TheBigShort

AlsobyMichaelLewis

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Liar'sPoker

TheMoneyCulture

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Next

Moneyball

Coach

TheBlindSide

EDITEDBYMICHAELLEWIS

Panic

TheBigShort

INSIDETHEDOOMSDAYMACHINE

MichaelLewis

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Copyright(c)2010byMichaelLewis

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Themostdifficultsubjectscan be explained to themost slow-witted man ifhehasnotformedanyideaof them already; but thesimplest thing cannot bemade clear to the mostintelligent man if he isfirmly persuaded that heknows already, without ashadow of doubt, what islaidbeforehim.

--LeoTolstoy,1897

Contents

ProloguePoltergeist

Chapter1ASecretOriginStory

Chapter 2 In the Land oftheBlind

Chapter 3 "How Can aGuy Who Can't SpeakEnglishLie?"

Chapter4HowtoHarvest

aMigrantWorker

Chapter 5 AccidentalCapitalists

Chapter 6 Spider-Man atTheVenetian

Chapter 7 The GreatTreasureHunt

Chapter8TheLongQuiet

Chapter 9 A Death ofInterest

Chapter10TwoMeninaBoat

Epilogue Everything IsCorrelated

Acknowledgments

PROLOGUE

Poltergeist

The willingness of a WallStreet investment bank topay me hundreds ofthousands of dollars todispenseinvestmentadvicetogrown-upsremainsamysteryto me to this day. I wastwenty-four years old, withnoexperienceof,orparticularinterest in, guessing whichstocks and bonds would riseand which would fall. WallStreet'sessentialfunctionwasto allocate capital: to decide

who should get it and whoshouldnot.BelievemewhenItellyouthatIhadn'tthefirstclue. I'd never taken anaccounting course, never runa business, never even hadsavings of my own tomanage. I'd stumbled into ajob at Salomon Brothers in1985, and stumbled out,richer, in 1988, and eventhough Iwrote a book aboutthe experience, the wholethingstillstrikesmeastotally

preposterous--which is onereasonthemoneywassoeasytowalk away from. I figuredthe situation wasunsustainable. Sooner ratherthan later, someone wasgoing to identify me, alongwith a lot of peoplemore orless like me, as a fraud.Sooner rather than laterwould come a GreatReckoning,whenWallStreetwouldwakeupandhundreds,if not thousands, of young

people like me, who had nobusiness making huge betswithotherpeople'smoneyorpersuading other people tomake those bets, would beexpelledfromfinance.

When I sat down towrite my account of theexperience--Liar's Poker, itwascalled--itwasinthespiritofayoungmanwho thoughthe was getting out while thegetting was good. I wasmerely scribbling down a

messageandstuffingitintoabottle for those who passedthrough theseparts in the fardistant future. Unless someinsidergotallofthisdownonpaper, I figured, no futurehuman would believe that ithadhappened.

Up to that point, justabout everything writtenabout Wall Street had beenabout the stock market. Thestockmarket had been, fromthe very beginning, where

mostofWallStreetlived.Mybook was mainly about thebond market, because WallStreetwas nowmaking evenbigger money packaging andselling and shuffling aroundAmerica's growing debts.This, too, I assumed wasunsustainable.IthoughtthatIwas writing a period pieceabout the 1980s in America,when a great nation lost itsfinancial mind. I expectedreadersofthefuturewouldbe

appalled that, back in 1986,the CEO of SalomonBrothers, John Gutfreund,was paid $3.1 million as heran the business into theground. I expected them togapeinwonderatthestoryofHowie Rubin, the Salomonmortgage bond trader, whohad moved to Merrill Lynchand promptly lost $250million.Iexpectedthemtobeshocked that, once upon atime on Wall Street, the

CEOs had only the vaguestidea of the complicated riskstheir bond traders wererunning.

And that's pretty muchhow I imagined it; what Inever imagined is that thefuturereadermightlookbackonanyofthis,oronmyownpeculiar experience, and say,"Howquaint."Howinnocent.Not for a moment did Isuspect that the financial1980swould last for twofull

decades longer, or that thedifference in degree betweenWall Street and ordinaryeconomic lifewould swell toa difference in kind. That asingle bond trader might bepaid $47 million a year andfeel cheated. That themortgage bond marketinvented on the SalomonBrothers trading floor,whichseemedlikesuchagoodideaatthetime,wouldleadtothemost purely financial

economic disaster in history.That exactly twenty yearsafter Howie Rubin became ascandalous household namefor losing $250 million,anothermortgagebondtradernamedHowie,insideMorganStanley,wouldlose$9billionon a single mortgage trade,and remain essentiallyunknown, without anyonebeyond a small circle insideMorgan Stanley ever hearingaboutwhathe'ddone,orwhy.

When I sat down towritemyfirstbook, Ihadnogreat agenda, apart fromtelling what I took to be aremarkable tale. If you'dgottenafewdrinksinmeandthen asked what effect thebook would have on theworld, I might have saidsomething like, "I hope thatcollege students trying todecide what to do with theirlivesmightreaditanddecidethat it's silly to phony it up,

andabandontheirpassionsoreven their faint interests, tobecome financiers." I hopedthat some bright kid at OhioState University who reallywanted to be anoceanographer would readmy book, spurn the offerfromGoldmanSachs,andsetouttosea.

Somehow that messagewas mainly lost. Six monthsafter Liar's Poker waspublished,Iwasknee-deepin

letters from students at OhioState University who wantedto know if I had any othersecrets to share about WallStreet. They'd read my bookasahow-tomanual.

In the two decades afterI left, Iwaited for theendofWallStreetasIhadknownit.The outrageous bonuses, theendless parade of roguetraders, the scandal that sankDrexelBurnham, the scandalthat destroyed John

Gutfreund and finished offSalomon Brothers, the crisisfollowing the collapse ofmyold boss John Meriwether'sLong-Term CapitalManagement, the Internetbubble:Overandoveragain,the financial system was, insome narrow way,discredited.Yet the bigWallStreetbanksatthecenterofitjust kept on growing, alongwith the sums ofmoney thatthey doled out to twenty-six-

year-olds to perform tasks ofnoobvioussocialutility.Therebellion by American youthagainst the money culturenever happened.Why botherto overturn your parents'world when you can buy itandselloffthepieces?

Atsomepoint,Igaveupwaiting. There was noscandal or reversal, Iassumed,sufficientlygreat tosinkthesystem.

Then came Meredith

Whitney,withnews.Whitneywas an obscure analyst offinancialfirmsforanobscurefinancial firm, OppenheimerandCo.,who,onOctober31,2007, ceased to be obscure.OnthatdayshepredictedthatCitigrouphadsomismanagedits affairs that it would needto slash its dividend or gobust. It's never entirely clearonanygivendaywhatcauseswhat inside thestockmarket,butitwasprettyclearthat,on

October 31, MeredithWhitneycausedthemarketinfinancial stocks to crash. Bythe end of the trading day, awoman whom basically noone had ever heard of, andwho could have beendismissed as a nobody, hadshaved 8 percent off thesharesofCitigroupand$390billion off the value of theU.S. stockmarket.Fourdayslater, Citigroup CEO ChuckPrince resigned. Two weeks

later, Citigroup slashed itsdividend.

From that moment,MeredithWhitneybecameE.F. Hutton: When she spoke,people listened.Hermessagewas clear: If you want toknowwhat theseWall Streetfirmsare reallyworth, takeacold, hard look at thesecrappy assets they're holdingwith borrowed money, andimaginewhatthey'dfetchinafire sale. The vast

assemblages of highly paidpeople inside them wereworth, in her view, nothing.All through 2008, shefollowed the bankers' andbrokers' claims that they hadput their problems behindthemwith thiswrite-downorthatcapitalraisewithherownclaim: You're wrong. You'restill not facing up to howbadly you have mismanagedyourbusiness.You'restillnotacknowledging billions of

dollarsinlossesonsubprimemortgagebonds.Thevalueofyour securities is as illusoryas the value of your people.Rivals accused Whitney ofbeing overrated; bloggersaccused her of being lucky.What she was, mainly, wasright. But it's true that shewas, in part, guessing. Therewas no way she could haveknown what was going tohappen to these Wall Streetfirms, or even the extent of

their losses in the subprimemortgage market. The CEOsthemselves didn't know."Either that or they are allliars,"shesaid,"butIassumetheyreallyjustdon'tknow."

Now, obviously,MeredithWhitneydidn't sinkWall Street. She'd justexpressed most clearly andmost loudly a view thatturned out to be far moreseditious to the social orderthan, say, the many

campaigns by various NewYork attorneys generalagainst Wall Streetcorruption. If mere scandalcould have destroyed the bigWallStreetinvestmentbanks,they would have vanishedlongago.Thiswomanwasn'tsaying that Wall Streetbankers were corrupt. Shewas saying that they werestupid. These people whosejob it was to allocate capitalapparently didn't even know

howtomanagetheirown.I confess some part of

me thought, If only I'd stuckaround, this is the sort ofcatastrophe I might havecreated.Thecharactersatthecenter of Citigroup's messweretheverysamepeopleI'dworked with at SalomonBrothers; a few of them hadbeeninmySalomonBrotherstrainingclass.AtsomepointIcouldn't contain myself: Icalled Meredith Whitney.

This was back in March2008, just before the failureof Bear Stearns, when theoutcome still hung in thebalance. I thought, If she'sright, this really couldbe themoment when the financialworld gets put back into theboxfromwhichitescapedintheearly1980s.Iwascuriousto see if shemade sense,butalso to know where thisyoung woman who wascrashing the stock market

with her every utterance hadcomefrom.

She'd arrived on WallStreet in 1994, out of theBrown UniversityDepartmentofEnglish."Igotto New York and I didn'teven know research existed,"she says. She'd wound uplandingajobatOppenheimerand Co. and then had themostincrediblepieceofluck:to be trained by a man whohelped her to establish not

merely a career but aworldview. His name, shesaid, was Steve Eisman."After I made the Citi call,"she said, "one of the bestthings that happened waswhen Steve called and toldmehowproudhewasofme."Having never heard of SteveEisman, I didn't thinkanythingofthis.

ButthenIreadthenewsthatalittle-knownNewYorkhedge fund manager named

John Paulson had made $20billionor so forhis investorsand nearly $4 billion forhimself. This was moremoney than anyone had evermade so quickly on WallStreet. Moreover, he haddone itbybettingagainst thevery subprime mortgagebonds now sinkingCitigroupand every other big WallStreet investment bank.WallStreet investment banks arelikeLasVegascasinos:They

set the odds. The customerwho plays zero-sum gamesagainst them may win fromtime to time but neversystematically, and never sospectacularly that hebankrupts the casino. YetJohnPaulsonhadbeenaWallStreetcustomer.Herewasthemirror image of the sameincompetence MeredithWhitney was making hername pointing out. Thecasino hadmisjudged, badly,

theoddsofitsowngame,andat least one person hadnoticed. I called Whitneyagain to ask her, as I wasasking others, if she knewanyone who had anticipatedthe subprime mortgagecataclysm, thus settinghimself up in advance tomake a fortune from it.Whoelse had noticed, before thecasino caught on, that theroulette wheel had becomepredictable?Who else inside

the black box of modernfinancehadgraspedtheflawsofitsmachinery?

Itwasthenlate2008.Bythen there was a long andgrowing list of pundits whoclaimed they predicted thecatastrophe, but a far shorterlist of people who actuallydid.Ofthose,evenfewerhadthe nerve to bet on theirvision. It's not easy to standapart from mass hysteria--tobelievethatmostofwhat'sin

the financial news is wrong,tobelievethatmostimportantfinancial people are eitherlying or deluded--withoutbeing insane.Whitneyrattledoff a list with a half-dozennamesonit,mainlyinvestorsshehadpersonallyadvised.InthemiddlewasJohnPaulson.AtthetopwasSteveEisman.

TheBigShort

CHAPTERONE

ASecretOriginStory

Eisman entered financeabout the time I exited it.He'dgrownup inNewYorkCity,gonetoyeshivaschools,graduatedfromtheUniversityof Pennsylvania magna cumlaude, and then with honors

fromHarvardLawSchool.In1991hewasathirty-year-oldcorporate lawyer wonderingwhy he ever thought he'denjoybeingalawyer."Ihatedit," he says. "I hated being alawyer.Myparentsworkedasbrokers at Oppenheimersecurities. They managed tofinagle me a job. It's notpretty but that's whathappened."

Oppenheimer wasamong the last of the old-

fashioned Wall Streetpartnerships and survived onthe scraps left behind byGoldman Sachs and MorganStanley. It felt less like acorporation than a familybusiness. Lillian and ElliotEisman had been givingfinancial advice to individualinvestors on behalf ofOppenheimer since the early1960s. (Lillian had createdtheir brokerage businessinside of Oppenheimer, and

Elliot,whohadstartedoutasa criminal attorney, hadjoined her after beingspooked once too often bymidlevel Mafia clients.)Beloved and respected bycolleagues and clients alike,they could hire whomevertheypleased.Beforerescuingtheirsonfromhislegalcareerthey'd installedhisoldnannyon the Oppenheimer tradingfloor.Onhiswaytoreportingto his mother and father,

Eisman passed the womanwho had once changed hisdiapers. Oppenheimer had anepotism rule, however; ifLillian and Elliot wanted tohiretheirson,theyhadtopayhis salary for the first year,whileothersdeterminedifhewasworthpayingatall.

Eisman's parents, old-fashioned value investors atheart, had always told himthat the best way to learnabout Wall Street was to

workasanequityanalyst.Hestarted in equity analysis,working for the people whoshaped public opinion aboutpublic companies.Oppenheimer employedtwenty-five or so analysts,most ofwhose analysiswentignored by the rest of WallStreet. "The only way to getpaid as an analyst atOppenheimerwasbeingrightand making enough noiseabout it that people noticed

it," says Alice Schroeder,who covered insurancecompanies for Oppenheimer,moved to Morgan Stanley,and eventually wound upbeing Warren Buffett'sofficial biographer. Sheadded, "There was acounterculture element toOppenheimer. The people atthe big firms were all beingpaid to be consensus."Eisman turned out to have aspecial talent for making

noise and breaking withconsensusopinion.Hestartedas a junior equity analyst, ahelpmate, not expected tooffer his own opinions. Thatchanged in December 1991,less than a year into thenewjob. A subprime mortgagelender called AamesFinancialwentpublic,andnoone at Oppenheimerparticularly cared to expressan opinion about it. One ofOppenheimer's bankers, who

hoped tobehiredbyAames,stomped around the researchdepartment looking foranyone who knew anythingabout themortgage business."I'm a junior analyst and I'mjusttryingtofigureoutwhichendisup,"saysEisman,"butItoldhimthatasalawyerI'dworked on a deal for TheMoney Store." He waspromptly appointed the leadanalyst for Aames Financial."What I didn't tell him was

that my job had been toproofread the documents andthat I hadn't understood awordofthefuckingthings."

Aames Financial, likeThe Money Store, belongedto a new category of firmsextending loans to cash-strapped Americans, knowneuphemistically as "specialtyfinance." The category didnot include Goldman Sachsor J.P. Morgan but didinclude many little-known

companies involved onewayor another in the early1990sboom in subprime mortgagelending. Aames was the firstsubprime mortgage lender togo public. The secondcompany for which Eismanwas given sole responsibilitywas called Lomas FinancialCorp. Lomas had justemerged from bankruptcy. "Iput a sell rating on the thingbecauseitwasapieceofshit.Ididn'tknowthatyouweren't

supposed to put sell ratingsoncompanies.Ithoughttherewere three boxes--buy, hold,sell--and you could pick theoneyouthoughtyoushould."Hewas pressured to be a bitmore upbeat, but upbeat didnot come naturally to SteveEisman. He could fakeupbeat, and sometimes did,but he was happier notbothering. "I could hear himshouting intohis phone fromdownthehall,"saysaformer

colleague. "Joyfully engagedin bashing the stocks of thecompanies he covered.Whatever he's thinking, itcomes out of his mouth."Eismanstucktohissellratingon Lomas Financial, evenafter the Lomas FinancialCorporation announced thatinvestorsneedn'tworryaboutits financial condition, as ithad hedged its market risk."The single greatest line Iever wrote as an analyst,"

says Eisman, "was afterLomas said they werehedged." He recited the linefrom memory: "'The LomasFinancial Corporation is aperfectly hedged financialinstitution: it loses money inevery conceivable interestrate environment.' I enjoyedwriting that sentence morethan any sentence I everwrote." A few months afterhe published that line, theLomas Financial Corporation

returnedtobankruptcy.Eisman quickly

established himself as one ofthe few analysts atOppenheimerwhoseopinionsmightstirthemarkets."Itwaslikegoingback to school forme," he said. "I would learnaboutanindustryandIwouldgoandwriteapaperaboutit."Wall Street people came toview him as a genuinecharacter. He dressed half-fastidiously, as if someone

had gone to great trouble tobuyhimnicenewclothesbutnottoldhimexactlyhowtheyshould be worn. His short-croppedblondhair lookedasif he had cut it himself. Thefocal point of his soft,expressive, not unkind facewas his mouth, mainlybecauseitwasusuallyatleasthalfopen, evenwhilehe ate.Itwas as if he feared that hemight not be able to expresswhatever thought had just

flitted through his mindquickly enough before thenext one came, and so keptthechannelperpetuallyclear.His other features allarranged themselves, almostdutifully,aroundtheincipientthought. It was the oppositeofapokerface.

In his dealings with theoutside world, a patternemerged. The growingnumber of people whoworked for Steve Eisman

loved him, or were at leastamused by him, andappreciated his willingnessand ability to part with bothhis money and hisknowledge. "He's a bornteacher," says one womanwho worked for him. "Andhe's fiercely protective ofwomen." He identified withthe little guy and theunderdog without everexactly being one himself.Important men who might

have expected from Eismansome sign of deference orrespect, on the other hand,often came away fromencounterswith him shockedand outraged. "A lot ofpeople don't get Steve,"Meredith Whitney had toldme, "but the people who gethim love him." One of thepeople who didn't get Stevewas the head of a largeU.S.brokerage firm, who listenedtoEismanexplain in frontof

several dozen investors atlunch why he, the brokeragefirm head, didn't understandhis own business, thenwatched him leave in themiddleofthelunchandneverreturn. ("I had to go to thebathroom," says Eisman. "Idon'tknowwhyIneverwentback.") After the lunch, theguy had announced he'dneveragainagreetoenteranyroomwithSteveEismaninit.The president of a large

Japanese real estate firmwasanother.He'dsentEismanhiscompany's financialstatementsandthenfollowed,with an interpreter, to solicitEisman's investment. "Youdon't evenownstock inyourcompany,"saidEisman,afterthe typically elaborateJapanese businessmanintroductions. The interpreterconferredwiththeCEO.

"In Japan it is notcustomaryformanagementto

ownstock,"hesaidatlength.Eisman noted that the

guy's financial statementsdidn'tactuallydiscloseanyofthe really important detailsabouttheguy'scompany;but,ratherthansimplysaythat,heliftedthestatementintheair,as if disposing of a turd."This...thisistoiletpaper,"hesaid."Translatethat."

"TheJapaneseguytakesoff his glasses," recalled awitness to the strange

encounter. "His lips arequavering.WorldWar Threeisabouttobreakout.'Toy-laypaper?Toy-laypaper?'"

A hedge fund managerwho counted Eisman as afriend set out to explain himtome but quit aminute intoit--after he'd describedEisman exposing variousbigwigs as either liars oridiots--and started to laugh."He'ssortofaprickinaway,buthe'ssmartandhonestand

fearless.""Even on Wall Street

people think he's rude andobnoxious and aggressive,"says Eisman's wife, ValerieFeigen, who worked at J.P.Morgan before quitting toopen the women's clothingstore Edit NewYork, and toraise their children. "He hasno interest in manners.Believeme,I'vetriedandI'vetried and I've tried." Aftershe'd brought him home for

thefirsttime,hermotherhadsaid,"Well,wecan'tusehimbutwecandefinitelyauctionhim off at UJA."* Eismanhadwhatamountedtoatalentfor offending people. "He'snot tactically rude," his wifeexplains. "He's sincerelyrude. He knows everyonethinks of him as a characterbut he doesn't think ofhimselfthatway.Stevenlivesinsidehishead."

When asked about the

pattern of upset he leaves inhis wake, Eisman simplylooks puzzled, even a bitwounded. "I forget myselfsometimes," he says with ashrug.

Here was the first ofmany theories about Eisman:Hewassimplysomuchmoreinterested in whatever wasrattlingaroundhisbrain thanhewas inwhoever happenedtobestandinginfrontofhimthattheoneoverwhelmedthe

other. This theory struckotherswhoknewEismanwellas incomplete. His mother,Lillian, offered a secondtheory. "Steven actually hastwo personalities," she saidcarefully.Onewasthatoftheboy to whom she had giventhe brand-new bicycle he sodesperately craved, only tohavehimpedalitintoCentralPark, lend it to a kid he'dnever met, and watch itvanish into the distance. The

other was that of the youngmanwhosetout tostudy theTalmud, not because he hadthe slightest interest in Godbut because he was curiousabout its internalcontradictions. His motherhadbeenappointedchairmanof the Board of JewishEducationinNewYorkCity,andEismanwascombingtheTalmud for inconsistencies."WhoelsestudiesTalmudsothat they can find the

mistakes?" asks his mother.Later, after Eisman becameseriously rich and had tothink about how to givemoneyaway,helandedonanorganizationcalledFootsteps,devoted to helping HasidicJews flee their religion. Hecouldn't even give away hismoney without picking afight.

By pretty much everyaccount, Eisman was acurious character. And he'd

walked onto Wall Street atthe very beginning of acuriousphase.Thecreationofthemortgage bondmarket, adecade earlier, had extendedWallStreetintoaplaceithadnever before been: the debtsof ordinary Americans. Atfirst the new bond marketmachineconcerneditselfwiththe more solvent half of theAmerican population. Now,with the extension of themortgage bond market into

the affairs of lesscreditworthy Americans, itfound its fuel in the debts ofthelesssolventhalf.

Themortgage bondwasdifferent in important waysfrom old-fashioned corporateand government bonds. Amortgage bond wasn't asingle giant loan for anexplicit fixed term. Amortgage bond was a claimonthecashflowsfromapoolof thousands of individual

home mortgages. These cashflows were alwaysproblematic,astheborrowershad the right to pay off anytime they pleased. This wasthe singlebiggest reason thatbond investors initially hadbeen reluctant to invest inhome mortgage loans:Mortgageborrowerstypicallyrepaid their loans only wheninterest rates fell, and theycould refinance morecheaply,leavingtheownerof

a mortgage bond holding apileofcash,toinvestatlowerinterest rates.The investor inhome loans didn't knowhowlong his investment wouldlast, only that he would gethismoneybackwhenheleastwanted it. To limit thisuncertainty, the people I'dworked with at SalomonBrothers, who created themortgage bond market, hadcome up with a cleversolution. They took giant

pools of home loans andcarvedupthepaymentsmadeby homeowners into pieces,called tranches.Thebuyerofthe first tranchewas like theownerofthegroundfloorinaflood:Hegothitwiththefirstwave of mortgageprepayments.Inexchange,hereceivedahigherinterestrate.The buyer of the secondtranche--the second story ofthe skyscraper--took the nextwave of prepayments and in

exchangereceivedthesecondhighest interest rate, and soon. The investor in the topfloorofthebuildingreceivedthelowestrateof interestbuthad the greatest assurancethat his investment wouldn'tendbeforehewanteditto.

Thebigfearofthe1980smortgage bond investor wasthat he would be repaid tooquickly,notthathewouldfailto be repaid at all. The poolof loans underlying the

mortgage bond conformed tothe standards, in their sizeand the credit quality of theborrowers, set by one ofseveral government agencies:Freddie Mac, Fannie Mae,and Ginnie Mae. The loanscarried,ineffect,governmentguarantees; if thehomeowners defaulted, thegovernment paid off theirdebts. When Steve Eismanstumbled into this new,rapidly growing industry of

specialty finance, themortgage bond was about tobe put to a new use:makingloans that did not qualify forgovernment guarantees. Thepurpose was to extend creditto less and less creditworthyhomeowners,notsothat theymightbuyahousebutsothattheycouldcashoutwhateverequity they had in the housetheyalreadyowned.

The mortgage bondscreated from subprime home

loans extended the logicinvented to address theproblem of early repaymentto cope with the problem ofno repayment at all. Theinvestor in the first floor, ortranche, would be exposednot to prepayments but toactuallosses.Hetookthefirstlosses until his investmentwas entirely wiped out,whereupon the losses hit theguyonthesecondfloor.Andsoon.

Intheearly1990s,justapair of Wall Street analystsdevoted their careers tounderstanding the effects ofextending credit into placeswhere that sun didn't oftenshine.SteveEismanwasone;the other was Sy Jacobs.Jacobs had gone through thesame Salomon Brotherstraining program that I had,and now worked for a smallinvestment bank called AlexBrown. "I sat through the

Salomon training programand got to hear what thisgreat new securitizationmodel Lewie Ranieri wascreatingwasgoingtodo,"herecalls. (Ranieri was theclosest thing the mortgagebond market had to afounding father.) Theimplications of turning homemortgages into bonds weremind-bogglingly vast. Oneman's liability had alwaysbeenanotherman'sasset,but

now more and more of theliabilitiescouldbeturnedintobits of paper that you couldselltoanyone.Inshortorder,theSalomonBrothers tradingfloor gave birth to smallmarkets in bonds funded byall sorts of strange stuff:credit card receivables,aircraft leases, auto loans,healthclubdues.To inventanewmarketwasonlyamatterof finding a new asset tohock. The most obvious

untapped asset in Americawas still the home. Peoplewith firstmortgageshadvastamounts of equity locked upintheirhouses;whyshouldn'tthis untapped equity, too, besecuritized? "The thinking insubprime," says Jacobs, "wastherewasthissocialstigmatobeing a second mortgageborrower and there reallyshouldn't be. If your creditratingwasa littleworse,youpaid a lot more--and a lot

more than you really should.If we can mass market thebonds,wecandrivedownthecost to borrowers. They canreplace high interest ratecredit card debt with lowerinterest rate mortgage debt.And it will become a self-fulfillingprophecy."

The growing interfacebetween high finance andlower-middle-class Americawas assumed to be good forlower-middle-class America.

This new efficiency in thecapital markets would allowlower-middle-classAmericans to pay lower andlower interest rates on theirdebts. In theearly1990s, thefirst subprime mortgagelenders--The Money Store,Greentree, Aames--soldshares to the public, so thatthey might grow faster. Bythe mid-1990s, dozens ofsmall consumer lendingcompanies were coming to

market each year. Thesubprime lending industrywas fragmented.Because thelenders sold many--thoughnot all--of the loans theymade to other investors, inthe form ofmortgage bonds,the industrywas also fraughtwithmoral hazard. "It was afast-buck business," saysJacobs. "Any businesswhereyou can sell a product andmake money without havingto worry how the product

performs is going to attractsleazy people. That was theseamyunderbellyofthegoodidea. Eisman and I bothbelieved in the big idea andwe both met some reallysleazy characters. That wasour job: to figure out whichof the characters were theright ones to pull off the bigidea."

Subprime mortgagelending was still a trivialfraction of the U.S. credit

markets--a few tens ofbillions in loans each year--but its existencemade sense,even to Steve Eisman. "Ithought it was partly aresponse to growing incomeinequality," he said. "Thedistributionof income in thiscountry was skewed andbecoming more skewed, andthe result was that you havemore subprime customers."Of course, Eisman was paidto see the sense in subprime

lending: Oppenheimerquickly became one of theleading bankers to the newindustry, in no small partbecause Eisman was one ofitsleadingproponents."Itooka lot of subprime companiespublic," says Eisman. "Andthestorytheylikedtotellwasthat 'we're helping theconsumer. Because we'retaking him out of his highinterest rate credit card debtand putting him into lower

interest rate mortgage debt.'And I believed that story."Thensomethingchanged.

Vincent Daniel had grownupinQueens,withoutanyofthe perks Steve Eisman tookfor granted. And yet if youmet them you might guessthat it was Vinny who hadgrown up in high style onPark Avenue and Eismanwho had been raised in thesmall duplex on Eighty-

second Avenue. Eisman wasbrazen and grandiose andfocusedonthebigkill.Vinnywas careful and wary andinterested in details. He wasyoung and fit, with thick,dark hair and handsomefeatures, but his appearancewas overshadowed by hisconcerned expression--mouthever poised to frown,eyebrows ever ready to rise.He had little to lose but stillseemed perpetually worried

thatsomethingimportantwasabout to be taken from him.Hisfatherhadbeenmurderedwhen he was a small boy--though no one ever talkedabout that--and his motherhad found a job as abookkeeper at a commoditiestrading firm. She'd raisedVinny and his brother alone.MaybeitwasQueens,maybeitwaswhat had happened tohis father, or maybe it wasjust the way Vincent Daniel

waswired,butheviewedhisfellow man with the mostintensesuspicion.Itwaswiththe awe of a championspeaking of an even greaterchampion that Steve Eismansaid,"Vinnyisdark."

Eisman was an upper-middle-class kid who hadbeen faintly surprised whenhewoundupatPenn insteadofYale.Vinnywas a lower-middle-class kid whosemotherwasproudofhimfor

gettingintoanycollegeatalland prouder still when, in1994, after Vinny graduatedfrom SUNY-Binghamton,he'd gotten himself hired inManhattan by ArthurAndersen, the accountingfirm thatwould be destroyedafewyearslater,intheEnronscandal. "Growing up inQueens, you very quicklyfigure out where the moneyis," said Vinny. "It's inManhattan." His first

assignmentinManhattan,asajunior accountant, was toaudit Salomon Brothers. Hewas instantly struck by theopacity of an investmentbank's books. None of hisfellow accountants was ableto explain why the traderswere doing what they weredoing. "I didn't knowwhat Iwasdoing,"saidVinny."Butthe scary thing was, mymanagers didn't knowanythingeither. Iasked these

basicquestions--like,Whydothey own this mortgagebond? Are they just bettingon it, or is it part of somelarger strategy? I thought Ineeded to know. It's reallydifficulttoauditacompanyifyoucan'tconnectthedots."

He concluded that therewaseffectivelynowayforanaccountantassignedtoauditagiant Wall Street firm tofigure out whether it wasmaking money or losing

money. They were giantblack boxes, whose hiddengears were in constantmotion. Several months intothe audit, Vinny's managergrew tired of his questions."Hecouldn'texplainittome.He said, 'Vinny, it's not yourjob. I hired you to do XYZ,do XYZ and shut yourmouth.' I walked out of hisoffice and said, 'I gotta getoutofhere.'"

Vinny went looking for

another job. An old schoolfriend of his worked at aplace called Oppenheimerand Co. and was makinggood money. He handedVinny's resume in to humanresources,anditmadeitswayto SteveEisman,who turnedouttobelookingforsomeoneto help him parse theincreasingly arcaneaccounting used by subprimemortgage originators. "I can'tadd,"saysEisman."Ithinkin

stories. I need help withnumbers." Vinny heard thatEismancouldbedifficultandwassurprisedthat,whentheymet, Eisman seemedinterested only in whetherthey'd be able to get along."Heseemedtobejustlookingfor a good egg," saysVinny.They'd met twice whenEismanphonedhimoutoftheblue. Vinny assumed he wasabouttobeofferedajob,butsoonaftertheystartedtotalk,

Eisman received anemergency call on the otherline and put Vinny on hold.Vinny sat waiting for fifteenminutes in silence, butEisman never came back ontheline.

Two months later,Eisman called him back.WhencouldVinnystart?

Eisman didn'tparticularlyrecallwhyhehadputVinnyonhold andneverpicked up again, any more

than he recalled why he hadgone to the bathroom in themiddle of lunch with a big-timeCEOandneverreturned.Vinny soon found his ownexplanation: When he'dpicked up the other line,Eisman had been informedthathisfirstchild,anewbornson named Max, had died.Valerie,sickwiththeflu,hadbeen awakened by a nightnurse,who informedher thatshe, the night nurse, had

rolled on top of the baby inhersleepandsmotheredhim.A decade later, the peopleclosest to Eisman woulddescribe this as an event thatchanged his relationship tothe world around him."Steven always thought hehadanangelonhisshoulder,"said Valerie. "Nothing badever happened to Steven.Hewas protected and he wassafe.AfterMax,theangelonhis shoulder was done.

Anything can happen toanyone at any time." Fromthat moment, she noticedmanychangesinherhusband,large and small, and Eismandid not disagree. "From thepointofviewofthehistoryoftheuniverse,Max'sdeathwasnot a big deal," saidEisman."Itwasjustmybigdeal."

At any rate, Vinny andEisman never talked aboutwhat had happened. AllVinny knew was that the

Eisman he went to work forwas obviously not quite thesameEismanhe'dmetseveralmonths earlier. The EismanVinny had interviewed withwas,bythestandardsofWallStreet analysts, honest. Hewas not completelyuncooperative. Oppenheimerwas among the leadingbankers to the subprimemortgage industry. Theyneverwouldhavebeengiventhe banking business if

Eisman,theirnoisiestanalyst,had not been willing to saynicethingsaboutthem.Muchasheenjoyedbashingthelessviable companies, heaccepted that the subprimelendingindustrywasausefuladditiontotheU.S.economy.His willingness to be rudeaboutafewofthesesubprimeoriginators was, in a way,useful. It lent credibility tohis recommendations of theothers.

Eisman was now aboutto become noticeably morenegatively disposed, in waysthat,fromthepointofviewofhis employer, werefinanciallycounterproductive."It was like he'd smelledsomething,"saidVinny."Andhe needed my help figuringoutwhatitwashe'dsmelled."Eisman wanted to write areport that more or lessdamned the entire industry,but he needed to be more

careful than usual. "You canbepositiveandwrongon thesellside,"saysVinny."Butifyou're negative and wrongyou get fired." Ammunitionto cause trouble had justarrived a few months earlierfrom Moody's: The ratingagency now possessed, andoffered for sale, all sorts ofnew information aboutsubprime mortgage loans.While the Moody's databasedidnotallowyoutoexamine

individual loans, it offered ageneralpictureofthepoolsofloans underlying individualmortgage bonds: how manywerefloating-rate,howmanyof the houses borrowedagainstwereowner-occupied.Most importantly: howmanywere delinquent. "Here's thisdatabase," Eisman saidsimply. "Go into that room.Don't come out until you'vefigured out what it means."VinnyhadthefeelingEisman

alreadyknewwhatitmeant.Vinnywas otherwise on

his own. "I'm twenty-sixyears old," he says, "and Ihaven't really understoodwhat mortgage-backedsecurities really are."Eismandidn't know anything aboutthem either--he was a stockmarket guy, andOppenheimer didn't evenhave a bond department.Vinny had to teach himself.Whenhewasdone,hehadan

explanationfortheunpleasantodor wafting from thesubprime mortgage industrythat Eisman had detected.These companies disclosedtheir ever-growing earnings,butnotmuchelse.Oneofthemany items they failed todisclosewas the delinquencyrate of the home loans theywere making. When Eismanhad bugged them for these,they'd pretended that the factwas irrelevant, as they had

sold all the loans off topeople who packaged themintomortgagebonds:Theriskwas no longer theirs. Thiswasuntrue.Allretainedsomesmall fraction of the loansthey originated, and thecompanies were allowed tobook as profit the expectedfuture value of those loans.Theaccountingrulesallowedthem to assume the loanswould be repaid, and notprematurely.Thisassumption

became the engine of theirdoom.

What first caughtVinny's eye were the highprepayments coming in fromasectorcalled"manufacturedhousing." ("It sounds betterthan'mobilehomes.'")Mobilehomes were different fromthe wheel-less kind: Theirvalue dropped, like cars', themoment they left the store.The mobile home buyer,unlike the ordinary home

buyer, couldn't expect torefinance in two years andtake money out. Why weretheyprepayingsofast?Vinnyasked himself. "It made nosense tome.Then I saw thatthe reason the prepaymentsweresohighisthattheywereinvoluntary." "Involuntaryprepayment" sounds betterthan "default." Mobile homebuyers were defaulting ontheir loans, their mobilehomes were being

repossessed, and the peoplewho had lent them moneywere receiving fractions ofthe original loans."Eventually Isawthatall thesubprime sectors were eitherbeingprepaidorgoingbadatan incredible rate," saidVinny. "I was just seeingstunningly high delinquencyrates in these pools." Theinterest rate on the loanswasn't high enough to justifythe risk of lending to this

particular slice of theAmerican population. It wasas if the ordinary rules offinance had been suspendedin response to a socialproblem. A thought crossedhismind:Howdo youmakepoor people feel wealthywhen wages are stagnant?Yougivethemcheaploans.

To sift every pool ofsubprime mortgage loanstook him six months, butwhen he was done he came

out of the room and gaveEisman the news. All thesesubprime lending companiesweregrowingsorapidly,andusing suchgoofyaccounting,that theycouldmask the factthattheyhadnorealearnings,just illusory, accounting-driven, ones. They had theessential feature of a Ponzischeme: To maintain thefiction that they wereprofitable enterprises, theyneededmoreandmorecapital

to create more and moresubprime loans. "I wasn'tactually a hundred percentsureIwasright,"saidVinny,"but I go to Steve and say,'This really doesn't lookgood.'Thatwasallheneededto know. I think what heneeded was evidence todowngradethestock."

ThereportEismanwrotetrashed all of the subprimeoriginators; one by one, heexposed the deceptions of a

dozen companies. "Here isthe difference," he said,"between the view of theworld they are presenting toyouand theactualnumbers."The subprime companies didnot appreciate his effort. "Hecreated a shitstorm," saidVinny. "All these subprimecompanies were calling andhollering at him: You'rewrong. Your data's wrong.And he just hollered back atthem, 'It's YOUR fucking

data!'" One of the reasonsEisman's report disturbed somany is that he'd failed togive the companies he'dinsulted fair warning. He'dviolatedtheWallStreetcode."Steveknewthiswasgoingtocreate a shitstorm," saidVinny. "And he wanted tocreate the shitstorm. And hedidn'twanttobetalkedoutofit. And if he told them, he'dhave had all these peopletryingtotalkhimoutofit."

"We were never able toevaluate the loans beforebecause we never had thedata,"saidEismanlater."Myname was wedded to thisindustry.Myentirereputationhad been built on coveringthese stocks. If Iwaswrong,thatwould be the end of thecareerofSteveEisman."

Eisman published hisreport in September 1997, inthe middle of what appearedto be one of the greatest

economic booms in U.S.history.Lessthanayearlater,Russiadefaultedandahedgefund called Long-TermCapital Management wentbankrupt. In the subsequentflight to safety, the earlysubprimelendersweredeniedcapital and promptly wentbankrupt en masse. Theirfailure was interpreted as anindictmentoftheiraccountingpractices, which allowedthem to record profits before

they were realized. No onebut Vinny, so far as Vinnycould tell, ever reallyunderstood the crappiness ofthe loans they had made. "Itmademefeelgoodthat therewas such inefficiency to thismarket," he said. "Because ifthe market catches on toeverything, I probably havethewrong job.Youcan'taddanything by looking at thisarcane stuff, so why bother?ButIwastheonlyguyIknew

whowascoveringcompaniesthatwereallgoingtogobustduring the greatest economicboom we'll ever see in mylifetime. I saw how thesausage was made in theeconomy and it was reallyfreaky."

Thatwas themoment it firstbecame clear that Eismanwasn'tjustalittlecynical.Heheldapictureofthefinancialworld in his head that was

radically different from, andless flattering than, thefinancialworld'sself-portrait.Afewyears later,hequithisjob and went to work for agiant hedge fund calledChilton Investment.He'd lostinterestintellingotherpeoplewheretoputtheirmoney.Hethought he might be able toremain interested if hemanaged money himself andbet on his own judgments.HavinghiredEisman,Chilton

Investment had secondthoughts. "The whole thingabout Steve," said a Chiltoncolleague,"was, 'Yeah,he'sareally smart guy. But can hepick stocks?'" Chiltondecided that he couldn't andrelegated him to his old roleof analyzing companies forthe guy who actually madethe investment decisions.Eismanhatedit,buthedidit,and in doing it he learnedsomething that prepared him

uniquely for the crisis thatwas about to occur. Helearnedwhatwasreallygoingon inside the market forconsumerloans.

Theyearwasnow2002.There were no publicsubprime lending companiesleft in America. There was,however, an ancientconsumerlendinggiantcalledHousehold FinanceCorporation. Created in the1870s, it had long been a

leader in the field. Eismanunderstoodthecompanywell,he thought, until he realizedthat he didn't. In early 2002he got his hands onHousehold's new salesdocument offering homeequity loans. The company'sCEO, Bill Aldinger, hadgrownHouseholdevenashiscompetitors went bankrupt.Americans, digesting theInternet bust, seemed in nopositiontotakeonnewdebts,

and yet Household wasmaking loansata fasterpacethanever.Abigsourceofitsgrowth had been the secondmortgage. The documentoffered a fifteen-year, fixed-rateloan,butitwasbizarrelydisguised as a thirty-yearloan. It took the stream ofpayments the homeownerwould make to Householdover fifteen years, spread ithypothetically over thirtyyears,andasked:Ifyouwere

making the same dollarpayments over thirty yearsthat you are in fact makingoverfifteen,whatwouldyour"effectiverate"ofinterestbe?It was a weird, dishonestsalespitch.Theborrowerwastold he had an "effectiveinterest rate of 7 percent"when he was in fact payingsomething like 12.5 percent."It was blatant fraud," saidEisman. "They were trickingtheircustomers."

It didn't take long forEisman to find complaintsfrom borrowers who hadfigured out what had justhappened to them. Hescoured small newspapersaround the country. In thetown of Bellingham,Washington--the last city ofany size before you reachCanada--he found a reporternamedJohnStark,whowrotefor the Bellingham News.BeforeEismancalledhimout

oftheblue,Starkhadwrittena small piece about fourlocals who thought they hadbeen deceived by Householdand found a plaintiff'sattorney willing to sue thecompany and void themortgage contracts. "I wasskeptical at first," saysStark."I thought, Here's anotherpersonwhohasborrowedtoomuch money and hired alawyer. I wasn't toosympathetic."Whenthepiece

was published, it drew acrowd:Hundredsofpeopleinand around Bellingham hadpicked up the newspaper todiscover that their 7 percentmortgage was in fact a 12.5percent mortgage. "Peoplewere coming out of thewoodwork," says Stark."They were angry. A lot ofthem didn't realize what hadhappenedtothem."

Whatever Eisman wasmeanttobedoinggotpushed

tooneside.Hisjobbecameasingle-minded crusadeagainst the HouseholdFinance Corporation. Healerted newspaper reporters,he called up magazinewriters, he became friendlywith the Association ofCommunityOrganizationsforReform Now (ACORN),whichmustbethefirsttimeaguyfromaWallStreethedgefund exhibited such interestinanorganizationdevoted to

guarding the interests of thepoor. He repeatedly pesteredthe office of the attorneygeneral of the state ofWashington. He wasincredulous to learn that theattorney general hadinvestigated Household andthen been prevented, by astate judge, from releasingthe results of hisinvestigation. Eismanobtained a copy; its contentsconfirmed his worst

suspicions. "I would say tothe guy in the attorneygeneral's office, 'Why aren'tyou arresting people?' He'dsay, 'They're a powerfulcompany. If they're gone,who would make subprimeloans in the state ofWashington?' I said, 'Believeme, there will be a train fullof people coming to lendmoney.'"

Really, it was a federalissue. Household was

peddling these deceptivemortgages all over thecountry. Yet the federalgovernment failed to act.Instead, at the end of 2002,Household settled a classaction suit out of court andagreed topaya$484millionfine distributed to twelvestates. The following year itsold itself, and its giantportfolio of subprime loans,for$15.5billiontotheBritishfinancial conglomerate the

HSBCGroup.Eisman was genuinely

shocked."Itneverenteredmymind that this couldpossiblyhappen,"hesaid."Thiswasn'tjust another company--thiswas the biggest company byfar making subprime loans.And it was engaged in justblatant fraud. They shouldhave taken the CEO out andhung him up by his fuckingtesticles.Insteadtheysoldthecompany and theCEOmade

a hundred million dollars.And I thought, Whoa! Thatone didn't end the way itshould have." His pessimismtoward high finance wasbecoming tinged withpoliticalideas."That'swhenIstarted to see the socialimplications,"hesaid."Ifyouaregoingtostartaregulatoryregime from scratch, you'ddesign it to protect middle-and lower-middle-incomepeople, because the

opportunity for them to getripped off was so high.Instead what we had was aregimewhere thosewere thepeople who were protectedtheleast."

Eisman left work atnoon every Wednesday sothat he might be present atMidtown Comics when thenew shipment of storiesarrived. He knew more thananygrownmanshouldaboutthe lives of various

superheroes. He knew theGreenLantern oath by heart,for instance, and understoodBatman'sinnerlifebetterthanthe Caped Crusader himself.Before the death of his son,Eisman had read the adultversions of the comics he'dread as a child--Spider-Manwashisfavorite.Nowhereadonlythedarkestadultcomics,and favored those that tookfamiliar fairy tales andrearranged them without

changing any of the facts, sothat the story became lessfamiliar,andsomethingotherthan a fairy tale. "Telling astory that is consistent witheverything that happenedbefore,"asheputit."Andyetthe story is totally different.Anditleadsyoutolookattheearlier episodes differently."He preferred relationsbetweenSnowWhiteandthedwarves to be a bit morefraught.Nowafairytalewas

being reinvented before hiseyes in thefinancialmarkets."Istartedtolookmorecloselyatwhata subprimemortgageloan was all about," he said."A subprime auto loan is insomewayshonestbecauseit'sat a fixed rate. Theymay becharging you high fees andrippingyourheart out, but atleast you know it. Thesubprime mortgage loan wasa cheat. You're basicallydrawing someone in by

tellingthem, 'You'regoingtopayoffallyourother loans--your credit card debt, yourautoloans--bytakingthisoneloan. And look at the lowrate!' But that low rate isn'ttherealrate.It'sateaserrate."

Obsessing overHousehold, he attended alunchorganizedbyabigWallStreetfirm.Theguestspeakerwas Herb Sandler, the CEOof a giant savings and loancalledGoldenWestFinancial

Corporation."Someoneaskedhimifhebelievedin thefreechecking model," recallsEisman. "And he said, 'Turnoff your tape recorders.'Everyoneturnedofftheirtaperecorders. And he explainedthat they avoided freechecking because it wasreally a tax on poor people--in the form of fines foroverdrawing their checkingaccounts.Andthatbanksthatused it were really just

banking on being able to ripoff poor people even morethan they could if theycharged them for theirchecks."

Eisman asked, "Are anyregulatorsinterestedinthis?"

"No,"saidSandler."That's when I decided

the system was really, 'Fuckthepoor.'"

In his youth, Eisman hadbeen a strident Republican.

He joined right-wingorganizations, voted forReagantwice,andevenlovedRobert Bork. It wasn't untilhe got toWall Street, oddly,that his politics drifted left.He attributed his first babysteps back to the middle ofthe political spectrum to theendofthecoldwar."Iwasn'tas right-wing because therewasn't as much to be right-wing about." By the timeHousehold's CEO, Bill

Aldinger, collected his $100million, Eisman was on hisway to becoming thefinancial market's firstsocialist. "When you're aconservativeRepublican,younever think people aremaking money by rippingotherpeopleoff,"hesaid.Hismind was now fully open tothe possibility. "I nowrealized there was an entireindustry, called consumerfinance,thatbasicallyexisted

torippeopleoff."Denied the chance to

manage money by his hedgefund employer, he quit andtried to start his own hedgefund. An outfit calledFrontPoint Partners, soon tobewhollyownedbyMorganStanley, housed a collectionofhedgefunds.Inearly2004,MorganStanleyagreed to letEisman set up a fund thatfocused exclusively onfinancial companies: Wall

Street banks, home builders,mortgage originators,companies with big financialservices divisions--GeneralElectric (GE), for instance--andanyoneelsewhotouchedAmerican finance. MorganStanleytookacutofthefeesoff the top andprovidedhimwith office space, furniture,and support staff. The onlything they didn't supply himwithwasmoney.Eismanwasexpected to drum that up on

hisown.Heflewallovertheworld and eventually metwith hundreds of big-timeinvestors. "Basicallywe triedto raise money, and didn'treally do it," he says."Everyone said, 'It's apleasure to meet you. Let'sseehowyoudo.'"

Bythespringof2004hewas in a state. He hadn'traisedmoney;hedidn'tknowthathewould;hedidn't evenknow if he could. He

certainly didn't believe thatthe world was fair, or thatthingsalwaysworkedout forthe best, or that he enjoyedsome special protection fromlife's accidents. He waswaking up at four in themorning, drenched in sweat.He was also in therapy. Hewas still Eisman, however,and so itwasn't conventionaltherapy."Workgroup,"itwascalled. A handful ofprofessionals gatheredwith a

trained psychotherapist tosharetheirproblemsinasafeenvironment. Eisman wouldburst in late to thesemeetings, talk throughwhateverwas bothering him,and then rush off before theothers had a chance to tellhim about their problems.Afterhe'ddone this a coupleof times, the therapist saidsomethingtohimaboutit,buthedidn'tappeartohaveheardher. So she took to calling

Eisman's wife, whom sheknew, to ask her to have awordwith her husband.Thatdidn't work either. "I alwaysknew when he'd been togroup," said Valerie,"because she'd call and say,'Hediditagain!'"

Valerie was clearlywearyoftheratrace.ShetoldEismanthatifthislatestWallStreet venture didn't workout, they would leave NewYork for Rhode Island and

open a bed-and-breakfast.Valerie had scouted placesand spoke often aboutspendingmore timewith thetwinsshe'dgivenbirthto,andeven raising chickens. Itwasalmost ashard forEisman toimagine himself raisingchickensas itwas forpeoplewho knew him, but he'dagreed."Theideaofitwassounbelievably unappealing tohim," says his wife, "that hestarted to work harder."

Eisman traveled all overEuropeand theUnitedStatessearching for people willingto investwithhimand foundexactly one: an insurancecompany, which staked himto $50 million. It wasn'tenoughtocreateasustainableequityfund,butitwasastart.

Instead of money,Eisman attracted people,whose views of the worldwere as shaded as his own.Vinny, who had just

coauthored a gloomy reportcalled "A Home withoutEquity Is Just a Rental withDebt," came right away.Porter Collins, a two-timeOlympic oars-man who hadworked with Eisman atChiltonInvestmentandneverreally understood why theguy with the bright ideaswasn't given more authority,came along too. DannyMoses,whobecameEisman'shead trader, came third.

Danny had worked as asalesmanatOppenheimerandCo. and had pungentmemories of Eisman doingand sayingall sortsof thingsthat sell-side analysts seldomdid. In the middle of onetrading day, for instance,Eisman had walked to thepodium at the center of theOppenheimer trading floor,called for everyone'sattention,announcedthat"thefollowing eight stocks are

goingtozero,"andthenlistedeight companies that indeedwent bankrupt. Raised inGeorgia, the sonofa financeprofessor, Danny was lessopenly fatalistic than Vinnyor Steve, but he neverthelessshared a general sense thatbad things can and dohappen, especially on WallStreet. When a Wall Streetfirmhelpedhim toget intoatrade that seemed perfect inevery way, he asked the

salesman, "I appreciate this,but I just want to know onething:How are you going tofuckme?"

Heh-heh-heh, c'mon,we'dneverdothat, the traderstarted to say, but Danny,though perfectly polite, wasinsistent.

We both know thatunadulterated good thingslike this trade don't justhappen between little hedgefunds and big Wall Street

firms.I'lldoit,butonlyafteryou explain to me how youaregoingtofuckme.Andthesalesman explained how hewas going to fuck him. AndDannydidthetrade.

All of them enjoyed,immensely, the idea ofrunning money with SteveEisman.WorkingforEisman,you never felt you wereworking for Eisman. He'dteach you but he wouldn'tsupervise you. Eisman also

put a fine point on theabsurdity they saweverywhere around them."Steve's fun to take to anyWall Street meeting," saidVinny. "Because he'll say'explain that to me' thirtydifferenttimes.Or'couldyouexplain that more, inEnglish?' Because once youdo that, there's a few thingsyou learn. For a start, youfigure out if they even knowwhat they're talking about.

And a lot of times theydon't!"

By early 2005 Eisman'slittle group shared a sensethat a great many peopleworking on Wall Streetcouldn't possibly understandwhat they were doing. Thesubprime mortgage machinewasupandrunningagain,asif it had never broken downin the first place. If the firstact of subprime lending hadbeen freaky, this second act

was terrifying. Thirty billiondollars was a big year forsubprime lending in themid-1990s.In2000therehadbeen$130 billion in subprimemortgage lending, and 55billiondollars'worthofthoseloanshadbeenrepackagedasmortgage bonds. In 2005therewouldbe$625billioninsubprime mortgage loans,$507 billion of which founditsway intomortgagebonds.Half a trillion dollars in

subprime mortgage-backedbonds in a single year.Subprime lending wasbooming even as interestrates were rising--whichmade no sense at all. Evenmore shocking was that theterms of the loans werechanging, in ways thatincreased the likelihood theywouldgobad.Back in1996,65percentof subprime loanshad been fixed-rate,meaningthat typical subprime

borrowers might be gettingscrewed, but at least theyknewforsurehowmuchtheyowed each month until theypaidofftheloan.By2005,75percent of subprime loanswere some form of floating-rate,usuallyfixedforthefirsttwoyears.

The original cast ofsubprime financiershadbeensunkby the small fractionoftheloanstheymadethattheyhadkept on their books.The

market might have learned asimple lesson: Don't makeloans to people who can'trepaythem.Insteaditlearneda complicated one: You cankeep on making these loans,just don't keep them on yourbooks. Make the loans, thensell them off to the fixedincome departments of bigWallStreetinvestmentbanks,which will in turn packagethemintobondsandsellthemto investors. Long Beach

Savingswasthefirstexistingbanktoadoptwhatwascalledthe "originate and sell"model. This proved such ahit--Wall Street would buyyourloans,evenifyouwouldnot!--that a new company,called B&C mortgage, wasfounded to do nothing butoriginate and sell. LehmanBrothers thought that wassuch a great idea that theybought B&C mortgage. Byearly 2005 all the big Wall

Street investmentbanksweredeepintothesubprimegame.Bear Stearns, Merrill Lynch,GoldmanSachs, andMorganStanley all had what theytermed "shelves" for theirsubprimewares,with strangenames like HEAT and SAILand GSAMP, that made it abit more difficult for thegeneral audience to see thatthese subprime bonds werebeing underwritten by WallStreet'sbiggestnames.

Eismanandhisteamhada from-the-ground-upunderstanding of both theU.S. housing market andWallStreet.Theyknewmostof the subprime lenders--theguys on the ground makingthe loans. Many were theverysamecharacterswhohadcreated the late 1990sdebacle. Eisman waspredisposed to suspect theworst of whatever GoldmanSachs might be doing with

the debts of lower-middle-class Americans. "You havetounderstand,"hesays."Ididsubprime first. I lived withthe worst first. These guyslied to infinity. What Ilearned from that experiencewas that Wall Street didn'tgiveashitwhatitsold."Whathe couldn't understand waswho was buying the bondsfrom this second wave ofsubprime mortgage lending."The very first day,we said,

'There'sgoingtocomeatimewhen we're going to make afortuneshortingthisstuff.It'sgoing to blow up. We justdon'tknowhoworwhen.'"

By "this stuff," Eismanmeant the stocks ofcompanies involved insubprime lending. Stockprices could do all sorts ofcrazy things: He didn't wantto short them until the loansstarted going bad. To thatend, Vinny kept a close eye

on the behavior of theAmericansubprimemortgageborrower.Onthetwenty-fifthofeachmonth,theremittancereports arrived on hiscomputer screen, and hescannedthemforanyupticksin delinquencies. "Accordingto the things we weretracking," says Vinny, "thecredit quality was still good.At least until the secondhalfof2005."

In the fog of the first

eighteen months of runninghisownbusiness,Eismanhadan epiphany, an identifiablemoment when he realizedhe'd been missing somethingobvious.Here hewas, tryingto figure outwhich stocks topick,butthefateofthestocksdepended increasingly on thebonds. As the subprimemortgagemarketgrew,everyfinancial company was, onewayoranother,exposedtoit."The fixed income world

dwarfs the equity world," hesaid."Theequityworldislikeafuckingzitcomparedtothebond market." Just aboutevery major Wall Streetinvestment bank waseffectively run by its bonddepartments. In most cases--Dick Fuld at LehmanBrothers, John Mack atMorgan Stanley, JimmyCayne at Bear Stearns--theCEOwasaformerbondguy.Ever since the 1980s, when

the leading bond firm,SalomonBrothers, hadmadesomuchmoneythatitlookedas if it was in a differentindustry than theother firms,the bond market had beenwhere the big money wasmade. "It was the goldenrule," said Eisman. "Thepeople who have the goldmaketherules."

Most people didn'tunderstand how whatamounted to a two-decade

boominthebondmarkethadoverwhelmedeverythingelse.Eismancertainlyhadn't.Nowhe did. He needed to learneverythinghecouldaboutthefixed income world. He hadplans for the bond market.Whathedidn'tknowwasthatthe bond market also hadplansforhim.Itwasabouttocreate an Eisman-shapedhole.

CHAPTERTWO

IntheLandoftheBlind

Writing a check separatesa commitment from aconversation.

--WarrenBuffett

Inearly2004anotherstock

market investor, MichaelBurry, immersed himself forthe first time in the bondmarket. He learned all hecould about how money gotborrowed and lent inAmerica. He didn't talk toanyone about what becamehisnewobsession;hejustsatalone in his office, in SanJose, California, and readbooks and articles andfinancial filings. He wantedto know, especially, how

subprime mortgage bondsworked. A giant number ofindividual loans got piled upinto a tower. The top floorsgottheirmoneybackfirstandso got the highest ratingsfrom Moody's and S&P andthe lowest interest rate. Thelow floors got their moneyback last, suffered the firstlosses, and got the lowestratings from Moody's andS&P. Because they weretaking on more risk, the

investorsinthebottomfloorsreceived a higher rate ofinterest than investors in thetop floors. Investors whobought mortgage bonds hadto decide in which floor ofthe tower they wanted toinvest, but Michael Burrywasn't thinking about buyingmortgage bonds. He waswondering how he mightshort subprime mortgagebonds.

Every mortgage bond

came with its own mind-numbingly tedious 130-pageprospectus. If you read thefine print, you saw that eachwasitsownlittlecorporation.Burry spent the end of 2004and early 2005 scanninghundredsandactuallyreadingdozens of them, certain hewas the only one apart fromthelawyerswhodraftedthemto do so--even though youcouldget themallfor$100ayear from 10K Wizard.com.

Asheexplainedinane-mail:

So you take somethinglike NovaStar, which wasan originate and sellsubprimemortgagelender,an archetype at the time.The names [of the bonds]would be NHEL 2004-1,NHEL 2004-2, NHEL2004-3, NHEL 2005-1,etc. NHEL 2004-1 wouldfor instance contain loans

from the first fewmonthsof 2004 and the last fewmonthsof2003,and2004-2 would have loans fromthemiddlepart,and2004-3wouldget the latterpartof 2004. You could pullthese prospectuses, andjust quickly check thepulse of what washappeninginthesubprimemortgage portion of theoriginate-and-sellindustry.And you'd see that 2/28

interest only ARMmortgages were only5.85%ofthepoolinearly2004, but by late 2004they were 17.48% of thepool, and by late summer2005 25.34% of the pool.Yet average FICO[consumer credit] scoresforthepool,percentofno-doc ["Liar"] loan to valuemeasures and otherindicators were prettystatic.... The point is that

thesemeasures could stayroughly static, but theoverall pool of mortgagesbeing issued, packagedand sold off wasworsening in quality,because for the sameaverage FICO scores orthe same average loan tovalue, you were getting ahigher percentage ofinterestonlymortgages.

Asearlyas2004, ifyoulooked at the numbers, youcould clearly see the declinein lending standards. InBurry's view, standards hadnotjustfallenbuthitbottom.Thebottomevenhadaname:the interest-only negative-amortizing adjustable-ratesubprimemortgage.You, thehome buyer, actually weregiven the option of payingnothing at all, and rollingwhatever interest you owed

the bank into a higherprincipal balance. It wasn'thard to see what sort ofperson might like to havesuch a loan: one with noincome.What Burry couldn'tunderstandwaswhyapersonwho lent money would wanttoextendsucha loan. "Whatyou want to watch are thelenders, not the borrowers,"he said. "The borrowers willalways be willing to take agreatdeal for themselves. It's

up to the lenders to showrestraint, andwhen they loseit, watch out." By 2003 heknew that the borrowers hadalreadylost it.Byearly2005hesawthatlendershad,too.

