Can't be done, and here's why: the 0.25% rate he's referring to is the federal funds rate, which is the rate banks borrow/loan money from/to each other. You don't just "borrow from the Fed". Most loans between banks are very short-lived, for example a bank might want to loan money to a major company but doesn't want to wait days or weeks until it has enough in reserves, so it loans the money from another bank. Because the loans are very short-lived and are usually between established banks, they're also very cheap compared to the loans offered to the public. The interest rates of the loans are also negotiated between banks. Now, when you take the fact that, in this case, the borrower would be a complete unknown, and especially the fact that this loan would be for a much longer period than what is usual, 0.25% is impossible. Hell, you could be the Goldman Sachs and be lucky to get under 5% for a 30-year loan.

(TL;DR: can't loan that much money with a rate that low for 30 years)

I think that's the point of the article (it's not something just anyone w/o the right connections could do). It's a satirical illustration of how this small group of people who should have gone bankrupt are making out like bandits at the general publics expense whilst the whole scheme is constructed in a way to obscure the nature of what is ultimately happening.

Also it isn't saying you should take out the .25 percent loan for 30 years it is saying you buy 30 year treasuries. I think it is assumed you can sell those treasuries back to the Fed at some point when the original loan needs to be repaid.

You don't need to take any loans at all - the bank with $1B in deposits could just "loan" a subsidiary $9B to buy US treasuries with via the magic of fractional reserve banking. Then it's earning 4-5%.

The real problems I see with the plan is that 1) that rate is on 30 year treasuries - so you don't get income immediately and 2) inflation may exceed the return on those treasuries.

Why not just use $3B of the $9B the fed let's you effectively print to buy 300% overpriced assets (say, mortgage bonds) from shadow companies you and your buddies own and lend the rest to whomever eg: loans for overpriced homes.

So you spent $1B on the bank, $1B on the assets and sold the assets you sold for $3B. You end up with $1B in profit (100% ROI) and who cares about what happens to the rest?

> 2) inflation may exceed the return on those treasuries.

This is not an issue, because you are getting 4% on borrowed money, which means you are really getting 40% on your money.

It doesn't matter how thin the margin is, as long as you can leverage the loan with borrowed money. This is essentially what every bank does.

That's a good point and a much simpler way to make good returns.

That's not how fractional reserve banking works.

I believe, if you have $1B, then you can loan out $900M, keeping 10% of the original balance in reserves.

Yes but that 900M is deposited into another bank, who then loans out 90% and eventually the system loans out 9B. And the system is dominated by a few banks.

Yes but $9b of "credit" is created this way. The US government emphatically does not sell bonds for credit, only cash, which you still only have $1b of...

Wait, you mean there isn't an easy way to make a billion?

Well you can "borrow from the Fed" but you are right that it is different from the federal funds rate. You can borrow from the Fed at the discount window which traditionally is about a point higher than the federal funds rate (and as such only used in emergencies when banks won't even loan to each other overnight). Traditionally it was also an overnight loan that was audited by the fed and which U.S Treasuries were put up as collateral. Traditionally, there was also a large stigma attached to borrowing from the Fed as it was sort of a "last resort" option.

That's changed a bit now as the Fed has does whatever it can to increase liquidity. Less of a stigma, the discount window rate is about what the fed funds rate is, the time period of the loans is longer, etc.

So, you can borrow from the discount window (the fed) and you can do so at a rather low rate. However, the whole theory that the recent upsurge in banking profits is from buying treasuries is a bit silly.

For starters it isn't risk free to buy a 30 year treasury note when you are financing it with short term loans the rate of which could be changed at any time. If interest rates go up your 30 year treasury you bought isn't going to be worth much and may actually start to lose you money. Remember if you are 10x leveraged the market price of that 30 year treasury only has to drop a little for you to lose money. So instead, let's invest in short term treasury rates ( http://www.bloomberg.com/markets/rates/index.html) well except the return on short term treasury rates is about what you would pay at the discount window.

