Q: “I am a bank and I make loans. Whose money am I lending?”
A: Nobody’s
You are creating new money. Lending creates money out of nothing, and that money is deposited somewhere, creating deposits.
Check out the following chart.
Total Credit Owed vs Base Money
Total credit owed exceeds $90 trillion. Base money is just over $6 trillion.
The Federal Reserve defines the Monetary Base as “The sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve).”
Bank Reserves
Bank reserves were 3.3 trillion as of the end of May.
They are a function of QE.
Via QE, the Fed shoved money down the banks’ throats which the banks park back at the Fed an collect interest.
Hooray, Free Money
The Fed pays interest on all reserves. At the end of May, the total reserves were $3.318 trillion.
The Federal Reserve currently pays 1.65% interest on reserves IOR.
If the Fed hikes to the range of 2.25-2.50 percent in July as expected, then expect IOR to jump to approximately 2.40 percent.
Q: On an annual basis, how much free money are we talking about?
A: 2.40 percent of $3.318 trillion is $79.63 billion!
Q: We are giving banks $79.63 billion in free money?
A: It’s a moving target.
The IOR keeps rising but the reserve balances keep declining.
That $79.63 billion reflects a hike that has not taken place yet. If the Fed keeps hiking at a pace that exceeds QT, then the amount will rise further. If not, the actual amount of free money will drop.
Constraints on Bank Lending
1: Bank cannot be capital impaired (too many bad loans)
2: People or corporations want to borrow
3: The bank has to think the loan will be paid back (believe the customer is a good credit risk)
The bank may very well be wrong about point number 3, but it will give a loan if it believes the customer is a good risk (or that the asset value will rise if the customer defaults)
Think about point 3 and the housing crisis. Banks knew damn well they were doing liar loans, but they did not foresee a housing price crash or people walking away from homes
Bank lending creates money that did not exist before. To the extent that any “reserves” are needed, the Fed can manufacture them at will and then some via QE as the above chart shows.
Banks used to collect free money on “excess reserves” now it’s “reserves”
Reverse Repos Hit a New Record High of $2.33 Trillion: Plus a Q&A on Free Money!
I discussed free money and also Reverse Repos in Reverse Repos Hit a New Record High of $2.33 Trillion: Plus a Q&A on Free Money!
This post is a follow-up to the above after a reader asked what money do banks lend.
I also added a note to the above post to state that it was primarily non-banks, especially money market funds that take advantage of the Reverse Repo Facility.
Addendum Q&A
These are reader questions and my responses.
Q: I just don’t get, though, how temporarily selling treasuries & MBS to banks for short periods allows the Fed to keep the Fed Funds Rate in its target range?”
A: Deposits are liabilities of banks. As silly as it sounds and I do think this is silly, banks have to maintain capital on these deposit liabilities.
At any rate, banks will act to get rid of this excess cash “reserves” (a perverse term) and they do that by buying any short term asset they can, typically short dated treasuries.
When the Fed had interest rates near zero, competition for short-term treasuries was so intense, it was driving the overnight rate below zero. Not only did this force rates below the Fed’s target rate, it also put them in negative territory, and nearly broke every money market fund unless the funds started charging interest on deposits!
In response, the Fed started offering nonbanks access to the repo facility whereas before it was only to banks and market-makers like Goldman Sachs.
Bernanke understood this would happen and lobbied Congress for the right to do this and Congress obliged.
Rather than get rid of enough of these “excess reserves” (a term no longer used probably because it points a finger at the Fed) the Fed does Reverse Repos and pay interest on reserves.
The Fed needs to do this to force “up” rates at the low end of the curve because the impact of QE is to force rates lower, below the Fed’s target.
That’s what competition for short-term treasuries has done to the market. “The system is functioning as designed” stated the Fed. And I mocked that design in my previous post.
What the Fed should do is drain all this damn QE as fast as it can. Instead it is dragging the process out for years.
Q: If banks aren’t lending my bank accounts, term deposits etc., then how does my money at the bank make it into a loan?
A: It doesn’t!
Deposits are a liability.
The only reason some banks actively seek deposits is they can park deposits at the Fed for higher rates than they are paying on the accounts. The big banks have so much QE they don’t even bother trying to attract small depositors. Small peon deposits are more of a nuisance.
Smaller lenders also hope that the deposit customers they attract become borrowers at some point.
Q: Mish, Are we headed for a deflationary recession or an inflationary recession? Or maybe both? Maybe asset prices decline in value while food, gas, commodities remain elevated?
A: We will have another round of asset deflation, in fact, it’s started. Whether that leads to CPI-measured inflation is another question. But if you properly throw housing into the equation it sure seems likely.
Historical Perspective on CPI Deflations: How Damaging are They?
It’s asset-price deflation that matters. I have written about this many times. Please see Historical Perspective on CPI Deflations: How Damaging are They?
A BIS study concluded “Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive. Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI ) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period.”
The central bank battle against beneficial routine deflation has started once again to create the very deflation that central banks ought to fear!
This post originated at MishTalk.Com.
