Intelligent Investing with Glenn Leest

Intelligent Investing with Glenn Leest: Unveiling the Intricacies of the US Banking System and the Rise of Digital Currencies

• Glenn Leest

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Prepare to fortify your financial know-how as Glenn Lee from WT Wealth Management joins us to dissect the complex organism that is the US banking system. This episode promises to not only reveal how banks truly work but also demystify the pivotal concept of fractional reserve banking, where banks hold only a fraction of your deposits. We scrutinize the double-edged sword of this system, exploring both its role as an economic catalyst and its inherent risks as recent banking events have shown. As interest rates climb, we'll help you grasp the repercussions on the investments that are the bedrock of banking stability. 

Venture further into the banking frontier as we deliberate the imminent rise of central bank digital currencies (CBDCs) and the seismic shifts they may trigger within the financial landscape. With Glenn's expertise, we evaluate the potential overhaul of traditional banking functions and the federal government's prospective role in direct lending. The episode doesn't stop there; we also shine a light on the comprehensive suite of services that banks offer, from credit cards to investment advice. Safeguarding against economic turmoil, we reflect on the stringent regulations born from the 2008 crisis, ensuring you're armed with the foresight to navigate the banking world's evolving tides.

Thanks for joining us on Intelligent Investing with Glenn Leest! Your go-to source for navigating the complex world of finance and becoming an intelligent investor. We appreciate your trust in us and your commitment to your own financial future.

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Glenn Leest
Senior Investment Advisor
WT Wealth Management
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Speaker 1:

The following is paid programming brought to you by WT Wealth Management. Nothing we discussed should be considered as investment advice. This conversation is for informational purposes only. Please do your own research and speak to an investment advisor or financial planner before making any investment decisions. All right, welcome to Intelligent Investing with Glenn Lee. I'm your host. Jeff Orvitz and Glenn welcome. We've got a big one here. It has to do with the banking system. I think that's something that is on a lot of people's minds nowadays, especially with what's happened recently. So, yeah, absolutely. I think your goal here is to do this over two parts, because it's quite a bit so, starting with the US banking system and then moving on next week I guess to the Federal Reserve and how all that works.

Speaker 2:

Yeah, it'll be fun, but I think it'll be enlightening and really help the listeners have a better understanding, because the more that we know, the more that we can make informed and educated decisions. So that was kind of the thought behind doing that show. And the other thing I was going to say is we've been doing a lot of client meetings and probably the last 15 of them I'll ask hey, do you know how the banking system works? And they kind of look at me and go kind of, and so I explained to them kind of all the ins and outs. They're like oh okay, now this is making sense with maybe some of the recent banking troubles that we've seen on the news. So yeah, I think it'll be a great topic to explore more.

Speaker 1:

What banking troubles? I don't remember anything?

Speaker 2:

Well, it's been a few.

Speaker 1:

Yeah, there's absolutely been a few, and so you want folks to learn more about the monetary system and one of the most important things out there. So I guess the simple place to start, glenn, is what is the US banking system? Maybe give us all the nuts and bolts on that as best you can.

Speaker 2:

Yeah, it's really just a framework financial institutions that provide a variety of services to individuals and businesses. They take in deposits, they make loans, they do investments and really that kind of just sums it up. They you know a bunch of different financial services that they offer and a bunch of different banks. I mean, in every town there's probably like 10, 15 banks. You know there's quite a few, so they're everywhere.

Speaker 1:

And then we'll get in next week to the Federal Reserve System and go over that a bit. So it takes the deposits from its customers right.

Speaker 2:

And that's one of their functions.

Speaker 1:

That's one of the functions, and then keep it safe.

Speaker 2:

Right, that's the idea. Right Is they take the deposits. Well, you would hope so it's safe.

Speaker 1:

Yeah.

Speaker 2:

Yeah, because you don't want to have a six figures of cash somewhere at your house. That's probably going to make you nervous. So you give it to a bank and they also provide some security or at least protection from someone coming in stealing it. Yeah, what you're probably alluding to is a whole other subject.

Speaker 1:

Well, yeah, yeah, keeping it safe, because they loan out, they loan out the money, yeah, and so I guess talk about that a bit.

Speaker 2:

Yeah. So I think that's the one area when I ask people about that they're really probably the most unfamiliar with is how banks function in that capacity. So they call it fractional reserve banking and what that means is each bank has a reserve requirement, meaning what percentage of that deposit you just made do they have to keep on hand available. So say, you deposit $100 into your local bank and their reserve requirements 10%. So that means they only have to keep $10 on hand at the bank or on their books and they can line loan out the other 90%, or they can invest the other 90% or $90. So yeah, you have that $90 and say another person comes in and you say I'm going to loan you $90 and here's $90 and you charge them interest. That's how they make money. And then that person takes their $90 that they just got loaned and deposited it back into the bank and now the bank can loan out on that again as well.

