As an addition to the blog post before I have some statistics on the amount of derivative currently in the market place.
Before the huge mortgage back derivative market of the 2000's the derivative market was averaging $80 trillion. The housing bubble drove the derivative market up to $600 trillion. It is estimated that about 60-75% of these derivatives are now worthless meaning we have about 400 trillion in derivative losses on paper. Now if that dont tell you $700 Billion wont do anything I dont know what to tell you, even if banks only hold 1/4 of these losses that $700 billion is just a bandaid on a huge deep wound.
MARKETJEDI
Thursday, October 2, 2008
Complexity of the Situation- Part 1.
I got a request today to explain what is going on in the Banking industry and where we stand as regular citizens in the equation. Well here it goes!!!!!
Firstly, many factors are at work here, some good and some bad, some easily explained and some rather complex in nature without going off on a scholastic tangent.
Personally I 'THINK' the credit crisis is mainly due to the banks lack of knowledge on what is on their books. Banks especially Investment banks were mainly pushing papers off as assets in the past years especially in the derivatives market. Today they find themselves scavenging through their books to valuate what these papers are now currently worth much linked to mortgages. In a desperate move by most banks to try and sure up their balance sheets they have currently cut off credit, some will ask why? as it is the banks' business to lend monies, I say yes and no. In the past few years banks have changed their core business model to mostly offering services, investing their own capital and acting as brokerage to wealth individuals. The model basically utilized their market capitalization into leverage (borrowed funds) to make money (profit). When this model stop working recently the leverage bit them where it hurts the most: their capitalization. As market forces drove their stock prices down their capitalization fell faster than they anticipated due to their high leverage they consequently had to go into the market to raise capital to sure up their books.
Leverage can be good and bad. Obviously it works great when you are right but when you are wrong it can be your demise as can be seen in the late Bear Sterns, Lehman etc.
Today the banks are so used to making money through leverage and advisory services, that they have forgotten the basics of banking and therefore don't understand the economic implications of their actions of not freeing up credit in the market. Today's credit crunch is solely to blame on the BANKS. The banks are the providers of capital and credit in the marketplace and their current actions of limiting funds have not only worked against them where depositors withdraw funds, essentially forcing a run on some banks but also has have the effect of decreased value of their stock and thus market capitalization.
The current $700Billion if passed wont have much effect if the Banks DONT start lending and grease the wheels of the economy again. The Banks are the root of the current economic problem and not the politicians who have no idea of economics in a more macro global sense.
Somethings have gotten me scared when it comes to the market and I will explain. Warren Buffet investment in Goldman and General Electric will go down in history as one of the greatest investments ever made in the markets. The two investments virtually have no negative implications for Buffet as he will get 10% per annum on his investment but if that's not good enough, he also has warrants to buy stock at a predetermined price, just an awesome deal all around. On the opposite side of the coin we have to look at the 10% being charged carefully. GE and Goldman Sachs paying so much for capital tells me no one is lending funds and capital has dried up for american corporations. GE paying 10% is like someone with perfect credit getting a mortgage for 15% in the current market for comparison. Capital is scare for us in America because all of the money is in China, Germany, Saudi Arabia, Russia and Japan, YEP America is broke on paper YES it is but I digress.
The FED has been pumping money into the system for the last 20 months and we are getting deeper and deeper into a credit crisis why??? Again it is SIMPLE, those injected funds are doing nothing but paying off for the leveraged losses of the banks, think of it like this: If you are heavily in debt, lets say 40k and you inherit a 60K cash windfall you are only 20K richer, that's exactly what is happening to the influx of money into the money supply by the FED. The FED is pannicking to say the least here! This past monday the FED injected $500 Billion into the system as the first voting of the Bill for $700 Billion failed. Imagine that! the FED injection of $500Billion SHOULD have some effect comparable to the $700Billion but it DIDN'T, this is SCARY!!!!!
Part 2 This weekend.
MARKETJEDI
Firstly, many factors are at work here, some good and some bad, some easily explained and some rather complex in nature without going off on a scholastic tangent.
Personally I 'THINK' the credit crisis is mainly due to the banks lack of knowledge on what is on their books. Banks especially Investment banks were mainly pushing papers off as assets in the past years especially in the derivatives market. Today they find themselves scavenging through their books to valuate what these papers are now currently worth much linked to mortgages. In a desperate move by most banks to try and sure up their balance sheets they have currently cut off credit, some will ask why? as it is the banks' business to lend monies, I say yes and no. In the past few years banks have changed their core business model to mostly offering services, investing their own capital and acting as brokerage to wealth individuals. The model basically utilized their market capitalization into leverage (borrowed funds) to make money (profit). When this model stop working recently the leverage bit them where it hurts the most: their capitalization. As market forces drove their stock prices down their capitalization fell faster than they anticipated due to their high leverage they consequently had to go into the market to raise capital to sure up their books.
Leverage can be good and bad. Obviously it works great when you are right but when you are wrong it can be your demise as can be seen in the late Bear Sterns, Lehman etc.
Today the banks are so used to making money through leverage and advisory services, that they have forgotten the basics of banking and therefore don't understand the economic implications of their actions of not freeing up credit in the market. Today's credit crunch is solely to blame on the BANKS. The banks are the providers of capital and credit in the marketplace and their current actions of limiting funds have not only worked against them where depositors withdraw funds, essentially forcing a run on some banks but also has have the effect of decreased value of their stock and thus market capitalization.
The current $700Billion if passed wont have much effect if the Banks DONT start lending and grease the wheels of the economy again. The Banks are the root of the current economic problem and not the politicians who have no idea of economics in a more macro global sense.
Somethings have gotten me scared when it comes to the market and I will explain. Warren Buffet investment in Goldman and General Electric will go down in history as one of the greatest investments ever made in the markets. The two investments virtually have no negative implications for Buffet as he will get 10% per annum on his investment but if that's not good enough, he also has warrants to buy stock at a predetermined price, just an awesome deal all around. On the opposite side of the coin we have to look at the 10% being charged carefully. GE and Goldman Sachs paying so much for capital tells me no one is lending funds and capital has dried up for american corporations. GE paying 10% is like someone with perfect credit getting a mortgage for 15% in the current market for comparison. Capital is scare for us in America because all of the money is in China, Germany, Saudi Arabia, Russia and Japan, YEP America is broke on paper YES it is but I digress.
The FED has been pumping money into the system for the last 20 months and we are getting deeper and deeper into a credit crisis why??? Again it is SIMPLE, those injected funds are doing nothing but paying off for the leveraged losses of the banks, think of it like this: If you are heavily in debt, lets say 40k and you inherit a 60K cash windfall you are only 20K richer, that's exactly what is happening to the influx of money into the money supply by the FED. The FED is pannicking to say the least here! This past monday the FED injected $500 Billion into the system as the first voting of the Bill for $700 Billion failed. Imagine that! the FED injection of $500Billion SHOULD have some effect comparable to the $700Billion but it DIDN'T, this is SCARY!!!!!
Part 2 This weekend.
MARKETJEDI
Subscribe to:
Posts (Atom)
