Teeninvestor
Warlord
As an investor, I find that people talk about the banking system and why it is in trouble. Here I will try to explain the whole issue of the trouble and what I think should be done.
Basically, the story goes back to the 1980's when something called derivatives was invented. Basically a derivative is an instrument whose value is related to another's.
For example, one derivative could be based on the stock of a company called XYZ. The derivative's value would be based on XYZ. This allowed something called leverage.
Leverage means to double or even triple your bets on paper by using derivatives. For example, if I think oil goes up , I can use leverage. This way, when oil goes up 1%, I will go up the amount of leverage I used---- 3% if 3X, 5% if 5X, and so on.
This new market grew like a storm. When derivatives were first used, they were so powerful they could manipulate the market easily. They were suspected of having caused the crash of 1987 and the crash in Japan.
The size of the derivative market grew heavily. As of now it stands at $300 TRILLION.
Leverage also grew---- US Lehman Brothers bank used 60X Leverage, which meant a 1% move was a 60% move for Lehman. Citigroup used 26X Leverage.
Anyways, it was only a matter of time before derivatives were based on housing and debt. This is when a new derivative called the CDS was invented. The CDS is sort of like insurance---- you pay a premium to make sure that an instrument(such as a bond) you bought would retain its value. If the bond became worthless, the bank you bought the CDS from would pay you. As of 2008, the CDS market stood at $50 trillion.
TRILLION. Of course, it along with the derivative market in general was unregulated. In addition, banks also invested heavily in subprime debt themselves.
When the subprime market began to collapse in 2007, the banks began to write down the value of their investments. However, that was not the only problem. Not only do the banks have most of their money tied up in the subprime debt, they also invested heavily in DERIVATIVES that were based on the subprime market. As you can imagine, when the subprime market collapsed they were all WORTHLESS. To make it even worse, the US Banks had guaranteed a lot of the debt by selling CDS's. When the subprime market collapsed, the CDS's activated and the banks had to pay out trillions of dollars.
The effects were devastating.
In october 2007, the dow was 14000
In March 2008, (when I started short selling banks) the dow was 12500
In October 2008, the dow dropped to 8400 after several companies went bankrupt.
In March 2009, the dow dropped to 6400.
No body knows how much the banks lost through this deadly combination. But just to tell you, here is a list of the bailouts/bankruptcies so far.
Citigroup= 3 bailouts
Bank of America=2 bailouts
AIG= 4 bailouts
Lehman= bankrupt
Bear Stearns, Merill Lynch= bought out
Fannie, Freddie= nationalized
In addition, Bernanke has spent $10 TRILLION as of January 2009 trying to plug this hole and this amount is increasing at $1 trillion monthly. THAT IS MONEY FROM YOUR POCKETS. And remember the derivatives market is $300 TRILLION.
Right now, the banks have one thread of hope- that the market for these subprime debt and more importantly the DERIVATIVES based on them will recover from the value they have now- which is zero. Right now these assets plainly put DO NOT HAVE A MARKET. NO ONE IS WILLING TO BUY THEM. In addition, CDS Payouts are increasing every month.
So what was Bernanke & Obama's solution?
Their solution was two-pronged. Their reasoning is that if the banks were kept alive for long enough and the economy recovered, the US banking system would not collapse. Therefore Bernanke is pumping 1 trillion+ of liquidity into the US banking system every month to stem the gap while Obama is trying to stimulate the economy through massive spending.
But here's the glitch:
If Obama's spending FAILS to revive the economy, than we are left with two options
Then, there will be two solutions:
a) print enough money to buy up all the derivatives which have gone bad at their 2007 PRICES. Considering the derivatives market is 300 trillion and the entire liquid wealth of americans is only 7.7 trillion, it will cause HYPERINFLATION.
b)NATIONALIZATION.
Isn't that socialism? is your first gasp. But it is actually the better solution.
It consists of this:
1. taking over all the banks and writing down the derivatives and other instruments they hold to ZERO.
2. Sell them back to the private sector.
This solution is not only less costly but also more market efficient- it punished the speculators who have blown up a HUGE bubble in derivatives.
Now I must explain i am not without bias in this matter as if this solution was pushed through I stand to double my money to 700% of my initial investments in March 2008.
