Geithner plan 5

WEBVTT
Kind: captions
Language: en

00:00:01.020 --> 00:00:03.510
In the last video I constructed
a scenario where

00:00:03.510 --> 00:00:06.480
we get all of the upside in an
investment and our downside

00:00:06.480 --> 00:00:09.340
was limited to essentially
15% of our investment.

00:00:09.340 --> 00:00:10.930
Or in that case it was $25.50.

00:00:10.930 --> 00:00:12.210
I think I made a slide
math error.

00:00:12.210 --> 00:00:13.790
I kept saying $24.50.

00:00:13.790 --> 00:00:15.010
It was really $25.50.

00:00:15.010 --> 00:00:17.000
And I also apologize, I
realize I had my sound

00:00:17.000 --> 00:00:17.750
settings a little off.

00:00:17.750 --> 00:00:19.540
But hopefully you'll be
able to still listen

00:00:19.540 --> 00:00:20.260
to that last video.

00:00:20.260 --> 00:00:25.140
But just to review what we did
is instead of putting $30--

00:00:25.140 --> 00:00:28.010
let's say the asset
price was $30.

00:00:28.010 --> 00:00:30.260
Instead of just going out there
and paying $30 for it,

00:00:30.260 --> 00:00:33.990
what we did is we put
$25.50 aside.

00:00:33.990 --> 00:00:37.810
And then we used $4.50 to
participate in Geithner's

00:00:37.810 --> 00:00:40.010
project, or his plan.

00:00:40.010 --> 00:00:42.530
And we put in $4.50.

00:00:42.530 --> 00:00:44.970
The Treasury puts in $4.50.

00:00:44.970 --> 00:00:48.590
Then the Fed lends us $51.

00:00:48.590 --> 00:00:52.360
And then we're able to buy $60
worth of security, or twice as

00:00:52.360 --> 00:00:54.260
many as we would've
otherwise bought.

00:00:54.260 --> 00:00:56.380
But we're splitting
the upside.

00:00:56.380 --> 00:00:58.340
So essentially we're getting
the upside on the security.

00:00:58.340 --> 00:01:01.470
And we saw in the last video
what the payoff looked like.

00:01:01.470 --> 00:01:04.319
And let me draw that here.

00:01:04.319 --> 00:01:07.750
So hopefully this'll be a
slightly cleaner version than

00:01:07.750 --> 00:01:09.580
I did in the last video.

00:01:09.580 --> 00:01:11.190
So this is going to
be the eventual

00:01:11.190 --> 00:01:12.440
price of the security.

00:01:19.560 --> 00:01:23.920
And let me make the y-axis
the eventual value of my

00:01:23.920 --> 00:01:25.170
investment.

00:01:27.510 --> 00:01:31.030
Now if I just straight up
invested in the thing then the

00:01:31.030 --> 00:01:35.400
value of my investment is the
value of the security.

00:01:35.400 --> 00:01:37.260
So it would just look
something like that.

00:01:41.730 --> 00:01:49.210
So let's say if the value of
the security ends up being

00:01:49.210 --> 00:01:53.710
$30, then the value of my
investment ends up being $30.

00:01:53.710 --> 00:01:54.970
This is the scenario
where I just

00:01:54.970 --> 00:01:56.630
straight up buy the thing.

00:01:56.630 --> 00:01:58.940
If the thing ends up being worth
nothing, then the value

00:01:58.940 --> 00:01:59.890
of my investment's nothing.

00:01:59.890 --> 00:02:01.990
If the thing ends up being worth
$60, then the value of

00:02:01.990 --> 00:02:03.180
my investment is $60.

00:02:03.180 --> 00:02:05.200
This is my investment value.

00:02:05.200 --> 00:02:06.420
Not too fancy there.

00:02:06.420 --> 00:02:08.900
But what we saw in the last
video is, if we do this

00:02:08.900 --> 00:02:13.440
scenario where I put $25.50
aside, and I only put $4.50 at

00:02:13.440 --> 00:02:19.340
risk in this type of reality,
what we had is that if the

00:02:19.340 --> 00:02:26.380
value of the security is
anything less than $25.50,

00:02:26.380 --> 00:02:28.200
then the equity holders
here get wiped out.

00:02:28.200 --> 00:02:31.120
My $4.50 is worth nothing.

00:02:31.120 --> 00:02:32.900
My $4.50 is worth nothing.

00:02:32.900 --> 00:02:37.070
But I still have that $25.50
that I put aside, the cash.

00:02:37.070 --> 00:02:42.850
So my losses were limited to
essentially $4.50 or the

00:02:42.850 --> 00:02:45.190
capital that I put at risk.

00:02:45.190 --> 00:02:48.760
So the payoff diagram then
looks like this.

00:02:48.760 --> 00:02:52.780
In an upside scenario, with my
$4.50 investment I'm able to

00:02:52.780 --> 00:02:55.520
capture all of the upside that
I would have normally gotten,

00:02:55.520 --> 00:02:59.540
and then my downside is
essentially capped to $4.50.

00:02:59.540 --> 00:03:03.540
No matter what happens to the
security, I'm going to be

00:03:03.540 --> 00:03:06.400
sitting with $25.50.

00:03:06.400 --> 00:03:10.440
So the worst case is that I
really just lose $4.50,

00:03:10.440 --> 00:03:14.350
assuming that my original price
that I pay is $30 for

00:03:14.350 --> 00:03:14.810
the security.

00:03:14.810 --> 00:03:16.010
This'll be my loss.

00:03:16.010 --> 00:03:19.530
And then this is obviously
my gain, just like that.

00:03:19.530 --> 00:03:24.350
Now let's see, if there was no
Geithner Plan, let's see if we

00:03:24.350 --> 00:03:29.640
could set up the same type of
payoff using more conventional

00:03:29.640 --> 00:03:31.750
securities, I guess we
could call them.

00:03:31.750 --> 00:03:33.950
And if we can do that, then we
can try to price those more

00:03:33.950 --> 00:03:37.000
conventional securities, and
then we have a good sense of

00:03:37.000 --> 00:03:40.150
the subsidy or essentially what
the government is giving.

00:03:40.150 --> 00:03:42.360
So instead of the Geithner
Plan, let's say that we

00:03:42.360 --> 00:03:44.230
invested straight up
in the security.

00:03:44.230 --> 00:03:50.570
And I'll just say, we invest
in the security for $30.

00:03:50.570 --> 00:03:53.330
And then we also buy an
insurance contract.

00:03:53.330 --> 00:03:58.090
So we buy the security
for $30.

00:03:58.090 --> 00:04:02.530
And then we also buy
a put option.

00:04:02.530 --> 00:04:06.250
And that sounds fancy, but all
it is is an insurance contract

00:04:06.250 --> 00:04:08.120
essentially on a security.

00:04:08.120 --> 00:04:09.370
So we buy a put.

00:04:12.240 --> 00:04:15.210
And the put gives us the right,
it's a contract that

00:04:15.210 --> 00:04:17.010
says that we can sell.

00:04:17.010 --> 00:04:30.470
We have the right to sell
our security for $25.50.

00:04:30.470 --> 00:04:32.780
And we don't have to sell
our security for $25.50.

00:04:32.780 --> 00:04:35.310
Let's say it ends up
being worth $60.

00:04:35.310 --> 00:04:36.610
We're out here.

00:04:36.610 --> 00:04:37.710
Then we're just going
to take our put

00:04:37.710 --> 00:04:38.920
contract and rip it up.

00:04:38.920 --> 00:04:40.400
It's worthless.

00:04:40.400 --> 00:04:42.770
We don't want it.

00:04:42.770 --> 00:04:43.950
We didn't need the insurance.

00:04:43.950 --> 00:04:46.070
Our house didn't burn
down, right?

00:04:46.070 --> 00:04:49.040
But let's say we're down here.

00:04:49.040 --> 00:04:50.590
The thing we bought, this toxic

00:04:50.590 --> 00:04:52.560
asset, really is worthless.

00:04:52.560 --> 00:04:53.950
Then wow, we have
this contract.

00:04:53.950 --> 00:04:56.090
We got into a contract with
someone else who said that

00:04:56.090 --> 00:04:58.370
they would agree to buy
that thing for us

00:04:58.370 --> 00:04:59.510
from $25.50, right?

00:04:59.510 --> 00:05:03.670
We have the right to sell it to
them, or to put it to them,

00:05:03.670 --> 00:05:05.610
for $25.50.

00:05:05.610 --> 00:05:08.240
And just so you get a little
bit of the lingo, although

00:05:08.240 --> 00:05:10.180
many of you all are probably
familiar with this, this is

00:05:10.180 --> 00:05:12.950
the strike price of
the put option.

00:05:12.950 --> 00:05:14.960
And what would the payoff
diagram look like?

00:05:14.960 --> 00:05:16.190
Well, I have the security.

00:05:16.190 --> 00:05:18.920
So in all of the scenarios where
the security is worth

00:05:18.920 --> 00:05:22.810
more than $25.50, my payoff is
going to look like this.

00:05:22.810 --> 00:05:26.180
It's going to be just
along this line.

00:05:26.180 --> 00:05:34.100
Now, in these scenarios down
here, what is my payoff?

00:05:34.100 --> 00:05:37.760
Well if the value of the
security ends up being

00:05:37.760 --> 00:05:42.020
something less than $25.50, well
I have this thing here

00:05:42.020 --> 00:05:43.670
saying, you know, the market's
saying that they're only

00:05:43.670 --> 00:05:46.270
willing to pay I don't know,
$12 for my security.

00:05:46.270 --> 00:05:49.480
But I have this contract with
somebody that says hey,

00:05:49.480 --> 00:05:51.620
they're willing to pay $25.50
for my security.

00:05:51.620 --> 00:05:54.380
So in any of these scenarios,
I'm just going to exercise my

00:05:54.380 --> 00:05:57.640
put option, and I'm just
going to sell it to

00:05:57.640 --> 00:05:59.610
this guy for $25.50.

00:05:59.610 --> 00:06:03.460
So, no matter in all of these
downside scenarios, I still

00:06:03.460 --> 00:06:06.400
get $25.50, because I have
that put option.

00:06:06.400 --> 00:06:08.730
So essentially, as you see,
this payoff diagram is

00:06:08.730 --> 00:06:11.450
identical to what the
government gave us.

00:06:11.450 --> 00:06:14.270
So throughout this whole
structure, this public private

00:06:14.270 --> 00:06:16.740
partnership, all the government
is essentially

00:06:16.740 --> 00:06:20.130
doing is giving us a
put option with a

00:06:20.130 --> 00:06:22.340
$25.50 strike price.

00:06:22.340 --> 00:06:25.240
And so to figure out how large
of a subsidy that is, we

00:06:25.240 --> 00:06:27.940
really just have to figure out
what is a put option with a

00:06:27.940 --> 00:06:29.520
$25.50 strike price.

00:06:29.520 --> 00:06:31.880
And people have Nobel-- It's
actually not that easy to

00:06:31.880 --> 00:06:33.830
calculate this type of thing,
because you have to know about

00:06:33.830 --> 00:06:37.530
the volatility of the security
and its dividends, and

00:06:37.530 --> 00:06:39.300
actually the math to originally
come up with this

00:06:39.300 --> 00:06:42.270
came out of-- People have won
Nobel Prizes for this.

00:06:42.270 --> 00:06:45.180
But it's a known problem.

00:06:45.180 --> 00:06:47.060
What I'm going to do here--
And it's a little bit

00:06:47.060 --> 00:06:47.520
theoretical.

00:06:47.520 --> 00:06:50.440
What a lot of people do in
reality is, they look at what

00:06:50.440 --> 00:06:53.610
the market is paying for these
options, and then they figure

00:06:53.610 --> 00:06:55.870
out what the implied assumptions
are, the

00:06:55.870 --> 00:06:56.440
volatility.

00:06:56.440 --> 00:06:57.680
And that's really the
big assumption.

00:06:57.680 --> 00:06:59.575
But I just did a little
bit of a web search.

