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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 1, 2008 - 11:03pm PT
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Here's another illustration for you with numbers since you like them.
from
http://moneygirl.quickanddirtytips.com/money-how-banks-work.aspx
How Banks Make Money
Banks make money by making loans. Depositors put money into the bank and the bank turns around and lends the money out to a borrower. The interest rate the bank charges a borrower is higher than the interest rate it pays on deposits. Banks make money off this difference, which is called the “spread.”
Banks Lend Many Times More than They Have
But that’s just the beginning. The amount of money that a bank can lend is actually much, much greater than the deposits in the bank. Banks lend out many times more money than they actually have. How much they can lend out depends on the reserve requirement set by the Federal Reserve.
In the United States, reserve requirements are typically 10% of the total value of the checking accounts at the bank. A small reserve requirement magnifies the amount of money banks make from lending money.
Think about it this way: If your bank has a 10% reserve requirement and you deposit $1000 in your checking account, the bank must keep 10% or $100, but it’s free to lend out $900 at interest. The person who borrows that $900 will spend it and it will usually be deposited into another bank. Then that bank will do the same thing. It will keep 10% or $90 and then it’s free to lend out the rest at interest, which is $900 minus the $90, or $810. This process is repeated again and again, and is called “fractional reserve banking.” Each time the bank receives a deposit, it keeps 10% as reserves and can lend out the rest at interest.
After this process has been repeated as many times as possible, that $1000 you originally deposited in your bank can actually be turned into as much as $10,000 in the overall money supply. You can calculate the $10,000 by dividing your initial $1,000 deposit by 10%.
In this way, the total money supply in the economy increases when banks make loans. But, when the money supply increases, the consequence is inflation. Fractional reserve banking leads to inflation."
I can find a thousand examples of this on the web, showing the same money is doubled up on paper to create imaginary "reserves" to justify loans. Why don't you get this?
I actually had a better example but I couldn't post the tables here and that made it confusing
it was from
http://www.discusseconomics.com/banking/where-do-banks-get-their-money/
Fatty says they make money on the multiplier. TIG, can you explain what the multiplier is? I seem close to your Loising point.
peace
karl
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JuanDeFuca
Big Wall climber
Stoney Point
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Anyone watch the video I linked?
juan
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 1, 2008 - 11:10pm PT
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I downloaded it but haven't watched it yet. I did paste criticisms from Ron Paul as an example in one of these posts.
Peace
karl
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JEleazarian
Trad climber
Fresno CA
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I teach economics at a local community college. I've also represented lenders and borrowers as insolvency counsel for almost 30 years. This thread would be hilarious if it didn't represent the beliefs of intelligent people.
I can't possibly address all of the misinformation, so I'll start with a bit about the banking system and "problem loans" that may help in the understanding of the current economic turmoil.
When a bank makes a loan, it changes its asset from cash to an account receivable. Banks make money by borrowing from depositors at a lower rate than they make by lending to borrowers. Banks perform a useful function by allowing those with money to loan and those seeking loans to get together, and for the lenders to spread their risk. Otherwise, if I wanted to buy a house, say, I'd either need cash or I'd need to find an individual with a few hundred thousand dollars he didn't need for, say, thirty years.
Regulations require banks to maintain certain cash reserves, and certain financial ratios. If a borrower defaults on a loan, for example, the bank is required to classify that loan as a non-performing asset. This diminishes the bank's capital base, its ability to make loans, and therefore its profitablity. That's why banks often sell fully secured but defaulted loans, with no realistic chance of non-payment, at a discount. Getting the cash now bolsters their cash reserve, and gets a defaulted (and probably undervalued) loan off the books.
The current market turmoil reflects the sorts of bubbles that always occur, but this one has rather more juice. Real estate values increased because consumers could get real estate loans for relatively low interest rates. Most consumers buy a house based on the monthly payment. A $100,000 30-year loan at 12% and a 200,000 30-year loan at 4.39% have the same monthly payment -- $1,028.61. As interest rates fall, the amount of money one can borrow rises. This leads to more ability to pay for real estate, which leads to higher demand, and higher real estate prices. Add a few subsidies, Fannies and Freddies, and prices can rise a lot.
