Continuing the theme of the article the current banking crisis has exposed two conflicting functions of money i.e., store of value and a vehicle of investment both of which are facilitated by banks.
Keeping money safe, whether physically or digitally, comes at a cost. Banks absorb this cost because they make money through credit creation, maturity transformation, and interchange fees. They even pass on some of that profit to depositors. However, each of these banking activities create risk, which is passed onto the deposit holders and is offset, to an extent, by deposit insurance. In low to zero-interest-rate scenarios, banks act as pure custodians as their revenues decline, which is why we saw EU banks charging negative interest rates, i.e., a fee, to maintain customer deposits.
There's a delicate balance and an inherent conflict between keeping money safe and earning yields, the two functions performed by a commercial bank. Customers don't perceive this conflict unless a bank breaks down as SVB did.
I think this crisis is the strongest yet reason to push for CBDCs as only a central bank can fully guarantee a deposit. In terms of systems design, this is a clear delineation of responsibilities.
CBDC: If you want safe custody of your money.
Bank: If you want to lend your money in return for a yield. And as with any lending, you take the risk of a borrower defaulting.
> I think this crisis is the strongest yet reason to push for CBDCs as only a central bank can fully guarantee a deposit
This makes zero sense. A CBDC doesn't have a stronger "guarantee" than normal central bank money, yet it has all kinds of negatives like total surveillance and control.
> only a central bank can fully guarantee a deposit
The buck stops at the government, as we are seeing with changing laws to allow Credit Suisse acquisition or by Biden and European representatives statements abou "doing whatever is needed" or similar.
On the other hand, imagine what level of services we could have if it wasn't for the tax dodgers and cash in hand payments. I reckon we could fund universal basic income just from whitening the economy, in any given country.
Most EU banks have always charged a fee for maintaining deposits (at least for private individuals).
In the UK, banking is normally free, but on the continent, you normally pay for the account itself and any cards you may hold. Some banks may offer fee waivers for those whose salaries get paid into the account, or if you have a cardless account etc, but it is fairly common practice to charge a small fee for the bank account itself.
In addition to the fee they are leveraging your deposits - and European banks are no less risky for the depositor than the US ones (just look at the 2008 era). Having a 'true bank' that does not leverage your money and has no investment risk would probably be useful to a certain segment of people but the assets would still have counterparty risk and everything else so in the end a very niche market since the best way to handle risk is to distribute to multiple counterparties, currencies, etc... and then you might as well get the interest from the money at that point since you've de-risked so much already.
A hybrid solution could be a grade of bank accounts whose deposits are backed 1:1 by short dated government debt.
You get most of the safe custody benefits of CBDC whilst minimising the costs of restructuring the banking system. Customers could still use all the same banking apps and branches.
Such a program could even be eased in over time by steadily increasing the proportion of bank balance sheets allocated to short dated government debt.
In the US there used to be the Glass-Steagall Act "effectively separating commercial banking from investment banking"; established in 1933 but it was partly repealed in 1999.
Not safe from the moralizing pricks (of which there is a surplus in our midst) who the executive or legislature will inevitably try to cozy up to by stealing my money on the basis of some attribute or box that I check.
The biggest challenge facing CBDCs (Central Bank control of Digital Currencies) is that any laws or regulations concerning them can be changed at anytime, without the consent of the governed.
I don't think you're actually proposing anything with that CBDC statement - CBDC doesn't imply any particular policies or mechanisms. It is a non-phrase without a concrete proposal. What exactly is the central bank supposed to do here?
That's cash. CBDC is if you want no control over your money. At the flip of the switch you can be put on a denial of service list. Except unlike when PayPal does it, you can't just switch providers.
Thinking CBDCs are “safe” is extremely naive. They’re a dystopian nightmare. They’re every dictators wet dream. This is why Bitcoin matters. Bitcoin = freedom.
An economy run on Bitcoin is an absolute dystopia. You reluinquish monetary control to a deflationary coin, being in the whim of Bitcoin whales. People who advocate for it, either are whales or they are stupid.
Ask south europe how well it worked for them having no power over their monetary policy.
