Gain of Function Wall Street: The Same Toxic Asset Trick That Caused the 2008 Crisis Is Back
The Virus Has a New Name
Ben Hunt over at Epsilon Theory coined a phrase I wish I had come up with myself: gain of function Wall Street. Just like the controversial lab research that takes a virus and makes it more infectious, Wall Street’s financial engineers take risky, illiquid assets and dress them up in a tuxedo until they look safe enough to sell to pension funds and insurance companies.
I’ve been calling these people financial alchemists for years. Ben’s description is better. And what I’m about to walk you through proves the point perfectly.
UBS Is Packaging Steaks Into Bonds. Yes, Really.
This past weekend I came across a report about UBS, the Swiss banking giant, proposing a product that bundles stakes in private credit funds into a bond. The target rating? A2 from Moody’s. The backstop? A rare insurance wrapper provided by Nationwide Mutual Insurance Company.
Let that sink in. We are talking about:
- Illiquid private credit assets bundled together
- Wrapped in insurance to make them appear safe
- Stamped with an investment-grade rating from a major ratings agency
- Sold to pension systems and insurers who are required to hold safe assets
If that sounds familiar, it should. This is exactly what happened with mortgage-backed securities leading up to the 2008 financial crisis. They took garbage mortgages, sliced and diced them, got the rating agencies to bless them, and sold them to every institutional buyer on the planet. When the music stopped, the entire financial system nearly collapsed.
Now they are doing it again. Verbatim. Same playbook, different asset class.
Why This Keeps Happening
The answer is simple: if Wall Street can package it and find a buyer, they will sell it. Full stop. There is no moral compass involved. There is no systemic risk concern that outweighs a fee. And why would there be? When these gain of function viruses spread and infect the broader financial system, the taxpayer steps in. The bailout arrives. The bankers walk away.
Regulators are already raising flags that they may lose visibility on the underlying risks inside these structures. Buyers are leaning on the stability of a small handful of firms, which creates correlated risk. When one cracks, they all crack. Forced selling follows. The contagion spreads.
This is not speculation. This is history repeating itself with better marketing.
How We Approach This at Markowski Investments
I am not going to pretend that staying away from toxic assets means we are immune to market corrections. We are not. When these viruses spread and infect the entire financial system, everyone feels it, including us. Our portfolios took hits during the Great Recession.
But here is the difference:
- We owned high-quality companies, not engineered financial products
- We continued buying through the downturn and dollar cost averaged
- We built portfolios that, as Nassim Taleb would say, are anti-fragile
- We do not chase short-term returns on hyped-up products, no matter what CNBC is telling you
Market corrections are inevitable. The gain of function products that Wall Street is creating right now will eventually unwind. That is not pessimism, that is math. The question is never whether it will happen. The question is whether your portfolio is positioned to come out the other side stronger.
The Bottom Line
Wall Street’s financial engineers are back in the lab, and they are cooking up the same infectious products that nearly brought down the global economy in 2008. New asset classes, same dangerous structure, same ratings-agency blessing, same institutional buyers who should know better.
The smartest thing any investor can do right now is understand what is inside their portfolio and avoid anything that smells like it was built in a lab. If your advisor cannot explain exactly what you own and why it is safe, that is your answer right there.