The Big Short_ Inside the Doomsday Machine - Michael Lewis [102]
A month after Hubler and his traders improved the terms of trade between themselves and their employer, Morgan Stanley finally asked the uncomfortable question: What happened to their massive subprime mortgage market bet if lower-middle-class Americans defaulted in greater than expected numbers? How did the bet perform, for instance, using the assumption of losses generated by the most pessimistic Wall Street analyst? Up to that point, Hubler's bet had been "stress tested" for scenarios in which subprime pools experienced losses of 6 percent, the highest losses from recent history. Now Hubler's traders were asked to imagine what would become of their bet if losses reached 10 percent. The demand came directly from Morgan Stanley's chief risk officer, Tom Daula, and Hubler and his traders were angered and disturbed that he would issue it. "It was more than a little weird," says one of them. "There was a lot of angst about it. It was sort of viewed as, These folks don't know what they're talking about. If losses go to ten percent there will be, like, a million homeless people." (Losses in the pools Hubler's group had bet on would eventually reach 40 percent.) As a senior Morgan Stanley executive outside Hubler's group put it, "They didn't want to show you the results. They kept saying, That state of the world can't happen."
It took Hubler's traders ten days to produce the result they really didn't want to show anyone: Losses of 10 percent turned their complicated bet in subprime mortgages from a projected profit of $1 billion into a projected loss of $2.7 billion. As one senior Morgan Stanley executive put it, "The risk officers came back from the stress test looking very upset." Hubler and his traders tried to calm him down. Relax, they said, those kinds of losses will never happen.
The risk department had trouble relaxing, however. To them it seemed as if Hubler and his traders didn't fully understand their own gamble. Hubler kept saying he was betting against the subprime bond market. But if so, why did he lose billions if it collapsed? As one senior Morgan Stanley risk manager put it, "It's one thing to bet on red or black and know that you are betting on red or black. It's another to bet on a form of red and not to know it."
In early July, Morgan Stanley received its first wake-up call. It came from Greg Lippmann and his bosses at Deutsche Bank, who, in a conference call, told Howie Hubler and his bosses that the $4 billion in credit default swaps Hubler had sold Deutsche Bank's CDO desk six months earlier had moved in Deutsche Bank's favor. Could Morgan Stanley please wire $1.2 billion to Deutsche Bank by the end of the day? Or, as Lippmann actually put it--according to someone who heard the exchange--Dude, you owe us one point two billion.
Triple-A-rated subprime CDOs, of which there were now hundreds of billions of dollars' worth buried inside various Wall Street firms, and which were assumed to be riskless, were now, according to Greg Lippmann, only worth 70 cents on the dollar. Howie Hubler had the same reaction. What do you mean seventy? Our model says they are worth ninety-five, said one of the Morgan Stanley people on the phone call.
Our model says they are worth seventy, replied one of the Deutsche Bank people.
Well, our model says they are worth ninety-five, repeated the Morgan Stanley person, and then went on about how the correlation among the thousands of triple-B-rated bonds in his CDOs was very low, and so a few bonds going bad didn't imply they were all worthless.
At which point Greg Lippmann just said, Dude, fuck your model. I'll make you a market. They are seventy-seventy-seven. You have three choices. You can sell them back to me at seventy. You can buy some more at seventy-seven. Or you can give me my fucking one point two billion dollars.
Morgan Stanley didn't want to buy any more subprime mortgage bonds. Howie Hubler didn't want to buy any more subprime-backed bonds: He'd released his grip on the rope that tethered him to