The Big Short Chapter 9: A Death of Interest - The Cracks Appear
This chapter is where it all starts to unravel. And it opens not with the heroes of this story, but with the guy who made the single biggest trading loss in Wall Street history. His name is Howie Hubler.
Meet Howie Hubler
Howie Hubler grew up in New Jersey, played football at Montclair State College, and had a thick neck, a huge head, and the personality to match. He was loud. He was a bully. When someone challenged him on an intellectual point about his trades, he didn’t argue back with logic. He just said, “Get the hell out of my face.”
But for nearly a decade, Howie Hubler had made money for Morgan Stanley. A lot of money. By 2006, his group of eight traders was generating about 20 percent of the entire firm’s profits. He was pulling in $25 million a year and was bored with it. So Morgan Stanley, terrified of losing their golden boy, gave him his own proprietary trading group called GPCG. The plan was to make $2 billion a year. The elite of the elite wanted to join him. They moved to a separate floor. Built walls around themselves. Felt very important.
The Clever Trade That Wasn’t
Hubler was actually one of the early players in the credit default swap game. Back in 2003, before Michael Burry started making his calls, Morgan Stanley invented bespoke credit default swaps to protect Hubler’s mortgage desk. By 2005, Hubler had $2 billion worth of these insurance policies betting against subprime loans. Good bets. Even a 4 percent loss in the loan pools would pay out in full, and that kind of loss happened in good times.
So far, so smart.
But there was a problem. Paying the premiums on this insurance cost $200 million a year. And when you are supposed to be making $2 billion, that is an annoying drag on your numbers.
So Hubler made a decision. To offset those costs, he sold credit default swaps on triple-A-rated CDOs. He figured these were rock-solid. Rated AAA. What could go wrong?
The problem was math. The premiums on triple-A CDOs were only one-tenth of what he was paying on his triple-B bets. So to break even on the premiums, he needed to sell ten times as much. And he did. He sold $16 billion worth.
Let me write that again so it sinks in. Howie Hubler had $2 billion in smart bets that subprime would fail. And he had $16 billion in dumb bets that it wouldn’t fail completely. He was smart enough to be cynical about his market, Lewis writes, but not smart enough to realize how cynical he needed to be.
The Correlation Problem
This is the heart of the chapter, and maybe the heart of the whole crisis.
Those $16 billion in triple-A CDOs were made up of triple-B subprime mortgage bonds. The rating agencies, Moody’s and S&P, said these bonds had a correlation of about 30 percent. That sounds like it means if one bond goes bad, there is a 30 percent chance the others will too. But it actually means something different. It means that if one bond goes bad, the others barely decline at all.
This was fiction. Pure fiction. These bonds were all built on the same thing: American homeowners’ ability to keep paying mortgages they couldn’t afford. The real correlation was 100 percent. When one went down, they all went down. Because they were all driven by the same force - house prices either going up or not going up.
Morgan Stanley had helped teach the rating agencies how to evaluate these things. The people who did the teaching knew it was a sales job. But Howie Hubler trusted the ratings. The bond market’s complexity had spent twenty years helping traders deceive their customers. Now it was helping traders deceive themselves.
When Morgan Stanley Finally Asked the Right Question
In June 2007, Morgan Stanley’s risk department finally got uncomfortable enough to ask: What happens if losses reach 10 percent?
Hubler and his traders were furious. They thought the question was stupid. “If losses go to ten percent, there will be, like, a million homeless people,” they said. That state of the world can’t happen, they insisted.
It took them ten days to run the numbers they didn’t want to run. The answer: their projected $1 billion profit turned into a $2.7 billion loss.
The risk officers came back from that stress test looking very upset.
Hubler told them to relax. Those kinds of losses would never happen. (The losses in his pools would eventually reach 40 percent.)
A risk manager at Morgan Stanley described the situation perfectly: “It’s one thing to bet on red or black and know that you are betting on red or black. It’s another to bet on a form of red and not to know it.”
“Dude, You Owe Us One Point Two Billion”
In early July 2007, Greg Lippmann from Deutsche Bank called. Those $4 billion in CDOs that Hubler had sold them six months ago? They had moved in Deutsche Bank’s favor. Or, as Lippmann put it: “Dude, you owe us one point two billion.”
Morgan Stanley couldn’t believe it. Their model said 95 cents on the dollar. Lippmann said 70.
“Our model says ninety-five,” the Morgan Stanley guy repeated.