00:06:59.575 --> 00:07:01.210
And just to give proper
credit, this is

00:07:01.210 --> 00:07:03.520
math.columbia.edu.

00:07:03.520 --> 00:07:10.420
And this is a little tilde sign
~smirnoff\options13.html

00:07:10.420 --> 00:07:12.170
But what he has here is a
little bit of an options

00:07:12.170 --> 00:07:13.140
calculator.

00:07:13.140 --> 00:07:16.980
And I'll take my chances with
this guy, who's probably a

00:07:16.980 --> 00:07:20.190
Ph.D student or a professor at
Columbia, that he knows how to

00:07:20.190 --> 00:07:22.610
calculate options, and that
his JavaScript is correct.

00:07:22.610 --> 00:07:23.650
And the numbers make sense.

00:07:23.650 --> 00:07:28.370
But let's say the security
in our case is $30.

00:07:28.370 --> 00:07:32.840
The strike price is $25.50.

00:07:32.840 --> 00:07:36.140
Let me make this larger.

00:07:36.140 --> 00:07:37.200
The interest rate.

00:07:37.200 --> 00:07:40.400
So this is the risk free
interest rate.

00:07:40.400 --> 00:07:41.770
It could also be the interest
on the debt.

00:07:41.770 --> 00:07:42.060
It depends.

00:07:42.060 --> 00:07:44.110
But you know, it's
something small.

00:07:44.110 --> 00:07:45.040
Interest is low right now.

00:07:45.040 --> 00:07:45.850
Say 2%.

00:07:45.850 --> 00:07:49.500
The dividend yield-- We're
buying these toxic assets that

00:07:49.500 --> 00:07:51.530
essentially have a pretty
high yield.

00:07:51.530 --> 00:07:54.570
And if you're buying it at
$0.30 on the dollar, your

00:07:54.570 --> 00:07:58.030
yield's probably in the range
of 30% or something.

00:07:58.030 --> 00:07:59.510
But you can play with
these assumptions.

00:07:59.510 --> 00:08:01.980
I'm trying to be as favorable
as possible to this, to kind

00:08:01.980 --> 00:08:04.570
of see how large the
subsidy could be.

00:08:04.570 --> 00:08:05.830
And maybe we'll come
up a range.

00:08:05.830 --> 00:08:08.150
And you could play with
this in your own time.

00:08:08.150 --> 00:08:09.990
Volatility per year.

00:08:09.990 --> 00:08:11.520
I think 30% is pretty fair.

00:08:11.520 --> 00:08:14.910
That in any given year, the
perceived value of this could

00:08:14.910 --> 00:08:16.650
fluctuate by 30%.

00:08:16.650 --> 00:08:18.060
And the time to expiration.

00:08:18.060 --> 00:08:20.180
These are long lived assets.

00:08:20.180 --> 00:08:22.450
A lot of mortgage assets, their
average maturity is

00:08:22.450 --> 00:08:23.390
around 10 years.

00:08:23.390 --> 00:08:25.480
So instead of 365 days, let's
make it 10 years.

00:08:25.480 --> 00:08:28.660
3,650 days.

00:08:28.660 --> 00:08:31.090
And let's calculate it.

00:08:31.090 --> 00:08:32.340
All right, and what we want
to worry about is

00:08:32.340 --> 00:08:34.190
the American put.

00:08:34.190 --> 00:08:36.289
In future videos, I'll talk
about the difference between a

00:08:36.289 --> 00:08:38.360
European put and an
American put.

00:08:38.360 --> 00:08:40.700
But an American put means you
can essentially exercise it at

00:08:40.700 --> 00:08:42.520
any time you want
to exercise it.

00:08:42.520 --> 00:08:45.950
While a European put just has an
exercise date, where that's

00:08:45.950 --> 00:08:48.120
the only time where you can
exercise your option.

00:08:48.120 --> 00:08:51.650
But the American put says that
the value of this, for the

00:08:51.650 --> 00:08:54.420
assumptions we gave,
is about $19.50.

00:08:54.420 --> 00:08:57.710
So it's a pretty big subsidy.

00:08:57.710 --> 00:09:01.430
And of course, the numbers
change a good bit depending on

00:09:01.430 --> 00:09:04.620
if we make the yield on
the security less and

00:09:04.620 --> 00:09:07.010
we calculate it.

00:09:07.010 --> 00:09:10.680
Whoops, I made a mistake here.

00:09:10.680 --> 00:09:12.290
It becomes something less.

00:09:12.290 --> 00:09:15.060
But no matter how you play with
the assumptions, you get

00:09:15.060 --> 00:09:17.470
something in the
$15-$20 range.

00:09:17.470 --> 00:09:22.810
So that option calculator told
us that the correct price or

00:09:22.810 --> 00:09:26.630
the theoretical price for
something like this, for a put

00:09:26.630 --> 00:09:29.350
option for a security like this,
with 30% volatility that

00:09:29.350 --> 00:09:32.320
maybe has a 30% yield
on it, because it's

00:09:32.320 --> 00:09:33.320
paying a lot of dividends.

00:09:33.320 --> 00:09:35.650
People are paying their
mortgage payments.

00:09:35.650 --> 00:09:38.020
That the option value of this
put, if you had to go buy it

00:09:38.020 --> 00:09:38.880
on the market.

00:09:38.880 --> 00:09:39.790
You know, it's a range.

00:09:39.790 --> 00:09:44.920
It's maybe $15 to $20.

00:09:44.920 --> 00:09:48.560
So a rational investor who would
have paid $15 to $20 for

00:09:48.560 --> 00:09:50.920
the option, how much are they
willing to pay for the

00:09:50.920 --> 00:09:53.330
security plus the option?

00:09:53.330 --> 00:09:55.430
Well, that same rational
investor, we're saying was

00:09:55.430 --> 00:09:59.090
willing to pay $30 for
the security before.

00:09:59.090 --> 00:10:01.240
And now they're getting the
security and the option.

00:10:01.240 --> 00:10:04.280
So now, if they had had to go
buy the option by themselves,

00:10:04.280 --> 00:10:06.090
they'd have to pay $15 to $20.

00:10:06.090 --> 00:10:10.050
So in theory, they would be
willing to pay up to $30 plus

00:10:10.050 --> 00:10:11.200
the value of the option.

00:10:11.200 --> 00:10:18.880
So they'd be willing to
pay up to $45 to $50.

00:10:18.880 --> 00:10:20.560
Now I want to be
clear on this.

00:10:20.560 --> 00:10:26.820
If the investor with this option
is, let's say they end

00:10:26.820 --> 00:10:30.480
up paying $50, who
is benefiting?

00:10:30.480 --> 00:10:33.400
If the private investor here
ends up paying $50 for the

00:10:33.400 --> 00:10:35.410
security, because the government
is essentially

00:10:35.410 --> 00:10:38.230
giving them a free option, if
they pay $50 they're actually

00:10:38.230 --> 00:10:40.690
paying for the what the
government is giving them.

00:10:40.690 --> 00:10:43.010
They're paying for the option.

00:10:43.010 --> 00:10:45.570
So the real benefit is the
person selling the toxic

00:10:45.570 --> 00:10:48.520
assets, which are these
banks that I'd argue

00:10:48.520 --> 00:10:50.730
are probably insolvent.

00:10:50.730 --> 00:10:52.810
So the subsidy wouldn't be
to the private investor.

00:10:52.810 --> 00:10:53.950
It would be to the banks.

00:10:53.950 --> 00:10:57.140
Only if the private investor
pays the same prices that they

00:10:57.140 --> 00:11:00.080
would have already
paid, the $30.

00:11:00.080 --> 00:11:02.360
And the bank's willing
to sell it for $30.

00:11:02.360 --> 00:11:04.500
Then you could say that the
subsidy is going to that

00:11:04.500 --> 00:11:05.490
private investor.

00:11:05.490 --> 00:11:06.630
But this begs the
whole question.

00:11:06.630 --> 00:11:11.180
The whole point of this exercise
was that the bid in

00:11:11.180 --> 00:11:12.590
the market right now,
or what people are

00:11:12.590 --> 00:11:15.020
willing to pay, is $30.

00:11:15.020 --> 00:11:19.500
While the banks, essentially,
they can't sell for anything

00:11:19.500 --> 00:11:21.830
less, because if they did then
the gig would be up.

00:11:21.830 --> 00:11:23.590
People would know they're
bankrupt.

00:11:23.590 --> 00:11:25.680
The offer is $60.

00:11:25.680 --> 00:11:29.690
So even with this option that
the government is giving them,

00:11:29.690 --> 00:11:33.750
and even if this investor were
to pay up for the entire price

00:11:33.750 --> 00:11:36.290
of the option, we're kind of
getting that maybe they'll be

00:11:36.290 --> 00:11:38.550
willing to pay up
to $45 or $50.

00:11:38.550 --> 00:11:40.260
In which case the private
investor is really getting no

00:11:40.260 --> 00:11:41.840
value from this whole gig.

00:11:41.840 --> 00:11:44.860
So even then, you don't
get to this point.

00:11:44.860 --> 00:11:46.900
And obviously if the private
investor's only paying in the

00:11:46.900 --> 00:11:50.710
$30, range, then that's no
different than the reality

00:11:50.710 --> 00:11:51.830
we're already into.

00:11:51.830 --> 00:11:54.570
And so this goes back to
that Geithner 2 video.

00:11:54.570 --> 00:11:57.980
That even with this option, a
rational investor is only

00:11:57.980 --> 00:12:01.190
willing to pay up to maybe
$40 or $50, how

00:12:01.190 --> 00:12:02.120
could this plan work?

00:12:02.120 --> 00:12:04.330
Well it either won't work.

00:12:04.330 --> 00:12:07.060
Because a rational investor
still won't pay the magic

00:12:07.060 --> 00:12:09.780
number that the banks need
in order to be solvent.

00:12:09.780 --> 00:12:12.980
Or the scenario that I described
in the Geithner Plan

00:12:12.980 --> 00:12:16.750
2 video will happen, where the
banks have this huge incentive

00:12:16.750 --> 00:12:18.850
to buy these for themselves.

00:12:18.850 --> 00:12:21.910
They just create these kind
of shill hedge funds.

00:12:21.910 --> 00:12:24.400
And maybe I'll do a bunch of
videos on all of the different

00:12:24.400 --> 00:12:25.310
ways they can do that.

00:12:25.310 --> 00:12:26.760
And banks are experts at this.

00:12:26.760 --> 00:12:28.610
At creating kind of off-balance
sheet entities

00:12:28.610 --> 00:12:30.210
that they really do control.

00:12:30.210 --> 00:12:31.880
And then those things
participate with the

00:12:31.880 --> 00:12:34.550
government and buy the
assets off of them.

00:12:34.550 --> 00:12:38.100
So my general take on it is,
if when we see this program

00:12:38.100 --> 00:12:43.730
start to happen, if we see
bids that are above $60.

00:12:43.730 --> 00:12:48.170
If we see bids at $0.70 on the
dollar or $0.80 on the dollar,

00:12:48.170 --> 00:12:50.880
then these bids are actually
coming from the banks

00:12:50.880 --> 00:12:51.420
themselves.

00:12:51.420 --> 00:12:54.290
Because there's no rational
reason, even with the put

00:12:54.290 --> 00:12:57.080
option, why a regular investor
would pay in

00:12:57.080 --> 00:12:59.080
excess of $40 or $50.

00:12:59.080 --> 00:13:02.130
And then there is a whole
liquidity argument here, that

00:13:02.130 --> 00:13:05.090
Geithner has made, that oh well
it's not just the subsidy

00:13:05.090 --> 00:13:05.570
we're giving.

00:13:05.570 --> 00:13:06.980
It's just also the
buying power.

00:13:06.980 --> 00:13:09.680
That right now, you have all
these distress sellers, and

00:13:09.680 --> 00:13:12.300
you don't have that
many buyers or

00:13:12.300 --> 00:13:13.650
dollars that are buying.

