Tuesday, May 25, 2010

Bank Reserves Are Phony

The United States has long required that banks keep 10 percent of their total assets in what we broadly call cash. This is usually fiat currency – i.e. paper money either physically at the bank or on reserve with the Federal Reserve. The purpose of this reserve is to guarantee the liquidity and safety of the banking system. Theoretically this will allow any bank to meet the demand to pay out liquidated deposits with cash. Sounds good enough I suppose, although 10 percent is not all that much,  But at least it is some safety margin right?

Wrong – in the mangled beanie baby swap meet which is the American economy most banks routinely meet their reserve requirements by borrowing money at the end of the day and then paying it back the next morning. In this manner, the Federal Reserve will consider that its reserve has been met and all is fine and dandy. They "rent" their security by the hour like hookers getting a room in a sleazy hotel.  Seems appropriate really.

In other words banks commonly do not actually have anywhere near 10 percent of assets in safe cash form. It is all another spun sugar fantasy like most of our finance system. If there was ever a serious run on the banks they would not be in any position to cover any the puny 10 percent reserve mandated by the Fed.

Oh and just to make you feel even better – the Fed waives reserves entirely for the really big money. Things like US corporate time deposits and all deposits made by foreign governments or overseas corporations. Additionally anything in a Eurocurrency deposit is also allowed to have zero reserve.

In other words in a serious financial panic our banks are no more secure than in the 1920s. This little update should take your mind off the destruction of the Gulf of Mexico and the abdication of national sovereignty to BP.  At least for a little while.

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