Awesome read if you have time…
The man who sold the world
Meet the Texan investor who made a fortune in the sub-prime chaos. Now he’s gambling big money on the collapse of entire countries
Michael Lewis Published: 2 October 2011
While I was at work on a book about the 2008 financial disaster I became interested in a tiny handful of investors who had made their fortunes from the collapse of the sub-prime mortgage market.
A lot of people had thought that the debt-fuelled US housing boom was unsustainable — but only 15 or so had gone all in and placed enormous bets that vast tracts of American finance would go up in flames. Most of these people ran hedge funds in London or New York. Most, usually, avoided journalists. But on this topic, at that moment, they were surprisingly open. All had experienced the strange and isolating sensation of being the sane man in an insane world.
Among them was Kyle Bass, the manager of a hedge fund called Hayman Capital in Dallas. He was a Texan in his late 30s who had spent the first years of his career selling bonds for Wall Street firms. In late 2006 he had taken half of the $10m he had saved on Wall Street, raised a further $500m, created his hedge fund and made a massive wager against the sub-prime mortgage bond market.
By the time I went to see him, the sub-prime mortgage bond market had collapsed. He was now rich and, in investment circles, a little famous. But his mind had moved on: having taken his profits, he had a new all-consuming interest, governments.
In his opinion, the financial crisis wasn’t over. It was simply being smothered by the full faith and credit of rich western governments, which had taken onto their own books the risks associated with dodgy securities worth trillions.
Bass and his colleagues were no longer talking about the collapse of a few bonds but about the collapse of entire countries. They had a shiny new investment thesis. From 2002 there had been something like a false boom in much of the rich, developed world. What appeared to be economic growth was activity fuelled by people borrowing money they probably couldn’t afford to repay. At a rough count, worldwide debts, public and private, had more than doubled since 2002, from $84 trillion to $195 trillion.
“We’ve never had this kind of accumulation of debt in world history,” Bass said.
Critically, the big banks that had extended much of this credit were no longer treated as private enterprises but as extensions of their governments, sure to be bailed out in a crisis. So the public debt of rich countries, already at dangerously high levels and growing rapidly, now included not just the official public debt but also the debts inside each country’s banking system.
“The first thing we tried to figure out”, Bass said, “was how big these banking systems were, especially in relation to government revenues. We took about four months to gather the data. No one had it.”
The numbers added up to astonishing totals: Ireland had debts of more than 25 times its annual tax revenues, Spain and France of more than 10 times their annual revenues. Historically, such levels of government indebtedness had led to government default.
The only way things could work out for these countries, Bass said, was if they started running real budget surpluses. “Yeah, and that will happen right after monkeys fly out of your ass.”
Still, he wondered if he was missing something. “I went looking for someone, anyone, who knew something about the history of sovereign defaults.” He found the leading expert on the subject, a professor at Harvard named Kenneth Rogoff.
“We walked Rogoff through the numbers,” Bass said, “and he just looked at them, then sat back and said, ‘I can hardly believe it is this bad.’ I said, ‘Wait a minute. You’re the world’s foremost expert on sovereign balance sheets. You are the go-to guy for sovereign trouble. You taught at Princeton with Ben Bernanke [chairman of the Federal Reserve]. You introduced Larry Summers [former US Treasury secretary] to his second wife. If you don’t know this, who does?’ I thought, holy shit, who is paying attention?”
Thus his new investment thesis: the sub-prime mortgage crisis was more symptom than cause. The deeper social and economic problems that gave rise to it remained. There was another, bigger financial crisis waiting to happen.
When we met, Bass had just bought his first credit default swaps on the countries he and his team of analysts viewed as the most likely to be unable to pay off their debts: Greece, Ireland, Italy, Switzerland, Portugal and Spain.
A credit default swap enables investors to bet against the price of a bond — to “short” it. It is an insurance policy with a twist: the buyer doesn’t need to own the insured asset. No insurance company can legally sell you fire protection on another person’s house, but the financial markets can sell you default insurance on another person’s investments.
