Insight: I used to think lending at interest was evil...

[terrytibbs]

The OP was about banks.  Maybe you should read it?

It relates to banks, because it talks about fractional reserve lending, but its primary focus is not banks.

Bailouts or regulatory problems have little to do with lending itself.

[Meni Rosenfeld]

The OP was about banks.  Maybe you should read it?

I was searching for how late in the post the word "bank" is first mentioned, and realized it doesn't appear in it at all. The post is about lending.

[molecular]

Meni, thanks for your answer, got some comments...

Taking a systemic view (nodes of a graph containing money with edges representing debt), lending at interest must over time concentrate the currency in the hands of a few (essentially one node in the end). I deducted: The rich will get richer, the poor will get poorer

Why must it be the rich that lend to the poor? Rich people borrow funds all the time for their ventures, which ultimately come from the public.

It doesn't have to be the rich that do the lending, but in the naive view I held back then (forgetting the lender was also spending), the lenders would perpetually grow richer and if they had been poor to begin with, they would become rich over time. With lending continuing the money would keep flowing towards the "already richer" nodes, because they can/will do more lending and therefore receive more interest, until in the end, all currency is concentrated at a single node. This might also answer your later question why I considered lending at interest to be evil: all money in the hands of one (even as a tendency) just had to be unethical in some way.

Also, even if the rich do lend to the poor, the net effect needn't be that money flows from the poor to the rich. Rich person lends to poor(er) person; poor person starts a business; business makes product; rich person buys product, moving funds from the rich to the poor, possibly more than the interest paid.

Yes, I ignored any other money flows in my naive view, which I retired.

Since fractional reserve lending is not possible with bitcoin

What do you mean by this? All the big lenders in this forum are fractional reserve, they take deposits, keep a small fraction in reserve, and lend out the rest to create a return on investment.

Fractional reserve banking, where people deposit funds for reasons other than receiving interest, and the bank does not keep it in full reserve, is obviously also possible with Bitcoin. It's just less likely to be common, because with Bitcoin there's not much need for a bank anyway.

I stand corrected. After reading the wiki article on frb and bitcoin (https://en.bitcoin.it/wiki/Fractional_Reserve_Banking_and_Bitcoin) I agree with you. Thanks for the kick. I will correct my original post to read "Since with bitcoin there is certainly no lender of last resort who can just print up more money, bitcoin-based lending/borrowing is not evil." and agree with Vitalik:

And that's why I point to what I think is the highest evil in the modern monetary system: unnatural collapse prevention financed on everyone else's backs.

[molecular]

The OP was about banks.  Maybe you should read it?

It relates to banks, because it talks about fractional reserve lending, but its primary focus is not banks.

Bailouts or regulatory problems have little to do with lending itself.

The existance of bailouts makes lending at interest unethical for the lenders potentially profiting from these bailouts (socialize the risks).

[Meni Rosenfeld]

Meni, thanks for your answer, got some comments...

Taking a systemic view (nodes of a graph containing money with edges representing debt), lending at interest must over time concentrate the currency in the hands of a few (essentially one node in the end). I deducted: The rich will get richer, the poor will get poorer

Why must it be the rich that lend to the poor? Rich people borrow funds all the time for their ventures, which ultimately come from the public.

It doesn't have to be the rich that do the lending, but in the naive view I held back then (forgetting the lender was also spending), the lenders would perpetually grow richer and if they had been poor to begin with, they would become rich over time. With lending continuing the money would keep flowing towards the "already richer" nodes, because they can/will do more lending and therefore receive more interest, until in the end, all currency is concentrated at a single node. This might also answer your later question why I considered lending at interest to be evil: all money in the hands of one (even as a tendency) just had to be unethical in some way.

Also, even if the rich do lend to the poor, the net effect needn't be that money flows from the poor to the rich. Rich person lends to poor(er) person; poor person starts a business; business makes product; rich person buys product, moving funds from the rich to the poor, possibly more than the interest paid.

Yes, I ignored any other money flows in my naive view, which I retired.

Cool, I know this was a view you no longer hold, but it just seemed that maybe you still hadn't shaken all of the flaws with it.

[Explodicle]

The OP was about banks.  Maybe you should read it?

I was searching for how late in the post the word "bank" is first mentioned, and realized it doesn't appear in it at all. The post is about lending.

Well, for other reasons: Mainly because these "rich" are able to lend out money they don't even have in the first place, and maybe more importantly because they are being bailed out every time a borrower has problems.

He didn't literally say "bank" but I don't know of any other rich entity that gets bailed out in the way described.

