For all of Greene’s concerns about his bet on the housing market, he couldn’t help but eye a twenty-seven-acre estate in Beverly Hills that was up for sale. The mansion had been under construction for more than four years and was only 80 percent complete; its previous owner, a Saudi, relinquished it after becoming ensnared in a bitter divorce. The mansion had 60,000 square feet and seven acres of planted vineyard and featured a 2,000-foot-long double-wide driveway, off Coldwater Canyon.
How can I pass it up? Greene thought.
One morning in early February, Greene and his fiancée, Mei Sze Chan, showed up at a receivership hearing in a courtroom in downtown Los Angeles to bid. The odds didn’t seem in their favor. Across the room stood attorneys for Anthony Pritzker, the billionaire scion of the fabulously wealthy Chicago family, and Alan Casden, a self-made real estate billionaire. Both men were listed by Forbes magazine as among the four hundred wealthiest people in the world.
The bidding began at $33 million. Soon it raced higher, in $500,000 increments. Greene swallowed hard and kept up with the billionaires. When Greene offered $35 million, the price proved too rich even for his wealthy rivals and they threw in the towel. Greene was thrilled—smaller properties in Beverly Hills were selling for more than $30 million. But now he would have to spend millions to complete the home and pay property taxes, adding to his financial pressures.
Hoping to finish the mansion and sell it for a profit, Greene began furnishing it in a way that might help draw attention. For the east wing, he chose two huge erotic paintings. Above the bar he hung a dark metal rendering of a dollar bill. He chose a mix of contemporary Vietnamese art and European antiques for other parts of the home. Later, Greene would hire Peruvian woodworkers to create fireplace carvings and ceiling crowns.
He christened the home Palazzo di Amore, Palace of Love. While the name sounded cheesy, Greene was convinced it would be a selling point.
“Every great home should have a great name,” Greene says.
He now owned even more real estate yet was convinced that housing was set to fall.
“If [the trade] doesn’t work, I’m cooked,” he confided to his old friend Jeff Libert. Libert thought the expensive new home might have been a way for Greene to impress Chan. “It was very daring,” Libert says. Greene had put “most of his marbles” in one trade.
Something bothered Greene about his maneuver, though. If he was buying all this subprime mortgage insurance at low prices, who was selling it to him?
“I asked a hundred people, ‘Who’s on the other side of these trades?’ ” Greene recalls. “I was sort of embarrassed to ask. I mean, I already own protection on $1 billion and only now am I asking?”
The answers weren’t very illuminating.
“People kept saying ‘It’s CDOs looking for yield.’ … Even after they explained, I didn’t fully understand it. Don’t they also want their principal back?”
Greene understood the concept of a CDO, but he couldn’t get his arms around the question of why they were selling insurance on what to him were dangerous mortgages at such inexpensive prices. Was he missing something?
“I kept waiting for someone to say, ‘Wait, you missed the real reason they’re doing all these deals.’ ”
Greene’s trade began to work in early 2007, and his daily calls to Zafran turned less intense.
“Finally, the market’s starting to understand how bad the problem is,” he told Zafran, after hearing that his bets against the ABX finally were rising in value.
When Greene read about a new government-run program called Hope Now, dedicated to helping struggling home owners stay in their homes, he panicked. He thought he’d finally found the fatal flaw in his strategy.
If the government program was a success, and more aggressive steps were taken to help borrowers, it might help to stabilize the housing market and limit losses from pools of subprime mortgages. Should I bail out of the protection now, before it’s too late? Greene wondered.
Greene decided to call the toll-free number of Hope Now to check it out for himself. When he got through, however, he was put on hold—for more than forty minutes.
This can’t be a good sign for home owners, Greene thought.
When a representative of the program finally picked up, Greene pretended he was a troubled home owner.
“Hi, I bought a condo in Canoga Park. The problem is the mortgage is $200,000 and the condo next door just sold for $160,000 and I’m really struggling to make my payments. What do you recommend?”
