The financial system is making the same mistake as Lehman Brothers did in 2007.
And the consequences will be the same...
It all centres on the fatal flaw that brought down investment banks in 2008: the misconstrued nature of risk.
To investment bankers, risk and volatility are synonymous. They’re even regulated based on this lie. Each day, an investment bank is only allowed to have a certain amount of its money at risk based on the levels of volatility in the market. These rules are called Value at Risk, or VaR. And they’re what failed spectacularly in 2007 for Lehman Brothers.
The reason is simple. The banks measure volatility in a backward looking way. The lower volatility has been, the more risk traders are allowed to take. The problem is, the cycle of lower and lower volatility and traders taking on more and more risk eventually snaps. And when it does, you get a crash.
If you’ve ever watched the movie Margin Call, which is about the failure of Lehman Brothers, this information will explain what happened in the film. A risk analyst realises that, due to the higher level of volatility in the market, all their calculations of VaR have to be updated. And the new calculations provided a simple conclusion: Lehman was broke. It had smashed way past its acceptable VaR levels given the new volatility.
Well, today the financial system is once again in Lehman Brother’s chair. They’ve been lulled into a false sense of security by low volatility for years. Lower and lower it went. But now the climax of the movie is approaching...
Thanks to February’s 10% correction, volatility is back at normal levels.
And right now, the industry is busy computing what this new volatility means for their positions...
If you have ANY money in western stock markets, read this letter immediately.
Capital & Conflict