Through a gla$$ darkly III

What is a bank? Silly question, is it not? Maybe, but I don't think so. There was a time when many of us knew (or thought we knew) what was meant when we used the term, but times (and conditions) have changed. Let's take a walk down memory lane.

Believe it not, there was a time when I took my "extra money", that is, the money I wanted to save (to buy a house, car, go to college, etc.), to a bank and deposited it because they paid me to have my money there. I had a savings account and they paid me (at the time) about 4% compounded semi-annually, and I thought this was a great deal. "How and why could they do that?" was the question that I had then and the answer was actually very simple: they used my money to invest in "whatever" and they shared their success with me. What a lovely idea. Almost idyllic, isn't it? My question, of course, was "What do they invest in?".

It turns out that they "invested" in the local businessman: the accountant who wanted to stabilize his cash flow, the metal-shop owner who wanted to buy new machines and equipment, and more. They also invested in the local community: the homeowner who wanted a second mortgage to make improvements to his property, the first-time buyer who needed a loan to buy a new house, a family who needed a new car and didn't have the cash to put down for a new one. In other words, people just like you and me doing things just like you and I do. They charged interest on these loans they made, because there was a certain risk involved. What if the accountant lost his clients, or the metal-shop owner didn't get the new production contracts or the home or car buyer became unemployed and couldn't make the payments? The level of "risk" (real or perceived) determined the amount of interest that the borrower had to pay for the loan. Young people buying their first car paid higher interest rates than long-term employees of a local company. The home owner paid a lower interest rate on his second mortgage than the first-time buyer. There was something to back up the loan: the house, the car, the reputation of the borrower, his or her standing in the community. Most bankers knew who they were dealing with and how reliable they were. Still, the risk was covered, and if everyone made their payments, then the bank could pay me my bonus for letting them use my money in the first place: the interest that accrued on my modest savings account.

OK, OK, I know, the past was in Technicolor. Reality tends toward black-and-white. But, in reality, that's not true. It's more shades of grey.

And that's where we'll pick up next time.

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