Couldn't you sub cash for Bitcoin here and have it make just as much sense? Also, isn't bitcoin highly traceable, especially for a sophisticated state actor?
Not to disparage the poster, but these type of comments always come across to me as astro-turfing.
At no point has anyone been advocating for a Central Bank Digital Currency (CBDC) and furthermore the only people who stand to gain from this are the powers that be. I'm vehemently against a CBDC purely because I like to play a thought experiment if I were from the 18th century and landed in the present day, how hard would it be for me to engage with society. A CBDC is 100% the anti-thesis to creating and supporting people.
I'm so confused by what role a CBDC is even supposed to play... why would the government establish a new currency pegged 1:1 to its existing currency? Why not just... allow normal Americans to keep deposits at federal reserve banks?
From what I understand, when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank (on behalf of the fed), and the bank needs to pay the fed interest. The bank also needs to pay the loan back by an agreed uppn time (which destroys the money).
Why can we not have a similar system for deposits? A bank takes a deposit, the fed "destroys" the money, but pays interest to the bank. When the depositor wants to withdraw their money, the fed/bank recreates the money.
I guess this is sort of what happens with banks buying bonds from various government bodies, but the banks are managing a mix of bond maturity durations.
If bank runs are a worry, why not do away with this flexibility for the banks?
And this cannot be "controlled" for because money is fungible, and if you do try to "prevent" it Bob just puts his 80 cents in another bank which does the same thing, and it all loops around.
Certificates of Deposit are supposed to be the thing that "helps" a bank balance the "short duration" deposits with "long duration" loans - but when interest rates are so low the CDs are not worth bothering with.
I wonder if we'll see a maximum interest rate on "cash accounts" or something in the near future to try to balance it.
Basically it’s a bank that puts all its deposits directly with the Fed. There have been attempts to start such a bank in the past and they have been denied a banking charter.
Cochrane's speculates a bit about the Fed's motives near the end. He doesn't think they're outright evil, in cahoots with the incumbent commercial banks, etc. He thinks it's a misguided attempt to cross-subsidize the lending activities at the current commercial banks. If the super safe narrow bank draws away a lot of the common depositors, the commercial bank will need to get more other (more expensive) funding sources (bonds and other loans) which can make mortgages, business loans etc more expensive.
The narrow bank would be safer than US Treasury Bonds. In a financial crisis similar to 2008 this would amplify chaos as money drained from all other investment classes into the narrow bank at a time when the government probably needs low interest rates on their debt to solve things.
It's not quite right that banks don't loan out their depositors money. They need depositors to be able to make loans. Stashing depositors money at the Fed keeps the bank from making loans.
Stashing money at the Fed is possible by the way, and effectively does destroy the money (or rather, takes it out of the economy).
Banks can deposit money at the Fed earning exactly the interest rate that the Fed controls. This effectively takes that money out of the economy. That is generally rather bad, because it stifles growth. But in case of inflation, it can sort of help. That is part of why the Fed interest rate helps regulate inflation.
But generally speaking, you want loans to be made! It helps good and productive ideas get of the ground. It is core to Western economies. Hence the Fed is quite scared of narrow banking. They want to be the 'borrower of last resort'.
I've never asked my loans to be paid out in cash or transferred to another bank. When people say commercial banks create/issue money they mean that cash/central bank reserves have become irrelevant other than as a rudimentary payment method or network to transmit between banks.
If you wanted to make the point that banks lends existing deposits you would have to basically argue that people never wire money and always pay with cash and deposit their cash paychecks manually and pay taxes in cash. Curiously, my government points me at major banks and their ATMs when I want to pay my taxes in cash.
>when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank (on behalf of the fed), and the bank needs to pay the fed interest.
Commercial banks can not create loans out of thin air during normal operation. They either have to use depositors' money or share holders' capital. In other words, bank's liabilities (e.g. user deposits) should not exceed its assets (loans to users, securities, reserves at Fed, etc.). There are games which can played with how assets worth is measured (e.g. mark-to-market vs. mark-to-maturity), but otherwise the rule must be followed by banks.
