A Drinkers Guide to Understanding Mortgage Derivatives

Mortgage and Lending with The Federal Savings Bank

Heidi is a bar owner.  She realizes that virtually all of her customers are unemployed alcoholics and 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 & pay later. She keeps track of the drinks consumed on a ledger tab, thereby granting customers loans.

Word gets around about Heidi's "drink now pay later" no income loan programs and huge numbers of customers flood into Heidi's bar.  Soon she has the largest sales volume for any bar in town!

By providing her customer's deferred payments Heidi gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Heidi's gross sales volume increases hugely!

A young and ambitious vice-president at the local bank lables Heidi's customer debts 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 mix these loans with those of employed alcoholics and transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS.  These new securities are bundled and traded on international security markets.  Naive investors don't really understand that the securities they think are AAA secured bonds are really mixed in with 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 unemployed drinkers at Heidi's bar but 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 value 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 their 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 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 mainly on employed, middle-class, non-drinkers.



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Donne Knudsen
Los Angeles & Ventura Counties in CA - Simi Valley, CA
CalState Realty Services

Greg - Great analogy and funny story.  Thx for the laugh.  Have a good day.  :)

May 27, 2009 08:05 AM #1
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Greg Zaccagni

Illinois Mortgage Lender
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