The last three posts have explained how the operations of banks are constrained by profitability and regulatory concerns, and how banks operate to try to bypass these constraints. It is now time to go into the details of how banks provide credit and payment services to the rest of the economy.
Monetary Creation by Banks: Credit and Payment Services
Bank A just opened for business and its balance sheet looks like this:
Now comes household #1 who wants to buy a house worth $100 from household #2. #1 sits down with a banker (a.k.a. loan officer) who asks a few questions regarding annual income, available assets, monetary balances, the downpayment #1 is willing to make, among others. The banker asks for documentations that corroborate the answers provided by #1. Continue reading →
By William K. Black
March 24, 2016 Bloomington, MN
Representative Nancy Pelosi has just written the latest effort by a prominent Democrat to bash Republicans for the high crime of not being financially illiterate. The Republicans are frequently financially illiterate on budget issues and they bash Democrats for the high crime of not being financially illiterate. The leaders of both parties share the hypocrisy of bashing the rival party for supporting budgetary stimulus in circumstances in which stimulus is vital. Particular forms of budgetary stimulus can be simultaneously desirable (relative to austerity) and inferior relative to alternative forms of budgetary stimulus. The Republican‘s favored form of budgetary stimulus – large tax cuts for the wealthy – is a remarkably inefficient means of providing stimulus that makes income inequality worse. Those two points are the correct bases for criticizing their proposed tax cuts. Far too many Democrats, however, cannot pass up the political opportunity to bash the Republicans for supporting stimulus when further stimulus is vital. When Democrats like Pelosi launch these myth-based political attacks on Republican stimulus programs they help to enshrine economically illiterate austerity policies that make it even harder for Democrats to make the case for stimulus even when it is essential.
It may surprise you to know that the banking sector is one of the most regulated industries in the United States with a bank having to file regulatory documents with several agencies. These regulations determine how banks should and should not operate their business in terms of many aspects; from disclosure of information to potential customers, to means of determining creditworthiness of a potential client, to the amount of reserves to hold, to management issues, among others. For example the National Association of Mortgage Brokers noted in 2006
Mortgage brokers are governed by a host of federal laws and regulations. For example, mortgage brokers must comply with: the Real Estate Settlement Procedures Act (RESPA), the Truth in Lending Act (TILA), the Home Ownership and Equity Protection Act (HOEPA), the Fair Credit Reporting Act (FCRA), the Equal Credit Opportunity Act (ECOA), the Gramm-Leach-Bliley Act (GLBA), and the Federal Trade Commission Act (FTC Act), as well as fair lending and fair housing laws. Many of these statutes, coupled with their implementing regulations, provide substantive protection to borrowers who seek mortgage financing. These laws impose disclosure requirements on brokers, define high-cost loans, and contain anti-discrimination provisions. Additionally, mortgage brokers are under the oversight of the Department of Housing and Urban Development (HUD) and the Federal Trade Commission (FTC); and to the extent their promulgated laws apply to mortgage brokers, the Federal Reserve Board, the Internal Revenue Service, and the Department of Labor.
The US financial system is extremely complicated and this series shades light only on some corners of that system by focusing on the banking sector. Here is a broad picture of the US financial system (some things have changed since the last time I made this). Since the beginning of this M&B series, posts have emphasized the importance of balance sheet to get a solid understanding the mechanics at play in the financial sector. This post continues that trend.
This weekend: March 11th – 15th 2016, there are events taking place at the Village East Cinemas in New York including a book signing by Randy Wray on the 15th as well as screening of the movie. You can get all the details and list of guest appearances from Village East Cinema’s website here. Flyer for the book signing is after the jump.
On January 6, 1941, President Franklin Delano Roosevelt delivered his State of the Union Address to Congress. It was a perilous stage in world history, and Roosevelt used his annual address to urge U.S. entry into the war then raging. Against the isolationists in Congress (and in the general population), Roosevelt contended that the main objective of U.S. entry was to fight for the universal freedoms that all peoples of the world should possess. These “four freedoms” were freedom of speech, freedom of worship, freedom from want, and freedom from fear. It is the third freedom—freedom from want—with which we are here concerned.
The Bank Whistleblowers United’s third weekly lemons award is made jointly to the Federal Housing Finance Agency (FHFA) and Fannie Mae (with a dishonorable mention to the federal judiciary). The award goes for these entities’ indifference and even hostility to whistleblowers. On September 6, 2008, the FHFA placed Fannie and Freddie into conservatorship in conjunction with the largest public bailout in global history. Fannie and Freddie failed in an orgy of fraudulent mortgage loans.
Given that the concept of leverage will be used often in the upcoming posts, this post spends some time explaining what leverage is and some of its impacts on the balance sheet of any economic unit.
What is Leverage?
Leverage is the ability to acquire assets in an amount that is larger than what one’s own capital allows to buy. Say that an economic unit has a net worth of $100, that it has no debt and that the counterparty is $100 in cash (Figure 1). The balance sheet looks like this: