Tuesday, November 9, 2010

Two For One Book Reviews: “The Greatest Trade Ever” and “The Big Short”

In short, I recommend reading both books to people interested in finding out more about the few investors who were able to make money during the housing meltdown in 2006-2008. The two books track several people, the bets they made, the challenges they faced from their investors, competitors, ill-wishers, families, partners and brokers. There is a certain overlap in two of the characters covered between the books (Michael Burry, Greg Lippmann) but otherwise “the tracks” are separate and yet complementary. Both books are generally “mass market,” that is, neither requires heavy finance background to comprehend and appreciate.

“If you’re not inside, you’re outside”- Gordon Gekko

The overriding (and highly inspiring) theme of both books is that several relative outsiders in the world of high finance (neither character had had a high profile bank/sell-side or fund/buy-side career) were able to see the magnitude of the bubble, and, with the substantial help of the “housing” CDS apostle, Greg Lippmann of Deutsche, were able to short it. Here is a run-down of the characters. If you like stories like Susan Boyle or Paul Potts, these books will inspire you. If you have ever been annoyed by the non-stop optimism types, these books are for you: most main characters are painted as rather somber, dark types.

Lippmann: the odd man out of the group as the only member of the “establishment.” A fixed income trader at Deutsche, Lippmann is instrumental to the creation and proliferation of the CDS contracts linked to the performance of mortgage bonds. He ends up accumulating a large position, making his superiors uncomfortable. Lippmann’s endless proselytizing raises the profile of the new instrument. His is the insight that housing prices just need to level off to see the defaults spike. He’s described as a brash, arrogant, flippant character: how much of that is stereotyping of bond traders, how much of that is a literary embellishment, and how much is the truth, we will never know.

Favorite quote: Deutsche is trying to collect $1.2 bn from Morgan Stanley. MS argues that it should be putting up less because the models indicate that the value of the bonds in question is higher. Lippmann: “Dude, f*ck 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 f*cking one point two billion dollars.”

Paulson: Paulson is probably the most connected, plugged and conventionally successful fund manager in the group. After enjoying a bon-vivant lifestyle for years, Paulson had moved up to become an M&A MD at Bear Stearns, eventually opening up a merger arb fund. The fund had been “another ham and cheese shop” until the big hit. There is quite a bit of interesting personal details on him in The Greatest Trade, especially his younger years. Otherwise, there is no deviation from the many media stories that have followed his hit.

Pellegrini: Pellegrini had known Paulson since business school and ended up working as a junior analyst at the fund basically as a last chance job substantially below his age. He had suffered setbacks both in his family life (twice divorced) and career (spent seven years as a VP at Lazard). Pellegrini had been the guy behind the housing analysis and the trades that netted Paulson the record wins. The relationship between the two is described as strenuous, mistrusting, and, ultimately, failing. It does not sound like Paulson ever fully trusted Pellegrini with decision-making. Ultimately, Pellegrini leaves the fund.

Burry: a bit of a fairy-tale story. Burry, as a medical resident, starts writing online about value investing at the height of the internet bubble. He ends up being seeded by Joel Greenblatt who had read his writings. Burry, an anti-social guy with one glass eye, ends up figuring out both the bubble and how to short it all by himself. However, he ends up having really hard time keeping his investors on board once they feel that he had shifted from value stock picking to macro. The stress and indignations he goes through are vividly described. Ultimately, he shuts down the fund. Burry’s problems with the banks are also detailed: from “massaging” the marks to outright lies about the contract values once the ball starts rolling to salespeople not even answering their phones, later blaming system problems at their respective banks on the same day.

Eisman: one of the “original” subprime specialists. Eisman had covered many now-bankrupt aggressive consumer finance companies since the early nineties as an analyst at Oppenheimer. He had been known for his too-honest analysis. Eisman had known the sleaze from before so he had been able to recognize it early on in the government-sanctioned expansion of subprime. Post Oppenheimer, he ends up trying to open his own fund only to find that the doors are all closed. Finally, he assembles a good crew of pessimists and some funding from a couple of places. Eisman was recently in the news with his aggressive questioning of Genworth’s management at the last conference call. It really sounds like the character from the book.

Favorite quotes: from his days as an analyst, “The Lomas Financial Corporation is a perfectly hedged financial institution: it loses money in every conceivable interest rate environment.”

Greene: a rich playboy real estate magnate and an acquaintance of Paulson’s ends up stealing the trade idea, and is the only individual able to pull off the CDS trade in size.

Lahde: Andrew Lahde made a splash with his long “good bye” letter. Younger than most, he had started out as a broker, getting his MBA at UCLA after a year of rejections, then working at a third-tier bank and a fund. He starts running his fund out of his apartment, almost runs out of savings before he gets a lucky break with funding. Lahde’s letter is reproduced in full in the book, as he touches on a wide variety of social problems, such as blind credentialism (a class struggle of a different sort) and inane government actions as well as his future plans.

Ledley, Hockett and Mai/Cornwall Capital. Three laid back guys that stumble into the trade somehow after having made outsized wins on a few options trades. Their story is probably the most underreported in the media pieces covering the housing debacle.

There are several other characters in the books that really help flesh out important pieces of the stories. Joe Cassano of AIG is there. CDO managers are there. Subprime industry leaders are there. Family members with various degrees of supportiveness for the main characters are there.

Full disclosure: no connection of any sort to the publishers or the authors of the books. Not that any of them clamor for my views.

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