On one level, banking is a simple business. People give the banks free money in exchange for no-fee ATM access and a government guarantee they will get at least some of it back. The banks then pay people slightly above minimum wage to lend this money back to our debt-loving asses to fund low margin businesses and buy shit we cannot afford, all at an interest rate inversely proportionate to one’s social class.
But if a bank wants in on this FDIC-guaranteed free money hustle, they gotta follow a few rules. For example, they can’t threaten to put a cap in your sister’s ass if you can’t pay them back, and this results in the occasional loan-loss. Additionally, the FDIC has an image to protect, and so as much as possible they try and limit the lending of any of this free money to white people who qualify for credit cards and TSA-pre.
But there are only so many borrowers like this left in America, so the government created another free money system with no real restrictions on who gets to borrow. This system goes by a lot of names, but let’s keep is simple and call it QE. And to make this system work, all the government needs to do is keep the money flowing and keep the loans cheap. This is something the US government does really, really well.
And so in 2012, with all this QE money pouring in and tricking down to wages and direct depositing into FDIC-insured free money bank accounts, the shit really starts to pile up way faster than the banks could lend it. And piles of money is dead money that could otherwise be used to donate to the political campaigns of politicians who favor more open banking rules. So to keep the money flowing, we got this little agreement between the ex-bankers in the government who make the banking rules and their former employers running the banks whereby the banks get a little latitude to make a few bucks here and there “hedging” this cash pile against loan losses, but they have to promise to make the shit really fucking complicated so that it doesn’t freak out the depositors. Because if that were to happen, the money might flow to Elizabeth Warren instead.
By late 2011, JPMC is sitting on shitloads of FDIC free money cash. In London, Bruno Iksil, a shy and cerebral 20-something Frenchman partial to black jeans and no tie, was one of the traders tasked with hedging the banks customer money. But wait, why the fuck do banks hedge again? I mean, shouldn’t they make enough profit off of the free money good loans to offset the bad ones? If not, then what the fuck are they doing in the lending business and why is the government guaranteeing their loans? And if they suck so bad at the simple lending game such that they need to take on stupid levels of risk trading hella complex financial dark-net derivatives to hedge their Main Street loan losses, then wait, what?
So banks gamble customer money for profit, ok? And in banker land, the only difference between a hedge and a bet is the outcome: a hedge pays and a bet loses.
In May of 2012, like eight dreams deep into this hedgebet Inception shit, Iksil was buying a bunch of credit default swaps (CDS) on investment grade high-yield US corporate bonds. These paid if the companies issuing the bonds in the US defaulted. But the economy was improving and the trade was working against him and so to hedgebet this trade, he started buying derivatives on a broad index of these same bonds — CDX.NA.IG.9 (insurance against a drop in the index), which amounted to a hedgebet against his hedgebet.
Enter Boaz Weinstein, the 38 year-old founder of Saba Capital, a NY-based hedge fund. Weinstein is said to be an interesting cat. An ex-Deutsche bank derivative trader, chess master and Vegas high roller, it was said he was once kicked out of the Bellagio for counting cards. He was known for an almost inanimate ability to stay cool under pressure, keeping his head clear while making huge bets with tremendous thought and conviction. Weinstein knew derivatives and he saw that there was a disparity forming between CDX.NA.IG.9 and their underlying assets (Iksil’s trading had depressed the index unnaturally) and so he and his numbers guys tore into this to try and figure out why. But it made no sense. Unless… Unless a trader or group of traders were making huge-ass hedgebets that were distorting the index. If so, the index would have to eventually revert back to reality.
So at a charity investment conference in February of 2012, filled with baller Wall Street money-types, Weinstein presents his trade: buy the CDX.NA.IG.9. It’s unnaturally low and will go up. And being the trend-whores they are, a bunch of them jumped in on the trade.
Meanwhile, back in London, Iksil sees that the buyers are taking his trade, which fucks up his plan, and so rather than unwind things, he starts writing CDS’s on the underlying bonds (or so i have read on the Internet), and with $350B of free money FDIC deposits to work with, he goes all-in, thinking he can shake those motherfuckers in NY out of the game. But the problem was, he’s got ginormous amounts of fucking money to trade with and that’s not something you can hide behind. In no time, Weinstein sees that this wasn’t some macro event or a bunch of traders fucking with markets, but one trader working for one bank and the only bank with that kind of cash was JPMC.
Now, you gotta remember that back in 2008, shit was fucked up. People were losing their homes and their jobs for reasons they did not understand. And they did not understand it because of this kind of shit, which is fucking financial North Korean rocket science trigonometry. Weinstein knows this and he knows that he can kill this whole fucking charade right now by going to the press to share his little secret: JPMC, the good guys, maybe aren’t so good after all. Lost your house or job? Look no further. And that is exactly what was said to have happened. In May of 2012 it is rumored that he contacts the NY Post and thestreet.com and in no time the press is all over it. JPMCs CEO, wanting nothing to do with this shit, orders the team to unwind and in no time the CDX.NA.IG.9 reverts to normal.
Some say JPMC lost over $6B. Other say they had another group, a bizzaro-land version of the hedgebet desk, who took the other side of the trade and made money. Who the fuck knows. Saba and a number of other hedge funds clearly made money but how much is a fucking mystery. There are congressional reports and whispers over Cristal at strip clubs in Manhattan but the depositors are still depositing and hedgebetters still hedgebetting so I guess we’re all good.
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