A lot of hedge fundmanagers spent timechitchatting with theirinvestors and treated theirquarterly letters to them as aformality. Burry dislikedtalking topeople face-to-faceandthoughtoftheselettersas

the single most importantthing he did to let hisinvestors know what he wasup to. In his quarterly lettershecoinedaphrasetodescribewhat he thought washappening: "the extension ofcreditbyinstrument."Thatis,a lot of people couldn'tactually afford to pay theirmortgages the old-fashionedway,andso the lendersweredreamingupnewinstrumentsto justify handing them new

money. "It was a clear signthat lenders had lost it,constantly degrading theirown standards to grow loanvolumes," Burry said. Hecould see why they weredoing this: They didn't keepthe loans but sold them toGoldman Sachs and MorganStanley andWells Fargo andthe rest, which packagedthem into bonds and soldthem off. The end buyers ofsubprime mortgage, he

assumed, were just "dumbmoney." He'd study up onthem,too,butlater.

He now had a tacticalinvestment problem. Thevariousfloors,ortranches,ofsubprimemortgage bonds allhad one thing in common:Thebondswereimpossibletosell short. To sell a stock orbond short, you needed toborrow it, and these tranchesofmortgage bondswere tinyand impossible to find. You

could buy them or not buythem, but you couldn't betexplicitly against them; themarket for subprimemortgages simply had noplace for people in it whotookadimviewofthem.Youmight know with certaintythat the entire subprimemortgage bond market wasdoomed, but you could donothingaboutit.Youcouldn'tshorthouses.Youcouldshortthe stocks of home building

companies--Pulte Homes,say,orTollBrothers--butthatwas expensive, indirect, anddangerous.Stockpricescouldrise for a lot longer thanBurrycouldstaysolvent.

A couple of yearsearlier,he'ddiscoveredcreditdefault swaps. A creditdefault swap was confusingmainly because it wasn'treallyaswapatall.Itwasaninsurancepolicy,typicallyona corporate bond, with

semiannual premiumpayments and a fixed term.For instance, you might pay$200,000ayeartobuyaten-year credit default swap on$100 million in GeneralElectricbonds.Themostyoucould lose was $2 million:$200,000ayearfortenyears.The most you could makewas $100million, ifGeneralElectric defaulted on its debtanytimeinthenexttenyearsand bondholders recovered

nothing. It was a zero-sumbet: If you made $100million,theguywhohadsoldyou the credit default swaplost$100million.Itwasalsoanasymmetricbet,likelayingdownmoneyonanumber inroulette. Themost you couldlose were the chips you puton the table; but if yournumber came up you madethirty, forty, even fifty timesyour money. "Credit defaultswaps remedied the problem

of open-ended risk for me,"said Burry. "If I bought acredit default swap, mydownside was defined andcertain, and the upside wasmanymultiplesofit."

He was already in themarket for corporate creditdefault swaps. In 2004 hebegan to buy insurance oncompanies he thought mightsuffer in a real estatedownturn: mortgage lenders,mortgageinsurers,andsoon.

This wasn't entirelysatisfying. A real estatemarketmeltdownmightcausethese companies to losemoney; there was noguarantee that they wouldactually go bankrupt. Hewantedamoredirect toolforbetting against subprimemortgage lending.OnMarch19, 2005, alone in his officewith the door closed and theshades drawn, reading anabstruse textbook on credit

derivatives, Michael Burrygot an idea: credit defaultswaps on subprimemortgagebonds.

The idea hit him as heread a book about theevolution of the U.S. bondmarket and the creation, inthe mid-1990s, at J.P.Morgan,ofthefirstcorporatecreditdefaultswaps.Hecameto a passage explaining whybanks felt they needed creditdefaultswapsatall. Itwasn't

immediately obvious--afterall, thebestway toavoid therisk of General Electric'sdefaultingonitsdebtwasnotto lend toGeneralElectric inthe first place. In thebeginning, credit defaultswaps had been a tool forhedging: Some bank hadloanedmorethantheywantedto General Electric becauseGEhadaskedforit,andtheyfeared alienating a long-standing client; another bank

changed its mind about thewisdom of lending to GE atall. Very quickly, however,the new derivatives becametoolsforspeculation:Alotofpeople wanted to make betson the likelihood of GE'sdefaulting. It struck Burry:WallStreetisboundtodothesame thing with subprimemortgage bonds, too. Givenwhat was happening in thereal estatemarket--and givenwhat subprime mortgage

lenders were doing--a lot ofsmartpeople eventuallyweregoing to want to make sidebets on subprime mortgagebonds. And the only way todoitwouldbetobuyacreditdefaultswap.

The credit default swapwould solve the singlebiggest problem with MikeBurry's big idea: timing.Thesubprime mortgage loansbeing made in early 2005were, he felt, almost certain

togobad.Butastheirinterestratesweresetartificiallylow,anddidn'tresetfortwoyears,itwould be twoyears beforethat happened. Subprimemortgages almost alwaysbore floating interest rates,butmostofthemcamewithafixed, two-year "teaser" rate.A mortgage created in early2005 might have a two-year"fixed"rateof6percent that,in 2007, would jump to 11percent and provoke a wave

of defaults. The faint tickingsound of these loans wouldgrow louder with time, untileventually a lot of peoplewould suspect, as hesuspected, that they werebombs. Once that happened,no one would be willing tosell insurance on subprimemortgage bonds. He neededto lay his chips on the tablenow and wait for the casinoto wake up and change theodds of the game. A credit

default swap on a thirty-yearsubprimemortgagebondwasa bet designed to last forthirty years, in theory. Hefigured that it would takeonlythreetopayitoff.

The only problem wasthat there was no such thingas a credit default swapon asubprimemortgagebond,notthat he could see. He'd needto prod the big Wall Streetfirms to create them. Butwhich firms? If he was right

and the housing marketcrashed, these firms in themiddle of the market weresure to lose a lot of money.There was no point buyinginsurance from a bank thatwent out of business theminute the insurance becamevaluable. He didn't evenbother calling Bear StearnsandLehmanBrothers,astheywere more exposed to themortgage bond market thanthe other firms. Goldman

Sachs, Morgan Stanley,Deutsche Bank, Bank ofAmerica, UBS, MerrillLynch,andCitigroupwere,tohis mind, the most likely tosurvive a crash. He calledthemall.Fiveofthemhadnoidea what he was talkingabout; two came back andsaid that, while the marketdidn'texist, itmightoneday.Inside of three years, creditdefault swaps on subprimemortgage bonds would

become a trillion-dollarmarket and precipitatehundreds of billions ofdollars'worthoflossesinsidebig Wall Street firms. Yet,whenMichaelBurrypesteredthe firms in the beginning of2005, only Deutsche Bankand Goldman Sachs had anyreal interest incontinuingtheconversation.NooneonWallStreet,asfarashecouldtell,sawwhathewasseeing.

He sensed that he wasdifferent from other peoplebefore he understood why.When he was two years oldhe'ddevelopedarareformofcancer, and the operation toremove the tumor had costhim his left eye.A boywithone eye sees the worlddifferently than everyoneelse,butitdidn'ttakelongforMike Burry to see his literaldistinction inmore figurativeterms. Grown-ups were

forever insisting that heshould look other people inthe eye, especially when hewas talking to them. "It tookall my energy to looksomeoneintheeye,"hesaid."IfIamlookingatyou,that'sthe one time I know I won'tbe listening to you." His lefteye didn't line up withwhomever he was trying totalkto;whenhewasinsocialsituations trying to makechitchat, theperson towhom

he was speaking wouldsteadily drift left. "I don'treally know how to stop it,"he said, "so people just keepmoving left until they'restandingway tomy left, andI'mtryingnottoturnmyheadanymore. I end up facingrightandlookingleftwithmygoodeye,throughmynose."

His glass eye, heassumed,was the reason thatface-to-face interaction withother people almost always

ended badly for him. Hefounditmaddeninglydifficultto read people's nonverbalsignals; and their verbalsignals he often took moreliterally than they meantthem.Whentryinghisbesthewas often at his worst. "Mycompliments tended not tocome out right," he said. "Ilearned early that if youcompliment somebody it'llcome out wrong. For yoursize, you look good. That's a

really nice dress: It lookshomemade. The glass eyebecame his privateexplanationforwhyhehadn'treally fit inwithgroups.Theeye oozed and wept andrequiredconstantattention. Itwasn't the sort of thing otherkids ever allowed him to beunselfconscious about. Theycalled him cross-eyed, eventhoughthewasn't.Everyyearthey begged him to pop hiseye out of its socket--but

whenhecomplied, itbecameinfectedanddisgustingandacauseoffurtherostracism.

Inhisglasseyehefoundthe explanation for othertraitspeculiar tohimself.Hisobsession with fairness, forexample. When he noticedthatprobasketballstarswerefarlesslikelytobecalledfortraveling than lesser players,he didn't just holler at therefs. He stopped watchingbasketball altogether; the

injustice of it killed hisinterest in the sport. Eventhough he was ferociouslycompetitive, well built,physically brave, and a goodathlete, he didn't care forteam sports. The eye helpedto explain this, asmost teamsportswereballsports,andaboy with poor depthperception and limitedperipheral vision couldn'tverywellplayballsports.Hetried hard at the less ball-

centric positions in football,but his eye popped out if hehitsomeonetoohard.

Again, it was hard forhimtoseewherehisphysicallimitations ended and hispsychologicalonesbegan--heassumed theglasseyewasatthe bottom of both. Hecouldn't stand the unfairnessofcoacheswho favored theirown kids. Umpires whomissed calls drove him todistraction. He preferred

swimming, as it requiredvirtuallynosocialinteraction.Noteammates.Noambiguity.Youjustswamyourtimeandyouwonoryoulost.

After a while even heceased to find it surprisingthathespentmostofhistimealone.Byhislatetwentieshethoughtofhimselfasthesortof person who didn't havefriends. He'd gone throughSanta Teresa High School inSan Jose, UCLA, and

Vanderbilt University SchoolofMedicineandcreatednotasingle lasting bond. Whatfriendships he did havewereformed and nurtured inwriting, by e-mail; the twopeople he considered to betruefriendshehadknownfora combined twenty years buthad met in person a grandtotal of eight times. "Mynatureisnottohavefriends,"he said. "I'm happy in myown head." Somehow he'd

married twice. His first wifewas a woman of Koreandescentwhowounduplivinginadifferentcity ("sheoftencomplainedthatIappearedtoliketheideaofarelationshipmore than living the actualrelationship")andhissecond,towhomhewasstillmarried,was a Vietnamese-Americanwoman he'd met onMatch.com.InhisMatch.comprofile, he described himselffranklyas "amedical student

with only one eye, anawkward social manner, and$145,000 in student loans."His obsession with personalhonesty was a cousin to hisobsessionwithfairness.

Obsessiveness--that wasanothertraithecametothinkofaspeculiar tohimself.Hismindhadno temperatezone:Hewaseitherpossessedbyasubject or not interested in itat all. There was an obviousdownside to this quality--he

had more trouble than mostfaking interest in otherpeople's concerns andhobbies, for instance--but anupside, too. Even as a smallchildhehadafantasticabilityto focus and learn, with orwithout teachers. When itsynced with his interests,schoolcameeasyforhim--soeasythat,asanundergraduateatUCLA, he could flip backand forth between Englishand economics and pick up

enough premedical trainingon the side to get himselfadmitted to the best medicalschools in the country. Heattributedhisunusualpowersofconcentrationtohislackofinterest inhuman interaction,and his lack of interest inhuman interaction...well, hewas able to argue thatbasically everything thathappened was caused, onewayor theother,byhis fakelefteye.

Thisability toworkandto focus set him apart evenfrom other medical students.In 1998, as a resident inneurology at StanfordHospital,hementionedtohissuperiors that, betweenfourteen-hour hospital shifts,he had stayed up two nightsin a row taking apart andputting back together hispersonal computer in anattempt tomake it run faster.His superiors sent him to a

psychiatrist, who diagnosedMike Burry as bipolar. Heknew instantly he'd beenmisdiagnosed: How couldyou be bipolar if you werenever depressed? Or, rather,if you were only depressedwhile doing your rounds andpretending tobe interested inpracticing, as opposed tostudying, medicine? He'dbecome a doctor not becausehe enjoyed medicine butbecause he didn't find

medical school terriblydifficult. The actual practiceof medicine, on the otherhand, either bored ordisgusted him. Of his firstbrush with gross anatomy:"One scene with peoplecarrying legs over theirshoulders to thesink towashout the feces just turned mystomach,andIwasdone."Ofhisfeelingaboutthepatients:"Iwantedtohelppeople--butnotreally."

He was genuinelyinterested in computers, notfor their own sake but fortheir service to a lifelongobsession:theinnerworkingsof the stock market. Eversince grade school,when hisfather had shown him thestocktablesatthebackofthenewspaper and told him thatthe stock market was acrookedplaceandnevertobetrusted, let alone invested in,the subject had fascinated

him. Even as a kid he hadwanted to impose logic onthis world of numbers. Hebegan to read about themarket as a hobby. Prettyquicklyhesawthattherewasno logic at all in the chartsandgraphsandwavesandtheendless chatter ofmany self-advertisedmarket pros.Thenalong came the dot-combubble and suddenly theentire stock market made nosenseatall."Thelatenineties

almost forced me to identifymyself as a value investor,because I thought whateverybody else was doingwas insane," he said.Formalizedasanapproachtofinancial markets during theGreat Depression byBenjamin Graham, "valueinvesting" required a tirelesssearch for companies sounfashionable ormisunderstoodthattheycouldbe bought for less than their

liquidation value. In itssimplestformvalueinvestingwas a formula, but it hadmorphed into other things--one of them was whateverWarren Buffett, BenjaminGraham's student, and themost famous value investor,happenedtobedoingwithhismoney.

Burry did not thinkinvestingcouldbereducedtoaformulaorlearnedfromanyone rolemodel.Themorehe

studied Buffett, the less hethought Buffett could becopied; indeed, the lesson ofBuffettwas:To succeed in aspectacular fashion you hadto be spectacularly unusual."Ifyouaregoingtobeagreatinvestor, you have to fit thestyle towho you are," Burrysaid. "At one point Irecognized that WarrenBuffett, though he had everyadvantage in learning fromBen Graham, did not copy

Ben Graham, but rather setoutonhisownpath, and ranmoney his way, by his ownrules.... I also immediatelyinternalized the idea that noschool could teach someonehowtobeagreat investor.Ifit were true, it'd be themostpopular school in the world,with an impossibly hightuition. So it must not betrue."

Investingwassomethingyouhadtolearnhowtodoon

your own, in your ownpeculiar way. Burry had noreal money to invest, but henevertheless dragged hisobsession along with himthrough high school, college,and medical school. He'dreached Stanford Hospitalwithoutevertakingaclassinfinance or accounting, letalone working for any WallStreet firm. He had maybe$40,000 in cash, against$145,000instudentloans.He

had spent the previous fouryears working medicalstudent hours. Nevertheless,he had found time to makehimself a financial expert ofsorts. "Time is a variablecontinuum," he wrote to oneof his e-mail friends, oneSundaymorningin1999:

Anafternooncanflybyorit can take 5 hours. Likeyou probably do, I

productively fill the gapsthat most people leave asdead time.Mydrive tobeproductive probably costmemyfirstmarriageandafew days ago almost costme my fiancee. Before Iwent to college themilitary had this "we domore before 9am thanmost people do all day"and I used to think and Idomorethanthemilitary.As you know there are

some select people thatjust findadrive incertainactivities that supersedesEVERYTHINGelse.

He wasn't bipolar. Hewas merely isolated andapart,withoutactuallyfeelinglonelyordeeplyunhappy.Hedidn't regard himself as atragedy; he thought, amongother things, that his unusualpersonality enabled him to

concentrate better than otherpeople.All of it followed, inhis mind, from the warpingeffectsofhisfakeeye."That'swhyIthoughtpeoplethoughtI was different," he said."That's why I thought I wasdifferent." Thinking himselfdifferent, he didn't find whathappened to him when hecollided with Wall Streetnearlyasbizarreasitwas.

Late one night inNovember 1996, while on a

cardiology rotation at St.Thomas Hospital, inNashville, Tennessee, helogged on to a hospitalcomputer and went to amessage board calledtechstocks.com. There hecreated a thread called valueinvesting. Having readeverything there was to readaboutinvesting,hedecidedtolearn a bit more about"investing in the realworld."A mania for Internet stocks

grippedthemarket.Asiteforthe Silicon Valley investor,circa1996,wasnot anaturalhome for a sober-mindedvalue investor. Still, manycame, all with opinions. Afew people grumbled aboutthe very idea of a doctorhavinganythingusefultosayabout investments, but overtimehecametodominatethediscussion.Dr.MikeBurry--ashealwayssignedhimself--sensed that other people on

the thread were taking hisadvice and making moneywithit.

Once he figured out hehad nothing more to learnfromthecrowdonhisthread,hequit it tocreatewhat laterwouldbecalledablogbutatthe time was just a weirdform of communication. Hewas working sixteen-hourshifts at the hospital,confininghisbloggingmainlyto the hours between

midnight and three in themorning. On his blog hepostedhisstockmarkettradesandhisargumentsformakingthetrades.Peoplefoundhim.AsamoneymanageratabigPhiladelphia value fund said,"The first thing I wonderedwas,When is he doing this?Theguywasamedicalintern.I only saw the nonmedicalpart of his day, and it wassimply awesome. He'sshowing people his trades.

Andpeoplearefollowingitinreal time. He's doing valueinvesting--in the middle ofthe dot-com bubble. He'sbuyingvaluestocks,whichiswhat we're doing. But we'relosing money. We're losingclients. All of a sudden hegoesonthistear.He'supfiftypercent. It's uncanny. He'suncanny. And we're not theonlyoneswatchingit."

MikeBurry couldn't seeexactly who was following

his financial moves, but hecouldtellwhichdomainstheycame from. In the beginninghis readers came fromEarthLink and AOL. Justrandom individuals. Prettysoon, however, they weren't.People were coming to hissite from mutual funds likeFidelity and big Wall Streetinvestment banks likeMorgan Stanley.One day helit into Vanguard's indexfunds and almost instantly

received a cease and desistorder from Vanguard'sattorneys. Burry suspectedthat serious investors mighteven be acting on his blogposts,buthehadnoclearideawho they might be. "Themarket found him," says thePhiladelphia mutual fundmanager. "He wasrecognizing patterns no oneelsewasseeing."

By the time Burrymoved to Stanford Hospital

in 1998 to take up hisresidency in neurology, thework he had done betweenmidnight and three in themorning had made him aminor butmeaningful hub inthe land of value investing.By this time the craze forInternet stocks wascompletelyoutofcontrolandhad infected the StanfordUniversity medicalcommunity."Theresidentsinparticular, and some of the

faculty, were captivated bythe dot-com bubble," saidBurry. "Adecentminority ofthem were buying anddiscussing everything--Polycom, Corel, Razorfish,Pets.com,TIBCO,Microsoft,Dell, Intel are the ones Ispecifically remember, butareyoukiddingme-dot-comwas howmy brain filtered alot of it.... I would just keepmy mouth shut, because Ididn't want anybody there

knowingwhatIwasdoingonthe side. I felt I could get inbig trouble if the doctorsthere saw I wasn't onehundred and ten percentcommittedtomedicine."

Peoplewhoworryaboutseeming sufficientlycommitted to medicineprobably aren't sufficientlycommitted to medicine. Thedeeperhegotintohismedicalcareer, the more Burry feltconstrained by his problems

withotherpeopleintheflesh.He briefly tried to hide inpathology, where the peoplehad the decency to be dead,but that didn't work. ("Deadpeople,deadparts.Moredeadpeople, more dead parts. Ithought, I want somethingmorecerebral.")

He'dmovedbacktoSanJose, buried his father,remarried, and beenmisdiagnosed by experts asbipolar when he shut down

his Web site and announcedhe was quitting neurology tobecome a money manager.ThechairmanoftheStanfordDepartment of Neurologythoughthe'dlosthismindandtold him to take a year tothinkitover,buthe'dalreadythought it over. "I found itfascinating and seeminglytrue,"hesaid,"thatifIcouldrun a portfolio well, then Icouldachieve success in life,and that it wouldn't matter

what kind of person I wasperceived to be, even thoughI felt I was a good persondeep down." His $40,000 inassets against $145,000 instudent loans posed thequestion of exactly whatportfolio he would run. Hisfather had died after anothermisdiagnosis: A doctor hadfailedtospotthecanceronanX-ray, and the family hadreceived a small settlement.Thefatherdisapprovedofthe

stock market, but the payoutfromhisdeathfundedhissonintoit.Hismotherwasabletokick in $20,000 from hersettlement, his three brotherskicked in $10,000 each oftheirs.Withthat,Dr.MichaelBurry opened Scion Capital.(Asaboyhe'dlovedthebookThe Scions of Shannara.) Hecreated a grandiosememo tolurepeoplenotrelatedtohimbyblood. "Theminimumnetworthforinvestorsshouldbe

$15 million," it said, whichwasinteresting,asitexcludednotonlyhimselfbutbasicallyeveryonehe'deverknown.

As he scrambled to findoffice space, buy furniture,and open a brokerageaccount,hereceivedapairofsurprising phone calls. Thefirst came from a biginvestmentfundinNewYorkCity, Gotham Capital.Gotham was founded by avalue investmentgurunamed

Joel Greenblatt. Burry hadread Greenblatt's book YouCan Be a Stock MarketGenius. ("Ihatedthetitlebutliked thebook.")Greenblatt'speopletoldhimthattheyhadbeen making money off hisideas for some time andwantedtocontinuetodoso--might Mike Burry considerallowingGothamto invest inhis fund? "Joel Greenblatthimself called and said, 'I'vebeenwaitingforyoutoleave

medicine.'" Gotham flewBurry and his wife to NewYork--and it was the firsttime Michael Burry hadflown toNewYorkor flownfirst-class--andputhimup ina suiteat the IntercontinentalHotel.

On his way to hismeeting with Greenblatt,Burry was wracked with theanxiety that always plaguedhim before face-to-faceencounters with people. He

tooksomecomfortinthefactthat the Gotham peopleseemedtohavereadsomuchof what he had written. "Ifyou read what I wrote first,and then meet me, themeeting goes fine," he said."People who meet me whohaven't read what I wrote--italmostnevergoeswell.Evenin high school it was likethat--evenwith teachers."Hewasawalkingblindtastetest:You had to decide if you

approved of him before youlaideyesonhim.Inthiscasehe was at a seriousdisadvantage, as he had noclue how big-time moneymanagers dressed. "He callsme the day before themeeting," says one of his e-mail friends, himself aprofessionalmoneymanager."Andheasks, 'WhatshouldIwear?'Hedidn'townatie.Hehad one blue sports coat, forfunerals." This was another

quirk of Mike Burry's. Inwriting he presented himselfformally, even a bit stuffily,but he dressed for the beach.Walking to Gotham's office,he panicked and ducked intoaTieRackandboughtatie.

He arrived at the bigNew York moneymanagementfirmasformallyattiredashehadeverbeeninhis entire life to find itspartners in t-shirts andsweatpants. The exchange

wentsomethinglikethis."We'dliketogiveyoua

milliondollars.""Excuseme?""We want to buy a

quarter of your new hedgefund.Foramilliondollars."

"Youdo?""Yes. We're offering a

milliondollars.""Aftertax!"Somehow Burry had it

in his mind that one day hewanted tobeworthamillion

dollars,aftertax.Atanyrate,he'd just blurted that last bitout before he fullyunderstood what they wereafter. And they gave it tohim!At thatmoment, on thebasisofwhathe'dwrittenonhisblog,hewent frombeingan indebted medical studentwith a net worth of minus$105,000 to a millionairewithafewoutstandingloans.Burry didn't know it, but itwas the first time Joel

Greenblatt had done such athing."Hewasjustobviouslythis brilliant guy, and therearen't that many of them,"saysGreenblatt.

Shortly after that oddencounter,hehadacallfromthe insurance holdingcompany White Mountains.WhiteMountainswas runbyJack Byrne, a member ofWarrenBuffett's inner circle,and they had spoken toGotham Capital. "We didn't

knowyouweresellingpartofyour firm," they said--andBurryexplainedthathedidn'trealize it either until a fewdays earlier, when someoneofferedamilliondollars,aftertax, for it. It turned out thatWhite Mountains, too, hadbeenwatchingMichaelBurryclosely. "What intrigued usmore than anything was thathewasaneurologyresident,"says Kip Oberting, then atWhiteMountains. "When the

hellwashedoingthis?"FromWhiteMountainsheextracted$600,000 for a smaller pieceofhisfund,plusapromisetosend him $10 million toinvest. "And yes," saidOberting, "he was the onlyperson we found on theInternet and cold-called andgavehimmoney."

InDr.MikeBurry'sfirstyear in business, hegrappledbriefly with the socialdimensionofrunningmoney.

"Generally you don't raiseanymoneyunlessyouhaveagood meeting with people,"hesaid,"andgenerallyIdon'twant to be around people.Andpeoplewhoarewithmegenerallyfigurethatout."Hewent to a conference thrownby Bank of America tointroducenewfundmanagersto wealthy investors, andthose who attended figuredthat out. He gave a talk inwhichhearguedthattheway

they measured risk wascompletely idiotic. Theymeasured risk by volatility:how much a stock or bondhappened to have jumpedaround in thepast fewyears.Real risk was not volatility;real risk was stupidinvestment decisions. "Byandlarge,"helaterputit,"thewealthiestofthewealthyandtheir representatives haveaccepted that most managersare average, and the better

ones are able to achieveaverage returns whileexhibiting below-averagevolatility. By this logic adollar selling for fifty centsone day, sixty cents the nextday, and forty cents the nextsomehowbecomesworthlessthan a dollar selling for fiftycents all three days. I wouldarguethattheabilitytobuyatforty cents presentsopportunity,notrisk,andthatthe dollar is still worth a

dollar." He was greeted bysilence and ate lunch alone.Hesatatoneofthebigroundtables just watching thepeople at the other tableshappilyjabberaway.

When he spoke topeople in the flesh, he couldnever tellwhat had put themoff, his message or hisperson. He'd made a closestudyofWarrenBuffett,whohadsomehowmanaged tobeboth wildly popular and

hugely successful. Buffetthad had trouble with people,too,inhisyouth.He'dusedaDaleCarnegiecoursetolearnhow to interact moreprofitably with his fellowhuman beings. Mike Burrycame of age in a differentmoney culture. The InternethaddisplacedDaleCarnegie.He didn't need to meetpeople. He could explainhimself online and wait forinvestors to find him. He

could write up his elaboratethoughts and wait for peopleto read them and wire himtheir money to handle."Buffett was too popular forme,"saidBurry."Iwon'teverbe a kindly grandfatherfigure."

This method ofattracting funds suited MikeBurry. More to the point, itworked. He'd started ScionCapitalwithabitmorethanamillion dollars--the money

fromhismotherandbrothersandhisownmillion,aftertax.Inhisfirstfullyear,2001,theS&P 500 fell 11.88 percent.Scionwasup55percent.Thenext year, the S&P 500 fellagain, by 22.1 percent, andyet Scion was up again: 16percent.Thenextyear,2003,the stock market finallyturnedaroundandrose28.69percent, butMikeBurrybeatit again--his investments roseby50percent.By theendof

2004, Mike Burry wasmanaging $600 million andturningmoneyaway."Ifhe'drunhis fund tomaximize theamount he had undermanagement, he'd have beenrunningmany, many billionsofdollars,"saysaNewYorkhedge fund manager whowatchedBurry's performancewithgrowingincredulity."HedesignedScionso itwasbadfor business but good forinvesting."

"While capital raisingmaybeapopularitycontest,"Burry wrote to his investors,perhaps to reassure themthatit didn't matter if they lovedtheirmoneymanager,orevenknew him, "intelligentinvestment is quite theopposite."

Warren Buffett had anacerbic partner, CharlieMunger,whoevidentlycareda lot less than Buffett didabout whether people liked

him. Back in 1995, Mungerhad given a talk at HarvardBusiness School called "ThePsychology of HumanMisjudgment." Ifyouwantedto predict how people wouldbehave, Munger said, youonly had to look at theirincentives.FedExcouldn'tgetits night shift to finish ontime; they triedeverything tospeed it up but nothingworked--until they stoppedpayingnightshiftworkersby

the hour and started to paythem by the shift. Xeroxcreatedanew,bettermachineonly to have it sell less wellthan the inferior older ones--until they figured out thesalesmen got a biggercommission for selling theolderone."Well,youcansay,'Everybodyknowsthat,'"saidMunger."I thinkI'vebeen inthetopfivepercentofmyagecohort all my life inunderstanding the power of

incentives,andallmylifeI'veunderestimated it. And nevera year passes but I get somesurprise that pushesmy limitalittlefarther."

Munger's remarksarticulated a great deal ofwhat Mike Burry, too,believed about markets andthe people who comprisedthem."IreadthatspeechandI said, I agree with everysingle word of that," Burrysaid, adding, "Munger also

hasafakeeye."Burryhadhisown angle on this samesubject,derivedfromthetimehe'd spent inmedicine. Evenin life or death situations,doctors, nurses, and patientsall responded to badincentives. In hospitals inwhich the reimbursementrates for appendectomies ranhigher, for instance, thesurgeons removed moreappendixes.The evolution ofeyesurgerywasanothergreat

example. In the 1990s, theophthalmologists werebuilding careers onperforming cataractprocedures. They'd take halfan hour or less, and yetMedicare would reimbursethem$1,700apop.Inthelate1990s, Medicare slashedreimbursement levels toaround $450 per procedure,and the incomes of thesurgically mindedophthalmologists fell. Across

America, ophthalmologistsrediscovered an obscure andrisky procedure called radialkeratotomy, and there was aboom in surgery to correctsmall impairments of vision.The inadequately studiedprocedurewasmarketed as acure for the suffering ofcontact lens wearers. "Inreality," says Burry, "theincentive was to maintaintheir high, often one-to two-million-dollar incomes, and

the justification followed.The industry rushed to comeup with something lessdangerous than radialkeratotomy, and Lasik waseventuallyborn."

Thus when Mike Burrywent into business he madesure that he had the properincentives.Hedisapprovedofthe typical hedge fundmanager's deal. Taking 2percent of assets off the top,asmostdid,meant thehedge

fundmanagergotpaidsimplyforamassingvastamountsofother people's money. ScionCapital charged investorsonly its actual expenses--which typically ran wellbelow1percentoftheassets.To make the first nickel forhimself, he had to makeinvestors' money grow."Think about the genesis ofScion," says one of his earlyinvestors. "The guy has nomoney and he chooses to

forgo a fee that any otherhedgefund takes forgranted.Itwasunheardof."

Right from the start,Scion Capital was madly,almost comically, successful.Bythemiddleof2005,overaperiod in which the broadstockmarketindexhadfallenby6.84percent,Burry's fundwas up 242 percent and hewas turning away investors.To his swelling audience, itdidn'tseemtomatterwhether

the stockmarket roseor fell;Mike Burry found places toinvest money shrewdly. Heusednoleverageandavoidedshortingstocks.Hewasdoingnothingmore promising thanbuying common stocks andnothing more complicatedthansittinginaroomreadingfinancial statements. Forroughly $100 a year hebecame a subscriber to 10-KWizard. Scion Capital'sdecision-making apparatus

consisted of one guy in aroom, with the door closedand theshadesdrawn,poringover publicly availableinformationanddataon10-KWizard.Hewent looking forcourt rulings, dealcompletions, or governmentregulatory changes--anythingthat might change the valueofacompany.

Often as not, he turnedup what he called "ick"investments.InOctober2001,

he explained the concept inhis letter to investors: "Ickinvesting means taking aspecial analytical interest instocks that inspire a firstreactionof'ick.'"

The alarmingly namedAvant! Corporation was agood example. He'd found itsearching for the word"accepted" in news stories.Heknewthat,standingontheedge of the playing field, heneeded to find unorthodox

ways to tilt it to hisadvantage, and that usuallymeant finding unusualsituationstheworldmightnotbe fully aware of. "I wasn'tsearchingforanewsreportofa scam or fraud per se," hesaid. "That would have beentoo backward-looking, and Iwaslookingtogetinfrontofsomething. Iwas looking forsomething happening in thecourts that might lead to aninvestment thesis. An

argument being accepted, aplea being accepted, asettlement being accepted bythe court." A court hadaccepted a plea from asoftware company called theAvant! Corporation. Avant!had been accused of stealingfrom a competitor thesoftware code that was thewhole foundationofAvant!'sbusiness. The company had$100 million in cash in thebank, was still generating

$100 million a year of freecash flow--and had a marketvalue of only $250 million!Michael Burry starteddigging; by the time he wasdone,heknewmoreabouttheAvant! Corporation than anymanonearth.Hewasabletoseethateveniftheexecutiveswent to jail (as theydid)andthe fines were paid (as theywere),Avant!wouldbewortha lot more than the marketthen assumed. Most of its

engineers were Chinesenationals on work visas, andthus trapped--there was norisk that anyone would quitbeforethelightswereout.Tomake money on Avant!'sstock,however,he'dprobablyhave to stomach short-termlosses, as investors puked upsharesinhorrifiedresponsetonegativepublicity.

Burry bought his firstsharesofAvant!inJune2001at $12 a share. Avant!'s

management then appearedon the cover of an issue ofBusiness Week under theheadline "Does Crime Pay?"The stock plunged; Burrybought more. Avant!'smanagementwenttojail.Thestock fell some more. MikeBurry kept on buying it--alltheway down to $2 a share.He became Avant!'s singlelargest shareholder; hepressed management forchanges. "With [the former

CEO's] criminal aura nolonger a part of operatingmanagement,"hewrotetothenew bosses, "Avant! has achance to demonstrate itsconcern for shareholders." InAugust, inanothere-mail,hewrote,"Avant!stillmakesmefeel I'm sleeping with thevillage slut. No matter howwell my needs are met, Idoubt I'll ever brag about it.The 'creep' factor is off thecharts. I half think that if I

pushed Avant! too hard I'dendupbeingterrorizedbytheChinesemafia."Fourmonthslater, Avant! got taken overfor $22 a share. "Thatwas aclassic Mike Burry trade,"says one of his investors. "Itgoesupbytentimesbutfirstitgoesdownbyhalf."

Thisisn'tthesortofridemost investors enjoy, but itwas, Burry thought, theessence of value investing.His job was to disagree

loudly with popularsentiment.Hecouldn'tdothisifhewasatthemercyofveryshort-termmarketmoves,andsohedidn'tgivehisinvestorsthe ability to remove theirmoney on short notice, asmosthedge fundsdid. If yougave Scion your money toinvest, youwere stuck for atleast a year. Burry alsodesigned his fund to attractpeoplewhowantedtobelongthe stock market--who

wantedtobetonstocksgoingup rather than stocks goingdown. "I am not a short atheart," he said. "I don't diginto companies looking toshort them, generally. Iwantthe upside to be much morethan the downside,fundamentally." He alsodidn't like the idea of takingthe risk of selling a stockshort, as the risk was,theoretically, unlimited. Itcouldonly fall tozero,but it

couldrisetoinfinity.Investing well was all

about being paid the rightprice for risk. Increasingly,Burryfeltthathewasn't.Theproblem wasn't confined toindividual stocks. TheInternetbubblehadburst,andyet house prices inSan Jose,the bubble's epicenter, werestill rising. He investigatedthe stocks of home builders,and then the stocks ofcompanies that insured home

mortgages, like PMI. To oneofhisfriends--abig-timeEastCoast professional investor--hewroteinMay2003thatthereal estate bubble was beingdriven ever higher by theirrational behavior ofmortgage lenders who wereextending easy credit. "Youjust have to watch for thelevel at which even nearlyunlimited or unprecedentedcreditcannolongerdrivethe[housing] market higher," he

wrote. "I am extremelybearish, and feel theconsequences could veryeasily be a 50% drop inresidential real estate in theU.S.... A large portion ofcurrent [housing] demand atcurrent prices woulddisappear if only peoplebecameconvinced thatpricesweren't rising. The collateraldamage is likely tobeordersof magnitude worse thananyonenowconsiders."

When he set out to betagainst the subprimemortgage bond market, inearly 2005, the first bigproblem that he encounteredwas that the Wall Streetinvestment banks that mightsell him credit default swapsdidn't share his sense ofurgency.MikeBurrybelievedhehad toplace thisbetnow,before the U.S. housingmarket woke up and wasrestored to sanity. "I didn't

expect fundamentaldeterioration in theunderlyingmortgagepools tohitcriticallevelsforacoupleyears," he said--when theteaserrateswouldvanishandmonthly payments wouldskyrocket.Buthethoughtthemarket inevitably would seewhat he had seen and adjust.Someone on Wall Streetwould notice the fantasticincrease in the riskiness ofsubprimemortgagesandraise

the price of insuring themaccordingly. "It's going toblowupbefore Icanget thistrade on," he wrote in an e-mail.

As Burry lived his lifeby e-mail, he inadvertentlykeptarecordofthebirthofanewmarketfromthepointofview of its first retailcustomer. In retrospect, theamazing thing was just howquickly Wall Street firmswent from having no idea

whatMikeBurrywastalkingabout when he called andasked them about creditdefault swaps on subprimemortgagebonds,toreshapingtheir business in a way thatleftthenewderivativesmackat the center. The originalmortgage bond market hadcome into theworld inmuchthe same way, messily,coaxed into existence by theextreme interest of a smallhandful of people on the

margins of high finance. Butit had taken years for thatmarket to mature; this newmarket would be up andrunning and trading tens ofbillions of dollars' worth ofriskwithinafewmonths.

The first thing MikeBurryneeded,ifhewasgoingtobuyinsuranceonabigpileof subprimemortgagebonds,was to create some kind ofstandard,widelyagreed-uponcontract.Whoeversoldhima

credit default swap on asubprime mortgage bondwould one day owe him agreat deal of money. Hesuspected that dealers mighttry to get out of paying it tohim. A contract wouldmakeit harder for them to do that,and easier for him to sell toone dealer what he hadbought from another--andthus to shop around forprices.AnorganizationcalledInternational Swaps and

Derivatives Association(ISDA) had the task offormalizing the termsofnewsecurities.*ISDAalreadyhada set of rules in place togovern credit default swapson corporate bonds, butinsuranceoncorporatebondswas a relatively simplematter. Therewas this event,called a default, that eitherdid or did not happen. Thecompany missed an interestpayment, you had to settle.

The insurance buyer mightnot collect the full 100 centson the dollar--just as thebondholder might not lose100centsonthedollar,asthecompany's assets were worthsomething--but anindependent judge coulddecide, in a way that wasgenerally fair and satisfying,what the recovery would be.If the bondholders received30 cents on the dollar--thusexperiencing a loss of 70

cents--the guy who hadbought the credit defaultswapgot70cents.

Buying insurance on apoolofU.S.homemortgageswas more complicated,because the pool didn'tdefaultallatonce;rather,onehomeowner at a timedefaulted.Thedealers--ledbyDeutscheBankandGoldmanSachs--cameupwithacleversolution: the pay-as-you-gocredit default swap. The

buyer of the swap--the buyerof insurance--would be paidoff not all at once, if andwhen the entire pool ofmortgages went bust, butincrementally, as individualhomeowners went intodefault.

The ISDA agreementtook months of hagglingamong lawyers and tradersfrom the big Wall Streetfirms, who would run themarket.Burry'slawyer,Steve

Druskin,wasforsomereasonallowed to lurkon thephonecalls--andeven jump in fromtime to time and offer theWall Street customer's pointof view. Historically, aWallStreet firm worried over thecreditworthiness of itscustomers; its customersoften took iton faith that thecasino would be able to payoff its winners. Mike Burrylackedfaith."I'mnotmakingabetagainstabond,"hesaid.

"I'm making a bet against asystem." He didn't want tobuy flood insurance fromGoldman Sachs only to find,when the flood came,GoldmanSachswashedawayandunabletopayhimoff.Asthe value of the insurancecontract changed--say, asfloodwaters approached butbeforetheyactuallydestroyedthe building--he wantedGoldmanSachsandDeutscheBank to post collateral, to

reflecttheincreaseinvalueofwhatheowned.

On May 19, 2005--amonth before the termswerefinalized--MikeBurrydidhisfirst subprime mortgagedeals.Hebought$60millionin credit default swaps fromDeutsche Bank--$10 millioneach on six different bonds."The reference securities,"thesewere called.Youdidn'tbuy insurance on the entiresubprime mortgage bond

market but on a particularbond,andBurryhaddevotedhimselftofindingexactlytherightonestobetagainst.He'dread dozens of prospectusesand scoured hundreds more,lookingforthedodgiestpoolsof mortgages, and was stillpretty certain even then (anddeadcertainlater)thathewasthe only human being onearth who read them, apartfromthelawyerswhodraftedthem. In doing so, he likely

alsobecametheonlyinvestortodothesortofold-fashionedbank credit analysis on thehome loans that should havebeen done before they weremade.Hewastheoppositeofan old-fashioned banker,however.Hewaslookingnotforthebestloanstomakebutthe worst loans--so that hecouldbetagainstthem.

He analyzed the relativeimportance of the loan-to-value ratios of the home

loans, of second liens on thehomes, of the location of thehomes,oftheabsenceofloandocumentation and proof ofincomeoftheborrower,andadozen or so other factors todetermine the likelihood thatahomeloanmadeinAmericacirca 2005 would go bad.Thenhewent lookingfor thebondsbackedbytheworstofthe loans. It surprised himthat Deutsche Bank didn'tseem tocarewhichbondshe

picked to bet against. Fromtheir point of view, so far ashe could tell, all subprimemortgage bonds were thesame.The price of insurancewas driven not by anyindependent analysis but bytheratingsplacedonthebondby the rating agencies,Moody's and Standard &Poor's.* If he wanted to buyinsurance on the supposedlyriskless triple-A-ratedtranche, he might pay 20

basispoints(0.20percent);onthe riskier A-rated tranches,hemight pay 50 basis points(0.50 percent); and, on theeven less safe triple-B-ratedtranches, 200 basis points--that is, 2 percent. (A basispointisone-hundredthofonepercentagepoint.)The triple-B-rated tranches--the onesthat would be worth zero iftheunderlyingmortgagepoolexperienced a loss of just 7percent--were what he was

after.Hefeltthistobeaveryconservative bet, which hewasable,throughanalysis,toturnintoevenmoreofasurething. Anyone who evenglanced at the prospectusescould see that there weremany critical differencesbetween one triple-B bondand the next--the percentageof interest-only loanscontained in their underlyingpool of mortgages, forexample. He set out to

cherry-pick the absoluteworst ones, and was a bitworried that the investmentbankswould catch on to justhow much he knew aboutspecificmortgagebonds, andadjusttheirprices.

Onceagaintheyshockedand delighted him: GoldmanSachs e-mailed him a greatlong list of crappy mortgagebonds to choose from. "Thiswas shocking to me,actually," he says. "They

were all priced according tothelowestratingfromoneofthe big three ratingsagencies." He could pickfrom the listwithout alertingthem to the depth of hisknowledge. It was as if youcouldbuyflood insuranceonthehouseinthevalleyforthesamepriceasfloodinsuranceon the house on themountaintop.

The market made nosense, but that didn't stop

otherWall Street firms fromjumping into it, in partbecause Mike Burry waspesteringthem.Forweekshehounded Bank of Americauntil they agreed to sell him$5 million in credit defaultswaps. Twenty minutes afterthey sent their e-mailconfirming the trade, theyreceived another back fromBurry: "So can we doanother?" In a few weeksMike Burry bought several

hundred million dollars increditdefaultswapsfromhalfa dozen banks, in chunks of$5 million. None of thesellers appeared to care verymuchwhichbondstheywereinsuring. He found onemortgage pool that was 100percentfloating-ratenegative-amortizing mortgages--wherethe borrowers could choosethe option of not paying anyinterest at all and simplyaccumulate a bigger and

biggerdebtuntil,presumably,theydefaultedonit.GoldmanSachs not only sold himinsuranceonthepoolbutsenthim a little notecongratulating him on beingthe first person, on WallStreet or off, ever to buyinsurance on that particularitem. "I'm educating theexperts here," Burry crowedinane-mail.

He wasn't wasting a lotof time worrying about why

these supposedly shrewdinvestment bankers werewilling to sell him insuranceso cheaply. He was worriedthat others would catch onand the opportunity wouldvanish. "I would play dumbquiteabit,"hesaid,"makingit seem to them like I don'treally know what I'm doing.'How do you do this again?''Oh, where can I find thatinformation?' Or, 'Really?'--when they tellme something

reallyobvious."Itwasoneofthe fringe benefits of livingfor somanyyearsessentiallyalienated from the worldaround him: He could easilybelieve that hewas right andtheworldwaswrong.

The more Wall Streetfirms jumped into the newbusiness,theeasieritbecameforhimtoplacehisbets.Forthe first few months he wasable to short, at most, $10million at a time. Then, in

late June 2005, he had a callfrom someone at GoldmanSachs askinghim if he'd liketo increase his trade size to$100 million a pop. "Whatneeds to be rememberedhere,"hewrote thenextday,afterhe'ddoneit,"isthatthisis $100 million. That's aninsaneamountofmoney.Anditjustgetsthrownaroundlikeit's three digits instead ofnine."

By the end of July he

owned credit default swapson $750 million in subprimemortgage bonds and wasprivatelybraggingaboutit."Ibelieve no other hedge fundon the planet has this sort ofinvestment, nowhere near tothis degree, relative to thesize of the portfolio," hewrotetooneofhis investors,whohadcaughtwindthathishedge fund manager hadsome newfangled strategy.Now he couldn't help but

wonder who exactly was onthe other side of his trades--what madman would beselling him so muchinsurance on bonds he hadhandpicked to explode? Thecredit default swap was azero-sum game. If MikeBurry made $100 millionwhen the subprimemortgagebonds he had handpickeddefaulted,someoneelsemusthave lost $100 million.GoldmanSachsmadeitclear

that theultimatesellerwasn'tGoldman Sachs. GoldmanSachs was simply standingbetween insurance buyer andinsurance seller and taking acut.

The willingness ofwhoever this person was tosellhimsuchvastamountsofcheap insurance gave MikeBurry another idea: to start afundthatdidnothingbutbuyinsurance on subprimemortgage bonds. In a $600

million fund that was meantto be picking stocks, his betwas already gargantuan; butif he could raise the moneyexplicitly for this newpurpose, he could do manybillions more. In August hewroteaproposalforafundhecalledMilton'sOpusandsentit out to his investors. ("Thefirst question was always,'What'sMilton'sOpus?'"He'dsay,"ParadiseLost,"but thatusually just raised another

question.)Most of them stillhad no idea that theirchampion stock picker hadbecome so diverted by theseesoteric insurance contractscalled credit default swaps.Many wanted nothing to dowithit;afewwonderedifthismeant that he was alreadydoing this sort of thing withtheirmoney.

Instead of raising moremoney to buy credit defaultswaps on subprimemortgage

bonds, he wound up makingit more difficult to keep theones he already owned. Hisinvestors were happy to lethim pick stocks on theirbehalf, but they almostuniversally doubted hisability to foresee bigmacroeconomic trends. Andthey certainly didn't see whyhe should have any specialinsight into themulti-trillion-dollar subprime mortgagebond market. Milton's Opus

diedaquickdeath.In October 2005, in his

letter to investors, Burryfinallycamecompletelycleanand let them know that theyowned at least a billiondollarsincreditdefaultswapsonsubprimemortgagebonds."Sometimes markets err bigtime,"hewrote.

Markets erred when theygave America Online the

currency to buy TimeWarner. They erred whenthey bet against GeorgeSoros and for the Britishpound.Andtheyareerringrightnowbycontinuingtofloat along as if the mostsignificant credit bubblehistoryhaseverseendoesnot exist. Opportunitiesare rare, and largeopportunities on whichone can put nearlyunlimited capital to work

at tremendous potentialreturnsareevenmorerare.Selectively shorting themost problematicmortgage-backedsecurities in history todayamounts to just such anopportunity.

In the second quarter of2005, credit carddelinquencies hit an all-timehigh--even though house

prices had boomed. That is,evenwiththisassettoborrowagainst, Americans werestruggling more than ever tomeet their obligations. TheFederal Reserve had raisedinterest rates, but mortgagerates were still effectivelyfalling--because Wall Streetwasfindingevermorecleverways to enable people toborrow money. Burry nowhadmorethanabillion-dollarbet on the table and couldn't

growitmuchmoreunlessheattracted a lot more money.So he just laid it out for hisinvestors:TheU.S.mortgagebondmarketwashuge,biggerthan the market for U.S.Treasury notes and bonds.The entire economy waspremised on its stability, andits stability in turn dependedonhousepricescontinuingtorise."Itisludicroustobelievethatassetbubblescanonlyberecognized in hindsight," he

wrote. "There are specificidentifiers that are entirelyrecognizable during thebubble's inflation. Onehallmarkofmaniaistherapidrise in the incidence andcomplexity of fraud.... TheFBI reports mortgage-relatedfraud is up fivefold since2000." Bad behavior was nolonger on the fringes of anotherwise sound economy; itwas its central feature. "Thesalient point about the

modern vintage of housing-related fraud is its integralplace within our nation'sinstitutions,"headded.

This wasn't all thatdifferentfromwhathe'dbeensaying inhisquarterly lettersto his investors for the pasttwoyears.BackinJuly2003,he'dwrittenthemalongessayon the causes andconsequencesofwhathetookto be a likely housing crash:"Alan Greenspan assures us

that home prices are notprone to bubbles--or majordeflations--on any nationalscale," he'd said. "This isridiculous, of course.... In1933, during the fourth yearof the Great Depression, theUnited States found itself inthe midst of a housing crisisthatputhousingstartsat10%ofthelevelof1925.Roughlyhalfofallmortgagedebtwasin default. During the 1930s,housing prices collapsed

nationwidebyroughly80%."Heharpedonthesamethemeagain in January 2004, thenagaininJanuary2005:"Wanttoborrow$1,000,000forjust$25amonth?QuickenLoanshas now introduced aninterest only adjustable ratemortgage that givesborrowers six months withboth zero payments and a0.03% interest rate, no doubtinsupportof thatwholesomesliceofAmericana--thehome

buyer with the short termcashflowproblem."

When his investorslearned that their moneymanager had actually puttheir money directly wherehismouthhadlongbeen,theywere not exactly pleased.Asone investor put it, "Mike'sthe best stock picker anyoneknows. And he'sdoing...what?" Some wereupset that a guy they hadhiredtopickstockshadgone

off to pick rotten mortgagebonds instead; somewondered, if credit defaultswapsweresuchagreatdeal,why Goldman Sachs wouldbe selling them; somequestioned the wisdom oftrying to call the top of aseventy-year housing cycle;somedidn't reallyunderstandexactly what a credit defaultswapwas, orhow itworked."It has been my experiencethat apocalyptic forecasts on

theU.S.financialmarketsarerarely realizedwithin limitedhorizons,"one investorwroteto Burry. "There have beenlegitimate apocalyptic casesto bemade onU.S. financialmarkets during most of mycareer.Theyusuallyhavenotbeen realized." Burry repliedthatwhile itwas true that heforesaw Armageddon, hewasn'tbettingonit.Thatwasthe beauty of credit defaultswaps: They enabled him to

make a fortune if just a tinyfraction of these dubiouspoolsofmortgageswentbad.

Inadvertently, he'dopened up a debate with hisown investors, which hecounted among his leastfavorite activities. "I hateddiscussing ideas withinvestors,"hesaid,"becauseIthen become a Defender ofthe Idea, and that influencesyour thought process." Onceyou became an idea's

defender you had a hardertime changing your mindabout it. He had no choice:Among the peoplewho gavehim money there was prettyobviously a built-inskepticismofso-calledmacrothinking. They couldunderstand why this verybright guy rooting around infinancial statements mightstumble across a smallcompany no one else waspaying attention to. They

couldn't see why he shouldhave a deeper understandingof trends and global forcesapparent to any Americanwho flipped on a cable newsprogram. "I have heard thatWhiteMountainwouldratherI stick to my knitting," hewrote, testily, to his originalbacker,"thoughitisnotclearto me that White Mountainhas historically understoodwhat my knitting really is."No one seemed able to see

what was so plain to him:These credit default swapswere all part of his globalsearchforvalue."Idon'ttakebreaks in my search forvalue," he wrote to WhiteMountains. "There is no golforotherhobbytodistractme.SeeingvalueiswhatIdo."

Whenhe'dstartedScion,he'd told potential investorsthat, because he was in thebusiness of makingunfashionable bets, they

should evaluate him over thelong term--say, five years.Now hewas being evaluatedmoment to moment. "Earlyon, people invested in mebecause of my letters," hesaid. "And then somehowafter they invested, theystopped reading them." Hisfantasticsuccessattractedlotsof new investors, but theywere less interested in thespiritofhisenterprisethaninhow much money he could

make them quickly. Everyquarter, he told them howmuchhe'dmadeor lost fromhis stock picks. Now he hadto explain that they had tosubtract from that numberthese...subprime mortgagebond insurance premiums.One of his New Yorkinvestors called and saidominously, "You know a lotof people are talking aboutwithdrawing funds fromyou."

As their funds werecontractually stuck insideScionCapital for some time,the investors' only recoursewas to send him disturbed-sounding e-mails asking himto justify his new strategy."People get hung up on thedifference between +5% and-5% for a couple of years,"Burry replied to one investorwho had protested the newstrategy."Whentherealissueis: over 10 years who does

10% basis points betterannually? And I firmlybelieve that to achieve thatadvantageonanannualbasis,I have to be able to lookoutpast the next couple ofyears....Ihavetobesteadfastin the face of populardiscontent if that's what thefundamentals tellme." In thefive years since he hadstarted, theS&P500,againstwhichhewasmeasured,wasdown 6.84 percent. In the

sameperiod,heremindedhisinvestors, Scion Capital wasup 242 percent. He assumedhe'd earned the rope to hanghimself. He assumed wrong."I'm building breathtakingsand castles," he wrote, "butnothing stops the tide fromcoming and coming andcoming."

Oddly, as Mike Burry'sinvestors grew restive, hisWall Street counterparties

took a new and enviousinterestinwhathewasupto.In late October 2005, asubprime trader at GoldmanSachs called to ask himwhyhe was buying credit defaultswaps on such very specifictranches of subprimemortgage bonds. The traderlet it slip that a number ofhedgefundshadbeencallingGoldman to ask "how to dothe short housing trade thatScionisdoing."Amongthose

asking about it were peopleBurry had solicited forMilton's Opus--people whohad initially expressed greatinterest."Thesepeoplebyandlarge did not know anythingabouthowtodothetradeandexpected Goldman to helpthem replicate it," Burrywrote in an e-mail to hisCFO. "My suspicion isGoldman helped them,though they deny it." Ifnothing else, he now

understood why he couldn'traise money for Milton'sOpus."IfIdescribeitenoughit sounds compelling, andpeoplethinktheycandoitforthemselves,"hewrotetoane-mail confidant. "If I don'tdescribe it enough, it soundsscary and binary and I can'traise the capital." He had notalentforselling.

Now the subprimemortgage bond marketappeared to be unraveling.

Outoftheblue,onNovember4, Burry had an e-mail fromthe head subprime guy atDeutsche Bank, a fellownamedGregLippmann.As ithappened, Deutsche Bankhadbrokenoff relationswithMike Burry back in June,after Burry had been, inDeutscheBank'sview,overlyaggressiveinhisdemandsforcollateral.Nowthisguycallsandsayshe'dliketobuybackthe original six credit default

swaps Scion had bought inMay. As the $60 millionrepresented a tiny slice ofBurry's portfolio, and as hedidn't want any more to dowith Deutsche Bank thanDeutscheBankwanted to dowithhim,hesold themback,at a profit. Greg Lippmannwrote back hastily andungrammatically, "Wouldyouliketogiveussomeotherbonds that we can tell youwhatwewillpayyou."

Greg Lippmann ofDeutscheBankwantedtobuyhis billion dollars in creditdefault swaps! "Thank youfor the look Greg," Burryreplied. "We're good fornow." He signed off,thinking, How strange. Ihaven't dealt with DeutscheBank in five months. Howdoes Greg Lippmann evenknowIownthisgiantpileofcreditdefaultswaps?

Three days later he

heard from Goldman Sachs.His saleswoman, VeronicaGrinstein, called him on hercellphone,whichiswhatshedid when she wanted to talkwithoutbeingrecorded.(WallStreet firmsnowrecordedallcallsmade from their tradingdesks.) "I'd like a specialfavor," she asked. She, too,wanted to buy some of hiscredit default swaps."Management is concerned,"she said. They thought the

traders had sold all thisinsurancewithouthavinganyplace theycouldgo tobuy itback. CouldMike Burry sellthem$25millionofthestuff,at really generous prices, onthesubprimemortgagebondsof his choosing? Just toplacate Goldmanmanagement,youunderstand.Hanging up, he pingedBankof America, on a hunch, tosee if they would sell himmore. They wouldn't. They,

too, were looking to buy.Next cameMorgan Stanley--again out of the blue. Hehadn't done much businesswith Morgan Stanley, butevidently Morgan Stanley,too, wanted to buy whateverhe had. He didn't knowexactly why all these banksweresuddenlysokeentobuyinsurance on subprimemortgage bonds, but therewasoneobvious reason:Theloans suddenly were going

badatanalarmingrate.Backin May, Mike Burry wasbetting on his theory ofhuman behavior: The loanswere structured to go bad.Now, in November, theywereactuallygoingbad.

Thenextmorning,Burryopened the Wall StreetJournal to find an articleexplaininghowthenewwaveof adjustable-rate mortgageswere defaulting, in their firstnine months, at rates never

before seen. Lower-middle-class America was tappedout. There was even a littlechart to show readers whodidn't have time to read thearticle.He thought, The cat'sout of the bag. The world'sabouttochange.Lenderswillraise their standards; ratingagencies will take a closerlook; and no dealers in theirrightmindwillsell insuranceon subprimemortgage bondsat anything like the prices

they've been selling it. "I'mthinking the lightbulb isgoing to pop on and somesmart credit officer is goingto say, 'Get out of thesetrades,'" he said. Most WallStreet traders were about tolose a lot of money--withperhaps one exception. MikeBurry had just receivedanother e-mail, from one ofhis own investors, thatsuggestedthatDeutscheBankmight have been influenced

by his one-eyed view of thefinancial markets: "GregLippmann, the head[subprimemortgage]traderatDeutscheBank[,]wasinherethe other day," it read. "Hetold us that he was short 1billion dollars of this stuffand was going to make'oceans' of money (orsomething to thateffect.)Hisexuberance was a littlescary."

CHAPTERTHREE

"HowCanaGuyWhoCan'tSpeakEnglishLie?"

BythetimeGregLippmannturnedupintheFrontPointconferenceroom,inFebruary2006, Steve Eisman knewenough about the bondmarket to be wary, and

VincentDaniel knew enoughtohavedecidedthatnooneinit could ever be trusted. Aninvestor who went from thestock market to the bondmarketwaslikeasmall,furrycreature raised on an islandwithoutpredators removed toa pit full of pythons. It waspossible to get ripped off bythe big Wall Street firms inthe stock market, but youreally had to work at it. Theentire market traded on

screens, soyoualwayshadaclearviewof thepriceof thestock of any given company.The stock market was notonly transparent but heavilypoliced. You couldn't expectaWall Street trader to sharewith you his every negativethought about publiccompanies, but you couldexpecthewouldn'tworkveryhard to sucker you withoutright lies, or blatantly useinside information to trade

against you, mainly becausethere was at least a chancehe'dbecaught ifhedid.Thepresenceofmillionsof smallinvestors had politicized thestock market. It had beenlegislated and regulated to atleastseemfair.

The bond market,becauseitconsistedmainlyofbig institutional investors,experienced no similarlypopulist political pressure.Evenas it came todwarf the

stock market, the bondmarket eluded seriousregulation. Bond salesmencould say and do anythingwithout fear that they'd bereported to some authority.Bond traders could exploitinside information withoutworrying that they would becaught. Bond technicianscould dream up ever morecomplicated securitieswithout worrying too muchaboutgovernment regulation-

-one reason why so manyderivativeshadbeenderived,one way or another, frombonds. The bigger, moreliquid end of the bondmarket--the market for U.S.Treasurybonds,forexample--traded on screens, but inmany cases the only way todetermine if the price somebond trader had given youwasevenclose to fairwas tocall around and hope to findsome other bond trader

making a market in thatparticular obscure security.The opacity and complexityof the bond market was, forbigWallStreet firms,ahugeadvantage. The bond marketcustomer lived in perpetualfear of what he didn't know.If Wall Street bonddepartments wereincreasingly the source ofWall Street profits, it was inpart because of this: In thebond market it was still

possible to make huge sumsof money from the fear, andtheignorance,ofcustomers.

And so it was noparticular reflection on GregLippmannthat,uponenteringSteve Eisman's office, hecollided with a wall ofsuspicion."Mosescouldhavewalked in thedoor,and ifhesaid he came from fixedincome,Vinnywouldn'thavetrustedhim,"saidEisman.

