Accidental Capitalists
The thing Eisman had found was indeed a gold mine, but it wasn't true that no one knew about it. By the fall of 2006 Greg Lippmann had made his case to maybe 250 big investors privately, and to hundreds more at Deutsche Bank sales conferences or on Deutsche Bank conference calls. By the end of 2006, according to the PerTrac Hedge Fund Database Study, there were 13,675 hedge funds reporting results, and thousands of other types of institutional investors allowed to invest in credit default swaps. Lippmann's pitch, in one form or another, reached many of them. Yet only one hundred or so dabbled in the new market for credit default swaps on subprime mortgage bonds. Most bought this insurance on subprime mortgages not as an outright bet against them but as a hedge against their implicit bet on them--their portfolios of U.S. real estate-related stocks or bonds. A smaller group used credit default swaps to make what often turned out to be spectacularly disastrous gambles on the relative value of subprime mortgage bonds--buying one subprime mortgage bond while simultaneously selling another. They would bet, for instance, that bonds with large numbers of loans made in California would underperform bonds with very little of California in them. Or that the upper triple-A-rated floor of some subprime mortgage bond would outperform the lower, triple-B-rated, floor. Or that bonds issued by Lehman Brothers or Goldman Sachs (both notorious for packaging America's worst home loans) would underperform bonds packaged by J.P. Morgan or Wells Fargo (which actually seemed to care a bit about which loans it packaged into bonds).
A smaller number of people--more than ten, fewer than twenty--made a straightforward bet against the entire multi-trillion-dollar subprime mortgage market and, by extension, the global financial system. In and of itself it was a remarkable fact: The catastrophe was foreseeable, yet only a handful noticed. Among them: a Minneapolis hedge fund called Whitebox, a Boston hedge fund called The Baupost Group, a San Francisco hedge fund called Passport Capital, a New Jersey hedge fund called Elm Ridge, and a gaggle of New York hedge funds: Elliott Associates, Cedar Hill Capital Partners, QVT Financial, and Philip Falcone's Harbinger Capital Partners. What most of these investors had in common was that they had heard, directly or indirectly, Greg Lippmann's argument. In Dallas, Texas, a former Bear Stearns bond salesman named Kyle Bass set up a hedge fund called Hayman Capital in mid-2006 and soon thereafter bought credit default swaps on subprime mortgage bonds. Bass had heard the idea from Alan Fournier of Pennant Capital, in New Jersey--who in turn had heard it from Lippmann. A rich American real estate investor named Jeff Greene went off and bought several billion dollars' worth of credit default swaps on subprime mortgage bonds for himself after hearing about it from the New York hedge fund manager John Paulson. Paulson, too, had heard Greg Lippmann's pitch--and, as he built a massive position in credit default swaps, used Lippmann as his sounding board. A proprietary trader at Goldman Sachs in London, informed that this trader at Deutsche Bank in New York was making a powerful argument, flew across the Atlantic to meet with Lippmann and went home owning a billion dollars' worth of credit default swaps on subprime mortgage bonds. A Greek hedge fund investor named Theo Phanos heard Lippmann pitch his idea at a Deutsche Bank conference in Phoenix, Arizona, and immediately placed his own bet. If you mapped the spread of the idea, as you might a virus, most of the lines pointed back to Lippmann. He was Patient Zero. Only one carrier of the disease could claim, plausibly, to have infected him. But Mike Burry was holed up in his office in San Jose, California, and wasn't talking to anyone.
This small world of investors who made big bets against subprime mortgage bonds itself contained an even smaller world: people for whom the trade became an obsession. A tiny handful of investors perceived what was happening not just to the financial system but to the larger society it was meant to serve, and made investments against that system that were so large, in relation to their capital, that they effectively gave up being conventional money managers and became something else. John Paulson had by far the most money to play with, and so was the most obvious example. Nine months after Mike Burry failed to raise a fund to do nothing but buy credit default swaps on subprime mortgage bonds, Paulson succeeded, by presenting it to investors not as a catastrophe almost certain to happen but as a cheap hedge against the remote possibility of catastrophe. Paulson was fifteen years older than Burry, and far better known on Wall Street, but he was still, in some ways, a Wall Street outsider. "I called Goldman Sachs to ask them about Paulson," said one rich man whom Paulson had solicited for funds in mid-2006. "They told me he was a third-rate hedge fund guy who didn't know what he was talking about." Paulson raised several billion dollars from investors who regarded his fund as an insurance policy on their portfolios of real estate-related stocks and bonds. What prepared him to see what was happening in the mortgage bond market, Paulson said, was a career of searching for overvalued bonds to bet against. "I loved the concept of shorting a bond because your downside was limited," he told me. "It's an asymmetrical bet." He was shocked how much easier and cheaper it was to buy a credit default swap than it was to sell short an actual cash bond--even though they represented exactly the same bet. "I did half a billion. They said, 'Would you like to do a billion?' And I said, 'Why am I pussyfooting around?' It took two or three days to place twenty-five billion." Paulson had never encountered a market in which an investor could sell short 25 billion dollars' worth of a stock or bond without causing its price to move, even crash. "And we could have done fifty billion, if we'd wanted to."
Even as late as the summer of 2006, as home prices began to fall, it took a certain kind of person to see the ugly facts and react to them--to discern, in the profile of the beautiful young lady, the face of an old witch. Each of these people told you something about the state of the financial system, in the same way that people who survive a plane crash told you something about the accident, and also about the nature of people who survive accidents. All of them were, almost by definition, odd. But they were not all odd in the same way. John Paulson was oddly interested in betting against dodgy loans, and oddly persuasive in talking others into doing it with him. Mike Burry was odd in his desire to remain insulated from public opinion, and even direct human contact, and to focus instead on hard data and the incentives that guide future human financial behavior. Steve Eisman was odd in his conviction that the leveraging of middle-class America was a corrupt and corrupting event, and that the subprime mortgage market in particular was an engine of exploitation and, ultimately, destruction. Each filled a hole; each supplied a missing insight, an attitude to risk which, if more prevalent, might have prevented the catastrophe. But there was at least one gaping hole no big-time professional investor filled. It was filled, instead, by Charlie Ledley.
