Two Men in a Boat
Virtually no one--be they homeowners, financial institutions, rating agencies, regulators, or investors--anticipated what is occurring.
--Deven Sharma, president of S&P Testimony before U.S. House of Representatives October 22, 2008
Pope Benedict XVI was the first to predict the crisis in the global financial system...Italian Finance Minister Giulio Tremonti said. "The prediction that an undisciplined economy would collapse by its own rules can be found" in an article written by Cardinal Joseph Ratzinger [in 1985], Tremonti said yesterday at Milan's Cattolica University.
--Bloomberg News, November 20, 2008
Greg Lippmann had imagined the subprime mortgage market as a great financial tug-of-war: On one side pulled the Wall Street machine making the loans, packaging the bonds, and repackaging the worst of the bonds into CDOs and then, when they ran out of loans, creating fake ones out of thin air; on the other side, his noble army of short sellers betting against the loans. The optimists versus the pessimists. The fantasists versus the realists. The sellers of credit default swaps versus the buyers. The wrong versus the right. The metaphor was apt, up to a point: this point. Now the metaphor was two men in a boat, tied together by a rope, fighting to the death. One man kills the other, hurls his inert body over the side--only to discover himself being yanked over the side. "Being short in 2007 and making money from it was fun, because we were short bad guys," said Steve Eisman. "In 2008 it was the entire financial system that was at risk. We were still short. But you don't want the system to crash. It's sort of like the flood's about to happen and you're Noah. You're on the ark. Yeah, you're okay. But you are not happy looking out at the flood. That's not a happy moment for Noah."
By the end of 2007 FrontPoint's bets against subprime mortgages had paid off so spectacularly that they had doubled the size of their fund, from a bit over $700 million to $1.5 billion. The moment it was clear they had made a fantastic pile of money, both Danny and Vinny wanted to cash in their bets. Neither one of had ever come around to completely trusting Greg Lippmann, and their mistrust extended even to this fantastic gift he had given them. "I'd never buy a car from Lippmann," said Danny. "But I bought five hundred million dollars' worth of credit default swaps from him." Vinny had an almost karmic concern about making so much money so quickly. "It was the trade of a lifetime," he said. "If we gave up the trade of a lifetime for greed, I'd have killed myself."
All of them, including Eisman, thought Eisman was temperamentally less than perfectly suited to making short-term trading judgments. He was emotional, and he acted on his emotions. His bets against subprime mortgage bonds were to him more than just bets; he intended them almost as insults. Whenever Wall Street people tried to argue--as they often did--that the subprime lending problem was caused by the mendacity and financial irresponsibility of ordinary Americans, he'd say, "What--the entire American population woke up one morning and said, 'Yeah, I'm going to lie on my loan application'? Yeah, people lied. They lied because they were told to lie." The outrage that fueled his gamble was aimed not at the entire financial system but at the people at the top of it, who knew better, or should have: the people inside the big Wall Street firms. "It was more than an argument," Eisman said. "It was a moral crusade. The world was upside down." The subprime loans at the bottom of their gamble were worthless, he argued, and if the loans were worthless, the insurance they owned on those loans should go nowhere but up. And so they held on to their credit default swaps, and waited for more loans to default. "Vinny and I would have done fifty million dollars and made twenty-five million dollars," said Danny. "Steve did five hundred and fifty million and made four hundred million."
The Great Treasure Hunt had yielded a long list of companies exposed to subprime loans. By March 14, 2008, they had sold short the stocks of virtually every financial firm in any way connected to the doomsday machine. "We were positioned for Armageddon," said Eisman, "but always at the back of our minds was, What if Armageddon doesn't happen?"
On March 14, the question became moot. From the time Bear Stearns's subprime hedge funds had collapsed, in June 2007, the market was asking questions about the rest of Bear Stearns. Over the past decade, like every other Wall Street firm, Bear Stearns had increased the size of the bets it made with every dollar of its capital. In just the past five years, Bear Stearns's leverage had gone from 20:1 to 40:1. Merrill Lynch's had gone from 16:1 in 2001 to 32:1 in 2007. Morgan Stanley and Citigroup were now at 33:1, Goldman Sachs looked conservative at 25:1, but then Goldman had a gift for disguising how leveraged it actually was. To bankrupt any of these firms, all that was required was a very slight decline in the value of their assets. The trillion-dollar question was, What were those assets? Until March 14, the stock market had given the big Wall Street firms the benefit of the doubt. No one knew what was going on inside Bear Stearns or Merrill Lynch or Citigroup, but these places had always been the smart money, ergo their bets must be the smart bets. On March 14, the market changed its opinion.
That morning, Eisman had been invited on short notice by Deutsche Bank's prominent bank analyst Mike Mayo to address a roomful of big investors. In an auditorium at Deutsche Bank's Wall Street headquarters, Eisman was scheduled to precede the retired chairman of the Federal Reserve, Alan Greenspan, and be paired with a famous investor named Bill Miller--who also happened to own more than $200 million of Bear Stearns stock. Eisman obviously thought it insane that anyone would sink huge sums of money into any Wall Street firm. Greenspan he viewed as almost beneath his contempt, which was saying something. "I think Alan Greenspan will go down as the worst chairman of the Federal Reserve in history," he'd say, when given the slightest chance. "That he kept interest rates too low for too long is the least of it. I'm convinced that he knew what was happening in subprime, and he ignored it, because the consumer getting screwed was not his problem. I sort of feel sorry for him because he's a guy who is really smart who was basically wrong about everything."