Don't get me wrong, I understand what you're saying; it is POSSIBLE to ethically lend fiat at low or no interest without accepting bailouts. But in a market where some participants get bailed out, those who don't accept bailouts will be unable to compete. You would either
* Charge customers enough to stay afloat and your rates are higher than big banks - everyone borrows from them instead
* Charge customers the same rates as big banks - your investors pull out in favor of safer options like the big banks

[ElectricBrain]

The OP was about banks.  Maybe you should read it?

It relates to banks, because it talks about fractional reserve lending, but its primary focus is not banks.

Bailouts or regulatory problems have little to do with lending itself.

I think you're fixating on him, fixating on banks. He's on topic, OP's realization is the flawed system of "risks" that can be written off at the cost of everyone.

[lonelyminer (Peter Šurda)]

What do you mean by this? All the big lenders in this forum are fractional reserve, they take deposits, keep a small fraction in reserve, and lend out the rest to create a return on investment.

I personally would only call it fractional reserve banking if it involved maturity mismatching. If the deposits are not payable on demand, for example, that would be an indication it might not be FRB, but loan banking.

Fractional reserve banking, where people deposit funds for reasons other than receiving interest, and the bank does not keep it in full reserve, is obviously also possible with Bitcoin. It's just less likely to be common, because with Bitcoin there's not much need for a bank anyway.

Based on what I read, what happened historically was that bringing together lenders and borrowers (loan banking) and keeping deposits were two different services, done by different businesses. Once the deposit keepers noticed that people use the deposit certificates as a medium of exchange, they expanded their business. They started to overissue. This allowed them to also act as lenders, and thus FRB was born.

[Meni Rosenfeld]

What do you mean by this? All the big lenders in this forum are fractional reserve, they take deposits, keep a small fraction in reserve, and lend out the rest to create a return on investment.

I personally would only call it fractional reserve banking if it involved maturity mismatching. If the deposits are not payable on demand, for example, that would be an indication it might not be FRB, but loan banking.

Generally the deposits are payable on demand, up to a few days.

[lonelyminer (Peter Šurda)]

Generally the deposits are payable on demand, up to a few days.

This is where it gets a bit fuzzy. In the monetary system we live in, I lean slightly towards not classifying "a few days" as on demand, but it's unclear. I suppose this could technically be called fractional reserve banking, even though without the deposits being accepted as a medium of exchange, it would not be "FRB as we know it".

[Boussac]

Fiat money lending is not a business because it involves money creation. Today its under regulatory capture by a cartel of banks organized around a monopolistic monetary system.

The "default" risk supposedly borne by the bankers is a joke when in fact they create money out of thin air by issuing credit. How can you lose something you don't own in the first place ? Bankers charge insurance premium on top of their interest rates so the borrowers pay twice (that's how it works for mortgages in Europe for instance).

Time value of money ? Another joke if bankers can create money out of thin air unless thin air is more valuable today than tomorrow (I know most bankers will argue for that with a straight face).

Bitcoin is a game changer because 1/unlike elastic money it does not facilitate FRB 2/ banking is no longer reserved to a cartel

[finkleshnorts]

Fiat money lending is not a business because it involves money creation. Today its under regulatory capture by a cartel of banks organized around a monopolistic monetary system.

The "default" risk supposedly borne by the bankers is a joke when in fact they create money out of thin air by issuing credit. How can you lose something you don't own in the first place ? Bankers charge insurance premium on top of their interest rates so the borrowers pay twice (that's how it works for mortgages in Europe for instance).

Time value of money ? Another joke if bankers can create money out of thin air unless thin air is more valuable today than tomorrow (I know most bankers will argue for that with a straight face).

Bitcoin is a game changer because 1/unlike elastic money it does not facilitate FRB 2/ banking is no longer reserved to a cartel

bingo.

[proudhon]

How I used to think about lending at interest:

Taking a systemic view (nodes of a graph containing money with edges representing debt), lending at interest must over time concentrate the currency in the hands of a few (essentially one node in the end). I deducted: The rich will get richer, the poor will get poorer and concluded: lending at interest is evil.

I deemed this view of mine validated by observing the rich actually becoming richer and the poor becoming ever poorer.

What I overlooked:

There's risk involved in lending, namely the risk of the borrower defaulting. Therefore above does not necessarily hold true, but why does it still seem to be true?

Why is it still true (that the rich get richer)?

Well, for other reasons: Mainly because these "rich" are able to lend out money they don't even have in the first place, and maybe more importantly because they are being bailed out every time a borrower has problems.

Also because at least some of them are in the business of just simply ripping people off and are able to get away with it somehow.

