At first glance, bank balance sheets are unintuitive and feel 'the wrong way round'. When someone deposits $1m at a bank, the bank doesn't have $1m more assets, it has $1m more liabilities.
(Yes, this is a gross over-simplification)
(Yes, this is a gross over-simplification)
The primary business of a bank is borrowing short and lending long - where short and long refer to the holding time: i.e. taking demand or short-duration term deposits and making mortgage, car and other types of loans.
If you do this badly, you can lose money due to duration risk (you might end up paying more on your demand deposits than your mortgage book is bringing in), but you also have liquidity risks because your depositors can ask for those deposits back faster than you unwind your lending.
If you have both of these occurring at the same time, you're then in severe difficulty, because the only way to repay your depositors is by borrowing money ... which is going to be harder if you look unprofitable ... and that very borrowing can exacerbate the perception of a bank in trouble.
That's basically what happened here.
Do they? Reserve requirements are almost non-existent. A better way to put it is that banks pretty much have a state-granted privilege for creating money and in the form of loans.
Banks create money from nothing to lend out:
> Therefore, if you borrow £100 from the bank, and it credits your account with the amount, ‘new money’ has been created. It didn’t exist until it was credited to your account.
> This also means as you pay off the loan, the electronic money your bank created is ‘deleted’ – it no longer exists. You haven’t got richer or poorer. You might have less money in your bank account but your debts have gone down too. So essentially, banks create money, not wealth.
* https://www.bankofengland.co.uk/explainers/how-is-money-crea...
> This article explains how the majority of money in the modern economy is created by commercial banks making loans. Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.
* https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
Money is a psychological construct of humans to facilitate trade and the exchange of goods and services. Some societies don't (didn't) even have money/currency: everyone kept a mental 'tally' of who gave or took things, and there were social expectations of giving "gifts" for repayment. Physical tokens (bones, shells, gold, paper, etc) came later.
When you decrease the reserve requirement, you're unlocking reserves that were previously locked up to back your deposits so that they can be loaned out to other customers, who will then promptly either directly or indirectly end up depositing their loaned amount into the banking system again, where the part that remains after the reserve requirement once again gets loaned out, deposited back in, etc.
In effect, because you're making this money go around, you're increasing the total supply of money, because these deposits are the money supply, and there can and often is more than a $1 net increase in overall deposits for each $1 deposited with a bank. Another way to state it is like so: you deposit $1, bank loans out $0.90, someone else deposits that $0.90, their bank loans out $0.81, so on and so forth for $10 of net deposit generation for a $1 initial deposit at 10% reserves held.
Of course, individual banks can elect to lock up more reserves than necessary, which would negate this effect.
This primer from the Bank of England is very clear: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
This says otherwise.
https://fred.stlouisfed.org/series/TOTRESNS
Lots more real evidence here https://fred.stlouisfed.org/categories/123
And in Canada, Australia, etc, they are zero:
* https://en.wikipedia.org/wiki/Reserve_requirement#Countries_...
"As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions."
It's not like banks suddenly loan out all the money. The Fed page has a FAQ and you can look up related papers.
From the FAQ: "For many years, reserve requirements played a central role in the implementation of monetary policy by creating a stable demand for reserves. In January 2019, the FOMC announced its intention to implement monetary policy in an ample reserves regime. Reserve requirements do not play a significant role in this operating framework."
People see the change, which is a good move for good reasons, and flip out, just like goldbug times or when CPI get adjusted and so on. A simple way to look at it for a long time there has been a idea battle between what's called endogenous and exogenous money creation (somewhat overview of the debate [1]), and over the past 50 years, most central banking systems have evolved as market needs evolved, to allow banks to lend beyond reserve requirements as long as they soon replenish, which was done via overnight lending windows through central banks. The practical effect is there has not been a "reserve requirement" except in name only for decades. Banks can lend whatever they want, and only have to borrow back to the old requirement which is simply an inefficiency.
This is summed up in one sentence on the Wikipedia article on reserve requirements as "Under this view, reserves therefore impose no constraints, as the deposit multiplier is simply, in the words of Kydland and Prescott (1990), a myth" [2]
Under the new system, the Fed changed other rates to account for this bookkeeping trick, with the same net effect on the banking system, but under simpler and more transparent accounting. They're not idiots.
So, since this was the reality of banking, the FED changed how things are tallied. Just like when CPI changed some terms to handle changes in reality, changes that were well documented, for good reason, people not reading carefully got upset and were sure they got cheated somehow.
So setting the old rate to zero and adopting the new methods for monetary control are the same pattern: terms change, in practice things are actually better off, but people used to the old term are upset and mischaracterize it as some a sign of financial calamity or underhandedness.
It's not. When people dig this out during an unrelated bank issue as some smoking gun it's worth stopping the nonsense in it's tracks in the same vein as COVID or climate or goldbug nonsense.
[1] https://www.sciencedirect.com/science/article/pii/S109094431...
In fact, reserve requirements became meaningless because banks had (and continue to have) so much more in reserves than they were ever required to have under the prior system.
If banks choose to keep lots of reserves (because you’re paying interest on them), it’s hard to change the willingness of banks to lend by changing the reserve requirement, right?
In economic terms, the supply of reserves is meeting the demand curve for reserves in an inelastic region.
So the Fed decided to announce a new approach; the so-called “ample reserves regime” where short term interest rate control would be achieved by administered rates rather than by the reserve requirements of the “limited reserves regime” that went before.
If this sounds very far from the quotidian business of deposit taking and loan making: that’s because it is.
Try this thought experiment. You and I are in a bar. We order drinks but oh no the bar's card machine is down and you don't have cash. No problem I'll lend you a tenner.
1) Am I a bank?
