The stock market works like so:
- A company – perhaps an Adventuring Company – does a thing or performs a service like “ridding the world of evil” or “selling insurance.”
- The company’s owner wants to raise some investment capital for said company.
- The owner sells bits of the company to the public in exchange for lucrative cash and prizes.
- The public hands over money in exchange for paper at some pre-determined financial starting point.
- Then, the public buys, sells, and passes around the paper to each other as the value of the paper “floats” on perceived company value.
Bundle stocks together, stand up a chalk board, gather a few dozen friends on one rooftop and poof! The local city has a stock market. Feed the traders coffee, and the stock market goes manic. Get the traders over-excited and watch the stock market develop bubbles. Watch them get bummed out and the stock market crashes. Rinse. Repeat. It’s a simple, straight forward thing.
The bond market, though, is a weird, transmutory black art.
Bonds turn nothing into money.
Bonds
Take the simple IOU presented to the 1st level adventurers as they kit up for their first foray against the local Kobold tribe. The adventurers need the basics: weapons, armor, travel gear, maps, magic light healing potions, and cheap, 1st level spells. But, they haven’t gone on adventure yet. A possible payday from killing a small boss is still in their future.
The adventuring gear costs more than they have on hand. In the context of the local economy, their aggregated equipment costs the same as a small SUV, should small SUVs exist in the adventuring cosmos. The 1st level adventurers could beg for local investment from the Local Rich Guy ™. They could raise capital from the local populace. Or, they could head to the nearest Transmuter Bank Branch and take out an Adventuring Loan with a calibrated interest rate to cover their initial investment expenses.
The adventurers sign on the dotted line and buy their equipment. They suit up and head out into the field. During the adventure, the adventurers kill Kobold parties and sell back the equipment. They cover their regular loan payment with interest paid up front. They take down the Kobolds and the Kobold King. The adventurers find the treasure at the end of the adventure and pay off the principal. Then, with both capital to upgrade their equipment and free of debt, they move on to the next adventure.
For the Transmuter Bankers, in normal times, with the right risk models built around Detect Alignment, loans are a safe way to turn adventurers into a steady income stream. Weed out the risky parties (ie, all barbarians vs all clerics), give money to parties with balanced composition, and threaten parties with instant turn flesh to stone should they fail to pay. Loan money to the noble, good, and greedy and avoid those led with a Chaotic bent.
And that is a normal adventuring loan the Transmuter Bankers underwrite.
A bond is when adventuring parties ask for investment directly from investors instead of getting a loan from the bank. Adventuring parties promise to pay an interest rate over a certain period until the bond matures – ie, the party pays back the original loan. Instead of selling a part of their success to raise capital as in a stock, the adventuring parties sell their own risk for investment.
For example:
- Low risk, well-balanced adventuring parties issues a bond with a low-interest rate. An adventuring party that raises a 1000 gold piece bond, say, with a 5% yield, will generate 50gp of interest over a year. These are safe and sane investments but don’t pay out spectacularly.
- High risk, crazy adventuring parties can issue a bond with a high interest rate to reflect their high risk to reward. (We’re 1st level and we’re going to take out the Lich King! It MIGHT HAPPEN!). An adventuring party that raises a 1000 gold piece bond with, say, a 15% yield, will generate 150gp of interest over the year.
Bonds create a safe income stream for the Princes and Dukes of the Realm. They have known terms and rates. Princes invest in adventurers, receive Peaceful Peasant Village safety and security, and get paid. Everyone wins.
Transmuting Bonds into Bond Funds
Investing in a single bond at a time still has its risks. Even the most low-risk adventuring party made of clerics wrapped in Styrofoam going off to fight cardboard cutouts of Kobolds still has the risk of tripping over their own feet, falling off a cliff, dying, and missing their interest payments. And, bonds do expire at the end of their term when the full principal on the investment is due. When dealing with conservative investors like the Princes and Dukes of the realm, the Transmuter Bankers offer a different investment vehicle: bond funds.
