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Saturday, January 22, 2011

"Understanding Derivatives-a Primer "

This explains the "derivatives" scam better than anything else I have read.
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 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 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 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 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, 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 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.

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.

Now do you understand?
Thanks to Jim.


Anonymous James said...

Did Heidi come up with the plan or was she told to do it by her "big brother"?

Great post.

4:48 PM  
Anonymous Thesis Writing said...

Whenever i see the post like your’s i feel that there are still helpful people who share information for the help of others, it must be helpful for other’s. thanx and good job.

7:31 PM  
Blogger Ernest said...

In days of ole, robber barons would ride into town and take whatever they wanted from the townsfolk; sheep, cattle, grain, and wares at the point of a sword.

They do the same thing today with computers, and banks but its still at the point of a sword, courtesy of the Gub’mint!

1:16 AM  
Anonymous Anonymous said...

That was funny but I can give you a more accurate bar examp[le of what a derivative is: A guy goes in a bar ans sees a pretty girl. He offers to buy her a drink and she accepts. they spend trhe eveniong together drinking. He is "buying" a derivative, i.e. investing in something in the hope it will provide a future benefit. The more attractive the assets the more willing he is to "invest". She is selling a derivative, i.e. taking his offer of a drink with no guarantee of producing a benefit. She can only play in this game if she can make her asset package attractive to the investor. In an ideal world both partners in this "contract" would benefit. We all know this doesn't always work out in real life.

5:29 AM  
OpenID porcupinerim said...

This assessment is about 10% correct.

The United States Government had Heidi's arm twisted behind her back the whole time.

If Heidi didn't provide impossible credit to the drunks, she would be guilty of red-lining.

The United States Government simultaneously enforced this requirement on ALL BARS; not just Heidi's.

Under the influence of the UNITED STATES GOVERNMENT alone, the price of alchohol soared; but the US Government told Heidi that she had to continue making loans to drunks.

ACORN picketed all liquor serving establishments, with Obama to make sure all the drunks were immediately served, REGARDLESS OF THE PRICE OF THE ALCOHOL.

Andrew Cuomo and Bill Clinton climbed into the band wagon with all four feet (each).

Even moron George Bush lauded the US Governments get drunk now (CRA) program.

Today, the world thinks that US Banks caused the problem.

Alcohol is not a right granted to all men by God.

6:33 AM  
OpenID porcupinerim said...

Pardon me; I neglected that Obama himself sued Citigroup Bar to give alcohol credit to more drunks.

6:41 AM  
OpenID porcupinerim said...

Pardon me further. The United States alone taught the bankers how to bundle the obviously bad liquor loans with their normal business. Government GSEs (Government Sponsored Enterprises) FNMA and FMAC) were chartered by the United States Government to teach bankers how to bundle the bad loans.

Impossible? It is the real history so easily forgotten.

6:49 AM  
OpenID porcupinerim said...

And yet again, pardon me.

There are several posts on this topic that might be interesting to readers of this blog. Here is one:

7:02 AM  
Blogger John said...

Excellent! Once I read this I thought, "Trevor should do a video on this like they did on quantitative easing!" Hint.

Great job!

8:10 AM  
Anonymous Anonymous said...

All the posts are great and right on target. Thanks!
I too think Trevor should come up with a video of this. Let me see, who can play the part of Heidi?

9:51 AM  
Anonymous Don said...

One simple solution to all this - keep government force out of all business and let the individual, one by one face their responsibilities.
Politically, it is known as laissez-faire capitalism.

9:58 AM  
Blogger Lisa G in NZ said...

great post and comments... its is good to know Americans and others are finally understanding some of the mess going on over in the USA...

guess 2 years of a hammer coming down and hitting folks on their heads has finally awoken the previouly sleeping giant...

real hope now exists for better changes and proven solutions rather than the marxist-socialist tripe currently in full swing...

much work to do, but awareness first is crucial

10:36 AM  
OpenID porcupinerim said...

“The [sub-prime] financial engineering that created the Wall Street meltdown was developed by the Pritzkers and Ernst and Young, working with Merrill Lynch to sell bonds securitized by sub-prime mortgages,” Timothy J. Anderson, a whistleblower on financial and bank fraud, told me in an interview.

“The sub-prime mortgages,” Anderson said, “were provided to Merrill Lynch, by a nation-wide Pritzker origination system, using Superior as the cash cow, with many millions in FDIC insured deposits. Superior’s owners were to sub-prime lending, what Michael Milken was to junk bonds.”

In other words, if you traced today’s sub-prime crisis back to its origins, you would come upon the role of the Pritzkers and Superior Bank of Chicago.

All along, FNMA and FMAC implied that the bundled sub-prime packages were guaranteed by the United States government.

You might find this article interesting:

2:56 PM  
Anonymous Don in N.Z. said...

I will elaborate a little further on one of my earlier postings.

One simple but unpopular solution to all this - keep government force out of all business and relegate it to its proper place: Police, Defense and Law courts (Justice), then let individuals, one by one face their responsibilities. Politically it is known as Laissez-faire Capitalism.(Laissez nous faire) i.e. leave us alone - government hands off. This is not anarchism. Anarchism is no central government at all. This is small and limited defensive government protecting your right to free association and free trade while penalizing you for any transgressions of the rights of other individuals.

8:13 PM  

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