Understanding Derivatives — A Primer
Heidi is the proprietor of a bar in Bend, OR. 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 a new marketing plan that allows her customers to drink now, but pay later. Heidi 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 Oregon. 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 figure a way to make huge commissions, and transform these customer loans into DRINK BONDS.
These “securities” then are bundled and traded on international securities markets. Naive investors don’t really understand that the securities being sold to them as “AAA Secured Bonds” really are 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 still are 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 Heidi’s 11 employees lose their jobs.
Overnight, DRINK BOND prices drop by 90%.
The collapsed bond asset value destroys the bank’s 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 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 multibillion dollar no-strings attached cash infusion from the government i.e. the Taxpayers. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, nondrinkers who have never been in Heidi’s bar. Bank employees receive record bonuses.

Eric, brilliant and astute parable. Well said. There are of course many who did qualify for the loans they received but later became unable to pay due to the economic crisis brought on by the defaults on so many loans that never should have been made in the first place, but this entire tragedy was predictable and in fact was predicted in detail by several writers years beore the actual collapse.

Blame it on Rio….LOL. Not to mention the unemployed are even taxed on the unemployment money they receive. I think we can all agree on this being called the TAX-PAYER BAILOUT…The Drunk is the Taxpayers!!!! Sooooo, What’s your point??

I’m sorry to be the wet-blanketed little Pollyanna here, but I know of far too many straight-up, totally respectable people who WERE qualified for these loans when originated, had conventional “safe” loans, who have been literally deceived by the banks (that’s the nice description). They were told to approach & work with their banks BEFORE they got behind and when/if they had a “rough spot”.They WERE lured into modifications that went nowhere except into foreclosure.
People, these are not a bunch of stoopid slackers making bad life decisions. They are simply families, not even with 2nds or a giant debt load, who once they entered the modification process eventually learned too late and with many fees, penalties added-in that they were being foreclosed upon at the same time (dual-track). I don’t know about you, but if you are bleeding financially and doing everything in your power to save your familie’s home and complying with what the bank asks of you, and apply for a FEDERAL program (HAMP) that is marketed HARD at these folks – WTF? Even more ludicous is the present HHF money going towards the Mortgage Payment Assistance programs in the hardest hit Oregon counties. If people qualify ( but don’t even think of applying if you are self employed!)they will receive free mortgage payments for a year of up to $20k – so guess what? The money goes right to you guessed it, the Banksters, but I suppose it does “buy” the homeowner time to save up and get the hell out of there, as surely the banks will re-start the f/c process all over again. I say, give the homeowner the option of taking the whole 20k and go find a good lawyer…….