Charlie Ledley--curiously uncertain Charlie Ledley--was odd in his belief that the best way to make money on Wall Street was to seek out whatever it was that Wall Street believed was least likely to happen, and bet on its happening. Charlie and his partners had done this often enough, and had had enough success, to know that the markets were predisposed to underestimating the likelihood of dramatic change. Even so, in September 2006, as he paged through the document sent to him by a friend, a presentation about shorting subprime mortgage bonds by some guy at Deutsche Bank named Greg Lippmann, Ledley's first thought was, This is just too good to be true. He'd never traded a mortgage bond, knew essentially nothing about real estate, was bewildered by the jargon of the bond market, and wasn't even sure Deutsche Bank or anyone else would allow him to buy credit default swaps on subprime mortgage bonds--since this was a market for institutional investors, and he and his two partners, Ben Hockett and Jamie Mai, weren't anyone's idea of an institution. "But I just looked at it and said, 'How can this even be possible?'" He then sent the idea to his partners along with the question, Why isn't someone smarter than us doing this?
Every new business is inherently implausible, but Jamie Mai and Charlie Ledley's idea, in early 2003, for a money management firm bordered on the absurd: a pair of thirty-year-old men with a Schwab account containing $110,000 occupy a shed in the back of a friend's house in Berkeley, California, and dub themselves Cornwall Capital Management. Neither of them had any reason to believe he had any talent for investing. Both had worked briefly for the New York private equity firm Golub Associates as grunts chained to their desks, but neither had made actual investment decisions. Jamie Mai was tall and strikingly handsome and so, almost by definition, had the air of a man in charge--until he opened his mouth and betrayed his lack of confidence in everything from tomorrow's sunrise to the future of the human race. Jamie had a habit of stopping himself midsentence and stammering--"uh, uh, uh"--as if he was somehow unsettled by his own thought. Charlie Ledley was even worse: He had the pallor of a mortician and the manner of a man bent on putting off, for as long as possible, definite action. Asked a simple question, he'd stare mutely into space, nodding and blinking like an actor who has forgotten his lines, so that when he finally opened his mouth the sound that emerged caused you to jolt in your chair. It speaks!
Both were viewed by contemporaries as sweet-natured, disorganized, inquisitive, bright but lacking obvious direction--the kind of guys who might turn up at their fifteenth high school reunions with surprising facial hair and a complicated life story. Charlie left Amherst College after his freshman year to volunteer for Bill Clinton's first presidential campaign, and, though he eventually returned, he remained far more interested in his own idealism than in making money. Jamie's first job out of Duke University had been delivering sailboats to rich people up and down the East Coast. ("That's when it became clear to me that--uh, uh, uh--I was going to have to adopt some profession.") At the age of twenty-eight, he'd taken an eighteen-month "sabbatical," traveling around the world with his girlfriend. He'd come to Berkeley not looking for fertile soil in which to grow money but because the girlfriend wanted to move there. Charlie didn't even really want to be in Berkeley; he'd grown up in Manhattan and turned into a pumpkin when he got to the other side of a bridge or tunnel. He'd moved to Berkeley because the idea of running money together, and the $110,000, had been Jamie's. The garage in which Charlie now slept was Jamie's, too.
Instead of money or plausibility, what they had was an idea about financial markets. Or, rather, a pair of related ideas. Their stint in the private equity business--in which firms buy and sell entire companies over the counter--led them to believe that private stock markets might be more efficient than public ones. "In private transactions," said Charlie, "you usually have an advisor on both sides that's sophisticated. You don't have people who just fundamentally don't know what something's worth. In public markets you have people focused on quarterly earnings rather than the business franchise. You have people doing things for all sorts of insane reasons." They believed, further, that public financial markets lacked investors with an interest in the big picture. U.S. stock market guys made decisions within the U.S. stock market; Japanese bond market guys made decisions within the Japanese bond market; and so on. "There are actually people who do nothing but invest in European mid-cap health care debt," said Charlie. "I don't think the problem is specific to finance. I think that parochialism is common to modern intellectual life. There is no attempt to integrate." The financial markets paid a lot of people extremely well for narrow expertise and a few people, poorly, for the big, global views you needed to have if you were to allocate capital across markets.
In early 2003 Cornwall Capital had just opened for business, which meant Jamie and Charlie spent even more hours of their day than before sitting in the Berkeley garage--Charlie's bedroom--shooting the shit about the market. Cornwall Capital, they decided, would not merely search for market inefficiency but search for it globally, in every market: stocks, bonds, currencies, commodities. To these two not so simple ambitions they soon added a third, even less simple, one, when they stumbled upon their first big opportunity, a credit card company called Capital One Financial.
Capital One was a rare example of a company that seemed to have found a smart way to lend money to Americans with weak credit scores. Its business was credit cards, not home loans, but it dealt with the same socioeconomic class of people whose home loan borrowing would end in catastrophe just a few years later. Through the 1990s and into the 2000s, the company claimed, and the market believed, that it possessed better tools than other companies for analyzing the creditworthiness of subprime credit card users and for pricing the risk of lending to them. It had weathered a bad stretch for its industry, in the late 1990s, during which several of its competitors collapsed. Then, in July 2002, its stock crashed--falling 60 percent in two days, after Capital One's management voluntarily disclosed that they were in a dispute about how much capital they needed to reserve against potential subprime losses with their two government regulators, the Office of Thrift Supervision and the Federal Reserve.
Suddenly the market feared that Capital One wasn't actually smarter than everyone else in their industry about making loans but simply better at hiding their losses. The regulators had discovered fraud, the market suspected, and were about to punish Capital One. Circumstantial evidence organized itself into what seemed like a damning case. For instance, the SEC announced that it was investigating the company's CFO, who had just resigned, for selling his shares in the company two months before the company announced its dispute with regulators and its share price collapsed.
Over the next six months, the company continued to make money at impressive rates. It claimed that it had done nothing wrong, that the regulators were being capricious, and announced no special losses on its $20 billion portfolio of subprime loans. Its stock price remained depressed. Charlie and Jamie studied the matter, which is to say they went to industry conferences, and called up all sorts of people they didn't know and bugged them for information: short sellers, former Capital One employees, management consultants who had advised the company, competitors, and even government regulators. "What became clear," said Charlie, "was that there was a limited amount of information out there and we had the same information as everyone else." They decided that Capital One probably did have better tools for making subprime loans. That left only one question: Was it run by crooks?
