bank failures

1205 Words5 Pages Bank Failures We have written before about the remarkable ability of banks to create money when making loans, and of their equally remarkable ability to multiply these newly created-from-nothing bank deposits via fractional reserve banking. What we have written is true, and easily verified. But banks fail! That fact is equally true, and easily verified as well. How can we reconcile these apparently contradictory facts? If banks can create, and multiply, money, how can they fail? Could your business fail if what you made was, literally, money, or what people took for money? The qualifier is important. It is what people assume about money that makes modern banking possible. The Federal Reserve itself points out that it is the people's confidence that make paper devices serve for money. Belief (i.e., "credit") is what keeps the system going. Psychology is everything. If modern money is an illusion, then bank failures are an important means of reinforcing that illusion. Consider the alternative. If a bank made loan after loan, and these loans were not repaid, and the bank continued to do business year after year with mounting millions of bad loans on its books, wouldn't that look odd? People would question how the bank could continue to thrive despite so many bad loans. Would they maintain their confidence in the system if the banker cheerfully admitted that he made those loans by simply crediting the borrower's account, and that to do so cost him nothing? Some might wonder why the bank would not honor checks written on insufficient funds, if the banks create those funds from nothing. Corporations which are unable to meet their financial obligations to banks might wonder why they must work to repay the bank for something it got with a flick of a loan officer's pen. No, it is important, if confidence is to be unshaken, that banks appear to be like other businesses, when, of course, they are nothing like other businesses. This means that banks must be allowed to fail, even though they are the source of modern money. Failure occurs when liabilities outweigh assets. What are a bank's assets? The IOUs of its customers. Its liabilities are their deposits. If a customer has borrowed a million dollars from the bank, and given the bank his IOU for that number, the bank has a million dollar asset---un... ... middle of paper ... ...op out of school and go to work? Will he face charges for check-kiting, or counterfeiting? It doesn't seem likely. The illusion can be maintained without such extreme measures! John Maynard Keynes put it succinctly: "If, however, a government refrains from regulations and allows matters to take their own course, the worthlessness of the money becomes apparent, and the fraud upon the public can be concealed no longer." Expect to see more bank failures as the economy declines. Otherwise, the worthlessness of the money might become apparent! Sorry this article is so long but I thought it was a great article and wanted to share it. It makes some great points about loaning money to the government and the fact that when you loan the money them they rarely re-pay the principle, so they have to continue to pay the interest payments. It also goes into some detail about the relationship between the government and banks. The government doesn’t want to see banks fail because they want their sources of money to be strong. I also like the way this article describes how banks fail. It gives some good examples about those banks that fail due to bad debts and non repayment on loans.

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