Here’s a story lead from the WSJ that should get your attention:
Even as the financial system collapsed last year, and millions of investors lost billions of dollars, one unlikely investor was racking up historic profits: John Paulson, a hedge-fund manager in New York.
His firm made $20 billion between 2007 and early 2009 by betting against the housing market and big financial companies. Mr. Paulson’s personal cut would amount to nearly $4 billion, or more than $10 million a day. That was more than the 2007 earnings of J.K. Rowling, Oprah Winfrey and Tiger Woods combined.
Wow, $20 billion seems like a lot of money, even in these post-trillion times. How did he do it? The short answer is that he went short the housing market and then financial services companies. For those not in the biz, it means he bought a bunch of insurance on the first and then bet on the second. For those still not tracking the story, he was on the other side of . . .
- All those credit default swaps that sunk the big financial companies, you know, the ones the tax payers bailed out? Well not all of them.
- Investors, some of whom were folks like you and me, some of whom were some of the “savviest” investors in the game who wanted a piece of that free money.
- Ultimately tax payers whose great, great grandchildren will still be paying the Chinese government for funding the clean up.
In retrospect, none of the bleating about “nobody could see it coming” was true. As a result of legislative changes pushed by the big investment banks, policies pursued by the Fed, and freaked out bond investors looking for higher fixed income yields where none existed (see the point about the Fed and ridiculously low interest rates), the Masters of the Universe leveraged up to the point where there was no margin for error and then kept going. As long as you were comfortable with the idea that no margin of error anywhere in the “system” would ever be required, you were in tall root beer.
One of the reasons you might have felt safe thinking that way is that history told you that when the chips were down (apt image), central banks, led by none other than that free market, Ayn Rand loving Maestro himself, had already demonstrated that he would prop up asset prices and would bail out stupid investors. That would be Alan Greenspan.
So lesson number one according to the author is “Don’t Rely on the Experts.” He says . . .
Many investors lost big in 2007 and 2008 as housing crumbled and the stock market tumbled. But no one lost more than commercial and investment banks caught with toxic mortgage-related securities. These bankers were the very same ones who created these investments, and Wall Street’s top analysts had vouched for their safety, even as Mr. Paulson and others bet against the investments.
It’s actually a brilliant point, but a bad example. For all sorts of good reasons, we rely on the apparent expertise of others as a heuristic for making quick decisions. If we didn’t do that, we’d barely make it out the door every morning. The trick of course is figuring out when to rely on the experts and when not to. More on that in a minute.
The big players were in part relying on the experts to be sure. Just not the ones mentioned here. They were relying on the expertise of Moody’s and S&P who have since proven to be manifestly corrupt and craven. The problem with the bankers was they were acting like street hustlers with better clothes. Post bailout they still are.
The better lesson one is “If something seems too good to be true, it probably is.” Another version of that same idea is, “There is no such thing as a free lunch.”
Go back through any bubble and that’s what you’ll find. People saying that real estate values will always go up because they always have. People saying not to worry that you can’t afford the mortgage when it resets, you’ll just refinance it. People selling trillions of dollars of Credit Default Swaps that in effect created infinity leverage, priced like they would never default. People bundling risky loans to create AAA rated securities, the same rating the US Government carries (at least right now), except they don’t have a printing press or an army.
Read the rest of the article. You won’t learn much but it will do a nice job of pouring salt on whatever wounds you still have open about the melt down. Moral Hazard is alive and well in the financial markets.