Speaker 1:

So they can grow exponentially.

Speaker 2:

Yeah, yeah, yeah. That's where the it starts to get complicated. So in that last scenario, that person that deposited $90, you can then loan out $81. And then the next customer, if they deposit the money right back into your bank, you can loan out and you'll have to keep 10% on reserve. So on 81, that's what? Is that $74-ish?

Speaker 1:

73. Yeah, you can see, they just keep doing that over and over.

Speaker 2:

Yeah. So the important thing to recognize is what is that fractional reserve for that particular bank? And because that determines a lot. And then what are they doing with the money too? Because they have a whole bunch of different options. They can do the loan process and they charge interest, which is how they make money. They can also do investments too, so they can take the money you deposited and invest it. Now, investing is a broad term. Most banks, when they invest quote unquote they are usually buying very safe assets like treasury bonds or fixed income products. Usually, buying high risk stocks is kind of frowned upon because it's so easy for it to go south.

Speaker 1:

But they could, they could yeah.

Speaker 2:

Yeah, and I think that was part of the 2008 problem with Lehman brothers is that they were making risky loans on those subprime mortgages and then they're investing their money back into it as well, so it was like a house of cards. It was just doomed from the beginning. Because of that, that reason.

Speaker 1:

But even the more safe is that what happened with signature bank and these couple banks? Because they were investing the quote unquote, really safe assets, the treasuries yeah. But then interest rates spiked what they raise interest rates nine or 10 times over the course of a year. So then those old treasury notes that they invested in maybe six months or a year before were worth less yeah, and they kind of they kind of got themselves caught in that.

Speaker 2:

Yeah. So here's a good example. So person deposits money into your bank and you say it was used, the same $100. We can add just bunch of zeros, because it's easy math that way, but $100 and they take 90 of it and deposit it into a US Treasury which is just a loan to the US government, and it pays. You say 3%, maybe you know, a couple years ago, and you lock it in for 10 years, but then they've been raising interest rates since then. Yeah, now that same loan or loan to the government is paying four, four and a half percent, and so your 3% bond is going to naturally have a price discount if you have to sell it. But if you keep until maturity, it's it doesn't matter, you get your principal back. So so it's. The SVB bank had a bunch of those and they were just planning on holding it to maturity and the problem they got into is they had to make all those withdrawals.

Speaker 2:

Yeah, they didn't have to facilitate all the withdrawals from the customers and in order to facilitate that, they had to sell all those those fixed income products, and they sold it at a massive loss. Okay, and so that was part of the. The big issue there is well, if you think about, any bank would probably have trouble if everyone pulled out their money simultaneously, because no bank has 100% of all the cash on hand.

Speaker 1:

Yeah, that's just not how the system works, or even close to 10% by what you were talking about, Glenn right. I mean so the classic run on the banks and people demand their money and get nervous, and then it forced them to sell the assets they had at a discount.

Speaker 2:

Yeah, and I thought I thought we learned as a nation not to do bank runs, but maybe we're learning it all over again, cause any, like I said, any bank. It's going to put pressure on them to every single person tries to pull out their money. Simultaneously, they're going to have to try and sell off a bunch of stuff and probably sell it at a loss, call in all their loans and notes and it's just going to be a disaster. Now, some banks are better than others as far as how much they keep in reserves, sure, and so that's where the next layer of when you're looking at a bank, of what's important, is what are their? What do they have reserves on hand that actually are available for deposits to make good on those, or sorry?

Speaker 1:

withdrawals yeah.

Speaker 2:

Yeah, and so SVB was like 93% of their assets or something like that was, uh, loaned out or invested and so yeah, like we had not readily.

Speaker 1:

Yeah, they had like 70% available on hand. And then you had billionaire, like funds and stuff, going in and saying I'm taking my money out. I think Peter teal was one of those and, um, and then the next person's like well, maybe I should do that, because each bank account, the stickers on the window Glenn $250,000, right Right.

Speaker 1:

Insurance, so people would get nervous if they had more than that. Um, do you think it's over? Or? I mean, nobody has crystal ball I saw Warren Buffett was talking about. Hey, he thinks more may be coming, but uh, the feds moved pretty quick on that one.

