“Sorry, we’re not willing to go to market with any Merrill Lynch counterparty risk,” the J.P. Morgan contact told him. They wouldn’t help wind down any trades with Merrill Lynch on the other side.
Greene’s stress level soared. “I wanted out right away but now I only have Merrill to help me, of all places.”
Greene called up his new Merrill Lynch broker and decided to play it cool, trying to hide the fear building inside.
“Hey, it’s Jeffrey Greene,” he said, very casually, as if he was bored and looking for something to occupy his time. “I wouldn’t mind winding down some of those positions; do you mind getting me a bid or two?”
“Well, it could take us a day or two,” the broker responded.
“Oh, that’s fine, thanks.”
Greene got off the phone, beating himself up for waiting so long to sell.
What an idiot I am!
“I’m thinking if they give me fifty cents [on the dollar], I’m going to have to take it,” Greene recalls.
When the broker called back, he had an offer for Greene: “We’ll pay you $156 million” for the position.
Greene couldn’t believe it—they were willing to buy his positions at eighty-seven cents on the dollar. He had been willing to sell them for just fifty cents. Maybe his bluff was working.
He decided to push it a bit further.
“Well, let me see. I’ll think about it.”
He hung up. Merrill soon called with a new offer: ninety-three cents on the dollar.
“Do it,” Greene responded.
Greene didn’t realize it at the time, but John Thain, Merrill’s new chief, had just issued an order to his troops to get rid of any exposure to toxic mortgages, no matter the cost. Merrill Lynch was eager to get out of their trades with Greene, at any price.
Dragging his feet worked to Greene’s benefit. “I was totally lucky at the end,” he acknowledges.
After Greene hung up, though, he realized he had another issue to worry about: If Merrill Lynch went under before his trade was complete, Greene’s profits would be in danger.
He rang the Merrill Lynch broker, once again.
“Um … when does this trade settle?”
Not taking any chances, Greene had his trade transferred to Credit Suisse, a more stable Swiss bank, to ensure that it went through.
By 2009, Greene was down to just $100 million in CDS protection, a valuable memento of a trade that netted him about $500 million in profit, one of the largest gains by an individual investor in Wall Street history.
“The trade worked better for amateurs than professionals,” Greene says, noting that those not a part of the business could more clearly see the looming problems, as well as dismiss potential obstacles to the trade. “There were so many things that could go wrong.”
DESPITE GREG LIPPMANN’S SUCCESS, his superiors seemed as skeptical as ever as 2008 began. As the ABX fell further, Anshu Jain, one of the bank’s top executives, e-mailed Lippmann, pushing him to sell some of his positions.
“No, it’s going to zero,” Lippmann shot back, according to an executive who saw the e-mail. Lippmann also began warning some on Deutsche’s trading floor that the housing troubles would infect other areas of the economy.
Watching a commentator on CNBC judge the stock market’s weakness as temporary, Lippmann quickly yelled out: “In your dreams!”
Sometimes, Lippmann was so openly joyful, shouting and screaming with so much pleasure, that it rubbed some other traders the wrong way, especially those losing money.
On one particularly bad day for the market, Lippmann called over a salesman, pointing to a spreadsheet on his computer.
“Look, I’m up $400,000!”
Flashing a big smile, Lippmann explained that in his personal account he had bet against an exchange-traded fund that tracked financial companies, like banks and brokerage firms. The worse things got for Deutsche’s brethren, the more his account rose in value.
“That’s wonderful for you,” the salesman said to him, sarcasm dripping, as he shook his head.
At one point, his boss, Misra, sat Lippmann down to tell him not to be so obnoxious about his winnings.
Lippmann’s cockiness masked a growing unease as he watched a figure in the corner of his computer screen: the tumbling shares of Deutsche Bank as its own problems multiplied. Lippmann’s team was a relatively small part of a global bank; he could see the profits and losses of some others and it was an ugly picture. By the middle of the year, the bank had taken $11 billion of write-downs, dwarfing Lippmann’s gains. His bets against financial shares—approved by the bank—were a futile attempt to limit the damage from the loads of Deutsche shares in the account. On the day his personal account rose $400,000, his Deutsche shares fell about $800,000.
