Charles
03-17-2010, 10:42 PM
Subject: An Easily Understandable Explanation of Derivative Markets
Heidi is the proprietor of a bar in Detroit . She realizes that virtually
all of her customers are unemployed alcoholics and, as such, can no longer
afford to patronize her bar. To solve this problem, she comes up with new
marketing plan that allows her customers to drink now, but pay later. She
keeps track of the drinks consumed on a ledger (thereby granting the
customers loans).
Word gets around about Heidi's "drink now, pay later" marketing strategy
and, as a result, increasing numbers of customers flood into Heidi's bar.
Soon she has the largest sales volume for any bar in Detroit .
By providing her customers' freedom from immediate payment demands, Heidi
gets no resistance when, at regular intervals, she substantially increases
her prices for wine and beer, the most consumed beverages. Consequently,
Heidi's gross sales volume increases massively. A young and dynamic
vice-president at the local bank recognizes that these customer debts
constitute valuable future assets and increases Heidi's borrowing limit. He
sees no reason for any undue concern, since he has the debts of the
unemployed alcoholics as collateral.
At the bank's corporate headquarters, expert traders figure a way to make
huge commissions, and transform these customer loans into DRINKBONDS,
ALKIBONDS and PUKEBONDS. These securities are then bundled and traded on
international security markets. Naive investors don't really understand that
the securities being sold to them as AAA secured bonds are really the debts
of unemployed alcoholics. Nevertheless, the bond prices continuously climb,
and the securities soon become the hottest-selling items for some of the
nation's leading brokerage houses.
One day, even though the bond prices are still climbing, a risk manager at
the original local bank decides that the time has come to demand payment on
the debts incurred by the drinkers at Heidi's bar. He so informs Heidi.
Heidi then demands payment from her alcoholic patrons, but being unemployed
alcoholics they cannot pay back their drinking debts. Since, Heidi cannot
fulfill her loan obligations she is forced into bankruptcy. The bar closes
and the eleven employees lose their jobs.
Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in price by 90%. The
collapsed bond asset value destroys the banks liquidity and prevents it from
issuing new loans, thus freezing credit and economic activity in the
community.
The suppliers of Heidi's bar had granted her generous payment extensions and
had invested their firms' pension funds in the various BOND securities. They
find they are now faced with having to write off her bad debt and with
losing over 90% of the presumed value of the bonds. Her wine supplier also
claims bankruptcy, closing the doors on a family business that had endured
for three generations, her beer supplier is taken over by a competitor, who
immediately closes the local plant and lays off 150 workers.
Fortunately though, the bank, the brokerage houses and their respective
executives are saved and bailed out by a multi-billion dollar no-strings
attached cash infusion from their cronies in Government. The funds required
for this bailout are obtained by new taxes levied on employed, middle-class,
non-drinkers who have never been in Heidi's bar.
Now, do you understand?
Chas
Heidi is the proprietor of a bar in Detroit . She realizes that virtually
all of her customers are unemployed alcoholics and, as such, can no longer
afford to patronize her bar. To solve this problem, she comes up with new
marketing plan that allows her customers to drink now, but pay later. She
keeps track of the drinks consumed on a ledger (thereby granting the
customers loans).
Word gets around about Heidi's "drink now, pay later" marketing strategy
and, as a result, increasing numbers of customers flood into Heidi's bar.
Soon she has the largest sales volume for any bar in Detroit .
By providing her customers' freedom from immediate payment demands, Heidi
gets no resistance when, at regular intervals, she substantially increases
her prices for wine and beer, the most consumed beverages. Consequently,
Heidi's gross sales volume increases massively. A young and dynamic
vice-president at the local bank recognizes that these customer debts
constitute valuable future assets and increases Heidi's borrowing limit. He
sees no reason for any undue concern, since he has the debts of the
unemployed alcoholics as collateral.
At the bank's corporate headquarters, expert traders figure a way to make
huge commissions, and transform these customer loans into DRINKBONDS,
ALKIBONDS and PUKEBONDS. These securities are then bundled and traded on
international security markets. Naive investors don't really understand that
the securities being sold to them as AAA secured bonds are really the debts
of unemployed alcoholics. Nevertheless, the bond prices continuously climb,
and the securities soon become the hottest-selling items for some of the
nation's leading brokerage houses.
One day, even though the bond prices are still climbing, a risk manager at
the original local bank decides that the time has come to demand payment on
the debts incurred by the drinkers at Heidi's bar. He so informs Heidi.
Heidi then demands payment from her alcoholic patrons, but being unemployed
alcoholics they cannot pay back their drinking debts. Since, Heidi cannot
fulfill her loan obligations she is forced into bankruptcy. The bar closes
and the eleven employees lose their jobs.
Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in price by 90%. The
collapsed bond asset value destroys the banks liquidity and prevents it from
issuing new loans, thus freezing credit and economic activity in the
community.
The suppliers of Heidi's bar had granted her generous payment extensions and
had invested their firms' pension funds in the various BOND securities. They
find they are now faced with having to write off her bad debt and with
losing over 90% of the presumed value of the bonds. Her wine supplier also
claims bankruptcy, closing the doors on a family business that had endured
for three generations, her beer supplier is taken over by a competitor, who
immediately closes the local plant and lays off 150 workers.
Fortunately though, the bank, the brokerage houses and their respective
executives are saved and bailed out by a multi-billion dollar no-strings
attached cash infusion from their cronies in Government. The funds required
for this bailout are obtained by new taxes levied on employed, middle-class,
non-drinkers who have never been in Heidi's bar.
Now, do you understand?
Chas