That’s probably the first question that Phelon Davis of District Heights, Maryland, asked himself when a homeless man shuffled into the Wells Fargo branch in Georgetown where Davis worked as a teller three years ago and tried to deposit a garbage bag full of cash.
His next question was probably "do you think he"d notice if some of it went missing?"
Instead of helping the customer deposit the money into his account, Davis instead decided to take advantage of the situation, setting up a fraudulent second account under the customers’ name and eventually stealing more than $185,000 from the man, according to the Washington Post.
The 29-year-old bank teller stole more than $185,000 from a homeless customer who tried to deposit a garbage bag full of cash at a Wells Fargo branch in Georgetown.
In a deal with prosecutors, Davis pleaded guilty this week to one federal felony count of interstate transportation of stolen property, which is punishable by up to 10 years in prison.
Deepening the intrigue surrounding the story, the court filings didn’t name the man, or furnish an explanation as to how he came to possess such a large sum of cash. It describes the man only as a "street vendor."
The victim was unnamed in court filings but was described as a homeless street vendor and longtime Wells Fargo customer who had more than one account that had gone dormant because of a lack of activity.
Court filings did not identify the customer or say why a homeless person would have a large amount of cash in a bag when he showed up at the M Street NW branch where Davis worked. Outside the courtroom, Davis’s attorney, Bruce Allen Johnson Jr., said he also did not know how the individual came to have the cache of cash. “That’s the million-dollar question,” Johnson said.
In plea papers, Davis acknowledged that the customer had “thousands of dollars of cash” that he wanted to deposit in October 2014, but he lacked identification. Davis told the customer where to get ID documents and a Social Security card, and also noted the customer “had a surprisingly large balance with the bank,” according to a signed, three-page statement of the crime.
Soon after the customer tried to deposit the cash, Davis fraudulently opened a new account by forging the customer’s signature, set up an ATM card, personal identification number, email address and online logon that he controlled.
He initially funded the account with $3,000 from one of the customer’s other accounts, according to WaPo.
Slowly over the next two years, Davis transferred $177,400 between the customer’s accounts, withdrew $185,440, and transported at least $5,000 withdrawn from ATMs in DC to his home in Maryland – triggering the federal charge.
The customer remained oblivious to the fraud, as he could only see the balance by checking on his account at an ATM.
Davis used the stolen money for a down payment on his home, to pay off personal debt, and fund vacations in Aruba, Jamaica, the Dominican Republic and Mexico.
As part of his plea, Davis agreed to pay back the stolen money, and Assistant US Attorney Kondi J. Kleinman said he would likely face a sentence of 18 to 30 months under federal guidelines. However, the sentencing judge has discretion to assign a longer, or shorter, sentence.
“Did you, in fact, take money from an account as Mr. Kleinman described?” U.S. Magistrate Robin M. Meriweather asked in the Thursday plea hearing.
“Yes, ma’am, I did,” said the soft-spoken Davis.
Davis’s attorney, Johnson, said outside of court that “he greatly regrets the decisions he made and is dedicated to doing everything he can to make it right, including restitution. He is putting everything aside to repay the money and do what he can to repair what he’s done to his name, his reputation and to the victim.”
WaPo reports that a date for Davis’s sentencing hasn’t been set.
One of the recurring laments about the Fed"s hiking cycle, most recently from Goldman, is that despite 2 rate hikes so far this year, financial conditions remain the loosest they have been in over two years.Whether that is due to the market being so drunk on the Fed"s "punch bowl" it is unable to grasp the liquidity is being dragged away, or for some other unknown reason despite repeated warnings by FOMC members that stocks here are overvalued, markets simply refuse to concede that financial conditions should be tighter, in fact, as Goldman observed yesterday "so far, the Fed’s efforts to tighten financial conditions have achieved too little, not too much."
That, in the view of Bank of America"s rates strategist Shyam Rajan is a big mistake because as he explains in his latest note titled "When paint dries, does the wall crumble?" despite the market"s repeated unwillingness to acknowledge what the Fed is doing, "recent market moves mark the beginning of a prolonged tightening of financial conditions."
