That's not shadow banking, that's the stock and bond markets

Paul Krugman has a flow chart showing flows of savings from ultimate lenders to ultimate borrowers. One arrow goes via the banks. Paul labels it "traditional banking"; that's fine. People deposit their savings in banks, and the banks lend those savings to other people or firms. But a second arrow goes directly from "the public" to "borrowers", and Paul labels it "shadow banking". Nope.

"Traditionally — i.e., before the 1980s — the public put its money in banks, and banks made loans to borrowers: thus the diagonal arrow from banks to borrowers represents traditional banking.

By 2007, however, much of this traditional channel had been supplanted by shadow banking: debt was securitized, and the securities sold to the public — the straight arrow across the bottom of the figure."

But there is nothing novel about direct lending from ultimate lenders to ultimate borrowers. That's what the stock market and bond market have done for centuries. I'm not an economic historian, but I think I'm right in saying that people were lending to each other long before anyone ever thought of banks.

Securitised lending is closer to some sort of hybrid between direct lending and bank lending. Banks make the initial loans, then sell those loans to the public. It starts as bank lending, then is transformed into direct lending.

The existence of direct lending is not puzzling. Some people want to lend, and others want to borrow, so the two sides get together, just like in any market. It's the existence of these new-fangled banks that needs explaining. Why do ultimate borrowers and lenders go through a middleman? And, of course, the job of money and banking textbooks is to provide explanations for the existence of banks.

The simplest explanation of the existence of banks is that there are economies of scale if one bank collects the information on a borrower rather than several individual ultimate lenders duplicating the costs of collecting that information. But if that's the benefits of banks, there must also be a cost, otherwise all lending would be channeled through banks, and direct lending would not exist.

The simplest explanation of the costs of banks is that when you introduce a  bank you introduce one more highly-leveraged entity that can go bust.

When banks have both benefits and costs, you generally get an "interior solution" where some lending goes through banks (where the benefits exceed the costs) and some lending is direct (where the costs of banks exceed the benefits).

Now lets look at Paul Krugman's question:

"But here’s my question: why does it have to be a return to shadow banking? The banks don’t need to sell securitized debt to make loans — they could start lending out of all those excess reserves they currently hold. Or to put it differently, by the numbers there’s no obvious reason we shouldn’t be seeking a return to traditional banking, with banks making and holding loans, as the way to restart credit markets. Yet the assumption at the Fed seems to be that this isn’t an option — that the only way to go is back to the securitized debt market of the years just before the crisis.

Why? Are we still convinced that securitization is a far superior system to conventional banking, and if so why?"

Dunno. Not really my area. But is it so hard to imagine that securitised debt might, in some cases, get most of the benefits of bank lending without most of the costs? Hybrids sometimes work like that (I was thinking hybrids between milk and beef cattle, but you can think Prius if you like).

All new-fangled inventions have a tendency to get over-enthusiastic support in some quarters initially, before people learn to use them sensibly. But direct lending is not new-fangled. It's only the hybrid between direct lending and bank lending that's newer than both its parents.

Comments

[Adam P]

Nick,

I think you're exactly right.

A second reason we have banks (besides economies of scale in information gathering) is to intermediate between those savers who want their funds to stay liquid and investors who have illiquid long term investment prjects. If the bank is well capitilized with a large set of unrelated depositors then the magic of fractional reserve banking allows the intermediary to simultaneoulsy have an illiquid loan portfolio while keeping the savers liquid (for the most part, provided it doesn't get run).

Those savers that are willing to accept less liquidity or bear the cost of information gathering in order to earn higher returns just buy bonds and shares direclty. (Perhaps they do it through a fund but then they are buying the manager's expertise/outsourcing the information gathering or, in the case of an index tracker, they are buying some economy of scale with respect to transactions costs. In either case this has nothing to do with credit intermediation per se).

[jg]

I think that Krugman refers to the securitization process of mortgages and other receivables (credit cards, auto loans etc), although he does not say it explicitly. To that extent, it is different from stocks and bonds in that individuals cant really go to the "market" and raise funds. They have to find a lender and that usually means a bank.

