In the last video clip I just
reviewed an individual equilibrium sheet and what illiquidity
or what insolvency indicates. And if you understood that,
I believe we” re currently prepared to tackle what an equilibrium sheet of
several of these potentially troubled banks may
look like. And I” m not mosting likely to go right into the details. I” m going to offer you the huge image and I assume that” s essentially what matters. Basically, these financial institutions have a bunch of possessions. And I” m going to chat regarding banks really usually right currently, both commercial and investment banks.In a future video clip I ‘ ll inform you the difference in between both and what policy means and what leverage indicates and all that Maybe I ‘ ll discuss that.’in this video. Allow” s just kind of think about a generic annual report for a financial institution. So its assets. I” m simply
going to make up some points. Allow ‘ s state that it has$ 1 billion in government bonds, U.S. federal government bonds. I ‘ m just tossing that therein just as filler just to reveal you that there can be a great deal of various kinds of assets in there. Let” s say that it has an additional $10 billion in AAA business bonds. So you understand these are lendings to actually solvent or really creditworthy business. Business that have actually great cash flows.There ‘ s
extremely bit possibility of them defaulting on their lendings. And what is a bond? A bond is just a car loan to one more entity. If you loan me money, I might provide you an IOU saying that Sal owes you $10. And that IOU, you can call that a Sal bond. So $1 billion of government bonds, that” s a possession that says the federal government owes me a billion dollars.And in the meantime, it ‘ s going to pay me interest.
Business bonds, that ‘ s saying that these corporations, any place these bonds are issued by, they owe me collectively $10 billion and in the meantime they” re mosting likely to pay me interest. That” s all it is And all a property is, is. something that has some future economic value.’Which ‘ s what these are.
These bonds have some future economic value. They have the value of the passion repayments. Plus eventually, they ‘ re
. mosting likely to pay you the $10 billion back. Or maybe it” s something. less than that. So the $10 is the passion. repayments plus what they” re going to pay you back, which.
could be $9.9 billion.I ‘ m making
up numbers. That” s not the concern below.
The essence of the’problem. is that there ‘ s this stinky possession below.
Really, allow me attract a pair. Let ‘ s say I have
another. Let ‘ s say it ‘ s
$ 10 billion.
As soon as again, it ‘ s simply. I ‘ ve offered is a property. And then finally, and I ‘ m not.
of the problem below. Allow me see, I have 21 now,.
Let” s state that I have. $4 billion, so it all includes up to 25.
residential CDOs, collateralized financial debt.
commitments. And I” ve done a video on CDOs,.
Just to kind of have review, CDOs are a derivative.
instrument. I recognize that appears difficult,.
however that just suggests they are derived from.
an additional instrument. Which possibly is a sign that.
the stink is starting to emerge from this component of.
the annual report. What does it mean, derivative? Well, you take a bunch.
of mortgages. So I” ll just draw.
it down here.These are residence mortgages. Perhaps you take a million. of them.
You group them entirely. And you end up with a mortgage.
backed safety. All a mortgage backed safety and security.
is a lending to a big team of people and you placed them all.
together so that you can kind of have the ability to statistically.
give it properties. If you provide to any kind of one, because.
individual, that” s hard to trade. If you provide to a lot of.
individuals, it begins to come to be something that you could trade.
with other individuals. Because they can.
understand it.And in aggregate, you can state.
8% of individuals are going to default and all of that. Anyhow, this isn” t the. crux of it either. I have an entire video clip on mortgage. backed securities.
CDOs, collateralized debt. commitments, are originated from mortgage backed safety and securities. Which ‘ s why they are called.
derivative tools. What CDOs are, you take these.
mortgage backed protections, they” re loans to some people in. some area of the nation,’or maybe they ‘ re diversified. throughout regions, after that you slice and dice them. So what you do is, you slice.
them and right into tranches. And I enter into a lot much more.
detail on this in the other video clips. And you state, this team.
