i'm a financial idiot. so asking for expert who can tell me why banks borrow money from other banks everyday and would collapse when fail to do so? what's the consequence of high Libor? Thanks!
Banks are geared to infinity. What they loan, they don't have as assets. What they invest, they don't have as assets. Basically, they loan out every asset they have, then borrow more to: a) either loan again or b) invest on behalf of the bank Bank operations depend on that revolving line of credit from other, more cash rich banks/institutions/funds, to maintain their day-to-day operations, cash flow, payments, market positions, hedge exposure etc. Basically, banks are wayyyyy too leveraged and need that money to ensure they don't blow up (or take a loss, or maximize profits). Thats my understanding, anyway. Could be wrong.
When this first started to melt down I started to read up on fractional reserve lending. I was told they have to have 10% liquid reserves. So I call my credit union, where I have a large chunk, and they say NCUA, FDIC equiv. only requires 7%, but they are great because they have 11%, wow I feel better!
The Bill just passed apparently legislated reserves to 0%. I kid you not. In theory, this could alleviate the FED of any control it has over price stability/inflation/interest rates by ceding control of Money Supply altogether. If this is indeed the case, it won't be long until the economy implodes totally. Maybe 10 years max before we get another colossal inflationary boom, then a apocalyptic Crash. Basically, if reserve is set to 0%, it won't matter what the FED lends at because banks would just create the money they need (and lend at whatever they want)......
i see! Thanks alot. 7% is very unbelivably low. assumes most participants in the economy only need less than 7% cash?? and they(banks) could still have extra cash to cover up astronomical loss on CDO and at the same time deal with withdrawal by savers who's lost confidence on them?? crazy people, crazy country.