Lehman And The Meta-Game Of Trading

by: Ben Hunt

A cornerstone of the Epsilon Theory research project is the meta-game. It's the subject of the most popular ET note to date - "Too Clever By Half" - and I think it's the most important game theoretic concept to master if you want to have a successful career in financial services. Or a successful career in anything, really. But what I haven't written about is when the idea of the meta-game first really hit home for me. It was 10 years ago to the day - September 15, 2008 - the day that Lehman went under.

A "game" in the technical sense of the word is a strategic interaction, meaning that your decisions are contingent on my decisions, and my decisions are contingent on your decisions, and we both know it. Consciously or not, we are all playing games all of the time. A meta-game is a larger game that contains a bunch of smaller games. It's typically a long-term strategic interaction, and it's almost always harder to wrap your head around than an immediate game. It's not the same thing as a repeated-play game, which is its own interesting thing, but not this interesting thing. A meta-game is the big picture. A meta-game is the forest, not the trees. A meta-game is the portfolio, not the trade. A meta-game is the career, not the assignment. And yes, there are meta-games on top of meta-games.

I can't say this next part without sounding braggy, but I'll make up for it by sounding quite meh and fallible at the end. 2008 made my career. Our hedge fund did well in 2005 and 2006 and 2007, but lots of hedge funds did well those years. Very few plain vanilla, stock-picking long-short hedge funds were up 20%+ in 2008, but we were. It was the best game I've ever played, and yes, it was by turns exhausting and terrifying, but also yes, by god it was fun!

Until Lehman went bust.

It was all funny money until September 15. It was all symbols and flashing numbers on your Bloomberg terminal. It was all playing the game of markets. It was all figuring out in your head how those symbols translated to a portfolio P&L for the day and what your cut of that would be. If you tell me you don't know what I'm talking about, then you're a liar. I know that few people had that experience in 2008, but everyone reading this note has had that experience sometime. It's the experience of greed and it's the experience of winning. It's a damn good feeling.

So yeah, I'd love to tell you that my transformative meta-game moment associated with the Lehman collapse was my sudden realization that I had friends who had just lost their jobs, that I was stricken by empathy for their plight or that I was worried about the lives and careers and fortunes that had been ruined. But nah.

How am I gonna get paid if everyone goes under?

Yep, that was my utterly selfish and utterly real meta-game moment. I didn't mean that I had counterparty risk with Lehman directly. No, I had rewritten (what's called novation) all of my Lehman OTC contracts over to JPMorgan a couple of months earlier, just like I had gotten out of Bear Stearns prime brokerage a few months before they went belly-up. Like I say, best game I ever played.

But what if it's ALL finished? What if ALL of the counterparties close their doors? What if the entire system collapses? Who's going to pay me?

I remember that day with a fair amount of remorse and shame, but not for the reasons you might think. I'm not at all remorseful or ashamed for being self-interested and greedy. If you're in the professional investment world and you're going to feel bad for that, then you are in the wrong line of work. No, I feel remorse because as well as I played the game of markets in 2008, I played the meta-game of markets like a noob. Which I was, but still.

September 15, 2008 was the day to start planning a levered long position, if not a levered long product, if not a levered long business. Because if the system collapses, then you're just part of the carnage, and if the system doesn't collapse, then you win.

This was David Tepper's famous "balls to the wall" thesis in 2010, and it's why he's a billionaire and I never will be. This was supposedly part of Warren Buffett's rationale for selling billions of dollars of naked puts on the S&P 500 and placing Berkshire in existential jeopardy, and it's part of why he's the greatest coyote of all time. No one plays the meta-games better than Uncle Warren. No one.

But instead of thinking through the meta-game in any consequential way, I stayed mired in the immediate game of markets. I breathed a sigh of relief when the world didn't end alongside Lehman, I got paid, and I went on my myopic way. I recognized the meta-game's existence, but I wasn't able to conceive of myself as a strategic actor within it.

And that's why I write Epsilon Theory the way I write Epsilon Theory … because I'm not going to make that mistake again.