Book Excerpt: Confidence Game - How A Hedge Fund Manager Called Wall Street’s Bluff

One of the questions being asked in the wake of the financial collapse is whether credit-default swaps should be done away with altogether.


Excerpted with permission of the publisher John Wiley & Sons, Inc. from Confidence Game: How A Hedge Fund Manager Called Wall Street’s Bluff by Christine Richard. Copyright (c) 2010 by Christine Richard. One of the questions being asked in the wake of the financial collapse is whether credit-default swaps should be done away with altogether. Should people be able to make vast profits on the collapse of a company?

Charlie Munger, Warren Buffett’s business partner, thinks there is something wrong in that: “Do you think it would be desirable if everybody in America could buy life insurance on any person they wanted to buy life insurance on?” Munger told Bloomberg News during an interview at the 2009 Berkshire Hathaway meeting. “That would be pretty dangerous for the person who was insured. Some of that danger exists once you get people who have a vested interest in the destruction of some business.”

Confidence Game

Confidence Game

There’s no doubt that these instruments were at the center of the collapse of the financial system—but not because skeptics used these instruments to destroy good companies. Credit-default swaps allowed banks to become very cynical in their lending practices. Firms such as Citigroup and Merrill Lynch were able to create complex securities backed by recklessly underwritten mortgages, knowing that they could pass the risk along to someone else who had less information about the underlying loans. In the end, the $62 trillion CDS market allowed Wall Street to lend without having confidence in the men and women it lent to. Wall Street hedged away the risk of lending and in the process undermined the entire system.

“Where is the conspiracy?” Jim Chanos, the investor who made his name shorting Enron before it collapsed, asks me as we sit in his office on an April afternoon in 2009. We are discussing the allegations that short sellers brought down financial firms in the summer of 2008. “To trade or to induce others to trade on information you know to be false. That’s market manipulation and securities fraud. That’s what puts you in jail,” Chanos says. Otherwise, “if you are a public company, if you trade in the public markets, expect scrutiny.”

Certainly, we all would have benefited had more investors scrutinized the reckless way in which many financial firms were piling up debt. Meanwhile, there was no shortage of lawyers, auditors, and credit-rating analysts who earned a living helping to construct rickety financial structures. On a shelf behind Chanos’s desk is a model of a house of cards under construction; at second glance, I notice that it is surrounded by a miniature scaffolding.

Some people did benefit from Ackman’s very vocal scrutiny, and not all were wealthy hedge fund investors: “You may remember that about a year ago you, Karen and I went trekking up and down the lovely spring-fresh hills of the Berkshires,” a letter Ackman received in May 2009 began. It was from the former MBIA employee turned hiking guide at Canyon Ranch.

“Though I may have sounded a bit skeptical of your views at the time, I took it all in and within a week of our discussion I had eliminated my personal position in the company,” he wrote. “For the record, my average transaction price was between $59 and $60 per share.” The day the letter was written, MBIA shares closed at $8.12. The letter arrived with two bottles of wine and a $250 check for Pershing Square Foundation.

Christine Richard

Christine Richard

Christine S. Richard is a Bloomberg News reporter whose work has been recognized by The New York Press Club and The Newswomen’s Club of New York. She has covered financial markets for 17 years from Washington, Hong Kong, Singapore and New York.