The above image from Fed Policy Tools.
“This action eliminated reserve requirements for all depository institutions.”
The Fed openly encouraged and sought both inflation and speculation. It got what it wanted and then some.
Now the Fed has no idea how to fix the mess it created.
Fictional Reserve Banking
The number of people defending fictional reserve banking caught me by surprise. Here is a Tweet chain worth exploring.
Schools Need Fractional Reserve banking?!
If It’s Not Fraud, What Is It?
Car Lease Comparison
Blind Spots
Ben Hunt is normally a good read. I follow him as well.
But for the life of me, I do not see how someone thinks money can or should be both available on demand and invested for years.
This is different than having a gold-backed dollar and it does not preclude lending money into existence.
Perhaps he sees things differently after reading this post.
We all have blind spots. When I look at stuff I wrote years ago I sometimes find myself thinking: Did I really say that?
What Stops a Bank From Doing This?
https://twitter.com/ClarkGab_le/status/1637919717074808832
Good question.
The answer is the Fed. It will not allow a safekeeping bank. If it did, there would be a run on every questionable bank to a bank that only invested in very short-term duration treasuries.
But the solution is to mandate 100% reserves on deposits across the board. It could be phased in.
Interest on Reserves
The Fed used to pay interest on excess reserves (IOER). That series has been discontinued.
Given there are no reserve requirements at all, the IOER series morphed into IORB.
Interest on Reserve Balances
Note that the Fed pays free interest on money it crammed down the throats of banks. The Fed also pays interest on Reverse Repos.
How Much Free Money?
There are two factors in play. Quantitative Tightening (QT) acts to slowly decrease the free money while rising interest rates increases free money.
Explaining the SVB Failure
- The Fed crammed deposits down the throats of banks via QE
- The Zero Reserve requirement by the Fed encouraged banks to speculate.
- Not happy with free money for nothing, banks invested deposits into long duration treasuries and mortgage backed securities.
- Regulators at the banks and Fed did no duration risk analysis
- As the fed hiked rates, total bank losses hit $620 billion.
Instead of making $253 billion in annualized free money, banks collectively managed to lose $620 billion. Way to go!
Silicon Valley Deposits
Silicon Valley Bank had about $200 billion in deposits before the bank run started.
Just by parking money at the Fed, it could have collected $9.3 billion in interest (at the current rate). Instead, greed wiped the bank out.
Not all of that free money would have been profit though. One has to factor in interest paid on deposits.
Most of the big banks paid nothing on deposits, so small businesses and venture capitalists (who knew the risk), flocked to SVB.
SVB was not happy with the free money spread.
A Profitable Safekeeping Bank
The above example shows that it would be easy to create a profitable safekeeping bank. Such a bank would pay a high enough rate to attract deposits but under the amount paid on deposits at the Fed or short term treasuries.
If the Fed stopped paying interest on reserves and the short term treasury rate went close to zero, a bank would have to charge a nominal fee for safekeeping.
The Perfect Solution to the Banking Crisis Is to Make a Truly Safe Bank
I explained my proposal in The Perfect Solution to the Banking Crisis Is to Make a Truly Safe Bank
Unfortunately, the Fed not only sponsored the biggest asset bubble in history, it also failed to understand how free money, student debt cancellations, and zero percent interest rates might cause inflation.
If the Fed cannot see the obvious, why is there a Fed? The only answer I can come up with is Congress would be worse.
I prefer a 100% gold-backed dollar. As it stands we do not even have a 100% dollar-backed dollar!
I can understand someone questioning parts of my proposal, specifically the idea of not lending money into existence.
However, it’s important to understand deposits do not fund loans, rather deposits result from lending money into existence and QE.
One Simple Rule
One simple regulatory rule would have saved SVB, that being a 100% reserve requirement on deposits instead of a 0% reserve requirement on deposits.
Money that is supposedly 100% payable on demand was in fact NOT payable on demand. It’s like leasing your car to two people simultaneously, banking on the notion one will not show up.
The story is simple: SVB took long-term risk on money available on demand. Then depositors wanted their money back. Oops. Two people wanted the same money at the same time.
If I lease the same car or house to two people hoping that one would not show up, I would be arrested.
Amazingly, people defend this practice when banks do it.
The Impact of Fraudulent Practices
A 100% reserve requirement would have stopped the run and thus bank failures due to greed.
