“Most people believe that money in society is generated by central banks accountable to governments”

“Roxie, what do you think really happened in the financial collapse that started in 2007?” asked Vanessa.

“Most people believe that money in society is generated by central banks accountable to governments” replied Roxie. “In reality, as I am sure you know, it is mostly created by commercial banks when they issue debt. When someone borrows money it creates a liability which is digitally balanced by an asset in the banks database. This is based on the expected payment of this liability with interest. A bank is considered solvent when the expected realisation value of these assets exceeds the liabilities of the debtors. Once these assets in the banks database have been created, this ‘money’ can be traded and exploited. The interest and charges attributed to all this trading can then be systematically extracted. The only thing required to create this money is the creation of a realistic asset, or more importantly, something that it is possible to get people to believe is a realistic asset.”

“I’m not sure I fully understand what you mean by getting someone to believe it is a realistic asset?” said Vanessa.

“Let me try to explain another way” said Roxie. “Let’s pretend that I am a budding amateur painter who has just produced my latest effort. As an unknown painter with no reputation my effort is worth maybe £5.00 to any prospective buyer that may take pity on me. In effect I have created an asset that is worth £5. I decide to put my painting into an auction where by chance it is spotted by an unscrupulous art dealer. The art dealer believes that my work could be confused with the work of a famous painter; let’s say for instance a Jackson Pollock. This is a bit unlikely I have to admit, if you have ever seen any of my pitiful efforts. The dealer, or rather an obscure company based in the Cayman Islands which is owned by the dealer now buys my painting for £5.00. The dealer then works in conjunction with a renowned art critic who categorically professes to the world that their painting is the genuine article, a previously undiscovered Pollock. This makes my painting worth a potential £500,000 to the dealer when his company sells the painting at auction.”

“We have now created a potential £499,995 of additional wealth that didn’t exist before. This is pretty impressive as you have to remember, should the art world discover the painting is a Roxie not a Pollock, the true worth of the asset is still only £5 not £½ million pounds!”

“Now that the painting has been verified as a Pollock it is possible for someone to borrow money against the expected value of this asset to purchase it. This borrowing is created in the database of their bank and viola, nearly £½ million of real money has been created where none existed before. Now humour me and let’s suggest that this money was borrowed from the bank by a museum in order to secure this ‘Pollock’ for the public interest. After the auctioneer’s commission the art dealer’s company in the Cayman Islands now has nearly £½ million of real money. As the Cayman Islands is a tax haven there is no tax payable by the dealer, and the public purse has accrued an additional £½ million pounds of debt, plus an additional liability for the interest owed to the museum’s bank. Horror upon horror it is now discovered by the museum that the newly purchased Pollock is actually a virtually worthless Roxie! The museum no longer has a tangible asset to cover the liability accrued, but the museum still has to pay off the debt to its bankers unless of course it goes into liquidation, in which case the bank has to write the loan off as a bad debt.”

“Now all we need to do to explain what has been going on in the financial markets is change the characters. The Roxie painting was the millions of sub-prime mortgages taken out on vastly overpriced property that the mortgage holders couldn’t possibly repay. These were basically worthless unsecured debts. At this point nobody would be seriously taken in, let alone invest in them.”

“The art dealer was the traders in the investment banks that invented a cunning financial device called a CDO (Collateralized debt obligation) which most people didn’t understand but which the traders insisted were sound financial instruments. In our scenario the sub-prime mortgages were the Roxie but the rebranding of this debt into CDOs made them into potential financial Jackson Pollocks.”

“The role of our art expert was taken up by the various credit rating agencies that, for a suitable fee, said that these CDOs were indeed sound financial instruments and who gave them top AAA ratings. The Roxie, the sub-prime mortgages, had now been verified as Pollocks, secure AAA rated investment opportunities by the so called experts.”

“I think I understand what you mean” interjected Vanessa. “By validating the worth of the CDOs the ratings agencies effectively created supposedly low risk valuable financial assets where before the same assets as high risk sub-prime mortgages were considered virtually worthless. They created a Pollock out of a Roxie.”

“Exactly my dear,” continued Roxie with approval “but unlike the mere £ ½ million of new money created in my little tale, this ploy created hundreds of billions of pounds of new money. The investment bankers traded these CDOs at great profit many times over and extract vast amounts of this new money through fees, charges and bonuses which were then placed in nice secure tax efficient financial instruments. The banks created vast amounts of debt on their balance sheets, secured against the value of these AAA rated assets which worked absolutely brilliantly as long as the majority of investors failed to understand their true nature. When it was eventually discovered that these CDOs were actually worthless, it left the banks with vast sums of unsecured debt which were then transferred to the public through the aforementioned bank bailouts. Meanwhile these traders, colluding politicians and their ultra-rich customers are now sitting on mountains of cunningly extracted wealth whilst the societies from which they systematically extracted it are now left holding unimaginable amounts of debt. In order to pay off these vast debts, the public have been subjected to ‘austerity measures’ by the self-same politicians who actively colluded in creating this debt in the first place. This has caused absolute misery to millions of the poorest and most vulnerable in our global societies.”