Derivative Markets Explained..
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 the Government.
The funds required for this bailout are obtained by new taxes levied on
employed, middle-class, non-drinkers.
Next time we shall talk about the bonus payments. |
