Federal Reserve pushes for elimination of reserve funds requirement

That got me to thinking.  This is probably just a push the can down the road a bit farther game.  After all, if banks can swap these loans, that means they can borrow to cover any liability such as bad loans.  How long until we see the big banks agree to "interest free loans" to each other to help insure liquidity in the system.  Isn't this a way to permanently keep the bad loans (defaults) on the banks balance sheet at full value?

It has only been a self- interested lack of total cooperation that has kept this from happening thus far,  but now it is only in self-interest that they attempt to keep each other artificially alive by playing an endless game of hot potato.  As long as they keep cooperating with each other under the pretense that they are competitors there is nothing to stop them.....

Isn't this the equivalent of giving a junkie a speed ball?

By eliminating  the reserve requirement  you eliminate the market for Fed funds (overnight loans between banks for reserve money)   making it faster  to expand bank credit.

Either I'm missing the point, or this story has been ridiculously under-reported. I haven't even seen anything on ZH about it yet, although I haven't caught up with Friday's posts yet.

If my understanding is correct, this means two banks can write a computer program in 5 minutes that lends money back and forth over and over again, and create an unlimited amount of money in the money supply by doing so. At will, with no governmental supervision or control.

If this really has the ramifications I think it does, it seems like it should be the big story of the year. Maybe I'm missing something, but without a reserve requirement it seems to me that banks effectively have an unlimited license to print an unlimited amount of money. What am I missing?

Erik

Hi Erik,

I am sure that you know a lot  more about banking than I do but that was my take also. It seemed that there was no limit on how much money could be created.

 In spite of the earlier comment from someone else that only Wall Street Banks would do what you are describing I think the smaller banks would soon fiqure out out to play the game.

It also seems to me that  What Bernanke Wants- Bernanke gets. So, it would not surprise me if the politicos actually do something like this.

Ken

Hey Erik-

   I just stumbled across this article, "Money Out Of Thin Air: Now Federal Reserve Chairman Ben Bernanke Wants To Eliminate Reserve Requirements Completely?" at: http://theeconomiccollapseblog.com/archives/money-out-of-thin-air-now-federal-reserve-chairman-ben-bernanke-wants-to-eliminate-reserve-requirements-completely.  (hat-tip to http://theautomaticearth.blogspot.com/2010/03/march-19-2010-bread-and-games.html).  Here's an excerpt

Up until now, the United States has operated under a "fractional reserve" banking system.  Banks have always been required to keep a small fraction of the money deposited with them for a reserve, but were allowed to loan out the rest.  But now it turns out that Federal Reserve Chairman Ben Bernanke wants to completely eliminate minimum reserve requirements, which he says "impose costs and distortions on the banking system". At least that is what a footnote to his testimony before the U.S. House of Representatives Committee on Financial Services on February 10th says. So is Bernanke actually proposing that banks should be allowed to have no reserves at all?

That simply does not make any sense. But it is right there in black and white on the Federal Reserve's own website....

The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.

If there were no minimum reserve requirements, what kind of chaos would that lead to in our financial system?  Not that we are operating with sound money now, but is the solution to have no restrictions at all?  Of course not.

What in the world is Bernanke thinking?

But of course he is Time Magazine's "Person Of The Year", so shouldn't we all just shut up and trust his expertise?

Hardly.

   The article also has a number of comments.  Some "right on" (from my perspective), others from people still taking the blue pill ("everything will be just fine!")!!  Unreal!

Forgive me if I'm missing something, but...

Suppose this goes thru. Then you go to your local bank branch and present a withdrawal slip, and say "Good Morning, I'd like to withdraw ten dollars, please."

What's to stop them from saying "Sorry, we don't have it".

But you better have it!!! I deposited $100,000 in cash just yesterday!

Yes, but we lent it all out, and we have no cash left.

But I want to make a withdrawal! You have to have some cash!!!

No, we don't. That was last week. Starting this week, we don't have to have any, and we don't. Sorry, come back tomorrow.

Am I totally missing the point here or something?

Erik

I read the Federal Reserve's position and two things really struck me.  First, the intended goal is to remove lending restraints from the irresponsible banks.  Second, there is no explanation as to how the new mechanics might work.

In Europe, I don't think there are any "fractional" reserve requirements on banks and more to our situation, I don't think they have been in place in the U.S. either.  At least not in the way we have been led to believe (fractional lending money multipliers that allow a percentage of deposits to be lent out).  Take for example the big investment banks that have few deposits but yet create a good portion of money for their own accounts.

My understanding is that there are two key ratios that determine if and how much a bank may create as loans. It is up to regulators to ensure that banks maintain the required minimum ratios.

1. Capital Ratio - is the ratio of a bank’s capital (equity) to a risk-weighted sum of the bank's assets. I think the weightings are 0 for reserves, 0 for government securities, 0.2 for loans to banks, and 1.0 for ordinary loans. The BIS (Bank of International Settlements) has established a minimum capital ratio of 8% but I am not sure if it is currently used by the Fed.

2. Leverage Ratio - is the ratio of a bank's equity to the unweighted sum of its total assets. I think the required minimum is 3 - 10%, depending on the size of the bank. The reserve ratio is the ratio of a bank's reserves (deposits at the Fed plus vault cash) to its demand deposits, i.e. checking deposits.

If a bank is unable to maintain the minimum ratios, technically they cannot lend regardless of any "fractional lending" multipliers that might be used. If a bank loses money through loan defaults, bad investments, fraud, etc., their liabilities may exceed their asserts and they become vulnerable to a bank run. This is a major problem today as regulators have not done their job and subsequently, we have lots of insolvent banks.

So what does this new policy mean?  I think Erik hit it earlier when he wrote that:

"My own take is that this can only mean one thing: The banking system is so totally insolvent (i.e. if they actually took the write-downs that sound accounting practices would dictate) that Bernanke has concluded that the now year-old effort to give the banks free money won't be enough to repair their balance sheets to the point of (true) solvency. Eliminating the reserve requirement effectively means they don't have to be solvent."

But it gets worse...consider this...

Banks are allowed to create money for their own investment accounts.  In the past, commercial banks were separate from investment banks but that barrier was removed under the Clinton administration.  Commercial banks were the traditional bank down the street that made loans and provided checking accounts.  Investment banks acted as money centers, they created money via acquisitions, mergers, investments, etc.

More details are needed but it looks as though banks will become gigantic hedge funds with an unlimited ability to create free money.  And don't forget, we back up every dollar they create even if we don't borrow them.  They are creating money under our national credit for their profit while we, and future generations, assume the losses and get stuck with a monetary system that is becoming totally debauched.

What will they do with the new money?  They will lend what makes sense and use the rest to buy the country with our credit.  Welcome to fascism and debt slavery.

Larry

Note, just to be more clear about the fractional reserve (money multiplier) myth, here is a chart from the Fed.  The "money multiplier" fell below 1.  I don't think deposits have grown this much.  I think it is because the banks are insolvent under the ratios I described above.

I'm especially curious as to how this will impact the banks on the troubled list. I.E. will it positively effect their perceived solvency?