The Big Short_ Inside the Doomsday Machine - Michael Lewis [40]
No wonder Goldman Sachs was suddenly so eager to sell Mike Burry credit default swaps in giant, $100 million chunks, or that the Goldman Sachs bond trader had been surprisingly indifferent to which subprime bonds Mike Burry bet against. The insurance Mike Burry bought was inserted into a synthetic CDO and passed along to AIG. The roughly $20 billion in credit default swaps sold by AIG to Goldman Sachs meant roughly $400 million in riskless profits for Goldman Sachs. Each year. The deals lasted as long as the underlying bonds, which had an expected life of about six years, which, when you did the math, implied a profit for the Goldman trader of $2.4 billion.
Wall Street's newest technique for squeezing profits out of the bond markets should have raised a few questions. Why were supposedly sophisticated traders at AIG FP doing this stuff? If credit default swaps were insurance, why weren't they regulated as insurance? Why, for example, wasn't AIG required to reserve capital against them? Why, for that matter, were Moody's and Standard & Poor's willing to bless 80 percent of a pool of dicey mortgage loans with the same triple-A rating they bestowed on the debts of the U.S. Treasury? Why didn't someone, anyone, inside Goldman Sachs stand up and say, "This is obscene. The rating agencies, the ultimate pricers of all these subprime mortgage loans, clearly do not understand the risk, and their idiocy is creating a recipe for catastrophe"? Apparently none of those questions popped into the minds of market insiders as quickly as another: How do I do what Goldman Sachs just did? Deutsche Bank, especially, felt something like shame that Goldman Sachs had been the first to find this particular pay dirt. Along with Goldman, Deutsche Bank was the leading market maker in abstruse mortgage derivatives. Dusseldorf was playing some kind of role in the new market. If there were stupid Germans standing ready to buy U.S. subprime mortgage derivatives, Deutsche Bank should have been the first to find them.
None of this was of any obvious concern to Greg Lippmann. Lippmann did not run Deutsche Bank's CDO business--a fellow named Michael Lamont did. Lippmann was merely the trader responsible for buying and selling subprime mortgage bonds and, by extension, credit default swaps on subprime mortgage bonds. But with so few investors willing to make an outright bet against the subprime bond market, Lippmann's bosses asked Lippmann to take one for the team: in effect, to serve as a stand-in for Mike Burry, and to make an explicit bet against the market. If Lippmann would buy credit default swaps from Deutsche Bank's CDO department, they, too, might do these trades with AIG, before AIG woke up and stopped doing them. "Greg was forced to get short into the CDOs," says a former senior member of Deutsche Bank's CDO team. "I say forced, but you can't really force Greg to do anything." There was some pushing and pulling with the people who ran his firm's CDO operations, but Lippmann found himself uncomfortably short subprime mortgage bonds.
Lippmann had at least one good reason for not putting up a huge fight: There was a fantastically profitable market waiting to be created. Financial markets are a collection of arguments. The less transparent the market and the more complicated the securities, the more money the trading desks at big Wall Street firms can make from the argument. The constant argument over the value of the shares of some major publicly traded company has very little value, as both buyer and seller can see the fair price of the stock on the ticker, and the broker's commission has been driven down by competition. The argument over the value of credit default swaps on subprime mortgage bonds--a complex security whose value was derived from that of another complex security--could be a gold mine. The only other dealer making serious markets in credit default swaps was Goldman Sachs, so there was, in the beginning, little price competition.