If you’ve ever tried to understand how our nation got into the financial mess and just couldn’t grasp the idea of faulty subprime mortgage loans sold with prime mortgages to lenders who then packaged them into CDOs, which then were packaged and sold overseas to sovereign investors and China…well, never mind. Just read this. It makes everything pretty clear.
Explaining Modern Finance with “Broke Boozers” at Helga’s Bar
Helga is the proprietor of a bar.
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.
Helga keeps track of the drinks consumed on a ledger (thereby granting her customers, loans).
Word gets around about Helgas Drink now, Pay later marketing strategy. As a result, increasing numbers of customers flood into Helga’s bar. Soon she has the largest sales volume for any bar in town.
By providing her customers freedom from immediate payment demands, Helga gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Helga’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 Helga’s borrowing limit.
The banker sees no reason for any concern, since he has the debts of unemployed alcohol patrons as collateral.
At the bank’s corporate headquarters, expert traders figure a way to transform these customer loans into Drink Bonds. These “securities” then are bundled and traded on the international securities markets. They make huge commissions.
Naive investors don’t really understand that the securities being sold to them as “AA” and “Secured Bonds” are really the debts of unemployed alcoholics.
Nevertheless, the bond prices continuously climb! 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 Helga’s bar.
He informs Helga.
Helga then demands payment from her patrons, but being unemployed they cannot pay their drinking debts.
Since Helga cannot fulfill her loan obligations she is forced into bankruptcy.
The bar closes and Helga’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 Helga’s bar had granted her generous payment extensions and had invested each of their firm’s pension funds in the Drink Bonds securities. They find they are now faced with having to write off Helga’s bad debt after 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/ Helga’s beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.
Fortunately, 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 who have never been in Helga’s bar.
And this is how modern economics works!
The Caregiver’s Voice thanks Les Hurdle for sharing this. We wish we knew the author of these posts that travel along the Internet–especially, educational ones like this! ENJOY.