At first glance, bank balance sheets are unintuitive and feel 'the wrong way round'. When someone deposits $1m at a bank, the bank doesn't have $1m more assets, it has $1m more liabilities.
To my mind, although it's in-principle equivalent, the clearer way to think about this is that banks borrow money from depositors and lend that money via loans or investments.
The primary business of a bank is borrowing short and lending long - where short and long refer to the holding time: i.e. taking demand or short-duration term deposits and making mortgage, car and other types of loans.
If you do this badly, you can lose money due to duration risk (you might end up paying more on your demand deposits than your mortgage book is bringing in), but you also have liquidity risks because your depositors can ask for those deposits back faster than you unwind your lending.
If you have both of these occurring at the same time, you're then in severe difficulty, because the only way to repay your depositors is by borrowing money ... which is going to be harder if you look unprofitable ... and that very borrowing can exacerbate the perception of a bank in trouble.
OK, sure. It’s a distinction without a difference though. If you read pg. 5 of that document, it explains how the effect of market forces results in essentially the same net effect for an individual bank as if they did “lend deposits”.
This, plus the other effects (like what the BoE calls “prudential regulation”) are the reason why you don’t see banks with zero deposits and a trillion pounds of loans.
Credit vs quantity theory of money is basically a concern of monetary policy (like: what is the expected effect of quantitative easing?) and doesn’t really bear on decisions at the level of individual banks or borrowers: things look consistent with both theories.
Like: it doesn’t matter whether classical or relativistic mechanics are “true” if you’re only following the flight of a baseball.
Maybe, but in the case of SVB, deposit amounts were suspiciously similar to assets....
The BOE is simply pointing out in the link that they are the only proper bank in the UK. All the others borrow from the BOE to make loans. Commercial banks don't "create" money any more than the BOE "borrows" it from elsewhere.... The BOE creates money and lends it to commercial banks who put up a deposit and make a reasonable case for credit.
In a fractional reserve system the amount they can loan out is a multiple of their deposits, with the excess money coming from the central bank.
Also why link an article from the UK when the subject is a US bank? There are differences between the two countries banking systems and monetary policies.
Of course banks are lending deposits. They're throwing in some investor money too but vast majority of loans they write is using deposits. You can try to make some sort of "number on screen go up" argument, btu the underlying value comes from somewhere. When someone takes a loan and withdraws dollars they're usually getting money that was deposited by a customer.
That's a misunderstanding - when a bank originates a loan:
- the bank records an asset (the loan) and a liability (the deposit in the borrower's account)
- the borrower records an asset (the loan money now deposited at the bank) and a liability (the loan)
But is it real? It’s more like an IOU, right? They don’t reduce the amount of money in the depositor’s account, but if the loan defaults would they be able to return the money to the depositor? My guess is no, not really (assuming no other outside cash sources).
So even though the amount of currency looks like it has increased, it hasn’t really… unless I’m misunderstanding still. But my impression is this is pretty much what happened yesterday with SVB.
That's wrong. The loan amount was never anything but a number that someone at the bank punched into a database. It doesn't have anything directly to do with someone else withdrawing their own money.
If the bank is giving cash to the withdrawer, that would come out of their capital reserve I guess. If they didn't have that, they FDIC insurance would kick in.
You’re wrong. If someone took out a loan and withdrew all the money before defaulting the bank would not be able to pay deposits. Insured deposits would be paid by the government and uninsured deposits would go poof.
You can say the loan is a number in a database, but once it’s withdrawn from the bank the bank can’t just go into the database and undo the loan.
Your understanding of banks taking in deposits then lending them out hasn't been true for decades. A bank with no deposits can make loans just fine. They can just borrow at a lower rate than they loan if they actually need to hand out cash.
Your example doesn't make much since because any bank has many good loans and a capital reserve to deal with the few bad loans.
This was basically what I was asking. Okay so, because the bank has access to an external supply of “money”, they can loan out more than they have in reserve. Thanks!
Yes, BUT they do not need to get 1000 USD from anywhere to put 1000 USD in your account. They literally just say you have 1000 USD. You can then electronically transfer that to anyone else's bank. The banks then borrow government money overnight to settle accounts. That's the only place government money comes into it.
Economists actually refer to the USD in your account as bank money because it did not come from the government. You could just as easily think of that money in your account as a bank issued stablecoin pegged to the dollar that's convertible to dollars.
except people withdraw money and the bank needs to give those people actual cash. That's deposits. Of course they could take overnight loans or whatnot but deposits are cheaper.
The vast majority of money is not withdrawn. It's all transfers. And that is a major point and difference.
Also, if it was all withdrawn it's a bank run, which has not been a problem in the US for quite a while.
Overall it cancels out for the large banks, of course people transfer money they just borrowed from the bank away, but that bank also has customers that are recipients of money. That, and other mechanisms between banks and banks and central bank(s) to balance such things within all the banks in the overall economy. Money withdrawn from one bank goes to another one, and everybody is not just sender but also recipient from someone else.
Why do you keep insisting on the "cash"? The by far least important kind of money? First of all everything is just virtual, electronic. Only a tiny fraction - and only temporary! It's not stocked at home, but used to buy something and that means deposited again in another bank - is "cash".
Yes banks need some reserves, but this is waayyyy more complicated than them using the deposits. Which, for the most part, are not cash. That's only that tiny fraction of paper money use din circulation, which also is a lot less than it used to be with all the card-money.
USD is different because that currency is used for far more than just regular circulation, and world-wide. But even then estimates are ca. 8% cash maximum, for the world, which includes a lot less sophisticated economies. A bit more for the USD for obvious reasons, but most of that is not circulating in the US economy.
In any case, even in the US, with all its cards and card payments, money is mostly electronic and not cash and is transferred from bank to bank and hardly leaves the banking system.
> commercial banks create private money by transforming an illiquid asset (the borrower’s future ability to repay) into a liquid one (bank deposits); they would quickly be insolvent otherwise
Uhm.. yes, exactly. They can't do it at will, they need a borrower to sign. I mean, now we start arguing definitions, always a bad sign, especially when both sides actually are in perfect agreement and it's about the words used. This article to me is just weird, arguing it's not out of thin air, while everything being described says just that, only that their understanding of "out of thin air" is subjectively different than that of many other people. But there is no difference in knowledge and opinion about the underlying mechanism, only disagreement about some fuzzy term that some like to use and some apparently hate for whatever reason.
I’m not reading that, but I’m using “cash” because that’s what I’m talking about. Yes most of the loan money isn’t cash, but the cash has to be available for withdrawal so “it’s just numbers on a screen” doesn’t actually work all the way down.
Banks don't hold substantial cash. They send whatever cash they collect to the local federal reserve to be recycled and get fresh cash to hand out to people every morning from the same federal reserve. I don't think I've gotten a "used" bill from a bank in over a decade.
So let's assume a bank has collected deposits worth £1000 from all of its customers. Now the bank makes a loan of £100 to one of its customers and puts the money into the customer's current account at the bank.
According to your theory, what is the total amount of deposits at this bank after making the loan?
If, as you say, banks were lending deposits, then the total amount of deposits cannot possibly have changed and that new loan of £100 would have to come out of some other customer's bank account.
I would be pissed if my bank account balance suddenly dropped and the bank told me, sorry we have lent your money to someone else.
They give your money to that guy. And he puts it in his account at the bank and they give it back to you. The money is still real though. Without the deposits they could not make any loans to begin with.
If someone comes to take out a loan for $1000 and withdraw the money what would happen? They'd go get the money everyone left there and give it to the new customer. Now they bank has no money because they just lent all the deposits. $1100 in deposits and $1100 in loans
“ Without the deposits they could not make any loans to begin with.”
Incorrect, banks create deposits when they issue loans and only require reserve balances sufficient to satisfy net flows of funds between institutions.
They can also borrow those reserves.
