Sunday, February 12, 2012

Credit II

This is a (modified) translation of an existing joke which doesn't seem to be available in English.

Mandy owns a bar in Berlin Kreuzberg. One day, to increase revenue, she decides to allow customers to order drinks without paying immediately. Denizens in Kreuzberg hear about this and more and more customers visit Mandy's bar. Since they don't need to worry about paying, Mandy can raise prices and dramatically increases her revenue. The young and dynamic consultant of a local bank notices Mandy's success and offers her a credit line to ensure her liquidity. He is not concerned about getting the money back because he has the debt of the customers as collateral.

A group of investment bankers hears about the successful local bank and they transform Mandy's credit into collateralized debt obligations called ALCBOND(R), PUKBOND(R) and GUZBOND(R). These papers are generally referred to as SMA (Super Mega Asset) and are insured with the help of an Uzbek online-insurance company via email.
Since they are insured and are based on a very successful business, several rating agencies attest very good credit ratings. Nobody understands what the SMA papers actually are but due to the soaring market value institutional investors love SMAs. In the next few years, managing directors and investment specialists receive several hundred millions worth of bonus payments.

One day, the prices are still rising, a risk specialist has a look at the papers. He advises to demand payment from a small part of Mandy's customers. He is soon fired for his negative attitude which is not compatible with the corporate image. However, to prove that the risk specialist was wrong the management of "SMA International" decides to ask for payment on just a tiny slice of Mandy's customers. Surprisingly they can't pay as their debts equal a multitude of their annual incomes. With the help of external consultants several investigations are launched but it turns out that almost none of Mandy's customers can pay. Mandy goes bankrupt. ALCBOND(R) and PUKBOND(R) lose 95% value. GUZBOND(R), which was generally considered a boring investment, retains 20%.

Since the fast growth and general success of Mandy were well known, many of Mandy's suppliers had granted her very generous terms of payment. Additionally, they had invested in SMAs, too. Since Mandy can't pay and since the SMAs are worthless, most of the suppliers go bankrupt. With the help of the government the rest is taken over by a private equity investor who promises to restructure the companies and make them profitable again. The local bank is rescued by tax payer money. The CEO of the bank agrees to pass on his bonus for the last year.


  1. I'm not sure that technically qualifies a "joke". More of a parable, maybe.

    The moral appears to be that risk specialists should keep their damn opinions to themselves :P

    On an MMO-related note, I wonder how Aventurine stand in the current economic climate? And CCP for that matter. MMOs must seem quite the attractive product line under the circumstances.

  2. Aren't MMOs under this business model too? Especially with F2P, the lifetime expectant revenue calculation models are used to determine ad rates and server capital.

    No one ever assumes the market can dry up or that customers decide not to pay their fair share. As long as that DAU value keeps going up, all is good in the land of analysts.

  3. Good summary of the banking crisis. I don't think it's the risk specialists that are really at fault though. The problem is that financial mavens get rewarded up front, before the toxic nature of the loans they organised is clear. By the time the loans are reaching maturity and it's clear they won't be paid, the guys who arranged them have already made their f*** you money and are happily ensconced in their estate in Surrey complete with trophy blonde.

    The insurance crisis (Lloyds) had similar causes. By the time the poor Lloyds names (investors) lost their shirts, the underwriters responsible had already stashed the early premiums away in offshore accounts that couldn't be touched.

  4. I guess it's more of thousands year old truth about trust and abuse of it. Trust chain got a bit more convoluted, but the principle works same way. Checks and balances failed, and system tipped over too much in one direction.

    We have a joke in Russian:
    "Russian went to London and played poker there. One of players says:
    - I got Royal Flush.
    - Show it! -, says Russian.
    - Here, in England, we trust gentleman's word.
    And you wouldn't believe luck with cards Russian got after that!"
    Works for credit too. :)

  5. But the real items (drinks) have been consumed and are gone. Those real items were produced with other real money. The consumers of the drinks can not give back the items (unless urine is allowed) and so the choices come down to:

    1) Taking away other asssets of the consumers up to the amount of their debt.
    2) The producers and investors that put up real money to create the real item are out their money.
    3) A combination of the two.

    Now to equate this to Greece/Germany the options are:
    1) Severe austerity measures in Greece to pay the loans back.
    2) Germany (banks/investors/suppliers) eat the loss.
    3) A combination of the two.

    1. Oh, the European crisis, and especially Greece is not really comparable to this, I think. The problem is not that Germany wants its money back. If that were the case we wouldn't transfer ever money over there.

      The problem is that the Greece institutions and their the government needs to be reformed - drastically. And this won't happen without pressure. And, unfortunately, the only way to put pressure on the Greek politicians is pain for their electorate.

      It's a terrible thing and it will actually cause some people to even die. But it's just the lesser evil. Even if the German population would be willing to transfer even more money (than 211billion €) over there, it wouldn't really help Greece. It would just enable them to continue the party and nothing would change.

