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The reason the FDIC has been taking losses is because THEY ARE NOT DOING THIER JOB. If we did not permit banks to hold paper against which there is no actual asset (including excess capital) then this sort of thing - including 'systemic risk' - CANNOT HAPPEN.

The big question is why this is happening.

Its happening because the FDIC, the Fed, the Government etc. have decided that proper accountability and policing of our financial system is not in the Pigmens best interest (then again, being one and the same, they would much rather abuse their regulatory powers to benefit themselves and their buddies).

Therefore the argument that a fractional reserve lending system works fine as long as it is properly regulated, and fraud is prosecuted can come under fire. Without this in place we have some kind of ambiguous, bull**** honor system method of preventing abuse of the fractional reserve system.

Would it be realistic to say that maybe the power that is given to banks by applying the FRL system requires a world view of both government and the financial sector that is almost utopian? Which incentive outweighs the other? The profits and quirks that can be gained by massive manipulation and abuse of the system by regulators straight out of the institutions themselves, or properly enforcing the law and being stuck in a dead end government job for the rest of your life.

Im not totally set against Fractional Reserve Lending, its just that to deny that there are legitimate arguments against it seems a bit short sighted.

The existance or not of FRL doesn't change a thing in terms of fraud.

To believe that getting rid of FRL will somehow make people not commit fraud is nutty, to be blunt.

Is that an argument I made?

I actually agree with you, its not going away and there is no actionable alternative to it at the time IMO.

But that doesnt render any arguments against FRL moot by any means. Its a little understood practice that REQUIRES accountability and oversight by definition. Theres so many jumbled factors in its regulatory fabric, that its hard to have much faith in it, and history has not been kind to it when you consider what it has caused both directly and indirectly.

Federal government doing there job, that must be an oxymoron

Why not let each bank set its own reserve level and make that very clear to depositors. Before you deposit you must sign a document that says: We only keep X% of your money, the rest is lent out. If the bank fails you are entitled to only X% of your money back plus a fraction of the assets the bank owns at the time of failure which could be zero

Then people can put their money in banks chosen by risk. The lower the risk, the lower the interest paid on deposits.

You lose your shirt in a high risk bank it's nobody's fault but your own. Time to grow up people and take responsibility for your own finances.

Actually there is a flaw in my logic. During good times (booms) people think risk is lower than it really is so they'll all use the higher risk banks anyway.

You may say the entire system is fraudulent. Why. Do you think if people really understood FRL they would put their money into banks? FRL is downplayed all the time so as not to scare (i.e. inform) the public. If people were told before they deposited their money that the bank only holds 10% of it, what would they do? The answer is: Whatever the government tells them to do.

"If, at any time, it is not, then the bank is immediately seized."

Forgive me being so blunt on your blog, but again, this is the point where your argument falls apart. Seized by whom? To what end, and using what money? What money is used to make good the depositors? Who takes the losses? What Constitutional authority is relied on to foist these losses on the taxpayers? The "regulated bank / deposit insurance" model is the thing that is broken. FRL merely makes it more profitable for the banksters. Yes I know that FDIC funding comes from bank premiums, but I also know perfectly well that the ultimate backstop is the U.S. taxpayer.

The lender of last resort introduces moral hazard and is the thing which must be removed, first. Regulation shmegulation; regulation is revealed as a total sham, isn't it? Can someone, anyone here make a case for the viability of bank regulation?

"Oh yes, banking regulation can be completely relied upon, as we have clearly seen for the past 18 months." Anyone?

I didn't think so.

And guess what else? Replies to this post will be....political. "We need FRL / FRB because otherwise loans cost too much and the world as we know it is poverty stricken." And that's a political statement, isn't it? It is impossible to separate economics from politics.

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The reason the FDIC has been taking losses is because THEY ARE NOT DOING THIER JOB. If we did not permit banks to hold paper against which there is no actual asset (including excess capital) then this sort of thing - including 'systemic risk' - CANNOT HAPPEN.

Not true. If you just look at hard facts, they would have told you everything was fine. Falling house values were a future event that was not a fact at the time.

The mortgage assets were valid at the time unless you probed deeper in more and more conjecture. Besides corruption and incompetence, this was what mainly caused the collapse. the fact that house prices would collapse was foreseeable to common sense, but computer models don't have that and for a human, having a negative attitude (being careful) is career suicide in a corporate environment.

