Too Big to Fail
"What's with all the sighing on your way in?"
The next day, Han Jae-yi walked into the office at the sound of my voice and spun toward me with a start.
"Oh, right. You were here."
"What's so shocking about that?"
"No, it's just... I thought I was alone in here, and not only are you here, but you're—you look different."
Ah.
I'd grown taller thanks to all the exercise I'd put in during my military service, and my hair was currently in what you'd call a full-on buzzcut. It was fair enough that she hadn't recognized me.
I smirked as I watched her set her bag down at her desk.
"So, how is it?"
"How is what?"
"The life. Clocking in at six in the evening and clocking out before dawn."
Since I'd told her to trade the US market, her days and nights had flipped entirely.
She said she used to leave work around two when school was in session, but with vacation underway, she'd been working straight through until the market closed.
"Honestly?"
"Yes, honestly."
"It's brutal. Leaving work when everyone else is heading in. But this is..."
"This is what?"
"Secretly kind of working for me."
Han Jae-yi came over and sat down on the couch where I was.
"The more I do it, the more I wonder if this is what I was born for."
"Glad to hear you're so positive. Just hang in there until the semester starts."
"Even when it starts, I'm not going to campus."
"Sorry, what?"
"It's my last semester anyway, and I've already finished my graduation credits, so I registered with the career office as job-seeking."
"They'll still knock your GPA down."
Plenty of professors gave D's to students with jobs, treating employment as a valid excuse—but just as many handed out F's without a second thought.
"Either way, the other students will be glad I'm laying the groundwork for them, and I've got no job worries to begin with. It's not like you're going to throw me away."
Han Jae-yi had clearly gained a lot of ease and confidence compared to when we'd first met.
And maybe because of it, she was starting to resemble the future Han Jae-yi I remembered—the Witch of Yeouido.
"Sounds good. Starting today, I'll be working too, so..."
"Hey, you're working the day after you get discharged? You're not even going to rest?"
"What kind of boss makes the employees do all the work while he relaxes? Anyway, sorry if I'm intruding..."
"You're not intruding. Honestly, working alone all this time, having one more person around is a relief."
I nodded at her words and handed her a stack of documents.
"The first thing we need to do, starting today, is investigate all the noise polluting the US economy."
"Like you said yesterday—don't believe in too big to fail, right?"
Too big to fail.
The belief that giant financial institutions could never collapse—that if something grew large enough, the government would have no choice but to bail it out.
And in truth, that was exactly what the US government had done every time a major financial firm found itself in crisis.
But what was about to happen would shatter that belief into pieces.
"Yes. Shall we go over the situation? Two hedge funds under Bear Stearns have just announced they're freezing redemptions."
In early June 2007, two hedge funds under Bear Stearns—one of Wall Street's five great investment banks—declared a halt on redemptions.
A redemption is when an investor in a fund asks for their money back.
Freezing redemptions meant one thing: there was no money to give back.
"The reason is simple. What they'd invested in were collateralized debt obligations—CDOs—and the delinquency rate on their underlying assets, subprime mortgages, was spiking as the US housing market slumped. In other words, the products they'd bought were losing value."
"Did you look this stuff up in the army too?"
Hardly.
I'd crawled my way through the military in miserable fashion right up until my discharge.
But in my previous life, I'd still been a student during this period, and as a business major, I'd studied this entire crisis in real time.
I didn't answer her question and pressed on.
"The redemption freeze is the loudest noise in the market right now. Because Bear Stearns's products were rated AAA."
The highest possible credit rating. The message it sent to the market was chilling: even the safest instruments—the ones rated safest of all—weren't safe.
"Can I be honest with you?"
Han Jae-yi gave me a puzzled look as she spoke.
"Go ahead."
"I get why you're worried, but the market right now isn't taking this anywhere near as seriously as you are. If anything, people are still talking about a Goldilocks economy."
Goldilocks.
An economic term borrowed from the British fairy tale "Goldilocks and the Three Bears."
In the story, the girl Goldilocks picks the porridge that's neither too hot nor too cold—just right.
In economics, "Goldilocks" meant an ideal state: neither overheated nor in recession.
And right now, the market believed it was in exactly that state.
"Besides, Bear Stearns headquarters injected $1.5 billion just five days ago, and the redemptions started back up. That's what everyone's saying."
Nearly everyone in the market thought that way in this period, so Han Jae-yi's doubts weren't wrong.
If I hadn't known the future, I would have trusted the market's judgment too.
My first task was to change her mind. I laid the documents I'd prepared in front of her.
"I printed these just now. They show the current prices of the products Bear Stearns's funds invested in."
"Minus fifteen percent?"
"Yes, down fifteen percent. In five days. So let me ask you this—do you think that $1.5 billion did any good?"
Han Jae-yi couldn't answer.
"Of course not. It's pouring water into a bottomless pit. Why? Because Bear Stearns's funds bought these products on leverage."
