Without consequence, of course not. But you should be able to 'separate' your professional and personal life, even as an entrepreneur.
I would NEVER found my own business if I knew that going bankrupt would take away my kid's house. This is why instruments such as limited responsibility companies have been invented.
Doesn’t seem like a big deal, but I imagine if you have your own butcher in the first place, you are somewhat particular and specific about what you want (kind of similar to a lot of people clinging onto their usual hair stylist/barber for their dear life, once they find one that does things the way they like). And I would bet that the number of barber options around would be much larger than that for butchers.
Why? In case of success, you have the personal benefit from it. So why should other people and society take the bill in case of your fail? Or how exactly is this supposed tor work?
Maybe it's a bit of both
I'm not aware of any jurisdiction where "wasting resources and harming society" by having a company with limited liability go bankrupt isn't fairly simple.
Germany, like some other companies in Europe has fairly "high" requirements of share capital, but it's still only 25k Euro.
In the UK it's £1. 25k Euros is ridiculously high!
In The European countries I have been living in, the concept of personal bankcrupty doesn't exist in the same way, at least. People who get too much loans kind of just hang with them, after 15-20 years they are forgiven AFAIK.
That's because once you do that, the supply of new student loans would most likely dry up. Thus shutting off the money fountain for the education industry.
We do this with drug reimbursement costs and construction already and I’m pretty sure those for-profit companies would also disagree on what the limit should be. I also don’t think it needs to be a one-size-fits all threshold; it could be adjusted to COL and/or job prospects that are tied to graduate statistics. IMO that goes a long way to aligning the incentives of the student and the institution.
I’m curious if you have an alternative solution
Personally I think limits (and significantly higher grants to make student loans unnecessary for a basic post-secondary education) are needed. But I think it's worth recognizing that limits will make what's already a very divisive issue, even more divisive...
I have seen other pilot programs. I think it was Purdue who was considering "buying stock" in students, where the student would pay a portion of their income for a certain number of years in exchange for a scholarship.
If people voluntarily want to pay high costs, and other people voluntarily want to make loans, who are we to judge?
We just need to get tax payer money out of the game. Afterwards, people can go nuts with their own money.
Yes, get the taxpayer out of the loan guarantee business. Sorry, I thought that was a given.
I actually want exactly the 'blowback': I want student loan creation to fall off a clip.
> Do you think there is an opportunity gap to be closed?
What is an opportunity gap?
> If so, how do you think that would work?
I'm guessing here what you mean by opportunity gap. I think the cheapest way is to open the US labour market to virtually anyone on the globe. That would be good for the US economy, wouldn't cost the tax payer anything (in fact you would save on border enforcement), and the people with the least opportunities globally would benefit enormously.
If you only care about Americans, I would suggest to give poor people money, and let them decide what to do with it.
Eg whatever the cost to subsidise education (including subsidised student loans) right now, just pay it out to poor people. Than they can buy education, or whatever else they deem more necessary.
It sounds like you may not understand how the system works. It doesn’t cost the government anything, with the exception of the loan repayment pause surrounding COVID.
I know the simple solutions like “Just give away money” can be seductive, but IMO they generally don’t work well in complex and nuanced problems. People aren’t rational actors by and large, and it’s a mistake to assume they can be modeled as such in many cases.
You'd still be on the hook explaining why you know what's better for people than they do.
> It sounds like you may not understand how the system works. It doesn’t cost the government anything, [...]
There are always opportunity costs. But what parts of the 'system' are you talking about?
There is much research, especially in behavioral economics, that shows that more objective decisions can be made by creating systems that facilitate more rational decisions. So my current position is that we should set up systems/institutions to foster those better decisions rather than push everything down to the individual, given the complexities of modern life. So to directly answer your question, there's decades of research that shows individuals aren't great at making rational decisions at the individual level. It's also interesting that you simultaneously seem to claim the "state" should make decisions, but also that institutions don't know what's better than individuals. It doesn't make for a very cohesive take.
The government guaranteeing arbitrary loans isn't free in economic terms. Just like eg increasing the length of patents from 20 years to 40 years ain't free, even though it won't show up as a cost on any government balance sheet.
At least with your patent example, we can measure it in economic terms, since patents are a commercial protection. Once we start getting into wishy-washy measures, people can make just about any arbitrary point to fit their narrative.
Unfortunately, the earning potential of a generic bachelor's degree seems to have mysteriously fallen at roughly the same time a flood of students were offered huge loans to achieve them. Maybe some day we'll be able to find the connection.
So the question still stands: if the government no longer guarantees the loans, what is the proposed solution to prevent banks from no longer lending to students?
