DBC Reed left a comment on Are central bankers really this stupid..?:
As I have said: your views that bankers are middlemen and are unjustly maligned is so unusual that you really need to adduce some evidence, quotations from other people, books and standard works of reference to back them. That is to satisfy the normal terms of written debate or academic discourse.
I never said they were unjustly maligned, they deserve all the kicking that they can get IHMO, but whichever way you look at it, they are middlemen between borrowers on one side; and depositors, bondholders and shareholders on the other (the precise distinction being a legal rather than an economic matter). The bank's net assets/shareholders' capital as a percentage of total assets/total liabilities is absolutely tiny - I believe that DBC himself mentioned the figure of three per cent, which sounds about right.
There is little point quoting people, banking is a very mechanical thing, let's understand the mechanics before we worry about polemics, or what the 'solution' might be, if any exists.
It is quite clear how everybody but you is using the term reserves as in the quote from The Times: they clearly mean bank money not loaned out or possibly on quick call (Libor money).
OK, we hereby agree to use common parlance - "reserves" now refers to liquid assets, that's fine.
"In the course of issuing money the commercial banks actually create it by expanding their deposits,but they are not not at liberty to create money all they may wish, whenever they wish, for the total is limited by the volume of bank reserves and by the prevailing ratio between these reserves and bank deposits - a ratio that is set by law, regulation or custom."
Yes, I agree with that statement and have said so myself often enough*, although the more modern approach (which I loosely refer to as Basel capital ratios) is to look at the ratio between shareholders funds and total deposits.
Kitty Ussher then at the Treasury: "By far the largest role in creating money is played by the banking system itself... When banks make loans they at the same time create a new deposit.."
That is saying the same thing, and again, I agree. However, once the dust has settled, the bank ends up with an asset (the loan to the borrower) and a liability (the new deposit it has created), and henceforth, it is a middleman between the two parties.
Remember that pecunia non olet: once the loan and deposit have been created, what happens after that is exactly the same as what would happen were the system to work the other way round, i.e. the bank waits patiently until people make deposits and keeps putting the cash received into "reserves" (as defined above) until it has enough to make a new loan.
Of all the money I have in bank accounts, it is impossible to tell which of it is my hard-earned net salary, and which of it is the easy money I made from selling flats and houses or my capital gains. The bank simply does not care, and the person who ultimately borrows the money will never find out, it all gets mixed up.
Even in a non-technical way, bankers are primarily middlemen in creating credit and asset price bubbles - they prey on the gullible who think that house prices or share prices can only go up by lending them money; and the more cynical people exchange what they think are overvalued houses or shares into a deposit at the bank (but not that cynical that they don't even trust banks!). The fact that the new loans and new deposits are created more-or-less out of thin air is a separate topic - the bank (i.e. the shareholders as a body) still only own three percent of the whole shooting match.
You could also argue that politicians, Home-Owner-Ists, estate agents and property pornstars like Phil & Kirsty are only middlemen in creating bubbles - they do not in themselves buy and sell every single house, but they con people into thinking that house prices can only go up - this makes them just as deserving of a good kicking as the banks are.
* See for example here: "The point is that building bank reserves [i.e. giving them more capital, the accounting meaning of the word 'reserves'] will not increase the bank’s capacity to lend. Loans create deposits which generate reserves."
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23 comments:
It might be helpful to remeber the old saw about bank managers:-
"borrow at three, lend at six and be on the golf course by three"
These are the legendary 363 managers.
Not much changes really.
Banks receive an unearned income through the super normal interest they charge. And then go and spend it on worthless production (football teams, F1, tennis, luxury etc) If its unearned, that's OK but it should be given back.
That it is not is good enough reason to say "Enough". Private banking is not worthy of such a cartel. And proceed on reform.
We could start that reform by some way refusing credit to buy land (not buildings though)
That would probably make the rest of the credit problem largely moot.
Try telling a fundamentalist money reformer that! They have this weird idea that money came before land ??? And that money is wealth ???
Spookey.
RS: "Private banking is not worthy of such a cartel. And proceed on reform. We could start that reform by some way refusing credit to buy land (not buildings though)"
Agreed. That is all part of my ten point plan for banking reform. Loans that are 'secured' on the land value element* of a mortgage count as unsecured and will be notionally written down 50% when looking at Basel ratios.
* To the extent that land has any capital value once I'm finished.
Not a very big crowd puller this particular argument is it? Apart from Robin whom we both know ( the Conservative land taxer may the gods preserve him).
