Summary
Eisman was, of course, not the only person to stumble upon the goldmine of shorting subprime mortgage bonds. Lippmann had managed to convince hundreds of investors to get involved, although only a small number (between ten and twenty) made a straightforward bet against the entire subprime mortgage market, as Eisman did. This goes to show that, although the catastrophe was clearly foreseeable, only a handful of people really noticed it. And those who had were all united by the fact that they had directly or indirectly heard Greg Lippmann’s arguments. One of these investors was John Paulson, who had become particularly obsessed with the trade. He succeeded in starting a fund that did nothing but buy credit default swaps on subprime mortgage bonds because he presented the trade not as a guaranteed windfall from an oncoming catastrophe, but rather as a cheap hedge against the remote possibility of catastrophe. This distinguished Paulson’s strategy from Burry’s, and made him more successful.
Another important investor was Charlie Ledley, who started Cornwall Capital with his friend Jamie Mai. He and Mai had little experience in investing when they started their firm from a friend’s shed in California. Their guiding principles were that thinking globally was important, but neglected by Wall Street, which paid a lot of people well for their narrow expertise, and a few people badly for seeing the big picture. They also thought that people tended to be too certain about inherently uncertain things, and thus had difficulty attaching appropriate probabilities to improbable events. These principles led them to look for long-term options that they could buy cheaply, when they had a good sense that they would become more valuable in the future. They coined the term “event-driven investing” for this strategy, which led them to make bets based on world events that they believed would influence a market. Their first success had been to bet on Capital One.
Ledley and Mai first figured out that Capital One was hiding information on subprime loans, and might not be as solid as it had always claimed to be. They went on to personally interview Peter Schnall, the VP in charge of the subprime portfolio, to get a sense of whether or not he was a crook. After the interview, they concluded he was likely honest, and so they ended up buying shares, believing that they would go up in price after Capital One resolved its problems with regulators. This was a strategy first recommended by Joel Greenblatt: when the value of a stock obviously depends on some upcoming event with a known date, such as a merger or court date, it makes sense to make a bet. This initial gamble was an enormous success, and Ledley and Mai went on to continue their company and its model.
Ledley and Mai also got involved with Ben Hockett, who had spent nine years selling and trading derivatives for Deutsche Bank. But Hockett had quit Deutsche Bank to join Ledley and Mai after getting sick of the company, and his role of working alone from home. He shared their view that people tended to underestimate the probability of extreme change, but took this even further than they did: he was very alarmist, and believed that disasters could strike in real life at any time. His proven experience in finance helped to make Cornwall Capital seem more legitimate to Wall Street, and helped it to secure an official license through Deutsche Bank. This was what allowed them to buy credit default swaps from Greg Lippmann. They viewed credit default swaps as just a financial option: you paid a small premium for which you would get rich if enough subprime borrowers defaulted on their mortgages. In this case, however, they could see that the defaulting on mortgages was almost certain to happen. Unlike many of their previous bets, this one seemed to not even include much risk, since the disaster seemed so assured.
Ledley, Mai and Hockett had gotten involved in credit default swaps in October 2006, much later than men like Eisman and Burry. They had the advantage of time in quickly realizing that this was a good deal, since the disaster was more obviously imminent. But even they had trouble understanding bond market terminology, and especially the “CDO” or collateralized debt obligation. When they did finally wrap their minds around them, they realized it might make the most sense to bet against the upper floors, or double-A tranches, of the CDOs. No one had done this yet, since even investors like Eisman and Burry had picked the triple-B-minus tranche, knowing it was most likely to fail spectacularly. The Ledley, Mai and Hockett strategy ended up being more profitable. This was thanks in part to the advantage they gained from joining the process so late, but also thanks to their strategy of looking mainly for long shots. In this case, the long shot was to bet against the upper floors, which would take longer to collapse.
Ledley and Mai begin working with David Burt, a market expert who could help them to understand CDOs. Burt had worked for the bond fund BlackRock, and was working on his own fund to invest in subprime mortgage bonds. He was able to tell them that they had picked very well in their choice of CDOs to bet against, although they thought they had been too indiscriminate. In fact, so many of the CDOs had bad bonds in them that they had ended up doing a good job after all. Around that time, weeks before the market turned, Ledley and Hockett headed to Las Vegas for an event where they could meet with Bear Stearns, and learn more about whether or not they had made a good choice in betting against the subprime mortgage market.
