The Big Short: Inside the Doomsday Machine

by Michael Lewis

  The Fed and the Treasury were doing their best to calm investors, but on Wednesday no one was obviously calm. A money market fund called the Reserve Primary Fund announced that it had lost enough on short-term loans to Lehman Brothers that its investors were not likely to get all their money back, and froze redemptions. Money markets weren't cash--they paid interest, and thus bore risk--but, until that moment, people thought of them as cash. You couldn't even trust your own cash. All over the world corporations began to yank their money out of money market funds, and short-term interest rates spiked as they had never before spiked. The Dow Jones Industrial Average had fallen 449 points, to its lowest level in four years, and most of the market-moving news was coming not from the private sector but from government officials. At 6:50 on Thursday morning, when Danny arrived, he learned that the chief British financial regulator was considering banning short selling--an act that, among other things, would put the hedge fund industry out of business--but that didn't begin to explain what now happened. "All hell was breaking loose in a way I had never seen in my career," said Danny.

  FrontPoint was positioned perfectly for exactly this moment. By agreement with their investors, their fund could be 25 percent net short or 50 percent net long the stock market, and the gross positions could never exceed 200 percent. For example, for every $100 million they had to invest, they could be net short $25 million, or net long $50 million--and all of their bets combined could never exceed $200 million. There was nothing in the agreement about credit default swaps, but that no longer mattered. ("We never figured out how to put it in," said Eisman.) They'd sold their last one back to Greg Lippmann two months earlier, in early July. They were now back to being, exclusively, stock market investors.

  At that moment they were short nearly as much as they were allowed to be short, and all of their bets were against banks, the very companies collapsing the fastest: Minutes after the market opened they were up $10 million. The shorts were falling, the longs--mainly smaller banks removed from the subprime market--were falling less. Danny should have been elated: Everything they had thought might happen was now happening. He wasn't elated, however; he was anxious. At 10:30, an hour into trading, every financial stock went into a free fall, whether it deserved to or not. "All this information goes through me," he said. "I'm supposed to know how to transmit information. Prices were moving so quickly I couldn't get a fix. It felt like a black hole. The abyss."

  It had been four days since Lehman Brothers had been allowed to fail, but the most powerful effects of the collapse were being felt right now. The stocks of Morgan Stanley and Goldman Sachs were tanking, and it was clear that nothing short of the U.S. government could save them. "It was the equivalent of the earthquake going off," he said, "and then, much later, the tsunami arrives." Danny's trading life was man versus man, but this felt more like man versus nature: The synthetic CDO had become a synthetic natural disaster. "Usually, you feel you have the ability to control your environment," said Danny. "You're good because you know what's going on. Now it didn't matter what I knew. Feel went out the window."

  FrontPoint had maybe seventy different bets on, in various stock markets around the world. All of them were on financial institutions. He scrambled to keep a handle on them all, but couldn't. They owned shares in KeyBank and were short the shares of Bank of America, both of which were doing things they'd never done before. "There were no bids in the market for anything," said Danny. "There was no market. It was really only then that I realized there was a bigger issue than just our portfolio. Fundamentals didn't matter. Stocks were going to move up or down on pure emotion and speculation of what the government would do." The most unsettling loose thought rattling around his mind was that Morgan Stanley was about to go under. Their fund was owned by Morgan Stanley. They had almost nothing to do with Morgan Stanley, and felt little kinship with the place. They did not act or feel like Morgan Stanley employees--Eisman often said how much he wished he was allowed to short Morgan Stanley stock. They acted and felt like the managers of their own fund. If Morgan Stanley failed, however, its share in their fund wound up as an asset in a bankruptcy proceeding. "I'm thinking, We've got the world by the fucking balls and the company we work for is going bankrupt?"

  Then Danny sensed something seriously wrong--with himself. Just before eleven in the morning, wavy black lines appeared in the space between his eyes and his computer screen. The screen appeared to be fading in and out. "I felt this shooting pain in my head," he said. "I don't get headaches. I thought I was having an aneurysm." Now he became aware of his heart--he looked down and he could actually see it banging against his chest. "I spend my morning trying to control all this energy and all this information," he said, "and I lost control."

