💸 SBF's insane risk

Zambia's debt restructuring | Saturday, November 19, 2022

Open in app View in browser   Presented By Barclays Corporate and Investment Bank   Axios Markets By Felix Salmon · Nov 19, 2022 Inevitably, I'm writing mostly about FTX and SBF for the second week in a row. Somehow I manage to mention helminths in item 3 — and then pivot to Zambia in item 4. The whole thing, edited by Kate Marino and copy-edited by Elizabeth Black, is 1,549 words, a 6-minute read.     1 big thing: Crazy risk Illustration: Shoshana Gordon/Axios   The 2008 financial crisis was caused when a formerly boring industry — banking — got taken over by risk-seekers. Crypto was dominated by risk-seekers from the beginning, making the current implosion all but inevitable. Why it matters: The bankruptcy of FTX has precipitated renewed calls for tougher and more effective regulation of the crypto markets, with the idea being that such regulation would make the industry safer and less risky. The catch: Almost no one in crypto has any real desire for it to be safe and boring. The only thing it's proved really good at is providing a venue for high-risk speculation. Indeed, there's a strong case that the best thing to do with crypto is to keep it entirely unregulated, lest regulation confer undeserved legitimacy on the asset class. Driving the news: In an interview with Kelsey Piper of Vox this week, FTX founder Sam Bankman-Fried admitted that his repeated calls for more regulation of the crypto industry were insincere and done only for their PR value. "F*ck regulators," he said. The big picture: Nick Dunbar, in "The Devil's Derivatives," his masterful account of the financial crisis, draws a distinction between "the men who hate to lose" and "the men who love to win." Most humans are in the "hate to lose" camp. As Dunbar says, "normal people are constitutionally, genetically, down-to-their-bones risk averse: they hate to lose money." Crypto speculators are in the risk-seeking minority: "somebody who, when confronted with uncertainty, sees not danger but opportunity ... For them, the misery of losing barely merits a moment's consideration. Such people have a very high tolerance for risk. To be more precise, they crave it." It's the mindset captured by Adam Fisher in his (sadly now deleted) profile of SBF: "Very high risk multiplied by dynastic wealth trumps low risk multiplied by mere rich-guy wealth." "SBF needed to find a path on which he'd be a coin toss away from going totally bust." The catch: If you take that path and flip enough coins, you're almost certain to go totally bust sooner or later. SBF was explicitly unworried about that. He calculated everything in terms of "expected value," even if the probability of actually realizing that value was tiny. "SBF would have kept flipping double or nothing," tweeted Harvard's Jason Furman. "With probability 0.00001% he would have ended up owning the entire universe. And with probability 99.99999% bankruptcy." What they're saying: "SBF needed extreme risk to maximize the expected value of his lifetime earnings," wrote Fisher. By the numbers: SBF told Fisher that his goal was to make $5 trillion. If his plan had a 0.02% chance of succeeding, and would otherwise go to zero, that would give it a positive expected value of $1 billion — a number high enough to make it well worth pursuing, even with a 99.98% chance of ignoble failure. The bottom line: As SBF explained in 2020, his philosophy was that "all-in maximizes long term growth." Always keep risking everything. That helps explain why his back-office and compliance teams were so small — and why FTX ended up going to zero. It also helps explain why crypto more broadly is so volatile and prone to blow-ups.     2. Good and bad risk Illustration: Shoshana Gordon/Axios   Risk-taking is, broadly, good for the economy — but only when the risks are being borne by people who are willingly taking them. Why it matters: A lot of people in both the crypto sector and the philanthropic sector turn out to have been unwittingly and unwillingly taking much bigger risks than they thought they were taking. The big picture: In the business world, spectacular crashes are normally associated with deliberately outsized risk-taking. Softbank's Masa Son encouraging WeWork's Adam Neumann to grow faster and burn more cash is one high-profile example. Morgan Stanley's John Mack, who led the firm to a point at which it was hours away from bankruptcy, boasts in his memoir of having "a titanium-strength stomach for risk" and says he wouldn't change a thing. "We had to take risks to make money," he writes. It was inevitable that some of those risks result in losses. That's just how it is." The catch: "Expected value" calculations often ignore the downside of failure. Failures like those of FTX, Lehman Brothers, or Enron don't just hurt the men — they're nearly always men — who were deliberately taking on outsize risk. They also hurt a much broader population of people who might not have considered themselves exposed to those companies at all. Between the lines: SBF's risk appetite was visible not just in how he ran his businesses, but also in how most of his social circle approached ethics and philanthropy. His "longtermist" effective altruism focused on interventions that had a small probability of having existential upside, rather than taking actions certain to make today's world a better place. How it works: As Tyler Cowen points out about SBF's philanthropy, "Hardly anyone associated with Future Fund saw the existential risk to…Future Fund." Similarly, FTX's customers thought they were taking crypto risk, and almost without exception paid much less attention to counterparty risk than they should have. The bottom line: Known risks tend to be relatively easy to absorb. Catastrophe strikes when risk turns out to be lurking in unexpected places.     