If you're allowed to make an IOU based on IOUs, then you can chain IOUs infinitely and a single default can chain-lightning every single financial actor for 40d6.
Imagine you have a bar of gold. You loan this bar of gold to someone. You now have his IOU for a bar of gold.
You then take out a loan yourself, using this IOU as a collateral. The bank now has an IOU. Bank B now loans to Bank A. Bank B has an IOU, collateralized by Bank A's IOU, collateralized by your IOU. Und so weiter. Only at the end is it collateralized by, like, collateral.
Better: banks don't even have to back an IOU with an IOU. They can back an IOU with 1/10th of an IOU. They create ten new IOUs based on your IOU.
If the original someone d'oh drops the bar of gold in the ocean, instead of him being jacked and you getting his collateral, every bank in the entire system is hijacked, and who gets the collateral? Just a little fucky wucky. A tiny oopsie boingo.
It is not exactly rocket science that lending against a loan is risky. You might even say it multiplies risk. You might say that by the time it becomes tens of thousands of IOUs backed by a chain of IOUs a hundred long, it's not so much 'risk' anymore but a guarantee. The only question is how far down the chain it will break.
It's like a weak-link finding machine that signals the weak link by displaying a financial crisis.
You could also say it's a busybodying machine. If you can back an IOU
with an IOU, then every person's debt becomes everyone else's business. I
need to know your credit worthiness. Yes, you personally. If I
want to know if a debtor is reliable, I have to trace his chain of
IOUs, and it goes through you. If I want to deal with anyone who holds
debt, to figure out their trustworthiness, I need to trace the chain of IOUs, and it goes through you. It goes through everyone.
It's not exactly rocket science that lending against a loan is risky. Nobody would do it if they were putting their own money on the line. Turns out theft is a crime, and widespread theft is, like, bad or something.
Banks will only buy an IOU because they're spending counterfeit money they made up on the spot. Investment bankers will only deal with these commercial banks because they're guaranteed by FDIC and the Fed. It's not their money. It's legalized laundering.
P.S. Being super explicit: if you loan a bar of gold and then take out a loan on the bar IOU, that's displaying a cake you already ate. The money is spent twice. It's counterfeiting. If a bank does it again, then it's spent three times. Shenanigans lead to divine wrath. Luckily Gnon is a sadist and enjoys the opportunity to torment you; give him a quick 'you're welcome' when you self-mutilate like this.
P.P.S. Peasants like to have peasant tantrums about 'usury.' They want to ban debt, which is backhandedly the right solution. If you can't ban IOUs being backed with IOUs, then yeah you can't let anyone have an IOU.
Problem: banning debt is logically impossible. Haha, peasants gonna pez.