Not claiming you are wrong, because I genuinely don’t know, but how does it gel with the fact that the federal student loans for undergrads cap out at the max of around $9.5-12k for independent students and $5.5-7.5k for dependent students per year[0]?
Given all the outrage I see online, where people claim paying upwards of $20-40k/yr for attendance, wouldn’t they need to supplement it with private loans?
I dont doubt that there are more federal loans out there than private ones (because it always makes sense to get the federal ones first, and only go for private ones later if needed, so pretty much everyone who has private loans also has federal ones). But what about in terms of the actual loan dollar amount?
0. https://financialaid.umbc.edu/types-of-aid/federal-loans/dir... (this is an UMBC page, but it breaks down the federal student aid limits that apply everywhere)
That 92% figure is in terms of debt amount, not number of loans.
The limits you mention are per student. Parent PLUS loans are limited only by the school’s official cost of attendance: https://studentaid.gov/understand-aid/types/loans/plus/paren... (“The maximum PLUS loan amount you can borrow is the cost of attendance at the school your child will attend minus any other financial assistance your child receives. The cost of attendance is determined by the school.”). Schools are extremely aggressive about ensuring parents are on the hook for the loans so students can take out the maximum.
Small caveat (that ultimately doesn’t negate your point): PLUS loans have credit check requirements for determing eligibility[0] (with exceptions available in certain cases if you can satisfy additional requirements, like bringing an eligible cosigner who can pass the credit check).
0. https://studentaid.gov/understand-aid/types/loans/plus/paren...
The net benefits of education accrue to more than 100% to the customer. And, people from well-off backgrounds can and do take more advantage of education.
We should just give poor people money, and let them decide for themselves how they want to spend it. If they want to spend it on (unsubsidised) education, that would be fine choice for them to make.
That's where we disagree, I guess.
I don't mind education in the sense of people learning something. That's harmless enough (but doesn't need special subsidies. Just give money to the needy, and let them decide whether they want to invest it in a library membership.)
What I'm against specifically is education in the sense of getting a certificate at the end. A degree etc.
That sort of education has negative externalities and should be highly taxed, not subsidised. It leads to an arms race of credentialism, and is a big reason why eg a high school graduate can't get a decent job these days.
(There are plenty of jobs that used to be done by high school dropouts, that haven't changed all that much. But now require a degree, if you want to be considered for an interview.)
I do also think over-credentialism is a problem, but that is largely up to the employer. All they have to do is start hiring people without credentials if they aren’t warranted and the problem is solved (for non regulated industries). But I wouldn’t go so far to say credentialism as a whole is worthless. I’m glad the food I buy is credentialed by the FDA, and the doctor I e see is credentialed as is the engineer who designed the bridge I drove across to get to work.
What I do see on HN is that the crowd generally biases towards libertarian autodidacts and that colors much of their worldview.
The library was just an example. People can use their own money and time to pursue whatever route they wish. They can attend schools (and pay the fees), they can go to the library, they can read Wikipedia, they can do an apprenticeship, etc, whatever works for them.
> I do also think over-credentialism is a problem, but that is largely up to the employer. All they have to do is start hiring people without credentials if they aren’t warranted and the problem is solved (for non regulated industries).
Alas, no. Employers aren't stupid (and neither are workers). Employers are paying attention to the credentials because they signal useful qualities in the prospective employee. Mostly compliance and conformity.
For an individual worker and an individual company, the credential is a useful signal. Just like it's useful for an individual country to get some extra nukes.
But from an economy-wide perspective, it's just an arms race. (Similarly, there's no global benefit from every country getting some extra nukes each.)
> I’m glad the food I buy is credentialed by the FDA, and the doctor I e see is credentialed as is the engineer who designed the bridge I drove across to get to work.
I'm not an American, but I think the FDA is pretty much useless. (But that's mostly because it's a federal agency, and the relevant authorities should probably sit at the state level at the highest or even lower. With voluntary coordination between the different states. Very similar to how traffic signs and rules are regulated and coordinated.)
>Employers are paying attention to the credentials because they signal useful qualities in the prospective employee. Mostly compliance and conformity.
Again, I think this is overly cynical and lacking nuance. There is debate in the economics circles on how much a college credential is signal for culture fit and how much is signal fit skills. It’s far from settled, and almost certainly a mixture of the two.
I personally think employers use credentials because they are incentivized to be risk adverse. It’s easier to defend a binary credential than to accurately gauge skillset and cultural fit through a behavioral interview. HR is concerned more with reducing false positives than letting a good candidate slip through the cracks.
I also disagree with the coordination piece at large scale. When societies get big enough, we don’t have the individual bandwidth to manage every interaction so we rely on institutions to shoulder some of that burden. I suspect that’s why you see a convergence on societies setting up a “council of elders” (ie govt) when they get to a certain size. Most of the people who lean into the unnuanced libertarian ideal tend to also lean towards certain troubles managing social dynamics.