00:13:13.650 --> 00:13:16.330
And by kind of leveraging things
up, you're increasing

00:13:16.330 --> 00:13:18.640
the buying power out there.

00:13:18.640 --> 00:13:20.650
And in the next video, I'll kind
of address that question.

00:13:20.650 --> 00:13:24.000
If that is the real problem that
Geithner wants to solve,

00:13:24.000 --> 00:13:26.070
there's a much better way to
solve it than doing this

00:13:26.070 --> 00:13:27.750
public private partnership.

00:13:27.750 --> 00:13:29.490
And essentially allowing
the banks to

00:13:29.490 --> 00:13:31.660
potentially set the price.

00:13:31.660 --> 00:13:33.710
You're either letting the banks
set the price, which

00:13:33.710 --> 00:13:37.430
would be a direct transfer of
wealth from taxpayers to banks

00:13:37.430 --> 00:13:38.540
that made mistakes.

00:13:38.540 --> 00:13:42.460
Or you're giving a put option,
which has a pretty good value,

00:13:42.460 --> 00:13:44.780
to a bunch of hedge funds and
investors, who maybe aren't

00:13:44.780 --> 00:13:47.460
the reason why we got into the
mess, but there's no reason

00:13:47.460 --> 00:13:48.830
why you should be transferring
money from

00:13:48.830 --> 00:13:50.920
taxpayers to hedge funds.

00:13:50.920 --> 00:13:53.470
So in the next video, I'll
address that, and hopefully

00:13:53.470 --> 00:13:57.450
this gave you a good sense of
what exactly the government is

00:13:57.450 --> 00:13:58.780
doing, and how you
can value it.

00:13:58.780 --> 00:14:00.560
See you in the next video.


Geithner plan 4

WEBVTT
Kind: captions
Language: en

00:00:00.820 --> 00:00:04.810
Let's try to construct a
situation where I participate

00:00:04.810 --> 00:00:08.320
in the new Treasury Public
Private Program.

00:00:08.320 --> 00:00:11.510
And I get all of the upside
I would have gotten in a

00:00:11.510 --> 00:00:13.840
traditional just straight up
investment in these toxic

00:00:13.840 --> 00:00:14.570
securities.

00:00:14.570 --> 00:00:17.360
But then I'm able to offload
some of the downside.

00:00:17.360 --> 00:00:24.100
And so just as a review, what
the program entails is that if

00:00:24.100 --> 00:00:27.130
I want to make an investment
in something.

00:00:27.130 --> 00:00:32.689
Let's say I want to make a
$100 or 100% investment.

00:00:32.689 --> 00:00:33.130
It doesn't matter.

00:00:33.130 --> 00:00:34.810
Either way.

00:00:34.810 --> 00:00:36.140
That's 100.

00:00:36.140 --> 00:00:43.250
The Fed is going to give us
a loan for 85% of it.

00:00:43.250 --> 00:00:46.900
And then the remainder, the
equity, is going to be split

00:00:46.900 --> 00:00:52.960
half, or 50-50, between myself
and the Treasury.

00:00:52.960 --> 00:00:54.960
And then this is the
private investor.

00:00:54.960 --> 00:00:56.120
So what happens here?

00:00:56.120 --> 00:00:58.430
And we talked a lot about it in
the last couple of videos.

00:00:58.430 --> 00:01:02.240
Is that the upside, if this
thing is worth more than 100,

00:01:02.240 --> 00:01:03.990
it's split between the Treasury

00:01:03.990 --> 00:01:05.370
and the private investor.

00:01:05.370 --> 00:01:07.980
And then the downside is split
between the private investor

00:01:07.980 --> 00:01:08.720
and the Treasury.

00:01:08.720 --> 00:01:13.220
Until the asset becomes
worth less than 85% of

00:01:13.220 --> 00:01:14.020
its original value.

00:01:14.020 --> 00:01:15.550
And then the Fed takes
the hit, right?

00:01:15.550 --> 00:01:17.320
Because this loan won't
be worth anything.

00:01:17.320 --> 00:01:19.820
And all this loan can go
after is this asset.

00:01:19.820 --> 00:01:21.560
It's a non recourse loan.

00:01:21.560 --> 00:01:25.270
The Fed can't say, oh, this
thing is only worth 84.

00:01:25.270 --> 00:01:27.630
Private investor and Treasury,
you guys owe me a dollar.

00:01:27.630 --> 00:01:31.250
The Fed is just left with this
asset that might be worth

00:01:31.250 --> 00:01:32.390
something less than that.

00:01:32.390 --> 00:01:35.300
But how could we use this
program to get the same upside

00:01:35.300 --> 00:01:38.030
we would have otherwise gotten,
if we had just bought

00:01:38.030 --> 00:01:39.530
the toxic security outright?

00:01:39.530 --> 00:01:43.970
So let's say that the toxic
security, in a before-this

00:01:43.970 --> 00:01:46.570
program world that Geithner
has come up with.

00:01:46.570 --> 00:01:51.130
Let's say that I'm willing to
pay $30 for a security.

00:01:51.130 --> 00:01:54.360
And obviously if the security
is worth $40, I'll make $10.

00:01:54.360 --> 00:01:56.490
If it's worth $50,
I'll make $20.

00:01:56.490 --> 00:01:57.480
And so forth and so on.

00:01:57.480 --> 00:01:58.610
That's obvious.

00:01:58.610 --> 00:02:02.110
Now what I can do is, instead
of just, with this plan-- I

00:02:02.110 --> 00:02:04.640
mean, before I would have to
take my $30 that I have in the

00:02:04.640 --> 00:02:07.880
bank, and use it to buy some
asset, if one of these banks

00:02:07.880 --> 00:02:09.589
were willing to sell it to me.

00:02:09.589 --> 00:02:12.550
But what I can do now is, I
could say, well, let me just

00:02:12.550 --> 00:02:14.450
take 15% of this.

00:02:14.450 --> 00:02:16.390
So what's 15% of $30?

00:02:16.390 --> 00:02:18.210
It's $4.50.

00:02:18.210 --> 00:02:21.420
And use that to invest
in this program.

00:02:21.420 --> 00:02:24.250
And essentially get the same
upside as I would if I

00:02:24.250 --> 00:02:25.690
invested the whole $30.

00:02:25.690 --> 00:02:29.800
And then put the rest of the
cash away essentially safe, so

00:02:29.800 --> 00:02:33.140
that my worst case is that I
just lose what I invest. So

00:02:33.140 --> 00:02:34.080
let's do that.

00:02:34.080 --> 00:02:36.780
And we'll see that the numbers
do all work out.

00:02:36.780 --> 00:02:39.860
So instead of just doing $30
all for the investment, I'm

00:02:39.860 --> 00:02:42.020
going to set aside 15%.

00:02:42.020 --> 00:02:46.820
So I'm going to put $4.50 to
participate in the plan.

00:02:46.820 --> 00:02:48.900
And then I'm going to set
aside what's left.

00:02:48.900 --> 00:02:55.190
$25.50 in cash.

00:02:55.190 --> 00:02:57.840
And using this $4.50 in the
plan, I'll show you that I'll

00:02:57.840 --> 00:03:00.610
get all of the upside that I got
if I had originally had to

00:03:00.610 --> 00:03:02.790
use all $30 by myself.

00:03:02.790 --> 00:03:04.370
And obviously my downside
is limited.

00:03:04.370 --> 00:03:06.925
My downside is limited to the
$4.50, because I'm still going

00:03:06.925 --> 00:03:09.730
to have the $25.50 in
cash on the side.

00:03:09.730 --> 00:03:10.760
So how is this going to work?

00:03:10.760 --> 00:03:15.660
I'm going to put in $4.50.

00:03:15.660 --> 00:03:19.200
That's from me, the
private investor.

00:03:19.200 --> 00:03:23.140
The Treasury is going to
match my investment.

00:03:23.140 --> 00:03:25.310
$4.50.

00:03:25.310 --> 00:03:26.560
That's the Treasury.

00:03:28.990 --> 00:03:31.550
Now I have $9 of equity.

00:03:31.550 --> 00:03:36.040
And this is going to be 15% of
the total equity, so the debt

00:03:36.040 --> 00:03:41.610
that the Fed will lend me
is going to be $51.

00:03:41.610 --> 00:03:43.580
And I did the math before I did
the video, but you could

00:03:43.580 --> 00:03:45.880
work it out yourself.

00:03:45.880 --> 00:03:53.100
$51 loan from the Fed.

00:03:53.100 --> 00:03:56.190
And so what's our total capital
that we've raised now?

00:03:56.190 --> 00:04:00.320
So if you add $51 plus
$9, we have $60.

00:04:00.320 --> 00:04:02.150
Let me do this in a
different color.

00:04:02.150 --> 00:04:06.600
We now have $60.

00:04:06.600 --> 00:04:08.230
And we could use that $60.

00:04:08.230 --> 00:04:11.640
If someone was willing to sell
me one, I guess we could say

00:04:11.640 --> 00:04:15.520
one of the units, or one of the
securities for $30, now

00:04:15.520 --> 00:04:18.570
with $60, we can buy
two of the units.

00:04:18.570 --> 00:04:23.420
So we could buy two
of them for $30.

00:04:23.420 --> 00:04:26.750
And why did I end up making the
math work so we'd get two

00:04:26.750 --> 00:04:27.770
securities?

00:04:27.770 --> 00:04:31.020
Because we split the
upside, right?

00:04:31.020 --> 00:04:33.090
We split the upside
with the Treasury.

00:04:33.090 --> 00:04:36.800
So in order to set up a
situation where I get all of

00:04:36.800 --> 00:04:42.140
the upside that I would have
gotten with a $30 security, I

00:04:42.140 --> 00:04:44.820
essentially have to set up a
configuration where we buy

00:04:44.820 --> 00:04:46.270
twice as many securities.

00:04:46.270 --> 00:04:48.840
I buy twice as many securities,
and then I split

00:04:48.840 --> 00:04:51.415
the upside 50-50 with the
Treasury, then I'm just going

00:04:51.415 --> 00:04:52.230
to get the upside.

00:04:52.230 --> 00:04:53.750
You could almost view
it on one security.

00:04:53.750 --> 00:04:56.770
Let's see how the math
works out now.

00:04:56.770 --> 00:04:59.050
Let's do a bunch of scenarios.

00:04:59.050 --> 00:05:06.060
So in the world where-- maybe
I should do a table.

00:05:06.060 --> 00:05:07.910
Yeah, let's say that the
eventual value of the

00:05:07.910 --> 00:05:10.930
security, let's say it's worth--
I'm going to make a

00:05:10.930 --> 00:05:12.020
bunch of numbers up.

00:05:12.020 --> 00:05:25.140
0, 10, 20, 30, 40, 50, 60.

00:05:25.140 --> 00:05:26.050
That's good enough.

00:05:26.050 --> 00:05:28.000
So let's say that these
securities end

00:05:28.000 --> 00:05:30.200
up being worth nothing.

00:05:30.200 --> 00:05:32.050
How much am I left with?

00:05:32.050 --> 00:05:35.670
What's the total value of
my total investment?

00:05:35.670 --> 00:05:38.100
Well if these are worth
nothing, then I

00:05:38.100 --> 00:05:38.860
get wiped out here.

00:05:38.860 --> 00:05:39.860
We all get wiped out here.

00:05:39.860 --> 00:05:41.510
In fact, everyone gets
wiped out here.

00:05:41.510 --> 00:05:43.140
So how much did I lose?

00:05:43.140 --> 00:05:44.760
Well my $4.50 is gone.

00:05:44.760 --> 00:05:45.660
This goes to 0.

00:05:45.660 --> 00:05:48.160
But what is my total investment
left with?

00:05:48.160 --> 00:05:53.590
I still have my $25.50 that
I put to the side, right?

00:05:53.590 --> 00:06:01.650
So I still have my
$25.50 in cash.

00:06:01.650 --> 00:06:05.750
If each of these securities
are worth $10, this is

00:06:05.750 --> 00:06:07.680
eventual value of each
of the units.

