Tuesday 5 June 2012

A Monstrous Power

Show Me The Money! Walt Disney's view of MB. Scrooge McDuck swims like a porpoise through the all-too-real cash piled up in his money bin . In reality, of course, the loan the bank gives you to buy a house is nothing more than a book entry. In the final anaysis it is your own hard work that secures the value of your mortgaged property - not to mention the bank's interest-derived profit.
EVER WONDERED where home loans come from? It’s worth a moment’s thought. A bank extends someone a line of credit amounting to hundreds of thousands of dollars – but from where? Where does the money come from? Is there a vast vault somewhere, filled with cash, like Scrooge McDuck’s money bin? Does the bank simply lower a big basket into the pile and haul up a home loan?

No. In reality, home loans are book entries – nothing more. The bank assesses its clients’ credit worthiness, fixes a repayments schedule, and, over the next fifteen-to-twenty years, in addition to recovering the loan, charges them an eye-wateringly large sum for the privilege of using its purely nominal capital.

So, in the beginning, there’s a book entry, and, by the end, the bank has taken thousands of dollars of its client’s very real cash, cancelled its book entry, pocketed the interest, and started the process all over again with a new generation of dupes – oops! – I mean clients.

Home loans are, therefore, a kind of wager. The bank bets on the debtor’s ability to repay, with interest, a sum of money which, strictly speaking, it does not possess. Since most human-beings are decent sorts, who almost always keep their word, this is a pretty safe bet on the bank’s part. Indeed, if we’re being truthful, the risk of the bank losing on the deal is negligible. (After all, it holds a mortgage on the house!) In fact, you could even argue that it’s the debtor who, through years of honest toil, creates his or her own home loan – while, simultaneously, paying the bank a small fortune for being generous enough to believe that its client was good for the money.

This is a monstrous sort of power, made even more frightening by being placed in private hands. Surely, the ability to financially enslave a reasonably large chunk of the population (mortgage, literally translated from the Old French, means “a death-dealing pledge”) shouldn’t be entrusted to just anyone. If someone’s going to create money out of thin air, and charge people to participate in the conjuring trick, then, surely, that someone ought to be the state?

That is certainly what a great many New Zealanders used to believe. Which is why, thirty years ago, the state used to own the Bank of New Zealand, the Post Office Savings Bank and the Rural Bank. It also, almost certainly, explains why a state-owned institution called the State Advances Corporation could finance couples into their first home at an interest rate of three percent.

The singular advantage states enjoy over both individuals and private institutions when lending money is immortality. Citizens, real and corporate, come and go but the citizenry lives forever. In practical terms, this means the state can afford to extend credit on vastly longer time horizons than any private financier. It also means it can lend with far greater assurance than the largest private bank. Being the institutional expression of its citizens’ collective needs and interests, the state is really only lending to itself.

In Our Own Interest: The First Labour Government availed itself of Reserve Bank credit to construct thousands of state houses for the nation's homeless citizens, creating thousands of new jobs in the process.

Back in the late 1930s, the first Labour Government used precisely this argument to finance its massive state housing programme. The Reserve Bank of New Zealand lent millions of pounds to the Government at nominal interest rates on the security of the thousands of homes it was about to build, and the rentals those houses would provide to the treasury for decades to come. It also knew that by setting such a construction programme in motion, and by using New Zealand sourced materials wherever possible, thousands of new jobs would be created, and that the men and women who were hired to do those jobs would pay taxes to the state instead of drawing welfare payments from its dwindling coffers.

Was the credit advanced to the Government by the Reserve Bank ever repaid? Nobody’s quite sure. What we do know, because they stand all around us, is that thousands of houses were constructed for New Zealand families to live in, at rents they could afford, and that thousands of New Zealanders found jobs that paid them a living wage and freed them from the dole. Some might say that if these achievements are considered as interest on its loans, then the Reserve Bank, and the nation for whom it acted, got a very good return on its investment.

Surveying the global havoc wreaked by the world’s privately owned financial institutions, I am moved to inquire whether any of them should ever again be permitted to create money out of thin air. And looking at the huge number of homes that need to be built in Christchurch and around New Zealand, perhaps the best place to turn for the financial resources required to build a fair and prosperous future – is to ourselves.

