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

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

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. And these are its liabilities. And so it has, at least on its
books, the book value of the CDOs that it has
is $5 billion. And what the government is
saying, is that right now, Bank B has lent Bank
A this loan. Bank B has given them $8 billion
that maybe has to be paid back next month. And the big fear is that Bank B
is going to get scared, and then when this loan is due in
a month's time, that Bank B won't give them a new loan
or renew the loan. They're just going to want to
take the money back, because they're afraid of keeping money
with these guys, when you don't know what these
CDOs are worth.

And that's a legitimate
fear, right? Because if these CDOs really are
worth $5 billion, then you really do have $4 billion
of equity here, right? Total assets are $12 billion
minus $8 billion of liabilities means you have
$4 billion of equity. Fair enough. But what happens if these CDOs
are only worth $1 billion? And this is worth $1 billion,
and these are worth $7 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 these CDOs
are worth zero? Then you have negative equity. Then if these guys were to go
bankrupt, if they were to be the next Lehman Brothers, then
all this Lender B would get if they went bankrupt are these
CDOs worth 0 and these $7 billion of assets. For every $8 they let lend to
Bank A, it'll only get $7. So what the government is saying
is, OK, to keep Bank B from pulling their money out of
Bank A, let's buy out these CDOs at essentially at a price
that keeps this bank solvent. Even if they really are worth
0, we're not the Fed or the Treasury– the Treasury's
the one doing it.

The Treasury's not going to pay
0, because if they paid 0, this guy would just
go bankrupt. It would be another
Lehman Brothers. So the Treasury wants to
essentially, maybe pay $5 billion for it. So that you take $5 billion–
buy these CDOs for $5 billion. And all of a sudden this doesn't
become CDOs of $5 billion, this becomes cash. And their argument is, if you
were to do this, no matter how unfair it might be, because this
is essentially a check of $5 billion, if you assume these
CDOs are worthless. This is essentially a check
that's being written to the equity holders and the
unsecured debt holders of this bank. But let's assume that– Let's
put all that aside. Let's assume that this works. That now Bank B will say, oh
boy, I don't have to worry about those CDOs anymore. Those CDOs have been
turned into cash. This company definitely has
positive book value, and therefore, I will continue
to loan 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. They're 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 there loan applications. So these are the Alt-A loans. Then above that– And these
might be Alt-A CDOs. They've been sliced and diced,
so some tranches are more risky, some tranches
are less risky. Above that, you might have
commercial real estate CDOs. So I'll call that commercial
real estate CDOs. Then above that, you might
have commercial loans.

Just a regular companies. Or even better, these could be
loans to private equity– actually, that's even better. Let's put some private equity
loans in there, because I wanted to show you that this
isn't the only stinky thing on the balance sheets,
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. 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 CDOs look a lot
like these Alt-A CDOs are starting to look. And the way these Alt-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 $700 billion. 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 isn't an idiot. They're probably more
prudent than Bank A. 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 sheets.

Alt-A. I mean, they definitely have
something stinky, which is called a loan to A. That's one of their assets. And then 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 that this
bank can look into its own assets, and it can see that the
fundamental value behind these assets are

Anyone who talks to anyone in
the real economy right now knows that the economy's
slowing. That consumers can't spend
any more money. 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 environment is if
either salaries increased, 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 Bank B, 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 things are deteriorating. And frankly, you have loans to
other people too, right? You have loans to Bank C. That's a loan to Bank E. That's a loan to some sovereign
wealth fund. And then you have your
equity here.

So you have a double
conundrum, right? You have all of these guys. These loans might come due, so
you're going to need some cash for that in the future. And you see the trend. You're not an idiot. You aren't as risk-taking as
this guy, and you see that this wasn't the only stinky
thing out there. That there are other assets
classes, 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's 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. Of my shareholders, or even
of my bond holders. So even on this first cut, even
if there wasn't all of this controversy, and even if
George Bush didn't go up, and do a primetime 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, I work in
the financial industry. Bankers were prudent. 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– they use words like "preicipice." These
are the real precipice. And they use "financial
armageddon." It's either their words, or some of the
other words that I've heard out there.

Financial armageddon. And 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 type of sense
of confidence in Bank B? If I'm the chairman or CEO of
Bank B, I'm like, you know what, I thought things
were bad. And that's why I was trying
to, instead of charge 2 percent for a loan, I was
going to charge 6 percent for a loan. But now the President of the
United States, 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 going
to lend right now.

I don't care even if
they do buy assets. And then I'm going to
throw another monkey wrench into the picture. The plan calls for a reverse
auction, where the essentially the Fed says, hey everybody,
I have $1 billion. Who wants to sell me
their mortgages for the lowest price? Well, guess what? The people who are willing to
sell their CDOs 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 going to 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 for 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 everyone– that George Bush and then the rest of
his gang is trying to scare the world and say, oh, 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 something I really
want to hit home with people. It's like when they started
banning short selling in a small number of stocks. When they said, oh 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 going to deal with
Banks A, B, and C. Because those are probably the
stinkiest of them all. Anyway, see you in
the next video..

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