Too Big to Fail
"Can I get you something to drink?"
That night, Danny Kim came looking for me at our lodging. It had been less than two hours since we'd parted ways at the banquet hall.
"No, thanks. As you can see, I had plenty at the banquet earlier."
When Danny declined, I gave a nod and took a seat.
"Sorry for asking you to come out so late."
"Well, I was the one who reached out first, so if anything, the apology's mine to make."
"How about you just speak casually with me? The honorifics seem to be a bit uncomfortable for you."
Maybe it came from living in the States, but his speech kept flipping between formal and informal. Figured it was better to just draw a clean line and keep things easy, and as I said so, Danny flashed a small smile and glanced around the room.
"That lady I saw at the banquet — where's she?"
"Ah, you mean Jae-yi? She's probably resting in her room."
I hadn't contacted Han Jae-yi separately. This conversation was meant for two people only — me and Danny Kim.
"So she's your senior?"
"Yes, from high school. We met in a stock investment club."
At my answer, Danny gave a slow nod. His expression said he now understood why both of us were so interested in the market.
"Asking to see me at this hour — I take it you've brought an answer to my proposal?"
At my words, Danny simply stared at me. I couldn't read every emotion in his eyes, but it felt as though he were sizing me up. And then, presumably, asking himself a question. What am I doing right now? Was it actually right to come here over some kid's proposal?
"Let me be blunt. Why did you make that offer to me? There are plenty of people out there trying to short Wall Street. Plenty who'd do it for you if you just hand them money. So why me?"
At Danny's question, I looked at him for a moment before answering.
"Because you're not shorting for the money, Danny."
His eyes flickered, ever so slightly.
"...How do you know that?"
"I could feel it in the way you talked. You were angry. At the system."
Danny said nothing, just kept his eyes on me. He didn't deny it.
"When you were explaining things at the banquet, I watched the faces of the people listening. Every one of them wore the same look — 'here he goes again.' But you didn't stop. Not because you wanted to make money. Because you wanted people to know."
Silence settled over the room. Danny met my gaze, and then he spoke.
"Three years ago, a client of my firm died."
His voice was flat, matter-of-fact.
"Not my client. So at first, I didn't care at all."
A self-mocking laugh escaped him.
"When I got into this industry, promotion was the only thing I knew. Team lead in two years, head of derivatives in seven. Youngest in the firm's history. I thought that was something to be proud of."
I listened in silence.
"But then I looked at the structure of the product that client had bought..."
Danny's voice caught for a moment.
"It was exactly like the ones I'd built."
Only then did emotion finally surface in his eyes. Regret.
"For seven years, all I saw were numbers. Returns, fees, bonuses. It never occurred to me that there were people behind those numbers."
Danny turned his head and looked at me.
"You know what the company said when that man's family came in? 'Investment decisions are the investor's responsibility.' That was it. End of story."
A brief silence passed between us.
"That's when I first asked myself — what had I been doing for those seven years? Had I just been running with my eyes shut the whole time?"
Danny let out a long breath.
"And that's when I felt it. I thought I was grabbing the system by the throat and shaking it down, but looking back, I was just another cog grinding away inside the great machine called the company."
Every so often, a single event comes along that rewrites a person's values — and their entire life. It seemed that moment had found Danny too.
"So I walked out. Spent three years doing nothing. Just watched from the sidelines while the same thing started happening all over again, on a much bigger scale."
"And this time?"
Danny was quiet for a beat, then spoke slowly.
"This time, I'm going to watch with my eyes open. Knowing full well what it is I'm doing."
I nodded. This man was exactly who I'd been looking for.
"Then let's do it together."
"...Why are you doing this? Money?"
I answered him honestly.
"Money's part of it. But that's not all."
"Then what?"
"I'm angry too, Danny. Same as you. Except mine isn't aimed at the system — it's aimed at people."
Danny wore a puzzled look.
"I'm angry at people who think money can buy everything. People who want to control the world with their own thinking and trample on other people's lives to get there."
I offered nothing more. It wasn't time yet to tell him about my circumstances.
"So — curious what you've been up to since you left the firm. What do you do these days?"
"...Doing what you see. Living like a bum."
"No firm you're working at?"