And Lippmann just said: “Dude, fuck your model. I’ll make you a market. They are seventy-seventy-seven. You have three choices. You can sell them back to me at seventy. You can buy some more at seventy-seven. Or you can give me my fucking one point two billion dollars.”
This is one of my favorite moments in the whole book. Because it captures the entire crisis in one phone call. One side is living in a model. The other side is living in reality. And reality doesn’t care about your model.
Morgan Stanley wired over $600 million as a compromise. Deutsche Bank offered Hubler more chances to exit on the way down. At $1.2 billion. Then $1.5 billion. Each time, Hubler argued and refused. “We fought with those cocksuckers all the way down,” one Deutsche Bank trader said.
The CDOs fell from 100 to 7. Total loss: over $9 billion. The single largest trading loss in Wall Street history. Hubler quietly resigned in October 2007 and retired to New Jersey with an unlisted number.
The Helium Balloon
Lewis uses a beautiful image here. The subprime market was a giant helium balloon held down by a dozen Wall Street firms clutching ropes. One by one, they realized the balloon would lift them off their feet. One by one, they let go. J.P. Morgan first, by late 2006. Goldman Sachs not only let go but turned and bet against the market. When Bear Stearns’ hedge funds collapsed in June, the rope was ripped from their hands.
Cornwall Capital Cashes Out From a Pub in England
Meanwhile, Cornwall Capital had a different problem. Their credit default swaps were purchased mostly from Bear Stearns, and Bear Stearns was starting to look like it might not survive. If your insurance company goes bankrupt, your insurance is worthless.
Ben Hockett understood this immediately. There can come a moment when you can’t trade with a Wall Street firm anymore, he said, and it can come like that. Problem: Ben was in the south of England, on vacation with his wife’s family.
And so the most improbable trading scene in the book unfolds. Ben Hockett in a pub called The Powder Monkey, in Exmouth, Devon, England. Spotty WiFi. Cell phone cutting in and out. British people drinking their pints, completely oblivious. And he is trying to sell $205 million in credit default swaps.
On Friday he called every major firm. Most said no. UBS said yes. Desperately yes. By Monday, Citigroup, Merrill Lynch, and Lehman Brothers were eager too. By Thursday night Ben was done. Cornwall Capital, started with $110,000, had turned a million-dollar bet into more than $80 million. An 80-to-1 return. And nobody at The Powder Monkey ever asked what he was doing.
His English in-laws didn’t quite understand either. Ben tried to explain that the banking system was insolvent, that Chicago had only eight days of chlorine for its water supply, that they should keep cash on hand. But it was hard to explain. “I can’t really talk to them about it,” he said. “They’re English.”
Michael Burry’s Bittersweet Victory
And then there is Michael Burry. On August 31, 2007, he started selling his credit default swaps. His investors could finally have their money back - more than twice what they had given him. The swaps that had been offered at 2 percent were now trading at 75, 80, 85 points. By the end of the year, he would realize profits of over $720 million on a portfolio of less than $550 million.
And nobody said thank you.
“Even when it was clear it was a big year and I was proven right, there was no triumph in it,” Burry said. “Making money was nothing like I thought it would be.”
To Gotham Capital, his founding investor who had tried to force him to sell his positions at the worst possible time, he sent one email: “You’re welcome.” Then he kicked them out of the fund.
A Death of Interest
The title of this chapter works on multiple levels. The literal death of interest - premiums eating into returns. The death of the market’s interest in maintaining the fiction. And Michael Burry’s own death of interest.
Burry had recently been diagnosed with Asperger’s, and his therapist helped him understand something. His intense interests served as a safe place to retreat from a world that had always felt hostile. When that interest started bringing him the same pain and misunderstanding he was trying to escape, it died. And a new one had to take its place.
So Michael Burry, the man who saw the crisis coming years before anyone else, who read thousands of mortgage bond prospectuses, who fought his own investors and the entire market and was proven right - bought a guitar. He couldn’t play it. He didn’t even want to play it. He just needed to learn everything about the wood used to make guitars. About tubes and amps.
His interest in financial markets was dead. Something vital was dead inside him. He could feel it.
And Lewis ends the chapter with an image that still gives me chills. Six months from that moment, the IMF would put losses on U.S. subprime assets at a trillion dollars. Every major financial institution held some share of those losses. There were no more buyers. It was as if bombs of differing sizes had been placed in virtually every major Western financial institution. The fuses had been lit and could not be extinguished. All that remained was to observe the speed of the spark, and the size of the explosions.
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