Fractional Reserve Lending and Risk Taking.

[Ryan Rudolph]

From researching on the internet, it seems that most of the developed world have adopted a banking system that practices some sort of fractional reserve lending, meaning they are able to lend out money that they do not actually have!

What I do not understand is what percentage of their reserves are supplied by the central banks and what percentage are provided by citizens.

And my other concern is: Its strange that banks should care about risk at all if the money they lend out is created out of thin air. Why care about loss if the money are you are lending wasn't actually earned?

The system seems to have evolved by the fact that lending demand drastically became out of proportion to reserve supply, so a fractional reserve system needed to be implemented to correct for the imbalance.

However, some nations are less dysfunctional than others.

In Canada, the effects are not as extreme because banks still maintain strict lending practicing, and they attempt to minimize risks, whereas countries like the US were much more out of control with lending practicing.

Its a strange system if you think about, but I cannot come up with anything else that would work better, any ideas?

[DHodges]

From researching on the internet, it seems that most of the developed world have adopted a banking system that practices some sort of fractional reserve lending, meaning they are able to lend out money that they do not actually have!

That is correct, fractional reserve banking is practiced most everywhere.

What I do not understand is what percentage of their reserves are supplied by the central banks and what percentage are provided by citizens.

I don't understand what you are asking. Money is fungible.

And my other concern is: Its strange that banks should care about risk at all if the money they lend out is created out of thin air. Why care about loss if the money are you are lending wasn't actually earned?

They do have some skin in the game, and they can go bankrupt.

The system seems to have evolved by the fact that lending demand drastically became out of proportion to reserve supply, so a fractional reserve system needed to be implemented to correct for the imbalance.

I don't think that's actually true. It arises because you can make more money by making more loans than by making fewer loans.

Its a strange system if you think about, but I cannot come up with anything else that would work better, any ideas?

Neither a borrower or a lender be.

[Nick]

It's important to know that monetary policy is basically a means to stimulate certain aspects of the economy by providing them with credit, and demand within the economy is supposed to determine interest rates which is supposed to control how much money business' and people borrow. What we actually have is the reverse where Ben Bernanke keeping interest rates low irrespective of market forces in an attempt to keep the economy afloat. Ultimately this is a monetary policy dictated by capitalists looking to give areas of the economy in which they are invested in vast amounts of credit to raise the stock price of the companies within those respective economic sectors. This is evident in how the Federal Reserve lends money to investment banks like Goldman Sachs at a very low interest rate, who then lend to business' they are invested in at a slightly higher interest rate, and then when those business' pay back those loans, they are basically paying their selves back because banks like Goldman Sachs are so heavily invested in those business'.

So you essentially have these giant parasites in the form of investment banks sucking vast amounts of money out of the economy which goes straight to the pockets of shareholders and executives. It's an incredibly corrupt system. The Glass-Steagall Act of 1933 was designed to prevent this from taking place by not allowing investment banks to perform the same duties as commercial banks so they couldn't lend to institutions they are invested in, effectively eliminating the corruption we are currently witnessing. Unfortunately Bill Clinton Repealed Glass-Steagall in 1999 which led to the economic collapse we are experiencing. There is basically no intelligent direction or oversight for this kind of system. It's driving force is nothing more than greedy capitalists trying accumulate vast amounts of credit in isolated economic sectors they happen to be invested in.

A system I'd like to see put in place is one where you have a central bank that intelligently injects credit into economic sectors that have been democratically determined to be important or essential to human progress and survival. This credit would be interest free and not have to be directly paid back. Instead the central bank would use intelligent taxation in areas of the economy where credit has become too abundant and is deemed a threat to society in the form of inflation and unfair leverage. It's an extremely simple and efficient system which could very quickly build up a strong and prosperous society by intelligently injecting credit into key economic sectors like food supply, sanitation, health care, housing, clean energy, transportation, communication, space exploration, and all kinds of scientific research with respect to the direction we want humanity to go. Then wherever there is an over accumulation of credit, we simply use intelligent taxation to keep the economy in balance. This is a dream system compared to the chaotic monetary policy we currently have in place.

