One theory is that Mt. Gox became fractional reserve some time in the past, either by losing bitcoins or by spending them. Then they were unable to replenish their supply, so it was a matter of time before a bank run.
The reason I tend to believe this scenario is because it's completely consistent with their behavior. I watched them very closely, and there seemed to be no rhyme or reason for their behavior. That is, unless they were missing everyone's bitcoin for some reason. Then their behavior made perfect sense.
In that scenario, Mt. Gox would have knowingly traded non-existent Bitcoins for far, far longer than two weeks.
EDIT: I should mention that there's still no evidence whatsoever that malleability somehow led to the loss of >500,000 BTC.
> One theory is that Mt. Gox became fractional reserve some time in the past, either by losing bitcoins or by spending them.
Maybe pedantic, but many people have been using fractional reserve wrt Mt Gox lately. The usual meaning of that term: A bank will loan out deposits, reserving a fraction for withdrawals. However, a key point is that the bank holds collateral against the loan, and that collateral has a fair-market value, so the balance sheet is still positive. (A major problem in the housing meltdown was that the value of the collateral dropped, making many banks technically insolvent.)
What Mt Gox did is take money from depositors and either lose or spend them. That's just either bad business (if they lost them) or fraud (if they spent them). Calling it "fractional reserve" gives it an air of legitimacy that they really do not deserve.
Edit: I did not intend to start a discussion on the finer points of bank accounting. The major point is: To my knowledge, Gox wasn't trying to make loans with money that deposited with them, which is what a fractional reserve business is.
> Maybe pedantic, but many people have been using fractional reserve wrt Mt Gox lately. The usual meaning of that term: A bank will loan out deposits, reserving a fraction for withdrawals. However, a key point is that the bank holds collateral against the loan, and that collateral has a fair-market value, so the balance sheet is still positive.
No, the balance sheet is still positive because the debt owed to the bank is an asset of the bank. This is independent of whether the debt is secured by collateral.
(Of course, even a risky loan that is unsecured by collateral is a very different thing than simply having deposits stolen, so, there is a good point that while Mt.Gox surely had less-than-full reserves, it was doing something very different than fractional reserve banking, even assuming that Mt. Gox's own explanations are correct.)
> No, the balance sheet is still positive because the debt owed to the bank is an asset of the bank. This is independent of whether the debt is secured by collateral.
Not always true. For non-recourse loans, the value never exceeds the collateral. When the collateral gets written down, so does the asset.
Or, put alternately, it taints actual fractional reserve banking (which has worked pretty well for hundreds of years) with a sense of being the same kind of shady business practice as this. (Which may be the point of the comparison, given the ideological bent of many Bitcoin advocates.)
i don't get how you can loan bitcoins in any other way other than full reserve - unless you somehow put trust into the bank (which you have to for fiat money, but for bitcoins, you can verify and so don't have to trust credit/notes offered by the lender).
Same way you don't get back the exact serial-numbered dollars you loan (deposit) to a bank. It's not the _identity_ of the bitcoin which matters, it's the value.
If you want a lockbox, get a lockbox. If you want a deposit account, you're storing and retrieving fully fungible and interchangeable entities.
And it's worth remembering that banks aren't the only institutions that make loans. There are a lot of businesses that extend credit (post-paid services, invoicing with net 60 terms, etc), which has the same exact macroeconomic effect.
Probably only the sort of fractional-reserve banking in which the banker lends out for a year or 30 deposits accepted under the promise to return them upon demand. That's the sort that can have bank runs. If depositors agree that their money is locked up for a while, no problem.
Huh? This isn't true. Banks loan without collateral all the time, such as via credit cards or unsecured lines of credit. This is why fractional reserve banking increases the money supply. Banks are allowed to literally invent money out of thin air, so long as their invented money is within the multiple required by law for cash they have on hand.
Mt. Gox was doing (attempting) the same thing our traditional banks do in that sense. They were increasing the bitcoin supply using an analogous scheme.
> Banks loan without collateral all the time, such as via credit cards or unsecured lines of credit.
Yes, I was avoiding that can of worms. Banks do unsecured lending, there is still an asset entry to offset it so that the books remain positive. Armies of regulators and accountants and volumes of laws in effect here.
But the salient point: A fractional reserve business consciously makes loans with an expectation of being paid back. To my knowledge, Gox was not trying run a fractional reserve business, and the term is being misapplied.
> This is why fractional reserve banking increases the money supply.
It increases a money supply, not the money supply. It does not increase M0 (and there was a time that banks were allowed to do just that.)
Note that in a secured loan, the security is rarely for the full amount of the loan (mortgages being a notable exception). Usually it covers only a fraction of it, but it's there to increase the borrower's "skin in the game". Rules also differ on whether or not the security itself is acceptable as discharging a loan's obligations (e.g., in Spanish real estate lending, if the property itself isn't sufficiently highly valued to pay off the loan balance, the borrower _remains_ on the hook for the balance, this is usually not the case in the US, where most mortgages are non-recourse loans.). See also "deficiency judgement".
