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

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Language: en

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Let's put all of the moral
hazard issues and all the

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fairness issues aside.

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And just think hard
about whether this

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bailout could work.

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Because frankly, if it doesn't
work, then it's definitely not

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something that any of us
should worry about.

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And even if it does work, then I
think you should worry about

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the moral hazard issues.

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But let's say this is Bank
A, shady Bank A.

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And it has-- and let's see,
these are its assets on the

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left hand side.

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And these are its liabilities.

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And so it has, at least on its
books, the book value of the

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CDOs that it has
is $5 billion.

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And what the government is
saying, is that right now,

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Bank B has lent Bank
A this loan.

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Bank B has given them $8 billion
that maybe has to be

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paid back next month.

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And the big fear is that Bank B
is going to get scared, and

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then when this loan is due in
a month's time, that Bank B

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won't give them a new loan
or renew the loan.

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They're just going to want to
take the money back, because

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they're afraid of keeping money
with these guys, when

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you don't know what these
CDOs are worth.

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And that's a legitimate
fear, right?

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Because if these CDOs really are
worth $5 billion, then you

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really do have $4 billion
of equity here, right?

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Total assets are $12 billion
minus $8 billion of

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liabilities means you have
$4 billion of equity.

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Fair enough.

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But what happens if these CDOs
are only worth $1 billion?

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And this is worth $1 billion,
and these are worth $7

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billion, then you only have
$8 billion in assets.

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And $8 billion in liabilities,
and there's no equity.

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Or even worse.

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What if this these CDOs
are worth zero?

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Then you have negative equity.

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Then if these guys were to go
bankrupt, if they were to be

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the next Lehman Brothers, then
all this Lender B would get if

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they went bankrupt are these
CDOs worth 0 and these $7

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billion of assets.

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For every $8 they let lend to
Bank A, it'll only get $7.

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So what the government is saying
is, OK, to keep Bank B

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from pulling their money out of
Bank A, let's buy out these

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CDOs at essentially at a price
that keeps this bank solvent.

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Even if they really are worth
0, we're not the Fed or the

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Treasury-- the Treasury's
the one doing it.

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The Treasury's not going to pay
0, because if they paid 0,

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this guy would just
go bankrupt.

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It would be another
Lehman Brothers.

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So the Treasury wants to
essentially, maybe pay $5

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billion for it.

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So that you take $5 billion--
buy these CDOs for $5 billion.

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And all of a sudden this doesn't
become CDOs of $5

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billion, this becomes cash.

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And their argument is, if you
were to do this, no matter how

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unfair it might be, because this
is essentially a check of

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$5 billion, if you assume these
CDOs are worthless.

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This is essentially a check
that's being written to the

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equity holders and the
unsecured debt

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holders of this bank.

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But let's assume that-- Let's
put all that aside.

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Let's assume that this works.

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That now Bank B will say, oh
boy, I don't have to worry

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about those CDOs anymore.

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Those CDOs have been
turned into cash.

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This company definitely has
positive book value, and

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therefore, I will continue
to loan to this company.

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But it isn't that simple.

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Because right behind these CDOs,
there are other assets

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on this book.

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On most banks' books.

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So these were the subprime
CDOs, the

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stinkiest of the stinky.

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Then you have other
things that are a

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little bit less risky.

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They're Alt-A CDOs.

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These are loans that were given
to people who aren't

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necessarily subprime.

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These are people who had
decent credit scores.

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But they still put no money
down, and they still were able

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to essentially fabricate their
income on there loan

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applications.

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So these are the Alt-A loans.

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Then above that-- And these
might be Alt-A CDOs.

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They've been sliced and diced,
so some tranches are more

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risky, some tranches
are less risky.

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Above that, you might have
commercial real estate CDOs.

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So I'll call that commercial
real estate CDOs.

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Then above that, you might
have commercial loans.

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Just a regular companies.

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Or even better, these could be
loans to private equity--

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actually, that's even better.

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Let's put some private equity
loans in there, because I

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wanted to show you that this
isn't the only stinky thing on

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the balance sheets,
these CDOs.

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That this is just the stinkiest
of them all.

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A good way to think about it is,
if you have a dead skunk

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in your house, you won't
notice that the

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milk is going bad.

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And that is the situation.

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These CDOs, they seem really
bad now, but you know what?

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Six months ago, or
even a year ago.

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Six months ago, these CDOs
looked a lot like-- these

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subprime CDOs look a lot
like these Alt-A CDOs

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are starting to look.

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And the way these Alt-A CDOs
looked six months ago is how a

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lot of these commercial real
estate CDOs are starting to

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look right now.

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So this is just the tip of
the iceberg, these CDOs.

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So you have an issue here.

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The government goes in.

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It spent $700 billion.

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It buys these assets that are
of questionable value.

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And it's claiming to us that
the problem will be solved.

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But Bank B isn't an idiot.

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Bank B isn't an idiot.

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They're probably more
prudent than Bank A.

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They didn't buy these
subprime assets.

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Subprime CDOs.

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But I wouldn't be surprised if
Bank B probably has some of

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these less stinky things on
their balance sheets.

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Alt-A.

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I mean, they definitely have
something stinky, which is

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called a loan to A.

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That's one of their assets.

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And then they might have loans
to private equity, private

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equity loans.

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Then they might have some
commercial real estate CDOs.

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They might have CDOs that are
backed by credit card debt.

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The bottom line is that this
bank can look into its own

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assets, and it can see that the
fundamental value behind

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these assets are
deteriorating.

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Anyone who talks to anyone in
the real economy right now

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knows that the economy's
slowing.

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That consumers can't spend
any more money.

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In fact, last year consumers
had negative savings, which

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means that they had to borrow
money to fuel their

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consumption.

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And the only way that you can
have consumption growth in

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that type of environment is if
either salaries increased,

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which isn't happening,
or people are able

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to borrow more money.

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And we already know that credit
is getting tightened.

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So if you're Bank B, will the
government buying out this

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asset, irregardless of how fair
it is, will that make you

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confident in loaning
to Bank A?

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Well, no, because you see in
your own balance sheet that

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things are deteriorating.

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And frankly, you have loans to
other people too, right?

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You have loans to Bank C.

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That's a loan to Bank E.

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That's a loan to some sovereign
wealth fund.

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And then you have your
equity here.

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So you have a double
conundrum, right?

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You have all of these guys.

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These loans might come due, so
you're going to need some cash

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for that in the future.

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And you see the trend.

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You're not an idiot.

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You aren't as risk-taking as
this guy, and you see that

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this wasn't the only stinky
thing out there.

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That there are other assets
classes, other types of CDOs,

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and just loans in general,
that are starting to

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deteriorate.

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That's starting to
deteriorate.

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That's starting to
deteriorate.

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That's starting to
deteriorate.

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So maybe this credit
crunch isn't just

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because of these CDOs.

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Maybe it's because this banker
is actually being prudent.

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Maybe this banker's actually
saying, you know what, I need

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to be careful.

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I see the left hand side of my
balance sheet deteriorating.

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I need to pull this money, just
in case, just really in

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the best interest of
my equity holders.

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Of my shareholders, or even
of my bond holders.

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So even on this first cut, even
if there wasn't all of

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this controversy, and even if
George Bush didn't go up, and

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do a primetime speech telling
us that we're about to reach

00:07:56.730 --> 00:08:00.970
financial armageddon, if I was a
prudent banker I would still

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be wary of loaning to Bank A,
even if the government were

00:08:05.290 --> 00:08:07.310
able to pull this buyout.

00:08:07.310 --> 00:08:11.060
Now on top of that, I work in
the financial industry.

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Bankers were prudent.

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They see reality.

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They see things are
deteriorating.

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So they want to be cautious.

00:08:16.930 --> 00:08:20.720
But frankly, when Bush, and
Paulson and Bernanke go up on

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TV and say, tell the world that
you have to pass this

00:08:24.690 --> 00:08:27.000
bill and if not, we're
essentially on-- they use

00:08:27.000 --> 00:08:31.950
words like "preicipice." These
are the real precipice.

00:08:31.950 --> 00:08:35.720
And they use "financial
armageddon." It's either their

00:08:35.720 --> 00:08:38.350
words, or some of the
other words that

00:08:38.350 --> 00:08:39.799
I've heard out there.

00:08:39.799 --> 00:08:40.960
Financial armageddon.

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And days away from
the precipice.

00:08:45.870 --> 00:08:48.830
So my question is to you,
regardless of whether the

00:08:48.830 --> 00:08:52.040
government buys this out, is
this type of language going to

00:08:52.040 --> 00:08:55.550
instill any type of sense
of confidence in Bank B?

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If I'm the chairman or CEO of
Bank B, I'm like, you know

00:08:58.450 --> 00:08:59.740
what, I thought things
were bad.

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And that's why I was trying
to, instead of charge 2

00:09:02.710 --> 00:09:04.560
percent for a loan, I was
going to charge 6

00:09:04.560 --> 00:09:05.520
percent for a loan.

00:09:05.520 --> 00:09:07.520
But now the President of the
United States, the Treasury

00:09:07.520 --> 00:09:10.080
Secretary, and the Chairman of
the Federal Reserve have

00:09:10.080 --> 00:09:13.830
frankly used language that no
elected or unelected official

00:09:13.830 --> 00:09:15.250
has ever used before.

00:09:15.250 --> 00:09:18.050
Days away from financial
armageddon?

00:09:18.050 --> 00:09:19.330
We're on the precipice?

00:09:19.330 --> 00:09:21.200
Hell, I'm definitely not going
to lend right now.

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I don't care even if
they do buy assets.

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And then I'm going to
throw another monkey

00:09:27.170 --> 00:09:28.430
wrench into the picture.

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The plan calls for a reverse
auction, where the essentially

00:09:35.880 --> 00:09:38.470
the Fed says, hey everybody,
I have $1 billion.

00:09:38.470 --> 00:09:40.030
Who wants to sell me
their mortgages

00:09:40.030 --> 00:09:41.510
for the lowest price?

00:09:41.510 --> 00:09:42.600
Well, guess what?

00:09:42.600 --> 00:09:46.560
The people who are willing to
sell their CDOs for the lowest

00:09:46.560 --> 00:09:49.350
price are probably the most
desperate out there.

00:09:49.350 --> 00:09:52.590
And if anyone participates in
those auctions and sells at a

00:09:52.590 --> 00:09:55.930
discount, those are the people
that are going to be on my red

00:09:55.930 --> 00:09:58.570
flag list. Those are the banks
that I'm going to be the least

00:09:58.570 --> 00:10:02.020
likely to lend to, because I
knew that they were desperate.

00:10:02.020 --> 00:10:04.570
That they were just covering up
their balance sheet for as

00:10:04.570 --> 00:10:05.290
long as they could.

00:10:05.290 --> 00:10:07.020
They were waiting for the
government bailout.

00:10:07.020 --> 00:10:09.420
And if they're willing to take
the government bailout, those

00:10:09.420 --> 00:10:12.700
are the very banks that I
don't want to lend to.

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Anyway, I'll leave you there.

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But I just want to give you the
point that everyone-- that

00:10:16.570 --> 00:10:19.240
George Bush and then the rest of
his gang is trying to scare

00:10:19.240 --> 00:10:23.320
the world and say, oh, we are
trying to save the economy.

00:10:23.320 --> 00:10:25.940
They don't mention the fact that
even with their bailout,

00:10:25.940 --> 00:10:28.560
regardless of how unfair it is,
we're probably going to

00:10:28.560 --> 00:10:29.980
end up in the same situation.

00:10:29.980 --> 00:10:34.360
And frankly, it might even
make the situation worse.

00:10:34.360 --> 00:10:37.190
And that's something I really
want to hit home with people.

00:10:37.190 --> 00:10:40.530
It's like when they started
banning short selling in a

00:10:40.530 --> 00:10:42.010
small number of stocks.

00:10:42.010 --> 00:10:45.620
When they said, oh you can't
short Banks A, B, and C.

00:10:45.620 --> 00:10:47.970
Immediately that made everyone's
ears go up and say,

00:10:47.970 --> 00:10:50.420
oh the government knows
something that we don't know.

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I'm not going to deal with
Banks A, B, and C.

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Because those are probably the
stinkiest of them all.

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Anyway, see you in
the next video.


Investment vs. consumption 1

WEBVTT
Kind: captions
Language: en

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I've been wanting to make a
video on a couple of terms

00:00:03.860 --> 00:00:06.050
that people have really thrown
around for a while now.

