Author Topic: Is Fractional Reserve Banking a Ponzi Scheme? [BLOG POST]  (Read 3267 times)

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Offline aaaxn

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Re: Is Fractional Reserve Banking a Ponzi Scheme? [BLOG POST]
« Reply #15 on: January 16, 2015, 09:56:20 pm »
Banks have assets to cover all their liabilities. Banks assets are for example mortgages, which can be sold on open market when bank needs liquidity. There are regulatory requirements that bank have to maintain some level of reserves, so basically deposits are always covered in more than 100%. Not so different than bitshares.

Of course there are times when bank assets are temporary illiquid or permanently loose value, but same thing can happen to collateral in bitshares.
« Last Edit: January 16, 2015, 09:59:23 pm by aaaxn »

Offline bytemaster

Re: Is Fractional Reserve Banking a Ponzi Scheme? [BLOG POST]
« Reply #16 on: January 16, 2015, 10:39:32 pm »
Banks have assets to cover all their liabilities. Banks assets are for example mortgages, which can be sold on open market when bank needs liquidity. There are regulatory requirements that bank have to maintain some level of reserves, so basically deposits are always covered in more than 100%. Not so different than bitshares.

Of course there are times when bank assets are temporary illiquid or permanently loose value, but same thing can happen to collateral in bitshares.

"Temporarily illiquid" is another word for "Temporarily insolvent".     

Everything can be sold at a "price" it just so happens that not everyone wants to "mark to market" and admit insolvency.   

If you owe someone $100,000 payable on demand and someone else owes you $100,000 payable over 30 years.    Then you are "insolvent" the moment they demand payment unless you can sell your 30 year bond for $100,000 to someone else "on demand". 

Now that $100,000 30 year bond might be backed by collateral, such as a house, that is worth $125,000.   Perhaps you have the right to seize collateral "on demand"... because of market conditions you cannot sell a house "on demand" even if you have clear title.  Thus you are insolvent.   

In any event, if there is a mismatch between the type of asset held and the type of liability then there must be a surplus of reserves sufficient to handle all price swings.  Thus if the value of a 30 year collateralized bond vs cash changes you can end up insolvent.   At this point in time the 30 year bond should be handed over to the person you owe "on demand" as part of bankruptcy settlement.

If you can find someone who is willing to lend you money then you are not "illiquid".  Your credit worthiness allows you to take on a 30 day "pay day loan" that allows you to meet your $100,000 payable on demand obligation.   

The key is this:  if a debtor is unable to pay when debts are due then they are insolvent period.    It doesn't matter that people owe him money or that he has property that could probably be sold.  If he cannot find someone to lend him the money he needs today based upon his property as collateral then he is insolvent. 

Lets take this a step further: if you use BTS as collateral for BitUSD then you are insolvent unless the collateral can actually be sold to realize the full value of the USD.   Hence, if I have $1000 BitUSD backed by $3000 worth of BTS then I can probably sell the BTS for $1000 without moving the market too much.   But if I have $1M worth of BitUSD I will probably need $3M or more worth of BTS at market price to realize $1M after all of the slippage.   

What this really means is that BitUSD is only worth a dollar in small quantities.   In large quantities BTS slippage will reduce the number of real dollars you can get for it unless you can cash out at a slow enough rate to minimize slippage.  As the market volume grows the situation gets better.

Bottom line, accountants like to offer "grace" when you are a high probability of being solvent "real soon", but the fact remains that you cannot pay your debts when they are due. 





 

 
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Offline aaaxn

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Re: Is Fractional Reserve Banking a Ponzi Scheme? [BLOG POST]
« Reply #17 on: January 16, 2015, 11:02:02 pm »
Banks have created very liquid secondary market for bonds, where they can instantly sell bonds to cover liquidity requirements. In fact much more liquid than bitassets are likely ever to be, because bonds are instruments with yield. BTS does not pay any yield as far as I know, so demand for it will always be smaller.
In any case there is far greater probability that you won't get your dollars back from bitusd than from well managed bank. If banks are ponzi then bitusd are even 'more ponzi' :).