In both secured and unsecured loans, the debt itself is the security, with a portion of the interest being attributable to the risk (default) component of the loan.
As for money supply, bank reserves are included in M2 which is used for inflation calculations, so I'd argue that yes, fractional reserve lending does increase money supply, as commonly used.
"Banks loan without collateral all the time, such as via credit cards or unsecured lines of credit."
It's true that there's no collateral, but there is a corresponding asset - the loan itself.
"This is why fractional reserve banking increases the money supply."
Fractional reserve banking would increase the money supply even if banks restricted themselves to fully secured lending. Bank deposit accounts act a lot more like money than does a mortgage.
i want to imagine uncollateralized load like this:
i'm a bank with 0 dollars in any asset, but 0 debt obligations. So my networth is 0 right now.
You come along to borrow off me $100. Now i have an asset of $100(the debt which you have to pay back + interest), but as soon as you spend your money, i also have a debt of $100.
Now isn't this a good way to make money from nothing?
If I have zero dollars, how did I have anything to loan you? I can put numbers on my ledger, but you won't be able to withdraw it - that's not fractional reserve, that's zero-reserve.
On the other hand, I've never objected to the notion that fractional reserve creates money - in fact, my comment above explicitly states it.
Thanks for this, you've just put your finger on something that's been bugging me about a lot of the recent Mt. Gox / Bitcointgasm discussion. Actually, it raises the point further that if so many people who claim to know what they're talking about can confuse Mt. Gox's position (fraud, incompetence, insolvency, bankruptcy) with fractional reserve lending, it makes me strongly question just who the hell actually knows what they're talking about.
My understanding is that few banks were actually made insolvent, but that lots had to eat fire-sale prices due to liquidity issues. Your sketch isn't wrong, though.
> My understanding is that few banks were actually made insolvent
This was another can of worms. Mark-to-Market accounting was rescinded, partly to address this issue (http://online.wsj.com/news/articles/SB123867739560682309) but many folks thought the banks were dragging their feet on re-marking their housing assets well before that. So were they insolvent because nobody put an accurate, timely value?
Those that anticipated the situation by shorting the banks made some serious money (and then made less when the SEC banned shorting.)
In which case the banks can simply have the gov't force future taxpayers to make them solvent again. Perhaps bitcoin will one day attain "too big to fail" as well.
Reserves are the cash on hand available to pay people able to demand it. Since in practice, except during a run, only a fraction of a bank's liabilities are called in at any given time, it is safe to keep less cash on hand than the entire amount that could be withdrawn instantly.
The rest is converted to assets with equivalent value that have worse than instant liquidity, but a higher return on investment. This keeps the balance sheet honest with respect to the total value of assets and liabilities, but technically, the bank cannot honor all of its commitments in the worst case scenario. That's fractional reserve.
Mt. Gox does not even have the imaginary, illiquid assets to balance out its depositor liabilities. That makes it bankrupt, not fractional reserve.
> Mt. Gox does not even have the imaginary, illiquid assets to balance out its depositor liabilities. That makes it bankrupt, not fractional reserve.
Strictly speaking, it makes them insolvent. The fact that they are insolvent is the reason they have sought the protection offered by bankruptcy, but the two states are distinct.
While the terms are easily distinguishable to a lawyer, to others, they are practically synonymous, with insolvency nuanced towards being a temporary condition and bankruptcy nudged towards a more permanent or intractable failure.
The implication is that an insolvent person could become solvent by immediate application of better financial management, but a bankrupt person has no choice but to default on a portion of his debts or other financial obligations. Bankruptcy is the noun/adjective descibing what the court does with bankrupt people and businesses.
The ACME brand hair-splitter is the only professional-grade capillascindor you will ever need.
I recall spinning this theory on another hn thread [1]. And sure, you are correct that Mt Gox didn't make loans, didn't act exactly in all respects like bank. But the literal term "fractional reserve" is certainly suggestive of what both a standard modern bank does and what a crocked bitcoin exchange could do - only keep a small amount of money to satisfy inflows and outflows while doing something else with the rest of the money entrusted with it. If Mt. Gox did this, they clearly weren't responsible in doing it since don't have the money entrusted to them. But it pretty much seems like this lack of responsibility would be what distinguishes a failed bitcoin exchange from an ordinary banks.
Consider, Wikipedia says: "Fractional-reserve banking is the practice whereby a bank retains reserves in an amount equal to only a portion of the amount of its customers' deposits to satisfy potential demands for withdrawals. Reserves are held at the bank as currency, or as deposits reflected in the bank's accounts at the central bank. The remainder of customer-deposited funds is used to fund investments or loans that the bank makes to other customers." [2]
Which is to say, a fractional reserve system involves keeping only some money handy and hoping that the money you remove for other purposes goes on to make more money. Now, if you don't tell people you're doing this, then yes it's fraud. Secretly operating something that people don't think of as a bank, as a bank, is fraud. Lose the money you've invested and a fractional system collapses, whether you are openly operating as a bank or secretly operating as a bank. Secret banks do tend to collapse more often just 'cause they're shady. But the secret banks that make money, well you don't hear about them most of the time.
