spends it and Larry deposits it. Soon ten people think they have your dollar, and any of them can spend it any time they want. Other things equal (like the speed that people spend money, and GDP, etc, other things never stay equal but what should we assume?) the banks have reduced the value of your dollar by 90%. For anything you want to buy, there are now 10 times as many people with the money to buy it. The effect is almost the same as if counterfeiters passed so much bad money that 90% of the money in circulation was bad.

How is this not the bankers stealing money? How is it not bankers lending money they don't have? "Well, they created it and after they created it they had it after all." Oh, yeah.


I think what you're overlooking in this example, is you're ignoring the debt that is also being created. When the bank lends to Carl, then Carl owes the bank a dollar. Because the bank is owed a dollar, it can lend out another dollar and still maintain the same amount of money on its balance sheet. The problem with overleveraging is that the people who the bank owes money to (the depositors) have very liquid accounts--part of the deal with banking is that you are pretty much supposed to be able to get your money out whenever you want--whereas the debts the bank might be accumulating could be longer term things, like mortgages, which the bank can't just call in if it needs to pay out some creditors. So the bank needs to keep enough on hand to deal with typical transactions of this nature. But if it needed to actually pay all of its creditors simultaneously, the only way it could do it would be to start demanding people repay their entire mortgages on the spot. This is the problem with bank runs. The bank has, in principle, enough assets to cover all of its liabilities, but it has a hard time calling all of those assets in on short notice.

The other problem with this type of overleveraging is that it multiplies the risk if someone defaults. In your example, if one person were to default on the loan, the bank would be completely out of money. If two people were to default on their loans, the bank would be insolvent because it would owe 10 and only have assets of 9. This is what happened in the bank failures in the subprime crisis.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby jules.LT » Wed Apr 03, 2013 7:06 am UTC

It seems that I require a substraction of information rather than an addition, here. Should I simply forget about the second part?
Rysto wrote:This is a flat-out lie.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Zamfir » Wed Apr 03, 2013 7:13 am UTC

jules.LT wrote:It seems that I require a substraction of information rather than an addition, here. Should I simply forget about the second part?
Rysto wrote:This is a flat-out lie.
Don't attribute to malice that which can be adequately explained by incompetence ;-)


What second part are you referring to?

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby jules.LT » Wed Apr 03, 2013 7:40 am UTC

- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Kulantan » Wed Apr 03, 2013 7:52 am UTC

An interesting look at the net bailout money flow between Cyprus and the rest of the EU. According to this article Cyprus' bailout interactions could be functionally be a negative amount up to €-7.5 billion Euros.

Even if you disagree with including the Greek Government debt write offs and Cypriot owned Greek bank ELA shenanigans, the analysis says that there is only €2.5 billion in the bailout that can be said to be money given to Cyprus. For which their economy is going to contract nastily by rather more.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Alexius » Wed Apr 03, 2013 7:54 am UTC

jules.LT wrote:
- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

Yes, that's wrong.
In a 10% reserve system, to lend out $900M a bank needs to have a billion dollars of which $100M is deposited at the reserve bank.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Wed Apr 03, 2013 8:34 am UTC

Alexius wrote:
jules.LT wrote:
- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

Yes, that's wrong.
In a 10% reserve system, to lend out $900M a bank needs to have a billion dollars of which $100M is deposited at the reserve bank.


So, do it gradually. Lend $10M, and send $1M to the reserve bank. Now you have assets of $110M. If you get your share of bank deposits, as fast as your debtors spend their $10M, other depositors will put $10M in your bank. Lend $20M, and send $2M to the reserve bank. Lend $30M and send $3M to the reserve bank. Unless too many people withdraw money and deposit it in other banks, you'll be fine. Eventually you will get to $100M in the central bank and a billion dollars of assets.

And if other banks get the deposits instead of you? Then they will make the loans, and will eventually bring it up to a billion dollars of assets based off $100 million in capital.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Alexius » Wed Apr 03, 2013 8:41 am UTC

J Thomas wrote:
Alexius wrote:
jules.LT wrote:
- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

Yes, that's wrong.
In a 10% reserve system, to lend out $900M a bank needs to have a billion dollars of which $100M is deposited at the reserve bank.


