The worst trades in history… a subprime disaster
Howie Hubler III was born in the town of Boonton in New Jersey and went on to study at Montclair State College before joining investment bank Morgan Stanley, specialising in trading mortgage-related bonds. Hubler’s team made consistent profits by buying up mortgages from third parties, pooling them to create bonds, and then reselling the bonds to the market. To minimise the risk of holding the bonds while they were processed and resold, Hubler persuaded other banks to sell credit default swaps (CDS), essentially insurance against the bonds going into default.
What was the trade?
Hubler’s success at this led Morgan Stanley in 2003 to put him in charge of a team that used CDS to bet against bonds believed to be going into default. This strategy worked so well that by 2006 the bank had put him in charge of Global Proprietary Credit Group, an internal hedge fund making bigger bets. Convinced that many of the lower-quality subprime mortgages were at a higher risk of defaulting, Hubler started to buy $2bn worth of CDS. To fund this his team sold $16bn of CDS on what he thought were higherquality mortgages.
What happened?
Hubler was correct in his judgement that the subprime mortgage market was about to collapse, increasing the price of the swaps he had bought, but he underestimated the impact that it would have on the supposedly higher-quality swaps. As the losses from the swaps he had sold started to outweigh the gains from the swaps he had bought, he refused to close his positions, insisting that the risk of them defaulting was still low. Finally, in autumn 2007 Morgan Stanley’s management intervened, removing Hubler and closing the positions.
Lessons for investors
Overall, Hubler’s team made $5bn from shorting various mortgage bonds, but lost $14bn from the sale of insurance, which meant that Morgan Stanley ended up with a loss of $9bn. Hubler’s disaster shows that in investing it isn’t enough to get the general idea right, you need to look at the details too, especially when you are dealing with a complicated product such as credit default swaps. Hubler’s refusal to allow Morgan Stanley to cut the team’s losses at an early stage by closing down the positions caused the bank’s losses to spiral.