24 January 2010
To: Bill Thomas - email@example.com
In response to your invitation to the member of the public to send questions that witnesses to the inquiry should answer, please find my questions below. The Background to these questions has been explained in detail in the evidence sent to the British Parliament House of Commons Treasury Committee that investigated the causes of the current Banking Crisis:
Further more detailed justification is on my blog:
"Financial crisis? It's a pyramid, stupid." - http://gregpytel.blogspot.com/
I trust my questions will be helpful with the Commission's work.
The current financial crisis began as a banking crisis called "credit crunch". Credit crunch was a shortage of liquidity, namely cash, i.e. one dollar real cash had to cover too many dollars of financial liabilities and there was insufficient volume of cash. A ratio how many dollars of liabilities on banks’ books one dollar cash has to cover is called Money Multiplier (MM).
With loan to deposit ratio (LTD) less than 100% Money Multiplier is constant for a constant LTD, and always finite (at the limit). I.e. if LTD = 0% then MM = 1, if LTD = 20% then MM = 1.25, if LTD = 50% then MM = 2, if LTD = 80% then MM = 5, if LTD = 90% then MM = 10, if LTD = 99% then MM = 100, if LTD = 99.9% then MM = 1000, and so on.
If LTD equals 100% then MM equals infinity at the limit, i.e. MM keeps growing without a limit linearly as a result of every multiple deposit creation cycle.
If LTD is greater than 100% then MM equals infinity at the limit, i.e. MM keeps growing without a limit exponentially (very fast) as a result of every multiple deposit creation cycle.
Therefore if LTD ratio is greater than (or equal) 100% in multiple deposit creation cycle then one dollar cash is expected to cover ever growing (technically infinite at the limit) number of dollars of liabilities on banks' balance sheets. In other words, Money Multiplier grows to infinity. In case of LTD ratio greater than 100%, it is an exponential, i.e. very fast, growth guaranteeing liquidity shortage in a finite time, i.e. the risk of credit crunch is 100%.
The exponential growth of Money Multiplier, MM, to infinity can be graphically represented and it looks like a pyramid.
Furthermore, if LTD ratio is less than 100%, the overall ratio of total loans to total deposits, on bank(s) balance sheets, gives an average LTD ratio and can be used as the reliable basis for calculating MM (for a banks, or a number of banks, or the financial system). If LTD is greater than (or equal) 100%, it is impossible to calculate a MM based on a ratio of total loans to total deposit.
The banks were using LTD ratio greater than 100% in the multiple deposit creation process (lending).
Questions to the financial executives (each of them):
Since lending with LTD ratio greater than 100% has been a standard banking practice:
1. Do you expect MM to be arbitrary high (potentially infinite) without causing a liquidity shortage (credit crunch)? The answer must be: "yes" or "no".
2. Two alternatives
2.1 If the answer is "yes", how do you expect one dollar cash to cover potentially infinite number of dollars of liabilities on the bank's balance sheets without causing liquidity shortage (credit crunch)?
2.2 If the answer is "no":
- can you advice on the maximum MM, what it should be (the answer must be a concrete figure: e.g. 5, 8, 10, 15, 20, 50, 100, etc)
- how do you expect the financial institutions to practically control and ensure that MM is never greater than that maximum.