Debt and default thereon are pretty easy concepts to understand. You borrow money; you fail to make the interest payments on time; the lender calls back the loan requiring you to repay. You cannot. You default. The lender loses his money.
When it comes to national debts and the global economy, would that it were so simple. Ah, but it is.
This is essentially what happened in the global financial crisis--but on a grand scale. The fact that millions of people were borrowing way beyond their ability to meet the interest payments and that "every" bank was doing it made it somehow seem safe and secure. It would be different this time. Normal realities no longer applied. We luxuriated in a "new world economic order". We had finally beaten the business cycle and the credit cycle. The West was lifting itself to a new plane of reality. A perception grew that it was all too big to fail. If anything happened the government would step in and bail things out. A contrary Armageddon was too awful to contemplate. Meanwhile, credit was abundant, the good times were rolling, and anyone issuing warnings was self-evidently a stupid, negative whiner.
The fact that numerous acronyms and plenty of different institutions were involved in the global financial crisis (now known as "GFC" to illustrate the point) only serves to disguise and obfuscate--it does not change the underlying simple realities. But the confusion of acronym-spaghetti serves a purpose: it obscures the hard truths needing to be faced. It allows for a multitude of crock, pseudo solutions to be promulgated. It sets up another mega-failure down the track.
Despite this, the underlying realities and causes remain simple, as the following analogy makes clear:
Heidi is the proprietor of a bar in Detroit .If only it were that simple. Actually, strip away all the dissembling, the avoidances, the misdirections. The global financial crisis is that simple.
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.
Heidi 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. Soon she has the largest sales volume for any bar in Detroit.
By providing her customers freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages.
Consequently, Heidi'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 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 figure a way to make huge commissions, and transform these customer loans into DRINK BONDS.
These "securities" then are bundled and traded on international securities markets.
Naive investors don't really understand that the securities being sold to them as "AAA Secured Bonds" really are 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 still are 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 Heidi's bar. He so informs Heidi.
Heidi then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts.
Since Heidi cannot fulfill her loan obligations, she is forced into bankruptcy. The bar closes and Heidi's 11 employees lose their jobs.
Overnight, DRINK BOND 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 Heidi'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.
The funds required for this bailout are obtained by new taxes levied on employed, middle-class, nondrinkers who have never been in Heidi's bar.
Now do you understand?
Do you think the gaggle of protesters camping out on Wall Street understand something this simple? Not a hope. They are way, way too sophisticated.
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