Bank deposit reserve ratios and ever increasing debt

When I claim that the deposits made in a bank by its customers serve to increase the banks reserves against which they can make further loans, I sometimes get the rebuttal that such deposits aren't assets to the bank, but liabilities. The rebutter notes that ones checking and savings accounts deposits represent liabilities to the bank, not assets.

This rebuttal is a half-truth talking point that is absurdly misleading. Banks don't and wouldn't just generate liabilites without a compensating asset. My cash deposit in my bank account represents two bookkeeping entries (as is typical with double entry bookkeeping) to the bank. The cash I handed over to the teller goes into their vaults, increasing their assets. The corresponding and balancing debit entry describes the IOU they essentially give me in return for my deposit, where that IOU grants me the right, under specified conditions, to demand the return of my money.

The bank can loan out the money it has, though it also has to retain some regulated amount of reserves to cover the liabilities of the potential withdrawals from the demand deposits it holds.

On related issues ...

We commonly account in blog discussions for this reserve requirement as requiring that the bank hold 10% of its demand account liabilities in reserves. However I seem to recall reading that the actual reserve requirements vary between 0% and 10%, depending on the size of the account, where small accounts have a 0% reserve requirement. I also seem to recall reading that actual reserve ratios of the major American banks is more like 3%.

Putting all this aside, things have gotten much worse (less conducive to stability in times of economic stress) for the major banks in the last five or ten years, due to their being able to package up the mortgages they hold for their customers into Mortgage Backed Securities and sell these securities for money. Just as the size of the available backing for Treasuries was greatly extended from just the banks to mutual funds and private investors in the 1970's (see the explanation of the "subsequent explosion in the size and breadth of bond markets", at http://www.gold-eagle.com/gold_digest_04/blumen081204.html), once again, in the 2002-2007 recovery following the dot-com bust, the available backing for bank reserves was greatly extended once again using securitized mortgages. Now a bank was not constrained to loan out some (large) percentage of its deposits and capital. Instead a bank could bundle up what loans it had extended so far, sell them for cash, and issue yet more loans. A vastly greater pool of debt was formed.

That pool is now draining.