The First Crack
The default rate on subprime mortgage bonds was rising. That was an undeniable fact. Lehman Brothers was closely monitoring its debtors’ conditions, yet Aaron Fuld and the other senior executives refused to interpret the situation as dire. Jose Beth offered a perfect example. He worked at a Silicon Valley startup specializing in image recognition. Married with a child, he had purchased a home in San Jose near his workplace. Because a single prime-rate mortgage was insufficient to cover the full price, he had also taken out a subprime loan.
Then his once-stable startup failed to secure an acquisition, and Jose Beth’s cash flow collapsed. In Silicon Valley, startups had two primary paths to big money. The first was an IPO. If a startup built significant presence in its field and stabilized its revenue model, it could aim for a Nasdaq listing. Once listed, employees could exercise stock options and become millionaires overnight. The second path was acquisition by a larger company—an outcome that delivered essentially the same result as an IPO, sometimes even better, because the acquired team could focus purely on technology under a stable corporate umbrella.
Jose Beth’s image-recognition startup had been widely expected to be acquired by Apple, the valley’s dominant player. Apple had been stunned by the sheer intelligence of AI Gold, which could handle natural conversation and instantly recognize objects through image sensors. Although Apple had launched Siri a year earlier, it had never anticipated being overtaken so quickly. Raising Siri’s intelligence became the top priority, and acquiring Silicon Valley startups was one way to achieve it.
The prospect of an Apple acquisition sent a thrill through Jose Beth and his colleagues. Of course, the biggest spender in the valley was ID Group, whose acquisition offers were rumored to be so overwhelming that no one could refuse them. Apple, by contrast, was known to be stingy—both with the purchase price and with post-acquisition restructuring. Still, being acquired was far preferable to navigating the harsh market alone.
Yet the rosy future Jose Beth and his team had imagined never materialized. Apple had been simultaneously evaluating multiple similar startups and had ultimately decided to scale back its acquisition plans. Contact from Apple dwindled. For Jose Beth, who had already increased his spending in anticipation of the deal, the news struck like a thunderbolt.
Apple had its own rationale. Its goal was to acquire not only Jose Beth’s startup but several other AI-related companies at once in order to dramatically improve Siri. The funding for those acquisitions was supposed to come from Steve Jobs’ sale of Pixar. Although Apple’s own cash flow was healthy thanks to its position in the smartphone market, the company preferred to use the Pixar proceeds for sudden, large-scale projects like the Siri upgrade. Negotiations between Steve Jobs and ID Group had dragged on, however, delaying the Pixar sale. What was merely an inconvenience for Jobs became a catastrophe for Jose Beth.
The consequences hit hardest with his mortgage payments. He tried borrowing from friends, but everyone claimed they were short on cash. In the end, Jose Beth defaulted on both principal and interest of his subprime loan. Only then did he regret buying such an expensive house without a safety net.
Even so, the worst had not yet arrived. If Apple withdrew its offer entirely, he might have to sell the house he had worked so hard to obtain.
“Tch.”
A deep sigh escaped Aaron Fuld as he reviewed the data. Jose Beth’s case was actually one of the better subprime stories. A large number of borrowers were struggling to pay even the interest, let alone the principal. Once interest payments stopped, the returns on the CDOs and related derivatives that Lehman Brothers had packaged from subprime mortgages would inevitably decline. Although those instruments still posted an impressive 9 percent annual yield, internal forecasts were grim.
The global economy was rising and falling in waves. Aaron Fuld, an optimist by nature, believed the long-term trend remained upward. The problem was that 2006 happened to be a downturn year. He saw no cause for alarm; even if growth slowed slightly, America’s economic scale would prevent serious social disruption. Moreover, mega-banks like Lehman Brothers historically made their largest profits not during explosive growth but during periods of mild crisis. When the economy weakened, lending rates rose, and the leverage built into CDOs and their derivatives multiplied returns several times over. Therefore, he viewed the rising subprime default rate as still within expected parameters and felt no great concern.
He also believed that even if difficult times came, America’s fundamentally sound economy would eventually recover. Yet the movie had warned that once losses began to accumulate, they would snowball beyond control. The increasingly complex derivatives, whose risks even supercomputers struggled to calculate, would amplify the impact of even a tiny fraction of subprime defaults far beyond projections. Losses, like returns, would be leveraged, and the film had accused Wall Street of deliberately concealing that reality. Watching in the theater, Aaron Fuld had wondered how anyone could be so relentlessly negative.
“Hmm.”
Now, staring at the actual data, he could no longer dismiss the warning. He had personally designed the CDOs and related derivatives and had received a $100 million performance bonus the previous year for that work. Logically, he should have rejected the movie’s claims outright, yet he could not. His own sharp mind told him the data presented in The Wolf of Wall Street was no fabrication.
Still, there was no turning back. The CDOs and derivatives issued by Lehman Brothers already totaled hundreds of billions of dollars. Lehman alone accounted for over 30 percent of the entire subprime mortgage market. Reversing course at this stage was unthinkable.
