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Dr. Kalinda Rose Stevenson
The Lending Game Gone Bad: The Money Reason Why Banks And Corporate Giants Are In Trouble
Welcome back!
One of the factors creating turmoil in the economy is the blurring of financial roles.
In the Monopoly Game®, the rules are clear. The players have a clear set of rules, which determine what they can and cannot do with money. The banker also has a clear set of rules, which allows the banker to use money differently than the players do.
This distinction between the money rules for players and the money rules for bankers is a critical element in No Money Limits.
In the real economic world, we have experienced significant blurring of roles among various institutions, as the rules have changed and evolved over time.
Banks are a prime example. It used to be that the lines between different types of banks were clearly defined. In broadest terms, commercial banks served businesses, thrifts served consumers by taking deposits and originating home mortgages, and investment banks help businesses acquire capital. In recent years, through a series of legal changes, these lines have become so blurred that most of us have only the vaguest idea of the difference between various types of banks.
During the same period of time, there has also been significant blurring of the lines between bankers, non-banking companies, and private lenders related to lending.
One particular example concerns large companies that have become both sellers and lenders.
Analysts point to two key reasons why some of the nation’s largest companies have unraveled in the current downturn. One is that they had come to rely on providing financing to their customers, lending money for sales of their own products. When the credit markets ground to a halt in mid-September, it set off chain reaction of pain, hurting consumers and manufacturers alike. Corporate America’s Giants Crumbling
As we analyze what went wrong with the economy, to lead us to this state of economic crisis, one theme keeps recurring. The economic crisis originated with lending practices gone bad.
Lending money can be extremely profitable. To get in on the profits, various types of banks kept expanding their services and their capacity to make loans. At the same time, big corporations realized that they could increase their profits if they became lenders for consumers who wanted to buy their products.
In the process, bankers made risky mortgages to people who could never repay them, because the lending process itself was highly profitable. Meanwhile, big companies set up their own lending divisions. Instead of sending car buyers to the bank to get car loans, why not provide financing directly to your customers? As a result, a company such as General Motors became both the maker of cars and financer of cars through its financing arm, GMAC.
In retrospect, [Ed] Yardeni said, the business model was essentially flawed. When companies like GM and GE financed customers, the loans must have been cheaper than what the customers could get elsewhere and must have meant that the risk of lending to them wasn’t being reflected in the loan rates. Corporate America’s Giants Crumbling
Self-financing by big companies led to the same trap that ensnared the banks that got caught up in making subprime mortgages.
“Self-financing is inherently a dangerous game,” Yardeni said. “You’re biased. You want to convince yourself that the borrower is good for it, and you want to make the sale. You’re not going to be an objective lender. That may be one of the problems here.” Corporate America’s Giants Crumbling
The driving force behind the expansion of their traditional roles—both for banks and large companies involved in self-financing—is the intention to create profit by increasing transactions. This is the essential goal of any business.
Ultimately, the nature of money made all of this possible. Money is not a commodity in limited supply. Money is created in transactions. By creating more transactions, banks and self-financing companies could make more money. The more transactions they made, the more money they would make.
The primary insight of No Money Limits is that the only limit to money is the belief that money is limited. What we are seeing in the current economic crisis is the result of people who took this insight too far.
In the desire to increase profits, banks and self-financing companies made more and more bad loans, throwing prudent lending practices out of the window, until the whole financial structure teetered on the edge of collapse.
Dr. Kalinda Rose Stevenson
Tags: bad loans, banks, lending, Monopoly, No Money Limits, recession, self-financingRelated posts
When Creative Financing By Banks Gets Out Of Control
What is the basic cause of the financial crisis? It is the process called creative financing, because creative financing creates money. Creating money is different from mining for gold or drilling for oil. Mining and drilling seek to find something that already exists. But money cannot be discovered the way that gold or oil can be discovered. Money is an idea of value and is created in transactions.
The Monopoly Game involves players and a banker. The rules of game state that the banker cannot go broke. The significance of this rule is a critical element in No Money Limits. Yet, one of the dominating experiences of recent months has been the spectacle of banks going broke. We have seen banks receive billions of dollars in “bailouts” or “rescue” packages, and still go broke.
At its core, the economic crisis began with the banks, as they multiplied techniques to use creative financing to fund the real estate boom. The reason banks have gone broke is that the banks stopping playing the kind of role the banker plays in the Monopoly Game.
In Monopoly, the banker serves the players as a utility. The banker provides a useful function to collect and distribute cash, to allow the players to play a real estate trading game. In the real world of the real estate boom, the banks were no longer content to be utilities. Instead, the banks began to be drivers of the economy. The banks used increasingly creative financing techniques because they understood that money is not found. Money is created.
