So the example of the bank we've
been studying, we're actually kind of doing
it in real time. And I was doing this
on the fly. We actually showed
how this bank got quote-unquote bailed out. And it got bailed out by the
sovereign wealth fund. Because when this last piece of
debt came due, it couldn't sell its CDOs for enough money
to pay off that debt. So they just kind of held fast
and didn't sell their CDOs. They couldn't get any other
loans to pay off this loan. But what they were able to do is
to convince some foreigners who were enamored by the brand
of this institution of American capitalism. So they were willing to buy some
shares in this company and essentially bail it out. So in the example, we used to
have 500 million shares. The company issued another
2 billion shares. Sold them at $1.50 per share. And they got $3 billion
for it. And so then you had $3
billion in cash. We had $1 billion before, so
now we had $4 billion. We could pay off the loan with
$3 billion of the cash and then we're left with
$1 billion. And now this company would have,
if you have $1 billion in cash and $4 billion of CDOs,
it would think that it has $5 billion of assets. If these are really
worth $4 billion. It has no liabilities, so it
has $5 billion of equity. Notice the equity
doesn't change. When you take some of your
assets and you get the value of the assets that you think
they're worth and you pay off some liabilities, it
doesn't change the value of your equity. But what's happened now? This is just to get comfortable
with some of this terminology. This company now is completely
delevered. Because it has no liabilities,
it has no debt, and its assets are equal to its equity. And you'll find that lot of
companies that are startups and technology companies,
a lot of those have very little debt. And so they're completely
delevered. Anyway, that was
just an aside. But this was an example
of how a company could get bailed out. And who lost here? Well the shareholders lost.
Because before, there was only 500 million shares that
split up the equity. And now there's 2.5 billion
shares to split this equity. So the book value of the shares,
if you eve believe that these are really worth
$4 billion, they went from $4 to $2. And I think this is an
important aside here. Because I've mentioned before
that the market price when you buy or sell a share, it's just
transacting between another person who used to be
holding that share. So how does it affect
the company? Well it affects the company
when the company needs to raise more money. And that's what happened
in this example. The company had to
raise more money. It had to go to, maybe it was
the government of Singapore's sovereign wealth fund. And they say, government of
Singapore, please invest in us, buy some of our shares. And when the government of
Singapore, or any investor, wants to buy new shares, they
use the market value, what that stock is trading at, as a
good reference point for what you might have to pay
for those shares. Oftentimes if it's kind of a
desperate situation and this person is kind of saving
you, they'll pay below the market price. But sometimes, if they say,
oh, this is a lucky opportunity to get such a large
number of shares and essentially take control of
the company, I might be a little premium over it. So I'll pay $2 per share,
which is a little bit of premium over the market value
at the time, which was $1. But anyway, that's why the
market price of something in the secondary markets, where a
share is just trading between people who aren't
related to the company, why that's important. Because when the company needs
to raise money, that is used as kind of the fair market value
of a company's shares. But anyway, this was the
situation where the company gets bailed out. But what happens in a situation
where it doesn't get bailed out? Let's do that. Let's say that the sovereign
wealth fund never happened. Let me clear this. So the assets, we had
$1 billion in cash. And we have these $4
billion of CDOs. For a total of $5 billion. The liabilities, we
had Loan C, it's coming due for $3 billion. And then you had the equity,
which is essentially the total assets minus the liability. So that's $2 billion. And that's split amongst
500 million shares. And that tells you that the book
value per share is $4. We're not going to worry right
now what the market value of the shares are. So let's say they shop
everything around. All of these sovereign wealth
funds, they've got burned, because they invested in
Citibank last year and the stock just continued
to plummet. They invested in Merrill Lynch,
all of these they invested in and it just
continued to plummet. So they've been burned. They don't want to be the last
guy holding the potato. So there's no-one who's willing
to invest equity. So it just forces the issue. These people, Loan C, they say,
we're not going to give you a new loan, you can't pay
this loan, because even if you sold these CDOs, you're only
getting a $1 for them. So we are going to force
you into bankruptcy. And that's how bankruptcy
happens. When you break one of the-- they
call it the covenants-- with one of the people
who lent you money. The covenants say, if you don't
pay a loan within this amount of time or some other
thing happens to your financials, you are then
declared insolvent and you go into bankruptcy. And what happens
in bankruptcy? Well, in bankruptcy, the
bankruptcy courts takes receivership of all
of your assets. They just say, OK this
is what you own. And we're not going to go
into the details now. Maybe I'll do a whole series
of videos on the details of bankruptcy. You might get some type of
loan that helps you just continue to do business. Because people have to figure
out, are they just going to restructure your liabilities? Or are they just going
to dissolve you? Because you're not a viable
entity anymore. But anyway, the bankruptcy court
will take hold of you. And let's assume that they're
going to dissolve you. They will then split you amongst
the stakeholders, the people who you owe money to. Actually, let's not say that
they dissolve you. Let's say that everyone
agrees that this brand is worth a lot. Whatever we call it, Goldman
Lynch or Lehman Sachs. Whatever our brand is,
it's worth a lot. No-one wants to see
it disappear. So what happens when you
go into bankruptcy? Well, the creditors get first
dibs on everything. So one way to think of
it is Loan C gets first dibs on the assets. And then anything that's
left over goes to the equity holders. So let's say the Loan C guys,
they say we want to keep this bank as an ongoing entity. But what we want to do is we
just want to dump these CDOs. So the bankruptcy court, OK
we'll liquidate these CDOs just because everyone agrees
that they're really shady. So they sell them and they only
get $1 billion for them. So now we have $2 billion
of assets. It's essentially $2
billion in cash. That's all that there is. Plus there's probably some
buildings in all that. Which we're not listing here. But there's the brand
and all that. So this guy is owed
$3 billion. So he says, OK fine, you know
what I'm going to do? I'm going to keep this
company running. I'm owed $2 billion. I'm going to keep that
$2 billion in there. But what I get is essentially
all of the new shares of the company. So what essentially the
bankruptcy court is going to do, they're going to create
a new corporate entity. They're going to put all of
these assets into it. And then issue another
100 million shares. So they essentially create a
new entity, where the new entity has $2 billion of assets,
$2 billion of cash. And let's say it has no debt. Or actually maybe these people,
they say we'll even give you some money-- no, I
don't want to confuse things. So let's say that you
have no debt. So you have $2 billion
of equity. And let's say that there
are 100 million shares. So the book value of the new
shares is $20 per share. And you might say,
wow that's great. Someone could have gotten these
shares for whatever I said they were trading
for before. They could've gotten them for $1
per share before, now they are worth $20 per share. But no, that's not the case. It's actually horrible. These shares, the shares
of the old company are worth zero. Because when you liquidated the
company, or at least when you tried to value
the company, we didn't liquidate it. Because we're saying we still
want the company to continue its operations. But we're saying that the value
of the company is only $2 billion. This guy is owed $3 billion. So he says, you know what? I should get the
whole company. And I'm still getting not
everything that I deserve. But I'm going to get
the whole company. So essentially, whoever lent
Loan C, all of these shares are now their shares. And the equity holders
get wiped out, the old equity holders. So those shares go to zero. So this is an interesting
example, because I've seen people on CNBC say, oh what a
great deal, I could buy shares of Lehman Brothers for $1. But that's not the case. They'll say Lehman Brothers has
all of these assets and it's never going to completely
disappear. That might be true
to some degree. But Lehman Brothers' assets
might be greater than its liabilities, which means
that its equity is actually worth negative. So that $1 isn't a great deal. If you really thought that
Lehman Brothers in the long term was going to come back,
what you might want to do is somehow try to become one
of its bondholders. And then when it goes through
bankruptcy, on the other side of the bankruptcy you might end
up in shares of the new bank, whatever it's called. Goldman Brothers or whatever. Anyway, I realize
I'm out of time. In the next video I'm going to
put it all together and show you, one, why our financial
system is freezing. And, two, what the government's
bailout is attempting to do. See you in the next video.