To understand the coming financial collapse of US banks you need to understand how they work. Banks take your money and give you interest. They are able to pay interest by finding people that they loan your money to. The interest they charge is higher than the interest they pay. The difference between what they charge and what they pay is the profit. Under Fractional Reserve Lending, a bank will lend many times over the cash they have in their reserve. They do this under the theory that people will not withdraw their money because they are earning interest. Fractional Reserve Lending is creating money out of thin air because it is not fully backed up by the reserves. In fact, banks are known to lend as much as ten times as much as they actually have in reserve. In the case of CDOs, Wall Street lent over 35 times as much money as they had in reserves.
Bank employees are paid commissions by the number of loans they bring into the bank. Adjustable Rate Mortgages (ARMs) pay more commission than regular mortgages. Agents sold ARMS to people they knew could not afford the mortgages once the rate was adjusted in two years just to earn the higher commission. They traded short term financial goals for long term financial health. The banks went along because it increased their quarterly profits. These ARMS were packaged and sold as security instruments on Wall Street. The loans were sliced up, bundled with less risky mortgages, and sold as mortgage-backed securities called "collateralized debt obligations" (CDOs). The banks used a computer model to estimate the percentage of foreclosures in a typical CDO and they determined that each CDO still made a handsome profit. These CDOs were sold to other banks that used them as collateral to make even more loans and then those loans were used as collateral to make even more loans with each bank using Fractional Reserve Lending practices. Unfortunately, the computer model was wrong.
As mortgage defaults grew beyond anybody’s wildest imagination, the value of these CDOs became suspect so nobody wanted to buy them. These CDOs were originally valued, according to the computer model, at two trillion dollars. But a commodity is only worth what a person is willing to pay for it, and nobody wants to buy a CDO, so they are now worthless. This means that the imagined value of two trillion dollars that was used as collateral to make even more loans expands the damage to a thousand trillion dollars in the global economy with $600 trillion in world liabilities, plus more than $400 trillion derivatives.
So banks that invested in CDOs are now stuck with financial instruments of no value, and due to Fractional Reserve Lending, do not have enough in reserve to cover this debt. And there are no more borrowers to cover this quadrillion dollar black hole. It means that only an optimist would be investing in gold right now. The best investment for the future is canned food. This, of course, is all the fault of Republicans because they have more faith in free markets than in regulation. The S&L crisis under Reagan was a puddle compared to the ocean of debt from the sub-prime crisis under Bush.
I am adding this link I found today (12/20/2007) http://www.informationclearinghouse....