From The Times:
Everyone needs a guru, even the Governor of the Bank of England. When Mervyn King mentioned him by name three times during evidence on the future of Britain's banking sector, MPs were left scratching their heads over the identity of a little-known American economist who, it appears, has been bending the Governor's ear. The owlish Mr King, it emerges, has become a keen advocate of the radical ideas of Laurence Kotlikoff, an American professor of economics at Boston University...
The Harvard-educated economist wants to ban banks from lending money that is not matched in cash reserves (1). He also wants the banking regulator to approve every single mortgage sold (2) and to force banks to turn their vastly lucrative investment arms into separate consultancies.
Modern bankers keep only small amounts, relative to the loans they make, in reserve in case of crisis (3). Under Professor Kotlikoff's plans, which he calls Limited Purpose Banking, banks would be turned into mutual funds that would take no risk and lend out only what they had taken in deposits from savers (4).
1) Cretinous comment. Let's imagine that a new bank starts on Day One with £1 million in coins and notes in its safe - the minute you take some money out of the safe and lend it to a borrower then it can no longer be matched by cash reserves! Unless he means that a bank can only lend out half of its total cash, which would be hyper-cautious, to which see 3)a).
2) Yeah right. In the UK, but especially in the USA, politicians were putting pressure on banks to approve all sorts of sub-prime or self-certified mortgage loans - politicians like rising house prices to keep the Home-Owner-Ists* happy - so sticking in another layer of regulators, accountable to the self-same politicians, will either make no difference or just lead to the whole system grinding to a halt.
3) Anybody who uses the word "reserve" is usually waffling and probably a moron. There is a mismatch between common parlance and the technical accounting term - it can mean two entirely opposite things:
a) If you are referring to the "assets" side, it means stuff which highly liquid, nigh 100% safe and which can't fluctuate in sterling terms - in other words, coins and notes in a safe; balances with the Bank of England; and short term UK government bonds.
b) If you are referring to the "financed by" side, it means shareholders' funds generally, i.e. non-repayable liabilities. These are not assets.
To explain the misunderstanding, in terms of a typical household, your house is an asset and your mortgage is a liability (the words have the same meaning in common parlance and in accounting).
However, if the household also has a couple of thousand quid tucked away in a rainy day account, the common man sees these as "reserves" but in accounting terms the rainy day money is also included as "assets" (albeit current rather than fixed). Conversely, in common parlance, the value of your house minus the outstanding mortgage is called "equity" but in accounting terms, it is analogous to "reserves".
As it happens, a higher ratio of either type of "reserve" compared to the balance sheet total will lead to "safer" banking, but the question is "safe for whom?". More highly liquid safe assets makes the bank safer for depositors and shareholders; a higher amount of shareholders' funds means it's safer for depositors, but not safer for shareholders, as they have more of their own capital at risk).
4) Yup. The good old-fashioned building society model. Firstly, even a well-run and cautious building society can and does create matching loans and deposits out of thin air, as I explained for the umpteenth time yesterday**; and secondly, a building society can and does fail as well if it makes reckless loans on overvalued properties, see e.g. Dunfermline BS. The depositors in a building society bear exactly the same total risk as do shareholders and bondholders in a bank.
The main reason why building societies were seen as "safe" and why they have become riskier is because from the 1980s onwards, they were allowed to issue bonds, borrow on the money markets etc - so it's a purely behavioural thing: if you are funded by short term deposits you tend to be much more cautious with lending decisions, so I'll give him half a mark for that, I suppose.
* Disclaimer - not all homeowners are Home-Owner-Ists. Only the NIMBYs and people who prefer taxation of incomes to taxation of property are Home-Owner-Ists.
** This is only a bad thing if the loans are taken out to acquire overvalued assets, i.e. in practice most of the time.
A grim document
1 hour ago
19 comments:
I took (1) to mean that he should only lend money he has, rather than money he has not.
Doesn't that make sense?
It is easily possible for a bank, if it is big enoughm to lend more money than it actually has. It does it in the form of a guarantee. Like a five-pound note, for example.
"In accounting terms it can mean two entirely opposite things": which is the sort of thing that seems to be routine in accountancy, an activity that seems largely devoid of intellectual content, but which makes do with an obscure and ambiguous jargon in its place.
Why should accountancy have intellectual content any more than say, engineering, agriculture or the Inland Revenue?
Kotlikoff is odd but the mutual scheme isn't quite as crazed as it sounds. We depositors (investors whatever) make the choice of what gets funded by which mutual we put the money into.
However,he bans short and long so we get a dreadful dearth of long term lending.
I have a feeling that 's other ideas of his that get King's attention. For example, "deficit" is in one sense a meaningless concept. You're either paying for the spending now in taxes or you will pay for the spending now in the future through taxation to pay for the borrowing.
