G. Edward Griffin is the author of the book
The Creature from Jekyll Island. In an incredibly well researched historical analysis, he takes us through the creation and operation of the US Federal Reserve Bank (the Fed). It's a real eye opener! He summarizes the book in a
YouTube video. There are parts of this 107 minute video that are as exciting as watching paint dry. But the impact of the information he shares is extremely significant on our lives! I urge everyone interested in a better financial future to watch it in full!
One of the key pieces of information I got from the book was the understanding of a system called
Fractional Banking. This is the magic which allows our banks to generate massive profits! Most people don't know how it works. First, a personal story...
In 1988, I was in my bank, looking at using a GIC to earn more interest on money that I would be using to buy a house in a year or so. I didn't want to keep it in my chequing account. When I enquired about the rates for GICs, I was surprised at how low the rates were. When I asked why the rates were so low, the Branch Manager (who I knew well) said, "Have you looked at mortgage rates lately?" When it was clear that I hadn't made the connection, he added, "5 year GICs fund 5 year fixed mortgages."
The Joy of Fractional Banking!
The answer was true, but not complete! It left me with the idea that I was making about two thirds of the income generated by the mortgage that my GIC would fund. I thought that the split was reasonable. Many others do likewise when given that partial, but truthful response.
But here's the full truth. Thanks to the magic of fractional banking, the bank can lend much more money in a mortgage than the amount I gave them. With a GIC funding a fixed mortgage of the same time duration, the bank has secure cashflows. At this level of security, the bank is required to maintain only 5% of the value of any loan in reserve. That means that the $10,000 I had saved for a down payment would actually allow the bank to lend out $200,000 in a mortgage, not the $10,000 I had assumed they would lend based upon the Branch Manager's answer.
This drastically changes the perspective. Let's look at it numerically. At the time this article is written, the large banks have a special offer on 5 year GICs. The "posted" rate is 2.7%, but they are available at the special rate of 3.6%. This means my GIC would earn me $360 a year. The current lowest rate for a 5 year fixed mortgage at a major bank is 4.14%. The $200,000 mortgage that my GIC secures generates annual revenue for the bank of $8,280.
You might ask, "Where did the other $190,000 come from for that mortgage?" The simple answer is that the bank created it in their computer. It is free money to them. The only marginal cost associated with this new $200,000 mortgage is the payment on the GIC of $360. Would you like to be in a business where the gross profit of the next product you sell is over 95% of the income? I certainly would!
In the Jekyll Island book, G. Edward Griffin demonstrates how fractional banking ensures that 90% of the value produced in the US economy transfers to the owners of the Fed. Of the 10% remaining, the fractional banking at the banks gets 90% of that! What's left is 1% for all the people who create value in our economies!
AND... That's not ALL!
Surely things can't get worse than this, can they? I wish it wasn't true, but the answer is "Yes it can, and yes it IS!"
About 25 years ago, the branches started charging for services, including account fees. When it started I visited my Branch Manager to complain. He said that every branch has to be profitable, which makes sense. But my chequing and savings accounts weren't my only dealings with the bank. I pointed to my mortgage, which was generating about $8000 a year for the bank. The manager's response was that the mortgage belongs to the bank's mortgage subsidiary, not to the branch, so the branch doesn't see that as revenue. The same applied to the credit cards the branch issues. The cost of enrolling a new client is in the branch, but the revenue is elsewhere. With limited forms of revenue left to cover the costs of running the branches the retail banking division implemented service fees!
My branch manager then told me that I could have a free account, so long as I keep a minimum daily balance of $2000, paying no interest. Using fractional banking, this deposit becomes the reserve for a floating rate mortgage of $20,000. The current rate is 4.5% for these mortgages. So, if I agreed to provide the bank a revenue source of $900 a year, then would waive my annual fees of $180. How very decent!
The major banks are complaining that their branches are not profitable, and need to be closed down to allow the banks to be more competitive on a global scale. If the bank's regulators were at all concerned about average Canadians, they would require full revenue recognition accounting for all the customers of any branch looking to close down. The "unprofitable branch" argument is an illusion created by corporate structure.
So, What Can We do?
The banking system requires deposits to operate. It would be nice to think that we are fairly compensated for our deposits. At a minimum, GICs should pay us 2% above the inflation rate! It is our money after all. This would only happen if the bank feels they need to increase the rates paid for deposits. The bank would react this way if it was losing deposits at a significant rate. Your leverage is to take your savings out of the banking system. Money market funds are available from independent advisors and a variety of other financial services providers. The good news? Because you are not paying for the convenience of a local branch, the rates are typically better than money market funds from the branch.
Avalanches start with a small amount of snow and build! You can be a difference maker.
