The Financial Crisis – A Dummies’ Guide

With all the broo-ha-ha in the news about bankers’ bonuses and all the chatter concerning the recession, economic downturns, market volatility, global recovery etc. it’s safe to assume, consultancies will want to see some awareness of what’s been going on regarding the Financial Services industry, especially since a huge chunk of their work came directly and is still pouring out from the big banks. PwC for example, have netted £154 million in Lehmans-related fees according to recent court filings. Furthermore, it has had a profound effect on nearly every other industry sector. [I’ll talk more about this in another post perhaps].

But first! The recession is (technically) over; so before you lose the chance to gain a strong understanding of how it all started while it remains relevant today, here is an excellent post from the Wikijobs blog I stumbled across, using an inspired analogy graduates are sure to absorb:

The financial crisis explained in simple terms

Heidi is the proprietor of a bar in Berlin . 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 and as a result increasing numbers of customers flood into Heidi’s bar.

Taking advantage of her customers’ freedom from immediate payment constraints, Heidi increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively.

A young and dynamic customer service consultant at the local bank recognizes these customer debts as valuable future assets and increases Heidi’s borrowing limit.

He sees no reason for undue concern since he has the debts of the alcoholics as collateral.

At the bank’s corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed. Nevertheless, as their prices continuously climb, the securities become top-selling items.

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

However they cannot pay back the debts.

Heidi cannot fulfill her loan obligations and claims bankruptcy.

DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %.

The suppliers of Heidi’s bar, having granted her generous payment due dates and having invested in the securities are faced with a new situation. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor.

The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties.

The funds required for this purpose are obtained by a tax levied on the non-drinkers.

In real terms…

Of course, the lending surrounded the sub-prime (super-risky) mortgage market in the US. Rising drinks prices = rising house prices. And when prices peaked in the US by mid 2006, and people started defaulting on payments – the s**t really hit the fan as the banks had backed multiple securities with these sub-prime mortages which were now rapidly disintegrating.

The hope of making some money by investing in a financial product that primarily relied on joe-public paying his mortgage sounds like an obviously silly idea, but as robust risk -management was considered a bit of a party-pooper in such prosperous times, investments became increasingly complex, convoluted and divorced from the truth. Capital and credit divebombed and the financial system exploded into a complete meltdown. The effects of which quickly became globally felt as these products were traded around the world.

For a more detailed explanation have a look at this genuinely fantastic video (MUST SEE):


So where does that leave us…..what next? Welcome to the ‘Zombie economy’ (next post coming soon).


2 responses to “The Financial Crisis – A Dummies’ Guide

  1. Yes, very nice analogies. But you wre only joking about the crisis being nearly over? There’s lots more jobs for consultants soon, with the qualification: can government or banks then still pay them?

  2. the video’s brilliant!

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