Every day a golden egg

When doing time in economics classes, I was taught that if I wanted to sell the item with the highest gross profit margin, I should sell cups of coffee. The substance needed costs about 2 cents to buy and you can sell it for $3 because you mixed it up with free water and kept it warm. Sell $3’000 worth and you’ll have $20 cost of goods sold, or in other words a profit margin of 99.33%, which equates to 14900% mark up.

That is indeed impressive. Not many retail items can claim such lucrative attributes, as a matter of fact I can think of only one other, bank fees.

Erwin Fletcher wants to put aside some money, build up a deposit so he can buy a family home. The idea is that every fortnight, shortly after Erwin's employer deposits the wages into his normal savings account, a certain amount, say $200 dollars, are transferred to a special saver account. So he goes to his bank branch and asks the staff to set up an automatic transfer every fortnight. No problems Sir.

It all goes well for months and months, but then one fortnight he did have only $180 in his regular account, just short of the $200 that is routinely debited. The bank charges him a $30 fee for not having had enough money in the account to do the transfer.

Let’s keep in mind that no bank employee had to move a finger. A computer tried to move money between accounts, but an IF statement in its program stopped the transactions as there weren't sufficient funds. What was the cost to the bank? Nil. But they charged Erwin $30 dollars. The fact that Erwin’s account did not have sufficient funds to be transferred did not inconvenience anyone. He didn’t borrow money from the bank or any third party. A computer program simply did what it was designed to do and not transferred an arranged sum.

The cost of this attempted transaction by the bank’s computer amounts to $0, sold to the customer for $30. Happening thousands of times a day across the nation. This, ladies and gentlemen, is one of the many rip off mechanisms the banks employ to make the obscene profits they are known for.

I guess it takes a banker to defend one, and so the Chief of all Australian bankers, Reserve Bank governor Glenn Stevens, had the following to say at last weeks hearing at the House of Reps committee on Economics:

"While I know, in some ways, people feel aggrieved that banks are highly profitable, there are other banks around the world that are bearing large losses and because of that, they're not in a position to make loans," Mr Stevens said.

"If you assess what's more preferable, the banks we have are far more preferable."

Whilst it is true that it is preferable to have banks which don’t make losses, apologists like Glenn Stevens translate this into banks must reap exorbitant profits.

The banks RBA governor Stevens is referring to, the ones who are currently under liquidity pressure, are not in dire straits because they failed to charge their customers enough bank fees, they are suffering big write offs due to their overpaid management teams not doing their homework and chose to invest borrowed money in crappy repackaged US housing loans, and are now called up on it.

And it’s not, as Stevens seems to imply, that only “other banks around the world” were sucked into the vortex of greed and are now bit by bit spat out at the other end with monster losses, there are potentially plenty of them right here at home. A couple of weeks ago I pointed in a post at the dilemma the Australian banking sector might be facing. According to some analysts, the risk exposure Down Under could be far greater than widely admitted, with the chances being moderately high that the current global liquidity crisis will also be forcing Australian banks to bring out their dead over the next two years.

Businesses, not unlike farmers, know that you gotta make hay while the sun shines, but banks, being masters in the art of cashing in, have figured out a way how to stuff their money sacks no matter which way the weather turns out. The only thing that could change that, is when asset prices are falling. And that is essentially what is happening in the US.

Our bankers know they are not immune to being caught in the global wave of balance sheet write offs due to the contracting US economy and its consequent deflating housing bubble. And so, with an approving RBA governor Glenn Stevens confirming this, Australian banks are already passing on their as yet unidentified but plausible losses to the customers in any shape or form they can. Be that with interest rate rises above the official rate or through ridiculous fees and charges just to have a computer program tell you how much money you allegedly have or don’t have.

Every time someone misses a mortgage payment or hasn’t got enough money in the account to cover an automatic transfer, the banks earn money, not even asking, they just deduct their fee out of your balance. What are the cows in the steeple aka the customers gonna do? Switch banks? They all do it. Massive sums are being raked in that way Australia wide:

Committee chairman Craig Thomson said annual bank profits had climbed to about $4 billion, up from about $1 billion five years ago.

That means quadrupled in 5 years, across the industry, all competitors in unison. Are there four times more customers in the world? No, banks making a packet is due to existing customers simply being milked more intensely. To get an understanding of the banks profit curves, I chose one of the larger banks, one with a pretty consumer friendly name, the Commonwealth Bank, the one that doesn’t like Mad Max koalas in its advertising, which in their eyes makes all the difference.

On the right is a graph I put together on how the CBA's net profits have developed over the past 10 years. And yes, this was your money once, at least if you are CBA customer.

According to the Reserve Bank’s March 07 Financial Stability Review, Australia’s 5 biggest banks made in 2006 a combined after tax profit of 24 Billion dollars. As a comparison, that is 10 times the amount of the federal government’s annual cash surplus, or close to being twice of what Australia spends on defense.

Profits are coming out of their ears, and yet, even in times when growing sections in the Australian housing market are experiencing some kind of mortgage stress, they have no scruples whatsoever to increase interest rates above RBA figures and mushrooming the earnings from fees & other charges.

The real idiocy about it is that banks are actually playing us all for fools and continuously get away with it. Supposedly their role is to be the middle men between the saver and the borrower. B deposits money with the bank, which A then loans, with the bank earnings being the difference between interest earned and paid. That however is not how the scheme is designed. I mean ask yourself, have you ever received a letter from your bank saying your deposited funds were unavailable for the time being because they lend it to someone else?

This is what someone who knows a little bit about the plot had to say:

"Banks lend by creating credit. They create the means of payment out of nothing."
- Sir Ralph Hawtrey, Secretary of the British Treasury during the 1930’s

This magic trick has a name, its called fractional reserve banking. How it works and what it means for Erwin Fletcher, is worth its own post. Hopefully I will get around to it in the not too distant future.