Those who saw this coming and spoke of it were removed.

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"If, at any time, it is not, then the bank is immediately seized."

Forgive me being so blunt on your blog, but again, this is the point where your argument falls apart. Seized by whom?

The FDIC.

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To what end, and using what money?

The banks money. The purpose is to prevent the remaining excess capital from being depleted before the assets can be sold off (e.g. before further deterioration causes an actual economic loss that must be backstopped.)

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What money is used to make good the depositors?

The bank's excess capital. No loss is taken by the taxpayer or the FDIC.

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The lender of last resort introduces moral hazard and is the thing which must be removed, first. Regulation shmegulation; regulation is revealed as a total sham, isn't it? Can someone, anyone here make a case for the viability of bank regulation?

Lender of last resort is a strawman.

If bank regulation is properly enforced there is never a risk of loss on the taxpayer or the FDIC. The FDIC's capital is there solely for the purpose of making good when it fails to do its job.

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And guess what else? Replies to this post will be....political. "We need FRL / FRB because otherwise loans cost too much and the world as we know it is poverty stricken." And that's a political statement, isn't it? It is impossible to separate economics from politics.

You are free to set up a non-fractional lending bank right now.

Nobody will patronize you, however, because your interest charges will be several times higher than the fractional lending bank.

Your solution to that is to outlaw FRL, which is the imposition of force - at gunpoint (as all government actions are, in the end.)

But the only justification for such force is to prevent fraud or force upon another. There is no need to prevent FRL in order to prevent fraud - what is required is to in fact prevent that fraud.

Provided that no fractional lender has more outstanding in unsecured loans than they have in excess capital, there is no fraud. If all of the depositors demand their money back they will all get it, without exception, provided that the unsecured loans outstanding do not exceed excess capital.

Fraud occurs when the unsecured loans do exceed excess capital. In that case the bank is in fact insolvent and under many state laws (but not federal law) a state-chartered bank is prohibited (under penalty of conviction for bank fraud - a criminal offense) from accepting deposits when it is in fact insolvent.

We are here because the unsecured loan value outstanding has exceeded excess capital. Our regulators (that would be the people who answer to us as elected representatives) have refused to perform their duty and we as citizens have refused to demand that perform their duty.

This entire mess can be fixed and prevented from ever happening again, and it is not necessary to outlaw FRL to do so.

I am working on a white paper outlining this and should have it ready either tonight or tomorrow.

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The reason the FDIC has been taking losses is because THEY ARE NOT DOING THIER JOB. If we did not permit banks to hold paper against which there is no actual asset (including excess capital) then this sort of thing - including 'systemic risk' - CANNOT HAPPEN.

Not true. If you just look at hard facts, they would have told you everything was fine. Falling house values were a future event that was not a fact at the time.

Irrelavent.

There is nothing wrong with making the original loan.

The error is in not forcing the banks to disgorge these "assets" (the loan paper) as house prices fell.

Again: If you demand that banks never have more outstanding in unsecured loan balance than they have in excess capital it is impossible for either a bank run to produce depositor loss or for a bank failure to produce loss to anyone other than the bank's owners (the shareholders.)

That is, the bank can go out of business (and that is the proper remedy for running your business poorly) but depositors never lose anything and the FDIC is never called upon to make good depositors' funds.

We are here due to massive fraud in our government.

When home prices began to deteriorate a proper regulatory function would have forced the immediate sale of the paper involved. Many banks would have failed as businesses but there would have been no systemic risk and no loss to the taxpayer or draw on FDIC funds to make the depositors whole.

The latter two outcomes occurred due to regulatory malfeasance - that is, fraud within our government and for no other reason.

WHEN the people realize this there will be a GREAT DEAL of anger directed at our politicians. I have every intention of making the people fully aware of exactly who is respoonsible for this and how it is, in fact, very simple to prevent it from ever happening again.

The problem is, during busts, the assets lose value and all the banks become unable to restore depositor nominal cash. Any new banks formed from the debris of the old have the same problem in a deflationary environment. They will be unable to predict future asset values and thus end up in the same boat.

This only happens if non-cash assets are allowed to count for the reserve ratio.

This is what happened. I'm not against FRL but a way around busts has to be found.