What I think now:

Fractional reserve lending with a lender of last resort that will bail lenders out at the expense of all other parties using the currency in question is evil.

And: stealing peoples money/assets is evil.

What I'm getting at:

Since fractional reserve lending is not possible with bitcoin and there is certainly no lender of last resort who can just print up more money, bitcoin-based lending/borrowing is not evil.

The lender is exposed to the risk: in case of default he is parted of his money, he can't be a cry-baby but has to take it like a man and just suck it up.

In a "good money"-based economy, the market will adjust the price of money (interest rate) such that lending is barely profitable and will reflect market participants needs.

any comments/corrections?

EDIT: added some strikethrough after realizing frb was possible with bitcoin.

Interestingly, over the past year and a half or so I've gone through a nearly identical change.  Very cool.

[molecular]

Interestingly, over the past year and a half or so I've gone through a nearly identical change.  Very cool.

Cool. Talking about changes in the last year and a half or so (since I found bitcoin, or the other way around): I've been educated by the bitcoin crowd on a lot of topics and it really changed my view in many areas. I have learned, among other things, about:

• money (functioning and history)
• libertarianism, anarcho-capitalism
• economics and functioning of markets, esp. austrian school
• the "greatest theft of a all times" and debt-slavery
• media and journalism
• politics, corporatism and the american empire
• human nature (greed, fear, trolling, trust, brainwashing, swarm behaviour,...)
• the importance of liberty, sound money and truly free markets

I want to hereby thank the many great and knowledgable minds in this community for helping me understand many things I only knew cloudy half-truths about before.

You guys are awesome!

[Roger_Murdock]

Fractional reserve banking, where people deposit funds for reasons other than receiving interest, and the bank does not keep it in full reserve, is obviously also possible with Bitcoin. It's just less likely to be common, because with Bitcoin there's not much need for a bank anyway.

That seems right.  Unless I'm missing something, there are two reasons that people hold fiat with banks today: (1) security (safer than keeping all of your money in cash in the house due to risk of burglary, fire, etc.) and (2) facilitation of digital / at-a-distance exchange (e.g., debit cards and online payments).  It's certainly not for the pathetic interest you're likely to earn on your deposit.  But a big part of the reason that banks are safer is because of government intervention, e.g. deposit insurance.  Nobody worries about a bank run anymore.  And that's why you allow the bank to lend out your deposit -- which is really a loan by you to the bank.  In an unregulated market, if your only interest was security (and you didn't want to expose yourself to the inherent risk of a fractional reserve-type institution), you'd rent a safe.  The safe storage place vs. lending aspects of banks have gotten lumped together but they don't have to be.  With Bitcoin, you don't need the security aspect.  It's relatively easy to secure your own wallet. And you also don't need to have an account with a third-party to facilitate digital / at-a-distance exchange.  That's what Bitcoin does!  So the only reason you'd have to lend your money to a bank-like institution operating on fractional reserve basis would be for the interest you could earn.  But your deposit (i.e. loan) won't be backed by federal deposit insurance so chances are you're going to demand a relatively high rate of return.  And even if we see a lot of those types of institutions spring up, it doesn't seem like they'll increase the money supply (at least not significantly).  From the wikipedia page on fractional reserve banking and bitcoin:

And so long as demand deposits are accepted as equivalent to standard money, they will function as part of the money supply. It is important to recognize that demand deposits are not automatically part of the money supply by virtue of their very existence; they continue as equivalent to money only so long as the subjective estimates of the sellers of goods on the market think that they are so equivalent and accept them as such in exchange.

Bitcoin is digital cash.  It seems to me that a Bitcoin demand deposit is very unlikely to be treated as the "equivalent" of cash (and thus add to the money supply) in the absence of government-guaranteed deposit insurance / "lender of last resort" interventions.  

Thoughts?

[Seal]

+1, I have to agree with you on the OP.

Learning about the banking industry gave me a great insight into how it can provide a great service if it is managed correctly. The perception of them being evil is in my mind due to a lack of understanding of how the banking system works.

I believe if FRB is explained clearly and governed correctly, there is no reason for anyone to worry about the service they offer:

• In order for a bank to lend, it has to hold deposits. To get deposits, it will offer its customers interest.
• To make money for its customers, the bank will lend some of the deposits out and charge interest on its loans.

Black and white right? Now let me explain in simple terms how everybody is a winner:

• A good bank will guarantee the safety of money that customers have deposited.
• A bank takes on risk when it lends as customers can 'default' and not pay back their loans.
• This is a well understood risk and a banks charge set their interest rates to make profits to cover potential losses.
• If all of the loans are paid back with interest, then the bank will have earned enough to pay its customers who have lent the bank money + more profit for themselves. This is a good thing as they have provided all parties with a good honest service.