00:00:06.050 --> 00:00:09.190
And I think it really hits the
core of some of the issues

00:00:09.190 --> 00:00:11.230
we're dealing with now with the
credit debacle but it's

00:00:11.230 --> 00:00:13.550
kind of at a deeper level.

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So the things I want to go over
are the ideas of savings,

00:00:20.970 --> 00:00:28.150
consumption, and investment.

00:00:28.150 --> 00:00:29.460
And you hear these a lot.

00:00:29.460 --> 00:00:31.980
Everyone obviously says, I've
invested in the stock market

00:00:31.980 --> 00:00:34.440
or I've invested in a house and
I really want to give you

00:00:34.440 --> 00:00:38.740
a framework for how I think
about these ideas.

00:00:38.740 --> 00:00:44.180
And frankly, I haven't seen them
depicted this way in any

00:00:44.180 --> 00:00:46.210
economics book, although they've
kind of touched on

00:00:46.210 --> 00:00:48.320
this, but I think this is really
how you should think

00:00:48.320 --> 00:00:49.690
about these things.

00:00:49.690 --> 00:00:52.680
So if you save money, and I
think we all know what that

00:00:52.680 --> 00:00:54.950
means, that's money that you
didn't spend, there's a couple

00:00:54.950 --> 00:00:56.370
of things that you
can do with it.

00:00:56.370 --> 00:00:58.800
You can either consume
your money or you

00:00:58.800 --> 00:01:00.130
could invest your money.

00:01:00.130 --> 00:01:02.530
So, let's just think about a
bunch of different situations

00:01:02.530 --> 00:01:07.110
and think about whether those
things are consumption or

00:01:07.110 --> 00:01:08.720
investment.

00:01:08.720 --> 00:01:15.066
So let's say, I have $100,000
that I'm dealing with.

00:01:15.066 --> 00:01:17.350
So let's say, I take
that $100,000

00:01:17.350 --> 00:01:19.415
and I build a factory.

00:01:23.100 --> 00:01:26.080
And I think that that factory
is going to be able to

00:01:26.080 --> 00:01:29.662
produce-- I'll make up some
product-- it'll be able to

00:01:29.662 --> 00:01:33.640
produce cars more efficiently
and cheaper than any other car

00:01:33.640 --> 00:01:35.130
factory out there.

00:01:35.130 --> 00:01:39.060
Well, I think we'd all agree
that this is an investment.

00:01:39.060 --> 00:01:42.390
And why is it an investment?

00:01:42.390 --> 00:01:46.550
Because I'm taking this $100,000
and I'm putting it to

00:01:46.550 --> 00:01:50.110
some use that is creating,
hopefully, more value than my

00:01:50.110 --> 00:01:52.110
original $100,000.

00:01:52.110 --> 00:01:55.220
In fact, I'm expecting some
type of a return on this

00:01:55.220 --> 00:01:55.690
investment.

00:01:55.690 --> 00:01:58.180
And I've made a bunch of videos
on what a return on

00:01:58.180 --> 00:02:00.430
investment is, and you can
usually quantify it.

00:02:00.430 --> 00:02:03.610
If I take a $100,000 and I build
this factory and this

00:02:03.610 --> 00:02:08.710
factory spits out $50,000 a
year, it's probably creating

00:02:08.710 --> 00:02:12.130
at least $50,000 a year value,
assuming that nothing corrupt

00:02:12.130 --> 00:02:13.490
is happening in our system.

00:02:13.490 --> 00:02:16.020
In fact, it's normally creating
more than $50,000 a

00:02:16.020 --> 00:02:16.490
year of value.

00:02:16.490 --> 00:02:20.930
It may be creating a $100,000 a
year of value and $50,000 of

00:02:20.930 --> 00:02:22.910
that may be going to the
person who's doing the

00:02:22.910 --> 00:02:25.150
production and then the other
half of the value is actually

00:02:25.150 --> 00:02:27.740
going to the consumer
of whatever

00:02:27.740 --> 00:02:28.730
this factory is making.

00:02:28.730 --> 00:02:30.550
And you have to think about
it, because if all of the

00:02:30.550 --> 00:02:33.150
value went to the person who
produced the factory then

00:02:33.150 --> 00:02:35.380
there's not a huge incentive
for someone to use his

00:02:35.380 --> 00:02:36.340
products anymore.

00:02:36.340 --> 00:02:38.560
But anyway, that's not the
topic of discussion.

00:02:38.560 --> 00:02:41.370
We're just trying to get at
a mental framework on what

00:02:41.370 --> 00:02:43.640
consumption is versus
investment.

00:02:43.640 --> 00:02:46.710
So I think we all agree that if
I were to build a factory

00:02:46.710 --> 00:02:49.680
that this is-- let's say I'll
do everything in green as

00:02:49.680 --> 00:02:51.320
investment.

00:02:51.320 --> 00:02:55.180
So building a factory
is an investment.

00:02:55.180 --> 00:03:00.460
Now let's say that I'm homeless

00:03:00.460 --> 00:03:01.960
and I have this $100,000.

00:03:01.960 --> 00:03:05.340
And because I'm homeless, I
don't have a place to go and

00:03:05.340 --> 00:03:08.180
eat dinner and rest and relax.

00:03:08.180 --> 00:03:11.360
Because I don't have that, I
can't get a job and I can't

00:03:11.360 --> 00:03:13.340
become a productive
member of society.

00:03:13.340 --> 00:03:17.830
So maybe, I'm going to use this
$100,000 to buy a simple

00:03:17.830 --> 00:03:19.560
house that meets all
of my needs.

00:03:19.560 --> 00:03:22.400
Let's say build a simple house,
and I'll do that in a

00:03:22.400 --> 00:03:23.650
neutral color.

00:03:31.590 --> 00:03:34.260
This is my other use of this
$100,000, instead of building

00:03:34.260 --> 00:03:36.730
a factory, I'm going to
build a simple house.

00:03:36.730 --> 00:03:39.830
And this house, it provides
shelter for me and my family,

00:03:39.830 --> 00:03:43.160
it allows us that security that
now my kids can go to

00:03:43.160 --> 00:03:45.640
school and they can
themselves become

00:03:45.640 --> 00:03:46.720
more productive citizens.

00:03:46.720 --> 00:03:49.410
I now have an address.

00:03:49.410 --> 00:03:51.440
I have a place to take a shower,
that allows me to go

00:03:51.440 --> 00:03:55.750
get a job and I can now create
value for society as a whole,

00:03:55.750 --> 00:03:58.710
instead of being on the
corner and begging

00:03:58.710 --> 00:04:00.220
for money from people.

00:04:00.220 --> 00:04:02.880
I would argue that this
is also an investment.

00:04:02.880 --> 00:04:03.340
Why is it?

00:04:03.340 --> 00:04:06.460
Because I'm taking this
$100,000, that maybe I had or

00:04:06.460 --> 00:04:10.150
someone gave to me, and it's
generating a return.

00:04:10.150 --> 00:04:11.690
And what is that return?

00:04:11.690 --> 00:04:12.940
Well, with a factory,
it's maybe a

00:04:12.940 --> 00:04:13.770
little easier to quantify.

00:04:13.770 --> 00:04:17.089
But at minimum, it's this work
that I'm able to do because I

00:04:17.089 --> 00:04:17.970
now have a house.

00:04:17.970 --> 00:04:19.670
Because I have the security,
I have the address.

00:04:19.670 --> 00:04:20.399
I have the shelter.

00:04:20.399 --> 00:04:21.880
I'm able to relax.

00:04:21.880 --> 00:04:24.360
It's that security and it's also
the return that probably

00:04:24.360 --> 00:04:27.420
my kids are going to be able to
now contribute to society.

00:04:27.420 --> 00:04:29.150
Maybe if they grew up homeless,
they would have

00:04:29.150 --> 00:04:30.500
never been able to contribute.

00:04:30.500 --> 00:04:33.120
And now that they have a roof
over their head, and are able

00:04:33.120 --> 00:04:35.670
to go to school, et cetera, they
are going to be able to

00:04:35.670 --> 00:04:38.130
give some economic value
back to society.

00:04:38.130 --> 00:04:40.920
It's hard to value, maybe I
didn't have any job before and

00:04:40.920 --> 00:04:42.970
now I have a job and
I can contribute

00:04:42.970 --> 00:04:45.480
$30,000 a year to society.

00:04:45.480 --> 00:04:47.670
Maybe I'm working at
someone's factory.

00:04:47.670 --> 00:04:49.130
Maybe I'm providing
some other-- maybe

00:04:49.130 --> 00:04:50.260
I'm a farmer now.

00:04:50.260 --> 00:04:52.330
Whatever, I'm providing
some source of value.

00:04:52.330 --> 00:04:54.390
And maybe my kids-- if they
never got an education, they

00:04:54.390 --> 00:04:59.300
would have maybe added $10,000
of value per year to people

00:04:59.300 --> 00:05:01.120
and now they can add
$20,000 of value.

00:05:01.120 --> 00:05:03.520
So that difference would also be
some of the return on this

00:05:03.520 --> 00:05:04.280
investment.

00:05:04.280 --> 00:05:09.880
So I also consider this
to be an investment.

00:05:09.880 --> 00:05:12.730
Now, my question to you is,
let's say that I already had a

00:05:12.730 --> 00:05:15.570
house-- so this is
an investment.

00:05:15.570 --> 00:05:17.900
Let's say I already had a house
and my family is happy

00:05:17.900 --> 00:05:20.020
and we have everything
we need.

00:05:20.020 --> 00:05:23.820
We have food on the table and
my kids go to school and I'm

00:05:23.820 --> 00:05:26.360
able to get a job and
all of that exists.

00:05:26.360 --> 00:05:30.960
But let's say, I still have
a $100,000 and I use that

00:05:30.960 --> 00:05:40.350
$100,000-- I'll do it in
yellow-- to put in some

00:05:40.350 --> 00:05:41.650
granite counter tops.

00:05:44.940 --> 00:05:46.960
I have some money left over,
let's say, I'm going to add a

00:05:46.960 --> 00:05:55.360
bathroom to my house and I will
put the latest hardwood

00:05:55.360 --> 00:06:00.990
floors, so that my family
will be impressed.

00:06:00.990 --> 00:06:01.660
You can imagine.

00:06:01.660 --> 00:06:04.410
And maybe I add 2,000
square feet.

00:06:04.410 --> 00:06:06.620
You normally can't get all
that for a $100,000 but I

00:06:06.620 --> 00:06:08.990
think you'll bear with me.

00:06:08.990 --> 00:06:11.750
So I'm essentially doing some
major home improvements.

00:06:11.750 --> 00:06:15.160
So my question to you is-- is
this an investment or is this

00:06:15.160 --> 00:06:16.620
consumption?

00:06:16.620 --> 00:06:20.480
Now, in our everyday world, with
most people we deal with,

00:06:20.480 --> 00:06:22.280
they will call this investment
in my house.

00:06:22.280 --> 00:06:23.080
And why are they saying that?

00:06:23.080 --> 00:06:26.990
Because they say, by spending
a $100,000 in the house in

00:06:26.990 --> 00:06:30.050
this way, that maybe-- if you
watch the Home and Garden

00:06:30.050 --> 00:06:32.210
channel, they're doing this
all the time-- that if you

00:06:32.210 --> 00:06:36.150
pour this a $100,000 into your
house, that maybe the value of

00:06:36.150 --> 00:06:39.170
your house is going to
increase by $150,000.

00:06:39.170 --> 00:06:41.990
Or someone else, all of a
sudden, is going to perceive

00:06:41.990 --> 00:06:44.690
the value of your house
as being $150,000.

00:06:44.690 --> 00:06:48.390
They'll say, well, you got a
$50,000 return on investment.

00:06:48.390 --> 00:06:50.440
I'd argue that that
is not investment.

00:06:50.440 --> 00:06:52.070
That it's speculation.

00:06:52.070 --> 00:06:56.000
You are, essentially, piling
money into this stuff-- and

00:06:56.000 --> 00:06:57.930
I'll do this in red,
consumption is red.

00:07:02.500 --> 00:07:05.080
What's happening here
truly economically?

00:07:05.080 --> 00:07:08.220
When you add granite, or you
add an extra bathroom or

00:07:08.220 --> 00:07:11.080
hardwood floors or this extra
2,000 square feet, is it

00:07:11.080 --> 00:07:14.260
making anyone who's living in
that house more productive?

