[HN Gopher] Demystifying financial leverage ___________________________________________________________________ Demystifying financial leverage Author : arkadiyt Score : 184 points Date : 2022-11-11 17:16 UTC (5 hours ago) (HTM) web link (bam.kalzumeus.com) (TXT) w3m dump (bam.kalzumeus.com) | ilaksh wrote: | Its just pretentious BS used as a smokescreen for _gambling with | your money_. | | What has happened with FTX is a demonstration of the value of a | block chain and the concept of user-controlled wallets versus | banks. FTX did what banks do, which is to take a cut of | transactions, and especially use customer funds to make bets | (that eventually they could not cover, even with all of your | funds). | | Using centralized exchanges to speculate is a ridiculous | perversion of the concepts in cryptocurrency. | | The basic advances of cryptocurrency are: | | 1) digital signatures used in transactions rather than disclosing | secrets such as credit card numbers | | and | | 2) a public ledger that is cryptographically verified with chains | of blocks | | Decentralized exchanges are probably usually also often nonsense | speculation, but if done right they can at least benefit from 2 | which means you can see what they are doing and not be surprised | at the last second about some secret "over-leveraging". | [deleted] | barrkel wrote: | > _FTX did what banks do, which is to take a cut of | transactions, and especially use customer funds to make bets_ | | Their terms of service didn't give them the right to do this, | as I understand it. | | > _None of the Digital Assets in your Account are the property | of, or shall or may be loaned to, FTX Trading;_ | wonder_er wrote: | Hilariously, this is _precisely_ what "fractional reserve | banking is". | | https://www.federalreserve.gov/monetarypolicy/reservereq.htm | | The banks have a zero-percent reserve ratio allowing them to | "loan out" (and have deposited in their own bank as new | funds) 100% of the 'digital assets' in their account. | ilaksh wrote: | This is why actually if people can understand what's | happening and what cryptocurrency is, this is another | incident that is a very good advertisement for | cryptocurrency. | | Because actually the idea is that instead of relying on some | third party to follow some words on paper, you trust math and | computer science. You don't need the third party at all for | most things, just use you own cryptocurrency wallet. | | For more complex things, we can use smart contracts, which | are not based on trust but actual math. The program being on- | chain literally makes it impossible for them to | misappropriate funds (at least without the details being in | public and reviewable beforehand). | btilly wrote: | Things that regularly go wrong in cryptocurrency go wrong | in cryptocurrency and that is an argument for using | cryptocurrency??? | | I couldn't make this up! | | As for the "smart contracts", nobody who is familiar with | programming bugs would want there not to be better checks | and balances there. The depressing frequency of 8 figure | hacks of the terms of said contracts is a concrete | demonstration of this principle. Thanks, but no thanks in | anything like its current state. | | For most users, traditional finance is faster, cheaper, and | safer in practice than crypto. Which is exactly why the | main use cases for crypto are speculation, money | laundering, and various illegal activities like paying | ransoms for ransomware attacks. | ilaksh wrote: | I have written and effectively used many smart contracts, | although not for speculation. | | There is constant abuse of customer funds, as a matter of | course, by banks. It generally is less public or visible | though than public ledgers (blockchains). | | Its the difference between trusting a company that is | trying to profit just from holding your funds in ways | that you cannot audit, versus trusting a math and | computer programs that you can audit. | | There have not been more abuses by cryptocurrency | exchanges than banks overall. They are just more recent. | But what I am saying is that these cryptocurrency | exchange companies really don't have anything to do with | cryptocurrency -- their business model is antithetical. | hindsightRegret wrote: | ...may not be loaned to, FTX Trading. They could lend it to | any other entity though, like Alameda. LOL | jldugger wrote: | > Its just pretentious BS used as a smokescreen for _gambling | with your money_. | | No, it's pretentious BS used to make more riskier, assymmetric | gambles. | kibwen wrote: | _> digital signatures used in transactions rather than | disclosing secrets such as credit card numbers_ | | Credit cards also offer this. I can go to my CC's website and | generate virtual cards which can be handed to vendors and | individually managed, frozen, or deleted, all without exposing | my actual card number. | wizeman wrote: | You're still exposing your virtual card number which gives | permission to charge money from your actual credit card. | Normal credit cards can also be individually managed, frozen | and deleted but that doesn't prevent unauthorized charges. | kibwen wrote: | Deleting a virtual card is tremendously easier than | revoking my primary credit card number and updating all the | vendors that are using it. It's quite easy to use a virtual | card once and then delete it immediately. Furthermore, I'm | not worried about a virtual card being exposed to | unauthorized charges, because (unlike in cryptocurrency- | land) chargebacks exist. | ilaksh wrote: | In cryptocurrency land there is no such thing as an | unauthorized charge because you don't ever give a third | party access to information that can be used to charge | funds, which you have to do constantly with credit cards. | aaronharnly wrote: | Unless you do, right? | | > Since token approval requests usually ask for unlimited | access to your token balance, if there is a security | vulnerability, all of the assets in your wallet could be | exposed. Depending on how severe the security | vulnerability is, disconnecting your wallet from a dapp | may not be enough to fully protect your assets. | | https://help.coinbase.com/en/wallet/security/dapp- | permission... | boring_twenties wrote: | FWIW, even when they request unlimited access, you can | set whatever limit you want. In MetaMask, the defacto | standard wallet, you simply just edit the field that | appears in the request/confirmation dialog. | ilaksh wrote: | Exactly.. of course we still have very significant | problems to solve. | | Such as the fact that most of these cryptocurrencies are | totally impractical to use for actually buying things, | leading to the need to use centralized exchanges for | swapping to fiat. | | And the fact that there are multitudes of competing | cryptocurrencies. And that there is a fundamental lack of | integration with government due to government actually | needing to radically reform and advance to incorporate | cryptocurrency. | | But still, they are core advancements that society should | take advantage of. Easier said than done. | wizeman wrote: | > Deleting a virtual card is tremendously easier than | revoking my primary credit card number and updating all | the vendors that are using it. It's quite easy to use a | virtual card once and then delete it immediately. | | Still harder and not as secure as a digital signature. | | > Furthermore, I'm not worried about a virtual card being | exposed to unauthorized charges, because (unlike in | cryptocurrency-land) chargebacks exist. | | You're not guaranteed to perform a chargeback | successfully. And both vendors and customers (like you) | are paying for that "service". | | Chargebacks are also one of the reasons for why there is | large-scale credit card fraud. And it is also why vendors | are incentivized to collect personal information from you | (to detect fraud before chargeback happens, for which | they are greatly penalized) and why they are also | incentivized to refuse service to legitimate customers in | many cases (due to flagging legitimate transactions as | suspicious). | | Worse, when they refuse service they cannot even tell you | why (as that would help fraudsters). | kibwen wrote: | _> You 're not guaranteed to perform a chargeback | successfully._ | | Even in the worst case, because a credit card is an | abstraction over my bank account, I have the option to | refuse to pay and won't lose my shirt or otherwise become | despondent. In the meantime, chargebacks are a feature of | the system, not a bug. To wit, cryptocurrency advocates | are the last people who should go around lecturing others | about fraud. :P | wizeman wrote: | > Even in the worst case, because a credit card is an | abstraction over my bank account, I have the option to | refuse to pay and won't lose my shirt or otherwise become | despondent. | | That may also have unintended consequences for victims of | credit card insecurity. | | > To wit, cryptocurrency advocates are the last people | who should go around lecturing others about fraud. :P | | Why not? Cryptocurrency advocates know a lot more about | it than most people (for good and bad reasons). | mritchie712 wrote: | can be a useful feature (in some scenarios) that crypto is | permissionless (unlike the bank that has to approve vendors, | limits, nations, etc.) | ilaksh wrote: | Sure but that's a workaround for a fundamentally outdated | system. | kibwen wrote: | Where "outdated" and "workaround" here means that it | integrates with existing payment processors and therefore | works with 99% of the things that you want to buy. There's | nothing unique about cryptocurrency solutions in this case | that traditional credit cards cannot achieve, and any | fancier solution just means that you can't actually use it | anywhere. | paxys wrote: | There is nothing inherently wrong with banks lending out your | deposits. This system is how a majority of new businesses are | funded and how the economy expands. There are a mountain of | regulations that banks have to keep up with and the reason why | FDIC insurance exists. Investors entering the crypto space | willingly rejected these regulations and are now finding out | their purpose the hard way. | wizeman wrote: | > There is nothing inherently wrong with banks lending out | your deposits. | | There wouldn't be anything inherently wrong with it 1) if | they didn't do it by default 2) if banks informed their | customers appropriately, including the risk in doing that | (most people don't know what banks do with their funds) and | especially 3) if it wouldn't be forced, i.e. if they would | let customers choose to keep their funds segregated if they | are not willing to take the inherent risk in lending and/or | the bank mismanaging their funds (e.g. having the option to | have both segregated and normal checking/savings accounts or | whatever), so that customers would never be exposed to losing | whatever amount they didn't want to (including anything above | the FDIC insured amount). | | But sure, allow customers to lend their money and expand the | economy if they want to. With an appropriate reward for the | risk, not a laughable 0% interest rate, which almost nobody | would ever take willingly. In fact, the 0% interest rate, or | anything below or close to the inflation rate, is a clue | which indicates that what they're doing to their customers is | wrong and that the customers aren't choosing to take that | risk knowingly and voluntarily. | | > There are a mountain of regulations that banks have to keep | up with and the reason why FDIC insurance exists | | You say that like it's a good thing. It's massively | inefficient and both "a mountain of regulations" and FDIC | insurance are inherently unfair (for several reasons) and | have many unintended (negative) consequences. | | And it doesn't even actually fix the problem, it just makes | it less likely to occur (for starters, because there ends up | being much less competition than there would be otherwise -- | less banks, less bank failures) but when it occurs, it's an | even bigger problem. Which means it also gives a false sense | of security. | makestuff wrote: | Yeah especially after 2008. I heard a joke from someone who | works at a big bank that after 2008 there are 2 compliance | people for every one banker. People in finance like to make | fun of the "back office" but they seem to be main reason the | bank stays solvent. | ilaksh wrote: | It's similar to the situation with credit cards. There is a | whole industry related to working around the problem of | constantly disclosing the secrets, such as refunding stolen | funds. | | Likewise we have had to rely on banks to control digital | money since we did not have a good alternative. And now there | are many regulations and compliance officers etc. dedicated | to preventing people from cheating, stealing, or | irresponsibly using customer funds. | | But at the core level the problem is that these the bank | ledgers are secret, difficult to verify or connect together | for tracing purposes. Cryptocurrency means using math and | computer science to solve these types of problems in a | holistic way. | | Like everything else, people have abused this technology | (such as using it to sell services that are antithetical to | the core concept). But that doesn't mean they aren't | important advances. | spyremeown wrote: | Off-topic, but can somebody recommend me a book on economics? I | need to learn how things generally work in the world and how to | manage my money. I'm almost 25 and I have zero clue what I'm | doing besides "I need a bigger salary and save more". | manjose2018 wrote: | Economics is supply/demand. | | I would focus on investing, particularly defensive investing. | | 1. 'The Intelligent Investor' By Benjamin Graham 2. 'David F. | Swensen' Unconventional Success: A Fundamental Approach to | Personal Investment | | If you want the easiest allocation possible put some portion of | your paycheck in an S&P500 fund and in 40 years you should have | enough for retirement. | | Good luck! | jacobr1 wrote: | https://www.bogleheads.org/wiki/Getting_started | faangiq wrote: | Tech bros should just stay away from this area. They don't have | the IQ for it. | dang wrote: | Maybe so, but please don't post unsubstantive and/or flamebait | comments here. | pragmatic wrote: | Leverage aside, there is no clearer evidence that we live in a | SciFi dystopia than this article. | [deleted] | [deleted] | jefftk wrote: | _> Interestingly, their customers are also often levered. A | homeowner who has just made their 20% down payment is levered | 5:1._ | | Isn't that only if the homeowner has no other equity or | liabilities? Which is especially tricky when talking about people | who, if we valued them like we value corporations, have equity in | the form of the net present value of their future earnings. | Ilverin wrote: | Well the bank can't get your future earnings or other assets if | you default, but they can get the house. So if the house is | worth zero dollars (never true) then you are 5 to 1 leveraged. | jefftk wrote: | I see: it is true, from the bank's perspective, in the | specific case of mortgages, because they're no-recourse | JumpCrisscross wrote: | > _in the specific case of mortgages, because they 're no- | recourse_ | | This varies jurisdiction to jurisdiction. And it isn't | really germane to the question of quantifying one's | leverage, which is a going-concern analysis. | jefftk wrote: | _> going-concern analysis_ | | But then don't we need to get into evaluating future | earnings? | JumpCrisscross wrote: | > _don 't we need to get into evaluating future | earnings?_ | | Yes, many flow leverage ratios look at this, _e.g._ | interest to Ebit. | jefftk wrote: | That's just a bit of a funny thing to do with a | homeowner, no? | JumpCrisscross wrote: | > _bit of a funny thing to do with a homeowner, no?_ | | This is why mortgage lenders test your debt burden and | interest cost against income. | JumpCrisscross wrote: | > _if the house is worth zero dollars (never true)_ | | There are numerous real-life scenarios where a house is worth | zero dollars. | paxys wrote: | There are numerous scenarios where the house is worth _less | than_ zero dollars. For example when there 's a large | overdue tax bill attached to the property. | NovemberWhiskey wrote: | Or it's in extremely bad repair and will need to be torn | down before you can rebuild on the land. If you look at | listings for land, a surprising number of them are | actually listings for "houses not fit for human | habitation". | selectodude wrote: | The land itself is worth about 35-50 percent of the house | depending on location. So there are never situations where | the value of the house is worth zero. | kgwgk wrote: | The cost of getting rid of the house - or other | liabilities - is sometimes higher than the value of the | land itself. There are situations of zero and even | negative value. | Ekaros wrote: | It is entirely possible for land that house stand on | being nearly valueless. Think of really rural or low | demand area. And on other hand house it self being | expensive to take down. Maybe containing mold or | asbestos. | JumpCrisscross wrote: | > _land itself is worth about 35-50 percent of the house | depending on location_ | | This is not always true. (Trivially: your land is | declared a superfund site. Less trivially: fire sale.) | | > _there are never situations where the value of the | house is worth zero_ | | I guess a decade and a half is all it takes to forget. | KerryJones wrote: | As a Googler, I really enjoy all the Chat-app mockery. | em500 wrote: | This seems a bit too wordy to demystify the concept. Here's a | simpler example. | | 1. Bank A offers you 5% interest for a 1 year deposit. You | deposit $100 of your own money. You are unlevered. Things go well | and after a year you receive $105, a neat 5% return on your | investment. Or things don't go well, bank A turns out to be a | scam and you receive $0, a -100% return. | | 2. Bank B offers you a loan for a year for 4% interest. You | borrow $900, together with your own $100 you deposit $1000 at | bank A. You are levered 1:9. Things go well and after a year you | receive $1050 ($1000+5% interest) from bank A, you repay bank B | $936 ($900 + 4% interest), so you're left with $114, a very neat | 14% return (almost triple the unlevered return). Or things don't | go well, bank A turns out to be a scam and you receive $0. But | now you still owe bank B $936, so together with your own $100 | loss you made a -1036% return. Oops. | | p.s. It's called leverage because (like a physical lever that | allows you to lift something much heavier than without) | supplementing your own funds with lots of borrowed money allows | you to tackle something much bigger than using only your own | money, like buying a house or starting a business or getting 5% | on $1000 instead of on $100. | divbzero wrote: | P.S. It is also called leverage because the same rule of | proportionality applies: With a 10x physical lever, _e.g._ the | lever is 10 cm on one side of the fulcrum and 100 cm on the | other, moving one end of the lever by 1 cm will move the other | end by 10 cm. With 10x financial leverage, _e.g._ you use $10 | of equity (your own money) and $90 of debt (borrowed money) to | invest $100 in assets, an extra +1% return on assets | corresponds to an extra +10% return on equity. | hn_throwaway_99 wrote: | I'm not a fan of your examples because taking on leverage for | fixed income assets is not the most common use of leverage, | precisely because the rewards aren't that much better but the | risks are so high. Also, "being a complete scam" is not the | most common downside risk in leverage. | | I think an easy example nearly anyone can understand is their | mortgage. You put down $50k for a $500k house. The house goes | up just 10% to $550k, if you sell you've doubled your money | after repaying the $450k you've borrowed. Of course, if the | price goes down 10%, you're completely wiped out. | em500 wrote: | Sure, mortgages are the most common example of leverage for | non financial pros. But that's also a reason _not_ to use it | as an example. Because even if they 're levered 9:1 nobody | thinks they're wiped out if their house price goes down 10%, | they'd think they just need to hold on to it till it | recovers. | hn_throwaway_99 wrote: | > Because even if they're levered 9:1 nobody thinks they're | wiped out if their house price goes down 10%, they'd think | they just need to hold on to it till it recovers. | | Amazing how time flies. I'm pretty sure anyone who was old | enough to own a home in 2007/2008 in a "hot" market knows | exactly how mortgage leverage can work on the downside. | rabidonrails wrote: | You could simplify this further by making it a bit more | abstract: | | You have $100 worth of stock in Google. You think Google stock | is going to appreciate so you borrow $50 of my money to buy | more stock. I see that you have $100 worth of Google stock | which provides me with some security that you have a valuable | asset and are a worthwhile borrower. | | But, instead of Google's stock value increasing it starts to | fall. You took my money and I'm getting nervous so I force you | to sell your Google stock. At one point you had $150 worth of | Google stock but now I've forced you to sell your stock for a | total of $75 which allows me to recoup my lent money ($50) plus | my fees and I really don't care how much money you are left | with, if any. | | This is important for the economy because credit (which this | is) helps create growth and drives economies - when credit is | tight then economies grow slowly if at all. | em500 wrote: | Btw, a great, well known quote from John Kenneth Galbraith | (from _A Short History of Financial Euphoria_ ) is: | | _" The world of finance hails the invention of the wheel over | and over again, often in a slightly more unstable version. All | financial innovation involves in one form or another, the | creation of debt secured in greater or lesser adequacy by real | assets."