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Finance and capital markets
Geithner plan 1
Overview of the Geithner Plan and the problem it is supposed to solve. Created by Sal Khan.
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- Note that the whole scheme is for the taxpayer to pay for the losses the banks suffered. In other words, if the bank makes money, the bank keeps it all. If it loses money, the taxpayer takes the loss. In any other business, the one who makes the bad business decision goes bankrupt, as so many companies have.
Sal himself says over and over that the taxpayer should not be funding hedge funds etc.
My question is, why should the taxpayer be subsidizing banks?
(7 votes)- I think the answer, as it often is, is politics. The banking/financial lobby has a lot of money and therefore political power. It's the "Golden Rule" - whoever has the gold makes the rules.(1 vote)
- Is this Plan still relevant?(4 votes)
- It's a little vague, but http://www.treasury.gov/initiatives/financial-stability/reports/Documents/TARP%20Four%20Year%20Retrospective%20Report.pdf indicates that the "financial stability plan" (aka "Geithner Plan") was 93% unwound in 2012. That may be misleading though, since they seem to not be counting all of the QE Treasury and asset purchases that have driven up asset prices in general. The QE assets are certainly not unwound - they're expanding every day.(1 vote)
- What are the fundamental differences between the Federal Reserve and treasury that would benefit or result in the Federal Reserve lending more money to purchase the toxic financial asset from the bank compared to the Department of treasury at? 7:08(3 votes)
- Maybe this is not the place to ask this question, but.. Where these toxic mortgages come from? For decades, I've never heard of them. Folks had to save 10-20% for down payment in order to be even considered for a mortgage, not to mention good job history. All of a sudden, they are lending to anybody and everybody. What changed? Who allowed this to happen and why? Will this be allowed in the future?(1 vote)
- For years and years the housing market only went up. The value of a home was considered certain to rise with time. Banks used to demand down payments and other safeguards--you're right. After a great housing market, though, they got lazy and started accepting more and more risky loans, because they assumed that even if the buyer defaulted on the loan, the home would be seized. By that time the value of the home would be higher, 'cause home values only go up, right? They were wrong, and now here we are.(4 votes)
- I noticed that the FED has billions upon billions upon trillions of assets throughout its 12 reserve banks. Couldn't the FED use that money to help bail out the depository banks that are in trouble instead of using tax payer money? How does tax payer money factor into all of this?(0 votes)
- To answer your question with a question - Where does the fed get its money from? (A: taxpayers)(5 votes)
- What is the role of the Treasury? Is Treasury acting sort of like another private investor here trying to make a profit, at the expense of the Fed? Otherwise to me the arrangement can be (out of $100) private investor $7, and the Fed $93.(2 votes)
- Can someone please explain what is the difference between the "Treasury" and the "Federal Reserve"? Also, why is the Treasury one of the investors in these special entities, would it not be possible with only the FED and private investors?(1 vote)
- When we say the treasury, we are talking about the government's money. The federal reserve is different. The federal reserve is the monetary authority, which means it decides how much money to issue.
The reason the Treasury is one of the investors was to deflect criticism that this would just be a handout to the banks. It still was, but adding the Treasury allowed Geithner to claim that the government would still be getting its money's worth if things went well.(2 votes)
- Why Sal is saying "can't go after equity holders"? Clearly, during downside, the equity is going to be zero, so equity holders are also taking a hit. 10:45(1 vote)
- Yes, but you can't make them pay anything out of pocket.(2 votes)
- How can this even be considered a solution?? I'm quite baffled.(1 vote)
- It was a solution because it would take away the problem that the banks were facing, and redistribute that problem onto private investors, who are not Too Big to Fail, and onto the Treasury and Federal Reserve, both of which can handle losing the toxic assets. Of course, there were too many problems with this solution, so thankfully it was never actually used.(3 votes)
- The treasury, the private investors and the FED buy the toxic assets from the bank. So why is Sal talking about loans, and about the FED not able to chase equity holders if they're not able to pay?(1 vote)
Video transcript
We've got a few more details
today from Geithner and the Obama administration
about their plan for saving the banks. So I figured that this is a
good time to analyze what they're proposing, and see
if we can come to any conclusions. So, just to simplify the
original problem, you have some bank. Maybe it's Citibank
or somebody else. Let's say they have one big bad
asset that they originally paid $100 for. So that was the original book
value for the asset. And they were able to do that. And obviously these banks have
a bunch of assets, so I'm oversimplifying it. But I think it'll get you
the crux of the issue. They did that by-- obviously a
lot of them leveraged much more-- but let's say they
used $40 of equity. And then they borrowed
the remaining $60 to get that asset. And now of course, this
asset right here is backed by toxic mortgages. And it's the equity tranche
on these mortgages. And I encourage you to watch the
videos on collateralized debt obligations, and mortgage
