February 19, 2012

How to lose $9 billion and walk away with $10 million

Wikipedia has an interesting list with the title: "List of trading losses." The list is a summary of the largest trading losses of at least $100 million. The article also says that this is not a complete list since some trading losses may be hidden from the public by private companies. One can however believe that none of the bigger trading losses have been hidden, how can one hide several billion dollars without no-one hearing about it?

The top five is as follows:
  1. Howie Hubler - $9 billion
  2. Jerome Kerviel - $7.22 billion
  3. Brian Hunter - $6.69 billion
  4. John Meriwether - $5.85 billion
  5. Kweku Adoboli - $2 billion
We have mentioned Kweku Adoboli at Trejdify earlier: The new rogue trader: Kweku Adoboli. But little seems to be known of Howie Hubler, he doesn't have his own article at Wikipedia as the other rogue traders have. But who was he, what did he do, and what can we learn from it?

Howie Hubler worked at Morgan Stanley and was described as being loud, headstrong and bullying - but he was good at what he did. In 2004, he became skeptical of the subprime mortgage business and wanted to make money from it if they decreased in value. He found Morgan Stanley customers willing to sell him credit default swaps on pools of subprime mortgage loans, which was like taking out an insurance policy on a house you have built on quicksand.  

But the fall of the subprime mortgages took longer than Howie Hubler had expected. In 2006, he was put in charge of his own Morgan Stanley hedge fund: the Global Proprietary Credit Group. But since the fall of the subprime mortgages didn't happen, he had to compensate for the millions of dollars that it cost to carry the subprime bets until they started to decrease in value. He compensated by selling insurance on slightly better mortgages. The problem was that because insuring something that is less risky is less lucrative, he had to sell several times the amount of swaps that he himself had bought. The long position on these slightly better mortgages had to be bigger than the short position on the subprime mortgages.  

This is the irony in the story. Even though he had a bet against subprime loans which decreased in value, he was betting on slightly better mortgages that turned out to be worthless in the end as well. Morgan Stanley understood that the position was risky. The chief risk officer ordered tests to see what would happen to their bets and the results showed that the coming drop was $3.5 billion.

In 2008, Morgan Stanley had lost $9 billion. Howie Hubler was allowed to resign from Morgan Stanley and he took with him around $10 millions of dollars in back pay.

Today, Howie Hubler seems to be back in the mortgage business. He has created the company Loan Value Group together with former Morgan Stanley colleagues to advise mortgage lenders whose borrowers are threatening to walk away from homes that are worth less than what is owed on them.  

Source: The New York Observer, New York Magazine, Wikipedia