Solving the credit crisis

Reply Sun 9 Nov, 2008 02:17 am
The normal Net Capital Rule is that there should be a 15:1 loan to cash ratio. The crisis occurred as the SEC changed the ratio to 33:1 which double the banks' exposure. With $65 trillion troubled certificates the required cash at hand would be $1.97 trillion or $2 trillion for bad loans. To get back to the normal 15:1 ratio would require another $2 trillion cash (liquidity).

The ratio is really a risk factor. If a bank had deposits of $1000 it can lend out $15,000 credit. Suppose the bank lent out $1000 to 15 borrowers if one fails and files bankruptcy $1000 is lost but the remaining 14 borrowers return the capital of $14,000 plus 5% interest ($700). The bank lost $300.

Suppose we used the 33:1 ratio. With 15 borrowers each receiving $2,200 for a total of $33,000 credit. The bank would have $1000 at hand. If one borrower fails then $2,200 is lost. The remaining 14 borrowers return $30,800 with 5% interest ($1,540). The bank lost $540.

This is just a simplified example. The banks usually involve many more transactions if borrowers are not good risks then the loans are likely to fail. Loans made to stock market short sellers are riskier and banks also borrows from other banks and so it is a mine laden field.
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Reply Sun 9 Nov, 2008 03:41 am
When a company goes bankrupt the banks have first shot at the assets. They usually let liquidators to take the stock at rock bottom price to save itself the time and bother of seeking buyers or auction off the stock get as much value as possible.

Now when a bank goes bankrupt with defaulted mortgage certificates it would be more difficult to go the auction route. If the bank is one of those where the country could not let it fail then the normal business of other other banks seizing the assets are out of the question. The mortgage was defaulted because if it is a 30 or 40 year type then a lot can happen with an economy that allows jobs to be out-sourced. The mortgage holder may have lost his/her job or interest rates went up and the monthly payments increased. Another thing was that the overall housing may have collapsed as too many houses may have been built with speculation filled demand. The prices were artificially rising as speculators were merely flipping the housing units. Whatever the case, the mortgage could be saved if the payments are lowered as a result of a drastic price mark down of the housing unit. Foreclosures could be avoided and the bank saved.
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Reply Sun 9 Nov, 2008 04:35 am
Another curiosity is that Texan Phil Gramm represented UBS, a Swiss bank and the one to push deregulation.

Another curiosity is the Bank for International Settlements which was behind the Net Capital Rule change. http://www.bilderberg.org/bis.htm
which in the Bilderberg website. Bilderberg itself is of interest spilling beans on BIS (Bank for International Settlements)
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Reply Sun 9 Nov, 2008 06:56 am
Starting an FDR like New Deal program of infrastructure spending would help job creation in turn helping home owners make the mortgage payments
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Reply Sun 9 Nov, 2008 11:44 am
The second loss should be $2,200-$1,540 = $660
Reply Tue 11 Nov, 2008 05:41 pm

October 3, 2008
Quote of the Day: Net Capital Rule

Here is the quote of the day:

...we and other global firms have, for many years, urged the SEC to reform its net capital rule to allow for more efficient use of capital. This is the single most important factor in driving significant parts of our business offshore, so that our firms can remain competitive with our foreign competitors risk-based capital standards must become the norm. The SEC has made it clear that risk-based capital rules can be implemented only when the Commission is confident that firms employing value-at-risk models have robust credit and risk management policies in place.

Translated into English, this testimony from back in 2000 was from someone asking that major brokerage firms be permitted to increase leverage subject to oversight of their wondrous mathematical risk models. The request was agreed to four years later, in 2004, and it helped lead to the meltdown in independent brokers this year.

The speaker? Some guy named Henry Paulson, the then-CEO of Goldman Sachs. I wonder what happened to him.
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