Events of globally seismic proportions echo throughout history, vivid in memory or lucid in theory, actually or hypothetically occurring both naturally (apart from human causal activity) and synthetically (resulting directly from human causation, whether deliberate or not). Disastrous or wondrous, with their ultimate impact foreseeable or not as they occurred, such events are indexical (causal) signs of their times that stand for tectonic shifts in the course of natural or human history – usually both.
Examples: world wars (I, II, and counting), scientific theories (relativity, quantum mechanics, and counting), technological advances (printing press, assembly lines for mass production, communications media, computers, internet and web), assassinations (Lincoln, Kennedys, King, and counting), financial booms and bubbles, major recessions and depressions, and natural phenomena (comet impacts, floods and tsunamis, volcanic eruptions, etc.). Air, soil, and water pollution, global warming, … and counting.
This post focuses on recent financial events and their evolving impact and effects, and the extent to which they qualify as being that kind of ‘world-(re)shaping’ event or not.
The precursor event was the near-collapse of the US and world financial system in 2008, the effects of which are still very palpable and continuing to unfold. Supposedly, actual collapse was averted by the intervention of the US government and the financial industry’s leading institutions – all at the multi-trillion dollar expense of US taxpayers for generations to come. The linchpin at the center of that debacle was a little-known abstruse financial instrument, the ‘credit default swap (CDS)‘.
A CDS is essentially a set of transactions through which an owner or holder of debt (the ‘CDS buyer’) insures against debt default by paying another party (the ‘CDS seller’) to assume that risk, i.e., in exchange for mutually agreed-upon premium payments, the CDS seller agrees to pay the (mutually agreed-upon) cost of debt default, if and when it occurs, to the CDS buyer.
In theory, if the debt default does not occur the CDS buyer transferred the risk that it might have at the expense of the CDS premiums paid to the CDS seller (for whom those premiums qualify as income and profit). If the debt default does occur, the CDS buyer avoids that loss and pays only the premium expenses, while the CDS seller must absorb the cost the default payable to the CDS buyer (where it is assumed the CDS seller will incur significant losses inasmuch as the debt default cost is likely to far exceed the total of premiums received from the CDS buyer).
In fact, the financial disaster of 2008 resulted in the ongoing ‘Great Recession’ dominating our world today, largely due to debt associated with another family of also little-known and equally (or more) abstruse financial instruments known as ‘collateralized debt obligations (CDOs)‘ in general, and ‘collateralized mortgage obligations (CMOs)‘ as a type of ’mortgage-backed securities (MBSs)‘, in particular. Put simply, the 2008 disaster occurred because regulatory and rating agencies totally failed (or deliberately corrupted) their fiduciary oversight responsibilities, allowing a small group of the world’s largest financial institutions to simultaneously, among themselves, and (one assumes) collaboratively (a) buy and hold debt in the form of MBS CMOs, (b) buy and sell CDOs to offset their MBS CMO risk, and (c) further short-trade their positions in an extremely risky, volatile, and multi-trillion dollar derivates market based on these financial instruments.
This nefarious tower of paper crashed and burned when homeowners began to default on their mortgages at an accelerating rate, having been sold debt for which they clearly did not qualify nor possess anywhere near the financial means to repay. Clear victims of the ruthlessly predatory subprime lending that erupted specifically to fuel the exploding markets in MBS CMOs and their CDOs, and their derivatives, which were yielding profits in hundreds or thousands of percentages. The 2010 Oscar-winning documentary, “Inside Job“, reports this disaster with remarkable clarity and objectivity. Michael Lewis’ book, The Big Short, tells the story from an insider’s view, as seen by the few renegade traders who saw it coming and reaped hundreds of millions by shorting that housing bubble.
Michael Burry and John Paulson (not related to Treasury Secretary Henry Paulson) are the most notable of those traders perhaps – Burry gained about $250 million, Paulson at least $3.5 billion. Paulson subsequently earned another $3.1 billion on gold investments during 2010-11, and has an estimated net worth of about $16 Billion, placing him at #39 on Forbes’ 2011 list of the world’s wealthiest people.
Burry, Paulson and few others are apparently blessed with outlier financial prescience – an astonishing ‘tip-of-the-long-tail-of-normal-or-Gaussian-distribution‘ 7-sigma ability to have foreseen inevitable causal outcomes of Wall Street banksters’ behavior in those markets. They saw the same signs everyone else saw at the time, but they alone accurately perceived the true indexical (causal) effects those signs ultimately would have. The other 99.9999% of their peers deluded themselves into an exactly opposite – and inversely false – belief that the financial world they were in was not a bubble at all, but a new reality of infinite (and obscene) profitability.
Sadly, I am no such outlier – certainly not to that telepathic extent. In answer to prayer, however, I was blessed with foresight in the summer of 2008 that led me along a similar path to some financial success, admittedly many orders of magnitude less lucrative, but no less interesting – and ongoing. But that’s another story.
