Be a bank to be bailed out

One of my team members asked an intriguing question last week – why is the federal government bailout been given only to those Banks and Investment Banks, but not for automobiles sector? Sounds logical; if we look internally, both Banks and Auto companies are asking for bailout plans, not to offer new products or new system; they just want to pay off the debts and payments. GM alone needs $10 billion to pay for its bills and another $6 billion to run its plant.

Let’s have a countering view for Banks and Autos.

The banks have collapsed just because of the greedy Investment bankers, who engineered and re engineered the whole Sub Prime papers and are now highly paid in the system.

The Automobile makers did not do any bad investment, but was just hit by the lowered demand which can even be attributed to those Investment bankers, who literally drained up the money.

The Big Three automobile manufacturers (General Motors, Ford and Chrysler) directly employ about 240,000 people. But each car makers has their own suppliers and small component suppliers who supply parts only to these companies. (Recently you would have heard the news of suppliers also moved out of Singur, once TATAs pulled out.) A recent survey shows around 4000 medium or Tier 1 supplier units employ around 974,000 people.

Let’s have a quick economics here.

Total automobile & related activity workers – 1.2 million

Now to take care the needs of any individual the society needs Doctors, lawyers, Groceries, Shopping, Entertainment, hotels, tourism, FMCG, clothing companies and everything.

So, as a whole, indirectly another million people will be dependent on these 1.2 million workers.

Add to them their family members. As an average let us take there is at least one dependant on every employed person. (If it is India, it would be a huge multiple factorJ ), so we get another 2.4 million.

So if GM/Chrysler/Ford file for bankruptcy, around 5 million people will be left with no source of income.

But the same time, the Investment bankers are very less in number (might be, that’s what they make it their USP). Their bank going bankrupt and they getting their jobs axed will not affect a large group of people, and even schools have taught us that Thou sinners shall be punished. J

 

But on the other side, if banks collapse, the impact will be very high in all parts of the economy.

1)     First, the depositors/Investors will lose money.

2)     There will not be any source of lending for any company /Industry to run. It means all industries to get locked down and follow bankruptcy route along with banks.

Think of a situation, you need a lac of rupee for an urgent requirement, but there is no lender. Your stomach feels cramping? That is what will happen if banks are not saved from bankruptcy, in any economy and particularly in US where there is negligible household savings.

Yes, when, these automobile companies are filing for bankruptcy, there will be a huge blow on the salaried middle class sector, which forms huge proportions of the society, also the retirees of the auto companies. Their retirement benefits would go in for a toss from the contribution to be made by the companies (but would be covered by Pension Benefit Guarantee Corp).

Even if the government bails out the auto majors, they will still be forced to do the restructuring. Cutting down costs, shutting down few plants and lots of job losses. Also the bailout comes from none other than taxpayer’s money, which will be splashed at the cost of their prosperity. That’s why the government is still hesitant to bailout Auto mobile companies because spending Tax payers money for a bank will yield more productivity in terms of Money supply, industrial activity and in turn consumer spending. But putting taxpayer’s money into auto companies will not increase the demand of the cars nor will it boost the consumer spending and economic turnaround. It might save the jobs for another three or four months for the companies to restructure their plans and plants, but again for the automobile companies to flourish, there need to be a demand created in the market, which could only be driven by banks.

It is just like what Edward Lorentz[1] had perceived, the near bankruptcy levels of GM or Chrysler might have been caused by the guy who lived in the 3^rd street of a  remote area in San Antonio, and featured in the list of defaulters by WaMu bank[2].

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[1] Edward Lorentz- Father of Chaos Theory and Butterfly Effect.

[2] WaMu- Washington Mutual- A Leading Mortgage lender, and off late bailed out by JP Morgan Chase.

