Fractional reserve banking...recipe for disaster?

Discussion in 'Business & Economics' started by Eflex tha Vybe Scientist, Jan 28, 2011.

  1. Eflex tha Vybe Scientist Registered Senior Member

    so, the consensus that I'm getting from the board is this:

    1. FRB works fine if properly regulated

    2. No banking system is perfect/free from corruption

    This leads me to 2 questions:
    1. How can we separate the current Federal Reserve System from politics in the USA when most presidents cabinet/inner circle is full of influential bankers?

    2. Can someone differentiate the German Banking system from the US one?
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  3. Eflex tha Vybe Scientist Registered Senior Member

    Examples in Obama's cabinet:

    Michael Froman, deputy national security adviser for international economic affairs, worked for Citigroup and received more than $7.4 million from the bank from January of 2008 until he entered the Obama administration..

    Citigroup has thus far been the beneficiary of $45 billion in cash and over $300 billion in government guarantees of its bad debts.

    Obama’s deputy national security adviser, Thomas E. Donilon, was paid $3.9 million by a Washington law firm whose major clients include Citigroup, Goldman Sachs and the private equity firm Apollo Management.

    Louis Caldera, director of the White House Military Office, made $227,155 last year from IndyMac Bancorp, the California bank that heavily promoted subprime mortgages. It collapsed last summer and was placed under federal receivership.

    The presence of multi-millionaire Wall Street insiders extends to second- and third-tier positions in the Obama administration as well. David Stevens, who has been tapped by Obama to head the Federal Housing Administration, is the president and chief operating officer of Long and Foster Cos., a real estate brokerage firm. From 1999 to 2005, Stevens served as a top executive for Freddie Mac, the federally-backed mortgage lending giant that was bailed out and seized by federal regulators in September.

    Timothy Franz Geithner 75th and current United States Secretary of the Treasury, serving under President Barack Obama. He was previously the president of the Federal Reserve Bank of New York.
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  5. Eflex tha Vybe Scientist Registered Senior Member

    Examples in Bush's cabinet:
    Henry Paulson
    Paulson had been chairman of Goldman Sachs for about eight years. It is considered one of the premier financial firms on Wall Street and has sent a number of its top executives to high positions in Washington

    Steve Preston
    senior vice president and treasurer of First Data Corp. and an investment banker at Lehman Brothers

    Elaine Chao
    vice president of Bank America Capital Markets Group in San Francisco

    Samuel Bodman
    president and chief operating officer of Fidelity Investments and director of the Fidelity Group of Mutual Funds

    Joshua Bolten
    He was executive director, Legal and Government Affairs, Goldman Sachs International in London
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  7. keith1 Guest

    Talent is a knack of being able to complete a task more efficiently, with a natural proficiency and love for the task, as if to be made for the position.

    When the talent is making money, there will be more money made than is actually present.

    At some point one ends up standing in mid air.
  8. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

    (1) IMHO, it makes that more likely but not "inevitable" FRB can more easily b e abused than for example gold backed currency, but has many offsetting advantages also. Government can always abuse their citizen's finances, with or without FRB.
    (2) Growth can be greater than the interest added, but only if the debt is not too high. Except in very strange conditions, which have only happened twice in human history, a debt of 0.9 times the GDP can not be recovered from as then the interest is too large to be paid by growth so is borrowed to pay the interest, making problem grow worse.
    (3) No. Many have obligations that they can not pay immediately. For example your home mortgage or life insurance company make reasonable projects of that they need to pay in the future, but they too could be wrong. You could have an adjustable rate mortgage, lose your income etc or their could be terrible epidemic that kills off 50% those insured, etc. It as always is a trade off between risk and reward. If the bank can lend as mortgages twice what it has in deposits they can pay higher interest to their depositors etc. If you agree to an adjustable rate, 20 year, mortgage the lender, who typically has borrowed the money for much shorter term, even as "demand deposits" of a bank, can charge you lower interest as he has protection that if interest on his borrow money rises he can soon pass that cost on to you, etc.

