[News] It all makes sense - An Easily Understandable Explanation of Derivative Markets
news at freedomarchives.org
Tue May 26 18:22:52 EDT 2009
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
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
Nevertheless, the bond prices continuously climb, and the securities
soon become the hottest-selling items for some of the nation's leading
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
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 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,
Now, do you understand?
522 Valencia Street
San Francisco, CA 94110
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