|时间: 2010-9-02 周四, 下午1:26 标题:
The third Bull Market since 1995？
Wednesday, September 1st
The last two Bull markets, including this one, have one thing is common ... what is it?
A quick look at the rectangle areas on today's Monthly S&P 500 chart gives you the answer. A level of 1103 on the S&P has been a pausing and consolidation area for each of the three Bull Markets.
The behavior of all 3 Bull markets has been for our red trend line to finally pull back and touch the blue trend line during a sideways consolidation. (** The red trend line is a 6 weighted moving average, and the blue is a 12 simple moving average.)
This Bull market has been no different because the trend lines have been merged. So, this model was saying that we are at that "old familiar place" once again.
Well, that was until this morning at 9:30 AM when the September monthly tick began. If you look closely (at the chart below), you will see that the red trend line was below the blue at 9:30 AM.
Is this a problem?
Is this a problem? Continued below ...
Actually, it may not be a problem if you look at what happened at the same level in 1998. That chart is below and the October area is what is similar this September's time period.
During that 1998 period, the S&P actually made a lower/low during the second week of the month. When that happened, the red trend line fell below the blue trend line. So, it looked like today's chart above ... except that the third week reversed the monthly condition in 1998 to where the red trend line went back above the blue trend line. The Bull market continued from on from that point.
So, what does all the above all mean? Continued below ...
So, what does all the above all mean?
It means that it is too early to tell on a monthly tick chart. So far, the pattern behavior is not much different than Bull markets of the past.
Granted, economic conditions appear to be very different. Most disturbing is the fact that debt levels have not been adequately purged yet. Most encouragingly (economically at least), is the fact that the Fed is keeping rates low with the intent of keeping liquidity flowing.
So, how will this one play out?
The real question at this level still remains: "Will the current Bull market now END and turn into a Bear market, or will it continue on and make new highs?"
This is an important, historic area. This is a monthly chart, so each bar represents one month of time. Historically, the process at this juncture has taken three to five months to resolve. This one has been going on for a while, so this month (September) is when the question should be resolved.
|时间: 2010-9-04 周六, 下午2:06 标题:
Philip Greenspun's Weblog
A posting every day; an interesting idea every three months…
Impending stock market crash?
A very smart friend was visiting from Manhattan this weekend. His proximity to Wall Street gives him a window into the world of finance. His tendency to be out of sync with the average American protects him from the herd instinct. Despite having a demanding academic science job, he has been a successful individual investor for a couple of decades. In the spring of 2008, with the Dow at 13,000, he moved all of his family’s investments into bonds.
When conversation turned to the latest sag in the stock market, he opined that much worse was yet to come and that the Dow might get back down toward 7000. He cited the moribund U.S. economy and the profligate U.S. government (people who argue for stimulus spending tend to underestimate the government’s ability to waste money, e.g., putting a 6-year-old girl on the no-fly list (story)).
I have trouble letting go of the Efficient Market Hypothesis. If the Dow is at 9700 right now then that is the best estimate of where it will be a few years from now (plus whatever the yield on a TIPS bond is, i.e., 1-2% per year). With the U.S. state and federal governments amping up taxes and handing out the money to the retired, the world’s least efficient health care system, and political cronies, and 15 million Americans unemployed, how can the S&P 500 not be dragged down? My argument is that most of the companies in the S&P 500 aren’t dependent on the continued prosperity of working Americans. General Electric can build factories in and sell products to customers in any part of the world that is thriving economically. Intel can sell processors to families in Turkey, Brazil, and India. Walt Disney can welcome visitors to its Shanghai theme park. Admittedly many of the companies in the S&P 500 would appear to be dependent on American consumers, e.g., Southwest Airlines or various insurers. But even these should still produce good profits. The U.S. economy may end up with big shifts in wealth, e.g., from workers to retirees, from the private sector to government employees, and from competitive industries to government-sponsored industries. The per capita income of the U.S. may fall, as the population increases and the GDP remains constant. But as long as GDP does not fall, the same amount of money is there circulating for a company to collect as profit. [In January 2009, I wrote a posting about how the U.S. economy does not need to crash or boom; it can simply slide sideways as England's did for decades.]
What do readers think? What plausible scenario causes the multinational companies in the S&P 500 to become worth significantly less than they are now?
26 Comments »
July 6, 2010 @ 12:46 am
* The U.S. is not done spending.
* Europe is going to cut spending.
* China’s real estate bubble is going to bust.
* Current attempts to shore up hot spots like Greece are going to fail.
* Other countries are going to have trouble (Spain for example).
* Political unrest around the world.
* Large layoffs in U.S. state and local govt. sector coming.
* U.S. housing still in trouble, going to be another leg down.
* Still unresolved issues with CA, IL, NY and others.
* Most trading volume is computerized insider day trading, this is an unknown. You can be sure they only trade when there are suckers still in the game, what happens when the suckers give it up and go home? We don’t know yet.
All reasons we will see Dow 8000 in my opinion.
July 6, 2010 @ 5:18 am
“What plausible scenario causes the multinational companies in the S&P 500 to become worth significantly less than they are now?”
Babyboomers retiring and selling stocks to fund their retirement?
Stock bubble from the nineties still deflating? I think stocks have been going down since the beginning of this century, both in inflation adjusted dollars and in gold. (this is from memory, I could be wrong) In nominal dollars it was interrupted by the loose money policy that caused the housing bubble, but that was just postponing stuff.
The US consumer as we knew him is dead. He spent more than he earned for many years and that game is ending now. Government had same problem. Too much debt was a factor in the Great Depression and now too. Austerity will hurt stocks. If austerity isn’t chosen, maybe one day default will come, or war. War gave the US worldwide power and influence that it is now losing. But war is not humane and I hope there is none in our future.
The US role in the world economy is changing. The empire is in decline, may be heading for bankruptcy and its currency may lose reserve currency status.
Longterm cycles? According to some we’re now in Kondratieff’s winter. Probably correct, but unfortunately this stuff is so vague that it’s not very helpful. Spring should be good for stocks, but when will it come?
July 6, 2010 @ 5:24 am
The new austerity in the EU probably means they too will buy less, hence less profits for the S&P 500 companies.
July 6, 2010 @ 5:37 am
Similarities with the Great Depression adding to negative market sentiment?
P.S. Please delete “I think stocks have been going down since the beginning of this century, both in inflation adjusted dollars and in gold. (this is from memory, I could be wrong)”.
July 6, 2010 @ 6:19 am
My reasons that stocks may drop further:
1. changes in US tax code (expiration of Bush tax cuts) mean that if you are going to sell some stocks, you should do so by the end of the year – thus some will start selling early, figuring that others will sell at the last minute, depressing prices.
2. A change in capital entering or staying in the market (i.e. net flow of money out of mutual funds that invest in the stock market) is likely as by the end of July some 3 million people will no longer be receiving unemployment benefits – as reality hits they may start to cash in any stocks or 401Ks they have held off from touching. Further, hard times in other countries may lead to investors there, also selling stocks and going to cash.
July 6, 2010 @ 7:03 am
I’m seeing the idea that the stock market is going to bite it again — and hard — from several places now. I believe it, but I don’t know what to do about it.
My brother-in-law works for an investment company, and he’s worked both the stocks and the bonds side of the business. In late 2008, I asked him about the situation, thinking I would shift all of my holdings into long-term stuff. He told me the worst was over, and that I ought to get really aggressive. So I did nothing, and, of course, have lost a significant chunk of my nest egg. At this point, what can I do? Take it all out, pay the exorbitant taxes, and get out of the market? The 30% hit would cover a pretty big downswing.
The worst part about it is that, with government spending the way it is, I don’t want to put it in T bills. What does that leave me? Gold? Foreign markets? (Probably worse!)
Maybe I should just start a business with the money…
July 6, 2010 @ 8:43 am
Ethan: All of your points except for the last one (computerized trading) should already be priced into the market, no? Investors already know that Greece and Spain won’t contribute to S&P 500 profit growth. Managers at big companies have already turned their attention to Latin America and Asia, no?
Jan: Has the stock market been deflating since the beginning of the century? Google Finance says that the Dow was 11,500 on Dec 31, 1999. That would be 15,060 in 2010 dollars, according to the Bureau of Labor Statistics’s CPI calculator. So the Dow is down 36 percent in real terms.
Patrick: I’m not sure that the unemployed have significant portfolios of stock in their 401ks. Let’s assume that the median American family net worth is back to its 2004 level of $93,000 (that includes equity in a house). Let’s assume that unemployed people tend to have been poorer than the median, with a net worth of $70,000 and perhaps $25,000 of that in stocks. If all 15 million unemployed Americans sold $25,000 in stocks each, that’s $375 billion in sales. http://seekingalpha.com/article/199294-world-stock-market-value-reaches-20-month-high says that world stock market value is about $50 trillion.
July 6, 2010 @ 9:50 am
How does a of volatility index relate to efficient market hypothesis? Is this an index which tries to predict our ability to predict the future direction of the market? If so, I guess I am saying that volatility is high and given that any index can be wrong, I believe volatility is higher than the index states at the moment.
July 6, 2010 @ 4:57 pm
Stick with your gut not to abandon the efficient market hypothesis, especially on macro events or indices. Using Google Archive News search, you can review what smart prognosticators have said in the past about then-future dates. Almost no one is correct on macro events more than once sequentially (if there are enough guesses, someone will be correct).
The reality is both camps can site a large number of reasons for their case, as your initial post shows. It’s a system with a massive number of players, emotions, and variables, all interacting. Predictions play to our human desire to understand something. Many people will try to make money capturing attention with predictions.
“Forecasts of the future tell you more about the forecast than the future.” – Warren Buffett
Increased inattention to the market increases returns: http://papers.nber.org/papers/w15010
July 6, 2010 @ 4:59 pm
Dow 7000 is as low as it can go, barring unforeseen events. A large portion of all instruments are held by entities with structural restrictions on what they can do with their funds, usually devised by people who haven’t noticed that 20 year stock market returns are around 0.4% (compound).
July 6, 2010 @ 9:54 pm
I once read about two stock market simulations, using genetic algorithms to evolve agent strategies. In the first, agents based their activities on their perceptions of fundamentals. Stock prices were stable and consistent with company values. In the second, agents traded based on their predictions of what other agents would do. Prices turned completely chaotic.
Which strategy do most people use these days?
And if you think the efficient market hypothesis is still valid and prevents any likelihood of a crash to 7000, then how do you explain the last time, and the immediate recovery?
July 6, 2010 @ 10:01 pm
Dennis: I didn’t say that the efficient market hypothesis “prevented” a crash down to 7000. Only that the best estimate of future value is current value. New information could arrive that would result in lower or higher prices. I think that the hypothesis says only that the current price is based on all currently available information.
Part of the last crash was a liquidity crisis in which some institutions or individuals had to raise money quickly and the only thing that they could sell were stocks. The world is currently awash in cash so I think that distressed selling will be less of a factor.
Another factor in the last crash was uncertainty about what the U.S. government would do. Would the feds nationalize banks, raise taxes to 85 percent, let GM, AIG and Fannie Mae go bust? Nobody knew. Now we can be pretty sure that the federal government will print money in response to any challenge. That may or may not be good for investors, but at least it is a predictable risk that can be planned around.
July 6, 2010 @ 11:03 pm
How about this, there are two scenarios,
1. The US government is able to fool its creditors and buy its way out of the recession and economy goes into an expansion. Result = Dow 14000.
2. The bond market forces austerity on the US, and the US goes into a deep recession. Result = Dow 6000.
Say the odds of each scenario are 50-50, giving an expectation value (or best estimate) of the Dow at 10000. Whether people believe scenario 1 or 2 depends on a lot of things, and can change dramatically. Much government spending and human psychology distorts the signals of whether scenario 1 or 2 is actually happening. Confusion reigns, until one of the two equilibrium states is reached.
Clearly the expectation value of the dow, will depend on the shape of the scenario distribution, which no one can know or calculate, but the idea is that the efficient market isn’t necessarily connected to a stable value.
Another way to look at is, we may know about all the issues listed in Ethan’s first comment, but we don’t know their effect on the economy. As we learn their effect, that’s new previously unknown information that the market will “efficiently” adjust too.
July 6, 2010 @ 11:54 pm
How about accounting and stock market fraud? Cendant (or its’ predecessor), Arthur Andersen, Enron, Waste Management, et al, are not such a distant past. How many cases like Enron will it take to really shake the current market? whatever accounting and financial reporting reforms they came up with, may not help much given enough determination – Madoff is but one such example.
How about the possibility of peace-seeking, virgin-loving freedom fighters (or whatever the current politically correct term for them may be), bombing the Intel HQ, R&D offices, and factories – and then AMD, Cisco, and whatever else they can reach, along with a couple of factories? Not all of these companies have everything of importance in bomb-proof facilities. And then the handlers of those mujahideen can short the stocks.
Then there’s always the possibility of some unforeseen regulations shaking up the industries – should they allow enough nuclear power stations to make say electric heat cheaper than oil, what would that do to the oil industry? Should they chase all the illegals out of the country, what will that do to meat processing industry, construction, or whoever can be relying on abundant supply of cheap labor?
How would large-scale market intervention by the government (say, manipulating the gold prices or the interest rates) affect stock indexes?
July 7, 2010 @ 12:14 am
Here’s another possibility:
A US company outsources development to India. The whole business (a substantial part of a major corporation) consists of 2-3 mainframes, one main application, and the customer database – and a small army of sales people. They outsource their development to India. Instead of providing the Indian developers with a subset of their customer database, or dummy records, they ship the whole database, and the whole code base, on mainframe backup tapes to India. And they’re helpful enough to transmit periodic updates as well.
A little while later, an unknown off-shore company begins direct-marketing the same service to the same customers – no sales people, just email. The service is provided by the web site – it took the company a couple of decades to perfect. The result? The company did not go out of business altogether – they had established customer and vendor relationships, name recognition, long-term contracts, etc. But the stock tanked.
Similar to that – the guy who stole the micro-trading code from Goldman Sachs and took it with him to the competing Chicago-based outfit.
July 7, 2010 @ 3:03 am
Sentiment. A rising tide lifts all boats and a receding one will lower them all.
I think it was some minor English economist, who I disagree with, who pointed out that railway stocks went up just before a bank holiday, and that companies selling winter goods went up as winter arrived, as if such events count not be priced in earlier.
How many stocks do you think are purchased based on an assessment of that particular company ? I bet it’s a lot less that would seem sensible.
July 7, 2010 @ 6:22 am
“The best kept secret in the investing world: Almost nothing turns out as expected.” –- Harry Browne
July 7, 2010 @ 10:50 am
Got it. My main point though is that when most investors base their decisions on what they think other investors will do, instead of on the underlying fundamentals, the market stops being a good predictor of fundamental values. That’s why we get bubbles. The stratospheric market caps of the dot-com era weren’t actually good estimates of company prospects. The efficient market hypothesis would tell you they were, based on the information available at the time, no matter how crazy it seemed when you looked at the fundamentals.
Believing in the EMH means that prices justify themselves. There’s no need to do all that hard work reading balance sheets. Any price is just as valid as any other, because the market is smarter than you are. But if everybody thinks that, how do prices stay connected to reality at all? How efficient is a market full of dart-throwers? The market is most efficient if everybody ignores the EMH.
The book The Wisdom of Crowds talked about the conditions that make group decisions accurate. One was independence of thought. When people base their opinions on what everybody else thinks, group think sets in and they go off the rails. Independence, along with a way of aggregating all those disparate opinions, gives great results.
Few investors have the arrogance to think they’re smarter than everyone else. The EMH gives them justification for doing what they want to do anyway: the same thing as everyone else. Believing in the correctness of market prices is the ultimate group think.
Consequently, the market isn’t always a wise crowd. Sometimes it’s a thundering herd. I don’t think it’s necessarily true that the sorts of fundamental problems mentioned by other people in this thread are already priced into the market.
July 7, 2010 @ 2:25 pm
I think whether I side with your friend depends on whether he shifted his money to *Treausuries* or mortgage/corporate bonds in spring 2008. World of difference in terms of his credibility! :->
July 7, 2010 @ 7:48 pm
Efficient market theory is good excuse for intellectual laziness. If all known information are accurately reflected in stock prices, then there would be no value in gathering information as you would just easily rely on current market prices. Yet finance companies do have big research departments trying to get competitive edge over one another by gathering and interpreting information. Information are neither equally distributed, nor equally absorbed and interpreted in the same way by participants. Market pricing is just a collection of actions taken by individuals based on their interpretations of whatever angle of market information they have available. General environments (such as market mood) do provide anchoring points for these participants to interpret market information. Successful investors exploit inefficiency in market pricing all the time.
July 7, 2010 @ 8:00 pm
If you are having trouble letting go of the efficient markets hypothesis you may wish to read “The Limits of Arbitrage”
Anderi Shleifer and Robert W. Vishny, 1997, ‘The Limits of Arbitrage’, The Journal of Finance, American Finance Association
This used to be available free but no longer, it seems. It explains why not all mispricings can be arbitraged away.
Didier Sornette’s work on rational bubbles – yes investing in bubbles can be rational – is also very illuminating.
July 8, 2010 @ 9:29 am
nbsp;scholar.google.com shows a bunch of available copies of ‘The Limits of Arbitrage” for anyone interested.
July 10, 2010 @ 4:26 pm
If markets were efficient (per the efficient market theory) then we would see much less volatility in pricing. Taleb addresses this as did Robert Shiller.
Taleb: “Prices swing more than the fundamentals they are supposed to reflect, they visibly overreact by being too high at times (when their price overshoots the good news or when they go up without any marked reason) or too low at others. Prices do not rationally reflect the long term value of securities by overshooting in either direction.
July 10, 2010 @ 9:54 pm
The government will eventually tax away all corporate income and most corporate assets.
Don’t know what that means for stocks. Dow 0?
July 16, 2010 @ 12:27 pm
Efficient Market Theory suggest to me that the value of a share at any instant should be equal to the present value of expected net future cash flow which that share is responsible for. From my limited experience on this planet I don’t see how a rationale being could model this cash flow without a crystal ball.
July 20, 2010 @ 11:11 pm
I would say that the price level in “efficient markets” reflects participants *current* limited knowledge *and* current perception of the likelihoods of future events. Knowledge and perception can change drastically in a short period of time.
Also, I wouldn’t call our stock markets “efficient” by any means; in fact, I don’t think they deserve the “market” moniker at all right now. Participants have different rules applied to them based on who they are.
|时间: 2011-2-20 周日, 上午4:36 标题:
|Defied Wall Street and Made Financial History
by Henry » Fri Nov 26, 2010 7:09 am
The Greatest Trade Ever
The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History
Table of Contents
The tip was intriguing. It was the fall of 2007, financial markets were collapsing, and Wall Street firms were losing massive amounts of money, as if they were trying to give back a decade's worth of profits in a few brutal months. But as I sat at my desk at The Wall Street Journal tallying the pain, a top hedge-fund manager called to rave about an investor named John Paulson who somehow was scoring huge profits. My contact, speaking with equal parts envy and respect, grabbed me with this: "Paulson's not even a housing or mortgage guy .... And until this trade, he was run-of-the-mill, nothing special."
There had been some chatter that a few little-known investors had anticipated the housing troubles and purchased obscure derivative investments that now were paying off. But few details had emerged and my sources were too busy keeping their firms afloat and their careers alive to offer very much. I began piecing together Paulson's trade, a welcome respite from the gory details of the latest banking fiasco. Cracking Paulson's moves seemed at least as instructive as the endless mistakes of the financial titans.
Riding the bus home one evening through the gritty New Jersey streets of Newark and East Orange, I did some quick math. Paulson hadn't simply met with success-he had rung up the biggest financial coup in history, the greatest trade ever recorded. All from a rank outsider in the world of real estate investing-could it be? s
The more I learned about Paulson and the obstacles he overcame, the more intrigued I became, especially when I discovered he wasn't alone-a group of gutsy, colorful investors, all well outside Wall Street's establishment, was close on his heels. These traders had become concerned about an era of loose money and financial chicanery, and had made billions of dollars of investments to prepare for a meltdown that they were certain was imminent.
Some made huge profits and won't have to work another day of their lives. But others squandered an early lead on Paulson and stumbled at the finish line, an historic prize just out of reach.
Paulson's winnings were so enormous they seemed unreal, even cartoonish. His firm, Paulson & Co., made $15 billion in 2007, a figure that topped the gross domestic products of Bolivia, Honduras, and Paraguay, South American nations with more than twelve million residents. Paulson's personal cut was nearly $4 billion, or more than $10 million a day. That was more than the earnings of J. K. Rowling, Oprah Winfrey, and Tiger Woods put together. At one point in late 2007, a broker called to remind Paulson of a personal account worth $5 million, an account now so insignificant it had slipped his mind. Just as impressive, Paulson managed to transform his trade in 2008 and early 2009 in dramatic form, scoring $5 billion more for his firm and clients, as well as $2 billion for himself. The moves put Paulson and his remarkable trade alongside Warren
Buffett, George Soros, Bernard Baruch, and Jesse Livermore in Wall Street's pantheon of traders.
They also made him one of the richest people in the world, wealthier than Steven Spielberg, Mark Zuckerberg, and David Rockefeller Sr.
Even Paulson and the other bearish investors didn't foresee the degree of pain that would result from the housing tsunami and its related global ripples. By early 2009, losses by global banks and other firms were nearing $3 trillion while stock-market investors had lost more than $30 trillion. A financial storm that began in risky home mortgages left the worst global economic crisis since the Great Depression in its wake. Over a stunning two-week period in September 2008, the U.S. government was forced to take over mortgage-lending giants Fannie Mae and Freddie Mac, along with huge insurer American International Group. Investors watched helplessly as onetime Wall Street power Lehman Brothers filed for bankruptcy, wounded brokerage giant Merrill Lynch rushed into the arms of Bank of America, and federal regulators seized Washington Mutual in the largest bank failure in the nation's history. At one point in the crisis, panicked investors offered to buy U.S. Treasury bills without asking for any return on their investment, hoping to find somewhere safe to hide their money.
By the middle of 2009, a record one in ten Americans was delinquent or in foreclosure on their mortgages; even celebrities such as Ed McMahon and Evander Holyfield fought to keep their homes during the heart of the crisis. U.S. housing prices fell more than 30 percent from their 2006
a peak. In cities such as Miami, Phoenix, and Las Vegas, real-estate values dropped more than 40
percent. Several million people lost their homes. And more than 30 percent of U.S. home owners held mortgages that were underwater, or greater than the value of their houses, the highest level in seventy-five years.
Amid the financial destruction, John Paulson and a small group of underdog investors were among the few who triumphed over the hubris and failures of Wall Street and the financial sector.
But how did a group of unsung investors predict a meltdown that blindsided the experts? Why was it John Paulson, a relative amateur in real estate, and not a celebrated mortgage, bond, or housing specialist like Bill Gross or Mike Vranos who pulled off the greatest trade in history? How did Paulson anticipate Wall Street's troubles, even as Hank Paulson, the former Goldman Sachs chief who ran the Treasury Department and shared his surname, missed them? Even Warren Buffett overlooked the trade, and George Soros phoned Paulson for a tutorial.
Did the investment banks and financial pros truly believe that housing was in an inexorable climb, or were there other reasons they ignored or continued to inflate the bubble? And why did the very bankers who created the toxic mortgages that undermined the financial system get hurt most by them?
This book, based on more than two hundred hours of interviews with key participants in the daring trade, aims to answer some of these questions, and perhaps provide lessons and insights for future financial manias.
John Paulson seemed to live an ambitious man's dream. At the age of forty-nine, Paulson managed more than $2 billion for his investors, as well as $100 million of his own wealth. The office of his Midtown Manhattan hedge fund, located in a trendy building on 57th and Madison, was decorated with dozens of Alexander Calder watercolors. Paulson and his wife, Jenny, a pretty brunette, split their time between an upscale town house on New York's fashionable Upper East Side and a multimillion-dollar seaside home in the Hamptons, a playground of the affluent where Paulson was active on the social circuit. Trim and fit, with close-cropped dark hair that was beginning to thin at the top, Paulson didn't enjoy exceptional looks. But his warm brown eyes and impish smile made him seem approachable, even friendly, and Paulson's unlined face suggested someone several years younger.
The window of Paulson's comer office offered a dazzling view of Central Park and the Wollman skating rink. This morning, however, he had little interest in grand views. Paulson sat at his desk staring at an array of numbers flashing on computer screens before him, grimacing.
"This is crazy," he said to Paolo Pellegrini, one of his analysts, as Pellegrini walked into his office.
It was late spring of 2005. The economy was on a roll, housing and financial markets were booming, and the hedge-fund era was in full swing. But Paulson couldn't make much sense of the market. And he wasn't making much money, at least compared with his rivals. He had been eclipsed by a group of much younger hedge-fund managers who had amassed huge fortunes over 10 the last few years-and were spending their winnings in over-the-top ways.
Paulson knew he didn't fit into that world. He was a solid investor, careful and decidedly unspectacular. But such a description was almost an insult in a world where investors chased the hottest hand, and traders could recall the investment returns of their competitors as easily as they could their children's birthdays.
Even Paulson's style of investing, featuring long hours devoted to intensive research, seemed outmoded. The biggest traders employed high-powered computer models to dictate their moves. They accounted for a majority of the activity on the New York Stock Exchange and a growing share of Wall Street's wealth. Other gutsy hedge-fund managers borrowed large sums to make risky investments, or grabbed positions in the shares of public companies and bullied executives to take steps to send their stocks flying. Paulson's tried-and-true methods were viewed as quaint.
It should have been Paulson atop Wall Street, his friends thought. Paulson had grown up in a firmly middle-class neighborhood in Queens, New York. He received early insight into the world of finance from his grandfather, a businessman who lost a fortune in the Great Depression. Paulson graduated atop his class at both New York University and Harvard Business School. He then learned at the knees of some of the market's top investors and bankers, before launching his own hedge fund in 1994. Pensive and deeply intelligent, Paulson's forte was investing in corporate mergers that he viewed as the most likely to be completed, among the safest forms of investing. 11
When the soft-spoken Paulson met with clients, they sometimes were surprised by his limp handshake and restrained manner. It was unusual in an industry full of bluster. His ability to explain complex trades in straightforward terms left some wondering if his strategies were routine, even simple. Younger hedge-fund traders went tieless and dressed casually, feeling confident in their abilities thanks to their soaring profits and growing stature. Paulson stuck with dark suits and muted ties.
Paulson's lifestyle once had been much flashier. A bachelor well into his forties, Paulson, known as J.P. among friends, was a tireless womanizer who chased the glamour and beauty of young models, like so many others on Wall Street. But unlike his peers, Paulson employed an unusually modest strategy with women, much as he did with stocks. He was kind, charming, witty, and gentlemanly, and as a result, he met with frequent success.
In 2000, though, Paulson grew tired of the chase and, at the age of forty-four, married his assistant, a native of Romania. They had settled into a quiet domestic life. Paulson cut his ties with wilder friends and spent weekends doting on his two young daughters.
By 2005, Paulson had reached his twilight years in accelerated Wall Street-career time. He still was at it, though, still hungry for a big trade that might prove his mettle. It was the fourth year of a spectacular surge in housing prices, the likes of which the nation never had seen. Home owners felt flush, enjoying the soaring values of their homes, and buyers bid up prices to previously unheard-of levels. Real estate was the talk of every cocktail party, soccer match, and family barbecue. Financial behemoths such as Citigroup and AIG, New Century and Bear Stearns, were scoring big profits. The economy was roaring. Everyone seemed to be making money hand over fist. Everyone but John Paulson, that is.
To many, Paulson seemed badly out of touch. Just months earlier, he had been ridiculed at a party in Southampton by a dashing German investor incredulous at both his meager returns and his resistance to housing's allures. Paulson's own friend, Jeffrey Greene, had amassed a collection of prime Los Angeles real estate properties valued at more than $500 million, along with a coterie of celebrity friends, including Mike Tyson, Oliver Stone, and Paris Hilton.
But beneath the market's placid surface, the tectonic plates were quietly shifting. A financial earthquake was about to shake the world. Paulson thought he heard far-off rumblings-rumblings that the hedge-fund heroes and frenzied home buyers were ignoring.
Paulson dumped his fund's riskier investments and began laying bets against auto suppliers, financial companies, anything likely to go down in bad times. He also bought investments that served as cheap insurance in case things went wrong. But the economy chugged ever higher, and Paulson & Co. endured one of the most difficult periods in its history. Even bonds of Delphi, the bankrupt auto supplier that Paulson assumed would tumble, suddenly surged in price, rising 50 percent over several days.
"This [market] is like a casino," he insisted to one trader at his firm, with unusual irritation.
He challenged Pellegrini and his other analysts: "Is there a bubble we can short?"
p AOLO PELLEGRINI felt his own mounting pressures. A year earlier, the tall, stylish analyst, a native of Italy, had called Paulson, looking for a job. Despite his amiable nature and razor-sharp intellect, Pellegrini had been a failure as an investment banker and flamed out at a series of other businesses. He'd been lucky to get a foot in the door at Paulson's hedge fund-there had been an opening because a junior analyst left for business school. Paulson, an old friend, agreed to take him on.
Now, Pellegrini, just a year younger than Paulson, was competing with a group of hungry twenty-year-olds-kids the same age as his own children. His early work for Paulson had been pedestrian, he realized, and Pellegrini felt his short leash at the firm growing tighter. Somehow, Pellegrini had to find a way to keep his job and jump-start his career.
Analyzing reams of housing data into the night, hunched over a desk in his small cubicle, Pellegrini began to discover proof that the real estate market had reached untenable levels. He told Paulson that trouble was imminent.
Reading the evidence, Paulson was immediately convinced Pellegrini was right. The question was, how could they profit from the discovery? Daunting obstacles confronted them. Paulson was no housing expert, and he had never traded real estate investments. Even if he was right, Paulson knew, he could lose his entire investment if he was too early in anticipating the collapse of what he saw as a real estate bubble, or if he didn't implement the trade properly. Any number of legendary investors, from Jesse Livermore in the 1930s to Julian Robertson and George Soros in the 1990s, had failed to successfully navigate financial bubbles, costing them dearly.
Paulson's challenges were even more imposing. It was impossible to directly bet against the price of a home. Just as important, a robust infrastructure had grown to support the real estate market, as a network of low-cost lenders, home appraisers, brokers, and bankers worked to keep the money spigot flowing. On a national basis, home prices never had fallen over an extended period. Some rivals already had been burned trying to anticipate an end of housing's bull market.
Moreover, unbeknownst to Paulson, competitors were well ahead of him, threatening any potential windfall Paulson might have hoped to make. In San Jose, California, three thousand miles away, Dr. Michael Burry, a doctor-turned-hedge-fund manager, was busy trying to place his own massive trades to profit from a real estate collapse. In New York, a brash trader named Greg Lippmann soon would begin to make bearish trades, while teaching hundreds of Paulson's competitors how to wager against housing.
Experts redirected Paulson, pointing out that he had no background in housing or subprime mortgages. But Wall Street had underestimated him. Paulson was no singles hitter, afraid of risk. A part of him had been waiting for the perfect trade, one that would prove him to be one of the greatest investors of all. Anticipating a housing collapse-and all that it meant-was Paulson's chance to hit the ball out of the park and win the acclaim he deserved. It might be his last chance. He just had to find a way to pull off the trade.