_ | | In the 2008 financial crisis, some have paraphrased this as | "All financial innovation is leverage dressed up as something | different." | shafoshaf wrote: | "I'm not so much interested in the return ON my money as I am | in the return OF my money." -- Will Rogers | NovemberWhiskey wrote: | That's actually a fascinating error that people make with | fixed-income investing; too much focus on safety of | principal vs. actual compounded yield and recovery rate in | the case of default. | [deleted] | asah wrote: | This is just as reductionist as saying that all computers or | programming languages are the same. | | Sure it's true at some level but not a useful distinction if | you're a customer or vendor. | didericis wrote: | It's a useful thing to keep in the back of your head to | inoculate yourself against marketing shenanigans. | | The basic underlying principle of a product/service should | be communicable and relatively universal. The details are | of how it's tailored to your specific situation should come | with cons and unknowns in other situations. | | If it's not communicable and/or sounds like there are no | cons they're not being honest about what it is | (intentionally or unintentionally). | lisper wrote: | There are some useful distinctions to be made. Insurance, for | example, could be seen as "negative leverage", but it really | is a different kind of animal. | askafriend wrote: | > This seems a bit too wordy to demystify the concept. | | Pretty normal for a patio11 post. | theonething wrote: | Was going to say something very similar. His content is | usually great, but the writing style doesn't appeal to me | because of the verbosity. It generally doesn't keep me from | reading them if the topic is interesting to me though. | | Anyways, this is all very subjective and based on personal | preference so it's probably not useful so I'll shut up now. | pooper wrote: | > Was going to say something very similar. His content is | usually great, but the writing style doesn't appeal to me | because of the verbosity. It generally doesn't keep me from | reading them if the topic is interesting to me though. | | I appreciate that patio11 states things that might seem | obvious to someone knowledgeable in a field. It reminds me | of [WP:Obvious] from back when I started using Wikipedia. | It states: | | > State facts that may be obvious to you, but are not | necessarily obvious to the reader. Usually, such a | statement will be in the first sentence or two of the | article. | | https://en.wikipedia.org/wiki/Wikipedia:Writing_better_arti | c... | | This is such a difficult thing to do "correctly" because | there is a danger as you see on the wikipedia link that you | might start stating that the sky is blue. (Meta: Did I just | do that?) This is what patio11 does so well. | | I mean this is pretty early on in the article: | | > Every business has a balance sheet, which contrasts its | assets (valuable things it owns) against liabilities | (valuable things it owes to other people). The difference | between assets and liabilities is equity. | | > Financial businesses will frequently have non-financial | assets and liabilities. Ignore those for the sake of | simplicity. Ignore the nice building, the computers, the | payroll due on Friday for work which has already been | completed. Focus just on the financial assets and | liabilities, things like "mortgages our bank owns" (asset) | and "deposits from customers" (liability). | | > Leverage is the ratio of your liabilities to your equity. | Simple division. Fourth grade math. If you have $110 | million in assets and $100 million in liabilities you, by | subtraction, have $10 million in equity against your $100 | million in liabilities. You are said to be levered 10:1. | | Now if I were to edit this, I'd probably go off a tangent | at this point. I would say something silly like You have | deposits from customers worth USD 100M. You loaned out USD | 110M. | | What happens if, of the people you loaned your money to, | half of them disappear with your money? Now, your assets | are only USD 65M. However, your liabilities are still USD | 100M. Your equity is USD 65M - USD 100M = a negative USD | 35M! You are properly screwed. | | In fact, you'd be screwed if your loans soured by anything | greater than your equity of USD 10M, let say USD 11M. Lets | say your borrowers are unable to repay you any more than | USD 99M of the USD 110 they owe you. Your equity is USD 99M | - USD 100M = - USD 1M. | | What just happened? I took you, the unsuspecting reader, on | my boat and threw you out in the middle of the ocean. I've | done you a disservice. Did you expect to read that tangent | after the quote I had from patio11? Probably not. Did you | expect to see a concept like negative equity and negative | leverage if you're just learning about leverage? Unlikely. | | In any case, the fact that I feel dissatisfied just writing | this comment is a testament to just how difficult