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| The Money Lenders by
Quentin Metsys - 1466 |
Robert Bonomo,
Contributing
WriterActivist
PostMuch has been said about both the moral hazard of banks
being bailed out and people bailing out of mortgages. The major question raised
was, Would this ‘bailout’ contagion infect the integrity of our economic and
political system? But far more interesting and much less discussed are the
mechanics of modern banking and their moral implications.
During the
housing boom trillions were loaned out in mortgages creating a housing bubble
and the eventual collapse of the financial markets. But where did all that money
come from? The vast majority of people think that banks borrow money from the
Fed or depositors at one rate, lend it at another and make a spread. This
concept is completely false. Banks create money, loan it out, make their margin
through compound interest, and destroy the same money that they created as it is
paid back.
The
Mechanics of Fractional Reserve Banking
The mechanics of
modern banking are opaque, misunderstood and arguably dishonest. Modern fiat
money, the dollar, euro, yen etc are all based on debt. For every dollar in
existence, there is somewhere an IOU for the same amount. This is best
illustrated with an example of a typical mortgage.
Imagine
Jack wants to buy Jill’s house for $100,000 and he has no money to buy it so he
goes to his local bank and asks for a mortgage which is approved. The bank will
ask Jack for a promissory note, an IOU, for the $100,000 and once he signs it,
they open an account in which they create from nothing $100,000 for Jack in
exchange for his IOU. That $100,000 is a liability for the bank, their asset is
the IOU. The bank just ‘created’ $100,000 which is backed by the good faith of
Jack to pay it back as well as the deed to the house he bought. Now the bank
loans that money to Jack, with compound interest. The interest is the fee the
bank charges for monetizing the debt. Jill would not have wanted an IOU from
Jack for the 100K, so the bank did him the service of converting his IOU into
dollars, and for this service they charge him interest. As Jack pays down his
mortgage principal, the value of the IOU will be drawn down as well, until all
the money ‘created’ is destroyed, and the IOU is worthless.
The money
never existed before Jack signed his IOU. It was created entirely and only as an
expression of his promissory note. All car loans, student loans and personal
loans are created in this way, and it is the exclusive right of banks and the
Fed to create money, except for coinage which is handled by the Federal
Government. Banks are restricted as to how much money they can create by the
amount they have on reserve with the Fed. The formula is complex, but, for
simplicity's sake, it is around 10 times as much as they have on reserve,
(actually more). If the bank has 1 million dollars on reserve with the Fed, for
which they are now paid interest, they can create and loan out about 10 million
dollars. Banks are paid for the privilege of creating and leasing money. This is
our modern, fractional reserve banking system.
How does this differ from how other things that are
borrowed or leased? When a house is leased, the owner must buy the house, then
rent it, forfeiting his capital in exchange for an asset, the house. The typical
return on residential real estate is about 5%, anything with a return of 10%
would be snapped up in an instant. So how much do banks make when they loan
their ‘created’ money out? Let’s assume Jack has been a good boy, and gets a
fixed rate loan of 5% on his $100,000 mortgage for a period of 10 years. The
bank is obligated to leave $10,000 in reserve, or 10% of the amount loaned out,
but they do not give up the money, and they are now paid interest on it, so the
bank now has no borrowing cost, only an opportunity cost. The return on the
bank’s $10,000 is Jack’s compound interest payments of 5% on $100,000, or
$5,000, a neat 50% return on their money. As he pays off the principal, the
banks also frees up the corresponding amount in reserves, so the margin stays
the same. On a 20% interest credit card with an outstanding balance of $10,000,
the bank is holding $1,000 in reserve on which it is making 200% a year. Of
course the bank has salaries to pay, rent, administration fees, marketing etc.
but it is, nonetheless, a very lucrative business model.
What is special
about banks that allows them such profitability? First, what is money? Money is
two things: a store of wealth, and a means of exchange. Many would define money
as human labor. Let’s say Jack is a truck driver and makes $50,000 a year, (very
close to median US household income). Jack has recently married, bought a house
and become a good boy and doesn’t pitter his money away anymore on wine and
women, he now saves $1,000 every month, about one week's work for Jack and the
average American family (before taxes). When he asks his bank how much they will
pay him on his saving account, they say 1%. This seems legitimate to Jack, since
they loaned him $100,000 at 5%. In fact, it seems like a very low margin to him
as he assumes that the banks are loaning the money that other people like Jack
have on deposit. Banks do not loan out deposits, deposits are used for
reserves.
