DBC Reed left this comment on my post And ... he's back in the room!:
Now you're back you'd better get in rebuttal mode because Ann Pettifor (in Guardian letters 27.i.10) is saying the kind of things about banks I've been saying for some time (that they just make up the money they dish out as loans,then have the brass neck charge interest on it).
Captain Ranty added:
This has been going on for a very, very long time. Our fiat currency is worthless. Even HM Treasury says so. Have a look at some interesting FOI's that were submitted to them. Pop over to Ranty Barracks. I have been screaming about this since last April.
Take it from me, while banks can cheerfully "create" as many new loans as they can find willing borrowers, those borrowers have to spend that money, and the recipient then puts the money straight back in the bank (taking all banks as a closed system)*.
So while the bank can charge and receive interest on the new loan, it also has to pay interest on the new deposit. The bank in just a middleman. A well-run bank will make a net profit (interest received minus interest paid minus administration costs) on the amounts, but it is not huge - somewhere in the region of half a per cent, which is easily wiped out of the borrower turns out to be less creditworthy than first hoped.
The recipient of the money is, by and large, home and dry and can continue to collect the interest on the full amount, of course.
* To give a simple practical example, I owned my last house outright. Some chap took out a £400,000 mortgage to buy it and gave me the money, which I put straight back in the bank. Hey presto, the banking system has increased its lending side (i.e. its assets) by £400,000 and increased its deposits side (i.e. its liabilities) by £400,000. That 'money' did not exist until the moment of the sale. The bank charges him 5% interest and pays me 3%, out of the £8,000 net profit it has to pay rents, salaries, taxes and some of the money goes to covering losses on the bad loans it makes.
UPDATE: Captain Ranty repeats many common misconceptions in the comments, which I have dealt with there.
Wednesday, 27 January 2010
Another crash course in banking
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8 comments:
One for econoheads:
http://www.youtube.com/watch?v=d0nERTFo-Sk
It looks like you (almost) pity the poor, poor bank.
Tell me where I go wrong here:
1. I need to borrow £100,000 (for a mortgage, say).
2. Before I sign the papers, that £100K does not exist. Just after I sign, the money appears in my account. I have just created money!
3. The bank shows that it has "lent" £100K. Using the fractional system, they can now "lend" their next customer 90% of the money I created.
4. And the next customer 90% of that £90K and so on, and so on.
5. The bank, (correct me if I am wrong here) has done sweet FA apart from shuffling paperwork, and moving digits from nowhere into my account.
6. My promise to pay (via contract) is all that holds this illusion together.
7. I created a great deal of wealth (or debt, if you want the truth) with my original £100K.
8. As a thank you for this, I have to repay the bank my original £100K plus say 5% interest.
9. For tapping a few keys, the bank ends up with £210K just from me.
10. Factor in the additional 90%'s on all the subsequent loans and I have done the country a great service just by walking in the bank and signing a piece of paper.
The bank risks nothing. The bank lends nothing. WE create wealth, and WE get spanked for it.
CR.
CR, that comment crossed with my footnote.
1,2 correct.
3, wrong. It has to give the £100,000 to the person who sells the house/manufactured the sports car etc.
4, wrong, see 3.
5, 6, 7, 8. Correct.
9. Wrong. The bank ends up with the opportunity to make a net profit of about £500 per annum on that loan until it is repaid (but it could also make huge losses if you lose your job etc).
10. Wrong, wrong, wrong.
"The bank risks nothing. The bank lends nothing."
Arguably correct, in these days of taxpayer funded bailouts.
"WE create wealth, and WE get spanked for it."
That's an argument for replacing income tax with Land Value Tax, to be honest.
Think about the guy who just realised a stupendous tax-free capital gain by selling his house at the top of the market. Who has to create another £400,000 of additional wealth to repay that mortgage?
It's the purchaser, and certainly not the vendor, who just sits there in amazement at people's stupidity.
CR You are, of course, quite right and this has been going on since the beginnings of the modern era. (Way back: banks keep people's gold money in the vaults;customers want to go to another town and don't want to carry gold [banditti; ship wrecks etc] :they get given promissory notes to access gold from banks at their destination;these notes start to circulate, being" as good as gold"; soon more notes are circulating than they have gold in the vaults: no one is any the wiser till a run starts on a bank).
Banks have been running this confidence trick for a good long time: it relies on confidence.
When it all goes belly up the truth is re-discovered : in the 1930's the Greenshirts used to march up and down shouting much the same thing you're saying. But the war supervened.
Mark W has a blind spot about this>
He doesn't get it in much the same way that people do n't get the equally bleedin'obvious LVT.(Which he most definitely does get!)
(This was typed before MW's reply above.)
Mark,
You need to explain why 10 is wrong. I have been neck-deep in this subject for nearly a year and no-one, apart from you, has said that I am wrong.
For me to be wrong, fractional reserve banking must have ended. It hasn't. It still operates in all developed countries.
This video:
http://www.youtube.com/watch?v=MxrdHBlPUZk
and another 159,000 links to information on the interweb says that I am right.
And if I am right on 10, I am also right on 3 and 4.
CR.
DBC: "... no one is any the wiser till a run starts on a bank.
Banks have been running this confidence trick for a good long time: it relies on confidence.
When it all goes belly up the truth is re-discovered."
Agreed, it works on confidence (or more worryingly, crass over-confidence in ever-rising house and asset prices). Which is easily fixed by ending taxpayer guarantees and/or insisting on higher own-capital ratios, debt-for-equity swaps etc.
CR: "You need to explain why 10 is wrong."
Your point 10 was this "Factor in the additional 90%'s on all the subsequent loans and I have done the country a great service just by walking in the bank and signing a piece of paper."
There ARE no additional 90%'s! You borrow £100,000 and your supplier/vendor gets a new deposit of £100,000. The bank is just a middleman. Instead of buying a house with a mortgage, you could have agreed to buy it for £100,000 and to pay the vendor in monthly instalments with interest. The overall position would be very similar. Where's the 'new money'? Answer, there isn't any.
Mark,
I have no misconceptions. I would appreciate it if you altered that line on your blog entry. By all means state that I am joining in the debate but that line damns me before anyone has even clicked on the comments button.
You don't appear to understand fractional reserve lending practises.
My £100k is not shown as a liability on the banks' books. A liability indicates a risk, it indicates that the bank has offered something of equal value in the contract and they have not. They do not take an equal risk. Dig a little, my friend, a mortgage contract is easily defeatable in court. Actually, it is fraudulent, as full disclosure is never, ever given by the bank.
CR.
I'm interested to learn that a mortgage contract is easily defeatable in court. Do you have any examples?
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