This leads to a higher valuation of two different types of assets: real estate, and loans secured by real estate. As soon as prices level off -- usually because interst rates rise (even a little) -- these loans get shaky because the loan-to-value ratio falls below acceptable limits.
Most of us think residential real estate prices are too high. Most people could not afford their current homes if they had to buy them just on their income. As those prices fall, the market value of loans secured by real estate go into a free fall. The reasons for this are complex, but involve, among other things, expectations of inflation and interest rates and legal restrictions such as California Code of Civil Procedure Secions 580b, 580d, and 726, that limit a real property secured lender's ability to get repaid except by foreclosure.
Right now, the market doesn't know how to value these real estate loan portfolios, and is valuing them at close to zero. Too low, but what's right? The buyout (called by its critics on the right and left the "bailout") involves We the People buying some of those loans for more than nothing, holding them and disposing of them in something other than a panic. The idea is that everyone will be better off, and it's probably right. I just can't help my natural instinct to hide my wallet when business and government collude.
Sorry for the length and dryness of this, but at least now my conscience is clear and I can go to the gym and boulder a bit.
John
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WBraun
climber
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Thanks John for sharing that information.
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Jeremy Handren
climber
NV
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"Banks perform a useful function by allowing those with money to loan and those seeking loans to get together, and for the lenders to spread their risk".
If Banks did this in actuality then we wouldn't have a problem. The value they add is in the management of risk..and there failure to do this well is the root of the problem.
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 12:00am PT
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Come on John, this thread is about fractional reserve banking and you did nothing to address the definition and meaning of it in terms of what has been written here. This thread is not about the current mess but they system itself.
Definer the banks multiplier for us and the central bank's ability to loan out 10x what it has. (or deny it and show us links to prove it)
Your post has refuted nothing here.
Peace
Karl
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WBraun
climber
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OK Karl
The senate passed the second 700 billion dollar bailout package idea today and sent it back to the house.
What does this mean?
Sorry I'm so stupid on economics and this kind of stuff and I learn from all you guys here, thanks.
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JEleazarian
Trad climber
Fresno CA
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OK, Karl. Now that I've worked out, my forearms are so tight maybe I'll be more succinct. Banks do NOT create money, they loan it. The federal government creates money by making it the only acceptable medium for paying taxes.
The fractional reserve banking system merely says how much of the bank's assets must be in cash, rather than in accounts receivable. It does not create money in any real sense.
Suppose that you and I each have one $20.00 bill. If I lend mine to you, and you give me a $20.00 IOU you now have $40.00, and I have a $20.00 IOU. Now suppose I sell your IOU to, say, Werner, who pays me $20.00 because he knows you're creditworthy (although we haven't met, you strike me as an honorable type). I now have $20.00 and you have $40.00. Do we have more money? You and I together now have more cash, but you also have a $20.00 liability to Werner, and he has $20.00 less. All I've done is transfer the loan from me to Werner.
Fractional reserve banking does essentially the same thing. If a Bank had to cover 100% of its deposits with cash, it could make no loans, and the only way it could make money would be charging customers a service charge on, say, a checking account. Fractional reserves -- meaning that the bank can cover a fraction of its IOU's to its depositors in cash, and the rest in IOU's from its borrowers, allows the bank to pool the money from depositors and loan it to borrowers at a profit. No one creates money by this. The bank takes money from some people and lends it to others. That money gets paid back.
I'll elaborate later, if so desired.
John
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 02:17am PT
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Thanks John
I'm quite certain your missing something. It's this
We both have 100. I loan you 90 but it's just an IOU that Fish will take to make you a haulbag. Fish gives the IOU to me for safekeeping (and interest) and I use his 90 IOW to loan you another 80, and so on.
really, even econ teachers don't really understand the banking system. wrap your mind around it and do the research.
peace
Karl
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 03:13am PT
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Don't worry Lois, the economy will stay depressed. Canning tomatoes, unfortunately, may be a better idea than we think.
