Finance and capital markets
- CNN: Understanding the crisis
- Bailout 1: Liquidity vs. solvency
- Bailout 2: Book value
- Bailout 3: Book value vs. market value
- Bailout 4: Mark-to-model vs. mark-to-market
- Bailout 5: Paying off the debt
- Bailout 6: Getting an equity infusion
- Bailout 7: Bank goes into bankruptcy
- Bailout 8: Systemic risk
- Bailout 9: Paulson's plan
- Bailout 10: Moral hazard
- Bailout 11: Why these CDOs could be worth nothing
- Bailout 12: Lone Star transaction
- Bailout 13: Does the bailout have a chance of working?
- Bailout 14: Possible solution
- Bailout 15: More on the solution
More on the "Plutsky Plan". Created by Sal Khan.
Want to join the conversation?
- Too bad I only dicovered this site last week, now I have a question about this alternative solution, how would you avoid a potential bank run and If you let all this banks to go under what would happend with all the depositors savings and their money in their checking accounts. I know that this question is 2 years late, but if somebody have the answer I'll apreciate the feedback.(4 votes)
- The FDIC does not have enough money to protect all depositors. In fact, it can only cover a small percentage of total deposits (somewhere around or below 1% I believe but not sure). It also has the ability to borrow money from the treasury, but as with most government programs it ultimately only has the capacity to redistribute wealth as opposed to creating it, and therefore is limited to protecting a (relative) few individuals. If it were to insure all deposits, it could only do so by borrowing massive amounts of money (for which tax-payers would ultimately be accountable) or by receiving newly printed moneys, thus depreciating the US' FRN's (federal reserve note) value.
Incidentally, one of the issues with deposit insurance is that it does not solve the underlying problems which would cause bank runs. Therefore, the funds available for insurance will diminish but the risk of bank runs will remain the same, all else remaining equal. Its existence is dependent upon the hope that most banks will survive. In any case, it's a very limited 'insurance'.
Here are a couple of quick quotes pertaining to the FDIC, from Wiki:
"The fund is mandated by law to keep a balance equivalent to 1.15 percent of insured deposits."
"According to the FDIC.gov website (as of January 2009), "FDIC deposit insurance is backed by the full faith and credit of the United States government". This means that the resources of the United States government stand behind FDIC-insured depositors." The statutory basis for this claim is less than clear. Congress, in 1987, passed a non-binding "Sense of Congress" to that effect, but there appear to be no laws strictly binding the government to make good on any insurance liabilities unmet by the FDIC."
So you might infer from this the FDIC's rather precarious nature.(8 votes)
- Around "6:30" you talk about the printing press. Isn't this actually the main issue? Because banks can lend out with leverage they earn a lot of interest. Money they use to lend out and earn more interest. This function is creating new money without making the 'Goods and services pie' bigger?
I cannot understand how the Fiat currency of a Federal Reserve can be sustainable long-term.(2 votes)
- But Brent, where does the farmer's corn go? It does not disappear when paid to the logger. The logger can then use it to hire an apprentice to help him cut wood. Thus, he can make two loans of wood to his neighbors in the coming winter, rather than just one.
What are the tangible positive effects of this loan? 1) He provided a livelihood for his apprentice all summer and that man has not starved. 2) He can keep twice as many neighbors from freezing to death in the coming winter. 3) His loans in the coming winter are supposed to bring him similar returns, allowing him to continue expanding his logging operation, feeding more people and keeping more neighbors from freezing.
The standing of living of everyone improves thanks to this logger's prudent lending practices and his debtors' ability to repay him. This is the idea of "growing the pie".
Now if he chooses not to loan the farmer some logs, then the farmer will die in the snow of the winter. The logger will starve while the farmer's fields lay bare in the summer. Then there is no pie for either of them.
Similarly if the farmer takes the logs and builds furniture for his home (if he mis-allocates the logs), they will each meet the same fate as if the loan not been made.