    Summary: prudent risk taking and leverage can benefit all.
    Last edited by a moderator: Feb 2, 2011
  9. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

    I think you will find that in the 17 & 1800s when there was no FED to "lean against the wind" the "business cycle" delivered more and worse boom and bust cycles.

    Recall my discussion of how the FED controlling the money supply can stimulate when economy is stagnet and break inflation when growing too fast.
  10. Syzygys As a mother, I am telling you Valued Senior Member

    >Has Fractional Reserve Banking run for two decades "successfully"?

    I am sure there are dozens of countries that have had 2-3 decades of prosperity without big economical problems... The US between 1945-mid 80s.... The 70s problem was energy (oil) related not FRB....
  11. Read-Only Valued Senior Member

    So what? Even wackos and idiots can get some things right. And even a blind squirrel finds a nut now and then. So your links STILL do not gain any credibility just because they state some obvious truth.
  12. dixonmassey Valued Senior Member

    P*(1+i)^n (simplest compound interest formula on which banking stands) is not simply absurd way to build economy around in the finite world, it's threatening physical survival of higher forms of life as we speak, right now. It's either fractional banking system or physical survival, there is nothing in the middle.
  13. dixonmassey Valued Senior Member

    "Unsustainable" expectation of the endless economic growth to satisfy compounding formulas, is not the only problem associated with fractional banking. The way new money are being injected into the system is another "issue" few truly understand.

    From what I understand, fractional banking is not just about a Bank having $1000 in "liquid" assets and giving away $900 in loans. If that would be so, why everybody was screaming about collapse of the financial system for the past 3 years? So, bank lost $900 in loans, that means only one thing - another bank "appropriating" those $900 sooner or later, what's big deal, what collapse? Money in this kind of fractional banking don't just disappear without a trace. Unfortunately, American fractional banking doesn't operate this straightforwardly. Commercial US banks are given de facto authority to create money out of nothing, to transform your signature on loan papers into new cash.

    Would you like a power to issue $10,000 worth of loans for every $1000 of your dollar assets? Would you? Isn't that sweet? And that's EXACTLY what American fractional banking is about. All bankers have to do - to make right bets on the loans because if they lose $1000 in bad loans (money for which they pulled from their ass to begin with, counterfeiters are innocent babies compared) they have to eliminate $10,000 of their "assets" (Hint, they have $1000 of real assets). This one of the most parasitic arrangements one can imagine under the Sun even without Federal Government "subsidizing" bad loans threatening to collapse bloodsucking house of cards. In this version of fractional banking money appear out of nothing and disappear into nothing. Without Federal Government subsidizing failing mega banks, they not just collapse they take "assets" with them.
    Last edited: Feb 2, 2011
  14. nietzschefan Thread Killer Valued Senior Member

    It is absolutely, certainly DOOMED TO FAIL EVENTUALLY by design.
  15. dixonmassey Valued Senior Member

    2 years is just enough even for the blind to see that Obama is yet another corporate bitch on the short leash doing master's bidding. Who did doubt that in November of 2008 except naive and otherwise challenged, really?

    I was thinking about this remarkable consistency, absolutely remarkable continuity and uninterrupted coherence of Presidential? policies for the past 200 something years. Virtually all Presidents and administrations were promoting, defending, fighting for the interests of the Financial Capital (not just Capital and Capitalists, Financial Capital). I wonder what is hiding behind this enchantment.
  16. jmpet Valued Senior Member

    I still feel the minimum requirements to start this thread have never been properly presented.

    You can't start a thread saying "Ooh- look at this on YouTube! And this! And this! And these other five! Then comment!" That is what YouTube comments are made for, not a forum.
  17. keith1 Guest

    The housing market debacle is still the deepest bleeding wound.
    Never let salesmen near your government....
  18. Eflex tha Vybe Scientist Registered Senior Member


    No matter what the government does, taxpayer bailouts of the financial sector will sometimes be necessary, according to the nation's second richest man.

