What Do Banks Produce?

Bernie Sanders says banks have assets equaling sixty percent of the Gross Domestic Product (GDP). Bloomberg says banks are bigger than the GDP. But what is GDP? Well, according to Investopedia “The gross domestic product (GDP) is one of the primary indicators used to gauge the health of a country’s economy. It represents the total dollar value of all goods and services produced over a specific time period. You can think of it as the size of the economy.

GDP is the size of the economy. Why would banks representing 60 percent or more than 100% of the economy be important? Well, the economy is the total dollar value of goods and services produced over a specific period of time. If GDP is used to gauge the health of the economy then it should follow that if banks are bigger than the economy then their health reflects the health of the economy. Anything that negatively affects banks negatively affects the economy. We felt that effect in the 2008 recession.

When you think of banks, what goods and services do you see them producing? The only thing tangible I ever see coming out of a bank is money. But banks don’t produce money, the federal reserve does right? That is partially true. The federal reserve prints paper money and the treasury mints coins. So the banks don’t physically produce anything. But how can they represent more than the GDP?

That’s where things get interesting. Again, according to Bloomberg banks are not required by U.S. accounting standards to record the full amount of derivatives and mortgage backed securities on their balance sheets. If they were required to then they would be twice as big as they are because derivatives and mortgage backed securities are considered assets. That’s where we may get to the difference between Bernie’s assertion and Bloomberg’s. Bernie might just be looking at what is recorded on the balance sheets and Bloomberg is looking at the additional securities that are not recorded.

What are derivatives and mortgage linked securities and why are they so important to the health of our economy? A derivative is a contract between two or more individuals based upon a specific asset. It’s total value is determined by the price of that underlying asset and has absolutely no ownership interest in that asset. So you have an asset like JPMorgan which closed at a price of $78.83 this last Friday and you have a derivative of JPMorgan. Let’s say the derivative is a call option at a strike price of $79 with an expiration date of December 2, 2016. The last traded value of that option was $.63. Now that call option gives me the right to buy JPMorgan stock for $79 and it costs me $.63 to buy that option. It’s cheaper to me to buy the option than it is to buy the stock but if the stock goes down then I lose my $.63. In order for me to make money the stock has to go above $79.63.

But why would anyone buy an option like that? Say the stock went to $80. If I bought the stock I would have made a dollar. If I bought the option I would make $.37. Not that great of a deal right? But if you look at it in terms of the return on my investment, investing in the option has afforded me a greater return, 58.7% vs 1.2%. In order to buy that option you have to pay JPMorgan’s market maker $.63.

So you have the stock’s intrinsic value and you have the value of the derivatives of that stock. To give you an idea of how large that derivative market is let’s look at just JPMorgan’s call options. The strike prices available range from $50-$115 in increments of $.50 for a total of approximately 120 different strike prices. Multiply that by 15 different expiration dates and you have 1800 different options you could invest in.  Now consider that JPMorgan can offer 50,000 of each of these 1800 different options for sale and you have significant amounts of money being gambled on the price of JPMorgan stock alone. Now multiply these numbers by 3831 which is the number of optionable stocks and you begin to see that Bloomberg is probably right when they say banks are bigger than the US economy.

But what does that mean for you and me? It means that as long as we invest in any of those 3831 optionable stocks there is a chance that once again our investment could be halved by a recession. My suggestion? You’ve heard it before buy local, buy used, compare prices, give yourself a raise, do your research and change the world by directing where your money goes.

 

Buy Used

One of the best ways to save money and keep it in your community is to buy used. This can be done with everything from automobiles, furniture, power tools, lawn equipment, hand tools, bicycles, camping gear, sports equipment, construction material and just about any other kind of hard good and even some soft goods like clothes. Buying used means that you’ll enjoy a 30-90% reduction off of original price and if you use a local thrift store or buy from a private party virtually all of that money stays in the community.

Let’s look at automobiles as an example. The minute you drive a new car off the show room lot it loses 20% of it’s value. That’s 20% that goes directly into the pockets of the wealthiest people in the country. On a thirty thousand dollar auto that’s $6000. So what do you do? You buy used. You want a new car. Don’t buy one. Instead buy a car that has less than 10,000 miles on it.

Let’s take an example. Say you want to buy a Chevrolet Malibu. To buy the LTZ model new you’re going to pay about $30k. If instead you spend that $30k on a used car you can get a 2014 Chevrolet Equinox, a 2011 Audi Q5, a 2009 Dodge Challenger, a 2006 BMW M5, or a 2009 Corvette. By buying a car that is one to five years old you upgrade your ride and keep a bigger portion of those dollars in the community.

Now there are some drawbacks to this, like the warranty will have less time on it or the car could have been in an accident. So you’ll have to do your due diligence. When you buy from a dealer or a private party have the car checked out by an auto body person and an auto mechanic that you trust.

Also, if you use a local dealer rather than one of the manufacturer’s franchises; more of your money will stay in the community, many times the shop rate is lower than the franchises and the customer service is often more personal.