What a hell happening in Wall Street? - Part 3

As mentioned in the earlier posting, we are going to talk about $800 billion bailout and U.S economy now.

This bailout plan is the first step from FED to recover the Wall Street, ultimately the economy as well. As a part of this plan, they are going to buy the bad mortgage assets from U.S banks. This will inject the liquidity(funds) into wall street and unfreeze the market by improving the current lending situation.

When this bailout bill was put forth in U.S congress on previous monday, it failed with votes of 228(against) to 205(support). Most of the Republicans were against this bill since it's going to be tax payers money to fix the wall street fault but there were no benefits for tax payers included. This resulted in market crash by around 800 pts, highest single day crash after 1983 for Dow Jones Industrial Average(DJIA) and other indices also fallen down. Investors lost around 1 trillion dollars on that day. Moreover investors lost around 4 trillion dollars on september alone and lost around 9 trillion dollars since jan 08.

On adding, sweetners such as raising the ceiling on insurance for bank deposits from $US100,000 to $US250,000, and adding up $US150 billion in tax breaks for middle class families and business in the bill, it was put forth again in U.S congress on previous thrusday and it went through with votes of 263(support) to 171(against) and later approved by White House to enact the bill.

Until now, federal government spent around $1.8 trillion in bailout and their debt increased to $11.3 trillion dollar. Except, $700 billion bailout, others provided will be profitable since they were provided with high interest rates with collateral. But, those mortgage assets which government going to get inturn on providing this $700 billion bailout will be profitable or not? What will be the value of those mortgage asset values in future? Noone knows the answer to this question.

In september, around 159,000 lost their jobs, the deepest in 5-1/2 years, which is more than 59,000 predicted by reuters in their survey. Morover, Labor Department report showed 760,000 jobs lost so far in 2008. This resulted in weak personal income and spending hence further job cuts may happen in manufacturing and factory order and shipments sectors as well.

Where this situation leading to? Everyone says the answer as recession. What is recession? In simple terms, decline in the the growth of economy (i.e) negative GDP growth for two quarter or so.

Does bailout provided will improve this situation? not really. Then what will
make this to improve? Fed Rate cut. What is Fed Rate cut? This is rate at which one lending institution lends money from another(mostly from Federal Reserve). How does layman going to benefit from this? Prime rate is the rate at which consumer and business gets the money from lending institution which may be around to 2-3% more than fed rate. If fed rate decreases, prime rate also decreases. If loans are available cheaper than before for person and business, then the following cycle will get triggered,

money flows -> consumer consumption of manufactured product -> manufacturing sector improves -> other dependent sector grows -> more jobs -> economy grows -> money flows

I hope this might helped you to understand the wall street. Your feedbacks about this series are welcome.

What a hell happening in Wall Street? - Part 2

In the earlier posting, we talked about list of investment banks and how they were affected by subprime mortgage crisis and what happened to them.

Before getting into this further, i am going to explain what is subprime mortgage crisis and about bear stearns, which was missed in the earlier posting and then followed by sequence of events happened after that.

Mortgage backed securities(MBS) are investment instruments available in the financial market through investment banks, which are nothing but bond by owner of the home to repay the home/mortgage loan to the lending institution(commerical bank) along with interest rates. There is no collateral to be submitted by borrower and the home bought buy him going to act as collateral and taken over by the bank in case if he forecloses(not able to pay back) the loan. This kind of securities are classified based on loan defaulting risk of the borrower and available in the stock market. Higher the risk, higher the return.

Sub-prime mortgage investment instruments are the ones with higher risk. During the year 2005-2006, there was a housing bubble in the US (i.e) Value of housing assets were overpriced and the price correction for the same happened latter resulted in fall of the asset value. This made the owner of the asset to default the loan since their asset value is less than loan payback value. So ,commerical banks and investment banks who owns these asset in one form or another(collaterals/securities/infrastructure funds/real estates), ran into deep problem called sub-prime mortgage crisis.

One among the investment banks, 85 years old Bear stearns ("Most Admired" securities firm in fortune's "America's Most Admired Companies" survey)who had high exposure to this crisis, started collapsing during march 2008 and went for filing bankruptcy. It was then bought by JP Morgan chase for $10 per share(initial quote was $2 per share and latter it moved to $10 to save the bear stearns investors)

Next, Fannie Mae and Freedie Mac are the liquidity(funds) providers for the mortgage based lending institution and added to that they were selling MBS to investors. So ultimately they had the exposure to this crisis and they are now under the control of government who took the major portion of the preferred stocks in these company as collateral and provided them $100 billion to each as bailout(funds as loan) to go ahead with their operations.

Next, AIG, one of the biggest insurer in the world who have clients across 130 countries who insured consumers, business, MBS, hollywood movies etc.. also got affected by this mortgage crisis. They got $85 billion as bailout by providing around 80% stake as collateral and they need to pay 12% interest on bailout. If this insurer was not saved as Lehman brothers by FED then lot of business insured by them would had got affected resulted in global economic meltdown.

Next, Washington Mutual(WaMu), 119 years old savings and loan bank closed by the government, the largest bank failure in the US history and its asset were sold to JP Morgan Chase for $1.9 billion on the same day of closure.

Next, Wachovia securities, the bigger one in the U.S east coast with around 3,400 branches. Citi who was ready to take over only securities division for $2.2 billion with guarantee from the government for the $312 billion wachovia mortgage asset. But Wells fargo & co who have huge client base in the U.S west coast comes up with $15 billion bid for the entire wachovia includes brokerage, securities and investment banking division. Citi or Wells fargo?
Lets see what happens..

What about to recently turned bank holding companies such as Goldman sachs, Morgan stanley. Whats happening with them? They are right now busy, looking for national banks with troublesome mortgage assets and taking them at cheaper price. Recently, Goldman took ohio national bank and looking for somemore troublesome assets.

Watchout for more here with respect to $700 billion bailout from government and US economy now.

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..