It wasn't a question two thirty-something would-be professional investors in Berkeley, California, with $110,000 in a Schwab account should feel it was their business to answer. But they did. They went hunting for people who had gone to college with Capital One's CEO, Richard Fairbank, and collected character references. Jamie paged through the Capital One 10-K filing in search of someone inside the company he might plausibly ask to meet. "If we had asked to meet with the CEO, we wouldn't have gotten to see him," explained Charlie. Finally they came upon a lower-ranking guy named Peter Schnall, who happened to be the vice-president in charge of the subprime portfolio. "I got the impression they were like, 'Who calls and asks for Peter Schnall?'" said Charlie. "Because when we asked to talk to him they were like, 'Why not?'" They introduced themselves gravely as Cornwall Capital Management but refrained from mentioning what, exactly, Cornwall Capital Management was. "It's funny," says Jamie. "People don't feel comfortable asking how much money you have, and so you don't have to tell them."
They asked Schnall if they might visit him, to ask a few questions before they made an investment. "All we really wanted to do," said Charlie, "was to see if he seemed like a crook." They found him totally persuasive. Interestingly, he was buying stock in his own company. They left thinking that Capital One's dispute with its regulators was trivial and that the company was basically honest. "We concluded that maybe they were crooks," said Jamie, "but probably not."
What happened next led them, almost by accident, to the unusual approach to financial markets that would soon make them rich. In the six months following the news of its troubles with the Federal Reserve and the Office of Thrift Supervision, Capital One's stock traded in a narrow band around $30 a share. That stability obviously masked a deep uncertainty. Thirty dollars a share was clearly not the "right" price for Capital One. The company was either a fraud, in which case the stock was probably worth zero, or the company was as honest as it appeared to Charlie and Jamie, in which case the stock was worth around $60 a share. Jamie Mai had just read You Can Be a Stock Market Genius, the book by Joel Greenblatt, the same fellow who had staked Mike Burry to his hedge fund. Toward the end of his book Greenblatt described how he'd made a lot of money using a derivative security, called a LEAP (for Long-term Equity AnticiPation Security), which conveyed to its buyer the right to buy a stock at a fixed price for a certain amount of time. There were times, Greenblatt explained, when it made more sense to buy options on a stock than the stock itself. This, in Greenblatt's world of value investors, counted as heresy. Old-fashioned value investors shunned options because options presumed an ability to time price movements in undervalued stocks. Greenblatt's simple point: When the value of a stock so obviously turned on some upcoming event whose date was known (a merger date, for instance, or a court date), the value investor could in good conscience employ options to express his views. It gave Jamie an idea: Buy a long-term option to buy the stock of Capital One. "It was kind of like, Wow, we have a view: This common stock looks interesting. But, Holy shit, look at the prices of these options!"
The right to buy Capital One's shares for $40 at any time in the next two and a half years cost a bit more than $3. That made no sense. Capital One's problems with regulators would be resolved, or not, in the next few months. When they were, the stock would either collapse to zero or jump to $60. Looking into it a bit, Jamie found that the model used by Wall Street to price LEAPs, the Black-Scholes option pricing model, made some strange assumptions. For instance, it assumed a normal, bell-shaped distribution for future stock prices. If Capital One was trading at $30 a share, the model assumed that, over the next two years, the stock was more likely to get to $35 a share than to $40, and more likely to get to $40 a share than to $45, and so on. This assumption made sense only to those who knew nothing about the company. In this case the model was totally missing the point: When Capital One stock moved, as it surely would, it was more likely to move by a lot than by a little.
Cornwall Capital Management quickly bought 8,000 LEAPs. Their potential losses were limited to the $26,000 they paid for their option to buy the stock. Their potential gains were theoretically unlimited. Soon after Cornwall Capital laid their chips on the table, Capital One was vindicated by its regulators, its stock price shot up, and Cornwall Capital's $26,000 option position was worth $526,000. "We were pretty fired up," says Charlie.
"We couldn't believe people would sell us these long-term options so cheaply," said Jamie. "We went looking for more long-dated options."
It instantly became a fantastically profitable strategy: Start with what appeared to be a cheap option to buy or sell some Korean stock, or pork belly, or third-world currency--really anything with a price that seemed poised for some dramatic change--and then work backward to the thing the option allowed you to buy or sell. The options suited the two men's personalities: They never had to be sure of anything. Both were predisposed to feel that people, and by extension markets, were too certain about inherently uncertain things. Both sensed that people, and by extension markets, had difficulty attaching the appropriate probabilities to highly improbable events. Both had trouble generating conviction of their own but no trouble at all reacting to what they viewed as the false conviction of others. Each time they came upon a tantalizing long shot, one of them set to work on making the case for it, in an elaborate presentation, complete with PowerPoint slides. They didn't actually have anyone to whom they might give a presentation. They created them only to hear how plausible they sounded when pitched to each other. They entered markets only because they thought something dramatic might be about to happen in them, on which they could make a small bet with long odds that might pay off in a big way. They didn't know the first thing about Korean stocks or third world currencies, but they didn't really need to. If they found what appeared to be a cheap bet on the price movements of any security, they could then hire an expert to help them sort out the details. "That has been a pattern of ours," said Jamie Mai. "To rely on the work of smart people who know more than we do."
They followed their success with Capital One with a similar success, in a distressed European cable television company called United Pan-European Cable. This time, since they had more money, they bought $500,000 in call options, struck at a price far from the market. When UPC rallied, they turned a quick $5 million profit. "We're now getting really, really excited," says Jamie. Next they bet on a company that delivered oxygen tanks directly to sick people in their homes. That $200,000 bet quickly turned into $3 million. "We're now three for three," said Charlie. "We think it's hilarious. For the first time I could see myself doing this for a really long time."
They had stumbled either upon a serious flaw in modern financial markets or into a great gambling run. Characteristically, they were not sure which it was. As Charlie pointed out, "It's really hard to know when you're lucky and when you're smart." They reckoned that by the time they had a statistically valid track record they'd be dead, or close to it, and so they didn't spend a lot of time worrying about whether they'd been lucky, or smart. Either way, they knew they didn't know as much as they should, especially about financial options. They hired a PhD student from the statistics department at the University of California at Berkeley to help them, but he quit after they asked him to study the market for pork belly futures. "It turned out that he was a vegetarian," said Jamie. "He had a problem with capitalism in general, but the pork bellies pushed him over the edge." They were left to grapple on their own with a lot of complicated financial theory. "We spent a lot of time building Black-Scholes models ourselves, and seeing what happened when you changed various assumptions in them," said Jamie. What struck them powerfully was how cheaply the models allowed a person to speculate on situations that were likely to end in one of two dramatic ways. If, in the next year, a stock was going to be worth nothing or $100 a share, it was silly for anyone to sell a year-long option to buy the stock at $50 a share for $3. Yet the market often did something just like that. The model used by Wall Street to price trillions of dollars' worth of derivatives thought of the financial world as an orderly, continuous process. But the world was not continuous; it changed discontinuously, and often by accident.