Frankly I'm shocked that with 6000 years of banking (lending) history, this hasn't been solved.

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The problem is, during busts, the assets lose value and all the banks become unable to restore depositor nominal cash. Any new banks formed from the debris of the old have the same problem in a deflationary environment. They will be unable to predict future asset values and thus end up in the same boat.

It doesn't matter if they can predict future asset values.

What matters is how they personally calibrate their own risk levels.

If I write a mortgage with no more than 80% of the value outstanding at inception, I have a decent cushion against asset price declines. Yes, I can invade my excess capital if the price declines by more than 20%. But if I also have 10% of the balance in excess capital, I now need a 30% decline before actual loss (to other than me, the bank owner) takes place.

The 6% Tier Cap requirement provides sufficient time for the FDIC to seize and sell the assets. Once you invade the 6% there is 5.99% left before a loss is taken. Provided the seizure happens immediately, it is highly unlikely that a further 6% loss will occur within the period of days required to auction off the assets involved. Thus, no loss (to other than than the bank's owners.)

I am entitled as a businessowner to run as close to the third rail of forced liquidation as I wish. If I touch it, I die. The risk:reward must be calibrated by me, the business owner, in a free market - but when I get too close and die I must not be permitted to kill others.

Properly enforced regulation would have forced asset sales starting in late 2007 and they would still be ongoing; balance sheets would have shrunk and so would have bank sizes. Many banks would have failed by now but there would have been no loss to anyone but the bank shareholders.

Instead we have poured in well over $1 trillion dollars, and the reason we did so was not risk-taking by the banks - it was regulatory fraud by the government.

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The 6% Tier Cap requirement provides sufficient time for the FDIC to seize and sell the assets. Once you invade the 6% there is 5.99% left before a loss is taken. Provided the seizure happens immediately, it is highly unlikely that a further 6% loss will occur within the period of days required to auction off the assets involved.

OK, but we see that invalidated in even non-bubble states already. When are real estate valuations going to occur ? As inventory hits the street; even the counties do not reassess for property tax revisions every year. In cases like we have now, unless the bank/regulatory agencies continually revalue their portfolio of loans every what - 3,6 months ? - you have no clue what your cap ratio looks like and there will not be timely action. Add in the ever present reality of regulatory capture and this will not ever, and did not ever, work, when values are on the downswing. Unless you start requiring 40-50% down for a house...

IMO relying on regulation is just more moral hazard. It becomes someone else's job to do due diligence. If you want to rely on laws, maybe you mandate something like the Underwriter's Labs equivalent for banks, a completely private entity that can be sued into oblivion if they get it wrong.

KD,

Maybe I should let this go, maybe not. Money is fungible, and accounting arguments reduce to sleight-of-hand. Can any argument be made that the taxpayers are not backing the banks' losses, thus helping FDIC to not have to refund depositors? The taxpayers are also implicitly backing Fed losses, just not explicitly (yet). Does anyone truly believe that the Fed will absorb losses when it has a printing press? The moral hazard trail leads right back to the Fed. Bank regulation has demonstrably and undeniably failed, ergo reliance on the regulatory state is futile and IMO an unsupportable position.

One more thing: your statement that I am free to start my own bank is true, but misleading. Bad money crowds out good money, so FRL will work, crowding out sound money, until it fails as it just has.

Thanks.

****s sakes, who determines the reserve requirements? the ****ing REGULATORS.

if your reserve is required to be 100%, it's up to the REGULATORS to ensure that you stay there. there is NOTHING to stop you otherwise from operating with less than 100%. this is where fractional lending came from, 100% reserved lenders realizing that they can lend more than they have. there were NO REGULATORS overseeing their actual deposits.

****, it's really bizarre seeing arguments about regulators being unreliable in enforcing reserves and yet full reserve requirements will some how work in the absence of regulation.

Regarding the reserve requirement:

Thrustvectoring wrote..

The number itself is irrelevant.

Okay, cool. Since the number doesn't matter, we can then take a large handful of dice and roll them once a day to arrive at tomorrow's reserve requirement, right Thrust? Should be no problem, right? Because the number doesn't matter, right Thrust?

Let me know if that's the path you'd like to argue -- or else admit that the number in fact does matter deeply. In which case, I ask you: what's the magic number, Thrust? Prove it. Show me why your number is better than the number next to it on the number line. Prove it.