[Animus]

For some reason I misread it as "Fictional Reserve Lending and Risk Taking", unconscious insight?

[guest_of_logic]

From researching on the internet, it seems that most of the developed world have adopted a banking system that practices some sort of fractional reserve lending, meaning they are able to lend out money that they do not actually have!

From my own research, I think that the last part of your sentence is a matter of interpretation, and my interpretation is different to yours. If you examine the ledger, as in the table (scroll down a little) in the Wikipedia article on fractional reserve banking, you'll see that at all times the total balance of all accounts remains the same, so I don't think that it's true to say that the bank "doesn't have" the money that it lends out. Where you might be getting that idea is from the fact that the lent out money is simultaneously available on-demand to both the original depositor and to the person to whom it has been lent out, however, conceptually, it doesn't actually occur in that way (i.e. the money being duplicated out of nothing) - conceptually what actually happens in the event that the original depositor goes to withdraw from his/her account money which has already been lent out, is that the withdrawal comes out of the bank's reserves (i.e. it comes from existing money, not out of nowhere), and ultimately (assuming that at that point the bank had only the minimum reserves allowable, and that the depositor did not re-deposit the money) the bank will have to return that amount to its reserves by some means such as calling in the same amount from a loan.

The seeming dual-availability of lent-out money under fractional reserve banking is more a flexibility feature than a creation ex nihilo scam.

[Elizabeth Isabelle]

I don't think that it's true to say that the bank "doesn't have" the money that it lends out.

Wait a minute Laird, I thought that was just about exactly what the video we both saw said. Actually, the bank only has a fraction of the money that they lend out, and the rest is created out of thin air.

[guest_of_logic]

I don't think that it's true to say that the bank "doesn't have" the money that it lends out.

Wait a minute Laird, I thought that was just about exactly what the video we both saw said.

Yes, but I've done some research and reading since watching that video, and I now think that it sensationalises and misleads somewhat. I don't have the bandwidth to watch it again right now, so I won't make a more specific comment than that for the moment. I've explained my current understanding in my post above - if there's anything that you don't understand in that post, then please ask.

Actually, the bank only has a fraction of the money that they lend out, and the rest is created out of thin air.

That's a misleading interpretation. The money isn't "created out of thin air": it comes out of the deposits. As I explained in my post above, it seems like new money is being created due to the fact that the original deposit is still available for on-demand withdrawal, but as I also explained above, the money for that on-demand withdrawal doesn't come out of "thin air", it comes from the (very real and existing) reserves, which have to be replaced.

[Elizabeth Isabelle]

I've explained my current understanding in my post above - if there's anything that you don't understand in that post, then please ask.

That and the wiki article just need some mental chewing. I'd say that wiki has more credibility than a basically anonymous youtube video, but I'd like to take some time to research like you did and understand better. If you have more supporting links that you'd recommend, I'd like to have a look. Otherwise, I'll get back to you later on this.

[guest_of_logic]

If you have more supporting links that you'd recommend, I'd like to have a look.

This YouTube video by a guy whose channel name is Shawnonomics might help: Demonstration: Fractional Reserve Banking. The sound and video quality are pretty poor, and the props are on the cheap, but his explanation is pretty good. In the end, whether you think money is being "created" though is, as I wrote earlier, a matter of interpretation. Some people will consider, even if they think that Shawn explains the mechanism of FRB correctly, that the fact that the 90% (or whatever figure it happens to be) of deposits that have been lent out are simultaneously available for on-demand withdrawal from reserves entails an "expansion" of the money supply. I think that it's mostly a semantic and definition issue, and mainstream economics seems to have definitions that some people, like Shawn, don't seem to accept.

[1456200423]

For some reason I misread it as "Fictional Reserve Lending and Risk Taking", unconscious insight?

Good one! :-)

Fiat money achieves value because a government demands it in payment of taxes and says it should be used within the country as a tender (offering) to pay all debts. In effect, this validates it to be used to buy and sell goods and services and mandates it to pay tax. Where fiat money is used as currency, the term fiat currency is used. Today, most national currencies, including the major reserve currencies, i.e. US dollar, euro, and pound sterling, are fiat currencies.

