Hello, and welcome to the latest edition of the Odd Lots Podcast. I'm Joe Wisenthal, Managing editor at Bloomberg Market. My co host Tracy Alloway is away again this week, but fortunately she is going to be back next week. But since she's out, we're doing another special episode or unusual episode. I wanted to talk to one of my colleagues here at Bloomberg who wrote a fantastic news story that I absolutely love entitled the Big Long making a
killing in the market everyone left for dead. It's about the people who made a fortune by going long risky assets down at the worst part during the worst period of the financial crisis. So essentially the opposite of the big short. So um, without further ado, I want to get right into it. I'm here with Alastair Marsh who wrote this story. Alistair, thank you very much for joining us. Thanks having me on. Let's give the quick round up.
What's your story about? Who were these investors who were bold enough to go along very risky assets right at the bottom of January two thousand nine. Who were they and what was their bad sure were They were trading asset back securities for a UK bank called h Boss H BOSS has a very interesting history in the UK. In fact that one of the most controversial ones, you might say, UM, ultimately collapsed back into the end of
two thousand and eight. It had a government bail out, it had a secret cash infusion from the Central Bank, and ultimately was taken over by Lloyd's Bank. So while all this UM was happening in the in the background, you had these two traders at h BOSS called Melam Patel and Richard Paddle, who had spent the last ten
years or so trading A B S every day. And when the crisis hit, A B S the asset back security is and these were the securities that were tied to mortgages mostly that everybody has come to know and understand. We're sort of a key variable in the financial crisis exactly. Yeah, these were typically backed by so these were bonds backed by mortgages in the UK, typically UM, and they were trading these for ten years or so. For most of
that time, these were considered a relatively vanilla product. Most of them were rated triple A, and it all seemed like a good and safest houses, so to speak, kind of bet. The title of your story is called The Big Long obviously a reference to the Big Short, So explain what they did in this trade and how it was sort of the mirror opposite of the Big Short trade. Sure,
there as many kind of paradles to the Big Shot. Effectively, the Big Short was saying that, um, the housing market is going to collapse, and these subprime mortgage bonds are priced at crazy levels that don't imply that collapse. Well, they had the opposite view that in the UK the housing market was not going to collapse, and that the mortgage bonds in the UK implied that the mortgage market had collapsed or was about too, and they believed it wasn't.
And they believed that the same kind of massful closures that we saw in the US, or the same spike in mortgage you is, was it wasn't going to happen in the UK. And obviously they they ultimately turned out to be correct. So anyone who's seen the movie or read the book The Big Short knows that it wasn't just enough to have a negative view on housing or asset values, but that these trades were not trivial to exercise.
They were complicated to structure. In the case of the story you reported, on, there were difficulties and complications in executing the opposite trade. What did they have to do to express their view on these assets? Sure? What the biggest difference between the two, leaving aside one was short and one was long, was that the short bet. These were mainly institutional investors, hedge funds and others trying to do this, but the big long These guys whilst they
were traders by profession, they worked for a bank. Actually they used there, they put up their own money. This was a kind of Ultimately they were retail investors and so they had to go They had to first get compliance from the bank and they managed to get this.