There was now hardly an important figure on Wall Street whom Eisman had not insulted, or tried to. At a public event in Hong Kong, after the chairman of HSBC had claimed that his bank's subprime losses were "contained," Eisman had raised his hand and said, "You don't actually believe that, do you? Because your whole book is fucked." Eisman had invited the bullish-on-subprime Bear Stearns analyst Gyan Sinha to his office and grilled him so mercilessly that a Bear Stearns salesman had called afterward and complained.
"Gyan is upset," he said.
"Tell him not to be," said Eisman. "We enjoyed it!"
At the end of 2007, Bear Stearns had nevertheless invited Eisman to a warm and fuzzy meet and greet with their new CEO, Alan Schwartz. Christmas with Bear, they called it. Schwartz told his audience how "crazy" the subprime bond market was, as no one in it seemed to be able to agree on the price of any given bond.
"And whose fault is that?" Eisman had blurted out. "This is how you guys wanted it. So you could rip off your customers."
To which the new CEO replied, "I don't want to cast blame."
Which Wall Street big shots Eisman had insulted was a matter of which Wall Street big shots' presence Eisman was allowed into. On March 14, 2008, he was invited into the presence of one of the biggest and most famous bullish investors in Wall Street banks, plus that of the illustrious former chairman of the Federal Reserve. It was a busy day in the markets--there were rumors that Bear Stearns might be having troubles--but, given a choice between watching the markets and watching Eisman, Danny Moses and Vincent Daniel and Porter Collins didn't think twice. "Let's be honest," said Vinny. "We went for the entertainment. It's like Ali-Frasier. Why would you not want to be there?" They drove to the fight with Ali, but took seats in the back row, and prepared to hide.
Eisman sat at a long table with the legendary Bill Miller. Miller spoke for maybe three minutes, and explained the wisdom of his investment in Bear Stearns. "And now for our bear," said Mike Mayo. "Steve Eisman."
"I got to stand up for this," said Eisman.
Miller had given his little talk sitting down. The event was meant to be more of a panel discussion than a speech, but Eisman made for the podium. Noting the presence of his mother in the third row, but ignoring his partners in the back, along with the crowd of twenty his partners had alerted (free tickets to Ali-Frasier!), Eisman launched a ruthlessly reasonable dissection of the U.S. financial system. "Why This Time Is Different" was the title of his speech--even though it still wasn't clear he was meant to be giving anything so formal as a speech. "We are going through the greatest deleveraging in the history of financial services and it's going to go on and on and on," he said. "There is no solution other than time. Time to take the pain..."
As Eisman had risen, Danny had sunk in his chair, instinctively. "There is always the possibility of embarrassment," Danny said. "But it's like watching a car crash. You can't not watch." All around him men hunched over their BlackBerrys. They wanted to hear what Eisman had to say, clearly, but the stock market was distracting them from the show. At 9:13, as Eisman was finding his place at the front of the room, Bear Stearns had announced that it had gotten a loan from J.P. Morgan. Nine minutes later, as Bill Miller explained why it was such a good idea to own stock in Bear Stearns, Alan Schwartz had issued a press release. "Bear Stearns has been the subject of a multitude of rumors concerning our liquidity," it began. Liquidity. When an executive said his bank had plenty of liquidity it always meant that it didn't.
At 9:41, or roughly the time Eisman made his bid for the podium, Danny sold some Bear Stearns shares that Eisman, oddly enough, had bought the night before, at $53 a share. They'd made a few bucks, but it was still mystifying that Eisman had bought them, over everyone else's objections. Every now and then, Eisman made some short-term trade of trivial size that totally contradicted everything they believed. Danny and Vinny both thought the problem in this case was Eisman's affinity for Bear Stearns. The most hated firm on Wall Street, famous mainly for its total indifference to the good opinion of its competitors, Eisman identified with the place! "He'd always say Bear Stearns could never be acquired by anyone because the culture of the firm could never be assimilated into anything else," said Vinny. "I think he saw some of himself in them." Eisman's wife, Valerie, had her own theory. "It's this weird antidote he has to his 'the world is going to blow up' theory," she said. "Every now and then he would show up at home with this totally bizarre long."
Whatever the psychological origins of Eisman's sudden urge, the previous afternoon, to buy a few shares in Bear Stearns, Danny was just glad to be done with the matter. Eisman was now explaining why the world was going to blow up, but his partners were only half-listening...because the financial world was blowing up. "The minute Steve starts to speak," said Vinny, "the stock starts to fall." As Eisman explained why no one in his right mind would own the very shares he had bought sixteen hours earlier, Danny dashed off text messages to his partners.
9:49. Oh my--Bear at 47
"If [the U.S. financial system] sounds like a circular Ponzi scheme it's because it is."
9:55. Bear is 43 last OMG
"The banks in the United States are only beginning to come to grips with their massive loan problems. For instance, I wouldn't own a single bank in the State of Florida because I think they might all be gone."
10:02. Bear 29 last!!!!