One bond carries a certain amount of risk of ending or disappearing– although the bigger the entity (the entire Realm, say), the lower the risk. Two adventuring bonds bundled together is less risk. One hundred adventuring bonds is, in theory, tiny risk. Even if one or two low-risk adventuring parties stumbles into a pit and dies, or walks into a dungeon filled with instant death traps, the bond stays whole. The entire bond still pays out its payments on the discount rate.
In exchange for managing the fund, the Transmuter Bankers take a percentage of fees. They turn risk – or avoiding risk – into a tidy cash flow for themselves. From debt comes money. It’s almost magic, but better.
Low risk bonds of this mold aren’t as exciting as stocks. They don’t bounce up and down with the mad whims of frenetic, insane, over-caffeinated traders. They don’t promise wild rides or crazy bubbles. They aren’t traded around much. The local Dukes invest their treasuries in bond funds. They receive a yearly cash flow while keeping their money parked somewhere safe. It’s a boring business.
Boredom creates markets. From markets, economies. A continuous, safe flow of investments to low-risk adventuring companies frees up capital. People get loans to build blacksmiths. They stand up fletchers. The magic item business moves to town. The local Duke takes the extra cash and builds a local college to attract more adventurer talent.
Transmuter bankers are the quiet heroes of towns and countries. Bards write songs about them.
But, what if the Transmuter Bankers add a bit of excitement to the adventuring bond business?
20th Level Wizards
Nothing carries lower risk than an investment in a 20th level wizard. That 20th level wizard can fireball a dragon out of existence with a whim and a raised eyebrow. Nothing stands between them and the glittering hyper-powerful magic item on that dais.
And, those guys are always building. They’re building wizard towers, spooky castles, vast dungeons, and portals to the Nether Dimensions. They always overspend. They claim they have all this liquid cash but, much like the Princes and Dukes, they tie liquidity up in investments.
The Wizards come to the Transmuter Bankers to whip together bonds to manage the loans for their vast wizardly schemes, both good or evil. Saving the world or destroying it, it all costs a big outlay up front. They could use an infrastructure investment.
Now, the Transmuter Bankers are managing this bond for their investors for a sizable fee. It’s an enormous bond and it pays out a pretty decent yield. The Bankers have no doubt that the wizard will make good on the coupons.
To gain confidence, bag more investors, and make more fees, the Bankers mix the wizard bond in with the low-risk, bubble wrapped clerics. This makes the low-risk clerics even safer investments. Frost giants may eat a percentage of the clerics and the bond won’t even notice. Not with 20th level Wizard money in the mix. And that 20th level wizard isn’t going anywhere.
But what if…
What if the Transmuter Bankers mix the 20th level Wizard loans in with high-risk chaotic alignment loans? The chaotic loans have a higher yield based on their higher risk profile. (Higher risks == higher interest rates == higher payments.) What if the bankers chop up the 20th level Wizard loan, take pieces of it, and mix them into a bunch of high risk funds? Doesn’t the risk around the Chaotic Adventurers fall? But the interest rate stays high?
All the sudden, higher risk bonds that may disappear without coming to maturity look like safe investment vehicles. They pay better than the normal bond funds. They’re more attractive to normal investment. 20th level wizard + Chaotic Evil thieves looks like a great investment bet.
Because investors like money, Dukes and Princes pull their money out of their low-yield investments. They put it into the fund that look fine. But, bits of Chaotic Evil thieves riddle the fund. Some will live, some will die, but the fund looks fine with the Wizard’s money in there.
The investors could ask for the bond prospectus, yes. But who reads those? They’re long, boring, and full of tiny print. High yield good, low yield bad.
This incentives three things:
- Mix in more, large, ultra-safe loans with the unsafe loans to make more bond funds to attract more investment and charge more fees.
- Chop the large, ultra-safe loans up into teeny bits so Transmuter Bankers can stuff safe loans into more unsafe bonds and poof them into safe bonds.
- Stand up a huge tracking system with Diviners to figure out what loan is going where so payments can flow into investor hands.