backed securities. And even the whole thing, all
of the videos that we did on Paulson's original
bailout plan. Because I talk about all the
liquidity issues there. The bottom line is that some of
these debts are coming due for these banks. So they need to offload these
assets to get cash. And the whole problem here is,
if they offload these assets-- let's say they know it's not
worth $100, dollars, right? Everyone knows it's really
not worth $100. But these banks don't want to
offload these assets for anything less than $60. Because if they offload these
assets for anything less than $60, then they have
negative equity. That means that the books values
here-- let's say if that was the only asset
they had, then you would have this situation. If they offloaded for 50 cents
on the dollar, then they're offloading it for $50. So you'd be with this reality. You would have $50. And you owe $60. So there's nothing left for the
equity, and in fact you would go into bankruptcy. You would be an insolvent
bank. So just to set the framework. There's a huge incentive why the
bank doesn't want to sell this asset for anything less
than 60 cents on the dollar. The problem is, the most that
anyone's willing to pay for it right now is not even the
60 cents on the dollar. People are just willing to pay--
I've read reports and it depends on what asset you're
looking at-- that people are willing to pay 30 cents. So let me write that down,
because it is important. This is what banks want. Greater than 60 cents
on the dollar. And in this case, it's
$100, so $60. My understanding is so far, for
the most part, without any government intervention, the
investors are willing to pay 30 cents or less. So there's this disconnect. The bank's like, well I'm not
willing to sell this for anything less than 60 cents,
because then I'm insolvent and the gig's up. And investors are saying, well
these are toxic assets. Every day there's more
foreclosures. It's even hard to get good
documentation on what backs up these loans. A lot of these were
these NINJA loans. No income, no job loans. Or these liar loans, or stated
income loans, where people can just fill out with anything
they want. And there's all this fraud. So people are discounting a lot
of risk into these assets. So essentially, the market
isn't functioning. The buyer's willingness to pay
is much slower than the seller's willingness to sell. And nothing happens. And so, these toxic assets are,
you could say, clogging up the system. Because the banks, I won't say
that they can't sell them. It's just they're not willing
to sell them. Because if they were willing
to sell them at the market price-- whether or not you agree
with this market price-- the banks will be bankrupt. So the government all along
has been trying to come up with different iterations of how
can we somehow get these assets off the banks' balance
sheets without causing the banks to get insolvent? And the original version of TARP
1 is that the government will essentially buy these
assets for, who knows, 70 cents on the dollar. And in that reality, if you
bought those assets for 70 cents on the dollar,
then those assets, you'd have $70 here. The bank would owe $60. And there would still be a
little bit left of equity. There would be $10 left. But the important thing is that
the bank would be able to pay off its liabilities, stay
liquid, and then be around for a better day or a better
economy, where it could grow the equity base again by
investing in all of that. And everyone realized
that the TARP was a fraud on some level. Because when you do that, if the
market price really is 30 cents on the dollar, and
you're paying 70 cents. Let me say, if this TARP 1. And the government pays 70
cents on the dollar. The government's overpaying
by 40 cents on the dollar. In this case, the government
would be writing a $40 check to the owners of this company. In this case, the
stockholders. And these are the very same
people the management and the original investors in a lot
of these companies. These are the very same people
who got us into this mess. And why should we be rewriting
them billions of dollars of checks to essentially
just bail them out. Why don't you just
take them into receivership and all that? And I'll do other
videos on that. So the new iteration that has
come about-- and let me scroll down a little bit-- is, and
let me draw the original circumstance. So you have this item
here that was originally paid for $100. They borrowed $60 to
purchase them. And then they have
$40 of equity. The new plan is, the
government's saying, you're right, taxpayer. We as a government, we're not
in a position to decide what things are worth. We're not hedge fund managers
or mutual fund managers. We're just bureaucrats. And you're right. We would probably just end
up overpaying for things. Because these guys are smart. And if they're not willing to
pay more than 30 cents, and we're paying 70, we're
overpaying, and it's just a big subsidy from the taxpayer. So the new Geithner plan is
saying, hey we're going to partner with the private
investors. And the way they're suggesting
they do that, is that let's say a private investor-- and
these are numbers that I've been reading in some of the
newspaper reports, and the numbers might change over time
because they do tend to. But private investors will
contribute, say, $7. This is from private
investors. The Treasury will contribute
another-- let me make another box-- will kind of match
that investment by the private investors. So the Treasury will contribute
another $7. And then the Fed is going
to lend the balance. So the Fed-- let's see, if you
want to get to $100, that's $14-- so the Fed has
to lend $86. Let me draw a box here. It's going to look something
like that. So that's $86. from the Fed. And of course, this entity,