So, do it gradually. Lend $10M, and send $1M to the reserve bank. Now you have assets of $110M. If you get your share of bank deposits, as fast as your debtors spend their $10M, other depositors will put $10M in your bank. Lend $20M, and send $2M to the reserve bank. Lend $30M and send $3M to the reserve bank. Unless too many people withdraw money and deposit it in other banks, you'll be fine. Eventually you will get to $100M in the central bank and a billion dollars of assets.

And if other banks get the deposits instead of you? Then they will make the loans, and will eventually bring it up to a billion dollars of assets based off $100 million in capital.

Yes, that is partly how banks are set up (I think). The exception being when you say
Lend $10M, and send $1M to the reserve bank. Now you have assets of $110M

which is flat-out wrong, and I have no idea how you got there.

And yes, it is a billion dollars of assets based off $100 million in capital- but the bank still only has $100M of equity because it also has $900M worth of liabilities to its depositors.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Wed Apr 03, 2013 9:01 am UTC

LaserGuy wrote:
J Thomas wrote:Try this thought experiment. You deposit a dollar into a bank account. You write your name on it, and you sort of imagine the bank is keeping it for you in their safe. But really, they lend your dollar to Anthony. Anthony spends it and Bob gets it. Bob deposits it in some bank. Now you can spend your dollar with your debit card, and so can Bob. The bank then lends your dollar to Carl, who spends it and Dan gets it. Dan deposits it in a bank. You, Bob, and Dan can spend it. The bank lends your dollar to Ed, who spends it and Frank deposits it in a bank. The bank lends it to George who spends it, and Harry deposits it in the bank. Ida spends it and Jerry deposits it, Katherine spends it and Larry deposits it. Soon ten people think they have your dollar, and any of them can spend it any time they want. Other things equal (like the speed that people spend money, and GDP, etc, other things never stay equal but what should we assume?) the banks have reduced the value of your dollar by 90%. For anything you want to buy, there are now 10 times as many people with the money to buy it. The effect is almost the same as if counterfeiters passed so much bad money that 90% of the money in circulation was bad.


I think what you're overlooking in this example, is you're ignoring the debt that is also being created. When the bank lends to Carl, then Carl owes the bank a dollar. Because the bank is owed a dollar, it can lend out another dollar and still maintain the same amount of money on its balance sheet. The problem with overleveraging is that the people who the bank owes money to (the depositors) have very liquid accounts--part of the deal with banking is that you are pretty much supposed to be able to get your money out whenever you want--whereas the debts the bank might be accumulating could be longer term things, like mortgages, which the bank can't just call in if it needs to pay out some creditors. So the bank needs to keep enough on hand to deal with typical transactions of this nature.


In today's economy, a bank usually needs around 0.1% cash on hand to deal with that kind of thing. The large majority of transactions are with plastic. The rest tend to average out. And if somebody does try to withdraw enough cash that it might possibly not average out, the bank can tip off the police who can then catch him with the money, accuse him of being a drug dealer, confiscate the cash, and deposit it in the bank.

But if it needed to actually pay all of its creditors simultaneously, the only way it could do it would be to start demanding people repay their entire mortgages on the spot. This is the problem with bank runs. The bank has, in principle, enough assets to cover all of its liabilities, but it has a hard time calling all of those assets in on short notice.


Yes, but mostly there are no bank runs. After all, the money is insured. And if a bank goes bad, the central bank arranges for other banks to take on the obligations (and whatever rewards there are) so that depositors usually do not suffer at all. If that fails, the government will bail out depositors. It's only when the whole country is in trouble that things go bad for depositors.

The other problem with this type of overleveraging is that it multiplies the risk if someone defaults. In your example, if one person were to default on the loan, the bank would be completely out of money. If two people were to default on their loans, the bank would be insolvent because it would owe 10 and only have assets of 9. This is what happened in the bank failures in the subprime crisis.


Normally it isn't as bad as that. If the bank can get, say, 6% simple interest, then 9 identical loans will bring in 0.54 of one loan in a year. So the bank comes out almost OK if 5% of the loans go bad in a year. And often the loans don't go completely bad. If the bank can average 50% collateral on bad loans then it can break even with 10% failures. It isn't many years that it gets 10% failure.

