Quite stunning really

What they say is:

Loans are made without any need for there to be deposits in a bank;
Loans are quite emphatically not the recycling of depositors’ money: all loans are made from newly created money;
All savings are therefore created by lending, representing the unspent and so deposited part of funds created out of monies borrowed;
There is, then, no such thing as fractional reserve banking and those thinking so; those economics text books that say there is; and those who based their economic thinking on this idea, are all wrong.
There are some things I should add I do not agree with in the video: the description of how QE works is just wishful thinking and not what has actually happened. It is also not true that QE has a cost: the interest paid on reserves is in real terms negative at present.

And there are things the video does not say. In particular it does not make clear that because of the argument made, savings do not serve a useful economic function as a source of funding for investment in the modern economy when that role has been supplanted by credit. Nor does it say that as a result the entire saving sector can in that case to some degree be seen as rent seeking and the whole edifice of the financial services industry that is built upon it a largely pointless activity that does not add value. But I won’t develop that argument further here: my point at present is to reiterate that savings are not required to permit banks to make loans. This is a myth now known to be wholly untrue. Those who say otherwise are from the economic dark ages.

We don’t have fractional reserve banking?

Then how can a bank suffer a run?

He’s just spiralling ever further up his own colon, isn’t he?

100 comments on “Quite stunning really

  1. He’s coming up with a new grand unified theory of money.

    In one parallel universe he wins the Nobel for his discovery, which proves him right.

    In the other parallel universe, the entire economics establishment shouts him down/ignores him for being completely wrong, leaving him alone with a handful of other crackpots. Which proves him right.

  2. …savings do not serve a useful economic function as a source of funding for investment in the modern economy when that role has been supplanted by credit. Nor does it say that as a result the entire saving sector can in that case to some degree be seen as rent seeking and the whole edifice of the financial services industry that is built upon it a largely pointless activity that does not add value.

    The fact that Murphy misuses the term “rent seeking” is as maddening as his misuse of the term “tax avoidance”.

    According to Murphy: (1) All savings are created by lending, and (2) Saving is rent seeking. So I am I correct in thinking Murphy views both lending and borrowing as rent seeking?

    And if he thinks credit has supplanted savings in the world of business investing, he obviously hasn’t tried to borrow money from a bank to start a small business.

    Completely and totally batshit crazy.

  3. There is a spectrum from delusional to demented on which Murphy crouches like a malevolent tarantula.

    If Carlsberg did bonkers…

  4. “Loans are made without any need for there to be deposits in a bank”

    Just savour that.

    All you have to do is declare yourself a “bank” and you can make loans of real money out of thin air!

    It’s financial breatharianism. Normal breatharianism contends that you can obtain all the nourishment your body requires from thin air. Ritchie’s just cleverly applied this same principle to money.

  5. There is a spectrum from delusional to demented on which Murphy crouches like a malevolent tarantula.

    Is there such a thing as a non-malevolent tarantula? The ones I’ve met have all seemed to come across as malevolent.

  6. @DTP. If savings and borrowing are rent seeking then we must give money away stopping the rentier class exploiting everyone else. QED In Ritchie land at least.

  7. I did once ask him on Twitter exactly why Northern Rock went belly-up if his thesis is true. “Confidence” was his reply. “But whose confidense and why does it matter?”I asked. I never got an answer.

  8. As a rule, the man’s a fool
    When it’s hot, he says it’s cool
    When it’s cool he says it’s hot
    Always saying what is not.

  9. Later: “Jumping off tall buildings doesn’t kill you and anyone who claims otherwise is a neoliberal troll”

  10. @ aaa
    One of my actuarial friends used to point out that it wasn’t jumping from 40,000 feet without a parachute that killed you – it was landing.
    Murphy’s monetary theory has a soft rubber mat of infinite depth upon which to land, spread out so as to cover the entire surface of the earth.
    .

  11. The last time I checked, Apple had north of $100 million in unrepatriated profits. Unless Apple has one really big mattress, that $100+ million is sitting in banks. As deposits. And while the likes of Murphy think of these monies only in terms of unrepatriated profits, another, just as accurate, characterization would be as savings.

    My question is this: According to Murphy, savings are simply borrowed monies unused and on deposit. Does that mean that Apple’s $100+ million is more accurately characterized as excess borrowings, as opposed the unrepatriated (and taxable) profits? If not, why?

  12. Bloke in Germany. Maybe there is a third category

    “Knows he is wrong but enjoys winding up thousands of people with some actual knowledge of economics”

    ….Nah.