I suggested that state level agencies can do that regulation. Why do you bring up the straw man of unregulated drugs?
Most countries are smaller than the US, and still manage to get safe drugs. In fact, many countries are even smaller than many US states. So it should be certainly possible for US states to regulate drugs. (Especially since they can cooperate, just like they do on traffic rules or the Uniform Commercial Code.)
I'm not sure why you want to paint my position here as some radical 'libertarian' fanatic? Even the Catholic Church likes subsidiarity, and it's (in theory) one of the guiding principles of the European Union. See https://en.wikipedia.org/wiki/Subsidiarity
> Again, I think this is overly cynical and lacking nuance. There is debate in the economics circles on how much a college credential is signal for culture fit and how much is signal fit skills. It’s far from settled, and almost certainly a mixture of the two.
Aren't you the cynical one? I am suggesting that most likely employers and employees ain't idiots and know what they are doing. And you suggest 'hold one, they probably are idiots'.
> I also disagree with the coordination piece at large scale. When societies get big enough, we don’t have the individual bandwidth to manage every interaction so we rely on institutions to shoulder some of that burden.
Sure, but that doesn't mean subsidising credentialism is the only way. We have examples from successful societies in other parts of the world and in other parts of history doing just fine with a lot less of that. So your argument from universal convergence doesn't fly, when there is no universal convergence in the first place.
Because it illustrates the problems of scale. Much of commerce is regulated at the federal level because crossing state lines makes the complexity of the problem much harder to manage. UCC is not a very good example; it has barely changed in half a century, in part because getting all states to update and agree becomes onerous. As an effect, the UCC largely boils down to a contract law policy of "shut up, pay me." That type of approach isn't great for handling nuanced problems.
>Most countries are smaller than the US, and still manage to get safe drugs.
You do understand much of this is predicated on the very institutions you are maligning. A vast and disproportionate amount of pharma R&D is done in, and regulated by, the U.S. Other countries generally use that information as a proxy for in-house regulation. Ever wonder how small countries manage to regulate their aircraft without much overhead? It's because they accept the US FAA certifications. They effectively outsource the oversight to the US.
>I am suggesting that most likely employers and employees ain't idiots
If you review my comments, I'm don't think you'll find me using the word "idiot." What you will find is that I claim individuals act irrationally and also struggle to manage information when the complexity of society gets high.
>Sure, but that doesn't mean subsidising credentialism is the only way.
If you read carefully, I have not been an advocate for subsidizing education per se. What I am saying is we need to be careful of the blowback of simple solutions. If the intent is to increase education, subsizing it is one way, but it obviously has unintended consequences. Simply removing subsidies does not necessary fix the problem without creating second order problems of its own. I'm saying we need to be cognizant of that, and asked for solutions that effectively manage those consequences. Generally, those simple fixes like "remove subsidies" or "just give people money" belie a lack of nuanced understanding and risk creating more problems than they solve. Most of your perspective seems to be built on an overly simple model of human behavior that tends to break down on complex situations.
Also, instead of allowing a bankruptcy at any time, student loan down payment could be limited to max 25% of income after tax OR 10% of net worth, whichever is greater, with any balance after 30 years transferred to the college.
Objectives: 1) Reduce the incentive for colleges to offer education tracks that they KNOW (or should have known) will never lead to much beyond a minimum pay job. 2) Prevent unlucky or unsuccessful students to get stuck with an impossibly large loan that just keeps growing, absorbing all they earn or own. 3) Ensure that students still do feel some pain when this happens, but not so much that they lose all incentive to build themselves up. They still keep 75% of their income after tax AND they're guaranteed that the loan will end within 30 years. 4) Incentivize pricing of of the student loans in ways that reflect the risks involved. If students that study "lesbian dance theory" have to pay a 10% interest rate while Physics students pay only 5%, that's a pretty strong indication that the "credit score" for the former is pretty bad. 5) Also incentivize minimizing cost while maximize the useful learning for the college, to minimize the risk that they'll be stuck with too much of the debt.
If this leads to some (presumed worthy) students having fewer opportunities than they otherwise would have, it's still possible for the collages, government or others to provide stipends or other similar forms of support.
Step 1 is außergerichtliches Schuldenbereinigungsverfahren where the debtor attempts to reach an out-of-court settlement with creditors. This stage usually lasts up to 6 months.
Then there is Eröffnung des Insolvenzverfahrens where if the out-of-court settlement fails, the debtor files for insolvency with the local court. The court appoints a trustee to manage the debtor's assets and liaise with creditors. This stage typically takes 1-2 months.