For Jack to earn $100,000 would take him two years of driving a
truck, for which he would be paid by a bank a few thousand dollars in interest a
year. For a bank, however, $100,000 is created digitally in miliseconds, and
they are paid $5,000 a year in interest and if the borrower defaults, the bank
will foreclose on the house with the full force of the law. Jack drove a truck
for 2 years to make 100k, it is a store of value of his work, but what did the
bank do in exchange for the interest on the 100k they loaned Jack?
Money
is human labor transferred to a store of value, like dollars, euros, gold or
silver. (NOTE: WHY NOT ISSUE EACH OTHER OUR OWN MONEY? LOOK UP "WHAT'S A DOLLAR" ON MY BLOG, FREEDOM GUIDE) For example, when someone pays $30 for a kilo of fish, they are not
paying for the fish in the ocean, they are paying for it on their plate. The
difference between a happy fish swimming in the deep blue sea and a grilled
halibut glistening before you is human effort. All other businesses that want to
get a return on an asset must first buy the asset with money earned through
work. This is not the case for banks. They earn interest on something they don't
create.
In fact, a Minnesota Judge, Martin V. Mahoney, and a jury threw
out a foreclosure on defendant Jerome Daly for just that reason. Daly argued
that the there was no consideration in the contract between himself and the
First National Bank of Montgomery. Consideration means both parties must give up
something for there to be a contract. For example, if Jack offers to paint
Jill’s apartment for free, there is no contract between them. If Jack bails on
his offer to paint, Jill cannot sue him. Judge Mahoney ruled the bank gave up
nothing in the contract. They created the money out of thin air hence they did
not commit anything to the contract; there was no consideration and the bank
could not foreclose.
For everyone except banks, money is an expression of
human labor, creativitity, or even luck. But for banks, money is something they
simply 'create' in exchange for IOU's. What Jack works ten years to pay back
should not have the same value as what the bank created in the blink of an eye.
They are two different things, yet they are treated as one.
How do
Banks Lose Money?It seems incredible with such a business model
how banks could ever lose money, but they do. The problem for the banks is
always the IOU’s. Fiat money is based entirely on outstanding debts. Modern
money is based on debt and every dollar must be tied to outstanding IOU. But
when the underlying IOU that backs up the debt becomes worthless, the bank must
back up the ‘created’ money up with real money: deleveraging.
Let’s say
Jack loses his job and stops paying his mortgage, and his $100,000 house is now
worth $50,000 due to a crash in housing prices. Once Jack has been found to be
certifiably broke, the bank must replace the IOU with reserves in the amount of
the loan outstanding. Assuming Jack never made a payment, the bank must now add
$90,000 to its reserves which, plus the original $10,000, will constitute the
full amount of money they created. Once they foreclose on his house and get the
$50,000 the bank is now in the whole for 50 grand. This is why banks
traditionally only loaned 80% of the value of a home. The 20% was calculated to
pay for expenses and fees, leaving them in a breakeven scenario in the case of
an initial default.
But the bank's bag of tricks seems to have no end,
according to
Forbes:
They (the commercial banks) are allowed to accrue interest on
non-performing mortgages until the actual foreclosure takes place, which on
average takes about 16 months. All the phantom interest that is not actually
collected is booked as income until the actual act of foreclosure. As a resullt,
many bank financial statements actually look much better than they actually are.
At foreclosure all the phantom income comes off the books of the banks. This
certainly explains some of the reluctance of banks to speed up the foreclosure
process.
The same leverage that allows banks to make 50% returns on
mortgages, and 200% returns on credit cards works in reverse when people default
on loans, and it sucks up the bank’s liquidity like a thirsty sailor.
The
liquidity problems of banks are directly tied to the very same leverage they use
to make their immense margins. Banks are given a machine that makes money, for
which they must leave deposoit of 10% of the money they want to ‘create’. When
they give the machine back, they must show that all the money they created has
been ‘destroyed’ (paid back) or they must make up the difference.
Banking
is a fabulous busniness on the simple condition that risk is always controlled.
When greed trumps risk, banks go south.
The Lure of
Sub-primeBanks will often package loans, securitize them into
mortgage backed securities, and sell them off. The principal money is destroyed
and the IOU is passed on to the buyer of the security. The banks keeps the
margin they make on the deal, plus whatever interest had been paid before they
sold the loan, along with fees etc. The problems began when greedy souls noted
the difference between a 5% mortgage and 8% mortgage. For the Ivy league
trained, this is no mere 3%, but a healthy 30% (10 leverage * 3%). Over a ten
year period, the difference in the amount of interest paid on a 5% $100k
mortgage ($27K) and an 8% $100k mortgage($45K) is a whopping 66% increase in
ROI. Jack sees 3% and says big deal, Lloyd Blankfien sees 66% and gets himself
into a frenzy doing God’s work...
