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By Root 297 0

had created an investment approach that harnessed their talent for distancing themselves from other people's convictions; to find such great conviction in themselves was new and uncomfortable. Jamie penned a memo to his two partners, in which he asked them if they were making a bet on the collapse of a society--and therefore a bet that the government would never allow to succeed. "If a broad range of CDO spreads starts to widen," he wrote,* "it means that a material global financial clusterfuck is likely occurring.... The U.S. Fed is in a position to fix the problem by intervening.... I guess the question is, How wide would the meltdown need to be in order to be 'too big to fail'?"

The conference in Las Vegas had been created, among other things, to boost faith in the market. The day after the subprime mortgage market insiders left Las Vegas and returned to their trading desks, the market cracked. On January 31, 2007, the ABX, a publicly traded index of triple-B-rated subprime mortgage bonds--exactly the sort of bonds used to create subprime CDOs--fell more than a point, from 93.03 to 91.98. For the past several months, it had drifted down in such tiny increments, from 100 to 93, that a full point move came as shocking--and heightened Charlie's anxiety that they'd discovered this sensational trade a moment too late to wager as much on it as they should. The woman from Morgan Stanley was, at first, true to her word: She pushed through their ISDA agreement, which would normally have taken months of negotiations, in ten days. She sent Charlie a list of double-A tranches of CDOs on which Morgan Stanley was willing to sell them credit default swaps.* Charlie stayed up nights figuring out which ones to bet against, and then called her up to find that Morgan Stanley had experienced a change of heart. She had told Charlie that he could buy insurance for around 100 basis points (1 percent of the insured amount a year), but when he called up the next morning to do the trade, the price had more than doubled. Charlie bitched and moaned about the unfairness of it and she and her bosses caved, a bit. On February 16, 2007, Cornwall paid Morgan Stanley 150 basis points to buy $10 million in credit default swaps on a CDO cryptically called Gulfstream, whatever that was.

Five days later, on February 21, the market began to trade an index of CDOs called the TABX. For the first time, Charlie Ledley, and everyone else in the market, was able to see on a screen the price of one of these CDOs. The price confirmed Cornwall's thesis in a way that no amount of conversation with market insiders ever could have. After the first day of trading, the tranche that took losses when the underlying bonds experienced losses of more than 15 percent of the pool--the double-A-rated tranche that Cornwall had bet against--closed at 49.25: It had lost more than half its value. There was now this huge disconnect: With one hand the Wall Street firms were selling low interest rate-bearing double-A-rated CDOs at par, or 100; with the other they were trading this index composed of those very same bonds for 49 cents on the dollar. In a flurry of e-mails, their salespeople at Morgan Stanley and Deutsche Bank tried to explain to Charlie that he should not deduce anything about the value of his bets against subprime CDOs from the prices on these new, publicly traded subprime CDOs. That it was all very complicated.

The next morning Charlie called back Morgan Stanley in hopes of buying more insurance. "She was like, 'I'm really, really sorry but we're not doing any more of this. The firm's changed its mind.'" Overnight, Morgan Stanley had gone from being wildly eager to sell insurance on the subprime mortgage market to not wanting to do it at all. "Then she puts us on the phone with her boss--because we were like, 'What the fuck is going on?'--and he's like, 'Look, I'm really sorry, but something has happened in another arm of the bank that's caused some kind of risk management decision at the very highest levels of Morgan Stanley.' And we never traded with them again."