In monetary economics, fiat money is an intrinsically useless good used as a means of payment and a storable object.
The term derives from the Latin fiat, meaning "let it be done".

$1,000 deposited in a bank can result in a $900 loan, since banks are allowd to loan 90% of their deposits. However, if that $900 loan is spent and then redposited in the bank, then the bank can loan $810 more dollars. This would result in $1,710 of loans coming from the original $1,000 deposit. As the loan monies are spent and redeposited and then reloaned, the original $1,000 can be leveraged up to create a further $9000 out of thin air in the form of an electronic loan. e-currency.
Technically this complies with the fractional reserve lending requirements as it has at least 10% of what it loaned out (created) still in reserve.
Now the total of the loan plus what it holds in reserve is $10,000. (IOU's)

That fact that the $9000 didn't exist prior to the loan being made doesn't matter.

The Fictional Reserve Banks "reserves" consist of mere promises (IOU's) to pay (loans) and there is no limit or government oversight on the amount of (IOU's) they can create.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard. - Alan Greenspan, Federal Reserve Chairman from 1987 to 2006

[Ryan Rudolph]

Dhodges,

I don't think that's actually true. It arises because you can make more money by making more loans than by making fewer loans.

well, it seems to me that the lending system failed in the 20s when lending demand became higher than reserve supply. From my understanding, the banks stopped lending because they didn't have the reserves needed, then people panicked and demanded their money, and the system failed.

Part of this was due to the gold standard. Guys like would Ron Paul disagree, but I'm believe Ron is incorrect on that one. Fractional reserve lending seems to have been adopted due to the inability of the gold standard to supply enough credit to the system because banks were not able to keep enough gold on reserve to match the currency needed.

Guest of logic,

If I'm wrong then explain what a 7:1 lending ratio means, which is what many banks are restricted to. Because I read that banks are able to lend out 7 times the amount of funds that they have on reserves, and they the money doesn't come from existing reserves, but from newly created credit. And when the money supply becomes too inflated, the central bank steps in to buy back bank-backed securities, taking them out of supply, and balancing things out.

Nick,

So you essentially have these giant parasites in the form of investment banks sucking vast amounts of money out of the economy which goes straight to the pockets of shareholders and executives. It's an incredibly corrupt system. The Glass-Steagall Act of 1933 was designed to prevent this from taking place by not allowing investment banks to perform the same duties as commercial banks so they couldn't lend to institutions they are invested in, effectively eliminating the corruption we are currently witnessing. Unfortunately Bill Clinton Repealed Glass-Steagall in 1999 which led to the economic collapse we are experiencing. There is basically no intelligent direction or oversight for this kind of system. It's driving force is nothing more than greedy capitalists trying accumulate vast amounts of credit in isolated economic sectors they happen to be invested in.

I didn't realize that, but it makes sense. What if there was a bill passed that government employments, including federal reserve employees, were not permitted to invest in investment banks, do you think that would help curb the level of corruption?

What did this glass-steagall bill do exactly?

[1456200423]

This highly informative and easy to understand film covers what money is, how is has been dealt with in the past and how our current Fractional reserve banking system works.

Money As Debt - Fractional Reserve Banking
http://www.youtube.com/watch?v=oguCNqCE0Kc

[Elizabeth Isabelle]

This highly informative and easy to understand film covers what money is, how is has been dealt with in the past and how our current Fractional reserve banking system works.

Money As Debt - Fractional Reserve Banking
http://www.youtube.com/watch?v=oguCNqCE0Kc

Yeah, that's the one that I linked above to Laird that we both saw before.

[Cory Duchesne]

And my other concern is: Its strange that banks should care about risk at all if the money they lend out is created out of thin air. Why care about loss if the money are you are lending wasn't actually earned?

If the money you lend isn't generating increased value (more goods and services within the culture), then not only does your bank fail to become richer in the long term, but the economy as a whole also contracts, which reduces your quality of life as a banker. A good, rational banker wants the country to be strong, because if the country is wealthy, then you are wealthy. If the country goes into a recession, then you go into a recession.

