An Easily Understood Study into Derivative Markets

The story of Heidi and how she ran a business in a bad neighborhood

Heidi is the proprietor of a new bar in a city located in the rustbelt of America. The local liberal government wants her to be fair to all customers coming in to her establishment, be they able to pay or not, saying she can't discriminate against those without money because the neighborhood is poor and everyone has to be treated equal.

Heidi realizes to late that virtually all of her customers are unemployed alcoholics and as such, cannot afford to continue to patronize her bar causing her to break the law. To solve this problem, she comes up with new marketing plan that allows her customers to drink now, pay later.

She keeps track of the drinks consumed on a ledger (thereby granting the customer's 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 the city.

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 increased 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 (Psst: Nobody tells them.)

Nevertheless, the bond prices continuously climb and the securities soon become the hottest-selling items for some of the nation's leading brokerage houses around the world.

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, and 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 value 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 at large.

The suppliers of Heidi's bar had granted her generous payment extensions and had also invested their firms' pension funds in the various BOND securities. They find they are now faced with having to write-off her bad debt 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 liberal national government backing up the city's mandate to treat everyone equal. The funds required for this bailout are obtained by new taxes levied on employed, middle-class people who don't waste money on drinking.

Or in other words, this is how you got screwed by your government giving out mortgages to people who couldn't afford them. They have a name for it. It is called Social Justice.

TKS to Connie of WNC