I return to the subject of fractional reserve banking and my recent
post in response to an article by David Howden, entitled “A Simple
Math Question for Bankers.”
Well, I have a simple question as well – a question about
property rights:
Are property rights divisible?
Now I don’t mean divisible as in shares of stock in a
commercial enterprise – I own 50%, you own 50%.
In this case, our property rights are identical (assuming the same class
of stock); the ownership of the enterprise is certainly divisible.
I mean divisible as in two different people have dissimilar
interests in the same property.
The answer is likely so obvious that it seems like a
purposely misleading question – what trick is BM trying to pull? Does he think I’m an idiot?
The most obvious examples of divisible rights in property
can be found in rental or leasing agreements.
Think of the typical landlord / tenant relationship. Each party has a right to the property – a
nice 3 bedroom, 2 bath home with a white picket fence. Typically, the landlord has rights associated
with ownership; the tenant has rights associated with occupancy and peaceful
enjoyment.
They each have property rights, yet the rights of each party
in the home are different. For brevity,
I will assume that a further explanation of this landlord / tenant relationship
is not necessary.
But, at its root, those who criticize FRB (for reasons other
than its inflationary consequences), do not accept or recognize that property
rights can be so divided or do not accept that today’s deposit contract does,
in fact, divide property rights in the digits commonly referred to as money
(and today’s deposit contract most certainly does divide the rights in the
deposit).
As it relates to the concerns by critics of FRB, the point
is captured well in Howden’s statement:
The conflict depositors and bankers
are subject to should be apparent. They each have a claim to the deposit, but
there is only one deposit available to satisfy each claim.
They do each have a claim to the deposit. But, like a landlord and a tenant, the claims
are different – divisible rights in the property, if you will. This is explained in detail in my previous
post (and embedded links in that post).
This concept is so simple that my mind cannot grasp why it
is missed. I am willing to accept that I
am the one missing something, yet I am yet to read a statement or argument that
addresses this directly.
I have asked others to point me to definitive
statements. Where does Rothbard best make
the case that fractional reserve banking is fraud (as he seems to be where this
idea was born)? I read the recommended
passages, and to my surprise I
find this in the same book!
It was recommended to me to read the most comprehensive work
by Jesús Huerta de Soto, “Money, Bank Credit, and Economic Cycles”; all my
questions would be answered. Instead, I
conclude this.
Again, the issue is not inflation – and if anyone is
interested as to why I say this, let me know.
The issue is directly found in Howden’s statement (and in those
who hold and support a similar view) – and he is wrong, because he does not
recognize (or will not admit) that two parties can have different rights in the
same property.
My head hurts.
Perhaps more scotch….
For rights to be divisible, shouldn't one be able to enumerate the rights in question? For example, if A rents a car to B, then the utility right in the car has been transfered to B, the exchange right has not (B can drive the car, but not sell it). But in FRB, it would seem precisely the same exchange right that is being claimed by both the depositor and the bank.
ReplyDeleteSalerno opened my eyes on this - it is impossible to contract the exact same right to the same property at the same time to two different parties.
DeleteThe right to exchange is divisible by priority.
But isn't that impossibility precisely the point? If someone represents that they are doing something that is impossible to do, isn't that why 100% reservists call it "fraud"?
DeleteAs for priority, I'm not sure that solves the issue. Firstly, there is no actual contractual priority in banking deposits. It is simply "first come, first served" (whence bank runs).
Secondly, I don't believe that simple subordination of a debt resolves the debtor of the moral and legal obligation to not be immediately insolvent. For example, compare two scenarios: if a debtor issued some 10 year notes, everyone accepts that the ability to pay principle in 10 years is unpredictable, so if some debt is senior to others, it is upfront and fair.
However, let us say the debtor issues a number of notes such that they cannot even pay the first coupon in full to all notes, but hopes it won't come up since the issue has some sort of reinvestment option. The debtor then pays their executives big bonuses on the tremendous haul from the sale of notes, and then defaults the notes, can you really argue that no fraud was perpetrated against the subordinated lenders simply because "hey, they knew they held junior debt"?
