Friday, January 28, 2011

"Less Than a 3 Percent Drop in Asset Values Could Wipe Out Wall Street"

It's all about leverage.  I've been waiting for this public quote for 2 1/2 years.  It's very simple math.  And it's also the key to understanding the crisis and why all of the banks are insolvent. You've heard it several times here before.  Henry Paulson, when he was still CEO of Goldman in 2004, successfully lobbied the SEC to change the rules on capital ratios.  Leverage exploded from a previous limit of 12:1 to beyond 40:1 for all 5 firms, and when you consider that a substantial portion of the assets were synthetics then the real leverage numbers were much higher.
By the way, reinstating the pre-2004 rules of 12:1 would go a long way toward a financial fix and yet it was left undone by Dodd-Frank, which only required that the Federal Reserve undertake a study of capital ratios and report findings to Congress.  That will certainly solve the problem.
Back to the math.  In a world of 40:1, assets don't have much downside.  Consider what this means in a simple example.
  • If your collective assets drop in value from 100 to 97, you're done.  Toast.  Game over.  At least that's how it's supposed to work.
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1 comment:

  1. It already happened .
    acording to these maths the financial system are black toast already since 2008.

    The extra money printing are only postscipt notes for smoothing over and drawing out the timing of the final collapse of the toasted by looting the assets of the middle class.


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