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Current time:0:00Total duration:11:52

Video transcript

I think we're now ready to tackle the big picture and what has our government officials so worried right now so what I've done is I've just drawn the balance sheets for a bunch of banks obviously this is simplified and I made all of their balance sheets look the same all of these banks each of these kind of represents the balance sheet of a bank and just to explain it the left-hand side of this balance sheet so this column right here maybe I can for the at least for this first bank I can mark a little bit so what I'm squaring off in magenta let me do a thicker what I'm squaring off there that's the assets of that Bank when I'm squaring off in la in blue that's the liabilities of the bank and what I wrote here has four billion of liabilities its assets I divided it between three billion of other assets and two billion of CDOs because we want to focus on the CDO because that's the crux of everything that's going on and we have five billion in assets four billion of liabilities so you have 1 billion in equity so that's what's left there so that just this is just another visual representation that liabilities plus equity is equal to assets or assets minus liabilities is equal to equity and I've just copied and pasted this one balance sheet a bunch of times I've been I don't know how much whether we're going to use all of those but let's just assume for simplicity that a ton of banks in the system have this identical balance sheet obviously they don't have an identical balance sheet but they cut all of their balance sheets might have kind of the similar properties where where the the part representing the CDO and I'm doing this this isn't always the case different banks have different exposures to CDOs some of them have a lot some of them a little bit some of them are valuing them more conservatively than others but just for the sake of simplicity I've just made all of the banks in a situation where the what the book value of the CDOs that they have on their balance sheet it's larger than their equity value and I did that for a reason because it leads to the issue of are these banks facing just a liquidity issue are they facing just a solvency issue if you believe that you know these are worth 3 billion these assets these liabilities worth 4 then the crux of whether it's a liquidity or a solvency issue all falls down as to whether these are worth two billion or not for example even then you have a billion dollars of equity right if these are worth 1.5 billion well maybe they're being a little optimistic here but you'll still have point five billion of equity so you're still solvent right and in that situation in theory one is just if they don't have the cash when some of their debt comes due they should just be able to borrow some money and get past that hurdle and then in the future maybe sell their assets and still have positive equity however if the true value of those CDOs and this is kind of a philosophical question what's the true value of anything and the best thing that we as humans have been able to come up with is a market for you know the market value tends to be the best representation of the true value of something but if the market value or that let's say the true value of this is a billion dollars or less then we have a situation for example if these are worth nothing then we only have three billion of assets four billion of liabilities we have negative equity the this company is worth nothing and to lend this Bank or this company any money would just be throwing good money after bad because you're not that money is just going to go into a black hole because one of the people who this company owes money to is probably not going to see their money so and if you are the most junior person lending the money which means that when all the money is distributed if they go into bankruptcy you're the last person to see the money then you're just throwing good money after bad so that's the issue but I want you to see the big picture now because if it was just an issue with one bank it wouldn't be a big deal if it was just Bear Stearns or four it was just Lehman Brothers not a big deal let the greedy bankers go bankrupt and you know they probably are doing just fine with the bonuses they've collected after sourcing these CDOs for the past eight years or five years or however long but what I want to show you in this video is what people are talking about when they say systemic risk so these four billion in liabilities right these are loans maybe from other banks in fact probably from other banks and those loans from other banks those are assets of other banks for example maybe a billion let's say the is Bank a this is Bank B maybe a billion of these are a loan from Bank B right so this is a loan from Bank B and if this is a loan from Bank B Bank B would have an asset called a loan to bank a write on banks B balance sheet we're calling this a loan to bank a this isn't one of its asset and then one of its liabilities will be a loan from Bank B right so how can I say it so let's say they took this money and they gave it to be sorry B had money gave it to a is firm form of a loan right and so that cash ended up here and that they got an asset called loan to bank a and this is a liability loan from Bank B and then they might have taken that money and they might have lent it to Bank I don't know Bank C down here I think you're you're starting to see how this gets gets pretty hairy very fast right so let's say that they Bank a one of its three billion in assets let's say it is a loan let me do that in a different color it has a loan to bank C right so this is it gave money to Bank C and so on Banksy's balance sheet it'll say loan from Bank A or so we owe a a billion dollars right and a says OC owes me a billion dollars and that's all fine and then you see that oeob a billion dollars and then we could you know we could keep doing this or I could just even make this into a circle already so maybe Bank B has some money that it owes to someone else and let's say that someone else just for fun just to make this