>Why can we not have a similar system for deposits? A bank takes a deposit, the fed "destroys" the money, but pays interest to the bank. When the depositor wants to withdraw their money, the fed/bank recreates the money.
When a bank receives a deposit, it has to decide what to do with it. It can either loan it to someone (either directly or by buying bonds), invest (e.g. by buying stocks), pay it as a dividend to share holders (assuming it has far more assets than liabilities), or keep it in bank's reserve account at Fed. In the later case it gets payed roughly the key interest rate. This is why rate hikes suppress inflation (at least in the near term), banks instead of deploying their capital into the economy deposit it at Fed, thus temporarily removing it from circulation. It also means that cost of loans in the wider economy rises accordingly, since banks will not loan without a sufficient premium to the Fed's rate.
> Commercial banks can not create loans out of thin air during normal operation.
Commercial banks create money, in the form of bank deposits,
by making new loans. When a bank makes a loan, for example
to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage.
At that moment, new money is created. For this reason, some economists have
referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.
If I'm a bank why would I want to get X% interest from the Fed when I can instead get X+Y% interest from some other investment option[0]? Yes the risk is higher, but typically only marginally so. Obviously you have big failures like SVB & others, but the reality is that those aren't common.
It also lets the bank pass on the increased rates to customers. The current fed interest rate is ~4.5%, but there are banks out there right now where you can get >5% in a savings account[1]. Your system would remove that option for consumers.
[0] Other option being some regulatorily approved option, not throw it all in the latest crypto ICO
>The bank also needs to pay the loan back by an agreed uppn time (which destroys the money).
Perhaps you can clarify by what you mean by 'destroyed'.
To my knowledge once the bank has 'created' the money it will always exist in the system. However it has devalued all other money by a small amount which we understand today as 'inflation'. So it's not clear to me what you mean by destroyed.
“High-powered money” is that which is created when the central bank lends to commercial banks. As it is a claim on the central bank’s assets, when it is returned to them it ceases to exist (as the central bank doesn’t need extra paper to dispose of its own assets).
> when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank (on behalf of the fed), and the bank needs to pay the fed interest. The bank also needs to pay the loan back by an agreed uppn time (which destroys the money).
Why can't I do that with the central bank directly? Why the rent-seeking middleman?
Creating money out of nothing is a mechanism to get large projects off the ground. Without it, it would be difficult to fun infrastructure, R&D, etc. like most mechanisms, it can be used in good and bad ways.
Yes, that's how it works. There's this amazing animated movie from 2011 that explains how banking works and the history of banks: "The Collapse of The American Dream Explained in Animation" [1] It has almost 10 million views.
When fed started raising interest rates to curb inflation, the prevalent wisdom was that the average consumer has too much money because of low rates and is spending way too much. The thought was raising rates would curb their spending and bring prices down slowly. However, it turns out the average consumer is very principled with money and is handling it very well. The rich/corporations like banks, VCs, companies felt super rich with the raising stock and began taking on abnormal risk. This was not expected by many. It may eventually lead to the average consumer getting hurt as a repercussion of the failure at the top though. Of course even the crisis of 2008 was caused by exuberant bankers. You need to have access to lots of money to cause lots of damage.
It requires great political training to believe the best person to spend your money isn't you — e.g. some people believe the poor can't be trusted with money, and so on (socialism etc)
Interestingly enough, the graph of bank failures looks like the ones Mandelbrot shows in his works about transmission errors if I recall correctly (can't check right now). My conjecture is that markets encode information rather than other things like value etc. Failures are just transmission errors.
This makes sense. Prices are literally encoding information - first the demand for the item being priced and then the cost of supplying the item. The price of beef is signaling a lot of phenomena including consumer tastes, weather, costs for feed, slaughter, and transportation, etc.
You could argue that central banks putting non-market pricing on the money supply distorts the information that a market-priced money supply would transmit effectively - and that's why all these crises seem to originate in the finance sector.
just found out this paper by Kelly (which may be widely known as the Kelly criterion), stating that one should maximize the expected value of the logarithm of its capital, independent from one's utility function of money, in which Kelly starts by mere information theory considerations.
