My earlier piece on Rothbard and Social Credit sparked off a long thread on another blog. One of the arguments made over there was that, in the absence of much other regulation, “fractional reserve”, as Rothbard understood it, simply could not be effectively banned.
Rothbard’s (and the Social Credit mob) saw fractional reserve as an evil thing as it allows banks to create money, as it is commonly defined – in that accepting a call deposit and then making a loan from the funds deposited effectively creates money. Both the deposited funds and the loan funds are money – so the bank has created money. I explored this a bit further on the earlier thread and so will not go into it here.
The point I would like to raise here is whether, in the absence of much other regulation, it can just be banned. My point is this. Say a government (for some odd reason) decides to agree with Rothbard and then bans the maturity transformation of call funds. I believe there will be a couple of major problems with this:
1. Firstly, the legislation would have to define “call” precisely. Once you think about this is becomes, to me at least, a tricky thing. How long a call period, and under what conditions, means that a deposit remains “money”? Is it only instant call, 1 second call, 1 hour call, 24 hour call, 11am call or what? Additionally, would a term deposit (of, say, 12 months) that has a call option with penalties remain a term deposit or does the call option render it a call deposit? If so, what penalties would be needed to make it a “term” deposit?
2. Would the banks not just walk around this anyway? Say the call period decided upon was one week. Could the customer not just deposit funds on one week term and the bank then just grant a revolving line of credit up to the value of the deposited funds, effectively allowing the customer full access to the total value of their deposit (and creating the same effect as an instant call deposit) without breaking the legal definition of “call”?
To me, the only things keeping banks within any mandated ratios that they could walk around are:
1. The ratio is set at a point where the bank would keep it anyway, such as a typical 7% reserve asset ratio (or 9% HQLA in Australia); or
2. The regulators have lots of other tools that the banks fear so they do not bother to try.
Rothbard imagined a world where the “fractional reserve” could be banned and then other regulations become unnecessary. I cannot see how he could be right.
12 comments
9 January, 2008 at 15:12
Mencius
Andrew,
These are very good questions and they actually have simple answers.
For my answers to make sense, I need to define some terminology. Your bank can advertise itself as temporally solvent if and only if the maturity structure of its assets matches the maturity structure of its liabilities.
The alternative to temporal solvency is scalar solvency. Scalar solvency is what everyone uses right now. To compute the scalar solvency of an institution, add up the value of its assets and the sum of its obligations, and define equity as the difference. If equity is negative, you are broke. Otherwise, you are not broke.
Perhaps you are familiar with this procedure. I gather it is also known as “balance-sheet accounting.”
To compute temporal solvency, sum the receipts and outlays of an institution as curves in the time domain. If you can predict receipts and outlays, which I understand is not exceptionally difficult in the fixed-income arena – in fact, I would consider it the basic job of a banker – you can predict the probability that some institution will be insolvent before time T.
Perhaps you are also familiar with this procedure. I gather it is also known as “cashflow accounting.”
Therefore, Rothbard’s point is that banks should use cashflow accounting, rather than balance-sheet accounting. I don’t think this is rocket science. If I am not using these terms correctly, please disregard them and focus on the substance.
I disagree with Rothbard – I don’t believe that FRB (which is one case of the more general problem of maturity mismatching) needs to be banned. However, I think that it will not exist in a free market without intervention. The typical form of intervention to protect maturity mismatching is the issuance of loan guarantees by the State or other monopoly mints.
Of course with a fiat currency, loan insurance can be written ad nauseam. And it typically is – often in terrifyingly informal ways. I’m sorry, but the State should not be guaranteeing private transactions, as it does when it uses its power of the press to issue perfect deposit insurance. This is a recipe for regulatory failure and massive skulduggery.
If you have loan insurance, mismatch your maturities to whatever extent your sponsor allows. Just be aware that you are coupled to the political system.
In the absence of such guarantees, however, I predict that temporally solvent financial intermediaries (which contract with reputable accountants or other private regulators to disclose their financial conditions) will rapidly outcompete and annihilate competitors which only offer scalar solvency.
The key is that a temporally solvent bank has no direct liquidity risk. Of course, liquidity fluctuations elsewhere in the financial system can affect it. But it, itself, is not a cause of such instability. Temporally solvent banks thus have an incentive to depend only on each other, and to avoid the notes issued by their tainted competitors. This process tends to build up a financial ecosystem in which temporal solvency is generally respected, and temporal insolvency is generally considered dodgy and shunned.