But then that's been said often enough anyway. "To spend is to tax".
UM, that's called "simultaneously creating loans and deposits" and we did that to death yesterday.
D, I have amended that section for clarity.
B, accounting strikes me as quite simple and straightforward but as 99% of the population (including many accountants) don't have a bloody clue, I can only assume it is trickier than it looks.
TW, hurray for building societies, if that is where some people like to put their money (more safety, lower interest rate, I know that I would prefer this) then let the markets decide. Agreed on tax and spend, of course.
@MW
No.I "cretinous comment" What the counter argument is saying is that
the bank does not lend out any of the original cash but despatches cheques or whatever out to the customers,with scant regard for what's "in the vaults" which stays yj.Since the bank keeps only a fractional reserve,at present only 3%,
Mark
I must have missed yesterday, or perhaps I didn't understand it, not being an accountant.
I wasn't meaning simultaneously creating loans and deposits. I was thinking more of lending money on the strength of what you're owed. Maybe I'm an arse.
Accounting isn't more difficult than it looks, BTW, I've seen all the gubbins you have to do to become one and you could probably do it pissed. Some of the accountants I know obviously did, as that's the way they always are.
The only reaosn I don't become one is that then I'd not be able to speak to myself, even.
Half of my message above has disappeared into the thin air out of which banks conjure loans.I was going to finish off by saying that banks can carry on dishing out loans until they hit the back-stop of the reserve ratio. But since you
believe the concept of "reserves" is the last refuge of the moron, I shall take comfort that I stand in the company of Melvyn King and everybody else in using it.
Please explain what is to stop banks dishing out loans and leaving the cash coins paper etc they have as start-up money untouched.
DBC, what you say makes a lot of sense.
Without giving too much away, though, the Co for which I do most of my work has huge, huge loans. Gargantuan. From at least fourteen different lenders, as there isn't one big enough or daft enough to fund it.
That represents not a lot of sense.
Someone tried to explain why big business has to be like this. He was incapable of explaing why big business has to be.
@UM "That represents not a lot of sense."
Lack of sense by lender or borrower?
@DBCR "Please explain what is to stop banks dishing out loans and leaving the cash coins paper etc they have as start-up money untouched."
You suggest this activity is a bad thing. Please could you explain why.
DBC, yes, to some extent that is what the banks do - but sending out cheques, drawn on the bank increases its liabilities as well as its assets in equal measure. That Basel capital ratio of 3% is terrifying, it ought to be more like 20% if you ask me.
I'm quite happy to talk about "reserves" provided you make it clear whether you mean physical cash and near cash (an asset) or shareholder's funds generally (a non-repayable liability).
UM: " I was thinking more of lending money on the strength of what you're owed."
Nope. You either lend what is already there, or you raise new funds, or you create a new liability/deposit to match the new loan. You cannot possibly lend on the strength of what you have already lent - but you can borrow on the strength of what you are lending (which leads to more lending etc until you hit your statutory capital ratio).
UM, do you work for Channel Tunnel?
B, I hope they come back and answer that.
@Bayard,
Would've thought this was kinda obvious.But to start at the beginning,this last bout of trying to get MW in line with orthodox opinion (he is now saying Mervyn King does n't know the basis of banking)began when I drew his attention to a letter written by Ann Pettifor in the Guardian.As neither he ,nor ,I gather, you have read it I will repeat the opening and a relevant passage:
27.i.10 "I was astonished to read Lord Myners's assertion that banks use our deposits to lend out to businesses and homebuyers.(Comment ,25th January)This is simply not the case ,and has not been the case since 1694..."
"The bank does not need savings,deposits or reserves to create credit.If this were the case there would only be as much as there are deposits in the bank".
So my question is really rhetorical and a reinforcement of her second statement: that bank's don't act as middlemen as Mark constantly asserts.They dish out cheques and don't move anybody's deposits (otherwise everybody's account would be always cleaned out,having been lent on).
Mark dealt with Ms Pettifor's statements of the orthodox position with a volley of abuse.
BTW I have never heard MW's argument before not even from the Ludwig von Miserabilists who are very aware of too much bank credit creation and seek to curtail it.Their groundbreaking contribution to Economics is: if you don't have much money in circulation you won't have much inflation.As the younger fellows say"No shit ,Sherlock!"
see above: should read
"If this were the case there would only be as much credit as there are bank deposits"
Also They dish out loans and don't move anybody's deposits.
DBC, I am not advancing arguments. I am not saying that banks are an unfettered good (they clearly aren't). I am just trying to explain, on a factual basis how it actually works.
I am surprised that you fall for her hysterical gibberish that banks somehow make loans in excess of deposits. The end position is always that loans=deposits (plus or minus shareholders' funds).
Quite how we get there is a slightly different issue. It is true that loans create deposits rather than the other way round, but I have never said anything else, but the end result is the same.
