Here's a secret: Most money isn't created by the Fed. It's created by banks.

When a bank makes a loan, it doesn't lend out existing deposits. It creates new money. The loan shows up as a new deposit in the borrower's account — money that didn't exist before. This is how the money supply actually expands in practice.

Commercial Banks:

• Create most money through lending (the 'credit multiplier')
• Transmission mechanism between Fed policy and the real economy
• Constrained by capital requirements, reserve levels, and risk appetite
• When banks feel safe, they lend more (credit expands). When they're scared, they stop (credit contracts).

Shadow Banking: Since 2008, traditional bank lending has become a smaller share of total credit. 'Shadow banks' — hedge funds, private credit funds, money market funds, REITs — have grown to become the majority of credit intermediation.

These entities:

• Aren't regulated like banks (less capital required)
• Can leverage aggressively (3-10x or more)
• Use repo markets and securities lending for funding
• Can amplify or dampen Fed policy effects

Why Shadow Banking Matters:

The MOVE Index (MOVE) (bond volatility) controls shadow bank leverage. When MOVE is low, shadow banks can leverage up — effective liquidity multiplies. When MOVE spikes, they must delever — liquidity evaporates even if the Fed hasn't changed policy.

This is why 80% of lending now involves collateral (Howell). Understanding the collateral system is essential for understanding modern liquidity.