"The upper classes of this country raped this country. You fucked people. You built a castle to rip people off. Not once in all these years have I come across a person inside a big Wall Street firm who was having a crisis of conscience. Nobody ever said, 'This is wrong.' And no one ever gave a shit about what I had to say."
Actually, Eisman didn't speak those final sentences that morning; he merely thought them. And he didn't actually know what was happening in the stock market; the one time he couldn't check his BlackBerry was when he was speaking. But as he spoke a Wall Street investment bank was failing, for a reason other than fraud. And the obvious question was, Why?
The collapse of Bear Stearns would later be classified as a run on the bank, and in a sense that was correct--other banks were refusing to do business with it, hedge funds were pulling their accounts. It raised a question, however, that would be raised again six months later: Why did the market suddenly distrust a giant Wall Street firm whose permanence it not so very long before took for granted? The demise of Bear Stearns had been so unthinkable in March of 2007 that Cornwall Capital had bought insurance against its collapse for less than three-tenths of 1 percent. They'd put down $300,000 to make $105 million.
"Leverage" was Eisman's answer, on this day. To generate profits, Bear Stearns, like every other Wall Street firm, was perching more and more speculative bets on top of each dollar of its capital. But the problem was obviously more complicated than that. The problem was also the nature of those speculative bets.
The subprime mortgage market had experienced at least two distinct phases. The first, in which AIG had taken most of the risk of a market collapse, lasted until the end of 2005. When AIG abruptly changed its mind, traders inside AIG FP assumed their decision might completely shut down the subprime mortgage market.* That's not what happened, of course. Wall Street was already making too much money using CDOs to turn crappy triple-B-rated subprime bonds into putatively riskless triple-A ones to simply stop doing it. The people who ran the CDO machine at the various firms had acquired too much authority. From the end of 2005 until the middle of 2007, Wall Street firms created somewhere between $200 and $400 billion in subprime-backed CDOs: No one was exactly sure how many there were. Call it $300 billion, of which roughly $240 billion would have been triple-A-rated and thus treated, for accounting purposes, as riskless, and therefore unnecessary to disclose. Much, if not all, of it was held off balance sheets.
By March 2008 the stock market had finally grasped what every mortgage bond salesman had long known: Someone had lost at least $240 billion. But who? Morgan Stanley still owned $13 billion or so in CDOs, courtesy of Howie Hubler. The idiots in Germany owned some, Wing Chau and CDO managers like him owned some more, though whose money they were using to buy the bonds was a bit murky. Ambac Financial Group and MBIA Inc., which had long made their living insuring municipal bonds, had taken over where AIG had left off, and owned maybe 10 billion dollars' worth each. The truth is it was impossible to know how big the losses were, or who had them. All that anyone knew was that any Wall Street firm deep in the subprime market was probably on the hook for a lot more of them than they had confessed. Bear Stearns was deep in the subprime market. It had $40 in bets on its subprime mortgage bonds for every dollar of capital it held against those bets. The question wasn't how Bear Stearns could possibly fail but how it could possibly survive.
Finishing his little speech and heading back to his chair, Steve Eisman passed Bill Miller and patted him on the back, almost sympathetically. In the brief question-and-answer session that followed, Miller pointed out how unlikely it was that Bear Stearns might fail, because thus far, big Wall Street investment banks had failed only after they were caught in criminal activities. Eisman blurted out, "It's only five past ten. Give it time." Apart from that, he'd been almost polite. In the back of the room, Vinny and Danny felt the curious combination of relief and disappointment that followed a tornado that narrowly missed the big city.
It wasn't Eisman who upset the tone in the room, but some kid in the back. He looked to be in his early twenties, and he was, like everyone else, punching on his BlackBerry the whole time Miller and Eisman spoke. "Mr. Miller," he said. "From the time you started talking, Bear Stearns stock has fallen more than twenty points. Would you buy more now?"
Miller looked stunned. "He clearly had no idea what had happened," said Vinny. "He just said, 'Yeah, sure, I'd buy more here.'"
After that, the men in the room rushed for the exits, apparently to sell their shares in Bear Stearns. By the time Alan Greenspan arrived to speak, there was hardly anyone who cared to hear what he had to say. The audience was gone. By Monday, Bear Stearns was of course gone, too, sold to J.P. Morgan for $2 a share.*
The people rising out of the hole in the ground on the northeast corner of Madison Avenue and Forty-seventh Street at 6:40 in the morning revealed a great deal about themselves, if you knew what to look for. Anyone in that place at that time probably worked on Wall Street, for instance. The people emerging from the holes surrounding Penn Station, where Vincent Daniel's train arrived at exactly the same time, weren't so easy to predict. "Vinny's morning train is only fifty-five percent financial, because that's where the construction workers come in," said Danny Moses. "Mine's ninety-five." To the untrained eye, the Wall Street people who rode from the Connecticut suburbs to Grand Central were an undifferentiated mass, but within that mass Danny noted many small and important distinctions. If they were on their BlackBerrys, they were probably hedge fund guys, checking their profits and losses in the Asian markets. If they slept on the train they were probably sell-side people--brokers, who had no skin in the game. Anyone carrying a briefcase or a bag was probably not employed on the sell side, as the only reason you'd carry a bag was to haul around brokerage research, and the brokers didn't read their own reports--at least not in their spare time. Anyone carrying a copy of the New York Times was probably a lawyer or a back-office person or someone who worked in the financial markets without actually being in the markets.
