Finance for dummies, as Time says…
Definition: Troubled Asset Relief Program, the government’s term for the Wall Street bailout bill. The term was first coined by Treasury Secretary Henry Paulson. The $700 billion bill passed the Senate Oct. 1, the House Oct. 3, and was signed by President Bush that same day.
Usage: ”The point is that TARP is the only plan on the table that has both a reasonable chance of political success and a reasonable chance of economic success.” (Washington Post, Oct. 2, 2008)
Definition: Calm down. Naked shorting isn’t really naked — actually, it would make more sense to call it invisible because a naked short is a trade that doesn’t exist. Short sales occur when someone borrows a stock from its owner, sells it, buys it back at a lower price, and pockets the difference. Naked shorts occur when the short seller doesn’t bother to borrow the stock before he sells it. “Oh sure, I can get you that stock, no problem,” he tells the buyer, and the transaction rides on nothing more than a promise. Sometimes the seller comes up with the stock, but sometimes he doesn’t — or worse yet, has no intention of even trying. Oh, and by the way, it’s illegal.
Usage: “Bob McTeer, formerly of the Federal Open Market Committee, says: ‘I didn’t even know about naked shorts until recently—where you sell stock without even bothering to borrow it. That is even more absurd.’” (New York Times, Sept. 18, 2008)
Definition: When a money-market fund doesn’t have enough assets to cover every dollar invested in it (i.e. its net asset value falls below $1.00 per share).
After Lehman Brothers declared bankruptcy (the largest in the nation’s history), one of the country’s money-market funds — the $60 billion Reserve Primary Fund — broke the buck for the first time since 1994.
Usage: Money funds are designed to act like bank accounts. When you put $1 in you expect to get $1 out, including all the interest earned, any time you want. Faith in this promise vanished last Tuesday, when the Primary Fund — owned by the Reserve, the company that invented money-market funds — closed at 97 cents a share. In industry parlance, it “broke the buck.” (Bloomberg, Sept. 24, 2008)
Definition: Insurance for municipal bonds, corporate debt, and mortgage securities. These insurance contracts can be swapped from buyer to buyer, with no guarantee that the buyer can actually cover default losses.
CDS allowed banks and hedge funds to lend billions of dollars without tying up their reserves to cover such loans. The CDS market, which is not regulated by the government, emerged in the 1990s and has since ballooned to more than $45 trillion in mid-2007 — roughly twice the size of the U.S. stock market.
Usage: [Insurance company] AIG was on one side of these trades only: They sold CDS. They never bought. Once bonds started defaulting, they had to pay out and nobody was paying them. AIG seems to have thought CDS were just an extension of the insurance business. But they’re not. When you insure homes or cars or lives, you can expect steady, actuarially predictable trends….
My death doesn’t, generally, hasten your death. My house burning down doesn’t increase the likelihood of your house burning down. Not so with bonds. Once some bonds start defaulting, other bonds are more likely to default. The risk increases exponentially. (Reuters, Sept. 18, 2008)
Definition: Mortgage-backed securities which often earned blue-chip grades from rating agencies but became toxic when the sub-prime crisis hit.
Usage: ”AIG was pushed to the brink of bankruptcy by derivative-based guarantees it sold on mortgages and more complex mortgage-related products known as collateralized debt obligations. AIG suffered huge losses on these exposures as the housing market slumped, triggering downgrades by ratings agencies.” (Marketwatch, Oct. 3, 2008)
Definition: A method of accounting that values assets based on what comparable assets are worth in the open market. Many have blamed mark-to-market accounting rules for deepening the economic crisis because when failing companies are forced to unload their securities at bargain-basement prices, similar assets go down in value across the industry. The new financial rescue plan passed by Congress gives the SEC the authority to suspend the practice.
Usage: ”This arcane accounting rule requires companies to write down the value of certain assets to their current market value—defined as the price that similar assets are fetching in an open market.” (USA Today, Oct. 4, 2008)
Definition: One of the foundations of the government’s bailout proposal plan. The Treasury Department would hold an auction under which financial institutions would try to sell their bad assets. Whichever bank offered the lowest bid would get to sell their junk for cash. In effect, banks (the sellers) are placing bids, not Treasury (the buyer). Hence, reverse auction.
Usage: Once the bill is signed into law, Paulson will have many options open to him on how to unclog the credit markets, which Senator Judd Gregg, the top negotiator on the bill for Senate Republicans, described as a massive car accident in the middle of the highway. The government must clear the accident away by buying the toxic debt so that normal traffic can flow freely. One avenue will be to do a reverse auction, where banks compete to sell the Treasury their bad paper, with the Treasury choosing the lowest offers. (TIME.com, Sept. 29, 2008)
Definition: Credit allows the American economy to keep chugging along. A business or corporation that can borrow money can pay its employees, grow, and cover its expenses. With the lack of current confidence in our financial system, a credit and lending freeze has descended, with few banks feeling comfortable enough to extend credit to individuals or businesses. An extended freeze may result in layoffs and other drastic measures.
Usage: “The credit markets are frozen with fear. You can say it’s irrational, but given the money that has been lost over the last 12 months by investors who were willing to take risks, it actually looks smarter to be irrational about this than to be rational.” (Los Angeles Times, October 4, 2008).
Filed under: Business , auction, break, buck, collateral, credit, Crisis, debt, default, Financial, market, naked, obligation, reverse, shorts, swap, tarp
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