Leverage meant investing with borrowed money. Putting in 100 million of your own cash and borrowing 900 million to make a 1 billion bet—that was leveraged investing.
Gains multiplied tenfold, but losses melted away tenfold just as fast.
A double-edged sword.
"So even a ten percent drop in the product's price would already wipe out the principal, right? And right now, it's down fifteen. That $1.5 billion evaporated the moment it was injected."
No matter how much more capital they poured in, there would be nothing to return to their clients.
"The bigger problem is that even if they wanted to unwind these positions, they can't. Look at the bottom of the data I gave you—see the trading volume?"
"It's dried up..."
"Exactly. The volume is gone. Bear Stearns's funds want to cut their losses and sell, but they can't. Why? Because there's no one willing to buy."
Even if the $1.5 billion doused the fire for a day, the market price would be lower the next morning.
With not a single buyer in sight, that $1.5 billion was effectively money thrown into the street—never mind the fact that far more would be needed going forward.
"And one more thing. Do you think that $1.5 billion actually reached the clients demanding redemptions?"
"..."
"It didn't. If I had to guess, it went first to paying down the debts owed to the other banks that had lent them money to run their leverage."
Because in my previous life, that was exactly the choice Bear Stearns had made during this period.
"Goldilocks. Nice phrase, isn't it? But the only reason everyone's fooled into believing it right now is that these people are hiding the truth. Not because things are actually good."
I finished and looked at Han Jae-yi.
She couldn't tear her eyes away from the documents in her hands.
"Pouring water into a bottomless pit..."
Murmuring my own words back to herself, she looked up at me and nodded.
"And you saw through what they're hiding."
"..."
I didn't answer. I couldn't exactly tell her I knew the future—and for now, letting her believe what she wanted about me didn't seem like a bad thing.
"So from today, we don't invest—we just track down every piece of noise. That's the play?"
"Yes. We start investing only after we've confirmed all of it."
"Good. Starting now."
Han Jae-yi's eyes lit up as she headed back to her desk, and I nodded with a smile.
"The derivatives market is hitting new highs every single day."
Mid-July 2007.
Two weeks later, Han Jae-yi and I were still collecting the noise spreading through the market.
But contrary to our expectations, the market just kept rolling along.
"We're sitting here holding cash, and meanwhile... the derivatives market keeps peaking, and the Dow and the S&P 500 have both climbed to the edge of all-time highs."
There was genuine worry in Han Jae-yi's voice.
"What if we read it wrong?"
I found myself struggling with doubt too.
No matter how thoroughly I'd studied this case in my previous life, that study had been retrospective—done with the results already in hand.
The outcome was certain, but exactly how the market had flowed during this period was something I couldn't know precisely.
That was why we were collecting the noise in the first place...
"Word is the Fed's about to cut rates too. If they cut at next month's meeting, all we'll have done is burn opportunity cost..."
Just as Han Jae-yi said, we'd liquidated every position and were holding everything in cash.
And yet the market, as if it had never heard of my worries, kept climbing.
Jae-yi's caught the FOMO bug.
FOMO. Fear of Missing Out.
The dread that everyone except you is making money.
It was an emotion every investor felt at least once, and watching Han Jae-yi feel it now, I could understand.
"Where's Bear Stearns at right now?"
"They sent a letter out to investors recently. Here."
I began reading through the documents Han Jae-yi handed me.
It was a letter from Bear Stearns—the firm we were watching so closely—informing investors that the value of the two funds that had suspended redemptions had effectively fallen to zero.
In other words: no value, no money to return.
"And it's not just Bear Stearns. The rating agencies slashed the credit ratings on those AAA derivatives. En masse. Same for the similar products."
I stared at the papers in silence.
Investors had put their money in trusting the agencies' ratings, and now the agencies were cutting those same ratings after the fact.
It was a betrayal in broad daylight.
"They downgraded the lookalike products too?"
"Yeah. They were all AAA, AA—and now the highest of the bunch barely scrapes BB. That's how hard they fell."
Just like the future I remembered, the vicious cycle was forming, step by careful step.
The only difference was that the market's mood was so euphoric, everyone was pretending not to see it.
I thought for a moment, then looked at Han Jae-yi.
"The market will move the way we predicted. It'll just take a little longer."
"So we just keep researching here the whole time?"
"No. It's time to change our approach."
I stood up and walked to my desk.
"Senior, do you have your passport?"
"My passport? Sure, why?"
"Then please fill this out."
I handed Han Jae-yi the documents I'd printed from the computer.
"What is this... a US visa application?"
"Yes. Let's go. To America."
Han Jae-yi stared at me, bewildered.
"However much we dig from here, we won't get answers. Let's fly to the US and meet the people who see exactly what we see. And while we're at it—make some money."
At my words, Han Jae-yi looked at me with wide eyes.