Event-driven investing: That was the name they either coined or stole for what they were doing. That made it sound a lot less fun than it was. One day Charlie found himself intrigued by the market for ethanol futures. He didn't know much about ethanol, but he could see that it enjoyed a U.S. government subsidy of 50 cents a gallon, and so was supposed to trade at a 50-cent-a-gallon premium to gasoline, and always had. In early 2005, when he became interested, it traded, briefly, at a 50-cent discount to gas. He didn't know why and never found out; instead, Charlie bought two rail cars' worth of ethanol futures, and made headlines in Ethanol Today, a magazine of whose existence he was previously unaware. To the intense irritation of Cornwall's broker, they wound up having to accept rail cars filled with ethanol in some stockyard in Chicago--to make a sum of money that struck the broker as absurdly small. "The administrative complexity of what we were doing was out of proportion to our assets," said Charlie. "People who were our size didn't trade across asset classes."
"We were doing the sort of things that might cause your investors to yell at you," said Jamie, "but we didn't get yelled at by investors because we didn't have any investors."
They actually thought about handing their winnings over to some certified, qualified, sanitized, honest-to-God professional investor to run the money for them. They raced around New York for several weeks, interviewing hedge fund managers. "They all sounded great when you listened to them," said Jamie, "but then you'd look at their numbers and they were always flat." They decided to keep on investing their money themselves. Two years after they'd opened for business, they were running $12 million of their own and had moved themselves and their world headquarters from the Berkeley shed to an office in Manhattan--a floor of the Greenwich Village studio of the artist Julian Schnabel.
They'd also moved their account, from Schwab to Bear Stearns. They longed for a relationship with some big Wall Street trading firm and mentioned the desire to their accountant. "He said he knew Ace Greenberg and he could introduce us to him, and so we said great," said Charlie. The former chairman and CEO of Bear Stearns, and a Wall Street legend, Greenberg still kept an office at the firm and acted as a broker for a handful of presumably special investors. When Cornwall Capital moved their assets to Bear Stearns, sure enough, their brokerage statements soon came back with Ace Greenberg's name on top.
Like most of what befell them in the financial markets, their first brush with a big Wall Street firm was delightfully weird but ultimately inexplicable. Just like that, without ever having laid eyes on Ace Greenberg, they were his customers. "We were like, 'So how is it that Ace Greenberg is our broker?'" said Charlie. "I mean, we were nobody. And we'd never actually met Ace Greenberg." The mystery grew with their every attempt to speak with Greenberg. They had what they assumed was his phone number, but when they called it someone other than Greenberg answered. "It was totally bizarre," said Charlie. "Occasionally, Ace Greenberg himself would pick up the phone. But all he'd say was, 'Hold on.' Then a secretary would come on the line and take our order."
At length they talked their way into a face-to-face encounter with the Wall Street legend. The encounter was so brief, however, that they could not honestly say whether they had met Ace Greenberg, or an actor playing Ace Greenberg. "We were ushered in for thirty seconds--literally thirty seconds--and then unceremoniously ushered out," says Jamie. Ace Greenberg was still their broker. They just never spoke to him.
"The whole Ace Greenberg thing still doesn't make sense to us," says Charlie.
The man to whom they now referred as "the actor who plays Ace Greenberg" failed to resolve what they viewed as their biggest problem. They were small private investors. The Wall Street firms were largely a mystery to them. "I've never actually, like, been on the inside of a bank," said Charlie. "I can only imagine what's going on inside by imagining it through someone else's eyes." To do the sort of trades they wanted to do, they needed to be mistaken by the big Wall Street firms for investors who knew their way around a big Wall Street firm. "As a private investor you are a second-class citizen," said Jamie. "The prices you get are worse, the service is worse, everything is worse."
The thought had gained force with the help of Jamie's new neighbor in Berkeley, Ben Hockett. Hockett, also in his early thirties, had spent nine years selling and then trading derivatives for Deutsche Bank in Tokyo. Like Jamie and Charlie, he had the tangy, sweet-smelling aroma of the dropout about him. "When I started I was single and twenty-two," he said. "Now I have a wife and a baby and a dog. I'm sick of the business. I don't like who I am when I get home from work. I didn't want my kid to grow up with that as a dad. I thought, I gotta get out of here." When he went in to quit, his Deutsche Bank bosses insisted that he list his grievances. "I told them I don't like going into an office. I don't like wearing a suit. And I don't like living in a big city. And they said, 'Fine.'" They told him he could wear whatever he wanted to wear, live wherever he wanted to live, and work wherever he wanted to work--and do it all while remaining employed by Deutsche Bank.
Ben moved from Tokyo to the San Francisco Bay area, along with $100 million of Deutsche Bank's money, which he traded from the comfort of his new home in Berkeley Hills. He suspected, not unreasonably, that he might be the only person in Berkeley looking for arbitrage opportunities in the market for credit derivatives. The existence just down the street of a guy roaming the globe in his mind looking to buy long-term options on financial drama caught him by surprise. Ben and Jamie took to walking their dogs together. Jamie pumped Ben for information about how big Wall Street firms and esoteric financial markets worked, and finally prodded him to quit his real job and join Cornwall Capital. "After three years in a room by myself, I thought it would be nice to work with people," said Ben. He quit Deutsche Bank to join the happy hunt for accident and disaster, and pretty quickly found himself working alone again. Charlie moved back to Manhattan as soon as he could afford the ticket, and, when his relationship with his girlfriend ended, Jamie eagerly followed.
Theirs was a union of the weirdly like-minded. Ben shared Charlie and Jamie's view that people, and markets, tended to underestimate the probability of extreme change, but he took his thinking a step further. Charlie and Jamie were interested chiefly in the probabilities of disasters in financial markets. Ben walked around with some very tiny fraction of his mind alert to the probabilities of disasters in real life. People underestimated these, too, he believed, because they didn't want to think about them. There was a tendency, in markets and life, for people to respond to the possibility of extreme events in one of two ways: flight or fight. "Fight is, 'I'm going to get my guns,'" he said. "Flight is, 'We're all doomed so I can't do anything about it.'" Charlie and Jamie were flight types. When he'd mention to them the possibility that global warming might cause sea levels to rise by twenty feet, for instance, they'd just shrug and say, "I can't do anything about it, so why worry about it?" Or: "If that happens I don't want to be alive anyway."
