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Is fractional reserve banking fraudulent?

I ran across this odd debate between Bryan Caplan and Walter Block. Here is Block's argument ("frb" means fractional reserve banking):

Consider this: A deposits 10 ounces of gold in B's bank; B gives A a demand deposit for these 10 ounces. B turns around and lends C 9 of these ounces, giving C a demand deposit for these 9 ounces. Thus, A and C both own full rights to these 9 ounces.

There is now a problem of over-determination or conflict in rights. A and C both have a FULL right to these selfsame 9 ounces of gold. They are both FULL owners of these 9 ounces.

But, one of the essences of the libertarian philosophy we share is that there CANNOT be a conflict in rights. Any seeming conflict is due to a misspecification of one or the other right. Yet, here, with frb, we have a GENUINE conflict in rights. Thus, frb is incompatible with libertarianism.

Note, I am NOT talking about practicality. It might well be (given no bank run) that A and C will not ACT incompatibly with one another; that is, both will not demand that B pay them these 9 ounces, an utter impossibility. No, I am talking about RIGHTS. Right now, before any bank run, there is STILL a rights contradiction.

Caplan just sputters. Here is the problem with Block's argument, as I think any lawyer would immediately recognize.

Block confuses property rights and contract rights. If I give the bank some cash and pay it to put this cash in a safety deposit box, then the bank can't use that cash. It can't lend it out to someone else; it can't list it as an asset on its balance sheet; it can't touch it without my permission. If the bank were to do so, then it would have engaged in theft, and the relevant employees would go to jail. Lawyers call this transaction a bailment.

But if I deposit some cash with the bank, I don't retain my property interest. Instead, I'm making a loan to the bank and I obtain a contractual right to repayment on demand. If I demand my cash (plus interest, if any) and the bank fails to pay me, then I can sue it for breach of contract and demand expectation damages. If the bank were not a bank but just an ordinary borrower, and it was insolvent, then I have to race other creditors for its assets; otherwise, my contract right is converted into a claim in bankruptcy, and I have to share with other creditors. (Since it is a bank, I may well obtain full compensation from the government, but that is not relevant to the debate.)

If you asked the bank whether it might lend out your money, it would most certainly tell you that it would. So it is not lying to you, and there can't be fraud. Nor is there any other contradiction, incompatibility, or problem with the arrangement. Depositors take a risk that the bank will breach the contract but anyone who enters a contract takes the same risk.

Block doesn't seem to have any problem with contract rights per se, but he does have a problem with a person entering a contract that gives another person the right to demand assets that the first person might not have. But all contracts are like this. People enter contracts expecting that they will be able to transfer money, goods, or services when they are due, but everyone understands that intervening events might make the transfer impossible, impractical, or unwise. The other party obtains a right to obtain damages for breach of contract, but if every contract where the probability of nonperformance is greater than zero were considered fraudulent, we would have no economy.

Sean M:
Note that Block uses an example of gold.

That suggests his problem is deeper than with fractional reverse banking. He probably also disagrees with fiat money.
11.4.2008 7:32am
Sean M:
Fractional /reserve/ banking. Sheesh.
11.4.2008 7:33am
NaG (mail):
The real problem with Block's example is the false statement that C has "a FULL right" to the gold. If B lent the 9 ounces of gold to C, then C has a right to the gold subject to repayment to B (with interest). Thus, C really doesn't have "FULL right" to the gold.

What Block fails to understand is that his example he presents is really no different than landowner to tenant to subtenant. Nobody out there mistakes the subtenant as an owner of the property. For the same reason, C does not have full rights to the gold.

Consider this: A lends $100 to B. B takes $90 to pay his debt to C. Obviously, C has full right to the $90. B has full right to $10. And A has a legal claim against B for $100, which is not the same thing as having $100 in your pocket. That's why lenders charge interest, because otherwise it's better to have $100 in your pocket than a mere claim for $100 against someone who may or may not be able to pay you later. A does NOT have the right to simply take money from B even though B owes A money. That's why B has full right to the ten dollars. Thus, Block is also wrong about the nature of A's rights in the exchange.
11.4.2008 7:45am
Ben P:

If B lent the 9 ounces of gold to C, then C has a right to the gold subject to repayment to B (with interest). Thus, C really doesn't have "FULL right" to the gold.



I'm not even sure this goes far enough. In banking law your deposits are basically pure unsecured debt. If you have a property right at all, it's only in that debt, not in the deposit you made.

