In an informative website called Money: What It Is, How It Works, William Hummel states that banks today account for only about 20 percent of total credit market debt. The rest is advanced by non-bank financial institutions, including finance companies, pension funds, mutual funds, insurance companies, and securities dealers. These institutions merely recycle pre-existing funds, either by borrowing at a low interest rate and lending at a higher rate or by pooling the money of investors and lending it to borrowers. In other words, they do what most people think banks do: they borrow low and lend high, pocketing the “spread” as their profit. What banks actually do, however, is something quite different. Hummel explains:

Banks are not ordinary intermediaries. Like non-banks, they also borrow, but they do not lend the deposits they acquire. They lend by crediting the borrower’s account with a new deposit . . . . The accounts of other depositors remain intact and their deposits fully available for withdrawal. Thus a bank loan increases the total of bank deposits, which means an increase in the money supply.16

If the money supply is being increased, money is being created by sleight of hand. What Elgin Groseclose called the “diviner law” of the bankers allows them to magically pull money out of an empty hat.

[Web of Debt, p. 30]

Laura adds:

By the way, on a $100,000 mortgage loan, one will typically pay much more than $10,000 in interest.

Assuming a low 4.25 interest rate and a 15-year loan, one will pay about $35,000 in interest. And of course, one will pay the bulk of that interest in the early years of the loan.

Zippy Catholic writes:

One of my readers pointed out your post to me.  I didn’t watch the youtube video (I find videos to be big time-wasters: I can read far more material in far shorter a time than it takes to watch a video).  Some of your readers may be interested in the following:

Pope Callistus III in 1455 defended lenders against borrowers in mortgage situations like you describe, when the borrowers were attempting to keep the property by claiming that the loans were usurious.  I transcribed the document from Denzinger here.

I have what I think is a better explanation of fractional reserve banking (because I take into consideration the Church’s constant condemnation of usury as an execrable mortal sin) here:

(As an aside, the typical economic measure M1 – by including bank deposits, which are really a kind of security against the bank’s balance sheet not cash – actually obscures the situation).

And I go into great detail on the Church’s condemnation of usury here.

I have a lot more material on this and related subjects but that’s probably enough for now.

Laura writes:

My point was not that my friend should have just reneged on the deal he made with the bank and gotten his house. Nor was I saying that all mortgage lending is immoral. I was pointing to the lack of risk for both parties in the loan and arguing that, all in all, he was exploited by a system that was rigged against him. For one, he was enticed into taking out expensive loans and paid heavily for them. The banks offer loans and people use them to pay for education, which is a necessity not a luxury good. The cost of education then goes up and people borrow more to pay for it. But all the time, the bank is using a portion of the credit that is established by the Federal Reserve. Credit for the sort of work he put into his dwelling and his children’s education should be more readily and cheaply available given that much of society’s credit resources belong to all of us, not to private banks. The bank was using what was essentially a portion of our collective credit as a commodity and selling it to him.

Laura adds:

More importantly, the system was rigged against him because in a usurious economy such as ours, in which the nation has surrendered its economic sovereignty by turning over its credit resources to profit-making ventures, there is never enough money in the system and some portion of the population, and the government itself eventually, must fall into bankruptcy in order to make up for the shortage. The banks create the principal. They do not create the interest. His loss of income, which made it impossible for him to keep up with the loans, is arguably related to this inherent shortage of money and instability.

Zippy writes:

My point was not that my friend should have just reneged on the deal he made with the bank and gotten his house. Nor was I saying that all mortgage lending is immoral. I was pointing to the lack of equal risk for parties in the loan and arguing that, all in all, he was exploited. For one, he was enticed into borrowing expensive loans and paid heavily for them. 

I have no objection to the contention that he was exploited, mistreated, etc.  I’d have to know a lot more about the objective situation before I could come to that conclusion myself, and your familiarity with the person and situation trumps any theoretical concerns I may have.  Nor am I defending modern banking practices in all of their details: quite the contrary.

I am simply trying to clarify the principles involved.

Secondly, credit for the sort of work he put into his dwelling and his children’s education should be more readily and cheaply available given that much of society’s credit resources belong to all of us, not to private banks. The bank was using what was essentially a portion of our collective credit as a commodity and selling it to him.

Here I don’t agree, or at least I don’t agree that this has been established by principles articulated in the original post or comments.  In the absence of usurious (personally guaranteed) interest-bearing loans and self-referential securities, both of which I discuss in some depth at my site, the process of making fractional reserve loans does not create money or credit out of ‘society’s credit resources’. That conceptualization of it is simply false.  So-called ‘fractional reserve lending’ securitizes property (exchanges various claims against property for each other) at the risk of the bank’s equity shareholders (who take by far the most risk) and other investors including depositors (depositors, as opposed to people who rent safe deposit boxes, are a kind of investor in the bank’s operations).

In effect, your neighbor sold a portion of his home to the bank.  He rented back the bank’s share of the house: the interest is rent for the bank’s share of the house, since he gets to use the whole house.  He also gradually purchased the bank’s share of the house back (the principal); but given his personal situation that did not work out so the bank reclaimed its contractual entitlements (both rent and ownership) from the property.

That doesn’t mean that he wasn’t wronged in some way by the bank, but it has not been established by what principle the bank wronged him, if in fact it did wrong him. Again, there is no way for me to reasonably say anything more about the particular situation without much more familiarity with the people and the details.

I’m not asking for more details — just, again, trying to make sure the principles at work are articulated correctly. I think it is important to get these things right as matters of principle, because usury and other financial exploitation form one of those areas where the Church’s timeless teaching is opposed or misunderstood on all sides by people who (often willfully, but perhaps even more often innocently) don’t have a good grasp of it.

