An Easily Understandable Explanation of Derivative Markets

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 new marketing plan that allows her customers 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. 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 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.

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 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. 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 the eleven employees lose their jobs.

Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in price 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.

The suppliers of Heidi’s bar had granted her generous payment extensions and had invested their firms’ pension funds in the various 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 multi-billion-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, non-drinkers.

Now, do you understand the derivatives market?

[This article first appeared in The Patriot Post about a year ago during the uproar over the mortgage scandal and government bailouts. Their archive for this piece is no longer available.]

Finally, a winter weather report that makes sense to the average Joe…

Question: What was the best thing about the “Cash for Clunkers” program?

Answer: It got rid of 95 percent of the Obama bumper stickers.

Dear Lord,

…in the past year, you have taken away
   my favorite actor (Patrick Swayze),
   my favorite actress (Brittany Murphy),
   my favorite musician (Michael Jackson),
   my favorite salesman (Billie Mays),
   and my favorite athlete (Chris Henry).

I just wanted to let you know … my favorite president is Barack Obama.

A woman, married three times, walked into a bridal shop one day and told the sales clerk that she was looking for a wedding gown for her fourth wedding.

“Of course, madam,” replied the sales clerk. “Exactly what type and color are you looking for?”

The bride-to-be said, “A long frilly white dress with a veil.”

The sales clerk hesitated a bit, then said, “Please don’t take this the wrong way, but gowns of that nature are considered more appropriate for brides who are being married for the first time — for those who are a bit more innocent, if you know what I mean? Perhaps ivory or sky blue would be nice?”

“Well,” replied the customer, a little peeved at the clerk’s directness, “I can assure you that a white gown would be quite appropriate. Believe it or not, despite all my marriages, I remain as innocent as a first time bride.

“You see, my first husband was so excited about our wedding, he died as we were checking into our hotel. My second husband and I got into such a terrible fight in the limo on our way to our honeymoon that we had that wedding annulled immediately and never spoke to each other again.”

“What about your third husband?” asked the sales clerk.

“That one was a Democrat,” said the woman, “and every night for four years, he just sat on the edge of the bed and told me how good it was going to be, but nothing ever happened.”