I’m currently working my way through economics 101 (i.e. The Mystery of Banking by Murray Rothbard), and I have a question about fractional reserve banking.
When loan on a house goes bad and the house is foreclosed, I think this means that the bank buys it. Does that mean that the cash reserves of the bank go down by the full amount of the loan on the house, whereas before the loan was covered by only a fraction of this amount?
If this is the case then if the bank was required to maintain a 10% reserve ratio, and 1 in 10 of their mortages defaulted leading to foreclosure, then would the bank have to call in or sell off every one of its mortgages to maintain its reserve ratio?
If the bank was unable to sell off mortgages in the amount of the inverse of the reserve ratio (in this example 10) times the dollar amount of its foreclosures to date, it would then be failing to meet its required ratio.
The bank already bought the home, hence there are mortgages. A mortgage is where the bank pays for the home and then the homeowner pays every (insert time period here) to buy the home from the bank. Because of this, if the owner neglects to pay for their home, the bank takes what they have already paid for. Therefore, the cash reserves have nothing to do with the equation since the original mortgage was already credited out on the left side of the equation. Banks never have to pay with their cash reserves for a home that has been defaulted on, because the forseeance of possible problems such as what would happen if that were the case today.