And chase the frothy bubbles,
While the world is full of troubles.
—William Butler Yeats
GUMPSE OF WALL STREET'S TRADING FLOORS AND INVESTMENT offices in 2005 would reveal a group of revelers enjoying a raging, multiyear party. In one corner, making a whole lot of noise, were the hedge-fund managers, a particularly exuberant bunch, some with well-cut, tailored suits and designer shoes, but others a bit tipsy, with ugly lampshades on their heads.
Hedge funds gained public consciousness in the new millennium with an unusual mystique and outsized swagger. But hedge funds actually have been around since 1949, when Alfred Winslow Jones, an Australian-born writer for Fortune Magazine researching an article about innovative investment strategies, decided to take a stab at running his own investment partnership. Months before the magazine had a chance to publish his piece, Jones and four friends raised $100,000 and borrowed money on top of that to create a big investment pool.
Rather than simply own stocks and be exposed to the whims of the market, though, Jones tried to "hedge," or protect, his portfolio by betting against some shares while holding others. If the market tumbled, Jones figured, his bearish investments would help insulate his portfolio and he could still profit. If Jones got excited about the outlook of General Motors, for example, he might buy 100 shares of the automaker, and offset them with a negative stance against 100 shares of rival Ford Motor. Jones entered his bearish investments by borrowing shares from brokers and selling them, hoping they fell in price and later could be replaced at a lower level, a tactic called a short sale. Borrow and sell 100 shares of Ford at $20, pocket $2,000. Then watch Ford drop to $15, buy 100 shares for $1,500, and hand the stock back to your broker to replace the shares you'd borrowed. The $500 difference is your profit.
By both borrowing money and selling short, Jones married two speculative tools to create a potentially conservative portfolio. And by limiting himself to fewer than one hundred investors and accepting only wealthy clients, Jones avoided having to register with the government as an investment company. He charged clients a hefty 20 percent of any gains he produced, something mutual-fund managers couldn't easily do because of legal restrictions.
The hedge-fund concept slowly caught on; Warren Buffett started one a few years later, though 1s he shuttered it in 1969, wary of a looming bear market. In the early 1990s, a group of bold investors, including George Soros, Michael Steinhardt, and Julian Robertson, scored huge gains, highlighted by Soros's 1992 wager that the value of the British pound would tumble, a move that earned $1 billion for his Quantum hedge fund. Like Jones, these investors accepted only wealthy clients, including pension plans, endowments, charities, and individuals. That enabled the funds to skirt various legal requirements, such as submitting to regular examinations by regulators. The hedge-fund honchos disclosed very little of what they were up to, even to their own clients, creating an air of mystery about them.
Each of the legendary hedge-fund managers suffered deep losses in the late 1990s or in 2000, however, much as Hall of Fame ballplayers often stumble in the latter years of their playing days, sending a message that even the "stars" couldn't best the market forever. The 1998 collapse of mega-hedge fund Long-Term Capital Management, which lost 90 percent of its value over a matter of months, also put a damper on the industry, while cratering global markets. By the end of the 1990s, there were just 515 hedge funds in existence, managing less than $500 billion, a pittance of the trillions managed by traditional investment managers.
It took the bursting of the high-technology bubble in late 2000, and the resulting devastation suffered by investors who stuck with a conventional mix of stocks and bonds, to raise the popularity and profile of hedge funds. The stock market plunged between March 2000 and October 2002, led by the technology and Internet stocks that investors had become enamored with, as the Standard & Poor's 500 fell 38 percent. The tech-laden Nasdaq Composite Index dropped a full 75 percent. But hedge funds overall managed to lose only 1 percent thanks to bets against high-flying stocks and holdings of more resilient and exotic investments that others were wary of, such as Eastern European shares, convertible bonds, and troubled debt. By protecting their portfolios, and zigging as the market zagged, the funds seemed to have discovered the holy grail of investing: ample returns in any kind of market. Falling interest rates provided an added boost, making the money they borrowed-known in the business as leverage, or gearing-inexpensive. That enabled funds to boost the size of their holdings and amplify their gains.
Money rushed into the hedge funds after 2002 as a rebound in global growth left pension plans, endowments, and individuals flush, eager to both multiply and retain their wealth. Leveragedbuyout firms, which borrowed their own money to make acquisitions, also became beneficiaries of an emerging era of easy money. Hedge funds charged clients steep fees, usually 2 percent or so of the value of their accounts and 20 percent or more of any gains achieved. But like an exclusive club in an upscale part of town, they found they could levy heavy fees and even turn away most potential customers, and still more investors came pounding on their doors, eager to hand over fistfuls of cash.
There were good reasons that hedge funds caught on. Just as Winston Churchill said democracy is the worst form of government except for all the others, hedge funds, for all their faults, beat the pants off of the competition. Mutual funds and most other traditional investment vehicles were decimated in the 2000-2002 period, some losing half or more of their value. Some mutual funds bought into the prevailing mantra that technology shares were worth the rich valuations or were unable to bet against stocks or head to the sidelines as hedge funds did. Most mutual funds considered it a good year if they simply beat the market, even if it meant losing a third of their investors' money, rather than half.
Reams of academic data demonstrated that few mutual funds could best the market over the long haul. And while index funds were a cheaper and better-performing alternative, these investment vehicles only did well if the market rose. Once, Peter Lynch, Jeffrey Vinik, Mario Gabelli, and other savvy investors were content to manage mutual funds. But the hefty pay and flexible guidelines of the hedge-fund business allowed it to drain much of the talent from the mutual-fund pool by the early years of the new millennium-another reason for investors with the financial wherewithal to turn to hedge funds.
For years, it had been vaguely geeky for young people to obsess over complex investment strategies. Sure, big-money types always got the girls. But they didn't really want to hear how you made it all. After 2000, however, running a hedge fund and spouting off about interest-only 1a securities, capital-structure arbitrage, and attractive tracts of timberland became downright sexy. James Cramer, Suze Orman, and other financial commentators with a passion for money and markets emerged as matinee idols, while glossy magazines like Trader Monthly chronicled, and even deified, the exploits of Wall Street's most successful investors.
Starting a hedge fund became the clear career choice of top college and business-school graduates. In close second place: working for a fund, at least long enough to gain enough experience to launch one's own. Many snickered at joining investment banks and consulting firms, let alone businesses that actually made things, preferring to produce profits with computer keystrokes and brief, impassioned phone calls.
By the end of 2005, more than 2,200 hedge funds around the globe managed almost $1.5 trillion, and they surpassed even Internet companies as the signature vehicle for amassing fortune in modern times. Because many funds traded in a rapid-fire style, and borrowed money to expand their portfolios, they accounted for more than 20 percent of the trading volume in U.S. stocks, and
80 percent of some important bond and derivative markets.
The impressive gains and huge fees helped usher in a Gilded Age 2.0 as funds racked up outsized profits, even by the standards of the investment business. Edward Lampert, a hedge-fund investor who gained control of retailer Kmart and then gobbled up even larger Sears, Roebuck, made $1 billion in 2004, dwarfing the combined $43 million that chief executives of Goldman Sachs, Microsoft, and General Electric made that year.
The most successful hedge-fund managers enjoyed celebrity-billionaire status, shaking up the worlds of art, politics, and philanthropy. Kenneth Griffin married another hedge-fund trader, Anne Dias, at the Palace of Versailles and held a postceremony party at the Louvre, following a rehearsal dinner at the Musee d'Orsay. Steven Cohen spent $8 million for a preserved shark by Damien Hirst, part of a $1 billion art collection assembled in four years that included work from Keith Haring, Jackson Pollock, van Gogh, Gauguin, Andy Warhol, and Roy Lichtenstein. Whiz kid Eric Mindich, a thirty-something hotshot, raised millions for Democratic politicians and was a member of presidential candidate John Kerry's inner circle.
Hedge-fund pros, a particularly philanthropic group that wasn't shy about sharing that fact, 19 established innovative charities, including the Robin Hood Foundation, notable for black-tie fundraisers that attracted celebrities like Gwyneth Paltrow and Harvey Weinstein, and for creative efforts to revamp inner-city schools.
The hedge-fund ascension was part of a historic expansion in the financial sector. Markets became bigger and more vibrant, and companies found it more inexpensive to raise capital, resulting in a burst of growth around the globe, surging home ownership, and an improved quality of life.
But by 2005, a financial industry based on creating, trading, and managing shares and debts of businesses was growing at a faster pace than the economy itself, as if a kind of financial alchemy was at work. Finance companies earned about 15 percent of all U.S. profits in the 1970s and 1980s, a figure that surged past 25 percent by 2005. By the mid-2000s, more than 20 percent of Harvard University undergraduates entered the finance business, up from less than 5 percent in the 1960s.
One of the hottest businesses for financial firms: trading with hedge funds, lending them money, and helping even young, inexperienced investors like Michael Burry get into the game.
MICHAEL BURRY had graduated medical school and was almost finished with his residency at Stanford University Medical School in 2000 when he got the hedge-fund bug. Though he had no formal financial education and started his firm in the living room of his boyhood home in suburban San Jose, investment banks eagerly courted him.
Alison Sanger, a broker at Bank of America, flew to meet Burry and sat with him on a livingroom couch, near an imposing drum set, as she described what her bank could offer his new firm.
Red shag carpeting served as Burry's trading floor. A worn, yellowing chart on a nearby closet door tracked the progressive heights of Burry and his brothers in their youth, rather than any commodity or stock price. Burry, wearing jeans and a T-shirt, asked Sanger if she could recommend a good book about how to run a hedge fund, betraying his obvious ignorance. Despite that, Sanger signed him up as a client.
"Our model at the time was to embrace start-up funds, and it was clear he was a really smart guy," she explains.
Hedge funds became part of the public consciousness. In an episode of the soap opera All My Children, Ryan told Kendall, "Love isn't like a hedge fund, you know ... you can't have all your money in one investment, and if it looks a little shaky, you can't just buy something that looks a little safer." (Perhaps it was another sign of the times that the show's hedge-fund reference was the only snippet of the overwrought dialogue that made much sense.) Designer Kenneth Cole even offered a leather loafer called the Hedge Fund, available in black or brown at $119.98.
Things soon turned a bit giddy, as investors threw money at traders with impressive credentials. When Eric Mindich left Goldman Sachs to start a hedge fund in late 2004, he shared few details of how he would operate, acknowledged that he hadn't actually managed money for several years, and said investors would have to fork over a minimum of $5 million and tie up their cash for as long as four and a half years to gain access to his fund. He raised more than $3 billion in a matter of months, leaving a trail of investors frustrated that they couldn't get in. Both Mindich and Burry scored results that topped the market, and the industry powered ahead. But traders with more questionable abilities soon got into the game, and they seemed to enjoy the lifestyle as much as the inherent investment possibilities of operating a hedge fund. In 2004, Bret Grebow, a twenty-eight-year-old fund manager, bought a new $160,000 Lamborghini Gallardo as a treat and regularly traveled with his girlfriend between his New York office and a home in Highland Beach, Florida, on a private jet, paying as much as $10,000 for the three-hour flight.
"It's fantastic," Mr. Grebow said at the time, on the heels of a year of 40 percent gains. "They've got my favorite cereal, Cookie Crisp, waiting for me, and Jack Daniel's on ice. (Grebow eventually pled guilty to defrauding investors of more than $7 million while helping to operate a Ponzi scheme that bilked clients without actually trading on their behalf.)
A 2006 survey of almost three hundred hedge-fund professionals found they on average had spent $376,000 on jewelry, $271,000 on watches, and $124,000 on "traditional" spa services over the previous twelve months. The term traditional was used to distinguish between full-body massages, mud baths, seaweed wraps and the like, and more exotic treatments. The survey reported anecdotal evidence that some hedge-fund managers were shelling out tens of thousands of 21 dollars to professionals to guide them through the Play of Seven Knives, an elaborate exercise starting with a long, luxuriant bath, graduating to a full massage with a variety of rare oils, and escalating to a series of cuts inflicted by a sharp, specialized knife aimed at eliciting extraordinary sexual and painful sensations. 6
Not only could hedge funds charge their clients more than most other businesses, but their claim of 20 percent of trading gains was treated as capital gains income by the U.S. government and taxed at a rate of 15 percent, the same rate paid on wage income by Americans earning less than $31,850.
For the hedge-fund honchos, it really wasn't about the money and the resulting delights. Well, not entirely. For the men running hedge funds and private-equity firms-and they almost always were men-the money became something of a measuring stick. All day and into the night, computer screens an arms-length away provided minute-by-minute accounts of their performance, a referendum on their value as investors, and affirmation of their very self-worth.
As THE HEDGE-FUND celebrations grew more intense in 2005, the revelers hardly noticed forty-nineyear-old John Paulson, alone in the corner, amused and a bit befuddled by the festivities. Paulson had a respectable track record and a blue-chip pedigree. But it was little wonder that he found himself an afterthought in this overcharged world.
Born in December 1955, Paulson was the offspring of a group of risk-takers, some of whom had met their share of disappointment.
Paulson's great-grandfather Percy Thorn Paulsen was a Norwegian captain of a Dutch merchant ship in the late 1890s that ran aground one summer off Guayaquil, Ecuador, on its way up the coast of South America. Reaching land, Paulsen and his crew waited several weeks for the ship to be repaired, getting to know the growing expatriate community in the port city. There, he met the daughter of the French ambassador to Ecuador, fell in love, and decided to settle.
In 1924, a grandson was born named Alfred. Three years later, Alfred's mother died while giving birth to another boy. The boys were sent to a German boarding school in Quito. Alfred's father soon suffered a massive heart attack after a game of tennis and passed away.
The Paulsen boys, now orphans, moved in with their stepmother, but she had her own children 22 to care for, so an aunt took them in. At sixteen, Alfred and his younger brother, Albert, fifteen, were ready to move on, traveling 3,500 miles northwest to Los Angeles. Alfred spent two years doing odd jobs before enlisting in the U.S. Army. Wounded while serving in Italy during World War II, he remained in Europe during the Allied occupation.
After the war, Alfred, by now using the surname of Paulson, returned to Los Angeles to attend UCLA. One day, in the school's cafeteria, he noticed an attractive young woman, Jacqueline Boklan, a psychology major, and introduced himself. He was immediately taken with her.
Boklan's grandparents had come to New York's Lower East Side at the turn of the century, part of a wave of Jewish immigrants fleeing Lithuania and Romania in search of opportunity. Jacqueline was born in 1926, and after her father, Arthur, was hired to manage fixed-income sales for a bank, the Boklan family moved to Manhattan's Upper West Side. They rented an apartment in the Turin, a stately building on 93rd Street and Central Park West, across from Central Park, and enjoyed a well-to-do lifestyle for several years, with servants and a nanny to care for Jacqueline.
But Boklan lost his job during the Great Depression and spent the rest of his life unable to return the family to its former stature. In the early 1940s, searching for business opportunities, they moved to Los Angeles, where Jacqueline, now of college age, attended UCLA.
After Alfred Paulson wed Jacqueline, he was hired by the accounting firm Arthur Andersen to work in the firm's New York office, and the family moved to Whitestone, a residential neighborhood in the borough of Queens, near the East River. John was the third of four children born to the couple. He grew up in the Le Havre apartment complex, a thirty-two-building, 1,021apartment, twenty-seven-acre development featuring two pools, a clubhouse, a gym, and three tennis courts, built by Alfred Levitt, the younger brother of William Levitt, the real estate developer who created Levittown. The family later bought a modest home in nearby Beechhurst, while Jacqueline's parents moved into a one-bedroom apartment in nearby Jackson Heights.
Visiting his grandson one day in 1961, Arthur Boklan brought him a pack of Charms candies. The next day, John decided to sell the candies to his kindergarten classmates, racing home to tell his grandfather about his first brush with capitalism. After they counted the proceeds, Arthur took his grandson to a local supermarket to show the six-year-old where to buy a pack of Charms for eight cents, trying to instill an appreciation of math and numbers in him. John broke up the pack and sold the candies individually for five cents each, a tactic that investor Warren Buffett employed in his own youth with packs of chewing gum. Paulson continued to build his savings with a variety of after-school jobs.
"I got a piggy bank and the goal was to fill it up, and that appealed to me," John Paulson recalls.
"I had an interest in working and having money in my pocket."
One of Alfred Paulson's clients, public-relations maven David Finn, who represented celebrities including Perry Como and Jack Lemmon, liked Alfred's work and asked him to become the chief financial officer of his public relations firm, Ruder Finn, Inc. The two became fast friends, playing tennis and socializing with their families. Alfred was affable, upbeat, and exceedingly modest, content to enjoy his family rather than claim a spotlight at the growing firm, Finn recalls. On the court, Alfred had an impressive tennis game but seemed to lack a true competitive spirit, preferring to play for enjoyment.
"Al didn't care about winning," says Finn. "He never made a lot or cared about making a lot. He was brilliant, very sensitive and friendly, but he was happy where he was in life."
A natural peacemaker, he sometimes approached colleagues involved in a dispute and gave each an encouraging smile, instantly healing the office rift.
Jacqueline, now a practicing child psychologist, was more opinionated than her husband, weighing in on politics and business at social gatherings as Alfred looked on. She believed in giving her children a lot of love and even more leeway. Jacqueline brought the Paulson children up Jewish, and their eldest daughter later moved to Israel. Alfred was an atheist, but he attended synagogue with his family. Until he turned twelve, John had no idea that his father wasn't Jewish.
John attended a series of local public schools, where he entered a program for gifted students.
By eighth grade, Paulson was studying calculus, Shakespeare, and other high-school-level subjects.
Every summer, Alfred took his family on an extensive vacation, in the United States or abroad. By 24 his sophomore year, John was going cross-country with friends, visiting Europe a year later.
John showed signs of unusual independence in other areas as well. Though the Paulsons were members of a local synagogue, the White-stone Hebrew Centre, Paulson listed in his yearbook at Bayside High the "Jesus club" and the "divine light club" among his interests during his senior year.
By the time Paulson entered New York University in the fall of 1973, the economy was floundering, the stock market was out of vogue, and Paulson's early interest in money had faded. As a freshman, he studied creative writing and worked in film production. He took philosophy courses, thrilling his mother, who loved the arts. But the young man soon lost his interest in his studies, slipping behind his classmates. Vietnam, President Nixon, and the antiwar and civil rights protests dominated the news.
"I felt directionless," says Paulson, who wore his hair to his shoulders, looking like a young Robert Downey Jr. "I wasn't very interested in college."
After John's freshman year, Alfred sensed he needed a change and proposed that his son take a summer trip, the Paulson family remedy. He bought him an airplane ticket to South America, and that summer John traveled throughout Panama and Colombia before making his way to Ecuador, where he stayed with an uncle, a dashing bachelor who developed condominium projects in the coastal city of Salinas. His uncle appointed Paulson his hombre de confianza, or trusted right-hand man. He kept an eye out for thieves trying to steal materials from his uncle, supervised deliveries at various construction sites, and kept track of his uncle's inventories.
For a young man from Queens, Salinas was a little piece of heaven. Paulson lived in the penthouse apartment of one of his uncle's buildings, the tallest in Ecuador, with a cook, a gardener, and a housekeeper. He found the women beautiful, the weather warm, and the beach close by. He grew to admire his uncle, a charismatic bon vivant who thoroughly enjoyed himself and his money. It was as if Paulson had been reborn into an affluent side of the family; he put off his return to NYU to extend his time in Ecuador.
"It brought me back to liking money again," Paulson remembers.
There was only one drawback: His family was conservative and proved too confining for a young 2s man just beginning to enjoy his independence. Paulson wasn't allowed to date without a chaperone and could choose only young women from the right families, as designated and approved by his uncle.
One day, Paulson met a pretty sixteen-year-old at one of his job sites, a young woman who turned out to be the daughter of the chief of police of Salinas. He invited her back to his apartment for dinner, asking his cook to whip up something for them to eat. The cook quietly called Paulson's uncle to tip him off. Soon an associate of Paulson's uncle came to the door. "What's going on in there?! What's going on?!" he demanded. He pulled aside Paulson and said, "We can't have that type of person here."
The young woman fled the apartment, running into the night.
Eager to be on his own, Paulson moved to the capital city of Quito, before traveling elsewhere in Ecuador. When he soon ran out of money and needed to drum up some cash, he discovered a man who manufactured attractive and inexpensive children's clothing; Paulson commissioned some samples to send to his father back home in New York. His father took the samples to upscale stores such as Bloomingdale's, which ordered six dozen shirts, thrilling the Paulsons. They continued to sell and Paulson hired a team in Ecuador to produce more shirts, spending evenings packing and shipping boxes of the clothing, learning to operate a business on the fly.
Later, though, as orders piled up, Paulson missed a delivery date with Bloomingdale's and they canceled the order. He was stuck with one thousand unwanted children's shirts, which he had to store in his parents' basement. Years later, whenever Paulson needed a little extra spending money, he would return to Queens, grab some shirts out of a box, and sell them at various New York retailers.
Another time during his two years in Ecuador, Paulson noticed attractive wood parquet flooring in a store in Quito. He tracked down the local factory that produced it and asked the owner if he could act as his U.S. sales representative, in exchange for a commission of 10 percent of any sales. The man agreed, and Paulson sent his father a package of floor samples, which Alfred showed to people in the flooring business in New Jersey. They confirmed that the quality and pricing compared favorably with that available in the United States. By then, Alfred had left Ruder Finn, 2s Inc. to start his own firm, but he made time to help his son. Working together, the Paulsons sold $250,000 of the flooring; his father gave John their entire $25,000 commission. The two spoke by phone or wrote daily while John was in Ecuador, bringing them closer together. It was John Paulson's first big trade, and it excited him to want to do more.
"I found it a lot of fun, and I loved having cash in my pocket," Paulson recalls.
Paulson realized that a college education was the best way to ensure ample cash flow, so he returned to NYU in 1976, newly focused and energized. By then, his friends were entering their senior year, two years ahead of Paulson, and he felt pressure to catch up. His competitive juices flowing, Paulson spent the next nineteen months accumulating the necessary credits to graduate, taking extra courses and attending summer school, receiving all As.
Among his classmates, Paulson developed a reputation for having a unique ability to boil down complex ideas into simple terms. After lectures on difficult subjects like statistics or upper-level finance, some approached Paulson asking for help.
"John was clearly the brightest guy in the class," recalls Bruce Goodman, a classmate.
Paulson was particularly inspired by an investment banking seminar taught by John Whitehead, then the chairman of investment banking firm Goldman Sachs. To give guest lectures, Whitehead brought in various Goldman stars, such as Robert Rubin, later secretary of the Treasury under Bill Clinton, and Stephen Friedman, Goldman's future chairman. Paulson was transfixed as Rubin discussed making bets on mergers, a style of investing known as risk-arbitrage, and Friedman dissected the world of mergers and acquisitions deal making.
An avid tennis player, like his father, Paulson sometimes invited friends to the Westside Tennis Club in Flushing, New York, where his father was a member, to play on the grass courts that served as home to the U.S. Open. But he rarely invited them back home, and some never even knew he was a native of Queens. For years, Paulson would simply say that he was from New York City.
It was his classmate, Bruce Goodman, who began calling Paulson "J.P.," a reflection of Paulson's initials as well as a sly allusion to J.P. Morgan, the legendary turn-of-the-century banker. The nickname, which stuck for the rest of his life, spoke to Paulson's obvious abilities, his growing ambition, and his blue-blood aspirations. Paulson smiled when he heard the new nickname, appreciating the compliment and the double entendre.
Paulson graduated first in his class from NYU with a degree in finance. As the valedictorian of the College of Business and Public Administration, he delivered a speech about corporate responsibility. A dean at the school suggested that he apply to Harvard Business School. Although Paulson was only twenty-two and didn't have much business experience, he cited the lessons of his business in Ecuador in his application; he not only gained acceptance but won the Sidney J. Weinberg/ Goldman Sachs scholarship.
One day at Harvard Business School, a classmate, on the way to a meeting of Harvard's investment club, approached Paulson, telling him, "You've got to hear this guy Kohlberg speak."
Paulson had never heard of Jerry Kohlberg, founder of investment powerhouse Kohlberg Kravis Roberts & Co., but he tagged along, one of only a dozen students to show up. Kohlberg, an early pioneer of so-called leveraged buyouts, brought two bankers with him, and they walked through the details of how to buy a company using little cash and a lot of borrowed money. Then Kohl berg detailed how KKR put up $500,000 and borrowed $36 million to buy an obscure company that they sold six months later, walking away with $17 million in profit.
For Paulson, it was a life-changing experience, like seeing the Beatles for the first time, one that opened his eyes to the huge paydays possible from big investments. Paulson calculated that partners at Goldman Sachs like Whitehead and Rubin made just $500,000 that year, a figure that seemed puny next to what could be made by Kohlberg Kravis Roberts & Co.
Jerry Kohlberg can make $17 million on just one deal, thought an astounded Paulson.
In his developing worldview, the acquisition of massive wealth deserved unabashed admiration. John Whitehead and Jerry Kohlberg played the game fairly, with intelligence and diligence. To Paulson, they seemed deserving of the rewards they commanded. During his second year in business school, Paulson undertook a research project to identify the key players in the leveragedbuyout industry. Upon graduation, Paulson assumed that he, too, would head to Wall Street.
Paulson graduated a George F. Baker Scholar in 1980, in the top 5 percent of his class. But when 2a firms came to recruit on campus, it was the consulting firms that offered the largest starting salaries, getting Paulson's attention. Wall Street was still battling a bear market. So Paulson accepted a job at Boston Consulting Group, a prestigious local firm that recruited only at upperechelon schools.
Early on in his new job, Paulson was asked to help Jeffrey Libert, a senior consultant, advise the Washington Post Co. on whether to invest in real estate. Paulson initially was bullish on the ideathe Paulson home in Beechhurst had increased in value over the previous two decades, and housing seemed like a good investment.
Libert, the same age as Paulson and also a native New Yorker who graduated Harvard Business School, showed Paulson a chart mapping the impressive growth of housing prices over the previous few decades. But when Libert factored in the rise of inflation over that period, the annual gains for housing turned out to be a puny 1.5 percent. Unless you can find an inexpensive home or building that can be purchased for less than its replacement cost, Libert argued, real estate isn't a very attractive investment.
"I was amazed to see that," Paulson says. "I wasn't an investor, so it didn't have meaning at the time, but the low rate of growth always stuck in my mind."
The work Paulson did at Boston Consulting Group was research intensive, and he excelled at it.
An upbeat presence in the office, he chatted up and even flirted with the secretaries and others, most of whom liked Paulson much more than his less-approachable colleagues. But Paulson quickly realized he had made a mistake joining the firm. He wasn't investing money, he was just giving advice to companies, and at an hourly rate no less. To the other executives at the firm, Paulson seemed out of place and uncomfortable.
"John would say, 'How can I make money off this' while others were giving advice," Libert remembers. "BCG was really about a bunch of geeks sitting around seeing who's smarter than the next guy, and that made him impatient. He seemed to have an instinctual sense of how to make money."
Paulson, for example, was taken with the story of Charlie Allen Jr., a high-school dropout who built an investment firm, Allen & Co., into a powerhouse in the first half of the twentieth century. "The shy Midas of Wall Street," Allen took taxis while members of his family enjoyed chauffeured Rolls-Royces. In 1973 Allen's firm took control of Columbia Pictures after an accounting scandal left it weakened, then sold it to Coca-Cola nine years later in exchange for Coke stock. Later Coke shares soared and Allen pocketed a billion-dollar profit. (Years later, Paulson would recall details of the transaction by memory, as if reciting the batting average of a favorite baseball player.)
Paulson wanted to move to Wall Street. But when he applied for various jobs, he found that his consulting experience accounted for very little. He didn't want to start at the bottom of the ladder with recent grads, placing him in a quandary. At a local tennis tournament, Paulson saw Kohlberg in the stands and approached him, telling the LBO doyen how much he had enjoyed his lecture at Harvard. Kohlberg invited the young man to drop by his New York office.
At their meeting a few days later, Paulson confided to Kohl berg, "I went into the wrong career." He asked for Kohlberg's help in finding a position on Wall Street.
Kohlberg didn't have any openings at KKR. When Paulson asked if Kohlberg might introduce him to other heavy hitters in the buyout world like Leon Levy at Oppenheimer & Co., Kohlberg picked up the phone and got him an appointment.
A few weeks later, Paulson went to Levy's Park Avenue apartment for an interview. He had never seen anything like it before-everywhere he looked he saw antiquities, collectibles, and objets d'art. Paulson couldn't help but gawk, unsure if the busts around the home were Roman, Greek, or of some other origin he knew even less about. Paulson felt that if he moved too quickly in any direction, he would knock over one of Levy's priceless pieces, a move unlikely to further his career. Sitting down, carefully, he began to talk with Levy, sipping coffee from delicate fine porcelain. It turned out that Levy was looking to expand his firm and needed a smart associate. By the end of the day, Paulson had landed a job.
Paulson was so eager to leave the world of consulting that he hadn't thought to ask many details about the firm he had joined. It turned out that Paulson had been hired by Oppenheimer, a partnership that owned a larger brokerage firm as well as an investment operation run by Levy and Jack Nash. When Paulson opened the door to his new office, he found another young Jo executive, Peter Soros, sitting in his seat. "What are you doing in my office?" Paulson snapped. "What are you doing in my office?" Soros replied.
A stare-down ensued, as neither Paulson nor Soros would vacate the room. "It wasn't the friendliest meeting," recalls Soros, a nephew of George Soros, who had been hired by another Oppenheimer executive, unbeknownst to Paulson. Eventually, however, Soros and Paulson became close friends.
Days later, Oppenheimer split up, with Levy and Nash leaving to start their own firm, Odyssey Partners. They convinced Paulson to join them. The move gave Paulson an enviable opportunity for hands-on experience working with Levy and Nash, who already were Wall Street legends with a string of successful investments. They later raised $40 million for John DeLorean, the auto executive famous for the sports car with gull-winged doors, among a string of high-profile transactions.
At Odyssey, Levy pushed Paulson to search for leveraged buyouts with the potential for huge, long-term upsides, Levy's specialty. He and his partners once paid less than $50 million to purchase the Big Bear Stores Co., a regional grocery chain, and immediately recouped their investment by claiming a fee that was almost as much as their entire investment. They gave management incentives to improve operations, and eventually walked away with a $160 million profit.
Paulson focused on underappreciated conglomerates selling at inexpensive prices. The firm bought a position in TransWorld Corp., a company weighed down by the struggling operations of its TWA Airlines. But TransWorld also owned Hilton Hotels, Century 21, and other profitable businesses. Levy and Paulson figured that if they broke up the company, investors would focus on the value of the other businesses and the stock would soar. So Odyssey bought a big position in the stock. But TransWorld resisted a breakup and fought back, resulting in a nasty public squabble. The Odyssey team eventually profited from the venture, but it taught Paulson a lesson in how difficult the buyout business could be.
