The Big Short_ Inside the Doomsday Machine - Michael Lewis [86]
On July 17, 2007, two days before Ben Bernanke, the Fed chairman, told the U.S. Senate that he saw no more than $100 billion in losses in the subprime mortgage market, FrontPoint did something unusual: It hosted its own conference call. They'd had calls with their tiny population of investors, but this time they just opened it up. Steve Eisman had become a poorly kept secret. "Steve was one of about two investors who completely understood what was going on," said one prominent Wall Street analyst. Five hundred people called in to hear what Eisman had to say, and another five hundred logged in afterward to listen to the recording. He explained the strange alchemy of the mezzanine CDO--and said that he expected losses up to $300 billion from this sliver of the market alone. To evaluate the situation, he told his audience, "Just throw your model in the garbage can. The models are all backward-looking. The models don't have any idea of what this world has become.... For the first time in their lives people in the asset-backed securitization world are actually having to think." He explained that the rating agencies were morally bankrupt and living in fear of becoming actually bankrupt. "The ratings agencies are scared to death," he said. "They're scared to death about doing nothing because they'll look like fools if they do nothing." He expected that fully half of all U.S. home mortgage loans--many trillions of dollars' worth--would suffer losses. "We are in the midst of one of the greatest social experiments this country has ever seen," said Eisman. "It's just not going to be a fun experiment.... You think this is ugly. You haven't seen anything yet." When he was done, the next speaker, an Englishman who ran a separate fund at FrontPoint, was slow to respond. "Sorry," the Englishman said wryly, "I just needed to calm down from hearing Steve say the world is ending." And everyone laughed.
Later that very day, investors in the collapsed Bear Stearns hedge funds were informed that their $1.6 billion in triple-A-rated subprime-backed CDOs had not merely lost some value, they were worthless. Eisman was now convinced a lot of the biggest firms on Wall Street did not understand their own risks, and were in peril. At the bottom of his conviction lay his memory of his dinner with Wing Chau--when he grasped the central role of the mezzanine CDO and made a massive bet against those very same CDOs. This of course raised the question: What exactly is inside a CDO? "I didn't know what the fuck was in the things," said Eisman. "You couldn't do the analysis. You couldn't say, 'Give me all the ones with all California in them.' No one knew what was in them." They learned enough to know, as Danny put it, that "it was just all the pieces of shit we'd already shorted wrapped up together, into a portfolio." Beyond that they were flying blind. "Steve's nature is to put it on and figure it out later," said Vinny.
Then came news. Eisman had long subscribed to a newsletter famous in Wall Street circles and obscure outside them, Grant's Interest Rate Observer. Its editor, Jim Grant, had been prophesying doom ever since the great debt cycle began, in the mid-1980s. In late 2006 Grant decided to investigate these strange Wall Street creations known as CDOs. Or, rather, he had asked his young assistant, Dan Gertner, a chemical engineer with an MBA, to see if he could understand them. Gertner went off with the documents explaining CDOs to potential investors and sweated and groaned and heaved and suffered. "Then he came back," says Grant, "and said, 'I can't figure this thing out.' And I said, 'I think we have our story.'"
Gertner dug and dug and finally concluded