Question Re Whoops By John Lanchester

[hp9man]

I've just read "Whoops" by John Lanchester. It's an interesting book which tries to explain how the credit crunch happened in layman's terms.

There's a good chapter called "Rocket Science" where he describes CDOs, CDS and SPVs. As an example he talks about how you could do the same things by lending money to your neighbours, getting another neighbour to insure the risk etc etc.

However, there's one bit which I still can't get my head around. It's half way down page 57 if you're browsing in Waterstones....

"So what you do is create a company, ideally based offshore where it pays no UK tax, and extend to it the credit to buy the loan back from you. You lend it a virtual £100,000, it buys the Wilsons' debt from you and recredits you with the £100,000, so you're back in the black. (In practice, the example breaks down here, because you can't lend money to yourself and create credit in quite this way. But large financial institutions can and do). ...... and then you do the same thing again and again."

Is this where the flood of credit came from? I thought only governments could create / print money?

Could anyone clarify?

[Cicero]

I've just read "Whoops" by John Lanchester. It's an interesting book which tries to explain how the credit crunch happened in layman's terms.

There's a good chapter called "Rocket Science" where he describes CDOs, CDS and SPVs. As an example he talks about how you could do the same things by lending money to your neighbours, getting another neighbour to insure the risk etc etc.

However, there's one bit which I still can't get my head around. It's half way down page 57 if you're browsing in Waterstones....

"So what you do is create a company, ideally based offshore where it pays no UK tax, and extend to it the credit to buy the loan back from you. You lend it a virtual £100,000, it buys the Wilsons' debt from you and recredits you with the £100,000, so you're back in the black. (In practice, the example breaks down here, because you can't lend money to yourself and create credit in quite this way. But large financial institutions can and do). ...... and then you do the same thing again and again."

Is this where the flood of credit came from? I thought only governments could create / print money?

Could anyone clarify?

"For while it is true that Governments create legal tender – which is to say the physical notes and coins that circulate in an economy – that legal tender represents, at its absolute highest, only 3 per cent of the total money in circulation in the global economy. It is in fact the commercial banks, largely unaccountable and privately owned, that create the world’s money in the manner I will describe below..."

Linky:

http://www.telegraph.co.uk/comment/personal-view/7273332/Darius-Guppy-our-world-balances-on-a-sea-of-debt.html

[davidg]

I've just finished this book. It is an easy introduction to many of the problems underlying the world's financial system however I disagree with Lanchester's conclusion that unfettered capitalism was not able to self correct. If we'd had unfettered capitalism the banks that had made bad gambles would have simply gone bust, bankers would have been destitute, fred goodwin's pension would not have been paid etc.

The issue for the govt. was the fear that this would have brought down the whole stack of cards... however would it have been any worse than germany post ww2? We might have been better without Gordon Brown saving the world ?

[Prescience]

What this skirts around are two separate however, interlinked realities: Fractional Reserve Lending: and Credit Money.

See Here:

The concept is that banks can "Create" money, through credit.

Yes they can: for a time.

However as with most truth, reality is rather simple.

In a modern fiat economy, monetary inflation is caused, simply by Money Supply increasing faster than GDP. or the old rule of "Too much money chasing too few goods!"

Credit cards can "create" money: short-term. From the simple perspective that you flash your plastic and buy something: you are immediately debited for your purchase: despite the reality that the card operator doesn't actually settle with the merchant for some time.

Thus in the null period, you've been debited (And charged interest if you don't settle the debt in full by the due date): yet the retailer hasn't been paid.

Fractional Reserve Lending only works since banks constantly borrow money from the interbank market: over time periods varying from Overnight/Over weekend: two day; seven day; one month and so on up to ten years when the market is easy (Ten Year money is not often seen now).

All is OK whilst the carousel keeps rotating: however, once the interbank and other capital markets get sniff of problems then the shutters bang down.

And the bank is toast.

Perhaps the best illustration of this problem and its dangers is exemplified by the case of Continental Illinois bank, Chicago.

When Paul Volcker, then head of the Fed stepped in he said" If the Federal Reserve had not have stepped in then we risked the thing all bankers fear: the Ultimate Domino Effect.

This is where banks stop lending to other banks and financial institutions via the (Usually) highly liquid Money Markets; and worse, call their debts in.

And one after the other banks topple and in so doing, topple others.

It will happen soon.

See Here: