Financial Crisis

Feel free to still comment on my last post. I want to know if you all agree/disagree with the benefits of Fractional Reserve lending and the example I posted.

In reading the book and following current events, it seems the current crisis is a good way to acid test some of Rothbard's critiques. I am curious to hear everyone's thoughts on the the underlying cause, because I am still trying to clarify my own. The Crisis we went through, and may still be going through, had a cause. The debate is still out on what it was. Politicians are throwing around solutions and enacting legislation (like the financial legislation passed today) without ever explaining what the cause was. Here is what I think they each claim:

Democrats: Lack of regulation allowed banks to become over-leveraged and make bad investments, especially in housing. Basically, banker's greed did us in.

Libertarians: They blame the FED and the business cycle for over supplying money by keeping rates low from the dot-com crash to 2006. Easy money led to bad bets by banks. The Fed manipulating the money supply is to blame.

Republicans: I have heard them blame gov't regulation, like one that encouraged banks to lend to minorities (I think it was the community reinvestment act...or something) which I think is ridiculous. I would think that if you want to blame regulation, you could blame the FED like the libertarians do, but perhaps Republicans are too in bed with big business (banks) to suggest the FED could be responsible.

Any thoughts on what the party's views are? other views?

Progress vs. Inflation

Half-way through Rothbard's book, I think I understand his argument. The FED legalizes a banking cartel which acts as a lender of last resort and bails-out banks that are overleveraged (We have seen evidence that this is exactly what it does). The banks, having this ability to pool risk, are able to practice Fraction Reserve Lending to a far greater extent than the free market would allow. Fractional Reserve Lending creates new money and inflates our currency. The FED tries to do this in an orderly manner, but inflation no doubt occurs. Without the FED, banks would not take on the same level of risks. Let me know if you disagree with that line of thinking.

On the flip side, the banks have taken on a greater amount of risk than they would have without the FED. They have lent out 30 bucks for everyone 1 they had in reserve. This money went to entrepreneurs working on computers in their garages, to skyscrapers throughout the country, roads and bridges, Cell-phone networks, etc...

Would we have experienced the progess we have had if the banks could only lend what they had in their reserve? 1 to 1 ratio lending would not have built up the country we have now. Anyone disagree?

Postage III (bear with me)

another question concerning "legal tender":

In general, does not the Government force the use of a particular tender, then once we've accepted it, also force us to accept their privilege of counterfeiting?

"So you're going to force me to accept/work for a particular medium of exchange (legal tender), then proceed to counterfeit, thus robbing me of property...?"

For the moment let's disregard the counterarguments of "well you don't have to live here, go work elsewhere; or ask your boss to pay you in gold; or feel free to exchange your paycheck for whatever medium you would prefer; etc." unless of course those are the best arguments and you would like to expound.

Postage II

"...Counterfeiters are generally reviled, and for good reason. But what happens when government sanctions, and in effect legalizes, counterfeiting, either by itself or by other institutions? Counterfeiting then becomes a grave economic and social problem indeed. For then there is no one to guard our guardians against their depredations of private property."

There are many potent arguments for endowing government with the monopoly on the use of force. I have yet to hear a good argument for giving them the green light to legalize counterfeiting. I know it was somewhat touched on in the first post (see comments of http://ramblingmatters.blogspot.com/2010/04/something-for-both-sides-cuz-there-are.html) but I would like to hear more from you all.

Postage

I find my views growing ever narrower, thus it is great to benefit from everyone's fresh perspectives...

I would like to hear your takes on the following two paragraphs until I either disagree with them, or confidently agree. At the moment I'm afraid I'm just blind to something.

"...For this way, without actually breaking and entering the property of others, he can insidiously steal the fruits of their productive labor, and do so at the expense of all holders of money, and especially the later receivers of the new money. Counterfeiting, therefore, is inflationary, redistributive, distorts the economic system, and amounts to stealthy and insidious robbery and expropriation of all legitimate property-owners in society.

