2008 Bank bailout
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Bailout 1: Liquidity vs. Solvency
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Bailout 2: Book Value
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Bailout 3: Book value vs. market value
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Bailout 4: Mark-to-model vs. mark-to-market
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Bailout 5: Paying off the debt
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Bailout 6: Getting an equity infusion
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Bailout 7: Bank goes into bankruptcy
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Bailout 8: Systemic Risk
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Bailout 9: Paulson's Plan
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Bailout 10: Moral Hazard
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Bailout 11: Why these CDOs could be worth nothing
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Bailout 12: Lone Star Transaction
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Bailout 13: Does the bailout have a chance of working?
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Bailout 14: Possible Solution
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Bailout 15: More on the solution
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CNN: Understanding the Crisis
Bailout 7: Bank goes into bankruptcy What happens when there is no equity infusion and the bank goes in to bankruptcy.
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- So the example of the bank we've been studying, we're
- actually kind of doing it in real time.
- And I was doing this on the fly.
- We actually showed how this bank got
- quote-unquote bailed out.
- And it got bailed out by the sovereign wealth fund.
- Because when this last piece of debt came due, it couldn't
- sell its CDOs for enough money to pay off that debt.
- So they just kind of held fast and didn't sell their CDOs.
- They couldn't get any other loans to pay off this loan.
- But what they were able to do is to convince some foreigners
- who were enamored by the brand of this institution of
- American capitalism.
- So they were willing to buy some shares in this company
- and essentially bail it out.
- So in the example, we used to have 500 million shares.
- The company issued another 2 billion shares.
- Sold them at $1.50 per share.
- And they got $3 billion for it.
- And so then you had $3 billion in cash.
- We had $1 billion before, so now we had $4 billion.
- We could pay off the loan with $3 billion of the cash and
- then we're left with $1 billion.
- And now this company would have, if you have $1 billion
- in cash and $4 billion of CDOs, it would think that it
- has $5 billion of assets.
- If these are really worth $4 billion.
- It has no liabilities, so it has $5 billion of equity.
- Notice the equity doesn't change.
- When you take some of your assets and you get the value
- of the assets that you think they're worth and you pay off
- some liabilities, it doesn't change the
- value of your equity.
- But what's happened now?
- This is just to get comfortable with some of this
- terminology.
- This company now is completely delevered.
- Because it has no liabilities, it has no debt, and its assets
- are equal to its equity.
- And you'll find that lot of companies that are startups
- and technology companies, a lot of those
- have very little debt.
- And so they're completely delevered.
- Anyway, that was just an aside.
- But this was an example of how a company
- could get bailed out.
- And who lost here?
- Well the shareholders lost. Because before, there was only
- 500 million shares that split up the equity.
- And now there's 2.5 billion shares to split this equity.
- So the book value of the shares, if you eve believe
- that these are really worth $4 billion, they
- went from $4 to $2.
- And I think this is an important aside here.
- Because I've mentioned before that the market price when you
- buy or sell a share, it's just transacting between another
- person who used to be holding that share.
- So how does it affect the company?
- Well it affects the company when the company needs to
- raise more money.
- And that's what happened in this example.
- The company had to raise more money.
- It had to go to, maybe it was the government of Singapore's
- sovereign wealth fund.
- And they say, government of Singapore, please invest in
- us, buy some of our shares.
- And when the government of Singapore, or any investor,
- wants to buy new shares, they use the market value, what
- that stock is trading at, as a good reference point for what
- you might have to pay for those shares.
- Oftentimes if it's kind of a desperate situation and this
- person is kind of saving you, they'll pay
- below the market price.
- But sometimes, if they say, oh, this is a lucky
- opportunity to get such a large number of shares and
- essentially take control of the company, I might be a
- little premium over it.
- So I'll pay $2 per share, which is a little bit of
- premium over the market value at the time, which was $1.
- But anyway, that's why the market price of something in
- the secondary markets, where a share is just trading between
- people who aren't related to the
- company, why that's important.
- Because when the company needs to raise money, that is used
- as kind of the fair market value of a company's shares.
- But anyway, this was the situation where the company
- gets bailed out.
- But what happens in a situation where it doesn't get
- bailed out?
- Let's do that.
- Let's say that the sovereign wealth fund never happened.
- Let me clear this.
- So the assets, we had $1 billion in cash.
- And we have these $4 billion of CDOs.
- For a total of $5 billion.
- The liabilities, we had Loan C, it's
- coming due for $3 billion.
- And then you had the equity, which is essentially the total
- assets minus the liability.
- So that's $2 billion.
- And that's split amongst 500 million shares.
- And that tells you that the book value per share is $4.
- We're not going to worry right now what the market value of
- the shares are.
- So let's say they shop everything around.
- All of these sovereign wealth funds, they've got burned,
- because they invested in Citibank last year and the
- stock just continued to plummet.
