Fact Check: Large banks “rehypothecate” money meaning they loan out the same amount of money to multiple parties, thus increasing the money supply.

The Claim: "Large banks 'rehypothecate' money meaning they loan out the same amount of money to multiple parties, thus increasing the money supply."

Introduction

The claim suggests that large banks engage in a practice known as rehypothecation, where they loan out the same amount of money to multiple parties, thereby increasing the overall money supply. This assertion raises questions about the mechanisms of banking, the nature of money creation, and the implications for financial stability.

What We Know

1. Rehypothecation Defined: Rehypothecation refers to the practice where banks or financial institutions reuse collateral that has already been pledged for a loan to secure additional borrowing. This can lead to a situation where the same collateral is used multiple times, potentially increasing liquidity in the financial system 35.

2. Money Creation: In traditional banking, banks operate under a fractional-reserve system, meaning they are required to keep only a fraction of deposits as reserves while lending out the remainder. This process can effectively increase the money supply, as loans create new deposits 10.

3. Federal Reserve Insights: The Federal Reserve has discussed the implications of collateral reuse, indicating that rehypothecation can influence liquidity and risk in the financial system. Their analysis suggests that while rehypothecation can enhance liquidity, it also introduces complexities and potential vulnerabilities 24.

4. Research on Banking Fragility: Recent academic work has explored the relationship between rehypothecation and banking fragility, suggesting that while it can provide liquidity benefits, it may also contribute to systemic risks if not managed properly 36.

Analysis

The claim that banks rehypothecate money to loan it out multiple times raises several points for scrutiny:

• Source Reliability: The sources cited include academic papers, government publications, and reputable institutions like the Federal Reserve. For instance, the Federal Reserve's notes on collateral reuse provide a foundational understanding of how rehypothecation operates within the financial system 2. However, the complexity of the topic means that interpretations can vary, and not all sources may agree on the implications of rehypothecation.

• Methodology Concerns: The methodologies used in studies examining rehypothecation often involve complex financial modeling and assumptions about market behavior. For example, the thesis by Andrew Fu discusses the potential impacts of rehypothecation on banking stability, but it is essential to consider the assumptions and limitations of such models 3.

• Potential Conflicts of Interest: Some sources may have inherent biases. For instance, academic institutions may focus on theoretical implications, while financial institutions might emphasize practical benefits. It's crucial to assess whether the authors have any affiliations that could influence their perspectives.

• Contradicting Views: While some sources argue that rehypothecation can enhance liquidity and efficiency in the banking system, others caution against its potential to exacerbate financial instability. The notion that rehypothecation directly increases the money supply is debated, as it may depend on broader economic conditions and regulatory frameworks 45.

Conclusion

Verdict: Mostly True

The claim that large banks rehypothecate money, allowing them to loan out the same amount to multiple parties and thereby potentially increasing the money supply, is mostly true. Evidence supports the notion that rehypothecation can enhance liquidity and facilitate the lending process within the banking system. The Federal Reserve and various academic studies indicate that while rehypothecation can lead to increased liquidity, it also carries risks that could affect financial stability.

However, it is important to note that the relationship between rehypothecation and money supply is complex and not universally agreed upon. The extent to which rehypothecation directly increases the money supply may depend on various factors, including regulatory frameworks and broader economic conditions. Additionally, the methodologies used in studies on this topic often involve assumptions that may not hold in all scenarios, which introduces a degree of uncertainty.

Readers are encouraged to critically evaluate the information presented and consider the nuances involved in discussions about banking practices and their implications for the economy.

Sources

1. Banks Cannot And Do Not "Lend Out" Reserves. Harvard Kennedy School. Link
2. The Fed - The Ins and Outs of Collateral Re-use. Federal Reserve. Link
3. Rehypothecation and Banking Fragility. Amherst College. Link
4. Liquidity Windfalls: The Consequences of Repo Rehypothecation. Federal Reserve. Link
5. Rehypothecation and Intermediary Leverage - University of Pennsylvania. Link
6. Shadow Banks and the Collateral Multiplier. UMass ScholarWorks. Link
7. Repo Market Intermediation. Office of Financial Research. Link
8. Csun. Link
9. How Banks Create Money. Harper College. Link
10. Fractional-reserve banking - Wikipedia. Link