Interest money

Who owns the money from the bank loans?

A reader asked this question today. For those who don’t know the answer, this may seem shocking: no one is.

Q: “I am a bank and I make loans. Who am I lending money to? »
A: No one is

You create new money. Lending creates money out of thin air, and that money is deposited somewhere, creating deposits.

See the following table.

Total credit due vs base money

Total Credit vs. Base Money, St. Louis Fed Data, Mish Chart

Total credit due exceeds $90 trillion. The base currency barely exceeds $6 trillion.

The Federal Reserve defines base money as “The sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve).”

Bank reserves

Bank reserves stood at 3.3 trillion at the end of May.

They are a function of EQ.

Via QE, the Fed pushed money down the throats of the banks, which the banks hand over to the Fed and collect the interest.

Hooray, free money

The Fed pays interest on all reserves. At the end of May, total reserves stood at $3.318 billion.

The Federal Reserve currently pays 1.65% interest on IOR reserves.

If the Fed moves into the 2.25-2.50% range in July as expected, expect the IOR to move to around 2.40%.

Q: On a yearly basis, how much free money are we talking about?
A: 2.40% of $3.318 billion is $79.63 billion!

Q: We are giving the banks $79.63 billion in free money?
A: It’s a moving target.

The IOR continues to rise but reserve balances continue to fall.

This $79.63 billion reflects an increase that has not yet taken place. If the Fed continues to climb at a rate above QT, the amount will increase further. Otherwise, the actual amount of free money will decrease.

Constraints on bank loans

1: The bank cannot be capital depreciated (too many bad debts)

2: Individuals or companies want to borrow

3: The bank must think that the loan will be repaid (think that the customer represents a good credit risk)

The bank may very well be wrong on point number 3, but it will grant a loan if it believes that the customer represents a good risk (or that the value of the asset will increase if the customer defaults)

Think about point 3 and the housing crisis. Banks knew full well they were making lying loans, but they didn’t anticipate a crash in house prices or people moving away from homes.

Bank loans create money that did not exist before. To the extent that “reserves” are needed, the Fed can manufacture them at will, and then some through QE, as shown in the chart above.

Banks used to collect free money from ‘excess reserves’ now it’s ‘reserves’

Reverse Repos Hits New High of $2.33 Trillion: Plus a Free Money Q&A!

I discussed Free Money and also Reverse Repos in Reverse Repos Hits New High of $2.33 Trillion: Plus a Free Money Q&A!

This post follows on from the above after a reader asked what money do banks lend.

I have also added a note to the post above to indicate that it is primarily non-banks, especially money market funds, that benefit from the Reverse Repo Facility.

Addendum Q&A

These are questions from readers and my answers.

Q: I just don’t understand how temporarily selling Treasuries and MBS to banks for short periods allows the Fed to keep the fed funds rate within its target range?”

A: Deposits are liabilities of banks. As silly as it sounds and I think it is silly, banks have to maintain capital on these deposit liabilities.

Either way, the banks will act to get rid of these excess cash “reserves” (a perverse term) and they do this by buying any short-term assets they can, usually short-term Treasury bills .

When the Fed had interest rates close to zero, competition for short-term Treasuries was so intense that it pushed the overnight rate below zero. Not only did this force rates below the Fed’s target rate, it also pushed them into negative territory and almost broke all money market funds unless the funds started charging interest on deposits!

In response, the Fed began offering non-banks access to the repo facility where previously it was only available to banks and market makers like Goldman Sachs.

Bernanke understood this would happen and lobbied Congress for the right to do it and Congress agreed.

Rather than getting rid of a sufficient amount of these “excess reserves” (a term that is no longer used probably because it points the finger at the Fed), the Fed performs a reverse repo and pays interest on reserves.

The Fed needs to do this to force rates “up” at the lower end of the curve, because the impact of QE is to force rates downbelow the Fed’s target.

That’s what the competition for short-term Treasuries has done to the market. “The system is working as expected,” the Fed said. And I mocked this design in my previous post.

What the Fed should be doing is draining all that damn QE as fast as possible. Instead, it drags out the process for years.

Q: If banks won’t lend my bank accounts, term deposits, etc., how can my money in the bank be turned into a loan?

A: It is not!

Deposits are a liability.

The only reason some banks actively seek deposits is that they can park deposits with the Fed at higher rates than they pay on accounts. Big banks have so much QE that they don’t even bother trying to attract small depositors. Small peon beds are more troublesome.

Small lenders also hope that the depositary customers they attract will eventually become borrowers.

Q: Mish, are we heading into a deflationary recession or an inflationary recession? Or maybe both? Perhaps asset prices are falling while food, gas and commodities remain high?

A: We will have another wave of asset deflation, in fact it has started. Whether this leads to inflation measured by the CPI is another question. But if you correctly add housing to the equation, it seems likely.

Historical perspective on CPI deflations: how damaging are they?

It is asset price deflation that matters. I have written about this several times. Please see Historical Perspective on CPI Deflation: How Damaging Are They?

A BIS study concluded “Deflation can actually boost production. Lower prices increase real incomes and wealth. And they can also make export products more competitive. Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI) deflations do not appear to be statistically significantly related to slower growth, even in the interwar period.”

The battle of central banks against beneficial routine deflation has started again to create the very deflation that central banks should fear!