      The only one who can change the Greece institutions and actually start to produce enough goods and services in Greece to pay for all the (necessary!) imports, are the Greek people. And the way to do it is to elect the correct politicians. Will it work? Probably not.

      But Germany decided to transfer hundreds of billions to the Greek people (called 'credit', but we all know that Greece won't repay these credits) to help them. Even more help is not going to happen because our politicians want to be re-elected, too.

      I should probably write an update on that topic ;)

    2. > The problem is not that Germany wants its
      > money back. If that were the case we
      > wouldn't transfer ever money over there.

      Now the question is who wants his money back and whose money was transferred. Germany is not a homogeneous entity.

    3. Actually, no money was transferred but Germany's government vouched for credit that private investors gave the Greek government.

      But if the Greek government doesn't pay back this money to the investors (and they couldn't right now), the German government will have to do it - unless it doesn't want to. Which would be a bankruptcy of the German government. If the German government wants to pay the money back it will have to raise credit for which it will have to pay interest. To do this - and to ultimately pay back the debt - it will have to raise taxes or make the ECB cause inflation.

      It's a complex story and you are very right to distinguish between a nation and it's government. I think the most important thing to understand about Greece is this:

      The basic problem are the Greek institutions. They can only be fixed with the help of a crisis. Germany uses the crisis the Greek institutions caused for themselves to force them to fix themselves. At all times the Greece people can elect politicians who pull Greece out of the Eurozone.

      In my opinion this will eventually happen. But it would (will?) transform Greece into a third world country. We would have to replace the credit with humanitarian aid. The moral is this: Societies must not live on external credit alone for a decade. The current situation for Greece is terrible. But there's just no easy way out. If I were a Greek, I'd learn some other language and get out of there asap. It's that bad.

    4. I have relatives living there right now. My grandparents moved here (US) when they were in their early 30s and moved back to Greece when they were in their late 60s / early 70s. Most of their money is in the US though.

      The government pretty much lied to the people there. They underplayed the problem, but the same as with the US housing crisis, no one likes to pull the punch bowl when the party is going strong. Its very unpopular, even if its for your own good. Many Greeks have already fled the country, mostly young people.

      I remember visiting Athens in 2005 and seeing more BMW X5s and Porsche Cheyennes than I could count. I also remember thinking, how is this possible? The gluttony was incredible. On the other hand, foreign lenders really should have known better than to lend that much credit. All you had to do was visit Athens like I did and see it for yourself. But that goes back to the punch bowl principle.

      The inefficiencies in the government jobs were terrible too. Just to get a business permit you had to apply and slip extra petty cash into the envelope just so that the processer would not "lose" your application. You literally had to pay people extra money to do a job they were already getting paid for.

      Watching the Greek TV (ANT1) last couple nights has been humorous/sad. Its full of political manuevering and grandstanding for votes rather than just doing the right thing. Reminds me of the current state of politics in the US.

  6. Well if Germany doesn't want their money back and really wanted to step away from all this the solution is simple. Declare two things. First forgive the old debt. Then tell Greece "Cash Only" for all future trade.

    So maybe the reason Germany is doing further credit is not for the benefit of Greece but as a way to keep their industry employed. Buy requiring cash/gold only for all future transactions this forces Greece to only buy what it can afford. So there has to be more to it than this.

    1. On the first paragraph:
      This would not help Greece at all. The incentives to reform would be lower. At the same time Greece would have a much larger problems importing anything. The problems for the population would be even worse.

      On the second paragraph:
      Germany's exports to Greece are neglectable ...

      There is more to it: Germany, and all of Europe, wants Greece to reform its institutions, e.g. tax everybody, including the rich. Then, once they have done that we will support Greece with an investment program. We want Greece to succeed because we want Europe to succeed. But the only people who can reform the Greek insitutions are the Greek. I mean, Germans would love to do it for them. But that would really be a kind of invasion. That's why Greece's corrupt politicians have to do it for themselves.

    2. Someone I'm having a difficult time accepting that Germany is filled with an altruistic belief that they are doing this for the bennefit of Europe and Greece. People and nations have historically been only concerned with how it helps them.

      Even the US implemented the Marshall Plan with the purpose of stopping the USSR as an important goal, if not the most important one. Rebuilding Europe was a means to that goal.

      Europe can succeed with or without Greece. In fact it may be even stronger without the Balkans being part of it.

      So maybe I'm have a cynical viewpoint but this still seems to lack the why. Just wanting their money back fits Occam's Razor best in my opinion.

    3. In the beginning, one important reason was that a dissolution of the Eurozone has been feared if any country would leave it. A chain reaction... But this fear is mostly gone by now. The ECB did away with it ...

      Now it's mostly the desire for a strong Europe. This is very important for Germany for many reasons; not least historic ones. If Greece could be made successful again this would be a very strong argument for a united Europe ...