Fw: An Easily Understandable Explanation of Derivative Markets


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 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 the Government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers.

Now, do you understand?


Anonymous said...

A lot of the description of how this worked is reasonably accurate and a somewhat good metaphor (of course, as good religitards, the example is of shiftless unemployed heathen alcoholics).

But what they left out at the end is that it was BUSH who gave away the TARP funds to the private sector with no strings attached.

And it's these same wingtards who are INCENSED that the Obama admin has had the TEMERITY to step in and, for ex, fire the CEO of GM (they shriek: gov't intervention! socialism! facism! etc), plus limit or curtail all of the bonuses & executive pay & such.

So, uh, what's the point of this nasty diatribe, then? Not sure if I'm getting it?

Oh yeah, right: we are sore, sore LOSERS!!!!!! and we don't want a n****r in the "white house."

Plus we are dishonest in every way possible, and we will blame the dimocrats for all eeeevuls in this world.

Got it!

Celia said...

I don't understand, because I couldn't be bothered to read it. Plus, that is an unpleasant shade of purple.

Anonymous said...

I need a drink.

The description of the market, while rudimentary isn't horribly wrong, but this middle class populism at the end is a joke.

Anonymous said...

This e-mail isn't particularly partisan, and it's pretty accurate. I'd say accusations of racism are overblown in this case.

zaoelpis said...

Wait, the privately owned bar had 11 employees?

Anonymous said...

The email isn't particularly partisan? Read the last couple of sentences. It's overtly partisan masquerading as a "think piece."

Tim said...

It isn't that far off, just badly written and stupid. There is no need of a 'bar' metaphor, since this is exactly what happened. The 'bar' was only brought in to compare people suckered into bad mortgages to alchoholics. It has no other purpose.

It left out, however, that this ingenious 'plan' was in fact hatched by banks and their deregulatory schemes, not 'discovered later as an opportunity' as the 'writer' states.

Marc with a C said...

Change the bar owner to a drug dealer and alcohol to meth, and I think you'd suddenly have a whole different ball game.

Marc with a C said...

Also, it should be noted that Heidi was also rather irresponsible for agreeing to sell alcohol on credit to people she knew had no realistic chance of paying it back, while at the same time charging interest and raising fees.

So yeah, while it sucks that the government has to foot the bill, I'm not particularly bothered to see Heidi lose her bar.

Thx 4 Fish said...

I can appreciate they were trying to make a simple illustration here but a small business owner like Heidi would NEVER have hatched a destined to fail scheme like this (maybe the bar manager would have). As a small business owner, I like to think we operate at a more logical, practical level than large corps.

Also, I imagine responsible people who lost their homes in this financial disaster will not appreciate being compared to unemployed alcoholics!

Anonymous said...

Bebe 99: you make a good point, and in fact, most of the smaller, community banks did just fine over the past while bc they did NOT engage in the ruthless, dishonest and ridiculous so-called "business practices" of the large banks.

So, yeah, while small business owners can and do make mistakes and/or can and do run their businesses poorly, I srsly doubt that a bar owner would do something as ridiculous as this.

As many have stated, using the bar analogy is mainly to demonize the PEOPLE who were loaned money for mortgages, rather than pointing at least some of the blame at the PUSHER (to use a different analogy suggested by a prior post).

C'est la vie...

Mark in SJ said...

Casino. The metaphor for this debacle is "casino", as in: "I went to the casino with other people's money".

There should be a levy on the use of purple font and poor writing on the internets...

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