Guest Post: The Opposite Of Apocalypse

Tyler Durden's picture

Submitted by JM

Fear is where the Power Is

November 2008:  the situation was dire.  But was it ever really an apocalypse?  We were all conditioned to think that without government intervention a waking hellscape of crappiness awaited.  And it continues.  Over and over, we are told of being just a step away from US government default if someone dares fiscal sensibility.  Or some variation of bank implosion catastrophe, or everyone going into foreclosure immediately, or something else equally horrible.  These outcomes are debatable, and they deserve to be debated.  Everything that happens in the future is debatable. 

What is not debatable is that we continue to be threatened with imminent doom if politicos don’t get what they want.  I’m not a believer in global conspiracy theories, much less a perpetual ruling class, but I am a believer that democracies are absolutely awash with propaganda, veiled threats, and fear-mongering. 

Why?  Fear is where the power is. 

Anybody who knew what was going on in November 2008 was afraid.  I know I was.  Being afraid of the unknown is exhausting and defeating.  The only way to defeat this fear is to make it known, to see the beast in the clarity of thought-light.  Being willing to communicate and engage is the step forward.  No matter how big, ugly, or evil it is, one can stand up to it, fight it, and break it. 

It’s time to break the spell of fear that makes this whole planet reek like week-old gym socks.  Breaking the spell means only this:  to be unafraid to communicate, to be open and receptive to ideas, to weigh them on their merits.  It doesn’t mean “find some guru and accept their crap ideology at face value.”  No one is totally, unambiguously, right.  Ideas may be challenging and unpleasant, but ones based on facts don’t wither under scrutiny.  Here goes.

Can a Company be “Shorted to Death?”

I’ve heard many reasonable, intelligent people say that AIG was shorted to death by Goldman Sachs among others.  On the face of it, sure looks like it.  After all, Goldman Sachs took out protection on AIG exactly when it was most vulnerable.  They profited from the demise of the largest insurance firm in the world.

The question is not if Goldman Sachs did it.  The question is why.

The reason why they did it is because AIG was the insurer of a large chunk of the equity tranche securitizations they held.  These securities were risky, and Goldman Sachs bought protection on them in the case of default.  This protection was desirable not just as default protection.  The price of protection goes up in times of stress, meaning profit, so it was a way to manage daily marks.

So Goldman knew there was a housing bubble that would pop and they would lose when it did because of these securities on book.  They also knew that AIG insured more than just their paper, but most of the world’s paper.  Before the crisis even started, AIG was having trouble posting needed collateral to cover their losses associated with the securitizations for which Goldman paid insurance.  This means Goldman would effectively pay insurance premiums for nothing, because AIG was at risk of not being around when they needed to pay out. 

So they bought CDS on AIG as a company. At least they would be able to recover a portion of their losses in the event that AIG went under.  This is the naked shorting that has been talked about so much.  It isn’t really naked at all, because it was insurance on the insurer of their book assets.  This is a good business decision.  It didn’t bankrupt AIG, because the swap counterparties, not AIG paid out if AIG went under. What bankrupted AIG were bad business decisions by AIG.  They had to mitigate risk exposure, which they did. 

So did this “shorting AIG” actually bankrupt AIG?  Could the situation be repeated for other companies?  No and no.  AIG didn’t pay out CDS upon default, the CDS counterparty paid out.  Now it is true that a blow out CDS curve can affect a company’s funding costs and this is especially bad for financial companies.  But insurance policy holders aren’t to blame for the spread blow-outs.  A company that makes bad business decisions that take them to bankruptcy is to blame for spread blow-outs.

And this isn’t a Goldman Sachs issue.  Just about everybody with securitizations on book that knew what was going on did the same thing.  In a sense, Goldman Sachs gets singled out because they weren’t a sucker holding the bag.  Why should anyone weep for some suckers on Wall Street?  Nobody weeps when the hammer comes down on retail. 