As far as to why securitization can be costly, James Kwak provides a good explanation today I think.
http://baselinescenario.com/2009/10/07/securitization-bubble/
Basically, it's about incentives.

[Nick Rowe]

Adam: Thanks! On liquidity though, one thing I've been trying to think about is whether and why bank deposits might be more liquid than (say) stocks or bonds that are traded on markets. When the bank deposits serve as a medium of exchange, they clearly are more liquid. But in principle, why should the other liabilities of a bank be any more liquid than assets traded on markets? Is it just that the bank is acting as a market maker? I'm also thinking about whether and why stock markets and bond markets cannot be subject to Diamond/Dybvig runs in exactly the same way as banks.

jg: Good link. Yes, when you buy a securitised bundle you either have to collect information or else trust someone else to provide it. But that seems no different from the case of regular stocks and bonds. We don't automatically trust the company that issued those stocks or bonds any more than we trust the bank that issues a securitised bundle; we know they have an incentive to lie when they issue them. Few of us ever go and inspect the companies whose stocks and bonds we buy. We rely on our brokers, or mutual fund managers.

The only difference I can see is in the bundling. The bank bundles a lot of little bonds into one big bond. Must be some sort of economies of scale story.

[Adam P]

Nick,

one more comment on your last paragraph, I agree again 100%. Securitization and the tranching of credit exposure are themselves very good ideas, they were misused but that doesn't mean we should prohibit them.

I seem to recall in the 1980's some companies blew themselves up with options and people then were talking about prohibiting or greatly restricting their use. But everyone learned and things moved on. The same will happen with ABS/MBS and CDO's and the like. The banks just need to learn that securitization doesn't remove their responsibiltiy to vet their debtors.

But again, with respect to Krugman, you're exactly right. Their is nothing new or shadowy about savers investing directly in real investment projects.

[Adam P]

Nick,

yeah, I had in mind demand deposit/checking acounts which basically can be used as medium of exchange.

The other liabilities of the bank are not any more liquid, but they are part of the class of debt owned directly by investors who accept less liquidity for higher returns.

[Nick Rowe]

Adam: Yep.
I went to a talk by David Laidler on the Financial crisis a few months back. He started his talk with a 200 year old quotation in French complaining about John Law and his terrible new advanced math technique that had caused the financial crisis: "algebra". And the terrible new financial instruments that had brought ruin to France: common stocks and paper money. Plus ça change.

[edited to correct the French - SG]

[Patrick]

I think it's hard to judge at this point whether securitization is a net benefit or not. I suspect some is (normal MBS), and some isn't (naked CDS). Clearly, Wall St. et. al. got ahead of itself. I'm thinking of posts I've read over at CR about the legal mess created when a mortgage that's been tossed into a CDO bucket goes into foreclosure. Seems everyone just jumped on the bandwagon and figured they'd work out the details later. Next thing you know ... oops, we blew-up the world.

Reminds me of the heady days of the dot com bubble when any shmo with a some glossy paper with 'Business Plan' printed on it and a domain name could get a hundred million dollars in venture capital.

The problem is that when finance blows-up it can take out the whole economy in a big way.

[Andy Harless]

I see it as a tradeoff between diversification (facilitated by securitization) and due diligence (facilitated by traditional banking). Paul Krugman seems to agree with Mark Twain's Puddnhead Wilson: "Behold, the fool saith, Put not all thine eggs in the one basket, -- which is but a manner of saying, Scatter your money and your attention, but the wise man saith, Put all your eggs in the one basket and -- watch that basket."

[Jon]

Krugman does not give an accurate rendition of 'shadow banking'. Shadow banking refers to a form of regulatory arbitrage that has taken place wherein certain intermediate institutions walk and talk like "banks" but have taken deliberate steps to avoid regulatory reserve and capital requirements.

Krugman confuses the timeline of developments with their naming in popular conception. The term "shadow banking system" first gained wide currency after its use at the Fed's 2007 Jackson Hole conference. Krugman contorts this to deliberately tie the concept to the last gasp of structured finance excess in 2007.