The prices Bass paid for default insurance now look absurdly cheap. Greek government default insurance cost him 11 basis points, for instance. That is, to insure $1m of Greek government bonds against default, Hayman Capital paid a premium of $1,100 dollars a year. He guessed that when Greece defaulted, as it inevitably would, it would be forced to pay down its debt by roughly 70% — which is to say that every $1,100 bet would return $700,000.
He couldn’t see how any sane person could do anything but prepare for another, bigger financial catastrophe. “It may not be the end of the world,” he said. “But a lot of people are going to lose a lot of money. Our goal is not to be one of them.”
He was totally persuasive. He was also totally incredible. A guy sitting in an office in Dallas, Texas, making sweeping claims about the future of countries he’d hardly set foot in: how on earth could he know how a bunch of people he’d never met might behave?
As he laid out his ideas, I had an experience I’ve often had while listening to people who seem perfectly certain about uncertain events. One part of me was swept away by his argument and began to worry the world was about to collapse; the other part suspected he might be nuts.
“That’s great,” I said, already thinking about the flight I needed to catch. “But even if you’re right, what can any normal person do about it?”
He stared at me as if he’d just seen an interesting sight: the world’s stupidest man.
“What do you tell your mother when she asks you where to put her money?” I asked.
“Guns and gold,” he said simply. So he was nuts.
“But not gold futures,” he said. “You need physical gold.”
He explained that when the next crisis struck, the gold futures market was likely to seize up, as there were more outstanding futures contracts than available gold. People who thought they owned gold would find they owned pieces of paper instead. He opened his desk drawer, hauled out a giant gold brick and dropped it on the desk. “We’ve bought a lot of this stuff.”
At this point I was giggling nervously and glancing at the door. I made my excuses and took my leave of Dallas, and more or less dismissed him. When I wrote the book, I left him on the cutting-room floor.
Then the financial world began to change again — and very much as Bass had imagined it might. Entire countries started to go bust. I began to travel to these places, just to see what was up.
The tsunami of cheap credit that rolled across the planet between 2002 and 2007 wasn’t just money; it was temptation. It offered entire societies the chance to reveal aspects of their characters they could not normally afford to indulge. Entire countries were told: “The lights are out, you can do whatever you want to do and no one will ever know.”
What they wanted to do with money in the dark varied. Americans wanted to own homes far larger than they could afford, and to allow the strong to exploit the weak. Icelanders wanted to stop fishing and become investment bankers. The Germans wanted to be even more German; the Irish wanted to stop being Irish. No response was as peculiar as the Greeks’, however.
For most of the 1980s and 1990s, Greek interest rates ran a full 10% higher than German ones, as Greeks were regarded as far less likely to repay a loan. There was no consumer credit in Greece: Greeks didn’t have credit cards. They didn’t usually have mortgage loans, either.
Of course, they wanted to be treated by the financial markets like a properly functioning northern European country. In the late 1990s they saw their chance: get rid of their currency and adopt the euro. To do that, they needed to prove they were capable of good European citizenship — that they would not, in the end, run up debts that other countries in the euro area would be forced to repay.
In particular they needed to show budget deficits under 3% of their gross domestic product (GDP) and inflation running at roughly German levels. To hit the targets, the government moved all sorts of expenses (pensions, defence) off the books, froze prices for electricity, water and other state utilities and cut excise taxes on petrol, alcohol and tobacco.
In 2001 Greece entered the European Monetary Union, swapped the drachma for the euro and acquired for its debt an implicit European (read: German) guarantee. Greeks could now borrow funds long term at roughly the same rate as Germans. To remain in the eurozone, they were meant, in theory, to maintain budget deficits below 3% of GDP; in practice, all they had to do was cook the books to show that they were hitting the targets.
Here entered Goldman Sachs, which engaged in a series of apparently legal but nonetheless repellent deals designed to hide the Greek government’s true level of indebtedness. For these trades Goldman Sachs — which, in effect, handed Greece a $1 billion loan — carved out a reported $300m in fees.
The machine that enabled Greece to borrow and spend at will was analogous to the machine created to launder the credit of the American sub-prime borrower — and the role of the American investment banker in the machine was the same. The investment bankers also taught Greek officials how to securitise future receipts from the national lottery, highway tolls, airport landing fees and even funds from the EU. Any future stream of income that could be identified was sold for cash and spent.