It's what's quite interesting and I've I've had feedback from a number of people in their ASBAC securities market here in the UK who are quite indignant that these guys were able to do this because they whilst working at various other banks, wish that they had had the opportunity
they were permitted to do so as well. But anyway, they they they had to ask compliance that that they managed to get that, and then they had to go to the retail broker and say I want to buy a BS please, and the retail broke would say, you want to buy what typically there are? These are retail brokers that are typically used to selling vanilla bond and stocks. Right, they're not acid back securities or the sort of more
complicated stuff that institutional traders trade, right exactly. Yeah, that they be the kind of thing like I want to buy BP shares or I want to sell bark these shares please. So asking for triple B granite bonds, for example, which is what their best trade was, was virtually unheard of, and they had to explain to these to the basically
called a call center in Glasgow. For some reason, in the UK, most of our call center operators are based in Scotland because there's something to do with the Scottish accent that's kind of soothing or something like that. Is that is that really a thing? That's really a thing called most most banks, which boards, etcetera. It's always in
Scotland anyway. So they call them, they call Glasgow, they're they're on the phone for two hours and they have to explain not only what they want, um, what it is, how it works, but also kind of where they can get it and in some cases who to call to get it. So for the A B s, they because they're sitting at the Bloomberg, they have all context in the market. They know that, for example, Morgan Stanley has got these bonds, so they know that Credit Swiss has
got those bonds. So they'd say, cool this guy, Morgan Stanley, please and get me these bonds. So basically they are doing the job before the retailer. I love this because there because their institutional traders, they know everything there is to know about what they're trading. But because they, for this weird quirk, were forced to go through a retail
brokerage to make these purchases. They had to sit there on the phone and walk the broker through the trade exactly so Melan Melan Patel said that he would while sitting at his desk, he'd be on hold or be listening to the Beethoven Symphony and then in the background whilst the cool center person tried to work out what it was and how to how to get hold of it. But but ultimately these retail brokers were able to do the mechanics of buying these assets and getting them into
their accounts. Ultimately, yes, but it was very painful. That was It was it, but it was very painful. Now, do the stories of these two traders, Patel and Paddle, do they sort of undermine a common argument? I mean, the view is, I think in popular culture and probably expressed by the books and movies, that the people trading these assets had no idea what they were trading. They had no idea what was in them. Everyone on Wall Street was kind of stupid and there were only a
few smart people. But does their experience show that actually a lot of the traders really did understand them and were at least more aware of what was in these assets than popular culture is depicted. Well, they certainly knew them, and there's no basically they The way they explained it is that they were trading for ten years. They knew the names of the bonds, that knew how they were structed, They knew were to buy them, who to sell them to, So they knew the market at the back of their hand.
And it kind of stands to reason that the same thing would be true of other traders and other institutions. Now that's not to say that they weren't kind of egregious things done in very very various times of various places, but it stands to reason that people who trade these products every day, and these are not simple products, are very complicated. That's why it took them so long to get it through the their brokers. Um, you know, they should know the risk, they should know what's backing them.
They should know what the mortgages are like, they should know the chances of um you know that the arrears history. They but it should know that stuff. But it does seem like the way people talk about this period always is very black or white. There's a few people that were warning and then all of the other people were cheap and not, you know, not paying attention to the risks at all. And it sounds like it's not quite
that simple. Yeah, that's true. And actually I think in some of the pages of The Big Short, actually it implies that some of the guys in the investment banks didn't know what they were doing. They were just hoping that the a merry go round to go on for a little bit longer than it did, so he knew what was in there. Of course, one of the things that makes The Big Short such a compelling story it just the jaw dropping returns that those traders got in the amount of money they made talk to me about
how well these two traders did. Well. They didn't do anything um on the scale of the big shot. They didn't become billionaires and they didn't become billionaires no, um, I think well that they were. They didn't give they didn't disclose fully the numbers. We had to do some calculations here, but we we estimated that Buttel made about one point too million pounds, which is not bad return that the best they put he put forward, we reckoned about four fifty thou pounds um. Their best return was
on bonds called Granite. These were sort of controversial and central to the whole thing. Tell us about the Granite bonds. Well, Grantite we're backed by mortgages from UK Bank called Northern Rock, and Northern Rock is probably the closest thing we had in the UK to sub prime and the bank basically massively over leveraged um Well. It had a huge residential mortgage backed securities program and which was called Granite and allowed it to fund fifty billion pounds worth of mortgage lending.
