If you had watched the movie “The Big Short” which is currently airing in theatre, you would have noticed that at the end of the movie, it quickly highlighted Bespoke Trance Opportunity as the next possible bubble to be burst which will cause another financial crisis greater than what we experienced in 2008.
Some of you may have been curious about what they are about, so I’ll try to describe and put them as simple as possible in layman terms.
Bespoke Tranche Opportunity is basically a synthetic CDOs which the banks are currently selling to the world which resonates to the same underlying portfolio that crashes the financial crisis in 2008. I will not have to go further to what happened back then but if you are unsure, the movie will help to explain in a very layman way of understanding it.
As part of the bank’s financial engineering to package this deal to make it attractive to investors, they put in a couple of assets (bonds, securities, derivatives) with different credit quality to entice investors to put their money in the bank with a specific targeted return and risk. In doing so, they attract a chain of compounding effects on people who bet on the products and this will create a bubble until the day it bursts (we never know when).
For example: You offer a bundle of mortgages to me for $100 with 10-to-1 odds that they will default. I accept your offer and buy them from you for $100 with 15-to-1 odds that they will not default. Whether or not they default or not at the end of the day it does not matter. The bet was realized one way or another. We would have a binary outcome of someone who lost and someone who won. This is the “synthetic CDO” which I was talking about. If the train of baseless transactions stopped at some point in time, then the damage would have been contained in 2008. Unfortunately, it is hardly the case. The problem would compound and easily become “atomic” when bets were made on our bet and so on and so forth. This creates a chain of events when the bubble burst.
You might wonder why history repeats itself despite the past warnings or incidence that has happened. The reason for this is simple. We have been living in almost a decade of low interest rate environment which has been kept low by the Federal Reserve until the recent hike so if you are working in an investment banking department, you would need to think of ways to come up with a customized product which will boost demand and earnings for the company. After all, your bonus would be directly impacted if otherwise. You certainly can’t do “enough” with simply selling mutual funds or treasury bonds. That is not the diamond you want to be working in investment banking.
If you had watched the movie, you would also have noticed that only one high profile leader by the name of Kareem Serageldin gets punished severely with jail term from the consequence of all the hazards they caused to the world. This is a far cry from giving sufficient warning to those greedy bank leaders and future participants because seemingly “everyone gets away from it” anyway. In other words, there are simply a lack of accountability on all these that matters.
There are plenty to learn from the history but there’s a huge tendency for history to repeat itself again because the financial structure is not build to last. At the end of the day, be wary of what is happening around you and protect yourself. Things are not going to be pretty if you are a victim of it.