Laura writes:

I actually did not bring up the Church and was not referring to its teachings in my post, although I obviously accept its principles on the issue. Whether I correctly applied its principles or not is a separate matter.

You write:

So-called ‘fractional reserve lending’ securitizes property (exchanges various claims against property for each other) at the risk of the bank’s equity shareholders (who take by far the most risk) and other investors including depositors (depositors, as opposed to people who rent safe deposit boxes, are a kind of investor in the bank’s operations).

So let’s say a bank has loaned some $200 million in mortgages. How much of that has typically been backed by the bank’s equity shareholders and other investors?

 Also, how is the total amount it has available to lend determined?

You write:

In effect, your neighbor sold a portion of his home to the bank.

But not really. The bank created some of the money to buy the home.

Zippy writes:

So let’s say a bank has loaned some $200 million in mortgages. How much of that has typically been backed by the bank’s equity shareholders and other investors?

All of it.

The term ‘mortgages’ is ambiguous, as readers of my Usury FAQ can tell you, because it does not distinguish between full recourse and non recourse lending.  But the problem is usurious lending and self referential securities, not banks securitizing homes and other property.

So the answer to your question, when ‘investors’ are understood to be people who have contractual claims against the bank’s balance sheet (the inventory of all actual property and fake ‘property’ a.k.a. usurious full recourse loans) in which the bank has claims,  is “all of it”.  The equity shareholders in particular have the most to lose of what they actually own: of property they have staked. Someone who “loses” property that he doesn’t really own – which he has encumbered by other claims in return for something he purchased with that encumbrance, for example the use of a house over 15 years – hasn’t really lost property.

Again, I’ll refer you to my post on fractional reserve lending and the specific difference that usury makes.

 Laura writes:

I’ll have to try and understand the difference between what you are saying and what William Hummel and Ellen Hodgson Brown, as well as in the judge in the Minnesota case, are saying in the quotes I included above. As I understand it, a bank loan increases the money supply.

I’m not denying what you say because I need to understand it better, but here is another description of the creation of money by banks by M. Oliver Heydorn:

Just last year, the Bank of England openly admitted that the private banks are responsible for creating the bulk of the money supply out of nothing. This is significant, because although the truth about the bank creation of money has been floating around in the public forum for at least the last one hundred years (largely due to the efforts of C.H. Douglas and others), some bankers and economists have denied this reality (while others, like Reginald McKenna, have been quite open about it) [1]. Even today, there are many people, including many politicians, who are blissfully unaware and/or seriously misinformed regarding the origin of our money supply.

     In the BofE document “Money Creation in the Modern Economy” (Cf. bofe-money.pdf) the relevant facts are presented in the paper’s overview as follows:

In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.

     Whenever banks make loans, i.e., whenever they purchase the IOU’s or promissory notes of firms, governments, or individuals, or buy securities, or pay their own operating costs, they create new money in the form of bank credit. This bank credit exists in the form of intangible, electronic numbers. In the typical industrial country, 95% or more of the money supply exists in the form of bank credit and most of that credit is created alongside a corresponding volume of interest-bearing debt (or debt equivalent). Only 5% or less exists in the form of notes and coins, or currency.

Zippy writes:

This bank credit exists in the form of intangible, electronic numbers.

In the case of a loan made against (new to the bank) property, those intangible numbers represent legal claims against that property which (those legal claims) the bank has just purchased from the borrower.  In effect the bank has purchased part of the property and added its claims against that newly purchased property to its balance sheet (the inventory of things it owns), and in return it grants the borrower a deposit account (a claim against the entire balance sheet of the bank not just that property) in the same amount.  A deposit account is not cash: it is a security which represents a claim against the balance sheet of the bank, a balance sheet which has just been increased by the bank’s claim to the property.

Basically the bank adds its new stake in the collateral property to the pool of all property in which the bank has a stake, and then it issues a generic deposit account to the borrower in the amount that it just added to the pool.  What ‘creates’ or introduces the new capital represented by the deposit account (erroneously lumped together with cash as ‘money’ by modern economists) is the new-to-the-bank property, not the bank.

Again as I explain in my post this process only ‘creates money out of nothing’ if there is no property against which the bank gets a claim in return for the deposit account.  That is, this only ‘creates money out of nothing’ when the loan is usurious, a loan based in the personal guarantee of the borrower to repay as opposed to some actual property.  Traditionally this distinction – the personally guaranteed loan as opposed to a loan against property – was called a mutuum, and all of the Church’s condemnations of usury were condemnations of contractual gain from mutuum loans specifically not everything that modern people call ‘loans’.

If the bank creates the deposit account out of the new financial interest it now owns in some actual property, ‘money’ (a deposit account) has not been conjured out of nothing.  If it creates the deposit account out of nothing but the promise of a borrower to repay with interest (usury), then it has created ‘money’ out of nothing, at least if we treat deposit accounts as ‘money’ even though they are not the same kind of thing as cash.

This is important simply because it is true, of course, but also because it shows not only that the Church was for thousands of years more morally correct than the rest of the world but that the Church’s doctrine on usury continues to this day to be more financially correct than pretty much all of the modern world.

It is no surprise that you can find plenty of folks claiming that banks ‘create money out of nothing’.   That is the standard line.  I say as much in my post, and that is how I was taught it when I got my MBA decades ago.  But again, that contention is based on two basic modern errors: the treatment of property and personal promises to repay as if they were the same kind of thing (“loans”), and the treatment of bank deposits and cash as if they were the same kind of thing (“money”).  But in both cases they are not the same kind of thing.

Laura writes:

Thanks for your response. Let me give it some thought.