Ultimately, you need to evade the question, which is exactly what you'll do.

If the number doesn't matter, then we can change it every minute of the day. If the number does matter, then show me which number it "ought" to be, and why.

I just want to make certain I understand your position before I show you why your position is pure hogwash.

Drunkle, that is the con-game, here; literally, it's all they've got.

Karl said to me yesterday:

Genesis wrote..

I will NOT tolerate you trying to turn this into a political debate. IT ISN'T ONE. It is a specific discussion about whether or not a practice is FRAUD.

If you want to start a POLITCAL debate do it in POLITICS.

The truth is that of course there will have to be a person, somewhere, setting a reserve requirement. At that point, the debate here on TF gets cut-off. Who sets the reserve requirement? Blank-out, leave the forum, that's political. Should that person be in Washington DC? Blank-out, leave the forum, that's political. Should that person be a political appointee? Blank-out, leave the forum, that's political.

That's the root of their argument.

I wrote, yesterday:

AynRandFan wrote..

...some politically well-connected bureaucrat -- chummy enough with the folks currently in power -- will pull a number out of his big fat ass. You're supposed to accept it -- remember, he's a "maestro," like Greenspan, who knows better than you do; he has the brains that you couldn't possibly hope to match -- and your job is to bow, to serve, to agree, and to obey. And to smile, don't forget that. Whatever number he pulls out of thin air is a number that you're supposed to accept -- remember, it's "prudent," it's "appropriate," it's been "carefully selected," and what you need to do is to just accept the fact that some ass-licking power-mad social-climber in Washington DC has the right to print-up as much toilet paper for money as he chooses to print-up, and "reserve require" whatever percentage he ****ing feels like. He's the Magic Man, remember? He's got the plan, he's got the answers. He knows better than you, he even knows better than the market. He's like God on Earth, man... how dare you question his number: he knows it all.

See, the argument can't go there, not here on TF. Because, "that's political." As long as the discussion can be cut-off at the point where it inevitably ends, their "argument" reigns supreme. But make no mistake about it, man, the argument does end, in the real world, right where I said it does, and that's the point where you have some political hack pulling numbers out of his ass in Washington DC.

But you can't argue that, not here.

That's political.

Blank-out.

Leave the forum, and stop posting.

See how it works?

dude, i understand what you're saying about karl, but your political argument here is pointless; all politicians, all people in power are corruptible. no system is incorruptible. none.

fractional reserves have benefits, enough so that it's worth keeping as a system. reduced cost of credit enables higher growth and prosperity. i don't think that's deniable. the fact that there is room for corruption is moot; no system is incorruptible. systemic danger can occur no matter how high, how stringent your standards are if those in charge are not doing their job.

that's the issue here, the cops have been paid off. the system is fine, it's just a ****ing tool. it's the people in charge of using the tool that are responsible for ****ing it up.

it's almost like you believe the 100% reserve standard is a kind of natural law, one that cannot be broken. it's not. banks are not natural, banks and reserve requirements do not exist without people. and where there's people, there's corruption and greed. it is not a function of the abstraction called "economics", it's a function of the people in charge of creating and operating the abstraction.

actually, a discussion of the costs/benefits of fully reserved vs fractional reserves would be interesting and cool. but the canard that 100% reserve requirements is somehow self regulating and is incorruptible needs to stop.

I'll probably be accused of flaming now, but let me point-out that my screenname is AynRandFan. Anybody familiar with the writings of Miss Rand will know her views on the gold standard -- and I absolutely advocate the same views.

My objection to FRB is actually the fact that it is political -- literally, Karl, that's what's ****ing wrong with it. It IS political. That's the problem. The "value" of our "money" should never be controlled by some thug in a Washington DC office.

I am continually amazed the people can not see beyond this simple concept.

Yes, I'm getting "political" again here, and I understand that's where you want to chop the convo off. Hey, it's your forum. But let me say that I am not flaming -- and also, let me point out that chopping-off the convo is not the same thing as an argument.

FRB ultimately ends with an ass-licking social-climbing thug in Washington DC pulling numbers out of his ass.

There is no getting around that, Karl.

No getting around that at all.

Thanks for the discussion, and the Ticker, but it's truly impossible to continue this without grasping that it simply must end in a political tête-à-tête.

I still love this place.

