• Choose a category
• All
• Classic-Fiction

CHAPTER FIVE

Accidental Capitalists

The thing Eisman had found was indeed a gold mine, but it wasn't true that no one knew about it. By the fall of 2006 Greg Lippmann had made his case to maybe 250 big investors privately, and to hundreds more at Deutsche Bank sales conferences or on Deutsche Bank conference calls. By the end of 2006, according to the PerTrac Hedge Fund Database Study, there were 13,675 hedge funds reporting results, and thousands of other types of institutional investors allowed to invest in credit default swaps. Lippmann's pitch, in one form or another, reached many of them. Yet only one hundred or so dabbled in the new market for credit default swaps on subprime mortgage bonds. Most bought this insurance on subprime mortgages not as an outright bet against them but as a hedge against their implicit bet on them--their portfolios of U.S. real estate-related stocks or bonds. A smaller group used credit default swaps to make what often turned out to be spectacularly disastrous gambles on the relative value of subprime mortgage bonds--buying one subprime mortgage bond while simultaneously selling another. They would bet, for instance, that bonds with large numbers of loans made in California would underperform bonds with very little of California in them. Or that the upper triple-A-rated floor of some subprime mortgage bond would outperform the lower, triple-B-rated, floor. Or that bonds issued by Lehman Brothers or Goldman Sachs (both notorious for packaging America's worst home loans) would underperform bonds packaged by J.P. Morgan or Wells Fargo (which actually seemed to care a bit about which loans it packaged into bonds).

A smaller number of people--more than ten, fewer than twenty--made a straightforward bet against the entire multi-trillion-dollar subprime mortgage market and, by extension, the global financial system. In and of itself it was a remarkable fact: The catastrophe was foreseeable, yet only a handful noticed. Among them: a Minneapolis hedge fund called Whitebox, a Boston hedge fund called The Baupost Group, a San Francisco hedge fund called Passport Capital, a New Jersey hedge fund called Elm Ridge, and a gaggle of New York hedge funds: Elliott Associates, Cedar Hill Capital Partners, QVT Financial, and Philip Falcone's Harbinger Capital Partners. What most of these investors had in common was that they had heard, directly or indirectly, Greg Lippmann's argument. In Dallas, Texas, a former Bear Stearns bond salesman named Kyle Bass set up a hedge fund called Hayman Capital in mid-2006 and soon thereafter bought credit default swaps on subprime mortgage bonds. Bass had heard the idea from Alan Fournier of Pennant Capital, in New Jersey--who in turn had heard it from Lippmann. A rich American real estate investor named Jeff Greene went off and bought several billion dollars' worth of credit default swaps on subprime mortgage bonds for himself after hearing about it from the New York hedge fund manager John Paulson. Paulson, too, had heard Greg Lippmann's pitch--and, as he built a massive position in credit default swaps, used Lippmann as his sounding board. A proprietary trader at Goldman Sachs in London, informed that this trader at Deutsche Bank in New York was making a powerful argument, flew across the Atlantic to meet with Lippmann and went home owning a billion dollars' worth of credit default swaps on subprime mortgage bonds. A Greek hedge fund investor named Theo Phanos heard Lippmann pitch his idea at a Deutsche Bank conference in Phoenix, Arizona, and immediately placed his own bet. If you mapped the spread of the idea, as you might a virus, most of the lines pointed back to Lippmann. He was Patient Zero. Only one carrier of the disease could claim, plausibly, to have infected him. But Mike Burry was holed up in his office in San Jose, California, and wasn't talking to anyone.

This small world of investors who made big bets against subprime mortgage