Answer this fundamental question about our banking system

[MindMatter]

There are sometimes things that are obvious, so obvious that nobody even notices them. I would really like to hear anybody give be a coherent answer to this question.

The basic operation of any bank is that they convince people with money to let them store it, and they pay interest to the customer. Then they lend that money to people who want to live on credit (actually they lend the money many times over, but that's a different issue), and they collect interest from the person seeking credit. They collect more interest from debtors then they pay to depositors. That's the basic engine of banking.

OK. Now 'splain this. Why is it that when a bank goes belly up (often because of crooked, or at least really stupid, dealing), the depositors lose their money, but the creditors are still expected to pay their debts?

Why is it not a two-way street? Somebody please explain this.

[BlooInBloo]

1. Uhh..... have you heard of the FDIC?

"the depositors lose their money"

[Trajan]

4. The FDIC is a late development ....

Banks prior to the 30's had no such artificial mechanism .....

[BlooInBloo]

6. Uh..... compared to the history of the planet maybe.

[Trajan]

8. Banks have existed MUCH longer than the last 70 years ....

Though some may not see that far back ...

In any case: the OP is asking a generalized question regarding basic bank operations, and you pull out the FDIC canard as if it were a standard throughout the history of banking ..... It is not ......

How nice .....

[BlooInBloo]

10. Ok - just so everyone's clear: you're not talking about anything that has existed for approx 100 yrs

[MindMatter]

19. No I am talking about 2007. This is how the system works TODAY

For Christ's sake, look it up before you spout off about it.

In the Indymac failure, lots of depositors will lose a substantial portion of their deposits, just as people did 20 years ago with the S&L scandal. There was insurance on the S&L accounts too, only up to a limit. Deposits above that level were lost.

If you have more than $100,000 to deposit, you can have it completely insured by being careful to put it into accounts with different banks. However, beware that banks are merging all the time. If you have $100,000 deposited at each of two different banks and they merge, you now have half your money at risk and have to move it again to get full protection.

[MindMatter]

13. Read my bonus question

When a bank goes under, only about 40% of the deposits are covered by FDIC. And that percentage will keep going down because of inflation.

[BlooInBloo]

15. I think I've read enough written by you for the time being....

Time to watch something more edifying.... Like Benny Hill.

[MindMatter]

17. Ignore it at your own peril.

The average American is a debtor, which is the whole point of our banking system. If that is your situation, then you don't have any risk in these bank failure scenarios.

[flvegan]

2. "the depositors lose their money"

When and how does this happen?

[Trajan]

5. It certainly happens if the bank that fails did so with over 100,000 in any one account

Then yes; depositors WILL lose money ....

[flvegan]

7. That's like driving without insurance.

The warnings about the $100k are pretty clear. If they have more, they should know better.

[Care]

66. No One "Should Know Better"

That kind of talk sounds like "blame the victim" to me. That is hurtful.

[MindMatter]

21. Not "any one account" . TOTAL deposits with the bank.

There are bankers who will tell you that they have clever ways to record your accounts so that all your money is protected. Don't count on that. It is not necessarily true. And if the banker got it wrong, nobody will be there to make good on his error.

[MiniMe]

68. I think it is per type of account, but I couldn't list the different types

I know that IRA counts as a separate account, not sure what else does.

[MindMatter]

14. If you have over $100K on deposit, you lost it. period

Well, OK, there are exceptions, like spousal accounts and retirement accounts where the number is higher, but the fact is that lots and lots of deposits are simply lost every time a bank fails. If you don't have $100K on account with a bank, you don't have a concern, but there are loads of middle class Americans who have managed to save more than that.

[flvegan]

18. Please read my post #7.

Maybe I give folks too much credit to not be stupid.

[MindMatter]

24. I don't think it is a question of stupidity

There are people here who I bet are way above average in intelligence, way above average in their knowledge of our political system, and way above average in having a healthy skepticism for the system. Yet as you can see from the posts, they don't believe what we know to be the true way the system works.

The banking system operates on an aura of trust. They don't want people to ask questions like this.

There are loads of financial analysts, radio talk shows, etc talking about the FDIC risk. That is real, and I do hope people will heed those concerns because we are entering an uncertain era. But that wasn't the point of this thread. I wanted to address the more basic question.

