The Big Short_ Inside the Doomsday Machine - Michael Lewis [73]
A guy from a rating agency on whom Charlie tested Cornwall's investment thesis looked at him strangely and asked, "Are you sure you guys know what you're doing?" The market insiders didn't agree with them, but they didn't offer persuasive counter-arguments. Their main argument, in defense of subprime CDOs, was that "the CDO buyer will never go away." Their main argument, in defense of the underlying loans, was that, in their short history, they had never defaulted in meaningful amounts. Above the roulette tables, screens listed the results of the most recent twenty spins of the wheel. Gamblers would see that it had come up black the past eight spins, marvel at the improbability, and feel in their bones that the tiny silver ball was now more likely to land on red. That was the reason the casino bothered to list the wheel's most recent spins: to help gamblers to delude themselves. To give people the false confidence they needed to lay their chips on a roulette table. The entire food chain of intermediaries in the subprime mortgage market was duping itself with the same trick, using the foreshortened, statistically meaningless past to predict the future.
"Usually, when you do a trade, you can find some smart people on the other side of it," said Ben. "In this instance we couldn't."
"Nobody we talked to had any credible reason to think this wasn't going to become a big problem," said Charlie. "No one was really thinking about it."
One of the Bear Stearns CDO guys, after Charlie asked him what was likely to happen to these CDOs in seven years, said, "Seven years? I don't care about seven years. I just need it to last for another two."
Three months earlier, when Cornwall bought their first $100 million in credit default swaps on the double-A-rated tranches of subprime CDOs, they believed they were making a cheap bet on an unlikely event--$500,000 a year in premium for the chance to make $100,000,000. The market, and the rating agencies, effectively had set the odds of default at 1 in 200. They thought the odds were better than that--say, 1 in 10. Still, it was, like most of their bets, a long shot. An intelligent long shot, perhaps, but a long shot nonetheless. The more they listened to the people who ran the subprime market, the more they felt the collapse of double-A-rated bonds wasn't a long shot at all, but likely. A thought crossed Ben's mind: These people believed that the collapse of the subprime mortgage market was unlikely precisely because it would be such a catastrophe. Nothing so terrible could ever actually happen.
The first morning of the conference, they'd followed a crowd of thousands out of the casino and into the vast main ballroom to attend the opening ceremony. It was meant to be a panel discussion, but of course the men on the panel had little interest in talking to each other and more interest in delivering measured, prepared remarks. They'd watch a dozen of these events over the next three days and all were tedious. This one session was different, though, because its moderator appeared to be drunk, or at least unhinged. His name was John Devaney and he ran a hedge fund that invested in subprime mortgage bonds, United Capital Markets. For a decade now, Devaney had sponsored this conference--called ASF, or the American Securitization Forum, in part because it sounded more dignified than the Association for Subprime Lending. To the extent that the market for subprime mortgage bonds had moral leaders, John Devaney was one. He was also an enthusiastic displayer of his own wealth. He owned a Renoir, a Gulfstream, a helicopter, plus, of course, a yacht. This year he'd paid some huge sum to fly in Jay Leno to serve as the entertainment.
Now, looking as if he had just rolled in from a night on the town without pausing to take a nap, John Devaney delivered what was clearly an extemporaneous rant about the state of the subprime market. "It was incredible," said Charlie.