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Current time:0:00Total duration:10:59

Bailout 13: Does the bailout have a chance of working?

Video transcript

let's put all of the moral hazard issues and all the fairness issues aside and just think hard about whether this bailout could work because frankly if it doesn't work then it's definitely not something that any of us should worry about and even if it does work then I think you should worry about the moral hazard issues but let's say this is Bank a shady bank a and it has and let's see these are its assets on the left hand side assets and these are its liabilities a liabilities and so it has or at least on its books the book value of the CDOs that it has is five billion dollars and what the government is saying is that you know like right now Bank B has lent Bank a this loan right bank B has given them eight billion dollars maybe has to be paid back next month and and the big fear is is that Bank B is going to get scared and then when this loan is doing it I'm in a in a month's time that Bank B won't give them a new loan or renew the loan that they're just going to want to take the money back because they're kind of afraid of keeping money with these guys when you don't know what these CDOs are worth and that's that's a legitimate fear right because if these CDOs really are worth five billion dollars then you really do have four billion dollars of equity here right total assets are twelve billion minus eight billion of liabilities means you have four billion of equity fair enough but what happens if these CEOs are only worth 1 billion dollars and this is worth 1 billion and these are worth seven billion then you only have 8 billion in assets and 8 billion in liabilities and there's no equity or even worse what if this is if these CDOs are worth zero then you have negative equity then if these guys were to go bankrupt if they were to do if they were to be the next Lehman Brothers then all all this this lender lender B would get if they went bankrupt are these CDOs worth zero and the 7 billion of assets so for every eight dollars they lent to Bank a they'll only get $7 so what the government is saying is okay to keep Bank B from pulling their money out of Bank a let's buy out these CDOs at essentially a price that keeps this Bank solvent so you know even if they really are worth zero we're the the Fed or the Treasury the Treasury's the one that's doing it the Treasury is not gonna pay zero because if they paid zero this guy would go bankrupt there'd be another Lehman Brothers so the Treasury wants to essentially maybe pay five billion for it so that you know you've take five billion out of take five billion by these CEOs for five billion and all of a sudden this doesn't become CDOs of five billion this becomes cash and their argument is is if you were do this no matter how unfair it might be because this is essentially a cheque of five billion dollars if you assume the CDO is worthless this is essentially a cheque that's being written to the equity holders and the unsecured debt holders of this of this Bank but let's let's assume that let's put all of that aside and let's assume that this works that this now now Bank B will say oh boy you know that I don't have to worry about those CDOs anymore those CEOs have been turned into cash this company definitely has positive positive Book value and therefore I will continue to lend to this company but it isn't that simple because right behind these CDOs there are other assets on this book on most banks books so these were the subprime CDOs the stinkiest of the stinky then you have other things that are a little bit less risky there are alt a CDOs these are loans that were given to people who aren't necessarily subprime these are people who had decent credit scores but they still put no money down and they still were able to essentially fabricate their income on their loan application so these are the altai loans and then of above that and these might be all taste CDO so they've been sliced and diced so some tranches are more risky some tranches or less risky above that you might have I don't know you might have a commercial real estate CDOs so I'll call that commercial real estate CDOs and then above that you might have commercial loans you know just a regular companies commercial loans or even better these could be loans to private equity actually that's even better let's put some private equity loans in there cuz I wanted to show you that this isn't the only stinky thing on the balance sheet these CDOs that this is just the stinkiest of them all a good way to think about it is if you have a dead skunk in your house you won't notice that the milk is going bad right and that is the situation these CDOs they seem really bad now but you know what six months ago or even a year ago six months ago these CDOs looked a lot like these subprime studios look a lot like these altes CEOs are starting to look and the way these off a CDOs looked six months ago is how a lot of these commercial real estate CDOs are starting to look right now so this is just the tip of the iceberg these CDOs so you have an issue here the government goes in it spent seven hundred billion dollars it buys these assets that are of questionable value and it's claiming to us that the problem will be solved but Bank B isn't an idiot Bank B is an idiot they were probably more prudent than bank a right they didn't buy the subprime they didn't buy these subprime assets subprime CDOs but I wouldn't be surprised if Bank B probably has some of these less stinky things on their balance sheet alt a I mean they definitely have something stinky which is called a