How we got into the financial mess

The following is a lighthearted explanation of how we got into the financial and housing mess we face today.

Understanding Derivatives

  (adapted from an email making the rounds)

The  proprietor of a bar …

(Well intentioned individuals (mostly democrats) who believed everybody is prepared to and is entitled to own a house and that mortgages should be easy to get.)

… realizes that virtually all of the customers are unemployed and, as such, can no longer afford to patronize the bar.

(Unprepared home buyers are certainly not alcoholics, but proof of employment was not required, nor was it necessary to show how repayment would happen.) See Article on Bill Clinton’s efforts to promote housing

 To solve this problem the owner comes up with a new marketing plan that allows customers to drink now, but pay later.  Drinks consumed are kept on a ledger (thereby granting the customers loans).

(Builders along with the help of mortgage brokers devised plans based upon congressional incentives to get anyone into a house.)

 Word gets around about the “drink now, pay later” marketing strategy and, as a result, increasing numbers of customers flood into the bar. Soon the bar has the largest sales volume for any bar around.

By providing customers freedom from immediate payment demands, there is little resistance when, at regular intervals, prices for wine and beer, the most consumed beverages, are substantially increased.  Consequently, gross sales volume increases massively.

(Builders could charge what they wanted and provide unreal incentives like 25,000.00 cash back.  This caused the owners to be immediately “underwater” on their house. The house could not bring the value of the mortgage because the owner could not offer new buyers cash back or other incentives that the builder was allowing, let alone the average 10% selling cost when re-selling a house.)

A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases the bar’s borrowing limit.

He sees no reason for any undue concern because he has the debts of the unemployed bar customers as collateral!

At the bank’s corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS (Sub Prime Mortgages?).  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 drinkers.

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 the bar. He so informs the bar owner.

The owner then demands payment from the patrons. But, being unemployed — they cannot pay back their drinking debts.  Since the bar owner cannot fulfill the loan obligations the bar closes, eleven employees lose their jobs and the bar is forced into bankruptcy.

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 the bar had granted 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 the bad debt and with losing over 90% of the presumed value of the bonds.

The wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations.  The 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 the bar.

Now …. Do we all understand derivatives?

There is plenty of blame to go around.  Troubles may have begun as far back as the 1990’s.  Correcting this travesty is going to take time.  First we must get the entitlement and rights crowd to go “sit in the truck” while clear thinking business practices are put into place.