Offline santaclause102

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Re: Is Fractional Reserve Banking a Ponzi Scheme? [BLOG POST]
« Reply #18 on: January 17, 2015, 10:51:06 pm »
Here is my feedback:

Insolvency is a very general word. I would suggest to either define it instrumentally (= saying "for this article I will assume that the word insolvency means ...") or always use more specific terms like "accounting insolvency" and "technical insolvency". See http://en.wikipedia.org/wiki/Insolvency

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It is in this situation that we consider the bank to have fractional reserves.
Isn't it that fractional reserves equal liabilities > assets? It at least sounds intuitive to me. But you said "It is in this situation" and the situation you described in the sentence before involves another condition besides the "liabilities > assets" condition.

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The bank will only be able to continue operation provided new depositors come in at a rate faster than withdraw requests, the classic characteristic of a Ponzi Scheme.
I would make extra clear here that this depends on BOTH conditions (liabilities > assets AND income < expenses). A reader that is convinced of the banking system would tend to oversee the necessary AND condition and then get the impression that you are wrong.

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If the new creditors were not aware of the financial condition of the company then that constitutes fraud.
This is at least inconsistent with how the word "fraud" is used: "Fraud is a deception deliberately practiced in order to secure unfair or unlawful gain". (http://en.wikipedia.org/wiki/Fraud)
How could we know the intentions of the bankers and how can we generalize their intention?

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In fact, I would argue that the easiest way to discover whether or not a system is a Ponzi Scheme is if all obligations can be met immediately when they are due.
Is "immediately" and "due" a contradiction here?
I would say that it is not true that "liabilities > assets" equals ponzi scheme. For it to be a "system determined to fail" it would in addition require that either expenses > income (net / over time) or that the system gives out "payable on demand IOUs". You described that above but reduced it here to just the "liabilities > assets" criterium. Here is an example: A company is also a system (if you don't agree I would suggest to define "system" more clearly) and it is not determined to fail just because its liabilities are greater than its assets.

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In other words, is the system solvent.
...needs a "?" behind "solvent".

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and a Ponzi Scheme is clearly fraud
fraud requires bad intent... Having the conclusion in mind that the banking system is determined to fail should not lead to using words like they normally are not used.

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We all know how the warehouse receipt game goes. Moving the debt instrument accounting from the internal database of the bank to a public transaction ledger does not change the risk or prevent the fraud that the banking system has been unable to prevent for hundreds of years.
This one I probably just don't understand: Since we are talking about warehouse receipts (like Bitreserve etc.), how is it possible to show their actual USD/gold/whatever deposits on a blockchain or is this not what you are saying here?

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There is another approach that technically avoids creating a Ponzi Scheme.
...added an "a".

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The price information that is used to trigger these margin calls is provided by over 50 independent sources elected by the shareholders which are implicitly trusted to be fair judges of the price.
Wouldn't it be worth adding here that the median is making up the price feed? Otherwise "judges of the price" sounds more susceptible to collusion than it is.

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It involves selling a crypto currency that you are not legally required to buy back at any price, but which you have established a proven history of doing so.
Shouldn't this say "buy back at a target price (for example 1 USD) per crypto currency unit at any time" also since in the next sentence you assume that the reader understands this mechanism?


My overall impression: Whether those articles (on general political, financial or economic issues) are a success with a wider audience, we will hopefully have later, hugely depends on whether it can be avoided that they are put in the same category of badly researched articles and videos that are just hating on the banking system and everything mainstream without making a concise argument. I think your article does make a concise argument and it nicely applies the arguments to crypto currencies. But there is the danger that many readers put it in the same category as described above because it suits their preexisting world view and the missing precision in many parts makes it easy for them to justify their perception of the article. This is especially true if it is regarded as more valuable to convince the unconvinced than confirm the world views of those that are critical of the banking system.

Even more general: Precision + implicitly making clear that one is aware of norms (in this context the norm to use words like they are normally used)  + conveying friendliness / goodwill + no over complication, makes it very hard to ignore an argument.
« Last Edit: January 18, 2015, 12:40:48 am by delulo »