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Full Reserve Banking

TheAtheistAllegiance
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4/7/2011 2:38:45 PM
Posted: 5 years ago
Most Libertarians/Anarchists advocate full reserve banking, but without state regulation of banks, why would they hold full reserves? I'd imagine that banks, in order to be competitive, would loan out more than they have in reserve. Consumers certainly like having easy access to credit, and a bank that can't loan as much as its competitors due to full reserve requirements would (I'm guessing) lose market share.

These banks are obviously more prone to failure, but I don't think that disincentive would override the incentive to make money by excessively issuing loans when the economy is doing well.

So, how can FRB be achieved without regulation?
LaissezFaire
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4/7/2011 2:40:33 PM
Posted: 5 years ago
Punishing those that don't have full reserves for fraud, in addition to them going bankrupt.
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Cody_Franklin
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4/7/2011 2:47:56 PM
Posted: 5 years ago
At 4/7/2011 2:38:45 PM, TheAtheistAllegiance wrote:
Most Libertarians/Anarchists advocate full reserve banking, but without state regulation of banks, why would they hold full reserves? I'd imagine that banks, in order to be competitive, would loan out more than they have in reserve.

That's what they do with state regulation. :P I know that banks now usually have more on hand than what the regulated reserve requirement is, though, given that reserves aren't checked on every day, it's actually the case that banks will lend out basically all of their funds, and will borrow from somewhere else in the money market to meet their reserve requirement when the check is performed. I think it's measured in 14-day periods, which means banks are out pretty far most days.

I imagine, though, that, with the abolition of the FDIC, bailouts, and other such programs, we're pulling the financial safety net out from underneath the banks. If you're a bank, and know that basically all of your risk is absorbed (and your ability to get money secure), you'll be a lot more liberal with the way you let your funds funnel out into the market. If you as an institution are forced to hold all your risk, though, I guarantee you're not going to be lending nearly as much.

Consumers certainly like having easy access to credit, and a bank that can't loan as much as its competitors due to full reserve requirements would (I'm guessing) lose market share.

Banking won't be as profitable, sure.

These banks are obviously more prone to failure, but I don't think that disincentive would override the incentive to make money by excessively issuing loans when the economy is doing well.

So, how can FRB be achieved without regulation?

Using regulation doesn't really work well anyway.
Reasoning
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4/7/2011 2:52:35 PM
Posted: 5 years ago
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TheAtheistAllegiance
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4/7/2011 3:23:45 PM
Posted: 5 years ago
At 4/7/2011 2:40:33 PM, LaissezFaire wrote:
Punishing those that don't have full reserves for fraud, in addition to them going bankrupt.

For fraud?!
TheAtheistAllegiance
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4/7/2011 3:53:24 PM
Posted: 5 years ago
At 4/7/2011 2:47:56 PM, Cody_Franklin wrote:
At 4/7/2011 2:38:45 PM, TheAtheistAllegiance wrote:
Most Libertarians/Anarchists advocate full reserve banking, but without state regulation of banks, why would they hold full reserves? I'd imagine that banks, in order to be competitive, would loan out more than they have in reserve.

That's what they do with state regulation. :P I know that banks now usually have more on hand than what the regulated reserve requirement is, though, given that reserves aren't checked on every day, it's actually the case that banks will lend out basically all of their funds, and will borrow from somewhere else in the money market to meet their reserve requirement when the check is performed. I think it's measured in 14-day periods, which means banks are out pretty far most days.

Without Federal Reserve monetary policy, banks would probably be less able to get their hands on such cheap capital. However, when the good times are rolling, it can still get pretty cheap, and banks might tend to become over-reliant on money markets, rather than full reserves.

I imagine, though, that, with the abolition of the FDIC, bailouts, and other such programs, we're pulling the financial safety net out from underneath the banks. If you're a bank, and know that basically all of your risk is absorbed (and your ability to get money secure), you'll be a lot more liberal with the way you let your funds funnel out into the market. If you as an institution are forced to hold all your risk, though, I guarantee you're not going to be lending nearly as much.

Doesn't the FDIC protect only depositor funds? Also, aren't most banks' loans (not including GSE's) not guaranteed by the government? Many banks that weren't tied to the government were issuing crazy loans during the housing boom, and the same could happen under market circumstances -- it's simply investment mania, unrealistic expectations, etc. Heck, they could just hedge all of their risk with derivatives, and when the business cycle goes into downturn, they would simply expect to collect their return from AIG or someone else.

Consumers certainly like having easy access to credit, and a bank that can't loan as much as its competitors due to full reserve requirements would (I'm guessing) lose market share.

Banking won't be as profitable, sure.

Well, I'm thinking that banks would issue beyond their reserves because they don't want to pass up profit opportunities.

These banks are obviously more prone to failure, but I don't think that disincentive would override the incentive to make money by excessively issuing loans when the economy is doing well.

So, how can FRB be achieved without regulation?

Using regulation doesn't really work well anyway.

Okay, but I'm asking how full reserve banking would be achieved without it.
Fabian_CH
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4/7/2011 4:18:58 PM
Posted: 5 years ago
At 4/7/2011 2:40:33 PM, LaissezFaire wrote:
Punishing those that don't have full reserves for fraud, in addition to them going bankrupt.
I'm not sure I understand why fractional reserve banking is fraud in the first place. I think the problem lies more with government subsidies, i.e. loaning money to banks in order to facilitate more loaning than a free market permits.

Then again, I'm hardly qualified to make such judgments.
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Cody_Franklin
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4/7/2011 4:49:47 PM
Posted: 5 years ago
At 4/7/2011 3:53:24 PM, TheAtheistAllegiance wrote:
At 4/7/2011 2:47:56 PM, Cody_Franklin wrote:
At 4/7/2011 2:38:45 PM, TheAtheistAllegiance wrote:
Most Libertarians/Anarchists advocate full reserve banking, but without state regulation of banks, why would they hold full reserves? I'd imagine that banks, in order to be competitive, would loan out more than they have in reserve.