That's not how fractional reserve works; that's just fraud. With fractional reserve, a bank holds maybe 1/8 of account balances in cash and the other 7/8 in loans due to the bank. So if eight people each deposit $100,000, the bank holds $100,000 in cash and can make three mortgages for $200,000 each plus ten $10,000 car loans. Either way they hold sufficient assets to cover their deposits, just not all of those assets are fluid. (The bank earns enough interest on the mortgages and car loans that they can pay interest to their depositors and take some profit off the top.)
Exactly. And for those unfamiliar I'll add that banks face a classic problem: their loans have long terms, but their deposits can be withdrawn at any time. That is normally not a problem, but there are issues and edge cases that we handle with things like bank capital standards, deposit insurance, and swift government takeover and resolution in the case of bank failures.
For those interested in this, I strongly recommend Sheila Bair's "Bull by the Horns". She was the head of the FDIC up to and during the 2008 financial crisis, and this is her memoir. She's a fiscally conservative Republican, but one who strongly believes in the value of regulation as a way to create a sound economy so that all citizens can thrive. The book was fun to read, and it gave me a much better understanding of the forces at play and why good regulation of banks is immensely valuable to us all.
It's justified via statistical multiplexing, just like when an ISP sells a total of 1 Gbps of bandwidth but only has a 256 Mbps upstream connection.
So long as only a low percentage of demand depositors ask for their money back at any one time it's not a problem. But when everyone decides to withdraw their money at the same time you have a liquidity crisis. Liquidity problems aren't so bad anymore though -- the Fed steps in an lends all the cash you need against your long term assets. The real problem is when those assets go bad. Now you don't have a liquidity problem you have a solvency problem. The only thing the Fed can do at that point is to simply give the bank money to make up for their bad investments. Which is exactly what they did and are doing, albeit in an obfuscated manner.
Great stuff. Although I should say that there's more you can do with bad assets than just give people money. My understanding is that classic resolution is where you create a "bad bank" [1], a holding company for all the bad assets. You then fire the bank managers, put less dumb people in charge, recapitalize the banks, and use the bad bank to slowly realize the value from the assets, which are often not totally bad, just part of a cyclical slump. And you also update regulations and capital controls so as to reduce the chance of a similar mess next time.
A lot of people are critical that after the 2008 crisis very few people got fired for FUBARing the world economy. I get why the US ended up doing that; people were scared of anything that looked like more instability. But I think it was a mistake.
The Fed can't do something like that. It usually takes the involvement of a bankruptcy court, though the FDIC has some powers it can exercise independently. A full Swedish style resolution would almost have certainly required new legislation.
All that said, I agree with your underlying point that just giving insolvent banks money wasn't a great solution at all, though it was minimally sufficient to prevent bank runs at least on formal banks. There were some runs on shadow banking institutions, though in at least one case -- money markets -- the government stopped one by guaranteeing them as though they had been insured banks. That too was a mistake in my opinion.
> banks face a classic problem: their loans have long terms, but their deposits can be withdrawn at any time.
Borrow short and lend long - great work if you can get it. Of course, this practice is fundamentally unsound (it provides nasty game-theoretic incentives to participants), but it tends to work "well enough" in practice that no one really cares, especially when there is a lender of last resort who is able to print money at will.
To be fair, the lender of last resort isn't necessarily printing/creating money in the long term.
If it is simply a classic bank run, and everyone wants their money back now, the lender of last resort could take over all of the distressed bank's illiquid assets and, over time, recover some or all of the lent moneys.
In this case, what the lender of last resort is really doing is making all illiquid assets liquid.
If you think a bank run is going to happen, you want to withdraw your money ASAP, before it's all gone. Everyone else does the same - so you can get a self-fulfilling prophecy, even if everything would have been fine if everyone had stayed calm. For personal banking, this is largely mitigated by FDIC insurance, because the Fed can print enough money to cover small bank failures without anyone noticing or caring. However, if you're fucking around with collateralized debt obligations (CDOs)...2008 happens.
Banks actually pay insurance premiums to FDIC, which are held in a fund which is used to pay claims. If the fund is wiped out, practically speaking the Fed would cover it but that's not the normal method of operation.
The "Calculated Risk" blog reports on bank failure, and even in 2010 (11?) when literally hundreds of banks failed there were only a couple cases in which the FDIC had to pay anything out.
which states that "The fund had a balance of negative $7.4 billion as of Dec. 31, though that was an improvement from the $20 billion hole it was in at the end of 2009."
I was under that impression they could make loans of 72/8 of their account balances. I may very well have misunderstood, but I had thought banks could loan out a given dollar multiple times at once. No?
