ELI5- how exactly do ‘bankers’ become the richest people around(Jp Morgan, Rockefeller, rothschilds etc.), when they don’t really produce anything.
In: 17100
The don’t produce a good, they perform a service — they exchange future money for present money, and vice versa.
A few get rich because it’s an extremely valuable service. But a lot of bankers go broke too.
What they produce is money for entrepreneurs to start their businesses which is repaid over time, with interest. Essentially, they get a cut of everyone else’s labor every time they are paid back.
Let me reword that a bit.
I’ll broaden “bankers” to financial services providers (FSP). That will include bankers, money lenders, money changers, escrow agents etc.
I’ll also expand “produce” to “add value”. As other have pointed out bankers provide services, not goods.
It’s actually an open question if FSPs provide value or not. One theory says that they add value in the form of things like liquidity, information generation, financial advising etc. The argument is that the service they provide is making other businesses more efficient. If that’s true it’s certainly worth something but we’re also not sure exactly how much it’s worth in practice.
An other theory says that when economies get big enough FSPs will just show up to take advantage of all the money floating around. This essentially says that FSP either don’t add value or add less value than they cost.
Economists have argued theories in both directions but they haven’t been able to test it. If you just look at historical records you see economies and FSPs rising together. That makes it hard to figure out which causes which. You also can’t really run an experiment because no country in the world will let you just turn FSPs on and off to see what happens.
The question of why the got so rich is because that’s their business. Who is possibly going to be better at making money than someone who’s entire business is nothing but money? Any other business may be the leader in their particular industry but all of them across all industries are potential FSP customers.
If you sell a service, you are selling your time for money. Since there is a limit to how much time you have, there is a limit to how much money you can make.
If you sell a product, the product is made of material. There is a limit on how much material you you can obtain so there is a limit on how much money you can make.
A banker uses money to make money. They loan money and charge interest. They don’t actually have to possess the money they loan. They don’t actually have to get any physical monkey back (just numbers on a ledger) and they can loan out even more money from the interest they get back. There are no physical limits, so they just keep getting more money.
As said before banks provide a service…
You keep your money (savings) in a bank. Currently, the bank pays 0.5% interest to you to hold your money. They use that money and loan it to people who want to borrow it. New home loan rates are ~4.0%.
As long as the person that took out the loan continues to pay back the money the bank is making the difference ~3.5% interest on the money the bank is holding for you. Rinse and Repeat.
Edit: Thanks for the awards. I did not expect that and it’s appreciated. My explanation was a very basic overview of retail banking. This did not cover fractional reserve banking or investment banking, which have some good explanations below.
The way banks make money is that the money you store with them, they then loan out to people. Those people pay back those loans with interest. The bank gives you a tiny portion of that interest, and keeps the rest for themselves.
The more money people store with them, the more they can lend out, the more profit they can make.
This is also why a bank never as as much money as the collective total of their customers. If every customer were to withdraw their money on the same day, the bank would quickly run out. This happened during the Great Depression.
BTW, Rockefeller wasn’t a banker. He was an oil man. He basically cornered the oil market so much that they had to split his company (Standard Oil) into [34 different competing companies](https://en.wikipedia.org/wiki/Standard_Oil#Breakup), companies well known even today, such as Arco, Amoco, Chevron, Exxon, Mobil, Phillips66
This just reminded me that I need to watch ” The Men Who Built America” again
That is all….. thank you 🙂
I know this will get buried but no one is talking about it.
Leverage.
Many of todays modern “bankers” can amass fortunes through the clever use of leverage. The neat thing about leverage? Every home owner is trying to engage in it.
Think about it, you buy your house in a hot market, put down your 20%. For easy math lets say you paid $100,000 for it. and in 5 years the market goes crazy, and you sell it for $200,000. If you paid $800 a month, you’d spend $48000 to own the house. But you’d make $52000 on selling it, so you just turned your $20,000 into $52000+ profit in 5 years, roughly 2.6X return (the actual number is a little different, but I’m keeping it simple)
Now take that same exact method *and go buy a company.*
Lets say you go out and buy a Greeting Card Company. You scratch together a million dollars, and then go to the banks and *borrow 79 million.* You use the company you just acquired as collateral, just like when you buy a house. 3 years later after some good management and improvements you sell the business via ipo for $290 million and after expenses you pocket 66 million. So you make 66x return on your investment.
When debt has a lower cost of capital, than equity you can use that to multiply equity growth.
First two corrections:
1. Rockefeller was not a banker. He made his fortune in oil.
2. When JP Morgan died it was discovered he was not uber rich like the peers of his age. He was just good at parleying his banking connections and assets to make it look like he was uber rich. He was flexing so he could be the banker for the uber rich but he himself was the next tier (or two tiers?) down in wealth.
The Rothschilds are the only people I know who got uber wealthy banking from a long time ago that is still around. I got to give you some some set up. During the Napoleonic Wars nations where borrowing money like mad (to give you perspective, the UK only finished paying off that war debt in the last 15 years on a war that happened 100 years before WW2). They even gave out IOUs to soliders in lieu of pay. Basically this war debt went up and down in value based on how war the was going. The Rothschilds were already rich at the time of the Napoleonic Wars and were doing well from financing the wars of various nations. What shot them to epic wealth is they had bought a lot of government debt during the war when people thought the Britain might loose, and sold it later after the war when deeply slashed government spending was maximizing need for safe debt to invest in.
Now another correction. A lot of these billionaire “bankers” you hear about now a days are not bankers. They work outside the banking system in the more general financial system of which the banking system is just part of the whole. From this point on I will call them “financiers”
**How financiers become overnight billionaires is by “arbitrage”. Arbitrage in finance is when you find a way to get an asset or liability treated as though it is a better asset or liability by either investors or the government.**
Let me give you an example of a common form arbitrage. Pension funds are funds that people have invested in for retirement. The thing about pension funds is that they are often under strict rules from their investors on what they can invest in. People don’t want their money for retirement to disappear. They like safe investments. But safe investments pay garbage and managers of the pension aren’t going to get fat bonuses at the end of the year if they stick to what is normally available. They many not even keep the pension fund liquid.
To the “rescue” come the financiers. They find ways to turn assets the pension fund is not allowed to own (and thus pay more interest) and turn them into assets the pension fund can buy. They do this buy bundling risky assets together, buying some default insurance, giving then assets to a shell company, and then selling bonds that have first right to cash flow to all those risky assets. The end result is something that pays like half a percent to 2 percent more than the traditional low risk assets.
To grant perspective, the California State Teachers’ Retirement System is worth $254.7 billion. If just that pension fund invests just $100 billion in your new asset you are looking at a commission of like $500 million. And the pension fund is glad to play your commission because this will result in like $1 billion more in earnings every year. Additionally you will still be managing this shell company for the rest of its existence and will be collect an annual fee to manage those assets every year of tens of millions a year. And this shell company only takes like $200k to run a year. Maybe some offices, a secretary, and lawyer on retainer.
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