Still,ifateamofexperts

hadsetouttocreateahumanbeing to maximize thelikelihood that he wouldterrify a Wall Streetcustomer, they might havedesigned something likeLippmann. He traded bondsfor Deutsche Bank, but, likemost people who tradedbonds forDeutscheBank--orfor Credit Suisse or UBS orone of the other big foreignbanks that had purchased atoehold in the U.S. financial

markets--he was anAmerican. Thin and tightlywound, he spoke too quicklyfor anyone to follow exactlywhathewassaying.Heworehis hair slicked back, in themanner of Gordon Gekko,andthesideburnslong,inthefashionofan1820sRomanticcomposer or a 1970s pornstar. He wore loud ties, andsaid outrageous thingswithout theslightestapparentawarenessofhowtheymight

sound if repeatedunsympathetically. Hepeppered his conversationwith cryptic references tohow much money he made,for instance. People onWallStreet had long ago learnedthat their bonuses were thelast thing they should talkabout with people off WallStreet. "Let's say they paidme six million last year,"Lippmann would say. "I'mnot saying they did. It was

less than that. I'm not sayinghow much less." Before youcould protest--But I neverasked!--he'dsay,"Thekindofyear I had, no way they payme less than four million."Now he had you thinkingabout it: So the number isbetween $4 million and $6million. You could havestartedouttalkingaboutNewYork City Ballet, and youwoundupplayingBattleship.Lippmann kept giving you

these coordinates, until youwerealmostforcedtoidentifythe location of the ship--exactly what just abouteveryone else onWall Streethopedyou'dneverdo.

In further violation ofthe code, Lippmann wasquicktoletpeopleknowthatwhatever he'd been paid byhis employer was notanything likewhat he'd beenworth. "Seniormanagement'sjob is to pay people," he'd

say. "If they fuck a hundredguys out of a hundred grandeach, that's ten million morefor them. They have fourcategories: happy, satisfied,dissatisfied,disgusted.Iftheyhit happy, they've screwedup: They never want youhappy. On the other hand,they don't want you sodisgustedyouquit.Thesweetspot is somewhere betweendissatisfied and disgusted."At some point in between

1986 and 2006 a memo hadgone out on Wall Street,saying that if you wanted tokeepongettingrichshufflingbits of paper around to noobvious social purpose, youhad better camouflage yourtrue nature. Greg Lippmannwas incapable of disguisinghimself or his motives. "Idon't have any particularallegiancetoDeutscheBank,"he'd say. "I justwork there."This was not an unusual

attitude. What was unusualwasthatLippmannsaidit.

The least controversialthing to be said aboutLippmann was that he wascontroversial.Hewasn'tjustagood bond trader, he was agreat bond trader. He wasn'tcruel.Hewasn'tevenrude,atleast not intentionally. Hesimply evoked extremefeelings in others. A traderwho worked near him foryears referred to him as "the

asshole known as GregLippmann." When askedwhy, he said, "He tookeverythingtoofar."

"I love Greg," said oneof his bosses at DeutscheBank. "Ihavenothingbad tosayabouthimexceptthathe'sa fucking whack job." Butwhen you cleared away thecontroversy aroundLippmann's persona youcouldseeitwasrootedintwosimple complaints. The first

wasthathewastransparentlyself-interested and self-promotional.Thesecondwasthat he was excessively alertto the self-interest and self-promotion of others. He hadan almost freakish ability toidentify shadowy motives. Ifyou had just donated $20million to your alma mater,say, and were feeling theglowofselflessdevotiontoacause greater than yourself,Lippmann would be the first

to ask, "So you gave twentymillion because that's theminimum to get your nameonabuilding,right?"

Nowthischaracter turnsup out of nowhere to sellSteve Eisman on what heclaims is his own originalbrilliant idea for bettingagainst the subprimemortgage bond market. Hemadehiscasewithalongandinvolved forty-two-pagepresentation: Over the past

three years housing priceshad risen far more rapidlythan they had over theprevious thirty; housingprices had not yet fallen buttheyhadceased to rise; evenso, the loans against themwerenowgoingsour in theirfirstyearatamazingrates--upfrom 1 percent to 4 percent.Whoborrowedmoneytobuya house and defaulted insideof twelve months? He wenton for a bit, then showed

Eisman this little chart thathe'd created, and which heclaimed was the reason hehad become interested in thetrade. It illustrated anastonishing fact: Since 2000,people whose homes hadrisen in value between1 and5 percent were nearly fourtimes more likely to defaulton their home loans thanpeople whose homes hadrisen in value more than 10percent. Millions of

Americans had no ability torepay their mortgages unlesstheirhousesrosedramaticallyinvalue,whichenabledthemtoborrowevenmore.

That was the pitch in anutshell: Home prices didn'teven need to fall. Theymerely needed to stop risingat the unprecedented ratesthey had the previous fewyears for vast numbers ofAmericanstodefaultontheirhomeloans.

"Shorting Home EquityMezzanine Tranches,"Lippmann called hispresentation."ShortingHomeEquity Mezzanine Tranches"was just a fancy way todescribeMikeBurry'sideaofbetting against U.S. homeloans: buying credit defaultswapsonthecrappiest triple-B slices of subprimemortgage bonds. Lippmannhimself described it morebluntly to a Deutsche Bank

colleague who had seen thepresentation and dubbed him"ChickenLittle.""Fuckyou,"Lippmann had said. "I'mshortyourhouse."

The beauty of the creditdefault swap, or CDS, wasthat it solved the timingproblem. Eisman no longerneededtoguessexactlywhenthe subprime mortgagemarket would crash. It alsoallowed him tomake the betwithout layingdowncashup

front, and put him in aposition to win many timesthe sums he could possiblylose. Worst case: InsolventAmericanssomehowpaidofftheir subprime mortgageloans, and you were stuckpayinganinsurancepremiumof roughly 2 percent a yearfor as long as six years--thelongest expected life span ofthe putatively thirty-yearloans.

The alacrity with which

subprime borrowers paid offtheir loans was yet anotherstrange aspect of thisboomingmarket.Ithadtodowith the structure of theloans, which were fixed fortwo or three years at anartificially low teaser ratebeforeshootinguptothe"go-to" floating rate. "Theyweremaking loans to lower-incomepeopleatateaserratewhentheyknewtheycouldn'tafford to pay the go-to rate,"

said Eisman. "They weredoing it so that when theborrowers get to the end ofthe teaser rate period, they'dhave to refinance, so thelenders can make moremoneyoffthem."Thirty-yearloans were thus designed tobe repaid in a few years. Atworst, if you bought creditdefault swaps on $100millioninsubprimemortgagebonds you might wind upshelling out premium for six

years--call it $12million. Atbest:Lossesontheloansrosefrom the current4percent to8percent,andyoumade$100million. The bookies wereoffering you odds ofsomewhere between 6:1 and10:1 when the odds of itworking out felt more like2:1. Anyone in the businessofmakingsmartbetscouldn'tnotdoit.

The argument stopperwas Lippmann's one-man

quantitativesupportteam.HisnamewasEugeneXu,but tothose who'd heardLippmann's pitch, he wasgenerally spoken of as"Lippmann's Chinese quant."Xuwas an analyst employedby Deutsche Bank, butLippmann gave everyone theideahekepthimtieduptohisBloomberg terminal like apet. A real Chinese guy--notevenChineseAmerican--whoapparently spoke no English,

just numbers. China had thisnational math competition,Lippmann told people, inwhich Eugene had finishedsecond. In all of China.Eugene Xu was responsibleforeverypieceofharddatainLippmann's presentation.OnceEugenewas introducedinto the equation, no onebotheredLippmannabouthismath or his data. AsLippmannput it,"Howcanaguy who can't speak English

lie?"Therewas a lotmore to

it than that. Lippmannbrimmed with fascinatingdetails:thehistoricalbehaviorof theAmericanhomeowner;the idiocy and corruption ofthe rating agencies, Moody'sandS&P,whostucka triple-B rating on subprime bondsthatwentbadwhen losses intheunderlyingpoolsofhomeloansreachedjust8percent;*the widespread fraud in the

mortgagemarket;thefollyofsubprimemortgage investors,some large number ofwhomseemed to live inDusseldorf,Germany. "Whenever we'daskhimwhowasbuyingthiscrap,"saidVinny,"healwaysjust said, 'Dusseldorf.'" Itdidn't matter whetherDusseldorfwasbuyingactualcash subprime mortgagebondsorsellingcreditdefaultswaps on those samemortgage bonds, as they

amounted to one and thesame thing: the long side ofthebet.

Lippmann brimmed,also, with Lippmann. Hehinted Eisman might get sorich from the trade he couldbuy the Los AngelesDodgers. ("I'm not sayingyou'regoingtobeabletobuytheDodgers.")Eismanmightbecome so rich that moviestars would crave his body.("I'mnotsayingyou'regoing

to date Jessica Simpson.")With one hand Lippmannpresented the facts of thetrade; with the other he tap-tap-tapped away, like adowser probing for a wellhidden deep in Eisman'scharacter.

Keeping one eye onGregLippmannandtheotheron Steve Eisman, VincentDaniel half expected theroom to explode. InsteadSteve Eisman found nothing

even faintly objectionableaboutGregLippmann.Greatguy!Eismanreallyonlyhadacoupleofquestions.Thefirst:Tellmeagainhow thehell acredit default swap works?The second: Why are youasking me to bet againstbonds your own firm iscreating, and arranging forthe rating agencies to mis-rate? "In my entire life Inever saw a sell-side guycome in and say, 'Short my

market,'" said Eisman.Lippmannwasn'tevenabondsalesman; he was a bondtraderwhomightbeexpectedto be long these very samesubprimemortgage bonds. "Ididn't mistrust him," saysEisman. "I didn't understandhim.Vinnywas theonewhowassurehewasgoingtofuckusinsomeway."

Eisman had no troublebetting against subprimemortgages. Indeed, he could

imagineverylittlethatwouldgivehimsomuchpleasureasthe thought of going to bedeach night, possibly for thenext six years, knowing hewas short a financial markethe had come to know anddespise and was certainwould one day explode."Whenhewalkedinandsaidyoucanmakemoneyshortingsubprime paper, it was likeputting a naked supermodelin frontofme," saidEisman.

"What I couldn't understandwaswhyhewantedmetodoit."Thatquestion,asitturnedout,wasmoreinterestingthanevenEismansuspected.

The subprime mortgagemarketwas generating half atrillion dollars' worth of newloansayear,butthecircleofpeople redistributing the riskthat the entire market wouldcollapse was tiny. When theGoldman Sachs saleswoman

called Mike Burry and toldhim that her firm would behappy to sell him creditdefaultswapsin$100millionchunks, Burry guessed,rightly, that Goldman wasn'tultimatelyontheothersideofhis bets. Goldman wouldneverbesostupidastomakehugenakedbetsthatmillionsofinsolventAmericanswouldrepay their home loans. Hedidn't knowwho, orwhy, orhowmuch, but he knew that

some giant corporate entitywithatriple-Aratingwasoutthere selling credit defaultswaps on subprimemortgagebonds. Only a triple-A-ratedcorporation could assumesuch risk, no money down,andnoquestionsasked.Burrywas right about this, too, butitwouldbethreeyearsbeforehe knew it. The party on theother side of his bet againstsubprime mortgage bondswas the triple-A-rated

insurance company AIG--American InternationalGroup, Inc.Or, rather, aunitofAIGcalledAIGFP.

AIG Financial Productswas created in 1987 byrefugees from MichaelMilken's bond department atDrexel Burnham, led by atrader named Howard Sosin,whoclaimed tohaveabettermodel to trade and valueinterest rate swaps. Nineteeneighties financial innovation

hadallsortsofconsequences,but oneof themwas a boomin the number of dealsbetween big financial firmsthat required them to takeeach other's credit risks.Interest rate swaps--in whichone party swaps a floatingrate of interest for anotherparty's fixed rateof interest--was one such innovation.Once upon a time, Chryslerissued a bond throughMorganStanley,andtheonly

people who wound up withcredit riskwere the investorswho bought the Chryslerbond. Chrysler might sell itsbonds and simultaneouslyenter into a ten-year interestrate swap transaction withMorganStanley--andjustlikethat, Chrysler and MorganStanleywereexposedtoeachother. If Chrysler wentbankrupt, its bondholdersobviously lost; depending onthe nature of the swap, and

the movement of interestrates, Morgan Stanley mightlose, too. If Morgan Stanleywent bust, Chrysler, alongwith anyone else who haddone interest rate swapswithMorgan Stanley, stood tosuffer. Financial risk hadbeen created out of thin air,and it begged to be eitherhonestly accounted for ordisguised.

Enter Sosin, with hissupposedly new and

improved interest rate swapmodel--even though DrexelBurnhamwasnotat the timea market leader in interestrate swaps. There was anatural role for a blue-chipcorporation with the highestcredit rating to stand in themiddle of swaps and long-term options and the otherrisk-spawning innovations.The traits required of thiscorporationwerethatitnotbea bank--and thus subject to

bankregulation,andtheneedto reserve capital againstrisky assets--and that it bewilling and able to buryexotic risks on its balancesheet. Itneeded tobeable toinsure $100 billion insubprimemortgage loans, forinstance, without having todisclosetoanyonewhatithaddone. There was no realreason that company had tobe AIG; it could have beenany triple-A-ratedentitywith

a huge balance sheet.Berkshire Hathaway, forinstance, orGeneral Electric.AIGjustgottherefirst.

Inafinancialsystemthatwas rapidly generatingcomplicated risks, AIG FPbecame a huge swallower ofthose risks. In the early daysit must have seemed as if itwas being paid to insureevents extremely unlikely tooccur, as it was. Its successbredimitators:ZurichReFP,

Swiss Re FP, Credit SuisseFP,GenReFP. ("Re"standsforReinsurance.)Alloftheseplaces were central to whathappened in the last twodecades; without them, thenew risks being createdwould have had no place tohide and would haveremainedinfullviewofbankregulators. All of theseplaces,when thecrisis came,wouldbewashedawaybythegeneral nausea felt in the

presence of complicatedfinancial risks, but therewasa moment when theirexistence seemedcartographically necessary tothe financial world. AIG FPwasthemodelforthemall.

The division's firstfifteen years wereconsistently, amazinglyprofitable--there wasn't thefirst hint that it might berunning risks that wouldcauseit to losemoney,much

lesscrippleitsgiantparent.In1993, when Howard Sosinleft, he tookwith him nearly$200 million, his share ofwhat appeared to be afantastic money machine. In1998, AIG FP entered thenew market for corporatecredit default swaps: It soldinsurancetobanksagainsttherisk of defaults by hugenumbers of investment-gradepublic corporations. Thecredit default swap had just

been invented by bankers atJ.P. Morgan, who then wentlooking for a triple-A-ratedcompanywillingtosellthem--and found AIG FP.* Themarket began innocentlyenough, by Wall Streetstandards.

Large numbers ofinvestment-grade companiesin different countries anddifferent industries wereindeed unlikely to default ontheir debt at the same time.

ThecreditdefaultswapssoldbyAIGFPthatinsuredpoolsof such loans proved to be agoodbusiness.By2001,AIGFP, now being run by afellow named Joe Cassano,could be counted on togenerate$300millionayear,or15percentofAIG'sprofits.

But then, in the early2000s, the financial marketsperformed this fantastic baitand switch, in two stages.Stage One was to apply a

formula that had beendreamed up to cope withcorporate credit risk toconsumer credit risk. Thebanks that used AIG FP toinsure piles of loans to IBMand GE now came to it toinsure much messier piles,which included credit carddebt, student loans, autoloans, prime mortgages,aircraft leases, and just aboutanythingelsethatgeneratedacash flow. As there were

manydifferentsortsofloans,to different sorts of people,the logic that had applied tocorporate loans seemed toapplytothem,too:Theyweresufficiently diverse that theywereunlikelyalltogobadatonce.

StageTwo,beginningatthe end of 2004, was toreplace the student loans andthe auto loans and the restwith bigger piles consistingofnothingbutU.S.subprime

mortgage loans. "Theproblem," as one AIG FPtrader put it, "is thatsomething else came alongthatwethoughtwasthesamething as what we'd beendoing."The "consumer loan"piles that Wall Street firms,ledbyGoldmanSachs,askedAIG FP to insure went frombeing 2 percent subprimemortgages to being 95percent subprime mortgages.In a matter of months, AIG

FP, in effect, bought $50billion in triple-B-ratedsubprimemortgage bonds byinsuringthemagainstdefault.Andyetnoonesaidanythingabout it--not AIG CEOMartinSullivan,not theheadofAIGFP, JoeCassano, notthe guy in AIG FP'sConnecticut office in chargeof selling his firm's creditdefault swap services to thebig Wall Street firms, AlFrost. The deals, by all

accounts, were simplyrubber-stamped inside AIGFP, and then again by AIGbrass. Everyone concernedapparentlyassumedtheywerebeing paid insurancepremiums to take basicallythesamesortofrisktheyhadbeen taking for nearly adecade. They weren't. Theywere now, in effect, theworld's biggest owners ofsubprimemortgagebonds.

GregLippmannwatchedhiscounterparts at GoldmanSachs find and exploitsomeoneelse'swillingness tosell huge amounts of cheapinsurance on subprimemortgage bonds and prettymuch instantly guessed theseller's identity.Word spreadquickly in thesmallworldofsubprime mortgage bondcreators and traders:AIG FPwasnowsellingcreditdefaultswaps on triple-A-rated

subprime bonds for a mere0.12 percent a year. Twelvebasispoints!Lippmanndidn'tknow exactly how GoldmanSachshadpersuadedAIGFPtoprovidethesameservicetothe booming market insubprimemortgageloansthatit provided to themarket forcorporate loans.All he knewwas that, in rapidsuccession,Goldman created a bunch ofmultibillion-dollar deals thattransferred to AIG the

responsibility for all futurelosses from $20 billion intriple-B-rated subprimemortgage bonds. It wasincredible: In exchange for afewmillionbucksayear,thisinsurance company wastaking the very real risk that$20 billion would simply gopoof. The deals withGoldmanhadgonedowninamatter of months andrequired the efforts of just afew geeks on a Goldman

bond trading desk and aGoldman salesman namedAndrew Davilman, who, forhis services, soon would bepromoted to managingdirector. The Goldmantraders had booked profits ofsomewhere between $1.5billion and $3 billion--evenby bond market standards, abreathtakingsum.

In theprocess,GoldmanSachs created a security soopaque and complex that it

would remain forevermisunderstood by investorsand rating agencies: thesynthetic subprime mortgagebond-backed CDO, orcollateralizeddebtobligation.Like the credit default swap,the CDO had been inventedto redistribute the risk ofcorporate and governmentbond defaults and was nowbeing rejiggered to disguisetheriskofsubprimemortgageloans. Its logic was exactly

that of the original mortgagebonds. In a mortgage bond,you gathered thousands ofloans and, assuming that itwas extremely unlikely thatthey would all go badtogether, created a tower ofbonds,inwhichbothriskandreturndiminishedasyourose.In a CDO you gathered onehundred different mortgagebonds--usually, the riskiest,lower floors of the originaltower--andusedthemtoerect

an entirely new tower ofbonds.Theinnocentobservermight reasonablyask,What'sthepointofusingfloorsfromone tower of debt simply tocreateanother towerofdebt?Theshortansweris,Theyaretoonear to theground.Morepronetoflooding--thefirst totakelosses--theybearalowercredit rating: triple-B.Triple-B-ratedbondswereharder tosell than the triple-A-ratedones,onthesafe,upperfloors

ofthebuilding.The long answer was

that therewerehugesumsofmoney to be made, if youcould somehow get them re-rated as triple-A, therebylowering theirperceivedrisk,however dishonestly andartificially. This is whatGoldman Sachs had cleverlydone. Their--soon to beeveryone's--nifty solution tothe problem of selling thelower floors appears, in

retrospect, almost magical.Having gathered 100 groundfloors from 100 differentsubprime mortgage buildings(100 different triple-B-ratedbonds), they persuaded therating agencies that theseweren't,astheymightappear,all exactly the same things.Theywereanotherdiversifiedportfolio of assets! This wasabsurd. The 100 buildingsoccupiedthesamefloodplain;in the event of flood, the

ground floors of all of themwere equally exposed. Butnever mind: The ratingagencies, who were paid fatfees by Goldman Sachs andother Wall Street firms foreach deal they rated,pronounced80percentofthenewtowerofdebttriple-A.

TheCDOwas,ineffect,acreditlaunderingserviceforthe residents of LowerMiddle Class America. ForWallStreet itwas amachine

thatturnedleadintogold.Back in the 1980s, the

originalstatedpurposeof themortgage-backed bond hadbeen to redistribute the riskassociated with homemortgage lending. Homemortgage loans could findtheirway to thebondmarketinvestors willing to pay themost for them. The interestrate paid by the homeownerwould thus fall. The goal ofthe innovation, in short, was

tomakethefinancialmarketsmore efficient. Now,somehow, the sameinnovative spirit was beingput to the opposite purpose:to hide the risk bycomplicating it. The marketwas paying Goldman Sachsbond traders to make themarket less efficient. Withstagnant wages and boomingconsumption, the cash-strapped American masseshad a virtually unlimited

demand for loans but anuncertain ability to repaythem.All they had going forthem, from thepointofviewof Wall Street financialengineers, was that theirfinancial fates could bemisconstruedasuncorrelated.Byassuming thatonepileofsubprime mortgage loanswasn't exposed to the sameforces as another--that asubprimemortgagebondwithloans heavily concentrated in

Floridawasn'tverymuchlikea subprime mortgage bondmore concentrated inCalifornia--the engineerscreated the illusion ofsecurity.AIGFPacceptedtheillusionasreality.

The peoplewhoworkedon the relevant GoldmanSachsmortgage bond tradingdesk were all extremelyintelligent. They'd all doneamazinglywell inschoolandhad gone to Ivy League

universities. But it didn'trequire any sort of genius toseethefortunetobehadfromthe laundering of triple-B-rated bonds into triple-A-rated bonds.What demandedgenius was finding $20billionintriple-B-ratedbondsto launder. In the originaltower of loans--the originalmortgagebond--onlyasingle,thin floor got rated triple-B.A billion dollars of crappyhome loans might yield just

$20 million of the crappiesttriple-B tranches.Putanotherway: To create a billion-dollar CDO composed solelyof triple-B-rated subprimemortgage bonds, you neededto lend$50billion incash toactual human beings. Thattooktimeandeffort.Acreditdefaultswaptookneither.

There was more thanoneway to thinkaboutMikeBurry's purchase of a billiondollars in credit default

swaps. The first was as asimple, even innocent,insurance contract. Burrymade his semiannualpremium payments and, inreturn, received protectionagainstthedefaultofabilliondollars'worth of bonds.He'deither be paid zero, if thetriple-B-rated bonds he'dinsured proved good, or abilliondollars, if thosetriple-B-rated bondswent bad. Butof course Mike Burry didn't

own any triple-B-ratedsubprimemortgagebonds,oranything like them. He hadnopropertyto"insure"itwasas if he had bought fireinsuranceonsomeslumwithahistoryofburningdown.Tohim, as to Steve Eisman, acredit default swap wasn'tinsurance at all but anoutright speculative betagainst the market--and thiswas the secondway to thinkaboutit.

There was also a third,even more mind-bending,way to think of this newinstrument: as a near-perfectreplica of a subprimemortgage bond. The cashflows of Mike Burry's creditdefault swaps replicated thecash flows of the triple-B-rated subprime mortgagebondthathewageredagainst.The 2.5 percent a year inpremium Mike Burry waspaying mimicked the spread

over LIBOR* that triple-Bsubprime mortgage bondspaid to an actual investor.The billion dollars whoeverhad sold Mike Burry hiscredit default swaps stood tolose, if the bonds went bad,replicated thepotential lossesofanactualbondowner.

On its surface, thebooming market in side betson subprimemortgage bondsseemed to be the financialequivalentoffantasyfootball:

abenign,ifsilly,facsimileofinvesting. Alas, there was adifference between fantasyfootball and fantasy finance:When a fantasy footballplayerdraftsPeytonManningtobeonhis team,hedoesn'tcreate a second PeytonManning. When Mike Burrybought a credit default swapbased on a Long BeachSavings subprime-backedbond, he enabled GoldmanSachs to create another bond

identical to the original inevery respect but one: Therewerenoactualhomeloansorhome buyers.Only the gainsand losses from the side betonthebondswerereal.

And so, to generate $1billion in triple-B-ratedsubprime mortgage bonds,Goldman Sachs did not needto originate $50 billion inhome loans. They neededsimply to enticeMikeBurry,or some other market

pessimist, to pick 100different triple-B bonds andbuy $10 million in creditdefault swaps on each ofthem. Once they had thispackage (a "synthetic CDO,"it was called, which was theterm of art for a CDOcomposed of nothing butcredit default swaps), they'dtake it over to Moody's andStandard & Poor's. "Theratings agencies didn't reallyhavetheirownCDOmodel,"

says one former GoldmanCDO trader. "The bankswould send over their ownmodel to Moody's and say,'How does this look?'"Somehow,roughly80percentofwhathadbeenriskytriple-B-rated bonds now lookedliketriple-A-ratedbonds.Theother 20 percent, bearinglowercreditratings,generallywere more difficult to sell,but they could, incredibly,simply be piled up in yet

anotherheapandreprocessedyet again, intomore triple-Abonds. The machine thatturned 100 percent lead intoan ore that was now 80percent gold and 20 percentlead would accept theresidual lead and turn 80percentofthatintogold,too.

The details werecomplicated, but the gist ofthisnewmoneymachinewasnot: It turned a lot of diceyloans into a pile of bonds,

mostofwhichwere triple-A-rated,thenittookthelowest-rated of the remaining bondsandturnedmostofthoseintotriple-A CDOs. And then--because it could not extendhome loans fast enough tocreate a sufficient number oflower-rated bonds--it usedcredit default swaps toreplicatetheveryworstoftheexisting bonds, many timesover. Goldman Sachs stoodbetween Michael Burry and

AIG. Michael Burry forkedout 250 basis points (2.5percent)toowncreditdefaultswaps on the very crappiesttriple-Bbonds,andAIGpaida mere 12 basis points (0.12percent) to sell credit defaultswaps on those very samebonds, filtered through asynthetic CDO, andpronounced triple-A-rated.Therewereafewothermessydetails*--some of the leadwas sold off directly to

German investors inDusseldorf--but when thedust settled, Goldman Sachshad taken roughly 2 percentoff the top, risk-free, andbookedalltheprofitupfront.There was no need on eitherside--long or short--for cashto change hands. Both sidescoulddoadealwithGoldmanSachs by signing a piece ofpaper. The original homemortgageloansonwhosefateboth sides were betting

played no other role. In afunnyway, they existedonlyso that their fate might begambledupon.

The market for"synthetics" removed anyconstraint on the size of riskassociated with subprimemortgagelending.Tomakeabillion-dollar bet, you nolonger needed to accumulatea billion dollars' worth ofactual mortgage loans. Allyou had to do was find

someone else in the marketwilling to take the other sideofthebet.

No wonder GoldmanSachswas suddenly so eagerto sell Mike Burry creditdefault swaps in giant, $100million chunks, or that theGoldman Sachs bond traderhad been surprisinglyindifferenttowhichsubprimebonds Mike Burry betagainst. The insurance MikeBurry bought was inserted

into a synthetic CDO andpassed along to AIG. Theroughly $20 billion in creditdefaultswapssoldbyAIGtoGoldman Sachs meantroughly $400 million inriskless profits for GoldmanSachs. Each year. The dealslasted as long as theunderlying bonds,which hadan expected life of about sixyears, which, when you didthemath, impliedaprofitforthe Goldman trader of $2.4

billion.Wall Street's newest

technique for squeezingprofits out of the bondmarkets should have raised afew questions. Why weresupposedly sophisticatedtraders at AIG FP doing thisstuff? If credit default swapswere insurance, why weren'tthey regulated as insurance?Why, for example, wasn'tAIG required to reservecapital against them? Why,

forthatmatter,wereMoody'sandStandard&Poor'swillingto bless 80 percent of a poolofdiceymortgage loanswiththe same triple-A rating theybestowedon the debts of theU.S. Treasury? Why didn'tsomeone, anyone, insideGoldmanSachs standupandsay, "This is obscene. Therating agencies, the ultimatepricers of all these subprimemortgage loans, clearly donot understand the risk, and

their idiocy is creating arecipe for catastrophe"?Apparently none of thosequestions popped into theminds of market insiders asquicklyasanother:HowdoIdo what Goldman Sachs justdid? Deutsche Bank,especially,feltsomethinglikeshame that Goldman Sachshadbeen thefirst to find thisparticular pay dirt. Alongwith Goldman, DeutscheBankwas the leadingmarket

maker in abstruse mortgagederivatives. Dusseldorf wasplaying some kind of role inthenewmarket.Iftherewerestupid Germans standingready to buy U.S. subprimemortgage derivatives,Deutsche Bank should havebeenthefirsttofindthem.

Noneof thiswasofanyobvious concern to GregLippmann.Lippmanndidnotrun Deutsche Bank's CDObusiness--a fellow named

Michael Lamont did.Lippmann was merely thetrader responsible for buyingand selling subprimemortgage bonds and, byextension, credit defaultswaps on subprimemortgagebonds. But with so fewinvestors willing to make anoutright bet against thesubprime bond market,Lippmann's bosses askedLippmanntotakeonefor theteam: in effect, to serve as a

stand-in forMikeBurry, andto make an explicit betagainst the market. IfLippmann would buy creditdefault swaps fromDeutscheBank's CDO department,they, too, might do thesetradeswithAIG, beforeAIGwoke up and stopped doingthem."Gregwasforcedtogetshort into theCDOs," says aformer senior member ofDeutsche Bank's CDO team."I say forced, but you can't

really force Greg to doanything." There was somepushing and pulling with thepeople who ran his firm'sCDO operations, butLippmann found himselfuncomfortably shortsubprimemortgagebonds.

Lippmann had at leastone good reason for notputtingupahugefight:Therewas a fantastically profitablemarketwaiting tobecreated.Financial markets are a

collection of arguments. Theless transparent the marketandthemorecomplicatedthesecurities, the more moneythe tradingdesks at bigWallStreet firms can make fromthe argument. The constantargument over the value ofthe shares of some majorpublicly traded company hasvery little value, as bothbuyer and seller can see thefair price of the stock on theticker, and the broker's

commission has been drivendown by competition. Theargument over the value ofcredit default swaps onsubprime mortgage bonds--acomplexsecuritywhosevaluewas derived from that ofanother complex security--could be a gold mine. Theonly other dealer makingserious markets in creditdefault swaps was GoldmanSachs, so there was, in thebeginning, little price

competition. Supply, thanksto AIG, was virtuallyunlimited. The problem wasdemand: investors whowanted to do Mike Burry'strade. Incredibly, at thiscritical juncture in financialhistory, after which somuchchanged so quickly, the onlyconstraint in the subprimemortgage market was ashortage of peoplewilling tobetagainstit.

To sell investors on the

idea of betting againstsubprimemortgagebonds--onbuying his pile of creditdefault swaps--GregLippmann needed a new andimprovedargument.EntertheGreat Chinese Quant.Lippmann asked Eugene Xuto study the effect of homeprice appreciation onsubprime mortgage loans.EugeneXuwent off and didwhatever the second smartestman in China does, and at

length returned with a chartillustrating default rates invarioushomepricescenarios:home prices up, home pricesflat, home prices down.Lippmann looked at it...andlooked again. The numbersshocked even him. Theydidn't need to collapse; theymerely needed to stop risingso fast. House prices werestill rising, and yet defaultrates were approaching 4percent; if they rose to just7

percent, the lowestinvestment-gradebonds,ratedtriple-B-minus, went to zero.If they rose to 8 percent, thenextlowest-ratedbonds,ratedtriple-B,wenttozero.

At that moment--inNovember 2005--GregLippmann realized that hedidn'tmind owning a pile ofcredit default swaps onsubprime mortgage bonds.They weren't insurance; theywere a gamble; and he liked

the odds. He wanted to beshort.

This was new. GregLippmann had traded bondsbacked by various consumerloans--auto loans, credit cardloans, home equity loans--since 1991, when he hadgraduatedfromtheUniversityof Pennsylvania and taken ajob at Credit Suisse. He'dneverbeforebeenabletosellthemshort,becausetheywereimpossible to borrow. The

only choice he and everyother asset-backed bondtrader ever had to make waswhether to like them or tolove them. There was neverany point in hating them.Now he could, and did. Buthating them set him apartfrom the crowd--and thatrepresented, for GregLippmann,anewcareer risk.As he put it to others, "Ifyou're in a business whereyou can do only one thing

and it doesn't work out, it'shard for your bosses to bemad at you." It was nowpossible todomore thanonething, but if he bet againstsubprimemortgagebondsandwasprovenwrong,hisbosseswould find it easy tobemadathim.

In therighteousspiritofa man bearing aninconvenient truth, GregLippmann, a copy of"Shorting Subprime

Mezzanine Tranches" tuckedunder his arm, launchedhimself at the institutionalinvesting public. He mayhave begun his investigationof the subprime mortgagemarket in thespiritofaWallStreet salesman, searchingless for the truth than for apersuasive-sounding pitch.Now, shockingly, he thoughthe had an ingenious plan tomake customers rich. He'dchargethemfatfeestogetin

andoutoftheircreditdefaultswaps, of course, but thesewouldprovetrivialcomparedto the fortunes they stood tomake. He was no longerselling; he was dispensingfavors.Behold.Agiftfrommetoyou.

Institutional investorsdidn't knowwhat tomake ofhim, at least not at first. "Ithink he has some kind ofnarcissistic personalitydisorder," said one money

manager who heardLippmann's pitch but did notdo his trade. "He scared theshit out of us," said another."He comes in and describesthis brilliant trade. It makestotal sense. To us the riskwas,we do it, itworks, thenwhat? How do we get out?He controls the market; hemay be the only onewe cansell to. And he says, 'Youhave no way out of thisswimming pool but through

me,andwhenyouaskforthetowel I'm going to rip youreyeballsout.'Heactuallysaidthat, thathewasgoing to ripoureyeballsout.Theguywastotallytransparent."

They loved it, in away,but decided they didn't wantto experience the thrill ofeyeball removal. "Whatworked against Greg," thisfundmanager said, "was thathewastoocandid."

Lippmann faced the

usual objections any WallStreet bond customer voicedto any Wall Street bondsalesmen--If it's such a greattrade,whyareyouofferingitto me?--but other, less usualones, too. Buying creditdefault swaps meant payinginsurance premiums forperhaps years as you waitedforAmericanhomeowners todefault. Bond marketinvestors, like bond markettraders, viscerally resisted

anytradethattheyhadtopaymoney to be in, andinstinctivelysoughtouttradesthat paid them just forshowing up in the morning.(One big bond marketinvestor christened his yachtPositive Carry.) Tradeswhereyouforkover2percentayearjusttobeinthemwereanathema. Other sorts ofinvestorsfoundothersortsofobjections. "I can't explaincredit default swaps to my

investors" was a commonresponse toGregLippmann'spitch. Or "I have a cousinwhoworksatMoody'sandhesays this stuff [subprimemortgagebonds]isallgood."Or "I talked to Bear Stearnsand they said you werecrazy." Lippmann spenttwenty hourswith one hedgefundguyand thoughthehadhim sold, only to have theguy call his collegeroommate, who worked for

some home builder, andchangehismind.

But the most commonresponseofallfrominvestorswho heard Lippmann'sargument was, "I'mconvinced. You're right. Butit's not my job to short thesubprimemarket."

"That's why theopportunity exists,"Lippmann would reply. "It'snobody'sjob."

It wasn't Lippmann's,

either. He was meant to bethe toll booth, taking a littlefrom buyers and sellers asthey passed through histradingbooks.Hewasnowina different,more opinionatedrelationshiptohismarketandhis employer. Lippmann'sshortpositionmayhavebeenforced upon him, but by theend of 2005 he'dmade it hisown,andgrownittoabilliondollars. Sixteen floors abovehim inside Deutsche Bank's

Wall Street headquarters,several hundred highly paidemployees bought subprimemortgage loans, packagedthem into bonds, and soldthem off. Another grouppackaged the most repellent,unsalable tranches of thosebonds, and CDSs on thebonds,intoCDOs.ThebiggerLippmann's short positiongrew, thegreater the implicitexpression of contempt forthese people and their

industry--an industry quicklybecoming Wall Street's mostprofitable business. Therunning cost, in premiumsLippmann paid, was tens ofmillionsofdollarsayear,andhislosseslookedevenbigger.The buyer of a credit defaultswapagreedtopaypremiumsfor the lifespan of theunderlying mortgage bond.So long as the underlyingbonds remained outstanding,bothbuyerandsellerofcredit

defaultswapswereobligedtopostcollateral, in response totheir price movements.Astonishingly, the prices ofsubprime mortgage bondswere rising. Within a fewmonths, Lippmann's creditdefault swap position had tobe marked down by $30million. His superiorsrepeatedly asked him toexplain why he was doingwhathewasdoing."Alotofpeople wondered if this was

the best use of Greg's timeandourmoney,"saidaseniorDeutsche Bank official whowatchedthegrowingconflict.

Rather than cave to thepressure, Lippmann insteadhad an idea for making itvanish: kill the new market.AIGwasverynearlytheonlybuyeroftriple-A-ratedCDOs(that is, triple-B-ratedsubprime mortgage bondsrepackagedintotriple-A-ratedCDOs).AIGwas,ultimately,

thepartyon theothersideofthecreditdefaultswapsMikeBurry was buying. If AIGstopped buying bonds (or,more exactly, stoppedinsuring them againstdefault), the entire subprimemortgage bondmarketmightcollapse, and Lippmann'screditdefaultswapswouldbeworthafortune.Attheendof2005, Lippmann flew toLondon to try to make thathappen.HemetwithanAIG

FP employee named TomFewings, who workeddirectly for AIG FP's head,JoeCassano.Lippmann,whowasforeveraddingdatatohispresentation, produced hislatest version of "ShortingMezzanine Home EquityTranches" and walkedFewings through hisargument. Fewings offeredhim no serious objections,and Lippmann left AIG'sLondon office feeling as if

Fewings had been convertedto his cause. Sure enough,shortlyafterLippmann'svisit,AIGFPstoppedsellingcreditdefault swaps. Even better:AIG FP hinted that theymight actually like to buysomecreditdefaultswaps. Inanticipation of selling themsome,Lippmannaccumulatedmore.

For a brief moment,Lippmann thought he'dchanged the world, all by

himself. He had walked intoAIGFPandhadshownthemhow Deutsche Bank, alongwith every otherWall Streetfirm, was playing them forfools,andthey'dunderstood.

CHAPTERFOUR

HowtoHarvestaMigrantWorker

They hadn't. Not really.ThefirstpersoninsideAIGFPtoawakentothemadnessof his firm's behavior, andsoundanalarm,wasnotTomFewings, who quickly forgot

his meeting with Lippmann,but Gene Park. Park workedin AIG FP's Connecticutofficeandsatcloseenoughtothecreditdefaultswaptraderstohaveageneralideaofwhattheywereupto.Inmid-2005he read a front-page story intheWallStreetJournalaboutthe mortgage lender NewCentury. He noted how highthe company's dividend wasand wondered if he shouldbuy some of its stock for

himself.Ashedug intoNewCentury, however, Park sawthat they owned all thesesubprime mortgages--and hecould see from their ownstatements that the quality ofthese loanswas frighteninglypoor. Soon after his privateinvestigation of NewCentury, Park had a phonecall fromapenniless, joblessold college friend who hadbeen offered several loansfrombankstobuyahousehe

couldn't afford. That's whenthe penny dropped for him:Park had noticed hiscolleague, Al Frost,announcing credit defaultswap deals with big WallStreet firms at a new clip.Ayearbefore,Frostmighthavedone one billion-dollar dealeach month; now he wasdoing twenty, all of theminsuringputativelydiversifiedpilesofconsumerloans."Wewere doing every single deal

witheverysingleWallStreetfirm, except Citigroup," saysone trader. "Citigroupdecided it liked the risk, andkept it on their books. Wetook all the rest." WhentradersaskedFrostwhyWallStreetwas suddenly so eagerto do business with AIG, asoneput it,"hewouldexplainthattheylikedusbecausewecould act quickly." Park puttwo and two together andguessed that the nature of

thesepilesofconsumerloansinsured by AIG FP waschanging, that theycontaineda lot more subprimemortgagesthananyoneknew,and that if U.S. homeownersbegan to default in sharplygreater numbers, AIG didn'thave anywhere near thecapital required to cover thelosses.When he brought thisup at a meeting, his rewardwas to be hauled into aseparate room by Joe

Cassano, who screamed athimthathedidn'tknowwhathewastalkingabout.

That Joe Cassano, thebossofAIGFP,was thesonof a police officer and hadbeenapoliticalsciencemajoratBrooklynCollegeseems,inretrospect, far less relevantthan his need for obedienceand total control. He'd spentmost of his career, first atDrexel Burnham and then atAIGFP,notasabondtrader

but working in the backoffice. Across AIG FP theview of the boss wasremarkably consistent:Cassano was a guy with acrude feel for financial riskbut a real talent for bullyingpeople who doubted him."AIG FP became adictatorship," says oneLondon trader. "Joe wouldbully people around. He'dhumiliatethemandthentrytomakeitupto thembygiving

them huge amounts ofmoney."

"One day he got me onthephoneandwaspissedoffabout a trade that had lostmoney," says a Connecticuttrader. "He said, When youlose money it's my fuckingmoney.Sayit.Isaid,'What?'

"Say, 'Joe, it's yourfuckingmoney'!SoIsaid,'It'syourfuckingmoney,Joe.'"

"The culture changed,"says a third trader. "The fear

level was so high that whenwe had these morningmeetings,youpresentedwhatyoudidnottoupsethim.Andif you were critical of theorganization, all hell wouldbreak loose." Says a fourth,"Joealwayssaid, 'This ismycompany. You work for mycompany.' He'd see youwitha bottle of water. He'd comeover and say, 'That's mywater.' Lunch was free, butJoe alwaysmadeyou feelhe

had bought it." And a fifth:"Under Joe, the debate anddiscussion that was commonunder Tom [Savage, theprevious CEO] ceased. Iwouldsay[toTom]whatI'msayingtoyou.ButwithJoeasthe audience." A sixth: "ThewayyoudealtwithJoewastostart everything by saying,'You'reright,Joe.'"

EvenbythestandardsofWall Street villains whosecharacterflawswindupbeing

exaggerated to fit the crime,Cassano, in the retelling,became a cartoon monster."Onedayhecameinandsawthat someone had left theweights on the Smithmachine, in thegym," says aseventh source, inConnecticut."Hewasliterallywalking around looking forpeople who looked buff,tryingtofindtheguywhodidit. He was screaming, 'Wholeftthefuckingweightonthe

fuckingSmithmachine?WholeftthefuckingweightonthefuckingSmithmachine?'"

Oddly, Cassano was aslikely to direct his anger atprofitable traders as atunprofitable ones, for theanger was triggered not byfinancial loss but by thefaintestwhiffof insurrection.Even more oddly, his angerhad no obvious effect on therecipient's paycheck; a tradermight find himself routinely

abused by his boss and yetdelighted by his year-endbonus, determined by thatsame boss. One reason noneof AIG FP's traders took aswing at JoeCassano, beforewalking out the door, wasthat the money was simplytoogood.Amanwhovaluedloyalty and obedience aboveall other traits hadno tool tocommand it except money.Money worked as amanagementtool,butonlyup

toapoint. Ifyouweregoingto be on the other side of atrade from Goldman Sachs,you had better know what,exactly, Goldman Sachs wasup to. AIG FP could attractextremely bright people whowere perfectly capable ofkeeping up with theircounterparts at GoldmanSachs. They wereconstrained, however, by aboss with an imperfectunderstanding of the nuances

of his own business, andwhose judgmentwascloudedbyhisinsecurity.

Towardtheendof2005,Cassano promoted Al Frost,then went looking forsomeonetoreplacehimastheambassador to Wall Street'sbond trading desks. The job,in effect, was to say "yes"every time someWall Streettrader asked him if he'd liketo insure--and so, in effect,purchase--abillion-dollarpile

ofbondsbackedbyconsumerloans. For a number ofreasons, Gene Park was alikely candidate, and so hedecided to examine theseloans that AIG FP wasinsuring a bit more closely.The magnitude of themisunderstanding shockedhim: These supposedlydiversified piles of consumerloans now consisted almostentirely of U.S. subprimemortgages. Park conducted a

private survey. He asked thepeoplemostdirectlyinvolvedin the decision to sell creditdefault swaps on consumerloans what percentage ofthose loans were subprimemortgages. He asked GaryGorton,aYaleprofessorwhohad built the model thatCassano used to price thecredit default swaps: Gortonguessedthatthepileswerenomore than 10 percentsubprime. He asked a risk

analyst in London, whoguessed20percent."Noneofthem knew it was 95percent," says one trader."And I'm sure that Cassanodidn't, either." In retrospect,their ignorance seemsincredible--but, then, anentire financial system waspremised on their notknowing,andpayingthemforthistalent.

BythetimeJoeCassanoinvitedGenePark toLondon

for the meeting in which hewould be "promoted" to thejob of creating evenmore ofthese ticking bombs, Parkknewhewantednopartofit.If he was forced to take thejob, he said, he'd quit. This,naturally, infuriated JoeCassano, who accused Parkofbeinglazy,ofdreamingupreasons not to do the dealsthat would requirecomplicated paperwork.Confrontedwiththenewfact-

-that his company waseffectivelylong$50billionintriple-B subprime mortgagebonds, masquerading astriple-A-rated diversifiedpools of consumer loans--Cassano at first sought torationalize it. He clearlythought that any money hereceived for selling defaultinsurance on highly ratedbonds was free money. Forthe bonds to default, he nowsaid,U.S.housepriceshadto

fall, and Joe Cassano didn'tbelieve house prices couldever fall everywhere in thecountry at once. After all,Moody's and S&P had bothratedthisstufftriple-A!

Cassano neverthelessagreed to meet with all thebig Wall Street firms anddiscuss the logic of theirdeals--to investigate how abunch of shaky loans couldbe transformed into triple-A-rated bonds. Together with

Gene Park and a few others,he set out on a series ofmeetings with traders atDeutsche Bank, GoldmanSachs, and the rest, all ofwhomarguedhowunlikelyitwasforhousingpricestofallallatonce."Theyallsaidthesame thing," said one of thetraders present. "They'd goback to historical real estateprices over sixty years andsay they had never fallennationally,allatonce." (Two

months after their meetingwith Goldman Sachs, one ofthe AIG FP traders bumpedinto the Goldman guy whohad made this argument andwho now said, Between youand me, you're right. Thesethingsaregoingtoblowup.)The AIG FP traders presentwere shocked by how littlethoughtoranalysisseemedtounderpin the subprimemortgage machine: It wassimplyabetthathomeprices

would never fall. Once heunderstood this, and once hecould construe it as his ownidea,JoeCassanochangedhismind. By early 2006 heopenly agreed with GenePark:AIGFPshouldn'tinsureany more of these deals--though they would continueto insure the ones they hadalreadyinsured.

Atthetime,thisdecisiondidn'treallyseemlikeallthatbig a deal for AIG FP. The

division was generatingalmost $2 billion a year inprofits.Atthepeak,theentirecredit default swap businesscontributedonly$180millionof that. Cassano had beenupsetwith Park, and slow tochange his mind, it seemed,mainly because Park haddaredtocontradicthim.

The one Wall Street traderwho had tried to persuadeAIGFPtostopbettingonthe

subprime mortgage bondmarket witnessed none ofthese internal politics. GregLippmann simply assumedthattheforceofhisargumenthad won them over--until itdidn't. He never understoodwhy AIG FP changed itsmind but left itself soexposed. It sold no morecredit default swaps to WallStreet but did nothing tooffset the 50 billion dollars'worththatithadalreadysold.

Even that, Lippmannthought, might cause themarket to crash. If AIG FPrefused to take the long sideof the trade, he thought, noonewould, and the subprimemortgage market would shutdown.But--and herewas thestart of a great mystery--themarket didn't so much asblink.WallStreetfirmsfoundnew buyers of triple-A-ratedsubprime CDOs--new placesto stuff the riskiest triple-B

tranches of subprimemortgagebonds--thoughwhothese people were was notentirely clear for some time,eventoGregLippmann.

The subprime mortgagemachineroaredon.Theloansthat were being made toactual human beings onlygrew crappier, but, bizarrely,the price of insuring them--the price of buying creditdefault swaps--fell. By April2006Lippmann'ssuperiorsat

Deutsche Bank were askinghim to defend his quixoticgamble. Theywanted him tomakemoneyjustbysittinginthe middle of this newmarket, the way GoldmanSachs did, crossing buyersand sellers. They reached anagreement: Lippmann couldkeep his expensive shortposition as long as he couldprovethat,ifhehadtosellit,there'dbesomeotherinvestorwillingtotakeitoffhishands

on short notice. That is, heneededtofosteramoreactivemarket in credit defaultswaps; if he wanted to keephis bet he had to find otherstojoinhiminit.

By the summer of 2006Greg Lippmann had a newmetaphor in his head: a tug-of-war. The entire subprimemortgage lending machine--including his own employer,Deutsche Bank--pulled ononeendoftherope,whilehe,

GregLippmann, hauled backon the other. He neededothers to joinhim.They'dallpull together. His teammateswouldpayhimafeeforbeingon his side, but they'd getrich,too.

Lippmann soon foundthat the people he mostexpectedtoseetheuglytruthof the subprime mortgagemarket--the people who ranfunds that specialized inmortgage bond trading--were

the ones least likely to seeanything but what they hadbeen seeing for years. Herewas a strange but true fact:The closer you were to themarket, the harder it was toperceive its folly. Realizingthis, Lippmann went lookingfor stock investorswith a lotof exposure to falling homeprices, or falling housingstock prices, and showedthem his idea as a hedge.Look,you'remakingafortune

as this stuff keeps going up.Why not spend a little tocover yourself in a collapse?Greed hadn't worked, so hetried fear. He obtained a listof all the big stockholders inNew Century, the bigsubprime lender. Prominenton the listwas a hedge fundcalled FrontPoint Partners.He called the relevantDeutsche Bank salesman toset up a meeting. Thesalesmanfailed tonotice that

there was more than onehedgefundinsideFrontPoint--itwasn't a single fund but acollection of independentlymanaged hedge funds--andthat the fund that was longNew Century stock was asmall group based on theWestCoast.

When Greg Lippmannarrived in Steve Eisman'sconference room inmidtownManhattan, Eisman surprisedhimbysaying,"We'renotthe

FrontPoint that is long NewCentury stock. We're theFrontPoint that is short NewCentury stock." Eisman wasalready betting against theshares of companies, such asNew Century and IndyMacBank, which originatedsubprime loans, along withcompanies that built thehousesboughtwiththeloans,such as Toll Brothers. Thesebets were not entirelysatisfying because they

weren't bets against thecompanies but marketsentiment about thecompanies. Also, the betswere expensive to maintain.The companies paid highdividends, and their shareswere often costly to borrow:New Century, for instance,paid a 20 percent dividend,anditssharescost12percenta year to borrow. For thepleasure of shorting 100milliondollars'worthofNew

Century's shares, SteveEisman forked out $32millionayear.

In his search for stockmarket investors he mightterrify with his Doomsdayscenario,Lippmannhadmadea lucky strike: He hadstumbledontoastockmarketinvestor who held an evendarker view of the subprimemortgagemarketthanhedid.Eismanknewmoreaboutthatmarket, itscharacters,and its

depravities than anyoneLippmann had ever spokenwith.Ifanyonewouldmakeadramatic bet againstsubprime, he thought, it wasEisman--and so he waspuzzled when Eisman didn'tdo it. He was even morepuzzledwhen,severalmonthslater, Eisman's new headtrader,DannyMoses,andhisresearch guy,VinnyDaniels,askedhimtocomebackintoexplainitalloveragain.

The problem withsomeonewhoistransparentlyself-interested is that theextentofhisinterestsisneverclear. Danny simplymistrusted Lippmann at firstsight. "Fucking Lippmann,"hecalledhim,asin,"FuckingLippmannneverlooksyouintheeyewhenhetalkstoyou.Itbotherstheshitoutofme."Vinny could not believe thatDeutscheBankwouldletthisguy loose to run around and

torpedotheirmarketunlessitservedthenarrowinterestsofDeutsche Bank. To Dannyand Vinny, Greg Lippmannwasawalkingembodimentofthe bondmarket,which is tosay he was put on earth toscrewthecustomer.

Three times in as manymonths, Danny and Vinnycalled, and Lippmannreturned--and that fact aloneheightened their suspicion ofhim. He wasn't driving up

fromWallStreet toMidtownto promote world peace. Sowhywashehere?Eachtime,Lippmannwouldtalkamileaminute,andDannyandVinnywould stare inwonder.Theirmeetings acquired the flavorof a postmodern literarypuzzle: The story rang trueeven as the narrator seemedentirely unreliable. At somepoint during each of thesesessions, Vinny would stophim to ask, "Greg, I'm trying

to figure out why you areevenhere."Thiswasasignalto bombard Lippmann withaccusatoryquestions:

If it's such a great idea,why don't you quitDeutscheBankandstartahedge fund and make afortuneforyourself?

It'd take me sixmonths to set up a hedgefund. The world might

wake up to this insanitynext week. I have to playthehandI'vebeendealt.

If it's such a greatidea,whyareyougivingitawaytous?

I'm not giving awayanything. The supply isinfinite.

Yeah.Butwhybothereventellingus?

I'llchargeyougettingin and getting out. I needtopaytheelectricbills.

It's zero-sum. Who'son the other side? Who'stheidiot?

Dusseldorf. StupidGermans.Theytakeratingagencies seriously. Theybelieveintherules.

Why does DeutscheBankallowyou to trash amarket that they sit at thecenterof?

I don't have anyparticular allegiance toDeutsche Bank...I just

workthere.Bullshit. They pay

you.Howdoweknowthepeople runningyourCDOmachine aren't just usingyour enthusiasm forshorting your ownmarkettoexploitus?

Have you met thepeople running our CDOmachine?

At some point Danny

and Vinny dropped even thepretense that they wereseeking new informationabout credit default swapsand subprime mortgagebonds.Theywerejusthopingtheguymightslipupinsomeway that confirmed that hewas indeed the lying WallStreet scumbag that theypresumed him to be. "We'retryingtofigureoutwherewefit into this world," saidVinny. "I don't believe him

that he needs us because hehastoomuchofthisstuff.Sowhy is he doing this?"Lippmann, for his part, feltlike a witness underinterrogation: These guyswere trying to crack him. Afew months later, he'd pitchhis ideatoPhilFalcone,whoranagianthedgefundcalledHarbinger Capital. Falconewouldbuybillionsof dollarsin credit default swapsvirtuallyon thespot.Falcone

knewone-tenthofwhattheseguys knew about thesubprime mortgage market,butFalconetrustedLippmannand these guys did not. Intheir final meeting, Vinnyfinallyputthematterbluntly."Greg," he said. "Don't takethis the wrong way. But I'mjust trying to figure out howyou'regoingtofuckme."

They never actuallyfinishedweighing thesoulofGregLippmann.Rather, they

were interrupted by twopieces of urgent news. Thefirst came in May 2006:Standard&Poor'sannounceditsplanstochangethemodelused to rate subprimemortgage bonds. The modelwould change July 1, 2006,the announcement said, butallthesubprimebondsissuedbefore that date would berated by the old, presumablyless rigorous, model.Instantly, the creation of

subprime bonds shot updramatically. "They werestuffing the channel," saidVinny."Gettingasmuchshitout so that it could be ratedbytheoldmodel."Thefearofnew and better ratingssuggested that even the bigWall Street firms knew thatthe bonds they'd beencreatinghadbeenoverrated.

Theotherpieceofnewsconcerned home prices.Eisman spoke often to a

housing market analyst atCredit Suisse named IvyZelman. The simplemeasureof sanity in housing prices,Zelmanargued,was the ratioof median home price toincome. Historically, in theUnited States, it ran around3:1;bylate2004,ithadrisennationally, to 4:1. "All thesepeople were saying it wasnearly as high in some othercountries,"saysZelman."Buttheproblemwasn'tjustthatit

was four to one. In LosAngelesitwastentooneandin Miami, eight-point-five toone. And then you coupledthat with the buyers. Theyweren't real buyers. Theywere speculators."* Thenumber of For Sale signsbeganrisinginmid-2005andneverstopped.Inthesummerof 2006, the Case-Shillerindexofhousepricespeaked,and house prices across thecountrybegantofall.Forthe

entire year they would fall,nationally,by2percent.

Either piece of news--rising ratings standards orfalling house prices--shouldhave disrupted the subprimebond market and caused thepriceofinsuringthebondstorise. Instead, the price ofinsuring the bonds fell.Insurance on the crappiesttriple-Btrancheofasubprimemortgagebondnowcost lessthan 2 percent a year. "We

finally just did a trade withLippmann," says Eisman."Then we tried to figure outwhatwe'ddone."

Theminutethey'ddonetheirfirst trade, they joined GregLippmann'slongandgrowinge-mail list.Rightupuntil thecollapse, Lippmann wouldpepper them with agitpropaboutthehousingmarket,andhis own ideas of whichsubprimemortgagebondshis

customersshouldbetagainst."Any time Lippmann wouldoffer us paper, Vinny and Iwould lookateachotherandsay no," said Danny Moses.They'd take Lippmann'sadvice,butonlyuptoapoint.They still hadn't gottenaround to trusting anyoneinside a Wall Street bonddepartment; anyway, it wastheir job, not Lippmann's, toevaluatetheindividualbonds.

Michael Burry focused,

abstractly,on thestructureofthe loans, and bet on poolswith high concentrations ofthe types that he believedweredesignedtofail.Eismanand his partners focusedconcretely on the peopledoing the borrowing and thelending.Thesubprimemarkettapped a segment of theAmerican public that did nottypicallyhaveanything todowithWall Street: the tranchebetween the fifth and the

twenty-ninth percentile intheir credit ratings. That is,the lenders were makingloanstopeoplewhowerelesscreditworthy than 71 percentof the population. Which ofthese poor Americans werelikely to jump which waywith their finances? Howmuch did their home pricesneed to fall for their loans toblow up? Which mortgageoriginators were the mostcorrupt? Which Wall Street

firms were creating themostdishonest mortgage bonds?What kind of people, inwhich parts of the country,exhibited the highest degreeof financial irresponsibility?The default rate in Georgiawas five times higher thanthat in Florida, even thoughthe two states had the sameunemployment rate. Why?Indiana had a 25 percentdefault rate; California, only5 percent, even though

Californianswere,onthefaceof it, far less fiscallyresponsible.Why?VinnyandDanny flew down toMiami,where they wandered aroundempty neighborhoods builtwithsubprimeloans,andsawwith theirowneyeshowbadthings were. "They'd call meandsay,'OhmyGod,thisisacalamity here,'" recallsEisman.

In short, theyperformedthe sort of nitty-gritty credit

analysis on the mortgageloans that should have beendone before the loans weremade in the first place.Thentheywent hunting for crooksand fools. "The first time Irealizedhowbaditwas,"saidEisman, "waswhen I said toLippmann, 'Sendmea listofthe 2006dealswith high no-doc loans." Eisman,predisposed to suspect fraudin the market, wanted to betagainst Americans who had

been lent money withouthavingbeenrequiredtoshowevidence of income oremployment. "I figuredLippmannwasgoing to sendme deals that had twentypercentnodocs.Hesentusalistandnoneofthemhadlessthanfiftypercent."

They called Wall Streettrading desks and asked formenus of subprimemortgagebonds,sotheymightfindthemost rottenonesandbuy the

smartest insurance. Thejuiciest shorts--the bondsultimately backed by themortgages most likely todefault--had severalcharacteristics. First, theunderlyingloanswereheavilyconcentrated in what WallStreet people were nowcalling the sand states:California, Florida, Nevada,andArizona.Houseprices inthe sand states had risenfastest during the boom and

so would likely crash fastestinabust--andwhentheydid,those low California defaultrateswouldsoar.Second,theloanswould have beenmadeby the more dubiousmortgage lenders. LongBeach Savings, whollyowned by WashingtonMutual,wasaprimeexampleof financial incontinence.Long Beach Savings hadbeen the first to embrace theoriginate and sell model and

now was moving money outthedoortonewhomebuyersas fast as it could, fewquestions asked. Third, thepools would have a higherthan average number of low-doc or no-doc loans--that is,loans more likely to befraudulent. Long BeachSavings, it appeared toEisman and his partners,specialized in askinghomeowners with bad creditand no proof of income to

accept floating-ratemortgages. Nomoney down,interest payments deferredupon request. The housingblogs of southern Californiateemed with stories offinancial abuses madepossible by these so-calledthirty-year payment optionARMs, or adjustable-ratemortgages. In Bakersfield,California, a Mexicanstrawberry picker with anincome of $14,000 and no

Englishwaslenteverypennyheneeded tobuyahousefor$724,000.

Themoretheyexaminedthe individual bonds, themore they came to seepatterns in the loans thatcould be exploited for profit.The new taste for lendinghuge sumsofmoney to poorimmigrants,forinstance.Oneday Eisman's housekeeper, aSouth American woman,cametohimandtoldhimthat

she was planning to buy atownhouse in Queens. "Theprice was absurd, and theywere giving her a no moneydown option adjustable-ratemortgage,"saysEisman,whotalked her into taking out aconventional fixed-ratemortgage. Next, the babynursehe'dhiredbackin2003to take care of his new twindaughters phoned him. "Shewas this lovely woman fromJamaica," he says. "She says

she and her sister own sixtownhousesinQueens.Isaid,'Corinne, how did thathappen?'" It happenedbecauseafter theyboughtthefirst one, and its value rose,the lenders came andsuggested they refinance andtake out $250,000--whichthey used to buy another.Then the price of that onerose, too, and they repeatedthe experiment. "By the timethey were done they owned

five of them, themarketwasfalling, and they couldn'tmakeanyofthepayments."