This essay was originally published by The Press on Tuesday, 5 June 2012.


kevin said...

Congratulations Chris,
your finest post yet.

Brendan McNeill said...


I'm not a banking expert, but your article declares that you are not one either.

Western nations run fractional reserve banking systems. That is, the Reserve Bank insists that the bank retains a fixed 'fraction' of it's depositors funds available and on-call, while being able to lend the balance to its customers.

Banks borrow short (i.e. depositors funds are usually on term deposit from 3 months to 5 years), but they lend long - 20 to 30 years on mortgages.

What this means in effect, is that if all investors wanted their funds back, the bank could not repay, as those funds are predominantly loaned out to other customers of the bank.

Banks are businesses, so depositing your funds into one carries a risk that the bank could go broke, and you lose your deposit. That risk is low, and so it attracts a low premium by way of interest payments.

What your article ignores, is that the private banks are all publicly listed companies. The share holders are usually private mum and dad investors, or institutions like 'kiwi fund' or insurance companies who purchase bank shares with their depositors savings.

The shareholders get a return on the bank's profits. The shareholders ultimately being ordinary people like you and me, not some mythological 'greedy corporate' invented by the local branch of the Greens or the Labour party.

Having the Reserve Bank print money to fund a housing revival would impact negatively upon our currency as other contributors to past columns have correctly advised.

We live in a vastly different world to the 1930's.

Insurance companies and EQC along with the NZ tax payer will ultimately fund the Christchurch housing rebuild.

I would suggest that there is no requirement for the Reserve Bank to get involved.

Adolf Fiinkensein said...

Goodness me.

So all thjose poor bloody 'slaves' were 'forced' to borrow from the banks?

Stick to politics Mr Trotter

Peter Wilson said...

I agree with the first commentator, this is your best post yet. The private banking monopoly on the creation of money (well, the 99.9% of money that isn't created by nation states) is both very old and very powerful.

What is fascinating about it is that it's existed in some form or the other for nearly 400 years since the goldsmiths discovered the trick of lending money at interest. Yes, at times, it's been subject to more government regulation, or sometimes outright government control, but more or less, it's continued in an unbroken form.

My thinking is that it's continued because it works. Interest is effectively a bet on future economic growth, or a wager that most people, will be able to pay back the principle plus the bank's fee (that interest). With economic growth, powered by fossil fuels, that has proven to be a fair bet, with very few exceptions.

The question is now, with economic growth unlikely to ever return, how can a system of lending money at interest work in the long run? We'll have to evolve new money systems to cope with zero or negative economic growth environment of the future. A start might be to look at the arrangements that were in place during the medieval period, or in ancient Egypt. Humans have been here before, and there are good systems that work.

Brendon said...

Another problem is banks only face the risk of individuals not repaying their loans.

If a group big enough to threaten the banks finances cannot pay, then an outside agency, like the Reserve bank or the government has to step in and gaurantee the ungoing functioning of the banking system.

So banking profits are privatised but losses are socialised. This is the cause of Spain and Ireland misery.

Given New Zealand's high level of private debt and fondness for property bubbles we should give some thought on how to avoid becoming another Ireland or Spain.

Sarah said...

I love the imagery conjured up by all these references to “mum and dad investors”. Conjures up nice pictures, doesn't It? Rosy-cheeked Mum whipping up a batch of scones while Dad sucks on a pencil and pores over the business pages of the Taranaki Bugle. Or a proud young couple putting their pennies away to building a secure portfolio to ensure financial security for sake of the kids.

Well I say “bollocks”. It's the Kiwi version of Potemkin villages and just as much a myth.

In general, Kiwi Mums and dads spend infinitely more time worrying about the rent or the mortgage or simply paying the day-to-day household bills. Dad's not calling out to the kitchen “What do you think about ANZ shares, Mother?” and Mum's certainly not weighing which shares to buy when that nice Mr Key gives everyone a chance to buy companies they already own.

