One thing is that the bank having repackaged might be able to do more loans because some regulatory limit is lowered by the lowered (or cancelled) risk of the bank.
The Bank frees up its regulatory capital. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
In fact, couldn't the bank just loan the money back to Metrovacesa? Bush is a symptom, not the disease.
However, that million of cash came from many sources, but (perfect world of economics thinking) wouldn't it come out of other banks in the system. Banks C, D, and E for example might have the three of us as customers, and we bought the bonds, paying for them from our bank accounts. And as we do so, banks C, D and E have a negative money multiplier that offsets the positve one of bank A.
However, that does leave us with the $1 million of bonds in our hands. But of course we are not banks. So it's a different process from here for us. For example I would likely have my $300,000 of the bonds in a brokerage account. I would have probably sold something, bonds or stocks, to pay for the bonds. So my financial assets are somewhat the same, with a slightly different mix of assets. Investors like me, us, can buy on margin, but I'm fairly risk adverse and my borrowings are normally below 5% of financial assets--never above 10%. and this new mortgage bond wouldn't change my thinking about risk levels. (and also I'm not sure that changes the money supply anyway--I'd have to brain crunch through the whole margin process to figure that impact. But let's ignore that for the moment.
Where does this original concept of Laurent's thinking break down? a $1 million positive impact at Bank A and the resulting positve multiplier effect, perfectly offset by $1million negative impact in banks C, D and E.
PS: I don't know if we want to go there, but WSJ had an interesting article that relates to the "margining" process I guess I'm suggesting that we put aside for the moment: OUTER LIMITS As Funds Leverage Up, Fears of Reckoning Rise Fed and SEC Question Wall Street on Policies; 'A Mockery' of Margin By RANDALL SMITH and SUSAN PULLIAM April 30, 2007;
Hedge-fund manager John Paulson made $1 billion using a complex financial instrument to pump up a bet that the subprime-mortgage market would crater. The parent company of retail giant Sears made $74 million using a similar device to boost its wager that a basket of stocks would rise in value. Both were playing with leverage -- the magical power that allows investors to make big investments without putting big money on the table. These days, they have lots of company. Thanks to advances in financial engineering, investors have never had so many different ways to make commitments that exceed their bankrolls. And never before has leverage wormed its way into so many nooks of the financial world. We're living on planet leverage, and regulators and market gurus are growing nervous. How did this happen? For starters, hedge funds and leveraged-buyout funds have proliferated. They're pioneers in boosting returns using borrowed money, the most traditional form of leverage. Also, investment banks are pumping out newfangled leveraging tools such as derivatives, complex securities that allow hedge funds and other investors to add leverage without borrowing money. Finally, mainstream America has gotten into the act. Once-conservative institutions are copying hedge-fund tactics. The Pennsylvania State Employees' Retirement System has begun dabbling in derivatives. Mutual-fund companies such as Easton Vance Corp. and Federated Investors Inc. have launched funds that rely heavily on derivatives. Garden-products maker Scotts Miracle-Gro Co. and other public companies have loaded up on debt to improve returns. This leveraging binge has regulators and others worried. In the first place, no one knows how much leverage there is. Much of it is hidden, because investors aren't just juicing returns with borrowed money, but with derivatives, which are harder for regulators to track. No one is sure what will happen to this complex brew in the event of a serious market downturn. When markets turn bad, leverage can create a snowball effect. Lenders and derivatives dealers demand that investors provide them with more collateral -- the stocks, cash or other assets they pledge to cover potential losses. Sometimes, investors dump stocks and bonds to raise cash. Prices drop more, losses accelerate, and more selling ensues. Some Wall Street analysts have taken to referring to a nightmare version of this scenario as "The Great Unwind." Timothy Geithner, president of the Federal Reserve Bank of New York, said in an interview that the torrent of money flowing into hedge funds has coincided with a troubling erosion in lending practices. The Fed, the Securities and Exchange Commission and European regulators have spent months trying to gauge the risk by gathering information from hedge funds and Wall Street firms. They've asked the brokerage firms, among other things, how much collateral they're demanding from hedge funds when they provide financing.
Both were playing with leverage -- the magical power that allows investors to make big investments without putting big money on the table. These days, they have lots of company. Thanks to advances in financial engineering, investors have never had so many different ways to make commitments that exceed their bankrolls. And never before has leverage wormed its way into so many nooks of the financial world.
We're living on planet leverage, and regulators and market gurus are growing nervous.
How did this happen? For starters, hedge funds and leveraged-buyout funds have proliferated. They're pioneers in boosting returns using borrowed money, the most traditional form of leverage. Also, investment banks are pumping out newfangled leveraging tools such as derivatives, complex securities that allow hedge funds and other investors to add leverage without borrowing money.
Finally, mainstream America has gotten into the act. Once-conservative institutions are copying hedge-fund tactics. The Pennsylvania State Employees' Retirement System has begun dabbling in derivatives. Mutual-fund companies such as Easton Vance Corp. and Federated Investors Inc. have launched funds that rely heavily on derivatives. Garden-products maker Scotts Miracle-Gro Co. and other public companies have loaded up on debt to improve returns.
This leveraging binge has regulators and others worried. In the first place, no one knows how much leverage there is. Much of it is hidden, because investors aren't just juicing returns with borrowed money, but with derivatives, which are harder for regulators to track.
No one is sure what will happen to this complex brew in the event of a serious market downturn. When markets turn bad, leverage can create a snowball effect. Lenders and derivatives dealers demand that investors provide them with more collateral -- the stocks, cash or other assets they pledge to cover potential losses. Sometimes, investors dump stocks and bonds to raise cash. Prices drop more, losses accelerate, and more selling ensues. Some Wall Street analysts have taken to referring to a nightmare version of this scenario as "The Great Unwind."
Timothy Geithner, president of the Federal Reserve Bank of New York, said in an interview that the torrent of money flowing into hedge funds has coincided with a troubling erosion in lending practices.
The Fed, the Securities and Exchange Commission and European regulators have spent months trying to gauge the risk by gathering information from hedge funds and Wall Street firms. They've asked the brokerage firms, among other things, how much collateral they're demanding from hedge funds when they provide financing.
In my own mind, I think of the money multiplier effect of the banking system in one compartment. Then I think of the whole world of investments, swaps, and margining as a separate compartment, since different rules outside the banking system apply--and admittedly because this is a set of rules, that is this article shows, is evolving and controversial. Maybe this is my mistake, and you and Chris are including this aspect in your thinking, as one compartment?