That's what they do with state regulation. :P I know that banks now usually have more on hand than what the regulated reserve requirement is, though, given that reserves aren't checked on every day, it's actually the case that banks will lend out basically all of their funds, and will borrow from somewhere else in the money market to meet their reserve requirement when the check is performed. I think it's measured in 14-day periods, which means banks are out pretty far most days.

Without Federal Reserve monetary policy, banks would probably be less able to get their hands on such cheap capital. However, when the good times are rolling, it can still get pretty cheap, and banks might tend to become over-reliant on money markets, rather than full reserves.

Meaning what?

I imagine, though, that, with the abolition of the FDIC, bailouts, and other such programs, we're pulling the financial safety net out from underneath the banks. If you're a bank, and know that basically all of your risk is absorbed (and your ability to get money secure), you'll be a lot more liberal with the way you let your funds funnel out into the market. If you as an institution are forced to hold all your risk, though, I guarantee you're not going to be lending nearly as much.

Doesn't the FDIC protect only depositor funds?

That is one of its functions.

Also, aren't most banks' loans (not including GSE's) not guaranteed by the government?

That sort of depends on the degree of regulation. During the whole housing business, for example, you have the Fed adjusting rates to artificially low levels and the government (in one way or another) willing to absorb much of the risk that banks were taking on. State agents wanted to stimulate spending because of the presupposition that the only way to offset economic turmoil is higher consumer confidence, which in turn produced government policies designed to get banks lending to people who would not have gotten loans under normal circumstances. If things went bad, the government would simply buy back those bad assets so that banks felt safe in making really weird financial decisions. In either case, the banks knew they would make money (the fact of bailouts and other subsidies notwithstanding).

Many banks that weren't tied to the government were issuing crazy loans during the housing boom, and the same could happen under market circumstances -- it's simply investment mania, unrealistic expectations, etc.

Define "tied to the government". Because, if the legal-financial structure applies to everyone, it's impossible not to be tied up in the state one way or the other.

And I don't disagree that banks could be idiots in a free society, either. The market doesn't promise that you'll experience constant prosperity with no sour periods. Any economist who promises you that is an idiot. What the free market promises is only causality. The current state of economic affairs, in other words, would simply be a consequence of antecedent conditions. If a lot of banks (and their investors/depositors/etc) are making really shoddy decisions regarding where their money goes, the consequences will likely be pretty dire. This is why any Austrian will tell you that people are right when they say turning to a free market now would result in economic chaos--it's because of the way that we've been trying to drug up the economy, so to speak. We've been delaying the consequences for so long that the results of our actions, when they come (and I do mean when, as opposed to if) will be pretty awful.

Heck, they could just hedge all of their risk with derivatives, and when the business cycle goes into downturn, they would simply expect to collect their return from AIG or someone else.

Without a lot of the safeguards which currently exist, trying to hedge your bets doesn't really solve the more fundamental problem that you're not guaranteed success under all scenarios.

Consumers certainly like having easy access to credit, and a bank that can't loan as much as its competitors due to full reserve requirements would (I'm guessing) lose market share.

Banking won't be as profitable, sure.

Well, I'm thinking that banks would issue beyond their reserves because they don't want to pass up profit opportunities.

Businesses don't just do things because profit is a possibility. Banks are especially careful, because they operate in one of the most volatile industries in existence. Currently, they can basically loan out massive amounts past their reserve because of their ability to borrow from the money market--usually, this means smaller banks who have surpluses or straight from the Fed, which can just use its powers of carte blanche to add new reserves). There may also be the added influence of financial safeguards, like government agencies/corporations willing to buy time bombs that banks stumble into (e.g. CDOs populated almost entirely by risky sub-prime mortgages financed by toxic loans, for example). The market doesn't prevent banks from doing that, sure--but it's probably going to punish them in the end for being idiots with their finances.

These banks are obviously more prone to failure, but I don't think that disincentive would override the incentive to make money by excessively issuing loans when the economy is doing well.

So, how can FRB be achieved without regulation?

Using regulation doesn't really work well anyway.

Okay, but I'm asking how full reserve banking would be achieved without it.

Like I noted earlier, I don't really oppose the principle of fractional-reserve, nor do I really see what advantage full-reserve offers other than being able to cover bank runs in times of depressively-low depositor confidence.

In other words, maybe I shouldn't be arguing this with you. Lol.
Sieben
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4/7/2011 4:49:59 PM
Posted: 5 years ago
A bank is just a warehouse for money. Other warehouses do not operate on fractional reserve.

In principle it is possible that consumers would accept some low chance of a bank run in exchange for higher interest or something. But the expected value to consumers would always be the same so that they would break even. There's no free money to be had...I don't really envision there being a demand for this kind of arrangement.
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Cody_Franklin
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4/7/2011 5:12:45 PM
Posted: 5 years ago
At 4/7/2011 4:49:59 PM, Sieben wrote:
A bank is just a warehouse for money. Other warehouses do not operate on fractional reserve.

Well, yeah, but a warehouse is usually just a place for a profitable producer to store stuff. In the case of a bank, the storing of the good is what the business is based on. If bankers don't have the ability to use deposits to make a profit by investing it (which is really their only means of turning a profit), they're not going to go into banking. I mean, yeah, you might be able to set aside some kind of money in savings or something and allow a bank to use that, but it wouldn't be worth the trouble for a banker when you have so much more capital just sitting around, and when your profit margin is bleakly low in comparison to the work you have to do to get there.

In principle it is possible that consumers would accept some low chance of a bank run in exchange for higher interest or something.

Depends on what kind of investor you are, I guess. But, even if you're the kind of guy who only trades in debt securities, you would probably assume that the threat of a sudden bank run (as well as not being able to get to the bank in time if such were to occur) is so low that you may as well write the risk off as negligible. You would have to be unbelievably risk-averse otherwise.

But the expected value to consumers would always be the same so that they would break even. There's no free money to be had...I don't really envision there being a demand for this kind of arrangement.

