I've been thinking about what's been going on in the financial world over the weekend, and I'm pretty upset by the collusion of business and the government. Basically JP Morgan bought out Bear Sterns with a "special funding arrangement" from the Federal Reserve System.

Read about it at MarketWatch

The Fed did this to keep the books of Bear Sterns away from the public view. But let's break this down the the root issue.

The banks are in big trouble now because of the fractional reserve system. Which basically means that for every dollar they have in assets in their books, they can lend out at least 9 TIMES that amount as new money (created from thin air) and collect interest on this "phantom money."

But the money is not really phantom money. People who borrow that money for a mortgage, for instance, pay real amortized interest on that debt.

So if a bank gets $10,000 in deposits, they can lend out $90,000.  Now imagine that extrpolated to the volume of dollars of deposits that the bank have access to…  Yeah, it's a big deal.

Now if you or I did that, it would be fraud. But it's totally legal for the banks. 

So now Bear Sterns has OVER-EXTENDED their card game. They were playing with derivates and futures and got burned.  Even with the odds in their favor by being able to collect interest on money on the 90% of assets that they do not own, they still got too greedy and overextended themselves. And so I don't have any remorse for them.

And the Fed continues to lower the interest rate to help these banks, even though doing so is hammering the US dollar into the ground.

Now I understand that the Fed is trying to make desperate moves to save the banking system, but you gotta be a little angry that they allowed the banking system to get so greedy. That's my 2 cents. (Or rather $2, which is what JP Morgan bought Bear Sterns for.)

Here's how it affect the US taxpayer:

The Federal Reserve Bank of New York's bailout of Bear Stearns … has unwillingly exposed innocent taxpayers to precisely the risk the smart ones have sought to avoid. The collectivist underpinning of such maneuvers is that, although many of us didn't invest in Bear Stearns — or leveraged hedge funds or speculative real estate for that matter — somehow "we're all in it together." As such we share the cost and responsibility for keeping many of these fundamentally unsound institutions and markets afloat. (Smartmoney)

In fact, the breakup value of Bear Sterns is 7.7 Billion and JP Morgan paid less than 240 Million for it.  And both Secretary Paulson and George W. Bush have signed off on the deal, because it is essentially backed by the American people.  So in essence, the taxpayers are footing the bill for a company that already had what would be a Ponzi scheme (the fractional reserve banking system which allows it to profit from money it loans out and collect interest on that it does not own), but got so greedy it was not even careful about the leverage it got by using this fractional reserve system.

And the same taxpayers that are now responsible (via the government intervention) for the financial mess, are the same ones that are paying mortgage interest on this money.  It's a weird financial world, and one of the reasons I've been in gold and silver for some time.

PS – To be fair, the fractional reserve system makes it easier for the country to expand and for homeowners to get a mortgage, but there's no excuse for companies to be given this much leeway.  They certainly don't extend the same to homeowners who default on their mortgages – that's why there are so many foreclosures in the US right now.

But let me know what YOU think about what's going on. 

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