Compositions of linear transformations 1

WEBVTT
Kind: captions
Language: en

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Let's see if we can build a bit
on some of our work with

00:00:03.430 --> 00:00:05.040
linear transformation.

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I have two linear
transformations.

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I have the transformation S,
that's a mapping, or function,

00:00:12.190 --> 00:00:16.870
from the set X to the set Y.

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And let's just say that X
is a subset of of Rn.

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Y is a subset of Rm.

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Then we know S is a linear
transformation.

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It can be represented by a
matrix vector product.

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We can write S of X.

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Let me do it in the same color
as I was doing it before.

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We can write that S of some
vector X, is equal to some

00:00:47.270 --> 00:00:50.170
matrix A times X.

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The matrix A, it's going to be
X, whatever X we input into

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the function, although we
take the mapping of.

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It's going to be in this set,
right here, is going to be a

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member of Rn.

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This is going to
be right here.

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Let me do it like this.

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X is going to be
a member of Rn.

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Well, it's actually going to be
a member of X, which is a

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subset of Rn.

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I'm just trying to figure out
what the dimensions of matrix

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A are going to be.

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This is going to have n
components right here.

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Matrix A has to have
n columns.

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Matrix A is going to be, let's
just say, is an m by n matrix.

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Fair enough.

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Let's say we have another
linear transformation.

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Let me draw what I've
done so far.

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We have sum set X, right
here, that is set X.

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It is a subset of Rn.

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Rn, I can draw out there.

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We have this mapping, S, or this
linear transformation,

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from X to Y.

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It goes to a new set,
Y, right here.

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Y is a member of Rm.

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The mapping X, right here.

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You take some element here,
and you apply the

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transformation S.

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I've told you it's a linear
transformation.

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You'll get to some value in
set Y, which is in Rm.

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I said that the matrix
representation of our linear

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transformation is going to
be an m by n matrix.

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You're going to start with
something that has n entries,

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or a vector that's
a member of Rn.

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You want to end up with
a vector that's in Rm.

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Fair enough.

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Now, let's say I have another
linear transformation, T.

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It's a mapping from the
set Y to the set Z.

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Let me draw.

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I have another set here
called set Z.

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I can map from elements of Y, so
I could map from here, into

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elements of Z using the linear
transformation T.

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Similar to what I did before.

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We know that Y is
a member of Rm.

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You know that this is a subset,
not a member, more of

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a subset of Rm.

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These are just arbitrary
letters.

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It could be 100 or
5, or whatever.

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I'm just trying to
stay abstract.

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Z is a member, I'm running out
of letters, let's say Z is a

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member of Rl.

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Z is a member of Rl.

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Then, what's the transformation
T, what's it's

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matrix representation
going to be.

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You know it's a linear
transformation.

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I told you that.

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We know it can be represented
in this form.

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We could say that T of X, where
X is a member of Rm, is

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going to be equal to some
matrix B times X.

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What are the dimensions of
matrix B going to be.

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X is going to be a member of Rm,
so B is going to have to

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have m columns.

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And then it's a mapping into a
set that's a member of Rl.

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It's going to map from members
of Rm to members of Rl.

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It's going to be
l by m matrix.

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When you see this, a very
natural question might arise

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in your head.

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Can we construct some mapping
that goes all the way, that

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goes all the way, from set
X all the way to set T.

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Maybe we'll call that the
composition of-- I mean we can

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create that mapping using a
combination of S and T.

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Let's just make up some word.

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Let's just call T, with this
little circle S, let's just

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call this a mapping from
X all the way to Z.

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We'll call this the composition
of T with S.

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We're essentially just combining
the two functions in

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order to try to create some
mapping that takes us from T,

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from set X, all the
way to set Z.

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We still haven't defined this.

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How can we actually
construct this.

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A natural thing might be to
first apply transformation S.

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Let's say that this is our X
we're dealing with right here.

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Maybe the first thing we want to
do is apply S, and that'll

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give us an S of X.

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That will give us this value,
right here, that's in set Y.

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And then what if we were to take
that value and apply the

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transformation T to it?

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We would take this value, and
apply the transformation T to

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it, to maybe get
to this value.

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This would be the linear
transformation T applied to

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this value, this member of the
set Y, which is in Rm.

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We are just going to apply that
transformation to this

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guy, right here, which was the
transformation S applied to X.

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This might look fancy, but all
this is, remember this is just

00:06:06.380 --> 00:06:08.640
a vector, right here,
in the set Y, which

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is a subset of Rm.

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This is a vector that is in X.

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When you apply mapping,
you get another

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vector that's in Y.

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You apply the linear
transformation T to that, then

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you get another vector
that's at set Z.

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Let's define the composition
of T with S.

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This is going to be
a definition.

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Let's define the composition of
T with S to be-- first we

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apply S to some vector in X.

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Apply S to some vector
in X to get us here.

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Then we apply T to that vector
to get us to set Z.

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To get us to set-- so we apply
T to this thing right there.

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The first question might be,
is this even a linear

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transformation?

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Is the composition of two linear
transformations even a

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linear transformation?

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Well there are two requirements
to be a linear

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transformation.

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The sum of the linear
transformation of the sum of

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two vectors, should be the
linear transformation of each

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of them summed together.

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I know when I just say that
verbally, it probably doesn't

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make a lot of sense.

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Let's try to take the
composition, the composition

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of T with S of the sum
of two vectors in X.

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I'm taking the vectors
x and the vectors y.

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By definition, what
is this equal to?

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This is equal to applying to
linear transformation T to the

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linear transformation S,
applied to our two

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vectors, x plus y.

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What is this equal to?

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I told you at the beginning of
the video, that S is a linear

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transformation.

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So by definition, of a linear
transformation, one of our

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requirements, we know that S of
x plus y is the same thing

00:08:02.940 --> 00:08:11.400
as S of x plus S of y, because
S is a linear transformation.

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We know that is true.

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We know that we can replace this
thing right there with

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that thing right there.

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We also know that T is a
linear transformation.

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Which means that the
transformation applied to the

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sum of two vectors is equal to
the transformation of each of

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the vectors summed up.

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The transformation of S of x, or
the transformation applied

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to the transformation of S
applied to x, I know the

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terminology is getting confused,
plus T of S of y.

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We can do this because we
know that T is a linear

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transformation.

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But what is this right here?

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All this statement right here is
equal to the composition of

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T with S, applied to x, plus the
composition of T with S,

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applied to y.

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Given that both T and S are
linear transformations, we got

00:09:12.320 --> 00:09:13.580
our first requirement.

00:09:13.580 --> 00:09:17.520
That the composition applied to
the sum of two vectors is

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equal to the composition
applied to each of the

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vectors summed up.

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That was our first requirement
for linear transformation.

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Our second one is, we need
to apply this to a scalar

00:09:28.930 --> 00:09:31.270
multiple of a vector in X.

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So, T of S, or let me say it
this way, the composition of T

00:09:36.030 --> 00:09:41.090
with S applied to some scalar
multiple of some vector x,

00:09:41.090 --> 00:09:42.790
that's in our set X.

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This is a vector x,
that's our set X.

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This should be a capital X.

00:09:46.510 --> 00:09:48.220
This is equal to what.

00:09:48.220 --> 00:09:52.740
Well, by our definition of our
linear, of our composition,

00:09:52.740 --> 00:09:57.620
this is equal to the
transformation T applied to

00:09:57.620 --> 00:10:03.760
the transformation S, applied
to c times our vector x.

00:10:03.760 --> 00:10:04.570
What is this equal to?

00:10:04.570 --> 00:10:07.380
We know that this is a linear
transformation.

00:10:07.380 --> 00:10:09.910
Given that this is a linear
transformation, that S is a

00:10:09.910 --> 00:10:13.060
linear transformation, we know
that this can be rewritten as

00:10:13.060 --> 00:10:19.860
T times c times S
applied to x.

00:10:19.860 --> 00:10:23.470
This little replacing that I
did, with S applied to c times

00:10:23.470 --> 00:10:25.600
x, is the same thing as
c times the linear

00:10:25.600 --> 00:10:27.170
transformation applied to x.

00:10:27.170 --> 00:10:29.630
This just comes out of the
fact that S is a linear

00:10:29.630 --> 00:10:30.330
transformation.

00:10:30.330 --> 00:10:32.370
We've done that multiple
times.

00:10:32.370 --> 00:10:35.170
Now we have T applied
to some scalar

00:10:35.170 --> 00:10:37.470
multiple of some vector.

00:10:37.470 --> 00:10:38.460
We can do the same thing.

00:10:38.460 --> 00:10:41.570
We know that T is a linear
transformation.

00:10:41.570 --> 00:10:44.990
We know that this is equal to,
I'll do it down here, this is

00:10:44.990 --> 00:10:51.960
equal to c times T applied to
S applied to some vector x

00:10:51.960 --> 00:10:53.370
that's in there.

00:10:53.370 --> 00:10:54.780
What is this equal =?

00:10:54.780 --> 00:11:00.990
This is equal to the constant c
times the composition T with

00:11:00.990 --> 00:11:05.400
S of our vector x right there.

00:11:05.400 --> 00:11:07.930
We've met our second requirement
for linear

00:11:07.930 --> 00:11:09.530
transformation.

00:11:09.530 --> 00:11:12.940
The composition as we've defined
it is definitely a

00:11:12.940 --> 00:11:14.190
linear transformation.

00:11:19.160 --> 00:11:23.400
This means that the composition
of T with S can be

00:11:23.400 --> 00:11:27.400
written as some matrix-- let
me write it this way-- the

00:11:27.400 --> 00:11:30.490
composition of T with
S applied to, or the

00:11:30.490 --> 00:11:33.580
transformation of, which is
a composition of T with S,

00:11:33.580 --> 00:11:40.210
applied to some vector x, can
be written as some matrix

00:11:40.210 --> 00:11:42.800
times our vector x.

