Let's think about me buying an apartment from you with a mortgage, from Citibank, my bank, okay, how does this really happen, well you know they all this credit check and stuff like that. That's all interesting, but it's not monetary economics, okay? So just assume all that's fine, they figured that I'm a professor, I have a tenure, I'm good for it, whatever. So Citibank is my bank and let's say you bank at Chase. And I am going to buy your tiny little apartment for some ridiculous amount of money, because this is Manhattan. How do I actually do that? This is going to involve the Fed funds market, believe it or not. Believe it or not. That's the startling thing. Well, the first thing I do, is I get a mortgage from Citibank. And what, and the way Citibank gives me that mortgage is by writing a deposit to my credit. So, there's plus mortgage, here. Plus deposit here. [SOUND] Okay? I haven't even put myself on here. Okay? On my balance sheet it'll be just the reverse. Right? I have mortgages of liability, I have this deposit as, as, as an asset. We're getting used to this I think by now. So, the way loans are made is by a swap of values with the bank. The bank says I owe you a million dollars let's make it for a million dollars. It's a nice apartment, it's 200 square feet. So, the, the a, let's make it for a million dollars, just fantasy, okay? And so I, I say to the bank, I owe you a million dollars over the next 30 years, okay? And the bank says to me I owe you a million dollars. On demand. Okay, that sort of deposit, yes. Okay, but it's a swap of IOU's but the timing is different and the person are signing those IOU's is different. You know, when, when, Citybank signs an IOU it's money, okay? When I sign IOU it's credit. So there is a swap of IOU's here. The whole point of this, is to transfer that deposit to you, okay, so that we can transfer ownership of this apartment to me, okay? But you have your deposit in another bank here. So how does that happen? This is a million dollars, we're not holding onto a million dollars worth of reserve just waiting in case I transfer this, there are no reserves here, okay? So what the Fed. I mean what, what what Citibank will do is, when, when they're expecting me to make this transfer and I'm making this transfer at the closing, all of this, I can go, they're going to go into the Fed funds market, they have had their credit department, they know that these payments are coming down, they've been following this, they've been tracking it, and they know they have to fund this mortgage, okay? They have to fund, eventually they're going to package this mortgage with all kinds of other mortgages, securitize it, sell it to Europe, do something. Okay? We'll do, deal with that later in the class. But that takes weeks and months. Okay? This payment has to happen now, and here's how it happens. Okay. Citibank goes into the, goes into the Fed Funds market. And it borrows reserves. A billion of them. And, I'm going to show it borrow, in order to make it more realistic, not borrowing from Chase, okay? Why would Chase do this but borrowing from some third party, let's say HSBC. Okay? HSBC is making this Fed funds loan. Okay? And it is doing this by running down. Some reserves it happens to have on hand. Okay. Perhaps these are, you know, fictional reserves. Perhaps it's running an overdraft somewhere, you know, itself. But at any rate, it's, it's making this loan here. So this is the counterpart of this. This is the counterpart of that. And now, I have, the Citybank has what it needs in order to make this payment. Right. It can make the payment this way. Minus reserves, minus deposit, right. Okay. And then over here Chase plus reserves plus deposit. And I'll put you next to that. Okay. So, the bank, is happy to give you a deposit account, why? Because it has money, okay. It is settled. This thing is settled, okay. It knows, it's not just saying, I won't let you see that money. I am going to clear this check. No, this is all clearing now because we're transferring title, okay. So this is all clearing right now. And it's clearing because there are these reserves that are, that are going back and forth between the banks. You and I never see these, okay? It's just, you just, it just moves in between these deposit accounts, okay? But behind the scenes, its a transfer from one bank's reserve account to another. But let's push this further, so now Chase has these reserves that aren't paying anything, and so it might go into the Fed funds market, and lend them. Okay? So, it might sell these reserves and lend them for a future date to HSBC. Okay? Which is borrowing in the Fed funds market, here. And acquiring reserves. Okay. This, there's a couple of important points about this graph now. Here's the ultimate credit. Mortgage. Okay? Who lent the money for this creditor? Who lent the money? If you follow through, you say, well, Citibank borrowed from HSBC, who borrowed from Chase. Who borrowed from you. In a certain sense, I bought it from you and you lent me the money for it. Okay? Now, you're, we're, we don't, I don't owe it to you. I owe it to these intermediaries so if I default, you'll still get your money. But in terms of the actual source of funds. Okay, it's here, until you spend these, you can spend these and then somebody else has to be the source of funds, okay, until this mortgage gets financed by some pension fund somewhere, okay, at the moment it's basically been funded through the payment system, through a expansion of balance sheets. No one is saved extra money in order to allow me to borrow this, okay. it's just been a transfer, a bouncy transfer at the moment, you have transferred your assets from a house okay into a deposit account okay, I've transferred you know I now have a house and I also have a mortgage, so I used have zero, I still have zero, okay, I'll probably put some down payment in there, too. The other thing I want to point out to you, now, is HSBC. What is HSBC doing, and why are they doing it? They're on both side of the market, right? They're lending Fed funds, and they're borrowing Fed funds. And they're, I'm showing them as flat, in terms of their exposure, but they wouldn't do this unless there was a spread there, okay, that they are lending at one rate, high rate, and they're borrowing at another rate, a low rate. HSBC is a new kind of entity, for this class now; HSBC is acting as a dealer. As a, as a dealer in the Fed funds market. [SOUND] Okay. It's, it's making a market, it's quoting prices, it's saying I'm willing to lend to you at this rate, I'm willing to borrow from you at this rate, and it's trying to set those rates. So that over the course of the day money flows in, money flows out and they match and I collect on the difference between the net asset value. Sometimes more money flows out than money flows in and I have to myself find extra, extra funds, or sometimes it's the other way around. Okay. But I'm as a dealer. Matched book means that I have exactly the same exposure on this side as I do on that side. A matched book dealer. I'm showing HSBC as a matched book dealer here, in the Fed Funds market. Here, what happens if this million dollar mortgage gets paid to the homeowner? Here, this is who you're talking about and he withdraws that. So that's 1mm. That's how Stigam writes a million dollars, 1mm. And now withdraw it, what do you mean by withdraw, in cash? Okay. In cash that is a demand for, that's an outflow of reserves. From the banking system of a million dollars. Okay? Chase, probably does not have, a million dollars, in cash. Certainly not in your local branch. Okay? And, but they might be able to accumulate it, somewhere, and they are promising to, to pay, to pay this. So they will have to come up with that. They can, they can take any reserve position they have in at the Fed. You know, if they have a deposit at the Fed, that's what this is, right. This is a deposit at the Fed. They can go to the Fed and they can say give me cash for this, and the fed will give them a million dollars cash for a million dollars worth of reserves. And then they give you the cash. So just sort of mechanically. There is a million dollars of cash downtown in 33 Liberty street, okay, and that's where they would get it from if they didn't have it in their own, in their own vaults, so, the Fed is then, if you think about, so now I shouldn't draw balance sheets in the air, okay, so the Fed, lets put the Fed in here, the Fed would be lowering its reserves by $1 million, and it's just printing a million dollars worth of cash. It's not printing, it has, it just down there, it's just putting in the circulation $1 million worth of cash. So, it's changing the form in which its liabilities are held, that there is a one more million worth of cash and one less less million worth of reserves. This, so these reserves become million dollars, these million dollars are given to the depositing account that flows out here. That, last time I talked about an internal drain versus an external drain, that's an internal drain right, and it causes no problems, causes no monetary problems because deposit becomes cash and reserve are the, are, are liabilities of the Fed just the same, no problem.