This is Part III of III of my mini-analysis and a continuation from Part II. Click here for Part II
For Bank A to make money in this cash from Bank C is vital. Why? Because without this, it can’t buy the second set of Treasury Bonds that it wants to short. Hence bye bye any chances of making money. More importantly it has to return the original $100 it borrowed from Bank B. The damage is two fold. So it has to use it’s own cash reserves to pay off Bank B.
Now, Imagine this scenario with Billions of dollars and multiple banks involved. Bear Stearns basically had to dip into it’s own reserves to pay off many many many Bank Bs and in the process lost all it’s cash reserves. This would have been ok if the securities it had in it’s position were valuable, ‘cause that way they can sell them off to raise cash. Unfortunately these securities (many of them mortgage backed ones) were useless as no on wanted to buy them. So they were basically screwed!
Post comments if you did not follow this. I would be glad to discuss.
Also, I will post later about the whole Bear Stearns saga once I understand it.
That’s how the cash crunch at Bear Stearns came about (atleast that’s the way I understand it!).
Sunday, March 23, 2008
Slaying of the Big Bad Bear - Mini-Analysis - Part II of III
This is Part II of my mini-analysis and a continuation from Part I. Click on this for Part I
Examining how 'repo' market transactions work:
Let’s say Bank A (investment bank) wants to make money by participating in a transaction including any security (bonds, equities, derivatives, etc). There is a series of transactions it would do to invest the security. Let’s say the amount it wants to invest is $100. And let’s say it wants to invest in Treasury bonds. The transaction sequence would be:
Transaction 1: Borrow $100 from Bank B. Tell Bank B it has $X in cash reserves as collateral.
Transaction 2: Buy Treasury Bonds for $100 from a Firm Y.
Transaction 3: Lend the $100 worth in bonds (not cash) to Bank C. Bank C sends $100 in cash as collateral.
Transaction 4: Use this $100 from Bank C as collateral to borrow $100 worth of Treasury Bonds (these bonds are different from those bought in Transaction 2).
Transaction 5: Sell bonds borrowed in Transaction 4 as a short (buy high, sell low).
Transaction 6: Sell bonds bought in Transaction 2 (they are with Bank C but can be sent back) long (buy low sell high).
Following so far? In effect the firm would make money if there is a difference in value of Bonds shorted and Bonds sold long. But the key point to remember is that Bank A has not used even a single $ of it’s own! Remember Transaction 1 began with Bank A borrowing $100 from Bank B. This $100 made it’s way around in the form of cash and bonds. But it was not Bank A’s to begin with.
Transaction 3 is what is known as the ‘repo’ market transaction. In effect Bank C is sending $100 to Bank A because it knows that the $100 worth of Treasury Bonds it is getting in return are valuable (since they are guaranteed by the US Treasury). Now Imagine if instead of these being Treasury Bonds, they are some of these Mortgage Backed Bonds (MBBs). By now it is common knowledge that these MBBs are not as valuable. Far being of any value everyone on the Street wants to avoid them like Plague!
So Bank C does not want any part of them and does not accept them as collateral. Uh oh! Bank A is now in trouble.
Continued in Part III.
Examining how 'repo' market transactions work:
Let’s say Bank A (investment bank) wants to make money by participating in a transaction including any security (bonds, equities, derivatives, etc). There is a series of transactions it would do to invest the security. Let’s say the amount it wants to invest is $100. And let’s say it wants to invest in Treasury bonds. The transaction sequence would be:
Transaction 1: Borrow $100 from Bank B. Tell Bank B it has $X in cash reserves as collateral.
Transaction 2: Buy Treasury Bonds for $100 from a Firm Y.
Transaction 3: Lend the $100 worth in bonds (not cash) to Bank C. Bank C sends $100 in cash as collateral.
Transaction 4: Use this $100 from Bank C as collateral to borrow $100 worth of Treasury Bonds (these bonds are different from those bought in Transaction 2).
Transaction 5: Sell bonds borrowed in Transaction 4 as a short (buy high, sell low).
Transaction 6: Sell bonds bought in Transaction 2 (they are with Bank C but can be sent back) long (buy low sell high).
Following so far? In effect the firm would make money if there is a difference in value of Bonds shorted and Bonds sold long. But the key point to remember is that Bank A has not used even a single $ of it’s own! Remember Transaction 1 began with Bank A borrowing $100 from Bank B. This $100 made it’s way around in the form of cash and bonds. But it was not Bank A’s to begin with.
Transaction 3 is what is known as the ‘repo’ market transaction. In effect Bank C is sending $100 to Bank A because it knows that the $100 worth of Treasury Bonds it is getting in return are valuable (since they are guaranteed by the US Treasury). Now Imagine if instead of these being Treasury Bonds, they are some of these Mortgage Backed Bonds (MBBs). By now it is common knowledge that these MBBs are not as valuable. Far being of any value everyone on the Street wants to avoid them like Plague!