00:11:42.800 --> 00:11:45.130
And what will be the dimensions
of our matrix?

00:11:45.130 --> 00:11:48.990
We're going from a n dimension
space, so this is going to

00:11:48.990 --> 00:11:53.210
have n columns, to a
l dimension space.

00:11:53.210 --> 00:11:55.290
So this is going
to have l rows.

00:11:55.290 --> 00:11:58.160
This is going to be
an l by n matrix.

00:11:58.160 --> 00:11:59.870
I'll leave you there
in this video.

00:11:59.870 --> 00:12:02.750
I realize I've been making too
many 20 minutes plus videos.

00:12:02.750 --> 00:12:05.010
The next video, now that we
know this is a linear

00:12:05.010 --> 00:12:07.205
transformation, and that we know
that we can represent it

00:12:07.205 --> 00:12:09.180
as a matrix vector product.

00:12:09.180 --> 00:12:12.990
We'll actually figure out how
to represent this matrix,

00:12:12.990 --> 00:12:16.490
especially in relation to the
two matrices that define our

00:12:16.490 --> 00:12:19.910
transformations, S and T.


FRB Commentary 3: Big Picture

WEBVTT
Kind: captions
Language: en

00:00:00.570 --> 00:00:03.470
My motivation for doing this
series of three or four videos

00:00:03.470 --> 00:00:07.800
on the fractional reserve
banking system isn't because I

00:00:07.800 --> 00:00:10.280
expect some type of
revolutionary change or I

00:00:10.280 --> 00:00:14.080
think that the world is going
to end if we keep fractional

00:00:14.080 --> 00:00:15.020
reserve banking.

00:00:15.020 --> 00:00:16.730
The whole reason why I want to
do it is just to kind of

00:00:16.730 --> 00:00:19.450
clarify our collective thoughts
on what it is and

00:00:19.450 --> 00:00:21.030
what are its weaknesses.

00:00:21.030 --> 00:00:24.260
I mean, it is the system that
we're in and by the way that

00:00:24.260 --> 00:00:26.680
it's often talked about, it's
kind of viewed as the only

00:00:26.680 --> 00:00:30.360
system because banks around the
world now use the system.

00:00:30.360 --> 00:00:33.640
But we have to realize this is
a system, a structure, that's

00:00:33.640 --> 00:00:36.930
been in a place and its modern
form for on the order of a

00:00:36.930 --> 00:00:37.790
hundred years.

00:00:37.790 --> 00:00:41.030
And it isn't the only way to do
banking and this has some

00:00:41.030 --> 00:00:43.280
very obvious flaws that
I've gone over in the

00:00:43.280 --> 00:00:44.160
last couple of videos.

00:00:44.160 --> 00:00:46.450
And just to kind of highlight
them-- the first one-- and

00:00:46.450 --> 00:00:49.490
this is one that would strike
anyone as, at least it would

00:00:49.490 --> 00:00:53.080
make them uncomfortable, is just
this disingenuous nature

00:00:53.080 --> 00:00:54.560
of fractional reserve.

00:00:58.960 --> 00:01:01.790
Look, you tell someone you can
get your deposits anytime you

00:01:01.790 --> 00:01:04.180
want, but the reality is you can
get your deposits anytime

00:01:04.180 --> 00:01:07.860
you want as long as no more than
10% of people want their

00:01:07.860 --> 00:01:09.330
money at that same time.

00:01:09.330 --> 00:01:11.910
And obviously that by itself
might make you a little

00:01:11.910 --> 00:01:15.510
uncomfortable, but that by
itself isn't a whole reason to

00:01:15.510 --> 00:01:18.710
say a system is bad, but the
more severe problem is that

00:01:18.710 --> 00:01:23.260
this kind of half-lie leads to
the notion of a bank run.

00:01:23.260 --> 00:01:26.800
Everyone has the right to get
all of their money back on--

00:01:26.800 --> 00:01:29.580
essentially on a day's notice
or an hour's notice, but the

00:01:29.580 --> 00:01:32.680
reality is that everyone can't
get all of their money back on

00:01:32.680 --> 00:01:35.570
an hour's notice so that leads
to an inconsistency and some

00:01:35.570 --> 00:01:37.800
people aren't going to get what
they expected and this

00:01:37.800 --> 00:01:42.270
leads to a panic, this leads to
a generalized panic-- which

00:01:42.270 --> 00:01:45.660
is, of course, a very unstable
situation for your entire

00:01:45.660 --> 00:01:47.160
financial system.

00:01:47.160 --> 00:01:49.323
You don't want an unstable
financial system.

00:01:56.110 --> 00:01:59.695
So to fix this problem of bank
runs and panics, there have

00:01:59.695 --> 00:02:01.580
been kind of two fixes here.

00:02:01.580 --> 00:02:10.630
You have your lender of last
resort in the Federal reserve

00:02:10.630 --> 00:02:14.240
and then probably more
importantly, you have the

00:02:14.240 --> 00:02:16.000
notion of FDIC insurance.

00:02:20.030 --> 00:02:22.690
And in the last video, I talk
about the idea that FDIC

00:02:22.690 --> 00:02:27.410
insurance-- the main negative
I see-- it essentially gives

00:02:27.410 --> 00:02:31.710
all banks the same access to
capital because they all say,

00:02:31.710 --> 00:02:32.780
hey, look give me your money.

00:02:32.780 --> 00:02:33.970
It's insured.

00:02:33.970 --> 00:02:44.940
So essentially it's a Federal
subsidy for all banks.

00:02:44.940 --> 00:02:47.810
By definition the fact that
the FDIC is about to be

00:02:47.810 --> 00:02:50.380
insolvent and will have to go
back to Congress to ask for

00:02:50.380 --> 00:02:52.110
more money-- that means
that it was

00:02:52.110 --> 00:02:53.780
undercharging for the insurance.

00:02:53.780 --> 00:02:56.590
So it was subsidizing these
banks and since all of these

00:02:56.590 --> 00:02:58.660
banks have the same as the FDIC
insurance and they're

00:02:58.660 --> 00:03:01.220
paying a slight different amount
for them, what it leads

00:03:01.220 --> 00:03:10.730
to is, it encourages risk taking
to essentially get more

00:03:10.730 --> 00:03:16.830
profits because all of the
banks' borrowing costs are the

00:03:16.830 --> 00:03:19.400
same because when they take on
more risk, people don't say,

00:03:19.400 --> 00:03:20.670
hey, you're a riskier bank.

00:03:20.670 --> 00:03:23.070
I need more money from you
to give me your deposits.

00:03:23.070 --> 00:03:25.800
They'll say, no, I might be a
riskier bank, but I'm FDIC

00:03:25.800 --> 00:03:28.440
insured just like that
more conservative

00:03:28.440 --> 00:03:29.400
bank down the street.

00:03:29.400 --> 00:03:31.650
So I should be able to-- I'll
just pay you a slightly higher

00:03:31.650 --> 00:03:34.290
deposit, just for giving me your
business, but then I can

00:03:34.290 --> 00:03:37.060
go take big risks and it's
essentially subsidized by the

00:03:37.060 --> 00:03:38.190
Federal government.

00:03:38.190 --> 00:03:40.790
But even here, you might say,
hey, look, we've been-- the

00:03:40.790 --> 00:03:44.130
U.S. runs on a fractional
reserve banking system and is

00:03:44.130 --> 00:03:46.940
clearly kind of the financial or
the economic powerhouse of

00:03:46.940 --> 00:03:48.810
the world and those
are both true.

00:03:48.810 --> 00:03:51.900
And obviously other modern
countries are all based on on

00:03:51.900 --> 00:03:53.890
fractional reserve banking,
so what's wrong with it?

00:03:53.890 --> 00:03:55.740
Maybe we have these weaknesses,
but we've

00:03:55.740 --> 00:03:57.930
engineered away the problem.

00:03:57.930 --> 00:04:00.400
And the main-- I guess the
best way to answer that

00:04:00.400 --> 00:04:04.200
question-- and I really don't
want to-- I guess I want to

00:04:04.200 --> 00:04:06.550
make it very clear that when I
started off thinking about

00:04:06.550 --> 00:04:08.100
this problem-- because I've
gotten a lot of requests from

00:04:08.100 --> 00:04:14.120
people to think about the
problem, I came at it from as

00:04:14.120 --> 00:04:16.170
neutral a position
as possible.

00:04:16.170 --> 00:04:18.873
I said, I don't want to just
say it's bad and be kind of

00:04:18.873 --> 00:04:21.029
this reactionary radical person,
but the more you think

00:04:21.029 --> 00:04:23.880
about it, the more that you
realize that there is

00:04:23.880 --> 00:04:26.470
something that just doesn't
fit right here.

00:04:26.470 --> 00:04:28.920
For example, when you talk
about any financial

00:04:28.920 --> 00:04:31.020
intermediary, what's
it's purpose?

00:04:31.020 --> 00:04:35.640
Let me draw a financial
intermediary right here.

00:04:35.640 --> 00:04:40.880
You have savers who like to put
their money in a nice big

00:04:40.880 --> 00:04:43.390
vault someplace or maybe they
would like it invested

00:04:43.390 --> 00:04:45.990
someplace, but they just don't
know how to invest it or they

00:04:45.990 --> 00:04:48.250
don't have-- their money doesn't
have the scale so it

00:04:48.250 --> 00:04:49.830
can be invested properly.

00:04:49.830 --> 00:04:52.100
And what the financial
intermediary says is, hey

00:04:52.100 --> 00:04:54.610
savers, give me all of your
money and I'll hire some

00:04:54.610 --> 00:04:57.700
really smart people to invest
your money properly in good

00:04:57.700 --> 00:04:58.470
investments.

