Through a gla$$ darkly V

So what did our example tell us?

A moment's reflection brings us to the realization that as long as everyone plays by the rules, there's really no problem. The bank "makes its money" by investing someone else's money (in this case its depositors') and earning a return (in the form of interest or value-appreciation of some sort), and the bank, at least ideally, then shares some of those earnings with the people who provide it with its resources.

You see, it's all actually very simple. But everything was simple in Leave-It-To-Beaver Land, and we don't live there anymore, in fact, we're not in Kansas anymore either.

There was a time – and there are some places – in which banking was a conservative, prudent, and cautious business. Banking was local for the most part. The bankers knew their clients, knew about their work and family relationships and assessed the risk of any of their loans, for example, based on this knowledge. A person with a steady job and without a lot of other debt was a pretty safe risk for a mortgage on a house suitable for his or her family. Yes, the house itself was used as collateral for the loan (that is, if you couldn't pay off the loan, the bank would end up with your house), but the bank really didn't want the house, it wanted the money you made in payments. Why? Because it could take that money that you paid in an loan it out to other loan seekers, or invest it somewhere they could expect a reasonable return. The key to the whole system was reason: the bank knew its customers, knew its strengths and weaknesses, knew its capabilities and acted accordingly.

All the while, outside the banking system as just described (in the last couple of posts) – the commercial banking system, there was another system for another set of clients and customers. This was called investment banking. Here, the stakes were higher and the returns were higher. It's called investment banking, but it really isn't investing in the same sense that we might have put our money in a savings bond or such. No, here more volatile things were involved: stocks and futures (the infamous "pork bellies" one often heard about), and more. Here, however, I need to make a small detour before moving on.

In the world of business, there are three ways for an organization to generate extra cash. Extra? Yes, that is, money that is not generated through regular operations. Money the organization wants to invest. We all know that it is wiser to save up for a large purchase before buying it, but in the go-go-go, consumer-driven world today, we too often resort to credit to satisfy our impulses. Some things, like a home, of course, are really too significant a purchase to save up for, but cars and stereos and smart phones and refrigerators are in fact manageable.
The savings of business are called retained earnings, and sometimes these reserves are not enough to finance the next step forward for a business, so they have to get the money elsewhere. The three avenues open to them are, as in everyday life, to beg, borrow or steal. Really? Let me explain what I mean (next time).

Note: This series was originally published in slightly modified form on the Daily Kos.