Geithner plan 3 | Money, banking and central banks | Finance & Capital Markets | Khan Academy | Summary and Q&A

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March 31, 2009
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Khan Academy
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Geithner plan 3 | Money, banking and central banks | Finance & Capital Markets | Khan Academy

TL;DR

Banks can potentially offload toxic assets by creating financial transactions and leveraging government subsidies.

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Questions & Answers

Q: How do banks reduce exposure to toxic assets through leverage?

Banks can lend cash to other parties, such as hedge funds, creating loans that appear on their balance sheet. This allows them to hold less of the toxic asset directly and instead have a loan exposure to it.

Q: Are there regulations in place to prevent banks from engaging in such transactions?

The Legacy Loans term sheet restricts private investors from participating in transactions with sellers who are affiliates, which means having control or being under common control. However, specific definitions and interpretations of "affiliate" may vary.

Q: How do credit default swaps play a role in offloading toxic assets?

Banks can sell credit default swaps on the toxic assets for cheap, allowing hedge funds to purchase the swaps. If the asset experiences a default, the hedge fund can claim the insurance policy and receive compensation from the bank.

Q: Is there a risk of abuse or dishonest behavior in these transactions?

While these transactions may have legitimate economic motivations, some concerns arise regarding the potential for manipulation or loopholes. Without proper regulations and scrutiny, banks could benefit at the expense of taxpayers.

Summary & Key Takeaways

  • The video discusses how banks can reduce their exposure to toxic assets by creating loans and selling credit default swaps to other parties.

  • By utilizing the Legacy Loans Program, banks can contribute a portion of the investment capital and leverage government funds to purchase the assets.

  • The video also explores alternative methods where banks can sell credit default swaps on the toxic assets to hedge funds, reducing their own exposure.

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