Even though I’ve heard Mish rail against fractional-reserve lending repeatedly, I’m not convinced that it is the ultimate problem. I think the mortgage market could work fine on fractional-reserve lending if everyone was forced to put 40% down on their mortgages. It would be easy to sell pretty much any mortgage at any time if there was a 40% equity cushion. Thus, even if a bank had all deposits withdrawn in a short time, it would likely be relatively easy for the bank to sell all of it’s mortgages in order to meet those withdrawals.
I think the real problem is ‘financial innovation’. It is likely that a decent financial system came into being after each of the financial panics and that banking lobbyists worked over time to weaken that system. In this most recent cycle, banking lobbyists were able to reduce the requirements for mortgage down payments from 20% to -10% on negatively amortizing loans. The Republicans led by Phil Gramm were also able to get Glass-Steagall repealed. There is no way a financial system can survive that type of chicanery regardless of whether fractional-reserve lending is used or not.
Besides, if banks can’t lend against deposits, what can they lend against? What is the alternative to fractional-reserve banking?