Speaker 2:

Yeah, yeah, I think in like before they implemented the uh FDIC, backstop um off. To double check the dates, I want to say it was in the early 1900s, but before that they were having like 10,000 banks fail per year. And then, once they implemented the FDIC, kind of as a fail safe, then they're like having 10, 10 or less banks fail per year. So that guarantee by the government and the, the Federal Reserve, really brought a lot more safety and stability to the banking system. And so, as you're alluding to um Silicon Valley bank uh, one of the big names out there looks like they're going to get bailed out and they're going to get some help, um, from the Federal Reserve, the government and whether or not that's right or wrong is a different conversation, but that's kind of what it looks like is going to happen, and it happened in 2008 too. Yeah, they too big to fail is what they said, and they just bailed out the banks for what was really just bad behavior on their part.

Speaker 1:

Okay, let's get more into and you're listening to intelligent investing with Glenn lease um, the secondary market and how banks sell their loans, I guess, when you make a loan. So I want to get into that a little bit more. Uh, and if you've got any questions for Glenn, give them a call at 928-225-2474. And you can always email as well. Intelligent investing at WT wealth managementcom. Okay, so we talked a bit about how they get the deposits in and how they then can um loan out that money and they only keep us a certain amount, usually 10% on the books, or so, uh, charge interest on loans, um, which means that the boroughs pay back. So so, talk, talk about that. You make a, you make a loan. You think a lot of times that they keep that on their books forever, that the bank um, you know, a lot of times they're going to have a Glenn's bank, for example.

Speaker 2:

Yeah, a lot of times banks sell their loans where they say they do a mortgage and they get it approved and everything's good to go, and they may say, as a bank, you know, really we really don't want to hold this mortgage for the next 15, 20, 30 years. We'd rather just sell it to another institution, another financial institution, and just get um all that money back and maybe they'll make a little bit of money on the initial purchase, the upfront interest, that sort of thing. So that happens pretty commonly. Um, you may have even had that happen in your mortgage, is that?

Speaker 1:

I have a side, yeah.

Speaker 2:

You see a different name on your mortgage statement. It means your, your loan was sold, and so some I knew this actually from a car dealership I worked at a long time ago is they would make the loan and then like 30 minutes later it's gone. Yeah, they sell it as soon as it got approved there, they did not want to hold that loan, which made me, you know, wonder why. Why didn't they want to hold that loan? Was it a bad loan? Or they just weren't in the business for long-term loans? I don't know.

Speaker 1:

But they make some fees on the loan and they just get it off their books.

Speaker 2:

Yeah, yeah. So the banking system, um, you know, they can also, uh, sell out those, those debt products, which they're doing in 2000. 2008 is the CDOs and mortgage back securities, all those kinds of things. Um, they're just selling the debt to other people.

Speaker 1:

I remember alone yeah, it was um bank X, for example, and uh, then you get the first statement, maybe from them, and then there was just somebody else that's like oh, where are your, where are your mortgage holder now, yeah, yeah, okay, who are you?

Speaker 1:

Yeah, you know you know you're like okay, I guess that's how it is now. Um, okay, so how do, before we go to break here, glenn? Um, how is new money created? Because we often times think about the old printing press is just Zipping out new hundred dollar bills or just a dollar bill, yeah, but there's another way.

Speaker 2:

Yeah, so there's a printing press. There's the computer on the keyboard.

Speaker 1:

It's, that's a zero.

Speaker 2:

The Federal Reserve level. The other way is through the banking system. The banking system actually creates a tremendous amount of new money. And so let's go back to that example of $100 gets deposited, take 90 of it and loan it back out. Okay, that person takes the 90, you know, deposits, loan that back out, and continue, and so forth and so forth, and then all of a sudden, now you have all these Dollars that were created off of that original dollar and so it actually creates money. By that process, by the fractional lending process itself, they can create new money out of kind of just thin air. Yeah, so it's actually. I never knew that until a couple years ago and I was like, wow, that's fascinating, banks actually create money.

Speaker 1:

Yeah, they're the ones that do it through the commercial Lending, through the lending process.

Speaker 2:

Yeah, yeah, just they can do it through consumers, commercial mortgages, you know, whatever they want to do, because when they get that deposit back in after they done loan now comes back on their balance sheet as a positive and they can loan that back out and then, you know, more gets added. So it's just this ongoing process of where they, you know, started with $100, but then towards the end maybe they have $175 because a bunch of how many times they love and you multiply that by.

Speaker 1:

You mentioned all the banks that are in this country and Every in every community.