I'm not really sure what you mean by this.
Sieben
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4/7/2011 5:43:04 PM
Posted: 5 years ago
At 4/7/2011 5:12:45 PM, Cody_Franklin wrote:
At 4/7/2011 4:49:59 PM, Sieben wrote:
A bank is just a warehouse for money. Other warehouses do not operate on fractional reserve.

Well, yeah, but a warehouse is usually just a place for a profitable producer to store stuff.

People with jobs are profitable.

In the case of a bank, the storing of the good is what the business is based on. If bankers don't have the ability to use deposits to make a profit by investing it (which is really their only means of turning a profit), they're not going to go into banking.

The idea is that you pay them to hold your money. One way or another. You can either pay them up front like a normal storage unit, which should be pretty cheap since cash is just electronic now, or you can pay them by letting them loan your money out.

It just depends what consumers demand. But the latter is usually called a "financial group", not a bank.

In principle it is possible that consumers would accept some low chance of a bank run in exchange for higher interest or something.

Depends on what kind of investor you are, I guess. But, even if you're the kind of guy who only trades in debt securities, you would probably assume that the threat of a sudden bank run (as well as not being able to get to the bank in time if such were to occur) is so low that you may as well write the risk off as negligible. You would have to be unbelievably risk-averse otherwise.

Well the threat of a bank run and no hope of a bailout might introduce some sort of indefinitely stable fractional reserve banking. I doubt it though.

But the expected value to consumers would always be the same so that they would break even. There's no free money to be had...I don't really envision there being a demand for this kind of arrangement.

I'm not really sure what you mean by this.

If they loan some of their deposits out, a bank run becomes more likely, and you have a chance at losing money. In order to get you to accept this deal, the bank has to give you something in return. Maybe they pay you more interest on your account to make up or the risk. But the amount you are compensated is proportional to the risk you take on. So you're not really (on average) gaining anything.

That's why I don't think we'll see FRBs. Even if there were a demand for risk, there is a whole bloody market that provides it - see casinos.
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Cody_Franklin
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4/7/2011 7:22:16 PM
Posted: 5 years ago
At 4/7/2011 5:43:04 PM, Sieben wrote:
At 4/7/2011 5:12:45 PM, Cody_Franklin wrote:
At 4/7/2011 4:49:59 PM, Sieben wrote:
A bank is just a warehouse for money. Other warehouses do not operate on fractional reserve.

Well, yeah, but a warehouse is usually just a place for a profitable producer to store stuff.

People with jobs are profitable.

What?

In the case of a bank, the storing of the good is what the business is based on. If bankers don't have the ability to use deposits to make a profit by investing it (which is really their only means of turning a profit), they're not going to go into banking.

The idea is that you pay them to hold your money. One way or another. You can either pay them up front like a normal storage unit, which should be pretty cheap since cash is just electronic now, or you can pay them by letting them loan your money out.

It just depends what consumers demand. But the latter is usually called a "financial group", not a bank.

I don't know if I would consider "letting them loan your money out" to be payment per se. It's not really consequential, since both parties are generally making money. The banks are investing in some kind of security, and the depositor reaps interest. :P

In principle it is possible that consumers would accept some low chance of a bank run in exchange for higher interest or something.

Depends on what kind of investor you are, I guess. But, even if you're the kind of guy who only trades in debt securities, you would probably assume that the threat of a sudden bank run (as well as not being able to get to the bank in time if such were to occur) is so low that you may as well write the risk off as negligible. You would have to be unbelievably risk-averse otherwise.

Well the threat of a bank run and no hope of a bailout might introduce some sort of indefinitely stable fractional reserve banking. I doubt it though.

Actually, I don't think those pressures will result in a full-reserve system. The threat of a bank run, realistically, is very low. I do agree that taking away the promise of bailouts will do something to the way bankers play with money, though. Still, I think that the immense profitability of using deposits to make external investments is going to drive banks to fractional-reserve. The only catch is that, as a result of increased risk, the reserve requirement will likely be much higher than normal, likely with surplus reserve on top of that (usually the case with smaller banks).

But the expected value to consumers would always be the same so that they would break even. There's no free money to be had...I don't really envision there being a demand for this kind of arrangement.

I'm not really sure what you mean by this.

If they loan some of their deposits out, a bank run becomes more likely, and you have a chance at losing money. In order to get you to accept this deal, the bank has to give you something in return.

The increased risk of a bank run is fairly negligible though, especially when you don't have really bad state-sponsored policies distorting the way the financial system operates, and the way risk is distributed.

Maybe they pay you more interest on your account to make up or the risk. But the amount you are compensated is proportional to the risk you take on. So you're not really (on average) gaining anything.

If you're a bank, you're definitely gaining something. If you're a depositor, your statement only holds true insofar that A) risk is taken into consideration (which is something that a lot of people just aren't going to care enough to do), and B) risk is reified. If you count in terms of units of compensation and "units of risk", and set the ratio of value to 1:1, then, yes, you're not really gaining anything by increasing returns in proportion to risk; however, if you put it on a time scale, and place greater subjective value on returns (with investing meaning you're willing to count the risk as a nonvalue up to a certain point), then you're definitely gaining more by allowing a bank to invest your deposit. It's just a matter of A) how much risk you're willing to take, and B) the aggregate demand for significant return without huge regard for the risk involved.

That's why I don't think we'll see FRBs. Even if there were a demand for risk, there is a whole bloody market that provides it - see casinos.

It's not even necessarily that there is a demand for risk--it's more that casual people tend to just search out banks promising the highest interest rates without really caring what happens to their money in the meantime. Professional investors might look to trading straight into equities, options, futures, etc., but anyone wanting to just bank their money and make a little interest off of it is going to put it in the bank without caring much whether the bank loans it out. Given that the bank can make a pretty hefty profit off of this, there seems to be no reason to believe that fractional-reserve won't remain in place, even if banks set the bar higher for what a safe and desirable reserve requirement is.
Reasoning
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4/7/2011 7:33:15 PM
Posted: 5 years ago
At 4/7/2011 4:49:59 PM, Sieben wrote:
A bank is just a warehouse for money.

