In an excellent Vanity Fair piece, Michael Lewis comes up with the best – and funniest – description I have yet seen of the business of investment banking (he used it with reference to Iceland’s spectacular collapse, but I think it applies to banking in general):
“You have a dog, and I have a cat. We agree that they are each worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners, but Icelandic banks, with a billion dollars in new assets.”
Just to make the picture complete, you could add that the assets were purchased with borrowed money, the debt sold to a third party in the form of a collateralised debt obligation, which was insured against the risk of default by yet another party in the form of a credit default swap, which was then sold on the someone else (perhaps one of the original Icelandic banks) as an asset. Ergo – your original dog and cat are now worth many billions of dollars.
But they’re fake dollars, and that, in a nutshell, is why we are in the mess we’re in.