Danny nodded slowly. He seemed a touch embarrassed to admit he'd been doing nothing at all.
"Perfect timing, then. Shall we get into specifics? The capital we have access to comes to about 140 million dollars."
Danny's eyes went wide.
"...140 million dollars?"
"Yes. 140 million dollars."
"College kids?"
I shrugged.
"We're not exactly ordinary college kids."
With that, I handed him the documents beside me.
"Information on the firm we run. More precisely, the firm managing my capital."
"Ribbon... Capital?"
"Yes. Started with a very small amount of seed capital and grown it to 100 million dollars."
Danny stared at me blankly for a moment, then broke into a hollow laugh.
"Ha... you're insane."
"With that money, we're going to buy CDS. Targets: Bear Stearns, Lehman, and Merrill Lynch."
CDS — Credit Default Swap. Put simply, it was insurance. A derivative structured to pay out if a specific company defaulted. You had to pay a premium every month, but if a default occurred, you'd receive several times your principal. The market was currently drunk on its Goldilocks euphoria, which meant CDS premiums were at rock bottom. This was the moment to strike.
"All three?"
Those three firms were, as far as I knew the future, the first to come crashing down.
"Mind if I ask why three?"
"Because those three are the biggest issuers of, and investors in, the toxic derivatives causing all the trouble right now."
Danny smiled knowingly.
"You and that girl really did your homework before coming to the States, didn't you?"
"......"
"Me, I've been staring at this stuff day in and day out. But for college kids from Korea to know all this... that couldn't have been easy."
The way he looked at me had changed.
"So? You in? I'll match your salary to what you were making before you quit."
Danny shook his head, muttering under his breath.
"You're really out of your mind."
But the corners of his mouth were turned up.
The next morning, we gathered in the hotel suite.
Han Jae-yi was eyeing Danny Kim warily. They'd met at the banquet, sure, but the two of them had never actually talked. And she knew perfectly well that Danny and I had met alone the night before.
"That question you asked at the banquet."
Danny spoke first.
"How can garbage get rated AAA? You nailed the heart of the whole thing."
Han Jae-yi raised an eyebrow slightly.
"...Isn't that a basic question?"
"That basic question is the one Wall Street never asks. They only look at returns, never at structure."
Danny shrugged.
"I spent seven years building derivatives, and you're the first person I've ever seen throw out that question."
Han Jae-yi's expression softened a touch. Still a sucker for compliments, that one. Honestly.
"Shall we get down to business, then? Jae-yi, brief us on where things stand."
At my words, Han Jae-yi nodded and opened her laptop.
"On August 9th, BNP Paribas froze redemptions on three of its funds."
Her voice was calm and measured — the Witch of Yeouido in full professional mode.
"The reason given: liquidity had evaporated completely, making it impossible to value the assets. One of France's largest banks officially waved the white flag."
Danny nodded along.
"After that declaration, banks started refusing to lend to each other. Nobody knew who was holding the toxic assets. The spread between LIBOR and OIS blew out to record highs."
Han Jae-yi turned her screen around to show us the graph. Two lines that normally sat nearly on top of each other had been tearing violently apart ever since August 9th.
"The ECB injected 95 billion euros in a single day, and the Fed put out 24 billion dollars. On August 17th, they even cut the discount rate by 50 basis points."
Han Jae-yi looked at me as she continued.
"The central banks have officially acknowledged the crisis. Which means this is only the beginning."
I nodded. Everything Han Jae-yi had laid out was accurate. The market would now begin slowly facing reality. But the full-blown panic hadn't arrived yet.
"Danny, did you work through anything last night?"
At my question, Danny pulled out a thick stack of documents.
"Going all-in on CDS is a good strategy. But I think a few tweaks would make it even better."
He spread the papers across the table.
"First — instead of putting 100% into CDS, we put in 70% and route the remaining 30% into put options on financial stocks."
Han Jae-yi tilted her head.
"Put options?"
A put option, simply put, was the right to sell at a set price. Say you bought the right to sell a stock currently worth 1,000 won for 1,000 won a month from now. If the price crashed to 700 won by then, you'd pocket the 300-won difference. If the stock rose instead, you'd lose out — but only the premium.