Am I saying all the bailouts and effectively free money was the right thing to do?  No.  I am saying that free money and political cronyism is a separate issue.  No hedge fund I know of got a bailout.  Is it Goldman’s fault that Uncle Sugar and the Fed screwed the taxpayers for generations to come?  I don’t know the answer to that and remain open to evidence to know either way.  I pass over it in silence until I know more.

The Opposite of the Black Swan:  Did Margining Mitigate the Apocalypse?

CDS were designed to manage credit risk: one leg gets a payout given a triggering event and the other leg receives a premium up to that event—sort of like an insurance premium.  To do this there has to be a buyer as well as a seller.  Market makers are flat credit risk.  Prop desks, hedge funds, and institutional books buy protection.  Net sellers are the monoclines and insurers—beat-up companies like AIG.  

Credit default swaps are transacted in terms of notional amounts, but the notional amount isn’t paid at the outset… it is funded, meaning it is paid in some series of installments.  Because they are paid in this way, and because the price of a credit default swap fluctuates in price based on supply and demand, the market value of the credit default swap position is monitored, mostly on a daily basis.  To cover adverse swings in price, the party affected must post collateral.    

So we come to times of crisis.  What do you think happens to CDS in these times?  That’s right, the spreads blow out and more collateral has to be posted.  More collateral is very beneficial to dealing with a crisis because a chunk of the crisis is paid for as spreads widen, before the default actually happens.   This means that the losses were less sudden and more manageable than they would have been otherwise.  Losses accumulated on a daily basis instead of all at once.  CDS helped because the problem was insolvency.  CDS procedurally expedite the insolvency process.

The problem was inordinate concentration of risk, meaning that one side of the risk was taken on by too few parties, or equivalently, the parties that paid in the event of default didn’t charge enough premium (because more premium reduces risk).

Has Nothing Been Learned?

Well, this is an open question which is in some ways a legal issue that others should address.    What I do know is that the industry is moving towards exchange traded derivatives, where there are a few central counterparties.  This isn’t just some cosmetic hogwash.  It can be clearly seen in the fact that non-OTC CDS contracts are being standardized.  Standardization means that contracts are more like homogenous transaction units where the differences in circumstance are dealt with via an upfront payment by buyer or seller. The events that trigger CDS payouts are simpler and straightforward to manage than OTC, so a clearing house can settle up a contract easily.  Counterparty exposures will be known, so you won’t have entities like AIGs effectively taking on risk that make no economic sense.  Far before crisis happens, entities won’t buy protection from counterparties with insane exposures.  

Exchange cleared CDS is huge because it means multiple layers of protection for transaction settlement.  More importantly, it means that dealers which make the market are responsible for each other’s failures.  The clearinghouse is a business that survives or fails on the basis of its risk management. How?

That’s how.  All this still does not mean that the system is unbreakable.  Things are simply better in an imperfect world.  But consider this… when was the last time that the CME busted on an options meltdown, or oil price spikes?  The answer is never. 

OTC (meaning non-clearinghouse for this purpose) CDS will continue to exist, at least until bank regulations catch up to how the market is evolving.  This is because some parties need to have trigger events that are contingent on restructuring events, not just defaults.  The motive is no speculation.  It is pure insurance need.

The Sun Also Rises

All the fear-mongering facilitates a symbiotic victimhood simply because it is so paralyzing.  It makes it easy to believe that never before has a society had to endure the trouble seen by those unfortunates living right now—because of the abomination unleashed by those whom voters legitimately brought into power.  The great depression needs its capital letters removed. Chairman Mao was a benevolent breeze of fresh air compared to Bush.  Cambodian genocide victims should heave a tremendous sigh of relief that they never saw the like of Ben Bernanke’s blasphemous money printing.  This socioemotional hypocrisy is an obscenity.

Take comfort in knowing that Joseph Fourier showed (Riemann proved) that everything can come in cycles, just like the sun coming up day after day on what is usually nothing new. And the sun will come up just like it always has independent of anything that happens on Wall Street. 

