Now available for download – a technical report written by Jacky Mallett, affiliate researcher of IIIM. Title of the paper is “What are the Limits on Commercial Bank Lending?”. Preprint submitted to Elsevier, September 20th, 2010.
The report presents a controversial theory, with backing evidence, about the cause of the financial crash in 2008, and why it will probably happen again soon. It took a computer scientist, with an eye on algorithms, to crack what many economists failed to understand. See download link and abstract below.
Asset backed securities have been extensively criticized for creating a moral hazard in loan issuance by removing any incentive on the lender to ensure that the recipient of such loans could repay them[? ]. However the inter-relationship between money and loans within the commercial banking system, also suggests that deeper systemic issues can accompany any form of unlimited commercial bank lending. This paper examines the question of why speculative demand for credit during recent credit bubbles was not constrained by the regulated limits within the banking system on the supply of loans. In particular, we propose an explanation for the current credit crisis, as a fundamental, systemic failure in the system of rules governing the behaviour of the reserve based banking system, which have resulted in the effective removal of central bank control over money and loan supply expansion. This situation is created as a result of the inter-working of two ’bugs’ in the underlying regulations controlling the banking system: securitized loans, which allow the sale of loans issued against fractional reserve controlled deposits to entities outside of the commercial banking system; and the inclusion of some forms of debt instrument in Bank regulatory capital in conjunction with a failure to explicitly regulate the total quantity of equity capital throughout the banking system. We argue that the interaction of these two problems has led to unregulated growth in both the money and loan supplies, and to a dangerously destabilizing imbalance between total money and loan supply growth, in that total lending from the commercial bank sector has increased at a faster rate than the accompanying money supply growth supporting it.
Download the report here: What are the Limits on Commercial Bank Lending? (PDF).
Preprint submitted to Elsevier, September 20th, 2010.