    As markets crashed in the fall of 2008, government officials feared that if certain financial institutions failed, the entire financial system -- or perhaps even the entire economy -- would come down with them. In the months after the government extended a $700 billion bailout to the financial sector, lawmakers have striven to ensure that no institution poses such a systemic risk that it would be too big, or too interconnected, to be allowed to fail.

    But famed investor Warren Buffett, whose own firm profited handsomely from the bailout, said bailouts are an inevitable feature of finance, Bloomberg reports.

    Buffett, who is personally worth at least $45 billion, told the government panel charged with investigating the causes of the financial crisis that its work would not prevent the phenomenon of "too big to fail."

    "You will always have institutions that are too big to fail, and sometimes they will fail," Buffett told the Financial Crisis Inquiry Commission in May, according to Bloomberg. His recorded comments were released Thursday by the FCIC, Bloomberg notes. (You can read the full set of FCIC documents here.)

    "We still have them now. We'll have them after your commission report."
  19. joepistole Deacon Blues Valued Senior Member

    Show me a better system.
  20. jmpet Valued Senior Member

    Fractional Reserve Banking

    By mod Billy T: This was the OP in new thread started by jmpet. Please look to see if an existing thread exists you can post in before starting a new one.
    If this is not done, next time, I may just delete you new thread instead of merge it as that is less trouble for me.

    Fractional Reserve Banking

    Fractional Reserve Banking (FRB) is the percentage of physical cash banks must have physically in order to lend out money. If you borrow $1 million from the Federal Reserve, you are obligated as a bank to keep 10% of those monies in your vaults. The other $900,000 you can lend out... it can become "non-physical money" i.e. mortgages etc...

    If banks borrowed $1 million and lent it all out, the bank's vaults would be empty and there's be no money in the vaults to give people if say a rush happens on the bank and everyone wants to cash out at once. 1929 was an example of that which is why all the banks crashed- they ran out of money.

    Today we have FDIC regulations. They're used to guarantee that $100,000 from your account was guaranteed by the Federal Government. This prevents a run on the banks. These days that amount has been raised to $250,000... even more security for the customer.

    The success of FRB is from the notion itself: if $1 million is borrowed from the Fed, they're allowed to loan out $9 million from thin air. This allows banks to offer relatively low interest rates- 10% and under. Because they did the math and if you lent out $9 million and X% defaults on you, you're still going to make Y% from the good investments based on Z% interest rates... you're still going to show a return from that original $1 million you borrowed from the Fed even though a percentage of your investments didn't pan out.

    Risk Vs Reward

    The riskier the loan, the higher the interest will be. It's a game banks play. The best run bank makes a 5% profit as a bank at the end of the year... the most profitable make 15% that same year with that same money. It's all a matter of risk. When real estate is going through the roof, it's a no-brainer to give loans for houses. But when the value of houses goes down as it did 3 years ago, those high rollers take a beating. Their risky loans all defaulted and they are in the red. This is how giants fall.

    This is why banks are always ready to give a loan... to the right person. In the '00's banks gave out loans to all kinds of people and the majority of them could not repay and defaulted and the banks lost their paper profit.

    I suggest now that times are better than they were during the crisis of 2008, we raise the FRB ratio- we require banks to physically have 20% of the money in physical reserves- we double it.

    This means they will have 50% less money to loan out; or 50% more responsibility on the monies they do borrow, depending on your point of view.

    FDIC should go back to $100,000 or better yet- go down to $50,000. Put more responsibility on the bank itself to fulfill its obligations as a bank. A bank having twice as much in their vaults fixes itself if there is a run on the bank... they have more money to hand out.

    It is hard to get a loan because there is risk involved. But that is mitigated by say, 20% down and an $80,000 a year salary... the capacity to repay that loan.

    This is a step towards fiscal conservatism but...

    What if we held banks more accountable for their actions? And what if they only lent out money to people who could repay them? What would be the results of this?

    My guess is still low interest rates but a much higher bar to meet to get that loan. Considering banks have the potential to make a profit on 80% of the money they take in- provided it all goes to faithful creditors- the good banks will weed out the bad banks.