Why is it that you lose your deposits (over $100,000) if a bank goes belly up, but debtors don't "lose their debt", so to speak. How can that be fair?

[flvegan]

29. It's called coverage limitation.

If folks own a car or a house, they should understand this. Why would a debtor lose the debt? That debt just gets sold to someone else.

No idea which folks you're listening to/reading that are talking about an FDIC "risk" but whatever.

[MindMatter]

34. Just about any talk show dealing with money

It is common knowledge in those circles, but not commonly know by the general public.

I'm sure I've heard that specific discussion twice in the past 24 hours. Clark Howard show yesterday and today some guy from "The Mutual Fund Store" who has a syndicated radio program. Deposits are lost every time a bank fails. That's a simple fact, not debatable. What is debatable is how relevant that is, or what strategies to use to protect yourself, or the motives of the bankers. But the basic fact is not debatable.

Of course, the average American doesn't have $100,000 to put in a bank, which is why it isn't discussed more broadly.

[flvegan]

37. You know, every bank I've been to

has a sign on the front door that says something about the FDIC insuring up to $100,000 for each depositor.

[MindMatter]

47. And as you can see from this thread

some people don't take that at face value. Some people believe that if you have multiple accounts you are protected. Ain't necessarily so. Some people believe that you'll get your $100,000 for certain, but really you'll get most or all of the rest of it too in the worst case. That is just plain wrong.

There are a lot of misconceptions out there, and some bankers add to those misconceptions deliberately.

[DaveJ]

52. I agree, it's pretty darned clear.

Anyone with over 100k should know how FDIC works. I'm poor and I understand it. WTF is wrong with all these rich people?!?!?!? They supposed to be running society and they can't even read a damn sign on the door.

[MindMatter]

54. The "rich people" do understand it.

They can afford layers and accountants to get them around all these pitfalls. But there are a lot of folks who have worked a lifetime and been able to save more than $100,000, but don't consider themselves rich. And many of these folks do not understand how the system is gamed against them.

[DaveJ]

60. Sorry for them but I doubt they're sorry for us.

If they can't even read an FDIC sticker then I doubt they have the depth of understanding to care about anyone else.

I really doubt they give a rats ass about me or anyone in my situation.

Okay, now they are poor now just like me. I feel sooo sorry for them.

Oh Well, they still at least have their $100k which I'll never have. But I guess I'm just lazy, and not hard working like they are?

Sorry for being bitter and self involved but this is getting ridiculous. There's all this concern about everyone except me. I'm doing everything to support progressive ideals but this is just getting ridiculous. It goes from caring about kids, so called minorities, then totally skips people like me, then goes on to show concern for the home owners, people with $100k+. There is no a single agenda I ever see on the DU that directly affects my concerns whatsoever, and I either get flamed or ignored whenever I mention one. Sorry this wealth topic is just becoming a sensitive issue.

[MindMatter]

63. I hear you.

That's a different topic, I think, but a very interesting and provocative one.

With these latest bailouts, I keep feeling myself thinking like an arch conservative. I mean, I think it is just wrong for the taxpayers (that includes me) to bail out either:

1) a Young Republican yuppie who bought one of those ridiculous McMansions using an absurd loan product that was well beyond their means to repay, just hoping for the continuation of the housing bubble, or

2) banks (and their shareholders) who were too stupid to not make those loans.

I find myself saying the same things that Kay Bailey Hutchinson argued today.

Strange. That just goes to show you that the big divide in our country is not between "liberals" or "conservatives". It is between the fascists and the rest of us. The fascists are all about gaming the system to extract the nation's wealth and send it to the moneyed elite. We have a lot in common with true conservatives. We won't always agree about solutions, but I bet most true conservatives (those who actually think about their philosophy) share many of your concerns, caring about kids, the challenges faced by minorities, the world we are leaving for our children, and so on.

The problem is that there has been a huge lot in the middle of the spectrum who are more concerned with their personal greed and gratification rather than a political philosophy.

[Care]

67. Those People Are Rich

It takes me years to make $100,000. Anyone who has accumulated that much money is rich. Why does anyone even need to have that much money in the bank? I would like them to think of giving more to worthwhile charities rather than keep money they don't need.