So deposits are required to increase profitability, and of course a minimum level of profitability is required to be solvent, but banks in now way “lend out deposits”.
If you actually believe this describes the process then follow me on this thought experiment.
TWB (unrelated to SVB) realizes that it’s in trouble - customers are taking a lot of their deposits out, and confidence in the institution is low.
So, instead of trying to liquidate some of their assets or raise capital (which is what would be conventional) they decide to lend their bank president a trillion dollars of interest free loan with a recall feature, on the contingency that he deposit it in a non-interest bearing account with a 300 year notice requirement.
In your understanding of the mechanics of banking; this is fine. The bank magics $1tn of deposits out of thin air, records an equivalent asset, and can then just pay all of their customers from these new deposits they have.
By issuing deposits, each bank creates essentially its own money which is valid as long as it is inside the bank (used in transactions with other clients that use the same bank), but when clients send money to other banks, the bank has to use 'central bank money'.
Which means banking system as a whole creates 'private money' when flows of 'central bank money' between banks are balanced, but each individual bank cannot do it faster than others, otherwise these flows will be negative and it will be losing 'central bank money' and/or hard assets (which would be sold to acquire 'central bank money').
In your worldview, where does the money a bank needs to operate from?
In your worldview, can you explain how it is possible for a bank to have far more loans on their books than they have deposits (see: fractional reserve banking)?
> A bank can make an infinite amount of loans. They are not constrained by anything.
They are constrained by capital and/or reserve requirements
> The way a loan works is: they make a loan to someone and then "just in time", they borrow the money from the Fed to cover that loan.
Nope. Banks can borrow against their government securities from Central Banks by "rediscounting" them during discount windows, should they need extra liquidity. Note that this is not the preferred method since Central Banks usually charges a premium. These are secured loans.
But loans aren't typically available immediately - they take time to clear. It doesn't seem unreasonable to me that they'd bundle the day's loans (or maybe a few hours at a very large bank) to limit the number of transactions they'd have to make.
The money that gets borrowed from the Fed is used to settle balances between banks. When a bank originates a loan, they just add a number to an account. The money doesn't come from anywhere. This works mainly because most money transfers are electronic.
tl;dr yes, banks create money out of thin air. It's been this way for decades.
> can you explain how it is possible for a bank to have far more loans on their books than they have deposits (see: fractional reserve banking)?
Fractional reserve banking is about having more deposits (on the liability side) than reserves (on the assets side).
I won't say that it's not possible for a bank to have far more loans on their books than they have deposits (they could finance themselves differently) but I'm not sure if that actually happens. Can you give an example of a bank having far more loans on their books than they have deposits?
Banks don’t have far more loans than deposits. When they make a loan most of the money is just redeposited, so effectively each oringal deposit gets 10x’d by people just leaving the money in the bank. That’s how fractional reserve banking and “creating money out of thin air” works.
If none of the loan money was redeposited than the bank couldn’t create new money.
You are thinking of a nation - and even a single bank - as a closed system. But this is an oversimplification that makes it impossible for you to make steps in your understanding of how this all works.
I've worked for a bank, both on the 'banking' side and on the IT side. One of the first things that gets drilled into your head is that banks create money. With every loan on the books more money gets put into circulation. There are some restrictions on how much you can put into circulation and there are some restrictions on how much cash you have to have on hand compared to the number of deposits that you have lying around.
But a bank could easily (as long as the bank is 'solvent' according to the rules set by the local central bank) write loans well in excess of it's deposits, technically it need not have any deposits at all.
I wonder if it’s correct to also think about it in this way: idle cash devalues over time. Coupled with interest (no matter how small) that they pay out to their depositors, this exposes banks to future liability. To counter that, they have to give “jobs” to as much of this cash as possible so that they can make those payments while also pocketing a profit for themselves.
As for money markets, don’t those get invested in treasury bills/notes anyway? Why go through a “middleman” when one has enough volume to invest directly?
Short-term obligations may not provide the yield that their financial structure requires.
10-year notes, in certain situations, provide an optimal combo of yield and risk. Provided, of course, that nothing major happens to the economy which wasn’t the case here. Then again, who’s good at predicting that?
In the end, it seemed like, given what was true at the time the decision was made, SVB made a rational choice.
> banks borrow money from depositors and lend that money via loans or investments.
Do they? Reserve requirements are almost non-existent. A better way to put it is that banks pretty much have a state-granted privilege for creating money and in the form of loans.
People read “reserve requirements have gone to zero” (which is true) and assume it is so that banks can keep lower reserves.
In fact, reserve requirements became meaningless because banks had (and continue to have) so much more in reserves than they were ever required to have under the prior system.
I don't understand this, could you clarify? If they have so much more money than the requirements demand, what is the point of lowering the requirements? Who does it help?
The point wasn’t that reserve requirements were “lowered”; they were removed - because the Fed moved to a different mechanism to set short-term interest rates.
If banks choose to keep lots of reserves (because you’re paying interest on them), it’s hard to change the willingness of banks to lend by changing the reserve requirement, right?
In economic terms, the supply of reserves is meeting the demand curve for reserves in an inelastic region.
So the Fed decided to announce a new approach; the so-called “ample reserves regime” where short term interest rate control would be achieved by administered rates rather than by the reserve requirements of the “limited reserves regime” that went before.
If this sounds very far from the quotidian business of deposit taking and loan making: that’s because it is.
I hear this a lot and it's in a lot of "explainer" videos on youtube and so on. The idea that banks have a special state-sponsored privilege to create credit is completely and very obviously untrue.
Try this thought experiment. You and I are in a bar. We order drinks but oh no the bar's card machine is down and you don't have cash. No problem I'll lend you a tenner.
1) Am I a bank?
2) Did I first contact the state to check it was ok to create money in the form of a loan to you?
I go back to the bar on another day on my own. Oh no! Their card machine is down again! This time I don't have cash on me. No problem the barman sees me all the time I can have the drink this time and pay up when I next get there and either have cash or their card machine is working.
3) Are they a bank?
4) Did they first contact the state to check it was ok to create money in the form of a loan to me?
The answer to all these questions is obviously no. Credit is created throughout the economy at all levels and it is not a special function perculiar to banks.
You are talking about credit, not money. Banks create actual state-backed money, which can be physically (or more likely electronically) paid to a third party after they've loaned it to you.
A better example would be if you were in the bar alone, and had no money, and instead just wrote an IOU on a bit of paper with your contact details. If we lived in a mythical 100% trustful utopia, then the barman would just accept this as money and so would anyone else in future who the barman needed to pay for anything. But we obviously don't live in such a society so unfortunately no, not anyone can just create money!
Banks don't create state-backed money either. The central bank creates money and gets it into the financial system by performing open market activities (eg buying treasuries with it) or depositing it into the accounts it holds with various banks.
Fractional reserve banking absolutely does not create money[1]. It creates credit exactly the same as if you lend a friend of yours some of your money. You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed.
The explainer videos I have seen are wildly wrong. I learned this stuff by reading the Basel accords [2], working with banking regulators and central bankers, working on banks' capital reserve models etc. That is to say I know how this actually works because I have been inside the sausage-making process for good or ill - I didn't learn it second-hand from someone who probably also learned it second-hand which is the feel I get from these videos.
Almost any time you see someone "explain" fractional reserve banking it is about 99% probably total bullshit. It's got to the point where "fractional reserve" is almost a trigger phrase for me - I know when I hear it that it is highly likely the speaker doesn't know what they are talking about. Almost like when you hear the word "fiat currency" you know it's very likely someone is going to try to shill you some crypto. An explanation which is not nonsense is here. [3] Fractional reserve banking means the bank doesn't need to keep the full amount of deposits in reserve, but can use some percentage to make loans. These loans are assets the bank has, but as with the example I gave above where you lend to a friend, no additional money is created in this process and when a bank does it, it's not fundamentally any different.