00:07:14.260 --> 00:07:16.670
Is it making you harder working;
is it making you more

00:07:16.670 --> 00:07:20.680
likely to invent the cure for
cancer, or more likely to

00:07:20.680 --> 00:07:26.120
invent a way of getting
cheap energy, or

00:07:26.120 --> 00:07:27.390
produce more widgets?

00:07:27.390 --> 00:07:31.900
No, it's just, if anything,
providing more things for you

00:07:31.900 --> 00:07:34.220
to have to take care of, that
you're not going to be able to

00:07:34.220 --> 00:07:35.480
focus as much on your work.

00:07:35.480 --> 00:07:37.790
Or more energy is going to
have to be extended to

00:07:37.790 --> 00:07:41.060
maintain this type of place,
to heat and cool a 2,000

00:07:41.060 --> 00:07:42.020
square foot house.

00:07:42.020 --> 00:07:46.100
So if anything, by actually
pouring the $100,000 here,

00:07:46.100 --> 00:07:47.920
you're actually creating
something that is going to

00:07:47.920 --> 00:07:49.420
suck more out of society.

00:07:49.420 --> 00:07:52.440
In fact, in no way is this going
to contribute to the

00:07:52.440 --> 00:07:53.870
collective wealth of society.

00:07:53.870 --> 00:07:56.770
The last two examples I gave
contribute to the collective

00:07:56.770 --> 00:07:59.530
wealth society, some of which
you share, and that is your

00:07:59.530 --> 00:08:00.710
return on the investment.

00:08:00.710 --> 00:08:02.950
But as a whole, this is an
investment into society.

00:08:02.950 --> 00:08:07.360
And it's going to make
the pie bigger.

00:08:07.360 --> 00:08:09.750
This right here, does not
make the pie bigger.

00:08:09.750 --> 00:08:12.130
It might make you a little bit
happier, make your ego feel a

00:08:12.130 --> 00:08:15.880
little bit better, let your
pride grow, and your self

00:08:15.880 --> 00:08:18.210
righteousness grow, and show
other people that you've

00:08:18.210 --> 00:08:21.490
arrived, but it's not
going to increase

00:08:21.490 --> 00:08:22.890
the wealth of society.

00:08:22.890 --> 00:08:24.980
And when you say that you've
invested, you are really just

00:08:24.980 --> 00:08:26.720
saying I've speculated.

00:08:26.720 --> 00:08:29.340
What you're saying is-- by
paying this $100,000, you're

00:08:29.340 --> 00:08:33.260
going to find, essentially,
a greater fool out there.

00:08:33.260 --> 00:08:34.830
They could have done the same
thing, they could have bought

00:08:34.830 --> 00:08:38.210
your house, spent $100,000 and
done this, if this is what

00:08:38.210 --> 00:08:39.640
would have made them happy.

00:08:39.640 --> 00:08:42.169
But what you're saying is,
essentially, that you're going

00:08:42.169 --> 00:08:45.730
to find somebody out there who's
willing to pay $150,000

00:08:45.730 --> 00:08:47.060
extra for something that should

00:08:47.060 --> 00:08:48.970
have only cost $100,000.

00:08:48.970 --> 00:08:51.800
And in fact, if anything, if you
use this at all, the value

00:08:51.800 --> 00:08:52.850
of this is going to go down.

00:08:52.850 --> 00:08:56.060
So you're just somehow assuming
that the granite

00:08:56.060 --> 00:08:58.110
counter tops that you choose are
going to be the taste that

00:08:58.110 --> 00:09:00.080
someone else would like or that
the hardwood floors are

00:09:00.080 --> 00:09:01.680
going to be the taste someone
else would like.

00:09:01.680 --> 00:09:04.280
I would actually argue that when
you customize your house

00:09:04.280 --> 00:09:08.820
in this way, you are creating
$100,000 of consumption to

00:09:08.820 --> 00:09:09.710
your taste.

00:09:09.710 --> 00:09:12.660
And I'd be surprised if someone
else, truly, is

00:09:12.660 --> 00:09:15.820
willing to pay more than
$100,000 unless they're being,

00:09:15.820 --> 00:09:18.360
in some way, irrational or they
can finance this because

00:09:18.360 --> 00:09:22.150
it's part of the mortgage.

00:09:22.150 --> 00:09:27.700
Anyway, this is, I think, just
the big picture: investment

00:09:27.700 --> 00:09:29.400
adds value to society.

00:09:29.400 --> 00:09:31.480
A simple house adds
value to society.

00:09:31.480 --> 00:09:36.230
Consumption is something where
people might call it an

00:09:36.230 --> 00:09:38.460
investment because it's
kind of speculation.

00:09:38.460 --> 00:09:41.840
One might find some other guy
willing to emotionally pay

00:09:41.840 --> 00:09:42.710
more for something.

00:09:42.710 --> 00:09:46.820
But it's money that's burned;
it's not creating more value

00:09:46.820 --> 00:09:47.970
for society.

00:09:47.970 --> 00:09:49.220
I continue this in
the next video.


Investment vs. consumption 2

WEBVTT
Kind: captions
Language: en

00:00:00.670 --> 00:00:03.750
Let's continue with this example
and I welcome you to

00:00:03.750 --> 00:00:06.120
throw examples my way, and we
can think about whether

00:00:06.120 --> 00:00:08.420
something is consumption
or investment.

00:00:08.420 --> 00:00:10.590
And my argument, in general,
is that investment is

00:00:10.590 --> 00:00:12.100
something good for society.

00:00:12.100 --> 00:00:13.340
It's good for you.

00:00:13.340 --> 00:00:15.030
It is capital, right?

00:00:15.030 --> 00:00:19.350
Or money that's being put to
work to create more wealth or

00:00:19.350 --> 00:00:21.400
more capital or more
good for society.

00:00:21.400 --> 00:00:26.100
While consumption is capital
that is, essentially, being

00:00:26.100 --> 00:00:29.730
burned in some way, usually for
some type of social status

00:00:29.730 --> 00:00:30.980
or ego gratification.

00:00:35.050 --> 00:00:36.750
Well, let's think about that.

00:00:36.750 --> 00:00:42.610
What about a going out once a
month-- Let's say a vacation,

00:00:42.610 --> 00:00:44.850
this is an interesting case.

00:00:44.850 --> 00:00:52.970
A simple vacation with family.

00:00:52.970 --> 00:00:55.370
Maybe it's a family reunion,
depending on your family, it

00:00:55.370 --> 00:00:58.360
might be simple, or it might
be relaxing, it might not.

00:00:58.360 --> 00:01:01.530
But let's assume this is
a relaxing vacation.

00:01:01.530 --> 00:01:02.720
You're going camping,
or you're going

00:01:02.720 --> 00:01:03.770
to Yosemite or something.

00:01:03.770 --> 00:01:05.860
It's a very peaceful, tranquil
thing to do.

00:01:05.860 --> 00:01:10.590
So your original gut reaction
would be, well, if we take a

00:01:10.590 --> 00:01:13.340
vacation, me and my family,
we're going to take time off,

00:01:13.340 --> 00:01:15.820
we're not going to work,
my kids aren't

00:01:15.820 --> 00:01:16.850
going to be in school.

00:01:16.850 --> 00:01:18.460
So you might say, oh, well,
that's consumption because

00:01:18.460 --> 00:01:19.270
we're going to spend money.

00:01:19.270 --> 00:01:23.120
Let's say, the vacation
cost $2,000, right?

00:01:23.120 --> 00:01:26.190
We're spending $2,000
on this vacation.

00:01:26.190 --> 00:01:29.150
So that might be an investment,
or that might be

00:01:29.150 --> 00:01:29.670
consumption.

00:01:29.670 --> 00:01:31.830
So, at first you might say
that's consumption, you're not

00:01:31.830 --> 00:01:32.840
going to be working.

00:01:32.840 --> 00:01:35.530
Once you go on that vacation,
there's nothing left over.

00:01:35.530 --> 00:01:37.650
But there could be a counter
argument here.

00:01:37.650 --> 00:01:40.460
There could be an argument that,
by taking this simple

00:01:40.460 --> 00:01:44.120
vacation with the family, it
recenters you, it bonds with

00:01:44.120 --> 00:01:46.910
your family, it makes you
a happier human being.

00:01:46.910 --> 00:01:49.530
And it makes you more likely
to be able to contribute to

00:01:49.530 --> 00:01:50.980
society once you
get back home.

00:01:50.980 --> 00:01:52.980
And if you didn't take this
vacation, you would

00:01:52.980 --> 00:01:54.390
eventually burn out.

00:01:54.390 --> 00:01:56.920
So in this example, and it
depends on what you consider a

00:01:56.920 --> 00:02:00.280
simple vacation, I would
consider that actually,

00:02:00.280 --> 00:02:01.260
probably an investment.

00:02:01.260 --> 00:02:03.560
Especially if it makes you more
relaxed, it eases your

00:02:03.560 --> 00:02:06.070
brain, it allows you to become
more creative and more

00:02:06.070 --> 00:02:07.090
productive for society.

00:02:07.090 --> 00:02:09.250
That could be an investment.

00:02:09.250 --> 00:02:10.680
That's why I think it's
important that

00:02:10.680 --> 00:02:12.190
people don't overwork.

00:02:12.190 --> 00:02:17.360
Now, what if I were to take me
and my family and we were to

00:02:17.360 --> 00:02:22.480
have someone carry us or we rode
on someone's back as they

00:02:22.480 --> 00:02:27.470
swam across the ocean to go stay
in golden thrones while

00:02:27.470 --> 00:02:29.480
an army of people
danced for us.

00:02:29.480 --> 00:02:29.760
Right?

00:02:29.760 --> 00:02:31.155
So let's say, an extravagant
vacation.

00:02:37.400 --> 00:02:39.570
So you could argue a lot of
things, this is, I have a

00:02:39.570 --> 00:02:46.780
family of four and let's say
it costs me $200,000.

00:02:46.780 --> 00:02:48.300
Well here, there's
a couple things.

00:02:48.300 --> 00:02:50.780
There might be some part of this
vacation that makes you

00:02:50.780 --> 00:02:53.440
more relaxed and might make
you more productive.

00:02:53.440 --> 00:02:55.690
I'd argue that it is probably
the opposite, the extravagant

00:02:55.690 --> 00:02:58.770
vacation is probably going to
make you more stressed and

00:02:58.770 --> 00:03:01.620
probably feed your ego in ways
that are in some ways

00:03:01.620 --> 00:03:02.910
self-destructive.

00:03:02.910 --> 00:03:05.750
But let's say that there is some
component, let's stick to

00:03:05.750 --> 00:03:07.590
the benefit of the doubt,
that does relax you.

00:03:07.590 --> 00:03:10.150
And I would say that that
component is an investment.

00:03:10.150 --> 00:03:10.780
But you know what?

00:03:10.780 --> 00:03:13.490
You probably could have gotten
that for $2,000.

00:03:13.490 --> 00:03:17.160
So we could say that $2,000
of this is something of an

00:03:17.160 --> 00:03:25.890
investment and that $198,000
of this probably is

00:03:25.890 --> 00:03:26.460
consumption.

00:03:26.460 --> 00:03:29.110
Because it's not making
you more productive.

00:03:29.110 --> 00:03:32.570
Sure enough, when you go to this
place, it is giving those

00:03:32.570 --> 00:03:36.750
people something to do and it
is giving them jobs, but I

00:03:36.750 --> 00:03:38.400
would call that a transfer
of wealth.

00:03:38.400 --> 00:03:39.730
This isn't investment.

00:03:39.730 --> 00:03:42.670
When you go to whatever country
you decide to go to

00:03:42.670 --> 00:03:46.380
and you blow, essentially,
$198,000 that you didn't need

00:03:46.380 --> 00:03:51.200
to just because it feels good
to have the locals dote on

00:03:51.200 --> 00:03:53.550
you, you're transferring
money to them.

00:03:53.550 --> 00:03:56.060
And then, maybe, they transfer
that money to someone else,

00:03:56.060 --> 00:04:01.000
but it in no way is increasing
the wealth of the world.

00:04:01.000 --> 00:04:03.120
It's not leading to innovation;
it's not leading

00:04:03.120 --> 00:04:08.550
to more factories; and
it's not leading to

00:04:08.550 --> 00:04:10.040
the pie getting bigger.

00:04:10.040 --> 00:04:10.510
And you know what?

