Recently there has been some serious commotion on wall street. Longstanding investment bank Lehman Brothers is declaring bankruptcy (or at least the main company is). Many are wondering why the ‘government’ let Lehman go under instead of fronting cash to bail it out (as in the case of Bear Sterns).
Repeat after me:
THE FEDERAL RESERVE IS NOT A BRANCH OF THE U.S. GOVERNMENT.
It is a group of private bankers. Amazingly, the Federal Reserve Act of 1913 arranged for them to print our money, and the government borrows money for them… at interest! You can bet the Fed board (via Mr. Bernacke) is ‘advising’ the government which institutions merit these emergency loans.
My good friend Philip was wondering over at his blog how our leaders could be saying that the “fundamentals” of our economy are still strong amid this chaos? Simple answer: they’re lying.
I posted a response on that blog that I will copy here to inform those who are curious how banking works, and how it plays into this particular situation. Also, I encourage you again to watch Money As Debt in order to educate yourself.
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Our current banking system works under a concept called fractional reserve lending. In the U.S., most banks are a part of the Federal Reserve System. It is not a part of the government, as is often thought. Rather, it is a private group of bankers who act as a central bank. If a bank wants to be a part of the Federal Reserve, they must make their initial deposit there. The bank is then allowed to lend out up to 9 times (sometimes more, depending on the account) the amount they have on deposit at the central bank. Banks may legally create money by simply writing funds into a debtor’s account upon initiation of a loan agreement. So for instance, if a bank has $1000 deposited at the central Federal Reserve Bank, then they may legally write a loan of $9000 based on that initial $1000 deposit at the Fed. Because of the Federal Reserve Act, our government allows this fictional money to be paid out in paper currency. (If you have any cash on you, take it out and look at the top of the note. There, you will see the words “Federal Reserve Note.” This means that the cash is actually lent from the private holders of the Federal Reserve bank to our government at interest. If you had a dollar before 1913, it would not say Federal Reserve, because the Fed did not exist yet.)
Due to the borrower’s agreement, he must pay this money PLUS interest back to the bank. Now the bank never had the money for the principle to begin with… they wrote it into the account from nothing. The borrower is allowed to redeem that bank loan check into actual currency which can be used to purchase items. However, the loan check does not include the interest amount. Where is the borrower supposed to get the money to pay back the interest? That money can ONLY come from the overall money pool. Most of that money was created the same way, by banks simply writing it into the account of borrowers. Only about 5% of our overall money supply in the U.S. is created at the Mint (printed or coins). The rest is this fictional money that never existed before the loans. That is what I mean by the fact that it is IMPOSSIBLE for everyone to pay their loans back. What I’m saying is that the amount of debt out there far exceeds the amount of money in circulation available to pay it back.
Just as money was created from nothing when someone takes out a loan, that PRINCIPLE amount also disappears back to nothing when the loan is paid back. Hence, the only gain the bank made in the process was the interest paid on the loan. The principle amount is now out in the economy being traded (increasing the overall money supply) or it is redeposited in another bank. Those deposits of currency from the overall money supply may be deposited back at the central bank and used as the basis for more loan-writing. However, in this case, proceeds directly derived from another loan may only be the basis of 8/9 of the loan amount instead of 9 * the loan amount. In a closed loop, an initial bank deposit could theoretically be multiplied nearly 100 times in terms of money going back into the overall money supply. Now you can see how we get inflation. It isn’t the government printing too much money, it is banks creating too much.
So how could a bank get in to trouble? There are two main ways. First, we talked about money being written from nothing and then going back to nothing when the principle is repaid. Basically the bank keeps 2 separate accounts. First, they have an account of real money deposited at the central Federal Reserve bank. The second account is the amount of money they have created from nothing due to new debt. The second account cannot become so large that it exceeds the required reserve ratio in comparison with the first account. When borrowers pay back their debts, this second account gets smaller. When they don’t, that account stays bigger, reducing the amount of loans the bank can make overall, and therefore reducing the potential interest income. If the debt money account gets too big, the bank can’t make loans, and then they can’t make income. The second way they can get into trouble is if the first account (real money deposited at the federal reserve) gets too small. How could that happen? If many depositors withdraw their money at one time, the first account becomes too small, and this is what is meant when a bank is called insoluble. It means they don’t have enough on reserve to support the debt they’ve lent out. If many depositors withdraw their deposits at one time, it’s called a ‘run on the bank’. In this case, the Federal Reserve may lend emergency cash to the bank to keep it from going under. However, if the bank is in bad enough trouble, the Federal Reserve may not believe that bank is a good risk, and hence the bank will go under, and the initial investors who footed the money for the bank to start with will lose out. The depositors themselves will not lose everything (in theory) because of insurance known as the FDIC. The idea is that they will protect up to $100K per account. The truth is that the FDIC itself does not have enough money to pay for all deposits at all banks. The primary reason the FDIC exists is to give the public a sense of security about their deposits, and this is designed to discourage bank runs which will undermine the system. The only way the FDIC can truly cover all outstanding deposits is to borrow from the Fed more printed money. In the event of a catastrophic collapse, this kind of printing would cause massive and devastating inflation.
Now, to deal with Lehman Brothers: they are an investment bank. Investments are essentially loans that individuals make to private companies, in hopes of recovering their loan amount with interest. The stock market system centralizes private investment. It provides security to investors by requiring the private companies to abide by guidelines regarding how much stock they sell, accountability of corporate assets, and truthful representation of certain financial decisions. The companies, in return, are provided with expanded access to investors, which usually translates into greater amounts of capital for them to use.
An investment bank trades securities, which are basically anything that can be given a price value. One commonly traded security is mortgage loans. If you obtain a mortgage with a bank, there is a good chance that loan will be sold to investors. They will pay back the bank the principle amount, plus some. The bank makes immediate profit, but does not acquire all the interest it would over time. The investor, in exchange, takes on the risk of the loan defaulting, but also takes on the added interest when the loan is paid back. However, investors are not allowed to write money into accounts like banks, they are actually paying for these loans. Therefore, when many mortgage loans fail, the investors are in deep trouble. This is part of what we are seeing today.
As you can imagine, these problems, when combined with bank insolvency, produce a snowball of financial chaos. So Lehman did go under because their debt turned out to be bad, and they did not have enough reserves to cover the losses. This is the risk part of investment lending. However, the initial situation that allowed them to be in that position is our Federal Reserve system.
This also explains another piece of the puzzle we are seeing. Who bails these companies out when they are in trouble? The Federal Reserve. Whenever they buy all of these bad loans from these companies, and the borrowers default, guess who gets the property? The collective private bankers who own the federal reserve.
So you can see 2 things. 1) There is no way everyone can pay their debts. There will be defaults. In this case, the real property defaulted will become the property of the central banks. 2) Eventually, all the money will be in the possession of the central banks as well, since they are owed more money than exists in the overall money pool to repay it. This is a complete transfer of wealth from the populace (and the government, who insanely chooses to borrow money from the Fed at interest, rather than printing its own money for free), and all of it goes to the banks.