“If someone represents that they are doing something that is impossible to do…”
DeleteThe contract does not state that the bank will do the impossible.
“Firstly, there is no actual contractual priority in banking deposits.”
There is a priority in normal operations – the deposit is the bank’s liability, recorded on the bank’s balance sheet. Think about the ramifications of this. There is a priority in bankruptcy – the depositor is an unsecured creditor, to be satisfied after senior, secured creditors.
“Secondly, I don't believe that simple subordination of a debt resolves the debtor of the moral and legal obligation to not be immediately insolvent.”
The bank is not immediately insolvent. When it takes a deposit, it records both an asset and liability on its books. There is no insolvency (separate from illiquidity) if assets are at least equal to liabilities.
The bank is also not immediately illiquid – to pre-empt your next comment. It is liquid so long as its calculations of prudent reserve requirements prove true. Like every entrepreneur, bankers must make estimations about the future. Also, like every entrepreneur, sometimes bankers are right, sometimes wrong.
“…can you really argue that no fraud was perpetrated against the subordinated lenders simply because "hey, they knew they held junior debt"?”
I have not made only this one assertion. Without repeating the thousands of words I have written on this subject, I will give you two reasons that are not this one: there is no fraud because, a) the contract doesn’t promise that the bank will hold your deposit – it is not a bailment, no matter how much supporters of FRB-is-fraud insist to treat is as such, and b) poor business judgment (via miscalculating future reserve requirements) is not evidence of fraud.
The system is messed up due to the monopoly, not due to FRB.
"the depositor is an unsecured creditor, to be satisfied after senior, secured creditors"
DeleteBut what if there are no other creditors? For example, let us say that I start a small town bank in a town of 10,000 people. Everyone in town makes a checking account deposit of $10,000. I now have $100,000,000. I turn around and loan those same 10,000 people $1,000,000 each, which they all turn around and redeposit in their checking accounts. I still have only $100 million in the bank, but 10,000 people each have $1.01 million in their accounts. 100 people immediately withdraw their accounts for cash. The other 9,900 people eat it. What priority was there other than "got there first"?
"When it takes a deposit, it records both an asset and liability on its books"
But that is not true. It records an asset and 10x that many liabilities on its books.
"It records an asset and 10x that many liabilities on its books."
DeleteIf you are a CPA that regularly audits banks, I will listen to your explanation of this wonder. Else, it is just nonsense.
"100 people immediately withdraw their accounts for cash."
Even assuming your example were possible, the bank (or the bankruptcy judge) will demand repayment of the loan.
Please do better.
How is it nonsense that the liabilities of the banks exceed their assets? That is what FRB means.
DeleteIn practice, I'm sure that the banks create made up money so they can book made up assets, but the whole question is whether or not this constitutes cooking the books.
"Even assuming your example were possible,"
Easily possible: each of the 100 people buy themselves a McMansion, and the sellers bank elsewhere, and the other banks demands transfer of assets.
"the bank (or the bankruptcy judge) will demand repayment of the loan."
An irrelevant demand, since the money may have already been spent. Also, not necessarily a legal demand. If I made a contract with the bank to take a $1mil, 30 year mortgage, what right does the bank have to call the loan because of their bad management?
You appeal (fairly, I might add) to the terms of the depositor agreement. Loan agreements are just as binding and valid. If the bank agrees to be repaid in 30 years, then over 30 years is when they get their money.
"How is it nonsense that the liabilities of the banks exceed their assets? That is what FRB means."
DeleteIf you are a CPA that audits banks, walk me through the t-accounts. If not, walk yourself through it. Follow these three simple rules and see if you can make it work:
1) Assets on the left; liabilities and equity on the right.
2) The left and the right must balance
3) Cash is an asset.
If necessary, make a spreadsheet and send it to me. Demonstrate how a one-dollar deposit (recorded on one side of the balance sheet) results in a ten-dollar entry on the other.
Don't yet move on to the bank lending the money, Get through this step first - as this is the issue you have raised.
"...what right does the bank have to call the loan because of their bad management?"
Then the bankruptcy judge will award the mortgages to the remaining creditors.
You don't know much about either accounting or bankruptcy, do you.