Links of Interest

Read something interesting lately? Post it in the comments or send it in.

Why I Fired my Broker. The intro says it all: “With his 401(k) in ruins, our correspondent visits investment gurus, hedge fund managers, and a freakish Arizona survivalist with one question in mind: How can the ordinary investor recover?” Sent in from Jim in Key West.

The Quiet Coup. How the finance industry has effectively captured our government. From the former chief economist of the International Monetary Fund, currently the blogger behind the terrific Baseline Scenario. From Kurt in D.C.

Over the Hedge. The journalist who first questioned Enron’s earnings looks at hedge funds, their exorbitant fees and the egos of those who manage them. Best quote: “They weren’t the gods you made them into, but they aren’t the whale turds they’re being portrayed as now.” From Marilyn in Key West.

And this, via Frank in Tavernier, on Understanding Derivative Markets:

“Heidi is the proprietor of a bar in Detroit. In order to increase sales, she decides to allow her loyal customers – most of whom are unemployed alcoholics – 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 Heidi’s drink now, pay later marketing strategy and as a result, increasing numbers of customers flood into Heidi’s bar and soon she has the largest sale volume for any bar in Detroit.

By providing her customers’ freedom from immediate payment demands, Heidi gets no resistance when she substantially increases her prices for wine and beer, the most consumed beverages. Her sales volume and profits increases massively.

A young and dynamic vice-president at the local bank is very impressed with Heidi’s phenomenal increase in sales and profits, recognizes these customer debts as valuable future assets, and increases Heidi’s borrowing limit.

He sees no reason for undue concern since Hedi is so profitable and he has the debts of the alcoholics as collateral.

At the bank’s corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then traded on security markets worldwide. Investors looking to get rich quick don’t don’t bother to look into the investment deep enough to really understand the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics.

Prices continuously climb, and the securities become the top-selling items for some of the nation’s leading brokerage houses.

One day, although the bond prices are still climbing, a risk manager at the bank (subsequently fired due to his negativity), decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi’s bar.

Heidi demands payment from her alcoholic patrons, but being unemployed, they cannot pay back their drinking debts. Therefore, Heidi cannot fulfill her loan obligations and files for bankruptcy.

DRINKBOND and ALKIBOND drop in price by 90 %. PUKEBOND performs better, stabilizing in price after dropping by 80%. The decreased bond asset value destroys the banks liquidity and prevents it from issuing new loans.

The suppliers of Heidi’s bar, having granted her generous payment extensions and having invested in the securities, are faced with writing off her debt and losing over 80% on her bonds. Her wine supplier claims bankruptcy, and her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 50 workers.

The bank and brokerage houses are made whole by the government following dramatic round-the-clock negotiations by leaders from both political parties. The owners and employees of the beer and wine supplier are out of work, but get a $13 a week stimulus from the government. The funds required to bail out the banks and brokers are obtained by a tax levied on employed middle-class non-drinkers.

Finally an explanation we can understand.”

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.

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