00:06:07.680 --> 00:06:11.440
So if each of these is worth
$10, then the whole asset side

00:06:11.440 --> 00:06:14.760
of this balance sheet is worth
$20, and once again, the Fed

00:06:14.760 --> 00:06:16.570
is going to take a $31 hit.

00:06:16.570 --> 00:06:17.850
And these two guys
are wiped out.

00:06:17.850 --> 00:06:19.720
So my investment is
worth nothing.

00:06:19.720 --> 00:06:22.130
But I still have that money
I set aside in the bank.

00:06:22.130 --> 00:06:24.750
$25.50.

00:06:24.750 --> 00:06:29.480
If these securities are worth
$20, then this whole asset

00:06:29.480 --> 00:06:31.785
side is worth $40, because
there's going

00:06:31.785 --> 00:06:32.980
to be two of them.

00:06:32.980 --> 00:06:34.240
The Fed is still taking a hit.

00:06:34.240 --> 00:06:35.370
Doesn't get all its
money back.

00:06:35.370 --> 00:06:37.010
And these two guys still
get wiped out.

00:06:37.010 --> 00:06:38.100
My $4.50 is gone.

00:06:38.100 --> 00:06:41.120
I still have my money
in my bank. $25.50.

00:06:41.120 --> 00:06:44.850
If this security is worth $30,
which is essentially the price

00:06:44.850 --> 00:06:46.150
that we're paying for it.

00:06:46.150 --> 00:06:47.850
Then this is what the balance
sheet is going to look like.

00:06:47.850 --> 00:06:50.710
So my equity is worth $4.50.

00:06:50.710 --> 00:06:53.720
But I have $4.50 plus
the money that I

00:06:53.720 --> 00:06:55.530
had set aside, right?

00:06:55.530 --> 00:06:59.070
I have $4.50 plus this
$25.50 that I'd put

00:06:59.070 --> 00:07:00.280
aside in the bank.

00:07:00.280 --> 00:07:01.610
Because I didn't have
to invest that.

00:07:01.610 --> 00:07:03.600
I just had to invest the
$4.50 initially.

00:07:03.600 --> 00:07:06.960
So I have my $4.50 here,
plus $25.50.

00:07:06.960 --> 00:07:12.510
So the value of all of my
investments is $30.

00:07:12.510 --> 00:07:12.780
What

00:07:12.780 --> 00:07:15.650
Happens if each of these
units are worth $40.

00:07:15.650 --> 00:07:20.110
If each of these are worth $40,
then we have $80 on the

00:07:20.110 --> 00:07:21.600
left-hand side of the
balance sheet.

00:07:21.600 --> 00:07:23.170
So let me draw that
really small here.

00:07:23.170 --> 00:07:26.310
So then we'll have two units
that are worth $40.

00:07:26.310 --> 00:07:28.190
That's $80.

00:07:28.190 --> 00:07:33.190
We owe $51 to the Fed.

00:07:33.190 --> 00:07:37.920
So we're going to have $29
to split between the

00:07:37.920 --> 00:07:39.170
Treasury and ourselves.

00:07:42.190 --> 00:07:47.420
$29 divided by 2 is $14.50.

00:07:47.420 --> 00:07:53.600
We're each going to
split that $29.

00:07:53.600 --> 00:07:56.290
So my equity is now
worth $14.50.

00:07:56.290 --> 00:07:58.500
So my total investment is going
to be the cash that I

00:07:58.500 --> 00:08:02.910
put aside-- so that's,
let's say, $25.50.

00:08:02.910 --> 00:08:05.200
Plus the value of my equity
investment now.

00:08:05.200 --> 00:08:08.660
So that's plus $14.50.

00:08:08.660 --> 00:08:12.340
And so it's worth $40.

00:08:12.340 --> 00:08:13.760
I think you see the
pattern here.

00:08:13.760 --> 00:08:17.320
In all of these kind of downside
scenarios, the most I

00:08:17.320 --> 00:08:18.600
lost was $4.50.

00:08:18.600 --> 00:08:20.660
And now in all of these upside
scenarios, we're going to see

00:08:20.660 --> 00:08:23.790
that I get the value of
the actual security.

00:08:23.790 --> 00:08:26.450
Now let's do it for $50, but I
think you know how the math's

00:08:26.450 --> 00:08:27.480
going to work out.

00:08:27.480 --> 00:08:31.950
If each of these ends up being
worth $50, then this whole

00:08:31.950 --> 00:08:34.700
left-hand side is $100.

00:08:34.700 --> 00:08:36.440
We owe the Fed $51.

00:08:36.440 --> 00:08:39.309
So this is going to be $49.

00:08:39.309 --> 00:08:44.700
And if you split that,
it's $24.50.

00:08:44.700 --> 00:08:48.450
The money we set aside in
the bank is $25.50.

00:08:48.450 --> 00:08:50.700
And so this is worth $50.

00:08:50.700 --> 00:08:53.460
And, likewise, if these are each
worth $60, this is going

00:08:53.460 --> 00:08:55.190
to turn out to be $60.

00:08:55.190 --> 00:08:56.240
So what you see here,
and I'm going to

00:08:56.240 --> 00:08:57.490
draw a payoff diagram.

00:09:01.662 --> 00:09:03.440
Let me draw a line here.

00:09:11.200 --> 00:09:15.030
Let's see if I can
do this right.

00:09:15.030 --> 00:09:20.300
So if this is the eventual
value of the asset.

00:09:20.300 --> 00:09:22.280
When we pay something in the
market, we're hoping we're

00:09:22.280 --> 00:09:24.250
buying it for less than its
real value, but we really

00:09:24.250 --> 00:09:26.910
don't know 100% what the
eventual value is.

00:09:26.910 --> 00:09:29.100
But this x-axis is the
eventual value.

00:09:33.580 --> 00:09:42.270
So it could be 10, 20,
30, 40, 50, 60, and

00:09:42.270 --> 00:09:43.640
so on and so forth.

00:09:43.640 --> 00:09:47.060
So depending on this eventual
value, what is the value of my

00:09:47.060 --> 00:09:48.270
investment?

00:09:48.270 --> 00:09:52.880
So we figured out if it's 0, 10,
20, all the way really up

00:09:52.880 --> 00:10:02.850
to-- The value of my investment
is going to be-- I

00:10:02.850 --> 00:10:05.400
didn't have to draw this stuff
down here-- let's say that

00:10:05.400 --> 00:10:09.420
this is $24.50.

00:10:09.420 --> 00:10:18.580
So in all of these scenarios--
whoops, trying to draw a

00:10:18.580 --> 00:10:29.310
line-- so 20, and
then at $25.50.

00:10:29.310 --> 00:10:33.780
If this thing is worth--
We could figure out the

00:10:33.780 --> 00:10:34.640
break-even, right?

00:10:34.640 --> 00:10:38.460
If these assets are worth
anything more combined than

00:10:38.460 --> 00:10:41.750
$51, then we start to have
value to the equity.

00:10:41.750 --> 00:10:43.080
So what's that value?

00:10:43.080 --> 00:10:46.560
That's this divided
by 2 is $25.50.

00:10:46.560 --> 00:10:50.860
So after $25.50 some value
starts going to the equity.

00:10:50.860 --> 00:10:55.550
And we know at $30-- let me draw
those points, actually.

00:10:55.550 --> 00:10:58.200
I'll do it in a different color
when we're in the money.

00:10:58.200 --> 00:11:04.660
So at $30, the value of
our security is 30.

00:11:04.660 --> 00:11:08.820
At $40, the value of
our security is 40.

00:11:08.820 --> 00:11:09.990
And so on and so forth.

00:11:09.990 --> 00:11:11.345
And let me draw a line now.

00:11:14.880 --> 00:11:16.422
That's not what I
wanted to do.

00:11:16.422 --> 00:11:17.960
I'll just draw a regular line.

00:11:17.960 --> 00:11:22.120
Our payoff would look
something like this.

00:11:22.120 --> 00:11:23.920
This is a good visualization
for what the

00:11:23.920 --> 00:11:24.850
government is giving us.

00:11:24.850 --> 00:11:26.790
And I'll show you that what
they're giving us is

00:11:26.790 --> 00:11:30.010
essentially insurance, or
a put option for free.

00:11:30.010 --> 00:11:31.820
And then we can talk in the
next video about how

00:11:31.820 --> 00:11:32.870
we can value it.

00:11:32.870 --> 00:11:35.800
And then we have a real sense
of what the government is

00:11:35.800 --> 00:11:37.530
handing over to the investor.

00:11:37.530 --> 00:11:39.360
Now, you might say that it's
handing it to the investor,

00:11:39.360 --> 00:11:41.750
but if because of this the
investor overpays for the

00:11:41.750 --> 00:11:44.990
asset, that subsidy is
really going to the

00:11:44.990 --> 00:11:46.270
person selling the asset.

00:11:46.270 --> 00:11:47.420
And we'll talk about
that a little bit

00:11:47.420 --> 00:11:48.220
more in the next video.

00:11:48.220 --> 00:11:50.520
But let me just finish
this up a little bit.

00:11:50.520 --> 00:11:52.660
So we said that the point
at which we start

00:11:52.660 --> 00:11:58.690
making money is here.

00:11:58.690 --> 00:12:02.370
Because this is what we
paid for the security.

00:12:02.370 --> 00:12:04.090
We're paying $30 for
the security.

00:12:04.090 --> 00:12:07.690
So these are all the scenarios
where we start making money.

00:12:07.690 --> 00:12:10.040
Where the security's worth
more than that.

00:12:10.040 --> 00:12:18.010
But the equity's actually worth
something above $25.50,

00:12:18.010 --> 00:12:19.730
but we're still taking
a slight loss.

00:12:19.730 --> 00:12:23.230
But the cool thing is, if we are
the private investor here,

00:12:23.230 --> 00:12:26.580
even if the thing is worth very
little, we don't take

00:12:26.580 --> 00:12:28.250
that much of a loss here.

00:12:28.250 --> 00:12:29.050
And this is much better.

00:12:29.050 --> 00:12:32.430
What would the payoff diagram
have looked like if we were

00:12:32.430 --> 00:12:34.330
just a straight-up investor?

00:12:34.330 --> 00:12:35.930
Let me just draw that in
a different color.

00:12:35.930 --> 00:12:37.870
Well then it would've looked
something like this.

00:12:37.870 --> 00:12:39.363
We would have had
the same upside.

00:12:45.130 --> 00:12:47.920
But our downside would've
gone all the way to 0.

00:12:47.920 --> 00:12:51.240
If the asset is worth 0, we
would have been worth-- well,

00:12:51.240 --> 00:12:54.006
these lines were supposed to
be on top of each other.

00:12:54.006 --> 00:12:57.260
But I think you get the idea
that the government is saving

00:12:57.260 --> 00:13:00.800
us from these losses
right here.

00:13:00.800 --> 00:13:01.705
Oh, I think you can't see it.

00:13:01.705 --> 00:13:02.430
I'm off the screen.

00:13:02.430 --> 00:13:05.240
The government's saving us from
these losses right there.

00:13:05.240 --> 00:13:06.700
And so I'm out of time
in this video.

00:13:06.700 --> 00:13:10.190
In the next video, I'm going to
actually analyze what that

00:13:10.190 --> 00:13:12.850
subsidy or what that insurance
or that option that the

00:13:12.850 --> 00:13:14.990
government is giving us,
what it might be worth.

00:13:14.990 --> 00:13:17.370
And then we could think about
whether now people are willing

00:13:17.370 --> 00:13:20.040
to actually overpay
for these things.

00:13:20.040 --> 00:13:21.910
See you in the next video.


Geithner plan 2

WEBVTT
Kind: captions
Language: en

00:00:00.750 --> 00:00:03.210
So just to get us back up to
speed where I left off in the

00:00:03.210 --> 00:00:07.740
last video, we have a bank
sitting on an asset that it

00:00:07.740 --> 00:00:09.550
maybe originally
paid $100 for.