00:04:58.470 --> 00:05:01.550
So you have your savers on this
side and then you have

00:05:01.550 --> 00:05:03.650
your projects or your
investments on this side.

00:05:07.730 --> 00:05:10.850
They might loan out the money--
I'm speaking in very

00:05:10.850 --> 00:05:11.450
general terms.

00:05:11.450 --> 00:05:12.910
We're talking about a
commercial bank or

00:05:12.910 --> 00:05:14.010
lending out the money.

00:05:14.010 --> 00:05:16.110
If you're talking about a
venture capital fund, they're

00:05:16.110 --> 00:05:19.010
making direct investments in
actual startup companies, but

00:05:19.010 --> 00:05:22.060
the idea for any financial
intermediary is the same.

00:05:22.060 --> 00:05:24.110
For them to create value,
they're taking the saver's

00:05:24.110 --> 00:05:26.600
money and they're putting it
in investments that should

00:05:26.600 --> 00:05:28.550
generate some positive yield.

00:05:28.550 --> 00:05:31.440
So it'll generate some positive
return if they

00:05:31.440 --> 00:05:32.690
invested right.

00:05:35.600 --> 00:05:37.640
And they'll give some
fraction of that

00:05:37.640 --> 00:05:39.045
return back to the savers.

00:05:43.110 --> 00:05:46.740
And they'll keep some of that
for themselves-- which you

00:05:46.740 --> 00:05:48.050
might say is reasonable.

00:05:48.050 --> 00:05:49.930
If they're doing this work and
they're allocating this

00:05:49.930 --> 00:05:52.933
capital, they're providing a
useful function for society.

00:05:58.710 --> 00:06:01.890
These people deserve to be
wearing their Armani suits and

00:06:01.890 --> 00:06:03.720
and have their Rolex watches.

00:06:03.720 --> 00:06:06.920
I'll put deserve in
quotation marks.

00:06:06.920 --> 00:06:09.825
But you can say they are adding
value to our economy.

00:06:13.060 --> 00:06:16.330
Is fractional reserve banking
a requirement to have

00:06:16.330 --> 00:06:18.160
financial intermediaries
like this?

00:06:18.160 --> 00:06:19.670
And the simple answer is, no.

00:06:19.670 --> 00:06:23.300
You don't need fractional
reserve banking to do this.

00:06:23.300 --> 00:06:26.420
In fact, many financial
intermediaries in no way

00:06:26.420 --> 00:06:29.830
participate in a fractional
reserve lending system.

00:06:29.830 --> 00:06:33.060
I guess the most obvious one
is venture capitalists and

00:06:33.060 --> 00:06:40.240
regardless of what you think
of them, they are not--

00:06:40.240 --> 00:06:44.260
there's not some kind of-- they
tell their investors,

00:06:44.260 --> 00:06:46.720
which are the equivalent of the
depositors for a bank--

00:06:46.720 --> 00:06:48.580
they tell them, look, you're
going to have your money

00:06:48.580 --> 00:06:54.350
locked up for X years.

00:06:54.350 --> 00:06:57.110
Or they'll say, look, we'll take
your money as we need it.

00:06:57.110 --> 00:06:58.900
Once we take our money, it's
going to be locked up.

00:06:58.900 --> 00:07:01.890
That's also true of private
equity funds.

00:07:01.890 --> 00:07:04.110
Some people consider venture
capital a subset of private

00:07:04.110 --> 00:07:06.520
equity, but private equity more
invests in companies that

00:07:06.520 --> 00:07:10.600
already exist. They do that--
and hedge funds, maybe they

00:07:10.600 --> 00:07:16.080
don't have a lockup
for the most part.

00:07:16.080 --> 00:07:17.900
Some of them might actually tell
you, look, we're going to

00:07:17.900 --> 00:07:18.750
lock your money up.

00:07:18.750 --> 00:07:21.660
So they're being very upfront
with their investors.

00:07:21.660 --> 00:07:24.700
I don't want to defend them, but
the ones that don't have a

00:07:24.700 --> 00:07:26.400
lockup, they'll invest in
liquid instruments.

00:07:33.380 --> 00:07:34.680
Hedge funds-- this is a
big group of people.

00:07:34.680 --> 00:07:37.760
Some of them are adding
some value to society.

00:07:37.760 --> 00:07:38.500
Some of them aren't.

00:07:38.500 --> 00:07:40.850
Probably the great majority of
them are just trading funds

00:07:40.850 --> 00:07:43.660
between each other in some type
of a game, but I won't go

00:07:43.660 --> 00:07:44.310
into that debate.

00:07:44.310 --> 00:07:48.110
I won't try to defend all of the
hedge fund world, but that

00:07:48.110 --> 00:07:50.570
the notion is that to be a
financial intermediary, you're

00:07:50.570 --> 00:07:54.500
not dependent on fractional
reserve banking-- even if you

00:07:54.500 --> 00:07:56.220
wanted to run a commercial
bank.

00:07:56.220 --> 00:07:58.300
I could take deposits.

00:07:58.300 --> 00:08:01.080
So let's say you come to me.

00:08:01.080 --> 00:08:02.570
Let's say a bunch of
people come to me.

00:08:02.570 --> 00:08:04.570
Let's say this is your
deposit right here.

00:08:04.570 --> 00:08:05.890
This is your money.

00:08:05.890 --> 00:08:10.560
Let's say you have
$100 right here.

00:08:10.560 --> 00:08:15.680
I could tell you, look, if you
want money on demand, I'm not

00:08:15.680 --> 00:08:18.210
going to pay you any
interest on that.

00:08:18.210 --> 00:08:20.870
For the service of you having
access to it on your ATM and

00:08:20.870 --> 00:08:23.170
for it to be secure and all of
that, I'm actually going to

00:08:23.170 --> 00:08:26.460
maybe charge you a little bit
of money for on demand money

00:08:26.460 --> 00:08:29.250
and everything-- and if you want
interest on your money,

00:08:29.250 --> 00:08:33.429
you have to give me your money
for a certain period of time.

00:08:33.429 --> 00:08:41.309
So what you do is-- so you've
given me your $100-- and you

00:08:41.309 --> 00:08:44.340
say, I would like to get some
interest on my money.

00:08:44.340 --> 00:08:45.750
I'm a sophisticated investor.

00:08:45.750 --> 00:08:49.070
I'd like to participate in the
miracles of capitalism.

00:08:49.070 --> 00:08:50.710
So let me tell you what.

00:08:50.710 --> 00:08:55.300
Out of this $100, I only need
$10 on a daily basis to run my

00:08:55.300 --> 00:08:58.020
business or my household so
I'm going to make this a

00:08:58.020 --> 00:09:00.140
demand account.

00:09:00.140 --> 00:09:02.210
So that would be just a checking
account-- and for

00:09:02.210 --> 00:09:05.070
that I'll get no interest.
I might even

00:09:05.070 --> 00:09:07.150
have to pay some money.

00:09:07.150 --> 00:09:13.770
Now the other part-- the longer
you're willing to lock

00:09:13.770 --> 00:09:14.750
up your money for, I'm
going to give you

00:09:14.750 --> 00:09:16.000
more interest in it.

00:09:18.260 --> 00:09:20.250
So this is $10 right here.

00:09:20.250 --> 00:09:23.540
Let'sw say, well, I might need
some of my money in a year.

00:09:23.540 --> 00:09:26.340
So let me put the rest of
it in for one year.

00:09:26.340 --> 00:09:31.940
We'll call that a one year
CD, which exists already.

00:09:31.940 --> 00:09:37.930
For this, the bank will pay
you 2% or maybe 3%.

00:09:37.930 --> 00:09:40.000
And then you said, the rest of
the money-- this is long term

00:09:40.000 --> 00:09:44.480
retirement money and I'll put it
in a 10 year CD and because

00:09:44.480 --> 00:09:48.050
I've locked it up longer, I'm
going to get more interest.

00:09:48.050 --> 00:09:50.390
Maybe I'll get 5% for that.

00:09:50.390 --> 00:09:53.250
And now me, the commercial bank
that's not participating

00:09:53.250 --> 00:09:56.380
in fractional reserve banking,
can say, look, this guy has

00:09:56.380 --> 00:09:59.330
this $10 that he wants access to
whenever and I'm not paying

00:09:59.330 --> 00:10:00.090
any interest on that.

00:10:00.090 --> 00:10:02.990
I'm just allowing him to use my
financial infrastructure so

00:10:02.990 --> 00:10:04.950
I'm just going to
put that aside.

00:10:04.950 --> 00:10:07.880
I'm just going to put it in my
vaults and he can access that

00:10:07.880 --> 00:10:11.710
from his ATM or wherever, but
this money out here, I can

00:10:11.710 --> 00:10:12.730
then lend this out.

00:10:12.730 --> 00:10:16.100
So if someone comes to me and
say, hey Sal-- or Sal Bank-- I

00:10:16.100 --> 00:10:19.380
have this project and I want to
be able to borrow-- let's

00:10:19.380 --> 00:10:22.840
say that this right
here is $45.

00:10:22.840 --> 00:10:27.270
I need to borrow $45
for eight years.

00:10:27.270 --> 00:10:28.320
You say, sure.

00:10:28.320 --> 00:10:30.900
I don't have to give this
guy his money back until

00:10:30.900 --> 00:10:31.815
10 years from now.

00:10:31.815 --> 00:10:36.910
So what you do is you take that
$45 and you loan it out--

00:10:36.910 --> 00:10:38.770
which is fine because you know
it's going to be back.

00:10:38.770 --> 00:10:41.300
As long as you're loaning it
out properly, it should be

00:10:41.300 --> 00:10:43.210
back in time to pay this guy.

00:10:43.210 --> 00:10:45.440
And this guy knows that you're
loaning out this money so he

00:10:45.440 --> 00:10:48.610
knows that there's some risk
inherentness and he should do

00:10:48.610 --> 00:10:51.550
his homework before he buys
this 10 year CD from you.

