Do you have 45 min's of spare time? If you do you really have to watch this video. It's a bit childish but it really explains how the banking system works and why the credit crisis is happening. I'll give you a brief synopsis. Some rich dude walks into a bank one day and opens a saving account with $1 Million. The bank is required to keep 10% on reserve so they get to lend out 900k. 9 guys walk into the bank and borrow 100k a piece to buy a house. What the bank does from here will probably shock you. The bank does not actually charge the 900k against the 1M the first guy deposited. They actually do the opposite. Because those 9 guys signed a mortgage and promised to pay the bank logs the 900k as an ASSET, not a liability because it is owed to them. Then, because of the 10% reserve requirement then now get to lend out another 810k (90% of the 900k they just logged as an asset). 9 more guys walk into the bank and borrow that 810k and the bank logs the 810k as another asset and and lends out 90% of that, or 729k. 9 more guys walk in and borrow that and the bank logs 656k as an asset, 9 more guys walk in and borrow and the bank logs another 590k, and this cycle keeps repeating until the lending ability from the initial $1M is used up. Once it is the bank needs another depositor. Now, not long ago banks were limited to doing this on a 10:1 leverage ratio, which meant the bank could only spin this web until they reached $10M in loans based on the $1M on deposit. Recently, the government allowed certain banks to go up to 30:1 leverage and in some cases up to 40:1 leverage so on $1M on deposit they could lend $40M. This is what everyone is talking about when they say deleverage and loans are based on current levels of debt NOT deposits. The more a bank lends the more they are able to lend and they can keep going until they reach 30:1. Now, if a guy in the beginning of the line doesn't pay his mortgage - as is the case with just about all subprime borrowers - the well runs dry. Banks don't have payments flowing in so they cannot lend out in addition to the fact that they have to deleverage. The Federal Reserve is pumping massive amounts of money into the system, praying that it won't collapse. Even if they are successful at keeping it afloat now it will eventually collapse at some point down the road. You can't support a debt based system with more debt. What the government is doing is like you and I getting a 10k credit card and if we charge up 9k on it we get another credit card for 8.1k. When we charge up 7.2k on that we get another one for 6.48k and so on, and on and on. You and I can't survive like that because we don't have the ability to borrow massive amounts of money from China or print money at will. The US's financial system is going into ruin. Watch the video: http://www.bigeye.com/moneyasdebt.htm
And, this system was created by the Federal Reserve Act of 1913. It took 16 short years for it to collapse and The Federal Reserve was blamed for making a bad situation worse when they tightened credit when the shit start hitting the fan. The Fed back then did exactly the right thing because they knew the financial system was built on a house of cards and they were caught with their pants down. They stopped creating debt on top of debt. The current Fed is doing the exact opposite. They are trying to fix a debt clogged system with more debt. They are pumping massive amounts of liquidity into the system to try and fix the problem. If the financial system doesn't collapse now it will simply collapse at a later date. The US is on a one way street to financial ruin and very few people understand why.
Wow, money and banking 101 all over again as it has been appearing many times on this site. Are all of you taking the class together?
Fractional reserve banking Money multiplier I knew about this before I started trading. It hasn't helped my timing any.
This is not a fractional reserve system. A FR system can only lend 900k on a $1M deposit. Our current system can lend 10M on a 1M deposit if banks are required to stay under a 10:1 leverage system. When the bank creates a loan it gives them GREATER lending power, not less. People think the Fed creates money by printing paper. That couldn't be farther from the truth. They lower rates to create demand for loans so a bank can fully realize their lending power on that 1M deposit. <b>Our system is not a FR system, it's a perpetual debt system</b> and few people realize it. A fiat currency system that is fueled by debt can only collapse.
I have a much shorter video. Maybe if Ben and Paulson would have watched cartoons more they could have learned something. http://www.youtube.com/watch?v=t_LWQQrpSc4
Thanks for posting that. It led me to this article, which I recommend reading: http://mises.org/story/3138