How Do Banks Create Money from Nothing? The Basics of the Economic Crisis in 5 Minutes

The economic crisis is the result of flawed banking rules. In 5 minutes, learn the basics of how banks operate and why the rules must change.

The rules of banking allow banks to lend out 90% or more of the money of depositors under a system known as "fractional reserve banking". This leads to the majority of all deposits in checking and savings accounts to be backed only by the promises of borrowers to pay back the loans on schedule and with interest. If the borrows are unwilling or unable to keep up their payments, the banks enter a state of crisis, and the deposits of all the savers are at risk.

In 5 minutes, review the basics of how banks "create" money from "nothing" by lending out money based on promises of future repayment. If the borrowers fail to repay, and if the collatoral backing the promises is insufficient, then crisis results. This is a key component of the current economic crisis, which led to bailouts, financial crisis, tightened lending standards, job losses, and a recession that some believe will continue indefinitely.

(Note: This is a 5-minute revision of a 10-minute video covering the same concepts. The 10-minute video goes through each step in more detail, bringing in more basics, and created with a school-aged audience in mind.)

Category:

News & Politics

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• bank
• fractional
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• banking
• loan
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• mortgage
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• credit
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• risks
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• house
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• financial
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• Ron
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• Kucinich
• illiquid
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• economic
• economy
• subprime

[boundtogetdown]

good job mr garrison

but what if mr hat lands on mr shoes boardwalk with 14 hotels

[newculture]

In later videos I was going to pull out the properties, but I was looking at Baltic, since it is "worth" only 70 but sells for 90...

Who is Mr. Garrison?

[boundtogetdown]

south park

[newculture]

Oh, I don't watch TV, so I didn't get that one.

[Bernd1964]

Are you really sure we know everything about banking and the creation and flow of (virtual) money? I believe there is a largely unknown privileged elite that gets money from the banks without creating any debt and without paying any interests. They are the kings and queens of the modern age, they own the world and the creation of wealth by working slaves. We live today in a latent kind of feudalism not very different from the middle age. Money has become too complex and virtual to be rational.

[cjgan80]

I lost where i was at when you introduced Mr.Hat xD

[tothemax01]

@Satarack No, just a correction (you said the money is owned by the depositors). There is a difference between owed and own. The significance is that if the money was owned by the customers (as is cash in a safe deposit box), any usage of the money by the bank would be illegal (in the same way that if you park your car in a carpark, the owner of that car park cannot lend the car to other people). Regarding failing to return, the difference is instead of bankruptcy it is theft.

[Satarack]

@tothemax01 Red herring. You're equivocating a technical legal meaning for the word ownership; with a common usage meaning of ownership. The majority of a bank's money is from loans; all of which is owed back to customers; their legal ownership is irrelevant to their contractual obligation to return that money if and when the customer demands it back.

[tothemax01]

@Satarack The bank owns the money, not the depositors. The depositors retain neither possession nor ownership of the money, and instead establish a debt contract (repayable on demand). A banking deposit is a loan, not a bailment, as far as common law is concerned.

[Satarack]

This is why a good banking system restricts itself to lending only to those who have a good credit history, and a good chance of repaying their loans. As long as only a minority of borrowers default on their loans, and the majority repay them, the system is stable. As such, a degree of regulation is necessary to monitor and control how such loans are made; since the bank is lending money owned by their depositors, not by themselves.

[misterfunnybones]

Mr. Hat took his $90 and scuttled off to the tax-free Bahamas, never to be seen again.  The money's gone...

[mds0014]

@airborneinfantry888 sorry for the long posts, just my two cents. :)

[mds0014]

@airborneinfantry888 having said all that, the one thing that makes america great is that there is the possibility to work your way up. it was possible in ages past, but much harder than it is in todays time. although i feel that its getting harder and harder to work your way up now. tech/innovation doesn't create wealth. it simply causes a transfer of wealth, ie people pay the company to get say an ipad. so now people transfer their wealth to apple, some of which goes to the workers.

[mds0014]

@airborneinfantry888 now in the medieval period, there was a middle class that enjoyed a decent lifestyle. hey funny thing, there's still a middle class with a decent lifestyle. the more things change, the more they stay the same. now, we don't have to worry about slavery....well unless you're a slave being pimped out in america (there are hundreds of thousands on the low estimate). oh yea, the kings actually owned several castles (ie mansions).

[mds0014]

@airborneinfantry888 actually, not true. the kings of the middle ages owned castles (ie mansions in today's terms), where we own houses (ie huts in medieval terms). also, many kings owned land equal in size to some of the states, i don't know of an average person owning land the size of the state of new york. there are still people working very hard for said bowl of soup. don't believe me, go to SOUP KITCHENS. i know, homeless, but some aren't able to get jobs (others just dont want to work)

[airborneinfantry888]

@Bernd1964 I must respectfully disagree with you. It's true that wealth is created. When we use our minds rationally, we invent,build,discover, and create. Technological progres,innovation, and free enterprise create wealth. We are not slaves. In the middle ages, a peasant worked 14 hours a day for a bowl of soup. Today you probably work 40 hours a week and you live in a house, drive a car, own a color TV, an iPod, and a computer. You are wealthier then the kings of the middle ages. :)