After a couple of years, Levy and Paulson realized that Paulson didn't have the experience to excel at his job. Nash agreed a change needed to be made. Paulson was smart and presented his ideas well, but he hadn't learned the financial skills necessary to lead buyout transactions, nor did he have a thick Rolodex of contacts in the corporate world to pull them off on his own.
"As much as Leon and I liked each other, they needed someone more senior," Paulson says. Looking for a new job, once again, Paulson now was more than four years behind his classmates from business school. Several investment banks offered him entry-level positions, where he would join the most recent business school graduates, but it was something he resisted. An opportunity at Bear Stearns suited him much better. The firm was just below the upper echelon of the investment banking business, and it didn't have extensive databases or other resources to help bankers compete. Banking wasn't even a focus at Bear; Dick Harriton's clearing operation was minting money loaning out customers' stock, Bobby Steinberg ran a top risk-arbitrage operation, and Alan "Ace" Greenberg was working magic on the trading floor.
What Bear did have in spades was a group of smart, hungry bankers who shared Paulson's lust for money. The firm was hoping to win business from the same financial entrepreneurs that Paulson was so enamored with and saw him as an obvious match.
Joining Bear Stearns in 1984, Paulson, now twenty-eight, quickly climbed the ranks, working as many as one hundred hours per week on merger-and-acquisition deals. Four years later he was rewarded with the title of managing director, catching up to and surpassing classmates from his graduating class. Other bankers boasted of their deal-making prowess and tried to impress clients with insights into high finance. But Paulson often took a more low-key approach, chatting about art or theater before discussing business. While he could snap at subordinates if they made mistakes, and often was curt and direct, Paulson impressed most colleagues with a cheerful, confident disposition.
"It was all about M&A in the eighties; bankers were Masters of the Universe. But John didn't take himself very seriously; he got the joke," recalls Robert Harteveldt, a junior banker at the firm who sometimes socialized with Paulson. "A lot of guys walked into a room, said they worked in M&A, and expected girls to melt, but John was debonair. He tried to charm women and was more interested in them than in saying who he was."
Paulson gravitated to Michael "Mickey" Tarnopol, a handsome senior banker and absolute force of nature. Upbeat and outgoing, Tamopol was admired for the big deals he reeled in for the firm. But he was held in equally high esteem for the lavish parties he hosted at his Park Avenue and Bridgehampton homes, as well as for his exploits on the polo field and for a surprisingly sturdy marriage to his high-school sweetheart.
Paulson was impressed when Tamopol succeeded in convincing a valued secretary to cancel her planned move to California, after Paulson and others failed to persuade her to stay at the firm. Amazed, Paulson asked him how he did it.
"A salesman's job starts when the customer says no," Tarnopol responded, a comment Paulson would take to heart and repeat years later.
Tamopol opened doors for Paulson on Wall Street and introduced him to key investors. For his part, Paulson considered Tarnopol, who had no sons of his own, something of a "second father," according to one friend. Paulson was included in family occasions, played polo with Tarnopol in Palm Beach, Florida, and spent weekends at Tarnopol's Greenwich estate. Rather than emulate the veteran banker and settle down, however, Paulson became increasingly enamored with a newly discovered passion: New York's after-hours world.
OHN PAULSON didn't seem like an obvious candidate to embrace the city's active social scene.J Though friendly and witty, Paulson could be quite stiff and formal, usually donning a jacket, if not a tie, in the evening hours. If a conversation bored him, Paulson sometimes walked away midsentence, leaving companions befuddled.
But Paulson thoroughly enjoyed socializing and soon hosted parties for several hundred friends and acquaintances in a loft he rented in Manhattan's trendy SoHo neighborhood, where he mingled with wealthy bankers, models, and celebrities like John F. Kennedy Jr. Throngs attended Paulson's annual Christmas party, and he would place small presents for his guests under the tree.
Many evenings, Paulson and a group of friends enjoyed a late dinner before hitting popular dance clubs like Nella's, Xenon, or The Underground. Sometimes the group traveled from uptown clubs to downtown spots, all on the same night. Paulson joined Le Club, a members-only club on Manhattan's East Side owned by fashion designer Oleg Cassini, where he would chat with highrollers such as billionaire arms dealer Adnan Kashoggi, record impresario Ahmet Ertegun, and Linn Ullmann, daughter of Ingmar Bergman and actress Liv Ullmann.
Despite his charm and flash, Paulson often chose to live in apartments that seemed grim to others, or were furnished in surprisingly pedestrian ways, with odd, plastic trees or ragged furniture. One of his apartments was located above a discount-shoe store.
At Bear Stearns, Paulson regaled younger colleagues with self-deprecating stories of dates that went awry, an appealing contrast to other bankers who took themselves far too seriously. Others at his level had cars waiting outside the office, but Paulson usually grabbed a bus or the subway, sometimes splitting a cab with Harteveldt, his junior colleague.
Before long, Paulson began to chafe at Bear Stearns. He was working long days and into most evenings, but too many bankers laid claim to the deals he had worked on, shrinking his slice of the profit pie. Paulson didn't play the political game very well, and was uncomfortable cozying up to the firm's partners, who determined annual bonuses.
In one deal, Paulson helped score a $36 million profit for Bear Stearns after the bank, along with an investment firm called Gruss & Co., made a $679 million buyout offer for Anderson Clayton Company, a food and insurance conglomerate. The $36 million score was a drop in the bucket at Bear Stearns, where it was divided among hundreds of partners. But Paulson noticed that Gruss, which hadn't previously undertaken a buyout, divided the same $36 million among just the firm's five partners. To Paulson, there seemed to be a limit to how much money he could make at a large firm like Bear Stearns, especially since most of its profit came from charging customers fees rather than undertaking deals like Anderson with a huge upside. Yet those were the ones he pined for.
Few were surprised in 1988 when Paulson told Bear Stearns executives he was leaving to join Gruss. They long ago figured that Paulson at some point would want to launch a career making investments of his own.
Gruss & Co. specialized in merger-arbitrage, taking a position on whether or not a merger would take place and investing in shares of companies being acquired. The firm hadn't undertaken buyouts on its own, but the Anderson experience convinced the firm's founder, Marty Gruss, to test the waters more deeply. He asked Paulson to lead a new effort to do similar buyout deals, hoping to potentially rival firms like KKR. Gruss was so eager to hire Paulson that he agreed to make
Paulson a general partner and give the young banker a cut of profits racked up by other groups at the firm.
Watching Gruss and his father, Joseph, up close, Paulson quickly picked up the merger-arbitrage business. By buying shares of companies being acquired, and selling short companies making acquisitions, Gruss was able to generate profits that largely were shielded from stock-market fluctuations. The ideal Gruss investment had limited risk but held the promise of a potential fortune. Marty Gruss drilled a maxim into Paulson: "Watch the downside; the upside will take care of itself."
Paulson's buyout business never really took off, however. The 1989 indictment of junk-bond king Michael Milken and a slowing economy made it hard to finance buyouts, and Martin Gruss seemed distracted, perhaps due to a recent second marriage. Soon he and Paulson parted company.
Despite Paulson's fierce ambition and his love of making money and landing big deals, other urges were distracting the thirty-five-year-old.
"John was throwing great parties in his loft; he was enjoying his bachelorhood, shall we say," Gruss recalls. "John was very bright but he was a little bit unfocused; he had a tendency to burn the candle at both ends."
On his own, Paulson had more time to devote to his extracurricular interests. He certainly didn't feel undue pressure to make money. Several years earlier, Jim Koch, a colleague in a nearby cubicle at Boston Consulting Group, came to Paulson to ask for an investment in a brewery he was launching. Koch told Paulson that a number of others at the consulting firm, along with several Harvard alumni from Paulson's graduating year, were investing in his company, and that Paulson would regret it if he passed on the opportunity.
Paulson gave him $25,000. Now the company, the parent of the Samuel Adams brand, was a raging success, and Paulson's investment was worth several million dollars. He also retained an interest in some of Gruss's businesses, receiving regular checks from the firm.
Paulson searched for new interests. He invested in a Manhattan night club, a disco, and various real estate deals. He bought an apartment building in Westchester with a friend, completed a triathlon, and traveled throughout the East Coast scouting various properties.
While many of his contemporaries had begun families, Paulson's circle of well-educated, highly Js cultured, and privileged friends tended to focus on enjoying life. They were too distracted to settle down. The group spent much of the summer in the Hamptons, the wealthy enclave on the south shore of Long Island. Weekends sometimes began with a lunch of grilled salmon and pasta for as many as one hundred people at a friend's home in Sagaponack, a town known for having the highest median income in the country. Lunch started around 1 p.m. and continued into the evening, with new arrivals joining as they came from work or nearby parties. The gatherings usually featured engaging conversation amon
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|Michael quickly became enamored with making money. Sometimes he'd wash dollar bills, drying them off with a towel and placing them between the pages of thick books on his shelf to make them look crisp and new. Working odd jobs on Sundays and holidays, including an $11-anhour stint at a local IBM research lab, he built a small savings account that he began to invest in mutual funds. Once, when the funds dropped sharply and he struggled to figure out why, his father wagged a finger.
"I told you, I told you," James Burry said. "They're going to take all your money."
His parents had remarried each other by the time Michael began Santa Teresa High, though the squabbling continued. As an outlet, he turned to sports, joining South Valley Aquatics, a prestigious local swimming club. He embraced the team's daily regimen, waking at 4:30 a.m. for practice and doing five hours of laps each day. He discovered a fierce competitive streak and relished his coach's positive feedback.
At school, Burry became more comfortable airing his opinions. The better his grades became, the later his father let him stay out at night. Michael soon began to equate academic achievement with freedom. He reckoned that if his grades were good enough, he'd be allowed to choose a college far away. That was all the incentive he needed; he scored As in almost every subject and aced the SATs, the college aptitude test. As he grew, his body adjusted to the artificial eye and he became more adept at taking care of it, another boon to the young man's self-assurance.
At a local swim meet, Burry's coach talked him up to Harvard University's swim coach, who suggested that Burry had a great shot to gain acceptance to Harvard. With help from a supportive English teacher, Burry sent in an application. But his guidance counselor submitted an incomplete form and Harvard rejected him. Burry was dejected for weeks, despite gaining admission to UCLA.
Partly to please his father, Michael enrolled in premed courses at UCLA, like many of his classmates. But he couldn't seem to blend in with the other students, feeling out of place in sunny Southern California. On most nights, classmates headed out to party while Burry waved good-bye from the dorm's study area.
Burry seemed cocky and tactless to some, and he couldn't figure out how to change the perception. It was as if he were missing some sensitivity chip. During his freshman year, he remarked that the school's premed classes seemed too easy. Other times he suggested that most of the undergraduate body was lazy, and he ridiculed the lengths that classmates took to be accepted by various fraternities and sororities.
He forced himself to listen rather than dominate conversations but continued to feel strangely disconnected from his classmates. Years later, Burry would be diagnosed with Asperger's syndrome, a variant of autism characterized by difficulties in social interactions.
His relationships with UCLA's faculty sometimes were just as strained. As a junior majoring in English, he was accused by a teaching assistant of plagiarizing a term paper. The instructor didn't have any proof; he simply said, "All I know is an undergraduate didn't write this."
Around this time, Burry rediscovered a passion for the stock market, drawn by what he considered to be the meritocracy of investing. It didn't matter if a mutual-fund manager was perceived as arrogant or was socially awkward, Burry figured, just as long as he produced good returns. Making a lot of money seemed among the most concrete and objective signs of success.
He opened a brokerage account with his summer earnings and skipped lectures to focus on his portfolio, purchasing class notes near the end of each quarter to help cram before final exams.
Burry soon switched his major to economics, while still juggling premed courses. In 1991, Burry was accepted to Vanderbilt University's medical school, where he thrived. A local ocular plastic surgeon succeeded in attaching his long-dormant extraocular muscles to a hydroxyapatite ball implanted in his left socket, and a more natural-looking artificial eye was made to fit over the ball. The result was realistic movement in the eye for the first time.
During Burry's third year of medical school, his father died after a short battle with lung cancer.
The death was so sudden that Burry never had a chance to say good-bye; he was unable to hold n
back tears long enough to speak at the funeral.
In the wake of his father's death, Burry adopted a detached aloofness. Classmates saw him as unapproachable, and he did little to try to change the perception.
"Everyone there was incredibly good-looking and superintelligent; I felt like a lower quintile as a person," he recalls.
Instead of using inheritance money to pay off mounting student loans, Burry poured it into the market, finding comfort and profit in his investments. Eager to share his budding investing views, Burry started an early Web site to discuss stocks, posting lengthy pieces several times a week. Several months later, an executive of the MSN online network came across Burry's site and offered him $1 a word if he'd become an MSN columnist.
"A dollar a word? I can write a lot of words," Burry joked, hungry for extra cash. He became known as "The Value Doc," weighing in on various stocks.
Burry's writing was raw, and his knowledge of the market had gaping holes. But he conducted valuable research on overlooked stocks and his insights seemed to resonate with readers.
Many evenings, Burry wandered into a local Office Depot, rummaging through the new items.
He was imagining what it might be like to run his own business. His behavior drew stares from the stores' employees, though they soon learned Burry was harmless and better left alone. Burry's life became a grueling mix of stock research, online postings, and a demanding medical internship. He avoided spending much time with fellow students.
Burry finished medical school in 1997, facing $150,000 of tuition-related debt. He accepted a residency in pathology at Stanford University Hospital and moved back to his childhood home in San Jose, claiming a bedroom down the hall from his brother.
That fall, on a dare from a friend, Burry placed a personal ad on Match.com. He chose a blunt approach: "I'm single and have one eye and a lot of debt." Just minutes after posting the ad, Burry received an e-mail from Anh-Thi Le, a woman who worked in corporate finance in nearby Palo Alto and was thrilled to find someone downplaying his qualities rather than exaggerating them. A whirlwind, three-week courtship and an engagement with Anh-Thi Le ensued.
At Stanford Burry soon suspected that he didn't measure up against his more-focused medical 1a colleagues. But he was making thousands of dollars a month through his trading and the online column, enough to buy a black Dodge Dakota truck and enjoy some extra spending money.
On his way to the hospital each morning, Burry drove through the heart of Silicon Valley, passing the world's most prestigious venture-capital firms. The local technology industry was humming, but Burry felt strangely out of place. One afternoon in 1999, a dozen doctors crowded around a small computer terminal in the clinic, almost cheering as shares of the latest technology wonder, Atmel Corp., soared. They debated which high-tech stock was more attractive, Applied Materials, Cisco Systems, or Polycom. Burry, who by then had switched to become a neurology resident, and at night was posting online columns arguing that all those stocks were wildly overpriced, bit his lip, wary of letting them know about his side job.
This isn't going to end well. Sell! Sell! Sell!
The bursting of the dot-com bubble in the spring of 2000, and the sudden losses suffered by his fellow doctors, confirmed to Burry the tendency of markets to go to extremes. By then he was posting late-night articles on a Web site of his own, valuestocks.net, after a long day tending to patients.
By the time his residency ended in June 2000, Burry, twenty-nine, had had enough of medicine. He had married Anh-Thi, and she, too, had moved into his parents' house, where the couple lived with Burry's brother.
Although Burry didn't know what a hedge fund was, he had read how Warren Buffett began his career with a partnership, to invest for himself and others. Burry figured he'd do the same. He obtained a one-year forbearance on his loans, and his family agreed to buy small stakes in his firm, giving Burry time to make a go of it. Anh-Thi emptied her retirement account to give her new husband more cash to invest. His broker at Bank of America, Alison Sanger, set him up with an account, and Burry's hedge-fund career was under way.
Two weeks later, a New York investor named Joel Greenblatt called Burry, disturbing the quiet of his living-room office, next to the drum set.
"Michael, I've been reading your work for a while, and I read that you're leaving medicine," Greenblatt said. It turned out that Greenblatt had been monitoring Burry's Web site. "You're a really talented analyst. My firm would like to make money from your ideas."
Greenblatt, who managed his own hedge fund and had published an investing book with a cult following, flew Burry and his wife to New York for a meeting, putting them up in the penthouse suite of the Intercontinental Hotel. A friend urged Burry to dress up for the meeting, so he stopped at a Tie Rack store and struggled to put on a blue tie as he rode the elevator. Greenblatt greeted him wearing an open-collar shirt; his partner, Rob Goldstein, was dressed in a sweater and jeans, putting Burry immediately at ease.
Greenblatt skipped the chitchat. He told Burry that he wanted a stake in his new business.
"I want to give you a million dollars," Greenblatt told him, pausing for effect.
Without missing a beat, Burry replied: "After tax." Burry sold Greenblatt a 22.5 percent piece of the business, using the proceeds to pay off his school loans. He named his firm Scion Capital, inspired by the book The Scions of Shannara, a Terry Brooks fantasy novel. Burry would be a scion of investing greats such as Buffett and Benjamin Graham, although he would chart his own path. Back in California, he rented a small office in a suburban office park, blocks from the headquarters of Apple Computer. The office had been Apple's cofounder Steve Wozniak's, which Burry took as an auspicious sign.
Burry wasn't very good at courting clients, but he figured if his results were strong enough, investors would line up. Early on in his fund, after top executives of Avanti Software were charged with stealing secrets from a rival and the stock plunged to $2 per share, Burry determined that customers still were relying on Avanti's products. So he bought all the shares he could afford. Just months later, he watched the stock shoot up to $22, his first coup.
As WorldCom weakened, Burry's clients urged him to buy the discounted shares. But he resisted, unable to figure out why the telecom giant's profits were so much fatter than those of its competitors. The company must be fudging its accounting, he concluded. In the summer of 2002, so
WorldCom admitted to accounting fraud and filed for bankruptcy, vindicating Burry. He beat himself up, though, for not profiting from the shares' collapse. He kept asking himself, what could
I have done differently?
Leafing through the finance section of a local bookstore, Burry found a particularly dense tome, Credit Derivatives & Synthetic Structures: A Guide to Instruments and Applications, that explained the knotty world of credit-default swaps, or CDS. The terminology sounded complex, and it was a slow slog getting through the jargon. But for Burry, it was like stumbling into an alternative world he never knew existed, one rife with possibility. While CDS contracts rarely garnered any mention in newspapers or on financial television, and most stock-focused investors hardly knew they existed, Burry discovered that the CDS market had soared to $2 trillion from about $100 billion the previous decade, becoming among the world's largest financial markets.
Burry quickly realized CDS contracts were not very different from everyday insurance contracts. A buyer of a CDS contract agreed to pay a premium, in regular installments, as with any insurance contract, in exchange for protection sold by the seller of the CDS. But instead of guarding against damage to a house or car, CDS contracts offered a relatively easy way to prevent damage to an investment portfolio resulting from a company's running into problems paying its debts.
If he was holding $1 million of IBM bonds, and was worried that the company might miss a debt payment, he could just buy a CDS contact costing as little as $10,000 annually, and receive a guarantee from the seller of the CDS to make him whole in the event IBM defaulted. If IBM ran into problems, or even looked like it might do so, the value of the CDS insurance contracts could be expected to rise in value. But if IBM proved a solid creditor, the CDS insurance contract would expire, and the buyer of the insurance would have lost only the annual cost of the insurance, just like any holder of insurance if a catastrophe never takes place.
Shorting shares of IBM could lead to big losses if the stock somehow soared, but losses from CDS contracts were capped. To Burry, CDS insurance seemed like the perfect kind of investment to own the next time he spotted trouble ahead.
By 2003, Burry was managing $250 million of client money, making $5 million a year. He and a1 his wife, with two children in tow, found a six-bedroom home in the nearby upscale community of Saratoga. It had sat on the market for more than two years, as the dot-com collapse weighed on local housing. The owners had asked $5.4 million for the home. Burry offered $3.8 million, and his bid was accepted.
Burry had a growing sense that other parts of the country might have their own housing problems. A number of investors were warming to shares of home builders and other real estate business, which seemed inexpensive given their growing earnings. But Burry's doubts grew as he studied the market.
He began to dig into the history of housing and why certain neighborhoods decay, and discovered that the value of land went nowhere in the sixty years preceding the 1940s, when the government began subsidizing the home purchases of returning Gis.
"It struck me that three generations had passed" since the last ugly period of real estate, says Burry, who wrote a long letter to his investors in the middle of 2003, warning about looming housing dangers. "There were no senior family members left who could, from experience, warn their children and grandchildren about the dangers of falling home prices; everyone felt that home appreciation was a right."
He read that PMI Group, one of the largest insurers of home mortgages, and a stock that had become quite popular, had moved beyond its traditional business of writing insurance for individual mortgages to insuring mortgage-backed securities, or MBS. The world of MBS and other complex-bond investments seemed to exist in another galaxy from Burry's easy-to-follow stocks.
Banks and other lenders who made home loans didn't usually hold on to them anymore, Burry realized. Instead, 80 pecent of home mortgages were sold to Wall Street firms and large companies, like Fannie Mae and Freddie Mac, soon after the closing on a home. These players pooled a hundred or so home mortgages, and used the stream of cash from the monthly principal and interest payments of the loans to back bond investments called mortgage-backed securities that were sold to investors around the globe. Burry also learned about the various slices, or tranches, of mortgage-backed securities, and how each carried a different yield, and risk profile. a2
To PMI's executives, insuring against missed payments from these MBS slices seemed like a natural extension of their traditional business. But Burry couldn't help but wonder whether PMI could be hurt if real estate slowed and borrowers ran into problems, something that could send the value of all those mortgage bonds falling. Remembering his experience with WorldCom, he picked up the phone to dial Veronica Grinstein, his broker at Deutsche Bank, at her office in New York.
"You guys trade credit derivatives, don't you?" Burry asked her. "How do I get started trading?"
Over the next few months, Burry purchased credit-default swaps protecting $800 million of bonds issued by a range of financial companies, including PMI and other mortgage insurers, as well as housing-related institutions like Fannie Mae. If the debt went bad, the value of the protection would soar in value, Burry figured; if it didn't, he was out just the $6 million or so annual cost of the insurance. By the end of 2003, 20 percent of Scion's portfolio was made up of these CDS contracts. He kept buying more throughout 2004. Scion's positions fell in value as housing strengthened throughout the year, but Burry offset the losses with gains from stocks in the rest of his portfolio, like McDonald's.
By the spring of 2005, Burry was managing about $600 million of investor money. He had also agreed to payouts totaling about $100 million over the course of five years for CDS protection against $6.5 billion of debt issued by various financial companies. But his positions dropped further in value. Burry grumbled to his wife that the Fed chairman Greenspan had replaced the tech bubble with a housing bubble. The country, he complained, would eventually suffer.
"It's just not right; it's manipulation," he insisted. His wife nodded patiently, already accustomed to her husband's periodic rants.
Years earlier, during an e-mail discussion on his Web site about the origins of past real estate bubbles, an older reader warned Burry: "Watch the lenders, not the borrowers-borrowers will always be willing to take a great deal for themselves. It's up to the lenders to show restraint. When they lose it, watch out."
So that's where Burry looked next. Traditional lenders, such as Bank of America, J.P. Morgan a3 Chase, and Countrywide, were being elbowed out of the mortgage business by upstart lenders with vaguely New Age names, including Ameriquest, Novastar, and New Century Financial.
Burry trolled the Internet for mortgage-lending Web sites; the terms were foreign but seemed slightly ominous. "Interest-only loans" reminded Burry of a type of loan flogged in the 1920s by door-to-door mortgage salesmen and later sworn off by bankers because borrowers had problems making the payments. Burry did a Google search for terms such as quick approval and no down payment and was stunned by the number of hits he got. Burry found some borrowers were taking out loans that were bigger than the purchase price of homes they were buying. A fifth-grader with an allowance could qualify for some of the loans offered, it seemed.
Burry holed up in his office, hour after hour, wearing a T-shirt, surfer shorts, and Birkenstocks, reading abstruse mortgage documents. Then he'd turn off the lights, close his eyes, and think.
Lenders have finally lost it, he realized. I have to take advantage of this.
Burry's wagers against various financial companies hadn't worked so far. But maybe there was a way to bet against mortgages themselves. He called a trader, asking if he could buy CDS protection for pools of risky mortgages, rather than on companies in the mortgage business, as he had done so far. The bank might be able to write a CDS contract for him, the trader responded, but it would take time to work out the complicated language of the agreement. And it wasn't the kind of thing Burry could sell to another investor.
No dice, Burry said. He was worried that if he entered into such a deal, he'd be stuck. If financial markets quaked and the bank suffered, it might not make good on its end of any contract with him.
Burry had another idea, though. He called Angela Chang, who had replaced Grinstein as his broker at Deutsche Bank. I want to be your first call when they standardize these things, he told her, making them easy to buy and sell. Wall Street loved to roll out new products-protection on toxic mortgages had to be their next trick, Burry concluded.
"It's going to happen, you'll be selling it eventually," Burry said. "When this starts, call me right away. It's going to be huge."
Hanging up, Burry thought, This will be my Soros trade.
ACK IN NEW YORK, Greg Lippmann, a trader at Deutsche Bank who had never quite fit in on Wall Street, was meeting with a few rivals to plot a change in the way debt was traded. He would set the groundwork for Burry and others to bet against housing, just as Burry had anticipated.
From the time he first arrived at Credit Suisse First Boston a decade earlier, Lippmann seemed out of place. He wore his hair a bit long and slicked back, as if he was an extra in the movie Wall Street. A strong chin further distinguished him. Lippmann favored European suits, and his shirts often were untucked and loose. Lippmann didn't have even a fleeting interest in sports and couldn't keep up with much of the banter on the trading desk. But he knew where to find the best sushi in the city and he eventually published an online guide to the best restaurants in New York,
earning him the moniker the "Robert Parker of raw fish." On the phone, and on the trading desk, Lippmann had the confidence of a veteran, and he seemed not to care what his colleagues thought of his opinions. He was so over the top and had so many affectations-such as pronouncing the word "tranche" with a soft ch, as if to remind colleagues that it was the French word for slice-that his colleagues grew to enjoy his company.
"He always struck me as a little odd," recalls Craig Knutson, a colleague at First Boston. "But he was an easy guy to like. He wasn't looking for others to accept his viewpoint or who he was-it was like he didn't care."
Lippmann traded the riskiest slices of securitized bond deals, slices at the bottom rung of deals that paid off big-time if the loans backing the debt paid off, but saw the first losses if they didn't. This section of the market had such little activity that Lippmann was forced to get on the phone with a potential investor and wax poetic on the beauty of these obscure debt slices, and why they should buy or sell them with Lippmann. Nearby, colleagues listened with appreciation, or sometimes rolled their eyes. Lippmann told them that he considered himself "more of an art dealer than a broker."
In 2000, after Lippmann was hired by Deutsche Bank, he warned colleagues about the health of mobile-home companies. He soon learned of the dangers of challenging the market's bullish consensus. When Lippmann offered lowball bids to purchase debt of these companies, making it clear how little he valued it, a senior salesman turned to him with a scowl, saying, "You're making us look stupid." Six months later, mobile-home debt collapsed in price. Lippmann eventually rose to become a senior trader, running a group that dealt with mortgagerelated bonds and other complicated debt investments. But he still couldn't bring himself to conform. Lippmann sometimes wore his sideburns unusually long and thick, ending in a point below the ear, Elvis Presley-like. At times, he wore bulky, pointed, brown dress shoes and a brown pinstriped suit, amid a sea of blue and beige at the trading desk.
By early 2005, Lippmann was thirty-six years old and impatient to grow his firm's lagging mortgage-bond business. But he ran into an issue frustrating others in the market: There just weren't enough mortgages to go around. Thousands of investors all over the globe were eager to buy slices of mortgage bonds backed by risky loans because they carried such high interest rates. For all its growth, though, the subprime-mortgage market couldn't keep up with the investor demand.
Lippmann's radical thought was, What if an investment could be created to mimic the existing mortgages? That way, new mortgages wouldn't have to be created to satisfy hungry investors; rather, a "synthetic" mortgage could be sold to them.
In February, Lippmann called traders from Bear Stearns, Goldman Sachs, and a few other firms struggling with the same issues, inviting them, along with a battalion of lawyers, to a conference room at Deutsche. Sitting around a blond-wood conference table, they debated ideas into the night, while picking at take-out Chinese food. Their light-bulb idea: Create a standardized, easily traded CDS contract to insure mortgage-backed securities made up of subprime loans. Yes, they'd be signed contracts between two parties, rather than a loan. But since they were contracts that insured all those aggressive mortgages, they would smell, touch, and feel like the mortgages as themselves, rising when they looked safer and falling as borrowers ran into problems.
"We called up the guys we felt like we knew and could work with," Lippmann told a reporter.
"It's not very glamorous . ... Just a bunch of guys eating Chinese discussing legal arcana." The discussions went back and forth for months; other banks soon demanded to be part of the conversations. By June, the group had introduced a new, standardized credit-default contract that would adjust in price as the underlying mortgages became more or less valuable. A buyer of a CDS contract protecting $1 million of risky debt would pay annual premiums to the seller of the contract. If the debt became worthless, the seller of the protection would hand over $1 million to the buyer. And buyers of the CDS protection would be paid in cash by those selling the insurance when something happened to affect the cash flows of the bonds underlying the CDS, something they called pay-as-you-go. Those bullish on subprime mortgages would sell the insurance and pocket cash, while bears might buy it. And because the language of the contracts was standardized, they could easily be traded, like any other bond.
Just as bettors on the Super Bowl enter an array of wagers on a single game, such as which team will score first and how many points will be racked up at the end of each quarter, Lippmann and his colleagues had invented derivative instruments to multiply the bets on a single, finite pool of home mortgages. The credit-default swaps were tied to actual mortgages-but the number of insurance bets on the subprime loans now were essentially unlimited. Finally, Burry and other housing skeptics had a way to short the market, while those who were bullish, such as insurance giant AIG, could make extra money by selling the insurance, confident they would never have to pay out. Their actuaries produced sophisticated models that showed the chances of a housing meltdown were minimal.
With a feat of financial and legal engineering, the subprime mortgage market had effectively grown by leaps and bounds, a fact that would come back to haunt both Wall Street and global economies. In the months ahead, the bankers created similar insurance contracts for securities a1
backed by loans for commercial buildings and collateralized debt obligations. They'd even create a CDS insurance contract for an index that tracked a group of subprime mortgages, called the ABX, a sort of a Dow Jones Industrial Average for risky home mortgages.
Lippmann and the other bankers had no idea of the impact their change would have on Wall Street, the banks, and the entire global economy. They just wanted another product to sell to their clients.
In fact, when the trading of CDS on subprime mortgage-backed securities began, Lippmann's first move was to sell protection on about $400 million of subprime mortgages to a hedge fund. He was oblivious to the looming problems for housing.
As MICHAEL BURRY was taking his four-year-old son to an ophthalmologist in nearby Sunnyvale for a checkup, he received a call on his cell phone from his broker, Angela Chang. He stepped outside the waiting room to the nearby parking lot to take the call.
"Okay, Mike, we're ready to sell that protection you asked about," she told him. Lippmann and the other bankers had just finished the paperwork on the "synthetic" CDS and were offering them to their first clients.
