Controversial Characteristics of Fractional Reserve Banking
Chances are, if everyone at your bank decided to withdraw the entirety of each of their bank accounts, the bank would not have enough money at its disposal to meet the demand. This is because banks commonly operate under a fractional reserve banking system. In other words, the bank uses your money however it wants, banking (ahem) on the fact that its account holders won’t protest. Unfair? It sure sounds like it. Stealing? The banks prefer to call it “borrowing.”
What Is Fractional Reserve Banking?
Many people believe that when they deposit money into a bank, the bank keeps all of their money on hand, in a vault, in cash. But this isn’t the way most banks work. According to Investopedia.com, fractional reserve banking refers to a system where banks only back a fraction of bank deposits with actual cash on-hand, available for immediate withdrawal.
This means only a fraction of the money you deposit into your account is required to be available for withdrawal at any given time. For most banks, that fraction is a mere 10 percent of your deposit. So, instead of putting $100 into the vault when you deposit a $100 check, only $10 goes in. That $10 is known as “reserves.”
Surprisingly, many banks are not required to even keep 10 percent on hand — and some aren’t required to keep any reserves at all. Any bank with less than $15.2 million in assets is exempt from keeping any reserves, and those with assets between $15.2 million and $110.2 million are only required to keep 3 percent.
There is an incentive, though, for your bank to keep more of your money in the vault: The Federal Reserve pays out interest on all reserves and excess reserves. The interest is called IOR (“Interest On Reserves”) or IOER (“Interest On Excess Reserves”), and since 2009, it pays out 0.25% at an annual rate.
Is Fractional Reserve Lending a Game of Musical Chairs?
If only a tiny portion of your money is available after you deposit it, then what does the bank do with the rest of it? Much of it is given to other people, in the form of loans.
Simply, banks lend money that they don’t have. They use your money and lend it to someone else, in the hopes that you don’t ask for your money back at the same time that all their other customers ask for theirs. Many consider this to be a fraudulent way to do business, because it would be unheard of to do this at a personal level. It is considered fraud in most states for someone to write a check when they know their checking account does not have sufficient funds to cover the amount. But why isn’t it fraud for a bank to write a loan when payees do have sufficient funds in their accounts to back that loan?
Most banks, even if they are required to have 10 percent reserves on hand, won’t necessarily have it available for you to use — because they’re already lending it out. And so, theoretically, if all of a bank’s customers asked for 10 percent of their account balances, the bank wouldn’t be able to pay that money either. There’s even a term for it — “a run on the bank,” which sounds more like the bank was played a bad card when it’s actually the bank customers who are denied their money.
In essence, if too many customers made a run on the bank, the bank’s attitude would be, “Sorry, but we lent your money to that person over there, and we don’t have it to give back to you.”
In Defense of Fractional Reserve Banking?
Fractional reserve banking is often defended by the argument that the system is the very nature of banks. To quote Forbes, “It’s certainly true that banks could maintain 100% of funds deposited, but if so, they wouldn’t be banks. Instead, they’d be warehouses for money, and those warehouses would charge depositors a fee for the right to deposit with them. Basically money saved would decline day after day and year after year; essentially compound interest in the reverse. Banks would routinely ‘break the buck.’”
Forbes goes on to say that even though a bank may not have enough cash on hand to pay out a demand, they can borrow the amount from another bank. And if that option falls through, the Federal Reserve is there as a last resort.
But the bottom line, for those in favor of fractional reserve banking, is that banking is a business, and so it functions through interest — and that interest is garnered through borrowing and lending money from one party to another. Perhaps the system is imperfect, especially if it experiences bank runs, but such circumstances are considered rare though its a risk most customers are unaware of.
More likely than not, barring any errors made by a teller, your money will be safe in your banking account, ready for you to withdraw as you please. But if you are concerned about an impending national crisis, perhaps you’ll want to take pre-emptive measures by closing your account, cutting a slit in your mattress, and stuffing all your dollar bills inside (preferably in small bills, so that you don’t need to exchange the big ones for bite-sized cash somewhere along the line).
Of course, financial experts would say that this would be an imprudent way to handle your money, and you’d only be hurting yourself — especially in the event of a natural disaster or a robbery. Plus, how else would they be able to gamble with your money and generate exorbitant profits for themselves if they weren’t keeping it “safe” for you.
Professor Finds $21 Trillion Missing from Government Budget
A Michigan State University economics professor discovered $21 trillion unaccounted for in the federal budget starting in 1998 until the end of fiscal year 2015. Professor Mark Skidmore enlisted the help of his graduate students to examine government documents from the Department of Defense and Housing and Urban Development to uncover an unfathomable amount of unauthorized spending.
According to the Constitution, all federal spending must be voted on and authorized by Congress each fiscal year. Any discrepancies found in the way of unauthorized spending would normally elicit a congressional hearing and investigation.
Skidmore and his students’ analysis used publicly available government documents from the two agencies’ websites to expose this inconsistency. Shortly after Skidmore published his findings, both agencies removed those documents from public access.
While no congressional committee tied to the budget had signaled the would open an inquiry prior to Skidmore’s findings, the Department of Defense allowed a first ever department-wide audit by independent firm Ernst & Young.
Skidmore says that sometimes there can be discrepancies meant to account for inadequate transactions, but those adjustments are usually no more than 1 percent of the total budget.
The Army’s annual budget for FY 2015 was $122 billion, meaning that an adjustment for inadequate transactions might be around $1.2 billion. The Army’s actual adjustments for FY 2015 were $6.5 trillion – 54 times what it was authorized to spend.
Out of thousands of documents spanning that period, Skidmore was able to find Army budget documentation for 13 of those years, saying its budget represented roughly $11.5 trillion of the missing $21 trillion. He also called these accounting documents “opaque,” saying it was not clear what the unauthorized adjustments were for.
That amount of unauthorized, “missing” money is equivalent to about $65,000 for every person in America. The government estimated that the federal deficit sits at around $20 trillion, an entire $1 trillion less than what Skidmore found missing in these adjustments.
So, what exactly is this money going towards? The revelation of a $56 billion Pentagon black budget for secret military, space, and surveillance programs has led some to speculate that it could be merely a fraction of what’s actually being spent.
Skidmore said he reached out to the Office of Inspector General, the Government Accountability Office, and Congressional Budget Office, asking if maybe the $6.5 trillion figure was a mistake and was instead supposed to be $6.5 billion. It was confirmed that $6.5 trillion was the correct adjustment. Though, when he asked if any of these agencies were alarmed or considering this a red flag, his questions were met with slight confusion and little concern.
Though Skidmore has reserved his speculation as to what he thinks the money might be going toward, it’s clear that either someone knows that a large amount of taxpayer dollars is being spent without authorized permission, or the accounting practices of those in charge of massive amounts of public money are that flawed.