[MindMatter]

71. Retirement. Hedge against bad luck. Many other reasons.

$100,000 is not that much money. That amount can easily be wiped out if you have the bad luck to need a heart bypass or chemotherapy and your insurance company has excluded you, for example. It may seem like a lot of money for young people who can't see how they can ever earn enough to be able to have any money left over at the end of the month.

In my case, I have worked 35 years, had some good luck, worked hard, and have never really been sick. So I have been able to put more than $100,000 in the bank, but would never consider myself rich financially. More comfortable than some, I'm sure, luckier than many. I know that I have to split it up if I want to have FDIC coverage.

[Pharaoh]

3. because.....

it's a rigged game and a sham.

[MindMatter]

25. I believe that is the only possible conclusion

once a person sees the emperor's (the banking system's) clothes.

[napi21]

9. First of all, the depositors DON'T lose their money! Every bank I know of

is insured by the FDIC. Not to sound callous, but if any depositor put in more than the insured amount of $100,000, they simply weren't paying attention!

Second, you are dealing with 2 separate contracts when you talk about depositors & borrowers. With the depositors, the bank contracts with them to be allowed to USE their money in exchange for getting paid "interest". Since all the banks pay into the FDIC fund, they can guarantee those depositors their money is safe.

With the borrowers, they sign a contract with the bank that they will be allowed to use the bank's deposited funds in exchange for paying "interest" to use it.

They are two different and distinct contracts, and are honored & enforced separately.

[MindMatter]

16. Only $100,000

That is the scam. And when was that amount last increased? In 2005, they increase IRA coverage to $1250,000, but lots of people have IRAs bigger than $250,000. I don't know when the $100,000 limit was put into place, but it seems to me it has been that number for at least 15 years, when that would be worth $400,000 in today's dollars. I'm sure somebody must know the history of the FDIC changes. I'd appreciate those facts. I can't find them anywhere.

[napi21]

23. Why do you say that's a scam? If you have more than $100,000

all you have to do is put it into several different banks! I honestly don't remember when that amount was increased, but I won't complain about it. I don't know how much the banks pay to belong to the FDIC, but I'm sure it functions the same as any other insurance does, and if enough BIG BANKS fail, the extra money it would require to pay off all the insured deposits would come out of OUR POCKETS! I think it's just fine at $100,000.

[WoodyM]

11. What the creditors owe

the bank is considered as an asset of the bank. The first thing the FDIC will try to do is sell the bank as an operating bank. If it cannot do this, it will try to sell the assets of the bank. What is realized from the sale of the assets is used to pay at least a part of what depositors had over the 100k limit.

[MindMatter]

12. Bonus question: Are bank failures a problem?

Obviously bank failures hurt the deposits who typically lose 40% of their deposits when a bank goes under.

And obviously a lot of bank employees get screwed in the process.

But my question is, does the banking system really care if banks go under?

My argument is the banking system (the Fed et al) actually prospers when banks go under. I will explain that below. If it were not for the major PR problem it causes, they would welcome 25 of the banks failing every year. Economically that works for them. What doesn't work is the failure of confidence in the system. That is the problem. And that is entirely a PR problem, not a money problem.

Let me say it again. They don't give a shit about bank failures. They actually welcome them. The only reason they address those situation is because of the PR problem it causes. It is purely a PR issue.

Now let me explain my reasoning. The banking system used the world over is based on putting people into debt, pure and simple. If a depositor deposits $1,000,000 into a bank account, the bank is allowed to lend that money MANY TIMES OVER. For sake of simple numbers, let's say they are allowed to lend 10 times their deposits. That means they can put $10,000,000 out on loan. Let's say they pay that depositor 4% interest and they charge the debtors 8% interest. Over the course of a year, the bank paid out $40,000 in interest. If all their debtors pay up, they collect $800,000 in interest because they were allowed to lend the depositors money many times over.

Now if they go belly up, only $100,000 of the original deposits are insured, so the original investor loses $900,000. But all those loans ($10,000,000 plus $800,000 a year interest) are still collectible. OK, a lot of those borrowers will go bankrupt. But remember, the banking system (the Fed/FDIC et al) is only out $100,000, so if only 20% of the borrowers actually pay up, they are still ahead of the game.

Bank failures are a great racket. If it were not for the PR problem, the bankers would want to engineer as many failures as they could pull off every year.