"They're two single guys in Manhattan," said Ben. "They're both like, 'And if we can't live in Manhattan, we don't want to live at all.'" He was surprised that Charlie and Jamie, both now so alive to the possibility of dramatic change in the financial markets, were less alert and responsive to the possibilities outside those markets. "I'm trying to prepare myself and my children for an environment that is unpredictable," Ben said.
Charlie and Jamie preferred Ben to keep his apocalyptic talk to himself. It made people uncomfortable. There was no reason anyone needed to know, for example, that Ben had bought a small farm in the country, north of San Francisco, in a remote place without road access, planted with fruit and vegetables sufficient to feed his family, on the off chance of the end of the world as we know it. It was hard for Ben to keep his worldview to himself, however, especially since it was the first cousin of their investment strategy: The possibility of accident and disaster was just never very far from their conversations. One day on the phone with Ben, Charlie said, You hate taking even remote risks, but you live in a house on top of a mountain that's on a fault line, in a housing market that's at an all-time high. "He just said, 'I gotta go,' and hung up," recalled Charlie. "We had trouble getting hold of him for, like, two months."
"I got off the phone," said Ben, "and I realized, I have to sell my house. Right now." His house was worth a million dollars and maybe more yet would rent for no more than $2,500 a month. "It was trading more than thirty times gross rental," said Ben. "The rule of thumb is that you buy at ten and sell at twenty." In October 2005 he moved his family into a rental unit, away from the fault.
Ben thought of Charlie and Jamie less as professional money managers than as dilettantes or, as he put it, "a couple of smart guys just punting around in the markets." But their strategy of buying cheap tickets to some hoped-for financial drama resonated with him. It was hardly foolproof; indeed, it was almost certain to fail more often than it succeeded. Sometimes the hoped-for drama never occurred; sometimes they actually didn't know what they were doing. Once, Charlie found what he thought was a strange price discrepancy in the market for gasoline futures, and quickly bought one gas contract, sold another, and made what he took to be a riskless profit--only to discover, as Jamie put it, "one was unleaded gasoline and the other was, like, diesel." Another time, the premise was right but the conclusion was wrong. "One day Ben calls me and says, 'Dude, I think there's going to be a coup in Thailand,'" said Jamie. There'd been nothing in the newspapers about a coup in Thailand; this was a genuine scoop. "I said, 'C'mon, Ben, you're crazy, there's not going to be a coup. Anyway, how would you even know? You're in Berkeley!'" Ben swore he had talked to a guy he used to work with in Singapore, who had his finger on the pulse in Thailand. He was so insistent that they went into the Thai currency market and bought what appeared to be stunningly cheap three-month puts (options to sell) on the Thai baht. One week later, the Thai military overthrew the elected prime minister. The Thai baht didn't budge. "We predicted a coup, and we lost money," said Jamie.
The losses, by design, were no big deal; the losses were part of the plan. They had more losers than winners, but their losses, the cost of the options, had been trivial compared to their gains. There was a possible explanation for their success, which Charlie and Jamie had only intuited but which Ben, who had priced options for a big Wall Street firm, came ready to explain: Financial options were systematically mispriced. The market often underestimated the likelihood of extreme moves in prices. The options market also tended to presuppose that the distant future would look more like the present than it usually did. Finally, the price of an option was a function of the volatility of the underlying stock or currency or commodity, and the options market tended to rely on the recent past to determine how volatile a stock or currency or commodity might be. When IBM stock was trading at $34 a share and had been hopping around madly for the past year, an option to buy it for $35 a share anytime soon was seldom underpriced. When gold had been trading around $650 an ounce for the past two years, an option to buy it for $2,000 an ounce anytime during the next ten years might well be badly underpriced. The longer-term the option, the sillier the results generated by the Black-Scholes option pricing model, and the greater the opportunity for people who didn't use it.
Oddly, it was Ben, the least personally conventional of the three, who had the Potemkin-village effect of making Cornwall Capital appear to outsiders to be a conventional institutional money manager. He knew his way around Wall Street trading floors and so also knew the extent to which Charlie and Jamie were being penalized for being perceived by the big Wall Street firms as a not terribly serious investor or, as Ben put it, "a garage band hedge fund." The longest options available to individual investors on public exchanges were LEAPs, which were two-and-a-half-year options on common stocks. You know, Ben said to Charlie and Jamie, if you established yourself as a serious institutional investor, you could phone up Lehman Brothers or Morgan Stanley and buy eight-year options on whatever you wanted. Would you like that?
They would! They wanted badly to be able to deal directly with the source of what they viewed as the most underpriced options: the most sophisticated, quantitative trading desks at Goldman Sachs, Deutsche Bank, Bear Stearns, and the rest. The hunting license, they called it. The hunting license had a name: an ISDA. They were the same agreements, dreamed up by the International Swaps and Derivatives Association, that Mike Burry secured before he bought his first credit default swaps. If you got your ISDA, you could in theory trade with the big Wall Street firms, if not as an equal then at least as a grown-up. The trouble was that, despite their success running money, they still didn't have much of it. Worse, what they had was their own. Inside Wall Street they were classified, at best, as "high net worth individuals." Rich people. Rich people received a better class of service from Wall Street than middle-class people, but they were still second-class citizens compared to institutional money managers. More to the point, rich people were typically not invited to buy and sell esoteric securities, such as credit default swaps, not traded on open exchanges. Securities that were, increasingly, the beating heart of Wall Street.
By early 2006, Cornwall Capital had grown its stash to almost $30 million, but even that, to the desks inside the Wall Street firms that sold credit default swaps, was a risibly small sum. "We called Goldman Sachs," said Jamie, "and it was just immediately clear they didn't want our business. Lehman Brothers just laughed at us. There was this impenetrable fortress you had either to scale or dig underneath." "J.P. Morgan actually fired us as a customer," said Charlie. "They said we were too much trouble." And they were! In possession of childish sums of money, they wanted to be treated as grown-ups. "We wanted to buy options on platinum from Deutsche Bank," said Charlie, "and they were like, 'Sorry we can't do this with you.'" Wall Street made you pay for managing your own money rather than paying someone on Wall Street to do it for you. "No one was going to take us," said Jamie. "We called around and it was one hundred million bucks, minimum, to be credible."
By the time they called UBS, the big Swiss bank, they knew enough not to answer when the guy on the other end of the line asked them how much money they had. "We learned to spin that one," said Jamie. As a result, UBS took a bit longer than the others to turn them down. "They were, like, 'How much do you short?'" recalled Charlie. "And we said not very much. So they ask, 'How often do you trade?' We say, not very often. And there was this long silence. Then, 'Let me talk to my boss.' And we never heard back from them."
