Fraud Is the Root of Fractional Reserve Banking, Part I
Now that I've rebutted Master C's series of articles defending the Fed, it's time to get down to the real root of the issue. This article is a must read. If you don't understand this simple but vitally important concept, you won't understand everything else that comes next. by Walt Thiessen
(libertarian)
Tuesday, October 7, 2008
To make sense out of banking, fiat money, the Fed, and the whole bailout mess, we have to go back to the beginning where it all started. It started with a simple act of fraud. History doesn't record when the first fraud took place, but we do know that it took place at some point. We know, because it runs rampant throughout modern banking.
Consider this simple example from Professor of Economics Dr. Murray Rothbard in his book The Case Against The Fed (p34):
"Suppose, for example, that you own a precious chair and that you place it in a warehouse for safekeeping over the summer. You return in the fall and the warehouseman says, "Gee, sorry sir, but I've had business setbacks in the last few months, and I am not able to pay you the debt (the chair) that I owe you." Would you shrug your shoulders and write the whole thing off as a "bad debt," as an unwise entrepreneurial decision on the part of the warehouseman? Certainly not. You would be properly indignant, for you do not regard placing the chair in a warehouse as some sort of "credit" or "loan" to the warehouseman. You do not lend the chair to him; you continue to own the chair; the chair is and always continues to be yours; he is storing it for safekeeping. If the chair is not there when you arrive, you will call for the gendarmes and properly cry "theft!..."
So why, oh why, should it be any different with money? Rothbard does point out that money is more homogeneous than chairs, so a single dollar bill looks much like all the rest, but the principle is still the same. When I shared this little story with Master C in private email correspondence, he wrote back and complained, "When you go to get your money out of the bank, it's always there. The bank hasn't loaned it out so that you can't have it as in your illustration." If only that were true. The bank does lend out your deposited money, keeping only a small fraction on reserve. That's why they call it "fractional reserve banking" professor, but I think you already knew that.
Banks regularly engage in a fiction. That fiction is that they're storing your money in the bank, and you can have it back anytime you want. If they lend all of it out except for a small fraction, they will have enough money to give you the cash you need most of the time. That's what banks have long counted on..."most of the time." The problem is most of the time isn't all of the time. When they can't give you the cash because they've got too many requests for cash or too much of it has been loaned out compared to the demand for cash, then they are literally found out for engaging in bank fraud. Or as the modern newspapers put it, there's a "credit crunch" and the credit system is "frozen."
To be fair, there's a whole lot more to this than just this one kind of fraud. There's a much more damaging kind of bank fraud which we haven't discussed yet (and which will be discussed in an upcoming article), but let's learn to crawl before we learn to walk by studying this form of fraud first.
Remember the movie, It's a Wonderful Life starring Jimmie Stewart and Donna Reed? It's that classic film they run all the time on cable at Christmas time. Uncle Billy Bailey loses the Bailey Building and Loan Association's deposit by absent-mindedly leaving it on a counter unattended in Mr. Potter's commercial bank, and thus our hero's bank is suddenly short on cash. Mean Mr. Potter takes possession of the money in a twisted version of "finders/keepers," doesn't tell the Baileys he's got it, and immediately calls in the bank examiner because he wants to take over the ol' Building and Loan for his own profit at no cost. Anyway, it leads to a run on the bank, and Jimmie Stewart (our hero, George Bailey) calms the run by reminding everyone that their deposits are invested in each others' mortgages and pleads with them to take just enough cash to get by. Later, because George Bailey is so popular in town and has so many friends, they come together and give him donations out of their own pocket money on Christmas Eve to help keep him out of jail and keep the Building and Loan from being taken over by Potter's bank. The moral, we are told, is that no man is a failure who has friends.
What the story don't mention is that Potter also engages in the same kind of fraud as the Building and Loan engaged in. The difference is that the Building and Loan was more honest and upfront about it (at least a little bit more). Besides, they were the good guys, so it must have been okay.
Unfortunately, Frank Capra's classic tale does us a disservice. It helps us to believe that it's okay to lend out money that has been deposited into a bank even when that money is deposited with the understanding that you can have it...all of it...on demand, no questions asked.
