Economics 101
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 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, I understand.
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 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, I understand.