And, more notably, he underscore that despite the benign financial condition regime, the market is missing one key thing: in light of what the market perceives as a "benign flow effect" the risk currently is in the the Fed"s balance sheet "stock" and adds that "we think the market is complacent on the stock effect of the Fed"s balance sheet decline. Specifically, higher deposit betas, UST supply and/or real rates could all trigger significantly tighter financial conditions."
To underscore his point, Rajan shows the following chart which shows just how vast the upcoming normalization will be, in light of the moves for both inflation expectations and real rates that took place during QE2 and QE3, and how small the unwind has been so far under the Fed"s tightening regime. As Rajan explains further (more below), "ever since the conversation for the Fed shifted from hikes to balance sheet after the March meeting, we have seen a significant increase in real rates and a decline in inflation expectations: the anti-QE trade. Recall that the primary objective of an expanded balance sheet was to push real yields lower (when the nominal funds rate was constrained at 0) and inflation expectations higher. As shown in our Chart of the day, when looked at through that lens, the reversal over the last few months is just the beginning of a long process."
Rajan"s main point, as noted above, is that while the market has remained focused on the central bank flow which it - erroneously - assumes will not be a major risk factor, what the market should be looking at instead is the stocks. He explains:
With rate hikes in the background, market and policymakers’ attention has squarely moved to the Fed’s balance sheet. In this regard, over-communication from Fed officials to prevent a repeat of the taper tantrum has no doubt helped. Repeated emphasis on the balance sheet being a “passive tool” and the tapering reinvestments being equivalent to “watching paint dry” seem to have convinced markets that the initial steps ($6bn UST, $4bn MBS runoffs) are unlikely to cause disruptions. Yet, while the market appears very comfortable with the flow effect, we think the longer-term stock effect is underappreciated.
Specifically, we identify three areas where the market seems most complacent going into the unwind experiment.
Does the balance sheet unwind lead to an increase in deposit betas sooner than expected?
Can the resulting increase in Treasury supply have a significant impact on yields?
Will the increase in real yields have knock-on implications for other asset classes? All three signal a significant, albeit slow moving, tightening of financial conditions up ahead.
Going back to a point we have pounded the table on since 2011, Rajan notes that the excess reserves created by the Fed have created a liquidity illusion on bank balance sheets, in the form of excess deposits (the same excess deposits which not only are not inert as many erroneously assume, but are in fact what JPM"s London Whale used - as collateral - to corner the IG market with notable consequences).
It is these deposits that wil now contract as the Fed proceeds to normalize. Here is Rajan:
Ultimately, as the Fed’s balance sheet shrinks, so does the banking systems’. On the asset side, banks lose cash (excess reserves) while on the liability side deposits leave (to absorb the new Treasury supply) triggering a mirror image decrease of the Fed’s sheet. However, critical to this process is the kind of deposits that leave the banking system. Although consensus remains that given the $2.1tn in excess reserves, competition for deposits will be non-existent, this assumption is heavily reliant on the less stable deposits leaving the system first (corporate, non-operational, etc.) before the more stable ones (FDIC insured retail deposits). Were the first run-offs in October to trigger the more LCR friendly retail deposit outflow, significant knock-on implications could result:
Deposit betas will be projected to rise faster than expected resulting in a repricing of the asset side of bank’s balance sheets (loans, mortgages etc.;
If deposit rates were to increase (and deposit-IOER spreads decline), demand for short-dated fixed income, especially at current levels (close to IOER) is likely to dramatically reduce.
Third, cash will increasingly become an attractive asset to rich valuations across asset classes. This would reduce the safe haven premium of USTs to hedge against a risk-off.
Then there is the issue of issue of Treasury supply-demand imbalance, something we first touched upon at the start of the month in "BofA: "If Bonds Are Right, Stocks Will Drop Up To 20%." This point can be summarized simply as follows: there is $1 trillion in excess TSY supply coming down the line, and either yields will have to jump for the net issuance to be absorbed, or equities will have to plunge 30% for the incremental demand to appear.
