The Creation of the Federal Reserve System (Part 2)

If deposits are equivalent to cash/reserves, how is it possible a bank could have $1,000,000 in deposit accounts, but only $100,000 in reserves?

 

Source: http://www.clevelandfed.org/banking/credit_risk_management/reserves/calculation_of_reserves.cfm

Deficiency Charges

If a depository institution has both reserve balance and clearing balance requirements, the institution’s average end-of-day account balance for the reserve maintenance period applies first to satisfy its reserve balance requirement, after which the remainder is used to satisfy the clearing balance requirement. Thus, an institution can be deficient either in its clearing balance requirement or in both its clearing balance and reserve balance requirements. In any given maintenance period, if an institution fails to maintain an average end-of-day balance over the reserve maintenance period adequate to meet its total balance requirement (after the application of as of adjustments, carry-over, and the clearing balance allowance), the institution may be subject to a monetary charge or, in rare instances, may be required to compensate for the deficiency in a future period.

The amount of the charge for a reserve balance deficiency is calculated at two percent per year above the Discount Rate effective on the first day of the calendar month in which the deficiency occurs. Charges are assessed on the basis of daily average deficiencies during each maintenance period. In determining whether to assess a charge for a reserve balance deficiency, the Reserve Bank will consider the circumstances of the specific deficiency and the reserve maintenance history of the institution incurring it. References can be found in Section 204.7, Regulation D, Penalties.

 

You are referencing an individual bank. This is why we have a central bank and a unified banking system.

By identity when one bank is in reserve deficiency there is another bank with a reserve surplus unless the entire banking system has a reserve deficiency.

So if the bank loses more checking accounts than it has in reserves, than another bank has more reserves than it needs for it's checking accounts.

So the bank who just became in reserve deficiency can simply borrow them back, thus deposit accounts basically are equivalent to cash/reserves.

Of course, if every single person decided to take out cash in exchange for their deposits there would not be enough cash.

 

But, the key is if everyone decided to spend all their money in their accounts on the same day, there would still be enough reserves. Which is why they say transaction accounts are money and which is why you and Dr. Righteous are wrong.

 

notice how bernacke, geitner, paulson and a host of other government officials are all former bankers

 

Bernanke is not a former banker.

 

I would say that his prior paid advisor status with the Federal Reserve and being a Federal Reserve governor would qualify him as being a former banker.

 

Sure. If Deposit accounts contain cash, how could an individual bank have 1/10 the amount of cash as reserves?

Sure. We've discussed several times how banks take short or give term loans to cover day to day deficiencies or surpluses in their minimum reserve requirements.

 

Here's a question for you to ponder.

If everyone spend aqll their accounts on the same day that would be no problem because deposit accounts have cash in them, then why did we need a Federal Deposit Insurance Corporation?

Do a little research on the problems that lead to the creation of the FDIC, how those problems could have existed if all deposit accounts had cash in them, and why we would need deposit insurance if all deposits had cash.

 

That would be true if there was money in deposit accounts.

I'm an electrical engineer. I have a good idea what makes them tick.

That is not my position at all. Explained countless times.

 

Depends on what you mean by "held accountable for their loans".

Does not answer the question at all.

Fractional reserve theory has nothing to do with what sort of money is being used.

Ridiculous. If what you are saying was true, there would be no logical reason for reserves in the first place. Banks could just always have zero reserves and then worry about finding reserves at some point later.

No. It probably winds up back in the bank (or some other bank) as another deposit eventually.

Do they have printing presses in the back? (*)(*)(*)(*) if it's that easy, let's open up a bank and print a couple billion.

I agree that investing in toxic assets will cause a bank to fail, but you're going to have to explain how making bad loans causes banks to fail.

 

Like I said and like you even corrected me on. Banks fail when they have to write off loans and investments cutting in to their capital.

The FDIC insurance is to give us faith in the banking system. And it seemed to work since during the crisis deposits actually went up instead of down. There wasn't a run on the banks. The banks simply leveraged all their capital/reserves in to crappy mortgages and crappy mortgage back securities.

Reserves are an after the fact issue with banks. They are not tied to your deposits.

 

They have to write off their capital. Once they lose all their capital they become insolvent. They don't become insolvent because they don't have any reserves since if they do have capital they can get reserves whenever they want.

There is a logical reason. Reserves are what the Fed uses to reach it's target rate. It's how it manipulates the money supply by making reserves more or less expensive to borrow. Right now if any bank wants to make a loan and finds a qualified borrower there is $1.6 trillion reserves that they can borrow at incredibly cheap rates.

Yes, which is why the bank is accountable for it

They have computers. Money does not have to be physical.

When a bank makes a bad loan as Iriemon pointed out. They have to write it off. When they write it off they have to balance their balance sheet. Therefore they have to cut in to their capital to write off a loan. If a bank has $100k in equity and they have a loan default of $100k... they no longer have any equity. When they have $100k in equity and loans default of $300k, then the bank is insolvent and they have to start selling assets or they have to borrow from others. But when you are in a capital position like this, other banks do not lend to you and you fail.

