When Mark Baum finds out about Morgan Stanley’s $15 Billion loss.

In the movie The Big Short, Kathy Tao explains to Mark Baum why Morgan Stanley has made $15 Billion losses during the crisis. During her explanation, she mentions Benny Kleeger. Benny Kleeger is a movie name; in reality, the real name of that person is Howie Hubler. 

Worst Trade In The Big Short

Howie Hubler was a bond trader at Morgan Stanley, and during the 2008 crisis, he made one of the worst trades in history. His trade was the number one trade until 2021 for losing the most money in a single trade. Overall, Morgan Stanley suffered $58 billion in losses, of which $9 billion came from Howie Hubler alone. 

What exactly did Howie Hubler do? 

Howie Hubler worked as a bond trader at Morgan Stanley for over a decade. In 2004, he got very suspicious about some of the BBB rated tranches in mortgage bonds, and he thought that they would fail. He needed to make money from those bonds by betting against them.

So, he bought credit default swaps on those BBB rated tranches, expecting them to fail. By 2005, he had bought $2 billion worth of credit default swaps on those BBB rated tranches. So, he had to pay around a $200 million premium on those swaps until those BBB rated tranches failed. Those premium payments reduced his overall profits from other trading activities. 

Howie didn’t like that the swap premiums were reducing his profit share. So, to solve this cash flow problem, he thought the AAA rated tranches of bonds were safe and would never fail. So, he started selling the credit default swaps on those AAA rated tranches of the bonds. But as those swaps were sold on the AAA rated tranches of bonds, which were considered very safe. So, the premium he would get for a single credit default swap was much less.

So, in order to balance the outgoing cash flow of $200 million, he needed to sell 10 times more swaps than the swaps he bought for BBB rated bonds. This resulted in Morgan Stanley owing around $16 billion to those AAA rated swap buyers. Basically, the exposure to AAA tranches was around $16 billion. 

But all these mortgage bonds and CDOs were filled with worthless loans that were given inflated ratings by the rating agencies. So, if BBB rated tranches of bonds were worthless, then AAA rated tranches were also worthless, as they were rated falsely. So, eventually, when the BBB rated tranches of bonds failed, the AAA rated tranches also failed.

Howie Hubler made a profit of $2 billion on his bet against the BBB rated tranches. But the long positions he sold on AAA rated tranches incurred huge losses of $16 Billion

Mark Baum Betting Against Morgan Stanley

The Cornwell Capital guys, Michael Burry and Mark Baum, were aware that all tranches of these bonds were worthless. So, they had a bet against these AAA rated bonds, which were sold by Howie Hubler. That’s why Mark Baum says, “All this time, I was betting against Morgan Stanley”.

Greg Lippmann aka Jared Vennett

When Howie Hubler sold these swaps on AAA rated tranches. The other bond sellers on Wall Street thought it was risk-free. During the deal with the Merrill Lynch bond trader, Hubler wanted them to pay him 28% interest, which amounted to an $800,000 premium per year. But the bond trader at Merrill Lynch was ready to pay him 24%. So, their deal didn’t go through.

When, with a similar offer, Hubler went to Deutsche Bank, Greg Lippmann, aka Jared Vennet, at Deutsche Bank knew that all the tranches of CDOs were worthless and they were all going to fail. So, he gave Hubler his 28% rate and bought $4 billion worth of swaps on those AAA rated bonds. 

When these AAA rated bonds failed, Deutsche Bank made $1.2 billion in profits. Because of such high-paying trades, Greg Lippmann, aka Jared Vennett, made a $1.5 billion profit for Deutsche Bank, which ultimately paid him a $47 million Paychex. You can watch this video to learn more about Jared Vennett and subscribe to the channel to learn more about money.

Total loss of Morgan Stanley

From the $4 billion worth of swaps sold to Deutsche Bank, Morgan Stanley suffered a loss of $3.7 Billion dollars. Howie Hubler also sold $2 billion worth of swaps on AAA rated bonds to UBS Bank and $1 billion worth of swaps to the second-biggest bank in Japan. Which reduced Howie’s total exposure from $16 billion to $13 billion. 

Morgan Stanley had to pay other swap buyers as they did to Deutsche Bank. Howie’s bet against BBB rated bonds did make some profit. But because the exposure to AAA swaps was much greater in total, his trade made a loss of $9.2 billion. A few months after Howie’s bad trade, Morgan Stanley posted a loss of $38 billion. This is how one of the worst trades in the history of Wall Street happened.

Conclusion

But if you look from a broader perspective, Howie Hubler correctly anticipated the failure of these bonds, but he didn’t figure out the depth of the problem like Michael Burry, Mark Baum, and Jared Vennett did. If he had figured out like these guys, Howie Hubler could have been one of the top earners during the 2008 crisis. 

If you want to know more about the 2008 crisis and The Big Short, then check out this playlist. 

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