Banks within this charmed circle have a much lower probability of default. They can only default if they make a serious pattern of miscalculations in predicting stable markets. This risk, of course, is inescapable.
While there is no conceivable system of accounting which does not depend on the services of real live accountants, I think you’ll see that the temporally solvent approach to banking actually requires fewer regulatory judgment calls than conventional maturity-mismatched banking.
That said, yours is the best response to the Rothbard thesis I have seen on the Intertubes so far. You appear to have actually read Rothbard’s work, considered it carefully, and formed your own opinion by asking questions that reveal some of the more unconvincing lacunae in the Rothbardian explanation. This puts you about a half mile in front of, say, Bryan Caplan.
Rothbard basically means that maturities should not be mismatched. But he has produced a very clunky way of saying it.
Again, to achieve temporal solvency: if you have obligations which mature in a year, you should have income which matures in a year. If you have assets which mature in a month, you should have income which matures in a month. If you have assets which mature in a second…
The reason this curve does not go down through epsilon, but drops to zero at a sufficiently low maturity, is that there is no real productive process that can increase your money in a second, even by some tiny slice of a percent. Thus we see the familiar phenomenon of the full-reserve bank – the Amsterdamsche Wisselbank being the classic example.
Note that in the Wisselbank monetary system, a bunch of meerschaum-smoking Dutchmen managed to turn a profit off multiyear trading voyages to Indonesia in wooden sailing ships. If you think modern risk management is up to this standard, perhaps you are smoking more than a meerschaum!
Interestingly enough, the fact that maturity mismatching is a fundamental cause of financial instability is sometimes discussed by “real” economists under the rather cryptic name of narrow banking. If you Google this you will get quite a few hits, and drag up quite a few prominent economists. None of them that I have ever seen has ever seen fit to so much as mention Mises or Rothbard, which I take as a sure sign that they know how guilty they are.
9 January, 2008 at 16:44
Andrew
Mencius,
Thanks for a well considered response.
On the general question of solvency you are right to differentiate between the two forms – but I would point to a crucial question about the definitions. The important question on “scalar solvency” is: should a bank be considered solvent when all the deposits that can be called are fully covered or should it be only those that will conceivably be called? The risk of an event outside the conceivable range is the important risk.
Your definition of scalar solvency misses this – and it is in this difference that modern banking and risk management is founded.
With that in mind, though, the debate does go to the heart of the argument of whether a government would really want to ban maturity mismatch (as Rothbard and deSoto essentially argued) or even if it would disappear in a fully free market (the difference should be, to a libertarian at least, trivial). If the one you have termed “scalar solvency”, with the caveat above, produces sufficient returns to the risks of not being fully “temporally solvent” then the scalar solvency is enough – and will be the outcome in a fully free market, even under free banking.
As I said in my comment on your blog, as an argument for temporal solvency simply illustrating the worst case (a bank, or banking system, failure) is not enough – if for example the worst case is a 50% chance of a $1bn loss every century then additional profits of $10m per annum in every other year of the century would make it worthwhile. This is particularly the case where a corporate structure allows asymmetric risk profiles. The people who sustain any losses will obviously not be happy, but provided there are enough who made a profit in the interim then the business model is sustainable – just possibly more volatile. The trick is to manage the risk of catastrophic loss well enough so that it is low enough to allow profits to be made in the interim. If you can do this then you have a good, sustainable (if occasionally volatile), business.
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On deposit insurance, the situation in Australia is different to that of the US in that we have no government deposit insurance scheme at all. At least at law, there is no need for the printing presses to start rolling if a bank should fail. Again, at law, the depositors are fully exposed as ordinary unsecured creditors of a failed institution.
Of course, the political reality may be different. If a major regulated bank went down the pressure to help, at least to some extent, may be irresistible. Precedents do give some grounds for hope, though, in that the failure of a major insurance company a few years ago did not trigger a bailout. A bank may be different, though.
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On the Wisselbank. I would suggest that this is not necessarily a good example as the reason they made so much money was fairly simple and nothing to do with full-reserve banking. Funding the trading voyages was an almost no-lose enterprise. The VOC they were funding had a monopoly of trading with the Spice Islands, enforced quite viciously. The sorts of returns from them were such that the VOC sending out 10 fully crewed ships for only one to come back still resulted in a near doubling of the original investment. While it may have been a risk management triumph, I think it would be difficult to argue that a modern bank could not also manage those sorts of risks – although the use of heavy cannon, crucifixions and torture to enforce a monopoly is discouraged these days.