[2] Which are not secret by the way - you don't have to be initiated into the templars or something to understand them. They are boring as all hell to read but otherwise reasonably understandable with a little bit of background https://www.bis.org/basel_framework/
I feel like there are quite a lot of people here that do not understand that the relationship between theories of money and the actual day-to-day operations of banks is about as close as that between weather forecasting and umbrella manufacturing.
I'm confused. Under link [3] you posted, the section entitled "Fractional Reserve Banking Process" states the following:
>The fractional reserve banking process creates money that is inserted into the economy. When you deposit that $2,000, your bank might lend 10% of it to other customers, along with 10% from five other customers' accounts. This creates a loan of $1,000 for the customer needing a loan.
>The bank essentially created $1,000 and lent it to the borrower.
The above explanation was always my understanding. Is this a case of semantics?
> Fractional reserve banking absolutely does not create money[1]. It creates credit exactly the same as if you lend a friend of yours some of your money. You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed.
When a bank gives someone a loan M1/M2 increases (unlike in your loan-between-friends example). The increase in "currency in circulation plus deposits" is the very thing that those numbers try to measure.
You assert that the act of individual act of lending creates the money - this is known as the credit creation theory of money; the GP asserts that the central bank creates the money and banks are just moving it around - this is known as the financial intermediation theory of money. That also happens to be the theory that underlies most banking regulation, like the various Basel Accords.
You can look at it either way; or indeed you can take a third view, the fractional reserve theory of money, which suggests that the banking system as a whole creates money in aggregate, but not individual banks.
All of these are theories with their adherents and none has yet been proven right or wrong. The only wrong position is a failure to acknowledge that discussion is still open on this point, or to believe that these are anything other than macroeconomic models.
As far as I can understand seanhunter asserts that bank lending doesn't create money - pointing to the definition of M1/M2 money - and claims that bank lending is not different from me lending you $100 and that the amount of M1 or M2 money in supply doesn't changed in either case.
> The only wrong position is a failure to acknowledge that discussion is still open on this point
Saying that bank lending doesn't increase M1/M2 money supply is wrong. I don't think that discussion is still open on that. It's just how those things are defined. That's the only thing that I asserted.
>As far as I can understand seanhunter asserts that bank lending doesn't create money - pointing to the definition of M1/M2 money - and claims that bank lending is not different from me lending you $100 and that the amount of M1 or M2 money in supply doesn't changed in either case.
Right. That is the basic definition of the financial intermediation theory of money. It's actually a predominant view in the literature: for example, the Diamond-Dybvig model is based on the assumption that banks are not special as intermediaries; and it won the Nobel Prize for its authors in 2022.
I don't know if the financial intermediation theory of money has its own definition of M1 and M2 but the one given by seanhunter is the standard one. If we're using the same definition [are we?] then it either changes or it doesn't.
If money supply is "currency in circulation plus deposits[, etc.]" how does bank lending not increase the "currency in circulation plus deposits[, etc.]" amount?
(Of course lending between friends doesn't: the $100 bill in circulation is the same as before and the friendly IOU is not a deposit nor included in the [, etc.]")
A loan only increases the money supply if it's made without replacing the deposits that were loaned out. The financial intermediation theory is that that doesn't happen: a bank is just a place where money flows come together to find allocations to investments, and that the benefit is that the size mismatches between those in surplus and those who need to borrow can be reconciled, so banks that do this skillfully are economically valuable and make profits.
This is not, prima facie a bad theory, right? Go take a look at JP Morgan's balance sheet. The asset and liability sides of the sheet are basically loans and investments (on the asset side) plus deposits and outstanding debt (on the liability side), and these balance.
One may also say that turning up the heater doesn't increase the temperature of a room - because I open the window at the same time.
Anyway, my point was that saying that bank lending is like lending money to a friend and "You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed." doesn't make sense.
M1 would change if it was defined as "currency in circulation plus debts between friends" and the "oh, but my friend would sell the debt to the central bank or whatever in the end so there is no change in money supply" argument seems goalpost moving. The original analogy doesn't work and bank lending does increase money supply everything else being equal.
>Still, my point was that saying that bank lending is like lending money to a friend and "You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed." doesn't make sense.
On the one hand, you go to a friend and say "hey, can you lend me $100; I'll pay you back $105 in a year?" and your friend agrees.
On the other hand, your friend puts $100 into a 12 month CD, and the bank pays him a 2% interest rate. The bank then turns around and lends $100 to you as a 12 month personal loan with 5% APR.
Can you not see why there are some who would say "it is obviously wrong to suggest money has been created in the second case, but not the first" or indeed "in neither case has money been created"?
By the way, in case it is not obvious: the fact you don't have a compelling rationale to make me believe your description of the world, and I don't have a compelling rationale to convince you of my view of the world is why there are multiple competing theories.
I am not trying to tell you that you're wrong; just that you're not right.
I'm just claiming that saying that M2 money supply doesn't change in the second case is wrong because it has been defined to measure exactly that. Under the assumption that money has been created in the second case, but not the first - whether we find that obviously wrong or not is irrelevant.
> the fact you don't have a compelling rationale to make me believe your description of the world
I'm only trying to make you believe that the thing that seanhunter wrote is seems incompatible with his own definition of money supply which makes the bank loan situation different from the friend loan situation.
No; M2 has been defined to measure the money stock. You're a believer in the credit theory of money creation, so you obviously think increase in the money stock happens due to lending. If you're a believer in the financial intermediation theory, you don't think that - you think the central bank adds to or removes from the money stock (by controlling short-term interest rates, and therefore the amount of loanable funds), and the banks just move it around.
These are macro theories; they don't tell you anything at all about an individual loan - only aggregate behavior of the entire system.
The only think I've been repeating all along is that in your own example
On the one hand, you go to a friend and say "hey, can you lend me $100; I'll pay you back $105 in a year?" and your friend agrees.
On the other hand, your friend puts $100 into a 12 month CD, and the bank pays him a 2% interest rate. The bank then turns around and lends $100 to you as a 12 month personal loan with 5% APR.
M2 goes up in the second case where they end with $100 each (but doesn't in the first case where $100 change hands) because the example doesn't include any mention to a central bank removing from the money stock.
In the first case, the friend has given you $100 and won't see it back for a year, and then will get $5 interest.
In the second case, the friend has given the bank $100 and won't see it back for a year, and will then get $2 interest. The bank then lends you $100 which it won't see back for a year, and will then get $5 in interest.
The cases are economically the same; except in the second case, the bank takes the net interest margin of $3.
The second case, scaled up hugely, is observably what happens in the real world; it's not my theoretical construct. I refer you again to JP Morgan's balance sheet - the extent to which assets (mostly loans) exceed liabilities (mostly deposits) is simply the equity of the bank. That's the whole point of a balance sheet; it balances. If deposits exceed loans then, well, we saw what happens there, right?
You can't break half of the balance sheet off and say "look, these loans are increasing deposits at other banks; M2 has gone up"; that's literally meaningless.
But that's literally the definition of M2. You look at the currency in circulation, the deposits at banks and other things not present in that example and you add them up.
(I'm not sure why would you think that I'm not aware that the balance sheet of a bank is full of deposits and loans among other things, by the way. The whole discussion is about banks taking deposits and making loans!)
> Fractional reserve banking absolutely does not create money[1]. It creates credit exactly the same as if you lend a friend of yours some of your money.
Yes, it creates credit that people think is money. I suspect that's a big problem with it. People think their money is in the bank. Instead the bank is just extending them some credit that they can pass on to others when they "purchase" something.
Sure, but they don't have unlimited ability to make loans. They are subject to complex balance sheet constraints. And it's cheaper to borrow money from depositors than the Fed.
"As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions."
Read more - the reason is the "ample reserves" regime, where, as I showed, reserves are vastly higher than usual. This is because the Fed has transitioned to a better method to handle what used to be called the reserve requirement. The new (and as the above data demonstrated) is higher actual reserves. This is done via changes in mechanisms, described in the FAQ.