When you made the deposit you didn't give the bank money to keep for you, it's not a bailment of any kind. You loaned the bank money under a contract that allows you to ask for payment on that loan at any time, and probably also gives you the right to issue an order for the bank to pay others for the funds you loaned them.


If the bank loans A's nine dollars to C that only means that the bank owes you $10 dollars, and C owes the bank $9 dollars.
11.4.2008 8:08am
Sasha Volokh (mail) (www):
Eric: I basically agree with you, but on one point I think you're not giving Block's argument its full due.

You say: "if every contract where the probability of nonperformance is greater than zero were considered fraudulent, we would have no economy." Block doesn't think all such contracts are fraudulent -- like where intervening events may make performance impossible. He only thinks it's fraudulent when... well, he doesn't spell it all out. But I think he would say something like it's fraudulent if you intentionally take the sorts of steps that make performance less likely.

The answer, of course, is -- as you say -- that this misconstrues the sort of arrangement that's going on. We know that the bank lends out the money, and we know that as a result, the bank may not have the money to pay us. We accept this coming in. Perhaps certain actions of the bank's may in some cases violate the rights of its depositors, but this isn't such a case, because the depositors have agreed to the bank's behavior and therefore accepted a certain risk, just like any lender accepts a certain risk of non-payment.

(I'm assuming that the depositors have in fact agreed to this. I've never looked at the depositor's contract with the bank. Perhaps, then, at most, this would be an argument for disclosure. But not an argument for the immorality of the system.)
11.4.2008 8:13am
oledrunk3 (mail):
Please remember that the loan made in a fractional reserve banking system will be spent and likely appear as deposits in other banks. Which in turn will lend. What matters is the reserve ration in the system.
11.4.2008 8:22am
oledrunk3 (mail):
Correction "reserve ratio"
11.4.2008 8:23am
Daniel San:
I think the problem begins with a misunderstanding of fungible assets. If I deposit 10 ounces of gold with a bank, I am not entitled to return of that gold; I am entitled to 10 ounces of gold. If the bank collapses and the last 10 ounces left in the vault is my deposit, that does not give me a priority. If the bank loans the 10 ounces I deposited to B and B defaults, that does not mean I have a loss. Your safety deposit box comment addresses this, but I think it is the core of the problem.
11.4.2008 8:26am
Ben P:

(I'm assuming that the depositors have in fact agreed to this. I've never looked at the depositor's contract with the bank. Perhaps, then, at most, this would be an argument for disclosure. But not an argument for the immorality of the system.)


here's one

I believe the relevant clause is XVIII (N)
11.4.2008 8:31am
NaG (mail):
Sasha: So Block's problem is not that banks are somehow creating overlapping and conflicting property rights, but rather that banks acted in a way that made them less able to fulfill their contractual obligations.

Surely Block understands that no bank has enough money on hand to satisfy every one of its obligations at this moment. If one did, it wouldn't be in business very long. Banks take deposits and use that money to make money by lending and investing. Otherwise they aren't making money. So the question becomes, at what point is a bank leveraging itself beyond the point where it can reasonably expect to satisfy its future obligations, and is that fraud? That seems like an awfully complicated question to answer.
11.4.2008 8:34am
Sasha Volokh (mail) (www):
Ben P: I'm not sure which part of XVIII (N) helps here.
11.4.2008 8:36am
byomtov (mail):
Eric is correct, but the understanding the accounting is important too.

The loan to C is an asset of the bank. Thus the balance sheet has assets worth 10 ounces - the ounce in reserve and the nine-ounce loan. Similarly it has 10 ounces of liability - A's deposit. No problem.

Of course, in real life loans are sometimes defaulted on, so the bank has capital to cover the possibility. This shows up as equity on the right side of the balance sheet. In this simple example the banker may have invested, say, five ounces of his own in the bank. Then the asset side shows six ounces of gold and, a nine-ounce loan. The right side shows a 10-ounce liability to A and five ounces of equity.

Caplan was right to sputter.
11.4.2008 8:37am
byomtov (mail):
Section II (A) of the agreement says:

This Agreement and the deposit relationship do not create a fiduciary, quasi-fiduciary or special relationship between us. We owe you only a duty of ordinary care. Our deposit relationship with you is that of debtor and creditor.

Emphasis added.

