This is a translation from Li Lu's Weibo (blog) from a post in 2016 which talks about CDS, Paulson, and finding the next Big Short.
https://www.weibo.com/p/23041813182fc6f0102wdsd
January 3, 2016 16:32 Sina Blog
At the beginning of the year in 2016, I watched the movie "The BigShort". The film is adapted from the novel of Michael Lewis. It tells the legendary story of several investors who first discovered the subprime mortgage crisis in 2007-08 and the loopholes in the entire US financial system and set out to make profits by shorting.
I have personally experienced some of the events involved in the film; when I watched it, I have a more immersive perception of the events, which triggered a few things that came to mind--
Beginning in 2005 and 2006, I accidentally discovered CDS (collateralized debt securities), and did some research, as I was preparing to enter it on a large scale in short-selling through CDS. Later, after several conversations with Charlie Munger, this idea was gradually dispelled.
The reason for Charlie’s objection is also very simple: if my analysis is correct, it means that in the end either the counter party to undertake these products-- the large financial companies, may not be able to cash out because of bankruptcy; or these large financial institutions will be bailed out by the government.
The money you make is actually the taxpayer’s and the government’s money. Later, the unfolding of events really confirmed Charlie’s judgment that the money made from the biggest short in history was actually obtained directly or indirectly from taxpayers around the world. Therefore, I have never regretted not making taxpayers' money.
Investment itself is a prediction of the future. Although the prediction may be correct, it will bring some joy to a certain extent, but the different means and results of making money still count.
After the publication of Michael Lewis’s book, I had several exchanges with Charlie and talked about my decision at that time. He said that if you made a lot of money from doing CDS, maybe you would still be looking for the next big Short.
This is human nature.
Hedge fund investor John Paulson was the biggest winner of this big short.
In the past few years, I have monitored the performance of John Paulson since 2008, and it has verified Charlie's judgment.
Most men have an affinity for wealth and status, but if it is not obtained in a benevolent means, a gentlemen should not accept it. To Charlie, the results in making money is important, but the means of income is just as important. I deeply agree with this point.
The money made by these big shorts came from the majority of taxpayers. Ordinary taxpayers are not only the biggest victims of the global financial crisis, but are also the ones who ultimately pay for the financial crisis. Making money in such a crisis is really unbearable. But this unforgettable experience made me even more frightened about the dangers of the financial industry.
More importantly, the film uses the experience of short-sellers as an introduction, revealing the various human affairs in the 2008 global financial crisis triggered by the United States, and the profound human reasons that led to this crisis.
In a large sense, this financial crisis was caused by the characteristics of the financial industry. Because unlike any other services industry, most people do not have the financial knowledge to judge the pros and cons of financial products. This has created a natural soil for corruption in the financial industry.
The global financial crisis triggered by the United States in 2008 is just the most extreme example in recent years. Friends who work in finance, no matter whether the movie has been introduced in China or not, should find a way to understand the crisis.
The Englishman Sir John Dalberg-Acton famously said: Power leads to corruption, and absolute power corrupts absolutely. More than two decades of experience in the financial industry often make me feel that power is tilted is due to information asymmetry-- couple this with the temptation of huge financial profits-- corrupting the entire financial industry and triggering a systemic financial crisis.
However, before 2008, the mainstream concept of Western regulatory agencies tended to believe that free market economies with our government intervention should be universally applied in the financial industry. This concept was most revered by the former Federal Reserve Bank President Alan Greenspan.
The free market economy is certainly the greatest institutional innovation in human history, but there are indeed exceptions. These exceptions are defined as market failures.
But so far, these market failures are considered to mainly exist in the areas of public services and natural monopolies, while market failures in the financial sector have been less discussed.
However, according to my own experience and observations, market failures are actually widespread in financial markets. Therefore, freedom and leniency to players in the financial field is often more destructive than restriction. The global financial crisis of 2008 and 2009 gave us an extreme lesson.
In 2015, the use of extreme leverage in China's over-the-counter financing also gave Chinese people a brief thrill. If the government did not take effective measures, the consequences would be disastrous.
Recently, due to a well-known acquisition spree in China, I had the opportunity to read the so-called universal insurance products and contracts of some insurance companies. After reading it, it sent shivers down my back. If I were in the position of the supervisory authority today, such a product would never become popular, and it would definitely keep me awake at night.
Financial markets are a mechanism that exposes human weaknesses, and it hasn't changed much since the inception of modern financial market. Today, China's financial integration seems to be imperative, and direct finance will also become one of the most important drivers for the development of the real economy in the future.
In this context, people from financial supervision to financial professionals should be more aware of the challenges faced by the financial industry to human nature. Because of the characteristics of human nature, financial liberalization will definitely lead to corruption; absolute financial liberalization will often lead to huge financial crises.
I am not advocating absolute financial control, nor am I advocating that the free market do not play an important role in the financial industry, but historical experience has shown that maintaining a high degree of vigilance against the natural risks of the financial industry is always a wise strategy.
2016 is the first year of China's 13th Five-Year Plan. Direct market financing will become more important, and mixed operations will also become a trend. Against this backdrop, I made this article by collecting my thoughts, to make myself more introspective during the beginning of 2016.
