Mackay's Querie, Part Deux

OK, so I completely flubbed my first attempt at Mackay's actual question, in a sign of my utter amateurism, and went on a rambling discussion of a bunch of garbage which was totally irrelevant. Let's try again. Once again, we see a misleading article structure coming out of the MSM. The article leads with how an obscure tax change is going to result in a $140 billion windfall for banks, when what it should have lead with is "FED desperately tries to encourage bank consolidation." So why does the FED want consolidation? Short answer: so it does not bankrupt the FDIC. To understand what happens here requires a basic understanding of fractional reserve banking. The dirty little secret of fractional reserve banking is this: all banks are technically bankrupt all the time. They have contracts to pay depositors what they have deposited, while at the same time all those deposits are tied up in credit contracts. The bank cannot satisfy both contracts simultaneously. The bank continues operations on the basis of revenues on the money lent out, plus a small reserve of funds which it keeps in case a few depositors want access to "their" money. As long as that number is few, the bank is not called on the scheme, and it can continue operations as if everthing were sound. But things are not sound at all. Enter Central Banking. This is the role of the FED, the central bank of the US, to make an irrational process work. If too many depositors come a-calling, the banks must borrow from one another to honor the contracts which they cannot honor on their own (because they are bankrupt). Normally the banks do lend at approximately the rate given by the FED open market rate. But if they will not lend at this rate, the FED "lends" completely new cash to keep the banks open, allowing them to fend off those depositor people with money created by expanding the monetary base. This is the AMB chart I put up awhile ago. Mostly this keeps things going at the expense of increasing the money supply. This instigates a speculative boom (the Austrian Business Cycle Theory) as prices increase in certain markets, which results in ill-advised investments and a warped, unsustainable capital structure. I don't wan to explain the whole thing here, but suffice it to say, influxes of cash create bubbles with inflationary funds that fleece savers out of their money. Think "housing bubble," which is one timely example. Eventually, inflation takes hold and the FED realizes it must stop expanding the cash base or risk an "overheating economy" (hyperinflationary boom). This is usually when things get ugly. Sometimes, when things are bad enough, even the aid of the central bank isn't enough. The credit holdings of the banks have gone so sour that there is absolutely no hope and they fail. What happens when a bank fails? First, the FED seizes control from the present ownership. It pays off all those pesky depositor people who have the audacity to actually want their own money back, restructures the debt (often with taxpayer/deficit money), then puts the bank on the auction block. All of this costs money, especially FDIC money. The FDIC has a few measly billion dollars (I don't know the exact number. It is less than $100 billion) backing several trillion in deposits. If the FDIC has to use its funds in this crisis, it will easily be overwhelmed. So Hank "Gunslinger" Paulson and "Gentle" Ben Bernanke would like somebody else to do the heavy lifting for them. The banks, however, are recalcitrant and don't want to help out. So Ben and Hank have thrown out all kinds of incentives for banks to do this, consolidating their assets so that the combination of weak and small institutions produces a new entity which can scrape by. It appears this particular tax break which Mackay has hit upon is one of them, which has offended some political groups who have found out about it. I'll finish this off later... right now I have to get to work.