Picture a bank lending money to a farmer who wants to create improved irrigation system. The farmer gets the money, buys his irrigation system, and ends up doubling his crops over the next decade. The farmer then pays back the loan, and also ends up more wealthy in the long term. He increases his income. He is producing a greater quantity of value, and that greater quantity of value ends up creating extra products/jobs. The excess of food he produces might end up becoming all these different specialty foods on top of just regular plain old apples, potatoes, carrots, etc.

So sometimes lending can increase the value of your society. In other words, if money is lent wisely, your society functions more efficiently, produces higher and higher quantity of products in shorter amounts of time. Debt gets paid, and profits and quality of life increase for everyone.

On the other hand, lending can sometimes decrease the value of your society. If money is lent foolishly, then your society consumes products, digs a hole of debt, but businesses aren't becoming more efficient and profitable, in fact, profits decrease, efficiency degenerates, and debt doesn't get paid.

So there is incentive for bankers to lend money wisely. It's in their interest and even their responsibility to help produce a valuable society, rather than a worthless one.

Increasing the money supply isn't necessarily bad, just as long as the culture itself has increased value. A huge amount of currency with a low quantity of valuable products, makes for a weak dollar.

[Nick]

What if there was a bill passed that government employments, including federal reserve employees, were not permitted to invest in investment banks, do you think that would help curb the level of corruption?

Well if they were going to do something along those lines, your best bet would be to bypass the private banking industry all together and have the Federal Reserve give credit directly to the people and organizations who need it. All banks are essentially a middle man, much like private health insurers, who do nothing but pass the money along and take a healthy cut for their selves.

What did this glass-steagall bill do exactly?

It actually did a few things, you can read up on it here.

The main things it did were:

Allowed the Federal Reserve to allocate paper currency.

Establish the FDIC.

And the part that Bill Clinton repealed; the introduction of the separation of bank types according to their business, e.g. commercial and investment banking.

[guest_of_logic]

$1,000 deposited in a bank can result in a $900 loan, since banks are allowd to loan 90% of their deposits. However, if that $900 loan is spent and then redposited in the bank, then the bank can loan $810 more dollars. This would result in $1,710 of loans coming from the original $1,000 deposit. As the loan monies are spent and redeposited and then reloaned, the original $1,000 can be leveraged up to create a further $9000 out of thin air in the form of an electronic loan. e-currency.

The only way you're able to make the claim that $9000 extra is "created out of thin air" is by believing that money exists in two places at once: the 90% of the original deposit still in the bank and the 90% of that deposit which is loaned out. It seems this way due to the fact that the original deposit is available for on-demand withdrawal, but that's actually not the case. What's actually the case is that the 90% which is loaned out comes out of the original deposit, and NOT out of "thin air". The reason that reserves are kept is so that, in the case that the depositor wants his loaned money back, the bank doesn't have to call in the loan immediately, but can repay him out of those reserves - but once the depositor makes that withdrawal, then the amount that the bank has authority to loan out is reduced by 90% of the withdrawal, meaning that conceptually the loan is being pulled back, just on a delayed time-frame.

That fact that the $9000 didn't exist prior to the loan being made doesn't matter.

It doesn't exist as "new" money at all, because you're counting the same money multiple times.

If I'm wrong then explain what a 7:1 lending ratio means, which is what many banks are restricted to.

It means that when a new deposit comes in, the bank must keep 1/7th of it in its reserves, and is free to loan out the remaining 6/7ths of it. Note that it's loaning out the 6/7ths of the deposit, not creating new money out of "thin air".

Because I read that banks are able to lend out 7 times the amount of funds that they have on reserves, and they the money doesn't come from existing reserves, but from newly created credit.

You're right that it doesn't come from existing reserves, because reserves are for paying back depositors on demand: it comes from deposits. I'm not an expert on banking though, so there might be other sources too that I'm not aware of.

You seem to have had an inkling that something is wrong with the explanations you've been reading, because this question hits the nail on the head:

And my other concern is: Its strange that banks should care about risk at all if the money they lend out is created out of thin air. Why care about loss if the money are you are lending wasn't actually earned?

