Understanding Derivatives

Discussion in 'Economy' started by Trajan, Jun 19, 2011.

  1. Trajan
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    Trajan conscientia mille testes

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    so.....

    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 "AA" "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.

    OK?
     
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  2. LordBrownTrout
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    LordBrownTrout Gold Member

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    Moral of the story: we, the taxpayers, get screwed whenever government acts on their supposed good intentions.
     
  3. expat_panama
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    expat_panama Silver Member

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    Still waiting for the 'understanding derivatives' part.
     
  4. Mad Scientist
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    Mad Scientist Deplorable Gold Supporting Member Supporting Member

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    :lol:

    How about this; Our politicians sold us out to International Banks that are fucking us to the tune of 1.5 Quadrillion dollars (1,500 Trillion dollars).
     
  5. william the wie
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    william the wie Gold Member

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    You mean derivatives such as titles, stock certificates, credit cards, checks and so forth don't you? Because all paper and plastic assets used in economic exchange are derivatives.

    Derivatives ain't the problem. The problem are innumerate politicians and bureaucrats who use models that are so wrong that they become the patsy in the game. When it comes to economics almost all politicians almost everywhere are dumber than dog-squat which is acceptable but they have convinced themselves that they know this stuff which is the real hazard:

    The efficient market hypothesis requires the price charts to look very slightly different than they are. (See Madelbrot's "(Mis)behavior of Markets" and be prepared to set a spell this ain't easy peasy.) So EMH/EMT was disproven in the 1960s but it is still used by some traders and almost all politicians. This has been causing avoidable financial crises since the 1960s and unavoidable financial crises prior to that.

    The models for the "real" economy ignore the compounding of rounding error (Chaos, a branch of math that was discovered in 1961), age related spending (an analysis tool developed by the department of Commerce in the 1980s) and wealth effects.

    So you can do away with whatever order derivatives you want but as long as the politicians are in the loop operating on unfounded certainty it won't do a bit of good.
     
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  6. Baruch Menachem
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    Baruch Menachem '

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    Only problem I have with this is that the government marketed the drink bonds as sound.

    And this is not really derivatives. A derivative is any investment based on another investment. This is the banking crisis is 2008.

    And as a consequence, the town is as dry as Saudi Arabia.
     
  7. uscitizen
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    uscitizen Senior Member

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    The independent ratings agencies such as Moodys rated the drink bonds not the govt.
    Essentially the distributor of the drink bonds?
     
  8. Baruch Menachem
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    Baruch Menachem '

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    Fannie and Freddie were/are quasi government agencies and Moody's rated them as US sovereign debt because they essentially were US sovereign debt.

    I remember the Wall St. Journal howling about this back during the Carter administration. This tsunami was a long time coming, but when it did, it was quite the monster.
     
  9. oreo
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    oreo Gold Member Supporting Member

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    ALL roads of this financial collapse lead right back to Fannie Mae and Fredie Mac.

    Basically the federal government thought it would be a great idea to co-sign our names to 50% of the mortgages in this country using Fannie/Fredie. This while at the same time they were pressuring banks to lower lending requirements. No collateral--no down payment--and less than a desirable credit rating along with sub-prime mortgages could get a loser a 400K custom home. Why? Because he had 310 million American co-signers.

    Then the derivities market fully supported and defended by Alan Greenspan and Robert Rubin--(Wall Street bankers started buying these mortgage backed securities) up as fast as they could to trade them in the mother of all casino's the hedge funds aka derivities market. All warnings of an imminent collapse were ignored by both congressional and senate banking boards.

    Basically the federal government built a house of cards that collapsed leaving the American tax payer holding the bag.

    Fannie Mae Eases Credit To Aid Mortgage Lending - NYTimes.com
     
    Last edited: Jun 19, 2011
  10. Salt Jones
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    Salt Jones BANNED

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    AIG selling insurance on subprime tranches, Moody's et al making hundreds of millions of dollars on bogus rating of junk and mortgage houses pushing subprime loans so they could sell them is all the fault fannie/freddie helping poor minorities, right?
     

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