Geithner plan 4

Let's try to construct a situation where I participate in the new Treasury Public Private Program. And I get all of the upside I would have gotten in a traditional just straight up investment in these toxic securities. But then I'm able to offload some of the downside. And so just as a review, what the program entails is that if I want to make an investment in something. Let's say I want to make a $100 or 100% investment. It doesn't matter. Either way. That's 100. The Fed is going to give us a loan for 85% of it. And then the remainder, the equity, is going to be split half, or 50-50, between myself and the Treasury. And then this is the private investor. So what happens here? And we talked a lot about it in the last couple of videos. Is that the upside, if this thing is worth more than 100, it's split between the Treasury and the private investor. And then the downside is split between the private investor and the Treasury. Until the asset becomes worth less than 85% of its original value. And then the Fed takes the hit, right? Because this loan won't be worth anything. And all this loan can go after is this asset. It's a non recourse loan. The Fed can't say, oh, this thing is only worth 84. Private investor and Treasury, you guys owe me a dollar. The Fed is just left with this asset that might be worth something less than that. But how could we use this program to get the same upside we would have otherwise gotten, if we had just bought the toxic security outright? So let's say that the toxic security, in a before-this program world that Geithner has come up with. Let's say that I'm willing to pay $30 for a security. And obviously if the security is worth $40, I'll make $10. If it's worth $50, I'll make $20. And so forth and so on. That's obvious. Now what I can do is, instead of just, with this plan-- I mean, before I would have to take my $30 that I have in the bank, and use it to buy some asset, if one of these banks were willing to sell it to me. But what I can do now is, I could say, well, let me just take 15% of this. So what's 15% of $30? It's $4.50. And use that to invest in this program. And essentially get the same upside as I would if I invested the whole $30. And then put the rest of the cash away essentially safe, so that my worst case is that I just lose what I invest. So let's do that. And we'll see that the numbers do all work out. So instead of just doing $30 all for the investment, I'm going to set aside 15%. So I'm going to put $4.50 to participate in the plan. And then I'm going to set aside what's left. $25.50 in cash. And using this $4.50 in the plan, I'll show you that I'll get all of the upside that I got if I had originally had to use all $30 by myself. And obviously my downside is limited. My downside is limited to the $4.50, because I'm still going to have the $25.50 in cash on the side. So how is this going to work? I'm going to put in $4.50. That's from me, the private investor. The Treasury is going to match my investment. $4.50. That's the Treasury. Now I have $9 of equity. And this is going to be 15% of the total equity, so the debt that the Fed will lend me is going to be $51. And I did the math before I did the video, but you could work it out yourself. $51 loan from the Fed. And so what's our total capital that we've raised now? So if you add $51 plus $9, we have $60. Let me do this in a different color. We now have $60. And we could use that $60. If someone was willing to sell me one, I guess we could say one of the units, or one of the securities for $30, now with $60, we can buy two of the units. So we could buy two of them for $30. And why did I end up making the math work so we'd get two securities? Because we split the upside, right? We split the upside with the Treasury. So in order to set up a situation where I get all of the upside that I would have gotten with a $30 security, I essentially have to set up a configuration where we buy twice as many securities. I buy twice as many securities, and then I split the upside 50-50 with the Treasury, then I'm just going to get the upside. You could almost view it on one security. Let's see how the math works out now. Let's do a bunch of scenarios. So in the world where-- maybe I should do a table. Yeah, let's say that the eventual value of the security, let's say it's worth-- I'm going to make a bunch of numbers up. 0, 10, 20, 30, 40, 50, 60. That's good enough. So let's say that these securities end up being worth nothing. How much am I left with? What's the total value of my total investment? Well if these are worth nothing, then I get wiped out here. We all get wiped out here. In fact, everyone gets wiped out here. So how much did I lose? Well my $4.50 is gone. This goes to 0. But what is my total investment left with? I still have my $25.50 that I put to the side, right? So I still have my $25.50 in cash. If each of these securities are worth $10, this is eventual value of each of the units. So if each of these is worth $10, then the whole asset side of this balance sheet is worth $20, and once again, the Fed is going to take a $31 hit. And these two guys are wiped out. So my investment is worth nothing. But I still have that money I set aside in the bank. $25.50. If these securities are worth $20, then this whole asset side is