A Brief Perspective of Limitations of Money

Money. We all want, need, and hate it, yet we cannot simply define it. When asked what money is, many would pull out the $20 from their pocket and call it money. Yet, if we go to Russia, China, or any country in the EU, they may accept the $20, but in most cases, they prefer their rubbles, yens, or euros. Sometimes we decide to trade like my brother did when he traded his new motorcycle for a non-operating vehicle to be fixed with a few screws, or we trade a bit of work for a meal.

Money is not necessarily a physical piece of paper or gold coin. Money is the transferable good or service the other person believes in your word of its value. We use dollars, gold coins, or other items because they are physical representations of stable, fungible, and storable forms of value gained from service, goods, or gained value.

Extending the idea of money, what is a loan? A loan promises to repay the physical or digital representation of stable, fungible, and storable forms of value with interest. The history of loans, as that of money, is long. Banks are said to have been created by the Phoenicians and perfected by the Babylonians, at least regarding their current advancements and technologies. Loans are as long or longer in terms of the idea of loans. How often did we “lend” something to a friend or neighbor, and they repaid us in full and kind? Loans were banned to Christians in the medieval ages due to beliefs, and bankers and lenders were hated for centuries. But as their utility and necessity grew and their professionalism and ethics changed, they became an essential pinnacle of finance and liquidity of companies and the growth of mercantilism in the past and capitalism of today.

The unfortunate part of loans is their hand in discrimination in the US against African Americans. This set up a horror of events that happened during and after, still affecting millions today. Loans were banned from being given to African Americans for most of the 20th century. This forced them to rent and never own homes. When the ban was finally lifted, and requirements lowered to accommodate them, homes with heavy values and substantial interest rates were given to them, except the monthly payments did not adjust until the federal increase in late 2005. Why was this an issue? To accept low creditworthy homes, lenders created a financial instrument called Collateralized Debt Obligations (CDO) through the securitization or ability to buy and sell bonds in the market, separately or by the bunch. These CDOs usually have a failed cap where the insurance of higher-quality credit owners compensates the number of loans with low credit. This allows the CDO to have a failure rate of 5 to 10%, in some cases, without decreasing the value of the CDO. The issue was that many CDOs sold in the market during the 2008 collapse had risk rates of 20 to 30%, at which these CDOs were worthless, with a default rate of 5% or more. The average default rate of these CDOs hit 20%. This does not include the synthetic CDOs or the derivatives of the CDOs and synthetic CDOs.

After the meltdowns of the 2008 crisis, the US implemented the use of Quantitative Easing, or QE, through many programs. One of the essential tools the Federal Reserve Bank uses to assist banks during liquidity crises that arise from CDO devaluations or other default risks that continue to cause havoc in our financial system is the Repurchase Agreement Market or the REPO market. The way this worked during 2008 is that when a bank needed cash for daily operations and could not sell their Mortgaged-Backed Security CDOs or MBS CDOs, they would go to the Fed and sell their MBS CDO for liquid cash and use that for daily operations, for a small interest fee. Why would something like this exist? The issue is that banks holding deposits have considerable costs to operate large deposits.

The more deposits, the higher the cost of management, which is why no large banks truly existed or lasted before the Federal Reserve Repo Market of 2008. After, a bank could collateralize and tie most of their deposits into loans that paid for their operations and made a profit. This risky endeavor grew as the interest rates remained depressed from the end of the 1990s up until 2002 and then aggressively raised in 2005/6. This caused the banks to have a liquidity crisis, where they did not have enough cash to pay for their withdrawals and daily operations. When this occurs, usually, a bank takes some of their loans and uses them as “collateral” for cash at a small interest rate, like with the REPO market. The collateral is repurchased after a few days or weeks, and the interest is paid. This is a regular operation of a bank.

When the MBS CDOs collapse in value. Banks had billions of dollars tied to MBS CDOs, and when they needed to offload, commit to a collateral swap, or close it, it was worthless, and they did not have worthy collateral for swaps, causing banks to fail and bankrupt. The repo market accepted fair and worthless collateral and, in some cases, paid interest to do so; that way, the bank could get their cash back and continue operations while gaining a minuscule interest on the worthless collateral. Was this beneficial? Is it far? These are questions for another time, but this did stop the collapse of the US and global markets, as millions of investment firms had US MBS CDOs in their investments. Some estimates say that 50% of all assets would have vanished instantly.

Today, we seem to be facing a similar issue. Four central banks collapsed in 2023: Silicon Valley Bank, Signature Bank, First Republic Bank, Heartland Tri-State Bank, and Citizen Bank. The total assets these banks had when they went bankrupt totaled over 550 billion dollars—amounts not seen since 2009, which had 145 billion dollars and over 120 bank failures. From a perspective, from 2010 to 2022, only 500 million dollars were assets under management by banks that failed. In one year, 2023, 4 banks failed and had three times the assets under them. These are alarming times. Only time will tell how we will endure these layoffs, bank failures, and stagnating productive economy.