The Bookmaker of Business: A Financial Tale by Murray H. Williams Read Free Book Online

available to the public in the bank’s
annual report.”
    David turned to another page in his binder showing the
following figures.
     

     
    “Here’s an example of a bank with a healthy balance sheet. A
depositor’s money would be safe from loss in this bank. This bank has $1
million in demand deposits. However, it only has $100,000 in cash. At first
glance it may seem shaky since there is not enough cash to meet depositor
demand should they all ask for their money at once. However, the bank does have
$1.2 million in government bonds. In the event of a liquidity crisis, or bank
run, the bank could sell its government bonds quickly and raise the cash it
needs for customer withdrawals. This bank would survive a liquidity crisis. You
can also see how this bank has $10 million in loans outstanding. I showed you
earlier how banks make loans. Although these loans may be generating income for
the bank, they are absolutely worthless during a liquidity crisis.”
    “That actually makes sense.”
    David turned to the next page in his binder.
     

     
    “Here’s an example of a bank with an unhealthy balance
sheet. Even though it’s meeting the legal reserve requirement of 10 percent,
this bank is dangerously over-leveraged. Similar to the first bank, there are
also demand deposits of $1 million, versus $100,000 in cash. Unlike the first
bank, however, this bank has a loan portfolio of $20 million. At first glance
it may seem like this bank is stronger financially since it has greater assets
and shareholder equity than our earlier example, but let’s take a closer look.
Although its loan portfolio is larger and would generate more interest income
than the earlier example, this bank has zero government bonds. If depositors
asked for their money all at once, this bank would not be able to meet the
withdrawal demand. It would be insolvent.”
    “How’s that?”
    “Well, with demand deposits of $1 million versus only
$100,000 in cash available, you do the math.”
    “I see your point.”
    “Unfortunately, most depositors are unable or unwilling to
do a simple balance sheet examination before putting their money in a bank.
That is why they fall victim to bank failures.
    “Honestly, I don’t understand why anyone would want to keep
most of their money in a bank when government bonds are freely available.
Considering how frequently banks fail, it just doesn’t make sense.”
    “How can a government bond be safer than a bank?”
    “When was the last time the United States government missed
an interest payment? And when was the last time a bank failed? The safest place
for your money is obvious.”
    “Are you saying that no one should have money in a bank
account?”
    “Of course not. Everyone needs a bank account. It makes it
easier to trade goods and services. All I’m saying is people shouldn’t keep the
majority of their assets in banks considering their failure rates historically.
    “The problem is that many bank executives act like margin
speculators and don’t consider all the risks. They over-leverage their banks
out of vanity and greed and then scratch their heads when their banks fail. The
tragedy is that while margin speculators lose only their own money, bank
executives lose their depositors’ money too. And if bank failures are
widespread, it harms the economy since the banking sector is so vital to a
nation’s commerce.”
     
    Colby stood. “Well fellas, I need to be getting back. I
gotta business to run, and it ain’t gonna run itself.”
    “OK,” Sean said as he got up too.
    “See ya around, kid.” Colby said as he shook hands with
Sean.
    “Thank you.”
    Colby and David nodded to one another once more before Colby
left the office. As he walked past the receptionist he winked at her. She
blushed.
    “This is probably the best lesson I’ve ever been taught. So
much so that I feel like a weight has been lifted off me.”
    “Knowledge can have that effect sometimes.”
    “I can’t tell you how