> when a bank collapses, some money disappears (because of fractional reserve banking)
The money doesn't disappear when the bank collapses. It disappears if the loans that defaulted and caused the bank to collapse are written off instead of being assumed by some other party. If the borrower's inability to pay is only temporary, the loan probably won't be written off; it will just be restructured, and the money won't disappear.
OK. But those loan defaults are what lettergram feared would cause the banks to collapse. So they're not independent. The bank can collapse from other reasons, and loans can default without the bank collapsing, but in the scenario lettergram was talking about, loan defaults cause the bank failures.
So, you're right, but I think my overall point still stands.
> those loan defaults are what lettergram feared would cause the banks to collapse. So they're not independent.
You're missing my point. I'm not arguing that the loan defaults are independent of the bank failures; obviously they're not.
I'm arguing that the loan defaults, and the consequent bank failures, by themselves don't cause money to disappear. For money to disappear, the defaulted loans have to be written off, instead of restructured. If they're only restructured--i.e., the borrower negotiates a new payment plan with the new lender (whoever takes over the bank's assets when the bank fails)--then the money doesn't disappear. And, as I said, since the borrower's inability to pay is only temporary, caused by an external event, I expect most of the loans to be restructured, not written off.
But if they're going to be restructured - if they're solid enough for that to be possible - would the bank fail? If I understand correctly, the bank becomes insolvent when the loans are written off. (Note well: I am not a banker.)
> if they're going to be restructured - if they're solid enough for that to be possible - would the bank fail?
That depends on the bank's cash flow position and their reserve assets. It's quite possible that the bank might not be able to sustain, say, a couple of months of loans not being repaid even if the loans are ultimately going to be restructured.
Of course, one obvious way to forestall this would be to extend short-term credit to the bank itself. IIRC this was done during the 2008 crisis. I have not seen talk yet of that being done now, but I would not be surprised if it were.
The money doesn't disappear when the bank collapses. It disappears if the loans that defaulted and caused the bank to collapse are written off instead of being assumed by some other party. If the borrower's inability to pay is only temporary, the loan probably won't be written off; it will just be restructured, and the money won't disappear.