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"?
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.
>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.
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.
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"?