Eduardo Goncalves & Davide Zanchi

20/09/2016

The Big Short narrates the story of a financial speculator who analyzed the composition of
CDOs and MBSs and thus anticipated the collapse of the market right before the crisis. Following
his discovery, he decided to buy huge amounts of CDS through his hedge fund in order to make
money by betting against the market. After some time, other speculators were convinced to follow
him.
On one hand, financial engineering, and derivatives instruments in particular, helped to
mitigate the risk of mortgages and obligations, but on the other hand, most of the financial risk was
hidden by those instruments, since no one knew the real compositions of the collaterals. The lack of
regulation led to collusion and even corruption between investment banks (which create CDOs and
MBSs packages) and rating agencies (which rate those). Therefore, rating agencies had profound
responsibilities in the crisis.
Rating agencies, indeed, hold a huge power. By just cutting their ratings they can produce
massive capital outflows to a company or force a country into recessions, whereas by giving
exaggerated ratings they can sustain capital flows into risky businesses. It is still debated whether
these institutions should be under governmental control or not.
Nowadays, finance and speculation are increasingly becoming political weapons. Many
observers, in fact, agree that the third world war will be probably fought using financial instruments
in order to damage the economy of opposite countries, rather than with traditional armaments.
One of the clearest examples of financial means used to reach a political objective is
illustrated by petroleum price. Everyone knows that oil market works as an oligopoly, since OPEC
have the power to set oil price by deciding output quantity. Saudi Arabia, the world largest oil
producer, decided not to cut oil production for several months even though price was dropping.
Many believe that this move had a political objective: Saudi was mainly interested in preventing
Iran from entering oil business as well as to damage economies of opposite countries. To do so, they
had to bring oil price at such level that other countries would no longer find profitable to extract oil,
and this is exactly what they did.
Many other evidences of this trend can be found in newspapers. Currency wars belong to
this category. On the Black Wednesday in 1992, George Soros launched a speculative attack
against England and the British Pound, through a series of shorting financial transactions. The
Bank of England, in the end, had to devaluate the Pound and Soros made over 1 Billion thanks to
this move. This is a clear example of how a small group of people can make a lot of money by
damaging another country.
Another currency war is going on nowadays between the US and China. The US blame
China for not letting the Remimbi float freely, and thus achieving an artificial competitive
advantage on global markets. On the other hand, China is threating the US to drop the dollar as
reserve currency and they are consistently increasing their gold reserves, using dollar to pay them.
Since China holds an important share of American debt, the US are facing a huge risk. If China
decides to sell all those debt obligations, the US would probably face serious consequences.
Under free market principle, all these strategies and tactics are legal, since they are aligned
with international laws; although many would argue that they are not ethical because of the social
repercussions such measures in the financial market would have world-wide.