Carver - By Tom Cain Page 0,30

terrible driver who was almost certain to crash.’

‘Or if I knew I could make you crash …’ Carver said.

Koenig clearly thought he was joking. ‘Ah, well, that would be cheating!’

‘If you say so.’

‘In any case, a default swap is just like a regular insurance policy,’ Koenig continued. ‘You buy a certain amount of cover for a fixed premium, over a given period – usually ten years – and it pays out in the event of loss. The premium is often very low. If you wanted to take out a credit default swap on a very safe, AAA-rated corporate bond, for example, it might only cost you fifteen thousand dollars a year for ten million dollars of coverage. So your downside is fixed: over the course of a decade the maximum you will ever spend is a hundred and fifty thousand dollars. But if the company collapses and its bonds become worthless, then you will make ten million dollars. Those are very good odds. And because the length of the term is so long, a default swap is very useful when you are sure that a collapse of some kind will occur at some point, but you don’t know exactly when.’

‘But what’s in it for the other guy, the one who’s selling?’ Carver asked.

‘Ah, well, he gets a guaranteed income, based purely on a promise,’ said Koenig, to whom this was clearly a perfectly reasonable proposition. ‘He does not have to spend any money of his own. He just collects your premium every year for ten years, and hopes that he never has to pay out. In most cases, he will be right. He will end up with a hundred and fifty thousand dollars for doing absolutely nothing. But sometimes, particularly in times of crisis, an unexpected, apparently impossible, failure occurs and he loses his bet. The market was certain that Lehman’s was safe, because it was too big to fail, and so it was very cheap for Monsieur Zorn to buy billions of dollars of credit default swaps. When Lehman Brothers collapsed, he collected those billions, and, of course, the banks that had sold him those swaps lost the billions they had to pay him.’

‘That wouldn’t make him too popular.’

‘Not if he did it more than once, certainly,’ Koenig agreed. ‘A bank is like a casino. The management do not mind the occasional jackpot. That encourages the other gamblers. But if someone creates a system for winning, and gets the jackpot again and again … well, then they are asked to leave the casino.’

‘Yes … and they aren’t always asked politely,’ said Carver. ‘So these swaps, are they the only way Zorn makes his money?’

‘I had no idea you were taking such an interest in finance, Sam. May I ask why you are so fascinated by Malachi Zorn in particular?’

‘His name came up in conversation.’

Koenig gave Carver the chance to say more, accepted that no further information would be forthcoming, and then smiled as he said, ‘You are very discreet. You would have made an excellent Swiss banker! OK … get me another martini and I will try to explain.’

Carver bought a second round of drinks and settled back for Koenig’s tutorial.

‘So, Zorn … Well, I imagine he’s using a great many different financial vehicles. His aim, though, will always be to leverage his money to the greatest possible extent, so that he gets the maximum possible return.’

‘The impression I got was that he bets on failure most of the time,’ Carver said.

‘In that case, another way to go is “put” options. Basically, that gives him the right to sell a quantity of a stock or a bond at a particular price, on or before a particular date. So, imagine a company that is doing well. Its shares cost ten dollars, and the price is very solid, very steady … But for some reason, Zorn thinks to himself, “These shares are overvalued, they must crash. Soon they will be worth much less.” So he buys the option to sell these shares at eight dollars. Financial institutions will sell Zorn these options, because they see no reason for this price to go down. If they are right, the price holds steady, and Zorn loses all the money he has spent buying the options. But if the share crashes – say to three dollars a share – Zorn exercises his options, sells at eight dollars, and pockets five dollars a share profit.’

‘Which the bank has to pay for?’

‘Effectively, yes.’

‘So what is Zorn