Oilfield Trash makes a good observation about how close Ed Harrison is to MR.
“Interesting post from Edward Harrison, seem like he would make a good addition to the MR team.”
We are friends with Edward over here at MR, and many of our views overlap. His most recent post on Endogenous Money and Fully Reserved Banking is excellent.
”One way some economists believe we can stop this kind of crisis from happening is to move to a fully reserved banking system. In such a system, the full amount of liabilities are held in reserve as cash or highly liquid assets. The benefit of this kind of system is that it limits the number of banks that can fail from a lack of liquidity. Now clearly banks in a fully-reserved system could still fail because banks could still grant credit to enough borrowers that defaulted to cause a huge hole to open up in the bank’s balance sheet and precipitate a bank run. But, the thinking here is that bank runs would be more limited in nature since other banks would be fully reserved. The need for a lender of last resort would be diminished if banks were not at as great a risk of failure due to liquidity crises.”
I don’t know if I agree with the bank run part, but banks can certainly go bankrupt under a 100% reserve system. A bank run implies depositors might not be able to get their deposits out of the bank, which causes the mad dash to be first in line to withdraw money.
Under a 100% reserve system, no matter how much the banks loses on it’s portfolio of loans, the money is available to re-pay depositors. It’s just all of the banks equity is wiped out, and can even go into negative territory. Negative equity for a bank under 100% reserves is entirely possible, and is the sign of an insolvent bank.
It’s as though the deposits are in a lock box, and the bank makes up an equivalent amount of new money to lend out to borrowers. The bank can make profits and losses on the newly created money, but can’t touch that money in the lock box. All the risk is on the bank shareholders, and none on the depositors.
Of course, this all depends on the legal setup allowed by the feds who charter these banks, but this is the way I envision 100% reserve banks working. Depositors get risk free deposits, banks compete on offering high rates for deposits and low rates for loans and collateral quality. Borrowers search for the best deals on their collateral.
This of course relies on having massive amounts of money/risk free collateral created by the feds through some program.