We Never Really Recovered From the 2008 Economic Crisis

Disclaimer: This is an extremely simplified version as I don’t want to bore you with the details. I am not a financial advisor and this is not financial advice. Most of this is speculation as information about the “behind-the-scenes” of mega-banks is very limited.

1990s

The derivative market started in the 1990s. The period where investors call “The opening of the casino in the financial world”.

What are derivatives

Officially, a derivative is a contract between two or more parties that derives its value from an underlying asset, index, or entity.

Imagine this: I say it’s going to rain in London tomorrow; you say it’s not. Then our friends John and Jane come in. They don’t care about the rain so they bet on our bet. Jane bets I win; John bets you win. And then another couple of our friends come into the room and bet on John and Jane’s bet.

Essentially, this is what a derivative is — A bet on a bet (maybe more down the line).

The same thing happens in the financial markets in the form of futures, options, and swaps.

Regulations

Understandably and theoretically, this bet could go on and on and on, until the point where nobody even knows what is the core product of their bet (in this example, whether it’s going to rain in London).

Over the 1990s, governments have tried to step in but they keep getting pushed back by Wall Street.

Why?

You know why.

2000s

In the year 2000, President Bill Clinton signed the Commodity Futures Modernization Act and made it virtually impossible for anyone to regulate the derivatives market. Because from then on until today, the only people who regulate this is the Federal government and their code is just “as long as we’re trying our best, it counts”.

Because of this, the derivatives market exploded and the money that was created has gone to exponential heights since the year 2000. And it’s extremely alarming because this money is only floating around the mega-banks and ultra-rich.

What happened in 2008?

To simplify it, it goes a little like this:

1. Homebuyers get a loan from lenders (commercial banks).
2. These lenders will then sell these loans to bigger investment banks.
3. The investment banks then take these loans and combined them with other types of loans such as car loans, student loans, and credit card debt to create an investment product called “Collateralized Debt Obligations (CDOs)”.
4. These CDOs all have ratings from the worse (C/D) to the best (AAA). But with the 2008 crisis, the investment banks actually paid the rating agencies to give them AAA ratings even when the quality of these CDOs are terrible.
5. (By terrible, it means that this investment product is actually extremely risky and homebuyers who took out the loan most likely cannot pay it back.)
6. So, with that AAA-rated CDOs, investment banks sold this investment product to outside investors and a lot of investors eventually bought this investment product because of the AAA rating.
7. It started falling apart because the investment banks did not care whether the homebuyers can pay the loan back. Investment banks just wanted the homebuyers to take out the loan so that they can eventually sell it as a product to the investors and make money out of it. The rating agencies did not care as well because they were getting paid and there weren’t any regulations that say they cannot do it. Not just that, the method of rating had no guidelines, it’s basically like saying: “Oh, I think this is pretty good, let’s give it an AAA rating.”
8. As you can imagine, the investment banks, who stayed true to their nature, kept doing this, and they went wild with it. Pretty much anybody, regardless of their income or low credit, could get a house now. And soon enough, prices of real estate started skyrocketing. But nobody did anything because everybody in this chain was profiting and it was unregulated. Capitalism huh?
9. By late 2006, my guess is that Goldman Sachs began to realise there is no way this scheme is sustainable and it will end badly. So, they took it one step further and protected themselves from the event where this scheme goes bust. Long story short, Goldman bought insurance from AIG (American International Group) and collected nearly $3 billion after the market collapse.
10. Then in 2007, Goldman took it one more step further. They started selling another type of CDOs that are designed to make money when their customers lose money (they also sold some to their customers). So, in the front, Goldman would show their customers it's an investment with an AAA rating, but in the back, Goldman is betting that all of these will eventually go bad. Goldman is essentially betting against the investments they are selling. Talk about being duplicitous!
11. Come 2008, there were more and more home foreclosures and defaults in payments. Lenders could no longer sell their loans to the investment banks so most of the lenders failed. That left the investment banks with billions of dollars of loans, which led to the collapse of Bear Stearns, Lehman Brothers, Fannie Mae, and Freddie Mac, all of which were rated AA and above.

The rest is history and its effects are what we know as the 2008 financial crisis.

2021

Here are some facts:

The cryptocurrency market today is estimated to be about $2.48 trillion.

The global stock market as of November 2020 was about $95 trillion. (This is the latest information I could find so I would assume that today, it’s around $100 trillion.)