Debtors do foolish things with borrowed money sometimes.
11.4.2008 8:49am
cboldt (mail):
Another problem here is to look at money as a resource of fixed supply. Money is just a trading device to get around the inefficient mechanism of barter, and money should exist in proportion to the amount of production and/or goods being bartered. Sometimes production increases and money supply should grow in recognition of that. Similarly (but in reverse) when a society who is using the same "money" contracts its production.
.
The contention that FRB is per se anti-libertarian is laughable on its face. FRB can be made unfair to wealth producers, and it can be made fair.
11.4.2008 8:58am
Malibu Bug (mail):
In the old days, A would give B the gold and B would give A a note; a "bank note." A would give that note to C to purchase goods, C would give the note to D in payment of debt, and so on. No one ever needed to bring the note back to B for payment. Those who figured that out never wanted to be anything other than bankers.
11.4.2008 9:12am
Crackmonkeyjr (www):
If a bank can't lend out at least some portion of its deposits, what is the point of having deposits? At that point, the bank is nothing but a money warehouse and they are going to be charging you to hold on to your money rather than giving you interest on the money.

If Block and other Austrian's care so much about banks lending out "their" money, they can go to the bank and buy a safety deposit box rather than open a savings/checking account.
11.4.2008 9:22am
Soronel Haetir (mail):
What I understand even less is the argument that gold has intrinsic value. About the only thing that does make sense about using gold is inflation control, but even then you run into trouble when somewhere, someone in the world is allowed to alter the exchange ratios.

It's all enough to make my head hurt.
11.4.2008 9:31am
some dude:
It isn't fraudulent because it is not a secret, I suppose. Or rather it wouldn't be fraudulent if banks were allowed to fail. People can agree to deposit knowing that 90% is going to be loaned out and there is a risk the whole scheme might go belly-up and they won't get their money back. If you start adding Federal Deposit Insurance into the mix, then you might be getting into fraud. Can the FDIC handle the situation in the theoretical situation if everyone withdrew at once? If not, FRAUD.

Sometimes it boggles my mind why anyone would deposit something in the bank. But I do too.


Crackmonkeyjr:
If a bank can't lend out at least some portion of its deposits, what is the point of having deposits? At that point, the bank is nothing but a money warehouse and they are going to be charging you to hold on to your money rather than giving you interest on the money.

Time deposits. People deposit money knowing they can't get it back for X months/years. In the mean time, the bank loans it out.
11.4.2008 9:40am
microtherion (mail):
Sasha Volokh

But I think he would say something like it's fraudulent if you intentionally take the sorts of steps that make performance less likely.


But of course, any bank that pays interest on deposits without loaning them out is guaranteed to eventually fail, so frb makes performance more likely.
11.4.2008 9:44am
some dude:

cboldt:
...money should exist in proportion to the amount of production and/or goods being bartered. Sometimes production increases and money supply should grow in recognition of that.

Why? What would happen if the money supply didn't grow in proportion to production increases? Simple. Prices would go down. This would benefit savers. Money, as you say, is a trading device and a fixed supply would automatically adjust prices for changes in levels of production and everything else.

This happens with computers all the time. The production of bytes of memory increases dramatically. The price of computer memory per byte decreases dramatically. This is not a disaster. If bytes of memory were the only thing trading in the economy, would it make sense to increase the money supply to keep up with the falling price of computer memory? Or should we just be glad that memory is cheaper. If you save a while and put off memory purchase, you get more memory. That's all.
11.4.2008 9:54am
some dude:

cboldt:
The contention that FRB is per se anti-libertarian is laughable on its face. FRB can be made unfair to wealth producers, and it can be made fair.

FRB is anti-libertarian because of government guarantees (FDIC). Where does the FDIC get money to guarantee deposits? Are bailouts compatible with free markets?

If banks were simply allowed to fail, it would not be anti-libertarian, but then again, without guarantees, there wouldn't be much FRB going on.
11.4.2008 10:03am
Crackmonkeyjr (www):
Some Dude:

It would seem horribly inconvenient to do away with normal deposits and only be stuck with CDs. I'm certainly willing to take the microscopic risk that my bank will fail AND the FDIC will be out of money in exchange for the convenience of not having to completely plan my finances and to have to pay for everything in cash.