Next there is either Regelinsolvenzverfahren or vereinfachtes Insolvenzverfahren. In the latter if the debtor's assets are insufficient to cover the costs of the proceedings, the court may initiate a simplified insolvency process. The debtor proposes an insolvency plan to the creditors, which includes a 6-year repayment period. If the plan is accepted, the court approves it, and the debtor begins making payments.
In the former, if the debtor's assets are sufficient to cover the costs, regular insolvency proceedings take place. The trustee liquidates the debtor's assets and distributes the proceeds among creditors. The debtor proposes an insolvency plan, which typically includes a 6-year repayment period.
After the insolvency plan is approved, the debtor enters a 6-year good conduct phase called Wohlverhaltensperiode. During this period, the debtor must adhere to the repayment plan, maintain gainful employment, and inform the trustee of any changes in their financial situation. The debtor is allowed to keep a portion of their income for living expenses.
If the debtor complies with the terms of the insolvency plan during the good conduct phase, the court grants a discharge of the remaining debts called Restschuldbefreiung. This typically occurs 6 years after the opening of insolvency proceedings.
This is really not that different from bankruptcies in America. I think Europeans are simply unaware of their options.
In the US Chapter 7 bankruptcy will remain on the individual's credit report for up to 10 years, making it difficult to obtain credit, secure housing, or find employment. Chapter 7 bankruptcy is a matter of public record, which can be accessed by anyone. The process is relatively quick, typically lasting 4-6 months. Most unsecured debts, such as credit card balances and medical bills, are discharged upon completion of the process.
Chapter 13 bankruptcy will remain on the individual's credit report for up to 7 years, which is less than Chapter 7. Like Chapter 7, Chapter 13 bankruptcy is a matter of public record. The repayment plan typically lasts for 3-5 years, during which the individual must make regular payments to creditors. After completing the repayment plan, the remaining eligible debts are discharged.
Verbraucherinsolvenzverfahren lasts longer (6 years) than both Chapter 7 (4-6 months) and Chapter 13 (3-5 years). Verbraucherinsolvenzverfahren and Chapter 13 involve a repayment plan, while Chapter 7 does not. Chapter 7 has a longer-lasting impact on credit ratings (10 years) compared to Verbraucherinsolvenzverfahren and Chapter 13 (6-7 years).
France has a procedure called "rétablissement personnel," which is similar to Chapter 7 in the US, allowing individuals to liquidate their assets and discharge their debts. In the UK, individuals can file for bankruptcy or enter into an Individual Voluntary Arrangement (IVA), which is similar to Chapter 13 in the US.
Bankrupcy is no fun. All your assets are wiped out (house, cars, etc). Sometimes you are excluded from the banking system. So it's not "without consequence".
Lending money is a risky business. That is why you get interest. Getting people off the hook is not ideal, but neither is the inverse. From a societal point of view, this arrangement allows people to take risks that they may not have otherwise. And we're all better off because of it.
Often cited, but wrong. When you dig in, it turns out to be one of those "wet streets cause rain" causal mix-ups:
So are you saying that 2/3 of personal bankruptcy cause medical debt?
This study deliberately does not - just for example - count it as a "medical bankruptcy" if you weren't hospitalized. So magically every person who was bankrupted by the cost of their must-take prescription medicine, they don't count because they need to be admitted to hospital to count for this study.
As it is, the 2/3 statistic is mainly used to score political points and indeed one of the authors of the original study that came up with the 60% number is Elizabeth Warren. Now, you could say she participated in her capacity as an academic, but I personally have a hard time believing she would have put her name on the paper if it had found, say, 4% of bankruptcies came from medical debt.
If people are arguing about whether the Earth is flat or spherical, you cant use the fact that both are "wrong" (as the Earth is closer to an ellipsoid) to say that "flat" is as correct as "spherical".
That coupled with private equity's involvement in all late / end of life care ensures no one dies with a penny to their name to pass down.
It still paints a picture of an out of control, over-financialized system that only gets more expensive the more money is put into it.
> people who were admitted to the hospital
Ah yes, because there's no other way to get large medical debt. Not like an ambulance and ER stay alone will be high.
> in California
Obviously representative of a wider area: the most expensive state in the country and #5 highest median income.
> adults 25 to 64 years of age
Yes, let's exclude those who tend to have the highest medical bills and lowest incomes.
> were admitted to the hospital (for a non–pregnancy-related stay)
Yes, let's exclude pregnancies, which can be extremely expensive (thank god medicaid covered ours).
> for the first time in at least 3 years.
Yes, let's exclude people who have the highest medical debt by virtue of having had multiple hospitalizations.
Medical bankruptcy isn’t really the problem. Medical insolvency might be, but the two alternatives are not to receive treatment at all, or for the State to pay for it. The former is obviously worse, and the latter is arguably worse when looked at in toto.
