Fractional Reserve Banking. Odds are, many of you have never heard that term before... Some of you are scratching your heads and not really giving a shit. But by the time I am done explaining Fractional Reserve Banking, you just might get a little red in the face.
Its definition is right in the name... Fractional Reserve, basically all they need to keep on reserve (REAL money, ACTUAL worth, in their vault) is a Fraction of what they loan out. Mad yet? Don't worry, you will be... you will be...
Let's use a nice simple example... I go into a local bank and open a checking account with $1,000. I own that $1,000 and should be able to access it at any time that I choose. It is real (relatively) tangible, and if I lit it on fire, it would burn and I would cry. So, I now have a bank account with $1,000 and the bank is holding on to $1,000 for me, right?
Wrong.
What you are doing, in essence, is giving the bank a $1000 loan, which can be called in at any time (supposedly). This is why on a bank’s financial statements you will see deposits listed as a liability instead of an asset. My bank is only required to keep 20% of that money (again, using a simple example) and can loan out the other $800.00 to another bank.
The next bank, now gets an $800.00 loan from Bank 1 from my money. They in turn, keep 20% of that in their vault and lend out the remaining $640. There is a real problem here folks, because unless my math is off, my $1,000 real deposit has just become $2,800 by some sort of (completely legal) magic! This is a gross oversimplification, but it is exactly how the process works. See the easy to understand picture below!
Depending on how many institutions take part in this chain of delusion determines how much your initial deposit becomes in magic money…
Its definition is right in the name... Fractional Reserve, basically all they need to keep on reserve (REAL money, ACTUAL worth, in their vault) is a Fraction of what they loan out. Mad yet? Don't worry, you will be... you will be...
Let's use a nice simple example... I go into a local bank and open a checking account with $1,000. I own that $1,000 and should be able to access it at any time that I choose. It is real (relatively) tangible, and if I lit it on fire, it would burn and I would cry. So, I now have a bank account with $1,000 and the bank is holding on to $1,000 for me, right?
Wrong.
What you are doing, in essence, is giving the bank a $1000 loan, which can be called in at any time (supposedly). This is why on a bank’s financial statements you will see deposits listed as a liability instead of an asset. My bank is only required to keep 20% of that money (again, using a simple example) and can loan out the other $800.00 to another bank.
The next bank, now gets an $800.00 loan from Bank 1 from my money. They in turn, keep 20% of that in their vault and lend out the remaining $640. There is a real problem here folks, because unless my math is off, my $1,000 real deposit has just become $2,800 by some sort of (completely legal) magic! This is a gross oversimplification, but it is exactly how the process works. See the easy to understand picture below!
Depending on how many institutions take part in this chain of delusion determines how much your initial deposit becomes in magic money…
Economists will tell you, in much the same way that a priest might, that you must have faith and everything will work out in the end. We have seen quite the opposite this year. Bank failures, caused by banks having insufficient capital to cover their obligations or other reasons have spiked since the ‘meltdown’ began in late 2007.
Here’s a statistic that speaks for itself, between Jan 1, 2000 and Jan 1, 2007, only 24 banks failed (According to the FDIC). Between Jan 2, 2007 and Today… Wait for it… 98 failed banks. That means that in two years time we had FOUR TIMES the bank failures than in the seven years that preceded it… Seriously, check my sources, it’s always good to! http://www.fdic.gov/bank/individual/failed/banklist.html
You see, the problem with this system, and I will admit readily that it is a problem, arises when too many of us ‘nobodies’ come to the bank at the same time and ask for our money! Then, the house of cards is revealed and subsequently collapses into a pile of useless paper. Look at what happened to IndyMac. It would have been the same case for Washington Mutual without Chase coming in to play sugar daddy. It even has a name, and this term many have heard by now. “Bank Run” See, the problem with Fractional Reserve Banking lies in the pure fact that none of these banks carry enough money to be able to pay us all at once. The history of this practice is quite suspect… *fade out to ‘ancient times’*
In Holland, in the 1600’s there was an institution named “Amsterdamsche Wisselbank” who made it their business to issue bank money to people who deposited silver or gold coins in their institution. They operated in a simple manner. You make your deposit, pay a safekeeping fee depending on whether it was gold bullion or silver, and you got a receipt with your terms and what you’re owed. This sort of system makes sense to me… Seriously we have car insurance to cover our car, homeowners insurance to cover our homes, why not pay fees to the bank in order to have your money covered? Well, as time passed our enterprising goldsmiths realized that people, more often than not, LEFT their money in the bank and didn’t come looking for it! At least not all at once, from this was born the idea that one could make shillings from shit. And make shillings from shit they did my friends, they used and bruised and abused of the system and the aforementioned bank runs were plentiful! In fact, this is the main argument used by central bank fans, that we need a central bank to avoid these sorts of catastrophes.
I don’t agree one bit. Fractional Reserve Banking, to me, seems like little more than taking your paycheck and going to the racetrack. Even if you’re really good, you are playing with borrowed money intended for other uses (like safekeeping!) and hoping for a good outcome. All those banks who invested heavily in SIV’s and MBS instruments (More on them later) are now finding themselves utterly screwed because their ‘investments’ are all but worthless but they still owe you and I some very real debt.
Lest someone call me biased, I will post the Federal Reserve’s own explanation as to why we need a fractional system;
“The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect. Referred to as the fractional reserve system, it permits the banking system to create money.”
Two points. If the person they deemed credit worthy defaults on their mortgage and ends up in foreclosure, the whole system breaks down (as we are seeing now). And secondly, create money??? If I create money it’s called COUNTERFEITING, why should a depository institution be allowed to take part in that? It was my understanding that we need the FED and Timmy G and his pals at the Treasury department for that!
It gets even shadier though, because in actuality our monetary system contains two types of ‘money’. But I’m going to have to end this here… because tomorrow, we are going to talk about the one thing everyone loves… No, not Raymond… MONEY!
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