And if the farmer does not make good on his promise of corn? He had better figure out a way to stay warm all winter once the logger either starves or refuses to do business with him.(5 votes)
- I see where Sal is going with this, it seems like a great idea! My question is, say you have a private bank that has existed for a while like Morgan Stanley (MS). My understanding is that MS has managed to weather the storm, maybe took some hits, but through prudent investment, kept themselves somewhat insulated against these CDOs and other "stinky" assets. Will they be able to compete against these 50 new banks that have pristine balance sheets and tons of liquid equity to lend at low interest to businesses? I would think that the new banks would be able to lend at low interest and would thus attract all sorts of customers to open up lines of credit. Also, whats stopping people from doing a bank run on existing banks so that they can in on the ground floor of the new banks?(4 votes)
- How I understood this video is that the old banks would either disappear or become more slim and efficient to compete with new banks as consequences of their wrong investments in the short term. I think what this video says government should not aid the broken old banks creating artificial demand to save them since this is not doing any good for economy. So I'm assuming that a lot of the old banks would not be able to compete well since they have all the bad deteriorating assets and there is no need to stop people to pursue their best interest.(1 vote)
- I am almost 60 and I have never seen a reduction in the price of goods and services. Granted I've seen interest rates go down but never retail price reductions. Can anyone explain why this is the case?(2 votes)
- With all due respect, the price of many retail goods go down all the time. Twenty-five years ago, I was buying a modest current-gen computer system (with a monitor and software) for around $1200, and nowadays you can get the same thing for more like $400. (Obviously, it's even more profound if you track goods that are actually equivalent. A computer as powerful as that $400 system twenty-five years ago would have cost millions.) I think you'll see the same thing across the entire range of consumer electronics.
Even some services have reduced in price as automation has reduced costs. How much did it cost to have a broker execute a stock trade thirty years ago -- nowadays you can even do it for free under many cirucumstances.(3 votes)
There's one problem with this plan you haven't addressed. What about the millions of deposits that ordinary people will loose if you let the big banks go under? What's it going to do to the economy if you have the savings of an entire middle class wiped out?
I think there must be a backstopper for this in the form of the Glass-Steagal Act. That separated the commercial banks from the investment banks, insuring that commercial banks couldn't get involved in speculation.(3 votes)
- What does "Leverage" in your video mean ? I often think of it as Loan - Down Payment ratio, but in this video I suppose you talk about the 10-90 rule for banks - 10% Reserve and 90% Lent out.(2 votes)
- Leverage is the ratio of the assets you control to the amount of equity you control them with, so in this case the leverage is 10:1 because the bank has 140B of assets (in loans) that it controls with 14B of equity. :)(2 votes)
- I wonder how much would the FDIC have to pay to depositors if there was a bank run because of the banks being allowed to fail. What about depositors who had deposits more than the FDIC limits? Finally what would have happened if instead of bailing out the banks or instead of the proposal of setting up new banks, these existing banks were nationalized.(2 votes)
- The FDIC insures deposits up to $250,000. Beyond that, the deposits would simply be lost. However, as I wrote to neoalvaro79, the FDIC is strictly limited in its capacity to actually insure deposits.(1 vote)
- Re practicality of the proposed possible solution, isn't competition an issue to be considered, i.e. determining the optimum number of banks that can operate profitably in the US economy? Also, what's the underlying philosophy - still free market idealogy, i.e., let the new banks compete and kill the existing ones if need be? Wha about the impact on their employees and other businesses affected?(2 votes)
- Why is lending of more than 1:1, such as 10:1 or 40:1 allowed? I always thought there is one level of banks and individuals make deposits, the bank then makes loans to individuals and businesses, collects interest and provides a yield for depositors. Why have bank to bank lending? Who does it benefit? Does it benefit the depositors?(1 vote)
- Isn't this plan also a plea to keep investment banks (who play around with derivatives) and commercial credit institutions as completely different entities?(1 vote)
- "Pleas" for good behavior don't work in the US (and I doubt anywhere else). The US Congress has to act to impose some sane regulation on the banks and/or keep large financial institutions from growing to be "too large to fail".(2 votes)