Just a reminder that this thread is not about the bailout. That's another level of leverage beyond the basic fractional reserve system we're trying to understand here.
Which is why this shakey tower is ready to fall so quickly. Bank Loan money is already predicated on the assumption that everybody won't take much money out of the bank at once. Then when those loans are packaged, many bad, into securities and bought by other institutions, it creates leveraged opportunities for trouble.
Werner writes
"OK Karl
The senate passed the second 700 billion dollar bailout package idea today and sent it back to the house.
What does this mean?
Sorry I'm so stupid on economics and this kind of stuff and I learn from all you guys here, thanks"
Werner, this is a screwed-up situation that nobody completely understands. It's meant to be that way. I think when the party's over and people look back on it, we'll realize that this is the final installment in the crime of the century.
Nobody is getting straight talk. The mainstream media just says the gov will be using this 700 Billion (that we are going to borrow) and cut taxes at the same time. How does that money work? It's insane.
Studying the corruption of government the past few years, I should have known that following the money would be the key. The Gov are just chumps who work for the money. The Fed and the Banks CREATE the money from debt. Really!
It's a scam. Read those presidential quotes I posted earlier. Why such STRONG words?
Peace
Karl
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 03:16am PT
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Sparky linked
http://www.youtube.com/watch?v=KJJW7EF5aVk
Coyote Catches Road Runner! I always wanted him to eat that Bastard! Too bad the devil was in the details.
Peace
Karl
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JEleazarian
Trad climber
Fresno CA
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Karl,
Thanks for your illustration. On that basis, our disagreement is purely definitional. I am defining money as cash. Your definition includes demand deposits. When the Federal Reserve increases cash, the "multiplier" you describe increases demand deposits by more than the amount of cash, but this isn't creating money from nothing.
Instead, we are, in effect, bartering. The Bank promises to pay me money now. In exchange, I promise to pay the bank more money later. We call that a loan. I trade the bank's promise to pay me to Fish for a pig. Fish trades the bank's promise to pay money now for the bank's promise to pay Fish more money later. We call that a deposit. In the end, I promise to pay the bank, the bank promises to pay Fish, and I have my pig -- and the money never left the bank. The bank acts as the middleman.
As long as Fish doesn't need his cash all at once, we're all fine. If Fish wants his money now, but I promised to pay the bank next year -- and we're the only bank customers -- the bank and Fish have a problem. If I default, and then Fish wants his money, again we have a problem. Ultimately, Fish's ability to get paid depends on my creditworthiness and the relative timing of the loan and deposit.
The FDIC and 70 years of history have thus far kept real world banks from being subject to those sorts of runs. Now investment banks are a different story. . .
John
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 03:34am PT
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Hi John,
Ok, we've come a ways. The bank gives out very little paper money. It's all checks which must be cashed in a bank! So if loan you 90 and get it back from Russ and loan you another 80 and get it back from Sally and loan somebody else 50, then out of my original $100, I've "created" an additional 220. Really.
All our money is created out of debt. Check it out. Google it. Learn money creation. It's amazing.
Interesting observation about the FDIC in Juan's video. Created in a similar situation to today. Now the FDIC limit has been sweetened to $250,000 no?
I'm told WAMU just failed because of a classic bank run (amidst other problems)
peace
Karl
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JEleazarian
Trad climber
Fresno CA
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Werner,
Perhaps surprisingly, I agree with Karl on the bailout-- it's intentionally obscure. I think what the Senate is hoping is that people will calm down and think that it's being taken care of. That's really all they can try to do. As many people have said, if everyone wants all of their money in cash, now, the house comes tumbling down.
From my perspective, the real problem is what I pointed out in my first post (that Karl reminds me is OT). Housing is overpriced relative to incomes. Either we need to lower the price of housing relative to everything else, or we need to raise the price of everything else, including wages, to catch up.
I feared that the Fed would try to do the latter, but thus far it's started to clamp down on money supply growth. (Sorry, Karl, but inflation [which I define as an increase in the GENERAL level of prices for goods and services, measured in current dollars] very much depends on the change in the money supply) The problem is that our economy doesn't deflate easily.
