Polswatch

Outlining a Progressive Future

Derivative Markets: An Explanation

Finally, someone has provided an explanation of derivative markets that is somewhat understandable (I guess the fact that it has taken this long shows how ridiculous derivative markets are). It is amazing how ridiculous this is – I hope you all enjoy!

Heidi is the proprietor of a bar in Detroit. In order to increase
sales, she decides to allow her loyal customers – most of whom are
unemployed alcoholics – 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 and soon she has the largest s ale volume for any bar in Detroit.

By providing her customers freedom from immediate payment demands,
Heidi gets no resistance when she substantially increases her prices
for wine and beer, the most consumed beverages. Her sales volume
increases massively.

A young and dynamic vice-president at the local bank recognizes these
customer debts as valuable future assets and increases Heidi’s
borrowing limit.

He sees no reason for undue concern since he has the debts of the
alcoholics as collateral. At the bank’s corporate headquarters, expert
traders transform these customer loans into DRINKBONDS, ALKIBONDS and
PUKIEBONDS. These securities are then traded on security markets
worldwide.

Naive investors don’t really understand the securities being sold to
them as AAA secured bonds are really the debts of unemployed
alcoholics. Nevertheless, their prices continuously climb, and the
securities become the top-selling items for some of the nation’s
leading brokerage houses.

One day, although the bond prices are still climbing, a risk manager
at the bank (subsequently fired due to his negativity), decides that
the time has come to demand payment on the debts incurred by the
drinkers at Heidi’s bar.

Heidi demands payment from her alcoholic patrons, but being unemployed
they cannot pay back their drinking debts. Therefore, Heidi cannot
fulfil her loan obligations and claims bankruptcy. DRINKBOND and
ALKIBOND drop in price by 90%. PUKIEBOND performs better, stabilizing
in price after dropping by 80 %. The decreased bond asset value
destroys the banks liquidity and prevents it from issuing new loans.

The suppliers of Heidi’s bar, having granted her generous payment
20extensions and having invested in the securities are faced with
writing off her debt and losing over 80% on her bonds. Her wine
supplier claims bankruptcy, her beer supplier is taken over by a
competitor, who immediately closes the local plant and lays off 50
workers.

The bank and brokerage houses are saved by the Government following
dramatic round-the-clock negotiations by leaders from both political
parties. The funds required for this bailout are obtained by a tax
levied on employed middle-class non-drinkers.

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May 3, 2009 - Posted by | Political Economy |

2 Comments »

  1. I take issue with this as an explanation. By equating the poorest victims of the housing collapse with unemployed alcoholics it seems to indulge in the same kind of victim blaming as that of many conservatives looking to place the blame anywhere but on a lack of regulation.

    Instead of looking at the avarice of the banks or the part played by greedy investors in taking advantage of the poor this piece says that the GFC is the fault of poor, stupid people buying houses and taking out loans that they shouldn’t.

    In the meantime, it says that these poor (who have in many cases lost their homes) are not the real victims of the housing collapse. No, the real victims are the “employed middle-class non-drinkers” who made smart financial decisions and now have to bail out these alcoholic losers. In doing so it also ignores that many middle class workers have also been hit hard by the housing collapse.

    Comment by Ben | May 4, 2009 | Reply

  2. Ben,

    Really good points and now looking back at it I agree with you on these issues. Thanks for pointing them out!

    Simon

    Comment by simon2013 | May 4, 2009 | Reply


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