Are we allowed to talk about Bitcoin?

In a way. The mechanics are very different, and the malinvestment is in a very different kind of market. But the similarties are that mispriced debt markets (making money too cheap to try to create faux prosperity) caused by central banks around the world over a very long period of time, created epic malinvestment.

When it corrects itself (usually because funding costs rise and people rolling over escalating piles of debt can't do it anymore), it not only destroys all the genuises who were riding a cheap money bubble. ... it exposes the fraudsters who thrived in that environment because whatever scheme they were running falls apart on them. It can be an outright fraudster like Bernie Madoff, but sometimes it doesn't start out as fraud. ... An example that comes to mind is MF Global, which was a commodity broker that crumbled after the financial crisis. It was a very similar story to what we are likely to find out about FTX now. ... MF Global had a separate trading operation that made a really bad leveraged bet on sovereign debt when Europe went into its debt crisis. ... and in the wake of it, we found out that they had tried to buy time by "borrowing" funds from segregated customer accounts to mask its liquidity shortfalls.

Even in the case of Enron, I don't think they set out to defraud people. They got in over their head (due to the leverage -- it is ALWAYS a leverage and margin story), and then rather than facing the music, they tried to hide a mountain of debt and some very toxic assets from their investors and creditors. I truly think those kinds of situations are one of the truest tests of character there is. A lot of people fail the test, unfortunately.

Don't be surprised if we see stories like this permeating A LOT of other things at some point. The amount of toxic debt out there (hiding in plain sight) is mammoth compared to what they had created in the 1990s and early to mid 2000s. The possible crises right now are lurking in so many places, from a crazy corporate leveraged-loan environment that sprung up to emerging markets debt (and even developed market sovereign debt) and way beyond.

 

BTW, FTX filed for Chapter 11 this morning. This is all happening so quickly. I just heard that according to their bankruptcy filing, they have liabilities between $10 billion and $40 billion. Putting aside the fact that you could drive a truck through that range (how in the hell don't they know their liabilities to the penny?), Enron had liabilities of $23 billion when it went bankrupt.

This is huge. And it's getting more huge with each hour. Yesterday, I was hearing $2 billion. Today, there has been a steady stream of people coming out to reassure their investors that whatever exposure they have is small. It sounds like a lot of people who had no clue what the blockchain is, were nonetheless investing their money on the rationales that "everyone is getting rich" and "he went to MIT so he must be smart."

It will be interesting to see if there is contagion.

 

This is the insidiousness of what more than a decade of ZIRP (zero interest rate) policy created. Pension plans have defined obligations to meet, and traditionally they could meet those obligations with minimal risk because the market insured a risk-free rate of return. You lend someone money to be paid back later, and they pay you back more in the future to compensate you for the time value of money. It calibrates itself well when zillions of lenders and borrowers -- are setting the rate of interest in a market.

But central banks have spent more than a decade robbing savers (like those pension plans) of that risk-free rate of return by subverting that market and price fixing rates. Unfortunately, a pension plans obligations don't go away, even when those central banks are essentially robbing savers (like those pension plans) to spur on more and more debt (in the name of "stimulus"). That policy forced most pension plans to take on risk in order to try to create the return they need. Which is how the Ontario Teacher's Pension Plan ends up involved in this.

Interest rates are the most important price we have. They naturally calibrate risk. When a central planning authority destroys the market for those rates and price fixes them to make the cost of money artificially too cheap for a very long time, the risky behavior they spur ends with a lot of malinvestment (like FTX), and it's not just "greedy" or clueless people who end up holding the bag. Pension fund managers have complained about the environment continually, but at the end of the day they still have obligations they have to meet. So they were forced into things like this. And it was fine as long as they can keep rates suppressed and debt levels growing.

But what they were doing was unleashing monetary inflation. For a decade it mostly inflated prices of risk assets and blew bubbles. But the amount of monetary inflation they created during the pandemic spread to other things. Which is why they have had to take their foot off the scales of finance a little and let rates rise. And with funding costs higher, some of the malinvestment they have spurred is crumbling.

A pension plan getting caught holding the bag on FTX is the same exact thing as what happened with pension funds in the UK that got caught offsides on liability-driven investment. They were being forced to reach for yield.