Burry could hardly contain his excitement. Pacing the length of the parking lot, Burry listened to Chang describe the details of the investment. Deutsche would sell him CDS protection for six slices of mortgage-backed securities backed by the iffiest subprime mortgages, each with a $10 million face value. The bank had lined up a European pension fund that was bullish on housing and willing to sell the protection and pocket some cash to juice its returns. Deutsche would act as the middleman. The slices of the mortgage securities were rated BBB, or one notch above the "junk bond" category, the lowest level of the so-called investmentgrade bonds. That seemed safe enough to the pension plan.
Burry's cost to buy CDS protection for each of the six slices would be about 155 basis points above the London Interbank Lending Rate, or about $155,000 annually-just under $1 million for all six, Chang said. Do you want it?
"Yes, yes," Burry quickly responded.
Over the next few months, Burry stepped up his research, poring over prospectus documents for hundreds of pools of bonds, trying to locate those pools holding the riskiest mortgages. He felt he didn't have much time to act-thousands of hedge funds and other kinds of investors were searching for attractive trades and were bound to find these investments.
Burry focused on pools stuffed with mortgages of borrowers from California, Nevada, Florida, and other frothy real estate markets. He became especially enthused when he found securities with names from Southern California, the epicenter of the subprime lending market, for example, SAIL (Structured Asset Investment Loan Trust), SURF (Specialty Underwriting and Residential Finance Trust), and HEAT (Home Equity Asset Trust). He told his brokers to buy protection on all of the mortgage pools.
He asked Chang who was selling him the CDS insurance. Institutions and wealthy European families, she told him, along with some other hedge funds. They were comforted by the top-grade investment ratings being placed on the mortgage bonds granted by credit-ratings companies like Moody's and Standard & Poor's.
"Well, they're totally wrong," Burry told her.
One night, late in the office, shades drawn tight, Burry tried to imagine what would happen if his analysis proved accurate. Sure, he'd make a ton of money holding mortgage protection, which likely would jump in value. But if real estate collapsed, some of the brokerage firms he traded with might be crippled. Perhaps they wouldn't be able to pay Burry his money. As a result, Burry began to avoid doing business with investment firms with big mortgage holdings, like Lehman Brothers and Bear Stearns. He focused his trades on other brokerage firms.
By the late summer of 2005, however, Burry realized that the first batch of insurance that Chang had sold him protected mortgages that weren't quite as risky as others he was discovering. He began to isolate mortgage pools with a high percentage of loans in which buyers took out two loans-one for the mortgage and one for the down payment, a "simultaneous second lien." Essentially, these houses had no equity whatsoever, making the loans risky if housing prices fell or even flattened. The protection was still dirt cheap, so he kept buying more. Burry felt like a kid in a half-priced candy store, trying to gobble up as much of the merchandise as possible before the sg other children found out about the markdown. Could it be that no other investors had caught on yet?
After doing one trade, Burry received a call from his broker at Goldman Sachs.
"What are you doing?? You're just buying, buying, buying. No one else is just going one way."
"I'm just buying, yeah. I think the whole system is going to hell."
Burry felt an urgency to boost the size of the trade-he was convinced that it was going to be huge, maybe even historic. Burry began calling and meeting with clients in an effort to try to start a new fund to just focus on buying up mortgage protection. He called it Milton's Opus LLC, an ode to John Milton's Paradise Lost, the seventeenth-century narrative poem. He argued that a new paradise was about to be squandered as housing crumbled.
In late 2005, Burry wrote an impassioned letter to his investors, trying to drum up interest in his new fund:
Markets erred when they gave America Online the currency to buy Time Warner. They erred when they bet against George Soros andfor the British pound. And they are erring right now by continuing to float along as if the most significant credit bubble history has ever seen does not exist Opportunities are rare, and large opportunities on which one can put nearly unlimited capital to work at tremendous potential returns are even more rare. Selectively shorting the most problematic mortgage-backed securities in history today amounts to just such an opportunity.
As they learned what Burry was up to, however, some of his investors grew unhappy. Burry was supposed to be a stock investor, not someone buying up all these derivatives. To many of his clients, Burry remained a former doctor who taught himself about the world of investing. He had a lot of potential but was still learning. Now he was making what seemed like a simplistic argument about problems in the subprime part of the housing market. Investors with degrees from some of the nation's leading business schools were comfortable relying on the complicated risk models developed by Wall Street's sharpest minds, models that predicted minimal housing-related losses. And here was Burry saying the emperor wore no clothes. Many of the clients didn't even bother to read his lengthy letter.
Longtime backers also raised questions.
"Why are you so sure this is a top" for housing? asked Rob Goldstein, one of his original investors.
Another investor cited sophisticated models developed by Wall Street firms showing that any housing-related losses would be contained, even in the event of a slowdown in housing prices.
"What model are you using?" the investor demanded of Burry.
Burry responded that the models Wall Street relied on were based on the performance of mortgage loans made over the past two decades. They didn't reflect the recent surge of aggressive home loans. As such, they were as good as useless.
"It's just a series of logical, commonsense conclusions," Burry told the investor. "Three to five years, just give me three to five years" to make the trade happen.
After spending so many long hours knee-deep in the intricacies of mortgages, Burry found he often was unable to clearly summarize his views. He became impatient that he couldn't convince investors of his thesis and began to leave the fund-raising to his team.
Every day, Burry rushed into the office of his chief financial officer, brimming with hope.
"Have we heard back yet?" he would ask, referring to potential clients in his new fund.
The answer usually was disappointing. Burry bought some positions, holding CDS protection on $1.1 billion of subprime mortgage pools by early 2006. But it wasn't nearly enough for him.
This should be my big trade! he fretted.
Burry turned sullen and reclusive, figuring someone else would catch on and buy the mortgage protection, driving up the price and profiting when housing turned sour. Most days, he sat alone in his office for hours at a time, shutting his door and playing heavy-metal music on a stereo system so loudly that it worried his employees. Soon, they became afraid to approach him.
The cost of some of the mortgage insurance soon rose a bit, making Burry furious. His trade seemed to be slipping away. Heavy-metal bands like Megadeth and Disturbed blasted out of his office, the bass shaking the entire floor. Metallica's "Kill 'Em All" and Pantera's "Cowboys from Hell" topped Burry's playlist.
Eventually, Burry could no longer take the stress and frustration. He threw in the towel and ended his efforts to launch the fund, unable to find enough investors who believed in him and his bearish views.
S 2005 BEGAN, GROWING CONCERNS ABOUT THE HOUSING AND debt markets gnawed at John Paulson.
He wasn't convinced that a housing storm was over the horizon, and didn't think that risky mortgages were much of a danger. But he noticed some threatening clouds and felt compelled to find protection, an umbrella just in case the rain started to pour. He just didn't know where to find it.
"You can't short a house," Paulson told a colleague, regretfully, as he surveyed the booming real estate market.
The CDS insurance that Pellegrini championed wasn't doing much for the firm, but it couldn't hurt to buy some protection on a few other financial companies, Paulson figured, particularly those dependent on consumers, who seemed up to their eyeballs in debt. So Paulson directed his trader, Brad Rosenberg, to buy CDS contracts to insure the debt of two big lenders, Countrywide Financial and Washington Financial, companies that Pellegrini had been studying.
But rumors soon circulated that the companies might receive big takeover offers, sending their stock and bond prices soaring. That weighed on the value of CDS protection on their debt, rattling Paulson and his team. The losses were small but the fund already lagged its competitors during the early part of the year, leaving little room for error if Paulson wanted to keep the firm growing.
One afternoon, Pellegrini walked into Paulson's office clutching a spreadsheet. He was there to discuss the latest chatter about who might buy Countrywide, rumors that were sending shares higher and sparking further losses for Paulson & Co.
As he turned to leave, Pellegrini threw out an idea.
"By the way, if you're concerned that someone might bid for Countrywide, why don't we figure out how to short mortgage securitizations," Pellegrini suggested. "If they go bad, they stay badit's a one-way street."
It was a phrase he had overheard from his ex-boss, Arif Inayatullah, at his last job, at Tricadia Capital. Insurance for bonds backed by risky mortgages couldn't be affected by any individual corporate takeover, so it might be a perfect way to get protection for any problems that might arise in the mortgage market.
Pellegrini could see that Paulson was immediately intrigued; a smile grew on his face. As interest rates rose, all those adjustable mortgages would reset at higher levels, and consumers would have difficulty meeting their monthly payments, Paulson quickly realized. That would put pressure on the mortgage-backed bonds.
Later, Paulson came to Pellegrini still more animated, telling him that the Fed wouldn't want to trim rates to help borrowers because it might cripple the already-weakening dollar and stoke inflation. So when interest rates climbed, a rash of home owners would be unable to pay their monthly mortgages, and the value of the mortgage bonds based on those loans would tumble in value.
Pellegrini agreed. But when he asked his boss which slice of mortgage bonds the firm should bet against, Paulson seemed confused. He didn't seem to understand what Pellegrini meant.
"Yeah, there's billions of dollars of this stuff out there."
Paulson's eyes widened. "That can't be!" he replied, with apparent shock.
Pellegrini only recently had learned of the complex details of the mortgage market, thanks to a series of tutorials from the firm's brokers at Bear Stearns and contacts at other firms, and after attending an industry conference. The lessons were brief, and he still wasn't sure about many details of that market, but they made Pellegrini something of an in-house expert, since few others at Paulson & Co. were even vaguely familiar with the area.
"I was flabbergasted," Paulson recalls.
In the following weeks, Pellegrini asked a few more experts, including Arif Inayatullah, to come by and teach him and Paulson more about the market.
"When I found out there was a separate category of subprime, risky mortgages, it was a big lift," Paulson says. "The fact that they could be tranched into eighteen layers was the ultimate; I had never seen a capital structure with more than five layers."
He pushed Pellegrini to find the purest way to wager against the riskiest mortgages.
"Dig deeper, Paolo, dig deeper."
Pellegrini focused on buying protection for BBB-rated slices of securitization deals backed by collections of subprime mortgages, or those that credit-rating agencies viewed as just a bit safer than junk. He ignored the most noxious 5 percent of the deals, rated BBB-or even worse, figuring that it might cost too much to protect the dreck of the mortgage market. The BBB slices seemed close enough to the bottom of the toxic-mortgage barrel.
Paulson agreed. If things go wrong, "these bonds don't have a prayer of getting paid," he told Pellegrini.
But it was difficult to buy CDS to protect these BBB slices, Pellegrini explained. There just weren't enough slices available in the market, the very problem that Lippmann at Deutsche Bank and his fellow bankers were busy trying to address. Pellegrini dug up figures showing that securitized subprime mortgages made up about 10 percent of the overall $10 trillion market, but there were only about $10 billion of BBB pieces outstanding. Much like Burry, Pellegrini guessed that tradable CDS contracts were soon on the way, to sate the appetite of investors for more BBB slices. He hired lawyers to complete the necessary paperwork so Paulson & Co. could be ready.
A month later, when Lippmann's gang finally rolled out its first batch of CDS to protect subprime bonds in the summer of 2005, Pellegrini rushed to Paulson's office, urging him to buy. Over the next two weeks, Paulson turned to his old firm, Bear Steams, to buy insurance protecting $100 million of subprime mortgages from defaults or losses, agreeing to pay just over $1 million for the coverage. It was such a pittance that Paulson couldn't figure out why others weren't also buying the cheap protection, if only for the inevitable rainy day.
As the summer heated up and the economy hummed along, Paulson's anxieties over the state of the economy and the housing market grew. Giddy investors were buying the BBB-rated mortgagebacked slices and all sorts of junk bonds without demanding much in return-interest rates of just 1 percentage point above those of supersafe U.S. Treasury bonds. It seemed absurd to Paulson. Who would buy a risky bond with a yield of 6 percent when Treasury bonds yielded 5 percent?
"This is like a casino," Paulson said of the market in a meeting with some of his analysts. "We need to sell everything and go short. " He ordered his traders to close dozens of trades.
Paulson asked them to find the most dangerous investments to bet against.
"Where's there a bubble we can short?"
Over the next few months, Paulson trimmed holdings that seemed especially sensitive to the economy and shorted the bonds of others, such as Delphi Corp., the nation's largest auto-parts maker. He seemed prescient, at least at first. Delphi's bonds fell to sixty-five cents on the dollar, and in October the company's troubles became so severe that it sought bankruptcy protection. But Delphi's bonds suddenly began to climb in price, for no obvious reason, stunning Paulson. Seventy cents, then seventy-seven and all the way up to ninety cents on the dollar. Finally Paulson threw in the towel and ended his trade, buying back the bonds to return them to his broker and close out the short.
The experience was painful, one more of a series of aggravating moves that year. But it convinced Paulson of the advantages of using CDS contracts to express a negative view. Unlike shorting a stock or a bond, losses from CDS contracts were capped at the annual payment of the insurance, Paulson realized. He was fast becoming a convert to the benefits of derivatives trading.
In truth, CDS contracts weren't quite ready for prime time. One reason Delphi's bonds had soared was that investors holding CDS contracts protecting against a loss in Delphi's debt needed to get their hands on the company's bonds, to present them for payment to investors who had sold them the CDS protection. They scrambled to buy up Delphi's bonds, bidding up their price, despite the bankruptcy.
"What a waste-we're obviously too early," Paulson told another analyst. "The market's getting more wild."
Paulson's frustrations grew as he watched a series of leveraged-buyout firms make acquisitions at nosebleed levels over 2005. An $11.3 billion takeover of SunGard Data Systems became the biggest buyout since RJR Nabisco sixteen years earlier, while household names like Hertz Corp. and Metro-Goldwyn-Mayer also were gobbled up, thanks to cheap debt financing from generous lenders and investors.
"This is insane!" Paulson said, as he pulled up a chair next to Brad Rosenberg and they watched news of a new acquisition on a businesstelevision channel. "There's so much money out there chasing things; they're lending too freely." Paulson told Pellegrini that they were up against a "wall of liquidity. "
Paulson shook his head as he noted a surge of borrowing by Wall Street's banks, saying "Do you realize these guys are leveraged thirty-five to one?"
Rosenberg brought Paulson stories from the Internet about how borrowers were receiving mortgages without having to document their income or assets. Lending was getting out of hand in cities such as Phoenix, San Diego, and Las Vegas. The subprime frenzy seemed to be spreading. Paulson, Pellegrini, and Rosenberg held a series of meetings and conversations with Wall Street's top mortgage analysts, trying to understand why so few of them were worried. They were the experts, Paulson's team realized, and Paulson a rank outsider. Was there something he was gs missing? Paulson wondered. "Our models say don't be worried," said Bear Stearns' Gyan Sinha, a top-rated analyst, on a phone call. "Home prices have never gone negative," another analyst said. Others emphasized that investment-grade mortgage investments had rarely defaulted. "They won't even go flat," one expert told Pellegrini.
"They thought we were crazy. They kept talking about 'our models,"' and said we didn't know what we were talking about," Rosenberg recalls.
p oR PELLEGRINI, a subprime trade that once was a mere sideshow to the fund's merger investments had become a potential lifeline. His contributions to the merger team were negligible, and it was obvious how low in the pecking order Pellegrini was. Most of the analysts reported directly to Paulson. Pellegrini, however, had to first run his ideas past Andrew Hoine, the firm's research director, as if he was a remedial student in need of a tutor.
In late summer, the young man he had replaced, Nikolai Petchenikov, returned to the hedge fund from a one-year stint in business school, adding to Pellegrini's anxiety. Paulson began to give the twenty-seven-year-old, rather than Pellegrini, key assignments in the international-merger area. Pellegrini's window of opportunity at the hedge fund seemed to be closing quickly.
Seeing the writing on the wall, Pellegrini approached Paulson, suggesting that he focus on the subprime and financial areas, an offer Paulson accepted with enthusiasm.
"This could be a gold mine for us," Paulson responded, encouraging him. It was an enormous gamble for Pellegrini, despite his boss's enthusiasm. Merger investing was at the core of Paulson & Co. The CDS trade was a diversion, one that Paulson might drop at a moment's notice. The firm employed fewer than a dozen people; any deadwood wouldn't survive long. Pellegrini was forty-eight years old and on tap to earn about $400,000 that year. It was a substantial sum, although much of it went to pay his sons' private-school tuitions. His bank account still showed an embarrassingly small sum for a finance-industry lifer.
"It wasn't clear to me that I was a keeper at the firm," Pellegrini recalls. "John wasn't comfortable with my work, and I was just as frustrated with myself. Anyone else would have fired me, but John saw I was making an effort."
Pellegrini was confident the subprime trade would work; he just hoped he would be allowed to stick around long enough to profit from it.
"I had everything on the line," Pellegrini says. But he had been certain before in his career, only to have something foil him.
Rather than become nervous, however, Pellegrini was more excited than he had been in years. He came to work a bit earlier and stuck around later, unable to stop thinking about the housing market. Over the summer, on a second date with Henrietta Jones, who ran the retail division for the Donna Karan clothing label, Pellegrini spent the evening replaying a presentation he made earlier in the day about the state of real estate; over dessert, he encouraged Jones to sell her Manhattan apartment.
Interest rates and mortgage products weren't the most romantic topics of conversation for a date, but Jones was taken with Pellegrini's passion.
Pellegrini soon realized that he and Paulson had missed something important, however. In November, Pellegrini joined a group of investors at a meeting at the Grand Hyatt hotel in Midtown Manhattan hosted by Robert Cole, the chief executive officer of New Century. Pellegrini sat quietly, listening to Cole's rosy presentation and a series of softball questions tossed by a group of upbeat investors, some of whom congratulated Cole on the low level of defaults among New Century's customers.
Pellegrini was convinced that his rivals were missing it.
Wait till rates reset, he thought.
He resisted speaking up, though, lest they figure out how bearish his firm was, and perhaps warm to the CDS protection that Paulson was becoming enamored with, pushing prices higher.
But Pellegrini had nagging concerns that he might be missing something. Was there a way to run his ideas past Cole?
After the speech, Pellegrini made a beeline to the lectern, grabbing Cole's attention before other investors had a chance.
"What will happen when the mortgages reset?" Pellegrini asked, thinking he had found the fatal flaw in Cole's bullish thesis. "Will there be defaults?"
Cole seemed remarkably unfazed.
"No, we'll just refinance the loans," he responded, matter-of-factly.
Cole explained that New Century, like other subprime lenders, earned so much in upfront fees from refinancings that his company was happy to refinance home mortgages before they had a chance to reset at higher interest rates even though it meant lower profits from new, lower-rate loans. That way New Century made sure that borrowers could still make their payments. They could keep refinancing their customers' loans as long as their underlying properties were worth more than when they took out their original loans, Cole said.
"Interesting," Pellegrini replied, meekly.
The Paulson team's original thesis, that a spike in interest rates would cause problems for home owners, seemed dead wrong. If rates moved higher, Pellegrini realized, lenders would just bail out borrowers, letting them refinance their homes at lower rates. Given that, a wave of defaults seemed unlikely, at least for the loans currently in the market for homes that had climbed in price.
Pellegrini had a sinking feeling as he hustled back to the office to tell Paulson.
It wasn't the kind of news anyone at Paulson & Co. wanted to hear, and it couldn't have come at a worse time. The various hedge funds run by the firm gained 5 percent or less in 2005, trailing gains of 9 percent or more for other hedge funds. Chatter on Wall Street was growing that Paulson was falling behind the times.
"It was very frustrating," recalls Jim Wong, Paulson's point man with investors.
At Concord Management, LLC, an associate, Martin Tomberg, was grilled by the New York firm's investment chief about Paulson's disappointing performance.
"Why are we in this fund?" Tomberg's boss asked him about one of Paulson's funds. Tomberg suggested that they give Paulson some more time before pulling out.
By the end of the year, even friends were asking questions about Paulson's investing strategy.
Visiting Paulson's office one day in November, Howard Gurvitch, his original investor, suggested that the firm's subpar performance might be due to the rush of easy money that was chasing every kind of deal, making mergers and other areas more difficult for more conservative investors like Paulson.
"Maybe it's a new world, John?" Gurvitch asked his old friend, gently.
Paulson told Gurvitch that he remained confident in his unpopular stance. Unbeknownst to Paulson, a few other investors were coming around to his view on housing and soon would be hot on his heels.
1 N MAY, after Greg Lippmann had helped develop the perfect means to bet against housing, he and his colleagues began racking up commissions trading their new CDS contracts on pools of subprime mortgages. Lippmann, who also operated a trading account for Deutsche Bank, initially joined the pack, selling the CDS contracts to the few bearish investors like Burry in San Jose.
By June, though, Lippmann's contrarian instincts had kicked in. He decided to do his own research to make sure the bullish crowd had it right when it came to the real estate market. Lippmann loved to boast about a research analyst at the bank named Eugene Xu, proudly telling colleagues that at just eighteen years of age, the Shanghai native finished second in a national math competition in China. Maybe Xu, who received a doctorate in mathematics from the University of California in Los Angeles, could test the bullish thesis.
Lippmann asked Xu to dig up as much data as he could about home-mortgage defaults, something Lippmann and most others in the business never thought to examine before, as housing seemed to be on an inexorable climb. Xu split the country into quartiles. He discovered that states with the lowest rates of default, like California, Arizona, and Nevada, also claimed the highest growth in home prices. The quartile with the highest rates of default, on the other hand, had the slimmest growth in home prices. Florida and Georgia, for example, seemed similar in many ways, but Xu's numbers showed Florida had a much lower rate of default than its northern neighbor, which seemed to be due solely to its soaring home prices.
The clear relationship between home prices and mortgage defaults didn't seem to be a recent development, either. Xu found that home prices had been key to loan problems for more than a decade, including during the mini-downturn in real estate in the early 1990s.
"Holy shit," Lippmann exclaimed to Xu on Deutsche Bank's trading floor while reading over his work, "if home prices stop going up, these guys are done."
Lippmann's thesis seemed logical-but at the time it was quite a radical viewpoint. Most economists and traders figured that a range of factors, including interest rates, economic growth, and employment, determined the level of mortgage defaults. Sure, home prices had an impact, and they were bound to plateau at some point. But if the other factors all held up, then default rates shouldn't climb very much, according to the conventional wisdom.
But Xu's data clearly showed that those other factors didn't mean nearly as much as home prices. Indeed, California's employment rate was about the same as a number of states with much higher default rates, but which had more limited gains in home prices. The lesson to Lippmann was that hot real estate areas like California actually were poor credit risks, not good ones. If home prices ever leveled off, defaults would shoot up.
"Why hasn't anyone done this research before?" he exclaimed to Xu. A sudden convert, Lippman wasn't shy about sharing his views within the bank. "These things are gonna blow up!" he bellowed across the trading floor one day, as the other traders shook their heads.
Lippmann rushed to tell others at the bank, anticipating that they would appreciate his insight. He patiently explained to them that when home prices came back down to earth in California and other raging real estate markets, mortgage defaults and delinquencies would be as high as they were in states like Indiana, where about 6 percent of home owners were delinquent on their home mortgages, double California's rates.
His colleagues remained skeptical, however. Even veteran analyst Karen Weaver, who had been warning investors to avoid all kinds of aggressive mortgage-related investments, wasn't convinced. At weekly meetings, the other Deutsche Bank executives snickered or laughed at Lippmann's diatribes about the problems ahead.
"There goes Greg again," Weaver joked to the group one day. Others began poking fun at Lippmann, sparking a round of laughter.
"You'll see; I'll be right," Lippmann shot back.
Some at the bank insisted that Lippmann must be missing something-maybe the explosion in population in California and Florida helped keep defaults low. So Lippmann and Xu went back to their data, controlling for population changes and other factors. But they continued to find that it was housing prices alone that were the key to mortgage defaults. Nothing else seemed to even be close. To Lippmann, it was as if his colleagues and rivals at other banks were insisting that the world was flat.
"All you need is for California [real estate] prices to start looking like Indiana's and you get twelve percent defaults, at least," an impassioned Lippmann insisted to one colleague. Home prices in Indiana were growing about 5 percent compared with more than 15 percent in California. Lippmann argued that when prices stopped climbing, a rash of problems would result, in even soaring real estate markets.
By the late fall of 2005, Lippmann was even more convinced of this, but he needed permission from the bank to buy up the CDS contracts and lay a big bet against housing. He took a deep breath and proposed to one of his bosses, Rajeev Misra, buying protection on more than $1 billion
1oo of risky mortgages.
"This seems like a great bet," Lippmann told him, holding twenty pages of documents. "If I'm right, I'll make a billion dollars for the bank and it will offset losses elsewhere; if I'm wrong, it's going to cost twenty million a year."
Lippmann suggested buying CDS protection on the BBB-rated slices of mortgage-bond deals, just as Paulson and Burry were doing. He noted that 80 percent of subprime mortgages adjusted to a higher rate after two years, so his trade wouldn't last very long-after four years or so, he'd know if it was working or not. The most he could lose the bank if he purchased insurance on $1 billion of BBB bonds was $20 million a year over four years, or $80 million, Lippmann argued.
"If we're right, we're looking at a sixfold gain," he told his superiors. But there wasn't a six-toone chance that California real estate would keep going up, because it can't go up forever, he told them. The bank should take the risk.
He was showing so much enthusiasm for shorting mortgages that some at the bank thought he might have gone too far. Lippmann's approach at times seemed unconventional to some at Deutsche, and they weren't convinced his strategy would work. Grudgingly, however, they assented to his trade, though not in the size he hoped. The Deutsche Bank executives allowed Lippmann to pay $20 million or so a year to buy protection on $1 billion of mortgages. And they told Lippmann to make sure to update them on how the trade was going, keeping the leash tight on the thirty-seven-year-old trader.
It didn't help Lippmann's case that he had antagonized some at Deutsche Bank with his strong opinions and brash trades, resulting in various stories circulating about him. One tale that spread, despite no evidence that it actually took place, concerned the evening Lippmann exited the bank's building, running late for a business dinner. He couldn't find a cab. When he saw a long line of employees waiting for Deutsche Bank's car service, Lippmann went straight to the front of the line and told a woman about to be picked up that he was a senior trader and needed the ride for a dinner. The woman asked for his name, saying that she'd like to tell people that she'd had the privilege of meeting him. He proudly announced that he was Greg Lippmann, head of asset-backed trading. At that point, the woman said she was the head of human resources and that Lippmann had just taken his last ride in a company car.
Friends say the story didn't happen, but that didn't stop some at the bank from sharing it, a sign of the jealousy and resentment Lippmann had engendered, at least among some at Deutsche Bank.
Indeed, for all his trading prowess, Lippmann had overlooked the personal risks he had assumed in making the most important trade of his life. He already was making several million dollars a year. If he got the subprime trade right, he'd surely make more millions, but it wouldn't change his life. If Lippmann was wrong, though, he risked his career.
As mortgage prices moved higher, and the value of his protection dropped almost immediately after he put the trade on, Lippmann's move seemed especially misguided. When Lippmann told friends what he was up to, they began to worry about him. They warned Lippmann that he risked ruining his reputation at the bank by bucking the rest of the team. A colleague pulled him aside, asking, "Why are you doing this? ... If you're wrong, they're not going to say thanks for having us buy this fire insurance we didn't need."
But Lippmann and Xu had picked up faint signals that housing already was moderating. Instead of pulling back on his trade, Lippmann was determined to figure a way to grow it.
1 F THE NEW CENTURY EXECUTIVE who had spoken with Paolo Pellegrini was right that borrowers would be able to refinance their mortgages and lower their payments, Paulson's insurance against $1 billion of sub-prime mortgages and corporate debt was unlikely to be worth much. In fact, while the value of his CDS protection rallied a bit in late 2005, the gains evaporated in early 2006, as some hedge funds sold their own insurance, convinced that housing would keep climbing.
Sensing a mistake, John Paulson sold his original CDS protection after concluding that it covered mortgages on homes that already had enjoyed so much appreciation that refinancings would be easy. But he continued to feel that the idea behind the trade was a good one. So he traded in his holdings for insurance on more recent subprime home mortgages-homes that wouldn't have appreciated in price yet, and which couldn't, therefore, get a refinancing if mortgage rates went up.
The moves did little for the fund, however.
"We weren't getting anywhere," Paulson recalls.
He and Pellegrini soon realized that the only likely scenario in which risky mortgages couldn't be refinanced, and a rash of defaults resulted, was if housing truly was in a bubble that eventually 102 burst. Only then would it be impossible for lenders to bail out the overleveraged borrowers by granting them refinancings, they reasoned.
Until that moment, in early 2006, Paulson's team hadn't put much thought or research into whether housing prices were bound to tumble. Sure, they seemed high, but consumers with heavy debt were at risk of missing their mortgage payments if interest rates rose, they figured, even if prices didn't fall.
Paulson wasn't even fully aware of how pervasive improper lending practices were until Rosenberg ripped a press release off a printer in January 2006 describing how Ameriquest Mortgage Co., then the largest maker of subprime loans, had agreed to pay $325 million to settle a probe of improper lending practices. The news seemed to startle Paulson.
"This is horrible," he told Pellegrini. That kind of aggressive lending was "crazy."
Paulson and Pellegrini concluded that the only way their trades would work was if the U.S. real estate market had reached unsustainable levels and began to fall, crippling the ability of borrowers to refinance their loans. The prospect seemed remote to many.
"At the time, everybody said home prices never had declined on a nationwide basis except during the Great Depression," Paulson recalls.
Paulson sent Pellegrini scurrying back to his cubicle to determine how overheated the real estate market was. It was a research project that seemed right up Pellegrini's alley. In the past, Pellegrini sometimes met criticism for spending too much time delving into a project. Paulson sometimes teased Pellegrini, saying that if he had to walk a block from their offices on 57th Street to 58th Street, Pellegrini likely would go across town, up the West Side, back to the East Side, and then downtown, to reach 58th Street. The dire
|时间: 2011-2-20 周日, 上午4:38 标题:
|Most mornings Zafran came back with data showing that Greene's protection was worth less than the day before. Demand for subprime mortgages was growing, not shrinking, Zafran told him.
"It doesn't make any sense to me," Greene responded one morning. "It just doesn't make any sense."
Zafran visited Greene's Hollywood Hills home to go over the results of the trade, and they pored over a giant spreadsheet of figures together.
Soon Greene's calls to Zafran became more heated. Greene couldn't even get a quote on his investments without asking a bond dealer for an estimate, feeding his frustrations. He couldn't figure out why the insurance wasn't rising in price, even as housing seemed to falter. The Merrill traders seemed reluctant to lower the value on all those subprime mortgages, he decided.
"How can you justify this price?!" Greene asked at a rapid-fire clip, his voice rising with anger. "It doesn't make any sense to me. Does it make sense to you!? Call me back!"
After Greene read a newspaper article about growing difficulties at Countrywide Financial, he called Zafran, who patched in a Merrill executive in New York, Cliff Lanier.
"I have to be in the money, right?" Greene said, bitterly.
Lanier retrieved a fresh quote for Greene from a trader, along with an update on the market: The ABX index tracking subprime mortgages indeed was falling. But Greene held insurance on a range 153 of mortgage bonds, not just the ABX, and those positions showed even more losses for Greene.
"Come on!!" Greene responded. "Countrywide's on the front page of the paper. I don't understand it!"
