A Primer On Fractional Reserve Banking
First published in the British humour magazine “Punch” on April 3, 1957:
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Q: What are banks for?
A: To make money.
Q: For the customers?
A: For the banks.
Q: Why doesn’t bank advertising mention this?
A: It would not be in good taste. But it is mentioned by implication in references to
reserves of $249,000,000,000 or thereabouts. That is the money they have made.
Q: Out of the customers?
A: I suppose so.
Q: They also mention Assets of $500,000,000,000 or thereabouts. Have they made that
too?
A: Not exactly. That is the money they use to make money.
Q: I see. And they keep it in a safe somewhere?
A: Not at all. They lend it to customers.
Q: Then they haven’t got it?
A: No.
Q: Then how is it Assets?
A: They maintain that it would be if they got it back.
Q: But they must have some money in a safe somewhere?
A: Yes, usually $500,000,000,000 or thereabouts. This is called Liabilities.
Q: But if they’ve got it, how can they be liable for it?
A: Because it isn’t theirs.
Q: Then why do they have it?
A: It has been lent to them by customers.
Q: You mean customers lend banks money?
A: In effect. They put money into their accounts, so it is really lent to the banks.
Q: And what do the banks do with it?
A: Lend it to other customers.
Q: But you said that money they lent to other people was Assets?
A: Yes.
Q: Then Assets and Liabilities must be the same thing?
A: You can’t really say that.
Q: But you’ve just said it! If I put $100 into my account the bank is liable to have to pay it
back, so it’s Liabilities. But they go and lend it to someone else, and he is liable to have to
pay it back, so it’s Assets. It’s the same $100 isn’t it?
A: Yes, but….
Q: Then it cancels out. It means, doesn’t it, that banks haven’t really any money at all?
A: Theoretically……
Q: Never mind theoretically! And if they haven’t any money, where do they get their
Reserves of $249,000,000,000 or thereabouts??
A: I told you. That is the money they have made.
Q: How?
A: Well, when they lend your $100 to someone they charge him interest.
Q: How much?
A: It depends on the Bank Rate. Say five and a-half percent. That’s their profit.
Q: Why isn’t it my profit? Isn’t it my money?
A: It’s the theory of banking practice that………
Q: When I lend them my $100 why don’t I charge them interest?
A: You do.
Q: You don’t say. How much?
A: It depends on the Bank Rate. Say a half percent.
Q: Grasping of me, rather?
A: But that’s only if you’re not going to draw the money out again.
Q: But of course I’m going to draw the money out again! If I hadn’t wanted to draw it out
again I could have buried it in the garden!
A: They wouldn’t like you to draw it out again.
Q: Why not? If I keep it there you say it’s a Liability. Wouldn’t they be glad if I reduced
their Liabilities by removing it?
A: No. Because if you remove it they can’t lend it to anyone else.
Q: But if I wanted to remove it they’d have to let me?
A: Certainly.
Q: But suppose they’ve already lent it to another customer?
A: Then they’ll let you have some other customers money.
Q: But suppose he wants his too….and they’ve already let me have it?
A: You’re being purposely obtuse.
Q: I think I’m being acute. What if everyone wanted their money all at once?
A: It’s the theory of banking practice that they never would.
Q: So what banks bank on, is not having to meet their commitments?
A: I wouldn’t say that.
Q: Naturally. Well, if there’s nothing else you think you can tell me….?
A: Quite so. Now you can go off and open a banking account!
Q: Just one last question.
A: Of course.
Q: Wouldn’t I do better to go off and open up a bank
>~~~
With this post, we add the category “Humor” cause if you aren’t laughing at all this, you’re probably crying . . .
Hat tip: BOB HOYE, INSTITUTIONAL ADVISORS
http://www.institutionaladvisors.com/
December 5th, 2008 at 5:10 pm
with this:
A: They wouldn’t like you to draw it out again.
Q: Why not? If I keep it there you say it’s a Liability. Wouldn’t they be glad if I reduced
their Liabilities by removing it?
A: No. Because if you remove it they can’t lend it to anyone else.
Q: But if I wanted to remove it they’d have to let me?
A: Certainly.
Q: But suppose they’ve already lent it to another customer?
A: Then they’ll let you have some other customers money.
should file it, the whole piece, under: Disinfo/Agitprop
for, it, in *Reality, is, wholly, Wrong, and misleading..
December 5th, 2008 at 5:26 pm
mark, I knew you would respond to this first.
December 5th, 2008 at 5:40 pm
Fractional reserve banking. Is that where the Federal Reserve gets involved too heavily in the problems of the private sector and winds up a “fraction” of its former self?
Fractional, fraction…get it? Guffaw, guffaw.