The problem with a fixed money supply is that, although it is irrational, people don't like lowing prices or getting pay cuts, even if the end result is that their purchasing power stays the same. As a result, people refuse to do so, there is insufficient money to actually pay for the goods and services, and the economy comes to a screaching halt.
11.4.2008 10:04am
Malvolio:
Aren't we breaking a butterfly on a wheel here? The idea that FRB is fraudulent because a bank couldn't pay back all its creditors at once is arrant nonsense. Could you pay back all your creditors at once? Is an advertisement that a restaurant is open misleading because it couldn't serve everyone who sees the ad at the same time? A gym that can host 100 simultaneous visitors can sell 1000 monthly memberships, can't it?

The idea that banks are misleading their customers is just silly. All the employees of the bank have bank accounts. The bank itself has accounts with other banks. They don't seem to think they are getting ripped off.

Is this really worth debating?
11.4.2008 10:07am
byomtov (mail):
What would happen if the money supply didn't grow in proportion to production increases? Simple. Prices would go down. This would benefit savers. Money, as you say, is a trading device and a fixed supply would automatically adjust prices for changes in levels of production and everything else

And no one would invest in anything. Why pay today's prices to build a factory when the price of your output is going to be dropping?

And no one would hire. Why pay a worker today's wage to produce goods that will not sell for that amount tomorrow?
11.4.2008 10:22am
some dude:

Crackmonkeyjr:
Some Dude:

It would seem horribly inconvenient to do away with normal deposits and only be stuck with CDs.

There is a free market solution to that. Free market interest rates. I would wager there is an interest rate out there that would help convince you to overcome your horrible inconvenience.

I'm certainly willing to take the microscopic risk that my bank will fail AND the FDIC will be out of money in exchange for the convenience of not having to completely plan my finances and to have to pay for everything in cash.

It would not be a microscopic risk (BANK RUN!) if there were no FDIC, and the FDIC is not free market. The FDIC is not part of a free contract between two parties for mutual benefit. It is a market distortion. Another thing is that FRB would not be workable without central planners at the central banks fixing interest rates and whatnot. Another market distortion.


The problem with a fixed money supply is that, although it is irrational, people don't like lowing prices or getting pay cuts, even if the end result is that their purchasing power stays the same. As a result, people refuse to do so, there is insufficient money to actually pay for the goods and services, and the economy comes to a screaching halt.

I agree there is something psychological if someone's salary was a smaller number than their grandfathers. But this would only be a problem if the people then demanded the government "do something about it." If they didn't do that, then they would have no choice but to make a smaller numbered salary.

If people really did refuse to work, then production would go down and prices would go back up. Self-correcting. But maybe that is the problem. Maybe the pressure for the government to "do something about it" is just too great to be overcome, and there is the flaw in the system.
11.4.2008 10:28am
some dude:
byomtov

What would happen if the money supply didn't grow in proportion to production increases? Simple. Prices would go down. This would benefit savers. Money, as you say, is a trading device and a fixed supply would automatically adjust prices for changes in levels of production and everything else

And no one would invest in anything. Why pay today's prices to build a factory when the price of your output is going to be dropping?

Prices would only go down if production goes up. If nobody is investing, production is not going up and prices are not going down. The prices only go down when people are investing. Same thing with jobs. Prices only go down when workers are producing.

And why are there ever any computers sold? If all someone has to do is wait a couple of months to get a much better one.
11.4.2008 10:35am
byomtov (mail):
Some dude,

What you've described is a depression.

Computers are sold because they are useful enough that the value of having one for six months or so is higher than the value of waiting.
11.4.2008 10:49am
some dude:
byomtov,

It is not a depression. It is just hard work. Growing an economy should require hard work. You can't get something for nothing, unless you just want to blow up investment bubbles.
11.4.2008 10:54am
cboldt (mail):
-- Why? What would happen if the money supply didn't grow in proportion to production increases? Simple. Prices would go down. --
.
Good point, as my comment was taken with a bias that the "value of money" should be the constant in the comparison. There is some worth in keeping the value of money "stable" (it simplifies present worth and other investment calculations), but of course, the calculations could be changed to account for a fixed supply of money and account for a unit of money increasing in value according to some sort of aggregate "production" measure.
.
-- The production of bytes of memory increases dramatically. The price of computer memory per byte decreases dramatically. This is not a disaster. --
.
There are other products on the other side of the product life cycle too. 8" floppy discs, just to pick one, or chemical-based photographic imaging films and cameras. Incentives to invest in new products or economy of scale in production look to market size and market share. As you point out with your example, the number of units produced is not, of its own, a good measure of their intrinsic value or worth.
11.4.2008 10:57am
cboldt (mail):
-- FRB is anti-libertarian because of government guarantees (FDIC). --
.
I think your contention bottoms out on "FDIC is anti-libertarian." FRB can operate without a government operated deposit insurance facility.
11.4.2008 11:01am
oledrunk3 (mail):
Someone should explain the difference between time deposits and demand deposits. I had no idea so many intelligent people were so innocent of knowledge about banking.
11.4.2008 11:02am
byomtov (mail):
Some dude,