No. The reason there's a multiplier effect that gets talked about a lot is because the money you borrow from the bank then ends up in another bank account (of the person you were borrowing money to pay). The bank it's deposited in there can then lend out against that deposit.
But each bank loan is balanced, to the reserve ratio that bank operates at, to a corresponding deposit.
I've been saying this for a while now, including on HN.
> The reason I tend to believe this scenario is because it's completely consistent with their behavior.
Another reason to believe this is that it is something that has happened often in the past before modern banking regulations. Seriously, read history of banking in Netherlands or England, the idea:
"Oops, I just lost my customer deposits. I'm probably going to get lynched now. But hey, if I just hide this until I make the loss back from fees/reckless trading, I'll be able to pay my customers back and avoid being lynched. It's a win-win."
Is something that at least hundreds, if not thousands of bankers have had over the course of history. As far as we know, it never works.
There's no way to know how often this sort of thing has happened in the past. We only find out about the cases where a bank is not able to earn back it's loss and runs out of cash. At that point they have to admit they're insolvent.
If the bank was able to earn back the money and become solvent again, then no one outside the bank would know it happened and the bank would have every reason to cover it up to save its reputation.
> Oops, I just lost my customer deposits. I'm probably going to get lynched now. But hey, if I just hide this until I make the loss back from fees/reckless trading,
One of my favorite bits of commentary on financial matters comes from that. Some laconic British commentator was referring to Nick Leeson as "that chap who made money hand over fist for Barings Bank, until he didn't".
That's not true at all. Almost every bank in the western world did this in the past six years. They became technically insolvent due to losses in the housing bubble, but through, for example, huge piles of free money given to them by the U.S. government, were able to keep on trucking until they could earn enough money and get back into solvency. That was the entire theory behind the bailout.
Not all banks that were insolvent managed to keep on going; many failed. But many survived.
So this strategy works perfectly well if you have the ear of the Federal Reserve or another entity that can provide very large amounts of money. It works well when the amount you are insolvent by is small compared to your revenue stream. It does not work well if you are a Ponzi scheme operator and if you have stolen ALL of the money.
> The reason I tend to believe this scenario is because it's completely consistent with their behavior. I watched them very closely, and there seemed to be no rhyme or reason for their behavior. That is, unless they were missing everyone's bitcoin for some reason. Then their behavior made perfect sense.
They didn't actually need to replenish their supply of good bitcoin; they only needed to buy up all of the bad goxcoin. For example, by halting withdrawals for 2 weeks in order to drive down the price.
No. They did not become a fractional reserve, they became insolvent. A large portion of the BTC community grossly abuse the term 'fractional reserve', and it's flatly wrong.
Fractional reserves refer to liqudity, not solvency. If I run a financial institution and I owe depositors $100, but have $10 cash and am owed $100 on top of that, I'm running a fractional reserve.
If on the other hand, I'm MtGox, and I owe depositors $100, but have $10 of cash and am owed nothing on top of that, I'm insolvent. Bankrupt. And if I keep operating, I am a fraud.
Yeah, I'm still constantly surprised how so many in the BTC community seem to lack even the most basic of accounting knowledge, yet have strong opinions on how international banking and currencies should work.
> A large portion of the BTC community grossly abuse the term 'fractional reserve', and it's flatly wrong.
A large portion of the BTC community grossly abuses all economic terms because it's a libertarian anarco-capitalist circle jerk much of the time. The sane and educated are few and far between but they're there.
The important side effect of such cash loans is that once on the market, they are indistinguishable from any other cash. So the bank essentially increased amount of cash in circulation. While technically they didn't "print money", for all practical purposes, they did. And since this cash slowly propagates throughout economy, it increases the total supply which leads to raising prices. Prices raise first where this newly loaned cash is being applied. Since 2000s it is stock market. It grows in total sync with Fed's "bonds buying".
Gonna have to disagree with it being an important distinction.
In times where you can't liquidate assets at a high enough fraction of their "I deserve this much" value, then you can't meet your obligations and are thus insolvent as well. If someone's willing to buy your illiquid assets (or lend on the assumption that they're) at full "I deserve it" value, you were still insolvent -- you just got bailed out.
If you are otherwise profitable, then a long enough line of credit can return you to profitability. In that respect as well, an "insolvent" institution can become solvent thanks to this added liquidity.
For those reasons, I believe that in the interesting cases, liquidity and solvency are too deeply entangled to distinguish.
So when MtGox tries to keep the facade up long enough for trading fees to cover the shortfall, then yes, that is different from an "illiquid but solvent" bank getting a loan from the Lender of Last Resort ... but it's a different of degree, not kind (edit: fixed wording, thanks dllthomas). Both of them are trying to cover up functional insolvency with future profits they hope to operate long enough to get.
In the US, at least, a bank would have a very hard time doing something this irresponsible. The FDIC would have noticed the problem and stepped in long before the situation could get this bad.