The last thing fear spreaders want is calm acceptance of truth; they want control.  It is truly debatable whether anything alive and feral like a financial market can be controlled.  But this is precisely what one is supposed to believe: a pretence that everything is under control.  Accept that the experts have it all worked out, simply because they say so.   Give in to public servant demands, or risk that hellscape scenario again and again.  And when the endgame finally vaporizes what is regardless of any action or reaction, the ruse just starts again with the hideously stupid formula:  “We can get things back under control.  Oh yes, we can!”

At their core, time-honored religious texts like Dao Te Ching and Ecclesiastes contain the vision of an intrinsic moral logic in the universe that makes things right.  Even if the universe rolls like that (debatable), convergence is slow and unpredictable. The support for anybody having anything completely under control is pretty flimsy.  Ben Bernanke could scarcely control himself on a “60 minutes” interview.  

Break on through to the Other Side

So what to do?  Let go of fear of the unknown and try to make it known.  Let go of easy comfortable ideas that just can’t stand up to news flow.  Holding on to shimmering BS is a sham unworthy of the intellect.  That is to say:  communicate and engage.

There’s no going back as memory ensures that ideas aren’t reversible.  There never was a Golden Age when everything was clean and easy anyway, because nothing has ever been easy or clean.  So what if the 1950s didn’t have derivatives. They had Jim Crow laws and H-bomb tests that literally annihilated pristine South Pacific islands instead.  They had to put up with this awful crap too.

Everybody needs containers to hold their insecurities, including the author of this joint.  But I know enough to know I haven’t figured it all out.  And I never will.  I will keep trying to figure out the nature of things, use the knowledge to make things better and adapt when it all changes in an instant.  This is the spice of life. 

Living things don’t stay still unless they are dead, so don’t let your thinking stall out.  Break on through to the other side. 


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Ned Zeppelin's picture

The only apocalypse imminent in the fall of 2008 was the loss of immense amounts of money on bad casino bets by the Wall Street super-rich.  That's all it was. The balance of the American economy would have easily survived the loss of the likes of Goldman, Citi and BAC. If we had let it clean out then and there, we'd be a whole lot better off. But the decision to do otherwise was never in doubt, as the decision-makers were complicit, bought and paid for. 

Them's the facts. 

Malcolm Tucker's picture

Algeria might be the next domino to fall because of Bernanke and company. Here are videos of the riots and even the hacking group Anonymous is getting in on the action!

Dr. Sandi's picture

The hacking groups with computers don't make me half as nervous as the hacking groups with machetes.

snowball777's picture

Even if its only the former that know where you live?

whatz that smell's picture

hilarious!...  Hotel 1984 has a room awaiting you..... "Room 101"

Joe Sixpack's picture

Here's what I was thinking then:

It's not the Forclosures- it's the deivatives; It is actually related

papaswamp's picture

Iceland proved your theory.

westboundnup's picture

Let's keep it real because I'm keeping it real.

TruthInSunshine's picture

Hank Paulson, bagman for and ex-CEO of The Goldman Sachs, went to Congress and told some whoppers, and he had help from The Bernank, The Geithner & even The Buffet, in scaring up a blank check for his boys on Wall Street - aka torture of the taxpayers.

Implicit simplicit's picture

True That. Gladman sucks along with the other banksters make Madoff look like a peeny candy thief.

Billy Shears's picture

But isn't the premise of this nonsense that "insurance" is a legitimate way to hedge risk? But isn't all insurance really a form of Ponzi...i.e. if everyone had to collect at the same time illiquidity would rule and insolvency would not be far behind. Sure, I own car insurance and other types but, if a black swan-type of event way can their be enough collateral available to satisfy all claims. Insurance is a bullshit scam...swim at your own risk!

Seasmoke's picture

Insurance is great (until you need it) the fine print

jm's picture

I'm not saying CDS is insurance per se.  There is an insurance motive, but CDS is much more than that, including expressing speculative views on credit risk of a name.

For example, I can't easily buy a Latvian cash bond, so I do the synthetic alternative... sell the CDS.

As far as insurance being a Ponzi, it's been around 4ever and serves an needed economic purpose, so who cares how you classify it?

