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| Bert - Your second post is the correct answer as you surmised.
One more thing to consider in our fractional banking reserve system is that if the economy goes south and causes an impairment to a plurality of the banks' capital on a nation wide basis, are these banks going to be expanding or contracting their balance sheets? As you likely already understand, they will be in contracting to make their lower capital base less leveraged as well. Simply put, they will be in survival mode. This also means that the money supply is also contracting on a national basis.
Think of it this way. If the nation's banks had collective capital of $5 Trillion and had a reserve ratio of 10%, there would be approximately $50 Trillion in bank Assets AND an equal $50 Trillion in Liabilities (deposits) combined with Bank Equity. But, the economy went south, the banks incurred some large charge-offs and now their capital has been impaired to $4 Trillion. So, their recalculated capital is now at the minimum the approximate 8% level ($4T in Equity/$49T/Assets). But, they want to be at their safer 10% level of capital. That means that they are going to quit lending, let the loans that are outstanding continue to pay-down to reduce their balance sheet size back down to the $40 Trillion level ($4T Equity/40T Assets). As they contract their balance sheets, that means there has been a reduction in the deposits as well by about $9 Trillion ($45T to $36T) which occurred as the banks contracted the economy by shrinking their balance sheets. This example is much more dire example than what we went thru in 2008, but I used the numbers b/c I think it will help you understand how the fractional banking system works.
That is why the FED did what they did.....and printed money out of thin air, The whole banking system very likely would have imploded if the FED did not act. Now we have the problem, though. What do you do with a $5 Trillion bloated FED financial statement? The only way the can unwind that transaction is over time, if all goes well, slowly sell those assets back to the private sector. That is our best hope. That is also one of the reasons I allocate part of my personal assets to Gold.
PS - Well stated post, John. Ours is a family owned bank, so it is our necks on the line. Banking can be very lucrative, BUT we can not afford many mistakes, especially large ones, b/c the margins we have are so small. Our margins are simply what we are receiving on interest in the form of loan, less what we are paying the deposit in interest to fund the loan. Ours is a conservative bank, so our margins are smaller than average, less than 4%. So, if you lose 50% on a loan that Bert is alluding to, it takes an awful lot of 4% margin loans to make up that difference. Not much room for error. | |
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Banking, one more time....