2) Did I first contact the state to check it was ok to create money in the form of a loan to you?
I go back to the bar on another day on my own. Oh no! Their card machine is down again! This time I don't have cash on me. No problem the barman sees me all the time I can have the drink this time and pay up when I next get there and either have cash or their card machine is working.
3) Are they a bank?
4) Did they first contact the state to check it was ok to create money in the form of a loan to me?
The answer to all these questions is obviously no. Credit is created throughout the economy at all levels and it is not a special function perculiar to banks.
A better example would be if you were in the bar alone, and had no money, and instead just wrote an IOU on a bit of paper with your contact details. If we lived in a mythical 100% trustful utopia, then the barman would just accept this as money and so would anyone else in future who the barman needed to pay for anything. But we obviously don't live in such a society so unfortunately no, not anyone can just create money!
The explainer videos I have seen are wildly wrong. I learned this stuff by reading the Basel accords [2], working with banking regulators and central bankers, working on banks' capital reserve models etc. That is to say I know how this actually works because I have been inside the sausage-making process for good or ill - I didn't learn it second-hand from someone who probably also learned it second-hand which is the feel I get from these videos.
Almost any time you see someone "explain" fractional reserve banking it is about 99% probably total bullshit. It's got to the point where "fractional reserve" is almost a trigger phrase for me - I know when I hear it that it is highly likely the speaker doesn't know what they are talking about. Almost like when you hear the word "fiat currency" you know it's very likely someone is going to try to shill you some crypto. An explanation which is not nonsense is here. [3] Fractional reserve banking means the bank doesn't need to keep the full amount of deposits in reserve, but can use some percentage to make loans. These loans are assets the bank has, but as with the example I gave above where you lend to a friend, no additional money is created in this process and when a bank does it, it's not fundamentally any different.
[1] You can find the definitions of M1 and M2 money and a good explanation of what's included in the definition of "money" here https://www.investopedia.com/terms/m/moneysupply.asp
[2] Which are not secret by the way - you don't have to be initiated into the templars or something to understand them. They are boring as all hell to read but otherwise reasonably understandable with a little bit of background https://www.bis.org/basel_framework/
[3] https://www.investopedia.com/terms/f/fractionalreservebankin...
Yes, it creates credit that people think is money. I suspect that's a big problem with it. People think their money is in the bank. Instead the bank is just extending them some credit that they can pass on to others when they "purchase" something.
When a bank gives someone a loan M1/M2 increases (unlike in your loan-between-friends example). The increase in "currency in circulation plus deposits" is the very thing that those numbers try to measure.
You can look at it either way; or indeed you can take a third view, the fractional reserve theory of money, which suggests that the banking system as a whole creates money in aggregate, but not individual banks.
All of these are theories with their adherents and none has yet been proven right or wrong. The only wrong position is a failure to acknowledge that discussion is still open on this point, or to believe that these are anything other than macroeconomic models.
> The only wrong position is a failure to acknowledge that discussion is still open on this point
Saying that bank lending doesn't increase M1/M2 money supply is wrong. I don't think that discussion is still open on that. It's just how those things are defined. That's the only thing that I asserted.
Right. That is the basic definition of the financial intermediation theory of money. It's actually a predominant view in the literature: for example, the Diamond-Dybvig model is based on the assumption that banks are not special as intermediaries; and it won the Nobel Prize for its authors in 2022.
If money supply is "currency in circulation plus deposits[, etc.]" how does bank lending not increase the "currency in circulation plus deposits[, etc.]" amount?
(Of course lending between friends doesn't: the $100 bill in circulation is the same as before and the friendly IOU is not a deposit nor included in the [, etc.]")
This is not, prima facie a bad theory, right? Go take a look at JP Morgan's balance sheet. The asset and liability sides of the sheet are basically loans and investments (on the asset side) plus deposits and outstanding debt (on the liability side), and these balance.
One may also say that turning up the heater doesn't increase the temperature of a room - because I open the window at the same time.
Anyway, my point was that saying that bank lending is like lending money to a friend and "You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed." doesn't make sense.
M1 would change if it was defined as "currency in circulation plus debts between friends" and the "oh, but my friend would sell the debt to the central bank or whatever in the end so there is no change in money supply" argument seems goalpost moving. The original analogy doesn't work and bank lending does increase money supply everything else being equal.
On the one hand, you go to a friend and say "hey, can you lend me $100; I'll pay you back $105 in a year?" and your friend agrees.
On the other hand, your friend puts $100 into a 12 month CD, and the bank pays him a 2% interest rate. The bank then turns around and lends $100 to you as a 12 month personal loan with 5% APR.
Can you not see why there are some who would say "it is obviously wrong to suggest money has been created in the second case, but not the first" or indeed "in neither case has money been created"?
By the way, in case it is not obvious: the fact you don't have a compelling rationale to make me believe your description of the world, and I don't have a compelling rationale to convince you of my view of the world is why there are multiple competing theories.
I am not trying to tell you that you're wrong; just that you're not right.
I'm just claiming that saying that M2 money supply doesn't change in the second case is wrong because it has been defined to measure exactly that. Under the assumption that money has been created in the second case, but not the first - whether we find that obviously wrong or not is irrelevant.
> the fact you don't have a compelling rationale to make me believe your description of the world
I'm only trying to make you believe that the thing that seanhunter wrote is seems incompatible with his own definition of money supply which makes the bank loan situation different from the friend loan situation.
These are macro theories; they don't tell you anything at all about an individual loan - only aggregate behavior of the entire system.
The only think I've been repeating all along is that in your own example
On the one hand, you go to a friend and say "hey, can you lend me $100; I'll pay you back $105 in a year?" and your friend agrees.
