Un­der­stand­ing the His­tory of Eco­nomic Dis­as­ters and Learn­ing to Rec­og­nize Their Reemer­gence

RECOIL OFFGRID - - Front Page - By Den­nis San­ti­ago

In the fall of 2008, I gave a speech in San Fran­cisco to a con­fer­ence of fund man­agers, loan bro­kers, and bankers who were just be­gin­ning to re­al­ize the con­se­quences of the col­lapse of the sub­prime mort­gage and ex­change-traded de­riv­a­tives mar­kets. They came ea­ger to hear from quan­ti­ta­tive wizards about the next trick they should try to con­tinue to el­e­vate their wealth. I opened my speech with this sen­tence: “Some­one you know, some­one you love, will be hurt be­cause of what we have done.”

I went on to ex­plain the ex­tent of the sys­temic fail­ure that had been loaded into the U.S. econ­omy by a com­bi­na­tion of in­dus­try and gov­ern­ment ac­tions. I ended with a pre­dic­tion for some of the peo­ple in that room: It would be their last year work­ing in the fi­nance in­dus­try; that much like the col­lapse of Dot Com One in Sil­i­con Val­ley a decade ear­lier, many of their firms would col­lapse and never come back. For those who re­mained, oner­ous gov­ern­ment reg­u­la­tion and com­pli­ance con­trols were in­evitable and would con­strain most of the wild profit-mak­ing prac­tices upon which the con­fer­ence at­ten­dees had en­joyed op­u­lent lives. The end of the pre­sen­ta­tion was met with stunned si­lence and painful re­al­iza­tion that their lives, and the lives of the peo­ple who had trusted them, would change dra­mat­i­cally. A sys­temic fail­ure of the fi­nan­cial sys­tem — what many peo­ple called a rare and un­pre­dictable “Black Swan” event had hatched.

Anatomy of a Man­made Dis­as­ter

A sys­temic fi­nan­cial dis­as­ter dif­fers from other calami­ties in that ev­ery­thing in the in­fra­struc­ture keeps run­ning. What breaks is the abil­ity of the pop­u­la­tion to af­ford to ac­cess the in­fra­struc­ture. At its ex­treme, jobs, in­comes, and even en­tire swaths of in­dus­tries dis­ap­pear for a sta­tis­ti­cally sig­nif­i­cant por­tion of the pop­u­la­tion, caus­ing eco­nomic dis­place­ment. The power com­pany re­mains, but you can’t af­ford to pay your

bills. Costs of ne­ces­si­ties, which may or may not have risen, be­come un­reach­able be­cause, if you’re one of the ones af­fected by the cri­sis, you don’t have the money. Peo­ple lose ca­reers. Fam­i­lies lose homes. The stress de­stroys re­la­tion­ships. And some in­di­vid­u­als com­mit sui­cide.

It’s a cru­elly un­fair phe­nom­e­non. Some peo­ple lose ev­ery­thing, some pros­per to new riches, and oth­ers are barely af­fected. The con­stant in the calamity is that you have to be able to fend for your­self in the path of a fi­nan­cial per­fect storm.

There are three core com­po­nents to sur­viv­abil­ity, and they ap­ply equally well to fi­nan­cial cri­sis sur­vival. First, you need to know the na­ture of the com­ing storm. Sec­ond, you need to re­duce your vul­ner­a­bil­ity and sus­cep­ti­bil­ity to it. And third, you need to have a plan that has the flex­i­bil­ity to nav­i­gate a sur­viv­able path through the cy­cle.

Avoid­ing a Trap by Know­ing it’s There

Fi­nance is, even for a pro­fes­sional, an ex­tremely nois­erid­den uni­verse. Sep­a­rat­ing nor­mal noise — such as the fact that bond mar­kets and stock mar­kets nat­u­rally move in op­po­site direc­tions and coun­ter­weight each other, go­ing back and forth in a volatile man­ner — can be con­fus­ing to some. At the time of this writ­ing, the global bond mar­ket was val­ued north of $82 tril­lion and the global eq­ui­ties mar­ket at just over $62 tril­lion; es­sen­tially, a nicely bal­anced see­saw.