The big shareholders in the banks are wealthy individuals, wealthy pension funds, corporate investors and the like. It's always been that way.

When I first came to this country 45 years ago. I was vastly impressed by the sheer humanity of enterprises like the Housing Corporation and State Advances. Ordinary people had not only the hope but the certainty of building a life in mainstream society. They weren't marginalised, as they now are, by not having the money or other resources needed to get them into a home of their own.

Keynesian economics worked brilliantly then in terms of jobs and housing and they could again. With the useful byproduct of helping create a more fair and equitable society.

Anonymous said...

Private Banks have lent mortgage money to Capital Gain Property Speculators, some of whom have up to 10 "investment properties", along with no Capital Gains Tax, little wonder that buying a house is nearly impossible for young kiwi couples starting out.That's a social evil in my book, greed has shut out our young people from owning their own home.

Anonymous said...

When you come to the conclusion that the best idea for almost everything-in this case banking is the STATE I shudder.
History is there to show us what can happen and a State big enough to give you everything you want is big enough to take everything you have!

peterpeasant said...

Adolf has added one of his lucid, erudite commentaries.

Ergo Chris , you must be right (ahem , I meant correct).

Brendan devastatingly exposes how absolutely correct his first five words are.

No this is not the 1930's, so what!

Fundamental issues do not change.

OneTrack said...

So, what you are saying, is that the banks (whether state or private) should only loan out money that they actually have, and once it has gone, no more home loans for anybody else for twenty five years? Yeah, that sounds like it would work.

Draco TB said...

My thinking is that it's continued because it works.

Note the fact that it's presently not working and all the other times it hasn't worked. It's continued solely because the people in power have been the bankers and they're the ones that profit from such a broken system. They're not about to get rid of their golden calf now, are they?

Jeremy Bowen said...

Many entities of the world borrow. We all need to remember that many entities do nothing but credit their money with the banks and other institutions in the middle borrowing and lending. None of us likes paying interest but we would all love to receive it. Therein lies the truth and therein there either is or isn't a problem, it depends on which side of the ledger you are.

Scouser said...

It's noticeable that NZ and to a lesser extent Ozz did not buy in to the bundled bad debt (CFDs) or lent to people who would never have the ability to repay in the longer term that were arguably the main causes of the GFC. We suffered the GFC second hand.

The GFC is a bit of a mislabel as it was predominantly a US sourced phenomenom that affected the globe.

Fannie Mae and Freddie Mac both Government sponsored enterprises where the main 'sponsors' of excessively stupid lending once the US government determined they had to compete with private lenders who had risky underwriting practises who could now lend as credit practises had been loosened and excessive money supply was available from the US government. They, in effect, copied them and ended up with the largest number of US based mortgages many of which are now underwater. They weren't the only organisations to behave so it is worth noting.

There was the usual boom and bust exacerbated by excessive money supply and excessively easy credit from the US government (in particular) and other governments.

There was minimal regulation and poor risk evaluation from the ratings agencies.

To me. The GFC looks like a team event where predominantly the US govt and US based 'global' financial institutions combined.

If we now look Europe we see a debt crisis based on excessive government debt not private debt.

So, stating that the current and recent financial crises are based on private organisations is simply wrong. They had their part to play but it is arguable that governments are as much if not more to blame.

On the fractional reserve banking systems. The banks don't get to magic the money. The Reserve bank determines the money supply and the banks need to get their money from private sources and/or the Reserve bank. In effect, they borrow the money themselves and also have a liability to repay.

Your financial analysis is pretty poor in that respect.

However, I do support other elements of your thread. As NZ has predominantly foreign owned banks we suffer from the regional office syndrome and having domestic competition in this area does bring down lending costs I believe. NZ has relatively high mortgage rates mainly based on a relatively high cost of money (even for our government). There is an element of cartel rates as NZ seems to have less bad debt (ie banks taking less risk) and bigger spreads between cost of money and lending rates than their Ozzie parents. This implies that it is harder to get a mortgage here than in OZ for essentially the same bank

Loz said...

New Zealand's banks are dominated by the big four Australian banks. The major shareholders of our banks are the largest banking multinational corporations on the planet. Even more surprisingly, the top shareholders for each bank are exactly the same!