What happens if production doesn't grow and there is no investment? Population grows, so incomes drop. Factories and equipment wear out, and aren't replaced (no investment, remember) so production actually drops. People don't spend, because their wages are falling. No demand. Not good. Borrowing drops, because borrowers will have to pay back more valuable dollars than they borrowed. Still less demand.

Depression.
11.4.2008 11:06am
Crackmonkeyjr (www):
Some Dude:
You are probably right that there is an interest rate at which I would be willing to give up liquidity, but that is horribly inefficient; the bank is paying more than they have to and I'm not getting the service I want. It makes much more sense to allow demand deposits.

Again the FDIC is not a necessary condition for FRB. A demand deposit account can exist uninsured, backed only by the bank itself. Sure the occasional bank may fail, but that's the risk. In fact, at least until a few months ago, this is exactly how money market accounts, and demand deposit accounts over $100k worked.

Nor is there any reason why the FDIC must function as a public entity. We could do away with the FDIC and let banks decide whether they want to buy private insurance for their accounts (and such insurance companies already exist to cover deposits over $100k).

Also, deflation causes problems even when people don't "demand the government to 'do something about it.'" The problem is that people will refuse to work, seeing low wages and hoping that their time is better spent waiting for a better job to come along. Also, as another person pointed out, there is little reason to invest in capital when it looks like the price for that capital is going to go down tomorrow. This all leads to depressions.
11.4.2008 11:26am
JBL:
Another problem with Block's argument is the same as the main problem with the "we should go back to bartering" argument. People who say we should barter are overlooking one fundamental point: we already can. It's legal now. Taxes are the only exchange that is legally required to be paid in dollars absent a voluntary agreement between parties. If you want to obtain all your food, shelter, etc through barter you are allowed to do so. The fact that nobody does is not due to legal barriers, it's because it's extremely impractical.

Though Block's argument isn't really advocating barter (or at least he's not advocating eliminating bartering for gold as an effective medium of exchange), it's not clear exactly what he is advocating - the legal requirement to use fractional reserve banks is very limited. You are required to pay taxes in fiat currency, but that's about it. You're not required to maintain a bank account, and in fact many people don't.

So is he advocating a popular movement to pull money out of banks, or is he advocating government intervention to force the withdrawals, or is he advocating that the government impose radically different terms for demand deposit versus time deposit accounts, or...
11.4.2008 11:38am
some dude:
I agree that a fractional reserve system can, in theory, work on a free market basis without government intervention if banks are routinely allowed to fail. If I were king, I would let people try. I would not set the reserve requirement to 100% by law. It is not the case today that banks are allowed to fail, so it is kind of a moot point. In the old days, the government did many things to prop up banks so they don't fail. One trick was to accept tax payment with depreciating bank notes instead of demanding that the people first withdraw the gold from the bank and then pay the taxes in gold. Neat, huh?

I don't think a free market FRB would be as pleasant as you think it would. It would be nerve racking. You would be on constant watch on the health of your bank.
11.4.2008 12:13pm
Dan Weber (www):
Without an FDIC, banks are pretty vulnerable to a panic. It doesn't matter if I think that the bank is solvent. If I think that you think that the bank is insolvent, I need to get my money out first.

CDs are inconvenient right now, but that's because setting one up requires paperwork. If I could just check a box on my bank's website that says "put this money into a month-at-a-time CD," then it would be a lot easier to move money into and out of time deposits.

I get about 0.1% on my checking account right now, so I wouldn't really mind going to 0.0%.

Another suggestion has been made is that the bank become a middle-man of bonds. It gathers together 100 people who want to borrow mortgages for 15 years. It then raises the money by selling 15 year bonds to the public. These are totally tradable, although perhaps not at what you bought them for. There's no risk of a run at all because there's no "first in line gets paid" risk.