I guess you could invest in short term bonds or other investments, but it isn't going to be risk free then. And it really isn't a scandal that trying to set low interest rates will encourage lending/investing some of which could turn out to be speculative or would not have been made if interest rates were higher. It could also lead to inflation. Those are sort of the costs/benefits of cheap money.

So basically this is just an elaborate shell game that allows the government to pump a bunch of no strings attached money into the big banks and make it look like they are paying back the tax payers TARP bailout money when in effect the only thing they are doing is calming the public outrage that would ensue if they just gave the money to the banks outright with no strings attached and no expectation of repayment.

Pretty much.

Can you really borrow $9B against $1B at such low rate? Obviously, I'm missing something here.

Only for certain values of "you" that don't include you.

existing banks with insiders can. you forming a bank with your buddies can not. otherwise every already existing small bank would be doing this.

Unless your buddies were until recently bankers, with those connections remain intact </dreamer>

This isn't about fractional reserve banking.

If the bank could only lend out 100% as much as it had, it would still be making free money here by borrowing from the government and lending the money back to the government at a higher rate.

The key to the money-making scheme is access to very cheap money from the federal reserve (what you're labeling as government) and lending it to the government (what you're calling the government.) The fed and the government are not the same thing. If they were, the government would not have to borrow money from the banks. It would just get it directly from itself.

So I think this is about fractional reserve banking because this is what enables the borrowing/creation of money at below market rates. If a bank had to buy its money on the open market like everybody else, it would have to pay more than what the government pays for money because it's a greater risk. Without a fractional reserve/fiat money/central bank system, a bank would not be able to borrow money at essentially 0% in a credit shortage.

Sorry, but you have no idea what you are talking about.

That is not fractional reserve banking. Maybe go and actually read what it is before posting about it?

Reading and thinking are hard. Understanding the complexities of our global financial system is even harder. Repeating economic "wisdom" you gleaned from a YouTube video of an obscure doctor-turned-Congressman that made the front page of Digg, then assuming everyone who doesn't agree with you is either uninformed or evil, is easy.

Would you care to elaborate more about why fractional reserve banking isn't the primary satire of the article? Because the more I read, the more I frown at your lack of distinction between the bond selling government and the money printing fed

Fractional reserve banking refers to banks holding only a fraction of their deposits in the form of liquid reserves, and lending out the rest.

The scheme in the article is about borrowing $9b from the Fed with $1b equity at a low rate, and then selling it to the government for a higher rate. So it's straight up interest-rate arbitrage.

In fact there's not even a claim in the article that the $1b in equity are deposits, so this bank is most likely not even a commercial bank. For all intents and purposes, this appears to be an investment bank, and it's very unlikely that it'd even have an account with the Fed to borrow that kind of money.

If money flows from one part of the government to another, there is no reason why it wouldn't flow through private banks. The government isn't one monolithic agent with a single (overdrawn) checking account.

Whether you count the Fed as being within "the government" is a complex issue but ultimately it is just semantics and doesn't change the nature of the situation. They are in a grey area with some private and some public characteristics, like the post office.

Shady maybe, but not grey. The Federal Reserve Bank is a privately owned and operated corporation. It is not in any way a part of the US government; it is given special rights by our government to manage our banking system as a monopoly. The Fed Chairman is appointed by the CEOs of the regional Fed banks, and the CEOs are appointed by the shareholders of those banks. There are no elected representatives running the Fed, nor any political appointees selected by the Executive branch.

There /is/ a lot of oversight, and the Fed chairman is required to spend a lot of time dealing with the president and congress. However, all Fed meetings, particularly policy-setting meetings, are private and hidden from the public and US government. No government agency is allowed to do that; even the most top-secret black projects of the CIA and DoD are ultimately overseen by someone in Congress, at least to some extent. (Congress could stop funding these projects, as a final control. They can't do that to the Fed.)