 

Why have Federal Deposit insurance if the accounts all have cash in them?

If everyone spent all their accounts on the same day and there would be no problem because deposit accounts have cash in them, then why did we need a Federal Deposit Insurance Corporation?

What was the FDIC set up to to provide faith for? What was the problem prior to the FDIC that caused the need for the FDIC to provide more faith?

What do you think is the difference between bank reserves and account cash since reserves are equivalent to cash?

If when you write a check, cash is transferred to the payee, why does the bank transfer reserves as shown in MMM step 6?

How is the cash in the deposits reflected on a bank's balance sheet?

How is the transfer of cash in deposit accounts reflected on a bank's balance sheet? Where is that step reflected in the MMM money creation steps?

 

We have been over this a million times. Reserves are banks money... Deposits are the nonbank publics money.

Reserves are the banks money that they use to satisfy payments of our money and to leverage them in to loans/investments.

When banks make loans and investments they are ADDING money to the money supply. When these loans and investments fail the nonbank public has MONEY not claims that they is not backed by any assets. So the bank has to write off it's loan assets and write off it's capital. If it doesn't have enough capital than the banks fail, the assets are sold off and then finally deposits are seized.

The Govt than has to issue debt in order to cover the backed deposits to create an asset for this money.

Deposits are OUR money. When someone takes out $100k and doesn't pay it back than there are $100k in deposits/equity that needs to be taken out of the system.

None of this has to do with reserves. Reserves are simply the Fed's way of controlling the demand for money by influencing it's borrowing costs.

Deposits are money and they have money in them and they can be used for transactions to purchase goods and services just like cash. The reserves that banks have to transfer or borrow are simply for the banks themselves.

 

Here's a better question to ponder. If the US Courts enforced contract law where the Federal Reserve had to redeem the outstanding (Federal Reserve) promissory notes in US Minted American Gold Eagles, which are currently the lawful money of the United States, how would the Federal Reserve do that? The Federal Reserve is required to keep gold and other assets on hand to back all Federal Reserve notes so could it redeem the trillions of dollars in outstanding Federal Reserve notes?

Factoid: $1 trillion in American Gold Eagles contains 20 billion ounce of gold and I believe there is $1 trillion in actual paper currency in circulation today and that only represents a small percentage of all Federal Reserve obligations.

 

Why do reserves money need to satisfy payments of our money when in your theory money is in our accounts?

Please answer the questions. The reason you are avoiding them is because the answers contradict your theory.

Why have Federal Deposit insurance if the accounts all have cash in them?

If everyone spent all their accounts on the same day and there would be no problem because deposit accounts have cash in them, then why did we need a Federal Deposit Insurance Corporation?

What was the FDIC set up to to provide faith for? What was the problem prior to the FDIC that caused the need for the FDIC to provide more faith?

What do you think is the difference between bank reserves and account cash since reserves are equivalent to cash?

If when you write a check, cash is transferred to the payee, why does the bank transfer reserves as shown in MMM step 6?

How is the cash in the deposits reflected on a bank's balance sheet?

How is the transfer of cash in deposit accounts reflected on a bank's balance sheet? Where is that step reflected in the MMM money creation steps?

 

That question takes no pondering at all.

You're just wrong in your position, as was proved to you in the last thread we discussed it.

Since this point your trying to inject is off topic here, I'll refer anyone interested to the discussion in that other thread.

 

You are confused with what money is. There doesn't have to be money in deposit accounts for it to be considered money. Just like there is no "money" in a dollar bill. It is simply a piece of paper that represents a value in a transaction. Just like deposits. A deposit is money by all definitions of money other than what they call base money. It is not a claim on money, it is money. There is no money IN your deposit because your deposit IS money.

You guys are very confused on how our banking system works.

Banks never need reserves until they need them... if that makes any sense. As in at the end of the day or week if too much money has been taken out or they have made too many loans, then they have to borrow reserves.

If a customer at Bank A writes a $1 million check to a customer at Bank B. Bank A DOESN'T need reserves on hand for Bank B to credit their customers account. If Bank A has sufficient capital Bank B can simply "loan" reserves to Bank A in which Bank A will pay back Bank B once they can attract more deposits or borrow reserves from the fed funds market.

Banks are capital constrained not reserve constrained.

 

To keep banks in check

Deposits don't have "cash" in them. They are money just like cash is money. And the reason there is insurance is to give people confidence and to protect them from banks reckless lending and investing.

Like I said, when a bank fails, their deposits go down with them. It's because there are deposits out there that are not backed by any asset. Therefore an equivalent amount of deposits need to be destroyed or an equivalent amount of debt needs to be created.

Banks failing

Because the bank has to meet requirements with the Federal Reserve

You mean vault cash?

Debit my account credit your account

 

I was never "proven" wrong in any thread.