Why do we even need banks? If they make money by lending money that mostly belong the people (state/feds) anyways, I guess we all would be better if banking was just a state monopol.
I guess I'm just missing some points here so maybe someone can help and explain me why this is a bad idea?!
We need banks because they make it possible for the rich to gamble with the income of the poor.
If your deposits are backed by mortgages or other secured loans you and the bank expect an added return for the "risk" - which is really just making a bet that enough people can pay something extra to compensate for those who default.
This is presented as "how things are" but it actually makes no sense - not least in failing to explain why most of the population is so starved of cash, in spite of long working hours, that it has to borrow at all.
That aside - there's a feedback loop which pushes investors to riskier and riskier lending, sometimes supported by more and more extreme kinds of fraud. Eventually, but somewhat predictably, the system suffers logistic collapse. Because that's what happens to recursive systems with permissive parameters.
In my understanding, the role of banking is to take on the intrinsic risk when doing money allocation.
1. The central banks control supply (by controlling their interest rates)
2. The banks allocate resources (lending out with a risk premium)
3. Consumers and entrepreneurs use the money for value creation.
To me it seems like banks ought to be able to fail. The problem is that banks have gotten the responsibility of the money infrastructure (the cash to e-money transition) which we can not afford to fail.
We should lift the money infrastructure responsibility of banks.
The old distinction between investment and savings banks seems like one of the many regulations we should bring back. Let businesses choose between the two and if their investment bank goes belly up well that's tough. Could even keep FDIC insurance low for both but like so many things legislatures keep falling to pressure to undo the regulations learned from past collapses.
> If they make money by lending money that mostly belong the people (state/feds) anyways,
Naa most of the loans are not using other people's money, banks just create money out of thin air (aka put a record in some database table) and that entry is your loan money.
There are things called Government Savings Banks. The UK has National Savings and Investments (NS&I [1]), which allows individuals to save money with unlimited protection (though I think their accounts typically allow maximum amounts of a few million pounds). The UK government uses this as a form of raising money. I believe other countries have similar schemes.
The government doesn't want to be responsible for making all the loans banks do. It's not easy to do and if the government makes bad ones and loses money people will complain.
The point being that there is a peak, that is to say bank failures are positively correlated. If they were negatively correlated or independent you wouldn't see peaks so much.
Nothing to see here, just garbage collection time. Everyone's successful when interest are low or near zero. Degens feel naked now with the higher cost of capital from interest rates.
Pretty Simple fix. Have the fed backstop all depositors to infinity. Today there are no limits on the number of 250k FDIC insured deposits. Logically the same thing as insuring a single account to infinity.
Backstops have a cost, and infinite backstop subsidizes risk taking activity of deposit taking institutions.
I'm not even saying that what was done in the wake of SVB and Signature was wrong, per se, but making it formal policy that all deposits in a bank are insured is a fundamental change to the foundation of banking in the US. It may be "right" or it may be "wrong", but the one thing it is not is "simple", because the consequences could be far reaching, unintended, and unpredictable, both short term and long term.
I think that's not necessarily true. They can do what was done for SVB and backstop deposits, but take over the bank if the insurance kicks in, firing the managers and wiping out many of the investors. That's probably enough to prevent moral hazard.
The bigger issue is the concentration of deposits and potential suppression of investment.
> Backstops have a cost, and infinite backstop subsidizes risk taking activity of deposit taking institutions.
To me this makes intuitive sense, but are the only options 250k or infinity?
What's the "magic" behind that $250k number? Is there some reason to expect that this is an optimal number? I feel like maybe it's cargo-culting - it isn't even re-adjusted for inflation is it?
Would it be easy nowadays to just have a software service that split up an account into n accounts of less than $250k, and then presented a single interface to all of them?
I guess individual purchases over $250k would be a problem, but I guess a short-term gather operation could be ok, as long as you aren’t too worried about a bank run while that transaction was occurring.
AFAIK, the current normal is for banking systems to ensure all of the deposits, the US is an exception. And this policy hasn't caused any disaster anywhere yet.
But yes, the US has more singular things that can interact badly with no limits on insurance. As a start, the insuring entity has much shallower pockets than most places I know about.
