On 31 Dec 99 08:24:35, Roberto Verzola wrote:
> >Actually, both answers are wrong. Sort of. And both are right. Sort
> >of.
>
>As I said, until one appreciates why this is so, one underestimates
>the power of banks to CREATE money. The 90 answer is not "sort of
>right"; it is wrong, period.
Overall, Roberto and I are not in disagreement. The above statement is
completely right for any given deposit. It is wrong for the whole
picture. Sure sounds like "sort of" to me. In the sense of incompletely
right.
>The 900 answer is the maximum, as I was careful to point out. It is
>not a "sort of wrong" answer, but the correct theoretical maximum.
>If it isn't reached, it is because not all banks reach their maximum
>target lending. But that simply means the banking system can lend more
>until it reaches the theoretical maximum.
They *don't* reach the theoretical maximum, but consistently only about
40% of it. Sure sounds like "sort of" wrong to me.
>This is not about bringing in money from abroad, but about local cash
>deposited by local citizens. I repeat: from a *local* $100 deposit,
>the banking system can lend a maximum of $900, given a 10% reserve
>requirement.
Yes, technically true. I chose to start with absolutely new money to
the system. Local cash is somewhere in the multiplier phenomenon, so I
merely tried to simplifiy the example by taking that component out of
the equation. Doesn't change a thing.
>Understand why this is so, and you'd know the real secret of how banks
>simply CREATE money. The rest are details.
>
>I've been asked: then why do some banks fail? Banks fail because their
>owners/managers are not happy enough making such easy money legally.
>They get too greedy and do illegal things like lending to their own
>companies and pocketing the cash, done elaborately of course to make
>it seem legal.
More often they get in trouble because in a pinch the supposed value of
the underlying assets against which they have lent that money they
allegedly "created" is simply insufficient to cover the amount they
have lent. This happens periodically with real estate.
Good bankers lend against cash flow, not against assets. They take a
lien on the assets to provide extra security if the cash flow doesn't
materialise. Bankers lending money for folks to buy 145 bushel corn
ground at $3500 per acre have their heads up their butts. The average
newly minted MBA banker working for some commercial outfit nested six
layers deep was three or four years old the last time ag land values
took a crapper. From his point of view it might just as well have been
in 1742. People don't learn from history, *that's* what consistently
gets banks (and everybody else) in $#!^load of trouble.
Banks make money not only on *fees,* but on the spread between what
they pay in interest and what they take in. Much of their reserve
they'll keep with the Federal Reserve (Bank of Canada, whatever) at
pre-determined interest. that's why it's called the Federal *Reserve*
ssystem --- these guys don't keep much of their resesrves in their own
vaults, after all.
So you're a banker, you take in a thousand bucks at 1% (if the
depositer is ignorant) to 4% (money market account), let's say 3%. You
lend out $900 at prime (let's call it 8% to make things easy). Pay out
$30 for a year, take in $72, plus whatever you get from the Fed. Not
bad. If the spread is good enough (it currently is) you make money, and
it is to your advantage to lend a *lot* of money, right up to the
officially established reserve limits.
If, however, people stop borrowing (as they usually do in deflation)
things get very ugly, very quickly for the banks. They lose their
spread because nobody borrows money, and the value of their underlying
assets collapses at the very moment their borrowers' cash flow has
headed south.
Remember, all debts are eventually paid, either by the borrower or the
lender. When there is an epidemic of bad balance sheets (as I believe
there is now) the only two options are to inflate the debt away, or
deflate it away by writing it off.
The usual result when governments try to inflate a debt away is that
the government is overthrown.
Bart
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