The U.S. do­mes­tic bond mar­ket was val­ued around $35 tril­lion and the U.S. eq­ui­ties mar­ket at around $23 tril­lion. The dif­fer­ence in the ra­tio means stocks tend to re­act more to a change in bonds, with about 1.5 times more volatil­ity. You now have ev­ery­thing you need to un­der­stand what ev­ery econ­o­mist, pun­dit, and news an­chor is cack­ling on about when they say the sky is fall­ing. It isn’t. It’s just vi­brat­ing nor­mally like a cat purring on your lap.

Don’t get me wrong. That cat has claws, and in a nor­mally op­er­at­ing fi­nan­cial sys­tem there are plenty of cat­a­clysmic wins and losses that could hurt you as nor­mal volatil­ity star­tles it in your lap. These cloud-lend­ing fi­as­cos and cryp­tocur­rency bub­bles come and go. All good fun, full of spec­u­la­tive hopes and dreams; but they don’t ac­tu­ally af­fect the over­all global fi­nan­cial sys­tem. The vast ma­jor­ity of peo­ple re­main un­af­fected by nor­mal foibles. What you re­ally need to worry about is what hap­pens to you if the cat dies in your lap.

Here’s your les­son in rec­og­niz­ing “sys­temic risk.” Ut­ter sys­temic col­lapse hap­pens when both the bond and eq­uity mar­kets move in uni­son into un­safe, un­sound, and un­sus­tain­able po­si­tions. No dif­fer­ent than deer herds that mul­ti­ply to the point that a bad win­ter starves all of them into a pop­u­la­tion col­lapse, the fi­nan­cial sys­tem is known to stupidly move in uni­son through a com­bi­na­tion of mis­guided gov­ern­ment poli­cies, in­dus­try in­no­va­tion that doesn’t

take un­in­tended con­se­quences into proper ac­count, and the greed-fu­eled ex­ploita­tion ten­den­cies of hu­mans in the fi­nan­cial ecosys­tem.

In re­cent times, ex­am­ples of these sys­temic sce­nar­ios have in­cluded the brick-and-mor­tar cases such as the glob­al­iza­tion and out­sourc­ing of the U.S. in­dus­trial base as well as fi­nan­cial en­gi­neer­ing cases such as the 2008 “Black Swan” con­flu­ence of sub-prime mort­gage lend­ing, faulty bonds to ab­sorb un­sound loans, and toxic spec­u­la­tive de­riv­a­tives that pre­tended to con­tain real risks. Both have dis­placed real peo­ple and real fam­i­lies, turn­ing Amer­i­cans into eco­nomic refugees in their own land. The thing is, it was pos­si­ble to see both these dis­as­ters com­ing to a head for decades.

Learn­ing From His­tory

Glob­al­iza­tion be­gan in the early 1990s at the end of the Cold War. His­tory called it a “peace div­i­dend,” and it was ac­cel­er­ated by a cadre of busi­ness-school wizards who quickly fig­ured out that in­vest­ing in new plants in lo­ca­tions where la­bor was re­ally cheap meant more prof­itabil­ity. This was even af­ter tak­ing into ac­count the cost of the lo­gis­tics to move raw ma­te­ri­als, par­tially fin­ished com­po­nents, and ship­ping to fi­nal con­sumer mar­kets. The ar­rival of an in­nocu­ous in­ter­net trans­mis­sion tech­nol­ogy known as SOAPxml re­moved al­most all the pa­per­work fric­tion for ma­te­rial re­quire­ments plan­ning so that com­pa­nies could ef­fi­ciently move off­shore.

To­day, global man­u­fac­tur­ing and fi­nan­cial sys­tems use these sort of tech­nolo­gies for trans­ac­tions; some­thing that of­ten makes me won­der why you need blockchain gen­eral ledgers that ba­si­cally repli­cate a sta­ble and ma­ture 25-yearold sys­tem, but I di­gress. Re­gard­less, the U.S. econ­omy con­verted from a man­u­fac­tur­ing econ­omy to a ser­vice econ­omy, de­pen­dent on out­sourc­ing for things as ba­sic as tele­phones and T-shirts. Mil­len­ni­als have never known a world where there were lo­cal GM, Ford, and Chrysler plants, along with parts sup­pli­ers and job shop­pers, dot­ting the land­scape em­ploy­ing armies of Amer­i­can work­ers.