On the other hand, your friend puts $100 into a 12 month CD, and the bank pays him a 2% interest rate. The bank then turns around and lends $100 to you as a 12 month personal loan with 5% APR.
In the second case, the friend has given the bank $100 and won't see it back for a year, and will then get $2 interest. The bank then lends you $100 which it won't see back for a year, and will then get $5 in interest.
The cases are economically the same; except in the second case, the bank takes the net interest margin of $3.
The second case, scaled up hugely, is observably what happens in the real world; it's not my theoretical construct. I refer you again to JP Morgan's balance sheet - the extent to which assets (mostly loans) exceed liabilities (mostly deposits) is simply the equity of the bank. That's the whole point of a balance sheet; it balances. If deposits exceed loans then, well, we saw what happens there, right?
You can't break half of the balance sheet off and say "look, these loans are increasing deposits at other banks; M2 has gone up"; that's literally meaningless.
But that's literally the definition of M2. You look at the currency in circulation, the deposits at banks and other things not present in that example and you add them up.
(I'm not sure why would you think that I'm not aware that the balance sheet of a bank is full of deposits and loans among other things, by the way. The whole discussion is about banks taking deposits and making loans!)
>The fractional reserve banking process creates money that is inserted into the economy. When you deposit that $2,000, your bank might lend 10% of it to other customers, along with 10% from five other customers' accounts. This creates a loan of $1,000 for the customer needing a loan.
>The bank essentially created $1,000 and lent it to the borrower.
The above explanation was always my understanding. Is this a case of semantics?
You might enjoy this light reading: https://www.investopedia.com/terms/n/npv.asp
There is no reason to lock money in 10 year notes, it can stay as cash or go to money market or short term obligations.
As for money markets, don’t those get invested in treasury bills/notes anyway? Why go through a “middleman” when one has enough volume to invest directly?
Short-term obligations may not provide the yield that their financial structure requires.
10-year notes, in certain situations, provide an optimal combo of yield and risk. Provided, of course, that nothing major happens to the economy which wasn’t the case here. Then again, who’s good at predicting that?
In the end, it seemed like, given what was true at the time the decision was made, SVB made a rational choice.
Yeah, but the market price basically stays at $1 and whenever they "break the buck" it's a huge deal.
10 year loans "break the buck" so often that it's extremely strange SVB didn't do anything about it.
Basically they should have invested in securities that were safer and fluctuated less, but they got greedy chasing yield and got found out.
Bank lending always creates new money. They don’t (and can’t) “lend deposits”.
The BOE is simply pointing out in the link that they are the only proper bank in the UK. All the others borrow from the BOE to make loans. Commercial banks don't "create" money any more than the BOE "borrows" it from elsewhere.... The BOE creates money and lends it to commercial banks who put up a deposit and make a reasonable case for credit.
This, plus the other effects (like what the BoE calls “prudential regulation”) are the reason why you don’t see banks with zero deposits and a trillion pounds of loans.
Credit vs quantity theory of money is basically a concern of monetary policy (like: what is the expected effect of quantitative easing?) and doesn’t really bear on decisions at the level of individual banks or borrowers: things look consistent with both theories.
Like: it doesn’t matter whether classical or relativistic mechanics are “true” if you’re only following the flight of a baseball.
- the bank records an asset (the loan) and a liability (the deposit in the borrower's account) - the borrower records an asset (the loan money now deposited at the bank) and a liability (the loan)
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
At this point the money literally came out of thin air, there's more total currency in the system then there was before.
It might seem like an irrelevant nuance but it's pretty important to understanding how the money supply works
So even though the amount of currency looks like it has increased, it hasn’t really… unless I’m misunderstanding still. But my impression is this is pretty much what happened yesterday with SVB.
It's very hard for people to accept this because of how most people basically trade 1/3 of their lives to get some. It just doesn't "feel right"
Currency is just a physical representation of that unit.
Perhaps because of the insurance from central banks this problem is avoided.
If the bank is giving cash to the withdrawer, that would come out of their capital reserve I guess. If they didn't have that, they FDIC insurance would kick in.
You can say the loan is a number in a database, but once it’s withdrawn from the bank the bank can’t just go into the database and undo the loan.
Your example doesn't make much since because any bank has many good loans and a capital reserve to deal with the few bad loans.
Economists actually refer to the USD in your account as bank money because it did not come from the government. You could just as easily think of that money in your account as a bank issued stablecoin pegged to the dollar that's convertible to dollars.
Maybe that’s already implied in your description but they don’t need to borrow from anyone if they had enough reserves to start with.
Yes. Money isn't 'real' in the sense people typically mean. It's an accounting unit, so it's exactly as real as a liter or a kilometer.
Also, if it was all withdrawn it's a bank run, which has not been a problem in the US for quite a while.
Overall it cancels out for the large banks, of course people transfer money they just borrowed from the bank away, but that bank also has customers that are recipients of money. That, and other mechanisms between banks and banks and central bank(s) to balance such things within all the banks in the overall economy. Money withdrawn from one bank goes to another one, and everybody is not just sender but also recipient from someone else.
> Bank lending always creates new money. They don’t (and can’t) “lend deposits”.
It's just not true. The banks do transfer literal cash from deposits out of the system through loans. The cash in banks didn't come from thin air.
Why do you keep insisting on the "cash"? The by far least important kind of money? First of all everything is just virtual, electronic. Only a tiny fraction - and only temporary! It's not stocked at home, but used to buy something and that means deposited again in another bank - is "cash".