While it may be difficult to see things this way, when you put money into a bank, you’re choosing to not invest that money into something else that might generate a better return for you and for society. The small but real risk of losing your deposits in a bank encourages companies and people with money to invest it into other things.
If there is no default risk, then money will be increasingly stored away inside banks, removing much of the healthy risk-taking activity that generates long term growth and improvements in the standard of living.
Rich people know there is a tiny chance of losing their cash if they stick it in a bank. So they buy other things instead. Those things generate real growth in the economy and improve productivity. Banks have to invest very conservatively because of regulations. Without the tiny risk of default, banks would get all the cash and the economy would stagnate.
Another word for this kind of stagnating economy is “the 1970s.”
Most people aren't thinking they're losing their money because the bank sets itself on fire; they're thinking they're losing their money because a savings account interest rate is well below inflation.
"The small but real risk of losing your deposits in a bank encourages companies and people with money to invest it into other things."
I'm surprised that belief still persists.
The counter to that, of course, is that the silly instability in the banking system we're now seeing worldwide will destroy risk taking as people scramble to protect their positions.
Look at the damage to stock market valuations. How many banks are thinking about creating loans at the moment?
Banks provide liquidity against real things by creating money. They don't invest, and they don't take in money. All they do is shuffle their balance sheet to try and improve their net interest margin.
This idea that banks will suck up all the money is yet another consequence of thinking about banks backwards. There isn't, and never has been, a fixed amount of money.
Just as you get fancier trapeze moves if you have a safety net installed, you get far more risk taking when the basics operate correctly, safely and without having to think about them.
Low levels of inflation already do what you think insolvency risk does. 2% loss of value per year hurts way more than a 0.001% chance of being completely wiped out.
That make no sense. I don't spend money on things because I'm afraid of loosing my deposit in the bank. My point is if I have 1M I want to deposit safely, then I have to make 5 FDIC accounts instead of just 1.
If there is infinity backstop, I will simply create a bank and lend millions to my friends and promptly go bust. They get paid out by the government and I walk away. They do the same for me. We laugh at the poor taxpayer who foots the bill.
This won't happen for the same reason people most don't just burn their house/business down for the insurance payout. People lose insurance all the time this way even if they're just unlucky. Like any insurance company, the FDIC can and will drop a bank and isn't obligated to insure a new one if it's run by unreliable people.
The money behind the $250k isn’t magic and can’t just be multiplied like that. each FDIC-insured bank pays a premium for each qualified account. 10x the accounts means 10x the money into the pool. So it scales logically.
This is a separate issue from the recent trend of the US federal government helping ensure that all deposits, even those beyond the limit, get assumed/recovered.
Your comment seems pretty unserious, but modern monetary theory (https://en.wikipedia.org/wiki/Modern_Monetary_Theory) adherents assert that the point of taxes is not to "fund" anything, but to engineer incentives, redistribute wealth, and remove excess money. And that, yes, we should simply print money, to the extent that we need to, subject to the constraint that excess money causes inflation in specific circumstances.
This is essentially a tax on wealth stored in the form of dollars, right? Which some folks would generally be in favor of, if not for the fact that the super-wealthy tend not to store their wealth in the form of dollars sitting in a bank account (or mattress). Seems rough of retirees and other folks on fixed incomes.
I don’t know why you’re being downvoted - it’s the only thing that makes sense. If the fed doesn’t, then we’ll just see a huge boom in middlemen offering accounts that automatically spread across 250k chunks behind the scenes. They already exist as a niche product, but would become mainstream with more failures. Either way the fdic is insuring the same total amount of money, so may as well cut out that inefficiency and overhead of forcing everyone to have spreaders.
> SVB had a ridiculously high uninsured deposits % of total liabilities
They focused on businesses and HNW individuals and used exclusive banking agreements as preconditions for some deals, so, this is not surprising; had it been engineered to maximize uninsured deposits, it would have been hard to do better.