00:04:10.510 --> 00:04:13.200
I don't even think this is,
necessarily, a bad idea

00:04:13.200 --> 00:04:15.840
because, frankly, this is just
the transfer of wealth from

00:04:15.840 --> 00:04:18.744
someone who needs ego
gratification to a transfer of

00:04:18.744 --> 00:04:21.470
wealth from someone who's
willing to do fairly simple

00:04:21.470 --> 00:04:23.480
things to, essentially, take
that wealth from them.

00:04:23.480 --> 00:04:26.960
But, at the end of the day,
it is consumption.

00:04:26.960 --> 00:04:30.190
And I think you can imagine,
let's say, a simple purse.

00:04:33.500 --> 00:04:35.990
My wife goes out and buys
a purse from Target

00:04:35.990 --> 00:04:38.440
and it costs $20.

00:04:38.440 --> 00:04:41.960
Is that consumption or is
that an investment?

00:04:41.960 --> 00:04:44.290
Well, I'd argue that that's
an investment.

00:04:44.290 --> 00:04:46.480
Maybe her old purse is falling
apart and by having a new

00:04:46.480 --> 00:04:49.080
purse, maybe it helps her get
a job, be more productive;

00:04:49.080 --> 00:04:50.980
maybe it helps her get
more organized.

00:04:50.980 --> 00:04:52.255
So this could be
an investment.

00:04:55.610 --> 00:04:57.670
And what about a Louis Vuitton--
not to pick on them

00:04:57.670 --> 00:05:00.390
in particular-- but what about
a Louis Vuitton purse.

00:05:00.390 --> 00:05:01.690
I don't know how much they--
I don't even know

00:05:01.690 --> 00:05:04.590
how to spell it.

00:05:04.590 --> 00:05:09.560
I think these cost upwards
of $2,000, or whatever.

00:05:09.560 --> 00:05:13.750
Well, this, clearly, is some
form of consumption.

00:05:13.750 --> 00:05:15.310
You could maybe make some
argument that in certain

00:05:15.310 --> 00:05:17.650
circles, you could get a job
if you carry around one of

00:05:17.650 --> 00:05:19.000
these purses.

00:05:19.000 --> 00:05:22.450
But there's some basic core
value to it that you probably

00:05:22.450 --> 00:05:24.220
could have gotten with
a simple purse.

00:05:24.220 --> 00:05:26.065
So that, maybe, is $20
of investment.

00:05:30.990 --> 00:05:35.790
And then the rest of it, I don't
know, the other $1,980,

00:05:35.790 --> 00:05:37.166
is consumption.

00:05:37.166 --> 00:05:40.450
Now, I'll ask you a further
question: do you think that

00:05:40.450 --> 00:05:43.490
this is bad or good
for society?

00:05:43.490 --> 00:05:45.990
Well, I'd actually argue that
it's probably neutral for

00:05:45.990 --> 00:05:49.430
society, because it does look
like a quote, unquote, waste

00:05:49.430 --> 00:05:53.830
of money, this extra almost
$2,000 that you spent that you

00:05:53.830 --> 00:05:57.050
really didn't have to, to get
something of fairly basic

00:05:57.050 --> 00:06:00.890
utility, but that those
resources weren't burned.

00:06:00.890 --> 00:06:04.720
Those resources went from,
frankly, someone who just

00:06:04.720 --> 00:06:06.110
wanted some ego gratification.

00:06:06.110 --> 00:06:09.680
It went from someone's
ego, essentially.

00:06:09.680 --> 00:06:12.780
So let's say this is
you, or your ego.

00:06:12.780 --> 00:06:19.260
And this is Louis Vuitton,
the company.

00:06:19.260 --> 00:06:23.980
So you gave them $1,980 that
you didn't have to.

00:06:23.980 --> 00:06:26.210
Their cost of making the purse
probably didn't cost a lot

00:06:26.210 --> 00:06:27.750
more than that simple purse.

00:06:27.750 --> 00:06:30.730
And in exchange, they gave
you ego gratification.

00:06:30.730 --> 00:06:32.690
So they really didn't have to
waste a lot of resources.

00:06:32.690 --> 00:06:35.720
They gave you all of this brand
imagery that makes you

00:06:35.720 --> 00:06:36.970
feel better about yourself.

00:06:40.440 --> 00:06:42.830
So I would argue that this
capital actually didn't get

00:06:42.830 --> 00:06:45.350
lost, it just got transferred
from someone who was probably

00:06:45.350 --> 00:06:47.960
a little insecure to someone
who knows how to sell to

00:06:47.960 --> 00:06:49.070
insecure people.

00:06:49.070 --> 00:06:52.950
And then Louis Vuitton will then
have that $1,980 and then

00:06:52.950 --> 00:06:56.400
who knows, maybe they give that
to their private equity

00:06:56.400 --> 00:06:58.220
friend or their venture capital
friend, and then that

00:06:58.220 --> 00:07:01.870
gets invested in some new
start-up idea, some solar-cell

00:07:01.870 --> 00:07:05.120
company that actually can create
energy from the sun.

00:07:05.120 --> 00:07:07.280
And in which case, that money
did not go wasted.

00:07:07.280 --> 00:07:10.970
So they might actually
invest it in solar.

00:07:10.970 --> 00:07:13.330
So this, actually, was
not a waste of money.

00:07:13.330 --> 00:07:16.300
Although, this transaction, I
would agree, is consumption.

00:07:16.300 --> 00:07:18.490
I would say that the waste
of money is all of the

00:07:18.490 --> 00:07:21.050
advertising and all the
sponsorship that Louis Vuitton

00:07:21.050 --> 00:07:25.110
has to do to convince you that
this will make you, somehow, a

00:07:25.110 --> 00:07:27.260
better person if you
buy that purse.

00:07:27.260 --> 00:07:30.515
Because those ads you see on TV
with those people you want

00:07:30.515 --> 00:07:34.630
to look like, that will not
give you-- that is not

00:07:34.630 --> 00:07:37.570
creating any net wealth for the
world, or is not making

00:07:37.570 --> 00:07:40.830
the pie any bigger.

00:07:40.830 --> 00:07:43.820
Anyway, let me think of
another example here.

00:07:43.820 --> 00:07:46.090
Well, let's say, so this example
with the Louis Vuitton

00:07:46.090 --> 00:07:47.550
purse, this is just a
transfer of wealth.

00:07:47.550 --> 00:07:53.152
But let's say, instead of doing
that, you had your ego

00:07:53.152 --> 00:07:56.510
and instead of buying a Louis
Vuitton purse, you just-- so

00:07:56.510 --> 00:08:08.740
this is you-- you thought it
would be nice-- but let's say,

00:08:08.740 --> 00:08:10.300
you thought it was nice, instead
of buying a Louis

00:08:10.300 --> 00:08:11.580
Vuitton purse, which we
established would just be a

00:08:11.580 --> 00:08:13.480
transfer of wealth-- it is
consumption, but at least that

00:08:13.480 --> 00:08:15.980
money doesn't disappear-- let's
say that you wanted to

00:08:15.980 --> 00:08:22.690
pay $2,000 to have-- I don't
know-- $10 an hour, you can

00:08:22.690 --> 00:08:33.510
have 200 people dance for you
and recite your name and talk

00:08:33.510 --> 00:08:35.919
about what an amazing
person you are.

00:08:35.919 --> 00:08:39.400
This, I would argue, is
pure consumption.

00:08:39.400 --> 00:08:44.520
Because those 200 people, sure
this money gets transferred to

00:08:44.520 --> 00:08:45.910
them, but they didn't
do anything

00:08:45.910 --> 00:08:47.200
productive with that time.

00:08:47.200 --> 00:08:47.460
Right?

00:08:47.460 --> 00:08:50.300
Those 200 people, they could
have been tilling the soil;

00:08:50.300 --> 00:08:52.120
they could have been working in
a factory; they could have

00:08:52.120 --> 00:08:54.970
been teaching their children how
to read; they could have

00:08:54.970 --> 00:08:57.570
been doing something that was
productive for society.

00:08:57.570 --> 00:09:02.580
But instead, they spent one hour
dancing for you for your

00:09:02.580 --> 00:09:04.210
ego gratification.

00:09:04.210 --> 00:09:06.960
And this is, in my mind, the
worst form of consumption

00:09:06.960 --> 00:09:09.930
because, not only-- it's not
just the transfer of wealth,

00:09:09.930 --> 00:09:11.340
it is the destruction
of wealth.

00:09:11.340 --> 00:09:16.930
Because 200 people's time is
wealth, that is capital that

00:09:16.930 --> 00:09:19.180
could be used to improve
someone's life.

00:09:19.180 --> 00:09:22.330
But instead, this $2,000 was,
essentially destroyed.

00:09:22.330 --> 00:09:24.590
Sure, it goes to those
people, right?

00:09:24.590 --> 00:09:26.310
But in the end, they didn't
create anything in

00:09:26.310 --> 00:09:27.200
that amount of time.

00:09:27.200 --> 00:09:28.870
And I'll touch more
about that anyway.

00:09:28.870 --> 00:09:31.930
In essence, the amount of money
didn't change in the

00:09:31.930 --> 00:09:34.310
system, but the amount of
value in the system got

00:09:34.310 --> 00:09:36.810
degraded because all these
people time got wasted.

00:09:36.810 --> 00:09:38.940
And, In the end, that actually
leads to inflation.

00:09:38.940 --> 00:09:41.830
If you have more money in a
system with less productive

00:09:41.830 --> 00:09:47.110
goods and services, the price
for our productive goods and

00:09:47.110 --> 00:09:48.740
services goes up.

00:09:48.740 --> 00:09:50.520
But anyway, I'm out
of time again.

00:09:50.520 --> 00:09:52.940
But I encourage you to think as
much as you can about just

00:09:52.940 --> 00:09:57.170
this idea: when you spend money,
is it consumption or is

00:09:57.170 --> 00:09:57.880
it investment?

00:09:57.880 --> 00:09:59.860
And I'll continue this more into
kind of a lot of what the

00:09:59.860 --> 00:10:02.430
government tells you to do when
the economy goes down.

00:10:02.430 --> 00:10:05.110
How they say, go by yourself a
nice dress, instead of saying,

00:10:05.110 --> 00:10:07.390
hey why don't you go
build a factory?

00:10:07.390 --> 00:10:09.270
Or why don't you save your
money and invest in your

00:10:09.270 --> 00:10:10.270
child's education?

00:10:10.270 --> 00:10:12.560
Anyway, see you in
the next video.


Bailout 9: Paulson's Plan

WEBVTT
Kind: captions
Language: en

00:00:00.610 --> 00:00:03.760
In the last video we saw that
it's not just an issue of one

00:00:03.760 --> 00:00:04.440
bank failing.

00:00:04.440 --> 00:00:06.380
Because maybe one bank
does fail, some of

00:00:06.380 --> 00:00:07.690
its loans come due.

00:00:07.690 --> 00:00:10.530
In this case, Bank A
had some loans from

00:00:10.530 --> 00:00:12.170
Bank B that come due.

00:00:12.170 --> 00:00:14.770
It couldn't liquidate
these assets.

00:00:14.770 --> 00:00:17.640
And then it couldn't liquidate
these CDOs for enough money to

00:00:17.640 --> 00:00:18.660
pay for this loan.

00:00:18.660 --> 00:00:20.780
So Bank A had to go
into bankruptcy.

00:00:20.780 --> 00:00:23.230
Then we saw that could create
a whole chain of events.

00:00:23.230 --> 00:00:27.750
Then this loan that Bank B had
made to Bank A, the one that

00:00:27.750 --> 00:00:30.340
actually precipitated
the event, that had

00:00:30.340 --> 00:00:31.200
to be written down.

00:00:31.200 --> 00:00:34.440
Because then Bank A is going to
go into bankruptcy and you

00:00:34.440 --> 00:00:35.740
don't know how much you're
going to get

00:00:35.740 --> 00:00:36.820
back for that loan.

00:00:36.820 --> 00:00:40.210
And of course, everybody who
had loans to Bank A, maybe

00:00:40.210 --> 00:00:43.270
Bank D had loans to Bank A.

00:00:43.270 --> 00:00:47.640
So maybe this asset right here
was also a loan to Bank A.

00:00:47.640 --> 00:00:50.980
Everyone with loans to Bank A
all of a sudden gets afraid.

00:00:50.980 --> 00:00:52.860
They might have to write
down their assets.