The 2008 fi­nan­cial cri­sis also be­gan in the early 1990s with the demise of Drexel Burn­ham Lam­bert LLP. As part of the bank­ruptcy, the court sold copies of a deeply se­cret struc­tured fi­nance soft­ware sys­tem to any­one will­ing to write the court a check. Struc­tured fi­nance is what’s used to create some­thing called a mort­gage backed se­cu­rity, which en­ables a bank to sell off loans it’s made on the bal­ance sheet in the form of bonds to a fi­nan­cial se­condary mar­ket. It ba­si­cally en­ables a bank to lend more, cap­tur­ing the orig­i­na­tion fees into its in­come stream.

Prior to the demise of Drexel, Wall Street was the only place re­gional mort­gage bankers could sell their non-con­firm­ing loans, aka sub-prime mort­gages, that the fed­eral agen­cies like GNMA and FNMA wouldn’t ac­cept. Wall Street, be­ing Wall Street, took ev­ery last dime from the re­gional banks in these trans­ac­tions. This made the in­cen­tive to find an al­ter­na­tive de­sirous. In my first year in the fi­nance in­dus­try, com­ing out of a decade in the de­fense in­dus­try and not know­ing any bet­ter, I helped a friend in­stall one of these Pri­vate Mort­gage Backed Se­cu­ri­ties at a tiny lit­tle bank in Pasadena, Cal­i­for­nia, named Coun­try­wide.

When the smartest peo­ple in the world act like lem­mings march­ing to the sea, that’s a sign of a sys­temic flaw

As early as 1995, when I fi­nally un­der­stood what fixed­in­come an­a­lyt­ics was all about, I had a wary eye about some of the prac­tices com­ing out of the sub-prime mort­gage sec­tor as their bonds be­gan to look less like agency pass-thru se­cu­ri­ties and more and more like the “junk bonds” that took down Drexel. And I won­dered what the im­pli­ca­tions were from the Elec­tronic Joint Ven­ture sys­tem in­vented by Wall Street to re­place the es­cape of struc­tured en­gi­neer­ing soft­ware by cre­at­ing this thing called the ex­change traded de­riv­a­tive — and even­tu­ally the toxic bond.

While I wasn’t the only one who made that mis­take at that time — nor was I that in­te­gral to the nearly two decades of gov­ern­ment and in­dus­try con­se­quence that came from it un­til it all col­lapsed — I’ve al­ways re­gret­ted be­ing part of in­stalling a ma­te­rial trig­ger into what would be­come the equiv­a­lent of an eco­nomic nu­clear bomb. When I gave that speech in San Fran­cisco in 2008, I very much meant “we” to that au­di­ence.

A lot of that was the dou­ble­s­peak of MBAs and econ­o­mists. I share the sto­ries of the begin­nings of these events to point out that sys­temic dis­as­ters of­ten be­gin in­nocu­ously. Ev­ery­one loved the thought of global out­sourc­ing and risk man­age­ment en­gi­neer­ing. From aca­demic the­o­rists, gov­ern­ment of­fi­cials, and prac­ti­tion­ers in in­dus­try, peo­ple em­braced new ideas and chased them with far too much en­thu­si­asm across the en­tire fi­nan­cial sys­tem for too many busi­ness cy­cles. That’s the sig­nal you’re look­ing for, the warn­ing within the noise. When the smartest peo­ple in the world act like lem­mings march­ing to the sea, that’s a sign of a sys­temic flaw, the birth cries of a Black Swan. No one sees or dares ut­ter that the em­peror is naked. It’s the fore­warn­ing of a po­ten­tial fi­nan­cial cri­sis com­ing.