And yes, the bank deposits are "out of thin air" -- https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
Yes banks need some reserves, but this is waayyyy more complicated than them using the deposits. Which, for the most part, are not cash. That's only that tiny fraction of paper money use din circulation, which also is a lot less than it used to be with all the card-money.
https://www.bankofengland.co.uk/explainers/what-is-money
In the UK, as an example:
> 96% is electronic
> 4% is cash
USD is different because that currency is used for far more than just regular circulation, and world-wide. But even then estimates are ca. 8% cash maximum, for the world, which includes a lot less sophisticated economies. A bit more for the USD for obvious reasons, but most of that is not circulating in the US economy.
In any case, even in the US, with all its cards and card payments, money is mostly electronic and not cash and is transferred from bank to bank and hardly leaves the banking system.
ABOUT THAT TERM "OUT OF THIN AIR"
I've seen articles arguing money is not create out of thin air, e.g. https://cepr.org/voxeu/columns/banks-do-not-create-money-out...
> commercial banks create private money by transforming an illiquid asset (the borrower’s future ability to repay) into a liquid one (bank deposits); they would quickly be insolvent otherwise
Uhm.. yes, exactly. They can't do it at will, they need a borrower to sign. I mean, now we start arguing definitions, always a bad sign, especially when both sides actually are in perfect agreement and it's about the words used. This article to me is just weird, arguing it's not out of thin air, while everything being described says just that, only that their understanding of "out of thin air" is subjectively different than that of many other people. But there is no difference in knowledge and opinion about the underlying mechanism, only disagreement about some fuzzy term that some like to use and some apparently hate for whatever reason.
For arguments about definitions I would like to point to "Disputing Definitions" (6 min read) https://www.lesswrong.com/posts/7X2j8HAkWdmMoS8PE/disputing-...
According to your theory, what is the total amount of deposits at this bank after making the loan?
If, as you say, banks were lending deposits, then the total amount of deposits cannot possibly have changed and that new loan of £100 would have to come out of some other customer's bank account.
I would be pissed if my bank account balance suddenly dropped and the bank told me, sorry we have lent your money to someone else.
So this is clearly not what's happening.
If someone comes to take out a loan for $1000 and withdraw the money what would happen? They'd go get the money everyone left there and give it to the new customer. Now they bank has no money because they just lent all the deposits. $1100 in deposits and $1100 in loans
Incorrect, banks create deposits when they issue loans and only require reserve balances sufficient to satisfy net flows of funds between institutions.
They can also borrow those reserves.
So deposits are required to increase profitability, and of course a minimum level of profitability is required to be solvent, but banks in now way “lend out deposits”.
TWB (unrelated to SVB) realizes that it’s in trouble - customers are taking a lot of their deposits out, and confidence in the institution is low.
So, instead of trying to liquidate some of their assets or raise capital (which is what would be conventional) they decide to lend their bank president a trillion dollars of interest free loan with a recall feature, on the contingency that he deposit it in a non-interest bearing account with a 300 year notice requirement.
In your understanding of the mechanics of banking; this is fine. The bank magics $1tn of deposits out of thin air, records an equivalent asset, and can then just pay all of their customers from these new deposits they have.
Or not? And if not, why not?
Which means banking system as a whole creates 'private money' when flows of 'central bank money' between banks are balanced, but each individual bank cannot do it faster than others, otherwise these flows will be negative and it will be losing 'central bank money' and/or hard assets (which would be sold to acquire 'central bank money').
In your worldview, can you explain how it is possible for a bank to have far more loans on their books than they have deposits (see: fractional reserve banking)?
The answer in the US is simple: the Fed.
A bank can make an infinite amount of loans. They are not constrained by anything.
The only "limitation" they have is the future default rate of the people who accept loans from them.
The way a loan works is: they make a loan to someone and then "just in time", they borrow the money from the Fed to cover that loan.
Now, many banks take customer deposits. I think there are 2 reasons they do that:
1. Deposits may be less expensive than borrowing from the Fed.
2. Account holders are warm leads for future loans.
But in principle, a bank doesn't have to take any deposits.
Ehhh, how does that work exactly? They go up to the discount window and borrow from the Fed every time they issue a loan?
I don't know. I don't work at a bank.
But loans aren't typically available immediately - they take time to clear. It doesn't seem unreasonable to me that they'd bundle the day's loans (or maybe a few hours at a very large bank) to limit the number of transactions they'd have to make.
tl;dr yes, banks create money out of thin air. It's been this way for decades.
They are constrained by capital and/or reserve requirements
> The way a loan works is: they make a loan to someone and then "just in time", they borrow the money from the Fed to cover that loan.
Nope. Banks can borrow against their government securities from Central Banks by "rediscounting" them during discount windows, should they need extra liquidity. Note that this is not the preferred method since Central Banks usually charges a premium. These are secured loans.
See https://www.federalreserve.gov/monetarypolicy/discountrate.h...
That's incorrect, there are very strict limits on the solvency ratio placed on the banks that you usually deal with.
https://www.investopedia.com/ask/answers/052515/how-are-risk...
If none of the loan money was redeposited than the bank couldn’t create new money.
I've worked for a bank, both on the 'banking' side and on the IT side. One of the first things that gets drilled into your head is that banks create money. With every loan on the books more money gets put into circulation. There are some restrictions on how much you can put into circulation and there are some restrictions on how much cash you have to have on hand compared to the number of deposits that you have lying around.
But a bank could easily (as long as the bank is 'solvent' according to the rules set by the local central bank) write loans well in excess of it's deposits, technically it need not have any deposits at all.
Fractional reserve banking is about having more deposits (on the liability side) than reserves (on the assets side).
I won't say that it's not possible for a bank to have far more loans on their books than they have deposits (they could finance themselves differently) but I'm not sure if that actually happens. Can you give an example of a bank having far more loans on their books than they have deposits?
Also why link an article from the UK when the subject is a US bank? There are differences between the two countries banking systems and monetary policies.