Exactly, and the reason they do care is because the explanation that you've been hearing is wrong (yes, I'm wording it more strongly than in my original post): the money is not created out of thin air, it comes from depositors, and if the banks make bad loans, then they lose real money.

[Animus]

What is "real money"? As far as I can tell its a joke.

Up here in Canadia we got monopoly money now. I prefer it to be honest because it screams "fake".

In this game I'm the banker and you are the depositor. You give $1,000 monopoly dollars and I put that into my vault for your safe keeping. Then some other comes along wanting a loan and I loan him $900 of your money, retaining $100 of your money as a "reserve". Then I, the banker, charge an interest rate on your money I loaned. I pay you an interest on the money you placed in my vault.

Lets use a real life example of this in action:

I have a TDCanadaTrust chequing account which isn't particularly useful for this example. However, TD does offer what they call "High interest savings accounts" ranging between 0.25% and 1.00% interest rates. TD "Prime Rate", interest on loans is 2.5% and changes daily.

So you come into my bank and give me $1,000 to deposit and I promise you 1%/m interest. After a month your account balance is $1010 (then I subtract access fees and account maintenance fees roughly $15). So you have $995 at the end of month 1. Meanwhile I've taken $900 of your money and lent this out to someone else with an interest rate of 2.5% and various fees totaling $25/month. After the first month I've turned that $900 of your money into $900 of your money and $22.50 interest and $25 loan fees ($47.50 after first month).

After the first month:

You have $995 of your $1000 deposit
I have $47.50 I acquired with your money

This alone raises a moral problem for me and i can see why in times past humans chose to outlaw charging interest. I don't actually need any money, i just need your money. Forget about earning money from money which the ancients found morally repugnant. Now I can earn money with your money and not even my own.

[guest_of_logic]

What is "real money"?

I was just using that term as a contrast to money supposedly being "created out of thin air", but perhaps it's not all that useful seeing that originally, all money is essentially "created out of thin air".

This alone raises a moral problem for me and i can see why in times past humans chose to outlaw charging interest. I don't actually need any money, i just need your money. Forget about earning money from money which the ancients found morally repugnant. Now I can earn money with your money and not even my own.

What do you think of the idea that the banker is performing a service for you: finding someone to lend to, assuming the risk of a bad loan, and collecting sums of money together so that there are sufficient funds to be able to lend? I agree that it seems wrong that you actually lose money whilst the banker makes money off your money, but if you had more funds then the interest would offset the fees so that you did make money.

[Animus]

What is "real money"?

I was just using that term as a contrast to money supposedly being "created out of thin air", but perhaps it's not all that useful seeing that originally, all money is essentially "created out of thin air".

This alone raises a moral problem for me and i can see why in times past humans chose to outlaw charging interest. I don't actually need any money, i just need your money. Forget about earning money from money which the ancients found morally repugnant. Now I can earn money with your money and not even my own.

What do you think of the idea that the banker is performing a service for you: finding someone to lend to, assuming the risk of a bad loan, and collecting sums of money together so that there are sufficient funds to be able to lend? I agree that it seems wrong that you actually lose money whilst the banker makes money off your money, but if you had more funds then the interest would offset the fees so that you did make money.

Right, so the system is as such: the poor get poorer and the rich get richer

If you have more than $1000 in your account you earn on the interest, if you have $1000 or less you lose on the bank fees. So the richer you are, the richer you get and the poorer you are the poorer you get. How sweet is that?


Ok, let's examine the "availability of loans" argument. Let's say I run out of money right now. I am broke, I have no money until friday when I get paid again. I'm a smoker and it costs me $8/day to smoke, which means I'm roughly $30 short of smoking my way to payday. In this scenario is it "good" that a loan is available to me? Is it a good thing that I can go to Money Mart and get a payday advance at some insane interest amount? - I've actually been here before, it's a vicious cycle of payday advances and ever decreasing money from interest rates -. It's a system that appears very provocative at first, very seductive, but which leaves its clients destitute in the long run. That is, unless you happen to already be rich, but then what would you need a loan for?