Time­lines to Be Mind­ful Of

It takes time to build to a na­tion­wide sys­temic col­lapse in an econ­omy like that of the United States. On av­er­age, about 25 years from the time the germ is planted, most likely in­ad­ver­tently, to the time the con­ta­gion reaches crit­i­cal mass. It took a around decade and a half for the sub-prime mort­gage mar­ket to crater. You’ve some time to rec­og­nize what’s go­ing on and pre­pare if you’re pay­ing at­ten­tion. The last three years of the pre­lude to col­lapse will be pretty ob­vi­ous and when you’ll need to act be­fore things hit the fan.

There’s also a well-proven time­line for how long it takes for an econ­omy to suf­fer the throes of a fi­nan­cial col­lapse and re­cover suf­fi­ciently from it. That num­ber is typ­i­cally one three-year busi­ness cy­cle for the throes of chaos fol­lowed by two three-year busi­ness cy­cles to re-reg­u­late and re­cover from the shock. In all, about a decade. If you wind up be­ing one of the peo­ple se­verely af­fected by a

fi­nan­cial cri­sis, you need to have a plan to sur­vive that decade. More specif­i­cally, you need a plan for the first three years of pan­de­mo­nium.

Pre­par­ing and Sur­viv­ing

So you’ve seen the fore­bod­ing fu­ture and de­ter­mined it’s go­ing to af­fect your life. Prep­ping for a fi­nan­cial cri­sis is about re­duc­ing your vul­ner­a­bil­ity and gen­er­at­ing op­tions you can ex­e­cute when the time comes. Start by repo­si­tion­ing your as­sets and ex­penses — and not just your phys­i­cal as­sets, your hu­man ones.

Let’s start with your skills. If your cur­rent way of earn­ing an in­come is at risk — for ex­am­ple, be­cause robotics and ar­ti­fi­cial in­tel­li­gence are go­ing to elim­i­nate your ser­vice in­dus­try job — start cul­ti­vat­ing fu­ture ways to make a liv­ing that aren’t vul­ner­a­ble to sys­temic dis­in­ter­me­di­a­tion. (That’s code for a ma­chine re­plac­ing you and be­ing laid off.) The time to think about this stuff is when you still have a liv­ing and not af­ter you and a whole bunch of other peo­ple are scratch­ing to find some­thing new to do. In an eco­nomic dis­place­ment cri­sis, those who’ve pre­vi­ously in­vested in needed skills will make a liv­ing.

As a rule when look­ing for in­come al­ter­na­tives, don’t be pride­ful — be flex­i­ble. It’s nor­mal in the course of one’s work­ing life to change ca­reers over time, even if eco­nomic con­di­tions are sta­ble. In cor­po­ra­tions and gov­ern­ment ser­vice, one pro­gresses through dif­fer­ent jobs over time. In en­trepreneurial ca­reers, one changes projects on a reg­u­lar ba­sis. In blue col­lar and re­tail work, one fol­lows the busi­ness cy­cles among mul­ti­ple em­ploy­ers. The point is we’ll all ex­pe­ri­ence change; an eco­nomic cri­sis-forced change is just one more change pass­ing “Go” around the board game of life.

While you’re still work­ing, start to cul­ti­vate that next dream ca­reer — one that isn’t vul­ner­a­ble to the same fi­nan­cial cri­sis you’re prep­ping for, of course. Then, turn your goal to make it a vi­able op­tion into an obli­ga­tion to make it so. Force your­self to do what it takes to ac­tu­ally have a leg up on com­pet­ing for that job when the time comes. Be mind­ful that you’re count­ing down to a cri­sis, and you don’t want to be caught lack­ing for op­tions when it hap­pens — act ac­cord­ingly.

You think AI is go­ing to take your ser­vice job in an army of ex­pen­sive hu­man re­sources? Be­come a mem­ber of the cadre the AI needs to run af­ter it takes over the jobs of ev­ery­one in the build­ing. You may want to cul­ti­vate some­thing very dif­fer­ent as a next ca­reer. Want to be a drone op­er­a­tor? Swarms of agri­cul­tural ro­bots and fleets of self-driv­ing cars are com­ing, and there’ll be a need to tend to their needs to or­ga­nize and ac­com­plish their func­tional mis­sions. You may need to in­vest in ad­di­tional ed­u­ca­tion.