With each call, he noticed that the quotes were getting a little better. That pleased him, but it also sowed suspicions about how Merrill was coming up with its quotes. The Merrill team said it was merely passing along the latest quotes.
Greene had spent millions investing in an obscure, opaque market. Now, as housing was slipping, his mortgage insurance wasn't budging. He couldn't even be sure what they were worth.
"I don't understand it, Alan. Explain it to me," Greene pleaded to Zafran.
ICHAEL BURRY was under even more pressure. He'd become bearish on housing a full year ahead of Paulson & Co., buying protection against mortgage securities and financial firms when no one else wanted it. But by mid-2006, his investments, too, were falling in value. And unlike the previous year, Burry couldn't find many winners with his stock picks to offset the losses. His trade was dealing his fund its worst setback ever.
Before long, he began to get calls from concerned clients. They weren't nearly as skeptical as Burry about real estate; in fact, many were openly dubious about his housing investments. A few advised him to stick with stock investing. What do you know about mortgages? he was asked.
In August 2006, Burry's brokers called to tell him that someone was buying up every piece of subprime mortgage protection out there, CDS on RMBS (residential mortgage-backed securities), CDS on the ABX, anything and everything. Huge chunks of credit-default swap contracts were flying off the shelf, sometimes more than a billion dollars of protection in a single day. Angela Chang, his broker, told Burry the buying was so lightning-quick and overwhelming, "it was like a drive-by." Another trader passed on chatter that an investor named John Paulson was doing the buying.
Burry was sure all the activity would boost the value of his firm's positions. But Burry's brokers refused to adjust the value of his investments, making it impossible for him to show any gains. Sometimes, the prices seemed dated or inconsistent. Brokers gave him different prices for the same protection on the very same day. Other times, they wouldn't update a quote for a full week. Burry couldn't believe it-Paulson was buying protection every day, housing prices finally had flattened out, the ABX index was dropping, and shares of home builders were weakening. But Burry was being told by his brokers that the value of his firm's protection on over $8.5 billion of mortgages and corporate debt was barely budging. Some brokers explained that Burry's positions didn't trade frequently, making it hard to prove they had risen in value. Burry fumed. He started to come home late at night, creeping up the stairs of his luxury home and going straight to bed, to avoid his family. He was afraid his kids might see him bristling with anger.
Fed up, Burry finally decided to pull the mortgage investments out of his hedge fund and place them in a separate account, called a sidepocket. There they'd sit, frozen in price, until Burry was ready to sell them. That way he could place a more exact value on the fund himself and treat his investors more fairly, without relying on quotes from unreliable brokers.
Hours after he announced his move to his investors, however, Burry's firm was in turmoil. His clients already were skeptical of his housing investments. Now Burry was telling them that they were stuck with the housing protection until he decided it was time to exit. The fine print of his agreements with his investors allowed Burry to undertake this kind of move. But it seemed like a money grab-a heavy-handed way to prevent the investors from fleeing, and to stop the mortgage protection from weighing down his fund.
In October, Joel Greenblatt, Burry's original supporter, demanded a face-to-face meeting. Several days later, he and his partner, John Petry, flew to San Jose and rented a car to drive to Burry's office for a late-afternoon sit-down. Months earlier, Greenblatt had told a financial-television network that Burry was among the world's top investors. But now, as Greenblatt grabbed a seat across from Burry in his small office, he fumed.
Greenblatt told Burry how foolish he was to set up the side account; it was harming Greenblatt's reputation, as well as his own, he said.
"Cut your losses now," he told Burry, and advised him to get out of his mortgage positions before clients revolted and his firm was ruined. Greenblatt could barely contain his anger. The 155 trades could be "a zero in the making."
For Burry, it felt like an uppercut to the jaw. One of Wall Street's most respected investors-the first to show any faith in him-was ordering him to cut short the biggest trade of his life, one that he had spent more than a year crafting. Like the rest of his investors, Greenblatt and Petry didn't even bother to try to understand his trade, or to read his letters that mapped it all out, Burry felt. Now, in the first rough period of Burry's career, they were turning on him.
Sitting behind his desk, Burry shifted in his seat, growing increasingly uncomfortable under the onslaught. As he listened to Greenblatt and Petry, he realized he might not have enough support to keep his firm going if he held on to the positions and was proved wrong.
Then it dawned on Burry that Greenblatt wasn't saying anything new. He had no information that in any way negated or changed Burry's original investing premise.
Looking past his guests through a window just behind their chairs, he could make out the red roof of a condominium, one of countless overpriced units recently erected in an area already teeming with new supply.
If Greenblatt wants proof, he thought, it's just a rock's throw away!
What Burry didn't know was that Greenblatt was facing his own pressures. His firm, Gotham Capital Management, which made investments but also placed money in various hedge funds for clients, had received withdrawal requests from 20 percent of its investors. If Burry refused to sell investments and hand money back to Greenblatt and Petry, they would be in a bind.
Greenblatt tried to compromise with Burry, suggesting that he cash in some of his trades, rather than freeze them all. But Burry wouldn't budge. "I can't sell any of them," Burry responded. "The market's just not functioning properly."
"You can sell some of them," Greenblatt responded, his anger rising again. "I know what you're doing, Michael."
To Burry, Greenblatt seemed to be suggesting that he was clinging to the trades to avoid handing back cash to his clients. Burry turned livid.
"Look, I'm not going to back down," Burry told his visitors. He was going to put the mortgage investments in the side account, as planned. 1ss
Greenblatt and Petry stormed out of the office, ignoring Burry's employees on their way to the door. Days later, Greenblatt's lawyers called Burry, threatening a lawsuit if he went through with his move.
Other investors, angry that Scion now was down about 18 percent on the year, also turned on Burry, withdrawing all the money they could from other accounts at the firm, pulling out $150
million over the next few weeks. A few potential clients, learning about the squabble, suddenly lost interest in Scion.
Burry turned sullen, stress obvious on his face. His wife began to worry about his health.
Late in 2006, Burry felt he had to do something to save his firm and his reputation. So, reluctantly, he began selling some of the CDS insurance, raising money to hand back to disgruntled investors. Over three weeks, he sold almost half of the protection he held on $7 billion of corporate debt of companies like Countrywide, Washington Mutual, AIG, and other financial players that seemed in dangerous positions.
Burry couldn't have picked a worse time to sell. At that point, Wall Street still held few worries about housing. The protection on $3 billion of debt, which originally cost Burry roughly $15 million or so a year, now cost new buyers only $6 million a year. In selling the insurance, he took a substantial loss. To Burry, it was like giving away a collection of family jewels, accumulated with loving care over two long years.
Money continued to flow out of the fund, though. Burry scrambled to cut his expenses, slashing salaries and firing employees. He flew to Hong Kong to close a small office there.
"Mike, you can't do this," a recently hired trader told Burry, his anger growing.
Burry tried to calm him down, explaining that he had no choice. But the trader turned even more agitated.
"You owe me the difference between what I would have made" at his previous job and the severance Burry now was promising. He demanded $5 million.
"I can't do that," Burry replied meekly.
His cost-cutting moves destroyed the morale of his remaining employees back in San Jose. In a tailspin, Burry withdrew from his friends, family, and employees. Each morning, Burry walked into his firm and made a beeline to his office, head down, locking the door behind him. He didn't emerge all day, not even to eat or use the bathroom. His remaining employees, who were still 1s1 pulling for Burry, turned worried. Sometimes he got to the office so early, and kept the door closed for so long, that when his staff left at the end of the day, they were unsure if their boss had ever come in. Other times, Burry pounded his fists on his desk, trying to release his tension, as heavymetal music blasted from nearby speakers.
The growing toll the trade placed on Burry seeped into an unusually frank letter that he sent his clients at the end of 2006: "A money manager does not go from being a near nobody to being nearly universally applauded to being nearly universally vilified without some effect."
REG UPPMANN had convinced his bosses at Deutsche Bank to let him buy protection on about $1 billion of subprime mortgages. But as the trade stalled in the summer of 2006, the Deutsche Bank executives became impatient, expressing doubts about his tactics. They seemed tempted to close Lippmann's trade.
"Just give me four years," Lippmann asked Rajeev Misra, his boss. Most subprime borrowers refinanced their mortgage loans after just a few years, Lippmann reminded him, so his trade surely would be over by then. "Give it a chance to work."
"Show me the research," Misra responded.
When he did so, Lippmann's bosses reluctantly gave him a green light to continue with the trade. The regular payments he was making for all the CDS insurance were slowly adding up, so those above him at the bank weren't thrilled. Yet for all his bluster and self-confidence, Lippmann wasn't prepared to quit Deutsche and go off on his own. Instead, he had to figure out a way to keep his trade alive and hold on to his job.
Lippmann managed a group that placed bond trades for investors. He realized that if he could convince enough investors to do the same trade he was undertaking, he might be able to rack up sufficient commissions to offset the costs of his bearish housing trade and placate his bosses. And if new investors could be convinced to buy the same CDS contracts that he owned, the price of these investments was bound to climb, which also would help Lippmann.
He traveled uptown to the offices of a hedge fund called Wesley Capital to meet two senior executives, to try to sell them on the idea. At first, they seemed impressed. Then they asked a friend who happened to be in the office, Larry Bernstein, who once managed a powerhouse bond-1sa trading team at Wall Street firm Salomon Brothers, to weigh in on the trade.
Bernstein was dubious. "Coase Law says you'll be wrong," he said, dismissively.
The executives looked at each other. Lippmann had no clue what he was talking about. Neither did the Wesley executives. Coase Law turned out to be an economic theorem-but it didn't seem to have much to do with the trade. Then the meeting turned contentious. If problems arose, Bernstein argued, the government likely would step in to bail out troubled borrowers. Even if you're right and the price of the mortgage protection rises, when investors began to sell their insurance, the price would be pushed down, sinking the trade, Bernstein said.
Ultimately Lippmann walked out with nothing.
Jeremy Grantham's GMO LLC seemed like a certain client. The Boston money-management firm had been cautious about the market for years, and Grantham was among the most vocal doomsayers, writing downbeat op-ed columns for various newspapers warning of "a sensational bust."
But when GMO executives consulted their resident bond expert, Allen Barlient, he shot down the idea, arguing that most mortgage deals had so much protection that they likely would be fine.
Some investors he met with leveled abuse at Lippmann. "My brother works for Fidelity and he's buying this stuff," one said, referring to subprime-related investments. "You're either an idiot or a liar" trying to wring trading commissions.
Behind his back, some on Wall Street called Lippmann names, such as "Chicken Little" or "Bubble Boy," chuckling at his quixotic effort. At conferences, some traders teased him, saying "Your crazy trade is losing money." Others repeated an industry maxim: "A rolling loan gathers no moss."
Lippmann began avoiding investors with deep knowledge of mortgages or complex bond investments. They understood his maneuver but were lost causes, wed to their markets and reliant on sophisticated models that suggested everything would be fine. Instead, Lippmann asked salesmen at his bank who catered to investors in the stock, junk-bond, and emerging markets worlds if they would help arrange meetings for clients with a potential interest in his idea.
He sometimes stumbled onto tough questions-why were the rates of mortgage delinquencies so 159 different in North Dakota and South Dakota? "You're missing it, you have to take a look at employment," an investor said.
Lippmann was stumped. North and South Dakota sure seemed the same; the fact was that Lippmann didn't know why the rate of delinquencies was so different. He had never even visited those states. So he and Xu went back to the data. Sure enough, the two states had similar levels of employment and seemed alike in other ways, but home prices were rising much more rapidly in North Dakota, explaining why delinquencies were lower. It confirmed that the biggest factor on default rates was whether or not houses were rising in value. It made Lippmann more certain than ever of his thesis.
Slowly, he began to win converts. A number of investors signed up in London, eager to profit from a U.S. economy they viewed as fragile. It took less than an hour for Lippmann to convince
Phil Falcone, a hedge-fund manager in New York, who seized on the limited downside and huge potential windfall of the trade. Falcone didn't even ask about the technical aspects of the mortgage market. The next day, he called Lippmann's team to buy insurance on $600 million of subprime mortgages. Later he made even more purchases.
By September, Lippmann had pitched the trade more than a hundred times and had his spiel down pat.
Lippmann won over dozens of investors, and CDS contracts began to fly out the door of Deutsche's Lower Manhattan office, $1 billion of protection a day. One investor even made a Tshirt that he gave to Lippmann and others saying "I shorted your house," a joke that seemed amusing at the time.
"What Lippmann did, to his credit, was he came around several times to me and said, 'Short this market,"' says Steve Eisman, a hedge-fund manager. "In my entire life, I never saw a sell-side guy come in and say, 'Short my market.' "2
A few hedge funds were such eager converts that they became as evangelical as Lippmann after doing their own research.
"You better get up to speed on the mortgage market ... fast," Alan Fournier, founder of New Jersey hedge fund Pennant Capital, wrote to a journalist in an e-mail in the summer of 2006. "All these crappy loans have been gobbled up by investors and they're gonna get burned ... the credit 1so unwind is really just getting started."
In all, Lippmann bought insurance on $35 billion of subprime mortgages, keeping about $5 billion of CDS protection for his own firm's account while selling the rest to eighty or so hedgefund investors. A few others who already had placed the trade, like John Paulson, compared notes with Lippmann, shared intelligence, and then did some buying through Deutsche. The growing commissions enabled Lippmann to buy even more subprime insurance for his own account.
Nonetheless, by the end of 2006, most of Lippmann's clients had lost money on the trade. He shared with a friend that his career would be affected if his scheme didn't work out. Within his bank, Lippmann had become an object of derision. When Paulson's trader, Brad Rosenberg, called to ask for him, a salesman answering the phone let out a loud laugh: "Why do you want to talk to him? That guy's crazy!"
Others at Deutsche Bank resented Lippmann. Yes, he was generating commissions, but his trade also was costing the bank about $50 million a year, reducing the firm's bonus pool, some traders grumbled.
Y LATE 20o6, housing prices finally had leveled off. Subprime lenders, including Ownit Mortgage Solutions and Sebring Capital, had begun to fail. John Paulson, Lippmann, Greene, and Burry should have been making oodles of money. But their positions barely nudged higher.
Late one afternoon, following another day of lackluster gains, Paulson picked up the phone to dial Lippmann, his subprime consigliere. To his investors and employees, Paulson showed absolute faith that the protection his firm owned on $25 billion of subprime mortgages would pay off.
With Lippmann, though, he could share his fears.
"Is there something I'm missing?" Paulson asked Lippmann. "Don't these people realize this stuff is crap? This is absurd!"
Paulson sounded like he might be wavering, surprising Lippmann.
"Relax, John. The trade will work."
Lippmann remained cocky because he was on the trading floor, buying and selling mortgage protection all day long. He knew better than almost anyone who the mysterious investors were on the other side of all the trades, a group so eager to sell insurance on all of those risky mortgages. And he knew their time would come to an end.
Never get high on your own supply. -Al Pacino in Scarface
SIMPLE, THREE-LETTERED ACRONYM EXPLAINED WHY PAULSON, Lippmann, Greene, and Burry weren't making much money in late 2006, even though housing was stalling out and home owners were running into problems: CDO.
A 1980s invention of some of the brightest financial minds, collateralized debt obligations, or CDOs, were investment vehicles that seemed to make the world a safer place-that is, until they fell into the wrong hands, not unlike other weapons of mass destruction.
Mortgage-backed bonds gave investors a claim on the cash flow of a group of mortgage loans; CDOs took it one step further. They were claims on giant pools of all kinds of debt that could include slices of loan and bond payments made by companies and municipalities, and even monthly payments by those leasing aircraft, cars, and mobile homes.
Investors were sold a set of securities with claims on all that flow of cash, each bearing a different degree of risk, like any securitization. The riskiest pieces of a CDO paid investors the highest returns but were first in line to suffer if the CDO received slimmer cash payments than it expected. Pieces with lower risk had lower returns but received the first income payments.
By the middle of the 2000s, the financial engineers were convinced that securitizations had spread the risk of all those loans, all but eliminating the chance of any big economic disaster. So they went back to the laboratory and concocted something called mortgage CDOs, featuring claims on a hundred or so mortgage-backed bonds, each of which in turn was a claim on thousands of individual mortgages.
The investments proved popular but their returns left something to be desired, spurring the bankers to craft CDOs that used the seemingly plentiful cash flow from slices of mortgage bonds rated BBB-and BBB-the ones backed by loans to borrowers with sketchy or limited credit histories-along with a sprinkling of other mortgages and loans. This investment was named a "mezzanine" CDO, after those dangerous BBB tranches.
The new CDO investments were an instant hit because they had juicy returns, thanks to all those 1s2 high-interest subprime mortgages. Some slices promised annual returns of nearly 10 percent. Just as important, rating companies were convinced that most of the slices of these CDOs should receive sky-high AAA ratings, or close to it, even though they simply were claims on huge stacks of risky home loans. The bankers argued that more cash was coming into the CDO than it needed to pay out, and that the mortgages came from all over the country and from more than one mortgage lender, making them safe. They had taken the straw of the mortgage market and spun gold: It was modern-day alchemy.
Lending by these CDOs powered the real estate market, ushering in the music, wine, and women chapter of the housing surge. In 2006, about $560 billion of CDOs were sold, including those using the cash flows from risky mortgages, almost three times 2004's levels. The "CDO system" had replaced the banking system, in the words of writer James Grant.
Few were as good at concocting CDOs as Chris Ricciardi. Growing up in affluent Westchester County, north of New York City, the son of a stock salesman, Ricciardi tagged along with his father to the floors of Wall Street firms and the New York Stock Exchange, captivated by the fast pace and huge sums of money changing hands.
Ricciardi couldn't find a job as a stock trader or an investment banker when he graduated during the economic slump of the early 1990s, so he started trading mortgage bonds. A few years later, as Wall Street pushed for ways to drum up higher fees and investors searched for better returns, Ricciardi was among the first to bundle the monthly payments from groups of dicey home mortgages with other debt to back securities with especially high interest rates.
Other bankers came up with their own CDOs but Ricciardi stayed a step ahead. As he moved from Prudential Securities to Credit Suisse Group, his groups always towered over competitors, as Ricciardi pushed his staff to churn out still more CDOs. Lured in 2003 to Merrill Lynch, a firm eager to take more risks under then-chief Stanley O'Neal, Ricciardi pushed Merrill to first place in the business, vaulting over bond powerhouse Lehman Brothers. New Century and others who made 163 risky loans knew that Merrill Lynch was eager for their product so it could sell more CDOs-the more the better.
Soon Merrill was the Wal-Mart of the business, producing CDOs at a furious pace. By 2005, the firm underwrote $35 billion of CDO securities, of which $14 billion were backed mostly by securities tied to sub-prime mortgages.
Every quarter, Ricciardi taped rankings near Merrill's trading desk, highlighting in yellow the firm's top-place finish. Staff members were pushed to grow sales by 15 percent a year. They hopped the globe to Australia, Austria, Korea, and France, selling CDOs to pension funds, insurance companies, and other investors. Back in the United States, they pitched hedge-fund investors such as Ralph Cioffi of Bear Stearns on the manicured lawns of the Sleepy Hollow
Country Club in Westchester, New York, the ski slopes of Jackson Hole, Wyoming, and elsewhere.
For each CDO Merrill underwrote, the investment bank earned fees of 1 percent to 1.5 percent of the deal's total size, or as much as $15 million for a typical $1 billion CDO. Soon Merrill's CDO profits topped $400 million a year or more.
Ricciardi's bosses cheered the activity, convinced profits would roll. "We've got the right people in place as well as good risk management and controls," Merrill's CEO, Stanley 0' Neal, said in 2005.
But as the CDOs became increasingly risky, some of Merrill's troops grew so uncomfortable selling certain products that they began lying to Ricciardi, telling him that clients had no interest in his group's latest creations, even before testing the waters. Ricciardi bolted Merrill in early 2006, after pocketing an $8 million paycheck for his work the previous year, to join Cohen & Co., a small firm that managed CDO deals. He continued to champion CDOs.
"These are the trades that make people famous," he told staff at his new firm that year, trying to drum up enthusiasm for CDOs, according to The Wall Street Journal. His new firm eventually would
manage with CDOs among the most defaults.
By the time Ricciardi left Merrill, the investment bank was hooked on profits from risky CDOs. Dow Kim, then head of markets and investment banking at Merrill, vowed to do "whatever it 164 takes" to stay number one in CDOs. In 2006, the firm pushed even harder to get these deals out the door, racking up $700 million of fees and issuing $44 billion subprime CDOs, up from $14 billion in 2005. That year, O'Neal was paid an $18.5 million cash bonus and $48 million in total pay.
Investors who bought the CDO slices often believed in their safety, or were assured by the topnotch investment ratings they received. Like firefighters going into yet another burning building, they had survived for so long, they began to see their work as routine.
Ralph Cioffi, a twenty-two-year Bear veteran who ran two hedge funds at Bear Stearns, first became worried about subprime borrowers in early 2006. But the military-history buff put almost all of his funds' cash in high-rated slices of CDOs, borrowing so much money that the funds owned $20 billion of these investments. Cioffi, who was personally worth $100 million at one point that year, didn't buy blindly; he also owned CDS contracts insuring other, lower-rated mortgage bonds, a strategy that seemed more conservative to him.
His investors had utmost confidence in Cioffi and his partner, Matthew Tannin.
"I often bragged about the fund because it didn't have a single down month in three years, and that was just amazing to me," says Ted Moss, a sixty-seven-year-old real estate developer from Cleveland, Tennessee, who invested about $1 million in one of Cioffi's funds at Bear Stearns.
It seemed like investors hungered for these CDO slices because housing was rising. But in reality, many were taking advantage of a slick accounting maneuver. When a bank purchased the AAA piece of a CDO while simultaneously buying credit-default swap insurance on that same slice, it often could immediately book as profit the present value of the future cash flows from that CDO as long as it had a higher interest payout than the cost of the CDS. Traders buying a CDO slice yielding 5 percent a year, e.g., while at the same time paying 4.8 percent a year to purchase a CDS contract on that same slice, could boast an easy 0.20 percent annual profit. They sometimes even 1ss claimed an immediate windfall based on the expected profit of these trades over the subsequent ten years.
Borrow enough money, repeat this trade frequently, and a huge bonus was in store for the traders, a windfall that even those harboring suspicions about housing found hard to turn down.
Eventually, these "negative basis" trades led to a major percentage of the losses on CDOs,
according to UBS Securities.
HROUGHOUT 20o6, Greg Lippmann was eager to find evidence of cracks in housing. Most mornings, after taking a cab or bus from his downtown loft to Deutsche Bank's Wall Streetarea office, he uncovered fresh proof that real estate was weakening. But the subprime mortgages he had bet against were not dropping. Sometimes colleagues would see Lippmann shake his head, a bemused smile on his face. He knew the CDOs were still buying, propping up the market.
It didn't make much sense to Lippmann. He got on the phone, urging investors to short the very same mortgage bonds that the CDOs were purchasing, reassuring those with losing trades that the CDO buying would have to stop, at some point.
Demand only grew, however. In fact, there weren't enough subprime mortgages to meet the rabid interest for the high-return "mezz" CDOs. So investment bankers turned ingenious, creating CDOs with claims on the income of other CDOs, calling these "CDO squared." They crafted other CDOs from the cash generated by selling CDS protection to investors like John Paulson. These "synthetic" CDOs, in fact, became the dominant form of CDOs by late 2006.
Investment banks favored synthetic CDOs because they were easier to construct, a quick way to generate fees. They didn't require the purchase of actual mortgage bonds, a process that typically took months. A billion-dollar CDO could be assembled in mere weeks by selling enough CDS contracts on home mortgages. By the end of 2006, there were $1.2 trillion of subprime loans, about 10 percent of the overall mortgage market. But by introducing so many CDOs, more than $5 trillion of investments had been created based on all those risky loans, according to some estimates.
This is the secret to why debilitating losses resulted from a market that seemed small to most 166
outsiders, unaware of the breakneck growth of CDOs.
There was just one hitch: The top-rated slices of these CDOs could be hard to sell, since they had lower yields than riskier CDO slices. So the banks often kept or bought these "supersenior" pieces for themselves. Giant insurance company AIG stopped selling insurance on these investments by 2006, but the banks kept piling them on, eager to get CDOs out the door. (At the time, AIG Finance, an arm of AIG, still had perhaps the most exposure to these investments.)
Merrill Lynch, Citigroup, Morgan Stanley, and UBS, the same investment banks creating CDO deals from toxic mortgages, all placed these supersenior CDO slices in their own accounts, like butchers bringing home noxious sausage to share with the family. Top management either approved the process or were clueless it was happening, assured by underlings that the securities were safe. Yes, the CDO investments they held shared AAA ratings with the debt of the U.S. government. That's where the similarities ended. They were both AAA rated the way that Miley Cyrus and Meryl Streep both get high marks from audiences. In other words, they were worlds apart.
Some bankers had vague worries, but they felt pressure to get as many CDOs completed before it all ended, like a giant game of musical chairs.
Charles "Chuck" Prince, chief executive of Citigroup, the largest bank in the world, who received a $13.2 million cash bonus and $25.6 million in overall pay in 2006, captured the sentiment in an unusually frank statement: "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing," he told the Financial Times. (By June 2008, Prince would resign from his job as the bank dealt over $15 billion in losses, much of it from CDO investments.)
Others believed in the safety of the high-rated debt slices, or relied on brainy quants and their whiz-bang computer models, which deemed the CDO slices safe, like illusionists fooling even themselves with a trick they had performed. 1s1
OHN PAULSON already had purchased billions in CDS investments that would pay off if the home J mortgages of borrowers with sketchy credit ran into problems. And he bought insurance contracts that would rack up profits if groups of subprime mortgages tracked by the ABX index suffered.
But if he was genuinely going to make the trade of a lifetime, he needed more. Like a cocksure Las Vegas card-counter, he was eager to split his winning blackjack hand, again and again.
"Given where the credit markets were, we had to find short opportunities," Paulson says.
As Paulson eyed the raging CDO market, he realized it, too, was bound to collapse. He decided he had to get his hands on insurance for these investments as well.
Pellegrini and the rest of Paulson's team searched the market for especially bad CDOs, like a shopper picking through a fruit bin. Rather than find the healthiest and ripest of the lot, though, Pellegrini and his team searched for the most rotten. Then they bought CDS insurance contracts on those CDO slices. A CDO with a lot of loans made by New Century? Throw it in the basket. One dominated by liar loans and interest-only mortgages? Definitely. A CDO with lots of mortgages from the superheated real estate markets of California and Nevada? Grab two handfuls.
But as Paulson's shorting became an open secret in the business, Pellegrini noticed that the Wall Street pros were treating him less warmly, as if he was throwing a wrench in their well-oiled machine. At one point in 2006, Pellegrini was eager to learn about a group of CDOs filled with mortgage bonds put together by Carrington Capital Management LLC, run by hedge-fund manager Bruce Rose. Pellegrini recognized that he remained an amateur in this world and he was worried that he might miss something if he didn't see the "tape" detailing the actual mortgages in the CDOs. He told his broker at Bear Stearns that if he sent the tapes of Carrington's mortgage-bond deals, he might consider buying safer slices of the CDOs.
After a few hours, the broker called Pellegrini with some bad news.
"I'm sorry," the broker said, sheepishly. "The issuer doesn't want you to see it."
"What do you mean? How is that even possible!?" 1sa
Later that day, Pellegrini got Bruce Rose on the phone to express his displeasure at the unusual blackballing.
"I've seen your investment presentation," Rose replied. "I find it amusing. But I don't want anything to do with you."
Rose then hung up, leaving Pellegrini boiling.
"They were closing ranks on us," Pellegrini says.
The activity began to wear on Rosenberg, the firm's only debt trader. Sometimes Paulson wanted him to buy protection on mortgage bonds. Other times he'd sell the ABX index of subprime bondsit was another way to be bearish on housing. None of the investments was traded on public exchanges or had clear pricing, making it harder to know if it had been a good deal. Rosenberg also bought protection on a few financial companies. And once in a while, Paulson asked him to buy some bonds, too.
Each morning before 10 a.m. Rosenberg e-mailed seven or eight Wall Street dealers an "OWIC" list, or Offers Wanted in Competition, a list of the names of mortgage slices that Paulson & Co. wanted to buy CDS protection for. At 2:30 p.m. he'd receive a spreadsheet of their best offers.
Pellegrini took the list to Paulson, and they'd huddle in his office, speaking in undertones. Rosenberg would emerge an hour later for a new round of furious phone calls.
There was no time for breaks. Paulson ordered lunch in for his staff, and Rosenberg ate at his desk. Rosenberg left the office exhausted, although he claimed the pace didn't faze him.
"I'm from Bear Steams, the toughest firm on the Street. I didn't need a pat on the back," says Rosenberg. "They ranked everyone and fired the lowest guy on the desk each year."
Rosenberg didn't know exactly how much mortgage protection Paulson wanted, but he knew Paulson hungered for more.
"We had to get on as many trades as possible before it was too late," Rosenberg says.
J OHN PAULSON, focused on creating a huge trade, soon took a controversial step that would lead to some resentment for his role in indirectly contributing to more toxic debt for investors.
Paulson and Pellegrini were eager to find ways to expand their wager against risky mortgages; 169 accumulating it in the market sometimes proved a slow process. So they made appointments with bankers at Bear Stearns, Deutsche Bank, Goldman Sachs, and other firms to ask if they would create CDOs that Paulson & Co. could essentially bet against.
Paulson's team would pick a hundred or so mortgage bonds for the CDOs, the bankers would keep some of the selections and replace others, and then the bankers would take the CDOs to ratings companies to be rated. Paulson would buy CDS insurance on the mortgage debt and the investment banks would find clients with bullish views on mortgages to take the other side of the trades. This way, Paulson could buy protection on $1 billion or so of mortgage debt in one fell swoop.
Paulson and his team were open with the banks they met with to propose the idea.
"We want to ramp it up," Pellegrini told a group of Bear Stearns bankers, explaining his idea.
Paulson and Pellegrini believed the debt backing the CDOs would blow up. But Pellegrini argued to his boss that they should offer to buy the riskiest slices of these CDOs, the so-called equity pieces that would get hit first if problems resulted. These pieces had such high yields that they could help pay the cost of buying protection on the rest of the CDOs, Pellegrini said, even though the equity slices likely would become worthless over time, as the debt backing the CDO fell in value. And if their analysis proved wrong and the CDOs held up, at least the equity investment would lead to profits, Pellegrini said.
"We're willing to buy the equity if you allow us to short the rest," Pellegrini told one banker.
To try to protect themselves, the Paulson team made sure at least one of the CDOs was a "triggerless" deal, or a CDO crafted to be more protective of these equity slices by making other pieces of the CDO more likely to take early hits. Paulson's goal was to make the equity piece a bit safer, but this step made the other parts of the triggerless CDO even more dangerous for anyone with the gumption to buy them.