Thesuddenabilityofhisbaby nurse to obtain loanswas no accident: Like prettymuch everything else thatwas happening betweensubprimemortgageborrowersand lenders, it followed fromthedefectsofthemodelsusedto evaluate subprimemortgage bonds by the twomajor rating agencies,

Moody's and Standard &Poor's.

The big Wall Streetfirms--Bear Stearns, LehmanBrothers, Goldman Sachs,Citigroup,andothers--hadthesame goal as anymanufacturing business: topay as little as possible forraw material (home loans)and charge as much aspossiblefortheirendproduct(mortgage bonds). The priceoftheendproductwasdriven

by the ratings assigned to itby the models used byMoody'sandS&P.The innerworkings of these modelswere, officially, a secret:Moody's and S&P claimedthey were impossible togame. But everyone onWallStreet knew that the peoplewhoranthemodelswereripefor exploitation. "Guys whocan'tgetajobonWallStreetgetajobatMoody's,"asoneGoldman Sachs trader-

turned-hedge fund managerput it. Inside the ratingagency there was anotherhierarchy,evenlessflatteringto the subprime mortgagebond raters. "At the ratingsagencies the corporate creditpeoplearetheleastbad,"saysa quant who engineeredmortgage bonds for MorganStanley. "Next are the primemortgage people. Then youhavetheasset-backedpeople,who are basically like brain-

dead."* Wall Street bondtrading desks, staffed bypeople making seven figuresa year, set out to coax fromthe brain-dead guys makinghigh five figures the highestpossible ratings for theworstpossible loans. Theyperformed the task with IvyLeague thoroughness andefficiency. They quicklyfiguredout, for instance, thatthe people at Moody's andS&P didn't actually evaluate

the individualhomeloans,orsomuchas lookat them.Allthey and their models saw,and evaluated, were thegeneralcharacteristicsofloanpools.

Their handling of FICOscores was one example.FICO scores--so calledbecause they were invented,in the 1950s, by a companycalled the Fair IsaacCorporation--purported tomeasure the creditworthiness

of individual borrowers. Thehighest possible FICO scorewas850;thelowestwas300;the U.S. median was 723.FICO scoreswere simplistic.They didn't account for aborrower's income, forinstance. They could also berigged.Awould-beborrowercouldraisehisFICOscorebytaking out a credit card loanand immediately paying itback. But never mind: Theproblem with FICO scores

was overshadowed by thewaytheyweremisusedbytherating agencies.Moody's andS&P asked the loanpackagersnotforalistoftheFICO scores of all theborrowersbutfortheaverageFICO score of the pool. Tomeet the rating agencies'standards--to maximize thepercentage of triple-A-ratedbondscreatedfromanygivenpool of loans--the averageFICO score of the borrowers

in the pool needed to bearound 615. Therewasmorethanonewaytoarriveatthataverage number.And thereinlay a huge opportunity. Apool of loans composed ofborrowersallofwhomhadaFICO score of 615 was farless likely to suffer hugelosses than a pool of loanscomposed of borrowers halfofwhomhadFICOscoresof550 and half of whom hadFICOscoresof680.Aperson

withaFICOscoreof550wasvirtually certain to defaultand should never have beenlentmoney in the first place.But the hole in the ratingagencies' models enabled theloantobemade,aslongasaborrower with a FICO scoreof 680 could be found tooffset thedeadbeat, andkeeptheaverageat615.

Where to find theborrowers with high FICOscores? Here theWall Street

bond trading desks exploitedanother blind spot in therating agencies' models.Apparently the agenciesdidn't grasp the differencebetween a "thin-file" FICOscoreanda"thick-file"FICOscore.A thin-fileFICOscoreimplied, as it sounds, a shortcredit history. The file wasthin because the borrowerhadn'tdonemuchborrowing.Immigrants who had neverfailed to repay a debt,

because they had never beengiven a loan, often hadsurprisingly high thin-fileFICO scores. Thus aJamaican baby nurse orMexican strawberry pickerwith an income of $14,000looking to borrow three-quarters of a million dollars,when filtered through themodelsatMoody'sandS&P,became suddenly moreuseful, from a credit-riggingpoint of view. They might

actually improve theperceived quality of the poolof loans and increase thepercentage that could bedeclared triple-A. TheMexican harvestedstrawberries; Wall StreetharvestedhisFICOscore.

Themodels used by therating agencies were riddledwith these sorts ofopportunities. The trick wasfinding them before othersdid--finding, for example,

that both Moody's and S&Pfavored floating-ratemortgages with low teaserratesover fixed-rateones.Orthat theydidn't care if a loanhadbeenmade inaboomingreal estate market or a quietone. Or that they wereseemingly oblivious to thefraud implicit in no-docloans.Orthattheywereblindto the presence of "silentseconds"--second mortgagesthat left the homeownerwith

no equity in his home andthus no financial incentivenot to hand the keys to thebank andwalk away from it.Every time some smartWallStreet mortgage bondpackager discovered anotherexample of the ratingagencies'idiocyorneglect,hehad himself an edge in themarketplace: Crappier poolsof loanswerecheaper tobuythan less crappy pools.Barbell-shaped loan pools,

withlotsofverylowandveryhigh FICO scores in them,were a bargain compared topools clustered around the615average--atleastuntiltherest ofWallStreet caughtontotheholeinthebrainsoftherating agencies and bid uptheir prices. Before thathappened, the Wall Streetfirm enjoyed a perversemonopoly. They'd phone upan originator and say, "Don'ttellanybody,butifyoubring

me a pool of loans teemingwith high thin-file FICOscoresI'llpayyoumoreforitthan anyone else." Themoreegregioustheratingagencies'mistakes, the bigger theopportunity for the WallStreettradingdesks.

In the late summer of2006Eismanandhispartnersknew none of this. All theyknew was that Wall Streetinvestment banks apparentlyemployed people to do

nothing but game the ratingagencies'models.Inarationalmarket, the bonds backed bypools ofweaker loanswouldhave been priced lower thanthebondsbackedbystrongerloans. Subprime mortgagebonds all were priced by theratings bestowed on them byMoody's. The triple-Atranches all traded at oneprice,thetriple-Btranchesalltraded at another, eventhough there were important

differences fromone triple-Btranche to another. As thebondswere all pricedoff theMoody's rating, the mostoverpriced bonds were thebonds that had been mostineptly rated. And the bondsthat had been most ineptlyrated were the bonds thatWallStreet firmshad trickedtheratingagenciesintoratingmost ineptly. "I cannotfucking believe this isallowed," said Eisman. "I

must have said that onethousandtimes."

Eisman didn't knowexactly how the ratingagencieshadbeengamed.Hehad to learn. Thus began histeam's months-long quest tofindthemostoverratedbondsin a market composed ofoverrated bonds.Amonth orso into it, after they boughttheirfirstcreditdefaultswapson subprimemortgage bondsfrom Lippmann, Vincent

Daniel and Danny Mosesflew to Orlando for whatamounted to a subprimemortgagebondconference. Ithad an opaque title--ABSEast--but it was, in effect, atrade show for a narrowindustry: the guys whooriginated subprimemortgages, the Wall Streetfirms that packaged and soldsubprime mortgages, fundmanagers who invested innothing but subprime

mortgage-backed bonds, theagencies that rated subprimemortgage bonds, the lawyerswhodidwhateverthelawyersdid. Daniel and Mosesthought they were paying acourtesy call on a cottageindustry, but the cottagewasacastle."Thereweresomanypeople being fed by thisindustry,"saidDaniel."That'swhen we realized that thefixed income departments ofthe brokerage firms were

builtonthis."That's also when they

made their first face-to-facecontact with the ratingagencies. Greg Lippmann'speople set it up for them, onthe condition they notmention that they werebetting against, and not for,subprime mortgage bonds."Our whole purpose," saidMoses, "was supposed to be,'We're here to buy thesesecurities.' People were

supposed to think, 'Oh,they're looking to buy paperbecause it's getting toattractive levels.'" In a littleroominsidetheOrlandoRitz-Carlton hotel, they met withboth Moody's and S&P.Vinny and Danny alreadysuspected that the subprimemarket had subcontracted itscreditanalysis topeoplewhoweren't evendoing the creditanalysis. Nothing theylearned thatdayallayed their

suspicion. The S&P peoplewere cagey, but the womanfrom Moody's wassurprisingly frank. She toldthem, for instance, that eventhough she was responsiblefor evaluating subprimemortgage bonds, she wasn'tallowedbyherbossessimplyto downgrade the ones shethought deserved to bedowngraded.Shesubmittedalist of the bonds she wishedtodowngradetohersuperiors

and received back a list ofwhat she was permitted todowngrade. "She said she'dsubmit a list of a hundredbondsandgetbackalistwithtwenty-fivebondson it,withno explanation ofwhy," saidDanny.

Vinny,theanalyst,askedmost of the questions, butDannyattendedwithgrowinginterest. "Vinny has a tell,"said Moses. "When he getsexcitedheputshishandover

hismouthandleanshiselbowonthetableandsays,'Letmeask you a question aboutthis...'WhenIsawthehandtofaceIknewVinnywason tosomething."

Here's what I don'tunderstand, said Vinny,hand on chin. You havetwo bonds that seemidentical. How is one ofthem triple-A and the

othernot?I'm not the one who

makes those decisions,said the woman fromMoody's, but she wasclearlyuneasy.

Here'sanotherthingIdon't understand, saidVinny. How could yourateanyportionofabondmade up exclusively ofsubprime mortgagestriple-A?

That's a very good

question.Bingo.

"She was great," saidMoses. "Because she didn'tknowwhatwewereupto."

They called Eismanfrom Orlando and said,However corrupt you thinkthis industry is, it's worse."Orlando wasn't even thevarsity conference," saidDaniel. "Orlandowas the JV

conference. The varsity metinVegas.WetoldSteve,'Youhave to go to Vegas. Just toseethis.'"Theyreallythoughtthat they had a secret.Through the summer andearly fall of 2006, theybehaved as if they hadstumbled upon a fantastictreasure map, albeit with afew hazy directions. Eismanwas now arriving home atnight in a better mood thanhis wife had seen him in a

very long time. "I washappy," says Valerie. "Ithought, 'ThankGodthere'saplace to put all thisenthusiasticmisery.'He'dsay,'I found this thing. It'sagoldmine. And nobody elseknowsaboutit.'"

CHAPTERFIVE

AccidentalCapitalists

The thing Eisman hadfound was indeed a goldmine, but it wasn't true thatnooneknewabout it.Bythefall of 2006 Greg Lippmannhad made his case to maybe250 big investors privately,

and to hundreds more atDeutsche Bank salesconferences or on DeutscheBankconferencecalls.Bytheendof2006,accordingtothePerTrac Hedge FundDatabase Study, there were13,675hedgefundsreportingresults, and thousands ofother types of institutionalinvestorsallowedtoinvest incredit default swaps.Lippmann'spitch,inoneformor another, reached many of

them. Yet only one hundredor so dabbled in the newmarket for credit defaultswaps on subprimemortgagebonds. Most bought thisinsurance on subprimemortgages not as an outrightbet against them but as ahedge against their implicitbet on them--their portfoliosof U.S. real estate-relatedstocks or bonds. A smallergroup used credit defaultswaps to make what often

turnedouttobespectacularlydisastrous gambles on therelative value of subprimemortgage bonds--buying onesubprime mortgage bondwhile simultaneously sellinganother. Theywould bet, forinstance, that bonds withlarge numbers of loansmadein California wouldunderperform bonds withvery little of California inthem.Orthattheuppertriple-A-rated floor of some

subprime mortgage bondwould outperform the lower,triple-B-rated, floor. Or thatbonds issued by LehmanBrothers or Goldman Sachs(bothnotoriousforpackagingAmerica'sworst home loans)would underperform bondspackaged by J.P. Morgan orWells Fargo (which actuallyseemed to care a bit aboutwhich loans it packaged intobonds).

A smaller number of

people--more than ten, fewerthan twenty--made astraightforward bet againstthe entiremulti-trillion-dollarsubprime mortgage marketand, by extension, the globalfinancial system. In and ofitselfitwasaremarkablefact:The catastrophe wasforeseeable, yet only ahandful noticed. Amongthem: a Minneapolis hedgefund called Whitebox, aBostonhedgefundcalledThe

Baupost Group, a SanFrancisco hedge fund calledPassport Capital, a NewJerseyhedgefundcalledElmRidge, and a gaggle of NewYork hedge funds: ElliottAssociates, Cedar HillCapital Partners, QVTFinancial, and PhilipFalcone's Harbinger CapitalPartners.Whatmost of theseinvestorshadincommonwasthat they had heard, directlyor indirectly, Greg

Lippmann's argument. InDallas, Texas, a formerBearStearnsbondsalesmannamedKyle Bass set up a hedgefund called Hayman Capitalin mid-2006 and soonthereafter bought creditdefault swaps on subprimemortgage bonds. Bass hadheard the idea from AlanFournier of Pennant Capital,in New Jersey--who in turnhad heard it fromLippmann.A rich American real estate

investor named Jeff Greenewent off and bought severalbilliondollars'worthofcreditdefault swaps on subprimemortgage bonds for himselfafterhearingaboutitfromtheNew York hedge fundmanager John Paulson.Paulson, too,hadheardGregLippmann's pitch--and, as hebuilt a massive position incredit default swaps, usedLippmann as his soundingboard.Aproprietarytraderat

Goldman Sachs in London,informed that this trader atDeutscheBank inNewYorkwas making a powerfulargument, flew across theAtlantic to meet withLippmann and went homeowning a billion dollars'worthofcreditdefaultswapsonsubprimemortgagebonds.AGreekhedge fund investornamed Theo Phanos heardLippmann pitch his idea at aDeutscheBankconference in

Phoenix, Arizona, andimmediately placed his ownbet.Ifyoumappedthespreadof the idea, as you might avirus, most of the linespointed back to Lippmann.He was Patient Zero. Onlyone carrier of the diseasecould claim, plausibly, tohave infected him. ButMikeBurry was holed up in hisofficeinSanJose,California,andwasn'ttalkingtoanyone.

This small world of

investors who made big betsagainst subprime mortgagebonds itself contained aneven smaller world: peoplefor whom the trade becamean obsession. A tiny handfulof investors perceived whatwashappeningnotjusttothefinancial system but to thelargersocietyitwasmeanttoserve, and made investmentsagainst that system thatwereso large, in relation to theircapital, that they effectively

gave up being conventionalmoneymanagersandbecamesomethingelse.JohnPaulsonhadbyfarthemostmoneytoplay with, and so was themost obvious example. Ninemonths after Mike Burryfailed to raise a fund to donothingbutbuycreditdefaultswaps on subprimemortgagebonds,Paulsonsucceeded,bypresenting it to investors notas a catastrophe almostcertain to happen but as a

cheap hedge against theremote possibility ofcatastrophe. Paulson wasfifteenyearsolderthanBurry,andfarbetterknownonWallStreet, but he was still, insome ways, a Wall Streetoutsider. "I called GoldmanSachs to ask them aboutPaulson," said one rich manwhom Paulson had solicitedforfundsinmid-2006."Theytold me he was a third-ratehedge fund guy who didn't

know what he was talkingabout."Paulsonraisedseveralbillion dollars from investorswho regarded his fund as aninsurance policy on theirportfolios of real estate-related stocks and bonds.What prepared him to seewhat was happening in themortgage bond market,Paulsonsaid,wasacareerofsearching for overvaluedbondstobetagainst."Ilovedthe concept of shorting a

bond because your downsidewaslimited,"hetoldme."It'sanasymmetricalbet."Hewasshockedhowmucheasierandcheaperitwastobuyacreditdefault swap than it was tosellshortanactualcashbond--eventhoughtheyrepresentedexactly the same bet. "I didhalf a billion. They said,'Would you like to do abillion?'AndIsaid,'WhyamI pussyfooting around?' Ittook two or three days to

place twenty-five billion."Paulson had neverencountered a market inwhich an investor could sellshort25billiondollars'worthof a stock or bond withoutcausing its price to move,even crash. "And we couldhave done fifty billion, ifwe'dwantedto."

Even as late as thesummer of 2006, as homepricesbegan to fall, it tookacertain kind of person to see

the ugly facts and react tothem--to discern, in theprofileofthebeautifulyounglady,thefaceofanoldwitch.Eachofthesepeopletoldyousomething about the state ofthe financial system, in thesame way that people whosurviveaplanecrashtoldyousomethingabouttheaccident,and also about the nature ofpeoplewhosurviveaccidents.All of themwere, almost bydefinition,odd.Buttheywere

not all odd in the sameway.John Paulson was oddlyinterested in betting againstdodgy loans, and oddlypersuasive in talking othersinto doing it with him.MikeBurrywasoddinhisdesiretoremain insulated from publicopinion, and even directhuman contact, and to focusinstead on hard data and theincentives that guide futurehuman financial behavior.SteveEismanwasodd inhis

convictionthattheleveragingofmiddle-classAmericawasa corrupt and corruptingevent, and that the subprimemortgagemarketinparticularwasanengineofexploitationand, ultimately, destruction.Each filled a hole; eachsuppliedamissinginsight,anattitudetoriskwhich,ifmoreprevalent, might haveprevented the catastrophe.But there was at least onegaping hole no big-time

professionalinvestorfilled.Itwasfilled,instead,byCharlieLedley.

Charlie Ledley--curiously uncertain CharlieLedley--wasoddinhisbeliefthat the best way to makemoneyonWallStreetwas toseekoutwhatever itwas thatWallStreetbelievedwasleastlikely to happen, and bet onitshappening.Charlieandhispartners had done this oftenenough, and had had enough

success, to know that themarkets were predisposed tounderestimating thelikelihood of dramaticchange. Even so, inSeptember2006,ashepagedthrough thedocumentsent tohim by a friend, apresentation about shortingsubprimemortgage bonds bysome guy at Deutsche Banknamed Greg Lippmann,Ledley's first thought was,This is just too good to be

true. He'd never traded amortgage bond, knewessentiallynothingabout realestate,wasbewilderedbythejargon of the bond market,and wasn't even sureDeutsche Bank or anyoneelsewould allow him to buycredit default swaps onsubprime mortgage bonds--since this was a market forinstitutional investors,andheand his two partners, BenHockett and Jamie Mai,

weren't anyone's idea of aninstitution."But I just lookedat it and said, 'How can thiseven be possible?'" He thensent the idea to his partnersalongwith thequestion,Whyisn'tsomeonesmarterthanusdoingthis?

Every new business isinherently implausible, butJamie Mai and CharlieLedley's idea, in early 2003,for a money management

firm bordered on the absurd:a pair of thirty-year-old menwith a Schwab accountcontaining$110,000occupyashed in thebackofa friend'shouseinBerkeley,California,anddubthemselvesCornwallCapitalManagement.Neitherof them had any reason tobelieve he had any talent forinvesting. Both had workedbriefly for the New Yorkprivate equity firm GolubAssociates as grunts chained

totheirdesks,butneitherhadmade actual investmentdecisions.JamieMaiwastalland strikingly handsome andso, almost by definition, hadthe air of a man in charge--untilheopenedhismouthandbetrayed his lack ofconfidence in everythingfrom tomorrow's sunrise tothe futureof thehuman race.Jamiehadahabitofstoppinghimself midsentence andstammering--"uh, uh, uh"--as

if hewas somehowunsettledby his own thought. CharlieLedley was even worse: Hehad the pallor of amorticianandthemannerofamanbentonputtingoff, for as longaspossible, definite action.Askedasimplequestion,he'dstare mutely into space,nodding and blinking like anactor who has forgotten hislines, so thatwhenhe finallyopened his mouth the soundthat emerged caused you to

joltinyourchair.Itspeaks!Both were viewed by

contemporaries as sweet-natured, disorganized,inquisitive,brightbutlackingobviousdirection--thekindofguys who might turn up attheir fifteenth high schoolreunions with surprisingfacial hair and a complicatedlife story. Charlie leftAmherst College after hisfreshman year to volunteerfor Bill Clinton's first

presidential campaign, and,though he eventuallyreturned, he remained farmore interested in his ownidealism than in makingmoney. Jamie's first job outofDukeUniversity had beendelivering sailboats to richpeopleupanddown theEastCoast. ("That's when itbecame clear tome that--uh,uh,uh--Iwasgoingtohavetoadopt some profession.") Atthe age of twenty-eight, he'd

taken an eighteen-month"sabbatical," travelingaroundtheworldwith his girlfriend.He'd come to Berkeley notlooking for fertile soil inwhich to grow money butbecause thegirlfriendwantedtomove there. Charlie didn'teven really want to be inBerkeley; he'd grown up inManhattan and turned into apumpkin when he got to theother side of a bridge ortunnel. He'd moved to

Berkeley because the idea ofrunning money together, andthe $110,000, had beenJamie's.Thegarage inwhichCharlie now slept wasJamie's,too.

Instead of money orplausibility, what they hadwas an idea about financialmarkets.Or, rather, a pair ofrelated ideas. Their stint intheprivateequitybusiness--inwhich firms buy and sellentire companies over the

counter--led them to believethat private stock marketsmight be more efficient thanpublic ones. "In privatetransactions," said Charlie,"youusually have an advisoron both sides that'ssophisticated.Youdon'thavepeople who justfundamentally don't knowwhat something's worth. Inpublic markets you havepeople focused on quarterlyearnings rather than the

business franchise.You havepeople doing things for allsortsofinsanereasons."Theybelieved, further, that publicfinancial markets lackedinvestors with an interest inthe big picture. U.S. stockmarket guys made decisionswithintheU.S.stockmarket;Japanese bond market guysmade decisions within theJapanesebondmarket;andsoon."Thereareactuallypeoplewhodonothingbut invest in

Europeanmid-caphealthcaredebt," said Charlie. "I don'tthink the problem is specificto finance. I think thatparochialism is common tomodern intellectual life.There is no attempt tointegrate." The financialmarkets paid a lot of peopleextremely well for narrowexpertise and a few people,poorly, for the big, globalviews you needed to have ifyou were to allocate capital

acrossmarkets.In early 2003 Cornwall

Capital had just opened forbusiness,whichmeant Jamieand Charlie spent evenmorehoursoftheirdaythanbeforesitting in the Berkeleygarage--Charlie's bedroom--shooting the shit about themarket. Cornwall Capital,they decided, would notmerely search for marketinefficiency but search for itglobally, in every market:

stocks, bonds, currencies,commodities. To these twonot so simple ambitions theysoonaddeda third, even lesssimple, one, when theystumbled upon their first bigopportunity, a credit cardcompany called Capital OneFinancial.

Capital One was a rareexample of a company thatseemedtohavefoundasmartway to lend money toAmericans with weak credit

scores.Itsbusinesswascreditcards, not home loans, but itdealt with the samesocioeconomic class ofpeople whose home loanborrowing would end incatastrophe just a few yearslater. Through the 1990s andinto the 2000s, the companyclaimed, and the marketbelieved, that it possessedbetter tools than othercompanies for analyzing thecreditworthiness of subprime

credit card users and forpricing the risk of lending tothem. Ithadweatheredabadstretch for its industry, in thelate 1990s, during whichseveral of its competitorscollapsed.Then,inJuly2002,its stock crashed--falling 60percent in two days, afterCapital One's managementvoluntarilydisclosedthattheywere in a dispute about howmuch capital they needed toreserve against potential

subprime losses with theirtwo government regulators,the Office of ThriftSupervision and the FederalReserve.

Suddenly the marketfearedthatCapitalOnewasn'tactually smarter thaneveryone else in theirindustry about making loansbut simply better at hidingtheir losses. The regulatorshad discovered fraud, themarket suspected, and were

about to punishCapitalOne.Circumstantial evidenceorganized itself into whatseemed like a damning case.For instance, the SECannounced that it wasinvestigating the company'sCFO, who had just resigned,for selling his shares in thecompany two months beforethe company announced itsdisputewithregulatorsanditssharepricecollapsed.

Over the next six

months, the companycontinued to make money atimpressive rates. It claimedthat it had done nothingwrong, that the regulatorswere being capricious, andannounced no special lossesonits$20billionportfolioofsubprime loans. Its stockprice remained depressed.CharlieandJamiestudiedthematter, which is to say theywent to industryconferences,and called up all sorts of

people they didn't know andbuggedthemforinformation:short sellers, former CapitalOne employees,managementconsultants who had advisedthe company, competitors,and even governmentregulators. "What becameclear,"saidCharlie,"wasthattherewasalimitedamountofinformationout thereandwehad the same information aseveryoneelse."TheydecidedthatCapitalOneprobablydid

have better tools for makingsubprimeloans.Thatleftonlyone question: Was it run bycrooks?

Itwasn't a question twothirty-something would-beprofessional investors inBerkeley, California, with$110,000 in a Schwabaccount should feel it wastheir business to answer.Butthey did. They went huntingfor people who had gone tocollege with Capital One's

CEO, Richard Fairbank, andcollected characterreferences. Jamie pagedthroughtheCapitalOne10-Kfiling in search of someoneinside the company hemightplausibly ask tomeet. "Ifwehad asked to meet with theCEO, we wouldn't havegotten toseehim,"explainedCharlie. Finally they cameupon a lower-ranking guynamed Peter Schnall, whohappened to be the vice-

president in charge of thesubprimeportfolio."Igottheimpression they were like,'WhocallsandasksforPeterSchnall?'" said Charlie."Because when we asked totalk to him they were like,'Why not?'" They introducedthemselves gravely asCornwall CapitalManagement but refrainedfrom mentioning what,exactly, Cornwall CapitalManagement was. "It's

funny," says Jamie. "Peopledon't feel comfortable askinghow much money you have,and so you don't have to tellthem."

They asked Schnall iftheymightvisithim,toaskafew questions before theymade an investment. "Allwereally wanted to do," saidCharlie, "was to see if heseemed like a crook." Theyfound him totally persuasive.Interestingly, he was buying

stock in his own company.They left thinking thatCapitalOne'sdisputewithitsregulatorswastrivialandthatthe company was basicallyhonest. "We concluded thatmaybe they were crooks,"said Jamie, "but probablynot."

What happened next ledthem, almost by accident, tothe unusual approach tofinancial markets that wouldsoon make them rich. In the

six months following thenews of its troubles with theFederal Reserve and theOffice of Thrift Supervision,CapitalOne's stock traded ina narrow band around $30 ashare. That stabilityobviously masked a deepuncertainty. Thirty dollars ashare was clearly not the"right"price forCapitalOne.The company was either afraud,inwhichcasethestockwas probably worth zero, or

thecompanywasashonestasit appeared to Charlie andJamie, in which case thestockwaswortharound$60ashare. Jamie Mai had justread You Can Be a StockMarket Genius, the book byJoel Greenblatt, the samefellow who had stakedMikeBurry to his hedge fund.Toward the end of his bookGreenblatt described howhe'd made a lot of moneyusing a derivative security,

calledaLEAP(forLong-termEquity AnticiPationSecurity),whichconveyed toits buyer the right to buy astock at a fixed price for acertainamountoftime.Therewere times, Greenblattexplained,whenitmademoresense to buy options on astock than the stock itself.This,inGreenblatt'sworldofvalue investors, counted asheresy. Old-fashioned valueinvestors shunned options

because options presumed anability to time pricemovements in undervaluedstocks. Greenblatt's simplepoint: When the value of astock so obviously turned onsome upcoming event whosedate was known (a mergerdate, for instance, or a courtdate),thevalueinvestorcouldin good conscience employoptions to express his views.It gave Jamie an idea:Buy along-term option to buy the

stockofCapitalOne."Itwaskindoflike,Wow,wehaveaview: This common stocklooks interesting. But, Holyshit, look at the prices oftheseoptions!"

The right tobuyCapitalOne's shares for $40 at anytime in the next two and ahalfyearscostabitmorethan$3. That made no sense.Capital One's problems withregulatorswouldberesolved,or not, in the next few

months.Whentheywere, thestockwouldeithercollapsetozeroorjumpto$60.Lookingintoitabit,JamiefoundthatthemodelusedbyWallStreetto price LEAPs, the Black-Scholesoptionpricingmodel,made some strangeassumptions. For instance, itassumed a normal, bell-shaped distribution for futurestock prices. If Capital Onewas trading at $30 a share,themodelassumed that,over

the next two years, the stockwasmorelikelytogetto$35asharethanto$40,andmorelikely to get to $40 a sharethan to $45, and so on. Thisassumption made sense onlyto those who knew nothingabout the company. In thiscase the model was totallymissing the point: WhenCapitalOne stockmoved, asit surely would, it was morelikely to move by a lot thanbyalittle.

Cornwall CapitalManagement quickly bought8,000LEAPs.Theirpotentiallosses were limited to the$26,000 they paid for theiroptiontobuythestock.Theirpotential gains weretheoretically unlimited. Soonafter Cornwall Capital laidtheir chips on the table,Capital One was vindicatedby its regulators, its stockprice shot up, and CornwallCapital's $26,000 option

positionwasworth$526,000."We were pretty fired up,"saysCharlie.

"We couldn't believepeople would sell us theselong-term options socheaply," said Jamie. "Wewent looking for more long-datedoptions."

It instantly became afantastically profitablestrategy: Start with whatappearedtobeacheapoptionto buy or sell some Korean

stock,orporkbelly,or third-world currency--reallyanything with a price thatseemed poised for somedramatic change--and thenwork backward to the thingtheoptionallowedyoutobuyorsell.Theoptionssuitedthetwomen'spersonalities:Theynever had to be sure ofanything. Both werepredisposed to feel thatpeople, and by extensionmarkets, were too certain

about inherently uncertainthings. Both sensed thatpeople, and by extensionmarkets, had difficultyattaching the appropriateprobabilities to highlyimprobable events. Both hadtrouble generating convictionoftheirownbutnotroubleatall reacting to what theyviewedasthefalseconvictionof others. Each time theycame upon a tantalizing longshot,oneofthemsettowork

onmaking the case for it, inan elaborate presentation,complete with PowerPointslides. They didn't actuallyhave anyone to whom theymight give a presentation.They created them only tohear how plausible theysoundedwhenpitchedtoeachother. They entered marketsonly because they thoughtsomething dramaticmight beabout to happen in them, onwhich they could make a

smallbetwith longodds thatmight pay off in a big way.They didn't know the firstthing aboutKorean stocks orthird world currencies, butthey didn't really need to. Ifthey found what appeared tobe a cheap bet on the pricemovements of any security,theycouldthenhireanexpertto help them sort out thedetails. "That has been apattern of ours," said JamieMai."Torelyontheworkof

smartpeoplewhoknowmorethanwedo."

They followed theirsuccess with Capital Onewith a similar success, in adistressed European cabletelevision company calledUnited Pan-European Cable.This time, since they hadmore money, they bought$500,000 in call options,struckat aprice far from themarket. When UPC rallied,theyturnedaquick$5million

profit. "We're now gettingreally, really excited," saysJamie. Next they bet on acompany that deliveredoxygen tanks directly to sickpeople in their homes. That$200,000 bet quickly turnedinto $3 million. "We're nowthree for three," saidCharlie."We think it's hilarious. Forthe first time I could seemyselfdoing this fora reallylongtime."

They had stumbled

either upon a serious flaw inmodern financial markets orinto a great gambling run.Characteristically, they werenot sure which it was. AsCharlie pointed out, "It'sreally hard to know whenyou'reluckyandwhenyou'resmart."Theyreckonedthatbythe time they had astatisticallyvalidtrackrecordthey'dbedead,orclose to it,andsotheydidn'tspendalotof time worrying about

whetherthey'dbeenlucky,orsmart.Eitherway,theyknewthey didn't know asmuch asthey should, especially aboutfinancial options. They hireda PhD student from thestatistics department at theUniversity of California atBerkeleytohelpthem,buthequit after they asked him tostudy the market for porkbelly futures. "It turned outthat he was a vegetarian,"said Jamie. "He had a

problem with capitalism ingeneral, but the pork belliespushed him over the edge."Theywere left to grapple ontheir own with a lot ofcomplicated financial theory."We spent a lot of timebuilding Black-Scholesmodels ourselves, and seeingwhat happened when youchanged various assumptionsin them," said Jamie. Whatstruck them powerfully washow cheaply the models

allowedapersontospeculateon situations thatwere likelytoendinoneoftwodramaticways. If, in the next year, astock was going to be worthnothing or $100 a share, itwassilly foranyone to sell ayear-long option to buy thestock at $50 a share for $3.Yet the market often didsomething just like that. ThemodelusedbyWallStreet toprice trillions of dollars'worth of derivatives thought

of the financial world as anorderly, continuous process.But the world was notcontinuous; it changeddiscontinuously,andoftenbyaccident.

Event-driven investing:Thatwasthenametheyeithercoinedor stole forwhat theywere doing. That made itsound a lot less fun than itwas. One day Charlie foundhimself intrigued by themarketforethanolfutures.He

didn't know much aboutethanol,buthecouldseethatitenjoyedaU.S.governmentsubsidy of 50 cents a gallon,andsowassupposedtotradeat a 50-cent-a-gallonpremium to gasoline, andalways had. In early 2005,whenhebecameinterested,ittraded, briefly, at a 50-centdiscount to gas. He didn'tknow why and never foundout; instead, Charlie boughttworailcars'worthofethanol

futures, and made headlinesinEthanolToday,amagazineof whose existence he waspreviously unaware. To theintense irritation ofCornwall's broker, theywound up having to acceptrailcarsfilledwithethanolinsome stockyard in Chicago--tomakeasumofmoneythatstruck the broker as absurdlysmall. "The administrativecomplexity of what we weredoing was out of proportion

to our assets," said Charlie."People who were our sizedidn't trade across assetclasses."

"Weweredoingthesortof things that might causeyourinvestorstoyellatyou,"saidJamie,"butwedidn'tgetyelledatbyinvestorsbecausewedidn'thaveanyinvestors."

They actually thoughtabout handing theirwinningsover to some certified,qualified, sanitized, honest-

to-God professional investorto run the money for them.TheyracedaroundNewYorkfor several weeks,interviewing hedge fundmanagers. "They all soundedgreat when you listened tothem," said Jamie, "but thenyou'd look at their numbersand they were always flat."They decided to keep oninvesting their moneythemselves. Two years afterthey'd opened for business,

they were running $12million of their own and hadmoved themselves and theirworld headquarters from theBerkeleyshed toanoffice inManhattan--a floor of theGreenwich Village studio oftheartistJulianSchnabel.

They'd alsomoved theiraccount, from Schwab toBearStearns.Theylongedfora relationship with some bigWall Street trading firm andmentioned the desire to their

accountant."HesaidheknewAceGreenberg and he couldintroduce us to him, and sowe said great," said Charlie.The former chairman andCEO of Bear Stearns, and aWall Street legend,Greenbergstillkeptanofficeat the firm and acted as abroker for a handful ofpresumably special investors.When Cornwall Capitalmoved their assets to BearStearns, sure enough, their

brokerage statements sooncame back with AceGreenberg'snameontop.

Likemostofwhatbefelltheminthefinancialmarkets,their first brush with a bigWall Street firm wasdelightfully weird butultimately inexplicable. Justlikethat,withouteverhavinglaid eyes on Ace Greenberg,theywerehiscustomers."Wewere like, 'So how is it thatAce Greenberg is our

broker?'" said Charlie. "Imean,wewere nobody.Andwe'd never actually met AceGreenberg." The mysterygrewwiththeireveryattemptto speak with Greenberg.Theyhadwhat theyassumedwas his phone number, butwhen they called it someoneother than Greenberganswered. "It was totallybizarre," said Charlie."Occasionally, AceGreenberg himself would

pick up the phone. But allhe'dsaywas, 'Holdon.'Thena secretary would come onthelineandtakeourorder."

At length they talkedtheir way into a face-to-faceencounter with the WallStreet legend. The encounterwas so brief, however, thatthey could not honestly saywhether they had met AceGreenberg, or an actorplayingAceGreenberg. "Wewere ushered in for thirty

seconds--literally thirtyseconds--and thenunceremoniously usheredout," says Jamie. AceGreenberg was still theirbroker.Theyjustneverspoketohim.

"The whole AceGreenberg thing still doesn'tmake sense to us," saysCharlie.

The man to whom theynow referred as "the actorwho plays Ace Greenberg"

failed to resolve what theyviewed as their biggestproblem. They were smallprivate investors. The WallStreet firms were largely amystery to them. "I've neveractually, like, been on theinside of a bank," saidCharlie. "I can only imaginewhat's going on inside byimaginingitthroughsomeoneelse'seyes."Todothesortoftradestheywantedtodo,theyneededtobemistakenbythe

big Wall Street firms forinvestorswhoknewtheirwayaroundabigWallStreetfirm."Asaprivateinvestoryouarea second-class citizen," saidJamie. "The prices you getare worse, the service isworse,everythingisworse."

The thought had gainedforcewiththehelpofJamie'snew neighbor in Berkeley,BenHockett.Hockett,alsoinhis early thirties, had spentnine years selling and then

trading derivatives forDeutsche Bank in Tokyo.Like Jamie and Charlie, hehadthetangy,sweet-smellingaroma of the dropout abouthim. "When I started I wassingle and twenty-two," hesaid."NowIhaveawifeandababyandadog.I'msickofthebusiness.Idon't likewhoI am when I get home fromwork.Ididn'twantmykidtogrowupwith thatasadad. Ithought, I gotta get out of

here." When he went in toquit, his Deutsche Bankbossesinsistedthathelisthisgrievances. "I told them Idon'tlikegoingintoanoffice.I don't like wearing a suit.AndIdon'tlikelivinginabigcity. And they said, 'Fine.'"They toldhimhecouldwearwhatever hewanted towear,live wherever he wanted tolive, and work wherever hewantedtowork--anddoitallwhileremainingemployedby

DeutscheBank.Benmoved fromTokyo

to the San Francisco Bayarea,alongwith$100millionof Deutsche Bank's money,which he traded from thecomfort of his new home inBerkeleyHills.Hesuspected,not unreasonably, that hemight be the only person inBerkeley looking forarbitrage opportunities in themarket for credit derivatives.The existence just down the

street of a guy roaming theglobe in hismind looking tobuy long-term options onfinancial drama caught himby surprise. Ben and Jamietook to walking their dogstogether. Jamie pumped Benfor information about howbig Wall Street firms andesoteric financial marketsworked, and finally proddedhim to quit his real job andjoinCornwallCapital. "Afterthree years in a room by

myself,I thought itwouldbenice to work with people,"said Ben. He quit DeutscheBank to join the happy huntforaccidentanddisaster,andpretty quickly found himselfworking alone again. Charliemoved back toManhattan assoon as he could afford theticket, and, when hisrelationship with hisgirlfriend ended, Jamieeagerlyfollowed.

Theirs was a union of

theweirdly like-minded.Benshared Charlie and Jamie'sview that people, andmarkets, tended tounderestimate the probabilityof extreme change, but hetook his thinking a stepfurther. Charlie and Jamiewere interestedchiefly in theprobabilities of disasters infinancial markets. Benwalked around with someverytinyfractionofhismindalert to the probabilities of

disasters in real life. Peopleunderestimated these, too, hebelieved, because they didn'twant to think about them.There was a tendency, inmarketsandlife,forpeopletorespond to the possibility ofextremeevents inoneof twoways: flight or fight. "Fightis, 'I'm going to get myguns,'" he said. "Flight is,'We're all doomed so I can'tdoanythingaboutit.'"Charlieand Jamie were flight types.

When he'd mention to themthe possibility that globalwarming might cause sealevels to rise by twenty feet,forinstance,they'djustshrugand say, "I can't do anythingabout it, sowhyworry aboutit?" Or: "If that happens Idon't want to be aliveanyway."

"They'retwosingleguysin Manhattan," said Ben."They'rebothlike,'Andifwecan't live in Manhattan, we

don'twant to liveat all.'"Hewas surprised that CharlieandJamie,bothnowsoaliveto the possibility of dramaticchange in the financialmarkets, were less alert andresponsive to thepossibilitiesoutside those markets. "I'mtrying to prepare myself andmy children for anenvironment that isunpredictable,"Bensaid.

Charlie and Jamiepreferred Ben to keep his

apocalyptictalktohimself.Itmade people uncomfortable.There was no reason anyoneneededtoknow,forexample,that Ben had bought a smallfarm in the country, north ofSan Francisco, in a remoteplace without road access,planted with fruit andvegetables sufficient to feedhis family, on the off chanceoftheendoftheworldasweknow it. Itwas hard forBento keep his worldview to

himself, however, especiallysinceitwasthefirstcousinoftheirinvestmentstrategy:Thepossibility of accident anddisaster was just never veryfar from their conversations.One day on the phone withBen, Charlie said, You hatetaking even remote risks, butyouliveinahouseontopofamountain that's on a faultline, in a housing marketthat'satanall-timehigh."Hejust said, 'I gotta go,' and

hung up," recalled Charlie."Wehad troublegettingholdofhimfor,like,twomonths."

"I got off the phone,"said Ben, "and I realized, Ihave to sell my house. Rightnow."Hishousewasworthamillion dollars and maybemore yet would rent for nomorethan$2,500amonth."Itwas trading more than thirtytimesgross rental,"saidBen."Theruleofthumbisthatyoubuyattenandsellattwenty."

In October 2005 he movedhis family into a rental unit,awayfromthefault.

Ben thought of CharlieandJamielessasprofessionalmoney managers than asdilettantesor, asheput it, "acouple of smart guys justpunting around in themarkets."Buttheirstrategyofbuyingcheap tickets to somehoped-for financial dramaresonated with him. It washardly foolproof; indeed, it

was almost certain to failmoreoftenthanitsucceeded.Sometimes the hoped-fordrama never occurred;sometimes they actuallydidn't know what they weredoing. Once, Charlie foundwhathethoughtwasastrangeprice discrepancy in themarket for gasoline futures,and quickly bought one gascontract, sold another, andmade what he took to be ariskless profit--only to

discover,asJamieputit,"onewas unleaded gasoline andthe other was, like, diesel."Another time, the premisewas right but the conclusionwas wrong. "One day Bencalls me and says, 'Dude, Ithink there's going to be acoup in Thailand,'" saidJamie. There'd been nothingin the newspapers about acoup in Thailand; this was agenuine scoop. "I said,'C'mon, Ben, you're crazy,

there'snotgoingtobeacoup.Anyway, how would youeven know? You're inBerkeley!'"Bensworehehadtalked to a guy he used toworkwith inSingapore,whohadhisfingeronthepulseinThailand.Hewassoinsistentthat they went into the Thaicurrency market and boughtwhat appeared to bestunninglycheapthree-monthputs (options to sell) on theThaibaht.Oneweeklater,the

Thai military overthrew theelected prime minister. TheThai baht didn't budge. "Wepredictedacoup,andwelostmoney,"saidJamie.

The losses, by design,were no big deal; the losseswere part of the plan. Theyhadmorelosersthanwinners,but their losses, the cost ofthe options, had been trivialcompared to their gains.There was a possibleexplanation for their success,

whichCharlieand Jamiehadonly intuited but which Ben,whohadpricedoptions for abig Wall Street firm, cameready to explain: Financialoptions were systematicallymispriced. The market oftenunderestimated the likelihoodof extreme moves in prices.The options market alsotended topresuppose that thedistant future would lookmore like the present than itusuallydid.Finally, theprice

ofanoptionwasafunctionofthe volatility of theunderlying stock or currencyor commodity, and theoptionsmarkettendedtorelyon the recent past todetermine how volatile astock or currency orcommodity might be. WhenIBMstockwastradingat$34ashareandhadbeenhoppingaround madly for the pastyear, an option to buy it for$35ashareanytimesoonwas

seldom underpriced. Whengoldhadbeentradingaround$650 an ounce for the pasttwoyears,anoptiontobuyitfor $2,000 an ounce anytimeduring the next ten yearsmight well be badlyunderpriced. The longer-termthe option, the sillier theresults generated by theBlack-Scholes option pricingmodel, and the greater theopportunity for people whodidn'tuseit.

Oddly, it was Ben, theleast personally conventionalof the three, who had thePotemkin-village effect ofmaking Cornwall Capitalappear to outsiders to be aconventional institutionalmoneymanager.Heknewhisway around Wall Streettrading floors and so alsoknew the extent to whichCharlieandJamiewerebeingpenalizedforbeingperceivedby the bigWall Street firms

as a not terribly seriousinvestor or, as Ben put it, "agaragebandhedgefund."Thelongest options available toindividualinvestorsonpublicexchanges were LEAPs,which were two-and-a-half-year options on commonstocks.Youknow,BensaidtoCharlie and Jamie, if youestablished yourself as aserious institutional investor,you could phone up LehmanBrothers or Morgan Stanley

andbuyeight-yearoptionsonwhatever youwanted.Wouldyoulikethat?

They would! Theywanted badly to be able todeal directly with the sourceof what they viewed as themostunderpricedoptions:themost sophisticated,quantitative trading desks atGoldman Sachs, DeutscheBank, Bear Stearns, and therest.Thehuntinglicense,theycalled it.Thehunting license

had a name: an ISDA. Theywere the same agreements,dreamed up by theInternational Swaps andDerivatives Association, thatMikeBurrysecuredbeforeheboughthis first creditdefaultswaps.IfyougotyourISDA,youcouldintheorytradewiththe big Wall Street firms, ifnotasanequalthenatleastasa grown-up.The troublewasthat, despite their successrunning money, they still

didn'thavemuchofit.Worse,whattheyhadwastheirown.InsideWall Street they wereclassified,atbest,as"highnetworth individuals." Richpeople. Rich people receivedabetterclassof service fromWallStreet thanmiddle-classpeople, but they were stillsecond-class citizenscompared to institutionalmoneymanagers.Moretothepoint, rich people weretypically not invited to buy

and sell esoteric securities,such as credit default swaps,not traded on openexchanges. Securities thatwere, increasingly, thebeatingheartofWallStreet.

Byearly2006,CornwallCapitalhadgrownitsstashtoalmost $30million, but eventhat, to the desks inside theWall Street firms that soldcredit default swaps, was arisiblysmallsum."WecalledGoldmanSachs," said Jamie,

"and it was just immediatelyclear they didn't want ourbusiness. Lehman Brothersjust laughedatus.Therewasthisimpenetrablefortressyouhad either to scale or digunderneath." "J.P. Morganactually fired us as acustomer," said Charlie."Theysaidweweretoomuchtrouble." And they were! Inpossession of childish sumsofmoney, theywanted to betreated as grown-ups. "We

wanted to buy options onplatinum from DeutscheBank," said Charlie, "andtheywerelike,'Sorrywecan'tdothiswithyou.'"WallStreetmade you pay for managingyour own money rather thanpaying someone on WallStreet to do it for you. "Noone was going to take us,"said Jamie. "We calledaround and it was onehundred million bucks,minimum,tobecredible."

By the time they calledUBS, the big Swiss bank,they knew enough not toanswer when the guy on theother end of the line askedthem howmuch money theyhad."Welearnedtospinthatone,"saidJamie.Asa result,UBS took a bit longer thantheotherstoturnthemdown."Theywere, like, 'Howmuchdo you short?'" recalledCharlie. "And we said notverymuch.Sotheyask,'How

often do you trade?'We say,notveryoften.Andtherewasthis long silence. Then, 'Letme talk tomyboss.'Andweneverheardbackfromthem."

They had no better luckwith Morgan Stanley orMerrill Lynch and the rest."They would say, 'Show usyour marketing materials,'"said Charlie, "and we wouldsay,'Uh,wedon'thavethose.'They'dsay, 'Okay,thenshowus your offering documents.'

We didn't have any offeringdocuments because it wasn'tother people's money. Sothey'd say, 'Okay, then justshow us your money.' We'dsay, 'Um, we don't exactlyhave enough of that, either.'They'd say, 'Okay, then justshow us your resumes.'" IfCharlie and Jamie had anyconnection to the world ofmoney management--formeremployment, say--it mighthave lent some credibility to

their application, but theydidn't. "It always endedwiththemsortofasking, 'Sowhatdoyouhave?'"

Chutzpah. Plus $30millionwithwhichtheywerewilling and able to doanything they wanted to do.Plus a former derivativestrader with an apocalypticstreak who knew how thesebigWallStreetfirmsworked."Jamie andCharlie had beenasking for an ISDA for two

years, but they really justdidn'tknowhowtoask,"saidBen."Theydidn'tevenknowtheterm'ISDA.'"

Charlie nevercompletely understood howBen did it, but he somehowpersuaded Deutsche Bank,whichrequiredaninvestortocontrol $2 billion to betreated as an institution, toaccept Cornwall Capital ontheir "institutional platform."Benclaimedthatitwasreally

onlyamatterofknowing theright people to call, and thelanguage inwhich toaddresstheir concerns. Before theyknew it, a team fromDeutscheBankagreedtopayacallonCornwallCapital todetermine if they wereworthy of the distinction:Deutsche Bank institutionalcustomer. "Ben gives goodbank,"saidCharlie.

Deutsche Bank had aprogram it called KYC

(Know Your Customer),which,whileitdidn't involveanything so radical asactually knowing theircustomers, did require themto meet their customers, inperson,atleastonce.Hearingthat they were to be on thereceiving end of KYC, itoccurred to Charlie andJamie, for the first time, thatworking out of JulianSchnabel's studio in thewrong part of Greenwich

Village might raise morequestions than it answered."We had an appearanceproblem," said Jamiedelicately. From upstairswafted the smell of freshpaint; from downstairs, thesite of the lone toilet, camethe sounds of a sweatshop."Before they came," saidCharlie, "I rememberthinking, If anyonehas to goto the bathroom, we're introuble." Cornwall Capital's

own little space inside thelarger space was charminglyunfinancial--a dark room inthebackwithredbrickwallsthat opened onto a small,junglelike garden inwhich itwas easier to imagine aseduction scene than thepurchase of a credit defaultswap. "There was anawkwardmomentortwo,duetothefactthatourofficeshada tailor working downstairs,andtheycouldhearher,"said

Jamie. But no one fromDeutsche Bank had to go tothe bathroom, and CornwallCapital Management got itsISDA.

This agreement, in itsfine print, turned out to belong on Cornwall Capital'sduties to Deutsche Bank andshort on Deutsche Bank'sduties toCornwallCapital. IfCornwall Capital made a betwith Deutsche Bank and itwound up "in the money,"

Deutsche Bank was notrequired to post collateral.Cornwall would just have tohope that Deutsche Bankcouldmakegoodonitsdebts.If, on the other hand, thetrade went against CornwallCapital,theywererequiredtopost the amount they weredown, daily. At the time,Charlie and Jamie and Bendidn'tworrymuch about thisprovision, or similarprovisions in the ISDA they

landed with Bear Stearns.They were happy just to beallowed to buy credit defaultswapsfromGregLippmann.

Now what? They wereyoung men in a hurry--theycouldn't believe the tradeexisted and didn't know howmuch longer it would--butthey spent several weeksarguing among themselvesabout it. Lippmann's salespitchwasasalien to themasit was intriguing. Cornwall

Capital had never bought orsold a mortgage bond, butthey could see that a creditdefaultswapwasreallyjustafinancial option: You paid asmall premium, and, ifenough subprime borrowersdefaultedon theirmortgages,you got rich. In this case,however, they were beingoffered a cheap ticket to adrama that looked virtuallycertain to happen. Theycreated another presentation

togivetothemselves."We'relooking at the trade," saidCharlie, "and we're thinking,like, this is too good to betrue.WhythehellshouldIbeable to buy CDSs on thetriple-Bs[creditdefaultswapson the triple-B tranche ofsubprimemortgage bonds] atthese levels? Who in theirrightmindissaying, 'Wow,Ithink I'll take two hundredbasispointstotakethisrisk?'It just seems like a

ridiculously low price. Itdoesn't make sense." It wasnow early October 2006. Afew months earlier, in June,national home prices, for thefirst time, had begun to fall.In five weeks, on November29, the index of subprimemortgage bonds, called theABX, would post its firstinterest-rate shortfall. Theborrowers were failing tomake interest paymentssufficient to pay off the

riskiest subprime bonds. Theunderlying mortgage loanswere alreadygoing sour, andyet the prices of the bondsbacked by the loans hadn'tbudged. "That was the partthat was so weird," saidCharlie. "They'd alreadystarted going bad. We justkept asking, 'Who the hell istaking the other side of thistrade?' And the answer thatkept coming back to uswas,'It's the CDOs.'" Which of

course just raised anotherquestion:Who, or what, wasaCDO?

Typically when theyentered a new market--because they'd found somepotential accident waiting tohappen that seemed worthbetting on--they found anexpert to serve as a jungleguide. This market was soremoved from theirexperience that it took themlongerthanusualtofindhelp.

"I had a vague idea what anABS [asset-backed security]was,"saidCharlie."ButIhadno idea what a CDO was."Eventually they figured outthat language served adifferent purpose inside thebondmarketthanitdidintheoutside world. Bond marketterminology was designedless to convey meaning thanto bewilder outsiders.Overpriced bonds were not"expensive"overpricedbonds

were "rich," which almostmade them sound likesomething you should buy.The floors of subprimemortgage bonds were notcalledfloors--oranythingelsethat might lead the bondbuyer to form any sort ofconcrete image in hismind--but tranches. The bottomtranche--the risky groundfloor--was not called theground floor but themezzanine, or the mezz,

whichmadeitsoundlesslikea dangerous investment andmorelikeahighlyprizedseatin a domed stadium.ACDOcomposed of nothing but theriskiest, mezzanine layer ofsubprime mortgages was notcalled a subprime-backedCDO but a "structuredfinanceCDO.""Therewassomuch confusion about thedifferentterms,"saidCharlie."In the course of trying tofigure it out, we realize that

there'sareasonwhyitdoesn'tquite make sense to us. It'sbecause itdoesn'tquitemakesense."

The subprime mortgagemarkethadaspecialtalentforobscuring what needed to beclarified. A bond backedentirely by subprimemortgages, for example,wasn't called a subprimemortgagebond. Itwas calledan ABS, or asset-backedsecurity.WhenCharlieasked

Deutsche Bank exactly whatassets secured an asset-backed security, he washanded lists of abbreviationsand more acronyms--RMBS,HELs, HELOCs, Alt-A--along with categories ofcredithedidnotknowexisted("midprime"). RMBS stoodfor residential mortgage-backed security. HEL stoodfor home equity loan.HELOC stood for homeequity line of credit. Alt-A

was just what they calledcrappy mortgage loans forwhich they hadn't evenbotheredtoacquiretheproperdocuments--to verify theborrower's income, say. "A"was the designation attachedto the most creditworthyborrowers; Alt-A, whichstood for "Alternative A-paper," meant an alternativeto the most creditworthy,which of course sounds a lotmore fishyonce it isput that

way.Asa rule,any loan thathad been turned into anacronym or abbreviationcouldmoreclearlybecalleda"subprimeloan,"butthebondmarket didn't want to beclear."Midprime"wasakindof triumph of language overtruth. Some crafty bondmarket person had gazedupon the subprime mortgagesprawl, as an ambitious realestate developer might gazeupon Oakland, and found an

opportunity to rebrand someof the turf. On Oakland'sfringe there was aneighborhood, masqueradingas an entirely separate town,called Rockridge. Simply byrefusingtobecalledOakland,Rockridge enjoyed higherproperty values. Inside thesubprime mortgage marketthere was now a similarneighborhood known asmidprime. Midprime wassubprime--and yet somehow,

ineffably, not. "It took me awhile to figureout thatallofthisstuffinsidethebondswasprettymuchexactlythesamething," said Charlie. "TheWallStreet firms justgot theratings agencies to acceptdifferentnamesfor it so theycould make it seem like adiversifiedpoolofassets."

Charlie, Jamie, and Benentered the subprimemortgage market assumingtheywantedtodowhatMike

Burry and Steve Eisman hadalready done, and find theveryworstsubprimebondstolaybetsagainst.Theyquicklygot up to speed on FICOscores and loan-to-valueratios and silent seconds andthe special madness ofCalifornia and Florida, andthe shockingly optimisticstructure of the bondsthemselves: The triple-B-minus tranche, the bottomfloorofthebuilding,required

just 7 percent losses in theunderlying pool to be worthzero.Butthentheywoundupdoing something quitedifferent from--and,ultimately, more profitablethan--whateveryoneelsewhobet against the subprimemortgage market was doing:They bet against the upperfloors--the double-Atranches--oftheCDOs.

After the fact, they'drealize they'd had two

advantages.Thefirstwasthatthey had stumbled into themarket very late, just beforeits collapse, and after ahandful of other moneymanagers. "One of thereasons we could move sofast,"saidCharlie,"isthatwewere seeing a lot ofcompelling analysis that wedidn't have to create fromscratch."Theotheradvantagewas their quixotic approachto financial markets: They

were consciously looking forlong shots. They werecombing themarkets forbetswhose true odds were 10:1,priced as if the odds were100:1. "Wewere looking fornonrecourse leverage," saidCharlie. "Leverage means tomagnify theeffect.Youhaveacrowbar,youtakealittlebitofpressure,youturnit intoalot of pressure. We werelookingtogetourselvesintoapositionwheresmallchanges

in statesof theworldcreatedhugechangesinvalues."

Enter the CDO. Theymay not have known what aCDO was, but their mindswereprepared for it, becauseasmallchangeinthestateofthe world created a hugechange in the value of aCDO.ACDO, in their view,was essentially just a pile oftriple-B-rated mortgagebonds.Wall Street firms hadconspired with the rating

agencies to represent thepileas a diversified collection ofassets, but anyone with eyescould see that if one triple-Bsubprimemortgagewentbad,most would go bad, as theywere all vulnerable to thesame economic forces.Subprime mortgage loans inFloridawould default for thesamereasons,andatthesametime, as subprime mortgageloans in California. And yetfully 80 percent of the CDO

composed of nothing buttriple-B bonds was ratedhigherthantriple-B:triple-A,double-A, orA.Towipe outanytriple-Bbond--thegroundfloor of the building--all thatwas needed was a 7 percentlossintheunderlyingpoolofhome loans. That same 7percent losswould thuswipeout, entirely, anyCDOmadeup of triple-B bonds, nomatter what rating wasassignedit."Ittookusweeks

to really grasp it because itwas so weird," said Charlie."But the more we looked atwhat a CDO really was, themorewewerelike,Holyshit,that's just fucking crazy.That'sfraud.Maybeyoucan'tproveitinacourtoflaw.Butit'sfraud."

It was also a stunningopportunity: The marketappeared to believe its ownlie. It charged a lot less forinsuranceonaputativelysafe

double-A-rated slice of aCDOthanitdidforinsuranceon the openly risky triple-B-rated bonds. Why pay 2percent a year to bet directlyagainst triple-B-rated bondswhen they could pay 0.5percent a year to makeeffectively the same betagainst the double-A-ratedsliceoftheCDO?Iftheypaidfour times less tomakewhatwas effectively the same betagainst triple-B-rated

subprime mortgage bonds,they could afford to makefourtimesmoreofit.

They called around bigWall Street firms to see ifanyone could dissuade themfrom buying credit defaultswaps on the double-Atranche of CDOs. "It reallylooked just too good to betrue,"saidJamie."Andwhensomething looks too good tobe true, we try to find outwhy." A fellow at Deutsche

BanknamedRichRizzo,whoworked for Greg Lippmann,gave it a shot. The ISDAagreement that standardizedCDSs on CDOs (a differentagreement than the ISDAagreement that hadstandardized CDSs onmortgage bonds) had onlybeen created a few monthsbefore, in June 2006, Rizzoexplained.Noonehadasyetbought credit default swapson the double-A piece of a

CDO, which meant therewasn't likely to be a liquidmarket for them. Without aliquid market, they were notassured of being able to sellthemwhentheywantedto,ortoobtainafairprice.

"The other thing hesaid," recalled Charlie, "wasthat[things]willnevergetsobadthatCDOswillgobad."

Cornwall Capitaldisagreed. They didn't knowfor sure that subprime loans

would default in sufficientnumbers to cause the CDOsto collapse. All they knewwas that Deutsche Bankdidn't know, either, andneither did anybody else.Theremight be some "right"price for insuring the firstlosses on pools of bondsbacked by pools of dubiousloans, but it wasn't one-halfof1percent.