The root cause of the financial crisis is that people who understand the essential nature of money carried creative financing too far. They became ingenious in their methods to create money on paper, with a variety of clever techniques.
The bankers on Wall Street created an array of techniques, such as mortgage securitization, credit swaps, and derivatives. All of these creative techniques created more and more paper assets, until the whole system was revealed as so much mumbo-jumbo, and collapsed like a giant soufflé.
In the Disney classic “Fantasia,” one of the most memorable episodes is the “Sorcerer’s Apprentice.” The young sorcerer taps into magic he cannot control. Watch the ”The Sorcerer’s Apprentice.”
This is one of the best illustrations of what went wrong with the banking system during the real estate boom. The bankers tapped into the magical power to create money by using creative financing techniques and the whole process quickly got out of control.
[This is the second post in a series about how creative financing techniques, which created money out of thin air, led to economic crises around the world.]
Dr. Kalinda Rose Stevenson
Find out more about the nature of money and how money is created out of thin air in No Money Limits For Real Estate Investors: Discover The Money-Making Secret In The Real Estate Game That Transforms Your Money Struggles Into Financial Abundance, National Best Books 2007 Awards Winner in Business: Real Estate Category and Finalist in Business: Personal Finance Category.
Tags: bailout, banks, banks create money out of thin air, creative financing, financial crisis, money, real estateRelated posts
Why Money Itself Is The Underlying Cause Of The Recession
Money itself is the underlying cause of the recession. Although you will hear many explanations for the economic meltdown, few explanations analyze the role of money itself in creating the problem. Instead, analysts blame a long list of usual suspects, including irresponsible consumers, greedy bankers, and corrupt government officials. However much truth there is in these explanations, the ultimate cause of our economic crises originates from the nature of money itself.
What is money? In most of the commentaries, accusations, and proposals about what went wrong and how to fix it, this critical question remains unasked.
Watch the news broadcasts about the economic stimulus plan. What do they show as they talk about proposed solutions? They show high-speed printing presses spewing out endless sheets of currency at the Bureau of Printing and Engraving in Washington D.C.
Listen to the commentators. You will hear again and again. “We need the government to step in because only the government can print money.”
This idea that the government can “print money” obscures the fundamental cause of the dire global economic crises. The notion that governments “print money” misrepresents the nature of money. It misrepresents what governments do. And it even misrepresents what we are seeing as the printing presses print out sheets of paper currency.
Let us start with the most basic question. Is the United States government in fact printing money? To answer this question, look carefully at a United States twenty-dollar bill and ask yourself: “What is this piece of paper?” You will see the answer printed on the paper itself. Conveniently and truthfully, United States paper currency identifies each piece of paper currency with this label: “Federal Reserve Note.”
And so then the question is: Is a Federal Reserve Note actually money? In fact, a “note” is a promise to pay. The pieces of paper the government prints out on its high-speed presses are in fact sheets and sheets of promissory notes.
If you wonder if these pieces of paper are equivalent to money, ask yourself another question: “If someone writes an IOU on a piece of paper, do you have money?” One way to find out is to take your IOU to your local supermarket, load up your cart with groceries, and then attempt to use your IOU to pay for them. You will quickly find out that your IOU won’t buy you anything. Your IOU is a piece of paper promising to pay a debt. It is not money.
The critical point is that every piece of currency is a promise to pay a debt. These pieces of paper printed by the Bureau of Printing and Engraving are not money at all. They are promissory notes. And yes, you can use those promissory notes from the United States government to pay for your groceries, but this does not change the fact that these pieces of paper are notes rather than money itself.
So what is money? Money can be represented by tangible things, but it is itself intangible. Money is fundamentally a belief. Money is not a piece of paper.
In fact, currency is a symbol for money, not money itself. Money itself is an idea and the currency we hold in our hands is the physical representation of the idea of money. No Money Limits
And why is money itself the cause of the recession? Money itself has no capacity to make decisions or take actions. Money as the cause of the recession comes from the nature of money as a belief in value. Because money is an idea, money can be created at will by people who understand that money is not equivalent to any tangible object. The long list of culprits who share responsibility for the financial crisis share one critical distinction. They know that money can be created out of thin air, through all sorts of creative financing techniques.
[This is the first post in a series about how creative financing techniques, which created money out of thin air, led to economic crises around the world.]
Dr. Kalinda Rose Stevenson
Find out more about the nature of money and how money is created out of thin air in No Money Limits For Real Estate Investors: Discover The Money-Making Secret In The Real Estate Game That Transforms Your Money Struggles Into Financial Abundance, National Best Books 2007 Awards Winner in Business: Real Estate Category and Finalist in Business: Personal Finance Category.
For a simple and clear guide to real estate notes as the safest way to increase profit, sell quickly, and increase cash flow, see Owner Financing Made Easy.
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