The answer is in regulation - not more - but enforcement of reasonable protections. However, the enforcement cannot be done by the banks themselves (the Federal Reserve 'regulating' the banks is a joke), and it obviously cannot be done by Congress who has shown its propensity to be easily bought. There needs to be some sort of untouchable regulator that can't be bought, can't be lobbyied and gets no financial benefit from the outcome of their enforcement.

The Fed is a distraction.

Force it to live within the limits of The Federal Reserve Act and I don't care if it exists or not, and can even make a cogent argument for it being of significant benefit.

If that was directed at me, I'm not dissing the Fed per say - I am however, pointing out that in its current form the members of the Federal Reserve tend to have conflicting interests - as have our most recent Treasury Secretaries.

Personal interest immediately prevents any sort of objective regulation. There is no way we can get 'unscrewed' with Paulson, Timmy, Summers et al. It's like asking the fox you have guarding the henhouse why he ate the hens.

It is the same situation with Congress, specifically in the leadership positions...which I addressed in my previous post above somewhere.

Bdcmc,

Central or non central is not important. Im arguing that the concept remains the same. You will still have the money supply inflating. And it has to. If i earn some money, it is there to spend. The very flow of money through a system inflates the money supply far more than mere fractional reserve banking. Its why even though (before Bernake's printing press went wild) with a 700 billion dollar money supply, and fractional reserve of..whatever...10 times? 15 times? you have a money supply of only 10 Trillion , but a GDP of 13 Trillion.

And from what ive read, vaults and the like existed well before the existence of promisary notes. Vaults to store money. They were the original banks. You paid them money to store your money and keep it safe.

Fractional reserve banking existed even with coins of precious metal.

and actually, andi am a firm believer of this, there is no such thing like "over leveraging". There is no exact number where leverage is ok, and then suddenly it goes bad if you go over and above that number.
Proof of this is in the fact thta an highly leveraged system was making money for everyone for so many years, and we called it growth. However, there are two parts to the fractional reserve system. One is the money you can lend out, and the other is the money you keep in reserve.
When things go bad, you have to fall back on your reserves. This is where the problem comes.
There is nothing to say that a 50% fractional reserve will always work. Suppose you had a 50% fractional reserve, and housing prices fell by 60%. You would still be insolvent. (Yes , people might argue that with fractional reserve at 50% housing prices wouldnt ever fall that much, but that is irrelevant. You are decreasing risk, you arent removing it completely. You may be decreasing it to 0.00001%, gbut it is still there.)

So i think people should stop using "over leveraged". There is no magical "correct" leverage number.

For those of you arguing so vehemently AGAINST FRL, how do you intended to make capital readily available for economic expansion otherwise?

I think the combination of FRL along with a fiat currencies leads to a ponzi scheme and an eventual deflationary collapse, but at this point antiquated monetary systems place unrealistic restraints on a modern economy driven by sceintific discovery and technological advances, both of which require large amounts of relatively cheap capital to work.

Quote:

There needs to be some sort of untouchable regulator that can't be bought, can't be lobbyied and gets no financial benefit from the outcome of their enforcement.

That's where you all run off the tracks. There is no such thing, ever, and there has never been in the history of the world. Read up on "regulatory capture". Pile a super regulator on top of all the other regulators and you still get...a person/agency that's as susceptible to influence as the lower-level regulators. Over time, it just gets worse, as fraud becomes institutionalized.

The ONLY regulator that never fails is FAILURE itself. It's your money at risk, you will lose all if you invest unwisely, therefore to take care with the investment. You think someone/regulator has your back - you develop a short-timer's attitude.

Look at the recent "innovation in Holland - they REMOVED all stop signs and stop lights at intersections. People got complacent on traffic engineers assuring their safety so the # of crashes kept going up. Remove the safety net of signs, and people's risk perception changed and they acted accordingly. Counterintuitively, accidents went down because people assumed the consequences of risk.

Same was true with bicycle helmet laws in this country - the # of accidents after implementation went up because people assumed by wearing a helmet they'd be safer, and they then took more risks.

The only way to keep risk within bounds is by failure and real loss.

None of this argues against fraud laws - however, laws against fraud do not require a regulatory agency and layer after layer of regulation.

Ultimately, I think history will show that WE THE IDIOT PEOPLE are to blame for all of this. We got complacent, distracted, and voted moron after moron into power. We were quick to blame the very people WE ELECTED. We forgot (or failed to learn) how our own gvmt works or our own monetary system functions. We ****ED UP - A LOT - and for many many years.

There was no way the Founding Fathers could have included any provision that would have FORCED future generations of Americans to act responsibly. Dumbed down ignorant people will allow themselves to be violated and abused. For those of us who did (and do) care, tough **** seems to describe the current state of affairs!