They had no better luck with Morgan Stanley or Merrill Lynch and the rest. "They would say, 'Show us your marketing materials,'" said Charlie, "and we would say, 'Uh, we don't have those.' They'd say, 'Okay, then show us your offering documents.' We didn't have any offering documents because it wasn't other people's money. So they'd say, 'Okay, then just show us your money.' We'd say, 'Um, we don't exactly have enough of that, either.' They'd say, 'Okay, then just show us your resumes.'" If Charlie and Jamie had any connection to the world of money management--former employment, say--it might have lent some credibility to their application, but they didn't. "It always ended with them sort of asking, 'So what do you have?'"
Chutzpah. Plus $30 million with which they were willing and able to do anything they wanted to do. Plus a former derivatives trader with an apocalyptic streak who knew how these big Wall Street firms worked. "Jamie and Charlie had been asking for an ISDA for two years, but they really just didn't know how to ask," said Ben. "They didn't even know the term 'ISDA.'"
Charlie never completely understood how Ben did it, but he somehow persuaded Deutsche Bank, which required an investor to control $2 billion to be treated as an institution, to accept Cornwall Capital on their "institutional platform." Ben claimed that it was really only a matter of knowing the right people to call, and the language in which to address their concerns. Before they knew it, a team from Deutsche Bank agreed to pay a call on Cornwall Capital to determine if they were worthy of the distinction: Deutsche Bank institutional customer. "Ben gives good bank," said Charlie.
Deutsche Bank had a program it called KYC (Know Your Customer), which, while it didn't involve anything so radical as actually knowing their customers, did require them to meet their customers, in person, at least once. Hearing that they were to be on the receiving end of KYC, it occurred to Charlie and Jamie, for the first time, that working out of Julian Schnabel's studio in the wrong part of Greenwich Village might raise more questions than it answered. "We had an appearance problem," said Jamie delicately. From upstairs wafted the smell of fresh paint; from downstairs, the site of the lone toilet, came the sounds of a sweatshop. "Before they came," said Charlie, "I remember thinking, If anyone has to go to the bathroom, we're in trouble." Cornwall Capital's own little space inside the larger space was charmingly unfinancial--a dark room in the back with red brick walls that opened onto a small, junglelike garden in which it was easier to imagine a seduction scene than the purchase of a credit default swap. "There was an awkward moment or two, due to the fact that our offices had a tailor working downstairs, and they could hear her," said Jamie. But no one from Deutsche Bank had to go to the bathroom, and Cornwall Capital Management got its ISDA.
This agreement, in its fine print, turned out to be long on Cornwall Capital's duties to Deutsche Bank and short on Deutsche Bank's duties to Cornwall Capital. If Cornwall Capital made a bet with Deutsche Bank and it wound up "in the money," Deutsche Bank was not required to post collateral. Cornwall would just have to hope that Deutsche Bank could make good on its debts. If, on the other hand, the trade went against Cornwall Capital, they were required to post the amount they were down, daily. At the time, Charlie and Jamie and Ben didn't worry much about this provision, or similar provisions in the ISDA they landed with Bear Stearns. They were happy just to be allowed to buy credit default swaps from Greg Lippmann.
Now what? They were young men in a hurry--they couldn't believe the trade existed and didn't know how much longer it would--but they spent several weeks arguing among themselves about it. Lippmann's sales pitch was as alien to them as it was intriguing. Cornwall Capital had never bought or sold a mortgage bond, but they could see that a credit default swap was really just a financial option: You paid a small premium, and, if enough subprime borrowers defaulted on their mortgages, you got rich. In this case, however, they were being offered a cheap ticket to a drama that looked virtually certain to happen. They created another presentation to give to themselves. "We're looking at the trade," said Charlie, "and we're thinking, like, this is too good to be true. Why the hell should I be able to buy CDSs on the triple-Bs [credit default swaps on the triple-B tranche of subprime mortgage bonds] at these levels? Who in their right mind is saying, 'Wow, I think I'll take two hundred basis points to take this risk?' It just seems like a ridiculously low price. It doesn't make sense." It was now early October 2006. A few months earlier, in June, national home prices, for the first time, had begun to fall. In five weeks, on November 29, the index of subprime mortgage bonds, called the ABX, would post its first interest-rate shortfall. The borrowers were failing to make interest payments sufficient to pay off the riskiest subprime bonds. The underlying mortgage loans were already going sour, and yet the prices of the bonds backed by the loans hadn't budged. "That was the part that was so weird," said Charlie. "They'd already started going bad. We just kept asking, 'Who the hell is taking the other side of this trade?' And the answer that kept coming back to us was, 'It's the CDOs.'" Which of course just raised another question: Who, or what, was a CDO?
Typically when they entered a new market--because they'd found some potential accident waiting to happen that seemed worth betting on--they found an expert to serve as a jungle guide. This market was so removed from their experience that it took them longer than usual to find help. "I had a vague idea what an ABS [asset-backed security] was," said Charlie. "But I had no idea what a CDO was." Eventually they figured out that language served a different purpose inside the bond market than it did in the outside world. Bond market terminology was designed less to convey meaning than to bewilder outsiders. Overpriced bonds were not "expensive" overpriced bonds were "rich," which almost made them sound like something you should buy. The floors of subprime mortgage bonds were not called floors--or anything else that might lead the bond buyer to form any sort of concrete image in his mind--but tranches. The bottom tranche--the risky ground floor--was not called the ground floor but the mezzanine, or the mezz, which made it sound less like a dangerous investment and more like a highly prized seat in a domed stadium. A CDO composed of nothing but the riskiest, mezzanine layer of subprime mortgages was not called a subprime-backed CDO but a "structured finance CDO." "There was so much confusion about the different terms," said Charlie. "In the course of trying to figure it out, we realize that there's a reason why it doesn't quite make sense to us. It's because it doesn't quite make sense."