Of course, if you aregoingtogambleonaCDO,it

helps to knowwhat, exactly,isinsideaCDO,andtheystilldidn't. The sheer difficultythey had obtaining theinformation suggested thatmost investors were simplyskipping this stage of theirdue diligence. Each CDOcontainedpiecesofahundreddifferent mortgage bonds--which in turnheld thousandsof different loans. It wasimpossible, or nearly so, tofind out which pieces, or

which loans. Even the ratingagencies, who they at firstassumed would be the mostinformed source, hadn't aclue."IcalledS&Pandaskediftheycouldtellmewhatwasin a CDO," said Charlie."And they said, 'Oh yeah,we're working on that.'"Moody'sandS&Pwerepilingup these triple-B bonds,assuming they werediversified, and bestowingratingsonthem--withoutever

knowingwhatwasbehindthebonds! There had beenhundreds of CDO deals--400billion dollars' worth of thethings had been created injust the past three years--andyetnone,asfarastheycouldtell,hadbeenproperlyvetted.Charlie located a reliablesource for the contents of aCDO, a data company calledIntex, but Intex wouldn'treturnhisphonecalls,andhegathered they didn't have

much interest in talking tosmall investors.At length hefound a Web site, run byLehman Brothers, calledLehmanLive.*

LehmanLive didn't tellyou exactly what was in aCDO,either,butitdidofferacrude picture of its salientcharacteristics:what year thebonds behind it had beencreated,forinstance,andhowmany of those bonds werebacked chiefly by subprime

loans. Projecting data ontothe red brick wall of JulianSchnabel'sstudio,CharlieandJamiewentsearchingfortwospecific traits: CDOs thatcontained the highestpercentage of bonds backedentirely by recent subprimemortgage loans, and CDOsthat contained the highestpercentage of other CDOs.Herewasanotherbizarrefactabout CDOs: Often theysimply repackaged tranches

of other CDOs, presumablythose tranches their WallStreet creators had founddifficult to sell. Even moreamazingwastheircircularity:CDO "A" would contain apiece ofCDO "B"CDO "B"would contain a piece ofCDO "C" and CDO "C"would contain a piece ofCDO "A"! Looking for badbondsinsideaCDOwaslikefishing for crap in a Port-O-Let: The question wasn't

whetheryou'dcatchsomebuthow quickly you'd besatisfied you'd caughtenough. Their very nameswere disingenuous, and toldyou nothing about theircontents, their creators, ortheir managers: Carina,Gemstone,OctansIII,GlacierFunding. "They all had theserandom names," said Jamie."A lot of them for somereason we never figured outwerenamedformountainsin

theAdirondacks."Theymadeahastylistof

what they hoped was theworst crap and called upseveral brokers. It had beenhardfor themtowriggle freeof the brokers who coveredrichpeopleandtogetintothearmsofbrokerswhocoveredbig, stock market-investinginstitutions. It was hard allover again to escape thebig-time stock market brokersandwin acceptance from the

people inside the subprimemortgagebondmarket."Alotof people when we calledthem said, 'Hey, why don'tyou guys buy some stocks!'"said Charlie. Bear Stearnscouldn't believe that theseyoung guys with no moneywanted to buy not just creditdefault swaps but a creditdefault swap so esoteric thatno one else had bought it. "Iremember laughing at them,"said the Bear Stearns credit

default swap salesman whotooktheirfirstinquiry.

At Deutsche Bank theywere passed off to a twenty-three-year-oldbond salesmanwho had never had acustomer of his own. "ThereasonIgottoknowBenandCharlie," says this youngman,"wasthatnooneelseatDeutsche Bank would dealwith them. They had, like,twenty-five million bucks,whichforDeutscheBankwas

not reallysignificant.Noonewanted topickup theircalls.People were making fun oftheir name--they'd say, like,'Oh, it's Cornhole Capitalcalling again.'" Still,Deutsche Bank proved, onceagain, the most willing todeal with them. On October16, 2006, they bought fromGregLippmann'stradingdesk$7.5million in credit defaultswaps on the double-AtrancheofaCDOnamed,for

no apparent reason, PineMountain. Four days later,Bear Stearns sold them $50million more. "They knewAcesomehow,"saidtheBearStearns credit default swapsalesman. "So we wound updealingwiththem."

Charlie and Jamiecontinued to call everyonethey could think ofwhowaseven remotely connected tothis newmarket, in hopes offinding someone who could

explain what appeared tothemtobeitssheermadness.A month later they finallyfound,andhired,theirmarketexpert--afellownamedDavidBurt.Itwasameasureofhowmuch money people weremaking in the bond marketthat the magazineInstitutional Investor wasabout to create a hot list ofpeople who worked in it,calledThe20RisingStarsofFixed Income. It was a

measureofhowmuchmoneypeople were making in thesubprime mortgage marketthatDavidBurtmadethelist.Burt had worked for the $1trillionbondfundBlackRock,owned, in part, by MerrillLynch, evaluating subprimemortgage credit.His jobwastoidentifyforBlackRockthebonds that were going to gobad before they went bad.Nowhehadquit in hopesofraisinghisownfundtoinvest

in subprimemortgage bonds,and, to make ends meet, hewas willing to rent hisexpertisefor$50,000amonthto theseoddballsatCornwallCapital. Burt had the mostsensational information, andmodels to analyze thatinformation--he could tellyou,forexample,whatwouldhappentomortgageloans,zipcode by zip code, in varioushouse price scenarios. Hecould then take that

informationandtellyouwhatwas likely to happen tospecificmortgagebonds.Thebest way to use thisinformation, he thought, wasto buy what appeared to bethe sounder mortgage bondsand simultaneously sell theunsoundones.

The insider's artfulcomplexity didn't muchinterest Cornwall Capital.Spendinga lotof time tryingto pick the best subprime

mortgage bonds was silly, ifyou suspected that the entiremarketwasabouttoblowup.They handed Burt the list ofCDOs they had bet againstand asked him what hethought. "We always lookedfor someone to explain to uswhywedidn'tknowwhatweweredoing," said Jamie. "Hecouldn't." What Burt couldtell themwas that they wereprobablythefirstpeopleeverto buy a credit default swap

on thedouble-A trancheof aCDO. Not reassuring. Theyassumedtherewasalotaboutthe CDO market they didn'tunderstand; theyhadselectedthe CDOs they had betagainst inside of a day, andassumed they could do acraftier job of it. "We werealready throwing darts," saidJamie. "Wesaid, 'Let's throwdartsalittlebetter.'"

The analysis Burt gavethem a few weeks later

surprised them asmuch as itdid him: They'd pickedbeautifully. "He said, like,'Wow, you guys did great.There are a lot of reallycrappy bonds in theseCDOs,'" said Charlie. Theydidn't realize yet that thebondsinsidetheirCDOswereactually credit default swapson the bonds, and so theirCDOsweren'tordinaryCDOsbut synthetic CDOs, or thatthebondsonwhichtheswaps

were based had beenhandpicked by Mike BurryandSteveEisman and othersbettingagainst themarket. Inmany ways, they were stillinnocents.

The challenge, asalways, was to play the roleof market generalist withoutalsoplayingtheroleoffoolatthe poker table. By January2007,intheirtiny$30millionfund, they owned $110million in credit default

swaps on the double-Atranche of asset-backedCDOs. The people who hadsold them the swaps stilldidn't knowwhat tomake ofthem. "Theywere putting onbetsthatweremultiplesofthecapital they had," said theyoungDeutscheBankbroker."And they were doing it inCDSs on CDOs, whichprobably, like, three or fourguysinthewholebankcouldspeak intelligently about."

Charlie and Jamie and Bensort of understoodwhat theyhad done, but sort of didn't."We're kind of obsessedabout this trade," saidCharlie. "And we'veexhausted our network ofpeopletotalktoaboutit.Andwestillcan'ttotallyfigureoutwho ison theother side.Wekept trying to find peoplewhocouldexplain touswhywewerewrong.Wejustkeptwondering if wewere crazy.

Therewasthisoverwhelmingfeeling of,Are we going outofourminds?"

It'sjustweeksbeforethemarket will turn, and thecrisis will commence, butthey don't know that. Theysuspect that this emptytheater into which they'vestumbledispreparingtostagethe most fantastic financialdrama they'll ever see, butthey don't know that, either.All theyknowis that there is

alottheydon'tknow.Onthephone one day, their BearStearns credit default swapsalesman mentioned that thebig annual subprimeconference would be heldfive days hence, in LasVegas. Every big cheese inthe subprime mortgagemarketwouldbethere,withaname tag, and wanderingaround The Venetian hotel.Bear Stearns was planning aspecial outing for its

customers, at a Vegas firingrange,wheretheycouldlearnto shoot everything from aGlocktoanUzi."Myparentswere New York Cityliberals," said Charlie. "Iwasn't even allowed to have,like,a toygun."Offheflew,with Ben, to Las Vegas, toshootwithBear Stearns, andto see if they could findanyone to explain to themwhy they were wrong to betagainst the subprime

mortgagemarket.

CHAPTERSIX

Spider-ManatTheVenetian

GolfingwithEismanwasn'tlikegolfingwithotherWallStreet people. The roundusually began with acollective discomfort on thefirst tee, after Eisman turned

up wearing something thatviolated the Wall Streetgolfer's notion of propriety.On January 28, 2007, hearrived at the swanky BaliHai Golf Club in Las Vegasdressedingymshorts,t-shirt,and sneakers. Strangersnoticed; Vinny and Dannysquirmed. "C'mon, Steve,"Danny pleaded with a manwho, technically, was hisboss, "there's an etiquettehere. You at least have to

wearacollaredshirt."Eismantookthecarttotheclubhouseand bought a hoodie. Thehoodie covered up his t-shirtandmadehim looka lot likea guywho had just bought ahoodietocoveruphist-shirt.In hoodie, gym shorts, andsneakers, Eisman approachedhisfirstshot.Likeeveryotherswing of the Eisman club,this was less a conclusiveevent than a suggestion.Displeased with where the

ball had landed, he pulledanother from his bag anddroppeditinanewandbetterplace. Vinny would hit hisdrive in the fairway; Dannywould hit his in the rough;Steve would hit his in thebunker, march into the sand,and grab the ball and toss itout,nearVinny's.Itwashardtoaccusehimofcheating,ashe didn't make the faintestattempt to disguise what hewas doing. He didn't even

appear to notice anythingunusual in the pattern of hisgame.TheninthtimeEismanretrieved a ball from somesand trap, or pretended hisshothadnotsplashedintothewater,heactedwiththesameunapologetic aplomb he haddemonstrated the first time."Because his memory is soselective, he has no scarsfrom prior experience," saidVinny. He played the gamelike a child, or like someone

whowasbentonlampooninga sacred ritual, whichamounted to the same thing."The weird thing is," saidDanny, "he's actually notbad."

After a round of golf,theyheadedouttoadinneratthe Wynn hotel hosted byDeutscheBank.Thiswas thefirst time Eisman had everbeentoaconferenceforbondmarket people and, notknowing what else to do, he

had put himself in GregLippmann'shands.Lippmannhad rented a private room insome restaurant and invitedEisman and his partners towhat they assumed wassomething other than a freemeal. "Evenwhenhe had anhonest agenda, there wasalwayssomethingunderneaththe honest agenda," saidVinny. Any dinner that wasLippmann's idea must havesome hidden purpose--but

what?As it turned out,

Lippmann had a newproblem: U.S. house priceswere falling, subprime loandefaults were rising, yetsubprime mortgage bondssomehow held firm, as didthepriceofinsuringthem.Hewasnoweffectivelyshort$10billion in subprimemortgagebonds,anditwascostinghim$100 million a year inpremiums, with no end in

sight. "He was obviouslygetting his nuts blown off,"said Danny. Thus farLippmann's giant bet hadbeen subsidizedby investors,like Steve Eisman, who paidhim a toll when they boughtandsoldcreditdefaultswaps,but investors like SteveEisman were losing heart.Some of Lippmann's formerconverts suspected that thesubprime mortgage bondmarket was rigged by Wall

Street to insure that creditdefault swaps would neverpay off; others began towonderiftheinvestorsontheother side of their bet mightknow something that theydidn't; and some simplywearied of paying insurancepremiums to bet againstbonds that never seemed tomove. Lippmann had stagedthisgreatgameoftug-of-war,assembled a team to pull onhis endof the rope, andnow

his teammates were in fullflight. He worried thatEismanmightquit,too.

The teppanyaki roominside the Okada restaurantconsistedoffourislands,eachwithalarge,cast-ironhibachiand dedicated chef. Aroundeach island Lippmann seateda single hedge fundmanagerwhom he had persuaded toshort subprime bonds, alongwithinvestorswhowerelongthosesamebonds.Thehedge

fundpeople,hehoped,wouldsee just how stupid theinvestorson theothersideofthosebetswere,andcease toworrythattheinvestorsknewsomething they did not. Thiswas shrewd of him: Dannyand Vinny never stoppedworrying if they were thefools at Lippmann's table."Weunderstoodthesubprimelendingmarketandknew theloans were going bad," saidVinny. "Whatwedidn'thave

any comfort inwas the bondmarket machine. The wholereasonwewenttoVegaswaswe still felt we needed tolearn how we were going togetscrewed,ifweweregoingtogetscrewed."

Eisman took hisassigned seat between GregLippmann and a fellow whointroduced himself as WingChau and said that he ran aninvestment firm calledHarding Advisory. When

Eisman asked exactly whatHarding Advisory advised,WingChauexplained thathewas a CDOmanager. "I hadnoideatherewassuchathingas a CDO manager," saidEisman. "I didn't know therewas anything to manage."Later Eisman would fail torecall what Wing Chaulooked like, what he wore,where he'd come from, orwhat he ate and drank--everything but the financial

ideaherepresented.Butfromhis seat across the hibachi,Danny Moses watched andwondered about the manLippmann had so carefullyseated next to Eisman. Hewasshort,withaWallStreetbelly--not the bleacher bum'sboiler but the discreet,necessarypouchofasquirreljust before winter. He'dgraduatedfromtheUniversityof Rhode Island, earned abusiness degree at Babson

College, and spent most ofhis career working sleepyjobs at sleepy life insurancecompanies--butallthatwasinthe past. He was newly,obviously rich. "He had thissmirk, like, I know better,"said Danny. Danny didn'tknow Wing Chau, but whenheheard that hewas the endbuyer of subprimeCDOs, heknewexactlywhohewas:thesucker. "The truth is that Ididn't really want to talk to

him," saidDanny, "because Ididn'twanttoscarehim."

When they saw thatLippmannhadseatedEismanrightnext to the sucker, bothDanny and Vinny had thesame thought: Oh no. Thisisn't going to end well.Eisman couldn't containhimself. He'd figure out theguy was a fool, and let himknow it, and then wherewould they be? They neededfools; only fools would take

the other side of their trades.And theywanted to domoretrades. "We didn't wantpeopletoknowwhatweweredoing,"saidVinny."Wewerespies, on a fact-findingmission." They watchedEisman double-dip hisedamame in the communalsoy sauce--dip, suck, redip,resuck--and waited for theroom to explode. There wasnothingtodobutsitbackandenjoytheshow.Eismanhada

curious way of listening; hedidn't somuch listen towhatyou were saying assubcontract to some remoteregionofhisbrainthetaskofdeciding whether whateveryou were saying was worthlistening to, while his mindwent off to play on its own.Asaresult,heneveractuallyheard what you said to himthe first time you said it. Ifhis mental subcontractordetecteda levelof interest in

what you had just said, itradioedasignaltothemothership, which then wheeledaroundwith themost intensefocus. "Say that again," he'dsay.Andyouwould!Becausenow Eisman was soobviously listening to you,and, as he listened soselectively, you felt flattered."Ikeeplookingoveratthem,"saidDanny."AndIseeStevesaying over and over, Saythatagain.Saythatagain."

Later, whenever Eismansetouttoexplaintootherstheoriginsof thefinancialcrisis,he'dstartwithhisdinnerwithWingChau.Onlynowdidhefully appreciate the centralimportance of the so-calledmezzanine CDO--the CDOcomposedmainlyoftriple-B-rated subprime mortgagebonds--and its syntheticcounterpart: the CDOcomposed entirely of creditdefault swaps on triple-B-

rated subprime mortgagebonds. "You have tounderstand this," he'd say."This was the engine ofdoom."He'ddrawapictureofseveral towers of debt. Thefirst tower was the originalsubprime loans thathadbeenpiled together. At the top ofthis tower was the triple-Atranche, just below it thedouble-A tranche, and so ondown to the riskiest, triple-Btranche--the bonds Eisman

had bet against. The WallStreet firms had taken thesetriple-B tranches--the worstof the worst--to build yetanother tower of bonds: aCDO. A collateralized debtobligation. The reason they'ddone this is that the ratingagencies, presented with thepile of bonds backed bydubious loans, wouldpronounce 80 percent of thebonds in it triple-A. Thesebonds could then be sold to

investors--pension funds,insurance companies--whichwereallowedtoinvestonlyinhighly rated securities. Itcameasnews toEisman thatthisshipofdoomwaspilotedby Wing Chau and peoplelike him. The guy controlledroughly $15 billion, investedin nothing but CDOs backedby the triple-B tranche of amortgagebondor,asEismanputit,"theequivalentofthreelevels of dog shit lower than

the original bonds." A yearago, the main buyer of thetriple-A-rated tranche ofsubprime CDOs--which is tosay the vast majority ofCDOs--had been AIG. Nowthat AIG had exited themarket,themainbuyerswereCDO managers like WingChau. All by himself, Chaugeneratedvastdemandfortheriskiest slices of subprimemortgage bonds, for whichthere had previously been

essentially no demand. Thisdemand led inexorably to thesupplyofnewhomeloans,asmaterial for the bonds. Thesoy sauce in which Eismandouble-dipped his edamamewassharedbyamanwhohadmade it possible for tens ofthousands of actual humanbeings to be handed moneythey could never afford torepay.

As it happened,FrontPointPartnershadspent

a lot of time digging aroundinthoseloans,andknewthatthedefaultrateswerealreadysufficient to wipe out WingChau's entire portfolio."God," Eisman said to him."Youmust be having a hardtime."

"No," Wing Chau said."I'vesoldeverythingout."

Saythatagain.It made no sense. The

CDO manager's job was toselect theWallStreet firm to

supply him with subprimebonds that served as thecollateral for CDO investors,and then to vet the bondsthemselves. The CDOmanagerwas further chargedwith monitoring the hundredor so individual subprimebonds inside each CDO, andreplacingthebadones,beforethey went bad, with betterones. That, however, wasmere theory; in practice, thesortsofinvestorswhohanded

their money to Wing Chau,and thusbought the triple-A-rated tranche of CDOs--German banks, Taiwaneseinsurance companies,Japanese farmers' unions,Europeanpensionfunds,and,in general, entities more orless required to invest intriple-A-rated bonds--did soprecisely because they weremeant to be foolproof,impervious to losses, andunnecessary to monitor or

even think about verymuch.The CDO manager, inpractice, didn't do much ofanything, which is why allsorts of unlikely peoplesuddenly hoped to becomeone. "Two guys and aBloomberg terminal in NewJersey" was Wall Streetshorthand for the typicalCDO manager. The lessmentally alert the two guys,and the fewer the questionstheyaskedaboutthetriple-B-

rated subprime bonds theywere absorbing into theirCDOs, the more likely theywere to be patronized by thebig Wall Street firms. Thewholepointof theCDOwasto launder a lot of subprimemortgagemarketriskthatthefirms had been unable toplace straightforwardly. Thelast thing you wanted was aCDOmanagerwhoaskedlotsoftoughquestions.

The bond market had

created what amounted to adouble agent--a characterwho seemed to represent theinterestsofinvestorswhenhebetter represented theinterests ofWall Street bondtrading desks. To assure thebiginvestorswhohadhandedtheir billions to him that hehad their deep interests atheart, theCDOmanagerkeptownershipofwhatwascalledthe "equity," or "first loss"piece, of theCDO--the piece

that vanished first when thesubprime loans thatultimately supplied the CDOwith cash defaulted. But theCDOmanager was also paida fee of 0.01 percent off thetop, before any of hisinvestors saw a dime, andanother, similar fee, off thebottom, as his investorreceived their money back.Thatdoesn'tsoundlikemuch,but,whenyou'rerunningtensof billions of dollars with

little effort and no overhead,it adds up. Just a few yearsearlier, Wing Chau wasmaking $140,000 a yearmanaging a portfolio for theNew York Life InsuranceCompany. In one year as aCDO manager, he'd takenhome $26 million, the haulfromhalfadozenlifetimesofworkingatNewYorkLife.

Now, almost giddily,Chau explained to Eismanthat he simply passed all the

riskthattheunderlyinghomeloanswoulddefaultontothebig investors who had hiredhimtovetthebonds.Hisjobwas to be theCDO "expert,"butheactuallydidn'tspendalot of time worrying aboutwhatwasinCDOs.Hisgoal,he explained, was tomaximize the dollars in hiscare.Hewas now doing thisso well that, from January2007untilthemarketcrashedin September, Harding

Advisory would be theworld's biggest subprimeCDO manager. Among itsother achievements, Hardinghad established itself as thego-to buyer for MerrillLynch's awesome CDOmachine, notorious not onlyfor its rate of production(Merrill created twice asmanyofthethingsasthenextbiggestWall Street firm) butalso for its industrial waste(its CDOs were later proven

to be easily the worst). "He'managed' the CDOs," saidEisman, "butmanagedwhat?I was just appalled that thestructured finance marketcouldbesoinsaneastoallowsomeone to manage a CDOportfolio without having anyexposuretotheCDOs.Peoplewould pay up to havesomeone 'manage' theirCDOs--as if this moron washelping you. I thought, Youprick, you don't give a fuck

about the investors in thisthing."Chau'srealjobwastoserve as a new kind of frontmanfortheWallStreetfirmshe"hired"investorsfeltbetterbuyingaMerrillLynchCDOifitdidn'tappeartoberunbyMerrillLynch.

TherewasareasonGregLippmann had picked WingChau to sit beside SteveEisman. If Wing Chaudetected Eisman'sdisapproval,hedidn'tshowit;

instead, he spoke to Eismanin a tone of condescension. Iknow better. "Then he sayssomething that blew mymind," said Eisman. "Hesays, 'I love guys like youwho short my market.Without you I don't haveanythingtobuy.'"

Saythatagain."He says to me, 'The

moreexcitedthatyougetthatyou're right, the more tradesyou'lldo,andthemoretrades

youdo, themoreproduct forme.'"

That's when SteveEismanfinallyunderstoodthemadness of the machine. Heand Vinny and Danny hadbeen making these side betswith Goldman Sachs andDeutscheBankonthefateofthe triple-B tranche ofsubprime mortgage-backedbonds without fullyunderstanding why thosefirmsweresoeagertoaccept

them. Now he was face-to-face with the actual humanbeingontheothersideofhiscreditdefault swaps.Nowhegot it: The credit defaultswaps, filtered through theCDOs, were being used toreplicate bonds backed byactual home loans. Thereweren't enough Americanswith shitty credit taking outloans to satisfy investors'appetite for the end product.WallStreetneededhisbetsin

order to synthesize more ofthem. "Theyweren't satisfiedgetting lots of unqualifiedborrowers to borrow moneyto buy a house they couldn'tafford," said Eisman. "Theywere creating them out ofwhole cloth. One hundredtimes over! That's why thelosses in thefinancialsystemaresomuchgreater than justthe subprime loans. That'swhen I realized they neededus to keep the machine

running. I was like, This isallowed?"

Wing Chau didn't knowhe'd been handpicked byGreg Lippmann to persuadeSteveEisman that thepeopleon theotherendofhiscreditdefault swaps were eithercrooks or morons, but heplayed the role anyway.BetweenshotsofsakehetoldEisman that he would ratherhave $50 billion in crappyCDOs thannoneatall, ashe

was paid mainly on volume.HetoldEismanthathismainfear was that the U.S.economy would strengthen,and dissuade hedge fundsfrom placing bigger betsagainst the subprimemortgage market. Eismanlistened and tried tounderstand how an investoron opposite ends of his betscould be hoping for more orless the same thing he was--and how any insurance

company or pension fundcouldhanditscapitaltoWingChau. There was only oneanswer: The triple-A ratingsgave everyone an excuse toignore the risks they wererunning.

Danny and Vinnywatchedthemcloselythroughthe hibachi steam. As far asthey could tell, Eisman andWing Chau were gettingalongfamously.Butwhenthemealwasover, theywatched

EismangrabGregLippmann,pointtoWingChau,andsay,"Whateverthatguyisbuying,Iwant toshort it."Lippmanntook it as a joke,butEismanwas completely serious: Hewanted to place a betspecifically against WingChau."Greg,"Eismansaid,"Iwanttoshorthispaper.Sightunseen."ThusfarEismanhadbought only credit defaultswaps on subprimemortgagebonds;fromnowonhe'dbuy

specifically credit defaultswapsonWingChau'sCDOs."He finally met the enemy,face-to-face,"saidVinny.

Inwhat amounted to a briefattempttolivesomeoneelse'slife, Charlie Ledley selectedfromthewallaBerettapistol,a sawed-off shotgun, and anUzi. Not long before he'dwalked out the door for LasVegas,he'ddashedane-mailoff to his partner Ben

Hockett,whoplannedtomeethim there, and Jamie Mai,who didn't. "Do you guysthinkwe'rescrewedsincewehaven't preregistered foranything?"heasked.Itwasn'tthe first time CornwallCapitalhadheardaboutsomebig event in the markets towhich they hadn't beenformally invited andmore orlessinvitedthemselves,anditwouldn't be the last. "If youjustkindof showupat these

things," said Jamie, "theyalmost always let you in."The only people Charlieknew in Vegas were a fewmembers of the subprimemortgage machine at BearStearns, and he'd neveractually met them in person.Nevertheless, they had senthim an e-mail telling him,afterhelandedinLasVegas,to meet them not at theconference but at this indoorshooting range, a few miles

from the strip. "We goin'shootin on Sunday...," itbegan. Charlie was so takenaback, he called to ask themwhatitmeant."Iwaslike,'Soyou're going to goshoot...guns?'"

That Sunday afternoonof January 28, at The GunStore inLasVegas, itwasn'thard to spot theBearStearnsCDO salesmen. They camedressed in khakis and poloshirtsandweresurroundedby

burly men in tight black t-shirts who appeared to betaking the day off fromhunting illegal immigrantswith the localmilitia.Behindthe cash register, the mostsensational array of pistolsand shotguns and automaticweapons lined the wall. Tothe right were the targets: aphotograph of Osama binLaden, a painting of Osamabin Laden as a zombie,various hooded al Qaeda

terrorists, a young black kidattacking a pretty whitewoman, an Asian hoodlumwaving a pistol. "They putdown theBear Stearns creditcard and started buyingrounds of ammunition," saidCharlie. "And so I startedpickingmyguns." Itwas theUzi that made the biggestimpressiononhim.That,andthe giant photograph ofSaddam Hussein he selectedfrom thewall of targets.The

shotgun kicked and bruisedyour shoulder, but the Uzi,with far more killing power,was almost gentle; therewasathrillingdisconnectbetweenthepainyouexperiencedandthedamageyoucaused."TheBeretta was fun but the Uziwas totally awesome," saidCharlie, who left The GunStore with both a lingeringfeeling of having brokensome law of nature, and anunanswered question: Why

had he been invited? TheBear Stearns guys had beengreat, but no one had uttereda word about subprimemortgages or CDOs. "It wastotally weird, because I'dnevermettheguysbeforeandI'm the only Bear Stearnscustomer who's there," saidCharlie. "They were payingfor all this ammo and so I'mlike, 'Guys, I can buy a fewrounds for myself if youwant,' but they insisted on

treating me like thecustomer." Of course, thesafestwaytoexpensetoone'sWall Street firm a day ofplayingFullMetalJacketwasto invite some customeralong. And, of course, themost painless customer toinvite was one whosebusiness was so trivial thathis opinion of the festivitiesdidn't actually matter. ThatthesethoughtsneveroccurredtoCharlietoldyousomething

abouthim:Hewasnotnearlyascynicalasheneededtobe.Butthatwouldsoonchange.

The next morning,Charlie and Ben wanderedthe halls of The Venetian."Everyonewhowas trying tosellsomethingwaswearingatie,"saidBen."Everyonewhowas there to buy wasn't. Itwas hard to find someone Iwanted to talk to. We werejust kind of interlopers,walking around." They knew

just one person in the entireplace--DavidBurt,theformerBlackRock guy whom theywere now paying $50,000 amonth to evaluate the CDOstheywerebettingagainst--butthey didn't think thatmattered,astheirplanwastogo to the open sessions, thebig speeches and paneldiscussions. "It was notentirely clear why we werethere," said Ben. "We weretryingtomeetpeople.Charlie

would sneak up on whoeverwas at the podium afterspeeches. We were trying tofindpeoplewhocouldtelluswhy we were wrong." Theywere looking for somepersuasive mirror image ofthemselves. Someone whocouldtell themwhywhat themarket deemed impossiblewasatleastimprobable.

Charlie's challenge wasto suck unsuspecting marketinsiders into arguments

before they thought to askhim who he was or what hedid. "The consistent reactionwhenever we met someonewas, like, 'Wait, where didyou guys come from?' Theywere just baffled," saidCharlie. "People were like,'Whyareyouhere?'"

A guy from a ratingagency on whom Charlietested Cornwall's investmentthesislookedathimstrangelyandasked,"Areyousureyou

guys know what you'redoing?" The market insidersdidn't agree with them, butthey didn't offer persuasivecounter-arguments. Theirmainargument, indefenseofsubprime CDOs, was that"theCDObuyerwillnevergoaway."Theirmainargument,in defense of the underlyingloans,was that, in their shorthistory, they had neverdefaulted in meaningfulamounts. Above the roulette

tables, screens listed theresults of the most recenttwenty spins of the wheel.Gamblers would see that ithad come up black the pasteight spins, marvel at theimprobability, and feel intheirbonesthatthetinysilverball was now more likely toland on red. That was thereason thecasinobothered tolist the wheel's most recentspins: to help gamblers todelude themselves. To give

people the false confidencetheyneededtolaytheirchipsonaroulettetable.Theentirefood chain of intermediariesin the subprime mortgagemarketwasdupingitselfwiththe same trick, using theforeshortened, statisticallymeaningless past to predictthefuture.

"Usually,whenyoudoatrade, you can find somesmartpeopleontheothersideof it," said Ben. "In this

instancewecouldn't.""Nobody we talked to

had any credible reason tothink this wasn't going tobecome a big problem," saidCharlie. "No one was reallythinkingaboutit."

One of theBear StearnsCDO guys, after Charlieaskedhimwhatwaslikelytohappen to these CDOs inseven years, said, "Sevenyears? I don't care aboutseven years. I just need it to

lastforanothertwo."Three months earlier,

when Cornwall bought theirfirst $100 million in creditdefault swaps on the double-A-rated tranches of subprimeCDOs, they believed theywere making a cheap bet onanunlikelyevent--$500,000ayear in premium for thechance to make$100,000,000. The market,and the rating agencies,effectivelyhadsettheoddsof

default at 1 in 200. Theythought the odds were betterthanthat--say,1in10.Still,itwas,likemostoftheirbets,alongshot.Anintelligentlongshot,perhaps,butalongshotnonetheless. The more theylistenedtothepeoplewhoranthe subprime market, themoretheyfeltthecollapseofdouble-A-rated bonds wasn'ta long shot at all, but likely.A thought crossed Ben'smind: These people believed

that the collapse of thesubprime mortgage marketwas unlikely preciselybecause it would be such acatastrophe. Nothing soterrible could ever actuallyhappen.

The firstmorningof theconference, they'd followedacrowdofthousandsoutofthecasinoandintothevastmainballroom to attend theopening ceremony. It wasmeant to be a panel

discussion, but of course themen on the panel had littleinterest in talking to eachother and more interest indelivering measured,prepared remarks. They'dwatchadozenoftheseeventsover the next three days andall were tedious. This onesessionwasdifferent,though,because its moderatorappeared to be drunk, or atleastunhinged.HisnamewasJohn Devaney and he ran a

hedge fund that invested insubprime mortgage bonds,UnitedCapitalMarkets.Foradecade now, Devaney hadsponsored this conference--calledASF, or theAmericanSecuritization Forum, in partbecause it sounded moredignifiedthantheAssociationforSubprimeLending.Totheextent that the market forsubprimemortgagebondshadmoral leaders, JohnDevaneywas one. He was also an

enthusiastic displayer of hisown wealth. He owned aRenoir, a Gulfstream, ahelicopter, plus, of course, ayacht. This year he'd paidsome huge sum to fly in JayLeno to serve as theentertainment.

Now, looking as if hehadjustrolledinfromanighton the town without pausingto take a nap, JohnDevaneydeliveredwhatwasclearlyanextemporaneous rant about

the state of the subprimemarket. "It was incredible,"said Charlie. "Stream ofconsciousness. He went onabout how the ratingsagencies were whores. Howthesecuritieswereworthless.How they all knew it. Hegavewords to stuff wewerejustsuspecting.Itwaslikehewas talking out of school.When he was finished therewascompletesilence.Noonespecifically attempted a

defense. They just talkedaround him. It was likeeveryone pretended he hadn'tsaid it."*On theonehand, itwas exhilarating to hear amarket insider say what hethought to be true; on theother, if the market becameself-aware, its madnesscouldn'tlastlong.CharlieandJamie andBen assumed theyhad time to think thingsoverbefore they went out andbought even more credit

default swaps on the double-AtrancheofsubprimeCDOs."That speech spooked us,"said Ben. "It seemed ratherthan six months to get ourtradeonwehadoneweek."

Thetrouble,asever,wasfinding Wall Street firmswilling to deal with them.Their one source of supply,Bear Stearns, suddenlyseemed more interested inshooting than in tradingwiththem. Every other firm

treated them as a joke.Cornhole Capital. But here,in Las Vegas, luck foundthem. To their surprise, theyfoundthattheconsultanttheynow employed to analyzeCDOs for them, David Burt,enjoyedseriousstature in theindustry. "David Burt waslike God in Vegas," saidCharlie. "We started justfollowing him around. 'Hey.That guy you're talking to.We're paying him--can we

talktoyoutoo?'"ThisrentedGod introduced Charlie to awomanfromMorganStanleynamed Stacey Strauss. Herjobwastofindinvestorswhowanted to buy credit defaultswaps as quickly as shecould. Charlie never figuredout why she was willing inthe extreme to bendMorganStanley's usual standards todo business with Cornwall.Charlie also accosted a manwho analyzed the subprime

mortgage bond market forWachovia Bank, whohappenedtohavebeenonthepanel moderated by theshocking John Devaney.During the opening paneldiscussion, he, like everyoneelse, had pretended he hadn'theard John Devaney. WhenDevaney was finished, theWachovia guy had given hislittle speech about thefundamentalsoundnessofthesubprime mortgage bond

market. As he came off thestage, Charlie ambushed himand asked him if maybeWachovia didn't want to putits money where its mouthwasandsellhimsomecreditdefaultswaps.

Themorningafterhisdinnerwith Wing Chau, Eismanwoke up to his first glimpseof the bond market in theflesh, and a lot ofsensationally phony baroque

ceiling frescoes. TheVenetian hotel--PalazzoDucaleontheoutside,DivineComedy on the inside--wasoverrun by thousands ofwhitemen inbusinesscasualnowearning their living, onewayoranother,off subprimemortgages. Like all of LasVegas, The Venetian was ajangle of seemingly randomeffects designed to heightenand exploit irrationality: thedays that felt like nights and

the nights that felt like days;the penny slots and the cashmachines that spat outhundred-dollar bills; thegrandhotelroomsthatcostsolittle and made you feel sobig.Thepointofallofitwasto alter your perception ofyour chances and yourmoney,andallofitdepressedEisman:Hedidn'tevenliketogamble. "I wouldn't knowhow to calculate odds if mylife dependedon it," he said.

AttheendofeachdayVinnywould head off to play low-stakes poker, Danny wouldjoin Lippmann and the otherbond people at the crapstables, andEismanwould goto bed. That craps was thegame of choice of the bondtrader was interesting,though. Craps offered theplayertheillusionofcontrol--after all, he rolled the dice--andasurfacecomplexitythatmasked its deeper idiocy.

"Forsomereason,whenthesepeople are playing it theyactuallybelievetheyhavethepower to make the dicework,"saidVinny.

Thousands andthousandsofseriousfinancialprofessionals,mostofwhom,justafewyearsago,hadbeendoing something else withtheir lives,werenowplayingcraps with the money theyhad made off subprimemortgage bonds. The

subprime mortgage industryEismanonceknewbetterthananyone on the planet hadbeen a negligible corner ofthe capitalmarkets. In just afew years it had somehowbecome the most powerfulengine of profits andemployment onWall Street--and it made no economicsense. "It was like watchingan unthinking machine thatcouldnotstopitself,"hesaid.He felt as if he had moved

intoanewhouse,openedthedoor to what he presumedwas a small closet, anddiscovered an entirely newwing. "I'd been to equityconferences," said Eisman."Thiswastotallydifferent.Atan equity conference you'reluckyifyougetfivehundredpeople. There were seventhousandpeopleat thisthing.Justthefactthatnoonefromthe equity world was theretold you that no one had

figured it out. We knew noone. We still assumed weweretheonlyoneswhowereshort."

He had no interest inlistening to other people'sspeeches. He had no interestin attending the paneldiscussion and hearing thepotted remarks. He wantedprivate sessions with marketinsiders. Lippmann hadintroducedthemtothepeopleinside Deutsche Bank

peddling CDOs to investors,and these helpful DeutscheBankpeoplehadarrangedforEisman and his partners tomeet the bond market'sfinancial intermediaries: themortgage lenders, the banksthat packaged the mortgageloans into mortgage bonds,the bankers who repackagedthebondsintoCDOs,andtherating agencies that blessedtheprocessateachstage.Theonly interested parties

missing from the conferencewere the ultimate borrowers,the American home buyers,buteventhey,inaway,wereon hand, serving drinks,spinning wheels, and rollingdice. "Vegas was booming,"said Danny. "Thehomeowners were at thefucking tables." A friend ofDanny'sreturnedfromanightonthetowntoreporthe'dmeta stripper with five separatehomeequityloans.*

The Deutsche BankCDO salesman--a fellownamedRyan Stark--had beenassigned to keep an eye onEismanandpreventhimfromcausing trouble. "I startedgetting these e-mails fromhim, before the conference,"saidDanny."Hewasnervousabout us. It was like, 'I justwanttoclarifythepurposeofthemeetings,'and, 'Justtobeclearwhywe'remeeting...'Hewantedtomakesureweknew

werememberedthatwewerethere to buy the bonds."DeutscheBankhadevensentalong the formal handoutsintendedforsubprimebuyers,asakindofscriptforthemtofollow. "The purpose of theconference is to convincepeopleit'sstillokaytocreateand to buy this shit," saidDanny."Itwasunheardofforan equity investor looking toshort the bonds to come inand scope the place out for

information. The only waywe got these one-on-onemeetings was by saying thatwe weren't short. DeutscheBank escorted us, to makesure we didn't blow up theirrelationships. They put asalesman in the meeting justtomonitorus."

There was of course nopoint in trying to monitorEisman.He sawhimself as acrusader, a champion of theunderdog, an enemy of

sinister authority. He sawhimself, roughly speaking, asSpider-Man.Hewasperfectlyaware of how absurd itsounded when, for instance,his wife told people, "Myhusband thinks he andSpider-Man are living thesame life." Eisman didn't goaroundtellingstrangersaboutthe shocking number ofparallelsbetweenhimselfandPeter Parker--when they hadgone to college, what they

had studied, when they'dmarried, and on and on--orthat, by the time he was inlawschool,hewaspickingupthe latest Spider-Man comichalf expecting to discover initthenextturnhislifewouldtake. But Eisman was quicktoseenarratives,heexplainedtheworld in stories, and thiswasoneofthestoriesheusedtoexplainhimself.

The first sign thatSpider-Manhadnointerestin

Deutsche Bank's darkdealingscameataspeechthatmorning, given by the CEOofOptionOne, themortgageoriginator owned by H&RBlock. Option One hadpopped onto Eisman's radarscreen seven months earlier,in June 2006, when thecompany announced asurprisinglossinitsportfolioof subprime mortgage loans.The loss was surprisingbecause Option One was in

the business ofmaking loansand selling them off toWallStreet--they weren't meant tobetakingrisk.Inthesedeals,however, there was aprovision that allowed WallStreettoputtheloansbacktoOption One if the borrowersfailed to make their firstpayment. "Who takes out ahome loan and doesn't makethe first payment?" askedDanny Moses, putting thematter one way. "Who the

fuck lends money to peoplewho can't make the firstpayment?" asked Eisman,puttingitanother.

When the CEO ofOptionOnegottothepartofhis speech about OptionOne's subprime loanportfolio, he claimed that thecompanyhadputitsproblemsbehind it and was nowexpectinga(modest)lossrateon its loans of 5 percent.Eisman raised his hand.

Moses and Daniel sank intheir chairs. "It wasn't aQ&A,"saysMoses."Theguywasgivingaspeech.HeseesSteve'shandandsays,'Yes?'"

"Wouldyousaythatfivepercent is a probability or apossibility?"askedEisman.

A probability, said theCEO, and went back togivinghisspeech.

Eismanhadhis handupin the air again, waving itaround. Oh no, thought

Moses,andsankdeeperinhischair. "The one thing Stevealways says is that youmustassume they are lying toyou,"saidDaniel."Theywillalwayslietoyou."DannyandVinny both knew whatEisman thought of thesesubprime lenders, but didn'tsee the need for him toexpress it here, in thismanner. For Steve wasn'traising his hand to ask aquestion.Stevehadhisthumb

and index finger in a bigcircle. Steve was using hisfingerstospeakonhisbehalf."Zero!"theysaid.

"Yes?" asked theobviously irritated CEO. "Isthatanotherquestion?"

"No," said Eisman. "It'sa zero. There is zeroprobability that your defaultratewillbefivepercent."Thelosses on subprime loanswould be far, far greater.Before the guy could reply,

Eisman's cell phone rang.Rather than shut it down,Eismanreachedinhispocketand answered it. "Excuseme," he said, standing up."ButIneedtotakethiscall."Andwiththat,hewalkedoutof thespeech.Thecallerwashiswife.

"It wasn't important atall," she says with a sigh. "Iwasaprop."

After that somethingmusthavecomeoverEisman,

for he stopped looking for afight and started looking forhigher understanding. HewalkedaroundtheLasVegascasino incredulous at thespectacle before him: seventhousandpeople,allofwhomseemed delighted with theworld as they found it. Asociety with deep, troublingeconomic problems hadriggeditself todisguisethoseproblems, and the chiefbeneficiaries of the deceit

wereitsfinancialmiddlemen.How could this be? Eismanactually wondered, albeitvery briefly, if he wasmissing something. "He keptsaying, 'What the hell isgoingonhere?Whothefuckare all these people?'" saidDanny Moses. The shortanswer to that secondquestion was: the optimists.The subprime mortgagemarket in its currentincarnation never had done

anythingbut rise.Thepeoplein it who were regarded assuccesseswerethosewhohadalways said "buy."Now theyshould really all be saying"sell," but they didn't knowhow to do it. "You alwaysknew that fixed income guysthoughttheyknewmorethanyou did," said Eisman, "andgenerally that was true. Iwasn't a fixed income guy,buthereI'dtakenthispositionthat was a bet against their

whole industry, and Iwantedto know if they knowsomething I don't. Could itreallybethisobvious?Couldit really be this simple?" Heenteredprivatemeetingswiththe lenders and the bankersand the rating agenciesprobingforanintelligencehehadyet todetect."Hewas inlearning mode," said Vinny."Whenhe'sfascinatedaboutasubject,hiscuriositybecomesfarmoreimportantthanbeing

confrontational.He'llclaimitwas years of therapy thatenabled him to behave, butthe truth is it was the firsttime he was connecting allthedots."

Much of Steve Eismanwanted to believe the worst,and that gave him a hugetacticaladvantageintheU.S.financialmarkets circa 2007.There was still some part ofhim, however, that was ascredulousasthelittlekidwho

lent his new bike to a totalstranger.Hewasstillcapableof being shocked. Hisexperience with HouseholdFinancehaddisabusedhimofanyhopethatthegovernmentwould intercede to preventrich corporations from doingbad things to poor people.Inside the free market,however,theremightbesomeauthoritycapableofcheckingits excess. The ratingagencies, in theory,were just

such an authority. As thesecurities became morecomplex, the rating agenciesbecame more necessary.Everyone could evaluate aU.S. Treasury bond; hardlyanyone could understand asubprime mortgage-backedCDO. There was a naturalrole for an independentarbiter to pass judgment onthese opaque piles of riskyloans. "In Vegas it becameclear to me that this entire

huge industry was justtrusting in the ratings,"Eisman said. "Everyonebelieved in the ratings, sothey didn't have to thinkaboutit."

Eisman had worked onWall Street for nearly twodecades, but, likemost stockmarket people, he'd neverbefore sat downwith anyonefromMoody's orStandard&Poor's. Unless they coveredinsurance companies, which

lost their ability to sell theirproduct the moment theirability to meet theirobligations was thrown intodoubt, stock market peopledidn't pay much attention tothe rating agencies. NowEisman had his firstexchanges with them, andwhatstruckhimimmediately--andstruckDannyandVinny,too--was the caliber of theiremployees. "You know howwhen you walk into a post

office you realize there issuch a difference between agovernment employee andother people," said Vinny."The ratings agency peoplewere all like governmentemployees."Collectivelytheyhadmorepower thananyonein the bond markets, butindividually they werenobodies. "They'reunderpaid," said Eisman."The smartest ones leave forWallStreetfirmssotheycan

help manipulate thecompanies theyused toworkfor. There should be nogreaterthingyoucandoasananalyst than to be theMoody'sanalyst.Itshouldbe,'I can't go higher as ananalyst.' Instead it's thebottom!Noone gives a fuckif Goldman likes GeneralElectric paper. If Moody'sdowngradesGEpaper, it isabigdeal.Sowhydoestheguyat Moody's want to work at

Goldman Sachs? The guywho is the bank analyst atGoldman Sachs should wanttogotoMoody's.Itshouldbethatelite."

The entire industry hadbeen floated on the backs ofthe rating agencies, but thepeople who worked at therating agencies barelybelonged in the industry. Ifthey roamed the halls theymight be mistaken, just, forsome low-level commercial

bankers at Wells Fargo, orflunkies atmortgage lenders,such asOptionOne: nine-to-fivers. They wore suits inVegas,whichtoldyouhalfofwhat you needed to knowabout them--the other halfyou got from the price ofthose suits. Just abouteveryone else dressedbusinesscasual;thefewguyswho were actually importantpeople wore three-thousand-dollar Italian suits. (One of

the mysteries of the WallStreet male was that he wasignorantofthefinerpointsofcouture but could still tell inan instant howmuch anotherWall Street male's suit hadcost.) The rating agenciesguys wore blue suits fromJ.C. Penney, with ties thatmatched too well, and shirtsthat were starched just a bittoo stiffly. They weren'tplayers and they didn't knowthe people who were, either.

They got paid to rate thebonds of Lehman and BearStearns and Goldman Sachs,but they couldn't tell you thenamesof,oranyof theotherimportant facts about, theguys at Lehman and BearStearns and Goldman Sachswho were making a fortuneexploiting loopholes in theratingagencies'models.Theyappeared to know enough tojustifytheirjobs,andnothingmore. They seemed timid,

fearful, and risk-averse. AsDanny put it, "You wouldn'tseethematthecrapstable."

It was in Vegas thatEisman realized that "all thestuffIwasworriedabout,theratingsagenciesdidn't care. Iremember sitting therethinking, Jeez, this is reallypathetic. You know whenyou're with someone who isintellectually powerful: Youjust know it. When you sitdown with Richard Posner

[the legalscholar],youknowit's Richard Posner. Whenyousitdownwiththeratingsagencies you know it's theratings agencies." To judgefrom their behavior, all theratingagenciesworriedaboutwas maximizing the numberof deals they rated for WallStreet investment banks, andthe fees they collected fromthem.Moody's,onceaprivatecompany, hadgonepublic in2000.Since then its revenues

had boomed, from $800million in 2001 to $2.03billion in 2006. Some hugepercentage of the increase--more thanhalf, certainly,butexactlyhowmuchmore thanhalf they declined to tellEisman--flowed from thearcane end of the homefinance sector, known asstructuredfinance.Thesurestway to attract structuredfinance business was toaccepttheassumptionsofthe

structured finance industry."Weaskedeveryonethesametwo questions," said Vinny."What is your assumptionabout home prices, andwhatisyourassumptionaboutloanlosses." Both rating agenciessaid they expected homeprices to rise and loan lossesto be around 5 percent--which, if true, meant thateven the lowest-rated, triple-B, subprimemortgage bondscrafted from them were

money-good. "It was likeeveryone had agreed inadvancethatfivepercentwasthe number," said Eisman."Theyallsaidfivepercent.Itwas a party and there was aparty line."* What shockedEismanwas that none of thepeople he met in Las Vegasseemedtohavewrestledwithanything. They were doingwhattheyweredoingwithoutthinkingverymuchaboutit.

ItwasinLasVegasthat

Eisman and his associates'attitudetowardtheU.S.bondmarket hardened intosomethinglikeitsfinalshape.As Vinny put it, "That wasthe moment when we said,'Holy shit, this isn't justcredit. This is a fictitiousPonzischeme.'" InVegas thequestionlingeringatthebackof their minds ceased to be,Dothesebondmarketpeopleknow something we do not?It was replaced by, Do they

deservemerelytobefired,orshould they be put in jail?Are they delusional, or dothey know what they'redoing? Danny thought thatthe vast majority of thepeople in the industry wereblindedby their interestsandfailed to see the risks theyhad created. Vinny, alwaysdarker, said, "There weremoremoronsthancrooks,butthe crooks were higher up."The rating agencies were

aboutaslowasyoucouldgoand still be in the industry,and the people who workedfor them really did not seemto know just how badly theyhadbeengamedbybigWallStreetfirms.TheirmeetinginLasVegaswith the thirdandsmallest rating agency, FitchRatings, stuck in Vinny'smind. "I know you're sort ofirrelevant,"he'dsaidtothem,as politely as he could."Therearethesetwobigguys

everyone pays attention to,and then there is you. If youwant to make a statement--andgetpeopletonoticeyou--why don't you go your ownway and be the honest one?"Heexpected thegoodpeopleofFitchRatingsservicetoseethe point, and maybe evenchuckle nervously. Insteadtheyseemedalmostoffended."Theywent all pure onme,"saidVinny. "Itwas like theydidn't understandwhat Iwas

saying."They had left for Las

Vegaswithashortpositioninsubprime mortgage bonds ofa bit less than $300 million.Upon their return they raisedit to $550 million, with newbetsagainsttheCDOscreatedby Wing Chau. With only$500 million undermanagement, the positionnow overwhelmed theirportfolio. They didn't stopthere, however. Their first

day back in the office, theyshorted the stockofMoody'sCorporation, at $73.25 ashare,thenwentsearchingforother companies and otherpeople, like Wing Chau, ontheothersideoftheirtrade.

CHAPTERSEVEN

TheGreatTreasureHunt

Charlie Ledley and BenHockett returned from LasVegas on January 30, 2007,convinced that the entirefinancial system had lost itsmind."Isaidtomymother,'Ithink we might be facing

something like the end ofdemocratic capitalism,'" saidCharlie. "She just said, 'Oh,Charlie,' and seriouslysuggested I go on lithium."They had created aninvestment approach thatharnessed their talent fordistancing themselves fromotherpeople's convictions; tofind such great conviction inthemselves was new anduncomfortable. Jamie penneda memo to his two partners,

in which he asked them iftheyweremakingabetonthecollapse of a society--andtherefore a bet that thegovernment would neverallow to succeed. "If abroadrange of CDO spreads startsto widen," he wrote,* "itmeans that a material globalfinancial clusterfuck is likelyoccurring.... The U.S. Fed isin a position to fix theproblem by intervening.... Iguess the question is, How

wide would the meltdownneedtobe inorder tobe 'toobigtofail'?"

The conference in LasVegas had been created,among other things, to boostfaith in the market. The dayafter the subprime mortgagemarket insiders left LasVegas and returned to theirtrading desks, the marketcracked. On January 31,2007, the ABX, a publiclytraded indexof triple-B-rated

subprime mortgage bonds--exactlythesortofbondsusedto create subprime CDOs--fell more than a point, from93.03 to 91.98. For the pastseveralmonths, ithaddrifteddowninsuchtinyincrements,from 100 to 93, that a fullpoint move came asshocking--and heightenedCharlie's anxiety that they'ddiscovered this sensationaltrade a moment too late towager asmuch on it as they

should. The woman fromMorganStanleywas, at first,true toherword:Shepushedthrough their ISDAagreement, which wouldnormally have taken monthsof negotiations, in ten days.She sent Charlie a list ofdouble-A tranches of CDOson which Morgan Stanleywaswillingtosellthemcreditdefault swaps.* Charliestayed up nights figuring outwhichonestobetagainst,and

thencalledheruptofindthatMorgan Stanley hadexperienced a change ofheart. She had told Charliethat he could buy insuranceforaround100basispoints(1percentoftheinsuredamountayear),butwhenhecalledupthe next morning to do thetrade,thepricehadmorethandoubled. Charlie bitched andmoaned about the unfairnessof it and she and her bossescaved,abit.OnFebruary16,

2007, Cornwall paidMorganStanley 150 basis points tobuy $10 million in creditdefault swaps on a CDOcrypticallycalledGulfstream,whateverthatwas.

Five days later, onFebruary 21, the marketbegan to trade an index ofCDOs called the TABX. Forthefirsttime,CharlieLedley,and everyone else in themarket,was able to see on ascreen the price of one of

these CDOs. The priceconfirmed Cornwall's thesisin a way that no amount ofconversation with marketinsiders ever could have.After the firstdayof trading,the tranche that took losseswhen the underlying bondsexperienced losses of morethan 15 percent of the pool--the double-A-rated tranchethatCornwallhadbetagainst--closed at 49.25: It had lostmore than half its value.

There was now this hugedisconnect: With one handthe Wall Street firms wereselling low interest rate-bearing double-A-ratedCDOsatpar,or100;withtheother they were trading thisindexcomposedofthoseverysame bonds for 49 cents onthe dollar. In a flurry of e-mails, their salespeople atMorganStanleyandDeutscheBank tried to explain toCharlie that he should not

deduce anything about thevalue of his bets againstsubprime CDOs from thepriceson thesenew,publiclytraded subprime CDOs. Thatitwasallverycomplicated.

The next morningCharlie called back MorganStanley in hopes of buyingmore insurance. "She waslike, 'I'm really, really sorrybutwe'renotdoinganymoreofthis.Thefirm'schangeditsmind.'" Overnight, Morgan

Stanley had gone frombeingwildlyeagertosell insuranceon the subprime mortgagemarkettonotwantingtodoitat all. "Then she puts us onthe phone with her boss--because we were like, 'Whatthe fuck is going on?'--andhe's like, 'Look, I'm reallysorry, but something hashappened in another arm ofthe bank that's caused somekind of risk managementdecision at the very highest

levels of Morgan Stanley.'And we never traded withthem again." Charlie had noidea what exactly hadawakened inside MorganStanley, and didn't think toomuch about it--he and Benwere too busy trying to talkthe guy from Wachoviawhom Charlie had pouncedon inLasVegas intodealingwithCornwallCapital."Theydidn't have one hedge fundclient, and they were sort of

excited to see us," said Ben."Theywere trying to be big-time." Wachovia, amazingly,remainedwillingtosellcheapinsurance on subprimemortgage bonds; the risk itscreditofficerswereunwillingtotakewastheriskofdealingdirectly with CornwallCapital. It took a while, butCharlie arranged for hisUzi-shooting companions fromBear Stearns to sit in themiddle between the two

parties, for a fee.The detailsofa$45milliontrademoreorless agreed upon in February2007 took several months tohammer out, and the tradedidn't go through until earlyMay. "Wachovia was a giftfromGod,"saidBen."Itwaslike we were in a plane atthirty thousand feet, whichhad stalled, and Wachoviastillhada fewparachutes forsale. No one else was stillsellingparachutes,butnoone

reallywanted to believe theywere needed, either.... Afterthat, the market completelyshutdown."

Inaportfoliooflessthan$30million,CornwallCapitalnow owned $205 million incredit default swaps onsubprime mortgage bonds,and were disturbed mainlythat they didn't own more."We were doing everythingwe possibly could to buymore," said Charlie. "We'd

putinourbidsattheofferingprices. They'd call back andsay,'Oops,youalmostgotit!'It was very sort of CharlieBrownandLucy.We'dgouptokickthefootballandthey'dpull it back. We'd raise ourbid and the minute we didtheirofferwouldjumpup."

It made no sense: Thesubprime CDO market wastickingalongasithadbefore,and yet the big Wall Streetfirmssuddenlyhadnousefor

the investors who had beensupplying the machine withraw material--the investorswho wanted to buy creditdefault swaps. "Ostensiblyotherpeopleweregoinglong,but we were not allowed togoshort,"saidCharlie.

He couldn't know forsure what was happeninginside the big firms, but hecould guess: Some of thetraders on the inside hadwoken up to the impending

disaster andwere scramblingto get out of the marketbeforeitcollapsed."WiththeBearguysIhadthissuspicionthat, if there were any creditdefault swaps on CDOs tobuy, they were buying it forthemselves," saidCharlie.Atthe end of February a BearStearns analyst named GyanSinha published a longtreatisearguingthattherecentdeclines in subprimemortgage bonds had nothing

to dowith the quality of thebonds and everything to dowith "market sentiment."Charlie read it thinking thatthe person who wrote it hadno idea what was actuallyhappening in the market.AccordingtotheBearStearnsanalyst,double-ACDOsweretrading at 75 basis pointsabove the risk-free rate--thatis, Charlie should have beenable to buy credit defaultswaps for 0.75 percent in

premiums a year. The BearStearns traders, by contrast,weren'twillingtosellthemtohim for five times that price."Icalledtheguyupandsaid,'Whatthefuckareyoutalkingabout?'Hesaid,"Well,thisiswhere the deals are printing.'I asked him, 'Are desksactuallybuyingandsellingatthat price?' And he says,'Gottago,'andhungup."

Their trade now seemedto themridiculouslyobvious-

-itwas as if theyhadboughtcheap fire insurance on ahouse engulfed in flames. Ifthe subprime mortgagemarket had the slightestinterest in being efficient, itwould have shut down rightthereandthen.Formorethaneighteen months, from mid-2005 until early 2007, therehad been this growingdisconnect between the priceof subprime mortgage bondsand the value of the loans

underpinning them. In lateJanuary 2007 the bonds--orrather, the ABX index madeupofthebonds--begantofallin price. The bonds fell atfirststeadilybutthenrapidly--by early June, the index oftriple-B-ratedsubprimebondswasclosing in thehigh60s--whichistosaythebondshadlost more than 30 percent oftheir original value. It stoodto reason that the CDOs,which were created out of

these triple-B-rated subprimebonds,shouldcollapse,too.Ifthe oranges were rotten, theorangejuicewasalsorotten.

Yet this didnot happen.Instead, between Februaryand June of 2007, big WallStreet firms, led by MerrillLynchandCitigroup, createdand sold $50 billion in newCDOs. "We're totallybaffled," said Charlie."Because everyone andeverything just goes back to

normal, even though itobviouslywasn't normal.Weknew the collateral for theCDOshadcollapsed.Andyeteverything went on, as ifnothinghadchanged."

It was as if an entirefinancial market had tried tochange its mind--and thenrealized that it could notafford to change its mind.Wall Street firms--mostnotably Bear Stearns andLehman Brothers--continued

to publish bond marketresearch reaffirming thestrengthofthemarket.InlateApril, Bear Stearns held aCDO conference, into whichCharlie sneaked. On theoriginal agenda was apresentationentitled"HowtoShort a CDO." It had beenremoved from the finalconference--so, too,hadbeenthe slides that accompaniedthe talk that had been postedontheBearStearnsWebsite.

Moody's and S&P flinched,too, but in a telling manner.In late May, the two bigrating agencies announcedthat they were reconsideringtheir subprime bond ratingsmodels. Charlie and Jamiehired a lawyer to callMoody'sandaskthem,iftheywere going to rate subprimebonds by different criteriagoing forward, might theyalso reconsider the twotrilliondollars'worthorsoof

bondstheyhadalreadyrated,badly. Moody's didn't thinkthat was a good idea. "Wewere like, 'Youdon't have tore-rate all of them. Just theones we're short,'" saidCharlie. "They were like,'Hmmmmmm...no.'"

ToCharlie andBen andJamie it seemed perfectlyclear that Wall Street wasproppingupthepriceoftheseCDOs so that they mighteither dump losses on

unsuspecting customers ormakealastfewbilliondollarsfrom a corrupt market. Ineither case, they weresqueezing and selling thejuice from oranges that wereundeniably rotten. By lateMarch2007,"Wewereprettysure one of two things wastrue,"saidCharlie."Eitherthegame was totally rigged, orwe had gone totally fuckingcrazy. The fraud was soobviousthatitseemedtousit

had implications fordemocracy. We actually gotscared." They both knewreporters who worked at theNewYorkTimesandtheWallStreet Journal--but thereporters they knew had nointerest in their story. Afriend at the Journal hookedthemupwiththeenforcementdivision of the SEC, but theenforcement division of theSEChadnointeresteither.Inits lower Manhattan office,

the SEC met with them andlistened, but politely. "Itwasalmost like a therapysession," said Jamie."Because we sat down andsaid,'We'vejusthadthemostcrazy experience.'" As theyspoke, they sensed theaudience's incomprehension."We probably had like thiswild-eyedwe've-been-up-for-three-days-straight look inour eyes," said Charlie. "Butthey didn't know anything

aboutCDOs, or asset-backedsecurities. We took themthrough our trade but I'mpretty sure they didn'tunderstand it." The SECneverfollowedup.

