How Credit Works

I got this from a mail list where I’ve been a long-time member. It was written by Ori Pomerantz and it explains how the current crises is affecting us in clear terms that anyone can understand. It’s not a banking crises, it’s a CREDIT crises precipitated by our government. I see no prognosis that BO will improve this.

Basics of banking:

1. The basic business is managing risk. You loan $100 to 100 people, and they agree to pay you back $102. If 99 people pay and one defaults, which is what you expected, you get back $10,098 so you made $98 in profit. Unfortunately, due to the high price of oil, only 90 people paid you back. so you only have $9180.

2. Banks are connected. You didn’t have $10,000 to loan out in the previous example, so you borrowed them from me. We both expected you to pay me back $10,050 and have $48 in pure profit. Instead, you’re now $820 short.

3. There is little to no “real” money around. It’s all borrowed from somebody else. The $10,000 you borrowed wasn’t mine either. I owe it to somebody else.

4. Until the mess is sorted out by the market we won’t know which banks need to go bankrupt, which are so close to bankruptcy that they can’t afford to loan out any new money, and which can afford to make loans – so no new loans, no capital for businesses that need it or consumers that feel like spending it. That’s a depression.

5. Politicians don’t like a depression to happen on their watch. They’d rather redefine contracts, money, etc. It’s been done before, multiple times.

1 thought on “How Credit Works

Comments are closed.