Understanding Derivatives

Heidi is the proprietor of a bar in Detroit. 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 because 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

“DRINKBONDS.”

 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, "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 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, laying 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 the employed,
middle-class, non-drinkers who have never been in Heidi's bar.

Now do you understand?