Monday, 17 November 2014

Monopoly Money

Update: I have got some details about spending of deposits wrong. I'll be writing a followup post with new details I'll be updating this post with a corrections

Most people have no idea how banks actually work. They don't lend deposits, they actually create the loan and the deposit simultaneously. If you don't believe me then go and have a look at what the Bank of England have to say about it. The good people at positive money also have a lot to say about it.

I thought it would be a great idea to put together some custom rules for Monopoly that would portray a realistic bank not because it would make the game any more fun but because it would perhaps give people a sense of how unfair it would be to have another player not only having the game rigged in their favour but also attributing their good fortune to skill or luck.

Game play would involve double entry book keeping so you can imagine that this variant of the rules would be tremendous fun for all the family

Having sat down to work out the mechanics of the gameplay using spreadsheets I was quite surprised at what it taught me.

So let's start with the rules and see how that goes.

The board is set up as usual except one player is designated the bank and they keep tally of all the transactions on a spreadsheet instead of handing out cash

All players get to keep their money in the bank. The bank not only gets to spend it's own money, but it gets to spend the player's money as if it was its own.

The bank can lend money to players without regards to deposits. Fresh money is deposited in the player's account and the bank is able to spend that money as if it was its own. The debt is counted as an asset of the bank. Loan repayments are made every time the player passes go. The player pays back 10% of the loan and no more than 10% interest. The bank may set the interest rate lower than 10% if it wishes.

If a player is unable to make a loan repayment, they may sell their assets to repay the loan in full, If they still have insufficient funds then they may restructure their loan spreading the remaining debt across 10 repayment periods.

If the bank has spent all of the deposited money and needs to pay its bills it may auction any property or debts that it  possesses to other players.

If the bank is not able to raise sufficient funds to pay its debts then it is declared bankrupt and all the players lose their money. The player with the highest value assets wins.

So how does this work in practice? Lets look at a three player game.

The players roll a dice to see how gets to be banker. The high roller gets to be the banker.

The bank has £1500 starting money as do the other two players. The bank records two liabilities of £1500 each for the other two players and increases its current account by £3000

So the bank has an asset (the money) and a liability (the money it owes the players) the bank has capital which is equal to its assets minus its liabilities.The capital hasn't changed so the net worth of the bank is still £1500 that it started with, but it now has £4500 that it can invest in revenue generating property.  What the bank has done is borrowed the savings of its customers.

Right from the start the bank has as much spending money as all of the players put together. That seems a little unfair doesn't it?

After  a few rounds the players are running out of money and want to borrow some so that they can continue buying property. So the bank lends a player £1000. For the sake of simplicity we will set the interest rate at 0%

The bank gets a new asset. It is the IOU from the borrower and it's worth £1000. The borrower gets a deposit of £1000 but a deposit is a liability because the bank gets to use the money as if it was its own.

So the bank has the deposit of £1000 plus the IOU of £1000 which makes £2000 of assets but it only has a liability of £1000 so by making a loan of money that it didn't possess, it increases its current account by £1000 and its capital has also gone up by £1000. This must be why banks like lending.

This capital gain is only temporary, when the borrower pays the money back this gain in current account and capital will go back down but in the meantime the bank can invest it and hopefully make more money. So even at 0% interest there is some value in making loans.

If the bank has spent all the deposits and gets faced with a bill, its going to have a liquidity crisis. It will have assets which are the streets that it bought with the money but in the real world these types of assets would take time to liquidate and the bank would have to borrow money to pay for it, if the bank is under-capitalised then the other banks might not want to lend to it. In which case it would go bust , or get bailed out by the tax payer.

In the game the bank will need to sell some of it's assets either to the players or directly to the state. You can probably tell that it is very unlikely that the bank is going to have a capital crisis where it has insufficient assets to pay money out.

What I have taken away from this is that not only does the lending of money create  money for the lender but it also creates money for the bank even if they are not charging fees. Lending money increases a bank's capital and liquidity simultaneously.

I'll be writing some more on this using worked examples from a spreadsheet to explore different transactions and what happens when people default.

We can also look at the moral hazards that are created by this situation.

Update: I have got some details about spending of deposits wrong. I'll be writing a followup post with new details I'll be updating this post with a corrections

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