So what do you think? what should be done???
Basically, the story goes back to the 1980's when something called derivatives was invented. Basically a derivative is an instrument whose value is related to another's.
For example, one derivative could be based on the stock of a company called XYZ. The derivative's value would be based on XYZ. This allowed something called leverage.
Leverage means to double or even triple your bets on paper by using derivatives. For example, if I think oil goes up , I can use leverage. This way, when oil goes up 1%, I will go up the amount of leverage I used---- 3% if 3X, 5% if 5X, and so on.
This new market grew like a storm. When derivatives were first used, they were so powerful they could manipulate the market easily. They were suspected of having caused the crash of 1987 and the crash in Japan.
The size of the derivative market grew heavily. As of now it stands at $300 TRILLION.
Leverage also grew---- US Lehman Brothers bank used 60X Leverage, which meant a 1% move was a 60% move for Lehman. Citigroup used 26X Leverage.
Anyways, it was only a matter of time before derivatives were based on housing and debt. This is when a new derivative called the CDS was invented. The CDS is sort of like insurance---- you pay a premium to make sure that an instrument(such as a bond) you bought would retain its value. If the bond became worthless, the bank you bought the CDS from would pay you. As of 2008, the CDS market stood at $50 trillion.
TRILLION. Of course, it along with the derivative market in general was unregulated. In addition, banks also invested heavily in subprime debt themselves.
When the subprime market began to collapse in 2007, the banks began to write down the value of their investments. However, that was not the only problem. Not only do the banks have most of their money tied up in the subprime debt, they also invested heavily in DERIVATIVES that were based on the subprime market. As you can imagine, when the subprime market collapsed they were all WORTHLESS. To make it even worse, the US Banks had guaranteed a lot of the debt by selling CDS's. When the subprime market collapsed, the CDS's activated and the banks had to pay out trillions of dollars.
The effects were devastating.
In october 2007, the dow was 14000
In March 2008, (when I started short selling banks) the dow was 12500
In October 2008, the dow dropped to 8400 after several companies went bankrupt.
In March 2009, the dow dropped to 6400.
No body knows how much the banks lost through this deadly combination. But just to tell you, here is a list of the bailouts/bankruptcies so far.
Citigroup= 3 bailouts
Bank of America=2 bailouts
AIG= 4 bailouts
Lehman= bankrupt
Bear Stearns, Merill Lynch= bought out
Fannie, Freddie= nationalized
In addition, Bernanke has spent $10 TRILLION as of January 2009 trying to plug this hole and this amount is increasing at $1 trillion monthly. THAT IS MONEY FROM YOUR POCKETS. And remember the derivatives market is $300 TRILLION.
Right now, the banks have one thread of hope- that the market for these subprime debt and more importantly the DERIVATIVES based on them will recover from the value they have now- which is zero. Right now these assets plainly put DO NOT HAVE A MARKET. NO ONE IS WILLING TO BUY THEM. In addition, CDS Payouts are increasing every month.
So what was Bernanke & Obama's solution?
Their solution was two-pronged. Their reasoning is that if the banks were kept alive for long enough and the economy recovered, the US banking system would not collapse. Therefore Bernanke is pumping 1 trillion+ of liquidity into the US banking system every month to stem the gap while Obama is trying to stimulate the economy through massive spending.
But here's the glitch:
If Obama's spending FAILS to revive the economy, than we are left with two options
Then, there will be two solutions:
a) print enough money to buy up all the derivatives which have gone bad at their 2007 PRICES. Considering the derivatives market is 300 trillion and the entire liquid wealth of americans is only 7.7 trillion, it will cause HYPERINFLATION.
b)NATIONALIZATION.
Isn't that socialism? is your first gasp. But it is actually the better solution.
It consists of this:
1. taking over all the banks and writing down the derivatives and other instruments they hold to ZERO.
2. Sell them back to the private sector.
This solution is not only less costly but also more market efficient- it punished the speculators who have blown up a HUGE bubble in derivatives.
Now I must explain i am not without bias in this matter as if this solution was pushed through I stand to double my money to 700% of my initial investments in March 2008.
So what do you think? what should be done???
Classic.