00:10:51.550 --> 00:10:53.520
He should see where you're
loaning your money and how

00:10:53.520 --> 00:10:57.100
risky it is and if it's really
risky, he should want more

00:10:57.100 --> 00:11:00.630
than 5%-- he should focus on the
interest rate or he should

00:11:00.630 --> 00:11:01.960
just not give you his money.

00:11:01.960 --> 00:11:07.140
So the natural supply and
demand and the natural

00:11:07.140 --> 00:11:09.860
feedback forces of capitalism
would come into play.

00:11:09.860 --> 00:11:14.580
So you could completely run a
financial system with banks

00:11:14.580 --> 00:11:17.430
and all sorts of financial
intermediaries without

00:11:17.430 --> 00:11:18.990
fractional reserve banking.

00:11:18.990 --> 00:11:20.060
So now the next question
is, OK.

00:11:20.060 --> 00:11:24.800
You can do without factional
reserve banking, but what's

00:11:24.800 --> 00:11:26.790
really wrong about
what fractional

00:11:26.790 --> 00:11:28.800
reserve banking is enabling?

00:11:28.800 --> 00:11:31.000
And for that I'll have
to review the

00:11:31.000 --> 00:11:33.140
yield curve for you.

00:11:33.140 --> 00:11:35.340
So the yield curve--
it's nothing fancy.

00:11:35.340 --> 00:11:38.390
It's really just a graph showing
how much interest you

00:11:38.390 --> 00:11:42.260
pay for different durations or
how much interest you get.

00:11:42.260 --> 00:11:44.220
So let's say this is
the yield curve.

00:11:44.220 --> 00:11:46.470
Let's say right here I
have overnight money.

00:11:46.470 --> 00:11:50.120
So let's say this is if you
give a loan for one day.

00:11:50.120 --> 00:11:52.810
This is if you give a
loan for one year.

00:11:52.810 --> 00:11:57.060
And this is-- let's say you
gave a loan for 10 years.

00:11:57.060 --> 00:11:59.590
And there could be all sorts
of-- a duration is just how

00:11:59.590 --> 00:12:01.430
long you're giving
the loan out for.

00:12:01.430 --> 00:12:03.590
Now, if you're lending money to
the government, which you

00:12:03.590 --> 00:12:07.590
view as safe-- maybe the safest
person to lend money

00:12:07.590 --> 00:12:10.750
to, then you can say, look, the
government for one day--

00:12:10.750 --> 00:12:14.080
I'm willing to lend money
to them for 1%.

00:12:14.080 --> 00:12:17.660
For one year-- I'm locking it
up-- maybe 2% and then for 10

00:12:17.660 --> 00:12:20.890
years, I'm willing to lend
it to them for 5%.

00:12:20.890 --> 00:12:22.520
The yield curve will look
something like this.

00:12:26.160 --> 00:12:28.350
Doesn't always go upward sloping
like that, but it

00:12:28.350 --> 00:12:30.360
tends to go upwards
sloping like that.

00:12:30.360 --> 00:12:33.395
So that's the yield curve and
this might be for treasuries.

00:12:38.560 --> 00:12:41.500
So one day, 1%, one year,
maybe-- the way I drew it--

00:12:41.500 --> 00:12:45.800
maybe this is 3%, maybe for 10
years, this would be 5%.

00:12:45.800 --> 00:12:47.050
This isn't the current
yield curve, but

00:12:47.050 --> 00:12:47.910
you you get the idea.

00:12:47.910 --> 00:12:48.550
This would just be for

00:12:48.550 --> 00:12:51.950
treasuries, the safest borrower.

00:12:51.950 --> 00:12:55.130
Now for investment grade
companies-- if I'm trying to

00:12:55.130 --> 00:12:58.710
lend money to them, maybe to a
GE or someone like that-- or a

00:12:58.710 --> 00:13:01.760
Berkshire Hathaway, I'd want
some premium over the

00:13:01.760 --> 00:13:04.120
treasuries because they're
not as safe as the U.S.

00:13:04.120 --> 00:13:07.190
government, but it's going to
have a curve similar to that.

00:13:07.190 --> 00:13:09.330
Maybe it looks like
that, right?

00:13:09.330 --> 00:13:12.330
And this premium right here is
essentially the amount of more

00:13:12.330 --> 00:13:13.890
interest you'd want
from these still

00:13:13.890 --> 00:13:15.120
relatively safe companies.

00:13:15.120 --> 00:13:17.700
relative to treasuries, but
you still have this upward

00:13:17.700 --> 00:13:19.280
sloping as you go up.

00:13:19.280 --> 00:13:21.930
And then, finally, you might
have your really risky guys--

00:13:21.930 --> 00:13:24.063
and every company will have its
own yield curve based on

00:13:24.063 --> 00:13:26.790
its borrowing costs, but you
might group a bunch of risky

00:13:26.790 --> 00:13:29.530
guys together and say, look,
the risky guys-- the yield

00:13:29.530 --> 00:13:31.570
curve looks like that.

00:13:31.570 --> 00:13:34.450
If there's some guy who's
looking to start some biotech

00:13:34.450 --> 00:13:36.960
firm and he wants to borrow
money from them, I'm going to

00:13:36.960 --> 00:13:39.080
charge a much higher premium
over treasuries because I

00:13:39.080 --> 00:13:43.610
don't even know if he's going
to be around in five years.

00:13:43.610 --> 00:13:46.100
So this is just the yield curve
and the whole reason why

00:13:46.100 --> 00:13:49.730
I drew this is to show how
fractional reserve banking

00:13:49.730 --> 00:13:52.390
allows banks to essentially take
advantage of the yield

00:13:52.390 --> 00:13:56.550
curve without really adding
any true value to society.

00:13:56.550 --> 00:13:59.270
This notion of a financial
intermediary does

00:13:59.270 --> 00:14:00.670
add value to society.

00:14:00.670 --> 00:14:03.020
When you have fractional reserve
banking, what you're

00:14:03.020 --> 00:14:09.590
allowing banks to do is to
take deposits and this--

00:14:09.590 --> 00:14:11.330
fractional reserve banking isn't
the only place where

00:14:11.330 --> 00:14:11.870
this happens.

00:14:11.870 --> 00:14:15.360
This happens a lot of places,
but they take deposits-- and

00:14:15.360 --> 00:14:16.760
they're demand deposits,
right?

00:14:16.760 --> 00:14:19.860
These are checking deposits,
which are essentially loans

00:14:19.860 --> 00:14:23.060
from their depositors and they
are essentially overnight

00:14:23.060 --> 00:14:23.860
loans, right?

00:14:23.860 --> 00:14:25.110
These are on demand loans.

00:14:29.010 --> 00:14:31.680
They're essentially-- when you
give your money to a bank in a

00:14:31.680 --> 00:14:34.520
checking deposit, that's
essentially every hour that

00:14:34.520 --> 00:14:36.680
you don't go and take your
money back, they're

00:14:36.680 --> 00:14:38.270
essentially just renewing
that loan.

00:14:38.270 --> 00:14:42.690
It's kind of the shortest
possible duration loan.

00:14:42.690 --> 00:14:45.700
And every day you don't do it,
it's just kind of a renewal of

00:14:45.700 --> 00:14:46.840
that loan, right?

00:14:46.840 --> 00:14:48.460
You could imagine a
world where every

00:14:48.460 --> 00:14:49.530
year you renew a loan.

00:14:49.530 --> 00:14:51.310
Every year that you don't
withdraw it, you just keep

00:14:51.310 --> 00:14:51.890
rolling it over.

00:14:51.890 --> 00:14:54.320
When you do on demand, it's
every second that you don't

00:14:54.320 --> 00:14:56.120
withdraw it, you're
renewing it.

00:14:56.120 --> 00:14:59.660
So they're able to borrow money
at this part of the

00:14:59.660 --> 00:15:02.890
yield curve and they can do it
very safely, pay very little

00:15:02.890 --> 00:15:06.270
interest, because people--
even though they might be

00:15:06.270 --> 00:15:07.550
doing risky activities.

00:15:07.550 --> 00:15:09.830
Maybe they're lending to
people like this guy.

00:15:09.830 --> 00:15:13.340
Because of the FDIC insurance,
people are lending to them

00:15:13.340 --> 00:15:15.720
like they're the government
because they're going to get

00:15:15.720 --> 00:15:17.980
paid back if the government
can pay them back.

00:15:17.980 --> 00:15:19.930
So it really lowers their
borrowing costs, so they

00:15:19.930 --> 00:15:24.830
borrow down here and what it
does is, it allows them to

00:15:24.830 --> 00:15:29.430
lend money over longer
durations.

00:15:29.430 --> 00:15:31.270
So this could be
a 10 year loan.

00:15:31.270 --> 00:15:33.680
So the money doesn't get paid
back, only interest does in

00:15:33.680 --> 00:15:34.800
the interirm, but the
money doesn't get

00:15:34.800 --> 00:15:36.820
paid back for 10 years.

00:15:36.820 --> 00:15:39.210
Maybe this right here
is a five year loan.

00:15:39.210 --> 00:15:42.140
And they can do it to
riskier investments.

00:15:42.140 --> 00:15:45.090
I mean, one, they could just
borrow money here, which is

00:15:45.090 --> 00:15:48.510
what they're paying the
depositors-- like 1%-- and

00:15:48.510 --> 00:15:50.750
then they could just invest it
if they wanted to and if the

00:15:50.750 --> 00:15:52.260
yield curve looked like this,
they could invest it in

00:15:52.260 --> 00:15:55.200
treasuries or maybe investment
grade bonds, essentially

00:15:55.200 --> 00:15:58.190
lending to the Berkshire
Hathaways of the world-- and

00:15:58.190 --> 00:16:02.700
getting a lot more interest.
And what they did here-- it

00:16:02.700 --> 00:16:04.890
doesn't take any special
genius to do this.