Their clothes told you a lot, too. The guys who ran money dressed as if they were going to a Yankees game. Their financial performance was supposed to be all that mattered about them, and so it caused suspicion if they dressed too well. If you saw a buy-side guy in a suit, it usually meant that he was in trouble, or scheduled to meet with someone who had given him money, or both. Beyond that, it was hard to tell much about a buy-side person from what he was wearing. The sell side, on the other hand, might as well have been wearing their business cards: The guy in the blazer and khakis was a broker at a second-tier firm; the guy in the three-thousand-dollar suit and the hair just so was an investment banker at J.P. Morgan or someplace like that. Danny could guess where people worked by where they sat on the train. The Goldman Sachs, Deutsche Bank, and Merrill Lynch people, who were headed downtown, edged to the front--though when Danny thought about it, few Goldman people actually rode the train anymore. They all had private cars. Hedge fund guys such as himself worked uptown and so exited Grand Central to the north, where taxis appeared haphazardly and out of nowhere to meet them, like farm trout rising to corn kernels. The Lehman and Bear Stearns people used to head for the same exit as he did, but they were done. One reason why, on September 18, 2008, there weren't nearly as many people on the northeast corner of Forty-seventh Street and Madison Avenue at 6:40 in the morning as there had been on September 18, 2007.
Danny noticed many little things about his fellow financial man--that was his job, in a way. To notice the little things. Eisman was the big-picture guy. Vinny was the analyst. Danny, the head trader, was their eyes and ears on the market. Their source for the sort of information that never gets broadcast or written down: rumors, the behavior of the sell-side brokers, the patterns on the screens. His job was to be alive to detail, quick with numbers--and to avoid getting fucked.
To that end he kept five computer screens on his desk. One scrolled newswires, another showed moment-to-moment movements inside their portfolio, the other three scrolled Danny's conversations with maybe forty Wall Street brokers and fellow investors. His e-mail in-box for the month contained 33,000 messages. To an outsider, this torrent of picayune detail about the financial markets would have been disorienting. To him it all made sense, as long as he didn't really need to make sense of it. Danny was the small-picture guy.
By Thursday, September 18, 2008, however, the big picture had grown so unstable that the small picture had become nearly incoherent to him. On Monday, Lehman Brothers had filed for bankruptcy, and Merrill Lynch, having announced $55.2 billion in losses on subprime bond-backed CDOs, had sold itself to Bank of America. The U.S. stock market had fallen by more than it had since the first day of trading after the attack on the World Trade Center. On Tuesday the U.S. Federal Reserve announced that it had lent $85 billion to the insurance company AIG, to pay off the losses on the subprime credit default swaps AIG had sold to Wall Street banks--the biggest of which was the $13.9 billion AIG owed to Goldman Sachs. When you added in the $8.4 billion in cash AIG had already forked over to Goldman in collateral, you saw that Goldman had transferred more than $20 billion in subprime mortgage bond risk into the insurance company, which was in one way or another being covered by the U.S. taxpayer. That fact alone was enough to make everyone wonder at once how much more of this stuff was out there, and who owned it.
The Fed and the Treasury were doing their best to calm investors, but on Wednesday no one was obviously calm. A money market fund called the Reserve Primary Fund announced that it had lost enough on short-term loans to Lehman Brothers that its investors were not likely to get all their money back, and froze redemptions. Money markets weren't cash--they paid interest, and thus bore risk--but, until that moment, people thought of them as cash. You couldn't even trust your own cash. All over the world corporations began to yank their money out of money market funds, and short-term interest rates spiked as they had never before spiked. The Dow Jones Industrial Average had fallen 449 points, to its lowest level in four years, and most of the market-moving news was coming not from the private sector but from government officials. At 6:50 on Thursday morning, when Danny arrived, he learned that the chief British financial regulator was considering banning short selling--an act that, among other things, would put the hedge fund industry out of business--but that didn't begin to explain what now happened. "All hell was breaking loose in a way I had never seen in my career," said Danny.
FrontPoint was positioned perfectly for exactly this moment. By agreement with their investors, their fund could be 25 percent net short or 50 percent net long the stock market, and the gross positions could never exceed 200 percent. For example, for every $100 million they had to invest, they could be net short $25 million, or net long $50 million--and all of their bets combined could never exceed $200 million. There was nothing in the agreement about credit default swaps, but that no longer mattered. ("We never figured out how to put it in," said Eisman.) They'd sold their last one back to Greg Lippmann two months earlier, in early July. They were now back to being, exclusively, stock market investors.
At that moment they were short nearly as much as they were allowed to be short, and all of their bets were against banks, the very companies collapsing the fastest: Minutes after the market opened they were up $10 million. The shorts were falling, the longs--mainly smaller banks removed from the subprime market--were falling less. Danny should have been elated: Everything they had thought might happen was now happening. He wasn't elated, however; he was anxious. At 10:30, an hour into trading, every financial stock went into a free fall, whether it deserved to or not. "All this information goes through me," he said. "I'm supposed to know how to transmit information. Prices were moving so quickly I couldn't get a fix. It felt like a black hole. The abyss."