The term principally covers hedge funds and special purpose entities--broadly speaking a corporation established to operate as an ad hoc bank. But these have been around forever--i.e., the first REIT dates to 1960. Of the latter two modern innovations have largely now been discredited. 1) Using CP to fund the SPE (e.g., SIVs). This ought to have been obvious but this is the 'bank run' problem. 2) Creating tranches. But these two failures are narrow portion of the shadow banking system overall.

A system which ultimately survived without tax payer money.

[Adam P]

Patrick,

I don't know if these new securities are really all that beneficial or not but like I said, I think that in general securitization and the tranching of risks is a good idea. It should, help people take just the exposures they want. It does not however, turn bad investments into good ones.

But to me, even the bad investments weren't the problem per se. It was the excess leverage (the extremely high number of bad investments). At the aggregate level you want the banking system to making enough loans that some will be defaulted on. Otherwise the economy would never fund any risky projects at all and this would be an economy with pretty much zero inovation.

Ultimately, what killed Lehman was the 44:1 leverage, they could still be a bank that lost a lot of money. Instead they're dead.

Now, I know that securitization facilitated the excess leverage by getting stuff off balance sheet but that is a regulatory issue. Write accounting rules that are a bit more conservative and enforce proper risk management. None of this requires outlawing CDOs.

[Patrick]

Adam: I think we agree. Whatever the arrangement of boxes and arrows on PK's diagram, the important thing is to minimize the likelihood that it can blow-up and take out the world economy.

The thing I have a really hard time understanding is how so many people get it so wrong at such a massive scale for so long? It was like lemmings marching off the cliff into the sea. At least with the dot com boom, there really was a cool new technology that did change the world, but 44:1 to bet the farm on houses?

[Adam P]

Patrick, yeah we do agree. After I wrote my post I realized I wasn't debating your statement, I was agreeing with it.

[Bruce Wilder]

Jon: "A system which ultimately survived without tax payer money."

Which "system" would that be? I must have missed it.

[Bruce Wilder]

I see you are back to the "ultimate borrowers" and "ultimate lenders" nonsense. This gives me such a headache.

What's leverage? Why leverage? What's its economic function?

[www.facebook.com/profile.php?id=611985302]

Who bet the farm? The whole point was the game was played with Other People's Money. The bonus babies got their bonuses. They were the ones making the decisions. The stockholders are just suckers.

The whole point of this was that it was a gigantic fraud.

[www.facebook.com/profile.php?id=611985302]

With respect to making CDO's actually work, it would be possible. But it would take a massive IT investment to make it work. You would have to be able to drill down on all the mortgages etc. making up the instrument and evaluate the risk on each one in order to price each tranche. The buyer (not the broker) needs to be able to do that.

Possible. Expensive. Take a long time to build. Would require information standardization.

[Nick Rowe]

Bruce: What's wrong with "ultimate lenders" and "ultimate borrowers"? (I didn't invent the concepts.)

If a bank takes $90 in deposits, and lends $100 (so it has $10 of its own capital), it has a leverage ratio of 10. Without leverage, there could be no banks. Ultimate lenders (sorry) would have to lend directly to ultimate borrowers.

Jim: "With respect to making CDO's actually work, it would be possible. But it would take a massive IT investment to make it work. You would have to be able to drill down on all the mortgages etc. making up the instrument and evaluate the risk on each one in order to price each tranche. The buyer (not the broker) needs to be able to do that."

But it takes exactly the same IT investment to work out the fundamental value of a share in a traditional bank. If a bank accepts deposits, and uses it to lend in the form of mortgages, the bank shares are identical to the lowest tranche of the mortgage portfolio. Bank shares are toxic waste.

By the same argument, there is no way traditional banks can possibly exist, except as a massive con game!

Traditional banks play with other people's money. Direct lenders play with their own money.

[www.facebook.com/profile.php?id=611985302]

CDO's are much narrower than banks. If I buy a share issued by a bank all of their businesses have to lose money to make me lose money. I also get to elect board members to pay attention to things. Plus there are bank regulators.

With a CDO the number of things that have to go bad is much smaller, even at the senior tranches. Also, with a CDO the seller has no skin in the game. They make their profit and lose their risk as soon as they sell it.

You just described the S+L crisis of some years ago.

Banks are fundamentally a potential con game, that's why we have bank regulation and deposit insurance. Unregulated banks ARE toxic waste.

[Nick Rowe]

Jim: " If I buy a share issued by a bank all of their businesses have to lose money to make me lose money."
No. As shareholder, you are the residual claimant. If the Bank loses $1, the shareholders lose $1.

[Too Much Fed]

"If a bank takes $90 in deposits, and lends $100 (so it has $10 of its own capital), it has a leverage ratio of 10. Without leverage, there could be no banks."

Why can't banks take in $100 in deposits, and only lend $100?

[Too Much Fed]

"Ultimate lenders (sorry) would have to lend directly to ultimate borrowers."

Why is there a need for ultimate borrowers (people who borrow with loans denominated in currency) at all?

[Too Much Fed]

Jon said: "Krugman does not give an accurate rendition of 'shadow banking'. Shadow banking refers to a form of regulatory arbitrage that has taken place wherein certain intermediate institutions walk and talk like "banks" but have taken deliberate steps to avoid regulatory reserve and capital requirements."

Would getting around reserve and capital requirements allow for the creation of more debt (loans denominated in currency) so that price deflation did not occur when china entered the wto?

Would that allow the fed to exploit cheap labor with cheap debt (loans denominated in currency) to produce wealth/income inequality and high asset prices for their spoiled and rich friends while trying to keep price inflation in their preferred range?

[Nick Rowe]

Too much Fed:

"Why can't banks take in $100 in deposits, and only lend $100?"

And keep $10 in currency reserves? They could. It doesn't change anything else I wrote, which is about banks' capital ratios, not currency reserve ratios. Canadian banks normally keep very small currency reserves, so I ignored them altogether, for simplicity.

"Why is there a need for ultimate borrowers (people who borrow with loans denominated in currency) at all?"

That strikes me as such a weird question. It's like asking: "why do we need people who buy apples?".

Well I expect we could say that people who want to sell apples need people who buy apples. Just as you need borrowers if you want to be a lender, so you can save for your retirement.

But apple buyers don't exist to serve some higher social or religious purpose. They just exist. I expect we could consider a ban on buying apples, and insist that everyone grow their own. Apple buyers would be pissed off; and so would apple sellers. Same with borrowers and lenders.

[www.facebook.com/profile.php?id=611985302]

Nick: No. As shareholder, you are the residual claimant. If the Bank loses $1, the shareholders lose $1.

I didn't say that clearly enough. If the bank loses $1 on residential mortgages and makes $1 on commercial mortgages we are both even. Investing in banks spreads risk more than buying CDOs which is why you don't need the same tools to investigate risk.

[Chris]

Q: "But here’s my question: why does it have to be a return to shadow banking?"
A: Two words: regulatory capture.

[Loof]

Andy says: I see it as a tradeoff between diversification (facilitated by securitization) and due diligence (facilitated by traditional banking). Paul Krugman seems to agree with Mark Twain's Puddnhead Wilson: "Behold, the fool saith, Put not all thine eggs in the one basket, -- which is but a manner of saying, Scatter your money and your attention, but the wise man saith, Put all your eggs in the one basket and -- watch that basket."

Except,there appears to be no tradeoff with eggs, foolishly scattered or wisely watched: when the basket, propelled by greed, is on its way to hell in a basket case.

[Loof]

Jim says: Who bet the farm? The whole point was the game was played with Other People's Money. The bonus babies got their bonuses. They were the ones making the decisions. The stockholders are just suckers.

The whole point of this was that it was a gigantic fraud.