it is to | explain something. Even when the concept I am trying to | explain is nothing more than "it is difficult to explain | something in brief". | sqs wrote: | Personally, I love the writing style. It's enjoyable to | read, and it conveys a lot more of his sentiment than dry | writing would. | [deleted] | chatterhead wrote: | Leverage is and has always been stealing from Peter to pay Paul. | People can justify it however they want and do, but the fact | remains profit is supposed to be the signal that an operation is | a viable going concern. Leverage masks this and trades the long- | term for the short-term. | | Most companies use leverage so their c-suite can make more while | producing less. That's the truth. It's bullshit and should be | outlawed. Corporations need to compete based on inputs and | outputs. | | Labor creates value. Leverage creates a mirage. Feel free to | disagree. Enjoy your business cycles. | thrwy_918 wrote: | I find this uncharacteristically hard to understand. | | In the stock brokerage example, we're told: | | >They might allow you 2:1 leverage when you buy stock: your | $1,000 buys 20 shares now. | | But then a couple of paragraphs later: | | >But you now owe $1,000 to your brokerage, and are 1:1 levered | | My brokerage offers 2:1 leverage, which results in me being 1:1 | levered? I think I understand what patrick is saying here but I | also find it hard to follow | | On the other hand: | | >One is that, because people can ask for money from their | checking accounts at any time, impecunious operation of the bank | could cause the value of the mortgages to be impaired just a tiny | little bit at a time when people need most of the money in their | checking accounts. | | I've read this four or five times and I don't understand the | chain of cause-and-effect here at all. Why does "people can ask | for money from their checking accounts at any time" mean that | "impecunious operation of the bank could cause the value of the | mortgages to be impaired just a tiny little bit at a time when | people need most of the money in their checking accounts"? | btilly wrote: | The first one seems like confusing word choices to me. They | allow you to buy 2x as much stock as you are putting money down | (2:1 leverage when you buy stock). After you do so, you have 10 | shares that you own to 10 shares that you control by don't own | (and therefore are 1:1 levered). | | The second one is only confusing because you're trying to find | a cause and effect between 2 events that simply happened to | happen at the same time. Though in practice the events may have | an underlying common cause and so do show up more often than | you'd expect. | | A concrete scenario is a community bank in a place where a | major employer just did a layoff. The value of the mortgages is | now impaired because some people won't be able to pay them | back. The laid off people also need most of the money in their | checking accounts because they have no job. The bank now has a | challenge - its cash reserves don't meet anticipated needs, and | it can't sell the mortgages to get more cash. | | The troubled bank has a good chance of surviving unless the | third leg of the trifecta shows up - word gets out about the | bank's trouble. Now everyone scared of losing their checking | accounts all show up to withdraw money at the same time. The | bank doesn't have the cash for this "run on the bank", and goes | bankrupt. | | This scenario was historically common. People accepted it until | there was an event during the Great Depression where enough | banks went under at the same time that people got scared about | what were otherwise healthy banks. Even though their assets | were good, they couldn't pay out all accounts at once, and | began going under en masse. FDR took fairly drastic actions to | fix this (bank holiday, confiscating gold, etc) and then put in | the FDIC to stop it from ever happening again. | | There is a well-known portrayal of this run on the banks in the | movie, _It 's A Wonderful Life_. | thrwy_918 wrote: | >The second one is only confusing because you're trying to | find a cause and effect between 2 events that simply happened | to happen at the same time | | The author uses "because", which in context clearly indicates | to me a cause and effect relationship. | | Even overlooking that, "impecunious operation of the bank | could cause the value of the mortgages to be impaired" is not | addressed by your explanation. You explain how external | factors could reduce the value of the mortgages. | btilly wrote: | You have a point, and I think there is a bit missing. | Currently it says: | | _... impecunious operation of the bank could cause the | value of the mortgages to be impaired just a tiny little | bit at a time when people need most of the money in their | checking accounts._ | | And probably should say something like: | | _... impecunious operation of the bank could cause trouble | if the value of the mortgages is impaired just a tiny | little bit at a time when people need most of the money in | their checking accounts._ | fhrow4484 wrote: | Very interesting read, especially the ELI5 part before the DeFi | story. | | Are the 3 ways explained to cover a margin call how it works in | practice? can one choose either of these 3 options? | | > Fourth grade math. If you have $110 million in assets and $100 | million in liabilities you are said to be levered 