He and Paulson didn't think there was anything wrong with working with various bankers to no create more toxic investments. Paulson told his own clients what he was up to and they supported him, considering it an ingenious way to grow the trade by finding more debt to short. After all, those who would buy the pieces of any CDO likely would be hedge funds, banks, pension plans, or other sophisticated investors, not mom-and-pop investors. And if these investors didn't purchase the newly created CDOs, they'd likely buy another similar product since there were more than $350 billion of CDOs at the time. However, at least one banker smelled trouble and rejected the idea. Paulson didn't come out and say it, but the banker suspected that Paulson would push for combustible mortgages and debt to go into any CDO, making it more likely that it would go up in flames. Some of those likely to buy the
CDO slices were endowments and pension plans, not just deep-pocketed hedge funds, adding to the
Scott Eichel, a senior Bear Stearns trader, was among those at the investment bank who sat through a meeting with Paulson but later turned down the idea. He worried that Paulson would want especially ugly mortgages for the CDOs, like a bettor asking a football owner to bench a star quarterback to improve the odds of his wager against the team. Either way, he felt it would look
"On the one hand, we'd be selling the deals" to investors, without telling them that a bearish hedge fund was the impetus for the transaction, Eichel told a colleague; on the other, Bear Stearns would be helping Paulson wager against the deals.
"We had three meetings with John, we were working on a trade together," says Eichel. "He had a bearish view and was very open about what he wanted to do, he was more up front than most of them.
"But it didn't pass the ethics standards; it was a reputation issue, and it didn't pass our moral compass. We didn't think we should sell deals that someone was shorting on the other side," Eichel says.
For his part, Paulson says that investment banks like Bear Stearns didn't need to worry about including only risky debt for the CDOs because "it was a negotiation; we threw out some names, m
they threw out some names, but the bankers ultimately picked the collateral. We didn't create any securities, we never sold the securities to investors . ... We always thought they were bad loans." Besides, every time he bought subprime-mortgage protection, someone had to be found to sell it to him, Paulson notes, so these big CDOs were no different.
Indeed, other bankers, including those at Deutsche Bank and Goldman Sachs, didn't see anything wrong with Paulson's request and agreed to work with his team. Paulson & Co. eventually bet against a handful of CDOs with a value of about $5 billion.
Paulson didn't sell any of these products to investors. Some investors were even consulted as the mortgage debt was picked for the CDOs to make sure it would appeal to them. And these deals were among the easiest for an investor to analyze, if they so chose, because they were "unmanaged" CDOs, or those in which the collateral was chosen at the outset and not adjusted later on like other CDOs. It wasn't his fault that others were willing to roll the dice.
A few other hedge funds also worked with banks to create CDOs of their own that these funds could short-so Paulson wasn't doing anything new. Nor did Paulson's moves create more troubled mortgages or saddle borrowers with additional losses-the deals were CDOs composed of CDS contracts, rather than actual mortgage bonds.
"We provided the collateral" for the CDOs, Paulson acknowledges. "But the deals weren't created for us, we just facilitated it; we proposed recent vintages of mortgages" to the banks.
But some investors later would complain that they wouldn't have purchased the CDO investments had they known that some of the collateral behind them was chosen by Paulson and that he would be shorting it. Others argued that Paulson's actions indirectly led to more dangerous CDO investments, resulting in billions of dollars of additional losses for those who owned the CDO slices when the market finally cratered.
In truth, Paulson and Pellegrini still were unsure if their growing trade would ever pan out.
They thought the CDOs and other risky mortgage debt would become worthless, Paulson says.
"But we still didn't know."
NDREW LAHDE WAS OUT OF WORK IN THE SUMMER OF 2006, HE had little left in his savings account, and he was stuck in a cramped one-bedroom, rent-controlled apartment. But Lahde was convinced he had at least one thing of value: a trade that was sure to make him a fortune.
He just couldn't get anyone to believe him.
The thirty-five-year-old had been let go by Los Angeles investment firm Dalton Capital, after a series of clashes with his boss and an abrupt shuttering of the hedge fund that Lahde was working on. He wasn't very concerned, at least initially. Young traders were launching hedge funds with ease, from coast to coast. Lahde figured he'd just do the same. But investors turned him down cold. The only nibbles came from those offering very little money but demanding a huge chunk of his new firm. That was something Lahde wouldn't consider, though in truth his firm amounted to little more than a glass desk and a simple chair in his Santa Monica living room, as well as an unyielding conviction that the housing market was about to crater.
It didn't help that Lahde looked more like a chilled-out surfer than a budding hedge-fund titan.
Six-foot-two with tousled blond hair, chiseled features, and sleepy, deep-blue eyes, Lahde seemed to have just rolled out of bed, more than a bit upset at having been awoken. He didn't seem comfortable around people, fidgeting in his seat during most meetings, and the slow, deliberate tone of his voice was so deep and muted, it sometimes was hard to make out what he was saying.
Lahde's mother, Bonnie, back home in Michigan, kept calling, badgering him to find a real job. His best friend, Will, insisted that his trade idea wouldn't pan out because the Fed and the government would ensure that housing held up, at least through the 2008 elections. It had been years since Lahde cared very much about the opinions of family members and friends, but their lack of confidence grated on him. It's not like he didn't at least apply for some jobs at nearby firms, but they didn't pan out, partly because Lahde, brimming with a confidence not yet reflected in his resume, was uninterested in junior positions.
"Dude, I stopped looking for a job, full on," he told Will after one more irritating call. Lahde's deep suspicions and bitter resentments always lay just below the surface. He grew up in a religious home, the son of a mechanical engineer and a physician's assistant, in the mostly white, wealthy Detroit suburb of Rochester, Michigan, Madonna's hometown.
His father, Frank, worked for Ford Motor Company and then for various auto suppliers in the area, but he was occasionally out of work as the industry's troubles grew. Nonetheless, the Lahde family stretched their finances to buy a 2,000-square-foot home, among the smallest in the neighborhood, adding to the tension in the home. Sundays were spent at St. John, a local Lutheran church, and all three of the Lahde boys attended the church's school from fourth to eighth grades.
But at fourteen, Lahde, hoping to generate some cash for himself amid the family's strain, began selling marijuana to wealthier kids in town, after starting with fireworks sales. Once, when he was caught dealing pot, Lahde argued to his parents that alcohol was a gateway drug and a far greater evil than cannabis.
"I figured out that the only way to have security was to have a business with good cash flow, or to be wealthy enough so you didn't have to work," Lahde recalls.
At Michigan State, where Lahde majored in finance and graduated with honors, he began subscribing to The Wall Street Journal, impressed with stories of traders making millions. Math courses came easily to Lahde, though he had little patience for much else. After college, and a few years making less than $30,000 a year as a broker at TD Waterhouse, Lahde was rejected by every business school he applied to. It happened again, a year later-Stanford University, the University of Chicago, the Wharton School, and Yale University all turned him down. Finally, he gained acceptance to UCLA's Anderson School of Management, the last student taken off their waiting list.
At UCLA, Lahde bristled at his more privileged classmates, some of whom graduated from prep schools and Ivy League universities but didn't seem especially bright to him. When he told them 174 that he had graduated Michigan State, rather than its more prestigious rival, the University of Michigan, he felt they looked down on him. Things didn't go any more smoothly inside the classroom. Lahde almost was kicked out after receiving an F in a Human Resources class. He blamed the grade on his repeated challenges to the professor's weak arguments during class discussions. The F drove Lahde nuts, because he was paying his own way at the expensive school, draining the savings from his earlier jobs and extracurricular activities, while many classmates were enjoying a free ride courtesy of their families.
"He almost took away everything I had worked for," Lahde recalls, referring to his professor. Placed on probation after the failing grade, Lahde graduated in 2002 to a discouraging job market. In his spare time during business school, he had taken courses to become a chartered financial analyst, helping to distinguish him in the market. Through a UCLA contact, Lahde landed a job at Roth Capital, a third-tier investment bank in nearby Newport Beach known for raising money for small, usually obscure companies. He was miserable from day one, itching to invest money rather than sell securities to investors. But Lahde quickly found his niche, picking a number of winning stocks for clients and learning to pitch the firm's various products.
In the fall of 2004, Lahde latched on as an analyst at Dalton. Steve Persky, the owner of the growing, $1 billion hedge fund on Wilshire Boulevard in Los Angeles, judged Lahde the hungriest of the job candidates he met. But Lahde soon began to clash with his demanding boss, unhappy when Persky publicly criticized employees in regular group meetings when they overlooked details in their work. On the other hand, Lahde's work impressed Persky, who named his firm after the prestigious New York prep school he had attended. But Lahde rankled his boss by overdramatizing investment opportunities, sometimes calling a promising company "another Microsoft," while m
referring to a problematic company as "the next Enron."
At the time, both Persky and Lahde were novices when it came to real estate. When he first joined Dalton, Lahde told his boss that he was thinking about buying a $600,000 condominium by paying $30,000, or 5 percent of the price, as a down payment. Persky seemed shocked.
"Are you serious, that's all they want?" Persky said.
"Yeah, that's the standard," Lahde replied. "I think I can even get a mortgage with no down payment at all."
One day, after Persky's wife told him that she wanted to start investing in the white-hot Los Angeles real estate market, despite the fact that she had no background in the business, Persky began to get concerned. Weeks later, he read a negative article in Barron's magazine about a big subprime-mortgage lender in nearby Orange County called New Century Financial and asked Lahde to check it out.
Lahde had a vague awareness of the company from his time at Roth Capital and spoke with an old friend who was still an analyst at the firm, Rich Eckert, who had a "Buy" rating on New Century's shares. But Lahde had been developing his own misgivings about housing and had recently convinced his parents to sell their second home, on a lake in Michigan. Lahde spent weeks studying New Century, quickly realizing the company had little cash of its own-only by selling its mortgages to Wall Street banks to be used in mortgage pools could New Century get the cash to make new loan commitments. If that securitization market ever disappeared, Lahde figured, New Century's business would disintegrate.
Lahde dug into the world of securitizations, telling Persky that it didn't seem like many slices of the mortgage pools would hold up if borrowers ran into problems. Even if housing prices just flattened out, the riskiest slices of the pools could be in trouble, because home owners wouldn't be able to refinance their mortgages.
Lahde walked into Persky's office one day and said the firm should short the entire Orange County, where real estate development and aggressive lending were running rampant. It was Lahde's usual hyperbole, and obviously impossible, but Persky fully agreed with him. Betting 11s against shares of New Century seemed to be the next best thing, though Lahde warned Persky that it might take a year or two before things slowed and the trade worked. By early 2005, New Century was Dalton's biggest short position; it soon would be joined by fellow subprime lender Accredited Home Lenders. Lahde and Persky visited another Orange County financial company, Downey Savings and Loan, and were amazed to realize that so much of their business was extending so-called option ARM loans, or loans that allowed borrowers to make monthly payments that didn't even cover the interest cost of the loan. They quickly began to short Downey as well.
But the stocks kept climbing throughout 2005, as respected hedge-fund investor David Einhorn established a big position in New Century and then joined the company's board of directors. Adding salt to Dalton's wounds, New Century paid its shareholders a hefty annual dividend that amounted to 13 percent of the value of its shares. By shorting, or borrowing and selling the shares, Dalton had to pay that dividend to the investors it had borrowed from, adding to the firm's losses.
But Dalton wouldn't give up, adding to its bearish positions in 2005 and into 2006, even buying CDS insurance contracts on a number of housing players and mortgage-related debt. The losses piled up, month after month. With each bad day, and each furious call from his investors, Persky became more frustrated.
"I was doing what I thought was prudent, but my performance was modest, and many of my investors had short leashes," Persky says.
Tempers simmered, and the bickering between Persky and Lahde escalated. When Persky criticized Lahde, who was on edge because his recommendations were losing money for the firm and his bonus was in jeopardy, he often fired back at his boss, even in public meetings. By April 2006, Persky had had enough. He began to sell all the fund's bearish housing bets, handing cash back to his clients, even though he remained convinced a real estate collapse was inevitable. He m
just couldn't take it anymore. The decision shocked Lahde, as did Persky's subsequent decision to fire him and give him just three months' severance pay, or about $30,000.
Lahde remained convinced that housing was set to crack. New Century and other lenders were starting to come under pressure because as interest rates rose, their borrowing costs were approaching those of the loans they were making to customers, crimping profits. It was a sure sign that their business couldn't last.
His unpleasant experience at Dalton weighed on Lahde. As he gazed out his window at the beach next to his apartment, he was tempted to give up on the financial business, find a girl, and go on a long vacation. But Lahde figured that if he could set up a hedge fund of his own dedicated to wagering against real estate, the payoff could be huge.
"It was always going to be a two-year thing," Lahde says. "I knew I couldn't hold it together longer than that."
He set up Lahde Capital in his 800-square-foot apartment, angling his chair to get a good view of the blue water glistening just a few hundred yards away. Some days the weather was so warm that Lahde took a break from his steamy apartment, which lacked central air-conditioning, to jump in the nearby Pacific Ocean.
All summer, the sun shone brightly outside the apartment while darkness grew within. Lahde was sure that housing was on its last legs, but he worried that all kinds of financial firms would be devastated by the fallout. The way he viewed it, he was about to get on a surfboard ahead of a tsunami. The wave would be huge but it could turn out at the last second, knocking him cold before he reached shore.
To avoid that, Lahde decided to buy only CDS protection on the ABX index of subprime residential mortgages, rather than on various MBS pools like other bearish investors. He figured the ABX was more actively traded and would be easier to exit on a dime when things surely crumbled.
In truth, Lahde didn't really know much about the ins and outs of trading CDS contracts. At Dalton, he had focused on New Century and other lenders. Persky didn't let him tackle the firm's m
CDS moves. So Lahde asked advice from the few traders he knew who were willing to spare him some time.
Lahde began to pitch potential investors on his two-year strategy of betting against risky mortgages, asking for minimum investments of $5 million, aiming to start with at least $100 million. But every meeting was another strikeout. No one was interested in Lahde or his bearish arguments. Pressure grew; Lahde felt he had only several weeks to place his trades before it all unraveled.
In a desperate moment, Lahde even tried Persky, who also turned him down. Lahde began leaving his tie and suit at home, wearing a polo shirt to meetings with investors, and adopting a jaded attitude; it was as if he had given up.
"Andrew's not a perfect guy to persuade you to invest," says Dr. Norman Zada, one of those who received a call from Lahde asking for an investment. Zada, founder of Perfect 10, an adult magazine featuring women willing to pose nude but unwilling to undertake cosmetic surgery, ignored Lahde's entreaties for months before finally giving him some cash. "He's a youngster and a little strange ... and he seems sort of nervous around people."
At first, Lahde couldn't convince brokers to enter into ISDA (International Swaps and Derivatives Association) agreements with him and serve as counterparties to his new firm, making it impossible for Lahde to buy the CDS contracts he so coveted. The brokers said his firm was too small. Lahde didn't even have much of his own money to invest, compounding matters. He was worth only about $150,000 and needed most of it to pay the firm's bills, not to mention his own living expenses.
After weeks of frustration, Lahde sweet-talked brokers at Lehman Brothers and Bear Stearns into considering selling him CDS contracts, telling them that big money was on the way and soon he'd be managing $100 million or more. They were skeptical but began working on complicated trading agreements just in case the money came through.
By November, Lahde had managed to raise $2 million from a few investors, but he was exhausted from the chase, and it didn't seem like he'd be able to turn up other investors. Holding 179 his breath, he asked the Bear Stearns and Lehman brokers if he could begin putting his trades on with the money he already had. He reminded them that his firm was sure to grow quickly and pointed out how much work they'd already done on the complex agreements. Why put it all to waste, Lahde argued.
He picked an opportune time to ask. By late 2006, Wall Street firms were squeezing every last drop from the housing market. After hemming and hawing, his contacts at Lehman Brothers and Bear Steams agreed to sell him CDS contracts, as long as the paperwork was approved by their superiors. But they insisted that their credit departments approve Lahde before each trade he made, much like a parent insisting on accompanying a new driver.
One day in November, just after 5:30 a.m., the phone rang in Lahde's bedroom, startling him.
His broker at Lehman Brothers called to say the paperwork was complete and Lahde could begin trading. Not only that, but the CDS insurance contracts he wanted were so unpopular that Lahde actually would be paid an up-front fee if he agreed to pay regular premiums on this insurance for risky mortgages. Lahde fumbled with the phone in the dark, trying to make out the implications of the quote.
Do you want the trade, the broker asked?
"Do it," Lahde responded, before he rolled over and went back to sleep.
Over the next few weeks, Lahde accumulated more protection on slices of the ABX index, ranging from those rated BBB-all the way up to AA, focusing on mortgages handed out during the first half of 2006, when the market was at its most exuberant.
But Lahde's stress level was building as the new year approached. He'd hired an associate for his firm, legal bills were due, and Lahde was down to $100,000 of savings. Even after raising another $1.5 million and buying more CDS contracts, he owned protection on just $17 million of risky mortgages, a figure so puny by Wall Street's standards that it was embarrassing. The trade of a lifetime was slipping through his fingers. Unless Lahde could quickly raise some serious money, he would have to shutter the firm and look for a job. 1so
A friend called to level with Lahde: The brochures with the summary of his investment thesis that he'd been sending out to prospective investors made him look like a rank amateur. Lahde had to concede the point.
A week before Christmas, Lahde sat down at his circular, glass desk, which doubled as his apartment's dining-room table, to rework his marketing materials. He kept at it, writing and rewriting the presentation, again and again. He canceled Christmas plans. Pretend I'm in a submarine and out of touch, he told his mother. Lahde put in a series of all-nighters, including one on New Year's Eve, finally finishing on January 17. The marketing materials now looked impressive. But he wasn't sure he had enough time left to pull off his trade.
1 N LATE 2006, Paulson stayed upbeat. He was waiting for his trade finally to begin to work. In
November, he closed his fund, the Paulson Credit Opportunities Fund, to new investors. He had raised $700 million and spent it all on various mortgage protection. Paulson immediately launched a sister fund to make the same bets, even though his trade, though profitable, wasn't clicking.
To let off stress, he spent hours swimming and sailing in Southampton, and playing tennis with his friend Tarrant, displaying a nasty serve. To keep his employees loose and upbeat, Paulson sometimes adopted a faux British accent, keeping the ruse going during an entire dinner with one client. Paulson started one meeting about the mortgage business with a spot-on imitation of a current television commercial:
"You just filed for bankruptcy? No job? No problem! No money down!"
For all his equanimity, however, his concern was growing. What if the subprime market really did collapse-who would be on the hook for the billions of insurance he was buying?
"We didn't know who was selling it all to us," recalls Rosenberg, who traded with investment banks, not directly with those who sold Paulson & Co. insurance. "But if the sellers got in trouble, it would hurt the investment banks."
Concerns about the health of his brokers led Pellegrini to set up separate accounts for the firm at 1a1 various banks, and to settle positions with his trading partners on a daily basis.
Paulson's outlook for the financial system became downright glum as a new advisor gained his ear. Paulson came across a newsletter, published by an obscure economist in suburban New Jersey named A. Gary Shilling, that predicted dour things for the economy. Paulson was so taken with the forecast that he asked Rosenberg to call Shilling and invite him to come by, to discuss his views. Shilling had spent more than a decade publishing a newsletter and periodic articles, usually with a single theme: The bad times were around the bend-sell everything! Most dismissed Shilling's warnings, sometimes with a laugh. The end was never as near as Shilling predicted.
Paulson was a merger guy-he didn't know Shilling was Wall Street's version of the Boy Who Cried Wolf. When Shilling met with Paulson and predicted a collapse of home prices and sharp rise in mortgages foreclosures, Paulson took notice.
Shilling, a septuagenarian with bushy eyebrows and a balding pate, favored bright-red pocket handkerchiefs in his blue blazers. He emphasized to Paulson's team that the subprime market wasn't a fringe area, but rather a key underpinning to the entire real estate market. When it went, so would housing, bringing down much more.
"Boy, if you're right, the financial system will fall apart," Paulson said to Shilling, after one more dire forecast to a room of Paulson's analysts. "Yes, John, it will."
Shilling, who vividly recalled the tears in his father's eyes during the Great Depression, predicted that housing prices would fall 37 percent.
"Do you really think it's going to get that bad?" Paulson asked, after another dire forecast.
"As sure as you can be."
Paulson began to focus on the linkages, and how troubles for sub-prime borrowers could topple housing, which might in turn bring down the financial system and the global economy.
This could really get bad. We need to broaden the trade.
But even Paulson didn't realize how quickly his prediction would come
|时间: 2011-2-20 周日, 上午4:39 标题:
|But Libert was getting excited about the signs of housing problems, the minister retorted.
A few of Libert's close friends were just as critical. Some called to take him to task, putting Libert on the defensive.
"I didn't cause it, I didn't have anything to do with the problems," he responded to one, as his wife, his moral compass, nodded.
"The friends made me feel guilty," Libert recalls. "I couldn't help myself ... I was cheering for people to lose their homes." Libert called his broker Zafran, to share his feelings and get some support. "It just gives me the creeps, Alan. I'm betting on people's misery."
"I understand," Zafran responded, sympathetically.
Libert only rarely brought up his conflicted feelings with Greene, though. Greene couldn't relate 211 to any of it.
"Libert, why are you being so uptight about it?"
"It just gives me the heebie-jeebies."
"You didn't cause it!"
"Yeah, I know. But we're cheering for it."
When it came to discussing the moral aspects of the trade, it was as if Libert and Greene spoke different languages.
"I didn't even think about it," Greene acknowledges. "If more people had been [shorting mortgages] early on, then the pricing of debt would have been higher and things wouldn't have become so crazy. The world would have been a better place had more people been shorting. We had nothing to do with what happened to home owners."
Part of Libert agreed with his friend. But he couldn't shake his qualms. It all left him a miserable ball of nerves.
ARIO AND LETICIA MONTES were the type of home owners Libert was wagering against and the reason he was so torn about his trade.
In mid-2005, the Monteses found a home they loved, a gray stucco bungalow with a hot tub in the backyard in a middle-class neighborhood of Orange County. It cost $567,000. The only catch was they didn't have money for a down payment and couldn't afford the home unless they agreed to a mortgage with a low interest rate for the first two years, but one that would then rise, increasing their monthly payments by more than 50 percent. Their mortgage broker assured the Monteses, who earned combined salaries of $90,000, that they'd easily be able to refinance their mortgage before the rate climbed. Sitting around the kitchen table with their two teenage daughters, they decided to cut back on vacations and restaurant outings, and to take the plunge to become home owners.
By the summer of 2007, however, their home had tumbled in value and lenders finally had tightened their standards, making a refinancing impossible. They faced yearly mortgage payments of $50,000, just about their entire take-home salary.
"We have a disaster on our hands," Mario, a forty-eight-year-old warehouse manager, told a reporter. Fears of a foreclosure gripped him, he said.
"At this point," he said at the time, "we really don't have a plan."
"Bottom line, it's our little home," Leticia told a visitor. "Hopefully, we won't go down, and if
we do, we're going to go down with a fight."
Y THE suMMER, the data was too overwhelming for Libert to ignore. Eight percent of a $1 billion pool of subprime home mortgage loans made in early 2007 already had defaulted-within just six months of being inked. Fifteen percent of them were in default after less than nine months. And the figures were only getting worse! Defaults didn't necessarily mean losses for the mortgage pools, but if losses in the pool reached 12 percent, or $12 million, even the AA-rated slices of the bonds would be wiped out, Libert knew.
Libert converted all his insurance on BBB-rated bonds to protection for AA-rated slices. Because they were still perceived as being largely safe, the insurance was still inexpensive, allowing Libert to get more bang for his buck. He now owned CDS insurance on $25 of toxic mortgages for each $1 he put down.
"You should really get into the AAs," Libert told Greene.
Now it was Greene's turn to feel torn. Should he follow Libert's lead and roll his own protection into insurance on those AA-rated slices? Greene arranged a phone conversation with analysts from Merrill Lynch and J.P. Morgan. They agreed that CDS contracts protecting AA-rated slices of subprime mortgages were a better bet than Greene's BBB protection.
Greene bought some protection on the AAs, but soon he became distracted. In late September, he and Mei Sze Chan married at his Beverly Hills mansion, a blowout affair that cost $1 million and was the buzz of the Los Angeles social scene. The guest list included Oliver Stone; Donald Sterling, the owner of the Los Angeles Clippers basketball team; and Robert Shapiro, O.J. Simpson's attorney. Mike Tyson was Greene's best man. Chan, wearing a gown of hand-beaded
Swarovski crystals, married Greene in a French limestone gazebo. After midnight, the revelers danced on a revolving dance floor in Greene's twenty-four-car garage. John Paulson didn't come, though he sent Greene a gracious card. But Greene never stayed away from the trade for long. In the middle of the wedding, Greene pulled aside Libert with urgent news: "Your trade is at 89.72 today!"
Libert was shaken. He had bought protection on the ABX index tracking AA subprime mortgages when it was trading at 80. Now it was almost 10 points higher. He had given back half the profits 213 from his BBB trade by shifting into the AA bonds much too early!
Then it dawned on Libert-there was no way Greene could know the price of the index in that kind of detail. Prices were never quoted to the penny. Greene was playing with Libert's head, preying on his insecurities.
He turned to his wife with a relieved smile.
"What's he talking about, 89.72??" Libert said. "I'm a schmuck; he's sticking it to me."
"He knew I just didn't have the stomach for the trade," Libert recalls.
By the end of the summer, Libert set aside his compunctions and made plans to put more money in the investments, convinced that something big was about to happen.
ITH EVERY NEW FIGURE on Greg Lippmann's computer screen in early 2007 came a single message: Your bonus is soaring!
As the ABX collapsed in February, Lippmann and his team racked up huge gains, thanks to protection they held on about $3 billion of sub-prime mortgages. One day early that month, they made $20 million, their best day ever. The next day, they did it again! The group followed it up with a still better day. Over one spectacular week, Lippmann's crew made $100 million of profit. Their Bloomberg terminals became best friends, the next price quote a cause for celebration, the end of the trading day a reason for sorrow.
At first, Lippmann tried to play it cool-his bonus check wouldn't be cut until the end of the year and he knew there was a lot of time for the trade to run into potential difficulties. But he couldn't help feeling relief. Walking with analyst Eugene Xu down a Manhattan street, after meeting a new hedge-fund client, Lippmann turned to his colleague with a look of astonishment.
"It's really working. Finally." Other traders approached Lippmann, asking his advice on their own moves and where he thought the market was going. Colleagues who once snickered at Lippmann now needed his help.
"It's just starting!" he responded, urging them to get bearish. Many did, buying CDS contracts of their own. Others trimmed their holdings of mortgage-related investments, heeding Lippmann's advice.
One day, Anshu Jain, Deutsche Bank's London-based head of global markets, visited the firm's New York office. He walked over to Lippmann, greeting him with a warm smile, an 214 acknowledgment of his huge gains and rising status at the bank. But Jain wasn't ready to congratulate Lippmann.
"Do you think you should cover here?" Jain asked. It was a pointed suggestion that Lippmann sell some positions to reap profits.
Lippmann pulled out the latest data on housing, showing Jain how the market was deteriorating. "No, we have to hold steady," Lippmann said, according to a nearby trader. "Prices are heading lower." Jain didn't push any further. But with every drop in the ABX, Lippmann received e-mails from superiors and risk specialists at the bank, each urging him to exit positions or at least consider trimming them. Some demanded it. Their message was clear: You better be right or you'll be blamed if the gains evaporate.
Lippmann couldn't believe it-the data was getting worse, not better. This was the time to increase the trade, not reduce it!
Didn't they get it?
As the ABX rebounded in the spring, Lippmann's mood turned sour. Nonetheless, the rally helped make mortgage protection cheaper, enabling him to generate additional commissions by teaching more hedge funds to do the trade. And home prices continued to weaken, making Lippman even more convinced that BBB mortgage bonds were doomed.
Lippmann was less sure about top-rated bond slices, but a conversation with John Paulson persuaded him that even A-rated pieces would run into trouble. Lippmann began urging clients to buy CDS protection on those investments as well.
By then, the various hedge funds that Lippmann had educated about the subprime trade had begun making their investments with various other brokers, quickly spreading word about what Lippmann was advocating around Wall Street. He soon received a phone call from Scott Eichel, his counterpart at Bear Stearns.
"Why are you telling people that things are going to blow up?" Eichel asked him. "Why are you so sure?"
Eichel argued that the trade wouldn't work because real estate was resilient.
"Dude, when home prices fall, the subprime market is toast," Lippmann responded.
1 N HIS SANTA MONICA APARTMENT, Andrew Lahde was staring at the same data that showed housing was deteriorating. February's panic brought gains to Lahde, as it did to Paulson, Greene, and Lippmann, less than three months after Lahde first bought mortgage protection and launched his 21s hedge fund, Lahde Capital. His firm now was up to about $6 million in assets.
But Lahde was feeling more pressure, not less. The value of his positions had climbed a few hundred thousand dollars, but he hadn't sold any of them to lock in any of the gains. Instead, his expenses were piling up as he struggled to pay a few staff members. Lahde was making only a few thousand dollars a month from his tiny fund, barely enough to pay the rent. If he ran out of money, he would have to sell his CDS protection, pocket the measly few hundred thousands dollars in profit, and look for a job, once again, watching others profit from the crumbling housing market. That was the last thing he wanted to do.
Lahde had to somehow keep his trade alive and his fund going. He had to somehow find an investor who believed in him. To cut his expenses, he rarely left his apartment. For lunch, Lahde grabbed a turkey sandwich at a nearby deli. At dinnertime, he cleared paperwork from his desk table and ate tuna fish out of a can.
When the ABX index suddenly snapped back in the spring and Lahde suffered losses, it seemed like a death knell for his ambitious plan. He ignored calls from friends and family, desperate to find investors to back him. His savings were almost depleted. Dispirited, Lahde spent much of the day at the nearby beach, suntanning and ogling bikini-clad women.
f*** it, I'm just going to hang out at the beach, he thought. The way Lahde figured it, he hadn't made much money. And yet, the ABX had dropped 10 percent since he started pitching his trade, making protection more expensive than it had been when he dreamed up the trade and tried to capture the interest of investors. If they didn't care about his trade then, they surely wouldn't care now that it was more expensive. He seemed out of luck.
Then Lahde caught a break. At a conference at Viceroy Hotel in Santa Monica, Lahde was introduced to Norman Cerk, a local investor who helped run a small hedge fund called Balestra Capital Partners. Cerk already had placed bearish bets against risky CDOs and the lowest slices of the ABX index for his own firm, but he wanted more. When he met Lahde, Cerk was stunned to
21s meet someone even more worried about the financial world than he was.
"He was apocalyptic," Cerk recalls. "Here was this laid-back guy who kept saying 'The world's gonna end, you should put all your money in gold."'
At his previous job, Lahde's histrionics turned off his boss, souring their relationship. But Cerk was impressed by Lahde's passion and conviction, and was taken by the depth of his knowledge about the housing market. Lahde recommended that Cerk buy protection on ABX tranches with high credit ratings. He even insisted that AA-rated slices would become worthless, a view that sounded radical, even to Cerk.
Lahde won him over, though, and Cerk handed him $6.5 million to invest. It was small potatoes compared with the kinds of funds Paulson and others were investing with, but it was enough for Lahde. He put the money to work as soon as the check cleared, buying more protection on ABX indexes tracking subprime mortgages. Finally, Lahde could execute the trade that he envisioned. He was sure he was months away from becoming a very rich young man.
