The Wall Street Ponzi Scheme called Fractional Reserve Banking

[Phred42]

Americans MUST understand that our banking system is based on a Ponzi scheme. We can't fix it if we don't know what the problem really is.

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The Wall Street Ponzi Scheme called Fractional Reserve Banking
http://globalresearch.ca/index.php?context=va&aid=11600

Borrowing from Peter to Pay Paul
- by Ellen Brown

Cartoon in the New Yorker: A gun-toting man with large dark glasses, large hat pulled down, stands in front of a bank teller, who is reading a demand note. It says, “Give me all the money in my account.”

Bernie Madoff showed us how it was done: you induce many investors to invest their money, promising steady above-market returns; and you deliver – at least on paper. When your clients check their accounts, they see that their investments have indeed increased by the promised amount. Anyone who opts to pull out of the game is paid promptly and in full. You can afford to pay because most players stay in, and new players are constantly coming in to replace those who drop out. The players who drop out are simply paid with the money coming in from new recruits. The scheme works until the market turns and many players want their money back at once. Then it’s game over: you have to admit that you don’t have the funds, and you are probably looking at jail time.

A Ponzi scheme is a form of pyramid scheme in which earlier investors are paid with the money of later investors rather than from real profits. The perpetuation of the scheme requires an ever-increasing flow of money from investors in order to keep it going. Charles Ponzi was an engaging Boston ex-convict who defrauded investors out of $6 million in the 1920s by promising them a 400 percent return on redeemed postal reply coupons. When he finally could not pay, the scam earned him ten years in jail; and Bernie Madoff is likely to wind up there as well.

Most people are not involved in illegal Ponzi schemes, but we do keep our money in accounts that are tallied on computer screens rather than in stacks of coins or paper bills. How do we know that when we demand our money from our bank or broker that the funds will be there? The fact that banks are subject to “runs” (recall Northern Rock, Indymac and Washington Mutual) suggests that all may not be as it seems on our online screens. Banks themselves are involved in a sort of Ponzi scheme, one that has been perpetuated for hundreds of years. What distinguishes the legal scheme known as “fractional reserve” lending from the illegal schemes of Bernie Madoff and his ilk is that the bankers’ scheme is protected by government charter and backstopped with government funds. At last count, the Federal Reserve and the U.S. Treasury had committed $8.5 trillion to bailing out the banks from their follies.1 By comparison, M2, the largest measure of the money supply now reported by the Federal Reserve, was just under $8 trillion in December 2008.2 The sheer size of the bailout efforts indicates that the banking scheme has reached its mathematical limits and needs to be superseded by something more sustainable.
Penetrating the Bankers’ Ponzi Scheme....

[.... callchet ....]

1. There is no difference

You say that a Ponzi scheme fails when there is not enough money to cover demand withdrawals. Well guess what, there is not enough money to cover

the stock market if everyone wants their money. What is the difference, there is no money except for the new people investing every day. Our

whole system is a pyramind scheme.

[Boojatta]

2. "there is not enough money to cover the stock market if everyone wants their money"

Since when is a stock guaranteed to be redeemable for a certain amount of money? I thought that someone who buys stock recognizes that he or she is buying some part of (or "share" in) a company. I thought that stocks trade between a seller and buyer who consent to a given transaction.

Obviously if there is no buyer then there is no transaction. "Everyone wants their money" in your hypothetical scenario sounds as though you are imagining that there are no buyers.

[.... callchet ....]

3. and there can very easily be no buyers

except that when it loses 90% of its value some big money will come in and buy it all up

[.... callchet ....]

4. and then

when umpteen millions lose umpteen trillions, whats the difference between that and a pyramid scheme

[.... callchet ....]

5. and

Madoff's investors were not guaranteed a refund were they ? But they ended up with nothing, just like a lot of stock market investors will end up with nothing

[Boojatta]

6. The difference is whether or not there's fraud.

If I have a package of five tulip bulbs and I tell you that it's a package of five tulip bulbs and you offer me $1000 for it because you hope to sell it to someone else for more than $1000, then you are taking a big risk. You might be hoping that a crazy trend will continue. However, I can accept your offer and I won't be committing fraud.

[.... callchet ....]

7. but if

you no the tulip bulbs will never be worth that, is that not fraud or is it just good business.

[.... callchet ....]

8. and why

did those bad mortgages get traded so quickly. They new they were junk when they sold them. Every body tried to make their money before the pyramid

collapsed.

[.... callchet ....]

9. and just

for the heck of it, You can explain the whole market by using math. Phase shifts while one action is taking place allows another trade to slide in

before the results of the prior trade have been realized. It is all like nonlinear equations that have two answers and the ability to take advantage

of one while the other matures.

[David Ricardo]

10. Current banking usually has public assurances to on deposits to a certain limit

But let's look at it structurally. A bank itself is not some noble institution made of marble, it is an investment for your money (the only risk-free action with your money is to stuff it in a mattress, but then you have the opportunity cost of holding money), and as an investment, there will be risk, FDIC notwithstanding.

Historically banks have lower risk, low enough that people are confident that they are willing to put their money in there as a place to store it, knowing they will probably get it back plus interest. It all comes back to investor confidence.