Does Title 12 specifically state that Federal Reserve notes are to be redeemed in lawful money on demand at the US Treasury or any Federal Reserve Bank? (hint: yes)

What two types of "legal tender" do we have in the United States? (hint: coins and currency)

Federal Reserve notes are what? (hint: currency)

Which of the two forms of legal tender is not a promissory note? (hint: gold and silver American Eagle coins)

If a "promissory note" which is currency is to be redeemed by the other form of legal tender then what is that other form of legal tender? (hint: American Gold Eagles)

Is the failure of an entity to fulfill the conditions of a promissory note it has issued considered to be fraud and/or theft under contract law? (hint: yes)

Is the Federal Reserve in material breach of a contract by refusing to redeem the promissory notes it has issued? (hint: yes)

 

They only write off the loan as a loss. It does not deplete their capital in any way.

That's true, as long as the capital is not in the form of toxic assets, and as long as other banks/the Fed are willing to liquidate those assets by swapping them for cash reserves. The only way money is created in this situation is when the Fed gets involved to create it to buy the bank's assets.

Target "rate"? What are you talking about?

This has nothing to do with your incorrect claim that banks first spend and then find reserves after they are deficient.

That makes no sense. The bank does not lose anything when a borrower defaults. The borrower has simply spent the money elsewhere in the economy and has admitted that he is incapable of continuing interest payments. The money the borrower spent elsewhere in the economy will wind up back into a bank somewhere as a deposit that can be used to make another loan again. The bank loses nothing except potential future interest payments.

Even better. We can just use the computers to credit our deposit accounts a couple billion.

Iriemon has pointed out no such thing.

That doesn't make any sense. If someone deposits $100 into a bank:
L=$100
A=$100 (cash reserves)

If I loan $90:
L=$100
A=$190 ($10 in cash reserves)

That loan comes back in as a deposit:
L=$190
A=$190 ($100 in cash reserves)

I loan $81:
L=$190
A=$271 ($19 in cash reserves)

If loan #2 defaults, then I have:
L=$190
A=$190 ($19 in cash reserves)

If loan #1 defaults after that, then I have:
L=$190
A=$100 ($19 in cash reserves)

(This is of course assuming that toxic assets are made worthless. In reality, the Fed buys up toxic assets of large failing banks.) The bank still the 10% required reserve ratio, still has positive assets, even though all of the loans have been defaulted on. Reduction of a bank's equity through defaulted loans does not lead to negative assets unless it simultaneously doesn't have enough cash reserves to meet the demand that depositors are claiming on its reserves. Ultimately, the problem boils down to inadequate reserves.

 

Just look what the Fed did with their QE policies. Banks were trapped with all sorts of toxic assets in which they didn't have reserves to pay off their loans from other banks, and no one would lend them reserves because their capital position was in the gutter.

So the Fed simply pumped $1.9 trillion worth of reserves in to the system. This didn't give anyone any money. You or I didn't make or lose any money by the Fed's actions. It was simply that banks leveraged their reserves to the point where the banking system came to a halt and no one would lend anyone else the reserves they need to meet the necessary requirements with the Fed.

People didn't lose their deposits or need the FDIC because banks ran out of cash. They lost them because banks had to write off 100s of billions of dollars of loans and investments. Lehman didn't fail because it ran out of reserves, it failed because it ran out of capital.

Deposits are lost when a bank doesn't have enough capital after writing off it's bad loans/investments.

Deposits are money just like cash is money. Nothing has to be in your deposit just like nothing has to be in cash.

 

Of course it does. Banks can't just make bad loans and write them off like they never happened.

Only reserves are created in this situation, not any money that the nonbank public can actually use.

Fed Funds rate. The borrowing cost of money. It's what the Fed uses to manipulate the money supply.

Of course the banks lose something. Banks can't just make loans, write it off, and act like nothing ever happened. Loans are an asset on the banks balance sheet. In order to balance their balance sheet banks have to dip in to equity. Once equity is depleted than the bank is insolvent and it fails. I can't believe you actually think banks just write off loans and nothing happens.

We could

Are you speaking from an individuals banks perspective or from the banking system as a whole? I assume you are speaking from an individual banks perspective. Because in this case, you would have

L = $100 (assuming the $90 loan was deposited in another bank)
A = $100 ($90 Loan + $10 Reserves since you lost $90 in reserves)

This makes no sense, do you mean the loan is paid off? Or just $90 came back in to your bank? If the loan is paid off

L = $100
A = $100 ($90 reserves replaces $90 loan)

This is questionable based on your description from above

On the liability side of your balance sheet you have equity. Your balance sheet can't look like

L=$190
A=$271

You still are forgetting about equity. In this case the bank is completely insolvent and they sell it's assets and use any deposits on the liability side to cross off the defaulted loans.

 

I'll refer any interested person to the thread where Shiva's claim was rebutted and disproven.

I'm not going to regurgiate it in an off topic discussion here.