Readit News
Keeping money safe, whether physically or digitally, comes at a cost. Banks absorb this cost because they make money through credit creation, maturity transformation, and interchange fees. They even pass on some of that profit to depositors. However, each of these banking activities create risk, which is passed onto the deposit holders and is offset, to an extent, by deposit insurance. In low to zero-interest-rate scenarios, banks act as pure custodians as their revenues decline, which is why we saw EU banks charging negative interest rates, i.e., a fee, to maintain customer deposits.
There's a delicate balance and an inherent conflict between keeping money safe and earning yields, the two functions performed by a commercial bank. Customers don't perceive this conflict unless a bank breaks down as SVB did.
I think this crisis is the strongest yet reason to push for CBDCs as only a central bank can fully guarantee a deposit. In terms of systems design, this is a clear delineation of responsibilities.
CBDC: If you want safe custody of your money.
Bank: If you want to lend your money in return for a yield. And as with any lending, you take the risk of a borrower defaulting.
This makes zero sense. A CBDC doesn't have a stronger "guarantee" than normal central bank money, yet it has all kinds of negatives like total surveillance and control.
> only a central bank can fully guarantee a deposit
The buck stops at the government, as we are seeing with changing laws to allow Credit Suisse acquisition or by Biden and European representatives statements abou "doing whatever is needed" or similar.
https://www.investopedia.com/terms/c/central-bank-digital-cu...
Dead Comment
In the UK, banking is normally free, but on the continent, you normally pay for the account itself and any cards you may hold. Some banks may offer fee waivers for those whose salaries get paid into the account, or if you have a cardless account etc, but it is fairly common practice to charge a small fee for the bank account itself.
You get most of the safe custody benefits of CBDC whilst minimising the costs of restructuring the banking system. Customers could still use all the same banking apps and branches.
Such a program could even be eased in over time by steadily increasing the proportion of bank balance sheets allocated to short dated government debt.
[0] - https://johnhcochrane.blogspot.com/2018/09/fed-nixes-narrow-...
Not safe from the moralizing pricks (of which there is a surplus in our midst) who the executive or legislature will inevitably try to cozy up to by stealing my money on the basis of some attribute or box that I check.
See Credit Suisse.
That's cash. CBDC is if you want no control over your money. At the flip of the switch you can be put on a denial of service list. Except unlike when PayPal does it, you can't just switch providers.
Ask south europe how well it worked for them having no power over their monetary policy.
At no point has anyone been advocating for a Central Bank Digital Currency (CBDC) and furthermore the only people who stand to gain from this are the powers that be. I'm vehemently against a CBDC purely because I like to play a thought experiment if I were from the 18th century and landed in the present day, how hard would it be for me to engage with society. A CBDC is 100% the anti-thesis to creating and supporting people.
In short, boo to OP, I doubt their legitimacy.
> Bank: If you want to lend your money in return for a yield. And as with any lending, you take the risk of a borrower defaulting.
Ideally, depositors in a CBDC would also get at minimum the central bank rate.
Similarly, the App Store mixes "Store" with "Content filter". We should be able to choose both independently.
Why can we not have a similar system for deposits? A bank takes a deposit, the fed "destroys" the money, but pays interest to the bank. When the depositor wants to withdraw their money, the fed/bank recreates the money.
I guess this is sort of what happens with banks buying bonds from various government bodies, but the banks are managing a mix of bond maturity durations.
If bank runs are a worry, why not do away with this flexibility for the banks?
Nah it’s simpler.
You put a dollar in the bank. The bank loans 80 cents to Bob. Bob puts 50 cents of that 80 cents in the bank. The bank loans out some of that.
Even without going beyond Bob, the same dollar is now in the bank twice. That’s what people mean by money being created.
Certificates of Deposit are supposed to be the thing that "helps" a bank balance the "short duration" deposits with "long duration" loans - but when interest rates are so low the CDs are not worth bothering with.
I wonder if we'll see a maximum interest rate on "cash accounts" or something in the near future to try to balance it.
