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walterallenhaxton's avatar

Do banks make serial bad loans so that they will have more money to lend?

Asked by walterallenhaxton (886 points ) April 13th, 2009
Observing members: 0 Composing members: 0

13 Answers

YARNLADY's avatar

Huh? A bad loan gives them less money to lend, not more. They make bad loans because of mismanagement.

Snoopy's avatar

How does making a bad loan make the bank money? It is called “bad” for a reason….

jrpowell's avatar

This is a really simple version of how a bank works.

#1—You give them money
#2—They are required to hold 10% of that money
#3—They loan out 90%
#4—They make money off the interest of that 90%you gave them that they loan out

That is about as simple as I can go.

wundayatta's avatar

I think the suggestion is that if your bank goes belly up, then you can get stimulus funds to keep on going, plus pay hefty bonusses to all the executives.

Of course, I could be reading too much into it, and this just might be an idiot question. But I think there’s more to it than that. (‘Course, maybe I’m the idiot!)

In either case, the answer is NO!

benjaminlevi's avatar

Why would they refrain from making high risk, high profit deals but have the taxpayers to bail them out if they fall through? Socialized risk and privatized profits is a very good business model.

wundayatta's avatar

@benjaminlevi: you have a very persuasive point. It is, however a very big risk to couint on socialized risk. It’ll only work if you attain a position in the market that means the whole thing fails if you fail.

This suggests that to avoid this problem in the future, anti-trust laws should either be enforced more strictly (I doubt if the Bushies had any interest in this), or made more stringent, so as to prevent any one firm from becoming so important to the economy.

walterallenhaxton's avatar

@YARNLADY You make a loan. You trun it in and get a large part of the money that you loaned back. You loan out that money and do the same thing. When a bank does this it winds up lending several times the original loan. Since the money that they are lending is based on the credit created by that loan it pays them to keep making such loans. Most of them are to the government today and they know for certain that they have no intention of ever paying such loans back.

YARNLADY's avatar

@walterallenhaxton Your explanation shows that you have very little understanding of finance and how banking works. I am a trained accountant, and have worked for loan companies.

Your answer has way too many ‘you’s and ‘they’s in it but I think I have figured out what you believe. Indeed, there are a few banks that are misusing the system, and they are the ones that make the news.

The newsbuying/reading public is not interested in reading about the successful, lawful banks, which are in the majority, but rather the ones that have made a mess of their own business, and caused a severe backlash.

walterallenhaxton's avatar

@YARNLADY You make a loan. You turn it in and get a large part of the money that you loaned back. You loan out that money and do the same thing. When a bank does this it winds up lending several times the original loan. Since the money that they are lending is based on the credit created by that loan it pays them to keep making such loans. Most of them are to the government today and they know for certain that they have no intention of ever paying such loans back.

walterallenhaxton's avatar

@YARNLADY No it is you that does not understand. The money in the USA and most of the world is not based on value but on promises to pay. I am sorry that you do not like my explanation of the process. Now that the biggest bad credit risk in history is rapidly taking on debt and the bank is using that debt to make new loans it is only a matter of time until the whole system falls completely apart. Accounting is a good job but it doesn’t have much to do with the understanding of economics. Do not include what I say in your question. It is my property and I do not wish it to be used that way. It is annoying.

I am sorry for the typo. I ran out of battery and It was post it or loose it. My inverter gives me little time until it kills the current.

I look forward to the days of hard currency again. What scares me is the hyper inflation that will come in between.
It is always a serious economic mistake to put all of your eggs in one basket. In this case most of the world has put the control of their money into the hands of a few proven thieves. A central bank is not a real bank. It has even stolen the name bank from more respectable institutions. It is a criminal organization. Basically a counterfeiting racket. To make a racket work you need to be in partnership with a government.

YARNLADY's avatar

@walterallenhaxton What do you mean “do not include what you say in my answer?” I have not included anything you said, and if I do, I put quotes around it. Do you mean my complaint about you’s and they’s?

I do understand the part that ‘promise to pay’ plays in the full process, and I have discussed it more fully in other questions. Because I participate in several different internet sites, I sometimes find myself referring to things I said on a different forum.

walterallenhaxton's avatar

@YARNLADY Promises to pay are the foundation of our fiat money system. The banks take them to a government bank and get back far more cash for them than they have to invest from depositors. The government banks just create that cash by putting a mark on a ledger and the banks just writes a check to get the freshly printed bills.
I don’t know if it is the same at your bank but our bank’s ATMs have been giving us uncirculated notes for some time now.
This format is confusing to me. Sorry. It was not you that did the double posting.

dabbler's avatar

One HUGE aspect missing to the above discussion, in the context of sub-prime mortgage meltdowns is that banks will commonly bundle a bunch of loans and sell the bundle (securitization) to investors (pension funds, hedge funds) and turn that cash back around to make more loans.

I.e. they don’t keep the loan around. They’ll want to make as many loans as possible (including “good” and “bad” loans) to make money on the ‘loan origination’ and other fees.
Since they aren’t holding the loan any more they don’t much care whether or not it is ‘good’ or ‘bad’.

Why does it seem not to matter whether the loans were ‘good’ or ‘bad’?

Back when securitization was in its infancy a lot of due dilligence went into describing the quality of the components of a bundle. If the composition of a bundle was all good that would earn the bundle a good rating. As these motgage-backed-securities (MBS) got popular (REALLY popular) institutions put far less diligence into describing the quality and something happened to the ratings agencies along the way.

Several decades ago If you wanted ratings information you paid the ratings agency for their analysis. They did not cover everything and to get their attention companies started hiring consultants from the rating agencies to get on the good side of the raters. The major ratings agencies eventually switched to a paradigm of getting paid by the people they are rating (can you say conflict of interest?!)
So an institution with a steaming pile of sub-prime mortgages can pay a rating agency to magically transform that heap into a AAA instrument.

This whole collusion has sort-of melted down in the past few years as the actual quality of sub-prime MBSs has been exposed. So currently there are a lot less ‘bad’ loans on real estate made. In fact it’s harder than ever to get a loan even if you are well qualified.

However there are whole classes of over-rated crap that aren’t tied to real stuff like houses. The ratings agencies are still paid by the bundled-crap-pushers. There are still many trillions of dollars of junk out there we have not heard much about yet.

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