Banking 101

When we’re young, we’re taught that banks take money we (the customers) have deposited and loan it out to other people.

This is not exactly correct.

Banks can loan out far more money than they have on deposit. Unlike you or me, if we only have $100, we can only loan out $100, a bank is only required to actually keep a small percentage of the money they loan out.

For example (let’s use round numbers for simplicity’s sake) – if a bank ‘has’ $100, they are legally permitted to ‘loan’ $1000.

Where does that ‘phantom’ money come from? Banks buy it from The Federal Reserve for a very, very low interest rate then loan it out at a higher interest rate.

Everyone is happy, because everyone makes money.

Until said loans default, or until customers want the money they deposited in the bank and it’s tied up in overvalued homes.

See the problem?

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