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I’m trying to reconcile Khan Academy’s teachings “Fractional Reserve Accounting”, with Cullen’s “Monetary Realism”, and I can’t do it.

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Here’s the problem. In 1990 many banks went insolvent presumably because the value of their assets (e.g. loan IOUs), were suddenly diminished so much that these banks failed to meet their Fractional Reserve Requirements and thus were put out of business by the Federal Reserve. The FDIC came in and partially took care of the depositors that held funds at these failed banks.

In 2010 again many banks went insolvent because the value of their assets (e.g. loan IOUs) went bad. This included those loans that were bundled and then “monetized” by selling off the IOUs to others around the world. This time the insolvent banks were allowed to borrow from the Federal Reserve. As long as they paid back the loans they got from the Fed, they could stay in business.

Was this a fundamental change from “Fractional Reserve Banking” of the last century to “Stress Test Banking” (e.g. meeting certain “reserve, capital and liquidity requirements”) that we have now (e.g. Cullen’s MR)?

https://www.khanacademy.org/economics-finance-domain/macroeconomics/monetary-system-topic/factional-reserve-accounting/v/simple-fractional-reserve-accounting-part-1

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    Posted by Dennis
    Posted on 11/24/2016 4:47 PM
    200 views
    Private answer

    Reserve requirements and Capital requirements are absolutely not the same thing.

    Reserve requirement are a technical requirement for smooth day to day payments.

    Capital requirements are a fundamental measure of a banks assets over and above its liabilities and so its abilaty to absorb losses on the assets and still meet its liabilities, and obtain reserves when required.

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    Posted by Dinero
    Answered on 11/24/2016 5:40 PM
      Private answer

      I think I understand that “Capital” is related to solvency/insolvency, and “Reserve” is related to liquidity/illiquidity. During the two crisis situations of 1990 and 2010 — what happened? Both, correct?

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      Posted by Dennis
      Answered on 11/24/2016 8:27 PM
        Private answer

        1990 and 2008 were both real estate related blowups arising from the typical regulatory stupidity. But 2008 was not singular in scope; it was multi-faceted. But the core of the problem was excessive margin used in combination with investing in bogus Triple A ratings on junky sub-prime debt. What happens when your balance sheet assets unexpectedly decrease in value is you get margin calls by your brokers and you have to pay up or you get forcefully liquidated. Banks per se were not really in trouble if they had avoided investing in the junky assets (and with securitization they had no reason to hold it if originating it). Almost all of the trouble came from investment firms leveraged to the hilt and insurance companies that stupidly sold protection on the junk. All the rest of the drama was more or less spillover effects.

        It’s easy pickings to blame to repeal of Glass Stegall but the fact is this securitization process occured at least a decade minimum before Clinton signed it. It’s still ongoing in other areas that are rather “bubbly” in terms of leverage and lending to sub-prime borrowers (i.e. auto and student debt).

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        Posted by MachineGhost
        Answered on 11/26/2016 1:37 AM
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          In “1990 and 2008 were both real estate related blowups arising from the typical regulatory stupidity”. As far as can figure out, there seems to have been NO regulatory stupidity, because the laws were canceled. In order to “regulate”, our congress needed to provide a legal basis for stopping the stupidity of the BANKS and the loan originators. The private banking system messed up, not the public hamstrung regulators. We agree these two events need not have happened, but they did. The response to the screw ups is what I’m trying to noodle out.

          In 1990 the banks were allowed to go bankrupt taking out billion$ of savers savings and the investor’s investments. That was not a happy situation and caused considerable hardship for many ordinary folks.

          In 2008, a very similar mess up happened, but this time the response was completely different. (see charts above). The folks that bought the loan papers (IOUs), were fantastically screwed because the bad loans were bundled and sold (securitized)? The loan originators got cold hard cash for the money they created out of whole cloth. The folks that bought the “securitized loan papers” were holding money bags filled with that very same cloth. The investors saw their stock investments in these banks disappear. The Fed, via loans of reserves that they did not actually have, saved the whole worldwide fiat currency system from collapse. The “money multiplier” is gone.

          The point I’m trying to make is that in 1990 we may have had “Fractional Reserve Banking” and the Fed regulators took down hundreds of banks because of the liquidity issues that in then caused solvency destruction. The banks were broke and the building “saved” by bankruptcy.

          In 2008 the Fed stopped the hemorrhaging, that was worldwide this time, thanks to loans of “reserves” created out of whole cloth (I think), coupled with onerous repayment plans. I believe, but I do not know if this was the death of “Fractional Reserve Banking” and the so-called “reserve requirement”. Was the old system replaced by “stress test banking” (e.g. “reserve, capital and liquidity requirements”), that took into consideration more than the sad/fake “reserve requirements” e.g. the so-called “money multiplier”? We now have “Stress Test Banking” correct? Or am I just making this up?

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          Posted by Dennis
          Answered on 11/26/2016 4:33 AM
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            A bank’s reserve position does not tell you anything about the health of that bank . Some countries have no mandated levels of reserve holding.
            A solvent bank with no reserves can get reserves when it needs them .
            An insolvent bank with plenty of reserves is still insolvent,
            Those two points illustrate that holding reserves is less significant than holding good assets.

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            Posted by Dinero
            Answered on 11/26/2016 7:51 AM
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              Banks don’t go bankrupt because they run out of reserves. Banks run out of reserves because they’re going bankrupt. In other words, they lose access to the interbank market because other banks won’t lend to them and because the Fed and FDIC determine them to be illiquid.

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              Cullen Roche Posted by Cullen Roche
              Answered on 11/26/2016 12:56 PM
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                Yeah, you’re confused about this reserve thing. It is just an anarchronistic legal requirement leftover from the gold standard era and granted it was probably encourage by the money multiplier ideal. We hardly still had it in 1990. Reserve requirements were being abolished gradually over time and I believe in 1990 it was completely finished in terms of not applying to any financial accounts whatsoever other than checking. With the Fed and FDIC, reserve requirements really don’t make much sense other than to deal with cash withdrawals from people standing in line. Once cash is eliminated completely (not going over so well in India at the moment), I expect the remaining reserve requirements to be eliminated as well.

                The only difference between 1990 and 2008 (aside from government removing common sense regulations that encouraged the resulting malinvestment), is that Congress dealt with the mess by putting the underwater S&L’s into receivership and placed the bad mortgages into a trust to be auctioned off to the public. In contrast, 2008 was a Treasury bail out to all financial institutions (they coerced even non-affected institutions to take the TARP money whether they wanted it or not) along with the later suspension of mark to market accounting rules. The Fed also illegally took onto its balance sheet all of the junky sub-prime assets… engaging in direct fiscal policy since it wasn’t in exchange for the monetary base, but outright monetization. If you ask Bernanke at his blog about all of this, he’s not gonna pull a mea culpa like Greenspan did and admit he or the Fed did anything wrong. Such is hubris and busywork with Ivory Tower academics.

                In both instances, the Fed lowered the FFR/DR so that the financial institutions could repair their balance sheet over time by arbitraging FFR/DR and Treasury yields.

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                Posted by MachineGhost
                Answered on 11/26/2016 2:36 PM
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                  P.S. Personally, I think the Federal Reserve Act should be reformed and freed from its triple political mandate to focus only on running the interbank clearinghouse system and acting as lender of last resort. Everything else is leftover political baggage from the socialist/progressive era (hello, 103 years and counting!!!).

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                  Posted by MachineGhost
                  Answered on 11/26/2016 2:56 PM
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