Re: Non-Banks versus Banks

From: The Trucker (mikcob_at_verizon.net)
Date: 07/22/04 

Date: Thu, 22 Jul 2004 10:25:51 -0700

William F Hummel wrote:

> On Wed, 21 Jul 2004 16:06:40 -0700, The Trucker <mikcob@verizon.net>
> wrote:
>
>>William F Hummel wrote:
>>
>>> On Wed, 21 Jul 2004 10:06:00 -0700, The Trucker wrote:
>>>>
>>>>This notion that a bank must have the dough that it lends BEFORE it
>>>>can lend is total horse manure. Due to the ability of the bank to
>>>>borrow whatever it might need at a discount, banks can routinely
>>>>loan what they do not have.
>>>
>>> Coburn, you are an idiot. When a bank creates a deposit to fund a
>>> loan, the bank must have reserves on deposit at the Fed at least equal
>>> to that loan. Otherwise the check written by the borrower, which
>>> could be on the day of the loan, would not clear the Fed for lack of
>>> funds. Likewise, if you write a check without sufficient funds in
>>> your bank account, the check will bounce -- no matter how much you
>>> might deposit after the fact.
>>
>>In a previous discussion Hummel wrote:
>>
>>"Before the new deposit of $1 billion, if it just met the reserve ratio
>>requirement, it could lend the entire $1 billion. After the loan is
>>cashed, the bank will lose the new reserves and the demand deposit
>>created by the loan, leaving it as before just meeting the reserve
>>ratio requirement. However the bank could lend more than $1 billion
>>if it makes up for the reserve deficiency created when the loan is
>>cashed. It can acquire the needed reserves by borrowing in the money
>>market. For example, it could lend $2 billion today and follow up by
>>borrowing $1 billion to cover the withdrawal of the entire loan. The
>>14-day averaging period in reserve account provides flexibility as to
>>when it must acquire the borrow the funds."
>
> A bank can borrow to meet the reserve requirements AFTER a new loan is
> made, but it must have enough reserves AT THE TIME it is made so the
> borrower's checks will clear.
>
> In the above example, the bank had $1B in reserves, just enough to
> meet its reserve requirements. Then it received a deposit of $1B,
> which increased its reserves to $2B, just enough to clear checks on a
> $2B loan. However when that $2B is spent, the bank would be left with
> zero reserves, assuming the payees deposited the funds in other banks.
> So the bank must promptly borrow $1B to restore the level of reserves
> required to meet its reserve requirements. It has a fourteen day
> averaging period to work with.
>
>>Then Hummel says:
>>
>>> A reserve requirement of 10% of demand deposits does not mean a bank
>>> can issue a loan 10 times what it has in reserves. Borrowing the
>>> reserves needed to cover the loan after it is issued is obviously too
>>> late.
>>
>>It would appear that Mr. Hummel is confused.
>
> Coburn would have us believe that when a bank receives a new deposit
> of $1B, it can immediately lend $10B. In the above example, that
> would leave the bank $8B short of what it needs to cover checks
> written against the loan. Absurd on its face.

So in the 10 seconds before the loan is granted the bank borrows
the $8B and does the deal, or the bank does the deal and then 10
seconds later borrows the $8B. I have never DEPENDED on this
after loan borrowing to make my case though I think it quite
realistic. I have said only that EVEN IF THE BANK ACTUALLY HAD
TO BORROW to make the loan then the bank would, and does, in fact
borrow so as to cover the loan.

My major point has been made and not once rebutted by you that
the FRACTIONAL RESERVE SYSTEM allows banks to routinely support
loans with only a fraction of the money (10%) ON HAND. That is
WHY they call it a FRACTIONAL RESERVE system and that is HOW
banks create money/credit. You admit that all the money/credit in
circulation was created/financed by the banking system and that
all the base money and T-bills and bonds were created by the
Fed/Treasury. You admit that the REAL money in the system
(base money/reserves) is only 10% of the outstanding loans/credit.
Yet when presented with the facts that are a result of this
system you simply bluster and delete what I have written.

So here is the simplified example AGAIN, awaiting any comment
or rebuttal from you:

---------------------------------------------------------
There are N banks (many banks) in the banking system. So we will create
a small example of a banking system where there are 3 banks: A, B, and C.

We will assume that all the banks have the same amount of capital and
assets and reserves. If the banks create loans in response to the
demand for loans and they compete pretty evenly then bank 'A' will
create loans that will be "cashed" by moving funds to bank 'B', and 'C'.
Bank 'B' will also create loans that will be "cashed" by moving funds
to Bank 'A' and 'C'. And bank 'C' will be creating loans that will
be "cashed" by moving funds to banks 'A', and 'B'. And at the end
of the day all the funds will balance so long as the banking system
as a whole has enough "reserves" to satisfy the overall level
of loan creation. If not, then the Fed will put some more dough in
the system by purchasing some T-Bills from the "public".
----------------------------------------------------------------------

And in support of this we have from the hot little fingers of
Hummel: ----------------------------------------------------"
Larger banks are normally able to borrow funds in the money market,
and thus acquire reserves on their own initiative. That allows them
to issue loans before they have the reserves to cover the increased
deposit liabilities. But borrowing in the money market does not
increase the reserves of the banking system as a whole. It merely
redistributes existing reserves among banks.

Lending by larger banks can therefore result in a net shortage of
reserves in the banking system. That puts upward pressure on the
interest rate that banks must pay to borrow reserves. In order to
keep that interest rate on its chosen target, the Fed has no
alternative but to add reserves itself. It does so by buying
securities from the public, thereby adding to the total of bank
deposits, and thus bank reserves. It also may lend reserves directly
to banks, but that accounts for a very small fraction of the reserves
in the banking system.

"----------------------------------------------------- 

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