Long story short, a judge plus two gorillas can and will confiscate every single thing you own and then put you in jail.
Bankruptcy is not a "haha, you'll never get me!" card like it's in the USA. It's actually diametrically the opposite.
Germany in particular takes a moralistic approach to finances that IMO harms the economy quite a bit and constrains entrepreneurship to the well connected and already established. You are only supposed to start businesses that succeed.
In reality money is not a real thing, money is numbers in a computer database that we collectively signal and coordinate the economic activity and utilization of the resources that hold the real value. As such a certain amount of default well above zero is optimal to maximize the amount of real world value being generated.
Someone who had worked in banking once told me they adjust lending standards to maximize profit. I was shocked that this meant about a 6-7 percent default rate on the mortgage loans. If you are too stringent you won't lend any money and if you let it flow freely you'll fail under all the defaults, so yes there is an optimal amount of failure even for the lender.
https://www.bitsaboutmoney.com/archive/optimal-amount-of-fra...
It's more pragmatic, than moralistic. Germany aims for high quality in business and workers, the whole system is based around this. USA seems more aiming for quantity. Just throw money at it, and see what sticks. But the difference is, USA is very big and wealthy in resources and manpower, so it can afford this. Germany, like other European countries, is rather small and lives from connecting with others. So efficiency is very important.
Also, Germany has the 3rd largest economy in the world, so not as large as the US or China, but I wouldn't exactly call them "small" economically.
US GDP: $28.7T China GDP: $18.5T Germany: $4.5T
Also, Germany is relatively small when it comes to land area, has to import most of the raw materials, and heavily relies on subcontractors from China. They do not really play in the same league as US and China.
There's a dude on twitter who has been detailing his process of going through a bankruptcy over the last few months. I think he lost about $4M. He's discussed another business idea that he's had and his plans for implementing it. Now, a month after his bankruptcy has been final, it seems that that some investors are very interested in going forward with him on this new venture. It's likely that his openness about everything was what caught their attention.
This is how bankruptcy is supposed to work: fail at something and there's a path to recovery.
A new business generally requires a director's guarantee to get a loan, completely defeating the point of a limited company.
Between personally guaranteeing a loan and not having the funding available at all, I'd take the former.
Once the business has been trading for a while and shows it has a working model, it shouldn't have any problem financing without a personal guarantee.
Either way, limited liability remains crucial. You're still in control of how much personal risk you're accepting, putting a backstop on any loss.
In Silicon Valley for instance, many founders of successful businesses had multiple failures founding other startups first, it seemingly is part of the Silicon Valley ethos, almost looked at with a badge of honor.
Attitudes to risk taking are similar, e.g. your fear of high wire walking depends hugely on whether you have a safety line or not. Wealthy kids might pride them themselves on taking chances where the reality is that in their whole existence they have never been exposed to the possibility of paying the price for failure.
Generally a much better deal for first time founders.
This offloads some risk from the owners of the company to its business partners, it ended up enabling a real revolution in business formation and ownership. In a lot of ways it has had a democratising effect, as many more folks can afford to invest in a company than just those who are wealthy enough to bear the risk of unlimited liability.
> Nobody's going to loan money to an LLC with no assets without a personal surety.
I think that’s the system working. Customers, vendors and other business partners are also free to adjust their expectations accordingly.
I am unable to rightly comprehend the confusion of ideas that would provoke such a question.
Recovering from a 10k€ loss will take some time in a country with extremely high taxes.
It was mind-boggling..
As stated, we are talking about established, multi-generational businesses with high-end equipment already in use, that would more than cover the necessary collateral by orders of magnitude.
There's still plenty to complain about regarding bureaucracy and red tape but don't let this alone deter you from running a business (especially not a software startup).
No. But it's complicated ... For example, income tax is charged on the employee, after the employer has been charged employer/social fees of 30-40%. And then, sale of most goods are charged ~20% VAT.
The total taxation pressure "per hour worked" is far above 40%.
But most people do not count employer contributions, because they are not part of the negotiated salary, and most people don't even know what they are. Yes, they of course affect how high salaries businesses will offer.
In terms of income tax and employee contributions, in the OECD scenarios Germany maxes out at 41.2% (the OECD average is 30%; the US is at 29.1%). As a comparison, Belgium is "always" worst in class on this in Europe, w/47.8%.
Overall Germany is still one of the highest tax countries in Europe, but it also has a higher difference than most countries the highest taxed (high income single earners) and families with children in total effective tax rate - for the later, Germany is much closer to the pack, to the point of being near or below the OECD average for a couple of categories.
