I was in Korea on a project when the financial meltdown of 2008 started. In a Seoul cab chatting with an American colleague in the early stages of the debacle, he confided that the worst was yet to come. Indeed, it came with a tsunami force. By the end of 2008 when I was back in the U.S., the shambles was evident, and was getting worse.
The term “black swan” is now in vogue after Nassim Taleb’s book of the same title, referring to events that we do not and likely cannot anticipate based on what we know. Europeans thought for ages that all swans were white ― they had not seen to the contrary ― until the first black swan was spotted in Australia. We didn’t expect the calamity of 2008 in the global financial system, hence that was metaphorically a black swan.
My agreement with some of Taleb’s assertions in his book notwithstanding, particularly the need for a robust system that would be able to weather through an extreme blow, I see the financial shock of 2008 differently.
One warning sign in front of houses of racy leisure that mixes escapade with peril is a red lighting. Making that flashing emphasizes the caution. Add a plastic-fake flamingo as a tacky marker, and the warning becomes hard to miss that dangers lie ahead along with blissful promises. Prudent minds more often than not avoid those premises.
I argue that what took place in 2008 that nearly brought down the global financial system to its knees, was a flashing red flamingo and not a black swan.
Between 2005 and 2007 I advised a well-respected private equity firm. During those heady days when the big party’s punch-bowl was kept being filled with the central banks of some of the world’s leading nations, the pressure to deploy capital in various shapes and forms was immense. Money was cheap and the supply of it appeared never to dry.
Towards the end of 2007, our analyses of different investments were at odds with others that were backing deals at astounding valuations. We held on to our guns and kept the powder dry, and did not throw in good money to the bonfire of euphoric frenzy. We were criticized for it at the time, but looking back we are obviously delighted now.
In the late 2007 before the mayhem started, I had a meeting with a trusted friend and colleague who is a renowned attorney in the Silicon Valley. Whereas I trusted my analyses, having convinced myself that we were witnessing assets being unsustainably transacted, I wanted to ensure that my conclusion was not a mere conviction but a solid wall to fend off a stream of toxic investments.
My friend explained it acutely. Whereas the official rate of inflation was relatively low in 2007 and the preceding years, the veiled rate at which assets were being transacted was sharply rising. All thanks to the easy supply of money, courtesy of central banks. As a result, investment bankers went to investors, arguing that they ought to acquire various assets, even “creative” asset-based derivatives, since there were other investors lined up to buy those assets later at higher valuations. Don’t have the money? No worries. Leverage the deal, backed by willing lenders, whose hedging introduced yet another element of toxicity in the form of now infamous credit default swap.
In fact, bankers argued that if you didn’t get into this cycle, you would keep losing the value of your liquidity since the price tag of assets changing hands would keep going up. Many fell for that without thinking that the last one holding those toxic assets would be the one paying for the gluttony of every prior owner.
My point is that if you did the analysis right, you knew that something incredibly fetid was brewing, and it didn’t matter when the lid blew off, you ought to stay away. It was a flashing red flamingo beyond simple “caveat emptor.”
Korea fared reasonably well in the crisis and its aftermath, as compared to nations that lost hugely. It is not that the same merchants of toxic assets did not try Korean investors. Be it its unique cultural traits that value industrial products and services over quick-earned transactional rewards, or its natural dislike for remuneration based on barren business activities, Korea did not expose the nation and its citizens to brazen hazards and mendacious financing.
Korea saw that flashing red flamingo, while others were jubilant over the financing schemes that they deemed intoxicatingly irresistible, only to be left to say now that what they experienced was a black swan.
By Jahan Alamzad
Jahan Alamzad is managing principal of CA Advisors in San Jose, California. He specializes in the application of advanced analytical techniques to complex business problems. ― Ed.