If things do go bad then the central bank steps in. It examines the situation and decides whether the problem is imprudent loans or just bad luck. If it sees nothing wrong, it may choose to prop up the bank for awhile, putting it on probation while it sees whether things turn around.

Then if the bank does fail, the bank owners lose their money but the depositors may hardly notice. The name of the bank changes, but things go on pretty much as before for them.

Things have to get very bad for the public to notice, and that hardly happens once a generation.

Alexius wrote:
J Thomas wrote:
Alexius wrote:
jules.LT wrote:
- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

Yes, that's wrong.
In a 10% reserve system, to lend out $900M a bank needs to have a billion dollars of which $100M is deposited at the reserve bank.


So, do it gradually. Lend $10M, and send $1M to the reserve bank. Now you have assets of $110M. If you get your share of bank deposits, as fast as your debtors spend their $10M, other depositors will put $10M in your bank. Lend $20M, and send $2M to the reserve bank. Lend $30M and send $3M to the reserve bank. Unless too many people withdraw money and deposit it in other banks, you'll be fine. Eventually you will get to $100M in the central bank and a billion dollars of assets.

And if other banks get the deposits instead of you? Then they will make the loans, and will eventually bring it up to a billion dollars of assets based off $100 million in capital.

Yes, that is partly how banks are set up (I think). The exception being when you say
Lend $10M, and send $1M to the reserve bank. Now you have assets of $110M

which is flat-out wrong, and I have no idea how you got there.


When you first make the loan, you have assets of $100M capital and $10M loans. You give your debtor a bank account with $10M in it. On average, people deposit money into banks as fast as other people withdraw it, so if that holds true for you, you will get $10M deposits about as fast as your debtors spend their $10M. So you can hope to continue to have $100M capital, $10 million deposits, and $10M loans.

If that doesn't work for you, it will work for the banks your money is draining to. Your $100M capital will result in $900M in loans, if banks can find $900M in loans they are willing to make.


And yes, it is a billion dollars of assets based off $100 million in capital- but the bank still only has $100M of equity because it also has $900M worth of liabilities to its depositors.


Agreed. Of course, we should also count something for the fees, and vigorish the bank charges.

A bank that can get 6% on $900M in loans is getting 54% on its capital, minus expenses. That looks like a good deal, and explains why so many people wanted bank stock before 2008.

Now we have a lot of things that are not banks that get to basicly do banking without getting regulated like banks. The more of the money they handle, the harder it gets for official banks.

Derek wrote:Ten people think they have your dollar, but only Larry can spend it. Why is this? Because only Larry's bank has any reserve left. The other banks have lent out their entire reserves. If anyone other than Larry tries to withdraw or spend their dollar, their bank will immediately default because it has no reserves to give back.


Not necessarily. If the dollar is sent to the central bank and everybody has debit cards, they can each spend their dollar. You buy something from Joe, and the dollar is subtracted from your account and added to Joe's. Bob buys something from Anthony, and a dollar is subtracted from Bob's account and added to Anthony's. Etc etc etc. The problem only comes when somebody tries to withdraw a dollar in cash. When that happens, the central bank can quick lend the dollar to whichever bank needs it. Then they hold their breath hoping nobody will withdraw a second dollar. When the withdrawer spends the money and somebody deposits it, then they all start breathing again.

In real situations they can depend on statistics. Nobody withdraws 10% of the cash. Nobody withdraws 1% of the cash.

If the government was running the banking system, it would not need to have any cash. Paper money has no use any longer except to let people do transactions without keeping records.
Last edited by J Thomas on Fri Apr 12, 2013 6:29 pm UTC, edited 2 times in total.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Wed Apr 03, 2013 9:25 am UTC

Alexius wrote:
J Thomas wrote:
Alexius wrote:
jules.LT wrote:
- The bank's deposit at the reserve bank ("high-powered money") allows it to lend 9 times that money (10% of the money is "in reserve"). So theoretically a bank could raise $100M of capital, deposit it at the reserve bank and immediately turn around and lend out $900M, couldn't it?

Yes, that's wrong.
In a 10% reserve system, to lend out $900M a bank needs to have a billion dollars of which $100M is deposited at the reserve bank.


