If you are new to this blog, you are invited to read first “The Largest Heist in History” which was accepted as evidence and published by the British Parliament, House of Commons, Treasury Committee.

"It is typically characterised by strong, compelling, logic. I loosely use the term 'pyramid selling' to describe the activities of the City but you explain in crystal clear terms why this is so." commented Dr Vincent Cable MP to the author.

This blog demonstrates that:

- the financial system was turned into a pyramid scheme in a technical, legal sense (not just proverbial);

- the current crisis was easily predictable (without any benefit of hindsight) by any competent financier, i.e. with rudimentary knowledge of mathematics, hence avoidable.

It is up to readers to draw their own conclusions. Whether this crisis is a result of a conspiracy to defraud taxpayers, or a massive negligence, or it is just a misfortune, or maybe a Swedish count, Axel Oxenstierna, was right when he said to his son in the 17th century: "Do you not know, my son, with how little wisdom the world is governed?".

Friday, 23 July 2010

The Economist on weed

In the last issue of The Economist an article "The banks on methadone" was published.

Its author wrote:

"All these banks are trying to lower the ratio of loans to customer deposits; sounder banks will be rewarded when a new banking levy comes into force next year. Lloyds Banking Group, for example, has a loans-to-deposit ratio of 169%, according to research by Nomura Securities. Barclays and RBS are at 130% and 134%, respectively."

It looks that, at long last, the banks acknowledged that lending with loan to deposit ratio greater than 100% was the cause of the crisis (or at very least that it is a huge problem). This was made clear in "The largest heist in history" written at the end of 2008, immediately after the crisis erupted. However the banks are not going to publicly acknowledged that but are trying quietly do the right thing: reduce this ratio. The snag is that it was not the ratio itself that hit with liquidity crunch but the ridiculously high money multiplier that directly resulted from lending with loan to deposit ratio greater than 100%. High money multiplier means that $1 (or £1, €1, i.e. cash, the legal tender, only real liquidity mean of settling liabilities) has to serve in the system a massive number of dollars (euros, pounds) of banks liabilities ($40, $100, $1,500, anyone's guess could be good as the control was lost by losing control over derivatives and shadow banking markets). This results in banks' assets turing to toxic waste as there is not enough cash in the system going around (due to high money multiplier) to settle the transactions.

Here is a banks' quagmire: continued any lending by banks even with a very low loan to deposit ratio (like 5% or 10%) still increases money multiplier (albeit at much slower rate), therefore exacerbating banks' liquidity position further. So the banks should not really lend at all. But if they do not lend at all the entire system would grind to a halt and the economy would collapse (most likely banks would not get any more of repayment of the loans). So we have a classic: "damn if you do, damn if you don't". So there is little wonder that the banks took all the money from the government but did not start lending again. If the politicians had a bit of intelligence (and basic knowledge of finance) they would have known it. They could not have expected banks to "repair" their balance sheets and lend money at the same time. These two things are contradictory. The point is that there are only two ways of reducing high money multiplier: inflate your way out (print money) or write off banks liabilities (or their combination). Both are not socially and politically acceptable (but a gradual inflating out is already happening).

The writer in The Economist continued:

"But the banks may be wrong to think that squeezing loans will improve these ratios; the Bank of England warned in June that growth in lending is usually the main driver of higher deposits."

It is a mathematical fact that if you stop lending and your loans come back as deposits (which are not re-lent), the ratios would be improved from above 100% to below 100%. However, on practical level the economy, as we know it, would be killed in this process as the money stopped circulating. If you lend less out of your deposits, your loan to deposit ratio will go down (however you may still struggle with high money multiplier). Higher lending indeed drives higher deposits, as the writer in The Economist said, but in absolute terms. This is false in terms for ratios: higher lending drives the loan to deposit ratio higher. This is a mathematical fact. The Economist writer does not understand the basics and confuses a relative figure of loan to deposit ratio with absolute figure of deposits. It is quite amusing to watch the banks doing the right things quietly (so they are not accused of not doing so in the first instance) whilst being lambasted by The Economist for doing these right things.

The paragraph cited in two bits above from The Economist epitomises what went wrong with the banking system (lending with too high loan to deposit ratios) and that mainstream commentators do not have a basic understanding of the mechanism how it works. Even nearly two years later. Although banks got round to it eventually: but it looks that it will be too little and too late and, of course, they will not acknowledge that they were effectively peddling and Albanian-type pyramid scam.


  1. But what will happen if the banks continue like they are and do nothing?? It is obvious to me that they can't do very much with nothing if they are in the situation you described due to the high loan to deposit ratio. Can they wait for money to be returned from the loans?? Or are they really waitng for something or someone to inject more tax payers money or maybe even for something to take the fall!! (the greek economy, the spanish economy, the British pound, the euro?) If the banks continue as they are- seemingly waiting idle for something to happen, what do you suppose will happen?? What do you think they will do?? Is it time to start growing some veggies??

    Best Regards

  2. Dear r3dt3z

    Thanks for reading my blog. I think that banks are really waitng for something or someone to inject more tax payers money or maybe even for something to take the fall. It appears the banks developed a relationship with taxpayers akin to loan sharks and their victims (who have to pay every penny they have and their debt is growing and the banks, sorry loan sharks, are coming back for more).

    However there is a solution. Please read "Prime Minister, sort out this mess, please" - http://gregpytel.blogspot.com/2010/06/prime-minister-sort-out-this-mess.html

    Best wishes


  3. Hi Greg, yes i had read and enjoyed that post many times - i have left a comment there already.
    What i think i am suggesting is:- maybe the write downs i think it was you called them:- are too big, to plentiful and too troublesome for this weak cowardly government to take on board, so instead they will attack the unemployed, the infirm and the elderly. In fact any part of the welfare state, and blame it on the failure of the last government.
    In a way i hope the real cause of the problem does rear its ugly head and bites so hard as to make plain it is the financial system and it's failings that caused the mess, not the victims of a failed system.
    I was wondering what would happen if they keep going for the welfare state and yet ignoring the financial pyramid that you informed us all was inevitably collapsing. Can they save the day with this mean and cowardly policy??

    Thanks for the blog and your reply.

    Best Regards.

  4. I share your point: it may be the case that we really have to hit the bottom in order to bounce back. My inkling is that things are still going to turn very nasty. Locally and globally.

    I repeat my mantra: the global crisis that started in 1929 with the Wall Street crash ended with WW2 10 years later. I think this crisis is slowly heading for a similar dramatic end. But what it will be exactly, I don't know.



  5. Have a look at these US figures:


    I have never seen the broad money supply spelt out so starkly. The National Post columnist seems to think further expansion would be a good idea - methinks he misses the point. Note the US$1trln gift from the Fed barely dents the $90trln loss from OTC's (which should never have existed) and overseas accounts (most of which should not have existed. Is the US taxpayer going to have to foot the $700trln bill for returning money supply to sanity? That would mean $500,000 per taxpayer. Doubt it. The entire financial system will have to be re-engineered, top to bottom.

  6. Hi Ed

    Precisely. $90tn loss balloons money multiplier in the financial system. The banks do not have enough cash to service/sustain such a loss on their balance book. Hence there are only two methods out of this (or their combination): inflate, i.e. print money and this way reduce the multiplier or (non-exclusive use of "or") write down big portion of such loss, i.e. by reducing liabilities on their books, banks would reduce money multiplier.

    Thanks for reading my blog. If you think it is worth it, please spread the link to it around.