The time to do it is now and not when you’re des­per­ately un­der­go­ing a sev­er­ance ben­e­fit-re­train­ing pro­gram. Yeah, it takes work to morph your­self — it's not easy.

OK, that’s your next dream job. Fur­ther in­crease your flex­i­bil­ity to make a liv­ing, even at a lower earn­ings level than you’re at now, do­ing some­thing less pres­ti­gious but per­son­ally tol­er­a­ble. Scour your mind for things you wouldn’t mind do­ing for a while to get by and, again, make it an obli­ga­tion to do what it takes to make your­self vi­able in those job roles.

Teach­ing ball­room danc­ing at a re­tire­ment home is still a liv­ing and, if you like to dance, a tol­er­a­ble way to carry on com­pared to hard la­bor on a road crew; al­though if you can get the cer­ti­fi­ca­tion to do that, pot­holes are an ever­green re­new­able re­source. The point is to be cre­ative in your think­ing and dis­ci­pline your­self to work to make these op­tions fea­si­ble.

If you’re mar­ried and both of you have sim­i­larly vul­ner­a­ble ca­reers, you should both cul­ti­vate vi­able op­tions al­ter­na­tives. That dou­bles your po­ten­tial to lessen the im­pact of a sys­temic cri­sis on your life.

Now to ma­te­rial things. If you own a home, pon­der your hous­ing sit­u­a­tion with an open mind. As a gen­eral rule, over the course of a fi­nan­cial cri­sis, (a) you want what you owe on your house to al­ways be less than the re­al­iz­able mar­ket value of the prop­erty, and (b) the cost of ser­vic­ing

your debt on your home to be within the to­tal of all in­come you’ll be able to garner dur­ing the du­ra­tion of that cri­sis. These are ba­sic cred­it­wor­thi­ness cri­te­ria that you have to be hon­est with your­self about.

Crunch your num­bers. You don’t want to be like the peo­ple from the 2008 cri­sis who lever­aged their homes to the hilt, saw their prop­erty val­ues fall be­low their out­stand­ing debt, and lost it all. Fa­mil­iar­ize your­self with op­tions to man­age your ex­po­sure. If you can, you may want to pay down your debt load. It's not the eas­i­est thing to do, but some peo­ple strate­gi­cally down­size to small, less costly homes. Some peo­ple even cash out com­pletely and rent for the du­ra­tion of the cri­sis if their num­bers in­di­cate that’s a prefer­able choice. The cri­sis al­ways does end. When pre­par­ing for a fi­nan­cial cri­sis, you’re plan­ning to get to that end.

Have an aus­ter­ity plan. The law that in­come must be more than ex­penses is set in stone. In good times, it’s easy to live hand to mouth and, for the most part, get away with it. Some peo­ple barely get by, even if they have enor­mous in­comes, be­cause they have equally enor­mous ex­penses. This doesn’t work in a fi­nan­cial cri­sis when in­come in­ter­rup­tion may be forced upon you. If you did your home­work on al­ter­na­tive re­al­iz­able in­come sources de­scribed ear­lier, you’ve an idea of where your ex­penses will need to be to stay within what you can real­is­ti­cally man­age dur­ing a fi­nan­cial cri­sis. Em­brace that num­ber. You’ll lit­er­ally live or die by it. Know how you’re do­ing to con­vert from what­ever your life­style is now to your aus­tere mode.

And don’t fool your­self. You don’t just snap your fin­gers and go from party an­i­mal to aus­tere sur­vival­ist. Like your in­come side-goals-to-obli­ga­tions dis­ci­pline, the same pro­gres­sion of turn­ing ex­pense goals into per­sonal obli­ga­tions ap­plies. You need a plan to ar­rive at the an­tic­i­pated cri­sis on­set date with your ex­pense habits in bal­ance for the tur­moil and re­cov­ery phases of that cri­sis. Save any sur­plus in a rainy-day re­serve fund for when the cri­sis storm clouds are thick­est. Yup, make that an obli­ga­tion too.

