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flow5
389 Comments
Bailout Backfire and the Ticking Debt Time Bomb
Relax Basel II's Bank Capital Adequacy Requirements
What should be done? The commercial banks should get out of the savings business - gradually (REG Q in reverse-but leave the non-banks unrestricted). What would this do? The commercial banks would be more profitable - if that is desirable. Why? Because the source of all time/savings deposits within the commercial banking system, are demand/transaction deposits - directly or indirectly through currency or their undivided profits accounts.
Money flowing "to" the intermediaries (non-banks) actually never leaves the com. banking system as anybody who has applied double-entry bookkeeping on a national scale should know. The growth of the intermediaries/non-ban... cannot be at the expense of the com. banks. And why should the banks pay for something they already have? I.e., interest on time deposits.
Instead of lowering reserves, as the proportion of deposits shifted from time/savings to transactions) would force bank credit contraction by the reduction of excess reserves (exactly the OPPOSITE proposal expoused by Jan VanDenBerg).
Bank credit contraction means, of course, reduced loan volume and reduced bank earnings, but if this is accoomplished by an even greater reduction in bank expenses, bank profits will obviously increase. And it is profits, not size, that is presumably the primary objective of bank managements.
As the proportion of time/savings deposits to transactions deposits is reduced, there would be an immediate increase the supply of loan-funds to the non-banks, and lower long-term interest rates (which would feed back to short-term rates), and the health and vitality of the whole national economoy would improve. The aggregate demand for loan-funds would expand, the volume of "bankable" loans would grow, and so will the banking system -- the FED being willing.
This commentator is Keynesian inspired disciple of voodoo economics and she doesn't have the foggiest idea of what she is talking about.
What Credit Crunch?
What Credit Crunch?
Financial intermediaries lend existing money (from saver to borrower)
You cannot take money out of the commercial banking system by channeling loan-funds to the intermediaries.
If REG ceilings were imposed on the CBs (not the non-banks) there would be an immediate increase in the supply of loan-funds, decreases in both short-term & long-term interest rates, the elimination of disintermediation in the non-banks, and the impetus to generate an economic recovery. - This is above the talking heads.
The Myth of the Credit Market 'Push'
When the proxy for the rates-of-change in monetary flows (MVt) exceeds the the proxy for rates-of-change in real-gdp (i.e, in excess of 2-3 percentage points) we have chronic inflation.
Chronic inflation breeds all types of speculation. I would narrow the period of contention to 2002-2005 (the beginning of the tight monetary policy initiated by Bernanke).
Collosal money flows (loan-funds) were channeled into a narrow and important, segment of the economy (housing). This was accomplised by the willingness of domestic and foreign financial institutions, to support a secondary market, that consisted of "negotiable instruments", having variable degrees of risk (i.e., Barry's right).
This, plus brokered loans, (68% of residential mortgages) overstimulated, commercial and residential construction. And the construction industry has long leads and lags. It cannot be quikly turned around.
I.e., the instrumentality created by securitization, initially had many of the marketability and liqudity qualties of Treasury bills. And the use of securitization enabled these institutions to draw funds out of investors from all over the country, and indeed the world. I.e., this created more market participants and speculators in the housing sector, than ever before.
This unequal distribution of loan-funds was promoted by the FED's low interest rate policy. But as interest rates began to rise, interest expenses increased, with no concomitant rise in income (from borrowers & for lenders). Participants slowly found that they could not pay the rising rates of interes, in the market conditions that prevailed.
Banks used to store their liquidity, but now they buy their liquidity, (which, e.g., gives the reference importance of the LIBOR inter-bank rate). Thus, there became both a lack of funds from lenders (generating both illiquidity and insolvency) and the increasing cost of funds for borrowers (resulting in bankruptcy), that precipated this credit crisis.
New York Fed Rate Cuts: Who Needs Meetings?
Credit Stress Evident in TAF, TED Spreads, Elsewhere
What Credit Crunch?
“Banks have long contended that the costs of reserve requirements (i.e., forgone earnings) put them at a competitive disadvantage relative to non-bank competitors that are not subject to reserve requirements – Testimony of Treasury
“These measures should help the banking sector attract liquid funds in competition with non-bank institutions and direct market investments by businesses” Testimony of Treasury
The most egregious error in Keynesian economics is the insistence that commercial banks are financial intermediaries:
A commercial bank becomse a financial intermediary only when there is a 100% reserve ratio applied to its deposits.
Any institution whose liabilities can be transferred on demand, without notice, and without income penalty, by data networks, checks, or similar types of negotiable credit instruments, and whose deposits are regarded by the public as money, can create new money, provided that the institution is not encountering a negative cash flow.