interesting I think you can see you can extrapolate and think about how this gets complicated very fast Bank B has borrowed money from Bank C so Bank C will have an asset here that says no I lent money to bank B so they lent money to bank B fair enough okay so now we're an interesting situation let's say this loan loan from Bank B to loan a comes due and we've studied this multiple times let's say that this comes due and let's say for whatever reason all of these other loans they're there they're not liquid you know they're not due yet so Bank a can't get rid of these loans so the situation here is that they would either have to get some type of so let's say say this comes due this is four billion dollars they can't sell any of this so they have to come up Bank a has to come up with a billion dollar somehow for Bank B right so that's the situation we're dealing with I'm just going to say that they can't sell any of these assets so it all comes down to CDOs so there's a couple of issues here if you think it is just an issue of illiquidity if these are two billion dollars of assets they're really worth two billion but bank aid just can't sell them because either there's quote/unquote no one willing to buy although I would argue if no one is willing to buy something then it's true value is probably zero but let's just say Bank a says oh no no one's willing to buy we're just illiquid this is really worth 2 billion so one situation is they could get a loan from someone maybe the Fed it would be willing to take this as collateral so they would give this as collateral to the Fed maybe the Fed will give them a billion dollar loan and then they can use that to pay Bank B let's say that's off the table because this is just toxins Meli enough collateral than not even the Fed which we now realize is willing to do anything to support the markets then not even the Fed is willing to give them a loan or enough of a loan to pay off that loan the other situation is maybe they can get an equity infusion from a sovereign wealth fund and we covered that a couple of videos ago where the sovereign wealth fund will essentially inject some cash it'll dilute the shares and that you know maybe we had 500 million shares before now we'll have 2 billion shares so the sovereign wealth fund will take over roughly what's 2 billion over when was that 80% of the company and in exchange for 80% of the company would give maybe 2 billion dollars and then you could use that to pay off this loan but let's say that that's not on the table anymore either because the sovereign wealth funds have gotten burned so much right so what happens well we learned what happens if you can't get a loan a new loan to replace this loan or if you can't get an equity infusion from kind of a greater fool what happens you go into bankruptcy and this is what happened to leave in brothers Lehman Brothers went into bankruptcy no sovereign wealth fund no one else bought the company and I should probably do another video on that send and they couldn't get alone so they went bankrupt I should call this company l actually but I'll call it company for now because I don't want to I don't want to impugn anyone actually don't think Lehmann was any worse or better than any of the other players here so when they go into bankruptcy something very interesting happens now bank B you know they were already worried about these CDOs right these CDOs were already an issue and they were probably thinking boy when when loan C comes due I'm going to be in trouble or one loan D or F or whatever it'll see I'm going to be in trouble because I'm going to be in that situation that Bank a is that I'm essentially forcing Bank a into right now but now I have a new problem this loan to bank a isn't getting paid off right this loan to bank a isn't getting paid off and who knows Bank a is going to go into bankruptcy Bank a is going to bankruptcy maybe in bankruptcy we realize that these are worth nothing and if those are worth nothing then maybe you know I'm very junior in seniority in terms of where my loan is and maybe I get nothing or get a few pennies on the dollar here so maybe I thought this was a billion dollars and I have to write this down 2.5 billion dollars so now I have two problems I have this and I have this and once again this is a non liquid loan right this isn't Bank A's and bankruptcy and if I wanted to somehow get the value of this I have to wait for all of Bank A's assets to go into liquidation and then I would have to whatever assets I get I would have to sell it so this is kind of a frozen asset so once again I'm stuck holding this non liquid asset so I have this long liquid asset that's probably not worth what I thought it was which was a loan to a then I also have these CDOs and now god forbid you know let's say that I had another loan to bank D right this is Bank D and now let's say Bank D goes bankrupt and then I have another loan that's bad on top of these CDOs but as the CDOs were the crux of the issue right that's what caused the situation if bank a could have only sold this CDO for two billion dollars it wouldn't have caused this chain reaction right and this you could Lehman Brothers really was the thing at that that catalyzed this whole this whole chain of events right and then you can imagine how Banksy is wired because now Bank B has all of these illiquid assets on top of the CDO so it starts to look bad and you can imagine now it's even less likely that when a bank let's say that Bank D is the next one to go into a dire situation it's even less likely that Bank D can get a loan from a third Bank because although all the banks are getting scared now all the mechs are i'm not going to loan money to anyone if I can get any cash from anybody I'm just going to keep it so that when it's my turn when the market starts looking at me I at least have a little cash so everyone is frozen everyone wants to collect their loans from everyone else and no one wants to give loans to anybody else so that's the situation we're ending and that's the the the difficulty that the Fed is somehow trying to unwind and I realize that a lot of time again I will I will confront that issue in the next video