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Vision: Time for a New Theory of Money

We as a community can create our own credit, without having to engage in the sort of impossible pyramid scheme in which we're always borrowing from Peter to pay Paul.

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Today, paper money is no longer redeemable in gold, but money is still perceived as a “thing” that has to “be there” before credit can be advanced. Banks still engage in money creation by advancing bank credit, which becomes a deposit in the borrower’s account, which becomes checkbook money. In order for their outgoing checks to clear, however, the banks have to borrow from a pool of money deposited by their customers. If they don’t have enough deposits, they have to borrow from the money market or other banks.

As British author Ann Pettifor observes: "the banking system... has failed in its primary purpose: to act as a machine for lending into the real economy. Instead the banking system has been turned on its head, and become a borrowing machine."

The banks suck up cheap money and return it as more expensive money, if they return it at all. The banks control the money spigots and can deny credit to small players, who wind up defaulting on their loans, allowing the big players with access to cheap credit to buy up the underlying assets very cheaply.

That’s one systemic flaw in the current scheme. Another is that the borrowed money backing the bank’s loans usually comes from shorter-term loans. Like Jimmy Stewart’s beleaguered savings and loan in It’s a Wonderful Life, the banks are “borrowing short to lend long,” and if the money market suddenly dries up, the banks will be in trouble. That is what happened in September 2008: According to Rep. Paul Kanjorski, speaking on C-Span in February 2009, there was a $550billion run on the money markets.

Securitization: “Monetizing” Loans Not with Gold But with Homes

The money markets are part of the “shadow banking system,” where large institutional investors park their funds. The shadow banking system allows banks to get around the capital and reserve requirements now imposed on depository institutions by moving loans off their books.

Large institutional investors use the shadow banking system because the conventional banking system guarantees deposits only up to $250,000, and large institutional investors have much more than that to move around on a daily basis. The money market is very liquid, and what protects it in place of FDIC insurance is that it is “securitized,” or backed by securities of some sort. Often, the collateral consists of mortgage-backed securities (MBS), the securitized units into which American real estate has been sliced and packaged, sausage-fashion.

Like with the gold that was lent many times over in the 17th century, the same home may be pledged as “security” for several different investor groups at the same time. This is all done behind an electronic curtain called MERS (an acronym for Mortgage Electronic Registration Systems, Inc.), which has allowed houses to be shuffled around among multiple, rapidly changing owners while circumventing local recording laws.

As in the 17th century, however, the scheme has run into trouble when more than one investor group has tried to foreclose at the same time. And the securitization model has now crashed against the hard rock of hundreds of years of state real estate law, which has certain requirements that the banks have not met—and cannot meet, if they are to comply with the tax laws for mortgage-backed securities. (For more on this, see here.)

The bankers have engaged in what amounts to a massive fraud, not necessarily because they started out with criminal intent (although that cannot be ruled out), but because they have been required to in order to come up with the commodities (in this case real estate) to back their loans. It is the way our system is set up: The banks are not really creating credit and advancing it to us, counting on our future productivity to pay it off, the way they once did under the deceptive but functional façade of fractional reserve lending. Instead, they are vacuuming up our money and lending it back to us at higher rates. In the shadow banking system, they are sucking up our real estate and lending it back to our pension funds and mutual funds at compound interest. The result is a mathematically impossible pyramid scheme, which is inherently prone to systemic failure.

 
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