The Big Short_ Inside the Doomsday Machine - Michael Lewis [101]
The Wall Street bond traders on the other end of the phone from Howie Hubler came away with the impression that he considered these bets entirely risk-free. He'd collect a tiny bit of interest...for nothing. He wasn't alone in this belief, of course. Hubler and a trader at Merrill Lynch argued back and forth about a possible purchase by Morgan Stanley, from Merrill Lynch, of $2 billion in triple-A CDOs. Hubler wanted Merrill Lynch to pay him 28 basis points (0.28 percent) over the risk-free rate, while Merrill Lynch only wanted to pay 24. On a $2 billion trade--a trade that would, in the end, have transferred a $2 billion loss from Merrill Lynch to Morgan Stanley--the two traders were arguing over interest payments amounting to $800,000 a year. Over that sum the deal fell apart. Hubler had the same nit-picking argument with Deutsche Bank, with a difference. Inside Deutsche Bank, Greg Lippmann was now hollering at the top of his lungs that these triple-A CDOs could one day be worth zero. Deutsche Bank's CDO machine paid Hubler the 28 basis points he craved and, in December 2006 and January 2007, cut two deals, of $2 billion each. "When we did the trades, the whole time we were both like, 'We both know there is no risk in these things,'" said the Deutsche Bank CDO executive who dealt with Hubler.
In the murky and curious period from early February to June 2007, the subprime mortgage market resembled a giant helium balloon, bound to earth by a dozen or so big Wall Street firms. Each firm held its rope; one by one, they realized that no matter how strongly they pulled, the balloon would eventually lift them off their feet. In June, one by one, they silently released their grip. By edict of CEO Jamie Dimon, J.P. Morgan had abandoned the market by the late fall of 2006. Deutsche Bank, because of Lippmann, had always held on tenuously. Goldman Sachs was next, and did not merely let go, but turned and made a big bet against the subprime market--further accelerating the balloon's fatal ascent.* When its subprime hedge funds crashed in June, Bear Stearns was forcibly severed from its line--and the balloon drifted farther from the ground.
Not long before that, in April 2007, Howie Hubler, perhaps having misgivings about the size of his gamble, had struck a deal with the guy who ran the doomed Bear Stearns hedge funds, Ralph Cioffi. On April 2, the nation's largest subprime mortgage lender, New Century, was swamped by defaults and filed for bankruptcy. Morgan Stanley would sell Cioffi $6 billion of his $16 billion in triple-A CDOs. The price had fallen a bit--Cioffi demanded a yield of 40 basis points (0.40 percent) over the risk-free rate. Hubler conferred with Morgan Stanley's president, Zoe Cruz; together they decided that they'd rather keep the subprime risk than realize a loss that amounted to a few tens of millions of dollars. It was a decision that wound up costing Morgan Stanley nearly $6 billion, and yet Morgan Stanley's CEO, John Mack, never got involved. "Mack never came and talked to Howie," says one of Hubler's closest associates. "The entire time, Howie never had a single sit-down with Mack."*
By May 2007, however, there was a growing dispute between Howie Hubler and Morgan Stanley. Amazingly, it had nothing to do with the wisdom of owning $16 billion in complex securities whose value ultimately turned on the ability of a Las Vegas stripper with five investment properties, or a Mexican strawberry picker with a single $750,000 home, to make rapidly rising interest payments. The dispute was over Morgan Stanley's failure to deliver on its promise to spin Hubler's proprietary trading group off into its own money management firm, of which he would own 50 percent. Outraged by Morgan Stanley's foot-dragging, Howie Hubler threatened to quit. To keep him, Morgan Stanley promised to pay him, and his traders, an even bigger chunk of GPCG's profits. In 2006, Hubler had been paid