Alternatively, I could go 5 days with smoking and possibly even quit. But this most likely will not happen as long as a shylock is around to relieve me from the torment of nicotine withdrawal. or gambling withdrawal, cocaine, heroin, methamphetamine, etc...

[guest_of_logic]

Right, so the system is as such: the poor get poorer and the rich get richer

Well, are poor people forced to use banks? Aren't there other options?

I do agree though that it's much easier to make money when you already have it, and that the poor get a rough ride under our system - your statement as a generality is pretty true. There are exceptions though - people do go from bust to riches.

Ok, let's examine the "availability of loans" argument.

I'm not sure whether you're responding to something I wrote, but you don't seem to be. I guess this is just something related that you wanted to raise.

Let's say I run out of money right now. I am broke, I have no money until friday when I get paid again. I'm a smoker and it costs me $8/day to smoke, which means I'm roughly $30 short of smoking my way to payday. In this scenario is it "good" that a loan is available to me? Is it a good thing that I can go to Money Mart and get a payday advance at some insane interest amount? - I've actually been here before, it's a vicious cycle of payday advances and ever decreasing money from interest rates -. It's a system that appears very provocative at first, very seductive, but which leaves its clients destitute in the long run.

Yeah, that's a tough situation to be in. I've been destitute to the point that I was hocking my last possessions (bar my - cheap - car), but I never took out a loan like that. If I couldn't meet my expenses without the loan, how would I be able to meet them when I had the additional expense of a loan repayment to make? It just doesn't make any sense. The only reason to take out a loan like that when you're destitute is if you have additional money coming in soon but need to urgently purchase something in the meantime that you can cover out of the additional money coming in.

That is, unless you happen to already be rich, but then what would you need a loan for?

I'd be interested to see what answers to that question you could come up with yourself.

Alternatively, I could go 5 days with smoking and possibly even quit. But this most likely will not happen as long as a shylock is around to relieve me from the torment of nicotine withdrawal. or gambling withdrawal, cocaine, heroin, methamphetamine, etc...

Another possibility is to budget so that you don't end up in that situation in the first place, but granted, unexpected expenses sometimes come up.

[Animus]

Well, are poor people forced to use banks? Aren't there other options?

That's an interesting question with obvious answers I think. In general the answer is no.

Let me issue an anecdote: I was the subject of sexual harassment at a job, my supervisor had propositioned me for extramarital sex and I declined. As a consequence she came down on me at work, wrote me up for things without precedence. Eventually I raised this issue with management, but her ass was covered, management didn't take my claim seriously and she had already "informed" them that I was "insubordinate". The entire HR staff blew me off and I continued to get written up at exponential rates. Eventually I was fired and I was able to prove to Human Resources Canada that I was wrongfully dismissed. This opened the door for EI insurance for a little while, but I was still out of house and home. So I appealed to Ontario Works for an emergency welfare check and I was told the following: "Well, you are a young white male, you don't really need any help. Don't you have a rich uncle you can borrow from?"

Even if I had a rich uncle, which I don't, no one in my family is going to lend me money. Our family doesn't do that sort of thing and quite honestly I'm not much a part of my family. Most of my family thinks I'm insane or a jerk and don't want to help me - they'd rather see me suffer.

So here is a generality, an obviously racist and sexist one, that simply does not apply to every situation.

I do agree though that it's much easier to make money when you already have it, and that the poor get a rough ride under our system - your statement as a generality is pretty true. There are exceptions though - people do go from bust to riches.

Malcolm Gladwell wrote an excellent book about the subject of going from rags to riches called Outliers. In it he examines several prime examples and mentions where the tipping point came (no pun intended, tipping point was one of Gladwell's previous books on behavioural economics). For example Bill Gates had incredible opportunities that no one else in his age group had. He had access to one of the only time-sharing computers available at the time. A lot of this had to do with his parents being able to afford sending him to that particular school. Another example is that of Sports recruiting and the age of recruits. It turns out rather consistently that the "best" hockey players are born in the first three months of the year (Jan, Feb, Mar) this has nothing to do with astrology and everything to do with the way in which recruits are selected.