And now how greed makes it all goes wrong:

• A good bank for safety will keep a set amount of depositors cash for security. This is called a 'Reserve Ratio' (sometimes Cash Reserve Ratio).
• It will not use this reserve to lend to others. The higher the bank's reserve, the safer it is deemed to be.
• Greed - For a depositor to make more money on what they lend, the bank needs to make more money.
• For the bank to make more money, it has to lend more.
• The more a bank lends, the lower the reserve will be.

Fear:

• If a negative world event happens, people worry and start withdrawing their savings.
• For immediate withdrawals, they can fulfil most requests using its cash reserves.
• If the fear spreads and everybody wants to withdraw their cash, problems will arise when the cash reserves it holds run out. (and this in the real world is where the GFC starts...)

Banking can be a good honest business as long they are careful. How can they be careful?

Well that is also simple. Ensure that you hold a high enough Cash Reserve Ratio and don't get greedy.

In the US, banking policy (enforced by the BASEL accords) states that your CRR should be around 10%. This is quite frankly ridiculous and was in my mind the sole root cause of the entire financial system collapsing.

Why on earth a bank would lend out $900,000 on $1,000,000 of deposits is stupid. Given that a bank's duty is to understand and manage risk, the risk of somebody defaulting on a payment has always been there and its not new.

Historically in the fiat market, the CRR used to be around 30% which created a robust banking system with plenty of monetary flow to ensure a healthy economy.

I would be fully behind any bitcoin bank who provides an honest deposit and lending service with a CRR of 50%. This should yield reasonable profit for all parties and will be very safe if managed well.

[molecular]

thanks for your cool post, Seal.

Banking can be a good honest business as long they are careful. How can they be careful?

Well that is also simple. Ensure that you hold a high enough Cash Reserve Ratio and don't get greedy.

How do you ensure they hold a high enough Cash Reserve Ratio and don't get greedy, though?

Well, that's also simple: by using fear (fear is stronger than greed): Remove lender of last resort bullshit and let the bank die in case it fucks up (no bailouts). Result: their depository customers (or their insurer) will demand higher reserve ratio (by fear of losing funds) and the bank will comply (by fear of death and competition).

Entities can act quite responsibly exactly if they know they will suffer the consequences of their actions. (meaning they will not act responsibly if they don't have to suffer consequences)

[herzmeister]

yup, then fear and panic caused the infamous bank runs and chaos (probably instigated).

Then the solution was presented, tadaaa: A central bank. The FED/EZB. It was meant to "regulate" the banks and the amount of money supply by being able to determine an authoritative key interest rate.

Today we know centralization is bad. It makes everything even worse. We have to go back and think of different solutions.

Guess a better solution would be some kind reinsurance system for banks against bank runs. Or they must take loans themselves from other banks in order to pay bank runners out. But what if there is a run on every bank? In my naive world view, every bank runner will be satisfied because most money is in circulation *somewhere*, it should be a zero sum game. Businesses that took loans use that money to pay their employees etc. There was never a need for creating money out of thin air by stretching balances.

[molecular]

yup, then fear and panic caused the infamous bank runs and chaos (probably instigated).

Then the solution was presented, tadaaa: A central bank. The FED/EZB. It was meant to "regulate" the banks and the amount of money supply by being able to determine an authoritative key interest rate.

Today we know centralization is bad. It makes everything even worse. We have to go back and think of different solutions.

Guess a better solution would be some kind reinsurance system for banks against bank runs. Or they must take loans themselves from other banks in order to pay bank runners out. But what if there is a run on every bank? In my naive world view, every bank runner will be satisfied because most money is in circulation *somewhere*, it should be a zero sum game. Businesses that took loans use that money to pay their employees etc. There was never a need for creating money out of thin air by stretching balances.

+1 on emphasis above. Let the banks figure out insurance themselves (it's part of their business) and let the market judge how well they do it (transparency).

Any problems with that approach?

[muyuu]

I think lending without sufficient collateral should be avoided at all cost.

The moment collateral doesn't suffice, you need to get the government and the legislative to intermediate in a private transaction. Should be a last resort and not a common occurrence.

If you don't have anything for collateral then I guess you should work your way up little by little without borrowing. I have never taken any loans whatsoever, and I have bought nothing on credit. I've given and received small-ish amounts of money from my family (particularly from my parents as I grew up, they paid for my food, shelter and education).

I really cannot see how cannot this work for anybody unless they're simply trying to punch above their weight.