The sixth chapter begins at The Venetian in Las Vegas, where Eisman went as well to get a better sense for the kinds of people who were on the other side of the credit default swaps. Lippmann had encountered a new issue: although US house prices were falling and subprime loan defaults were rising, subprime mortgage bonds and the price of insuring them was somehow holding firm. He deliberately seated Eisman next to Wing Chau, who ran an investment firm called Harding Advisory and managed CDOs. Chau had a superior attitude but actually was remarkably ignorant of the details of CDOs, and his work in general. Eisman was fascinated by his conversation with Chau, who revealed just how sloppy and irresponsible he and his coworkers really were.
For example, Chau readily admitted that he had sold everything from his portfolio, which, as Eisman knew, was about to be wiped out by the very high default rates on the loans it insured. The job of a CDO manager was to select a Wall Street firm to supply him with subprime bonds that could serve as collateral for CDO investors, and then to vet bonds themselves. Then, they were supposed to monitor the individual subprime bonds inside each CDO and replace the bad ones, before they went bad, with better. Investors, however, usually expected that CDO managers would never even have to resort to this, because triple-A-rated bonds were supposed to be foolproof and impervious to losses. This lead many managers to feel that they did not have to closely monitor triple-A-rated bonds, and so CDO managers, in practice, did not have to do very much. Thus, CDO managers tended to be fairly incompetent, in comparison to other positions in finance. Plus, Wall Street came to prefer CDO managers who were less mentally alert and did not ask many questions, so that the CDO could launder a lot of subprime mortgage market risk that firms hadn’t been able to place straightforwardly. CDO managers were supposed to keep ownership of the equity, or “first loss” piece of the CDO (the one that would vanish first if the subprime loans defaulted) in order to show that they had full confidence in the CDO. But they also got a fee of .1 percent off the top, before investors got any money from it.
But Chau had been passing the risk that the underlying home loans would default on to the big investors who had hired him to vet the bonds. He focused mainly on maximizing the dollars in his care, which meant that he made Harding Advisory the world’s biggest subprime CDO manager. Eisman was outraged that this kind of person, who knew nothing about the CDOs in his care, had been trusted by his investors. He also realized just how bad the system had become. There were not enough Americans with bad credit taking out loans to satisfy investors’ appetite for creating more credit default swaps. Wall Street depended on bets against credit default swaps to create more replications of bonds backed by home loans, and keep the system going. The conversation with Chau convinced Eisman to buy credit default swaps on Wing Chau’s CDOs, in particular.
At the same time, Ledley went shooting with men from Bear Stearns. From them, he learned that no one was invested in the long-term future of CDOs; they only cared about having them last another two years, so they could make a profit off of them. Ledley also concluded that these kinds of people did not believe the subprime mortgage market could collapse because it would be such a catastrophe that it was simply unimaginable to them. He listened to a speech by John Devaney, a conference moderator who also ran a hedge fund that invested in subprime mortgage bonds. Devaney went off on an unhinged rant about how terrible the market was and how corrupt the ratings agencies were. This speech alarmed Ledley, who became convinced that he had made a good decision in betting against the subprime mortgage bond market, but everyone else at the conference seemed to ignore the speech and pretend as though nothing negative had been said.
Eisman started thinking of himself as Spider-Man. He saw parallels between their life stories: where they had gone to college, what they had studied, when they’d married, etc. As Spider-Man, he believed that he needed to work against the dark forces of companies like Deutsche Bank. He tended to see his life in narratives and explained the world to himself in stories, so this was how he framed his dealings with Deutsche Bank. At a conference in which the CEO of Option One talked about subprime loan portfolios and claimed that they expected a loss rate of five percent on its loans, Eisman confronted the CEO. He asked whether that five percent was a probability or a possibility, and was met with the answer that it was a probability. In response, he raised his hand again to assert that there was a zero percent probability of the default rate being only five percent. Then, he dramatically exited to take a phone call. After this incident, he began to seek a higher understanding of how the industry worked and how it had become so corrupt in the first place. He concluded that one of the major problems was that to be an analyst at a ratings agency was one of the easiest and least respected positions to get on Wall Street; if it had been a more important job, maybe more competent people would have taken it, and none of this would have happened. The people who worked at ratings agencies knew just enough to justify their jobs. They were timid, fearful, and risk-averse, in general.