  He'd had this experience only once before. On September 11, 2001, at 8:46 a.m., he'd been at his desk on the top floor of the World Financial Center. "You know when you're in the city and one of those garbage trucks passes and you're like, 'What the fuck was that?'" Until someone told him it was a commuter plane hitting the North Tower, he assumed the first plane was one of those trucks. He walked to the window to look up at the building across the street. A small commuter plane wouldn't have been big or strong enough to do all that much damage, to his way of thinking, and he expected to see it poking out of the side of the building. All he could see was the black hole, and smoke. "My first thought was, That was not an accident. No fucking way." He was still working at Oppenheimer and Co.--Steve and Vinny had already left--and some authoritative-sounding voice came over the loudspeaker to announce that no one was to leave the building. Danny remained at the window. "That's when people started jumping," he said. "Bodies are falling." The rumble of another garbage truck. "When the second plane hit I was like, 'Bye, everybody.'" By the time he reached the elevator, he found himself escorting two pregnant women. He walked them uptown, left one at her apartment on Fourteenth Street and the other at the Plaza Hotel, and then walked home to his pregnant wife on Seventy-second Street.

  Four days later he was leaving, or rather fleeing, New York City with his wife and small son. They were on the highway at night in the middle of a storm when he was overcome by the certainty that a tree would fall and crush the car. He began to shake and sweat with sheer terror. The trees were fifty yards away: They could never reach the car. "You need to see someone," his wife said, and he had. He had thought he might have something wrong with his heart, and had spent half a day hooked up to an EKG machine. The loss of self-control embarrassed him--he preferred not to talk about it--and he was deeply relieved when the attacks became less frequent and less severe. Finally, a few months after the terrorist attack, they vanished completely.

  On September 18, 2008, he failed to make the connection between how he'd felt then and how he felt now. He rose from his desk and looked for someone. Eisman normally sat across from him, but Eisman was out at some conference trying to raise money--which showed you how unprepared they all were at the arrival of the moment for which they thought themselves perfectly prepared. Danny turned to the colleague beside him. "Porter, I think I'm having a heart attack," he said.

  Porter Collins laughed and said, "No, you're not." An Olympic rowing career had left Porter Collins a bit inured to the pain of others, as he assumed they usually didn't know what pain was.

  "No," said Danny. "I need to go to the hospital." His face had gone pale but he was still able to stand on his own two feet. How bad could it be? Danny was always a little jumpy.

  "That's why he's good at his job," said Porter. "I kept saying, 'You're not having a heart attack.' Then he stopped talking. And I said, 'All right, maybe you are.'" This actually wasn't all that helpful. Unsteadily, Danny turned to Vinny, who had been watching everything from the far end of the long trading desk and was thinking about calling an ambulance.

  "I got to get out of here. Now," he said.

  Cornwall Capital's bet against subprime mortgage bonds had quadrupled its capital, from a bit more than $30 million to $135
million, but its three founders never had a Champagne moment. "We were focused on, Where do we put our money that's safe?" said Ben Hockett. Before, they had no money. Now, they were rich; but they feared they had no ability to preserve their wealth. By nature a bit tortured, they were now, by nurture, even more so. They actually spent time wondering how people who had been so sensationally right (i.e., they themselves) could preserve the capacity for diffidence and doubt and uncertainty that had enabled them to be right. The more sure you were of yourself and your judgment, the harder it was to find opportunities premised on the notion that you were, in the end, probably wrong.

  The long-shot bet, in some strange way, was a young man's game. Charlie Ledley and Jamie Mai no longer felt, or acted, quite so young. Charlie now suffered from migraines, and was consumed with what might happen next. "I think there is something fundamentally scary about our democracy," said Charlie. "Because I think people have a sense that the system is rigged, and it's hard to argue that it isn't." He and Jamie spent a surprising amount of their time and energy thinking up ways to attack what they viewed as a deeply corrupt financial system. They cooked up a plan to seek revenge upon the rating agencies, for instance. They'd form a not-for-profit legal entity whose sole purpose was to sue Moody's and S&P, and donate the proceeds to investors who lost money investing in triple-A-rated securities.