Go to part 2
The man who sold the world
Meet the Texan investor who made a fortune in the sub-prime chaos. Now he’s gambling big money on the collapse of entire countries
Michael Lewis Published: 2 October 2011
While I was at work on a book about the 2008 financial disaster I became interested in a tiny handful of investors who had made their fortunes from the collapse of the sub-prime mortgage market.
A lot of people had thought that the debt-fuelled US housing boom was unsustainable — but only 15 or so had gone all in and placed enormous bets that vast tracts of American finance would go up in flames. Most of these people ran hedge funds in London or New York. Most, usually, avoided journalists. But on this topic, at that moment, they were surprisingly open. All had experienced the strange and isolating sensation of being the sane man in an insane world.
Among them was Kyle Bass, the manager of a hedge fund called Hayman Capital in Dallas. He was a Texan in his late 30s who had spent the first years of his career selling bonds for Wall Street firms. In late 2006 he had taken half of the $10m he had saved on Wall Street, raised a further $500m, created his hedge fund and made a massive wager against the sub-prime mortgage bond market.
By the time I went to see him, the sub-prime mortgage bond market had collapsed. He was now rich and, in investment circles, a little famous. But his mind had moved on: having taken his profits, he had a new all-consuming interest, governments.
In his opinion, the financial crisis wasn’t over. It was simply being smothered by the full faith and credit of rich western governments, which had taken onto their own books the risks associated with dodgy securities worth trillions.
Bass and his colleagues were no longer talking about the collapse of a few bonds but about the collapse of entire countries. They had a shiny new investment thesis. From 2002 there had been something like a false boom in much of the rich, developed world. What appeared to be economic growth was activity fuelled by people borrowing money they probably couldn’t afford to repay. At a rough count, worldwide debts, public and private, had more than doubled since 2002, from $84 trillion to $195 trillion.
“We’ve never had this kind of accumulation of debt in world history,” Bass said.
Critically, the big banks that had extended much of this credit were no longer treated as private enterprises but as extensions of their governments, sure to be bailed out in a crisis. So the public debt of rich countries, already at dangerously high levels and growing rapidly, now included not just the official public debt but also the debts inside each country’s banking system.
“The first thing we tried to figure out”, Bass said, “was how big these banking systems were, especially in relation to government revenues. We took about four months to gather the data. No one had it.”
The numbers added up to astonishing totals: Ireland had debts of more than 25 times its annual tax revenues, Spain and France of more than 10 times their annual revenues. Historically, such levels of government indebtedness had led to government default.
The only way things could work out for these countries, Bass said, was if they started running real budget surpluses. “Yeah, and that will happen right after monkeys fly out of your ass.”
Still, he wondered if he was missing something. “I went looking for someone, anyone, who knew something about the history of sovereign defaults.” He found the leading expert on the subject, a professor at Harvard named Kenneth Rogoff.
“We walked Rogoff through the numbers,” Bass said, “and he just looked at them, then sat back and said, ‘I can hardly believe it is this bad.’ I said, ‘Wait a minute. You’re the world’s foremost expert on sovereign balance sheets. You are the go-to guy for sovereign trouble. You taught at Princeton with Ben Bernanke [chairman of the Federal Reserve]. You introduced Larry Summers [former US Treasury secretary] to his second wife. If you don’t know this, who does?’ I thought, holy shit, who is paying attention?”
Thus his new investment thesis: the sub-prime mortgage crisis was more symptom than cause. The deeper social and economic problems that gave rise to it remained. There was another, bigger financial crisis waiting to happen.
When we met, Bass had just bought his first credit default swaps on the countries he and his team of analysts viewed as the most likely to be unable to pay off their debts: Greece, Ireland, Italy, Switzerland, Portugal and Spain.
A credit default swap enables investors to bet against the price of a bond — to “short” it. It is an insurance policy with a twist: the buyer doesn’t need to own the insured asset. No insurance company can legally sell you fire protection on another person’s house, but the financial markets can sell you default insurance on another person’s investments.
