Thursday, September 18, 2008

#146 - Financial Crisis in a very simplified nutshell

The current economic crisis is beast created by irresponsible banking, and the governement that creates the environment that makes banks think they can get away with it. What is needed is not more regulation, but stripping away of some of the powers that are given to banks by government, which means less laws not more.First you need to learn a few things about the current system:

- Fractional Reserve: We have a fractional reserve system which allows banks to lend as much as they want as long as they have enough deposits to cover a certain % of it (currently 10%). If I had one buck and tried to lend somebody 10... I think someone would call BS on me.

- Securities: to be blunt, Stocks and Bonds- Derritives: Securities backed by other securities, the ones causing the problem specifically are CDO/CMO.

Summary of a CMO/CDO- money is lent out @ 6%- I then take those loans and create a bond backed by those loans @ 4%

Result: banks make a free 2% cause the money from the bonds pay the loans... but then those bonds can be repackaged into Variable Annutiies and Mutual Funds which can be repackaged into participating investments trusts etc.Eventually it gets repackaged so many times that when the oroiginal mortage is defaulted on (due to interest rate manipulation by our central bank, The Federal Reserve, boooo) all the securities derrived from this mortages are also defaulted.This creates a very strong interdependency among banks... so when one falls... you get a domino effect that has only begun.

In the system we should have, a 100% reserve system with NO CENTRAL BANK this wouldn't happen cause:

a) credit would tighten since banks have to have enough deposits to cover their loans, even though at first less loans seems like it constrict the economy. This is alright cause the loans lent out will be fairly secure, and the businesses funded will be sound so during tough economic crisis they will be able to survive instead of having massive job losses during economic downturns.

b) same as above, but this will also be in part due to market interest rates instead of it being dictated by the federal reserve with inflation, which would mean stronger currency and more sound business practices and bank.

it goe s alittle farther than that, but that's the gist.In general... things are pretty bad.

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