Learn about Bailout 7: Bank goes into bankruptcy Video

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Learn about Bailout 7: Bank goes into bankruptcy

So the example of the bank we’ve been studying, we actually kind of doing it in real time and I was doing this on the fly. We actually showed how this bank got “bailed out” and I got bailed out by this 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 debts. So they just kind of held fast, they didn’t sell their CDOs. They couldn’t get any other loan to pay off this loan. But what they were able to do is to convince some foreigners who are 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 use to have 500,000,000 shares, the company issued another 2,000,000,000 shares, sold them at $1.50 per share and they got $3,000,000,000 for it. And then so you have $3,000,000,000 in cash, we had a billion before so now we have 4,000,000,000. We could pay off the loan with 3,000,000,000 of the cash and then were left with $1 billion left. And now this company would have, let’s see if we have a billion cash and 4,000,000,000 of CDOs it would think that it has $5 billion of assets if this are really worth the $4 billion. It has no liabilities so it has $5 billion of equity. Notice the equity doesn’t change, when you take some of you’re assets and you get what your if when you, if you get the value of the assets if you think they’re worth it and you pay out some liabilities, it doesn’t change the value of your equity. But what’s happen now, well one this is just to get comfortable with some of terminology. This company now is completely di levered because it has no liabilities, it has no debt and its assets are equal to its equity and you’ll find that a lot of companies that are start ups and technology companies, lots of those have very little debt and so their completely levered. Anyway, that was just aside but this was an example of how a company could get bailed out. And who lost here, well the share holders lost, right. Because before, there’s only 5,000,000,000 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 would believe that this are really worth 4,000,000,000, they went from $4.00 to $2.00. And I think this is an important aside here because I know I’ve mentioned before that me on this, the market price when you buy or sell a share is just transacting between another person who used to be holding that share, right. So how does it affects the company? Well it affects the company when the company needs to raise more money and that’s what happens in this example. The company had to raise more money, you have to go to this maybe it was the government of Singapore’s savern well fund and they say government of Singapore please invest in us. Buy some of our shares and when the government of Singapore went any investor, wants to buy new shares they use the market value, what that’s stock is trading at as a good reference point for what you might have to pay for those shares. Often times if it was 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 this is a lucky opportunity to get such a large number of shares and essentially take control of the company, I might pay a little premium over it so I’ll pay $2.00 per share, which was a little bit of a premium over the market value of the time, which was a dollar. But anyway, that’s why the market price of something in the secondary markets worth a share is a 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 fare market value of a company shares. But anyway, this was the situation where the company gets bailed out. But what happens in the situation where it doesn’t get bailed out. Let’s do that, let’s say that the sovern well fund never happened, let me clear this let me see if I can. So the assets, I’ll write assets had billion dollars of cash 1000000000 of cash and we have this 4,000,000,000 of CDOs for a total of $5,000,000,000, the liabilities. See we had a loan C is coming due for $3,000,000,000 and then you have the equity which is essentially the total assets minus the liability, so that’s $2,000,000,000 and that split amongst 500,000,000 million shares, right and that tells you that the book value per share is $4.00 of book value per share. Were not going to wire you right now with the market value of the shares are. So let’s say they shop everything around, all of this sovern well funds they’ve got burned because the investment in Citibank last year and the stock just continue to plummet, they invested in all of that and it gives us you know, Merrill Lynch, all of this they invested in and they just continue to plumb it so they’ve been burned, they don’t want to be the last guy holding the potato. So there’s no one whose willing to invest equity so just forces the issue, this people loan C they say you know what were not going to give you new loan, you can’t pay this loan because even if you sold this CDO’s you only getting a dollar for them. So were going to force you into bankruptcy and that’s how bankruptcy happens when what when you break one of the, they call it their covalence with one of the people who lend you money. When the covalence say if you don’t pay alone within this amount of time or if some other thing happens to you’re financial, you are then declared insolvent and you go into bankruptcy. And what happens in bankruptcy? Well in bankruptcy, either the bankruptcy courts takes receivership of all of you’re assets. So the bankruptcy courts take receivership of all of the assets and they just say okay were going to, this is what you own and you might get some were not going into the details now maybe do a whole serious 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 if are they just going to restructure you’re liabilities or they just going to dissolve you because you’re not a viable entity anymore. But anyway, the bankruptcy could take hold of you and essentially let’s assume that they’re going to dissolve you. They would then split you amongst the stakeholders, the people who you might do. And actually now let’s say that they dissolve, let’s say that everyone agrees that this brand is worth a lot whatever we call it Goldman Lynch or Sachs, whatever our brand is, it’s worth a lot no one want to see disappears. So what happens when you go in a bankruptcy? Well the creditors get first debs in everything. So one way to think of it is loan C gets first debs on the assets and then anything that’s leftover goes to the equity holders. So let’s say the loan C guys, they say you know what we like this , we want to keep this bank as ongoing entity but what we want to do is we don’t, let’s just, we just want to dump this CDO’s so the bankruptcy court, okay yeah we’ll liquidate the CDO’s just because everyone agrees that they’re really shady. So they sell them and they only get a billion dollars for them. So they get a billion dollars for the CDO’s so now we have two billion dollars of assets. So essentially, two billion of cash right could have got a billion cash for those. So if two billion of cash, that’s all at the risk plus there’s I mean there’s probably some buildings and all that which were not listing here but there’s a brand and all of that. So this guy all three billion dollars, so he says okay fine, you know what I’m going to do, I’m going to keep this company running, I mode two billion dollars, I’m going to keep that two billion dollars in there but what I get is essentially I get all of the new shares of the company. So what essentially the bankruptcies 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 hundred million shares. So essentially create a new entity where the new entities say has two billion of assets, two billion of cash and let’s say it has no debt or actually maybe this people to say you know what well even give you some money because this are the people, I don’t wan to confuse things. So let’s say that you don’t have debt so you have two billion of equity and let’s say that there are hundred million shares. So the book value of the new shares is $20.00 per share and you might say wow that’s great someone couldn’t get these shares for whatever they were, eyes are they trading for it before, they could have gotten $4.00 per share before. Now they were $20.00 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 capillaris, when you tried to value the company what was we didn’t liquidated because were saying we still want to create, we still want the company to continue its operations. But were saying that the value of the company is only two billion, this guys ode three billion dollars. 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 there shares and the equity holders get wiped out, the old equity holders. So those shares go to zero and so this is an interesting example because I’ve seen people on CNBC say, oh what a great deal I could buy shares of Limon brothers for a dollar, right. But that’s not the case because they say—versus all of these assets and its never going to completely disappear. That might be true to some degree but Limon brothers assets might be greater than this liabilities, which means that its equity is actually worth negative. So that dollar is into great deal. If you really though that Limon bothers in a long term is going to come back, what you might want to do is somehow try to become one of its bond holders 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 its called Goldman brothers or whatever. Anyway, I realize I’m out of time and in the next video, I’m going to put it all together and show you, one why are financial system is freezing and two, what the government’s bail out is attempting to do see you in the next video.