Even after reaching that conclusion, Aaron Fuld did not rise from his desk. Instead, he opened his personal trading terminal. U.S. exchanges were closed, but some futures markets operated around the clock. Overseas markets in the U.K., Japan, Korea, and Shanghai were just beginning their trading sessions. Thanks to rapid advances in IT, he could now access foreign exchanges directly from his chair and trade not only stocks but every kind of derivative.
Ding!
A cheerful alert sounded moments later. The purchase had gone through—put options. Driven by rising anxiety, Aaron Fuld bought puts not only in the U.K., Japan, and Shanghai but also in Korea. While Lehman Brothers itself could no longer change its position, his personal account remained flexible. By the time he finished buying, the total had easily exceeded ten million dollars.
His actions stood in direct contradiction to the bullish subprime narrative he and Lehman Brothers had championed. Yet he felt not the slightest hesitation while purchasing the puts. Interestingly, he was far from alone; numerous Wall Street elites were making similar moves.
“It’s not just momentum—it’s already entered the ranks of major hits,” Yoo Jae-won grumbled while scanning his scrapbook.
“Indeed, sir. Reports indicate it has already surpassed the break-even point and entered clear profitability,” Kim Dae-seok, the chief of staff seated beside him in the car, replied with a nod.
The break-even point for The Wolf of Wall Street stood at $300 million. Although the film avoided expensive CGI, the high salaries of its cast and the need to faithfully recreate the glittering world of Wall Street had driven production costs upward. Combined with a global marketing budget nearly equal to the production cost, the break-even threshold had risen significantly. Yoo Jae-won had declared he did not mind losing money, but the producers and distributors certainly did.
In the days immediately following release, they had lived and died by the daily box-office numbers. After one week, their expressions had transformed completely. Most films determine their commercial fate within the first seven days of release, which is why distributors fight viciously for opening-day screen counts. The more screens a film secures, the higher the chance it appears on audiences’ shortlists.
The Wolf of Wall Street had opened on roughly one thousand screens. Theaters allocate screens based on expected audience interest and the director’s reputation; because the film ranked low on both counts, it had not secured a larger number. Korea was rapidly converting to multiplexes, yet the United States, where multiplexes had arrived earlier, was actually slower to adapt. Thanks to the backing of Time Warner Nextcom, the film had at least managed to secure its thousand screens.
Far from losing steam in its second week, however, the film’s performance accelerated. First-week domestic gross stood at $12 million; the second week climbed to $16 million. Because the release had been simultaneous worldwide, no new territories were contributing additional revenue, yet the numbers still rose.
“Word-of-mouth marketing among netizens appears to be more effective than anticipated,” Kim Dae-seok summarized after reviewing the report from Time Warner Nextcom.
The film was not fiction; it reflected reality. For anyone who had bought a home with a subprime mortgage, it was their own story.
Many viewers left the theater and dismissed the film as mere entertainment. Others, however, felt both empathy and alarm at the protagonist’s warnings. They checked their own cash flows, sold portions of their stock holdings, and began stockpiling cash. Though their numbers were small, they were sufficient to move a stock market whose upward momentum had already stalled.
Meanwhile, the so-called experts continued to repeat the optimistic forecasts they had maintained since the previous year. Even those privately shaken by the film found themselves unable to change their public stance; after all, they had spent the past year dismissing ID Investment’s warnings as irrelevant.
Some media outlets had finally begun fact-checking the very risks Yoo Jae-won and ID Investment had highlighted months earlier. The put options ID Investment had purchased from Lehman Brothers and AIG now had exactly one hundred days remaining until expiration.
“We’ve arrived.”
The conversation about subprime mortgages had carried them swiftly to their destination: the 2GW thorium nuclear power plant in the Mojave Desert. Construction that had begun early the previous year was now complete. Prior to commercial operation, the plant had received full safety certification from the U.S. Department of Energy. With every preparation finalized, a grand commissioning ceremony was about to commence, attended by the Governor of California, Vice President Lieberman, and numerous VIPs from energy companies.
A short while later, inside a control center whose digital monitoring and interface rivaled the cockpit of an F-22 fighter jet, Yoo Jae-won and the other distinguished guests pressed the red start button. The fully prepared thorium reactor began its reaction, releasing enormous heat. That heat passed through a heat exchanger to a gas turbine, which drove the generator and produced electricity.
— Thorium reactor operating rate stable.
— Output rising: 50, 60… 100%.
The massive screen displayed 100 percent alongside the maximum output of 2GW. Those who had watched the percentage climb in breathless silence now burst into applause. The generated power flowed through already-installed transmission lines toward major California cities including Los Angeles and San Francisco.
As the thorium reactor lit up the Mojave Desert and the state of California with its massive output, a small regional bank in Alabama declared bankruptcy. Most people on Wall Street had never even heard of the tiny institution, yet the sound of its collapse echoed as loudly as an avalanche.