So you see, so much of it is a matter of chance and nothing else. Its a good book.

Yeah, that's a tough situation to be in. I've been destitute to the point that I was hocking my last possessions (bar my - cheap - car), but I never took out a loan like that. If I couldn't meet my expenses without the loan, how would I be able to meet them when I had the additional expense of a loan repayment to make? It just doesn't make any sense. The only reason to take out a loan like that when you're destitute is if you have additional money coming in soon but need to urgently purchase something in the meantime that you can cover out of the additional money coming in.

Well, judging by the fact that you are posting on "Genius Forums" I'm going to guess that you are slightly more rational than the average person and probably make semi-wise decisions with your money. But most people are not very rational when it comes to economics. As behavioural economist Dan Ariely elucidates in his book Predictably Irrational. People are often irrational and especially when it comes to money, but they are irrational in predictable ways, which provides banks with something to exploit. They know that people are not entirely rational and so they leave it up to the customers to exercise their irrationality in making loans.

The subprime mortgage crises was caused, at least in part, by people taking out mortgages that they couldn't afford. Clearly this was not a rational thing to do, the banks should no better, but what do they care? If the system crashes completely, bankers are the only people with real wealth. If it crashes in part, and causes inflation-deflation, the net result is a greater portion of total wealth owned by the bankers. The bankers win no matter what because they don't actually have any risk. The money they lend out does not even belong to them and when they screw up, the taxpayers bail them via the central bank.

Another possibility is to budget so that you don't end up in that situation in the first place, but granted, unexpected expenses sometimes come up.

Again this assumes that people are rational and capable of inhibiting their impulses to purchase. Commercialism is in large part about breaking down barriers and getting people to buy stuff. People in general are not geniuses and we can't expect them to be, some of the responsibility needs to fall on the bankers to not make loans which cannot be repaid. The bank is an organization of people, not just one person. One person is much more likely to fall prey to decreased comprehension or irrationality than an organization of individuals.

[guest_of_logic]

Well, are poor people forced to use banks? Aren't there other options?

That's an interesting question with obvious answers I think. In general the answer is no.

[Responding to the above as illuminated by your anecdote:] I was thinking more in terms of savings or operating accounts than accessing loans - wondering how feasible it would be to simply keep cash "under the mattress" rather than in an electronic account. The main problem other than security that I can see is that some employers/welfare organisations only issue payments by electronic deposit into a bank account.

Let me issue an anecdote: I was the subject of sexual harassment at a job, my supervisor had propositioned me for extramarital sex and I declined. As a consequence she came down on me at work, wrote me up for things without precedence. Eventually I raised this issue with management, but her ass was covered, management didn't take my claim seriously and she had already "informed" them that I was "insubordinate". The entire HR staff blew me off and I continued to get written up at exponential rates. Eventually I was fired and I was able to prove to Human Resources Canada that I was wrongfully dismissed. This opened the door for EI insurance for a little while, but I was still out of house and home. So I appealed to Ontario Works for an emergency welfare check and I was told the following: "Well, you are a young white male, you don't really need any help. Don't you have a rich uncle you can borrow from?"

Even if I had a rich uncle, which I don't, no one in my family is going to lend me money. Our family doesn't do that sort of thing and quite honestly I'm not much a part of my family. Most of my family thinks I'm insane or a jerk and don't want to help me - they'd rather see me suffer.

So here is a generality, an obviously racist and sexist one, that simply does not apply to every situation.

Tough breaks. Poverty puts you in good company here though, as I'm sure you already know.

More topically: I don't imagine that a bank would lend you money under those circumstances either.

Malcolm Gladwell wrote an excellent book about the subject of going from rags to riches called Outliers. [...]

So you see, so much of it is a matter of chance and nothing else. Its a good book.

I might have read it if I still had an appetite for reading, but these days I don't have the concentration and stamina for it. It would be an interesting topic to study in depth: how much of an average success story is due to hard work, how much to luck, and how much to personal qualities and/or talent.

