I write on this primarily because the author [Edward Conrad] of the referenced piece is also from Bain Capital (Mitt’s former private equity firm) and is expounding on a commonly-held, but false, premise.
The financial crisis stems from the fact that the U.S. economy finds itself on the horns of a dilemma. Price-insensitive, risk-averse savers hoard rather than invest their savings and insist on the right to withdraw their funds “on-demand.” If these savings sit idle, growth slows and unemployment rises. Banks are the vehicle through which the economy puts short-term savings to work. Because it takes time to repay loans, the economy runs the risk that short-term savers may panic and demand withdrawals en masse—when real estate prices fall 30%, for example. When that happens, lenders must sell assets—namely loans—to fund withdrawals. In a panic, when sellers vastly outnumber buyers, asset values sink to fire sale prices. At low enough prices, banks cannot sell enough assets to fund withdrawals and still remain solvent. Depositors race to withdraw funds before insolvency, which amplifies withdrawals.
Our friend here inadvertantly tripped over his own foolishness, and disclosed the truth.
Did you figure it out?
When one borrows money against nothing, that is, simply against a promise to work tomorrow, then one has put credit money into the economy without a predicate of value behind it.
Again, we start with GDP = (M + C) * V
(M = Money, C = Credit, V = Velocity, or number of times each unit “turns over” in a year)
This must be true because GDP measures production and the value of a thing that is produced is zero if nobody buys it. That is, we measure GDP based on actual goods and services produced and delivered (we allow inventory build to count, but we subtract off inventory that is never sold and disposed of by destruction instead.)
So how does a bank wind up in a situation where, as our Edward said, “At low enough prices, banks cannot sell enough assets to fund withdrawals and still remain solvent.”
That’s simple — it creates credit without an asset pledged as collateral of at least equal value to the credit extended.
This increases “C” which must, mathematically, debase the value of every unit of “M” or “C” that already exists.
If you’ve discerned from that little fact that over time this must make it impossible for some of the people to pay, you’re right.
The cause of the panic withdrawal is the original counterfeiting — it is mathematically impossible for what the bank did in issuing unbacked credit to “work” forever and they know it.
What Edward wants the government to do is to provide a means to prevent the consequence of counterfeiting from being served on the people who engaged in this outrageous practice.
And how would government do that? By forcing you to pay twice.
First, when the counterfeiting takes place, your purchasing power is debased. You are forced to hand over more units of currency (or credit) for the same goods and services since the total number of them in circulation has been increased faster than production increased. You are thus robbed by the counterfeiting act, exactly as you would be if I ran off $100 bills on my office copier.
Then, when the market discerns that this happened and seeks to punish the entity that made the bad loans (that is, the market figures out that the “assets” held by the bank are of insufficient value to pay the depositors) and the market “runs” the bank (because he who panics first gets his cash, everyone else gets nothing) then you are robbed again by the government who steps in and demands that you pay a second time for the counterfeiting that the bank originally engaged in to pay the depositors!
This is the essence of what Ron Paul has espoused (along with myself) — while Ron Paul gets the mechanics of fixing the problem wrong (e.g. “gold standard”) he gets the premise right.
Edward, on the other hand, along with Mittens, have made their money through the inflation of asset values that result from counterfeiting of the monetary supply. By doing so and then selling to a “greater fool” before the bubble pops, they effectively skim off your purchasing power debasement and keep it for themselves. This is the essence of how you have your prosperity stolen from you and it’s been going on for the last 30 years.
To have a sustainable and honest economic system this practice must be stopped.
One Dollar of Capital stops it.