    “Loans are made without any need for there to be deposits in a bank”

    This is true in a sense, as when you get a loan the deposit that backs it is created by the bank. The deposit did not have to ‘be there’ before it was loaned.

    You absolutely could start your own bank with not much money set aside to loan out as long as you could sort out pesky things such as having enough capital to meet regulatory requirements.

  13. p.s.
    clearly if you then tried to withdraw the deposit the bank would be in trouble if they couldn’t access liquidity on the market…..

  14. @LPT. this is true up to the point where the borrower wants to take their money and do something with it. Then suddenly you have the loan and no deposits, so you have to rustle some up. In reality people spend loans quickly otherwise they are paying interest for nothing so the whole “loans make deposits” argument lasts about 5 minutes until the money is withdrawn the and the bank fails.

    It’s just plain daft when you think about it for more than 10 seconds.

  15. It looks like Jerome has re-emerged as AJ Brown and has Murf firmly on the ropes.

    I sense a rare and temporary moment of self awareness – the Murf now knows he’s not going to make the count…

  16. I can assure you, knowing Jerome personally, that he isn’t AJ Brown. Seems someone else has taken up the baton.

  17. Tyler

    My mistake – it looked consistent, and I didn’t “check” properly.

    Well played, sir…

  18. So a bank doesn’t need any deposit’s. It can just lend us what it wants. And we can take that loan, newly created by the bank, and pay it over taxes. Which is just us giving the government back the money it created, doing it with loans created out of thin air by the bank.

    All makes perfect sense doesn’t it.

  19. Isn’t more accurate to say that in order to make loans a bank needs meet regulatory capital requirements, and needs to be able to settle its payments in central bank money?

    The latter being made easier by defered net settlement systems.

  20. The spudotollah reminds me of someone i unfortunately know. He’s known by the moniker “mad martin” and people go out of their way to avoid him. His speciality is mishearing or misunderstanding something on thee radio or in the news and convincing himself and everyone else he meets that he has understand the something correctly and everyone else is wrong. Long and frustrating arguments are usually the end result if you don’t have the sense to not engage with him. The same with the spud – he half understands something and then builds up a grand theory based on his misunderstanding. He’s obviously hoping for a repeat of corbynomics and the chance to appear in the press or on tv. I bet he’s got a scrap book of articles from newspapers about himself.

  21. “@LPT. this is true up to the point where the borrower wants to take their money and do something with it. Then suddenly you have the loan and no deposits, so you have to rustle some up.”

    If you borrow money from the bank, you have to sign a loan agreement – a contract to repay over a set time – which itself has value. This is the asset the bank uses to back the currency it issues 100%. People keep on forgetting or ignoring the loan agreements!

    If you take out a £100 loan, you have to give the bank a signed piece of paper contractually obliging you to repay, which is itself worth £100. If the bank needs more cash to repay depositors, it can sell that piece of paper to another bank for cash. Or anyone else who has cash they don’t need right now, but are willing to have to wait to access to.

    There are two separate issues – money and liquidity. Money is a legally enforceable promise to deliver value at a later date. Liquidity is about how soon that date is required to be. Anyone can create money by signing a contract promising to pay. But to turn that from value to be delivered over a 25 year period to value right now means creating liquidity.

    The borrower (not the loaner) creates the money. The bank exchanges it for a more liquid form of money, but in doing so neither creates nor destroys any.

    Borrowers create money, and are limited by their credible ability to repay. Banks create liquidity, and are limited by their reserves of highly liquid funds (i.e. deposits). Don’t confuse the two.

  22. And there was me thinking I was being a good citizen by saving my excess money, beyond leading quit a good lifestyle, to ensure that I could pay for a reasonable lifetstyle in retirement. To my horror I now find out that I was being an evil rent seeker and should have been spending all my money on something and then in my old age I’d have err…..

    Worked till I dropped like Boxer?

    Tried to live on the State pension?

  23. Spud does not like ISAs:

    http://www.taxresearch.org.uk/Blog/2017/05/31/its-time-to-scrap-isas-and-other-tax-related-savings-schemes/

    Of course there are things calls Shares ISAs, which are a ISA wrapper around which one can invest in businesses and the like. However, it would appear that while Spud likes people investing, he wants to control what people invest in.

    After all, you cannot have people doing research and actually investing in ventures that will make money. That would just be wrong.