Soon, all bond funds are a slurry of unsafe things and very unsafe things and ridiculously unsafe things. But tainted with the 20th level Wizard’s loan, they were all marked extremely safe.
As bonds look safer but pay better than caffeine-fueled stocks, Transmuter Bankers make an awful lot more of them. They also hand out more loans to more unsafe individuals. And, when they run out of unsafe willing individuals for loans, they grab people off the street and turn them into adventurers. Soon, everyone is an adventurer. The farmer? Adventurer loan. The tanner? Super huge adventurer loan.
Princes and Dukes move their money to these so-called safe bond funds. They make a ton of money in a short-term. Who wouldn’t want to make a ton of safe money instead of betting on a bunch of guys on a rooftop?
And then, the Worst Happens
And, of course, nothing bad could happen.
The thing about risk profiles: a percentage of the time, the thing the risk profile states is improbable happens. That’s why it’s called risk.
A Chaotic Adventuring Company, running on loans the Transmuter Bankers underwrote, kills in a climatic and bizarre battle an indebted 20th level wizard. It ends the entire campaign with one stroke.
They save the world.
Dead people cannot pay their coupons. A giant hole appears in dozens of bond funds. And no one but the Diviners really know which ones have sucking chest wounds. The Transmuter Bankers took the 20th Level Wizard’s loan, chopped it up, and sprinkled it like fairy dust across the entire portfolio. It’s everywhere.
It’s everywhere and in everything. They bundled the 20th level Wizard’s loan with safe loans and unsafe loans. It blows holes in otherwise completely safe bond funds and ridiculously unsafe funds.
In fact, with the mixing of loans from one bit of safety to another, they were all unsafe.
Worse, with the world saved, chaotic adventuring companies stop paying their loans. They have nothing to kill, so no point in paying their sky-high interest rates. They default.
And the bond funds collapse.
As the bonds fail, Transmuter Bankers blame the adventurers. Had they not adventured, everyone would be fine. What were they doing adventuring?
With the end of scheduled payments, Dukes and Princes hoard. They yank their treasuries out of bond funds. Access to liquid money dries up.
Reacting to hoarding, the Bankers and investors aren’t willing to even give the most safe adventuring company money. But, that money paid for blacksmiths, leatherworkers, fletchers, magic workers, and dudes running Identify kiosks. Without liquidity, the economy built around the adventurers seizes up. Dungeons go foul. Kobolds run amok.
Monsters dance in the street and eat the local peasantry.
The crash wipes out the Princes and Dukes. They can’t save the world. Worse, communities, entire villages who invested in those bonds, see their investments fail. They go from being flush to deeply in debt. Those survivors with failing so-called safe bond investments pull their cash out of all markets, including the stock market guys on the roof.
Stock prices fall like a stone. The stock market crashes. It takes profitable adventuring support companies, suddenly zeroed out, with it.
Without money liquidity, the economy seizes. Instead of playing in fantasy adventure, the adventuring companies are suddenly playing Apocalypse World. It’s a different rule set with different classes. But, adventurers are pretty adaptable. After all, the crazy, desperate, destitute, and insane have overrun the world. The world is full of dangers, dungeons and monsters. It needs heroes. They’re those heroes. If only they can get a loan for starting equipment…
And the Transmuter Bankers, well. All this has happened before and all this will happen again. They’re transmuters. They have enough cash left to offer loans to starting adventuring parties wandering the burned out husk of the apocalypse. They offer good rates to those going after brain eating zombies and biker gangs. For a fee, of course.
Image Credit: Art by Jaydot Sloane of Vanity Games – http://www.patreon.com/VanityGames
You’ve been reading The Big Short, haven’t you?
One thing to note: Interest rates in medieval and renaissance periods were much higher than in the modern age. An annual rate of 40% on a loan was not unusual. Heck, it wasn’t all that long ago that getting 9% on a home mortgage was considered a screaming good deal. There’s a lot more risk floating around a pre-modern economy.
