If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:11:26

Video transcript

in the next series of videos I'm going to give my best attempt at trying to get a handle on the bailout and the financial crisis and so I'm going to try to explain different concepts in more than one way then I think hopefully it'll all sink in but the big picture really is is that there's a lot of fancy terminology being thrown around but but the underlying concepts really aren't that fancy so I think a good place to start is just with the idea of the balance sheet and you could watch some of the videos that I did before the whole financial mess on the balance sheet and they'll give you a good primer but it doesn't hurt to review it here so a balance sheet is just a snapshot of what you have and what you owe and the difference between and the difference between is kind of like your well so if I just had a a personal balance sheet I could write my assets so my assets and they mean what you think they mean these are things that will give you future benefit so let's say my assets I have I don't know let's say I have $1,000 cash to have $1,000 cash let's say I have a I don't know let's say I have a hundred a hundred thousand dollar house let's say I have a ten thousand dollar car ten thousand dollar car and I don't know let's say all everything else you know call it other my furniture and I don't know my my TV and everything else how to know is another five thousand dollars so those would be my assets and so what are my total assets see a thousand a hundred ten thousand one thousand hundred eleven thousand hundred and sixteen thousand dollars I $116,000 well it would be great if we lived in a world of only assets but unfortunately let's say that I had liabilities as well so liabilities liabilities and these the liabilities what you think it means it means something that you you have to give future economic benefits for you're kind of on the hook for something and so let's say my liabilities I don't know let's say I have a $20,000 student loan and let's say on that house unfortunately I don't own it outright let's say that I have a $80,000 mortgage on that house so essentially I borrowed $80,000 from the bank but and let's store some credit card debt in there you just make this realistic relative to I think a lot of households out there let's say that there's $5,000 of credit card debt although for most households right now this house is a lot more and this mortgage is a lot more but anyway well well I won't make social commentary this is just to explain what a balance sheet is so what is left over for me what is my assets minus my liability so let me look let's calculate our total liabilities so this is total assets I'll use it with an a : so what are my total liabilities 20 plus 80 plus 5 so it's one hundred and five thousand dollars one hundred five thousand total liabilities so the difference between these two my assets minus my loot liabilities this is essentially my net worth right this is if I just liquidated everything tomorrow if I sold all of this and paid off all this this is what I would be left standing with that's my net worth or you could view that is that is my equity you often hear equity in the context of a house in the context of a house is just the asset of the house - a liability but I'm talking about in the context of my personal balance sheet not that these are the actual numbers I don't want to give away too much about my life at this just just yet but anyway so what is that number here so my equity and I'll do that in a make it green since that's if it's positive it's a good number my equity is one hundred sixteen thousand minus one hundred five thousand so what is that that's $11,000 $11,000 that's my equity so there's a couple of things to you know think about here you know you may be a lot you'll meet people with a you know a hundred thousand dollar house or a million dollar house and they say oh I am worth a million dollars and what you like well you're not really worth a million dollars unless you own that house outright and you could actually sell that house for a million dollars it's not what you paid for it it's what you could the market is willing to give for it but your real net worth is your assets - all of your liabilities so in this case your net worth is actually 11,000 not a hundred and sixteen thousand dollars and this is another important thing to think about assets are always equal to liabilities plus equity and that just comes out of the definition of what equity is equity was assets minus liabilities but you know when you if you take an mba they'll they'll write it down and it looks like an equation but it's you know assets is equal to liabilities plus equity but that's that's almost a by definition that that's going to be true so what can we do with this how does this help us well there's there's a couple of ways that we can we can think about this first of all what happens if my liabilities are larger than my assets so if I owe the world more than the world owes me well then this number is going to be negative right and if this number is negative then there's no really good reason for me maybe to preserve my credit score but other than that if we put credit score's if we take that out of the equation there's no good reason for me to continue living this existence if my liabilities are greater than my assets so let's say let's let's think about that situation let's say that my house is only worth a hundred thousand but for whatever reason I owe $120,000 to the bank let's say maybe I originally bought the house with a no money down payment for a hundred twenty thousand dollars and now I'm honest with myself I'm like