Speaker 1:

Of course, it's not just your banks. You got credit unions, things like that. Yep, yeah, all really the same. I. Another topic we should probably do another time, glenn, would be the. You know how there's been a push for essential bank digital currency. Would that take out the commercial banks from creating this process and, you know, creating money, I guess, out of thin air? And then then it's the. The federal's, the feds, just do it directly all the time. Just food for thought. I mean it's yeah, yeah, because there's definitely a push for that right now.

Speaker 2:

Yeah, if you change the dynamics of the fractional lending system, it'll definitely Make less dollars out of created in that process. So yeah, if the federal government says you know we're gonna have the Fed dollar or the Fed coin, whatever it may be, and that's the only way you can loan out, we'll just do all the loans. That seems Really not up there, alley. Yeah, this is a big task. I would want to take on all the loans.

Speaker 1:

Another topic for another day. Well, let's get into, when we come back, some of the other services that the banks actually offer the guardrails, I guess, the supposed banking regulations and all that that's supposed to protect everybody out there. And you're listening to intelligent investing with Glenn. Least Give Glenn a call 928 225 24 74. That's 928 225 24 74. And you can also email Intelligent investing at WT wealth management. Don't go anywhere. We got a lot more to come back in just a few minutes. You're listening to intelligent investing with Glenn. Least give Glenn a call right now at 928 225 24 74. That's 928 225 24 74. More intelligent investing with Glenn, least when we come back. Welcome back.

Speaker 1:

You're listening to Intelligent Investing with Glenn Least. We've got a call at 928-225-2474. Also, email Intelligent Investing at WTWealthManagementcom. We're talking about the banking system. Next week we'll get into the Federal Reserve a bit more, but before we move on, glenn, we'll talk about some of the guardrails that are supposed to be there with banking regulations. What other things do we get from the banks? What are the services? Just got to round out the whole topic.

Speaker 2:

Yeah, banks offer credit cards. They offer mortgages, investments most banks do. They also, in addition to that, do payment processing. So you've got your debit card or credit card, you swipe it at Starbucks. Starbucks says charge $10. It goes to the bank electronically. You have the funds, are there, process it through. So they facilitate the sending of money electronically back and forth, and then even checks as well, the same thing, and so that's the other thing that they do in addition to what we talked about is not just the loans, the deposits is some of the other ancillary services.

Speaker 1:

You still write checks. I still have checkbooks, you still do? Yeah, I find their use. Occasionally my wife says we have one somewhere. One singular check Just in case they make a lot of money on those fees on those debit and credit card transactions. We don't think a lot of people realize that.

Speaker 2:

Yeah, and some of them are 2%-ish. This can be as high as 3% for some credit cards, and evidence by if you've ever had a credit card and you do a cash advance or whatever, they charge you that 3% or 4% upfront. The other times, when you're using your card, you may not see that 3% charge. It's because the merchant is absorbing that and raising their prices accordingly. So, yeah, the banks are definitely making money on the transactions. I mean, visa and Mastercard are just absolutely monstrous, right, can it?

Speaker 1:

in yeah, yeah, and everything's really a little bit more. 2%, 3% more, if you think about it. Yeah, because everybody uses that card, even nowadays, for a couple of coffee. It's hard. You rarely see people whipping out some change or a couple of dollars.

Speaker 2:

Yeah, it's why you see those signs where it's like if your purchase is less than $5, we're going to attack on 50 cents. Yeah, it's because of the minimum transaction fees that they incur, like if you just buy a pack of bubblegum with your debit card, they get a little annoyed. Yeah.

Speaker 1:

Probably losing money because there's like a there's that minimum fee, like you said and then cuts into their profit margin. Yeah, Exactly Okay. So the guardrails and banking regulations and a lot of us, a lot of people listening, are familiar with 2008 and how the system really failed. So there's supposed to be regulations out there that protect people from the failures and bad doings of banks If they get into trouble and invest in things, and they're not not supposed to talk about that a bit.

Speaker 2:

Yeah, so one of the other jobs of the Federal Reserve is to oversee the banking system and make sure it's uh there's stability in it. And so the Federal Reserve implements a number of um criteria that the banks need to meet Um, and one of them is their capital requirements. So the minimum amount they need to have is that buffer. They'll say, okay, here's the amount of money you need to keep in case that you incur a loss on your investments, that sort of thing Um. And then, additionally, on top of that, it's liquidity requirements Um, how much you actually have liquid available to make the deposits Um, because you can have, say, 10% available um for withdrawals, uh, of your total assets, but you only need liquidity of, say, 5%, because the other 5% is just sitting there as a buffer or whatever the case may be. So you've got your liquidity requirements.

