Drano
Thu Jul 12th, 2012, 03:46 PM
Understanding the European Debt Crisis
For anyone finding it hard to understand the present financial crisis in Europe, and indeed the whole western world economies, here is an amusing, yet interesting allegory:
Mary is the proprietor of a bar in Dublin. 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 new marketing plan that allows her customers to drink now, but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans.)
Word gets around about Mary's "drink now, pay later" marketing strategy and, as a result, customers flood into Mary's bar. Soon she has the largest sales volume for any bar in Dublin.
By providing her customers' freedom from immediate payment demands, Mary gets no resistance as she regularly and substantially increases her prices. Consequently, Mary's 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 Mary'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 headquarters, expert traders figure a way to make huge commissions by transforming these customer loans into Drinkbonds and Alkibonds. These securities are then bundled and traded on international security markets. Naïve investors don't really understand that the securities being sold to them as 'AAA' are really the debts of unemployed alcoholics. Nevertheless, the bond prices continue to 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 drinkers at Mary's bar. He so informs Mary. Mary then demands payment from her alcoholic patrons. But being unemployed alcoholics they cannot pay back their drinking debts. Since Mary cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.
Overnight, Drinkbonds and Alkibonds drop by 90%. The collapsed bonds destroy the bank's liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. The supplier of Mary's bar had granted her generous payment extensions, and had also invested their firm's pension funds in the Drinkbonds and Alkibonds. They find they are now faced with having to write-off her bad debt as well as losing over 90% of the value of the bonds. It isn't long until the supplier claims bankruptcy, closing the doors on a family business that had endured for three generations, and lays off 150 workers.
Fortunately though, the bank, the brokerage houses and their respective executives are bailed out by a multi-billion euro 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 Mary's bar.
For anyone finding it hard to understand the present financial crisis in Europe, and indeed the whole western world economies, here is an amusing, yet interesting allegory:
Mary is the proprietor of a bar in Dublin. 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 new marketing plan that allows her customers to drink now, but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans.)
Word gets around about Mary's "drink now, pay later" marketing strategy and, as a result, customers flood into Mary's bar. Soon she has the largest sales volume for any bar in Dublin.
By providing her customers' freedom from immediate payment demands, Mary gets no resistance as she regularly and substantially increases her prices. Consequently, Mary's 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 Mary'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 headquarters, expert traders figure a way to make huge commissions by transforming these customer loans into Drinkbonds and Alkibonds. These securities are then bundled and traded on international security markets. Naïve investors don't really understand that the securities being sold to them as 'AAA' are really the debts of unemployed alcoholics. Nevertheless, the bond prices continue to 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 drinkers at Mary's bar. He so informs Mary. Mary then demands payment from her alcoholic patrons. But being unemployed alcoholics they cannot pay back their drinking debts. Since Mary cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.
Overnight, Drinkbonds and Alkibonds drop by 90%. The collapsed bonds destroy the bank's liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. The supplier of Mary's bar had granted her generous payment extensions, and had also invested their firm's pension funds in the Drinkbonds and Alkibonds. They find they are now faced with having to write-off her bad debt as well as losing over 90% of the value of the bonds. It isn't long until the supplier claims bankruptcy, closing the doors on a family business that had endured for three generations, and lays off 150 workers.
Fortunately though, the bank, the brokerage houses and their respective executives are bailed out by a multi-billion euro 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 Mary's bar.