It's not like banks suddenly loan out all the money. The Fed page has a FAQ and you can look up related papers.
From the FAQ:
"For many years, reserve requirements played a central role in the implementation of monetary policy by creating a stable demand for reserves. In January 2019, the FOMC announced its intention to implement monetary policy in an ample reserves regime. Reserve requirements do not play a significant role in this operating framework."
People see the change, which is a good move for good reasons, and flip out, just like goldbug times or when CPI get adjusted and so on. A simple way to look at it for a long time there has been a idea battle between what's called endogenous and exogenous money creation (somewhat overview of the debate [1]), and over the past 50 years, most central banking systems have evolved as market needs evolved, to allow banks to lend beyond reserve requirements as long as they soon replenish, which was done via overnight lending windows through central banks. The practical effect is there has not been a "reserve requirement" except in name only for decades. Banks can lend whatever they want, and only have to borrow back to the old requirement which is simply an inefficiency.
This is summed up in one sentence on the Wikipedia article on reserve requirements as "Under this view, reserves therefore impose no constraints, as the deposit multiplier is simply, in the words of Kydland and Prescott (1990), a myth" [2]
Under the new system, the Fed changed other rates to account for this bookkeeping trick, with the same net effect on the banking system, but under simpler and more transparent accounting. They're not idiots.
So, since this was the reality of banking, the FED changed how things are tallied. Just like when CPI changed some terms to handle changes in reality, changes that were well documented, for good reason, people not reading carefully got upset and were sure they got cheated somehow.
So setting the old rate to zero and adopting the new methods for monetary control are the same pattern: terms change, in practice things are actually better off, but people used to the old term are upset and mischaracterize it as some a sign of financial calamity or underhandedness.
It's not. When people dig this out during an unrelated bank issue as some smoking gun it's worth stopping the nonsense in it's tracks in the same vein as COVID or climate or goldbug nonsense.
Not how it works. How it works is that there are a number of constraints and metrics placed on banks that they need to satisfy and prevent them taking risk. At any time it could be any one of these that is the limiting factor on risk. It may not be a measure of "reserves" that is the constraint.
That's not what GP is saying. When reserve requirements are low, banks are essentially no longer forbidden from lending out other customers' deposits.
When you decrease the reserve requirement, you're unlocking reserves that were previously locked up to back your deposits so that they can be loaned out to other customers, who will then promptly either directly or indirectly end up depositing their loaned amount into the banking system again, where the part that remains after the reserve requirement once again gets loaned out, deposited back in, etc.
In effect, because you're making this money go around, you're increasing the total supply of money, because these deposits are the money supply, and there can and often is more than a $1 net increase in overall deposits for each $1 deposited with a bank. Another way to state it is like so: you deposit $1, bank loans out $0.90, someone else deposits that $0.90, their bank loans out $0.81, so on and so forth for $10 of net deposit generation for a $1 initial deposit at 10% reserves held.
Of course, individual banks can elect to lock up more reserves than necessary, which would negate this effect.
> Is it possible for a regular bank to lend money it does not have?
Banks create money from nothing to lend out:
> Therefore, if you borrow £100 from the bank, and it credits your account with the amount, ‘new money’ has been created. It didn’t exist until it was credited to your account.
> This also means as you pay off the loan, the electronic money your bank created is ‘deleted’ – it no longer exists. You haven’t got richer or poorer. You might have less money in your bank account but your debts have gone down too. So essentially, banks create money, not wealth.
> This article explains how the majority of money in the modern economy is created by commercial banks making loans. Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.
Money is a psychological construct of humans to facilitate trade and the exchange of goods and services. Some societies don't (didn't) even have money/currency: everyone kept a mental 'tally' of who gave or took things, and there were social expectations of giving "gifts" for repayment. Physical tokens (bones, shells, gold, paper, etc) came later.
The posts above are incorrect about how banks work, but your question is spot on. Actually, banks always lend out money they don’t have - they can’t actually “lend deposits”. The risk of what banks do is why banking licenses are hard to get and it’s so regulated.
They borrow and repay with interest, so the don't borrow unless they have some use for the money that will return value to the borrower, and some profit to the bank, in order to repay the loan the bank got.
This isn't really an over-simplification as it is wrong. When someone deposits $1m in the bank, the bank's assets increase by $1m in cash, while liabilities also increase by $1m and owners' equity is unaffected. The problem is that for interest-bearing deposit accounts, those liabilities increase over time, which decreases owners' equity in the absence of a sufficiently appreciating asset (such as a good loan or cash flow-generating security). Further, the bank has certain operational costs that must be paid, and investors must make some return or they'll pull capital from the bank (that's a simplification for publicly traded banks like SVB). In practice, it seems that banks need about 3 percentage points above the interest rate they pay on deposits to cover these costs, based on the typical spread between the Prime rate and the Federal Funds rate, though I imagine this necessary yield has a much higher variance for smaller banks.
When interest rates were effectively zero and their deposits increased by a huge amount, SVB decided to buy long-term bonds w/ 1.5% interest to cover the extra liability over time so that assets would grow with liabilities. Then interest rates went up. Cash assets stopped growing, but liabilities remained the same, so they started selling their bonds. Bonds lose value when interest rates increase, so their bonds sold for a loss, decreasing asset values. In the last 48 hours, depositors got spooked. SVB's equity effectively went negative, since asset values decreased below outstanding liabilities. That's typically when the FDIC steps in to liquidate a bank.
For banks, assets must in general be growing faster than liabilities. If the bank experiences a situation where assets are not growing relative to liabilities, they need to have sufficient capitalization (i.e. owners' equity) to weather the storm.
Just to add to this excellent answer, because I don't think it's clear to most people: if the deposit is not created by that bank, the assets the bank takes on are the balancing side of the original deposit (so a loan at another correspondent bank or, if the spending was from the government, an asset at the central bank). Clearing might simplify the net situation, but fundamentally the asset the bank takes on matches the original asset that created the money.
Let debt be a graph where the nodes are people (with ledgers) and the edges are all of the form "alice rents $x from bob for y% APR". Actions that resolve/relax graph are payments of the form "alice pays bob $z", that lead to all balances being 0. Let the edges decay to null when balance is 0, such that a 'resolved graph' is simply a list of nodes with no edges, meaning 'no one is in debt to anyone'.
From this we can infer:
1. There is only one logical 'debt graph' in the world since they can (and do) all join.
2. The people running the graph do not want the graph to die, ever.
3. The profit of the debt business is proportional to transactions over time,
which is proportional to edges of the debt graph.
4. They want to (add, prevent from decay) as many edges as possible.
I somehow feel like I've caught my first, hazy glimpse of something important.
Your model feels trueish to me, but I think the analogy is actually overcomplicating it.
The basic nature of finance is that some people have money they don't immediately need and others have needs they can afford over time but not upfront.
It's basically a layer on top of money in general, which is a way of decentralizing value production. Instead of pairwise trades, money serves as credit for value creation, recognized by 3rd parties.
The people running the graph are everyone with excess money or the ability to acquire it. Basically, everyone but the poor.
Convert “$x” into “something Alice wants”. Alice doesn’t really want $x, she wants a new car, a house, a vacation, a new machine for her factory.
Now “They want to (add, prevent from decay) as many edges as possible” becomes “They want to encourage different parties to lend each other things they want”.
hold up hold up. there's a key distinction between the two categories of things you list in your examples. The first three are items that are consumed to meet Alice's specific desires, with features that match these desires-- a specific car, a specific house, a specific vacation. Alice buys them because she wants to use them.
In a sense Alice also buys physical capital to use them, but she's not using physical capital because of its specific qualities but instead because of the money the products it produces will fetch when sold on the market. Alice wants a vacation because she wants to go to Paris or New Zealand or whatever. Alice wants a machine part because she wants the money it will make her. Two very different categories of thing!