Credit - if we say FRNs are a store of value representing production, then leftover FRNs after "necessary" consumption is surplus, representing money that can be lent. Look at MSFT as one example - they have a stash of cash to use for investment in other productive ventures or complementary lines of business.

FRL is just production pulled forward - I don't necessarily see it as bad or good per se, the question to ask is, can it be supported via the increased productivity necessary to pay it back with interest ? If you ask that question, you have to wonder just how much growth we need/can support. There's no one right answer to that, ever.

Regarding a car being an asset - it's really one accident away from junk.

CJ wrote..

what is fraudulent is the government allowing banks to continue to operate while below regulatory capital limits.

But what is being said, around these parts, is that regime change sprinkled in with a bit of statutory overhaul is all we need to fix that.

But - that has been tried, and has failed. Why will it not fail again?

Some people would rather take their chances with a more-anarchic, less-governmental approach altogether. Mish is in that category, and that's what ultimately drives his philosophy. The FRL thing is just an innocent error. I'm trying to get at the underlying mindset, which is looking compelling at the moment, for want of a better alternative.

To effectively counter the libertarian approach, something more substantive than, "The laws we have/had are fine, we just need regime change" is going to have to be put forth.

Pel, it DIDN'T fail for nearly 70 years.

WHEN it failed it is because we repealed the laws that made it hard to cheat!

"FRL is just production pulled forward - I don't necessarily see it as bad or good per se, the question to ask is, can it be supported via the increased productivity necessary to pay it back with interest ? If you ask that question, you have to wonder just how much growth we need/can support. There's no one right answer to that, ever."

As long as you give out loans correctly that actually provide a service to society, then there is nothing wrong with debt or fractional reserve banking. We had banks during the housing bubble giving out mortgages to people who clearly would not be able to pay it, and they didn't seem to care. This eventually lead to deflationary collapse when people started defaulting on loans.

Debt is a claim on the future, and if I loan out $1,000,000 to build a factory or something that provides many nice goods for people and that factory is successful and pays back the price for the money, then everyone in society benefits. The problem is when we have irresponsible lenders giving out money to people who will not provide any benefit to society which will just lead to wealth destruction.

You rail against ponzi schemes.

The Federal Reserve system is a ponzi scheme by definition; it rewards the earliest borrowers who buy cheaper goods. It requires ever more credit to pay off the interest and eventually (like now) that goes exponentially unpayable. The 1913 dollar is only worth 97 cents after less than 100 years if that's not a ponzi then what is ?

No its not (fraudulent), provided it is performed properly.

Since when have banksters not bent the rules, and bought the system, to hose everyone but them? Since when have regulators done their job effectively, let alone corruption free? Not in the course of American history, at the very least, I'll tell you that.

I like most of your Tickers, but I am not a fan on this one. Your arguement rests on a hypothetical, a suspension of disbelief. This is the real world where the notions of a bank on the up and up, and solid regulation are laughable. It's like when an economist says ceteris paribus, but everything else isn't always equal...ever. Experiments, computer models, and rules that work in a vacuum don't work in an entangled system like the one that presents itself in everyday life. Your reasoning may be sound, but only in a vacuum.

The symbolic effect of denuding the Fed as it's presently constructed would be priceless. If that's accomplished by firing Bernanke and putting the Fed in quasi-receivership for a season to shake things out then I say let's do it. At any rate that ****in place needs a public cleansing in spades.

Ghost, there is no system that cannot be cheated and gamed.

Arguing against FRL because people gamed FRL requires that you prove that whatever you'd replace it would could not be gamed.

Good luck with that; the earliest moneychangers gamed supposedly-not-fractional lending too.

Quote:

Credit - if we say FRNs are a store of value representing production, then leftover FRNs after "necessary" consumption is surplus, representing money that can be lent. Look at MSFT as one example - they have a stash of cash to use for investment in other productive ventures or complementary lines of business.

I understand what you're saying, but with FRL, over time interest and debt build within the system to the point where the actual cash levels in the economy, i.e. physical dollars in circulation, isn't there to sustain them.

Without continual injections of cash by the central bank or treasury you wind up with a ponzi scheme.

edit: I don't think there is a better system out there, I just strongly feel FRL is a necessary evil at this point.

I don't see how physical dollars has anything to do with this. We can have an economy that has no physical money, we could have a society where your "money" is an electronic transfer. All of it.

I wonder what would happen if the regulatory bodies were run by elected officials instead of appointed, besides the obvious issue of them being bought off just like Congress.

Credit - it's why I stand with Mish just a bit on this. I wouldn't make it illegal, however.

I wouldn't call it fraud, either...I'd just require all banks to publicize their balance sheet, no games, so any who deposit with the bank can see that there are assets of the bank "at risk". It's then up to you the depositor to determine how much risk you want to take. There would be banks with a lot of risk and higher returns as a result, and banks with little risk and lower returns.

