As told in the movie The Big Short, a group of hedge fund managers who saw the housing crash coming used Credit Default Swaps (CDS) to make a fortune.
These exotic financial instruments conveyed information crucial to seeing the 2008 financial crisis in advance. That knowledge allowed astute speculators to get positioned for massive profits as the crisis unfolded.
In the coming crisis—which has already started—I expect CDS will again play a key role in telegraphing important information shrewd speculators can use to their advantage.
A CDS is a contract between two parties. Think of it like an insurance policy against a borrower—typically a large company or a government—defaulting. One party underwrites the insurance policy, and another buys it. If the borrower defaults, the CDS issuer pays out the CDS buyer.
CDS trade in the open market and reflect investor expectations of the default probability of a particular borrower. The more likely the underlying entity is to default, the more expensive the insurance (CDS) will cost.
Often times the biggest dangers turn out to be things very few people are thinking about. From Scott Galloway at profgalloway.com:
In February 1946, President Truman directed his intelligence apparatus to prepare a daily summary of critical national security issues. The President’s Daily Brief (“PDB”) has been produced ever since, and those that have been made public illustrate the breadth and complexity of the threats facing our nation. For example, in 1962, while President Kennedy dealt with the risk of Soviet nuclear weapons being stationed 200 miles off Miami, his PDBalso alerted him to chaos in the Saudi and Congolese governments, Khrushchev’s plans for a “major reorganization” in the USSR, worsening tensions between Laos and North Vietnam, and a destabilizing student protest in South Korea.
The U.S. has survived for 250 years in part because its leaders have worried about, fortified against, and repelled a wide range of emerging threats. Many threats are obvious and popularly understood; however, many others are self-inflicted, uncomfortable to acknowledge, or come hidden under the guise of opportunity. These threats can register the greatest damage, as fewer defensive measures have been taken against them. In sum, it’s productive to worry about things that others (e.g., the media, colleagues) do not.
Below are the threats that I believe to be most present and not clear.
It’s hard to argue with John Rubino; this is undoubtedly the biggest financial bubble ever. From Rubino at dollarcollapse.com:
If you’re over 40 you’ve lived through at least three epic financial bubbles: junk bonds in the 1980s, tech stocks in the 1990s, and housing in the 2000s. Each was spectacular in its own way, and each threatened to take down the whole financial system when it burst.
But they pale next to what’s happening today. Where those past bubbles were sector-specific, which is to say the mania and resulting carnage occurred mostly within one asset class, today’s bubble is spread across, well, pretty much everything – hence the term “everything bubble.”
When this one pops there won’t be a lot of hiding places.
Way too much money
Most bubbles start when an influx of outside cash sends the price of something up dramatically. This captures the imagination of the broader investing public and the process takes on a life of its own, culminating in an orgy of bad decisions and eventually a wipe-out of the easy fortunes made on the way up.
So to understand the everything bubble, let’s start at the beginning with that influx of outside money. This time it’s coming from the Federal Reserve in what can only be described as the mother of all print runs. M2, a medium-broad measure of the US money supply, has more than tripled so far in this century, and lately the arc has gone vertical, rising by nearly a third in just the past year.
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