Lippmann was almost right in his prediction to his bosses—the ABX index tracking the riskiest subprime mortgages eventually fell to two cents. His group would make several hundred million dollars more in 2008. In the fall, Lippmann even began recommending select subprime bonds that he thought had become attractive, bonds that began to rise in early 2009.
For all Lippmann’s success, Deutsche was dealing with so many problems by late 2008 that it could pay him only a few million dollars as a bonus, another disappointment for him. Adding salt to his wounds, his Deutsche shares had dropped more than 70 percent over the previous twelve months.
IN SEPTEMBER 2007, Andrew Lahde pressed his bets, raising a larger fund from newly interested investors to buy protection against commercial mortgages and another fund to wager against banks, brokerage firms, and other companies that he was sure would fall.
“Our entire banking system is a complete disaster,” he wrote in late 2007. “In my opinion, nearly every major bank would be insolvent if they marked their assets to market.”
By the end of the year, Lahde owned protection on $1 billion of subprime debt in three hedge funds and managed $100 million. But as he became increasingly worried about the fragility of the financial system, he began doing some selling.
In March, exhausted from a grueling year, he invited two young women to Miami, trying to relax. He rented a penthouse suite at the Ritz-Carlton for the women and another room nearby to ensure that he’d get some rest during the day as the women shopped. Lahde couldn’t seem to relax, however. He still held hundreds of millions of dollars of protection and increasingly was convinced that he needed to cash in his big trade before it was too late. Two weeks later, bringing a young woman with him, he left for St. Thomas to research the tax benefits of moving to the island. The hotel was so crowded, in part due to a visit to the island by a group including President Barack Obama, that Lahde was unable to book an extra room and, frustrated, he was forced to share his suite with his traveling partner.
For days, Lahde avoided calling his office, trying unsuccessfully to catch up on his rest. One afternoon, napping in bed, he reached for his BlackBerry and saw a text message with the subject line “Bear Stearns is 700 over.” Lahde sat straight up and reached for his nearby cell phone to dial his office.
“Dude, is Bear really at seven hundred?!” he asked Rich Eckert, his chief financial officer.
Credit-default swap contracts protecting the debt of Bear Stearns indeed were trading at 7 percentage points above the rate that top-rated banks lent to each other. Lahde instantly understood that the market had turned desperately worried about the health of his brokerage firm, which still owed him millions of dollars of profits from his remaining positions.
Lahde long had expected banks to collapse under the weight of all their toxic mortgages. Now it was happening, but like a gambler sitting on huge piles of chips from a casino on its last legs, Lahde fretted he might not be able to cash in his winnings.
“Shut it down tomorrow,” he told Eckert, a tinge of fear in his voice.
As calmly and deliberately as he could, Lahde gave his associate detailed instructions about how to sell the firm’s entire positions. Do it slowly and before
anyone can figure out what we’re doing, Lahde said. That way, traders couldn’t take advantage of his sudden desperation to sell and push prices lower.
Eckert managed to exit all of the commercial fund’s positions just days before Bear Stearns was forced to sell itself to J.P. Morgan. By September, Lahde had closed his credit fund, and in October he shuttered his entire firm, unwilling to trade with any brokers or banks, many of which he feared were close to collapse. These funds weren’t nearly as successful as the one that bet against subprime mortgages, leaving some investors grumbling and giving Lahde one more reason to think about quitting the business.
Investing in mortgage protection in the eleventh hour of the housing craze, in late 2006, Lahde’s residential-mortgage fund gained 1,000 percent, or about $75 million, over just fifteen months, one of the best runs in history. Lahde himself pocketed more than $10 million from his trade and more than $100 million for his clients.
AS SUBPRIME MORTGAGES continued to plummet throughout 2008, John Devaney suffered so many losses that he had to take drastic measures. Just a year earlier, he had mocked those nervous about sobering news from New Century.