  As Jamie put it, "Our plan was to go around to investors and say, 'You guys don't know how badly you got fucked. You guys should really sue.'" They'd had so many bad experiences with big Wall Street firms, and the people who depended on them for their living, that they feared sharing the idea with New York lawyers. They drove up to Portland, Maine, and found a law firm who would listen to them. "They were just like, 'You guys are nuts,'" said Charlie. Suing the rating agencies for the inaccuracy of their ratings, the Maine lawyers told them, would be like suing Motor Trend magazine for plugging a car that wound up crashing.

  Charlie knew a prominent historian of financial crises, a former professor of his, and took to calling him. "These calls often came late at night," says the historian, who preferred to remain anonymous. "And they would go on for a pretty long time. I remember he started out by asking, 'Do you know what a mezzanine CDO is?' And he started to explain to me how it all worked": how Wall Street investment banks somehow had conned the rating agencies into blessing piles of crappy loans; how this had enabled the lending of trillions of dollars to ordinary Americans; how the ordinary Americans had happily complied and told the lies they needed to tell to obtain the loans; how the machinery that turned the loans into supposedly riskless securities was so complicated that investors had ceased to evaluate risks; how the problem had grown so big that the end was bound to be cataclysmic and have big social and political consequences. "He wanted to talk through his reasoning," said the historian, "and see if I thought he was nuts. He asked if the Fed would ever buy mortgages, and I said I thought that was pretty unlikely. It would have to be a calamity of colossal proportions for the Fed to ever consider doing something like that." What struck the distinguished financial historian, apart from the alarming facts of the case, was that...he was hearing them for the first time from Charlie Ledley. "Would I have ever predicted that Charlie Ledley would have anticipated the greatest financial crisis since the Depression?" he said. "No." It wasn't that Charlie was stupid; far from it. It was that Charlie wasn't a money person. "He's not materialistic in any obvious way," said the professor. "He's not driven by money in any obvious way. He would get angry. He took it personally."

  Even so, on the morning of September 18, 2008, Charlie Ledley was still capable of being surprised. He and Jamie did not normally sit in front of their Bloomberg screens and watch the news scroll by, but by Wednesday, the seventeenth, that's what they were doing. The losses announced by the big Wall Street firms on subprime mortgage bonds had started huge and kept growing. Merrill Lynch, which had begun by saying they had $7 billion in losses, now admitted the number was over $50 billion. Citigroup appeared to have about $60 billion. Morgan Stanley had its own $9-plus billion hit, and who knew what behind it. "We'd been wrong in our interpretation of what was going on," said Charlie. "We had always assumed that they sold the triple-A CDOs to, like, the Korean Farmers Corporation. The way they were all blowing up implied they hadn't. They'd kept it themselves."

  The big Wall Street firms, seemingly so shrewd and self-interested, had somehow become the dumb money. The people who ran them did not understand their own businesses, and their regulators obviously knew even less. Charlie and Jamie had always sort of assumed that there was some grown-up in charge of the financial system whom they had never met; now, they saw there was not. "We were never inside the belly of the beast," said Charlie. "We saw the bodies being carried out. But we were never inside." A Bloomberg News headline that caught Jamie's eye, and stuck in his mind: "Senate Majority Leader on Crisis: No One Knows What to Do."

