Thursday, January 29, 2009

Following is an excerpt from the conversation I had with my friend where he explains Lehmann crash. Just thought it could be useful to other duds like me!

11:39 PM Anirudh: hanji
ab batao
wht do u wanna knw?
me: everything
11:40 PM Anirudh: the question
ek baar phir se bolo
me: need someone who can explain to me the economic crisis and lehman bros. crash story
11:41 PM Anirudh: okies
see this is how it all started
me: ok
11:42 PM ??????????
11:43 PM Anirudh: well.... going abt a decade bk
housing as a sector started to cm up big time in the US
primarily prompted by availablity of cheap credit
11:44 PM me: ok
Anirudh: people who cud afford it brought houses not jus whr they cud stay
bt also for investment purposes
with the over all economy doing gud thr was a fresh breed of rich ppl tht were hitting the mkt on a regular basis
11:45 PM coz of which the demand for these homes jus kept increasing
me: ok
Anirudh: banks were booming
me: do u have a headfone?
Anirudh: and ppl who had brought it for inv pruposes jus kept getting richer
i do
bt tht wudnt work untill 12
11:46 PM me: ok
Anirudh: voice chat is banned till midnight
me: oh!
achcha den
Anirudh: u wanna wait?
me: well lets finish
i ll ask u ques if i have ne later on
Anirudh: sure sure
11:48 PM me: den?
11:49 PM Anirudh: so every one wanted a share of this housing book
nt jus tht ppl frm US
bt else whr as well
and tht prompted the creation of entities like lehmann bro's
11:50 PM who wrote contract notes saying tht
as long as a select group of ppl continue to pay their emi's
thr wud b an x% of these emi's which'd get paid to ppl who invest in such sontracts
and to do so they started buying over the loans from banks
11:51 PM me: matlab?
Anirudh: c i m lehmann
i hv 100 cr's
i go to icici bank
11:52 PM n say i wanna buy over ur loan portfolio worth 100 cr's
so frm next mth...the emi's tht this ppl wil pay
will come to me n nt go to ur bank
me: nd why will you do tht?
11:53 PM Anirudh: m coming to tht
me: ek min
loan portfolio matlab
Anirudh: yeah
me: icici bank jo loan logon ko deta hai?
Anirudh: icici bank wud hv distributed loans worth 100 of cr's
me: u take over that so that emi and interest comes to u?
Anirudh: of which i wanna buy over jus 100 cr's
11:54 PM me: hmm
Anirudh: yeah
besides... given tht icici is getting their money bk b4 time they r ok giving a discount
11:55 PM me: ohk....
Anirudh: so i get 110 cr's worth of loans
for 100 cr;s
me: with intrst?
11:56 PM Anirudh: ofcourse
me: ok
11:57 PM Anirudh: nw i hv a loan book of 110 cr's
n i knw i;d get an EMI worht "x" frm it every mth
me: ok
11:58 PM den
12:00 AM Anirudh: so i create a contract.... and attract investors worth 110 cr's
so i hv an aimmedaite profit of 10 cr;s on my investment
and all i need to do is distribute the money i get frm the EMI's amongst the ppl who hv invested with me
12:01 AM me: errr
one query
Anirudh: go one
me: why do i need outside investors?
12:02 AM Anirudh: coz i wanna make more money frm my investment
n i wanna do the same thing again n again
bt i had jus 100 cr's which i hv already invested
me: oh...
k but isnt it foolish?
12:03 AM Anirudh: foolish?
u make 10 cr's on 100 cr's in less than a week
which is 10% absolute
in annualised terms v r talking of over 12000% returns
12:04 AM me: greek!!!
Anirudh: n plus i;d chanrge a fees to my investors
so this is hw it started
n then ppl got greedier
n then they said
12:05 AM the asset v r talking abt is a house.... which is rock solid
and so my investment is never at risk
so let me go and give loans to ppl with a bad credit history
n in return charge a higher interest
me: ok
12:08 AM Anirudh: things kept moving the way ppl had expected for abt 7-8 yr's
me: ohk
Anirudh: n then cost of funds started to rise up
coz of which interest rates moved up
me: what is cost of funds?
Anirudh: the EMI amount moved up as a result
the rate at which a bank sources funds
12:09 AM me: repo rate jaisa?
Anirudh: nah nah
repo is the rate at which rbi borrows
12:10 AM this is the rate at which a bank borrows
me: borrows?
Anirudh: more like fd rates
me: rbi borrows from whom?
sorry i hve no idea
Anirudh: tht's ok
12:11 AM so when the interest rates moved up
me: arre
hw did cost of funds increase?
12:12 AM Anirudh: well.... coz the supply of money in the economy went down
equity mkts were doing equally gud
n ppl found in better to invest in equities rather than invest in fixed deposits
n so the money at the banks disposal went down
me: equity matlab share market?
12:14 AM Anirudh: yeah
me: ok
Anirudh: so as interest rates went up
emi;s went up
me: so ppl cudnt repay
Anirudh: n tht's when defaults hapenned
12:15 AM with the first series of defaults the whole system was shook up
as they had never expected it to happen
me: ok
Anirudh: so this so called SAFE instrument suddenly became UNSAFE
me: hw ws it safe?
12:16 AM didnt dey knw that cost of funds cud go up?
Anirudh: well.... they nevr expected the ppl who took loans to default so easily
12:17 AM infact the whole systtem was based on this assumption tht they wudnt default
12:18 AM me: ok... but even if ppl didnt repay... the bank cud still get hold of their property......
Anirudh: this instrument was considered so safe
tht even banks... pension funds.... insurance companies had investmnt into it
tht's wht they eventually did
bt then the volume of ceasars went so high
12:19 AM tht suddenly thr was a big supply of second hand property in the mkt
as banks had sell this property... they cudnt hv sat on it
this prompted the decline in real estate prices
me: i didnt get this part
Anirudh: n this is y u c those mamoth melt downs
c.... price for any things is controlled by demand and supply
12:20 AM me: ya
no the part where second hand property comes in
Anirudh: so property prices were going up as demand was more and supply was less
n suich contract's were written at every level
so as defaults mounted
12:21 AM banks had more and more properties tht they had seazed
me: so wasnt it gud fr dem?
Anirudh: gud? well banks need money nt properties
me: sell them
Anirudh: n so they had to sell the properties which they had seazed to realize funds
12:22 AM me: ok ok
at a same price or higher?
Anirudh: well... u dont command the price when u jus wanna get rid of some thing
n in a situation whr every one wants to get rid of their property
12:23 AM who'd pay a higher price
so prices started to fall
and this is when asstes which were valued at 100 cr's were suddenly nw valued at 50 cr's
so 50 cr's of a write down
12:24 AM me: k
Anirudh: n this is it
rest u c and hear in the news
me: cripple down effect yeh hai?
12:26 AM Anirudh: yep
wht comes down.... keeps coming down
gravity ;)
me: oh
so it is basically gravity
the problem
12:27 AM Anirudh: hehehe

1 comment:

  1. An Intelligent person's guide to Financial crisis !!!