I'll cut off the inevitable reference to 2007 at the pass by pointing out that none of the big banks that got bailed out ever made it anywhere close to digging themselves into a hole as deep as Mt. Gox did. For example, the biggest bank failure in US history, Washington Mutual, went down with about $300bn in assets against $200bn in deposits. Creditors ended up getting wiped out, but deposits were safe.
> In the US, at least, a bank would have a very hard time doing something this irresponsible.
Did you completely miss out the part where Goldman Sachs drafted gvt regulation to its advantage and conducted insider market manipulation that led to the 2008 crash ?
"Creditors ended up getting wiped out, but deposits were safe."
Deposits were safe, but all of society got kicked by inflation and increased unemployment. Of course, that only hurts poor people, so, win for the depositors!
It's higher than that, because the CPI does a lot of adjustments to the offical figure. Moreover, your years are cherry-picked; there was a wave of deflation (that occurred in 2008-2009) as loans went though a cycle of defaults to clear out bad debt. Finally, the effects of top-down stimulus take a long time to propagate, especially since the current money multiplier for dollars is still quite low, and bank's lending activities have been relatively stagnant (roughly speaking, base currency went up, but debt expansion, which is what really counts, has not caught up yet because people are reluctant to go into debt - hence the popularity of debit cards vs. credit cards). Eventually as people start using debt to paper of catastrophes and emergencies, the overall indebtedness will increase, and the inflationary increase in the base currency will propagate into the debt burden, and we will have a sudden increase in inflation.
I personally think it's unlikely to be hyperinflationary, but it will be very uncomfortable, especially for poor and middle class.
But, perhaps i should not have used the past tense.
Inflation actually tends to benefit the poor in the long run, as it devalues debt. (By definition, the poor don't have a lot of savings and tend to be in debt). Hyperinflation of course causes problems for everyone, but that's not going to happen. That said, there's little reason to worry about out of control inflation for several years to come: these economies still have enormous under-utilized resources.
No. The poor are typically in debt on short-term scales (days, weeks) which does not benefit from inflation, and at rates (often double digits) which inflation does not mitigate.
The rich are typically in debt a lot, via leveraged investment ('trading on margin'), or, indirectly by things like leveraged ETFs, leveraged currency FX trading, etc, which enjoy very low, bank-level interest rates because it's done in bulk. Not to mention banks with direct access to low-interest loans, (as in bank corporations) which are not begging in the streets for alms (they get bailouts). These debts that the rich enjoy benefit greatly from inflationary devaluation of nominal prices.
Moreover, the investment activity of the rich tends to benefit from inflation.
While I'm sure there are some rich that are heavily leveraged, the majority are not leveraged that highly relative to their asset base. This has been shown in most available statistics on household wealth. For example:
In particular the debt-equity ratio of the top 1% (>$8.2m net worth) is 2.8% ; the next 19% (> $473k < $8.2m) is 12.1%, and the middle three quintiles ($200 dollars-$480k) is is 61.1%.
Moreover, the rich representatives in press & politics (WSJ editorial page, Forbes, the GOP, etc.) have been clamouring to raise interest rates for the past 5 years out of inflation fears... for what reason? To benefit the poor?
Right, but the regulations do tend to grant the customers some sort of protection in the face of this sort of behavior, which is the whole argument in favor of financial regulation.
That said, I did smile and chuckle at your response :)
More importantly, they vastly reduce both the frequency and the scope for this sort of malfeasance.
If MtGox had been expecting to face bank audits, they would have been forced to a) hire some people who actually understood finance, b) would have had much better internal accounting controls, and c) would have had a much harder time blowing up quite so thoroughly.
When I hear people carping about "unnecessary regulation" I imagine some guy looking up at a major bridge and saying, "Ha! You don't need half that metal. I could have done it for way less." Maybe he's right. But more likely, he isn't thinking about high winds, earthquakes, and all of the other extreme circumstances that are the real drivers for how thick the supporting pillars have to be.
However, I think everyone screaming "see! regulation works!" is completely forgetting that this site really did bring Bitcoin up from some obscure hacker/modder toy into what it became today. Perhaps some other site would have filled the void, but with regulation mtgox or anything like it could not have existed.
So yes, regulation has it's places. However, regulation would have made these early "bootstrap" exchanges unworkable, and probably criminal. How does that help anyone either?
I'm not a finance guy but I took a finance class once...
I believe that all banks are required to hold a minimum reserve that is set by the Fed. Each day banks with assets greater than needed "sell" their reserves to banks with less via T-notes.
This is all due to regulation, banks on their own wouldn't participate in this because it costs the banks with low reserves money but it keeps banks from disappearing overnight like MtGox.
To be fair though Gox was an exchange and not a bank and that is a bit different
If you're referring to the subprime mortgage crises, the problem appeared to be the removal of regulation more than regulation itself. There was a reason there had used to be laws placing firm lines between banks and securities firms.
This encouraged banking institutions to increase the number of sub-prime mortgages with the stated goal of increasing home ownership among lower income communities.