  Early on, long before others came around to his view of the world, Michael Burry had noted how morbid it felt to turn his investment portfolio into what amounted to a bet on the collapse of the financial system. It wasn't until after he'd made a fortune from that collapse that he began to wonder about the social dimensions of his financial strategy--and wonder if other people's view of him might one day be as distorted as their view of the financial system had been. On June 19, 2008, three months after the death of Bear Stearns, Ralph Cioffi and Matthew Tannin, the two men who had run Bear Stearns's bankrupt subprime hedge funds, were arrested by the FBI, and led away in handcuffs from their own homes.* Late that night, Burry dashed off an e-mail to his in-house lawyer, Steve Druskin. "Confidentially, this case is a pretty big stress for me. I'm worried that I'm volatile enough to send out e-mails that can be taken out of context in ways that could get me in trouble, even if my actions and my ultimate outcomes are entirely correct.... I can't imagine how I'd ever tolerate ending up in prison having done nothing wrong but be a bit careless with having no filter between my random thoughts during tough times and what I put in an e-mail. In fact I'm so over worried about this that tonight I started to think I should shut the funds down."

  He was now looking for reasons to abandon money management. His investors were helping him to find them: He had made them a great deal of money, but they did not appear to feel compensated for the ride he had taken them on over the past three years. By June 30, 2008, any investor who had stuck with Scion Capital from its beginning, on November 1, 2000, had a gain, after fees and expenses, of 489.34 percent. (The gross gain of the fund had been 726 percent.) Over the same period, the S&P 500 returned just a bit more than 2 percent. In 2007 alone Burry had made his investors $750 million--and yet now he had only $600 million under management. His investors' requests for their money back came in hard and fast. No new investors called--not a single one. Nobody called him to solicit his views of the world, or his predictions for the future, either. So far as he could see, no one even seemed to want to know how he had done what he had done. "We have not been terribly popular," he wrote.

  It outraged him that the people who got credit for higher understanding were those who spent the most time currying favor with the media. No business could be more objective than money management, and yet even in this business, facts and logic were overwhelmed by the nebulous social dimension of things. "I must say that I have been astonished by how many people now say they saw the subprime meltdown, the commodities boom, and the fading economy coming," Burry wrote, in April 2008, to his remaining investors. "And if they don't always say it in so many words, they do it by appearing on TV or extending interviews to journalists, stridently projecting their own confidence in what will happen next. And surely, these people would never have the nerve to tell you what's happening next, if they were so horribly wrong on what happened last, right? Yet I simply don't recall too many people agreeing with me back then." It was almost as if it counted against him to have been exactly right--his presence made a lot of people uncomfortable. A trade magazine publi
shed the top seventy-five hedge funds of 2007, and Scion was nowhere on it--even though its returns put it at or near the very top. "It was as if they took one swimmer in the Olympics and made him swim in a separate pool," Burry said. "His time won the gold. But he got no medal. I honestly think that's what killed it for me. I was looking for some recognition. There was none. I trained for the Olympics, and then they told me to go and swim in the retard pool." A few of his remaining investors asked why he hadn't been more aggressive on the public relations--as if that were a part of the business!

  In early October 2008, after the U.S. government had stepped in to say it would, in effect, absorb all the losses in the financial system and prevent any big Wall Street firm from failing, Burry had started to buy stocks with enthusiasm, for the first time in years. The stimulus would lead inevitably to inflation, he thought, but also to a boom in stock prices. He might be early, of course, and stocks might fall some before they rose, but that didn't matter to him: The value was now there, and the bet would work out in the long run. Immediately, his biggest remaining investor, who had $150 million in the fund, questioned his judgment and threatened to pull his money out.

  On October 27, Burry wrote to one of his two e-mail friends: "I'm selling off the positions tonight. I think I hit a breaking point. I haven't eaten today, I'm not sleeping, I'm not talking with my kids, not talking with my wife, I'm broken. Asperger's has given me some great gifts, but life's been too hard for too long because of it as well." On a Friday afternoon in early November, he felt chest pains and went to an emergency room. His blood pressure had spiked. "I felt like I am heading towards a short life," he wrote. A week later, on November 12, he sent his final letter to investors. "I have been pushed repeatedly to the brink by my own actions, the Fund's investors, business partners, and even former employees," he wrote. "I have always been able to pull back and carry on my often overly intense affair with this business. Now, however, I am facing personal matters that have carried me irrefutably over the threshold, and I have come to the sullen realization that I must close down the Fund." With that, he vanished, leaving a lot of people wondering what had happened.