Moreover, given that money is lent into existence (rather than deposits funding loans), a mandatory requirement to park money at the Fed or in very short term treasuries would not have impeded bank lending at all!
Free money was just not enough for these banks.
And now, capital impairment due to greed and incompetent regulators will dampen lending. That’s the sorry irony of it all.
As I explained in The Perfect Solution to the Banking Crisis Is to Make a Truly Safe Bank “We don’t need to up the FDIC limit, we need to eliminate the need for FDIC and create a safekeeping bank.“
A 100% reserve requirement on deposits would do just that, and it would not at all hinder lending.
This post originated on MishTalk.Com.
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Mish
universal guarantee on all bank deposits, like during the GFC, will reduce the
supply of loan funds, will reduce the transaction’s velocity of funds, will
reduce the real rate of interest, and thus will lower R-gDp and raise the
Federal Deficit.
a bank from a nonbank.
The time horizon of the
trading desk’s policy has been 24 hours rather than 24 months.
The problems stemmed from using
the wrong criteria (interest rates, rather than member bank legal reserves) in
formulating & executing monetary policy. Net changes in Reserve Bank credit
(since the Accord) were determined by the policy actions of the Federal
Reserve. But William McChesney Martin, Jr. changed from using a “net free” or
“net borrowed” reserve approach to the Federal Funds “Bracket Racket” c. 1965.
Note: the Continental Illinois bank bailout provides a spectacular example of
this practice.
The effect of tying open market
policy to a fed funds bracket was to supply additional (& excessive) legal
reserves to the banking system when loan demand increased. Since the member
banks had no excess reserves of significance, the banks had to acquire additional
reserves to support the expansion of deposits, resulting from their loan
expansion.
If they used the Fed Funds
bracket (which was typical), the rate was bid up & the Fed responded by
putting though buy orders, reserves were increased, & soon a multiple
volume of money was created on the basis of any given increase in legal
reserves.
This combined with the rapidly
increasing transaction velocity of demand deposits resulted in a further upward
pressure on prices. This is the process by which the Fed financed the rampant
real-estate speculation that characterized the 70’s, et. al.
inflation by raising interest rates, he stopped inflation, the “time bomb”, the
release of savings in the 1st qtr. of 1981, by imposing reserve requirements on
NOW accounts in the 2nd qtr.
not non-borrowed reserves as Paul Volcker found out. Volcker targeted
non-borrowed reserves (@$18.174b 4/1/1980) when total reserves were (@$44.88b). I.e., Volcker let the economy burn itself out.
Monetary policy should delimit all required
reserves to balances in their District Reserve bank (IBDDs, like the ECB), and
have uniform reserve ratios, for all deposits, in all banks, irrespective of
size (something Nobel Laureate Dr. Milton Friedman advocated, December 16,
1959).
California: February 26, 1947:
blackboard and worked the whole problem out, which Viner was unable to do”…
errors in Keynes’ fundamental equations.
Keynes admitted the errors and this gave him, at least in part, the impetus to
write the General Theory.”…
Treatise on Money grew out of these criticisms.”
Unfortunately, the only tool, credit control device, at the disposal of the
monetary authority in a free capitalistic system through which the volume of
money can be properly controlled is legal reserves. Powell eliminated legal
reserves in March 2020.
Daniel L. Thornton, May 12, 2022 agrees with me:
“However, on March 26, 2020, the Board of Governors reduced the reserve
requirement on checkable deposits to zero. This action ended the Fed’s ability
to control M1. In February 2021 the Board redefined M1 so that M1 and M2 are
very nearly identical. Consequently, it makes little sense to distinguish
between them. In any event, the checkable deposit portion of M2 cannot be
controlled now because there are no longer reserve requirements on these
deposits. Here is the reason the Fed cannot control these deposits.”
As I said: “The
FED will obviously, sometime in the future, lose control of the money stock.”
May
8, 2020. 10:38 AMLink
Lawrence K. Roos, former
President, Federal Reserve Bank of St. Louis and part-time member of the FOMC
(the Fed’s policy arm), was cited in the Wall Street Journal’s “Notable
and Quotable” column, April 10, 1985, as follows:
“…I do not believe
that the control of money growth ever became the primary priority of the Fed. I
think that there was always and still is a preoccupation with stabilization of
interest rates”.
Buying overnight treasuries are loans
Mish. Start up a bank run they way you suggest. It would be a great free market experiment. I’m guessing it would not survive. You need some revenue to cover all the costs. Your bank wouldn’t be profitable.