Campaign for debt free money, stable house prices, pension still worth something...

princeofpounds

Sorry I'm bit behind on the discussion now, but:

That's all very well. At the point Barclays sold themselves out to the Arabs the balance sheet was leveraged up to £72 of assets to a £1 of reserves. So a loan default rate of over under 2% had them in trouble.

I think you are confusing capital adequacy/equity with liquidity reserves.

The reserves are there so that when depositors come to the bank to demand some of their money back, there is some cash available to give to them.

If the reserves weren't there, the depositors would not lose any money, but they would have to wait for the loans to mature before they could get access to it.

You might ask why we allow banks to invest in loans that are less liquid (i.e. quickly accessible) than the deposits they take. But the truth is that this 'maturity transformation' is one of the most socially valuable things a bank does. It collects granny's weekly pension money and allows it to fund useful things like roads and factories which take more than a week to build.

The price for this is that if everyone walks into a bank at once and demands their money back, the bank will have to shut its doors to them and give the money back only as quickly as it can manage. This is the famed 'bank run'.

The bank is NOT bankrupt. Depositors have NOT lost money. BUT... because people typically only turn up and demand all their money back when they worry about the creditworthiness of the bank, and because being a forced liquidator of your loans is never a good idea, then often such insolvency problems end up being associated with bankruptcy problems.

So reserves are there to allow savers access to their money, liquidity. What matters is the amount of loans given out and their maturity relative to the deposits. Leverage doesn't come into it.

Where leverage comes in is in the notion of capital adequacy.

When banks make loans, not every loan will be paid back. Depositors put their money in the bank with the assumption that they will not lose it. So the owners of the bank have to put in equity capital, their own money, in order to provide a safety buffer. (There are other types of capital, but this is the simplest and most important)

If a bank loses money, the equity capital gets hit first. But if the banks makes money on its loans greater than the cost of its deposits, the equity capital gets the benefit.

The leverage, therefore, is the ratio of loans to that equity capital (in simple terms, there are various ways of thinking about it). As you correctly point out in your post, when you have a ratio of 72:1 you only need a tiny proportion of loans to go bad to wipe out the money of owners of the bank.

So you can see it's a different concept to reserves, although there are similarities. Money creation through lending is not a problem for this, as long as you put enough equity capital in to give the required buffer for the lending (OK, there are systematic high level interrelationships but for a stand-alone bank it's totally different)

Sorry if the explanation is laboured, I'm not making a point, just writing for people's interest.

You might ask why we let banks have such a high leverage ratio in the first place! The answer to that is pretty complex, but I'd highlight two things:

1) There is a philosophical stance that the less money a bank owner has to put into the bank to sustain its existence, the better. You get all the same returns for less equity. This was popular before the crisis, but I must underline this belief is *not* universal amongst bankers, not remotely.

The problem is that the bankers who rose to the top in the preceding 20 years were those who believed this and therefore took maximum risk. The bankers who believed that having sustainable profit is more important than maximising profit would have 'underperformed' for 20 years. The beauty of banks is that you can wipe out 20 years of profits in one year, as they are leveraged, but people (i.e. your boss, customers, politicians, shareholders) don't appreciate long-term sense 95% of the time.

2) regulators were stupid. Not only were they lax, they also look at the amount of capital in the bank differently the the way an owner (and many would say, a rational person) would look at it. They got caught up with their own cleverness and made the rules complex (Go look at Basel II if you want!).

Complexity meant that bankers could put in small amount of equity capital and make them look like larger amounts the way the regulator counts them.

Light touch regulation combined with financial engineering are the real issues.

Financial engineering yes, although don't forget basic financial engineering can be a net good for everyone.

Light touch is a bit more difficult. There was loads of regulation prior to the crisis. Check out the link for just *one* of the principal policies below (read the PDFs at the bottom, all 251 pages).

http://www.bis.org/publ/bcbs107.htm

Regulators were, and continue to, interfere in almost every aspect of the banking system down to minute details. They could see what was going on in banks almost on a daily basis.