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interest on interbank demand deposits (at a level higher than the general level
of short-term interest rates – which was illegal per the FRSSA of 2006). The banks are in competition with the nonbanks, but not the other way around.
The DIDMCA was a
monumental mistake. It caused the Savings and Loan Association crisis (as
predicted in May 1980) and the July 1990-Mar 1991 recession.
WSJ: “In a
letter of March 15, 1981, Willis Alexander of the American Bankers Association
claims that: ‘Depository Institutions have lost an estimated $100b in potential
consumer deposits alone to the unregulated money market mutual funds.’
unbiased banker should know, all the money taken in by the money funds goes
right back into the banks, in the form of CDs or bankers acceptances or other
money market instruments; there is no net loss of deposits to the banking
system. Complete deregulation of interest rates would simply allow a further
escalation of rates by the banks, all of which compete against each other for
the same total of deposits.”
Written by Louis
Stone whom the movie “Wall Street” was dedicated to – Vice President
Shearson/American Express
The differentiating question ostensibly illustrating the
pseudo economic reasoning is: How is the growth of bank held savings explained
in the consolidated balance sheet of the Federal Reserve System?
The answer is that it cannot be explained – because monetary
savings, from the standpoint of the banking system, is a function of the
velocity or rate of turnover of deposits, it is not a function of volume.
The growth of bank held savings thus results in no
alteration in the “footings” of the consolidated balance sheet.
Interest-bearing deposit growth signifies a transfer from demand deposits
either in the same institutions, or a transfer within the system, a bottling-up
of existing money.
In these days of the universal acceptance of the
Gurley-Shaw thesis nonsense, there are a few who realize that the commercial
banks are not conduits between savers and borrowers; who know that commercial
banks do not loan out time deposits, nor the “proceeds” of time-deposits, nor
or the owner’s equity, nor any liability item. The banks are not middlemen in
the lending process for either depositors or stockholders.
It is axiomatic that the demand and time
deposits in the commercial banks can only be invested by their owners, that
time-deposits, basically, are demand-deposits with zero velocity, and that as
long as any deposit, time or demand, has a zero velocity it quite obviously
isn’t, nor can’t, be used to finance investment.
In other words, if the public chooses to hold
savings in the commercial banks the funds are not being spent as long as they
are so held—and the funds are, for the time being, lost to investment.
The drive by the commercial bankers, as perpetrated by the
ABA (the most powerful U.S. oligarch), to expand their savings accounts
(derivative deposits), has a totally irrational motivation, since it has meant,
from a system’s perspective, competing for the opportunity to pay higher and
higher interest rates on pre-existing core deposits in the payment’s system.
But it does profit a particular bank, to pioneer the
introduction of a new financial instrument, such as the negotiable CD in 1961 –
until their competitors catch up; and then all are losers.
The question is not whether net earnings on assets are
greater than the cost of the funding [sic] to the bank; the question is the
effect on the total profitability of the payment’s system. This is not a
zero-sum game. One bank’s gains is less than the losses sustained by other
banks. The whole (the forest), is not the sum of its parts (the trees), in the
money creating process.
flow of income, the Japanese save a higher percentage of their income, and they
keep more of their savings impounded in their banks. “Japanese households
have 52% of their money in currency & deposits, vs 35% for people in the
Eurozone and 14% for the US.” That destroys the velocity of circulation.
“The Depository Institutions Monetary Control Act will have
a pronounced effect in reducing money velocity”.
economic syllogism posits:
require prompt utilization if the circuit flow of funds is to be maintained and
deflationary effects avoided”…
aggregate demand and therefore produces adverse effects on gDp”…
#3) ”The stoppage
in the flow of funds, which is an inexorable part of time-deposit banking,
would tend to have a longer-term debilitating effect on demands, particularly
the demands for capital goods” (CAPEX)
the banking system [and there is a one-to-one relationship between time and
demand deposits. An increase in TDs depletes DDs by an equivalent amount],
there cannot be an “inflow” of time deposits and the growth of time deposits
cannot, per se, increase the size of the banking system.
Whether the public saves or dis-saves, chooses to hold their
savings in the commercial banks or to transfer them to non-banks will not per
se, alter the total assets or liabilities of the commercial banks nor alter the
forms of these assets and liabilities.
American Bankers Association, to expand their savings accounts has a totally irrational motivation,
since it has meant, from a system’s perspective, competing for the opportunity
to pay higher and higher interest rates on pre-existing deposits in the
payment’s system. But it does profit a particular bank, to pioneer the
introduction of a new financial instrument, such as the negotiable CD – until
their competitors catch up; and then all are losers.
The question is not whether net earnings on assets are
greater than the cost of the CDs to the bank; the question is the effect on the
total profitability of the payment’s system. This is not a zero-sum game. One
bank’s gains is less than the losses sustained by other banks. The whole (the
forest), is not the sum of its parts (the trees), in the money creating
process.
Haha they must have more money than they know what to do with. Us bank just charged me a 5 dollar fee( dormant acct) while paying something like 10 cents in interest. Mean while wells fargo is starting to charge 25 bucks a month if you dont have 10 grand in your accounts with them. Sounds like 2008 all over again.
Yeah mine didnt either. Until they did.