The Big Short: Inside the Doomsday Machine (13 page)

That Joe Cassano, the boss of AIG FP, was the son of a police officer and had been a political science major at Brooklyn College seems, in retrospect, far less relevant than his need for obedience and total control. He'd spent most of his career, first at Drexel Burnham and then at AIG FP, not as a bond trader but working in the back office. Across AIG FP the view of the boss was remarkably consistent: Cassano was a guy with a crude feel for financial risk but a real talent for bullying people who doubted him. "AIG FP became a dictatorship," says one London trader. "Joe would bully people around. He'd humiliate them and then try to make it up to them by giving them huge amounts of money."

"One day he got me on the phone and was pissed off about a trade that had lost money," says a Connecticut trader. "He said,
When you lose money it's my fucking money. Say it
. I said, 'What?'

"Say, 'Joe, it's your fucking money'!
So I said, 'It's your fucking money, Joe.'"

"The culture changed," says a third trader. "The fear level was so high that when we had these morning meetings, you presented what you did not to upset him. And if you were critical of the organization, all hell would break loose." Says a fourth, "Joe always said, 'This is my company. You work for my company.' He'd see you with a bottle of water. He'd come over and say, 'That's my water.' Lunch was free, but Joe always made you feel he had bought it." And a fifth: "Under Joe, the debate and discussion that was common under Tom [Savage, the previous CEO] ceased. I would say [to Tom] what I'm saying to you. But with Joe as the audience." A sixth: "The way you dealt with Joe was to start everything by saying, 'You're right, Joe.'"

Even by the standards of Wall Street villains whose character flaws wind up being exaggerated to fit the crime, Cassano, in the retelling, became a cartoon monster. "One day he came in and saw that someone had left the weights on the Smith machine, in the gym," says a seventh source, in Connecticut. "He was literally walking around looking for people who looked buff, trying to find the guy who did it. He was screaming, 'Who left the fucking weight on the fucking Smith machine? Who left the fucking weight on the fucking Smith machine?'"

Oddly, Cassano was as likely to direct his anger at profitable traders as at unprofitable ones, for the anger was triggered not by financial loss but by the faintest whiff of insurrection. Even more oddly, his anger had no obvious effect on the recipient's paycheck; a trader might find himself routinely abused by his boss and yet delighted by his year-end bonus, determined by that same boss. One reason none of AIG FP's traders took a swing at Joe Cassano, before walking out the door, was that the money was simply too good. A man who valued loyalty and obedience above all other traits had no tool to command it except money. Money worked as a management tool, but only up to a point. If you were going to be on the other side of a trade from Goldman Sachs, you had better know what, exactly, Goldman Sachs was up to. AIG FP could attract extremely bright people who were perfectly capable of keeping up with their counterparts at Goldman Sachs. They were constrained, however, by a boss with an imperfect understanding of the nuances of his own business, and whose judgment was clouded by his insecurity.

Toward the end of 2005, Cassano promoted Al Frost, then went looking for someone to replace him as the ambassador to Wall Street's bond trading desks. The job, in effect, was to say "yes" every time some Wall Street trader asked him if he'd like to insure--and so, in effect, purchase--a billion-dollar pile of bonds backed by consumer loans. For a number of reasons, Gene Park was a likely candidate, and so he decided to examine these loans that AIG FP was insuring a bit more closely. The magnitude of the misunderstanding shocked him: These supposedly diversified piles of consumer loans now consisted almost entirely of U.S. subprime mortgages. Park conducted a private survey. He asked the people most directly involved in the decision to sell credit default swaps on consumer loans what percentage of those loans were subprime mortgages. He asked Gary Gorton, a Yale professor who had built the model that Cassano used to price the credit default swaps: Gorton guessed that the piles were no more than 10 percent subprime. He asked a risk analyst in London, who guessed 20 percent. "None of them knew it was 95 percent," says one trader. "And I'm sure that Cassano didn't, either." In retrospect, their ignorance seems incredible--but, then, an entire financial system was premised on their not knowing, and paying them for this talent.

