I don’t have to tell anyone that our economy is slowly coming to a collapse. However, do individuals, like myself, even understand what lead to our current economic depression? I mean, just watch the news, they aren’t trying to explain the problem. They’re arguing over on the various plans and packages that could save us.
Fortunately, there are people that are trying to help that our trying to help others like myself understand what exactly lead to our country’s economy turning into this particular nightmare. Alex Blumberg and Adam Davidson have been recently been added to my personal collection of heroes. They’ve been featured on This American Life and the Planet Money podcasts explaining the multiple problems of our current economy. They recently tackled the current problems most of today’s banks are facing. If you have the time, I highly recommend you check out the podcasts. The following is just an echoing of what they’ve been saying about banking, just in my own words.
The basic rule of every bank is you need two kinds of customers: Someone to invest in your bank and someone to borrow from your bank. For example, the bank will charge the borrower a 6% yearly interest on their loan and give the investor 3% yearly interest for investing in their bank. Banks make their money, or capital, from the 3% difference between the investors and the borrowers and, in theory; everything balances out on the grand balance sheet.
The bank’s got greedy though and started giving loans to whacked out individuals that didn’t or couldn’t pay their mortgages. The balance sheet still has to be even, resulting in evictions of homes and reposing of property and with the recent housing slump the banks are stuck with a house that is of less value than before the transaction. This is called a toxic asset because there was a loss of money on the borrower’s side. The banks have developed a twisted ideology through believing that if they keep the toxic assets until the ailing market recover, they can then turn around and sell it, resulting in a profit and capital.
The wrinkle in this idea is that the two biggest banks in America, Bank of America and Citi, are insolvent meaning that they owe more money than they have. The problem is if they declare bankruptcy it would almost certainly lead to the complete and utter destruction of our economy, which is where the government steps in.
The government is siding with the banks. Mainly due to the fact that if the two biggest banks collapse, so will the economies of the world. Which is why our government buys these toxic assets from banks like Citi, they hope that as the market recovers they’ll be able to.
Too be continued… hopefully
Joel Samson Berntsen (This American Life-Bad Bank)