Discussion Paper

No. 2011-8 | April 19, 2011
Release of the Kraken: A Novel Money Multiplier Equation’s Debut in 21st Century Banking

Abstract

Use of a promise to pay by a bank to insure an outstanding loan in order to return the value of the insured amount into capital for use in writing a new loan is an invention in banking with calculably greater potential economic impact than the original invention of reserve banking. The consequence of this lending invention is to render the existing money multiplier equations of reserve banking obsolete whenever it is used. The equations describing this multiplier do not converge. Each set of parameters for reserve percentage, nesting depth, etc. creates a unique logarithmic curve rather than approaching a limit. Thus it is necessary to show behavior of this new equation by numerical methods. It is shown that remarkable multipliers occur and early nesting iterations can raise the multiplier into the thousands. This money creation innovation has the demonstrated capacity to impact nations. Understanding this new multiplier is necessary for economic analyses of the GFC.

Data Set

Data sets for articles published in "Economics" are available at Dataverse. Please have a look at our repository.

The data set for this article can be found at: http://hdl.handle.net/1902.1/16628

JEL Classification

E17 E20 E51 H56 H63

Cite As

Brian P. Hanley (2011). Release of the Kraken: A Novel Money Multiplier Equation’s Debut in 21st Century Banking. Economics Discussion Papers, No 2011-8, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2011-8

Assessment



Comments and Questions


Anonymous - Very helpful
April 20, 2011 - 01:52

I found this paper to be extremely helpful in grasping the mathematics of the recent meltdown. It is very well-written, well-researched and helpful. I hope that it will be published very soon.


BPHanley - Thanks - this is a narrowly focused facet
December 15, 2011 - 23:12

This is not a complete explanation of the GFC. It is, rather, an aspect that needs to be understood.

For instance, according to legal records, the practice of creating "liar loans" may have been deliberate by Citibank. Those loans were then bundled into securities, sold, and CDS's were ...[more]

... acquired for the maximum possible amount. In theory, more than one CDS could be acquired for a single CDS. Obviously though, rigging the underlying security to fail in order to profit is an economically parasitic activity akin to arson fraud on the conventional insurance industry. This is why the court threw out the proposed SEC settlement on the case.

There is a further problem, however. Equally obviously, any insurer is set up to handle events on a reasonable actuarial basis. Gaming the insurer must crash the insurer. Anybody who designs a large-scale system to expect payment beyond what the insurer can possibly pay off is either not thinking straight, or expecting public bailout from the start.

I did not attempt to account for such activity.

I also want to point out here, as some seem to have missed it in the conclusions, that in theory, as long as ratings agencies properly rate underlying securities, the banking multiplier I elucidate should not create problems. Problems occur, as in standard banking, when loans are granted to borrowers who are not sound. That is a failure of judgment, which is different.


Brian Hanley - Attachment to the paper
October 12, 2011 - 11:40

See attached file


BPHanley - Corrected strange print formatting
December 15, 2011 - 22:59

The posted version of the Powerpoint slides print has odd formatting.
I also added page numbers. Kraken equation detail proper starts on page 11.


BPHanley - Synthetic capital sans CDS
December 15, 2011 - 22:17

Note this announcement that implements the kind of synthetic capital described in the "Release of the Kraken" article, but without the formality of obtaining a CDS as a promise to pay in order to move a loan into available capital.

Essentially, this is backdoor fiat money creation in ...[more]

... my opinion.

http://www.ecb.int/press/pr/date/2011/html/pr111208_1.en.html

8 December 2011 - ECB announces measures to support bank lending and money market activity

The Governing Council of the European Central Bank (ECB) has today decided on additional enhanced credit support measures to support bank lending and liquidity in the euro area money market. In particular, the Governing Council has decided:
...
To reduce the reserve ratio, which is currently 2%, to 1%
...
To increase collateral availability by (i) reducing the rating threshold for certain asset-backed securities (ABS) and (ii) allowing national central banks (NCBs), as a temporary solution, to accept as collateral additional performing credit claims (i.e. bank loans) that satisfy specific eligibility criteria.


Anonymous - Comment
December 16, 2011 - 09:34

The paper provides a nice illustration of the potential implications of allowing banks to substitute credit default swaps for tier 1 or tier 2 capital. As concerns the consequences for overall money multipliers the author should balance his presentation by discussing potentially countervailing effects via the CDS originator’s balance sheets. ...[more]

... Otherwise a nice paper that might be publishable after a bit of polishing.