Deleted Comment
Dead Comment
Basically it’s a bank that puts all its deposits directly with the Fed. There have been attempts to start such a bank in the past and they have been denied a banking charter.
https://johnhcochrane.blogspot.com/2018/09/fed-nixes-narrow-...https://johnhcochrane.blogspot.com/2019/03/fed-vs-narrow-ban...
edit: It was Scott Sumner, commenting on Cochrane's blog, who speculated that the motive might be cross-subsidizing the normal bank lending activities: https://www.econlib.org/why-does-the-fed-oppose-narrow-banki...
The narrow bank would be safer than US Treasury Bonds. In a financial crisis similar to 2008 this would amplify chaos as money drained from all other investment classes into the narrow bank at a time when the government probably needs low interest rates on their debt to solve things.
Stashing money at the Fed is possible by the way, and effectively does destroy the money (or rather, takes it out of the economy). Banks can deposit money at the Fed earning exactly the interest rate that the Fed controls. This effectively takes that money out of the economy. That is generally rather bad, because it stifles growth. But in case of inflation, it can sort of help. That is part of why the Fed interest rate helps regulate inflation.
But generally speaking, you want loans to be made! It helps good and productive ideas get of the ground. It is core to Western economies. Hence the Fed is quite scared of narrow banking. They want to be the 'borrower of last resort'.
I've never asked my loans to be paid out in cash or transferred to another bank. When people say commercial banks create/issue money they mean that cash/central bank reserves have become irrelevant other than as a rudimentary payment method or network to transmit between banks.
If you wanted to make the point that banks lends existing deposits you would have to basically argue that people never wire money and always pay with cash and deposit their cash paychecks manually and pay taxes in cash. Curiously, my government points me at major banks and their ATMs when I want to pay my taxes in cash.
Commercial banks can not create loans out of thin air during normal operation. They either have to use depositors' money or share holders' capital. In other words, bank's liabilities (e.g. user deposits) should not exceed its assets (loans to users, securities, reserves at Fed, etc.). There are games which can played with how assets worth is measured (e.g. mark-to-market vs. mark-to-maturity), but otherwise the rule must be followed by banks.
>Why can we not have a similar system for deposits? A bank takes a deposit, the fed "destroys" the money, but pays interest to the bank. When the depositor wants to withdraw their money, the fed/bank recreates the money.
When a bank receives a deposit, it has to decide what to do with it. It can either loan it to someone (either directly or by buying bonds), invest (e.g. by buying stocks), pay it as a dividend to share holders (assuming it has far more assets than liabilities), or keep it in bank's reserve account at Fed. In the later case it gets payed roughly the key interest rate. This is why rate hikes suppress inflation (at least in the near term), banks instead of deploying their capital into the economy deposit it at Fed, thus temporarily removing it from circulation. It also means that cost of loans in the wider economy rises accordingly, since banks will not loan without a sufficient premium to the Fed's rate.
Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage.
At that moment, new money is created. For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.
It also lets the bank pass on the increased rates to customers. The current fed interest rate is ~4.5%, but there are banks out there right now where you can get >5% in a savings account[1]. Your system would remove that option for consumers.
[0] Other option being some regulatorily approved option, not throw it all in the latest crypto ICO
[1] https://www.ufbdirect.com/
Perhaps you can clarify by what you mean by 'destroyed'.
To my knowledge once the bank has 'created' the money it will always exist in the system. However it has devalued all other money by a small amount which we understand today as 'inflation'. So it's not clear to me what you mean by destroyed.
An asset is removed from the lendee in the form of a debit against their deposits thus destroying outstanding cash.
Why can't I do that with the central bank directly? Why the rent-seeking middleman?
[1] https://www.youtube.com/watch?v=mII9NZ8MMVM
If they took large losses or lent out too much, inflation would skyrocket.
I'm sure it was all the low rates, and not at all due to printing 40% of the money supply in two years and mailing people checks.
> printing 40% of the money supply in two years
You could argue that central banks putting non-market pricing on the money supply distorts the information that a market-priced money supply would transmit effectively - and that's why all these crises seem to originate in the finance sector.
Edit: the paper https://www.princeton.edu/~wbialek/rome/refs/kelly_56.pdf
If your deposits are backed by mortgages or other secured loans you and the bank expect an added return for the "risk" - which is really just making a bet that enough people can pay something extra to compensate for those who default.