Cornwall had a problemmore immediate than thecollapse of society as weknow it: thecollapseofBearStearns. On June 14, 2007,Bear Stearns AssetManagement, a CDO firm,likeWingChau's,but runby

former Bear Stearnsemployees who had theimplicit backing of themother ship, declared that ithad lost money on bets onsubprimemortgage securitiesand that it was being forcedto dump 3.8 billion dollars'worth of these bets beforeclosingthefund.Upuntilthismoment, Cornwall Capitalhad been unable to see whyBearStearns,andnooneelse,hadbeensoeagertosellthem

insurance on CDOs. "Bearwasabletoshowusliquidityin the CDOs that I couldn'tunderstand," saidBen. "Theyhad a standing buyer on theother side. I don't know thatour trades went directly intotheir funds, but I don't knowwhere else they would havegone."

And therein lay a newproblem: Bear Stearns hadsold Cornwall 70 percent ofits credit default swaps.

BecauseBearStearnswasbigand important, and CornwallCapital was a garage bandhedge fund, Bear Stearnshadn't been required to postcollateral to Cornwall.Cornwall was now totallyexposedtothepossibilitythatBearStearnswouldbeunabletopayoffitsgamblingdebts.Cornwall Capital couldn'thelp but notice that BearStearns was not so muchshaping the subprime

mortgage bond business asbeingreshapedbyit."They'dturned themselves from alow-risk brokerage operationinto a subprime mortgageengine," said Jamie. If thesubprime mortgage marketcrashed, Bear Stearns wasgoingtocrashwithit.

Back in March,Cornwall had bought $105million in credit defaultswaps on Bear Stearns--thatis, they'd made a bet on the

collapse of Bear Stearns--fromtheBritishbankHSBC.IfBearStearns failed,HSBCwould owe them $105million. Of course this onlyshifted their risk to HSBC.HSBC was the third largestbankintheworld,andoneofthose places it was hard tothink about going down. OnFebruary 8, 2007, however,HSBC rocked the marketwiththeannouncementthatitwas taking a big, surprising

loss on its portfolio ofsubprime mortgage loans. Ithad entered the U.S.subprime lending business in2003, when it had boughtAmerica's biggest consumerlendingoperation,HouseholdFinance. The sameHousehold Finance that hadpushedSteveEismanoverthenarrow border between WallStreetskepticandWallStreetcynic.

From the social point ofview the slow and possiblyfraudulent unraveling of amulti-trillion-dollar U.S.bond market was acatastrophe. From the hedgefund trading point of view itwas the opportunity of alifetime. Steve Eisman hadstarted out running a $60million equity fund but wasnowshortaround600milliondollars' worth of varioussubprime-related securities,

andhewantedtoshortmore."Sometimes his ideas cannotbemanifestedinatrade,"saidVinny. "This time theycould." Eisman wasenchained, however, byFrontPoint Partners and, byextension, Morgan Stanley.As FrontPoint's head trader,Danny Moses found himselfcaughtinthemiddle,betweenEisman and FrontPoint's riskmanagement people, whodidn't seem to completely

understand what they weredoing. "They'd call me andsay, 'Can you get Steve totake someof thisoff?' I'dgotoSteveandStevewouldsay,'Just tell them to fuck off.'And I'd say, 'Fuck off.'" Butrisk management houndedthem, and cramped Eisman'sstyle. "If risk had said to us,'We're very comfortablewiththisandyoucandotentimesthis amount,'" said Danny,"Steve would have done ten

times the amount." GregLippmann was now blastingVinny and Danny with allsorts of negative informationabout the housing market,and, for the first time,VinnyandDannybegan tohide theinformation from Eisman."Wewereworriedhe'dcomeout of his office and shout,'Doatrillion!'"saidDanny.

In the spring of 2007,the subprime mortgage bondmarket, incredibly, had

strengthened a bit. "Theimpact on the broadereconomy and the financialmarkets of the problems inthe subprime markets seemslikely to be contained," U.S.Federal Reserve chairmanBenBernankewas quoted assaying in the newspapers onMarch 7. "Credit qualityalways gets better in Marchand April," said Eisman."And the reason it alwaysgetsbetterinMarchandApril

is that people get their taxrefunds. You would thinkpeople in the securitizationworldwould know this.Andthey sort of did.But they letthecreditspreadstighten.Wejust thought that wasmoronic. What are you,fucking stupid?" Amazingly,thestockmarketcontinuedtosoar, and the television overthe FrontPoint trading desksemitted a ceaselessly bullishsignal. "We turned off

CNBC," said Danny Moses."It became very frustratingthat they weren't in touchwith reality anymore. Ifsomething negativehappened, they'd spin itpositive. If somethingpositive happened, they'dblow it out of proportion. Italtersyourmind.Youcan'tbecloudedwithshitlikethat."

Upon their return fromLas Vegas, they set out topestertheratingagencies,and

the Wall Street people whogamedtheirmodels,formoreinformation."Weweretryingto figure out what, ifanything, would make theratings agencies downgrade,"said Danny. In the process,they picked up moredisturbing tidbits. They'doftenwondered, for instance,why the rating agenciesweren'tmorecriticalofbondsunderpinned by floating-ratesubprime mortgages.

Subprime borrowers tendedto be one broken refrigeratoraway from default. Few, ifany, should be running therisk of their interest paymentspiking up.Asmost of theseloans were structured,however, the homeownerwouldpaya fixed teaser rateof,say,8percentforthefirsttwo years, and then, at thestart of the third year, theinterest rate would skyrocketto, say, 12 percent, and

thereafter it would float atpermanently high levels. Itwas easy to understand whyoriginators like Option OneandNewCenturypreferredtomake these sorts of loans:Aftertwoyearstheborrowerseither defaulted or, if theirhome price had risen,refinanced. To them thedefault was a matter ofindifference, as they keptnone of the risk of the loan;the refinance was merely a

chance to charge theborrowernewfees.Bouncingbetween the rating agenciesand people he knew in thesubprime bond packagingbusiness,Eismanlearnedthatthe rating agencies simplyassumed that the borrowerwould be just as likely tomake his paymentswhen theinterest rate on the loan was12 percent as when it was 8percent--which meant morecash flow for the

bondholders. Bonds backedby floating-rate mortgagesreceived higher ratings thanbonds backed by fixed-rateones--which was why thepercentage of subprimemortgageswith floating rateshad risen, in the past fiveyears,from40to80.

Alotoftheseloanswerenowgoingbad,butsubprimebonds weren't moving--because Moody's and S&P,disturbingly, still hadn't

changed their officialopinions of them. As anequity investor, FrontPointPartnerswascoveredbyWallStreet stockbrokers. Eismanasked stockmarket salesmenat Goldman Sachs andMorgan Stanley and theothers tobringover thebondpeopleforavisit."Wealwaysasked the same question,"saysEisman."'Whereare theratings agencies in all this?'And I'd always get the same

reaction. It was a physicalreaction because they didn'twant to say it. It was asmirk." Digging deeper, hecalled S&P and asked whathappened to default rates ifreal estate prices fell. Theman at S&P couldn't say:Their model for home priceshad no ability to accept anegativenumber."Theywerejust assuming home priceswould keep going up," saysEisman.*

Eventuallyhe'dhopontothe subway with Vinny andride down to Wall Street tomeet with a woman at S&Pnamed Ernestine Warner.Warnerworkedasananalystin the surveillancedepartment. The surveillancedepartment was meant tomonitor subprime bonds anddowngrade them if the loansthat underpinned them wentbad. The loans were goingbad but the bonds weren't

being downgraded--and soonceagainEismanwonderedif S&P knew something hedid not. "When we shortedthebonds,allwehadwasthepool-leveldata,"hesaid.Thepool-level data gave you thegeneral characteristics--theaverage FICO scores, theaverage loan-to-value ratios,theaveragenumberofno-docloans, and so forth--but noview of the individual loans.Thepool-level data toldyou,

for example, that 25 percentof the home loans in somepool were insured, but notwhich loans--the ones likelyto go bad or the ones lesslikelyto.Itwasimpossibletodetermine how badly theWall Street firms had gamedthe system. "We of coursethought that the ratingsagencies had more data thanwehad," saidEisman. "Theydidn't."

Ernestine Warner was

workingwiththesameroughinformation available totraderslikeEisman.Thiswasinsane: The arbiter of thevalue of the bonds lackedaccesstorelevantinformationabout the bonds. "When weasked her why," said Vinny,"she said, 'The issuers won'tgive it to us.' That's when Ilost it. 'You need to demandto get it!' She looked at uslike, We can't do that. Wewere like, 'Who is in charge

here? You're the grown-up.You're the cop! Tell them tofucking give it to you!!!'"Eisman concluded that "S&Pwas worried that if theydemandedthedatafromWallStreet,WallStreetwouldjustgo to Moody's for theirratings."*

As an investor, Eismanwas allowed to listen in onthequarterlyconferencecallsheld by Moody's, but notinvitedtoposequestions.The

people at Moody's weresympathetic to his need formore genuine interaction,however; and the CEO, RayMcDaniel, even invitedEisman and his team to hisoffice for a visit, a gesturethat forever endeared him toEisman. "When are shortswelcome anywhere?" askedEisman. "When you're short,the whole world is againstyou. The only time acompany met me with

complete knowledge that wewere short was Moody's."After their trip toLasVegas,Eismanandhis teamweresocertain the world had beenturnedupsidedown that theyjust assumed RaymondMcDanielmust know it, too."But we're sitting there,"recallsVinny,"andhesaystous, like he actuallymeans it,'Itrulybelievethatourratingswill prove accurate.'" AndSteve shoots up in his chair

and asks, 'What did you justsay?'--as if the guy had justuttered themostpreposterousstatement in the history offinance. He repeated it. AndEisman just laughed at him."With all due respect, sir,"said Vinny deferentially, asthey left, "you're delusional."This wasn't Fitch or evenS&P.ThiswasMoody's.Thearistocrats of the ratingbusiness, 20 percent ownedby Warren Buffett. And its

CEO was being told he waseither a fool or a crook, byVincentDaniel,fromQueens.

By early June thesubprime mortgage bondmarket had resumed whatwould become anuninterrupteddecline,andtheFrontPointpositionsbegantomove--first by thousands andthen bymillions of dollars aday. "I know I'm makingmoney,"Eismanwould oftenask. "So who is losing

money?" They already wereshort the stocks of mortgageoriginators and the homebuilders. Now they added totheir short positions in thestocksof the rating agencies."Theyweremakingtentimesmore rating CDOs than theywere ratingGMbonds," saidEisman,"anditwasallgoingtoend."

Inevitably, theirattentionturnedtothebeatingheart of capitalism, the big

WallStreetinvestmentbanks."Our original thesis was thatthe securitization machinewas Wall Street's big profitcenter and it was going todie,"saidEisman."Andwhenthathappened, their revenueswould dry up." One of thereasons Wall Street hadcooked up this new industrycalled structured financewasthatitsold-fashionedbusinesswaseverydaylessprofitable.The profits in stockbroking,

alongwith those in themoreconventional sorts of bondbroking, had been squashedby Internet competition. Theminute the market stoppedbuying subprime mortgagebonds and CDOs backed bysubprime mortgage bonds,the investmentbankswere introuble. Right up until themiddle of 2007, Eisman hadnot suspected that the firmsweresofoolishastoinvestintheirowncreations.Hecould

see that their leverage hadincreaseddramatically,injustthe past few years.He couldof course see that they wereholdingmoreandmore riskyassetswith borrowedmoney.What he could not see wasthe nature of their assets.Triple-A-rated corporatebonds, or triple-A-ratedsubprime CDOs? "Youcouldn't know for sure," hesaid. "There was nodisclosure. You didn't know

what they had on theirbalance sheet. You naturallyassumed that they got rid ofthis shit as soon as theycreatedit."

A combination of newfacts, and actual humancontact with the people whoran the big firms and therating agencies, had stirredhis suspicion. The first newfact had been HSBC'sannouncement, in February2007, that itwas losing a lot

of money on its subprimeloans, and a secondannouncement,inMarch,thatit was dumping its subprimeportfolio. "HSBC weresupposed to be the goodguys," said Vinny. "Theywere supposed to havecleaned up Household. Wethought,Holy crap, there areso many people worse thanthat." The second new factwas in Merrill Lynch'ssecond-quarterresults.InJuly

2007, Merrill Lynchannounced yet anothersensationally profitablequarter, but admitted it hadsufferedadeclineinrevenuesfrommortgagetradingduetolosses in subprime bonds.What sounded to mostinvestors like a trivial pieceofinformationwastoEismanthe big news: Merrill Lynchowned a meaningful amountof subprime mortgagesecurities.Merrill'sCFO,Jeff

Edwards, told BloombergNews that the market neednot worry about this, as"activeriskmanagement"hadallowed Merrill Lynch toreduce its exposure to thelower-rated subprime bonds."I don'twant to get toodeepinto exactly how wepositioned ourselves at anyone point in time," Edwardssaid,butwentdeepenoughtosay that the market waspaying toomuch attention to

whateverMerrillhappenedtobe doing with subprimemortgage bonds. Or, asEdwards elliptically put it,"There's a disproportionatefocus on a particular assetclassinaparticularcountry."

Eisman didn't think so--and two weeks laterpersuaded a UBS analystnamedGlennSchorrtoescorthim to a small meetingbetweenEdwardsandMerrillLynch's biggest shareholders.

The Merrill CFO began byexplaining that this littlesubprime mortgage problemMerrillLynchseemedtohavewas firmly under the controlof Merrill Lynch's models."We're not that far into themeeting," said someone whowasthere."Jeffisstillgivinghis prepared remarks andSteve just bursts out, 'Well,yourmodelsarewrong!'Thisvery awkward silence comesovertheroom.Doyoulaugh?

Doyou try to think up somequestion so everyone canmoveon?Stevewassittingatthe end of the table and hestarts to put his papers inorder really conspicuously--asif tosay, 'If itwasn'trude,I'dwalkoutnow.'"

Eisman, for his part,considered the event a politeexchange of views, afterwhichhelostinterest."Therewas nothing more to say. Ijustfigured,Youknowwhat?

Thisguydoesn'tgetit."Onthesurface,thesebig

Wall Street firms appearedrobust; below the surface,Eisman was beginning tothink, their problems mightnotbeconfinedtoapotentiallossofrevenue.Iftheyreallydidn't believe the subprimemortgage market was aproblem for them, thesubprime mortgage marketmightbetheendofthem.Heand his team now set about

searching for hiddensubprime risk: Who washiding what? "We called itTheGreatTreasureHunt,"hesaid. They didn't know forsure if these firms were insomewayontheothersideofthe bets he'd been makingagainst subprime bonds, butthemorehelooked,themoresure he became that theydidn'tknoweither.He'dgotomeetings with Wall StreetCEOsandask themthemost

basic questions about theirbalance sheets. "They didn'tknow," he said. "They didn'tknow their own balancesheets."Once,hegothimselfinvited to ameetingwith theCEO of Bank of America,Ken Lewis. "I was sittingthere listening to him. I hadanepiphany.Isaidtomyself,'Oh my God, he's dumb!' Alightbulb went off. The guyrunning one of the biggestbanks in theworld isdumb!"

They shorted Bank ofAmerica, along with UBS,Citigroup, Lehman Brothers,and a few others. Theyweren't allowed to shortMorganStanleybecause theywere owned by MorganStanley, but if they couldhave, they would have. Notlong after they establishedtheir shorts against the bigWallStreetbanks,theyhadavisitfromaprominentanalystwho covered the firms, Brad

Hintz, at Sanford C.Bernstein&Co.Hintz askedEismanwhathewasupto.

"WejustshortedMerrillLynch,"saidEisman.

"Why?"askedHintz."We have a simple

thesis," said Eisman. "Thereisgoingtobeacalamity,andwhenever there isacalamity,Merrill is there." When itcame time to bankruptOrange County with badadvice, Merrill was there.

When the Internetwent bust,Merrill was there.Way backin the 1980s, when the firstbond trader was let off hisleash and lost hundreds ofmillions of dollars, Merrillwastheretotakethehit.ThatwasEisman's logic: the logicof Wall Street's peckingorder. Goldman Sachs wasthebigkidwhoranthegamesin this neighborhood.MerrillLynch was the little fat kidassigned the least pleasant

roles, just happy to be a partof things. The game, asEismansaw it,wascrack thewhip. He assumed MerrillLynch had taken its assignedplaceattheendofthechain.

On July 17, 2007, twodays before Ben Bernanke,the Fed chairman, told theU.S. Senate that he saw nomore than $100 billion inlosses in the subprimemortgage market, FrontPointdid something unusual: It

hosted its own conferencecall. They'd had calls withtheir tiny population ofinvestors, but this time theyjust opened it up. SteveEismanhadbecomeapoorlykeptsecret."Stevewasoneofabout two investors whocompletely understood whatwas going on," said oneprominent Wall Streetanalyst. Five hundred peoplecalledintohearwhatEismanhad to say, and another five

hundred logged in afterwardto listen to the recording.Heexplained the strangealchemy of the mezzanineCDO--and said that heexpected losses up to $300billion from this sliverof themarketalone.Toevaluatethesituation, he told hisaudience, "Just throw yourmodel in the garbage can.Themodelsareallbackward-looking. The models don'thave any idea of what this

world has become.... For thefirsttimeintheirlivespeoplein the asset-backedsecuritization world areactually having to think."Heexplained that the ratingagencies were morallybankruptandlivinginfearofbecoming actually bankrupt."The ratings agencies arescared to death," he said."They're scared to deathabout doing nothing becausethey'll look like fools if they

donothing."Heexpectedthatfully half of all U.S. homemortgage loans--manytrillions of dollars' worth--would suffer losses. "We arein the midst of one of thegreatest social experimentsthis country has ever seen,"said Eisman. "It's just notgoing to be a funexperiment.... You think thisis ugly. You haven't seenanything yet." When he wasdone, the next speaker, an

Englishman who ran aseparate fund at FrontPoint,wasslowtorespond."Sorry,"theEnglishmansaidwryly,"Ijust needed to calm downfrom hearing Steve say theworld is ending." Andeveryonelaughed.

Later that very day,investors in the collapsedBear Stearns hedge fundswere informed that their$1.6billion in triple-A-ratedsubprime-backed CDOs had

not merely lost some value,they were worthless. Eismanwas now convinced a lot ofthe biggest firms on WallStreet did not understandtheir own risks, and were inperil. At the bottom of hisconvictionlayhismemoryofhis dinnerwithWingChau--when he grasped the centralrole of the mezzanine CDOand made a massive betagainst those very sameCDOs. This of course raised

thequestion:Whatexactly isinsideaCDO?"Ididn'tknowwhat the fuck was in thethings," said Eisman. "Youcouldn't do the analysis.Youcouldn't say, 'Givemeall theones with all California inthem.'Nooneknewwhatwasin them." They learnedenough to know, as Dannyputit,that"itwasjustallthepieces of shit we'd alreadyshortedwrapped up together,intoaportfolio."Beyondthat

they were flying blind."Steve'snature is toput itonand figure it out later," saidVinny.

Then came news.Eisman had long subscribedto a newsletter famous inWall Street circles andobscureoutsidethem,Grant'sInterest Rate Observer. Itseditor, Jim Grant, had beenprophesyingdoomever sincethegreatdebtcyclebegan,inthe mid-1980s. In late 2006

Grant decided to investigatethese strange Wall Streetcreations known as CDOs.Or, rather, he had asked hisyoungassistant,DanGertner,a chemical engineer with anMBA, to see if he couldunderstand them. Gertnerwent off with the documentsexplainingCDOs topotentialinvestors and sweated andgroaned and heaved andsuffered. "Then he cameback," saysGrant, "and said,

'I can't figure this thing out.'And I said, 'I think we haveourstory.'"

Gertnerduganddugandfinally concluded that nomatter howmuch digging hedid he'd never be able to gettothebottomofwhatexactlywas insideaCDO--which, toJim Grant, meant that noinvestorpossiblycouldeither.In turn this suggested whatGrant already knew, that fartoomanypeoplewere taking

far too many financialstatements on faith. In early2007Grantwrote a series ofpieces suggesting that therating agencies hadabandoned their posts--thatthey were almost surelyrating these CDOs withoutthemselves knowing exactlywhat was inside them. "Thereaders ofGrant's have seenforthemselveshowastackofnon-investment grademortgage slices can be

rearranged to form acollateral debt obligation,"one piece began. "And theyhave stared in amazement atthe improvements that thismysteriousprocesscaneffectin the credit ratings of theslices..." For his troubles,Grant, alongwith his trustedassistant,wascalledintoS&Pfor a dressing-down. "Wewere actually summoned tothe rating agency and told,'You guys just don't get it,'"

says Gertner. "Jim used theterm'alchemy'andtheydidn'tlikethatterm."

JustafewmilesnorthofGrant's Wall Street offices,an equity hedge fundmanager with a darkeningview of the world waswondering why he hadn'theard others voice suspicionaboutthebondmarketanditsabstruse creations. In JimGrant's essay, Steve Eismanfound independent

confirmation of his theory ofthe financial world. "When Iread it," said Eisman, "Ithought,Oh my God, this islike owning a gold mine.When I read that, I was theonly guy in the equityworldwhoalmosthadanorgasm."

CHAPTEREIGHT

TheLongQuiet

The day Steve Eismanbecame the first man everto take almost sexualpleasure in an essay inGrant's Interest RateObserver, Dr.Michael BurryreceivedfromhisCFOacopy

ofthesamestory,alongwitha jokey note: "Mike--youhaven't taken a side jobwriting for Grant's, haveyou?"

"I haven't," Burryreplied, seeing no obviousgood news in the discoverythat there was someone outtherewho thought as he did."I'm a bit surprised wehaven't been contacted byGrant's..."Hewasstill in thefinancialworldbutapartfrom

it,asifontheothersideofapane of glass he couldn'tbring himself to tap upon.He'dbeenthefirstinvestortodiagnose the disorder in theAmerican financial system inearly 2003: the extension ofcredit by instrument.Complicated financial stuffwasbeingdreamedupforthesole purpose of lendingmoney to people who couldnever repay it. "I really dobelievethefinalactinplayis

a crisis in our financialinstitutions, which are doingsuchdumb,dumbthings,"hewrote, in April 2003, to afriend who had wonderedwhyScionCapital'squarterlyletters to its investors hadturned sodark. "I have a jobto do. Make money for myclients.Period.Butboyitgetsmorbid when you startmakinginvestmentsthatworkout extra great if a tragedyoccurs." Then, in the spring

of 2005, he had identified,before any other investor,precisely which tragedy wasmostlikelytooccur,whenhemade a large, explicit betagainst subprime mortgagebonds.

Now, in February 2007,subprime loans weredefaultinginrecordnumbers,financial institutions werelesssteadyeveryday,andnoonebuthimseemed to recallwhat he'd said and done. He

had told his investors thattheymightneedtobepatient--thatthebetmightnotpayoffuntil themortgages issued in2005reachedtheendoftheirteaser rate period. They hadnotbeenpatient.Manyofhisinvestorsmistrustedhim,andhe in turn felt betrayed bythem. At the beginning hehad imagined the end, butnoneof theparts inbetween."IguessIwantedtojustgotosleep andwake up in 2007,"

he said. To keep his betsagainst subprime mortgagebonds, he'd been forced tofire half his small staff, anddump billions of dollars'worth of bets he had madeagainst the companies mostclosely associated with thesubprime mortgage market.He was now more isolatedthanhe'deverbeen.Theonlything that had changed washisexplanationforit.

Notlongbefore,hiswife

haddraggedhimtotheofficeofaStanfordpsychologist.Apreschool teacher had notedcertainworryingbehaviors intheir four-year-old son,Nicholas, and suggested heneeded testing. Nicholasdidn't sleep when the otherkids slept. He drifted offwhen the teacher talked atany length.Hismindseemed"very active."Michael Burryhad to resist his urge to takeoffense. He was, after all, a

doctor, andhe suspected thatthe teacherwas trying to tellthem that he had failed todiagnose attention deficitdisorder in his own son. "Ihad worked in an ADHDclinic during my residency,and had strong feelings thatthis was overdiagnosed," hesaid. "That it was a 'savior'diagnosis for too many kidswhose parents wanted amedical reason to drug theirchildren, or to explain their

kids' bad behavior." Hesuspected his son was a bitdifferent from theother kids,but different in a good way."Heaskedatonofquestions,"saidBurry."Ihadencouragedthat, because I always had atonofquestionsasakid,andI was frustrated when I wastold to be quiet." Now hewatched his son morecarefully, and noted that thelittle boy, while smart, hadproblems with other people.

"When he did try to interact,even though he didn't doanything mean to the otherkids,he'dsomehowtickthemoff."Hecamehomeand toldhis wife, "Don't worry aboutit!He'sfine!"

His wife stared at himand asked, "How would youknow?"

To which Dr. MichaelBurry replied, "Because he'sjust like me! That's how Iwas."

Theirson'sapplicationtoseveral kindergartens metwith quick rejections,unaccompanied byexplanations. Pressed, one oftheschoolstoldBurrythathisson suffered from inadequategross and fine motor skills."He had apparently scoredvery low on tests involvingart and scissor use," saidBurry."Bigdeal, I thought. Istilldrawlikeafour-year-old,andIhateart."Tosilencehis

wife, however, he agreed tohave their son tested. "Itwouldjustprovehe'sasmartkid, an 'absentmindedgenius.'"

Instead, the testsadministered by a childpsychologistprovedthattheirchild had Asperger'ssyndrome.Aclassiccase,shesaid, and recommended thatthe child be pulled from themainstream and sent to aspecial school. And Dr.

Michael Burry wasdumbstruck: He recalledAsperger's from med school,but vaguely. His wife nowhanded him the stack ofbooks she had accumulatedon autism and relateddisorders. On top were TheCompleteGuidetoAsperger'sSyndrome, by a clinicalpsychologist named TonyAttwood, and Attwood'sAsperger's Syndrome: AGuide for Parents and

Professionals."Marked impairment in

theuseofmultiplenon-verbalbehaviors such as eye-to-eyegaze..."

Check."Failuretodeveloppeer

relationships..."Check."A lack of spontaneous

seeking to share enjoyment,interests, or achievementswithotherpeople..."

Check.

"Difficulty reading thesocial/emotional messages insomeone'seyes..."

Check."A faulty emotion

regulation or controlmechanism for expressinganger..."

Check."...One of the reasons

why computers are soappealingisnotonlythatyoudo not have to talk orsocialize with them, but that

they are logical, consistentandnotpronetomoods.Thusthey are an ideal interest forthe person with Asperger'sSyndrome..."

Check."Many people have a

hobby.... The differencebetween the normal rangeand theeccentricityobservedin Asperger's Syndrome isthat these pursuits are oftensolitary, idiosyncratic anddominate the person's time

andconversation."Check...Check...Check.After a few pages,

Michael Burry realized thathe was no longer readingabout his son but abouthimself. "How many peoplecan pick up a book and findan instruction manual fortheir life?" he said. "I hatedreading a book telling mewho I was. I thought I wasdifferent, but thiswas sayingI was the same as other

people.MywifeandIwereatypicalAsperger'scouple,andwe had an Asperger's son."His glass eye no longerexplained anything; thewonder is that it ever had.Howdid aglass eye explain,in a competitive swimmer, apathological fear of deepwater--the terror of notknowingwhatlurkedbeneathhim? How did it explain achildhood passion forwashing money? He'd take

dollar bills and wash them,dry them off with a towel,pressthembetweenthepagesof books, and then stackbooksontopofthosebooks--all so he might have moneythat looked "new." "All of asudden I've become thiscaricature," said Burry. "I'vealwaysbeenable to studyupon something and acesomething really fast. Ithought it was all somethingspecial about me. Now it's

like, 'Oh, a lot of Asperger'speople can do that.' Now Iwasexplainedbyadisorder."

Heresistedthenews.Hehad a gift for finding andanalyzing information on thesubjects that interested himintensely. He always hadbeen intensely interested inhimself. Now, at the age ofthirty-five, he'd been handedthisnewpieceofinformationabout himself--and his firstreaction to itwas towish he

hadn'tbeengivenit."Myfirstthought was that a lot ofpeople must have this anddon'tknowit,"hesaid."AndI wondered, Is this really agoodthingformetoknowatthispoint?Whyisitgoodforme to know this aboutmyself?"

He went and found hisownpsychologisttohelphimsort out the effect of hissyndrome on his wife andchildren. His work life,

however, remaineduninformed by the newinformation. He didn't alterthe way he made investmentdecisions,forinstance,ortheway he communicated withhisinvestors.Hedidn'tlethisinvestors know of hisdisorder."Ididn'tfeelitwasamaterial fact that had to bedisclosed,"hesaid."Itwasn'ta change. I wasn't diagnosedwith something new. It'ssomething I'd always had."

On the other hand, itexplained an awful lot aboutwhat he did for a living, andhow he did it: his obsessiveacquisition of hard facts, hisinsistenceonlogic,hisabilityto plow quickly throughreams of tedious financialstatements. People withAsperger's couldn't controlwhat theywere interested in.Itwasastrokeofluckthathisspecial interest was financialmarkets and not, say,

collecting lawn mowercatalogues.When he thoughtofitthatway,herealizedthatcomplex modern financialmarkets were as good asdesigned to reward a personwithAsperger'swho took aninterest in them. "Onlysomeone who has Asperger'swould read a subprimemortgage bond prospectus,"hesaid.

By early 2007 MichaelBurry found himself in a

characteristically bizarresituation. He'd boughtinsurance on a lot of trulycrappy subprime mortgagebonds, created from loansmade in 2005, but theywerehiscreditdefaultswaps.Theyweren't traded often byothers; a lot of people tookthe view that the loansmadein 2005 were somehowsounder than the loans madein 2006; in bond marketparlance, they were "off the

run." That was their biggestclaim:The pools of loans hehad bet against were"relativelyclean."Tocounterthe assertion, hecommissioned a privatestudy, and found that thepoolsofloanshehadshortedwerenearlytwiceaslikelytobe in bankruptcy and a thirdmore likely to have beenforeclosed upon than thegeneralrunof2005subprimedeals. The loans made in

2006wereindeedworsethanthose made in 2005, but theloansmadein2005remainedatrocious, and closer to thedateswhentheirinterestrateswould reset. He had pickedexactlytherighthomeownerstobetagainst.

All through 2006, andthefirstfewmonthsof2007,Burry sent his list of creditdefault swaps to Goldmanand Bank of America andMorganStanleywiththeidea

they would show it topossible buyers, so he mightget some idea of the marketprice.That, after all,was thedealers' stated function:middlemen. Market-makers.That is not the function theyserved, however. "It seemedthe dealers were just sittingon my lists and biddingextremely opportunisticallythemselves," said Burry. Thedata from the mortgageservicers was worse every

month--the loans underlyingthe bonds were going bad atfaster rates--andyet thepriceof insuring those loans, theysaid,was falling. "Logic hadfailed me," he said. "Icouldn'texplaintheoutcomesI was seeing." At the end ofeach day there wasmeant tobe a tiny reckoning: If thesubprime market had fallen,they would wire money tohim;ifithadstrengthened,hewould wire money to them.

The fate of Scion Capitalturnedon thesebets, but thatfatewasnot,intheshortrun,determined by an open andfree market. It wasdetermined by GoldmanSachs and Bank of Americaand Morgan Stanley, whodecided each day whetherMike Burry's credit defaultswaps had made or lostmoney.

It was true, however,that his portfolio of credit

default swaps wasuncommon. They wereselected by an uncommoncharacter,withanuncommonviewofthefinancialmarkets,operating alone and apart.This fact alone enabledWallStreet firms todictate tohimthemarketprice.Withnooneelse buying and sellingexactly what Michael Burrywasbuyingandselling, therewas no hard evidence whatthese things were worth--so

they were worth whateverGoldman Sachs and MorganStanleysaidtheywereworth.Burry detected a pattern inhow they managed theirmarket:Allgoodnewsaboutthe housing market, or theeconomy, was treated as anexcuse to demand collateralfrom Scion Capital; all badnewswas pooh-poohed as insome way irrelevant to thespecific bets he had made.The firms always claimed

that they had no positionthemselves--that they wererunning matched books--buttheir behavior told himotherwise. "Whatever thebanks'netpositionwaswoulddeterminethemark,"hesaid."I don't think they werelookingtothemarketfortheirmarks. I think they werelooking to their needs." Thatis, the reason they refused toacknowledgethathisbetwaspayingoffwasthattheywere

ontheothersideofit."Whenyoutalktodealers,"hewroteinMarch2006tohisin-houselawyer, Steve Druskin, "youare getting the view fromtheir book.Whatever they'vegotontheirbookwillbetheirview.Goldmanhappenstobewarehousingalotofthisrisk.They'll talk as if nothing hasbeen seen in the mortgagepools. No need to incitepanic...and this has worked.As long as they can entice

more [money] into themarket, the problem isresolved. That's been thehistoryofthelast3-4years."

By April 2006 he'dfinished buying insurance onsubprimemortgagebonds. Ina portfolio of $555 million,he had laid $1.9 billion ofthese peculiar bets--bets thatshouldbepayingoffbutwerenot.InMayheadoptedanewtactic: asking Wall Streettraders if they would be

willingtosellhimevenmorecredit default swaps at theprice they claimed theywereworth, knowing that theywere not. "Never once hasanycounterpartybeenwillingto sell me my list at mymarks,"hewroteinane-mail."Eighty to ninety per cent ofthe names onmy list are noteven available at any price."A properly functioningmarketwould assimilate newinformationintothepricesof

securities; this multi-trillion-dollar market in subprimemortgage risk never budged."One of the oldest adages ininvesting is that if you'rereadingabout it in thepaper,it's too late," he said. "Notthistime."SteveDruskinwasbecoming more involved inthe market--and couldn'tbelievehowcontrolleditwas."What's amazing is that theymakeamarketinthisfantasystuff," said Druskin. "It's not

arealasset."ItwasasifWallStreet had decided to alloweveryone to gamble on thepunctuality of commercialairlines. The likelihood ofUnitedFlight001arrivingontime obviously shifted--withthe weather, mechanicalissues, pilot quality, and soon. But shifting probabilitiescould be ignored, until theplanedidordidnotarrive.Itdidn't matter when bigmortgage lenders like Ownit

and ResCap failed, or somepool of subprime loansexperienced higher thanexpected losses. All thatmattered was what GoldmanSachs and Morgan Stanleydecidedshouldmatter.

The world's singlebiggest capital market wasn'ta market; it was somethingelse--butwhat?"Iamactuallyprotesting to mycounterpartiesthattheremustbe fraud in the marketplace

forcreditdefaultswapstobeatall-timelows,"Burrywroteinane-mailtoaninvestorhetrusted. "What ifCDSs are afraud? I am asking myselfthatquestionallthetime,andneverhaveIfeltlikeIshouldbe thinking that way morethannow.Nowayweshouldbedown5% thisyear just inmortgage CDSs." To hisGoldman Sachs saleswoman,hewrote, "I think I am shorthousingbutamInot,because

CDSsarecriminal?"When,afew months later, GoldmanSachs announced it wassetting aside $542,000 peremployeefor the2006bonuspool, he wrote again: "As aformer gas station attendant,parkinglotattendant,medicalresidentandcurrentGoldmanSachs screwee, I amoffended."

In the middle of 2006,he began to hear of othermoneymanagerswhowanted

tomake thesamebethedid.A few actually called andasked for his help. "I had allthese people telling me Ineeded to get out of thistrade," he said. "And I waslooking at these other peopleand thinking how lucky theyweretobeabletogetintothistrade."Ifthemarkethadbeenat all rational it would haveblownuplongbefore."Someof the biggest funds on theplanet have picked my brain

and copied my strategy," hewrote in an e-mail. "So itwon't just be Scion thatmakesmoneyifthishappens.Still,itwon'tbeeveryone."

Hewas now undeniablymiserable. "It feels like myinsides are digestingthemselves," he wrote to hiswife in mid-September. Thesource of his unhappinesswas, as usual, other people.The other people whobothered him the most were

his own investors. When heopened his fund, in 2000, hereleased only his quarterlyreturns,andtoldhisinvestorsthat he planned to tell themnexttonothingaboutwhathewas up to. Now they weredemandingmonthlyandevenfortnightly reports, andpesteredhimconstantlyaboutthewisdomofhispessimism."I almost think the better theidea, and the moreiconoclastic the investor, the

more likely you will getscreamedatbyinvestors,"hesaid. He didn't worry abouthow screwed-up the marketfor some security becamebecause he knew thateventually it would bedisciplined by logic:Businesses either thrived orfailed.Loanseitherwerepaidoff or were defaulted upon.But these people whosemoneyheranwereincapableof keeping their emotional

distance from the market.Theywerenowrespondingtothe same surface stimuli asthe entire screwed-upsubprime mortgage market,and trying to force him toconformtoitsmadness."Idomybesttohavepatience,"hewrote to one investor. "But Ican only be as patient asmyinvestors."Toanothergripinginvestor he wrote, "Thedefinition of an intelligentmanager in the hedge fund

worldissomeonewhohastheright idea, and sees hisinvestors abandon him justbefore the idea pays off."When he was making themhuge sumsofmoney, he hadbarely heard from them; themomenthestartedactuallytolose a little, they pepperedhim with their doubts andsuspicions:

So I take it the monster

dragging us out to sea isthe CDS. You havecreated the plight of theoldmanandthesea.

When do you see the endof the bleeding? (Augustdownagain5%.)Areyourunning a riskier strategynow?

You make me physically

ill....Howdareyou?

Can you explain to mehow we keep losingmoneyonthisposition?Ifour potential losses arefixeditwouldseemtomebased on how much wehave lost that they shouldbe a tiny part of theportfolionow.

This last question keptpopping up: How could astock picker be losing somuch on this one quixoticbondmarketbet?Andhekepttrying to answer it: He wascommitted to paying annualpremiumsamountingtoabout8 percent of the portfolio,everyyear,foras longas theunderlying loans existed--likely around five years butpossibly as long as thirty.Eightpercenttimesfiveyears

came to 40 percent. If thevalue of the credit defaultswaps fell by half, Scionregistered a mark-to-marketlossof20percent.

More alarmingly, hiscredit default swap contractscontained a provision thatallowed the big Wall StreetfirmstocanceltheirbetswithScion if Scion's assets fellbelow a certain level. Therewas suddenly a real risk thatthat might happen. Most of

his investors had agreed to atwo-year "lockup" and couldnot pull their money out atwill.But of the $555millionhe had under management,$302 million was eligible tobe withdrawn either at theendof2006or in themiddleof 2007, and investors werelining up to ask for theirmoney back. In October2006,withU.S. house pricesexperiencing their greatestdecline in thirty-five years,

and just weeks before theABX index of triple-Bmortgage bonds experienceditsfirst"creditevent"(thatis,loss), Michael Burry facedthelikelihoodofarunonhisfund--a fund that was nowdevotedtobettingagainstthesubprime mortgage market."We were clinicallydepressed," said one of theseveral analysts Burryemployed but never figuredout what to do with, as he

insisted on doing all theanalysishimself."You'dgotowork and you'd say, 'I don'twant to be here.' The tradewas moving against you andinvestorswantedout."

Onenight,asBurrywascomplainingtohiswifeaboutthecompleteabsenceoflong-term perspective in thefinancial markets, a thoughtstruck him: His agreementwith his investors gave himtheright tokeep theirmoney

if he had invested it "insecurities for which there isno public market or that arenot freely tradable." It wasleft to themanager to decideif there was a public marketfor a security. If MichaelBurry thought there wasn't--for instance, if he thought amarket was temporarily notfunctioning or somehowfraudulent--he was permittedto "side-pocket" aninvestment. That is, he could

tell his investors that theycouldn't have their moneyback until the bet he'd madewith it had run its naturalcourse.

And so he did whatseemed to him the onlyproper and logical thing todo: He side-pocketed hiscreditdefaultswaps.Thelonglist of investors eager to gettheirmoneybackfromhim--alistthatincludedhisfoundingbacker, Gotham Capital--

received the news from himin a terse letter: He waslockingupbetween50and55percentoftheirmoney.Burryfollowed this letter with hisquarterly report, which hehoped might make everyonefeel a bit better. But he hadno talent for caring whatothers thoughtofhim:Itwasalmost as if he didn't knowhow to do it.What hewrotesounded less like an apologythananassault."Neverbefore

have I been so optimisticabout the portfolio for areason thathasnothing todowith stocks," it began, andthen it went on to explainhow he had established aposition in the markets thatshould be the envy of anymoneymanager.Howhehadplaced a bet not on "housingArmageddon" (even thoughhe suspected that wascoming)buton"theworst5%orsoofloansmadein2005."

Howhisinvestorsshouldfeellucky.Hewrote as if hewassitting on top of the world,whenhewasexpectedtofeelas if theworldwassittingontopofhim.OneofhisbiggestNewYorkinvestorsshothiman e-mail: "I'd be careful inthe future using derogatoryphrases such as 'we're shortthe mortgage portfolioeveryone would want if theyknew what they were doing'and'soonerorlateroneofthe

bigboys should really readaprospectus.'" One of hisoriginal two e-mail friends--bothhadstuckbyhim--wrote,"Nobody else except theNorth Korean dictator KimJong-Il would write a letterlike thatwhen theyaredown17%."

Immediately, hispartners at Gotham Capitalthreatened to sue him. Theysoon were joined by others,who began to organize

themselves into a legalfighting force. Whatdistinguished Gotham wasthat their leaders flew outfrom New York to San Joseand tried to bully Burry intogiving them back the $100million they had investedwith him. In January 2006Gotham's creator, JoelGreenblatt, had gone ontelevision to promote a bookand,whenasked tonamehisfavorite "value investors,"

had extolled the virtues of arare talent named MikeBurry. Ten months later hetraveled three thousandmileswith his partner, John Petry,to tell Mike Burry he was aliar and to pressure him intoabandoning the bet Burryviewed as the singleshrewdest of his career. "Ifthere was one moment Imight have caved, that wasit,"saidBurry."Joelwaslikea godfather to me--a partner

in my firm, the guy that'discovered' me and backedmebeforeanyoneoutsidemyfamily did. I respected himand lookedup tohim."Now,as Greenblatt told him nojudge in any court of lawwould side with his decisionto side-pocket what wasclearly a tradable security,whateverfeelingsMikeBurryhad for him vanished.WhenGreenblatt asked to see a listof the subprime mortgage

bondsBurry had bet against,Burry refused. FromGreenblatt'spointofview,hehad given this guy $100million and the guy was notonly refusing to give it backbuttoeventalktohim.

And Greenblatt had apoint. It was wildlyunconventionaltoside-pocketaninvestmentforwhichtherewas obviously a market.There was clearly some lowpriceatwhichMichaelBurry

might bail out of his betagainst the subprimemortgage bond market. Tosome meaningful number ofhis investors, it looked as ifBurrysimplydidnotwant toaccept the judgment of themarketplace:He'dmadeabadbet andwas failing to accepthis loss. But to Burry, thejudgment of the marketplacewas fraudulent, and JoelGreenblatt didn't know whathe was talking about. "It

becameclear tome that theystill didn't understand the[credit default swap]positions,"hesaid.

He was acutely awarethat a great many of thepeople who had given himtheir money now despisedhim. The awareness causedhim to (a) withdraw into hisofficeandshout"Fuck"atthetop of his lungs even morethanusual;(b)developanewcontempt for his own

investors;and(c)keeptryingtoexplainhisactionstothem,even though they quiteclearly were no longerlistening."Iwouldpreferthatyoutalklessandlistenmore,"his lawyer, Steve Druskin,wrote tohim, in lateOctober2006. "They are strategizinglitigation."

"It was kind ofinteresting," said KipOberting, who had arrangedfor White Mountains to

becomeBurry'sotheroriginalinvestor, before leaving forother ventures. "Because hehad explained exactly whathe was doing. And he hadmade people a bunch ofmoney. You would havethought people would stickwith him." They weren'tmerely not stickingwith himbut fleeing as fast as hewould allow them. Theyhated him. "I just don'tunderstand why people just

don't see that I don't meanany harm," he said. Late onthe night of December 29,MichaelBurrysataloneinhisoffice and typed a quick e-mail to his wife: "Soincredibly depressing; I'mtryingtocomehome,butI'mjust so mad and depressedrightnow."

AndsoinJanuary2007,justbeforeSteveEismanandCharlie Ledley headedgleefully to Las Vegas,

Michael Burry sat down toexplain to his investors how,in a yearwhen the S&P hadrisen by more than 10percent, he had lost 18.4percent. A person who hadhadmoneywithhimfromthebeginning would haveenjoyed gains of 186 percentover those six years,comparedto10.13percentforthe S&P 500 Index, butBurry's long-term successwas no longer relevant. He

was now being judgedmonthly. "The year justcompletedwasoneinwhichIunderperformednearlyallmypeers and friends by,variably, thirty or fortypercentage points," hewrote."Amoneymanager does notgofrombeinganearnobodyto being nearly universallyapplauded to being nearlyuniversally vilified withoutsome effect." The effect, hewent on to demonstrate, was

to make him ever morecertain that the entirefinancial world was wrongand he was right. "I havealways believed that a singletalented analyst, workingvery hard, can cover anamazing amount ofinvestment landscape, andthis belief remainsunchallengedinmymind."

Then he returned, as healways did, to the not sosmall matter of his credit

default swaps: All theimportant facts pointed totheireventualsuccess.Injustthelasttwomonths,threebigmortgage originators hadfailed...The Center forResponsible Lending wasnowpredicting that, in 2007,2.2 million borrowers wouldlose their homes, and one infive subprime mortgagesissued in 2005 and 2006wouldfail...

Michael Burry was as

good as teedup to becomeaWall Street villain. Hisquarterly letters to hisinvestors, which Burryconsideredprivate,werenowroutinely leaked to the press.A nasty piece appeared in atrade journal, suggesting thathehadbehavedunethicallyinside-pocketing his bet, andBurry felt certain ithadbeenplanted by one of his owninvestors. "Mike wasn'tparanoid," said a New York

investor who observed thebehavior of other New Yorkinvestors in Scion Capital."Peoplereallywereouttogethim.Whenhebecomesabadguy he becomes this greedysociopath who is going tosteal all the money. And hecanalwaysgobacktobeinganeurologist. It was the firstthing everyone jumped towithMike:Hewasadoctor."Burry began to hear strangerumors about himself. He'd

left his wife and gone intohiding.He had fled to SouthAmerica. "It's an interestinglifeI'mleadinglately,"Burrywrote to one of the e-mailfriends.

With all that has gone onrecently, I've had theopportunity to talk withmany of our investors,whichisthefirsttimeI'vedone so in the history of

the funds. I've beenshocked by what I'veheard. It appears thatinvestors only havepassinglypaidattention tomyletters,andmanyhavebeen clinging to variousrumors and hearsay inplace of analysis ororiginal thought. I'vevariably launched aprivate equity fund, triedto buy aVenezuelan goldcompany, launched a

separatehedgefundcalledMilton's Opus, gotdivorced, got blown up,never disclosed thederivatives trade,borrowed$8billion,spentmuchofthelasttwoyearsinAsia, accused everyonebut me onWall Street ofbeing idiots, siphoned offthe capital of the fundsintomy personal account,and more or less turnedScion into the next

Amaranth.* None of thisismadeup.

He'd always beendifferent from what onemight expect a hedge fundmanager to be. He wore thesame shorts and t-shirts towork for days on end. Herefused to wear shoes withlaces. He refused to wearwatches or even hisweddingring.Tocalmhimselfatwork

he often blared heavy metalmusic."Ithinkthesepersonalfoiblesofmineweretoleratedamongmanyaslongasthingswere going well," he said."But when things weren'tgoingwell,theybecamesignsofincompetenceorinstabilityon my part--even amongemployees and businesspartners."

After the conference inLas Vegas the market haddropped,thenrecoveredright

throughuntiltheendofMay.To Charlie Ledley atCornwall Capital, the U.S.financial system appearedsystematically corruptedbyacabal of Wall Street banks,rating agencies, andgovernment regulators. ToSteve Eisman at FrontPointPartners, the market seemedmainly stupid or delusional:A financial culture that hadexperienced so many tinypanics followed by robust

booms saw any sell-off asmerely another buyingopportunity. To MichaelBurry,thesubprimemortgagemarket looked increasinglylike a fraud perpetrated by ahandful of subprime bondtrading desks. "Given themassive cheating on the partofourcounterparties,theideaof taking the CDS[s] out ofthe side pocket is no longerworth considering," hewroteattheendofMarch2007.

The first half of 2007was a very strange period infinancialhistory.Thefactsonthe ground in the housingmarket diverged further andfurtherfromthepricesonthebonds and the insurance onthe bonds. Faced withunpleasantfacts,thebigWallStreet firms appeared to bechoosing simply to ignorethem. There were subtlechanges in the market,however, and they turned up

in Burry's e-mail in-box. OnMarch 19 his salesman atCitigroup sent him, for thefirst time,seriousanalysisona pool of mortgages. ThemortgageswerenotsubprimebutAlt-A.*Still,theguywastrying to explain how muchof the pool consisted ofinterest-only loans, whatpercentage was owner-occupied,andsoon--thewaya person might do whoactually was thinking about

the creditworthiness of theborrowers. "When I wasanalyzing these back in2005," Burry wrote in an e-mail, sounding like Stanleywatching tourists marchthrough the jungle on a pathhehadhimselfhacked,"therewas nothing even remotelyclose to this sort of analysiscoming out of brokeragehouses. I glommed onto'silent seconds'* as anindicatorofastretchedbuyer

and made it a high-valuecriterion in my selectionprocess, but at the time noone trading derivatives hadany idea what I was talkingabout and no one thoughtthey mattered." In the longquiet between February andJune2007,theyhadbeguntomatter. The market was onedge. In the first quarter of2007 Scion Capital was upnearly18percent.

Then something

changed--though at first itwas hard to seewhat it was.On June 14, the pair ofsubprime mortgage bondhedge funds effectivelyowned by Bear Stearns wentbelly-up. In the ensuing twoweeks, the publicly tradedindex of triple-B-ratedsubprimemortgagebondsfellby nearly 20 percent. Justthen Goldman Sachsappeared to Burry to beexperiencing a nervous

breakdown. His biggestpositionswerewithGoldman,and Goldman was newlyunable, or unwilling, todetermine the value of thosepositions, and so could notsay how much collateralshould be shifted back andforth. On Friday, June 15,Burry's Goldman Sachssaleswoman, VeronicaGrinstein,vanished.Hecalledand e-mailed her, but shedidn't respond until late the

following Monday--to tellhimthatshewas"outfor theday."

"This is a recurrenttheme whenever the marketmoves our way," wroteBurry. "People get sick,peopleareoffforunspecifiedreasons."

On June 20, Grinsteinfinally returned to tell himthat Goldman Sachs hadexperienced "systemsfailure."

That was funny, Burryreplied, because MorganStanleyhadsaidmoreorlessthe same thing. And hissalesmanatBankofAmericaclaimed they'd had a "poweroutage."

"Iviewed these 'systemsproblems' as excuses forbuyingtimetosortoutamessbehind the scenes," he said.The Goldman saleswomanmade a weak effort to claimthat, even as the index of

subprime mortgage bondscollapsed, the market forinsuring them hadn't budged.But she did it from her cellphone, rather than the officeline, on which theconversations would havebeenrecorded.

Theywerecaving.Allofthem. At the end of everymonth, for nearly two years,Burry had watched WallStreet traders mark hispositionsagainsthim.Thatis,

attheendofeverymonthhisbets against subprime bondswere mysteriously lessvaluable. The end of everymonth also happened to bewhenWallStreettraderssenttheir profit and lossstatements to their managersand risk managers. On June29, Burry received a notefrom his Morgan Stanleysalesman, Art Ringness,saying that Morgan Stanleynowwantedtomakesurethat

"themarksarefair."Thenextday, Goldman followed suit.It was the first time in twoyears that Goldman Sachshad not moved the tradeagainst himat the endof themonth. "That was the firsttime they moved our marksaccurately," he notes,"becausetheyweregettinginonthetradethemselves."Themarket was finally acceptingthe diagnosis of its owndisorder.

The moment Goldmanwas getting in on his tradewas also the moment themarketflipped.Somekindofroutwasnowon:Everyoneatonce seemed eager to talk tohim. Morgan Stanley, whichhad been, by far, the mostreluctant to acknowledgenegative news in subprime,now called to say it wouldlike to buy whatever he had"in any size." Burry heard arumor--soon confirmed--that

a fund run by Goldman,called Global Alpha, hadtakenhugelossesinsubprimeand that Goldman itself hadrapidly turned from bettingon the subprime mortgagemarkettobettingagainstit.

It was precisely themoment he had told hisinvestors,backinthesummerof 2005, that they onlyneeded to wait for. Crappymortgages worth three-quarters of a trillion dollars

were resetting from theirteaser rates to new, higherrates. A single pool ofmortgages, against whichBurry had laid a bet,illustrated the general point:OOMLT 2005-3. OOMLT2005-3 was shorthand for apool of subprime mortgageloans made by Option One--thecompanywhoseCEOhadgiven the speech in LasVegas thatSteveEismanhadwalked out of, after raising

hiszerointheair.MostoftheloanshadbeenmadebetweenAprilandJulyof2005.FromJanuary to June 2007, thenews from the pool--itsdelinquencies, itsbankruptcies, its houseforeclosures--had remainedfairly consistent. The losseswere much greater than theyshould have been, given theratings of the bonds theyunderpinned, but the lossesdid not change a great deal

from one month to the next.FromFebruary25toMay25(the remittance data alwayscame on the twenty-fifth ofthe month), the combineddelinquencies, foreclosures,and bankruptcies insideOOMLT 2005-3 rose from15.6 percent to 16.9 percent.On June 25 the total numberof loans in default spiked to18.68 percent. In July itspikedagain, to21.4percent.In August it leapt to 25.44

percent,andbytheendoftheyearitstoodat37.7percent--more thana thirdof thepoolofborrowershaddefaultedontheir loans. The losses weresufficienttowipeoutnotonlythebondsMichaelBurryhadbet against but also a lot ofthemorehighlyratedonesinthe same tower. That thepanicinsideWallStreetfirmshad begun before June 25suggested to Michael Burrymainly that the Wall Street

firmsmight beworkingwithinside information about theremittance data. "The dealersoften owned [mortgage]servicers," he wrote, "andmight have been able to getan inside track on thedeteriorationinthenumbers."

Inthemonthsleadingupto the collapse of OOMLT2005-3--and all of the otherpools of home loans he hadbought credit default swapson--Michael Burry noted

several remarks from bothBen Bernanke and theSecretary of the U.S.Treasury, Henry Paulson.Eachsaid,repeatedly, thathesaw no possibility of"contagion" in the financialmarkets from the losses insubprimemortgages."WhenIfirst started shorting thesemortgages in 2005," Burrywrote in an e-mail, "I knewfullwellthatitwasnotlikelytopayoutwithin twoyears--

andforaverysimplereason.The vast majority ofmortgages originated the lastfew years had a ratherominously attractive featurecalled the 'teaser rate period.'Those 2005 mortgages areonlynowreachingtheendoftheir teaser rate periods, andit will be 2008 before the2006 mortgages get there.What sane person on Earthwould confidently concludein early 2007, smack dab in

themidstofthemotherofallteaser rate scams, that thesubprime fallout will notresult in contagion? The billliterally has not even comedue."

Across Wall Street,subprime mortgage bondtraderswere longandwrong,and scrambling to sell theirpositions--ortobuyinsuranceon them. Michael Burry'scredit default swaps weresuddenly fashionable. What

still shocked him, however,wasthat themarkethadbeensoslowtoassimilatematerialinformation. "You could seethat all these deals weresucking wind leading up tothe reset date," he said, "andthe reset just goosed theminto another dimension offail. I was in a state ofperpetual disbelief. I wouldhave thought that someonewould have recognized whatwas coming before June

2007. If it really took thatJune remit data to cause asudden realization, well, itmakes me wonder what a'Wall Street analyst' reallydoesallday."

By the end of July hismarksweremovingrapidlyinhisfavor--andhewasreadingabout the genius of peoplelike John Paulson, who hadcometothetradeayearafterhehad.TheBloombergNewsservice ran an article about

thefewpeoplewhoappearedto have seen the catastrophecoming.Only oneworked asa bond trader inside a bigWall Street firm: a formerlyobscure asset-backed bondtrader at Deutsche Banknamed Greg Lippmann.FrontPoint and Cornwallwere both missing from thepiece, but the investor mostconspicuously absent fromthe Bloomberg News articlesat alone in his office, in

Cupertino, California.Michael Burry clipped thearticleande-maileditaroundthe office with a note:"Lippmann is the guy thatessentially took my idea andranwithit.Tohiscredit."Hisown investors,whosemoneyhe was doubling and more,said little. There came noapologies, and no gratitude."Nobodycamebackandsaid,'Yeah, you were right,'" hesaid. "It was very quiet. It

was extremely quiet. Thesilence infuriated me." Hewas left with his favoredmode of communication, hisletter to investors. In earlyJuly 2007, as the marketscrashed, he posed anexcellent question. "Onerathersurprisingaspectofallthis," hewrote, "is that therehave been relatively fewreports of investors actuallybeing hurt by the subprimemortgage market

troubles....Why have we notyet heard of this era's Long-TermCapital?"

CHAPTERNINE

ADeathofInterest

Howie Hubler had grownup in New Jersey andplayed football at MontclairStateCollege.Everyonewhomet him noticed his thickfootball neck and his greathuge head and his

overbearing manner, whichwas interpreted as bothadmirablydirect and amask.He was loud and headstrongand bullying. "Whenconfronted with someintellectual point about histrades,Howiewouldn't go toan intellectual place," saidone of the people chargedwith supervising Hubler inhis early days at MorganStanley."Hewouldgoto'Getthe hell out of my face.'"

SomepeopleenjoyedHubler,some people didn't, but, byearly 2004, what othersthought didn't really matteranymore,becausefornearlyadecade Howie Hubler hadmade money trading bondsfor Morgan Stanley. He ranMorgan Stanley's asset-backed bond trading, whicheffectively put him in chargeofthefirm'sbetsonsubprimemortgages. Right up to thepoint the subprime mortgage

bond market boomed, andchanged what it meant to bean asset-backed bond trader,Hubler'scareerhadresembledGregLippmann's.Likeeveryother asset-backed bondtrader, he'd been playing alow-stakespokergameriggedin his favor, since nothinghad ever gone seriouslywrong in the market. Pricesfell, but they always cameback. You could either likeasset-backed bonds or you

could love asset-backedbonds,buttherewasnopointinhating them,because therewas no tool for bettingagainstthem.

Inside Morgan Stanley,the subprime mortgagelendingboomcreatedawho-put-chocolate-in-my peanut-buttermoment.The firmhadbeen a leader in extendinginto consumer loans thefinancial technology used topackage corporate loans.

Morgan Stanley's financialintellectuals--their quants--had been instrumental inteaching the rating agencies,Moody's and S&P, how toevaluate CDOs on pools ofasset-backed bonds. It wasonly natural that someoneinsideMorganStanleyshouldalso wonder if he mightinvent a credit default swapon an asset-backed bond.Howie Hubler's subprimemortgage desk was creating

bonds at a new and fasterrate.Todoso,Hubler'sgrouphad to "warehouse" loans,sometimes for months.Between the purchase of theloans and the sale of thebonds made up of thoseloans,hisgroupwasexposedto falling prices. "The wholereason we created the creditdefault swap was to protectthe mortgage desk run byHowie Hubler," said one ofits inventors. If Morgan

Stanley could find someoneto sell it insurance on itsloans,Hublercouldeliminatethe market risk ofwarehousinghomeloans.

As originally conceived,in 2003, the subprimemortgage credit default swapwas a one-off, nonstandardinsurance contract, struckbetweenMorganStanley andsomeotherbankorinsurancecompany,outside thegazeofthe wider market. No

ordinary human being hadever heard of these creditdefault swaps or, if MorganStanley had its way, everwould. By design they werearcane, opaque, illiquid, andthusconvenientlydifficultforanyone but Morgan Stanleytoprice."Bespoke,"inmarketparlance.Bylate2004Hublerhad grown cynical aboutcertain subprime mortgagebonds--and wanted to findclever ways to bet against

them. The same idea hadoccurred toMorganStanley'sintellectuals. In early 2003one of them had proposedthat they cease to beintellectuals and form a littlegroupthathe,theintellectual,wouldmanage--afactthatthetraderswould quickly forget."One of the quants actuallycreates all this stuff and they[Hublerandhis traders]stoleit from him," said aMorganStanley bond saleswoman

who observed theproceedingsupclose.OneofHubler's close associates, atrader named Mike Edman,becametheofficialcreatorofa new idea: a credit defaultswaponwhat amounted to atimeless pool of subprimeloans.

One risk of bettingagainst subprime loans wasthat, as long as house priceskept rising, borrowers wereabletorefinance,andpayoff

their old loans. The pool ofloansonwhichyou'veboughtinsurance shrinks, and theamount of your insuranceshrinks with it. Edman'scredit default swap solvedthis problem with some fineprint in its contracts, whichspecifiedthatMorganStanleywas buying insurance on thelast outstanding loan in thepool. Morgan Stanley wasmakingabetnotontheentirepoolofsubprimehomeloans

but on the few loans in thepool least likelytoberepaid.Thesizeof thebet,however,remained the same as if noloan in the pool was everrepaid. They had boughtfloodinsurancethat,ifadropof water so much as grazedany part of the house, paidthem the value of the entirehouse.

