Well that created a stir.... including a couple of bans for people who decided (despite being warned!) that this would NOT turn into their personal version of a place to run conspiracy theories unrelated to the topic (e.g. "The Fed is an illegal xxxx", or even better, "income taxes are unconstitutional")

This is one of the unfortunate realities of Internet discussion forums, and why I don't have comments directly enabled here on The Ticker, instead redirecting them to the forum.  There are only 24 hours in a day and despite some people's belief that I'm Borg, I do need to sleep.  Trying to spread all this out would make it impossible for me to keep track of it all - so I don't.

One astounding disconnect I have found in those who argue against fractional reserve banking is the utter lack of comprehension of how credit intermediation works.  We have become so numb to reality in our life that we don't even notice it any more.

One simple example was found last night; I filled my truck with gasoline, swiping a credit card at the pump.  We do this every day and don't think a bit about it - but in fact this is relatively new in our financial system.

Does anyone remember 20, 30 years ago?  Most people either paid cash for their fuel or had a company-specific gas credit card.  Your SHELL card was worthless at a MOBIL station.

Why?

Because there was no real intermediation of credit as we have today.  Banks could not cross state lines in their operation and credit was not, to the degree today, fungible (equivalent) with money.

Today this has all changed.  Your credit card is accepted basically everywhere, even though the fact that it says "VISA" on it doesn't tell you which bank issued it - and thus who has to settle that transaction in the ultimate.  Electronic networks have made credit and money - that is, actual cash - effectively equivalent.

At the same time fractional lending has made speculative and productive investment possible to a never-before possible degree.  You are reading this blog in no small part as a consequence of that - while the Internet Bubble was devastating to those who got caught on the wrong side of it, but for that we likely would not have an Internet as we do today.

Here's the bottom line folks:

• Fractional reserve banking has both costs and benefits.
• The benefits, by and large, appear to this writer to outweigh the costs.
• Attempting to game the costs, however, leads to dramatic and extraordinarily bad outcomes.

Simply put, leverage limits prevent excessive expansion of credit without interfering with the intermediation function that we now find essential in modern life.

Government is, of course, always pressed by business to override these limits in one form or another, because with greater leverage comes greater profits when things go well.

Of course the corollary is that you get greater losses when things go poorly.

One corrective measure we should apply is to set regulatory capital limits as the inverse of leverage.  That is, if we have a 6% regulatory capital requirement for 10:1 reserve lending, if someone wants 20:1 they should be required to hold 12%.

If you couple this with two more demands you can effectively eliminate systemic failure risk:

1. Everything you hold as an asset must be traded on a public exchange or have an exposed and public model, both run nightly, with no hidden or off-sheet exposures of any kind.
2. Your regulatory capital ratios must be published and exposed every night.

Immediate seizure and liquidation of any firm that violates limits now provides the safety necessary to insure that depositors are protected, and public exposure of (1) and (2) means that the sort of game-playing we saw with IndyMac, where capital was improperly moved from one reporting period to another, will be immediately detected both by investors and the public at large.

We must also reverse all the game-playing that has plagued the system, including but not limited to the items set forth in the previous Ticker.  Glass-Steagall must be reinstated, off-balance-sheet financial games must be banned, and the common crime of fraud in peddling instruments must be prosecuted and enforced, including those people in our government that have intentionally enabled such misdirection and fraudulent accounting.