The Big Short: Chapter Summary (Chapter 6)
Eisman in Las Vegas--Lewis’s retelling of the more personal side of events can be amusing, and Chapter 6 is no exception. It opens with a description of Eisman’s faux pas on the course of the Bali Hai Golf Club in Las Vegas, where he showed up in a T-shirt and shorts—much to the dismay of his fellow FrontPointers. Danny Moses even went out of his way to persuade him to buy a collared shirt to cover up his T-shirt, but it didn’t much improve his look.
Eisman’s blunders—not that he perceived them that way—didn’t stop there. He was completely indifferent to the rules of the game as he fished a stray ball from the sand trap or some other place that was not to his liking. His general air, as Lewis describes it, was that he didn’t care, or at least that he didn’t take the game too seriously. Apparently, the other golfers decided to tolerate his idiosyncrasies.
After golf came dinner, which was masterfully orchestrated by Greg Lippmann, who deliberately seated the primary representatives of the short side of the subprime bet next to their counterparts on the long side. The idea was to help the short sellers see how clueless the other side was so that they would stop worrying and make more bets. Accordingly, he seated Eisman next to a man named Wing Chau, the CDO manager for Harding Advisory, who happened to be the primary long buyer of subprime CDOs.
Knowing how blunt Eisman could be, Daniel and Moses watched with trepidation as they waited for things to blow up. What actually happened was not what they expected. Eisman had a habit of tuning out unless he was genuinely interested in what you were saying, in which case he would suddenly snap to attention and focus with all his energy as he blurted out, “Say that again.” Apparently, whatever Wing Chau was saying was extremely interesting to Eisman, because he kept repeating “Say that again” over and over.
Sitting next to Wing Chau was indeed a revelation for Eisman, who finally began to understand how perilous the subprime mortgage bond situation actually was. “The engine of doom” was how he phrased it. He had finally recognized that 80 percent of the bonds contained in the CDOs being generated had been completely misrated: the worst triple-B bonds were being misrepresented as triple-A bonds and then sold to unsuspecting investors who were prohibited from buying anything less than triple-A quality. Wing Chau, who managed $15 billion of these appallingly low-quality CDOs, apparently thought nothing of selling them off to places such as foreign insurance companies, banks, or pension funds. And his appetite for them in turn created an increased demand for substandard home loans to unqualified homebuyers.
Role of the CDO manager--Briefly, the job of the CDO manager was to evaluate and maintain the quality of the bonds in each CDO by replacing them as needed, that is, before they were wiped out by defaulting loans. In reality, the less responsible managers (which apparently was most of them) looked the other way as they conveniently collected a fee for acting as intermediaries between Wall Street’s deceptive CDO-packaging practices and their investors’ oblivious and trusting ignorance. Those fees, which looked small in terms of percentages, quickly added up when multiplied by billions of dollars.
Eisman’s reaction--Eisman was shocked by the carelessness of the whole operation. Merrill Lynch, the market’s primary supplier of CDOs, was indifferent to the fact that investors were being deceived and cheated; and Harding Advisory, which had become the primary purchaser of the garbage that was being churned out, didn’t seem to care, either. But what completely floored Eisman was Wing Chau’s enthusiasm for Eisman’s bets. Again, the light bulb went on: Wall Street needed the short-side bets because of the demand they created in the market. The presence of that demand gave them the license to create synthetic CDOs to make up for the insufficient number of low-quality home loans. Wing Chau’s position was that he wanted as many of these low-grade CDOs as possible. The more he sold to investors, the more money he made. The whole scenario made no sense to Eisman, until he realized that it was based on a false triple-A rating—the unwarranted belief that the CDOs were low-risk.
Lippmann’s plan worked. Eisman had seen the light and now wanted to specifically bet against whatever Wing Chau bought. He had understood on a new level how the subprime machine worked, and he now had a precise target.
Meanwhile, Charlie Ledley of Cornwall Capital had decided that it would be a good idea to drop in on the Las Vegas conference, even though (as usual) Cornwall hadn’t been invited and knew virtually no one there. When he contacted the few people he did know, the Bear Stearns subprime representatives, they reciprocated by inviting him to a Sunday shooting match—the antithesis of how Ledley’s parents had raised him. It was a strange feeling for Ledley to be choosing between different gun types and target photographs of various terrorists, some of them famous (or rather, infamous), but he had to admit that he found it thrilling. He finally settled on an Uzi and a large picture of Saddam Hussein.
