Black Monday's Reckoning
The Dow Jones, an index built solely from heavyweight corporations boasting substantial market weight, plunged to -13%. The Nasdaq, more sensitive to economic conditions, posted an unbelievable -15%. Even Android Inc. and ID Technology, which typically offered greater stability than the companies in the Dow Jones Industrial Average, suffered declines exceeding -5%. The fear of falling had instantly surpassed investors' breaking points, triggering a cascade of sell orders. The only buyers left were stock-trading AI programs, yet the volume of the plunge exceeded even their capacity to absorb. Once the programs themselves switched to selling, nothing remained to halt the index's freefall.
Naturally, companies with heavy exposure to subprime mortgage investments experienced unprecedented drops. Investment firms whose stock prices had soared toward the stratosphere only months earlier vomited up years of gains in a single day. The most representative case was Lehman Brothers. The blue-chip stock, once trading above $200 per share, fell to the low $100s on October 23 in a single day. A brutal -48% decline in twenty-four hours. Even in the United States, where stock prices have no theoretical ceiling, seeing a giant like Lehman Brothers halved in a single day was a historical rarity. It avoided the worst record only because the 1929 Great Depression had already set an even darker benchmark, with declines surpassing -20%. Still, the drop was severe enough to be compared to that catastrophe, and the global shock was immense.
The next day brought more of the same. The Dow fell another -9%, the Nasdaq -12%. Lehman Brothers was halved once more, its share price collapsing into the $50 range. Even that figure exceeded the company's actual value. Most of Lehman Brothers' assets consisted of housing, MBS, and CDOs—the very instruments at the root of the crisis now engulfing Wall Street. The housing market's decline outpaced both the Nasdaq and the Dow. It simply lacked the real-time visibility of the highly computerized stock market. Indirect confirmation came through MBS and CDO yields and default rates, which began rising at a terrifying pace from October onward. Especially after Black Monday, Lehman Brothers' Class A CDO yields turned negative. They recorded a -5% loss on Black Monday alone, and the aftershocks over the following two days pushed the loss into double digits. By October 31, the confirmed yield on Class A CDOs stood at -16%. It was fair to say that every CDO issued by Lehman Brothers had exploded.
In truth, the century's guillotine match had been decided before it even began. Though Yoo Jae-won and ID Group's emergence had altered the flow from the previous timeline, the housing bubble had formed exactly as before. On the contrary, the absence of the Iraq War combined with the recovery of Qing Dynasty bonds had left even greater liquidity trapped inside the United States, inflating the bubble to a far larger size and producing the current disaster.
November 1, 2006. Whether they held stocks or knew nothing about them, everyone sank into despair at the grim news pouring from televisions, newspapers, and the internet. The world felt as though it might end today, yet ironically the weather was perfect. The late-autumn sky was an impossibly deep blue, without a single cloud. When a cool breeze blew, leaves drifted down in an almost artistic scene. Most people, however, could not appreciate the autumn atmosphere. The modern financial system was so advanced, and so many lives were connected to it, that everyone felt the aftershocks of Black Monday, which had erupted the previous week.
Even South Korea, across the Pacific, took a direct hit from the American Black Monday. The KOSPI plunged -10%. After the IMF crisis, Korea had fully opened its financial markets and aligned its systems with global standards. Once systemic instability was resolved, foreign capital poured into the country, drawn by its undervalued blue-chip companies. The largest driver of the steady stock-market rise that had continued since the early 2000s IT bubble had been precisely this foreign investment. When the crisis erupted in the United States, investors urgently withdrew funds to meet margin calls, in a mechanism reminiscent of Japan's yen-carry-trade unwind during the IMF crisis.
Fortunately, Korea's economy was grounded in real industry, so a second IMF crisis never materialized. Having learned a bitter lesson from the foreign-exchange crisis, Korea maintained foreign reserves exceeding $100 billion even after the mass exodus of overseas investors. Still, for individual investors whose portfolios were heavily weighted toward stocks, it was a brutal autumn. They had tended their fields for a year and were ready to harvest, only to watch a typhoon sweep everything away. Those who had invested in derivatives suffered losses of 90% or more. Only about 10% turned a profit—the handful who had bet on the decline. Some recorded astonishing returns measured not in percentages but in multiples. Dozens or hundreds of times their investment. The most extreme case involved a 50,000-won put option that would have expired worthless the next day; it closed at 100 million won, delivering a 2,000-fold return. The buyer was a retail investor who had accidentally purchased 3 million won worth due to an order mistake. In a single day, 3 million won became 6 billion won.
Yet when viewed on a global scale, even that was modest. ID Investment, which had been positioning for the crash since the previous year under Yoo Jae-won's direction, existed.
—Chairman, please prepare yourself before I begin.
“I'm ready.”
A week after Black Monday, with the storm still raging, Yoo Jae-won received a comprehensive report on the subprime mortgage investments from Vincent Greenhill via an ID Talk video meeting. Vincent, who had far too much work on Wall Street, would have to rush to multiple appointments the moment the call ended. Though he had warned Yoo Jae-won to brace himself, the man on the monitor appeared more excited than his employer. Understandably so—media outlets were already calling Yoo Jae-won's trade the greatest success in history, and the returns were indeed the largest ever recorded. Because the precise structure had never been disclosed, however, the press could only speculate. Vincent himself had only confirmed the exact figures a few hours earlier, once market prices for the underlying assets had been calculated across the global financial network and the linked derivatives could finally be valued.
—First, the Class A CDOs issued by Lehman Brothers recorded a yield of -16.25% as of October 31. Consequently, the put options written on those yields delivered a return of 8,125%. In dollar terms, that equates to $162.5 billion.
“Wow.”
Even though Yoo Jae-won had designed the trade himself, the sheer size of the $162.5 billion profit drew an involuntary exclamation.
—The options purchased on AIG and Citibank, $500 million each, produced identical returns. Each $500 million investment generated $40.625 billion in profit. Because the puts on AIG and Citibank were also based on Lehman Brothers' Class A CDOs and used the same strike, their returns matched exactly.
—Therefore, the total profit from this put-option strategy stands at $243.75 billion.
“Whoa.”
The number was staggering. ID Technology's entire net profit the previous year had barely exceeded $50 billion. Hundreds of thousands of employees had worked tirelessly manufacturing and selling Android smartphones and computers, dominating the online advertising market through AdSense, and capturing overwhelming market share in servers with ID Cloud Service. They had posted record revenue and margins above 20%—returns traditional smokestack industries could never dream of. Yet even that had not surpassed $50 billion in net profit. While $50 billion was enormous, it paled beside what ID Investment had just achieved. ID Investment employed barely over a thousand people. Those few employees had generated $243.75 billion. Of course, the put-option trade had been executed entirely according to Yoo Jae-won's strategic judgment, but the actual work had been carried out by ID Investment. Numerous other investments of a similar nature had also been made, and everyone at the group had worked themselves to the bone preparing for the financial crisis. The terrifying returns were the result.
Yet something even more frightening existed: the futures and options markets operated under a perfect zero-sum rule. If Yoo Jae-won had earned $243.75 billion, someone else had lost exactly that amount. The astronomical losses naturally fell upon the investment banks that had issued the put options.
“Will we actually be able to collect the profits?”
At this scale, the possibility that the counterparties would simply refuse to pay could not be dismissed.
—If they refuse, we will make them pay. Just as they once did to others.
Vincent Greenhill's voice on the monitor was resolute. Debt collection against Lehman Brothers, AIG, and Citibank would be merciless. These same institutions had played a major role in the housing-market collapse through aggressive margin calls. Many borrowers could have continued paying principal and interest with a little forbearance, even as the economy deteriorated. Instead, executives gripped by fear had issued excessive margin calls to squeeze out every last cent. Those unable to repay had been forced to surrender their homes. With the housing market already flooded with inventory, sellers had no choice but to slash prices to move properties quickly. In the end, both the individual borrowers and the lending institutions had been destroyed.
Now Lehman Brothers, AIG, and Citibank faced the prospect of paying out more than $243 billion. When a gambler hits an absurd jackpot at the table, the greatest concern is whether they can walk away with the winnings. Though comparing Wall Street to an illegal gambling den run by gangsters was absurd, the present situation itself was absurd.
“Then please handle it. Once the profits are realized, you can look forward to a generous reward.”
—Yes, Chairman!
Vincent Greenhill was precisely the expert for this kind of work. He had spent his entire life on Wall Street and had lived through previous crashes of this magnitude. It was obvious how Lehman Brothers, AIG, and Citibank would respond.
The next day:
—Lehman Brothers Files for Bankruptcy Protection!
—Astronomical Losses from Direct Hit of Black Monday!
—Losses Exceed $500 Billion!
Lehman Brothers acted exactly as Yoo Jae-won and Vincent Greenhill had predicted. They truly walked away from the table. Bankruptcy! With the company insolvent, the option settlement process itself was suspended. AIG and Citibank likewise spread rumors of impending default. The mass media seized upon the story, and television, newspapers, and the internet were soon flooded with tabloid speculation. Reading their articles, one might think Yoo Jae-won and ID Investment were the hidden architects of the financial crisis. The housing market would have achieved a soft landing if not for them; by spreading pessimism they had created this disaster. Now, unless they were deliberately trying to trigger further chaos in global markets by forcing the puts to settle, they should simply wait. The implication was that aggressively enforcing settlement would bankrupt AIG and Citibank just as it had Lehman Brothers, deepening the crisis, and that all resulting turmoil would be Yoo Jae-won and ID Investment's responsibility.
Yoo Jae-won and Vincent Greenhill's response was strict adherence to principle. The contracts with Lehman Brothers included collateral provisions for the profit amounts. This made ID Investment the senior secured creditor, with priority over all other claimants in the disposition of Lehman Brothers' assets. Vincent Greenhill immediately petitioned the court for an asset freeze. That was not all. He also filed criminal complaints with the federal prosecutor's office against Lehman Brothers' entire management team on charges of breach of fiduciary duty and embezzlement. To demonstrate that the complaints were not mere bluffs, they included concrete evidence: collusion with credit-rating agencies to manipulate the credit ratings of the Class A CDOs. Furthermore, Vincent Greenhill's complaints extended beyond Lehman Brothers to AIG and Citibank as well.
At the same time, in a brief press conference, he declared that the full $243.75 billion in put-option profits would be collected without a single cent deducted. Not only the principal, but also interest for every day of delay, down to the last penny, would be pursued relentlessly.