AHDE SEEMED TO PUT his trade on just in the nick of time. In July 2007, Standard & Poor's, the big bond-rating company, lowered its ratings on 612 classes of residential mortgage bonds made between 2005 and 2006, a total of $12 billion of debt. These were the very same investments that Paulson, Lippmann, Greene, Burry, and Lahde were betting against. S&P even warned that it was taking a look at CDOs that used subprime mortgages as their collateral, a clear threat that tens of billions of additional bonds would see their ratings slashed. S&P also dropped its ratings on $12 billion of debt issued by Lehman Brothers and Bear Stearns, bond-market powerhouses. Both firms now faced ratings that were close to "junk" level. Moody's, the other big rating company, reduced its own ratings on $5 billion of subprime debt and warned that it could reduce its grades on even more mortgages.
By the summer of 2007, it was clear that the subprime-mortgage market was in deep trouble. The ABX index tracking the riskiest home loans had tumbled to 37. On one brutal day for the mortgage market, Greg Lippmann's team scored more than $100 million in profits. Sitting on the subway on his way home, Lippmann looked stunned.
Despite the gloom in the subprime-mortgage market, Wall Street's titans seemed to breathe a 211 sigh of relief because the rest of the economy appeared to have been spared. In late June, Blackstone Group, the leveraged-buyout kings, broke records by raising nearly $5 billion in an initial public offering that left Stephen Schwarzman, the firm's co-founder, with a stake in the company valued at almost $8 billion.
A few months earlier, Schwarzman had thrown such an extravagant sixtieth-birthday party for himself that several lanes of Park Avenue in New York City were closed in order to allow guests to
come and go more easily. The message from the world's financial leaders was that the subprime mess was no reason for concern for the overall economy. Keep moving, nothing to see here, they seemed to say.
"Fundamental factors-including solid growth in incomes and relatively low mortgage ratesshould ultimately support the demand for housing," Federal Reserve chairman Ben Bernanke said on June 5. "We will follow developments in the subprime market closely. However, at this point, the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system."
In Newport Beach, California, investors at Pimco, the biggest bond investors, began to buy some debt issued by big brokerage firms, convinced they were bargains. In August, Pimco's chief, Bill Gross, said, "I think the global economy is sufficiently strong and the U.S. economy probably will avoid a recession."
At AIG, Joseph Cassano, who ran a division for the insurer that until late 2005 wrote protection for billions of mortgage investments, said on an investor conference call: "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing $1 on any of those transactions."
Even the ABX index tracking risky EBB-rated subprime mortgage bonds popped up a bit, topping
40. The index following AA-rated loans surged past 95. And in early October, the Dow Jones Industrial Average hit a record 14,164, amid growing confidence that the worst was over.
While others rejoiced that the good times were back, John Paulson sat on a secret few were privy to. The subprime-mortgage domino had indeed been toppled. But many more were set to fall.
OHN PAULSON LEFT WORK EARLY AND WALKED TO A NEARBY SUBWAY STATION. It was a slow Friday in early August. Manhattan was steaming, and Paulson was looking forward to a relaxed weekend with his family in the Hamptons. But first there was someone he needed to meet.
Paulson hopped on a No. 7 train heading toward the borough of Queens, one of thousands getting a jump on the weekend. Two stops later, at Hunters Point Avenue, Paulson got off and transferred to the 4:06 p.m. "Cannonball Express," a Long Island Railroad train heading east. Paulson was a regular most Fridays in the summer and usually reached his home in Southampton less than two hours later. A car and driver, or even a helicopter, couldn't get him there nearly as fast, he told friends, explaining why he still took the train.
Sliding into a seat already saved for him in a front car, Paulson greeted his friend Jeff Tarrant.
Soon, throngs of passengers crowded in, some carrying tall beers in the aisles.
Opening a cold bottle of water, Paulson seemed to relax as the train pulled away from New York, as if a load had been lifted from his shoulders. Paulson always loosened up on the weekly ride, showing a glimpse of his former, looser self. A few weeks earlier, Paulson noticed his college mate Bruce Goodman and his son, John, on the train and invited them to sit with him.
"I want you to hear what I did," Paulson said, more enthusiastic than boastful. He spent more than an hour patiently explaining details of his bet against subprime mortgages, as John Goodman, an economics student who once spent a summer at Paulson & Co., listened eagerly.
On this August Friday, though, the financial markets seemed increasingly fragile, and Paulson and Tarrant met to trade intelligence and to answer a billion-dollar riddle, one that threatened the sunny day with thick, dark clouds: If Paulson was sitting on a stunning $10 billion of gains that year, who was facing dramatic losses? Which firms were hiding deep problems, and what would the consequences be?
Paulson's tie was loose and he looked tired, if relaxed. It was the cost of making more than $100 million during that week alone. Normally, Tarrant, well dressed in a crisp blue blazer, his silver hair perfectly coifed, looked as if he had just stepped out of an issue of GQ magazine. But this afternoon it was Tarrant who seemed frazzled. His firm, Protege Partners, had invested in a z19 number of hedge funds and other kinds of financial firms; Tarrant worried that there could be more shoes to drop on the economy and the market, potentially crushing his company. He needed to know if he had placed money with firms that were on the other side of Paulson's trades. "Who's holding the bag on all this stuff?" Tarrant asked Paulson. Tarrant had consulted with a round of experts, who told him that European insurance companies had sold the bulk of the CDS contracts to investors like Paulson. Many of these companies didn't need to own up to any losses, at least immediately, thanks to various accounting conventions, so the problems likely would be swept under the rug and wouldn't cause too much damage, they assured Tarrant.
He didn't buy it. Many of his clients were European insurers and they promised Tarrant that they hadn't touched the insurance on subprime debt.
"Who owns this stuff?!" he again asked Paulson, before rattling off a series of his other worries about the financial system.
Paulson seemed oddly serene, as Tarrant continued with his hand-wringing.
That's when Paulson let his friend in on a secret. A few months earlier, he had reflected on how easy it was for him to buy billions of dollars of protection on all those toxic mortgages. All day long, his trader, Brad Rosenberg, heard the same answer when he asked to purchase bucketsful of CDS protection: "You're done"-trader lingo for a completed trade. No hassle, no problem, the insurance was theirs for the taking.
Paulson began to wonder, if his fund found it so easy to buy billions of dollars of protection, who was selling it all to them? And what would happen to them as housing came crashing down?
Back in July, Paulson popped his head into Andrew Hoine's office and asked his research director to swing by for a chat. Hoine once had specialized in brokerage stocks as a young analyst. So Paulson put him on the case, asking Hoine the same question that was now puzzling Tarrant.
"If we're making all this money, who's on the other side?" Paulson wanted to know. Maybe there was a chance to pull off another big trade by wagering against some of these apparent losers, Paulson thought. Even if it was half as alluring as betting against subprime mortgages, it could be a coup.
Hoine spent days pestering the salesmen selling Paulson all that protection. Was there a big, bullish investor on the other side of the trades? Was it a group of hedge funds or some other investor?
The salesmen weren't allowed to give Hoine much intelligence, in keeping with custom in the marketplace, where trades are supposed to take place in anonymity. But after asking enough questions, Hoine began to surmise the answer: Banks were selling subprime protection to investors like Paulson and often keeping the positions for themselves. The banks then fed the positions to CDOs and other products and kept slices of the CDOs on their balance sheets, like retailers holding on to the merchandise for their own families.
"They wouldn't say the specific banks, but we got ideas," Hoine says. "You could tell from traders that Merrill and some others couldn't sell it all."
It all made sense to Paulson. Much like Greene on the West Coast, Paulson has been struck by how far the ABX index had fallen for much of the year, even though prices of most CDOs and other mortgage pools made up of subprime mortgages were barely budging. The CDOs and other pools didn't trade as frequently as the ABX, so there was a lag in their pricing, Paulson understood. But he became concerned that banks were overstating the value of the CDO slices they quoted, to avoid owning up to big losses of pieces that they themselves owned. Paulson had an associate join a group of hedge funds to write a pointed letter to the Securities and Exchange Commission. Now they were asking questions of the banks.
Even if the inquiries didn't lead anywhere, Paulson knew that as long as the ABX kept tumbling and home owners continued to have difficulties meeting their monthly mortgage payments, all the pools of dangerous mortgages, and the CDOs built from them, were bound to eventually fall in price, too. Then, the banks and others holding these investments would have to record deep losses because they held so much of it themselves. It was just a matter of time before the pain began.
It was no secret that banks and investment banks like Merrill Lynch, Morgan Stanley, Countrywide, and Bank of America had pushed into subprime lending. They hadn't acknowledged any huge losses just yet, though, reassuring some investors. But as the ratings companies lowered their grades on various pools of subprime home loans, it would have to happen, Paulson told 221 Hoine.
Hoine and another analyst at the fund took a guess at how exposed various banks were to CDOs, and to every kind of home loan-subprime, "Alt-A," "jumbo," and "Prime-rate." They added up all the potential losses and compared them to the capital of the banks, instantly identifying which institutions likely would run into problems. Then they figured out how many of the banks' assets could be difficult to price or sell, called Level One and Level Two assets, adding more demerits to certain banks.
Paulson kept shaking his head as he read the latest figures on how much money investment banks had borrowed to run their businesses. It made him more certain of trouble ahead. Hedge funds like his could never get away with all that leverage, he said.
"This could be the next wave!" Paulson exclaimed to Hoine as he showed him a spreadsheet of all the debt problems.
They also realized that those selling the CDS contracts didn't have to set aside much money to cover payments they might have to make. An investor selling Paulson CDS insurance on even $1 billion of subprime bonds didn't have to have nearly as much money ready to pay for it.
When Rosenberg told Paulson how inexpensive it was to buy CDS protection on a range of financial companies, it reminded Paulson of his subprime trade-very little downside and tons of upside.
So the Paulson team began accumulating protection on all kinds of companies. CDS contracts to insure $100 million of Bear Stearns debt cost just $200,000? We'll take it! Lehman protection costs $400,000? We'll take that, too, please. UBS, Credit Suisse, and all kinds of other big financial players? Most definitely. They could have it all for well under 0.50 percent of any amount they wished to insure. It was as if Paulson's team was shopping at a dollar store, but finding the choicest goods from Tiffany down each row.
"Look at these spreads!" Paulson said to Rosenberg after getting an update on the latest pricing. "You don't need a smoking gun" proving that a bank was in trouble-the insurance was so cheap, it was worth holding just on the off-chance trouble developed.
As Paulson recounted it all to Tarrant on the train out to Long Island, his friend turned anxious. He recently had met a senior banker who hinted at "systemic" problems if the housing market 222 turned still lower. Now he had confirmation of his worst fears.
"Oh my God, these guys really have retained it all," Tarrant said.
Paulson moved closer to Tarrant's seat, trying to keep their conversation private.
"It's even beyond that, Jeff," Paulson said quietly. Even if it turned out that the banks had somehow sold off much of the mortgage protection to clients, the losses likely would run so deep that the clients wouldn't be able to handle them, leaving the banks on the hook.
"They're stuck," Paulson said, referring to the big banks, which seemed in trouble either way.
In one sitting, Paulson had described why the entire financial system was in jeopardy. And yet, Paulson seemed calm, even upbeat. Tarrant couldn't figure out why.
"What are you going to do?" Tarrant asked.
Paulson confided that his firm had purchased CDS protection on all the investment banks his firm traded with. That way, even if they went under and couldn't pay him his winnings, he'd profit on the way down.
"How can these smart guys get into these positions?" Paulson asked with a shrug of his shoulders and a little smirk, as if he had it all figured out. Tarrant was left shaken, unable to muster much of an answer.
When they got off the train, Paulson and Tarrant were met by their wives and whisked away to their respective estates.
But Tarrant couldn't shake a morose feeling.
Over a martini that night, he described Paulson's doomsday scenario to his wife. That night, Tarrant, normally a deep sleeper, tossed and turned, waking her. Tarrant had figured that investing with Paulson was like a security blanket, one that could protect him and his firm in case housing and the economy went south. But the conversation he had with Paulson on the train left Tarrant rattled. He realized he was going to need much more protection for the coming storm.
ACK IN NEW YORK, Paulson received another tip that bigger problems were brewing. In September, a nanny for Paulson's two young daughters quit and moved out. Bills began to come for the woman, an immigrant from Eastern Europe. It turned out that she had given Paulson's address to a string of credit-card companies, cellular-phone providers, department stores, and others, and she never paid any of the bills.
Paulson couldn't track down the woman, so he began to trace her billing history, trying to get 223 the creditors off her back and halt the sometimes threatening letters coming to his home. It turned out that the nanny had a pattern of ordering cell-phone service, ignoring the subsequent bills, and then simply moving on to the next provider when they cut off her service. Sprint to T-Mobile to AT&T and then to Verizon, thousands of dollars in unpaid bills left in her wake. She sometimes defaulted on her account and found new providers eager to win her business. She also had ignored her dozens of credit cards and store cards.
"I can't believe this," Paulson said to Jenny, a touch bewildered. "It's out of control what's going on."
Each company Paulson called seemed more bureaucratic than the next. He couldn't get to the bottom of how much his former nanny owed, or how to stop the bills from coming.
When Paulson got to his office, he shared the story of his nanny, ranting about the endless chain of bills.
"Can you believe she doesn't pay her bills and she's still getting new credit-card promotions left and right?" Paulson asked Andrew Hoine.
Paulson looked befuddled, as if he had just gained a glimpse of how the other half lived, much like President George H. W. Bush when he encountered a supermarket scanner during his presidency.
Hoine wasn't surprised. A good friend who made automobile loans to low-rated borrowers in Florida told him that a cook at a local Applebee's restaurant recently obtained a loan to buy a new Bentley, agreeing to pay sky-high rates. And there was heated competition among lenders to make the loan, despite its low probability of being paid in full.
Paulson now was even more convinced that the nation's debt problems weren't confined to subprime home mortgages. He told his team to begin shorting shares of banks with significant exposure to the credit-card business, as well, and those making commercial real estate, construction, and almost other kind of risky loans.
Gary Shilling, the downbeat septuagenarian economist from New Jersey, kept telling Paulson's team that subprime mortgage problems would infect the entire housing market. So Paulson's hedge fund shorted shares of Fannie Mae and Freddie Mac, the big mortgage lenders, as well.
At the time, others were becoming more upbeat about the future of the economy. At a panel 224 discussion at an industry conference, Jim Wong, Paulson's head of investor relations, endured a series of presentations about the big returns that hedge funds were making buying "leveraged loans," or those made to companies dealing with heavy debt from recent takeovers. Asked his opinion, Wong said his firm viewed these loans as too risky.
After the discussion, an investor pulled aside Wong, saying, "Paulson's gonna miss the boat on leveraged loans ... he doesn't understand these securities are safe."
Back at the office, Wong relayed the conversation to Paulson. He appeared more amused than angry at the insult. "Go tell him that I don't want to be on that boat," Paulson replied with a grin.
B v THE FALL oF 2001, the dominoes were beginning to topple. As more borrowers ran into problems paying their home mortgages, ratings firms scrambled to lower their ratings on all kinds of mortgage debt. It turns out that the debt was risky after all, they acknowledged. In October, Moody's downgraded the ratings on $33 billion worth of mortgage-backed securities. By midDecember, ratings had been dropped on $153 billion of CDO slices. Because banks and investment banks around the globe, such as Citgroup, UBS, Merrill Lynch, and Morgan Stanley, owned many of the slices of CDOs made up of toxic mortgages, they were forced to write down more than $70 billion in three short, painful months.
Blame was soon apportioned. Chuck Prince, Citigroup's chief executive-who once said his bankers would dance until the music stopped-was ousted. So, too, was Stanley O'Neal, Merrill Lynch's CEO, who was paid $46 million just a year earlier and lauded for pushing Merrill to hold $40 billion of CDO slices, up from $1 billion two years earlier. Shares of many major financial companies were cut in half in a matter of weeks.
(O'Neal left with $161 million in his pocket, on top of $70 million that he took home during his four-year tenure; Prince was given $110 million, an office, an assistant, a car, and a driver.)
Other losses soon sparked concern about companies like Ambac that insured bonds for investors, adding to the market's angst.
Pellegrini had spent countless hours worrying about what could upend the firm's trades and making sure its winnings were secure. About $10 billion of profits was waiting for them at various 22s firms, the sum of the daily exchange of cash from those who sold the hedge fund protection. Now, Pellegrini had it placed in institutional Treasury-bond funds to which the hedge fund had easy access, rather than allow it to sit within reach of investment banks under increasing pressure. The profits they had accumulated so far seemed safe.
But some of Paulson's team had concerns about how they were going to exit their remaining investments without pushing down the price. The debt markets they focused on had limited trading, and it wasn't clear how they would get out of the trades. Selling so much mortgage protection might push down prices dramatically, slicing their gains. They had sold a number of their more liquid positions, but who would buy the rest of it, especially the mortgage protection that traded so infrequently?
It was time for Paulson to test the waters. He walked out of his office to the desk of Brad Rosenberg and asked the trader to begin circulating BWIC lists, or bids wanted in competition. Various ABX indexes had crashed below 50. Investors' perception of risk seemed at panic levels. Paulson wanted to see what kind of demand he might find for his CDS insurance.
Rosenberg made a round of calls and walked into Paulson's office with news he wanted to hear: Banks and investors were clamoring for their insurance, to protect their holdings of mortgage securities. Over the next few weeks, Paulson sold about 40 percent of his CDS insurance. The rest proved harder to get rid of, frustrating Rosenberg at times.
Paulson got some help from a surprising place, however. Among the traders most eager to buy Paulson's CDS insurance were some at Bear Stearns, of all places, the firm he squabbled with and was among the most critical of his original thesis. Scott Eichel and other senior traders at Bear Stearns, who once scoffed at Paulson and Lippmann, realized the severity of the real estate problems. It was late in the game, but the traders now called the Paulson team, desperate to buy their positions.
Eichel's group eventually made about $2 billion of profits owning protection that Paulson had discarded. It was a valiant effort to save their firm.
Tension was building elsewhere within Bear Stearns, as executives argued about how to right their sinking ship. The investment bank held too many risky mortgages, and clients, including 22s major hedge funds, were losing faith. Some discussed pulling their money from the firm. Within the executive suites, some argued for urgent action.
"Cut the positions, and we'll live to play another day," argued Wendy de Monchaux, a senior trader.
"We've got to cut!" agreed Alan "Ace" Greenberg, the firm's former CEO and fifty-nine-year veteran.
But the firm's chief, Alan Schwartz, urged caution. Many of the markets for mortgage debt had become difficult to trade in. Unloading tens of billions of dollars' worth of mortgages and related bonds at fire-sale prices would create devastating losses, he argued.
"Stand calm ... we've got it under control," he told some at the firm.
HILE IT wAs MONEY that drove John Paulson, he also wished to be recognized as one of the investment wizards, an objective that long eluded him over the years as he toiled in obscurity.
In the fall of 2007, that all began to change. One day he got a phone call from George Soros, the man renowned for his own famous trade, a 1992 bet against the British pound, one that earned $1 billion for his Quantum hedge fund. The figure paled in comparison to the $12 billion or so of gains that Paulson had accumulated at that point. But Paulson didn't have the heart to bring that up when Soros invited him to lunch at his office, at Seventh Avenue and 57th Street.
Although Soros's nephew, Peter, was a longtime friend of Paulson's and an investor in his funds, Soros had heard about Paulson's coup through his contacts on Wall Street. Soros, quasi-retired at the time, was itching to get back in the game. He turned to Paulson for help.
Soros was painfully aware that the investing game had dramatically changed in recent years; he was like a ballplayer attempting a comeback and realizing that the rules had been altered. Stocks and other investments listed in the daily newspaper and running across the bottom of businesstelevision screens were no longer as crucial to making the big money. Instead, credit-default swaps, instruments that didn't even exist a few years earlier, were where the real action was. After complimenting Paulson on his coup, Soros asked for a tutorial.
Over grilled halibut and vegetables, Paulson described the ABX indexes, how CDS was traded, and some of his moves. At first, Soros seemed preoccupied, even perturbed. It turns out the fish 221 wasn't up to his standards and he complained about it to his assistant.
But Soros enjoyed the patient and thorough lesson and was struck by Paulson's understated manner. Weeks later, Soros became more engaged at his firm, and in the last three months of the year, he racked up several billion dollars of profits of his own.
During the lunch, when Paulson argued that banks were in trouble and shared that he was betting against some of them, however, Soros thought he was a bit too downbeat. "I thought the risk-reward was better in other trades," Soros recalls.
Even in Paulson's moment of triumph, skeptics thought they knew better.
J EFFREY UBERT bought some protection on subprime mortgages rated BBB-in early 2007, and then converted it to insurance on even more AA-rated loans in August.
He remained tom about whether to add more or whether to give in to his misgivings and just get rid of the investments. He watched the market closely, trying to decide what to do. The ABX index tracking top-rated loans was at 90, implying that few thought they would run into any trouble. But these were dangerous mortgages made to home buyers with scuffed or limited credit. There's no way they were genuine AAA bonds, Libert concluded.
Libert was set to spend $1 million to buy CDS contracts on $10 million of these loans. But he didn't have an opportunity to speak with his broker before leaving with his wife to spend a week at their home in Provincetown, the picturesque town at the tip of Cape Cod. Libert was recovering from back surgery and hadn't worked for several months as he tried to deal with the pain. He figured he'd just call his broker and make the trades a few days later.
On their first day in Provincetown, Libert received a call from his broker in New York. Tomassetti sounded unusually stressed as he filled in Libert on startling losses announced by Citigroup and Merrill Lynch.
Tomassetti told Libert that the ABX indexes were reacting dramatically to all the news, as investors and banks scrambled to buy their own insurance on toxic mortgages.
"Jeffrey, they're really moving."
It was time to do the buying he planned, Libert decided, sure that big profits awaited.
"Okay, get me in at ninety."
"We can't, we're way past that."
"What?! You mean we're at eighty??"
"What? In one day?!"
Libert was in a panic. He was finally prepared to toss his moral qualms into the nearby Atlantic Ocean, but now it was too late. The sharp drop in the index meant that the CDS insurance he already owned was worth millions of dollars. He was miserable, though, thinking about the gains he had squandered by dithering.
The AAA-rated mortgage loans that Libert wanted to bet against traded at sixty cents by the end of that month. Libert would have made close to $10 million more had he picked up the phone and pulled the trigger on his trade.
"The truth is, when Greene thinks he's right, he puts the wad down," Libert says. "When I think I'm right, I'm not as sure."
B v ocTOBER, Jeffrey Greene's own CDS protection had climbed in value by as much as $300 million. If he cashed out, Greene knew he could live as extravagantly as he wished the rest of his life and never have to think twice.
But unlike his former friend John Paulson, Greene couldn't bear to let go of his mortgage protection, convinced that deeper troubles for housing were ahead. Every day in the fall, Greene received a summary of his account. And every day, his positions climbed in value by millions of dollars. This was what Greene spent almost two years waiting for. He wasn't going to close his glorious trade now.
Months earlier, Greene had been peppering Zafran with calls, trying to understand why his trade wasn't working. Now it was Zafran's turn to pursue Greene. He called at least once a week, urging his client to do some selling.
"Jeff, you really should take some chips off the table. Don't be foolish, just take a hundred million out," Zafran advised his client. "God forbid, the government gives one hundred percent mortgage relief to everyone," then the CDS insurance will be worthless.
"No way," Greene responded. "They're going down further, they're fundamentally bad."
Later in the fall, though, friends helped convince Greene to take some profits. He was up twentyfold and even fortyfold in some of his investments. Why not take some off the table?
Greene called Zafran, ready to do some selling. Zafran rang various traders within Merrill Lynch to get a price at which they could find a buyer for Greene's protection. The CDS insurance he had bought on various slices of the ABX index was a cinch to sell, so Greene did some of that. But he 229 owned protection against specific pools of ugly mortgages, and they were such unique investments that it was hard to get prices for the protection, let alone find someone to buy it. Sometimes it took Zafran days to get back to Greene with a quote; other times it took several weeks.
Greene turned livid, unable to comprehend the delay. "You've got to be kidding me," he barked at Zafran. "What kind of amateurish operation does Merrill run?"
The pricing issues were part of the reason why Merrill and other firms had been so reluctant to sell these instruments to individuals-they might be hard to exit if no buyers emerged. Zafran didn't want to mention that and set Greene off again, though. "I told you so" likely would make him even angrier, Zafran figured.
Sometimes, Zafran came back with quotes on only three of the eighteen pools of mortgages that Greene was betting against-and the three were the best-performing pools, not the ones that Greene figured to make the most from.
Greene was sick and tired of Merrill's traders and their quotes. And he wasn't sure whether Zafran's true interests lay with his firm or with Greene. For their part, Merrill's traders had had enough of Greene-over and over again they had to round up quotes for his tricky investments, but he never did any trading. Now he said he wanted to sell, but how could they be sure? Greene tried pushing his broker to get better prices: "Alan, you're a big guy at Merrill; get it done." Zafran understood Greene's nervousness. If he couldn't sell the positions, his hard work might be for naught.
Finally, Greene gave up, exasperated. He told Zafran that he was just going to hold on to his investments and not try to sell any more of them, at least for now.
"I would have closed the positions at fifty cents on the dollar but I couldn't even get a bid," Greene recalls.
THE FALL oF 2007, Greg Lippmann scored huge gains. A growing number of Deutsche Bank executives hinted that he should do some selling but Lippmann fought to hang on to his investments.
They put even more pressure on Lippmann after a Rose Garden speech by George Bush on August 31, when the president announced measures to help some borrowers and suggested more might be in the offing.
Meeting with Lippmann and a half dozen senior executives in a conference room in Deutsche zJo Bank's New York office, Rajeev Misra was clear with his orders: The subprime trade has worked, we've made money, let's move on.
"It's been a great race," but it's coming to an end, Misra said. He didn't believe the housing troubles were over, but it was time to move on to another trade, he repeated.
Lippmann wouldn't let it go, though, like a dog clinging to a bone.
"Why?" Lippmann asked, looking straight at Misra. The senior banker backed off. In the subsequent weeks, most of Deutsche's traders who had purchased CDS protection exited many of their trades. Misra himself was forced to cut short many of the positions he held after his own superiors urged caution. Lippmann cashed in some chips. But he convinced his bosses that the market was getting worse. Once again, they let him hold on to most of his positions, grudgingly.
The sudden panic in the fall of 2007 created a peculiar scene at Deutsche Bank. In one corner, Lippmann and his team of twenty-five traders racked up large gains, almost on a daily basis. But many of the rest of the hundred or so traders in Deutsche's large trading room looked glum, sometimes because they were holding the very same investments that Lippmann bet against. It was as if they existed in a Bizarro World of finance-everything that went wrong for these traders went right for Lippmann and his crew.
Lippmann had waited for this moment for two years. Now that it was here, he was going to enjoy his vindication to the utmost.
"The market is tanking!" he yelled across the trading floor one day, in a teasing tone. "Ha, ha, ha, ha."
After seeing Lippmann carrying on, a salesman warned him: "Be careful what you wish for." Lippmann laughed him off. But by the end of 2007, Deutsche had acknowledged making some of the same mistakes that the other investment banks had made. It couldn't sell all the CDO deals that it had created to help Paulson short more securities. Like a game of hot potato, the big bank found itself stuck with too many CDO slices.
When Lippmann sat down at year's end with his bosses, including Rajeev Misra and Richard Dalbear, they were complimentary and appreciative. Then they gave Lippmann the figure he had been waiting to hear all year: his bonus. He had taught dozens of hedge funds how to score billions 231 of dollars of profit in a single year. And he directed a team that made close to $2 billion in profits.
Lippmann's reward was more than he ever expected to make in a lifetime, let along in a single year: $50 million, much of it in Deutsche Bank shares. It was an astonishing figure, even for a Wall Street trader.
But Lippmann couldn't help feel slighted. If it weren't for him, the bank would have suffered like many other of the biggest financial players.
"This is not fair," Lippmann told his superiors, his voice rising. "It's too low!"
They ignored his tantrum. Lippmann threw a fit every year, then he settled down and nothing much changed.
Lippmann was upset enough that he quietly interviewed for jobs with a number of hedge funds and other firms, to see if he could do better. Word got back to Misra.
"If he doesn't get paid, he's gonna come work for us," one hedge-fund manager told Misra.
"Fine," Misra responded, nonplussed. "We paid him well."
In the end, Lippmann stayed at Deutsche Bank, partly out of loyalty and also because he would have been forced to forgo all of the shares had he bolted.
AUGUST oF 2007, Michael Burry's hedge fund was up 60 percent in the year, making it one of the best performers in the world. The subprime housing market had crumbled, just as Burry predicted.
His returns were so impressive that his staff hesitated to tell clients, just in case there was another snafu in the accounting department, as they had had earlier in the year.
"Please check that again," Steve Druskin, Burry's general counsel, said to staff members going over the results. "We can't afford a mistake right now."
Burry couldn't enjoy his belated success, however, still weary from the battles with his investors and too sensitive to ignore their unhappiness. Most nights, Burry came home glum, frustrating his wife.
"Has Joel called to apologize to you?" she asked him one evening in August. She was referring to Joel Greenblatt, Burry's original investor.
Burry shook his head, looking even sadder. "Look how far you've come! Try to enjoy it," his wife said. All Burry could do was shrug. She urged him to splurge on a present for himself, but he couldn't think of anything he wanted.
Burry flew to New York to apologize to Greenblatt for the audit snafu, reestablishing more 232 cordial relations with him. By then, though, Burry had had enough of the headache of the side account that antagonized so many of his investors. He shifted the remaining CDS investments from the account back to his main fund, just as the credit crisis erupted in full sight. Over the next few months he successfully exited the positions, slowly selling the mortgage insurance.
He finished 2007 with a gain of over 150 percent. Scion itself pocketed about $700 million in the year. Burry's subprime trades had quadrupled in value, scorings gains of about $500 million, over two years. He personally made about $70 million.
He wasn't done, though.
"I patiently await a deepening of the U.S. recession and the string of bankruptcies that are sure to follow," he wrote his investors in early 2008. "For the record, I do not smile fiendishly as I do so. If you know me, you know I neither smile fiendishly nor easily."
Maybe he still had a chance to pull off his historic trade.
p AOLO PELLEGRINI remained reluctant to tell his wife, Henrietta Jones, much about how the firm's trade was doing, still unwilling to risk jinxing it. But as the problems of the housing market became as clear as the front page of her morning New York Times, Henrietta couldn't resist bringing up the matter with her husband.
One day in September, she turned to Pellegrini, asking, "We don't really need me to work, do we?" She enjoyed her position running a division for retailer Donna Karan and wasn't demanding to quit, but her paycheck had become a drop in the family's bucket and she had a young daughter she enjoyed spending time with. If Pellegrini's bonus at the end of the year was likely to be sizable, she might like the chance to spend more time at home.
Pellegrini couldn't give her a sense of how much he was going to make. He didn't know what kind of bonus check Paulson might give him. But he agreed that Jones probably didn't need to work. She soon quit her job.
