Thursday, September 25, 2008

What a hell happening in Wall Street? - Part 1

you might have already read/heard about this in media but here it is going to be crisp and make you understand easier and better.

Goldman sachs, morgan stanley, meriyll lynch, lehman brothers...These were list of investment banks existed in wall st for decades. What happened/happening with them?

Before getting into this, i like to give a brief about the term "Leverage" which was often used by investment banks. To explain this with example, you have $1 and buying one equity worth $1. Now the equity worth becomes $2 and the profit you earned is $1. Suppose you have $1 and borrowing $1 and buying two equity, each worth $1. Now each equity worth becomes $2 then you earned $4 ,then after giving back the borrowed $1, you have $3 with the profit of $2. If you have $1 and borrowing $20 dollar, then your leverage ratio is 20:1

To compensate the hole happened because of mortgage crisis, Lehman brothers went for high leverage ratio and not able to payback resulted in bankruptcy.

Next Merriyl, who had the next high exposure in mortagage crisis, after paying back the debt, not able to run their operation. So went for merger with Bank of America who have enough liquidity(funds) since it is commerical bank with lot of deposits.

This resulted in fear on the market about rest of the investment banks and stocks of theirs were started tumbling.

Even goldman sachs and morgan stanley had comparitively less exposure in mortgage crisis and had liquidity to run their operation. But still there was fear about these banks existed so the clients of them got scared about their invesments and started to withdraw them.

Now both banks announced last week, to become bank holding company. Thats the end of investment banking model in wall street. This gave the confidence to clients since federal reserve regulates bank holding company and provides bailout(funds as loan) when they require. Since bailout plan is in US congress yet and funds which they will be getting from Federal reserve would be less(less exposure to mortgage crisis), the stocks of them are not still doing good as expected, so they went for generating capital. Morgan stanley sold their 20% stake to Mitusubhi UFJ financial group and goldman sachs sold $5 billion preferral stocks to Warren buffet and $2.5 billion common stocks in the market.

Now they have enough funds to run...How these two investment banks will get affected by becoming bank holding company will be posted soon?

Keep watching here for more..


krutika said...

I was bit confused with the happenings in the wall street..You made a good explanation.

Kasiperumal Achappan said...

Sorry for late reponse to your comment. Hey i posted some more on this series.