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So the example of the bank we’ve been studying, we actually kind of doing it in real time and I was doing this on the fly. We actually showed how this bank got “bailed out” and I got bailed out by this 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 debts. So they just kind of held fast, they didn’t sell their CDOs. They couldn’t get any other loan to pay off this loan. But what they were able to do is to convince some foreigners who are 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 use to have 500,000,000 shares, the company issued another 2,000,000,000 shares, sold them at $1.50 per share and they got $3,000,000,000 for it. And then so you have $3,000,000,000 in cash, we had a billion before so now we have 4,000,000,000. We could pay off the loan with 3,000,000,000 of the cash and then were left with $1 billion left.

And now this company would have, let’s see if we have a billion cash and 4,000,000,000 of CDOs it would think that it has $5 billion of assets if this are really worth the $4 billion. It has no liabilities so it has $5 billion of equity. Notice the equity doesn’t change, when you take some of you’re assets and you get what your if when you, if you get the value of the assets if you think they’re worth it and you pay out some liabilities, it doesn’t change the value of your equity. But what’s happen now, well one this is just to get comfortable with some of terminology. This company now is completely di levered because it has no liabilities, it has no debt and its assets are equal to its equity and you’ll find that a lot of companies that are start ups and technology companies, lots of those have very little debt and so their completely levered. Anyway, that was just aside but this was an example of how a company could get bailed out. And who lost here, well the share holders lost, right. Because before, there’s only 5,000,000,000 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 would believe that this are really worth 4,000,000,000, they went from $4.00 to $2.00. And I think this is an important aside here because I know I’ve mentioned before that me on this, the market price when you buy or sell a share is just transacting between another person who used to be holding that share, right. So how does it affects the company? Well it affects the company when the company needs to raise more money and that’s what happens in this example. The company had to raise more money, you have to go to this maybe it was the government of Singapore’s savern well fund and they say government of Singapore please invest in us. Buy some of our shares and when the government of Singapore went any investor, wants to buy new shares they use the market value, what that’s stock is trading at as a good reference point for what you might have to pay for those shares. Often times if it was 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 this is a lucky opportunity to get such a large number of shares and essentially take control of the company, I might pay a little premium over it so I’ll pay $2.00 per share, which was a little bit of a premium over the market value of the time, which was a dollar.