The farming recessions in the middle 1980's and the early 2000's are actually pretty good parallels. Farm prices and consequent values of farmland dropped like a rock (I'm hesitant to use that cliche here). The Farm Credit System -- meaning the FmHA, Land Banks and PCA's -- needed restructuring itself, but most of the loans eventually paid off, because what goes down often comes up in real estate.
I did, however, negotiate one loan in the 1980's to be repaid in an inflating foreign currency (name withheld to protect the guilty). When the loan was repaid, the bank took an enormous haircut, but could book it to currency fluctuations, not to loan defaults.
Hope this helps. If nothing else, it's curing my insomnia.
John
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happiegrrrl
Trad climber
New York, NY
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I agree that Lois canning her tomatoes is the smart choice for her. It would suck very much for me to lose $10,000. Luckily, the only evaporation of my money in the last 2 weeks was about a grand on Teddy medical care(he has contracted Lyme Disease, but he is on meds and hopefully will fully recover). That thousand dollars is money gladly given parted with. About stocks - everyone knows it is gambling. Win some. Lose some. I know my proclivities to gambling and so it is best I steer clear. Having no rady cash makes it a lot easier to do....hahaha.
Americans are being good, and trying our best to assist in this crisis. We ain't running the banks en masse. That is actually - very - huge, when one considers what is going on.
Someone at Facelift said that in these times, the thing to do is to become very generous. I think that we everyday people are doing just that.
Group hug!
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TradIsGood
Chalkless climber
the Gunks end of the country
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Should have called GE, fattie.
Where were you when they wanted a loan?
Commercial paper market market dropped by 95 billion this week.
Pick up the phone and make some calls...
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Karl Baba
Trad climber
Yosemite, Ca
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Topic Author's Reply - Oct 2, 2008 - 12:06pm PT
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All money is debt and is owed to someone. Let's put that in our pipe and smoke it.
from
http://www.freerepublic.com/focus/f-news/888963/posts
"Marriner Eccles was the Governor of the Federal Reserve System in 1941. On September 30 of that year, Eccles was asked to give testimony before the House Committee on Banking and Currency. The purpose of the hearing was to obtain information regarding the role of the Federal Reserve in creating conditions that led to the depression of the 1930s. Congressman Wright Patman, who was Chairman of that committee, asked how the Fed got the money to purchase two billion dollars worth of government bonds in 1933. This is the exchange that followed.
ECCLES: We created it.
PATMAN: Out of what?
ECCLES: Out of the right to issue credit money.
PATMAN: And there is nothing behind it, is there, except our government's credit?
ECCLES: That is what our money system is. If there were no debts in our money system, there wouldn't be any money.
It must be realized that, while money may represent an asset to selected individuals, when it is considered as an aggregate of the total money supply, it is not an asset at all. A man who borrows $1,000 may think that he has increased his financial position by that amount but he has not. His $1,000 cash asset is offset by his $1,000 loan liability, and his net position is zero. Bank accounts are exactly the same on a larger scale. Add up all the bank accounts in the nation, and it would be easy to assume that all that money represents a gigantic pool of assets which support the economy. Yet, every bit of this money is owed by someone. Some will owe nothing. Others will owe many times what they possess. All added together, the national balance is zero. What we think is money is but a grand illusion. The reality is debt.
Robert Hemphill was the Credit Manager of the Federal Reserve Bank in Atlanta. In the foreword to a book by Irving Fisher, entitled 100% Money, Hemphill said this:
If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash, or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless situation is almost incredible -- but there it is."
Think about it. Who knows this? It's mind boggling. Every dollar in existence is owed to somebody somewhere (from a certain perspective)
Peace
Karl
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John Moosie
climber
Beautiful California
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Thanks Karl for studying this. We need to get back to a system based on real good. I think perhaps fractional lending would be okay if the original money was based on some real good. It all starts with the federal reserve that lends the country money it doesn't have and then makes a profit on this money. Something is definitely wrong with this picture.
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