3. The hit to effective altruism Via CasPiancey/Twitter   The downfall of SBF hit the effective altruism (EA) movement particularly hard. State of play: SBF was one of the largest donors in the EA ecosystem, and that source of funds has dried up forever. Other believers in EA are reconsidering their prior beliefs in light of what they've learned about SBF. Even SBF himself turns out to have professed his belief in EA largely for selfish reasons. The big picture: One of the central debates in philanthropy is when and whether to make risky investments that might have zero positive effects. The so-called "worm wars" are a prime example. Oversimplifying massively, EA-adjacent philanthropies like GiveWell can support deworming programs even if they think they probably don't work, if the cost is low enough and the benefits (if they do exist) are high enough. Where it stands: The weakness of pursuing low-probability outcomes with positive expected value has become very obvious — especially within the EA community, which is small and very focused on the FTX fiasco. For the record: In a Twitter DM conversation, Vox's Kelsey Piper put it to SBF that he was "really good at talking about ethics, for someone who kind of saw it all as a game." "Ya," SBF replied. "hehe." "I had to be. It's what reputations are made of." SBF talked about how "we woke westerners" play a game — where "we say all the right shibboleths and so everyone likes us." In other words: By talking at length about EA, SBF gained exactly the credibility he needed within Silicon Valley and the broader culture. The bottom line: EA did more for SBF than SBF did for EA. EA should have been much less reliant on SBF. Now it's paying the price for being too closely associated with him.     A message from Barclays Corporate and Investment Bank Powering your perspective on deglobalization's acceleration     With geopolitical and macroeconomic events continuing to shake global value chains, governments and businesses are looking closer to home for future resilience and growth. Barclays Research explores the factors behind accelerating deglobalization. Learn more.     4. The Zambia precedent Illustration: Aïda Amer/Axios   The history of sovereign debt restructuring is, in one sense, quite simple: Ruritania borrows money by issuing some kind of debt instrument. Ruritania discovers it can't pay its debts. Ruritania's creditors eventually realize the same thing, and agree to restructure their debt instrument so that they get something back. Ruritania's creditors conclude that they held the wrong kind of debt instrument, and need to hold something that can't get restructured. Ruritania, now with a smaller debt burden, returns to the market — but this time issues a new debt instrument that doesn't have a history of getting restructured. Goto line 2. Why it matters: Zambia is restructuring its debts, and causing a stare-down battle between China, on the one hand, and the IMF and World Bank, on the other. Like all the best stare-down battles, this one is taking place in the footnotes of G20 communiqués. For the record: The latest communiqué, which came out this week, has 52 paragraphs, 9,700 words, and one footnote. (There's also a 1,186-page version "with annexes" but I am too scared to open it.) The footnote, in full: "Noting that one member has divergent views on debt issues in paragraph 33, and emphasized the importance of debt treatment by multilateral creditors like MDBs." To be clear: The "one member" in question is China. The big picture: The MDBs, or multilateral development banks, have so-called preferred creditor status. Which means they always get paid back in full, partly because they lend at well below market rates. China, however, wants them to participate in "debt treatment" — which means it wants them to write down at least some of their debts. Where it stands: Zambia owes China $5.9 billion, per former Treasury official Brad Setser's excellent summary of the situation. The MDBs are owed $2.7 billion. Total external debt is $20 billion. "I don't think there is any 'give' in the MDBs," Setser emails Axios. "Their preferred status is not up for negotiation." The bottom line: Zambia is a crucial test case for many other countries that are going to have to restructure their debt in coming years. (Looking at you, Ghana.) Eventually, either China or the MDBs are going to have to blink. An important precedent will be set either way.     A message from Barclays Corporate and Investment Bank Exploring deglobalization     Barclays Research provides insights into accelerating deglobalization. The background: Geopolitical and macroeconomic events continue to shake global value chains, and governments and businesses are looking closer to home for future resilience and growth. Get the insights.   Nick Dunbar ends "The Devil's Derivatives" with an epigram from "The Master and Margarita," by Mikhail Bulgakov. During your act you made bank notes float down from the ceiling . . . Today, when I came to check the till, there was nothing in it but a lot of strips of paper. Why stop here? Let's go Pro. Join the thousands of professionals using Axios Pro to keep up with the companies, deals and trends changing their industries.   Axios thanks our partners for supporting our newsletters. If you're interested in advertising, learn more here. 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