  24. @ Bind -Rent seeker is his new buzz word. he doesn’t understand what it means – didn’t he say holding cash was rent seeking? Next step is when he starts booting people off his site – instead of calling them trolls he’ll be calling them rent seekers. the mans a poltroon.

  25. He makes mistakes which confirm that he is not bright.

    He cannot grasp that people talking in trade shorthand are talking in shorthand and that does not mean what he thinks it means. Hence he cannot grasp that he has something wrong.

    He really is profoundly dim.

  26. Back now. It’s going swimmingly – I have lent £200 million with no deposits and tomorrow the doctor is going to let me run the Treasury.

  27. “Loans are made without any need for there to be deposits in a bank”

    Basically, what Andrew (again) says. The bank may make a book entry to create a loan and a deposit in its accounts, but at at that point in time the borrower doesn’t actually have any funds apart from those on deposit at the bank and the banks loan is fully cash collaterlaised and hence (depending on the precise terms of any aoffset agreement between the bank and the lender and local banking and insolvency laws, the bank has no risk on the “borrower” and may not have to apply any capital against the loan. The loan really starts when the borrower spends the money (i.e. transfers the money out of the account and the bank has to raise deposits or other funding to cover the cash outflow). Murphy is a dolt not to accept this and the idiots at the BofE in his video aren’t much better. Murphy suffers from the accountant’s syndrome whereby he thinks that the facts follow the accounting rather than accepting that the accounting simply tries to reflect the facts

  28. Holding cash is rent seeking? Surely only in a world where you are a slave so… The fact you have cash means you have another source of income. Holding cash is not enough to recompense anyone unless it is in Murphyesque quantities. If you are a slave, you have no capacity to earn cash so if you do earn cash you will buy your freedom. So you have stopped being property thus you are getting transfer earnings and can become independent labour. For no other factor of production is holding cash beneficial

  29. Alex

    “that the facts follow the accounting rather than accepting that the accounting simply tries to reflect the facts”

    In a nutshell. Thank you.

  30. Murphy is right that we (the UK) do not have fractional reserve banking – in fact there is no reserve required by regulation.

    “all [bank] loans are made from newly created money” is true. When a bank makes a loan it increases the broad money supply.

    I’m not saying that Murphy has a sound grasp of how banking actually works. But it would be a mistake to suppose that he’s wrong about everything.

  31. Cannot say Murphy has a grasp of anything. Except how to get noticed.
    The British Kardashian, Richard Murphy!

  32. NiVea: If you borrow money from the bank, you have to sign a loan agreement

    No, an overdraft facility has no such requirement.

    – a contract to repay over a set time –

    No, an overdraft facility is generally evergreen until the bank chooses to revoke it.

    which itself has value. This is the asset the bank uses to back the currency it issues 100%.

    No, in England and Wales commercial Banks are not issuing banks, elsewhere in the UK the Bank of England controls the issuing of specie by commercial banks.

    If you take out a £100 loan, you have to give the bank a signed piece of paper contractually obliging you to repay, which is itself worth £100.

    No, if you negotiate a loan from a bank for £100, yes, you will have to sign an application and, yes, the bank will approve it before making the advance. Nothing supports the contention that the bank’s asset is worth £100 since they may have been negligent in assessing your ability to repay or the value of your collateral. Your “piece of paper” is worth nothing. If your loan is supported by negotiable bills of exchange or a series of a forfait bills or some other commercial paper, then possibly but only if permitted by an offset agreement which you will have also agreed to.

    If the bank needs more cash to repay depositors, it can sell that piece of paper to another bank for cash. Or anyone else who has cash they don’t need right now, but are willing to have to wait to access to.

    OK, let’s assume your bank has the right to sell on your obligation to a third party. In the case of a default on your part they will probably have to dispose of your loan at a discount. The nominal £100 asset at your bank will have lost value either through your behaviour or your bank’s poor evaluation of risk.

    There are two separate issues – money and liquidity. Money is a legally enforceable promise to deliver value at a later date. Liquidity is about how soon that date is required to be.

    Eh?

    Anyone can create money by signing a contract promising to pay.

    Eh?

    But to turn that from value to be delivered over a 25 year period to value right now means creating liquidity.

    Eh??

    The borrower (not the loaner) creates the money. The bank exchanges it for a more liquid form of money, but in doing so neither creates nor destroys any.

    Borrowers create money, and are limited by their credible ability to repay. Banks create liquidity, and are limited by their reserves of highly liquid funds (i.e. deposits). Don’t confuse the two.