...Counterfeiters are generally reviled, and for good reason. But what happens when government sanctions, and in effect legalizes, counterfeiting, either by itself or by other institutions? Counterfeiting then becomes a grave economic and social problem indeed. For then there is no one to guard our guardians against their depredations of private property."

Prior to this book I hadn't given nearly enough thought to fractional-reserve banking, and I had no idea this book would discuss it so much. At the moment Rothbard seems to have gotten away from discussing the FED directly, but I'm guessing the underlying implication being that the FED, to a large extent, enables the continued existence of large scale fractional-reserve banking, primarily as lender of last resort (let's enable irrationality and extreme leveraging, yeah, that'll make for a stable economy, all while socializing the costs), but also as the number one regulator of the banking system. That is, it must be great when he who is called on to maintain a watchful eye on you, aides you in your unhealthy activities. Such an implication is not a bad case against the FED, with my current limited understanding.

I'm always hesitant to make any mention of Ayn Rand as I disagree with so much of her philosophy, yet one quote keeps coming to mind, "No political system can establish universal rationality by law (or by force). But Capitalism is the only system that functions in a way which rewards rationality and penalizes all forms of irrationality, including racism." -Ayn Rand, Racism, 19th paragraph, or pg 151 of Virtues of Selfishness.

Capitalism, as true capitalists define it (as true capitalists define true capitalists, so on and so forth), in no way advocates a central bank.

Ain't the new sound, just like the old sound

Why would banks exist if it wasn’t for the concept of Fractional Reserve Banking? Isn’t this the way banks make money? Why else would I want to be a bank unless I thought I could “invest” funds from depositors? This is how banks make money and pay an interest rate to those that have accounts, right? Am I missing something here?

I read further into our reading, I imagine Rothbard will get into the idea that banks can’t always cover their funding due customers or daily reserve requirements. To cover these balances, banks use “overnight loans” i.e. Federal funds, or fed funds. These are unsecured loans of reserve balances at Federal Reserve Banks that depository institutions make to one another. The rate at which these transactions occur is called the fed funds rate. This fed funds rate is the primary tool the Fed uses for monetary policy. If the economy is growing too rapidly and a bubble is forming, the fed will raise the fed funds rate. The effect is banks will have a tendency to “loan” less money. The inverse creates the opposite effect.

When in doubt, use a T-Account. As an accountant, I liked Roth’s use of T-Accounts to detail banking works. Visually this helped think through the balance sheet. I don’t like how he is analyzing the banks financial position. You can look at any publicly traded bank and you’ll see they do not hold much excess cash. ( http://finance.yahoo.com/q/bs?s=ZION+Balance+Sheet&annual )Banks tend to have a high amount of long-term receivables (other assets) - loans /etc. Banks’s have a high amount of current liabilities. Banks hold amounts due depositors as liabilities, classified as short or long term (pending the deposit terms). Thinking through the accounting of Fractional Reserve Banking, this is the banking business, right? A public banks will disclose its financial position to investors, anyone can see how leveraged a public bank is. You run a poor banking business.

In summary of the above, yes, we increase reserve requirements or let’s regulate the type or ratio (based on risk) of securities public banks hold. However, to argue the concept of fractional reserve banking, the very root of why a bank would exist - for profit, is garbage.

Through all this discussion and through what I’ve read thus far, its not so much that I question what makes the economy work (a central banks role in the economy, including the tools and methods used). My questions more concern how it has been working. Let’s question how the Fed 's monetary has worked and is working. How about the tech and housing bubble’s of the 2000’s?

Critics have long urged the Fed to intervene in bubbles - an argument that seems even stronger given the financial crisis. Had the Fed raised the fed funds rate more aggressively, it is possible that banks would not have made so many questionable loans. We can't know for sure, but we do know what did happen. From 2001 to 2003, the Fed lowered short-term interest rates 13 times. They rates stayed low for another year, and then rose at a sharp pace. With credit so cheap 2001-2003, people and institutions borrowed as if there were no tomorrow. And when the bust came, it spawned the worst recession in 75 years. This brings me to a comment I made in my first post “too much government interference does hurt capital markets. Capital markets do find balance naturally through supply and demand”