To get this over with quickly: you now use the term bank reserves like everybody else but do not seem able to admit that banks increase the money supply through the normal pattern of lending-on.
"In the course of issuing money the commercial banks actually create it by expanding their deposits"NB expanding not balancing their loans with deposits as you imply in the middleman scenario, of which the Green New Deal Group says in their new report " The Cuts won't work"
section 4 :
"In public the financial services industry maintains that the banks are humble intermedaries between the customer
who has surplus funds to lend and another customer who desires to borrow.Interest is charged to the borrower to recompense the lender,but if the money is created from thin air,there is nobody to reward.The vast share of the reward goes to the banks" (This report can be accessed via Tim Worstall's archived blog for 8th Dec last.)
I am afraid your refusal to come up
with any similar evidence for your argument ,which oddly mirrors that ascribed to the financial authorities above,does not inspire confidence that you have a finished explanation of where money comes from.Much more third party corroboration is surely required.
DBC, you keep contradicting yourself.
We have agreed that banks, to a large extent, create loans and deposits out of thin air. The banks collect interest on the loans (A) and pay interest on deposits (B). As long as A is greater than B (plus write offs, plus actual real life running costs), the banks make a profit. Sos it is very much in the banks' short term interests to create credit/asset price bubbles.
But then you spoil it all again by repeating this, which is typical one-sided economics:
"Interest is charged to the borrower to recompense the lender, but if the money is created from thin air, there is nobody to reward. The vast share of the reward goes to the banks"
Sure, the loan is usually created out of thin air - BUT ONLY IF the bank ALSO creates a deposit out of thin air; but once created those are REAL loans and REAL deposits and the bank not only collects REAL interest it also has to pay REAL interest to the new depositor. The person who is rewarded is the new depositor.
DCB, for the zillionth time, I give you a practical real-life example:
A chap came along who wanted to buy my house for £400,000. He didn't have the money so he borrowed it from a bank. I then got a cheque, drawn on that same bank for £400,000, which I stick straight back into the bank and I become a depositor.
Hey presto - the banking system has created a loan out of thin air (which, once created is a REAL loan and the mug borrower has to pay REAL interest) but it has also created a deposit out of thin air (i.e. my handsome bank balance) on which the banking system has to pay me REAL interest, proper hard cash that I can withdraw every month and use to pay my rent.
Can you give me a single worked example where the banks create new loans and charge interest on them without creating a corresponding deposit? If this were possible then there would never be a run on a bank, would there? People like Northern Rock would just merrily lend more and more money to bail themselves out, which is clearly not possible (or else they would have done it long ago).
I am beginning to lose the will to live or at least continue with this.
After giving you hundreds (more like ten) quotes describing how the system works,while you offer nothing but accounts,you now ask for a worked example ,as if none of the quotes or references works an example.
You might look up the quote you ascribe to Karl Denninger (but which actually comes from Marshall
Auerback but no matter) which you end up directing people to above showing why Quantitative easing won't work.Far from the middleman (MW) or "humble intermediary" (nasty sarcastic New Green Deal Group)relationship,Auerback plausibly describes the banks as dishing out loans with no regards for reserves whatsoever.I follow the pattern that he describes students being taught ,that loans are built on a multiplier of deposits.He says stuff that banks don't stand in the middle taking in and dishing out even handedly.They just dish out loans willy nilly and worry about reserves/deposits later if at all.This is a kind of mad punk view of banking but it tramples the middleman (or MOR)everything balances out explanation (the harmony of the massed banks) emanating from MW underfoot.
DBC: "They just dish out loans willy nilly and worry about reserves/deposits later..."
Again, I agree with that as a statement of fact. I have never said anything differently. The banks can get away with this (e.g. in my real life example) is because I am happy to accept a cheque from the buyer's lender in payment (instead of insisting on coins and notes, in which case he wouldn't need a lender, would he?).
But think about what happens to that cheque that I received. I took it straight round to my bank and handed it over and got a credit to my personal bank account.
Taking all banks as one closed system, they do not need to worry about "reserves/deposits" in the slightest (as long as people are happy to be paid by cheque) because the banking system knows that all that happens is that he gets a big minus on his loan account and I get a big plus on my deposit account.
So the banks can cheerfully dish out loans willy nilly, because they know in the short term, it does not cost them anything, all they do is enter a minus against purchaser/borrower and a plus against vendor/depositor.
Hey presto, out of thin air, they have conjured a REAL mortgage and a REAL deposit. But from that second on, that mortgage and that deposit is very real indeed.