The next day, Ben showed up (Jamie had decided not to come), and the two of them walked around doing what they usually do—looking for someone who could convince them that their strategy was wrong. They would attend the big discussions and speeches and afterwards corner the main speaker to try to pick his brain. But they couldn’t find anyone with a good argument—only people who wanted to know who they were and what they were doing there. These people’s arguments were based on short-term thinking and a supposedly likely probability. But their concept of probability was delusive, being based on a random pattern and the refusal to believe that anything so disastrous as a subprime market crash could actually happen.
Eisman never fell for the glitzy Las Vegas façade that drew in so many others and fed the illusion that their odds of winning at the gaming tables and slot machines were better than they were in actuality—which in turn encouraged them to throw around their money. In a way, Las Vegas was a metaphor for the subprime convention itself. The subprime mortgage industry had grown exponentially, and its growth, like Las Vegas’s gambling industry, was predicated on mass delusion. What amazed Eisman was the size of the convention: 7000 attendees—more than 10 times the size of a large equity conference.
Eisman’s main mission in being there was to understand the inner workings of the subprime market. Through Lippmann, he had met the relevant Deutsche Bank people, who in turn had hooked him up with the different people involved in creating the bonds and their derivatives—the lenders, the rating agencies, and the mortgage bond and CDO packagers. Even the subprime home loan borrowers were represented by the service people working at the hotel.
Lewis named this chapter “Spider-Man at the Venetian” because of Eisman’s thing for the superhero comic-book character. He had been convinced for a long time that he and Spider-Man had a connection—that their lives were somehow intertwined. He knew it sounded silly, but the many parallels helped him to understand his life and his attitudes. Deutsche Bank wasn’t directly aware of Eisman’s Spider-Man connection, but they knew enough about him to know that he was a maverick and that they needed to keep an eye on him. For this reason, they sent a CDO salesman along to make sure he behaved himself. Eisman and his group were supposed to pretend, for instance, that they were interested in buying bonds, not shorting them.
The problem, of course, was that someone with a superhero complex was not someone who could be controlled. Eisman was Eisman, and he was not about to change just because he was in unusual surroundings. When the Option One CEO was giving his speech, Eisman raised his hand to ask a question, even though there was no question-and-answer period. While Daniel and Moses tried to hide from embarrassment, Eisman asked whether the CEO thought it was a “probability or a possibility” that Option One’s projected subprime losses would be a mere 5 percent. When the CEO answered that it was a probability, Eisman raised his hand again, this time forming a zero, which he then explained as meaning that there was zero probability that their losses would be that low. He then took a staged call from his wife and left the room.
After that, Eisman seemed more concerned with figuring out what was going on than with causing a disturbance. He could not comprehend who these thousands of people were and how they could all be so deluded. He even met privately with the different subsets of people involved in the subprime bond market process—the lenders, the raters, and so on—to see what, if anything, he had missed. That thousands of people could all be so deluded completely mystified him, and he wanted to make sure that he was indeed seeing what he was seeing. The whole subprime mortgage industry had placed its faith in the ratings delivered by Moody’s and S&P’s. The problem was that the agencies’ raters were the bottom of Wall Street’s barrel. In Eisman’s mind, their jobs should have been the most sought-after and highest-paid; instead, it was the other way around. The result was that the most intelligent people would leave for Wall Street’s better paying jobs, where they would take advantage of the mediocre group that was left behind. In Lewis’s words, they learned how to “game” the raters by figuring out the loopholes in the system.
Suffice it to say that the rating agencies were asleep on their feet. To Eisman’s group’s questions about home prices and probable loan losses, their answers were the standard line: home prices would rise, and loan losses would hover around 5 percent. This, of course, was ridiculous, but everyone bought into it out of either blindness, stupidity, or corruption. The only question remaining now for Eisman and his partners was “Which was it?” Danny ascribed the state of the subprime market to general blindness due to self-interest, while Vinny saw it more as a hierarchy, with corruption at the top and stupidity on the lower rungs.
Lippmann had been right in his assessment. After their Las Vegas experience, FrontPoint nearly doubled its portfolio of around $300 million in short-position subprime mortgage bonds to $550 million. Eisman and his partners had now seen the people on the other side, so their targets were clear: Moody’s and Wing Chau. And beyond those two, they knew that there were many thousands of others to choose from in their quest to maximize their portfolio.