Joe Sixpack's picture

CDS is somewhat of a fraud in that it is used to skirt insurance regulations that make insurance somewhat sure. CDS is not insurance, it is a derivatives contract. maybe the clearinghouse will make it more legit, but it is still not insurance.

jm's picture

I didn't say it was insurance, Joe.  I said there was an insurance motive in it and much more.

chumbawamba's picture

JM, another fine article, but along these lines, I'm reading this description of the way Goldman used the CDS and all that as just mental masturbation.  The whole practice itself is really just a form of mental masturbation with a vibrator in the ass and some midget porn.  It's all just manipulation and arrangement of dollar figures, like a life-sized board game.  I'm not sure if you were just explaining the new system or glorifying its sheer beauty, like a crazed inventor who can never finish an invention, always finding one more way to improve it, yet only adding complexity ad infinitum.  What you describe is madness.  These complex finance systems are complete crap.  The whole idea of finance has been lost.  It's all just a stupid game.

I am Chumbawamba.

DoChenRollingBearing's picture

Ahh, Chumba, great to write with you again.  I hope you got to see Cog Dis's nice piece today about veterans of Zero Hedge, your name came up favorably several times.  It is good to have you back.

I have become more and more a fan of simplicity, or perhaps better said, transparency.  I am still a fan(atic) of gold.  Simple and transparent (as long as it is not tungsten).  The incredible complexity of our financial system will lead to its destruction...  But, who benefits, cui bono...?

I would imagine that you would agree with my contention that NONE of our financial problems have been solved.  The SHTF scenarios are still in play...  Myself, as before, I am trying to prepare and accumulate actual products of value, in case (I would guess probably) things go bad...


It is either (for me) to flee to Peru when TSHTF, or fight it out here with weapons ready and stocked.  Which way will the Bearing go?  Maybe it depends on how much capital I can get to Peru...  But, if stuck here, watch out Fascist Goons, some of us await you, and you will not like (or even live) through the experience.

jm's picture

Another thing.  Much of the collateral needed to cover is posted as the spreads widen before the default event.

Central clearing mitigates the jump to default losses.  You have a point, but I think it unlikely.

Seasmoke's picture

i for one do NOT believe any one here would have been all that badly hurt and if we were , it probably would have been a good cleansing that we all needed anyway (even if done by a fire hose)

docj's picture

Thread winner, right out of the gate.

Well done, Sir Ned.

Lord Koos's picture

As outlined in "Disaster Capitalism" by Naomi Wolf

spinone's picture

Don't let them convince you that your interests are aligned with theirs.  I am all for libertarianism for individuals, and strict regulation of corporations.  banks are utilities, and must be regulated as such.

jm's picture

Banks shoudl have been forced to pay the piper.  If they couldn't settled up, they should have been nationalize with shareholders and bondholders wiped out.  Recapitalize then IPO them to cover a part/all of the cost.

More regulation is never the answer.  Market discipline is the answer.

Wynn's picture

But they didn't have to pay the piper. That's the point.

jm's picture

A reason for all of us to be pissed, yes.  But it has nothing do with the usefulness of CDS contracts.

DoctoRx's picture

Is it Goldman’s fault that Uncle Sugar and the Fed screwed the taxpayers for generations to come?

Since GS made it corporate strategy to insinuate itself into the government, "fault" is not the term to use.  Undue influence, perhaps?

jm's picture

It seems likely that Goldman had a man in the White House--Paulson.The question is to what extent did he exert influence to benefit Goldman and others.  I do not know.  The influence peddling appears to be getting worse.

But like I said, it is a separate issue from my central point.


alien-IQ's picture

"It seems likely that Goldman had a man in the White House--Paulson"

It "seems" likely? Are you joking?

DeeDeeTwo's picture

"Fear is where the power is" = Human Condition

Paulson played Fear like a violin. His brazen theft was the end of pretense of Rule of Law in America. It's been all downhill since. History will not be kind, baby.


Joe Sixpack's picture



Sorry, didn't mean to exaggerate

In Fed We Trust's picture

And it also seems that this man Paulson threatened Congress with words like Martial La w and Great Depression.