It had been four days since Lehman Brothers had been allowed to fail, but the most powerful effects of the collapse were being felt right now. The stocks of Morgan Stanley and Goldman Sachs were tanking, and it was clear that nothing short of the U.S. government could save them. "It was the equivalent of the earthquake going off," he said, "and then, much later, the tsunami arrives." Danny's trading life was man versus man, but this felt more like man versus nature: The synthetic CDO had become a synthetic natural disaster. "Usually, you feel you have the ability to control your environment," said Danny. "You're good because you know what's going on. Now it didn't matter what I knew. Feel went out the window."
FrontPoint had maybe seventy different bets on, in various stock markets around the world. All of them were on financial institutions. He scrambled to keep a handle on them all, but couldn't. They owned shares in KeyBank and were short the shares of Bank of America, both of which were doing things they'd never done before. "There were no bids in the market for anything," said Danny. "There was no market. It was really only then that I realized there was a bigger issue than just our portfolio. Fundamentals didn't matter. Stocks were going to move up or down on pure emotion and speculation of what the government would do." The most unsettling loose thought rattling around his mind was that Morgan Stanley was about to go under. Their fund was owned by Morgan Stanley. They had almost nothing to do with Morgan Stanley, and felt little kinship with the place. They did not act or feel like Morgan Stanley employees--Eisman often said how much he wished he was allowed to short Morgan Stanley stock. They acted and felt like the managers of their own fund. If Morgan Stanley failed, however, its share in their fund wound up as an asset in a bankruptcy proceeding. "I'm thinking, We've got the world by the fucking balls and the company we work for is going bankrupt?"
Then Danny sensed something seriously wrong--with himself. Just before eleven in the morning, wavy black lines appeared in the space between his eyes and his computer screen. The screen appeared to be fading in and out. "I felt this shooting pain in my head," he said. "I don't get headaches. I thought I was having an aneurysm." Now he became aware of his heart--he looked down and he could actually see it banging against his chest. "I spend my morning trying to control all this energy and all this information," he said, "and I lost control."
He'd had this experience only once before. On September 11, 2001, at 8:46 a.m., he'd been at his desk on the top floor of the World Financial Center. "You know when you're in the city and one of those garbage trucks passes and you're like, 'What the fuck was that?'" Until someone told him it was a commuter plane hitting the North Tower, he assumed the first plane was one of those trucks. He walked to the window to look up at the building across the street. A small commuter plane wouldn't have been big or strong enough to do all that much damage, to his way of thinking, and he expected to see it poking out of the side of the building. All he could see was the black hole, and smoke. "My first thought was, That was not an accident. No fucking way." He was still working at Oppenheimer and Co.--Steve and Vinny had already left--and some authoritative-sounding voice came over the loudspeaker to announce that no one was to leave the building. Danny remained at the window. "That's when people started jumping," he said. "Bodies are falling." The rumble of another garbage truck. "When the second plane hit I was like, 'Bye, everybody.'" By the time he reached the elevator, he found himself escorting two pregnant women. He walked them uptown, left one at her apartment on Fourteenth Street and the other at the Plaza Hotel, and then walked home to his pregnant wife on Seventy-second Street.
Four days later he was leaving, or rather fleeing, New York City with his wife and small son. They were on the highway at night in the middle of a storm when he was overcome by the certainty that a tree would fall and crush the car. He began to shake and sweat with sheer terror. The trees were fifty yards away: They could never reach the car. "You need to see someone," his wife said, and he had. He had thought he might have something wrong with his heart, and had spent half a day hooked up to an EKG machine. The loss of self-control embarrassed him--he preferred not to talk about it--and he was deeply relieved when the attacks became less frequent and less severe. Finally, a few months after the terrorist attack, they vanished completely.
On September 18, 2008, he failed to make the connection between how he'd felt then and how he felt now. He rose from his desk and looked for someone. Eisman normally sat across from him, but Eisman was out at some conference trying to raise money--which showed you how unprepared they all were at the arrival of the moment for which they thought themselves perfectly prepared. Danny turned to the colleague beside him. "Porter, I think I'm having a heart attack," he said.
Porter Collins laughed and said, "No, you're not." An Olympic rowing career had left Porter Collins a bit inured to the pain of others, as he assumed they usually didn't know what pain was.
"No," said Danny. "I need to go to the hospital." His face had gone pale but he was still able to stand on his own two feet. How bad could it be? Danny was always a little jumpy.
"That's why he's good at his job," said Porter. "I kept saying, 'You're not having a heart attack.' Then he stopped talking. And I said, 'All right, maybe you are.'" This actually wasn't all that helpful. Unsteadily, Danny turned to Vinny, who had been watching everything from the far end of the long trading desk and was thinking about calling an ambulance.
"I got to get out of here. Now," he said.
Cornwall Capital's bet against subprime mortgage bonds had quadrupled its capital, from a bit more than $30 million to $135 million, but its three founders never had a Champagne moment. "We were focused on, Where do we put our money that's safe?" said Ben Hockett. Before, they had no money. Now, they were rich; but they feared they had no ability to preserve their wealth. By nature a bit tortured, they were now, by nurture, even more so. They actually spent time wondering how people who had been so sensationally right (i.e., they themselves) could preserve the capacity for diffidence and doubt and uncertainty that had enabled them to be right. The more sure you were of yourself and your judgment, the harder it was to find opportunities premised on the notion that you were, in the end, probably wrong.