Changes to this regulation made during the 1990s, specifically the 1992 change to require Fannie Mae and Freddie Mac (USG-sponsored entities) to devote a percentage of their annual budget to securitizing (read: buy the loans made by other banks and bundle them into securities) these sub-prime mortgages.
This, among other factors, eliminated a lot of the risk for banks - there was always going to be someone to buy the sub-prime mortgages, thanks to this regulation.
And as long as housing prices went up they could afford to keep issuing predictably bad loans, since the assets that would fall under forfeiture would have a greater value than the principle of the loan.
When housing prices tanked in the mid-2000s, after a solid 10+ year housing bubble, all of this mania inevitably caught up with reality as home values went under water.
So let's not pretend that regulation is some short of magic wizard armor that prevents human stupidity and greed (on all parties: the banks, the Government, the realtors, the home builders, and the consumers who took the loans).
Regulation doesn't guarantee anything other than unintended consequences and should be looked at as a tool of absolute last resort when it comes to addressing market issues.
Consider the FDIC, often held up as an example of successful financial regulation - it's enabled plenty of new forms of reckless behavior on the part of financial institutions (see the Savings & Loan crisis from the 1980s) and more or less guarantees government bailouts to the depositors.
Laws are not magic patches to the fabric of reality and human behavior. They often don't even achieve their stated goals and aren't always so easy to correct.
You should consider reading the article you linked. ""However, the Financial Crisis Inquiry Commission formed by the US Congress in 2009 to investigate the causes of the 2008 financial crisis, concluded that "the CRA was not a significant factor in subprime lending or the crisis"."" - http://en.wikipedia.org/wiki/Community_Reinvestment_Act#Repo...
> According to American Enterprise Institute fellow Edward Pinto, Bank of America reported in 2008 that its CRA portfolio, which constituted 7% of its owned residential mortgages, was responsible for 29 percent of its losses. He also charged that "approximately 50 percent of CRA loans for single-family residences ... [had] characteristics that indicated high credit risk," yet, per the standards used by the various government agencies to evaluate CRA performance at the time, were not counted as "subprime" because borrower credit worthiness was not considered.[125][126][127][128] However, economist Paul Krugman argues that Pinto's category of "other high-risk mortgages" incorrectly includes loans that were not high-risk, that instead were like traditional conforming mortgages.[129] Additionally, another CRA critic concedes that "some of this CRA subprime lending might have taken place, even in the absence of CRA. For that reason, the direct impact of CRA on the volume of subprime lending is not certain."
So if you're basing your argument on the authoritative application of the label "sub-prime," please feel free to indulge in as much or as little semantic pedantry as you like.
Pinto was pretty much the central figure in CRA-blaming, and the vast majority of his claims have been repeatedly and exhaustively debunked.
In a piece deeply critical of Fannie and Freddie, William Black (again of S&L crisis fame) addresses Pinto's attempts to place Fannie and Freddie's terrible risk management on the back of CRA regulation:
Pinto estimated that Fannie and Freddie held “34% of all the subprime loans and 60% of all Alt-A loans outstanding” [p. 7]. Pinto seems to have treated subprime loans as non-liar’s loans, but that is clearly incorrect. I cited Credit Suisse’s finding that by 2005 and 2006, half of all subprime loans were also stated income (liar’s loans). The presence of such large amounts of Alt-A loans is one of the demonstrations that Pinto, Wallison, and the Republican Commissioners’ “Primer” are flat out wrong to claim that it was affordable housing goals that drove Fannie and Freddie’s CEOs’ decisions to purchase loans they knew would cause the firms to fail. That claim doesn’t pass any logic test. One of its unobvious flaws is that no one was making Fannie and Freddie buy liar’s loans. For the reasons I’ve explained, and Pinto admits, Fannie and Freddie actions with respect to liar’s loans were the opposite of what they would have been if they were trying to demonstrate that the loans were made for affordable housing purposes.
The GSEs were deeply irresponsible with their lending and were poorly run, but both were prevalent long before any CRA impact would have been felt. If AEI / Pinto / Wallison had focused on the actual causes of the mortgage / financial crisis instead of trying to blame poor people and Barney Frank, the world would be a lot better off.
Do you honestly think that a few poor people in the US caused a Global Financial Crisis that took down dozens of banks and sent most of the Western World into a recession?
I would encourage you to read 'The Big Lie' by Barry Ritholtz that completely debunks this nonsense.[1] He even offered a bet of $100,000 to debate anyone in front of a 'jury' about the role of CRA in the crisis (unsurprisingly, he had no takers).[2]
I'll just point out some facts that address your most incorrect assertions, but just about everything you wrote is incorrect or extremely misleading.
This encouraged banking institutions to increase the number of
sub-prime mortgages with the stated goal of increasing home
ownership among lower income communities.
CRA loans looked nothing like sub-prime loans.[3] In 2004, about 3.5% of CRA loans defaulted, while about 18% of subprime loans did, and 25% of broker-placed subprimes did. By 2006, 15% of CRA loans were defaulting, but almost 50% of subprimes were and 40% of broker-placed subprimes were.[4]
Additionally, many subprime defaults originated in prime loans, up to 60% in Massachusetts![5] So these people qualified for Prime mortgages, and then refinanced with Subprimes. They couldn't possibly be CRA loans.