Rajan summarizes these concerns below:
An unwind of the Fed’s balance sheet also increases UST supply to the public. Ultimately, the Treasury needs to borrow from the public to pay back principal to the Fed resulting in an increase in marketable issuance. We estimate the Treasury’s borrowing needs increase roughly by $1tn over the next five years due to the Fed rolloffs. However, not all increases in UST supply are made equal. This will be the first time UST supply is projected to increase when EM reserve growth likely remains benign. Note both the 2003-06 and 2009-13 increase in UST supply were met with the largest increase in Chinese buying of USTs. With this unlikely to repeat, we believe price sensitive buyers need to step up. Our analysis suggests this would necessitate a significant rise in yields or a notable correction in equity markets to trigger the two largest remaining sources (pensions or mutual funds) to step up to meet the demand shortfall. Again, this is a slower moving trigger that tightens financial conditions either by necessitating higher yields or lower equities.
Treasury market dynamics aside, BofA says that the third, and perhaps most important, aspect of renormalization is that the forward path of the balance sheet decline is already having an impact on one market in the form of rising real yields:
Ever since the conversation for the Fed shifted from hikes to balance sheet after the March meeting, we have seen a significant increase in real rates and a decline in inflation expectations: the anti-QE trade (Chart 3). Recall that the primary objective of an expanded balance sheet was to push real yields lower (when the nominal funds rate was constrained at 0) and inflation expectations higher. As shown in our Chart of the day, when looked at through that lens, the reversal over the last few months is just the beginning of a long process.
The message from this combination (higher real rates, lower breakevens) is that even though there is a decline in nominal interest rates, the composition is a “bad” decline.
Besides rates, the "bad" decline shown above is negative for risk assets because ultimately "lower inflation expectations (if right) should lower forward earnings growth estimates (as earnings grow with nominal GDP) while higher real rates should raise discount rates for these earnings: an unfriendly outcome for risky assets."
Which brings us to Ra"jan"s gloomy conclusion: "Ultimately, all three of the above – a repricing of the asset side on bank balance sheets higher, higher term premium because of UST issuance, and higher real yields – signal tighter financial conditions up ahead."
While slow moving, the knock-on impact on asset classes either through a shift in the underlying supply or demand dynamics is significant. We remain a structural bear on real rates to position for this scenario.
And, if right, the conclusion by the BofA strategist is precisely what Yellen, Fischer, Dudley and others have been desperate to communicate to the market over the past 5 months - unsuccessfully - when pointing out as recently as Tuesday, that “Asset valuations are somewhat rich if you use some traditional metrics like price earnings ratios, but I wouldn’t try to comment on appropriate valuations, and those ratios ought to depend on long-term interest rates."
Judging by stocks" reaction to the latest yield spike, the market may be finally getting it.
Private Banks - Not the Government or Central Banks - Create 97 Percent of All Money
Who creates money?
Most people assume that money is created by governments ... or perhaps central banks.
In reality - as noted by the Bank of England, Britain"s central bank - 97% of all money in circulation is created by private banks.
Bank Loans = Creating Money Out of Thin Air
But how do private banks create money?
We"ve all been taught that banks first take in deposits, and then they loan out those deposits to folks who want to borrow.
But this is a myth ... The Bank of England the German central bank have explained that loans are extended before deposits exist ... and that the loans create deposits:
The above is from an official video released by the Bank of England. The Bank of England explains:
Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money. The reality of how money is created today differs from the description found in some economics textbooks:
Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
***
One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them. In this view deposits are typically ‘created’ by the saving decisions of households, and banks then ‘lend out’ those existing deposits to borrowers, for example to companies looking to finance investment or individuals wanting to purchase houses.
***
In reality in the modern economy, commercial banks are the creators of deposit money .... Rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.
***
Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created. For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans. *** This description of money creation contrasts with the notion that banks can only lend out pre-existing money, outlined in the previous section. Bank deposits are simply a record of how much the bank itself owes its customers. So they are a liability of the bank, not an asset that could be lent out.
Similarly, the Federal Reserve Bank of Chicago published a booklet called “Modern Money Mechanics” in the 1960s stating:
[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts.
Monetary expert and economics professor Randall Wray explained to Washington"s Blog that:
Bank deposits are bank IOUs.
Economics professor Richard Werner - who obtained his PhD in economics from Oxford, was the first Shimomura Fellow at the Research Institute for Capital Formation at the Development Bank of Japan, Visiting Researcher at the Institute for Monetary and Economic Studies at the Bank of Japan, Visiting Scholar at the Institute for Monetary and Fiscal Studies at the Ministry of Finance, and chief economist of Jardine Fleming - was granted access to study a bank"s books, and confirmed that private banks create money when they simply create fictitious deposits into a borrower"s account. Werner explains:
What banks do is to simply reclassify their accounts payable items arising from the act of lending as ‘customer deposits’, and the general public, when receiving payment in the form of a transfer of bank deposits, believes that a form of money had been paid into the bank.