00:16:04.890 --> 00:16:07.630
Everyone knows that you'll get
higher interest here than over

00:16:07.630 --> 00:16:10.390
here, but the only reason why
they can do it this way is

00:16:10.390 --> 00:16:12.560
because they have this implicit
guarantee-- actually

00:16:12.560 --> 00:16:16.300
it's an explicit guarantee--
from the FDIC.

00:16:16.300 --> 00:16:20.010
So this FDIC insurance
is what allows people

00:16:20.010 --> 00:16:21.380
to lend them money.

00:16:21.380 --> 00:16:23.330
People are only willing to part
with their money at this

00:16:23.330 --> 00:16:26.970
point of the yield curve because
of the FDIC insurance.

00:16:26.970 --> 00:16:29.420
And then the bank can then go
and invest at this point of

00:16:29.420 --> 00:16:32.410
the yield curve and then make
the difference on the spread.

00:16:32.410 --> 00:16:36.500
They'll get 5% on the money
and then only pay 1%.

00:16:36.500 --> 00:16:37.720
And where's the value here?

00:16:37.720 --> 00:16:40.470
Because I could do this,
but I'm not an

00:16:40.470 --> 00:16:42.820
FDIC insured entity.

00:16:42.820 --> 00:16:45.680
Clearly these people would love
to get 5% on their money,

00:16:45.680 --> 00:16:47.690
get that money that the bank's
getting, but they don't get

00:16:47.690 --> 00:16:51.400
that insurance from the FDIC so
it doesn't allow them to.

00:16:51.400 --> 00:16:53.780
So essentially what fractional
reserve banking and the

00:16:53.780 --> 00:16:56.690
insurance that's come about
to make fractional reserve

00:16:56.690 --> 00:17:00.930
lending viable-- all it does
is it allows banks to

00:17:00.930 --> 00:17:04.880
arbitrage the yield curve-- to
borrow money at the short end

00:17:04.880 --> 00:17:09.440
and lend it out in the long end,
and make up the spread.

00:17:09.440 --> 00:17:12.250
And this is kind of a, one, that
doesn't add any value.

00:17:12.250 --> 00:17:13.200
Anyone can do this.

00:17:13.200 --> 00:17:16.020
You don't need a a fancy
MBA to figure this out.

00:17:16.020 --> 00:17:17.704
This doesn't add any true
value to society.

00:17:17.704 --> 00:17:20.099
It actually just flattens out
the yield curve a little bit,

00:17:20.099 --> 00:17:23.490
but we can debate about
the value of that.

00:17:23.490 --> 00:17:26.690
But I want to kind of make a
bigger point here-- is that

00:17:26.690 --> 00:17:29.710
obviously a lot of people in the
banking system are kind of

00:17:29.710 --> 00:17:40.000
the champions of capitalism
and unless they're being

00:17:40.000 --> 00:17:42.680
bailed out, they're the first
ones to be against any form of

00:17:42.680 --> 00:17:45.400
government intervention or
government safety net.

00:17:45.400 --> 00:17:49.370
But their whole industry is
predicated on a government

00:17:49.370 --> 00:17:50.460
safety net.

00:17:50.460 --> 00:17:54.240
This notion of a financial
intermediary that I outlined

00:17:54.240 --> 00:17:58.430
here and venture capitalists
and private equity-- they

00:17:58.430 --> 00:18:00.600
still operate on this
model right here.

00:18:00.600 --> 00:18:03.590
They are in no way dependent
on the Federal government.

00:18:03.590 --> 00:18:05.990
I mean, some of them might end
up being indirectly, but they

00:18:05.990 --> 00:18:10.620
don't need a whole elaborate
system of FDIC insurance and

00:18:10.620 --> 00:18:12.830
the Federal and the discount
window and all of these

00:18:12.830 --> 00:18:14.720
interventions that the Federal
government does.

00:18:14.720 --> 00:18:17.520
They don't need that to operate
efficiently-- or to

00:18:17.520 --> 00:18:18.750
operate in general.

00:18:18.750 --> 00:18:22.380
And even this banking system
here, where you just had

00:18:22.380 --> 00:18:25.390
people get CDs instead of having
this kind of halfway

00:18:25.390 --> 00:18:27.760
truth of fractional reserve
lending-- this could

00:18:27.760 --> 00:18:30.610
completely operate without any
government intervention.

00:18:30.610 --> 00:18:32.830
This system, on the other
hand, fractional reserve

00:18:32.830 --> 00:18:35.660
lending-- it could not exist
without government

00:18:35.660 --> 00:18:36.910
intervention.

00:18:39.660 --> 00:18:43.330
And so you have to you have to
debate-- or I guess think in

00:18:43.330 --> 00:18:47.640
your mind-- some system like
fractional reserve banking

00:18:47.640 --> 00:18:53.650
that is dependent on the
government-- is this even

00:18:53.650 --> 00:18:54.900
capitalism?

00:18:57.460 --> 00:18:59.160
I mean, where is the
competition here?

00:18:59.160 --> 00:19:00.760
Where is the innovation here?

00:19:00.760 --> 00:19:03.610
If you're big enough, you get
your FDIC insurance and you

00:19:03.610 --> 00:19:06.760
just keep arbitraging the yield
curve and you make money

00:19:06.760 --> 00:19:10.610
to buy your Rolex and your fancy
trips in your private

00:19:10.610 --> 00:19:12.120
jets, but there's no
innovation here.

00:19:12.120 --> 00:19:15.270
You're just big and you were one
of the lucky ones to get a

00:19:15.270 --> 00:19:19.030
bank charter with the FDIC and
be insured by them-- there's

00:19:19.030 --> 00:19:19.770
no innovation here.

00:19:19.770 --> 00:19:20.980
Where's the competition?

00:19:20.980 --> 00:19:23.690
If anything, the person who
takes the most risk and who

00:19:23.690 --> 00:19:25.630
does the most silly things is
going to be able to generate

00:19:25.630 --> 00:19:28.300
the highest yield and they have
the subsidized insurance

00:19:28.300 --> 00:19:30.940
from the Federal government and
so they're going to be the

00:19:30.940 --> 00:19:31.750
most successful.

00:19:31.750 --> 00:19:33.670
It's all dependent
on government.

00:19:33.670 --> 00:19:34.975
It's all dependent
on a subsidy.

00:19:37.910 --> 00:19:42.180
And in the end, this money that
these people are making

00:19:42.180 --> 00:19:45.440
by arbitraging this, this is
coming from a subsidy from the

00:19:45.440 --> 00:19:47.970
Federal government and it's
coming from the taxpayer.

00:19:47.970 --> 00:19:50.630
So you essentially have the
taxpayers subsidizing this

00:19:50.630 --> 00:19:52.960
world where people can just
arbitrage this yield curve--

00:19:52.960 --> 00:19:56.130
not take on real risk and make
real investments and

00:19:56.130 --> 00:20:00.130
efficiently allocate capital,
just arbitraging the yield

00:20:00.130 --> 00:20:05.360
curve with cheap insurance-- and
you're essentially making

00:20:05.360 --> 00:20:08.510
a small percentage of the
population-- being able to

00:20:08.510 --> 00:20:11.690
extract, essentially, rents or
or some type of subsidy from

00:20:11.690 --> 00:20:12.470
the rest of the population.

00:20:12.470 --> 00:20:16.440
And obviously this isn't the
part of our economic system

00:20:16.440 --> 00:20:18.100
that is the most in need.

00:20:18.100 --> 00:20:20.240
So I'm not saying this
to kind of impugn

00:20:20.240 --> 00:20:21.250
the financial system.

00:20:21.250 --> 00:20:24.170
I think for the most part,
people here, they're taking on

00:20:24.170 --> 00:20:27.910
risk and they're getting return
and the savers here

00:20:27.910 --> 00:20:29.360
know what they're getting
into, but there's no

00:20:29.360 --> 00:20:30.620
government intervention here.

00:20:30.620 --> 00:20:33.050
There's no implicit government
subsidy.

00:20:33.050 --> 00:20:36.240
This whole thing is based
on a government subsidy.

00:20:36.240 --> 00:20:39.460
Fractional reserve banking could
not exist without the

00:20:39.460 --> 00:20:44.040
FDIC and the FDIC could not
exist without the implicit

00:20:44.040 --> 00:20:47.070
backing that the Congress would
make them solvent if

00:20:47.070 --> 00:20:50.040
they ever ran out of money, like
is the case right now.

00:20:50.040 --> 00:20:52.710
Anyway, hopefully this informs
your view a little bit more.

00:20:52.710 --> 00:20:57.530
I don't want to be some kind
of crazy reactionary.

00:20:57.530 --> 00:21:00.230
I'm resigned to the fact that
fractional reserve banking

00:21:00.230 --> 00:21:02.430
isn't going to go away, but it
does bother me a little bit

00:21:02.430 --> 00:21:04.900
because it is completely
dependent on government

00:21:04.900 --> 00:21:05.380
intervention.

00:21:05.380 --> 00:21:08.040
As you see right now over the
past year, you have this whole

00:21:08.040 --> 00:21:11.370
financial system where we're
piling more and more money

00:21:11.370 --> 00:21:15.850
into the very same entities that
took on the most risk--

00:21:15.850 --> 00:21:19.420
and essentially they have
us at gunpoint.

00:21:19.420 --> 00:21:21.960
They're like, you better pour
more money into us or else

00:21:21.960 --> 00:21:24.440
we're going to blow up because
of the risk I took, but I'm

00:21:24.440 --> 00:21:26.890
going to take you
down with me.