I'm not really convinced that FRB is de facto bad, but some of the arguments against it don't hold water for me.
11.4.2008 12:20pm
some dude:

byomtov:
Some dude,

What happens if production doesn't grow and there is no investment?

If demand also stayed the same, prices would stay the same. If demand went up, prices and profits would go up, sending a market signal that there is money to be made in this industry which would draw investment. If demand went down, prices and profits would go down causing the industry to contract.

Population grows, so incomes drop.

Population would grow, but income would only drop if that new population also worked. If they sat on their butts, the pool of available workers would stay the same and income would stay the same they would also have no money so demand would stay the same. The economy would not notice they were there. If that new population went to work, they would find work in the industries where profit margins are high. This would increase production in industries that need it. Production in that industry would go up, sending prices and profit margins down to the point where there are no more workers needed. Those new workers now have money and with their money increase demand somewhere, where new jobs are filled to meet that demand.

Factories and equipment wear out, and aren't replaced (no investment, remember) so production actually drops.

If factories and equipment wear out and are not replaced, production goes down (supply goes down). Those factories that are left can charge higher prices, bringing in nice profit margins. Nice profit margins are a market signal for more investment.

People don't spend, because their wages are falling.

Suppose people don't spend. If they are working, they have an income which they are saving. If they are saving, free market interest rates (remember those?) go down because banks do not have to compete for saver's money. They are willing to lend it to the bank.

If interest rates go down because people are saving, borrowing becomes easier, investment becomes easier, because people are willing to lend money.


No demand. Not good. Borrowing drops, because borrowers will have to pay back more valuable dollars than they borrowed. Still less demand.

If there is no demand for goods, for whatever reason, they are saving instead which makes borrowing easier, just when it is needed. At this point, I don't know why people continue to shun spending. Interest rates are low, so there is little incentive to save, and prices are low because demand is low. They can get some good bargains somewhere. They can only put off buying that washing machine because they think it will be a little cheaper next month only so long.
11.4.2008 12:50pm
David Schwartz (mail):
I seem to recall some people who thought fiat money and fractional reserve banking were scams and fraudulent creating gold warehouses. They would store your gold for a fee. Somehow, this was expected to be seen as superior to banks that pay you to borrow your money. Needless to say, it was not seen as superior, much to the consternation of their investors.
11.4.2008 12:55pm
Gary McGath (www):
Bank "deposits" should be called what they are: loans to the bank.
11.4.2008 1:03pm
some dude:

David Schwartz:
I seem to recall some people who thought fiat money and fractional reserve banking were scams and fraudulent creating gold warehouses. They would store your gold for a fee. Somehow, this was expected to be seen as superior to banks that pay you to borrow your money. Needless to say, it was not seen as superior, much to the consternation of their investors.


There are things like legal tender laws which might just possibly have something to do with that.
11.4.2008 1:38pm
Crackmonkeyjr (www):
Some Dude:

Legal tender laws are much less draconian that Austrians want you to believe. It is perfectly legal to pay for things in gold, silver or chickens, so long as the seller agrees to take payment in that denomination and you aren't using this to avoid paying taxes.

That dollar bills are legal tender only means that, when a debt is liquidated, it may be paid in dollar bills. This is only really relevant though when you pay taxes or if you have a money judgment against you.
11.4.2008 1:50pm
Daniel Newby (mail) (www):
It's fradulent, through and through. And by fradulent, I do not mean unfair, prone to psychological panic, socially unjust, or any other ideological twaddle.

I mean factual deception with a view to stealing from the depositor.

Why? The sudden gigantic increase in Level 3 assets, the accounting category used for investments whose value is difficult to measure. Huge chunks of Level 1 and 2 assets (directly-measurable value) are being recategorized as Level 3 assets by fiat at or near their full face value. This is being done (1) to hide the stupendous losses suffered by those investments, to keep depositors from fleeing, and (2) so the investments can be used as Fed/Treasury collateral at an inflated value, sticking taxpayers with the loss.

Honest bankers do not need a Romulan cloaking device for their books. If they need a taxpayer backstop to ride through a market dislocation, they can easily make a case about the rational hold-to-maturity value of their would-be collateral.
11.4.2008 3:04pm
DavidBak (www):
Paddington Bear once deposited a 1 pound note (bill?) into an account at the Bank of England. When he later asked for it back he was given a different 1 pound note - he had carefully written down the serial number of the note he had given them. Boy was he upset! The cops had to come and straighten everything out! Paddington Bear would never use a bank after that.

