Creature From Jekyll Island by G. Edward

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book money back to the bank and request cash. The issuing bank, therefore, has a potential money pay-out liability equal to the amount of the loan asset.

When a borrower cannot repay and there are no assets which can be taken to compensate, the bank must write off that loan as a loss- However, since most of the money originally was created out of nothing and cost the bank nothing except bookkeeping overhead, there is little of tangible value that is actual lost. It is primarily a bookkeeping entry.

A bookkeeping loss can still be undesirable to a bank because it causes the loan to be removed from the ledger as an asset without a reduction in liabilities. The difference must come from the equity of I hose who own the bank. In other words, the loan asset is removed, but the money liability remains. The original checkbook money is still circulating out there even though the borrower cannot repay, and the issuing bank still has the obligation to redeem those checks.

The only way to do this and balance the books once again is to draw upon the capital which was invested by the bank's stockholders or to deduct the loss from the bank's current profits. In either case, the owners of the bank lose an amount equal to the value of the defaulted loan. So, to them, the loss becomes very real. If the bank is forced to write off a large amount of bad loans, the amount could exceed the entire value of the owners' equity. When that happens, the game is over, and the bank is insolvent.

This concern would be sufficient to motivate most bankers to be very conservative in their loan policy, and in fact most of them do act with great caution when dealing with individuals and small businesses. But the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Federal Deposit Loan Corporation now guarantee that massive loans made to large corporations and to other governments will not be allowed to fall entirely upon the bank's owners should those loans go into default. This is done under the argument that, if these corporations or banks are allowed to fail, the nation would suffer from vast unemployment and economic disruption. More on that in a moment.

THE PERPETUAL-DEBT PLAY

The end result of this policy is that the banks have little motive to be cautious and are protected against the effect of their own folly. The larger the loan, the better it is, because it will produce the 28 THE CREATURE FROM JEKYLL ISLAND

greatest amount of profit with the least amount of effort. A single loan to a third-world country netting hundreds of millions of dollars in annual interest is just as easy to process—if not easier—

than a loan for $50,000 to a local merchant on the shopping mall. If the interest is paid, it's gravy time. If the loan defaults, the federal government will 'protect the public' and, through various mechanisms described shortly, will make sure that the banks continue to receive their interest.

The individual and the small businessman find it increasingly difficult to borrow money at reasonable rates, because the banks can make more money on loans to the corporate giants and to foreign governments. Also, the bigger loans are safer for the banks, because the government will make them good even if they default.

There are no such guarantees for the small loans. The public will not swallow the line that bailing out the little guy is necessary to save the system. The dollar amounts are too small. Only when the figures become mind- boggling does the ploy become plausible.

It is important to remember that banks do not really want to have their loans repaid, except as evidence of the dependability of the borrower. They make a profit from interest on the loan, not repayment of the loan. If a loan is paid off, the bank merely has to find another borrower, and that can be an expensive nuisance. It is much better to have the existing borrower pay only the interest and never make payments on the loan itself. That process is called rolling over the debt. One of the reasons banks prefer to lend to governments is that they do not expect those loans ever to be repaid. When Walter Wriston was chairman of the Citicorp Bank in 1982, he extolled the virtue of the action this way:

If we had a truth-in-Government act comparable to the

truth-in-advertising law, every note issued by the Treasury would be obliged to include a sentence stating: 'This note will be redeemed with the proceeds from an identical note which will be sold to the public when this one comes due.'

When this activity is carried out in the United States, as it is weekly, it is described as a Treasury bill auction. But when basically the same process is conducted abroad in a foreign language, our news media usually speak of a country's 'rolling over its debts.' The perception remains that some form of disaster is inevitable. It is not.

THE NAME OF THE GAME IS BAILOUT

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To see why, it is only necessary to understand the basic facts of government borrowing. The first is that there are few recorded instances in history of government—any government—actually getting out of debt. Certainly in an era of $100-billion deficits, no one lending money to our Government by buying a Treasury bill expects that it will be paid at maturity in any way except by our Government's selling a new bill of like amount.

THE DEBT ROLL-OVER PLAY

Since the system makes it profitable for banks to make large, u n s o u n d loans, that is the kind of loans which banks will make.

Furthermore, it is predictable that most unsound loans eventually will go into default. When the borrower finally declares that he cannot pay, the bank responds by rolling over the loan. This often is stage managed to appear as a concession on the part of the bank but, in reality, it is a significant forward move toward the objective of perpetual interest.

Eventually the borrower comes to the point where he can no longer pay even the interest. Now the play becomes more complex.

The bank does not want to lose the interest, because that is its stream of income. But it cannot afford to allow the borrower to go into default either, because that would require a write-off which, in turn, could wipe out the owners' equity and put the bank out of business. So the bank's next move is to create additional money out of nothing and lend that to the borrower so he will have enough to continue paying the interest, which by now must be paid on the original loan plus the additional loan as well. What looked like certain disaster suddenly is converted by a brilliant play into a major score. This not only maintains the old loan on the books as an asset, it actually increases the apparent size of that asset and also results in higher