Umm, no. A bank is an institution that takes deposits and makes loans.
"What we really ought to ask the liberal, before we even begin addressing his agenda, is this: In what kind of society would he be a conservative?" - Joseph Sobran
Reasoning
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4/7/2011 7:34:17 PM
Posted: 5 years ago
If you just want safe storage of your money there are these things called safe deposit boxes. You could just put a wad of cash in one of those. The reason people don't do that is that they don't just want a warehouse.
"What we really ought to ask the liberal, before we even begin addressing his agenda, is this: In what kind of society would he be a conservative?" - Joseph Sobran
djsherin
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4/7/2011 7:42:37 PM
Posted: 5 years ago
At 4/7/2011 7:33:15 PM, Reasoning wrote:
At 4/7/2011 4:49:59 PM, Sieben wrote:
A bank is just a warehouse for money.

Umm, no. A bank is an institution that takes deposits and makes loans.

Historically, deposit banking wasn't always associated with loan banking.
Reasoning
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4/7/2011 7:45:37 PM
Posted: 5 years ago
At 4/7/2011 7:42:37 PM, djsherin wrote:
At 4/7/2011 7:33:15 PM, Reasoning wrote:
At 4/7/2011 4:49:59 PM, Sieben wrote:
A bank is just a warehouse for money.

Umm, no. A bank is an institution that takes deposits and makes loans.

Historically, deposit banking wasn't always associated with loan banking.

Historically name me one bank, that called itself a bank, that operated under full reserves.

The only one that comes to mind is Gringotts and that's not even a real bank.
"What we really ought to ask the liberal, before we even begin addressing his agenda, is this: In what kind of society would he be a conservative?" - Joseph Sobran
djsherin
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4/7/2011 7:49:35 PM
Posted: 5 years ago
At 4/7/2011 7:45:37 PM, Reasoning wrote:
At 4/7/2011 7:42:37 PM, djsherin wrote:
At 4/7/2011 7:33:15 PM, Reasoning wrote:
At 4/7/2011 4:49:59 PM, Sieben wrote:
A bank is just a warehouse for money.

Umm, no. A bank is an institution that takes deposits and makes loans.

Historically, deposit banking wasn't always associated with loan banking.

Historically name me one bank, that called itself a bank, that operated under full reserves.

The Bank of Amsterdam.

The only one that comes to mind is Gringotts and that's not even a real bank.
Reasoning
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4/7/2011 7:58:50 PM
Posted: 5 years ago
At 4/7/2011 7:49:35 PM, djsherin wrote:
At 4/7/2011 7:45:37 PM, Reasoning wrote:
At 4/7/2011 7:42:37 PM, djsherin wrote:
At 4/7/2011 7:33:15 PM, Reasoning wrote:
At 4/7/2011 4:49:59 PM, Sieben wrote:
A bank is just a warehouse for money.

Umm, no. A bank is an institution that takes deposits and makes loans.

Historically, deposit banking wasn't always associated with loan banking.

Historically name me one bank, that called itself a bank, that operated under full reserves.

The Bank of Amsterdam.

Mmm, ok. You got me.
"What we really ought to ask the liberal, before we even begin addressing his agenda, is this: In what kind of society would he be a conservative?" - Joseph Sobran
Reasoning
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4/7/2011 8:17:59 PM
Posted: 5 years ago
Selgin says that "The Bank of Amsterdam had 100% reserves only for a few years before going (mildly) fractional."
"What we really ought to ask the liberal, before we even begin addressing his agenda, is this: In what kind of society would he be a conservative?" - Joseph Sobran
TheAtheistAllegiance
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4/7/2011 9:37:08 PM
Posted: 5 years ago
At 4/7/2011 4:49:47 PM, Cody_Franklin wrote:
At 4/7/2011 3:53:24 PM, TheAtheistAllegiance wrote:

Without Federal Reserve monetary policy, banks would probably be less able to get their hands on such cheap capital. However, when the good times are rolling, it can still get pretty cheap, and banks might tend to become over-reliant on money markets, rather than full reserves.

Meaning what?

Not much; I'm just considering the factors that might influence banking in a free market. Basically, banks might be prompted to rely on money markets when times are good and capital is cheap, rather than maintain full reserves, even if the Fed isn't making money REALLY cheap.

Doesn't the FDIC protect only depositor funds?

That is one of its functions.

Well, does it really do anything significant in order to protect banks? I think the agency is (almost) solely focused on consumer protection.

Also, aren't most banks' loans (not including GSE's) not guaranteed by the government?

That sort of depends on the degree of regulation. During the whole housing business, for example, you have the Fed adjusting rates to artificially low levels and the government (in one way or another) willing to absorb much of the risk that banks were taking on. State agents wanted to stimulate spending because of the presupposition that the only way to offset economic turmoil is higher consumer confidence, which in turn produced government policies designed to get banks lending to people who would not have gotten loans under normal circumstances. If things went bad, the government would simply buy back those bad assets so that banks felt safe in making really weird financial decisions. In either case, the banks knew they would make money (the fact of bailouts and other subsidies notwithstanding).

Well, HUD-influenced banks only accounted for a small fraction of the sub-prime mortgage market, and Fannie and Freddie were the only ones issuing loans that were guaranteed, while other banks basically hedged sub-prime risk with OTC's. The housing boom began before the Fed even lowered rates, so I'm thinking that this sort of financial over-leveraging could (mostly) take place under certain market circumstances, even without the presence of governmental manipulation.

Many banks that weren't tied to the government were issuing crazy loans during the housing boom, and the same could happen under market circumstances -- it's simply investment mania, unrealistic expectations, etc.

Define "tied to the government". Because, if the legal-financial structure applies to everyone, it's impossible not to be tied up in the state one way or the other.

I'm mostly referring to banks that issued guaranteed loans, or expected those loans to be purchased by Fannie and Freddie.