    You’ve no idea what you’re on about but you pretend that you do.

    It’s time to seek help or a a job at City “University” beacuse, like Murphy, you have no understanding of a reasonably complex business which evolved over centuries but feel able to extemporise on the basis of your own limited intellect.

  33. SJW: But it would be a mistake to suppose that he’s wrong about everything.

    He works in London, he lives in Ely and he goes to a pub near Waterloo Station?

    If he’s not wrong about everything then at least he needs to reinstall grindr on his smart phone.

  34. @ Social Justice Warrior

    We do have fractional reserve banking in the UK. Between basel 3, and CA ratios, most banks have somewhere between 10-14% Tier 1 capital.

    So whilst there is no UK specific legislation, we do follow the rest of the world and abide by Basel 3.

  35. A fractional reserve is a fraction of deposits not lent out.

    The tier 1 capital ratio is (simplifying) the ratio of equity capital to loans.

  36. Fractional reserve simply means a percentage of capital (equity, deposits etc) not lent out. It’s a limit on the money multiplier of credit creation.

    This is exactly what Basel 3 achieves, and B3 was explicitly designed to do this.

  37. Mr Murphy has evidently managed to encourage some gullible conformist minds to take the BoE seriously when it says “the majority of money in the modern economy is created by the commercial banks making loans”.
    Next question: if the banks are creating the money, why is the government paying interest on money from the banks ( deceptively called loans)?

  38. DBCR: when a bank makes a loan, it creates offsetting deposit and loan accounts. Since the various measures of broad money include deposit accounts, that increases the broad money supply. What you call gullible conformism is just trivially true.

    What that doesn’t imply is that loans should be interest free. When the borrower takes his loan money out of the bank (in cash, or by transferring it to an account with another bank) the lending bank has to come up with the funds.

    Tyler, DtP: The tier 1 capital ratio is a measure of what losses a bank can withstand on its assets. It’s a solvency measure. Fractional reserve is a measure of what withdrawals a bank can withstand by its depositors. It’s a liquidity measure. They are different things. If I take a pile of cash from under my mattress and put it in the bank, the bank’s fractional reserve increases; it’s tier 1 capital is unaffected.

  39. A fractional reserve is a fraction of deposits not lent out.

    DtP: The tier 1 capital ratio is a measure of what losses a bank can withstand on its assets. It’s a solvency measure. Fractional reserve is a measure of what withdrawals a bank can withstand by its depositors.

    You know, after my last post above the first thought was ‘will he be stupid enough to say that a fractional reserve is the fraction of deposits not lent out’. Question answered.

    And Tier 1 is most certainly NOT a measure of what losses a bank can withstand on its assets. Nor is it a measure of what withdrawals a bank can withstand by its depositors. Nor is it a “solvency measure”.

    You seem to think you’re walking a fine line between being deliberately obtuse and completely dishonest. I’m here to tell you that’s not the line you’re walking. What you’re walking is between being completely dishonest and just plain stupid.

  40. @ SJW

    Tier 1 capital has very little to do with what losses can withstand. It is simply the core capital of the bank, including prefs, common stock, retained earnings and term deposits. It has no risk measure built into it. It’s simply a sum of it’s parts.

    Tier 1 capital ratio is the fractional reserve part of the system. It compares the banks T1 capital to it’s risk weighted assets. Under basel 3 that ratio can’t fall below 6% without penalties.

    Fractional reserve banking is most definitely not a measure of what withdrawals a bank can withstand. Suggest you read the fairly comprehensive wikipedia entry on it.

  41. Simplistically, FR banking is simply a way of describing the credit creation process of commercial banks (operating within a fiat monetary system) where their ability to extend credit is limited by a “reserve”. That reserve might be capital or legislation based, but the end is the same – banks can only extend a certain amount of credit without extending their deposit base or increasing their core capital.

  42. “Tier 1 capital…including…term deposits”

    Just no. Go away and find out what Tier 1 capital actually is.

  43. Tyler –

    There is no real use in engaging him. SWJ’s modus operandi is to strike a thoughtful pose, pretend he can’t really agree with whatever Murphy’s stupidity du jour happens to be, and then goes on to attempt to defend said stupidity du jour.

    He’s not as aggressively stupid as Arnald was, but he’s stupid none the less.

  44. Go away and find out what Tier 1 capital actually is.

    I love that.

    Especially when he give us this: The tier 1 capital ratio is (simplifying) the ratio of equity capital to loans.