李录2016年新年感言---人性与金融危机
2016年新年伊始，观看了电影“大空头”（The BigShort）。影片自MichaelLewis的同名小说改编，讲述了几位最早发现07-08年次贷危机以及美国整个金融系统的漏洞、并着手做空来获利的几位投资人的传奇故事。影片中涉及的许多事件，我都亲身经历过；影片中的各色人物，我都或多或少有过交集，所以观看起来，更多了一些身临其境的现实感，由此也引发了一些感想。
从05、06年开始，我个人也因为偶然的原因发现了CDS这个产品，并做了一些研究，也一度准备大规模进入，通过CDS做空。后来在和芒格师的几次谈话之后，逐渐打消了这个念头。查理反对的原因也很简单：如果我的分析是正确的，那就意味着最终要么承接这些产品的交易对方，那些大的金融公司可能因为破产而不能兑现；要么这些大的金融机构被政府通过纳税人的钱救活了，这时你赚的钱其实也是纳税人、政府的钱，于心并不踏实。后来结果果然证实了查理的这个判断，那些从这次历史上最大空头中赚的钱其实最终都是直接或间接从全球纳税人手中拿到的。因此我也从来没有因为没有赚到纳税人的钱而后悔过。
投资本身就是对未来的预测，虽然预测得对，多多少少会带来一些愉悦感，但是不同的赚钱方式导致的结果还是不一样。后来在MichaelLewis的这本书出版之后，我又和查理有过几次交流，谈到当时的这个决策，他说当时如果你因为做CDS赚了很多钱，可能你直到今天还在寻找下一个大空头的机会。人的本性就是这样。对冲基金投资人鲍尔森（JohnPaulson）是这次大空头最大的赢家。这几年，我观察JohnPaulson自2008年以后的业绩，倒是又一次验证了查理的这个判断。君子爱财，取之有道，指的不仅是赚钱的方式、方法，在查理看来，所赚之钱的来源也同样重要。在这一点上，我也深以为然。这些大空头赚的钱，其实最终还是由广大的纳税人填补上来的。普通纳税人既是这次全球金融危机最大的受害者，又是这次金融危机最终买单的人。在这样的危机里赚钱实在是于心不忍。但这次刻骨铭心的经历，让我对于金融行业的危险更加胆战心惊。
更重要的是，影片以做空人的经历为引子，揭示了由美国引发的08年全球金融危机中的种种人事，以及酿成这次危机的深刻的人性原因。
酿成这次金融危机，在很大意义上是因为金融行业的特点。因为与其他任何服务行业不同，金融产品在绝大多数时间里对绝大部分人来说，都很难判断优劣。这为金融行业腐败缔造了天然的土壤。08年从美国引发的全球金融危机仅仅是近年来最极端的一个例子。从事金融工作的朋友，无论国内有没有引进这部电影，大家都应该想办法找来看一看。
英国人阿灵顿有一句名言：权力导致腐化，绝对权力导致绝对腐化。二十几年从事金融行业的经历，常常让我觉得，由信息不对称引起的权力倾斜，加之巨大的金融利润诱惑，对整个金融业的腐化更甚，更能引发系统性的金融危机。
然而至少在08年以前，西方监管机构的主流观念倾向认为，自由市场经济在金融行业内同样普适，所以以少干预、不干预为优。这一观念最为前联邦储备银行行长格林斯潘所推崇。
自由市场经济当然是人类历史上最伟大的制度创新，不过确确实实也存在例外。这些例外被定义为市场失灵。但到目前为止，市场失灵被认为最主要存在于公共服务、自然垄断及外部性领域，对金融领域内的市场失灵则讨论较少。然而据我本人的经验和观察，市场失灵实际上广泛存在于金融市场。所以在金融领域里，负面清单式的自由比起正面清单自由，常常更具破坏力。08、09年全球金融危机就是一次极端性的教训。
我们刚刚经历过的2015年，中国场外融资极端杠杆的使用也让国人经历了一次惊险。如果政府当时没有及时采取有力措施，后果实在不堪设想。
最近一段时间，由于一桩众所周知的收购风波，我有机会阅读了一些保险公司的所谓万能险产品合同，读后让我后背发出阵阵寒意。如果今天我处在监管部门的位置上，这样的产品大行其道，一定会让我夜不能寐。
金融市场就是一个暴露人性弱点的机制，从现代金融市场诞生的那一刻起，就没有变过。今天中国的金融混业看来已是势在必行，直接金融也会成为今后实体经济发展最重要的推手之一。在这样的大背景下，从金融监管到金融从业人员应该更加警醒金融行业本身对人性的挑战。因为人性的特点，金融自由化一定会引发腐败；绝对的金融自由化常常会导致巨大的金融危机。
我也并非主张绝对金融管制，更不是主张自由市场在金融业里不发挥重要作用，但是所有的历史经验都表明，对金融行业的天然风险保持高度警惕，永远是个明智的策略。2016年是中国十三五开局之年，市场直接融资将变得更加重要，混业经营也成为趋势。在这样的背景下，作此感想一篇，以为2016年开年自省。
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