10 January, 2008 at 06:44
Mencius
Andrew,
Thanks for your interesting responses! If you don’t mind I will point UR readers at this discussion – I think it may answer others’ questions as well.
I will concede your point on the Wisselbank straight up. I shouldn’t disparage modern risk management. I don’t think anyone would be so bold as to claim your profession has solved the problem of liquidity risk. But it certainly has its statistical ducks in a row on entrepreneurial default risk – of which the spice voyages are a textbook example. Mea culpa.
In fact, I would be tempted to say that if there is a one-sentence explanation of the present financial crisis, it’s that it’s what happens when exquisite mathematical systems perfectly optimized for normal, entrepreneurial default risk are confronted with the irreducible and unquantifiable game-theoretic uncertainty of liquidity risk, with its savage feedback loops, its correlations that pop up out of nowhere, and of course its linkage to the political system.
(Perhaps you have read Satyajit Das’s new book? The one that is actually written in English? Here is an excerpt which I think makes the point quite well. You may also have seen Nassim Taleb making basically the same point.
Das and Taleb do not explicitly connect the failure of statistical risk management to the liquidity problem, the game theory of bank runs, and the problem of maturity mismatches. It’s not clear to me that Mises, Rothbard and de Soto have come to the attention of the Dases and Talebs of the world. If this is the case, I can only describe it as a serious communication failure.)
In any case, my point about the Wisselbank was meant to preempt a fallacious argument that you did not make. Without accusing you of making this argument, let me answer it even more directly, because it is a common argument and I often see it.
The argument is that in a “temporally solvent,” “100%-reserve,” or “narrow” banking system, no one would take financial risks, and profitable opportunities for productive investment would go unserved. The theoretical answer to this is that risks remain profitable – the time structure of risk and investment just needs to be matched. The empirical answer is the existence of the VOC.
Not that I am endorsing crucifixions and torture, although I do confess to the opinion that the world would be a smaller, duller place without heavy cannon. But we have subtler, more effective ways to enforce our monopolies these days! I hope you’re not under some illusion that your intellectual property laws originate in Canberra :-)
Your “important question” is I think a pair of questions. But they are both important! Let me try and take a whack at them.
The first question is the accounting treatment of rollovers. This is fundamental to the entire distinction between “scalar” and “temporal” solvency.
What is a rollover? Perhaps you think of it as a mature obligation which is not “called.” A classical checking-account “demand deposit,” for example, can be seen as a loan from the depositor to the bank with a term of zero. Except when the depositor “calls” the deposit, it is automagically rolled over. If the term of this loan was, say, one second, the reality would be almost the same – the depositor would have to wait one second for his or her check to clear.
In the ABCP markets that have been imploding lately, the term is not zero or one second, but 30 or 90 days. Nonetheless, the situation is basically the same – short-term obligations are balanced by long-term revenues, and the system is stable (or at least appears stable) only because of rollovers. Next to a 30-year mortgage, 90 days is basically still epsilon.
In a frictionless digital financial system, which is admittedly an entity that does not exist on this planet, has never existed in the past, and may never exist in the future, we could do away with this concept of a “call” and a “deposit.” Logically, a rollover is not one transaction but two. You make a mandatory payment to your creditor. Your creditor turns around and makes a voluntary loan to you.
When we see a rollover as two transactions, we realize that from the perspective of the bank, the fact that the old creditor who we just paid off, and the new creditor who has just been so kind as to extend us a new loan, happen to be the same person, is quite irrelevant.
So what we have constructed is a financial structure which is dependent on a continuous supply of new loans. And, most importantly, we can identify no entity or entities who is contractually obligated to make these loans. This is a key difference between “liquidity risk” and ordinary “default risk.” The latter is dependent on the contractual obligations of strangers. The former is dependent only on their kindness.
So when you ask should a bank be considered solvent when all the deposits that can be called are fully covered or should it be only those that will conceivably be called?, your real question is whether the solvency of a bank should depend on the kindness of strangers.
And if this is what modern banking and risk management is founded on, I would definitely have someone in as soon as possible to look at the foundations! As I will explain, though, they are a bit more stable than this. But not as stable as I feel they ought to be.
Because “scalar solvency” – which is of course the current definition of bank solvency, ie, the net market price of your assets exceeds the sum of your contractual obligations, considering both as scalar values – actually solves the rollover problem. In theory. Unfortunately, the theory is not quite right.