Any type of repayments immediately go
. And after that the next payments.
go to this set. And then this top tranche, you.
can call it the most junior tranche, it” s in some cases called.
the equity tranche.This tranche,
they” re going
to. get whatever is left over. So if everyone pays, they get.
made whole, however if a great deal of people default, all.
the defaults are mosting likely to strike this tranche. And to type of make up for the
. truth that this is the riskiest tranche, or basically these.
individuals are tackling all of the threat, or essentially these.
And a tranche is simply a.
layer, just a slice. I put on” t desire to use.
of the danger, this person is going to obtain a.
greater return. So while he or she may be.
getting 6%, he or she may be obtaining 7% on their cash,.
perhaps this individual gets 12% on their money.This is an additional intriguing. thing.
Since this individual is the.
most safe, the rankings agency, which I” ll most likely.
do one more whole series of videos on. They could offer it.
a AAA score. And maybe they give this.
tranche, and I” m comprising points, however possibly they.
offer it a AA ranking. Yet this equity tranche, it.
And since it” s a junkier. The person that created.
this entire collateralized debt responsibility and that offered.
these tranches to the general public markets. And this procedure incidentally is.
called securitization, because you” re creating protections out.
of these assets that you offer to every person, perhaps the Chinese,.
or whoever, sovereign riches funds.But people
only wish to.
get these tranches. So the banks have to number.
out what to do with this tranche, which is the smelly.
equity tranche. Most of them simply maintained it.
on their annual report. They stated, oh it looks like.
real estate never decreases, we obtain an actually high return on this,.
so we are going to keep this tranche for ourselves. And that” s what these. property CDOs are, that are the crux of the problem. Yet anyway, that was.
simply an apart. Therefore I wished to show you this.
They might be, some of them.But simply for the benefit of. Anyway, that” s my instance
. Allow” s believe around.
Well let ‘ s just claim it.
Let ‘ s say it has car loan. Let me actually throw.
some money in right here. Let ‘ s claim it has a billion. bucks of cash money. A bank always has to.
Simply in situation a person asks for
. That ‘ s in the context of.
a business back. However anyhow, allow ‘ s claim it has. some cash money just for prompt liquidity needs.
It owes somebody $10 billion. It has car loan B, it ‘ s an additional. And allow ‘ s claim it has loan C. Loan C is, just to make it.
fascinating, allow” s state it ‘ s for$ 3 billion.So in this example today,.
, if we assumed that all of these property values are proper.
.
and all of these obligation values are right, what.
is this financial institution” s equity? And in this case,
it ‘ s a. openly traded company, what is its investors ‘ equity? Allow ‘ s figure it out.
Well, its assets are$ 21, $25,.
$ 26 billion in properties. Its responsibilities are.
$ 23 billion. So $26 billion of assets minus. $23 billion of responsibilities suggests that we have $3 billion. of equity, of investors ‘ equity. And just to make it clear.
what this equity is. Allow” s say this is a publicly.
traded company.If you possess a share of the.
business, you possess a share of this equity. Actually, let” s simply. create it out. Allow ‘ s call this Yachovia Bank. In fact, I shouldn” t,. that ‘ s too close. Let ‘ s call this Bank A. And let ‘ s state that Financial institution A has,.’let me compose something, let ‘ s claim that it has. 500 million shares.
You if go right into Yahoo Financing. stated the amount of shares are exceptional? It has 500 million shares. Each share cost, or the.
publication worth of each share cost, essentially ought to be.
this $3 billion of equity based upon the equilibrium sheet. And that” s why they call.
This is this$ 3 billion. Each share needs to be worth,.
Which ‘ s something essential. to recognize.
Due to the fact that a great deal of people assume.
that if a stock cost mosts likely to absolutely no, that suggests that.
you” re obtaining the business for absolutely nothing. No, that” s not real. That just implies that the.
equity is worth absolutely no. And I just realized that.
I” m out of time. I” m mosting likely to proceed this.
in the following video clip. And we” ll discover this.
a little a lot more. See you soon.
Allow ‘ s claim it ‘ s
$ 10 billion. Anyhow, that” s my instance
. It has loan B, it ‘ s an additional. And in this situation,
it ‘ s a. publicly openly company, what is its shareholders ‘ equity? No, that” s not real.