    People will save up more money. Want to open that beauty salon? It no longer needs a projected profit as a basis- today it needs 20% down in cash. At that point (with the 20% we borrowed from the Fed paid back), you are free to borrow and pay interest on the balance- it's all gravy. This is how banks should work ideally.
    Last edited by a moderator: Mar 1, 2011
  21. jmpet Valued Senior Member

    I posted the above post in the hopes someone could shoot some holes into the concept. Didn't really want it here as it's a different topic with the same name but I do not question the mod gods.
  22. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

    The US has had FRB for decades, and it does permit the creation of "thin air money" by the banks, but as graph below shows the bank made money is not of much importance compared to what the FED can do / has done:

    Please Register or Log in to view the hidden image!

    Blaming the FRB system for excessive growth in the money supply is misguided. It has worked quite well for decades to provide loans, but did get into trouble with the creative construction of "derivativies" which quickly moved the risk off the banks books, thus greatly motivating the banks to lend to any un employed wino who was sober enough to sign the loan papers., as the bank immediately got a slice in fees, etc. and soon a profit on selling the derivatives, some math whizzes structured for it.

    IMHO, the FRB system is a great blessing, but banks must be required to keep more of their own "skin" in the loans they grant. With that restriction added, I would like to see more thin air money made by banks and less by the FED.* I think banks making loans, and keeping significante "skin" are much more likely to get the funds invested productively than when the FED makes thin air money. For example by creating credit on the books of one of the 12 banks it deals directly with. They in turn take this free money and buy bonds with it, which does very little good as FED is doing that too and by its actions alone holding interest rates at historic lows. Much better if the bank lent funds to some guy who, for example, wanted to start a small business, employing two now unemployed workers.

    * Chew on this idea: When economic stimulation is needed drop the bank's reserver requirements. E.g. instead of the current 10% make it 5% giving the banks twice their current lending power. Brazil changes the reserve requirements to modulate the economic activity, and that keeps the banks making loan decisions instead of the government making "make jobs" loans. Brazil also has a government agency that makes loans mainly for infrastructure projects or new plant construction -things with too costly investment for most banks to make.

    Not much different, IMHO. Although I don't like new treads cluttering up B&E, unless their subject really is impossible to fit in existing thread I am quite tolerant of "smooth detours" - I.e. thread's subject can evolve. For example, if someone thinks all "thin air money" is the work of the devil they could contrast FRB and return to the gold std. That would likely get some replies telling the faults of the gold std. So thread might take a detour of a dozen or so post about the gold std, but some new comer would read the title and get thread back on track, so I don't kill smooth detours, but if out of left field someone posts here about food price inflation etc. I will try to move that post or kill it.

    Note there is only one "sticky" thread, which I doubt you have read, but should, at B&E. This is so almost all the B&E forum page list available threads that are active - It is easy to look for a suitable thread to post in before starting a new one.
    Last edited by a moderator: Mar 2, 2011
  23. Eflex tha Vybe Scientist Registered Senior Member

    Old news, just thought I'd share
    The stimulus package the U.S. Congress is completing would raise the government’s commitment to solving the financial crisis to $9.7 trillion, enough to pay off more than 90 percent of the nation’s home mortgages.

    The Federal Reserve, Treasury Department and Federal Deposit Insurance Corporation have lent or spent almost $3 trillion over the past two years and pledged up to $5.7 trillion more. The Senate is to vote this week on an economic-stimulus measure of at least $780 billion. It would need to be reconciled with an $819 billion plan the House approved last month.

    Only the stimulus bill to be approved this week, the $700 billion Troubled Asset Relief Program passed four months ago and $168 billion in tax cuts and rebates enacted in 2008 have been voted on by lawmakers. The remaining $8 trillion is in lending programs and guarantees, almost all under the Fed and FDIC. Recipients’ names have not been disclosed.

    “We’ve seen money go out the back door of this government unlike any time in the history of our country,” Senator Byron Dorgan, a North Dakota Democrat, said on the Senate floor Feb. 3. “Nobody knows what went out of the Federal Reserve Board, to whom and for what purpose. How much from the FDIC? How much from TARP? When? Why?”

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