G. K. Chesterton, demonstrating his genius at the art of paradox, once referred to optimism as "morbid." Since the moment I read that (it appears in the second chapter of The Everlasting Man, I have felt in my bones that it is true, and have accordingly nurtured a healthy repugnance for the braggarts of optimism. But as with many paradoxes, it is difficult to explain without vitiating its power to surprise and thus enlighten. A true paradox is not a mere turn of phrase, a linguistic subtlety. It is attempt to fill a gap in man's power of understanding. It is a rhetorical reach, a heuristic device to explain what is in the end a mystery to our meager powers of mind. The paradox is a human reflection of the mystery of being.
So in the hands of a master like Chesterton, the paradox becomes an instrument of extraordinary explanatory power. It can show us, as in a flash, a principle or precept which might by other means requires hours of lecture to impart. (There is an obscure masterpiece, long out of print, called Paradox in Chesterton, by a critic named Hugh Kenner, which lays all this out with great elegance. It ends with the astonishing claim for GKC that he be called a Doctor of the Church; and more astonishing still, the reader finds himself convinced.)
In this case of the problem of optimism, Chesterton's paradox opened my mind's eye to the surprising truth that optimism, being so engrossed with the potential for good things, courts ruin and despair by minimizing bad things -- or, in the parlance of finance, by minimizing the downside risk. Especially when abetted by the modern doctrine of progress, optimism is morbid because of its tendency to induce blindness concerning man's limitations.
Now I have a concrete, factual illustration of the problem of optimism, right in front of everyone's eyes.
As I understand it, AIG was basically ruined by the wild bets of a 300-man unit out of London, the Financial Products office. This 300-man operation lost the equivalent of a big state's budget and more, all by themselves. We now have a partial counterparty list since the federal bailout in September. Forced out into the open by congressional pressure this letter reveals that the AIGFP London office paid roughly $22 billion in straight collateral on credit default swaps; and then on top of that, another $27 billion used to purchase underlying bonds, and thereby cancel the swaps associated with them. (This latter course of action to extinguish these toxic assets was a project undertaken along with an entity confected by the New York Federal Reserve Bank called "Maiden Lane III," which is said to be the holding company of AIG's bailout.)
300 hundred men -- a single office -- wrote contracts forcing an otherwise profitable company to pay out sums huge enough to bring down the entire 100,000-man firm.
And let's not forget that you don't have to hold the underlying debt to buy the swaps. You can just short-sell and speculate with it. Michael Lewis' piece some months back in Portfolio described exactly such an operation: a bunch of doomsayers who, fiercely disbelieving the reckless optimism, used CDS to short-sell durn near everything in the mortgage-bond market. They short-sold the whole shadow banking system itself, on the grounds that it was unreal: a web of hedging and counter-hedging, of selling risk out the front door and buying it from the back.
What AIG did was sell insurance on Lehman and other banks' bonds with feverish abandon, then package new securities from that insurance-premium revenue stream, and unleash these engineered monstrosities on everyone else. They passed around financial timing grenades with the pins pulled. My friend calls it a "horizontal" Ponzi scheme.
Was this an act of fraud? I say usury is a better word for it, because we're lacking the element of malicious intent. Instead we have optimism.
The means of this usury was the extraordinarily reliance upon mathematical abstraction for financial performance, and the blindness was ubiquitous assumption that real estate would appreciate forever. By analogy this was a kind of sophistry which played on the audience's trust, and the performer's talent, to erect a great pretense, a facade, a house of cards, an illusion that bedeviled performer and audience alike. The poor mesmerized Optimists -- they thought Lehman could never fall! it had been on the Exchange since before the Civil War! It was reckless optimism that ruined them. It was, as Chesterton put it, morbidity of optimism.
In short, the whole financial world was brought to its knees, in the Great Usury Crisis, by the 300 Optimists, the Morbid Optimists of London.