Thus designed, MorganStanley's new bespoke creditdefault swap was virtually

certain one day to pay off.For it to pay off in fullrequired losses in thepoolofonly 4 percent, which poolsof subprime mortgage loansexperienced in good times.The only problem, from thepoint of view of HowieHubler's traders, was findinga Morgan Stanley customerstupid enough to take theother side of the bet--that is,to get the customer to sellMorgan Stanley what

amounted to home insuranceon a house designated fordemolition. "They found oneclienttotakethelongsideofthe triple-B tranche of somepiece of shit," says one oftheir former colleagues,which is a complicated wayof saying that they found amark. A fool. A customer tobetakenadvantageof."That'show it starts--it drivesHowie'sfirsttrade."

By early 2005 Howie

Hublerhadfoundasufficientnumberoffoolsinthemarketto acquire 2 billion dollars'worthofthesebespokecreditdefaultswaps.Fromthepointofviewofthefools,thecreditdefault swaps Howie Hublerwaslookingtobuymusthavelooked like free money:Morgan Stanley would paythem 2.5 percent a year overthe risk-free rate to own, ineffect, investment-grade(triple-B-rated) asset-backed

bonds. The idea appealedespecially to Germaninstitutional investors, whoeither failed to read the fineprint or took the ratings atfacevalue.

By the spring of 2005,HowieHublerandhistradersbelieved, with reason, thatthese diabolical insurancepolicies they'd created weredeadcertain topayoff.Theywantedmore of them. Itwasnow, however, that Michael

Burrybegantoagitatetobuystandardized credit defaultswaps. Greg Lippmann atDeutsche Bank, a pair oftraders at Goldman Sachs,and a few others cametogether to hammer out thedetails of the contract. MikeEdman at Morgan Stanleywas dragged kicking andscreaming into theirdiscussion, for the momentcredit default swaps onsubprime mortgage bonds

were openly traded andstandardized,HowieHubler'sgroupwouldlosetheirabilitytopeddletheirmurkier,moreprivateversion.

It'snowApril2006,andthe subprime mortgage bondmachine is roaring. HowieHubler is Morgan Stanley'sstar bond trader, and hisgroup of eight traders isgenerating, by their estimate,around20percentofMorganStanley'sprofits.Theirprofits

haverisenfromroughly$400million in 2004 to $700millionin2005,ontheirwayto $1 billion in 2006.Hublerwillbepaid$25millionattheend of the year, but he's nolonger happy working as anordinary bond trader. Thebest and the brightest WallStreet traders are quittingtheir big firms to work athedge funds, where they canmakenottensbuthundredsofmillions. Collecting nickels

anddimes from the tradesofunthinking investors feltbeneath the dignity of a big-timeWallStreetbond trader."Howie thought thecustomerbusiness was stupid," saysone of several traders closestto Hubler. "It was what he'dalways done, but he'd lostinterest in it."* Hubler couldmake hundreds of millionsfacilitating the idiocy ofMorgan Stanley's customers.He could make billions by

using thefirm'scapital tobetagainstthem.

Morgan Stanleymanagement, for its part,alwaysfearedthatHublerandhis small team of tradersmight quit and create theirown hedge fund. To keepthem, they offered Hubler aspecial deal: his ownproprietary trading group,withitsowngrandiosename:GPCG, or the GlobalProprietary Credit Group. In

his new arrangement,Hublerwouldkeepforhimselfsomeof the profits this groupgenerated. "The idea," says amember of the group, "wasforustogofrommakingonebillion dollars a year to twobillion dollars a year, rightaway."Theidea,also,wasforHublerandhissmallgroupoftraderstokeepforthemselvesabigchunkoftheprofitsthisgroup generated. As soon asfeasible, Morgan Stanley

promised, Hubler would beallowed to spin it off into aseparate money managementbusiness, of which he'd own50 percent. Among otherthings, this business wouldmanage subprime-backedCDOs.Theywould compete,for instance, with WingChau'sHardingAdvisory.

The putative best andbrightestonMorganStanley'sbond trading floor lobbied tojoinhim."Itwassupposedto

be theeliteof theelite," saidone of the traders. "Howietook all the smartest peoplewith him." The chosen fewmoved to a separate floor inMorgan Stanley's midtownManhattanoffice,eightfloorsabovetheiroldtradingdesks.Theretheyerectednewwallsaround themselves, to createat least the illusion thatMorgan Stanley had noconflict of interest. Thetraders back down on the

second floor would buy andsell from customers and notpass any information abouttheir dealings to Hubler andhis group on the tenth floor.Tony Tufariello, the head ofMorganStanley'sglobalbondtrading and thus in theoryHowieHubler's boss,was soconflicted that he builthimself an office insideHowie's group, and bouncedback and forth between thesecond floor and the tenth.*

Howie Hubler didn't wantonly people. He wanted,badly, to take with him hisgroup's trading positions.Their details werecomplicated enough that oneof Morgan Stanley's ownsubprime mortgage bondtraderssaid,"Idon'tthinkanyof the people above Howiefully understood the trade hehad on." But their gist wassimple:Hublerandhisgrouphadmade a massive bet that

subprimeloanswouldgobad.The crown jewel of theirelaborate trading positionswas still the $2 billion inbespoke credit default swapsHublerfeltcertainwouldonedayverysoonyield$2billionin pure profits. The pools ofmortgage loans were justabouttoexperiencetheirfirstlosses, and the moment theydid,Hublerwouldbepaid infull.

There was, however, a

niggling problem: Therunning premiums on theseinsurance contracts ate intothe short-term returns ofHowie's group. "The groupwas supposed to make twobillion dollars a year," saidone member. "And we hadthis credit default swapposition that was costing ustwohundredmilliondollars."To offset the running cost,Hubler decided to sell somecreditdefaultswapsontriple-

A-rated subprimeCDOs, andtakeinsomepremiumsofhisown.* The problemwas thatthe premiums on thesupposedly far less riskytriple-A-rated CDOs wereonly one-tenth of thepremiums on the triple-Bs,and so to take in the sameamount of money as he waspaying out, he'd need to sellcredit default swaps inroughlytentimestheamounthealreadyowned.Heandhis

traders did this quickly, andapparently without a greatdeal of discussion, in half adozen or so massive trades,with Goldman Sachs andDeutsche Bank and a fewothers.

By the end of January2007, when the entiresubprime mortgage bondindustryheadedtoLasVegasto celebrate itself, HowieHublerhadsoldcreditdefaultswaps on roughly 16 billion

dollars' worth of triple-AtranchesofCDOs.Neverhadthere been such a clearexpression of the delusion ofthe elite Wall Street bondtrader and, by extension, theentire subprime mortgagebond market: BetweenSeptember 2006 and January2007, thehighest-statusbondtrader insideMorgan Stanleyhad, for all practicalpurposes, purchased $16billion in triple-A-rated

CDOs, composed entirely oftriple-B-rated subprimemortgage bonds, whichbecame valueless when theunderlyingpoolsofsubprimeloans experienced losses ofroughly 8 percent. In effect,Howie Hubler was bettingthat some of the triple-B-rated subprime bonds wouldgo bad, but not all of them.He was smart enough to becynical about his market butnot smart enough to realize

howcynicalheneededtobe.Inside Morgan Stanley,

there was apparently nevermuch question whether thecompany's elite risk takersshouldbeallowedtobuy$16billion in subprimemortgagebonds. Howie Hubler'sproprietarytradinggroupwasof course required to supplyinformationaboutitstradestoboth upper management andrisk management, but theinformation the traders

supplied disguised the natureof their risk. The $16 billionin subprime risk Hubler hadtaken on showed up inMorganStanley's riskreportsinsideabucketmarked"tripleA"--which is to say, theymightaswellhavebeenU.S.Treasurybonds.Theyshowedup again in a calculationknownasvalueatrisk(VaR).The tool most commonlyused by Wall Streetmanagement to figure out

what their traders had justdone,VaRmeasuredonlythedegreetowhichagivenstockorbondhadjumpedaroundinthe past, with the recentmovements receiving agreater emphasis thanmovements in the moredistant past. Having neverfluctuated much in value,triple-A-rated subprime-backed CDOs registered onMorgan Stanley's internalreportsasvirtuallyriskless.In

March 2007 Hubler's tradersprepared a presentation,delivered by Hubler's bossestoMorganStanley'sboardofdirectors,thatboastedoftheir"great structural position" inthe subprime mortgagemarket. No one asked theobvious question: Whathappenstothegreatstructuralpositionifsubprimemortgageborrowersbegin todefault ingreater than expectednumbers?

Howie Hubler wastakingahugerisk,evenifhefailed to communicate it or,perhaps, understand it. He'dlaid a massive bet on verynearly the same CDOtranches that CornwallCapital had bet against,composedofnearly thesamesubprime bonds thatFrontPointPartnersandScionCapital had bet against. Formore than twenty years, thebondmarket'scomplexityhad

helped the Wall Street bondtrader to deceive the WallStreet customer. It was nowleading the bond trader todeceivehimself.

Atissuewashowhighlycorrelated the prices ofvarious subprime mortgagebonds inside a CDO mightbe. Possible answers rangedfrom zero percent (theirpriceshadnothingtodowitheach other) to 100 percent(their prices moved in

lockstep with each other).Moody's and Standard &Poor's judged the pools oftriple-B-ratedbondstohaveacorrelation of around 30percent, which did not meananything likewhat it sounds.It does not mean, forexample, that if one bondgoesbad,thereisa30percentchancethattheotherswillgobad too. Itmeans that if onebond goes bad, the othersexperience very little decline

atall.The pretense that these

loanswere not all essentiallythe same, doomed to defaulten masse the moment houseprices stopped rising, hadjustified the decisions byMoody's and S&P to bestowtriple-Aratingsonroughly80percent of every CDO. (Andmade the entire CDObusiness possible.) It alsojustified Howie Hubler'sdecision to buy 16 billion

dollars' worth of them.Morgan Stanley had done asmuchasanyWallStreetfirmto persuade the ratingagencies to treat consumerloans as they treatedcorporate ones--as assetswhose risks could bedramatically reduced ifbundled together.Thepeoplewhohaddonethepersuadingsaw it as a sales job: Theyknew there was a differencebetween corporate and

consumerloansthattheratingagencieshadfailedtograpplewith.Thedifferencewas thattherewasverylittlehistorytowork with in the subprimemortgage bond market, andno history at all of acollapsingnationalrealestatemarket. Morgan Stanley'selite bond traders did notspend a lot of timeworryingabout this. Howie Hublertrustedtheratings.

The Wall Street bond

tradersontheotherendofthephone from Howie Hublercame away with theimpressionthatheconsideredthese bets entirely risk-free.He'd collect a tiny bit ofinterest...for nothing. Hewasn't alone in thisbelief,ofcourse.HublerandatraderatMerrill Lynch argued backand forth about a possiblepurchasebyMorganStanley,from Merrill Lynch, of $2billion in triple-A CDOs.

HublerwantedMerrillLynchto pay him 28 basis points(0.28 percent) over the risk-freerate,whileMerrillLynchonlywanted to pay24.On a$2 billion trade--a trade thatwould, in the end, havetransferred a $2 billion lossfrom Merrill Lynch toMorgan Stanley--the twotraders were arguing overinterest payments amountingto$800,000ayear.Overthatsum the deal fell apart.

Hubler had the same nit-picking argument withDeutsche Bank, with adifference. Inside DeutscheBank, Greg Lippmann wasnowholleringatthetopofhislungs that these triple-ACDOs could one day beworth zero. Deutsche Bank'sCDO machine paid Hublerthe28basispointshecravedand, in December 2006 andJanuary 2007, cut two deals,of$2billioneach."Whenwe

didthetrades,thewholetimewe were both like, 'We bothknowthereisnoriskinthesethings,'" said the DeutscheBank CDO executive whodealtwithHubler.

In the murky and curiousperiodfromearlyFebruarytoJune 2007, the subprimemortgagemarketresembledagiant helium balloon, boundtoearthbyadozenorsobigWall Street firms. Each firm

helditsrope;onebyone,theyrealized that no matter howstrongly they pulled, theballoon would eventually liftthem off their feet. In June,one by one, they silentlyreleased their grip. By edictof CEO Jamie Dimon, J.P.Morgan had abandoned themarket by the late fall of2006. Deutsche Bank,because of Lippmann, hadalways held on tenuously.GoldmanSachswasnext,and

did not merely let go, butturned and made a big betagainstthesubprimemarket--further accelerating theballoon's fatalascent.*Whenits subprime hedge fundscrashedinJune,BearStearnswasforciblyseveredfromitsline--and the balloon driftedfartherfromtheground.

Not long before that, inApril 2007, Howie Hubler,perhaps having misgivingsabout the size of his gamble,

hadstruckadealwiththeguywho ran the doomed BearStearns hedge funds, RalphCioffi. On April 2, thenation's largest subprimemortgage lender, NewCentury, was swamped bydefaults and filed forbankruptcy. Morgan StanleywouldsellCioffi$6billionofhis $16 billion in triple-ACDOs.Thepricehadfallenabit--Cioffi demanded a yieldof 40 basis points (0.40

percent) over the risk-freerate. Hubler conferred withMorgan Stanley's president,Zoe Cruz; together theydecided that they'd ratherkeep the subprime risk thanrealize a loss that amountedto a few tens of millions ofdollars.Itwasadecisionthatwound up costing MorganStanleynearly$6billion,andyet Morgan Stanley's CEO,John Mack, never gotinvolved. "Mack never came

and talked to Howie," saysone of Hubler's closestassociates. "The entire time,Howieneverhadasinglesit-downwithMack."*

ByMay 2007, however,there was a growing disputebetween Howie Hubler andMorgan Stanley. Amazingly,it hadnothing to dowith thewisdom of owning $16billion in complex securitieswhosevalueultimatelyturnedon theabilityofaLasVegas

stripper with five investmentproperties, or a Mexicanstrawberry picker with asingle $750,000 home, tomake rapidly rising interestpayments. The dispute wasoverMorganStanley'sfailureto deliver on its promise tospin Hubler's proprietarytradinggroupoffintoitsownmoney management firm, ofwhich he would own 50percent.OutragedbyMorganStanley's foot-dragging,

Howie Hubler threatened toquit. To keep him, MorganStanleypromisedtopayhim,and his traders, an evenbigger chunk of GPCG'sprofits. In 2006, Hubler hadbeen paid $25 million; in2007, it was understood, hewouldmakefarmore.

A month after Hublerand his traders improved theterms of trade betweenthemselves and theiremployer, Morgan Stanley

finally asked theuncomfortable question:What happened to theirmassive subprime mortgagemarket bet if lower-middle-class Americans defaulted ingreater than expectednumbers? How did the betperform, for instance, usingthe assumption of lossesgenerated by the mostpessimistic Wall Streetanalyst? Up to that point,Hubler's bet had been "stress

tested"forscenariosinwhichsubprime pools experiencedlosses of 6 percent, thehighest losses from recenthistory.NowHubler's traderswere asked to imagine whatwould become of their bet iflosses reached 10 percent.The demand came directlyfrom Morgan Stanley's chiefrisk officer, Tom Daula, andHubler and his traders wereangeredanddisturbedthathewould issue it. "It was more

than a littleweird," says oneof them. "Therewas a lot ofangst about it. It was sort ofviewed as, These folks don'tknow what they're talkingabout. If losses go to tenpercent there will be, like, amillion homeless people."(Losses in thepoolsHubler'sgroup had bet on wouldeventually reach 40 percent.)As a senior Morgan Stanleyexecutive outside Hubler'sgroup put it, "They didn't

wanttoshowyoutheresults.They kept saying, That stateoftheworldcan'thappen."

It took Hubler's traderstendaystoproducetheresultthey really didn't want toshow anyone: Losses of 10percent turned theircomplicated bet in subprimemortgages from a projectedprofit of $1 billion into aprojectedlossof$2.7billion.As one senior MorganStanleyexecutiveputit,"The

risk officers came back fromthe stress test looking veryupset."Hublerandhistraderstried to calm him down.Relax, they said, those kindsoflosseswillneverhappen.

The riskdepartmenthadtroublerelaxing,however.Tothem it seemed as if Hublerand his traders didn't fullyunderstandtheirowngamble.Hubler kept saying he wasbetting against the subprimebond market. But if so, why

did he lose billions if itcollapsed? As one seniorMorganStanleyriskmanagerputit,"It'sonethingtobetonred or black and know thatyou are betting on red orblack.It'sanother tobetonaformof red and not to knowit."

In early July, MorganStanley received its firstwake-up call. It came fromGreg Lippmann and his

bosses at Deutsche Bank,who,inaconferencecall,toldHowieHublerandhisbossesthat the $4 billion in creditdefault swaps Hubler hadsold Deutsche Bank's CDOdesk six months earlier hadmoved in Deutsche Bank'sfavor.CouldMorganStanleyplease wire $1.2 billion toDeutscheBankby theendofthe day? Or, as Lippmannactually put it--according tosomeone who heard the

exchange--Dude, you owe usonepointtwobillion.

Triple-A-rated subprimeCDOs, of which there werenow hundreds of billions ofdollars' worth buried insidevariousWallStreetfirms,andwhich were assumed to beriskless,werenow,accordingto Greg Lippmann, onlyworth 70 cents on the dollar.Howie Hubler had the samereaction.What do you meanseventy?Ourmodelsaysthey

are worth ninety-five, saidone of the Morgan Stanleypeopleonthephonecall.

Ourmodelsaystheyareworthseventy, replied one oftheDeutscheBankpeople.

Well, our model saysthey are worth ninety-five,repeated theMorgan Stanleyperson, and then went onabout how the correlationamong the thousands oftriple-B-rated bonds in hisCDOswasverylow,andsoa

few bonds going bad didn'timplytheywereallworthless.

At which point GregLippmann just said, Dude,fuckyourmodel.I'llmakeyoua market. They are seventy-seventy-seven.Youhavethreechoices. You can sell themback to me at seventy. Youcan buy some more atseventy-seven. Or you cangivememyfuckingonepointtwobilliondollars.

Morgan Stanley didn't

want to buy any moresubprime mortgage bonds.Howie Hubler didn't want tobuy any more subprime-backed bonds: He'd releasedhis grip on the rope thattethered him to the risingballoon.Yethedidn'twanttotake a loss, and insisted that,despite his unwillingness tobuy more at 77, his triple-ACDOs were still worth 95centsonthedollar.Hesimplyhanded the matter to his

superiors,whoconferredwiththeir equivalents at DeutscheBank, and finally agreed towire over $600 million. Thealternative, for DeutscheBank, was to submit thematter to a panel of threeWall Street banks, randomlyselected, to determine whatthese triple-A CDOs wereactually worth. It was ameasureoftheconfusionanddelusion on Wall Street thatDeutscheBank didn't care to

runthatrisk.At any rate, from

Deutsche Bank's point ofview, the collateral wasn'tthat big a deal. "When Gregmade thatcall," saida seniorDeutscheBank executive, "itwaslikelastonthelistofthethings we needed to do tokeep our business running.Morgan Stanley had seventybillion dollars in capital.Weknew the money was there."There was even some

argument inside DeutscheBank as to whetherLippmann's price wasaccurate. "It was such a bignumber," said a personinvolvedinthesediscussions,"that a lot of people said itcouldn't possibly be right.Morgan Stanley couldn'tpossibly owe us one pointtwobilliondollars."

They did, however. Itwas the beginning of a slidethat would end just a few

months later, in a conferencecall between MorganStanley's CEO and WallStreet'sanalysts.Thedefaultsmounted, the bondsuniversally crashed, and theCDOscomposedofthebondsfollowed. Several times onthe way down, DeutscheBankofferedMorganStanleythe chance to exit its trade.ThefirsttimeGregLippmanncalled him, Howie Hublermight have exited his $4

billion trade with DeutscheBankatalossof$1.2billion;the next time Lippmanncalled,thepriceofgettingouthadrisento$1.5billion.Eachtime,HowieHubler,oroneofhis traders, argued about theprice, and declined to exit."We fought with thosecocksuckers all the waydown," says one DeutscheBanktrader.And,allthewaydown, the debt collectors atDeutsche Bank sensed the

bond traders at MorganStanley misunderstood theirown trade. They weren'tlying;theygenuinelyfailedtounderstand the nature of thesubprime CDO. Thecorrelation among triple-B-ratedsubprimebondswasnot30 percent; it was 100percent.Whenonecollapsed,they all collapsed, becausethey were all driven by thesame broader economicforces. In the end, it made

little sense for aCDO to fallfrom 100 to 95 to 77 to 70anddownto7.Thesubprimebonds beneath them wereeitherallbadorallgood.TheCDOswerewortheitherzeroor100.

At a price of 7, GregLippmann allowed MorganStanley to exit a trade it hadentered into at roughly 100cents on the dollar. On thefirst $4 billion of HowieHubler's$16billionfolly,the

loss came to roughly $3.7billion. By then Lippmannwas no longer speaking toHowie Hubler, becauseHowieHublerwas no longeremployedatMorganStanley."Howiewas on this vacationthing for a fewweeks," saysone member of his group,"and then he never cameback." He'd been allowed toresign inOctober 2007,withmany millions of dollars thefirmhadpromisedhimat the

end of 2006, to prevent himfromquitting.Thetotallosseshe left behind him werereported to the MorganStanley board as a bit morethan $9 billion: the singlelargest trading loss in thehistory ofWall Street. Otherfirmswouldlosemore,muchmore; but those losses weretypically associated with thegeneration of subprimemortgage loans. CitigroupandMerrillLynchandothers

satonhugepilesofthethingswhenthemarketcrashed,butthese were the by-product oftheir CDO machines. Theyowned subprime mortgage-backed CDOs less for theirown sake than for the feesthat their deals wouldgenerate once they had soldthem. Howie Hubler's losswastheresultofasimplebet.Hubler and his tradersthoughttheyweresmartguysput on earth to exploit the

market'sstupidinefficiencies.Instead, they simplycontributed moreinefficiency.

Retiring to New Jersey,with an unlisted number,HowieHubler tookwith himthe comforting sense that hewasnotthebiggestfoolatthetable.Hemighthaveletgoofthe balloon rope too late tosaveMorganStanley, but, ashefelltoearth,hecouldlookup at the balloon drifting

higher in the sky and seeWall Street bodies stilldangling from it. In earlyJuly, just days before GregLippmann had called him toask for $1.2 billion, Hublerhadfoundapairofbuyersforhis triple-A-ratedCDOs.Thefirst was the MizuhoFinancial Group, a tradingarmofJapan'ssecondbiggestbank. As a people, theJapanesehadbeenbewilderedby these new American

financial creations, andsteeredclearofthem.MizuhoFinancial Group, for somereason that would remainknownonlytoitself,setitselfup as a clever trader ofU.S.subprimebonds, and took$1billion in subprime-backedCDOs off Morgan Stanley'shands.

The other, bigger, buyerwas UBS--which took $2billion in Howie Hubler'striple-A CDOs, along with a

couple of hundred milliondollars' worth of his shortposition in triple-B-ratedbonds. That is, in July,moments before the marketcrashed, UBS looked atHowie Hubler's trade andsaid, "Wewant someof that,too." Thus Howie Hubler'spersonal purchase of $16billion in triple-A-ratedCDOsdwindledtosomethinglike $13 billion. A fewmonths later, seeking to

explaintoitsshareholdersthe$37.4billionithadlostintheU.S. subprimemarkets,UBSwould publish a semi-frankreport, in which it revealedthat a small group of U.S.bond traders employed byUBS had lobbied hard rightupuntil the end for thebankto buy even more of otherWall Street firms' subprimemortgage bonds. "If peoplehadknownaboutthetrade,itwould have been open

revolt," said one UBS bondtrader close to the action. "Itwasaverycontroversialtradein UBS. It was kept very,very secret. Therewere a lotof people, had they knownthe trade was happening,would have screamed eightways from Sunday.We tookthe correlation trade offHowie's hands wheneveryone knew thecorrelationwasone." (Whichis to say, 100 percent.) He

further explained that thetradersatUBSwhoexecutedthe trade were motivatedmainlybytheirownmodels--which, at the moment of thetrade, suggested they hadturnedaprofitof$30million.

On December 19, 2007,Morgan Stanley held a callfor investors. The companywanted to explain how atrading loss of $9.2 billion--give or take a few billion--had more than overwhelmed

the profits generated by itsfifty thousand or soemployees. "The results weannounced today areembarrassing forme; for ourfirm," began John Mack."Thiswasaresultofanerrorin judgment incurred on onedesk in our Fixed Incomearea, and also a failure tomanage that riskappropriately.... Virtually allwritedownsthisquarterwerethe result of trading about

[sic] a single desk on ourmortgage business." TheCEO explained that MorganStanley had certain "hedges"againstitssubprimemortgagerisk and that "the hedgesdidn't perform adequately inextraordinary marketconditionoflateOctoberandNovember." But marketconditions in October andNovember were notextraordinary;inOctoberandNovember, for the first time,

the market began accuratelyto price subprime mortgagerisk.Whatwas extraordinaryiswhathadhappenedleadinguptoOctoberandNovember.

After saying he wanted"to be absolutely clear [that]as head of this firm, I takeresponsibility forperformance," Mack tookquestions from the bankanalysts of otherWall Streetfirms. It took this group awhile to get to the source of

embarrassment, buteventually they did. Fouranalysts elected not to probeMack too closely aboutwhatwas almost certainly thesingle greatest proprietarytrading loss in Wall Streethistory, and then WilliamTanona, from GoldmanSachs,spoke:

TANONA: Aquestion on the risk

again, [which] Iknoweverybodyhasbeen dancingaround.... Help usunderstandhow thiscould happen thatyou could take thislarge of a loss. Imean, I wouldimagine that youguys have positionlimitsandrisklimitsas such. I just--it[bewilders] me to

think that you guyscouldhaveonedeskthat could lose $8billion[sic].JOHN MACK:That's a wrongquestion.TANONA: Excuseme?JOHN MACK:Hello.Hi.And...TANONA:Imissedyou...JOHNMACK:Bill,

look, let's be clear.One, this trade wasrecognized andentered into ouraccounts. Two, itwasenteredintoourrisk managementsystem. It's verysimple. When thesegot, it's simple, it'svery painful, so I'mnot being glib.When these guysstress loss the

scenario on puttingon this position,they did notenvision...that wecould have thisdegree of default,right.Itisfairtosaythat our riskmanagementdivision did notstressthoselossesaswell.* It's justsimple as that.Thosearebigfattail

risks that caught ushard, right. That'swhathappened.TANONA: Okay.Fairenough.Iguessthe other thing Iwould question. Iam surprised thatyour trading VaRstayed stable in thequarter given thislevel of loss, andgiven that I wouldsuspect that these

were trading assets.Socanyouhelpmeunderstand whyyour VaR didn'tincrease in thequarterdramatically?+MACK:Bill,IthinkVaR is a very goodrepresentation ofliquid trading risk.But in terms of the(inaudible)of that, I

am very happy toget back to you onthat when we havebeen out of this,because I can'tanswer that at themoment.

Themeaninglessflowofwords might have left theaudiencewiththesensethatitwas incapable of parsing thedeep complexity of Morgan

Stanley's bond tradingbusiness. What the wordsactuallyrevealedwasthattheCEO himself didn't reallyunderstandthesituation.JohnMack was widely regardedamong his CEO peers asrelatively well informedabout his bond firm's tradingrisks. After all, he washimselfaformerbondtrader,and had been brought in toembolden Morgan Stanley'srisk-taking culture. Yet not

only had he failed to graspwhat his traders were up to,backwhen theywere still upto it; he couldn't even fullyexplain what they had doneaftertheyhadlost$9billion.

At length the moment hadcome: The last buyer ofsubprime mortgage risk hadstoppedbuying.OnAugust1,2007, shareholders broughttheirfirstlawsuitagainstBearStearns in connection with

the collapse of its subprime-backed hedge funds. Amongits less visible effectswas toalarmgreatlythethreeyoungmenatCornwallCapitalwhosat onwhatwas for them anenormous pile of creditdefault swaps purchasedmostly from Bear Stearns.EversinceLasVegas,CharlieLedley had been unable toshake his sense of theenormity of the events theywere living through. Ben

Hockett, the only one of thethreewho hadworked insidea big Wall Street firm, alsotended to travel very quicklyin his mind to somecatastrophic endgame. AndJamieMai just thought a lotofpeopleonWallStreetwerescumbags. All three wereworried that Bear Stearnsmight fail and be unable tomake good on its gamblingdebts. "There can come amomentwhenyoucan'ttrade

with a Wall Street firmanymore," said Ben, "and itcancomelikethat."

That first week inAugust, they kicked aroundand tried togeta feel for theprices of double-A-ratedCDOs, which just a fewmonths earlier had beentrading at prices thatsuggested they wereessentially riskless. "Theunderlying bonds werecollapsing and all the people

we'd dealt with were sayingwe'll give you two points,"said Charlie. Right upthrough late July, BearStearns and Morgan Stanleywere saying, in effect, thatdouble-A CDOs were worth98 cents on the dollar. Theargument between HowieHubler and Greg Lippmannwas replaying itselfthroughoutthemarket.

Cornwall Capital ownedcredit default swaps on

twenty crappy CDOs, buteach was crappy in its ownspecial way, and so it washard to get a readon exactlywhere they stood. One thingwasclear:Theirlong-shotbetwas no longer a long shot.TheirWallStreetdealershadalways told them that they'dnever be able to get out ofthese obscure credit defaultswaps on double-A tranchesofCDOs,butthemarketwaspanicking, and seemed eager

tobuy insuranceonanythingrelated to subprimemortgagebonds. The calculation hadchanged: For the first time,Cornwallstoodtolosequiteabit of money if somethinghappened that caused themarket to rebound--if, say,the U.S. government steppedin and guaranteed all thesubprime mortgages. And ofcourse if Bear Stearns wentdown,they'dloseitall.Oddlyalert to the possibility of

catastrophe, they now feltoddly exposed to one. Theyrushed to cover themselves--to find some buyer of thesestrange and newly relevantinsurance policies they hadaccumulated.

The job fell to BenHockett. Charlie Ledley hadtried a few times to act astheir trader and failedmiserably. "There are allthese little rules," saidCharlie. "You have to know

exactly what to say, and ifyou don't, everyone getspissedoffatyou.I'dthinkI'dbe saying, like, 'Sell!' and itturnedout Iwassaying, like,'Buy!' I sort of stumbled intothe realization that I shouldnotbedoingtrades."Benhadtraded for a living and wastheonlyoneofthethreewhoknewwhattosayandhowtosay it. Ben, however, was inthe south of England, onvacation with his wife's

family.And so it was that Ben

Hockett foundhimself sittingin a pub called The PowderMonkey, in the city ofExmouth, in the county ofDevon, England, seeking abuyer of $205 million incredit default swaps on thedouble-A tranches ofmezzanine subprime CDOs.ThePowderMonkeyhad thetown's lone reliable wirelessInternetconnection,andnone

of the enthusiastic Britishdrinkers seemed to mind, oreven notice, theAmerican inthe corner table bashing onhis Bloomberg machine andtalking into his cell phonefrom two in the afternoonuntil eleven at night. Up tothat point, only three WallStreet firms had provedwillingtodealwithCornwallCapital and give them theISDA agreements necessaryfor dealing in credit default

swaps: Bear Stearns,Deutsche Bank, and MorganStanley."Benhadalwaystoldus that it's possible to do atradewithoutanISDA,butitwas really not typical," saidCharlie. This was not atypical moment. On Friday,August 3, Ben called everymajor Wall Street firm andsaid,Youdon'tknowmeandIknow you won't give us anISDAagreement,but I'vegotinsurance on subprime

mortgage-backed CDOs I'mwilling to sell.Would you bewilling to deal with mewithout an ISDA agreement?"The stock answer was no,"said Ben. "And I'd say, 'Callyour head of credit tradingand call your head of riskmanagement and see if theyfeeldifferently.'"ThatFridayonly one bank seemed eagerto deal with him: UBS. Andtheywereveryeager.Thelastman clinging to the helium

balloonhad just letgoofhisrope.

On Monday, August 6,Ben returned to The PowderMonkey and began to trade.Forinsurancepoliciescostinghalf of 1 percent, UBS wasnow offering him 30 pointsup front--that is, Cornwall's$205millionincreditdefaultswaps, which cost about amillion bucks to buy, weresuddenly worth a bit morethan $60 million (30 percent

of$205million).UBSwasnolonger alone in their interest,however; the people atCitigroup and Merrill Lynchand Lehman Brothers, sodismissive on Friday, wereeager on Monday. All ofthem were sweating andmoaning toprice the risksofthese CDOs their firms hadcreated."Itwaseasierformebecause they had to look atevery single deal," said Ben."And I just wanted money."

Cornwallhadtwentyseparatepositions to sell. Ben'sInternetconnectioncameandwent, as did his cell phonereception. Only the ardor ofthe Wall Street firms,desperate to buy fireinsurance on their burninghome, remained undimmed."It's the first time we'reseeing any prices that reflectanything close to like whatthey're really worth," saidCharlie. "We had positions

that were being valued byBear Stearns at six hundredgrandthatwenttosixmillionthenextday."

By eleven o clockThursday night Ben wasfinished.ItwasAugust9,thesame day that the Frenchbank BNP announced thatinvestors in their moneymarket funds would beprevented from withdrawingtheir savings because ofproblemswithU.S. subprime

mortgages.Ben,Charlie, andJamiewerenot clearonwhythree-quarters of their betshad been bought by a Swissbank. The lettersU B S hadscarcely been mentionedinside Cornwall Capital untilthe bank had started beggingthem to sell them what wasnow very high-pricedsubprimeinsurance."Ihadnoparticular reason to thinkUBS was even in thesubprime business," said

Charlie."Inretrospect,Ican'tbelievewedidn't turnaroundandgetshortUBS."IntakingCornwall's credit defaultswaps off its hands, neitherUBS nor any of their otherWall Street buyers expressedthe faintest reservations thatthey were now assuming therisk that Bear Stearns mightfail: That thought, inside bigWall Street firms, was stillunthinkable. CornwallCapital, started four and a

half years earlier with$110,000, had just netted,from a million-dollar bet,more than $80 million."There was a relief that wehad not been the chumps atthe table," said Jamie. Theyhad not been the chumps atthe table. The long shot hadpaid80:1.AndnooneatThePowder Monkey ever askedBenwhathewasupto.

His wife's extendedEnglish family of course

wonderedwherehehadbeen,and he tried to explain. Hethought what was happeningwas critically important. Thebanking system wasinsolvent, he assumed, andthat implied some graveupheaval. When bankingstops, credit stops, andwhencredit stops, trade stops, andwhen trade stops--well, thecity of Chicago had onlyeight days of chlorine onhand for its water supply.

Hospitalsranoutofmedicine.Theentiremodernworldwaspremisedontheabilitytobuynowandpay later. "I'd comehome at midnight and try totalk to my brother-in-lawabout our children's future,"said Ben. "I asked everyonein the house to make suretheir accountsatHSBCwereinsured. I told them to keepsome cash on hand, as wemight face some disruptions.But it was hard to explain."

How do you explain to aninnocent citizen of the freeworld the importance of acredit default swap on adouble-A tranche of asubprime-backedcollateralizeddebtobligation?He tried, but his English in-laws just looked at himstrangely. They understoodthat someone else had justlostagreatdealofmoneyandBen had just made a greatdealofmoney,butnevergot

muchpastthat."Ican'treallytalk to them about it," hesays."They'reEnglish."

Twenty-two days later,onAugust31,2007,MichaelBurry lifted the side pocketandbegan tounloadhisowncredit default swaps inearnest. His investors couldhavetheirmoneyback.Therewas nowmore than twice asmuchof it as theyhadgivenhim. Just a few monthsearlier, Burry was being

offered200basispoints--or2percent of the principal--forhis credit default swaps,whichpeakedat$1.9billion.Nowhewasbeingoffered75,80, and 85 points by WallStreet firms desperate tocushion their fall.At the endofthequarter,he'dreportthatthe fund was up more than100percent.Bytheendoftheyear, in a portfolio of lessthan $550 million, he wouldhave realized profits ofmore

than $720 million. Still heheard not a peep from hisinvestors. "Evenwhen itwasclear it was a big year and Iwas proven right, there wasno triumph in it," he said."Makingmoney was nothinglike I thought it would be."To his founding investor,Gotham Capital, he shot offanunsolicitede-mailthatsaidonly,"You'rewelcome."He'dalready decided to kick themoutofthefund,andinsistthat

they sell their stake in hisbusiness. When they askedhim to suggest a price, hereplied,"Howaboutyoukeepthe tens of millions younearly prevented me fromearning foryou last year andwecalliteven?"

When he'd started out,he'ddecidednottochargehisinvestors the usual 2 percentorsomanagementfeeforhisservices. In the one year inwhich he had not turned his

investors' money into moremoney, the absence of a feehad meant having to fireemployees.Henowwrotehisinvestorsa letter letting themknow he'd changed hispolicy--which enabled hisinvestors to be angry withhimalloveragain,evenashewasmakingthemrich."Ijustwonder where you come upwiththewaysyoufindtopisspeopleoff,"oneofhise-mailfriends wrote to him. "You

haveagift."One of the things he'd

learned about Asperger's,since he'd discovered that hehad it, was the role that hisinterests served.Theywereasafe place towhich he couldretreat from a hostile world.That was why people withAsperger's experienced themso intensely. That was also,oddly, why they couldn'tcontrolthem."ThetherapistIsee helpedme figure it out,"

hewroteinane-mail,"anditmakes a lot of sense when Ilookbackatmyownlife:

Let me see if I can get itright--it always soundsbetter when the therapistsays it. Well, if you startwith a person who hastremendous difficultyintegrating himself intothe social workings ofsociety, and often feels

misunderstood, slighted,andlonelyasaresult,youwill see where an intenseinterest can be somethingthat builds up the ego inthe classical sense.Asperger's kids can applytremendous focus andramp up knowledge of asubjectinwhichtheyhavean interest very quickly,often well beyond thelevel of any peers. Thatego-reinforcement is very

soothing, providingsomething that Asperger'skidsjustdonotexperienceoften, if at all.As longasthe interest provides thatreinforcement, there islittle danger of a change.But when the interestencounters a rocky patch,or the person experiencesfailure in the interest, thenegativitycanbefeltveryintensely, especiallywhenit comes from other

people. The interest insuch a case can simplystart tomimic all that theAsperger's person wastrying to escape--theapparent persecution, themisunderstanding, theexclusion by others. AndthepersonwithAsperger'swouldhavetofindanotherinterest to build up andmaintaintheego.

Most of 2006 and early2007 Dr.Michael Burry hadexperienced as a privatenightmare. In an e-mail, hewrote, "The partners closesttome tend toultimatelyhateme.... This business kills apart of life that is prettyessential. The thing is, Ihaven't identified what itkills.Butitissomethingvitalthat is dead inside of me. Icanfeelit."Ashisinterestinfinancial markets seeped out

of him, he bought his firstguitar. It was strange: Hecouldn't play the guitar andhadnotalentfor it.Hedidn'tevenwant to play the guitar.He just needed to learn allabout the sortsofwoodusedto make guitars, and to buyguitars and tubes and amps.He just needed to...knoweverythingtherewastoknowaboutguitars.

He'd picked anintelligent moment for the

death of his interest. It wasthemomentatwhich theendwas written: the moment atwhich there was nothing leftto prevent. Six months fromthat moment, theInternational Monetary Fundwould put losses on U.S.-originated subprime-relatedassets at a trillion dollars.One trillion dollars in losseshad been created byAmerican financiers, out ofwholecloth,andembeddedin

the American financialsystem.EachWallStreetfirmheld some share of thoselosses, and could do nothingtoavoidthem.NoWallStreetfirm would be able toextricate itself, as therewereno longer any buyers. It wasasifbombsofdifferingsizeshad been placed in virtuallyevery major Westernfinancial institution. Thefuses had been lit and couldnot be extinguished. All that

remained was to observe thespeed of the spark, and thesizeoftheexplosions.

CHAPTERTEN

TwoMeninaBoat

Virtually no one--be theyhomeowners, financialinstitutions, ratingagencies, regulators, orinvestors--anticipatedwhatisoccurring.

--Deven Sharma,

president of S&PTestimony beforeU.S. House ofRepresentativesOctober22,2008

Pope Benedict XVI wasthe first to predict thecrisis in the globalfinancial system...ItalianFinance Minister GiulioTremonti said. "Theprediction that an

undisciplined economywouldcollapseby itsownrules can be found" in anarticlewrittenbyCardinalJoseph Ratzinger [in1985], Tremonti saidyesterday at Milan'sCattolicaUniversity.

--Bloomberg News,November20,2008

Greg Lippmann had

imagined the subprimemortgage market as a greatfinancial tug-of-war: On oneside pulled the Wall Streetmachine making the loans,packaging the bonds, andrepackaging the worst of thebonds into CDOs and then,when they ran out of loans,creatingfakeonesoutofthinair; on the other side, hisnoble army of short sellersbettingagainst theloans.Theoptimists versus the

pessimists. The fantasistsversustherealists.Thesellersofcreditdefaultswapsversusthebuyers.Thewrongversusthe right. The metaphor wasapt, up to a point: this point.Now the metaphor was twomen in a boat, tied togetherby a rope, fighting to thedeath. One man kills theother, hurls his inert bodyover the side--only todiscover himself beingyanked over the side. "Being

short in 2007 and makingmoney from it was fun,because we were short badguys,"saidSteveEisman."In2008 it was the entirefinancial system that was atrisk.Wewere still short.Butyoudon'twant the system tocrash. It's sort of like theflood's about to happen andyou're Noah. You're on theark. Yeah, you're okay. Butyouarenothappylookingoutat the flood. That's not a

happymomentforNoah."By the end of 2007

FrontPoint's bets againstsubprimemortgageshadpaidoff so spectacularly that theyhad doubled the size of theirfund, from a bit over $700million to $1.5 billion. Themomentitwascleartheyhadmade a fantastic pile ofmoney, both Danny andVinnywantedtocashintheirbets.Neitheroneofhadevercome around to completely

trustingGreg Lippmann, andtheir mistrust extended evento this fantastic gift he hadgiven them. "I'd never buy acar from Lippmann," saidDanny. "But I bought fivehundred million dollars'worthofcreditdefaultswapsfrom him." Vinny had analmost karmic concern aboutmaking so much money soquickly."Itwasthetradeofalifetime,"hesaid."Ifwegaveup the trade of a lifetime for

greed,I'dhavekilledmyself."All of them, including

Eisman, thought Eismanwastemperamentally less thanperfectly suited to makingshort-termtradingjudgments.He was emotional, and heacted on his emotions. Hisbets against subprimemortgage bonds were to himmore than just bets; heintended them almost asinsults.WheneverWallStreetpeopletriedtoargue--asthey

often did--that the subprimelending problem was causedby the mendacity andfinancial irresponsibility ofordinaryAmericans,he'dsay,"What--the entire Americanpopulation woke up onemorning and said, 'Yeah, I'mgoing to lie on my loanapplication'? Yeah, peoplelied. They lied because theyweretoldtolie."Theoutragethat fueled his gamble wasaimed not at the entire

financial system but at thepeople at the top of it, whoknew better, or should have:thepeopleinsidethebigWallStreet firms. "It was morethan an argument," Eismansaid."Itwasamoralcrusade.Theworldwasupsidedown."The subprime loans at thebottom of their gamble wereworthless, he argued, and ifthe loanswereworthless, theinsurance they owned onthose loans should go

nowherebutup.Andso theyheldontotheircreditdefaultswaps, and waited for moreloanstodefault."VinnyandIwouldhavedonefiftymilliondollars andmade twenty-fivemillion dollars," said Danny."Steve did five hundred andfifty million and made fourhundredmillion."

TheGreatTreasureHunthad yielded a long list ofcompanies exposed tosubprime loans. By March

14,2008, theyhadsoldshortthe stocks of virtually everyfinancial firm in any wayconnected to the doomsdaymachine. "We werepositioned for Armageddon,"said Eisman, "but always atthe back of our minds was,What if Armageddon doesn'thappen?"

On March 14, thequestion becamemoot. Fromthe time Bear Stearns'ssubprime hedge funds had

collapsed, in June 2007, themarket was asking questionsabouttherestofBearStearns.Over the past decade, likeevery otherWall Street firm,Bear Stearns had increasedthe size of the bets it madewith every dollar of itscapital. In just the past fiveyears,BearStearns'sleveragehad gone from 20:1 to 40:1.Merrill Lynch's had gonefrom16:1 in 2001 to 32:1 in2007. Morgan Stanley and

Citigroup were now at 33:1,Goldman Sachs lookedconservativeat25:1,butthenGoldman had a gift fordisguising how leveraged itactuallywas.Tobankruptanyof these firms, all that wasrequired was a very slightdecline in the value of theirassets. The trillion-dollarquestion was, What werethoseassets?UntilMarch14,the stock market had giventhe bigWall Street firms the

benefit of the doubt. No oneknew what was going oninsideBearStearnsorMerrillLynchorCitigroup,buttheseplaces had always been thesmart money, ergo their betsmust be the smart bets. OnMarch 14, the marketchangeditsopinion.

That morning, Eismanhad been invited on shortnotice by Deutsche Bank'sprominentbankanalystMikeMayotoaddressaroomfulof

big investors. In anauditorium at DeutscheBank's Wall Streetheadquarters, Eisman wasscheduled to precede theretired chairman of theFederal Reserve, AlanGreenspan, and be pairedwithafamousinvestornamedBill Miller--who alsohappened to own more than$200million ofBear Stearnsstock. Eisman obviouslythought it insane that anyone

would sink huge sums ofmoney into any Wall Streetfirm.Greenspanheviewedasalmost beneath his contempt,whichwassayingsomething."I thinkAlanGreenspanwillgo down as the worstchairman of the FederalReserve inhistory,"he'd say,when given the slightestchance."Thathekeptinterestrates too low for too long isthe least of it. I'm convincedthat he knew what was

happening in subprime, andhe ignored it, because theconsumer getting screwedwasnothisproblem.Isortoffeel sorry for him becausehe'saguywhoisreallysmartwho was basically wrongabouteverything."

There was now hardlyan important figure on WallStreetwhomEisman had notinsulted, or tried to. At apublic event in Hong Kong,after the chairman of HSBC

had claimed that his bank'ssubprime losses were"contained," Eisman hadraised his hand and said,"You don't actually believethat, do you? Because yourwhole book is fucked."Eisman had invited thebullish-on-subprime BearStearnsanalystGyanSinhatohis office and grilled him somercilessly that a BearStearns salesman had calledafterwardandcomplained.

"Gyanisupset,"hesaid."Tellhimnottobe,"said

Eisman."Weenjoyedit!"Attheendof2007,Bear

Stearns had neverthelessinvitedEismantoawarmandfuzzy meet and greet withtheir new CEO, AlanSchwartz. Christmas withBear,theycalledit.Schwartztoldhisaudiencehow"crazy"the subprime bond marketwas,asnooneinitseemedtobe able to agree on the price

ofanygivenbond."And whose fault is

that?" Eisman had blurtedout. "This is how you guyswanted it. So you could ripoffyourcustomers."

Towhich the new CEOreplied, "I don't want to castblame."

Which Wall Street bigshots Eisman had insultedwas a matter of which WallStreet big shots' presenceEismanwasallowedinto.On

March 14, 2008, he wasinvited into the presence ofone of the biggest and mostfamous bullish investors inWall Street banks, plus thatof the illustrious formerchairman of the FederalReserve.Itwasabusydayinthe markets--there wererumors that Bear Stearnsmight be having troubles--but, given a choice betweenwatching the markets andwatching Eisman, Danny

Moses and Vincent DanielandPorterCollinsdidn'tthinktwice. "Let's be honest," saidVinny. "We went for theentertainment. It's like Ali-Frasier. Why would you notwanttobethere?"TheydrovetothefightwithAli,buttookseats in the back row, andpreparedtohide.

Eisman sat at a longtable with the legendary BillMiller. Miller spoke formaybe three minutes, and

explained the wisdom of hisinvestment in Bear Stearns."Andnowforourbear,"saidMikeMayo."SteveEisman."

"I got to stand up forthis,"saidEisman.

Miller had given hislittle talk sitting down. Theevent was meant to be moreof a panel discussion than aspeech, butEismanmade forthe podium. Noting thepresenceofhismother in thethird row, but ignoring his

partners in the back, alongwith the crowdof twentyhispartners had alerted (freetickets to Ali-Frasier!),Eisman launched a ruthlesslyreasonable dissection of theU.S. financial system. "WhyThis Time Is Different" wasthe title of his speech--eventhough it stillwasn't clearhewas meant to be givinganything so formal as aspeech. "We are goingthrough the greatest

deleveraginginthehistoryoffinancial services and it'sgoing to go on and on andon," he said. "There is nosolution other than time.Timetotakethepain..."

As Eisman had risen,Dannyhad sunk in his chair,instinctively. "There isalways the possibility ofembarrassment," Danny said."But it's like watching a carcrash. You can't not watch."Allaroundhimmenhunched

over theirBlackBerrys.Theywanted to hear what Eismanhad to say, clearly, but thestock market was distractingthemfromtheshow.At9:13,as Eisman was finding hisplaceatthefrontoftheroom,Bear Stearns had announcedthatithadgottenaloanfromJ.P. Morgan. Nine minuteslater,asBillMillerexplainedwhy itwas such a good ideatoownstockinBearStearns,Alan Schwartz had issued a

press release. "Bear Stearnshas been the subject of amultitude of rumorsconcerning our liquidity," itbegan. Liquidity. When anexecutive said his bank hadplenty of liquidity it alwaysmeantthatitdidn't.

At 9:41, or roughly thetimeEismanmadehisbidforthepodium,DannysoldsomeBear Stearns shares thatEisman, oddly enough, hadbought the night before, at

$53 a share. They'd made afew bucks, but it was stillmystifying that Eisman hadbought them, over everyoneelse's objections. Every nowand then,Eismanmadesomeshort-termtradeoftrivialsizethat totally contradictedeverything they believed.Danny and Vinny boththought the problem in thiscasewasEisman'saffinityforBearStearns.Themosthatedfirm on Wall Street, famous

mainly for its totalindifference to the goodopinion of its competitors,Eisman identified with theplace!"He'dalwayssayBearStearns could never beacquired by anyone becausethe culture of the firm couldnever be assimilated intoanythingelse,"saidVinny."Ithinkhesawsomeofhimselfin them." Eisman's wife,Valerie, had her own theory."It'sthisweirdantidotehehas

to his 'the world is going toblow up' theory," she said."Every now and then hewouldshowupathomewiththistotallybizarrelong."

Whatever thepsychological origins ofEisman's sudden urge, theprevious afternoon, to buy afew shares in Bear Stearns,Danny was just glad to bedonewiththematter.Eismanwas now explaining why theworldwas going to blowup,

but his partners were onlyhalf-listening...because thefinancial world was blowingup. "The minute Steve startsto speak," said Vinny, "thestock starts to fall." AsEismanexplainedwhynoonein his rightmindwould owntheveryshareshehadboughtsixteen hours earlier, Dannydashed off text messages tohispartners.

9:49.Ohmy--Bearat47

"If [the U.S. financialsystem]soundslikeacircularPonzi scheme it's because itis."

9:55.Bearis43lastOMG

"ThebanksintheUnitedStates are only beginning to

come to grips with theirmassive loan problems. Forinstance, I wouldn't own asingle bank in the State ofFlorida because I think theymightallbegone."

10:02.Bear29last!!!!

"The upper classes ofthis country raped thiscountry. You fucked people.

You built a castle to rippeople off. Not once in allthese years have I comeacross a person inside a bigWall Street firm who washavingacrisisofconscience.Nobody ever said, 'This iswrong.'Andnooneevergavea shit about what I had tosay."

Actually, Eisman didn'tspeak those final sentencesthat morning; he merelythought them. And he didn't

actually know what washappening in the stockmarket; the one time hecouldn'tcheckhisBlackBerrywas when he was speaking.ButashespokeaWallStreetinvestment bank was failing,forareasonother thanfraud.And the obvious questionwas,Why?

The collapse of BearStearns would later beclassified as a run on thebank,andinasensethatwas

correct--other banks wererefusing to do business withit, hedge funds were pullingtheir accounts. It raised aquestion,however,thatwouldbe raised again six monthslater: Why did the marketsuddenlydistrustagiantWallStreet firm whosepermanence it not so verylongbeforetookforgranted?The demise of Bear Stearnshad been so unthinkable inMarchof2007 thatCornwall

Capital had bought insuranceagainst its collapse for lessthanthree-tenthsof1percent.They'dputdown$300,000tomake$105million.

"Leverage" wasEisman'sanswer,onthisday.To generate profits, BearStearns,likeeveryotherWallStreet firm, was perchingmore and more speculativebets on top of each dollar ofits capital. But the problemwas obviously more

complicated than that. Theproblem was also the natureofthosespeculativebets.

The subprime mortgagemarket had experienced atleast twodistinctphases.Thefirst,inwhichAIGhadtakenmost of the risk of a marketcollapse, lasted until the endof 2005.WhenAIGabruptlychanged its mind, tradersinsideAIGFP assumed theirdecision might completelyshut down the subprime

mortgagemarket.*That's notwhat happened, of course.Wall Street was alreadymaking too much moneyusing CDOs to turn crappytriple-B-ratedsubprimebondsintoputatively riskless triple-A ones to simply stop doingit. The people who ran theCDOmachine at the variousfirms had acquired toomuchauthority. From the end of2005 until the middle of2007, Wall Street firms

created somewhere between$200 and $400 billion insubprime-backed CDOs: Noone was exactly sure howmanytherewere.Callit$300billion, of which roughly$240billionwouldhavebeentriple-A-rated and thustreated, for accountingpurposes, as riskless, andtherefore unnecessary todisclose.Much,ifnotall,ofitwasheldoffbalancesheets.

By March 2008 the

stock market had finallygraspedwhateverymortgagebond salesman had longknown: Someone had lost atleast $240 billion. But who?Morgan Stanley still owned$13 billion or so in CDOs,courtesy of Howie Hubler.TheidiotsinGermanyownedsome, Wing Chau and CDOmanagers like him ownedsome more, though whosemoneytheywereusingtobuythe bonds was a bit murky.

Ambac Financial Group andMBIA Inc., which had longmade their living insuringmunicipal bonds, had takenoverwhereAIGhad left off,and owned maybe 10 billiondollars'wortheach.Thetruthis itwas impossible to knowhow big the losses were, orwho had them. All thatanyone knew was that anyWall Street firm deep in thesubprime market wasprobablyonthehookforalot

more of them than they hadconfessed. Bear Stearns wasdeep in the subprimemarket.It had $40 in bets on itssubprimemortgagebondsforeverydollarofcapital itheldagainst those bets. Thequestion wasn't how BearStearns could possibly failbut how it could possiblysurvive.

Finishing his littlespeech and heading back tohis chair, Steve Eisman

passedBillMiller and pattedhim on the back, almostsympathetically. In the briefquestion-and-answer sessionthat followed, Miller pointedout how unlikely it was thatBear Stearns might fail,because thus far, big WallStreet investment banks hadfailed only after they werecaught in criminal activities.Eismanblurtedout,"It'sonlyfive past ten. Give it time."Apart from that, he'd been

almost polite. In the back ofthe room, Vinny and Dannyfelt the curious combinationof relief and disappointmentthat followed a tornado thatnarrowlymissedthebigcity.

It wasn't Eisman whoupset the tone in the room,butsomekid in theback.Helooked to be in his earlytwenties, and he was, likeeveryone else, punching onhis BlackBerry the wholetime Miller and Eisman

spoke. "Mr.Miller," he said."From the time you startedtalking, Bear Stearns stockhas fallen more than twentypoints.Would you buymorenow?"

Miller looked stunned."Heclearlyhadno ideawhathad happened," said Vinny."He justsaid, 'Yeah,sure, I'dbuymorehere.'"

Afterthat,themenintheroom rushed for the exits,apparentlytosell theirshares

in Bear Stearns. By the timeAlan Greenspan arrived tospeak, there was hardlyanyone who cared to hearwhat he had to say. Theaudience was gone. ByMonday,BearStearnswasofcoursegone, too, sold to J.P.Morganfor$2ashare.*

The people rising out of thehole in the ground on thenortheast corner of MadisonAvenue and Forty-seventh

Street at 6:40 in themorningrevealed a great deal aboutthemselves,ifyouknewwhatto look for. Anyone in thatplace at that time probablyworked on Wall Street, forinstance. The peopleemerging from the holessurrounding Penn Station,where Vincent Daniel's trainarrived at exactly the sametime, weren't so easy topredict. "Vinny's morningtrainisonlyfifty-fivepercent

financial, because that'swhere the constructionworkerscomein,"saidDannyMoses. "Mine's ninety-five."To the untrained eye, theWall Street people who rodefromtheConnecticutsuburbsto Grand Central were anundifferentiated mass, butwithinthatmassDannynotedmany small and importantdistinctions. If they were ontheir BlackBerrys, they wereprobably hedge fund guys,

checking their profits andlossesintheAsianmarkets.Ifthey slept on the train theywere probably sell-sidepeople--brokers, who had noskin in the game. Anyonecarrying a briefcase or a bagwas probably not employedon the sell side, as the onlyreasonyou'dcarryabagwasto haul around brokerageresearch, and the brokersdidn'treadtheirownreports--atleastnotintheirsparetime.

Anyone carrying a copy ofthe New York Times wasprobably a lawyeror aback-office person or someonewho worked in the financialmarkets without actuallybeinginthemarkets.

Their clothes told you alot, too. The guys who ranmoneydressedasiftheyweregoing to a Yankees game.Their financial performancewas supposed to be all thatmattered about them, and so

it caused suspicion if theydressedtoowell.Ifyousawabuy-side guy in a suit, itusuallymeant that hewas introuble,or scheduled tomeetwithsomeonewhohadgivenhimmoney, or both. Beyondthat, itwashard to tellmuchaboutabuy-sidepersonfromwhat he was wearing. Thesell side, on the other hand,might as well have beenwearing their business cards:The guy in the blazer and

khakis was a broker at asecond-tier firm; the guy inthe three-thousand-dollar suitand the hair just so was aninvestment banker at J.P.Morgan or someplace likethat. Danny could guesswhere people worked bywhere they sat on the train.The Goldman Sachs,Deutsche Bank, and MerrillLynch people, who wereheaded downtown, edged tothe front--though when

Danny thought about it, fewGoldmanpeopleactuallyrodethe train anymore. They allhad private cars.Hedge fundguys such as himselfworkeduptown and so exited GrandCentral to the north, wheretaxis appeared haphazardlyand out of nowhere to meetthem,likefarmtroutrisingtocorn kernels. The LehmanandBearStearnspeopleusedto head for the same exit ashe did, but they were done.

One reason why, onSeptember 18, 2008, thereweren't nearly as manypeople on the northeastcornerofForty-seventhStreetandMadisonAvenue at 6:40in the morning as there hadbeenonSeptember18,2007.

Danny noticed manylittle things about his fellowfinancial man--that was hisjob, in a way. To notice thelittle things. Eisman was thebig-picture guy. Vinny was

the analyst. Danny, the headtrader,wastheireyesandearson the market. Their sourcefor the sort of informationthat never gets broadcast orwritten down: rumors, thebehavior of the sell-sidebrokers, the patterns on thescreens. His job was to bealive to detail, quick withnumbers--andtoavoidgettingfucked.

To thatendhekept fivecomputerscreensonhisdesk.

One scrolled newswires,another showed moment-to-moment movements insidetheirportfolio,theotherthreescrolled Danny'sconversations with maybefortyWallStreetbrokersandfellow investors. His e-mailin-box for the monthcontained 33,000 messages.Toanoutsider,thistorrentofpicayune detail about thefinancialmarketswouldhavebeen disorienting. To him it

allmadesense,as longashedidn't really need to makesense of it. Danny was thesmall-pictureguy.

ByThursday,September18, 2008, however, the bigpicturehadgrownsounstablethat the small picture hadbecome nearly incoherent tohim. On Monday, LehmanBrothers had filed forbankruptcy, and MerrillLynch, having announced$55.2 billion in losses on

subprime bond-backedCDOs,hadsolditselftoBankof America. The U.S. stockmarket had fallen by morethanithadsincethefirstdayof trading after the attack onthe World Trade Center. OnTuesday the U.S. FederalReserveannouncedthatithadlent $85 billion to theinsurance company AIG, topay off the losses on thesubprimecreditdefaultswapsAIG had sold toWall Street

banks--the biggest of whichwas the $13.9 billion AIGowed to Goldman Sachs.When you added in the $8.4billion in cash AIG hadalready forked over toGoldman in collateral, yousaw that Goldman hadtransferred more than $20billion in subprimemortgagebond risk into the insurancecompany, which was in onewayoranotherbeingcoveredby the U.S. taxpayer. That

fact alone was enough tomake everyone wonder atonce howmuchmore of thisstuffwas out there, andwhoownedit.