00:00:09.550 --> 00:00:14.320
Let's say it has
$60 liability.

00:00:14.320 --> 00:00:17.490
$40 of equity.

00:00:17.490 --> 00:00:18.570
That's when they paid for it.

00:00:18.570 --> 00:00:20.230
So this is $100.

00:00:20.230 --> 00:00:23.640
This is $60 of debt.

00:00:23.640 --> 00:00:25.490
And they had $40 of equity.

00:00:25.490 --> 00:00:26.910
And these are the
toxic assets.

00:00:26.910 --> 00:00:28.570
We're just assuming
a world that only

00:00:28.570 --> 00:00:30.360
has one set of assets.

00:00:30.360 --> 00:00:32.180
And the problem that we said
from the beginning of the

00:00:32.180 --> 00:00:36.020
banking crisis is, that the
banks can't sell these assets

00:00:36.020 --> 00:00:39.090
to pay off its liabilities,
its deposits, or other

00:00:39.090 --> 00:00:43.880
debtors, for the price that
it wants to sell them at.

00:00:43.880 --> 00:00:46.200
Because obviously if they sell
this for anything less than

00:00:46.200 --> 00:00:49.170
$60, the bank is bankrupt.

00:00:49.170 --> 00:00:53.220
So this is the bank, and it
wants to sell for greater

00:00:53.220 --> 00:00:54.860
than-- I'll say $60.

00:00:54.860 --> 00:00:56.220
I won't say 60 cents
on the dollar, but

00:00:56.220 --> 00:00:57.050
it's the same thing.

00:00:57.050 --> 00:00:58.560
Wants to sell for greater
than $60.

00:00:58.560 --> 00:01:04.080
While the market is willing
to pay less than

00:01:04.080 --> 00:01:05.230
$30 for this asset.

00:01:05.230 --> 00:01:07.280
And obviously if the bank went
and sold this at the market

00:01:07.280 --> 00:01:09.220
price and only got
$30 for this.

00:01:09.220 --> 00:01:13.540
If this whole thing became
$30, then the liabilities

00:01:13.540 --> 00:01:16.950
become worth much more than
the asset, than the $30.

00:01:16.950 --> 00:01:18.550
And the bank is bankrupt.

00:01:18.550 --> 00:01:22.020
And so as I outlined at the
end of the last video, the

00:01:22.020 --> 00:01:26.180
current incarnation is for,
you have a public private

00:01:26.180 --> 00:01:28.160
partnership.

00:01:28.160 --> 00:01:30.072
Let me draw their equity.

00:01:30.072 --> 00:01:31.940
And let me try to draw it
a little bit better.

00:01:31.940 --> 00:01:34.980
So let's say that you have--
and I'll do the number

00:01:34.980 --> 00:01:38.100
slightly different--
so you have $5.

00:01:40.770 --> 00:01:43.060
from a private investor.

00:01:43.060 --> 00:01:45.360
This is a review of
the last video.

00:01:45.360 --> 00:01:47.600
You have $5 from the Treasury.

00:01:47.600 --> 00:01:49.600
These are both the
equity investors.

00:01:49.600 --> 00:01:52.770
And then you have $50 borrowed
from the Fed.

00:01:52.770 --> 00:01:54.330
And I'm doing this a little
bit differently, so the

00:01:54.330 --> 00:01:56.160
numbers match up exactly
with what they're going

00:01:56.160 --> 00:01:58.150
to pay for the asset.

00:01:58.150 --> 00:02:02.170
So you have $50.

00:02:02.170 --> 00:02:02.680
Let me see.

00:02:02.680 --> 00:02:04.740
So if that's $10, $50 would
be something that looks

00:02:04.740 --> 00:02:06.360
something like that.

00:02:06.360 --> 00:02:08.030
So you have $50 that you borrow

00:02:08.030 --> 00:02:11.264
from the Federal Reserve.

00:02:14.050 --> 00:02:17.010
And so, this entity will
have $60 here.

00:02:17.010 --> 00:02:18.545
When it gets capitalized.

00:02:18.545 --> 00:02:19.795
We'll do that in green.

00:02:26.340 --> 00:02:28.040
And what they can now
do, is they can give

00:02:28.040 --> 00:02:30.530
that $60 to the banks.

00:02:30.530 --> 00:02:33.200
Essentially paying a price that
the banks are willing to

00:02:33.200 --> 00:02:34.480
part with the assets for.

00:02:34.480 --> 00:02:36.410
And then the banks are going
to give them the assets.

00:02:36.410 --> 00:02:41.530
So now the bank has $60 of cash
that it can use to keep

00:02:41.530 --> 00:02:43.590
its liabilities liquid.

00:02:43.590 --> 00:02:47.620
And now this entity right
here has a toxic asset,

00:02:47.620 --> 00:02:49.026
we could call it.

00:02:49.026 --> 00:02:51.340
And I addressed it in the last
video, you know, why is the

00:02:51.340 --> 00:02:52.110
investor doing this?

00:02:52.110 --> 00:02:53.100
Because they share

00:02:53.100 --> 00:02:54.930
disproportionately in the upside.

00:02:54.930 --> 00:02:56.860
They paid $60 for this thing.

00:02:56.860 --> 00:02:58.990
And just as a real quick review,
if this thing ends up

00:02:58.990 --> 00:03:04.590
being worth-- let's say it
ends up being worth $100.

00:03:04.590 --> 00:03:08.800
Then they owe $50 to the
Federal Reserve.

00:03:08.800 --> 00:03:10.490
That's this loan right here.

00:03:10.490 --> 00:03:11.530
To the Fed.

00:03:11.530 --> 00:03:14.670
And then they split the equity
with the Treasury.

00:03:14.670 --> 00:03:15.400
So, how much equity?

00:03:15.400 --> 00:03:18.230
There's a total of $50
of equity left.

00:03:18.230 --> 00:03:20.490
$25 for the Treasury.

00:03:20.490 --> 00:03:24.040
$25 for them, for the
private investor.

00:03:24.040 --> 00:03:30.280
So their initial investment was
$5, and it went to $25.

00:03:30.280 --> 00:03:30.880
That's awesome.

00:03:30.880 --> 00:03:32.630
Five times your money.

00:03:32.630 --> 00:03:34.500
And then in the down case.

00:03:34.500 --> 00:03:35.530
What's their down case?

00:03:35.530 --> 00:03:37.370
Their down case is-- let's
say that toxic asset

00:03:37.370 --> 00:03:39.480
really is worth $30.

00:03:39.480 --> 00:03:40.750
Let me draw that.

00:03:40.750 --> 00:03:43.512
And this is a review
of the last video.

00:03:43.512 --> 00:03:45.610
But it's important, because
it really bears

00:03:45.610 --> 00:03:48.780
into what might happen.

00:03:48.780 --> 00:03:52.700
So let's say that this
is optimistic.

00:03:52.700 --> 00:03:54.576
This is pessimistic.

00:03:54.576 --> 00:03:57.960
So let's say these assets
end up being worth $30.

00:03:57.960 --> 00:04:00.930
Then you have this $50
loan from the Fed.

00:04:00.930 --> 00:04:02.650
And you have no equity
left over.

00:04:02.650 --> 00:04:04.540
And the Fed essentially
is left taking

00:04:04.540 --> 00:04:05.890
a loss on its loan.

00:04:05.890 --> 00:04:08.370
But the private investor, since
there's no equity, is

00:04:08.370 --> 00:04:09.370
going to be left with zero.

00:04:09.370 --> 00:04:13.630
So you went from $5 to zero.

00:04:13.630 --> 00:04:15.550
But this is still a pretty
good risk/reward.

00:04:15.550 --> 00:04:17.670
Depending on how you weight
these probabilities.

00:04:17.670 --> 00:04:19.630
But a lot of people, if you
thought that there's an equal

00:04:19.630 --> 00:04:21.950
chance of this and this
happening, you

00:04:21.950 --> 00:04:23.010
would take this bet.

00:04:23.010 --> 00:04:27.090
If you had a 50% chance of
making five times your money,

00:04:27.090 --> 00:04:29.370
and only a 50% chance of
losing your money, the

00:04:29.370 --> 00:04:35.030
expected value here is, it would
be 0.5 times 25 plus 0.5

00:04:35.030 --> 00:04:36.240
times zero.

00:04:36.240 --> 00:04:39.170
It would be a $12
expected value.

00:04:39.170 --> 00:04:42.130
So I would pay $5 for something
that has a $12

00:04:42.130 --> 00:04:42.670
expected value.

00:04:42.670 --> 00:04:43.390
That's a great return.

00:04:43.390 --> 00:04:47.220
You're making 140%
on your money.

00:04:47.220 --> 00:04:49.710
You don't see returns
like that every day.

00:04:49.710 --> 00:04:52.840
Unfortunately, the probability
of these two things happening

00:04:52.840 --> 00:04:55.400
aren't equally likely.

00:04:55.400 --> 00:04:57.160
Because obviously right now, the
market's willing to only

00:04:57.160 --> 00:04:59.650
pay $30 for these things.

00:04:59.650 --> 00:05:03.580
The market, if they thought that
there was any chance that

00:05:03.580 --> 00:05:06.630
these things are worth more than
$60, any chance, they'd

00:05:06.630 --> 00:05:08.670
be trading at higher than $30.

00:05:08.670 --> 00:05:11.670
So given where the current
market is, before government

00:05:11.670 --> 00:05:16.410
intervention, clearly no-one
thinks that there's a really

00:05:16.410 --> 00:05:19.000
good chance of them
being worth $60.

00:05:19.000 --> 00:05:22.830
There's a much higher
probability of this scenario

00:05:22.830 --> 00:05:24.990
occurring than this.

00:05:24.990 --> 00:05:25.900
And you could do
a spreadsheet.

00:05:25.900 --> 00:05:27.400
And you could weight
the probabilities.

00:05:27.400 --> 00:05:29.450
And if you make this probability
high enough

00:05:29.450 --> 00:05:32.840
relative to this one, then of
course the expected value is

00:05:32.840 --> 00:05:33.980
still going to be
less than $5.

00:05:33.980 --> 00:05:35.580
You're still expected
to lose money.

00:05:35.580 --> 00:05:37.540
And so you might say, well,
who would do that?

00:05:37.540 --> 00:05:39.840
Even though Paul Krugman is out
there saying, you know,

00:05:39.840 --> 00:05:44.120
this is one of those heads
I win, tails you

00:05:44.120 --> 00:05:44.970
lose type of scenarios.

00:05:44.970 --> 00:05:46.100
And that is true.

00:05:46.100 --> 00:05:50.030
In the positive scenario, the
private investor makes the

00:05:50.030 --> 00:05:52.440
bulk of the money, alongside
the Treasury.

00:05:52.440 --> 00:05:55.120
With the Fed just getting a very
low interest rate back on

00:05:55.120 --> 00:05:56.010
this money.

00:05:56.010 --> 00:05:59.520
While in the negative scenario,
most of the hit is

00:05:59.520 --> 00:06:01.940
going to be taken by the Federal
Reserve with their

00:06:01.940 --> 00:06:04.870
loan, and then the Treasury
who's an equity investor

00:06:04.870 --> 00:06:06.530
alongside them.

00:06:06.530 --> 00:06:08.040
So that is one of these
things that Paul

00:06:08.040 --> 00:06:09.340
Krugman is talking about.

00:06:09.340 --> 00:06:11.960
But I'd say, that even if that,
an intelligent investor,

00:06:11.960 --> 00:06:15.120
just because the risk soon.
reward is disproportionately

00:06:15.120 --> 00:06:17.100
weighted to the other guy, they
still wouldn't want to

00:06:17.100 --> 00:06:19.910
invest it, if this is the
more likely scenario.

00:06:19.910 --> 00:06:22.320
So the question is, who
is going to do this?

00:06:22.320 --> 00:06:24.770
And this is what I mentioned
in the last

00:06:24.770 --> 00:06:26.860
video, could be troubling.