This is presented as "how things are" but it actually makes no sense - not least in failing to explain why most of the population is so starved of cash, in spite of long working hours, that it has to borrow at all.
That aside - there's a feedback loop which pushes investors to riskier and riskier lending, sometimes supported by more and more extreme kinds of fraud. Eventually, but somewhat predictably, the system suffers logistic collapse. Because that's what happens to recursive systems with permissive parameters.
1. The central banks control supply (by controlling their interest rates)
2. The banks allocate resources (lending out with a risk premium)
3. Consumers and entrepreneurs use the money for value creation.
To me it seems like banks ought to be able to fail. The problem is that banks have gotten the responsibility of the money infrastructure (the cash to e-money transition) which we can not afford to fail.
We should lift the money infrastructure responsibility of banks.
Naa most of the loans are not using other people's money, banks just create money out of thin air (aka put a record in some database table) and that entry is your loan money.
[1] https://en.wikipedia.org/wiki/National_Savings_and_Investmen...
Backstops have a cost, and infinite backstop subsidizes risk taking activity of deposit taking institutions.
I'm not even saying that what was done in the wake of SVB and Signature was wrong, per se, but making it formal policy that all deposits in a bank are insured is a fundamental change to the foundation of banking in the US. It may be "right" or it may be "wrong", but the one thing it is not is "simple", because the consequences could be far reaching, unintended, and unpredictable, both short term and long term.
The bigger issue is the concentration of deposits and potential suppression of investment.
To me this makes intuitive sense, but are the only options 250k or infinity?
What's the "magic" behind that $250k number? Is there some reason to expect that this is an optimal number? I feel like maybe it's cargo-culting - it isn't even re-adjusted for inflation is it?
Would it be easy nowadays to just have a software service that split up an account into n accounts of less than $250k, and then presented a single interface to all of them?
I guess individual purchases over $250k would be a problem, but I guess a short-term gather operation could be ok, as long as you aren’t too worried about a bank run while that transaction was occurring.
But yes, the US has more singular things that can interact badly with no limits on insurance. As a start, the insuring entity has much shallower pockets than most places I know about.
If there is no default risk, then money will be increasingly stored away inside banks, removing much of the healthy risk-taking activity that generates long term growth and improvements in the standard of living.
Rich people know there is a tiny chance of losing their cash if they stick it in a bank. So they buy other things instead. Those things generate real growth in the economy and improve productivity. Banks have to invest very conservatively because of regulations. Without the tiny risk of default, banks would get all the cash and the economy would stagnate.
Another word for this kind of stagnating economy is “the 1970s.”
I'm surprised that belief still persists.
The counter to that, of course, is that the silly instability in the banking system we're now seeing worldwide will destroy risk taking as people scramble to protect their positions.
Look at the damage to stock market valuations. How many banks are thinking about creating loans at the moment?
Banks provide liquidity against real things by creating money. They don't invest, and they don't take in money. All they do is shuffle their balance sheet to try and improve their net interest margin.
This idea that banks will suck up all the money is yet another consequence of thinking about banks backwards. There isn't, and never has been, a fixed amount of money.
Just as you get fancier trapeze moves if you have a safety net installed, you get far more risk taking when the basics operate correctly, safely and without having to think about them.
If there is infinity backstop, I will simply create a bank and lend millions to my friends and promptly go bust. They get paid out by the government and I walk away. They do the same for me. We laugh at the poor taxpayer who foots the bill.
The money behind the $250k isn’t magic and can’t just be multiplied like that. each FDIC-insured bank pays a premium for each qualified account. 10x the accounts means 10x the money into the pool. So it scales logically.
This is a separate issue from the recent trend of the US federal government helping ensure that all deposits, even those beyond the limit, get assumed/recovered.
The fed has already been using a lot of that 250. And this is likely not over. Not to mention this seems like it spread overseas
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They focused on businesses and HNW individuals and used exclusive banking agreements as preconditions for some deals, so, this is not surprising; had it been engineered to maximize uninsured deposits, it would have been hard to do better.
Maybe there needs to be regulation that forces banks to hold way more cash?