“There’s really no point in making any more payments,” the friendly voice on the other line said. “You won’t get anything out of them … save your money and then just buy another place.”
The answer floored Greene.
The government is actually telling people not to make their mortgage payments?!
If that’s what the government was advocating, it was going to get real ugly for the housing market, Greene figured.
The ABX rebounded in the spring, and his positions dropped in price, giving Greene another bout of nerves. He quickly sold some of his protection and had his broker put him on a call with three senior mortgage analysts at J.P. Morgan to get their sense of the market. The analysts claimed housing prices wouldn’t drop more than 24 percent, from peak to trough. Greene couldn’t believe what they were saying—his own buildings seemed already down by that much. Did the guys in New York know what they were talking about? Where are they getting their numbers??
Other analysts Greene spoke with predicted that even a rush of defaults wouldn’t lead to deep losses for investors in mortgage bonds, because the homes could be sold at full prices when the owners moved out. That, too, sounded unrealistic to Greene. Tenants with poor credit living in his buildings often trashed their apartments when they missed their rental payments and were evicted, taking every appliance they could manage to carry out the door.
“They usually feel ripped off,” Greene told a friend. “Why would subprime borrowers be any different?”
There’s going to be little for bondholders to recapture after this mess, Greene figured, making his mortgage insurance valuable.
But as the ABX kept rising in the spring, Greene’s positions continued to drop further in value. He once again turned abrasive and short-tempered with Zafran. Greene became especially upset when he was told that his CDS insurance on the ABX index tracking risky mortgages still showed some gains, but similar protection on various pools of subprime mortgage bonds was relatively worthless. Greene had spent months picking out especially toxic pools of loans, mortgages with little equity behind them from states where housing seemed to be running into trouble. And yet his CDS protection on the loans was barely moving.
“This pool has more exposure to Florida and California, has lower FICO scores and more ‘liar loans,’ and yet is priced higher than the ABX,” Greene told Zafran, growing more animated. “Why?!?”
On days the ABX index moved sharply, Greene sometimes couldn’t even get an updated quote on the value of his CDS on various mortgage pools. And when he asked how the underlying loans in the pools were performing, his brokers often couldn’t even tell him. It was like taking the biggest test of one’s life and guessing at the final grade.
He hounded Zafran with more phone calls, several times a day, even on weekends. Together, they analyzed thousands of loans that Greene had wagered against, trying to get a sense for how they were doing. Greene sounded even more agitated, and their conversations were sometimes short and verging on hostile.
“Are you watching the same market I am??” Greene bellowed into the phone.
Greene couldn’t figure out why he wasn’t making money. Zafran couldn’t understand it either, adding to Greene’s frustration. As he asked his firm’s traders to explain why their quotes for Greene were so bad, Zafran felt pushback from his colleagues at Merrill Lynch, who suggested that his allegiance seemed to be more in line with his client than with his employer.
To Greene, th
e answers that Zafran was getting from the traders just didn’t add up. Housing finally was crumbling and yet his trade was a dud! At times, Greene became so angry in his calls to Zafran that his sentences ran into each other, rattled off so fast and furiously that Zafran couldn’t make out what he was saying.
“Prices have to fall—how can you not understand this—call me back—bye!” Then he would hang up. One day he ended the call crying out: “Why?! Why!? WHY??!!”
AS JEFFREY LIBERT WATCHED the housing problems unfold, his own frustrations were growing as well. A handsome, salt-and-pepper-haired fifty-one-year-old real estate developer in Boston, his midsized firm controlled four thousand apartments and 1.5 million square feet of retail space throughout New England and Florida.
Libert seemed a natural candidate to profit from the real estate meltdown. He had three decades of experience in the business, starting with a handful of homes that he and Greene bought while students at Harvard. Libert had anticipated the problems with subprime mortgages and had encouraged Greene to buy CDS protection. It was Libert who had taught John Paulson years earlier that real estate investing wasn’t as profitable as most thought.
