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By Root 378 0

any Wall Street bond salesmen--If it's such a great trade, why are you offering it to me?--but other, less usual ones, too. Buying credit default swaps meant paying insurance premiums for perhaps years as you waited for American homeowners to default. Bond market investors, like bond market traders, viscerally resisted any trade that they had to pay money to be in, and instinctively sought out trades that paid them just for showing up in the morning. (One big bond market investor christened his yacht Positive Carry.) Trades where you fork over 2 percent a year just to be in them were anathema. Other sorts of investors found other sorts of objections. "I can't explain credit default swaps to my investors" was a common response to Greg Lippmann's pitch. Or "I have a cousin who works at Moody's and he says this stuff [subprime mortgage bonds] is all good." Or "I talked to Bear Stearns and they said you were crazy." Lippmann spent twenty hours with one hedge fund guy and thought he had him sold, only to have the guy call his college roommate, who worked for some home builder, and change his mind.

But the most common response of all from investors who heard Lippmann's argument was, "I'm convinced. You're right. But it's not my job to short the subprime market."

"That's why the opportunity exists," Lippmann would reply. "It's nobody's job."

It wasn't Lippmann's, either. He was meant to be the toll booth, taking a little from buyers and sellers as they passed through his trading books. He was now in a different, more opinionated relationship to his market and his employer. Lippmann's short position may have been forced upon him, but by the end of 2005 he'd made it his own, and grown it to a billion dollars. Sixteen floors above him inside Deutsche Bank's Wall Street headquarters, several hundred highly paid employees bought subprime mortgage loans, packaged them into bonds, and sold them off. Another group packaged the most repellent, unsalable tranches of those bonds, and CDSs on the bonds, into CDOs. The bigger Lippmann's short position grew, the greater the implicit expression of contempt for these people and their industry--an industry quickly becoming Wall Street's most profitable business. The running cost, in premiums Lippmann paid, was tens of millions of dollars a year, and his losses looked even bigger. The buyer of a credit default swap agreed to pay premiums for the lifespan of the underlying mortgage bond. So long as the underlying bonds remained outstanding, both buyer and seller of credit default swaps were obliged to post collateral, in response to their price movements. Astonishingly, the prices of subprime mortgage bonds were rising. Within a few months, Lippmann's credit default swap position had to be marked down by $30 million. His superiors repeatedly asked him to explain why he was doing what he was doing. "A lot of people wondered if this was the best use of Greg's time and our money," said a senior Deutsche Bank official who watched the growing conflict.

Rather than cave to the pressure, Lippmann instead had an idea for making it vanish: kill the new market. AIG was very nearly the only buyer of triple-A-rated CDOs (that is, triple-B-rated subprime mortgage bonds repackaged into triple-A-rated CDOs). AIG was, ultimately, the party on the other side of the credit default swaps Mike Burry was buying. If AIG stopped buying bonds (or, more exactly, stopped insuring them against default), the entire subprime mortgage bond market might collapse, and Lippmann's credit default swaps would be worth a fortune. At the end of 2005, Lippmann flew to London to try to make that happen. He met with an AIG FP employee named Tom Fewings, who worked directly for AIG FP's head, Joe Cassano. Lippmann, who was forever adding data to his presentation, produced his latest version of "Shorting Mezzanine Home Equity Tranches" and walked Fewings through his argument. Fewings offered him no serious objections, and Lippmann left AIG's London office feeling as if Fewings had been converted to his cause. Sure enough, shortly after