The government agency you're thinking of is the Treasury. It is the Treasury's job to produce and manage US currency, as directed by Congress. Congress had done a lousy job of setting economic policy, so back in 1913 Congress decided to outsource the job to a private corporation: the Fed. The Treasury still makes all of our coins, but the paper money and 'accounting' money were given to the Fed. This wouldn't necessarily be bad, except the Fed effectively charges the government a fee for every dollar put into circulation; $1 of circulating currency is added to the economy, but $1.05 in debt is added at the same time. That doesn't balance, so the currency has to be inflated to make it balance; the value of $1.05 has to be reduced to the value of $1 in order for the originally created $1 to be sufficient to pay it back. Except that $1 is now worth only $0.95 if used for any other purpose.

This is a very, very rough and inaccurate description of the situation, but the basic premise is correct: the Fed is a private company that makes a profit by lending money into the US economy at a rate that can't be paid for using the money that's been lent into the economy. This allows the Fed and its shareholders to slowly draw all of the wealth out of the US economy, leading to the highly concentrated wealth in the hands of very few very rich people we have today.

There are so many inaccuracies here that it can only be described as "fiction."

1. You often mix The Fed with the Board of Governors of the Fed. These are distinct. And the Board of Governers is definitely part of the government. It's an independent agency. Other indy agencies? NASA. The CIA. EPA. FEC. FCC. Dozens of them.

2. The Fed Chairman is part of the Board of Governors. All of them are appointed by the President and confirmed by the Senate. Definitely not appointed by the "CEOs of the regional Fed banks." There is a term limit. And one of those Governors is appointed (again, by the Prez, and confirmed by the Senate) to be Chairman.

3. New paper notes are created when the Fed purchases T-bills from the Tres. Dept. Yes, the Gov't pays interest on these notes. And yes, that is in general the mechanism of inflation. But it is _nowhere near_ the 5% you cited. And yes, that makes a very big deal. At no time is the value of money controlled by anybody enough that they could just will it to be reduced. And it's very easy to rail on Inflation when you don't concede that deflation would cause even more fiduciary problems. Inflation is worst for lenders. Deflation is worst for debtors. There are for more debtors in my family than there are lenders. How about yours?

4. The federal reserve is not the source of concentrated wealth in this country. Wealth was far more concentrated during the "free banking era" in the 19th century when there was no federal central bank.

It's easy to riff on this stuff. Easy to bash big biz and big gov't. And they have serious flaws. But if our Government is going to borrow money to fund it's operation, I'd rather it borrows 90% of that debt from our own banks (eg The Fed) than from foreign banks. People act like China funds our debt. No. The Fed does. Our biggest lender is ourselves. I'll take that over the opposite.

It could be reformed, though. And the House banking reform bill passed a few days ago is a good start. Not nearly good enough, but a good start.

I'm no expert, and you may be right about my inaccuracies. From what I've read, part of the problem is that the system set up in 1913 was designed to be complicated and confusing to conceal exactly where the control lies. It's probably also overly complicated because it's designed by committee with many competing interests, just like all of our laws are.

One thing you said which I'm not so sure about is the dangers of inflation vs deflation. Inflation is bad for lenders because they money they get back isn't as valuable as the money they lent, but the interest they charge is supposed to cover that. Lenders are only really hurt when the inflation rate exceeds interest rates. For debtors, inflation helps them pay their debts with less valuable money, but only if their income keeps up with inflation. For most people that hasn't happened; I believe inflation-adjusted incomes peaked in the early 70s, and has held steady or dropped since then while debt has climbed dramatically. So, inflation has not been good for debtors.

Deflation is good for lenders because they get paid back with more valuable money then they lent, if they get paid back. Deflation could be bad for debtors because their debts are harder to pay, but the cost of other living expenses ought to drop in a deflationary environment which would leave more money available to pay debts off. It would probably be more difficult for employers to reduce salaries in a deflationary environment than it is for them to avoid raising salaries in an inflationary environment, so debtors are more likely to keep or increase their spending power during deflation. If we had a long-term deflationary environment, interest rates could drop to zero or even go negative without hurting lenders, so long as the rates are higher than the deflation rate, and this will help the debtors as well.