10:1. | | Actually got some trouble on the 4th grade math ... morning | coffee not working properly? | | $110m assets - $100m liabilities = $10m of "surplus". | | liabilities:surplus ratio is 100:10 --> 10:1. | | > You've got $1,600 in assets against $1,000 in debt, so $600 in | equity, so ~1.67:1 levered. | | here liability = 1000, a better name for the surplus is "equity" | at 600, | | 1000:600 ratio --> ~1.67:1 | | 4th grade math checks out :) | [deleted] | photochemsyn wrote: | Nice writeup. A good popular discussion of leverage is in the | movie Margin Call, regading the 2008 meltdown: | | > "Well, as you probably know, over the last 36 to 40 months, the | firm has begun packaging new mortgage-backed security products | that combine several different tranches of rating classification | in one tradeable security. This has been enormously profitable... | Well, the firm is currently doing a considerable amount of this | business every day. Now the problem, which is I guess why we are | here tonight, is that it takes us, the firm, about a month to | layer these products correctly, thereby posing a challenge from a | risk management standpoint... Well, we have to hold these assets | on our books longer than we might ideally like to. But the key | factor here is, these are essentially just mortgages, so that has | allowed us to push the _leverage_ considerably beyond what you | might be willing or allowed to do, in any other circumstance, | thereby pushing the risk profile without raising any red flags. " | | Running the money printing press was the government response to | that situation, i.e. 'deleveraging the bank holding companies | (BHCs) via quantitative easing' - which does illustrate how a | government controlled by financial oligarchs operates in | practice. The actual homeowners could have been the recipients of | the bailouts - i.e. the government would have taken over their | loans, provided a zero-interest period, converted the loans from | adjustable to fixed-rate, sold them back to the banks (or just | set up a separate institution), and then the homeowners could | have stayed in their homes and continued to pay off their | mortgages at an acceptable monthly rate - or some combination of | the above. The BHCs would have suffered much more significant | losses under that scenario, and perhaps more would have gone the | way of Bear Stearns and Countrywide. | | Notably, this illustrates that regardless of whether monetary | policy is tight or loose, the government's fiscal policy can be | engineered to support the financial oligarchs. For example, | today's high interest rates are going to be used to justify | government fiscal policies that benefit the oligarch class (i.e. | pushing for mass unemployment to bring down wages to 'fight | inflation', etc.). Similarly, large banks are not being forced to | raise personal savings interest rates as the Fed rate rises (as | that would benefit ordinary people, even if inflation is | outpacing interest rates). | | https://thehill.com/policy/3656474-lawmakers-slam-big-bank-c... | | As far as cryptocurrencies, it seems fairly unlikely that crypto | funds will be the beneficiaries of quantitive easing or other | government largesse, as crypto hasn't yet bought enough corrupt | politicians. | [deleted] | [deleted] | kqr wrote: | There's a form of leverage not mentioned here: | | You promise you'll fix Johnny's roof for $200. He hooks you up | with a computer for $300. You pay him the difference of $100. You | have transacted for $500 but only circulated money of $100. | That's 5:1 leverage. | | Futures markets work on this principle, among many other things. | jefftk wrote: | And the tax agency still wants their share of the uncirculated | $200 from each of you. | | (Even though your didn't use cash, barter transactions are | still taxed at their fair market value) | triceratops wrote: | I thought leverage implied borrowing money. This is just | bartering. | | EDIT: Never mind, I missed where you said that the roof fixing | will happen later in the future. | JumpCrisscross wrote: | > _a form of leverage not mentioned here_ | | You're alluding to operating leverage [1]. The carrying cost of | the computer and cost of services for the labor being working | capital constituents. | | This is distinct from the financial leverage, which deals with | explicit borrowing. (Futures markets do not work on operating | leverage. They work on offsetting financially-levered claims.) | | [1] https://en.wikipedia.org/wiki/Operating_leverage | kqr wrote: | No, what I'm describing has nothing to do with fixed or | variable costs. | | What I'm saying is that when you separate the action (fixing | roof, hooking up with computer) from the payment, you're in | debt, you're creating an implicit loan. | | If you then clear this debt not by opposing transactions but | with just the minimal set of transactions (similar to ring | clearing after a poker game) then you have allowed | transactions with far more money than any party actually | produced cash for. | | That is financial leverage. | | That is exactly what happens in future markets, too. You | don't need cash corresponding to the full value of a 5000 bu | wheat contract to buy one. All you need is enough to cover | the mark-to-market payments and then a little safety buffer. | It's all an implicit loan until the contract expires. If you | offset it, you continue to transact