With Occupy Wall Street rapidly gaining steam, I thought I'd give a reminder of just how insidious the banks' behavior can be, and describe just how they have so easily profited by destroying the middle class. In the aftermath of the meltdown of 2008, the traditional media portrayed the problem as one involving financial concepts too difficult for us mere mortals to understand, so we should just trust the powers that be that they knew what they were doing, providing the banks that caused the problems with enormous sums of taxpayer money. Not so -- the concepts aren't that difficult. What it boils down to is that banks create money. And when you can create money at will, you can make yourself very, very rich. So rich, in fact, that you can buy policymakers into keeping you rich and making you richer. Which is exactly what the banks have done. How they've done this over the jump.
This description is based on my memory of the only economics class I've ever taken, and that was nearly 20 years ago. That's how simple it is for banks to create money. Of course, I'm sure there's a lot of nuance I'm missing, and it would be great for those more knowledgable to weigh in.
Here's how it works: Let's say a bank has $1 million in deposits from various account holders. The bankers loan out that $1 million to a homebuilder to construct some houses. The homebuilder pays its employees and suppliers, who then...deposit that money right back in the bank. The bank can then turn that money around and lend it right back to the homebuilder to build some more real estate. And around and around this goes, until the bank has turned this money over a few dozen times. The bank is now sitting on, say, $30 million in assets (on paper) created from that original $1 million. The bank also owes close to the same amount to depositors, since the money has been put back into the bank many times over. And of course, along the way, the bank will lend some money to homebuyers to actually purchase the homes -- but that's still just moving money around; the buyers pay the builders, who pay off their bank loans. Now this is all well and good, but only if at some point someone is willing to pay for those houses with money generated by creating real wealth, not just money cycled through the system. Until then, it's just phantom money, created out of thin air.
Now, the obvious problem with this is, what if the people getting paid by the homebuilders deposit the money in a different bank than the one that original lent the money? Then the lender can't just keep turning the money over. This was certainly a problem when the financial landscape was dominated by local community banks and credit unions. If the homebuilder bought drywall from a supplier a few towns over, then the local bank wouldn't get the money back, and the cycle ends. But when we've got a handful of really big banks that operate globally, the cycle can continue a lot longer. The complex derivatives we've heard about were just means to perpetuate the money-creation process even further. Does the drywall supplier deposit its money in a Citigroup-owned bank, when the money was originally lent from B of A? No problem -- B of A will just borrow the money back from Citigroup. And JP Morgan will step in and, for a fee, insure those loans through a credit default swap. So all this phantom money seems to be much more secure than it actually is.
But if the banks are just moving this money around, cycling it through the system, how do they make money themselves? Easy: Every time they make a loan, they collect fees and interest. And since they kept the cycle going for a number of years, they could skim a sizable amount of money off the process, especially at subprime rates. As I wrote above, if you can create money out of thin air, you can make yourself very, very rich.
Though the phantom money the banks create is purely on paper, and there's only the original $1 million in cash to back it up, its effect is just as real as if the banks had printed cash themselves. It causes inflation. We saw that in the runup in gas and food prices, and subsequent drop in 2008. And, of course, in the housing bubble itself. You think the value of the dollar in your pocket is secure? Think again. The banks might disagree, and they can just create more.
So what happens when the cycle runs out of steam -- when it turns out there's no source of money from outside the banking system to prop up the phantom money? We get sudden deflation, and the ensuing recession and unemployment we've seen. As much as the Tea Party vilifies the Fed, printing money, to a certain extent, is exactly what the Fed should be doing. That just replaces the phantom money with real cash. The money was actually created by the underregulated banks, and the damage was done before the crisis even hit.
But who gets that replacement cash is then up to the government -- which should represent everyone. They could have cycled the cash to struggling homeowners and small businesses to help repair the economy. But instead they gave it to the 1%, and in particular the banks that created the problems in the first place. This is the real shame: That banks can so easily profit through the following simple process, leaving financial ruin for many in the 99% in their wake:
- Create phantom money out of thin air.
- Take a cut of that money off the top.
- When the process breaks down, get the government to give you real cash in exchange for the phantom money.
Nice work if you can get it.