Friday, October 24, 2008

Corrupt Banking

Well the market is crashing to new lows for the year today. I have been in the market since 1994 and today was the biggest percentage down gap I have ever seen. Pretty amazing. The worst is yet to come imho. The dollar keeps making new highs and gold and silver new lows. I put about 3/4 of my money into gold and silver about a week and a half ago and have taken a pretty big hit as they have steadily dropped against the dollar. Bad timing on my part but I am more than sure it will work to my advantage when the dollar rolls over and resumes its terminal decline.
So let's discuss fractional reserve banking. This is the second piece of the monetary puzzle which is and has been working against us for way to long.
You and I earn money by trading our labor for it. We work for somebody else or work to create something we can sell for a profit. Blood, sweat and tears are the capital we employ to earn a living. So how do bankers earn their money? Through the magic of fractional reserve banking, thats how. They take in our hard earned "money" and wave their government backed magic wand over it. Suddenly it multiplies in value by a factor of 10. 1,000,000 worth of deposits earned through our labors and borrowed from us for a pittance are transformed into 10,000,000 which get loaned out at much higher rates of interest. Lets run some numbers.
Average american deposits money. Gets paid 1/2% interest (far less than inflation, meaning in real terms you lose money)
Average banker Receives money and pay 1/2% to sucker(I mean average american) Multiplies it by 10 and loans out 9 times the original deposit
at 6% interest on a mortgage, 10% on a car or 15% on a credit card.
Lets run some numbers. cost to banker to borrow your $1000 is $50.
He loans $9000(fractional reserve magic money) out at an average of 9%.
He gets $810 before late fees, bounced check fees, overlimit fees, etc.
You get $50 he gets $810+. Don't you feel sorry for the poor bankers who you just bailed out?
Consider this; You want to buy a house. You find a nice house you want to buy for 200k. You have 20k to put down and the bank agrees to loan you $180k to complete the purchase. Where did the bank get that $180K? Do you think it was laying around in the vault behind that huge, thick steel door? Nope. Your 20k down payment gave the bank a reserve under fractional reserve banking laws to magically create the other 180k out of thin air and loan it to you at 6%, assuming you have great credit. And don't forget the 8 grand in fees they charge you upfront to get the mortgage your very own capital created.
What is their risk in this situation? Less than zero. If they kept this loan on their books they make 8k upfront and you pay them about $1080 every month to borrow money which never even existed until you borrowed it. Feel like a sucker?
Lets say after 3 years you fall on hard times and lose your job. You quit making payments and bank forecloses. So you paid 28k upfront and another
$38,880 in payments. You paid down the original 180k you borrowed by $7118 meaning you still owe the bank $172,882. But the economy tanked and the house now only has a market value of $130k. The bank forecloses and you are wiped out. You paid $66,880 over that 3 year period to realize the american dream before taxes and maintenance. About $1900 a month to
live in a house you probably could have rented for about $1000 or less. You got screwed.
So how did the bank make out? 8k upfront + 38,880 in payments or $46,880 and now since the house is worth less than you owe they can foreclose and sell the house again or rent it out. Their choice. You are out in the cold. Let's say they firesale and net 90k after expenses. So 90k + 47k =137k profit. Not bad considering they never loaned you a dime of their own money and thus never took a risk. What was their return? Infinite.
So how do you explain the current banking crisis we are in giving what I just stated? Simple, they got greedy and sold the loan as soon as they made it and foolishly enough guaranteed the full value of the loan to the new buyer who also sold it and so on. The banks figured if you can make 8k packaging and selling loans that was better than sitting on them and collecting monthly payments. So they became volume loan originators and sellers. Worked great for awhile. . . until the value of the underlying houses collapsed and they had to make good on the full amount. To bad. They got to greedy and the law of unintended consequences came back and bit them.
Of course they own the politicians and rather than suck it up and take their losses they just called in the favors and stuck us, the People with the losses.
So far it looks like we are going to take it.

1 comment:

The King of America said...

Thanks for spelling it out so clearly. I had heard the terms before and halfway understood but your explanation made it much more clear.