A scalar-solvent bank can, in theory, meet all its obligations without depending on the kindness of its creditors. If they refuse to roll over, if it cannot find new short-term loans, it can just sell assets and convey the proceeds.
For example, consider the case of a bank all of whose obligations are demand deposits, and all of whose assets are mortgage securities. One day, for god only knows what reason, its creditors demand all their deposits, and no fresh customers appear to replace them.
No problem! Since the bank’s assets are held on the books at their market price, and since the net market price of all these assets exceeds the sum of the bank’s deposits (scalar solvency), we can meet all our obligations by selling said assets. In a modern digital financial market, this can happen just as fast as the depositors can demand their money. In the end, the bank is closed, but it is certainly not broken. The shareholders retain their equity.
This is the implicit scenario we are thinking of when we describe any bank whose assets exceed its liabilities, calculated as scalars, as “solvent.”
Of course, in real life, it does not work out that way. Because when we hold this fire sale for mortgage securities, we depress the price of said securities, driving implicit mortgage interest rates through the roof, driving down housing prices, feeding back into mortgage default risk, causing everyone who holds short-term obligations backed by mortgages to refuse to roll over their loans, further depressing the price of mortgage securities, und so weiter.
This is the game-theoretic degringolade I described on my blog – for “dragons,” read “mortgages.” As we can see, this process is not at all theoretical. It can happen in reality. It is happening right now. It is this that scalar solvency “misses,” and it is this that makes scalar solvency an inadequate description of a bank’s financial soundness.
Most important: this is not a quantifiable risk. It is not in any way analogous to an Indonesian spice voyage. It is a fundamental systemic instability. It is a textbook example of a critical state. Like the sandpile collapses on which Buchanan’s book is based, it is a state transition between multiple equilibria. And it cannot be predicted by any algorithm or market.
The only way to deal with it is to avoid not only maturity transformation, but all markets in which prices may be affected by maturity transformation, or similar inherent instabilities. For example, in the mortgage case above, even a temporally solvent bank which holds mortgages will find its solvency tested by the wave of defaults which the collapse will create.
My belief, again, is that in a free financial market with no Bagehotian lender of last resort, creditors will demand temporal solvency. Here is why.
You argue: The trick is to manage the risk of catastrophic loss well enough so that it is low enough to allow profits to be made in the interim. If you can do this then you have a good, sustainable (if occasionally volatile), business.
Profits can be made “in the interim” because, since long rates are naturally higher than short rates (again, see my blog), any system which can arbitrage the two by transforming maturities can produce positive return. But this return has to be adjusted for the probability of a maturity collapse, ie, bank run.
First, there is no way to predict a bank run using the statistical tools generally used to analyze default risk. You are depending on the kindness of strangers. To predict this, you need to be Hari Seldon. You are not Hari Seldon.
Second, the ability to accept a statistical profit over a long term, at the expense of volatility, is the very definition of a long-term investor. But when you are engaged in maturity transformation, your creditors are not long-term investors! People make demand deposits and buy AAA-rated commercial paper because they think the real default risk is not just low, but negligible. When this changes, they flee. How’s that TED spread doing?
As a banker, you profit by taking risky investments and aggregating them to diversify the risk. Risk goes in one end and does not come out the other. This is a tremendous service not only to humanity, but also to your creditors. If you are not actually disarming the risk, if you are actually just pretending to disarm it and in reality passing it through, you are not doing good business.
Third, a financial system in which temporal solvency is the generally accepted definition of bankerly rectitude is stable – by definition, no one in this system will invent the new criterion of scalar solvency. Moreover, if someone does, the attractive force of scalar accounting is relatively minor – the lure of slightly higher rates on short-term money.
Whereas an outbreak of temporal accounting in a world of scalar accounting has a name. It’s called a “bank run,” and its power of contagion is legendary. So temporal accounting is stabilized by the force of massive existential fear, and destabilized by the force of mild picking-up-nickels greed. Whereas scalar accounting is stabilized by mild greed and destabilized by massive fear. You do the math.
The puzzle therefore is: why do we live in a world of universal scalar accounting? Since all market forces have been removed, there is only one conceivable answer: the State. Considering the human consequences of the last 300 years of financial panics in the Anglo-American banking system, this is a rather incendiary accusation! But I can find no way to avoid it.