Libert’s father, a graduate of West Point who served under Gen. George Patton in the Battle of the Bulge, became wealthy operating a Chevrolet car dealership in Chappaqua, New York, a suburb in upper Westchester County. Libert attended upscale private schools in the area before majoring in economics at Amherst College, where he graduated in the top 3 percent of his class, and was a finalist for a Rhodes scholarship. While Greene was enjoying an extended bachelorhood on the West Coast, Libert met Mardee Brown, a Smith College graduate and the daughter of a lifetime General Electric executive, and married her.
After several years working at Boston Consulting Group, including the period with John Paulson, Libert quit the firm, unhappy with the constant travel, and went into real estate development with his brother. In 2005, Libert, worried about the local real estate market, sold one-third of his firm’s holdings. He wanted to get rid of more of it, but he didn’t want to have to fire his staff. Besides, his kids now worked with him and they’d have nothing to do if he sold the remainder of his properties. So Libert nervously clung to them, even as his concerns grew.
“Every doctor I knew was getting into real estate; at every upscale restaurant we went to they were speaking about real estate investing at every table,” he recalls. “And you could already see higher incidence of defaults from mortgages handed out in 2006.”
But Libert himself did almost nothing to prepare for a meltdown, even as it threatened his firm and the $100 million or so of wealth he had accumulated. After hearing from Greene about shorting the market, Libert called a few brokers to buy CDS contracts of his own. He was rejected by them all—Goldman Sachs, Merrill Lynch, Salomon Smith Barney. They judged Libert too small an investor to be able to buy the investments. Unlike Greene, Libert didn’t push the brokers very hard, figuring it was a lost cause. Paulson agreed to let Libert into his hedge funds that were wagering against subprime mortgages, but Libert was reluctant to tie up his money, or to pay Paulson’s fee of 20 percent of any gains.
“I just said screw it,” Libert recalls. “Greene wasn’t making money at the time and I just lost interest—how many times can I get rejected?”
After New Century’s shocking news in February 2007, Libert called Greene to catch up on Greene’s trade, figuring he had squandered his own chance at huge winnings.
“You must be making a fucking fortune,” Libert said.
“Actually, things have moved, but not that much,” Greene responded.
Greene told Libert to hurry up and figure out a way to buy his own CDS contracts before it was too late.
“You’re such a wimp, Libert!”
At that point, Libert had enough. I can’t stand on the sidelines anymore.
Libert called J.P. Morgan again, trying once more to gain approval to buy CDS contracts. This time he was transferred to John-Paul Tomassetti, the same broker in New York who was working with Greene. Over Easter weekend in 2007, Tomassetti approved Libert to buy the same CDS protection that Greene had purchased. (Tomassetti went by the nickname J.P., just as Paulson did, creating some confusion when Libert called Greene to discuss the trade. “I didn’t know who he’s talking about half the time when he said ‘J.P. said this’ or ‘J.P. said that,’ ” Libert recalls.)
Days later, Zafran, Greene’s other broker, also approved Libert to trade with Merrill Lynch. Libert spent about $500,000 to buy CDS protection on BBB-rated slices of the ABX index, just like Greene.
“It was so simple that I thought we were missing something,” Libert recalls. “I figured I didn’t understand the business.”
Once he owned the investment, Libert discovered an odd impulse: He found himself rooting for a rash of home owners to run into problems paying their mortgages, something that would help his trade pay off. The feelings made Libert increasingly uncomfortable. He knew he had no control over whether or not home owners would make good on their mortgage payments, and yet he felt guilty. How could he root against everyday home owners?
As the investments played mind games with Libert, he tried to distract himself from the trade, vowing to check the ABX index only once a day, at the close of trading. It was as if he was trying to control an addiction.
“Greene was looking at it all day long, but I couldn’t take it,” Libert says. “I tried to avoid” watching the fluctuations.