I bring this up not exactly as a critique of your analysis, but instead because none of the discussion in this thread is particularly tethered to the process of production, and it's specifically the disruption to production that makes the SVB collapse troubling.
I think what makes this sound so profound is that the second point sounds like a shadowy, centralised cabal. In reality it's a lot of the participants in the graph, for various reasons.
I also feel like having caught a hazy glimpse of something monumental. Thank you.
A few thoughts to add:
1. Should individuals inherit edge weight from their employers/governments? What should this inheritance be like? If I have no debt but have very little in savings, and if my company has debt to some other company which they have to default on, leading to my getting laid off, I can still be affected by debt.
2. I do not think it is accurate to think if "the people running the graph". I think it's more accurate to state local laws such as: any node which has more outgoing weight than incoming weight (i.e. net lenders) wants to prevent edges from decaying as much as possible while simultaneously making their borrowers more financially stable.
3. Would it be possible to quantify each vertex's credit-worthiness from just the labels you mentioned on edges? Would we need to add any other weights to the edges? e.g. the lender's estimate of the borrower's credit-worthiness?
Thanks for that, but after thinking about it a bit I don't think I have much to offer. Perhaps if we were in a pub and I could understand where you're coming from. The thing about models is that they can be used in a lot of different ways, and can be pushed in many more ways. The model seems so trivial that it must be part of a 1000 other models if it is correct, or it must be well-known why this model fails. I imagine the quants rolled their eyes and didn't even bother responding, like how physics people do when laymen riff on quantum mechanics. (My ego would love it if this is novel, but my brain knows better.)
I like the graph idea, but I might be missing some of what your saying... Although I think that it should be more than just people as nodes. Anything that can participate in the economy via signing contracts woukd be my first approximation. So, businesses, cities/states/nations, etc...
Also, I think it's reasonable for individuals to inherit edge weights from their governments, as a way to model taxes, national debt, etc.
> 2. The people running the graph do not want the graph to die, ever.
The problem with formulating it like this is it makes readers think that the set of people is a small-ish set of globalists or capitalists (or insert conspiratorial "others" as appropriate). But the set is far from small: basically anyone who ever wants to acquire debt for any reason (most common reasons include "attend college", "buy a car", or "buy a house"), or anyone who wants to profit from lending money to people, which is a fancy way of saying anyone who wants to invest money (such as buying stocks or bonds).
If we're modeling the flow of value (in the more abstract), then holders of most currencies on the planet have real value constantly flowing away from them... by virtue of inflation.
Or in a larger macro sense, positive central bank interest rates create a requirement for everyone to acquire some debt in order to counterbalance the drag.
Yep, this is indeed what is going on, and relates to concepts like "capitalism motivating nationalism, imperialism and colonialism" - it's the large scale expansion of the debt graph. It's something you can pull off profitably temporarily by coordinating your nation towards a stronger state bureaucracy, aggressive trade policies, industrialization, and destabilization or dehumanization of rivals. When we speak of "this is good for the nation", what's really at stake, materially speaking, is this kind of Machiavellian machination of debt, tempered only by whether it can be justified in terms of national myth, dominant ideology, party politics, etc.
It produces a grand, generational historical narrative, but it's also a form of pyramid scheme and guaranteed to run out of runway at some point when the graph, rather than expanding, finds ways to get by with different trade flows that ignore the center - and each time that happens, you get a massive economic crisis, elites vying for power and drumming up scapegoats to avoid heat, but also waves of material change(different lifestyles and work arrangements).
So there is downside to debt in that it can reinforce hierarchies, but also upsides in that the network itself is acting to transfer useful information about material needs. All things that, having becoming so much more digitally connected in the last 30 years, we can probably revise again to become more abstracted.
Yes, it strikes me as perverse that if your business is debt, then a debt-free world is a very bad world. It's perverse in the same way it is perverse for a doctor to be sad when fewer people get sick. So, I empathize. Be that as it may, I don't see fewer people getting sick or wanting debt, so I think the point is somewhat moot.
It is troubling that the debt industry will attempt to increase the total debt in the world however it can. This is like a doctor attempting to increase the total sickness in the world - which is evil (not a word I use lightly, btw). But to say that either debt or medical industries should 'die' because perverse incentives exist seems wrong to me.
To a large extent it reflects liquidity demands. When governments are falling over themselves to profess "fiscal responsibility" the liquidity demands are met through private banking.
There's a concept in Anthropology/Primitive Economics called "Gift Economy" where participants in a community gifted each other help, goods, food, and rely on being gifted back similar things in higher/lower proportions sometimes in the near future.
If I'm not mistaken, Debt: the First 5000 Years and the Dawn of Everything books examined this.
Your graph is a formalization of such relationship, no?
This system will settle on a solution if there is no net total creation of money in the world. As long as new money is allowed to enter this system, edges will keep appearing to protect it.
1. This doesn't actually mean anything. It's true by your definition.
2. There is noone running the graph
3. This is true of all econonomic activity in a free market economic model. The assumption underlying market capitalism is that on net rational actors will only perform transactions which add value to them. Therefore the profit of the system is proportional to transactions over time which is proportional to the edges of the "financial transaction" graph. Debt is not required for this observation to be true - it's intrinsic to the model or the transactions won't occur.
4. There is no "they" other than "all the participants in the financial system". On net everyone participating in the financial system is doing so for their own benefit and therefore are invested in keeping the system running.
What makes you say that? It seems to be a restructuring of a supply/demand curve along a lattice. (Ironic, given your name lol?)
https://en.m.wikipedia.org/wiki/Total_order
This isn't an over simplification it's just wrong. The bank does have more assets (the 1 million in cash) that balances the liability (the 1 million they owe to their customer).
Yes, but the problem is the 1 million is unlikely to be in cash. Here, it is in MBS issued at low interest rates and thus practically ~$500k if the security is sold right now.
Banks have a serious problem in their hands as they have to figure out a way to keep buying assets that they have to buy by law, while the Fed is going to keep increasing the interest rates via selling their MBS portfolio at a rate that makes "yesterday's treasury or MBS" the loser.
If action is not taken we haven't heard the end of this.
The $1 million deposit creates a $1 million cash asset and a $1 million account liability.
The value being in MBS now is a result of a separate transaction (well, a lot of them, probably) where (in aggregate) the bank takes a bunch of money from its cash assets and trades them for an (initially) equal value in MBS assets.
It becomes a problem when the MBS assets lose value, and the bank needs cash to cover withdrawals.
This is right, though I think we should be clear that the MBSs lost value because they are normally like bonds, and bond prices decrease when yields increase.
MBSs tend to remind people of '08 when MBSs lost value because too many had a bunch of garbage loans which defaulted, causing MBSs' face values to decrease. In this case, the fact that they were MBSs is mostly a coincidence. If SVB had invested in Treasuries, they'd be in the same world of hurt that they're in today.
> If SVB had invested in Treasuries, they'd be in the same world of hurt that they're in today.
Not necessarily, if they were investing/laddering in short term Treasury Bills (< 52 weeks) instead of longer dated bonds things might have panned out differently.
”97% of these MBS were 10+ year duration, with a weighted average yield of 1.56%.”
Treasury Bills from 6 months ago had yields of 3.37%.
Sure, but you don't get a useful model of a bank by only looking at the short term like this.
> The point is that when banks receive deposits, in the short term, their assets/liabilities doesn’t change.
They do change: Cash is a (risk-free, modulo safe storage) asset, the deposit is a liability. This has consequences for all kinds of metrics vital to the running of a bank.
Correct, although if they don't do something to make money with the cash they take in as deposits, they won't have sufficient income to cover their expenses, let alone make a profit.
One way to generate interest is to simply park it at the Fed. Check out The Narrow Bank for the story of an upstart that wanted to make that their whole business model.