From my perspective as an economist, it's an important risk for society to absorb: If fractional reserve banking didn't, exist, i.e. if the required reserves were 100%, there would be no money multiplier and loans would be essentially impossible to get and economic growth would be hardest, especially for those looking to make their way up the ladder (school loans, car loans, house loans, etc.)

After all, we've seen what happens when credit markets tighten. It's not pretty.

[Phred42]

11. So taxpayers have been put on the hook to guaranty the Ponzi Scheme up to $150K

[David Ricardo]

13. Yes, the investment is covered up to whatever the limit is now

You're referring to the moral hazard issue relating to the deposit insurance of the FDIC, which itself was part of New Deal legislation for people to have their confidence restored in the banking system.

If my investment is guaranteed, then why not make a risker investment since the payoff is presumably higher and any losses will be subsidized by taxpayers. That in a nutshell was the cornerstone of the S&L Crisis.

[.... callchet ....]

12. The point

is that you make known the risk. And then when it goes belly up there are no sore losers. There are a lot of successful business that never sell

stock. And going up the ladder requires inflation. As the population expands exponentially, there can not be enough money for everyone to make it.

So then they have to print more money or give you more value to count on ( tail it crashes ). The point is that the stock market in its present form

is creating money. By leveraging loans and betting on the leverage, money is being created on paper. We don't need the stock market like it is. The

market is acting like an industry that doesn't exist. I had a problem with my knee and my arthropod said he solves problems by operating. That is the

only solution he uses. So maybe we need to look at the economy from a different perspective. Maybe theologians or philosophers or bricklayers should

look at it. When they found the problem with the hubble telescope, they said that it was like solving a 6th grade science problem. So maybe we need

the 6th graders look at the economy also.

[David Ricardo]

15. I understand your argument

But the fact that money is not necessarily backed by reserves isn't an issue because historically over time, economic growth occurs. Certainly there are recessions and even depressions, but if you look at any measure of economic activity, I would conjecture since the beginning of time it has grown.

Given that, the existence of money not backed by deposits is justified. So even if banking is a Ponzi Scheme, is that bad? and is there a better way to efficiently extend credit?

[.... callchet ....]

17. Thats true

and the only fly in the ointment is that when the money changers can't create enough money to pay their fees because the phone banks can't raise

any more money, then all hopes and dreams are crushed. The big money goes in and scoops up all the cheap stocks and the government is forced to save

the rest of nation. And the big money fights all the steps because they have to finance the recovery because they are the only ones with money. SO

then the rest of the middle class has to give up the rest of what little money they have to pay their "fair share "of the recovery.

[.... callchet ....]

14. And if

you are smart enough you can make it complicated enough to hide the fraud. And sometimes it doesn't even look like fraud unless you examine it under

a " microscope " at instant. And maybe the rest of the people are too proud to admit they can't figure it out so they give it their ok. And then

when the doo doo hits the fan they say " never saw that coming "

[David Ricardo]

16. Why is why I support government (taxpayer) subsidies

to make information better available to investors (and thus fraud less likely). I generally am wary of government subsidies, but access to information is a barrier to a competitive market and everyone is better off if better information exists on the nature of investment.

[.... callchet ....]

18. You are

not able to receive emails yet, so I would like to thank you here for your time and information. Great posts.

[.... callchet ....]

19. And what

would be wrong with this? A company issues stocks, gets money to build and grow. The stock holders never sell their stock. The company builds and

grows and pays a dividend to the stock holders. And the original stock holders still have their original stock.

[Statistical]

20. What if the original investor has financial problems and needs cash now?

That is why we have markets.

Stock market is simply a market of stocks. If is no more evil than a market for used cars (autotrader anyone?) or a market for consumables (grocery store).

One of my first jobs was writing software to make a very very specialized market.
It is a B2B (business to business) market where companies could buy,sell,trade electronic components

You know all those little parts that go into gdadgets: leds, diodes, transformers, microprocessors, ASICs.

Rather than a company needing to make 20-30 calls to line up suppliers they could use the market and instantly see how much is available and at what price.

Markets are simply a way to connect buyer and seller.

Without markets people would still trade stocks. They would trade them on forums:
"Hey I got 1000 MSFT, I am looking for $22 a share. Give me your best offer".

Or in person, or via want ads.

Markets (for stocks and for anything tradable) are simply clearinghouses that facility LIQUIDITY.
The ability to sell anything at anytime is very useful.

It would be kinda stupid to have to file for bankruptcy because you don't have cash (LIQUID wealth) to pay the bills but you are sitting on $1 million in stock that you can't sell because some market-nazi believed that markets are inherently evil.

[Boojatta]

21. Not all businesses are listed on stock exchanges.

Even if a business has never been listed on a stock exchange, it doesn't follow that its shares are never sold. For example, suppose that there are seven shareholders and at least one shareholder wants to increase his or her share of the business. A shareholder might sell some or all of his or her stake to someone who already has a stake but wants a bigger stake.

What would be wrong with this? A building is constructed. It consists of condominium units. People buy them. When they are all sold, the owners never sell their units. The original owners still have their original units. Of course, we know that sometimes people have good reason to move long distances and relocate. Even if the condominium agreement allowed you to be a long-distance landlord, you probably wouldn't want to be one. You would probably sell your unit. However, there are plenty of other possible reasons that you might wish to sell. Use your imagination!