Let's talk a little bit about what I'll call the Plutsky Plan, because it came from my friend, Todd Plutsky. But I think it's a good plan. But let's think about a little bit of its repercussions and see if it's more or less likely to actually work. Well first of all, you know, I threw out in the last video 50 banks, maybe that's logistically difficult. Instead of having 50 banks with $14 billion initial capital, maybe you do five banks with $140 forty billion initial capital. But the point being is that you should have more than one bank, it shouldn't be too big to fail, and you should try to instill some type of competition there. But because they have pristine balance sheets, all of these banks are going to be able to lever 10:1, which we know isn't crazy. Merrill Lynch and Morgan Stanley and all the likes have been leveraging up 30 to 40:1. So 10:1 is normal for a bank. And frankly, they're probably going to be able to attract a lot more-- you know we said foreign governments probably would be willing to lend to them, the private sector is willing to lend to them. If these are commercial banks, which means that they can take deposits, a lot of people are going to be willing to essentially put their money with this bank because it has a clean balance sheet, and essentially it'll be owned individually by the American people, and it will have the federal backstop above and beyond the FDIC insurance limit and all that. Although I do like the one provision to increase the FDIC caps. Maybe I'll do the insurance caps on deposits. But it will actually be able attract a lot of deposits from everyday people. They'll feel safer with these banks. So in terms of whether you'll be able to capitalize these banks and lever up 10:1, I don't think there's an issue there. Then there's a question, will it solve the fundamental problem of keeping credit markets flowing to those people that it needs to keep credit to? Well we already said it'll have no trouble being able to have access to funds above and beyond how much the government capitalizes it with. It'll be able to attract deposits, it'll be able to attract investment from the private sector and from international money, especially with this five year government backstop. So it will be able to essentially put 10 times this money back into the system. So if you take $700 billion collectively, this will introduce 10 times as much. So $7 trillion of new loans. So this $7 trillion -- I mean that's literally half of the American GDP. I mean you might argue that is too much -- that might provide too much credit, and it might go from, you know, thawing to overheating credit markets. So then you might say well if $7 trillion is too much liquidity, well why don't we just reduce this number a little bit. Instead of saying $700 billion, why don't you make it a $100 billion, right? Because then $100 billion, if you do 10 banks with $10 billion each, so you introduce $100 billion. They all lever up because it's all new liabilities and new assets, clean balance sheets, it'll introduce $1 trillion of new loans that it can go put to work for people building factories and doing real things. And because their incentive is not to bail out their friends, it's not to help out the companies they used to work for, the companies that are donating to them in some way or contributing to them, or promising jobs in some way. It won't go -- this $1 trillion is not going to go to buy assets at higher prices than they should. You know it could go to buy assets at discount prices if the new managers of these banks do see a good return. But most probably they'll invest it in areas of the economy where they do see a positive return on investment. And one person had sent me a note and said, hey, wouldn't introducing all of this liquidity into the financial system, whether it's $7 trillion or $1 trillion, wouldn't that lead to hyperinflation? And I'll probably do a whole series on inflation. I think there's a lot of misunderstanding around it. In general, if anyone makes a positive investment -- so if I have $1 and I make it an investment where it generates $1.20 of benefit, that by definition is not inflationary. Because I had $1 in the world and I created $1.20 of wealth. So actually, the pie gets bigger. A good way to think about inflation -- I'll do a lot about this because it is a very abstract concept. Let's say this is the pie of goods and services in the world. Or let's just say a country right? Goods and services. Goods and services in a year. You could say it's our GDP, or however you want to measure it. Goods and services in a year, right? That's the goods and services in a year. And let's say I have another pool of the amount of money there is in a given year. So money. And the money supply is an interesting thing, because it's not just dependent on the amount of physical coins or dollars. It also is a function of how quickly those transact and how much leverage there is in the system. So you can actually have a whole economy where everyone just has one dollar bill, but every time someone needs something from someone else, they exchange that one dollar bill. So that one dollar bill gets used, you know, 15 trillion times a year. So you'd actually have $15 trillion of money, because the velocity