By the time Joe Cassano invited Gene Park to London for the meeting in which he would be "promoted" to the job of creating even more of these ticking bombs, Park knew he wanted no part of it. If he was forced to take the job, he said, he'd quit. This, naturally, infuriated Joe Cassano, who accused Park of being lazy, of dreaming up reasons not to do the deals that would require complicated paperwork. Confronted with the new fact--that his company was effectively
long
$50 billion in triple-B subprime mortgage bonds, masquerading as triple-A-rated diversified pools of consumer loans--Cassano at first sought to rationalize it. He clearly thought that any money he received for selling default insurance on highly rated bonds was free money. For the bonds to default, he now said, U.S. house prices had to fall, and Joe Cassano didn't believe house prices could ever fall everywhere in the country at once. After all, Moody's and S&P had both rated this stuff triple-A!

Cassano nevertheless agreed to meet with all the big Wall Street firms and discuss the logic of their deals--to investigate how a bunch of shaky loans could be transformed into triple-A-rated bonds. Together with Gene Park and a few others, he set out on a series of meetings with traders at Deutsche Bank, Goldman Sachs, and the rest, all of whom argued how unlikely it was for housing prices to fall all at once. "They all said the same thing," said one of the traders present. "They'd go back to historical real estate prices over sixty years and say they had never fallen nationally, all at once." (Two months after their meeting with Goldman Sachs, one of the AIG FP traders bumped into the Goldman guy who had made this argument and who now said,
Between you and me, you're right. These things are going to blow up
.) The AIG FP traders present were shocked by how little thought or analysis seemed to underpin the subprime mortgage machine: It was simply a bet that home prices would never fall. Once he understood this, and once he could construe it as his own idea, Joe Cassano changed his mind. By early 2006 he openly agreed with Gene Park: AIG FP shouldn't insure any more of these deals--though they would continue to insure the ones they had already insured.

At the time, this decision didn't really seem like all that big a deal for AIG FP. The division was generating almost $2 billion a year in profits. At the peak, the entire credit default swap business contributed only $180 million of that. Cassano had been upset with Park, and slow to change his mind, it seemed, mainly because Park had dared to contradict him.

The one
Wall Street trader who had tried to persuade AIG FP to stop betting on the subprime mortgage bond market witnessed none of these internal politics. Greg Lippmann simply assumed that the force of his argument had won them over--until it didn't. He never understood why AIG FP changed its mind but left itself so exposed. It sold no more credit default swaps to Wall Street but did nothing to offset the 50 billion dollars' worth that it had already sold.

Even that, Lippmann thought, might cause the market to crash. If AIG FP refused to take the long side of the trade, he thought, no one would, and the subprime mortgage market would shut down. But--and here was the start of a great mystery--the market didn't so much as blink. Wall Street firms found new buyers of triple-A-rated subprime CDOs--new places to stuff the riskiest triple-B tranches of subprime mortgage bonds--though who these people were was not entirely clear for some time, even to Greg Lippmann.

The subprime mortgage machine roared on. The loans that were being made to actual human beings only grew crappier, but, bizarrely, the price of insuring them--the price of buying credit default swaps--fell. By April 2006 Lippmann's superiors at Deutsche Bank were asking him to defend his quixotic gamble. They wanted him to make money just by sitting in the middle of this new market, the way Goldman Sachs did, crossing buyers and sellers. They reached an agreement: Lippmann could keep his expensive short position as long as he could prove that, if he had to sell it, there'd be some other investor willing to take it off his hands on short notice. That is, he needed to foster a more active market in credit default swaps; if he wanted to keep his bet he had to find others to join him in it.

By the summer of 2006 Greg Lippmann had a new metaphor in his head: a tug-of-war. The entire subprime mortgage lending machine--including his own employer, Deutsche Bank--pulled on one end of the rope, while he, Greg Lippmann, hauled back on the other. He needed others to join him. They'd all pull together. His teammates would pay him a fee for being on his side, but they'd get rich, too.