This isn't really an over-simplification as it is wrong. When someone deposits $1m in the bank, the bank's assets increase by $1m in cash, while liabilities also increase by $1m and owners' equity is unaffected. The problem is that for interest-bearing deposit accounts, those liabilities increase over time, which decreases owners' equity in the absence of a sufficiently appreciating asset (such as a good loan or cash flow-generating security). Further, the bank has certain operational costs that must be paid, and investors must make some return or they'll pull capital from the bank (that's a simplification for publicly traded banks like SVB). In practice, it seems that banks need about 3 percentage points above the interest rate they pay on deposits to cover these costs, based on the typical spread between the Prime rate and the Federal Funds rate, though I imagine this necessary yield has a much higher variance for smaller banks.
When interest rates were effectively zero and their deposits increased by a huge amount, SVB decided to buy long-term bonds w/ 1.5% interest to cover the extra liability over time so that assets would grow with liabilities. Then interest rates went up. Cash assets stopped growing, but liabilities remained the same, so they started selling their bonds. Bonds lose value when interest rates increase, so their bonds sold for a loss, decreasing asset values. In the last 48 hours, depositors got spooked. SVB's equity effectively went negative, since asset values decreased below outstanding liabilities. That's typically when the FDIC steps in to liquidate a bank.
For banks, assets must in general be growing faster than liabilities. If the bank experiences a situation where assets are not growing relative to liabilities, they need to have sufficient capitalization (i.e. owners' equity) to weather the storm.
Let debt be a graph where the nodes are people (with ledgers) and the edges are all of the form "alice rents $x from bob for y% APR". Actions that resolve/relax graph are payments of the form "alice pays bob $z", that lead to all balances being 0. Let the edges decay to null when balance is 0, such that a 'resolved graph' is simply a list of nodes with no edges, meaning 'no one is in debt to anyone'.
From this we can infer:
1. There is only one logical 'debt graph' in the world since they can (and do) all join.
2. The people running the graph do not want the graph to die, ever.
3. The profit of the debt business is proportional to transactions over time,
which is proportional to edges of the debt graph.
4. They want to (add, prevent from decay) as many edges as possible.
Thanks for this, I am now also having some thoughts.
A few thoughts to add:
1. Should individuals inherit edge weight from their employers/governments? What should this inheritance be like? If I have no debt but have very little in savings, and if my company has debt to some other company which they have to default on, leading to my getting laid off, I can still be affected by debt.
2. I do not think it is accurate to think if "the people running the graph". I think it's more accurate to state local laws such as: any node which has more outgoing weight than incoming weight (i.e. net lenders) wants to prevent edges from decaying as much as possible while simultaneously making their borrowers more financially stable.
3. Would it be possible to quantify each vertex's credit-worthiness from just the labels you mentioned on edges? Would we need to add any other weights to the edges? e.g. the lender's estimate of the borrower's credit-worthiness?
Also, I think it's reasonable for individuals to inherit edge weights from their governments, as a way to model taxes, national debt, etc.
Now “They want to (add, prevent from decay) as many edges as possible” becomes “They want to encourage different parties to lend each other things they want”.
In a sense Alice also buys physical capital to use them, but she's not using physical capital because of its specific qualities but instead because of the money the products it produces will fetch when sold on the market. Alice wants a vacation because she wants to go to Paris or New Zealand or whatever. Alice wants a machine part because she wants the money it will make her. Two very different categories of thing!
I bring this up not exactly as a critique of your analysis, but instead because none of the discussion in this thread is particularly tethered to the process of production, and it's specifically the disruption to production that makes the SVB collapse troubling.
The problem with formulating it like this is it makes readers think that the set of people is a small-ish set of globalists or capitalists (or insert conspiratorial "others" as appropriate). But the set is far from small: basically anyone who ever wants to acquire debt for any reason (most common reasons include "attend college", "buy a car", or "buy a house"), or anyone who wants to profit from lending money to people, which is a fancy way of saying anyone who wants to invest money (such as buying stocks or bonds).
Or in a larger macro sense, positive central bank interest rates create a requirement for everyone to acquire some debt in order to counterbalance the drag.
It is troubling that the debt industry will attempt to increase the total debt in the world however it can. This is like a doctor attempting to increase the total sickness in the world - which is evil (not a word I use lightly, btw). But to say that either debt or medical industries should 'die' because perverse incentives exist seems wrong to me.
If I'm not mistaken, Debt: the First 5000 Years and the Dawn of Everything books examined this.
Your graph is a formalization of such relationship, no?
The basic nature of finance is that some people have money they don't immediately need and others have needs they can afford over time but not upfront.
It's basically a layer on top of money in general, which is a way of decentralizing value production. Instead of pairwise trades, money serves as credit for value creation, recognized by 3rd parties.
The people running the graph are everyone with excess money or the ability to acquire it. Basically, everyone but the poor.
It produces a grand, generational historical narrative, but it's also a form of pyramid scheme and guaranteed to run out of runway at some point when the graph, rather than expanding, finds ways to get by with different trade flows that ignore the center - and each time that happens, you get a massive economic crisis, elites vying for power and drumming up scapegoats to avoid heat, but also waves of material change(different lifestyles and work arrangements).
So there is downside to debt in that it can reinforce hierarchies, but also upsides in that the network itself is acting to transfer useful information about material needs. All things that, having becoming so much more digitally connected in the last 30 years, we can probably revise again to become more abstracted.
2. There is noone running the graph
3. This is true of all econonomic activity in a free market economic model. The assumption underlying market capitalism is that on net rational actors will only perform transactions which add value to them. Therefore the profit of the system is proportional to transactions over time which is proportional to the edges of the "financial transaction" graph. Debt is not required for this observation to be true - it's intrinsic to the model or the transactions won't occur.