Yeah, I came temporarily out of retirement. Ali did it. Jordan did it. I will do it occassionally. I have seen some VERY commendable efforts from Scott F and BG and Jeff M. (you will always be “Jeff M.” to me, Mannwich) on threads like http://www.ritholtz.com/blog/2008/12/nfp-533000/, but you guys need to work a little more on your anger and contempt. Don’t ask me how, you just have to do it. You have to find your inner asshole. I mean that figuratively. Like Ali had the rope-a-dope, Jordan had the fadeaway during his second threepeat, and Michelle Caruso-Cabrera has certain “mad skillz” having nothing to do with finance or journalism, I developed the “registered Republican”. Since we are on the topic of “primers”, let me close with a demonstration:
“As a registered Republican, I am so proud of the stock market. Two million job losses for the year and the Dow goes up 260 points. Woo hoo! Who cares if the recession lasts for a few more years and WHO THE HELL cares about Barry the Commie’s (Ritholtz, not Obama) daily blabberings about fractional reserve banking and other arcane but ginormously critical potholes in our financial and economic system. We finally have what we have always wanted: the reality-proof stock market.
Have a smoky weekend, you Wesburies of the world. Happy days are here again!”
December 5th, 2008 at 5:43 pm
Well, well, well. Look whose back. Leftback & I predicted you wouldn’t stay away for long, CNBC Sucks. How could you? This site is like a good narcotic.
December 5th, 2008 at 6:50 pm
BR - thought you might want to see this interview from my friend Win smith who runs sugarbush ski area and is the son of MER founder.. he gave a moving speech at MER shareholder mtg today…
http://www.cnbc.com/id/15840232?video=951827235&play=1
~~~
BR: The text is already scheduled for tomorrow’s cafe.
December 5th, 2008 at 6:52 pm
and the speech..
http://dealbreaker.com/images/thumbs/RateLab%20A%20Proper%20Eulogy.pdf
December 5th, 2008 at 7:33 pm
Barry,
Do you realize Kudlow has been addressing the term “bailout nation” all week? I keep expecting you to be a guest, but instead we get Jerry Bowyer every night.
December 5th, 2008 at 7:42 pm
Maybe Jerry Bowyer has a book coming out with the same title. Wait, he still doesn’t think we’re in a recession yet, so maybe not…….
December 5th, 2008 at 7:48 pm
I’ve been lurking on the site for a year and now must post to say thank you Barry, and all, for what you bring. You did an awesome encore, CNBC Sucks.
December 5th, 2008 at 8:58 pm
While it was first published in “Punch” in 1957, it is also the introduction to “The Creature from Jekyll Island, A Second Look at the Federal Reserve” by G. Edward Griffen. And, in my copy of the book, I found an old Richard Russell print out from 23 February, 2004, with a quote from Adrian Ash, “I think it is time NOW to batten down the hatches and prepare for a financial storm ahead in Real Estate.” We all know how that played out…
Jung must be CNBC incognito : ) but welcome back my fellow registered republican…
Steve Barry, i cannot believe you subject yourself to Larry Kudlow; I wouldn’t even look at him with no sound. Are you okay???
December 5th, 2008 at 10:08 pm
Vermont Trader, thank you! the interview and the speech transcription were outstanding, imo. i can’t wait to confer with my grad school friend that has worked for MER for 20+ ? years now (that’s scary.)
(note: I didn’t go to grad school… I just supported my husband thru grad school.)
December 5th, 2008 at 10:23 pm
“Q: What are banks for?
A: To make money.
Q: For the customers?
A: For the banks.”
Every business is in business to make money for themselves. If they aren’t after profits, they are some sort of political boondoggle (think fannie mae and amtrak). Far better to be after profits I say.
I do agree about the assets and liabilites part though - nobody seems to understand which is which.
December 5th, 2008 at 10:32 pm
Plans for auto bailout by Dems just announced. Next week should be interesting. Could scream higher for a while with panic buying (don’t want to miss the bottom!) through the holidays but one never knows with this wacky “market”.
Karen - if that’s the case, I could be paying up on that fictitious case of wine, and if so, actually a bit sooner than I thought.
Starting to think about picking up some DIG. Oil’s gotta bottom sometime, especially with all of this inflationary activity by the Treasury, doesn’t it? Might pick up some more GDX too.
December 5th, 2008 at 10:54 pm
Re: automaker bailout news.
Will $15B be enough to move the market higher next week? It may be a bit of a disappointment.
I hope there is follow through buying Monday morning. If there is, I don’t think I am going to be able to resist reloading at least some “shorts”. SRS, SKF, TWM, EEV, and SCC are looking very succulent again.
December 6th, 2008 at 12:36 am
The Merrill eulogy was great, and serves to remind me that a company can survive just about anything, except bad management.
With that in mind, contemplate the number of companies that manage to last more than a few human lifetimes.
Promoting or hiring those who are not worthy into senior management positions is the kiss of death.
December 6th, 2008 at 4:13 am
NOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO!
Fractional reserve banking:
Q: What did you do with my ‘liability’
A: We lent the money out
Q: Where did the money go?
