Diary of a Very Bad Year Chapter 9 Part 1 - The End Begins
This is part of my series retelling Diary of a Very Bad Year. Today we’re covering Chapter IX, Part 1. The chapter was too long for one post so I split it in two.
It’s August 27, 2009. The Dow is at 9,580. Unemployment is at 9.7%. Foreclosures hit 360,149. And HFM just came back from vacation.
This is the final interview. The last chapter. And it opens with something unexpected. HFM actually went outside.
Ghost Towns in California
HFM took almost a month off and road-tripped across America. D.C. to Jackson Hole to Montana to Washington state, then down the California coast. Hiking, kayaking, the whole thing. For a guy whose entire existence is flat-screen monitors, this was basically a different life.
But he couldn’t turn off the finance brain. Everywhere he stopped, he counted For Sale signs and grabbed brochures from the little boxes under the signs.
Washington D.C. was doing great. No signs of distress at all. Of course not. When the government is the one spending money to fix everything, the government town gets fat.
California was a different story. Stretches of road where every house had a For Sale sign. Brand new subdivisions sitting empty. He calls them “ghostly.” Built recently, barely lived in, and now abandoned. You didn’t have to go looking for them. You’d just get off the highway to stop somewhere and there they were. A whole neighborhood with no people.
California as an Emerging Market
Here’s where it gets really interesting. HFM used to work in emerging markets. Argentina, places like that. And he noticed something at the ATMs in California. There was a message saying the bank no longer accepted California’s IOUs for deposit.
California had run out of cash. Its tax system leaned heavily on high earners, and high earners’ income is volatile. During the boom, tax revenue shot way up. The state spent like it would last forever. Then the economy flipped, high earners’ incomes dropped, and revenue fell off a cliff. California couldn’t close its budget gap. Without a passed budget it couldn’t borrow. So it started paying suppliers with IOUs instead of cash.
This had happened before, but in small amounts and for short periods. Banks used to accept those IOUs for deposit. Not this time. It was too big, and nobody knew when it would end.
And here’s the best part. The suppliers who got paid in IOUs still owed taxes on that revenue. In cash. They couldn’t pay taxes with the IOUs. California wouldn’t accept its own paper. So if you were a small business that did work for the state, you got paid in something that wasn’t money, owed real taxes on it, and had to borrow just to pay those taxes.
HFM saw the ATM message and thought of Argentina. During the crisis there, ATMs asked you: “Do you want pesos or patacones?” Patacones were the provincial IOUs. California in 2009 felt like Buenos Aires in 2001. An American state behaving like an emerging market.
Unemployment and the Feedback Loop
Back in New York, the financial markets were feeling good. Credit spreads recovered. The stock market was up. The guts of the credit system were working again. By Wall Street’s measures, the heart attack was over.
But the real economy was a different story. And the biggest problem was jobs.
HFM explains why unemployment is called a “lagging indicator.” When the economy starts recovering, demand comes back first. Companies use that demand to squeeze more out of existing workers. Longer hours, more output per person. They don’t hire until they’re absolutely sure the recovery is real. Hiring is always last.
But here’s the thing. With unemployment near 10%, you get feedback loops. Unemployed people can’t buy houses. They can’t consume. And even people who still have jobs get scared. Everyone pulls back spending. That drags on the recovery itself. High unemployment doesn’t just reflect a bad economy. It actively makes the economy worse.
Auto companies were a good example. Credit markets recovered enough that car loans could be issued again. Sales went from 8.5 million units per year back up to 11 million. But the companies weren’t hiring. They were still overstaffed from the boom when they sold 16 million. Same with construction. New home sales ticked up, but nobody was building like before. All those construction workers needed to find new jobs in new industries. And people aren’t interchangeable widgets. You can’t take a construction worker and plug them into IT. There are skills, geography, relocation barriers. That process is slow and painful.
The Return of the Low-Margin Bankers
This is the part that made HFM genuinely frustrated. And coming from a guy who spent the entire crisis sounding calm and analytical, that says something.
Before the crisis, banks were doing derivatives trades with hedge funds and demanding very little margin. A trade where you’d expect $100,000 of risk, the bank would ask for $30,000 or $40,000. This was the exact problem with AIG and Goldman. Not enough skin in the game. When the crisis hit and counterparties started failing, banks had nowhere near enough margin to cover their losses.
So during the crisis, margins jumped. A position that used to require $30,000 now required $200,000 or $250,000. Everyone said: “We learned our lesson. The old system was broken.” Regulations were discussed. New rules proposed.
Six months later, HFM’s team is working on a new trade. They ask about the margin. It’s back to $20,000 or $30,000.
The same people. Not new people who didn’t live through it. The same exact bankers, six months after the worst financial crisis since the Depression, going right back to the same practices.
HFM says he always thought financial markets had short memories because of turnover. Old traders leave, new ones come in, and the lessons die with the departing generation. Like mayflies. But this wasn’t that. These were the same people who just went through it, and they already forgot.
Bullies and Betrayers
HFM is honest about his own position. When a bank offers low margin, he doesn’t volunteer to post more money. Why would he? He doesn’t fully trust the bank’s credit either. But internally, his fund reserves capital against those positions. They know the real risk is higher than what the margin reflects.
The problem is that most funds don’t do this. Many treat the bank’s margin requirement as the actual measure of risk. If the bank says $20,000, they set aside $20,000 and use the rest to take bigger positions.
And that’s exactly what the banks want. Low margins mean more business. More deals get done. The trader gets his bonus. The salesperson hits her target. If it blows up later, well, they got paid already.
On top of that, banks that survived the crisis relatively unscathed started hiring aggressively. Before the crisis, these less-prestigious banks couldn’t attract top talent. Now they were scooping up traders and investment bankers with big compensation packages. Headhunters started calling HFM again. Business as usual, less than a year after the system almost collapsed.
HFM finds this “galling.” And his conclusion is clear. You can’t build a system that depends on regulators catching every bad margin policy at every bank. That’s too fine-grained. You need blunter rules. Force derivatives onto exchanges with standard margin requirements. Assume that hedges carry inherent risk instead of pretending they’re zero-risk positions.
Because the aliens are already back. And this time, everyone knows what they look like.
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