So Bank C does not want any part of them and does not accept them as collateral. Uh oh! Bank A is now in trouble.
Continued in Part III.
Slaying of the Big Bad Bear - Mini-analysis Part I of III
By now all y’all must have heard and read the autopsy of the demise of Bear Stearns. I will not go into the details that have been put out by various news outlets in the past week or so but what I will do is bulletize them:
-JP Morgan’s buying price = $2 per share=0.0547 shares of JPMC for a share of BS
-Closing price of BS on Friday, March 14=$30 per share. Hence discount=28/30=93.3% (ouch)
-Fed loaned $30 billion in ‘liquidity’ to BS through JP Morgan Chase
-Glass-Steagall legislation was invoked to help out BS indirectly
-Two Bear Stearns managed Hedge Funds filed for bankruptcy in July 2007. Net worth lost=$1.6 billion
-Cash reserves of Bear Stearns on March 13, 2008 = $17 billion
-Cash reserves of Bear Stearns on March 15, 2008 = $0
-Fact= On Thu, March 13 (nite) Alan Schwartz approached the SEC and NY Fed and mentioned that Bear Stearns would have to file for bankruptcy on Friday morning.
I still have not got my hands and mind around analyzing this monumental failure of Bear Stearns but what I have tried to understand over the past week is how exactly would cash reserves dwindle so dramatically in such a short time and spark this demise. Here is an attempt from me to explain this:
Let me start by pointed to a passage in the Financial Times weekend edition, March 22-23, 2008. Link
“The motivation behind the Fed’s plan was for Bear to lend the Treasury debt in the repurchase (repo) market for cash and shore up its capital, which was straining under a massive withdrawal of funds by investors. Some $17bn (€11bn, £8.5bn) had been pulled in two days. Bear could not raise funds from any of its non-Treasury assets as its rivals had lost faith in its creditworthiness.”
The key words in the above passage are “…to lend the Treasury debt in the repurchase (repo) market for cash and shore up its capital…”. What exactly is a “repo” market and how is this key to cash reserves. See Part II.
-JP Morgan’s buying price = $2 per share=0.0547 shares of JPMC for a share of BS
-Closing price of BS on Friday, March 14=$30 per share. Hence discount=28/30=93.3% (ouch)
-Fed loaned $30 billion in ‘liquidity’ to BS through JP Morgan Chase
-Glass-Steagall legislation was invoked to help out BS indirectly
-Two Bear Stearns managed Hedge Funds filed for bankruptcy in July 2007. Net worth lost=$1.6 billion
-Cash reserves of Bear Stearns on March 13, 2008 = $17 billion
-Cash reserves of Bear Stearns on March 15, 2008 = $0
-Fact= On Thu, March 13 (nite) Alan Schwartz approached the SEC and NY Fed and mentioned that Bear Stearns would have to file for bankruptcy on Friday morning.
I still have not got my hands and mind around analyzing this monumental failure of Bear Stearns but what I have tried to understand over the past week is how exactly would cash reserves dwindle so dramatically in such a short time and spark this demise. Here is an attempt from me to explain this:
Let me start by pointed to a passage in the Financial Times weekend edition, March 22-23, 2008. Link
“The motivation behind the Fed’s plan was for Bear to lend the Treasury debt in the repurchase (repo) market for cash and shore up its capital, which was straining under a massive withdrawal of funds by investors. Some $17bn (€11bn, £8.5bn) had been pulled in two days. Bear could not raise funds from any of its non-Treasury assets as its rivals had lost faith in its creditworthiness.”
The key words in the above passage are “…to lend the Treasury debt in the repurchase (repo) market for cash and shore up its capital…”. What exactly is a “repo” market and how is this key to cash reserves. See Part II.
Saturday, March 15, 2008
How it goes?
Been a while. So what's shaking?
Stories I've been following recently:
-B Rack's dissociating himself from his pastor. Potentially campaign-ending if not handled right.
-Bear Stearns in trouble. FT has a fascinating behind-the-scenes account today.
-The Spitzer saga. No comment other than to point out that this country's media focus is too myopic.
-Dollar getting killed! I expect some sort of intervention in the next few weeks.
-Crude Oil, Natural gas prices, Gold, Corn, and metals shooting up. It is going to be an ugly year!
-Iran's 'democratic' elections. Pakistan's power struggles.
-Tucker cancelled on MSNBC! Oh nooooo!!
Things with moi:
-Asked for and granted a 2 week extension of deposit deadline from MIT Sloan. (April 1)
-Wharton decision on March 27.
-Opened a FX (forex) trading account. Following the USDJPY closely. Fascinating stuff.
-2 week vacation in India! April 18-May 3. Yeeeeeaaaaah!
-Discovered LinkedIn and Facebook! LinkedIn has been great to get back in touch with a lot of friends.
-I may have to get reading glasses! Booooo! Had my eyes checked and was given a prescription for reading glasses. Not too thrilled about this.
-Postponed the decision to let people at work know about my B school plans until May 2.