The entire value of the world’s real estate as of late 2017 is about $280 trillion.

According to Credit Suisse, the current global wealth is $418.3 trillion.

The derivatives market, however, is estimated to be valued anywhere from $640 trillion to $1 quadrillion. In case you don’t know, that is $1,000 trillion, and in numbers, $1,000,000,000,000,000.

(The reason the range is so huge is that the Bank of International Settlements (BIS) reported the lower range, and the upper range includes other specialised products that do not meet BIS’s standard requirements but still qualify as a derivative.)

From 2008 to present

Instead of what analysts label as “predatory lending” (lending to those that most likely cannot pay back) to normal people, lenders have been lending it to businesses this time. Done in the form of Commercial Mortgage-Backed Securities (CMBS).

Just not long ago, the online publication The Intercept did some research on 40,000 of these CMBS loans between 2013 to 2019. What they found was the reported income falls 5% short or more for 28% of the loans they gave out. On the other side, banks like Goldman Sachs, Citigroup, UBS, and JP Morgan have also reported inflated income data on 35% or more of the loans they gave out. These lenders and banks over-reported the income of their clients because they want to put forth the image that the businesses are doing great.

And all of this is before the pandemic.

Now, enter a pandemic.

It’s more than obvious that many businesses just couldn’t generate enough revenue to cover their cost, let alone generate profits. Yet, the banks still reported it. So technically, this entire scheme should have unfolded in 2019 or 2020 when the business couldn’t pay up and ended the chain of profiting. But we’re still here. Why?

Speculation

Okay, here is the part where the facts get a little vague, so I inserted some of my speculations.

Nobody expected a pandemic to happen and what should have happened during the pandemic is a lot of foreclosures and mortgage defaults (just like in 2008). But instead, we got several stimulus packages and forbearance plans to buy the mega-banks some time. To do what? My guess is for them to buy some insurance or have bets that when the economy falls, they will make money (something called CDXI).

Basically, the banks know the financial system is screwed and they want to make money off of the downfall of the entire financial system.

Yep, that’s the world we live in, fellas!

Gamestop

What happened with Gamestop was most probably the first time the institutions lost control and it exposed their schemes to the public. The short squeeze happened because of the abuse of the derivatives market. If I were to guess, I’d say they are scrambling to protect themselves from anything like this ever happening again. Because if brokerages did not restrict the buying on Gamestop, theoretically, the losses that the mega-banks would have had to incur is technically infinite.

It was never about Melvin Capital, Citadel, or Point72, it’s always been about how these institutions abuse derivatives to exponentially grow their money while retail investors scavenge in traditional assets. And they’ll do anything to protect it, even hurting the working class badly.

But, it’s their game. We’re just the pawns, and money always talks.

My thoughts

Nobody can tell for sure when all of it will collapse, not Warren Buffett, not Ray Dalio, and not even Michael Burry. But we know from history none of this is sustainable. Like a balloon, there comes a point where there is too much air inside it just bursts.

What I also know is that no politician or the Chairman of the Federal Reserve wants to have a bubble burst on their watch. There is so much work to do after, so many explanations need to be made to the public and people will just hate them for it, even if it’s the better decision in the long run. It’s always easier to re-inflate it or sustain it just a little longer and let someone else deal with it.

Like fellow writer Tim Denning said: “The current state of the financial system is wild.” Sprinkle some politics into the mixture and greed as a cherry on the cake and it becomes a time-bomb.

What I’m doing

Extremely cliche, but I’m diversifying. Not only am I invested in stocks and crypto, but I’m also spending a lot on courses. The value of the skills I acquire will never be inflated, diluted, or any other depressing financial terms. So it really doesn’t matter if the financial world is falling. If I have something that others want, I can sell it. That’s all.

Physical items

A house, a car, a computer, etc. These are things that provide utility. The utility aspect of these items does not change with price. Whether the market prices your house at $1 million or $100k, you’ll still be able to live in it as long as you’re the owner.

Keep investing

I’m going to be a little more conservative, but I’ll keep investing, despite all of these. Why? Because waiting for a correction or a bear market to come is the death of my investment portfolio. I have faith that the market will eventually flourish under better regulations, hopefully before I reach 50.

Sources: Reddit thread, The Intercept, John M. Griffin & Alex Priest

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