You're right, the full million isn't a liability. But anyone depositing 1M isn't putting it in a non-interest bearing account. So now you are generating liability every second you sit on the cash. Which means you need to "invest" it.
Doesn't matter if it's physical cash or an electronic ledger since both the electronic ledger and the physical green pieces of paper are liabilities of the banking system, specifically for US dollars they're both liabilities of the Federal Reserve.
> specifically for US dollars they're both liabilities of the Federal Reserve.
I don't think that's right. There are banks outside the US that hold US dollars that the Federal Reserve has no jurisdiction over. They create more currency through fractional reserve lending for their local currency as well as any dollar denominated loans they make. I don't see how those are liabilities of the Federal Reserve, but maybe I'm missing something?
Dollars are bank notes “promises to repay”. It used to be many different bank issues notes payable in gold, now it’s one bank - the Fed, and it’s no longer gold.
It doesnt matter if the US dollars is held outside the US. The dollar represents a promise by the fed to pay, and thus is a liability to the fed.
Of course the fed has the power to create and destroy dollars.
> Of course the fed has the power to create and destroy dollars.
So to banks outside the US. That's how fractional reserve banking works. If I go to the UK and deposit $1m USD, and they loan out $900k of that to you, that UK based bank has created $900k.
A $1M deposit adds to both assets and liabilities.
In double entry accounting, you mark any changes with both a debit and a credit. This allows you to see not only why one account changes (a single entry), but also the cause of that change (the second entry).
I think programmers find double-entry bookkeeping counterintuitive. It feels error-prone. In programming, you keep a single source of truth. Any time you copy the same data to two different places, one of them is always wrong.
Double-entry bookkeeping makes sense once you understand the the invariants you have to keep, and why you need to track 5 different types of books. Some of those accounts work in opposite ways, such that credit to one is a debit to another.
It all works out and is essential for "debugging" problems (when money appears to go missing -- or worse, materializes and you don't know why). But there's some counterintuitive language and it'll mess you up until you accept it.
The name "double-entry" is a little bit misleading. The "double" part makes it sound like you are duplicating work, but that's not really what's happening.
If you were accounting with pen and paper, you would write the transaction amount twice — positive in one column and negative in another. This maintains the invariant that money cannot be created or destroyed.
In terms of an abstract data model, though, each transaction is best thought of as a flow, or a weighted arrow. It has one amount and two ends: a source and a destination. The "double" in "double-entry" really just means that the arrow has two ends. Obviously every arrow has to have a head and a tail — it doesn't make sense for there to be no source or no destination.
The credit vs. debit thing confuses people a lot, and in my opinion is a red herring. If I could wave a magic wand, I would delete the words "credit" and "debit" from accounting because they are hopelessly inconsistent.
All you have to do is think of the conservation of money like the conservation of mass — when it moves, it leaves one place and arrives at another. The moment I stopped using the words "credit" and "debit", my understanding of accounting went from "I have no idea what I'm doing" to "Everything is intuitively obvious."
Yeah I agree. I aced my MBA accounting class but it makes a hell of a lot more sense to conceptualize everything as “stocks and flows”.
Also, I would say transactions are actually “multi-arrows” since there can be multiple sources and/or multiple destinations. A Bitcoin transaction captures this structure more or less perfectly.
Yeah, I just treat credit and debit as opaque blobs. They're words, I don't really know what they mean, but I know one means "side A" and one means "side B" ;)
> This maintains the invariant that money cannot be created or destroyed.
And if you wonder, if money cannot be created or destroyed, how does a monetary system handle the population tripling over the past 50 years?
The answer is national debt. The US national debt is just an artifact of this double entry bookkeeping. In order for there to be +money in the economy for the ever-growing number of citizens to do commerce with, the treasury incurs on itself -money. That's national debt.
The corollary then, if the US ever pays back all of its national debt, the economy will crash because there just aren't cash available for people to do commerce with. A +90trillion on the government balance sheet equals a -90trillion on the private sector balance sheet.
> And if you wonder, if money cannot be created or destroyed, how does a monetary system handle the population tripling over the past 50 years?
There is ONE special actor (in the US) that can create money out of the thin air: the Federal Reserve.
It alone can "buy" securities by crediting banks with money created out of nothing. Banks simply see a transaction with a dollar amount on their accounts within the Federal Reserve, and that's it. The money just appears.
The invariant "money can't be created or destroyed" holds for everybody else, including individual banks.
> The answer is national debt.
That's completely incorrect. The Federal Reserve can arbitrarily create (or destroy) money even if the national debt goes away entirely.
Most of the Federal Reserve's balance sheet is Treasury securities. If the Treasury stops issuing those securities, then the Federal Reserve don't have anything to buy.
Saying that the Fed can arbitrarily create and destroy money misses the point, that they then have to buy SOMETHING with those money, and there are strict rules about what they can buy, and it just happens that the Treasury controls the supply of the primary asset class that the Fed is allowed to buy. Once you clear out all the dance and ceremony, you arrive at the conclusion that the Treasury issues new money by issuing new securities.
> Most of the Federal Reserve's balance sheet is Treasury securities.
That's true, simply because they're the most convenient way to manipulate the monetary supply. Not much else is readily available in the volumes needed.
But they are not _essential_.
> Saying that the Fed can arbitrarily create and destroy money misses the point, that they then have to buy SOMETHING with those money, and there are strict rules about what they can buy
Sure, the invariant: "money goes out, asset goes in" holds.
Not really. Money is created but it is created by the fractional reserve baking model where banks borrow from people who are willing to lend for short periods of time (depositors) and lend to those who are looking to borrow in the long term. The fact that you tend to deposit in checking accounts is what creates the money.
The private banking system can only multiply off of the monetary base up to a certain multiplier, it cannot expand that base. Only the government treasury can expand that monetary base.
If the private banks have conjured up 100x the monetary base in 1970, then when the population doubles by 2020, the banks cannot multiply further up to 200x. The treasury has to expand the base while the banks keep their multiplier fairly constant.
Double entry bookkeeping IS error prone - you have 2 opportunities to make each mistake.
However single entry bookkeeping is FRAUD prone. Just change one number and your theft is hard to track down!
That is why the adoption of double entry bookkeeping was critical for allowing commercial institutions to outgrow a size where owners could individually trust all who were working for them with access to money.
Yes, and once you get the programmer to realize this, it all makes sense.
The ledgers are not the source of truth. No: this is a journaled filesystem; the transaction log is the ultimate source of truth. When you detect faults you recover from the journal, if something isn't completely written into the journal then it does not exist. The zero-sum property exists on every individual transaction and each transaction has an ID and the ledgers point at these IDs for auditing purposes.
So why have the zero sum property? Well, for one thing, it creates a uniform access model, I can't just credit my account, I have to debit someone else's account and they can have rules that might prohibit me from doing so. By carefully setting up these accounts you can also do what's sometimes called "behavior anomaly detection."
So for instance normal financial cards kind of work by opening up your entire wallet to a cash register and asking the cash register to pull out exactly the amount that you owe, understandably this might not be desirable if you are tracking some in-game-gold transactions in an internet game. You can get as elaborate as you want but think for example of a quick-consistency-check rule saying that “accounts starting 4xxx (player balances) never transfer directly to each other, instead users are expected to put the exact sum of money plus a little 5% padding into one of their 5xxx accounts and then give someone else a token permitting them to withdraw from that account." Stuff like that. A developer tries to code something up that doesn't go through this process and runs into errors in testing and has to conform their code’s behavior to the less risky process so that nobody is ever opening their entire wallet to a griefer.
The zero sum property also makes it really easy to just add up along (any subset of) each column and find most errors. Not so important now when everything's stored in a computerized database anyway, but a lot more relevant to actual books with actual writing in them.
That’s an oversimplification. Saying that it’s error prone because you have to write in two places is akin to saying that using a checksum is error prone: you have to write now the vale AND the checksum! More opportunities to make an error!
