The Big Short Chapter 5: The Accidental Capitalists of Cornwall Capital
Every chapter of this book introduces a different kind of weirdo who saw the crisis coming. Michael Burry was the data obsessive. Steve Eisman was the loud angry truth-teller. And now we meet Charlie Ledley and Jamie Mai, two guys who started a hedge fund in a friend’s garage in Berkeley, California, with $110,000 in a Schwab account. They called it Cornwall Capital Management. Nobody asked them to do this. Nobody told them they should. They just kind of… did it.
And it worked. Eventually, spectacularly well. But the way they got there is one of the funniest stories in the whole book.
Two Guys With No Business Being in Business
Here is what Charlie and Jamie did not have when they started Cornwall Capital in 2003: experience, credentials, investors, a track record, an office, or a convincing argument for why anyone should give them money.
Here is what they did have: a shed behind Jamie’s house, and an idea.
Neither of them had made actual investment decisions before. They had both worked briefly at a private equity firm, but as low-level grunts chained to desks. Jamie was tall and handsome but stammered through sentences. Charlie had the manner of someone permanently trying to delay any definite action. Lewis describes him as having “the pallor of a mortician.”
Charlie left college to volunteer for Bill Clinton’s campaign. Jamie’s first job was delivering sailboats to rich people. They ended up in Berkeley because Jamie’s girlfriend wanted to live there. Charlie moved to Berkeley because Jamie’s garage was there. That’s it. That’s the origin story.
The Capital One Bet That Changed Everything
Their first big trade happened almost by accident. Capital One Financial, a credit card company that lent to people with bad credit, had its stock crash 60 percent after a dispute with regulators. The market was afraid Capital One was a fraud.
Charlie and Jamie did what any reasonable investor with $110,000 and zero credibility would do: they started calling everyone they could find who had ever worked at or with Capital One. Short sellers, former employees, consultants, even government regulators. They dug up people who went to college with Capital One’s CEO and collected character references. Then they found some mid-level guy named Peter Schnall inside the company and asked to meet him.
“I got the impression they were like, ‘Who calls and asks for Peter Schnall?’” Charlie recalled. They introduced themselves gravely as Cornwall Capital Management, without mentioning what Cornwall Capital Management actually was. “People don’t feel comfortable asking how much money you have,” Jamie said. “And so you don’t have to tell them.”
After meeting Schnall, they concluded Capital One was probably honest. The stock was trading at $30. If the company was a fraud, it would go to zero. If it was legitimate, it should be worth about $60. The market was treating this like a coin flip, but the options market was not pricing it that way at all.
Jamie had read a book called You Can Be a Stock Market Genius by Joel Greenblatt, which explained how sometimes it makes more sense to buy options on a stock than the stock itself. They found they could buy a long-term option (called a LEAP) to purchase Capital One stock at $40 per share, anytime in the next two and a half years, for just $3.
Think about this for a second. If Capital One was real, the stock would jump to $60 and their $3 option would be worth $20. If it was a fraud, they’d lose $3. The worst case cost them almost nothing. The best case paid off huge.
They bought 8,000 of these options for $26,000. When Capital One was cleared by regulators, the stock jumped, and that $26,000 turned into $526,000.
The Philosophy of Cheap Lottery Tickets
That first trade taught them something fundamental. The Black-Scholes model that Wall Street uses to price options assumes stock prices move in small, gradual steps following a bell curve. But the real world doesn’t work that way. Sometimes a company is worth zero or $60 and nothing in between. The model doesn’t account for that.
Cornwall Capital turned this into a strategy they called “event-driven investing.” It sounds fancy but really means: find situations where something dramatic is about to happen, buy cheap options on the outcome, and wait.
They made $5 million on a European cable company. They made $3 million on a company that delivered oxygen tanks to sick people. They bought ethanol futures and ended up taking delivery of two rail cars of the stuff in a Chicago stockyard, making headlines in a magazine called Ethanol Today.
They even predicted a coup in Thailand, bought cheap options on the Thai baht, and lost money when the baht didn’t move even after the military overthrew the prime minister. “We predicted a coup, and we lost money,” Jamie said.
But that was the point. The losses were cheap. The wins were massive. They didn’t need to be right most of the time. Two years in, that $110,000 Schwab account had become $12 million.
Enter Ben Hockett, the Doomsday Prepper
Ben Hockett had spent nine years trading derivatives for Deutsche Bank in Tokyo. He burned out, tried to quit, and Deutsche Bank begged him to stay. They said he could wear whatever he wanted, live wherever he wanted, work from home. He moved to Berkeley Hills and traded $100 million of Deutsche Bank’s money from his house.