So overall, I think deflation is better for everybody, so long as it's gradual. Deflation means that the value of our money is increasing over time instead of decreasing, and that can benefit everyone. There is a potential problem with interest rates on existing debt, but if the deflation is low and consistent, lenders could be encouraged, or forced, to reduce rates accordingly. This wouldn't even have to be government-mandated; competition among the banks would bring back 0% loans that people would use to refinance their debt at lower rates.

The Federal Reserve System is run by a Board of Governors. The Governors are appointed by the President. They must be confirmed by the Senate. The Board of Governors is accountable to the House of Representatives and must give them an annual report of the Fed's operations.

If the Federal Reserve System were private, then the people who govern it would ultimately be accountable to private shareholders and not to Congress who represent the People.

However, the individual member banks are private, which is why it is a grey area.

Much of the confusion comes from the fact that "the Fed" can be used to mean the Federal Reserve System as a whole or the Board of Governors ("the Fed decided to raise interest rates") or the member banks depending on the context.

Interestingly enough, fractional reserve banking is not significantly different from the way any other business works.

If I loan money to a business, that business almost always does something with the money, like buy stuff or pay expenses. It doesn't keep the money sitting around to pay me back. If things go wrong, the biz won't have money to pay me back.

Let's compare that with the Wikipedia description of fractional reserve banking. "The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds)."

Yes, there's the quibble about "demand deposits" vs other kinds of loans, but that doesn't really have anything to do with the expansion in the actual money supply.

Yes, I know that the article defines "money supply" as "cash plus demand deposits". However, as a loan matures, it becomes closer to a "demand deposit" and eventually becomes one. The original money, meanwhile, has already left the biz. Maybe some came back, maybe it didn't. Either way, the only thing that's there for sure is the obligation to pay.

Note that a bank has loans as assets. A biz has whatever it got in return for the borrowed money that it spent. Either one can go bad.

The big difference is that when a bank loans money to a business, the business can bring in revenue from other parts of the economy to enable it to pay that loan back.

When the Fed loans money into the US economy, there is no place to pull money from to pay the loan interest; only the principle can be repaid. The loans can only be repaid with hard assets (gold, real estate, etc) or by inflating the currency sufficiently to devalue the principle that was borrowed to below the repayment cost.

> The big difference is that when a bank loans money to a business, the business can bring in revenue from other parts of the economy to enable it to pay that loan back.

That's not a difference. When a biz spends borrowed money, it does so with the expectation that money will come back, just as the bank expects that its loan (of deposit money) will be repaid. In both cases, the bank/biz sent borrowed money out the door and only has an expectation that sufficient money will come back. (Yes, deposits are borrowed money.)

The Fed is different because it gets to print money. We're talking about ordinary banks here.

Yes, banks can get into trouble if its lenders call at an inconvenient time, but so can biz.

The first thing I want to ask when I hear something about easy money, is: "Then what stops everybody from doing it?"

I think everybody is not doing it because 1) most people don't understand it, 2) it's not easy to form a bank, and 3) although banks can easily get money for loans, they will be shut down if the loans are not paid back.

Because new money is created whenever a loan is created, the cost of money is artificially low. This discourages savings and encourages debt. So even though there are massive amounts of money to be made with a bank, I think that it's pretty hard to come up with the capital needed to open a bank. In this sense being a banker is like being a drug dealer. You can make a lot of money, but you can't consume what you sell. If you do, you end up being just another customer, a buyer not a seller.

In this case, the government. This article shows what would happen if everyone were able to operate the way the big banks do now.

I'd say that $1 billion in initial capital's got to stop at least a couple people.

No process is easy when step 1 is "form a bank".

Wait, it's very easy to borrow at short term rates (3M LIBOR) and then receive fixed long term rates (30 Years). It's called an interest rate swap.

http://en.wikipedia.org/wiki/Interest_rate_swap

And no, simply receiving on 30Y swaps is not a sure path to money. Sure you will probably pick up carry in the first year or so, but eventually you need to get out of the trade (or take on the risk for 30 years), and if LIBOR / Treasuries sell off you'll have to pay a hefty amount to unwind.