And I don't disagree that banks could be idiots in a free society, either. The market doesn't promise that you'll experience constant prosperity with no sour periods. Any economist who promises you that is an idiot. What the free market promises is only causality. The current state of economic affairs, in other words, would simply be a consequence of antecedent conditions. If a lot of banks (and their investors/depositors/etc) are making really shoddy decisions regarding where their money goes, the consequences will likely be pretty dire. This is why any Austrian will tell you that people are right when they say turning to a free market now would result in economic chaos--it's because of the way that we've been trying to drug up the economy, so to speak. We've been delaying the consequences for so long that the results of our actions, when they come (and I do mean when, as opposed to if) will be pretty awful.

No argument here.

Heck, they could just hedge all of their risk with derivatives, and when the business cycle goes into downturn, they would simply expect to collect their return from AIG or someone else.

Without a lot of the safeguards which currently exist, trying to hedge your bets doesn't really solve the more fundamental problem that you're not guaranteed success under all scenarios.

Sure, there could be more prudence; I just doubt that banks would implement full reserve requirements in a free market.

Well, I'm thinking that banks would issue beyond their reserves because they don't want to pass up profit opportunities.

Businesses don't just do things because profit is a possibility. Banks are especially careful, because they operate in one of the most volatile industries in existence. Currently, they can basically loan out massive amounts past their reserve because of their ability to borrow from the money market--usually, this means smaller banks who have surpluses or straight from the Fed, which can just use its powers of carte blanche to add new reserves). There may also be the added influence of financial safeguards, like government agencies/corporations willing to buy time bombs that banks stumble into (e.g. CDOs populated almost entirely by risky sub-prime mortgages financed by toxic loans, for example). The market doesn't prevent banks from doing that, sure--but it's probably going to punish them in the end for being idiots with their finances.

Well, you actually make a good point about how much the Fed contributes to the money markets, which wouldn't exist in a free market. And, without the other safeguards, increased prudence might be forced in some respects.

Okay, but I'm asking how full reserve banking would be achieved without it.

Like I noted earlier, I don't really oppose the principle of fractional-reserve, nor do I really see what advantage full-reserve offers other than being able to cover bank runs in times of depressively-low depositor confidence.

In other words, maybe I shouldn't be arguing this with you. Lol.

Yeah, that's true lol.
Sieben
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4/7/2011 10:27:31 PM
Posted: 5 years ago
At 4/7/2011 7:22:16 PM, Cody_Franklin wrote:

What?

You said a warehouse is usually just a place for a profitable producer to store stuff. Workers are profitable in that they earn money. They need a place to store money. A money warehouse is not out of the question.

I don't know if I would consider "letting them loan your money out" to be payment per se. It's not really consequential, since both parties are generally making money. The banks are investing in some kind of security, and the depositor reaps interest. :P

If you let them loan your money out, you are making a "payment" in that wealth is transferred from you to them. They get whatever profits from loaning the money, and you have to deal with the chance that your money may be lost.

Its kind of like how if someone let you keep their car in your garage, you could "pay" them by allowing them to use it.

Well the threat of a bank run and no hope of a bailout might introduce some sort of indefinitely stable fractional reserve banking. I doubt it though.

Actually, I don't think those pressures will result in a full-reserve system. The threat of a bank run, realistically, is very low. I do agree that taking away the promise of bailouts will do something to the way bankers play with money, though. Still, I think that the immense profitability of using deposits to make external investments is going to drive banks to fractional-reserve. The only catch is that, as a result of increased risk, the reserve requirement will likely be much higher than normal, likely with surplus reserve on top of that (usually the case with smaller banks).

I don't see why loaning out money is immensely profitable. You mean that there's a potential for high cash flow... Its a competitive environment for both depositors and banks. Arbitrage will tend to eliminate any profit opportunities rendering all possible combinations of reserve ratios equally lucrative. What's left is just people's risk preference.

But preference for risk is again just another arbitrage opportunity. It can be entirely and cleanly handled by the gambling industry. I think this stomps out demand for a variety of differently-fractioned reserve banks.

Kind of like how there aren't storage units that operate on fractional reserve. In principle its possible, but there's just no demand.

The increased risk of a bank run is fairly negligible though, especially when you don't have really bad state-sponsored policies distorting the way the financial system operates, and the way risk is distributed.

I don't know how negligible it is. I don't see the marketability of a 99.99999% reserve bank though.

If you're a bank, you're definitely gaining something. If you're a depositor, your statement only holds true insofar that A) risk is taken into consideration (which is something that a lot of people just aren't going to care enough to do), and B) risk is reified. If you count in terms of units of compensation and "units of risk", and set the ratio of value to 1:1, then, yes, you're not really gaining anything by increasing returns in proportion to risk; however, if you put it on a time scale, and place greater subjective value on returns (with investing meaning you're willing to count the risk as a nonvalue up to a certain point), then you're definitely gaining more by allowing a bank to invest your deposit. It's just a matter of A) how much risk you're willing to take, and B) the aggregate demand for significant return without huge regard for the risk involved.

So this falls under what I'm saying about the market for risk. I don't think it organically lends itself to the banking any more than other warehouse industries, barber shops, watermelons, etc.

It's not even necessarily that there is a demand for risk--it's more that casual people tend to just search out banks promising the highest interest rates without really caring what happens to their money in the meantime. Professional investors might look to trading straight into equities, options, futures, etc., but anyone wanting to just bank their money and make a little interest off of it is going to put it in the bank without caring much whether the bank loans it out. Given that the bank can make a pretty hefty profit off of this, there seems to be no reason to believe that fractional-reserve won't remain in place, even if banks set the bar higher for what a safe and desirable reserve requirement is.

The "people are stupid and will get robbed" argument. I don't think this applies to banking any more than any other industry.
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Cody_Franklin
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4/8/2011 7:43:12 AM
Posted: 5 years ago
At 4/7/2011 9:37:08 PM, TheAtheistAllegiance wrote:
At 4/7/2011 4:49:47 PM, Cody_Franklin wrote:
At 4/7/2011 3:53:24 PM, TheAtheistAllegiance wrote:

Without Federal Reserve monetary policy, banks would probably be less able to get their hands on such cheap capital. However, when the good times are rolling, it can still get pretty cheap, and banks might tend to become over-reliant on money markets, rather than full reserves.

Meaning what?

Not much; I'm just considering the factors that might influence banking in a free market. Basically, banks might be prompted to rely on money markets when times are good and capital is cheap, rather than maintain full reserves, even if the Fed isn't making money REALLY cheap.

Doesn't the FDIC protect only depositor funds?

That is one of its functions.

Well, does it really do anything significant in order to protect banks? I think the agency is (almost) solely focused on consumer protection.

Also, aren't most banks' loans (not including GSE's) not guaranteed by the government?

That sort of depends on the degree of regulation. During the whole housing business, for example, you have the Fed adjusting rates to artificially low levels and the government (in one way or another) willing to absorb much of the risk that banks were taking on. State agents wanted to stimulate spending because of the presupposition that the only way to offset economic turmoil is higher consumer confidence, which in turn produced government policies designed to get banks lending to people who would not have gotten loans under normal circumstances. If things went bad, the government would simply buy back those bad assets so that banks felt safe in making really weird financial decisions. In either case, the banks knew they would make money (the fact of bailouts and other subsidies notwithstanding).

Well, HUD-influenced banks only accounted for a small fraction of the sub-prime mortgage market, and Fannie and Freddie were the only ones issuing loans that were guaranteed, while other banks basically hedged sub-prime risk with OTC's. The housing boom began before the Fed even lowered rates, so I'm thinking that this sort of financial over-leveraging could (mostly) take place under certain market circumstances, even without the presence of governmental manipulation.

Many banks that weren't tied to the government were issuing crazy loans during the housing boom, and the same could happen under market circumstances -- it's simply investment mania, unrealistic expectations, etc.

Define "tied to the government". Because, if the legal-financial structure applies to everyone, it's impossible not to be tied up in the state one way or the other.

I'm mostly referring to banks that issued guaranteed loans, or expected those loans to be purchased by Fannie and Freddie.

And I don't disagree that banks could be idiots in a free society, either. The market doesn't promise that you'll experience constant prosperity with no sour periods. Any economist who promises you that is an idiot. What the free market promises is only causality. The current state of economic affairs, in other words, would simply be a consequence of antecedent conditions. If a lot of banks (and their investors/depositors/etc) are making really shoddy decisions regarding where their money goes, the consequences will likely be pretty dire. This is why any Austrian will tell you that people are right when they say turning to a free market now would result in economic chaos--it's because of the way that we've been trying to drug up the economy, so to speak. We've been delaying the consequences for so long that the results of our actions, when they come (and I do mean when, as opposed to if) will be pretty awful.

No argument here.

Heck, they could just hedge all of their risk with derivatives, and when the business cycle goes into downturn, they would simply expect to collect their return from AIG or someone else.

Without a lot of the safeguards which currently exist, trying to hedge your bets doesn't really solve the more fundamental problem that you're not guaranteed success under all scenarios.

Sure, there could be more prudence; I just doubt that banks would implement full reserve requirements in a free market.

Well, I'm thinking that banks would issue beyond their reserves because they don't want to pass up profit opportunities.

Businesses don't just do things because profit is a possibility. Banks are especially careful, because they operate in one of the most volatile industries in existence. Currently, they can basically loan out massive amounts past their reserve because of their ability to borrow from the money market--usually, this means smaller banks who have surpluses or straight from the Fed, which can just use its powers of carte blanche to add new reserves). There may also be the added influence of financial safeguards, like government agencies/corporations willing to buy time bombs that banks stumble into (e.g. CDOs populated almost entirely by risky sub-prime mortgages financed by toxic loans, for example). The market doesn't prevent banks from doing that, sure--but it's probably going to punish them in the end for being idiots with their finances.

Well, you actually make a good point about how much the Fed contributes to the money markets, which wouldn't exist in a free market. And, without the other safeguards, increased prudence might be forced in some respects.

Thank you. :)

Okay, but I'm asking how full reserve banking would be achieved without it.

Like I noted earlier, I don't really oppose the principle of fractional-reserve, nor do I really see what advantage full-reserve offers other than being able to cover bank runs in times of depressively-low depositor confidence.

In other words, maybe I shouldn't be arguing this with you. Lol.

Yeah, that's true lol.

I'm going to stop putting up a defense for the most part, because I'm not actually trying to defend full-reserve banking. In reality, what I think the free market would produce is a fractional-reserve system, but one whose reserve requirements are simply higher than they are now to offset the increase in risk that banks take by removing safeguards (not to mention that there would probably be more numerous banks to replace the huge state-backed groups which currently exist). I would be very surprised if full-reserve banks popped into existence.
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4/8/2011 8:16:37 AM
Posted: 5 years ago
At 4/7/2011 10:27:31 PM, Sieben wrote:
At 4/7/2011 7:22:16 PM, Cody_Franklin wrote:

What?

You said a warehouse is usually just a place for a profitable producer to store stuff. Workers are profitable in that they earn money. They need a place to store money. A money warehouse is not out of the question.

Oh, okay. The connection wasn't immediately clear, I guess. Still, I don't think that setting up a more warehouse-ish system is really in the interest of most banks, especially since, on a free market, there will likely be far more banks than currently exist. Making money by requiring payment from depositors is a way to perhaps turn a profit, but that's nowhere near as profitable as also practicing fractional-reserve (which isn't really that risky overall unless you're basically loaning out all your money and taking loans from banks with surpluses to meet your reserve requirement while there's a depression going on).

I don't know if I would consider "letting them loan your money out" to be payment per se. It's not really consequential, since both parties are generally making money. The banks are investing in some kind of security, and the depositor reaps interest. :P

If you let them loan your money out, you are making a "payment" in that wealth is transferred from you to them.

I don't know about that. Most people who put their money into banks put into easily accessible accounts. This means that they're not transferring their wealth per se, because they can easily withdraw at any time. It's a transfer of a wealth only so far as to say that both parties cannot use the money simultaneously.