VAT in most countries add very little, because most of your gross income does not go towards VAT rates products - for starters you're first paying tax, and then covering housing and most places exclude a number of others things from VAT as well. Depending on country and income level and spending patterns, it does add a few percentage points, but it's rarely significantly skewing the overall taxation level all that much (last time I did the numbers, at a far above average income, VAT increased my total taxation by about 4%)
So instead you ruin other people's lives?
Eg they also provide 'checking' accounts. There's no conceptual reason why that function needs to be bundled with the 'aggregating default risk' function; but it happens to be so in many countries.
To illustrate, on the one hand, think of an institution that takes deposits and lets you transfer money to pay your rent etc, but doesn't make any 'real' investments: all they do is park the deposits in government loans.
On the other hand, think of exchange traded funds that invest in a wide array of bonds (or even equities). They diversify defaulting risk across the economy, without taking deposits, like your typical bank does.
(And if banks could create loans from 'nothing', so could any other company that can issues bonds.)
There have been episodes in history with very lightly regulated banks, and they were very stable banking systems by and large. See the 'free banking episodes' in eg Canada, Scotland, Australia and China. There was no 'creating loans from nothing' that needed to be regulated away.
DR Loan, CR Deposit.
Job done.
No need to issue bonds or do anything. It's just splitting the zero in accounting.
Any operation can do that. Generally there is legislation that then brings these 'deposit holders' under specific requirements.
> Job done.
You can do that, sure. And if that was all there was to banking, it would be a fantastic business to be in.
Alas, the whole point of taking out a loan is to spend the money on something, eg to invest it.
And once the bank's customer withdraws the deposit half of that newly created pair of anti-particles, the situation isn't nearly as symmetrical and neat anymore: the bank better have some money in the vault to be able to satisfy that withdrawal request.
(Slightly less antiquated: the customer will likely spend their borrowed money electronically, but then just means that you need to have the funds available to settle with the bank who runs the account on the receiving end of that transaction.)
> Generally there is legislation that then brings these 'deposit holders' under specific requirements.
Even without legislation or specific requirements, you can't just keep creating these loan/deposit pairs out of thin air. At least not, if your customers are supposed to be able to spend their borrowed funds.
Withdrawing is always just transferring to another bank - even if that bank is the central bank.
Banks settle with each other by the target bank taking over the deposit in the source bank. That is how correspondent banking has worked for at least four hundred years.
Everything else is a collateral optimisation.
There is never any "money" in a vault. There might be some receipts for money, but that's about it.
No. You can withdraw cash. But you are right, that the common case is a transfer.
> Banks settle with each other by the target bank taking over the deposit in the source bank.
That's one way they can settle. But at the end of the day (or whatever the relevant period is), they send each other the net difference in the underlying base money. These days, that's deposits at the central bank.
> That is how correspondent banking has worked for at least four hundred years.
Correspondent banking being important is mostly an American thing (and perhaps a 18th and 19th century English, but not Scottish, thing, too.)
> There is never any "money" in a vault. There might be some receipts for money, but that's about it.
These days, the 'vault' is (mostly) an account at the central bank.
If a company takes out a loan from the bank, the bank isn’t putting up existing money, it just creates a new asset and starts accounting for it. Hence new money is created from nothing.
What stops the bank from creating too many loans is that the bank would become insolvent and all the workers have to carry their stuff out in cardboard boxes (except the execs they probably have someone to do that for them).
> If a company takes out a loan from the bank, the bank isn’t putting up existing money, it just creates a new asset and starts accounting for it. Hence new money is created from nothing.
Sorry, your analogy doesn't work out, because the roles are reversed.
Look at the situation where a company sells me a bond, to be paid back in ten years. But instead of me handing money over to them, I give them an IOU (or credit line) that they can draw down any time they wish to.
We can create this pair of bond and IOU out of nothing, just like the bank can create deposit-loan pairs out of nothing.
However, just like with the bank, people don't borrow money to let it just sit there. They want to invest.
So they spend their deposit, and draw down their IOU.
And once your customer does that, you better have some money in your 'safe' that you can hand to them.
In the classic case, that money comes from outside deposits.
> What stops the bank from creating too many loans is that the bank would become insolvent and all the workers have to carry their stuff out in cardboard boxes (except the execs they probably have someone to do that for them).
How would they go insolvent in your model?
That somewhere is the bank’s depositors.
The only relationship with deposits (which are actually liabilities) and assets is that enforced by regulators.
This is how money creation works in the modern economy - so the money supply can grow as economic activity increases, all guided by central banks / governments with levers such as interest rates, open market activities (QE), and regulations.
Again - banks really do create money from nothing, all day, every day.
The only institution that can "create" money from thin air is the government. And even that is a polite fiction when you realize that "printing more money" also inherently devalues the money already in the system.