00:06:26.860 --> 00:06:29.560
The obvious thing is that the
banks might want to buy it

00:06:29.560 --> 00:06:30.810
from themselves.

00:06:30.810 --> 00:06:32.510
So let me redraw everything.

00:06:32.510 --> 00:06:34.300
Because this is an important
point to make.

00:06:34.300 --> 00:06:36.050
And frankly, I don't
know how you can

00:06:36.050 --> 00:06:37.830
prevent this from happening.

00:06:37.830 --> 00:06:41.480
If this version of Geithner's
plan ends up passing.

00:06:41.480 --> 00:06:45.800
So this is the bank's
balance sheet.

00:06:45.800 --> 00:06:47.480
Kind of their before
balance sheet.

00:06:50.300 --> 00:06:54.330
They paid $100 for
these assets.

00:06:54.330 --> 00:06:55.750
They owe $60.

00:06:55.750 --> 00:06:57.390
All liabilities, deposits,
whatever.

00:06:57.390 --> 00:07:00.460
And originally they have
$40 in equity.

00:07:00.460 --> 00:07:05.790
What the bank does is it takes
some extra money, and they

00:07:05.790 --> 00:07:07.940
could raise equity,
or for all we know

00:07:07.940 --> 00:07:08.760
they could raise money.

00:07:08.760 --> 00:07:11.200
I mean, the government is giving
them loans right now.

00:07:11.200 --> 00:07:12.910
This isn't fiction.

00:07:12.910 --> 00:07:21.200
So what you do is let's say
you borrow $7 from the

00:07:21.200 --> 00:07:22.550
government.

00:07:22.550 --> 00:07:23.360
And this is happening.

00:07:23.360 --> 00:07:27.500
I mean, the government is giving
loans to these major

00:07:27.500 --> 00:07:30.950
banks, to Citibank and Bank
of America, et cetera.

00:07:30.950 --> 00:07:33.960
And they'll get $7 of
cash right here.

00:07:36.460 --> 00:07:39.270
Now what the bank does is, they
create a separate entity.

00:07:39.270 --> 00:07:40.500
They can call it whatever
they want.

00:07:40.500 --> 00:07:42.920
They could put it in a hedge
fund to do this.

00:07:42.920 --> 00:07:44.850
I mean, banks are great.

00:07:44.850 --> 00:07:46.780
Special purpose entities
happen all the time.

00:07:46.780 --> 00:07:50.530
And there's nothing to stop a
bank from putting this $7 into

00:07:50.530 --> 00:07:51.780
another entity.

00:07:54.200 --> 00:07:55.820
Another special purpose
entity.

00:07:55.820 --> 00:07:58.330
Where the bank essentially
owns the equity.

00:07:58.330 --> 00:08:00.280
And this cash went to that.

00:08:00.280 --> 00:08:04.800
And then taking this $7
and using this to

00:08:04.800 --> 00:08:07.830
participate in the plan.

00:08:07.830 --> 00:08:09.060
In this new Geithner plan.

00:08:09.060 --> 00:08:11.550
So the bank takes that $7 that
they essentially might have

00:08:11.550 --> 00:08:13.170
just borrowed from
the government.

00:08:13.170 --> 00:08:17.060
Participates in the plan as
the private investor.

00:08:17.060 --> 00:08:18.440
And I'll put that in quotes.

00:08:18.440 --> 00:08:20.660
And they could put a bunch of
layers here and obfuscate it.

00:08:20.660 --> 00:08:23.760
Or even get one of their hedge
fund clients to do it, by

00:08:23.760 --> 00:08:25.480
giving them good terms
on something else.

00:08:25.480 --> 00:08:26.810
I mean, there's a million
and one ways you

00:08:26.810 --> 00:08:27.810
could set this up.

00:08:27.810 --> 00:08:30.610
And that's why I think it's
impossible to legislate

00:08:30.610 --> 00:08:33.059
around, or legislate
to prevent it.

00:08:33.059 --> 00:08:35.309
So they do that there.

00:08:35.309 --> 00:08:40.090
The Treasury will participate
side by side

00:08:40.090 --> 00:08:41.520
as an equity investor.

00:08:41.520 --> 00:08:45.660
And then they'll borrow $86
from the Federal Reserve.

00:08:50.490 --> 00:08:52.990
That's from the Treasury.

00:08:52.990 --> 00:08:54.010
And now the bank is

00:08:54.010 --> 00:08:55.610
essentially the private investor.

00:08:55.610 --> 00:08:57.100
They're controlling
this entity here.

00:08:57.100 --> 00:08:58.860
They're controlling entities
that control that entity.

00:08:58.860 --> 00:09:00.430
It doesn't matter.

00:09:00.430 --> 00:09:05.110
But they essentially set the
price for which this entity is

00:09:05.110 --> 00:09:08.060
going to pay for
its own assets.

00:09:08.060 --> 00:09:11.060
So they could pay $100
for this thing.

00:09:11.060 --> 00:09:13.650
Even though everyone knows that
these things are worth

00:09:13.650 --> 00:09:15.070
nowhere near $100.

00:09:15.070 --> 00:09:17.600
So they pay $100 for this.

00:09:17.600 --> 00:09:19.020
Take it off their
balance sheet.

00:09:19.020 --> 00:09:21.070
And then they're sitting
with $100 cash.

00:09:21.070 --> 00:09:23.740
And this is sitting there
with a toxic asset.

00:09:23.740 --> 00:09:25.200
And why would a bank do this?

00:09:25.200 --> 00:09:26.040
Well, think about it.

00:09:26.040 --> 00:09:29.010
In this reality, before any of
this happened, the banks had

00:09:29.010 --> 00:09:31.290
100% exposure to these
toxic assets.

00:09:31.290 --> 00:09:36.420
It had this whole thing right
here, it had exposure to.

00:09:36.420 --> 00:09:38.620
And for all we know, they're
only worth $30.

00:09:38.620 --> 00:09:41.400
But the bank never wanted
to accept that reality.

00:09:41.400 --> 00:09:43.030
While in this reality,
the bank only has

00:09:43.030 --> 00:09:44.480
$7 exposure to it.

00:09:44.480 --> 00:09:47.390
So even if this thing ends up
blowing up, who's going to

00:09:47.390 --> 00:09:48.350
take the loss?

00:09:48.350 --> 00:09:50.890
The bank's just going to
take a $7 loss here.

00:09:50.890 --> 00:09:52.390
And then the rest of the loss
is going to go to the

00:09:52.390 --> 00:09:54.810
taxpayer; the Treasury and
the Federal Reserve.

00:09:54.810 --> 00:09:56.260
So this is an awesome
situation.

00:09:56.260 --> 00:10:00.730
Because in this reality when
there was a hit, if this was

00:10:00.730 --> 00:10:04.270
worth $30 the bank would
have to take a $70 hit.

00:10:04.270 --> 00:10:07.690
While in this reality, if this
toxic asset now is only worth

00:10:07.690 --> 00:10:10.650
$30, the bank's only going
to take a $7 hit.

00:10:10.650 --> 00:10:13.210
And the bank is going
to stay solvent.

00:10:13.210 --> 00:10:17.220
So this investment right here
is going to be wiped out.

00:10:17.220 --> 00:10:19.640
But still, the bank
got $100 in cash.

00:10:19.640 --> 00:10:23.080
So my fear is, and frankly
since there's nothing to

00:10:23.080 --> 00:10:26.440
prevent it, it's almost a
self-fulfilling prophecy

00:10:26.440 --> 00:10:27.830
that's going to happen.

00:10:27.830 --> 00:10:30.420
You have this big question
mark, why would a private

00:10:30.420 --> 00:10:33.660
investor ever participate
in this?

00:10:33.660 --> 00:10:36.280
Even if the government is kind
of giving you more of the

00:10:36.280 --> 00:10:38.050
upside than the downside.

00:10:38.050 --> 00:10:39.510
You wouldn't participate in
it if you thought that the

00:10:39.510 --> 00:10:41.520
downside scenario
is more likely.

00:10:41.520 --> 00:10:44.520
But you would participate in
it, if you were the actual

00:10:44.520 --> 00:10:46.070
seller of the security.

00:10:46.070 --> 00:10:48.090
Because if you are the seller
of the security, you are

00:10:48.090 --> 00:10:54.700
Citibank, you're going from
100% exposure to only 7%

00:10:54.700 --> 00:10:56.960
exposure, and you're going
to be staying solvent.

00:10:56.960 --> 00:10:59.710
But the net effect of this is
that the Treasury and the

00:10:59.710 --> 00:11:03.970
Federal Reserve, they got
$100 for something.

00:11:03.970 --> 00:11:06.920
Or I guess, if you take
out the $7, they

00:11:06.920 --> 00:11:09.310
essentially got $93.

00:11:09.310 --> 00:11:11.810
Because they had to spend $7
to make this thing happen.

00:11:11.810 --> 00:11:13.100
But they got $100.

00:11:13.100 --> 00:11:19.990
So they got $93 for something
that's really worth $30.

00:11:19.990 --> 00:11:24.560
So the difference, the $63, it
essentially would be a check

00:11:24.560 --> 00:11:28.470
that's being written from the
U.S. taxpayer to these banks.

00:11:28.470 --> 00:11:30.050
And in the magnitude that
we're talking about, it

00:11:30.050 --> 00:11:31.650
wouldn't be a $63 check.

00:11:31.650 --> 00:11:35.020
It would be a $630
billion check.

00:11:35.020 --> 00:11:38.220
So to me, this would be kind
of the biggest travesty of

00:11:38.220 --> 00:11:39.190
capitalism.

00:11:39.190 --> 00:11:42.870
And it would be a sad day.

00:11:42.870 --> 00:11:45.900
It would frankly just make the
AIG bonuses look trivial.

00:11:45.900 --> 00:11:51.580
The right answer is, you take
that $630 billion, make the

00:11:51.580 --> 00:11:53.580
banks wipe out their
shareholders, and then you

00:11:53.580 --> 00:11:55.430
recapitalize the banks
with the money.

00:11:55.430 --> 00:11:59.920
And then you start, instead of
writing the $63 or the $630

00:11:59.920 --> 00:12:03.280
billion check directly to
the management and the

00:12:03.280 --> 00:12:06.370
shareholders who got us into
the mess, you essentially

00:12:06.370 --> 00:12:07.930
recapitalize the new banks.

00:12:07.930 --> 00:12:09.600
And I've written a paper
about that, and

00:12:09.600 --> 00:12:10.580
there's a new bank plan.

00:12:10.580 --> 00:12:12.270
And distribute the shares
to the American people.

00:12:12.270 --> 00:12:15.230
And you get the same effect
without this hugely negative

00:12:15.230 --> 00:12:19.400
repercussion of providing a huge
wealth transfer to the

00:12:19.400 --> 00:12:21.340
very same people who
got us in the mess.

00:12:21.340 --> 00:12:24.590
Anyway, I hope people kind of
get on this story, because

00:12:24.590 --> 00:12:26.260
it's got me pretty troubled.

00:12:26.260 --> 00:12:28.200
Anyway, see you


Geithner plan 1

WEBVTT
Kind: captions
Language: en

00:00:01.210 --> 00:00:04.550
We've got a few more details
today from Geithner and the

00:00:04.550 --> 00:00:06.310
Obama administration
about their plan

00:00:06.310 --> 00:00:08.380
for saving the banks.

00:00:08.380 --> 00:00:10.900
So I figured that this is a
good time to analyze what

00:00:10.900 --> 00:00:12.860
they're proposing, and see
if we can come to any

00:00:12.860 --> 00:00:13.800
conclusions.

00:00:13.800 --> 00:00:16.960
So, just to simplify the
original problem,

00:00:16.960 --> 00:00:17.880
you have some bank.

00:00:17.880 --> 00:00:20.900
Maybe it's Citibank
or somebody else.

00:00:20.900 --> 00:00:23.510
Let's say they have one big bad
asset that they originally

00:00:23.510 --> 00:00:26.020
paid $100 for.

00:00:26.020 --> 00:00:28.970
So that was the original book
value for the asset.