Hell, I'd probably still contribute even I did get banned.

[EDIT, ONE MORE TIME]: It turns-out that tête-à-tête is quite the spelling chore after all.

(ARF? I've learned that you can't drag someone into their "Sherwood Forest Moment".)

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My objection to FRB is actually the fact that it is political

It is, of course, by fiat. It needn't be in theory, however. The fact that X is regulated by thugs does not mean that X-qua-X is intrinsically unethical.

In a laissez-faire world, banks wouldn't have ANY capability of soaking the taxpayer. "Bank runs" would be something they'd have to fear, and so private entities similar to the original Lloyds of London would emerge to cushion risk. Member banks would pay dues and abide by rules.

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FRB ultimately ends with an ass-licking social-climbing thug in Washington DC pulling numbers out of his ass.

Everything does now; DC is now a black-hole sucking in the entire country.

I chip in with a couple suggestions:

1) The FDIC should be abolished as an entity. If the job is to insure, it obviously has done a spectalarly awful job in it's actuarial duties to cover the banks. And it isn't the first time, recall the S&L disaster.
Deposits should be protected and the banks should pay for it. By they haven't done their job. The function itself is needed and needs to be replaced with a risk-based asset class insurance premia system. The Fed should run it as they are responsible for setting reserve requirements.
(little side note, not sure if you all aware that the banks pass along the FDIC premia to customers in the form of baked in fees or in the spreads, roughly 90% of it is passed through).

2) The Fed needs to utilize true asset based reserve requirements, that is, holding reserves based on MTM asset classes. The Fed is supposed to do this, set reserves based on load portfolio quality, but they really don't. It's too broad, not kept up to date, attempt to one-size-fits-all, and the governance process makes the entire RR process a slow, slow, mess.
Make RR based on all asset classes, apply to any financial firm, not just chartered banks (aha....time to regulate hedgies, PE, etc). Not all deposits are created equal, nor are assets.
The Fed ought to use predictive analytics in setting these paramaters, just like the capital markets and best in class risk management processes do to do hypothesis testing on portfolios, etc. Transparent.

What we've got is an insular, backward looking, regulatory non-compliant incompetent organization who's job to protect the financial assets of the people has been a complete failure.

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Instead we have poured in well over $1 trillion dollars, and the reason we did so was not risk-taking by the banks - it was regulatory fraud by the government.

I'll have to disagree with part of this. Risk-taking by the banks is an integral part of the mess. Specifically, it is the systematic misrepresentation of risk combined with the risk equivalent of money laundering/regulatory evasion that was going on at AIG and probably elsewhere.

Private banks and public officials worked together, hand in hand, all the way. Primarily because the latter were and still are paid off by the former, but whatever.

"My objection to FRB is actually the fact that it is political -- literally, Karl, that's what's ****ing wrong with it. It IS political. That's the problem. The "value" of our "money" should never be controlled by some thug in a Washington DC office."

money itself is defined by people. whether a thug in dc or the ****ing pope himself. money is defined by us, not the other way around. what are you going to do...

i've never read ann rand. i've never read anything on economics outside of the blogs, wiki, etc. my problem with gold/gold standard is this. how do you control the amount of gold in circulation. nevermind the obvious moral dilema that such control is "political", how do you determine the correct level of liquidity? a government super duper ooper computer that can exactly forecast and model global economic activity? population changes? migration changes? political climate? etc etc etc?

snowman:

1) how well is the private sector doing in the insurance and ratings arena? by the looks of aig, moody's, s&p, fitch... not too ****ing well. the same problems exist, what is needed here is pretty much nothing short of revolt. (hi mr homeland security fbi man!)

2) mark to market, by definition is it's own pricing mechanism...

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My objection to FRB is actually the fact that it is political -- literally, Karl, that's what's ****ing wrong with it. It IS political. That's the problem. The "value" of our "money" should never be controlled by some thug in a Washington DC office.

Money is inherently a political thing. Get over yourself.

And by the way, gold-backed currency (and gold ITSELF) was cheated - all the way back to Hammurabi.

The cheating has NOTHING to do with the currency base or the form of lending which is why I have put down the hammer on this - it is a DELUSION that you can avoid these problems by "simply" getting rid of fractional reserves.

Four words:

No.
You.
Can.
Not.

Effort solving the problem instead of jacking off.