(Does this have something to do with this post?)

-- David
11.4.2008 3:14pm
Peter G. Klein (mail) (www):
I hate posting this far down in the comments thread because presumably almost nobody is reading by now. But, in case Eric is getting comment notifications, I can't help chiding him for dismissing, so cavalierly, an old and quite serious debate in monetary theory and history, ultimately going back to the nineteenth-century controversy between the Currency School and the Banking School. Modern participants in this debate, including people like Murray Rothbard, George Selgin, Larry White, and more recently, Jesús Huerta de Soto have written, like, you know, entire books on the subject. And they actually know the difference between a bailment and a loan contract. Indeed, whether demand deposits are properly classified as bailments is precisely the core issue. (De Soto argues that historically, under Roman law, demand deposits were bailments.) You might actually consult some of this literature before your next post on the subject.
11.4.2008 3:56pm
scineram (mail):
Here is an intended reply to the claims of Posner.
Spot the error!
11.19.2008 9:19am
Russell Cornell (mail):
There is no error. Most of the posts on this site make an error in changing the true nature of the depositor/bank relationship so that it fits with their understanding of the system. While the system in practice seems to indicate that the relationship is one of debtor/creditor, the depositor, acting on the promises made to him/her, certainly doesn't see it that way. For example, if I were to "borrow" 100 dollars from A, and gave a promise that he could have that 100 dollars back "upon demand" would I be breaking my promise if I did not have 100 dollars in immediately liquid assets available on my balance sheet? Now let me clarify the promise a bit. I didn't tell A that if he wanted his money back I would liquidate assets and give it to him as soon as possible. In fact, I told A that the money was available for him to spend at his demand, at any time, immediately. This is precisely the promise the bank makes, and the reason that comparisons to ordinary debtor/creditor relationships are invalid. In fact, the depositor has the right to promise the very same money to a third party, without even asking the bank. That third party expects the bank to honor the check it received from the bank's depositor immediately, not upon it being able to liquidate certain loans. Just because the system works in practice (most of the time, thanks to our fiat money system, which is another long discussion), does not make the underlying promises legitimate. In order for the system to not be fraudulent, banks would have to change their promises. They would have to tell their depositors that only 10%, or whatever the reserve ratio is, is available to them on demand, and more importantly, when a depositor writes a check to a third party, the third party would need to understand that the check is not a fully liquidated cash equivalent, but rather a claim against certain liquid and certain illiquid assets of the bank.
11.29.2008 7:25am
David Hillary (mail) (www):
from BofA

:

'This Agreement and the deposit relationship do not create a fiduciary, quasi-fiduciary or special relationship between us. We owe you only a duty of ordinary care. Our deposit relationship with you is that of debtor and creditor.'

Pretty clear disclosure there!

I've checked the terms and conditions for bank accounts here in New Zealand and I can't find any that make this debtor-creditor relationship explicit: it is so obvious it goes without saying and necessary for the contract to work.
12.11.2008 6:28pm
JOSH (mail):
Truthfully,the fact that WE,the people are the only ones ever putting our money in financial danger!The bank(FED)creates 10x the ammount of any deposit. The bank relies on the basics of the FRS. And the FRN's that are in circulation are demand cert.of DEBT backed by WHAT?Not gold or silver that was outlawed(thank you Roosevelt,Nixon)Honestly it's FAITH and CONFIDENCE!Wow the moneychangers got us good,totally SLAVES paying to be SLAVES!!!Because with every FRN printed there is already debt attached to that FRN,the interest.Why do we endure this yoke of the moneychangers?Through careful manipulation of the masses not to disclose that money loaned at interest is scam,and the perpetrators are the so called experts all the top economists know this BUT who would stop that monopoly of the worlds money and recieve 1/3 total cut,if not better. I propose that we abolish the FRA1913,eliminate the debt by prohibition of all interest,it's a fradulant number.Then the true dollar(GREENBACK)would be reserved at the ratio if dollar for dollar,by gradually inducing the level of money in circulation with the GB to offset the vacuum of interest accrued money(that never should have been there anyway. aaaah Lincoln-esque.HONEST and SIMPLE
1.23.2009 6:21pm
scineram (mail):
Apparently, maturity mismatch is now illegal.
We cannot have a source of business cycle remain legal.
4.1.2009 11:19pm

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