General Question

Fieryspoon's avatar

Why is leveraged banking legal?

Asked by Fieryspoon (1058points) September 29th, 2008

Why is it legal for a bank to loan out more money than the bank holds in its vault? Pulling money out of thin air seems like like fraudulent behavior, to me.

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12 Answers

kevbo's avatar

Not an answer, but it is a centuries-old practice. See here.

SquirrelEStuff's avatar

As Mayer Amschel Rothschild said, ”“Give me control of a nation’s money
and I care not who makes the laws.”

robmandu's avatar

Not a financier myself, but there is a concept of financial risk management.

The idea is that a bank lending out any money at all exposes itself to the risk of not being able to pay back all depositors if they should all come wanting their money back at the same time. But that (almost) never happens. So, in practice, there are established rules that govern how a bank can make use of various financial instruments (like loans) and stay within acceptable risk guidelines.

The problem we’re seeing with the bailout today is not simply that banks loaned out more money than they could handle… but that government regulations forced them to do it to avoid penalties. The free market was maneuvered into this untenable position. And it was known years ago that this would be the result.

Skip the last 60 seconds at the very end if you don’t want the partisan sales pitch: video.

marissa's avatar

I just watched the video, but now the link won’t work it says it’s been removed.

robmandu's avatar

Huh… well, whoever produced it can always load it back up sans music to avoid copyright infringement with Warner Music Group.

If I come across it again, I’ll post a new link.

marinelife's avatar

The reason that things are in the mess they are now is that prudent banking practices required by regulation about how much risk banks could assume were thrown out the window by Phil Gramm (McCain’s proposed Treasury Secretary) and John McCain in a systematic effort to deregulate banking.

Here is one article that details it.

SquirrelEStuff's avatar

You are correct, Marina.
“Former Senator Phil Gramm, who now advises Senator John McCain and is the person who says that folks who fret about current economic conditions are “whiners”; Clinton Treasury Secretary Robert Rubin, one of whose protégés advises Senator Barack Obama; and Alan Greenspan, former chief of the Federal Reserve.

Gramm, Rubin, and Greenspan made this debacle possible.”

I believe most of what caused what is happening, happened during Bill Clinton though.

fireside's avatar

So, what that article is saying is that Monica Lewinsky is to blame for the current crisis just like she is responsible for us not getting Bin Laden earlier, right?

I think the blame lies squarely on Ty Pennington and HGTV.

if it hadn’t been for all those home improvement shows about fixing up houses, people wouldn’t have thought it would be easy to buy real estate and “flip it” and they wouldn’t have gone out to get ridiculous mortgages

robmandu's avatar

Ah, the video I mentioned above is back… (unfortunately, with soundtrack intact, so it might get yanked again).

kevbo's avatar

@rob, thanks for bringing that chain of events to light. Obama isn’t my candidate, but I had no idea how deep he was in the pockets of Fannie & Freddie (not to mention the other backstory).

robmandu's avatar

@Kevbo, yah, I was amazed to see this video where the democrat representatives actually ridicule the Director of Federal Housing Enterprise Oversight in a meeting discussing how FM/FM had engaged in improper conduct… back in 2004.

lloydbird's avatar

Because it is a long established trick, about which too few are, as yet, aware.

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