Wednesday, September 18, 2019

Frances Coppola - If You Don't Understand Banks, Don't Write About Them

Many economists don't understand how the banking system works, says Frances Coppola, and  go on to write inaccurate books or give ill advice to governments. Here, in this article, she severely criticises a prominent economist for writing such a misinformed book.

One thing MMTers are pretty clued up on is how banking works, and yet many economists - who don't understand how banks work at all - criticise MMT.

The author, a young economist with a first-class degree from Oxford, the famous English university, acknowledges that banks don’t need deposits in order to lend. But she then reintroduces the discredited “money multiplier” explanation of bank lending. Furthermore, she confuses bank reserves with liquid assets, and liquid assets with capital. This confusion exists not just in this paragraph, but throughout the book. How on earth can someone write a book about “financialization” without apparently even a rudimentary understanding of how banks work?

Having to explain all this again has made me realize that the new generation of economists is every bit as ill-informed as the old one. Though this is not surprising. After all, they’ve been taught by them. The “money multiplier” has been shown many times to be an inadequate and misleading explanation of how banks work, yet it still features in many undergraduate economic courses. No university would teach the Ptolemaic system to young astrophysicists, so why are they still teaching its financial equivalent to young economists?

Forbes

Frances Coppola - f You Don't Understand Banks, Don't Write About Them=true

16 comments:

Matt Franko said...

This is wrong:

“For a bank, “capital” is the difference between the amount it has borrowed (including customer deposits) and the amount it has lent (including securities it has purchased). This difference represents the bank’s “net worth”, and is made up of shareholders’ equity plus forms of debt that can be converted to equity (“contingent convertible” bonds, for example). If the bank ‘s capital is positive, the bank is solvent. If it is negative, the bank is bust.”

Capital = Assets - Liabilities

And the regulatory ratio is (A-L)/A >or= 0.1

‘Reserves’ are properly Reserve Assets.

The CB directly controls the amount of Reserve Assets in the depository system.

So a rapid increase in system reserve assets by the CB “to lend out!” can force the ratio below regulatory minimums and cause cessation of the provision of credit by the depository system.

Which is exactly what happened in September 2008 and caused the crash....

All recessions are caused by this type of CB activity.... US hasn’t witnessed that type of activity in 10 years so we haven’t had a recession in 10 years...

When they do it again we’ll have another recession...


Kaivey said...

Interesting - no one gets it right, especially the professionals.

Matt Franko said...

They’re not qualified KV... trained in an inappropriate methodology...

We have to watch the Fed today they may panic and do it again and crash the whole f-ing thing again...

Just hope if they do they give us a week or two advance notice to reposition...

Mike Norman said...

Good stuff, Matt!

Joe said...

Question, about the equation (A-L)/A>=0.1

Reserves are "Reserve Assets", so they go into the L term for an increase to cause the ratio to go below 0.1? Then why call them reserve "assets"?

Since
lim A->inf (A-L)/A=1
and
lim L->inf (A-L)/A=-inf

Matt Franko said...

Joe the corresponding Deposits are the Liabilities...

so if CB takes it upon itself to increase Reserve Assets in the depository system "so banks have more Reserves to lend out!" (MAJOR Reification Error which is the root problem... its a pretty serious cognitive error at core...) it buys on the run USTs with new issued reserves...

A and L both increase at Depositories, A increases in Reserve Assets account and L increases in Deposits account of former UST holder as Treasury Dept holds the General Account constant...

Both A and L increase... Delta A-L is unchanged... so numerator unchanged...

Denominator A increases due to additional Reserve Assets... Reserve Assets increase...

Ratio can immediately decrease below regulatory threshold and Depositories lose ability to create any additional loan assets... they lose ability to create any new assets...

Credit system shuts down... GFC...

Its an algebraic regulatory function...

The problem is cognitive though... its a cognitive error they keep making... they are reifying the accounting abstractions... they think "money!" is real, etc... so they can "lend it out!"...

(btw Frances makes a bunch of these errors in her piece here too... like "money is real!"...)

The people there are not trained correctly/adequately...



Joe said...

Ah, I see. Yes, if A and L increase simultaneously, then the ratio tends towards zero as A increases. Thanks.

Carlitos said...