He met Jamie while walking their dogs. Jamie convinced Ben to quit and join Cornwall Capital. Ben’s critical contribution was knowing how Wall Street actually worked. Charlie and Jamie had never been inside a bank. They didn’t even know the term “ISDA” - the agreement you need to trade derivatives with big firms. Ben knew who to call and what language to speak.
But Ben was also different. While Charlie and Jamie worried about financial disasters, Ben worried about actual disasters. He bought a remote farm north of San Francisco, without road access, planted with enough food to feed his family in case civilization collapsed. Charlie and Jamie preferred he keep this to himself.
Here is my favorite moment in the chapter. One day Charlie said to Ben: “You hate taking even remote risks, but you live on top of a mountain on a fault line, in a housing market at an all-time high.” Ben hung up. They couldn’t reach him for two months. He had gone to sell his house. It was worth over a million dollars but rented for only $2,500 a month. The rule of thumb says buy at 10 times rental, sell at 20. His house was trading at 30. Ben moved his family into a rental immediately.
Getting a Seat at the Big Boys’ Table
Cornwall Capital had $30 million by early 2006, but Wall Street still treated them like nobodies. Goldman Sachs didn’t want their business. Lehman Brothers laughed at them. J.P. Morgan actually fired them as a customer. Every firm asked for marketing materials, offering documents, resumes - none of which they had.
“It always ended with them sort of asking, ‘So what do you have?’” Charlie recalled.
What they had was chutzpah and Ben Hockett. Ben somehow convinced Deutsche Bank, which normally required $2 billion minimum, to accept Cornwall Capital on their institutional platform. Deutsche Bank sent a team to inspect their offices, which were in the back of an artist’s studio in Greenwich Village. Tailor working in the basement, paint fumes from upstairs, and only one toilet. “Before they came,” Charlie said, “I remember thinking, if anyone has to go to the bathroom, we’re in trouble.”
Nobody needed the bathroom. Cornwall Capital got its ISDA.
The CDO Discovery
When they finally got Greg Lippmann’s presentation about shorting subprime mortgage bonds, their first reaction was: this is too good to be true. Their second reaction was: why isn’t someone smarter than us doing this?
But then they did something nobody else had done. Instead of betting against the triple-B bonds like Burry and Eisman, they looked at CDOs - collateralized debt obligations. What they found horrified them.
A CDO was basically a pile of the worst mortgage bonds, repackaged and somehow rated as safe. The triple-B bonds at the bottom needed only 7 percent losses in the underlying loans to be wiped out. A CDO made of those same bonds would get wiped out by that same 7 percent loss, regardless of what rating the agencies gave it. Yet 80 percent of these CDOs were rated higher than triple-B.
“The more we looked at what a CDO really was,” Charlie said, “the more we were like, holy shit, that’s just crazy. That’s fraud.”
Here was the brilliant part of their trade. Insurance on a double-A-rated CDO slice cost one-quarter of what insurance on a triple-B bond cost. But it was essentially the same bet. So they could make four times as much of it for the same money. By January 2007, their $30 million fund owned $110 million in credit default swaps on the double-A tranches of CDOs.
They were probably the first people ever to make this particular bet. The Deutsche Bank salesman assigned to them - a 23-year-old nobody else wanted to deal with - put it best: “They were putting on bets that were multiples of the capital they had. And they were doing it in CDSs on CDOs, which probably, like, three or four guys in the whole bank could speak intelligently about.”
Why This Chapter Matters
What I love about the Cornwall Capital story is how relatable these guys are. Burry is a genius with a glass eye who reads SEC filings for fun. Eisman is a Wall Street insider with rage issues. But Charlie and Jamie? They are two regular guys who paid attention, asked questions, and refused to be embarrassed by what they didn’t know.
Their philosophy boils down to something simple: the world is more uncertain than people think, and uncertainty is chronically underpriced. Markets assume tomorrow will look like today. But sometimes it doesn’t.
They didn’t need to be experts in mortgage bonds. They just needed to understand that nobody else was an expert either, and the whole thing was priced as if there was nothing to worry about.
As the chapter ends, Charlie and Ben fly to Las Vegas for the big subprime conference at The Venetian hotel. Bear Stearns is taking customers to a firing range to shoot Glocks and Uzis. Charlie, raised by New York City liberals, wasn’t allowed to have a toy gun as a kid.
They are weeks away from the market turning, but they don’t know that yet. All they know is that they bet on something that looks insane, and they still can’t find a single person who can tell them why they’re wrong.
That should terrify you.