From a systems viewpoint, commercial banks as contrasted to financial intermediaries: , never loan out, and can’t loan out, existing deposits (saved or otherwise) including existing transaction deposits (TRs), or time deposits (TDs) or the owner’s equity or any liability item.
When CBs grant loans to, or purchase securities from, the non-bank public (which includes every institution, the U.S. Treasury, the U.S. Government, state, and other governmental jurisdictions) and every person, except the commercial and the Reserve Banks), they acquire title to earning assets by initially, the creation of an equal volume of new money- (TRs).
The lending capacity of the member CBs of the Federal Reserve System is limited by the volume of free gratis legal reserves put at their disposal by the Federal Reserve Banks in conjunction with the reserve ratios applicable to their deposit liabilities (transaction accounts), as fixed by the Board of Governors of the Federal Reserve System.
Since 1942, money creation is a system process.
No bank, or minority group of banks (from an asset standpoint), can expand credit (create money), significantly faster than the majority banks expand. If the member banks hold 80 percent of all bank assets, an expansion of credit by the nonmember banks and no expansion by member banks will result, on the average, of a loss in clearing balances equal to 80 percent of the amount being checked out of the nonmember banks.
From the standpoint of the individual commercial banker, his institution is an intermediary. An inflow of deposits increases his bank’s clearing balances, and probably its free/gratis legal reserves, not a tax [sic] – and thereby it’s lending capacity. But all such inflows involve a decrease in the lending capacity of other commercial banks (outflow of cash and due from bank items), unless the inflow results from a return flow of currency held by the non-bank public, or is a consequence of an expansion of Reserve Bank credit. Hence, all CB liabilities are derivative.
That is, CB time/savings deposits, unlike savings accounts in the “thrifts”, bear a direct, one-to-one, unvarying relationship, to transactions accounts. As TDs grow, TRs shrink pari passu, and vice versa. The fact that currency may supply an intermediary step (i.e., TRs to currency to TDs, and vice versa) does not invalidate the above statement.
Monetary savings are never transferred to the intermediaries; rather monetary savings are always transferred through the intermediaries. Indeed, as evidenced by the existence of “float”, reserve credits tend, on the average, to precede reserve debits. Therefore, it is a delusion to assume that savings can be “attracted” from the intermediaries, for the funds never leave the commercial banking system.
Consequently, the effect of allowing CBs to “compete” with financial intermediaries (non-banks) has been, and will be, to reduce the size of the intermediaries (as deregulation did in the 80’s) – reduce the supply of loan-funds (available savings), increase the proportion, and the total costs of CB TDs.
Contrary to the DIDMCA underpinnings, member commercial bank disintermediation is not, and has not been, predicted on interest rate ceilings. Disintermediation for the CBs can only exist in a situation in which there is both a massive loss of faith in the credit of the banks and an inability on the part of the Federal Reserve to prevent bank credit contraction, as a consequence of currency withdrawals. The last period of disintermediation for the CBs occurred during the Great Depression, which had its most force in March 1933. Ever since 1933, the Federal Reserve has had the capacity to take unified action, through its "open market power", to prevent any outflow of currency from the banking system.
However, disintermediation for financial intermediaries- (non-banks), is predicated on their loan inventory (and thus can be induced by the rates paid by the commercial banks); earning assets with historically lower fixed rate and longer term structures.
In other words, competition among commercial banks for TDs has: 1) increased the costs and diminished the profits of commercial banks; 2) induced disintermediation among the "thrifts" with devastating effects on housing and other areas of the economy; and 3) forced individual bankers to pay higher and higher rates to acquire, or hold, funds.
Savers (contrary to the premise underlying the DIDMCA in which CBs are assumed to be intermediaries and in competition with thrifts) never transfer their savings out of the banking system (unless they are hoarding currency). This applies to all investments made directly or indirectly through intermediaries. Shifts from TDs to TRs within the CBs and the transfer of the ownership of these TRs to the thrifts involves a shift in the form of bank liabilities (from TD to TR) and a shift in the ownership of (existing) TRs (from savers to thrifts, et al). The utilization of these TRs by the thrifts has no effect on the volume of TRs held by the CBs or the volume of their earnings assets.
In the context of their lending operations it is only possible to reduce bank assets and TRs by retiring bank-held loans, e.g., the only way to reduce the volume of demand deposits is for the saver-holder to use his funds for the payment of a bank loan, interest on a bank loan for the payment of a bank service, or for the purchase from their banks of any type of commercial bank security obligation, e.g., banks stocks, debentures, etc.
The financial intermediaries can lend no more (and in practice they lend less) than the volume of savings placed at their disposal; whereas the commercial banks, as a system, can make loans (if monetary policy permits and the opportunity is present) which amount to server times the initial excess reserves held.