Combine the greed with a rising prices
that kept foreclosures to a minimum (who defaults on a house they can sell and
make money on?) and it is clear how the leveraged orgy began and what kept it
going. As Citibank's John Prince put it “you have to keep dancing while the
music is playing”.
Perfect Games and Rigged
GamesFrom
The New York
Times :
Perfect trading quarters on Wall Street are about as rare as perfect
games in Major League Baseball. On Sunday, Dallas Braden of the Oakland
Athletics pitched what was only the 19th perfect game in baseball history. But
Bank of America, Citigroup, Goldman Sachs and JPMorgan Chase Company produced
the equivalent of four perfect games during the first quarter(2010). Each one
finished the period without losing money (trading) for even one day.
Did the same "beautiful minds" doing "God’s work" that blew up the
world financial system suddenly find their fast ball? More like Vaseline and a
razor blade, or in banking lingo, the carry trade.
The Fed Discount
Window was a mechanism used by the Fed to make very short term loans to member
banks facing liquidity problems, the loans where generally paid back within
hours and the rate was 100 basis points (1%) above the Fed funds rate. During
the credit crunch in 2008 the Fed loosened the terms on the Discount Window,
extending the terms up to 90 days (one quarter) and reducing the rate to 25
basis points (.25%).
So how did the banks turn this into a money machine? They
borrowed from the Fed using around 30 times leverage at .25% and immediately
bought US Treasury 10 Year Notes at 3.5%. Doesn’t seem like a big spread?
Imagine that you start with $10 million in assets. You borrow $300 million, you
make 3.25% (3.5% - lending cost .25%) on 300 million dollars. The banks interest
earnings are $9.75 million a year, or about $800K a month on an initial outlay
of $10 million, 8% return a month or 97% a year. One hell of a big strike
zone.
This begs the question of how interested are the banks in stopping
wars and reigning in the federal budget deficit. The moral hazard here is
twofold as the banks reap risk free, incredibly high returns from budget
deficits and all the destruction they entail and the taxpayer ends up paying the
spread. The Fed charges banks .25% and the Treasury pays the banks 3.5% and the
difference is paid by Jack and Jill.
In the current PIIGS crisis,
Portugal, Ireland and Greece are being 'bailed out' to insure that the banks
recieve full payment on the bonds they hold. At least one generation will live
and work in austerity in order to pay back banks with 'real' money raised with
hard earned taxes to pay for that which was created without a drop of sweat and
with a few clicks of a mouse.
The New York
TimesIn May of 2010, two months after the banks ‘perfect’
quarter,
The New York Times ran a
front-page
piece about a middle-class family in Florida that had opted without
qualms for strategic default on their home .
Foreclosure has allowed them to stabilize the family business. Go to
Outback occasionally for a steak. Take their gas-guzzling airboat out for the
weekend. Visit the Hard Rock Casino.
The article had over 800
comments, a lot even for
The New York Times. The blogoshpere lit up with
outrage over these ‘deadbeats’. But how many people understand how banks
actually work? Would there be the same outrage if people understood that the
money they were given was made with a few clicks of a mouse? You don’t see cover
stories in
The New York Times on the mechanics of banking. It just
doesn’t happen.
Everywhere banks are foreclosing on homes and even
forcing austerity on entire nations as payment for the money they loaned, and
the risks they assumed. But did they actually lend real money? Was the money
they lent created through work or was it simply a slight of hand for which they
now demand their pound of flesh? As the entire world financial system becomes
undone people will begin to understand that money as a store of value and work
and the money banks lend are two very different things for which the banks want
you to think they are one and the same.
Read more from Robert
Bonomo at his blog, Cactus
Land, which continues to explorethe ideas of his novel, Cactus Land available at Amazon.
Posts
Now, the question comes to HOW?
You can go after the elected officials in a emergency recall election-and the death of Mr. Cooper qualifes by itself as a scandal worthy to topple those oath traitors, but dig up as much dirt as possible. Run with a full campaign ticket of candidates to do a proper job.
To find out more google “freedom guide it’s time” and “freedom guide recall election: obstacles to overcome”.
The other means require physical training, marksmanship and combat training, and a good rifle you’ve mastered.
http://www.theagitator.com/2011/06/21/police-man-killed-by-police-during-paramilitary-drug-raid-shows-dangers-of-paramilitary-drug-raids-dangers-police-must-face-every-day/comment-page-2/#comment-1196486