An easily understandable explanation of derivative markets.

MonkieSocks

Brian Cowen is the proprietor of a bar in Dublin .

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

To solve this problem, He comes up with a new marketing plan that allows his customers to drink now, but pay later.

He keeps track of the drinks consumed in a ledger (thiseby granting the customers loans).

Word gets around about Brian Cowen's "drink now, pay later" marketing strategy and, as a result, increasing numbers of customers flood into Brian Cowen's bar.

Soon He has the largest sales volume for any bar in Dublin.

By providing his customers freedom from immediate payment demands, Brian Cowen gets no resistance when, at regular intervals,
He substantially increases his prices for wine and beer, the most consumed beverages.

Consequently, Brian Cowen'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 Brian Cowen'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 transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS.

These securities are then bundled and traded on international security markets.

Naive investors don't really understand that the securities being sold to them as AAA secured bonds are really 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 drinkers at Brian Cowen's bar.

He so informs Brian Cowen. Brian Cowen then demands payment from his alcoholic patrons.

But being unemployed alcoholics, they cannot pay back their drinking debts.

Since Brian Cowen cannot fulfill his loan obligations,
He is forced into bankruptcy.

The bar closes and his eleven employees lose their jobs.

Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in price 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.

Suppliers of Brian Cowen's bar had granted his generous payment extensions and had invested their firms' pension funds in the various BOND securities.

They find they are now faced with not only having to write off his bad debt but also with losing over 90% of the presumed value of the bonds.

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

His 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 multi-billion Euro, no-strings attached cash infusion from their cronies in 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 Brian Cowen's bar.