Analysis
In the beginning of chapter five, Lewis strays from his pattern of introducing a new major character with the start of every chapter. Instead, he focuses on contextualizing Eisman’s knowledge of the disaster to come by noting that only a handful of other people also managed to predict the catastrophe. This signals a change in the text’s treatment of characters; at this point, most major players have been introduced, and the plot is moving forward around the new things they do and discover, rather than the new characters they meet. Lewis revisits characters introduced earlier in the text and begins to show how they are all interrelated, as well as how they differed from the other players involved in betting against the housing market. He also begins to make clear how all of these characters revolved around Greg Lippmann in some way, emphasizing the ways in which Lippmann found himself at the center of events. This refocusing on the few main characters of the story—Eisman, Burry, and Lippmann—allows Lewis to switch between their varied perspectives on events. It also emphasizes just how few people were actually fully aware of the risk at hand in advance of the housing market crash.
The change in style, away from introducing a new major character with each chapter, also reflects that new characters who do come up are less individually important for the plot. Lewis begins adding several new characters at once instead of introducing one at a time, which reduces the individual importance of these new players. It also reflects the fact that they had a less central role in events, because they became involved in the situation much later, closer to the date of the crash, which left them less time to make an impact. This text focuses above all on those people who were able to foresee and get involved in the crisis early. Thus, Lewis’ focus on these characters reflects one of the main points of the book: it was only a small handful of people, who all had some exceptional qualities, that looked deeply enough to see the early signs of the crisis.
Lewis’ focus on characters and personalities also stands out as an important feature of the text. It can be tied to some of the main points of the book: namely, the importance of character in determining whether someone will be able to predict disaster, or will wilfully ignore it. Some of the characters in the text collect character references from others, in fact, when trying to make financial decisions. For example, Ledley and Mai make sure to interview a VP of Capital One to determine whether or not he is a “crook” and, thus, whether or not to get involved with the company. Eisman is also most convinced to get involved in subprime mortgage bonds after he meets some of the people who work at ratings agencies in Las Vegas, and realizes just how ignorant and overconfident they all are. The narrator’s fixation on the nuances of his characters’ personalities and all of their quirks helps to bring out the general importance of personality to the substance of this story.
In the scene in which Ledley and Mai attempt to get in touch with Ace Greenberg, who has agreed to be their broker, Lewis emphasizes the strangeness and disconnect inherent to Wall Street. He illustrates just how surreal their encounter with Wall Street is: they repeatedly attempt to get in touch with Greenberg, but the phone number they are given leads to someone else most of the time, and their eventual encounter with him is so brief that they do not get a good sense of him. This anecdote functions not just as an isolated example of Ledley and Mai’s odd experiences on Wall Street, but also as a kind of allegory for Wall Street in general, as it appears in this book: the higher-ups are mysterious and hard to reach, and work hard to stay hidden from the “common people,” from whom they have to withhold evidence of their carelessness and actual, selfish motives.
In this section, Lewis also brings out more of the quirky underdog story behind each of his characters’ narratives. Throughout his profile of Ledley and Mai of Cornwall Capital, for example, he emphasizes the unlikeliness of their success and the extremity of their spirit. He tells the story of someone on Wall Street asking them what they had to offer, if not money, experience, or marketing materials. “Chutzpah. Plus $30 million with which they were willing and able to do anything they wanted to do. Plus a former derivatives trader with an apocalyptic streak who knew how these big Wall Street firms worked,” Lewis fills in on their behalf. The fact that Lewis is the one to answer the question, “So what do you have?” posed by UBS to Ledley and Mai shows that he is stepping in to shape their narrative. And the way he shapes it is with an emphasis on just how little they have in the way of the common, expected Wall Street resources, but how much they make up for it with their “chutzpah” and odd cast of supporting characters. This is a deliberate interpretation of the story, and not an inevitable one; to some, the $30 million that Ledley and Mai had would make it impossible to see them as “underdogs” getting by only on chutzpah. But, in the world of Wall Street, where such money was trivial, Lewis makes clear that that is how they should be interpreted. His story is one in which the odd characters and the underdogs are glorified for their courage and their very strangeness, and eventually come out on top because of their unusual qualities.
