Bank Reserve Contraction

A little while ago I wrote a post about how to make money fast by using margin on a stock that’s going consistently up. The theory is that if you catch a stock that’s consistently going up, you can keep buying and selling it, creating more margin for you to buy even more shares. It’s essentially a pyramid scheme.

Well now I’m watching the news tonight (Sunday) and Bear Stearns, the fifth largest banker in the US, just got sold to JP Morgan for $2/share. $2 a fucking share! Bear (BSC) closed on Friday at $30/share, after falling 47% in the morning, even after a bailout by the Fed and JP Morgan. Bear was at $170/share earlier in the year.

So what’s scary about all this is that the banks have been leveraged for a bull market for decades. Now that losses are so great on junk that they cannot sell to anyone, and that the Fed cannot print enough money to replace, that leverage has to be unwound.

The way banks work is that they are required to only keep on hand a certain portion of the money they attract from clients. So their reserve limit may be something like 20%. If they have $100 total, then they have to keep $20 on hand but can loan out the other $80 to other people or banks. So another bank could get that $80 loan, and maybe it already had $120. So now it has $200, and it can loan out $160 to other people. So this inflates the amount of available money out there for borrowers and investors.

But what if banks hemorrhage money? Then all that money is unwound. It’s essentially destroyed. Credit gets locked up, the money supply contracts, people can’t get money to do business. Not that they want to because there’s no demand out there for houses, the chief source of equity for most people out there.

This is all extremely scary.