“In a funny way I want to thank the market for dealing me a direct hit,” he told the New York Times in February, adding that he was buying still more bonds, taking advantage of the lower prices. “I don’t think there is anything fundamentally wrong.… Most of the stuff I have has limited downside.”
By the summer of 2008, however, Devaney was desperate for cash. First he sold his Renoir painting for $13.5 million, and then his helicopter, his Gulfstream plane, and even his mansion in Key Biscayne. Then came his 145-foot yacht. It wasn’t enough, though. In late June, just before his thirty-eighth birthday, Deutsche Bank called in a loan, demanding that Devaney repay $90 million the next day. When he couldn’t, the bank seized his fund’s remaining assets.
In July, Devaney shuttered his fund, telling his investors that he had lost all their money.
“I’m devastated, I’m totally devastated,” Devaney told the New York Times, saying that he personally had lost more than $150 million. He also suffered $50 million of trading losses at his brokerage firm, United Capital Markets Holding, which remained in business.
MICHAEL BURRY began 2008 worried about the economy and determined to cement his own legendary trade. His concerns soon were borne out.
But Burry’s investors continued to bolt, pulling more than $100 million from his fund early in the year, convinced that he couldn’t replicate his huge gains of the previous year. Their withdrawals forced him to do some more selling of prized investments.
Burry ended up losing money in 2008, getting back into the market several months too early, though he beat the overall market. Few new clients emerged and his existing investors continued to grumble.
After a front-page story in The Wall Street Journal described John Paulson’s winnings from his subprime trade, Burry shot off an e-mail to the reporter that was as bitter as it was factual: “Well, I was first. If anyone can be shown to be one that really did his own work and created this strategy from scratch, it’d be me.… A physician with no true education in anything Wall Street. Completely self-taught, working by myself.”
Late in 2008, clients entrusted just $450 million with Burry, down from $650 million when he first discovered the mortgage protection in 2005. At the end of the year, Rob Lusardi, an executive at White Mountains Insurance Group, one of Burry’s original investors, said, “To us here at White Mountain, you’re a zero.” (Lusardi says he didn’t call Burry a “zero”; rather, his company had “zero” interest in investing with Burry.)
“I’m running less money than I gained last year, less than I managed even in 2003,” Burry said to his wife. “No one cares.” Why am I doing this? Burry thought.
By late 2008, Burry had had enough. He was thirty-seven, had millions in the bank, and was worn out. He came to the office one morning to tell his employees he was closing down his firm. Just before Burry went into a meeting with the staff, he heard a hard pounding on the door. It was his wife, Anh-Thi.
“Don’t do it, don’t do it,” she pleaded with her husband, convinced he would regret the move.
“I’ve made my decision,” he said somberly.
Burry then told his investors he was going to shutter his firm in early 2009 and spend more time with his family. He might go back to medicine or even get a Ph.D. in astronomy, he told one. Few of his clients protested his decision.
For Burry, the subprime trade brought wealth, but it also gave him reason to ponder what could have been. If his investors had backed his idea for a housing-dedicated fund, or if they didn’t force him to sell so much mortgage protection before cracks began to show in the housing façade, Michael Burry might have joined John Paulson as a Wall Street legend.
“It was a successful trade; it just wasn’t what it could have been. I didn’t realize my full potential,” Burry says.
As his voice seemed to catch, and his eyes filled with tears, Burry explained that he was worried about friends who were losing their jobs and how many would suffer from the economic downturn.
“I thought this was my Soros trade.”
FOR MOST OF 2008, John Paulson tried to keep a low profile. He told a reporter that he was reluctant to celebrate while housing troubles were causing pain for others. On rainy days, when it was hard to find a cab home, he still hopped on the local bus heading uptown to his East Side town house. The locals didn’t seem to realize they had a billionaire in their midst, and Paulson liked it that way.