They get whatever profits from loaning the money, and you have to deal with the chance that your money may be lost.

You collect some of the profits too, in the form of interest. I do agree, however, that removing deposit insurance does introduce the risk of loss. I don't agree that the risk is as important as it seems, though. Most depositors don't really give a second thought to most of this stuff, and are hardly educated on banking and finance to the point where any of this would matter to them. They want to put their money away and earn interest--they find a bank with high rates, and voila.

Its kind of like how if someone let you keep their car in your garage, you could "pay" them by allowing them to use it.

Fair enough.

Well the threat of a bank run and no hope of a bailout might introduce some sort of indefinitely stable fractional reserve banking. I doubt it though.

Actually, I don't think those pressures will result in a full-reserve system. The threat of a bank run, realistically, is very low. I do agree that taking away the promise of bailouts will do something to the way bankers play with money, though. Still, I think that the immense profitability of using deposits to make external investments is going to drive banks to fractional-reserve. The only catch is that, as a result of increased risk, the reserve requirement will likely be much higher than normal, likely with surplus reserve on top of that (usually the case with smaller banks).

I don't see why loaning out money is immensely profitable. You mean that there's a potential for high cash flow... Its a competitive environment for both depositors and banks.

Loaning out money becomes really profitable depending on what you loan it into, and the volume which you're loaning out. If I loan you ten dollars and expect a dime's interest every day, I'm probably not going to make all that much. But, if I'm loaning out millions (or billions, as the case may be), I'm going to make a much larger return. In truth, I'm not too clear on the full list of everything that banks do with their money. They can loan it out for investments, to other banks, they can use it for massive leveraging (which often comes from money other banks loan out), and so on. It just isn't all that profitable to keep a 100% reserve as opposed to a fractional-reserve + whatever you may choose to do with the rest.

Arbitrage will tend to eliminate any profit opportunities rendering all possible combinations of reserve ratios equally lucrative. What's left is just people's risk preference.

How is that the case? Can I get an example of what you mean?

But preference for risk is again just another arbitrage opportunity. It can be entirely and cleanly handled by the gambling industry. I think this stomps out demand for a variety of differently-fractioned reserve banks.

I think there are two problems with this way of thinking, though:

1. You're assuming too much about the gambling industry. Yeah, it provides risk and the promise of reward; however, this isn't going to absorb everything because people demand profit, not risk. If what you say is true, people would never invest on a free market either, since the gambling industry allows for as much risk as you want. Risk, however, is only a secondary negative concern which has to be balanced with the profit one hopes or expect to turn from an investment. Sure, some people go to casinos just for the thrill of gambling, but that's not the only reason that people invest.

2. Even so, the whole previous paragraph could be considered pointless, because you're tampering with the causality. It's not that depositors demand risk, therefore banks practice fractional-reserve. Banks realize that this sort of banking leads to profit without a lot of risk, so they engage in it. Usually, depositors aren't really educated enough about finance to know or care, and those that are educated generally don't find that it's all that risky barring a massive depression. They're going to put their money in and collect interest, and the bank is going to practice fractional-reserve. This is one case in which consumer demand doesn't drive business strategy--the two groups are like two trains passing in the night. The depositors' only role in this is enabling the bank to practice that sort of banking.

Kind of like how there aren't storage units that operate on fractional reserve. In principle its possible, but there's just no demand.

Well yeah, but that's because money is a lot more fluid, abundant, easy to transfer/work with, not to mention useful in operating on fractional-reserve than, say, a storage unit full of antiques.

The increased risk of a bank run is fairly negligible though, especially when you don't have really bad state-sponsored policies distorting the way the financial system operates, and the way risk is distributed.

I don't know how negligible it is. I don't see the marketability of a 99.99999% reserve bank though.

First, I'd say it's pretty negligible. For those who are educated, it's easy to recognize that the potential for massive failure and widespread depression and runs isn't really that large unless everyone in the market is screwing around.

Second, I don't understand why you recourse to a bank whose fractional-reserve is 99.99999%. That's obviously unrealistic. If you're going to use .00001% for investment, you may as well not bother. When I say that market forces will drive desirable reserve requirements higher, you and I both know that I'm not talking up to a hundred-thousandth of a percent.
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4/8/2011 8:21:36 AM
Posted: 5 years ago
At 4/7/2011 10:27:31 PM, Sieben wrote:
At 4/7/2011 7:22:16 PM, Cody_Franklin wrote:
If you're a bank, you're definitely gaining something. If you're a depositor, your statement only holds true insofar that A) risk is taken into consideration (which is something that a lot of people just aren't going to care enough to do), and B) risk is reified. If you count in terms of units of compensation and "units of risk", and set the ratio of value to 1:1, then, yes, you're not really gaining anything by increasing returns in proportion to risk; however, if you put it on a time scale, and place greater subjective value on returns (with investing meaning you're willing to count the risk as a nonvalue up to a certain point), then you're definitely gaining more by allowing a bank to invest your deposit. It's just a matter of A) how much risk you're willing to take, and B) the aggregate demand for significant return without huge regard for the risk involved.

So this falls under what I'm saying about the market for risk. I don't think it organically lends itself to the banking any more than other warehouse industries, barber shops, watermelons, etc.

I think it does because it's money. You're not going to hand out books, watermelons, or haircuts to other banks, or to investors, or to mortgage lenders. You clearly can't manipulate those markets in the same way that you can manipulate the world of finance.

It's not even necessarily that there is a demand for risk--it's more that casual people tend to just search out banks promising the highest interest rates without really caring what happens to their money in the meantime. Professional investors might look to trading straight into equities, options, futures, etc., but anyone wanting to just bank their money and make a little interest off of it is going to put it in the bank without caring much whether the bank loans it out. Given that the bank can make a pretty hefty profit off of this, there seems to be no reason to believe that fractional-reserve won't remain in place, even if banks set the bar higher for what a safe and desirable reserve requirement is.

The "people are stupid and will get robbed" argument. I don't think this applies to banking any more than any other industry.