Ultimately it succumbed to the first bank run in the UK in a hundred and forty years. So the I remember the scenes of watching people queuing outside of Northern Rock branches on the high streets of various towns across the UK. That that that sort of that is almost as iconic as the images of the Lehman Brothers bankers leaving the building with the you know, their crates and so on and so so. Northern Rock is a very kind of controversial and um institution, and it was bailed
out by the UK government. Um. But granite bonds because they were sold, I mean without going to all the technicalities of securitization. They were sold by a separate vehicle that continue to exist once Northern Rock didn't. In the story you quote Paddle is saying, quote there was a concern in the market that the UK government would rip it up. What did that mean that they would theoretically pay nothing in the end? Yeah, well they they bought these bonds. So they were initially sold at a hundred
pence on the pound. They brought them eightpence, So now this was discount. Yeah. Um, Now that that was for the riskiest bonds, the ones that were first in line to take losses. Um. But even so, that's that's kind of huge decline and the view was simply that basically it was down to political risk that the UK government having taken over the institution. I don't think we've had a nationalization like that in well in anyone's memory. Um,
what's going to happen? This is unprecedented. Are they just going to say, do you know what, we're not paying those bonds back. This bank doesn't have enough money, We're not going to pay. Why did they feel confident that the government would not rebub those bonds? Well they didn't actually, but what there basically their view was that m mathematically it worked out that they should get at least get their money back. So they bought eight pence on the pound.
And I think the way they described by the way they described it to me was that it would take about two years for the granite structure to be unwound, as in it's quite a complicated structure and lots of mortgages behind it, and soon it would take about two years in their calculations to unwind. And in that period they should have two years of five coupons, so ten, so they should get ten back having put eight in.
So that was their very kind of basic bet. Obviously, they then had a huge huge price rally, so that that's where the huge returns came from. But at that point they were just thinking. Yeah. So in you have this chart that obviously the list a nurse to the podcast can't see, but I'm looking at it right now, and it shows that they bought in around eight and then they sold around sixty. But actually the bonds continued
to rally. Uh what well, uh, you know, there's a little bit of volatility, but they actually rallied much more even after they sold them. Yeah, that's right, um, and I did, Austin, why didn't you try to hold on? Because actually they were redeemed in January and December so that they don't exist anymore and they were paid back at pass so at one. That's just let's just pause right there. How unbelievable that is that you know that we all remember these bonds, these first in line losses
from two thousand eight and two thousand nine. I don't even think that got much attention that in ten they had essentially recovered a hundred percent of their value. Not that they recovered some, but virtually the entire thing. I think that part is almost entirely unknown to people. Yeah, it's pretty unbelievable really, Um, but they said or Patel specifically said that his start of investing is not to try to time the top and not to try to
hold on for the last or so. But having gone from eight to seventy or sixty, he thought, you know what, that's a pretty good return. I'll take that. And actually, at the time they sold out, which was about eleven, it wasn't clear at all that the UK government was going to sell them. That's that's why they were deemed because the government sold them, but it wasn't clear at all that was going to happen at that point. So yeah, so no reason to get greedy. Eight to sixty is
a pretty a pretty nice return, isn't it. Yeah. Um, let's let's look big picture for a second. Um. You know one thing I want I'm always curious about is um the sort of psychology of trading, making a making a bed, or making a trade that's the exact opposite of how the market sees like, basically, having the guts to make a call that's different from what everyone around you is um calling for. And it seems to me that bears, they're always bears, are always people who think
the world is coming to an end. There are always people who are predicting doom, and that sort of accepted. People just accept that there's going to be negative people out there. But in a way, optimism in the face of panic actually strikes me as much more brave, because no one likes to hear someone called a perma ball, or people mock the balls. People have an intellectual respect for negative people. How does that? What's your view on that?
