The Big Short: Chapter 9 Summary & Analysis

Howie Hubler is an ex–college football player who, in 2004, runs Morgan Stanley’s asset-backed bonds trading, effectively putting him in charge of subprime mortgage bets. During this period, quants at Morgan Stanley invent the credit default swap specifically to protect Hubler from risk—but Hubler and his traders steal the idea as their own.

Hubler’s credit default swap is so tilted in Morgan Stanley’s favor that they essentially predict that it would pay off no matter what—it’s like buying flood insurance that pays out the entire value of the house, even if the house only got dusted with rain. They need to find really clueless traders to take such a bad deal, and by early 2005, Hubler has found enough of them to have $2 billion in credit default swaps. By spring of 2005, Hubler wants more credit default swaps, but it’s getting harder because more traders like Mike Burry and Greg Lippmann are buying them.

Hubler becomes a powerful force at Morgan Stanley, making up about 20 percent of the firm’s profits by April 2006. He expects that his $2 billion in credit default swaps will soon yield $2 billion in profits. Because of pressure to make a profit, however, he sells off some of his credit default swaps on triple-A-rated subprime CDOs (which are supposedly less risky than lower ratings). Basically, Hubler is betting that some triple-B-rated bonds will go bad but not all of them. As Lewis puts it: “He was smart enough to be cynical about his market but not smart enough to realize how cynical he needed to be.”

Hubler is taking a huge risk, perhaps without realizing it, by essentially betting on the same CDO tranches that Cornwall Capital are betting against and the same bonds that FrontPoint Partners and Scion Capital are betting against. Hubler trusts the bond ratings and considers the bets he’s making to be risk-free.

From early February to June 2007, the subprime mortgage market is being propped up by a few Wall Street firms, but starting in June, they all begin to quietly change their minds.

In April 2007, Hubler second-guesses his large gamble but ultimately decides to keep some of his subprime position rather than take a loss of tens of millions of dollars. The decision ends up costing Morgan Stanley almost $6 billion.

By May 2007, Hubler is in conflict with Morgan Stanley management, but not over credit default swaps. He threatens to quit but is offered more money, which he takes.

It takes another month before Morgan Stanley starts asking what would happen if large numbers of lower-middle-class Americans began defaulting on their debt. They are frightened by the possible answers, but they continue to believe that such a thing would never happen.

In early July 2007, Morgan Stanley gets a call from Greg Lippmann at Deutsche Bank: Hubler and his team owe them $1.2 billion, since the credit default swaps have moved in Lippmann’s favor. Morgan Stanley and Deutsche Bank dispute the value of the credit default swaps. Ultimately, Morgan Stanley wires over $600 million to Deutsche Bank.

As time passes, Hubler and his team keep refusing to make deals and ultimately lose money for Morgan Stanley. He doesn’t understand that the triple-B bonds in a CDO are 100 percent correlated, meaning if one goes bad, they’re all bad. Hubler loses billions for Morgan Stanley—the single worst trade in the history of Wall Street—and he also loses his job. Other major banks lose even more money.

In December 2007, Morgan Stanley holds a call with investors to explain the year’s extreme losses. The CEO of the company is asked to explain the loss and gives a jargon-filled response that leads Lewis to conclude “the CEO himself didn’t really understand the situation.”

By August 1, 2007, the last buyer of subprime mortgage bonds finally stops purchasing more. Shareholders bring a lawsuit against Bear Stearns, which frightens Cornwall Capital, since many of their credit default swaps are through Bear Stearns. They also stand to lose money if the U.S. government steps in to guarantee all subprime mortgages.

Ben, currently living in England, is put in charge of reducing Cornwall’s exposure if Bear Stearns were to go down. On Friday, August 3, he calls several places and only gets interest from one bank, UBS. But by Monday, August 6, people at Citigroup, Merrill Lynch, and Lehman Brothers are also clamoring for a deal. By Thursday, Ben has completed a deal with UBS, turning their initial million-dollar bet into over $80 million.

Later, on August 31, 2007, Mike Burry takes his own credit default swaps out of the side pocket and begins to unload them. By the end of the year, his portfolio of less than $550 million will have earned profits of more than $720 million. He shoots off an email to Greenblatt’s firm that simply says, “You’re welcome.” Burry buys them out of his company.

Burry reflects on the role Asperger’s has played in his life. Like many with Asperger’s, Burry uses his intense interests as a way to escape from the real world. His therapist helps him identify the role that “ego-reinforcement” plays in his mental health—and the stress that his interest in the financial markets is causing for him. Eventually, he loses interest in the markets altogether and picks up guitar, even though he didn’t previously have any particular talent for it or interest in it.

Six months after Burry gives up finance, the International Monetary Fund estimates that U.S. subprime-related assets have lost a trillion dollars. Every major Wall Street firm is negatively affected in some way.