Until that moment, until you closed out your positions – until you bought back the stocks you had shorted, or sold the stocks you were holding – you had no profit. It was all on paper. And what was on paper, no matter how solid it looked, could disappear in a puff of smoke.
If he closed out his short positions now, buying stock to return the stock he had borrowed, it was copper-bottomed profit. Four hundred fifty million or thereabouts, a little over half from Fidelian. If he waited, and the market bounced, that profit could be gone. On the other hand, if the market plunged further, that profit could be doubled in a day. To Ed Grey, who was worth a couple of billion in his own right, the thrill was in making enormous, staggeringly outsize profits. A few tens of millions did nothing for him. Four hundred was nice. But eight hundred, say, or a nice round billion, that was something different. There was something special in being able to say you had made a figure with nine zeroes on the end.
Grey had another reason to have those short positions intact if the market plunged. It wasn’t just the thrill of the kill. If the market dropped, he would need that extra profit to offset the additional paper losses he would make on the long positions he held. If he didn’t have that offset, the losses would start to reach a size when the banks that had lent money to Red River would come knocking. They held his stocks as collateral and marked his positions to market – which meant that they calculated the value of his positions against market prices – on a daily basis. That was how they assessed the value of the collateral they held. It didn’t matter that losses were notional unless he actually sold the stocks – as long as he held them, the banks treated them as if they were worth their market value on any given day. If his notional losses reached a certain level they would demand additional cash on the margin he had borrowed. If he couldn’t provide it, they would sell his stocks from under him until they had what they wanted.
In a word, his short positions had turned into a hedge against the notional losses he had incurred from the very same market correction that had notionally made him so much money.
Yet if the market bounced, and he hadn’t closed out those same short positions, the four hundred fifty million he had on paper would be gone forever, the market would be back where it started and the entire exercise would have yielded nothing.
He scanned the screens, gazed at the sporadically flickering numbers. Were they going to rise or fall? He was reaching into the void, into the great collective unknown that was the market, straining to find a direction.
That was what everyone was doing, he knew. He could almost feel it, smell it. People were waiting. Prices were drifting in narrow ranges. Volumes were low.
Was it a lull, or had the Fed put a floor under the market? Was the market sitting temporarily on a shelf on the way down, catching its breath before the slide continued, or was it about to get a grip, turn around and start climbing?
Ed Grey believed the banking system was fundamentally sound. He believed stock prices had been somewhat overvalued but were now heavily oversold. Both of those beliefs argued for a bounce. But timing, as always, was everything.
Fidelian was the one that was worrying him. It accounted for a quarter billion of his paper profit. How much lower could it go? There were rumors that credit lines to Fidelian were being rapidly shut down and that investors were pulling anything they could get out. Grey didn’t know how Bill Custler was resisting the demands for him to release a statement. By now the rumor that Fidelian would need to come to the market for cash was all over the Street. People were saying crazy things. Eight billion. Ten billion. One wild rumor even talked about fifteen billion. When people started saying things like that, the reality never turned out to be as bad. If that was the case, when Custler finally broke his silence, the stock would bounce. After the hit it had taken it would bounce big. If that happened, a good part of that quarter billion in paper profit would go up in smoke right in front of his eyes.
Ed Grey had heard another rumor that there was interest from a number of parties in buying Fidelian. That gave him additional confidence in his hunch that the stock had been oversold. Buyers come in when they can sniff a bargain. If that was what was attracting them, they had detected a floor and would likely pay above the current price.
He watched the numbers on the screens a little longer. Then he called Evangelou and Malevsky into his office.
‘What do you think?’ he said.
‘We’re going to bounce,’ said Evangelou.
‘And then? We coming down again?’
‘Depends on what else is out there.’
‘What else
is
out there?’
Evangelou shrugged. ‘Who the fuck knows?’
Grey glanced at Malevsky. ‘What do you think?’
‘We could bounce.’
‘How much?’
‘Some. Not all the way back.’
‘How much is your cut now?’
‘Twenty-two million.’
