While, in all this Mumbo Jumbo of analyses on Great Recession, it is extremely hard to figure out the actual causes, I have designed a series of basic what and why questions, and respective answers to get to the bottom of problem. Once we clear out all that clutter in economic and financial analyses, created by political and media pundits, and get to the common sense and obvious causes, an alternative scenario will be discussed to understand this crisis better. To understand any problem, first of all, we must establish what the crisis was. The simple answer of this ‘what’ is that the crisis happened because major financial institutions were not able to meet their obligations.
After establishing what, we now need to find out the answer for ‘why’? The answer to this ‘why’ is because they did lend and invest far more than they actually owned. Therefore, when their customers and investors started losing money, and came back to claim their investments and money, these institutions quickly ran out of limited assets and money they actually owned, and could not have the ability to honor any further claims. So, the root cause turns out to be their ability to lend and invest far more than they actually own.
Now, on alternate scenario, if all their lending and investments were 100% backed up by real money and assets, there would have been no crisis, as they would have been able to honor 100% of claims, with the help of their 100% backed up money and assets. So, out of all that crepe that you and me have been hearing all along from politicians, media and experts of economics, the single most important cause of crisis turns out to be very easy to identify, just by asking and answering common sense what and why questions. As we just discovered, the actual cause of the crisis is fractional lending, the ability of financial institutions to lend and invest far more than they own.
Do you really believe that all these pundits and expert have not been able to identify this very simple correlation between fractional lending and financial crisis? Or they just do not want to understand? Or they do not want to tell us? For me, and for you, the third possibility is more obvious. They just do not want to tell us the truth, and keep confusing us with all those complex and skewed criticism. Why would they do this, is very obvious, too.
They would do this because all the status quo is attached to the current system. As it has always been the case, throughout the course of history, around the world, status quo wants to defend and preserve the existing system. They would never lead you to a conclusion which would dismantle the very bases of system. After all, fractional lending is the base of all current global banking and financial system. Governments, banks and elite have been able to attain this goal after a long history of gimmicks and deceptions. They also had to go through several painstaking steps to achieve this goal.
Insolvency, in case of a crisis is not the only problem created by fractional lending. It is actually responsible for creating the bubbles which finally burst and cause crises. How does that happen? To properly understand this, first we need to learn some basic principles in Economics and finance, and lessons from history. Traditionally speaking, the investments always came from savings. People worked hard, got paid appropriately for it, spent some of it, saved the remaining, and those savings then went into lending and investments. Since, savings were mostly deposited in banks, those gradually became an intermediary in investment process.
Banks would make investments with deposits, especially with the savings account deposits. They would make profits on those investments, and a portion of the profits was then passed on to depositors as interest. As usual, gradually in this process banks wanted to make more profits on the money deposited in accounts. So, they started lobbying government to change laws. They offered a very tricky and attractive partnership to government. This partnership was based on the formation of a central bank, privately owned by big banks, but, named like a federal government agency, to deceive the voters.
I am calling this as partnership because this proposal had mutual benefits for both partners, government and big banks. In accordance with this plan, this privately owned central bank would be partly controlled by government. Although it would be totally above and beyond most legislative process, as much as possible, government would nominate a portion of its governing board and chairman. This new bank would have the monopoly on money generation. You know that money is the basis of all transactions in a Capitalist society. So, whoever controls the money, controls the whole economy and financial system.
The way Federal Reserve was proposed to work was that it would also issue the government backed bonds and securities, and banks would buy those bonds at a certain interest rate, fixed by Fed itself. The money earned by Fed, in this way, in addition to printed money would be offered to federal government at an interest rate. This was genius because the central bank would be owned by private banks. All the interest earned by selling bonds and printing money would be re-routed to banks owning it. Now, if it is a partnership than there should be something for other partner, government, too, in it.
What government got from this proposal was a virtually unlimited potential to spend. This was made possible by introducing other mischievous concepts like debt financing, fractional lending and 100% paper money, by giving away the gold standard. All this was supposed to be done gradually, step by step, so that public was like a frog in a container of water that was put on fire. Frog gets gradually boiled away without even knowing it. Federal Reserve would cover all the government’s over spending or budget deficits by “financing the government debt” which in simple terms means by borrowing money through bonds’ sell and by printing paper money out of thin air. Deposit requirements on banks’ lending would ultimately be reduced to zero or near zero.