In late November, Paulson & Co. held a dinner for five hundred or so thankful investors at Manhattan's Metropolitan Club. The two credit funds were up an average of 440 percent that year, even as the stock market rose 3.5 percent, such a stunning figure that some investors at the dinner gushed their appreciation when they grabbed a few minutes with Paulson and Pellegrini. Others 233 chatted about how big the firm had become-it now managed a shocking $28 billion, making it one of the largest hedge funds on the planet, all from investors who were far under the radar screen just a year earlier.
The mood was jovial as a cocktail reception was followed by a three-course dinner featuring boneless duck confit over celery root and black truffles, and roast rack of lamb.
Paulson gave a downbeat presentation about the economy, warning that a recession was likely. He provided details about how he and his team were shifting to wager against financial companies while trimming their protection against subprime mortgages.
Paulson named Bear Stearns, Merrill Lynch, Citigroup, and bond insurer Ambac Financial group and credit-ratings company Moody's Corp. as those in hot water, a suggestion to his investors that the firm was betting against those companies.
It was still "not too late" to bet against those firms, Paulson said.
Pellegrini proudly did his part at the event, starting off the evening's wine tasting by explaining that all the evening's selections were from his native Italy. It was a tip of the cap from Paulson to Pellegrini. The duck appetizer was accompanied by a $200 bottle of Tenuta San Guido 1999 Sassicaia.
But Pellegrini soon began to chafe. He had been an architect of the subprime trade, working elbow-to-elbow with Paulson to craft moves that now were reaping billions of dollars. Pellegrini had begun to gain his own recognition on Wall Street and sometimes was asked to speak on various economic topics.
Paulson & Co. had bet against about $5 billion of CDOs and made more than $4 billion from these trades-including $500 million from a single transaction-according to the firm's investors and an employee of the firm. One of the biggest losers, however, wasn't any investor on the other side. It was the very bank that worked with Paulson on many of the deals: Deutsche Bank. The big bank had failed to sell all of the CDO deals it constructed at Paulson's behest and was stuck with chunks of toxic mortgages, suffering about $500 million of losses from these customized transactions, according to a senior executive of the German bank.
These were some of Paulson & Co.'s largest scores. And they were moves that Pellegrini had masterminded.
As 2007 drew to a close and the firm's focus shifted away from sub-prime mortgages, Pellegrini 234 felt left out, however. He was just as convinced as his colleagues that the banks were in trouble-he knew where all the bad mortgage loans were buried. And yet Hoine, not Pellegrini, was given the mandate of helping Paulson quarterback the new trade. Pellegrini couldn't even make the final decisions about which subprime-mortgage protection to sell.
"John never got to the point where he would trust me," Pellegrini recalls. "He never gave me trading authority."
Paulson continued to tease Pellegrini about how methodical he was. When Paulson moved another analyst to work under Hoine's wing, to focus on the financial companies and their debt, Pellegrini was hurt. He viewed the decision as an attempt by Paulson to preserve his control of the firm, handing power to Hoine because he was younger and represented the next generation.
"I wanted an analyst to work with me to short the equities but he gave it to Andrew; John didn't want to give me that," Pellegrini says. "So I became disengaged."
Pellegrini still helped manage the two big credit hedge funds, though, and they were a whopping $9 billion in size. Late in the year, Pellegrini came to Paulson with an idea: Let's give back half the money in the fund and extend the fund's "lockup" for another few years. That way, the firm could cash in some of its gains while ensuring that investors wouldn't pull all the money out when the existing lockup ended in 2009.
Pellegrini already was hearing complaints from European investors who were desperate for cash amid the market's downturn and unhappy they couldn't pull any of their huge gains from the hedge funds, due to the lockup agreement. Other investors grumbled that the Paulson credit funds had pocketed some cash from various sales of investments but they were not doing anything with the money. Why not give some money back and then raise money anew in 2008? Pellegrini argued to Paulson.
Paulson seemed taken aback. Maybe it was a sign that Pellegrini didn't believe in the remaining positions. Or he was just looking to make sure he had a key role at the firm for an extended period, while he helped run those funds.
"When I hear you saying these things, it makes me question what you've accomplished in the last two years," Paulson responded, tersely. zJs
Paulson's comment "made me feel I was no longer special," Pellegrini recalls.
N THE FRIDAY BEFORE CHRISTMAs, Paulson called an emergency meeting in the firm's reception area. Standing in front of the group, with Pellegrini and Rosenberg nearby, Paulson opened a case of French champagne sent over by an investment bank as a thank-you for all the trading commissions of the previous year.
Paulson passed around bottles of the bubbly, poured a glass for himself, and raised it to his team. He beamed; some of his staff never had seen their boss look so happy. Paulson then toasted his employees, singling out the firm's back-office staff and some other areas away from the limelight.
"I just want to thank everyone," Paulson said, looking around the room, meeting the eyes of both senior and junior executives. "It was the best year ever."
Applause rocked the office. Then the team quickly got back to work, to try to make some more money.
A few days later, Pellegrini took his wife on vacation in Anguilla. Stopping at an automatedteller machine in the hotel lobby on New Year's Eve to withdraw some cash, she checked the balance of their checking account.
She was immediately taken aback. On the screen before her was a figure she had never seen before, at least not on an ATM. It's not clear how many others ever had, either: $45 million, newly deposited in their joint account. It was Pellegrini's bonus for the year, including some deferred compensation. He was still special to John Paulson, after all.
In truth, Pellegrini had withheld more from his bonus than he needed in order to pay the year's taxes, so the figure in the bank account that day was skimpier than it could have been. Paulson paid him about $175 million for his work in 2007. Pellegrini would never again have to worry about finding a career, keeping a job, or stretching his savings.
"Wow," his wife said quietly, still staring at the ATM.
Then they left, arm in arm, to meet a chartered boat to take them to nearby St. Barts.
Paulson did quite well for himself as well. His hedge fund got to keep 20 percent of the $15 billion or so of gains of all his funds. He also was a big investor in the credit funds. His personal tally for 2007: nearly $4 billion. It was the largest one-year payout in the history of the financial markets.
N FEBRUARY 20, 2008, PAULSON RECEIVED AN INVITATION FROM Samuel Molinaro, Jr., the chief operating and financial officer at Bear Steams, inviting him to a lunch at the investment bank's executive dining room. A rash of hedge-fund clients had pulled money out of Bear
Stearns and shifted accounts to rival brokers, worried about the firm's health. The moves left Bear in a weak position and fed rumors that the storied firm might not survive. If Molinaro could bring the hedge funds back into the fold it would be a shot in the arm for Bear Stearns and could help right his tottering ship.
Paulson & Co. was an especially attractive catch for Molinaro. It now was among the world's largest funds, and Paulson had remained a loyal customer of his former employer, despite the speculation about Bear Steams' future. But Paulson also had moved cash elsewhere, concerned about the health of the investment bank If Molinaro could get Paulson back in Bear Steams' comer again, it would be an instant boon and likely would reassure others who were mulling over whether to return as clients.
After a lunch of salad, grilled chicken, and chilled string beans, Molinaro rose to address the select group of twenty or so hedge-fund bigwigs, all facing one another around a circular diningroom table. For twenty minutes, Molinaro outlined how Bear had improved its financial position, why its business was healthy, and how much cash the firm held. The press had it out for Bear Stearns, Molinaro emphasized. There really was nothing terribly wrong with the firm.
Then another Bear executive gave a speech, saying that he couldn't share many details, but business definitely was picking up. He appealed to the group to bring back the cash, reminding them of the long-term relationships many had with Bear and how the investment bank had helped many of their firms in times of need. Listening to it all, some of the hedgies began to feel pangs of guilt, remembering times they indeed had been aided by various Bear Stearns executives.
For another twenty minutes, Molinaro easily handled softball questions from the group. It seemed he was winning them over and a crucial victory was within sight. Maybe Bear Stearns could save itself after all.
Then John Paulson raised a hand. The executives turned to watch him, eager to hear what he might say. zJ7
"Sam, do you know what your Level Two and Level Three assets are on your balance sheet?" Paulson asked, referring to investments that could be hard to price, sometimes because they are risky.
"Not off the top of my head."
"Do you have an idea?"
"I'd rather not guess, John. Let me give you the right number when I get back to my desk."
"Well, I'll tell you what the number is. It's $220 billion. So what I'm seeing is that if you have
$14 billion of equity and $220 billion of Level Two and Level Three assets, a small movement in the assets can wipe out your equity completely." Molinaro didn't realize it, but Paulson had spent weeks reworking his firm's holdings, dropping dozens of stocks and bulking up its bets against a range of financial giants, from Lehman Brothers and Washington Mutual to Wachovia and Fannie Mae. He had deep concerns about Bear Steams, too. Paulson & Co. had become the most popular investment firm on the planet. Investors had poured $6 billion into his firm in the previous year, and Paulson had put a good chunk of it to work wagering against banks and investment banks with flimsy balance sheets. He had done his homework.
Molinaro suddenly looked uncomfortable. He either didn't have a good response for Paulson, was wary of publicly squabbling with a good client with a growing reputation, or didn't want to give a faulty figure.
"I'll have to check the number, but you may not be accounting for the fact that some of the assets are hedges." In other words, Paulson might not be getting a true view of the firm's risk, Molinaro argued.
His response was for naught. Paulson had pushed open the floodgates. Two other hedge-fund managers quickly followed Paulson with their own questions, adopting much harsher tones.
"How can you not know the number, Sam?!"
"Paulson's right, you guys are in trouble!"
Paulson watched quietly as the two investors bullied Molinaro for several more minutes. The grilling got so harsh that some of the investors began to feel sorry for Molinaro. So many doubts had been raised about Bear Stearns' health, though, that the accounts never would return to the investment bank.
As the meeting broke up, one hedge-fund executive said to a friend, "Shit, Bear's really in trouble." Chatter about the meeting began to circulate as soon as the executives returned to their zJa firms.
It was a dagger in the staggering investment bank's heart. Soon a rash of hedge funds pulled money out of Bear Stearns, including a $5 billion shift by hedge fund Renaissance Technologies.
Tempers flared within Bear Steams as the investment bank's shares plunged and its cash dwindled. The firm's CEO, Alan Schwartz, tried to calm various executives. During one meeting, though, Michael Minikes, a sixty-five-year-old veteran, abruptly cut off his boss.
"Do you have any idea what is going on?" Minikes asked. "Our cash is flying out the door. Our clients are leaving us."
A month later, Bear Stearns had to be rescued in an emergency sale to J.P. Morgan coordinated by the Federal Reserve and the Treasury Department at a price of just $2 per share, a figure later increased to $10 per share.
After the original sale was struck, Alan Schwartz wearily made his way to the company gym for an early-morning workout. Dressed in his business suit, he trudged into the locker room. There, Alan Mintz, a forty-six-year-old trader at the firm, in sweaty gym clothes, made a beeline for his boss.
"How could this happen to fourteen thousand employees?" Mintz demanded, getting in
Schwartz's face. "Look in my eyes, and tell me how this happened!"
On the Sunday that Bear Steams fought for its life, and while others on Wall Street were glued to their computers, worrying about the impact, Paulson watched his two daughters frolic in his home's indoor pool. Mont
|时间: 2011-3-27 周日, 下午9:23 标题:
如果罗杰斯买入隔夜美元，他一定是一位“幸运”的赌徒。3月21日，美元指数创出自2009年12月以来新低。而从当天至今，其已累计反弹 0.2%。资料显示，截至昨日18时30分，本周主要货币中，美元仅对澳元和加元走低。其中，美元对瑞士法郎、英镑涨幅最大，分别为1.38%和 0.8%。
目前，澳元和加元的利率分别是4.75%、1%。堪称发达经济体中的高息货币。更有意思的是，由于澳大利亚和加拿大都是资源出口大国，资金推高 两大货币汇率也反映出对大宗商品的追捧。截至昨日19时，本周以来，全球主要大宗商品价格全线走高。其中美期油合约上扬3.7%至105.7美元/桶。伦 铝和伦铜主力合约则分别上涨3.6%和0.9%。
作为美元的对手货币，欧元本周遭到抛售。投资者为何抛售欧元？答案就是葡萄牙。事实上，本周前三天，欧元对美元累计下跌了0.6%。由于欧元占 到美元指数权重近一半，其一旦走低将极大程度上推动美元走高。据悉，近期，标普和惠誉国际评级均下调了葡萄牙主权评级。昨日，葡萄牙10年期国债收益率攀 升至8%上方，创欧元问世以来新高。
值得一提的是，葡萄牙政府有约42.3亿欧元债务将在下个月到期，但可用于偿还债务的现金储备却仅有40亿欧元左右。有分析人士指出，随着葡萄 牙债券收益率飙升，该国融资成本将不堪重负。一旦下月到期的债务无力偿还，最终只能寻求欧盟金融援助。据了解，2010年葡萄牙债务占GDP84.6%。 2009年公开赤字占GDP9.4%。两项指标均位列欧洲第四。
南华期货宏观总监张一伟向《每日经济新闻》表示，罗杰斯认为美元反转只是他个人观点。但短期这种概率并不大。首先，葡萄牙尽管出现了债务危机， 但这也是预期内的。最极端情况是，欧盟再次实施金融援助。这样一来，资金又可能重新做多欧元。中期而言，欧元内部问题是非常严重的。一方面，各国协调机制 难以通行。特别是德国这种大国对自己在欧元区内部的角色定位模糊。另一方面，爱尔兰、希腊、葡萄牙等小国陆续出现信用危机。只可能让市场对欧元的信心走向 瓦解。不过需要注意的是，利率期货反映，今年欧元很可能有两次加息，而不是此前预期的一次。这种条件下，短期卖空欧元的风险溢价会很大。
有人说，历史总是在轮回。金融市场同样如此。一个有趣的现象是，如今的葡萄牙，与此前接受援助的爱尔兰颇为类似。2010年，爱尔兰的债务占 GDP比重为82.9%，较葡萄牙仅低不到2个百分点。去年7月20日，标普下调爱尔兰主权债务评级。4个月后，爱尔兰终于与欧盟达成金融救助计划。前者 宣称救助总额将少于1000亿欧元。
抛开今年道琼斯指数已上涨5%的事实外，美股和美元近期同时上涨也让人有些兴奋。这说明，陆续回流美元资产的资金，正看好美国经济复苏。 2010年，美元与美股曾在2、3和4月同时收高。当时，受大规模的汽车和住房财政刺激政策推动，美国各项经济指标均大幅好于预期。人们也纷纷看到了经济 复苏的希望。如今，QE2已完成逾70%，接近收尾。而其效果同样明显。今年2月，美国失业率连续3个月下降至8.9%。
截至周四收盘，道指收涨84.54点至12170.56点，涨幅0.7%。纳斯达克综合指数、标普500则分别上扬1.4%和0.9%。据悉， 科技类公司发布利好的业绩预期和盈利报告是市场走好主因。其中，美光科技第二财季超预期，收入增长15%。源码供应商REDHAT则在第四财季净利润增长 43%提振下，股价暴涨18%。
张一伟指出，美国股市走高很大程度上与全球风险偏好情绪有关。首先，日本核反应堆危机已基本过去。推动资金从部分大宗商品、黄金(1426.40,0.20,0.01%)以 及瑞士法郎、日元等避险货币撤离至风险资产。而美股正是近期表现最好的风险资产之一。其次，美国短期进行货币紧缩的概率不大。由于美联储设定的核心通胀目 标是2%，而伯南克也曾表示一旦核心CPI持续稳定在2%上方。联储可能收紧货币政策。但由于美国核心CPI中没有计入食品和能源。未来数月，核心CPI 仍可能在1.5%以下。另外，据测算，美国失业率需要回落至7.5%下方，联储才可能考虑加息。这与2月水平仍有不小差距。这就可能使美联储下半年处于一 个观望态度。即不再推出QE3，但也不会立即收紧货币政策。而且日本进行QE的空间仍很大。在全球流动性充裕情况下，资金肯定愿意押注风险资产特别是股 市。根据路透和花旗最新数据显示，资金近期正往美国和日本回流。值得一提的是，美国目前是财报集中期，一般情况下上市公司盈利利好将推动美股走高。不排除 近期道指测试前期新高12283点。
|时间: 2011-4-09 周六, 上午2:47 标题:
上周六，在上海世界投资博览会(World Money Show)间隙，我在对量子基金(Quantum Fund)创始人之一、《牛市中国：世界最大市场投资收益研究》(A Bull in China: Investment Profitability in the Worlds Greatest Market)等畅销投资书籍作者吉姆・罗杰斯(Jim Rogers)采访期间对这三个问题都进行了探讨。
|时间: 2011-5-06 周五, 下午3:16 标题:
PIMCO will purchase Treasuries on recession risk
By Jennifer Ablan，Friday May 6, 2011
NEW YORK (Reuters) - PIMCO's Bill Gross, who runs the world's largest bond fund, said on Friday the only way he
would reverse his "short" position on U.S. government-related bonds and purchase Treasuries again is if the
United States heads into another recession.
Since the news on April 11 that Gross turned more bearish on government debt including Treasuries, reflecting his
growing worries over the country's fiscal deficit and debt burden, Treasury prices have been soaring.
On Friday Treasury prices fell after an unexpectedly strong U.S. monthly employment report. For details on payrolls
data see (ID:nOAT004799). Treasuries then reversed course on a media report, later denied, that Greece is
mulling quitting the euro zone, which revived safe-haven demand for bonds.
Asked Friday what would change his bet against government debt, Gross told Reuters: "Treasury yields are
currently yielding substantially less than historical averages when compared with inflation. Perhaps the only justification
for a further rally would be weak economic growth or a future recession that substantially lowered inflation and
The benchmark 10-year U.S. Treasury note was flat, with the yield at 3.15 percent, in early afternoon trading on
Friday. On April 11, the yield stood at 3.58 percent.
Gross said for now, the impact of negative real interest rates on commodity prices and other inflation generators
argues for Treasury yields to move in an upward direction.
"Debt ceilings and deficit reduction frustrations, as well as the end of QE2 in June are other bearish influences," Gross added.
(Editing by James Dalgleish)
|时间: 2011-5-14 周六, 上午12:04 标题:
5 things that Gary Shilling sees as threats large enough to derail the recovery:
“First was housing. Shilling was among those who correctly identified the housing bubble and predicted its collapse in 2006. Today, excess inventories – between 2.0 and 2.5 million houses – may lead to a further price decline of 20%, Shilling said, which is the decline necessary to bring housing back to its long-term trend. He cautioned that markets usually overshoot on the downside.
The oil market and the turmoil in the Middle East were Shilling’s next concern. He said he wasn’t sure how severe the problem might become, but he was adamant that high oil prices would not trigger inflation. “As long as you have high unemployment, there is virtually no risk that high oil prices would seep over into the wage structure,” he said. “It isn’t inflation; it’s a tax – and it is a big tax on the consumer.”
Japan was Shilling’s third concern, and he called that country’s economy a “slow motion train wreck.” Japan faces a serious problem down the road financing its huge government debt, he said, which it has done so far largely by selling bonds to its citizens. That worked while Japan ran a trade surplus, but unfavorable demographics and a weak US consumer will eventually create a current account deficit, at which point the Japanese will have to borrow from foreign markets – at much higher interest rates than the 1.25% it pays now. That could lead to a “death spiral,” he said, wherein additional debt would be necessary to fund interest payments.
Fourth on Shilling’s list was the Eurozone debt crisis. Shilling said that he expects a restructuring to take place to resolve the problems facing Greece, Portugal, Ireland and perhaps Spain. A recession in Europe would follow, which would impair US exports. It will also create problems for the US banks, which collectively own 28% of the debt in the Eurozone.
A likely “hard landing” in China completed Shilling’s list of concerns. China now faces 12% inflation, he said, which is very significant for the bulk of its population that earns modest incomes. Slowing down China’s economy will be very difficult. Its central bank has already raised reserve requirements eight times since January of last year and raised interest rates four times over that period.”
首先是住房。Shilling正确地确定了房地产泡沫，并预测在2006年崩溃。今天，超额存货 在2.0和2.5万所房屋， 可能导致价格进一步下跌20％，Shilling说，这是必要的下降，将住房回到其长期趋势。他告诫说，通常在市场下跌时会出现过冲。
石油市场和中东动乱。他说，他不知道有多严重，但他坚持认为，高油价不会引发通货膨胀。 “只要你有高失业率，几乎没有风险，高油价会渗入工资结构。 这不是通货膨胀，它是一个很大的消费税。”
|时间: 2011-5-16 周一, 下午4:42 标题:
Why Are the Media Ignoring Plans By George Soros to Remake the Entire Global Economy?
By Dan Gainor，March 23, 2011
Two years ago, George Soros said he wanted to reorganize the entire global economic system. In two short weeks, he is going to start – and no one seems to have noticed.
On April 8, a group he’s funded with $50 million is holding a major economic conference and Soros’s goal for such an event is to “establish new international rules” and “reform the currency system.” It’s all according to a plan laid out in a Nov. 4, 2009, Soros op-ed calling for “a grand bargain that rearranges the entire financial order.”
The event is bringing together “more than 200 academic, business and government policy thought leaders” to repeat the famed 1944 Bretton Woods gathering that helped create the World Bank and International Monetary Fund. Soros wants a new “multilateral system,” or an economic system where America isn’t so dominant.
More than two-thirds of the slated speakers have direct ties to Soros. The billionaire who thinks “the main enemy of the open society, I believe, is no longer the communist but the capitalist threat” is taking no chances.
Thus far, this global gathering has generated less publicity than a spelling bee. And that’s with at least four journalists on the speakers list, including a managing editor for the Financial Times and editors for both Reuters and The Times. Given Soros’s warnings of what might happen without an agreement, this should be a big deal. But it’s not.
What is a big deal is that Soros is doing exactly what he wanted to do. His 2009 commentary pushed for “a new Bretton Woods conference, like the one that established the post-WWII international financial architecture.” And he had already set the wheels in motion.
Just a week before that op-ed was published, Soros had founded the New York City-based Institute for New Economic Thinking (INET), the group hosting the conference set at the Mount Washington Resort, the very same hotel that hosted the first gathering. The most recent INET conference was held at Central European University, in Budapest. CEU received $206 million from Soros in 2005 and has $880 million in its endowment now, according to The Chronicle of Higher Education.
This, too, is a gathering of Soros supporters. INET is bringing together prominent people like former U.K. Prime Minister Gordon Brown, former Fed Chairman Paul Volcker and Soros, to produce “a lot of high-quality, breakthrough thinking.”
While INET claims more than 200 will attend, only 79 speakers are listed on its site – and it already looks like a Soros convention. Twenty-two are on Soros-funded INET’s board and three more are INET grantees. Nineteen are listed as contributors for another Soros operation – Project Syndicate, which calls itself “the world's pre-eminent source of original op-ed commentaries” reaching “456 leading newspapers in 150 countries.” It’s financed by Soros’s Open Society Institute. That’s just the beginning.
The speakers include:
• Volcker who is chairman of President Obama’s Economic Advisory Board. He wrote the forward for Soros’s best-known book, “The Alchemy of Finance” and praised Soros as “an enormously successful speculator” who wrote “with insight and passion” about the problems of globalization.
• Economist Jeffrey Sachs, director of The Earth Institute and longtime recipient of Soros charity cash. Sachs received $50 million from Soros for the U.N. Millennium Project, which he also directs. Sachs is world-renown for his liberal economics. In 2009, for example, he complained about low U.S. taxes, saying the “U.S. will have to raise taxes in order to pay for new spending initiatives, especially in the areas of sustainable energy, climate change, education, and relief for the poor.”
• Soros friend Joseph E. Stiglitz, a former senior vice president and chief economist for the World Bank and Nobel Prize winner in Economics. Stiglitz shares similar views to Soros and has criticized free-market economists whom he calls “free market fundamentalists.” Naturally, he’s on the INET board and is a contributor to Project Syndicate.
• INET Executive Director Rob Johnson, a former managing director at Soros Fund Management, who is on the Board of Directors for the Soros-funded Economic Policy Institute. Johnson has complained that government intervention in the fiscal crisis hasn’t been enough and wanted “restructuring,” including asking “for letters of resignation from the top executives of all the major banks.”
Have no doubt about it: This is a Soros event from top to bottom. Even Soros admits his ties to INET are a problem, saying, “there is a conflict there which I fully recognize.” He claims he stays out of operations. That’s impossible. The whole event is his operation.
INET isn’t subtle about its aims for the conference. Johnson interviewed fellow INET board member Robert Skidelsky about “The Need for a New Bretton Woods” in a recent video. The introductory slide to the video is subtitled: “How currency issues and tension between the US and China are renewing calls for a global financial overhaul.” Skidelsky called for a new agreement and said in the video that the conflict between the United States and China was “at the center of any monetary deal that may be struck, that needs to be struck.”
Soros described in the 2009 op-ed that U.S.-China conflict as “another stark choice between two fundamentally different forms of organization: international capitalism and state capitalism.” He concluded that “a new multilateral system based on sounder principles must be invented.” As he explained it in 2010, “we need a global sheriff.”
In the 2000 version of his book “Open Society: Reforming Global Capitalism,” Soros wrote how the Bretton Woods institutions “failed spectacularly” during the economic crisis of the late 1990s. When he called for a new Bretton Woods in 2009, he wanted it to “reconstitute the International Monetary Fund,” and while he’s at it, restructure the United Nations, too, boosting China and other countries at our expense.
“Reorganizing the world order will need to extend beyond the financial system and involve the United Nations, especially membership of the Security Council,” he wrote. “That process needs to be initiated by the U.S., but China and other developing countries ought to participate as equals.”
Soros emphasized that point, that this needs to be a global solution, making America one among many. “The rising powers must be present at the creation of this new system in order to ensure that they will be active supporters.”
And that’s exactly the kind of event INET is delivering, with the event website emphasizing “today's reconstruction must engage the larger European Union, as well as the emerging economies of Eastern Europe, Latin America, and Asia.” China figures prominently, including a senior economist for the World Bank in Beijing, the director of the Chinese Academy of Social Sciences, the chief adviser for the China Banking Regulatory Commission and the Director of the Center on U.S.-China Relations.
This is all easy to do when you have the reach of George Soros who funds more than 1,200 organizations. Except, any one of those 1,200 would shout such an event from the highest mountain. Groups like MoveOn.org or the Center for American Progress didn’t make their names being quiet. The same holds true globally, where Soros has given more than $7 billion to Open Society Foundations – including many media-savvy organizations just a phone call away. Why hasn’t the Soros network spread the word?
Especially since Soros warns, all this needs to happen because “the alternative is frightening.” The Bush-hating billionaire says America is scary “because a declining superpower losing both political and economic dominance but still preserving military supremacy is a dangerous mix.”
The Soros empire is silent about this new Bretton Woods conference because it isn’t just designed to change global economic rules. It also is designed to put America in its place – part of a multilateral world the way Soros wants it. He wrote that the U.S. “could lead a cooperative effort to involve both the developed and the developing world, thereby reestablishing American leadership in an acceptable form.”
That’s what this conference is all about – changing the global economy and the United States to make them “acceptable” to George Soros.
-- Iris Somberg contributed to this commentary.
Dan Gainor is the Boone Pickens Fellow and the Media Research Center’s Vice President for Business and Culture. His column appears each week on The Fox Forum. He can also be contacted on FaceBook and Twitter as dangainor.
Read more: http://www.foxnews.com/opinion/2011/03/23/media-ignoring-plans-george-soros-remake-entire-global-economy/#ixzz1MYPX8Rxe
|时间: 2011-5-17 周二, 上午10:27 标题:
Great minds head straight to Google’s Zeitgeist
By Kamal Ahmed, Sunday Telegraph Business Editor 8:00AM BST 15 May 2011
The word Zeitgeist comes from the German – time and spirit, or more literally in English "ghost".
Clockwise from far left: Digital guru Martha Lane Fox;Google's Eric Scmidt; George Osborne; Stephen Hawking and Burberry chief executive Angela Ahrendts
Tonight one of the most high-powered gatherings of business leaders, thinkers and those that are considered to generally shape the global future will gather for the start of Zeitgeist – Google's two day think-fest with cookery lessons and golf thrown in.
The collection of the business great and good, now in its sixth year, has become something of a barometer of what's hot and what's not in the world of technology, the broader economy and what is sometimes called, rather inelegantly, "thought leadership". Zeitgeist is fast becoming the UK equivalent of the Sun Valley annual gathering in Idaho – where everyone from Michael Eisner to Mark Zuckerberg display their wares – and the World Economic Forum's grander, and colder, gathering in the Swiss Alpine resort of Davos in January.
Attendees this year will include Angela Ahrendts, chief executive of Burberry, Maurice Levy, chief executive and chairman of Publicis, the Chancellor, George Osborne, Yuri Milner, the founder of Russian tech-giant and Facebook investor, DST, and Professor Stephen Hawking, the director of research at the Centre of Theoretical Cosmology at Cambridge. Joseph Stiglitz, the American economist, Martha Lane Fox, the founder of lastminute.com and the Government's "digital champion", and Simon Wolfson, the chief executive of Next, will also be at the Grove Hotel in Hertforshire, where the event is being held amid tight security.
Subjects covered will include the future of Europe and the single currency, how social media, television and gaming are coming together to produce a new business sector, the development of brands, the role of the royal wedding in driving engagement and philanthropic giving.
Mr Osborne is expected to put further flesh on the bones of Government plans to promote an equivalent of Silicon Valley in east London and also how technology firms can boost growth.
"Our aim with our annual Zeitgeist conference is very simple: to bring together a disparate group of global thought leaders to explore the spirit of the times through discussions of politics, the economy, technology, and culture," said Nikesh Arora, Google's chief business officer.
"But the real magic is in the unplanned stuff: the connections, ideas, and inspirations in the in-between spaces of the gathering.
"With this year's Zeitgeist, we're honoured to have Stephen Hawking join us. I'm looking forward to another two day stretch of wonders."
Another delegate is Wael Ghonim, the internet activist from Egypt who many credited with sparking that country's democracy campaign.
He was imprisoned for 11 days after the authorities claimed he was behind a Facebook page backing the demonstrations against President Hosni Mubarak, who was later deposed.
Eric Schmidt, Google's executive chairman, is expected to talk about the role of the internet and social media in promoting political and business change.
• they should watch zeitgeist addendum and free their thinking.everyone should, but the international banking cartel would hate it if they did.
|时间: 2011-6-07 周二, 下午3:50 标题:
来源: miat42 于 2011-06-02 17:34:56
|时间: 2011-7-07 周四, 下午3:43 标题:
这是他1998年得预测，TIME LINE基本都对。有兴趣可以去http://www.martinarmstrong.org/ 看看。
如果他正确的话, 06/18/2011 是比04/23/09 还要重要的重要底部啊...
1998.55... 07/20/98 顶部
2007.15... 02/27/2007 顶部
2011.45... 06/18/2011 底部
2015.75... 10/07/2015 顶部
2024.35... 05/16/24 顶部
2032.95... 12/24/2032 顶部。51.6年大周期大顶，类似1929年10月
ECONOMICS AND ESOTERICA FOR A NEW PARADIGM
The Business Cycle and the Future by Martin A. Armstrong
Princeton Economic Institute
Originally published September 26, 1999