Yes, it was a game, fools gambling, playing with other people’s money. Stockholders were suckers. We all sucked. Now the gamblers are back gaming with taxpayers’ money. We all suck some more. And households sicken, homes continue to depress, devalued and unemployed - and governments are betting on them. Still, it’s not a gigantic fraud, which implies intent to deceive; more mass delusion, being addicted to greed with the system geared for gluts. And, it’s MAD: mutually assured destruction on the highway to hell with unsustainable supply and wanton demand.

Self-interest is the Archimedean point of the modern economic/political system worldwide. It centres the economic pre-analytic Vision and all micro/macro schooling, as i see it. Archimedes who knew about leverage, said: “Give me a place to stand and I will move the world”. Notice that in the present financial crisis the “me” and “I” of the greediest not only got a place to stand, they were outstanding with casino capitalism and freewheeling markets. It was exceptional, admired; the guys whose greed was greatest were considered heroes, got bonuses, cheered on – when really they are a basket case. It’s all mass delusion and mental: ego sans empathy is a key factor in determining psychopathic behaviour, after all. Organically, the economic system is sick, physically and psychically.

It is a dark age of macroeconomics forgetting that hidden hand leverage through enlightened self-interest (modernized as ego and empathy) is the grand theoretical key to happiness and utility maximization. A reformation is needed so enlightened self-interest has a place to stand and work their Archimedean lever like a hidden hand (two actually). A start is made in theory by clarifying self-interest relative to the healthy individual person balanced by ego and empathy, which is commonsense backed by increasing empirical evidence. Firms, as ideal types, would be centered by maximizing self-interest with a minimum of empathy (a hidden hand); just as the healthy households, families, are centered by maximizing empathy with a minimum of self-interest (a hidden hand). In firms and households, the two hands would be visible and invisible – and complementary correlates. The overall pre-analytic picture (Schumpeter’s Vision) would not have an overall circular shape; it’d be elliptical centered by two Archimedean points, side-by-side. The paradigm shift is slight, simple – and fundamental. In analysis theorists would be working with two pivotal points and unfamiliar math, I believe.

So says this backward old fool. I put all my eggs in one basket, so I can hopefully watch the basket case transform into a healthy case and turnabout to move towards heaven.

[Patrick]

Loof,

There certainly was and is criminality. And the policy response is not what I would have liked (see Simon Johnson's writings). But there's nothing new in any of this (e.g Andrew Jackson, Teddy Roosevelt). It's magneto trouble.

[Loof]

Patrick,

Yes, some outright criminality, some inside conspiracy exists. And, somewhat similar to problems in the Jackson and Roosevelt eras though more akin, in essence, to the Revolutionary era of the 1770s, as I see it: as now a part of the commercial system so completely overrides economy/polity that a similiar theoretical revision as well as a political reformation (though not to the extent of a revolution, I hope)may be needed. I’ll think about the problem in light of Johnson’s “Silent Coup” thesis and the Greedy Archimedes anti-thesis. I suspect his thesis can be sublated.

[Too Much Fed]

Hopefully, will comment on the October 9th 7:51 a.m. comment later.

[Too Much Fed]

I said: "Why is there a need for ultimate borrowers (people who borrow with loans denominated in currency) at all?"

Nick said: "That strikes me as such a weird question. It's like asking: "why do we need people who buy apples?".

It is not about the apples. It is about the loans denominated in currency. If everyone's salary (or other means) was high enough and prices low enough, everyone could save. Would there still be differences in salary and standard of living? Probably.

It seems to me your idea of borrowing is more like a futures exchange with no interest rates and maybe no time differences.

So I think it comes down to this question. What is/are the difference(s) between borrowing with loans denominated in currency and loans denominated in apples?

[Too Much Fed]

"Just as you need borrowers if you want to be a lender, so you can save for your retirement."

It seems to me that more and more debt on the lower and middle class in the high wage countries is an attempt to trick them into not being able to retire.

Also, why does a lender need a borrower to able to save for retirement?

[Too Much Fed]

EDIT: "more and more debt on the lower and middle class"

TO: "more and more debt (loans denominated in currency) on the lower and middle class"

[Too Much Fed]

"Apple buyers would be pissed off; and so would apple sellers. Same with borrowers and lenders."