Whether that's currently legal or not is another matter that I cannot comment on.
At which point you will realise there can be no devaluation since money is destroyed as it moves around, and money in drawers may as well not be there.
I see money as units of resource allocation. There are only so many available resources at any given moment. More units of allocation means less resources allocated per unit.
I'm also not an economist. :)
There isn't and never has been a one-to-one relationship between money and stuff. At best it is inductive.
Just as with electrical engineering, the real world requires a reactive supply, which is what allows electrical innovation beyond direct resistive loads.
Electrical supply engineers hate reactive power, but without it we don't get iPhones.
The power triangle gives the best engineering analogy to the way the monetary system works.
But it is both novel and correct. As in it has both novel and correct parts.
If it was true no banks would ever fail, qed.
Ultimately being fundamentally wrong in how the financial system works is extremely unlikely to impact anyone's daily life.
If it is VC or SF Tech related, I usually learn something. Anything around Banking, Finance, Trading, Crypto etc... not so much.
You still need assets in fractional reserve banking. Those assets just don't need to be reserves.
Ie 90% of your assets could be diamonds in the vault, and 10% could be reserve cash in the vault. That would be fractional reserve banking, but you still have 100% assets. (In practice, you have more than 100% assets. The excess is your equity cushion.)
If your liabilities outstrip your assets, that's when you are bankrupt. Fractional reserve banking doesn't help you there.
I have two customers A & B. A has $1000 on deposit. B has $500 on deposit. I have $1500 in my safe. Assets = $1500, Liabilities = $1500.
B borrows $500, which for simplicity's sake he deposits in his account.
Now A has $1000 on deposit, B has $1000 on deposit. I have $1500 cash in my safe and a note from B for $500. Assets = $2000, Liabilities = $2000.
I just created $500. It's really that simple.
> B borrows $500, which for simplicity's sake he deposits in his account.
If you stop there, your analysis is indeed correct. However, people don't typically take out loans to stuff the borrowed money into their accounts until the loan comes due.
They go out and buy stuff with the proceeds. So B withdraws the money.
So now you have:
- Assets: 1000$ cash in your safe plus an IOU of 500$ from B = 1500$.
- Liabilities: 1000$ deposit from A + 500$ deposit from B = 1500$.
So far so good.
You can repeat that game two more times, and then you run out of cash to withdraw.
So if you repeated it a third time, you'd need to sell the loan from B to a third party for cash, so you can fulfill B's withdrawal request.
If B is credit worthy, you will generally be able to make that sale. (But it takes time and hassle to organise.) Ie you have short term liquidity trouble, but you ain't insolvent.
If B is a deadbeat, you won't be able to sell that loan for enough to cover the withdrawal request, and now you are insolvent, and go into bankruptcy.
That’s why central banks typically make the rules about reserves, etc.
Yes. But that means you got newly created base money from the central bank. Which sort of goes against the original claim.
However banks don't create money out of thin air. However they can create it out of assets.
As a silly thought experiment: if your bank has a vault full of valuable assets, like diamonds and deeds to houses in prime real estate, stocks etc, they can in principle create loan/deposit pairs (ie make loans and credit the borrowed funds to the borrower account).
When people make withdrawals, especially when they make more withdrawals than the bank has reserves, they just sell some of their assets to cover the difference. That's all pretty normal and boring.
Customers think of their deposits of 100% like money and economically behave as if that was true, but in practice they are backed by 10% money, ie reserves, and 90% other assets.
(The percentages are for illustration only.
Also we ignore minimum reserve requirements and other laws here. Many countries don't have minimum reserve requirements anyway.)
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
Btw, you might want to study the section 'Managing the risks associated with making loans'.
The pdf is pretty vague about the limits of creating these loan/deposit pairs in general. But there's eg this:
> One way in which they do this is by making sure that they attract relatively stable deposits to match their new loans, that is, deposits that are unlikely or unable to be withdrawn in large amounts. This can act as an additional limit to how much banks can lend. For example, if all of the deposits that a bank held were in the form of instant access accounts, such as current accounts, then the bank might run the risk of lots of these deposits being withdrawn in a short period of time.
In general, the limit to loan/deposit pair creation is withdrawals and transfers of the new deposits.
---
Btw, I agree that fractional reserve banking can create money. (Just not base money, and not without limits.)
The only entity that creates money is the central bank. They may even accept mortgages from banks as collateral (including repurchase agreements) to inject new money into the system.
Regulations are supposed to prevent bankruptcy and liquidity issues, but even without any regulations regarding asset ratios, banks can go bankrupt or illiquid.
