Fictional Reserve Lending Is the New Official Policy
With little fanfare or media coverage, the Fed made this Announcement on Reserves.
As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.
Amusingly, a few days ago yet another article appeared explaining how the Money Multiplier works. The example goes like this: Someone deposits $10,000 and a bank lends out $9,000 and then the $9,000 gets redeposited and 90% of the gets lent out and so an and so forth.
The notion was potty. That is not remotely close to how loans get made. Deposits and reserves never played into lending decisions.
What's Changed Regarding Lending?
The announcement just officially admitted the denominator on reserves for lending is zero.
There are no reserve lending constraints (but practically speaking, there never were).
Fictional Reserve Lending Flashback
I wrote about this in December of 2009 in Fictional Reserve Lending and the Myth of Excess Reserves.
The flashback is amusing as I reference a number of people worried about hyperinflation.
Here are the facts of the matter as I explained in 2009.
Money Multiplier Theory Is Wrong
- Lending comes first and what little reserves there are (if any) come later.
- There really are no excess reserves.
- Not only are there no excess reserves, there are essentially no reserves to speak of at all.
The rationale behind the last bullet point pertains to banks hiding losses. Regulators suspended mark-to-market accounting.
When Do Banks Make Loans?
- They meet capital requirements
- They believe they have a creditworthy borrower
- Creditworthy borrowers want to borrow
All three requirements must be met.
- Banks generally do not lend if they are capital impaired.
- Clearly someone must want to borrow.
Point two is worthy of discussion.
Banks may not have a creditworthy borrower, they just have to believe it, or they have an alternate belief that applies. In 2007 banks knew full well they were making mortgage liar loans.
So Why Did They?
Because banks bought into the idea home prices would not go down so they did not give a rat's ass if someone was out on the street. All they cared about was the quality of the loan. If Home prices appreciated, they were covered.
From a bank lending aspect, nothing has changed. Neither reserves nor deposits never entered into the picture.
Denominator Officially Zero
The denominator on lending is now officially zero. But nothing really changed. The Fed was always ready, willing, and able to supply unlimited reserves.
The only thing that's new is the official announcement that reserves are fictional.
Capital Concerns in 2009
There are capital concerns, but note that in March of 2009 the Fed suspended mark-to-mark accounting.
That was the key announcement that launched the bull market.
Capital Concerns Now
There are still capital concerns, but the Fed stepped up to the plate and is willing to buy corporate bonds.
Guess who is going to unload as much questionable junk as possible and guess who will buy it.
Banks know they have losses but hey will not admit them.
All it takes to mask them is a clever swap takes the assets off the balance sheet of the banks and temporarily hides them on the balance sheet of the Fed.
What About New Lending?
Hiding junk is not new lending. It is not new production. And it is not new hiring.
To achieve real growth we need new production, not hiding of losses.
Losses and Zombies
Once again, the Fed has chosen to hide losses and shelter zombie corporations.
This will be a drag on any recovery.
All Excess Now
Hey, look on the bright side.
By definition, all reserves are now excess reserves. Banks can collect on all reserves.
The rate may not be much, but Interest on Excess Reserves = Interest on Reserves
Ain't life grand?
But, But, But, But
- Unemployment Claims Spike to 3.28 Million, New Record High
- Coronavirus Trend: One in 10 of Those Hospitalized Die
- Retail Grinds to a Halt as 47,000 Stores Close
- US Output Drops at Fastest Rate in a Decade
But banks are saved. What more could you possibly want?
Meanwhile, Nothing is Working Now (Except for Banks)
For a 20-point discussion of where we are headed, please see What's Next for America?
Mike "Mish" Shedlock