Welcome back. And I’ve made this balance
sheet so messy I think it would make sense to redraw it
cleaned up a little bit. So what’s our new balance sheet,
after we’ve unloaded a lot of those assets? All I have now, I have a little
bit of cash, let me write that down, I had
$1 billion of cash. I’ll write the ‘b’ there
so you know. And just so you know, a bank
needs cash to operate. It can’t just use all of its
cash to pay off things. Because then it won’t be able
to even transact with its customers, or pay its rent, or
send its executives on their Learjets, whatever
it needs to do. But anyway, you have
$1 billion of cash. So you might have been thinking,
why not just use its cash to unload some
of that debt? Well, you always have to keep
some cash on line just to conduct business. And actually, that’s called
working capital. But anyway, back to the
point of this video. So you have $1 billion
in cash. And at least the management of
this company thinks that it has $4 billion worth of
residential CDOs. And this is the toxic stuff
that’s the focus of this government bailout, which is
really historic in its proportions. And I’ll talk more
about that later. And on the liabilities
side, what was left? I think I had called
it Loan C. I’ll write liabilities in red,
just because they’re bad. They’re not bad, but they’re
something you owe, so they’re not as pleasant. So Loan C, we said
was $3 billion. And then what is the equity? I’ll do that in yellow. So the total assets were
$5 billion in assets. Total assets. You have $3 billion
in liabilities. So if you believe what the
accountants or the bank management has said about their
assets, if you wanted to just liquidate everything. If you had $5 billion in assets,
you liquidate them, got $5 billion, you paid off
your $3 billion in loans, you’d be left with $2 billion. So that’s the equity. And just as a reminder, how
many shares where there? I think I originally set in
the original video that we have 500 million shares. So each of those shares is one
500 millionth of this equity. So let’s see, the book value
per share is what? It’s going to be the book value,
$2 billion, divided by 500 million. So it’s $4. Remember, it was $6
not too long ago. But we had to take those
commercial mortgages that we thought were worth $10 billion,
actually ended up being worth $9 billion. So we lost $1 billion
of our book value. And $1 billion translates to
$2 of the share price. Anyway, fair enough. And maybe at this point the
market value of the share, so that’s essentially the stock
price if you were to look up this company’s ticker price,
let’s say it’s at $1. Because they’re like, boy, after
all this Bear Stearns and Lehman Brothers, this
is all getting a little nerve racking. And they have this shady
thing over here. So we have to be careful. So if the market value
is $1, what are they saying about the assets? Or what are they saying
about the equity? Well, what’s the market cap? It’s the share price times
the number of shares. So they’re saying essentially
that the market cap, and that’s equivalent to the market
value of the equity, or what the market thinks the
equity is worth, that’s $1 times 500 million shares. So it’s worth $500 million. Or $0.5 billion. So the market is actually
saying, no, you don’t have $2 billion of equity, you only have
half a billion of equity. And it’s probably because they
think this is worth a billion and a half left. But anyway, we’ll leave
that aside for now. But now we’re getting to
the crux of the issue. Two of those other loans, they
came due, no-one was willing to renew the loans, or
give them new loans. So the company had to liquidate
some of their assets in order to pay those
loans down. Now, this is the endgame. We have Loan C. And let’s say Loan
C comes due. So they say, things are really
shady, your assets they look very similar to Lehman Brothers
and Bear Stearns, we’re not going to
renew your loan. You go out to the credit
markets, you try to issue bonds, you try to do
anything you can. No-one’s willing to give you a
loan, just because they’re all a little bit scared. So what do you do? Well, you have to pay
$3 billion of loans. You just have to. Because no-one’s willing
to give you $3 billion. Well you say, out of this cash
I can’t use all of it. If I just wanted to operate
bare-bones, maybe I could give $0.5 billion in cash. But that’s not going to help
my situation at all. Because I still would have
$2.5 billion left. So you’re like, wow I’m in a
situation where I have to sell these CDOs. So now, all my models and all
my assumptions are going to see if they were even
vaguely accurate. If these things are really
worth $4 billion. So I go out there and I
try to sell my CDOs. I try to sell them for whatever
I can get for them, because I have to sell them. And one, there’s no
market for them. Because there’s a lot of people
who want to unload them, but there’s not
really anybody who’s keen on buying it. So there there might not
even be any market. But you’re like, no I
want to sell them. So you broadcast it out to every
hedge fund and private equity fund and every
bank out there. And you say, who wants
to buy my CDOs? And some private equity firm
comes and says, OK well, I think that those things are
pretty toxic, but they’re probably worth maybe
something. I’m pretty optimistic about