The long-shot bet, in some strange way, was a young man's game. Charlie Ledley and Jamie Mai no longer felt, or acted, quite so young. Charlie now suffered from migraines, and was consumed with what might happen next. "I think there is something fundamentally scary about our democracy," said Charlie. "Because I think people have a sense that the system is rigged, and it's hard to argue that it isn't." He and Jamie spent a surprising amount of their time and energy thinking up ways to attack what they viewed as a deeply corrupt financial system. They cooked up a plan to seek revenge upon the rating agencies, for instance. They'd form a not-for-profit legal entity whose sole purpose was to sue Moody's and S&P, and donate the proceeds to investors who lost money investing in triple-A-rated securities.
As Jamie put it, "Our plan was to go around to investors and say, 'You guys don't know how badly you got fucked. You guys should really sue.'" They'd had so many bad experiences with big Wall Street firms, and the people who depended on them for their living, that they feared sharing the idea with New York lawyers. They drove up to Portland, Maine, and found a law firm who would listen to them. "They were just like, 'You guys are nuts,'" said Charlie. Suing the rating agencies for the inaccuracy of their ratings, the Maine lawyers told them, would be like suing Motor Trend magazine for plugging a car that wound up crashing.
Charlie knew a prominent historian of financial crises, a former professor of his, and took to calling him. "These calls often came late at night," says the historian, who preferred to remain anonymous. "And they would go on for a pretty long time. I remember he started out by asking, 'Do you know what a mezzanine CDO is?' And he started to explain to me how it all worked": how Wall Street investment banks somehow had conned the rating agencies into blessing piles of crappy loans; how this had enabled the lending of trillions of dollars to ordinary Americans; how the ordinary Americans had happily complied and told the lies they needed to tell to obtain the loans; how the machinery that turned the loans into supposedly riskless securities was so complicated that investors had ceased to evaluate risks; how the problem had grown so big that the end was bound to be cataclysmic and have big social and political consequences. "He wanted to talk through his reasoning," said the historian, "and see if I thought he was nuts. He asked if the Fed would ever buy mortgages, and I said I thought that was pretty unlikely. It would have to be a calamity of colossal proportions for the Fed to ever consider doing something like that." What struck the distinguished financial historian, apart from the alarming facts of the case, was that...he was hearing them for the first time from Charlie Ledley. "Would I have ever predicted that Charlie Ledley would have anticipated the greatest financial crisis since the Depression?" he said. "No." It wasn't that Charlie was stupid; far from it. It was that Charlie wasn't a money person. "He's not materialistic in any obvious way," said the professor. "He's not driven by money in any obvious way. He would get angry. He took it personally."
Even so, on the morning of September 18, 2008, Charlie Ledley was still capable of being surprised. He and Jamie did not normally sit in front of their Bloomberg screens and watch the news scroll by, but by Wednesday, the seventeenth, that's what they were doing. The losses announced by the big Wall Street firms on subprime mortgage bonds had started huge and kept growing. Merrill Lynch, which had begun by saying they had $7 billion in losses, now admitted the number was over $50 billion. Citigroup appeared to have about $60 billion. Morgan Stanley had its own $9-plus billion hit, and who knew what behind it. "We'd been wrong in our interpretation of what was going on," said Charlie. "We had always assumed that they sold the triple-A CDOs to, like, the Korean Farmers Corporation. The way they were all blowing up implied they hadn't. They'd kept it themselves."
The big Wall Street firms, seemingly so shrewd and self-interested, had somehow become the dumb money. The people who ran them did not understand their own businesses, and their regulators obviously knew even less. Charlie and Jamie had always sort of assumed that there was some grown-up in charge of the financial system whom they had never met; now, they saw there was not. "We were never inside the belly of the beast," said Charlie. "We saw the bodies being carried out. But we were never inside." A Bloomberg News headline that caught Jamie's eye, and stuck in his mind: "Senate Majority Leader on Crisis: No One Knows What to Do."
Early on, long before others came around to his view of the world, Michael Burry had noted how morbid it felt to turn his investment portfolio into what amounted to a bet on the collapse of the financial system. It wasn't until after he'd made a fortune from that collapse that he began to wonder about the social dimensions of his financial strategy--and wonder if other people's view of him might one day be as distorted as their view of the financial system had been. On June 19, 2008, three months after the death of Bear Stearns, Ralph Cioffi and Matthew Tannin, the two men who had run Bear Stearns's bankrupt subprime hedge funds, were arrested by the FBI, and led away in handcuffs from their own homes.* Late that night, Burry dashed off an e-mail to his in-house lawyer, Steve Druskin. "Confidentially, this case is a pretty big stress for me. I'm worried that I'm volatile enough to send out e-mails that can be taken out of context in ways that could get me in trouble, even if my actions and my ultimate outcomes are entirely correct.... I can't imagine how I'd ever tolerate ending up in prison having done nothing wrong but be a bit careless with having no filter between my random thoughts during tough times and what I put in an e-mail. In fact I'm so over worried about this that tonight I started to think I should shut the funds down."