Do you think that like that this view that they expressed was particularly brave and gutsy given the prevailing negative sentiment at the time. I think it was, and especially when you think about the very place where they were sitting that when they put these trades on, or when they first asked permission to do that. That was in January two thousand and nine, and it was that month
that the takeover of h Boss actually happened. So they've had in in a few months earlier Lehman had gone down, then HBOS itself had had a twenty billion pound bail out from the government, it had a Central Bank additional top up from the Central Bank, and so with all that background for them to be sort of bullish for lack of a better way, but it is um. It's quite remarkable. But what's also interesting about these guys is that that they're not particularly um. They're not how you
might think or a caricature of a bond trader. They're not kind of gregarious types or brash. That they're both quite um, quiet and quite thoughtful. And actually Milan in particularly very interesting because he's he had he started um investing in bank bonds, not a B S, even though he traded a B S for living. He first started investing in bank bonds and he told me, having not known this market that well, he spent his evenings for
about a month or so reading through bond prospectuses. So this is just like Michael burry So was like someone who's actually willing to dive into all the paperwork to really figure out what's in there and how did you find the story. Just as a reporter, it was quite fun finding them. Actually, I spent quite a bit of time in reporting on the sale of Granite the UK government announced it was going to sell. At the time, it was thirteen billion pounds and it was the biggest
ever sale of assets from the UK government. And because granted was such a well known um series of bonds. I wanted to investigate and actually managed to break some news on who was bidding for them, who wanted to buy them. In the end, it was Cerberus who won.
And but as part of that I kept hearing about these mystical traders or the mythical I should say, traders who bought granted at the bottom, and I guess there had to be someone, right, Yeah, Well, one one whimsical hedge fund manager told me that it was Harold Tynesite
who bought the bonds at the bottom. But I wanted to find out who did, particularly when in December the first bond started to be redeemed and they were paid back at part at one hundred, which to me thought, if he bought at the bottom and got a hundred back,
that's amazing UM. And so I kind of made it a bit of a mission to find out who brought them, and through asking various contacts in the market, came across Richard Paddell and he was kind enough to to speak to me in turn with the tale and was fascinating. And then Milan also, so yeah, it was a really interesting investigative process and looking back at the crisis in the will the UK's experience of the crisis really interesting.
Other other others that you think probably you haven't found, Well, there's others I know of, but I haven't necessarily included in the piece. Um, there were some others who did it with them at h BOSS. I mean, Milan and Richard were effectively the brains of the trade, but there were other traders that got in on various various purchases with them. Um. We also know of a few other hedge funds and one particularly large US investment bank UM that shall remain unnamed. I guess that that, yeah, that
also got in on the trade. But they were doing it not for them, not for themselves or their own personal money, but for for the either the prop desk or for the hedge funds. So looking ahead to today, are they're always these types of stories in the market, people finding assets with extreme dislocations or is this really the type of thing that when there's a huge crisis or a huge bubble, Yes, you find them, but most of the time people can't really be expected to find
these extraordinary dislocations. I think you could probably argue that
both ways. Actually, I mean, Richard Paddles said something very interesting that he reckons that every ten years this or approximately every ten years, there's some big market event that happens, whether it be the dot com the do calm bubble bursting, whether it be the Asian financial crisis, whether the e M debt in Russia for example, And this time around he said, well this in so in the two thousand two thousand and nine, it was in the A B
S market, aspect securities market, and since he was trading that market, he was in the perfect position to profit from it. Now, following his logic, then you know, in a few years time, we should see something else, something similar, and perhaps some people might say, oh, that's bank bonds, or maybe that's high yield, or some people might even say that's et F s um. So I'm sure that there are going to be more of these type of scenarios. I guess you just need to be in the right
place at the right time. I really know that market well, Alistair, thank you very much for joining us. I'm looking forward to in a few years you reporting on who made the big money in and sixteen. I'm sure you'll find them and I really appreciate you coming on the other podcast. Thank you very much. Thank you, and thank you very much for joining us on the Odd Lodge podcast. I'm
Joe Wisenthal. You can follow me on Twitter at the Stalwart and you should follow Alistair too because he'll be turning up the next great uh, the next grade scoop. He's on Twitter at at Alistair j Marsh and we'll be back here next week. We at Bloomberg are proud of our new and growing slate of original content podcasts. They include Benchmark, a jargon free dive into the stories that drive the global economy. It's hosted by Tory Stillwell,
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