Economic Theory
Published by Rick on Saturday, December 18, 2010.
An occasional explanation of modern Economic Theory, Part 94 - Ireland
O'Mara is the proprietor of a bar in Borrisokane, County Limerick. 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 on a ledger (thereby granting the customers loans).
Word gets around about O'Mara’s drink now, pay later marketing strategy and, as a result, increasing numbers of customers flood into O'Mara’s bar. Soon he has the largest sales volume for any bar in County Limerick.
By providing his customers' freedom from immediate payment demands, O'Mara gets no resistance when, at regular intervals, he substantially increases his prices for wine and beer, the most consumed beverages. Consequently, O'Mara's gross sales volume and profitability increases massively.
A young and dynamic Customer Relationship Manager at the local bank recognizes that these customer debts constitute valuable future assets and increases O'Mara's borrowing limit. He sees no reason for any undue concern, since he has the debts of the regular customers (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 financial bonds. 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, while the bond prices are still climbing, one of O'Mara's unemployed alcoholic clients drops down dead from consuming just too much of O'Mara's booze. This is a bit of a problem as his personal assets (principally made up of 150 empty Guinness cans and his flat hat) do not come anywhere close to covering his tab. This attracts the attention of a credit risk manager at the original local bank who decides that the time has come to demand some payment on account of the debts run up by the other unemployed alcoholic clients of O'Mara. He so informs O'Mara. O'Mara then demands payment from his alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts. Since O'Mara cannot fulfill his loan obligations he is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.
Overnight, the bonds drop in price by 90%. The collapsed bond asset value destroys the banks liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community.
The suppliers of O'Mara’s bar had granted him generous payment extensions and had invested their firms' pension funds in the various bond securities. They find they are now faced with having to write off his bad debt and with losing over 90% of the presumed value of the bonds. O'Mara's wine supplier also 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 Government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who have never been in O'Mara’s bar, or even live in Ireland.
Such is the development of Economic Theory.
O'Mara is the proprietor of a bar in Borrisokane, County Limerick. 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 on a ledger (thereby granting the customers loans).
Word gets around about O'Mara’s drink now, pay later marketing strategy and, as a result, increasing numbers of customers flood into O'Mara’s bar. Soon he has the largest sales volume for any bar in County Limerick.
By providing his customers' freedom from immediate payment demands, O'Mara gets no resistance when, at regular intervals, he substantially increases his prices for wine and beer, the most consumed beverages. Consequently, O'Mara's gross sales volume and profitability increases massively.
A young and dynamic Customer Relationship Manager at the local bank recognizes that these customer debts constitute valuable future assets and increases O'Mara's borrowing limit. He sees no reason for any undue concern, since he has the debts of the regular customers (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 financial bonds. 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, while the bond prices are still climbing, one of O'Mara's unemployed alcoholic clients drops down dead from consuming just too much of O'Mara's booze. This is a bit of a problem as his personal assets (principally made up of 150 empty Guinness cans and his flat hat) do not come anywhere close to covering his tab. This attracts the attention of a credit risk manager at the original local bank who decides that the time has come to demand some payment on account of the debts run up by the other unemployed alcoholic clients of O'Mara. He so informs O'Mara. O'Mara then demands payment from his alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts. Since O'Mara cannot fulfill his loan obligations he is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.
Overnight, the bonds drop in price by 90%. The collapsed bond asset value destroys the banks liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community.
The suppliers of O'Mara’s bar had granted him generous payment extensions and had invested their firms' pension funds in the various bond securities. They find they are now faced with having to write off his bad debt and with losing over 90% of the presumed value of the bonds. O'Mara's wine supplier also 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 Government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who have never been in O'Mara’s bar, or even live in Ireland.
Such is the development of Economic Theory.
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