By the way, have you ever taken the trouble to read an accountancy text book and do worked examples with a sharp pencil, or to print off and understand a bank's balance sheet (start with a simple one like a building society)?
I do not regard Ann Pettifor's letter as hysterical.I wonder if this opinion is not gender biassed.If anything solid old Mervyn King's position is more hysterical as he seems to want to get rid of fractional reserve banks and replace them locally with credit unions.But of course you do not believe anything the Governor of the BoE has to say either.Perhaps if he approached the problem as an accountant and put all the deposits in the liability column (when they are reserve assets )then he would rid himself of these misconceptions born of inexperience.
The following quote from The Times story on King and Kotlikoff neatly encapsulates where you are going wrong:
"Modern bankers keep only small reserves relative to the loans they make..Under Kotlikoff's plans banks would be turned into mutual funds but would take no risks and lend out only what they have taken in deposits from savers" In other words they are not lending out only what they have taken in deposits now.They are not acting as middlemen .Loans exceed deposits finito .Support for Pettifor and me lets be honest.
So you have The Governor of the B of E,all the reference works I have quoted at you over the months, the UK Treasury as represented by Kitty Ussher,Ann Pettifor,James Robertson and the massed ranks of orthodox opinion on one side,plus unorthodox Land taxers like me&libertarians like Captain Ranty while on your side you have basically you and some accounts.You have never referred to any authority on the subject quoted any third parties,or objective substantiation and generally there is a lack of the usual academic presentation of evidence.You are relying on saying the same thing over and over and over.
"The dogs bark but the caravan moves on"
DBC, any bank, building society or credit union, however cautious and well run engages in fractional reserve banking (in the old fashioned meaning of the term), that is a simple fact.
Or do you imaging that the BSs and CUs of this world just pop all the coins and notes in a safe? And never lend anything out? Unless they never lend out a single penny then they are engaged in FRB.
And yes, as a matter of fact, I do know a lot more about banking than any of the people you mention (OK, M King may know more, but as a political appointee, he is quite prepared to do and say whatever he thinks his masters want him to do or say).
I was the one who, back in September 2007 said what they ought to do with Northern Rock, it was them who took over two years to get round to doing it.
Further you are repeating yourself without answering my simple question - when you say 'reserves', do you mean liquid assets or shareholders' funds? One is an asset, one is a non-repayable liability - they are opposites.
Try and work out what you mean and then maybe we can discuss this properly.
I won't lecture you about Shakespeare sonnets if you accept that I know about this stuff and most other people, quite clearly, don't. Deal?
Bayard: not a lot of sense by lender, borrower and "the way things are".
Big is not good, normally. I guess it might be, somewhere, somehow, but I've not seen it yet.
Mark: no, I don't work for the Channel Tunnel. I work for the devil, as an advocate. You don't get a good debate when everyone agrees.
So the deal is: only you know about banking ;everybody else including the Governor of the BoE know nothing.So we should shut up.
Don't you think this a tad arrogant?
As matter of fact I would welcome a debate about a Shakespearean sonnet: at least literary criticism is democratic where it is impossible "to pull rank" (on the basis of a qualification in accountancy) and the actual words have to be discussed.
As I have said : your views that bankers are middlemen and are unjustly maligned is so unusual that you really need to adduce some evidence,quotations from other people,books and standard works of reference to back them.That is to satisfy the normal terms of written debate or academic discourse.
It is quite clear how everybody but you is using the term reserves
as in the quote from The Times: they clearly mean bank money not loaned out or possibly on quick call (Libor money).
" In the course of issuing money the commercial banks actually create it by expanding their deposits,but they are not not at liberty to create money all they may wish ,whenever they wish,for the total is limited by the volume of bank reserves and by the prevailing ratio between these reserves and bank deposits- a ratio that is set by law , regulation or custom." Encyclopaedia Britannica Vol 12 p357 15th ed (1981) (obviously morons).You really need to come up with some heavyweight backing as your case is only based on your assumption of superiority.
Kitty Ussher then at he Treasury
"By far the largest role in creating money is played by the banking system itself...When banks make loans they at the same time create a new deposit.."
I will gladly shut up when you adduce one bit of third-party written evidence to back your outlandish claims.
In contrast your arguments for LVT are backed by a long tradition of canonical works,going back to Quesnay (who was a doctor to Madame de Pompadour BTW.)
@UM: I thought that huge borrowings were good in some businesses - the buy it, do it up/turn it around and flog it sort of business, because the borrower gets to keep nearly all the profit, which though small in respect of the total amount, is huge in respect of the borrower's own capital.
@DBCR: You still haven't said why "banks dishing out loans etc" is a bad thing. I wasn't really interested in what Lord Mynors or Ann Pettifor had to say, I wanted to know why you thought it.
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