Speaker 2:

And then they also the Federal Reserve, manage overseas banks and does a lot of risk management. So they look at what they're doing with those deposits that come in and say are you being overly risky and are you um being prudent with some of these, the dollars that are deposited in? And if they're too risky or they're overextended or they've been over lending, they will definitely, um, impose changes. You know, say, hey, you're required to make these changes to your system. Um, and I think maybe in the last couple of years they've been more friends to the bank. You know, federal Reserve was like all kind of buddy buddy with a lot of the big banks and banking systems, but in reality they're the overseers, they're the you know, the supervisor, if you will, the boss. And so times they got to. You know, take action, say we have to make a change here, otherwise it's going to be a big problem.

Speaker 1:

And sometimes I miss it and then, but then sometimes, silicon Valley bank, which you mentioned, glenn, they actually had to go in and say we're taking over.

Speaker 2:

Yeah, yeah. So I mean by by by the Federal Reserve not enforcing their policies more strictly, which is, I think, what was kind of happening a little bit. It just made it. So when banks run into trouble, the trouble is magnified, yeah, yeah, because they're already kind of in a predicament, if you will. So, yes, those are some of the things the Federal Reserve is. You know, monitoring their risk, monitoring their liquidity, you know monitoring their Reserve requirements. And are they actually cash on hand? What are they doing with their deposits? Are they buying treasury bonds or are they buying Stock and some tech startup company?

Speaker 1:

Yeah, kind of make up the logic.

Speaker 2:

Yeah, so SBB was actually interesting because their loans were primarily to startup companies. In fact, I think all about 50% of all startups in United States got their funding from SBB, so that was like their bread and butter, wow. And startups are risky. Yeah, hopefully get your money back, but there's a chance it goes under and business fails and you know they default on the loan.

Speaker 1:

So ramifications of that might be felt for a while as far as startups who were expecting money, or Maybe they're still doing it. They're still in existence. The feds have just taken them over, but I wonder if that spigot kind of was cut off as far as funding for a lot of startup companies going forward.

Speaker 2:

Yeah. So I think a lot of the banks Looked at that scenario and might get a little bit more gun-shy, yeah, as far as making riskier loans, and just be a little bit more prudent, because they didn't want to have what happened. Svb happened to them and each, each, each bank in or has their amount that you can look it up, like how much they have for reserve requirements, how much they lending out, how much you know, yada, yada, yada. And some banks are a lot stronger than others. The big banks are, and you know they're in good shape. Svb was just was, it was pushing it to the absolute max.

Speaker 2:

And then some yeah, I'm, the other thing I was gonna say the Federal Reserve does is the, the FDIC Insurance, and so that's the 250, you know, deposit insurance. So that way, if the bank goes under, yet the you know Federal Reserve's basically saying, hey, we'll back that. You know account for up to $250,000, and so FDIC, yeah, yeah, yeah, yeah. So you know that gives people more, more confidence in the banking system. And you imagine if you went in to go deposit your money and they're like, well, if we make it, we make it, if we don't, you're out of luck. You're gonna say I'm not gonna deposit a bunch of money with you and you could go under and I have no control over that and I lose all my money. But if they have the FDIC guarantee, at least there's a backstop where you can limit some of those losses and as long as you don't have over the threshold you know it's reasonably.

Speaker 1:

The reasonable assumption is if the bank goes under, that you'll be just fine, you'll get your deposits back alright, a lot on banking and I always encourage and you do Glenn as well to Subscribe to the podcast because you might want to listen back and catch something that. What wait, what was that? Yeah, you've got a lot of episodes up there now. Look up intelligent investing on just about any podcast provider out there. Yeah, also, if you want to talk with Glenn, I'm always willing to have that conversation about your individual situation. Call Glenn least that intelligent or at WT wealth management. Yeah, my, my things mixed up here at 928 225 24 74. That's 928 225 24 74 or email intelligent investing at WT wealth managementcom. So next week let's get into the Federal Reserve.

Speaker 2:

Yeah, we talked a lot about today, yeah, so I think the next logical step is talking about what they do.

Speaker 1:

Yeah, probably some history there as well. Yeah, a lot of stuff for you. Okay, everybody, have a great day. We'll see you soon. The following has been paid programming brought to you by WT wealth management. Nothing we've discussed should be considered as investment advice, as Conversation was for informational purposes only. Please do your own research and speak to an investment advisor, financial planner, before making any investment decisions.