00:00:52.860 --> 00:00:56.110
And now, on top of the CDO
problem that we were all

00:00:56.110 --> 00:00:59.920
talking about, these smelly
assets that no one wants to

00:00:59.920 --> 00:01:02.920
value correctly, on top of that
you have this issue of

00:01:02.920 --> 00:01:05.420
these loans that I made to this
other bank, now all of a

00:01:05.420 --> 00:01:07.050
sudden those are impaired
assets.

00:01:07.050 --> 00:01:09.890
These are assets that probably
aren't worth what I

00:01:09.890 --> 00:01:11.240
thought they were.

00:01:11.240 --> 00:01:12.390
And so you have this
situation.

00:01:12.390 --> 00:01:15.110
One, Bank A was the
last one to fall.

00:01:15.110 --> 00:01:19.230
But maybe everyone starts
looking at Bank C next.

00:01:19.230 --> 00:01:21.500
And it's usually reflected
in the stock price.

00:01:21.500 --> 00:01:23.970
People start shorting the stock,
the stock go starts

00:01:23.970 --> 00:01:24.820
going down.

00:01:24.820 --> 00:01:28.170
And then Bank C has a situation
where it has some

00:01:28.170 --> 00:01:31.560
loan to Bank F, it comes due.

00:01:31.560 --> 00:01:34.800
And because its stock price is
going down, no one wants to

00:01:34.800 --> 00:01:37.210
lend it money because they say
oh you're just another Bank A,

00:01:37.210 --> 00:01:38.230
I'm not going to
lend you money.

00:01:38.230 --> 00:01:40.590
No one wants to jump in and give
them equity, no sovereign

00:01:40.590 --> 00:01:41.050
wealth fund.

00:01:41.050 --> 00:01:43.620
Because you're just going to
go to zero, why would I buy

00:01:43.620 --> 00:01:46.250
any stock for even $1 a share
when it's going to go to zero

00:01:46.250 --> 00:01:48.550
because your liabilities are
greater than your equity.

00:01:48.550 --> 00:01:50.270
So no one wants to
save them either.

00:01:50.270 --> 00:01:53.750
And so now, you have this chain
reaction occurring, this

00:01:53.750 --> 00:01:55.540
cascade of negative events.

00:01:55.540 --> 00:02:00.830
All the banks are afraid to
lend to any other bank.

00:02:00.830 --> 00:02:02.650
And you've probably read
articles that the Fed is

00:02:02.650 --> 00:02:03.940
injecting liquidity.

00:02:03.940 --> 00:02:06.810
What the Fed was doing was, they
were saying, OK, we'll

00:02:06.810 --> 00:02:11.260
take some of these assets
that Bank C has.

00:02:11.260 --> 00:02:13.490
We'll take them as collateral
and we'll lend you money.

00:02:13.490 --> 00:02:16.460
And even if this was horrible
collateral, the Fed just got

00:02:16.460 --> 00:02:19.500
very nervous and just started
lending money to anybody.

00:02:19.500 --> 00:02:21.580
Anybody who was allowed to
borrow from the Fed.

00:02:21.580 --> 00:02:23.050
And I don't know if you
remember, but the

00:02:23.050 --> 00:02:23.750
Fed extended it.

00:02:23.750 --> 00:02:25.280
Normally, it's just
commercial banks.

00:02:25.280 --> 00:02:27.480
But at the beginning of the
credit crisis-- or actually

00:02:27.480 --> 00:02:31.080
after the Bear Stearns collapse,
the Fed allowed

00:02:31.080 --> 00:02:33.910
investment banks and other
people to start borrowing from

00:02:33.910 --> 00:02:37.590
the Federal Reserve directly.

00:02:37.590 --> 00:02:39.590
Normally, when the Federal
Reserve lends money to

00:02:39.590 --> 00:02:43.100
someone, that person borrows
that money, keeps some of it,

00:02:43.100 --> 00:02:44.670
and lends the rest
to someone else.

00:02:44.670 --> 00:02:46.620
And so that money enters
the system.

00:02:46.620 --> 00:02:51.420
And it allows the actual money
supply to increase.

00:02:51.420 --> 00:02:55.250
But what's been happening now
is when banks use this money

00:02:55.250 --> 00:02:58.720
to borrow from the Fed or to
borrow any money, they used

00:02:58.720 --> 00:03:00.500
these assets as collateral,
they just sit

00:03:00.500 --> 00:03:01.240
tight on that cash.

00:03:01.240 --> 00:03:03.980
Because they're like, I don't
know what my assets are worth.

00:03:03.980 --> 00:03:06.860
I don't know what other of my
assets are going to fail.

00:03:06.860 --> 00:03:09.210
When these loans come
due that I owe, I

00:03:09.210 --> 00:03:10.330
better have some cash.

00:03:10.330 --> 00:03:13.120
Otherwise, I'm just going
to be another Bank A.

00:03:13.120 --> 00:03:15.900
So people were borrowing from
the Fed, or borrowing in

00:03:15.900 --> 00:03:17.730
general, but they weren't
lending out again.

00:03:17.730 --> 00:03:20.310
So that money just kind of
went into a black hole.

00:03:20.310 --> 00:03:23.880
So everyone was just sitting
tight on top of their money.

00:03:23.880 --> 00:03:25.030
So what's the problem here?

00:03:25.030 --> 00:03:27.600
Well clearly, one bank
failure can lead to

00:03:27.600 --> 00:03:28.770
multiple bank failures.

00:03:28.770 --> 00:03:31.280
Especially if no one's willing
to lend them more money.

00:03:31.280 --> 00:03:33.980
So you can say, oh well the only
problem is all of these

00:03:33.980 --> 00:03:36.180
banks just fail and who knows
the world might be

00:03:36.180 --> 00:03:37.030
better off for that.

00:03:37.030 --> 00:03:39.160
Because you won't have all
these people who frankly

00:03:39.160 --> 00:03:40.540
aren't making anything.

00:03:40.540 --> 00:03:42.280
Although, I don't want
to say that.

00:03:42.280 --> 00:03:46.020
Because there is a use for the
financial services sector.

00:03:46.020 --> 00:03:49.190
But to some degree a lot of what
happened in the last five

00:03:49.190 --> 00:03:51.160
years, they weren't creating
value, they were just

00:03:51.160 --> 00:03:53.950
leveraging up and increasing
the risk in the system.

00:03:53.950 --> 00:03:55.420
But anyway, let's
put that aside.

00:03:55.420 --> 00:03:57.060
So you might say, OK,
worst case, these

00:03:57.060 --> 00:03:58.510
banks all go bankrupt.

00:03:58.510 --> 00:03:59.820
They get restructured.

00:03:59.820 --> 00:04:01.270
But they come back.

00:04:01.270 --> 00:04:03.550
The only negative of that
will be that the current

00:04:03.550 --> 00:04:05.180
shareholders lose
all their money.

00:04:05.180 --> 00:04:07.720
But that's OK, no
risk no return.

00:04:07.720 --> 00:04:08.440
There was risk.

00:04:08.440 --> 00:04:11.640
And the risk was that your
stock goes to zero.

00:04:11.640 --> 00:04:13.760
But then the banks will come
back with new equity.

00:04:13.760 --> 00:04:15.040
And then they'll
be back in five

00:04:15.040 --> 00:04:16.870
years under new ownership.

00:04:16.870 --> 00:04:19.800
You might say that's OK.

00:04:19.800 --> 00:04:22.280
What the problem is maybe all of
these banks, there's just a

00:04:22.280 --> 00:04:23.160
cascade, they go under.

00:04:23.160 --> 00:04:26.820
But not all of these loans
that they make out are to

00:04:26.820 --> 00:04:28.180
other banks.

00:04:28.180 --> 00:04:31.850
Some of these loans they make
out to the real economy, what

00:04:31.850 --> 00:04:33.640
everyone is calling
Main Street now.

00:04:33.640 --> 00:04:38.500
Some of these loans they're
making out are to a company

00:04:38.500 --> 00:04:40.990
that makes tractors.

00:04:40.990 --> 00:04:44.400
Or company maybe it's an
agricultural company that

00:04:44.400 --> 00:04:50.650
needs loans to buy seeds for
the next year's crop.

00:04:50.650 --> 00:04:53.040
So these are loans that are
actually funneled into the

00:04:53.040 --> 00:04:53.790
real economy.

00:04:53.790 --> 00:04:56.870
And if every bank is just
sitting on their money, then

00:04:56.870 --> 00:04:59.190
these loans aren't going to be
made into the real economy.

00:04:59.190 --> 00:05:01.040
Those real companies aren't
going to be able to make

00:05:01.040 --> 00:05:05.650
investments, to buy seeds, or
to make a loan to build a

00:05:05.650 --> 00:05:08.090
factory for a product that's
actually doing quite well.

00:05:08.090 --> 00:05:10.080
And so everyone will
be starved off.

00:05:10.080 --> 00:05:12.380
And we'll go into this
massive recession.

00:05:12.380 --> 00:05:15.590
Because even though there is
good uses of capital, if you

00:05:15.590 --> 00:05:18.700
were to give someone a loan,
they could use that loan to

00:05:18.700 --> 00:05:21.210
actually create value by
planting seeds, or

00:05:21.210 --> 00:05:22.640
by building a factory.

00:05:22.640 --> 00:05:24.220
Those loans aren't available.

00:05:24.220 --> 00:05:25.770
Those factories won't
get built.

00:05:25.770 --> 00:05:27.510
Those seeds won't get planted.

00:05:27.510 --> 00:05:29.130
The farmers will
lay off people.

00:05:29.130 --> 00:05:30.340
The factories will
lay off people.

00:05:30.340 --> 00:05:32.080
And you could imagine,
we'll go into this

00:05:32.080 --> 00:05:34.750
economic down cycle.

00:05:34.750 --> 00:05:38.560
So that's what Paulson and
the Federal Service

00:05:38.560 --> 00:05:39.390
are concerned about.

00:05:39.390 --> 00:05:41.070
Although, some people would
debate that they're more

00:05:41.070 --> 00:05:44.250
concerned about the banks
than the real economy.

00:05:44.250 --> 00:05:48.220
And they're just using the
real economy as kind of a

00:05:48.220 --> 00:05:50.040
sideshow or the rationale.

00:05:50.040 --> 00:05:53.750
So what are they arguing
that they want to do?

00:05:53.750 --> 00:05:56.930
Well they said the crux of this
issue is, if these $2

00:05:56.930 --> 00:06:02.090
billion in CDOs, whatever the
CDOs at any of the banks are

00:06:02.090 --> 00:06:05.200
holding, if only the people
could realize the value.

00:06:05.200 --> 00:06:07.570
If only this $2 billion that
they have on their books could

00:06:07.570 --> 00:06:10.230
be turned into $2 billion
of cash, this

00:06:10.230 --> 00:06:11.410
wouldn't be a problem.

00:06:11.410 --> 00:06:14.180
Because when these loans come
due, if you believe this $2

00:06:14.180 --> 00:06:18.520
billion, then all of these banks
have positive net worth.

00:06:18.520 --> 00:06:19.780
They all have positive equity.

00:06:19.780 --> 00:06:23.110
And then this whole chain
reaction won't happen.

00:06:23.110 --> 00:06:27.350
So when the bailout plan first
came out and they said we'll

00:06:27.350 --> 00:06:30.340
create this $700 billion
fund to buy some

00:06:30.340 --> 00:06:31.830
of these toxic assets.

00:06:31.830 --> 00:06:35.500
and at first they said we'll
buy them at a discount and

00:06:35.500 --> 00:06:37.070
we'll hold them to maturity
and then we

00:06:37.070 --> 00:06:38.010
might even make a profit.

00:06:38.010 --> 00:06:41.250
I said, well that might sound
good, but how's that going to

00:06:41.250 --> 00:06:42.040
solve this situation?

00:06:42.040 --> 00:06:46.260
Because if you were to go to
this bank and buy the CDOs,

00:06:46.260 --> 00:06:49.920
you'd be an idiot to pay $2
billion for them if the market

00:06:49.920 --> 00:06:52.390
is only giving, instead
of $2 billion, only

00:06:52.390 --> 00:06:54.720
$100 million for them.

00:06:54.720 --> 00:06:55.960
Why would you pay $2 billion?

00:06:55.960 --> 00:06:58.270
In fact, these $2 billion are
actually based on assumptions

00:06:58.270 --> 00:07:02.350
from 2006 when housing prices
can't go down and everyone was

00:07:02.350 --> 00:07:03.590
paying off their mortgages.

00:07:03.590 --> 00:07:05.880
And everything was rosy.