FRB Commentary 2: Deposit Insurance

WEBVTT
Kind: captions
Language: en

00:00:00.410 --> 00:00:03.140
In the last video, I touched
on the core weakness of

00:00:03.140 --> 00:00:07.400
fractional reserve banking and
that's the idea of the bank

00:00:07.400 --> 00:00:11.340
run-- where if you have a bunch
of banks and they've all

00:00:11.340 --> 00:00:14.780
lent out 90% of their reserves--
let's say that

00:00:14.780 --> 00:00:19.280
here's all my banks-- Bank One,
Bank Two, Bank Three--

00:00:19.280 --> 00:00:21.010
and you could have
a ton of banks.

00:00:21.010 --> 00:00:23.700
I mean, you could imagine you
go all the way to Bank 100.

00:00:23.700 --> 00:00:26.810
The problem with a bank run is
if just even one bank all of a

00:00:26.810 --> 00:00:31.990
sudden isn't able to give its
depositors its money-- so it

00:00:31.990 --> 00:00:37.470
is illiquid-- and we'll reserve
judgment as to whether

00:00:37.470 --> 00:00:39.910
it is truly insolvent, but it
really just doesn't have the

00:00:39.910 --> 00:00:42.410
money to give it to depositors,
then all of the

00:00:42.410 --> 00:00:46.200
depositors of all of the other
banks get scared and run over

00:00:46.200 --> 00:00:48.710
to the banks and ask for
their money back.

00:00:48.710 --> 00:00:51.920
And by definition, in a
fractional reserve banking

00:00:51.920 --> 00:00:58.220
system, these guys only have
10% of their deposits as

00:00:58.220 --> 00:01:01.910
reserves, 10% reserves.

00:01:01.910 --> 00:01:04.890
So if more than 10% of the
people ask for their money,

00:01:04.890 --> 00:01:06.140
they're all going
to be illiquid.

00:01:09.390 --> 00:01:12.410
Then you're going to have
just an all-out panic.

00:01:12.410 --> 00:01:14.000
You're going to have
an all-out panic of

00:01:14.000 --> 00:01:16.180
the financial system.

00:01:16.180 --> 00:01:19.380
As soon as any of these guys'
loans come due-- so let me

00:01:19.380 --> 00:01:21.410
draw one of their balance
sheets-- let's assume that

00:01:21.410 --> 00:01:23.400
they were actually good
investors, which is a big

00:01:23.400 --> 00:01:26.160
assumption, but let's say
that their balance

00:01:26.160 --> 00:01:27.720
sheets look like this.

00:01:27.720 --> 00:01:30.140
Here's all of the deposits that
they owe to people-- to

00:01:30.140 --> 00:01:31.730
me and you.

00:01:31.730 --> 00:01:33.290
That's their liabilities.

00:01:33.290 --> 00:01:38.425
They have 10% of their assets
as actual currency reserves.

00:01:42.320 --> 00:01:45.470
And then the rest is loans
out to businesses

00:01:45.470 --> 00:01:46.720
and whatever else.

00:01:52.230 --> 00:01:55.590
And that's an asset because
businesses owe them something.

00:01:55.590 --> 00:01:57.380
And what's going to happens--
as soon as there's a panic,

00:01:57.380 --> 00:01:58.840
everyone wants their
money out.

00:01:58.840 --> 00:02:00.635
The reserves are depleted
very quickly.

00:02:06.340 --> 00:02:08.419
And then these guys sit there
waiting for their money.

00:02:08.419 --> 00:02:11.560
Essentially it shuts
down the bank.

00:02:11.560 --> 00:02:13.710
As soon as these loans mature--
maybe this guy owed

00:02:13.710 --> 00:02:15.670
his money in a year.

00:02:15.670 --> 00:02:17.270
Then they're going to say, just
give me the money back.

00:02:17.270 --> 00:02:19.120
I'm not going to renew the loan
even though you have a

00:02:19.120 --> 00:02:20.070
good business.

00:02:20.070 --> 00:02:21.790
And so everyone's going to want
their money back and the

00:02:21.790 --> 00:02:24.510
whole financial system's going
to break down and credit is

00:02:24.510 --> 00:02:25.760
going to freeze.

00:02:33.120 --> 00:02:34.380
And this is a huge problem.

00:02:34.380 --> 00:02:38.040
Remember, this could be just
because by one bad actor who

00:02:38.040 --> 00:02:40.010
couldn't manage their
liquidity properly.

00:02:40.010 --> 00:02:43.810
Even worse, it could be caused
just by one panicky

00:02:43.810 --> 00:02:44.480
withdrawer.

00:02:44.480 --> 00:02:46.590
There's doesn't even have
to be a bad actor.

00:02:46.590 --> 00:02:49.160
It could just be some fear that
enters the system-- and

00:02:49.160 --> 00:02:51.750
even for a completely legitimate
bank-- and I'll use

00:02:51.750 --> 00:02:54.150
legitimate in quotations
because we're assuming

00:02:54.150 --> 00:02:58.350
legitimate-- because some
would debate whether

00:02:58.350 --> 00:03:00.440
fractional reserve banking
is legitimate.

00:03:00.440 --> 00:03:04.190
But even if this is a completely
up-and-up bank, if

00:03:04.190 --> 00:03:07.070
for whatever reason more than
10% of their deposits get

00:03:07.070 --> 00:03:09.680
scared, then all of a sudden
they'll be illiquid and you'll

00:03:09.680 --> 00:03:12.120
be in this all-out
panic condition.

00:03:12.120 --> 00:03:14.150
Now I talked in the last video,
some of the things that

00:03:14.150 --> 00:03:17.260
have been engineered to
fix this problem.

00:03:17.260 --> 00:03:19.350
So these are the fixes.

00:03:19.350 --> 00:03:22.615
The first one is to have a
banker of last resort, a

00:03:22.615 --> 00:03:23.865
lender of last resort.

00:03:28.810 --> 00:03:32.000
And that's our central bank--
or the Federal reserve bank.

00:03:36.590 --> 00:03:41.010
And they'll never run out of
reserves, because these

00:03:41.010 --> 00:03:45.490
reserves can be borrowed from
them and all these are, are

00:03:45.490 --> 00:03:53.230
IOUs from the Federal reserve.

00:03:53.230 --> 00:03:55.590
So what the Federal reserve
does-- and I've talked about

00:03:55.590 --> 00:03:57.960
this in the past-- let's say
that their balance sheet

00:03:57.960 --> 00:03:59.390
currently looks like this.

00:03:59.390 --> 00:04:03.000
Let's say that this is their
current liabilities.

00:04:03.000 --> 00:04:04.430
These are their current
assets.

00:04:04.430 --> 00:04:05.510
And their current
liabilities are

00:04:05.510 --> 00:04:06.880
essentially going to be IOUs.

00:04:06.880 --> 00:04:09.420
These are going to be their
reserve notes, but let's say

00:04:09.420 --> 00:04:12.830
someone else comes and says,
hey, federal reserve, lend me

00:04:12.830 --> 00:04:14.355
some money.

00:04:14.355 --> 00:04:18.370
So what they're going to do is
that they're going to print

00:04:18.370 --> 00:04:21.010
some-- so these are Federal
reserve notes.

00:04:23.940 --> 00:04:26.250
And then they're going to just
create an offsetting liability

00:04:26.250 --> 00:04:30.240
and they have no
reserve limits.

00:04:30.240 --> 00:04:33.770
Let me make it a new color just
to ease the monotony.

00:04:33.770 --> 00:04:36.160
So they'll have this
corresponding notes

00:04:36.160 --> 00:04:38.740
outstanding liability and
they're going to give those

00:04:38.740 --> 00:04:40.030
notes to you.

00:04:40.030 --> 00:04:42.420
They're going to give those
notes to the bank that's in a

00:04:42.420 --> 00:04:45.190
desperate situation if
it couldn't borrow

00:04:45.190 --> 00:04:46.790
from any other bank.

00:04:46.790 --> 00:04:48.470
And so the Federal reserve
balance sheet will

00:04:48.470 --> 00:04:49.240
now look like this.

00:04:49.240 --> 00:04:51.190
This is what it looked
like before.

00:04:51.190 --> 00:04:56.910
It has these new notes
outstanding and now this will

00:04:56.910 --> 00:05:00.570
say-- instead of federal reserve
notes in its vaults,

00:05:00.570 --> 00:05:04.510
it'll now have this little thing
on its books called loan

00:05:04.510 --> 00:05:07.780
to the bank, loan to this guy
right here, which is an asset

00:05:07.780 --> 00:05:09.760
because he owes him something.

00:05:09.760 --> 00:05:12.140
And there's no limit to
which the Federal

00:05:12.140 --> 00:05:13.010
reserve could do this.

00:05:13.010 --> 00:05:15.910
Obviously there might be some
kind of implicit limit.

00:05:15.910 --> 00:05:18.590
If they keep doing this
arbitrarily, people might not

00:05:18.590 --> 00:05:21.370
accept these Federal
reserve notes as

00:05:21.370 --> 00:05:22.600
actually carrying value.

00:05:22.600 --> 00:05:24.940
So that's probably the main
limiting concern.

00:05:24.940 --> 00:05:27.280
And I'll probably talk more in
future videos on other things

00:05:27.280 --> 00:05:30.030
that are kind of keeping the
Federal reserve from just

00:05:30.030 --> 00:05:33.030
doing this willy-nilly, but the
general idea is that they

00:05:33.030 --> 00:05:33.790
never run out.

00:05:33.790 --> 00:05:36.610
So this is one idea-- lender of
last resort, but not even

00:05:36.610 --> 00:05:39.230
the Federal reserve wants to
keep doing this because what

00:05:39.230 --> 00:05:42.870
if this guy is essentially
insolvent?

00:05:42.870 --> 00:05:51.090
If these loans are actually
going bad, then there's no

00:05:51.090 --> 00:05:53.210
reason that even the central
bank should actually be

00:05:53.210 --> 00:05:54.700
lending to this guy.

