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Brian D. Butler
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Table of Contents:
see also Commercial Banking , leverage , Possible recession in 2008, credit crisis of 2007, margin call , Private equity
Deleveraging
In early 2008, there was talk about "deleveraging" of the financial markets (and how that was going to cause a recession). But what is "deleveraging" exactly? and what is causing it?
According to Jan Hatzius, chief US economist at Goldman Sachs, major banks and brokers would suffer about $200bn (£99bn, €127bn) in subprime-linked losses in early 2008. But, due to deleveraging, the impact of these losses on bank lending could be much greater. Mr Hatzius suspected that a $200bn subprime loss would cut bank capital by 12 per cent; if banks then shrank their balance sheets by 12 per cent, the implied reduction in overall lending - due to leverage - would total $2,300bn.
Lending is based on "leverage". If a bank looses a certain amount of assets (x), then they must reduce lending by some multiple of (x).
Effects of the (USA) credit crunch:
Less money to lend, less money to borrow....After the subprime lending crisis in the US, banks became more fearful that borrowers may not be as credit-worthy as they may appear. As a result of deleveraging, there was a subsequent reduction in credit available to all borrowers. This led to a fear of recession (Possible recession in 2008)
In the leveraging era, the world's banks and other great lenders lent far too much - to businesses, to various financial speculators, such as hedge funds and private-equity investors, to homeowners, to shoppers, and even to each other.
A great bubble of debt was created.
That bubble was punctured last summer, when lenders suddenly realised that some of their loans - the subprime ones to US homeowners with poor credit histories - weren't ever going to be repaid in full.
'Bad risks'
Since then lenders have been asking for their money back from those perceived to be a lousy credit prospect - and pushing up the cost of credit for almost everyone.
This deleveraging process, which has gone in fits and starts, moved up a gear in the past fortnight, as lenders became increasingly fearful about the outlook for the biggest economy in the world, that of the US
Margin Call
And the credit crunch of 2007 / 2008
Headlines:
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"Hedge funds and Private equity industries face "margin calls" as brokers
deleverage"....but, what does this mean?
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Carlyle Group -world's second-largest buy-out group- trading suspended; further expected margin calls could deplete capital--> made leveraged bets on AAA agency bonds
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Sudden Debt, FT: Almost all structured finance transactions are based on unfunded margin debt--> Margin debt cannot be "restructured" with falling asset prices
Definition / Interpertation:
according to investopedia: "A broker's demand on an investor using margin to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin. This is sometimes called a "fed call" or "maintenance call". " You would receive a margin call from a broker if one or more of the securities you had bought (with borrowed money) decreased in value past a certain point. You would be forced either to deposit more money in the account or to sell off some of your assets"
related terms:
Broker's Call
Buying Power
Call Loan
Call Loan Rate
Federal Reserve Board - FRB
Initial Margin
Leverage
Maintenance Margin
Margin
Margin Account
Market Value
Remargining
There are two restrictions imposed on the amount you can borrow. First, the initial margin, which is the initial amount you can borrow. Second, the maintenance margin, which is the amount you need to maintain after you trade. These amounts are set by the Federal Reserve Board, as well as your brokerage. Individual brokerages can have stricter limits, but the Federal Reserve Board sets a minimum initial margin of 50% and a maintenance margin of at least 25%.
Our focus in this section is the maintenance margin. In volatile markets, prices can fall very quickly. If the equity (value of securities minus what you owe the brokerage) in your account falls below the maintenance margin, the brokerage will issue a "margin call". A margin call forces the investor to either liquidate his/her position in the stock or add more cash to the account.
If for any reason you do not meet a margin call, the brokerage has the right to sell your securities to increase your account equity until you are above the maintenance margin. Even scarier is the fact that your broker may not be required to consult you before selling! Under most margin agreements, a firm can sell your securities without waiting for you to meet the margin call. You can't even control which stock is sold to cover the margin call.
read more here...
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