00:00:28.970 --> 00:00:30.140
And they were able to do that.

00:00:30.140 --> 00:00:32.130
And obviously these banks have
a bunch of assets, so I'm

00:00:32.130 --> 00:00:33.110
oversimplifying it.

00:00:33.110 --> 00:00:36.020
But I think it'll get you
the crux of the issue.

00:00:36.020 --> 00:00:41.610
They did that by-- obviously a
lot of them leveraged much

00:00:41.610 --> 00:00:47.530
more-- but let's say they
used $40 of equity.

00:00:47.530 --> 00:00:48.950
And then they borrowed
the remaining

00:00:48.950 --> 00:00:56.370
$60 to get that asset.

00:00:56.370 --> 00:00:59.100
And now of course, this
asset right here is

00:00:59.100 --> 00:01:01.640
backed by toxic mortgages.

00:01:01.640 --> 00:01:03.890
And it's the equity tranche
on these mortgages.

00:01:03.890 --> 00:01:07.710
And I encourage you to watch the
videos on collateralized

00:01:07.710 --> 00:01:09.990
debt obligations, and mortgage
backed securities.

00:01:09.990 --> 00:01:14.210
And even the whole thing, all
of the videos that we did on

00:01:14.210 --> 00:01:15.770
Paulson's original
bailout plan.

00:01:15.770 --> 00:01:18.020
Because I talk about all the
liquidity issues there.

00:01:18.020 --> 00:01:20.820
The bottom line is that some of
these debts are coming due

00:01:20.820 --> 00:01:21.760
for these banks.

00:01:21.760 --> 00:01:24.390
So they need to offload these
assets to get cash.

00:01:24.390 --> 00:01:29.040
And the whole problem here is,
if they offload these assets--

00:01:29.040 --> 00:01:31.900
let's say they know it's not
worth $100, dollars, right?

00:01:31.900 --> 00:01:34.200
Everyone knows it's really
not worth $100.

00:01:34.200 --> 00:01:36.710
But these banks don't want to
offload these assets for

00:01:36.710 --> 00:01:40.630
anything less than $60.

00:01:40.630 --> 00:01:43.430
Because if they offload these
assets for anything less than

00:01:43.430 --> 00:01:46.350
$60, then they have
negative equity.

00:01:46.350 --> 00:01:49.880
That means that the books values
here-- let's say if

00:01:49.880 --> 00:01:52.170
that was the only asset
they had, then you

00:01:52.170 --> 00:01:53.130
would have this situation.

00:01:53.130 --> 00:01:58.160
If they offloaded for 50 cents
on the dollar, then they're

00:01:58.160 --> 00:02:00.110
offloading it for $50.

00:02:00.110 --> 00:02:01.250
So you'd be with this reality.

00:02:01.250 --> 00:02:05.320
You would have $50.

00:02:05.320 --> 00:02:09.759
And you owe $60.

00:02:09.759 --> 00:02:11.450
So there's nothing left for the
equity, and in fact you

00:02:11.450 --> 00:02:13.730
would go into bankruptcy.

00:02:13.730 --> 00:02:15.330
You would be an insolvent
bank.

00:02:15.330 --> 00:02:17.130
So just to set the framework.

00:02:17.130 --> 00:02:20.690
There's a huge incentive why the
bank doesn't want to sell

00:02:20.690 --> 00:02:23.660
this asset for anything less
than 60 cents on the dollar.

00:02:23.660 --> 00:02:26.910
The problem is, the most that
anyone's willing to pay for it

00:02:26.910 --> 00:02:29.680
right now is not even the
60 cents on the dollar.

00:02:29.680 --> 00:02:32.010
People are just willing to pay--
I've read reports and it

00:02:32.010 --> 00:02:34.790
depends on what asset you're
looking at-- that people are

00:02:34.790 --> 00:02:35.990
willing to pay 30 cents.

00:02:35.990 --> 00:02:38.980
So let me write that down,
because it is important.

00:02:38.980 --> 00:02:40.270
This is what banks want.

00:02:43.870 --> 00:02:45.850
Greater than 60 cents
on the dollar.

00:02:45.850 --> 00:02:55.640
And in this case, it's
$100, so $60.

00:02:55.640 --> 00:02:58.440
My understanding is so far, for
the most part, without any

00:02:58.440 --> 00:03:01.420
government intervention, the
investors are willing to pay

00:03:01.420 --> 00:03:02.650
30 cents or less.

00:03:02.650 --> 00:03:03.680
So there's this disconnect.

00:03:03.680 --> 00:03:05.940
The bank's like, well I'm not
willing to sell this for

00:03:05.940 --> 00:03:08.810
anything less than 60 cents,
because then I'm insolvent and

00:03:08.810 --> 00:03:09.810
the gig's up.

00:03:09.810 --> 00:03:11.850
And investors are saying, well
these are toxic assets.

00:03:11.850 --> 00:03:13.620
Every day there's more
foreclosures.

00:03:13.620 --> 00:03:16.440
It's even hard to get good
documentation on what backs up

00:03:16.440 --> 00:03:17.100
these loans.

00:03:17.100 --> 00:03:19.540
A lot of these were
these NINJA loans.

00:03:19.540 --> 00:03:21.180
No income, no job loans.

00:03:21.180 --> 00:03:23.800
Or these liar loans, or stated
income loans, where people can

00:03:23.800 --> 00:03:25.460
just fill out with anything
they want.

00:03:25.460 --> 00:03:26.490
And there's all this fraud.

00:03:26.490 --> 00:03:29.070
So people are discounting a lot
of risk into these assets.

00:03:29.070 --> 00:03:31.080
So essentially, the market
isn't functioning.

00:03:31.080 --> 00:03:33.950
The buyer's willingness to pay
is much slower than the

00:03:33.950 --> 00:03:35.145
seller's willingness to sell.

00:03:35.145 --> 00:03:36.220
And nothing happens.

00:03:36.220 --> 00:03:39.820
And so, these toxic assets are,
you could say, clogging

00:03:39.820 --> 00:03:40.470
up the system.

00:03:40.470 --> 00:03:43.420
Because the banks, I won't say
that they can't sell them.

00:03:43.420 --> 00:03:45.000
It's just they're not willing
to sell them.

00:03:45.000 --> 00:03:48.330
Because if they were willing
to sell them at the market

00:03:48.330 --> 00:03:51.140
price-- whether or not you agree
with this market price--

00:03:51.140 --> 00:03:53.110
the banks will be bankrupt.

00:03:53.110 --> 00:03:56.070
So the government all along
has been trying to come up

00:03:56.070 --> 00:04:01.670
with different iterations of how
can we somehow get these

00:04:01.670 --> 00:04:05.160
assets off the banks' balance
sheets without causing the

00:04:05.160 --> 00:04:06.310
banks to get insolvent?

00:04:06.310 --> 00:04:09.600
And the original version of TARP
1 is that the government

00:04:09.600 --> 00:04:12.720
will essentially buy these
assets for, who knows, 70

00:04:12.720 --> 00:04:14.630
cents on the dollar.

00:04:14.630 --> 00:04:17.870
And in that reality, if you
bought those assets for 70

00:04:17.870 --> 00:04:20.540
cents on the dollar,
then those assets,

00:04:20.540 --> 00:04:23.350
you'd have $70 here.

00:04:23.350 --> 00:04:26.810
The bank would owe $60.

00:04:26.810 --> 00:04:28.800
And there would still be a
little bit left of equity.

00:04:28.800 --> 00:04:30.110
There would be $10 left.

00:04:30.110 --> 00:04:32.920
But the important thing is that
the bank would be able to

00:04:32.920 --> 00:04:37.785
pay off its liabilities, stay
liquid, and then be around for

00:04:37.785 --> 00:04:39.730
a better day or a better
economy, where it could grow

00:04:39.730 --> 00:04:42.180
the equity base again by
investing in all of that.

00:04:42.180 --> 00:04:43.930
And everyone realized
that the TARP was a

00:04:43.930 --> 00:04:45.090
fraud on some level.

00:04:45.090 --> 00:04:48.950
Because when you do that, if the
market price really is 30

00:04:48.950 --> 00:04:51.630
cents on the dollar, and
you're paying 70 cents.

00:04:51.630 --> 00:04:52.890
Let me say, if this TARP 1.

00:04:56.760 --> 00:05:02.040
And the government pays 70
cents on the dollar.

00:05:02.040 --> 00:05:04.480
The government's overpaying
by 40 cents on the dollar.

00:05:04.480 --> 00:05:07.790
In this case, the government
would be writing a $40 check

00:05:07.790 --> 00:05:09.110
to the owners of this company.

00:05:09.110 --> 00:05:11.920
In this case, the
stockholders.

00:05:11.920 --> 00:05:14.590
And these are the very same
people the management and the

00:05:14.590 --> 00:05:16.060
original investors in a lot
of these companies.

00:05:16.060 --> 00:05:18.100
These are the very same people
who got us into this mess.

00:05:18.100 --> 00:05:20.750
And why should we be rewriting
them billions of dollars of

00:05:20.750 --> 00:05:22.740
checks to essentially
just bail them out.

00:05:22.740 --> 00:05:23.610
Why don't you just
take them into

00:05:23.610 --> 00:05:25.010
receivership and all that?

00:05:25.010 --> 00:05:26.380
And I'll do other
videos on that.

00:05:26.380 --> 00:05:29.560
So the new iteration that has
come about-- and let me scroll

00:05:29.560 --> 00:05:33.710
down a little bit-- is, and
let me draw the original

00:05:33.710 --> 00:05:34.960
circumstance.

00:05:36.900 --> 00:05:40.020
So you have this item
here that was

00:05:40.020 --> 00:05:42.490
originally paid for $100.

00:05:42.490 --> 00:05:48.310
They borrowed $60 to
purchase them.

00:05:48.310 --> 00:05:52.030
And then they have
$40 of equity.

00:05:52.030 --> 00:05:57.040
The new plan is, the
government's saying, you're

00:05:57.040 --> 00:05:59.660
right, taxpayer.

00:05:59.660 --> 00:06:01.910
We as a government, we're not
in a position to decide what

00:06:01.910 --> 00:06:03.180
things are worth.

00:06:03.180 --> 00:06:05.790
We're not hedge fund managers
or mutual fund managers.

00:06:05.790 --> 00:06:07.550
We're just bureaucrats.

00:06:07.550 --> 00:06:08.580
And you're right.

00:06:08.580 --> 00:06:10.930
We would probably just end
up overpaying for things.

00:06:10.930 --> 00:06:12.420
Because these guys are smart.

00:06:12.420 --> 00:06:14.810
And if they're not willing to
pay more than 30 cents, and

00:06:14.810 --> 00:06:17.310
we're paying 70, we're
overpaying, and it's just a

00:06:17.310 --> 00:06:19.280
big subsidy from the taxpayer.

00:06:19.280 --> 00:06:21.610
So the new Geithner plan is
saying, hey we're going to

00:06:21.610 --> 00:06:26.770
partner with the private
investors.

00:06:26.770 --> 00:06:29.563
And the way they're suggesting
they do that, is that let's

00:06:29.563 --> 00:06:31.200
say a private investor-- and
these are numbers that I've

00:06:31.200 --> 00:06:33.550
been reading in some of the
newspaper reports, and the

00:06:33.550 --> 00:06:36.930
numbers might change over time
because they do tend to.

00:06:36.930 --> 00:06:42.810
But private investors will
contribute, say, $7.

00:06:46.510 --> 00:06:50.400
This is from private
investors.

00:06:50.400 --> 00:06:55.660
The Treasury will contribute
another-- let me make another

00:06:55.660 --> 00:06:57.980
box-- will kind of match
that investment

00:06:57.980 --> 00:06:59.130
by the private investors.

00:06:59.130 --> 00:07:02.170
So the Treasury will contribute
another $7.

00:07:07.310 --> 00:07:10.850
And then the Fed is going
to lend the balance.