‘That’s money. Huh, Boris?’ said Evangelou. ‘You want to take it? Go and retire in Florida.’
Malevsky laughed.
‘So you’re saying we close out?’ said Grey. ‘Is that it?’
Evangelou nodded. Malevsky nodded as well.
‘You’re both wimps.’
‘Ed, you want to keep going? You’re fucking crazy! You want to do that, I’ll bet you a thousand to the mil on our position we go up. What do you say?’
‘Tempting.’
‘I thought you had a pair of cojones.’
Ed Grey grinned. Then he was serious again. ‘Alright. What about Fidelian? What do we think?’
‘Oversold,’ said Evangelou. ‘Largely because of us.’
‘The whole market’s spooked on it now.’
‘Where’s the money they need going to come from?’ asked Grey.
‘I heard there’s a buyer.’
‘What if there isn’t?’
‘Depends how much they need.’
‘Who’s going to buy those bonds? Look at their stock price. Who’d put anything into that company?’
Evangelou shrugged. ‘Their shareholders will put in.’
Malevsky nodded.
‘They’re fucked if they don’t.’
‘So what if they’re fucked?’
‘No way they’re fucked. The Chinese own, what? Twenty-five per cent. Plus who knows what else. They’re not going to watch that investment go down the tube. Pulling out five, ten billion’s not going to be an issue for them. The other shareholders get diluted but if they want they can put in as well. If you’re the Chinese, what’s your alternative? Less is better than nothing, right?’
Grey leaned back in his chair. ‘So we’re done?’
‘Aggressively,’ said Malevsky, ‘let’s assume Fidelian needs to raise ten billion. If it’s ten billion, and nothing else has changed from six weeks ago, that values them around seven per cent above where they are today. The rest of the downside is noise.’
‘As soon as things calm down a little, those are the figures everyone’s going to do,’ added Evangelou.
Grey nodded. In about a thousand offices all over the city, those were probably the exact figures that were being crunched already. Provided everyone felt some kind of a floor had been put under the sector by the Fed’s actions. If not, the noise would get louder and the downward pressure would continue.
‘Okay,’ said Grey, ‘let’s pretend like we’re smart for a second. Everyone’s saying the same thing. At a cash requirement of ten billion, Fidelian’s seven per cent undervalued so we close out our short positions now and say thank you very much. What if we’re wrong?’
‘That’s an aggressive case,’ said Malevsky. ‘If the cash requirement is less, the undershoot is even greater.’
‘What if the cash requirement is more?’
‘Off the top of my head, if the requirement is thirteen billion, they roughly come into line with today’s price.’
‘Let’s take the extreme. What if they can’t get it?’
‘Then they get sold. From what I’ve heard, they probably get sold anyway and the Chinese don’t have to put in anything.’
‘What if they don’t? What if they fail?’
‘If they fail, everyone’s fucked,’ said Evangelou. ‘The government’s wind-up powers are bullshit. We’re in 2008. But what’s the probability, Ed?’
Grey nodded. ‘I agree, but we make our money on getting the low probability events right.’
‘But we lose it on getting the high probability events wrong. Look, if there weren’t any dominant shareholders involved here, I’d say this is a chance we might consider taking. But the risk-reward isn’t there. You’ve got the PIC with twenty-five per cent of the stock and effectively an unlimited cash supply from the Chinese government. If Fidelian can’t raise the cash anywhere else, that’s where they’ll get it.’
Grey agreed. He looked at Malevsky. ‘What do you think?’
‘It’s not a low probability event. It’s a zero probability event.’
Grey laughed. ‘Nothing’s a zero probability event. Stick around in the business for a while.’
Malevsky shrugged. ‘In the final analysis, the government can’t let this bank fail. We’re a week away from an election. We can create whatever scenarios we like about how much cash they need, and what the shareholders will or won’t do, or whether there’ll be a buyer or not, but in the end there’s no scenario in which it will fail because it can’t be allowed to happen.’
Grey agreed with that.
‘He wants his twenty-two million,’ said Evangelou.
‘I wouldn’t say no,’ quipped Malevsky.