worth $40, because there's going to be two of them. The Fed is still taking a hit. Doesn't get all its money back. And these two guys still get wiped out. My $4.50 is gone. I still have my money in my bank. $25.50. If this security is worth $30, which is essentially the price that we're paying for it. Then this is what the balance sheet is going to look like. So my equity is worth $4.50. But I have $4.50 plus the money that I had set aside, right? I have $4.50 plus this $25.50 that I'd put aside in the bank. Because I didn't have to invest that. I just had to invest the $4.50 initially. So I have my $4.50 here, plus $25.50. So the value of all of my investments is $30. What Happens if each of these units are worth $40. If each of these are worth $40, then we have $80 on the left-hand side of the balance sheet. So let me draw that really small here. So then we'll have two units that are worth $40. That's $80. We owe $51 to the Fed. So we're going to have $29 to split between the Treasury and ourselves. $29 divided by 2 is $14.50. We're each going to split that $29. So my equity is now worth $14.50. So my total investment is going to be the cash that I put aside-- so that's, let's say, $25.50. Plus the value of my equity investment now. So that's plus $14.50. And so it's worth $40. I think you see the pattern here. In all of these kind of downside scenarios, the most I lost was $4.50. And now in all of these upside scenarios, we're going to see that I get the value of the actual security. Now let's do it for $50, but I think you know how the math's going to work out. If each of these ends up being worth $50, then this whole left-hand side is $100. We owe the Fed $51. So this is going to be $49. And if you split that, it's $24.50. The money we set aside in the bank is $25.50. And so this is worth $50. And, likewise, if these are each worth $60, this is going to turn out to be $60. So what you see here, and I'm going to draw a payoff diagram. Let me draw a line here. Let's see if I can do this right. So if this is the eventual value of the asset. When we pay something in the market, we're hoping we're buying it for less than its real value, but we really don't know 100% what the eventual value is. But this x-axis is the eventual value. So it could be 10, 20, 30, 40, 50, 60, and so on and so forth. So depending on this eventual value, what is the value of my investment? So we figured out if it's 0, 10, 20, all the way really up to-- The value of my investment is going to be-- I didn't have to draw this stuff down here-- let's say that this is $24.50. So in all of these scenarios-- whoops, trying to draw a line-- so 20, and then at $25.50. If this thing is worth-- We could figure out the break-even, right? If these assets are worth anything more combined than $51, then we start to have value to the equity. So what's that value? That's this divided by 2 is $25.50. So after $25.50 some value starts going to the equity. And we know at $30-- let me draw those points, actually. I'll do it in a different color when we're in the money. So at $30, the value of our security is 30. At $40, the value of our security is 40. And so on and so forth. And let me draw a line now. That's not what I wanted to do. I'll just draw a regular line. Our payoff would look something like this. This is a good visualization for what the government is giving us. And I'll show you that what they're giving us is essentially insurance, or a put option for free. And then we can talk in the next video about how we can value it. And then we have a real sense of what the government is handing over to the investor. Now, you might say that it's handing it to the investor, but if because of this the investor overpays for the asset, that subsidy is really going to the person selling the asset. And we'll talk about that a little bit more in the next video. But let me just finish this up a little bit. So we said that the point at which we start making money is here. Because this is what we paid for the security. We're paying $30 for the security. So these are all the scenarios where we start making money. Where the security's worth more than that. But the equity's actually worth something above $25.50, but we're still taking a slight loss. But the cool thing is, if we are the private investor here, even if the thing is worth very little, we don't take that much of a loss here. And this is much better. What would the payoff diagram have looked like if we were just a straight-up investor? Let me just draw that in a different color. Well then it would've looked something like this. We would have had the same upside. But our downside would've gone all the way to 0. If the asset is worth 0, we would have been worth-- well, these lines were supposed to be on top of each other. But I think you get the idea that the government is saving us from these losses right here. Oh, I think you can't see it. I'm off the screen. The government's saving us from these losses right there. And so I'm out of time in this video. In the next video, I'm going to actually analyze what that subsidy or what that insurance or that option that the government is giving us, what it might be worth. And then we could think about whether now people are willing to actually overpay for these things. See you in the next video.