A delightful tale sent to me by Richard Maugham.
Richard and I go back too many years! He has been a dear friend despite the obvious hurdle that when we first met, he declared that he was a typewriter salesman for Olivetti in the UK with me admitting that I was a typewriter salesman for IBM UK! Here’s the story.
oooOOOooo
WHAT WENT WRONG IN EUROPE – SIMPLY EXPLAINED!
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 volumes and paper profits increase massively. A young and dynamic vice-president at the local bank recognises 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.
He is rewarded with a six figure bonus.
At the bank’s corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS. These “securities” are then bundled and traded on international securities markets.
Naive investors don’t really understand that the securities being sold to them as “AA Secured Bonds” are really 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.
The traders all receive six figure bonuses.
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 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.
They all receive a six figure bonus.
The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who’ve never been in Helga’s bar……………………….!
oooOOOooo
I can add not a single word to this!
Learning from Dogs 
Delightful but, unfortunately, incomplete. I can add some words to it…
And because bank regulators completely forgot that all major financial disasters occur only because of excessive exposures to what was believed to be absolutely safe, and never because of any excessive exposures to what is believed risky; and bank regulators also believed that the rating agencies were incapable of being wrong, and therefore those DRINKBONDS must be safe, they authorized the banks to engage in that business holding practically no capital at all, which meant that when disaster struck, there was absolutely no buffers between the disaster…. and the taxpayers of tomorrow.
Paul, could Mr. Richard Maugham perhaps have left the typewriter business, to become a bank regulator? I say this because though his story contains only truths, in the end, by missing the truth, it serves as a distraction from understanding, who really did Europe in! http://bit.ly/t3mQe0
PS. Had the banks been required to hold more capital there would never have been those huge returns on capital, and ergo no huge bonuses.
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Thanks Per, hopefully Richard will be along at some point to answer the question you raise? 😉
Trust all is well with you, Paul
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Dear Per: Your excellent paper focuses on the risk perception, lending to sovereigns in Europe, and how much banks could make that way. You criticize who you call the “bank buttlers” in that particular crisis.
However the bank crisis, worldwide, is much more general. The crisis started in the USA. So you point out a characteristic, but partial aspect of the worl wide financial crisis.
At this point, the Eurozone is more severely affected, because it has forsaken the possibility of “Fiat Currency”. Yet, a reform in the mentality of the ECB and the bending of rules, has made the ECB ready to shower Fiat Currency. But the Bundesbank is opposed, and those who want reforms in the South are also opposed.
So they are playing chicken. Things will change when Germany too sinks in recession, which is only a question of months.
BTW the funny Helga business (German, I presume) happened because government let it happen. Ultimately, banks are just institutions enabled by the state. They become truly private, only whe the state has been privatized (plutocracy).
PA
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The crisis started in America… with securities that were backed with lousily awarded mortgages to the subprime sector and because these were rated AAA banks could hold them with minimum capital and therefore leverage bank equity the most and earn fabulous rates of returns… even after bonuses!
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Most fascinating and simply put in laymen’s terms! Although not funny, I did chuckle, if they were all unemployed why did Helga ever believe they would have the funds to pay back the debt. Get a clue world! Again, it all gets back to greed in the financial industry…
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Helga would never ever had given those credits had she not been persuaded she could get them repackaged in some complex securities, which miraculously made these very well rated, and therefore, given current bank regulations, highly desirable by the banks.
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Thanks Merci.
Per, on a more serious note, prompted by your comments, how do you see it all correcting over time? I mean half the world can see the emperor has no clothes, so to speak, and yet …….!
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As a former ED at the World Bank, 2002-2004, living close to Washington, writing articles and being an assiduous blogger, I’ve been in the middle of many discussions about those many of the challenges our world faces. And my friend, I am sorry to say, our prospects to solve these problems, do not seem good.
One of the main reasons for that negative outlook, is that I have been able to witness how the discussion of many of these problems, no matter how urgent these are, so often get hijacked by a political agenda, or by a group that decides making a business, or a living, out of it.
If we cannot break out of this mold, unfortunately, the world is toast, and this, not only from a global warming perspective.
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If it weren’t so tragic it would be hilarious! Alas, History repeats itself!!!albeit on the other side of the pond…Enjoyable even if….mary anne
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Sort of makes me think that if we didn’t laugh about it, we’d all be driven to jumping off the nearest cliff!
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I’m confused… your headline suggests that this refers only to Europe, but this isn’t a local, it’s a global phenomenon (and one that looks like it’s about to bite us in the backside again, as a result of the failure of the IMF et al to realise that 2008 proved that capitalism is as broken as sheeple said communism was in the mid-1980s, when the wall came down).
I would like to offer some additional words to your tale…
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By the very nature of their profession, the politicians authorising the taxpayer bail-out of the corrupt finance industry are experts in spin. They dress up the solution as ‘a temporary nationalisation’: and yet, when the banks and those running them begin once again making obscene profits, there is little sign of any return to the shareholders. On the contrary: the politicians, with sombre faces, agonise at length about the importance of returning the banks to their ‘rightful owners’ as soon as possible, even if this means a loss to the public purse.
The politicians, naturally, pat each other on the back for saving the day. And award themselves, in one way or another, a six figure bonus.
One uses his to buy Helga’s bar.
oooOOOooo
(Incidentally, here’s my take, in 2009, of what would happen following the 2008 ‘credit crunch’.)
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P. thanks so much for coming by Learning from Dogs again. I took a quick look at that link in your comment and just loved it. Any chance of me posting that as a guest poem on LfD?
And, of course, all that you wrote in your comment is spot on. Thanks again, Paul
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I don’t drop by more often, only because there are only so many hours in each day…
If you wish to republish my poetry, please do! (There’s really no need to ask, though I feel honoured that you did.)
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Know what you mean about only so many hours in the day! 😉 Typing this sitting up in bed when the light should be out! Thanks for letting me republish your pieces, Paul
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Poor, poor Helga! Whatever shall we do!
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Poor, poor all of us; whatever shall we do. Sorry we missed you today, Paul
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By the way, I managed to sit down a prominent and important bank regulator in my chair yesterday, though he was invisible and quite silent
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Per, just love that. Any chance of you penning a guest post that could set the background to that video in terms that make it easy for the punter to understand? I really would like to have that and the video as a post on Learning from Dogs. Paul
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Paul… well here is “a brief summary of my thoughts on banks and risks”
(Note to readers) I have taken Per’s summary and will be posting that as a separate article this week as it deserves greater prominence than as a comment to this post.
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Dear Per: Very well done and very funny, plus several important philosophical points, well taken, about risks and regulations. And the corruption of the banking system interacting with governements. And the abysmal private rating agencies (and Buffet going long and short according to what the rating agencies he owns tell him!)
Saying more would perhaps get me accused of myopia. Let me just ask, if I dare, with all due respect, what is the connection with the failure of Lehman and AIG? Yes, right, AIG was not a bank. Same for GM financial, or GE capital: shadow banks.
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AIG was rated AAA and therefore any loan with a credit default guarantee by AIG automatically classified for ultra-low capital requirements for the banks… and AIG sold and sold and sold these CDS
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To answer Per’s question…………… No I didn’t become a bank regulator – I stayed in the marginally less dishonourable profession of sales (!) until retirement a few weeks ago.
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Richard, delighted to see you grace these pages! Stay in touch! Paul
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How unfortunate! You might have saved us. … May I offer a tweet?
An economic war is raging, so we need ministers and bank regulators to be men of vision, not janitors and nannies! http://bit.ly/SjBFnL
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Thanks Per.
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Dear Per:
True, we need vision.
So what are banks for, what do they do? Should Shadow Banking and Derivatives be eliminated? Where does money come from? What is it? What’s the connection with government? What’s private about a private bank?
Should Royal Bank of Scotland be nationalized fully so that it can be forced to lend to the future, as you put it, id est small and medium companies, as is presently discussed even in the right wing Cameron government?
Many of these philosophical and quasi philosophical, and some even mathematical, questions are not discussed, but they are central to the present Greater Depression.
PA
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The way they are regulating our formal banks, our best chance to get out of this alive might be in the shadows!
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PA. So to understand my frustrations have a look at some of my early public opinions on this and take in consideration that I was not a banker and not a bank regulator.
http://subprimeregulations.blogspot.com/2004/11/some-of-my-early-public-opinions-on.html
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