Now, here's the scary part. With the S&L scandal a generation ago, the people running the S&Ls decided they didn't care about the PR problem. They decided to paint the town -- they blew up the whole system. It could happen again, and if it happens with the federal banks, a whole lot more money will be involved. I'm not predicting that, but just saying there could be a strong motivation for the system to go that direction.

ANy thoughts? Agree? Disagree? Different insights?

[flvegan]

20. Turning $1 million into $10 million in loans is news to me.

Enlighten me.

[MindMatter]

27. It is fundamental to the system, and they don't want you to understand it.

If you can take 47 minutes to view this video, I believe that is a wise investment in time.

http://video.google.com/videoplay?docid=-9050474362583451279

[flvegan]

31. Howsabout you

give me a brief rundown. I spent 4 years in college as a finance and economics major. Doubt I'll learn much from a 47 minute video.

[MindMatter]

35. Well, if you don't understand how reserves and multipliers work

then I believe you would find the video informative.

[flvegan]

38. As I stated

having majored in the field, and having done pretty well in the investment community a decade ago, I doubt Grignon's video will help me.

Maybe YOU don't get it, and can't explain it.

So again, how does a bank turn $1 million in a deposit into $10 million in loans that net them what you've stated?

[MindMatter]

40. OK, take two minutes then

and read the section of this paper that talks about the fractional banking system. This is the system used all over the world today. I guess they didn't teach that at your school. Here's a chance to fill in an important gap.

http://www.lewrockwell.com/rothbard/frb.html

[flvegan]

49. Okay

I read it. Thanks for supporting my NOT missing something. That link, makes zero actual sense, and explains nothing. As expected.

[MindMatter]

53. Alright. Then take 30 seconds

and look at this graphic from wikipedia. It shows the lending that is possible from an original deposit of $100 at various reserve rates. And understand that the reserve rates are often MUCH less than 10%, so the multiplier can be far greater than shown in this chart.

[flvegan]

55. Listen

the originating bank isn't collecting interest on $100 million in loans on a $1 million deposit. There are 10 (or more) other banks collecting on the initial deposit cum loan. That's what I'm trying to explain to you.

[MindMatter]

57. There is effectively ONE bank

It is the FED. The walls between banks are porous. Money from bank A spills to bank B. Money from bank B spills to bank A. It is all the same pool and all one multiplier.

To settle this in your mind, simply consider the case where all the multiplication occurs within a single bank. Then you should understand that it doesn't change the concept or arithmetic at all if some of the money jumps back and forth across those bank boundaries.

[napi21]

26. BIG FLAW in your reasoning! All banks MUST keep a % of the money deposited

as a reserve. They are NOT permitted to lend it ALL OUT!

[MindMatter]

28. No, that is the point

The reserve is just another way to say that they can lend your money many times over. If you deposit $100,000, that is a "reserve" against which they can lend many multiples of that $100,000.

[napi21]

33. No that's wrong! I don't remember what the % was when I worked for

a bank, but it was a LONG time ago. Let's assume it's 25%. If that bank takes in $1,000,000 in deposits, they MUST retain at least $250,000 in reserves. They cannot lend the same money out multiple times.

Most banks manage deposits of hundreds of millions, and some of the big ones that number is MUSH HIGHER. I don't know where you got the idea that they lend the same money out multiple times, but it not true!

[Extend a Hand]

43. It's a pitifully small reserve...

http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html

Reserve Requirements



* Reserve requirements, a tool of monetary policy, are computed as percentages of deposits that banks must hold as vault cash or on deposit at a Federal Reserve Bank.

* Reserve requirements represent a cost to the banking system. Bank reserves, meanwhile, are used in the day-to-day implementation of monetary policy by the Federal Reserve.

* As of December 2006, the reserve requirement was 10% on transaction deposits, and there were zero reserves required for time deposits.

Reserve requirements are the portion of deposits that banks may not lend and have to keep either on hand or on deposit at a Federal Reserve Bank

The Monetary Control Act (MCA) of 1980 authorizes the Fed's Board of Governors to impose a reserve requirement of 8% to 14% on transaction deposits (checking and other accounts from which transfers can be made to third parties) and of up to 9% on nonpersonal time deposits (those not held by an individual or sole proprietorship). The Fed may also impose a reserve requirement of any size on the amount depository institutions in the United States owe, on a net basis, to their foreign affiliates or to other foreign banks. Under the MCA, the Fed may not impose reserve requirements against personal time deposits except in extraordinary circumstances, after consultation with Congress, and by the affirmative vote of at least five of the seven members of the Board of Governors.