The subprime mortgage market had a special talent for obscuring what needed to be clarified. A bond backed entirely by subprime mortgages, for example, wasn't called a subprime mortgage bond. It was called an ABS, or asset-backed security. When Charlie asked Deutsche Bank exactly what assets secured an asset-backed security, he was handed lists of abbreviations and more acronyms--RMBS, HELs, HELOCs, Alt-A--along with categories of credit he did not know existed ("midprime"). RMBS stood for residential mortgage-backed security. HEL stood for home equity loan. HELOC stood for home equity line of credit. Alt-A was just what they called crappy mortgage loans for which they hadn't even bothered to acquire the proper documents--to verify the borrower's income, say. "A" was the designation attached to the most creditworthy borrowers; Alt-A, which stood for "Alternative A-paper," meant an alternative to the most creditworthy, which of course sounds a lot more fishy once it is put that way. As a rule, any loan that had been turned into an acronym or abbreviation could more clearly be called a "subprime loan," but the bond market didn't want to be clear. "Midprime" was a kind of triumph of language over truth. Some crafty bond market person had gazed upon the subprime mortgage sprawl, as an ambitious real estate developer might gaze upon Oakland, and found an opportunity to rebrand some of the turf. On Oakland's fringe there was a neighborhood, masquerading as an entirely separate town, called Rockridge. Simply by refusing to be called Oakland, Rockridge enjoyed higher property values. Inside the subprime mortgage market there was now a similar neighborhood known as midprime. Midprime was subprime--and yet somehow, ineffably, not. "It took me a while to figure out that all of this stuff inside the bonds was pretty much exactly the same thing," said Charlie. "The Wall Street firms just got the ratings agencies to accept different names for it so they could make it seem like a diversified pool of assets."
Charlie, Jamie, and Ben entered the subprime mortgage market assuming they wanted to do what Mike Burry and Steve Eisman had already done, and find the very worst subprime bonds to lay bets against. They quickly got up to speed on FICO scores and loan-to-value ratios and silent seconds and the special madness of California and Florida, and the shockingly optimistic structure of the bonds themselves: The triple-B-minus tranche, the bottom floor of the building, required just 7 percent losses in the underlying pool to be worth zero. But then they wound up doing something quite different from--and, ultimately, more profitable than--what everyone else who bet against the subprime mortgage market was doing: They bet against the upper floors--the double-A tranches--of the CDOs.
After the fact, they'd realize they'd had two advantages. The first was that they had stumbled into the market very late, just before its collapse, and after a handful of other money managers. "One of the reasons we could move so fast," said Charlie, "is that we were seeing a lot of compelling analysis that we didn't have to create from scratch." The other advantage was their quixotic approach to financial markets: They were consciously looking for long shots. They were combing the markets for bets whose true odds were 10:1, priced as if the odds were 100:1. "We were looking for nonrecourse leverage," said Charlie. "Leverage means to magnify the effect. You have a crowbar, you take a little bit of pressure, you turn it into a lot of pressure. We were looking to get ourselves into a position where small changes in states of the world created huge changes in values."
Enter the CDO. They may not have known what a CDO was, but their minds were prepared for it, because a small change in the state of the world created a huge change in the value of a CDO. A CDO, in their view, was essentially just a pile of triple-B-rated mortgage bonds. Wall Street firms had conspired with the rating agencies to represent the pile as a diversified collection of assets, but anyone with eyes could see that if one triple-B subprime mortgage went bad, most would go bad, as they were all vulnerable to the same economic forces. Subprime mortgage loans in Florida would default for the same reasons, and at the same time, as subprime mortgage loans in California. And yet fully 80 percent of the CDO composed of nothing but triple-B bonds was rated higher than triple-B: triple-A, double-A, or A. To wipe out any triple-B bond--the ground floor of the building--all that was needed was a 7 percent loss in the underlying pool of home loans. That same 7 percent loss would thus wipe out, entirely, any CDO made up of triple-B bonds, no matter what rating was assigned it. "It took us weeks to really grasp it because it was so weird," said Charlie. "But the more we looked at what a CDO really was, the more we were like, Holy shit, that's just fucking crazy. That's fraud. Maybe you can't prove it in a court of law. But it's fraud."
It was also a stunning opportunity: The market appeared to believe its own lie. It charged a lot less for insurance on a putatively safe double-A-rated slice of a CDO than it did for insurance on the openly risky triple-B-rated bonds. Why pay 2 percent a year to bet directly against triple-B-rated bonds when they could pay 0.5 percent a year to make effectively the same bet against the double-A-rated slice of the CDO? If they paid four times less to make what was effectively the same bet against triple-B-rated subprime mortgage bonds, they could afford to make four times more of it.
They called around big Wall Street firms to see if anyone could dissuade them from buying credit default swaps on the double-A tranche of CDOs. "It really looked just too good to be true," said Jamie. "And when something looks too good to be true, we try to find out why." A fellow at Deutsche Bank named Rich Rizzo, who worked for Greg Lippmann, gave it a shot. The ISDA agreement that standardized CDSs on CDOs (a different agreement than the ISDA agreement that had standardized CDSs on mortgage bonds) had only been created a few months before, in June 2006, Rizzo explained. No one had as yet bought credit default swaps on the double-A piece of a CDO, which meant there wasn't likely to be a liquid market for them. Without a liquid market, they were not assured of being able to sell them when they wanted to, or to obtain a fair price.
"The other thing he said," recalled Charlie, "was that [things] will never get so bad that CDOs will go bad."
Cornwall Capital disagreed. They didn't know for sure that subprime loans would default in sufficient numbers to cause the CDOs to collapse. All they knew was that Deutsche Bank didn't know, either, and neither did anybody else. There might be some "right" price for insuring the first losses on pools of bonds backed by pools of dubious loans, but it wasn't one-half of 1 percent.
Of course, if you are going to gamble on a CDO, it helps to know what, exactly, is inside a CDO, and they still didn't. The sheer difficulty they had obtaining the information suggested that most investors were simply skipping this stage of their due diligence. Each CDO contained pieces of a hundred different mortgage bonds--which in turn held thousands of different loans. It was impossible, or nearly so, to find out which pieces, or which loans. Even the rating agencies, who they at first assumed would be the most informed source, hadn't a clue. "I called S&P and asked if they could tell me what was in a CDO," said Charlie. "And they said, 'Oh yeah, we're working on that.'" Moody's and S&P were piling up these triple-B bonds, assuming they were diversified, and bestowing ratings on them--without ever knowing what was behind the bonds! There had been hundreds of CDO deals--400 billion dollars' worth of the things had been created in just the past three years--and yet none, as far as they could tell, had been properly vetted. Charlie located a reliable source for the contents of a CDO, a data company called Intex, but Intex wouldn't return his phone calls, and he gathered they didn't have much interest in talking to small investors. At length he found a Web site, run by Lehman Brothers, called LehmanLive.*
LehmanLive didn't tell you exactly what was in a CDO, either, but it did offer a crude picture of its salient characteristics: what year the bonds behind it had been created, for instance, and how many of those bonds were backed chiefly by subprime loans. Projecting data onto the red brick wall of Julian Schnabel's studio, Charlie and Jamie went searching for two specific traits: CDOs that contained the highest percentage of bonds backed entirely by recent subprime mortgage loans, and CDOs that contained the highest percentage of other CDOs. Here was another bizarre fact about CDOs: Often they simply repackaged tranches of other CDOs, presumably those tranches their Wall Street creators had found difficult to sell. Even more amazing was their circularity: CDO "A" would contain a piece of CDO "B" CDO "B" would contain a piece of CDO "C" and CDO "C" would contain a piece of CDO "A"! Looking for bad bonds inside a CDO was like fishing for crap in a Port-O-Let: The question wasn't whether you'd catch some but how quickly you'd be satisfied you'd caught enough. Their very names were disingenuous, and told you nothing about their contents, their creators, or their managers: Carina, Gemstone, Octans III, Glacier Funding. "They all had these random names," said Jamie. "A lot of them for some reason we never figured out were named for mountains in the Adirondacks."