Sorry, but that's fraud. Worse, when you allow that kind of fraud to institutionalize, as our country has done, as all the countries around the world have done, you also institutionalize fraud itself, and it grows like a cancer. Today, fraud is threatening the economic lifeblood of the world, and we are being held hostage to it to the tune of $700 billion bailouts which are only going to get worse in the long run (more on that in future articles).
Curiously enough, if you look up the term "bank fraud" on the Internet or in a dictionary, you'll find something like this: "Bank fraud is the use of fraudulent means to obtain money, assets, or other property owned or held by a financial institution." So what used to be fraud by the bank against a depositor has been turned around in most recent times to mean fraud against the bank by someone else.
My friends, the act of lending out your deposited money as loans to other people is fraud. If you or I attempted to do it, we'd be thrown in prison. For instance, let's assume my next door neighbor came over to my house with $1000 in cash and said, "I'm having a party at my home tonight, and some of the guests my wife has invited have a tendency to have slippery fingers. I'm afraid to keep all this cash lying around. Would you mind holding it for me for the night? There's a tenner in it for you!" So I agree to his terms and take the money inside my house.
Later that day, I check the fridge and notice that my food supply is low. But no worries! I've got $1,000 cash! I just go to the store, buy $200 worth of groceries, and I've got $800 left. No problem!
The next day, my neighbor comes back and says he wants his $1000 back. I tell him of my sudden need for groceries and give him his $800 back with an IOU for $200. My neighbor calls the cops, who arrest me for theft.
Why is it theft if I steal my neighbor's money that he has entrusted it to me, and use it for my own purposes (buying groceries) but it's not theft if the bank does the same thing (investing it in mortgages for their own profit)? Curiously enough, it's considered "not theft" if a bank does it because...the British courts said they could do it, and American courts (indeed, all courts around the world) have gone along with the bluff for centuries. And why did they go along with the bluff? Because the cases that decided the issue were brought against wealthy British noblemen who owned the banks, and a British judge followed by the House of Lords rejected the claims. Rothbard sites three such cases, Carr v Carr (1811), Dewaynes v Noble (1816), and Foley v Hill and others (1848). There are probably others, but these cases are certainly good enough to illustrate what happened. In Carr v Carr, Rothbard writes:
"...the British judge, Sir Wiliam Grant, ruled that since the money paid into a bank deposit had been paid generally, and not earmarked in a sealed bag, (i.e., as a 'specific deposit') that the transaction had become a loan rather than a bailment [a legal word meaning something that the depositor continues to own independently of the bank]. Five years later, in the key follow-up case of Dewaynes v Noble, one of the counsel argued correctly that a 'banker is rather a bailee of his customer's fund than his debtor...because the money in ...[his] hands is rather a deposit than a debt, and may therefore be instantly demanded and taken up.' But the same Judge Grant again insisted that 'Money paid into the banker's becomes immediately a part of his general assets; and he is merely a debtor for the amount.' In the final culminating case, Foley v. Hill and Others, decided by the House of Lords in 1848, Lord Cottenham, repeating the reasoning of the previous cases, put it lucidly if astonishingly:
"The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted.
"The argument of Lord Cottenham and of all other apologists for fractional-reserve banking, that the banker only contracts for the amount of the money, but not to keep the money on hand, ignores the fact that if all the depositors knew what was going on and exercised their claims at once, the banker could not possibly honor his commitments. In other words, honoring the contracts and maintaining the entire system of fractional-reserve banking requires a structure of smoke-and-mirrors, of duping the depositors into thinking that 'their' money is safe, and would be honored should they wish to redeem their claims. The entire system of fractional-reserve banking, therefore, is built on deceit, a deceit connived at by the legal system."
Does this sound familiar? It should. In modern times, Lord Cottenham would be talking about Countrywide Mortgages investing poorly in the sub-prime mortgage market; Bank of America, Chase Manhattan, and the rest taking on risky mortgage loan portfolios; Fannie Mae and Freddie Mac loaded down with defaulted mortgages that aren't any good any more.; and the bankers, according to the courts, have no legal responsibility for any of it, except ultimately (at some point, in some undertermined way) to return the money entrusted to them "because they have contracted." If there happens to be a credit crunch, then, well, the money will have to come from somewhere. That "somewhere" is where the Fed comes into the picture. We'll get to that next article. Unfortunately, this is only the beginning of the fraud, not the end. In my next article (after suitable rebuttals of Master C, I'm sure), I'll start laying out the next great fraud, which is the Fed itself.