In order to lighten the reserve requirements on small banks, the MCA provided that the requirement in 1980 would be only 3% for the first $25 million of a bank's transaction accounts, and that the $25-million figure would be adjusted annually by a factor equal to 80% of the percentage change in total transaction accounts in the United States. An adjustment late in 2006 put the amount at $45.8 million. Similarly, the Garn-St. Germain Act of 1982 provided for a 0% reserve requirement for the first $2 million of a bank’s deposits. This level, too, rises each year as deposits grow, but it is not adjusted for declines in deposits. As of December 2006, that level is $8.5 million.

[WoodyM]

22. Banks are not allowed

to lend money many times over. The FDIC requires that a certain percentage (it varies for many reasons) of their deposits be on hand to be able to have readily available any money a depositor my want.

[MindMatter]

30. Yes they are. That is fundamental to the modern banking system.

This video explains it well.

http://video.google.com/videoplay?docid=-9050474362583451279

[PDJane]

39. Oh, bloody hell.

Yes, they are. That's part of the banking system, and has been for a very long time; which is one of the reasons this stuff happens over and over. Right now, the banking liquidity is borrowed cash; that's part of the problem. There is, at the bottom, outright fraud involved in a lot of this, but it has the effect of moving money to the top of the chain, and that's not really good for anyone.

Add to that the fact that the Federal Reserve is run by a private consortium and you have a recipe for disaster.

By the way, the run on Fannie Mae and Freddie Mac isn't a run of bank customers; it is a run of shareholders.

[MindMatter]

42. Thank you. Any doubters should educate themselves on the concept of "fractional reserve banking"

It is fundamental to our banking system, and the practical effect is that banks lend their deposits MANY TIMES OVER. That is how they make money.

[PDJane]

51. And the fact that the fed is not

in the hands of the government, and it means that the government has no control over the money supply. It's a daft way to run a country.

[Speck Tater]

41. You REALLY need to watch that video.

Banks can and DO lend out money many times over.

In a nutshell:

I deposit $1000.00 in savings.
Banks keeps 10% in reserve and loans out $900.00 in the form a cashier's check.
Borrower deposits that $900.00 in the bank (for the sake of simplicity, assume it's in the same bank, but it really makes no difference because it all averages out over all the differnt banks involved.)
Bank now shows my $1000.00 deposit PLUS the $900.00 deposit made by the borrow.
Bank keeps 10% of the $900.00 as reserve and loans out the other $810.00.

Now bank's books show $1900.00 in deposits and $1700.00 in loans on the original $1000.00 cash deposit. The additional $700.00 was created out of thin air by the bank.

Bank now gets a deposit from the second borrower who deposits his $810.00.
Bank now show $2710.00 in deposits. It keeps 10% of the new $810.00 as reserve and loans out 90% of $810.00, or $729.00.

Now bank's books show $2710.00 in deposits and $2429.00 in loans on the original $1000.00 cash deposit. The additional $1429.00 was created out of thin air by the bank.

Now the original depositor (run on the bank) pulls out his $1000.00.

Now the bank has $2429.00 in outstanding loans which are NOT backed by ANY deposits. The run on the bank has caused the bank to become insolvent by unwinding all the leveraged assets, making them disappear. Out of the $2710.00 on the books as deposited, $1000.00 was withdrawn by the run on the bank, and the other $1429.00 shown as deposits has simply evaporated.

[MindMatter]

46. Thank you for that detailed scenario.

I know my discussion was grossly simplified. But the practical effect is that banks are allows to loan many times the amount of the actual deposits. And if there is a run on the deposits, the Fed steps in. Therein is the importance of PR. If the public ever really understands just how much hocus pocus there is in the system, they might make a run for deposits in huge numbers which would cause the system to come tumbling down. So the bankers impose some disciplines on themselves to stay just slightly inside that breaking point.