when it's originally capitalized, is going to be
sitting on $100 cash. That's its assets. Well I'm saying it
has $100 of cash. It could be something less, but
let's say this is what it originally sets out to be. Fed lent $86. This is a loan. The Treasury made a direct
equity investment of $7. And private investors make a
direct investment of $7. And then this entity can then
go and buy these assets. And what the government-- at
least my reading of it is-- is that the private investors are
going to set the price. So the private investors are
going to say, you know what? I think that this thing right
here is worth, I don't know, I think it's worth 70 cents
on the dollar. And let's say that they
are the winning bid. They are the people willing to
pay the most. Because that's my reading. Is that there will
be an auction. And the private investor, in
partnership with the Treasury that's willing to pay the most,
will get the assets. So that in that case-- let's say
they decide to pay $100, just to make the math easy. So then this cash will
go to this bank. So then they'll have
$100 of cash. So then we'll have the toxic
asset sitting here. And you might say, hey
Sal, that's crazy. Why would a private
investor do that? And you're right. I mean, in a lot of
circumstances, they obviously wouldn't pay. Actually, because of that, let
me not make $100 the number. Let's say that they
pay $60 for it. Because, remember, the banks
weren't even willing to part with them for less than $60. So for this to even work,
someone's going to have to pay at least $60 for this thing. So let's say they
pay $60 for it. And then they get the asset. And they're going to
have $40 left over. So they have toxic asset, and
then they're going to have $40 left over, because they only
paid $60 for the security. The way I set it up. Although, they probably designed
this thing so there isn't any cash left over. But let's just use these
numbers for the sake of convenience. So now, you might say,
well, this was good. The private investors, they made
an educated decision, and they've decided to price
these things at 60 cents on the dollar. And my question to you is, why
would these same people who, before this plan, weren't
willing to pay any more than 30 cents on the dollar, now
be willing to pay 60 cents on the dollar? Now they're willing to pay
this much for the asset. And there's a couple
of answers here. I mean, the kind of naive answer
is that the government takes the first hit. Or if these things end
up being worth 30 cents on the dollar. Let's say that we go to some
future state, and these really are worth only 30 cents, the
most that the private investor loses in this situation
is his $7. The rest of the loss is
going to be borne by the Fed and the Treasury. This loan by the Federal
Reserve is a non-recourse loan. Which means that, if for
whatever reason this entity can't pay back the loan, the
lender-- which is in this case the Fed --can't go after
the equity holders. All the lender can do
is take the asset. So if this asset is worth
nothing, the Fed, all it can do is just take the asset, and
essentially it's going to get nothing back for its loan. So in this situation, the
private investor would get all of the upside. If this thing that they paid $60
for ends up being worth, let's say it ends up being
worth-- I'll draw it down here because it's all going to the
equity holder-- if that asset they paid $60 for, it if it ends
up being worth $80 then that extra $20 of value is
going to be split by the Treasury and the private
investor. So let me give you
that situation. So what would the balance
sheet look like? They pay $60 now. All of a sudden that
asset is worth $80. So this is a good scenario,
an upside scenario. Remember, we had $40 left over
in cash, just based on the way I had originally set it up. You owe $86 to the Fed, the
Federal Reserve, which is officially separate from the
Treasury, separate entity. And then the equity is split
between the Treasury and the private investor. So how much equity is there? You have $120 here minus
$86 So you have $34 of equity, right? Because you have $6 more here,
so this is $34 of equity. And it's going to be split
50-50, so it's going to be $17 for the private investor. And then you have $17
for the Treasury. And this looks great. In this situation, the private
investor's original investment was $7. And it went to $17. So it's got a huge return
on investment. So this is the positive
scenario. And then the negative scenario,
where let's say that original investment actually
ends up being worth $30. Remember they had $40 of cash
in the way I set it up. Now all of a sudden the Federal
Reserve, you had a loan from the Fed for $86. Now your assets are worth less
than your liabilities. Your equity is wiped
out, right? So in this bad situation, the
private investor invested $7, and it went to zero. So this doesn't actually look
like that bad of a scenario. That in an up case, you go from
$7 to $17, And in a bad case, you go from $7
to zero dollars. And actually, this could be
magnified a lot more, depending on how these
things work out. But this still begs the
question, if an investor really thinks that these things
are worth 30 cents, and that there's no chance that
they're worth more than 60 cents, even though they
disproportionately can participate in the upside,
relative to the downside, which I think in of
itself is wrong. That the government shouldn't be
subsidizing hedge funds and other private investors. But if they really thought that
the value was closer to 30 than to 60, then the question
is, why would they participate at all? I mean, if you know you're
going to lose money, you shouldn't do it to begin with. And I realize I've
run out of time. I'm going to cover that
in the next video. And to some degree,
the next video you might find troubling. See you soon.