00:05:54.700 --> 00:05:55.970
They shouldn't be lending
to this guy.

00:05:55.970 --> 00:05:57.990
So let's say the Federal reserve
looks at this guy's

00:05:57.990 --> 00:05:59.180
books and say, you know what?

00:05:59.180 --> 00:06:01.240
These loans are really
worthless.

00:06:01.240 --> 00:06:03.060
I'm not going to lend
more money to you.

00:06:03.060 --> 00:06:05.510
What I'm going to do is take
you into receivership.

00:06:05.510 --> 00:06:07.450
And I haven't even talked
about what that is.

00:06:07.450 --> 00:06:09.090
That's the second fix.

00:06:09.090 --> 00:06:16.260
The second fix is to have this
notion of insurance, of

00:06:16.260 --> 00:06:17.510
deposit insurance.

00:06:23.830 --> 00:06:26.700
So if a bank just has a
liquidity problem-- it's a

00:06:26.700 --> 00:06:35.160
good bank-- it just ran out of
reserves and no other bank is

00:06:35.160 --> 00:06:38.016
willing to lend to it-- which
you might debate whether it's

00:06:38.016 --> 00:06:40.010
even a good bank if the other
banks aren't willing to lend

00:06:40.010 --> 00:06:44.170
to it-- then it can go to the
discount window at the Federal

00:06:44.170 --> 00:06:46.230
reserve and borrow some
reserve notes.

00:06:46.230 --> 00:06:48.730
Now, in the situation where even
that's not good enough

00:06:48.730 --> 00:06:51.590
and the bank is essentially out
of business, it had been

00:06:51.590 --> 00:06:59.270
paying the FDIC a little bit of
money-- the Federal Deposit

00:06:59.270 --> 00:07:05.560
Insurance Corporation-- a little
bit of money-- I mean,

00:07:05.560 --> 00:07:07.920
probably a lot of money by an
individual's point of view,

00:07:07.920 --> 00:07:10.720
but a little bit of money from
a bank's point of view-- and

00:07:10.720 --> 00:07:13.440
it's a fraction of a percent--
a little bit of money every

00:07:13.440 --> 00:07:16.400
year so that it could tell its
depositors, look, even in the

00:07:16.400 --> 00:07:20.840
situation that our bank goes
bust, the Federal reserve is

00:07:20.840 --> 00:07:22.310
going to pay you directly.

00:07:22.310 --> 00:07:24.530
These are FDIC bank accounts.

00:07:24.530 --> 00:07:28.190
The Federal reserve will make
you whole completely,

00:07:28.190 --> 00:07:30.650
regardless of what happens
to the banks.

00:07:30.650 --> 00:07:33.300
Now this, to me, is a big fix.

00:07:33.300 --> 00:07:35.680
I mean, I'll tell you right now,
all of my savings right

00:07:35.680 --> 00:07:39.180
now are in Federal deposit
insured-- FDIC

00:07:39.180 --> 00:07:43.340
insured-- bank accounts.

00:07:43.340 --> 00:07:46.180
This might sound great to the
depositor, but what's the side

00:07:46.180 --> 00:07:48.490
effect on the banking system?

00:07:48.490 --> 00:07:50.890
Let me draw all of
my banks again.

00:07:50.890 --> 00:07:55.080
So I have Bank One, I have Bank
Two, I have Bank Three, I

00:07:55.080 --> 00:07:56.120
have Bank Four.

00:07:56.120 --> 00:08:00.540
Now, they are all
FDIC insured.

00:08:00.540 --> 00:08:04.670
They pay some small fraction of
a percentage every year so

00:08:04.670 --> 00:08:06.980
that they can tell their
depositors, look, if we ever

00:08:06.980 --> 00:08:10.040
go bust, if we ever blow up
for whatever reason, your

00:08:10.040 --> 00:08:14.570
deposits are 100% safe.

00:08:14.570 --> 00:08:15.810
And what's going to happen?

00:08:15.810 --> 00:08:18.470
This will solve the bank
run problem, right?

00:08:18.470 --> 00:08:21.040
Let's say for whatever reason
this guy runs out of reserves

00:08:21.040 --> 00:08:23.660
or he goes bankrupt--
let's say that

00:08:23.660 --> 00:08:24.720
this guy goes bankrupt.

00:08:24.720 --> 00:08:27.970
In the old situation, before the
insurance, everyone else

00:08:27.970 --> 00:08:29.570
is going to get scared
and you're going

00:08:29.570 --> 00:08:30.470
to have a bank run.

00:08:30.470 --> 00:08:31.990
They're going to ask for their
money and there's just not

00:08:31.990 --> 00:08:34.260
going to be enough reserves
because they only keep a

00:08:34.260 --> 00:08:35.600
fraction of the reserves.

00:08:35.600 --> 00:08:38.530
That's what fractional reserve
banking is, but now everyone's

00:08:38.530 --> 00:08:39.870
going to feel comfortable,
like, you know what?

00:08:39.870 --> 00:08:42.730
Everything is backed by the
Federal reserve, which can

00:08:42.730 --> 00:08:45.340
print as many notes is
it wants so I'm just

00:08:45.340 --> 00:08:46.010
going to sit pretty.

00:08:46.010 --> 00:08:48.580
So this does solve the
bank run problem.

00:08:53.180 --> 00:08:55.560
And so you might say, this
doesn't make it an unstable

00:08:55.560 --> 00:08:57.500
equilibrium any more-- which
is kind of true, but

00:08:57.500 --> 00:08:58.900
what does this do?

00:08:58.900 --> 00:09:01.440
All of these guys are
now FDIC insured.

00:09:01.440 --> 00:09:05.540
I'm equally willing to give my
money to any of these guys.

00:09:05.540 --> 00:09:07.510
So I'm going to essentially
going to give my money to the

00:09:07.510 --> 00:09:18.600
guy who gives me the highest
interest. And I've actually

00:09:18.600 --> 00:09:19.820
done that with my personal
accounts.

00:09:19.820 --> 00:09:22.530
I've gone and I've seen which
bank provides the highest

00:09:22.530 --> 00:09:25.210
interest and I've ignored how
they're investing their

00:09:25.210 --> 00:09:28.300
money-- I mean, otherwise I'd
be pretty suspicious about a

00:09:28.300 --> 00:09:30.190
bank offering more interest
because they're probably doing

00:09:30.190 --> 00:09:32.870
something risky, but now I don't
care because I know it's

00:09:32.870 --> 00:09:35.560
FDIC insured and even if that
bank blows up, I'm going to

00:09:35.560 --> 00:09:36.960
get all my money back.

00:09:36.960 --> 00:09:39.890
So I might as well give my
deposit to the bank with the

00:09:39.890 --> 00:09:41.270
highest interest.

00:09:41.270 --> 00:09:44.250
Now based on what you saw in
that last video, which is the

00:09:44.250 --> 00:09:46.710
bank that's going to be giving
the highest interest?

00:09:46.710 --> 00:09:47.920
What's going to be
the bank that's

00:09:47.920 --> 00:09:49.240
taking on the most risk?

00:09:57.100 --> 00:10:00.120
So once again, when you give
this relatively cheap

00:10:00.120 --> 00:10:06.520
insurance to all of these banks
and all of these banks

00:10:06.520 --> 00:10:09.390
can attract money much easier by
paying this insurance-- if

00:10:09.390 --> 00:10:10.990
they didn't have this insurance,
they would have to

00:10:10.990 --> 00:10:11.660
pay much more.

00:10:11.660 --> 00:10:19.130
Let's say this insurance
is 0.1% per year.

00:10:19.130 --> 00:10:21.080
If they didn't have this
insurance, they would have to

00:10:21.080 --> 00:10:24.610
pay much more than 0.1% per
year to the depositor in

00:10:24.610 --> 00:10:27.810
interest to make up for the risk
that they're taking on,

00:10:27.810 --> 00:10:29.810
that they're not being backed
by the government.

00:10:29.810 --> 00:10:33.360
So it's a really good deal
for the depositor.

00:10:33.360 --> 00:10:34.530
Let's put it this way.

00:10:34.530 --> 00:10:36.690
When you give a deposit to
a bank, you're lending

00:10:36.690 --> 00:10:37.970
money to the bank.

00:10:37.970 --> 00:10:41.130
So your checking deposit rate--
so let me write this

00:10:41.130 --> 00:10:50.840
down-- your checking deposit
interest rate is the same

00:10:50.840 --> 00:10:54.050
thing as the bank's borrowing
cost, right?

00:10:54.050 --> 00:10:56.750
When I go to some bank and
they're paying me 2% a year,

00:10:56.750 --> 00:11:04.600
that's the bank's borrowing
cost. They're the same thing.

00:11:04.600 --> 00:11:07.220
Now if the bank didn't have FDIC
insurance, it wouldn't

00:11:07.220 --> 00:11:10.620
have to pay 0.1% a year, but it
would have to give me more

00:11:10.620 --> 00:11:13.500
interest. It would have to pay
me 3% or 4%, probably more,

00:11:13.500 --> 00:11:14.910
because I'd say this
is a risky bank--

00:11:14.910 --> 00:11:16.110
or it's more risky.

00:11:16.110 --> 00:11:18.680
Any bank would be more risky
than someone who can

00:11:18.680 --> 00:11:20.120
print out the notes.

00:11:20.120 --> 00:11:23.020
So it would have to pay more,
but now it can just pay 0.1% a

00:11:23.020 --> 00:11:32.240
year or whatever the Federal
Deposit Insurance Corporation

00:11:32.240 --> 00:11:38.810
pays it, but it's going to lower
to FDIC, but the main

00:11:38.810 --> 00:11:42.000
side effect of this is it's
going to lower what it has to

00:11:42.000 --> 00:11:44.340
pay the depositors because the
depositors say, this is a lot

00:11:44.340 --> 00:11:45.850
safer than what I thought.

