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0 pointseru3y ago0 comments

Properly unregulated banks are actually less likely to experience runs.

Backing by USD is not required. As you say, anything they can liquidate is good. Doesn't have to be USD. This works best when you are over-capitalised, ie when you have a thick equity cushion, so that when your assets go down in terms of USD, you still have enough balance sheet assets left to cover all your USD obligations.

You are right that trying to be stable makes things more systematically risky. If Tesla stock drops by 20% over night, some people are going to lose money, but the finance system won't collapse. If supposedly stable assets drop by 20%, everything can go wrong.

That's part of why government backed deposit insurance for banks and too-big-to-fail are problems.

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dalbasal3y ago

Being stable just gives it a certain risk profile: regular profits, with a chance of occasional apocalypse. Modest, of course, relative to the sum "under management." Two-and-twenty. The kind of game we've been known to lose.

I don't think it really matters what the underlying assets are. Once the bank runs, it'll probably run dry. "Equity cushions" don't work. The banks own shares suck as a hedge against a run. Assets do hedge against a run. But, once a run is truly happening... it's unlikely to stop. Eventually reserves run out. Assets, credit, etc. I don't buy the idea of assets "calming" a run. In a collapse, the assets are only good as a currency to literally pay out exiting holders.

That said, it's possible to keep the game going a long time. Decades even, depending on the levels of greed and luck.

Stablecoins are still new. The derivatives death star is still not fully operational.

eruOP3y ago

I'm not sure you understand how an equity cushion works.

Suppose you start a company with 1,000 kg of gold. No other assets, no liabilities. Currently, that gold is worth about 60 million USD.

Now you issue 1,000,000 'stable' tokens. Each can be redeemed for one USD. For simplicity, assume that you just give them away.

At current gold prices, your tokens are 60x over-capitalised. If the gold price collapses 90%, your tokens are still 6x over-capitalised. That's what I mean by an equity cushion.

A 'run' is everyone trying to redeem their tokens. If that happens, you just sell one million dollars worth of gold, and pay that obligation. You are not running out of anything here.

In historical practice in eg Scotland, the banks that issued private bank notes there kept an equity cushion of about 30% around. That means for every 70 pounds in liabilities, they had 100 pounds of assets on their balance sheet. (For comparison, in our example of 60x over-capitalisation, that's an equity cushion of 59/60 = ~98%. Or for the 6x over-capitalisation, it's 5/6 = ~83%.)

It's called an equity cushion, because on a balance sheet the excess of assets shows up at equity.

That equity on the books is very different from the banks shares. It's the difference between 'book value' and 'market value'. See https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile... for a table with price-to-book-values (PBV). You can also look up that value for any specific firm online.

> I don't think it really matters what the underlying assets are. Once the bank runs, it'll probably run dry.

That might be true in the most trivial sense: if a bank has plenty of underlying assets, like our example that was 6-60x over-capitalised, there will never be a run. So the 'once the bank runs' condition would never happen.

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Technical detail: I completely avoided the question of reserves here. Mostly, because it's not actually very interesting. The bank will keep some reserves on hand, so that they can pay out routine redemptions immediately. They would be well advanced to follow the role model of the Scottish banks: their notes came with an 'option clause'.

The 'option clause' says that the bank can either redeem notes right away at par, or they can opt to 'pay' with a super-senior IOU that accumulates a punitive interest rate but that the bank can choose to pay back any time.

That option gives the bank time to liquidate assets, if they ever ran out of reserves. The punitive interest rate re-assures customers that the bank would not abuse that privilege it willy-nilly.

(Of course, that mechanism only helps with illiquidity. It does not protect against insolvency. But that's fine: it's better for the economy when insolvent companies cease operations.)

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