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« Angela Merkel vows to create a 'fiscal union' | Main | Eric Sprott: So here’s the question »

Dummies' guide to what went wrong in banking

One of our readers has very kindly sent us this Dummies Guide to what went wrong with the banking system in a few easy to understand moves!

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 the
  customers' loans).
Word gets around about Helga's "drink now, pay later" marketing strategy
 and, 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.
 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
 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
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 so informs Helga.
Helga then demands payment from her alcoholic patrons, but being unemployed
alcoholics they cannot pay back their drinking debts.
Since Helga cannot fulfil her loan obligations she is forced into
bankruptcy. The bar closes and Helga'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 Helga'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, non-drinkers who have never been in Helga’s bar.
Now do you understand?

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    Silver Prices - Silver Prices - Dummies' guide to what went wrong in banking

Reader Comments (1)

Is this an analogy to the mortgage housing bubble in NA or what has happened with the PIGS countries in Eur?

December 2, 2011 | Unregistered CommenterBrian

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