But anyway, that’s why the market price of something in the secondary markets worth a share is a 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 fare market value of a company shares. But anyway, this was the situation where the company gets bailed out. But what happens in the situation where it doesn’t get bailed out. Let’s do that, let’s say that the sovern well fund never happened, let me clear this let me see if I can. So the assets, I’ll write assets had billion dollars of cash 1000000000 of cash and we have this 4,000,000,000 of CDOs for a total of $5,000,000,000, the liabilities. See we had a loan C is coming due for $3,000,000,000 and then you have the equity which is essentially the total assets minus the liability, so that’s $2,000,000,000 and that split amongst 500,000,000 million shares, right and that tells you that the book value per share is $4.00 of book value per share. Were not going to wire you right now with the market value of the shares are.

So let’s say they shop everything around, all of this sovern well funds they’ve got burned because the investment in Citibank last year and the stock just continue to plummet, they invested in all of that and it gives us you know, Merrill Lynch, all of this they invested in and they just continue to plumb it so they’ve been burned, they don’t want to be the last guy holding the potato. So there’s no one whose willing to invest equity so just forces the issue, this people loan C they say you know what were not going to give you new loan, you can’t pay this loan because even if you sold this CDO’s you only getting a dollar for them. So were going to force you into bankruptcy and that’s how bankruptcy happens when what when you break one of the, they call it their covalence with one of the people who lend you money. When the covalence say if you don’t pay alone within this amount of time or if some other thing happens to you’re financial, you are then declared insolvent and you go into bankruptcy. And what happens in bankruptcy? Well in bankruptcy, either the bankruptcy courts takes receivership of all of you’re assets. So the bankruptcy courts take receivership of all of the assets and they just say okay were going to, this is what you own and you might get some were not going into the details now maybe do a whole serious 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 if are they just going to restructure you’re liabilities or they just going to dissolve you because you’re not a viable entity anymore.

But anyway, the bankruptcy could take hold of you and essentially let’s assume that they’re going to dissolve you. They would then split you amongst the stakeholders, the people who you might do. And actually now let’s say that they dissolve, let’s say that everyone agrees that this brand is worth a lot whatever we call it Goldman Lynch or Sachs, whatever our brand is, it’s worth a lot no one want to see disappears. So what happens when you go in a bankruptcy? Well the creditors get first debs in everything. So one way to think of it is loan C gets first debs on the assets and then anything that’s leftover goes to the equity holders. So let’s say the loan C guys, they say you know what we like this , we want to keep this bank as ongoing entity but what we want to do is we don’t, let’s just, we just want to dump this CDO’s so the bankruptcy court, okay yeah we’ll liquidate the CDO’s just because everyone agrees that they’re really shady. So they sell them and they only get a billion dollars for them. So they get a billion dollars for the CDO’s so now we have two billion dollars of assets. So essentially, two billion of cash right could have got a billion cash for those. So if two billion of cash, that’s all at the risk plus there’s I mean there’s probably some buildings and all that which were not listing here but there’s a brand and all of that.

So this guy all three billion dollars, so he says okay fine, you know what I’m going to do, I’m going to keep this company running, I mode two billion dollars, I’m going to keep that two billion dollars in there but what I get is essentially I get all of the new shares of the company. So what essentially the bankruptcies 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 hundred million shares. So essentially create a new entity where the new entities say has two billion of assets, two billion of cash and let’s say it has no debt or actually maybe this people to say you know what well even give you some money because this are the people, I don’t wan to confuse things. So let’s say that you don’t have debt so you have two billion of equity and let’s say that there are hundred million shares. So the book value of the new shares is $20.00 per share and you might say wow that’s great someone couldn’t get these shares for whatever they were, eyes are they trading for it before, they could have gotten $4.00 per share before. Now they were $20.00 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 capillaris, when you tried to value the company what was we didn’t liquidated because were saying we still want to create, we still want the company to continue its operations. But were saying that the value of the company is only two billion, this guys ode three billion dollars. 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 there shares and the equity holders get wiped out, the old equity holders. So those shares go to zero and so this is an interesting example because I’ve seen people on CNBC say, oh what a great deal I could buy shares of Limon brothers for a dollar, right. But that’s not the case because they say—versus all of these assets and its never going to completely disappear. That might be true to some degree but Limon brothers assets might be greater than this liabilities, which means that its equity is actually worth negative. So that dollar is into great deal. If you really though that Limon bothers in a long term is going to come back, what you might want to do is somehow try to become one of its bond holders 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 its called Goldman brothers or whatever. Anyway, I realize I’m out of time and in the next video, I’m going to put it all together and show you, one why are financial system is freezing and two, what the government’s bail out is attempting to do see you in the next video.

Transcription by: Scribe4you Transcription Services