"CDS makes you pay premiums every month. If this drags on, the bleeding gets serious. Put options, you pay once and you're covered to expiry. Mixing the two is good for risk diversification."
Han Jae-yi nodded.
"Cutting the premium burden. Sounds good to me."
Danny flipped to the next page.
"Second — we don't enter all at once. We scale in over three months. Timing the exact bottom is impossible."
A reasonable proposal. I knew the future, but I didn't remember down to the day when each collapse would hit. Staggered buying was the way to hedge that uncertainty.
"Third — we add AIG to the target list."
I looked up at Danny.
"AIG?"
The name of one of America's largest insurers. Thinking back on my past life, AIG had also taken catastrophic losses around this time and gone under. The name that I — who supposedly knew the future — had forgotten while fixating on the investment banks, had been dredged up by a man who knew no such future. Proof, once again, that my instincts about him had been right.
"AIG issued guarantees on derivatives like there was no tomorrow. Their CDS issuance is monstrous. When the rot sets in, they'll be on the hook to honor every one of those guarantees — and there's no way they can cover it."
Han Jae-yi jumped in.
"I dug into that too. The CDS written out of AIG's financial products division tops 400 billion dollars. That's a completely absurd level relative to their equity capital."
Danny nodded at her.
"Exactly. Which is why AIG goes on the target list."
I fell into thought for a moment. Every one of Danny's proposals was sound. The kind of refinement that came from a man who knew the practical machinery of the trade.
"Good. So, to sum up."
I said,
"CDS 70%, put options 30%. Targets: Bear Stearns, Lehman, Merrill Lynch, and AIG. Scaled entry over three months."
Danny and Han Jae-yi nodded at the same time.
"We should divide up the roles, too."
I looked back and forth between the two of them.
"Danny, you take the hands-on execution of the CDS and put option trades. And securing counterparties."
Every trade needed a buyer and a seller. If we wanted to buy puts or CDS, we'd need banks, brokerages, hedge funds willing to sell them to us — those were our counterparties. Danny had deep roots on Wall Street; he'd be able to track them down. That was half the reason we'd come to America in the first place.
"Got it."
"Jae-yi, you manage Ribbon Capital's positions and monitor the data. And handle communications with the Korea side, too."
"Yep, that one's mine."
"I'll take overall command — final decisions and capital approval."
The three roles were set. The team was finally complete.
"So how are we allocating it?"
Danny's question sent me into thought. I knew the future, but exactly where to stake the most money for the greatest return — that was entirely my call to make.
"I want to bet the most on Lehman."
Danny's eyes narrowed.
"Lehman? Shouldn't Bear Stearns go first?"
"Bear Stearns is going to be acquired. But Lehman is..."
I stopped mid-sentence.
Lehman would go all the way to the end. And I knew exactly what that end looked like.
"Lehman?"
Han Jae-yi asked.
I looked at the two of them and spoke.
"Lehman fails. Completely."
My voice was resolute. Danny and Han Jae-yi both stopped breathing at once.
"Of the 100 million dollars, I'm putting 40 million on Lehman."
Silence.
Forty percent. Nearly half our entire capital, staked on a single name.
Danny spoke slowly.
"...On what basis?"
"The government doesn't bail anyone out twice."
I looked at both of them as I said it.
"They'll save Bear Stearns. The government will step in personally — they have to, to stop the system from unraveling. But would they save the next one that blows up right after? No. The logic of politics doesn't work that way. If they did, everyone would come to believe that being too big to fail is a license to live forever."
Too big to fail. The proposition that some institutions are simply too enormous to be allowed to collapse.
"The government isn't stupid either. They can't keep absorbing the backlash of rescuing Wall Street's pigs with taxpayer money. Once they save Bear Stearns, the criticism over moral hazard will come pouring down. So who's next on the chopping block?"
"......"
"They'll need a sacrificial lamb to prove that they stand on principle. And that lamb will be the biggest, most rotten one of all — Lehman. Trust me."
Han Jae-yi studied me in silence. There was no doubt in her eyes. Only the trust of years spent at my side.
"...All right."
Han Jae-yi nodded first. Danny let out a long sigh and shook his head.
"You really are a lunatic. Damn it — you've convinced me."
But the corners of his mouth were turned up.
"Then let's begin. Starting today."