Liquidity Explained
 

Helga is the proprietor of a bar.

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.

Helga keeps track of the drinks consumed on a ledger (thereby granting the customers’ loans).

Word gets around about Helga’s “drink now, pay later” marketing strategy and, as a result, increasing numbers of customers flood into Helga’s bar. Soon she has the largest sales volume for any bar in town.

By providing her customers freedom from immediate payment demands, Helga gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Helga’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 Helga’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 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 “AA” “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 Helga’s bar.

He so informs Helga.

Helga then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts.

Since Helga cannot fulfil her loan obligations she is forced into bankruptcy.

The bar closes and Helga’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 Helga’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, non-drinkers who have never been in Helga’s bar.

from the ethernet

But one of the employees (let's call him "Hunter"), makes out like a bandit. He has read The Big Short and put his life savings into credit default swaps on DRINKBONDS. Hunter now lives in Switzerland. :D

Hasn't that rant already ran its course as a thread-starter?

Please feel free to offer your own explanation of liquidity, you may also want to look up the meaning of the word "rant".:D

I think that is the key point -- How did the bonds get a "AA" rating and why did that rating carry so much weight?

Good point, the ratings agencies are in the direct employ of the companies issuing the paper, no real surprise that ratings are often way out of kilter with reality. The other side was that government guaranteed mortgages, thus lending an air of legitimacy and removing the risk from lenders-who naturally ran up the loans because all risk was removed.

Recent sovereign debt rating down grades were very far behind the curve, it is clear that ratings don't change until after a disaster.

Tom mentioned this book and it is a very interesting story of why things went south in such a big way and why many think there is an even bigger bubble brewing right now.
The Big Short: Inside the Doomsday Machine is a 2010 non-fiction book by Michael Lewis about the build-up of the housing and credit bubble during the 2000s. It describes several of the key players in the creation of the credit default swap market that sought to bet against the collateralized debt obligation (CDO) bubble and thus ended up profiting from the financial crisis of 2007–2010. The book also highlights the eccentric nature of the type of person who bets against the market or goes against the grain. The work follows people who believed the bubble was going to burst, like Meredith Whitney, who predicted the demise of Citigroup and Bear Stearns; Steve Eisman, an anti-social hedge fund manager; Greg Lippmann, a Deutsche Bank trader, Eugene Xu, a quant, who created the first CDO market by matching buyers and sellers; the founders of Cornwall Capital, who started a hedge fund in their garage with $100,000 and built it into $120 million when the market crashed; and Dr. Michael Burry, an ex-neurologist who created Scion Capital despite suffering from blindness in one eye and Asperger's syndrome.[1] The book also highlights some of the biggest losses created by the market crash: like Merrill's $300 million mezzanine CDO manager Wing Chau; Howie Hubler, infamously known as the person who lost $9 billion in one trade, the largest single loss in history[2]; and Joseph Cassano's AIG Financial Products, which suffered over $99 billion in losses. wiki

I thought the The Big Short was pretty good. His new book, Boomerang, focuses on the Euro crises (the "New Third World") and looks interesting as well.

Liquidity simply refers to an asset that can easily be converted to cash. There are no liquid assets in the pub story. A more accurate thread title would have been "The Absense of Liquidity Explained."

The pub story wasn't a rant the first time. It became a rant when it was re-posted in a demand for more attention.

Liquidity refers to both the presence or absence of assets that can be converted to cash.

Could you please point out any previous post of this pub story by me or would you just admit it is you who are doing the ranting and seeking the attention?

Your move, put up or shut up.

You seem to be slightly confused sir.

The liquidity cycle
 

There were "liquid" assets, but the pub's customers converted them to debt. The debts were bundled into securities and sold to unwary investors for cash. The securities were eventually used as toilet paper, flushed, and became liquid again. :p