Are Banks A Legal Ponzi Scheme?

Have you  ever wondered why banks exist?  With the current debate over healthcare and bank bailouts taking place in Washington DC it just seemed like a logical question to ask.  Let me first start off by saying that I have never really understood the concept of banks (from a business standpoint) and recent events have further fueled my skepticism.  That being said I have always been curious about one thing when to comes to banks…how do they make their money?

When I walk into a bank there is no product or service they are simply looking for a way to loan me money.  You really are either depositing money or withdrawing money and the bank charges you for the privilege of doing so.  Sure having a checkbook is nice but money orders and the internet have made checkbooks obsolete.  So I began to think…this is either the greatest business model ever created or the biggest legalized ponzi scheme enacted upon people in history (outside of the stock market).

With the recent headlines involving Bernie Madoff I thought it would make sense to start off with defining what a ponzi scheme is.  A quick search on Google bought up the following definition – a ponzi scheme is “a fraudulent investment operation that pays returns to investors from their own money or money paid by subsequent investors rather than from any actual profit earned.”  Wow…that definition blew me away!  Now substitute the words “ponzi scheme” for “bank.”  A bank is a “investment operation that pays returns to investors from their own money or money paid by subsequent investors rather than from any actual profit earned.”

It gets even worse….

There is a little main stream knowledge about the practice of these institutions called “fractional reserve banking.”  It sounds complicated but it simply means that banks are legally allowed to lend out more money than they have on hand.  This was a major reason for the meltdown in the economy that has taken place over the past year and that is still continuing with the bank failures that are happening on a weekly basis (104 and counting in 2009 alone).  So hypothetically every time you deposit one dollar into a bank they have the legal right to lend out $10.  This is also known as “leverage.”

So this seems to be how a bank makes money.  We, as depositors, deposit our money into a bank because it is safe and secure protected by FDIC insurance (as noted on the drive through window) and they turn around and lend our money back to us at a higher rate.  Think about it…what is the typical rate on a savings account right now? Less than 1% and what is the rate on your credit card, car loan, student loan, personal loan, home equity loan, and/or mortgage?  Let’s tack on fees for missing a payment, overdrawing your account, not keeping enough money in your account, not using using your credit card, etc, etc…the picture starts to become clearer.

One of the greatest legal ponzi schemes ever created…

A bank makes it money off of the money you deposit into it and they make their money off of interest payments and fees.  Now you see why it is so important for them to find ways to “catch” people with these crazy rules noted in the fine print of the applications and ever changing agreements we sign.  It behooves them to contractually be able to raise rates for any reason or without cause.

It is actually taking Congressional intervention in order to stop banks from charging “excessive” fees and the bank are fighting the legislation tooth and nail!  It’s a great business practice to allow your account to go over the limit or to sell you that variable rate mortgage.  They build in the profit margins on the front end and rake in the dough on the back end and no one is any wiser.  It is literally a multibillion dollar business enterprise built solely off of other people’s money (like the stock market).

It gets even better….

Now fundamentally just by the mere fact that a bank can lend out more than we deposit tells us something that is just common sense…if everyone went to the bank at the same time to withdrawal money it would not be there.  This is why people fear a “run on the banks” because in the back of everyone’s mind they are afraid that one day they can go to a bank to withdraw money and it won’t be there.  Sounds crazy but it can happen…think of September 11, 2001.  A bank DOES NOT have to give you your money back and they can place limits on how much you can withdrawal!

It sounds absurd that a bank wouldn’t have your money but that again goes back to “regulation” (the word absolutely hated by the banking industry) and the fact that they do not have to have money on hand to cover the loans they provide their customers.  Not to mention the amount of leveraging that takes place.  Don’t believe me ask your banker this question:  “is there ever a possibility that I could come to the bank and be denied access to my money?”  If they say “no” you already know they are lying because if that were the case there would not be a need for FDIC insurance and there would not be limits on the amounts of money that FDIC covers.

In closing…

The average person spends over 30% of their after tax income on interest payments alone.  Case in point, look at the amortization schedule of any type of loan you get.  Notice that nearly all the interest is always front loaded so that the bank gets their money first and then the principal gets repaid.  A never ending cycle as people continuously refinance houses and get new cars over their lifetime.

For fun, calculate and total all your current loan payments and see how much of your income is going towards the interest…that’s banking…the great American ponzi scheme in action!!!