The top four shareholders for all of the largest Australian banks are exactly the same, namely, JPMorgan Chase, CitiGroup HSBC and National Nominees Limited (which is a subsidiary of National Australia Bank itself). Collectively they own 51.33% of ANZ, 47.93% of National Australia Bank, 42.85% of Westpac and 36.7% of Commonwealth Bank.

A study of JPMorgan Chase, CitiGroup and HSBC ownership shows that the largest shareholders in those organisations are common. "Fidelity Investments" is one of the top three institutional Holders for all three banks & half of it's shareholding is in the hands of a single family. The top 4 controlling shareholders of Citigroup are the same top 4 controlling shareholders of J.P. Morgan Chase. Within those two banks, seven of their respective top ten Mutual Funds Holders are identical.

So much for the free-market fairy tale of competition!

Citigroup and JPMorgan Chase are two of the three largest banks of the Americas and were heavily involved with the practices that led to the financial crisis that tax payers are now footing the bill for. Citigroup and JPMorgan Chase were major lobbyists for overturning the Glass-Steagall Act which had previously limited the ability of financial institutions to be involved in speculation & was undoubtedly a major contributor to the financial crisis.

Tax-payer backed Reserve Bank's slash interest rates (at tax payer risk and expense) as a means of stimulating the economy. Yet, the institutions that caused the crisis were not only bailed out as being "too big to fail" but now can choose if they pass on lower interest rates (back to the taxpayers).

The multinational banks and investment funds represent nothing but a parasitic cartel.

Scouser said...


Looking at the actual website of top 20 shareholders of Ozzie banks it is clear that the top 7 (approx) shareholders are all Nominee companies or Trust companies. They are companies that the investments of all these banks' customers are held via - unit trusts, EFTs, 401, pensions etc. They are not held by the banks themselves. Profits (or losses) go to the investors and not the banks.

However, it also clear that by holding such an amount of shares they do have voting control - just not the ability to profit from that control. It's a long arrow to translate that to some international control.

Brendan McNeill said...

Hi Loz

Interesting research. I note that HSCB is a major shareholder in in ANZ bank.

I looked up HSBC's annual report, and they have about 1,000 shareholders who between them effectively own the bank.


Page 414 lists the shareholding percentages, page 415 shows voting on remits which probably accounts for the top dozen or so shareholders.

I agree that's a lot of wealth tied up in a few hands.

I'm not convinced it makes up a conspiracy, as there is still competition between banks, however I do agree that these people are 'mega-wealthy' and no doubt have political influence in their countries of origin that the average voter does not have.

Nick said...

To leave the current banking system is to leave the "Empire". The fractional banking system is merely part of the wealth pump that tranfers money and profit from the masses to the owners of these banks, from the poor to the rich, from the periphery to the core institutions of empire.

To discuss fractional banking in isolation from this system is fraught with danger. For example every country that has "bucked" the rules of Pax America has had subtle and not so subtle reactions reverse their course. Iraq tried to break the grip of US control of their oil, they got invaded. Gaddafi attempted to set up an alternative banking system for eastern Africa: where is he now? If we were to take away the prerogatives of the likes of Citicorp etc who own much of our system we would get similar treatment: trade would suddenly become difficult, letters of credit withdrawn.

In short we are currently serfs and vassals to a huge financial imperial system: we must play by the rules or risk total ruin. These powers do not take prisoners.

Loz said...

Hi Brendan,

When a small group of people calculate and act on what best serves their personal interests it's not a conspiracy (as conspiracies are defined as being illegal). What is concerning is how few people are actually in control of the international banking and monetary system. As Scouser points out, the controlling shareholders are various wealth funds... even though they pass profits back to anonymous investors, actual investment and board control remains in the hands of a very small group.

I was stunned to see the same institutions being the major shareholders in each of the large Australian banks. The major-shareholder list within key Fortune 500 firms is even worse. The same group of wealth funds hold the major shareholding of every major New York based bank & by that fact they indirectly have great power over the New York Federal Reserve itself. Is there a conflict of interest (or at least a lack of checks and balances) when the same small group dominates the shareholding of competing firms and firms in their related industries?

Vanguard, State Street Corporation, Fidelity and Blackrock and the fund management firms most dominant within banking and finance as they are major shareholders in all of the banks. A further four investment firms (Wellington Management, Capital Investors, Oppenheimer Funds and Dodge & Cox) are also large shareholders normally found together as major shareholders. This group of eight funds (when considered with cross ownership) seem to dominate everything.

In terms of Banks, they probably hold enough shares to collectively be controlling interests of:

Citigroup - 24.14%
Bank of America - 22.66%
JPMorgan Chase - 25.07%
Wells Fargo - 27.93%
Goldman Sachs - 29.44%
Morgan Stanley - 20.07%

They also hold major interests within the ratings firms that oversee the banks:

Standard & Poor’s
(McGraw-Hill) - 46.73%
Moody's - 25.95%

Also the media itself, which influences market perception

Time Warner - 38.95%
The Walt Disney Company - 23.93%
News Corporation - 22.57%

The same small group of firms maintain dominance over major defence contractors

Lockheed Martin - 49.24%
Boeing - 24.27%
Northrop Grumman - 31.99%
General Dynamics - 31.83%
General Electric - 18.65%
Raytheon - 26.59%

The power of this group of eight wealth investment firms stretches into the onership of competing firms everywhere:

Coca-Cola Company - 18.15%
PepsiCo - 20.88%
McDonalds - 27.89%
Exxon Mobil - 17.85%
Chevron - 30.15%

Regardless of political leanings, the major players in the financial crisis were the Federal Reserve (& government policy), major financial institutions, ratings agencies and the media. With the same investment funds / firms playing a dominant role in all of those areas questions have to be raised as to the power they hold in shaping the world in their own interests.

Jeff said...

It seems (from Wikipedia) that money IS created out of thin air but in a slightly more subtle way:

"As an example for a very simple idea of how the fractional reserve system can work if there is only one bank, for a Reserve Fraction of 10%, a bank can turn a $1000 deposit of "M0" money, into $18,997 of "M1" money. Ignoring interest & fees, which makes banks even more profitable, this is how a bank can copy 90% of "M0" money to make "M1" money, where in this example the money loaned out is simply re-deposited in the bank and loaned out again, and so on, that is how the $18,997 "M1" money comes from the $1000 of "M0" money. Banks do this by accumulating loans and deposits (effectively multiplying) the "M0" supply to make a larger "M1" supply. Banks can collect interest on the spread of the higher loan interest from the lower deposit interests. Return On Investment (ROI) for a bank is theoretically infinite considering the bank is using none of its own money, if one excludes the cost of setting up and maintaining the accounting system."

The hook in the juicy bait is that the interest component of any debt is NOT created and so the cumulative effect is to suck money from the marketplace into the banks. All very well if the profits from this are then distributed back into the community (while still making the shareholders richer) but mostly it seems to end up offshore. To replenish this requires MORE borrowing and further growth, always one step behind.

I wonder if it's a co-incidence that we've had global financial woes almost immediately after reaching the rocky plateau of peak oil and its subsequent handbrake on unlimited growth?

paul scott said...

Banks by law,here in NZ, have to have cash reserves,

Distracted said...

Sterling post Chris, the best I have seen from you yet!

You have gone straight to the heart of the problem facing humanity. It transcends the left right thing, money is a ponzi scheme that will explode in dramatic form at some point not too far away.

Great to see someone having the conversation about a different way.

If you can't answer the question "what is the process by which new money is bought into circulation" you don't understand the banking system, learn it!

Alex said...

@ Sarah - Great point.

jh said...

Federal Reserve Board data show that:

More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.

Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.

Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that's being lambasted by conservative critics.

Read more here: http://www.mcclatchydc.com/2008/10/12/53802/private-sector-loans-not-fannie.html#ixzz12xTyWY91A#storylink=cpy

Anonymous said...

As a number of comments have said,thanks chris for a great article,& thanks too to all the commentators for their meaty comments.food forthought.I love this stuff