# How the "alchemy of banking" creates deposits with a loan it can use as # collateral to fund the deposit. Bank: your assets are Loan and your liabilities are Deposit Person: your assets are Deposit and your liabilities are Loan Bank: your assets are Reserves? and your liabilities are Cash Person: your assets are -Deposit, Cash Bank: your assets are Cash and your liabilities are Short-term Loan, Collateral # Balance sheets: Bank Person assets | liabilities assets | liabilities --------------------------------------- ----------------------------- Loan | Deposit Deposit | Loan ---------- | ---------- ---------- | ---------- Reserves | Cash -Deposit | ---------- | ---------- Cash | Cash | Short-term Loan | | Collateral | # The Bank created a Loan and Deposit by keystroke. # The Person converted the Deposit into Cash. # The Bank may have had Reserves to cover the Cash withdrawal; # Or, the Bank can get a short-term loan to provide the Cash to the Person. # The Bank can post the original Loan, that it created in the first step, # as collateral. Fed: your assets are Short-term Loan, Collateral and your liabilities are Cash # Suppose the Short-term loan is not repaid. The Fed (or a private money dealer) # has several options: Fed: your assets are -Short term Loan Fed: your assets are Rolled over Short-term Loan Fed: your assets are Collections on Collateral # Fed's balance sheet: Fed assets | liabilities --------------------------------------------------------------- Short-term Loan | Cash Collateral | ---------- | ---------- -Short term Loan | ---------- | ---------- Rolled over Short-term Loan | ---------- | ---------- Collections on Collateral | | # The Fed can write off the Short-term Loan ("-Short term Loan"). # In this case, what has the Fed lost? The Fed's Cash liability is not # constrained. # The Fed can roll over the Short-term Loan. The Bank can put off final # settlement for another day. # The Fed can try to collect on the Collateral provided by the Bank, # i.e. the original loan. In this case, the Fed again has the same options: # The Fed can write off the loan if it can't collect. What has the Fed lost? # The Fed can roll over the loan for the person. # The Fed can garnish the Person's wages or otherwise try to repossess assets # from the Person. Why does the Fed need to collect, though?