00:07:05.880 --> 00:07:08.120
Those are maybe the assumptions
that drove this $2

00:07:08.120 --> 00:07:09.200
billion price.

00:07:09.200 --> 00:07:11.710
So if you paid $2 billion for
this asset, sure, you would

00:07:11.710 --> 00:07:12.990
save Bank C.

00:07:12.990 --> 00:07:15.030
But you would essentially be
buying something that's worth

00:07:15.030 --> 00:07:15.660
a lot less.

00:07:15.660 --> 00:07:17.970
And even if you held it to
maturity, you're not going to

00:07:17.970 --> 00:07:21.600
ever see a present value
of $2 billion.

00:07:21.600 --> 00:07:24.280
So when I first read the bailout
proposal, I said

00:07:24.280 --> 00:07:26.310
they're going to pay some
discount on that, but that's

00:07:26.310 --> 00:07:27.550
not going to help
the situation.

00:07:27.550 --> 00:07:30.510
Because let's say these
are only worth

00:07:30.510 --> 00:07:32.730
$0.10 on the dollar.

00:07:32.730 --> 00:07:34.620
If they paid 10%
of $2 billion.

00:07:34.620 --> 00:07:37.530
If the the Fed came in and paid
$200 million for this.

00:07:37.530 --> 00:07:40.840
And it's not even clear that
it's worth $200 million, maybe

00:07:40.840 --> 00:07:42.620
the market is only willing
to pay $100 million.

00:07:42.620 --> 00:07:45.490
But let's say the Fed comes in
and pays $200 million for it.

00:07:45.490 --> 00:07:49.700
They would have to mark this
down to $200 million.

00:07:49.700 --> 00:07:52.200
So that's $1.8 billion
writeoff.

00:07:52.200 --> 00:07:53.910
Something that was worth
$2 billion is

00:07:53.910 --> 00:07:55.780
now worth $200 million.

00:07:55.780 --> 00:07:58.280
So if you write out $1.8
billion, then you're going to

00:07:58.280 --> 00:08:02.610
have minus $800 million
of equity.

00:08:02.610 --> 00:08:04.590
Or $0.8 billion of equity.

00:08:04.590 --> 00:08:05.970
And then you would still
go bankrupt.

00:08:05.970 --> 00:08:08.860
In fact, it would just
force the issue.

00:08:08.860 --> 00:08:11.520
If the Fed were to go in and
buy at what they're calling

00:08:11.520 --> 00:08:13.250
now fire sale prices,
but it's actually

00:08:13.250 --> 00:08:14.470
probably an accurate price.

00:08:14.470 --> 00:08:16.470
Even if they were to buy
slightly above that, but still

00:08:16.470 --> 00:08:18.680
at a discount, it would
force this bank to

00:08:18.680 --> 00:08:19.970
write down this asset.

00:08:19.970 --> 00:08:21.890
It might have to then realize
negative equity.

00:08:21.890 --> 00:08:24.930
And it would still create this
whole chain of events.

00:08:24.930 --> 00:08:27.050
And so this is what the
Fed actually said.

00:08:27.050 --> 00:08:28.670
They actually said no we
don't want to buy it

00:08:28.670 --> 00:08:29.920
at fire sale prices.

00:08:32.210 --> 00:08:34.700
I think Bernanke's exact words
were that, we're not going to

00:08:34.700 --> 00:08:36.900
buy at fire sale prices, we're
going to buy at hold to

00:08:36.900 --> 00:08:38.200
maturity prices.

00:08:38.200 --> 00:08:40.980
So to me, what the Fed is
saying, we're going to pay

00:08:40.980 --> 00:08:44.680
enough money for these assets so
that these banks still have

00:08:44.680 --> 00:08:45.740
positive equity.

00:08:45.740 --> 00:08:48.555
And so the these banks can still
pay off any liabilities

00:08:48.555 --> 00:08:50.010
that come due.

00:08:50.010 --> 00:08:52.000
Well you might say, well hey
Sal, that's not a bad idea.

00:08:52.000 --> 00:08:53.370
And I say, that's
a horrible idea.

00:08:53.370 --> 00:08:58.470
Because if these are really
worth $100 million, and you're

00:08:58.470 --> 00:09:02.440
paying $2 billion for it, you're
essentially writing a

00:09:02.440 --> 00:09:06.420
government check,
$1.9 billion.

00:09:06.420 --> 00:09:08.740
Let's say this is really
worth minus $0.8.

00:09:14.000 --> 00:09:15.610
Let's say that they're
really worth zero,

00:09:15.610 --> 00:09:16.490
just to simplify things.

00:09:16.490 --> 00:09:19.240
Let's say these are actually
worth zero and the government

00:09:19.240 --> 00:09:21.150
pays $2 billion for it.

00:09:21.150 --> 00:09:24.150
The government is essentially
writing a $2 billion check to

00:09:24.150 --> 00:09:26.250
the equity holders
of this company.

00:09:26.250 --> 00:09:28.540
The real equity is worth
minus $1 billion.

00:09:28.540 --> 00:09:30.880
But the government is going to
essentially write them a $2

00:09:30.880 --> 00:09:33.150
billion check so they can get
their billion dollars back.

00:09:33.150 --> 00:09:35.330
And it's also going to benefit
the bond holders.

00:09:35.330 --> 00:09:39.160
Because if this is worth zero,
not only will these guys get

00:09:39.160 --> 00:09:42.980
wiped out, but then these guys
are only going to be able to

00:09:42.980 --> 00:09:45.190
capture back some of
these $3 billion.

00:09:45.190 --> 00:09:49.000
So these liabilities are going
to be written down.

00:09:49.000 --> 00:09:50.800
These guys that are owed $4
billion are only going to be

00:09:50.800 --> 00:09:52.230
able get $3 billion back.

00:09:52.230 --> 00:09:54.560
So if the government were to pay
$2 billion for this, it's

00:09:54.560 --> 00:09:56.700
essentially writing a $1
billion check to the

00:09:56.700 --> 00:10:00.110
shareholders and a $1 billion
check to the bond holders or

00:10:00.110 --> 00:10:01.880
the people who lent this
company money.

00:10:01.880 --> 00:10:04.080
And essentially, those are
the worst people to be

00:10:04.080 --> 00:10:04.870
writing a check to.

00:10:04.870 --> 00:10:08.350
Because these are the people
who essentially lent money

00:10:08.350 --> 00:10:09.630
that shouldn't have been lent.

00:10:09.630 --> 00:10:11.020
These are people
who took risk.

00:10:11.020 --> 00:10:13.650
They took all the reward over
the last five years and now

00:10:13.650 --> 00:10:15.960
when the risk hits, the
government is essentially

00:10:15.960 --> 00:10:19.680
having welfare for the
private sector.

00:10:19.680 --> 00:10:22.000
So that in my mind is
the worst idea.

00:10:22.000 --> 00:10:25.500
The government is arguing, I
know it's bad, and these are

00:10:25.500 --> 00:10:28.310
the people we don't want to
reward, but by doing this, we

00:10:28.310 --> 00:10:29.390
save the real economy.

00:10:29.390 --> 00:10:31.690
Because by doing this,
we prevent this

00:10:31.690 --> 00:10:32.990
cascade from happening.

00:10:32.990 --> 00:10:36.590
And hopefully, these banks will
still lend to the farmer

00:10:36.590 --> 00:10:43.200
and still lend to the the guy
who wants to build a factory.

00:10:43.200 --> 00:10:46.140
In the next video I want to show
you one, why that might

00:10:46.140 --> 00:10:47.000
not be the case.

00:10:47.000 --> 00:10:50.250
That even if they were to do
this, as much as I disagree

00:10:50.250 --> 00:10:53.010
with it, if it worked
maybe it's worth it.

00:10:53.010 --> 00:10:57.230
But one, I'll argue that
it probably won't work.

00:10:57.230 --> 00:10:59.950
And two, there are better
ways to do this.

00:10:59.950 --> 00:11:02.470
More equitable, more fair
ways to do this.

00:11:02.470 --> 00:11:04.780
And we'll show you that
in the next video.


Present Value 2

WEBVTT
Kind: captions
Language: en

00:00:00.000 --> 00:00:04.790
Now I'll give you a slightly
more complicated choice

00:00:04.790 --> 00:00:06.320
between two payment options.

00:00:06.320 --> 00:00:08.100
Both of them are good, because
in either case

00:00:08.100 --> 00:00:09.260
you're getting money.

00:00:09.260 --> 00:00:10.510
So choice one.

00:00:17.620 --> 00:00:28.510
Today I will give you $100.

00:00:28.510 --> 00:00:32.820
I'll circle the payment when
you get it in magenta.

00:00:32.820 --> 00:00:35.720
So today you get $100.

00:00:35.720 --> 00:00:36.912
Choice two.

00:00:36.912 --> 00:00:39.990
And I'll try to write this
choice a little bit neater.

00:00:39.990 --> 00:00:45.410
Choice two is that not in
1 year, but in 2 years.

00:00:45.410 --> 00:00:46.660
So let's say this is year 1.

00:00:50.650 --> 00:00:55.270
And now this is year 2.

00:00:55.270 --> 00:00:57.390
Actually I'm going to give
you three choices.

00:00:57.390 --> 00:01:00.425
That'll really hopefully
hit things home.

00:01:00.425 --> 00:01:03.930
So actually let me scoot this
choice two over to the left.

00:01:07.380 --> 00:01:09.000
Back to green.

00:01:09.000 --> 00:01:10.500
So now I'm back in business.

00:01:10.500 --> 00:01:21.530
So choice two, I am willing to
give you, let's say, oh I

00:01:21.530 --> 00:01:25.820
don't know, $110 in 2 years.

00:01:25.820 --> 00:01:26.650
So not in 1 year.

00:01:26.650 --> 00:01:30.460
In 2 years I'm going
to give you $110.

00:01:30.460 --> 00:01:34.280
And so I'll circle in
magenta when you

00:01:34.280 --> 00:01:36.450
actually get your payment.

00:01:36.450 --> 00:01:37.570
And then choice three .

00:01:37.570 --> 00:01:39.150
And choice three is going
to be fascinating.

00:01:42.830 --> 00:01:46.400
I've done it in a slightly
different shade of green.

00:01:46.400 --> 00:01:52.430
Choice three, I am going to pay
you-- I'm making this up

00:01:52.430 --> 00:02:01.910
on the fly as I go-- I'm going
to pay you $20 today.

00:02:01.910 --> 00:02:09.566
I'm going to pay you
$50 in 1 year.

00:02:09.566 --> 00:02:11.500
That's $70.

00:02:11.500 --> 00:02:13.780
Let me make this
so it's close.

00:02:13.780 --> 00:02:26.080
And then I'm going to pay you,
I don't know, $35 in year 3.

00:02:26.080 --> 00:02:28.580
So all of these are payments.

00:02:28.580 --> 00:02:30.740
I want to differentiate between
the actual dollar

00:02:30.740 --> 00:02:32.920
payments and the
present values.

00:02:32.920 --> 00:02:35.930
And just for the sake of
simplicity, let's assume that

00:02:35.930 --> 00:02:37.810
I am guaranteed.

00:02:37.810 --> 00:02:40.820
I am the safest person
available.

00:02:40.820 --> 00:02:45.230
If the world exists, if the sun
does not supernova, I will

00:02:45.230 --> 00:02:48.730
be paying you this
amount of money.

00:02:48.730 --> 00:02:53.180
So I'm as risk-free as the
federal government.

00:02:53.180 --> 00:02:57.250
And I had a post on the previous
present value, where

00:02:57.250 --> 00:02:59.550
someone talked about,
well is the federal

00:02:59.550 --> 00:03:02.060
government really that safe?

00:03:02.060 --> 00:03:03.330
And this is the point.

00:03:03.330 --> 00:03:06.740
The federal government, when
it borrows from you $100.

00:03:06.740 --> 00:03:08.720
Let's say it borrows $100
and it promises

00:03:08.720 --> 00:03:09.730
to pay it in a year.

00:03:09.730 --> 00:03:11.690
It'll give you that $100.

00:03:11.690 --> 00:03:13.700
The risk is, what is
that $100 worth?

00:03:13.700 --> 00:03:16.290
Because they might inflate
the currency to death.

00:03:16.290 --> 00:03:17.850
Anyway, I won't go into
that right now.

00:03:17.850 --> 00:03:22.860
Let's just go back to this
present value problem.

00:03:22.860 --> 00:03:24.010
And actually sometimes
governments

00:03:24.010 --> 00:03:24.930
do default on debt.

