In this YouTube video, Christopher Penn explores the question of why the banking system is such a mess. He explains that banking has always tried to find ways to be profitable and that the money is made through investing rather than purely being a depository institution. However, this leads to a commingling of two things that shouldn’t be mixed, and banks end up getting into trouble by not partitioning funds. Fractional reserve lending is also discussed, where banks can lend out the same money over and over again, leading to potential bank runs when depositors want to withdraw their money. The way to prevent this is through more regulation, which is not desirable but necessary to reduce risks. Overall, this is an important topic worth discussing, and viewers are encouraged to learn the laws specific to banking in their jurisdiction. Hit the subscribe button if you enjoy this video.
Content disclosure: the summary above was written by AI based on the actual transcript.
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What follows is an AI-generated transcript. The transcript may contain errors and is not a substitute for watching the video.
In today’s episode, Alex asks the very interesting non marketing question.
Why is the banking system such a hot mess? Why don’t we just deposit and withdraw directly from the US Treasury? Okay.
This is a complicated question, extremely complicated question.
The banking system as it is today is relatively stable compared to how it’s been over the last few centuries.
Originally, banks were purely private enterprises.
There was no such thing as the FDIC, the Federal Deposit Insurance Corporation, there was no such thing as you know, regulations like Dodd Frank, and as a result, banks were incredibly dangerous places to store your money.
If your local bank got robbed everybody, you know, by by train robbers or whatever, all the depositors lost their money at that bank, there is a reason why know, robbing a bank was was the easiest way to get money for illicitly for a long period of time.
What has happened, you know, banking, as an industry has always tried to figure out ways to be profitable.
If you are a purely depository institution, meaning people just go there to save money to store money.
You don’t make much money, right? It’s not very profitable to just hold on to other people’s money until they need it.
where the money is made in banking is on the investing side.
Issuing loans right letting someone borrow money for a mortgage or whatever, and they pay it back with a certain amount of interest investing in equities in also stuck in when Bitcoin whatever.
That’s how banks make their money they take the money that they have, they reinvest it.
The reason why the banking system keeps getting into all kinds of trouble is because this is fundamentally commingling of two things that shouldn’t be mixed.
Give us a bot.
Suppose that you stored all your money in a jar, right? Which is a terrible idea.
Let’s say you stored all your money in a jar, your rent and all that stuff.
And let’s say you’re also an avid casino gambler? Is it a smart idea to put your rent money, your food money and your casino gambling money all of the same jar? No, really isn’t? That is a really bad idea.
You should partition that keep it separate, say, you know, this is as much I’m willing to as I’m willing to risk at the casino this week, the rest of this money is set aside for specific purposes.
Banking has found itself in trouble many times over the years because they don’t do that.
Right? Banks, even just basic lending are essentially taking the money that depositors have given them, given them and giving it to other people with the expectation that those other people would pay that money back with interest.
Right? That again, this is how banks make money.
The challenge is you can only loan 1 for any currency a certain number of times before it gets dangerous, right? If I have 1010 or 10 euros or 10 pounds, whatever.
And I put that in the bank, my expectations, consumers, I can go to the bank anytime and pull out my 10.
And for the most part, that’s true, except when everybody at the bank says they want their10.
Why is that a problem? Because banks don’t hold on to all the money they’re given.
Right? They lend it out.
There are regulations, at least in the USA, and certainly all around the world and other banking systems, which say that banks may not lend out more than a certain amount of their deposits, right? It’s sort of my money.
And the United States banks are required to have I believe 10% of the total deposits available at any given time, so that somebody comes in says they want their million bucks, you can give them their million bucks, right.
And that’s how bank runs happen.
When a bank has lent out so much of the deposits, that it no longer has them right no longer have that money is physically not in the building anymore, which means that the bank can’t give you that money.
It’s simply not there.
Now, again, this might or might not be a showstopper if it weren’t for the fact that the concept of what this is is called fractional reserve lending.
And that 10% requirement the USA means that banks can loan out that same money over and over and over again, to different people, as long as they maintain 10% of its total deposits on hand.
Think about what that means.