It is interesting to learn that Australia has no formal deposit insurance scheme. I was unaware of this fact. As you point out, however, the importance of this is unclear. What is clear is that Australia has a political system which has the power to monetize in a crisis. It also has the incentive to monetize in a crisis. Given these facts, the formalities are probably irrelevant. (See under: Northern Rock. See also: Fannie and Freddie.)
In fact, FDIC itself is protected by the same informal power to monetize. It does not have a zillionth of the capital it would need to survive as an actual private institution. The US banking system is protected not by the formal, contractual responsibilities of FDIC, but by the informal political understanding that FDIC itself is too important to default. (Ie, “too big to fail.”)
What I find troubling about this is that informality is another name for lawlessness. Since these kinds of informal loan guarantees are both pervasive in the present Western financial system, and absolutely essential to its continued survival, we can say without risk of hyperbole that “modern banking and risk management” is fundamentally rooted in official lawlessness. The foundations look impressive, but they are poured on sand.
If this is an accurate analysis of the situation, I hope you’ll agree with me that the issue is quite a bit more important than, say, a bit of warm weather. We are awfully dependent on this here financial system. Is there a way to repair it, without mass panic, riots, starvation, war, cannibalism, etc? Possibly. But the first step is to understand that we do indeed have a problem.
10 January, 2008 at 12:54
Andrew
Mencius,
Firstly, apologies for the delay in getting the comment out – it was caught in moderation due to the three links. As you can see, fixed now.
To pick up what I believe is your main point:
Just to start, I would not claim to be Hari Seldon – nor, from what I remember of reading the Foundation series, would even Hari claim to be able to do this as psychohistory generally did not work on small numbers of people, certainly on a typical bank’s depositors. :)
On to the main point – I would disagree (to an extent) that you are dependant on the kindness of strangers – it is not kindness but that more stable of motivators – greed. Like all commerce, banking is based on the balance between greed and fear. Provided the desire to earn interest on deposited funds overcomes the fear they will be lost the deposit base will remain stable – or at least stable enough. The trick to preventing a run is to manage what bankers call “name risk” – the failure of your good name. Northern Rock failed this test – see here for my take on this – but there is no reason for an institution in a similar position to also fail. Any poorly managed business, even with no maturity mismatch can still fail, so even getting to a point where banks had no mismatch would guarantee stability.
That is one of the reasons why I disagree with this contention: “Since all market forces have been removed, there is only one conceivable answer: the State.” Market forces have not been removed – they have been ignored (IMHO) in your argument. Investors will still invest and depositors will still deposit if the greed outweighs the fear.
For example – if I need to deposit funds, and want call access to those funds to deal with my own uncertainty of cash flow I have several options – 1. Keep them under my mattress;
2. Form what amounts to my own Wisselbank and put the funds in a safety deposit box at my local bank. I will not earn interest – in fact I will pay fees – but, ignoring the theft risk I will have secure, if inconvenient, access to my funds.
3. I can also choose to deposit them in an immediate call account with the bank, and earn at least some interest or I can put them on longer term (with a call option for a fee). In either case the bank will transform the maturity and earn more interest than they pay me.
There are (of course) many other options, but they will do for the moment.
Which do I choose? Option 1 is only as good as the security in my home and the hope a thief will not find them. with option 2, I pay for extra security – but even that is not perfect. Option 3, provided I believe the bank is “sound” is not only the sensible course it can provide benefits the other cannot – like 24 access to the funds through an ATM or the internet. Of course, the risk there is that the bank goes phut and I lose access to, or even the amount of, the deposit.
The banking system does not rely on “the kindness of strangers”, but that old mainstay of any good free market system – greed.
I would agree that this is much more important than a bit of warm weather – but thanks to the banking system we can go on holiday to Bali (in the spice islands) and do what the VOC would have really liked to be doing – earning returns on deposited money and still have instant access to it through an ATM in Denpasar or using our Visa Debit card to purchase something on eBay.
Just read back through that and apologies if it seems a bit flippant – not intentional. Maturity mismatch, though, is what I see as providing the benefits of a modern banking system. We can deposit funds on the maturity we need as depositors and the banks can then lend it back to others (or even back to us) at a differing maturity to match our needs as borrowers. Essentially, we pay for that in two ways – the interest gap between what we receive as depositors and pay as borrowers and through the risk that the bank itself may collapse.
To me, the argument is a risk management one – is it worth taking that risk? Provided the risk is appropriately managed then I see that as a risk that is worth taking.
12 January, 2008 at 12:15
Mike Sproul
Mencius:
The view that fractional reserve banking is fraudulent and inflationary is simply wrong. A customer deposits 100 paper dollars in a bank. The bank lends $90, promising that the customer can get his money not quite 100% of the time, but only 99.99% of the time. The customer accepts the deal because the bank pays him interest in return for any inconvenience. It’s voluntary trade, not fraud.
As for inflation: A checking account dollar is a call option on a paper dollar. The issue of call options does not affect the value of the base security. The call option is the liability of the call writer, and not the liability of the issuer of the base security. Someday, economists might understand that a checking account dollar is the liability of the private bank that issued it, and not the liability of the Fed. Therefore, issuing checking account dollars is not inflationary.
18 February, 2008 at 11:48
graemebird
Andrew you idiot. What bank is going to advertise term deposits for one week?
A one week term deposit? How could this be profitable? And if it could be profitable how would it be a violation of fractional reserve in the first place.
Banks aren’t going to play these silly games in a hard money situation Andrew. And if they did it wouldn’t be fractional reserve would it.
18 February, 2008 at 15:03
Andrew
graemebird,
If it got around the regulation it would be offered. It really is that simple. If not, then a longer period would be used. The period of the deposit is not the main point, graemebird – it could just as easily be a century or two. The point is that a back to back revolving credit account allows the cash flows of the current system in a way that gets around a restriction on “fractional reserve”.
12 October, 2008 at 00:55
graemebird
Of course its easy to ban. Or rather phase out.
Its simply a matter of not selling or lending what you don’t own. And the other thing would be to keep matters in a state of growth-deflation.
Stop this idiotic subterfuge Reynolds. Nothing is easier than banning this once its phased out. If they practice it, onces its illegal, they get closed down, fined, or thrown in prison.
Its just the same as making embezzlement illegal. The bank does very well stopping its own employees from embezzling funds from it. Well this is the same thing.
Why would it be difficult to ban? If its a crime, its outlawed, so its banned.
So supposing you have a gold dealer. He cannot sell what he does not have. He cannot pretend to sell gold on fractional reserve. Currently this is what is happening. Gold and silver shortages everywhere. You cannot take delivery of the stuff. Because people have been making trades in ponzi-gold, ponzi-silver.
So the regulations are just about stopping people from selling or borrowing what they don’t own and cannot supply.
You are just being dishonest to even so much as suggest that there is some difficulty with this.
10 November, 2008 at 13:26
Andrew
graemebird,
The point is that, at law, they do own the funds deposited – see the previous thread. This is also clear from any and all contracts signed – have a look at the contract you made with your bank when you opened your deposit account. It is clear on that.
You may argue, IIRC, that some “natural law” or Roman law over-rides that point, and that was the point DeSoto tried to make, but I find this unconvincing.
You have also not even tried to deal with the back-to-back revolving credit issue. To me, you would need to ban revolving credit lines too.
If you want to try to over-ride the freedom of contract in such a major way with law then, fine, I believe a government would be able to do that. It just would have no right to call itself libertarian, conservative or even liberal one. It would also need to impose heavy-handed regulation to stop all of the possible ways around it.
13 December, 2008 at 16:46
Peter
Mencius, You wrote:
> The US banking system is protected not by the formal, contractual responsibilities of FDIC, but by the informal political understanding that FDIC itself is too important to default. (Ie, “too big to fail.”)
The FDIC is protected by the formal responsibility of the US treasury to keep the FDIC liquid (full faith and credit of the US government). Fannie and Freddie, on the other hand, had nor formal protection, but were deemed to be too big to fail. Now we pay.
Otherwise, I really enjoyed your description, Mencius, and saved it for later reference.
13 December, 2008 at 17:04
Peter
graemebird, you wrote:
> Why would it (fractional reserve banking) be difficult to ban? If its a crime, its outlawed, so its banned. So supposing you have a gold dealer. He cannot sell what he does not have.
He can sell you a promise to deliver gold. Similarly, a bank could sell you a promise to give you money at a certain time, a bond in other words. The difference to the current fractional reserve systems would be that the promise would not be legal tender, you couldn’t pay taxes with it or force other people to take it as payment. You could try to convince other people though, probably for a discount.
13 December, 2008 at 19:59
Andrew
Peter,
A bank deposit is not legal tender in any case – even under fractional reserve. You cannot go up to the taxation authorities and tell them that they must accept your bank deposit. They may accept payment by cheque (they do not have to) or they may accept payment by credit or debit card.
Bank deposits, therefore, are not legal tender even under fractional reserve.