00:03:24.930 --> 00:03:27.610
But the U.S. government
has never defaulted.

00:03:27.610 --> 00:03:29.970
It has inflated its currency.

00:03:29.970 --> 00:03:33.880
So that's kind of a round
about way of defaulting.

00:03:33.880 --> 00:03:36.580
But its never actually said,
I will not pay you.

00:03:36.580 --> 00:03:39.720
Because if that happened, our
entire financial system would

00:03:39.720 --> 00:03:42.970
blow up and we would all be
living off the land again.

00:03:42.970 --> 00:03:44.490
Anyway, back to this problem.

00:03:44.490 --> 00:03:46.080
Enough commentary from Sal.

00:03:46.080 --> 00:03:48.380
So let's just compare choice
one and choice two again.

00:03:48.380 --> 00:03:51.870
And once again let's say that
risk-free, I could put money,

00:03:51.870 --> 00:03:53.900
I could lend it to the federal
government at 5%.

00:03:57.630 --> 00:04:04.090
Risk-free rate is 5%.

00:04:04.090 --> 00:04:06.990
And for the sake of simplicity--
in the next video

00:04:06.990 --> 00:04:11.120
I will make that assumption less
simple-- but for the sake

00:04:11.120 --> 00:04:13.830
simplicity, the government will
pay you 5% whether you

00:04:13.830 --> 00:04:15.750
give them the money for 1 year,
whether you give them

00:04:15.750 --> 00:04:18.380
the money for 2 years, or
whether you give them the

00:04:18.380 --> 00:04:20.490
money for 3 years, right?

00:04:20.490 --> 00:04:26.380
So if I had $100, what would
that be worth in 1 year?

00:04:26.380 --> 00:04:28.210
We figured that out already.

00:04:28.210 --> 00:04:32.400
It's 100 times 1.05.

00:04:32.400 --> 00:04:36.550
So that's $105.

00:04:36.550 --> 00:04:38.440
And then if you got
another 5%?

00:04:38.440 --> 00:04:42.800
So the government is giving
you 5% per year.

00:04:42.800 --> 00:04:49.000
It would be 105 times 1.05.

00:04:49.000 --> 00:04:51.310
And what is that?

00:04:51.310 --> 00:05:08.230
So I have 105 times 1.05,
which equals $110.25.

00:05:08.230 --> 00:05:10.010
So that is the value
in 2 years.

00:05:10.010 --> 00:05:12.500
So immediately, without even
doing any present value, we

00:05:12.500 --> 00:05:16.540
see that you'll actually be
better off in 2 years if you

00:05:16.540 --> 00:05:19.120
were to take the money now
and just lend it to the

00:05:19.120 --> 00:05:19.550
government.

00:05:19.550 --> 00:05:21.080
Because the government,
risk-free, will give you

00:05:21.080 --> 00:05:28.150
$110.25 in 2 years, while I'm
only willing to give you $110.

00:05:28.150 --> 00:05:30.610
So that's all fair and good.

00:05:30.610 --> 00:05:32.860
But the whole topic, what we're
trying to solve, is

00:05:32.860 --> 00:05:33.550
present value.

00:05:33.550 --> 00:05:35.570
So let's take everything
in today's money.

00:05:35.570 --> 00:05:39.470
And to take this $110 and say
what is that worth today, we

00:05:39.470 --> 00:05:43.000
can just discount it backwards
by the same method, right?

00:05:43.000 --> 00:05:48.350
So $110 in 2 years, what
is its 1-year value?

00:05:48.350 --> 00:05:54.280
Well, you take $110 and
you divide it by 1.05.

00:05:54.280 --> 00:05:56.710
You're just doing the reverse.

00:05:56.710 --> 00:05:58.160
And then you get some
number here.

00:05:58.160 --> 00:06:02.450
Well that number you get
is 110 divided by 1.05.

00:06:02.450 --> 00:06:05.680
And then to get its present
value, its value today, you

00:06:05.680 --> 00:06:07.530
divide that by 1.05 again.

00:06:07.530 --> 00:06:11.280
So you get 110 divided.

00:06:11.280 --> 00:06:15.260
If I were to divide by 1.05
again what do I get?

00:06:15.260 --> 00:06:19.310
I divide by 1.05, and then
I divide by 1.05 again.

00:06:19.310 --> 00:06:22.440
I'm dividing by 1.05 squared.

00:06:22.440 --> 00:06:25.040
And what does that equal?

00:06:25.040 --> 00:06:26.550
And I'm writing this on purpose,
because I want to get

00:06:26.550 --> 00:06:27.690
you used to this notation.

00:06:27.690 --> 00:06:30.110
Because this is what all of
our present values and our

00:06:30.110 --> 00:06:34.020
discounted cash flow, this type
of dividing by 1 plus the

00:06:34.020 --> 00:06:38.300
discount rate to the power of
however many years out, this

00:06:38.300 --> 00:06:39.820
is what all of that's
based on.

00:06:39.820 --> 00:06:41.520
And that's all we're doing
though, we're just dividing by

00:06:41.520 --> 00:06:44.670
1.05 twice because we're
2 years out.

00:06:44.670 --> 00:06:47.930
So let's do that.

00:06:47.930 --> 00:07:08.390
110 divided by 1.05 squared
is equal to $99.77.

00:07:08.390 --> 00:07:10.830
So once again we have verified,
by taking the

00:07:10.830 --> 00:07:15.610
present value of $110 in 2
years to today, that its

00:07:15.610 --> 00:07:18.330
present value-- if we assume
a 5% discount rate.

00:07:18.330 --> 00:07:23.530
And this discount rate, this
is where all of the fudge

00:07:23.530 --> 00:07:24.930
factor occurs in finance.

00:07:24.930 --> 00:07:27.600
You can tweak that discount
rate and make a few

00:07:27.600 --> 00:07:29.110
assumptions in discount
rate and

00:07:29.110 --> 00:07:30.160
pretty much assume anything.

00:07:30.160 --> 00:07:32.900
But right now, for
simplification, we're assuming

00:07:32.900 --> 00:07:34.770
a risk-free discount rate.

00:07:34.770 --> 00:07:39.180
But when the present value is
based on that, you get $99.77.

00:07:39.180 --> 00:07:43.070
You say, wow, yeah, this really
isn't as good as this.

00:07:43.070 --> 00:07:48.530
I would rather have $100 today
than $99.77 today.

00:07:48.530 --> 00:07:49.960
Now this is interesting.

00:07:49.960 --> 00:07:51.490
Choice number three.

00:07:51.490 --> 00:07:52.780
How do we look at this?

00:07:52.780 --> 00:07:56.020
Well what we do is, we
present value each of

00:07:56.020 --> 00:07:57.540
the payments, right?

00:07:57.540 --> 00:08:01.570
So the present value of $20
today, well that's just $20.

00:08:01.570 --> 00:08:07.160
What's the present value
of $50 in 1 year?

00:08:07.160 --> 00:08:12.000
Well the present value of that
is going to be-- so plus $50

00:08:12.000 --> 00:08:15.460
divided by 1.05, right-- that's
the present value of

00:08:15.460 --> 00:08:17.530
the $50, because it's
1 year out.

00:08:17.530 --> 00:08:19.990
And then I want the present
value of the $35.

00:08:19.990 --> 00:08:25.510
So that's plus $35 divided by
what-- it's 2 years out,

00:08:25.510 --> 00:08:27.390
right, so you have to
discount it twice--

00:08:27.390 --> 00:08:31.230
divided by 1.05 squared.

00:08:31.230 --> 00:08:32.780
Just like we did here.

00:08:32.780 --> 00:08:34.309
So let's figure out what
that present value is.

00:08:34.309 --> 00:08:36.590
Notice I'm just adding up the
present values of each of

00:08:36.590 --> 00:08:39.000
those payments.

00:08:39.000 --> 00:08:42.299
Get out my virtual TI-85.

00:08:42.299 --> 00:08:44.740
Let's see, so the present value
of the $20 payment is

00:08:44.740 --> 00:08:48.580
$20, plus the present value
of the $50 payment.

00:08:48.580 --> 00:08:56.920
Well that's just 50 divided by
1.05, plus the present value

00:08:56.920 --> 00:08:58.685
of our $35 payment.

00:08:58.685 --> 00:09:03.240
35 divided by-- and it's 2 years
out, so we discount by

00:09:03.240 --> 00:09:12.120
our discount rate twice-- so
it's divided by 1.05 squared.

00:09:12.120 --> 00:09:25.600
And then that is equal to--
we'll round it-- $99.37.

00:09:25.600 --> 00:09:28.770
So now we can make a very
good comparison

00:09:28.770 --> 00:09:29.760
between the three options.

00:09:29.760 --> 00:09:31.270
This might have been
confusing before.

00:09:31.270 --> 00:09:33.080
You know, you have this
guy coming up to you.

00:09:33.080 --> 00:09:35.380
And this guy is usually in
the form of some type of

00:09:35.380 --> 00:09:37.790
retirement plan or insurance
company, where they say, hey,

00:09:37.790 --> 00:09:40.440
you pay me this for years a,
b, and c, and I'll pay you

00:09:40.440 --> 00:09:41.790
that in years b, c, and d.

00:09:41.790 --> 00:09:43.990
And you're like, boy, how do I
compare if that's really a

00:09:43.990 --> 00:09:44.840
good value?

00:09:44.840 --> 00:09:46.010
Well this is how
you compare it.

00:09:46.010 --> 00:09:48.490
You present value all of the
payments and you say well what

00:09:48.490 --> 00:09:50.440
is that worth to me today.

00:09:50.440 --> 00:09:51.590
And here we did that.

00:09:51.590 --> 00:09:53.870
We said well actually choice
number one is the best deal.

00:09:53.870 --> 00:09:56.450
And it just depended on how
the mathematics work out.

00:09:56.450 --> 00:09:59.130
If I lowered the discount rate,
if this discount rate is

00:09:59.130 --> 00:10:01.160
lower, it might have changed
the outcomes.

00:10:01.160 --> 00:10:03.430
And maybe I'll actually do that
in the next video, just

00:10:03.430 --> 00:10:06.360
to show you how important
the discount rate is.

00:10:06.360 --> 00:10:08.400
Anyway I'm out of time,
and I'll see

00:10:08.400 --> 00:10:09.650
you in the next video.


Introduction to present value

WEBVTT
Kind: captions
Language: en

00:00:00.000 --> 00:00:04.420
We'll now learn about what is
arguably the most useful

00:00:04.420 --> 00:00:08.860
concept in finance, and that's
called the present value.

00:00:08.860 --> 00:00:11.220
And if you know the present
value, then it's very easy to

00:00:11.220 --> 00:00:14.620
understand the net present value
and the discounted cash

00:00:14.620 --> 00:00:16.570
flow and the internal
rate of return.

00:00:16.570 --> 00:00:19.200
And we'll eventually learn
all of those things.

00:00:19.200 --> 00:00:20.340
But the present value.

00:00:20.340 --> 00:00:22.170
What does that mean?

00:00:22.170 --> 00:00:24.580
Present value.

00:00:24.580 --> 00:00:28.910
So let's do a little exercise.

00:00:28.910 --> 00:00:32.090
I could pay you $100 today.

00:00:32.090 --> 00:00:41.470
So let's say today, I
could pay you $100.

00:00:41.470 --> 00:00:50.690
Or, and it's up to you, in one
year I will pay you-- I don't

00:00:50.690 --> 00:00:58.010
know-- let's say in a year
I agree to pay you $110.

00:00:58.010 --> 00:01:01.840
And my question to you-- and
this is a fundamental question

00:01:01.840 --> 00:01:04.930
of finance, everything will
build upon this-- is which one

00:01:04.930 --> 00:01:06.490
would you prefer?

00:01:06.490 --> 00:01:07.580
And this is guaranteed.

00:01:07.580 --> 00:01:08.490
I guarantee you.

00:01:08.490 --> 00:01:10.800
I'm either going to pay you
$100 today, and there's no

00:01:10.800 --> 00:01:13.980
risk, even if I get hit by
a truck or whatever.

00:01:13.980 --> 00:01:15.010
This is going to happen.

00:01:15.010 --> 00:01:18.630
The U.S. government, if the
earth exists, we will pay you

00:01:18.630 --> 00:01:20.740
$110 in one year.

00:01:20.740 --> 00:01:22.010
It is guaranteed.

00:01:22.010 --> 00:01:23.780
So there's no risk here.