He was now looking for reasons to abandon money management. His investors were helping him to find them: He had made them a great deal of money, but they did not appear to feel compensated for the ride he had taken them on over the past three years. By June 30, 2008, any investor who had stuck with Scion Capital from its beginning, on November 1, 2000, had a gain, after fees and expenses, of 489.34 percent. (The gross gain of the fund had been 726 percent.) Over the same period, the S&P 500 returned just a bit more than 2 percent. In 2007 alone Burry had made his investors $750 million--and yet now he had only $600 million under management. His investors' requests for their money back came in hard and fast. No new investors called--not a single one. Nobody called him to solicit his views of the world, or his predictions for the future, either. So far as he could see, no one even seemed to want to know how he had done what he had done. "We have not been terribly popular," he wrote.
It outraged him that the people who got credit for higher understanding were those who spent the most time currying favor with the media. No business could be more objective than money management, and yet even in this business, facts and logic were overwhelmed by the nebulous social dimension of things. "I must say that I have been astonished by how many people now say they saw the subprime meltdown, the commodities boom, and the fading economy coming," Burry wrote, in April 2008, to his remaining investors. "And if they don't always say it in so many words, they do it by appearing on TV or extending interviews to journalists, stridently projecting their own confidence in what will happen next. And surely, these people would never have the nerve to tell you what's happening next, if they were so horribly wrong on what happened last, right? Yet I simply don't recall too many people agreeing with me back then." It was almost as if it counted against him to have been exactly right--his presence made a lot of people uncomfortable. A trade magazine published the top seventy-five hedge funds of 2007, and Scion was nowhere on it--even though its returns put it at or near the very top. "It was as if they took one swimmer in the Olympics and made him swim in a separate pool," Burry said. "His time won the gold. But he got no medal. I honestly think that's what killed it for me. I was looking for some recognition. There was none. I trained for the Olympics, and then they told me to go and swim in the retard pool." A few of his remaining investors asked why he hadn't been more aggressive on the public relations--as if that were a part of the business!
In early October 2008, after the U.S. government had stepped in to say it would, in effect, absorb all the losses in the financial system and prevent any big Wall Street firm from failing, Burry had started to buy stocks with enthusiasm, for the first time in years. The stimulus would lead inevitably to inflation, he thought, but also to a boom in stock prices. He might be early, of course, and stocks might fall some before they rose, but that didn't matter to him: The value was now there, and the bet would work out in the long run. Immediately, his biggest remaining investor, who had $150 million in the fund, questioned his judgment and threatened to pull his money out.
On October 27, Burry wrote to one of his two e-mail friends: "I'm selling off the positions tonight. I think I hit a breaking point. I haven't eaten today, I'm not sleeping, I'm not talking with my kids, not talking with my wife, I'm broken. Asperger's has given me some great gifts, but life's been too hard for too long because of it as well." On a Friday afternoon in early November, he felt chest pains and went to an emergency room. His blood pressure had spiked. "I felt like I am heading towards a short life," he wrote. A week later, on November 12, he sent his final letter to investors. "I have been pushed repeatedly to the brink by my own actions, the Fund's investors, business partners, and even former employees," he wrote. "I have always been able to pull back and carry on my often overly intense affair with this business. Now, however, I am facing personal matters that have carried me irrefutably over the threshold, and I have come to the sullen realization that I must close down the Fund." With that, he vanished, leaving a lot of people wondering what had happened.
What had happened was that he had been right, the world had been wrong, and the world hated him for it. And so Michael Burry ended where he began--alone, and comforted by his solitude. He remained inside his office in Cupertino, California, big enough for a staff of twenty-five people, but the fund was shuttered and the office was empty. The last man out was Steve Druskin, and among Druskin's last acts was to figure out what to do about Michael Burry's credit default swaps on subprime mortgage bonds. "Mike kept a couple of them, just for fun," he said. "Just a couple. To see if we could get paid off in full." And he had, though it wasn't for fun but vindication: to prove to the world that the investment-grade bonds he had bet against were indeed entirely without value. The two bets he had saved were against subprime bonds created back in 2005 by Lehman Brothers. They'd gone to zero at roughly the same time as their creator. Burry had wagered $100,000 or so on each, and made $5 million.
The problem, from the point of view of a lawyer closing an investment fund, was that these strange contracts did not expire until 2035. The brokers had long since paid them in full: 100 cents on the dollar. No Wall Street firm even bothered to send them quotes on the things anymore. "I don't get a statement from a broker saying we have an open position with them," says Druskin. "But we do. It's like no one wants to talk about this anymore. It's like, 'All right, you've got your ten million dollars. Don't keep haranguing me about it.'"
On Wall Street, the lawyers play the same role as medics in war: They come in after the shooting is over to clean up the mess. Thirty-year contracts that had some remote technical risk of repayment--exactly what that risk was he was still trying to determine--was the last of Michael Burry's mess. "It's possible the brokers have thrown the contracts away," Druskin said. "No one three years ago expected this to happen on the brokerage side. So no one's been trained to deal with this. We've pretty much said, 'We're going out of business.' And they said, 'Okay.'"