Doble entry accounting is very similar to a checksum in that sense. It provides error detection. If you make a mistake in one of those two places, you will know immediately. As opposed to single entry, where you can carry that error indefinitely until somehow you catch it.
> That is why the adoption of double entry bookkeeping was critical for allowing commercial institutions to outgrow a size where owners could individually trust all who were working for them with access to money.
Wikipedia tells us that double-entry bookkeeping is first attested in the late 13th century.
But commercial institutions larger than the personal-trust threshold are attested as far back as written history goes.
> commercial institutions larger than the personal-trust threshold are attested as far back as written history goes
[citation needed]? I don't necessarily doubt you but I'd like to see an example. The only thing I can really think of would be governments, but that was definitely personal trust (mixed with a little bit of threat of summary execution if the king didn't like you).
I guess I'm confused. If you're willing to consider governments (makes sense to me!), we are informed that the Achaemenid Empire (roughly 2 million square miles, mid-6th-century to mid-4th-century BC) was divided into 20 "tribute" districts: https://en.wikipedia.org/wiki/Taxation_districts_of_the_Acha...
The smallest amount of tribute listed there is more than five and a half tons of silver. If we make the assumption that each of these districts was handled by a different person, we already have a staff of 20 people plus the king.
(Not to mention, the large majority of Achaemenid taxation was not collected in this form. It was collected in kind and stored in an empire-wide system of distributed warehouses. I assume metal tribute was centralized. If you think the warehouse administrators - who inventory the goods and are responsible for making payments out of them - are "responsible for money", you're probably adding at least a couple dozen more people.)
By contrast, https://www.theofficialboard.com/org-chart/exxonmobil suggests that the top two levels (including the board) of Exxon total 26 people, or (excluding the board as a level, but still including the CEO) 24 people. The CEO has 13 direct reports.
So if the argument is that ancient kingdoms were below the personal trust threshold because the king had a low - and therefore manageably trustworthy - number of direct reports, it appears to be the case that our largest corporations today are also comfortably below the personal trust threshold, so there was never any need to exceed the threshold and in fact we never have.
(This isn't quite an apples-to-apples comparison; maybe there are 20 tribute administrators who report to a high overseer of tribute who reports to the king. Maybe each tribute administrator is one of five reporting to a low overseer of tribute, the four low overseers report to a high overseer, and he reports to the king. I don't know. How many employees do you think Exxon has who are directly responsible for submitting revenue totals in excess of three million dollars?)
On the other hand, if we think Exxon is beyond the personal trust threshold by virtue of its geographic extent (huge!), or its total number of employees (huge!), or its total number of employees touching money with the potential opportunity to steal that money (still huge!)... I think we have to say the same thing about ancient palaces, and really about ancient temples. A temple might "only" employ a few hundred people, but that's more people than you can personally trust. An important temple employed a few thousand people.
In a business I hand you my money and trust that you will hand me back my profits.
A ancient government put someone in charge and demanded tribute. Failure to produce tribute resulted in an army showing up to collect tribute. It was so common as to be expected that the administrator, called a satrap, would collect excess tribute and live a lavish lifestyle. The king sent spies to root out the worst of the abuse, but it was an uphill battle.
Governments can be run this way because efficiency is not particularly essential to their profitability. But efficiency is required for commercial enterprises. It is not enough to collect money and let your subordinates enrich themselves. You want to track all the money and not let your subordinates cheat the enterprise to their personal profit.
The claim above is that empires are below the threshold where everything runs on personal trust, not that governmental administration is fundamentally different from other kinds of administration.
> But efficiency is required for commercial enterprises. It is not enough to collect money and let your subordinates enrich themselves. You want to track all the money and not let your subordinates cheat the enterprise to their personal profit.
The first two sentences are obviously false; you want to track all the money, but you have no particular need to do so as long as some of the money is making its way to you.
Single entry bookkeeping isn't really a thing and isn't really keeping books. It's just an account register or account statement with no totals or anything to check against.
Double entry basically just means that for every transaction on your books, you are showing where the money/asset/liability came from and/or where it's going. If you enter that you paid $100 for the AWS bill, you need to indicate from what account that money came from. So you would debit AWS Expense and you would credit your Wells Fargo Checking Account. With modern software, this basically just amounts to entering the expense and specifying which account it came from.
In my mind it would be more like only a total - 'single entry' is how most people manage their wallets: '£5 change, put that in there, oh I have £15 now'. No record of where anything came from or where anything's gone.
> I think programmers find double-entry bookkeeping counterintuitive. It feels error-prone. In programming, you keep a single source of truth. Any time you copy the same data to two different places, one of them is always wrong.
Double-entry bookkeeping is creating of an audit-trail/error-evident data store; which is the purpose of the apparent duplication. But it can be viewed as a view of dataset reflecting a single source of truth, that documents value flows; every movement of value has a source and a sink, and the amount that moves from the source must equal the amount that moves to the sink. Losing the redundancy that allows error-checking of records, you could view each accounting transaction as a triple of (source, sink, amount).
I think if a programmer were designing accounting, they'd put the flows in the database, and build views out of that. They might materialize the views for performance reasons, but they'd treat those views as suspect and the first response to any bug would be "blow away the accounts and recreate them".
You couldn't do bookkeping with actual books that way, and historically this way makes sense. Nor is it likely that the accountants are going to rethink their field from the ground up for the convenience of programmers.
> I think if a programmer were designing accounting, they'd put the flows in the database, and build views out of that. They might materialize the views for performance reasons, but they'd treat those views as suspect and the first response to any bug would be "blow away the accounts and recreate them".
That is actually how it works, if you don't have "flows" you don't have accounting postings and if you have to fix an error you redo the postings from the flows. In this sense I would say that the "flows" are the source of truth.
Right. The only actual raw data is transactions. Account balances are just filtered rollups. Double entry bookkeeping is just how you manually accumulate a set of account balances from transaction data, and a set of conventions for consistently labeling and grouping the transaction sources and destinations.
I mean, this is kind of how accounting does work. To a basic approximation a reconciliation is a line by line review of each of the flows, and an audit is "blow away the accounts and recreate them" and both happen all the time.
The other thing you get into as scenarios get complex is that there's a tendency to ask questions like "Why are you recording it this way rather than that way? The second way seems more logical to me."
The answer usually being some variation of "Because that's the way the Financial Accounting Standards Board says to do it."
I've been running my own finances with double entry bookkeeping (via beancount) for about 4 years now, and it's ended up being super useful. As long as I'm 90% sure I got all the income, expenses, investment buys and sells, and transfers between accounts, I can add "balance" statements for a date and easily work backwards to find if I missed anything.
I have a friend that's an accountant that tried to explain how it worked. I thought it was more or less being responsible for counting money, but I think my eyes glazed over a bit trying to understand it.
But to be fair he did pretty much the same when I tried to explain programming.
Always important to step outside your software bubble once and a while.
I'm trying to understand how to read older 10-Ks and apply the capitalization of operating leases to those reports (converting property that is leased into capital to get an accurate estimate of the capital employed at the business) and with my background in IT and physics it is still a bit hard to follow (what I'm slow at is language, and really this is just learning a foreign language).
Double-entry bookkeeping is essentially the law of conservation of energy applied to balance sheets. It's much more deep as it was invented some 5 centuries earlier than programming.
If by 'error' you mean the amount of a transaction then yes you enter it twice but that should not really increase errors.
Now, on the other hand, it is especially designed to account correctly for that amount in order to keep your accounts correct and balanced. It is be much easier to lose track of things with single-entry accounting.
I think programmers find double-entry bookkeeping counterintuitive. It feels error-prone. In programming, you keep a single source of truth. Any time you copy the same data to two different places, one of them is always wrong.