would be so high. But anyway let's just say that this is the pool of money. If this pool, the pool of money grows faster than the actual goods and services and the actual productive capacity of that country, then you have inflation. So if this circle grows faster than this one you have inflation. If this circle grows faster than this circle, you have deflation. You have the same, or you have some amount of money representing more goods and services, so goods and services actually become cheaper. And the problem that we're talking about right now, this credit crisis, this is a problem of deleveraging, where the government injects a dollar into this current broken banking system, and instead of that dollar -- you know, the normal system is you lend a dollar to a bank, so you lend $1 to a bank, and then, let's say this is the Fed right? This is how they inject liquidity. They lend a dollar to a bank. Let me draw a bank here. Then that bank has to keep -- it can only lever 10:1-- so it essentially has to keep in reserve $0.10 of that dollar, but then it lends $0.90 to somebody else, to another bank, right? Then that other bank has to keep 10% of that, so it lends $0.81 to someone else. And then that someone else can lend whatever $0.81 times 0.9 is, so I don't know, seventy-something cents to someone else. But you get the idea, that in a normal, functioning banking system, one dollar injected into the system has this multiplier effect, so it actually creates a lot of money. And that's what people are implicitly talking about when they talk about the printing press. But what's going on right now is the Fed lends $1 to Bank A, but Bank A is so scared that it doesn't lend out to anyone else, it just keeps that dollar. Because right now their main priority isn't to try to get a little bit of incremental interest on whatever money they have, their main priority is survival. So that dollar just goes into a black hole. And so that's what the Fed's frustration is. It keeps lending money into the system but that money keeps disappearing. And actually as the economy slows, the velocity of money is going to slow down as well. So the main problem when you have a credit crisis and when you have a recession is actually the money supply shrinks. The amount of goods and services probably shrinks as well, but the money supply shrinks even more. So your main problem is deflation. And you know, that was the main problem in the Great Depression, and that was the main problem in the Japanese crisis. And you know, Ben Bernanke, he's written papers about this and he's like, well you can always cure deflation by printing money and dropping money from a helicopter. Well to some degree that's what they've already been trying to do. They've already been-- the Fed's been willing to take pretty large credit risks on bank and lending money into the system. But the problem is, if this multiplier effect is disappearing at a faster rate than you are dropping money from a helicopter, you still have deflation, right? Before when you not only let people lever 10:1, you let them lever 30:1 and 40:1, every dollar you put in the system became $40 that was given to someone else, and then they could lever up. So you had this huge explosion of money. And frankly, the only reason why we didn't have inflation-- I mean the last 5, 10 years we had this huge explosion of money. And the only reason why it didn't, at least in measurable inflation, show up, is that on the other side of the equation, you had all of this new productive capacity come on line in China and India. And so manufactured goods got a lot cheaper. But in things that were not manufactured goods, like commodities, like homes, you had this huge asset inflation. Or even college tuition, or healthcare-- things that are dependent on American labor-- became hugely expensive, and that's because you had this huge, huge infusion-- you know, there's different ways to measure money, but the broadest indicator, which is called M3-- and I know I'm kind of going out of the domain, but I'll make a bunch of videos on this. The broadest indicator, M3, which the government stopped officially reporting, exploded because there was so much leverage in the system. Now things are-- the exact opposite is happening. The leverage is disappearing from the system. There's no lending to each other. Everyone is going from 1:30 leverage to 1:10 leverage. So money is actually disappearing in the system. The velocity is slowing. This is shrinking, but this is shrinking more, no matter what the Fed is doing. And frankly, this new $700 billion bail out, I personally think this is the helicopter that Ben Bernanke always talked about using. And whenever you're going to drop money from a helicopter, the question is, where do you drop it? And they think they should drop it into an already broken banking system. The point of this video and the last is maybe you should just drop it into a new banking system, or maybe you just drop it into everyone's pockets and see what happens. And you let new banks form where they can. Anyway, that's all for this video. I know it was a little bit rambling. But hopefully you learned a little bit. See you in the next video.