00:07:10.850 --> 00:07:12.900
So the Fed-- let's see, if you
want to get to $100, that's

00:07:12.900 --> 00:07:16.872
$14-- so the Fed has
to lend $86.

00:07:16.872 --> 00:07:18.440
Let me draw a box here.

00:07:23.600 --> 00:07:25.040
It's going to look something
like that.

00:07:28.030 --> 00:07:30.460
So that's $86.

00:07:30.460 --> 00:07:31.710
from the Fed.

00:07:34.340 --> 00:07:36.790
And of course, this entity,
when it's originally

00:07:36.790 --> 00:07:42.150
capitalized, is going to be
sitting on $100 cash.

00:07:42.150 --> 00:07:44.880
That's its assets.

00:07:44.880 --> 00:07:47.100
Well I'm saying it
has $100 of cash.

00:07:47.100 --> 00:07:49.090
It could be something less, but
let's say this is what it

00:07:49.090 --> 00:07:50.590
originally sets out to be.

00:07:50.590 --> 00:07:52.840
Fed lent $86.

00:07:52.840 --> 00:07:54.640
This is a loan.

00:07:54.640 --> 00:07:58.120
The Treasury made a direct
equity investment of $7.

00:07:58.120 --> 00:08:02.030
And private investors make a
direct investment of $7.

00:08:02.030 --> 00:08:06.630
And then this entity can then
go and buy these assets.

00:08:06.630 --> 00:08:09.140
And what the government-- at
least my reading of it is-- is

00:08:09.140 --> 00:08:12.170
that the private investors are
going to set the price.

00:08:12.170 --> 00:08:14.730
So the private investors are
going to say, you know what?

00:08:14.730 --> 00:08:18.870
I think that this thing right
here is worth, I don't know, I

00:08:18.870 --> 00:08:21.740
think it's worth 70 cents
on the dollar.

00:08:21.740 --> 00:08:23.510
And let's say that they
are the winning bid.

00:08:23.510 --> 00:08:26.490
They are the people willing to
pay the most. Because that's

00:08:26.490 --> 00:08:27.060
my reading.

00:08:27.060 --> 00:08:28.100
Is that there will
be an auction.

00:08:28.100 --> 00:08:31.010
And the private investor, in
partnership with the Treasury

00:08:31.010 --> 00:08:33.230
that's willing to pay the most,
will get the assets.

00:08:33.230 --> 00:08:39.789
So that in that case-- let's say
they decide to pay $100,

00:08:39.789 --> 00:08:40.770
just to make the math easy.

00:08:40.770 --> 00:08:44.790
So then this cash will
go to this bank.

00:08:44.790 --> 00:08:49.350
So then they'll have
$100 of cash.

00:08:49.350 --> 00:08:51.590
So then we'll have the toxic
asset sitting here.

00:08:56.530 --> 00:08:58.850
And you might say, hey
Sal, that's crazy.

00:08:58.850 --> 00:09:00.270
Why would a private
investor do that?

00:09:00.270 --> 00:09:01.260
And you're right.

00:09:01.260 --> 00:09:03.890
I mean, in a lot of
circumstances, they obviously

00:09:03.890 --> 00:09:04.315
wouldn't pay.

00:09:04.315 --> 00:09:06.410
Actually, because of that, let
me not make $100 the number.

00:09:06.410 --> 00:09:10.365
Let's say that they
pay $60 for it.

00:09:10.365 --> 00:09:13.180
Because, remember, the banks
weren't even willing to part

00:09:13.180 --> 00:09:14.750
with them for less than $60.

00:09:14.750 --> 00:09:17.100
So for this to even work,
someone's going to have to pay

00:09:17.100 --> 00:09:18.900
at least $60 for this thing.

00:09:18.900 --> 00:09:21.270
So let's say they
pay $60 for it.

00:09:21.270 --> 00:09:22.520
And then they get the asset.

00:09:22.520 --> 00:09:24.500
And they're going to
have $40 left over.

00:09:24.500 --> 00:09:27.920
So they have toxic asset, and
then they're going to have $40

00:09:27.920 --> 00:09:30.860
left over, because they only
paid $60 for the security.

00:09:30.860 --> 00:09:31.740
The way I set it up.

00:09:31.740 --> 00:09:38.940
Although, they probably designed
this thing so there

00:09:38.940 --> 00:09:39.870
isn't any cash left over.

00:09:39.870 --> 00:09:42.970
But let's just use these
numbers for the sake of

00:09:42.970 --> 00:09:44.310
convenience.

00:09:44.310 --> 00:09:46.200
So now, you might say,
well, this was good.

00:09:46.200 --> 00:09:50.540
The private investors, they made
an educated decision, and

00:09:50.540 --> 00:09:52.540
they've decided to price
these things at 60

00:09:52.540 --> 00:09:53.130
cents on the dollar.

00:09:53.130 --> 00:09:57.510
And my question to you is, why
would these same people who,

00:09:57.510 --> 00:10:00.370
before this plan, weren't
willing to pay any more than

00:10:00.370 --> 00:10:04.370
30 cents on the dollar, now
be willing to pay 60

00:10:04.370 --> 00:10:05.320
cents on the dollar?

00:10:05.320 --> 00:10:08.490
Now they're willing to pay
this much for the asset.

00:10:08.490 --> 00:10:10.310
And there's a couple
of answers here.

00:10:10.310 --> 00:10:13.980
I mean, the kind of naive answer
is that the government

00:10:13.980 --> 00:10:15.060
takes the first hit.

00:10:15.060 --> 00:10:18.710
Or if these things end
up being worth 30

00:10:18.710 --> 00:10:19.480
cents on the dollar.

00:10:19.480 --> 00:10:21.840
Let's say that we go to some
future state, and these really

00:10:21.840 --> 00:10:25.080
are worth only 30 cents, the
most that the private investor

00:10:25.080 --> 00:10:28.270
loses in this situation
is his $7.

00:10:28.270 --> 00:10:30.910
The rest of the loss is
going to be borne by

00:10:30.910 --> 00:10:32.200
the Fed and the Treasury.

00:10:32.200 --> 00:10:34.090
This loan by the Federal
Reserve is a

00:10:34.090 --> 00:10:35.710
non-recourse loan.

00:10:35.710 --> 00:10:39.060
Which means that, if for
whatever reason this entity

00:10:39.060 --> 00:10:43.030
can't pay back the loan, the
lender-- which is in this case

00:10:43.030 --> 00:10:45.190
the Fed --can't go after
the equity holders.

00:10:45.190 --> 00:10:47.480
All the lender can do
is take the asset.

00:10:47.480 --> 00:10:50.460
So if this asset is worth
nothing, the Fed, all it can

00:10:50.460 --> 00:10:52.590
do is just take the asset, and
essentially it's going to get

00:10:52.590 --> 00:10:54.090
nothing back for its loan.

00:10:54.090 --> 00:10:56.420
So in this situation, the
private investor would get all

00:10:56.420 --> 00:10:58.070
of the upside.

00:10:58.070 --> 00:11:01.870
If this thing that they paid $60
for ends up being worth,

00:11:01.870 --> 00:11:05.410
let's say it ends up being
worth-- I'll draw it down here

00:11:05.410 --> 00:11:07.850
because it's all going to the
equity holder-- if that asset

00:11:07.850 --> 00:11:11.470
they paid $60 for, it if it ends
up being worth $80 then

00:11:11.470 --> 00:11:16.200
that extra $20 of value is
going to be split by the

00:11:16.200 --> 00:11:18.940
Treasury and the private
investor.

00:11:18.940 --> 00:11:20.300
So let me give you
that situation.

00:11:20.300 --> 00:11:22.020
So what would the balance
sheet look like?

00:11:22.020 --> 00:11:23.150
They pay $60 now.

00:11:23.150 --> 00:11:28.510
All of a sudden that
asset is worth $80.

00:11:28.510 --> 00:11:30.345
So this is a good scenario,
an upside scenario.

00:11:30.345 --> 00:11:32.720
Remember, we had $40 left over
in cash, just based on the way

00:11:32.720 --> 00:11:34.730
I had originally set it up.

00:11:34.730 --> 00:11:44.160
You owe $86 to the Fed, the
Federal Reserve, which is

00:11:44.160 --> 00:11:46.820
officially separate from the
Treasury, separate entity.

00:11:46.820 --> 00:11:50.560
And then the equity is split
between the Treasury and the

00:11:50.560 --> 00:11:52.230
private investor.

00:11:52.230 --> 00:11:53.920
So how much equity is there?

00:11:53.920 --> 00:11:57.920
You have $120 here minus
$86 So you have

00:11:57.920 --> 00:12:01.560
$34 of equity, right?

00:12:01.560 --> 00:12:05.740
Because you have $6 more here,
so this is $34 of equity.

00:12:05.740 --> 00:12:09.310
And it's going to be split
50-50, so it's going to be $17

00:12:09.310 --> 00:12:12.010
for the private investor.

00:12:12.010 --> 00:12:14.450
And then you have $17
for the Treasury.

00:12:14.450 --> 00:12:15.280
And this looks great.

00:12:15.280 --> 00:12:17.860
In this situation, the private
investor's original

00:12:17.860 --> 00:12:19.380
investment was $7.

00:12:19.380 --> 00:12:22.630
And it went to $17.

00:12:22.630 --> 00:12:24.900
So it's got a huge return
on investment.

00:12:24.900 --> 00:12:26.490
So this is the positive
scenario.

00:12:26.490 --> 00:12:30.780
And then the negative scenario,
where let's say that

00:12:30.780 --> 00:12:37.050
original investment actually
ends up being worth $30.

00:12:37.050 --> 00:12:42.720
Remember they had $40 of cash
in the way I set it up.

00:12:42.720 --> 00:12:44.600
Now all of a sudden the Federal
Reserve, you had a

00:12:44.600 --> 00:12:48.270
loan from the Fed for $86.

00:12:48.270 --> 00:12:50.740
Now your assets are worth less
than your liabilities.

00:12:50.740 --> 00:12:53.330
Your equity is wiped
out, right?

00:12:53.330 --> 00:12:59.150
So in this bad situation, the
private investor invested $7,

00:12:59.150 --> 00:13:01.930
and it went to zero.

00:13:01.930 --> 00:13:04.070
So this doesn't actually look
like that bad of a scenario.

00:13:04.070 --> 00:13:10.600
That in an up case, you go from
$7 to $17, And in a bad

00:13:10.600 --> 00:13:13.920
case, you go from $7
to zero dollars.

00:13:13.920 --> 00:13:15.690
And actually, this could be
magnified a lot more,

00:13:15.690 --> 00:13:17.460
depending on how these
things work out.

00:13:17.460 --> 00:13:20.310
But this still begs the
question, if an investor

00:13:20.310 --> 00:13:26.690
really thinks that these things
are worth 30 cents, and

00:13:26.690 --> 00:13:29.470
that there's no chance that
they're worth more than 60

00:13:29.470 --> 00:13:33.260
cents, even though they
disproportionately can

00:13:33.260 --> 00:13:35.210
participate in the upside,
relative to the downside,

00:13:35.210 --> 00:13:37.250
which I think in of
itself is wrong.

00:13:37.250 --> 00:13:40.215
That the government shouldn't be
subsidizing hedge funds and

00:13:40.215 --> 00:13:41.510
other private investors.

00:13:41.510 --> 00:13:44.360
But if they really thought that
the value was closer to

00:13:44.360 --> 00:13:48.120
30 than to 60, then the question
is, why would they

00:13:48.120 --> 00:13:48.910
participate at all?

00:13:48.910 --> 00:13:51.190
I mean, if you know you're
going to lose money, you

00:13:51.190 --> 00:13:52.710
shouldn't do it to begin with.

00:13:52.710 --> 00:13:54.140
And I realize I've
run out of time.

00:13:54.140 --> 00:13:55.600
I'm going to cover that
in the next video.

00:13:55.600 --> 00:13:58.140
And to some degree,
the next video

00:13:58.140 --> 00:13:59.426
you might find troubling.

00:13:59.426 --> 00:14:00.676
See you soon.