And in future, as long as they can charge him more interest than they pay me, the bank is laughing. If of course he loses his job and property values plummet, the bank is pretty much f***ed, whereas I shifted my money to NS&I anyway so my risk is minimal.
To sum up, the banks are just middlemen between him and me.
Whether banks are evil or not is a separate issue - to give you another analogy, without "evil" drug dealers there would be no drug addicts in the UK or a civil war in Afghanistan. But the drug dealers create demand and demand creates supply, so the fact that drug dealers are "just middlemen" between your English junkie (the borrower) and the Taliban warlord (the depositor) does not exonerate them.
Caveat - I personally would legalise drugs again, I am just using drug dealers as an example of somebody who most people think is evil.
You never accept that the loan is another new quantity of money as all but you recognise.If the deal had been in the gold coin era or in a strictly regulated or middleman system,the bank would have to empty some poor sod's account or more likely skim a few accounts,hoping that everybody would n't want to take their money out at once (bank run- or moment of truth).But since banks can give cheques or promissory notes,they can leave all the savers' money where it is and make up new money
with a cheque and give it to the borrower.So the money supply expands with multiple + signs,no checks and balances no minuses save in the accounts. As the girl said They would would n't they?
If you accept the Auerback scenario
that banks dish out loans with no concern to debit savers accounts as an honest middleman would do,I like to think in a smacked-up frenzy, then we have come full circle to the initial Pettifor letter which had you hopping with indignation.
"Far from the bank starting with a deposit or reserves as a basis for lending,the bank starts with an application ,the asset (e.g.property) against which to guarantee secure repayment and the promise to repay with interest....
The bank does not need savings,deposits or reserves to creat credit.If this were the case there would only be as much credit as there are deposits in the bank"
Exactly.Since you now appear to agree that savings are of no consequence in bank lending and it is all loans,loans a-go-go a l'Auerback and Pettifor I rest my case it being Saturday and all and my wife wants the computer to look up the odds on the football.
DCB, for some reason you insist on looking at only half the picture.
I ask you yet again to consider the example of a bank creating a NEW loan (an asset from the bank's point of view) by handing a cheque to a borrower, who buys a house with it and gives it to the seller. The seller takes that cheque and puts it back in the bank to create a NEW deposit (a liability from the bank's point of view).
In the grander scheme of things, if you look at a bank's balance sheet, the total ASSETS = total LIABILITIES. So, ignoring small amounts for shareholder's funds and fixed assets like buildings, total LOANS = total DEPOSITS (OK, some deposits are called "bonds" or "debentures" but they are all liabilities)
I don't want you to quote stuff second hand, i just want you to think about that transaction. If you can come back with a counter example where the bank creates a new loan* WITHOUT creating a new deposit or liabilty for itself, then we can continue the debate.
* Adding interest to the loan (once it exists) makes the bank richer, for sure, but at the same time the bank has to add interest to deposit accounts, which makes it poorer, that is a side-issue.
You leave the CBs off the kicking list, Mark.
JH, if you mean the Central Bankers, they get an implied kicking in the post title.
Yeah I\m getting bored with this too.Havibg been educated in the Humanities where any proposition has to be aupported with at least three confirmatory pieces of independent evidence I am not used to jettisoning this approach as you do.
In the homespun instance you keep coming back to, the bank gives the geezer a cheque which we we both agree is a perfectly new ,ex nihilo sum of money (so we can stop talking about reserves and banks as a bridge)and the geezer is fixed up with an account which he has to pay income into.The cheque gets spent and returns to the banking systema as a new account.You insist that this account is a liability to the bank ,when in ordianry language it is an asset and is used to on-lend for further banking magic.
Just because they appear in the accounts as liabilities there is no reason ,apart from accounting convention to believe these accounts are liabilites.
If you want to keep it homespun: if someone gave you half a million to look after you would n't regard this as a liability ,would you?
You would see it as an opportunity, particularly if you had the legal power to cover up the fact that you'd spent it by issuing another phoney cheque.
I wwould suggest that the accounts of banks are a fudge,if they are as you say they are.
DCB: "if someone gave you half a million to look after you wouldn't regard this as a liability"
If I have to pay it back, then of course it is a liability. If I borrow a bicycle which I have to give back after a week, then I physically have an asset (the bike) and a liability (to return the bike). I do not get richer by borrowing a bike and the person who lent me is does not get poorer - he has swapped a physical asset (a bike) for a legal right of the same value (the right to demand his bike back in a week).