Financial intermediaries (non-banks) lend existing money which has been saved, and all of these savings originate outside the intermediaries; whereas the CBs lend no existing deposits or savings; they always, as noted, create new money in the lending process. Saved TRs that are transferred to the S&Ls, etc., are not transferred out of the CBs; only their ownership is transferred. The reverse process, which is called “disintermediation”, has the opposite effect: the intermediaries shrink in size, but the size of the CBs remains the same.
Professional economists have no excuse for misinterpreting the savings investment process. They are paid to understand and interpret what is happening in the whole economy at any one time. For the commercial banking system, this requires constructing a balance sheet for the System, an income and expense statement for the System, and a simultaneous analysis of the flow of funds in the entire economy.
From a System standpoint, time deposits represent savings have a velocity of zero. As long as savings are held in the commercial banking system, they are lost to investment. The savings held in the commercial banks, whether in the form of time or demand deposits, can only be spent by their owners; they are not, and cannot, be spent by the banks.
From a system standpoint, TDs constitute an alteration of bank liabilities, their growth does not per se add to the “footings” of the consolidated balance sheet for the system. They obviously therefore are not a source of loan-funds for the banking system as a whole, and indeed their growth has no effect on the size or gross earnings of the banking system, except as their growth affects are transmitted through monetary policy.
Lending by intermediaries is not accompanied by an increase in the volume, but is associated with an increase in the velocity or turnover of existing money. Here investment equals savings (and velocity is evidence of the investment process), whereas in the case of the CB credit, investment does not equal savings but is associated with an enlargement and turnover of new money (money supply).
The difference is the volume of savings held in the commercial banking system is idle, and lost to investment as long as it is held within the commercial banking system. Such a cessation of the circuit income and transactions velocity of funds, funds which constitute a prior cost of production, cannot but have recessionary effects in our highly interdependent pecuniary economy. Thus, the growth of time deposits shrinks aggregate demand and therefore produces adverse effects on GDP and the level of employment.
It began with the General Theory, John Maynard Keynes gives the impression that a commercial bank is an intermediary type of financial institution serving to join the saver with the borrower when he states that it is an “optical illusion” to assume that “a depositor and his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”
In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to substitute the term financial intermediary in order to make the statement correct. Perhaps this is the source of the pervasive error that characterizes the Keynesian economics, the Gurley-Shaw thesis, Reg Q, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, etc.
How does the FED follow a "tight" money policy and still advance economic growth.? What should be done? The commercial banks should get out of the savings business (REG Q in reverse-but leave the non-banks unrestricted-compensat... for transition). What would this do? The commercial banks would be more profitable - if that is desirable. Why? Because the source of all time deposits within the commercial banking system, is demand/transaction deposits - directly or indirectly through currency or their undivided profits accounts. Money flowing "to" the intermediaries (non-banks) actually never leaves the com. banking system as anybody who has applied double-entry bookkeeping on a national scale should know. The growth of the intermediaries/non-ban... cannot be at the expense of the com. banks. And why should the banks pay for something they already have? I.e., interest on time deposits.
The Fed's Next Move: Money Supply
The Fed's Next Move: Money Supply
Savings held within the commercial banking system are lost to investment and to any type of expenditure. These deposits have a velocity of zero. These deposits can only be spent by their owners, they cannot be spent by the commercial banks.
Imposing interest rate ceilings & then lowering them until the CBs are out of the savings business does the following:
(1) it provides an immediate increase in the supply of loan funds
(2) it decreases the level of short & long term interest rates
(3) it vastly increases the profits of the commercial banks and the financial intermediaries
(4) it contributes to much higher rates of change in real-gdp
The proof? Take the housing crisis of 1966. Ceilings for CBs were lowered. There was an immediate increase in mortgage lending money. The housing crisis slowly recoverd, but slowly only because rates weren't lowered fast enough, and low enough.
If you don't understand this you have no idea how money & central banking works.
The Truth About the Current State of Financial Regulation
I would point out that the primary reason for the lack of regulation stems from the Keynesian dogma that maintains a commercial bank is a financial intermediary. Never are the commercial banks financial intermediaries in the lending process. A commercial bank only becomes a financial intermediary when it has a 100% reserve ratio. Commercial banks should be SEVERELY regulated in both their assets and liabilities.
Rising Unemployment Shows Where the Economy Stands
The Treasury Bull Is Alive and Kicking
Exactly right. The money supply (and debt levels of monetization), is unknown & unknowable.
The Treasury Bull Is Alive and Kicking
Exactly right.
Another Look at Preliminary Q2 GDP