Build your sup­port net­work be­fore the cri­sis hits. Most peo­ple won't want to aban­don their lives for a three- to five-year cri­sis — they’ll want to work their way though it where they are. That means you need to build your eq­uity within your com­mu­nity; the peo­ple you’ll most likely lean on when things just feel bad. That also means valu­ing the com­mu­nity eq­uity of oth­ers and be­ing pre­pared to help them though the cri­sis to the ex­tent you can.

But be sure to set your net­work’s ex­pec­ta­tions prop­erly. You want it to sur­vive the cri­sis, not fall apart leav­ing each of you ut­terly alone to suf­fer it in lone­li­ness. As the cri­sis ap­proaches, oblige each other to com­plete your goals so you en­ter the cri­sis strong and on par­ity. You’ll be bar­ter­ing good­will with each other. You’ll prob­a­bly not be fi­nan­cially sup­port­ing each other. If you do, set up a com­pany like an LLC so any money, barter, and ser­vices aren’t per­sonal. It’ll be stress­ful enough; shift­ing the obli­ga­tions and ex­pec­ta­tions to a busi­ness en­tity will help ease that stress.

Don’t be pride­ful. Dur­ing a cri­sis, use ev­ery av­enue of aid that can ex­tend your abil­ity to hold on. Re­fi­nanc­ing ex­ten­sions. Un­em­ploy­ment ben­e­fits. Wel­fare. The bot­tom line un­der such con­di­tions is to do any­thing that in­creases in­come and de­creases ex­penses. There’s no room for pride and leav­ing things on the ta­ble. Sur­viv­ing and get­ting to the other side of the cri­sis should be your fo­cus.

Fi­nally, man­age your ex­pec­ta­tions. If your fi­nances crater, it’s OK to be poorer. Yes, re­ally. It’s fine. You’re start­ing over. Re­mem­ber, the ad­mo­ni­tion is that life has many nat­u­ral start-overs, even if the econ­omy isn’t crash­ing. This fi­nan­cial cri­sis is just an ex­tra start-over. Dur­ing a cri­sis, you aren’t pas­sively wait­ing for it to end; you’re ag­gres­sively repo­si­tion­ing your­self us­ing all the op­tions you pre­pared to keep an eye out on where the open­ing in the clouds shows it­self; then, mov­ing on it first, be­fore any­one else takes your spot in line for an exit out of the cri­sis.

In a world wheretech­nol­ogy is con­stantlydis­plac­ing hu­man work­ers, it makes sense to ex­am­ine the fu­ture vi­a­bil­ity of the in­dus­try you’re in. If you’re a den­tist, peo­plewill al­ways need their teethworked on. If you’re a cashier at a re­tail store, you might want to look at otherca­reer and ed­u­ca­tionalop­tions.

danielfela/is­tock­ As the say­ing goes, if com­mon sense were com­mon, ev­ery­one would have it. Start look­ing at your in­come ver­sus ex­pense ra­tio now, lest you have to throw the keys to your life to those you owe money to.


While many op­er­ate on the “you can’t take it with you” phi­los­o­phy, that won’t help you if you havenoth­ing to fall back on. Look at sav­ings ac­count op­tions. Smallercom­mu­nity banks wel­come the busi­ness and typ­i­cally have bet­ter in­ter­est rates than largerchains.DNY59/is­tock­


SARINYAPINNGAM/is­tock­ As­sume there are peo­ple at work right now try­ing to bank­rupt the United States through ar­ti­fi­cial means of in­ter­net hack­ing and ma­nip­u­la­tion. See Den­nis’ book re­view on this topic else­where in this is­sue.

Thou­sands of peo­ple trusted Bernie Mad­off with their money only to find outthey’d been swindled. Think of how many oth­ers are out there right nowen­gag­ing in sim­i­lar prac­tices. Here we see an auc­tion of Mad­off's prop­erty in Mi­ami 2011.Spondy­lolithe­sis/is­tock­

Al­though it may be a blow to your ego, any­thing that de­creasesdebt and in­creases in­comeis pro­duc­tive when times­gorly/is­tock­

fstop123/is­tock­ As Jim Rohn once said, "If you don't de­sign your own life plan, chances are you'll fall into some­one else's plan. And guess what they have planned for you? Not much.”

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