(And, for the record, this is also what I’ve been meaning by “currency”)
Incidentally, the only claim you as a lowly individual ever have on central bank money in most (all?) current currency areas is as physical currency, and even then for the most part you only ever get to exchange it for commercial bank money. For the purposes of this discussion, all digital money between most normal entities is commercial bank money. Commercial bank money _is_ money.
And I rarely exchange physical currency for digital money these days— Usually I’m exchanging it for food instead.
I just wave my phone at a terminal.
It's important that you _can_ get physical currency on demand. It's not nearly as important whether you personally actually make that demand.
It (probably) is, but if all of your bank's account holders asked for that at the same time it would be what's known as a "run on the bank" and you'd very quickly find out that they don't have anywhere near enough physical currency to cover even a fraction of their account holders.
This is true, and most of the rest of what you are saying is also true.
> The only entity that creates money is the central bank.
This is not true. Banks really can take arbitrary assets and turn them into money. Just not base money!
No. The other banks demand settlement in outside currency. In the olden days, they shipped gold around every so often. Nowadays, in the end you settle in central bank deposits.
Thankyou to hgomersail for providing the definitive answer, from the BoE no less!
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
You go to a bank with an asset. In this case the new house. The bank then creates a new financial asset called a 'mortgage' that goes on the asset side of their balance sheet. Against that they create a liability called an 'advance' that they give to you.
You then give the advance to the builder in return for the house, where it becomes a deposit of the builder than they can then transfer to anybody else in payment for goods and services.
If any of them happen to be at another bank then all that happens is the deposit is transferred to the bank and it becomes an 'inter bank loan'. The target bank then simply creates another deposit in its books to balance that loan and that is allocated to the customer being paid.
It's all just debits and credits. What limits bank money creation is the assets they are prepared to discount and the creditworthiness of the individuals they choose to advance to and whether the bank believes they can pay the current price of money.
Modulo some amount of transaction batching, when one bank’s customer initiates a payment to an account at another bank, reserves are actually transferred between the two banks (these days, in the form of central bank account transfers).
Each bank’s main concern is managing its daily cashflow— They need to have sufficient reserves each day to cover that day’s net outflow of payments. But holding reserves is expensive; they would much rather use that currency as an advance payment for a new loan if they can, so that somebody else is stuck with the currency.
And here’s where the inter-bank loans come into play: Because most of a bank’s outflows happen on an irregular schedule as directed by their depositors, and they have an incentive to hold as few reserves as possible, they may find themselves in a position where they would need to suspend payments. When this happens, they borrow reserves from another bank in order to continue operating. If the borrowing bank is considered trustworthy by the banking community, they generally have no trouble securing such a loan on standard terms.
Of course, if a bank systematically misjudges the default risk of their borrowers, they may have a bigger problem that their assets (future loan repayments) won’t cover their liabilities (future withdrawals by depositors). If that imbalance isn’t corrected quickly, they will eventually find themselves unable to secure future inter-bank loans because they will have become an unacceptable default risk to the other banks.
Not in the slightest.
If the bank doesn't take over the deposit in the source bank, then their customer doesn't get paid. At which point they will close their account and move to the source bank. That's a deposit outflow they won't want to have.
Both the source and the destination bank have an interest in ensuring the payment clear. Therefore it does.
Inter bank loan negotiation is about shuffling the risk around for a price afterwards.
"reserves are actually transferred between the two bank"
Reserves don't exist in aggregate. Central banking is a collateral optimisation of correspondent banking.
There was no such thing as reserves in the UK banking system for three hundred years, for example.
Correspondent banking is the base for payments, and is still used for most international currency payments - even with the advent of the CLS central clearing mechanism.
The destination bank can demand to withdraw that balance. And they typically do that with the net flows at the end of the settlement period.
(And they don't withdraw physical currency these days. The 'withdrawal' comes in the form of a transfer of electronic central bank reserves.)
> Reserves don't exist in aggregate. Central banking is a collateral optimisation of correspondent banking.
No? This is easiest to see in a gold standard system: your physical gold are your reserves.
In typical modern fiat system, the reserves are account entries at the central bank (and vault cash, but that's a small-ish amount).
Private commercial banks can create 'money' via their normal commercial operations. But they can't create central bank reserves that way, nor are they allowed to print central bank notes.
> There was no such thing as reserves in the UK banking system for three hundred years, for example.
Citation needed. And also an explanation of exactly what you mean by reserves.
(Btw, talking about the 'UK banking system' over the last three hundred years already makes me very suspicious of your argument. During most of that time, Scottish banking differs remarkably from English banking. So there are not many blanket statement about the 'UK banking system' that are true.)
The very purpose of even smaller banks is to spread risk across multiple loans and investments in such a way that a client's bankruptcy doesn't ruin them at all. Given the interest rates they charge on certain financial services, they seem to have no problem not going under themselves in most cases.