So, do it gradually. Lend $10M, and send $1M to the reserve bank. Now you have assets of $110M. If you get your share of bank deposits, as fast as your debtors spend their $10M, other depositors will put $10M in your bank. Lend $20M, and send $2M to the reserve bank. Lend $30M and send $3M to the reserve bank. Unless too many people withdraw money and deposit it in other banks, you'll be fine. Eventually you will get to $100M in the central bank and a billion dollars of assets.

And if other banks get the deposits instead of you? Then they will make the loans, and will eventually bring it up to a billion dollars of assets based off $100 million in capital.

Yes, that is partly how banks are set up (I think). The exception being when you say
Lend $10M, and send $1M to the reserve bank. Now you have assets of $110M

which is flat-out wrong, and I have no idea how you got there.


When you first make the loan, you have assets of $100M capital and $10M loans. You give your debtor a bank account with $10M in it. On average, people deposit money into banks as fast as other people withdraw it, so if that holds true for you, you will get $10M deposits about as fast as your debtors spend their $10M. So you can hope to continue to have $100M capital, $10 million deposits, and $10M loans.

If that doesn't work for you, it will work for the banks your money is draining to. Your $100M capital will result in $900M in loans, if banks can find $900M in loans they are willing to make.


And yes, it is a billion dollars of assets based off $100 million in capital- but the bank still only has $100M of equity because it also has $900M worth of liabilities to its depositors.


Agreed. Of course, we should also count something for the fees, and vigorish the bank charges.

A bank that can get 6% on $900M in loans is getting 54% on its capital, minus expenses. That looks like a good deal, and explains why so many people wanted bank stock before 2008.

Now we have a lot of things that are not banks that get to basicly do banking without getting regulated like banks. The more of the money they handle, the harder it gets for official banks.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Wed Apr 03, 2013 9:38 am UTC

Derek wrote:
jules.LT wrote:
firechicago wrote:The way you wrote it implied that a bank could raise $100 million in capital and immediately turn around and lend out $400 million, lending out money it did not have. That's simply not true.
I learned about this stuff from the Money As Debt video, so pardon my cluelessness. It talks about two different things (at 13:10):

Money as Debt is a horrible video that is largely responsible for spreading these misconceptions about the fractional reserve system (I suspect J Thomas has also seen it).


I have not.

And yet, they do.

Try this thought experiment. You deposit a dollar into a bank account. You write your name on it, and you sort of imagine the bank is keeping it for you in their safe. But really, they lend your dollar to Anthony. Anthony spends it and Bob gets it. Bob deposits it in some bank. Now you can spend your dollar with your debit card, and so can Bob. The bank then lends your dollar to Carl, who spends it and Dan gets it. Dan deposits it in a bank. You, Bob, and Dan can spend it. The bank lends your dollar to Ed, who spends it and Frank deposits it in a bank. The bank lends it to George who spends it, and Harry deposits it in the bank. Ida spends it and Jerry deposits it, Katherine spends it and Larry deposits it. Soon ten people think they have your dollar, and any of them can spend it any time they want. Other things equal (like the speed that people spend money, and GDP, etc, other things never stay equal but what should we assume?) the banks have reduced the value of your dollar by 90%. For anything you want to buy, there are now 10 times as many people with the money to buy it. The effect is almost the same as if counterfeiters passed so much bad money that 90% of the money in circulation was bad.


Ten people think they have your dollar, but only Larry can spend it. Why is this? Because only Larry's bank has any reserve left. The other banks have lent out their entire reserves. If anyone other than Larry tries to withdraw or spend their dollar, their bank will immediately default because it has no reserves to give back.


Not necessarily. If the dollar is sent to the central bank and everybody has debit cards, they can each spend their dollar. You buy something from Joe, and the dollar is subtracted from your account and added to Joe's. Bob buys something from Anthony, and a dollar is subtracted from Bob's account and added to Anthony's. Etc etc etc. The problem only comes when somebody tries to withdraw a dollar in cash. When that happens, the central bank can quick lend the dollar to whichever bank needs it. Then they hold their breath hoping nobody will withdraw a second dollar. When the withdrawer spends the money and somebody deposits it, then they all start breathing again.

In real situations they can depend on statistics. Nobody withdraws 10% of the cash. Nobody withdraws 1% of the cash.