***
No balance is drawn down to make a payment to the borrower.
***
The bank does not actually make any money available to the borrower: No transfer of funds from anywhere to the customer or indeed the customer’s account takes place. There is no equal reduction in the balance of another account to defray the borrower. Instead, the bank simply re-classified its liabilities, changing the ‘accounts payable’ obligation arising from the bank loan contract to another liability category called ‘customer deposits’.
While the borrower is given the impression that the bank had transferred money from its capital, reserves or other accounts to the borrower’s account (as indeed major theories of banking, the financial intermediation and fractional reserve theories, erroneously claim), in reality this is not the case. Neither the bank nor the customer deposited any money, nor were any funds from anywhere outside the bank utilised to make the deposit in the borrower’s account. Indeed, there was no depositing of any funds.
***
The bank’s liability is simply re-named a ‘bank deposit’.
***
Banks create money when they grant a loan: they invent a fictitious customer deposit, which the central bank and all users of our monetary system, consider to be ‘money’, indistinguishable from ‘real’ deposits not newly invented by the banks. Thus banks do not just grant credit, they create credit, and simultaneously they create money.
***
Instead of discharging their liability to pay out loans, the banks merely reclassify their liabilities originating from loan contracts from what should be an ‘accounts payable’ item to ‘customer deposit’ ....
How Can Banks DO This?
Professor Werner explains the reason that banks - but no one else - can create money out of thin air is that they are the only institution exempted from normal accounting rules. Specifically, every other company would be busted for fraudulent accounting if they conjured new money out of thin air by reclassifying a liability (i.e. an accounts payable) as an asset (i.e. a deposit). But the banks have pushed through exemptions so that they don"t have to follow normal accounting rules:
What enables banks to create credit and hence money is their exemption from the Client Money Rules. Thanks to this exemption they are allowed to keep customer deposits on their own balance sheet.This means that depositors who deposit their money with a bank are no longer the legal owners of this money. Instead, they are just one of the general creditors of the bank whom it owes money to. It also means that the bank is able to access the records of the customer deposits held with it and invent a new ‘customer deposit’ that had not actually been paid in, but instead is a re-classified accounts payable liability of the bank arising from a loan contract.
***
What makes banks unique and explains the combination of lending and deposit-taking under one roof is the more fundamental fact that they do not have to segregate client accounts, and thus are able to engage in an exercise of ‘re-labelling’ and mixing different liabilities, specifically by re-assigning their accounts payable liabilities incurred when entering into loan agreements, to another category of liability called ‘customer deposits’.
What distinguishes banks from non-banks is their ability to create credit and money through lending, which is accomplished by booking what actually are accounts payable liabilities as imaginary customer deposits, and this is in turn made possible by a particular regulation that renders banks unique: their exemption from the Client Money Rules. [Werner gives a concrete example on British law for banking and non-banking institutions.]
Sound fraudulent? Professor Werner thinks so, also:
But he also makes some more important points ...
What Does It All Mean? The Implications of Money Creation By Private Banks
Mainstream economists believe that private debt doesn’t even “exist“ as a force that acts on the economy. For example, Ben Bernanke and Paul Krugman assume that huge levels of household debt don’t hurt the economy because more debt among households just means that savers have loaned them money … i.e. that it is a net wash to the economy. To make this assumption, they rely on the myth debunked above ... that banks can only loan as much money out as they have in deposits. In reality, 143 years of history shows that excessive private debt – in and of itself – can cause depressions.