4. There is no "they" other than "all the participants in the financial system". On net everyone participating in the financial system is doing so for their own benefit and therefore are invested in keeping the system running.
Banks have a serious problem in their hands as they have to figure out a way to keep buying assets that they have to buy by law, while the Fed is going to keep increasing the interest rates via selling their MBS portfolio at a rate that makes "yesterday's treasury or MBS" the loser.
If action is not taken we haven't heard the end of this.
No, it's cash.
If I deposit $1m in cash at the bank, the bank suddenly has an extra $1m liability and an extra $1m cash asset.
The point is that when banks receive deposits, in the short term, their assets/liabilities doesn’t change.
> The point is that when banks receive deposits, in the short term, their assets/liabilities doesn’t change.
They do change: Cash is a (risk-free, modulo safe storage) asset, the deposit is a liability. This has consequences for all kinds of metrics vital to the running of a bank.
The deposit creates a cash asset and an equal liability for the increases account balance.
Other transactions have other effects.
Yes, it is initially cash. But if the bank wants to make any money, it needs to convert that cash into some other vehicle for generating interest.
https://johnhcochrane.blogspot.com/2018/09/fed-nixes-narrow-...
That $1M you're depositing is presumably the liability of another bank.
I don't think that's right. There are banks outside the US that hold US dollars that the Federal Reserve has no jurisdiction over. They create more currency through fractional reserve lending for their local currency as well as any dollar denominated loans they make. I don't see how those are liabilities of the Federal Reserve, but maybe I'm missing something?
It doesnt matter if the US dollars is held outside the US. The dollar represents a promise by the fed to pay, and thus is a liability to the fed.
Of course the fed has the power to create and destroy dollars.
So to banks outside the US. That's how fractional reserve banking works. If I go to the UK and deposit $1m USD, and they loan out $900k of that to you, that UK based bank has created $900k.
To my sibling: Missing is the fact that US dollars are bank notes issued by the Federal Reserve. Issuing a note creates a liability.
https://www.federalreserve.gov/monetarypolicy/bst_frliabilit...
The value being in MBS now is a result of a separate transaction (well, a lot of them, probably) where (in aggregate) the bank takes a bunch of money from its cash assets and trades them for an (initially) equal value in MBS assets.
It becomes a problem when the MBS assets lose value, and the bank needs cash to cover withdrawals.
MBSs tend to remind people of '08 when MBSs lost value because too many had a bunch of garbage loans which defaulted, causing MBSs' face values to decrease. In this case, the fact that they were MBSs is mostly a coincidence. If SVB had invested in Treasuries, they'd be in the same world of hurt that they're in today.
Not necessarily, if they were investing/laddering in short term Treasury Bills (< 52 weeks) instead of longer dated bonds things might have panned out differently.
”97% of these MBS were 10+ year duration, with a weighted average yield of 1.56%.”
Treasury Bills from 6 months ago had yields of 3.37%.
In double entry accounting, you mark any changes with both a debit and a credit. This allows you to see not only why one account changes (a single entry), but also the cause of that change (the second entry).
Double-entry bookkeeping makes sense once you understand the the invariants you have to keep, and why you need to track 5 different types of books. Some of those accounts work in opposite ways, such that credit to one is a debit to another.
It all works out and is essential for "debugging" problems (when money appears to go missing -- or worse, materializes and you don't know why). But there's some counterintuitive language and it'll mess you up until you accept it.
The answer usually being some variation of "Because that's the way the Financial Accounting Standards Board says to do it."
However single entry bookkeeping is FRAUD prone. Just change one number and your theft is hard to track down!
That is why the adoption of double entry bookkeeping was critical for allowing commercial institutions to outgrow a size where owners could individually trust all who were working for them with access to money.
The ledgers are not the source of truth. No: this is a journaled filesystem; the transaction log is the ultimate source of truth. When you detect faults you recover from the journal, if something isn't completely written into the journal then it does not exist. The zero-sum property exists on every individual transaction and each transaction has an ID and the ledgers point at these IDs for auditing purposes.
So why have the zero sum property? Well, for one thing, it creates a uniform access model, I can't just credit my account, I have to debit someone else's account and they can have rules that might prohibit me from doing so. By carefully setting up these accounts you can also do what's sometimes called "behavior anomaly detection."
So for instance normal financial cards kind of work by opening up your entire wallet to a cash register and asking the cash register to pull out exactly the amount that you owe, understandably this might not be desirable if you are tracking some in-game-gold transactions in an internet game. You can get as elaborate as you want but think for example of a quick-consistency-check rule saying that “accounts starting 4xxx (player balances) never transfer directly to each other, instead users are expected to put the exact sum of money plus a little 5% padding into one of their 5xxx accounts and then give someone else a token permitting them to withdraw from that account." Stuff like that. A developer tries to code something up that doesn't go through this process and runs into errors in testing and has to conform their code’s behavior to the less risky process so that nobody is ever opening their entire wallet to a griefer.
Double entry basically just means that for every transaction on your books, you are showing where the money/asset/liability came from and/or where it's going. If you enter that you paid $100 for the AWS bill, you need to indicate from what account that money came from. So you would debit AWS Expense and you would credit your Wells Fargo Checking Account. With modern software, this basically just amounts to entering the expense and specifying which account it came from.
Doble entry accounting is very similar to a checksum in that sense. It provides error detection. If you make a mistake in one of those two places, you will know immediately. As opposed to single entry, where you can carry that error indefinitely until somehow you catch it.
Wikipedia tells us that double-entry bookkeeping is first attested in the late 13th century.