The point is, YOU can decide, unlike the games the regulators allow the banks to play now, and the backstop we give the banks' risk via the FDIC and other guarantees.

The debate is great, I would never presume that I could sway anyone's opinion one way or another due to my lack of knowledge and experience. However, I will say that I believe the Austrian School has correctly identified the moral hazard built into the system by the Fed being created as a lender of last resort.

If banks in the system make unsound loans, and defaults cascade the Fed can always bail them out either through the FOMC or their influence in congress getting access to "bail out" monies. The only true regulator is risk, and the nanny state has striven to keep big banks free of any of that pesky responsibility.

What is the collateral with the FOMC? I take the collateral to be the "soundness" of the dollar. More debt, more money, more dilution of capital and savings in the economy undermining purchasing power. How much of the future capital can we pull forward before the present catches up to the future?

Gen is right on FRL. FRL, with an overall interest rate that tracks less than the economic growth rate, is completely and totally fine.

The reason it is fine is because assets are being returned faster than they are being consumed.

When the interest rate exceeds growth, well, that's when you have a problem. But that problem is unavoidable, because growth rates cannot be reliably predicted.

You would have to outlaw all risk-based lending, which is impossible.

What full reservist proponents seem to be ignoring is that nobody is stopping full reserve banks from going into business. Anybody with initial capital could establish a true, full reserve "bank" which does nothing but store your cash for you, and extract a fee for clearing checks, paying tellers & guards, and buying a big, secure building.

Why do these banks not exist? Because people don't want a negative rate of interest.

I suppose that's the irony of the libertarian "solution" to fractional reserve lending. The free market doesn't want it.

I never said such an entity existed - I said that would be the ultimate cure for this problem.

That being said, publishing bank balance sheets in the lobby, with no exceptions for ANY reason, would probably work pretty well too.

And Cruiser's rebuttal to KD:

"Oh God, the naïvete borders on DELUDED."
http://slcruiser.blogspot.com/2009/05/mo....

From the Ticker:

Quote:

Now the argument against Fractional Reserve Lending is that it constitutes "printing" money.

I think the argument the FRL is fraudulent stands on the idea that the bank is making a contract with each depositor that any (and all) depositors can get his money back at any time on demand (at least with no interest checking accounts, maybe technically with 14 days notice from savings accounts) but that the bank using FRL is incapable of meeting those contracts if even a small percentage of depositors decide to pull out their money at the same time - so fraudulent contract making by the bank. (Another fraud is that the banks talk to depositors as though the deposits are bailments rather than loans, but that is separate from the FRL issue).

Per Snowman

Quote:

FRL is like the insurance business, not all claims will happen all at once.

Seems to me that this is a sort of the correct analogy, except banking isn't regulated the way insurance business is and except that banking isn't sold in the way the insurance business is. Seems to me that banking is treated more like the way AIG was handling CDS agreements - everything is fine as long as only one or two events happen at the same time. Banking is more like CDS "inurance" sold in safety deposit box clothing - selling something as other than what it is is also fraud.

Also, most insurance companies wouldn't put all of their company assets on flood insurance all in New Orleans, just waiting for Katrina to hit the whole place at once. The equivalent of Katrinas hit economies from time to time.


from CJ

Quote:

what is fruadulent is the government allowing banks to continue to operate while below regulatory captial limits.

Regulations are arbitrary - there are no rules of science that says that such and such regulation will keep any bad stuff from happening from the banks. You call fraud when banks don't meet regs, but then the regs get changed to what the banks are doing - are they now not commiting fraud? seems like an arbitrary definition of fraud.

Gen wrote..

Pel, it DIDN'T fail for nearly 70 years.

WHEN it failed it is because we repealed the laws that made it hard to cheat!

I'm not so sure I agree. The FSLIC didn't save the S&Ls.

And the "system" didn't prevent the sickening inflation that occurred between the 60's and 80's.

The system didn't bring the country out of the depression in the 30's.

I have a fear that the "system" we set up in the 30's has enabled us to bubble so big, and "diverse" so much, that it will take decades to unwind, short of massive sacrifice to get us there quicker (WWII, but worse).

You're saying that a properly run "system" will have us growing slower and smaller, more safely, as long as we don't change it and regulators do the right thing.

The other side to the coin is, if lawmakers try to change it (as they did) and if regulators don't do the right thing (as they did), the system will fail, and it will fail big, huge, and spectacular.

That's why I'm skeptical. Given my druthers, I would almost rather have a pre-Fed-Reserve, pre-big-government-regulation approach where the growth is smaller, more regional, and booms/busts happen smaller and faster.

And again, that's why I'm saying I want to see something more substantive than, "Do what we did last time, but don't make the same mistakes."

Well, duh. That goes without saying. But what are we really going to do this next time that is a complete departure from the previous approach so as to not make the same mistakes?