If "borrowers" don't need to borrow, won't they be happy?

If lenders are pissed off because they can't find anyone to get into debt (loans denominated in currency), then that is tough. What do the lenders want from the borrowers anyway?

[Too Much Fed]

I can't stand don kohn but ...

Here is one other thing about low interest rates to think about and from:

http://www.calculatedriskblog.com/2009/10/feds-kohn-economic-outlook.html

"Low market interest rates should continue to induce savers to diversify into riskier assets, which would contribute to a further reversal in the flight to liquidity and safety that has characterized the past few years."

Maybe he should also mention goldman sachs borrowing in currency at really low interest rates to jack up stock prices and oil prices to attempt to trick people into thinking a recovery is coming?

[Loof]

Greedy Archimedes and the Silent Coup (1)

The Silent Coup thesis appears reciprocally related to Re-evaluating the Modernization Thesis (June, 2009) which Simon Johnson and other heavyweights are formally involved. They’ve correlated a lot of evidence to argue that “events during critical historical junctures can lead to divergent political-economic development paths, some leading to prosperity and democracy, others to relative poverty and non-democracy.” Right on; we’re there at a historical juncture – and it’s good to see such prominent people working on underlying values ascertaining valid points along a baseline. Eh, perhaps they’ll look below and re-evaluate that key pivotal point deep down that might connect to their endpoints along the base.

In observing a “silent coup” the sudden alteration of an existing government by a small group could be rationalized as needed to save the status quo system. Authorities could be viewed as working for national interest, efficiently aligned to their corporate and personal interests; and, naively believing this setup was in the best interest of everyone. Certainly wasn’t a crony coup bent on corrupting the system; they’re experienced professionals on a warlike footing willing to bend the rules and conspire with some shadow banking and some shady business to get a job done – even though it increasingly looks delusional, poor policy and the people appear to increasingly sacrificed for an illusory greater good. Still, easy to say in hindsight. The point is Greedy Archimedes won the jackpot again as he does in all war footings: in silent and peaceful coups; in cold or hot wars. Indeed, never has there been a bigger payoff to the ‘greed is great’ guys as the prevailing benevolent despot (before republican; now democrat) reaping at home. And, not even the malevolent tyrant abroad has come close.

So, the Goldman Sachs-White House revolving door as a focal point for the coup may be qualified by selfish interests aligning “me”, “my” group,” my” country – virtual egoism lined up vertically without empathy. I deem they’re blinded by selfishness in themselves, in their businesses and in the their state. I also wouldn’t rule out addiction to gambling as part of the problem.

Self interest used to be aligned with the State via Main Street with the worker and capitalist in the proverbial ‘what’s good for General Motors is good for America': now showing in the nostalgic and sentimental Capitalism: A Love Story documentary. But, the collective egoistic mindset sans empathy found a better alignment for selfishness: what is good for me first is good for Goldman Sachs is good for Wall Street is good for the White House and best for America. For efficient selfishness, worldwide economical polity, workers and Main Street not only could, they should be sacrificed just as the future can be burdened with monstrous debt. Consequently, globally Greedy Archimedes can continue to reap where he doesn’t sow with ever bigger businesses and ever bigger governments.

[Patrick]

Loof - I pretty much agree with Simon Johnson, but understand that what motivates him is a desire for MORE capitalism, not less - which fine by me. I suspect that if you asked him, you'd find that he doesn't get too upset about greed, or 'big business' as long as it can fail without blowing-up the economy or holding taxpayers hostage.

[Curtis]

"It is not about the apples. It is about the loans denominated in currency. If everyone's salary (or other means) was high enough and prices low enough, everyone could save."

No. People borrow (and save) to smooth consumption over their lifetimes. Real incomes can increase, and depending on where in a life-cycle earning profile the increase falls, private debt can increase. An increase in private debt can be the result of (and a cause of) a pareto improvement.

[Too Much Fed]

Curtis said: "No. People borrow (and save) to smooth consumption over their lifetimes."