you know what the value has gone down it's only worth a hundred thousand now so I'm in this situation where you could say I'm upside down in my mortgage well one you could say there's no incentive for me to continue paying this house an even bigger picture if I now look at my if I now look at my balance sheet what are my liabilities now one forty my liabilities would be one hundred forty five thousand and my equity would be my assets minus my liabilities so one sixteen minus forty five what is that twenty minus twenty nine thousand dollars so I'll do that in red because that's a bad number for your equity minus twenty nine thousand dollars so in this situation in this situation there's really no reason for me to continue living like the way I am at least financially there's no you should use you know as long as you're breathing there's no reason not to continue breathing but you wouldn't want to live like this financially anymore so there's no reason not to go seek bankruptcy protection and bank property protection is essentially saying is admitting or I am insolvent which means that there's no way that I'm going to be able to unwind all of my liabilities courts protect me my lenders can't come back after me everything is going to be erased they're going to take all my assets all my liabilities and they're essentially going to take these and divide them up amongst the people that I owe stuff to so that's bankruptcy that's insolvency and I want to highlight the word insolvency insolvency because that's a word that we're going to touch on when we actually talk about the credit crisis and that is opposed to a liquidity so what is a liquidity so it liquidity so insolvency means there's no reason for you to continue with this type of a financial situation you're bankrupt you go get bankruptcy protection that's insolvency it liquidity is a different situation it liquidity says no I actually do have positive equity so let me let me go back to the original circumstance let me go back so let's let me just go back to the original circumstance it really was I only owe $80,000 on the house so my liabilities really are only one hundred five thousand so I really do have a positive equity of eleven thousand dollars but let's say let's say so this isn't insolvency more so I'm going to describe what illiquidity means to you or to me in this case because this is my balance sheet so let's say that um I don't know a my my my my my wife comes to me and says oh you know we need to pay our child tuition it is five thousand dollars for the upcoming year I need to pay five thousand dollars in tuition so I need to pay five thousand dollars pay fanta actually let me take a better situation because if I'm talking about tuition it should have shown up on liabilities let's say that I have to make a five thousand dollar payment on my student loan so there's I had some kind of weird student loan where five thousand dollars comes do all of a sudden so I have to make a five thousand dollar payment on student loan so let me do that in red make $5,000 payment 5k payment and it could be for anything but let's say it's to satisfy part of one of these liabilities so if you look at my equity if you look at my assets my lot - my liabilities I clearly have $11,000 I am worth $11,000 and if I could liquidate all my assets and all my liabilities overnight I would have $11,000 in cash and then I could pay that $5,000 in fact in the process of doing it I would have paid that $5,000 but in this circumstance if I just look at my situation let's say that student loan payment is due tomorrow I only have a thousand dollars of cash right I only have $1,000 maybe sitting in my checking account so I can't make that $5,000 payment just with my cash and then I look at everything else I'm like boy can I unload any of these assets overnight well a house absolutely not there's no way I'm going to be able to unload my house tomorrow maybe if I did you know I could find someone who'd buy it for $50,000 tomorrow but that wouldn't help my situation then I'm going mine equity essentially will go negative again so that won't help I can't sell my car overnight you know maybe I could sell it at a super low price for $4,000 just to kind of make this payment but I don't want to do that either and same thing your furniture that's something you know you'd have to go on Craigslist in and take pictures of it you couldn't do it so this is a situation where you are you having a liquidity crisis you are illiquid but you're not insolvent you have positive you have a positive net worth if assuming that you're not lying about what's going on your balance sheet and and that's another issue so how do you get past a liquidity crisis like this well someone has to give you we could call it a bridge loan because they're giving you a financial bridge from here to where you need to get to go or they're giving you a bridge that essentially buys you time right let's say you're your dad says okay Sal I'm or my dad I guess I'll give you a $5,000 loan for the next two months and over the next two months I expect you to find some other source of cash maybe sell your car buy a cheaper car sell some your furniture or something so that is a loan to prevent a liquidity crisis and that loan wouldn't be a bad idea because if this person isn't lying their balance sheet if I'm not lying about my balance sheet then I actually am good for the money on the other hand that loan would be a bad idea if I had insolvency because it would just be throwing good money after bad it's I wouldn't I'm not able to pay my current loans and he was giving me another loan that I wouldn't be able to pay anyway I'm out of time I'll see you in the next video