As long as we're at it, let's be really clear that all of this stuff is almost entirely outside the control of our government or any elected official. The "Federal Reserve" is a club formed and controlled by bankers. They set their own rules and the government has practically nothing to say about it. In a very real sense, our government is subservient to the Fed. We saw that relationship in action today as the Fed coerced our lawmakers to pledge unlimited taxpayer funds to keep Fannie Mae and Freddie Mac in business.

[Dreamer Tatum]

44. It's called the deposit multiplier.

The Fed simply requires that a portion of deposits be kept on hand at any one time - the rest can be lent...and re-lent...and so on.

[elleng]

32. Depositors only lose their money

to the extent it exceeds 100,000; protected by govt. As to 'creditors,' its a contract.

[MindMatter]

36. OK. And why is the deposit not also a contract.

[Speck Tater]

56. It is. So is your credit card, but if you go bankrupt,

what good is the contract to the credit card company. The contract becomes worthless and the credit card company gets stiffed.

BUT if you go bankrupt and your brother-in-law owes you a hundred bucks, YOUR bankruptcy does NOT let your bother-in-law get away with not paying. He still owes you the hundred bucks.

By your logic, if an individual person goes bankrupt then the bank he has his savings account in doesn't have to let him have his money.

Bankruptcy wipes out the bank's debts, NOT the bank's assets. Account balances are debts owed by the bank. Debts owed TO the bank are the bank's assets.

[elleng]

77. It is,

and the govt. recognized that most rely on our bank deposits, so in time of adversity for banks, govt decided to help depositors AND banks; gets $ to depositors, and may prevent runs on banks.

[dems_rightnow]

45. Why...

Can a bank customer declare bankruptcy and not pay their loan, yet the bank is required to honor the checks they write?

[PDJane]

48. they can't............

at least, not since the change in bankruptcy rules.

You really, really, have to pay attention.

[MindMatter]

50. I don't understand that question

Banks rarely honor bad checks. They return them NSF, and every bank in the chain tried to put a big fee on top of that.

There we go with another great banking scam. This happens to me several times a month in my business, so I am speaking the painful truth. A customer pays my invoice with a bad check. When that check bounces, my customer's bank charges him a $25.00 NSF fee. But my bank ALSO charges me an $8.00 fee for what? For being on the receiving end of an NSF check they had to return. And God help me if I turn around and bounce a dozen checks because my original customer's check bounced.

In practice, checks can bounce up to 14 days from the date of deposit, so that means I have to keep in my checking account a balance that is essentially 3 week's cash flow if I want to be safe. That is all money that the bank considers part of their reserve. They pay me nothing for it, and then they turn around and lend that money many times over.

Quite a system they have set up for themselves.

[napi21]

58. Did you realize that NSF chargers are set by each State?

http://marketing.checkagain.com/statefees.asp

At least the ones your bank charges YOU if You overdraw your account. I was looking for info on what banck charge a depositor who innocently accepted a bad check when I found this. I must admit, I always thought those fees were set by the individual banks!

[MindMatter]

59. Did not know that

But my beef is with my bank charging me an NSF charge when all I did was RECEIVE an NSF check.

I have no problem with banks charging a fair fee to the party that wrote a bad check, and I would expect that state or Federal laws would cap those fees.

[napi21]

61. That's why we see signs in a lot of stores stating what THEIR charge

is to the customer who passes them a bad check. I know I've seen those notices in almost every retailer I've been to lately.

I'm not trying to defend the banking practices. Years ago, when I used to work for a bank, the charge for an NSF check was $5.00 but when we actually calculated how much it really cost us to process them, it was 25¢ I know it's higher now, but for sure it's nowhere close to $25-$30! The banks have all joined the greedy group, and they charge for EVERYTHING!

[TexasObserver]

70. Because that's the way the Bankruptcy Code is written.

The instant a person files Bankruptcy, their finances become a new entity, known as the Bankruptcy Estate. It includes all the bankrupt's assets and liabilities. An Automatic Stay goes into effect immediately upon such a filing of bankruptcy, and it prohibits all creditors from seizing assets for non payment, until they have granted by the bankruptcy court a Motion to Lift Stay.

So, in the hypothetical you posited, the bank cannot repo the car or house UNTIL they file a motion and get it approved by the court. Upon such a motion, which will likely be granted if the debtor cannot pay CURRENT payments, the court will allow the bank to foreclose its security interest in the pledged assets.