For now, I want you to remember just one, extremely important point. If the British courts hadn't flushed all our rights down the toilet with their ruling that when you deposit money in a bank it becomes the banker's money and is no longer your money, all of this mess, including the Fed itself, would never have been necessary or even possible. The entire mess would have been avoided forever!
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Posted By: Jeremiah Johnson
Date: 2008-10-07 19:05:53
I have ruling before that which ought to have taken precedence at that time but did not. Refer to Exodus 22:7-12.
Treating the commodity we use to measure all other commodities as some sort of special property creates many moral hazards and creates much injustice.
Had our justices put money under the same gravity of justice as every other commodity, we would be a far more advanced society today. Progress always occurs much faster when justice prevails.
Posted By: Walt Thiessen
Date: 2008-10-08 04:17:51
I don't trust the Bible in these matters as you do, because the very same Bible, the very same book you cited, in fact, contains passages that advocate immoral and cruel behavior. For instance, Exodus 31:14 says, "Observe the Sabbath, because it is holy to you. Anyone who desecrates it must be put to death; whoever does any work on that day must be cut off from his people." Clearly, this law is disgusting and immoral, and there are many, many other similar laws, particularly in the first five books, which have similarly ugly, unjust, immoral, and unnecessary prescriptions for what the Bible loosely calls "justice."
Even the passage you cited has a problem in it. It says, "If a man gives a donkey, an ox, a sheep or any other animal to his neighbor for safekeeping and it dies or is injured or is taken away while no one is looking, the issue between them will be settled by the taking of an oath before the LORD that the neighbor did not lay hands on the other person's property. The owner is to accept this, and no restitution is required. But if the animal was stolen from the neighbor, he must make restitution to the owner."
So in other words, if the animal wanders away without the neighbor's knowledge, the neighbor makes no restitution, but if it was stolen from the neighbor, then the the neighbor makes restitution. This raises the question: why should the neighbor be entrusted in the first place? If the neighbor makes no effort to keep the animal from wandering away, shouldn't he be held liable? The Bible says no. It's absurd.
There are certainly some things that the Bible gets right, but it gets enough things wrong that it cannot rightfully be considered an authority in such matters simply by what it says.
Posted By: Brian McCandliss
Date: 2011-03-20 18:36:18
Fractional-reserve banking reminds me of the comedy-film "The Producers," where Zero Mostel plays a producer whose plays would always bomb. So one day he tried to make this work for him, by secretly selling 80% of his next play's profits to about 100 different sponsors, EACH; that way, when his next play bombed, he wouldn't have to pay them anything, since there would be no profit, and he could pocket the extra.
This is exactly what the Fed does however, with Fractional Reserve Banking; i.e. it tells people that they have a demand-claim to money, while at the same time lending it to others. Of course, this is only possible by forcing the taxpayers-- or the economy-- to back the defaulted loans and risk... which is simple armed robbery: i.e. they can "have their cake and eat it too," by stealing your cake.
But this is what the Fed is all about: i.e. armed extortion by an oligarchy, so that the few can benefit at the expense of the many. The bad part is when they pretend it's for our benefit... but hey, they gotta sell it somehow, and anyway it all depends on what your definition of "is" is (i.e. they can't fool all the people all the time, but the majority is good enough for them).
Posted By: Brian McCandliss
Date: 2011-03-20 18:47:40
Walt Thiessen says:
For instance, Exodus 31:14 says, "Observe the Sabbath, because it is holy to you. Anyone who desecrates it must be put to death; whoever does any work on that day must be cut off from his people." Clearly, this law is disgusting and immoral.....
There's plenty of American laws that are just as bad. However the phrase "thou shalt not steal" is tough to refute-- and it's exactly what our current economic policy does, i.e. steals from us by deciding how our money should be spent. I didn't vote for it, neither did any other American citizen; but Congress usurped constitutional power to establish a central bank based on their own authority.
Posted By: Robert Meldahl
Date: 2011-06-02 17:12:59
Actually, there is a Seinfeld episode that demonstrates how fractional reserve banking works. George and Kramer find a parking lot for their cars only to find out that their cars, while on deposit, are being used by other people. When Kramer demands the use of his car, the parking lot meets the demand by supplying another person's deposit.
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