Fannie Mae and Freddie Mac (USG-sponsored entities) to devote
a percentage of their annual budget to securitizing [..]
these sub-prime mortgages.
Fannie and Freddie did securitize many mortgages, yet during the housing bubble, their market share was cut in half by all the private banks running wild with MBS products.[6] They also had proper due diligence and lending standards, so their 'high-risk' loan performance was almost 3x better than private lender subprime performance.[7]
Also, if Fannie and Freddie were at fault, then why did the commercial real estate market, with absolutely no government support, have a much more severe price drop (45% compared to 30% [8])?
Or you could take it from the Financial Crisis Inquiry Commission[9]:
The study found that only 6% of such higher-cost loans
were made to low or moderate-income borrowers or in low
or moderate-income neighborhoods covered by the CRA. The
other 94% of higher-cost loans either were made by CRA-
covered institutions that did not receive CRA credit for
these loans or were made by lenders not covered by the CRA.
I think that's enough for now.
I would love to hear how the Savings and Loan crisis was the fault of the FDIC though, that promises to be entertaining. Especially when the guy who literally wrote the book on the crisis noted that[10];
Deposit insurance was not essential to S&L control frauds.
He then goes on to demonstrate an argument regarding how CRA loans had virtually nothing to do with the crisis. How on earth do you feel he isn't addressing an argument you made?
What the?? Your argument is thoroughly debunked and THIS is your response? When your wife calls you a bitch do you also thank her for the quasi-relevant information? Because that's basically what you just did.
Please do a serious study of the facts. There's no reason that any thinking person in 2014 should still believe that the CRA was to blame for the 2008 financial crisis. It is supremely ludicrous that anyone ever bought that line.
Just start by comparing the total value of subprime loans at that time with the total value of derivatives, CDOs, etc. built upon them. Then, see where that takes you. It's been covered ad nauseum, so it won't be hard to find.
>Consider the FDIC
I have. Bank runs aren't cool. Neither is depositors losing all of their money.
>it's enabled plenty of new forms of reckless behavior on the part of financial institutions
That's why you regulate with something like Glass-Steagall. It worked pretty well for what it sought to prevent until it was repealed, which really set up the 2008 meltdown. And the S&L crisis? Well, that's why the Fed shouldn't double the interest rate over night. You can't just have actors do any mindless thing, then blame unrelated regulation for not mitigating the consequences. The FDIC didn't have anything to do with creating or escalating that crisis. The eventual scale of that crisis was a product of outright fraud.
In fact, Congress had deregulated the thrifts (S&Ls) just prior to the crisis, which opened the door for that fraud [0]:
>Congress finally acted on deregulating the thrift industry. It passed two laws, the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn–St. Germain Depository Institutions Act of 1982. The deregulation...significantly expanded [the thrifts'] lending authority and reduced supervision, which invited fraud.[6] These changes were intended to allow S&Ls to "grow" out of their problems...Other changes in thrift oversight included authorizing the use of more lenient accounting rules to report their financial condition, and the elimination of restrictions on the minimum numbers of S&L stockholders. Such policies, combined with an overall decline in regulatory oversight (known as forbearance), would later be cited as factors in the collapse of the thrift industry
>Regulation...should be looked at as a tool of absolute last resort when it comes to addressing market issues.
So, in summary, you believe, for example, that Glass-Steagall has no value and that banks should be able to place ultra-risky market bets on exotic, esoteric derivative products, using their customers' deposits? And, further, that those customers should not have any form of insurance or recourse?
It's stunning that someone could look back at 2008 and conclude that less regulation is the solution.
I know, I was trying to add to it by bringing up the sub prime mortgage debacle, but apparently that isn't a funny topic, or I lost something in the delivery.
To be fair, MtGox was an exchange, not a bank. My understanding is that if a standard exchange (eg, Ameritrade) went down in a similar fashion, you'd be equally screwed.
So if they screwed something up, and somehow lost all of your stock and cash, your cash would be covered by the FDIC and your stock would be lost? (Assuming they don't have some sort of supplemental insurance to cover loss of stock.)
IIRC, real banks trade imaginary dollars all the time by operating as a fractional reserve. The average person probably doesn't know nor care, but FDIC insurance prevents the bank run from causing people without a lot of assets from losing it all.
Of course, I could be completely wrong. Any experts care to chime in?
EDIT:
From the explanation linked below it looks like banks keep a fraction on hand and the rest is due to the bank in the form of lines of credit. Which I suppose explains why the FDIC still needs to exist - it's not like the bank can just tell everyone they loaned money to pay it back right away if everyone withdraws their money at once.
Also, it seems we are continuously conflating 'regulated currency' with 'regulated banks'.
The banks have most of their as assets as liabilities, and only keep a certain percentage liquid (cash).
Also, the FDIC (and eventually the NCUA) was created out of a need to stabilize the dollar, post Great Depression. It's considered an organization that helps regulate liquidity of the currency, which is essential to being a currency.
Bitcoins on the other hand do not have any such regulation, and exhibit recessionary behavior not unlike gold, which was decoupled from the U.S. dollar about the same time the FDIC was created.
Because bitcoins lack liquidity regulation and have an impending production cap, they will almost never make it as a currency. That's not to say some other cryptocurrency won't solve the problem later.
Okay internet tough guy. People say this all the time, but users still went to the SEC when Pirate@40's Ponzi collapsed, instead of meting out justice themselves.
AFAIK no one who has had money stolen in any of the countless bitcoin scams like BMR, Sheep, etc. used vigilante justice, even though many of them threatened to.
That is correct. I am not endorsing vigilantism. I am saying that it has happened a lot in the absence of law.
What does it mean for bitcoin to be unregulated? Do people want bitcoin regulated and how?
Is someone stealing your bitcoins illegal? What if an exchange steals your bitcoins? What if you conduct a transaction in bitcoins and you never receive the bitcoins? What if someone conducts a ponzi scheme with bitcoins? Would front running and faking trading activity be legal?
EDIT: Note I hold no bitcoins, never have, nor am I shorting them so I have no skin in the game.
I was just thinking the same though. Perhaps a bit more crass, however, my thought process was something like 'tough shit'. My assumption would be those investing heavily in BC were thinking 'high risk, high reward'. Well, it proved to be pretty risky.
That preceded the public face of the Mt. Gox situation, which is what the original comment refers to.
There are always small speculative bubbles here and there, it happened exactly like that 6, and 12 months prior. It's interesting how bitcoin prices are highly cyclical. I think there's going to be ONE MORE expansion, in approximately 3 months, that takes the price of btc to about 5k, although it may pop as high as 10k on its way. If for no other reason than there are often self-fulfilling prophecies in finance.
Lost trust does not mean the price has to fall. As I said, there is close to zero trust in the bitcoin economy, so a loss of the little trust isn't a big surprise. Most savy investors/bitcoin users won't have lost much money in this affair either, because they didn't trust MtGox more than some common criminal...
...and Bitcoiners once again discover the need for regulation. If my bank didn't have a dollar on hand for every dollar it reported as being in customer accounts, it would be shut down by nightfall and every customer made whole.
Edit: Satire, guys. Sadly, it sometimes becomes indistinguishable from actual misconceptions. Don't believe me? Similar post from my history: https://news.ycombinator.com/item?id=7227291
Yeah yeah, satire. However I think it is important to be clear that "bitcoin" in the US is not "unregulated". There is a reason so many people were using an obviously fly-by-night exchange based out of Japan instead of an exchange based out of the US. That reason is regulation. Just because the laws don't explicitly mention the string "bitcoin" doesn't mean that anything done with bitcoin is untouchable by the law.
The aspect of bitcoin that is "unregulated" by the US government (meaning "not controlled by" the US government) is the production of bitcoin. In that respect, you can think of bitcoin as similar to a bog-standard foreign currency (which the US does not control the production of).
Your bank doesn't have a dollar on-hand for every dollar reported in customer accounts.
It does fractional reserve banking - some proportion of the bank's assets are indeed held in liquid currency, but the rest are held in assets (read: interest-bearing loans) that are worth of the sum or excess of your deposits.
If every depositor tried to withdraw from the bank all at once, the bank would be in trouble and it would likely have to rely on deposit insurance from the government to cover it.
I doubt they would have to resort to deposit insurance. Those loans have value -- they would either borrow from another bank (one of the central banks, or the Fed) against the value of those loans, or sell the loans.
Now this is another interesting thing -- the market value of the bank selling a loan fluctuates inversely with interest. If they have a loan that a customer is paying 8% on, then that loan has a market value much higher if current rates are 3%, and much lower if current rates are 12% (assuming the risk of the loan doesn't change -- that also affects its market value).
No need to be a literalist. My point being: the cash needed to cover withdrawals would have to come from outside the bank's own reserves in the scenario I described.
> If my bank didn't have a dollar on hand for every dollar it reported as being in customer accounts, it would be shut down by nightfall and every customer made whole.
Your bank almost certainly doesn't. Check out fractional reserve banking.
While normal banking regulation allows fractional reserve banking, it is also required to keep tight records of everything and pay into an insurance account that makes everyone whole when these kinds of things happen.
The reason I tend to believe this scenario is because it's completely consistent with their behavior. I watched them very closely, and there seemed to be no rhyme or reason for their behavior. That is, unless they were missing everyone's bitcoin for some reason. Then their behavior made perfect sense.
In that scenario, Mt. Gox would have knowingly traded non-existent Bitcoins for far, far longer than two weeks.
EDIT: I should mention that there's still no evidence whatsoever that malleability somehow led to the loss of >500,000 BTC.