If the government was running the banking system, it would not need to have any cash. Paper money has no use any longer except to let people do transactions without keeping records.
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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Zamfir » Wed Apr 03, 2013 10:20 am UTC

No double posting on this forum

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby firechicago » Wed Apr 03, 2013 10:26 am UTC

J Thomas wrote:A bank that can get 6% on $900M in loans is getting 54% on its capital, minus expenses. That looks like a good deal, and explains why so many people wanted bank stock before 2008.

Except the banks also have to pay their depositors something, and worry about defaults, and pay loan officers and bank tellers and database managers and...

When all is said and done return on equity for commercial banks floated around between 10% and 15% in the boom years before 2008. Which is in line with the 11.9% average return on equity for the S&P 500 since 1926.

More generally, yes, you seem to have arrived at a basically sound description of how finance has worked in the Western world for the last three or four hundred years, but you have yet to indicate why you think it somehow constitutes theft on the part of bankers. From my point of view everyone walks away from this transaction happy: the depositor gets a place to put their money that both is safer than hiding it under the mattress and provides a modest return. The borrower gets money to make productive investments or finance consumption. The bank takes a little off the top for acting as a matchmaker and taking on most of the risk on both ends. Who's picking who's pocket?

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Zamfir » Wed Apr 03, 2013 11:13 am UTC

When you first make the loan, you have assets of $100M capital and $10M loans. You give your debtor a bank account with $10M in it. On average, people deposit money into banks as fast as other people withdraw it, so if that holds true for you, you will get $10M deposits about as fast as your debtors spend their $10M. So you can hope to continue to have $100M capital, $10 million deposits, and $10M loans.

If that doesn't work for you, it will work for the banks your money is draining to. Your $100M capital will result in $900M in loans, if banks can find $900M in loans they are willing to make.
...
A bank that can get 6% on $900M in loans is getting 54% on its capital, minus expenses. That looks like a good deal, and explains why so many people wanted bank stock before 2008

This mechanism is typical for any company financed by leveraged capital, like pretty all of them. Obviously, very few get that kind of return on capital. Including banks, who sure as hell don't get 6% returns on loans once you take losses and costs into account.

It's a red herring that the company's business happens to be banking. Fractional banking itself is a red herring, if your concern us leverage. You can have leveraged companies without any money-creating banks in the economy.

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby J Thomas » Wed Apr 03, 2013 11:39 am UTC

Zamfir wrote:No double posting on this forum


Oops! I apologize, I forgot.

I thought I could delete my posts, but it only lets me delete this one.


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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby Kulantan » Fri Apr 12, 2013 3:41 pm UTC

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Re: Cyprus Bailout: Wealth Tax, Bank Runs on the Horizon

Postby HungryHobo » Fri Apr 12, 2013 5:49 pm UTC

J Thomas wrote:If you had $20 and you found a sneaky trick that let you "lend" $80 to other people and then claim you had $100, you would be guilty of fraud. But banks have a license to do it.


I offer accounts and loans to people.

I offer to keep Joes money and even give him 5% more next week on the condition that he not take it out before next week and accepts that there's a small chance that I might go bankrupt before then.

I have 20 bucks.

I loan 20 bucks to Joe and he agrees to pay me back 30 bucks next week.
Joe spends that 20 bucks at Bills shop.
Bill drops off the 20 bucks with me.
I loan 20 bucks to Jill and she agrees to pay me back 30 bucks next week.
Jill spends that 20 bucks at Bills shop.
Bill drops off the 20 bucks with me.
I loan 20 bucks to Jane and she agrees to pay me back 30 bucks next week.
Jane spends that 20 bucks at Bills shop.
Bill drops off the 20 bucks with me.
I loan 20 bucks to Jack and he agrees to pay me back 30 bucks next week.
Jack spends that 20 bucks at Bills shop.
Bill drops off the 20 bucks with me.

I end up with 84 bucks I owe Bill and "assets" of 120 bucks I'm owed.

I(or anyone at all, there was only one 20 dollar bill in the whole town that week) only had 20 bucks yet without committing any fraud I loaned out 80 bucks and on paper ended up with more assets than I started with.

Even if one of them defaults I'm still up 16 bucks.

of course this isn't the most stable situation so the government insists that if things go really bad I should be able to handle a higher than expected number of defaults so they insist that I keep a reasonable amount of money deposited with them. if 100% of my customers default Bill and I are still screwed but the chances of that are extremely small.
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