As for big charitable gifts, Paulson mostly held back. Paulson told some associates that he planned to do more, but gave few details. Naming a building or institution after himself wasn’t his style. Still, friends and associates said Paulson never shared any ambitions about tackling big charitable projects.
The best use of his time is to make still more money, Paulson says, so that there might be more wealth to give away someday down the line, a stance that investor Warren Buffett adopted until his later years.
“It takes a lot of time to contribute intelligently,” Paulson says. “My greatest advantage now is managing money; there’s a time for that and a time for this.”
Paulson got to know a bit of the discomfort the rest of the country was feeling. Early in 2008, he traded up in Southampton, spending $41.3 million for a 10.4-acre lakefront estate known as Old Trees, a 1911 Georgian mansion with two guesthouses, a pool, staff quarters, and a vast expanse on Lake Agawam.
But when Paulson tried to sell his 6,800-square-foot “cottage” near by, it sat for more than a year. He slashed the price from $19.5 million to $13.9 million but still found no takers. Finally, in the summer of 2009, he sold it for $10 million, well below the $12.75 million price he had paid for the home in 2006. Few seemed to feel very sorry for Paulson.
In November 2008, more than one hundred of Paulson & Co.’s investors converged on Manhattan’s Metropolitan Club, facing Central Park, for the fund’s annual dinner. A year earlier, Pellegrini had picked and introduced the wines. This year, Paulson hired a sommelier to present the French wines, including $500 bottles of Château Haut-Brion, Château Margaux, and Château Rothschild.
The dinner, which took place in the teeth of a developing recession and the worst financial crisis since the 1930s, seemed a bit over the top: jumbo crabmeat and avocado; Colorado rack of lamb with tarragon jus; and Parmesan polenta cake, eaten by candlelight. But Paulson seemed determined to enjoy his success, saying that he didn’t feel any shame celebrating the firm’s accomplishments.
Paulson’s choice of a speaker for the agenda also suggested something of a tin ear: former Federal Reserve chairman Alan Greenspan, a new consultant to the Paulson team. While others leveled blame at Greenspan for keeping interest rates low enough to pump air into the housing bubble, Paulson defended his recent hire, calling the critics Monday-morning quarterbacks and telling colleagues he was proud to call on Greenspan for his views.
; At the event, Paulson spoke a bit about developing opportunities, even in troubled mortgages, though he said it was premature to do much buying. What Paulson didn’t share was that he was in the early stage of planning a new trade, one that would be just as unorthodox and controversial as his subprime trade and would be implemented in early 2009.
Paulson also didn’t speak about a surprise subpoena he had received a month earlier from the House of Representative’s powerful House Committee on Oversight. The day he received it, Paulson seemed nervous as he walked into Michael Waldorf’s office, asking the attorney for his advice. There was an ongoing backlash against well-paid executives in the financial world and against those firms taking too much risk in the markets; the committee had asked for a range of sensitive information about how Paulson’s hedge fund was being run.
“Why do they want to hear from me, I didn’t do anything wrong?” he asked Waldorf with some annoyance. Paulson was especially concerned that details of his pay would be released publicly.
When the committee met on November 13, Paulson sat in a row of luminaries of the hedge-fund world: George Soros, Jim Simons, Kenneth Griffin, and Philip Falcone. For years, Paulson aspired to be viewed as one of the top investors. Now he would have to deal with the consequences.
As the hearings got under way, Soros expounded on global markets while Griffin showed a feisty side, pushing back against a congressman who challenged some of his initiatives. When it was his turn, Paulson was so soft-spoken that he repeatedly was asked to speak up. He adjusted the microphone and moved it closer, but it didn’t seem to have much effect. One congressman asked if the mic was even working. When another incorrectly minimized his track record, Paulson remained silent.
But when the question-and-answer period began, the congressmen warmed to Paulson, who gave his own views on how to improve the banking crisis.
“I’m thinking we’ve probably got the wrong Paulson handing out the TARP money here,” said Massachusetts Democrat John Tierney, a dig at the treasury secretary at the time, Henry Paulson.
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