That's possible. I don't believe that is what is happening. I believe that some people are borrowing with loans to make up for negative real earnings growth, and some people are borrowing with loans to consume more now than they should be. Both of these are helping the fed to fight price deflation from cheap labor and positive productivity while claiming to be fighting price inflation and to "trick" people into working longer than they should be so that corporate america won't be running out of workers.

IMO, people should not be borrowing with loans to smooth consumption. I believe that is what got us into this mess.

[Loof]

Patrick says:
"Loof - I pretty much agree with Simon Johnson, but understand that what motivates him is a desire for MORE capitalism, not less - which fine by me. I suspect that if you asked him, you'd find that he doesn't get too upset about greed, or 'big business' as long as it can fail without blowing-up the economy or holding taxpayers hostage."

Patrick,
I too agree more capitalism is needed: but not greedy capital that drives out good capital; I can agree with big business but not bent on ever bigger business driving out good business. Johnson doesn’t get upset about greed; he does recognize greed is a problem asking: “Have we really built a system in which greed fully overshadows responsibility?”

Yes, professor – and the profession has misunderstood the role of greed and is inadvertently structuring the system so sick selfishness drives out healthy self-interest, as I see it. It seems the opposite movement of self-interest towards enlightened self-interest is needed for responsibility to develop.

Mainstream schools of economics works the pivotal point, self-interest, in different ways and alignments; and none that I’m aware, exclusively works with self-interest as Adam Smith did: relative to the personal individual in the form of the neighbourly banker, baker, manufacturer, etc. in free and fair markets. Simply look at Smith’s Vision as an ideal type, a utopian good to work towards. As far as I can see the overall movement of the economic system is headed in the opposite direction: on the bad side moving to dystopia.

[Loof]

Here is some news today of Greedy Archimedes on Dystopia Road to serfdom. On his right side: Wall Street is set to award record pay; JP Morgan got its second-highest quarterly profits ever; Comcast wants to take over NBC Universal. On his wrong side: Record # of foreclosures; unemployment is up; income is down. Greedy will never provide for everyone’s needs and limited wants; after all, he can’t even satisfy one wanton man or woman let alone whole gangs of them.

[Declan]

"Too much Fed:

"Why can't banks take in $100 in deposits, and only lend $100?"

And keep $10 in currency reserves? They could. It doesn't change anything else I wrote, which is about banks' capital ratios, not currency reserve ratios. Canadian banks normally keep very small currency reserves, so I ignored them altogether, for simplicity."

This is an old thread now, but just for the record, a typical Canadian bank these days has a deposit-loans ratio of around 80% and a leverage ratio of 15-20, so a more realistic Canadian example would be taking in $100 in deposits, lending $80, and having $5 of its own capital.

By current standards, a loan/deposit ratio of 80% might be considered low, but by historical standards its quite high.

Some interesting historical perspective on the loan/deposit ratio here. Perhaps unsurprisingly, like almost all measures of leverage, loan-deposit ratios peaked in the late 1920's, then fell sharply by end of WW2 before rising steadily for decades until we once again were hit with financial meltdown.

As for the main point of the post, securitization is just a way of evading (capital) regulations put in place to safeguard the financial system, and as such, I would consider securitization a bad thing, even aside from the lack of wisdom in separating the loan origination and default risk assuming functions.

[Nick Rowe]

Declan: "As for the main point of the post, securitization is just a way of evading (capital) regulations put in place to safeguard the financial system, and as such, I would consider securitization a bad thing, even aside from the lack of wisdom in separating the loan origination and default risk assuming functions."

I've been thinking about this comment of yours ever since you wrote it. I strongly disagree. But I'm trying to decide if I should write a post on why I disagree (and waiting for my brain to recover enough to make a half-decent go of it).

Do you think your viewpoint is widely held?

Also, do you know to what extent an originating bank typically "guarantees" a securitised loan it has sold to third parties? (Or is that an impossibly complex question to answer?). Because if there is a 100% guarantee, I withdraw my strong disagreement with what you wrote.