During all this time, the bank must honor its obligation to pay checks written by the debtor on the debtor's checking account with the bank, provided the debtor has funds on deposit. The bank may not simply seize the checking or savings accounts of the bankrupt, as that would violate the Bankruptcy Court's Automatic Stay. If they do so, the bankruptcy court will make them return the money to the bankrupt's account.

[MindMatter]

72. But the bank is never forced by the court to honor bad checks

The bank may be forced to accept a loss as part of a bankruptcy settlement. I get that. And the bankers keep pushing for laws that push us deeper and deeper into credit that is unlikely to be paid. Why would they do this? Because the deck is so stacked in their favor, it is almost beyond imagination.

Once again, the practical effect of the fractional system is that they are able to lend many times the original deposits, so they can afford an amount of bad debt that any normal business could never survive. I'm not saying that banks like bad debt. Of course they don't. But they really, really like the system that enables them to maximize their earnings by putting us into impossible debt situations, even when that increases their uncollectibles.

[TexasObserver]

75. That's what I said. The bank only honors the bankrupt's checks to the extent of his deposits.

You're mixing up concepts.

A bank loan is usually a bad loan BEFORE anyone files bankruptcy. If it's a bad loan, it's not being timely paid, and that is usually true before anyone takes the action of filing for bankruptcy. The entire bad loan is written off against bank capital. To the extent that the bad loan is then collected, in whole or in part, the bank capital is increased accordingly.

You are correct that the fractional system allows banks to lend many times the amount of their bank capital. That does not mean they can afford losses the ordinary business would not be able to absorb. In fact, banks are subject to much more oversight and regulation than your ordinary business.

Suppose you have a business that sells cell phone contracts that cost $100 up front, on a cell phone card. Suppose they have 100,000 cards out at $100 each, or a total of $10,000,000 the company has taken in from customers, and still owes the customers in terms of air time. If that business suddenly fails, every customer of that failed business loses every dollar they spent, even if the check they used to pay just cleared yesterday.

[1]

62. this is an amazing thread....

i should weep for anyone that has MORE than $100,000.00 deposited in a bank? weep for those that stash their excess cash in banks above the stated insurance limit that even i know about?

me with my $57.12 in my checking account knows this, yet these "captains of industry" don't?


wow, if i ever meet one of these poor schmucks that lost an amount OVER THEIR $100,000.00 in life it will be the first time, and i might weep. laughing...

and then i would hold my right hand up to my forehead and make the symbol of a "L" with my thumb and index finger. and whisper...

"you are a loser."

[MindMatter]

64. I don't blame you.

That was not my intent with the thread. The thread took a side trip because there are evidently a lot of folks who didn't understand some of the basics of the gamed system like the fractional deposits and the limits on deposit insurance.

My point and question had nothing to do with those things, but it did assume a basic knowledge level that I guess I should not have assumed.

My point is simply that the banking system is gamed in every possible way to favor the bankers. The extent of the rigging is truly mind-boggling. But that is what happens when we allow the bankers to run their own system without any government involvement, oversight, or interference.

[1]

65. hey, that was not a shot at you...

i just look at my sad little checking account. and i envision the day, standing in line (for hours and hours and hours) waiting for my $57.12 fdic insurance payout, when the woman in front of me wearing a fur shouts "what do you mean only $100,000.00?"

uuuggghhh...

[TexasObserver]

69. Banks loan tens times their CAPITAL, not 10x their deposits.

A bank's CAPITAL is the amount of EQUITY the bank's stockholders have in the bank. That number is reduced, dollar for dollar, every time a bank examiner from the Office of the Comptroller of the Currency requires the bank to write off a bad loan. As banks have bad loans, and ultimately have to write off those loans, it reduces the bank's CAPITAL.

The amount of money a bank can have out in loans is a multiple of the bank's CAPITAL. It's about 10-11 times the amount of the CAPITAL that a bank can have out in loans. So a bank with a CAPITAL of $10 million might have loans outstanding of $100 million. However, let us assume that of that $100 million, 4% of the loans go bad and must be written off. That $4 million cuts the bank's CAPITAL, making it not $10 million, but $6 million. Under that scenario, the bank would be unable to make loans, because it would be far in excess of the aggregate loan cap of that bank.