    Evidently “loans” and “risk weighted assets” mean the same thing… in his world.

  45. @ Dennis

    Yes, I am getting that feeling. I know jerome through my work in finance, first in banking and now as a consultant. I specialise in Asset/Liability type stuff (LDI,ALCO etc).

    @ SJW

    T1 capital consists of common equity, pref stock, retained earnings and disclosed reserves.

    This is supplemented in the reserve requirements by liquid assets, such as cash (in the form of deposits), liquid short and long term debt T-bills, govt bonds etc).

    Under Basel 3 have to abide by the basic capital ratio, leverage ratio and additionally (under B3) the liquidity coverage ratio and net stable funding ratio.

    Whilst I suppose in theory you could have a bank with no deposits and get through the CA and LR, there is simply no way on earth to get through the LCR and NSF ratio tests without a deposit base.

  46. It didn’t take long to look that up, did it? Now reconsider what you wrote earlier when you wrongly thought term deposits were part of Tier 1 capital.

    (It’s faintly amusing being lectured like this by the junior staff.)

  47. “I know jerome through my work in finance”

    Ah – I was confused! I thought “knowing Jerome personally” was a euphemism..

  48. Let me guess…

    As a staff auditor the first time you went out to audit a bank your in-charge accountant sent you off to count the cash in the bank’s retained earnings drawer.

    And you went.

    Right?

  49. (It’s faintly amusing being lectured like this by the junior staff.)

    It’s more than faintly amusing that the junior staff understands the difference between a loan and a risk weighted asset and you don’t.

  50. One advantage of knowing what I’m talking about is that I can use an appropriate one-word simplification rather than having to copy and paste pages of risk weightings.

  51. It works better when your one word simplification is factually correct. Which yours isn’t.

    Loans and RWAs aren’t the same thing… It they were, Basil woulda called ’em loans and not RWAs. See how it works now?

    Once again, you get cornered because of your inadequacies. And rather than learning something, your airily wave off the facts in all your affected glory. Then again, when goal in life is to pimp for Richard Murphy, what else is there?

  52. “Risk-weighted assets” is meaningless unless one lists all the risk weightings – it’s what you’d write if all you knew was what you’d read in an accountancy textbook. “Loans” is an entirely appropriate simplification, given that I said it was a simplification.

    I don’t much mind your covering up your feelings of inferiority with insults. But kindly leave Murphy out of it – I’m not a fan.

  53. “Risk-weighted assets” is meaningless unless one lists all the risk weightings – it’s what you’d write if all you knew was what you’d read in an accountancy textbook. “Loans” is an entirely appropriate simplification, given that I said it was a simplification.

    If you’re not a fan of Murphy, you should be. You’re standing shoulder to shoulder with him.

    Just as savings are not borrowings, loans are not RWAs… Simplified or otherwise. Oh, by the way, the RWAs figure (and not the loan balance figure) is what matters to every bank regulator on the planet. That’s because that’s the number you use to calculate your Tier 1 capital ratio. Loan balances don’t figure into the capital ratio, as you’d know if you knew what you were talking about.

    And as to feelings of inferiority, first I’d have to feel inferior. With you, that isn’t gonna happen.

  54. Banks are typically in the business of making loans. Those loans are bank assets. In many cases the risk weighting for a loan is 100%, so loans translate directly to risk-weighted assets.

    I suppose you have a working understanding of how the numbers are calculated. But the big picture escapes you.

  55. @ SJW

    Capital doesn’t distinguish between liquid and illiquid assets. (Most) liquid assets are part of T1 in the retained earnings line. Banks don’t just sit on piles of cash.

    When you are looking at LCR and NSF you have to separate things out further.

    Risk weighted assets definitely isn’t shorthand for loans either. Given the bulk of bank RWAs are derivatives. Not loans.

    But of course, you should know that right? maybe I should invite you along with me to work one day so you can see what actually happens, not what you think/hope happens.

  56. ugh, that should have read:

    Until B3 the total capital ratio was looked at. Which is why you get some slightly odd situations for definitions as Capital….

    Really shouldn’t pull so many all-nighters.

  57. Tyler, the asset mix depends what sort of bank you’re talking about. And I’ve forgotten more about derivatives than you’ll ever know.

    Thanks for the invitation, if it was one. But no thanks, I need to be paid to do that stuff.

  58. “No, an overdraft facility has no such requirement.”