loan to be sorry a loan to a right that's one of their assets and then they have you know they might have loans to private equity private equity loans then they might have some commercial real estate CDOs they might have CDOs that are backed by credit card debt the bottom line is is that this Bank can look into its own assets and it can see that the fundamental value behind these assets are deteriorating anyone who talks to anyone in the real economy right now than those that the economy is slowing that consumers can't spend any more money if in fact in fact last year consumers had negative savings which means that they had to borrow money to fuel their consumption and the only way that you can have consumption growth in that type of an environment is if either salaries increase which isn't happening or people are able to borrow more money and we already know that credit is getting tightened so if you're a bank B will will this will the government buying out this asset irregardless of how fair it is will that make you confident in loaning to Bank a well no because you see in your own balance sheet that these things are deteriorating and frankly you have loans to other people to write you have loans loans to you know I'll say that's a loan to bank see that's a loan to bank II that's a loan to I don't know some sovereign wealth fund and then you have your equity here right so you have you have a double conundrum right you have all of these guys these loans might come due so you're gonna need some cash for that in the future and you see the trend you're not an idiot you weren't as risk-taking is this guy and you see that this that this wasn't the only stinky thing out there that there are other asset classes there are other types of CDOs and just loans in general that are starting to deteriorate that's starting to deteriorate that's starting to deteriorate that's starting to deteriorate so maybe this credit crunch isn't just because of these CDOs maybe it's because this banker is actually being prudent maybe this banker is actually saying you know what I need to be careful I see the left-hand side of my balance sheet deteriorating I need to pull this money just in case just really in the best interest of my equity holders right or my shareholders or even in my bond holders so even on this first cut even if even if there wasn't all of this controversy and even if George Bush didn't go up and you know do a prime-time speech telling us that we're about to reach financial Armageddon if I was a prudent banker I would still be wary of loaning to bank a even if the government were able to pull this buyout now on top of that you know I work in the financial industry bankers were prudent you know they see reality they see things are deteriorating so they want to be cautious but frankly when bush and Paulson and Bernanke go up on TV and say tell the world that you have to pass this bill and if not we're essentially on you know they use words like precipice these are the real precipice and they you know they use financial Armageddon I don't know if that was that's either their words or some of the other words that that I've heard out there for financial Armageddon and you know days away days away from the precipice so my question is to you regardless of whether the government buys this out is this type of language going to instill any heipo sense of confidence in Bank B if I'm the chairman or I'm the CEO of Bank B I'm like you know what I thought things were bad and that's why I was trying to you know instead of charge two percent for a loan I was gonna charge six percent for a loan but now the president estates the Treasury secretary and the chairman of the Federal Reserve have frankly used language that no elected or unelected official has ever used before days away from financial Armageddon we're on the precipice hell I'm definitely not gonna lend my now I don't care even if they do even if they do buy asset and then I'm gonna throw another monkey wrench into the picture the the the plan calls out the plan calls for a reverse mortgage a sorry a reverse auction where though essentially the Fed says hey everybody I have a billion dollars who wants to sell me their mortgages for the lowest price well guess what the people who are willing to sell their mortgages for their CEOs for the lowest price are probably the most desperate out there and if anyone participates in those auctions and sells at a discount those are the people that are gonna be on my red flag list those are the banks that I'm going to be the least likely to lend to because I knew that they were desperate that they were just covering up their balance sheet as long as they could they were waiting for the government bailout and if they're willing to take the government bailout those are the very banks that I don't want to lend to anyway I'll leave you there but I just want to give you the point that you know everyone that George Bush and the rest of his gang is trying to scare the world and saying oh you know we are trying to save the economy they don't mention the fact that even with their bailout regardless of how unfair it is we're probably going to end up in the same situation and frankly it might even make the situation worse and that's that's something I really want to hit home with people it's like it's like when they started banning short selling in a small number of stocks right when they said oh you can't but you can't short banks a B and C immediately that made everyone's ears go up and say oh the government knows something that we don't know I'm not gonna deal with banks a B and C because those are probably the stinkiest of them all anyway see in the next video