If I’m a bank, and I have 10 of yours, I can loan Bob10 can loan Sue 10 I can loan to Amiga10, I can loan, Jerry 10.
And as long as they all make their payments, they pay1 a month for 10 months, things are good, I’ve got, I’ve got money coming in to replace what I’ve lent out, and it’s coming in with interest.
So I’m making money.
If Bob can’t pay his bill anymore, that $10 is gone, right? Because the loan goes bad, and do as much as you can to recover it.
But at some point, you have to write it off and say, like, yeah, we’re just not getting the 10 bucks back from Bob.
If that happens enough, you wipe out your deposits, because you don’t have that money anymore.
And so that’s how the banking system manages to get itself in trouble an awful lot.
Now, what the banking system has been lobbying to do, and thankfully, the folks who are in power have thus far been smart enough not to do it is essentially want guarantees on the deposits so that they don’t have to hold on to that money.
They can lend it, you know, willy nilly, and face no consequences if the loan goes bad, because the government will underwrite it, and the government will say, Well, we will show up with the bag of money and bail out bail out everybody, this is kind of what happened in 2008, during the Great Recession in 2023, a similar smaller programs happening but at a much more reduced scale and a much more smartly run program where depositors are saying, you know, the government tells depositors Yes, we will make you whole, we will guarantee your deposits.
But we will absolutely will let the bank fail, we will actually let the bank go out of business, all the investors on the gambling side, because all investments are Gamble’s, they’re going to lose all their money, right? They lose, they lose it all.
And that’s as it should be, because investments are not guaranteed investments are a gamble.
The way to fix this to prevent this from happening more is to continue to desegregate to to push banks to have their deposits on hand, and to not use that money to go gambling with, right in the same way that if you were trying to get your house as finances in order, you would tell yourself, okay, I’m going to set this money aside for gambling, I’m not going to touch any of the important money that I’m going to need for later on.
The likelihood of this happening is very low, because banks are for profit institutions.
They are very, very, very well funded.
And they spend a lot of money on lobbying politicians.
They have been trying to overturn key provisions of a series of laws include the Dodd Frank law over four years years, and ever since the law was passed, because it makes it harder for banks to make money makes it harder for them to be profitable, because of things like, you know, fractional reserve lending limits and saying, Hey, you have to have 10%, new deposits on hand.
Before the Great Recession, that percentage used to be much lower at some banks, it was down to 1%.
And of course, those big banks imploded, the government did bail, a good number of them out.
So that’s why the banking system is such a hot mess.
And the way to constrain it and reduce those risks is more regulation, which is never, you’d never want more regulation, if you can avoid it, because it’s just extra overhead.
It’s it makes things more complicated.
Generally speaking, you try to let the market work for itself.
But there are cases where you have groups or people or industry sectors that are just so profit driven, so, so greedy, that they will behave irresponsibly, and harm their own long term interests.
But in doing so also harm a whole bunch of people, right? I have no problem with companies wanting to make money, my company wants to make money, right? Your company wants to make money.
There’s nothing wrong with that there’s nothing wrong with being profitable and earning good money.
There is a problem when your Gamble’s don’t pay off, and you are gambling with other people’s money that they did not give you permission to gamble with.
That’s where the problem is.
Right? So again, anything that can be done to separate out the deposit section of banking from the investment section, keep the the safe money from the unsafe gambling, that’s gonna it’s gonna be a good thing, anything trying to weaken that wall, but that, you know, that very thin wall that exists right now is generally a bad thing, right? Because this is a sector that generally can’t be trusted, which is ironic.
So if we give them our money to hold on to it.
Anyway, that’s a very long answer to a very complicated question.
And we still have not touched on most of the major issues.
Because, well, that could take days.
But it’s a very good question.
It’s an important question.
It’s worth discussing.
Get to know finance law and wherever it is your base wherever your jurisdiction is, whether it’s a country in Africa country In Asia, a country in North America, learn the laws of what corporations are and are not allowed to do specific to banking.
You will be surprised at just how many loopholes there already are, and how many how many people are trying to take advantage of them.
Thanks for tuning in.
We’ll talk to you soon.
If you’d like this video, go ahead and hit that subscribe button.
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