    Yes it does. You sign the T&Cs for the current account when you open it. What, you think you can take out an overdraft and there’s no contractual obligation to pay it back?

    “No, an overdraft facility is generally evergreen until the bank chooses to revoke it.”

    True. There’s no time limit. But you are still required/expected to pay it back at a later date.

    “No, in England and Wales commercial Banks are not issuing banks, elsewhere in the UK the Bank of England controls the issuing of specie by commercial banks.”

    The BoE controls the issueing of cash. But the currency also includes broad money.

    “Nothing supports the contention that the bank’s asset is worth £100 since they may have been negligent in assessing your ability to repay or the value of your collateral. Your “piece of paper” is worth nothing.”

    No, the face value is weighted by the estimated probability of repayment. There’s a market for debts – that’s what the “sub-prime mortgage” people were trading. Banks account for debt agreements as assets with a market value.

    Seriously, you think that because repayment is not 100% certain that their value is zero?!

    “OK, let’s assume your bank has the right to sell on your obligation to a third party. In the case of a default on your part they will probably have to dispose of your loan at a discount.”

    Agreed. I was simplifying. That will already be accounted for by means of the interest rate the bank charges.

    The bank will give you £100, but the loan agreement will be to repay £100+interest, say £150. The *value* of the repayment agreement will be £150 (minus overheads and profit) times probability of repayment = £100. It will be worth pretty much the same to any other bank.

    “Eh?”

    They’re standard textbook definitions. What’s your problem?

    “You’ve no idea what you’re on about but you pretend that you do.”

    I’m guessing you’re one of those people who think if *you* don’t understand it, it must be nonsense? Skip the insults (I treat them as empty bluster or ad hominem anyway) and explain why you think it’s wrong. “Eh?” is not an argument.

    I didn’t invent this – so far as I know it’s still the standard accountancy interpretation. Liquidity is distinct from money, and loans are dealt with in double-entry by balancing the credit in the borrower’s account against the debt represented by the loan agreement, and the loan agreements are accounted as an asset of the bank. It’s reasonable enough that non-accountants might not have come across this way of looking at it, but it’s not exactly complicated. It’s just basic book-keeping.

  59. Tier 1 is, by definition, a fractional reserve.
    loans are not RWAs… Simplified or otherwise

    I think you’ve lost track of your own argument there Dennis.

  60. Banks are typically in the business of making loans. Those loans are bank assets. In many cases the risk weighting for a loan is 100%, so loans translate directly to risk-weighted assets.

    Nice try, but the logical sleight-of-hand doesn’t work. In any event, you’ve got the risk weight percentage ass-backwards. What you wanted to say was 0%.

    So let’s review: You’re (1) factually incorrect and (2) you don’t know how to properly calculate a capital adequacy ratio.

    To simplify, basically only cash and short-term government bonds have a zero risk percentage. Even long-term government bonds have a risk weight (10%). Home mortgages have a risk weight of (50%).

    You keep mocking folks for looking stuff up… Perhaps you should try it sometime.

    By the way, when are you moving to Ely?

  61. It looks as if another internet debate has turned into a squabble about loose uses of technical terms. But the question still lurking is why SJW thinks that the UK does not operate fractional reserve banking. The parties who think it does include the staff of the Bank of England. So is this another case of definitions?

  62. “It looks as if another internet debate has turned into a squabble about loose uses of technical terms.”

    🙂

  63. “To simplify, basically only cash and short-term government bonds have a zero risk percentage. Even long-term government bonds have a risk weight (10%). Home mortgages have a risk weight of (50%).”

    Interesting! In that case I’ll be happy to take out a mortgage for £100k and then immediately buy back the debt from the building society at 51% of its face value.

  64. ok, squabbling with DtP is dull. He’s still wrong. The risk weighting for ordinary commercial loans is 100%.

    why SJW thinks that the UK does not operate fractional reserve banking

    Because no fractional reserve is required. Ask Northern Rock.

  65. SJW your response is meaningless.

    Northern Rock was bankrupted. What is your implied point about fractional reserves?

    Did NR have reserves?

    Did they meet central bank requirements?

  66. @SJW (see above)
    From Net (Canada)
    “Rocco Galati has taken on a case for a group called the Committee for Monetary and Economic Reform, or COMER, which wants the (Canadian) central bank to return to the practice of lending federal and provincial governments interest- free money for infrastructure”.

  67. “Northern Rock was bankrupted. What is your implied point about fractional reserves? Did NR have reserves?”

    Not precisely. They used securitization – they sold long-term securities to raise the liquid funds to pay the mortgage loans.

    I think SJW’s point is that fractional reserve is a measure used to provide a minimum acceptable level of liquidity to deposits with instant access (i.e. high liquidity), and therefore don’t apply to deposits accepted under terms that don’t offer such high liquidity. Something like a bond – where the depositor cannot get their money back for an agreed considerable period – or a pension – where you can’t get your money until you retire – doesn’t allow bank runs, and so requires no reserves.

    While a loan replaces an illiquid type of money for a liquid form, buying bonds and paying into pensions does the reverse. In principle, one could trade one against the other precisely and pay back the bonds on the dates they mature from the mortgage repayments.

    However, there is a problem starting the process off. On day 1, you’ve got no bonds sold with which to pay out the mortgages, and no mortgages to pay the interest on the bonds. It takes ages to build up enough business for the profits from it to pay your overheads. So to get the scheme off the ground they simply borrowed capital from the market, and used that to get the thing going. They then paid the interest from the profits on the bond-mortgage exchange. The loans they took out with the market acted effectively as a giant deposit.

    When the financial crash happened, the market for bonds evaporated, and they had no new income from which to pay the interest on those original loans (which they ought to have got rid of once the cycle was going, but you know how it is when you’re under pressure to deliver maximum profits and the risk seems low…).

    They went bankrupt because they raised capital for their business with a loan, and then couldn’t pay the interest when they stopped getting new business. Millions of bankrupts go in exactly the same way. Had they actually done what SJW seems to be hinting at, and balanced the long-term securities against the long-term mortgages on a like-for-like basis, they could in principle have operated with at least theoretical safely with no reserves. They wouldn’t have had to pay off the bonds until the mortgage repayments were due. (Although with the crash, there would have been a lot of mortgage defaults as other people went bankrupt, which could still take them out even if they had made their investments a perfect dutch book. There’s no defence against everyone who owes you money going bankrupt, except to go bankrupt yourself.)

    It was something like that, anyway. I never was interested enough to look up all the precise details.

  68. Oh, for Pete’s sake Dennis, this is the UK and In English, as distinct from American, unsecured commercial loans have a risk-weighting of 100% , that’s how risk-weighting is defined over here and SJW is right on that one. The Capital Requirements used to be that the bank had free equity of 8% of risk-weighted assets to cover the risk of bad debts. (Modern rules are more complicated with slices of subordinated debt deemed to be allowed to provide some partial protection to depositors but the old rules of free equity > 8% of RWA is easier to see).
    American words probably say something different but if we’re talking English English then you’re handicapped like if you’re trying to beat the New York Yankees with a team of 8-year-old schoolgirls.
    @ Roddo Siffredi I have read the accountant’s report on Northern Rock. You obviously have not. Northern Rock was not bankrupt.
    IMHO Applegarth *deserved* to be bankrupt – *but* NR was not and Chadwick had to lie through his teeth to pretend that it was.
    Yes NR had reserves and yes, they met Central bank requirements.
    WTF do you mean by “third parties holding those reserves”? NR held the reserves. Have you done Accounting 101? Who do you imagine holds a company’s assets other than the company? The reserves of NR were the excess of its assets, net of provisions for bad debts, over its liabilities.

  69. @ NiV
    Northern Rock was NOT bankrupt.
    Darling nationalised it because Robert Peston, the son of a New Labour Life Peer, had caused a run on the bank with an inadequately reserarched report and then hired an accountant from a second-class firm to justify his decision. I have read the report. Mr Chadwick chose not to respond to my criticism. So I shall mention here one item – Mr Chadwick classed as a liability of NR at the time that Mr Darling chose to expropriate it the fee paid by HM Treasury to Goldman Sachs as a result of a request, some time later, for Goldman Sachs to analyse the financial condition of Northern Rock. That is NOT a joke.
    The bigger fudge was the claim that NR would have to make a “fire sale” of assets because he assumed that the Bank of England would default on its statutory obligations and a large part of its mortgage book would be sold at a 20+% discount to its *written-down* (after provisions for bad debts value.

  70. The long rigmarole above of how banks and especially American banks could nor raise enough regulatory capital to cover the inevitable onset of house price inflation needs considering alongside the traditional model of British building societies where the loan capital could not be leveraged.

  71. john77: thanks for the moment of sanity.

    Traditionally, building societies were mutual organizations which took money from depositors and lent it to house buyers, retaining some fraction as a reserve.