As to your 'humanities' background, if we wanted to discuss Shakespeare sonnets, then I think you would expect me to have actually read them, rather than just quoting what other people have said about them.
Similarly, as we are discussing banks and accounting, is it too much for me to expect you to actually print some off and look at them?
If you can pay it back with a phoney cheque its not a liability.It's just money in hand.
If the geezer gives you the money with an understanding that you can trade with it,make money on it,and pay him some interest,which is the banks' situation then you are at liberty to buy some property, charge rent, pay back some interest and pocket the difference.If somebody lends you a bike and you use it to deliver newspapers or to save
on bus fare the bike is not a liability but a profit-making asset.Same with deposits.Lehman Bros used all their customers' money to develop a whacking great speculative housing project in Bakersfield.The customers' money was still money (pecunia non olet and all that)and formed the bankster's up-front wodge.It did n't suddenly become not-money because it was classed as a liability.
This is no time to re-open the Two Cultures' debate about humanities
versus the scientists and technicians,save to say that modern philosophers have a lot to say about the relationship of words to "reality."In other words just because banks call their liquid assets "liabilities" does n't mean doodley.
DCB: "In other words just because banks call their liquid assets "liabilities" doesn't mean doodley."
But they don't do that and I have never said they did that. The depositor gives his money to the bank. The bank now has an asset (coins and notes) and a corresponding liabillity (to repay the depositor).
If you were to look at a balance sheet of a bank, you will see that coins and notes are assets and deposits are liabilities*.
In our more advanced and realistic model, the seller of the house puts his cheque for £400,000 back into the bank. This does not really change anything - the bank heaves a sigh of relief that the seller doesn't turn up and demand £400,000 in crisp £50 notes (because that would have triggered a bank run) but there is always the possibility that the seller will do so, ergo it is a liabllity.
You might as well argue that as it is unlikely that the borrower will ever rock up at the bank counter with a suitcase containing £400,000 in crumpled fivers, that the mortgage is not really an asset.
And the bank which receives that cheque for £400,000 cannot lend it on yet again, because it has already lent the money, a few minutes previously, to the man who bought the house and took out the £400,000 mortgage which triggered all this.
* I refer back to my bike analogy. I borrow a bike, I have in my possession an asset (a bike) and a liability to 'repay' that bike in a week's time. The act of borrowing a bike does not make me richer - but as you rightly point out, maybe the real owner of the bike just had it in his shed and wasn't using it so I can put it to better use. Which is why the owner of the bike might be charging me £1 a week rent or something, which is his 'interest'.
So to me that bike is simultaneously an asset, a liability, a source of income and also triggers expenses. The true owner of the bike has an asset (the legal right to demand return of the bike) and a source of income (the £1 a week rent).
It's all basic bookkeeping.
The act of borrowing a bike or money does make you richer.You are richer by one bike and all that money,albeit time-limited (possibly until there is a "calling-in".)You would n't borrow the things if they were a complete liability.
This sentence is just plain wrong "And the bank which receives that cheque for 400k cannot lend it on yet again,because it has already lent that money a few minutes previously to the man that bought the house and took out the mortgage." Of course they can and do.Thats how they expand the money supply and cause all these problems with governments desparately clinging to their coats tails as they go off on another coke-fueled lending binge with no reserves.
The illustration of the 400k going into the bank and creating coins & notes as assets and simultaneously the same amount as a liability is also peculiar.For one thing the money was n't deposited into the bank in specie: for another deposits are n't really liabilities in anything
save as a convenient fiction for the bank.
Please explain in a homely context if you prefer,how the banks are hindered or impaired in their merry madcap money creating activities by having deposits.
DBC: "Please explain in a homely context if you prefer, how the banks are hindered or impaired in their merry madcap money creating activities by having deposits."
In the modern sense, they are not. Coins and notes are meaningless. In the absence of any capital ratios whatsoever, you could start up a bank from scratch with no assets whatsoever, provided that people are prepared to leave 'money' on deposit with you.
Let us assume that in our example, the buyer of my house can't get a loan from a normal bank, but Basher Jones, the 'doorstep' lender says that he can put up the money and gives him a cheque, drawn on Basher Jones Finance plc for £400,000.
Question: would I sign over my house in exchange for a cheque drawn on BJF? Probably not, but if I did, then the only thing I can do with it is take it to BJF and ask him to credit it to my account.
So BJF suddenly has one asset, a £400,000 mortgage and one liability, a £400,000 deposit. As long as BJF can collect more in interest and repayment from the borrower than he has to pay me in interest or cash withdrawals, then everybody is happy.