Grey didn’t respond. Unusually, he found himself undecided. Normally he had a clear sense when a trade had run as far as it was going to run and it was time to get out. In this instance, he just wasn’t sure. His trading style was always to pile more capital into a trade that was going well, and that was what he had done in this case. That was one of the first lessons he had learned in the business, that it was almost impossible to overestimate how far a move could go. When a trade hit your target, it didn’t mean it was over. Often the move had just begun.
All of that argued in keeping the Fidelian position open, even increasing it. But you had to temper zeal with rationality. At some point you did have to close out. Gery didn’t believe the fundamentals were there to justify a further fall either in the banking sector or across the market generally. Other than rumor and panic, it was hard to see how it had even come this far. And that argued to get out. To take four hundred fifty million out of a market that should never have given him anything like that and be damn happy he had done it.
‘So what we’re saying,’ he said, ‘is that even on an aggressive case, Fidelian’s undervalued already. We’ve got two fifty in the bag and even on the aggressive case if we don’t act we lose it. On the other hand there’s a failure scenario where they can’t either recapitalize or sell this bank and we get a huge blowout, but we’re saying the probability’s virtually zero. And we believe the fundamentals of the sector are strong, so that says we’re going to bounce. And all of that says we close out. Now.’
Evangelou nodded. So did Malevsky.
‘And that means we lose the hedge against our long positions. And that means that if the market really crashes, the banks come knocking.’
‘But that’s the zero probability event,’ said Evangelou.
‘The
virtually
zero probability event – which wipes us out.’
‘No, it doesn’t,’ said Evangelou. ‘We close out Fidelian and we have the cash to meet the margin calls if that happens. Ed, it’s the perfect scenario. We take our profit. In the low probability event that the market keeps falling – and it’s probably no more than a one to five per cent probability – that cash covers the margins and we can hold the stocks until they recover. I’ve had one of the quants running the numbers with the market falling another twenty per cent from here. Worst comes to the worst, we survive the short term with the Fidelian cash.’
‘What if the market goes down fifty per cent?’
‘Now you’re not even talking about a one per cent chance. You know me, Ed. I’m a numbers guy. But this market’s going up. It’s corrected. It’s overcorrected. And if it hasn’t, we have the cash to cover any realistic scenario.’
It was decision time. This was how Ed Grey earned his money, making decisions. If you weren’t prepared to do that, you’d never get your profits off paper and back into your fund.
He agreed with every word Tony said. The difficulty was the fact that this trade had turned into a massive hedge. He was way down on long positions that assumed a rise in the market, and would be down even more if the market kept falling.
But if he closed out, the cash was in the fund. Not on paper. And that would cover his margins if the market kept falling. It was only if the government stood by while Fidelian failed to raise the capital it needed, or failed to find a buyer, that the cash would be insufficient to cover him. And even then, only if the market fell to an almost unprecedented degree. The probability of all of that happening was vanishingly small.
Still, Ed Grey knew that even with those odds, it was a bet.
21
JERRY RABIN SLAMMED
his fist down on the table. The president of the New York Fed was generally slow to anger, but right now he was incandescent with rage.
‘What do you think is going to happen, Bill? What in God’s name do you
think
is going to happen?’
Bill Custler shook his head. He didn’t know what else to say. His throat was dry.
‘You asked me for two more days for your board to decide. I gave that to you. Then another day. Then another day.’
‘I didn’t guarantee–’
‘And now you come back and tell me they won’t put any capital in, and they won’t sell? Is that what you’re telling me? They won’t do one and they won’t do the other!’
Custler raised his hands helplessly and let them drop. Rabin stared at him. The situation was inconceivable. For a week he and Susan Opitz had struggled to find a party that would make an offer for the remains of the shambles that was Fidelian Bank, haranguing, cajoling, holding off rumors swirling in the market and now, on Friday morning, when they had just about managed to find a buyer, Bill Custler had come to them with the news that the problem was the one thing Rabin couldn’t do anything about, couldn’t ever have seriously believed would be the obstacle – not that they didn’t have a buyer, but that they didn’t have a seller.