And is seems this man Paulson, executed a man named Lehman Bros in the back rooms of the White House.  

And the next day changed his mind with AIG.  

And this man Paulson didn;t see it coming, the real estate thing even though he was just CEO of Goldman for 8 years.  



jm's picture

Lehman executed themselves with their funding structure, combined with their clearing bank saying "I'm done with you."  This was their legal onus to do so.  Really Lehman is at fault for Lehman's demise.

The reason why AIG was bailed out I think is because TPTB saw the damage caused by a Lehman bankruptcy as miniscule compared to an AIG bankruptcy.

Panic?  Cronyism?  Not sure we'll ever know.

Joe Sixpack's picture

Wasn't a chunk of US Federal pension funds invested in AIG?


Also, Paulson had to be sure that GS got paid by AIG.

jm's picture

These very well could be the true motives.

snowball777's picture

It's been my understanding that AIG was rationalized as different because of the amount of international exposure to the name, whereas LameAss Repos would not cause "an international incident", if and when it souffled.

And Dick Fuld was (and most certainly is) a fucking asshole.

jm's picture

LOL.  the past part.

papaswamp's picture

Because the 'american' is lazy and apathetic..the screwing will continue. Not until a riot calling for heads will anything change...I don't see that happening anytime soon.

steveo's picture

Not just fault, direct planned knowingly criminal activity

Robslob's picture

I know fear sells better when idle minds (unemployed) have too much time on their hands.
Fear sells when people feel dependent not independent.
Fear sells when your gut tells you...I am being lied too.
Fear sells when control is lost.
Fear sells when confidence is lost.

I would rather fight for freedom with the uncertainty of obtaining it than not fight at all in a complacent life....

papaswamp's picture

little past that point now aren't we? Freedom was lost a while ago. As long as the masses had 'things' (ex big plasma screen tv, mcnasty's) they are placated. 

snowball777's picture

Fear sells only when you buy into it.

RockyRacoon's picture

Yes.  But if I am not buying in and 20 million others are, what good does my resistance do?

TeMpTeK's picture

The Apocalypse is still dormant on bank balance sheets..




Kreditanstalt's picture

What's he trying to say??

jm's picture

Can a company be shorted to death? No.  So stop talking nonsense, people.

CDS weren't the issue, CDS may have mad the situation easier to take.

Central clearing substantially makes the financial system more stable.

We need to drop the self-pity, things have been bad before. 

Try some contructive approaches to relating to our situation instead of relying on outdated or incorrect information.

Joe Sixpack's picture

CDS themselves are not the issue. The entire shadow banking complex/derivatives are. CDS are part of  this- maybe the more benign and useful part.


TimmyM's picture

I have not heard anybody talk about a shorting death spiral in ages. Why bring it up? Only idiots ever talked about it. The SEC used it as an ineffective temporary ploy.
CDS were an enabler of the credit bubble. They were and are a part of the shadow banking system. Their social utility is questionable. They have no place on the balance sheet of the still TBTFs. Socializing losses is bad policy. Collateral be damned, markets are not continuous.
Central clearing is the spreading of risk becoming the concentration of risk. Sounds like a security blanket used to justify excessive leverage until we socialize losses again.
Breaking out of self-pity I agree with. Destroying the wasteful financial culture and replacing it with a manufacturing base sounds like a good constructive place to start.

jm's picture

Hey Timmy.  Good to see you.  I just saw that short to death business mentioned last friday here on ZH. 

Was it CDS that enabled the credit bubble?  Or was it epic low interest rates that soaked the world in cheap money and moral hazard that made banks use CDS and just about everything else in an overly risky way?

If CDS can't stand the test of time in a non-cheap money, lower moral hazard environment then we'll know I was wrong.  If that ever happens.

I agree that central clearing concentrates the risk, but the incentive structure it puts in place is powerful.  It makes exposures clear, so buyer won't buy from crazies with too much risk.  It also creates incentives for market makers to police each other to some extent because they are on the hook for each other to some extent.