Tuesday, December 20, 2011

How derivative works .

 "How derivative works!!"

Gordon was the proprietor of a bar in Glasgow ...

He realizes that virtually all of his customers are unemployed alcoholics
and, as such, can no longer afford to patronise his bar.




To solve this problem, he comes up with a new marketing plan that allows
his customers to drink now, but pay later.

Gordon keeps track of the drinks consumed on a ledger (thereby granting the
customers loans).

Word gets around about Gordon's "drink now, pay later" marketing strategy
and, as a result, increasing numbers of customers flood into his bar. Soon
he has the largest sales volume for any bar in Glasgow .

By providing his customers freedom from immediate payment demands, Gordon
gets no resistance when, at regular intervals, he substantially increases
his prices for wine and beer, the most consumed beverages.

Consequently, Gordon's gross sales volume increases massively.

A young and dynamic president at the local bank recognises that these
customer debts constitute valuable future assets and increases
Gordon's borrowing limit.

He sees no reason for any undue concern because 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
DRINKBONDS.

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 Gordon's bar. He so informs Gordon.

Gordon then demands payment from her alcoholic patrons. But, being
unemployed alcoholics -- they cannot pay back their drinking debts.

Since Gordon cannot fulfil his loan obligations he is forced into
bankruptcy. The bar closes and Gordon's 11 employees lose their jobs.

Overnight, DRINKBOND 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 Gordon's bar had granted him 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 his bad debt and with
losing over 90% of the presumed value of the bonds.

His wine supplier also claims bankruptcy, closing the doors on a family
business that had endured for three generations, his 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 pound 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 who have never been in
Gordon's bar. 

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