Also: The amortizing mortgage didn’t come into being until the 1930s. It’s a fairly recent invention. Earlier loans were much simpler instruments: They had a due date and an included interest. There was no such thing as “Paying the loan down early.” It came due on a date, and you paid the money and the interest, or you got someone else to loan you more money. (Yes, we’ve been watching Poldark.) This sort of simplicity in finance is appealing in a game setting, where the GM has enough to track without trying to draw up spreadsheets to do amortization calculations.
I read the Big Short years ago.
It’s almost impossible to really get into the bond market in 2K words so I cut some corners and simplified it radically. But the bond market is the real thing, the true thing, the thing that is the economy. It’s what underpins liquidity. Scary.
You are right that mortgages were much simpler in the 19th century and there were no pre-payment terms. Pre-payments and shortening the life of a loan by wiping out principal early are a later 20th century innovation. Derivatives, of course, are last 20 years.
I kinda figured you’d read The Big Short. There’s so many parallels to it in this piece.
Derivatives in the bond market are an invention of the last twenty years, for sure. But derivatives in general stretch all the way back to the 18th century tulip market in Amsterdam. Short sales have been a thing for a long time, as have stock options.
This leads me to think of the wild disparities that must exist between treasury bonds tied to non-human kingdoms, and other super-long-term financial vehicle shenanigans. I’m imagining elves tying their bond yields to something other than currency, due to the risk of inflation collapsing a casual 500-year bond into near-worthlessness. Or dwarves marching to war due to the treasonous actions of their neighbors, who committed the unspeakable crime of defaulting on their payments when their promising new sapphire vein turned out to be a dud. I can even imagine some enterprising young dragon, with an expected lifespan in the millenia, forging bonds with local communities for a steady interest payment measured out in small tributes over literally centuries. Are dragons allowed to buy bonds? Is there an interest penalty for longer-lived races issuing bonds or other debt to shorter-lived races? Or what about the other way around–do half-orcs suffer higher interest rates than other races, and if so, would that be fantastic racism, or simply financial prudence? Are their laws against so-called “sub-prime” sub-species being given variable interest rates? What about (functionally immortal) outsiders?
Heck, this makes me think of a fantastic adventure in its own right. The ancient dracolich rises from the gloom of the shadowed valley ruins to demand payment of a bond that has lied, forgotten and dusty, in the treasury of some thriving empire for hundreds of generations, all the way back to its founding by an ambitious warlord. It is discovered that the dracolich has been collecting payment of smaller bonds from local tribesmen for hundreds of years, but the tribes were recently defeated by the empire; thus, the dracolich, needing capital to fund its twisted rituals and forays into the Far Realm, has decided to collect on old debts…. and the interest (and late fees) on the bond has been accruing so long, the dracolich is determined to legally own the entirety of the empire. Do the lawful heroes help the ancient monster? Or do they march to their certain doom, in order to preserve the world they love from the clutches of whatever foul deeds such a fiend might commit? Or, could the clever party witch come up with a better solution, and ensnare the dracolich into an eternal political trap where, in order to maximize its return, it is crowned emperor and is suckered into ruling benevolently, modernizing infrastructure and maximizing public welfare in order to reach peak taxable productivity?
Mind = blown. I dig it.
I think you blew your own mind. 🙂
This is absolutely terrific. Thank you for this comment! I might steal bits of it for a later input into some column or essay. Bonds and debts have alot of legs…. sometimes literally.
Awesome. And yes, it’s a good thing my mind is a lot more flexible than my body, or I might never leave the house.
I just stumbled upon this post, and I have to say, you’re a kindred spirit. I wrote a book with an alternate take on advanced trading in a fantasy world—it’s called Orconomics. It shows how banks like Goldson Baggs and Lamia Sisters deal with a looming financial crisis as loot from hoards is drying up and plunder funds are diminishing in value.
Great minds think alike. Apparently, financially demented ones do as well.
And here I thought the logical economy was to employ the dragon as debt collector.
My financial institution has a situation. Count von Bloody has defaulted on a significant loan. His lands are his collateral. We will pay you twenty thousand gold if you rip his castle down and eat him. That way we can recoup our costs by managing his agricultural lands.