 Asset backed securities have been extensively criticised for creating a moral hazard in loan issuance by removing any incentive on the lender to ensure that the recipient of such loans could repay them. However the inter-relationship between money and loans within the commercial banking system, also suggests that deeper systemic issues can accompany any form of unlimited commercial bank lending . This paper examines the question of why speculative demand for credit during credit bubbles is not naturally constrained by regulated limits within the banking system on the supply of loans. In particular, we propose an explanation for the current credit crisis, as a fundamental, systemic failure in the system of rules governing the behaviour of the reserve based banking system, which have resulted in the effective removal of central bank control over money and loan supply expansion. This situation has arisen from the presence of two 'bugs' in the underlying regulations controlling the banking system: securitized loans, which allow the sale of loans issued against fractional reserve controlled deposits to entities outside of the commercial banking system; and allowing debt instruments , in particular securitized loans to be part of bank equity capital reserves which are used for the purpose of regulating the total quantity of credit created by the banking system. We  argue that the interaction of these two problems has led to unregulated growth in both the money and loan supplies, and to a dangerously destabilising imbalance between total money and loan supply growth, in that total lending  from the commercial bank sector has increased at a faster rate than the accompanying money supply growth supporting it .
Analysis of the 2007-8 credit crisis has concentrated on issues of relaxed lending standards, and the perception of irrational behaviour by speculative investors in real estate and other assets. Asset backed securities have been extensively criticised for creating a moral hazard in loan issuance and an associated increase in default risk, by removing the immediate lender's incentive to ensure that the underlying loans could be repaid. However significant monetary issues can accompany any form of increased commercial bank lending , and these appear to have been overlooked by this analysis. In this paper we propose a general explanation for credit crises based on an examination of the mechanics of the banking system, and in particular its internal controls on the supply of credit. We suggest that the current credit crisis is the result of multiple failures in the Basel regulatory framework, including the removal of central bank reserve requirements from some classes of deposit accounts within the banking system, allowing financial instruments representing debt to be used as regulatory capital, and in particular the introduction of securitized lending which effectively removed a previously implicit control over the total quantity of lending originating from the banking system. We further argue that the interaction of these problems has led to a destabilising imbalance between total money and loan supply growth, in that total lending sourced from the commercial bank sector increased at a faster rate than accompanying growth in the money supply. This not only created a multi-decade macro-economic debt spiral, but by increasing the ratio of debt to money within the monetary system acted to increase the risk of loan defaults, and consequentially reduce the overall stability of the banking system .
A
Analysis of the 2007-8 credit crisis has concentrated on issues of relaxed lending standards, and the perception of irrational behaviour by speculative investors in real estate and other assets.
R
by removing any incentive on the lender
and an associated increase in default risk, by removing the immediate lender's incentive
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recipient of such loans could repay them. However the inter-relationship between money and loans within the commercial banking system, also suggests that deeper systemic
underlying loans could be repaid. However significant monetary
R
unlimited
increased
R
. This paper examines the question of why speculative demand for credit during credit bubbles is not naturally constrained by regulated limits within the banking system on the supply of loans. In particular, we propose an explanation for the current credit crisis, as a fundamental, systemic failure in the system of rules governing the behaviour of the reserve based
, and these appear to have been overlooked by this analysis. In this paper we propose a general explanation for credit crises based on an examination of the mechanics of the
R
which have resulted in the effective removal of central bank control over money and loan supply expansion. This situation has arisen from the presence of two 'bugs' in the underlying regulations controlling the banking system: securitized loans, which allow the sale of loans issued against fractional reserve controlled deposits to entities outside of the commercial banking system; and allowing debt instruments , in particular securitized loans to be part of bank equity capital reserves which are used for the purpose of regulating the
and in particular its internal controls on the supply of credit. We suggest that the current credit crisis is the result of multiple failures in the Basel regulatory framework, including the removal of central bank reserve requirements from some classes of deposit accounts within the banking system, allowing financial instruments representing debt to be used as regulatory capital, and in particular the introduction of securitized lending which effectively removed a previously implicit control over the
R
credit created by
lending originating from
A
further
D
two
R
unregulated growth in both the money and loan supplies, and to a dangerously
a
A
sourced
D
has
R
the accompanying money supply growth supporting it
accompanying growth in the money supply. This not only created a multi-decade macro-economic debt spiral, but by increasing the ratio of debt to money within the monetary system acted to increase the risk of loan defaults, and consequentially reduce the overall stability of the banking system