But commercial institutions larger than the personal-trust threshold are attested as far back as written history goes.
[citation needed]? I don't necessarily doubt you but I'd like to see an example. The only thing I can really think of would be governments, but that was definitely personal trust (mixed with a little bit of threat of summary execution if the king didn't like you).
The smallest amount of tribute listed there is more than five and a half tons of silver. If we make the assumption that each of these districts was handled by a different person, we already have a staff of 20 people plus the king.
(Not to mention, the large majority of Achaemenid taxation was not collected in this form. It was collected in kind and stored in an empire-wide system of distributed warehouses. I assume metal tribute was centralized. If you think the warehouse administrators - who inventory the goods and are responsible for making payments out of them - are "responsible for money", you're probably adding at least a couple dozen more people.)
By contrast, https://www.theofficialboard.com/org-chart/exxonmobil suggests that the top two levels (including the board) of Exxon total 26 people, or (excluding the board as a level, but still including the CEO) 24 people. The CEO has 13 direct reports.
So if the argument is that ancient kingdoms were below the personal trust threshold because the king had a low - and therefore manageably trustworthy - number of direct reports, it appears to be the case that our largest corporations today are also comfortably below the personal trust threshold, so there was never any need to exceed the threshold and in fact we never have.
(This isn't quite an apples-to-apples comparison; maybe there are 20 tribute administrators who report to a high overseer of tribute who reports to the king. Maybe each tribute administrator is one of five reporting to a low overseer of tribute, the four low overseers report to a high overseer, and he reports to the king. I don't know. How many employees do you think Exxon has who are directly responsible for submitting revenue totals in excess of three million dollars?)
On the other hand, if we think Exxon is beyond the personal trust threshold by virtue of its geographic extent (huge!), or its total number of employees (huge!), or its total number of employees touching money with the potential opportunity to steal that money (still huge!)... I think we have to say the same thing about ancient palaces, and really about ancient temples. A temple might "only" employ a few hundred people, but that's more people than you can personally trust. An important temple employed a few thousand people.
In a business I hand you my money and trust that you will hand me back my profits.
A ancient government put someone in charge and demanded tribute. Failure to produce tribute resulted in an army showing up to collect tribute. It was so common as to be expected that the administrator, called a satrap, would collect excess tribute and live a lavish lifestyle. The king sent spies to root out the worst of the abuse, but it was an uphill battle.
Governments can be run this way because efficiency is not particularly essential to their profitability. But efficiency is required for commercial enterprises. It is not enough to collect money and let your subordinates enrich themselves. You want to track all the money and not let your subordinates cheat the enterprise to their personal profit.
> But efficiency is required for commercial enterprises. It is not enough to collect money and let your subordinates enrich themselves. You want to track all the money and not let your subordinates cheat the enterprise to their personal profit.
The first two sentences are obviously false; you want to track all the money, but you have no particular need to do so as long as some of the money is making its way to you.
But to be fair he did pretty much the same when I tried to explain programming.
Always important to step outside your software bubble once and a while.
OTOH, once you have double-entry bookkeeping in your brain, you won't want to go back. I now feel that, from the perspective of a business or consumer, money is never created or destroyed, it only moves between accounts.
Double-entry bookkeeping is creating of an audit-trail/error-evident data store; which is the purpose of the apparent duplication. But it can be viewed as a view of dataset reflecting a single source of truth, that documents value flows; every movement of value has a source and a sink, and the amount that moves from the source must equal the amount that moves to the sink. Losing the redundancy that allows error-checking of records, you could view each accounting transaction as a triple of (source, sink, amount).
You couldn't do bookkeping with actual books that way, and historically this way makes sense. Nor is it likely that the accountants are going to rethink their field from the ground up for the convenience of programmers.
That is actually how it works, if you don't have "flows" you don't have accounting postings and if you have to fix an error you redo the postings from the flows. In this sense I would say that the "flows" are the source of truth.
Now, on the other hand, it is especially designed to account correctly for that amount in order to keep your accounts correct and balanced. It is be much easier to lose track of things with single-entry accounting.
If you were accounting with pen and paper, you would write the transaction amount twice — positive in one column and negative in another. This maintains the invariant that money cannot be created or destroyed.
In terms of an abstract data model, though, each transaction is best thought of as a flow, or a weighted arrow. It has one amount and two ends: a source and a destination. The "double" in "double-entry" really just means that the arrow has two ends. Obviously every arrow has to have a head and a tail — it doesn't make sense for there to be no source or no destination.
The credit vs. debit thing confuses people a lot, and in my opinion is a red herring. If I could wave a magic wand, I would delete the words "credit" and "debit" from accounting because they are hopelessly inconsistent.
All you have to do is think of the conservation of money like the conservation of mass — when it moves, it leaves one place and arrives at another. The moment I stopped using the words "credit" and "debit", my understanding of accounting went from "I have no idea what I'm doing" to "Everything is intuitively obvious."
And if you wonder, if money cannot be created or destroyed, how does a monetary system handle the population tripling over the past 50 years?
The answer is national debt. The US national debt is just an artifact of this double entry bookkeeping. In order for there to be +money in the economy for the ever-growing number of citizens to do commerce with, the treasury incurs on itself -money. That's national debt.
The corollary then, if the US ever pays back all of its national debt, the economy will crash because there just aren't cash available for people to do commerce with. A +90trillion on the government balance sheet equals a -90trillion on the private sector balance sheet.
If the private banks have conjured up 100x the monetary base in 1970, then when the population doubles by 2020, the banks cannot multiply further up to 200x. The treasury has to expand the base while the banks keep their multiplier fairly constant.
There is ONE special actor (in the US) that can create money out of the thin air: the Federal Reserve.
It alone can "buy" securities by crediting banks with money created out of nothing. Banks simply see a transaction with a dollar amount on their accounts within the Federal Reserve, and that's it. The money just appears.
The invariant "money can't be created or destroyed" holds for everybody else, including individual banks.
> The answer is national debt.
That's completely incorrect. The Federal Reserve can arbitrarily create (or destroy) money even if the national debt goes away entirely.
Saying that the Fed can arbitrarily create and destroy money misses the point, that they then have to buy SOMETHING with those money, and there are strict rules about what they can buy, and it just happens that the Treasury controls the supply of the primary asset class that the Fed is allowed to buy. Once you clear out all the dance and ceremony, you arrive at the conclusion that the Treasury issues new money by issuing new securities.
That's true, simply because they're the most convenient way to manipulate the monetary supply. Not much else is readily available in the volumes needed.
But they are not _essential_.
> Saying that the Fed can arbitrarily create and destroy money misses the point, that they then have to buy SOMETHING with those money, and there are strict rules about what they can buy
Sure, the invariant: "money goes out, asset goes in" holds.
But they can buy quite a lot of different securities if needed. E.g. the Fed directly bought about $3T of MBS: https://www.newyorkfed.org/markets/programs-archive/large-sc...
Also, I would say transactions are actually “multi-arrows” since there can be multiple sources and/or multiple destinations. A Bitcoin transaction captures this structure more or less perfectly.
There is a reason why planes use 3+ CPUs running the same code, or why Google runs more than just one cluster of search.
In essence you are just recording transactions with source and destination accounts and the amount. And at least in principle you could just log all transactions in this way without any redundant information. If you insist on making the change to each account more obvious, then you will have to record the amount twice, once for each account, but if you are doing the accounting with a computer, then I would guess that you always just record the transaction and only show the amount twice with different signs for the two involved accounts. Or does bookkeeping for some weird reasons really record each amount twice?
There is a surprisingly common reason, but it isn't weird. Consider a paycheck. You have income, but then you split that up. Some pays for insurance premiums, some is withheld for taxes, some may be contributed to a retirement account, and some is deposited into a bank account. Earnings is a credit to an income account, but everything else is a debit to some other account. The total debits equal the total credits, but each credit and debit must necessarily be a separate entry, because they all affect different accounts.
That's equally true in programming. The problem is that it only helps you debug problems that it created or participated in...
The difference in accounting is that it's not "two entries for the same thing". It's a credit and debit entry. It's a source and a target entry. It's two different entries for two different things, even though some of the details (like the transaction that they actually relate to) will be shared.
(And they're treated as separate "rows", rather than as additional columns on a single row, because it's a many-to-many relationship. Very database-designy!)
But that does not reflect risk.
For instance, now they take those $1m in cash and use them to make risky loans or investments. At face value the balance sheet is the same because they still have $1m in asset... except that the risk that this asset turns into eff all has significantly increased.
Theoretically they had assets, but most of them were just internal magic beans.
Individual investors don't even have that option and also have inflation to deal with. Banks don't.
That money isn’t doing anything to cover those expenses if some of it isn’t “working” to produce returns.
It’s not that people are greedily chasing returns, it’s that they don’t want to lose significant chunks of their capital due to loss of value.
Real rates were negative for 10+ years (and still are on the short end!). That's everyone paying for trillions of dollars of wars, speculation and bad investments. The bill has to be paid.
But as mentioned, none of this applies to intermediaries like banks. They aren't forced to take on any risk.
They sure were, and fortunately humanity took that free money and invested it in sustainable energy technology so that at least we got a bunch of infrastructure out of it.
Oh actually wait we just had austerity for some reason.
Edit: maybe I wasn't clear and should have said "between" banks. Synchrony bank will give you 4% in a _savings_ account (https://www.synchronybank.com/banking/high-yield-savings/?UI...) while my local credit union and many big banks (ex: bank of America are at 0.01%) are still effectively 0%
In the past (<2008), cash accounts (savings/cds/etc) I remember there being a %1 or so between banks, but these days its huge.
That's really the big reason why savings rates vary so much between banks, if you have a bunch of consumer credit lines then high savings rates make sense, if you have a bunch of lower fixed-rate collateralized loans then you can't get away with lowering your spread so much.
There's other epicycles to this too. For example, a bank can just "buy" deposits through a correspondent bank (a bank-for-banks). So the direct connection between your kind of borrowing and kind of lending, particularly when its consumer / credit card stuff, can be tenuous. In SVB's case, though, all of the stuff happened in a tight echo chamber ecosystem -- SVB got deposits from tech cos, who got money from VCs, who were working off of capital call LOCs from SVB. So your observation is germane.
Not quite. It actually has both.
Yes, it owes $1m to the depositor, but it also has $1m in cash now, at least for a while. Until it does something with it, like loaning it out or investing it in some debt instrument. The cash is an asset, as is the loan or debt instrument it exchanges the cash for.
Until we all can self-bank!
(Often, the asset comes from the bank making a loan. You can pay later.)
So given an interest per annum of 1% (for example), a $1m deposit would add $1m liquid, non-earning assets while also adding $1.01m to their liabilities. So, effectively, they’d have $10,000 in unsecured liabilities.
To counter that imbalance (as well as protect the cash from the effects of inflation), they’d have to put some of that cash to work via various investments.
Money for banks is what raw material is for manufacturing. What they are doing is risk management (analyzing risk, packaging risk, selling it, buying it).
On my balance sheet, money I deposit is an asset: The bank owes me.
On the bank's balance sheet, money I deposit is a liability: The bank owes me.
https://www.federalreserve.gov/releases/h8/current/
Note that cash is a single line item. The banks could get that from other sources, such as loan repayments.