Moreover, Professor Werner points out that attempts to shore up the banking system with capital requirements (such as the Basel accords) are doomed to failure, since they don"t recognize that banks create money at will:
Basel rules were doomed to failure, since they consider banks as financial intermediaries, when in actual fact they are the creators of the money supply. Since banks invent money as fictitious deposits, it can be readily shown that capital adequacy based bank regulation does not have to restrict bank activity: banks can create money and hence can arrange for money to be made available to purchase newly issued shares that increase their bank capital. In other words, banks could simply invent the money that is then used to increase their capital. This is what Barclays Bank did in 2008, in order to avoid the use of tax money to shore up the bank’s capital: Barclays ‘raised’ £5.8 bn in new equity from Gulf sovereign wealth investors — by, it has transpired, lending them the money! As is explained in Werner (2014a), Barclays implemented a standard loan operation, thus inventing the £5.8 bn deposit ‘lent’ to the investor. This deposit was then used to ‘purchase’ the newly issued Barclays shares. Thus in this case the bank liability originating from the bank loan to the Gulf investor transmuted from (1) an accounts payable liability to (2) a customer deposit liability, to finally end up as (3) equity — another category on the liability side of the bank’s balance sheet. Effectively, Barclays invented its own capital. This certainly was cheaper for the UK tax payer than using tax money. As publicly listed companies in general are not allowed to lend money to firms for the purpose of buying their stocks, it was not in conformity with the Companies Act 2006 (Section 678, Prohibition of assistance for acquisition of shares in public company). But regulators were willing to overlook this. As Werner (2014b) argues, using central bank or bank credit creation is in principle the most cost-effective way to clean up the banking system and ensure that bank credit growth recovers quickly. The Barclays case is however evidence that stricter capital requirements do not necessary prevent banks from expanding credit and money creation, since their creation of deposits generates more purchasing power with which increased bank capital can also be funded.
Moreover, Werner points out that banks create the boom-bust cycle by lending too much for speculative, non-productive purposes:
By failing to take into account the fact that banks create money, economists and governments are sowing the seeds for future crashes. But the economics field is very resistant to change ... Economics professor Steve Keen notes in Forbes:
In any genuine science, empirical data like this would have forced the orthodoxy to rethink its position. But in economics, the profession has sailed on, blithely unaware of how their model of “banks as intermediaries between savers and investors” is seriously wrong, and now blinds them to the remedy for the crisis as it previously blinded them to the possibility of a crisis occurring.
A wit once defined an economist as someone who, when shown that something works in practice, replies “Ah! But does it work in theory?”
Around [the 1960s] banks began to completely disappear from most macroeconomic models of how the economy works.
This helps explain why, when faced with the Great Recession in 2008, macroeconomics was initially unprepared to contribute much to the analysis of the interaction of banks with the macro economy. Today there is a sizable body of research on this topic, but the literature still has many difficulties.
***
Virtually all recent mainstream neoclassical economic research is based on the highly misleading “intermediation of loanable funds” description of banking ...
***
In modern neoclassical intermediation of loanable funds theories, banks are seen as intermediating real savings. Lending, in this narrative, starts with banks collecting deposits of previously saved real resources (perishable consumer goods, consumer durables, machines and equipment, etc.) from savers and ends with the lending of those same real resources to borrowers. But such institutions simply do not exist in the real world. There are no loanable funds of real resources that bankers can collect and then lend out. Banks do of course collect checks or similar financial instruments, but because such instruments—to have any value—must be drawn on funds from elsewhere in the financial system, they cannot be deposits of new funds from outside the financial system. New funds are produced only with new bank loans (or when banks purchase additional financial or real assets), through book entries made by keystrokes on the banker’s keyboard at the time of disbursement. This means that the funds do not exist before the loan and that they are in the form of electronic entries—or, historically, paper ledger entries—rather than real resources.
***
This “financing through money creation” function of banks has been repeatedly described in publications of the world’s leading central banks—see McLeay, Radia, and Thomas (2014a, 2014b) for excellent summaries. What has been much more challenging, however, is the incorporation of these insights into macroeconomic models [how true].
What"s the Solution?
We"ve seen the problems created by failing to take into account the fact that private banks create money. But there are solutions ... Initially, Professor Werner notes that preventing banks from creating new money to loan for speculation and mere personal consumption would prevent booms and busts:
Werner says that the "Asian Miracle" happened for exactly this reason:
Additionally, allowing small community banks to grow would cause the real economy to flourish ... since small banks loan to small businesses (which create most of the jobs), while big banks only loan to giant companies and speculators:
There"s a war raging in connection with banking. Remember that the giant banks tried to kill off community banking through the Trans Pacific Partnership. And as Professor Werner points out, the European Central Bank is currently in a war to destroy community banks:
