patrick.net

1. Banks create money. This is called endogenous money. Monetary circuit theory or circuitism is the first one to come up with this insight. However, this way of creating money is not same as ponzi scheme (for instance, Steve Keen believes that it is a debt ponzi; he is wrong on this count).

2. When a bank lends you $1M money, it creates two things: $1M assets (the IOU note you give to the bank); $1M liabilities ($1M deposited in your account). Net = Zero. So, there is no money out of thin air.

3. Bank reserves are for clearing payment system, not for lending. That reserves are required for lending is the nonsense sold by neo-liberal economists of both varities (like Paul Krugman and Mankiw).

4. So, one may ask this question: why doesn't a bank create infinite assets and infinite liabilities? Yes, they can create such assets, but these assets are constrained by capitals. Study Basil pact, etc. If they create bad mortgages, they create bad assets for themselves. So, when people stop paying mortgage, banks loose money. How do they pay back the money they have lost here? From their capital.

5. So, the way banks are playing now is to NOT follow mark-to-market accounting. By doing this, they are not showing losses.

6. Capital controls are enforced by regulatory framework. Here, they work the system. One such way is 5.

7. When I work for a bank, I don't give a hoot for the long term prospects for that bank; instead, I focus on my short term interest (bonus, options, etc). So, I am inclined to create bad assets for my bank. Making money for myself as an individual is rational. Individual rationality here is in conflict with the institutional rationality. This is analogous to the paradox of thrift: if majority of consumers stop spending (and start saving more)--and this is a rational strategy at an individual level--, the savers end up loosing jobs. The current recession is one such manifestation.

Brentok3 says

Some people seem to believe that there is some sort of “absolute” value in housing, completely independent of what the bank will lend

Yes, those people are called patrick.net posters.

Brentok3 says

Home loans are not self-liquidating in the sense that there is a business entity that pays off the loan out of business income. The borrower must pay off the loan out of his personal funds, which can depend on many, many factors (health problems, unemployment, outsourcing, etc).

I don't think many business owners would view their loans as "self-liquidating" either, given that businesses are also subject to "many, many factors" that can affect the business' income and profits, and therefore ability to repay the loan.

Despite how impossible you make it sound, most people manage to go out there, compete, and come home with enough money to pay the mortgage, everything else, and still buy a flat screen TV on top of it. Additionally, for most, especially these day with more normal lending standards back in vogue, the bank passes judgment on one's ability to compete and repay.