The prices Bass paid for default insurance now look absurdly cheap. Greek government default insurance cost him 11 basis points, for instance. That is, to insure $1m of Greek government bonds against default, Hayman Capital paid a premium of $1,100 dollars a year. He guessed that when Greece defaulted, as it inevitably would, it would be forced to pay down its debt by roughly 70% — which is to say that every $1,100 bet would return $700,000.
He couldn’t see how any sane person could do anything but prepare for another, bigger financial catastrophe. “It may not be the end of the world,” he said. “But a lot of people are going to lose a lot of money. Our goal is not to be one of them.”
He was totally persuasive. He was also totally incredible. A guy sitting in an office in Dallas, Texas, making sweeping claims about the future of countries he’d hardly set foot in: how on earth could he know how a bunch of people he’d never met might behave?
As he laid out his ideas, I had an experience I’ve often had while listening to people who seem perfectly certain about uncertain events. One part of me was swept away by his argument and began to worry the world was about to collapse; the other part suspected he might be nuts.
“That’s great,” I said, already thinking about the flight I needed to catch. “But even if you’re right, what can any normal person do about it?”
He stared at me as if he’d just seen an interesting sight: the world’s stupidest man.
“What do you tell your mother when she asks you where to put her money?” I asked.
“Guns and gold,” he said simply. So he was nuts.
“But not gold futures,” he said. “You need physical gold.”
He explained that when the next crisis struck, the gold futures market was likely to seize up, as there were more outstanding futures contracts than available gold. People who thought they owned gold would find they owned pieces of paper instead. He opened his desk drawer, hauled out a giant gold brick and dropped it on the desk. “We’ve bought a lot of this stuff.”
At this point I was giggling nervously and glancing at the door. I made my excuses and took my leave of Dallas, and more or less dismissed him. When I wrote the book, I left him on the cutting-room floor.
Then the financial world began to change again — and very much as Bass had imagined it might. Entire countries started to go bust. I began to travel to these places, just to see what was up.
The tsunami of cheap credit that rolled across the planet between 2002 and 2007 wasn’t just money; it was temptation. It offered entire societies the chance to reveal aspects of their characters they could not normally afford to indulge. Entire countries were told: “The lights are out, you can do whatever you want to do and no one will ever know.”
What they wanted to do with money in the dark varied. Americans wanted to own homes far larger than they could afford, and to allow the strong to exploit the weak. Icelanders wanted to stop fishing and become investment bankers. The Germans wanted to be even more German; the Irish wanted to stop being Irish. No response was as peculiar as the Greeks’, however.
For most of the 1980s and 1990s, Greek interest rates ran a full 10% higher than German ones, as Greeks were regarded as far less likely to repay a loan. There was no consumer credit in Greece: Greeks didn’t have credit cards. They didn’t usually have mortgage loans, either.
Of course, they wanted to be treated by the financial markets like a properly functioning northern European country. In the late 1990s they saw their chance: get rid of their currency and adopt the euro. To do that, they needed to prove they were capable of good European citizenship — that they would not, in the end, run up debts that other countries in the euro area would be forced to repay.
In particular they needed to show budget deficits under 3% of their gross domestic product (GDP) and inflation running at roughly German levels. To hit the targets, the government moved all sorts of expenses (pensions, defence) off the books, froze prices for electricity, water and other state utilities and cut excise taxes on petrol, alcohol and tobacco.
In 2001 Greece entered the European Monetary Union, swapped the drachma for the euro and acquired for its debt an implicit European (read: German) guarantee. Greeks could now borrow funds long term at roughly the same rate as Germans. To remain in the eurozone, they were meant, in theory, to maintain budget deficits below 3% of GDP; in practice, all they had to do was cook the books to show that they were hitting the targets.
Here entered Goldman Sachs, which engaged in a series of apparently legal but nonetheless repellent deals designed to hide the Greek government’s true level of indebtedness. For these trades Goldman Sachs — which, in effect, handed Greece a $1 billion loan — carved out a reported $300m in fees.
The machine that enabled Greece to borrow and spend at will was analogous to the machine created to launder the credit of the American sub-prime borrower — and the role of the American investment banker in the machine was the same. The investment bankers also taught Greek officials how to securitise future receipts from the national lottery, highway tolls, airport landing fees and even funds from the EU. Any future stream of income that could be identified was sold for cash and spent.
Go to part 2