As the ABX rose in the spring and Libert was dealt instant losses, he found himself pulling even harder for mortgage problems to develop. Then, as the subprime market wobbled and he made some gains, Libert felt intense shame about his feelings—while also wondering if he should have bought more protection. It was all too much.
A closet smoker, Libert began bumming cigarettes from his employees and sharing a smoke with some of them in front of their office building in Newton, outside of Boston.
“Michelle, if I was smart, I’d do more of these trades,” he told one colleague on an especially stressful day. She listened sympathetically as her boss shared more of his angst. No one should own the bonds that he was wagering against, she agreed.
But when Libert’s father came by the office to visit, he had a very different take.
“What do you think you’re doing??” his father said, heatedly. “This is Wall Street you’re talking about; these guys must know something.”
“Dad, would you own these bonds at these prices?”
“No … but the guys on Wall Street know what they’re doing.”
Greene regularly called Libert, tweaking him for not buying more protection, making him feel even worse.
On the twenty-fifth day of each month, Libert called his brokers to check the latest “remittance” reports that provided a snapshot of how the pools of subprime mortgages were performing and the number of home owners that were delinquent on their loans that month.
For all his attempts to become a dispassionate observer of the housing market, Libert couldn’t wait to get the results.
“Is it in yet? Is it in?” he would ask.
“I needed to see if defaults were escalating. I was hoping, praying, that another hundred thousand people would lose their homes.”
Libert asked others for their opinions on his new investments, trying to find some reassurance that he wasn’t doing anything improper. Rev. Steve Smith, a local minister and good friend, was not pleased.
“You’ve got to stop,” Smith told him. “I can’t believe you’re happy about this.”
“I’m not happy. It makes me feel creepy.”
Libert’s wife stepped in, trying to defend him to Smith.
“It’s like being at a craps table. Jeffrey’s just betting on it, he’s not making the loans.”
But Libert was getting excited about the signs of housing problems, the minister retorted.
A few of Libert’s close friends were just as critical. Some called to take him to task,
putting Libert on the defensive.
“I didn’t cause it, I didn’t have anything to do with the problems,” he responded to one, as his wife, his moral compass, nodded.
“The friends made me feel guilty,” Libert recalls. “I couldn’t help myself … I was cheering for people to lose their homes.”
Libert called his broker Zafran, to share his feelings and get some support.
“It just gives me the creeps, Alan. I’m betting on people’s misery.”
“I understand,” Zafran responded, sympathetically.
Libert only rarely brought up his conflicted feelings with Greene, though. Greene couldn’t relate to any of it.
“Libert, why are you being so uptight about it?”
“It just gives me the heebie-jeebies.”
“You didn’t cause it!”
“Yeah, I know. But we’re cheering for it.”
When it came to discussing the moral aspects of the trade, it was as if Libert and Greene spoke different languages.
“I didn’t even think about it,” Greene acknowledges. “If more people had been [shorting mortgages] early on, then the pricing of debt would have been higher and things wouldn’t have become so crazy. The world would have been a better place had more people been shorting. We had nothing to do with what happened to home owners.”
Part of Libert agreed with his friend. But he couldn’t shake his qualms. It all left him a miserable ball of nerves.
MARIO AND LETICIA MONTES were the type of home owners Libert was wagering against and the reason he was so torn about his trade.
In mid-2005, the Monteses found a home they loved, a gray stucco bungalow with a hot tub in the backyard in a middle-class neighborhood of Orange County. It cost $567,000. The only catch was they didn’t have money for a down payment and couldn’t afford the home unless they agreed to a mortgage with a low interest rate for the first two years, but one that would then rise, increasing their monthly payments by more than 50 percent. Their mortgage broker assured the Monteses, who earned combined salaries of $90,000, that they’d easily be able to refinance their mortgage before the rate climbed. Sitting around the kitchen table with their two teenage daughters, they decided to cut back on vacations and restaurant outings, and to take the plunge to become home owners.
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