Monday, October 10, 2011

OC Phang does not understand the meaning of bonds

Former Port Klang Authority (PKA) general manager OC Phang told the High Court here today she had no clue what bonds were or how they worked.

“I don’t understand bonds. I remember asking my project accountant what is this bonds thing. He also didn’t know,” she told Tun Dr Ling Liong Sik’s cheating trial.

Okay, for the less informed on the investment market, bond is nothing more than an asset which is part of a derivative instrument. Other assets include stocks, commodities, currencies, interest rates and market indexes.

A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.

To simplify it so that lay people like us can understand, this is how it goes.

Michael Wee is the proprietor of a pub in Damansara.

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.

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

Word gets around about Michael's "drink now, pay later" marketing strategy and, as a result, increasing numbers of customers flood into Michael's pub. Soon he has the largest sales volume for any bar in the Klang Valley.

By providing his customers freedom from immediate payment demands, Michael gets no resistance when, at regular intervals, he substantially increases his prices for wine and beer, the most consumed beverages.

Consequently, Michael'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 Michael'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 Michael's pub. He so informs Michael.

Michael then demands payment from his alcoholic patrons. But, being unemployed alcoholics -- they cannot pay back their drinking debts.

Since Michael cannot fulfill her loan obligations he is forced into bankruptcy. The pub closes and Michael'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 Michael's pub had granted him 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 his bad debt and with losing over 90% of the presumed value of the bonds.

His beer supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, his wine 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 ringgit no-strings attached cash infusion from the government.

The funds required for this bailout are obtained by new taxes levied on employed, middle-class, nondrinkers who have never been in Michael's pub.

Now do you understand?

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