A: The bank wrote a check for the value of a loan so that the borrower can pay the seller
Q: What happened to the check
A: It was given to the borrower who gave it to the seller of the good who then deposited it back into our bank. It then became our liability from which we can make more loans
Q: WHAT! Are you saying that my money liability was deposited into your bank by a seller that got paid from someone you loaned my money to….and that is now another liability on your books?
A: Yes….of course.
Q: WHAT!! What if both I and the other person demand our deposits of the same liability?
A: That is the Treasury’s problem not ours. They are required to print dollars to cover all the legal checks(and we assure you, the central bank considers that deposited check legal) we make in loaning money into existence and that are thus deposited into our accounts. They are not the same liability, they are now two liabilities. Loaning the money created a new liability for the banking system on which the borrower now has to pay interest and the treasury has to print dollars for if the deposit is demanded
At this point(usually): BRAIN FRY
December 6th, 2008 at 8:29 am
Let’s get back to basics in North Amercia. When colonists first settled, we got barter. This bartering got annoying so they went to writing IOUs. As they traveled farther and farther away from known people, they needed IOUs that everyone would recognize, that’s when a national currency was needed.
So basically, the central bank’s initial role was to replace these IOUs (by increasing money supply according to business growth) and to create a currency that everyone would recognize and trust. These functions obviously don’t command very big margins! Since they are sleeping with the governement, any foresight could have easily told us that they would do everything in their power to increase these margins.
So we went from an industry that greases the wheels of the economy to being the wheel itself.
But they don’t produce anything, they just find new ways of repackaging debt and take a huge cut from the population’s labor. And if people truly had to work hard for their money, they wouldn’t have let this happen.
December 6th, 2008 at 10:23 am
Exactly Danm,
Everybody thinks that they can borrow and not add to the problem because they have the power to pay back the loan. The problem is that it drives up the cost for everything and the pool of money it creates helps the banks to hire the smartest sales and money men in the room who turn around and loan money to the less smart and those who need their money managed just to keep up. At some point(like about 35 years ago) you can no longer own a major asset like a business or a house(or a …..chuckle, chuckle…..car or a……..*cough*……cell phone….*wheeze*….pair of underpants….*CHOKE*…..AIR!) without taking on the banker as your partner and it leads the whole economy into debt bondage. At that point the bankers then decide how that economy is shaped. They decide who wins and who loses. How it grows, when it grows and when it contracts. Eventually the banking system owns and controls the very government itself when it is supposed to be the other way around. By the time these smart borrower’s(that is an oxymoron) kids and grandkids enter the stage they are bondslaves who work for companies that can only afford to pay them poverty wages
……and that my friends is why you call people like Greenspan and Bernanke the Emperor and not George Bush
I’m dead
December 6th, 2008 at 11:50 am
@constantnormal: I agree with your point but I’ve always been surprised (and even shocked) at just how long a company can muddle along (and even appear to be doing well…..in today’s world “appearance” is sadly all that matters anyway) with some really terrible, incompetent management and leadership. In fact, I used to remark all the time that I was amazed at just how many companies can appear to be successful “in spite of themselves”. The thing is, it usually takes a long time for a big, established company to destroy itself but with bad enough management over a long period of time, it almost always happens eventually.
December 6th, 2008 at 12:00 pm
Mannwich:
Never underestimate the power of shrinking rates. Since 1982, companies have been able to file under Bankruptcy portection and recapitalize. And someone could always buy them up with lower rates.
With today’s credit spreads, I’m willing to bet that we are going to witness in the coming quarters a load of outright liquidations, something we have not witnessed in many decades. Unless of course, government starts controlling credit spreads in every industry!
December 6th, 2008 at 5:43 pm
@danm: I agree with you. Case in point: retail.
December 6th, 2008 at 8:14 pm
The saddest part is that the quite reasonable requirement of 50% reserves has been reduced over the years to practically nothing. 10% on demand deposits, after retail sweeps.
50% reserves would mean that on average every dollar could be lent out about once. Nowadays every dollar is lent out way more than ten times.
It is quite sobering that earlier this year, bank reserves were actually quite a lot less than those $249,000,000,000 mentioned in the exchange. And those were 1950’s dollars…
Without reserve requirements, can one even talk about fractional reserve banking? It’s more like no-reserve banking. And without binding reserve requirements, the Fed is indeed pushing on a string.
December 7th, 2008 at 2:22 am
And those were 1950’s dollars…
Interesting phrase isn’t it. If we could just teach kids why that phrase is so bad for them we’d be a lot better off
Without reserve requirements, can one even talk about fractional reserve banking? It’s more like no-reserve banking.
It really is. Many countries have already gone to that. FR banking is just a pretense now. Since the CBs of the world will replace by printing all deposits up to X amount(and now most recently the full amount) depending on the country, they don’t even need to bother with reserves any more. They can lend to their heart’s content making winners and losers by jacking the interest rate this way or that. Only a borrowers revolt can end it now