Bank Reserves And Loans: The Fed Is Pushing On A String 

The money multiplier effect no longer works.

As you (hopefully) know, we live in a fractional reserve banking system: if the bank is required to have $1 in cash reserves for every $10 in loans, it means the bank creates $10 of new money when it issues a $10 loan. When the $10 loan is paid off, that money vanishes from the system.

The problem with fractional reserve lending is the leverage. A 10-to-1 reserve ratio means that if the bank issues a $10 loan, the borrower defaults and the borrower’s collateral (home, auto, etc.) only fetches $8 on the open market, the bank lost $2, which is more than the bank’s cash reserves ($1).

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