The Fed and theTreasury were doing theirbesttocalminvestors,butonWednesday no one wasobviously calm. A moneymarket fund called theReserve Primary Fundannounced that it had lostenoughonshort-termloansto

Lehman Brothers that itsinvestors were not likely togetall theirmoneyback,andfroze redemptions. Moneymarkets weren't cash--theypaid interest, and thus borerisk--but, until that moment,people thought of them ascash.You couldn't even trustyour own cash. All over theworld corporations began toyank their money out ofmoney market funds, andshort-term interest rates

spiked as they had neverbefore spiked. The DowJones IndustrialAverage hadfallen449points,toitslowestlevel in four years, andmostof the market-moving newswas coming not from theprivate sector but fromgovernmentofficials.At6:50on Thursday morning, whenDanny arrived, he learnedthatthechiefBritishfinancialregulator was consideringbanning short selling--an act

that, among other things,would put the hedge fundindustry out of business--butthat didn't begin to explainwhatnowhappened."AllhellwasbreakinglooseinawayIhadneverseeninmycareer,"saidDanny.

FrontPoint waspositioned perfectly forexactly this moment. Byagreement with theirinvestors, their fundcouldbe25 percent net short or 50

percent net long the stockmarket, and the grosspositions could never exceed200percent.Forexample,forevery $100 million they hadto invest, they could be netshort$25million,ornetlong$50 million--and all of theirbets combined could neverexceed $200 million. Therewasnothingintheagreementabout credit default swaps,but that no longer mattered.("We never figured out how

to put it in," said Eisman.)They'd sold their last oneback to Greg Lippmann twomonths earlier, in early July.They were now back tobeing, exclusively, stockmarketinvestors.

At that moment theywereshortnearlyasmuchastheywereallowedtobeshort,and all of their bets wereagainst banks, the verycompanies collapsing thefastest: Minutes after the

market opened they were up$10million. The shortswerefalling, the longs--mainlysmaller banks removed fromthe subprime market--werefalling less. Danny shouldhave been elated: Everythingthey had thought mighthappen was now happening.Hewasn'telated,however;hewas anxious. At 10:30, anhour into trading, everyfinancial stock went into afree fall, whether it deserved

to or not. "All thisinformation goes throughme," he said. "I'm supposedto know how to transmitinformation. Prices weremoving so quickly I couldn'tget a fix. It felt like a blackhole.Theabyss."

It had been four dayssince Lehman Brothers hadbeen allowed to fail, but themost powerful effects of thecollapsewerebeingfelt rightnow. The stocks of Morgan

Stanley and Goldman Sachsweretanking,anditwasclearthatnothingshortof theU.S.governmentcouldsave them."It was the equivalent of theearthquake going off," hesaid, "and then, much later,the tsunamiarrives."Danny'strading life was man versusman, but this felt more likeman versus nature: ThesyntheticCDOhadbecomeasynthetic natural disaster."Usually, you feel you have

the ability to control yourenvironment," said Danny."You're good because youknowwhat'sgoingon.Nowitdidn't matter what I knew.Feelwentoutthewindow."

FrontPoint had maybeseventy different bets on, invarious stockmarkets aroundthe world. All of them wereon financial institutions. Hescrambled to keep a handleon them all, but couldn't.They owned shares in

KeyBank and were short theshares of Bank of America,both of which were doingthings they'd never donebefore. "There were no bidsin the market for anything,"said Danny. "There was nomarket. It was really onlythen that I realized therewasa bigger issue than just ourportfolio.Fundamentalsdidn'tmatter. Stockswere going tomove up or down on pureemotion and speculation of

what the government woulddo." The most unsettlingloose thought rattling aroundhis mind was that MorganStanley was about to gounder.TheirfundwasownedbyMorganStanley.Theyhadalmost nothing to do withMorganStanley,andfeltlittlekinship with the place. Theydid not act or feel likeMorgan Stanley employees--Eismanoften saidhowmuchhewishedhewas allowed to

short Morgan Stanley stock.They acted and felt like themanagers of their own fund.If Morgan Stanley failed,however, its share in theirfundwoundupasanassetinabankruptcyproceeding."I'mthinking,We'vegottheworldby the fucking balls and thecompanyweworkforisgoingbankrupt?"

Then Danny sensedsomething seriously wrong--with himself. Just before

eleven in themorning, wavyblack lines appeared in thespace between his eyes andhis computer screen. Thescreen appeared to be fadingin and out. "I felt thisshootingpaininmyhead,"hesaid."Idon'tgetheadaches.Ithought I was having ananeurysm." Now he becameawareofhisheart--helookeddown and he could actuallysee it banging against hischest. "I spend my morning

trying to control all thisenergy and all thisinformation," he said, "and Ilostcontrol."

He'dhadthisexperienceonly once before. OnSeptember 11, 2001, at 8:46a.m.,he'dbeenathisdeskonthe top floor of the WorldFinancialCenter. "Youknowwhen you're in the city andone of those garbage truckspasses and you're like, 'Whatthe fuck was that?'" Until

someone told him it was acommuter plane hitting theNorthTower,heassumedthefirst plane was one of thosetrucks. He walked to thewindow to look up at thebuilding across the street. Asmall commuter planewouldn't have been big orstrong enough to do all thatmuch damage, to his way ofthinking, and he expected tosee it poking out of the sideof the building.All he could

see was the black hole, andsmoke. "My first thoughtwas, That was not anaccident. No fucking way."He was still working atOppenheimer and Co.--Steveand Vinny had already left--and some authoritative-soundingvoicecameovertheloudspeaker to announce thatno one was to leave thebuilding. Danny remained atthe window. "That's whenpeople started jumping," he

said."Bodiesarefalling."Therumble of another garbagetruck. "When the secondplane hit I was like, 'Bye,everybody.'" By the time hereachedtheelevator,hefoundhimself escorting twopregnant women. He walkedthem uptown, left one at herapartment on FourteenthStreet and the other at thePlazaHotel,and thenwalkedhometohispregnantwifeonSeventy-secondStreet.

Four days later he wasleaving, or rather fleeing,NewYorkCitywithhiswifeand small son.Theywereonthe highway at night in themiddle of a storm when hewas overcome by thecertaintythatatreewouldfalland crush the car. He begantoshakeandsweatwithsheerterror. The trees were fiftyyardsaway:Theycouldneverreach the car. "You need tosee someone," his wife said,

and he had. He had thoughthe might have somethingwrongwithhisheart,andhadspenthalfadayhookeduptoanEKGmachine.Thelossofself-controlembarrassedhim--hepreferrednottotalkaboutit--andhewasdeeplyrelievedwhentheattacksbecamelessfrequent and less severe.Finally, a few months afterthe terrorist attack, theyvanishedcompletely.

OnSeptember18,2008,

he failed to make theconnectionbetweenhowhe'dfeltthenandhowhefeltnow.He rose from his desk andlooked for someone. Eismannormallysatacrossfromhim,but Eisman was out at someconference trying to raisemoney--which showed youhowunpreparedtheyallwereat the arrival of the momentfor which they thoughtthemselves perfectlyprepared.Dannyturnedtothe

colleaguebesidehim."Porter,I think I'm having a heartattack,"hesaid.

Porter Collins laughedandsaid,"No,you'renot."AnOlympic rowing career hadleftPorterCollinsabitinuredto the pain of others, as heassumed they usually didn'tknowwhatpainwas.

"No," said Danny. "Ineed to go to the hospital."Hisfacehadgonepalebuthewas still able to stand on his

owntwofeet.Howbadcouldit be? Danny was always alittlejumpy.

"That'swhyhe'sgoodathis job," said Porter. "I keptsaying, 'You're not having aheartattack.'Thenhestoppedtalking.AndIsaid,'Allright,maybe you are.'" Thisactually wasn't all thathelpful. Unsteadily, Dannyturned to Vinny, who hadbeen watching everythingfrom the far end of the long

tradingdeskandwasthinkingaboutcallinganambulance.

"Igottogetoutofhere.Now,"hesaid.

Cornwall Capital's betagainst subprime mortgagebonds had quadrupled itscapital, from a bitmore than$30 million to $135 million,but its three founders neverhad a Champagne moment."Wewerefocusedon,Wheredo we put our money that's

safe?" said Ben Hockett.Before, they had no money.Now,theywererich;buttheyfeared they had no ability topreserve their wealth. Bynature a bit tortured, theywere now, by nurture, evenmore so. They actually spenttime wondering how peoplewho had been sosensationally right (i.e., theythemselves) could preservethe capacity for diffidenceand doubt and uncertainty

that had enabled them to beright. The more sure youwere of yourself and yourjudgment,theharderitwastofind opportunities premisedon the notion that you were,intheend,probablywrong.

The long-shot bet, insome strange way, was ayoung man's game. CharlieLedley and Jamie Mai nolonger felt, or acted, quite soyoung. Charlie now sufferedfrom migraines, and was

consumed with what mighthappennext."I think there issomething fundamentallyscary about our democracy,"saidCharlie."BecauseIthinkpeople have a sense that thesystemisrigged,andit'shardtoargue that it isn't."HeandJamie spent a surprisingamount of their time andenergy thinking up ways toattackwhat theyviewedas adeeply corrupt financialsystem. They cooked up a

plantoseekrevengeupontherating agencies, for instance.They'd form a not-for-profitlegal entity whose solepurpose was to sue Moody'sand S&P, and donate theproceeds to investors wholostmoneyinvestingintriple-A-ratedsecurities.

As Jamie put it, "Ourplan was to go around toinvestors and say, 'You guysdon't know how badly yougot fucked.You guys should

really sue.'" They'd had somany bad experiences withbigWallStreetfirms,andthepeople who depended onthemfortheirliving,thattheyfeared sharing the idea withNew York lawyers. Theydrove up to Portland,Maine,and found a law firm whowould listen to them. "Theywere just like, 'You guys arenuts,'"saidCharlie.Suingtherating agencies for theinaccuracy of their ratings,

theMaine lawyers told them,would be like suing MotorTrendmagazine for pluggingacarthatwoundupcrashing.

Charlie knew aprominent historian offinancial crises, a formerprofessor of his, and took tocalling him. "These callsoftencamelateatnight,"saysthe historian, who preferredto remain anonymous. "Andtheywouldgoonforaprettylong time. I remember he

startedoutbyasking,'DoyouknowwhatamezzanineCDOis?'Andhestarted toexplainto me how it all worked":how Wall Street investmentbanks somehow had connedthe rating agencies intoblessing piles of crappyloans; how this had enabledthe lending of trillions ofdollars to ordinaryAmericans; how the ordinaryAmericans had happilycomplied and told the lies

they needed to tell to obtaintheloans;howthemachinerythat turned the loans intosupposedly riskless securitieswas so complicated thatinvestors had ceased toevaluate risks; how theproblem had grown so bigthat theendwasbound tobecataclysmic and have bigsocial and politicalconsequences. "Hewanted totalk through his reasoning,"said thehistorian,"andsee if

I thought he was nuts. Heasked if the Fed would everbuy mortgages, and I said Ithought that was prettyunlikely. Itwouldhave tobea calamity of colossalproportions for the Fed toever consider doingsomething like that." Whatstruck the distinguishedfinancialhistorian,apartfromthealarmingfactsofthecase,was that...he was hearingthem for the first time from

Charlie Ledley. "Would Ihave ever predicted thatCharlie Ledley would haveanticipated the greatestfinancial crisis since theDepression?"hesaid."No."Itwasn't that Charlie wasstupid;farfromit.ItwasthatCharlie wasn't a moneyperson."He'snotmaterialisticinanyobviousway,"saidtheprofessor."He'snotdrivenbymoney in any obvious way.Hewouldgetangry.Hetook

itpersonally."Evenso,onthemorning

of September 18, 2008,Charlie Ledley was stillcapable of being surprised.He and Jamie did notnormally sit in front of theirBloombergscreensandwatchthe news scroll by, but byWednesday, the seventeenth,that's what they were doing.The losses announced by thebig Wall Street firms onsubprimemortgagebondshad

started huge and keptgrowing. Merrill Lynch,which had begun by sayingthey had $7 billion in losses,nowadmittedthenumberwasover $50 billion. Citigroupappeared to have about $60billion. Morgan Stanley hadits own $9-plus billion hit,andwhoknewwhatbehindit."We'd been wrong in ourinterpretation of what wasgoing on," saidCharlie. "Wehadalwaysassumedthatthey

sold the triple-A CDOs to,like, the Korean FarmersCorporation. The way theywere all blowing up impliedthey hadn't. They'd kept itthemselves."

The big Wall Streetfirms, seemingly so shrewdand self-interested, hadsomehow become the dumbmoney. The people who ranthemdidnotunderstandtheirown businesses, and theirregulators obviously knew

even less. Charlie and Jamiehad always sort of assumedthattherewassomegrown-upin charge of the financialsystemwhomtheyhadnevermet;now,theysawtherewasnot. "We were never insidethe belly of the beast," saidCharlie. "We saw the bodiesbeing carried out. But wewere never inside." ABloomberg News headlinethat caught Jamie's eye, andstuck in his mind: "Senate

Majority Leader on Crisis:NoOneKnowsWhattoDo."

Early on, long before otherscame around to his view oftheworld,MichaelBurryhadnoted how morbid it felt toturn his investment portfoliointo what amounted to a beton the collapse of thefinancial system. It wasn'tuntilafterhe'dmadeafortunefrom that collapse that hebegan to wonder about the

social dimensions of hisfinancial strategy--andwonderifotherpeople'sviewof him might one day be asdistorted as their viewof thefinancialsystemhadbeen.OnJune 19, 2008, three monthsafter the death of BearStearns, Ralph Cioffi andMatthewTannin,thetwomenwho had run Bear Stearns'sbankrupt subprime hedgefunds, were arrested by theFBI, and led away in

handcuffs from their ownhomes.* Late that night,Burrydashedoffane-mailtohis in-house lawyer, SteveDruskin. "Confidentially, thiscase is a pretty big stress forme. I'm worried that I'mvolatileenoughtosendoute-mailsthatcanbetakenoutofcontextinwaysthatcouldgetme in trouble, even if myactions and my ultimateoutcomes are entirelycorrect....Ican'timaginehow

I'd ever tolerate endingup inprison having done nothingwrong but be a bit carelesswithhavingnofilterbetweenmy random thoughts duringtoughtimesandwhatIputinane-mail. InfactI'msooverworried about this thattonight I started to think Ishouldshutthefundsdown."

Hewasnowlookingforreasons to abandon moneymanagement. His investorswere helping him to find

them: He had made them agreatdealofmoney,buttheydid not appear to feelcompensated for the ride hehad taken them on over thepast threeyears.By June30,2008, any investor who hadstuckwithScionCapitalfromits beginning, on November1,2000,hadagain,afterfeesand expenses, of 489.34percent. (The gross gain ofthe fund had been 726percent.) Over the same

period, theS&P500returnedjustabitmorethan2percent.In 2007 alone Burry hadmade his investors $750million--and yet now he hadonly $600 million undermanagement. His investors'requestsfortheirmoneybackcame in hard and fast. Nonew investors called--not asingle one. Nobody calledhimtosolicithisviewsoftheworld, or his predictions forthefuture,either.Sofarashe

could see, no one evenseemedtowanttoknowhowhe had done what he haddone. "We have not beenterriblypopular,"hewrote.

It outraged him that thepeople who got credit forhigher understanding werethose who spent the mosttime currying favor with themedia.No business could bemore objective than moneymanagement,andyeteven inthis business, facts and logic

were overwhelmed by thenebulous social dimension ofthings."ImustsaythatIhavebeenastonishedbyhowmanypeoplenowsay they saw thesubprime meltdown, thecommodities boom, and thefading economy coming,"Burrywrote,inApril2008,tohisremaininginvestors."Andif they don't always say it insomanywords,theydoitbyappearingonTVorextendinginterviews to journalists,

stridently projecting theirown confidence in what willhappen next. And surely,these people would neverhave the nerve to tell youwhat'shappeningnext,iftheywere so horribly wrong onwhat happened last, right?Yet I simply don't recall toomany people agreeing withmeback then." Itwasalmostasifitcountedagainsthimtohave been exactly right--hispresencemadealotofpeople

uncomfortable. A trademagazine published the topseventy-five hedge funds of2007,andScionwasnowhereon it--even though its returnsput itatornear thevery top."It was as if they took oneswimmerintheOlympicsandmadehimswiminaseparatepool," Burry said. "His timewon the gold. But he got nomedal. I honestly think that'swhat killed it for me. I waslookingforsomerecognition.

Therewasnone.I trainedforthe Olympics, and then theytoldmetogoandswimintheretard pool." A few of hisremaining investors askedwhy he hadn't been moreaggressive on the publicrelations--as if that were apartofthebusiness!

In early October 2008,aftertheU.S.governmenthadsteppedin tosayitwould, ineffect,absorballthelossesinthe financial system and

prevent any big Wall Streetfirm from failing, Burry hadstarted to buy stocks withenthusiasm, for the first timeinyears.The stimuluswouldleadinevitablytoinflation,hethought,butalsotoaboominstock prices. He might beearly, of course, and stocksmight fall some before theyrose,but thatdidn'tmatter tohim: The value was nowthere,andthebetwouldworkout in the long run.

Immediately, his biggestremaining investor, who had$150 million in the fund,questioned his judgment andthreatened to pull his moneyout.

On October 27, Burrywrotetooneofhistwoe-mailfriends: "I'm selling off thepositionstonight.IthinkIhita breaking point. I haven'teatentoday,I'mnotsleeping,I'mnot talkingwithmykids,nottalkingwithmywife,I'm

broken. Asperger's has givenmesomegreatgifts,butlife'sbeen too hard for too longbecause of it as well." On aFriday afternoon in earlyNovember,hefeltchestpainsand went to an emergencyroom.Hisbloodpressurehadspiked. "I felt like I amheadingtowardsashortlife,"he wrote. A week later, onNovember 12, he sent hisfinal letter to investors. "Ihave been pushed repeatedly

to the brink by my ownactions, the Fund's investors,business partners, and evenformeremployees,"hewrote."I have always been able topull back and carry on myoften overly intense affairwith this business. Now,however, I am facingpersonal matters that havecarried me irrefutably overthe threshold, and I havecometothesullenrealizationthat I must close down the

Fund." With that, hevanished, leaving a lot ofpeople wondering what hadhappened.

Whathadhappenedwasthat he had been right, theworld had been wrong, andthe world hated him for it.AndsoMichaelBurryendedwhere he began--alone, andcomfortedbyhissolitude.Heremained inside his office inCupertino, California, bigenough for a staff of twenty-

fivepeople,but thefundwasshuttered and the office wasempty.The lastmanoutwasSteve Druskin, and amongDruskin's last acts was tofigure out what to do aboutMichaelBurry'screditdefaultswaps on subprimemortgagebonds."Mikekeptacoupleofthem, just for fun," he said."Just a couple. To see if wecould get paid off in full."Andhehad, though itwasn'tfor fun but vindication: to

prove to the world that theinvestment-grade bonds hehad bet against were indeedentirely without value. Thetwo bets he had saved wereagainst subprime bondscreated back in 2005 byLehman Brothers. They'dgone to zero at roughly thesame time as their creator.Burry hadwagered $100,000or so on each, and made $5million.

The problem, from the

point of view of a lawyerclosing an investment fund,was that these strangecontracts did not expire until2035. The brokers had longsince paid them in full: 100cents on the dollar. NoWallStreet firm even bothered tosend them quotes on thethingsanymore."Idon'tgetastatement from a brokersaying we have an openposition with them," saysDruskin."Butwedo.It'slike

no one wants to talk aboutthis anymore. It's like, 'Allright, you've got your tenmillion dollars. Don't keepharanguingmeaboutit.'"

On Wall Street, thelawyersplaythesameroleasmedicsinwar:Theycomeinafter the shooting is over toclean up the mess. Thirty-year contracts that had someremote technical risk ofrepayment--exactly what thatriskwashewasstilltryingto

determine--was the last ofMichael Burry's mess. "It'spossible the brokers havethrown the contracts away,"Druskin said. "No one threeyears ago expected this tohappenonthebrokerageside.So no one's been trained todeal with this. We've prettymuch said, 'We're going outof business.' And they said,'Okay.'"

By the time Eisman got the

call from Danny Mosessaying that he might behavingaheartattack,andthatheandVinnyandPorterweresitting on the steps of St.Patrick'sCathedral,hewasinthe midst of a slow, almostmenopausal, change. He'dbeen unprepared for his firsthot flash, in the late fall of2007.By then itwasclear tomany that he had been rightandtheyhadbeenwrongandthat he had gotten rich to

boot. He'd gone to aconference put on byMerrillLynch,rightafterthey'dfiredtheir CEO, Stan O'Neal, anddisclosed$20billionorsooftheir$52billioninsubprime-related losses. There he hadsidled up to Merrill's chieffinancial officer, JeffEdwards, the same JeffEdwardsEismanhadtaunted,some months earlier, aboutMerrill Lynch's risk models."You remember what I said

about those risk models ofyours?" Eisman now said. "Iguess I was right, huh?"Instantly, and amazingly, heregrettedhavingsaidit."Ifeltbadaboutit,"saidEisman."Itwas obnoxious. He was alovely guy. He was justwrong. I was no longer theunderdog. And I had toconductmyself in a differentway."

Valerie Feigen watchedin near bewilderment as her

husband acquired, haltingly,in fits and starts, a traitresemblingtact."Therewasavoid after everythinghappened," she said. "Oncehe was proved right, all thisanxietyandangerandenergywent away. And it left thisbigvoid.Hewent on an egothing for a while. He wasreallykindoffullofhimself."Eisman had been so vocalabout the inevitable doomthat all sorts of unlikely

people wanted to hear whathe nowhad to say.After theconference in Las Vegas, hehad come down with aparasite.He'd told the doctorwho treated him that thefinancialworldasweknewitwas about to end. A yearlater, he went back to thesame doctor for acolonoscopy. Stretched outon the table, he hears thedoctor say, "Here's the guywho predicted the crisis!

Come on in and listen tothis." And in the middle ofEisman's colonoscopy, aroomfulofdoctorsandnursesretold the story of Eisman'sgenius.

The story of Eisman'sgeniusquicklygrewoldtohiswife. Long ago she hadestablished a sort of Eismansocial emergency task forcewith her husband's therapist."We beat him up and said,'Youreallyjusthavetoknock

this shit off.' And he got it.And he started being nice.And he liked being nice! Itwas a new experience forhim." All around, she andothers found circumstantialevidence of a changed man.At theChristmaspartyat thebuilding next door, forexample.Shewasn'tplanningto even let Eisman knowabout it, as she never knewwhat he might do or say. "Iwas just kind of trying to

sneak out of our apartment,"she said. "And he stops meandsays, 'Howwill it lookifI don't go?'" The sincerity ofhis concern shocked her intogiving him a chance. "Youcan go, but you have tobehave," she said. To whichEisman replied, "Well, Iknow how to behave now."And so she took him to theChristmas party, and he wasassweetashecouldbe."He'sbecome a pleasure," said

Valerie."Gofigure."That afternoon of

September18,2008, thenewand possibly improvingEisman ambled toward hispartners on the steps of St.Patrick's Cathedral. Gettingplaces on foot always tookhimtoo long."Steve'ssuchafucking slow walker," saidDanny. "He walks like anelephant would walk if anelephant could only takehuman-size steps." The

weatherwasgorgeous--oneofthose rare days where theblue sky reaches downthrough the forest of tallbuildingsandwarmsthesoul."We just sat there," saysDanny, "watching the peoplepass."

Theysat togetheron thecathedralstepsforanhourorso."Aswesat therewewereweirdly calm," said Danny."We felt insulated from thewhole market reality. It was

an out-of-body experience.We just sat and watched thepeople pass and talked aboutwhatmighthappennext.Howmany of these people weregoingtolosetheirjobs?Whowas going to rent thesebuildings, after all the WallStreetfirmshadcollapsed?"

Porter Collins thoughtthat "it was like the worldstopped.We're looking at allthese people and saying,'These people are either

ruinedorabouttoberuined.'"Apart from that, therewasn'tawhole lotofhand-wringinginside FrontPoint. This waswhat they had been waitingfor:totalcollapse.

"Theinvestmentbankingindustry is fucked," Eismanhad said six weeks earlier."These guys are onlybeginning to understand howfuckedtheyare.It'slikebeingascholastic,priortoNewton.Newtoncomesalongandone

morning youwake up: 'Holyshit, I'm wrong!'" LehmanBrothers had vanished,Merrill had surrendered, andGoldman Sachs and MorganStanley were just a weekaway from ceasing to beinvestmentbanks.Investmentbankerswerenotjustfucked:They were extinct. "ThatWall Street has gone downbecause of this is justice,"Eisman said. The only oneamong them who wrestled a

bitwiththeirrole--astheguyswho had made a fortunebetting against their ownsociety--was Vincent Daniel."Vinny, being from Queens,needs to see the dark side ofeverything,"saidEisman.

TowhichVinnyreplied,"The way we thought aboutit,whichwedidn't like,was,'Byshortingthismarketwe'recreating the liquidity to keepthemarketgoing.'"

"It was like feeding the

monster," said Eisman. "Wefed themonster until it blewup."

The monster wasexploding.Yet on the streetsof Manhattan there was nosign anything important hadjusthappened.The force thatwouldaffectallof their liveswas hidden from their view.That was the problem withmoney:Whatpeopledidwithithadconsequences,buttheywere so remote from the

original action that the mindneverconnectedtheonewiththe other. The teaser-rateloans you make to peoplewho will never be able torepay them will go bad notimmediatelybutintwoyears,when their interest rates rise.Thevariousbondsyoumakefrom those loanswill go badnot as the loans go bad butmonths later, after a lot oftedious foreclosures andbankruptciesandforcedsales.

ThevariousCDOsyoumakefrom the bonds will go badnot right then but after sometrusteesortsoutwhethertherewill ever be enough cash topaythemoff.Whereupontheend owner of the CDOreceives a little note, DearSir,We regret to inform youthat your bond no longerexists...But thebiggest lagofall was right here, on thestreets. How long would ittake before the people

walking back and forth infront of St. Patrick'sCathedral figured out whathadjusthappenedtothem?

EPILOGUE

EverythingIsCorrelated

Around the time Eismanandhis partners sat on thesteps of the midtowncathedral,Isatonabanquetteon the east side, waiting forJohnGutfreund,myoldboss,to arrive for lunch, andwondering, among otherthings, why any restaurantwouldseat, sidebyside, twomen without the slightestinterest in touching eachother.

When I published my

book about the financial1980s, the financial 1980sweresupposedtobeending.Ireceived a lot of undeservedcredit for my timing. Thesocial disruption caused bythe collapse of the savingsandloanindustryandtheriseof hostile takeovers andleveraged buyouts had givenway to a brief period ofrecriminations. Just as moststudents at Ohio StateUniversity read Liar's Poker

asahow-tomanual,mostTVand radio interviewers readme as a whistle-blower.(Geraldo Rivera was the bigexception.Heincludedmeina show, along with somechildactorswho'dgoneontobecome drug addicts, called"People Who Succeed TooEarly in Life.") Anti-WallStreet feelings then ran highenough for Rudolph Giulianitofloatapoliticalcareeruponthem,but theresultfeltmore

like a witch hunt than anhonest reappraisal of thefinancial order. The publiclynching of Michael Milken,andthenofSalomonBrothersCEO Gutfreund, wereexcuses for not dealing withthe disturbing forcesunderpinning their rise.DittothecleaningupofWallStreettrading culture. Wall Streetfirms would soon befrowning upon profanity,forcing theirmale employees

to treat women almost asequals, and firing traders forsomuch as glancing at a lapdancer. Bear Stearns andLehman Brothers in 2008more closely resemblednormal corporations withsolid, Middle Americanvalues than did any WallStreetfirmcirca1985.

The changes werecamouflage. They helped todistract outsiders from thetruly profane event: the

growing misalignment ofinterests between the peoplewho trafficked in financialrisk and the wider culture.Thesurfacerippled,butdownbelow, in the depths, thebonus pool remainedundisturbed.

The reason thatAmerican financial culturewas so difficult to change--the reason the politicalprocesswouldprove so slowtoforcechangeuponit,even

after the subprime mortgagecatastrophe--was that it hadtaken so long to create, andits assumptions had becomeso deeply embedded. Therewas an umbilical cordrunningfromthebellyof theexploded beast back to thefinancial1980s.Thecrisisof2008had its rootsnot just inthe subprime loans made in2005 but in ideas that hadhatched in 1985.A friend ofmineinmySalomonBrothers

training program created thefirst mortgage derivative in1986, the year after we leftthe program. ("Derivativesarelikeguns,"hestilllikestosay. "The problem isn't thetools. It's who is using thetools.") ThemezzanineCDOwas invented by MichaelMilken's junk bonddepartment at DrexelBurnham in 1987. The firstmortgage-backed CDO wascreated at Credit Suisse in

2000 by a trader who hadspent his formative years, inthe1980sandearly1990s,inthe Salomon Brothersmortgage department. Hisname was Andy Stone, andalong with his intellectualconnection to the subprimecrisis came a personal one:HewasGregLippmann'sfirstbossonWallStreet.

I'd not seen Gutfreundsince I quit Wall Street. I'dmethim,nervously, acouple

of timeson the trading floor.A few months before I quit,my bosses asked me toexplain to our CEO what atthe time seemed like exotictrades in derivatives I'd donewith aEuropean hedge fund,and I'd tried.He claimed notto be smart enough tounderstand any of it, and IassumedthatwashowaWallStreet CEO showed he wasthe boss, by rising above thedetails. There was no reason

for him to remember any ofthese encounters, and hedidn't: When my book cameout, and became a publicrelations nuisance to him,he'dtoldreporterswe'dnevermet.Overtheyears,I'dheardbits and pieces about him. Iknew that after he'd beenforced to resign fromSalomonBrothers,he'dfallenonhardertimes.Iheard,later,that a few years before ourlunch, he'd sat on a panel

about Wall Street at theColumbia Business School.Whenhisturncametospeak,he advised the students tofind some more meaningfulthing to do with their livesthan go to work on WallStreet. As he began todescribe his career, he'dbrokendownandwept.

When I e-mailedGutfreund to invite him tolunch,hecouldnothavebeenmore polite, or more

gracious. That attitudepersisted as he was escortedto the table, made chitchatwith the owner, and orderedhisfood.He'dlostahalf-step,and was more deliberate inhismovements,butotherwisehe was completelyrecognizable. The sameveneer of courtlinessmaskedthe same animal impulse tosee the world as it is, ratherthanasitshouldbe.

We spent twenty

minutes or so determiningthatourpresenceat thesamelunch table was not going tocause the earth to explode.We discovered a mutualfriend. We agreed that theWallStreetCEOhadno realability to keep track of thefrantic innovation occurringinside his firm. ("I didn'tunderstand all the productlines and they don't either.")We agreed, further, that theCEO of the Wall Street

investment bank hadshockingly little control overhis subordinates. ("They'rebuttering you up and thendoingwhatever thefuck theywant to do.")He thought thecause of the financial crisiswas "simple. Greed on bothsides--greed of investors andthe greed of the bankers." Ithought it was morecomplicated. Greed on WallStreetwasagiven--almostanobligation. The problem was

the system of incentives thatchanneledthegreed.

The line betweengambling and investing isartificial and thin. Thesoundest investment has thedefining trait of a bet (youlosing all of your money inhopesofmakingabitmore),and the wildest speculationhas the salient characteristicof an investment (you mightget your money back withinterest). Maybe the best

definition of "investing" is"gambling with the odds inyour favor." The people ontheshortsideofthesubprimemortgage market hadgambled with the odds intheirfavor.Thepeopleontheotherside--theentirefinancialsystem, essentially--hadgambled with the oddsagainstthem.Uptothispoint,the story of the big shortcould not be simpler.What'sstrange and complicated

about it, however, is thatprettymuchall the importantpeople on both sides of thegamble left the table rich.Steve Eisman and MichaelBurry and the young men atCornwall Capital each madetensofmillionsofdollarsforthemselves, of course. GregLippmann was paid $47millionin2007,although$24millionof itwas in restrictedstockthathecouldnotcollectunless he hung around

Deutsche Bank for a fewmore years. But all of thesepeople hadbeen right; they'dbeen on the winning end ofthe bet. Wing Chau's CDOmanagingbusinesswentbust,but he, too, left with tens ofmillions of dollars--and hadthenervetoattempttocreateabusinessthatwouldbuyup,cheaply, the very samesubprime mortgage bonds inwhich he had lost billions ofdollars' worth of other

people's money. HowieHublerlostmoremoneythanany single trader in thehistory of Wall Street--andyethewaspermitted tokeepthetensofmillionsofdollarshe had made. The CEOs ofeverymajorWall Street firmwere also on the wrong endof the gamble. All of them,without exception, either rantheir public corporations intobankruptcy or were savedfrom bankruptcy by the

United States government.Theyallgotrich,too.

What are the odds thatpeople will make smartdecisionsaboutmoneyiftheydon't need to make smartdecisions--iftheycangetrichmakingdumbdecisions?Theincentives on Wall Streetwere all wrong; they're stillall wrong. But I didn't arguewith JohnGutfreund. Just asyoureverttobeingaboutnineyearsoldwhenyougohome

to visit your parents, yourevert to total subordinationwhenyouareinthepresenceof your former CEO. JohnGutfreund was still the KingofWallStreetand Iwasstilla geek. He spoke indeclarative statements, Ispokeinquestions.Butashespoke, my eyes kept driftingto his hands. His alarminglythick andmeaty hands. Theyweren't the hands of a softWall Street banker but of a

boxer.Ilookedup.Theboxerwas smiling--though it wasless a smile than aplaceholder expression. Andhe was saying, verydeliberately,"Your...fucking...book."

I smiled back, though itwasn'tquiteasmile.

"Whydidyouaskmetolunch?" he asked, thoughpleasantly.Hewasgenuinelycurious.

You can't really tell

someone that you asked himtolunchto lethimknowthatyou didn't think of him asevil.Norcanyoutellhimthatyou asked him to lunchbecause you thought youcould trace the biggestfinancial crisis in the historyof the world back to adecision he had made. JohnGutfreund had done violenceto the Wall Street socialorder--and got himselfdubbed the King of Wall

Street--when, in 1981, he'dturned Salomon Brothersfrom a private partnershipintoWall Street's first publiccorporation.He'd ignored theoutrage of Salomon's retiredpartners.("Iwasdisgustedbyhis materialism," WilliamSalomon, the son of one ofthe firm's founders, who hadmade Gutfreund CEO onlyafter he'd promised never tosell the firm, had told me.)He'd lifted a giant middle

finger in the direction of themoral disapproval of hisfellow Wall Street CEOs.And he'd seized the day. Heand the other partners notonly made a quick killing;they transferred the ultimatefinancial risk fromthemselves to theirshareholders. It didn't, in theend, make a great deal ofsense for the shareholders.(One share of SalomonBrothers, purchased when I

arrived on the trading floor,in 1986, at a then marketpriceof$42,wouldbeworth2.26 shares of Citigrouptoday,which,onthefirstdayof trading in 2010, had acombined market value of$7.48.) But it made fantasticsenseforthebondtraders.

But from that moment,theWallStreetfirmbecameablack box. The shareholderswho financed the risk takinghad no real understanding of

what the risk takers weredoing,and,as the risk takinggrew ever more complex,their understandingdiminished.Allthatwasclearwasthat theprofits tobehadfrom smart people makingcomplicated betsoverwhelmed anything thatcould be had from servicingcustomers, or allocatingcapital to productiveenterprise. The customersbecame, oddly, beside the

point. (Is it any wonder thatmistrust of the sellers by thebuyers in the bond markethad reached the point wherethe buyers could not see aget-rich-quickschemewhenaseller, Greg Lippmann,offeredittothem?)Inthelate1980s and early 1990sSalomon Brothers had entireyears--great years!--in whichfive proprietary traders, theintellectual forefathers ofHowie Hubler, generated

more than the firm's annualprofits. Which is to say thatthe firm's ten thousand or soother employees, as a group,lostmoney.

The moment SalomonBrothers demonstrated thepotentialgainstobehadfromturning an investment bankinto a public corporation andleveraging its balance sheetwith exotic risks, thepsychological foundations ofWallStreetshifted,fromtrust

to blind faith.No investmentbankownedbyitsemployeeswould have leveraged itself35:1,orboughtandheld$50billioninmezzanineCDOs.Idoubt any partnership wouldhave sought to game therating agencies, or leapt intobedwithloansharks,orevenallowed mezzanine CDOs tobe sold to its customers.Theshort-term expected gainwould not have justified thelong-termexpectedloss.

No partnership, for thatmatter,wouldhavehiredme,or anyone remotely like me.Was there ever anycorrelationbetweenanabilityto get into, and out of,Princeton, and a talent fortakingfinancialrisk?

AtthetopofCharlieLedley'slist of concerns, afterCornwall Capital had laid itsbets against subprime loans,was that the powers that be

might step in at any time toprevent individual Americansubprimemortgageborrowersfromfailing.Thepowersthatbe never did that, of course.Instead they stepped in toprevent the failure of the bigWall Street firms that hadcontrived to bankruptthemselvesbymakingalotofdumb bets on subprimeborrowers.

After Bear Stearnsfailed, the government

encouraged J.P. Morgan tobuy it by offering aknockdown price andguaranteeing Bear Stearns'sshakiest assets. Bear Stearnsbondholders were madewhole and its stockholderslost most of their money.Thencamethecollapseofthegovernment-sponsoredentities, Fannie Mae andFreddie Mac, both promptlynationalized. Managementwas replaced, shareholders

badly diluted, and creditorsleft intact but with someuncertainty. Next cameLehmanBrothers,whichwassimply allowed to gobankrupt--whereupon thingsbecame even morecomplicated. At first, theTreasury and the FederalReserveclaimedtheyallowedLehman to fail to send thesignal that recklesslymanaged Wall Street firmsdid not all come with

government guarantees; butthen, when all hell brokeloose, and the market froze,andpeoplestartedsayingthatletting Lehman fail was adumb thing to have done,they changed their story andclaimed they lacked the legalauthority to rescue Lehman.But then AIG failed a fewdays later, or tried to, beforetheFederalReserveextendedit a loanof$85billion--soonincreased to $180 billion--to

cover the losses fromitsbetsonsubprimemortgagebonds.This time the Treasurycharged a lot for the loansand tookmost of the equity.WashingtonMutualfollowed,and was unceremoniouslyseized by the Treasury,wiping out both its creditorsand its shareholders entirely.And then Wachovia failed,and the Treasury and FDICencouraged Citigroup to buyit--again at a knockdown

priceandwithaguaranteeofthebadassets.

Thepeople inapositionto resolve the financial crisiswere, of course, the verysame people who had failedto foresee it: TreasurySecretary Henry Paulson,future Treasury SecretaryTimothy Geithner, FedChairman Ben Bernanke,Goldman Sachs CEO LloydBlankfein, Morgan StanleyCEO John Mack, Citigroup

CEO Vikram Pandit, and soon.A fewWall StreetCEOshadbeen fired for their rolesin the subprime mortgagecatastrophe, but mostremained in their jobs, andthey, of all people, becameimportant charactersoperating behind the closeddoors, trying to figure outwhat to do next. With themwereahandfulofgovernmentofficials--the samegovernment officials who

shouldhaveknownalotmoreaboutwhatWall Street firmswere doing, back when theywere doing it. All shared adistinction: They had provenfar less capable of graspingbasictruthsintheheartoftheU.S. financial system than aone-eyed money managerwithAsperger'ssyndrome.

By late September 2008the nation's highest financialofficial, U.S. TreasurySecretary Henry Paulson,

persuaded the U.S. Congressthatheneeded$700billiontobuysubprimemortgageassetsfrom banks. Thus was bornTARP, which stood forTroubled Asset ReliefProgram. Once handed themoney, Paulson abandonedhis promised strategy andinstead essentially begangiving away billions ofdollars to Citigroup, MorganStanley,GoldmanSachs, anda few others unnaturally

selected for survival. Forinstance, the$13billionAIGowedtoGoldmanSachs,asaresult of its bet on subprimemortgage loans,waspaidoffin full by the U.S.government:100centsonthedollar. These fantastichandouts--plus the implicitgovernment guarantee thatcame with them--not onlyprevented Wall Street firmsfrom failing but spared themfromrecognizingthelossesin

their subprime mortgageportfolios. Even so, justweeksafter receiving its first$25 billion taxpayerinvestment, Citigroupreturned to the Treasury toconfess that--lo!--themarketsstill didn't trust Citigroup tosurvive. In response, onNovember 24, the Treasurygranted another $20 billionfrom TARP and simplyguaranteed $306 billion ofCitigroup's assets. Treasury

didn't ask for a piece of theaction, or managementchanges, or for that matteranything at all except for ateaspoonofout-of-the-moneywarrants and preferred stock.The $306 billion guarantee--nearly2percentofU.S.grossdomestic product, androughly the combinedbudgetsofthedepartmentsofAgriculture, Education,Energy, Homeland Security,Housing and Urban

Development, andTransportation--waspresented undisguised, as agift.TheTreasurydidn'teveractually get around toexplaining what the crisiswas, just that the action wastaken in response toCitigroup's "declining stockprice."

Bythenitwasclearthat$700 billion was a suminsufficient to grapple withthe troubled assets acquired

over the previous few yearsby Wall Street bond traders.That'swhen theU.S.FederalReserve took the shockingand unprecedented step ofbuying bad subprimemortgagebondsdirectlyfromthe banks.By early 2009 therisks and losses associatedwith more than a trilliondollars' worth of badinvestments were transferredfrombigWallStreetfirmstothe U.S. taxpayer. Henry

Paulson and TimothyGeithner both claimed thatthechaosandpaniccausedbythe failure of LehmanBrothers proved to them thatthe system could not toleratethe chaotic failure of anotherbig financial firm. Theyfurther claimed, albeit notuntil months after the fact,thattheyhadlackedthelegalauthority towinddowngiantfinancial firms in an orderlymanner--that is, to put a

bankrupt bank out ofbusiness. Yet even a yearlater they would have donevery little to acquire thatpower. This was curious, asthey obviously weren't shyaboutaskingforpower.

The events on WallStreet in 2008 were soonreframed, not just by WallStreetleadersbutalsobyboththe U.S. Treasury and theFederal Reserve, as a "crisisinconfidence."Asimple,old-

fashioned financial panic,triggered by the failure ofLehmanBrothers.ByAugust2009 the president ofGoldman Sachs, Gary Cohn,even claimed, publicly, thatGoldman Sachs had neveractually needed governmenthelp, as Goldman had beenstrong enough to withstandany temporary panic. Butthere's a difference betweenan old-fashioned financialpanicandwhathadhappened

onWallStreetin2008.Inanold-fashioned panic,perception creates its ownreality: Someone shouts"Fire!" in a crowded theaterandtheaudiencecrusheseachother to death in its rush forthe exits. On Wall Street in2008 the reality finallyoverwhelmed perceptions: Acrowdedtheaterburneddownwith a lot of people still intheir seats. Everymajor firmon Wall Street was either

bankrupt or fatallyintertwined with a bankruptsystem. The problem wasn'tthat Lehman Brothers hadbeen allowed to fail. Theproblem was that LehmanBrothershadbeenallowedtosucceed.

This new regime--freemoney for capitalists, freemarkets for everyone else--plus the more or less instantrewriting of financial historyvexedall sortsofpeople,but

few were as enthusiasticallyvexed as Steve Eisman. Theworld's most powerful andmost highly paid financiershadbeenentirelydiscredited;without governmentintervention every single oneof them would have lost hisjob; and yet those samefinanciers were using thegovernment to enrichthemselves."Icanunderstandwhy Goldman Sachs wouldwant to be included in the

conversationaboutwhattodoabout Wall Street," he said."What I can't understand iswhy anyone would listen tothem." In Eisman's view, theunwillingness of the U.S.government to allow thebankers to fail was less asolutionthanasymptomofastill deeply dysfunctionalfinancial system. Theproblemwasn'tthatthebankswere, in and of themselves,critical to the success of the

U.S. economy. The problem,hefeltcertain,wasthatsomegargantuan, unknown dollaramount of credit defaultswaps had been bought andsold on every one of them."There'snolimittotheriskinthemarket,"hesaid."Abankwith a market capitalizationof one billion dollars mighthave one trillion dollars'worthofcreditdefaultswapsoutstanding. No one knowshowmany there are!Andno

one knows where they are!"Thefailureof,say,Citigroupmight be economicallytolerable. It would triggerlosses to Citigroup'sshareholders, bondholders,and employees--but the sumsinvolved were known to all.Citigroup's failure, however,wouldalso trigger thepayoffofamassivebetofunknowndimensions:frompeoplewhohadsoldcreditdefault swapson Citigroup to those who

hadboughtthem.This was yet another

consequence of turningWallStreetpartnershipsintopubliccorporations: It turned themintoobjectsof speculation. Itwas no longer the social andeconomicrelevanceofabankthatrenderedittoobigtofail,but the number of side betsthathadbeenmadeuponit.

At some point I could nothelp but ask John Gutfreund

about his biggest and mostfateful act: Combing throughthe rubble of the avalanche,the decision to turn theWallStreet partnership into apublic corporation looked alotlikethefirstpebblekickedoff the topof thehill. "Yes,"he said. "They--the heads ofthe otherWall Street firms--allsaidwhatanawfulthingitwas to go public and howcould you do such a thing.Butwhenthetemptationrose,

they all gave in to it." Heagreed, though: The maineffectofturningapartnershipinto a corporation was totransfer the financial risk tothe shareholders. "Whenthings go wrong it's theirproblem," he said--andobviously not theirs alone.When the Wall Streetinvestment bank screwed upbadly enough, its risksbecame the problem of theUnited States government.

"It'slaissez-faireuntilyougetin deep shit," he said,with ahalf chuckle. He was out ofthe game. It was now allsomeoneelse'sfault.

He watched mecuriouslyasIscribbleddownhiswords. "What's this for?"heasked.

I toldhimthat I thoughtit might be worth revisitingthe world I'd described inLiar'sPoker, now that itwasfinally dying. Maybe bring

out a twentieth anniversaryedition.

"That's nauseating," hesaid.

Hardasitwasforhimtoenjoy my company, it washarder for me not to enjoyhis: He was still tough,straight, and blunt as abutcher.He'dhelpedtocreateamonster but he still had inhim a lot of the old WallStreet, where people saidthings like "a man's word is

hisbond."OnthatWallStreetpeopledidn'twalkoutoftheirfirms and cause trouble fortheirformerbossesbywritinga book about them. "No," hesaid, "I think we can agreeaboutthis:Yourfuckingbookdestroyed my career and itmade yours." With that, theformerkingofaformerWallStreetliftedtheplatethatheldhis appetizer and asked,sweetly, "Would you like adeviledegg?"

Until that moment Ihadn'tpaidmuchattention towhathe'dbeeneating.NowIsaw he'd ordered the bestthing in the house, thisgorgeous, frothy confectionof an earlier age. Who everdreamed up the deviled egg?Whoknew that a simple eggcould be made socomplicated, and yet soappealing?Ireachedoverandtook one. Something fornothing. It never loses its

charm.

Acknowledgments

My editor at the nowdeceased Portfolio, KylePope, encouraged me at thestart,asIsetofftoretracemysteps back to Wall Street.Brandon Adams generouslyoffered his help digging outstrange facts and figures andproved to be so smart aboutthe subject that I half-wondered if perhaps he,insteadofI,shouldbewritingthe book. Among othertreasuresheunearthedwasA.

K. Barnett-Hart, a Harvardundergraduate who had justwritten a thesis about themarket for subprimemortgage-backed CDOs thatremainsmoreinterestingthanany single piece of WallStreetresearchonthesubject.MarcRosenthalservedasmyjungle guide in thenetherworld of subprimelending, and the innerworkings of the ratingagencies' models, and could

nothavebeenmoregenerouswith his time or his insight.Al Zuckerman, at WritersHouse, represented this bookably, as he has my others.Severalpeoplereadallorpartofthismanuscriptandoffereduseful advice: John Seo,Doug Stumpf, my father,Tom Lewis, and my wife,Tabitha Soren. Janet Byrneperformed an almoststartlingly thorough,energetic, and intelligent job

copyediting the manuscript,andalsoprovedtobeanidealreader. Starling Lawrence atW. W. Norton, who hasedited all but one of mybooks, andwho editedLiar'sPoker,washisusualwiseandwonderfulself.

I've found it impossibleto write a decent nonfictionnarrative without unusuallydeep cooperation from mysubjects. Steve Eisman,Michael Burry, Charlie

Ledley, Jamie Mai, VincentDaniel, DannyMoses, PorterCollins, and Ben Hockettallowed me to enter theirlives.Atsomeunquantifiablerisk to themselves, theysharedwithmetheirthoughtsand feelings. For that I'meternallygrateful.

*UnitedJewishAppeal.

* ISDA had been createdbackin1986,bymybossesatSalomon Brothers, to dealwith the immediate problemof an innovation called aninterest rate swap. Whatseemedlikeasimpletradetothepeopledoingit--Ipayyoua fixed rate of interest inexchangeforyourpayingme

a floating rate--wound upneedingablizzardofrules togovern it. Beneath the ruleswas the simple fear that theparty on the other side of aWallStreetfirm'sinterestrateswap might go bust and failto pay off its bets. Theinterest rate swap, like thecredit default swap, exposedWall Street firms to otherpeople's credit, and otherpeople to the credit of WallStreetfirms,innewways.

* The two major ratingagencies employ slightlydifferent terminology toconvey the same idea. WhatStandard&Poor'sdenotesasAAA, for instance, Moody'sdenotes as Aaa, but bothtermsdescribeabondjudgedto have the least risk ofdefault.Forsimplicity'ssake,

thetextwilluseonlytheS&Pterms, and AAA will becalledtriple-A,andsoforth.In2008,whentheratingsofagiantpileofsubprime-relatedbonds proved meaningless,their intendedmeaningswerehotly disputed. Wall Streetinvestorshadlonginterpretedthem to mean the odds ofdefault. For instance, a bondratedtriple-Ahistoricallyhadless than a 1-in-10,000chance of defaulting in its

first year of existence. Abond rated double-A--thenexthighestrating--stoodlessthan a 1-in-1,000 chance ofdefault, and a bond ratedtriple-B, less than a 1-in-500chance of default. In 2008,the rating agencies wouldclaim that they neverintended for their ratings tobe taken as such precisemeasurements. Ratings weremerely the agencies' bestguess at a rank ordering of

risk.

* These losses turned notonlyonhowmanyborrowersdefaulted,butalsoonthecostofeachdefault.Afterall, thelender held the collateral ofthehouse.Asaruleofthumb,in the event of default, thelender collected roughly 50cents on the dollar. And soroughly 16 percent of the

borrowersinamortgagepoolneededtodefaultforthepoolto experience losses of 8percent.

*The story of how andwhythey did this has beenpainstakingly told byFinancial Times journalistGillian Tett, in her bookFool'sGold.

* London Interbank OfferedRate--the interest rate atwhichbankswilllendmoneyto each other. Once thoughtmore or less riskless, it isnow,moreorless,not.

* Dear Reader: If you havefollowed the story this far,you deserve not only a goldstar but an answer to acomplicatedquestion:IfMikeBurry was the only onebuying credit default swapsonsubprimemortgagebonds,and he bought a billiondollars' worth of them, who

took the other $19 billion orso on the short side of thetrade with AIG? The answeris,first,MikeBurrysoonwasjoined by others, includingGoldmanSachs itself--andsoGoldmanwas in the positionof selling bonds to itscustomerscreatedby itsowntraders, so they might betagainst them.Secondly, therewasacrude,messy,slow,butacceptablesubstituteforMikeBurry's credit default swaps:

the actual cash bonds.According to a formerGoldman derivatives trader,Goldman would buy thetriple-A tranche of someCDO, pair it off with thecreditdefaultswapsAIGsoldGoldman that insured thetranche (at a costwell belowthe yield on the tranche),declare the entire packagerisk-free, and hold it off itsbalance sheet. Of course, thewhole thing wasn't risk-free:

If AIG went bust, theinsurancewasworthless, andGoldman could loseeverything. Today GoldmanSachs is, to put it mildly,unhelpful when asked toexplain exactly what it did,and this lack of transparencyextends to its ownshareholders. "If a team offorensic accountants wentoverGoldman'sbooks,they'dbe shocked at just how goodGoldmanisathidingthings,"

says one former AIG FPemployee, who helped tounravel the mess, and whowas intimate with hisGoldmancounterparts.

* Zelman alienated herWallStreet employer with herpessimism, and finally quitandsetupherownconsultingfirm. "It wasn't that hard inhindsight to see it," shesays."It was very hard to knowwhen itwould stop."Zelmanspoke occasionally withEisman,andalwaysleftthese

conversations feeling betterabout her views, and worseabouttheworld."Youneededthe occasional assurance thatyouweren'tnuts,"shesays.

* Confusingly, subprimemortgagebondsareclassifiednot as mortgage bonds but,along with bonds backed bycredit card loans, auto loans,and other,wackier collateral,as"asset-backedsecurities."

*Evennow,afterthedeathofLehman Brothers,LehmanLive remains theghostly go-to source for thecontentsofmanyCDOs.

* When the market cracked,Devaney went bust and wasforced to sell his yacht, hisplane, and his Renoir (for anice profit) and defendhimself against several nastynewspaper articles. "It takesanhonest individual toadmitthathewaswrong,"hewrote,in one of several rambling

letters released over the PRNewswire. "I was long in2007andwaswrong.""He was incredibly cynicalabout the market," saidCharlie."Andhe lostmoney.Ineverfiguredthatout."

*Twoyearslater,LasVegaswould lead the nation in itsrateofhomeforeclosures.

*InLasVegastheyalsometwith David Wells, who ransubprime lending for acompany called FremontInvestment & Loan. Wellsalso said he expected lossesto run 5 percent. InSeptember,ninemonthslater,Fremontwouldannouncethat30 percent of its subprime

loans were in default. Itspoolsof loanswould registerlosseshigherthan40percent--which is to say that, evenafter it sold the houses itforeclosed upon, it was outnearly half the money itloaned.

*The"spread"onanybondissimplythedifferencebetweentheinterestrate itpaysto theinvestor,andsomeputativelyrisk-free rate--say, the ratepaid to investors in U.S.Treasurybonds.

* A brief reminder: Inthinking about these towersofdebt,it'shandytosimplifythem into three floors: abasement,calledthe"equity,"which takes the very firstlosses and is not aninvestment-grade security;the lower floor, called the"mezzanine," with triple-B

rating; and the upper floor,with triple-A rating, andgenerally referred to as the"senior." In practice, thetowers were far more finelysliced: a CDO might havefifteen different tranches,eachwith a slightly differentrating, from triple-B-minusall the way up to triple-A:triple-B-minus, triple-B, A-minus, A, and so on. Thedouble-A rating of thetranche shorted by Cornwall

Capital implied that theunderlying bonds, thoughslightly more risky thansupposedlygold-platedtriple-As, still had a less than 1percentchanceofdefaulting.

*AspokesmanforS&Platerdoubted that any S&Pemployee would ever havesaid such a thing, as theirmodel was capable ofhandlingnegativenumbers.

* On October 22, 2008, aformer S&P subprimemortgagebondanalystnamedFrank Raiter would testifybefore the Committee onOversight and GovernmentReform that the S&Pmanaging director in chargeof the surveillance ofsubprime mortgage bonds

"did not believe loan-leveldata was necessary and thathadtheeffectofquashingallrequestsforfundstobuildin-house data bases." Raiterintroduced an e-mail fromS&P's managing director ofCDO ratings, RichardGugliada, in which Gugliadasaid: "Any request for loan-level tapes is TOTALLYUNREASONABLE!! Mostoriginators don't have it andcan't provide it. Nevertheless

we MUST produce a creditestimate.... It is yourresponsibility to providethose credit estimates andyour responsibility to devisesomemethodtodoso."

*AConnecticut-basedhedgefund that lost $6.8 billion inbets on natural gas in early2006 and blew up inspectacularfashion.

*Thedistinctionhadbecomesuperficial. Alt-A borrowershadFICOcreditscoresabove680; subprimeborrowershadFICO scores below680.Alt-A loans were poorlydocumented, however; theborrower would fail toprovide proof of income, forinstance. In practice, Alt-A

mortgage loans made in theUnited States between 2004and2008totaling$1.2trillionwere as likely to default assubprime loans totaling $1.8trillion.

*Asilentsecondisasecondmortgage used, in thepurchase of a house, tosupplement a first mortgage.It is silent only to the guywhomade the first loan, andwho is less likely to berepaid,astheborrowerislesslikely to have any financialstakeatallinhisownhome.

* Just about everyoneinvolved in the financialcrisisstands to losemoney ifhe is caught talking aboutwhat he saw and did.Obviously those stillemployed at the big WallStreet firms, but even thosewho havemoved on, as theyhave typically signed some

nondisclosure agreement.Morgan Stanley's formeremployees are not quite asspookedasthosewhoworkedatGoldmanSachs,butthey'reclose.

* Of all the conflicts ofinterests inside aWall Streetbond trading firm, here wasboth themost pernicious andleast discussed.When a firmmakes bets on stocks andbonds for its own account atthe same time that it brokersthem to customers, it facesgreat pressure to use its

customersforthepurposesofits own account. Wall Streetfirms like to say they buildChinese walls to keepinformation about customertrading from leaking to theirown proprietary traders.VincentDaniel of FrontPointPartners offered the mostsuccinct response to thispretense: "When I hear'Chinesewall,'Ithink,You'reafuckingliar."

*Hereit'susefultorememberthat selling a credit defaultswap on a thing leaves youwith the same financial riskas if you owned it. If thetriple-A CDO ends up beingworthzero,youlosethesameamountwhetheryouboughtitoutright or sold a creditdefaultswaponit.

* The timing of Goldman'sdeparture from the subprimemarket is interesting. Longafterthefact,Goldmanwouldclaim it hadmade thatmoveinDecember2006.Tradersatbig Wall Street firms whodealt with Goldman feltcertain that the firm did notreverse itself until the spring

and early summer of 2007,after New Century, thenation's biggest subprimelender, filed for bankruptcy.If this is indeed whenGoldman "got short," itwould explain the chaos inboththesubprimemarketandGoldmanSachs,perceivedbyMikeBurryandothers,inlateJune.GoldmanSachsdidnotleave the house before itbegan to burn; itwasmerelythe first to dash through the

exit--and then it closed thedoorbehindit.

*Thereissomedisputeaboutthe conversations betweenHublerandCruz.Theversionof events offered by peopleclose toZoeCruz is that shewas worried about the legalrisk of doing business withBearStearns'stroubledhedgefunds, and that Hubler nevercompletelyexplained therisk

of triple-A-rated CDOs toher, and led her to believethatMorganStanleystoodnochance of suffering a hugeloss--probably becauseHubler himself didn'tunderstand the risk. Hubler'sfriendsclaimthatCruzseizedeffective control of Hubler'stradeandpreventedhimfromditchingsome largechunkofhis triple-A CDOs. In myview,andintheviewofWallStreet traders, Hubler's story

line is far less plausible."There's no fucking way hesaid, 'I have to get out now'and she said no," says onetrader close to the situation."NowayHowieeversaid, 'Ifwe don't get out now wemightlosetenbilliondollars.'Howie presented her with acasefornotgettingout."Theability ofWall Street tradersto see themselves in theirsuccess and theirmanagement in their failure

would later be echoed,whentheir firms, which disdainedthe need for governmentregulation in good times,insisted on being rescued bygovernment in bad times.Success was individualachievement; failure was asocialproblem.

* It's toomuch to expect thepeople who run big WallStreet firms to speak plainEnglish, since so much oftheir livelihood depends onpeople believing that whatthey do cannot be translatedintoplainEnglish.WhatJohnMack's trying to say,withoutcoming right out and saying

that no one else at MorganStanleyhadacluewhatrisksHowieHublerwasrunning,isthat no one else at MorganStanleyhadacluewhatrisksHowie Hubler was running--and neither did HowieHubler.

+ Another way to put thesame question: How couldHowieHubler'sbondsplungefrom100to7andthereportsyoureceivedstillsuggestthatthey were incapable ofdramaticmovement?

* It's interesting to imaginehow the disaster might haveplayed out if AIG FP hadsimply continued to take allthe risk. If Wall Street,following Goldman Sachs'slead, had dumped all of therisk of subprime mortgagebonds into AIG FP, theproblem might well have

been classified as havingnothing to do with WallStreet and as being the soleresponsibility of this bizarreinsurancecompany.

*Laterrevisedtoabout$10ashare.

* The case brought by theU.S. Department of Justiceagainst Cioffi and Tanninsought to prove that the twomenhadknowinglydeceivedtheir investors, overlookingthe possibility that theysimplyhadnoideawhattheywere doing, and failed tograsptherealriskofatriple-

A-rated subprime-backedCDO. The case was weak,and turned on a couple of e-mails obviously ripped fromcontext. A member of thejury that voted to acquit theBear Stearns subprime bondtraders toldBloombergNewsafterward not only that shethoughttheywereinnocentascharged but that she wouldhappily invest money withthem.