By the time Eisman got the call from Danny Moses saying that he might be having a heart attack, and that he and Vinny and Porter were sitting on the steps of St. Patrick's Cathedral, he was in the midst of a slow, almost menopausal, change. He'd been unprepared for his first hot flash, in the late fall of 2007. By then it was clear to many that he had been right and they had been wrong and that he had gotten rich to boot. He'd gone to a conference put on by Merrill Lynch, right after they'd fired their CEO, Stan O'Neal, and disclosed $20 billion or so of their $52 billion in subprime-related losses. There he had sidled up to Merrill's chief financial officer, Jeff Edwards, the same Jeff Edwards Eisman had taunted, some months earlier, about Merrill Lynch's risk models. "You remember what I said about those risk models of yours?" Eisman now said. "I guess I was right, huh?" Instantly, and amazingly, he regretted having said it. "I felt bad about it," said Eisman. "It was obnoxious. He was a lovely guy. He was just wrong. I was no longer the underdog. And I had to conduct myself in a different way."
Valerie Feigen watched in near bewilderment as her husband acquired, haltingly, in fits and starts, a trait resembling tact. "There was a void after everything happened," she said. "Once he was proved right, all this anxiety and anger and energy went away. And it left this big void. He went on an ego thing for a while. He was really kind of full of himself." Eisman had been so vocal about the inevitable doom that all sorts of unlikely people wanted to hear what he now had to say. After the conference in Las Vegas, he had come down with a parasite. He'd told the doctor who treated him that the financial world as we knew it was about to end. A year later, he went back to the same doctor for a colonoscopy. Stretched out on the table, he hears the doctor say, "Here's the guy who predicted the crisis! Come on in and listen to this." And in the middle of Eisman's colonoscopy, a roomful of doctors and nurses retold the story of Eisman's genius.
The story of Eisman's genius quickly grew old to his wife. Long ago she had established a sort of Eisman social emergency task force with her husband's therapist. "We beat him up and said, 'You really just have to knock this shit off.' And he got it. And he started being nice. And he liked being nice! It was a new experience for him." All around, she and others found circumstantial evidence of a changed man. At the Christmas party at the building next door, for example. She wasn't planning to even let Eisman know about it, as she never knew what he might do or say. "I was just kind of trying to sneak out of our apartment," she said. "And he stops me and says, 'How will it look if I don't go?'" The sincerity of his concern shocked her into giving him a chance. "You can go, but you have to behave," she said. To which Eisman replied, "Well, I know how to behave now." And so she took him to the Christmas party, and he was as sweet as he could be. "He's become a pleasure," said Valerie. "Go figure."
That afternoon of September 18, 2008, the new and possibly improving Eisman ambled toward his partners on the steps of St. Patrick's Cathedral. Getting places on foot always took him too long. "Steve's such a fucking slow walker," said Danny. "He walks like an elephant would walk if an elephant could only take human-size steps." The weather was gorgeous--one of those rare days where the blue sky reaches down through the forest of tall buildings and warms the soul. "We just sat there," says Danny, "watching the people pass."
They sat together on the cathedral steps for an hour or so. "As we sat there we were weirdly calm," said Danny. "We felt insulated from the whole market reality. It was an out-of-body experience. We just sat and watched the people pass and talked about what might happen next. How many of these people were going to lose their jobs? Who was going to rent these buildings, after all the Wall Street firms had collapsed?"
Porter Collins thought that "it was like the world stopped. We're looking at all these people and saying, 'These people are either ruined or about to be ruined.'" Apart from that, there wasn't a whole lot of hand-wringing inside FrontPoint. This was what they had been waiting for: total collapse.
"The investment banking industry is fucked," Eisman had said six weeks earlier. "These guys are only beginning to understand how fucked they are. It's like being a scholastic, prior to Newton. Newton comes along and one morning you wake up: 'Holy shit, I'm wrong!'" Lehman Brothers had vanished, Merrill had surrendered, and Goldman Sachs and Morgan Stanley were just a week away from ceasing to be investment banks. Investment bankers were not just fucked: They were extinct. "That Wall Street has gone down because of this is justice," Eisman said. The only one among them who wrestled a bit with their role--as the guys who had made a fortune betting against their own society--was Vincent Daniel. "Vinny, being from Queens, needs to see the dark side of everything," said Eisman.
To which Vinny replied, "The way we thought about it, which we didn't like, was, 'By shorting this market we're creating the liquidity to keep the market going.'"
"It was like feeding the monster," said Eisman. "We fed the monster until it blew up."
The monster was exploding. Yet on the streets of Manhattan there was no sign anything important had just happened. The force that would affect all of their lives was hidden from their view. That was the problem with money: What people did with it had consequences, but they were so remote from the original action that the mind never connected the one with the other. The teaser-rate loans you make to people who will never be able to repay them will go bad not immediately but in two years, when their interest rates rise. The various bonds you make from those loans will go bad not as the loans go bad but months later, after a lot of tedious foreclosures and bankruptcies and forced sales. The various CDOs you make from the bonds will go bad not right then but after some trustee sorts out whether there will ever be enough cash to pay them off. Whereupon the end owner of the CDO receives a little note, Dear Sir, We regret to inform you that your bond no longer exists...But the biggest lag of all was right here, on the streets. How long would it take before the people walking back and forth in front of St. Patrick's Cathedral figured out what had just happened to them?