the real estate market. And maybe in 10 years they
might come back. So I’m willing to give you $1
billion for those CDOs. So essentially, what’s the
market price of something? It’s the best price that
someone’s willing to give you for something. So the market price of this,
because you’ve shopped it around, you’ve gone to the
market, you’ve gone to everyone you can, the market
price for this is, essentially, the market
is offering you $1 billion for this CDO. So what do you do? Well, if you sell it for
$1 billion, does that help your situation? If you sell this for $1 billion,
you get $1 billion here, you have $1 billion of
cash, you have a total of $2 billion, that still won’t
pay your loan. You’re still going
to be bankrupt. And even more, the company
management is very stubborn. They say, if I sell it I’m
going to go bankrupt. And I think that that’s some
kind of fire sale price, quote-unquote. That’s not the real price. All of a sudden for the first
time in my career when I was getting $30 million a year
bonuses, I heavily believed in the market. But now I’m in denial
of the market. I say, the only reason why I’m
only getting $1 billion for this is because everyone
is afraid. And these things, if someone
were to just hold them to maturity, if someone were to
just hold these assets for the 30 years over which the
underlying mortgages will just pay out, someone’s going to
collect roughly $4 billion. Or maybe at worst,
$3.5 billion. So I’m not going to do this. But really, you have
no choice. So what you try to do is you
say, well can someone give me some type of a loan? Just lend me some money in the
short term just so that I could get this paid off. And I’ll be willing to give
this as collateral. Collateral on a loan is you give
me a loan, and you take this as collateral, and if I
don’t pay the loan, you just keep the asset. And that’s essentially what
the Fed was doing. The Fed traditionally only
gives loans if you give something really nice as a
collateral, like treasuries, essentially just treasuries. And they’ll still take a
little discount of your collateral. Like if you give the Federal
Reserve $1 of treasuries, they might give you $0.80 of loans. But over this whole credit
crunch, the Fed has gotten looser and looser in terms of
what it’s willing to accept as collateral. So actually, the Fed, I don’t
know the details of how toxic of an asset they were willing
to take as collateral, but they started loosening it up
to pretty toxic assets. So maybe you could get a loan. But let’s just put that
aside right now. But this is the situation
we’re facing. You have a bank, and it’s
essentially being forced, or it perceives it, forced
into bankruptcy. Even though, it thinks that
it has positive equity. So you could get a loan from
the Fed or someone else if they’re willing to take this
kind of toxic stuff as collateral. Let’s assume that they’re
not for now. The other option is you
can recapitalize. You can get someone to
invest in the firm. You can sell equity in the firm
and get some more cash to pay off this loan. If you can convince someone that
no, your firm is really in the future going to
be worth a lot more. This is just a stressful
situation. So you go to some sovereign
wealth fund, and that’s just a way of saying some foreign
government that’s been collecting dollars because
they’ve been selling us oil or cheap manufactured goods. So you go those and say, look,
we are Goldman Brothers or we’re Lehman Sachs. We are this great brand in the
banking industry, wouldn’t you like to have a piece of this
thing that represents American capitalism? And they say sure, we’ll be
interested in investing. So they say, well the market
price is $1 and I think that’s probably a little distressed,
so we’ll be willing to pay $1.50 per share. And we’ll buy, how
much do you need? We’ll buy 2 billion shares
at $1.50 per share. So what happens? So let’s say the sovereign
wealth fund, they’re going to buy 2 billion shares
at $1.50 per share. So now what does the balance
sheet look like? So 2 billion, $1.50 per share,
that is equal to $3 billion. So now you get $3 billion
more in cash, so this becomes $4 billion. But you can’t get something for
free, so what happened? Are our liabilities
increasing? Well no, our liabilities
didn’t increase. They didn’t give us a loan. They invested in us. They essentially bought
shares of the company. They bought 2 billion shares. So how does that get
accounted for? Well instead of our share
account being 500 million shares, this is how many shares
we had before, the company essentially created
2 billion new shares. So now the company has
2.5 billion shares. And it’s something
interesting here. What is the new book value
of the shares? So what are our total assets?
$4 billion plus $4 billion, it’s $8 billion of assets. Our liabilities are
still $3 billion. Now the the value of our share
after the investment, and you can kind of call this the post
money valuation or book value, is $5 billion. $8 billion minus $3 billion. And now what’s the book
value of our shares? $5 billion divided by $2.5
billion, it’s $2 per share. And that’s interesting. It’s someplace in between our
old book value and the price that the company paid, or the
sovereign wealth fund paid, $1.50 per share. But anyway, I just realized I’m
out of time again, I’ll continue this in
the next video.