The subprime mortgage crises was caused, at least in part, by people taking out mortgages that they couldn't afford. Clearly this was not a rational thing to do, the banks should no better, but what do they care? If the system crashes completely, bankers are the only people with real wealth. If it crashes in part, and causes inflation-deflation, the net result is a greater portion of total wealth owned by the bankers. The bankers win no matter what because they don't actually have any risk. The money they lend out does not even belong to them and when they screw up, the taxpayers bail them via the central bank.

The bailouts do seem a bit dubious, I admit, although again I add the caveat that I'm not a banking/finance expert.

Again this assumes that people are rational and capable of inhibiting their impulses to purchase. Commercialism is in large part about breaking down barriers and getting people to buy stuff. People in general are not geniuses and we can't expect them to be, some of the responsibility needs to fall on the bankers to not make loans which cannot be repaid. The bank is an organization of people, not just one person. One person is much more likely to fall prey to decreased comprehension or irrationality than an organization of individuals.

I take your point, but I want to take the opportunity to mention that I'm wary of taking a patronising approach to other people: "You're only going to make the wrong choice so we're going to prevent you from making it in the first place" - I think that that kind of attitude is unegalitarian if not dangerous and even chilling in certain contexts. In the current context, though, I don't think your proposal is patronising at all - definitely the loan-makers need to refuse excessively risky loans, both out of self-interest and out of rationality.

[Animus]

It would be an interesting topic to study in depth: how much of an average success story is due to hard work, how much to luck, and how much to personal qualities and/or talent.

This is something behavioural economists have asked and it turns out that "hard work" and "talent" as much products of chance themselves. People born into poverty, whose parents are impoverished and don't stimulate them to achieve anything, are generally lazy. This a kind of inhereted laziness, they are taught to put in so much effort by their parents. Children born to upper class parents are usually over-stressed with all kinds of ambitious activities and extracurricular tutoring. So they are taught to be ambitious from a young age and probably feel shameful if they are not working towards some economic goal all the time. Behvarioural economists have also asked the question: are people innately talented? And what they have found is that in general people are not innately talented, but achieve a level of mastery after about 10,000 hours of practice.

[guest_of_logic]

Interesting information, thanks. You know your stuff.

[Animus]

I try to stay on top of things. This is an understanding I've developed from the likes of Gladwell and Ariely, but also coheres with my understanding of human psychology and my understanding of reality in general. All of this is a rather large undertaking and I don't have the necessary lifespan to realize everything. But I mean, that's the ideal and this is all in the service of doing that. So certainly there is a whole heck of a lot I don't know and will never know. Probably an inexorable amount of stuff in any given subject. Anyway, as far as I know anything its what I know.

What I like about Gladwell and Ariely is that they aren't strictly economists crunching numbers in some boardroom. They are behavioural economists doing actual experiments with human beings and currency. For example Ariely found that students in a draw for local sports game tickets put more or less value on the ticket whether they won or lost (respectively). People were more likely to travel 15 minutes by car to save $7 on a $15 purchase than on a $1,000 purchase, an irrational choice considering the cost (15 minutes by car) and the savings ($7) are equivalent in both scenarios. They found that people given the choice to cheat openly on tests indulged in the ability to do so, but not so after signing a code of conduct. When people were not prompted with a code of conduct or told that they could openly cheat, they cheated moderately. A great example from Ariely's book Predictably Irrational is the Economist subscription page. In the first condition participants are asked which of the options they would choose from the listed options (see image). An overwhelming split between options 1 and 3 occurs and virtually no one chooses 2. The ratio was 40/60 for options 1/3 if I remember correctly. However, when they removed the 2nd option from the list, the weight shifted towards option 1. A greater ratio of people selected the first option, presumably because of price progression. If the customer is able to start small and work their way up, they are more likely to make the climb. If they have to make a huge leap in price they are more likely to take the cheap option.

All of this kind of stuff is readily utilized by marketers in order to systematically exploit the subconscious human mind. And as far as they are aware there is nothing intrinsically wrong with it. All is fair in love and war, and I guess business too.

Edit: Sorry, the economist subscription thing is probably because people feel like they are getting something free with latter choice. I don't know exactly, its a strange one.