So when people talk about 'light touch', they often think more rules are what is needed. In terms of rules, there never was a light touch.

BillJones

Thrugelmir wrote: »

Banks need to lend responsibly. To suggest otherwise takes us back to the 2003-2008 era. When the lunatics were allowed to run free.

The public want it both ways, though, and often at the same time. They want banks to take less risk, and also to lend more money. We see the howls of outrage on here when they turn people down, and also when they lent and the person can't repay.

They can't even work out (as a group) if they want banks to make profits, or not, or if they want savings or investors protected, or not.

Through it all, despite public perceptions, retail and investment banks are getting on with their normal business, attempting to make a profit from shuffling money and risk between people that do or don't want some of each right now, and charging a fee each time.

It's a system that works pretty well, and which has played it part in the vast increase in personal wellbeing that we've seen in Europe over the last few hundred years.

What I can't understand is why everyone believes that the whole system is broken when it takes a (major) stumble once in a while, and sets us back a few years from whatever pre-crisis peak we happen to look at at the time. It's as though some people want to completely ignore the value it added before, and since, each crash, and only look at the bad times.

GeorgeHowell

BillJones wrote: »

The public want it both ways, though, and often at the same time. They want banks to take less risk, and also to lend more money. We see the howls of outrage on here when they turn people down, and also when they lent and the person can't repay.

They can't even work out (as a group) if they want banks to make profits, or not, or if they want savings or investors protected, or not.

Through it all, despite public perceptions, retail and investment banks are getting on with their normal business, attempting to make a profit from shuffling money and risk between people that do or don't want some of each right now, and charging a fee each time.

It's a system that works pretty well, and which has played it part in the vast increase in personal wellbeing that we've seen in Europe over the last few hundred years.

What I can't understand is why everyone believes that the whole system is broken when it takes a (major) stumble once in a while, and sets us back a few years from whatever pre-crisis peak we happen to look at at the time. It's as though some people want to completely ignore the value it added before, and since, each crash, and only look at the bad times.

Governments should be blamed more than the banks themselves. It's governments who are supposed to protect the public's interests first and foremost, not private companies.

Under New Labour, banks and other financial institutions were feted and pampered because they generated so much tax revenue to fund its wasteful and damaging socialist programme. Instead of being properly regulated they were set loose. Instead of being kept, or reduced to, a sensible size they were encouraged to get too big to fail -- as with the disreputable Brown's disgraceful shenanigans with Lloyds and HBOS. Add to that the fact that politicians and civil servants don't understand real world finance (in the case of Labour don't understand business at all), so they were too scared to intervene. As a result the taxpaying public has been stitched up unmercifully while the banks got away with far too much. Nothing unusual there in this incredibly badly governed country.

BillJones

GeorgeHowell wrote: »

As a result the taxpaying public has been stitched up unmercifully while the banks got away with far too much. Nothing unusual there in this incredibly badly governed country.

Well, possibly. It was in part the "taxpaying public"'s savings, though, that were being protected by the bailouts, and the total cost has been greatly exaggerated in some quarters, with people listing the total size of the guarantees given (which were paid for by the banks that took them, and never called on) as a cost.

It's not fair to account for things in that way on the debits side, without also accounting for the growth that the expansionary lending allowed on the other side. Alternatively, a more narrow view of costs and benefits would offset actual costs borne through the bailout with corporate tax receipts from the sector over the last twenty years.

GeorgeHowell

BillJones wrote: »

Well, possibly. It was in part the "taxpaying public"'s savings, though, that were being protected by the bailouts, and the total cost has been greatly exaggerated in some quarters, with people listing the total size of the guarantees given (which were paid for by the banks that took them, and never called on) as a cost.

It's not fair to account for things in that way on the debits side, without also accounting for the growth that the expansionary lending allowed on the other side. Alternatively, a more narrow view of costs and benefits would offset actual costs borne through the bailout with corporate tax receipts from the sector over the last twenty years.