Lippmann soon found that the people he most expected to see the ugly truth of the subprime mortgage market--the people who ran funds that specialized in mortgage bond trading--were the ones least likely to see anything but what they had been seeing for years. Here was a strange but true fact: The closer you were to the market, the harder it was to perceive its folly. Realizing this, Lippmann went looking for stock investors with a lot of exposure to falling home prices, or falling housing stock prices, and showed them his idea as a hedge.
Look, you're making a fortune as this stuff keeps going up. Why not spend a little to cover yourself in a collapse?
Greed hadn't worked, so he tried fear. He obtained a list of all the big stockholders in New Century, the big subprime lender. Prominent on the list was a hedge fund called FrontPoint Partners. He called the relevant Deutsche Bank salesman to set up a meeting. The salesman failed to notice that there was more than one hedge fund inside FrontPoint--it wasn't a single fund but a collection of independently managed hedge funds--and that the fund that was long New Century stock was a small group based on the West Coast.

When Greg Lippmann arrived in Steve Eisman's conference room in midtown Manhattan, Eisman surprised him by saying, "We're not the FrontPoint that is long New Century stock. We're the FrontPoint that is
short
New Century stock." Eisman was already betting against the shares of companies, such as New Century and IndyMac Bank, which originated subprime loans, along with companies that built the houses bought with the loans, such as Toll Brothers. These bets were not entirely satisfying because they weren't bets against the companies but market sentiment about the companies. Also, the bets were expensive to maintain. The companies paid high dividends, and their shares were often costly to borrow: New Century, for instance, paid a 20 percent dividend, and its shares cost 12 percent a year to borrow. For the pleasure of shorting 100 million dollars' worth of New Century's shares, Steve Eisman forked out $32 million a year.

In his search for stock market investors he might terrify with his Doomsday scenario, Lippmann had made a lucky strike: He had stumbled onto a stock market investor who held an even darker view of the subprime mortgage market than he did. Eisman knew more about that market, its characters, and its depravities than anyone Lippmann had ever spoken with. If anyone would make a dramatic bet against subprime, he thought, it was Eisman--and so he was puzzled when Eisman didn't do it. He was even more puzzled when, several months later, Eisman's new head trader, Danny Moses, and his research guy, Vinny Daniels, asked him to come back in to explain it all over again.

The problem with someone who is transparently self-interested is that the extent of his interests is never clear. Danny simply mistrusted Lippmann at first sight. "Fucking Lippmann," he called him, as in, "Fucking Lippmann never looks you in the eye when he talks to you. It bothers the shit out of me." Vinny could not believe that Deutsche Bank would let this guy loose to run around and torpedo their market unless it served the narrow interests of Deutsche Bank. To Danny and Vinny, Greg Lippmann was a walking embodiment of the bond market, which is to say he was put on earth to screw the customer.

Three times in as many months, Danny and Vinny called, and Lippmann returned--and that fact alone heightened their suspicion of him. He wasn't driving up from Wall Street to Midtown to promote world peace. So why was he here? Each time, Lippmann would talk a mile a minute, and Danny and Vinny would stare in wonder. Their meetings acquired the flavor of a postmodern literary puzzle: The story rang true even as the narrator seemed entirely unreliable. At some point during each of these sessions, Vinny would stop him to ask, "Greg, I'm trying to figure out why you are even here." This was a signal to bombard Lippmann with accusatory questions:

If it's such a great idea, why don't you quit Deutsche Bank and start a hedge fund and make a fortune for yourself?

It'd take me six months to set up a hedge fund. The world might wake up to this insanity next week. I have to play the hand I've been dealt
.

If it's such a great idea, why are you giving it away to us?

I'm not giving away anything. The supply is infinite.

Yeah. But why bother even telling us?

I'll charge you getting in and getting out. I need to pay the electric bills.

It's zero-sum. Who's on the other side? Who's the idiot?

Dusseldorf. Stupid Germans. They take rating agencies seriously
.
They believe in the rules.

Why does Deutsche Bank allow you to trash a market that they sit at the center of?

I don't have any particular allegiance to Deutsche Bank...I just work there.