Behavior Never Lies

It’s not that banks want to foreclose on delinquent homeowners; it’s that they really don’t lose when they do.

It’s time to stop theorizing about whether or not banks want to take foreclosures back. By peering behind the curtain and exploring how banks create mortgages, it becomes easy to understand why the foreclosure crisis is not going away. Foreclosures are, after all, a planned scenario built in to bank’s business models and are quite a profitable part of their overall business.

Banks don’t lend money – they create it

In 1961, the Federal Reserve Bank of Chicago published a booklet entitled Modern Money Mechanics, which revealed the inner workings of our modern banking system. Known as a fractional reserve system, banks must maintain legally required reserves equal to a prescribed percentage of its total deposits. Generally speaking, banks must always keep a monetary reserve of 10% against most transaction accounts. In other words, if a bank has $10 billion in total deposits, $1 billion must be held as “required reserves”; the other $9 billion is considered to be an “excessive reserve” and this amount can be used as the basis for new loans.

We would logically assume that banks are taking quite a risk by creating new loans for consumers derived from 90% of depositors’ money, but this is not reality. What really happens is that banks create new loans for consumers on top of their excessive reserves out of nothing; banks don’t actually touch their depositor’s reserves for lending purposes. If they did, banks and their depositors would be in big trouble; especially in today’s economy. This practice of fractional reserve lending is how our money supply expands and where the term inflation is derived from. As stated in Modern Money Mechanics:

“Of course, they (banks) do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes(home loans) in exchange for credits (money earned by a borrower and paid to the bank) to the borrrowers’ transaction accounts.”

As long as the 10% reserve requirement is satisfied, banks can keep creating new loans with none of their own monetary backing to satisfy consumer demand. It’s important to realize that new loans to borrowers represent money that will probably be deposited into other banks by individuals and businesses being paid off with each borrowers’ loan money. These new deposits increase the reserves at those particular banks, allowing them to re-create the process just described, which adds exponentially to the money supply. This deposit/money creation loan cycle can go on to infinity. For every new deposit that exists in the banking system, nine times that amount can be created out of nothing and lent to consumers. In fact, $10 billion in deposits turns into $90 billion in newly created money available for loans. This money is simply created out of thin air by the Federal Reserve Bank and wired to the web of commercial banks it sponsors. A bank “loan” literally springs into existence based on consumer demand; that’s when the printing press starts churning out the new money to satisfy the “loan”. Homeowners believe their mortgage is money derived from their bank’s existing assets, not fractional reserve “funny money”.

In the case of a home loan, banks simply create a piece of paper called a Mortgage Note that a homeowner makes installment payments on every month; with interest. If a homeowner fails to pay as stipulated in the note, the bank can take that homeowner’s home. The homeowner literally bears all the risk while the mortgage lender puts up nothing, as stipulated in Modern Money Mechanics. To banks, a home “loan” is a nothing more than a bookkeeping entry – a theoretical liability on paper.

Some consideration would be nice

Most people assume that a home loan comes from actual bank funds or a bank’s existing assets and not from simple bookkeeping entries as fractional reserve practices allow. In 1969 there was a Minnesota court case involving the First National Bank of Montgomery v. Jerome Daly. Commonly called “The Credit River Case”, the First National Bank of Montgomery was seeking to evict Mr. Daly from his residence, which it had foreclosed on. The defendant, Mr. Daly argued that according to the mortgage document he signed with the bank, both parties had agreed to each put up a legitimate form of property for the exchange. In legal terms, this is referred to as consideration. Mr. Daly went on to explain that the banks did not honor their contract with him because the money for the home was not the property of the bank before it was lent to Mr. Daly, and was created out of nothing as soon as the loan agreement was signed.

If we refer to Modern Money Mechanics, published by the Federal Reserve Bank itself, it states in plain English that when banks make loans, they “…accept promissory notes (mortgages or other loans) in exchange for credits (money earned by a borrower and paid to the bank) to the borrowers’ transaction accounts.” Modern Money Mechanics elaborates further by stating “Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system.” In other words, mortgages come into existence based on consumer demand and banks literally invent the “loan” out of nothing.

As the case progressed, Mr. Morgan who was the president of the First National Bank of Montgomery at the time, took the stand. He admitted the following facts, which can be found in the judge’s personal memorandum:

• The plaintiff, (bank’s president) admitted that in combination with the Federal Reserve Bank, did create the money and credit upon its books by bookkeeping entry.
• The money and credit first came into existence when they created it.
• Mr. Morgan admitted that no United States law or statute existed which gave him the right to do this.
• The jury found there was no lawful consideration and the court rejected the bank’s claim for foreclosure.

Jerome Daly kept his home. The actual court documents from the court’s files in First National Bank of Montgomery vs. Jerome Daly case can be found in the Minnesota State Law Library at

Only a tiny number of people know about the case because it was tried in a “justice of the peace” court; these cases are not precedent-setting and are therefore not widely published or well known. The underlying ramifications behind this case are immense though.

Banks don’t lose money when they reclaim a home

Many would argue that banks actually do lose money when they take a home back in a foreclosure situation. Those who pose that argument need to understand the difference between losing money and spendingmoney. Banks have to spend money on the foreclosure process itself, accrued property taxes, upkeep of the home and on fees associated with selling the home. These expenses usually don’t produce a net loss their books because homeowners’ initial interest payments build offsetting cash reserves for banks before a home is foreclosed on. While it is true that banks would prefer that homeowners pay their mortgage over time, they still profit from foreclosing on non-paying homeowners. In all honesty, the bank is indifferent – they win either way. They make more money in slower fashion when a homeowner pays their mortgage over time; mainly in the form of interest. Banks make less money, but make that money much faster when a homeowner defaults and a home is foreclosed on. Those who still stubbornly argue that banks indeed lose money on foreclosures must remember that taxpayers historically are forced to “bail out” banks and will continue to do so in the future. Where is the bank’s “loss” in that scenario?

If the banks put up valuable consideration for the purpose of lending for real estate, such as depositor funds, their own money or existing assets, they’d be scrambling to re-write people’s loans right now in an attempt to be replenished financially. This is not the case however. In reality, banks put up nothing for the purpose of lending and have taxpayers as a crutch; so they may as well just sit back and collect more homes.