But Basher Jones is still just a middleman between borrower and depositor, let's assume his interest margin is 1% so he makes £4,000 a year.
Similarly, my purchaser and I might dispense with the services of a bank entirely. We could agree that he gets the house and repays the money directly to me in weekly instalments.
As I am no expert in getting people repossessed and am not inclined to physical violence, I might well engage the services of Basher Jones to go round every Friday and collect the monthly repayments on my behalf, and pay him a fee for his services.
Basher Jones is still just a middleman. Assuming he charges me £80 for each visit, he also earns £4,000 a year from the deal.
Basic bookkeeping you call this?
The bank's expenditure on loans counts as an asset:the bank's income, deposits,counts as a liability.Do you not think this is an inversion of normal double entry bookkeeping?I imagine that if a bank is stuffed with deposits,say at its inception, it is also by accounting standards bankrupt having no assets.No wonder you feel that it does n't matter if loans totally part company with deposits:such a bank is in rude health.Until the whole system comes crashing down.
There is no need to continue this discussion: you are using words in a diametrically opposite way to normal economics.
I don't understand why you are so fussed by the inflation of land values as it increases loans wonderfully.
At least this goes to show that a belief in LVT transcends vast differences.
DCB says: "The bank's expenditure on loans counts as an asset: the bank's income, deposits, counts as a liability. Do you not think this is an inversion of normal double entry bookkeeping?I"
1. The banks does not 'spend' money on loans - it 'grants' loans. Instead of having coins and notes, it has a legal right to be repaid in coins and notes plus interest. That legal right is an asset of approx. similar value to the coins and notes it handed out.
Conversely, a bank may e.g. spend money on advertising - once the coins and notes have been handed over to the advertising agency, it is gone - there is no corresponding asset, so that is a true expense.
2. Deposits are not a source of income (the bank's true source of income is interest etc). Deposits they are a source of finance, but like all sources of finance (apart from share capital) they have to be repaid, therefore they are liablities.
Like I say, this is basic bookkeeping, feel free to read a couple of books on it and look at some balance sheets and profit and loss accounts.
No need, I take your word for it: that in bookkeeping deposits are liabilities, out goings assets and + = -.Bookkeepers must have been rejoicing when a run started on Northern Rock and all those liabilities(deposits) walked out the door.If only they could have persuaded them to take out loans at the same time and the bank would never have beem more profitable.
Since we agree that banks invent the money they dish out as loans ,then banking appears a bigger long con for the dodgy accounting practices you describe, I don't doubt wholly accurately.
DCB, that's a funny way of looking at the run on Northern Rock. The correct version of events is as follows:
The bank had taken deposits of £20 billion (approx), which were liabilities (they must be liabilities because from the point of view of a saver, it is an asset).
The NR obviously had very little spare coins and notes etc kicking about ('reserves; in your parlance) i.e. assets. Hardly any banks have a enough 'reserves' to repay all their depositors at the drop of a hat.
Savers demanded that their liablities be repaid.
The NR did not have enough assets to repay them, certainly not in the short term.
It's that simple.
Those coming out of NR with their deposits in their hands were carrying cheques not cash.Even in the through the looking glass world of bookkeeping ,I don't suppose that accountants think that a bank's only reserves or capital ratio are notes and coins.
Similarly the saver may notionally have an asset in the form of a deposit account but he has signed it over to the banker to do what he likes with it.The banker has de facto ownership of it and the customer kisses goodbye to it even if, as at Lehmann's they go in for piker investments in real estate.As with your homely example of the bicycle,the borrower (ie the banker has borrowed the money off the saver)can make money out of it:the cyclist can deliver papers until he has made enough to buy his own bike. Because using the word in its generally accepted sense the junior bicycle-borrowing entrepreneur recognises that the bike/deposit is a productive asset not a liability.
The banks are bound to invert the normal meaning of words because they are up to no good:when reality bites and a bank run starts the banks wake up to the fact (or pretend to) that their working capital is going out the door not their liabilities.
There is no point in going on with this because, as I said before, you keep saying that deposits are a liability to the bank,with no productive advantage whatsoever.It is like the bit in Spinal Tap where Nigel keeps insisting his amp goes up to 11, taking offence to the suggestion that the measuring system 's been fiddled and bears no relationship to reality.
Although I have given up citing standard works of academic reference on the question and ,at your insistence ,am discussing it in the most mundane,even commonplace terms ,you keep reverting to the same error.
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