About the reserves and about interest

[truedelphi]

Interesting discussion found over here:(YOUr choice - tinyurl or safer long URL)

http://tinyurl.com/ybkvcha


http://groups.google.com/group/understandingmoney/browse_thr
ead/thread/9785c5af4ae4be41?hl=en


Thesea re off Williams's google group
Quoting from the article: "Paying interest on reserves breaks the link between the quantity of reserves and banks' willingness to lend.

By raising the interest rate it pays on reserves, the central bank can increase market rates and slow the growth of bank lending and economic activity without changing the quantity of reserves. In other words, paying interest on reserves allows the central bank to follow a path for short-term interest rates that is independent of the level of reserves. By choosing this path appropriately, the central bank can guard against inflationary pressures even if financial conditions lead it to maintain a high level of excess reserves."

"This logic applies equally well when financial conditions are stable. A central bank may choose to maintain a high level of reserve balances in normal times because doing so offers some important advantages, particularly for the operation of the payments system. For example when banks hold more reserves they tend to rely less on daylight credit from the central bank to make their payments. They also tend to send payments earlier in the day, which reduces the likelihood of a significant operational disruption or of gridlock in the payments system. To capture these benefits, the central bank may opt to create a high level of reserves as part of its normal operations, again using the interest rate it pays on reserves to influence market interest rates."

Nowhere in the article is there any mention of where the funds would come from or what is implied in the banks receiving the interest payments. Frankly I'm appalled at the flimsy rationale given for maintaining a large supply of excess reserves considering the free lunch that banks will enjoy and its effect on the government's budget deficit. That lunch would be generous indeed if monetary policy called for raising the Fed funds rate to say 10% with about 1 trillion$ of reserves in the system. That would be 100 billion$ of free lunch for banks and that much additional budget deficit.

What do you think?

[bemildred]

1. Sounds like magical bullshit to me.

The theory seems to be that you can control bank lending practices by manipulating the interest you pay them (the banks) on the reserves you require them (the banks) to keep. Hence it seems to be an argument to use interest payments as a substitute for changeing reserve requirements for banks. I assume that the idea of changeing reserve requirements for banks is anathema to the banks.

It would be much more straightforward (it seems to me) to just get rid of the banks and do it all yourself, since you can in fact do that, but that would also be less obfuscated and might spook the Rubes, who might realize that our monetary system is all bullshit, and has been that way for some time.

[FBaggins]

3. Getting rid of banks may be appealing, but it could be a big mistake.

People often associate "bank" as if that's a single group of homogeneous institutions.

Most don't realize that a big part of the mess we've been in was caused by cutting the main-street commercial banks out of the lending circuit - replacing them with a "shadow banking" industry (the wall-street banks). 30-40 years ago "normal" banks made 80%+ of the commercial loans in this country. Right before the current crisis it was down to (guestimating) 25-30% of commercial lending. The rest was done with commercial paper and traded/sold through the Wall street firms.

Why is this a bad thing? Well, banks exist because (in theory at least) they're supposed to understand how to price for risk. Cut them out and either most people pay much more for credit (if loans are made directly), or the same thing we just saw happens again, too many loans go bad because the people who are funding them assume they have far less risk then they actually do.

[bemildred]

4. What we are doing now looks like a pretty big "mistake" to me.

I don't see that we have much to lose by getting rid of these self-serving parasites.

[FBaggins]

5. See... that was "kinda" my point.

The parasites are the ones we need to get rid of... because they give the rest of the banks a bad name.

And yes, "what we're doing now" has been a pretty big mistake... but that's no reason to make even bigger ones.

[bemildred]

6. OK, I can live with that.

Though I want to offer a free plug for credit unions here.

[FBaggins]

7. I'm a big fan of some credit unions

A member of one for decades in fact...

...but there are some thing to be aware of. They can't handle most lending (though consumer lending is rarely a problem), and - more importantly - one reason they're better is because they don't pay taxes.

You could think of it as an ongoing "bailout" that has lasted for decades. :)

[truedelphi]

10. I am folowing what you are saying and I agree. n/t

[whattheidonot]

9. goofy.

All of this theory is well and good. If someone is thinking about going into many businesses right now they would have to be a little goofy. The problem is being looked at in reverse. Businesses need customers who can pay for products. Right now due to a multitude of factors too long to go into here there are not many. The trick is putting value into the recovery. Floating much more money around will make it valueless. There will be lots of talk about jobs this year. Do not hold your breathe. There is not much room for jobs and making room might make your pay worthless. The government has the money all tied up on the deficit. Need a job. Go in the army. That is where the money is. Is this anyway to run a democracy? Sometimes you need a dictator for awhile to get things straight. Break things up and start over. Or a revolution.

[westerebus]

2. This is how the FED is re capitalizing the banks in part.

By requiring the banks to hold large reserves on which they will be paid interest doesn't add much velocity to the system. Interest rates and inflation remain with in the reach of the Central bank's grasp. The banks would still need enough ready money(on hand cash)to complete transactions without pulling from reserves.

They would at first blush look liquid. Which is why the deficit is held by the central bank's government. If the banks were in deficit, by definition they are illiquid, hence insolvent.

The reserves held by the banks would not of them selves force lending, unless the banks paid interest to the Central bank on the excess of reserves beyond those set by the Central bank. Where would the excess go to avoid payment of interest by the banks? They could invest in Treasuries to accommodate the central bank's monetary policy. The you scratch my back and I'll scratch your's policy.

If the credit collapse unwound the bank's ability to lend, the Central bank would have to force reserves into the system to prevent panic. The banks in turn are not going to lend until and unless they find credit worthy borrower's willing to take out a loan. Even then, there is still the requirement to hold reserves.

Who would lend the banks money, knowing they will not make loans, until they have adequate reserves so they could start lending again? Why, that would be us.

Of course in rational self regulating markets that would never happen.

[whattheidonot]

8. what you can pay back

banks were once in the business of giving you a loan that given your means you would in the great majority of situations pay back. Banks sold money for awhile, that is really all they wanted to do. They did not want the cars, the houses, or whatever the loan was for. They wanted their money back plus interest. All the chasing after bad loans is costly. Foreclosures, auctions, selling stuff off takes time , money banks did not want to expend. it was the bankers job to be like a good horse racing handicapper. The better the prediction of pay back the better for the banker, better for everyone involved.
Credit became king. Bankers lost there senses. Things began to unravel. People floated along living on credit way beyond their means. The idea of propping up an economy on easy credit is insane. instead of a slow road to prosperous democracy the fast road to hell was taken.

[westerebus]

11. Bankers are more like..

Race track owners. You pay to park, you pay to play, you pay to race. They charge a fee for everything.

Should you win, they pay you with some one else's money.

The up side is, they admit it's gambling.