In essence you are just recording transactions with source and destination accounts and the amount. And at least in principle you could just log all transactions in this way without any redundant information. If you insist on making the change to each account more obvious, then you will have to record the amount twice, once for each account, but if you are doing the accounting with a computer, then I would guess that you always just record the transaction and only show the amount twice with different signs for the two involved accounts. Or does bookkeeping for some weird reasons really record each amount twice?
> Or does bookkeeping for some weird reasons really record each amount twice?
There is a surprisingly common reason, but it isn't weird. Consider a paycheck. You have income, but then you split that up. Some pays for insurance premiums, some is withheld for taxes, some may be contributed to a retirement account, and some is deposited into a bank account. Earnings is a credit to an income account, but everything else is a debit to some other account. The total debits equal the total credits, but each credit and debit must necessarily be a separate entry, because they all affect different accounts.
> It all works out and is essential for "debugging" problems (when money appears to go missing -- or worse, materializes and you don't know why).
That's equally true in programming. The problem is that it only helps you debug problems that it created or participated in...
The difference in accounting is that it's not "two entries for the same thing". It's a credit and debit entry. It's a source and a target entry. It's two different entries for two different things, even though some of the details (like the transaction that they actually relate to) will be shared.
(And they're treated as separate "rows", rather than as additional columns on a single row, because it's a many-to-many relationship. Very database-designy!)
You'd think that the solution to that confusion would be database transactions (commit everything or nothing), but there are exceptions. In ACH, sometimes you have to send out a lone credit or debit with no matching entry. It feels very wrong, but it's necessary because it balances out some other entry in another file (that you might not have access to.)
OTOH, once you have double-entry bookkeeping in your brain, you won't want to go back. I now feel that, from the perspective of a business or consumer, money is never created or destroyed, it only moves between accounts.
They have both $1m more assets and $1m liabilities.
But that does not reflect risk.
For instance, now they take those $1m in cash and use them to make risky loans or investments. At face value the balance sheet is the same because they still have $1m in asset... except that the risk that this asset turns into eff all has significantly increased.
Too much money is only a problem if you are greedy for returns, like all the investors who lost money when yields were unsustainably low the last few years. They could have deposited it with the Fed and have been totally fine.
Individual investors don't even have that option and also have inflation to deal with. Banks don't.
No, they were greedy. They were going to lose it one way or another, either through inflation or through asset depreciation. There was no way around it. Going to a riskier asset doesn't help because all assets have the same interest-rate risk embedded. They just took on more risk in addition to that.
Real rates were negative for 10+ years (and still are on the short end!). That's everyone paying for trillions of dollars of wars, speculation and bad investments. The bill has to be paid.
But as mentioned, none of this applies to intermediaries like banks. They aren't forced to take on any risk.
I think coredog64 is speaking more generally. The bank in the article was foolish. Other banks can still encounter real problems with too much cash on hand... granted they don't have to go hog wild on MBS or anything like that.
> Real rates were negative for 10+ years (and still are on the short end!). That's everyone paying for trillions of dollars of wars, speculation and bad investments. The bill has to be paid.
They sure were, and fortunately humanity took that free money and invested it in sustainable energy technology so that at least we got a bunch of infrastructure out of it.
Oh actually wait we just had austerity for some reason.
Banks don't pay the Fed rate on deposits so they already have that to pay expenses. In fact more deposits = more money on the interest differential but expenses don't scale with money.
Which is why there is a ~4% spread on savings/CD interest rates at banks right now.
Edit: maybe I wasn't clear and should have said "between" banks. Synchrony bank will give you 4% in a _savings_ account (https://www.synchronybank.com/banking/high-yield-savings/?UI...) while my local credit union and many big banks (ex: bank of America are at 0.01%) are still effectively 0%
In the past (<2008), cash accounts (savings/cds/etc) I remember there being a %1 or so between banks, but these days its huge.
Synchrony offers such high yields on savings because their big product is consumer credit cards, and even at 4% APY on savings accounts the spread to a 25% APR credit product, even factoring in risk, makes it extremely profitable to do so.
That's really the big reason why savings rates vary so much between banks, if you have a bunch of consumer credit lines then high savings rates make sense, if you have a bunch of lower fixed-rate collateralized loans then you can't get away with lowering your spread so much.
It's not nearly that simple, though. You are ignoring capital requirements. For things like Treasuries, you don't need any capital % against it. ($100 in deposit -> $100 in Treasuries, if you borrow at 1 and lend at 4 you made a 3% spread on $100). But for risky things that might yield much more, you might need to reserve far more, meaning you need to fund part of it with equity. ($100 in deposit but with a 50% capital requirement means you can -> buy $100 of high-yield stuff, but you need to use $50 of your equity to do so)
There's other epicycles to this too. For example, a bank can just "buy" deposits through a correspondent bank (a bank-for-banks). So the direct connection between your kind of borrowing and kind of lending, particularly when its consumer / credit card stuff, can be tenuous. In SVB's case, though, all of the stuff happened in a tight echo chamber ecosystem -- SVB got deposits from tech cos, who got money from VCs, who were working off of capital call LOCs from SVB. So your observation is germane.
Yeah, I oversimplified it to a large degree because getting to deep into the nightmare that lies beneath the banking system can make ones head explode. It's accurate enough for a layperson, if nothing else.
Not exactly. The banks do not want less deposits (ask SVB how bad that can be!) but they try to get away with paying as little as possible and keep the spread. (You wouldn't say that the main objective of companies when they raise prices is to have less customers, would you?)
If they wanted more deposits, why would they pay as little as possible to 'keep the spread'? No bank is anywhere near monopoly; there are tons more deposits to get (if you want them, and can make money safely on a spread).
For the same reason that many businesses do not want "more customers" above anything else - to the point of selling at cost or at a loss - and if they increase prices is not necessarily because they want "less customers".
Some banks actually do want less deposits. They do things like increasing fees to chase them away. But it takes some real discipline and investor management to pull it off.
If a bank is noticing they are getting more deposits then they can safely make returns for (like SVB in 2020), can banks "simply" return deposits to customers and/or decline new customers/deposits? Is there a precedent to doing this? Or does everyone decide it's better to take risky bets to grow with the increasing deposits and we'll keep seeing runs when those bets go south?
> When someone deposits $1m at a bank, the bank doesn't have $1m more assets, it has $1m more liabilities.
Not quite. It actually has both.
Yes, it owes $1m to the depositor, but it also has $1m in cash now, at least for a while. Until it does something with it, like loaning it out or investing it in some debt instrument. The cash is an asset, as is the loan or debt instrument it exchanges the cash for.
Yes, bank deposits are a liability for the bank, which is why a bank won’t increase the amount you have in your account if you ask nicely. You have to pay them. If someone’s bank account went up by $1 million, the bank better have gotten $1 million more in assets from them somehow, or something weird is going on.
(Often, the asset comes from the bank making a loan. You can pay later.)
I think the additional liability from that event would be much less because it would be computed from the interest payments that the bank eventually owes the depositors.
So given an interest per annum of 1% (for example), a $1m deposit would add $1m liquid, non-earning assets while also adding $1.01m to their liabilities. So, effectively, they’d have $10,000 in unsecured liabilities.
To counter that imbalance (as well as protect the cash from the effects of inflation), they’d have to put some of that cash to work via various investments.
Money for banks is what raw material is for manufacturing. What they are doing is risk management (analyzing risk, packaging risk, selling it, buying it).
No, the $1M deposit is an asset and liability (which offset each other). SVB then invested those assets in bonds/securities/T-bills but then had to sell them at a 20% loss because they needed funds for liquidity—-so now they don’t have as many assets as they do liabilities and hence are taken over by FDIC.
Deposits are liabilities to the bank's customers. The cash the bank has, regardless of how it got it, is an asset. The cash may result from a customer making a deposit, but its still just cash. Deposits and cash are separate items on the balance sheet. Here is an example from the Fed:
(Yes, this is a gross over-simplification)