Actually, it's not "people are stupid and will get robbed". They're not getting robbed, because banks aren't outright stealing their funds. And it's not even necessarily that they're incompetent. Usually, they're just lazy, want good interest rates, and will store their money there. Banks, seeing an opportunity, will lend it out, or maybe buy massive amounts of debt securities, collateralize them, and sell them out. Who knows? Like I said before, the two groups are more like two trains passing in the night.
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4/8/2011 9:28:46 AM
Posted: 5 years ago
At 4/8/2011 8:16:37 AM, Cody_Franklin wrote:

Oh, okay. The connection wasn't immediately clear, I guess. Still, I don't think that setting up a more warehouse-ish system is really in the interest of most banks, especially since, on a free market, there will likely be far more banks than currently exist. Making money by requiring payment from depositors is a way to perhaps turn a profit, but that's nowhere near as profitable as also practicing fractional-reserve (which isn't really that risky overall unless you're basically loaning out all your money and taking loans from banks with surpluses to meet your reserve requirement while there's a depression going on).

Higher cash flow =/= profitable.

I don't know about that. Most people who put their money into banks put into easily accessible accounts. This means that they're not transferring their wealth per se, because they can easily withdraw at any time. It's a transfer of a wealth only so far as to say that both parties cannot use the money simultaneously.

They think they can withdraw it at any time. They're wrong. There's a chance they won't be able to.

They get whatever profits from loaning the money, and you have to deal with the chance that your money may be lost.

You collect some of the profits too, in the form of interest. I do agree, however, that removing deposit insurance does introduce the risk of loss. I don't agree that the risk is as important as it seems, though. Most depositors don't really give a second thought to most of this stuff, and are hardly educated on banking and finance to the point where any of this would matter to them. They want to put their money away and earn interest--they find a bank with high rates, and voila.

Are you really relying on the "people are stupid" argument?

I don't see why loaning out money is immensely profitable. You mean that there's a potential for high cash flow... Its a competitive environment for both depositors and banks.

Loaning out money becomes really profitable depending on what you loan it into, and the volume which you're loaning out. If I loan you ten dollars and expect a dime's interest every day, I'm probably not going to make all that much. But, if I'm loaning out millions (or billions, as the case may be), I'm going to make a much larger return. In truth, I'm not too clear on the full list of everything that banks do with their money. They can loan it out for investments, to other banks, they can use it for massive leveraging (which often comes from money other banks loan out), and so on. It just isn't all that profitable to keep a 100% reserve as opposed to a fractional-reserve + whatever you may choose to do with the rest.

You didn't answer what I said at all. This is a competitive environment for both banks AND consumers. Fractional reserve banks would compete and wind up paying a lot of interest for the privilege of lending out money. The higher cash flow would not automatically translate into higher profits because profits = revenue - costs.

Arbitrage will tend to eliminate any profit opportunities rendering all possible combinations of reserve ratios equally lucrative. What's left is just people's risk preference.

How is that the case? Can I get an example of what you mean?

So if banks want to operate on 30% reserve ratio, they are competing for consumers. In order to attract consumers, they offer higher interest rates on deposits up until their profit margins are zero. So banks have no incentive to try to seek lower reserve ratios.

Consumers are similarly competitive, with the prospect of increase/decreased saving putting a lid on depositor advantage.

1. You're assuming too much about the gambling industry. Yeah, it provides risk and the promise of reward; however, this isn't going to absorb everything because people demand profit, not risk. If what you say is true, people would never invest on a free market either, since the gambling industry allows for as much risk as you want. Risk, however, is only a secondary negative concern which has to be balanced with the profit one hopes or expect to turn from an investment. Sure, some people go to casinos just for the thrill of gambling, but that's not the only reason that people invest.

Okay. Financial markets also cater to risk. What I'm saying is that I don't expect to see any risk popping up in regular banking any more than any other regular consumer market.

Like walmart doesn't try to sell you egg cartons 2% off if there's a chance some of the eggs will be missing. You just don't risk making its way into other industries because of consumer demand.

2. Even so, the whole previous paragraph could be considered pointless, because you're tampering with the causality. It's not that depositors demand risk, therefore banks practice fractional-reserve. Banks realize that this sort of banking leads to profit without a lot of risk, so they engage in it. Usually, depositors aren't really educated enough about finance to know or care, and those that are educated generally don't find that it's all that risky barring a massive depression. They're going to put their money in and collect interest, and the bank is going to practice fractional-reserve. This is one case in which consumer demand doesn't drive business strategy--the two groups are like two trains passing in the night. The depositors' only role in this is enabling the bank to practice that sort of banking.

The idea is that even if consumers dont understand the mechanics of FRB, they are still shopping for stability. Knowing this, banks might advertise "your money on demand guaranteed". Now banks making this promise might think they can get away with going on fractional reserve, but it's not a stable business model. I see it being easy bait for competitors who just point out that its a FRB engaging in fraud. I don't see it being able to persist.

Well yeah, but that's because money is a lot more fluid, abundant, easy to transfer/work with, not to mention useful in operating on fractional-reserve than, say, a storage unit full of antiques.

What about grain markets? Oil reserves? Corporate stock? Those are not traded on fractional reserve.

First, I'd say it's pretty negligible. For those who are educated, it's easy to recognize that the potential for massive failure and widespread depression and runs isn't really that large unless everyone in the market is screwing around.

Everyone in the market CAN be screwing around.

Second, I don't understand why you recourse to a bank whose fractional-reserve is 99.99999%. That's obviously unrealistic. If you're going to use .00001% for investment, you may as well not bother. When I say that market forces will drive desirable reserve requirements higher, you and I both know that I'm not talking up to a hundred-thousandth of a percent.

I know. I'm just saying that "negligible" is a fuzzy word. You mean something like 10%?

Let's do some math. 10% reserve ratio earning 10% real profit per year will yield a 1% return on deposits. That would not be super competitive in the face of regular financial groups. A 50% reserve ratio would yield a 5% return on deposits, which is a little better, but that's probably way more leveraged than you were imagining.
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