- They invested in Merrill Lynch, all of these they
- invested in and it just continued to plummet.
- So they've been burned.
- They don't want to be the last guy holding the potato.
- So there's no-one who's willing to invest equity.
- So it just forces the issue.
- These people, Loan C, they say, we're not going to give
- you a new loan, you can't pay this loan, because even if you
- sold these CDOs, you're only getting a $1 for them.
- So we are going to force you into bankruptcy.
- And that's how bankruptcy happens.
- When you break one of the-- they call it the covenants--
- with one of the people who lent you money.
- The covenants say, if you don't pay a loan within this
- amount of time or some other thing happens to your
- financials, you are then declared insolvent and you go
- into bankruptcy.
- And what happens in bankruptcy?
- Well, in bankruptcy, the bankruptcy courts takes
- receivership of all of your assets.
- They just say, OK this is what you own.
- And we're not going to go into the details now.
- Maybe I'll do a whole series of videos on the details of
- bankruptcy.
- You might get some type of loan that helps you just
- continue to do business.
- Because people have to figure out, are they just going to
- restructure your liabilities?
- Or are they just going to dissolve you?
- Because you're not a viable entity anymore.
- But anyway, the bankruptcy court will take hold of you.
- And let's assume that they're going to dissolve you.
- They will then split you amongst the stakeholders, the
- people who you owe money to.
- Actually, let's not say that they dissolve you.
- Let's say that everyone agrees that this
- brand is worth a lot.
- Whatever we call it, Goldman Lynch or Lehman Sachs.
- Whatever our brand is, it's worth a lot.
- No-one wants to see it disappear.
- So what happens when you go into bankruptcy?
- Well, the creditors get first dibs on everything.
- So one way to think of it is Loan C gets
- first dibs on the assets.
- And then anything that's left over goes
- to the equity holders.
- So let's say the Loan C guys, they say we want to keep this
- bank as an ongoing entity.
- But what we want to do is we just want to dump these CDOs.
- So the bankruptcy court, OK we'll liquidate these CDOs
- just because everyone agrees that they're really shady.
- So they sell them and they only get $1 billion for them.
- So now we have $2 billion of assets.
- It's essentially $2 billion in cash.
- That's all that there is.
- Plus there's probably some buildings in all that.
- Which we're not listing here.
- But there's the brand and all that.
- So this guy is owed $3 billion.
- So he says, OK fine, you know what I'm going to do?
- I'm going to keep this company running.
- I'm owed $2 billion.
- I'm going to keep that $2 billion in there.
- But what I get is essentially all of the new
- shares of the company.
- So what essentially the bankruptcy court is going to
- do, they're going to create a new corporate entity.
- They're going to put all of these assets into it.
- And then issue another 100 million shares.
- So they essentially create a new entity, where the new
- entity has $2 billion of assets, $2 billion of cash.
- And let's say it has no debt.
- Or actually maybe these people, they say we'll even
- give you some money-- no, I don't want to confuse things.
- So let's say that you have no debt.
- So you have $2 billion of equity.
- And let's say that there are 100 million shares.
- So the book value of the new shares is $20 per share.
- And you might say, wow that's great.
- Someone could have gotten these shares for whatever I
- said they were trading for before.
- They could've gotten them for $1 per share before, now they
- are worth $20 per share.
- But no, that's not the case.
- It's actually horrible.
- These shares, the shares of the old
- company are worth zero.
- Because when you liquidated the company, or at least when
- you tried to value the company, we
- didn't liquidate it.
- Because we're saying we still want the company to continue
- its operations.
- But we're saying that the value of the company is only
- $2 billion.
- This guy is owed $3 billion.
- So he says, you know what?
- I should get the whole company.
- And I'm still getting not everything that I deserve.
- But I'm going to get the whole company.
- So essentially, whoever lent Loan C, all of these shares
- are now their shares.
- And the equity holders get wiped out,
- the old equity holders.
- So those shares go to zero.
- So this is an interesting example, because I've seen
- people on CNBC say, oh what a great deal, I could buy shares
- of Lehman Brothers for $1.
- But that's not the case.
- They'll say Lehman Brothers has all of these assets and
- it's never going to completely disappear.
- That might be true to some degree.
- But Lehman Brothers' assets might be greater than its
- liabilities, which means that its equity is
- actually worth negative.
- So that $1 isn't a great deal.
- If you really thought that Lehman Brothers in the long
- term was going to come back, what you might want to do is
- somehow try to become one of its bondholders.
- And then when it goes through bankruptcy, on the other side
- of the bankruptcy you might end up in shares of the new
- bank, whatever it's called.
- Goldman Brothers or whatever.
- Anyway, I realize I'm out of time.
- In the next video I'm going to put it all together and show
- you, one, why our financial system is freezing.
- And, two, what the government's bailout is
- attempting to do.
- See you in the next video.
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At 5:31, how is the moon large enough to block the sun? Isn't the sun way larger?
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