in way more money than | you put in. Financial leverage! | JumpCrisscross wrote: | > _what I 'm describing has nothing to do with fixed or | variable costs_ | | I linked to an admittedly terrible Wikipedia article. What | you're describing involves leveraging working capital, a | form of operational leverage. Every business does this. | Restaurants are operationally levered--they serve you food | before you pay. In your example, services were rendered in | anticipation of payment. None of this is financial | leverage. | | > _offset it, you continue to transact in way more money | than you put in_ | | This is netting. The loan is explicit in a way distinct | from operating leverage. These differences are meaningful | in both how we measure the phenomena as well as the law. | friend_and_foe wrote: | Liabilities / (Assets - Liabilities). That's really all there is | to it, the article explained it in the second paragraph. | JumpCrisscross wrote: | > _If you have $110 million in assets and $100 million in | liabilities you are said to be levered 10:1_ | | There is no single leverage ratio [1]. On an asset basis, this is | an 11:1 leverage ratio, _i.e._ $11 of assets for each dollar of | equity. A lot of miscommunication around leverage seems to stem | from this ambiguity. | | [1] | https://corporatefinanceinstitute.com/resources/accounting/l... | Nemi wrote: | Yes, it seems he even mixed definitions as well. He said that | the $110M in assets and $100M in liabilities was a 10:1 | leverage. | | However, later he says that a home owner with a down payment of | 20% is levered 5:1. Yet, if we do the same math as he did | above, then 20% of $100,000 loan is $20k in equity with an $80k | loan, giving a leverage ratio of 4:1. | gota wrote: | I came to the comments to check if that was correct - I was | following that definition and calculated 4:1 in my head, too. | | Later he uses the example of purchasing $2000 worth of ($10) | stock by paying just $1000 and having the other thousand lent | by the brokerage. | | As per his definition, $2000 in stocks (assets) minus the | $1000 loan (liability) equals $1000 in equity. Then if | leverage = equity/liability, in this case it turns out to be | 1:1 | pdntspa wrote: | Where does the ratio of 10 to 1 come in here? I see 110:100, or | 1.1:1, or 10%. | | His explanation doesn't make sense to me. Are those assets | borrowed or something? And having $10 million extra in assets | means that if suddenly all your liabilities come due, you have | $10m left over? How could that possibly wipe you out? | | Very confused. | JumpCrisscross wrote: | > _Where does the ratio of 10 to 1 come in_ | | Debt to equity. $10 of debt for every dollar of equity. | pdntspa wrote: | I get that, but the example as given seems to be $1.10 of | equity (assets) to every $1 of debt (liabilities). | JumpCrisscross wrote: | > _the example as given seems to be $1.10 of equity | (assets)_ | | Equity (in accounting) is assets minus liabilities. | $110mm assets, $100mm liabilities and thus $10mm equity. | | You may be thinking of equities (from trading), which is | another word for stock. (The link being equities | represent ownership of equity, _i.e._ the value of a | company's assets net of liabilities.) | skizm wrote: | I forget the exact phrasing, but something along the lines of: | "Leverage almost always works out. But when it doesn't, you die." | ogogmad wrote: | Why is leveraged long even legal? I'm naive about finance. | everfree wrote: | Every time you borrow cash with an asset as collateral - a | house loan, a car loan, an iPhone loan, a 401k loan, a margin | loan - it could all be said to be a leveraged long in some | sense. | | Or would you say that you're against the idea of borrowing | against stocks specifically? | jefftk wrote: | Things are legal by default. What's the argument for banning | it? | wonder_er wrote: | I'd say "leverage" is the slightly affirmative, slightly | pejorative term for a phenomena that could also be labeled | 'fractional reserve banking'. | | Read the Federal Reserve's on words on what they 'guide' banks to | do with deposited funds: | | > The Federal Reserve is carefully monitoring credit markets and | is prepared to use its full range of tools to support the flow of | credit to households and businesses and thereby promote its | maximum employment and price stability goals | | https://www.federalreserve.gov/monetarypolicy/reservereq.htm | | Following the "quacks like a duck" rule, a fractional reserve | 'policy' and 'using leverage' look very similar. Both root in | criminal misuse of deposited funds. | | There is nothing new under the sun: | | Leverage, fractional reserve banking, and most of the shenanigans | in crypto are all violations of the legal principles governing | the monetary irregular-deposit contract. | | I _love_ reading anything new by patio11, so absolutely just took | a long break from my day to read this and leave the comment. | Thanks much! Looking forward to the next BAM! | JumpCrisscross wrote: | > _" leverage" is the slightly affirmative, slightly pejorative | term for a phenomena that could also be labeled 'fractional | reserve banking'_ | | Leverage is deeper and more pervasive than fractional-reserve | banking. Leveraged merchants going bust was commonplace in the | days of hard money. ___________________________________________________________________ (page generated 2022-11-11 23:00 UTC)