00:11:45.850 --> 00:11:54.560
So it's going to lower
borrowing costs by

00:11:54.560 --> 00:11:58.420
much more than 0.1%.

00:11:58.420 --> 00:12:01.290
So it's a really good deal
for the bank and it's an

00:12:01.290 --> 00:12:05.000
especially good deal for the
ultra-risky banks who might

00:12:05.000 --> 00:12:08.030
have to pay a little bit more,
but because they can now do

00:12:08.030 --> 00:12:09.810
super duper risky things.

00:12:09.810 --> 00:12:11.480
You say, hey, but this
is insurance.

00:12:11.480 --> 00:12:13.820
The Federal Deposit Insurance
Corporation isn't stupid.

00:12:13.820 --> 00:12:17.310
It should just charge more
for riskier banks.

00:12:17.310 --> 00:12:20.590
But I guess the rebuttal to
that is that's easier said

00:12:20.590 --> 00:12:26.860
than done because when times are
good, like in the '20s or

00:12:26.860 --> 00:12:32.520
during the housing bubble,
you get hidden risk.

00:12:32.520 --> 00:12:36.360
So you don't know who's
taking on the risk.

00:12:36.360 --> 00:12:39.050
It's usually the person who's
getting the highest returns,

00:12:39.050 --> 00:12:42.280
but if they're always good for
it, you don't see it and that

00:12:42.280 --> 00:12:43.545
person just looks
like a genius.

00:12:47.500 --> 00:12:50.780
And then when times are
bad, that guy blows

00:12:50.780 --> 00:12:52.200
up, but guess what?

00:12:52.200 --> 00:12:53.690
He's not on the line for it.

00:12:53.690 --> 00:12:56.040
It's the Federal Deposit
Insurance Corporation, who all

00:12:56.040 --> 00:12:57.200
along was probably

00:12:57.200 --> 00:12:59.720
undercharging for that insurance.

00:12:59.720 --> 00:13:02.090
I want to make one last
point about this.

00:13:02.090 --> 00:13:03.010
It's called insurance.

00:13:03.010 --> 00:13:05.385
It's the Federal Deposit
Insurance Corporation.

00:13:08.460 --> 00:13:10.970
And I want to point out the
difference between financial

00:13:10.970 --> 00:13:13.230
insurance-- and you could
watch my video on credit

00:13:13.230 --> 00:13:15.380
default swaps, which is another
form of financial

00:13:15.380 --> 00:13:18.830
insurance-- between financial
insurance and what we normally

00:13:18.830 --> 00:13:20.660
associate with insurance.

00:13:20.660 --> 00:13:23.890
If I have car insurance-- let's
say I'm a car insurance

00:13:23.890 --> 00:13:28.060
person and I agree-- let's say
that they are Driver One--

00:13:28.060 --> 00:13:31.180
let's say I have a bunch of
drivers-- so Driver One,

00:13:31.180 --> 00:13:36.210
Driver Two, Driver Three,
Driver Four.

00:13:36.210 --> 00:13:39.230
And I know that in any given
year, they each have a 10%

00:13:39.230 --> 00:13:43.050
chance of an accident.

00:13:43.050 --> 00:13:44.860
That's a lot higher than
reality, but we'll make the

00:13:44.860 --> 00:13:45.750
numbers easy.

00:13:45.750 --> 00:13:53.620
And if there is an accident,
it will cost me $10,000.

00:13:53.620 --> 00:13:56.190
So I could go to Driver One and
say, look, there's a 10%

00:13:56.190 --> 00:13:57.510
chance you're going to
have an accident.

00:13:57.510 --> 00:13:59.770
It would cost $10,000
if you do.

00:13:59.770 --> 00:14:01.450
So I'm going to charge
you-- the fair

00:14:01.450 --> 00:14:02.330
price would be $1,000.

00:14:02.330 --> 00:14:03.760
I'll charge you $1,100.

00:14:03.760 --> 00:14:08.040
I'll charge $1,100 just so I
can make a little bit of a

00:14:08.040 --> 00:14:08.760
profit, right?

00:14:08.760 --> 00:14:10.600
What you would charge is $1,000
if you wanted to break

00:14:10.600 --> 00:14:13.060
even, but I'll charge $1,100--
and I might do this more than

00:14:13.060 --> 00:14:13.780
just four drivers.

00:14:13.780 --> 00:14:15.670
I might do it with
4,000 drivers.

00:14:15.670 --> 00:14:23.530
So on average in any given
year-- let's say I have one

00:14:23.530 --> 00:14:30.140
million drivers-- in any given
year, how much am I

00:14:30.140 --> 00:14:30.740
going to bring in?

00:14:30.740 --> 00:14:33.310
I'm going to bring in a million
times $1,100, which

00:14:33.310 --> 00:14:37.510
is-- I'm going to get $1.1
billion in input, or in

00:14:37.510 --> 00:14:40.980
revenue, from people paying
their premiums. And how much

00:14:40.980 --> 00:14:42.310
am I going to have to pay out?

00:14:47.090 --> 00:14:49.670
Well, roughly 10% if you believe
these statistics are

00:14:49.670 --> 00:14:51.300
going to have an accident.

00:14:51.300 --> 00:14:55.330
So that means that 100,000 are
going to have an accident.

00:14:55.330 --> 00:14:57.220
Each of those 100,000
accidents are

00:14:57.220 --> 00:14:59.300
going to cost me $10,000.

00:14:59.300 --> 00:15:00.830
$10,000 times $100,000.

00:15:00.830 --> 00:15:04.200
I'm going to have to pay out $1
billion for the accidents.

00:15:04.200 --> 00:15:09.110
So I will net every year-- if my
actuaries did their job, I

00:15:09.110 --> 00:15:11.840
will net $100 million
every year.

00:15:11.840 --> 00:15:14.340
And this works out pretty good
assuming these statistics are

00:15:14.340 --> 00:15:17.130
right and people are willing to
pay the premium because if

00:15:17.130 --> 00:15:19.690
you have enough drivers-- like
a million drivers-- the

00:15:19.690 --> 00:15:21.190
statistics really hold.

00:15:21.190 --> 00:15:24.530
In any given year, the chance
of 20% of the drivers having

00:15:24.530 --> 00:15:27.040
an accident is very,
very, very-- almost

00:15:27.040 --> 00:15:28.310
infinitesimally small.

00:15:28.310 --> 00:15:29.790
It's almost zero.

00:15:29.790 --> 00:15:32.140
And one driver having an
accident doesn't make it more

00:15:32.140 --> 00:15:34.770
or less likely that another
driver will have an accident

00:15:34.770 --> 00:15:36.480
when you're talking
about on the order

00:15:36.480 --> 00:15:37.860
of a million drivers.

00:15:37.860 --> 00:15:40.030
And that's true of health
insurance and everything else.

00:15:40.030 --> 00:15:42.260
It's just purely probabilistic
and if you have enough people

00:15:42.260 --> 00:15:45.070
insured, the statistics
can actually hold up.

00:15:45.070 --> 00:15:47.040
Now with financial
insurance, you

00:15:47.040 --> 00:15:49.010
have a different situation.

00:15:49.010 --> 00:15:57.220
You might say, look, in any
given year, on average, the

00:15:57.220 --> 00:16:03.100
FDIC might say, look, only-- I
don't know-- one out of out of

00:16:03.100 --> 00:16:04.410
1,000 banks fail.

00:16:04.410 --> 00:16:07.200
So there's a 0.1% chance
of failure.

00:16:07.200 --> 00:16:09.260
Of course it'll capture back
some money because it'll have

00:16:09.260 --> 00:16:11.030
some assets on average.

00:16:11.030 --> 00:16:15.700
But the reality is that when
times go bad, the bank

00:16:15.700 --> 00:16:18.210
failures tend to be correlated
because they're all

00:16:18.210 --> 00:16:18.370
interlinked.

00:16:18.370 --> 00:16:21.680
And I've done a lot-- one
might be lending to some

00:16:21.680 --> 00:16:24.520
business that's dependent on
some business that this guy's

00:16:24.520 --> 00:16:25.350
lending to.

00:16:25.350 --> 00:16:27.200
The whole financial system
is all linked up.

00:16:27.200 --> 00:16:30.990
So the failures aren't-- they
all correlate with each other.

00:16:30.990 --> 00:16:32.360
They're not independent
events.

00:16:32.360 --> 00:16:35.870
So if one bank fails, it's much
more likely that other

00:16:35.870 --> 00:16:38.740
banks are going to fail all
at the same time and we're

00:16:38.740 --> 00:16:41.580
experiencing that right now.

00:16:41.580 --> 00:16:45.550
So you can't really follow the
insurance model because the

00:16:45.550 --> 00:16:46.800
statistics really don't apply.

00:16:46.800 --> 00:16:49.800
You can do this insurance model
when each of the events

00:16:49.800 --> 00:16:52.350
that you're insuring are
uncorrelated, but when all the

00:16:52.350 --> 00:16:54.940
events that you're insuring are
likely to all happen at

00:16:54.940 --> 00:16:57.270
the same time, what you're going
to have is-- when times

00:16:57.270 --> 00:17:02.220
are good, you're going to see a
much lower kind of loss rate

00:17:02.220 --> 00:17:04.430
and then when times are bad, all
of your guys are going to

00:17:04.430 --> 00:17:06.200
blow up and you're essentially
on the hook

00:17:06.200 --> 00:17:06.950
for all these people.

00:17:06.950 --> 00:17:10.410
We see that right now and the
FDIC is actually-- it's going

00:17:10.410 --> 00:17:13.050
to have to go back to Congress,
I'm 100% sure, and

00:17:13.050 --> 00:17:15.890
ask for more money and it's we
the taxpayers that are going

00:17:15.890 --> 00:17:18.910
to be on the line for
this type of thing.