Same scenario, except the bank has to write off $11 million in loans, or $1 mil more than its CAPITAL. That bank has failed. Its assets are seized by the federal government, its bad loans are written off, and whatever remains is rolled into a new bank, which typically is run by some other existing bank favored by the FDIC, which may provide some funds for initial operation.

When the bank CAPITAL is exceeded by the bad loans written off, the bank has failed.

The EQUITY owned by the stockholders in the bank falls to ZERO dollars. They lose everything they had invested. The DEPOSITS are transferred to the newly created bank. To the extent the bank has lost the money of depositors, that money is funded, up to $100,000 per customer, by the FDIC, assuming there is a shortfall. There may not be a shortfall, but there often is by the time the bank fails. The depositors who have more than $100,000 in deposits at the failed bank are not guaranteed anything more than that. However, the FDIC can and does pay some percentage of the funds on deposit above the $100,000 per depositor. In the case of IndyMac, for example, they're $.50 on the dollar for the amounts above $100,000 per depositor.

The supposition that bank failures do not matter is mistaken. They typically mean that a local bank is replaced by a component of a much larger bank, usually a big bank, and all the local investors who put up the capital for the original bank lose their investment. They lose control of the bank and all its assets. They're often on the hook for years, and may be sued for mismanagement (assuming they were officers or directors in the failed bank).

Some depositors, such as people who placed all their life savings or all their late husband's insurance proceeds into the bank, will lose some portion of their money.

Bank failures do help one group of people: big banks. They are the scavengers, and they not only get everything of value from the failed bank, but they do so without all the bad loans that dragged down the original bank.

When we spend $1 billion because a bank fails, that is $1 billion that cannot be spent by the federal government on things like rebuilding the nation's bridges.

EDIT: PERFORMING loans, or loans that are not delinquent, are part of the asset package that goes to form the new bank. NON PERFORMING loans, or failed loans, are sold to separate entities. The commercial paper that represents those loans is often sold and resold, as Collection Entities buy the paper for cents on the dollar, and then try to collect as much of the loans as they can. The newly formed bank that succeeds the failed bank does not take the bad loans in its purchase of the failed bank's assets, only the good ones. All the good stuff goes one direction, to the new bank, and all the bad stuff goes another direction, to collection groups and such, as stated just above.

[MindMatter]

76. I agree with that

Really, all of your post, but I'll comment specifically on:

"The amount of money a bank can have out in loans is a multiple of the bank's CAPITAL. It's about 10-11 times the amount of the CAPITAL that a bank can have out in loans. So a bank with a CAPITAL of $10 million might have loans outstanding of $100 million. However, let us assume that of that $100 million, 4% of the loans go bad and must be written off. That $4 million cuts the bank's CAPITAL, making it not $10 million, but $6 million. Under that scenario, the bank would be unable to make loans, because it would be far in excess of the aggregate loan cap of that bank."

I definitely agree with you that when a given bank fails, it is bad for that bank, and I'm willing to assume that most banks are not run by crooks who are just trying to make the bank fail. I hope that is a good assumption. It most certainly was not a good assumption 20 years ago with the S&L fiasco, and when one looks at the monkey business that has been going on with real estate loans, one wonders if we are seeing the same thing all over again.

I also agree with the distinction between deposits and capital, but it is only an important distinction at the point of failure. Prior to that, the bank is able to achieve great leverage, lending many times the about of actual DEPOSITS, and getting interest income for money that only exists in the form of this fictional fractional system. And while the bank doesn't enjoy defaults, your numbers show why they are willing to continue to extend credit until we are all hopelessly over our heads.

In your scenario there is $10M of capital on which the bank must pay interest. But they are able to lend $100M on which they can charge interest. With that leverage, they can afford a whole lot of defaults and still make money. That is the key think that many folks don't understand. The bankers define their own rules and they have set the system up this way -- where they have built-in incentives to bankrupt Americans by the millions. There were about 2.5 million bankruptcies in 2005. That's a number that works for banks under the new bankruptcy law. 10 million bankruptcies probably don't work out so well. There is a "happy value" (happy if you are a banker) somewhere in between those numbers where they can maximize their profits.

[SammyWinstonJack]

73. Federal Reserve privately owed bank? I think that is where we got screwed.

:shrug:

[dsc]

74. the loans are resold

either before or after the fact. Thus the money is still owed, under the same terms, just to someone else.