POSTSCRIPT

How did I know something very bad was forthcoming in 2008?

For a long time I had been wondering how the housing bubble was being sustained. It wasn't a genuine demand pushed by population growth. I thought, perhaps it's a good thing...if too many rich people with excess money put it into this sort of speculation, that'll keep it tied up and not fueling inflation in other areas of the economy. If it's money that would be idle or going to other luxuries anyway, as long as they don't mind the risk of losing it when the bubble bursts, then it won't hurt the rest of us.

I thought that because I did not yet understand about mortgage backed derivatives.

In the late summer of 2007, I heard an obscure news report about one of the major French investment banks asking for regulatory intervention because, "we no longer know how to value our assets." That is a moment of candor and transparency unheard-of in the banking industry, and it sent chills down my spine. I assumed it would do likewise among regulators everywhere...but apparently not here.

Stop and think about it--those are the nine scariest words a banker can ever utter! An investment bank makes its money precisely by knowing the exact worth of everything it puts money into, so it is able to figure important details like when and how much return it can expect.

An investment bank that suddenly doesn't know the value of its assets is floundering in the dark. It'd be as if you were in an accident, and the emergency room doctor walked in, took a look, and whispered to the nurse, "Omigosh, I can't figure out where to insert the thermometer and where to stick the I.V. in... him? Her?" It's an unmistakable sign that something is very scary-bad wrong.

My immediate question was, what kind of assets could they possibly hold whose worth had become so uncertain? Turns out it was American real estate mortgages of a form called "derivatives." Over the next few weeks, as I learned more about how those worked, I came to understand why the bank could no longer value their assets correctly. These things were impossibly complex (and intentionally so), not FDIC insured whatsoever, and there was plenty of incentive for those making big commissions putting them together to lie about rates of return, qualifications of borrowers, all kinds of things like that. Even though it did not appear my pension plan was very heavily dependent on mortgage backed derivatives directly, I discovered the fund was insured by AIG, one of the companies most heavily at risk of collapse if more derivatives started going bad. How cheery.

It didn't look like anyone else in the U.S. understood the scope of the problem. The government's hired economics experts (which included many of the folks who created those derivatives in the first place) kept parroting "the fundamentals are sound, the fundamentals are sound. Awwk."

But I started cutting expenses, liquidating personal property I could do without, and trying to make sure I was OK any big-ticket items I might need over the next few years of possible income cutbacks and no credit availability. Fortunately, I had the better part of a year before everything really hit the fan, but that was still little comfort.