They made a hasty list of what they hoped was the worst crap and called up several brokers. It had been hard for them to wriggle free of the brokers who covered rich people and to get into the arms of brokers who covered big, stock market-investing institutions. It was hard all over again to escape the big-time stock market brokers and win acceptance from the people inside the subprime mortgage bond market. "A lot of people when we called them said, 'Hey, why don't you guys buy some stocks!'" said Charlie. Bear Stearns couldn't believe that these young guys with no money wanted to buy not just credit default swaps but a credit default swap so esoteric that no one else had bought it. "I remember laughing at them," said the Bear Stearns credit default swap salesman who took their first inquiry.
At Deutsche Bank they were passed off to a twenty-three-year-old bond salesman who had never had a customer of his own. "The reason I got to know Ben and Charlie," says this young man, "was that no one else at Deutsche Bank would deal with them. They had, like, twenty-five million bucks, which for Deutsche Bank was not really significant. No one wanted to pick up their calls. People were making fun of their name--they'd say, like, 'Oh, it's Cornhole Capital calling again.'" Still, Deutsche Bank proved, once again, the most willing to deal with them. On October 16, 2006, they bought from Greg Lippmann's trading desk $7.5 million in credit default swaps on the double-A tranche of a CDO named, for no apparent reason, Pine Mountain. Four days later, Bear Stearns sold them $50 million more. "They knew Ace somehow," said the Bear Stearns credit default swap salesman. "So we wound up dealing with them."
Charlie and Jamie continued to call everyone they could think of who was even remotely connected to this new market, in hopes of finding someone who could explain what appeared to them to be its sheer madness. A month later they finally found, and hired, their market expert--a fellow named David Burt. It was a measure of how much money people were making in the bond market that the magazine Institutional Investor was about to create a hot list of people who worked in it, called The 20 Rising Stars of Fixed Income. It was a measure of how much money people were making in the subprime mortgage market that David Burt made the list. Burt had worked for the $1 trillion bond fund BlackRock, owned, in part, by Merrill Lynch, evaluating subprime mortgage credit. His job was to identify for BlackRock the bonds that were going to go bad before they went bad. Now he had quit in hopes of raising his own fund to invest in subprime mortgage bonds, and, to make ends meet, he was willing to rent his expertise for $50,000 a month to these oddballs at Cornwall Capital. Burt had the most sensational information, and models to analyze that information--he could tell you, for example, what would happen to mortgage loans, zip code by zip code, in various house price scenarios. He could then take that information and tell you what was likely to happen to specific mortgage bonds. The best way to use this information, he thought, was to buy what appeared to be the sounder mortgage bonds and simultaneously sell the unsound ones.
The insider's artful complexity didn't much interest Cornwall Capital. Spending a lot of time trying to pick the best subprime mortgage bonds was silly, if you suspected that the entire market was about to blow up. They handed Burt the list of CDOs they had bet against and asked him what he thought. "We always looked for someone to explain to us why we didn't know what we were doing," said Jamie. "He couldn't." What Burt could tell them was that they were probably the first people ever to buy a credit default swap on the double-A tranche of a CDO. Not reassuring. They assumed there was a lot about the CDO market they didn't understand; they had selected the CDOs they had bet against inside of a day, and assumed they could do a craftier job of it. "We were already throwing darts," said Jamie. "We said, 'Let's throw darts a little better.'"
The analysis Burt gave them a few weeks later surprised them as much as it did him: They'd picked beautifully. "He said, like, 'Wow, you guys did great. There are a lot of really crappy bonds in these CDOs,'" said Charlie. They didn't realize yet that the bonds inside their CDOs were actually credit default swaps on the bonds, and so their CDOs weren't ordinary CDOs but synthetic CDOs, or that the bonds on which the swaps were based had been handpicked by Mike Burry and Steve Eisman and others betting against the market. In many ways, they were still innocents.
The challenge, as always, was to play the role of market generalist without also playing the role of fool at the poker table. By January 2007, in their tiny $30 million fund, they owned $110 million in credit default swaps on the double-A tranche of asset-backed CDOs. The people who had sold them the swaps still didn't know what to make of them. "They were putting on bets that were multiples of the capital they had," said the young Deutsche Bank broker. "And they were doing it in CDSs on CDOs, which probably, like, three or four guys in the whole bank could speak intelligently about." Charlie and Jamie and Ben sort of understood what they had done, but sort of didn't. "We're kind of obsessed about this trade," said Charlie. "And we've exhausted our network of people to talk to about it. And we still can't totally figure out who is on the other side. We kept trying to find people who could explain to us why we were wrong. We just kept wondering if we were crazy. There was this overwhelming feeling of, Are we going out of our minds?"
It's just weeks before the market will turn, and the crisis will commence, but they don't know that. They suspect that this empty theater into which they've stumbled is preparing to stage the most fantastic financial drama they'll ever see, but they don't know that, either. All they know is that there is a lot they don't know. On the phone one day, their Bear Stearns credit default swap salesman mentioned that the big annual subprime conference would be held five days hence, in Las Vegas. Every big cheese in the subprime mortgage market would be there, with a name tag, and wandering around The Venetian hotel. Bear Stearns was planning a special outing for its customers, at a Vegas firing range, where they could learn to shoot everything from a Glock to an Uzi. "My parents were New York City liberals," said Charlie. "I wasn't even allowed to have, like, a toy gun." Off he flew, with Ben, to Las Vegas, to shoot with Bear Stearns, and to see if they could find anyone to explain to them why they were wrong to bet against the subprime mortgage market.