-Watched 'Vantage Point'. Sub-standard movie-making.
-Heard SIRIUS satellite radio this past weekend. Loved the Raw Dog stand-up comedy channel.
Rest seemed average.
-New York City rocks!
later
Stories I've been following recently:
-B Rack's dissociating himself from his pastor. Potentially campaign-ending if not handled right.
-Bear Stearns in trouble. FT has a fascinating behind-the-scenes account today.
-The Spitzer saga. No comment other than to point out that this country's media focus is too myopic.
-Dollar getting killed! I expect some sort of intervention in the next few weeks.
-Crude Oil, Natural gas prices, Gold, Corn, and metals shooting up. It is going to be an ugly year!
-Iran's 'democratic' elections. Pakistan's power struggles.
-Tucker cancelled on MSNBC! Oh nooooo!!
Things with moi:
-Asked for and granted a 2 week extension of deposit deadline from MIT Sloan. (April 1)
-Wharton decision on March 27.
-Opened a FX (forex) trading account. Following the USDJPY closely. Fascinating stuff.
-2 week vacation in India! April 18-May 3. Yeeeeeaaaaah!
-Discovered LinkedIn and Facebook! LinkedIn has been great to get back in touch with a lot of friends.
-I may have to get reading glasses! Booooo! Had my eyes checked and was given a prescription for reading glasses. Not too thrilled about this.
-Postponed the decision to let people at work know about my B school plans until May 2.
-Watched 'Vantage Point'. Sub-standard movie-making.
-Heard SIRIUS satellite radio this past weekend. Loved the Raw Dog stand-up comedy channel.
Rest seemed average.
-New York City rocks!
later
Monday, March 3, 2008
OH/TX/RI/VT and Yeah, This is Inflation Allrite!
First, kondum's predictions for tomm. democratic primaries:
RI
-Hill Dawg
VT
-B Rack
OH
-Hill Dawg
TX
-Both*
* = Hill Dawg will win the popular vote but B Rack's gets more delegates. You watch!
---
YEAH, UH-HUH THIS IS INFLATION ALLRITE
so, y'all are probably hearing these strange terms: recession, stagflation (what? stags are going to fellate?), CPI etc. Normally we, ordinary folks (atleast I am ordinary), dont see much direct affect of this. But hold it peeps!
Episode 1: When I get lazy (I do get lazy often) I give up and order Chinese from City Garden, this Chinese Rest that is housed in my building. My fav is Sesame Crispy Shrimp w. Broccoli. I dont pay TOO much attention to the price but the other day I semi-freaked when the girl asked to pay $12.45 for it! I am like "what the hell?". The girl at the counter (she is a surly teenager btw) matter of factly goes: "yeah we change prices". To be honest I did not remember how much I paid before so I came back to my apt and compared prices from an old menu. The price has indeed gone up 5%. Again I can't remember when the last menu was printed but it can't be older than 6 months. So there you have it: evidence I of Inflation.
Episode 2: I was shopping for Ground Turkey at Rittenhouse Market today and for some reason looked at the price label and yelled out softly "Holy Shit!". The price said $6.15 for 1.4 lbs of 7% lean Ground Turkey. I can clearly remember the price to be in the $4.75 - $5 range not too long ago. That's got to be a close to a 20% price increase. (unless my memory is fading badly). Evidence II of Inflation.
Not good folks. I need to look into this more.
RI
-Hill Dawg
VT
-B Rack
OH
-Hill Dawg
TX
-Both*
* = Hill Dawg will win the popular vote but B Rack's gets more delegates. You watch!
---
YEAH, UH-HUH THIS IS INFLATION ALLRITE
so, y'all are probably hearing these strange terms: recession, stagflation (what? stags are going to fellate?), CPI etc. Normally we, ordinary folks (atleast I am ordinary), dont see much direct affect of this. But hold it peeps!
Episode 1: When I get lazy (I do get lazy often) I give up and order Chinese from City Garden, this Chinese Rest that is housed in my building. My fav is Sesame Crispy Shrimp w. Broccoli. I dont pay TOO much attention to the price but the other day I semi-freaked when the girl asked to pay $12.45 for it! I am like "what the hell?". The girl at the counter (she is a surly teenager btw) matter of factly goes: "yeah we change prices". To be honest I did not remember how much I paid before so I came back to my apt and compared prices from an old menu. The price has indeed gone up 5%. Again I can't remember when the last menu was printed but it can't be older than 6 months. So there you have it: evidence I of Inflation.
Episode 2: I was shopping for Ground Turkey at Rittenhouse Market today and for some reason looked at the price label and yelled out softly "Holy Shit!". The price said $6.15 for 1.4 lbs of 7% lean Ground Turkey. I can clearly remember the price to be in the $4.75 - $5 range not too long ago. That's got to be a close to a 20% price increase. (unless my memory is fading badly). Evidence II of Inflation.
Not good folks. I need to look into this more.
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