Sunday, February 08, 2009
Securities lending business: The "two cows" version
Heh:
You have two cows.
John Paulson borrows one cow so he can sell it for $100. He gives you $10 as collateral.
You buy your neighbors cow for $100, which you finance by taking out a $90 loan from the bank and use John's $10 to make up the rest.
You brag to everyone about your financial health. You have assets--two cows you own, plus one Paulson owes you--worth $300, and liabilities of just $100.
A third of the country goes vegetarian.
You thought your two cows were worth $200 and now they are worth $140.
You express confidence in your financial health. Your assets are now worth only $200--your two cows plus the one John owes you--but your liabilities are still only $100. If necessary, you could sell the assets at this distressed price and pay off all your loans.
You hold onto your cows because you are sure the market is "dislocated." Some day someone will want to eat beef again.
The rest of the country goes vegetarian. Your two cows are now worth $2 each to guys who want to make dog food.
John Paulson buys a cow in the market for $2 and he gives it to you as repayment of the loan. You now have three cows worth six bucks.
John wants his $10 back.
The bank calls. It wants its $90 back.
You call the Federal Reserve and ask for a bailout.
8 Comments:
By 
, at
Mon Feb 09, 12:32:00 AM:
This comment has been removed by a blog administrator.
By 
Donna B., at
Mon Feb 09, 04:59:00 AM:
Armageddon, I think you completely missed the point of the post.
By JPMcT, at
Mon Feb 09, 07:24:00 AM:
You missed the part where Barney Frank and Chris Dodd force banks to finance cow purchases to people with no collateral, massively inflating the "cow bubble" until the banks roll over and die because nobody can make cow payments....forcing all existing and potential cow owners to become vegetarians.
By , at
Mon Feb 09, 09:08:00 AM:
Barrons points out this week that there was no deregulation during the Bush years, only re-regulation, and Ed Morrissey blames the collapse of the cow market on too much regulation (specifically, Sarbanes Oxley).
Bidens head just exploded, as he reached the confusion tipping point ("What? Too much regulation? But they told me there is no regulation! What day is it? What's my IQ?") .
By , at
Mon Feb 09, 10:16:00 AM:
Bloomberg has a story up that sounds much like the cows story TH tells in his post. The story states the value of all the liabilities the treasury has assumed, without mentioning the value of the assets. Obviously, in the worst case, that's because the cow market has dropped just when you need price stability most of all!
"The pledges, amounting to almost two-thirds of the value of everything produced in the U.S. last year, are intended to rescue the financial system after the credit markets seized up about 18 months ago. The promises are composed of about $1 trillion in stimulus packages, around $3 trillion in lending and spending and $5.7 trillion in agreements to provide aid."
If that doesn't make you want to add a little bourbon to your morning coffee, I don't know what will. Let's hope all the land the Feds still own out west has some good under-the-hammer value!
By , at
Mon Feb 09, 12:12:00 PM:
Great! A good example of how the crisis is looking... I think the only other part is that John Paulson also buys you condoms to make you feel better and stimulate the economy. No pun intended!
By , at
Mon Feb 09, 01:38:00 PM:
But wait, there's more!
The cows also produce "biomass", which can be converted into fuel, which they have converted by eating grass.
So there's a "green power" subsidy in the future to increase the production of bovine excrement.
And that sounds like a typical function of the Congress.
-David
By , at
Tue Feb 10, 02:58:00 AM:
The unanswered question is whether the country ever starts eating beef again. If they do, then Paulson doesn't just buy back the one cow, he buys as many as he can and sells as the price rises.
The vast majority of the assets being funded by US taxpayers will mature without default meaning this will only be a funding exercise. Probably.