Sub Prime Crisis- Part 4

 

 

 

 

 

 

Now, fit all these incidents in one line,

 

 

 

 

House owner (Borrower) ——– Bank/Mortgage lender (e.g.; Fannie/Freddie) ———–sells loans———Investment Bank (e.g.: Lehman Bros) ——— Securitization——– Reengineered products——- MBS———Insurer (e.g.: AIG / other I banks) —————Credit Default Swaps————Investors (again Banks/HNI’s/Institutions)

 

So, as the real estate prices are dropping down and, when the home owner and his fellas stops paying their loan dues, the loans which they took are now worthless in the hands of the bank, and indirectly, the securitized MBS/ABS issued by I banks and the bonds issued by them from the pool of already junk bonds will be meaningless or in financial parlance, loses ground and depreciates in value overnight. Now, as we already saw, the leverage that the I Banks have taken, will bankrupt them once the bonds declines in value. Now the banks and HNI’s and other Institutions which has subscribed to the bonds issued by I Banks will approach the Insurer. The insurer also will not have enough assets to cover all the losses, since the CDS issued by him is also equally worthless. Now it’s their turn to file for chapter 11 or 7.

Bailout Plans:

·         As the US government has got the $700 billion bailout bill passed in the senate, the bill lets the government spend billions of dollars to buy bad mortgage-related securities and other devalued assets held by troubled financial institutions.

·         The institutions which got bailed out will get money for the bonds (MBS/ABS of Sub Prime Securities) of zero value which they hold now. So, from the money which they collected from Government, they can revive their business and can have a better liquidity.

·         The bailout plan passes the money to the Financial Institutions in trenches only.

·         The Bailout does not mean that the tax payer’s money is given free. The Federal Government will receive convertible warrants, which they can convert it to shares if the company is doing well or it can get the coupon back in the stipulated period of time.

·         Also the Bailout packages announced for AIG, will hand over the Controlling state with the government.

Alas, we forgot about the banks who has subscribed to the entire senior, mezzanine or any other superlatively nomenclature bonds. Now the only option or cushion left with them is to merge with the biggies at a throwaway price or can run behind the Fed’s secretaries and Congressmen to Bail them out and if they are lucky enough to have their ex-boss as the chairman of Treasury, They can survive. Back home in India, you can compare the miniscule losses of 0.1% in comparison with your total book size, in a press meet and assure the investors along with SEBI Chairman, just putting back the real value of that 0.1%  loss is equal to that of nearly 460 Crores of Public Money.

 

                                                           

-Desire is the root cause of all evil – Gautama Buddha, Founder, and Preacher-Buddhism.

 

Sub Prime Crisis-Part 3:- Investment Banks/Bankers

The News channels and public, now scream at these guys as ‘Devils in disguise’, whom they unanimously hailed as the ‘Financial Messiahs’ a year back.  They were awarded by their bosses and markets for their Sheer Innovativeness in the financial markets. The last decade saw a wide range of products, tailored (Structured in their parlance) for every conditions or outcome of the market. Just imagine, what would have happened, if they see a vast, trillion dollar opportunity, lying untouched or handled the traditional way…yeah, what now we call as Subprime Crisis, is the financial reengineered child of these I bankers.

 

Step 1: Investment Banks purchase the Mortgage loans from Banks/Lenders

Step 2:  Segregate them into different types and rate them.

Step 3: Making these loans as underlying assets, created Derivatives

Step 4: Insure all the Instruments according to the rating, with an insurer

Step 5: The Insurer creates Credit Default Swaps (CDS) and sells it in the market.

Step 6: Investment Bank creates SPV’s (Special Purpose Vehicles) and holds all the unsold/high risky Sub Prime loans with them. These SPV’s will be their sister company, registered in Mauritius or some Island, where no questions are asked, and the parent company will invest its share capital/its clients money in the sister company.

Step 7: What else, every instrument created will be marketed well to the so called sophisticated Hedge funds, HNI’s, Corporate, Pension Funds, and even Banks in every nook and corner of the world, be it UK, Europe, Japan, and why not the conservative Indian Banks… (ICICI, SBI, AXIS bank  …)

 

Step8: All these papers a.k.a Sub Prime Mortgage Backed Securities/CDS are to be redeemed when the mortgage payments are received in full from the borrower. (If at all he pays…)