00:01:23.780 --> 00:01:26.060
So it's just the notion of
you're definitely going to get

00:01:26.060 --> 00:01:30.740
$100 today in your hand, or
you're definitely going to get

00:01:30.740 --> 00:01:33.910
$110 one year from now.

00:01:33.910 --> 00:01:35.390
So how do you compare the two?

00:01:35.390 --> 00:01:37.780
And this is where present
value comes in.

00:01:37.780 --> 00:01:41.940
What if there were a way to
say, well what is $110, a

00:01:41.940 --> 00:01:44.570
guaranteed $110,
in the future?

00:01:44.570 --> 00:01:45.930
What if there were a way
to say, how much

00:01:45.930 --> 00:01:48.690
is that worth today?

00:01:48.690 --> 00:01:51.630
How much is that worth
in today's terms?

00:01:51.630 --> 00:01:54.360
So let's do a little
thought experiment.

00:01:54.360 --> 00:02:00.120
Let's say that you could
put money in the bank.

00:02:00.120 --> 00:02:02.220
And these days banks
are kind of risky.

00:02:02.220 --> 00:02:03.350
But let's say you could
put it in the

00:02:03.350 --> 00:02:05.010
safest bank in the world.

00:02:05.010 --> 00:02:07.630
Let's say you , although someone
would debate, you put

00:02:07.630 --> 00:02:09.199
it in government treasuries.

00:02:09.199 --> 00:02:13.360
Which are considered risk-free,
because the U.S.

00:02:13.360 --> 00:02:15.930
government, the Treasury,
can always

00:02:15.930 --> 00:02:17.610
indirectly print more money.

00:02:17.610 --> 00:02:19.460
We'll one day do a whole thing
on the money supply.

00:02:19.460 --> 00:02:22.380
But at the end of the day, the
U.S. government has the rights

00:02:22.380 --> 00:02:25.040
on the printing press,
et cetera.

00:02:25.040 --> 00:02:26.180
It's more complicated
than that.

00:02:26.180 --> 00:02:28.100
But for those purposes, we
assume that with the U.S.

00:02:28.100 --> 00:02:30.740
Treasury, which essentially is
you're lending money to the

00:02:30.740 --> 00:02:33.330
U.S. government, that
it's risk-free.

00:02:33.330 --> 00:02:39.970
So let's say today I could give
you $100 and that you

00:02:39.970 --> 00:02:42.510
could invest it at
5% risk-free.

00:02:49.160 --> 00:02:50.920
And then in a year from now,
how much would that

00:02:50.920 --> 00:02:53.170
be worth, in a year?

00:02:53.170 --> 00:02:57.520
That would be worth
$105 in one year.

00:02:57.520 --> 00:03:03.240
Actually let me write
the $110 over here.

00:03:03.240 --> 00:03:05.270
So this was a good way
of thinking about it.

00:03:05.270 --> 00:03:09.840
You're like, OK, instead of
taking the money from Sal a

00:03:09.840 --> 00:03:13.780
year from now and getting $110,
if I were to take $100

00:03:13.780 --> 00:03:16.910
today and put it in something
risk-free, in a year

00:03:16.910 --> 00:03:18.940
I would have $105.

00:03:18.940 --> 00:03:23.020
So assuming I don't have to
spend the money today, this is

00:03:23.020 --> 00:03:25.820
a better situation
to be in, right?

00:03:25.820 --> 00:03:29.200
If I take the money today, and
risk-free invest it at 5%, I'm

00:03:29.200 --> 00:03:31.610
going to end up with
$105 in a year.

00:03:31.610 --> 00:03:34.990
Instead, if you just tell me,
Sal, just give me the money in

00:03:34.990 --> 00:03:37.520
a year-- give me $110-- you're
going to end up with more

00:03:37.520 --> 00:03:39.080
money in a year, right?

00:03:39.080 --> 00:03:41.490
You're going to end
up with $110.

00:03:41.490 --> 00:03:43.950
And that is actually the right
way to think about it.

00:03:43.950 --> 00:03:46.060
And remember, and I keep saying
it over and over again,

00:03:46.060 --> 00:03:48.330
everything I'm talking about,
it's critical that we're

00:03:48.330 --> 00:03:49.760
talking about risk-free.

00:03:49.760 --> 00:03:52.400
Once you introduce risk, then
we have to start introducing

00:03:52.400 --> 00:03:54.590
different interest rates
and probabilities.

00:03:54.590 --> 00:03:55.560
And we'll get to that
eventually.

00:03:55.560 --> 00:03:59.880
But I want to just give the
purest example right now.

00:03:59.880 --> 00:04:02.050
So already you've made
the decision.

00:04:02.050 --> 00:04:04.800
But we still don't know what
the present value was.

00:04:04.800 --> 00:04:07.320
So to some degree when you took
this $100 and you said

00:04:07.320 --> 00:04:10.110
well if I lend it to the
government, or if I lend it to

00:04:10.110 --> 00:04:14.000
a risk-free bank at 5%, in a
year they'll give me $105.

00:04:14.000 --> 00:04:18.750
This $105 is a way of saying
what is the one-year value of

00:04:18.750 --> 00:04:20.339
$100 today?

00:04:20.339 --> 00:04:23.810
What is the one-year-out
value of $100 today?

00:04:23.810 --> 00:04:27.140
So what if we wanted to go
in the other direction?

00:04:27.140 --> 00:04:29.040
If we have a certain amount of
money and we want to figure

00:04:29.040 --> 00:04:32.450
out today's value,
what could we do?

00:04:32.450 --> 00:04:34.720
Well, to go from here to
here, what did we do?

00:04:34.720 --> 00:04:41.250
We essentially took $100 and we
multiplied by- what did we

00:04:41.250 --> 00:04:43.760
multiply by-- 1 plus 5%.

00:04:43.760 --> 00:04:47.230
So that's 1.05.

00:04:47.230 --> 00:04:51.170
So to go the other way, to say
how much money, if I were to

00:04:51.170 --> 00:04:55.120
grow it by 5%, would
end up being $110?

00:04:55.120 --> 00:05:01.430
We'll just divide by 1.05.

00:05:01.430 --> 00:05:04.085
And then we will get
the present value.

00:05:04.085 --> 00:05:06.220
And the notation is PV.

00:05:06.220 --> 00:05:20.180
We'll get the present value
of $110 a year from now.

00:05:20.180 --> 00:05:30.030
So the present value of $110,
let's say in 2009.

00:05:30.030 --> 00:05:31.240
It's currently 2008.

00:05:31.240 --> 00:05:33.430
I don't know what year you're
watching this video in.

00:05:33.430 --> 00:05:34.750
Hopefully people will
be watching

00:05:34.750 --> 00:05:36.910
this in the next millennia.

00:05:36.910 --> 00:05:41.250
But the present value of $110
in 2009, assuming right now

00:05:41.250 --> 00:05:54.270
it's 2008, a year from now, is
equal to $110 divided by 1.05.

00:05:54.270 --> 00:05:56.980
And let's take out this
calculator, which is probably

00:05:56.980 --> 00:06:00.660
overkill for this problem.

00:06:00.660 --> 00:06:02.630
Let me clear everything.

00:06:02.630 --> 00:06:14.740
OK so I want to do 110 divided
by 1.05 is equal to-- let's

00:06:14.740 --> 00:06:25.120
just round-- so it
equals $104.76.

00:06:25.120 --> 00:06:29.580
So the present value of $110 a
year from now, if we assume

00:06:29.580 --> 00:06:32.780
that we could invest money
risk-free at 5%, if we were to

00:06:32.780 --> 00:06:37.460
get it today -- let me do it in
a different color just to

00:06:37.460 --> 00:06:39.460
fight the monotony--
the present

00:06:39.460 --> 00:06:46.760
value is equal to $104.76.

00:06:46.760 --> 00:06:50.180
Another way to kind of just talk
about this is to get the

00:06:50.180 --> 00:06:54.430
present value of $110 a year
from now, we discounted the

00:06:54.430 --> 00:06:56.690
value by a discount rate.

00:06:56.690 --> 00:06:59.830
And the discount rate is this.

00:06:59.830 --> 00:07:04.440
Right here we grew the money by,
you could say, our yield.

00:07:04.440 --> 00:07:08.600
A 5% yield or our interest.
Here we're discounting the

00:07:08.600 --> 00:07:10.270
money, because we're going
backwards in time.

00:07:10.270 --> 00:07:12.190
We're going from year-out
to the present.

00:07:12.190 --> 00:07:14.650
And so this is our yield.

00:07:14.650 --> 00:07:19.330
To compound the amount of money
we invest, we multiply

00:07:19.330 --> 00:07:22.650
the amount we invest times
1 plus the yield.

00:07:22.650 --> 00:07:26.640
Then to discount money in the
future to the present, we

00:07:26.640 --> 00:07:31.490
divided by 1 plus the discount
rate-- so this is a 5%

00:07:31.490 --> 00:07:39.000
discount rate-- to get
its present value.

00:07:39.000 --> 00:07:41.000
So what does this tell us?

00:07:41.000 --> 00:07:45.960
This tells us if someone's
willing to pay $110, assuming

00:07:45.960 --> 00:07:49.020
this 5%-- remember this is
a critical assumption.

00:07:49.020 --> 00:07:52.710
This tells us that if I tell
you I'm willing to pay you

00:07:52.710 --> 00:07:57.650
$110 a year from now, and you
could get 5%-- so you could

00:07:57.650 --> 00:08:01.750
kind of say that 5% is your
discount rate risk-free-- that

00:08:01.750 --> 00:08:06.780
you should be willing to take
today's money, if today I'm

00:08:06.780 --> 00:08:09.070
willing to give you more
than the present value.

00:08:09.070 --> 00:08:14.455
So if this comparison were-- let
me clear all of this, let

00:08:14.455 --> 00:08:24.920
me just scroll down-- so let's
say that today, 1 year.

00:08:24.920 --> 00:08:31.520
So we figured out that $110 a
year from now, its present

00:08:31.520 --> 00:08:39.145
value is equal to-- so the
present value of that $110--

00:08:39.145 --> 00:08:46.260
is equal to $104.76.

00:08:46.260 --> 00:08:48.680
And that's because I used a 5%
discount rate, and that's a

00:08:48.680 --> 00:08:51.360
key assumption.

00:08:51.360 --> 00:08:52.390
This is a dollar sign.

00:08:52.390 --> 00:08:53.310
I know it's hard to read.

00:08:53.310 --> 00:08:58.190
What this tells you is that,
if your choice was between

00:08:58.190 --> 00:09:06.260
$110 a year from now and $100
today, you should take the

00:09:06.260 --> 00:09:08.400
$110 a year from now.

00:09:08.400 --> 00:09:09.140
Why is that?

00:09:09.140 --> 00:09:12.320
Because its present value
is worth more than $100.

00:09:12.320 --> 00:09:17.740
However, if I were to offer you
$110 a year from now or

00:09:17.740 --> 00:09:20.790
$105 today.

00:09:20.790 --> 00:09:25.620
This, the $105 today, would
be the better choice.

00:09:25.620 --> 00:09:29.100
Because its present value ,
right, $105 today, you don't

00:09:29.100 --> 00:09:29.890
have to discount it .

00:09:29.890 --> 00:09:31.030
It's today.

00:09:31.030 --> 00:09:33.280
Its present value is itself.

00:09:33.280 --> 00:09:38.110
$105 today is worth more than
the present value of $110,

00:09:38.110 --> 00:09:41.710
which is $104.76.

00:09:41.710 --> 00:09:44.980
Another way to think about it
is, I could take this $105 to

00:09:44.980 --> 00:09:48.760
the bank-- let's assume
I have a risk-free

00:09:48.760 --> 00:09:51.440
bank-- get 5% on it.

00:09:51.440 --> 00:09:54.800
And then I would have-- what
would I end up with-- I'd end

00:09:54.800 --> 00:09:59.870
up with 105 times 1.05.

00:09:59.870 --> 00:10:04.180
Equal to $110.25.

00:10:04.180 --> 00:10:07.890
So a year from now, I'd be
better off by $0.25.

00:10:07.890 --> 00:10:10.980
And I'd have the joy of being
able to touch my money for a

00:10:10.980 --> 00:10:14.840
year, which is hard to quantify,
so we leave out of

00:10:14.840 --> 00:10:15.680
the equation.

00:10:15.680 --> 00:10:17.730
Anyway, I'll see you
in the next video.