Tuesday, November 18, 2008

BAILOUT 6: TRUTH IN LENDING--PEOPLE LEND MONEY TO BANKS

I have been led to believe my whole life that banks/finance companies lend money to people. I assume that most other people have been led to believe the same thing. But as we have seen, nothing could be further from the truth.

The Fed admits as much--in a roundabout way--in the quote I used below. Let's break it down again. Here's the quote:

"Banks actually create money when they lend it. Here's how it works: Most of a bank's loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank once again holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times."


First of all, despite the Fed's protestation to the contrary, "lending" does not create anything. By its very definition, the act of "lending" assumes that what is being lent already exists--in other words, one cannot lend something one does not have. That is to say, I can't lend someone a bicycle if I don't have a bicycle. I can't create a bicycle by lending someone a bicycle--it's impossible. So right off the bat, we can see that we are being misled because lending doesn't create anything. But this idea that money is created through bank lending is very pervasive. And this misconception is a fundamental part of the system under which we currently labor.

Okay, fine, but...

...how is it that people lend to banks? Well, the Fed comes right out and says it--again, in a backhanded way. They point out that "loans" are made to bank customers and are then deposited in a checking account. The bank then uses that deposit as the engine to lend more money. So without saying it in so many words, the Fed is acknowledging that deposits lent to them by us are what they then use to lend.

In fact, every deposit of any kind into a bank is a loan to that bank from people. Without deposits, which are essentially and fundamentally loans from people to banks, the bank could do nothing, it would have no assets. So banks are helpless without the people. But we are always led to believe that in fact people are helpless without banks. That's the whole premise of the bailout--that if banks fail, people suffer. And that may be true if we insist on clinging irrationally to our current system in which we allow banks to dole out the money that is loaned to them by the people at great expense to the people.

A little more


Even with our current system, in which we all go along with the mass delusion that banks, not people, create money, it's still blatantly obvious that it is people that create money instead of banks. I used the illustration of an auto loan below to make this point but now let's illustrate the point with something more expensive, like a mortgage.

But first let's recap a little bit of what posts below mentioned. We already see, by the Fed's own admission, that "very little" of a bank's deposits is "kept in the bank's vault." In fact, they only keep enough on hand "to meet routine withdrawals." In other words, they don't have the money "on hand" at any given time to actually lend any significant amount of real money, i.e., cash. That's what the Fed is essentially saying.

So let's say Bill goes into the bank to get a mortgage loan on a $500K house. We already know that the bank doesn't have $500K in cash on hand to give to Bill to pay for his house. Their deposits, i.e., loans from people, may total many times more than that amount on paper, but they don't actually physically have that amount of money in cash on the day that Bill comes in for his loan.

So the bank judges Bill to be good for the "loan" and they have him fill out a promissory note stating that he will pay the bank the $500K plus interest. The bank then enters some digits into a computer and print Bill or Bill's attorney or real estate agent a check for the proper amount, which they don't have on hand, remember (by the way, if one doesn't have something "on hand," that necessarily means one doesn't have it, even if it is listed as an asset on a ledger book somewhere).

So the bank essentially writes a bad check to the owner of the house Bill wants. But under our current system, the bank's check--again, written for an amount that they do not currently have on hand--is made good by, guess who? Bill and his promise to pay. So the fact that Bill will be giving money to the bank for the next 30 years is viewed as being the same as cash by all parties involved. But that view does not change the fact that the bank does not have the $500K on hand at the time of the transaction.

Quite literally then, Bill is creating the amount of his loan himself by paying it in installments over the next 30 years. That is to say, he's literally loaning the bank the money to cover the bad check it wrote because they don't have the cash on hand to pay for Bill's house.

When looked at this way, one can understand the predatory and fraudulent nature of interest. Again, Bill does not have $500K on hand to pay for the house he wants, but neither does the bank! So because we have created the illusion that banks have the "divine right" of money creation, the bank now gets to charge Bill interest for lending them the money to pay for his house!

No one would ever agree to this system if they realized how it works, and that's why the Fed tells us that banks, not people, create money. But we have seen that the opposite is true--people, not banks, create money but the people have been suckered into letting banks charge them money for loaning money to banks.

So much for "Truth in Lending"...

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