The taxpaying public was protected by bailouts funded out of taxes, so it was only a big insurance scheme -- the taxpaying public did not benefit overall.

I agree that there are intangible benefits to be had from a thriving financial sector oiling the wheels of the real economy. But we could have had it all ways given sensible government policies, properly and competently managed. We could have had sufficient freedom for the banks to fund those who need funding, but without a significant number of failures, nor gazillions of bad debts to be grappled with.

A lot of the stunts pulled by the investment bankers in the unregulated environment yielded little or no benefit to the economy. They were just a giant sleight of hand, whereby they creamed off loads of money with very few outside their own orbit having a clue what they were really up to, including their own senior (so-called) managements.

Thrugelmir

princeofpounds wrote: »

Sorry I'm bit behind on the discussion now, but:



I think you are confusing capital adequacy/equity with liquidity reserves.

In very simple terms the point I was making. Is that a banks assets are its loans and capital reserves. Its liabilities its customers/wholesale deposits. With high leveraging only takes a low % default for a bank to be in trouble. Even under Basle3 banks could still potentially be in trouble with a rate around 3%.

CLAPTON

GeorgeHowell wrote: »

Governments should be blamed more than the banks themselves. It's governments who are supposed to protect the public's interests first and foremost, not private companies.

Under New Labour, banks and other financial institutions were feted and pampered because they generated so much tax revenue to fund its wasteful and damaging socialist programme. Instead of being properly regulated they were set loose. Instead of being kept, or reduced to, a sensible size they were encouraged to get too big to fail -- as with the disreputable Brown's disgraceful shenanigans with Lloyds and HBOS. Add to that the fact that politicians and civil servants don't understand real world finance (in the case of Labour don't understand business at all), so they were too scared to intervene. As a result the taxpaying public has been stitched up unmercifully while the banks got away with far too much. Nothing unusual there in this incredibly badly governed country.

so government is rubbish and private enterprise even worse?

antrobus

CLAPTON wrote: »

so government is rubbish and private enterprise even worse?

That's the conclusion I've often reached.

Mike4DebtFreeMoney

In terms of this thread, I conclude that the discussion has become too technical for most. In this case I'd like to propose Pascal's wager as applied to banking:
* If my proposal as supported by the Bank of England description and that from the Financial Times is correct, then signing the petition will be of no immediate yet great long term benefit for you:
http://epetitions.direct.gov.uk/petitions/64050
* If my proposal is incorrect then signing it will do you no harm whatsoever.

princeofpounds wrote: »

It collects granny's weekly pension money and allows it to fund useful things like roads and factories which take more than a week to build.

I don’t agree with your analysis. When a bank makes a loan, it creates new money and simultaneously creates a liability on its books. I think this is without connection to reserve and have posted a graph in evidence; Generali thinks it is and I would welcome any evidence in support of this outside the Accounting 101 textbook, which in hindsight has got it wrong. Either way, the banks magic at least their multiplier of money from fresh air. This brings into question the concept of loaning Granny’s pension out: not how it works, or there would not be a money multiplier. So the argument of social usefulness falls down if the majority of what the banks do is print electronic money, rather than any activity that generates wealth.

Because these loans and liabilities are just numbers in a computer, if enough people want to take out real cash or transfer their debt to another bank, then when the bank goes through the clearing process and settles up with other banks using Central Bank Reserves and can’t meet its payments or borrow to cover them, it will indeed go bust and people with these IOU deposits in their computer system will indeed lose money. When banks settle up between themselves, they want real money from the BoE not the fresh air computer numbers they generate themselves.

So liquidity is very much the issue. Your point as I understand your post is that if the bank has enough capital equity to cover the loans that are assumed to be bad, then it should not go bust. I don’t think history supports this.

Masomnia

I think the petition would probably go down better in the Discussion Time section of the forum.