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What caused this current global credit crunch?

October 6th, 2008 by admin | Filed under Daily News, Global Credit Crisis, Recession, UK Banks.

Like many economic upheavals, the global credit crunch was caused by many factors. At the root of all of them is modern banking…yet it has scarcely been mentioned in the media. Its name is fractional reserve banking. This fractional reserve principle was first started by Goldsmiths centuries ago. Goldsmiths would keep gold safe for wealthy merchants and give them notes of ownerships to exchange at other Goldsmiths branches in distant countries…they were essentially the first banknotes.

Over time, these crafty goldsmiths noticed that the depositors usually only ever took about 10% of their gold out during any one year, so the goldsmiths decided to lend out the remaining gold at interest to profit from the merchants gold deposits. So for every ounce of gold deposited, the goldsmiths were able to lend 10 ounces of gold and charge interest on it, secured on property, creating money out of thin air. Modern banking was born.

Fast forward to the modern era. In the 1970s, the US left the gold standard and the discipline that gold forces onto central banks and governments was removed. Ever since then , we have seen a steady upward march in the money supply as the temptation to print more money has been too much for the Federal reserve and congress to resist. I don’t know about you, but if someone handed me a cheque book and told me I’d never have to pay back any checks I wrote, Id have writer’s cramp! Now we have a systems with creates money out of thin air and a blank cheque book….can you spell DISASTER!

Since 1977, this fractional reserve banking principle and the ability to print as much money as you wanted has been put on steroids. The community reinvestment act. the Community Reinvestment Act (CRA), the 1977 federal law that has facilitated the flow of more than $1.5 trillion in private capital to underserved communities in the United States, for pressuring Fannie Mae, Freddie Mac, banks and other lenders to offer mortgages “to people who were borrowing over their heads.” It wasn’t the CRA that created the subprime mess but the proliferation of unregulated mortgage originators during the housing boom, financed in part by the government-sponsored enterprises Fannie Mae and Freddie Mac.

CRA lending by leading national banks involves loans that help people with low or moderate incomes buy homes of high quality and lasting value, homes that remain affordable.

By contrast, Fannie and Freddie didn’t have to be led to the water to drink; they ran. The two were determined to thwart the spirit, if not the letter, of a 1992 federal law that permitted them to take “less than the return earned on other activities” to assist “mortgages on housing for low- and moderate-income families.”

Instead of taking less of a return, Fannie Mae and Freddie Mac decided to take more of a return on affordable housing by issuing more than $400 billion in debt to finance higher-cost, higher-yield subprime mortgages, helping to fuel the subprime feeding frenzy. It was the government stupid…through irresponsible laws which had (unintended?) consequences and reckless quasi government institutions.

Not only are the banknotes lent our, in some cases at 30/1 rations, but those notes and the assets they buy are also multiplied, by many more times, through derivatives. This all works well when the underlying asset (housing) is rising in price, but when house prices start falling, and the derivative you hold is leveraged 300/1, it doesn’t take much downward price movement for that derivative to become worthless. This is what we are seeing today. Fractional reserve banking, not monetary discipline and a law that was meant to deliver “OK” returns to a quasi government institution led to greedy executives, not happy with their returns. They may have dammed us all.

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