A moo point, basically …

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Get Shorty

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(NB: This post has references to some fancy  financial terms – like ‘assets’, ‘stock market’ and ‘destruction’. Prior knowledge of these will not help you appreciate this post in any way, but it will distract you from ‘intrinsic thought’ of the post. Understanding this thought, however, is of no material consequence. Also, this post is like 500 words too long).

People recently have demonized Credit Default Swaps by calling them ‘Weapons of Mass Destruction’, ‘Offerings from the Devil’, ‘That-which-must-not-be-named’  et cetera. These innocent-little instruments, for the uninformed, started out as insurance tools to hedge (v: to protect by erecting shrubs around yourself) for people who did not have the risk appetite for their assets defaulting (i.e their value going to sh*t). It’s like the Japanese folks buying Earthquake Insurance for their houses – the premiums they pay are substantial, but the security they achieve against a future outcome which isn’t that unlikely is often worth the cost.

This is often easier said than done. Valuing the ‘cost’ is usually the toughest part. An insurance agent will use emotional blackmail (‘think about your kids’) or fake common sense (‘what good is all your dough if you’re dead’ or ‘whotcha gonna do with all that junk, all that junk inside your trunk’) to sell you a ridiculous policy with hefty premiums. It’s a whole new ball game however if you take personal emotions/concerns out of the equation.

The subprime mess happened in the not-so-distant past, as we all know. People took home loans when they couldn’t afford them; Credit companies gave away loans when they didn’t have any real money to dole out; banks bought these loans in bunches and assumed that because the bunches looked pretty, they would all survive peacefully. Everyone was happy because ‘risk’ was being ‘magically’ ‘diversified’. When things did in fact go south, and oh did it go so wrong, a lot of finger-pointing happened in the direction of, among others, CDSs (who were, to be honest, one of the chief culprits).

In hindsight, the crisis seems inevitable because of the unsteady nature of the equilibrium. You essentially had people, who had no real business or interest in a company or a stock, betting on it going bust. Because you weren’t restricted by the market value or the number of shares, there ended up being bets of negative expectations hundreds of times worth the companies’ actual value. It seems astonishing now that we didn’t see how it was all destined to fail. But hindsight is often useless unless it involves sighting hinds.

CDSs encourage people with short (negative) views to put their money where there mouth is, irrespective of how ridiculous this idiom is. However (in an alternate universe perhaps?) if the crisis had not happened and if CDSs had not ended up being such horrible things, I wouldn’t have been surprised to see the notion of ‘going short’ permeate into different facets of life.

Short thy frenemy:
This is fairly obvious. You sell/ buy CDSs on something as trivial as someone you dislike slipping on a banana peel or unintentionally passing wind not-so-silently in public; a movie flopping or earning critical acclaim (some might say they’re the same thing); someone missing a lecture or a flight; me buying Earthquake Insurance on Japanese houses – the possibilities are endless. Oh what fun.

Short yourself (… is all that you can do): **
– There’s this blokey called Trichet who’s like the head of the ECB. That’s the European Central Bank, which shares not just its abbreviation with the English Cricket Board but also the same sense of chaos, infighting and confusion (and the fact that they both depend on a ‘foreign hand‘ for success). The ECB decides what the interest rate will be for the Euro currency. This decision has pretty much nothing to do with how the Euro moves with respect to the US Dollar these days. However, whenever Trichet starts speaking at a press conference, at a dinner table or even at a coffee counter, the Euro starts falling. This happens Every.Single.Time, unless when Trichet wants it to fall – then, it dutifully shoots up. This near perfect correlation (negative correlation for the finicks) is nothing less than unbelievable, and it is a self-short opportunity just waiting to be monetized. Clearly, if there is anyone who knows what Trichet wants, the best bet would be Trichet himself – well most of the times.

– I had a fairly horrible run of luck in the Twenty20 cricket extravaganza called ‘IPL 3’ last summer, when pretty much every team I bet on ended up losing. (I take credit for shorting the Mumbai Indians and thereby ensuring that they went on to play in the final. Needless to say, I bet on them winning the final which they subsequently lost). It didn’t matter which team it was or what its form was – I had an astonishingly large miss-to-hit ratio, so much so that people kept requesting that I don’t bet on their favourite teams. Some gracious souls actually paid me to not bet at all. It’s a complex thing, shorting yourself – you start off by believing strongly that outcome A will happen. Just as you’re about to bet on A, you’re reminded of your shite track record. This immediately makes ~A (converse of A) a fool-proof certainity. On the back of this rock-solid logic, you realize that you should instead bet on ~A (since no one wants to voluntarily lose money). But the law of converse kicks in again, which means that the more likely outcome is now A … there is essentially no way out unless you truly forget what you wanted to bet on at the very beginning. It’s like you’ve just anti-Incepted yourself.

As is quite obvious, CDSs go hand in hand with speculation, gambling, pessimism (for the protection buyers), optimism (for the protection sellers) and greed. Most stock markets work on the assumption/hope that value will go up ‘in the long run‘. Sure, there are ‘Puts‘ you can buy if you have a negative view. But nothing captures negativitiy and a ruthless desire to see someone or something get destroyed as efficiently as a CDS, especially if it’s a naked short (i.e. short bets made by Traders Gone Wild). Shorting stuff requires a complete absence of morals & ethics as well as a lack of sympathy for someone else, which explains why it caught on like wildfire in the trading community.

All I want to say is – Damn you subprime crisis. I was itching to go short non-financial stuff – like this relationship between a couple who I’m convinced are going to break up – but because of your screw up, now I can’t.

My posts usually have better endings, but this isn’t one of them.

** The ‘short yourself’ bit was what prompted this whole post.


Written by sujaybedekar

December 11, 2010 at 7:07 pm

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