If the banks sell securities to the Fed, it's just an asset swap and the ratio doesn't decline unless you are suggesting that the banks sold securities and agency debt to the Fed below their present value.

QE was b/n the Fed and its member banks, not individuals or non-Fed members. If they bought from the public (non-Fed members) that would lower the leverage ratio of the banks as their deposit liabilities and reserve assets go up.

When the leverage ratio becomes a problem the banks (should) cut costs, retain earnings, withhold dividends, and/or dilute shares (their stock price is devalued).

In any event, what started the GFC was the world-wide discovery of fraudulent asset backed securities primarily from liar's loans - institutions started failing (because they were insolvent), credit slowed, and the whole thing spiraled out of control as governments did nothing to fiscally adjust proactively to fill the gap caused by the contracting credit expansion. Instead govt deficits blew up the ugly way while CBs dicked around with interest rates and other extraordinary measures that pushed on the string - when credit worthiness was the problem.









sths said...

Carlitos said;

"In any event, what started the GFC was the world-wide discovery of fraudulent asset backed securities primarily from liar's loans - institutions started failing (because they were insolvent), credit slowed, and the whole thing spiraled out of control as governments did nothing to fiscally adjust proactively to fill the gap caused by the contracting credit expansion. Instead govt deficits blew up the ugly way while CBs dicked around with interest rates and other extraordinary measures that pushed on the string - when credit worthiness was the problem. "

That seems to be the dominate narrative around what happened in 08. However from Matt's posts it seems that he thinks its the CB's actions that was actually the catalyst and then the above as per Carlito's post happened.
What's interesting is that they both points of view seem to point to massive credit contraction as the cause (I think most people acknowledge that), it's just difference of opinion on what the catalyst was and I think Matt's view is certainly something you don't see mentioned anywhere else. Would be interesting to see if this CB induced bank credit contraction causing recession thesis can be more fleshed out.

Matt Franko said...

"If the banks sell securities to the Fed"

The banks DONT sell their USTs to Fed they have them as Tier1 ('not available for sale') to comply with the regulations in the first place...

The Fed buys them from the "open market" ('available for sale') so previous USD savers as holders of USTs get BANK DEPOSITS in place of previous ownership of USTs...

Increases both A and L at the banks...

Leverage Ratio collapses and shuts down the provision of credit by the regulated Depository Institutions...

G... F.... C....

Its criminal negligence NOT "control fraud!" BS...

mikehall said...

Matt Franko's 'regulatory ratio' comments don't seem to bear any accounting similarity to that stated here for banks...

https://en.m.wikipedia.org/wiki/Capital_adequacy_ratio

Carlitos said...

Matt is correct with respect to my comment. The Fed deals with primary dealers, and the do get securities from individuals. The process of OMO does increase deposits and lower leverage ratios. But he’s still way off that this caused the GFC or is some general widespread problem that drags or reduces lending.

mikehall said...

Carlitos, yes, that was my thinking too. Which, tbh, was a bit of a surprise, considering he posts a lot here, and appears to claim some knowledge of monetary system matters.

Carlitos said...

The key point to make with Matt is that as (A-L)/A trends toward the regulatory minimum, other things are also happening to satisfy regulatory compliance.

If OMO were such a problem, would we have seen such massive stock buy backs?


Matt Franko said...

There are other Regulatory Ratios in the US besides the CAR...

There is the SLR and now (post GFC) the CCAR requires banks to maintain additonal Tier1 quality assets as a % of total assets (which includes reserves)

Carlitos is apparently ignorant of these non-risk weighted leverage regulations...

https://www.bnymellon.com/_global-assets/pdf/our-thinking/arriving-at-new-capital-ratios.pdf

SLR includes NON_RISK assets (ie Reserve Assets) as well as risk assets (such as loans)...

If the Fed increases Reserve Assets they can put their own Depositories into violation... which is what they did in September 2008...

Go back and look at the H.8 for Sept into October 2008 and you can see what they did...

Matt Franko said...

https://www.americanbanker.com/opinion/setting-the-record-straight-on-why-leverage-ratio-must-change

"Commercial banks in the United States have been required to satisfy a leverage ratio requirement since 1981, but until recently, banks in other jurisdictions have not."

US has always had an SLR regulatory requirement...

Checkmate...