    But after it demutualized in 1997, Northern Rock wanted to lend out much more than it took in. And there was nothing in the regulations to stop it. It funded its lending by short–term borrowing on the money markets, then in due course securitizing and selling on the mortgages. Which worked well for it until the mortgage-backed securities market collapsed, leaving Northern Rock with a lot of borrowing to roll. The other banks then decided it was too risky to keep lending to it.

    Was Northern Rock bankrupt? That depends on whether its assets – its mortgage book – were worth at least as much as its liabilities. I take the boring view that an asset is worth what you can sell it for, given a reasonable time to make the sale in. By that measure, Northern Rock was bankrupt – otherwise it would have been able to rescue itself by selling on the mortgages, or alternatively to sell itself as a going concern.

  72. @ SJW
    ” I take the boring view that an asset is worth what you can sell it for, given a reasonable time to make the sale in. ”
    Don’t you remember that Darling expropriated Northern Rock, while it was solvent?
    One of the points of the BoE being a lender of last resort to UK banmks sanctioned by the BoE was that the banks then had a reasonable time to sell some assets to meet any liquidity shortfall.
    Chadwick assumed in his so-called valuation that the BoE would *not* provide liquidity and that NR would be forced into a fire sale of assets and consequently have to accept a horrendous discount (15% to the value after provisions) on its residential mortgage book, thereby converting a net asset position of £1.63bn to a notional deficit of £2.44bn, and then *forgot* to adjust the deferred tax provision by 28% of the alleged loss – but hey! what’s a £billion between friends?
    He did this in order to find a way of claiming that the then government did not need to compensate the shareholders for the theft of their assets.
    No, Northern Rock was *not* bankrupt. Try reading the accounts and Chadwick’s report without your rose-coloured spectacles.

  73. I remember that the BoE stepped in to support BR in September 2007, with I think £25bn. And it was more than five months later that NR was nationalized, still owing £25bn. Five months is my idea of a reasonable time to sell assets, and NR came nowhere near doing that. Nor could they find a buyer at zero (ie who would repay the BoE in exchange for the company). If your business is not worth zero in the market, you’re bankrupt.

    The details of Chadwick’s accounting make no difference to the fact that the market value of NR was less than zero.

  74. I know a couple of people in this saga. Ex-chairman (mumble mumble), bloke who was trying to organise the shareholders’ case against the govt (mumble, mumble) and have discussed it at length with both. Never been wholly convinced by either of their arguments. I’m not sure that they were justly, wholly so, treated. But FRB is a shadow play, all the time. To make it work those who fail to make the kabuki convincing might well be very slightly unjustly treated.

    Those Granite bonds are paying off, the basic idea wasn’t bad. But that funding gap of not being able to finance those loans already out waiting for securitisation? Well, yes, yeeeees even. But tough.

    It’s along with my view that FRB is inherently unstable (and no, don’t damn tell me we ain’t got it) but as A Smith said, it’s worth it. Mild injustice for the system? Suck it up.

    No, this don’t mean gross injustice for the system, you go and starve in the Pol Pot fields to make the system work is worth it. Mild, balance, umm, probably.

  75. @ SJW
    NONSENSE
    There were TWO buyers for Northern Rock, who were blocked by New Labour’s unilateral decision to nationalise it, as well as one which said it would bid if the government changed the conditions and half-a-dozen more which had proposed bids but dropped out due to government conditions.
    In September Northern Rock borrowed £3billion, not £25 billion: the borrowing later rose to £26bn as a resuilt of the Peston-inspired bank run. By August it had repaid £9.4bn, 36% of the loan *in less than six months* – so *you* think that the assets were ubsaleable?
    There is a difference between bankruptcy and no-one wanting to buy your business – many bankrupt businesses have been bought in takeovers because they had value for the buyer and other solvent businesses had no buyer.
    The market of Northern Rock when expropriated was over £1 billion.
    The difference between right-wingers and left wingers is that the old-fashioned right-winger believed in original sin – he also believed that truth and honesty mattered, unlike New Labour.

  76. The would-be buyers refused to agree to the entirely reasonable requirement that they pay back the BoE loan.

    However much you bluster, the fact remains that no one was willing to pay 0 net for the company,

  77. Oh, and August 2008 was 6 months after nationalization, that would be 11 months after the loan. And the money was raised not by sale of assets, but by not rolling good mortgages which could refinance elsewhere, so the remaining book was lower quality. “Truth and honesty”.

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